Note: The following is our testimony to Kansas’ Senate Committee on Assessment and 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. ation; and Kansas’ House Committee on Taxation presenting: Kansas Tax Modernization: A Framework for Stable, Fair, Pro-growth Reform
Thank you for inviting us to present today before your committee, and for the openness and hospitality we have experienced in meeting with some of you and your staff members over the past year. My name is Michael Lucci, and I am the Vice President of State Projects at the Tax Foundation. Here with me today are my brilliant colleagues Erica York and Katherine Loughead. We are here to present the findings of our recently published study, Kansas Tax Modernization: A Framework for Stable, Fair, Pro-growth Reform.
We think the time is right for Kansas lawmakers to take a comprehensive look at restructuring the state’s tax code. Indeed, it is amazing how many tax changes Kansas policymakers and citizens have confronted over the past eight years. Now is a perfect time to address what Kansas’ tax code should look like in the 21st century.
Over the past eight years, Kansas has experienced significant changes in tax policy from both internal and external causes. Kansas policymakers made substantial changes to state tax policy in 2012, then largely reversed those changes in 2017. Then in late 2017, the federal government enacted the Tax Cuts and Jobs Act, which had significant ramifications for all states, many of which are still being addressed. Finally, the United States Supreme Court ruling on the Wayfair case opened new pathways for states to legally tax remote sales. Kansas is already in the midst of confronting this series of changes, and we believe that the time is right for a comprehensive look at Kansas’ tax code.
First, I’m going to explain the reform guide so that you understand our purpose and process in creating these books. Then I will address Kansas’ current rankings in our State Business Tax Climate Index. Finally, I will provide our recommended priorities for this year. My colleague Erica York will then present on Corporate Income taxes, Katherine Loughead will present on Individual Income Taxes and Sales and Use Taxes, and then I’ll wrap up by covering 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. es and Other Tax considerations.
This reform guide is the tenth such book we have published for an individual state, and it represents the culmination of a year of work. We partnered with the Kansas Chamber of Commerce on this book, although Tax Foundation maintains full editorial independence on its recommendations. Our process began with background research and preparation; we then conducted approximately 50 interviews with hundreds of Kansans across the state’s industries and geography. After the interview process, we conducted an intensive analysis of Kansas’ tax provisions and began writing our recommendations into a book while factoring in what we had learned through the interview process. We published this book in December of 2019, and we are dedicated to serving as an educational resource going forward.
Now, if we look at Kansas’ rankings on our State Business Tax Climate Index, we can see that Kansas ranks below average on the whole, coming in with the 34th best-structured tax code. The Index ranks states for the structure of their code, rather than the state’s total tax burden. It speaks to how you collect tax revenue, rather than how much revenue you collect. Corporate income taxation 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. ation are areas of relative weakness for Kansas. We will address ways to improve these areas along with the rest of the code.
Finally, we have three recommended priorities for getting started this year. The first is to address unlegislated tax increases that have occurred in recent years. Tax Foundation’s four core tax principles are transparency, simplicity, neutrality, and stability. Part of having transparency in the tax code is having the people’s representatives decide if there will be a tax increase. We recommend Kansas undo several of the unlegislated tax increases of recent years. Next, we recommend that Kansas prioritize corporate tax reform. There are powerful changes that can be made within the corporate tax code that will make Kansas more competitive and unlock the state’s economic growth. Finally, we recommend that Kansas policymakers begin the broad process to modernize the state’s tax code to improve Kansas’ long-term competitiveness.
With that, I will hand it off to my colleague Erica York, who will address Kansas’ corporate tax code.
Corporate Income Tax
Kansas has a corporate income tax with a top rate of 7 percent, comprised of a 4 percent base rate and a 3 percent surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. . Over the last two decades, the tax has raised revenue ranging from $23 million to $87 million per percentage point. In the most recent fiscal year, the tax raised close to $63 million per percentage point.
First, I will highlight one of the unlegislated tax increases that Michael mentioned.
