Republicans Are Getting Ready to Repeat Kansas’ Tax Cut

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Republicans Are Getting Ready to Repeat Kansas’ Tax Cut Disaster

By Jordan Weissmann

•Nov. 29, 2017, 6:27 PM

In a rational world, Kansas’ notorious experiment with radical business tax cuts, which came to a close this year after a half decade of disaster, would serve as a cautionary tale for the Republicans who are now attempting to pass their own tax bill through Capitol Hill—a historical example to be avoided at all costs.

Instead, they’re on the verge of repeating it, nearly step for step.

At this point, Kansas’ budget nightmares have become a part of public policy lore. In 2012, Gov. Sam Brownback attempted to turn his state into a conservative model for the nation by enacting a series of sweeping tax cuts.

Most importantly, he entirely eliminated taxes on what are known as pass-through businesses—which around that time made up 94 percent of all U.S. firms and accounted for about half of the country’s business profits. Brownback insisted that the move would act “like a shot of adrenaline into the heart of the Kansas economy” and create “tens of thousands of new jobs.”

Pass-throughs are often misleadingly described as “small businesses” in order to justify lightening their tax loads. In reality, they’re simply firms like partnerships or S-corps that aren’t subject to the corporate tax rate.

Instead, they pass profits through to their owners, who pay taxes on them on their personal returns (hence the name). They are often small—your corner bodega or pediatrician’s office is probably a pass-through—but can also be huge. The Trump Organization? Its various tentacles are organized as pass-throughs.

Suffice to say, cutting taxes on these businesses didn’t do Kansas’ economy much good. Instead of a jobs boom, the state found itself slogging through years of unimpressive growth and massive budget deficits as its tax base disappeared, forcing lawmakers to cut spending on public schools, colleges, Medicaid, and more.

The state’s credit rating was humiliatingly downgraded. Eventually, legislators got fed up with the pain, and this year they finally voted to reverse the cuts, with Republicans joining Democrats to override Brownback’s veto.

In April, a group of economists took stock of the Kansas misadventure, using administrative tax data to figure out whether the cuts had done any good at all. In short, the researchers concluded, they had not.

The main effect, it seemed, was that business owners relabeled some of their income as “profits” rather than wages in order to cut their tax bills. Business investment by passthroughs actually seemed to decline slightly.

If states are supposed to be the laboratories of democracy, then Kansas now looks like a blown-out chemistry workshop where some reckless kids got burned in a chemical fire. You would have to be blind to follow in its footsteps.

But that is exactly what Republicans have decided to do. Both the House and Senate versions of the bill include generous cuts to pass-throughs, worth hundreds of billions of dollars over a decade. The House version, which is larger, carves out a special, 25 percent top tax rate for them. The Senate bill allows pass-through owners to deduct up to 17.4 percent of their business profits from their taxes—though lawmakers like Ron Johnson of Wisconsin would like to bump that number up.

One would be hard pressed to exaggerate just how pointless these cuts are from an economic standpoint. Politicians like Johnson argue that if Congress doesn’t reduce taxes on pass-throughs, they will be at a disadvantage compared with big companies that benefit from the 20 percent corporate rate Republicans have planned.

This ignores two key details: First, corporations are typically taxed twice, once on the company level and then when they distribute dividends (which is why they have a higher average tax rate than passthroughs today).

Second, any business that decided it was getting a raw deal on taxes could just choose to convert to a C-corp and get the better rate. “Pass-through businesses have the opportunity to convert to C-corporation form any time they wish by checking a particular box on a particular IRS form,” Scott Greenberg of the conservative Tax Foundation told me, explaining why he thought the pass-through cuts were needless. “I don’t think that these provisions are ultimately justifiable.”

It goes almost without saying, meanwhile, that these cuts will mostly benefit the wealthy. According to one recent study, about 69 percent of income earned by pass-throughs ends up in the hands of members of the top 1 percent.

Unlike Brownback’s tax cuts, the GOP’s current proposals do include some elaborate guard rails meant to prevent the new tax breaks from being abused by people who want to pretend their wages are really business “profit,” as happened in Kansas.

They’re also designed to limit highly paid professionals like lawyers, doctors, and accountants from taking advantage of the lower tax rates, since their “profits” are really more like salary, rather than returns to capital investments.

But it’s not clear how sturdy those guard rails actually are. And as long as there’s significant tax savings to be had by getting the special pass-through rate, chances are business owners will try to find a way.

Already, tax experts have mentioned to me how law offices could try splitting themselves into multiple firms to get the break, or how people could abuse the carve-outs for passive investors in the House bill.

And the savings from those shenanigans really could be quite large. As Tax Policy Center co-director William Gale pointed out in a blog post, business owners in Kansas were spared a 4.9 percent income tax thanks to Brownback’s cuts. The new pass-through rates Republicans are contemplating could save business owners roughly 7 to 15 points.

Ultimately, though, the most important problem with the Kansas cuts wasn’t that rich guys started playing accounting games to take advantage of them. According to the study in April, only about 8 percent of the state’s revenue losses were due to that kind of income shifting.

The issue was far more fundamental than that. The state simply handed out a massive tax cut to business owners which yielded no economic gains to speak of. Republicans are on track to repeat that self-destructive trick, nationwide.

Worst of all, just like in Kansas, these needless tax breaks for the rich could lead to excruciating budget cuts. Under Congress’s Paygo rules, the tax bill’s deficits will result in large automatic spending cuts to programs including Medicare or Social Services Block Grants, unless the Senate can get 60 votes to prevent them.

Meanwhile, Republicans are now talking about adding an automatic trigger that will cut spending even further if their tax plans don’t generate heroic amounts of economic growth and revenues falls. We could very well be looking at tax cuts for the Trump family paid for by spending cuts on your grandmother’s health care.

Of course, many Republicans would see spending cuts as a feature, not a bug, of their plan. And if slashing taxes on construction companies and midsized manufacturers doesn’t lead to booming economic growth, it may not matter, either.

Republicans have repeatedly admitted that they need to pass this tax plan in order to appease their donors. And pass-through owners are especially powerful interest group whose demands can’t be ignored. After all, rich car dealers give a lot of money to political campaigns. Those guys want their tax cut, too. And so the whole country is doomed to repeat Kansas’ mistake.