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Carve outs for the few, or, lower taxes for the many?

From Kansas Policy Institute.

Carve Outs For The Few? Or, Lower Taxes For The Many?

By Steve Anderson, Kansas Policy Institute

There has been much ado in media outlets and from “people that matter” about whether Kansas has enough revenue after the tax cuts of recent years. Unfortunately, few of them make an honest effort to examine and understand Kansas’ full financial picture. They focus on just those funds currently in the appropriation process and feed the claim that the state is short on revenues. These same pundits and politicians have either chosen to ignore the billions of special interest tax ‘deals’ which have been made over the years or are woefully naïve on their existence and fiscal impact on the state treasury.

Kansas has a significant amount of revenues that don’t flow through the appropriation process. These “off the tops” primarily come in three forms. They are either a deduction, credit or an exemption that an individual or company can take to reduce the tax burden. Or, they are a dedicated directed revenue to a specific agency for either a specific purpose or the general use of the agency. In short, these are spending mandates or revenue loopholes that have a very real budget impact but rarely go through the legislative process. The $8.3 billion in annual budget impact is a staggering sum as the following chart shows for the last fiscal year the data is fully available.*

The volume of deductions, credits and exemptions that either reduce or eliminate the amount of tax owed by an individual or company favors those who can hire high powered lobbyists to manipulate the legislative process. These are often the same individuals and companies with the means to hire tax attorneys or CPAs to navigate the complexities of the state’s tax rules. The result is that the average taxpayer carries the load while billions of dollars go to those fortunate enough to have lobbyists and tax experts on their payroll. We can level the playing field for the average Kansan by eliminating their income taxes altogether largely by removing or reducing the special interest tax breaks that currently exist for the political class.

This is a free market approach to tax reform that avoids the use of the tax code to pick and choose winners and losers — usually winners and losers amongst the well-connected. However, the issues with these special interest “deals” goes further than just the inherent unfairness of the tax code. The well documented long term economic malaise that Kansas has suffered through shows the ineffectiveness of the special interest approach to economic growth. In fact, KPI’s Dave Trabert has repeatedly said this stagnation is the reason FOR lower taxes across the board. Conversely those states that simply have no individual income tax have prospered with vastly superior private sector job growth (more below on specifics).

Individual Income Taxes

The individual income tax deductions, credits and exemptions present an immediate opportunity for the Legislature to reduce the size and complexity of the Kansas tax code. This begins the process of leveling the playing field for individuals and industry located in Kansas. The first step on that path is as easy as eliminating those tax credits that where not used in the last fiscal year. Because even if they aren’t “used” by taxpayers the official revenue estimates must assume that they are and the budget picture looks scarier still.

One of the realities in tax reform in Kansas is that every piece of tax legislation requires a fiscal impact study on the “cost” to the state coffers and under the “pay and go” rules of the House of Representatives requires an offsetting expense reduction or revenue. The special interest tax credits listed in the following chart had no filers using them during the last year that data is available. Their removal from the tax code would have no fiscal impact nor require “pay and go” offsets thus making the process relatively easy. Again, this simple adjustment would immediately reduce both the size and complexity of the state tax code.

However there are a significant number of tax credits that are being used, some of which favor only a small number of filers. The following chart shows the nearly $503 million in tax credits that were used on 2012 individual and fiduciary tax returns and the number of filers claiming them.*

An examination of this list provides lots of opportunity to reform or eliminate questionable credits. The credits vary in size, usage, and stated goal but each is worthy of review. As with all government programs, we should examine each credit to determine if it is actually achieving the broader policy outcome rather than simply relying on their stated goal.

Other issues abound in these tax breaks including the lack of information, due to confidentiality rules, on several of the tax credits. These disbursements affect all citizens and it should be a transparent and accountable system. Their size and scope should be known including who receives these taxpayer-funded handouts. Any program that cannot be transparent should be a target for elimination. We are unable to estimate the amount of saving, precisely because of their opaque nature, but regardless of the dollar amount these programs should be discontinued or the statute should demand transparency. Those receiving the credits should be aware their use of taxpayers’ funds will be revealed. It is not unreasonable for the financier (e.g. taxpayers) of the credit to know the recipient. Once the amount of funds expended and number of filers using the credits are known, citizens can make it known to their legislator if they object to a particular credit.

The numerous credits with smaller amounts of expenditures and claimed by very few filers would better serve Kansas if they were discontinued and the savings — $31 million in 2012 — used to fund the elimination of the individual income tax for all taxpayers. Why not use the elimination of these credits to help accelerate the buy down of the income tax now as they will ultimately need to be removed when the income tax rate hits zero?

Corporate Income Tax

Unused credits for corporations should be eliminated just the same as they should for individual filers. Eliminating these corporate credits would have a significant impact on the size and complexity of the state tax code. The chart below shows those which had no usage in 2012.

