The Impact of State Taxes on Pass-Through Businesses: Evidence from the 2012 Kansas Income Tax Reform

Abstract

In 2012, Kansas undertook a large-scale tax reform that excluded certain forms of business income from individual taxation. In theory, these changes enhance the incentives to undertake more real economic activity such as new business formation or increases in employment or investment. But, the reform also shifted the incentives to avoid taxation by recharacterizing income sources. This paper provides evidence of these effects using federal administrative taxpayer data. Drawing on these data from 2010 to 2014, we find evidence suggesting that, at both extensive and intensive margins, the behavioral responses were overwhelmingly tax avoidance rather than real supply side responses.

Keywords: Taxable Income Elasticity, Pass-Through Income, Business Taxation, State Income Taxation, Kansas

JEL Classification: H24, I38