When Kansas exempted pass-through income from state income tax beginning in 2013, the Department of Revenue estimated that 191,000 entities would take advantage of the provision, but the actual number of 330,000 claimants in the first year prompted media to declare that the exemption created a massive wave of tax evasion. Tax return data from the Internal Revenue Service, however, shows that the original estimate was mistaken.
According to KDOR Chief Economist Michael Austin, ” In 2011, when the tax policy was estimated, KDOR referred to Federally-held IRS data. The most recent dataset available at the time was for tax year 2009 and it had three categories of returns that would be considered as tied to a personal business; “Business or Profession Net Income”, “Number of Farm Returns”, and “Partnership/S-Corp Net Income”. The sum of these three business returns resulted in an estimate of 330,000 filers that would be impacted by the tax policy.”
There were 191,991 Schedule C proprietors in 2009, which is very close to the number of entities used in legislative and media discussions but including farm returns from Schedule F and other entities from Schedule E, Kansas actually had 329,511 total pass-through entities in 2009.
The largest tax increase in state history just passed by the 2017 Legislature is projected to exceed long term inflation by $1.45 billion in FY 2019. If General Fund tax revenue had been increased for inflation since FY 1995, it would be $5.06 billion by FY 2019 but instead is projected to be $6.51 billion by Kansas Legislative Research Department.
Inflation is the Bureau of Labor Statistics’ Consumer Price Index for Midwest Urban Cities calculated on a fiscal year basis, with inflation for FY 2018 and FY 2019 assumed to be at the FY 2017 rate of 1.4 percent.
The Legislature’s override of the Governor’s veto will impose a $3 billion / 5-year income tax hike on Kansans. Marginal tax rates on all individuals are increased retroactive to January 1, 2017 and then hiked again in 2018. So not only will your employer have to withhold more from your paycheck starting July 1, you’ll either have to further increase withholding or write a check next April for the tax increase on your earnings for the first half of this year.
The rate on the first $15,000 single / $30,000 married taxable income jumps 15 percent by next year, going from 2.7 percent to 3.1 percent. A new second bracket on the next $15,000 single / $30,000 married taxable income goes up 14 percent and there’s a 24 percent increase of every dollar of taxable income thereafter. The rate increases for those who itemize will be partially offset by the phase in of deductions for mortgage interest and medical expenses (50 percent this year and next, 75 percent in 2019 and 100 percent in 2020.). The child care tax credit will be brought back in 2018 at 12.5 percent of the allowable federal amount and moving to 18.75 percent in 2019 and 25 percent thereafter.
The marginal rates may be lower but the sales tax and cigarette tax increases instituted since then remain in place. According to an analysis from the Kansas Department of Revenue, the net effect of all taxes changes between 2012 and 2016 was only a $393 million tax reduction for Fiscal 2018; the $591 million Kansas income tax hike just imposed for Fiscal 2018 means citizens will be $198 million worse off next year on net than in 2012.
Of the $3 billion total increase tallied by Kansas Legislative Research, the Kansas Department of Revenue says $1.2 billion is attributable to elimination of the pass-through exemption (presuming, of course, that none of those businesses pick up and leave). The remaining $1.8 billion tax increase means the ordinary citizens are stuck with 61 percent of the total increase.
The exemption on pass-through income for proprietors, partnerships, limited liability corporations (LLCs) and sub-S corporations is eliminated effective January 1, 2017. That income passes through to the individuals owners and is therefore taxed at the above marginal rates.
The Legislature also put many of the lowest earners back on the tax rolls. Previous law exempted the first $5,000 of taxable income for single filers and the first $12,500 for married filers; those exemptions are reduced to $2,500 and $5,000 respectively.
The budget and large tax increase passed by the 2017 Legislature will increase General Fund spending by nearly $500 million between FY 2016 and FY 2019, topping out at another new record of $6.613 billion.
Contrary to many claims over the last few years, General Fund spending actually increased several times since tax cuts went into effect in 2013 and assuming inflation continues at its current pace, spending will consistently be $1.3 billion higher than long term inflation (BLS Consumer Price Index for Midwest Urban Cities on a fiscal year basis).
