Back to Tax Reform in Kentucky: Principles and PracticeBy David E. Wildasin
From Financing State and Local Government
p. 15-26, published 2001
A review of trends in tax policy in Kentucky, and a comparison of taxation in Kentucky with other states and localities elsewhere in the nation, provides a foundation for discussion of possible reforms. Taking state and local governments together, tax burdens in Kentucky, expressed as a share of income, have risen gradually over time, bringing Kentucky closer to the U.S. average. By contrast with the rest of the country, Kentucky relies more heavily on the state government to collect taxes and less heavily on localities. Income taxes play a more prominent role in the tax structure of both state and (especially) local governments in Kentucky than elsewhere in the country, while local property taxes are comparatively less important. Substantial fiscal transfers from the state to the local governments, primarily for the financing of local schools, are a noteworthy feature of Kentucky’s fiscal system.
As difficult as it may be to find an ideal system of taxation, revenues do have to be raised somehow. Tax policies change over time because of changing economic conditions, as a matter of deliberate policy choice, and in response to changing legal and other constraints on policy. This chapter reviews, in a summary fashion, some of the principal developments in the evolution of Kentucky’s fiscal system over recent years.
Perhaps it is best to begin with an overview of the trends in the levels of different revenue sources, first for state and local governments combined and then for each separately. Subsequent discussion then examines the composition of revenues and direct attention toward particular components of the overall fiscal system.
The overall level of taxation in Kentucky can be measured in many different ways, and no one way of doing so is uniquely correct. Over time, the total amount of tax revenue has certainly risen, but of course the population and economy of the state vary over time as well. One useful way to describe the broad trend in the amount of revenue is to express tax revenues as a proportion of total income.(16) Figure 1 shows that total own-source revenues have increased gradually as a share of personal income in Kentucky over the past quarter century, presently constituting about 15 percent of income. These own-source revenues include both tax and nontax revenues such as charges of various kinds (from higher-education institutions, hospitals, and the like) plus miscellaneous revenues like interest earnings. As shown in Figure 1, these nontax revenue sources are quite significant in magnitude, although tax revenues of course account for the largest share of own-source revenues. Kentucky, like other states, also receives a significant amount of revenue in the form of transfers from the federal government; as shown in the figure, these have consistently amounted to about 5 percent of personal income.
Figure 1: State and Local Revenue as Percent of Personal Income, Kentucky
It is natural to ask how Kentucky’s fiscal system compares with those in the rest of the country. Figure 2 sheds some light on this question by showing the result of a comparison of the data in Figure 1 with comparable data calculated for all state and local governments in the United States. This figure, like several to follow, looks at the difference between fiscal indicators for Kentucky and those for state and local governments for the country as a whole. Where this difference is equal to zero, the value of the fiscal variable for Kentucky is identical to the value for the same variable for all state and local governments in the United States, always expressing these variables as a proportion of personal income. Thus, as Figure 2 shows, Kentucky has consistently received intergovernmental transfers that are somewhat higher, as a share of personal income, than is true for other U.S. state and local governments. One can also see from Figure 2 that state and local governments in Kentucky collected a somewhat smaller fraction of income in taxes, relative to other state and local governments, until roughly the early 1990s; since that time, Kentucky’s performance in this regard has been relatively close to the national average.
Figures 3-6 break this fiscal picture down by level of government. Figure 3 shows the amount of state government revenue, again separating out own-source from intergovernmental revenue, and distinguishing tax revenue from nontax sources, showing in particular that state tax revenue has risen gradually though not dramatically over time, expressed as a share of personal income. Note from Figure 4 that state government revenues in Kentucky have been consistently higher, as a share of income, than for other state governments in the United States. Most of this difference is attributable to a higher share of own-source revenues.
Figure 3: State Revenue as Percent of Personal Income, Kentucky
Figure 4: State Revenue as Percent of Personal Income, Kentucky, Relative to the U.S. Average
Figure 5 shows the trend of local government revenues over time. Note first that intergovernmental transfers now include transfers from the state government as well as from the federal government. State-local transfers are a major source of revenue for local governments in Kentucky, consistently exceeding local tax revenues and sometimes exceeding total own-source revenues for local governments. Note also that nontax revenues are much more important for local governments than for the state, often accounting for close to half of local own-source revenues. Figure 6 shows that local governments in Kentucky are not unique in their dependence on transfers from higher-level governments, and in fact receive transfers, as a share of income, that are actually slightly less than average for the nation as a whole. More remarkable is the relatively low level of own-source revenues for local governments in Kentucky, including both tax and nontax revenues.
Figure 5: Local Revenue as Percent of Personal Income, Kentucky
Figure 6: Local Revenue as Percent of Personal Income, Kentucky, Relative to the U.S. Average
Putting together the results of Figures 1 through 6, one can see that the overall revenue picture for state and local governments in Kentucky, when combined, is not too different from that for other state and local governments in the United States. However, the balance between state and local revenues in Kentucky is quite different from that for the rest of the country, with state government revenues accounting for a relatively high share of personal income and with local government own-source revenues a relatively low share.
Let us now focus more specifically on the major taxes used by state and local governments in Kentucky. The chief revenue sources for state and local governments in Kentucky are and have traditionally been taxes on income, on sales, and on property. However, the degree of reliance on each of these sources fluctuates over time, at the state and local levels individually and for state and local governments combined, and Kentucky differs from other states in some important ways.
