Budget & Tax

Kansas Tax Reforms Having Positive Economic Impact

February 1, 2017

William Boyes, Stephen Slivinski

The tax reforms enacted in Kansas over the past few years have sparked a national discussion that primarily focused on budget deficits and less on the economic impacts of the reforms. While budget deficits did occur in Kansas following the tax reform, state government spending contributed critically to the deficits. Simply put, Kansas cut revenue while simultaneously increasing expenditures.

In a new study published by the Kansas Policy Institute, we clarify the data on job growth in Kansas and determine whether the tax reforms enacted in Kansas impacted the state’s job growth. To date, much criticism has been aimed at the so-called “pass through” income tax exemptions, which allowed businesses that are structured in a certain way to exempt their income from the income tax. This was but one of the provisions in a multi-year and wide-reaching set of reforms passed in 2012. While more data analysis in the coming years will provide for a more complete analysis, there is substantial evidence to date that this tax reform delivered quite a bit of bang for the buck.

Job growth is critically dependent on new business formation. Several studies have found that start-ups and young firms drive overall job creation. A key academic study found that “firm births contributed substantially to both gross and net job creation.”

The U.S. Census Bureau defines an establishment as “a single physical location where business is conducted or where services or industrial operations are performed”; they define a firm as “a business organization consisting of one or more domestic establishments that were specified under common ownership or control, with the firm and the establishment being the same for single-establishment firms.” For example, new establishments could be a new biotech start-up, a proprietor opening a new restaurant, or even a new Wal-Mart location.

In Kansas, with the exception of 1979 and 1984, the total number of jobs created would actually have been negative if not for the job creation from new establishments. This phenomenon is not unique to Kansas. The United States would not have had a single year of positive job growth since 1977 if not for jobs created by new establishments.

This economic dynamism is a good thing: states that are more dynamic—have more of this “economic churn”—actually have greater economic growth rates, as reported by Dr. Arthur P. Hall of the University of Kansas. Investors and business owners—and certainly state policymakers—do not know which bets will pay off at the beginning, however. So, the economic policy strategy that has the best chance of increasing net job growth is one that, to borrow an old saying, allows “a thousand flowers to bloom” and maximizes the chances a company will succeed and grow and employ more Kansas workers.

Meanwhile, pass-through firms—like sole proprietorships, S-corporations, joint partnerships, and many LLCs—accounted for 46 percent of the for-profit private-sector Kansas workforce in 2014 based on U.S. Census County Business Patterns data, which use Bureau of Labor Statistics (BLS) data that exclude proprietors; pass-through firms may well employ the majority of the for-profit private sector workforce if full-time proprietors are included.

As we mention in our study, most pass-through firms are small. Thus, the reality of the amount of job creation due to new establishments and the proportion of overall employment growth attributed to pass-through firms suggests that many new establishments are also pass-through firms. This should have real consequences in terms of how employment changes can be influenced by tax policy in Kansas.

Analysis of employment outcomes that followed these tax policy changes needs to take into account employment growth across the entire spectrum of job losers and job creators, particularly among new firms and pass-through firms. Making sure that Kansas is being compared to other states that are economically similar is also important. It is also vital that policy changes are viewed over the long term and include a recognition of relevant trends that exist notwithstanding the policy change. Finally, in tax policy, patience is a virtue. It can take upwards of five years for tax policy’s effects to be fully seen. It could take even longer if the initial change was diminished shortly thereafter as was the case in Kansas; the 2012 tax plan was reduced in 2013 and modified again in 2015. It is essential that the pass-through exemption be allowed to exist long enough for measurable results to be collected, and tested.

Moreover, legislators should keep in mind that the businesses in Kansas are also planning with an expectation of consistency in the tax rules over a long time period so they can make stable long-term business plans going forward. Dramatically changing the tax treatment of pass-through firms could have adverse economic consequences by upsetting the growth potential of these new firms.

Many Criticisms of the Kansas Reforms Are Misguided

These considerations are often lost in the reporting on the Kansas reforms. Our study is an attempt to add more context, nuance, and factual basis to the discussion and to connect readers to the economic logic and importance of the tax policy reforms. This is important because much of the discussion over economic growth in Kansas after the tax cuts of 2012 were enacted is misguided—hobbled by a misunderstanding of what the tax cuts were trying to accomplish and a reliance on incomplete data.

Additionally, much of the discussion fails to take into account the fact that most job growth in Kansas has been—and will continue to be—from pass-through businesses (i.e., sole proprietorships, S-corporations, limited liability corporations, and joint partnerships).

In fact, the 36,135 jobs created by pass-through entities in Kansas represent 82 percent of all private sector jobs created in 2013 and 2014, the latest data available from the U.S. Census Bureau, and the growth is more than three times as great after tax reform than before.

Using these Census data and other appropriate private-sector data, our analysis indicates that the impact of the tax reforms has been positive. Kansas comes out on top or at least shows strong growth in almost every relevant state comparison of the most comprehensive private-sector job growth metrics. Kansas also matches up well with other states, even when the less-comprehensive data often used to make comparisons are adjusted for the size of the state.

It is also important to consider the source of job creation data, the structure of a state’s economic make-up, and a state’s population when comparing job numbers. In short, just as it would not be appropriate to compare student achievement for the Kansas City and Blue Valley school districts for obvious demographic differences, it is not appropriate to compare certain states just because of geographic proximity.

The monthly employment numbers from the Bureau of Labor Statistics (BLS) use a different methodology to count employment than does a more comprehensive, but less frequent, analysis from the Bureau of Economic Analysis (BEA).

For instance, the BLS data estimates that in 2015, Kansas had an employed private-sector workforce of nearly 1.4 million, while the BEA data puts it at 1.9 million. So while the BLS data warrants monthly media coverage, our study puts more emphasis on the BEA analysis as it better captures those employed by proprietorships and in farm employment.

Our study also uses new data from the Kansas Department of Revenue (KDOR) to clearly demonstrate that tax evasion or strategic corporate tax planning has not been widespread. KDOR records also make clear that the total value of the tax cuts from 2012 was primarily driven by lowering the income tax burden on individual wage earners. This is yet another overlooked aspect of the tax cut, as 71 percent of the overall tax relief went to individual taxpayers and 29 percent went to pass-through businesses through the income tax exemption.

A final data point from KDOR also makes clear who is benefitting from the pass-through exemption. Median family income in Kansas is around $52,000, and 88 percent of the filers in 2014 with business income had Kansas adjusted gross income that year of less than $50,000.

While there is still more analysis to be done and more data are to be released over the coming years, we believe the preliminary signs indicate that tax reform in Kansas has had and, more importantly, will continue to have, a positive impact on state job growth.

William Boyes is professor emeritus and founding director of the Center for the Study of Economic Liberty at Arizona State University. Stephen Slivinski is a senior research fellow at the Center. This article is adapted from their January 2017 study “A Thousand Flowers Blooming: Understanding Job Growth and the Kansas Tax Reforms,” published by the Kansas Policy Institute and available at www.kansaspolicy.org.