Threat of Another Kansas Credit Downgrade after Veto of Tax Package

February 28, 2017

Last week, Kansas Governor Sam Brownback vetoed legislation passed by the legislature that would have closed the state’s controversial pass-through carveout and partially undone some of the individual income tax rate cuts enacted in 2012. Monday, Moody’s announced that the veto by the governor counts against the state’s credit rating, which impacts the cost of state borrowing.

Jonathan Shorman of the The Topeka Capital-Journal writes:

Gov. Sam Brownback’s veto of tax legislation represents a “credit negative” to Kansas, a ratings agency said Monday — a label that amounts to a warning shot for the fiscally challenged state.

Brownback’s vetoed House Bill 2178 on Wednesday. The Legislature attempted to override the veto hours later, succeeding in the House but falling three votes short in the Senate.

Moody’s criticized the veto in a statement:

“With the state for now sticking with a lower-tax policy, Kansas will continue to struggle to balance its budget, consider deferring pension contributions again, and drain its highway fund of funding for crucial transportation projects,” Moody’s senior analyst Dan Seymour said.

Moody’s commentary constitutes a “credit negative” to the state, but the ratings agency didn’t change the state’s credit outlook or downgrade its rating. Still, Seymour warned the state’s credit may be at risk in the future.

“Continuing to resort to stop-gap measures that do not resolve, or may even worsen, the state’s long-term structural problems would intensify the pressure on Kansas’ credit quality,” Seymour said.

The agency said that while it expects Kansas to resolve its fiscal problems eventually, the longer [its] budget remains out of balance, “the greater the risks to its credit quality.”

[…]

Moody’s rates Kansas Aa2, with a negative outlook. Another major ratings agency, S&P, rates Kansas at AA-.

S&P moved the state’s credit outlook from stable to negative earlier this month.

We have been critical of Kansas’ budget practices, in particular the pass-through carveout, which exempts all LLC, S-corp, sole proprietor, partnership, and farm income (Schedules C, E, and F) from state income tax. Kansas has suffered recurring budget shortfalls and has struggled with a negative cash situation, opting to try to ameliorate these issues with one-time money and volatile revenue streams instead of long-term fixes.

It is worth noting that tax reform is perfectly compatible with a strong credit rating if done right. Indiana and North Carolina, the sites of two of the most impressive tax reforms of the last decade, both hold AAA credit ratings despite substantial rate reductions in corporate and individual income taxes. The key difference is that their tax reforms have opted for broader tax bases, lower tax rates, and a spending trajectory that matches their tax revenues. Kansas, by contrast, significantly narrowed its tax base while slashing rates and holding spending steady, and the numbers won’t add up until something on that list gives.


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