Prior to federal tax reform in 2017, the taxation of international income had not really been a state tax issue. However, for states that conform to the federal tax code for portions of their state tax calculations, federal reform has created an issue of bringing international income into the state 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. . Specifically, the creation of Global Intangible Low-Taxed Income (GILTI)Global Intangible Low-Taxed Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage. , intended to tax the supernormal returnSupernormal returns are payoffs to investment greater than the typical market rate of return. They are often approximated as company profits that exceed 10 percent. This additional return on capital or labor is above breaking even on an investment relative to the amount of risk and time that investment required. s of foreign subsidiaries in low-tax countries, could potentially be taxed in Kansas because Kansas automatically adopts the current version of the Internal Revenue Code.
State tax systems were not made to accommodate international income, and many of the resulting tax regimes give rise to serious constitutional questions. As such, many states have decoupled from GILTI or provided a deduction that removes GILTI from the state tax base: failure to do this would make doing business in Kansas considerably more costly for multinationals and create a potential constitutional issue because of how Kansas would apportion GILTI. Kansas should remove international income from its tax base to avoid constitutional issues and avoid an uncompetitive, unlegislated tax increase.
The next two reform options are both related to how the base of the corporate income tax is structured. Specifically, the issues of timing and of investment are important to get right.
On timing, a yearly snapshot of a corporation often does not accurately represent the business’s actual profitability over the long run. To accommodate this, the tax code offers net operating loss provisions, allowing a business to deduct prior losses to smooth tax obligations over time. Net operating loss provisions have two important variables: the number of years allowed and any caps on the amount of loss. Currently, Kansas limits carryforwards to 10 years. Many states allow 20 years, and at the federal level, the years are unlimited while the amount is limited to 80 percent of tax liability. Transitioning to either a 20-year option or federal conformity would be an improvement.
On investment, as a tax on net income, the corporate income tax base should exclude business costs—which includes what is spent on investment. This means that for tax purposes, businesses should immediately deduct investment costs in the year they occur, rather than taking depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deductions over time. The new federal tax law shifted to a policy of immediate and full deductions for investment in machinery and equipment, and Kansas conforms to this, affording these investments the proper tax treatment. However, this policy is scheduled to phase out after 2022. It would make sense for Kansas to make full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of machinery and equipment a permanent part of the tax code.
The two reform options are related to how Kansas apportions the income of corporations that do business in multiple states. The first recommendation highlights an inconsistency within the Kansas tax code, and the second highlights a counterproductive, but often not well-understood, part of the Kansas tax code that deserves attention.
States must determine the amount of a business’s income that is subject to the state’s corporate income tax through a process called apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. . States apportion business profits based on a combination of the percentage of company property, payroll, and sales located within their borders. Kansas uses the traditional method, which weights each of these three factors evenly. However, Kansas currently has a different set of rules based on whether a business sells goods or services. Specifically, for firms that sell services, these sales are apportioned to Kansas if the labor occurs in Kansas, rather than if the sale occurs in Kansas. This is the opposite of the destination-based rule for the sale of goods, which apportions sales to Kansas when the purchaser resides in Kansas. This inconsistency can be resolved by shifting the way service income is apportioned to be consistent with the way goods income is apportioned.
When corporate income is apportioned among states for tax purposes, some income can be earned in states which don’t have the jurisdiction to tax the business, which results in so-called nowhere income that isn’t taxed by any state. For example, a business in State A might sell into State B, but for whatever reason that income might not be taxed in State B, a throwback rule would subject the income from the sale into State B to State A’s corporate tax. In other words, states designed rules to capture this otherwise untaxed income, with the goal of making sure that 100 percent of corporate income gets taxed. However, it may be better to tax less than 100 percent of corporate income than to tax 100 percent in a harmful manner. These rules can lead to very high and uncompetitive levels of tax for some businesses, to the point that out-migration caused by the rules can offset any revenue gains from taxing this “nowhere income.” These rules are non-neutral, uncompetitive, and counterproductive, and should be repealed.
And to wrap up the corporate reform section, these two recommendations are related to long-term competitiveness.
