Here’s our summary of the major legislation of interest to the Kansas Economic Progress Council and how it fared during the 2012 Kansas Legislature.
THE MAMMOTH INCOME TAX CUT
Senate Substitute for House Bill 2117
One of the most difficult legislative sessions in Kansas history ended with the passage the “nuclear option” tax cut bill.
Governor Brownback’s signature on the bill forces significant budget cuts in future years. He will almost certainly propose changes to the 2013 Legislature, including revenue enhancements to help offset the cuts.
Here’s what the bill does. Our description comes from the Supplemental Note prepared by Kansas Legislative Research Department and from the bill itself.
Rate Reduction and Restructuring
Married, filing jointly
The current three bracket structure for married individual income taxes is:
- For taxable income under $30,000, 3.5%
- For those making over $30,000 but under $60,000, $1,050 plus 6.25% of the excess over $30,000
- For those making over $60,000, $2,925, plus 6.45% of the excess over $60,000
Here’s the new two bracket structure for married, filing jointly, beginning with tax year 2013:
- For taxable income under $20,000, 3.0%
- For those making over $30,000, $900 plus 4.9% of the excess over $30,000
The current three bracket structure for single individual income taxes is:
- For taxable income under $15,000, 3.5%
- For those making over $15,000, but under $30,000, $525 plus 6.25% of excess over $15,000
- For those making over $30,000, $1,462.50 plus 6.45% of the excess over $30,000
Here’s the new two bracket structure for single, beginning with tax year 2013:
- For taxable income under $15,000, 3.0%
- For those making over $15,000, $450 plus 4.9% of the excess over $15,000
Business Income Exemption
The bill would totally exempt certain non-wage business income that under current law is subject to individual income tax: income reported by LLC’s, Subchapter-S Corporations, and sole proprietorships on lines 12, 17, and 18 of federal form 1040. This is basically non-wage income.
Tax Credits Repealed
Additional sections would repeal tax credits currently allowed to individuals (but not to corporations) for the following:
- food sales tax rebates
- abandoned well plugging
- adoption expenses
- alternative fuel equipment expenditures
- assistive technology
- child and dependent care expenses
- child day care expenses
- disabled access expenditures
- environmental compliance expenditures
- individual development account contributions
- law enforcement training center contributions
- small employer health benefit plan contributions
- swine facility improvement expenditures
- port authority contributions
- small employer health benefit plan contributions
- telecommunications property tax payments
- venture capital contributions
- certain temporary assistance to family contributors
Other language would increase the standard deduction amount for single head-of-household filers from $4,500 to $9,000; and for married taxpayers filing jointly from $6,000 to $9,000.
Other Income Tax Provisions
Additional provisions of the bill would eliminate a subtraction modification for certain long-term care insurance expenditures; and eliminate the ability of individuals to utilize the income tax deduction for expensing enacted in 2011.
Severance Tax Provisions
The two-year new pool severance tax exemption would be repealed relative to all oil production from any pool producing in excess of 50 barrels per day, provided the initial production occurs on and after July 1, 2012.
Beginning in tax year 2013, renters would no longer be eligible to participate in the Homestead Property Tax Refund program.
Cost of the income tax cut
The Legislative Research Department estimates the following ending balances for the Kansas General Fund in future years as the result of the income tax cut. The estimate includes human services caseload adjustments and a 4% revenue increase.
FY 2013 $509.7 million (8.3% ending balance)
FY 2014 -$242.2 million (-3.9%)
FY 2015 -$914.6 million (-14.5%)
FY 2016 -$1.5053 billion (-23.3%
FY 2017 -$1.9869 billion (-30.2%)
FY 2018 -$2.4751 billion (-36.3%)
(Please click on the graph to view an full-size version.)
Although the Administration continues to try to put a positive face on the legislation, even some conservative national organizations have expressed strong concern.
The Tax Foundation, which has often been quoted by the Administration and legislators in trying to justify an income tax cut, had this to say May 29 about the exemption of businesses.
“First, the exemption creates an incentive for businesses to structure as pass-throughs for tax reasons, even if it might be unwise to do so for non-tax reasons. Instead of the Kansas tax system treating similar activity similarly, the system will encourage economically inefficient, though tax-reducing activities.
“While this can be difficult and complicated, especially in business taxation, Kansas’s decision to exempt one type of business structure completely from taxation (pass-throughs) while continuing to tax others (C corporations) is problematic. It rewards certain business structures while punishing others. There is no sound economic justification for treating these two types of business activity so dramatically differently.”
