Five Facts on State Budget and Tax Policy

Five Facts on State Budget and Tax Policy

When
the Kansas Legislature reconvenes next Wednesday, the major unfinished business
will be reaching an agreement on a state budget and tax policy.  The Governor and Senate Republicans are
pushing to keep in place the current state sales tax rate.  The House has rejected that plan so far, with
Democrats in both chambers strongly opposed. 
Here are five important facts about the latest official Consensus
Revenue Estimate released April 19 and the competing budget and tax plans.
1. The Kansas
economy continues to recover, but more slowly than in the past.

State
officials and university economists, who develop the consensus estimates twice
a year, project Kansas Personal Income (total income of Kansas residents from
all sources) will increase by 3.1 percent this year and 4 percent next year, to
$129.5 billion.  That is an increase of
$21.1 billion since the bottom of the recession in 2009, an average of nearly 5 percent per year.  By contrast, KPI
increased an average of 8 percent the previous five years (2003 to 2008), and an average of 7 percent between 1992 and 2012.
According
to the US Census Bureau, Kansas per capita income (personal income divided by
population) was $41,835 in 2013, ranking 24th in the nation; down
from 21st in 2010 but up from 28th in 2000.  Kansas per capita income has increased 3.9
percent per year on average since 2000, higher than the national average of 3.4
percent.
2. State income
tax cuts are not projected to have a significant economic impact – yet.
Governor
Brownback and Republicans who support the major income tax cuts passed last year
believe they will accelerate economic growth. 
They expect more jobs will be created, leading to higher personal
income, which will create more spending and therefore more tax revenue for the
state and local governments, which will offset some of the revenue lost through
the tax cuts.
The
consensus estimating group apparently does not see this is happening so far.  Projected state general fund (SGF) revenue
for Fiscal Year 2014, when the tax cuts are fully implemented, is $5.45
billion.  That is almost exactly what was
expected under the so-called “static” model that does not factor in economic
stimulation from tax cuts.  In other words,
the official estimate of economic and revenue growth almost one year after
the tax cuts were passed is almost identical to the Kansas Legislative Research
Department’s estimate before the tax cuts passed.
However,
the new April estimate increased the revenue projection for the current year (FY
2013) by $30 million – slightly more than projected under a “dynamic” analysis
developed by the Beacon Hill Institute and the Kansas Policy Institute released
last July.  That model projected state
general fund revenue in FY 2014 would be between $80 and $108 million higher
than the “static” model.  The new
consensus estimate does not agree with that projection; in fact, the revised
estimate for FY 2014 is slightly lower than the amount projected last November.
At the
same time, there were fears that more small businesses than expected would change
tax status to reduce tax liability and result in a deeper drop in state revenue.  The consensus group does not see that
happening, either.
Finally, there are
many factors other than tax rates influencing the state economy, such as
drought, federal budget policies and the international economy.  One of the problems with evaluating economic policy is the difficulty in determining how much any single factor contributed to the overall result.
3. The tax cuts are
having a major budget impact.

The $5.45
billion estimate of state general fund receipts next year (FY 2014) is almost
$1 billion, or 15 percent, below last year (FY 2012), mostly due to income tax
rate cuts.  SGF revenues would be the lowest
since 2006, except for the recession year of 2009.
This is
an even more dramatic shrinking of state government when compared to the state
economy and taxpayer income.  The FY 2014
SGF revenue estimate equals 4.2 percent of projected Kansas personal income for
2014.  That would be the lowest ratio of
state revenues to state personal income since at least 1976.  In fact, since 1988, SGF receipts have only
been below 5 percent of KPI twice (1992 and 2010).
However,
both the Senate and House have agreed to transfer $118 million from other sources
into the state general fund.  These
transfers are not counted in the revenue estimate, which is based on current
law.  The Senate has also agreed with the
Governor’s call to keep the state sales tax at 6.3 percent permanently, rather
than dropping to 5.7 percent under current law; and has approved a phase-down
of income tax deductions and other revenue adjustments
that would generate SGF
revenue of $5.9 billion, or 4.6 percent of Kansas personal income.  The House revenue plan does not include the
sales tax rate extension and would produce SGF revenue equal to 4.4 percent of
KPI.  Under both the House and Senate
plans, state revenues as a percent of personal income would be lower than any
point since the 1980s, before the state assumed a larger role in school finance
in 1992.
4. Kansas school
spending compared to personal income is the lowest in decades.

The
House and Senate have both adopted the Governor’s proposals to hold K-12
funding “harmless” from spending cuts, partly by replacing state general fund
aid with state highway fund transfers, and actually increasing funding for
Kansas Public Employees Retirement System contributions and bond and interest state aid.
However,
school district general operating budgets for FY 2014, with no increase in base
state aid, special education aid and local option budget aid, are projected by
KASB to equal 3.1 percent of Kansas personal income, lower than any year since
prior to 1975, and well below the 38-year average of 3.6 percent.  State aid for school districts (which
excludes local revenues) is projected at 2.5 percent of KPI, and would be even
lower without the significant increases in KPERS funding.  This level of state aid compared to state personal income
would be the lowest since passage of the 1992 School Finance Act, which
significantly increased state aid to reduce and equalize local property tax
rates for schools.
5. The key budget
challenges are long term, not next year.

Because
the state is projected to have an ending balance of at least a $625 million (over
10 percent) on June 30, both the House and Senate budget proposals for next
year could be funded without any changes in tax policy.  However, under the House plan without the
sales tax extension, the ending balance drops to 7 percent in 2014, 2.6 percent
in 2015, and essentially zero in 2016.
The
Senate plan, which keeps the sales tax in place, also includes additional
income tax reductions beginning with less than $40 million in FY 2014, but
rising to over $500 million in 2017 and over $1 billion in FY 2018.  As a result, the ending balance would remain at
least 6.5 percent through 2016, but would face a deficit by 2018.  Since SGF revenue is expected to grow by
about $1 billion between 2014 and 2018 with a normal growth rate of about 4
percent, actual growth would have to be more than double this amount to offset
additional tax cuts in the Governor’s and Senate’s plans.
Under
“normal” growth assumptions, if the House defeats the extension of the sales
tax, the state general fund balances will drop to a point with where state aid
payments may be delayed and there will be “no margin for error” if revenues
fall below expectations in FY 2015 and beyond. 
If the Senate plan is passed with the sales tax extension but also with
deep income tax cuts mounting over the next five years, the state will again
face a significant budget shortfall.  For
either approach to work without further significant spending cuts, the state
economy will have to grow much faster than is currently projected.