Currently, the corporate tax code contains 38 different incentive programs; however, many of these are not utilized or are underutilized. For example, in 2017, only eight credits were utilized enough to generate reportable data. Recently, these incentives have reduced corporate income tax collections by 11 to 14 percent. A well-structured tax code with a broader base and a lower rate would do far more to encourage job creation and economic growth. So our recommendation is that all incentives ought to be evaluated in a formalized review process and any programs that fail to meet expectations could be rolled back and the revenue used to pay down corporate rate reductions.
As it stands, Kansas’s 7 percent top corporate income tax rate is slightly worse than average, tied for 21st highest among the 44 states with corporate income taxes. Subject to revenue availability, Kansas should prioritize getting the rate to 6 percent or lower and potentially consolidating the rate structure.
Individual Income Tax
First, I’ll spend the new few minutes talking about Kansas’ individual income tax system.
It’s important to point out, though, that even if Kansas maintains its current individual income tax rate schedule for years to come, because Kansas does not adjust its income tax provisions for 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. , simply maintaining the status quo will result in increased effective rates and tax burdens from one year to the next.
Ideally, all of a state’s major individual income tax provisions (but especially its brackets, 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 as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. , and personal exemption) ought to be adjusted annually for inflation.
When brackets aren’t adjusted, an increase in nominal income can bump a taxpayer into the next marginal 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. , even if that taxpayer’s income increased only at the rate of inflation. This concept is known as “bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. .”
One way to illustrate bracket creep is by looking at Kansas’ tax rate schedule between 1998 and 2012. During those years, Kansas’ rates and brackets didn’t change at all, either for policy reasons or for inflation, so the effects of bracket creep are easy to measure.
For example, take a Kansan who was making $50,000 in 1998. If that taxpayer received cost of living adjustments but no other raises to their base pay, they’d be bringing home $70,000 in 2012. However, because Kansas’ tax brackets weren’t adjusted for inflation, that taxpayer would have had a lot more of their income exposed to the top marginal rate in 2012 than they did when making the equivalent amount of money in 1998.
If Kansas’ brackets had been adjusted for inflation, in 2012, the middle rate would have kicked in at about $21,000 in marginal income instead of $15,000, and the top rate would have kicked in at about $42,000 instead of $30,000.
The federal government—and the majority of states with graduated-rate income taxes—index their brackets for inflation, so it would be prudent for Kansas policymakers to consider doing the same.
Additionally, Kansas’ single filer standard deduction of $3,000 has remained stagnant since 1988, so it has lost more than half of its value over time. If it had been adjusted for inflation, it would be over $6,500 in today’s dollars. Currently, two-thirds of the states that offer a standard deduction adjust it for inflation.
Similarly, Kansas’ personal exemption of $2,250 has remained unchanged since 1998. If it had been adjusted for inflation, it would be around $3,550 today. More than a third of the states that offer a personal exemption adjust it for inflation.
Moving forward, to prevent bracket creep and to preserve the value of the standard deduction and personal exemption, it would make sense for Kansas policymakers to ensure these provisions—especially the brackets—are indexed for inflation.
Our third individual income tax recommendation is to consider adjusting Kansas law to allow taxpayers to claim itemized deductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers. s on their state tax return even if they claim the standard deduction on their federal return.
Currently, five of the itemized deductions that are available at the federal level are also available under the Kansas tax code. However, under Kansas law, if a taxpayer claims the standard deduction at the federal level, he or she must also claim the standard deduction at the state level.
The problem taxpayers are running into is that, since the Tax Cuts and Jobs Act nearly doubled the federal standard deduction, approximately nine out of 10 filers now find it more advantageous to claim the federal standard deduction than to itemize, up from only about seven out of 10 who found it advantageous to claim the standard deduction previously.
As a result, among the approximately 20 percent of filers who switched from itemizing to claiming the standard deduction after the TCJA took effect, most of those taxpayers now face a lower federal individual income tax burden—but a higher Kansas individual income tax burden—than they did previously.
Numerous states (like Iowa, Idaho, Georgia, Missouri, and others) used TCJA conformity legislation as a chance to reform their own tax codes and prevent or reverse these unlegislated state income tax increases. And many states now either match the federal standard deduction or offer a slightly different, but still comparable, standard deduction of their own.
