Tax cuts. Does it work?
Trump unveils his new tax proposal this week, and if passed, would be one of the first major tax reforms in decades. At a high level, the proposal consists of tax cuts, which are really the basis of what Republicans champion. Democrats, meanwhile, are pointing to the major tax cuts in Kansas a few years ago to argue against it—in 2012, Governor Sam Brownback enacted a tax cut that has been deemed a massive failure. I thought it’ll be interesting to explore what actually happened.
Brownback’s proposed tax cut that rolled out in 2013 consisted of the following:
- Slashing of state income taxes by $3.7 billion over 5 years, analyst project budget deficits to reach $2.5 billion in 2018.
- 3 bracket tax system to two. Highest income tax rates are cut from 6.45 and 6.25 percent to 4.9 percent, the lowest tax rate from 3.5 percent to 3 percent.
- State sales tax drops by 6/10th of a cent. Keeps deductions for charitable contributions and interest on home mortgages.
- Removes tax credits (food sales tax rebates, credits for taxpayers who work and have children, disabled dependents)
- Exempts non-wage business income for 190k LLC and sole proprietorships.
The idea is that lower taxes will spur small businesses to create more jobs, increase their demand for goods, and increase consumption taxes. It might even incentivize people from other states to come to Kansas. The theory is that this will earn the government even more revenue. Income tax would be phased out by increased taxes on consumption. The administration imagined the creation of 22k more jobs and 35k more people moving to the state in the next 5 years.
So what was the aftermath? What followed were nine rounds of budget cuts over four years, three credit downgrades, and missed state payments.
Brownback actually won the reelection race (though a close margin) in 2014. But a few months after the election, the state projected that they were at a budget gap of over $600 million, when tax revenues came up $200 million short than projected. Brownback proposed to slow income tax cuts, raise taxes on cigarettes and alcohol, overhaul school funding, and divert money from the state’s highway fund to balance the budget. The state transportation department delayed major highway projects and schools and universities faced funding cuts. And when these funds got cut, Democrats and Republicans alike have criticized Brownback. Many of Brownback’s allies in the Legislature got ousted and more moderates were put in power.
Brownback blamed the budget shortfall on automatic increases in education spending, and unanticipated slumps in the farming and energy industries. He pointed to an uptick in job growth that the tax cut was working and claims that the target of the tax cuts were job creation and business formation, which has happened–there were a record number of new business filings in Kansas and record employment last year. The only issue with that claim is that compared to nearby states, those with even high taxes, its growth lagged behind.
- Since January 2013, total employment in Kansas rose by 2.7%, compared to 6.5% nationally. Private sector employment rose 3.5%, compared to 7.6% nationally.
- Kansas GDP grew 4.8% between 2012-2016, national GDP rose 11.9%.
- Kansas’ share of newly open businesses actually declined.
- The reduction in unemployment rate in Kansas, from 6.8% to 3.9%, is a slower decline from the US nationally in the same period (9 to 5%).
In Feb 2017, Kansas’ Republican-led Legislature voted to roll back the tax cut, implementing income tax increases that would raise more than $1 billion over two years. Brownback has vowed to not sign the bill, and neither chamber had enough votes to be able to overcome a veto. Through 2019, the state projects a budget shortfall of over $1.1 billion.
So why didn’t it work? In theory, it sounds so great. NPR did a podcast episode on this topic and interviewed two small business owners. Both made inventory purchases with their tax cuts, but there wasn’t the “trickle down” job creation it was suppose to offer. The reason is that they make hiring decisions based on need, and there wasn’t a need for more of their product. Another possible reasoning is that businesses don’t make large investments on things if the tax cut is a one time, temporary thing. It’s not a tax cut that is big enough that would actually change behaviors or habits.
There are probably a multitude of reasons, or things to debate about whether or not supply-side economics work, but for now, Kansas is scrambling to figure out a way to make up their budget gaps. The Kansas Supreme Court ruled in March 2017 that the state’s spending on public education was unconstitutionally low, with minorities harmed by the lack of funding leading to low graduation rates and test scores. The legislature will have to come up with a solution by June 30.
As this continues to unfold, Kansas has been a glaring warning for Trump’s proposal for tax reform.