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Brownback: Kansas’ budget problems will be short-lived Brownback betting tax cuts lure business to Kansas

  • Kansas City Star and The Wichita Eagle
  • Published Saturday, Jan. 12, 2013, at 7:37 p.m.
  • Updated Wednesday, Feb. 26, 2014, at 7:23 p.m.

Third in a series

The Eagle and the Kansas City Star are collaborating on a series of stories about Gov. Sam Brownback’s remaking of Kansas government. This is the final installment.

Read earlier installments attached to this story at Kansas.com.

Part 1: Bold agenda makes the state a proving ground for conservative theory.

Part 2: How the governor’s policies affect the poor.

Kansas Gov. Sam Brownback is shaking the state’s money tree.

Starting New Year’s Day, his bold tax cuts began showering millions of dollars onto Kansas workers, investors and business owners.

The promised payoff: more jobs as a stronger state economy blooms.

The tradeoff: less money in state coffers.

Budget shortfalls triggered by the new tax law almost certainly mean more spending cuts ahead for a state that already has tightened purse strings at some Kansans’ expense.

Brownback has acknowledged the budget gap but hasn’t said specifically how he’ll fix it.

Many will be listening for a solution when the Republican governor delivers his State of the State address on Tuesday.

Brownback has said the state needs to make do with less revenue.

“We’re going to be proposing a two-year budget to show here’s how we can make it through this period of time,” he told the Wichita Metro Chamber of Commerce in December.

But he also says the state’s budget problems will be short-lived. Growth – fueled by a tax-cut-induced surge in Kansas business – will fill state pockets of the future.

Indeed, William McBride, the chief economist of the Tax Foundation, argued in a recent paper that tax cuts intended to spur growth actually work “sooner than previously thought, such as within the first few years” of taking effect.

Other economists, however, doubt that state tax changes – even as bold as Brownback’s – can have much impact on a state’s economy. Some question whether the state’s new but untried tax exemption for some businesses will work out as planned.

If the tax plan fails, they contend, Kansans will be a stunted state less able to educate its children, provide for public safety and care for the poor.

“Kansas will hit a wall relatively quickly,” said economist John Wong, who worked on official state revenue forecasts until 2010.

It’s a multibillion-dollar experiment in how to boost the state’s economy and finance its government.

“It’s a shame there’s not a way to test this thing,” said certified public accountant Scott McRuer in Kansas City. “Hopefully, they’re right.”

Big breaks

The idea is that taxes get in the way of economic growth and jobs. And Topeka delivered two big tax breaks that kicked in New Year’s Day.

The biggest slashed tax rates on Kansans’ personal income. The state’s highest tax rate fell to 4.9 percent from 6.45 percent for couples earning $60,000 or more.

A higher standard deduction means Kansas won’t tax the first $9,000 of earnings, up substantially from before.

Kansans with adjusted gross income between $25,000 and $50,000 would save an average of $217.63 on their taxes. Those between $50,000 and $75,000 would save $533.66, a state estimate showed.

The state also stopped collecting taxes on the profits of about 191,000 businesses that experts call pass-through businesses.

These companies – many of them with “LLC” at the end of their names instead of “Inc.” or “Corp.” – didn’t pay state taxes under the old law. Instead, the tax bills “passed through” to their owners, who counted the companies’ profits as personal income for tax purposes.

Now, even the owners are off the hook. Traditional corporations, however, still will pay Kansas income taxes.

The idea is that zero tax on the profits of pass-through companies will get more Kansans to start businesses. And pass-through companies in other states will move to Kansas to enjoy tax-free profits. Both mean more jobs for Kansans, advocates say.

It’s a bold idea tried by no other state, though North Carolina last year exempted the first $50,000 of pass-through business profits from its state income tax.

Combined, the tax cuts mean Kansas will collect roughly $800 million less from Kansans each year, with the difference increasing over the years.

“If you’re interested in creating jobs, that’s the type of significant tax change that would be required,” said Donald Bruce, an economist at the University of Tennessee who studies state taxes and economic development.

But economists say it matters greatly how a state hands out tax breaks and makes up for its lost revenue. Spending cuts – especially in education and infrastructure like roads and bridges – can weigh heavily on an economy, too.

“It would help in jobs and growth, but you create other problems like revenue adequacy,” Bruce said of Kansas’ new tax code.

Big gaps

New businesses and new hires are only half the math behind Kansas’ tax cuts. Less revenue means less government.

The math starts to change with the budget year that begins July 1.

Forecasts show the Kansas general fund collecting $5.46 billion for the state’s 2014 budget. But the state is spending $6.2 billion now.

Topeka faces a budget shortfall of more than $700 million.

