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

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.

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.