KANSAS TAX MODERNIZATION A FRAMEWORK FOR STABLE, FAIR, PRO-GROWTH REFORM MICHAEL LUCCI | KATHERINE LOUGHEAD | JANELLE CAMMENGA | JARED WALCZAK TABLE OF CONTENTS Introduction 1 Introduction 2 A Menu of Tax Reform Solutions 5 CHAPTER 1 Kansas’ Economy 11 Introduction 12 State Gross Domestic Product (GDP) 13 Personal Income 15 Major Industries 18 Employment 20 Population Patterns 21 CHAPTER 2 Kansas’ Tax and Budget Structure 27 Introduction 28 Recent Tax and Spending Policies 28 School Funding Litigation and the State Budget 30 Kansas’ Current Budget Makeup 31 Measure of State Tax Competitiveness 33 CHAPTER 3 Corporate Income Taxes 37 Introduction 38 Overview of Kansas Corporate Taxation 39 Comparing Kansas’ Corporate Income Taxes Regionally and Nationally 41 Rate Structure Considerations 44 Structural Elements 46 Corporate Income Tax Expenditures 58 Corporate Tax Solutions 63 CHAPTER 4 Individual Income Taxes 67 Introduction 68 A Brief History of Kansas’ Individual Income Tax 68 Comparing Kansas’ Individual Income Tax Regionally and Nationally 70 Individual Income Tax Collections 72 Impact of the Individual Income Tax on Kansas Businesses 73 Structural Elements 73 Deductions, Exemptions, and Credits 77 Individual Income Tax Reform Solutions 82 CHAPTER 5 State and Local Sales Taxes 85 Introduction 86 Sales Tax Collections 87 Comparing Kansas’ Sales Tax Structure to Regional and National Competitors 89 Sales Tax Rate Composition 89 Sales Tax Base Composition 92 Sales Taxes in the Modern Era 105 Sales Tax Reform Solutions 109 iii CHAPTER 6 Property and Related Taxes 113 Introduction 114 A General Overview and Brief History of Kansas Property Taxes 114 Property Tax Rates and Collections 116 Property Tax Structure 119 Property Tax Refunds, Credits, and Exemptions 121 Other Property Taxes Issues 123 Property Tax Administration 127 Property Tax Solutions 129 CHAPTER 7 Other Taxes 133 Introduction 134 Border Wars 134 Rainy Day Fund 136 Severance Taxes on Oil and Natural Gas 137 Cigarette Taxes 140 iv TAX FOUNDATION INTRO INTRODUCTION 1 KANSAS TAX MODERNIZATION Introduction INTRO Kansas achieved a history of tax reform success throughout the 19th and 20th centuries, as evidenced by the dramatic evolution of Kansas’ code over the state’s 158-year history. The result is the current tax code, constructed primarily upon a relatively balanced three-legged stool of property, sales, and income taxes funding Kansas’ state and local governments. While the majority of Kansans we met with are proud of this structure, they also agreed that the time has come to review certain provisions within each of these major taxes to achieve lasting tax reform for the 21st century. In the course of producing the research for this book, we conducted dozens of interviews across the state, discussing tax reform options with hundreds of Kansans with an interest in tax reform. Several themes arose consistently in our meetings with citizens and stakeholders across Kansas. Those themes include an aspiration to make the state more competitive while ensuring stability, a willingness to learn from the past coupled with a desire to step forward into a better future, and a hunger for a thoughtful and comprehensive look at improving Kansas’ tax code. Kansans we met with carry a shared desire for a balanced conversation to achieve successful tax reform for the people and businesses that call Kansas home. It is our goal to meet these demands with the work contained in this book, and by serving as an educational resource for the people of Kansas. We seek to apply the lessons of Kansas’ past, take a thoughtful and comprehensive look at Kansas’ tax code, and be a resource for modernizing Kansas’ tax code for the 21st century. In the introductory text below, we summarize the recent history of Kansas’ tax changes and then lay out our objectives and guiding principles for thinking about tax reform. In the Executive Summary we list the building blocks with which Kansas can construct an enhanced, simplified, modernized tax code. The first two chapters of this book look at Kansas’ economy and budget. Chapters 3-7 build out the details to explain the building blocks of tax reform, with a view to creating structural improvements across the code over coming years. Finally, we pledge to serve as a resource to lawmakers and stakeholders across Kansas as they fit and mortar together these building blocks into the architecture of comprehensive tax reform. Synopsis of Kansas’ Recent Tax Changes Few subjects are as fraught as is tax reform in Kansas. Unfortunately, “Kansas” has become a byword in many quarters, shorthand for the dramatic fight over what has been dubbed the “Kansas tax experiment” and its consequences. Although many of the tax changes adopted in 2012 and subsequent years have since been reversed, the issue remains fresh for many—and unresolved. Some proponents of the 2012 tax changes feel that the efforts were