Kansas’ budget problems keep getting worse.
State officials said this week that the tax cuts championed by Gov. Sam Brownback would force them to start a new round of substantial budget cuts before the end of June.
They need to cut $279 million, $239 million of which is attributable to lower-than-expected personal income tax collections. Those aren’t small numbers in a state budget of approximately $6 billion and where revenues have already declined sharply. Kansas state revenues dropped 11 percent in the fiscal year 2014 (which ended in June) after the tax cuts took effect.
But that may not even be the whole picture. A close look at the state’s new revenue projections makes clear they are highly optimistic, even after this week’s cut in the forecast. Kansas says it expects to collect slightly more personal income tax this year than it did last year, even though, with four months of collections in, they are 11 percent behind last year’s pace.
If the last four months’ performance is similar to the next eight, the state won’t miss its original income tax estimate by $239 million.
It will miss it by $546 million.
And because the state was already scheduled to spend down nearly its entire rainy-day fund balance (which totaled over $700 million in 2013) by the end of this year, it will have to respond to any widening budget gap with some combination of further spending cuts and tax increases.
“They’re clearly expecting income tax revenue to beat last year in April and May, but we’re not on any path to do that,” said Duane Goossen, a former state budget director under governors including Bill Graves, a Republican, and Kathleen Sebelius, a Democrat. “I would expect that the estimate is still too high.”
If the state’s estimate is right, it will be because payments next April (the ones people send in with their tax returns) are much bigger than they were this past year. That hasn’t been true of the revenue streams the state gets from the income tax withheld from employees’ paychecks and the estimated tax payments that people make quarterly on nonpayroll income.
There is a theory about why things could improve in the spring. Last year’s collections were very weak, and taxpayers who make estimated payments usually set this year’s payments based on what they owed last year. If their incomes are going up this year, they won’t send in the extra taxes they owe until April.
But not as many Kansas taxpayers need to pay estimated taxes. A cornerstone of the state’s tax cuts was a decision to exempt from tax most kinds of “pass-through” income. In most states, if you own a small business, you most likely organize it in a form such as an S-corporation, which pays no tax at the company level and passes profits through to you; you then pay tax on the profits on your individual tax return. But in Kansas, those kinds of businesses now owe no income tax at either the corporate or individual level.
One consequence of Kansas’ tax overhaul is that some taxpayers will reorganize their income, earning less taxable wages and more nontaxable profits. For example, payroll employees can become freelance contractors, collecting “consulting fees” instead of wages. To the extent those sorts of effects drove the weak tax collections this summer, there’s no reason to expect a rebound in the spring.
One reason to believe Kansas would issue a rosy estimate is that both liberals and conservatives in the state have incentives to believe in a high estimate and just cross their fingers. For conservatives, a lower revenue estimate would be embarrassing, because it shows the Brownback tax cuts were much more costly than advertised. For liberals, a lower revenue estimate would require a bigger round of state spending cuts in the short term.
A detailed memo about the estimates, which may explain why revenues would be better in the remainder of the fiscal year, should be released late this or early next week by the Consensus Revenue Estimating Group, a group made up of Kansas budget officials and state academics. Efforts to reach state officials for comment on the issue were not successful.
There may be even bigger challenges coming. In addition to the likelihood the state will face another unpleasant revenue surprise in the spring, a pending court decision could obligate the legislature to add hundreds of millions of dollars a year to state aid to school districts. And bond rating agencies, which already downgraded the state’s debt this year, could be expected to react negatively to both of those events.
The tax cuts were the leading issue in the Kansas governor’s race this year, and in addition to re-electing Governor Brownback, voters expanded the Republican supermajority in the state’s House of Representatives. This was a clear mandate for the policy of deep tax cuts. What remains to be seen is how the legislature, once the rainy-day fund is exhausted, will deal with the spending pressures they have created.