“Somehow that gap’s got to be closed. And that’s not going to be easy,” said Duane Goossen, the former Kansas budget director who now follows state finances as vice president for fiscal and health policy at the Kansas Health Institute.

The Kansas Legislative Research Department last May compared expected spending with predicted revenues under the new tax code for the next six years. And the forecast revenues persistently fell short of budget needs.

Backers of the tax cuts are doing different math. They’re counting thousands of new jobs they say the tax changes will spawn in Kansas.

Number crunchers at the Kansas Department of Revenue used an economic model to “score” how many jobs the new tax code will create. They predict 22,900 new jobs by June 2020, jobs that wouldn’t exist but for the tax cuts.

It also means $2 billion in additional income for Kansans and nearly 36,000 more Kansans, according to the model.

Another model predicted more job growth, and sooner.

The tax changes should deliver 33,430 additional jobs in Kansas by mid-2018, according to the Beacon Hill Institute at Suffolk University in Boston. Its analysis appeared in a report last July from the Kansas Policy Institute in Wichita, which supported the tax cuts.

“You’re putting $800 million back into the private economy. People have that money to spend,” said Paul Bachman, an economist at Beacon Hill.

Slashing state taxes also gives Kansans incentives to work, save and invest, Bachman said.

Brownback’s backers say much of the economic boost will come from new business.

Kansas will know the tax cuts worked when tax filings show the state has more companies, said Nick Jordan, the state’s revenue secretary.

Economically, counting new businesses makes sense.

A study by the Ewing Marion Kauffman Foundation showed that new and young businesses account for essentially all of the net job growth in the nation’s economy.

“New business creation is extremely important to economic growth,” Jordan said. “That’s why we’ll be watching that.”

Will they come?

Missouri business owners are looking at Kansas.

“Anyone in their right mind is thinking about it,” said Jeff Roe, whose Republican political strategy firm is based in Kansas City. He’s relying on his accountant to sort through the pros and cons of a move.

So far, experts are holding up stop signs at the state line.

Scott Lindstrom, an attorney advising clients at Polsinelli Shughart P.C., said Kansas needs to fix “gaps” in its new pass-through business tax law to keep the promise that the income won’t face taxes.

Jordan promised a “technical fix” from the Legislature.

Missouri officials have highlighted this and other issues in an effort to close off the exits. And some Missouri lawmakers have pushed for business tax changes to compete with the Kansas exemption.

Lindstrom said businesses are worried that other taxes will go up, offsetting the benefits of moving.

Jordan said other tax hikes are on the table.

Ultimately, business owners say they don’t make key decisions such as where to operate and live based solely on taxes. Other things matter, too.

“If you like where your kids go to school, and if you like your neighbors and like where you work, maybe it’s not worth 6 percent of your income to relocate,” said McRuer, the Kansas City accountant.

Winners and losers

Kansans Claude Aldridge and Jason Reid formed a new business, Trellie LLC, early last year as a pass-through Kansas company. They launched its first product last week – a device to alert its user that the cellphone buried in her purse is ringing.

Although the men knew about the Kansas tax break, they converted Trellie into a traditional corporation last summer that will have to pay state taxes.

Capital was more important than taxes. Aldridge said raising money from investors is “nice and neat” as a traditional corporation but more difficult as an LLC.

This week marks a key moment for another Kansas company. KickAss Candy, made in Lenexa, begins widespread distribution in Canada on Tuesday.

If things work out, co-founder Todd Stutzman said, the pass-through business could hire six more people.

“We expect it to be a blow-out year,” Stutzman said.

Aldridge said his company, Trellie, could see four to six new jobs, too, depending on how well its device sells.

The thing economists don’t understand is why Kansas has decided to treat the companies differently. Trellie will pay taxes, because it’s a traditional corporation. KickAss Candy won’t, because it’s a pass-through business.

“You’re choosing some winners and losers without really knowing which of those categories truly contribute more to the economy,” said Bruce, at the University of Tennessee.

Jordan said the state targeted pass-through companies because they are mostly the small businesses likely to create jobs. He said many tax breaks already target traditional corporations that tend to be larger.

Kansas’ new tax code also may make life a bit harder for many business owners who are just starting out, according to accountants.

New businesses typically lose money for a year or more, which is why entrepreneurs and their spouses tend to keep their day jobs until the business gets on its feet.

Under the old Kansas tax law, pass-through business owners were able to deduct these business losses from their other income. Their tax savings could help finance the business.

Not so under the new Kansas tax code.

“The good news is if you have (business) income – no tax on it. But if you have a loss – no deduction for that,” said Julie Welch, a partner at the accounting firm Meara Welch Browne PC in Kansas City.

The new tax exemption may still motivate entrepreneurs.

