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Friday, September 22, 2017

Kansas Tax Cuts: The Real Story

The welfare statists here in Wyoming, in their fear of tax cuts, are beginning to once again toss out references to the "failure" of tax cuts in Kansas. Among them, Better Wyoming's July 10 article is one example; back in June, Wyoming Public Media also gloated over the Republican back-pedaling in Kansas. 

That was this summer. As the fight for Wyoming's future tightens, the so-called failure of the Kansas tax cuts will most certainly jump to the frontline of the debate again. Yesterday, CNBC reporter Kate Rogers made her contribution at the national level:

The tax cuts caused the state to have a budget shortfall in the billions in less than five years, according to the Tax Foundation, a Washington, D.C.- based advocacy group. The Tax Foundation also claimed that the cumulative budget deficits in fiscal 2018 and 2019 alone were $850 million. The experiment also drained funding for the school system, state pensions and road maintenance. Under the reversal, individual rates range from 2.9 percent to 5.2 percent and will increase again in 2018.
A word of caution: do not trust anything that comes out of the Tax Foundation without proper scrutiny. I have followed their work for years, and there has been a tragic deterioration in quality under current the reign of Executive Vice President Joe Henchman. The TF still has some nice databases you can trust, but I do suggest that you do not take anything for granted in any piece they write, whether analysis or commentary.

The Kansas tax-cut issue is a good example. I have another point I want to make about that issue, one unrelated to the Tax Foundation, but since they were so deeply involved in Kansas, it is important to expose the poor quality of their analysis. Let us get that one taken care of right away, so we can move on to the meat on these bones.  

The Tax Foundation has tried, on numerous occasions, to defend its consulting-style involvement in Kansas state tax policy. One of their most startling contributions was a piece from February, written by Executive Vice President Henchman and Scott Drenkard, the TF's director of state projects. There, Henchman and Drenkard suggest that it was not government spending that derailed the Sunflower State's tax reductions.

As I explained back in June (in an article that was admittedly a bit "chewy", as one reader put it - my apologies!) there are three problems with the "calculations" that the Henchman and Drenkard use as back-up for their startling, and entirely untrue, statement:
1. They break down spending per capita, thus implying that spending is not a problem because each Kansan should pay the taxes that fund "his" share of spending. This ignores the egalitarian design of state government taxes and, especially, spending. In plain English: the Kansas budget, just like the Wyoming budget, is not designed to balance on a per-capita basis. (This point has significant implications for neutrality-based tax reforms, implications that the Tax Foundation ignores. For lack of space in this article, we will have to return to them, too, in a later piece.)
2. They take inflation out of the picture. That is good when we try to estimate whether or not an economy is really growing, of if growth is just an inflation bubble, but it is a bad idea when dealing with government finances. Government, like taxpayers, lives in the real world where inflation - like it or not - is as integrated a part of life as time. Thus, deflated government spending figures tell us absolutely nothing about how that spending matches up with tax revenue or the performance of the economy as a whole.
3. Only the General Fund is counted. That, however, is less than 40 percent of total state spending in Kansas, and 56 cents of every dollar that the state pays for with in-state sourced revenue (not counting capital spending). 
In the quote from the CNBC article, the Tax Foundation even goes as far as to suggest that it was the tax cuts themselves that caused big deficits in the Kansas state budget!

I don't know what has happened to the Tax Foundation, a once respectable think tank, but the Kansas tax cuts is not the only issue where they have plummeted. Earlier this summer they offered their help to the Joint Revenue Committee here in Wyoming in creating a Gross Receipts Tax.

The core of the problem here is that any attempt at understanding a state budget problem without including spending, is thoroughly stupid. The Tax Foundation is far from alone here; they are just one voice in a chorus of welfare statists gladly turning a blind eye to government over-spending.  

Because that is really what happened in Kansas. As I explained in a follow-up article in July, pointing to a critical discrepancy between spending and the state's tax base:
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.
These numbers are not hard to come by. All you need to know is how to read and understand national-accounts data and government budgets. Yet every leftist critic of the Kansas tax cuts, from Better Wyoming to the Tax Foundation, apparently fails to even understand this imbalance. But if your tax base is growing at just over half the rate as your spending, then inevitably you are going to build up unsustainable budget deficits. 

Now for the main point: Kansas did not fail with its tax cuts. It failed with reining in spending. In order to get tax cuts right, we have to follow two simple rules:

1. Decide why you want to cut taxes. Do you want to preserve government revenue - i.e.m pursue revenue neutrality - or do you want to generate economic growth? The Tax Foundation (sorry for kicking a dead horse, or more aptly, a horse with four left legs) wanted the former kind of tax cuts, but what Kansas really went for was the second kind. The lawmakers in Topeka did the right thing in not listening to the Tax Foundation, but in doing so they had to understand that budget balancing becomes a secondary issue; increased growth, relative the same economy without tax cuts, is the variable to evaluate. 

2. Choose growth or government spending. A tax-cut strategy that is driven by revenue neutrality is a tax-cut strategy that puts government spending first, the private sector (taxpayers) second. You cannot maintain government spending "as is" and at the same time hope that growth will generate enough tax revenue to catch up. The reasons for this are embedded in the constructs of government spending programs (they are redistributive and have built-in growth parameters that guarantee annual spending growth), which effectively turn a neutrality-based tax cut into a cat trying to catch its own tail. A tax cut without at least a leash on government spending is bound to fail; the difference between a neutrality-driven tax cut and one pursuing growth is that the growth-oriented tax cut has a fighting chance of permanently closing the budget deficit. If it is coupled with structural, permanent spending cuts, the long-term outlook is decidedly positive for both the private sector and the core functions of government (law enforcement, fire and rescue and infrastructure). 

Republicans in Kansas tried to have it both ways. Even though they were more stringent with spending after the tax cuts, they still allowed it to outpace their tax base. More importantly, they failed to understand the basic fiscal mechanics of an egalitarian-based government. Going back to rule number two above, about the choice between growth or government, any tax cut - even growth-oriented - that fails to take into account the inherent spending drivers in entitlement programs, from K-12 education to Medicaid, is going to run into persistent problems with budget deficits. Eventually, it was this problem that brought the Kansas tax cuts to an end - not the tax cuts themselves. 

By pairing growth-oriented tax cuts with structural reforms to government spending, we can get right from day one what the Kansans got wrong. If we also make sure to ignore welfare statists from such consulting groups as the Tax Foundation, we will be in really good shape. 

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