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‘Primary culprit’ in Arizona’s $1.7 billion budget hole is sagging income tax

By: - January 25, 2024 1:16 pm

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Arizona lawmakers must address a $1.7 billion deficit in the coming months as they craft legislation to patch up the current year’s budget and develop a spending plan for the upcoming fiscal year, budget analysts said Thursday.

In their briefing to the Finance Advisory Committee, a panel of state and private economists that advises lawmakers on the economy and budget, Richard Stavneak, director of the nonpartisan Joint Legislative Budget Committee, explained that the “primary culprit” behind the shortfall is a precipitous drop in individual income tax collections — largely due to the full implementation of the state’s flat tax in 2023.

Last year, when lawmakers approved the current year’s budget, they expected the flat income tax would slash $2.3 billion from state revenues. But the drop-off has been much worse than anticipated, and individual income tax collections are already $481 million less than projected. Stavneak said there have been issues with the timing of the tax cut and estimates of its impact.

“It’s a little hard with a tax cut of that size,” he explained.

Through December, overall tax collections for the fiscal year were $480 million below expectations.

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Hans Olofsson, JLBC’s chief economist, noted that there is “a lot of uncertainty” for tax collection in the remainder of the current fiscal year, and that the revised estimate is that revenues will be $905 million less than what lawmakers expected just seven months ago.

Sales taxes also remain weak, primarily because of slow growth in retail sales, which make up more than half of all sales taxes. So far this fiscal year, sales taxes have grown by just 4.2%, the lowest rate since the 2017 fiscal year. 

Those sluggish figures are attributed to declines in motor vehicle sales, building material sales and other large-dollar merchandise, which collectively make up about 40% of all retail sales. And sales taxes from restaurants and bars are up by just 2.9%, the slowest growth since the 2011 fiscal year (excluding the pandemic).

Meanwhile, Gov. Katie Hobbs has a much rosier outlook on the state’s finances. The budget proposal she released earlier this month assumed both a smaller deficit — about half the size of JLBC’s estimate — and higher revenues. In the current and upcoming fiscal years, Hobbs’ budget predicts a combined $820 million more in tax collections.

JLBC Deputy Director Jack Brown noted that Hobbs’ revenue predictions for the current fiscal year are so optimistic that the state would have to post no more losses in the final six months of the year to meet them.

Hobbs proposed addressing the deficit largely through a combination of clawing back money that has been appropriated for one-time ventures — many of them road and highway projects — drastically reforming the state’s private school vouchers to remove about 50,000 students from the program and eliminating a private school scholarship tax credit. Those ideas have already been declared dead on arrival by Republican lawmakers.

The baseline budget from which legislators will start crafting a spending plan scraps $2.3 billion of the $2.9 billion in one-time spending in the current year’s budget. But with increased formula spending on education and health care, the baseline spending is only $1.5 billion less than the current year.

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Jim Small
Jim Small

Jim Small is a native Arizonan and has covered state government, policy and politics since 2004, with a focus on investigative and in-depth policy reporting, first as a reporter for the Arizona Capitol Times, then as editor of the paper and its prestigious sister publications. He has also served as the editor and executive director of the Arizona Center for Investigative Reporting.

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