Tax cutting may be a good idea, but don't overdo it

Pulitzer Prize winner (2009) Eugene Robinson is an eloquent exponent of liberal viewpoints. He generally gets the facts right, but has been known to engage in hyperbole. Witness his gleeful column about a big setback for fiscal conservatives in a “red state” where Republicans have generally dominated the political conversation. Kansas’ failed experiment in trickle-down economics should be a lesson to the GOP, Eugene Robinson,, 6/12/17.

Here’s a recap of
Robinson’s column and our reactions. In sum, we agree that the Kansas tax cuts were poorly handled, but don’t buy his conclusions about cutting taxes below “sane levels.”

A. Tax cut debacle – Robinson’s version of this story is basically accurate, although he arguably heaps too much of the blame on a fiscally conservative governor. We would also be inclined to fault the legislature for ignoring some elements of the governor’s fiscal plan, and the Kansas judiciary arguably exceeded its proper role in the battle over public school funding.

In 2012, as proposed by Governor Sam Brownback, Kansas “slashed the state’s already-low tax rates, eliminated state income tax for most owner-operated businesses and sharply reduced vital government services.” Brownback characterized these measures as “a real live experiment,” which was supposed to deliver “a shot of adrenaline into the heart of the Kansas economy.”

Governor Brownback proposed a “tax reform” plan in 2012, but the legislature passed the tax cuts (notably a reduction in the top personal income tax rate from 6.45% to 4.9%) without eliminating various tax preferences. A previously scheduled sales tax reduction wasn’t canceled as recommended, nor was spending pruned at the time. Kansas may face budget problems as Senate again strips tax reform out of tax cut bill, Liz Malm & Joseph Henchman,,

Compounding these errors, the legislation exempted small business income realized through “pass through” entities from Kansas income tax. Observers on both the left and the right panned this “LLC exemption” as misguided. What’s wrong with Kansas’ tax reform? Penelope Lemov,,

•Joseph Henchman (Tax Foundation): [If] you're a wage earner, you're taxed at the top rate, which is currently 4.9 percent in Kansas. If you're a partnership, an LLC or any form of recognized business entity with limited liability that's not a corporation, your income is taxed at zero percent. That's an incentive to game the tax system without doing anything productive for the economy.

•Nick Johnson (Center of Budget and Policy Priorities): [The law’s] exemption of pass-through entities creates inequities and tax avoidance, which of course then goes back to sustainability because it balloons cost.

The hoped-for boost to the Kansas economy failed to materialize, e.g., there was no surge in business entrepreneurs moving to Kansas. Business owners take more than taxes into account when deciding where to locate; they also want (for themselves and employees) good healthcare, first-rate schools, and modern, well-maintained infrastructure.

The Kansas governor’s budget report for FY 2018, pp. 14-16,
1/11/17 (download PDF) acknowledges “lackluster tax collection growth,” but offers a different explanation.

• Kansas has experienced five consecutive years of record business formations, with over 17,000 new domestic entity filings in 2015 alone. Furthermore, recent data from the U.S. Census Bureau indicates that 82.0 percent of all new private sector jobs created in the first two years of the tax plan were created by pass-through entities, the very businesses targeted by Governor Brownback’s tax cuts. Unemployment has remained below 5.0 percent for three consecutive years.

• The lackluster tax collection growth in Kansas can be attributed, in part, to the weakness of the energy and agriculture sectors. Declining oil production plus sharply lower prices – steady drop in grain prices – overall value of crop production in 2017 likely to be at its lowest level since 2009.

Deficits mounted to unsustainable levels. Services withered. Brownback had set in motion a vicious cycle, not a virtuous one.

If tax revenue plateaus, spending must be correspondingly limited to avoid growing deficits. And that inconvenient fact was amply demonstrated by Kansas fiscal trends after 2012, as summarized by two charts from the governor’s
budget report.

Screen Shot TaxReceipts

Screen Shot State Gov't

The revenue shortfall was addressed initially by drawing down the reserve fund – but when that fund was exhausted a choice became necessary. Cut spending sharply or raise taxes. Brownback’s right-wing “experiment” is bankrupting Kansas. His solution: more radical cuts, Danny Vinik,, 2/13/15.

In late January [2015], Brownback sent the legislature a proposed budget to address the [$600 million budget short-fall in fiscal year 2016] problem. He wants to cut more than $100 million from school finances and $50 million from Medicaid *** increase cigarette taxes by $0.79 *** [increase] taxes on liquor *** [eliminate] certain [income] tax deductions *** transfer another $200 million from other funds to the general fund.