Population growth may account for some spending changes, particularly in demographics such as school-aged children and seniors on social services, but infrastructure and other fixed costs of government need not change proportional to population. But even if one adjusts for inflation and full population growth, Kansas is still budgeting to spend $625 million above that adjusted level in FY 2019. General Fund spending $2,050 per capita this year by adjusting for inflation, but Kansas plans to spend $2,263 per capita based on consistent population growth.
General Fund spending by agency is available here, going back to 2005.
Kansas has more state and local government employees per-capita than almost every state in the nation. U.S. Census data ranks Kansas #48 among the fifty states, with 32 percent more state and local government employees than the national average; only Alaska (#49) and Wyoming (#50) are worse.
Kansas is ranked #33 for state government employees per-capita with 27 percent more than the national average and #49 for local government employees, with 34 percent more than the national average. Wyoming is the only state with more local government employees per-capita.
Nebraska is the only regional state that comes close to having as many state and local government employees per-capita, ranked #44. The complete state listing can be found here on pages 20 and 21.
The FY 2016 Comprehensive Annual Financial Report (CAFR) from the Kansas Department of Transportation (KDOT) shows spending on transportation projects in 2015 and 2016 was the highest over the last ten years.
Excluding debt service and administration, spending was $1.105 billion in FY 2015 and $1.069 billion last year. The condition of Interstate highways and bridges remain above minimum KDOT standards and are consistent with previous years, and other state highways are actually in the best condition since at least 2009. It’s also noteworthy that Reason Foundation recently rated Kansas as having the 3rd best highway conditions in the nation.
Is it true that making small businesses pay income tax would allow a lot more spending on education, highways and other services?
The Department of Revenue says reinstating the tax on pass-through income and their loss carryforward capability would generate between $195 million and $200 million. But as explained here that would only help get the state’s ending balance up to the statutorily-required level for at least two years, so there would be nothing left to pay for additional spending.
Data provided by the Kansas Department of Revenue shows 71 percent of net income tax reductions went to individuals and 29 percent is attributable to the exemption on pass-through business income. Their information is based on the 2013 tax year so even if the tax savings was the same each year, individual tax filers (excluding business filers) would have saved $2.1 billion through 2016.
Even though income taxes were reduced on all individuals, General Fund tax revenue is still running well ahead of long term inflation. (Almost all state tax revenue goes to the General Fund, except for motor fuels tax and a portion of general sales tax transferred to the another fund.)
The adjacent chart compares General Fund tax revenue (actual through FY 2016 and estimated for 2017) with what tax revenue would have been if it increased for inflation each year since 1995.
In fact, tax revenue for FY 2017 is predicted to be $787 million higher than if it had increased for inflation since 1995.
Total General Fund tax revenue would be $111.9 billion between 1995 and 2017, and while the growth is well above inflation it’s not enough to keep up with spending of $115.4 billion. General Fund spending is now consistently above long term inflation by roughly $1 billion annually.
History shows that General Fund tax revenue exceeded spending in just ten of the last twenty-three years (including the budget year of FY 2017). An interesting pattern is seen in the adjacent table, with blocks of time where revenue exceeded spending is followed by several years of spending exceeding tax revenue.
Like many families, some states set money aside in a rainy day fund that can be accessed in recessionary times to avoid dramatic spending cuts as Kansas did in 2003 and 2010. Since Kansas does not have a rainy day fund, recessions and/or choices to overspend tax revenue have resulted in reserves being depleted and money being transferred from other funds over the course of many administrations in recent decades.
Recent histories of General Fund tax revenue components can be found here, and tracking of FY 2017 revenue is available here.
The most recent data from the U.S. Census Bureau shows that Kansas is ranked #7 among the states for share of total school funding being provided by state government. The Census report includes all state funding, not just the amount provided through the General Fund.
The 2014 funding reported by KSDE did not include $522.5 million in state-mandated property tax (20 mills in each district) that had erroneously been reported as Local Aid in state records until 2015. It was also discovered that Census inadvertently left the Shawnee Mission district out of its totals, but provided revised totals to Kansas Policy Institute. This table properly reflects state-mandated property tax as State Aid.
With the national average at 47 percent, Kansas is providing 65 percent of total funding through the State. But even before the 20 mill reporting error was discovered, Kansas still had the highest rank in the region; as reported to Census for 2014, the State of Kansas provided 56 percent of total school funding and would have been ranked #16.