Thursday, May 2, 2013

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.

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