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The State Budget

by Rodney Berry

Recent History

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A great accomplishment? Grover Norquist, president of Americans for Tax Reform, certified Kentucky’s tax modernization legislation as “revenue neutral” and within the approved limits of officials signing the “no new tax pledge.” Gov. Fletcher said that tax modernization is “truly historic, unprecedented and astounding.” Some elements of the plan – particularly the elimination of personal income taxes for the poor – are broadly endorsed. A missed opportunity? Critics say that tax modernization will allow only marginal increases for education and vital services. They say that changes fell short of expanding sales tax to the growing service sector, awarded excessive tax reductions on corporate net profits, and did not establish a progressive income tax which would draw more from those most able to pay.

2005 General Assembly

Various circumstances, issues and trends affected the climate of the 2005 legislative session:

• pressure to adopt a budget (a budget agreement was not reached in 2004)
• severe state government financial pressures predicted by the Fox Report, an independent study commissioned by the legislature
• a “no new tax” pledge signed by Gov. Ernie Fletcher and 50 members of the legislature
• a “revenue neutral” tax modernization proposal from Fletcher
• the governor’s position that tax increases can be averted by finding efficiencies and eliminating waste, fraud and abuse in state
  government

Tax Modernization

Most of Gov. Fletcher’s tax modernization proposal (JOBS – Jobs, Opportunities, Bi-Partisan, Solution) was adopted by the 2005 legislature.

Taxes were increased on cigarettes, alcohol package sales and satellite, telephone and cable television. Some corporate tax loopholes were closed, particularly with regard to limited liability corporations. The state corporate license tax was exchanged for an alternative minimum tax.

Tax modernization included significant cuts in corporate tax rates and personal income taxes, eliminating income taxes for individuals and families in poverty and lowering income taxes for everyone else. (Fletcher proposed a “trigger” to automatically continue income tax reductions over time, but it was removed by the legislature.)

Tax modernization is expected to produce a one year revenue increase of $110 million in fiscal year 2006. Over five years, however, the $707 million in new revenue it is projected to generate will be offset by $710 million in revenue reductions.

Pressures

Despite tax modernization, administrative efficiencies, and overall improved economic conditions, state government faces immense financial challenges.

The Fox Report, commissioned by the state legislature, projected that state government would need to raise $2.3 billion by 2010 to maintain existing services. This was attributed to an outdated tax system. However, the restructured tax system adopted by the 2005 legislature is revenue neutral, meaning it won’t raise more money for the state.

Why is state government under such financial pressure? Analysts point to the following:

• House Bill 44, enacted in 1979, put limits on state and local property tax increases. State property tax rates decreased from 31 cents per $100 valuation to 13 cents. (The estimated current annual revenue loss is $300 million.)
• Since 2001, six rounds of budget cuts have reduced revenues by $1.1 billion.
• In the 1990s, state taxes were cut 26 times.
• While some tax exemptions are warranted (such as the sales tax exemption on groceries), many reflect the influence of special interests. Tax exemptions reduce state government revenue by $6.4 billion per year.
• Skyrocketing health care and prescription drug costs intensified by unhealthy lifestyles, an aging population and growing numbers of state government retirees.
• An exploding prison population due, in large part, to tougher drug sentencing.
• Excessive economic development incentives.
• Federal tax cuts and unfunded mandates that shifted responsibilities and costs to state government.
• Significant reduction in corporate taxes.

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