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 It appears that a majority in the new Kansas Legislature know the loophole must be repealed, and fully intend to end it.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.

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