“We’re not talking about (entrepreneurs) succeeding, we’re talking about them deciding to try,” said Jarrett Homann, a Shawnee resident whose newest business, www.soldierup.net, debuts in April.

For some businesses, any savings from the tax cut won’t lead to immediate investment in people or plant.

It’s more about trying to catch up, said Gary Unruh, who runs Unruh Automotive LLC, a family-owned chain of four repair shops that has operated in Wichita since 1947.

Unruh said the tax cut will help him keep pace with the rising cost of doing business, including federal regulations that have increased the expense of disposing of old tires and used oil.

“Pocketing extra income or buying new equipment, that’s not happening,” he said of the tax cut. “I don’t know that it is going to add people or add equipment or anything like that.”

Will it be enough?

To Brownback, Kansas had no choice but to cut taxes and to cut them boldly.

The state has been losing out to other states economically, Brownback has said, so he designed his tax cuts to stir small employers into action.

And he is counting on business growth to support state government. Like the new businesses, he contends, the tax revenues will come.

“This policy is designed to bring economic growth, and all areas of the budget benefit if the growth comes,” Jordan said. “We’ll probably be in a year or maybe two years of tight budgets, but we’re going to see some growth come and all boats will start floating a little higher.”

The idea that tax cuts can pay for themselves stems from the federal tax reforms under President Ronald Reagan in 1986. Economist Arthur Laffer backed Reagan’s tax cuts and has actively backed Brownback’s Kansas tax cuts.

Laffer’s contribution in the Reagan debate was the idea that heavy taxes cut into economic activity so much that they end up costing tax revenue. Cut the tax, he reasoned, and the economic boom is so big that even the lower tax rate brings in more money than the stifling high tax rates did.

His idea was dubbed the Laffer Curve.

Bachman said Kansas tax rates simply aren’t high enough to have that much impact on economic behavior. In short, there’s no Laffer Curve here. Kansas taxes were already so low that cuts wouldn’t make enough difference.

“You’re still losing revenue,” Bachman said.

Beacon Hill’s 2018 forecast shows Kansas with 11 percent less revenue than the state would see without the tax cuts, as forecast by the Kansas Legislature Research Department.

A smaller general fund would mean a smaller state government.

Next steps

The key question for economists – and Kansans – is how the state will close the projected budget gap.

The tax cuts already leave some Kansans worse off.

Gone is the partial rebate Kansas had been giving poor residents for sales taxes they paid when buying food. Also repealed were tax credits for low-income homeowners who are elderly or disabled.

One state analysis found the new law will cost nearly 280,000 low-income Kansans more than $35.7 million in state refunds.

Most of the tax cuts, the analysis showed, will go to higher-income Kansans.

Residents reporting income of more than $100,000 will save $428 million in state taxes as a group, or more than 60 percent of the benefits expected.

Economists are watching how Kansas deals with its budget gap because state spending can benefit the economy, too.

“There’s a whole lot more that state governments can do to expand an economy on the spending side,” said Robert Tannenwald, a former economist at the Federal Reserve Bank of Boston and now with the Heller School at Brandeis University.

For example, preschool programs deliver tenfold returns compared with the state’s costs, he said. Higher education and skills programs such as vocational training help to attract businesses by improving the local labor force.

Business owners want to see good roads, utilities and other economic infrastructure their companies need. And they’re as interested as homeowners in fire and police protection.

Brownback has vowed to keep Kansas education “fully funded,” ensure public safety and provide medical care for the poor.

The pledge doesn’t leave much room for cuts. Goossen said education and health care consume about 80 cents of every dollar in the general fund.

And a Shawnee County District Court ruling said Friday that the state needs to spend more money on its schools. The state plans to appeal the ruling.

All of this increases the pressure to cut spending everywhere else.

“The bottom line is there’s going to be a huge hole,” said Wong, who now teaches economics at the University of North Texas. “They’ll cut across the board.”

One number being bantered about is an 8 percent across-the-board cut, said Bernie Koch, head of the Kansas Economic Progress Council that opposed the tax changes. Koch said such talk may be leverage to get a higher sales tax or other revenue through the Legislature.

Brownback’s budget director has said the administration plans to seek a continuation of the 0.6-cent sales tax that is set to expire next July.

Brownback, meanwhile, has said he’s not finished cutting taxes. He wants to do for all Kansas taxpayers what he’s already done for owners of those pass-through companies.

“I want to ride the income tax rates on down, keep this glide path going to zero that we’re on, to get to a pro-growth position,” Brownback told the Wichita chamber last month.

Reach Mark Davis at 816-234-4372 or mdavis@kcstar.com. Reach Dion Lefler at 785-296-3006 or dlefler@wichitaeagle.com.

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