In contrast, Kansas’ single filer standard deduction has neither increased nor been adjusted for inflation in over 30 years.
Increasing the Kansas standard deduction to make it comparable to the federal deduction would be an excellent solution to help the largest number of taxpayers, but if a substantial increase to the standard deduction isn’t feasible, allowing an independent choice of itemization would specifically help those who switched from itemizing to claiming the standard deduction but are facing higher Kansas tax burdens as a result.
Currently, many states, including Arizona and Delaware, allow taxpayers to itemize on their state return even if they claim the standard deduction on their federal return. This usually requires those taxpayers to complete and include Federal Form 1040 when they file their state tax return.
The four reform recommendations I just mentioned—avoiding rate increases, indexing for inflation, allowing an independent choice of itemization, and increasing the standard deduction—are the most important in terms of making Kansas’ individual income tax less burdensome and more competitive. However, we do have a few additional reform considerations, explained in more detail in our book, which I’ll mention briefly now.
The first consideration is to remedy the marriage bonusA marriage bonus is when a household’s overall tax bill decreases due to a couple marrying and filing taxes jointly. Marriage bonuses typically occur when two individuals with disparate incomes marry. Marriage penalties are also possible. and marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. that currently exist in Kansas’ standard deduction and additional standard deduction.
Currently, Kansas’ standard deduction is $3,000 for single filers but $7,500 for married couples.
Meanwhile, the additional standard deduction, which is available to taxpayers who are blind or are over the age of 65, is $850 for single filers but only $700 per person per qualifying condition for married couples.
These discrepancies are more the result of piecemeal legislative changes than cohesive, intentional decisions. (For example, the married couples’ standard deduction increased unilaterally, from $6,000 to $7,5000 with no corresponding increase to the single filers’ deduction, in 2012, but in 2013 was reduced to where it stands today).
To make the tax code fairer and more neutral, it would make sense to adjust these amounts, as part of any broader increase to the standard deduction, in order to make the married couples’ deductions double—but no more and no less than double—the amount of the single filer deduction.
Another reform consideration is to regularly reevaluate, and to ultimately roll back, excessive individual income tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s. While different groups enjoy various credits because they offset part of their overall tax burden, they are not available to everyone, so they are a very non-neutral way of offering tax relief.
There is ample evidence that, when used as economic development or social policy tools, most tax credits incentivize investments or activities that would have occurred anyway. It would therefore be more effective for Kansas to cut down on both its corporate and individual income tax incentives in order to use that revenue to reduce overall income tax rates or make other pro-growth reforms.
Finally, it’s worth pointing out that Kansas’ system of taxing some Social Security benefits, but not others, is a form of non-neutral tax treatment that carries with it certain unintended consequences.
Under current Kansas law, the amount of income a person earns determines whether that person’s Social Security benefits are considered 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. .
In Kansas, if a taxpayer’s federal adjusted gross income is $75,000 or less, none of their Social Security benefits are taxable, but if their AGI is over $75,000, all of their Social Security benefits are taxed. And that threshold applies whether a taxpayer is a single individual making just over $75,000 or is married and the spouses together make over $75,000 when their income is combined. Not only is this a substantial marriage penalty, but this creates a significant tax cliff.
The federal government has a similar system in place, but the benefit is much less generous. At the federal level, if you earn income while claiming Social Security benefits, those benefits are likely taxed, since the income threshold is only $25,000 for single filers and $32,000 for married filers.
There is no policy reason why someone who makes $75,000 should have none of their SS benefits taxed while someone who makes $75,001 should have all of their benefits taxed, but that’s how the law currently stands. Such a cliff can cause individuals, especially those making around $75,000, to decide either not to work, or to cut back their hours, in order to avoid having all of their Social Security benefits taxed.
Short of taxing all Social Security benefits equally, or conforming to the federal system, Kansas could mitigate this unintended consequence by gradually phasing out the exemption at certain income levels instead of letting the exemption “fall off a cliff” when a taxpayer’s income exceeds $75,000.
