Arizona’s state Senate Finance Committee met last week to discuss what the new tax law that resulted from passage of Proposition 208 last month will mean for the state’s economic future and what can be done to offset potential negative consequences.
While the new tax is meant to tax the wealthy to help fund education, it has an unintended consequence: It will affect tens of thousands of small businesses as well.
That could have dire consequences for Arizona’s economic health, said the chair of the committee, Senator J.D. Mesnard (R-Chandler), who scheduled the meeting to hear from legislative budget analysts and others on what the impact will be.
“We don’t want to become a flyover state,” Mesnard said when referring to Arizona’s future economic development prospects.
Arizona now in top 10 for high income tax bracket
Before the new tax was approved, Arizona’s top income tax rate was the 13th lowest in the nation. Now, economists calculate the state has the ninth highest rate in the U.S.
“Having the ninth highest income tax rate, the 11th highest combined average sales tax rate and high business property tax, you can’t have all those things at the highest end and not have at some point a collapse in economic growth,” said Mesnard, who is working with fellow lawmakers and others to find ways to lessen the impact on business and protect Arizona’s ability to attract investment.
Initiative almost doubled top tax rate
Under the new tax law, Arizona’s top income tax rate went from from 4.5 to 8 percent – a 78 percent increase for individuals who earn $250,000 and joint filers who earn $500,000.
Businesses that file under the individual tax code instead of the corporate tax code are also impacted. Corporate filers are not affected by the tax increase.
Positive and negative impacts of the new tax
At the committee hearing, Hans Olofsson, longtime chief economist for the Joint Legislative Budget Committee (JLBC), laid out the potential outcomes from the new 3.5 percent surcharge.
Using a static analysis that doesn’t account for potential secondary budgetary impacts, Olofsson estimates that the state will gain about $874 million in tax revenues for education the first year.
Olofsson said the majority of the taxes, 75 percent, will go to increase teacher and staff salaries. With more money in their pockets, they could spend more and that will push up sales tax collections, he said.
On the negative side, high income earners could decide to leave the state, Olofsson said. Higher tax rates also could reduce incentives for businesses to locate or expand in Arizona.
High income tax states end up losers in the long run
National economist Steven Moore also spoke at the meeting about what happens when states raise their income tax rates.
Moore and fellow economist and researcher Dr. Arthur Laffer conducted an analysis for the Arizona Chamber of Commerce & Industry to determine just that. The report, “Arizona’s Proposition 208 Loses Jobs and Harms Small Businesses,” analyzed how tax rates have affected states over the past 30 years.
Almost all states with lower tax rates perform better
According to Moore and Laffer’s research, almost all states with low or zero income tax rates performed better in most economic indicators than those states with high tax rates.
High tax states saw less revenue for government responsibilities, including education. An analysis of the 11 states that introduced income taxes since the 1960s shows they are at the “very bottom of performance” in not only economic and population growth, but revenue for public services.
Harsh implications for Arizona
Using data from other states, the economists measured the impact Arizona’s Proposition 208 would likely have on jobs, wages, interstate migration, tax revenue collections, state competitiveness, and small businesses.
They found that all areas would likely suffer, making “Arizona residents poorer and the state’s economy less competitive.”
Among their findings:
•An estimated 200,000 jobs and about $25.5 billion in personal income would be lost over the next 10 years.
• Fifty percent of the tax would be borne by small business owners and operators that typically generate from half to two-thirds of the jobs in a state.
• Arizona’s economic competitive position among the 50 states would fall from No. 10 to No. 16.
•The state would lose 700,000 people in net in-state migration over just the next decade.
Arizona needs to find ways to keep growing
Glenn Hamer, the president and CEO of the Arizona Chamber, also spoke at the meeting to encourage state lawmakers to find a way to fund education without harming the backbone of the state’s economy, small businesses.
Before Proposition 208, Arizona was among the fastest growing states and “always seemed to be a finalist when it came to big corporate announcements,” Hamer said.
Now, it will have a much harder time competing with other states that have lower or zero income taxes, he said.
“This is something that affects all of us,” Hamer said. “We need to figure things out so we can fund education in a sustainable way, but we don’t want to do something to hurt our economy and the incredible growth we’ve all enjoyed and experience with this dramatic change.”