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The Real Lessons from the Kansas Experiment

Ryan Bourne

What is it about leftwingers and overreach? Two weeks ago,
Labour’s defeat in the general election was being spun as the
“death of neoliberalism”. It even emboldened the party to advocate
the requisition (i.e. taking) of people’s private houses and
apartments after the Grenfell Tower fire. Now we have the partial reversal of
large income tax cuts
in the American state of Kansas being
heralded as the death of supply-side economics and the idea that
lower marginal tax rates can improve growth prospects.

Back in 2012, the Kansas Republican Governor, Sam Brownback,
slashed his state’s marginal income tax rates, reducing the
top rates from 6.45 per cent and 6.25 per cent to 4.9 per cent and
cutting the rates for low earners from 3.5 per cent to 3 per cent.
He doubled the personal allowance from $4,500 to $9,000 and,
perhaps most significantly, proposed exempting so-called
“pass-through” entities from income tax altogether.

As politicians often do, he over-egged the likely positive
effects of such measures, describing them as a “real live
experiment” in supply-side economics. But left-wing commentators
are now using the stubbornness of the state’s budget deficit,
and the relatively weak growth performance since, to attempt to
discredit the case for cutting marginal tax rates anywhere. Their
partial account of what really happened and its lessons deserves
correction.

Taxes are not everything,
and in many cases may not even be the most important policy lever
to improve growth prospects. But there is a much broader
theoretical and empirical literature than just the Kansas
“experiment” which shows that they really do matter.

First, the impact of the tax cuts on the Kansas budget deficit
owed more to politics than the tax reform. In Brownback’s
original proposal, almost all of the “cost” of lost revenues was
made up for for by broadening the tax base. He wanted to eliminate
a number of tax credits and deductions, such that overall there
would be little budget impact. But his opponents in the Kansas
Senate defeated implementation of these “pay for” measures, meaning
the tax cuts alone led to more government borrowing in the absence
of significantly cutting spending.

Second, though taxes are important, they aren’t
everything. A range of other things have affected the Kansas
economy in the time since the tax cut was passed. In particular,
the state is strongly affected by what goes on in the agricultural
and energy industries. Given the weakness of commodity prices over
this period, the state economy has struggled for reasons nothing to
do with the tax cuts.

Third, the specific tax package proposed went against good tax
practice in one crucial regard, which even most supply-siders would
denounce. By completely eliminating the income tax on pass-through
businesses, the Governor significantly increased opportunities for
tax avoidance for individuals working in certain types of
company.

The take up of this provision was much, much higher than
expected and one of the key reasons why state revenues were lower
than expected. But this type of bad tax policy need not be part of
a rate-cutting agenda. In North Carolina,
the Tax Foundation
has shown how income taxes can be cut in a
way that, alongside base-broadening, leads to sharpened incentives
and reduced opportunities for avoidance, and so does not lead to
large budget shortfalls.

Finally, state income taxes are already very low in America. Few
economists would suggest that cutting them would lead to such a
huge impact on economic growth that they would be self-financing,
especially without the “pay-fors”. But because the economist Art
Laffer was associated with drafting this reform, many mistakenly
viewed Kansas as a test of whether
the Laffer Curve thesis works
(i.e. that there is some
revenue-maximising rate of tax above which higher tax rates even
lower revenues). It was no such thing.

Of course, one can understand why the Left is so keen to
highlight Kansas’ failures. For decades, the free-market
Right has broadly won the argument on whether low marginal tax
rates on income and corporate profits boost growth by increasing
incentives to work and invest. With President Trump promising large
cuts to marginal rates too, the critics are perhaps right to point
out that free-marketeers sometimes overplay the case for tax cuts
relative to other areas of policy.

But it is another thing entirely to ignore the specific
conditions of Kansas, and the history of how this tax cut occurred,
and to extrapolate that it illustrates how supply-side economics
does not work. An extensive review on the link between taxation and
economic growth published here by
the Institute of Economic Affairs
last year showed that high
marginal taxes, other things given, tend to slow the growth of
economic activity.

Taxes are not everything, and in many cases may not even be the
most important policy lever to improve growth prospects. But there
is a much broader theoretical and
empirical literature
than just the Kansas “experiment” which
shows that they really do matter.

Ryan Bourne occupies the R. Evan Scharf Chair for the Public Understanding of Economics at Cato.