State and Local Sales Tax
Now I’d like to transition to talking about state and local sales taxes.
As you’re well aware, the sales tax is a significant revenue generator in Kansas, bringing in over $3 billion in revenue for the state and another $1 billion for local governments in FY 2017 (the most recent year for which the state and local breakdown of data is available).
Over the course of its 83-year history, Kansas’ sales tax rate has been increased eight times. The only time the rate was ever reduced was in 2013.
With a state sales tax rate of 6.5 percent and an average local sales tax rate of 2.17 percent, the combined state and average local sales tax rate is 8.67 percent, which is the eighth-highest in the country.
Kansas is in a high sales tax region of the country, but even so, Kansas’ sales tax is higher than most of its neighbors. Among its immediate neighbors, only Oklahoma has a higher combined state and average local sales tax rate.
However, when it comes to Kansas’ sales tax system, taxing online sales the right way, and reforming the sales tax base, should be prioritized over any rate changes.
The most urgent sales tax priority for policymakers right now should be getting the state into a position to tax online sales the right way, without violating the U.S. Constitution’s Dormant Commerce clause or Undue Burden clause.
When the U.S. Supreme Court handed down its landmark South Dakota v. WayfairSouth Dakota v. Wayfair was a 2018 U.S. Supreme Court decision eliminating the requirement that a seller have physical presence in the taxing state to be able to collect and remit sales taxes to that state. It expanded states’ abilities to collect sales taxes from e-commerce and other remote transactions. decision in June 2018, it removed physical presence as the standard for sales tax collection and replaced it with economic nexus.
While the Court did not outline exactly what makes an economic nexus statute constitutional, the Majority Opinion highlighted several key features of South Dakota’s remote sales tax law that make it likely to withstand constitutional muster. These include a safe harbor for small remote sellers with only occasional sales into the state, a prohibition against retroactive sales tax collection, a single state-level administration of all state and local sales taxes, uniform definitions of products and services at the state and local levels, a simplified sales tax rate structure, access to sales tax administration software provided by the state, and immunity for sellers who rely on such software.
Unlike many states, Kansas was actually in a great position, post-Wayfair, to simply update some statutory language and begin requiring remote sellers to collect. As a member of the Streamlined Sales and Use Tax Agreement, Kansas already largely satisfies items 3-7 on the so-called “Wayfair checklist.”
However, the state’s decision to enforce remote sales tax collection without a small seller safe harbor in place makes Kansas’ remote sales tax collection regime one of the most likely to draw a legal challenge. Currently, even one transaction into Kansas triggers economic nexus, requiring the seller to not only determine whether a good or service is included in Kansas’ sales tax base but also what the appropriate combined state and local sales tax rate should be. This responsibility comes with significant compliance costs that could very easily outweigh any benefit the seller receives from selling into the state. Lack of any sort of safe harbor makes Kansas’ provision very constitutionally suspect.
Adopting a reasonable de minimis exemption, explicitly prohibiting retroactive collection, and providing clear statutory language for marketplace facilitators are priorities the legislature ought to address as soon as possible this legislative session.
This committee and the legislature did, of course, attempt to create a $100,000 de minimis exemption last year with SB 22 and HB 2033. With neither bill adopted, it’s important that the safe harbor issue be reconsidered as soon as possible this year, and that an agreement ultimately be reached to prevent the state from getting wrapped up in unnecessary litigation. Specifically, any legislation considered this year should include a safe harbor of at least $100,000, prohibit retroactive collections, outline clear statutory requirements (including a safe harbor threshold) for marketplace facilitators, and eliminate Kansas’ legally dubious click-through and affiliate nexus laws that were created pre-Wayfair in an attempt to skirt the physical presence rule.
After these Wayfair-related issues are addressed, the next highest sales tax policy priority is to broaden the state’s sales tax base.
Applying the sales tax to a broader scope of goods and services would make the tax code more neutral and would be one of the best ways to offset reductions to either the income or sales tax rates, or to pay for some of the other pro-growth tax policy changes recommended in our presentation today.
