By Howard Fischer
Twitter: @azcapmedia

PHOENIX — With the state flush with cash, Republican legislators and the governor are circling in on a plan to permanently cut $1.5 billion in annual tax collections over the next several years.

The proposal would implement a flat 2.5% state income tax rate. That compares with the current graduated structure that has rates as low as 2.59% on taxable income up to $53,000 for married couples, and as high as 4.5% on earnings about $318,000.

But the proposal favors those at the top end in more ways then one.

Lawmakers intend to essentially have the state pay all or part of the 3.5% income tax surcharge approved by voters in November on earnings above $250,000 for individuals and $500,000 for married couples filing jointly. That levy imposed by Proposition 208, being challenged in court, is designed to generate up to $940 million a year for public education.

It's not just the income tax that GOP lawmakers are hoping to cut.
The proposal seeks to trim the assessment ratio of businesses, the figure used to compute their property taxes.

It currently stands at 18% of full-cash value, a figure that is supposed to approximate market value. The plan is to drop that in steps to 17% which would lower the taxes owed.

Strictly speaking, that doesn't affect the state as it does not collect property taxes.

But any reduction in what businesses pay in local taxes normally would translate into a politically unacceptable commensurate increase in what is paid by residential property owners. So the plan is to make other alternations to the system to keep homeowners from seeing their local tax bills go up.

Also wrapped up in the deal is a plan being pushed by Senate President Karen Fann to make the first adjustment in state jobless benefits in 17 years. It would take the cap from $240 a week — only Mississippi is lower — to $320.

What's fueling the state revenues in some ways is related to the COVID-19 pandemic.

That certainly cut into tax revenues from bars, restaurants and hotels. And even sales at brick-and-mortar stores were weak as people did not go out.

But what it also did is shift shopping patterns. Arizonans were buying more online.

A lot more.

What made that crucial is state lawmakers decided to take advantage of a 2018 U.S. Supreme Court ruling that said that states can mandate that businesses without a physical presence in the state collect sales taxes on purchases made by residents.

That change in tax policy alone has generated more than $338 million since the beginning of the fiscal year on July 1, more than offsetting slow collections form hotels, bars and restaurants; at the current rate, the collections from online sales should top $500 million a year.

On top of that, the state has been the beneficiary of billions of federal dollars to deal with the pandemic. While some of that was earmarked for specific purposes, Gov. Doug Ducey used at least $300 million to fund regular state agency operations, freeing up the tax dollars they had been given.

The plan also contains some other tax cuts.

For example, one of these would totally exempt military pensions from any state income taxes.

Arizona law currently exempts the first $3,500 of any such pension from state taxes. Ducey has been at the forefront of trying to remove that cap entirely — at a cost of about $43 million a year — calling it a matter of economic development to attract veterans to retire here.

But the big-ticket item is that flat tax.

Democrats already are railing against the idea of cutting taxes when there are needs for things like schools and teacher salaries.

There is some additional cash in the plan for K-12 education as well as helping schools make repairs. That failure of the state to properly fund that account for building repair and maintenance remains the basis of an ongoing lawsuit first filed in 2017.

There also is some additional money for some road repairs and expansion of freeways. And the universities will get some additional dollars.

But the biggest debate could be around the underlying concept of giving the biggest percentage breaks to those who make the most.
Proponents of the plan are hoping to blunt that with ways to ensure not only that no one pays more but that some at the very bottom pay nothing at all.

That starts with existing deductions and exemptions from taxable income based on the number of people in the household. There even are deductions for qualifying parents and grandparents.

Add to that the fact that even people who do not itemize on their state tax returns get a standard deduction of up to $24,400 for a married couple filing jointly. That already means most people at the bottom of the income scale have no taxable income against which to compute the tax rate.

On top of that, the plan includes yet an additional dependent deduction.

What could derail all of that is not Democrat opposition.

Sen. Paul Boyer, R-Glendale, pointed out that cities get a share of state income tax revenues. That's based on a 1972 voter-approved amendment to the Arizona Constitution where cities gave up the right to levy their own income and luxury taxes in exchange for revenue sharing.

He said any cut to cities would most immediately affect their ability to finance public safety.

Sen. Boyer's concerns are crucial because there are only 16 Republicans in the 30-member Senate. And there are similar concerns among some House members where all 31 GOP votes are needed for a budget.

At this point, legislative leaders are looking for some sort of compromise.

A short-term plan would include a "hold harmless'' agreement, guaranteeing cities would continue to receive the same dollar payout for some period, perhaps three years, even as the total state revenues declined. But that still leaves the question of what happens afterwards.

One option is to boost the revenue sharing from 15% of total tax collections to some higher figure, perhaps 18% or more, to compensate for the smaller tax collection pie.

That has generated some opposition among those who point out that revenue sharing goes only to cities even though it is the entire state, including residents of unincorporated rural areas, who contribute to the pie.

None of this appears to be headed for a quick resolution, with GOP leaders asking members about their plans for June.