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Research & Commentary: Many Paths for Tax Conformity are Available for Arizona

February 7, 2019

In this Research & Commentary, Matthew Glans discusses the debate over tax conformity in Arizona and how the state can and should proceed with conforming state tax laws to the new federal tax changes.

Like many states, Arizona is now considering state income tax reforms in the wake of the 2017 Tax Cuts and Jobs Act. Without changes to Arizona’s tax code, the federal changes could create an inadvertent increase in taxes for Arizonans. This issue emerged due to Arizona’s policy of conformity with federal tax guidelines. Arizona is one of nineteen states that conforms its state taxes to the Internal Revenue Code (IRC) on a “static” basis.  This means Arizona must rewrite its tax code each year to make sure state laws align with changes in the federal law.

The end result of not conforming to federal tax law is an increase in the state tax revenue collected in Arizona. According to a report from the Department of Revenue, Arizona could collect roughly $236 million in additional revenue during fiscal 2019, the first full year impacted by the change in federal law. Revenue could increase even further to $286 million in fiscal 2020. This means that Arizona taxpayers will see a tax increase without conformity.

Unfortunately, agreeing on how to implement tax conformity has proven difficult in Arizona. The key disagreement between the legislature and the governor’s office has revolved around how to use the increased revenue created through tax conformity. The legislature wants to use the new revenue to decrease taxes, a sound tax reform goal. The governor wants to wait and see the effects of the new federal tax laws on state returns before changing state tax rates. In 2018, Gov. Doug Ducey (R) vetoed a bill that would have reduced rates in a way that would have been nearly revenue neutral, meaning there was little to no change in the amount of revenue coming into the government’s coffers.

If the governor wants to wait and see what effects the federal tax changes will have on state revenue, there are alternatives that allow for tax cuts while ensuring budget discipline that have been recommended by the Tax Foundation. First, states could phase in reforms over time or use tax trigger language to ensure adequate revenue exist to cover important budget items. Arizona has already successfully used a phase in model for corporate taxes; the state could use the new revenue to phase in tax cuts. If the state does not want to move to rolling conformity, Arizona could also use contingent enactment clauses to allow for future reforms. These clauses allow for reform changes to occur predicated on a specific event occurring, such as federal tax reform. This would allow the state to keep static conformity while being prepared for future federal tax changes.

Another option that has been introduced would enact much of the conformity measures needed to match up with federal laws while leaving the changes generating the financial windfall for later. This bill, SB 1166, would give the state the time to observe any effects of the federal law and act accordingly.

Recently, Arizona has improved its tax laws, making the Grand Canyon State more inviting to businesses and development. Last year, Arizona implemented a new multiyear corporate income tax reduction, which vastly improved the state’s corporate income tax ranking from 19th to 13th, as calculated by the Tax Foundation.  In May, Arizona policymakers passed a law that increases the personal tax exemption and indexes it to inflation.

Several states have passed conformity laws as a springboard for tax reform through tax relief and rate reductions. For example, Missouri reduced its top individual income tax rate from 5.9 to 5.4 percent in 2019 and included triggers to reduce the rate to 5.1 percent based on revenue availability. Utah made similar changes, cutting individual and corporate income tax rates from 5 percent to 4.95 percent while increasing tax credits.

Providing a tax environment that encourages relocation, investment, and economic growth is essential for keeping Arizona competitive with its neighboring states. Arizona is ranked 27th in the Tax Foundation’s 2019 State Business Tax Climate Index, a study that compares states across multiple areas of taxation that impact businesses. The 2019 ranking moved Arizona down six places from 2018. Arizona’s ranking is lower than many of its neighboring states, including Wyoming (1st), Utah (8th), Nevada (9th), Texas (15th), and Colorado (18th).

The following documents examine tax conformity in greater detail.
 

Ten Principles of State Fiscal Policy
https://www.heartland.org/publications-resources/publications/ten-principles-of-state-fiscal-policy?source=policybot
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”

Federal Tax Reform: The Impact on States
https://taxfoundation.org/federal-tax-reform-the-impact-on-states/
Nicole Kaeding and Kyle Pomerleau of the Tax Foundation examine the effect of the federal tax reform on the states and how they can use the changes to push for tax reforms of their own.

Federal Tax Reform May Cost Arizona Taxpayers $200M More
https://www.azcentral.com/story/money/business/consumers/2018/01/16/federal-tax-reform-could-mean-arizonans-pay-200-m-more-state-taxes/1029560001/
Russ Wiles of the Arizona Republic discusses the possible effects of the federal tax reforms and how it could result in a tax hike for Arizona taxpayers without tax conformity.

Tax Reform Moves to the States: State Revenue Implications and Reform Opportunities Following Federal Tax Reform
https://taxfoundation.org/state-conformity-federal-tax-reform/#9
This paper by Jared Walczak of the Tax discusses what options are available to states as they respond to federal tax changes. “In the wake of federal tax reform, states have a golden opportunity to move their own tax codes in a more simple, neutral, and pro-growth direction,” writes Walczak.

Rich States, Poor States
https://www.richstatespoorstates.org/
The eleventh edition of this publication from the American Legislative Exchange Council and authors Laffer, Moore, and Williams offers both individual-state and comparative accounts of the negative effects of income taxes.

State Tax Conformity: Revenue Effects
https://taxfoundation.org/state-tax-conformity-revenue-effects/
On this webpage, the Tax Foundation has catalogued each state’s projected revenue impact of federal tax reform.

The Historical Lessons of Lower Tax Rates
http://www.heritage.org/research/reports/2003/08/the-historical-lessons-of-lower-tax-rates  
Examining the historical results of income tax cuts, Daniel Mitchell of the Heritage Foundation finds a distinct pattern throughout American history: When tax rates are reduced, the economy's growth rate improves and living standards increase.

The U.S. Tax System: Who Really Pays?
https://www.manhattan-institute.org/html/us-tax-system-who-really-pays-5748.html
Writing for the Manhattan Institute, Stephen Moore examines popular conceptions and misconceptions about the impact of tax rates on economic productivity and fairness, addressing these statements and debunking attendant myths. He provides useful information on how the rich are taxed and how much they contribute.

The Historical Lessons of Lower Tax Rates
http://www.heritage.org/research/reports/2003/08/the-historical-lessons-of-lower-tax-rates  
Examining the historical results of income tax cuts, Daniel Mitchell of the Heritage Foundation finds a distinct pattern throughout American history: When tax rates are reduced, the economy's growth rate improves and living standards increase.

Policy Tip Sheet: Corporate Income Taxes
http://heartland.org/policy-documents/policy-tip-sheet-corporate-income-taxes
Taylor Smith examines corporate income taxes and their effects on economic development. Smith suggests how legislators can limit or eliminate their corporate taxes.

Balancing State Budgets the Smart Way
http://taxfoundation.org/article/balancing-state-budgets-smart-way
Joseph Henchman of the Tax Foundation examines an array of options states can use to remedy both short-term and long-term fiscal woes and put their budgets back on sounder legal footing.
 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News website, The Heartland Institute’s website, and PolicyBot, Heartland’s free online research database.

The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state, or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact Lindsey Stroud, Heartland’s government relations manager, at lstroud@heartland.org or 757/354-8170.

Author
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance. In 2012, Glans was named senior policy analyst.
mglans@heartland.org @HeartlandGR