New tax law faces range of reality checks

Will the economy grow? Will legislators approve major spending cuts?

0 | Budget, Legislature

Gov. Sam Brownback, seated right, attended a recent business conference in Overland Park to describe the benefits of the tax cuts he signed into law in May. At the podium is Gary Allerheiligen, former president of the Kansas Society of CPAs. The law, which becomes effective for tax year 2013, is expected to eliminate income tax liability for about 190,000 business owners and reduce the state income tax obligations of more than 1 million Kansas filers.

Gov. Sam Brownback, seated right, attended a recent business conference in Overland Park to describe the benefits of the tax cuts he signed into law in May. At the podium is Gary Allerheiligen, former president of the Kansas Society of CPAs. The law, which becomes effective for tax year 2013, is expected to eliminate income tax liability for about 190,000 business owners and reduce the state income tax obligations of more than 1 million Kansas filers.

— Kansas officials haven’t kept a running tally of state tax cuts versus tax increases, but two little-circulated reports prepared in recent years show that since 1995, the dollar values of the tax cuts have outpaced the increases by more than three to one, or about $15.6 billion in tax reductions versus about $4.6 billion in tax increases. And that was before the biggest tax cut in state history was signed into law in May.

The first report was prepared for Gov. Mark Parkinson, a Democrat. Nonpartisan legislative researchers prepared the second report. Neither report was published on letterhead or widely distributed, so the audience for each has been relatively small.

A timeline of changes in state tax policy over the past 25 years prepared by KHI News Service shows that since 1987, lawmakers more often have agreed to tax cuts, with increases the exceptions driven by downturns in the economy coupled with revenues lost to earlier tax rollbacks. The most notable tax increases were in 2002 and 2010, with the biggest years for tax cuts being 1998 and 2012.

Using conventional projection methods, the new tax law signed by Gov. Sam Brownback in May is expected to reduce state revenues between $4.5 billion and $4.7 billion over five years. Brownback officials, citing “dynamic” projections that assume healthy growth in the economy, predict the losses to the treasury will be less but still quite significant. They also project the tax cuts will mean 22,900 additional jobs, which will benefit local governments and school districts by growing the tax base.

Best-case scenario

The best-case scenario, prepared by the conservative Kansas Policy Institute, is that a one-time cut in state spending of 8.5 percent — or about $500 million from the state general fund — would keep the budget balanced as required by the Kansas Constitution. That would be a record one-year cut in state spending, though reductions of that order might have happened in fiscal 2010 without about $1 billion in federal stimulus relief that helped prop up the Kansas budget.

Despite the anticipated losses to the treasury, Brownback has pledged to adequately fund “core” services such as schools and public safety. Critics say they don’t know how that will be possible given the magnitude of the tax cuts, which are the largest in state history, and the fact the biggest single category of state spending is for education.

“I think the schools is where it hits first,” said Joan Wagnon, chairperson of the Kansas Democratic Party and a former secretary of revenue.

Video

Nick Jordan on the 2012 Kansas Tax Cut

Nick Jordan, Kansas secretary of revenue, explains how he thinks the tax cut plan signed by Gov. Sam Brownback will benefit Kansas.

Nick Jordan, Kansas secretary of revenue, explains how he thinks the tax cut plan signed by Gov. Sam Brownback will benefit Kansas.

Watch Video

Brownback officials declined to comment about the details of the budget they are preparing for the coming fiscal year, but various agency officials have confirmed privately that they’ve been instructed to prepare spending plans that cut 10 percent or more.

“While protecting funding for K-12 schools, social services and public safety, the governor asked agencies to prioritize their spending in a manner that provides a reduction in expenditures,” said Sherriene Jones-Sontag, Brownback’s chief spokesperson. “There are opportunities to restructure, retool and repurpose how we provide services to our citizens that will allow for significant savings while improving the delivery of those services.”

Reality checks

What seems clear is that the long-running philosophical divide between conservative Republicans — most of whom have signed pledges to never increase taxes — and Democrats and moderate Republicans — who argue that some basic government services are underfunded — soon is about to get a series of reality checks. Voters in November or more likely in 2014 or later presumably will be the ultimate arbiters of the results.

For one, there will be a test of how much Kansans value government services as currently delivered and whether legislators are prepared to go along with major cuts in state spending. That’s an open question even for some staunch conservatives.

Video

Joan Wagnon on the 2012 Kansas Tax Cut

Joan Wagnon, former Kansas Secretary of Revenue and current chair of the state Democratic Party, outlines why she thinks the tax cut plan signed by Gov. Sam Brownback will be bad for Kansas.

Joan Wagnon, former Kansas Secretary of Revenue and current chair of the state Democratic Party, outlines why she thinks the tax cut plan signed by Gov. Sam Brownback will be bad for Kansas.

