Budget & Tax
Steve Anderson | February 23, 2015
Marching to Freedom
Conservative policymakers in Kansas care more about your family budget than the state budget.
The state of Kansas is on a “march to zero.” The state’s political leaders have decided to eliminate the state individual income tax for all income earned in Kansas.
As Governor Sam Brownback reiterated this year in his State of the State address, “we will continue our March to Zero income taxes. Because the states with no income tax consistently grow faster than those with high income taxes.”
Why are the political leaders in Kansas doing this?
Well, they saw 50 years of population growth that was consistently less than in the vast majority of the other states. They saw even more worrisome data showing huge amounts of capital leaving for low- or no-income-tax states. The status quo was no longer an appealing option.
The lessons of the past, and what could be done to stem the tide, dominated my first meeting with then newly elected Gov. Brownback in November 2010, prior to my appointment as his budget director. Governor Brownback made it clear that reducing the tax rate was important, but he was insistent that “if you don’t pull it up by the roots it will regrow.”
That mindset was shared by many state lawmakers. So began the effort to eliminate the individual income tax.
The more difficult question was: How could Kansas accomplish it?
Of the states that have individual income taxes, only Alaska has successfully eliminated its individual income tax. (Eight other states have never had one.) After oil was discovered on Prudhoe Bay, the sheer amount of “oil taxes,” coupled with low population, allowed Alaska to eliminate its income tax. No other state had ever attempted to do so.
Kansas had the typical structural imbalances in its finances that plague many other states marked by out-of-control spending growth. Among those spending increases were politically crafted built-in escalators in Medicaid, pensions, and K-12 spending that seemed to tie the hands of smaller-government supporters.
In addition to those fundamental expenditure issues, Kansas’ revenue stream had been constricted by 50 years of tax policy emphasizing special interests rather than a free-market approach. Tax policy was marked by a multitude of income and sales tax credits, exemptions, and deductions. Not only had this approach failed to correct Kansas’ economic woes, these “giveaways” had reached a staggering impact of $8.3 billion on the state’s revenues.
The revenue and expenditure issues combined to create a situation where the state was constantly increasing income and sales tax rates to offset the special-interest tax breaks, and shifting the source of state revenue from consumption taxes to production-based taxes. The state’s Legislative Division of Post Audit noted in 2010 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.”
How We Did It
In order to have any chance of success with our ambitious “march to zero” agenda, we first had to win broad-based legislative and citizen support. Our first move on the tax-reduction front was to propose an income-tax-free zone in certain rural counties.
The Rural Opportunity Zone (ROZ) was a low-cost-to-the-state approach to helping those Kansas counties that had lost significant population over the last decade. The ROZ created a five-year state income-tax exemption for anyone from out of state who moved to one of these rural counties.
Additionally, there was an option for counties to provide student loan payments in equal shares over a maximum term of five years for ROZ-qualified individuals. The annual payments are equal to 20 percent of the individual’s outstanding student loan balance up to a maximum of $15,000. That feature was intended to target recent college graduates, a subset of the population much needed in rural areas because of their income and age demographics.
There was immediate anecdotal impact from the ROZ that reinforced the belief that income taxes matter to individuals and businesses. Counties that moved aggressively to promote and use the ROZ as an economic tool were so successful that in the next legislative session several counties that were on the cusp of the population-reduction qualification were added to the ROZ program.
The most important function of the ROZ may have been how it set the tone for the state’s bold tax reduction, a reduction which some people call the largest proportional tax cut in modern U.S. history.
This tax cut collapsed the three-bracket system into two and lowered rates. The top personal income tax rate will drop to 3.9 percent for 2018, down from 4.9 percent. To continue and finish the march to zero, the law also put in place a plan to use all revenues in excess of two percent growth per year to buy down the rates until they were eliminated. The most aggressive part of the tax plan exempted the owners of 191,000 partnerships, sole proprietorships, and other businesses from income taxes.
These business owners were overwhelmingly small operations but had the potential to fuel significant growth. Small businesses create more than 50 percent of nonfarm private Gross Domestic Product and 75 percent of the net new jobs in our economy. It was our belief that, over time, leaving funds in the hands of these small business owners would reset the course for Kansas. There is evidence that this is beginning to take place. For the second straight year Kansas has had record business formation, and job growth has begun to reflect that trend.
Many liberals and their friends in the media have portrayed the Kansas tax cuts as having a disastrous impact on the state’s revenues. They have even generated or cited completely false data.
To have a vibrant free-market economy, the government must extract from the private sector only the amount of funding that is needed.
For example, the Kansas Center for Economic Growth (KCEG), a liberal think tank, attributed to tax cuts a $700-plus million reduction in state aid for property tax relief and city/county revenue. That turned out to be a fabrication. The source for KCEG’s data was a paper published by KCEG, which says, “Cities and counties across the state have lost more than $700 million since 2008 from lawmakers defunding of two important sources of local support …” In reality, the tax cuts did not go into effect until 2013. The source of this “lost” revenue was a statute passed in 2002 that had not been funded since 2002! These sorts of misstatements echoed through the blogosphere and even the mainstream media, creating a false perception of what the impact of the tax cuts was in Kansas.
The reality is that there has been a reduction in revenue to the state; interestingly, however, the reduction is actually less than our original revenue estimations. Those in the Kansas legislature and the administration understood that when you reduce taxes it will impact revenues. We embraced it. Remember, conservatives typically don’t want the government to have more money to spend.
To have a vibrant free-market economy, the government must extract from the private sector only the amount of funding that is needed. Elected officials like to talk about achieving efficiencies, eliminating waste and fraud, and focusing on core services. What we found in Kansas is this: those things become realities when you reduce the amount of money that makes its way to the state treasury.
So the march to zero continues. “There may be some who consider this course too bold,” Gov. Brownback said in his State of the State address this year. “Well, I’m the sort of guy who would have sent Alex Gordon from third base.”
A Certified Public Accountant with more than 30 years of experience in private practice, he is currently a partner at Anderson, Reichert & Anderson LLC. Anderson spent two years as a budget analyst in the Oklahoma Office of State Finance, and most recently served as budget director for the State of Kansas. At one time he held 17 state teaching certifications ranging from mathematics to physics to business.