Thursday, February 9, 2017

Repeal the Loophole, and More

The LLC loophole has come to epitomize budget-busting tax policy in Kansas. It appears that a majority in the new Kansas Legislature know the loophole must be repealed, and fully intend to end it. But if viewing the situation with clear-eyed honesty, those legislators also know that loophole repeal corrects only a fraction of the problem. To fix Kansas financially, lawmakers must produce a more comprehensive solution.

The loophole, put in place in 2012 as part of the Brownback tax experiment, set up a highly unfair tax situation. Individual Kansans who receive income through a limited liability corporation (LLC), self-employment, a farm, or rental property pay no Kansas income tax. But people who receive a pay check, do owe tax. An owner pays no tax on personal income taken from a business, yet employees of the business pay taxes.

Exempting such a large swath of income from tax has obviously lowered receipts and contributed to financial woes in Kansas, but with little economic payoff. The promise of explosive job growth failed to pan out, maybe because creating a job was never required as a condition of receiving the tax cut. Since the loophole opened, Kansas job creation has been anemic, running far behind our region and the U.S. as a whole.

The loophole has to go. No other state does tax policy this way.

While most Kansans have figured this out, they may not realize that just killing the loophole still leaves Kansas in deep financial trouble. Thanks to the 2012 tax changes, Kansas does not have nearly enough income to pay bills. The loophole caused about one-third of the revenue loss. Income tax rate reductions, which especially benefit the wealthiest Kansans, caused the rest.

The current dire Kansas financial situation will not cure itself; nor will one-time tricks and maneuvers work. Lawmakers need a comprehensive solution that raises enough recurring revenue to meet expenses. “Comprehensive” does not necessarily mean a complete return to pre-2012 tax law, but lawmakers at least need to consider moving the upper income tax rate back where it once was, in addition to closing the loophole. If money continues to be siphoned from the highway fund, a higher gas tax could allow a reasonable level of road maintenance.

The governor’s proposals are of little help: borrow, sell assets, renege on retirement funding, and grab even more from highways. Legislators have to produce the real solution on their own. Strategically, legislators may even need to vote against a stand-alone loophole repeal in order to force a vote on a broader revenue package. A piecemeal approach in which lawmakers cast individual votes on each potential revenue change will likely doom a comprehensive solution.

Irresponsible decisions made five years ago have left a huge mess in Kansas today. Our situation was a lot easier to get into than to unwind. Clean-up requires realistic assessment, courageous votes, and comprehensive tax reform. Anything less leaves Kansas in the same downward spiral.

—This entry was originally published last week in a variety of Kansas newspapers.

Friday, February 3, 2017

January Revenue In Perspective

January general fund tax revenue turned out to be a bit “higher than estimated.” Good. That’s certainly a better situation than if monthly revenue were lower than estimated, as has been the case so many times over the last four years.

However, the January result does not alter the grim financial situation facing Kansas. Nor does it indicate that Kansas is now on some new financial trajectory.

The key words to consider are “higher than estimated.”

Remember, last November Kansas officials made revisions that dramatically lowered the estimate of FY 2017 revenue. The target was set so low that Kansas now expects to receive less tax revenue in FY 2017 than in FY 2016, and far, far less than in FY 2013, the year before income tax cuts fully kicked in. Beating the revenue estimate in January is not exactly a high bar.

In FY 2014, general fund tax revenue fell $700 million when income tax rate reductions and the LLC loophole were implemented. Receipts never recovered, staying at that lowered level in succeeding years.

Think about it this way: Even if revenue collections meet the “estimate,” Kansas has an almost $700 million structural budget gap in FY 2017. The official estimate forecasts recurring general fund revenue at $5.6 billion, against expenses of nearly $6.4 billion. A portion of that gap has already been closed by transferring hundreds of millions from the highway fund and other funds, but lawmakers still have around $350 million to go. The Legislative Research Dept. projects that the gap between revenue and expenses in FY 2018 will grow to around $900 million.

Through the month of January, FY 2017 general fund tax revenue is $32 million higher than officially expected, but $11 million lower than the same period of the last fiscal year. The $32 million helps, but has essentially already been offset by a lower-than-expected amount from the sale of the Bioscience Authority and higher-than-planned-for Medicaid costs. If anything, the current gap between revenue and expense has grown, not diminished.

Kansas’ financial troubles remain very, very serious. The financial wound inflicted by unaffordable income tax cuts will not heal on its own or through accounting tricks and one-time maneuvers. The amount of recurring revenue must be raised back up in order to reasonably meet expenses.

Kansas lawmakers have to face the hard fact that they need a comprehensive revenue reform package to bring structural balance back to the Kansas budget.

—This entry was originally published on the Kansas Center for Economic Growth website.