Two years later, the state’s fiscal woes continued. Revenue estimates remained dismal, e.g., “the revised estimate of [state general fund] receipts for FY 2017 is $5.980 billion, a decrease of $345.9 million below the previous estimate.” Spending growth would continue to be strictly limited, and even so a raft of budget gimmicks would be needed to balance the books. It was proposed, for example, to raise some $0.5 billion in fiscal years 2018-2019 by borrowing against anticipated future receipts from the 1998 settlement of a multistate lawsuit against the tobacco companies. Governor’s budget report, pp. 32-34.

Kansas legislators had apparently tired of fiscal frugality. They passed a bill in February that would have ended the income tax exemption for pass-through business income and created a new top income tax rate (5.45% vs. the 6.45 top rate eliminated in 2012) for affluent individuals. Governor Brownback vetoed this legislation, however, and the veto override attempt fell short. Kansas sends tax overhaul to Governor Brownback, Joseph Henchman & Scott Drenkard,,

At long last, the legislature — still controlled by Republicans — overrode Brownback’s veto of legislation “restoring taxation to sane levels.”

The legislature passed a second tax increase bill in June, and this time the governor was bested. Legislature overrides Brownback’s veto of bill that rolls back his 2012 tax cuts, Hunter Woodall,,

Tuesday’s vote to turn away from Brownback’s wishes was the most recent signal that a statehouse that moved more towards the center after the 2016 election cycle has come to resist the policy points long championed by the Kansas Republican.

More revenue-raising measures may be needed. Education funding under Brownback was reduced to levels that the state Supreme Court recently ruled unconstitutional. It is unclear whether a $488 million increase for the schools over the next two years — which Brownback may still try to block — will be enough to satisfy the court.

Here’s some background on the Kansas Supreme Court decision, which was handed down only days after the governor vetoed the first tax increase bill in February.

The case had been brought by over 50 school districts in 2010, with numerous procedural twists and turns along the way, and in 2017 was ripe for decision. One might be excused for imagining that the governor’s veto of a tax increase steeled the resolve of the justices to proceed.

In any case, the Court held that state funding for secondary public schools (K-12) in Kansas was both inadequate (not enough on an overall basis) and inequitable (not fairly allocated between school districts). The decision did not specify what level of school funding would be deemed adequate, although an attorney for the plaintiff school districts was talking in terms of $800 million (per year?).

Given that over 50% of the outlays from the State General Fund go to support K-12 education, the Court was effectively ruling that the state was constitutionally required to raise taxes. There had been earlier claims that the Supreme Court justices were overstepping their bounds by getting into such matters, but five justices had been on the ballot in the 2016 elections and all of them had been reelected.

The state was given until June 30 to come up with a remedial plan. Efforts to comply (using proceeds from the second tax increase bill) will be made, no doubt, but a lengthy, court-supervised negotiation process seems likely. Kansas Supreme Court rules school funding inadequate,,

The foregoing saga has undoubtedly been traumatic for Governor Brownback, and it’s possible that he will choose to step down. If so, he has reportedly been offered a job (e.g., ambassador post) in the Trump administration. Budget bill anticipates Brownback may resign,,

B. Lessons to be learned – For those who may have forgotten, the tax cut debacle in Kansas should serve as a reminder that it’s unwise to overdose on tax cuts while neglecting to broaden the tax base (e.g., by eliminating tax preferences) and/or slow the growth of government spending. Robinson goes further, however, by lumping all fiscally conservative ideas as “trickle-down” economics and dismissing the combination as folly.

Republican leaders in Congress will probably try to ignore the Kansas fiasco or say Brownback’s implementation was flawed. But that would be unfair. All Brownback did was apply what passes for mainstream Republican orthodoxy these days: Cut taxes, eliminate regulation, shrink government, then stand back and watch as economic growth soars.

A predisposition against shrinking government might make sense if all government programs/activities were of equal value, but such is not the case.

Some government functions are crucial, e.g., maintaining a credible US nuclear deterrent, and merit strong support. Can the US afford modern nukes; forty billion a year isn’t much for America’s survival, Matthew Costlow, Wall Street Journal,

When President Obama left the White House, he punted on a tough choice: how to modernize the U.S. nuclear force. In the coming weeks, the Congressional Budget Office is expected to release a report that estimates modernization as currently proposed would cost $1.2 trillion over 30 years, or about $40 billion a year. Congress and the Trump administration shouldn’t be intimidated by the ostensibly big number.

Other functions are of questionable value; instead of being funded year after year, they should be restructured or eliminated. The debt bomb, Senator [since retired] Tom Coburn,

ome say the problem in Washington these days is “gridlock,” which prevents politicians from getting things done. Coburn strongly (and we think convincingly) rebuts this idea (page 110): “Over the past several decades . . . Congress has been an assembly line of new programs and a favor factory for special interests. Our economy is on the brink of collapse not because politicians can’t agree, but because they have agreed for decades. For years, a bipartisan supermajority in both parties has agreed to borrow and spend far beyond our means.”

