From Foresight, Vol. 8, No.1
published 2001
Editor’s Note: The following is an Executive Summary of a December 1999 report prepared by the Barents Group, a consulting arm of KPMG based in Washington, D.C., for the Office of Financial Management and Economic Analysis, Commonwealth of Kentucky.
This project for Kentucky's Office of Financial Management and Economic Analysis updates and extends Barents Group LLC’s 1995 study entitled “Comparative Analysis of Kentucky’s Tax Structure.” The update includes more recent data, covers subsequent changes in legislation, and increases the number of industries and households analyzed. The main objective of this project, like the original 1995 project, is to provide a comparative tax study that focuses on the competitiveness of Kentucky’s business and personal taxes, with balanced consideration of other important tax policy criteria such as equity and uniformity. Our inclusion of recent changes in tax law and more recent statistical data on industries and households produces results that are, in some cases, significantly different from those presented in the 1995 study: Indeed, such a comparison serves to illustrate the value of occasional updates to studies of this type.
Neighboring states and others continue to review and revamp their tax structures to attract investment, support job creation and eliminate obstacles to economic development. At the same time, state policymakers are challenged to maintain an adequate and stable revenue base, to ensure an accountable system of tax administration, to promote an economically efficient tax system, and to achieve fairness in the distribution of the tax burden. This study illustrates the need for and the consequences of finding an appropriate balance in these sometimes-competing objectives.
Kentucky depends less on general sales taxes than do either the selected comparison states or all fifty states. On average, Kentucky has a relatively greater dependence on selective sales taxes than the comparison states or all fifty states. Property taxes and corporate income taxes contribute a smaller percentage to total tax collections in Kentucky than in either the comparison states or the nation. In 1996, the most recent year for which we have reliable data, individual income tax collections represent 30.3 percent of total Kentucky tax collections, compared to a national average of 21.3 percent.
We have updated and expanded the Kentucky Business Tax Competitiveness Model to perform the business tax analysis. The Model calculates pre-tax and after-tax rates of return on a hypothetical marginal investment made by a representative firm in each study industry. Balance sheets and income statements are developed based on actual financial data for each industry. Income and taxes are projected over a thirty-year period. Effective income, property and sales tax rates are calculated as the measure of marginal tax burdens on investment for purposes of performing the analysis. The effective tax rate is computed as the difference between the pre-tax and after-tax rates of return divided by the pre-tax rate of return. For example, the effective tax rate is computed as 9.09 percent if the pre-tax return is 11 percent and the after-tax rate of return is 10 percent [((11.0 - 10.0)/11.0)=9.09]. The effective tax rate is the marginal rate that applies to the additional income generated by the hypothetical investment, and is the widely-accepted measure of business tax burdens since it accounts for the time value of money over the life of an investment.
The updated study includes nineteen industries as follows: Agriculture; Coal Mining; Furniture; Printing; Industrial Chemicals; Plastics; Primary Metals; Metal Forgings; Metalworking Machinery; Electronic Components; Auto Parts; Trucking and Warehousing; Telephone Communications; Wholesale Trade; Computer Services; Business Services; Health Services; R&D; and Catalogue Retailers.
These industries were selected because of their significance to the economic development of Kentucky. Of course, our results are limited to the states and industries that are included in the study.
Fourteen states, in addition to Kentucky, are covered in the business portion of the study. They are: Alabama, Arkansas, Georgia, Illinois, Indiana, Michigan, Mississippi, Missouri, Ohio, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia.
Key findings from our development and use of the Business Tax Competitiveness Model analysis include:
Kentucky’s state and local business tax system ranks tenth highest of the fifteen study states in terms of overall tax competitiveness across all of the study industries.
Kentucky ranks tenth highest of the fifteen study states in sales taxes, twelfth highest in property taxes, and second in combined income and net worth taxes.
Across locations, trucking, coal mining, primary metals, telecommunications, and many services have a higher effective tax rate than most other industries. Traditional manufacturing industries generally are burdened with lower effective tax rates than others.
