Gov. Doug Ducey’s proposed 2.5% state flat tax would cut revenue by $1.9 billion a year while slashing annual payouts to cities and town. The mayor of Sahuarita said the town is in a good position to absorb it if it passes, but many areas could be hard hit.
Here’s a rundown of the plan, which will be the subject of a special session this week.
What’s Ducey’s flat tax plan and why all the uproar?
Ducey’s plan would do away with Arizona’s four income tax brackets, cutting taxes for nearly everybody as early as next year.
It would put in place a 2.5% flat tax on income. It also would set a 4.5% cap for higher-income taxpayers subject to Proposition 208, passed in November. (Proposition 208 created a 3.5% surcharge for individuals earning $250,000 or more per year and couples who earn at least $500,000. The money supports schools.)
Here’s why cities and towns are concerned. Under a formula set in 1972, all 91 of the state’s municipalities split 15% of the state’s income tax revenue, allotted based on population. The flat tax would cut taxes overall and greatly diminish that pot of money — so, less money going to towns and cities.
Sahuarita, for example, anticipates it would lose $1.5 million, or about 1.6% of its current proposed budget.
Why is Ducey pushing a flat tax?
The governor sees tax cuts as a way to keep Arizona competitive by drawing companies to the state and supporting businesses already here.
He also thinks it’s good for taxpayers. Ducey spokesman C.J. Karamargin said the proposal would reduce taxes an average $300 annually for the typical taxpayer.
“That means more money for gas, for groceries, other basic needs and entertainment,” Karamargin said.
But $1.9 billion is a lot of money to give up, isn’t it?
Karamargin said the governor’s plan is balanced and "fully paid for by the remote sellers tax, a new privilege fee on sports betting and an ongoing revenue surplus in the state's economy."
In 2019, Ducey signed off on a law requiring remote sellers and marketplace facilitators, like online sellers, to begin filing and paying sales taxes in Arizona. The legislation is made possible by the South Dakota v. Wayfair case in 2018, which allowed states to require out-of-state online businesses without a physical presence to collect and remit sales tax from transactions in their state.
One report said the new tax brought $57 million into Arizona in 2020 and will bring in $85 million this year.
What do legislators think?
Democrats are in the minority and don’t have much of a voice on this. But Ducey has met opposition from two GOP lawmakers who are holding out and blocking the budget.
Sen. Paul Boyer of Glendale and Rep. David Cook of Globe said the cuts are too deep and would hurt their communities. So there’s work underway on a compromise.
The House proposed several amendments, including raising the percentage of shared revenue from 15% to 17%.
The League of Arizona Cities and Towns, which advocates for municipalities, said that’s not enough. A study it commissioned from the Rounds Consulting Group said that to hold municipalities harmless, that percentage needs to be 18.9%.
In its newsletter Friday, the League stated, “the 17% distribution share would still leave local governments with a 21% cut to income tax revenues that they currently rely on to fund essential services.”
Karamargin said there will be a special session early this week, though Ducey is focusing time and attention on the fires in eastern Arizona. He said they fully expect to have the budget approved by the end of the fiscal year.
Why isn’t Sahuarita worried?
Sahuarita Mayor Tom Murphy said he is concerned about the possibility of a big loss in state-shared revenue, but thinks the town is in a better position to handle it than rural communities.
“I have concerns but I can easily see where other municipalities would be more concerned," he said Friday. "To be frank, with our growth and the position we’re in now, coupled with our reserves and our council and staff, I believe we could maintain our level of service.”
Other municipalities see the potential for impacts on the services they can provide to residents, especially when it comes to public safety.
Murphy said he understands concerns from rural communities with "recent memories of the 2008-09 recession,” and after the hard hit by COVID, especially in tourist areas.
“We haven't been as negatively affected but I can see where it would raise some concerns for them," he said. "How long will we be held harmless?”
Murphy said he thinks even if the flat tax passes and they see a loss, the town could still figure it out.
“It would be more difficult. We might have to delay some things, make some choices, adding a new park for instance, keeping our staff growth — personnel is the biggest part of the budget,” he said. “It could have an impact on us but we’re in a better position. I'm grateful for all that we've seen through the pandemic with people shopping more locally because that goes directly to our coffers and directly to services.”
Murphy sees the benefits to Ducey’s proposal, but it’s a balancing act.
“I’m a proponent of providing the highest quality of life at the lowest tax burden to residents but when you look at states that have no state income tax, it’s coming from somewhere,” he said. “It's definitely being made up where the sweet spot is and where it comes from, where it’s being taken away from. I believe in entrusting money into families to make the best choice where funds should be sent but there is a foundational role of government to provide a high quality of life to residents and needed services like police, roads and infrastructure.”
Murphy is confident that as business returns to a post-pandemic normal, the economy will improve and the town’s reserve funds and policies will allow them to weather the loss of state shared revenue without it being a huge hit.
“We’re definitely watching and monitoring it, but I'm grateful to residents because our business community put us in a better place than normal, knowing the importance of shopping local,” he said. “We have come out of this stronger and in a better place than most would have predicted a year ago.”