“Further, while tax reductions can have positive economic benefits, they will cost revenue and will ultimately have to be paid for either by cutting spending or increasing taxes elsewhere.”
On June 12, the conservative business publication Forbes said this.
“Kansas slashed the tax rate for the better off and exempted huge chunks of business, farm and self-employment income from its individual income tax, while increasing the burden on some of the state’s poorest residents by eliminating a rebate they now get to offset the state’s sales tax on food.”
“When the food sales tax rebate disappears next year, Kansas will join Alabama and Mississippi as the only states that levy a tax on food and don’t in some way compensate lower income residents for the strain on their budgets.”
PROPERTY TAX RELIEF
The Kansas Senate passed property tax relief in the form of $45 million a year that would be pumped into the Local Ad Valorem Tax Reduction Fund. The legislation was part of the mix in attempting to agree on an income tax cut, but was not passed.
Governor Brownback’s plan for sweeping school finance changes did not gain any traction.
Lawmakers added $40 million from the state general fund to the base state aid per pupil. This amounts to an increase of about $59 per pupil.
SB 155 passed containing the following education items.
- The bill requires the State Board of Education (State Board) to conduct or contract for a study of the implementation of a new requirement that each school district maintain an individual career plan of study for each student enrolled in grades 8 through 12. The State Board must submit findings from the study to the Legislature by January 15, 2014. This provision will go into effect on July 1, 2013. The State Board also is required to report to the Legislature by January 15, 2014, regarding a proposed strategy and a proposed plan for providing state aid to career technical education programs or courses in school districts and shall consider the funding scheme under the Postsecondary Tiered Technical Education State Aid Act.
- The bill makes changes to career and technical education to deal with duplicate programs between high schools and community colleges and technical colleges.
- The 0.5 vocational weighting for K-12 schools remains in place with no sunset.
- Provides for a $1000 award for each high school student who graduates with a certificate in a high demand Career Technical Education program.
- When a K-12 student on free lunch is found to be ineligible, the school loses at-risk funding for that student.
Senate Bill 11 passed with these education items.
- School districts can continue holding up to 10% of their operating budget in a contingency reserve fund.
- Continues the flexibility to use fund balances from several accounts.
The budget for higher education in Kansas is basically flat. The heads of Regents Institutions have been told to expect flat funding for the next three years.
The result of budget cuts through and after the Recession means tuition increases. The State Board of Regents established new tuition rates June 20 ranging from 3.5% at Wichita State to 6.5% at Emporia State.
Retiring Wichita State University President Don Beggs recently told a business group that when he became the school’s President in 1999, 70% of the school’s budget came from state funding. It is now about 48%.
A House leadership plan proposed to take $159.6 million from transportation to help fund an income tax cut. The proposal would have frozen sales tax revenue for transportation at Fiscal Year 2013 levels, paying the money back later, but still resulting in a loss to the T-WORKS program.
After a frantic lobbying effort by transportation coalition Economic Lifelines, the item was removed from the House plan.
Previous transfers from highways have been noted by the bond rating agency Moody’s, which revised KDOT’s outlook to negative from stable in June of 2011.
STAR BONDS EXTENDED
House Bill 2382 extended the sunset date for Sales Tax and Revenue (STAR) Bonds from July 1, 2012 to July 1, 2017.
STAR Bonds are an economic development tool that provides Kansas municipalities the opportunity to issue bonds to finance the development of major commercial, entertainment, and tourism areas. The sales tax revenue generated by the development is used to pay off the bonds.
The Brownback Administration moved forward with its plan to reorganize Kansas’ three main social service agencies, including a makeover of Medicaid known as KanCare. Forecasting at least $850 million in savings over five years, the state would contract with three private entities to manage Medicaid.
However, the fast pace of the plan has many legislators and advocates for the needy concerned. In particular, the outcry about putting the developmentally disabled into KanCare forced the Administration to delay that portion of the plan. A bill to create a KanCare oversight group passed the Kansas Senate, but failed to receive enough votes in the House of Representatives.
Meanwhile, the U.S. Department of Justice is now looking at the Kansas waiting lists for developmentally disabled services to determine if the state is in violation of a U.S. Supreme Court ruling which favors home care over institutions.
MACHINERY & EQUIPMENT VS. FIXTURES
Senate Bill 59 sought to put a hold on a dispute between the Montgomery County Appraiser and a nitrogen fertilizer company over the firm’s 2008 tax assessment.
