February 14, 2005, 8:28 a.m.
Crabgrass for the Bluegrass State
Gov. Fletcher’s flawed tax-reform plan.

By Paul J. Gessing

Republican Gov. Ernie Fletcher of Kentucky, having recently announced his tax-reform plan, has been looking for support from state legislators across the political spectrum. There is of course much for taxpayers to like in the governor’s package, including a reduction of the top corporate income-tax rate to 6 percent (from 8.25 percent) and a repeal of the corporate license tax. The impetus for the focus on income taxes is Kentucky’s notoriously unfriendly tax climate for business. In fact, the Tax Foundation recently found that Kentucky had a worse business-tax burden than all but six states, including slow-growth, anti-business Hawaii, New York, West Virginia, and Vermont.

Clearly, the tax-reduction portion of Fletcher’s proposal will be an economic boon for Kentucky. The state is in dire need of an economic “shot in the arm” that will allow it to more effectively compete with its neighbors, particularly Tennessee. As Ohio University economist Richard Vedder points out, in 1970 Kentucky was ahead of Tennessee in per capita income, but by 1990, the average Kentuckian had fallen $1,255 behind the average Tennessean. That gap has only worsened. By 2003 the average Kentuckian made $2,213 less than the average Tennessean. Vedder and others have attributed this yawning gap to two factors: Kentucky’s high income-tax rate and Tennessee’s lack of an income tax.

By taking a whack at his state’s income-tax policies, Fletcher has started a much-needed debate over the taxation of income in the commonwealth. Unfortunately, in order to interest tax-and-spend legislators, the governor has made his tax-reform plan “revenue neutral.” This means that instead of lessening the burden on all Kentuckians by cutting taxes outright, some taxpayers will win and others will lose.

The most prominent losers in Fletcher’s plan would be those who smoke, drink alcohol, or watch satellite television. Smokers would see cigarette taxes rise from 3 cents to 34 cents. This is bad enough, but most troubling is the fact that in the future the cigarette tax would be tied to the cigarette tax rates in surrounding states. Worse, even if nothing new happens, under the governor’s plan the cigarette tax rate would jump to 53 cents a pack by 2008. Alcohol consumers, meanwhile, would see the existing 6 percent sales tax that people pay in restaurants and bars added to package sales of liquor, beer, and wine. Lastly, users of satellite TV services would be subject to a 7.62 percent tax, while telephone and cable television subscribers would see their taxes rise from 6 percent to 7.62 percent. Together, these tax-hike proposals would raise an estimated $214 million in 2006.

In piecing together this complicated, convoluted plan, Fletcher has made both tactical and political errors. For one, the choice between economically vital income-tax reductions and significant tax hikes on smaller groups of people is a false dichotomy. Worse, by proposing a plan that directly harms some of the industries that are too often singled out as whipping boys for tax hikes, Fletcher has hurt his chances for real reform immeasurably.

Instead of gouging a few groups of consumers and industries — industries that have some political clout and are significant employers and taxpayers in Kentucky — Fletcher should act the part of a consistent, conservative governor. That means proposing a frugal budget and looking to cut spending, cut taxes, and reduce the overall size of government whenever possible.

By adhering to the conservative model outlined above, South Carolina Gov. Mark Sanford has achieved approval ratings of more than 60 percent. Fletcher, on the other hand, has upset several business and taxpayer constituencies on the right, while not winning any friends on the left. (Liberals see his plan as shifting taxes from corporations onto individuals.) Regardless of whether his plan is really revenue neutral — it is too complicated to really tell — Gov. Fletcher should have stuck to the basic conservative messages of frugal government and low taxes, not fancy tax-redistribution schemes where good intentions are trumped by economic reality.

— Paul J. Gessing is director of government affairs for the National Taxpayers Union.