Opponents of federal income tax cuts besieging Congress with dire warnings about what happened in Kansas may not realize it, but they aren’t dealing in facts. Kansas does have budget problems, but that’s largely because legislators cut revenue and set new spending records. Every state provides the same basket of services, but those that do so at better prices can keep taxes lower. Kansas needed only to go from being morbidly inefficient to grossly inefficient to balance the budget, but legislators in both parties increased spending instead.
Claims about missing revenue estimates have also been misrepresented. Most of the revenue decline was planned – that is the point of a tax cut. But decreased collections from precipitous drops in agriculture, oil, and gas prices had a significant effect. Never mind that Kansas’ revenue estimating process has long been off the mark.
As for Kansas trailing national economic averages, that’s almost always been the case, as Kansas lags the nation across business cycles. What isn’t shared is that cutting taxes on small business did spur private sector job growth. Kansas didn’t cut taxes for the big C-corporations; only pass-through companies like proprietorships, partnerships, sub-S corporations, and LLCs got a tax cut (their income was exempted from taxation) and those small businesses had very large gains. Pass-through company jobs averaged just 1.2 percent annual growth in the two years before the change but those companies have grown at 4.1 percent annually since. Companies that didn’t get a tax cut had virtually no employment gains.
The data also show the small business job gains came from organic growth rather than the result of large-scale tax avoidance schemes as has been alleged. The Kansas Department of Revenue says the percentage of C-corporations converting to pass-through status was less than two percent and barely higher than the pre-cut conversion rate, and IRS data also refutes any notion of any significant tax avoidance conversion. And for perspective, an independent academic study attributed only 2 percent of Kansas’ revenue decline to tax status conversions.
Cutting the marginal income tax rate on pass-through companies is one of the major aspects of tax relief being considered in Washington, and for good reason. It’s not simply that the top marginal rate for small business is even higher than that imposed on C-corporations (39.6 percent vs. 35 percent); these companies are also vitally important to the national economy.
The most current Census data tracking employment by legal form of organization shows C-corporations accounted for 45 percent of private sector jobs in 2015, while pass-throughs employed 42 percent of the private workforce; the rest is in non-profit employment. If Congress wants to spur job growth by cutting taxes, it makes more sense to provide relief to small pass-through businesses that are poised for growth.
Cutting taxes encourages risk-taking, and research conducted by Arthur Hall, director of the Brandmeyer Center for Applied Economics at the University of Kansas, demonstrates the importance of doing so. Hall says the goal should be to create “…conditions necessary to induce as much commercial experimentation as possible…” by finding "gazelles" that start very small but become huge companies over time. Think of Amazon, Garmin, Walt Disney, Apple, Whole Foods, Nordstrom, and Dell – each of which started as a small business in a garage, basement, or bedroom but became huge companies.
Hall’s research on job creation over the life cycle of businesses shows that, if not for jobs created by new establishments, there wouldn’t have been a single year of private sector job growth in the U.S. since 1977. Given the entrepreneurial spirit of small businesses and knowing that the U.S. is critically dependent upon the creation of new establishments, it’s in the nation’s best interest to cut small business taxes.
Yes, the Kansas tax relief effort suffered many self-inflicted injuries, but those attempting to scuttle federal tax reform by misrepresenting what occurred in Kansas are simply trying to justify high taxes for political purposes.
Dave Trabert (@davetrabert) is president of the Kansas Policy Institute.
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