Arizona's finances are in a world of hurt.
We've seen revenue plummet. Agencies have gone through repeated rounds of cuts. The state made national headlines when it mortgaged the Capitol.
What does this say about our state tax system?
Should we overhaul it?
Raise rates? Lower rates? Flatten them? Change what we tax?
Today, The Arizona Republic explores the issue of taxation as part of a new, periodic series, "Ideas for Arizona." The goal isn't to stage debates, although there will be plenty of disputation, nor to seek an often elusive consensus.
Instead, the goal is to elicit a wide range of ideas on key issues from a diverse group of experts and advocates. And to bring these ideas to the attention of Arizona leaders and policymakers.
This series is part of the newspaper's "Arizona 2020" initiative, promoting a discussion of what we want our state to be by the end of the decade and the steps we need to be taking now to get there.
Future topics for discussion will include K-12 education, higher education, the economy, and political and governmental reform.
Participating in this first discussion were Dennis Hoffman, professor of economics at Arizona State University; Kevin McCarthy, president of the Arizona Tax Research Association; Dana Naimark, president and CEO of Children's Action Alliance; and Steve Voeller, president of the Arizona Free Enterprise Club. It was moderated by Arizona Republic editorial columnist Robert Robb.
Robert Robb: In light of the state's budget condition, should voters be asked to extend the temporary sales tax for an additional period of time, say three years, since it expires in 2013?
Dana Naimark: Voters and leaders of Arizona should be asked about some revenue-raising choices. I am not sure that extending the sales tax is the best option. Politically, it might be the smoothest option given that it's already in place.
Dennis Hoffman: You have to do something - either extend the temporary tax or do some type of base-broadening reform that generates net revenue - or you are going to have yet another round of cuts to figure out.
Robb: Kevin, as a practical matter politically, can anything more board-based really get to the voters before the temporary tax expires?
Kevin McCarthy: I think you wouldn't put a high likelihood on a major tax reform that expanded the sales-tax base and changed the rates in some regard. I am hopeful that would be possible. I don't see the likelihood that we will walk away from that temporary sales tax without some major bloodletting. It's a lot of money.
Steve Voeller: I would not want to do it in a vacuum. We support a broad tax-reform package that (replaces) the current personal (and corporate income) tax and the sales tax with two flat-rate taxes. So, if we were going to be more reliant on a higher sales-tax rate, I would rather do that in concert with reforming the current income-tax code and having that broader discussion about who all is going to be in the new sales-tax system.
Robb: Dennis, you've been an advocate of expanding the sales tax in some way or form to include services. Why is that important, and how would you do that?
Hoffman: What I would like to see is just simply recognize that people spend a lot more of their incomes today on personal services than they used to. We also historically in this state taxed food. I would like to see a broadening of the base to encompass all sorts of items. The food tax is a difficult one for some folks to deal with because they think it is very regressive. I think you can deal with regressivity in a number of different ways and negate it. I think having a food-tax exemption is a poor way to deal with regressivity, actually.
Robb: So, what sort of services do you think should be taxed?
Hoffman: Largely personal services. I think business services are problematic. It creates distortions in the system, encouraging some of our business-services purchasers to purchase those services from out of state - accounting services, legal services, some of those things. The rate I think would have to be very low to avoid creating distortions if we are going to go down the business route.
Naimark: I agree that personal services should be the top priority. Taxable sales are becoming narrower and narrower compared to our total economy. That's dangerous and puts upward pressure on the rate. So, I think personal services should be considered for base expansion.
Robb: What about Dennis' idea of including food in the base? Is it time to consider that?
Naimark: I think we should consider it. I think we do have to have a way to deal with the regressivity. Our overall state and local tax system is quite regressive in Arizona, partly because we rely so much on the sales tax, which is regressive. It would have to be a package that is solid.
McCarthy: Individual taxes in Arizona are quite low in comparison to what they are on business - some of the lowest personal income taxes in the United States; some of the lowest residential property taxes in the United States. You have to factor that in if you are going to do some analysis on regressivity/progressivity.
Robb: Other sales-tax issues?
McCarthy: Arizona is one of three states that allow for an independent municipal sales-tax structure. The costs to Arizona businesses to comply with this dual system are enormous. There should be one state and local sales-tax base. While rates could and would vary across jurisdictions, the activities subject to tax would be the same.
Robb: Steve, your organization co-sponsored a report by economist Arthur Laffer, which sort of sidestepped the sales-tax-base expansion issue and recommended that Arizona substitute a business value-added tax for both the corporate income tax and the state sales tax. Why don't you explain the rationale behind that?
Voeller: Basically two flat taxes, at 3.34 percent. (For personal income taxes), you would just take your gross income minus charitable deductions and home-mortgage interest and maybe one other. On replacing the sales tax and the corporate-income tax, it was all business income minus the cost of doing business. So, minus every purchase you made from another business and charitable contributions. That, in effect, broadened the base because there were no other income-tax credits, no sales-tax exemptions or exclusions. So, the theory behind that was Arizona would have a tax system that is more transparent, more neutral - agnostic to the business you're in - with a broader base and low rate.
Robb: I reacted to the Laffer recommendations with an alternative suggestion - a business gross-receipts tax that would have no deductions. I crudely estimated that at a 2 percent rate, it could replace the state sales tax, replace the corporate income tax and produce a little bit of extra money for state coffers. What about that idea?
Hoffman: I think it's a concept that needs to be explored because it seems to me it gets that basic notion - broadest of bases, lowest of rates. It seems to me that if you could get everybody to buy in on this, everybody with a little skin in the game, you get away from this business about export-based businesses and domestically serving businesses - which ones we want to incent and which ones we don't. You can get away from that debate with a rate (sufficiently low that) it essentially is not worth debating.