Under an ideal sales tax, all final consumer goods and services would be subject to taxation, while business inputs would be excluded.
Excluding business inputs is structurally important to prevent the sales tax from being embedded in the final price of the good multiple times over, known as 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. , since this increases the price of the good and is a form of hidden tax.
Most states, including Kansas, have sales tax bases that are far narrower than economists would recommend. There are a couple reasons for this.
The first is that, like many states, Kansas established its sales tax in the 1930s, when the vast majority of personal consumption was goods-based, not service-based. As a result, most sales taxes were designed to apply to the sale of tangible personal property, with intangible goods and services not considered for inclusion.
However, in the decades since Kansas’ sales tax system was established, our economy has become increasingly service-oriented. Video and music streaming services, app-based food delivery services, and so many other services are now commonplace that wouldn’t have even been imaginable in the 1930s.
And with so many more people streaming movies and music instead of buying them on a tangible disk, it’s easy to see how the sales tax base has eroded over time, meaning rates have had to increase in order to generate the same amount of revenue.
The share of national consumption of both goods and services since 1929. You can see how much the consumption of goods has declined, and the consumption of services has increased, as a share of total consumption.
This is a national reality that states will have to address sooner or later. We believe the time has come for states to modernize their sales tax bases and apply the sales tax more neutrally to all final personal consumption, whether goods or services. Modernizing the sales tax base in this way will not only make the tax more fair, applying equally to all final personal consumption, but it also will generate new revenue that can be used to reduce overall tax rates, whether income tax rates or sales tax rates or a combination of the two.
Certain states, like Indiana, North Carolina, and most recently, Utah, have broadened their sales tax bases to select new goods and services and have used that revenue to pay down income tax reductions.
Table 5.9 on page 111 of our book shows a list of goods and services to which Kansas’ sales tax could be extended. It includes goods like gasoline and lottery tickets, to which excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es but not sales taxes apply, as well as services like hair salons, massages, golf lessons, music downloads, carpet cleaning, parking garages, and a lot more.
Now, when considering sales tax base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. , it’s very important to apply the sales tax only to consumer goods and services; any goods and services that are primarily sold business-to-business ought to remain exempt.
This is not to give businesses special treatment, but rather to prevent tax pyramiding, which occurs when sales taxes are embedded multiple times over in the price of the final good or service. Tax pyramiding is harmful because it raises prices for consumers, and because the taxes that get embedded in the price of the good are hidden and nontransparent.
By and large, Kansas currently does a good job of recognizing the importance of exempting business inputs from the sales tax.
For example, most broad categories of business inputs, such as raw materials used in manufacturing and agriculture, have long been explicitly exempted from the sales tax.
Now, there are some exemptions where certain business inputs are taxed when they really should not be. A pretty comprehensive list is available in Table 5.5 of our publication, which shows that packing and crating services, welding services, certain construction and machinery rentals, nonresidential utility services, and other primarily business-to-business transactions are currently subject to the sales tax. In the medium to long term, Kansas ought to work on exempting these business inputs from taxation.
In the short term, though, if policymakers set out to broaden the sales tax base, it’s important to use caution to prevent new business inputs from getting caught up in the tax.
For example, accounting services are not currently subject to the sales tax in Kansas. Under an ideal tax code, accounting services would be subject to the sales tax when purchased by households but would not be subject to the sales tax when purchased by businesses. Again, this isn’t about special treatment for businesses, but is about preventing taxes on business-to-business sales from getting passed along to consumers.
If Kansas broadens the sales tax base to additional goods and services, policymakers should take care to ensure primarily business-to-business transactions (advertising, marketing, and janitorial services, for example) remain exempt. For goods and services that could either be purchased by households or in the course of doing business (like accounting services), another option would be to create 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 IRS, preventing them from having to pay income tax. certificates that could be used when purchasing goods or services for business purposes.
The same goes for nonprofit organizations. Currently, Kansas uses an abnormal approach in that nonprofit purchases and nonprofit sales are by default included in the sales tax base, but many exemptions have been granted over time on an ad hoc basis.
