Wednesday, July 12, 2017

The Kansas Tax Cuts Revisited

Total state government spending in Kansas has essentially tracked that of the nation as a whole. For 2001-2011, in-state sourced spending, which adds together the General and Other Funds, increased by widely varying numbers, reaching 11 percent in 2009. Due to a one-year drastic and anomalous spending cut, the average only reached 4.5 percent, though without that anomalous cut the trend growth was 7.4 percent per year, in current prices. After the reform, General and Other funds spending again exhibited considerable volatility, with a trend growth of 4.7 percent per year when anomalous reductions are removed. The fact that Republicans in Kansas have abandoned their 2012 tax cuts has been used over and over again by welfare statists, nationally as well as here in Wyoming, as a general argument against tax cuts. They conveniently avoid mentioning spending in the same sentence.

The blog Better Wyoming is a good example.
In what is essentially a regurgitation of now-standard talking points from around the statist blogosphere, Better Wyoming argues as though the spending spree had nothing to do with the budget problems that Kansas ran into soon after the 2012 tax reform. Yet somewhere, somehow the money that pays for government comes out of the private sector of the economy:
  • In 2007-11, when the growth trend in Kansas state spending (not counting federal funds) was 7.4 percent per year, private industry output (the economy's tax base viewed from the production side) expanded by 3.9 percent per year;
  • In 2012-16, when the growth trend in Kansas state spending (still not counting federal funds) was 4.7 percent per year, private industry output (still the economy's tax base viewed from the production side) expanded by 2.5 percent per year.
Here is another way to review those numbers:

Figure 1
Raw data sources: NASBO (state spending) and Bureau of Economic Analysis (private sector)

Anyone see a problem here? 

So long as the trend in spending persistently outpaces the trend in the tax base, no tax reform can really make a permanent difference. It takes permanent, structural reforms to both sides of the budget to bring about a balance. Those reforms must be led by spending reforms, with tax reforms designed to pay for the small government that emerges from the reforms.

If spending reductions do not guide government reforms, it really does not matter how much we cut taxes. No doubt, tax cuts can bring more into the government coffers by stimulating growth. The most recent success story is in the federal government's finances under Bush Jr. Kansas also saw a revenue spike after its tax cuts: in 2014, two years into the new tax structure, state revenue had increased by a total of 16 percent. What had been a shortfall in paying for total expenditures in 2012 was turned into a surplus: in 2012 total state spending exceeded total state revenue by $336 million; in 2014 that balance had turned to a $2bn surplus. 

For full disclosure, these numbers include federally funded spending, but the federal contributions to the Kansas state budget stayed essentially flat around $4 billion, so the changes reported here (which are from the Census Bureau) are inherent to Kansas.

The year 2014 was generally very good for the Kansas economy. Its three largest industries, manufacturing, finance and insurance, and professional and business services, all saw strong growth. Manufacturing jumped by 12.2 percent in one year (in current prices) with finance and insurance growing at 7.7 percent. Professional and business services contributed a 6.1-percent expansion. Since these industries together account for approximately half of Kansas state GDP, their growth numbers did a lot of good for the state's economy. 

After another strong growth year in 2015, these three industries saw growth taper off in 2016. Manufacturing flattened out, business and professional services grew at 1.7 percent while finance and insurance managed to expand by 4.7 percent. With the rest of the Kansas economy in stagnant mode (aligned with the ho-hum national economy) this resulted in a turn for the worse in state tax revenue. In 2015, total revenue fell by just over $1 billion to $17.95bn. 

Spending, on the other hand, kept creeping upward, growing by a full $1bn from 2014 to 2015. The budget gains from the 2012 tax cuts were being eroded by a never-ending growth in spending. 

Since the state legislature allowed state spending to continue to grow, the budget situation of 2012 inevitably re-emerged. The $2.6bn increase in revenue that followed the tax cuts were soon neutralized by evaporating macroeconomic growth effects and by a $2.3-billion spending increase. The only difference between spending and revenue is that while the revenue growth peaked in 2014 and turned into a decline, spending continued to grow through 2015. 

If we, again, look at in-state sourced revenue alone (and exclude federal funds) the trend continues upward. This observation begs the very simple question: if private-sector economic activity is not growing, then why should government spending grow? 

It was the failure to address this question that led Kansas Republicans to the point where they had to acknowledge that their tax increases had not worked. This does not mean that tax cuts don't work - they do, and they did so in Kansas - but it means that tax cuts without spending reform are pointless to the brink of being completely meaningless.

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