The appraiser said trade fixtures were part of the company’s real property, not machinery and equipment. Machinery and equipment acquired after 2006 is exempt from property tax in Kansas. The quarrel started after the Kansas Court of Tax Appeals upheld the Montgomery County Appraiser’s valuation and classification.
Despite attempt to compromise, no solution was reached. The House passed SB 59, which would have delayed the new appraisal to give the parties and the legislature time to work on the problem. The bill died in Senate committee.
RESTRAINT OF TRADE
A Kansas Supreme Court decision said manufacturers in Kansas cannot engage in resale price maintenance without facing significant legal risk. The case is O’Brien v. Leegin Creative Leather Products, Inc.
Leegin is probably best known for its Brighton line of leather products and jewelry. Brighton (and Leegin) requires agreements from retailers that they will not discount their products. The Kansas Supreme Court essentially ruled that was restraint of trade and illegal vertical price fixing.
The problem is that many consider these types of agreement standard business practice.
The decision may have implications for agriculture interests, which appeared at legislative hearings in support of a clarification. No legislation passed.
KANSAS PUBLIC EMPLOYEES RETIREMENT SYSTEM
HB 2333 contains changes designed to curb the future funding problems of the Kansas Public Employees Retirement System. It contains many new and modified provisions, including changes in retirement benefits, increased KPERS contributions by both employers and employees, and many other adjustments.
A new plan is put into place for future KPERS eligible employees. The so-called Tier 3 plan would be a cash balance plan, similar to an annuity.
Despite several behind-the-scenes negotiations and some open attempts, no state immigration legislation passed. One proposal required all new state employees to be run through the federal E-verify system, but it did not advance.
A proposal by a business coalition and backed by Kansas Agriculture Secretary Dale Rodman also failed to advance. It recognizes that most illegal immigrants will not be deported by the federal government. It would set up a network of undocumented immigrants and willing employers that could hire them. The plan would have required a federal waiver.
It did not advance.
LOOKING AHEAD TO 2013
Issues often flow from one legislative session to the next. Here are some of the issues we can expect to emerge in 2013 as the result of this year’s session:
Changes to PEAK (Providing Employment Across Kansas)
The valuable economic development PEAK program will have immediate and dramatic problems when the income tax cut becomes official. PEAK allows qualifying companies to retain 95% of state payroll withholding for each eligible job for up to ten years. When the tax cuts go into effect in January, withholding drops and the cash flow expected by businesses in the program will drop dramatically, possibly violating some contracts.
There are dozens of Kansas businesses in the PEAK program that will be affected and have built the incentive into their long-range plans. Most are in Johnson and Wyandotte Counties, but there are PEAK incentives also going to companies in Sedgwick, Cherokee, and Harper Counties.
The largest beneficiary is the General Motors expansion in Wyandotte County with $107 million in payroll and 1,479 new PEAK jobs.
Kansas credit ratings will be impacted. The financial publication Bloomberg warned recently that cutting income taxes may hurt the state’s bond ratings. In November, Moody’s Investor Services issued a negative outlook for state bonds used to fund the Capitol renovation project, saying “The outlook for the State of Kansas is negative,” even before an income tax cut was proposed. The income tax cut will be viewed as additional weakness
Machinery and Equipment vs. Fixtures Issue
Business groups warned that failure to deal with the Montgomery County appraisal situation could spread to other parts of the state as other appraisers are emboldened to change assessments. Since lawmakers did not pass legislation in 2012, they will have to deal with the issue in 2013.
Restraint of Trade issue
It’s likely that business and farm groups will return to the 2013 Legislature requesting a bill to deal with the Supreme Court restraint of trade ruling on resale price maintenance.
We will begin to see the impact of the income tax cuts in January of 2013, as the first lower withholding comes out of paychecks. Estimated tax payments by businesses will also change with the enactment of the business income exemption. There are some reports of “C” Corporations exploring a change in status to take advantage of the exemption.
Many lawmakers who opposed the income tax cut believe the cost of the business income exemption is much greater than projected by the Department of Revenue. If true, lawmakers may have to adjust the already-passed FY 2013 budget downward.
This is not lost on the Brownback Administration, which has admitted that adjustments will probably have to be made due to the income tax legislation.
Expect to see proposals for “revenue adjustments” that will offset some of the income tax cut. Possibilities include elimination of tax credits, income and sales tax exemptions, deductions, and a repeat of efforts to make the temporary one-cent sales tax increase enacted in 2010 permanent.
However, these will not be enough. We fully expect another attempt to take transportation funds to mitigate the damage to education, social services, and other important state operations.
There will also be proposals to cut the budget.