'Bleeding' Kansas a worry for muni investors

GOP's tax cuts leave $2.5B revenue hole; race to zero

Jan 28, 2013 @ 10:49 am (Updated 11:39 am) EST

Kansas, taxes
Gov. Brownback: He did start the fire ((Photo: Bloomberg News))

Kansas Governor Sam Brownback has a prairie-wide smile, a friendly manner and an abiding hatred of his state's income tax. He pushed an unprecedented cut for individuals and small businesses through the legislature last year and is now plotting, as he says, to “take it to zero.”

Neighboring states in the nation's sprawling midsection have taken note and are moving to piece together tax cuts, lest Kansas lure away jobs -- which is exactly what Brownback, a 56- year-old first-term Republican, wants to do. At least eight governors have said this month they want to cut or eliminate their levies.

“Kansas is the starter gun for tax competition,” said Grover Norquist, president of Americans for Tax Reform, the Washington-based group that pressures members of Congress to sign a no-tax-increase pledge. “Brownback fired off the shot that said 'Go.'”

The race presents significant hurdles. Kansas lawmakers haven't figured out how to pay for the tax cuts without potentially crippling public schools and other local government functions. Reducing the income tax has left a projected $2.5 billion revenue hole through fiscal 2018, according to the Kansas Legislative Research Department. On Jan. 11, a state court ruled that the legislature was illegally underfunding schools and ordered a payment of $440 million.

“It's a major fiscal risk,” Chris Mier, managing director of analytical services at Loop Capital Markets in Chicago, said of Brownback's income-tax push. “Are the alternative revenue sources going to produce the revenue they need?”

Bond Penalty

Other investors may share that view. Kansas issuers trailed gains in the $3.7 trillion tax-exempt market during the past year. The bonds' 5.5 percent return in 2012 was the eighth-worst among all U.S. states, beating only Connecticut, Delaware, Maryland, New Mexico, North Carolina, Utah and Virginia, according to Barclays Plc data.

Moody's Investors Service said Jan. 17 that the school-funding ruling represents a negative credit risk for the state and “underscores the challenge” confronting Kansas to offset the revenue loss from the income-levy reductions.

The tax-cut drama in Topeka, the state capital, pits competing visions of economic development. Brownback and other Republicans share the bedrock belief that eliminating income taxes will spur economic growth that would make those levies unnecessary. Texas, one of seven states that don't have a levy on wages, is held out as the example of how growth thrives when income isn't taxed.

“What this is is a plan, a strategy that gets us to job growth,” Brownback said in an interview yesterday in his office in the capitol. “I'm tired of losing jobs to Texas, so alright, let's start fighting with them. That's what we're doing.”

Schools Risk

Critics say education and other government services are important components of economic development and are at risk under the governor's plan. Texas has the good fortune of living on an ocean of oil, they say, and Brownback's belief in the power of tax cuts is misguided.

“In the governor's mind, if you take two and subtract one you come up with three,” said Representative Nile Dillmore, a Democrat from Wichita. “It just doesn't add up.”

The top Kansas income-tax bracket dropped Jan. 1 to 4.9 percent from 6.45 percent. The change also eliminated taxes on almost 200,000 small businesses.

Brownback went further in a Jan. 15 speech to lawmakers, calling for more cuts in 2014, 2016 and 2017. To help pay for it, he proposed eliminating some tax exemptions and making permanent a temporary 1-percentage point increase in the sales tax enacted in 2010. The higher sales tax isn't popular among some Republicans and interest groups.

Tax Well

“It's going back to the tax well again,” said Mike O'Neal, a former Republican speaker of the House of Representatives and now president and chief executive officer of the Kansas Chamber, the largest business trade group in the state. “When you have a problem, let's not have taxes be the first thing out of your mouth.”

Brownback said in the interview that education and other vital services would be protected. Without the higher sales tax, now at 6.3 percent, and other changes, “the options are pretty stark,” he said.

The Kansas approach is one bookend of state economic development efforts. The other is represented by Massachusetts Governor Deval Patrick, who on Jan. 16 proposed a 1-percentage point hike in his state's income-tax rate, to 6.25 percent, to help cover the costs of education and transportation. Patrick also urged cutting the sales levy.

'Bleeding Kansas'

Brownback said 30 years of spending hasn't improved the state of 2.9 million people, with its long history of political struggle. Nineteenth-century slavery battles with neighboring Missouri earned the state the moniker “Bleeding Kansas.” Topeka schools were one of the defendants in the landmark 1954 Supreme Court decision Brown v. Board of Education, which outlawed racially segregated schools.

More recently, politicians have fought over abortion, evolution, immigration -- and now taxes, reviving the specter of border wars.

Missouri is one of at least eight states -- Nebraska, Oklahoma, Wisconsin, Indiana, Ohio, Virginia and North Carolina are the others -- considering tax cuts. It has long had a competitive business relationship with Kansas. Television ads sponsored by a group advocating tax cuts are running in the Kansas City, Missouri, market, raising fears that jobs will leave the state for lower taxes next door.

“I do think it's hard to be anywhere near Kansas right now,” said Amy Blouin, executive director of the Missouri Budget Project, a St. Louis-based nonprofit group that analyzes state spending.

'Valuable Lessons'

While Blouin says Kansas is providing “some valuable lessons” on the difficulties of tax-cutting, some Republicans in the Missouri legislature are pushing measures that would roll back business levies. St. Louis businessman Rex Sinquefield sponsored a ballot proposal last year that would have eliminated the income tax and replaced it with a higher sales tax. The measure didn't qualify for the 2012 ballot.

It's too soon to draw conclusions about the outcome of the Kansas tax debate, said Mark Tallman, associate executive director for advocacy at the Kansas Association of School Boards. If state aid is cut, he said, the pressure will mount on many districts to raise property taxes -- if voters allow it. Many school districts are close to their levy limits, he said.

The consequences of cutting taxes don't only concern Brownback's opponents. Don Hineman, a Republican House member from the western Kansas town of Dighton, compared the state- versus-state tax battle to an arms race.

“Everybody's racing to zero and then we lose that advantage,” he said. “It becomes a zero-sum game.”

It's still “productive” to cut taxes, Hineman said, though it remains to be seen whether lawmakers can balance the desire to reduce levies with the need to preserve government services.

“That's the big question,” he said. “There are no easy answers.”

--Bloomberg News--

  @IN Wire

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