At issue | Dec. 15 Herald-Leader editorial, "Illusion of action won't fix taxes; candidate Williams talks up reform"
Your Dec. 15 editorial was right to call into question Senate President David Williams' proposal to gather a commission to develop legislation to shift Kentucky's tax code from income-based to consumption-based. This means eliminating corporate and personal income taxes and expanding and increasing the sales tax.
We commend Williams for calling for a review of Kentucky's inadequate and outdated tax system if it actually brings attention to the need for real tax reform. However, it needs to be a full review, that puts all the options on the table. It's a bad decision to appoint an expert commission and then tell them what their findings must be.
Before this idea gains any more undeserved credibility, it is important to understand what this huge tax shift would mean for the commonwealth. Proposals to replace Kentucky's income and business taxes with a higher and broader sales tax would threaten the state's ability to provide services benefitting children and families. These proposals would also sharply increase the taxes the average Kentuckian pays. This system would:
■ Reduce the commonwealth's revenues by almost 10 percent. After the first year, Kentucky's revenues would drop by $850 million a year.
■ Require significant sales tax rate hikes to maintain anything near adequate revenues. Tennessee has a 7 percent sales tax and even taxes food at 5.5 percent. Additionally, cities and counties can charge up to 2.75 percent in sales tax. The Tennessee average combined state and local sales tax rate is 9.4 percent. By comparison, Kentucky has a 6 percent sales tax, no local option sales tax and does not tax food.
■ Levy those higher rates on transactions Kentucky has never attempted to tax, causing political, technical and economic problems. For example, suddenly taxing new home sales could seriously disrupt the housing market.
■ Raise taxes on the middle class. Kentuckians making an average of $36,000 currently pay 9 cents on the dollar in taxes, while those making an average of $957,500 pay only 6 cents on the dollar, when sales and excise, property and income taxes are all taken into account. Because people with lower incomes pay a larger percentage of their income in sales tax, eliminating the income tax and increasing the sales tax would increase that burden on middle- and lower-income families.
Tennessee, a state frequently cited as a model of tax reform for Kentucky, operates under a consumption-based tax system. Tennessee's tax system is no model for Kentucky. A 2004 report from the Tennessee Tax Structure Study Commission concluded that the state's tax structure was deeply flawed. It recommended that Tennessee reduce the sales tax rate, eliminate the local sales tax option and introduce a graduated income tax.
Kentucky has been severely impacted by the national recession, and it is yet unclear how long it will take for the economy to fully recover. Weathering this financial downturn will provide valuable lessons for strengthening the imbalances in the budget to withstand future challenges.
Learning from this experience, legislators should begin putting into place a structure for the long-term fiscal health of our commonwealth, and not develop a commission with the implicit goal of weakening the system. Balanced efforts toward reform on both the revenue and spending sides of the budget equation would help stabilize the state now and strengthen our position relative to other states in the future. Better options for reforming our tax system exist that our elected leaders should consider.
One simple step — a review of the cost-effectiveness of economic development tax breaks — would help us manage our scarce tax revenues responsibly. No one really knows which tax breaks should be expanded because they foster economic growth and which need to be eliminated because they drain revenues. A study would allow legislators to make responsible decisions about the best use of Kentucky's tax dollars.
The legislature should require the Legislative Research Commission to conduct such a study in 2011 in preparation for the inevitably tough budget deliberations of 2012. Moving to a consumption tax system will only make revenues scarcer and increase the need for more painful budget cuts.