In just a few short months, Arizona will officially have the lowest flat income tax rate in the country. Governor Ducey announced last week that the Department of Revenue will be implementing the final stage of individual income tax rate and bracket reductions to a single 2.5% flat rate in 2023, a year sooner than originally planned. This is great news for Arizona taxpayers and job creators as well as the overall economic outlook of the state for years to come.
Given what is coming out of Washington, D.C. these days, this news couldn’t have come at a better time…
Arizona will have just one personal income tax rate of 2.5 percent instead of four rates as of Jan. 1, Gov. Doug Ducey announced last week. That is an effective date one year sooner than was originally expected when the governor signed legislation in 2021 for what was designed as a three-year phase in.
“It’s time to deliver lasting tax relief to Arizona families and small businesses so they can keep more of their hard-earned money,” Ducey wrote to Arizona Department of Revenue Director Robert Woods on Sept. 29. “This tax relief keeps Arizona competitive and preserves our reputation as a jobs magnet and generator of opportunity.”
It is Arizona’s thriving economy and record revenues which allows for full implementation of the flat tax now instead of January 2024, according to Ducey. The Joint Legislative Budget Committee and the Governor’s Office of Strategic Planning and Budgeting jointly informed the governor last week that Arizona’s General Fund revenues, excluding the beginning balance for Fiscal Year 2022, were at $16.7 billion.
This exceeded the statutory economic condition phase-in triggers written into the flat tax law in 2021. In addition, Arizona’s Rainy Day Fund is at its highest level ($1.4 billion) in state history and economists are forecasting Arizona will report at least a $4 billion budget surplus through 2024.
“It’s no secret that Arizona’s economy is booming,” Ducey added in his letter to Woods. “Over the last eight years, we’ve made responsible decisions to live within our means, reduce burdensome government regulations, lower taxes every year and ensure our state remains a great place to live.”
Arizona House Majority Leader Ben Toma was instrumental in getting personal income tax reform passed during the 2021 legislative session to eventually replace the state’s four-rate system of 2.59 to 4.5 percent with the 2.5 percent flat rate.
“I am happy to report that revenue thresholds have been exceeded one full year in advance, enabling the implementation of a single flat rate of 2.5% a year earlier, providing Arizonans with significant economic relief when they need it most,” he said in response to the governor’s announcement.
Several business groups and economic development organizations lauded the news, which will give Arizona the lowest flat tax in the country when it takes effect Jan. 1.
Americans For Prosperity – Arizona:
“This is a historic win for Arizona that couldn’t come at a better time,” said State Director Stephen Shadegg of AFP-Arizona. “Over time, Arizonans will continue to reap the benefits of more tax relief and the state will become even more attractive to businesses and investors, growing the state’s economy while letting hardworking taxpayers keep more of their paychecks.”
Common Sense Institute Arizona, a non-partisan research organization dedicated to the protection and promotion of Arizona’s economy:
The 10-year combined impact of Arizona’s recently enacted 2.5 percent flat rate income tax along with repealing the state’s progressive income tax structure with an 8.0 percent top rate included in 2020’s illegal Proposition 208 would increase Arizona’s GDP by about $11.9 billion with about 58,000 more employed workers.
That’s the conclusion from Common Sense Institute Arizona which took a deep look into the long-term effect of the Arizona Supreme Court’s rejection of Prop 208 and the signing into law of Arizona’s first flat tax.
“Generally, economists agree that high income taxes are economically harmful, particularly when they tax capital gains and other income on savings and investment at the same rate as ordinary income (as in Arizona and most other states),” the CSI report states. “This is because the tax discourages taxpayers from saving or investing ordinary income in the taxing jurisdiction, and instead spending it today on consumption locally or moving their investment to lower taxed jurisdictions.”
Arizona is one of 42 states with an individual income tax. When first enacted in 1933, the state had 11 tax rates ranging from 1.0 percent to 4.5 percent. Over the years, the tax rates have changed, bringing Arizona to its current four rates which range from 2.59 to 4.5 percent, the 40th lowest in the country.
According to Glenn Farley, CSI-Arizona’s Director of Policy & Research, Arizona is the 11th state to adopt a simplified flat tax structure. And when the state’s 2.5 percent flat rate is transitioned in, it will give Arizonans “the lowest income tax rate in the country” among the states with such a tax.
Farley added that Arizona currently has a happy revenue problem, in that the State has experienced unprecedented annual growth in income and sales tax collections since Fiscal Year 2018.
“Arizona is collecting at least $2.4 billion more per year due to the 2019 Tax
Omnbius, passed by the Arizona state legislature, than it was under the pre-2018 tax base,” the CSI report states. “The problem is best addressed by revisiting the state’s tax structure adopted in 2019, and not by trying to use one-time spending to absorb the excess cash. The 2.50% flat tax plan helps further the intended goal begun back in 2019: a revenue-neutral modernization of the state tax code, and not a permanent tax increase.”
The transition to a flat tax comes as Arizona continues to enjoy unprecedented revenue windfalls. The report notes that by FY2025, current trends and forecasts show the State General Fund adding $5.8 billion in new revenue despite all taxpayers paying in at a lower rate.
Which makes it all the more important that Prop 208 with its surcharge to a 8.0 percent rate was invalidated on constitutional grounds, the report states.
“Economic theory suggests high income taxpayers will relocate income in response to tax and other fiscal policy, without necessarily relocating themselves,” according to the CSI report. “A 77% increase in the states marginal tax rate on its highest earners would have reduced both Arizona’s long-term growth prospects and short-term revenue collections.”
