Arizona Policy Choices

Balancing Acts: Tax Cuts and Public Policy in Arizona

A Study of the Arizona State Tax Reduction Program

Frank J. Sackton, Professor Emeritus
School of Public Affairs, Arizona State University

Taxes always generate controversy. Some people argue that tax cutting is good for the individual and stimulates the economy. Others contend that tax cutting in Arizona has gone too far resulting in the reduction of essential services to unacceptable levels.

Tax cuts are popular among people because they provide additional spending opportunities and a feeling of increased well-being. Some economists argue that tax cuts, particularly reductions in marginal personal income tax rates, can meaningfully improve economic performance. Further, they argue that states can improve the economic performance of their local economies by pursuing tax-cut policies.

The prevailing contrary view is that essential services should be funded by a government before undertaking tax reductions. Also, a determination should be made of the relative tax burden of that government entity before the tax reduction takes place.

This study explores the tax reduction program in Arizona from FY 1993 through FY 1998. The study covers the extent of tax reduction and how tax cuts were funded.

Extent of Tax Reduction

From FY 1993 and projected through 1998, tax cuts amount to $2.56 billion (see Table 1). These cuts reflect the efforts of the administration of Governor Fife Symington to reduce the burden of taxes on Arizona citizens. The reductions amount to permanent tax cuts. Thus, the tax reductions continue to occur in each year subsequent to enactment. Note the buildup of tax reductions in the years 1996, 1997, and 1998. Perhaps a term more descriptive than tax cut for what is happening is "reduction of the revenue stream." Beginning in 1998, a total of $2.56 billion will be eliminated each year from what would have been the normal revenue stream. Senator George Cunningham (D-Tucson) argues that this huge loss of revenue has compromised the effectiveness of state government, and that we have ignored critical needs, principally education.

Table 1
Tax Cuts ($ in Millions)

Category of Tax

FY93

FY94

FY95

FY96

Proj.
FY97

Proj. FY98

Total

Percent of All Tax Reductions

Sales

$0.6

$7.8

$59.0

$85.7

$146.2

$213.8

$513.1

20.0%

Income
Individual
Corporation
Tax Added
Tax Cut

8.1

30.0

159.2

(3.1)1

382.8

28.4

414.4

41.5

 553.1*

45.2


1547.6

(3.1)
115.1

60.4

4.5

Property

0.2

1.8

6.7

143.5

151.3

303.5

11.8

Luxury

6.3

8.1

8.8

23.2

0.9

Insurance
Tax Added
Tax Cut

(0.8)

(0.9)

(0.9)

2.7

2.8

(2.6)
5.5

0.2

Other (not identified) Tax Added Tax Cut

0.4

0.6

 (0.6)

4.8

19.3

35.8

(0.6)

60.9

2.4

Total Tax Reduction

$9.1

$37.8

$215.4

$513.8

$775.7

$1,010.8

$2,562.6

100.0%**


* Includes $110.0 million which is shown in JLBC report as "reserved for tax cuts."

** Does not add due to rounding.

1 Tax increases in parenthesis offset tax cuts/ Figures should be subtracted from sum of tax cuts to obtain the total for each fiscal year.

Source: Joint Legislative Budget Committee Staff

Senator Scott Bundgard (R-Glendale), current chair of the Senate Finance Committee, counterargues that much of the tax cuts went back into the economy, contributing to the economic growth of the state. This "supply-side economics" argument was offered also by Representative Mike Gardner (R-Tempe). Senator Cunningham rejects that argument, pointing out that supply-side economics (the Laffer Curve) is not a proven economic concept and did not work when tried at the federal level.2

Representative Sue Gerard (R-Phoenix) arguing against permanent cuts, expressed the concern that the state will have difficulty coping with a downturn in the economy. She believes that instead of permanent tax cuts, the administration should have considered yearly tax rebates in order to keep the base revenue stream intact.3

Along the same lines, a March 18, 1997 memorandum to Senator Edward Cirillo (R-Sun City) by Ted Ferris, then director of the JLBC staff, stated that there is a "large and growing shortfall for both Fiscal Year 1999 and Fiscal Year 2000." He identified the combined projected deficit for both years at $600 million.4 (See * page 96.)


