Limit tax exemption for small businesses

It’s no wonder the state’s revenue estimates have been so far off. The number of Kansas business owners who aren’t paying state income taxes is nearly twice what state officials projected.

For the sake of the state government’s fiscal health – as well as public schools and critical social services – Gov. Sam Brownback and state lawmakers should limit this exemption.

Lawmakers decided in 2012 to eliminate state income taxes for owners of limited-liability corporations, S corporations, sole proprietorships and other pass-through entities. At the time, the state estimated that about 191,000 business owners would benefit.

But in the 2013 tax year, nearly 280,000 business filers used the exemption, The Eagle reported. In addition, about 53,000 farmers qualified, putting the total number of people not paying state taxes on their business income at more than 333,000.

The cost to the state of granting the exemption – which was initially estimated to be about $160 million – was $206.8 million in 2013.

Though critics said it was unfair to exempt one group of taxpayers while their employees continue to pay income taxes, Brownback championed the exemption as a way to help small businesses. But if that is truly the purpose, why not limit the exemption to, say, the first $100,000 of income? That would boost small businesses without giving a free pass to some of the state’s large businesses.

Sen. Jim Denning, R-Overland Park, proposed another alternative. He wants to tax the first $118,000 of business income, an amount roughly equivalent to the Social Security wage base limit, but exempt the next $150,000. Any income above $268,000 also would be taxed.

As evidence of the wisdom of his administration’s policy, Brownback pointed to a recent proposal by Ohio Gov. John Kasich to eliminate income taxes on small businesses in his state. But Kasich’s plan would be limited to small businesses with annual gross receipts of $2 million or less (and he wants to raise other business taxes to help pay for it).

There also are doubts about whether eliminating taxes on small businesses has much impact on the economy. More than three-fourths of small businesses have no employees, according to the U.S. Small Business Administration. And many small businesses earn so little income that the amount of their tax savings is small – certainly not enough to justify hiring new employees (though the state’s tax loss adds up).

Two Wichita State University professors recently wrote a commentary questioning the economic benefit of large state tax cuts. Kenneth A. Kriz, a Regents distinguished professor of public finance and director of the Kansas Public Finance Center, and Arwiphawee Srithongrung, an associate professor of public administration at the Hugo Wall School of Public Affairs, noted that tax cuts often necessitate government spending cuts, which can harm the economy.

“Our results suggest that the size of the spending cuts effect would be much larger than the positive effects of the tax cut,” they wrote.

Brownback hasn’t wanted to admit that his tax cuts aren’t working as he hoped. In fact, his administration has blamed about everyone and everything else for the state’s budget problems.

But leadership is being willing to look honestly at policies and make needed course corrections. Brownback needs to lead.

For the editorial board, Phillip Brownlee

This story was originally published February 28, 2015 at 6:06 PM with the headline "Limit tax exemption for small businesses."