Tax Foundation report recommends reforms to spur growth in Kentucky

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A report released this week by the Tax Foundation says Kentucky still trails the nation in economic growth, but there’s “a unique opportunity” for the state to attract new workers thanks to the rise of virtual offices and work.

To cash in on that opportunity, though, the public policy group said Kentucky needs to continue reforming its tax policies – a movement that started in 2018 – to promote personal and business income growth.

“Kentucky is projected to experience robust revenue growth over the next few years, presenting a valuable opportunity for policymakers to pursue reforms,” the report’s executive summary states. “Ultimately, the goal of tax reform should be to enable the state and local governments to raise sufficient revenue to fund government services in a manner that avoids hindering business productivity, job growth, and personal wage growth.”

The foundation’s 78-page report came out Tuesday.

The Tax Foundation's recommendations include repealing the limited liability entity tax. The group says the gross receipts tax presents challenges to start-up businesses and those that operate on low margins or lose money. The state should also reduce corporate and personal income taxes, especially since businesses and workers also pay local taxes and occupational fees. Ending the inventory tax would also help businesses.

To counter those reductions, the Tax Foundation encourages Kentucky to “modernize” and put more emphasis on use and consumption taxes. That would include the possibility of raising the state’s 6% sales tax and giving cities and counties the ability to add a sales tax as well.

Of its neighboring states, only Virginia’s average combined sales tax rate of 5.75% is lower than Kentucky’s 6%. While the 2018 reforms expanded the sales tax to cover additional services, the rate has not changed in more than 30 years.

“If a rate increase offsets income tax rate reductions, that could leave Kentucky with a sales tax rate that is competitive with its regional rivals while offering an enviously low income tax rate that would have a more significant effect on economic growth and opportunity,” the report said.

Prior to the reforms passed by the Republican-led General Assembly in 2018, the Tax Foundation ranked Kentucky 36th nationally for its business tax climate. In its 2021 report released last month, Kentucky came in 19th, one spot behind neighboring Tennessee.

Tennessee, which has no personal income tax and relies heavily on sales taxes, is often held up as a poster child for tax reform efforts in Kentucky. The foundation’s report said that over the past two decades, Tennessee’s economy grew 60 percent faster than Kentucky’s.

Adjusting for inflation, “Tennessee’s gross state product grew almost 36% between 2001 and 2020, while Kentucky’s economy increased at a much more modest 22%, significantly below the national average of 35% growth for the period,” the report states.

In a press conference Monday with other members of the state Senate’s Republican leadership, state Sen. Mike Wilson, R-Bowling Green, said there have been “high-level” discussions about additional reforms.

Any tax bill would have to start in the state House of Representatives.

“There’s nothing in concrete about that, but I’m certain that all of us would like to see us move more towards a consumption-based tax and less of an income tax,” said Wilson, the majority whip. “

The Tax Foundation received a grant from the Kentucky Chamber of Commerce to help with its independent research and development of the report. “Can we get to where Tennessee is? That would be very hard, but again, we might be able to get to someplace like Indiana in their model.”

According to the Tax Foundation report, Indiana’s 4.9% top marginal corporate tax rate is almost comparable to Kentucky’s 5% rate. The top marginal individual income tax rate is 3.23% in Indiana, while Kentucky’s is at 5%. Indiana’s average effective local income tax is .5%, nearly one-third of the 1.4% effective rate in Kentucky.

Indiana also has a 7% state sales tax and, like Kentucky, does not allow cities or counties to add on to that.

The foundation’s report was researched and drafted independently with a grant by the Kentucky Chamber of Commerce.

Kentucky Chamber CEO Ashli Watts said in a statement that the national nonprofit group’s report presents “critical data, valuable context, and a unique nationwide perspective” on ways state leaders can tackle pro-growth reforms.





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