There are indications that the 2022 Kentucky General Assembly will consider major changes to the state’s tax system. While big proposals are often referred to as “tax reform,” the change itself won’t necessarily make things better — and could easily make them a lot worse.
Across the country, states take two different paths when it comes to taxes, which have very different effects on the well-being of individuals and communities.
One way is making government economies stronger and quality of life better by strengthening schools, health care and other core public investments. These states fund improvements by requiring the wealthy to pay their fair share of taxes. States the other way increase hardship for working families while further enriching those in power and corporations. These states cut taxes at the top and pass losses on to everyone else as investment in education, health care and other core services slacks.
Kentucky would be wise to take the first route. As the top 1% amass massive wealth and corporate profits hit record highs, a dozen states have passed higher taxes on millionaires in recent years. States like Colorado, Maryland, Washington, Oregon and others are also limiting deductions for high-income households, increasing taxes on capital gains and closing corporate tax loopholes.
Residents of states that have taken this approach benefit: The 9 states with the highest income tax rates have experienced faster economic growth over the past decade than states with no income taxes. States that introduced millionaire taxes after 2000 experienced growth that matched or exceeded neighboring states that did not. And a comparison showed that Minnesota outperformed neighbor Wisconsin after the former raised taxes for those at the top while the latter lowered them.
When states close loopholes and remove tax breaks for the rich and well-connected, they can channel that money into early childhood education, infrastructure, clean air and water, and more. This fuels state growth by improving quality of life, fostering innovation, supporting business creation and circulating dollars in local communities.
While the first option is the path to prosperity, there is a real danger that the General Assembly will go in the wrong direction.
In the early 2010s, Maine, Ohio, Wisconsin, Kansas and North Carolina made large cuts to individual income taxes with claims that their economies were taking off. But all 5 states experienced slower gross domestic product growth than the United States as a whole in subsequent years, and 4 of the 5 states experienced weaker job growth.
The Kansas income tax cuts were such a failure that the state famously had to rescind them after 5 years to save its budget-strapped schools. Kentucky would likely end up in the same boat if policymakers cut our income taxes further. Just a one percentage point cut from 5% to 4% would cost the Kentucky budget more money than we spend on our entire higher education system: 8 universities and 16 community colleges. A cut from 5% to 4.9% would cost more than the state spends on preschool.
We know we can’t get anything for free. Schools, roads and other necessities cost money, and when income taxes are cut, that money has to come from somewhere. That’s why states that lower income and corporate taxes end up raising sales and other consumption taxes. This turns the tax system on its head. Sales taxes take a much larger share of the income of the poor and working class – disproportionately people of color – who have to spend all of their income on necessities. And it weakens long-term revenue by leaning on people whose incomes are stagnant while lowering taxes on wealthy people whose incomes are manipulated to grow.
If Kentucky lowered its income tax rate to 4%, it would have to raise the sales tax rate from 6% to 7.4% to make up for the lost revenue, according to the Institute on Taxation and Economic Policy. That would give our state the highest state sales tax in the country. The bottom 60% of Kentucky residents would pay more taxes as a result, while the richest 1% — who earn an average of $1.4 million a year — would be the big winners, with a typical annual tax cut of $8,731.
Shift-and-shaft tax policy works, as does the underlying “trickle-down economics” — that is, not at all. Kentucky should not squander its one-time surplus and hamper its economy going forward with tax policies that give more of our precious resources to the powerful few.
Jason Bailey is executive director of the Kentucky Center for Economic Policy, www.kypolicy.org.