Revenue neutrality (at a minimum) is the first principle of tax reform

Kentucky is a high tax state. Not enough attention is paid to this fact. The focus in Frankfort is usually on tax rates while Kentucky’s overall tax burden is ignored.

The 2018 tax reform is a case in point. Legislative champions sold a minor reduction to the personal and corporate income tax rates and an expansion of the sales tax to a limited set of services as pro-growth. What they avoided discussing was its other purpose was to raise revenue. (Tom Loftus, the former capital reporter for the Courier-Journal, reported at the time the tax bill raised an estimated $487 million in additional revenue over two years).

Defenders of the tax changes continue to make the argument the reforms enhanced the state’s competitiveness. True enough, rebalancing the tax code to favor taxing consumption over income and investment has been a core principle of conservative tax policy. However, someone will have to explain to us how raising the overall tax burden on Kentuckians was supposed to make Kentucky more competitive.

Total tax burden is equally as important as tax rates. For a state like Kentucky (with an already high tax burden) how tax changes weigh down taxpayers in the aggregate must be the first consideration.

For additional context, consider the following facts from the most recent BIPPS report, “The Lost Decades: Kentucky’s Economic Underperformance 1980-2020”:

  • Kentucky ranks 21st nationally in overall tax burden. For comparison, North Carolina ranks 33rd, Indiana 35th and Tennessee 48th. (WalletHub 2020 Tax Burden by State)

  • Only five states - New York, Oregon, Maryland, Minnesota and California - have heavier income tax burdens than Kentucky. (WalletHub 2020 Tax Burden by State)

  • A 2020 presentation from the Office of the State Budget Director calculated the net effect of tax changes adopted by the General Assembly in 2018 and 2019 would equal $448 million in new tax revenue for Frankfort to redistribute.

  • Restricted fund revenues from a variety of fees and surtaxes accounted for $7.3 billion in state government spending in fiscal year 2018. These hidden taxes are paid out of the same family budgets as the sales tax and are a significant contributor to the Kentucky’s high rate of government spending.

Tax reform is a perennial issue in the state capital. We agree that a pro-growth tax policy should shift taxation from income towards consumption. However, changes that increase the overall tax burden, like 2018, will further fuel Frankfort’s culture of redistribution at the expense of sound economic policy. Future changes must be driven by principles that support limited government and economic freedom.

We offer a three-part test for lawmakers to evaluate tax reform going forward:

  1. Are the tax changes revenue neutral (at a minimum) and, therefore, won’t increase the overall tax burden on Kentuckians?

  2. Do the tax changes favor taxing consumption over income, savings and retirement?

  3. Do the tax changes favor individuals and entrepreneurs over narrow special interests?

These shouldn’t be controversial to conservative majorities in the General Assembly. However, rejecting redistribution in favor of economic freedom will require challenging a status quo that powerful constituencies and business organizations forcefully defend. Lawmakers must begin to recognize that when organizations say there isn’t enough revenue coming into Frankfort what they really mean is there isn’t enough to match their redistribution agenda.