It would make more sense to offer all businesses and nonprofit organizations sales tax exemption certificates to use for purchases made in the course of doing business. That way, those goods and services will remain taxable when purchased by household consumers but will not be taxed when purchased as business inputs.
It’s also worth pointing out that when it comes to the taxability of sales made by nonprofits, it would make sense to apply the sales tax to sales made by nonprofits just like it applies to sales made by regular businesses, especially when the nonprofit is selling goods or services in direct competition with for-profit businesses, as this would create a more equitable system.
Now, for administrative simplicity, it’s understandable why many sales made by nonprofits are currently tax-exempt, but it’s worth considering that that might not be the most economically-neutral approach.
While getting into compliance with Wayfair is the most pressing immediate sales tax policy change, and broadening the sales tax base the right way is the most pressing medium- to long-term sales tax change, a couple additional topics came up frequently in our meetings throughout the state and are worth mentioning briefly here.
The first is Kansas’ application of the sales tax to unprepared foods.
It’s no secret that many in Kansas want to see a lower sales tax rate on groceries, or even a full exemption. Many bills have been brought before this committee, and have been considered by the full legislature, to do just that.
Proponents argue that a lower tax rate on groceries, or a complete exemption, would provide tax relief to lower-income individuals.
While proposed with good intentions, if tax relief for those with lower incomes is the goal, there are several reasons why preferential tax treatment of groceries is not the best policy solution to achieve that objective.
For one thing, if the state were to reduce or eliminate sales taxes on unprepared foods, that tax relief would be extended not just to those struggling to make ends meet, but also to plenty of higher-income individuals. Foods considered to be more luxurious—such as steak and lobster—and foods purchased at high-end grocery stores would receive a large share of this tax relief. To offer a tax exemption this broad, the state would either have to reduce spending or generate that revenue elsewhere.
It’s also important to keep in mind that when qualifying individuals make purchases using SNAP or WIC benefits, federal law mandates that state and local sales taxes not be applied to those purchases. So the lowest-income individuals are already not paying sales tax on their groceries.
Furthermore, it’s important to remember that prepared foods are taxable, not just in Kansas but in every state with a sales tax, and these sales taxes apply whether the food is purchased at a high-end restaurant or a fast food chain. Does it really make sense to apply the sales tax when a lower-income individual purchases a sandwich at McDonalds but not to apply the sales tax when a higher-income individual purchases steak at Whole Foods? But that’s exactly what grocery exemptions do.
A more effective approach would be to make Kansas’ existing “Food Sales Tax Credit” refundable or to extend eligibility for the credit to additional lower-income Kansans. Currently, eligibility for this credit is only extended to those with federal AGI of $30,615 or less who also either have a dependent, are 55 or older, or are blind or disabled. Making the credit refundable, or making sure it can be claimed by everyone who needs it most, is a more effective solution.
Finally, I’ll briefly mention the STAR bond program.
Kansas’ STAR bond program was designed to finance major commercial, entertainment, and tourist attractions of state and regional significance but has often been used for projects of only local significance. This has resulted in revenue being shifted from the state to localities for economic development projects that may be of dubious state importance.
Enhanced oversight of this program, and additional statutory parameters, would help ensure projects meet certain state standards and prevent the unnecessary diversion of state tax revenue.
Property and Related Taxes
Property taxes are relatively efficient taxes in that research shows they cause less distortions to economic decision-making than individual and corporate income taxes. Furthermore, property taxes can function in line with the benefit principle of taxation insofar as they are a direct way for local residents to pay for the services of local government. However, as you all know too well, property taxes are the most disliked tax in America. While Kansas has a relatively well-structured property tax code, the state has above-average property taxes measured as a portion of home value, as a portion of personal income, and on a per-capita basis.
Kansas currently has several positive features to its property tax code, including no estate or inheritance taxAn inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate. , no capital stock tax, and an exemption for business tangible personal property. And Kansas also has an admirable system of property tax administration, ranked as one of the top two by the Council on State Taxation.