Watch Video

“I don’t know if we can,” said Sen. Les Donovan, a Wichita Republican who heads the Senate Taxation Committee and is running for Senate president. “I don’t know if people are ready to give up some of the services.”

Also facing a possible test is the Legislature’s willingness to defy or comply with whatever the Kansas Supreme Court rules in the school finance lawsuit currently before it. Lawyers for the 54 school districts suing the state say more than $500 million in education spending has been cut in recent years and that the law requires about 20 percent more than currently is spent on base state aid per pupil. The court could order hundreds of millions in additional expenditures. Given current budget projections, that would be impossible without a tax increase.

School funding and the court

“What is the Supreme Court in its almighty wisdom going to tell us that we need to do on school finance?” Donovan asked. “Cough up another half billion dollars? Do we (the Legislature) challenge them and defy their ruling? I think there’s a good chance that might happen.”

Also facing a fresh test is the theory of supply-side economics and the Laffer Curve, whose staunchest adherents believe that tax cuts always produce economic growth. The governor has said the tax cuts will be a “shot of adrenaline to the heart” of the economy that will create jobs. That has been his chief argument in supporting the rollback of income tax rates for about 1 million taxpayers and the elimination of income taxes for about 190,000 business owners.

But supply-side theory remains just that. When tested under President Ronald Reagan, Howard Baker dubbed it a “riverboat gamble” and the senior George Bush called it “voodoo economics.” Google chief economist Hal Varian said: "The Laffer analysis demonstrates both good and bad economic theory. The bad theory is that inference that because the Laffer effect can occur it does occur.”

Balance and fairness

Also being tested are long-standing Kansas notions of fairness and balance in the tax structure. Among those whose pocketbooks are expected to directly suffer from the new tax law, according to an analysis by the Kansas Department of Revenue, are about 288,000 of the state’s poorest people, mostly due to the reduction or elimination of tax credits.

With respect to balance, critics say reduction in income taxes will force greater reliance on sales and property taxes, both of which are more regressive — that is, they have a greater impact on people with less income — than taxes on income. They also point to the fact that thousands of business owners will be exempted from income tax, essentially leaving only wage earners with income tax liabilities.

“I believe most Americans, most Kansans, would say that a regressive tax is not fair,” said Martin Dickinson, a University of Kansas law professor and tax specialist who has been an outspoken critic of the new law.

Several critics said they considered it particularly unfair that income from so-called “pass-through” enterprises — Subchapter S corporations, limited liability partnerships, sole proprietorships and trusts — will be exempted from state income tax once the new rules become effective next year. That means, for example, that a physician in an LLC would have no state income tax to pay but the nurses and lab techs employed by the doctor would. Farm income also will be exempt from the income tax.

Who pays

Racquel Alexander, a former KU business professor, authored a 2010 report commissioned by the pro-business Kansas, Inc. She said she objected to the new law for various reasons. For one, she said, her research showed that Kansas had a generally good business climate and that where the state compared poorly to others in the region was relatively high local taxes, not state taxes. Cutting state income taxes, she predicted, would continue the shift in the tax burden from state to local governments.

She said she also was dismayed by the unfairness of taxing wage earners while exempting people whose business dealings were more sophisticated or lucrative.

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Kansas Tax Timeline

An interactive glance at the past 25 years of Kansas tax history. Use the arrows to move back and forth through the years. Use the sidebar to scroll up and down through each year's content.

“The person cleaning Allen Fieldhouse will have to pay income tax,” said Alexander, who now teaches at Washington and Lee University in Virginia. “But the person who makes the most money at the University of Kansas (basketball coach Bill Self) just had their (Kansas income) taxes knocked down 100 percent.”

Brownback officials have repeatedly said that the law’s exemptions will mostly benefit the state’s small business owners, which is true in the sense that the majority of Kansas businesses are small. But the exemption makes no distinction for size, which means virtually any closely held business could qualify and potentially benefit.

Wichita-based Koch Industries, which has a number of large LLCs as subsidiaries, including Georgia-Pacific, could use the law to exempt many of its income-producing holdings.

Koch is one of the world’s largest conglomerates with annual revenue of about $100 billion, according to Forbes. Owners Charles and David Koch helped launch Americans for Prosperity, the anti-tax group that has been a major donor to conservative Republican candidates, including Brownback and dozens of Kansas legislators. The brothers’ support for conservative politicians is well-known.

The fact that the law also could benefit the state’s largest business is a sensitive point for Brownback officials and one they do not willingly raise.

“I don't know the structure of Koch Industries. We didn't write this for them. We wrote this for small business,” said Revenue Secretary Nick Jordan. “We’re hoping everyone gains from the bill.”

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