Scott Sumner  

Why no Kansas miracle?

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Piketty Bleg... Free Intentions...

The past two years Kansas reduced its state income tax rates. As a result, the top rate of income tax faced by Kansas residents (combined state and federal) rose from 41.45% in 2012 to 48.3% in 2013 and then fell a tad to 48.2% in 2014 (if they don't itemize.) That's a pretty tiny drop in the top marginal tax rate in 2014, and a much bigger rise in 2013.

I consider myself a moderate supply-sider, but I certainly wouldn't expect such a tiny tax cut to significantly affect behavior. And any effects that did occur would happen very gradually, over a period of many years. For instance, firms might be slightly more likely to move to Kansas. But even after the tax cut, the top rate is almost as high as in Massachusetts, so Kansas is certainly not a tax haven like Washington or Texas, which have no state income tax.

I can't imagine any serious economist predicting that the Kansas rate cut would boost Kansas GDP by 25% or more. Why did I pick that figure? Because the Kansas state income tax top rate fell from 6.45% in 2012 to 4.8% in 2014, which is roughly a 25% rate cut. In order for that rate cut to boost Kansas tax revenues, you'd have to see Kansas GDP rise by more than 25%. That's obviously absurd.

Why am I even discussing such crazy ideas? Because Paul Krugman seems to want to convince his readers that lots of supply-siders believe such nonsense:

Two years ago Kansas embarked on a remarkable fiscal experiment: It sharply slashed income taxes without any clear idea of what would replace the lost revenue. Sam Brownback, the governor, proposed the legislation -- in percentage terms, the largest tax cut in one year any state has ever enacted -- in close consultation with the economist Arthur Laffer. And Mr. Brownback predicted that the cuts would jump-start an economic boom -- "Look out, Texas," he proclaimed.

But Kansas isn't booming -- in fact, its economy is lagging both neighboring states and America as a whole. Meanwhile, the state's budget has plunged deep into deficit, provoking a Moody's downgrade of its debt.

There's an important lesson here -- but it's not what you think. Yes, the Kansas debacle shows that tax cuts don't have magical powers, but we already knew that. The real lesson from Kansas is the enduring power of bad ideas, as long as those ideas serve the interests of the right people.

Why, after all, should anyone believe at this late date in supply-side economics, which claims that tax cuts boost the economy so much that they largely if not entirely pay for themselves?


Actually, supply-siders do not claim that tax cuts pay for themselves, except in very unusual cases. Kansas is not one of those cases. The Laffer curve effect is typically applied to cases of extremely high marginal tax rates.


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CATEGORIES: Macroeconomics , Tax Reform



COMMENTS (24 to date)
David R. Henderson writes:

Scott,
Very nicely done.
One little correction. The Laffer curve applies to all tax rates. What I’m sure you meant to say is that what Art called the “prohibitive region” of the Laffer curve applies only to him marginal tax rates.

Arnoll writes:

Pointing out that tax-cuts are unlikely to be self-financing for an entity that takes ~5% in taxes is really un-important because the right margin to look at is from an aggregate perspective of 50% taxes.

If one takes into account the effect on the federal tax revenue, it might easily be that the tax cut pays for itself, but it is only another level of government that gets the increased tax revenue.

wufwugy writes:

Wait, isn't Krugman pro-fiscal-stimulus?

I'm having a tough time figuring out what's going on with him. One minute he's ultra-pro-monetary-stimulus by advocating a 5% inflation target; the next minute he derides an NGDP target that would amount to half that. One minute he's against more revenue in the hands of producers and consumers; the next minute he proposes middlemen to take that revenue and reroute it to...um...the same producers and consumers

tjames writes:

Lowering tax rates in expectation of a tax revenue windfall seem like a bad idea at the outset. It's an attempt to give everyone what they want; lower rates, yet the same amount of government. Politicians have been trying this trick since there have been politicians.

How about cutting government first, then returning savings to the people after - and if - they materialize. Politically tougher to do, but certainly much less financially risky.

Or, maybe, promoting legislative policy aimed at improving the business climate which doesn't involve an outright give away of revenues needed to cover the budget. Taxes are not the only carrot/stick that business cares about. Property rights, barriers to market entry (e.g. licensing), regulatory compliance - there are many things which could be addressed without touching taxes.

Scott Sumner writes:

David and Arnoll, I agree.

tjames, Yes, they should cut spending first.

Kevin Erdmann writes:

Hmm. With state and federal taxes, even when total tax rates are over the peak of the Laffer Curve, each taxing entity would be incentivized to raise taxes. So, Kansas could raise rates and see $x in added revenue, but the federal government might experience more than $x in lost revenue. The test of the effect of the change in any case would have to account for all taxes collected.

Lance writes:

Scott,

Part of the income taxes included eliminating taxes on income generated from partnerships, LLCs, and sole proprietors. Only wages paid to the owner from these enterprises would be taxed.

JT writes:

I have followed Tax Analyst's weekly updates on this in their State Tax Notes publication. Art Laffer himself is the one trumpeting the economic growth this will supposedly cause. The legislature in the Missouri has wanted to imitate Kansas very badly, with Republican legislators also citing Laffer approvingly. Krugman isn't necessarily attacking a straw man here.