cut short, or that tax 2 changes were not allowed to proceed as intended. Many opponents feel that the reversals TAX FOUNDATION INTRO to date are incomplete. What cannot be disputed is that the past few years have been tumultuous, and that few policymakers would care to repeat that experience. Kansas’ tax rate cuts that began in 2012 reduced revenues without commensurate reductions in expenditures to the point that the state struggled to meet its obligations. Reducing the tax wedge can certainly promote economic growth, but such growth is not sufficient to close the resulting revenue gap. Businesses became understandably wary about Kansas’ fiscal instability. When the state could neither meet its obligations within given revenues nor reduce expenditures in kind, it became inevitable that the tax changes begun in 2012 would be reversed, as they approximately were in 2017. The tax debate that took course over the last several years is still raw for many Kansans. The 2012 tax changes yielded uncertainty rather than greater competitiveness. The changes might well have kept business investment at bay, not because companies don’t like lower taxes—they do—or don’t have increased investment opportunities when tax burdens are lower—again, they do—but because they understood that the situation was unsustainable. The 2012 tax changes were mostly focused on rates, not structure. The signature structural change from the 2012 law, the exemption of pass-through income from the individual income tax, was nonneutral in that it favored certain sorts of economic activity over others and created opportunities for tax arbitrage. Suddenly, a dentist’s income was likely to be tax-exempt, but her hygienist’s income was not. An independent consultant to corporations incurred no individual income tax liability in Kansas, but someone performing the same job responsibilities but as a corporate employee paid full freight. The subsequent reversals were not particularly attentive to structural improvements either, focused as they were on fiscal sustainability. Retroactive tax increases—a usually highly undesirable policy move—were hastily enacted to close the revenue gap. Policymakers pushing the rollback and rate increases were impelled by a sense of urgency, and doubtless believed that it was no time to undertake a broad tax study. So why even consider tax reform? Because, in short, addressing the structural inadequacies of Kansas’ tax code is now more important than ever. In recent years, Kansas policymakers have cut rates and they have raised them. They have created exemptions and repealed them. What they have not done is take a serious look at the actual scaffolding upon which the tax code is built and considered a plan to improve that scaffolding for a 21st century economy. Now that the dust has begun to settle, the time has come to review the tax code, not with an eye either to slim or to grow revenues—the optimal revenue target is a policy choice outside the scope of this project—but to make sure that the state is raising the revenue it needs in the most neutral, efficient, transparent, and pro-growth way possible. It’s time to ask what’s working and what isn’t—to evaluate whether incentives are achieving their objectives, to identify ways to reduce compliance costs, and to better align the tax code 3 KANSAS TAX MODERNIZATION to promote economic growth. INTRO Furthermore, there is an issue at stake beyond simply reforming Kansas’ tax code. The Sunflower State’s brand will gain as much as its tax code from a successful tax reform. Kansans can come together, put the past behind them, and build a better future. The purpose of this book is to provide the tools and trajectory for the structure of Kansas’ tax code to be significantly improved. This book will address how those revenues should and should not be collected, and we leave it to Kansans to decide how much revenue should be collected. Our Purpose To be clear: this is not a book about tax cuts. All else being equal, lower rates and lower tax burdens will incentivize investment and spur economic growth. However, the real world is complex, and all else is not always equal, in particular in a state that has undergone the significant tax and revenue changes Kansas has enacted since 2012. Regardless of how much revenue will be collected, Kansas can modernize the structure of its tax code to ensure that collections are made in a way that will encourage growth. It’s time to turn the page on the debates of the past decade and chart a new course, one that makes Kansas a different kind of watchword. We are excited by the prospect that, a few years hence, “Kansas” will cease to be a word of warning and instead be a word that connotes reform and renewal. In recent years many states, including regional competitors like Iowa and Indiana, have modernized their tax codes to become more competitive and are enjoying the benefits of those reforms.