Kansas May Face Budget Problems as Senate Again Strips Tax Reform Out of Tax Cut Bill

Most economists will describe a good tax system as one with broad bases and low rates. Such a tax system is neutral, simple, and transparent by design, and is able to provide adequate and stable revenues from year to year. By not favoring certain industries, groups, or activities with targeted carve-outs, tax rates can be kept low for taxpayers of all types. Any tax reform measure that moves in this direction is on the right track. Rate cuts coupled with spending reductions make sense in states where there is a desire to reduce the tax burden and the scope of government. Less defensible are rate reductions that lose revenue without cutting spending, as that just causes budget problems.

That’s what Kansas is doing. Last year, Governor Sam Brownback (R) proposed a comprehensive tax reform plan that would have moved Kansas toward a simpler and more neutral tax code. His plan offered lower individual income tax rates and the closing of numerous carve-outs (such as most itemized deductions). A modified version of this plan eventually passed in the House. Less-costly compromise legislation in the form of a House-Senate Conference Committee was intended to replace the House bill, but that ultimately did not occur. According to the Wall Street Journal, “in an attempt to embarrass the Governor and House Republicans, the Senate passed a giant income tax cut that it believed the House would reject because of its price tag. The ploy backfired when the House approved the Senate plan.” Other versions of the story argue (Tax Analysts, subscription required) that the Senate passed the tax cut bill under the assumption that the House would choose the compromise version, but the House instead sent the larger plan straight to the Governor’s desk for approval.

Regardless of why, the final tax plan kept the income tax cuts (dropping the top rate from 6.45 percent to 4.9 percent, effective this year) but dropped the income tax base broadening that would have made the budget impact manageable. Additionally, it problematically exempted certain non-wage business income from the income tax, increased the standard deduction for certain individual taxpayers, and halted the suspension of a sales tax rate drop that was set to occur mid-year. The fiscal note estimated that the plan would cost $231 million in 2013 and $803 million in 2014. Spending was not cut, so a hole developed in future years—a hole that cannot be closed by any reasonable expectation of economic growth, and one that threatens to discredit other tax reform efforts.

One year later, the Governor again proposed some base-broadening to close this budget hole. The bill would have further reduce income taxes rates over the next few years (reducing it down to 3.5 percent by 2017), phased out most itemized deductions, and frozen the sales tax rate at its current level. Once again, legislators stripped out the base broadening and kept the tax cuts. Some conservatives openly spoke of “starving the beast”—the notion that spending cuts will have to happen once the state is deprived of extra revenue. However, the spending cuts have not yet been identified, let alone implemented. According to the Houston Chronicle, even Governor Brownback “acknowledge[s] that last year's aggressive cuts created budget problems.”

The eventual goal for Gov. Brownback and for many legislators is to completely phase-out the individual income tax. I’d feel a lot more comfortable if there was a good game plan on how to do it—whether that involves spending cuts or replacement revenue. The Senate has rejected the Governor’s proposals for replacement revenue, preferring to just promise the current level of services and hoping that enough time passes before it all comes to a head. Kansas can do better than that: that’s what the federal government is doing, after all. Kansas also has to do it, as they have a balanced budget mandate. (The Kansas Policy Institute has offered some suggestions.)

Base-broadening, in addition to offsetting revenue losses from decreasing rates, eliminates distortionary tax preferences and can create a neutral and simple tax code. Kansas can provide a valuable lesson to all states—tax reform is a tough process that requires politically difficult decisions. I bet they’re up to the task.