Christopher Brown
January 12, 2017 

Kansas Gov. Sam Brownback (R) began the 2017 legislative session by acknowledging that tax increases will need to be a part of the state’s response to its fiscal woes.

The state faces a $350 million budget shortfall for the current fiscal year and a budget crisis that threatens to wreak havoc with the state’s finances for years to come.

But Brownback also defended a controversial tax exemption for passthrough income that even members of his own party say has contributed to the crisis, leading critics to claim that his proposals are little more than a Band-Aid, rather than the comprehensive approach to a tax overhaul that the state needs.

The debate over the passthrough exemption in Kansas has taken on a new salience since the election of President Donald Trump, who is working with Republicans in Congress on a variety of tax cut proposals, including a proposal that would tax income from passthrough entities at 25 percent, well below the proposed 33 percent top income tax rate.

Small Business Support

In his State of the State address Jan. 10, Brownback acknowledged that further spending cuts and revenue transfers would be needed to address the shortfall in the current fiscal year, and that his budget proposals for the 2018 and 2019 fiscal years would contain “modest, targeted revenue measures to fund essential state services.”

Brownback then turned to the exemption for passthrough income, which is claimed by about 330,000 filers and costs the state around $290 million each year, arguing that the exemption had succeeded in spurring private-sector job growth and increasing the number of small businesses in the state. The governor also argued that the state’s budget woes were a result of economic downturns in key sectors of the state’s economy, especially agriculture and oil and gas, rather than the state’s tax policies.

“As a state, we have pioneered new ground on small business policy,” Brownback told the Legislature. ”With two-thirds of Kansans working for small businesses, this policy is targeted support that Kansans have used to increase pay for their employees, hold prices down for their products or expand their businesses.”

Structural Deficit

But Heidi Holliday, executive director of the Kansas Center for Economic Growth, told Bloomberg BNA that repealing the exemption for passthrough income was a necessary part of any attempt to deal with the state’s structural deficit.

“The exemption for passthrough income costs the state nearly $300 million a year, and the importance of that is obvious right now, when we are facing a $350 million shortfall for the current year,” she said. “That exemption needs to be removed as part of a comprehensive tax package.”

The passthrough exemption is only part of the problem, Holliday added. “Our structural deficit is around $800 million, and Gov. Brownback’s proposals don’t even begin to address that,” she said. “This is a Band-Aid, the same old game of budget transfers and dodges, without fixing the underlying problem.”

Repeal Bill in Committee

Key lawmakers on the House Taxation Committee and the Senate Assessment and Taxation Committee weren’t available for comment Jan. 11, but there are indications that the Republican-controlled Legislature is more willing to part company with Brownback on the subject of the passthrough exemption than it has been in recent years.

Eric Stafford, vice president of government affairs for the Kansas Chamber of Commerce, which opposes a repeal of the passthrough exemption, expressed unease to Bloomberg BNA about a hearing of the House Taxation Committee that has been scheduled for Jan. 19, when the committee will take up a bill ( H.B. 2023) that would eliminate the passthrough exemption, and make the elimination retroactive to Jan. 1, 2017.

“It looks to me like the committee is looking at everything this time around, the passthrough exemption, income tax rates, even the repeal of the whole 2012 tax-cut package that the passthrough exemption was part of,” he said. “I’m afraid that they’re going in the wrong direction.”

Holliday looked at the same trends with a more sanguine attitude. “We think that comprehensive tax reform is what our state needs,” she said. “And we’re seeing increasing support for this kind of reform in the tax committees.”

Tax Increase Proposals

The details of Brownback’s budget and tax proposals were released the day after he addressed the Legislature. According to information from the state’s budget office, the budget proposal for the current year includes transferring $317 million from the Pooled Money Investment Board, an entity that invests the state’s idle fund balances, and replacing those funds with money generated by the sale of the state treasurer’s unclaimed property fund. The budget proposal for 2017 also includes a variety of other smaller-scale adjustments.

Brownback’s tax proposals, which are aimed at 2018 and thereafter, include eliminating tax exemptions for passive income, increasing cigarette and tobacco taxes and the liquor-enforcement tax, increasing the corporate franchise filing fee, and freezing the income tax rate for the bottom tax bracket at 2.7 percent.

Taken together, the proposals would generate an additional $180 million in 2018, including $52 million from the liquor enforcement tax, $48 million from cigarette and tobacco taxes, $40 million from taxing passive income, and $34 million from increasing report-filing fees imposed on for-profit entities.

Read more from Bloomberg BNA here.

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