How conservatism's grand tax experiment fell apart
Later today, Kansas Gov. Sam Brownback will unveil his proposals for repairing the state’s gaping budget hole. His task is a cruel one, and largely of his own making. It's also a useful glimpse into the limits of Republican economic thinking at the foundational level.
In 2012 and 2013, Brownback and Kansas Republicans passed what has become infamously known as a kind of grand experiment in tax policy. A top income tax rate of 6.45 percent for families making over $60,000 was eliminated completely. Rates dropped from 6.25 to 4.9 percent for those making over $30,000, and from 3.5 to 3 percent for those making less, with further reductions for the former bracket to come. “Pass through” companies — whose profits go directly to their owners rather than to a corporate legal entity — saw their state taxes reduced to zero.
A handful of tax credits were also eliminated, and a scheduled drop in the sales tax to 5.9 percent — following a hike to 6.7 percent in 2010 — was changed to 6.3 percent, to try to make up some of the lost revenue.
Still, Kansas’ budget faces a shortfall of $280 million for this fiscal year and as much as $648 million for next fiscal year. That’s because the one thing the tax cut was supposed to create — renewed job growth in Kansas — has not materialized.
Job growth over the 2012-2013 period was 2.5 percent — a modest improvement over the 2.3 percent from 1998 to 2012 — but it fell to just 1.6 percent in 2013 specifically. Defenders point out that job growth nationwide dipped that year, but then the whole point of the tax cut was to pull Kansas away from the pack. Job growth on the Kansas side of the Kansas City metro area topped the Missouri side at 2.2 percent to 0.4 percent in 2013, then flipped to 0.4 percent on the Kansas side and 1.5 percent on the Missouri side in 2014. New business creation in the state also fell through 2012 and 2013.
At root here is a disagreement over the "ecology" of economies. Just how is it that economic growth happens? Conservatives and sympathetic economists have long insisted that high investment is the key to growth, and the point makes sense: investment means new equipment, new hires, new capacity of every sort. This is growth by definition. All that new economic activity will lead to new income, which will then lead to more spending.
This is the basis of "supply side" economics — policies that focus on unburdening the mechanisms that supply jobs, like deregulation and cutting taxes on income, business profits, and investments. And it was the conceptual justification for the Kansas tax experiment specifically: “To cut the tax out on these certain types of income — business income — is an incentive for people to hire more people,” Kansas State Senator Les Donovan (R) told NPR’s Planet Money.
But there’s a hitch. Businesses don’t hire people just to hire people. They hire people when they think it will boost their profits; when the business believes there’s untapped demand for their goods and services that a new hire could exploit. Supply-side policies rest on a critical unspoken assumption: that consumers’ current capacity to spend will support a greater supply of jobs, and all that’s required to tap that pent up demand is the removal of the supply-side barriers.
So what happens when that assumption is wrong? What if businesses are already getting all the job growth they can out of what consumers can spend? What if job growth is low because consumers can't spend that much, and then policymakers cut taxes anyway? In that case, the money’s just going to sit there.
Planet Money actually did a story late last year on Kansas’ tax cuts that illustrates this in very concrete terms. Alex Harb runs a restaurant and a computer store chain in Wichita, so he got the zero percent tax rate for pass-through businesses, and used the money to buy a bunch of iPads — i.e. more investment. But he never hired anyone. “You hire people, not based on how much money you have, [but] based on your business,” Harb explained. ”I didn't really notice any more business purchasing, you know, around here. So didn't really trigger anything to hire more employees.”
Around the same time, the Kansas City Star talked to Dan Doyle, a partner at an Overland Park law firm, another one of those pass-through businesses. He said the firm hired some new people when it took on a particularly big recent case, but the tax windfall itself didn’t inspire any new hires. Doyle did, however, decide to take his family to Cancun.
The tax cut's more sober defenders argue this is a long-game attempt to boost the state's economy, and time may yet render a verdict in Brownback's favor. Maybe. But that brings us back to today’s budget announcement. Kansas is legally required to balance its budgets over two-year periods. The state has already tapped into reserves and the highway budget to fill the hole, but Brownback has promised a revenue-positive budget, and few of his (politically realistic) options are good: there’s talk of hiking the state’s sales tax, increasing taxes on alcohol and tobacco, and slicing into the state’s education budget. What all these options have in common is that they will suck even more money out of the pockets of Kansas consumers — especially the low-income ones — as well as the state’s education infrastructure. The Planet Money story has an especially poignant note about the small ghost towns left behind in rural Kansas by school closures.
As long as Brownback and his allies insist on maintaining the tax cuts, all of their budget-balancing choices will require this trade-off in some form. They’ll keep trying to boost Kansas’ economy with one hand, while slowly bleeding it with the other.
And the money Brownback is handing to Kansas businesses will likely keep going to Cancun.