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Governor Kelly’s Tax Proposals Can Be Targeted Towards Right-Sizing Kansas’ Tax Base

4 min readBy: Michael Lucci

Kansas Gov. Laura Kelly’s Fiscal Year 2021 budget and tax proposals can be targeted to effectively restructure Kansas’ taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. base. Her budget proposal includes expanding Kansas’ sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. and providing state funding for local property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. relief. These proposals can be used to restructure Kansas’ sales and property tax bases, respectively.

Sales TaxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. Restructuring

The proposal by Gov. Kelly (D) proposal expands Kansas’ sales tax base to include the sale of digital property and to implement a tax on online marketplace facilitators. These proposals are estimated to collect $22.4 million and $25.0 million in sales tax dollars, respectively, and are steps towards a broader, more neutral sales tax base. The majority of states currently include some digital goods and services (most commonly, streaming services) in their sales tax base, and the majority of states also implemented marketplace facilitator regimes. Our recent book Kansas Tax Modernization: A Framework for Stable, Fair, Pro-Growth Reform recommends both of these changes be used to restructure the sales tax code.

A number of lawmakers have noted that as a standalone issue these proposals are a tax increase, given that they would increase state tax collections by an estimated $47.4 million per year. Local sales tax collections would presumably increase by $16 million per year given that local governments share the state’s sales tax base and impose an average local sales tax rate that is one-third (2.17 percent) the state rate (6.50 percent).

However, this change need not be a net tax increase for Kansans. The revenue from Gov. Kelly’s base-broadening proposals can be used to either buy down the state’s sales tax rate or exempt business-input purchases that provide an equivalent amount of tax revenue, thus resulting in no net tax increase. First, the new revenues could be used to buy down the state sales tax rate from 6.50 percent to approximately 6.37 percent. Alternatively, Kansas policymakers can exempt from tax business-to-business purchases that are currently taxed. The Tax Foundation’s Kansas Tax Modernization book includes a list of business-to-business transactions (page 97) that are currently subject to sales taxation, such as packing and crating, machinery rentals, sign construction and installation, and non-residential utilities. Kansas policymakers can find a set of such business inputs that generate approximately $47.4 million in state revenue and exempt them from taxation.

Tax economists of all stripes agree that a proper sales tax base should include all final retail consumption of goods and services to generate a broad tax base and a low tax rate. Tax economists also widely agree that business inputs should be exempt from taxation. The idea behind exempting intermediate transactions is not to provide a special tax break for businesses but rather to avoid the economically harmful process of “tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. ” whereby products and services are taxed at multiple stages of production, ultimately distorting supply chains and raising the price for final retail consumption. Either revenue-neutral change would simultaneously make Kansas’ tax code more neutral, fair, and pro-growth.

Property Tax Restructuring

Furthermore, Gov. Kelly’s budget proposes transferring $54.0 million for the Local Ad Valorem Tax Relief Fund (LAVTR) as a tool for local property tax relief. The LAVTR distributes state funds to local governments based on local population (65 percent) and property valuation (35 percent). State law requires 3.63 percent of sales tax revenue to be used for the LAVTR fund. However, Kansas’ LAVTR has not been funded since 2004 as the legislature has waived the rule requiring the sales tax revenue to be sent to the LAVTR fund.

State-local tax swaps are inherently complicated, and providing state money for local property tax relief does not always guarantee that such relief will occur. If policymakers decide to use state tax dollars for local property tax relief, they should prioritize reducing reliance on tangible personal property (TPP) taxes such as the taxation of cars. This might be done by creating a state exemption of a certain amount of car value from property taxation, with the revenue loss to local governments made up by the inflow of property tax relief dollars from the state. This would provide targeted property tax relief for car owners and knock lower-valued cars off the tax rolls altogether. Furthermore, such a step would reduce reliance on TPP, thus taking a step towards appropriately circumscribing the property tax base to land and its improvements.

Kansas policymakers will have much to consider in tax policy over the coming years and should prioritize the long-term goal of making Kansas’ tax code more efficient, neutral, and pro-growth.

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