Sunday, January 29, 2017

Governor’s Budget: Don’t Look Here for Structural Balance

The governor claimed he was producing a structurally balanced budget.  The lieutenant governor predicted that a structurally balanced budget was coming.  And after its unveiling, the governor’s staff asserted the budget was indeed structurally balanced.

But it’s not.  Not even close.  Unfounded claims and assertions can’t make it so.

“Balancing recurring revenue with recurring expenditures is the foundation of a structurally balanced budget ... A truly structurally balanced budget is one that supports financial health for multiple years into the future.”  A&M KansasStatewide Efficiency Study, 2016

Kansas faces a giant gap between recurring revenue and recurring expenses, a gap that opened up immediately when revenue dropped sharply upon implementation of the 2012 income tax cuts.  Subsequently, the FY 2014, FY 2015, FY 2016, and FY 2017 budgets have all been structurally unbalanced, the general fund kept barely solvent by using up reserves, grabbing money from the other funds, borrowing, and one-time tricks.  In each of those years, Kansas became poorer—bank accounts depleted, debt way up, credit rating down.

The governor’s revised FY 2017 budget and newly proposed FY 2018/FY 2019 budget brings more of the same!

FY 2017 (July 1, 2016 to June 30, 2017).  In this half-completed fiscal year, the general fund is $350 million short of being able to meet expenses, even though hundreds of millions have already been transferred from the highway fund, and deep emergency budget cuts applied to higher education and Medicaid providers.   The governor’s budget recommends two main things to address the $350 million shortfall:
  • Borrow.  The governor proposes to borrow $317 million to be paid back over 7 years.  If the Legislature agrees, that would increase expenses over the next 7 years, widening the structural imbalance.
  • Don’t pay bills.  In order to stay financially afloat in FY 2016, the state simply did not pay $87 million worth of bills, including $75 million owed to school districts.  The bills were carried over to FY 2017 to be paid as soon as money was available.  The governor now recommends not paying those bills at all.  (A $96 million KPERS bill also went unpaid in FY 2016, with a promise that it would be paid with interest in FY 2018.  The governor also now recommends not paying that.)

FY 2018/FY 2019.The Legislative Research Dept. calculates the gap between revenue and expenses at about $900 million per year.  The governor’s recommendations to close the gap can essentially be distilled down to four main financial moves:
  1. Sell the tobacco settlement revenue stream.  “Securitization” would sell the next 30 years of tobacco settlement payments (which currently pay for early childhood programs) for a lump sum to prop up the general fund in the short term.  It’s the same concept as a payday loan.
  2. Gut the highway fund.  Between directly transferring money to the general fund and sending general fund bills to the highway fund for payment, more than $500 million of highway fund resources would be diverted to the general fund each year. Administration officials claim this would not harm highways, but that’s as believable as the claim that the budget is structurally balanced.
  3. Don’t make required KPERS payments.  Kansas law sets out a clearly defined schedule of payments into the state retirement system. The governor’s budget proposes paying almost $600 million less than required over the next two years.  Defaulting on these payments doesn’t reduce the state obligation, just pushes it off to future years.
  4. Tax increases.  The governor wants to raise about $180 million per year with a package of tax hikes that include doubling the taxes Kansans pay when they make purchases at liquor stores, and adding $1.00 to the per-pack tax on cigarettes.
Except for the proposed tax increases, none of these recommendations move Kansas toward structural balance by upping recurring revenue or lowering recurring expenditures.  And even if all components of the governor’s tax recommendation would pass, at best the revenue raised only closes about 20 percent of the structural gap. 

The governor’s budget appears designed to avoid the obvious.  The income tax cuts that broke the Kansas budget must be revisited and a comprehensive tax reform plan put in place.   That’s the only realistic way to regain structural balance without severely damaging education, key services, and the state’s infrastructure.   

The proposed budget from the governor does not open a path to a stable financial future.  It’s a recipe for yet another credit downgrade.  Legislators will serve the state best by disregarding much of it and starting fresh.

—This entry was originally published on the Kansas Center for Economic Growth website.

Saturday, January 14, 2017

Happy New Year Legislators, Now Fix the Budget

By Duane Goossen

For Kansas legislators, the new year may not feel all that happy. Veterans and first-termers alike have to be wondering why they ran for the job. In the upcoming legislative session, they face a daunting task, brimming with political risk.

Brownback’s “Kansas experiment” has brought the state budget to crisis. Kansas lacks the income to pay its bills, and not by a little. By hundreds and hundreds of millions. The politically thankless task for lawmakers: either restore revenue to meet obligations, or chop up education, highways, human services, and public safety. Doing nothing will result in damaging service cuts by default.

