Did Kansas prove that liberals are right to raise taxes?
Recently, Kansas voted to increase taxes, overriding the governor's veto and rolling back tax cuts. On the left, this was hailed as a definitive case against tax cuts and evidence as to why President Trump's tax reform should not be enacted. Tax reform, however, is much more complicated than it seems.
It is generally accepted among economists that tax cuts increase growth and tax hikes decrease growth. Yet a 2010 study by Christina and David Romer found that every dollar in tax increases takes three dollars out of the economy. Christina Romer served as the chairwoman of President Obama's Council of Economic Advisers, so she's a far cry from a staunchly supply-side economist like Arthur Laffer.
Studies by the OECD and the National Bureau of Economic Research confirm these findings as well, and these institutions are far from being considered conservative or libertarian think-tanks. The U.S. tax code desperately needs reform, and that includes making responsible rate reductions to free up American capital and spur investment.
Simply cutting taxes with no regard for which taxes to cut – or which exemptions are kept – is not the best strategy. Public finance is complicated, and the failure of tax cuts to boost growth while also fueling deficits in one state is certainly not going to provide enough evidence to prove that taxes needed to be raised rather than lowered.
The findings of mainstream institutions and think-tanks are validated by Kansas's experience. The Kansas debacle shows that indiscriminately cutting taxes has just as many unforeseen costs as indiscriminately raising them. If politicians are going to be setting policy that directly impacts how much of your paycheck you can keep, it is important that they understand all of the evidence.
One of the major problems that Kansas faced was that revenues kept declining, leaving the state unable to fund essential programs such as education. Lowering tax rates does not have to result in lower revenues, however, if these revenue losses are offset by a combination of economic growth and expanding the amount of taxable income – namely, by removing deductions. For example, the Tax Foundation, a nonpartisan think-tank devoted to researching the impact of tax policy, found that cutting the top rate down to 27 percent and eliminating all deductions except charitable contributions and mortgage interest would boost growth by 1 percent while increasing revenue by $255 billion over ten years, both of which are sorely needed in this environment, in which two-percent growth represents an upper limit.
Growth does not have to be nearly as sluggish as it is, and tax reform would free up capital needed to spur investment. In general, indiscriminate tax cuts will not generate as much growth as a targeted reform effort. This is precisely the problem Kansas encountered in its tax cuts. The Kansas legislature cut the top rate and exempted some business income from taxation altogether without planning to offset the loss in government revenues.
In fact, reforming the corporate tax code shows the benefits of responsible, measured changes over indiscriminate cutting. According to Tax Foundation data, implementing full capital expensing, which lowers the tax rate on new investments and thus encourages more business investment, will increase growth by twice as much as an equivalent corporate tax rate cut while lowering revenue by the same amount.
Public finance is not merely the question of the perfect rate of taxation. It also involves the proper structuring of tax rates, expenditures, credits, and exemptions, as well as deciding which organizations pay which taxes. Tax rates should be lowered – economic analysis from the left, right, and center has confirmed that finding. The error of the tax cuts in Kansas was that since they represented reform at the state level, only state taxes were cut. But since so much taxation occurs at the federal level, it was not a meaningful enough reform to offset the revenue reductions with new growth. Since the federal government collects around 61 percent of all taxes, while states collect only 28 percent, any meaningful change has to originate from the federal level.
To unleash the engines of economic growth in the United States, it is of paramount importance to make a tax code that spurs investment and innovation by incentivizing investment and letting households keep their hard-earned paychecks.
Matthew Fagerstrom is a student at Villanova University studying economics and political science. He has written for Squared Politics, a bipartisan political blog on Villanova's campus, and can be found at @mattjfstrom on Twitter.