“We’re not in Kansas anymore.” It’s a good thing because the radical tax cuts Kansas Governor Brownback implemented back in 2012 did serious harm to his state and its economy.
Governor Sam Brownback convinced the Republican controlled legislature in 2012 to reduce personal taxes significantly and exempt small business and agricultural income which is passed through to owners from taxation in order to spur economic growth. He claimed that this business expansion would easily produce enough new state revenue to enable Kansas to balance its budget with these lower tax rates.
Brownback cited economist Arthur Laffer, creator of the Laffer Curve, for support of his proposal. Back in the late 1970s, Laffer drew a simple curve which showed that high marginal tax rates actually produce less revenue than government would receive if these tax rates were lower. While there was no empirical evidence supporting this claim, Laffer’s Curve was embraced by Presidential Candidate Ronald Reagan during the 1980 campaign.
Even though Reagan’s primary opponent George HW Bush called this approach “Voodoo Economics,” the Reagan-Bush ticket rode the Laffer Curve to victory; what could be better than cutting taxes, growing the economy and balancing the budget? A true Hollywood ending, happily ever after.
In office, Reagan passed the largest tax cuts in history (until then); tax rates on personal income were reduced 25 percent. The economy did grow after the deep recession of 1981-83, but the federal budget was never balanced. When Reagan left office the government’s debt had doubled.
What happened? The economic expansion was funded by loans from foreign investors and governments including China and Saudi Arabia which covered eight years of budget deficits. When Reagan’s successor, the elder Bush, left office in 1993, the national debt had actually tripled compared to 1980.
To be fair to Laffer, his claim that reducing tax rates would increase revenue is valid if the existing tax rates are so high that they do discourage business activity, for instance 60 percent or 70 percent. The claim is unsubstantiated, however, if the current rates are within any normal range.
The math shows why this is true. If we reduce taxes, say from 7 percent to 5 percent and lose $1 billion in revenue, the lost revenue cannot be recaptured by economic growth. If this tax cut producers $1 billion in economic activity, the additional revenue is only 5 percent of this or $50 million. There will not be enough growth to replace the lost revenue.
Nevertheless, the Laffer Curve fantasy has become dogma for many in the Republican Party. Dogma is a belief which cannot be affected by contradictory empirical evidence.
What happened in Kansas? The tax cuts created deficits in the Kansas budget, starting in 2013. To balance the budget, Brownback reduced funding for public education and other services including police and fire safety. In 2014, 20 legislative allies of the Governor lost their re-election races but Brownback rejected pleas for new funding sources.
Between January, 2014 and April, 2017, Kansas added 28,000 jobs. Neighboring Nebraska, a smaller state, however added 35,000 jobs during the same period. Kansas economic and job growth was slower than the national average. Standard and Poors downgraded the rating of Kansas bonds due to the growing annual deficits and unstable fiscal future. The Kansas Supreme Court declared that the state’s funding of public education was unfair and inadequate.
Earlier this year, both houses of the Kansas legislature achieved two-thirds majority votes to over-ride the governor’s veto of tax increases in order to increase revenue $1.2 billion over two years. Personal income tax rates were increased and re-imposed on pass through income. Funding for services would be increased but would still be below national standards. Gov. Brownback’s approval rating has fallen to about 25 percent.
The Republican plan to cut taxes at the federal level, though somewhat in flux, seems still tied to the Laffer Curve belief that tax cuts will dramatically stimulate new business activity and (at least partially) replace lost government revenue.
The proposed reduction of corporate business tax rates from 35 percent to 20 percent are supported by the Laff(er)able claim that doing so will increase average American worker wages by $4,000 annually. Two points deserve attention here.
First, while the official corporate tax rate is 35 percent (and over 39 percent for some income), the rate American corporations actually pay is much less. According to a Congressional Budget Office report, after credits and deductions, American firms on average pay only 18.6 percent of their income in taxes. Many large corporations pay only 5 percent.
Second, Proponents claim that the lower corporate tax rates will encourage American firms to repatriate much or all of the hundreds of billions of dollars they have kept abroad to avoid paying the high corporate rates here. This view, however, ignores the fact this most of this money is kept in global banks, many of which are American, which move these funds around the world, including here, to fund new business spending. Where do they think this money sits? Under the pillow?
The plans also intend to reduce the tax rate on income which LLC’s other ownership forms pass through to their owners. While Kansas temporarily eliminated this tax altogether, the current federal plan is to reduce the rate to the recipient to 25 percent. While the business stimulus effect of this remains unknown, its impact on income earners is clear. The Tax Policy Center estimates that reducing the pass through rate to 25 percent would pass 85 percent of the benefits to the top 1 percent of earners.
What is the economic or ethical argument that these people need financial assistance?
Kenneth Zapp, Ph.D., is professor emeritus, Metropolitan State University, and mentor for Savannah SCORE.