Kansas budget busting a lesson to tax cutters

Three Republican governors of Midwestern states talked about Missouri River flooding when they got together in 2011, but Nebraska's Dave Heineman, left, and Iowa's Terry Branstad, middle, might want to talk taxes now with Sam Brownback. A year ago, the Kansas governor, right, passed an aggressive and controversial tax-cut plan.

LINCOLN — A conservative Republican governor pushes an ambitious plan to eliminate state income taxes and join the states, such as Texas and Alaska, that don't levy that tax.

His argument is that it would put more dollars in the hands of business owners, who, in turn, would increase investment and create jobs. Everyone wins.

Sound familiar?

That scenario could describe Nebraska's Dave Heineman, but it also describes Kansas Gov. Sam Brownback, who won passage of an aggressive and controversial tax cut plan a year ago.

But the Kansas “experiment,” as some call it, should provide a warning to tax reformers in the Cornhusker State, according to some lawmakers and tax authorities.

In Kansas, lawmakers left a $700 million hole in the state budget last year when they passed tax cuts without dealing with the loss in tax revenue. This year the hole was partially closed — by cutting $50 million from higher education spending, paring some popular middle-class tax breaks and raising state sales taxes.

The lesson from Kansas: Don't wade into the complicated swamp of state policy without thinking through the consequences on state services and other taxes.

“They kind of rolled the dice,” said State Sen. Galen Hadley of Kearney, who is heading the Nebraska Legislature's Tax Modernization Commission.

“You have to go at (tax changes) slow and with some caution,” Hadley said. “The stakes are pretty high on this if it doesn't turn out the right way.”

Joe Henchman, a policy analyst with the conservative Tax Foundation, labeled Kansas' approach “irresponsible budgeting,” because — initially, at least — it cut taxes without cutting spending or broadening other taxes to offset the lost revenue.

“They just left a hole,” he said.

Kansas and Nebraska are among a group of states headed by Republican governors that have debated tax reform in the past two years. A common refrain has been the desire to cut or eliminate state income taxes because economic growth has been higher in states, such as Texas, that don't levy state income taxes.

Kansas got ahead of the pack, enacting an aggressive tax-cut plan in 2012.

“Look out, Texas. Here comes Kansas,” Brownback declared in his 2012 State of the State address to the Kansas Legislature.

Brownback employed Arthur Laffer, an economist often called the “father of supply-side economics,” to craft a plan.

As amended this year, the state will gradually cut personal income tax rates over several years and eventually eliminate the state income tax completely, if other state tax revenues rise high enough. State taxes were eliminated on “non-wage income” like investments for about 200,000 small businesses.

A popular rebate program for sales taxes paid on food was trimmed a bit, and a state tax deduction for mortgage interest was cut in half.

An even more controversial change was reneging on the rollback of a temporary state sales tax increase. The tax was increased to 6.3 cents during the recession. It was slated to drop to 5.7 cents July 1 but instead dropped only to 6.15 cents because of budget concerns.

The general goal of the plan was to put more money in the pockets of small-business owners, who would then reinvest that money into new jobs and new equipment, improving Kansas' standing as tax-friendly for business.

“We were just puttering along as a state,” said Mike O'Neal, president and CEO of the Kansas Chamber. “We wanted to be better than average.”

Nick Jordan, Kansas secretary of revenue, said that although it was too early to say if the plan is creating jobs and business growth, he is hearing “a lot” of anecdotal stories about companies considering moves to Kansas. Corporate filings set a record last year, and small businesses have purchased $145million in new equipment because of a tax change that allows them to depreciate them faster.

“In Kansas, we've said the private sector is the way to grow the economy,” Jordan said. “We feel this is the way to do it.”

O'Neal, a former speaker of the Kansas Senate, called the changes “pretty historic.” He dismissed criticism that the reforms were not well-conceived and that they will deeply cut services that businesses care about, like roads and universities.

Kansas, he pointed out, rose from 26th to 11th in one year in the Rich States, Poor States rankings of economic outlook by the conservative American Legislative Exchange Council (ALEC). Laffer, the rankings' lead author, was the consultant hired to help craft the Kansas plan.

“We think we're really on the right track here,” O'Neal said. “We did not take money away from core functions. Agencies didn't get some increases (in funding). But this argument that budgets were cut to the bone just isn't true.”

Critics say the way to increase economic activity is to increase demand for products by cutting consumer taxes and investing in services that attract businesses, including better roads and universities and safer streets. The Kansas plan, they said, mostly helped the wealthy to the detriment of the middle and lower classes.

“It was Robin Hood in reverse,” said Kansas State Sen. Anthony Hensley, D-Topeka, the Senate minority leader. “It's an unfair income tax.”

Hensley said that the wealthiest 1 percent of Kansans will see an average tax cut of $21,000 while the poorest 20 percent of state residents will see an overall tax increase. That's because the state sales tax didn't drop back on July 1 as planned.

Henchman, the Tax Foundation analyst who favors income tax cuts, drew fire for criticizing Kansas' elimination of income taxes on “non-wage income,” or capital gains, by small businesses. He predicted that sort of income tax break will inspire companies to restructure as limited liability corporations or partnerships in order to qualify for the break.

“It's not likely to encourage additional business activity,” said Henchman, who has traveled to Nebraska the past two years to urge changes in this state's tax system.

He is encouraging Nebraska to cut its personal income tax rates, which he says are too high compared with those in neighboring states.

Heineman unveiled a plan in January to eliminate state income taxes by ending sales tax exemptions now enjoyed by businesses, farmers and nonprofits. The proposal was shot down in a barrage of complaints from those entities, which said the plan would drive jobs out of the state and make Nebraska products uncompetitive.

That spurred the creation of the Tax Modernization Commission, which will meet twice this week.

Part of Tuesday's session will focus on income taxes. Hadley, the chairman, said that among the things he's interested in hearing is whether there's evidence that cuts in income taxes spur increased economic activity.

“I'd love to cut income taxes, but how much? And what would we have to not fund to afford it?” he asked. “Those are questions we'd have to ask.”

Omaha Sen. Beau McCoy, another member of the commission, said he's not sure what can be learned from Kansas' bumpy ride to tax reform because each state, and each state's tax system, is unique.

“That's why we're doing what we're doing,” McCoy said of the Nebraska study.

McCoy and Hadley both said the experience in Kansas, and the still uncertain impacts of its reforms, illustrate the wisdom of studying tax reforms before embarking on them.

Hensley, the Kansas senator, agreed. Some Kansas universities have already increased tuition to offset the state budget cuts, there's a pending court order that the state increase aid to K-12 schools by $440 million, and by 2018, the state may need another round of budget cuts.

“Be very cautious,” Hensley said. “What we have is a self-inflicted budget crisis.”

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