Ky. Voices: Poverty growing in state; tax reform a way to change trend

Today, three quarters of a million Kentuckians, or over 17 percent, live in poverty, nearly one in four children live in poverty, and in several counties in Eastern Kentucky almost one-in-two children still live below the poverty line.

That poverty in Kentucky is severe is not news. But what is news is that our relative standing among states has significantly worsened in the last decade.

In 1993, Kentucky's poverty rate was the fourth-highest of all states, but because of strong economic growth by 1999 it had fallen to the 20th. Unfortunately, the decline in Kentucky's poverty rate was short-lived. Over the past 10 years, only three other states — Indiana, Arizona, and South Dakota — have experienced a larger increase in poverty.

Today we have the sixth-highest poverty rate in the nation. And this retrenchment has perpetuated Eastern Kentucky's position as one of five "persistently poor" regions in the country as defined by the U.S. Departmemt of Agriculture.

So what has gone wrong?

In short, economic growth and job creation over the past decade have been tepid at best, and downright awful at times. And whatever growth we did have has been accompanied by a failure of the U.S. and Kentucky economies to widely distribute the rewards of growth.

For the first time in post-war history, inflation-adjusted median household income actually fell between the business-cycle peak of the 1990s and the peak of the 2000s. Moreover, the share of income that accrued to the top 1 percent of the income distribution rose to levels not seen since the roaring 1920s.

A rising tide is not enough to eradicate poverty if that growth is accompanied by widening income inequality; and weak or declining growth combined with rising inequality, as in the past decade, is a toxic mixture for the poor and middle class.

So what is to be done?

Actions that rank at the top of any list on how to combat poverty and inequality include strengthening the social safety net, substantial new investments in human capital (that is, education from pre-K through college) and fundamental tax reform.

Why do I include tax reform as an anti-poverty strategy? Because robust economic growth is key to eradicating poverty and inequality, and a tax code that is simple and fair is more likely to spur future growth than the current code that is chock-a-block full of favors for special interests.

Scores of papers have been written by economists evaluating the Tax Reform Act of 1986, and the consensus evidence is that the reform spurred labor supply, investment and saving. What did the reform do? It lowered rates and expanded the tax base.

In 1980, there were 16 marginal tax brackets in the federal tax code, with the highest rate at 70 percent. By 1987, there were just four rates, with the one facing the top income bracket plummeting to 28 percent.

The tax base was substantially broadened by eliminating certain tax shelters and expanding the sources of income subject to taxation. At the same time, the personal exemption and standard deduction were raised, which removed 6 million low-income taxpayers from the rolls, and the Earned Income Tax Credit (EITC) was expanded to provide further assistance to low-income working taxpayers.

Although it is sometimes called the second Reagan tax cut, the 1986 reform was officially sponsored by two Democrats, Richard Gephardt in the House and Bill Bradley in the Senate. And without the support of Tip O'Neill and Dan Rostenkowski in the House, and Robert Packwood in the Senate, it never would have seen the light of day. This truly was a bipartisan effort, and it underscores how both parties can come to embrace tax reform.

This reform also set important benchmarks of how one should go about structuring the tax code, including at the state level.

First, in order to minimize inefficiencies, tax rates should be low and tax bases should be broad. Yes, this means a sales tax that covers a broad swath of economic activity, including services. A wider base with lower rates for both income and sales taxes is likely to lead to greater stability in tax revenue during downturns and growth in upturns for much needed investments in education.

The other attraction of a low rate/wide base system is that we live in a highly mobile and competitive society where businesses, and in turn locales, compete for the best and brightest.

Research by my colleague Bill Hoyt along with University of Louisville economist Paul Coomes suggests Kentucky loses out to neighbors in the race for high-income taxpayers in part because of our tax code that tends to rely on income taxes.

Second, in order to ensure fairness, our tax code needs to be redesigned to more progressively assist low-income taxpayers. Many oppose a broad-based sales tax on the grounds that it is unfair to the poor because they spend a higher share of their income on these services than the rich.

This concern is real. But there are ways to alleviate that burden. One is to adopt a state earned income tax credit.

Today about half of states have adopted an EITC to supplement the federal credit. Research suggests that the federal EITC is the most effective anti-poverty policy in America after Social Security, and the most effective among working Americans.

Unlike most other credits, the EITC is refundable, which means families get cash back. For example, a family with two qualifying children earning $15,000 is currently eligible for an EITC of roughly $5,000, which boosts their take-home pay by a third.

If Kentucky adopts a state EITC worth 10 percent of the federal credit it will mean an additional $500 in cash back to the family, and evidence suggests this money is spent in the local economy, providing a much-needed boost to our businesses.

Gov. Steve Beshear has recently opened the door for tax reform in Kentucky. The time is now for the legislature and executive branch to come together in bold bipartisan fashion to reform our tax code to set a path to prosperity and end the scourge of persistent poverty.