Bryan Lowry
February 21, 2015

Far more people are taking advantage of a Kansas tax exemption for business owners than expected.

When lawmakers eliminated income taxes in 2012 for owners of certain businesses, such as limited-liability corporations and S corporations, the state estimated 191,000 business owners would benefit, based on 2009 data.

However, 280,737 business filers used the exemption in tax year 2013, updated numbers from the revenue department show.

Farm returns account for an additional 53,055 beneficiaries overlooked in the original figure, putting the total number at more than 333,000.

That number does not reflect the number of businesses benefiting from the policy but rather the number of business owners. If a law firm has four partners, for example, each would file a separate return and be counted separately.

Gov. Sam Brownback has touted the policy as a way to spur economic growth, but critics question the fairness of exempting one group of taxpayers while their employees continue to pay income taxes.

And some lawmakers say the policy needs to be tweaked or abandoned in the face of a projected $700 million deficit for the next budget year.

The cost to the state of granting the exemption – estimated to be about $160 million – was $206.8 million in 2013, according to the department.

The revenue department said Friday that the change in numbers was proof the policy was working and growing businesses.

“The number of small business in Kansas grows over time, in tax year 2013 alone there were 8,666 new filers representing $464.6 million in new income. The estimate was based on data from 2009, much of the difference is because of four years of growth in small businesses,” revenue secretary Nick Jordan said in an e-mailed statement.

The department said it also had limited data on the number of sole proprietorships at the time the bill passed.

“All this is typical of the Brownback administration,” Senate Minority Leader Anthony Hensley, a Topeka Democrat, said when asked about his view of the change in numbers. “Everything is a moving target.”

Like a puzzle

Some lawmakers say closing or narrowing the exemption should be part of a package of spending cuts and tax increases to fix the budget deficit.

Brownback has suggested slowing scheduled income tax cuts but has not shown any indication he wants to revisit the exemption for business owners.

House Majority Leader Jene Vickrey, a Louisburg Republican, compared putting together the budget fix to assembling a thousand-piece puzzle. Right now, lawmakers are dumping out all the pieces on the table and sorting through them.

There’s no shortage of ideas. Suggestions include closing sales tax exemptions for certain charities and businesses, ending the sales tax exemption on utility bills for residential and agricultural properties and recalculating taxes on agricultural properties.

Rep. Jim Ward, a Wichita Democrat, wants to revisit the tax exemption for business owners. “Until you address that 500-pound gorilla in the room … everything else is just noise, because you don’t get the revenue you need to meet essential services.”

Annie McKay, executive director of the Kansas Center for Economic Growth, a think tank that opposes Brownback’s tax plan, said lawmakers were avoiding addressing the root of the state’s revenue woes and proposing policies that would disproportionately affect the middle class and the poor.

“Quite frankly, we’re building something that looks far uglier than Frankenstein,” she said. “And we’re going to continue to have this conversation year after year, because we’re not addressing the root problems.”

‘Tax experiment’

Some on the political right have panned the policy.

Last month, Scott Drenkard, an economist for the Tax Foundation, a pro-business think tank based in Washington, authored an opinion piece criticizing a similar proposal in Ohio. He called the exemption a gimmick “made famous (not in a good way) by the ill-fated tax experiment in Kansas.”

“Don’t get me wrong; individual income tax cuts are great. But cutting individual income taxes by excluding a whole class of taxpayers costs a lot to state coffers and won’t give the economic growth that (Ohio) Gov. (John) Kasich wants,” Drenkard wrote.

Republicans, who control both houses of the Kansas Legislature, disagree over whether the exemption should be considered along with the other puzzle pieces this session.

Legislative leaders have discussed tweaking the exemption.

“I won’t say it’s not on the table. But I don’t see that as a strong possibility,” Sen. Les Donovan, a Wichita Republican, who chairs the Senate Tax Committee, said after meeting with Brownback and other lawmakers this week.

Asked whether this was because the governor was opposed or because lawmakers were opposed, he replied, “Yes.”

“I just don’t think we’re ready to go there yet,” Donovan added. “The state’s creating more jobs. We’ve started up new businesses. Unemployment is much more favorable.”

Tweaking exemption

Sen. Jim Denning, an Overland Park Republican, on the other hand, wants to alter the exemption. Denning’s plan would tax the first $118,000 of income of a business owner, an amount roughly equivalent to the Social Security wage base limit, but it would exempt the next $150,000.

It would tax any income after that point.

“Right now, it’s unlimited,” Denning said. “If we’re trying to get small businesses a head start and give them seed money, so we don’t tax their working capital, I think letting $100,000 to $150,000 pass through tax-free is plenty.

“If we don’t do that, we’re going to get some enormous corporations – I’m talking like utility companies – are going to team up and form an LLC, and they’re going to pay zero tax on projects,” Denning said. “That’s not what we set out to do.”

The governor’s office provided a general statement that did not specifically say whether the exemption was off the table.

“The Governor has put forward a plan that keeps taxes low for families and small businesses in Kansas, and transitions from productivity taxes to consumption taxes,” the statement said.

Job creation

Brownback’s administration has repeatedly touted the tax exemption, contending it creates jobs by giving business owners extra capital to grow their businesses.

Kansas has added jobs in the past two years, but so has the nation as a whole – and at a faster rate – as part of a national recovery. It’s difficult to get concrete data showing the exemption is responsible for job growth; the Kansas Department of Labor said it does not track the number of employees at tax-exempt businesses.

The department also was unable to provide the number of tax-exempt businesses paying unemployment insurance, which would help give a rough picture of how many entities receiving the exemption have employees.

McKay bemoaned the lack of solid data. She said other states were lapping Kansas in job growth and contended there’s little evidence to suggest the job growth the state is seeing is the result of the tax plan.

The exemption extends to real estate and mineral holdings as well as LLCs and S corporations. Donovan and his House counterpart, Rep. Marvin Kleeb, R-Overland Park, are open to looking at that to ensure the policy is being used to help businesses create jobs.

Donovan said lawmakers need a better picture of the revenue and budget outlook, which will come in April, before moving forward with plans to increase taxes.

“We need to see how deep this pothole is … before we start buying asphalt,” he said.

Read more from the Kansas City Star here.

ClayKANSAS CITY STAR: More business owners are using tax exemption in Kansas than expected