three-legged stool

Gov. Kelly promotes flawed “Three-Legged Stool” tax policy

In their report to the 2020 Kansas legislature, Governor Kelly’s Council on Tax Reform promoted state tax policy with co-equal income, sales, and property taxes, a “three-legged stool.” However, upon further review, the flawed tax policy creates unstable budgets and encourages the government to decide who benefits from the wealth of others.

Governor Kelly wished for a return to a “three-legged stool” of tax revenue. The Council on Tax Reform concurred, discussing how the policy would “cushion Kansas from recessionary pressures.” The belief here is that a state government with income and sales tax revenues is akin to an investor with a “diverse” portfolio with stocks and bonds. The hope is that when one is underperforming, the other is overperforming, and vice versa. Over time, the diversity of the portfolio reduces risk and keeps the expected return stable. There’s only one problem with such a thought, income and sales don’t move in opposite directions; they are positively related. When one rises, the other generally rises as well. An even closer look says one revenue stream doesn’t contribute much to budget stability.

A necessary stress test of government budget stability is how it fares during economic downturns. For this reason, we tracked income and sales tax performance two years after The Great Recession. For the “three-legged stool” theory to have legs (pun intended), income and sales taxes should consistently move opposite each other during economic downswings. Starting from the fiscal year 2008 (the Great Recession began in December 2007), income taxes fell a collective $700 million or 21% over the following two years.  Yet, sales/use taxes didn’t move in the opposite direction, instead of growing it also fell. Sales/use taxes fell a collective $100 million or 5%. However, what is interesting to note is that the change in sales/use tax was consistently smaller than the change in income tax. If the last recession taught us anything, it’s that income tax is inferior to sales (consumption) tax for budget stability.

Why does this matter to the average Joe or Jane out there? It’s because economic recessions create a considerable strain on government budgets. Tax revenues fall, while spending and the demand for government services rise. Kansans need government programs to function. Therefore, only taxes resistant to economic downswings should fund such programs. Income taxes fail this test. If policymakers want to avoid a boom and bust budget, they must decrease the reliance on the income tax. Research supports these findings. The National Tax Journal published an article noting that more progressive income tax structures have higher variability than states with less progressive income tax structures. Research published in the Southern Economic Journal found that over the long run, income taxes are twice as responsive to economic swings as sales taxes.

State government budgets don’t need income taxes for stability. The analogy of a “three-legged stool” does not work. If it’s true that it doesn’t work, then why do some Kansas policymakers still promote it?  Logically, the three-legged stool makes little sense when the focus is on the state budget as major tax revenues are income and sales taxes and little in property taxes. When focusing on local (sub-state) government, the major tax sources are sales and property taxes, with little collection in income taxes. However, when both levels of government are considered, income tax collections have the smallest share of the three.  In other words, because the state Tax Council combined the state and local budgets, they now manufactured a “reason” to propose raising income taxes. That’s like saying because there’s no national sales tax, state governments should raise their own even higher. The “three-legged stool” seems like a trick, a trojan horse to justify raising income taxes.

Keep in mind the state budget has an impending budget hole by 2023. It seems convenient, that even though income taxes have risen every year since 2017, another justification is made to raise them again. The tax council didn’t consider that perhaps the most massive budget in state history is partly to blame for the shortfall. The Tax Council is setting the stage for income tax hikes by the 2021 legislative session.  The “three-legged stool” isn’t tax policy, it’s a ruse to take more from the paychecks of hard-working Kansans.  “Budget stability” shouldn’t be about taking money from one group and giving it to another.