Business tax break mainly caused ‘tax avoidance’

As Kansas lawmakers look at repealing the pass-through income tax exemption for business, Gov. Sam Brownback and others doggedly stick to their assertion that it has created new business entities. They are correct, but those new businesses overwhelmingly were created to avoid taxes and resulted in little real economic growth.

That’s the conclusion of a unique new economic study released April 25.

But this isn’t just any study. It’s not based on some philosophical reasoning from a think tank or derived from a computer simulation. It is arguably the most real evidence ever assembled on the impact of the Kansas business exemption, because it is based on actual federal income tax returns.

This was possible because the U.S. Treasury Department was one of the authors, along with economists at Indiana University and the University of South Carolina.

The researchers used a sample of 1.7 million federal tax returns, including 255,918 from Kansas. The non-Kansas returns were used to compare behavior of pass-through businesses in Kansas and neighboring states both before and after the income tax cuts.

The study is entitled “The Impact of State Taxes on Pass-Through Businesses: Evidence from the 2012 Kansas Income Tax Reform.” The authors call Kansas “a unique case-study.”

Their conclusion: “The behavior responses were overwhelmingly tax avoidance rather than real supply side response.”

Their evidence suggests that Brownback and supporters of the business pass-through exemption are correct in their assertion that new businesses were formed, but that this occurred mostly because wage earners simply became contract workers.

Evidence shows many of those taxpayers received wages from a business before the tax cut and received contract income from the same company after the tax cut, suggesting “recharacterization of income rather than new economic activity.”

Some other findings of the study:

▪  The tax reform had little effect on location choices of business. The researchers used census migration data from the American Community Survey to estimate migration into and out of Kansas compared to the surrounding states around the time of the policy change. They found no significant change in migration into or out of Kansas in the post-reform period.

▪  The reform had no measurable impact on the number of filers reporting income from S-corporations or partnerships.

▪  The researchers looked at business expenses reported on income taxes to determine how existing businesses were reacting. For example, purchasing equipment to expand and higher wage expenses would suggest a positive response. There are small increases consistent with the possibility that some sole proprietors increased employment. The researchers termed that increase “modest.”

▪  New capital investment decreased after the tax cut, not increased. That strongly suggests no impact.

Removing the pass-through exemption is something the Legislature intends to do, despite the protests of Brownback. This study not only hammers the last nail in the coffin of the business growth argument; it lowers the coffin into the ground and covers it with dirt.

This story was originally published May 5, 2017 at 5:02 AM with the headline "Business tax break mainly caused ‘tax avoidance’."