Barry Ritholtz: Supply-side test is failing Kansas

Every year, right after the April 15 tax deadline, the U.S. Census releases its data on the prior year’s state tax collections. It reveals a good deal about the state of local economies, economic trends and results of specific policies. In broad terms, the financial fortunes of the states are improving. Some fascinating data points:

▪  North Dakota had the biggest percentage increase in revenue, almost 16 percent, as drillers and workers flocked to the region to join the fracking boom.

▪  Alaska had the largest decreases in revenue, 34 percent, as royalties from oil and gas leases plummeted.

▪  Kansas also had a big decline in revenue, falling 3.8 percent, from $7.6 billion to $7.3 billion.

Let’s focus on Kansas, because of all the states its tax data reflects conscious policy choices as opposed to larger economic forces.

Under the leadership of Gov. Sam Brownback, the state radically cut income taxes on corporations and individuals. Going on the assumption that this would generate a burst of economic growth and higher tax revenue, no alternative sources of revenue were put into place. Similarly, the state failed to lower spending.

Alas, reality trumps theory. As we have seen almost every time this thesis has been put into practice, it fails. The tax cuts don’t magically kick the economy into higher gear and the government ends up short of money. Remember former President George W. Bush and his tax cuts? Same deal.

Much of the intellectual heft for this theory can be traced to Arthur Laffer, a former member of President Reagan’s Economic Policy Advisory Board who is sometimes referred to as the father of supply-side economics.

Excessively high tax rates can cause economic harm. Think about when the Rolling Stones decamped from Britain to France in response to Britain’s 98 percent wealth tax; more recently the band U2 shielded some of its assets by shifting them from Ireland to the Netherlands.

The argument goes that cutting tax rates would have led these big earners to stay, and that capturing a reduced amount of revenue is better than losing the potential revenue completely.

Nor is anything wrong with the underlying premise of supply-side economics per se: We can increase economic growth by lowering barriers for producers to supply goods and services and make capital investments. A greater supply of goods and services at lower prices benefits all consumers, helping to expand business activity, hiring and spending.

And yet some economic radicals have taken the supply-side theory to absurd places. Perhaps the most radical is Grover Norquist, the promoter of the “Taxpayer Protection Pledge.”

While serving as Kansas’ U.S senator, Brownback signed the pledge, and was a central player behind putting the theory into practice in the state. Unfortunately for Kansas, the real world has a tendency of introducing frictions that theory often ignores. Kansas now is confronting annual budget deficits, severe cuts in education and road maintenance, and credit-rating downgrades.

Ideally, states should be looking for the optimal point where tax rates produce the greatest revenue with the lowest burden. The range includes value choices between somewhat more revenue versus somewhat lower taxes.

Now, after Brownback’s supply-side experiment, Kansas has become a sort of mirror image of the high-tax nation that the wealthy like Mick Jagger and U2 tend to flee.

The bottom line: The results from the economic laboratory known as Kansas are in. Supply-side theory – and Kansans – lost. The only question is whether those like Brownback have learned anything.

This story was originally published April 18, 2015 at 7:03 PM with the headline "Barry Ritholtz: Supply-side test is failing Kansas."