More Bad News for Missouri Competitiveness

With the stroke of a pen, Kansas Gov. Sam Brownback has changed the competitive landscape in the Midwest. What happens next will depend upon how Missouri and other Midwestern states respond to a bill the Kansas Legislature passed at the end of the last session and Brownback signed into law.

The new law reduces the state’s top tax on wage income from 6.45 percent to 4.9 percent. Much more dramatically, however, it also abolishes the state income tax for many entrepreneurs and small business owners.

Under the new law, partnerships, S-corporations, and sole proprietorships are now exempt from paying any state income tax in Kansas. For example, if the owner of an S-corporation has $10 million in sales and $500,000 in “pass-through income” — meaning income after wages and other expenses — he would pay zero taxes to the state of Kansas on his $500,000 income.

Officials in Kansas make no secret of the fact that they want to promote their state as a Midwestern tax haven — appealing to entrepreneurs and small businesses in neighboring states, including Missouri, which has a top individual income tax rate of 6 percent, or $30,000 on $500,000 in income.

If small business owners in Missouri, Oklahoma, or other states want the same deal that Kansas is now offering to more than 190,000 small businesses, they just need to relocate to the Sunflower state.

How big a threat does this pose to the future growth and prosperity of our state? As economists, we can offer a few back-of-the-envelope calculations.

Missouri entrepreneurs in the 11 counties bordering Kansas would presumably be among the first to move. The population within these counties is 1.48 million people, or just more than 24 percent of the state’s total. For 2010, the total aggregate income of people filing individual income tax forms in Missouri for partnerships, S-corporations, limited liability partnerships, and sole proprietorships is $13.2 billion. Based on the population distribution, we would therefore expect that people with pass-through income in the border counties would account for roughly 24 percent of the $13.2 billion, or $3.17 billion.

Let us suppose that 10 percent of small businesses and entrepreneurs in those border counties deemed it worthwhile to move. That would translate into a $317 million reduction in goods and services and a roughly 1 percent reduction in income in the border counties. Based on 2011 income per worker, Missouri would see about 4,500 jobs go across the border.

Of course, people in other parts of Missouri might also elect to take advantage of the welcome mat that Kansas has put out for entrepreneurs and small business owners and that would further erode the base of our already weak and under-performing state economy. Entrepreneurs who might otherwise have launched their new business in Missouri may choose to launch it in Kansas instead.

Oklahoma Gov. Mary Fallin is advocating a reduction in her state’s top income tax rate to 4.5 percent from the current 5.25 percent, and she has cited the new Kansas law as cause for urgency. “Oklahoma needs to compete with our neighbors,” Fallin said. “To do that we need to lower our income tax.”

In a recent press conference, Missouri Gov. Jay Nixon sounded strangely complacent, saying “we haven’t spent a great deal of time talking about what they (Kansas) did.” With all due respect, we suggest that this is something worth discussing.

Our lawmakers need to start thinking seriously about creating a more favorable tax regime for economic growth and job formation in Missouri.

Joseph Haslag is chief economist and Michael Podgursky is a co-founder and director of the Show-Me Institute, which promotes market solutions for Missouri public policy.