The priority areas that I will address in Kansas’ property tax code are the total property tax burden, tangible and intangible property taxation, and issues with the administration of property assessments and valuations.
First, we consider ways to address the state’s total property tax burden. Ultimately, property tax levels will be dictated by the expenditures that property taxes fund. One area to consider is the property tax lid. We heard from advocates on both sides of this issue—those who want a tighter lid and those who want more local government autonomy.
Kansas can restructure the lid in the form of Utah’s “Truth in Taxation” model and extend the property tax control to more categories of currently-exempt expenditures. For example, police, fire, and emergency medical services are currently exempt from the lid. Furthermore, increased revenues from the expiration of property tax abatements, tax increment financing districts and other tax rebates and redirections should be subject to Kansas’ chosen property tax restraint. Merits to this approach include a neutral restraint over more categories of local expenditures and revenue sources, a high degree of taxpayer transparency and engagement, and increased autonomy for local government officials. Utah has seen property taxes significantly decline as a portion of state income since enacting “Truth in Taxation.”
In addition, our book compares metrics between Kansas and peer states that point to the fact that Kansas might benefit from local government consolidation. We recommend taking up a study on this issue, as it significantly affects property taxes. Consolidation could mean more effective delivery of local government services achieved at a lower cost to taxpayers.
Next, the proper base for property taxation should be circumscribed to land and its improvements. Taxes on tangible and intangible property are inefficient, anachronistic, and taxpayer-active, meaning that taxpayers must do substantial compliance work to calculate their liability.
We recommend phasing out Kansas’ remaining tangible and intangible property taxes. Tangible personal property taxes can be phased out by lifting the de minimis threshold under which taxpayers have no liability, exempting new tangible property purchases, or some combination of both. If state government is planning to fund the reduction of local property taxes, we strongly recommend targeting that relief at tangible personal property taxes and intangible property taxes. Raising the de minimis threshold or exempting new property will remove some amount of property from the base and will immediately put Kansas on a path to carving tangible personal property out of the base altogether.
Kansas is one of the few states that allows for intangible property taxes. This local tax on the earnings of intangible property is highly anachronistic, complex, non-neutral, and distortive of wealth allocation. One-third of counties and townships levy such taxes and one-fifth of cities do the same. We recommend assessing local dependence on these revenues and then working to gradually phasing them out.
Next, we look at issues related to assessments. We recommend providing guidance and perhaps training to ensure that appraisals are made in line with the repeated decisions of Kansas’ Board of Tax Appeals and court rulings that property must be valued at its market value rather than valuations based on a lease-in-place or the income potential of a tenant. A stable and transparent tax code should have a set “rules of the game” for determining tax liability in line with state law and judicial rulings so that taxes are predictable and understandable.
We recommend that the Director of the Division of Property Valuation provide guidance for appraisal in line with the decisions from the Kansas Board of Tax Appeals and the Kansas court system. Furthermore, if the practice of significant increases in appraisals continues, we think Kansas lawmakers can revisit partial payment of tax under appeal to ensure that local government officials don’t have an incentive to over-assess property values in order to get more tax dollars up front.
Other Tax and Revenue
We have two additional recommendations. First, we applaud the so-called “Border Wars” truce with Missouri. We think this is a positive development and we recommend seeking ways to incentivize local governments to abide by the truce rather than defecting by using local incentives to lure businesses back and forth across the immediate border counties near Kansas City.
Our second recommendation is to shore up Kansas’ Rainy Day fund, which was created in 2016. A budget stabilization fund, or rainy day fund, is an important tool in state budget making to help smooth revenues over the business cycle. The current law requires deposits only from 2020-2022, and then only in the cases when revenues are above forecast. Funding the rainy day fund based on forecast accuracy is somewhat arbitrary and could lead to perverse outcomes like deposits being made in the depth of a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. , and no deposits being made during growth periods if revenue forecasts are too high. Furthermore, Kansas has been maintaining significant ending fund balances in recent years. Some of this money could be appropriated to shoring up the Rainy Day Fund so that Kansas is better prepared for a future recession.
In conclusion, we thank you for your time and attention today, and we welcome your questions.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe