Kansas legislators are considering several 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. policy changes this legislative session, and the Senate got the ball rolling on February 23rd by passing a series of bills that make senators’ tax policy priorities clear.
Some of the proposed changes, such as converting to a flat individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. structure and inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. -indexing the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. , would promote economic growth while making the tax code more structurally sound. But other proposed changes, like exempting retirement income and removing groceries from the local 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. , would narrow income and 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. bases, making the tax code less neutral while doing little to grow the economy.
While the House is expected to consider its own proposals, the Kansas Senate-passed bills serve as a starting point for future negotiations between the two chambers. As these negotiations occur, policymakers should consider the long-term effects and trade-offs associated with each of the changes being considered.
Converting to a Flat TaxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. Structure
One Kansas Senate-passed bill, S.B. 169, would move Kansas from a graduated-rate to a single-rate individual income tax structure beginning in 2024, which would make Kansas the sixth state to enact legislation converting to a flat individual income tax structure in the past two years alone. Instead of imposing a graduated-rate tax with a top rate of 5.7 percent, Kansas would levy a more competitive, flat rate of 4.75 percent on taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. exceeding $5,225 for single individuals and $10,450 for married couples filing jointly. This exclusion is in addition to the existing standard deduction and personal exemption and would ensure that all income taxpayers experience tax relief even though the new flat rate is higher than the existing lowest rate of 3.1 percent.
Absent any changes to the standard deduction or personal exemption, single filers would pay approximately $76 less in taxes on their first $35,750 in income than they pay under the current graduated-rate structure, and married couples filing jointly would pay approximately $151 less on their first $72,500 in income. And, with a flat rate of 4.75 percent rather than a top marginal rate of 5.7 percent, taxpayers would pay $9.50 less in taxes on every $1,000 of income they earn over $35,750 (single filers) or $72,500 (joint filers) than they pay under current law.
The proposed single-rate structure would be more conducive to job, wage, and overall economic growth in Kansas than the current graduated-rate structure, as lower-rate flat taxes avoid penalizing additional labor and investment on the margin. Reducing tax burdens on labor and investment in this manner would allow all workers to keep more of their earnings while allowing pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es to retain more of their profits to increase employee wages, hire more workers, make new capital investments, and otherwise grow their businesses.
One shortcoming of S.B. 169 in its current form, however, is that the real value of the zero bracket would erode over time because the income thresholds at which the flat tax rate kicks in are not annually adjusted for inflation. If left unindexed, the share of a taxpayer’s real income exposed to taxation would increase over time, as has already occurred for many years due to the lack of inflation indexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. of Kansas’ standard deduction, personal exemption, and income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. thresholds.
Inflation-Indexing the Standard Deduction
A separate Kansas Senate-passed bill, S.B. 33, would, among other changes, index the standard deduction to inflation beginning in tax year 2023, a change we have long recommended to prevent further erosion of the real value of the standard deduction.
Policymakers should also consider inflation indexing the $2,225 personal exemption that is available for each Kansas resident taxpayer, spouse, and qualifying dependent, as the real value of this exemption also continues to erode over time.
Exempting Retirement Income from Taxation
Another provision in S.B. 33 would substantially narrow the income tax base in a nonneutral manner by exempting from state taxation all income from federally taxable retirement plans and all Social Security benefits.
Under current law, the Social Security benefits of Kansans whose total federal adjusted gross income (AGI) from Social Security and other sources exceeds $75,000 pay taxes on all their Social Security benefits, while those with $75,000 or less in income pay none. This proposal would exempt currently taxable Social Security benefits beginning this year and all of retirees’ retirement plan income as of 2024. This would make the tax code substantially less neutral by providing preferential treatment to traditional over Roth retirement accounts. Specifically, for retirees with traditional IRA or 401(k) plans, the state would no longer tax that income when it is distributed even though such income is also untaxed when it is earned and contributed to such accounts. Meanwhile, Kansans who are not yet retired and who contribute to Roth accounts would not receive a similar benefit, since contributions to Roth accounts are taxed on the way in.
Regarding the proposed new exemption for all Social Security benefits, ideally, Social Security benefits should be treated as ordinary income for income tax purposes. Social Security, at its most basic level, is like a mandatory retirement plan that requires workers to set aside a portion of their earnings during their working years with the assurance that they will have a basic source of income in retirement. As such, Social Security benefits should be taxed like income that is accessed in retirement from a traditional IRA or 401(k) plan. Instead of removing Social Security benefits from the income tax base altogether, Kansas should consider fixing the $75,000 exemption threshold tax cliff, which we have written and testified about previously, by converting it into a more gradual phaseout.
While proponents of an exemption for Social Security benefits have expressed a desire to make Kansas’ tax code friendlier to retirees, large income tax base carveouts put upward pressure on the overall rate that applies to all income, including retirees’ income as well as income earned by the workers and job creators who drive productivity and economic growth in Kansas the most.
Removing Groceries from the State and Local Sales Tax Base
A third Kansas Senate-passed bill, S.B. 248, would remove unprepared food and food ingredients from the state sales tax base one year earlier than planned. It would also go beyond current law to remove groceries from local sales tax bases as well, which would result in substantial revenue loss to local governments.
Under current law (H.B. 2106, enacted in May 2022), the state sales tax rate on unprepared food and food ingredients was reduced from 6.5 percent (the general state sales tax rate) in 2022 to 4 percent in 2023, and the rate is scheduled to phase down to 2 percent in 2024 before going to zero in 2025. However, under current law, local sales taxes would continue to apply to groceries.
Grocery purchases represent a sizable and stable share of local sales tax bases, so without this revenue, local governments are likely to turn to other revenue sources in the future—such as 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. increases or local sales tax rate increases—to offset the revenue loss associated with an exemption for groceries, making any net tax relief associated with a grocery exemption likely to be short-lived.
Furthermore, while many people assume removing groceries from state and local sales tax bases is a progressive policy change, given existing state and local sales tax exemptions for food purchased with SNAP and WIC benefits, our research shows lower-income taxpayers are often better off with groceries included in sales tax bases at lower across-the-board rates than they would be with groceries exempted but with the current general sales tax rate applying to all other taxable purchases.
It is also worth noting that while Kansas’ continued status as a Streamlined Full Member State—a state that adheres to Streamlined Sales and Use Tax Agreement (SSUTA) policies—is contingent upon maintaining much uniformity between state and local sales tax bases, the sales tax treatment of food is one area in which member states are allowed to apply the sales tax to groceries at the local level without doing the same at the state level.
Finally, compared to income tax rate reductions—which increase returns to labor and investment—sales tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s do little to promote long-term economic growth.
As Kansas legislators consider additional tax policy changes this legislative session, they should prioritize economic growth and a structurally sound tax code. While base-narrowing provisions may be politically popular among those who would receive an exemption, narrowing tax bases puts upward pressure on tax rates over time, which could negate the revenue-negative impact of many of the exemptions currently being proposed.