Kentucky cities must adopt a new ordinance each year that sets the city’s real property tax rate. Unless exempted by the Kentucky Constitution, cities must tax real property – buildings and land – located within the municipality. The constitution caps real property rates based on city population, although most cities do not come near the maximum rates.
State law requires cities to calculate the compensating rate – the rate that when applied to the current year’s assessment would produce about the same amount of revenue as the preceding year. The calculation excludes new property added to the tax rolls as well as homestead exemptions. (Kentucky law allows homestead exemptions for age – 65 or older – and disability; however, the amount exempted this year totals only $39,300.)
Cities may adopt the compensating tax rate without having to advertise and conduct a hearing on the matter. If the proposed tax rate exceeds the compensating rate, the city must give notice and conduct a hearing. If the rate set would produce more than 4% more revenue than the compensating rate, voters may recall the portion of the rate above the 4% figure. Statutory timing also makes it nearly impossible to adopt a rate above the 4% tax rate. As a result, the compensating tax rate acts as a de facto cap, and two-thirds of Kentucky cities adopt the compensating rate or lower each year.
Adopting the compensating rate presents a long-term problem: because property values typically increase, the compensating rate must decrease to produce the same amount of tax revenue. For instance, if a city’s real property valuation increased from $10 million in 2019 to $10.5 million in 2020 – a 5% increase – the compensating rate would drop. If the city had a rate of 20 cents/$100 in 2019, the 2020 compensating rate would total 19.048 cents/$100. Even the 4% rate would decrease – 19.809 cents/$100. Over time, the compensating rate formula depresses tax rates and results in a significant loss of potential city revenue.
Property owners may celebrate that city real property tax rates have declined around 20% since 1979. However, cities have relied more on occupational license taxes, insurance premium taxes, and service fees/charges, which are more volatile than property taxes. Without more diverse options, cities will continue to depend on these less predictable revenue streams.