Kansas Approves Tax Increase Package, Likely Will Be Back for More

The Kansas Senate just voted 21-19 to concur in the House tax plan (SB 270/HB 2109), sending it to Governor Brownback who has said he will sign it. The plan has eight major components:

• Increases the state sales tax from 6.15 percent to 6.5 percent, effective July 1, 2015 (although retailers have 30 days to implement, which may push back the actual effective date). Coupled with local sales taxes, Kansas now leapfrogs California to have the 8th highest sales tax in the United States. The final bill drops earlier proposals to end a grocery tax credit for low-income individuals and instead lower the sales tax rate on food, and to expand the sales tax to some currently exempt services. The sales tax increase is expected to generate $164 million.
• Increases the cigarette tax from 79 cents per pack to $1.29 per pack, effective July 1, 2015. Imposes a tax on vapor (e-cigarette) products at a rate of 20 cents per milliliter of consumable material, effective July 1, 2016. Kansas already has a net inflow of smuggled cigarettes, and these changes will likely exacerbate that trend. Expected to generate $40 million.
• Eliminates most deductions and carveouts in the individual income tax. Itemizers will still be able to deduct 100 percent of charitable deductions and 50 percent of mortgage interest and property tax from their state income tax. Expected to generate $97 million.
• A one-time tax amnesty to run from September 1 to October 15 for any taxes unpaid as of December 31, 2013, expected to generate $30 million.
• Exempts low-income individuals from the income tax, defined as single filers with income below $5,000 and joint filers with income below $12,500. Expected to reduce revenues by $19 million when it takes effect in FY 2017.
• Requires voter approval for cities and counties to spend property tax revenues above the rate of inflation, unless the funds were used for new infrastructure, certain bonds and interest, special assessments, costs associated with federal or state mandates, or payments of judgments.
• Requires revenue growth above 2.5 percent per year, after adjusting for growth in the Kansas Public Employees Retirement System (KPERS), to reduce individual income tax rates starting in the year 2019. Previously scheduled income tax rate reductions are canceled, keeping the rates at 2.7 percent and 4.6 percent through 2017, then 2.6 percent and 4.6 percent in 2018.
• Re-imposes income tax on “guaranteed payments” received by members of pass-through businesses. Kansas in 2012 completely exempted the income from such individuals, who now total over 330,000 exempt entities. Efforts to repeal this unusual and non-neutral total exclusion of pass-through income earned a veto threat from Governor Brownback. The guaranteed payments provision is estimated to generate approximately $20 million per year.

All told, the package is expected to generate $384 million in additional revenue in FY 2016. This will make Kansas’s total available revenue $6.407 billion, a 6 percent increase over FY 2015. However FY 2015 had a significant cash deficit, masked by draining the rainy day fund and beginning balances, and helped by very slow spending growth (only 1.1 percent from the previous year). The crisis had led the state to issue furlough notices to non-essential state employees, as the first FY 2016 pay period would fall in mid-June 2015 (due to earlier efforts to push expenses into future years).

The narrow surpluses now projected depend on a big boost in revenue in 2018 (4.7 percent) over the previous year, constrained spending growth each year (1.2 percent), no further diversions of income tax revenue caused by the pass-through exclusion, and $50 million of further unidentified spending cuts. If any of these prove untrue, a budget gap of tens of millions, or even hundreds of millions of dollars, would reopen. The pass-through exclusion is especially tricky, as the number of Kansas taxpayers taking advantage of it to reconfigure their wage income into exempt income has greatly exceeded expectations, causing significant revenue instability for the state.

Some elements of this package are good tax policy. But overall, it is a grab bag of ideas that does little to address the problems underlying Kansas’s tax and budgetary instability. Absent more fundamental changes, legislators will likely have to return in coming years to address budget gaps.