FAIRWAY, KS — In late 2012 and early 2013, reporters in Kansas began to take note of an oddity in the massive tax-cut plan pushed by statehouse conservatives and Gov. Sam Brownback. Profits generated by certain local companies, they found, would suddenly face no state tax liability at all, while other companies of comparable size would still have to pay state taxes. Some local attorneys would now face no state income tax, while their secretaries (much like Warren Buffett’s) would still have to pay up on April 15 as before.
These discrepancies were the result of a novel and largely unremarked part of the new legislation: Along with significant cuts to income and corporate tax rates, state taxes for so-called “pass-through” business income would now be eliminated entirely. This is the income that many companies–sole proprietorships, partnerships, limited liability corporations, and S corporations–“pass through” to their owners to be taxed as personal income rather than business income. Kansas, home to an estimated 191,000 such companies, would be the first state to do away with taxes on pass-through income.
“This is pretty unprecedented,” Matthew Gardner, executive director of the nonpartisan (but left-of-center) Institute on Taxation and Economic Policy, told me in an interview.
The Hutchinson News and the Kansas City Star put a human face on the changes in Kansas, noting confusion among local business owners and drawing comparisons between the companies that would benefit and those that would not. These stories raised important questions about the efficacy and fairness of the unprecedented, untested new measure.
But by the time these stories went to press–in August 2012 and January 2013, respectively–the debate in Topeka was effectively over. While the tax changes didn’t go into effect until New Year’s Day 2013, Brownback had already signed the tax cuts into law in May 2012, over objections that they would bust the state’s budget and lead to cuts in social services. That August, many of the moderate Republican state senators who had fought the governor over the tax cuts were ousted in primary battles, having been targeted by conservative groups funded by Wichita-based energy magnates David and Charles Koch.
This year, history is repeating itself in neighboring Missouri. In a rush to compete with Kansas, this spring both Republican-led chambers of the legislature in the Show-Me State passed similar tax-cut packages, including a 50-percent exemption for pass-through income phased in over five years. A revised plan that abandons a proposed increase in the state sales tax passed the Senate on Wednesday and the House on Thursday; it now goes to the desk of Gov. Jay Nixon, a Democrat. As in Kansas, the move is backed by conservative groups funded by deep-pocketed local financiers–in this case, largely by retired financial executive Rex Sinquefield. And, as in Kansas, statehouse reporters have been scrambling to stay ahead of the story.
Sinquefield’s role
“There are so many moving parts in the bill, and that’s been one of the obstacles in writing about it,” Virginia Young, statehouse reporter for the St. Louis Post-Dispatch, told me.
Young’s April 29 story, “Tax shuffle could shake up Missouri,” provides some of the most comprehensive coverage of the pending tax measures so far.
In addition to outlining the proposed changes, Young’s story foregrounds the role of Sinquefield and Save Missouri Jobs, an advocacy organization that he is helping to bankroll, which has run ads promoting tax cuts in the state. Young told me that lawmakers have been trying to publicly distance themselves from the controversial Sinquefield even as he has been a major force behind the proposals.
“I felt it was important to step back and get his role in it,” Young said. Her story notes that, “[t]hough they say they didn’t draft it, Sinquefield’s lobbyists have been working the Capitol’s hallways” for the bill–and quotes a representative from Save Missouri Jobs voicing his support for the measure.
The Show-Me Institute, a nonprofit organization cofounded by Sinquefield, released a report in February advocating a tax reduction on pass-through income to help Missouri remain competitive with Kansas. Noting that the Sunflower State has reduced its top income tax rate and, “[p]erhaps more importantly,” eliminated taxes on pass-through income, the authors of the report argue that “Kansas has made its tax environment far more attractive not only to businesses already in Kansas, but also to businesses in neighboring states.”
Wanted: Experts
Yet, despite the importance that Sinquefield and his allies have placed on the pass-through issue, the 50 percent pass-through reduction has received little attention in stories about the tax cut initiative–only a passing sentence in Young’s April 29 story, and brief treatment in Post-Dispatch articles about the earlier House and Senate plans. Coverage of this week’s revised Senate bill from the Kansas City Star, the Columbia Daily Tribune, and the start-up St. Louis Beacon similarly devoted little space to the issue.
One good reason for this is that other aspects of the story are, if not exactly sexy, at least more accessible and familiar. Young’s April 29 piece gives close attention to the proposed sales-tax increase that was included in the earlier proposals, which was the most controversial provision of the bills–and the one that drew a veto threat from Nixon, who argued the hike would place too high a burden on lower-income residents.
Everybody understands what sales tax is. The same goes for income tax, and, more or less, corporate tax. By contrast, pass-through taxation is fairly arcane stuff; the term itself is off-putting jargon. Statehouse reporters know politics inside and out, but, like most voters, they don’t necessarily understand the intricacies of the tax code.
“You can’t be an expert on everything, and tax policy is one of the more opaque issues,” said ITEP’s Gardner. “Sadly, I think lawmakers rely on that–the opacity of the issue.”
