Kansas legislators are considering several tax policy changes this legislative session, and the Senate got the ball rolling on February 23rd by passing a series of bills that make senators’ tax policy priorities clear.
Some of the proposed changes, such as converting to a flat individual income tax structure and inflation-indexing the standard deduction, would promote economic growth while making the tax code more structurally sound. But other proposed changes, like exempting retirement income and removing groceries from the local tax base, would narrow income and sales tax bases, making the tax code less neutral while doing little to grow the economy.
While the House is expected to consider its own proposals, the Kansas Senate-passed bills serve as a starting point for future negotiations between the two chambers. As these negotiations occur, policymakers should consider the long-term effects and trade-offs associated with each of the changes being considered.
Converting to a Flat Tax Structure
One Kansas Senate-passed bill, S.B. 169, would move Kansas from a graduated-rate to a single-rate individual income tax structure beginning in 2024, which would make Kansas the sixth state to enact legislation converting to a flat individual income tax structure in the past two years alone. Instead of imposing a graduated-rate tax with a top rate of 5.7 percent, Kansas would levy a more competitive, flat rate of 4.75 percent on taxable income exceeding $5,225 for single individuals and $10,450 for married couples filing jointly. This exclusion is in addition to the existing standard deduction and personal exemption and would ensure that all income taxpayers experience tax relief even though the new flat rate is higher than the existing lowest rate of 3.1 percent.
Absent any changes to the standard deduction or personal exemption, single filers would pay approximately $76 less in taxes on their first $35,750 in income than they pay under the current graduated-rate structure, and married couples filing jointly would pay approximately $151 less on their first $72,500 in income. And, with a flat rate of 4.75 percent rather than a top marginal rate of 5.7 percent, taxpayers would pay $9.50 less in taxes on every $1,000 of income they earn over $35,750 (single filers) or $72,500 (joint filers) than they pay under current law.
The proposed single-rate structure would be more conducive to job, wage, and overall economic growth in Kansas than the current graduated-rate structure, as lower-rate flat taxes avoid penalizing additional labor and investment on the margin. Reducing tax burdens on labor and investment in this manner would allow all workers to keep more of their earnings while allowing pass-through businesses to retain more of their profits to increase employee wages, hire more workers, make new capital investments, and otherwise grow their businesses.
One shortcoming of S.B. 169 in its current form, however, is that the real value of the zero bracket would erode over time because the income thresholds at which the flat tax rate kicks in are not annually adjusted for inflation. If left unindexed, the share of a taxpayer’s real income exposed to taxation would increase over time, as has already occurred for many years due to the lack of inflation indexing of Kansas’ standard deduction, personal exemption, and income tax bracket thresholds.
Inflation-Indexing the Standard Deduction
A separate Kansas Senate-passed bill, S.B. 33, would, among other changes, index the standard deduction to inflation beginning in tax year 2023, a change we have long recommended to prevent further erosion of the real value of the standard deduction.
Policymakers should also consider inflation indexing the $2,225 personal exemption that is available for each Kansas resident taxpayer, spouse, and qualifying dependent, as the real value of this exemption also continues to erode over time.
Exempting Retirement Income from Taxation
Another provision in S.B. 33 would substantially narrow the income tax base in a nonneutral manner by exempting from state taxation all income from federally taxable retirement plans and all Social Security benefits.
Under current law, the Social Security benefits of Kansans whose total federal adjusted gross income (AGI) from Social Security and other sources exceeds $75,000 pay taxes on all their Social Security benefits, while those with $75,000 or less in income pay none. This proposal would exempt currently taxable Social Security benefits beginning this year and all of retirees’ retirement plan income as of 2024. This would make the tax code substantially less neutral by providing preferential treatment to traditional over Roth retirement accounts. Specifically, for retirees with traditional IRA or 401(k) plans, the state would no longer tax that income when it is distributed even though such income is also untaxed when it is earned and contributed to such accounts. Meanwhile, Kansans who are not yet retired and who contribute to Roth accounts would not receive a similar benefit, since contributions to Roth accounts are taxed on the way in.
Regarding the proposed new exemption for all Social Security benefits, ideally, Social Security benefits should be treated as ordinary income for income tax purposes. Social Security, at its most basic level, is like a mandatory retirement plan that requires workers to set aside a portion of their earnings during their working years with the assurance that they will have a basic source of income in retirement. As such, Social Security benefits should be taxed like income that is accessed in retirement from a traditional IRA or 401(k) plan. Instead of removing Social Security benefits from the income tax base altogether, Kansas should consider fixing the $75,000 exemption threshold tax cliff, which we have written and testified about previously, by converting it into a more gradual phaseout.
While proponents of an exemption for Social Security benefits have expressed a desire to make Kansas’ tax code friendlier to retirees, large income tax base carveouts put upward pressure on the overall rate that applies to all income, including retirees’ income as well as income earned by the workers and job creators who drive productivity and economic growth in Kansas the most.
Removing Groceries from the State and Local Sales Tax Base
A third Kansas Senate-passed bill, S.B. 248, would remove unprepared food and food ingredients from the state sales tax base one year earlier than planned. It would also go beyond current law to remove groceries from local sales tax bases as well, which would result in substantial revenue loss to local governments.
Under current law (H.B. 2106, enacted in May 2022), the state sales tax rate on unprepared food and food ingredients was reduced from 6.5 percent (the general state sales tax rate) in 2022 to 4 percent in 2023, and the rate is scheduled to phase down to 2 percent in 2024 before going to zero in 2025. However, under current law, local sales taxes would continue to apply to groceries.
Grocery purchases represent a sizable and stable share of local sales tax bases, so without this revenue, local governments are likely to turn to other revenue sources in the future—such as property tax increases or local sales tax rate increases—to offset the revenue loss associated with an exemption for groceries, making any net tax relief associated with a grocery exemption likely to be short-lived.
Furthermore, while many people assume removing groceries from state and local sales tax bases is a progressive policy change, given existing state and local sales tax exemptions for food purchased with SNAP and WIC benefits, our research shows lower-income taxpayers are often better off with groceries included in sales tax bases at lower across-the-board rates than they would be with groceries exempted but with the current general sales tax rate applying to all other taxable purchases.
It is also worth noting that while Kansas’ continued status as a Streamlined Full Member State—a state that adheres to Streamlined Sales and Use Tax Agreement (SSUTA) policies—is contingent upon maintaining much uniformity between state and local sales tax bases, the sales tax treatment of food is one area in which member states are allowed to apply the sales tax to groceries at the local level without doing the same at the state level.
Finally, compared to income tax rate reductions—which increase returns to labor and investment—sales tax exemptions do little to promote long-term economic growth.
As Kansas legislators consider additional tax policy changes this legislative session, they should prioritize economic growth and a structurally sound tax code. While base-narrowing provisions may be politically popular among those who would receive an exemption, narrowing tax bases puts upward pressure on tax rates over time, which could negate the revenue-negative impact of many of the exemptions currently being proposed.