State officials misstated the cause of unexpected drops in tax revenues in April and May, says a policy analyst whose research was cited by the state to dismiss the poor performance as a fluke.
State tax revenues fell $217 million short of projections in May. That puts tax revenues $310 million below estimates for the fiscal year with only one month left.
If the shortfalls are caused by federal tax changes, as the governor and officials with the Department of Revenue say, they should not continue into the next fiscal year.
But if they are caused largely by the state’s tax cuts, as several economists and lawmakers say, the shortfalls may continue and the state may be unable to avoid budget cuts.
Lucy Dadayan, a policy analyst with the Rockefeller Institute of Government, says the revenue department misrepresented her research about state tax revenue and that Kansas could be forced to make cuts in the near future.
In announcing the May shortfall, the department pointed to an April report Dadayan co-authored that said state officials across the country are having trouble accurately forecasting revenues because of uncertainties with the capital gains tax created by the fiscal cliff.
Money managers and high-income earners across the country sold stock at the end of 2012, expecting the federal tax on capital gains to increase because of the fiscal cliff. This boosted income for that tax year and resulted in windfalls for states; now, many states are seeing 2014 revenues drop after the previous year’s inflation.
“Kansas has been affected by this one-time 2013 tax year event. This is evidenced by a 47 percent drop in April and May payments attributed primarily to capital gains,” the Department of Revenue said in its release.
But the report tells a significantly different story for Kansas, one of six states to experience a double-digit percentage decline in personal income tax revenue.
“The large declines in Delaware, Kansas, and North Dakota are mostly attributable to the legislative changes that cut income tax rates as well as restructured tax brackets,” the report states.
Dadayan, a senior policy analyst at the Rockefeller Institute in Albany, N.Y., said the capital gains phenomenon had a bigger impact in other states like California and New York that rely more on non-wage income.
“In Kansas it’s really not of that much importance,” she said in a phone call.
“Of course the fiscal cliff had an impact in almost every state that has income tax. But Kansas is a special case because they had the largest tax cut in their history and the large tax cuts in income tax is the primary cause of the declining revenues,” she said.
Other states cut taxes less dramatically, she added.
The revenue department quoted her research accurately, but by not showing the full context it painted an incomplete picture, Dadayan said.
“Everyone knows that they are just trying to present the information to their advantage. But what can I do? I can’t prevent them from quoting us,” she said with a laugh.
Secretary of Revenue Nick Jordan said the department quoted the report “to show that other states were experiencing the same thing.”
“That’s the quote we used, and that’s why we did it,” he said.
Although he found the Rockefeller Institute’s analysis on capital gains reliable enough to quote, he disputed its analysis on the primary cause for Kansas’ revenue decline.
“I don’t know what they’re basing this on,” Jordan said. “We’re basing it on real numbers. We’re basing it on what we see from actual returns.”
He said that the department always predicted a drop in total revenue because of the tax cuts, but that estimates were off primarily because of capital gains.
“Why we didn’t meet estimates was because of capital gains,” he said. “They’re probably including, ‘Yeah, you cut taxes, and so your actuals aren’t going to be the same’ and we’ve said all along they weren’t going to be the same.”
The state has taken in $685 million less this fiscal year than it had by May 2013, a drop of more than 12 percent. The fiscal year ends in June.
Jordan said the state knew about the capital gains phenomenon and had factored that into its estimates, but had severely underestimated the full impact. The department has blamed the underperformance squarely on that.
The nonpartisan Kansas Legislative Research Department said it cannot say at this time what extent capital gains or other factors played in the shortfalls.
Jordan said he expects a stronger performance in June, and he predicts a bump next tax year because capital gains will normalize. He cautioned against putting too much focus on the past two months.
“It’s better not to look at it month to month and if one month is down to go crazy, because you really need to look at the long-term,” he said.
“I mean look at March. We were $130 million over estimates. I don’t remember anybody ever saying, ‘Yahoo, wahoo, man, this is working great!’
“And then we have two months where we had a federal, national situation that threw us down and it just to me shows how things can just change quickly.
“This is significant, no doubt about it, April and May is significant, but wasn’t $130 million over in March significant?” he said. “But we would agree it’s better to look at long-term.”
The Kansas Legislative Research Department analyzed the state’s budget and revenue factoring in April and May shortfalls at the request of Senate Democrats.
If the state meets its projections for June and the next 12 months, it will be left with an ending balance of $56 million by the end of fiscal year 2015, the analysis said. If revenues continue to drop, the situation will be more dire.
Democrats say the state’s revenue is unlikely to bounce back. They warn that budget cuts may be necessary.
Gov. Sam Brownback dismissed that fear during a trip to Wichita this week.
“We’ll finish this year with several hundred millions of dollars cash on hand so we’re going to be in fine shape,” he said. “We projected a dip. We’ve had good overall performance of our agencies being able to hold back costs, so it’s two sides of the equation.”
Brownback also disputed the notion that Kansas’ shortfalls were self-inflicted and said that it was similar to other states, resulting from the national economy.
Democrats accuse the governor of refusing to face reality.
“We’re headed down a path of fiscal disaster,” said Senate Minority Leader Anthony Hensley, D-Topeka. “It’s always easy to blame it on Washington, D.C., or blame it on Barack Obama. But they’re not taking responsibility for the financial disaster they’ve created through these tax cuts.”
Cuts during recession
The governor has promised that the income tax cuts would spur economic growth.
But Dadayan said Kansas should serve as a cautionary tale to other states.
It was unwise to enact tax cuts while the state and nation are still recovering from the recession, she said.
“At the time when you are fighting to get back to where you were, I mean, cutting the taxes, and cutting so dramatically, is not really the best policy choice,” she said.
“It’s not a sustainable model and eventually they will have to kind of address the imbalance and the most common way to address the imbalance is to cut services.”
Art Hall, a professor of economics at the University of Kansas, defended the tax cuts but said budget cuts probably will be necessary.
“My personal opinion is you’ve got to cut spending in line with cutting taxes,” he said. Hall said lawmakers should have coupled the tax cuts with spending cuts from the beginning and that cuts likely will be necessary.
He said the state needs to wait until growth is further belong to spend at the same levels it did before the cuts.
“Even though I do agree that you’re going to get more growth with better tax policies and better fiscal policies, you can’t spend the money before you have it,” he said.
Hall is still confident that over time the tax reductions will help attract investment in Kansas. He said the strength of the Kansas economy is closely tied to the national economy, but its tax policies will eventually help it break free.
“If we’re going to enter the top half of states’ growth rates, which we almost never are in, then you’re going to have to make some kind of significant change,” he said. “And that will take time.”
Contributing: Dion Lefler of The Eagle