But do the lawmakers themselves even understand it? Ken Stephens of The Hutchinson News, who wrote about Kansas’s pass-through tax cut last year, isn’t so sure.
“I guess my advice to Missouri reporters would be that they need to find some expert analysis of the law, because the legislators writing the tax law are amateurs and don’t understand it themselves,” Stephens told me in an e-mail. “The Kansas law had many flaws, some of which they tried to fix through administrative interpretations by the Kansas Department of Revenue.”
Who benefits?
For his story, Stephens spoke with a local accountant and with a tax-law expert from the University of Kansas, both of whom expressed uncertainty, even puzzlement, about the pass-through measure.
“It’s kind of weird,” law professor Martin Dickinson told Stephens. “I’ve talked to a lot of lawyers who are very self-conscious about this. … He’s not going to have to pay any tax and his secretary will. Those folks feel self-conscious about an arrangement of that kind, which they don’t feel is proper.”
Given the pass-through exemption and all the other Kansas tax cuts, Stephens wrote: “If you’re wondering who’s left to pay taxes, Dickinson said it basically comes down to employees who work for wages, retirees, and people with passive investment income.”
Meanwhile, who’s benefiting? Many press accounts say that the pass-through exemption benefits businesses, or even “small businesses”–the line pushed by the Show-Me Institute and other advocates. In fact, many so-called pass-through entities are not small at all.
“We know there are some really large ones, like PricewaterhouseCoopers,” Gardner said. “They’re not Mom-and-Pops in any sense.”
Other notable pass-through entities include numerous Koch Industries subsidiaries such as Koch Business Solutions LP and Koch Fertilizer, LLC, as well as the investment firm cofounded by Sinquefield, Texas-based Dimensional Fund Advisors LP, and the Sinquefield-affiliated, St. Louis-based lobbying shop Pelopidas LLP.
“The real question is: Where is the lion’s share of pass-through income located?” Gardner said.
It isn’t at the Mom-and-Pop store. Or even the Mom-and-Pop accounting firm.
“Firms with receipts over $50 million accounted for more than 40 percent of pass-through revenues [in 2005],” Donald Marron of the centrist Tax Policy Center told a congressional subcommittee in 2011, citing data from the Joint Committee on Taxation, “and those with receipts over $10 million accounted for almost 60 percent of pass-through revenues.”
If the profits that flow from these revenues are taxed at a lower rate or not at all, Gardner said, “sure, there are benefits to actual small businesses, but they’re almost incidental.”
What will it cost?
So if wealthier business owners are the biggest beneficiaries, will they use their newfound tax savings to create jobs in their states, as the Show-Me Institute and like-minded groups promise?
Not according to the Center on Budget and Policy Priorities. The center-left fiscal think tank argued against the Kansas pass-through exemption in March 2012, claiming that “[a] substantial share of the profit exempted from taxation under the proposal is earned by the wealthy owners of large investment funds and other business entities that have no employees.” The CBPP authors also noted that new jobs tend to be created by young small companies that aspire to become big–but because businesses typically earn little profit to pass through to their owners at that stage, they would see little benefit from the cut.
It’s possible that the statistics on the concentration of revenues among an elite set of pass-through corporations is skewed by financial centers like New York, and that the picture is a bit different in Kansas and Missouri. Private companies aren’t required to disclose their tax status, and state-by-state data on pass-through entities is hard to come by.
But these objections do raise the question that reporters need to be asking lawmakers as these unprecedented tax cuts zoom through their legislatures: What is the evidence that the benefits of these untested measures–in jobs created, economic growth, or new opportunities for entrepreneurs–will outweigh the costs, in terms of diminished tax revenues, distortions to business decisions about corporate structure, and in all likelihood a more regressive tax burden?
With the revised bill clearing the legislature this week, it’s almost too late to put this question on the news agenda. But Young’s article in Thursday’s Post-Dispatch, about Senate passage of the measure, is a good start. The story notes up high that the pass-through provision is a “centerpiece” of the bill; farther down, it notes the benefits for well-heeled consultants, and the doubts about how many jobs those benefits might create.
Here’s hoping her fellow statehouse reporters will start asking some of the same questions as the measure heads to Nixon’s desk.
Author’s note: Lest the reader detect any bias here against the beneficiaries of the pass-through tax cut, it may be noted that, in researching this story, I was pleasantly surprised to learn that I am one of them. As a Kansas-based “Mom-and-Pop” freelancer–a sole proprietor–I am greatly indebted to Gov. Brownback for his largesse. Whether I will make use of this windfall to join the ranks of the job creators remains uncertain. I will at least have more cash in my pocket to head out to the mall and goose the Kansas economy, although the governor’s proposed sales-tax hike extension may give me pause.
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Deron Lee is CJR’s correspondent for Iowa, Missouri, Kansas, and Nebraska. A writer and copy editor who has spent nine years with the National Journal Group, he has also contributed to The Hotline and the Lawrence Journal-World. He lives in the Kansas City area. Follow him on Twitter at @deron_lee.