News from the Capitol--June 19, 2015

The Veto Session concluded last Sunday in what ended up being the longest legislative session in state history. While the length of the session was not what was preferred, the reason for the extended session is due the seriousness of the issue we were facing and the difficulty that comes with reaching a solution that could earn the votes necessary for passage.

First of all, a history lesson. As a result of a long history of over-spending dating back a decade or more, the state had a dip in revenues which resulted in a $400 million deficit. Known as “the lost decade” in the period from 1998 to 2008 Kansas was in last place of the 50 states for private sector job growth and Kansas was losing population due to its hostile policies toward businesses. Under the stewardship of the Sebelius Administration, Kansas was 49th place for its state pension fund, KPERS, for its unfunded actuarial liability (UAL). Illinois was the only state that was worse.

It got so bad that the SEC investigated Kansas in 2014 for the 2009-2011 time period because of mischaracterizations on the health of KPERS from the Sebelius/Parkinson administrations. Our government became so bloated that Kansas had 696.3 public employees per 10,000 of population, ranking 48th in the nation. This is far too many for a medium sized agricultural state.

Under the leadership of Sam Brownback, things have begun to turn around. Conservatives such as myself have consistently pushed for a smaller government in which the spending problems became part of the past and were replaced with a zero-based budgeting model in which every government expense has to be justified for need, rather than a simple increase over what was appropriated the year before.

Keep in mind, while many justifiably decry across the board cuts, the past trend of across the board increases is equally as problematic when you’re trying to establish a state government that spends your tax dollars in a way that is most efficient.

In addition, Kansas has become incredibly uncompetitive with our neighbors and hostile to small businesses and families in terms of its tax policy. This is particularly important in our state, when 85% of all workers work for a small business with 10 or fewer employees.

Yet, in other states, things were booming. Of the 10 states with a great deal of economic growth, nine of those 10 states have no state income tax. Kansas opted to emulate these most successful states in the country and worked to modernize our tax code to be competitive economically. The most successful states derive the bulk of their income from sales and other consumption taxes.

Since Governor Brownback took office in January 2011, we embarked on a path to zero income tax. While some of us would like to get there quicker than others, the march to zero has already helped spur an increase of 49,400 private sector jobs in Kansas, as of 2014. This has catapulted Kansas economic outlook ranking to 18th, from a low of 29th place under Sebelius/Parkinson. Kansas is ahead of all of the surrounding states except Oklahoma.

The conundrum which faced the legislature was that there were a number of factions with different ideas on how to deal with that deficit, ranging from a massive income tax increase on one end of the spectrum to the willingness of some to have the governor make deep across the board cuts.

To provide you more insight into my philosophy, I point you to the The 10 Golden Rules of Effective Taxation (Laffer, Moore, Williams 6th Ed)

  1. When you tax something more you get less of it, and when you tax something less you get more of it.
  2. Individuals work and produce goods and services to earn money for present or future consumption.
  3. Taxes create a wedge between the cost of working and the rewards from working.
  4. An increase in tax rates will not lead to a dollar-for-dollar increase in tax revenues, and a reduction in tax rates that encourages production will lead to less than a dollar-for-dollar reduction in tax revenues.
  5. If taxes become too high, they may lead to a reduction in tax receipts. The relationship between tax rates and tax receipts has been described by the Laffer Curve.
  6. The more mobile the factors being taxed, the larger the response to a change in tax rates. The less mobile the factor, the smaller the change in the tax base for a given change in tax rates.
  7. Raising tax rates on one sources of revenue may reduce the tax revenue from other sources, while reducing the tax rate on one activity may raise the taxes raised from other activities.
  8. An economically efficient tax system has a sensible, broad tax base and a low rate.
  9. Income transfer (welfare) payments also create a de facto tax on work and, thus, have a high impact on the vitality of a state’s economy.
  10. If A and B are two locations, and if taxes are raised in B and lowered in A, producers and manufacturers will have a greater incentive to move from B to A.

It’s important to remember that the free enterprise system is organic. Like an overgrown plant that has gone for years without systematic scrutiny or pruning, we have begun to analyze workings of the government and its agencies from top to bottom, and studied its impact on the Kansas economy.

