Don’t Let Judicial Spending Mandates Ruin Tax Climate
Marching to the brazen order of the Kansas Supreme Court, Kansas legislators are now debating how to raise an additional $143 million a year to spend on schools.
Raising taxes will undoubtedly be one of the first suggestions, but before that idea takes root, Kansas lawmakers need to consider that their already poor business tax climate could get even worse.
Kansas’s state-local tax burden is 15th highest nationally. Among neighboring states, only Nebraska (ranked 8th) pays a higher share of state income for government. Oklahoma, Colorado, and Missouri all have much lower taxes – they’re ranked 40th, 37th, and 41st respectively. This does not bode well for Kansas’s regional competitiveness, particularly since Oklahoma recently passed a major package of tax cuts.
Though Kansas takes a comparatively big tax bite out of its taxpayers, it could mitigate the damage by extracting those taxes in ways that do the least damage to its economy. In many cases, the structure of a tax system can be just as important for its business climate as the size of the tax burden. The Tax Foundation’s State Business Tax Climate Index provides a gauge of how the structure of the Kansas tax system compares with other state systems.
The guiding principle of the Index is tax neutrality. Within each tax, we give a state credit for taxing efficiently if it treats all groups of taxpayers equally. Distortions occur when a state’s tax code induces taxpayers to base financial decisions on tax considerations rather than on economic factors. Neutrality is best achieved with a tax system that levies a low, flat-rate on a broad base with few if any exemptions, credits and deductions.
During 2004, Kansas ranks 32nd overall in the Index, which is a poor score. Regionally, only Nebraska (35th) ranked worse. Colorado (8th), Missouri (11th), and Oklahoma (14th) all have excellent business tax climates.
Much has been written about jobs being “outsourced” to India and China, but most jobs that leave Kansas are more likely to end up in Indiana rather than India. Simply put, state taxes matter to business. They are an input cost and effect business decisions. In an increasingly borderless world, states do not enact tax changes in a vacuum. Every tax law change in a state alters the state’s competitive position in relation to other states, and exerts competitive pressure on other states.
The best way for Kansas to improve its business tax climate is to rescind one of the three major taxes: individual income, corporate income, or sales. Nine states don’t tax wages; five states do without a corporate income tax, and five states have no sales tax. These states have benefited in a number of ways. Most obviously, businesses are attracted to locate jobs in a state where an entire layer of unproductive administrative work is absent and where the overall tax burden may be lighter. Less obviously, when a state government has one less revenue source, it must administer its remaining revenue sources much more judiciously. With no sales tax revenue, for instance, state tax officials are more reluctant to promote politically motivated exemptions and deductions in its income tax.
Short of eliminating one of these taxes, Kansas needs to overhaul its current progressive income tax systems. On the individual side, Kansas could tax personal income at a flat 6 percent level (a small cut from the current top rate of 6.45%), and on the business side, Kansas could institute a flat 6 percent rate on corporate income (a significant cut from the current top rate of 7.35%), adopt a single-sales apportionment factor, and make improvements to its net operating loss and capital stock tax systems. As a result, Kansas would move up to 23rd overall in the State Business Tax Climate Index, making Kansas’s tax system substantially more competitive with its surrounding states.
These changes would of course have revenue impacts, most likely resulting in a small tax cut, something that Kansas needs anyway if it is to compete with its low-tax neighbors. Politically, it is always tempting to offer revenue-neutral tax reform so that legislators’ pet spending programs aren’t threatened. Unfortunately, in the process of making the “minor adjustments” that force a tax reform plan into the revenue-neutral mold, tax-writers can quite easily complicate the law to the point that most of the potential benefit is lost.
One good way to control spending in the long run without requiring specific cuts to existing programs is to adopt a Colorado-style Taxpayer Bill of Rights. The idea is to create a slowly rising ceiling on annual spending, usually linked to the growth of population and inflation. Most states with such laws create loopholes that make them ineffective, but if the ceiling can be enforced, Kansas could have an orderly way to control and prioritize spending and reduce waste. This will naturally reduce the tax burden over time.
Competition between states is increasing and those states with poor business tax climates will suffer. With a few simple changes aimed at simplifying, broadening, and flattening the tax code Kansas lawmakers can make their state a premiere place to conduct business.