Tax Analysts Blog

What Went Wrong in Kansas? Maybe Nothing

Posted on Jul 16, 2014

Kansas is collecting hundreds of millions of dollars less than its budgeted projections. That number has a lot of people in a lot of states wondering what happened.

Here is why answering that question is important. In 2012 Kansas enacted what Nick Johnson at the Center on Budget and Policy Priorities called the largest tax cut ever. The state repealed its top individual income tax bracket of 6.45 percent and lowered its other two brackets of 3.5 percent and 6.25 percent to 3 percent and 4.9 percent, respectively. More significantly, the state exempted from taxation all income earned by passthrough entities.

Everybody knew the tax cuts would cost money; the fiscal note for 2014 estimated that the cuts would cost $800 million in 2014. But the tax cut package was sold as a panacea for all that ails the Kansas economy. Gov. Sam Brownback (R) predicted that the tax cuts would spur economic development, investment, and a lot of job creation. Indeed, Arthur Laffer, who developed the Kansas tax cut plan, practically guaranteed success. But it didn't work. The Kansas economy is stagnating, the deficit has grown, and the state's bond ratings have been embarrassingly downgraded.

The tax cuts' failure to magically transform Kansas has prompted much discussion. Michael Leachman and Chris Mai at the CBPP wrote a paper skewering the Kansas experiment, saying the tax cuts cost money, the benefits inured to the rich, and the economy took a hit because of less government spending. They say that as a result, the state's economy remains in the doldrums. The CBPP opposed the Kansas tax cuts from the beginning, and Leachman and Mai's paper is one big "I told you so." Even The Wall Street Journal wrote a piece noting that the Kansas failure has caused conservative politicians in other states to rethink significant tax cuts.

Conservatives in Kansas admit that the tax cuts did not result in the expected economic boost. Some have blamed the failure on President Obama (no, really). And some conservatives say the tax cuts did not go far enough to significantly stimulate the economy, which seems like a silly argument because the tax cuts were huge.

I think it's too early to tell if the Kansas experiment was a failure. It may be that the tax cuts have not been given enough time, because tax changes rarely have immediate consequences at the state level. I have often pointed out that tax increases almost never harm the economy in the short run. Neither businesses nor people move immediately after a tax increase. Corporations don't sell their plants and equipment and move their workforce on short notice. And people don't sell their houses, quit their country clubs, or take their kids out of school because the income tax rate goes up. I believe that increasing tax burdens harms economic development in the long run -- it doesn't happen overnight.

Why would tax cuts be any different? Individual tax cuts will not cause a flood of new residents in the short run, and the ill-advised changes to exempt passthrough income will not cause budding entrepreneurs to immediately move to Lawrence or Topeka. But I do think those kinds of tax changes will have positive long-term effects on the overall economy.

So what went wrong in Kansas? I think Brownback and Laffer oversold the short-term benefits of substantial tax cuts. Those benefits did not materialize. But it may be too early to know if the Kansas experiment is a long-term failure. Only time will tell if the CBPP is right.

***This post is an excerpt of an article that first appeared in State Tax Notes.***

Read Comments (4)

emsig beobachterJul 15, 2014

If taxes, which are the price of public services, are that important we would
all be living in the lowest tax jurisdiction in the country. If prices were all
that important we'd all be dining out at fast food restaurants, driving Fits
and similar cars, and living in yurts, etc.

The question that appears to have been unasked is: what are they giving up? I
don't see businesses, especially manufacturing, flocking to places where the
transportation infrastructure is crumbling, roads are not maintained, etc. If
one were to ascribe to the Rational Expectations school of economic thought,
they would see that tax cuts today can result in tax increases later on. If a
business were to make future profit projections, possible future tax increases
can reduce the profit potential of Kansas.

The literature on the impact of taxes and economic development among the states
is conflicting. This is not surprising because there are many factors other
than taxes that influence business decisions an residential location decisions.
Further, exempting pass-through income from taxation may increase entrepreneurs
to invest in new businesses but those businesses need not be in Kansas. THE
ECONOMY SUCH AS KANSAS. As usual, those who profess to have all the answers,
often don't know what the questions are.