The Arizona Secretary of State’s Office announced last week that enough valid signatures were turned in to let voters decide next year whether they support substantially reduced income tax rates set to take effect in 2022 or want to maintain the current higher rates.
But whether voters can actually weigh in on such issues in the November 2022 General Election is something the Arizona Supreme Court will likely be asked to decide.
In June, Gov. Doug Ducey signed an overhaul of Arizona’s income tax system as part of the $12.8 billion budget packet approved by the Legislature. It changes the state’s current five-tier income tax rates -from 2.59 percent up to a 4.5 percent base- to a two-tier plan with lower rates in 2022.
The legislation which created the new tax structure could even trigger a single 2.5 percent tax rate as soon as 2023 if Arizona’s revenues meet certain levels.
The flat tax system also addresses the impacts of Prop 208, which voters narrowly passed last year. Known as the Invest in Education Act, Prop 208 imposed an additional 3.5 percent tax surcharge effective 2021 on any income above $250,000 for a single filers or $500,000 for joint filers. The surcharge is on top of the current 4.5 percent base rate.
The revenue from the surcharge is slated to be used for public K-12 schools, but it does so by kicking Arizona’s highest earners to an 8 percent income tax. This put businesses in the state at a competitive disadvantage with Texas and Nevada which have no income tax, while New Mexico has a top rate of 4.9 percent.
Because the 3.5 percent Prop 208 surcharge was put into law by voters, state lawmakers could not directly undo it. Instead, the new flat tax rate plan would top out at 4.5 percent by absorbing the 3.5 percent surcharge.
However, supporters of Invest in Ed, now known as Invest in Arizona, want to void the new tax rate law despite the fact all Arizonans would share in the projected $1 billion savings. The group is trying to kill the flat rate plan by utilizing a provision of the Arizona Constitution which gives citizens 90 days after the legislative sessions ends to attempt to refer new state laws for voter approval.
Last week Invest in Arizona successfully submitted enough valid petition signatures to get the matter on the ballot next November as Proposition 307. In response to the petition drive, Ducey’s spokesman has continued to champion the new income tax structure, which would ultimately be the lowest flat tax in the country if state revenue targets are met.
“It keeps Arizona competitive,” said C.J. Karamargin. “We are returning tax dollars to the citizens of Arizona.”
Whether new laws dealing with state revenues such as income taxes are eligible for voter referendum has never been ruled on by a state court.
A lawsuit by the Arizona Free Enterprise Club argues that the Arizona Constitution actually prohibits issues related to the support and maintenance of state government to be referred to the ballot. A decision by Judge Katherine Cooper of the Maricopa County Superior Court is expected any day.
Whichever side loses in Cooper’s court is expected to appeal, with the Arizona Supreme Court expected to hear the case eventually.
Another wrinkle in the tax saga is that the Arizona Supreme Court ruled earlier this year that Prop 208 can be challenged on the basis of the state’s constitutional spending limits for K-12 schools. The justices recently sent the matter back to the Maricopa County Superior Court for additional arguments although the case is expected to be back at the Arizona Supreme Court early next year.
Positive reactions continue to come in from business groups in response to the Arizona Legislature’s passage this week of a Fiscal Year 2022 budget package which includes more than $1.3 billion in tax cuts, $1 billion in payments toward state debt, and a transition of the state’s multi-tied income tax system to a flat rate.
The nonprofit, nonpartisan Arizona Tax Research Association called passage of the FY2022 budget “a watershed moment” for Arizona, while Scot Mussi, president of the Arizona Free Enterprise Club, commended the Legislature for passing what he called “historic” tax cuts.
“Every single taxpayer in Arizona will now get a tax cut,” Mussi said. “This is great news for the future of our great state!”
The National Federation of Independent Business, which advocates for small and independent businesses across the country, gave a shout out to the Legislature via Twitter for adopting “landmark property & income tax reforms” which support small businesses. “Your work will allow small businesses to grow our state economy and create more jobs #ForArizonans,” the message said.
On Friday, Gov. Doug Ducey issued a video statement celebrating passage of the 11 bills which make up what he calls the state’s “fiscally conservative, forward-looking budget” that starts July 1.
“Here in Arizona our economy is booming,” said Ducey, thanking House Speaker Rusty Bowers, Senate President Karen Fann, and all the legislators. “New people and businesses are moving here every day. And at the state level that’s resulted in record revenue. With this budget we’re investing those dollars in the things that matter: schools, universities, community colleges, and new roads and bridges, just to name a few.”
Ducey added that “most importantly we’re giving a bulk of the surplus dollars back to the people who earned them.”
A budget signing ceremony must wait until at least Monday when the Senate returns from recess to formally transmit the budget bills to the governor.
Meanwhile, supporters of the voter initiative known as Proposition 208 are promising a court fight over a bill Ducey is also expected to sign next week.
Prop 208 passed last November by a slim margin of 51.75 to 48.25 percent. The purpose of the initiative was to provide additional funding for public and charter school by way of a new 3.5 percent income tax surcharge for many Arizonans.
Among those subject to the new tax surcharge would be thousands of small business owners who currently report business profits on their state personal income tax return. SB1783, however, provides a small business alternate income tax as an option for those who operate as sole proprietors, LLCs, professional partnerships, and S Corporations.
Under the alternate tax, income derived from small business can be reported on a special small business income tax form. This will ensure the income is not added into personal income for purposes of calculating the amount of Prop 208 surcharge a taxpayer owes.
Critics contend SB1783 is a way to unlawfully circumvent the taxation provision of Prop 208. Proponents of the bill point to the many statements made prior to the 2020 General Election which assured business owners that “business income” would not be subject to the surcharge.