Robinson also ignores current and projected budget deficits, which must be addressed to avert an eventual fiscal meltdown, or perhaps assumes – unrealistically in our opinion - that any problems could be readily solved by collecting more taxes (never mind the consequences for the US economy). Fixing fiscal problem won’t be easy,

[The GOP orthodoxy] never works. Republicans cannot point to an instance in which this prescription has led to the promised Valhalla of skyrocketing growth. Before Kansas, they could at least argue that the program had only been attempted partially and piecemeal, never in full and unadulterated form. After Kansas, that excuse is gone.

OK, tax cuts backfired in Kansas, but that doesn’t prove they are invariably a bad idea. What about the JFK tax rate cuts in the 1960s or the Reagan tax cuts in the 1980s? How come the Texas economy is prospering, even though the Lone Star State doesn’t have an income tax?

On the other hand, some blue states that have followed liberal fiscal policies are experiencing serious difficulties. Thus, the Land of Lincoln is teetering on the edge of insolvency with no solutions in sight. Illinois must dig itself out of the fiscal ditch, Jonathan Williams,,

Considering the enormous budget issues the state is facing, with pensions being a key driver, one might assume the state government is not bringing in enough revenue and merely needs to raise taxes. This is simply false. According to Tax Foundation’s analysis, Illinois’ taxpayers pay the 5th highest combined state-local tax burden in America. *** It should come as no surprise, then, that nearly 700,000 Illinois residents left from 2006-2015 [cite]. Only New York and California experienced higher levels of domestic out-migration during the same period.

President Trump and the Republican-led Congress . . . threaten to run Brownback’s experiment on a national scale, with predictably disastrous consequences.

We aren’t convinced this is what Republicans have in mind, i.e., that they plan to cut tax rates without broadening the tax base or curbing overall spending. Tax cuts are popular whereas the other elements of the equation are not, however, and there is a lot of pressure on the administration to “get some points on the board” quickly.

The legislative outcome (as it was in Kansas in 2012) might be a big tax cut versus tax reform. Such an outcome would inflate the deficit versus helping to whittle it down, which in our view would be a grave mistake. A tax cut sounds appealing, but can we afford it?

White House budget director Mick Mulvaney proposes amputational cuts to the social safety net and bureaus such as the State Department and the Environmental Protection Agency.

In our view, the spending cuts proposed by the administration for fiscal year 2018 were well supported and merit thoughtful consideration. Further cuts will probably be required, moreover, because it should not take 10 years to bring the budget back into balance. Pluses and minuses: assessing the president’s budget proposal,

Trump’s “tax reform” plan proposes, among other cuts, to slash the top tax rate for “pass-through” businesses — basically, owner-operated firms such as the Trump Organization — from 39.6 percent to 15 percent.

It’s clear that the income tax exemption for pass-through business income promoted tax avoidance efforts in Kansas, although there was probably some economic stimulus involved as well. Kansas’ pass-through carve-out: a national perspective, Scott Drenkard, Tax Foundation,

When the exemption was passed in 2012, it was projected that 191,000 entities would take advantage of the provision. As more and more people have realized the very sizeable tax advantage of being a pass-through entity in Kansas, that number ended up being 330,000 claimants, over 70 percent more than was anticipated. [Thus,] the pass-through carve out is primarily incentivizing tax avoidance, not job creation.

The administration will propose a lower tax rate for pass-through business income, not exemption as was done in Kansas. A 15% tax rate for such income is arguably in harmony with the proposed 15% corporate income tax rate, and Treasury Secretary Steve Mnuchin says there will be rules to prevent wealthy taxpayers from getting too creative in their use of the reduced pass-through rate. Briefing by Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn,,

Well, again, what we've said is that the business rate is going to be available for small and medium-size businesses as well as corporations.  However, we will make sure that there are rules in place so that wealthy people can't create pass-throughs and use that as a mechanism to avoid paying the tax rate that they should be on the personal side.

Maybe there will be a problem here, maybe not, but it doesn’t seem necessary to make assumptions about the details of a tax plan that is under development and won’t be put on the table for some time.

The GOP trembles before tax-cut guru Grover Norquist, who wants to reduce government “to the size where I can drag it into the bathroom and drown it in the bathtub.” But it is failed trickle-down ideology that deserves to be snuffed out. And not just in Kansas.

A vivid description, no wonder Mr. Robinson won a Pulitzer Prize!

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