The Arizona legislature has approved a new budget proposal that revises an earlier unsuccessful attempt to impose a flat personal income tax. Senate Bill 1828 will initially reduce the state’s four income tax rates to two. Currently, Arizona income tax rates range from 2.59% to a top rate of 4.5% for incomes over $159,000. The new law would create two brackets – 2.55% and 2.98% – effective Jan. 1, 2022, with a minor reduction to both of those rates (to 2.53% and 2.75%) if a certain general fund revenue is reached. And, if the general fund revenue reaches $12,976,000, the two rates would be further reduced to one 2.5% flat rate. An earlier version of the flat tax was narrowly defeated in the Senate. Unlike the earlier version, the new bill does not limit the top combined income tax rate at 4.5% which was proposed in response to Proposition 208 which imposes a 3.5% tax on income over $250,000 for individuals and $500,000 for joint filers. However, the 4.5% cap has been introduced in another bill, Senate Bill 1827, which has also been approved in the Senate and House. If the cap is enacted, high earners will essentially be subject to a 1% general income tax rate and Proposition 208’s 3.5% rate. Both bills appear to have a good chance of being enacted.
RSM state and local tax policy experts provide their take on the Arizona proposal.
I’m very much in favor of personal income tax cuts, particularly those that have a broad impact and put more money in the hands of skilled workers and middle market and small business owners. However, I think it’s important to put this one in context. Arizona voters approved Proposition 208 to impose an additional 3.5% tax on income over $250,000 for individuals and $500,000 for joint filers. This ballot measure was intended to layer on top of the current 4.5% rate bracket. The two bills moving through the Arizona legislature appear to be intended specifically to thwart the will of the people of the State of Arizona, which I am unwilling to blithely condone. Was Proposition 208 a good idea? Maybe not in hindsight. Will the people of Arizona benefit from the passage of the flat tax proposal? Possibly; maybe even probably. But, with heightened tensions, ongoing litigation on point, and a high likelihood of pushback through the ballot and the courts, it seems to me like this one could have used some additional time and consideration. The narrow margin of approval in the State House and Senate suggests that many legislators agree.
Let us take a moment and consider a 2.5% flat personal income tax rate as that appears to be the goal the state is intending to achieve here. That’s low. It’s lower than the state’s existing lowest bracket at 2.59% and much lower than the state’s highest bracket at 4.5%. It’s lower than Pennsylvania’s flat 3.07%, coincidentally, David, Brian and I’s former home state. A 2.5% rate would be the lowest flat rate in the country. In fact, while we’re going low, why impose a personal income tax at all? Nine states have chosen that path and impose no general personal income tax, instead relying on other revenue sources like from sales and use taxes. According to the Tax Foundation, Arizona has the 11th highest combined average sales and use tax rate. Surely no one would notice if it cracked the top ten in the years to come to help balance the reduction in personal income taxes. At least the further rate reductions require revenue triggers.
I do jest at the low proposed flat rate, but with good reason. Nation-wide, individual income taxes make up at least 37% of all state tax revenues. I have not reviewed any fiscal notes or scoring of the proposal, but understand the rate cuts to take at least a billion-dollar hit to revenues. It was only a handful of years ago we were discussing the 40-plus states with budget shortfalls before the Tax Cuts and Jobs Act broadened state tax bases. Still, at a time that state revenues have been surprisingly fertile, states should be considering rainy-day funds and common sense tax cuts that will drive business and employment forward. Such a tax cut appears to have faith in a level of economic growth and revenue which is anything but certain – I enthusiastically direct you to the last decade for reference. And to emphasize David’s point, the voters approved the 3.5% increase on high-earners. Yet under Senate Bill 1827, while the voters will still see their 3.5% surcharge, it could come at the expense of at least a 1.5% general income tax reduction on those same earners if the rate cap is enacted – I’m pretty sure the 52% that approved the measure never saw that one coming.
I am somewhat torn on what is going on in Arizona. On one hand, I believe that reducing personal income taxes when a state can afford it is generally good policy. People spend their money more effectively and efficiently than any government could ever hope. And lower income tax burdens make a state more competitive lead to greater economic growth. In this case Arizona has a $2 billion surplus; some reports have the surplus as high as $4 billion. The flat tax will cost $1.9 billion. So affordability is not really the issue. What troubles me however is that the people of Arizona voted in favor of Proposition 208 last November. The people said they wanted to tax the wealthy more. While I think that is misguided, I am concerned that political leaders would disregard that election so cavalierly. I do not like when political leaders disregard popular votes to limit taxes. I don’t like it when the disregard popular votes to raise taxes. Still, a flatter and lower personal income tax will be good for Arizona.