Introduction
When it comes to taxes, each state in the United States has its own unique approach to raising revenue for local governments. Among the various tax structures and codes across the country, Kentucky stands out as an outlier due to its heavy reliance on occupational license fees, or taxes on payroll (wages) and business income. This dependency sets the Bluegrass State apart from others and has both advantages and disadvantages that shape its local tax landscape.
The Role of Occupational Taxes
Occupational taxes, commonly understood as a local income tax, are a primary source of revenue for many cities and counties in Kentucky. According to data from the Kentucky League of Cities and the Kentucky Association of Counties, on average in FY 2022, Kentucky cities raised 59% of their general fund revenues from this tax revenue source, while counties raised 44%. These taxes are levied on individuals and businesses based on their income earned within the local jurisdiction. Individual earnings are based on wages paid to employees by employers, while business earnings are the net profits gained by a business. The revenue from these taxes remain local in order to fund local services and infrastructure.
The primary reason for the heavy prevalence of occupational taxes in Kentucky is the absence of other sources of local revenue generation. Whereas the majority of other states in the United States have a variety of other sources through which to raise local revenue, Kentucky is constitutionally restricted from that flexibility. The lack of diverse revenue streams creates a significant overreliance on occupational taxes, one that is abnormal from the rest of the country. As one of only a handful of states without local revenue flexibility – for example and most commonly, local sales tax – Kentucky relies heavily on occupational taxes to fund essential services such as public safety, education, and local government operations.
In addition to occupational taxes, Kentucky’s local tax structure also involves payroll taxes, which are levied on employers based on the wages they pay to their employees. These taxes are yet another vital component of the state’s revenue system, providing a significant portion of the funds required for local services.
Advantages of Occupational Taxes
Local Autonomy: One of the most significant advantages of Kentucky’s reliance on occupational taxes is that it grants local governments a level of autonomy. Being able to set the rate of occupational tax (to an extent) allows them more control over their financial resources, enabling them to address local needs and priorities without relying heavily on state funding for basic services.
Stability: Speaking generally, Kentucky’s local governments have been dependent on local wage taxes to generate much of their general funds to provide for their residents for many years. Knowing that this revenue source is always there as employment and businesses continue to flourish provides peace of mind to local leaders.
Fairness and Equity: By taxing individuals and businesses based on their earnings within the local area, occupational taxes are perceived as more equitable than other taxes such as property taxes, which might burden homeowners disproportionately.
Potential Disadvantages
Business Competitiveness: The heavy reliance on occupational and payroll taxes in Kentucky impacts the state’s business competitiveness. High taxes on businesses and their employees, and from multiple levels of government, might discourage new businesses from setting up shop or cause existing ones to relocate to states with more favorable tax climates. It could also negatively impact workforce and population in an increasingly migratory country, discouraging current residents from choosing to stay and making it harder to convince others to move to Kentucky.
Economic Downturn Sensitivity: Kentucky’s local tax structure heavily tied to income and employment can leave local governments vulnerable during economic downturns. When businesses face financial challenges or layoffs occur, tax revenues can decline, leading to budget shortfalls and difficulties in maintaining critical services.
Stable Revenue Source: Occupational taxes are increasingly unstable and unpredictable since they are directly tied to local economic activity. In a fluctuating economic landscape, tying government coffers to such limited sources can be unwise and irresponsible for local leaders aiming to remain fiscally conscious. Today’s workplace shift from in-person offices to remote work – which can alter the jurisdiction in which occupational tax is generated – is an example of how a change outside of government’s control can significantly impact the ability to provide a steady stream of income for essential services.
Conclusion
Kentucky’s local tax structures and codes are undoubtedly unique and distinguishable from the rest of the country due to local governments’ heavy reliance on few sources of revenue generation and inability to have flexibility in creating more competitive, modern tax codes. While these taxes, which have long supported the states’ diverse communities, can offer advantages such as consistency and perceived fairness, they also present challenges in terms of business competitiveness, sensitivity to economic fluctuations, and stability.
As Kentucky continues to navigate its tax policy landscape, striking the right balance between occupational taxes and exploring other revenue sources is crucial to the state’s vitality. Various revenue sources have the opportunity to provide a balanced approach to funding local government, as opposed to needing to rely solely on limited ways from which to raise revenue, and in a way that is in-line with competitive policies to attract and retain population and businesses. The state must strive to find a sustainable approach that supports its local governments, fosters economic growth, and ensures the well-being of its citizens.