Despite the protestations from our opponents and the liberal press, we have accomplished much in modernizing Kansas for the 21st century. In addition, the transition to a consumption economy is one of several multi-year reforms we are enacting:

  • Fundamental structural changes, and organizational changes have been made in our workers compensation laws.
  • We have reformed our welfare law.
  • We have reformed election law to dramatically increase the voter participation rates by changing local and school board elections to the fall of odd numbered years, and this increase in participation will undoubtedly increase the quality of governance in those areas.
  • Additionally, we passed the Voter Fraud bill, which stiffens penalties for voting unlawfully.
  • We have begun dramatic reform of the dysfunctional K-12 education funding formula by retiring it. The block grants give schools more money, lifts restrictions, and allows schools more freedom and flexibility to manage their funds. Now there is no excuse at all why many of these school districts cannot give their teachers the raises they deserve. During the 2-year interim the school districts will take what they have learned from this freedom and flexibility and provide input to the Legislature as we draft the new, more logical and economically sound methodology for funding K-12 education.

The consumption economy, reorganizing Kansas’ agency and department structure, block grants and new funding methods, and reorganizing administrative functions is completely interrelated with this year’s tax bill and appropriations bills.

So, in addition to these important tax reduction, what are the other core reasons for the budget deficit?

First of all, it is important to remember that Kansas is not its own country! We are just one state, and we are impacted by national policy on everything from tax policy to ObamaCare. Here are a few examples:

  • Obama Administration policies have caused the slowest recovery to any recession in the past one hundred years. The sluggish national economy has caused state tax revenues to decrease nationwide.
  • Second, the threatened capital gains tax hike from the Obama Administration caused a large segment of the population to sell assets, resulting in a revenue spike in 2013, which many states mistook as a trend. This caused errors in the revenue estimates, which caused part of the revenue shortfall. Kansas planned its 2013 tax and appropriations bills for 2014 based on the erroneous revenue estimates.
  • Medicaid caseloads are a major non-discretionary part of the budget. The State cannot control how much it increases each year. The states are required by the Federal Government to spend money on the caseloads for Medicaid. Obamacare or legally known as the Patient Protection and Affordable Care Act made this problem even greater, which is why the state of Kansas has resisted expanding Medicaid even further.

Second of all, KPERS is one of the non-discretionary areas of the budget that was one of the main reasons why we were not able to decrease funding this year. For decades the pension benefits were made more and more luxurious without a corresponding increase in the funds being paid to the KPERS system. That is how Kansas fell to 50% funding of the actuarial unfunded liability (UAL) and was second to last place in the nation under Governor Sebelius.

Because of this, we enacted reforms which make double (or greatly increased) payments to KPERS, which should reach 80% UAL around the year 2040. An economist recently indicated that is the point where Kansas will be able to convert to a defined contribution plan similar to a 401k, which is what 90% of the American workforce has. If it becomes feasible sooner, we will pursue it then. Bills were introduced to remedy the abuse of pension spiking and other abuses such as ‘retiring’ and then returning to a job in the KPERS system, while still receiving the pension payments at the same time. Unfortunately, these bills did not make it to the House floor.

By far the biggest culprit, however, is the amount of money we spend on schools. For decades the schools spent money in excess of the consumer price index for inflation (CPI). Notwithstanding this immoderate spending, they always seemed to have funds left over at the end of the year, which they, stashed in accounts known as “unrestricted funds”, rather than returning the excess to the state general fund. On average, the school districts keep these cash reserves in excess of what a similarly sized business would retain. Some claim they keep such excessive amounts because the state may not send funds to make payroll by deadlines, but this is a rare occurrence and represents more of a red herring than a real concern.

A good example of the upward cycle of spending was in 2014, when the education establishment sent its funding request to the state, and the state planned its budget on these figures. But, that proved to not be enough when that same establishment returned that same year requesting tens of millions more. This is one of the reasons why a great number of Republicans from all over the state demanded that the school districts spend down these extra cash reserves (approximately $800 million unencumbered; $1.4 billion total). In regards to higher education, the Regents Universities had approximately $250 million in unencumbered funds in 2014!

Of course, when these topics were discussed, the schools went on spending sprees to reduce their unencumbered fund balances. It seems the only emergency was the potential of a reduced budget.

However, this year we enacted the block grant program, which also increased funding for schools. Because of this important reform and the fact this budget was adopted in March, we could not realistically take further action on school spending this year.

