Supreme Court ruling could mean millions in lost revenue for Kansas and Kansas City

Kansas lawmakers, already struggling with a $400 million budget shortfall, may be facing another multimillion-dollar revenue headache.

Legal experts believe a recent U.S. Supreme Court decision could mean Kansas must offer full tax credits to thousands of residents who pay the earnings tax in Kansas City, Mo. The theory, if upheld by the courts, could cost Kansas $35 million or more in revenue each year, according to early estimates.

The loss would further challenge a legislature looking for ways to balance the state’s budget. At the same time, though, it would mean millions of dollars in the pockets of Kansans who work on the Missouri side in Kansas City.

“The jig might be up,” said Lisa Soronen, executive director of the State and Local Legal Center in Washington, D.C., a group that represents several municipalities and states before the Supreme Court.

The revenue challenge is based on a case from Maryland. On May 18, the court — in a 5-4 decision — said Maryland’s policy of providing only a partial credit for income taxes paid to other states was unconstitutional.

“The effect of this scheme is that some of the income earned by Maryland residents outside the state is taxed twice,” Justice Samuel Alito wrote.

The majority said Maryland, and other states, could solve the problem by giving residents full credit for all the income taxes they paid to other states.

Kansas already does that. Its residents get a full credit against their state tax bills for any income taxes they pay to other states where they work.

But Kansas provides no such credit for the 1 percent earnings tax paid by residents who work in Kansas City, Mo. Some experts now believe the high court’s ruling makes that policy unconstitutional.

“You need to analyze the local tax as if it were a state tax, just as the court did,” said Walter Hellerstein, a professor at the University of Georgia and a nationally recognized expert in state and local tax law.

Some states already give their residents a credit for the local income taxes they pay. Illinois, for example, provides a full credit for residents who work in St. Louis and pay its 1 percent earnings tax — precisely the policy Kansas may now be required to follow.

“Kansas is going to have to either give a credit for that tax paid to Kansas City,” Soronen said, “or they’re going to have to come up with something else.”

She did not know what that something else would be.

A federal court will likely decide the issue. If a judge determines Kansas owes the full credit, the dent in the state’s budget would be substantial.

Kansas City, Mo., collected roughly $180 million in earnings taxes from individuals last year. If just 20 percent of those individuals live in Kansas — and if they’re owed a full credit from the state for their earnings tax payments — Kansas could lose $36 million in revenue a year.

Some Kansas City officials think the number of Kansans paying the earnings tax is closer to 40 percent. If that many Kansans deserve a full tax credit, that could double the hit to the Kansas budget — $72 million each year.

A spokeswoman for Kansas Department of Revenue Secretary Nick Jordan said the estimates were high “for multiple reasons,” but declined to provide a different projection for possible losses to the state’s treasury.

“We need additional data to provide an accurate number,” spokeswoman Jeannine Koranda said in an email, “which is why we are in the process of examining the case’s impact.”

A spokeswoman for Kansas Attorney General Derek Schmidt said he was aware of the case but would “defer” to the Revenue Department for an assessment of the ruling.

The fallout isn’t limited to Kansas and Missouri. Dozens of cities and counties now collect an earnings tax from nonresidents, and states are scrambling to understand how the court’s ruling will affect them.

Opponents of the court’s ruling predicted just such an outcome earlier this year.

“There is no sound argument for constitutionalizing the issue and taking this policy judgment away from state and local lawmakers,” a coalition of state and local governments argued in its brief in the case.

That concern was echoed by an unusual coalition of Supreme Court justices, including conservative Antonin Scalia and liberal Ruth Bader Ginsburg, who wrote opinions for the minority.

But the majority justices said double taxation of income — which now exists for Kansans who pay Kansas City’s earnings tax — violates the U.S. Constitution’s commerce clause, because it amounts to an impermissible tariff between states.

That worries cities such as Kansas City, Mo., because the court’s decision works in both directions. Kansas City residents now pay a 1 percent tax on their income regardless of where the money is earned.

But if the city’s earnings tax falls under the court’s ruling, it may have to offer its residents a full credit for any taxes they pay to other states. Kansas City already offers a tax credit for earnings taxes paid to St. Louis, but not for any state-based income levies.

Kansas City officials say they don’t know how many residents work in Kansas.

City Hall may argue the earnings tax isn’t really a state tax, and therefore doesn’t fall under the court’s ruling. Hellerstein rejected that argument.

“For federal constitutional purposes, the distinction between state and local taxes has no meaning,” Hellerstein said. “They’re all exercises of state power insofar as the Constitution is concerned.”

The Supreme Court ruling did not order states to offer full credit for taxes paid to other states. It said there might be other ways to cure the constitutional problem, but did not specify what those other policies might be.

The ruling potentially pits states against each other, and cities.

Kansas, for example, would lose no revenue if Kansas City, Mo., simply stopped collecting the earnings tax from Sunflower State residents. But Kansas City is highly unlikely to do that because the city would simply bear the loss of revenue instead of Kansas.

Kansas could also protect itself by claiming that an earnings tax violates the Constitution, at least as it applies to nonresidents. Pursuing such a case, however, might make the economic development “border war” look tame by comparison.

Yet Kansas is now in the peculiar position of potentially losing millions in revenue because of a law passed for the benefit of Kansas City, Mo. And Kansas can’t control what Kansas City does.

For now, all sides are waiting — and holding their breath.

“There seem to be many different takes on the Supreme Court’s ruling,” said City Attorney Bill Geary of Kansas City. “It may be left to lower courts to sort out.”

This story was originally published May 27, 2015 at 6:28 PM with the headline "Supreme Court ruling could mean millions in lost revenue for Kansas and Kansas City."