Monday, May 30, 2016

A Case Study of State Tax Reform Efforts

by Levi Russell

Adam Millsap of the Mercatus Center has a new case study on state tax reform. I have not yet read the study, but his Forbes column has some good stuff in it. I reproduce the sections on Utah and Kansas below.

Success in Utah

Of the five states studied, Utah’s 2006 reform appears to have been the most successful. The income tax was simplified from six brackets to one and many deductions were eliminated, which made it less distortionary and easier to understand. The study also notes that Utah was able to improve the efficiency of its tax system without experiencing severe drops in revenue.

According to the study, Utah’s tax reform was successful because its supporters were able to identify key stakeholders and include them in the reform process. This ensured that any reform that reached the governor’s desk had broad support. The study also points out that Utah has had a relatively high level of economic freedom for many years. This is a sign that the institutions and cultural attitude required for comprehensive tax reform were in place.

Problems in Kansas

Contrary to Utah’s experience, Kansas’ 2012 tax reform was more problematic. While the number of tax brackets was reduced from three to two and several tax credits were eliminated in order to broaden the base, Kansas’ reform also created a major distortion by exempting some business income from taxation.

This reform has allowed some businesses to avoid income taxes altogether which encourages others to mimic that behavior in order to minimize their tax own tax burden. One such example is University of Kansas basketball coach Bill Self, who is primarily paid through his business entity that is exempt from state income taxes. The distortion in Kansas’ tax code incentivizes this behavior.

Another problem with Kansas’ tax reform is that the decline in tax revenue due to the reform was not matched by a similar decline in spending. This has resulted in budget deficits. In Utah and the other cases studied tax reform was accompanied by reductions in state spending, which is crucial for maintaining a balanced budget.

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