OCTOBER 11, 2014

The Local Option Sales Tax and What Kentuckians Can Learn from Henry Hazlitt

Thomas E. Travis, Executive Editor[1]

There is an issue quietly looming under the radar in Kentucky politics,[2] and ironically, it happens to be so uniformly praised that it is difficult to discern that any controversy exists at all.[3] However, at its core, it represents the single most destructive device that can be introduced to budding economies: more taxes.

This spring, Kentucky lawmakers toyed with the idea of a constitutional amendment to implement a local option sales tax (hereinafter “LOST”).[4] As can be inferred from its name, the amendment would give local governments the ability to supplement the 6% state sales tax to generate more revenue or fund specific projects. In theory, these increased tax rates would sunset once the revenue increase or project was completed.[5] Perhaps the greatest proponent of LOST is Louisville Mayor Greg Fischer, who contends the city would increase annual revenue by $138 million from a one-cent sales tax markup.[6] Lexington proponents assert that the Rupp Arena downtown renovation project could be funded through LOST, as annual tax receipts are anticipated to increase by $34 million.[7]

The Kentucky Constitution currently prohibits the General Assembly from allowing local governments to levy their own sales taxes.[8] Thirty-eight states, including all of Kentucky’s neighboring states (except Indiana), allow local government entities to supplement the existing state sales tax.[9] Indeed, a recent poll of Kentucky voters revealed that 60% of Kentuckians favor an amendment to extend the option to local governments.[10] Moreover, the plan has broad support, including from Governor Steve Beshear, former Governors Ernie Fletcher and Paul Patton, and the Kentucky Chamber of Commerce. Why is there so much trepidation concerning the amendment in Frankfort?

Decades ago, famed economist Henry Hazlitt boldly asserted that there is but one lesson in economics: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”[11] Thus, to truly evaluate LOST and its commercial impact, it is necessary to evaluate the policy as applied to all parties in all areas. Such an inquiry will reveal many logistical and economic flaws that follow the new tax scheme.

Implicit in the terms of the amendment is local autonomy to tax the sale of goods at any rate of the local government’s choosing, but no lower than 6%. Kentucky has 120 counties and even more local government entities not bound to answer to county executives. Therefore, at a given time, there could be dozens of different sales taxes rates operating simultaneously across the Bluegrass. This would be a huge burden on businesses operating across multiple localities, which would have to comply with 120 different sales tax liabilities.

Making matters worse, the metro areas themselves may stumble from this decentralization of authority. The Louisville metro area includes eighty independent cities that do not answer to the Louisville mayor. [12] As a result, the anticipated $138 million in new revenue would be fragmented among the localities, making large-scale projects (the whole purpose of the LOST) functionally improbable, absent a coalition of metro governments, councils, and commissions.

Some say the LOST is necessary to make Kentucky a more competitive business state.[13] While the plan would potentially allow local governments to fund their pet projects, the tax does so at the expense of existing businesses and Kentucky consumers. Local businesses are already struggling to compete with online retailers, which are not subject to sales taxes. Increasing the existing rate would mean the local governments would be wedging themselves between businesses (the interests of which the governments purport to represent) and economic viability in those communities. Undoubtedly, the ultimate result would be the movement of commerce from areas with high tax rates to areas with lower tax rates, or a complete shift to e-commerce.

One of the hardest hit Kentucky industries will be the agriculture industry. Farmers are large volume purchasers but operate on hairline budgets. A one percent increase in sales taxes will present farmers with a difficult decision: whether they should move business elsewhere or face a lower bottom line. Simultaneously, farmers and other large-scale consumers will have that much less to money to reinvest in the local economy because of the coercion to bankroll projects favored by local politicians. Thus, while Louisville may net an extra $138 million, that same figure could remain in private hands to organically stimulate new investment, rather than gambling on centrally planned economic prosperity with government-favored businesses. Indeed, if the underlying local or urban projects needing an additional penny per dollar in sales tax truly represent profitable community economic ventures, then an additional local tax would not be needed in the first place.

Of course, just because local governments have the ability to supplement state sales tax rates, they do not have to do so. But once the public is sold on the idea of funding expansive projects through the take-a-penny-leave-a-penny-jar, it will not be long before such action is expected. Realistically, the projects (and thus, supplemental taxes) will be demanded primarily by those largely not paying for them, at the expense of farmers and other large scale consumers, for the benefit of crony corporations.

Despite assurances that Kentucky is doing all it can to attract new businesses (and necessarily, jobs) to the Commonwealth, supplemental tax measures will achieve the exact opposite result. A steady flow of jobs and commerce will trickle away from localities with LOST measures, leaving them left with nothing but empty buildings and vacant storefronts.

[1] B.S. 2012 Western Kentucky University; J.D. expected May 2015 University of Kentucky College of Law.

[2] Thanks to University of Kentucky College of Law Associate Dean Danny Murphy for presenting this issue to the Ky. J. Equine Agri. & Nat. Resources L. Staff.

[3] See generally Lift Kentucky, http://liftkentucky.com/ (last visited Sept. 1, 2014).

[4] Gregory A. Hall, Local option sales tax bill dead, Fischer admits, Louisville Courier-Journal, Mar. 24, 2014, available at http://www.courier-journal.com/story/news/politics/ky-legislature/2014/03/24/local-option-sales-tax-bill-dead-fischer-admits/6840625/. While LOST died in the House of Representatives during the 2014 session, it is expected that state lawmakers will press the issue in 2015.

[5] There is still some debate on exactly how the proposed scheme would operate. Most proposals use a ballot referendum to pass the tax hike. These proposals also advocate allowing the public to either term limit the duration of the tax hike or sunset it once the specific project involved is completed. The public would also likely prohibit local governments from placing revenues collected from the tax into the general fund, but that is a conversation for a different blog post.

[6] See LouisvilleKy.gov, Local Option Sales Tax: A Louisville Perspective, available at http://www.louisvilleky.gov/MetroCouncil/Members/07/Local+Option+Sales+Tax+Study.htm (last visited Aug. 31, 2014).

[7] See Beth Musgrave, Lexington mayor asks lawmakers to let voters decide on sales taxes for projects, Lexington Herald-Leader, Feb. 27, 2014, available at http://www.kentucky.com/2014/02/27/3111732/mayor-gray-asks-ky-leaders-to.html.

[8] See Ky. Const. § 181 (prohibiting the General Assembly from allowing local governments to impose excise taxes, or a tax on the sale of goods).

[9] See Kentucky League of Cities, Local Option Sales Tax, available at http://www.klc.org/info/detail/102/Local_Option_Sales_Tax (last visited Aug. 31, 2014).

[10] Bluegrass Poll, provided by The Courier-Journal, WHAS-TV, the Herald-Leader, and WKYT-TV, available at http://liftkentucky.com/.

[11] Henry Hazlitt, Economics in One Lesson: The Shortest & Surest Way to Understand Basic Economics 5 (1979 ed.).

[12] Chris Otts, Small cities complicate Louisville mayor’s local-option sales tax plan, WDRB.com, available at http://www.wdrb.com/story/23917270/sunday-edition-small-cities-complicate-louisville-mayors-local-option-sales-tax-plan (last updated May 6 2014).

[13] See Tom Martin, Mayors favor local option sales tax, Business Lexington, Jul. 18, 2012, available at http://bizlex.com/2012/07/mayors-favor-local-option-sales-tax/ (Mayor Fischer contended LOST is necessary to “…compete effectively with the Austins, the Chicagos and Denvers…”).