By Anna Baumann
In Kentucky, the income inequality that exists between our poorest and wealthiest residents is magnified by the structure of our tax system. And thanks to the new tax law enacted by the 2018 General Assembly, that problem is getting worse.
Income inequality is soaring in an economy where the winners increasingly take all. The wealthiest 1 percent of Kentuckians make 94 times more a year on average than the bottom 20 percent. Despite that yawning gap, the state tax system is tilted in favor of those at the very top, as shown in a new report by the Institute on Taxation and Economic Policy (ITEP). The wealthiest 1 percent of Kentuckians pay only 6.7 percent of their income in state and local taxes, the study shows, while the middle 20 percent pay 11.1 percent and the poorest 20 percent pay 9.5 percent.
This upside-down tax system is especially harmful to particular groups. Wealth is not evenly distributed across the commonwealth, and poverty is concentrated in certain regions and communities. What’s more, our country’s longstanding system of racial barriers to education, jobs, housing and capital means Kentuckians of color are more likely to be poor and less likely to be rich than white Kentuckians. Our regressive taxes worsen existing divides between metro and rural areas and between whites and Kentuckians of color.
The problem with our tax system boils down to the fact that Kentucky, like most other states, over-relies on sales, excise and property taxes – which ask more of low-income people, and which don’t tend to grow with our economy – while underutilizing the income tax, which is the best resource we have to generate reliable revenue based on ability to pay.
A broad-based, graduated individual income tax that asks more of those who have more helps to offset the regressivity of other state taxes. At the same time, it provides more robust revenue for investments in good schools, a modern infrastructure and other public services that help build thriving communities. Corporate income tax laws that prevent tax avoidance and minimize expensive, inefficient tax breaks can also help generate revenue for the investments that benefit the whole economy and help to maintain a level playing field between businesses.
Instead of a well-balanced system that is fair and produces sustainable revenue, Kentucky’s tax system favors the wealthy. For example, the low-income tax credit means people in poverty do not pay state income taxes. But because the state fails to provide refundable tax credits to offset sales, excise and property taxes that low-income people pay, and because the state has a flat rather than progressive income tax rate, the poorest 20 percent of Kentuckians, who make just $10,000 a year on average, end up chipping in more of their income in taxes than do millionaires.
The 2018 General Assembly’s tax shift from progressive income taxes to regressive sales taxes made Kentucky’s tax system even more imbalanced. The new tax law was a cut for the richest 5 percent of Kentuckians — especially the top 1 percent, who received a cut of over $5,000 — and an increase for everyone else. Because of these changes, Kentucky now ranks 25th worst among states on ITEP’s inequality index, which measures the effect of state tax systems on income inequality. Without those changes, Kentucky would have ranked 34th. This shift could get even worse as some political leaders have indicated that they support an even greater shift away from the income tax in favor of the sales tax.
Assertions that this shift is about economic development are completely untrue. According to a separate study from ITEP, over the last decade, the nine states with the highest top personal income tax rates outperformed the nine states lacking broad-based personal income taxes in terms of per-capita GDP growth and personal income growth. Economists from the University of Kentucky’s Center for Business and Economic Research have also found that “business climate” variables like level of individual and corporate income taxes are not strongly related to economic growth.
The wealthiest Kentuckians benefit the most from our growing economy, and the magnitude of their gains has increased over time. Though our regressive tax system didn’t cause income inequality, it exacerbates it. By returning to a graduated income tax and cleaning up corporate tax breaks, we can push back against worsening income inequality and strengthen our investments in an economy that works for all Kentuckians.
Anna Baumann is senior policy analyst at the Kentucky Center for Economic Policy.