Kentucky is generally more competitive than the other study locations for the agriculture, printing, industrial chemicals, and primary metals industries.
Kentucky is generally less competitive than the other study locations for the wholesale, catalogue retail, business services, computer services, and health services industries.
Kentucky is moderately competitive relative to the other study locations for the plastics, metal working machinery, auto parts and electronic components industries.
Table ES-1 presents a summary of Model results for all study industries.
Table ES-1: Summary of Effective Business Tax Rates and Rankings
Figure ES-1 illustrates the combined effective tax rates presented in Table ES-1.
Figure ES-1: All State and Local Taxes
A state’s household taxes can also have an effect on economic development. For example, small business owners, professional and executive personnel may consider personal as well as business taxes in assessing options related to business and household location decisions. In a broader sense, the state income tax is a key component that influences the performance of the Kentucky tax system overall. The individual income tax is the primary tax type that introduces progressivity into a state tax system and thus affects the perception of fairness in the distribution of the tax burden.
For purposes of this project, we have updated and expanded the Kentucky Household Tax Model to perform the household tax analysis. In addition to personal income taxes, several other taxes contribute to the direct tax burden on families. Household taxes covered by the Model include personal income taxes, residential property taxes and property taxes on motor vehicles, sales and use taxes on consumer purchases, excise taxes, gross receipts taxes on utility purchases, and intangibles taxes. The calculation of household tax liability reflects the differences in tax base definitions, as well as tax rates, across states. These results are limited to the specific households and locations included in the study. For purposes of the updated study, ten households were selected for study. These households include:
Two-parent family of four at the poverty level,
Two-parent family of four at twice the poverty level,
Single-parent family of three at the poverty level,
Single-parent family of three at twice the poverty level, and
Two-parent families of four with annual incomes of $30,000, $50,000, $75,000, $100,000, $150,000, and $200,000.
Specific characteristics for these households were generated using an IRS public-release file of U.S. federal income tax records that has been statistically augmented with wealth, consumption, and property data from a variety of well-respected data sources. The wealth information was imputed using Survey of Consumer Finance data from the U.S. Department of Commerce; the consumption information was imputed using Consumer Expenditure Survey data from the U.S. Bureau of the Census, and demographic and property ownership data are available because the tax database was statistically merged with the Census’ Census of Population and Housing.
Fifteen states in addition to Kentucky are covered by the study. These states differ slightly from those included in the business tax analysis. They are: Alabama, Florida, Georgia, Illinois, Indiana, Louisiana, Mississippi, Missouri, Ohio, Oklahoma, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia.
Key findings from the Household Tax Model analysis include:
For the representative two-parent family of four at the federal poverty income level, Kentucky's household tax system ranks seventh highest of the sixteen study states for overall tax burden.
For two-parent families of four at the $50,000, $75,000, $100,000, $150,000, and $200,000 income levels, Kentucky's household tax system ranks fourth highest of the sixteen study states for overall tax burden.
For the two-parent family of four at the $30,000 income level, the two-parent family of four at twice the poverty level of income, and the single-parent family of three at twice the poverty level of income, Kentucky's overall tax burden ranks third highest of the sixteen study states.
For the single-parent family of three at the poverty level of income Kentucky's overall tax burden ranks sixth highest.
Table ES-2 presents a summary of results for four of the ten representative families. The tax burdens presented in the table combine sales, property, income, excise, and intangibles taxes for each family.
Table ES-2: Summary of Overall Individual Tax Burdens and Rankings
In general, Kentucky has lower than average business tax burdens and slightly higher than average individual tax burdens. For businesses, the income and net worth taxes present the most significant tax burdens in comparison with other states. For households, individual income taxes are generally the source of the greatest burden relative to other states.
Among the industries included in the business tax analysis and the representative households analyzed in the household component of the study, there is significant variability. While Kentucky is near the average in overall comparisons, the differences between individual results can illuminate further discussions of Kentucky's tax competitiveness.
Table: Percent of State and Local Tax Revenue by Tax Source, 1997