Those credits that were used are revealing both in their size and usage. As the following chart shows, nearly half of the $114 million known tax credit filings for corporate filers goes to a relatively small number of filers — 170 in total — for the High Performance Incentive Program (HPIP). HPIP provides a training tax credit and a 10% income tax credit to eligible companies for capital investments (i.e., facility or equipment purchases or upgrades) and is by far the largest credit in terms of cost. In fact, HPIP has come under fire for issues of non-compliance. This is compounded by very little evidence that the credits are cost effective for Kansas citizens in creating economic growth. HPIP receives 51% of the total of known corporate tax credits and the small number using the credit is indicative of a program that is benefiting a few with a high cost to the overwhelming majority of taxpayers.

Even without knowing the amount of the credits that are listed as confidential, simply eliminating the $114 million in existing known credits in 2012 could have been used to significantly reduce other tax rates. Be they individual income taxes, small business or corporate taxes the elimination of credits used by the few would benefit all Kansans by lowering their burden.

Just as with the individual income tax, the lack of information on several of the tax credits creates a troubling lack of transparency. These disbursements affect all citizens and the size and scope should be known.

Payroll Withholding Tax Exemptions

The payroll withholding exemptions are programs where the state abates collection of state income tax withheld on employee’s wages. The state then provides either a program or directly funds some benefit for the employer. These programs come in many forms and often are nearly impossible to find within the very complex tax and revenue reporting statements.

Programs such as IMPACT, PEAK, the “deal closing fund” of the Job Creation Fund and the Kansas Bioscience Authority were covered in some detail on this blog earlier this year. In short, “These programs come in many forms and often are nearly impossible to find within the very complex tax and revenue reporting statements. In general these programs require relatively long commitments by the state of taxpayer funds. The discontinuance of these types of programs will not generally eliminate the programs immediately but it will create savings going forward that could be substantial to the maintenance of a stable fiscal environment and a more transparent tax code.”

The Consumption Part of the State Revenue Puzzle: Sales Tax

Surprisingly, in the not too distant past Kansas had a more consumption tax based revenue system. Kansas Legislative Post Audit noted that “the percentage of State revenues provided by income taxes tripled between 1960 and 2009, rising from 15% to 45% of the total. During the same period, the percentage of State revenues from sales and excise taxes declined from 71% of the total to 49%. This reduction occurred even though the State’s sales tax rate more than doubled, from 2.5% in 1960 to 5.3% in 2009”.

One of the “causes” of that reduction is evident when you examine the Summary Table of “Off the Tops” at the beginning of this section. Over $5.6 billion — yes that is a billion — in exemptions, deductions or credits were claimed on sales tax in 2012.* Conceptual or General Exemptions alone were just over $4 billion. The second largest area of exemptions is actually the government excluding itself. The amount of tax income removed from state coffers by category is show in the following chart.

The list of each category is far too voluminous for listing here but the size and scope of the sales tax statute exemptions provide opportunity for legislators to consider if they seek consumption based tax policy using a more broad based approach.

Measure the Policy by the Results

How effective has the approach of the aggressive use of credits, deductions and exemptions for special interests in the income tax code coupled with increased sales tax exemptions been on the Kansas economy? The real answer is that Kansas’ economy has lagged behind our region for most of the 21st Century. A May 2014 commentary from Dave Trabert, “Media has often reported over the years that Kansas typically goes in and out of recessions later than the rest of the country. Private sector job growth in Kansas trailed the national average in ten of the last fifteen years.” A commentary from across the pond makes the same point, a July piece from London’s Daily Telegraph, “Delve a little deeper, however, and you find growing cause for optimism. Kansas has been an essentially stagnating economy for a long time now — substantially agrarian in its make-up but with some important manufacturing industries, particularly aerospace, which have been the subject of repeated downsizing. Trailing the national economic averages therefore doesn’t really amount to evidence that tax cutting has failed; it was the reason the reforms were introduced in the first place.” Or, The Wall Street Journal stateside, “Economic growth in Kansas has trailed the Great Plains region and nation for decades. Between 1982 and 1997, Kansas’ private GDP growth ranked 43rd in the country—ahead of only West Virginia, Oklahoma, Montana, Louisiana, North Dakota, Wyoming and Alaska. While some of those states have since boomed, Kansas has plodded along. Between 1997 and 2012, Kansas’ private economy grew by 4% a year compared with 4.3% nationally, 4.9% in Colorado and Nebraska, 5.3% in Oklahoma, and 6.1% in Texas.”

The answer to solving these problems isn’t in giving more handouts to selected individuals or businesses. The answer is in giving each Kansan the chance to keep a little more of their own money in their own pocket. As income tax rates continue to come down we’ll see this in real time. It likely will not be “a shot of adrenaline” but it will, over time, make Kansas a regional leader in job creation, population growth and faster wage growth.

This isn’t an experiment but a study in facts. Data from U.S. Bureau of Labor Statistics show this fact in stark detail — state with no income tax have grown jobs by 18.25% since 1998 while state with an income tax have grown jobs by only 5.63%. The question isn’t whether Kansas will see the same benefits in the long run, but whether Kansas has the will to stop giving handouts to the politically connected and focus on creating a better overall environment in which each Kansan has a chance to succeed.
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*Kansas State Tax Expenditure Report, Calendar Year 2012