Kansas tax overhaul skeptics

In yesterday’s Wichita Eagle, editorial writer Rhonda Holman expresses her skepticism that income tax cuts in Kansas will do much good for the state.

First, of all, there’s one very good reason to reduce taxes in Kansas — and everywhere: doing that lets people keep more of their own money, and keeps it in the productive private sector. This is good.

There’s also a dangerous misconception contained in this editorial. Holman mentions the $4.2 billion in sales tax exemptions, referring to the amount of additional sales tax revenue that the state would purportedly collect if the exemptions were eliminated. First, eliminating most of these exemptions is a great idea. But some are not really exemptions at all, at least if we’re talking about a retail sales tax.

Last year the Kansas Legislative Division of Post Audit looked at these exemptions. Its report is Kansas Tax Revenues, Part II: Reviewing Sales Tax Exemptions.

The audit described one exemption labeled 79-3606 (m), described as “Ingredient/Component parts: Of items manufactured or produced for sale at retail.” The audit report estimates that for 2009, this exemption cost the state $2,248.1 million in lost sales tax revenue. This is over half the $4.2 billion Holman cited as available to the state by eliminating exemptions.

But this exemption isn’t really an “exemption,” at least if the sales tax is a retail sales tax designed to be levied as the final tax on consumption. That’s because these goods aren’t being sold at retail. They’re sold to manufacturers who use them as inputs to products that, when finished, will be sold at retail. Most states don’t tax this type of sales. If Kansas decided to tax these transactions, it would place our state’s manufacturers at a severe disadvantage compared to almost all other states.

There are two other exemptions that fall in this category of inputs to to production processes, totaling an estimated $461 million in lost revenue.

Another big-dollar exemption is “items already taxed” such as motor fuel. This is an estimated $232.5 loss in revenue. Two other categories of exemptions are purchases made by government, or purchase made by contractors on behalf of government. Together these account for an estimated $449.9 million in lost revenue. If these two exemptions were eliminated, the government would be taxing itself.

All told, these six exemptions account for $3,391.5 million of the total $4,234.2 million in exemptions for 2009. That’s about 80%.

So $4.2 billion has shrunk to $842.7 million. That’s still a lot of money, but not near as much as spending advocates would like to have Kansans believe is lying in wait just for the taking.

By the way, the $4.2 billion figure doesn’t include all the sales tax exemptions given, as the audit looked at only those exemptions placed into statute. Many sales tax exemptions are one-time deals, such as the over $500,000 exemption the Wichita City Council awarded to the developers of a hotel in downtown Wichita.

In her editorial, Holman wrote that “Brownback likened eliminating the exemptions to raising taxes,” the implication being that the governor would not support eliminating these exemptions. But these exemptions should not have been granted in the first place.

Holman contends that businesses make location decisions based on “availability of labor and land and the regulatory climate.” Given this, we’re told that Kansas has a skilled work force, we’ve got plenty of inexpensive land, and in many rankings, our regulatory climate is not too bad. That leaves taxes as an additional field on which to compete, and we’re moving in the wrong direction regarding taxes.

Holman also writes that K-12 education is underfunded. This argument is difficult to sustain in light of the facts, which are that until very recently, Kansas school spending soared.

Kansas school spending, per student.

Instead of spending more on a state school system, we could spend less and give parents more choice by implementing various forms of school choice. Despite the claims of school spending advocates, school choice saves money for the state. Additionally, local districts are actually better off under school choice, as explained in The arithmetic of school choice in Wichita.

There’s much more Kansas could do to reduce spending, which in turn would let us reduce tax rates without cutting services. First, Kansas makes little use of outsourcing. In Wichita, our one major experiment in outsourcing produced savings greater than anticipated. Yet, we don’t have plans to expand this practice.

Another thing Kansas must do is to use zero-based budgeting, at least periodically. The current practice is to form new budgets based on last year’s spending. While he was a member of the Kansas House of Representatives, Jason Watkins explained the need, as I reported: “Watkins said that the present system, where each year’s budget is based on the past year’s plus an increase, produces anomalies. He illustrated a case where an agency might be able to get some federal money if the state spends some if its own. It might be, say, a three-year program. So the legislature authorizes and appropriates the funds. Then three years later the federal money is gone, so the program ends because the state funding alone is not sufficient for continuation. But the money the state allocated is still in the agency’s base budget — even through the program no longer exists.”