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Taking a Pass on “Pass-Through” Income Would Cost Kansas

Owners of large corporations, well-heeled law firms, and big investment funds would pay no taxes on millions of dollars in income under Kansas Governor Sam Brownback’s plan to abolish the income tax on business earnings that are “passed through” to owners, rather than taxed at the corporate level.

The plan would make Kansas the first state in the nation to exempt pass-through income from an otherwise broad-based income tax.  Owners of a business entity normally pay personal income taxes on pass-through income.

Proponents say the plan would be a boon to small businesses and encourage job creation.  But when my colleague Michael Mazerov and I took a closer look, we found that much of the benefit would flow to large corporations and to investment funds and other entities that have few or no employees and are unlikely to create more jobs.

Small, job-creating businesses would get much less.  Small businesses that spend at least $10,000 on labor — the small-business employers that the governor claims to be targeting — generate only 28 percent of all pass-through income, according to a recent U.S. Treasury Department study (see graph).

Moreover, the state budget would take a big hit.  The plan likely would cost Kansas $266 million a year or more in lost revenue, when schools and other vital services that bolster the state’s economy and create a better foundation for future economic growth are still reeling from deep cuts.

The plan also would make the tax code less fair.  For example, a wage earner would pay more in taxes than a pass-through business owner, even if they have the same earnings.

And exempting pass-through income could create new incentives for tax avoidance, such as prompting some taxable corporations to reorganize as pass-through entities purely to take advantage of the tax break.

With unemployment still high and balancing the Kansas budget still a challenge, this is the wrong road for Kansas to take, or for other states to follow.