On the same day thousands of teachers descended on the Capitol to protest a surprise pension bill passed late last week, the legislature presented them with another surprise Monday: the most significant change to Kentucky’s tax code in more than a decade.
The tax hike, which balances cuts to the individual and corporate income tax by imposing a sales tax on select services, were introduced at 8:30 a.m. in attempts to provide funding in a tight budget year. Both bills received final passage more than 11 hours later, before they were available to the public.
“The whole way this was done is unconscionable,” said Rep. Jim Wayne, D-Louisville, a longtime proponent of progressive comprehensive tax reform. “It’s heavy handed, it’s done by an elite and it’s done behind closed doors without any opportunity for the public to voice opinions or to vet these ideas.”
Despite Republicans having complete control of the budget process for the first time in recent history, the bill did not win unanimous support among Republicans in the House or Senate and was condemned by Kentucky’s Republican Governor, Matt Bevin.
“I am very concerned that the current proposals from the General Assembly may not meet these basic standards of fiscal responsibility,” Bevin said in a prepared statement. “It is our obligation to ensure that any budget and tax changes put Kentucky on a stronger financial foundation.”
In passing the bill Monday, the legislature will have the ability to override any veto from Bevin.
Several Republican lawmakers heralded the bill for cutting the individual and corporate tax code to a flat 5 percent tax, while increasing revenue as the state grapples with stagnant revenue growth and an ailing pension system. Currently, anyone who makes more than $8,000 pays 5.8 percent on their individual income tax. Those who make more than $75,001 pay 6 percent.
The income tax changes cost the state $114.1 million over the next two years, while the corporate tax changes cost the state $80 million. Some of the changes are cuts, while others are increases like removing the $10 individual income tax credit and eliminating tax deductions.
The Legislative Research Commission analysis of the revenue bill does not contain a breakdown of how much the tax cuts alone would cost the state.
“We all agree we need comprehensive tax reform,” Rep. Steven Rudy, R-Paducah, told the budget committee. “This is the step to move Kentucky way up the ladder of competitiveness.
The bulk of the new revenue comes from the sales tax on select services. While the bill avoided levying taxes on any of the large services in Kentucky—attorneys, accountants and hospitals in particular—through a series of taxes on smaller services, the state estimates it will bring in $436.3 million in revenue.
The state will also bring in $244.7 million over the two-year budget with a 50 cent increase to the cigarette tax and a 15 percent tax on electronic cigarettes.
The LRC analysis did not contain an estimated revenue from each tax on services. However, the 2016-2018 Kentucky Tax Expenditure Report estimated the state lost $288 million in 2017 and 2018 by not taxing automotive and miscellaneous repair services.
Along with automobile repair services, the bill goes after some of the luxury services Wayne recommended taxing in his annual tax bill, like landscaping services and golf courses. But it also included some that were not limited to the wealthy, like a tax on veterinary services for small animals and a service tax on gyms.
“Most of them are going to hurt poor people,” Wayne said. “For instance if you are a widow living on a fixed income and you have two cats and you take them to the vet.”
It is unclear whether the tax on fitness and recreational sports centers will apply to non-profit fitness centers and pools, like the YMCA.
Senate President Robert Stivers, R-Manchester, said legislators applied the sales tax on certain services because it expands the state’s tax base and is the “fairest, most equitable” way to raise more money for the state.
But Jason Bailey, the executive director of the Kentucky Center for Economic Policy, said the bill will disproportionately affect poor Kentuckians.
“The whole plan is a big tax shift from the wealthy and corporations to the middle class and poor,” Bailey said.
The conservative policy group Americans for Prosperity Kentucky, opposed the tax increases as well, saying they funded out-of-control spending.
“It is disgusting that even with large Republican majorities in both chambers, lawmakers chose to continue unchecked spending and fund it with massive new tax increases,” said Andrew McNeil, the state director of AFP and a former Bevin staffer. “This proposal is a gift for special interests and a slap in the face to hardworking Kentuckians.”
The increased taxes, which raise $486.9 million over the two-year budget, when combined with $310 million from the Kentucky Employees Retirement Fund will help fund an increase to K-12 education and will help pay down Kentucky’s $41 billion unfunded pension liability.
The budget completely funds transportation costs for K-12 schools, which Gov. Matt Bevin had proposed cutting, and it provides an increase to $4,000 per pupil in the funding formula for K-12 schools, known as SEEK.
Even though the bill fully funds Kentucky’s pension systems, teachers swarmed throughout the Capitol, still upset over the pension bill Republicans rushed through Thursday, and urged lawmakers to vote against the bill.
It also changes how pensions are taxed. Currently pensions are only taxed if they are more than $41,110. Under the new law any pension larger than $31,110 will be taxed. The average teacher’s pension in Kentucky is $37,000.
While the budget maintains the 6.25 percent cuts to higher education, Rep. Steve Rudy, R-Paducah, says it provides $31 million back to the universities through performance based funding. It maintains the provision that faculty could lose tenure when programs are eliminated.
It eliminates funding for future private prisons, instead making changes to allow county jails to accept more state inmates to deal with Kentucky’s overcrowded prison population.
Lawmakers claimed they fully funded health insurance for 8,554 retired teachers who aren’t old enough to qualify for Medicare through a House-proposed mechanism that provides $59.5 million in the first year of the budget and then requires the Teachers’ Retirement System to pick up the funding in the second year.
The money also allowed the legislature to fund some of the 70 programs Bevin proposed cutting in his version of the budget, including the Kentucky Mesonet, the state’s civil legal aid program and partial funding for the Robinson Scholars program at the University of Kentucky.
It also provides $13 million in funding for the State Fair Board and removes the state’s angel investment tax credit.
Seven Republican Senators voted against the bill for tax increases, which passed 20-18. The same bill passed the House 51-44 with nine Republican Representatives voting against it.
In the final hour Monday night, the House attached to Senate Bill 197, dealing with water well drillers, provisions that would restore a health insurance subsidy for retired teachers’ dependents and provide that pensions would only be taxed over the current $41,110.
House Minority Leader Rocky Adkins, D-Sandy Hook, said removing both provisions could cost $24 million.
The measure now goes to the Senate on April 13. Stivers said Monday night that he could not comment because he had not yet seen the legislation.
Herald-Leader Reporter Linda Blackford contributed to this story.