Eliminating occupational tax is the key to local tax reform

Editor’s note: The Bluegrass Beacon is a weekly syndicated newspaper column posted on the Bluegrass Institute’s website after appearing in publications statewide.

If there is one priority about which Frankfort’s Republicans have been clear and consistent, it’s lowering, and ultimately eliminating, the individual income tax.

The state’s media – primarily speaking to their liberal audience in Louisville and Lexington – has done its best to stoke controversy. That echo chamber, however, is completely disconnected from the rest of Kentucky.

Already in this current legislative session, the House of Representatives voted 79-19 to lock in an income tax rate reduction from 5% to 4%. The Senate is expected to follow suit in early February.

This makes for an interesting tension: what happens when powerful interest groups’ agendas conflict with Republicans’ low tax vision for the Bluegrass State?

Local governments, represented by the Kentucky League of Cities (KLC) and the Kentucky Association of Counties (KACO), want to amend the state’s constitution to empower the legislature to rewrite the local tax code. You’ll get no argument from me that local taxes don’t need to be overhauled.

Where we differ is that KACO and KLC seek new tax options for the purpose of “raising revenue” – a common euphemism in Frankfort for tax increases.

The Bluegrass Institute (BIPPS), where I am a visiting policy fellow, told a legislative committee in October that the first principle of tax reform must be “revenue neutrality,” meaning no net increase in Kentuckians’ overall tax burden. Legislation passed last year setting the framework for methodically lowering the income tax meets and exceeds this principle. KACO and KLC’s long term goals for local tax reform don’t.

Rep. Michael Meredith, R-Oakland, the amendment’s legislative champion, is making a real effort to balance the competing tensions. As prior chairman of the House Local Government Committee, Meredith’s relationships with local officials run deep. He’s also a fiscal conservative and averse to giving cities and counties a blank check to raise taxes.

BIPPS’ recommendation is to include “guardrails” in the amendment. However, language to constitutionally lock in “revenue neutrality” isn’t practical. As the economy grows, so do tax revenues. (Economists call this “organic revenue growth.”)

Still, there’s an option that can give taxpayers certainty this isn’t just another effort to tap their wallets while also aligning local tax reform with the reforms at the state level.

Local governments depend heavily on occupational taxes. According to the Tax Foundation, “15 states tax either personal or business income at the municipal level, and only eight – including Kentucky – tax both.”

These local income taxes stack on top of the state’s income tax and, in certain parts of the state, on top of each other. Most of Kentucky’s competitor states don’t have an occupational tax or, if they do, a much lower one.

Cities and counties want to be able to levy a local sales tax. This fits with state level reforms shifting taxation away from income towards consumption.

The legislature should seriously consider doing it with one non-negotiable condition: the amendment must sunset the local occupational tax within 10 years.

KACO and KLC are certain to claim eliminating the occupational tax is impossible. That’s true if the only replacement is a local sales tax. However, the proposed amendment would give the legislature the power to enact a comprehensive rewrite of local taxes.

The amendment’s proponents must also consider the politics at the ballot box. They may try to frame it as something other than a path to a local sales tax but even a moderately funded issue campaign opposing it will cut the knees out from under their messaging.

Asking Republican legislators to vote on what amounts to putting a local sales tax referendum on the ballot? KACO and KLC might as well offer a t-shirt with “Please Primary Me” written on the back.

Put the issue forward as a vote to eliminate local income taxes in the next decade? That might just sell to Kentucky’s conservative electorate.

Andrew McNeill is the former Kentucky deputy state budget director and a visiting policy fellow at the Bluegrass Institute for Public Policy Solutions. He can be reached at amcneill@freedomkentucky.com.