In the current, already half-completed fiscal year, the general fund has come up $350 million short, even after huge one-time transfers from the highway fund and emergency budget cuts to Medicaid providers and higher education. Most lawmakers will feel obligated to address that immediate pressing problem before grappling with the much larger structural gap between income and expense in next year’s budget.

But they should not proceed in that order. Addressing the long-term structural problem in the Kansas budget must have the highest priority! That may seem counter-intuitive, but it’s a bit like the safety instruction you hear from an airline attendant, “If the oxygen masks come down and you are traveling with a child, put your own mask on first; then attend to the child.” Stabilize the budget structure first, and then deal with the current fiscal year.

Only financially awful alternatives exist to cure the $350 million shortfall. Lawmakers cannot logistically raise new revenue fast enough. So that leaves either sudden budget cuts concentrated at year’s end, or some kind of one-time patch. With the bank account empty and the highway fund tapped out, the “easy” one-time patches have already been used up, but insiders talk of selling something (tobacco settlement revenue, the turnpike), or paying bills late, or grabbing the unclaimed property of Kansas citizens, or somehow borrowing the money.

One-time patches do not solve the real problem. Without a long-term solution in place, selling assets or borrowing become just another hopeless component in the downward spiral of Kansas finances.

But if lawmakers can muster the political will to put a long-term plan in place first, Kansas has hope for financial stability. Then a $350 million patch solution in the current year becomes a “bridge” to a more hopeful future, rather than a step into deeper crisis.

Kansas simply must raise revenue to structurally balance the budget. Closing the LLC loophole alone will not fix the problem. Hopefully Kansans will give their legislators political breathing room to pass a broad revenue reform plan correcting the irresponsible decisions of the past. Otherwise, we’ll face damaging cuts to education and key services.

Lawmakers, make it a happy new year for Kansas. End the ill-fated experiment and structurally fix the budget. Do it early in the legislative session. Do it quickly.

—This entry was originally published this week in a variety of Kansas newspapers.

Thursday, January 5, 2017

The Gap Lawmakers Must Close

The Kansas budget has a huge structural imbalance, a daunting gap between income and expense. For the Kansas general fund to remain solvent, lawmakers must close the gap.

The general fund became structurally unbalanced immediately after the 2012 income tax cuts were implemented, but the situation has become especially dire now with reserves used up and the highway fund tapped out.

Look closely at revenue. The latest Consensus Revenue Estimate (CRE) forecasts total general fund revenue in FY 2017 at just under $6.0 billion, but that total already includes previously authorized one-time transfers of about $400 million from many different funds (especially the highway fund). That means real income, actual money coming in during FY 2017 to pay bills, is just under $5.6 billion. And the CRE forecast for FY 2018: Just under $5.6 billion. And for FY 2019: Just under $5.6 billion. Before the tax cuts the general fund took in more than $6.3 billion annually, but by FY 2017 income has dropped under $5.6 billion without any prospect for improvement.

Now consider expenses. Even a constrained set of expenses for FY 2017 totals over $6.3 billion. Block-granted school funding, and emergency budget cuts to Medicaid providers and higher education have already been baked into that number. And those expenses will certainly grow in FY 2018 and beyond. Medicaid costs always rise. Required contributions to the retirement system (KPERS) increase each year. Enormous pressures across state government—no raises for state employees in 9 years, understaffed hospitals and prisons, underfunded schools—will push costs up.

The Legislative Research Department’s general fund profile outlines the grim structural problem. If the gap is closed only by cutting expenses, another $349 million must be chopped during the 6 months that remain of FY 2017, then an additional $582 million cut from services in FY 2018. Closing the gap by forcing expenses below $5.6 billion may be theoretically possible “on paper,” but highly dangerous and irresponsible, if actually done.

Alternatively, the governor and some lawmakers may promote some type of one-time solution—selling assets, borrowing, paying bills late—to address the remaining $349 million shortfall in FY 2017. (Remember, lawmakers have already approved about $400 million in one-time transfers for FY 2017.) But doing that does nothing to fix the structural problem. It only delays the inevitable reckoning and makes Kansas poorer in the process.

Kansas simply needs more ongoing revenue. The recent Rise Up coalition proposal provides a plan that restores financial solvency and tax fairness, without resorting to damaging program cuts or one-time solutions. The situation that Kansas faces requires a broad plan, more than just closing the LLC loophole. It’s either restore revenue to meet expenses, or whack away at education, highways, human service programs, and public safety.

The task ahead is critically important, though not politically easy. Many key services, which have already been cut or constrained, now hang in the balance. Hopefully when the next legislative session ends, Kansas will be moving toward financial stability, no longer consigned to downward descent.

—This entry was originally published on the Kansas Center for Economic Growth website.

