Trickledown and the cautionary tale of Kansas
Tax reform, a perennial darling for the left and right alike come election time, has Congress aflutter once again. This time it seems less a torrid hot-and-cold romance and more clingy desperation, with Republicans clutching at tax reform as a point of hope in a legislative year that has led to a string of failures: healthcare, immigration, the budget.
As in those other legislative causes, precise details are ever-shifting. However as it stands, the corporate tax rate is proposed to drop from 35% to 20%. The proposed reduction in income tax brackets, and potential decrease in the percentage paid by the highest bracket, points to a redistribution of tax burden onto middle and working class earners.
The Tax Policy Center estimates middle class earners would save about 1.2%, but, according to the Economic Policy Institute, the top 20% of households would see 3.3% savings and the top 1% would see 8.5%. And the debt would balloon by $7 trillion over the next decade, according to the Tax Policy Center.
Cut, cut, cut in Kansas
Which brings me to the cautionary tale of Kansas’ great tax-cut “experiment”.
It was drafted with help from conservative heavy-hitters, including Ronald Reagan adviser and supply-side advocate Arthur Laffer and economist Stephen Moore from the Heritage Foundation. The reforms, passed in 2013, included phasing out state income taxes and eliminating taxes for “pass-through” businesses, which pay taxes via the individual tax code rather than the corporate tax code.
Economic growth, it was argued, would drive up tax revenue and balance the cuts. The initial plan was to also gain some additional revenue by eliminating some deductions, exemptions, and the income tax credit.
These didn’t make it into the final law.
Instead, Gov. Sam Brownback and the state legislature followed up with increasing sales taxes permanently to 6.15% rather than let them roll back to 5.7%, as designated by earlier legislation. And they cut standard deductions for married people and heads of households. Two tax increases that predominantly hurt the middle class and poor.
By mid-2014 Standard & Poor’s had downgraded Kansas’ bond rating and by 2017 Kansas had plummeted into a staggering $900 million budget hole that led the Republican-led legislature to revolt and end this great trickledown fiasco.
Business Insider has a fantastic article on the effects of Kansas’ tax policy. I like it because they don’t focus on economic theory, but rather keep to the numbers. They center their analysis on a quote from Governor Brownback, from an interview with the Kansas City Star:
Nick Jordan, the state’s revenue secretary, said the administration ultimately imagines the creation of 22,000 more jobs over ‘normal growth’ and 35,000 more people moving into the state over the next five years. And he expects the tax changes to expand disposable income by $2 billion over the same period.
See this is why politicians waffle over numbers. Numbers can come back to bite you if they don’t pan out. So kudos I guess to Brownback for actually putting some out there. Even if they turned out to be wrought more out of wishful thinking than sound economic policy.
So how did these tax cuts pan out? Business Insider’s analysis concludes,
All told, not only did the tax cuts fail to deliver faster job growth, faster population growth, or faster disposable income growth, but the growth rates of all three metrics declined noticeably after the tax cuts went into effect. Furthermore, the surrounding states, which did not impose massive tax cuts aimed at the rich, outpaced Kansas on all three measures over the same time period.
My favorite figure in their analysis gets to the meat of the issue: disposable income.
Disposable income is crucial to a thriving capitalist economy. Our economic measures are built around the idea that people are always buying. But a person can only eat so much, can only have so many widgets. If wealth is concentrated with just a few, they may buy another property or splurge on a yacht, but they aren’t going to suddenly eat twice as much or build a backyard fort out of iPhones.
A large middle class that feels comfortable making purchases is crucial. And when people are buying, companies will see stable profit and invest in production, research and development, and all the jobs that come with those things.
It’s a snowball effect. But not the chicken-and-egg question economists make it out to be debating supply-side versus demand-side. It begins with disposable income. Demand. An abundant supply of widgets won’t give anyone the cash to buy them.
Even the Kansas tax plan ultimately banked on increasing disposable income. It was supposed to come from all those plum jobs created by business tax breaks and tax breaks on the wealthy.
So how did that pan out?
As the figure above shows, while Kansas and its neighbors all saw a drop in disposable income, Kansas growth plummeted over 3% while its neighbors saw about a 1% contraction. Kansas’ growth had been stronger than its neighbors before the new tax policy, now it lags by over 1%.
There you have it. I wonder if the lesson will be heeded in Washington. Wanna place your bets? Let me know in the comments.