A ballot initiative to raise income taxes on certain taxpayers and small businesses is “poorly conceived” and “will not create a sustainable source of funding that is worth the economic malady it will cause” according to a new analysis by a tax watchdog group.
The report by the Arizona Tax Research Association examines Arizona’s journey from a comparatively high-tax state in the 1990s to one that is more competitive today regionally and nationally and the effect the initiative’s passage could have on the state’s prospects for future economic growth.
The report finds that despite Arizona reducing individual income tax rates by 36% since the 1990s, the individual income tax produces far more revenue today than it did in 1991 when adjusted for inflation.
“Adjusted for inflation, Arizona’s individual income tax rate is bringing in 185% more revenue today than it was back in the 90s when the highest rate was 7%,” ATRA Senior Research Analyst Sean McCarthy and the paper’s author said. “The proponents of the tax increase want to establish a new 8% tax bracket, which is 77% higher than the current top rate. We know from history, however, that doing so risks undermining the ability to attract new taxpayers and investment to Arizona.”
The paper cites data indicating that high-wage earners have sought out Arizona as a destination as the state’s tax code has become more attractive.
Between 1991 and today, tax filers with an annual adjusted gross income greater than $500,000 grew nearly 400%. Those filers are now responsible for more than $1 billion in state revenues.
McCarthy rejects the notion that high earners would still choose Arizona if income tax rates were to spike.
“We hear often that New York and California have lots of millionaires despite having high tax rates and that Arizona can do the same,” McCarthy says. “That ignores certain inherent factors those states have that Arizona simply doesn’t. People can move around. Arizona has been a net importer of new residents and tax filers from high-tax states, but that can all change if we join the top-10 list of states with the highest income tax rates.”
Small businesses that are organized as pass-through entities, like partnerships or S Corps, pay their taxes on the individual tax code and will be affected by the proposed tax increase. Citing IRS data, the ATRA report says more than a quarter of Arizona business filers and a large percentage of Arizona’s revenue will be impacted by the increase.
“Businesses make decisions on a number of factors, but a state’s tax environment is near the top of the list,” McCarthy said. “If increased hiring, expansions, and new investments don’t pencil out on a spreadsheet because of a higher tax burden, then Arizona’s economic growth is likely to be severely slowed.”
The paper takes issue with the claim by proponents that Arizona’s K-12 education system will benefit from the tax increase.
“The entire premise of this proposal is incredibly cynical. The proponents aren’t shooting straight with teachers,” McCarthy said. “Not only is the revenue that will come from this tax highly volatile and highly unlikely to deliver what the proponents are promising, but the dollars won’t even go to base K-12 funding.”
McCarthy says advocates for increased education funding would be better served to support policies that will encourage more robust economic growth and, as a result, generate more available resources for the Legislature and governor to appropriate to schools and teacher salaries.
“Lawmakers and the governor have demonstrated that they’re ready and willing to devote more dollars to the education system when the resources are available,” McCarthy said. “This initiative won’t even deliver for teachers the dollars that the 20×2020 teacher pay raise plan and the restoration of additional assistance funds have, but it will certainly create a drag on economic growth.”