McCarthy: The truth is we have a very broad base, one of the broadest sales-tax bases in the country. So, if you wanted to take the next step and move toward a gross-receipts tax with an eye toward eliminating corporate income (taxes), which is the lowest revenue source that we've got at the state level, I think it is something that is doable. I agree with Dennis, you don't get out of the starting gate if you're not talking about a low rate. I think it would be hard politically to get off the ground. You're picking fights on a much broader basis than you would on a narrower effort to try to expand the sales-tax base with an eye toward trying to get uniformity with the state and the cities.
Personal income taxes
Robb: Since the early 1990s, Arizona has dramatically reduced income-tax rates across the board. Were that large of income-tax-rate reductions a mistake, and should the state be considering increasing personal and corporate income-tax rates?
Naimark: Let me separate the two and talk about personal. Yes, I think the repeated cuts in personal income-tax rates were a mistake. We are in a place now where the state can't pay its bills and we can't pay for the services that the majority of voters want. So, I do think we need to restore those income-tax cuts or at least a portion of them. The income tax has the potential for offsetting the regressivity of the sales tax, so it is an important instrument in that regard, as well.
Robb: Would you raise them on everybody or just on higher-income taxpayers?
Naimark: We probably should raise the rates for everyone, but more so for people at the high-income levels. We cut the rates more for those levels, and I think we should restore them closer to where we were.
Robb: Steve, I know that you have a contrary view.
Voeller: In the competitive world that we're in, especially in the western half of the United States, I think it would be a huge mistake to raise income taxes with capital being as mobile as it is. States like Utah, which has a flat tax or modified flat tax. Colorado has a low flat tax. Texas has no income tax. I think it would be a big mistake to reverse the tax cuts of the '90s.
Robb: I seem to recall your group advocating an elimination of the capital-gains tax. Why would that be a good idea?
Voeller: Capital-gains taxes tend to impede economic decisions and distort economic decisions. We think it is good public policy from the standpoint of having to do the budget next year knowing what kind of revenues you can expect, and it is also good public policy from a growth standpoint.
Hoffman: I simply don't see any evidence that (eliminating capital-gains taxes) would be somehow growth enhancing. I do see that it adds considerable volatility to the revenue base and leads to the potential that policymakers make the mistake of permanently cutting revenues or permanently putting expenditure programs in place thinking that this revenue is going to be there forever. I guess an alternative to Steve's proposal of simply eliminating it would be to simply recognize (the volatility) as we go forward. Instead of just getting rid of that revenue, use that revenue to put it away for a rainy day.
Robb: Dana, you had some ideas other than increasing rates with respect to deductions.
Naimark: The deductions benefit higher-income people more than lower-middle-income people. So, I think there are potential reforms to look at there that would end up being a tax increase for some people when you make those reforms. Basically, the higher income you are the more you are benefiting from deductions, which is kind of counterintuitive if you are looking at a fair tax.
Hoffman: Broaden the base, get rid of the deductions, the distortions, and lower the rate but build in some (measures to counteract) regressivity to deal with people in the $20,000 to $40,000 income brackets.
Robb: Dana, if a flat income-tax rate was coupled with a refundable income-tax credit to handle regressivity, is that something that you would find acceptable?
Naimark: I think a flat tax that has some kind of exemption and something built in to deal with regressivity could work. I would prefer to see a range of rates, but I do think it is a good thing to trim and slim the deductions and credits and try to simplify.
Robb: A policy decision was made in the 1990s for the state basically to get out of the property-tax business. Was that a mistake?
Hoffman: I think it was a mistake. I've suggested that we do bring it back at a uniform assessment ratio - not just extending the tax on the current system where current homeowners get tremendous breaks. If you benchmark our property taxes against other states', you will find that our residents get very good treatment; our businesses not such a good treatment. I think that is problematic, and it is stifling on businesses.
Amid all this, I think that we have to do something about the homeowners rebate - that would be another way of backdooring a statewide property tax. I've heard countless times our legislators say over the last couple of years that we can't fund X because we don't have the money. Well, it seems they've always had the money to pay 35 percent of my residential property-tax bill.
McCarthy: We still have high business-property taxes, so I am concerned about any change that looks to increase taxes in that area. The state average (property) tax rate is down probably 30 percent since 1996. That is a positive development. We now rank 16th nationally in business-property taxes, (down) from third. We ought to be cautious about doing anything that reverses that process by piling on more.
Naimark: We did make mistakes. I think that it was a mistake to essentially take out statewide property taxes from education funding and replace it with nothing else and take out local property taxes for education capital funding and replace it with nothing else other than the general fund. I think if we can phase down the (business) assessment ratio all the way to be equal with the residential assessment ratio, then we could have a more rational conversation about the other property-tax issues.
Voeller: One of the things that's a positive trait about the current property-tax system is that it's close to the voters. We've seen the last couple of elections some overrides pass, some don't. Some bond elections pass and some don't. Removing that role and putting it more at the state level separates that voter closeness, and, I think, to a detriment.
Robb: If there was a single change in Arizona tax policy that you could make, what would it be?
Voeller: A pure flat tax. A real flat tax.
McCarthy: Reform in the sales-tax system. A uniform sales-tax base for the state and cities.
Hoffman: Any measure that broadens the tax base and enables most citizens to contribute at least in part, according to their means, to paying for the services they consume - a broadening of the sales-tax base to include personal services or food, an elimination of the homeowners rebate for residential-property owners, a flat income tax that taxes all income at a low rate.
Naimark: Reversal of individual income-tax cuts.