The Kansas Experiment

TIDE-HSV · Jun 17, 2017

RammerJammer14 said:
Man, who knew you could tax your way to prosperity. Might as well take it all then!

(For the record I believe there is a balance somewhere to be struck)

I agree. Kansas hasn't found it...

CharminTide · Jun 17, 2017

TIDE-HSV said:
I haven't looked up the numbers from Kansas, but my impression has been that they slashed revenue without decreasing spending materially. That won't work. Magic won't cut it...

I admit to not knowing the past few years of Kansas state policy in detail, but it sounds like few or no spending reductions were enacted. When Brownback signed his supply-side tax reform bill, he insisted that the tax cuts would spur the economy, and more than cover the tax revenue deficit. Clearly, that fiction did not come to pass.

Here's a summary of the actual effects, quoted in part below.
And here's the white paper that's referenced in the summary.

Instead, the Kansas economy tanked. For two years in a row, the state’s credit rating has been downgraded because of its budget problems. Job creation and economic growth is far below the national average. The state is facing a budget shortfall of about $889 million in the next two years.

How did this happen? According to economists, one major factor was that Brownback’s plan eliminated taxes on owner-operated businesses, known as pass-throughs. Brownback promised this would kick-start economic growth by encouraging business owners to reinvest the extra money and expand their businesses.

Instead — according to new research from economists at the University of South Carolina, Indiana University, and the US Treasury Department — it led to serious tax avoidance.

The researchers analyzed federal tax returns for more than 1 million taxpayers in Kansas and four bordering states — Missouri, Oklahoma, Colorado, and Nebraska — in the two years before the tax reform went into effect in 2013, and two years after.

If Brownback’s theory had been right, the tax returns would have shown that business in Kansas was booming.

“The initial expectation was that lowering the tax rate would increase business activity,” says Jason DeBacker, an economics professor at the University of South Carolina and the lead author of the study. “You might see people earning more income or businesses expanding in employment or investment. But there was little or nothing of that going on.”

The analysis showed that while reported business income did go up, it was mostly from people who previously earned wages from an employer (in a W-2 tax form), and later reported earnings from the same employer as contract business income (in a 1099 tax form).

In other words, people were gaming a particular aspect of the new system. Owner-operated businesses are treated differently by the tax code than other businesses. Instead of the business paying corporate taxes on the profits, the owners pay individual income taxes on them. (Income you make as profit from a business you own is known as “pass-through income.”)

But Brownback got rid of the tax on pass-through income. So there was suddenly a big incentive for people to find a way to reclassify their income as business income. If you were an engineer working for a company, you’d pay individual income taxes on the money you made. But if you were a self-employed freelance engineer — a one-person business — who contracted with the company instead, you’d pay zero income taxes.

And that’s exactly what happened. Businesses did not expand and invest more as a result of the tax savings.

When Kansas' tax revenue tanked, it created a downward spiral. Suddenly, Kansas couldn't afford upkeep on its roads, which further harmed businesses. They tried to find money by removing funds from public education (screwing over the future is always a good investment). Then they tried to do the state equivalent of taking money out of their 401k and pinky swear to pay it back. Ultimately, they just had to admit that the promise of free market supply side nirvana was a myth and rolled back the changes.

Trump's tax policy advisers were the same ones that wrote Kansas' tax reform bill. He wants to do the same thing on a national scale, and there is absolutely no evidence that it will produce a different outcome. The change will be great for Trump's business, but catastrophic for America.

Tidewater · Jun 17, 2017

CharminTide said:
I admit to not knowing the past few years of Kansas state policy in detail, but it sounds like few or no spending reductions were enacted. When Brownback signed his supply-side tax reform bill, he insisted that the tax cuts would spur the economy, and more than cover the tax revenue deficit. Clearly, that fiction did not come to pass.

Here's a summary of the actual effects, quoted in part below.
And here's the white paper that's referenced in the summary.

When Kansas' tax revenue tanked, it created a downward spiral. Suddenly, Kansas couldn't afford upkeep on its roads, which further harmed businesses. They tried to find money by removing funds from public education (screwing over the future is always a good investment). Then they tried to do the state equivalent of taking money out of their 401k and pinky swear to pay it back. Ultimately, they just had to admit that the promise of free market supply side nirvana was a myth and rolled back the changes.

Trump's tax policy advisers were the same ones that wrote Kansas' tax reform bill. He wants to do the same thing on a national scale, and there is absolutely no evidence that it will produce a different outcome. The change will be great for Trump's business, but catastrophic for America.

