Kansas Downgraded

From WaPo:

An ambitious plan to cut income taxes in Kansas will end up costing the state more money than it initially estimated after a key ratings agency downgraded the state’s debt on Wednesday.

Standard & Poor’s cited structural imbalances created by the tax cut in its decision to slice Kansas’s bond rating from AA+ to AA. That means Kansas will have to offer a higher interest rate to lenders when it issues new bonds.

The package of tax cuts, backed by Gov. Sam Brownback (R) and his conservative allies in the state legislature, was never offset with equal spending cuts, S&P said Wednesday. The lost revenue is expected to eat up much of Kansas’s budget reserves during this fiscal year; S&P said it expected the state to face a $333 million budget shortfall this year.

“In our opinion, there is reason to believe the budget is not structurally aligned,” S&P analysts wrote.

Moody’s has already downgraded Kansas. And so the experiment continues.

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15 thoughts on “Kansas Downgraded

  1. Ricardo

    Oh my, Kansas is being downgraded just like the federal government and for basically the same reason, lack of cuts in government spending.

    Menzie, do I understand that you are now on the austerity bandwagon with this post?

  2. baffling

    actually the downgrade was for a structurally unbalanced budget, not lack of cuts directly.

  3. DeDude

    Yes the downgrade was for putting the horse in front of the cart. You cannot cut taxes before you cut spending and be expected to be rated as a responsible adult. Just the same way that you cannot just drop your job at age 62 without either another income source (pension) or a realistic and tried out reduction in your spending habits to demonstrate that they can be covered by your social security check.

    I am all for the idea of less taxing and less spending if it is implemented in a responsible way. First you identify those items in the budget that are spending money that we do not need to spend (e.g., absurdly overblown defense spending). Then you cut those spending items and use the first few years of savings to pay back debt. Only after the cuts have been implemented for a few years, and debt has been reduced to a desirable level (at the federal level there may be a need to keep some debt), do you consider tax cuts (targeted to where they do the most good for the economy and society as a whole).

  4. Ricardo

    DeDude,

    You sound just like the Republicans in the 1960s who opposed the Kennedy tax cuts.

    1. Brian

      Ricardo,

      Even in the most theoretical construction, the Laffer Curve is not continuously downward sloping. There’s a big difference between combined federal and state marginal rates of 90%+ and 35-45%. We are pretty plainly in a situation where tax reductions, at a bare minimum in the short term, do actually cost you revenue. This is true over the long-term as well since there’s not much evidence that they cause sufficient marginal growth to offset their cost even over a number of years, and certainly not a present value basis to offset current deficits. Since state budgets have to be balanced, you have to weigh it against long-term public investment losses as well in education, health, and infrastructure.

      To return to a point you said at the beginning of the thread, I wanted to say how odd what you said truly was. Leaving aside the federal government credit rating, which was cut by a single rating agency due to a legislative impasse more than anything, Kansas’s rating has been cut because of a severe projected revenue shortfall. Kansas has not been radically increasing spending in recent years. You would be awfully strained to say that it has. http://budget.ks.gov/publications/FY2015/Directors_Budget_Overview–1-16-2014.pdf

      No, the issue is that they have seen a much more radical reduction in tax revenues than they had expected. This wasn’t solely due to rate reductions or the fiscal cliff capital gains shift phenomenon. Part of it is a result of how they entirely excluded pass-through income from taxation, which was an odd choice to make. Pass-through entities are only taxed once while C-Corps are taxed twice. Now in Kansas pass-through entities are not taxed *at all* while C-Corps continue to be taxed on both profits and dividends. First, I want to say that pass-through entities are no synonymous with “small businesses.” Many LLCs, partnerships, and S-Corps are quite large while C-Corps can be quite small. Secondly, this creates an incentive to reclassify business entities and even to shift employment classifications to be an independent contractor as opposed to an ordinary employee. When they release tax statistics on Tax Year 2013, I’ll be fascinated to see what happened.

      The point of this is that Kansas has seen a far greater erosion in their tax base than expected, which has left their budget, even with no real increases in spending over the past few years, badly out of balance. To say that the problem is spending is really rather absurd. I guess in a technical sense if we completed eliminated taxes and still tried to provide some government services the “problem” from your perspective would be that we still tried to maintain some spending. However, I think most fair-minded people can see what the true problem is.

      Let’s drop the high-level superficial political differences between Democrats and Republicans here. What Kansas did was horrendous tax policy on an objective basis. Even the Tax Foundation called them out on the silliness of the pass-through exemption. Tell me how that’s good policy. I dare you.

  5. Ricardo

    Brian.

    I do not disagree with you on the way Kansas tax structure treats pass-through taxes for S-Corps. There will be an initial loss of revenue as many of these are professional individuals where the change in their tax condition will not generate more production.

    I can understand that you probably missed my post on July 1, 2014 regarding Menzie’s June 30, 2014 post “Whistling Past the Intellectual Graveyard” where he references this article by Josh Barro who does a good job of explaining the same phenomenon in other words.

    Excerpt of my post:

    …For a tax system to have a supply side effect it must impact those taxes that are on the disincentive side of the [Laffer] curve.

    …Barro was very clear in his analysis of the Kansas tax cuts…. It is cleear from Barro that Kansas has implemented tax cuts that have a negative supply side effect. Unlike the demand side theories (Keynesian and monetarist) supply side economists do not believe that all tax cuts and all monetary expansions are the same. Digging holes and then covering them up do not generate production, employment, nor wealth. When tax cuts are implemented (such as the first Bush Keynesian tax cut) that do not impact production or, as in the case of Kansas, actually reduce tax revenue without generating additional supply through production they are not supply side tax cuts.

