As the state House of Representatives prepares to take up debate on the state budget, legislators should keep in mind the following:
1. A flatter income tax is better. It removes negative incentives that reduce productivity and investment.
2. If the Legislature does nothing to blunt the negative impact of the nearly 78% income tax increase from Proposition 208’s new surtax, there will be a negative effect on small businesses and on the state’s ability to attract and grow both small and large businesses in the future.
3. If the Legislature does nothing to change our tax code, state and local governments will still lose revenue. Proposition 208 has forced the state into an income tax structure that is uncompetitive.
We have long been proponents of a flatter income tax structure. If a state is going to impose an income tax, we believe a flat tax is the best system.
A flatter tax decreases the potential for lost productivity typically present with a progressive income tax system, so a switch to a flat tax lessens the disincentive to work and invest locally.
A flatter tax system also recognizes that progressive systems tend to be enormously lopsided, relying on a small base of taxpayers to pay a substantial amount of the tax. Currently, according to the Joint Legislative Budget Committee, 4.75% of Arizona income taxpayers in the highest income brackets pay 48.5% of all income taxes in the state. Under Proposition 208, these taxpayers (at least 50% of which are small businesses) are responsible for 100% of the income tax surcharge, increasing their total liability to 55% of all income taxes collected.
We have also seen several new tax revenue sources in recent years amounting to a substantial amount of extra tax. These new revenues come from sales taxes on sales by third party sellers on internet marketplaces, and from taxes resulting from the legalization of recreational marijuana and sports betting. New tax cuts should be warranted commensurate with these new revenue streams when they place the state in a structural surplus.
Arizona is facing a pending economic development headache caused by the implementation of the tax surcharge. As any economic development professional will tell you, deals and investments are won at the margins. New businesses, both large and small, with higher income job opportunities have come to the state in increasing numbers over the last few years, with capital expenditure commitments that have exceeded all expectations. They came based on a set of economic conditions that, importantly, included our tax structure. Then, we changed it to their disadvantage.
Higher income taxes won’t mean we lose every deal going forward, but it means we will lose those deals at the margin that are sensitive to changes in the tax structure. This could mean we lose out on companies hiring professionals with advanced degrees or headquarter locations that bring executives and their high salaries.
A small number of high‐income taxpayers pay a large share of tax. Losing even a small percentage of them has an outsized impact on tax collections. And many who will be affected are also small business owners. If they vote with their feet and leave the state, or future small businesses and other high earners decide not to come, we are worse off.
Something must be done to “unring” the bell and signal to people and companies that they are welcome in Arizona to thrive and prosper without unnecessary and burdensome taxation. We need to retain our pro‐growth reputation and remain competitive.
The state Senate passed a flatter income tax structure that addresses the looming impacts to many small business owners. The House should do the same.
Danny Court is a principal and senior economist with Elliott D. Pollack & Company