To begin with, Table 1 shows that the "big three" revenue sources account for about 90 percent of all revenues for state and local governments, both in Kentucky and for the nation as a whole. As Table 1 shows, Kentucky is much like other states in this respect. It is noteworthy, however, that the combined state and local government fiscal system in Kentucky exhibits much greater reliance on income taxes and much less reliance on property taxes than other state and local governments in the United States. As is clear from the bottom panel of the Table, which reports the revenue sources for state governments alone, the relatively limited reliance on property taxes and relatively heavy dependence on income taxes is not attributable to the state-level revenue structure; in fact, at the state level, Kentucky depends somewhat less heavily on income taxes, and somewhat more heavily on property taxes, than other states throughout the country. This indicates that many of the important differences between Kentucky’s revenue system and that of other states arise from the system of local government finance, as is discussed further.
Table 1: Composition of Revenue, State and Local Governments, Kentucky and US, 1997
Figures 7 and 8 illustrate the development, over time, of the combined tax structures of the state and local governments in Kentucky. Figure 7 shows that most of the major taxes have been fairly stable as a share of personal income over the past 25 years, although income taxes have exhibited significant growth, especially during the past decade. Figure 8 shows that property taxes have persistently made a relatively modest contribution to state and local tax revenue in Kentucky, by comparison with other states. By contrast, Kentucky has depended more heavily on income taxes as compared with other states, particularly in recent years.
Figure 7: State and Local Tax Revenue as Percent of Personal Income, Kentucky
Once again, it is important to decompose the combined state and local sector in order to look at each level of government separately. Figure 9 shows that the income and sales taxes are the most substantial contributors to the state’s tax system, with both having risen somewhat in recent years. Figure 10 reveals that state-level taxes in general—not just the income and sales taxes, but the state property tax and other taxes as well—are relatively high in Kentucky. This is not unexpected, in view of Figure 4. As for local governments, Figure 11 shows that the property tax has been a major contributor to local tax revenues, with other local taxes playing a somewhat more limited role. These other taxes, however, are much more important in Kentucky than elsewhere in the United States, as shown in Figure 12. Most remarkably, Figure 12 shows that local governments in Kentucky are far less dependent on property taxes than is the case for local governments elsewhere in the United States, although this differential has diminished somewhat over time.
Figure 9: State Tax Revenue as Percent of Personal Income, Kentucky
Figure 10: State Tax Revenue as Percent of Personal Income, Kentucky, Relative to the U.S. Average
Figure 11: Local Tax Revenue as Percent of Personal Income, Kentucky
Figure 12: Local Tax Revenue as Percent of Personal Income, Kentucky, Relative to the U.S. Average
In describing state and local government finance in Kentucky, it is important to pay particular attention to education finance. In Kentucky, as elsewhere in the country, both state government and local governments—the local school districts—share responsibility for education finance and expenditures. This and other important features of school finance in Kentucky are illustrated in Tables 2 and 3. To begin with, the first four columns of Table 2 show that total state and local expenditures on education in Kentucky, expressed as a share of personal income and as a share of total state and local expenditures, have been relatively stable over time and have not differed dramatically from comparable figures for other states. Of all state and local expenditures, Kentucky’s school districts have consistently accounted for a bit more than 60 percent, and in this respect as well, Kentucky’s experience has been similar to that for other states.
Table 2: State and Local Education Expenditures, KY and US, Selected Years
When we look more closely at the relative roles of state and local governments in education spending, however, we see some significant differences between Kentucky and national averages. Table 3 shows the relative importance of different revenue sources for local school districts, both for Kentucky and for school districts elsewhere in the nation. The first two columns show that intergovernmental revenue, that is, transfers from higher-level governments, have accounted for 60 to 75 percent of school district revenues in Kentucky during the past quarter century, significantly higher than the corresponding national average of 45 to 55 percent.(17) School districts in Kentucky are thus substantially more dependent on state government transfers than is true elsewhere in the country. Not surprisingly, taxes collected by local school districts account for a much smaller share of school-district revenue in Kentucky as compared with other states. Furthermore, while the local property tax accounts for a substantial share of local school district tax revenue in Kentucky (for example, about 72 percent in 1997), other local taxes are far more important to Kentucky school districts as compared with other states. In the rest of the country, over 95 percent of local school district tax revenues have consistently been obtained from local property taxes.
Table 3: Sources of Revenue for School Districts, KY and US, Selected Years
In this overview of Kentucky’s fiscal system, a few important points stand out. First, the combined state/local tax burden in Kentucky is not dramatically different from that found elsewhere in the United States, at least when measured in relation to personal income. Kentucky does differ from other states in the composition of its tax structure. Income taxes play a larger role in Kentucky than is true elsewhere in the country, both at the state and the local level. By contrast, while the local property tax remains a major revenue source for local governments in Kentucky, this is much less the case than for other local governments in the United States. With respect to primary and secondary education, Kentucky’s overall expenditures do not differ markedly from other states. But the financing of education spending is quite different, with Kentucky relying much more heavily on the state government to finance local school districts. These features of Kentucky’s fiscal system are interrelated. Since the property tax plays a minor role as a revenue source for the state government but a major role for local governments, heavy state involvement in education finance is likely to contribute to a shift in the combined state-local fiscal system away from property taxation and toward income and sales taxation.
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16 The discussion in this chapter is drawn from data available from the U.S. Census Bureau, especially the Census of Governments. Return to text.
17 Both in Kentucky and elsewhere in the country, almost all of these transfers come from the state government, with transfers from the federal government accounting for less than 5 percent of all intergovernmental revenue received by school districts. Return to text.