The Kansas Experiment

The Kansas experiment began in May 2012 and was led by Republican governor Sam Brownback. The plan was to drastically reduce taxes across the board, prompting economic growth, thereby increasing tax revenues to plug the initial loss of tax revenues. What occurred was a fall in tax revenues by hundreds of millions of dollars and poor economic growth, resulting in sharper than anticipated spending cuts. The Kansas experiment represented a catastrophic disaster for several reasons – notably the shocks in agricultural and oil prices, alongside the extent and nature of the tax reductions implemented. The experiment serves as a reminder that tax cuts do not always produce economic growth, as externalities and the level to which taxes are cut also have a part to play.

Background

In 2010, Sam Brownback was elected as governor of Kansas, following eight years of a Democratic governor. Brownback was said to represent the growing Tea Party faction within the Republican Party. The Tea Party was a political movement that swept the country, calling for lower taxes and lower spending, coupled with reductions in public debt. Tea Party Republicans were elected across the US, leading to a Republican majority in both the Senate and the House of Representatives; the Democrats had previously held both houses.

As a result, it is unsurprising that Brownback enacted extremely fiscally conservative policies. His 2012 tax cuts led to the top marginal income tax rate falling from 6.45% to 4.90% – a tax cut of 24%, applied to all income above $60,000. Income between $30,000-$60,000 was taxed at a new rate of 4.90%, a fall from the old rate of 6.25%. This was an effective tax cut of 22%. Finally, the lower tax bracket that applied to income below $30,000 was cut from 3.50% to 3% – a cut of 14%. The personal allowance was doubled from $4,500 to $9,000. At the same time, small business taxes were abolished with income-tax normally applied to ‘pass-through’ businesses also eliminated.

Results

The aftermath of these tax reductions was a fiscal crisis that lasted for many years. In the year following the tax reductions, tax revenues by $231 million. This wasn’t surprising, as tax cuts have historically led to initial revenues decreasing, with revenues increasing over the long term. However, tax revenues didn’t pick up in the following years; by 2014, the state was in crisis. As of June 2014, tax revenues fell $282 million short of what was initially predicted; the state received $369 million instead of the predicted $651 million. As a result, the S&P downgraded Kansas’ credit rating from AA+ to AA in August.

The budget shortfall forces the state’s legislature to enact deep spending cuts. By 2017, Kansas had implemented nine rounds of budget cuts over four years. These included cuts to transportation, healthcare and education – the latter of which Brownback had promised to increase spending in his gubernatorial election campaign. Credit ratings were further downgraded to AA- in February 2017. At the same time, Kansas was lagging behind neighbouring states with similar economies in most categories, including job creation, unemployment, GDP and tax revenues.

Causes of the failure

How did Brownback’s plan for growth fail? Tax cuts normally stimulate and grow the economy, right? Whilst this normally holds, excessively slashing tax cuts when they are already at low rates will do little to stimulate growth and produce tax revenues. This is inherent in the Laffer curve, highlighting an optimum tax rate that produces the greatest amount of tax revenue. As tax levels were already low in Kansas, with the top rate at 6.45% before the tax reductions, a cut to 4.90% did little to stimulate growth. By comparison, the top marginal tax rate in New York is well over 10%; a cut to 4.90% would likely produce a large increase in economic activity.

At the same time, Kansas’ economy was hit by falling oil prices and an agricultural decline. Oil prices fell from over $100 per barrel to $50 in 2015, with Kansas ranking in the top 10 of oil-producing states. The economic downturn caused by falling oil prices contributed greatly to falling tax revenues and the subsequent growing budget deficit. Agricultural prices also fell during this period. The price of soybeans per bushel fell from $15 in 2013 to $8 by the end of 2015 – a decline of nearly 50%. This was coupled with a sharp fall in corn prices, from $7 to $3 per bushel during the same period. Such a dramatic fall in commodity prices resulted in falling farm income. Unsurprisingly, this prompted falling tax revenues, further exacerbating the budget deficit and the state’s economic calamity. Regardless of whether the tax cuts were implemented, Kansas was going to suffer a revenue shortfall from these falling commodity prices as the Kansan economy depended so heavily on these sectors.

Eliminating small business taxes sounds great in theory; in reality, it led to widespread tax fraud and avoidance by individuals and larger firms. Many large corporations, including those owned by the billionaire Koch brothers, were deemed small businesses, allowing them to avoid paying any state corporate taxes. The elimination of income tax for pass-through businesses also created legal loopholes by which individuals could structure their employment to avoid paying income taxes altogether. This measure increased tax avoidance for individuals working in these types of companies.

Ultimately, Kansas’ failed experiment with tax reform can be attributed to negative externalities, alongside the nature of the tax changes. The commodities crisis that greatly impacted the agricultural and oil sectors of the Kansan economy would’ve happened regardless of the tax cuts; as these industries make up a large portion of the state’s economy, a shortfall in tax revenue was inevitable. At the same time, as Kansan tax rates were already very low, it is unsurprising that tax cuts did little to stimulate growth, with the elimination of small business taxes and taxes for pass-through businesses creating loopholes for many firms and individuals.