How Tax Reductions Were Funded

Use of the K-12 Rollover

When the Symington administration took office in FY 1991, it inherited an indebtedness of $143 million which had been used to balance the budget by delaying state-aid payments to school districts, and making the payments in the following fiscal year. Instead of paying the debt as a first priority, the governor and the legislature elected to retain the debt while establishing the priority to cut taxes. The rollover was maintained at $143 million in 1992, 1993, and 1994. The rollover was reduced to $54 million in 1995, and finally eliminated. During this period, the administration used the rollover to balance the budget and provide tax cuts. Thus, the administration had no difficulty in balancing the budget in 1992, 1993, and 1994, while funding the $9.1 million tax cuts in 1993 and $37.8 million in 1994. The K-12 rollover was "borrowed" money on which the state paid $3.5 million in interest.

Savings from Project SLIM

Project SLIM (State Long-Term Improved Management) was initiated in 1992 by the Symington administration. It was aimed largely at the lower-priority agencies which meant all agencies other than Education-K-12, Higher Education, AHCCCS, Economic Security, Corrections, Courts, and Health Services. The intent of Project SLIM was to improve management and reduce the cost of state government. Initially, the program was successful in cutting costs thus providing some offset to reduced revenue. After the apparent success in slimming down these agencies in the early years of the program, Project SLIM went into reverse (see "All others," Table 2). After 1995, Project SLIM was not instrumental in providing any savings to assist in the tax-reduction program. In fact, it had become a drain on the General Fund. At the start of the program in 1992, the expenditures were $289.0 million. They jumped to $438.8 million in 1997, and are projected to $771.6 million in 1998.


Added Revenue in a Growth Economy

In the last several years, the growth in the state economy provided additional revenue (see Table 3). The increase in revenue in 1994 was 8 percent over 1993; it was 14 percent in 1995 over the previous year; then, 11 percent in 1996, and projected as 9 percent in 1997 and 5 percent in 1998. Clearly, the added revenue helped, but by itself, was not sufficient to accommodate funding the high-priority agencies, increasing the funding of the "all other" agencies, and for the tax reductions.

FY 1993
Actual

FY 1994
Actual

FY 1995
Actual 

FY 1996
Actual

FY 1997
Projected

FY 1998
Projected

Balance Forward

$5.2

$86.0

$229.2

$269.5

$399.9

$347.9

Revenues - Before Tax Reductions  
Sales

1,632.0

1,800.0

2,027.6

2,189.0

2,365.2

2,498.8

Income

         
Individual

1,375.2

1,490.0

1,663.1

1,893.9

2,032.0

2,186.8

Corporation

239.2

302.5

413.6

476.4

561.5

542.9

Urban Revenue Sharing*

(183.7)

(185.4)

(205.6)

(218.5)

(257.8)

(291.2)

Federal Retiree Program*

--

(55.2)

(25.0)

(17.5)

(56.2)

(6.2)

Property

203.2

186.4

180.5

195.0

190.8

193.0

Luxury

73.1

73.3

74.0

79.5

76.5

72.6

Insurance Premium

103.0

109.9

110.8

113.2

127.9

138.9

Motor Vehicle License

103.1

115.9

132.1

149.4

165.5

170.7

Other Revenue

248.8

272.9

307.9

314.2

421.5

382.5

BSF Transferred to GF Due to 5% Cap

0.0

0.0

1.8

2.2

3.7

6.4

Total Base Revenue

$3,793.9

$4,111.1

$4,680.8

$5,176.8

$5,631.6

$5,895.2

* These denote reductions in revenue.