If you exclude these areas, Kansas only increased spending this year by approximately 0.6%. While some of us would like to actually reduce spending, doing so is a difficult endeavor. However, the rate of growth is certainly a reasonable level, particularly given state employees have not received pay raises in many years.

Bringing this back to the tax debate, this is all important because it explains that despite what you may read, the reason for the deficit is not purely related to the reductions we made in taxes. Moreover, the tax reductions are very important for our economy and the growth of our state, and reversing those policies in their infancy would be a profound mistake. This is why the governor and conservative legislators were so resistant to reversing course on that matter, particularly when there is so much real evidence the policies we enacted are working.

Of course, these funding issues aside, the Kansas Constitution does not provide us an out. We are obligated to pass a budget that’s balanced by the revenues collected. As one could imagine in a 165-member legislature, there are many different ideas about how to go about that. In truth, though there are two parties, there are actually several factions, and who can unify their factions together to reach a majority wins the day.

In one corner, you have the Democratic Party and liberal wing of the Republican Party, which in the House of Representatives represented about 45 legislators or so. They decided early on that short of a full repeal of all the income tax cuts we enacted in 2012 and 2013, they would vote no. So, right out of the bat you have more than 1/3 of the legislature taking themselves out of the equation.

Then, within the remainder of the Republican ranks, which totaled about 75-80, you had a faction of about 25 who was continually pushing for us to eliminate the exemption for LLCs, claiming it was a ‘loophole’ that was not legislative intent. This could not be further from the truth, and apparently this coalition of legislators forgot that the 2012-2013 tax bill reduced individual income taxes for the high and low tier (which was the biggest reason for a decline in revenues), eliminated income taxes on small business to jump start the economy and to incentivize businesses to come to Kansas, and that C-corps, or what are considered large companies, would have their income tax rates reduced later as the consumption tax system matures. The idea was that EVERYONE in Kansas was eventually to have no income tax – individuals rich and poor, and small and large businesses. The notion that this was not legislative intent is completely erroneous and you should not believe that contention when you read it.

Another more limited faction was mostly comprised of legislative leaders and others who were most concerned about enacting a policy that would end the session as quickly as possible and meet our revenue shortfall, and while they were not necessarily looking to increase taxes, they were much less concerned about the policy principles than simply maneuvering through the process towards its conclusion.

Finally, there was a coalition of approximately 30 conservative legislators whose aim it was to protect and defend the important tax reductions I referenced earlier, continue to push for spending reductions and other reforms, and do so with either no or a limited tax increase.

In the end, the latter three factions of Republicans willing to craft a solution would continually meet. Of course, each individual legislator had to vote consistent with their own conscience. It was my goal to have the ultimate piece of legislation we enacted be as conservative as reasonably possible, while preserving the path to zero and a consumption-based economy.

Bills 270 and 2109 were far from perfect. In the end, they did not include policy that many wanted – such as the sales tax exemption review commission and a reduction in food sales tax. Moreover, it included an increase in the sales tax, as well as on cigarettes, including a new tax on e-cigarettes. However, on the positive side, it reinstate a property tax lid on local governments who have habitually raised taxes year after year without a vote of the people, and it did Include some provisions to help out lower income families.

In the end, I had to make a vote and I voted yes. I do so knowing fully that tax policy is not permanent, and that there will be opportunities in the immediate next session to remedy the negative or missing parts of the bill. For those who are concerned about the fact our food sales tax is 5 x that of Missouri, I believe there will be a bill next year to bi-furcate our sales tax so we can reduce the tax on food so Kansans near the border do not feel like they must shop for groceries in Missouri. I also will push to ensure we embark on a serious review of all of the sales tax exemptions in Kansas, as there is a great deal of revenue tied up in those exemptions, and getting rid of them would perhaps allow us to lower the general sales tax rate back down to a reasonable level.

Of course, the thing we must focus on the most is spending. We must pursue a system which will allow us to have a thorough review of each agency’s budget and change the culture so that agency heads don’t ask for what they think they can get, but what they truly need. Furthermore, we must take a serious and comprehensive look at our K-12 and higher education spending and look for ways to reform the spending so that more money is actually going to educate the child and not line the pockets of wealthy administrators.

In closing, I respect the fact some may disagree with the vote outcome and even the process it took to get there. That is understandable and there are many aspects of this session which were incredibly frustrating. However, as I sit here today, I remain committed to a path of prosperity for our state, and will continue to do my best to vote in a manner consistent with that commitment.