P.S. I just thought of a way Kansas can reduce costs and not do harm to their
society. Fire all science teachers from secondary schools and replace them with
those who have little opportunity costs -- creation science teachers.

Plus ca change, plus ca meme chose!!!

Michael KarlinJul 16, 2014

Here's the problem: Neither Republican nor Democratic electorates wish to pay
for the services they want. The Republicans may wish for a lower level of
services (by which I mean a lower level of services for anyone other than
themselves) and the Democrats may wish for a higher level of services (at
someone else's expense), but the end result is going to be a gap between what
people want and what they are willing to pay for. And that gap cannot, human
nature being what it is, be bridged.

Politicians may not think about the problem this way, but they certainly base
their actions on an intuitive understanding of it. And so the debate proceeds
at an entirely superficial level and one that is quite contrary to common sense.

What is needed in every state is a measured debate in which the state
constructs a budget, family style, of what it wants and what it may reasonably
expect its taxpayers to contribute. Then the state must adjust its wants and
its taxpayer contributions to the reality of the situation on the ground. This
is a process that needs to be done on a multi-year basis, because some of the
things we need and want, such as infrastructure projects and a more educated
workforce require multi-year commitments.

Anyone out there think that this process was tried in Kansas? Or that it has
been or will be anywhere else? I think not. In Kansas, we got an
analysis-free, seat of the pants set of tax cuts with little or no basis for
expecting a positive outcome. In California, we simply slammed the wealthy
with the highest state tax rates in the nation and ignored all the people and
investment who will leave (possibly measurable) and all the people and
investment who won't come (much less easy to measure) in exchange for a short
term fix for problems we refuse to address in a systematic way. In both cases,
the solutions had immense popular appeal, but both are equally thoughtless.

I have no expectation that reason will prevail in either state.

emsig beobachterJul 17, 2014

It's too bad Gov. Brownback did not cast a wider net when seeking economic
advice. Had he asked a group of ore mainstream economists, either left-leaning
or right leaning, he would have been told that tax cuts, while somewhat
efficacious for a large, more of less closed economy whose debts are
denominated in its own currency and does not need to balance its budget ever,
much less then on an annual basis, cannot be replicated in a small open economy
such as Kansas. I'll bet that if the Governor had really pressed Laffer, Laffer
would have agreed.

The Kansas legislature had to cut expenditures in response to the tax cuts,
which, even in a small open economy such as Kansas can initially cause a
localized small economic downturn. This initial downturn may be reversed but I
doubt that businesses will flock to a state where infrastructure is crumbling,
school performance suffers, etc. A rational expectations adherent would assume
that tax cuts now can lead to tax hikes in the future. Furthermore, state and
local governments are in a form of monopolistic competition with each other.
They can get a lot of business if they cut their price (taxes)and none of their
competitors cut their taxes. The converse is also true. However it is doubtful
that Kansas' competitors will not cut their taxes in response to Kansas. Thus
you are correct -- high taxes, relative to others, can harm the economy but tax
cuts may not benefit the economy very much.

I'm going to take a nap now. Responding to this post has used up my few
remaining working brain cells.

edmund dantesJul 21, 2014

Kansas is just trying to emulate low-tax Texas, which has experienced economic
growth much higher than the rest of the country. I agree with Mr. Brunori, it
is too soon to tell how well the strategy will work long term.

The problem with creating a state "family budget" and then taxing to the budget
is that it isn't only about infrastructure, you'll need line items for welfare,
food stamps, all manner of support for favored constituencies, and pension
payments to former employees. That last one is the real killer. Once you
itemize that budget, everyone will wonder, do we really have to spend this
much? How can we change the incentives to bring this spending down? Because
if we do, we can bring down our tax obligations to match. But no one actually
wants that debate.

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