FRANKFORT — Kentucky must dramatically alter the way it taxes businesses and people if it wants state revenues to grow with the economy in coming decades, according to a study released Wednesday.
Three consultants told Gov. Steve Beshear's Blue Ribbon Commission on Tax Reform that Kentucky lawmakers should consider a variety of changes, including expanding sales taxes, overhauling business taxes, lowering personal income taxes and limiting deductions.
The consultants said Kentucky's tax structure — which relies heavily on personal and corporate income taxes — is not growing to meet the needs of its citizens. By 2020, the gap between what the state needs to provide basic services and the revenue it generates will be $1 billion, the report projected.
The 114-page study, issued by William Hoyt and Michael Childress of the University of Kentucky and William Fox of the University of Tennessee, suggested several policy options to change the tax system.
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The commission is expected to make final recommendations for possible tax changes to Beshear by Nov. 15. Beshear will then make a decision on what tax changes to seek from the legislature when it convenes in January.
Fox, who first studied Kentucky's tax system more than a decade ago, told the group that an analysis of other states' tax structures showed Kentucky is at an economic disadvantage because of the way it taxes.
"The options for improving the state tax structure are based on two core ideas — broadening the tax base will make the system more elastic; and shifting taxation away from business capital and labor earnings and toward consumption will make it more competitive," the report said.
Fox noted that broadening the base of people and companies paying taxes would allow the state to decrease overall tax rates. Lower tax rates typically translate to higher compliance rates, he said.
Childress stressed that the consultants were not making recommendations but were giving the commission a variety of options. Some of the options could be used together, and some options are mutually exclusive. It will be up to the commission to make those decisions.
The policy options the group proposed include:
■ Expanding the sales tax to include more services. Very few services in Kentucky are taxed. Adding bricks-and-mortar services, such as dry cleaners and nail salons, to the state's tax rolls could add more than $176 million in revenue.
■ Imposing the 6 percent sales tax on food.
■ Imposing a sales tax of 3 percent on residential utilities.
■ Enacting an Earned Income Tax Credit for Kentucky's lowest wage earners.
■ Increasing taxation on pensions and retirement income.
■ Lowering income tax rates or moving to a flat tax while reducing or eliminating deductions.
■ Replacing the corporate income tax and other corporate taxes with a gross-receipts tax. That means more businesses would pay taxes on their revenue instead of fewer businesses paying taxes on their profits.
Many on the commission — made up of advocates, business leaders, education leaders and legislators — expressed concerns about broadening the tax base to include groceries.
According to the report, taxing groceries would generate $484 million each year for the state. But that additional tax would put an undue burden on the poor, said Sheila Schuster, a member of the commission and a mental health advocate.
Schuster said she was "stunned" to see the food tax option included in the group's presentation.
"I have a real problem with it," Schuster said. "We've been hearing about lower-income Kentuckians paying a higher percentage of their total income on taxes. Now we are going to sock them ... with a tax on eating?"
Hoyt said the state could offset the cost to poorer families by offering a tax credit to low-income families.
"There is no question that this makes the tax more regressive," Hoyt said.
Expanding the sales tax base to include food would allow the state to decrease the overall sales tax rate by 1 percent, Fox said.
Broadening the sales tax to services such as funeral services, dry cleaning, nail salons and auto body repair would generate an additional $176 million in revenue, the report said.
Fox noted that the state could tax those services without fear of those businesses leaving the state. He said the economists did not suggest taxing professional services — lawyers, accountants and advertisers — because that would be considered a business-to-business sales tax.
"The biggest tax imposed on businesses in Kentucky is sales taxes," Fox said. "It makes you less competitive."
The state has looked at revamping its tax code several times in recent decades, but little has been changed.
Former University of Kentucky president Lee T. Todd Jr., a member of the commission, acknowledged Wednesday that many have said they don't expect the commission to accomplish much based on past history. But it's not because the commission isn't serious about reform, he said.
"We've even had legislators tell us, 'You better figure out something that we can pass,'" Todd said. "Well, if there's an election coming up anytime in the next 10 years, I am not sure that there is one that some of them will pass."
Senate President David Williams, R-Burkesville, and House Speaker Greg Stumbo, D-Prestonsburg, had not seen the report and were not available for comment on Wednesday.
Rep. Rick Rand, D-Bedford, chairman of the House Budget Committee, said he could not say whether any of the proposals would pass either chamber. Rand is a member of the tax commission.
"This is a macro proposal," Rand said. Until it gets down to specifics, it's difficult to say what lawmakers could support, he said.