By Jordan Harris
Most of us know the centuries-old parable of the boiling toad. If you place a toad in boiling water, the story goes, it will detect the threat and immediately jump out. If you instead place it in lukewarm water and slowly increase the temperature to a boil, it will remain there until it dies from the heat.
For several decades, Kentucky’s economy has been a slowly boiling toad.
By the very nature of their business, political leaders often think in short two-, four- or six-year cycles. This makes it easy to recognize and respond when a crises occurs, but more difficult to see slow erosions taking place over multiple decades. Retrospective economic growth numbers provide a clear picture though – we’re nearing the boiling point.
Since 1977, Kentucky’s GDP growth has been a pathetic 30 percent below national average, ranking it 44th in the United States. The last decade is equally troubling. The commonwealth’s real per-capita GDP growth in the last decade is only 0.3 percent, putting us well behind our neighbors. Tennessee’s per capita GDP growth is 2.56 percent in that same period. Indiana is even higher at 4.7 percent.
The immediate next question turns to fixing the problem. To do so, we must first note that the tax structure of a state is the single most important way it dictates the direction of its economy. A nation, which has a central bank, guides its economy through monetary policy and tax policy, with long-standing debates about which is a more important factor. For a state, which cannot produce its own money, it is clearly tax policy.
There are two basic theories about how to shape a tax structure to encourage growth. One theory, known as the Keynesian Theory, believes that increased consumption is the key to economic growth, therefore taxes should be concentrated on production. The other theory offers the opposite view, believing that the production side of the economy should be relieved or even spurred, providing more money for hiring, expanding and innovating, ultimately driving and growing the economy, thus taxes are focused on what people choose to consume.
Since Kentucky’s income and corporate taxes were introduced in 1936, the state has relied heavily on production taxes. Today, the two make up approximately 46 percent of all revenue to the General Fund. When gross receipts and other production taxes are added, the percentage increases to more than half of General Fund revenue.
The broader impact of this structure is evident. Kentucky’s household income is 18 percent below national average, ranking it 45th in the nation. Our labor force participation rate as of May 2017 was 60 percent, ranking it 43rd. By virtually every metric, our antiquated structure has given us a broken economy.
Pegasus Institute, the public policy think tank that I serve as co-executive director of, released a plan last month to provide a roadmap for tax reform that can help reverse these trends. We believe that it should eventually be the goal of our state to join the nine other states that don’t have an income tax, but understand that a gradual process might be required. For that interim we have proposed what we call the 3-3-6 Plan.
The 3-3-6 Plan will immediately make Kentucky one of the top business climates in America by eliminating the graduated income tax and cutting the top marginal rate in half, to a flat 3 percent. We propose doing the same to the corporate tax rate, also moving to a 3 percent rate. Closing existing sales tax loopholes will help make up for this revenue shift. The sales tax remains at 6 percent, but current exemptions should be curtailed.
This change will give the average Kentucky household nearly $1,000 in additional take-home pay, allowing them to use their money as they see fit. Equally important, it allows for businesses of all sizes to grow, providing more opportunities for employment, a wider variety of job options, and the hope of upward mobility.
With bold tax reform, Kentucky lawmakers have an opportunity to completely reshape our economy and build a tax structure that exists for the “common wealth” of every Kentucky citizen. Doing so will be the most important economic change in nearly eight decades, and ensure that people at every level are more prosperous in the eight to come. ■
Jordan Harris is founder and co-executive director of Pegasus Institute.