Source: Joint Legislative Budget Committee Staff

Reduction in the General Fund Appropriations for Education

Historically, education (K-12 and Higher Education) has received over 55 percent of the General Fund. The problems of underfunding the growing K-12 system have received widespread publicity; i.e., withholding the inflation increment from the K-12 budget over several years, the continuing challenge to the Arizona Supreme Court decision of July 1994 requiring equity in funding for schools statewide, and the attempt by the administration to solve the problem with a piecemeal approach (the ABC plan Assistance to Building Classrooms) in 1997. However, none of these measures approach the $835 million required for emergency repairs alone, as determined by a legislative-sponsored study.5

The U.S. Department of Education reported that for fiscal year 1992, the average expenditure per pupil in public elementary and secondary schools was $5,594 nationally and $4,510 for Arizona. Arizona was 40th in amount of funding. Only 10 states had a lower expenditure figure.6 The pupil-to-teacher ratio in fall 1993 was 17.1 nationally and 18.9 in Arizona, the sixth highest pupil-to-teacher ratio among the states.7 The average annual salary of teachers in public elementary and secondary schools in FY 1994 across the country was $36,846 and $32,711 in Arizona.

In the period FY 80 to FY 95, after adjusting for inflation, Arizona teachers received pay increases amounting to 10 percent compared with the U.S. average of 19.4 percent. Only 12 of the 50 states received a lower rate of increase than Arizona.8

As Table 4 indicates, higher education received a smaller share of General Fund revenues from FY 1991 through projections for FY 1998. Its share of the revenue dropped from 18.7 percent in 1991 to 15.0 percent projected for 1998. Thus, it has not kept pace with other agencies in General Fund increases.

Table 4
Higher Education General Fund Allocation

Year

Funding ($ in Millions)

Percentage of Total General Fund Allocated to Higher Education

Percentage Change in Expenditures for Each Year from Previous Year

1991

$603.3

18.7%

--

1992

607.4

17.3

1%

1993

619.3

16.9

2

1994

627.1

16.7

1

1995

679.1

15.9

8

1996

662.7

15.7

-2

Projected 1997

745.8

15.4

13

Projected 1998

781.5

15.0

5

Source: Joint Legislative Budget Committee and State of Arizona Annual Budget

Conclusions

In the early to mid 1990s, before most of the state tax cuts became effective, Arizona's tax burden already was a little below the national average. For the fiscal years 1993 to 1996 and for the projected (appropriated) years 1997 and 1998, state government has engaged in a tax reduction program that totals $2.56 billion. The tax cuts are permanent and will reduce the base revenue stream annually by $2.56 billion in 1998 and beyond. An alternative view on tax cuts is to give tax rebates in revenue surplus years, thus preserving the base revenue stream.

The major forces that contributed to the tax reductions were the:

  • K-12 rollover, for 1993 and 1994 only
  • economies generated by Project SLIM for 1993, 1994, and 1996 only (The project since has become a drain on state funding, thus negating any contribution it made previously.)
  • added revenue in a growth economy
  • reduction of the General Fund appropriations for education

A view held by proponents of tax reduction is that the tax cuts will maintain and improve the growth of the state's economy, thus generating more revenue for the treasury. The opposing view is that this is not a proven economic concept, and that the state will have funding problems in the next downturn of the state's economy notwithstanding the tax cuts. Economic activity cycles are part of our free-market system. There will continue to be peaks and valleys in the cycle of economic activity. Although Arizona is currently enjoying a period of prosperity, it should prepare now for the next economic recession.

Notes

  1. Quoted in "GOP Counts $2.5 Billion in Tax Cuts," The Arizona Republic, March 27, 1997, p. A-1.
  2. Ibid.
  3. Ibid.
  4. Ibid.
  5. Liz Montalbano, "Lives Hang in Balance Due to Poor Education Laws," State Press, February 21, 1996, p. 5.
  6. National Center for Education Statistics, Statistics of State School Systems, May 1995, U.S. Department of Education Digest of Education Statistics 1995, Table 164, p. 165.
  7. Digest of Education Statistics 1995, Table 65, p. 76.
  8. Digest of Education Statistics 1995, Table 77, p. 85.

* Revenue projections were revised upward significantly in June and September 1997, thus eliminating the deficits previously projected for FY 1999 and FY 2000. However, at the November 1997 meeting of the Arizona Tax Research Association, the JLBC's new director, Richard Stavneak, projected an out year deficit in 2001 of approximately $300 million under a scenario of moderate economic growth and a further $200 million tax cut in the next legislative session.



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