Interesting. It seems like incentivizing one-person businesses is poorly targeted to cause them to expand employment, just incentivising them to reclassify themselves/their businesses to a lower tax status. That does nothing for employment or cause those businesses to somehow expand their level of activity. It appears that some people were allowed to maintain their previous economic activity and declare themselves to be in a lower tax status.
The source I cited above indicates that "Education accounted for 43.5 percent of state expenditures in fiscal year 2015, while 22.4 percent went to Medicaid." That's 67% for those two budget items.
On an interesting note, Kansas makes a certain amount of its state government income from oil revenues. When I lived in Kansas (1998-2000, and 2003-2005) there were lots of capped (inactive) wells. I was not there since 2003 (thankfully), but I'd bet that a good number of those idle wells were uncapped when oil went to %80/barrel. Oil prices since have tanked (the horror of having cheaper gasoline!)
- 2014: $82.97 per barrel
- 2015: $38.81 per barrel
- 2016: $33.62 per barrel
and the amount of oil extracted from Kansas wells drooped as well declined 20.5%, so Kansas oil companies are extracting a good bit less and earning a good bit less on what they do extract.

The major economic activity in Kansas (as one would imagine) is farming (crops and livestock).
Agriculture sector
- Net farm income from grain and livestock is expected to decline through calendar year 2017.
- Overall value of crop production in 2017 is likely to be at its lowest level since 2009.
- Net farm income declined significantly in 2015 and was the lowest amount since 1981. Expected to continue to decline in 2016.
Effect on sales tax receipts
- KS Dept. of Agriculture estimates that for every 1% decrease in agriculture prices there is a corresponding $7.7 million decrease in sales tax receipts.

The lesson I learn from these data is that relying on extractive industries is a rollercoaster. When times are good, they can be really good. When these industries are not doing well (since prices for such commodities as grain and oil are determined globally), they can be really bad. The 2014-2017 drop in revenues seemed at least partially related to bad market conditions unrelated to Brownback's tax changes.

Since Federal taxes are not so dependent on extractive industries, I'm not sure the lessons hold at the Federal level either way.

Tidewater · Jun 17, 2017

TIDE-HSV said:
I agree. Kansas hasn't found it...

It looks like they are moving in that direction.
As I noted above, if your state economy is based on extractive industries (oil and farming), when experiencing flush times, you'd better be running a state budget surplus so when times are bad (and eventually they will be bad), you're going to need that money.
Unfortunately, politicians look at a budget surplus the way a crack addict looks at a pile of crack.

KrAzY3 · Jun 17, 2017

Well, the libertarian position is that the government should stay out of the economy as much as possible. What does or doesn't happen, shouldn't be orchestrated by the state. You know, the whole free market, freedom thing, that silly idea that we get to decide what to do with our money and what not. I'm tired of the idea of a third party trying to decide what is best for me and implementing that. I want government spending and taxes both to both go down, and my argument isn't that it's best. It's that it's my damn money they're taking and spending.

NationalTitles18 · Jun 17, 2017

Tidewater said:
Interesting. It seems like incentivizing one-person businesses is poorly targeted to cause them to expand employment, just incentivising them to reclassify themselves/their businesses to a lower tax status. That does nothing for employment or cause those businesses to somehow expand their level of activity. It appears that some people were allowed to maintain their previous economic activity and declare themselves to be in a lower tax status.
The source I cited above indicates that "Education accounted for 43.5 percent of state expenditures in fiscal year 2015, while 22.4 percent went to Medicaid." That's 67% for those two budget items.
On an interesting note, Kansas makes a certain amount of its state government income from oil revenues. When I lived in Kansas (1998-2000, and 2003-2005) there were lots of capped (inactive) wells. I was not there since 2003 (thankfully), but I'd bet that a good number of those idle wells were uncapped when oil went to %80/barrel. Oil prices since have tanked (the horror of having cheaper gasoline!)
- 2014: $82.97 per barrel
- 2015: $38.81 per barrel
- 2016: $33.62 per barrel
and the amount of oil extracted from Kansas wells drooped as well declined 20.5%, so Kansas oil companies are extracting a good bit less and earning a good bit less on what they do extract.

The major economic activity in Kansas (as one would imagine) is farming (crops and livestock).
Agriculture sector
- Net farm income from grain and livestock is expected to decline through calendar year 2017.
- Overall value of crop production in 2017 is likely to be at its lowest level since 2009.
- Net farm income declined significantly in 2015 and was the lowest amount since 1981. Expected to continue to decline in 2016.
Effect on sales tax receipts
- KS Dept. of Agriculture estimates that for every 1% decrease in agriculture prices there is a corresponding $7.7 million decrease in sales tax receipts.

The lesson I learn from these data is that relying on extractive industries is a rollercoaster. When times are good, they can be really good. When these industries are not doing well (since prices for such commodities as grain and oil are determined globally), they can be really bad. The 2014-2017 drop in revenues seemed at least partially related to bad market conditions unrelated to Brownback's tax changes.

Since Federal taxes are not so dependent on extractive industries, I'm not sure the lessons hold at the Federal level either way.

This is very important data and I'm not sure how much the study the OP brought up takes these things into account. It seemed more to compare nearby states to one another. IMHO, it did not do well in completely explaining the situation in KS or in considering alternative explanations. I didn't see any mention of authors' conflicts of interest, but that doesn't mean I should assume they have none. I'd like to see a more robust effort than this prior to reaching a conclusion.

