Lawmakers defy Ducey, push drop in tax rate in federal conformity
PHOENIX — Picking a fight with Gov. Doug Ducey, Republican lawmakers in the House and Senate voted Thursday, Jan. 31, to conform Arizona’s allowable income tax deductions to federal law and offsetting that with a drop in tax rates.
The legislation is designed to keep tax filing simple for Arizonans, making it easy for them to prepare their state tax returns once they have filled out their federal forms. In essence, it means that any deductions allowed by the Internal Revenue Code are permitted by the state.
That’s what Ducey told lawmakers he wants.
But what has proven unacceptable to members of his own Republican Party is that conforming to current federal law means fewer deductions on the state form. And that would boost state revenues by anywhere from $133 million to $200 million.
“This is simply a tax increase by any other name,” said Rep. Ben Toma, R-Peoria.
To make up for that, SB 1143 cuts tax rates across the board by 0.11 percentage points. So, for example, the top tax rate of 4.54 percent on income over $150,000 for individuals and $300,000 for couples would drop to 4.43 percent, with similar decreases for lower tax brackets.
In essence, it’s designed to be overall “revenue neutral,” meaning that the amount of money collected from Arizona taxpayers will be no more when they file their returns this year than it would have been without conformity.
But, by definition, a drop in tax rates means that those with higher incomes — those who pay the most now in income taxes — will see the biggest dollar difference.
Projections by the Arizona Center for Economic Progress put the actual reduction in state taxes at $1,174 for the top 1 percent of Arizona wage earners, meaning those with income averaging $1.45 million. By contrast, it says the lowest 20 percent, those earning less than $23,688, would see their income taxes go down by about $9.
But Rep. Regina Cobb, R-Kingman, sniffed at the idea that somehow the state was cutting taxes.
“This is not a tax cut,” she said. “This is an offset” to the additional dollars the state will be taking in from federal conformity.
All that, however, presumes that the governor signs the bill. In giving final approval to SB 1143, the Republicans made the conscious decision to pick a fight with Ducey, effectively daring him to veto the measure.
And Ducey on Thursday would not say what he will do.
Arizona has generally matched its allowable deductions to what is allowed under federal law.
There are a few exceptions. For example, Arizonans can deduct all their medical expenses; the federal law permits deductions only after they exceed a set percentage of an individual’s income.
The annual bill to conform usually goes through without controversy.
What changed this year is that the Tax Cuts and Jobs Act signed by President Trump in late 2017 sharply slashed many of the allowable deductions for things like home mortgages and taxes paid to other levels of government. But it made up for that by doubling the standard deduction available on the federal form.
If Arizona conforms, the most recent estimate by legislative budget staffers shows it would generate close to $153 million in state revenues because of the disallowed deductions, as Arizona is not increasing its own standard deduction.
SB 1143 is designed to reduce collections by about $155 million.
Rep. Randy Friese, D-Tucson, said that, at the very least, that means Arizona is going to be reducing revenues this year by $2 million.
But Rep. Pamela Powers Hannley, D-Tucson, said the real issue is that the state is turning away needed revenues.
She pointed out that Ducey said the money should be put into the state’s “rainy-day” fund. And Powers Hannley agreed with the governor that account is underfunded.
“We need to look at our financial future, not just where we are today but what could happen in the future,” she said.
As proof, Powers Hannley said the state still hasn’t fully restored the cuts that were made a decade ago to education and other services during the Great Recession.
“And so if we have another recession and give these taxes away today, we could face massive cuts in the future if there’s another economic downturn,” she said. “And many people are predicting that.”
Rep. Mitzi Epstein, D-Tempe, warned her colleagues that the estimates of what the state would gain from federal conformity are just that.
She said if there is a desire to offset the additional revenues the state should wait until they have better numbers.
The vote to offset the higher income tax collections with a cut in rate did not gain unanimous support of all Republicans. Sen. Kate Brophy McGee of Phoenix sided with the Democrats in refusing to go along.