Sam Brownback had an experiment in Kansas where he decided to cut the taxes. He took a chance on the understanding of Supply side economics.
Right when he got into office, he decides to do a flashy thing. The plan was that if Kansas has the least tax in Mid-west, the businesses will start coming there to establish their businesses. The ones which are already in Kansas, they will start thinking about expanding their businesses through the money they saved from lower tax rates.
They brought taxes on small businesses to literally zero. Personal income taxes went down by a lot. The highest income bracket tax went down by 25%.
Well, the first step got success after discussions with legislature and the taxes were brought down. But then the question remains that from where will the government bring money to spend on education, health, maintenance, etc. For this Sam had a famous conservative economic theory in mind which says that if tax cuts are done in a proper way, they would bring more money eventually. This theory was pushed by Economist Arthur Laffer. (You would be knowing him if you are into economics and have heard of Laffer curve).
What Laffer was trying to convey is that
If the government has a 100% tax rate, then whatever you earn- the government will take it away completely. This way, nobody would want to work as they aren’t earning anything. So with a 100% tax rate, the revenue that the government got is zero. So now when the government reduces the rate to 90%, a few people will think of working again to get that 10% amount for themselves. This way, the government will earn some money which is greater than what they would have had the tax rate been 100%. This was something Laffer had thought of and drew a curve explaining this phenomenon on a Napkin in a restaurant. This curve is called Laffer curve. But in this curve, he also mentioned that it is not always true. Laffer had explained that if the government brought down the taxes from let’s say 30% to 25%, the revenue might not increase as this didn’t motivate enough people to start their work again. Thus the revenue would actually decline.
So what would happen if you cut down the taxes (which were already quite low) on small businesses to 0%? Will this show that the government will earn more revenue according to Laffer curve? Actually yes. They thought that since this will motivate more small businesses, employment will increase. People will start moving into Kansas to work and this will increase in the number of payroll taxes. All republicans thought the same too. Theoretically, the government, the law-makers, Mr Laffer – all thought that the plan was going to succeed. The experiment begins.
The small businesses seeing the tax cut, they became happy. With the additional money flowing in, they decided to re-invest the same into their businesses. They did. So Brownback’s thought of people re-investing money was coming out right. So far so good. People were starting to buy more and more – which eventually was helping the government earn sales taxes.
But Brownback had thought that the businesses will start to hire more people while expanding. But this didn’t happen as the entrepreneurs/small players didn’t think the business culture was growing in Kansas. So they didn’t hire any more people- which eventually pushed the treasures of Kansas government go down and down. And down.
In other words, the government that gave $100 of tax cut, was earning only $6-7 on sales taxes for the same amount. This was resulting into $93-94 of revenue reduction per every $100 tax-cut.
The state budget office knew that there would be a shortfall of money. They had projected a reduction of $300 million. But in the first year, the reduction was twice of that. $600 million.
To balance this budget, Kansas brought down their spending on highways, infrastructure, health, etc. Public schools started to close early for lack of operating revenue. Kansas was shorting pension funds, reducing medical spending and slashing outlays for state universities.
Sam Brownback always believed that the results wouldn’t be visible within a year or two. Give him a timeline for a decade and the growth will be visible. But in 2016 data (six year into Governor’s command) showed that Kansas lost 9400 jobs compared to other states which were showing the growth in employment.
Eventually, the elected representatives are finally digging out. The white flag was unfurled and the government are now increasing rates step by step. It definitely will take at least a generation to get back to where Kansas was. Burdett Loomis quotes on the consequence of this experiment that This failure probably cost us $4 billion.
Lastly, I will just add one point: Economics is tough to understand. If you think that you have grasped everything, think again. You haven’t.
-Arjuna@War (Parth Shah)