Tidewater · Jun 17, 2017

NationalTitles16 said:
This is very important data and I'm not sure how much the study the OP brought up takes these things into account. It seemed more to compare nearby states to one another. IMHO, it did not do well in completely explaining the situation in KS or in considering alternative explanations. I didn't see any mention of authors' conflicts of interest, but that doesn't mean I should assume they have none. I'd like to see a more robust effort than this prior to reaching a conclusion.

I do agree with the opening post that these tax rate cuts (apparently allowing taxpayers to simply declare themselves to be in a lower tax bracket) seem to be poorly designed to generate economic activity.

seebell · Jun 17, 2017

Tidewater posted:

I do agree with the opening post that these tax rate cuts (apparently allowing taxpayers to simply declare themselves to be in a lower tax bracket) seem to be poorly designed to generate economic activity.

Trump is trying to make the same mistake by lowering the corporate tax rate to 15% without limitations. Already much talk on the inner webs about everybody will become a corporation and subcontract and get a form 1099 from the company they used to work for. This would be illegal under the rules of self-employment but the IRS enforcement was gutted a few years ago. This would create an additional tax shortfall.

NationalTitles18 · Jun 17, 2017

Tidewater said:
I do agree with the opening post that these tax rate cuts (apparently allowing taxpayers to simply declare themselves to be in a lower tax bracket) seem to be poorly designed to generate economic activity.

I agree. However, when we try to extrapolate to the idea that tax cuts lead to economic decline and tax increases lead to prosperity it gets preposterous quickly. I need not remind you that a tax, by definition, is a burden and burdens tend to cause slowing and dragging while lightening of burdens tends to cause more efficient movement. This is simply common sense, or should be. Many of us can agree that Kansas probably made multiple poor decisions while disagreeing with the premise that tax cuts or spending cuts or both, in general, cause poor economic growth. I would venture to say that most prior studies seem to suggest there is a sweet spot and much above or below that line worsens the situation. It is my contention that we have to choose on what and by how much to spend and do so wisely. Curtailing needed spending on education and infrastructure, to me, seems counterproductive - not even short-sighted, just counterproductive. Tax cuts for the sake of tax cuts is also not wise. The same goes for regulations. More or even less is not necessarily better. It does matter what we regulate and how. It matters what we tax and how. It matters on what we spend and how. Some things, like mental health for instance, are unavoidable spends. So do we wait for bad stuff to happen and put people in jail or do we get out in front of it and make everyone's life better (prison guards and police officers can find other security work or change professions) by preventing a lot of misery? I don't mean to go off on a tangent. I'm just saying that the value of the decisions made for the public good matter.

TIDE-HSV · Jun 17, 2017

Tidewater said:
I do agree with the opening post that these tax rate cuts (apparently allowing taxpayers to simply declare themselves to be in a lower tax bracket) seem to be poorly designed to generate economic activity.

More than that, tax cuts, being normally heavily influence by lobbyists and others with economic firepower. IMO, tax cuts to either the highest brackets or the lowest do the least good for immediate impact. Tax cuts to the lowest do the least good, because that group is rarely paying taxes and every cent they have is going into consumption spending. In the highest brackets, those also don't funnel directly into the economy. That economic incentive is very, very indirect, without going into excruciating detail. In Kansas' case, it obviously didn't go where it was needed. For immediate impetus, the middle class is where cuts should target, but they seldom do. I agree about the type of budgeting needed by extractive states (and countries). Look at Norway for a shining example. And I agree that a lot of Kansas' problems are caused by the extractive roller coaster. However, Kansas' base problem is "pie in the sky." It's independent of the oil problem, which probably only accelerated the crisis...

TIDE-HSV · Jun 17, 2017

NationalTitles16 said:
I agree. However, when we try to extrapolate to the idea that tax cuts lead to economic decline and tax increases lead to prosperity it gets preposterous quickly. I need not remind you that a tax, by definition, is a burden and burdens tend to cause slowing and dragging while lightening of burdens tends to cause more efficient movement. This is simply common sense, or should be. Many of us can agree that Kansas probably made multiple poor decisions while disagreeing with the premise that tax cuts or spending cuts or both, in general, cause poor economic growth. I would venture to say that most prior studies seem to suggest there is a sweet spot and much above or below that line worsens the situation. It is my contention that we have to choose on what and by how much to spend and do so wisely. Curtailing needed spending on education and infrastructure, to me, seems counterproductive - not even short-sighted, just counterproductive. Tax cuts for the sake of tax cuts is also not wise. The same goes for regulations. More or even less is not necessarily better. It does matter what we regulate and how. It matters what we tax and how. It matters on what we spend and how. Some things, like mental health for instance, are unavoidable spends. So do we wait for bad stuff to happen and put people in jail or do we get out in front of it and make everyone's life better (prison guards and police officers can find other security work or change professions) by preventing a lot of misery? I don't mean to go off on a tangent. I'm just saying that the value of the decisions made for the public good matter.

Great post. Wish I'd've written it...

Elefantman · Jun 17, 2017

I understand that it has gotten so bad, Kansas City has moved to Missouri.

Bamaro · Jun 17, 2017

Two words:

Laffer Curve

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