Steve J writes:

Supply-siders need to do a better job of explaining their ideas. Governor Brownback and his team clearly misunderstood the anticipated effects of tax decreases.

R. Pointer writes:

This is Laffer et al's most recent attempt to justify reducing state taxes.

http://www.amazon.com/gp/aw/d/1118921224/ref=mp_s_a_1_fkmr0_1?qid=1404828108&sr=8-1-fkmr0&pi=AC_SX110_SY165_QL70

Haven't read it but I am sure it is top level stuff...

An-Jen Tai writes:

So it seems to me that Brownback believed there would be substantial positive impact on Kansas' economy, enough to offset most if not all of the loss in revenue. Is there any doubt that he believed this would be the case? That certainly is the basis on which the plan got through. (Does anyone know what the estimates are for what the loss of revenue was relative to trend?) Seriously, if the fools in the Kansas legislature actually understood what was going to happen would they have been able to pass the cut in the first place?

Whether Krugman's attack is fair or not comes down to whether Brownback qualifies as a supply sider or not. I might feel differently if some "supply sider" actually spoke up during the initial debate over the rate cut and made clear that Kansas was likely to suffer a 20%+ loss of revenue from passing this measure.....

Thomas Hutcheson writes:

Apparently the governor of Kansas to sell the tax cut was claiming to believe what "no supply sider" believes, that the tax reduction would NOT increase the deficit.

Krugman's conclusion, "The real lesson from Kansas is the enduring power of bad ideas, as long as those ideas serve the interests of the right people." seems quite on the mark.

msnthrop writes:

Brownback's team included Art Laffer...http://blogs.kansas.com/gov/2012/01/19/economist-laffer-offers-guidance-to-kansas-senate/

Ben S. writes:

To offset a reduction of 25% of the tax rate, you actually need a 33% increase in the tax base, because 4/3 is the reciprocal of 3/4.

Aaron Zierman writes:

So, if I'm looking at this right, there was a 25% drop in state income tax and a 24% increase in federal tax (from 35% to 43.4% of the total share). But Krugman is ignoring the total tax burden as being any sort of factor? Wouldn't he at least have to compare Kansas and it's actions with a similar state that did not have the tax cut?

blsdaniel writes:

There's a simpler question here: if even the supply siders don't think you'll get enough revenue to replace what you lost, if much of whatever new taxes off of new economic activity that gets generate will go to the federal government, if you're legally obligated to run a (more or less) balanced budget, and if the resulting deficits cause your rating to fall, why do the tax cut in the first place?

blsdaniel writes:

Of for the days when conservatives credibly claimed to care about deficits.

Scott Sumner writes:

JT, Even I think the Kansas tax cuts generated economic growth---that wasn´t my complaint. My complaint was over the implication that supply-siders would expect a large growth response, given those MTR reduction numbers. They would not.

JTodd writes:

Scott, the only quibble I have, living in Washington state, is declaring our fair state a "tax haven." Although we don't have an income tax, we have very high sales taxes.

Worse, however, is our significant state business tax, which is a gross receipts tax - taxing companies whether or not they make a profit. It is one reason we have a high rate of small business failure.

That's why, although we have enjoyed home-grown business success like Microsoft and Starbucks, you don't see many companies moving to Washington state.

Leon E writes:

I read the Vox article and hopped over to this blog hoping for some interesting discussion but find this thread lacking in relevance. Sumner's discussion of Kansas taxes + Federal taxes is beside the point, since the issue is not about what Sumner would have expected had he been asked to comment on the policy. Brownback sold his tax cut with hoary supply side slogans and it has depleted state revenue while leaving Kansas no better off than most states including immediate neighbors in job creation. That is what Krugman's and others' comments are about-- because Brownback is still crowing about his cuts as if he had done something laudable instead of making a mess of state finances.
Disappointing blog.

Scott Sumner writes:

JTodd, I'd much prefer no income tax and high sales/business taxes to a system like Oregon, which has high income taxes and no sales taxes. And more people move to Washington than Oregon, despite the latter having better weather and more room. So there must be some job creation going on.

Leon, It's a bit naive to assume Krugman's comments are "about" Brownback. Everyone knows that politicians in both parties are clueless on economics, and also that the sky is blue.

Krugman was going after supply-side economics.

blsdaniel writes:

Scott, is Krugman going after legitimate supply side ideas or way they are irresponsibly over-sold?

JTodd writes:

"And more people move to Washington than Oregon, despite the latter having better weather and more room."

I think your economic analysis on this point is woefully incomplete. I mean, having to put up with Portlandia alone is worth one or two percent on Oregonians' income tax.

And really, more sunny days just means more days to look at Oregon's vast wastelands.

P.S. Go Huskies!

Michael Moran writes:

While I agree with your basic point, state income taxes are not the same as federal income taxes and not all federal income taxes are the same (I would argue the capital gains tax rate is different as capital gains are often a voluntary tax).

Federal taxes only Laffer effect is incentive, you can work and produce income or not (I know that is really wrong as you can produce income in low taxed forms and engage in other forms of tax avoidance, but good enough for government work), while with state taxes businesses and individuals can relocate to a lower tax state. Look at difference between Oklahoma and Texas, and realize Oklahoma likely has more oil/gas per capita than Texas, and both have business friendly low regulation governments, yet over long term lack of state income taxes has made big difference.

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