    Supply side theory requires much deeper thinking than the demand side mercantilist thinking. Mercantilism is based on emotional feel-good economics founded in illusion. Rather than disproving supply side economics the experience in Kansas, Illinois, California, and New York prove supply side theory, but only for those who do not settle for superficial thinking.

    I encourage you to read Barro’s article to better understand economics.

  6. Ed Hanson

    I had a real problem with Barro’s analysis. When referring to a 1099, it simply did not ring true. As it still stands Federally and previously before the tax change in Kansas; all income beyond expenses in s-type corps were taxed at the the owners personal tax rate. Now in Kansas the tax is only applied to that money that is taken out of business. If a profit is left within the business, it is now allowed to accumulate and grow. This should allow greater self financed capital for business growth. It is a longer term benefit to Kansas economy, as well as business in general. In no way is Barro correct to say a 1099 is untaxed to him, unless he never touches the money and leaves it within his business forever.

    About Kansas politics. I suspect that most farms fall under S-type, LLC or partnership. These businesses, by necessity, look ahead several years. I see this tax treatment as beneficial for this type of business, one that is quite important for the Kansas economy.

    Ed

      1. Ed Hanson

        Even if farming accounted for 4% that is a significant segment, but I am highly suspect of your figure.

        Ed

        1. Menzie Chinn

          Ed Hanson: You can confirm for yourself, from the Kansas Department of Commerce, in the table about the midway down the webpage (data for 2012, total of agriculture, forestry and fishing, at 3.91%).

          So be suspicious no longer. Or suspect the BEA of a conspiracy so vast…

          1. Ed Hanson

            Menzie,

            your better than that. But rather than just respond myself, I will quote directly from the Kansas Department of Agriculture.

            “How Does Kansas Agriculture affect the Kansas Economy?

            Agriculture is the largest economic driver in Kansas, valued at more than $35 billion, accounting for 25 percent of the state’s total economy.
            In Kansas, there are 52,320,102 acres of land. Farmland accounts for 88.6 percent of all Kansas land. More than 28 million acres in Kansas is devoted to growing crops and nearly 16 million is pastureland for grazing animals.
            The agriculture sector in Kansas employs more than 427,000 people through direct, indirect and induced effect careers, according to information from the U.S. Census Bureau and the U.S. Department of Agriculture.
            Agriculture in Kansas is not just about growing crops and raising animals. The Kansas agricultural sector includes renewable energy production, food processing, research and education, agribusiness and more.
            Kansas is part of the animal health corridor. Between Columbia, Missouri and Manhattan, Kansas sits the single largest concentration of animal health interests in the world.
            Kansas farmers and ranchers are feeding the world. In 2012, Kansas exported nearly $4.9 billion in agricultural products. The top four exports include wheat, beef and veal, soybeans and corn.

            This is from Kansas Department of Agriculture

            Menzie, I do not expect you to become an ag economist, but really, lighten up a little on the slant and try to attempt to create a broader and truer picture.

            Ed

        2. Menzie Chinn

          Ed Hanson: Thank you for your comment. I see, despite the fact you commented in that thread, you did not read my response to Steve Kopits when he quoted a similar document and asserted this tremendous import to agriculture — so let me recap verbatim:

          Well, let’s see, I understand how BEA calculates the shares. It divides value added by gross state product (which is the sum of value added in all sectors in the state) to obtain the number. I do not know how the Kansas Ag Sec calculated his figure, but I suspect he took total output and divided by state gross state product. Gross farm income was $15 bn in 2011, Kansas GSP in 2012 was about $140 bn, so at least we are in the ballpark of the 19% figure. I know what I learned in graduate school was the right thing to do, and it is not (apparently) what the AgSec did (I think that is why he used the word “accounted”). If you have a new treatise that says it is correct to divide total output by the sum of sector value added in a state, I would welcome learning of it.
          So…I’ll stick with 3.9% as reported in the Kansas Department of Commerce website.”

          Well, I have even less idea how the numbers were generated in the document you linked to — but I suspect the same sort of problems arise.

          Now, you mention the concept of other industries being reliant on agriculture — that is a dollar’s production in agriculture “multiplies” into dollars of spending in other sectors. Hmm, I think I like that idea of “multipliers”, and I hope you take it to heart. Of course, if we took the Classical presumption that factors of production are always at full employment, then agriculture-dependent linkages would only be reallocating resources from one activity to another….

          Now, you say I should lighten up. Well, this is pretty rich for a guy who writes:

          This is the second “economic” post in recent memory that is beneath you as an economist, the other being your GDP numbers before and after WWII. What is in common with both of those post is your acceptance of numbers without any written thought to what they mean. And anyone can do that, read the following written in the style of Menzie Chinn.

          My advice — go back to your hole and return to your mission of misinterpreting data.

  7. Ricardo

    Ed Hanson,

    I need to amend my post to Brian. Barro clearly showed that there would be a tax shortfall due to the Brownback tax cuts. That could mean that Kansas would have to cut government spending. There is a shift of income from the state to individuals. This will be a benefit for small businesses and for those that are manufacturing Kansas will see a boom in business. The problem is that this boom will take time. This is a case of running a deficit in the short-run to gain long-term benefits.

    But that does not change the fact that there will be in near-term loss of tax revenue. The real question is, is this really a bad thing? Is it better to have politicians spening money or small businesses spending the money?

    Also, I said this was not a supply side tax cut. What I should have said is that this will not show a Laffer effect in the short-term. Any time that productive businesses have more revenue and governments have less is a net benefit to the long-term health of the state.

    Ed, I believe Barro’s analysis is fine but incomplete. The loss of tax revenue he demonstrates is true, but is worth the long-term investment. What you understand but most non-supply side economists do not is that deficits and loss of tax revenue are part of supply side economics if it involves real private sector investment rather than the phoney Keynesian “investment” of government spending.

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