The first three months of the 2018 legislative session now seem like prologue: The sexual harassment scandals and shakeups within House leadership that informed the opening weeks of the session were left in the rearview mirror by a grand finale that included pension reform, a state budget, tax reform, vetoes, veto overrides and fixes to bills that were passed earlier in the session – all within the last four legislative days.
To some extent, the process became as much the focus as the policies themselves, as a seemingly more engaged public witnessed firsthand how the “Schoolhouse Rock” version of ‘sausage making’ is largely discarded by General Assembly once they are staring down the clock.
Tax reform began as a straightforward revenue bill (HB366) to balance the budget, but it grew to encompass major tax policy shifts over a series of behind-closed-doors meetings prior to the veto recess. The legislature passed it after being in the public domain for mere hours, the governor vetoed it, then legislators overrode. House and Senate leaders, acknowledging the need to change the bill over the veto break but unable to make further changes to it, amended a new bill altogether that superseded HB366. HB487 was passed on the last day of session and is now law.
It flattens the state individual and corporate tax rates to 5 percent, phases out the inventory tax, moves the state to a single-sales-factor corporate tax apportionment, suspends or caps several tax credits, requires combined filing among business groups, expands the sales tax to several services, and increases the per-pack cigarette tax by 50 cents, among other changes. The legislature estimates the bill will generate $400 million over the biennium, a number disputed by the governor’s budget director.
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The state budget (HB200) faced similar circumstances following the governor’s veto. The legislature overrode the veto, and changes to the law were included in a new bill, HB265. The combination of generating new revenue in HB487, draining the “rainy day” fund and preserving some of the governor’s proposed reductions balanced the budget without cuts to public education. As a result, public education advocacy groups, who were organized and motivated to rally against pension reforms, came out in support of the budget and revenue measures in the session’s final days.
Pension reform, which became law with the signing of SB151, drew the ire of educators statewide. The law largely held harmless existing employees and retirees across most state retirement systems, but it puts future teachers into a hybrid cash balance plan, which new state and county employees have had since 2014. Such plans guarantee a minimal rate of return during periods of market downturns.
Pensions, budget and tax reform were considered a collective financial three-legged stool for purposes of final legislative negotiations, but other meaningful items were considered over the 60-day session. Workers’ compensation reform (HB2) passed following defeat last year. Tort reform was filed as a constitutional amendment (SB2), and it did not get through the Senate. However, medical peer review panels (HB4) are now law. The General Assembly passed a balanced road plan (HB202), but they did not act on a proposed 10-cent increase in the motor fuels tax (HB609).
It may take some time to ultimately score this session. The General Assembly passed a pension reform measure that doesn’t cut the unfunded liability in the short term but will likely reduce the state’s long-term public-pension risk by making changes to future hires. The new two-year budget funds the pension systems and per-pupil public school spending at unprecedented levels, but does not reflect commensurate investments in higher education and other areas of state government. Tax reform places Kentucky on a more competitive footing with its peer states, but as always, there are winners and losers any time substantial revisions to the code are made.
By passing a budget, the General Assembly appears to have headed off the need for a special session, although it is completely within the governor’s purview to call one. It is also within the governor’s ability to make budget reductions without legislative input if tax receipts do not meet their budgeted amounts, a scenario his office predicted while the floor debate on the revenue bill veto override was going on. Regardless of whether a special session takes place, the legislature is setting the table for “tax reform 2.0” in 2019 by establishing a task force to review the voluminous tax breaks and incentives that may negatively impact overall general fund returns.
Sean Cutter is director and James Higdon is a principal with MML&K Government Solutions.