Kentucky's Opportunity for Fundamental Tax Transformation

With just two legislative days left in the 2022 Regular Session, legislators have an opportunity to pass two transformative tax changes. House Bill 8 would give tax relief to Kentuckians facing high inflation and a state economy with a labor force participation rate nearly 4% below the national average. Meanwhile, House Bill 475 (and its companion HB 476) would fundamentally change the way local governments raise revenues to be more in line with the state’s pro-growth priorities. HB 8 has been vetoed by Governor Beshear and warrants override; HB 475 awaits a hearing before the Kentucky Senate Appropriations and Revenue Committee. It ought to get one and then pass the state Senate.

A full breakdown of HB 8 is available here from the Washington DC-based Tax Foundation. At its core, HB 8 attempts to make Kentucky’s business environment more competitive by gradually eliminating the state income tax if certain revenue triggers are met. This builds on 2018’s reform efforts that eliminated the progressive income tax and reduced the rate to 5%. Getting to zero is a laudable goal, especially given our close proximity to a number of low- or no-income tax states. Currently, Kentucky’s rate of 5% is higher than the top rates in neighboring Illinois (4.85%), Ohio (3.99%), Indiana (3.23%), and Tennessee (0%). Missouri’s rate will also be lower once a 2021 tax change is fully implemented (4.8%).

Kentucky isn’t alone in attempting to reduce the burden placed on individuals and companies by the income tax. In 2021 alone, twelve states reduced their incomes taxes. Doing so will make Kentucky more competitive in the region and the use of revenue triggers ensures budget stability during the process.

Reforming state taxes will only do so much in terms of competitiveness, though. Unfortunately, local government revenue is overly reliant on production-side taxes like state revenue. In fact, the state constitution currently precludes local governments from raising revenues on consumption-side activities by levying local sales taxes. Doing so would be far less economically destructive than the hodge-podge of occupational, restaurant, and insurance premium taxes currently used by local governments to raise funds.

HB 475 would give the voters of Kentucky the chance to decide if the status quo isn’t working for them. HB 476 would ensure that if the voters approved giving the General Assembly the ability to alter this structure, local governments couldn’t impose runaway taxes before a new structure was in place. This would allow both a pro-growth transition in tax policy at the local level in Kentucky and allow local governments to better account for local needs.

Currently, any Kentuckian who takes a trip to Nashville, TN or Orlando, FL helps pump money into city revenues there via a local sales tax. That’s not the case if their folks come up to Louisville or visit another tourist attraction around the state. We may capture some revenue via hotel and restaurant taxes, but not nearly the same.

This has real world consequences for the most basic functions of government. According to the libertarian-leaning Cato Institute, Kentucky spends the least per capita on law enforcement in the country when combining state and local dollars at just $186 per person. We are dwarfed in law enforcement spending per capita by some of our neighbors and outspent by all of them. This includes Illinois ($413 per person), Ohio ($327 per person), Virginia ($298 per person), Missouri ($296 per person), Tennessee ($295 per person), West Virginia ($217 per person), and Indiana ($200 per person). The consequences of this are real, as Louisville continues to struggle with unprecedentedhomicide and violent crime numbers.

Taken together, the reforms of HB8 and HB475/476 will make Kentucky more competitive while ensuring a transition away from reliance on incomes tax is done intelligently and revenues remain stable and ensure that local governments have both the flexibility they need to attend to local needs and raise revenues in economically neutral ways.