Kentucky legislators are contemplating numerous gross sales and property tax modifications this legislative session as a part of H.B. 360, a invoice that handed the Home on March eighth with a committee substitute and the Senate on March thirteenth with a Senate committee substitute. The invoice is prone to head to a convention committee that may resolve variations between the Home- and Senate-passed variations, as has been achieved in previous classes. Whereas a few of the modifications being thought-about—corresponding to eradicating further classes of tangible private property from taxation—are a step in the precise course, numerous proposed gross sales tax modifications might make Kentucky’s state tax panorama significantly extra burdensome for producers and different companies.
Most notably, the Senate-passed model comprises a regarding provision that might jeopardize Kentucky’s gross sales tax exemption for manufacturing provides. For background, the Kentucky Supreme Courtroom, in its December 2022 determination in Century Aluminum of Kentucky, GP v. Division of Income, held that industrial provides consumed inside the manufacturing or industrial course of inside a 12 months are gross sales tax-exempt when they’re bought once more sooner or later, not handled as taxable restore elements.
The Senate committee substitute to H.B. 360, nonetheless, comprises a provision specifying that the Century Aluminum courtroom ruling shall apply solely to that firm and just for dates between November 2010 and Might 2015. This may successfully stop the Courtroom’s interpretation of the legislation associated to the provides exemption from making use of to different corporations or present purchases, opening the door for the Division of Income to implement an excessively broad definition of taxable restore elements that features objects consumed inside the manufacturing course of. Such an interpretation might sharply enhance the price of manufacturing for a lot of Kentucky companies, which might pressure them to boost their costs, scale back prices (corresponding to by shedding staff or canceling deliberate investments), or go away Kentucky for states that keep extra acceptable gross sales tax exemptions for these and different enterprise inputs.
Beneath a correctly designed retail gross sales tax construction, the gross sales tax ought to apply to remaining private consumption solely, to not enterprise inputs. Manufacturing and industrial provides are fairly clearly enterprise inputs as a result of they’re immediately consumed within the manufacturing course of, however many economists would likewise contemplate restore elements—presently taxable in Kentucky—to be enterprise inputs that should be exempt.
Taxing enterprise inputs—particularly these which might be a direct part of the ultimate product, as manufacturing and industrial provides are—raises the prices of manufacturing and results in economically dangerous tax pyramiding, the place taxes are embedded in the price of items offered a number of instances over, resulting in a tax on a tax when the ultimate retail gross sales tax is collected from the patron.
At a minimal, Kentucky legislators ought to enable the Kentucky Supreme Courtroom’s Century Aluminum determination to face. Past that, Kentucky legislators ought to rethink the proposed therapy of assorted enterprise inputs in H.B. 360 in addition to the present therapy below current legislation.
Each the Home- and Senate-passed variations of H.B. 360 would take away advertising providers from the gross sales tax base, which is a step in the precise course, as advertising providers are one other type of enterprise enter. Each variations of the invoice take a step within the flawed course, nonetheless, by increasing the definition of taxable telemarketing providers to an excessively broad definition that features some digital promoting, together with text- and social media-based communications.
Since gross sales taxes—together with Kentucky’s—are typically destination-sourced, the tax is imposed on the corporate benefiting from the web advertising, which means it falls on Kentucky companies inserting social media adverts wherever, not on companies wherever that publicize through social media in Kentucky. Whereas that is already the case for telemarketing below present legislation, the proposal dramatically expands the definition of taxable telemarketing into areas prone to be extra important for Kentucky companies in competitors with out-of-state companies.
The very best answer can be to take away advertising and telemarketing providers from the gross sales tax base totally, because the inclusion of those providers within the gross sales tax base places Kentucky companies at a aggressive drawback in comparison with out-of-state rivals. And Kentucky actually shouldn’t increase its base to tax extra promoting, which is nearly invariably exempted in different states.
In actual fact, Kentucky ought to transcend that by reversing the provisions inside H.B. 8, enacted in 2022, that broadened the gross sales tax base to incorporate further enterprise inputs. Whereas H.B. 8’s earnings tax reductions and broadening of the gross sales tax base to further client purchases are examples of excellent tax coverage, the legislation’s broadening of the gross sales tax base to providers bought primarily by companies was a less-than-ideal coverage determination. Government recruitment providers, lobbying providers, nonresidential safety system monitoring providers, janitorial providers, linen provide providers, social occasion planning providers, and house rental providers, to call a number of, shouldn’t be taxable when bought in a business-to-business context, as these too result in gross sales taxes being handed alongside to remaining shoppers in a nontransparent method.
Notably, the Home model of the invoice (however not the Senate model) would exempt further classes of tangible and intangible private property from the property tax base, in line with Tax Basis suggestions. Farm implements and farm equipment, livestock, sure automobiles, and laptop software program are among the many types of tangible private property that might not be topic to taxation. Ideally, property taxes ought to prolong to actual property—together with land and constructions—however not tangible or intangible property. Taxing non-real property penalizes capital funding in Kentucky, causes financial distortions, and creates a posh, nonneutral tax construction. It ought to be averted.
As remaining negotiations happen between the Home and Senate, legislators ought to keep away from adopting new insurance policies that might jeopardize Kentucky’s enterprise tax competitiveness. Kentucky took nice strides to enhance tax competitiveness with the earnings tax-reducing provisions in H.B. 8, however a few of that progress could possibly be negated by the applying of the gross sales tax to broad new classes of enterprise inputs, together with numerous varieties of manufacturing and industrial provides, sure digital promoting providers, and others.