Friday, December 2, 2016

Bipartisanship Required to Fix Kansas Financially

When the Kansas Legislature convenes in January, one-third of the seats will be filled by someone new. The election results show that many voters recognized the serious financial trouble in Kansas and now expect a change in direction.

But will they get it?

Lawmakers face a daunting task. To successfully alter the situation, they must take a big risk and do something that does not come naturally to politicians — gather a bipartisan coalition and reform the tax system to raise revenue.

State finances have so soured that the current budget sunk $350 million underwater even after record amounts were taken out of the highway fund and large spending cuts were unceremoniously applied to universities and Medicaid providers. This leaves Kansas schools and other key state services highly vulnerable to another round of debilitating cuts.

Kansas simply does not have enough revenue to pay even a constrained set of bills. The 2012 income tax cuts unbalanced the Kansas budget from the moment of implementation, but the situation has become especially dire today because lawmakers emptied reserves and exhausted other one-time budget maneuvers in earlier efforts to patch up the budget.

We have few options left. Without more revenue, lawmakers must make deep cuts-to-the-bone in state programs. For those legislators who voted in 2012 to deliberately starve the state’s revenue stream in order to downsize government, this is a happy climax. But that group lost heavily in the elections.

In the 2017 Legislature, moderate Republicans and Democrats now have enough numbers in each chamber to pass policy changes, if they work together. But forming coalitions becomes challenging whenever there’s hard medicine to swallow. Kansas lawmakers will face headwinds as the Trump administration and a Republican Congress attempt to pass the very kind of tax legislation on a national scale that Kansas seeks to undo here.

Then, even if tax policy changes pass the Legislature, the governor may not sign the bill. But despite the barriers, lawmakers must forge ahead because the stakes for Kansas are enormous. The financial sickness will not heal up on its own without corrective action.

One obvious step forward would close the LLC loophole which allows business income to go untaxed. The recent Kansas Speaks survey showed that 61 percent of Kansans support this action. Some lawmakers may be tempted to do only this and declare victory, but that alone will not fix the budget.

At a minimum, lawmakers must make revenue equal expenses, which requires ending the LLC loophole as well as enacting a package of other financial corrections. Reducing sales tax on food as part of this package — as some lawmakers propose to do — would require further upward adjustments to balance the cost.

Can lawmakers work across party lines to enact change? Will the governor sign a bill rescinding at least a portion of the 2012 tax cuts?

Unless the answer to both questions is “yes,” the financial suffering of Kansas will worsen, plunging our state into a further downward spiral.

—This entry was originally published this week in a variety of Kansas newspapers.

Sunday, November 20, 2016

Budget Disaster Deepens

Kansas finances have come to a tragically grim place.

The official estimate of revenue for this fiscal year has just been revised sharply downward, and brand new forecasts for FY 2018 and FY 2019 show a meager, unworkable revenue stream. This new information means that lawmakers must immediately cut $340 million from the current budget, just to keep the general fund barely solvent.

The cause of this disaster traces straight back to the Brownback income tax cuts of 2012. After implementation, income tax receipts fell $700 million, from $2.9 billion in FY 2013 to $2.2 billion in FY 2014, and never recovered. Now, the new revenue estimate forecasts that same $2.2 to $2.3 billion level of income tax receipts all the way through FY 2019.

A huge swath of revenue that Kansas formerly depended on to pay bills has simply disappeared.

As a result, for the fourth year in a row, Kansas does not have nearly enough revenue to pay bills. This year, though, the situation is dire because lawmakers have already used up all of the reserves ($709 million at the beginning of FY 2014), and tapped out the highway fund, leaving little flexibility. Plus, the governor earlier applied deep emergency budget cuts to state agencies, higher education, and Medicaid providers.

Even so, another $340 million must somehow go before June 30. Public education and every other state service stand in serious danger.

This problem will not heal on its own. Without corrective action, things only get worse in FY 2018.

In this current fiscal year Kansas expenses are pegged at about $6.3 billion, and that’s a constrained set of expenses with emergency spending reductions already baked in.

In FY 2018 expenses will only grow: Estimators have already predicted that Medicaid costs will rise $30 million. A $100 million retirement system payment (an unpaid bill from FY 2016) comes due. A Supreme Court decision on education looms. And problems exist throughout state government from years of cutbacks and constraints.

So what’s the new forecast for total revenue in FY 2018? $5.5 billion. And in FY 2019? $5.5 billion.

Even if expenses do not go up a dime from current levels, a completely unrealistic assumption, Kansas revenue is $800 million off the mark in FY 2018 and again in FY 2019.

Kansans, we have to fix this! We have to stop the bleeding and reform our tax structure. We have to start now. The serious damage from the 2012 tax policy deepens every day.

—This entry was originally posted on the Kansas Center for Economic Growth website.

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