Republican lawmakers and the governor are moving ahead with a tax-reduction plan they say would enable Arizona to attract more businesses and jobs to the state, even though the likely result would be a heavier tax burden for homeowners.
Some economists and tax foes view the state’s property tax system as a balloon — push in one side and the other side bulges. So if lawmakers lower tax rates for businesses, which is a cornerstone of Republicans’ economic development plan, homeowners will be forced to make up the difference by paying higher taxes.
“The way the law is written now, it’s a zero-sum game,” said Lynn Weaver, the head of a group that has been trying to pass California-style limits on property tax increases. “If you reduce commercial property taxes, then automatically — and the key word is automatically — the residential property taxes go up.”
Still, the goal of tax reformers is to reduce business taxes to a level they believe would correct Arizona’s unappealing image to companies.
The various proposals that have so far emerged contemplate a slew of tax cuts for businesses. But because of the way taxing jurisdictions collect revenues, any reduction in commercial property taxes, a key provision of a Senate plan, would either result in higher taxes for homeowners or further cuts to local government budgets.
And local governments, which are already groaning from budget cuts because of the economic downturn, are unlikely to make further reductions in services. Instead, they’ll make up for the loss by increasing residential property taxes.
Supporters of the business property tax reductions argue that the state for years has disproportionately shifted the property tax burden to businesses, and lowering the business tax rate is necessary to create an economic environment that will allow Arizona to compete more fiercely to attract new businesses.
Dennis Hoffman, a professor at Arizona State University’s W.P. Carey School of Business, said Arizona’s tax policies have been kind to homeowners but tough on businesses.
“It is certainly fair to acknowledge that we have historically crafted a property tax structure that places an undue burden on our business sector when compared with our residential property owners,” Hoffman said.
Consider this: Commercial properties are assessed at twice the rate of residential homes, 21 percent to 10 percent, respectively.
In 2008, for example, 44 percent of property tax collections came from business and agriculture even though they only make up a quarter of the tax base.
Byron Schlomach, an economist with the conservative Goldwater Institute, said this imbalance “tells business they’re really not wanted in Arizona.”
Politicians recognized this imbalance and worked to phase down the commercial assessment ratio to 20 percent next year from a high of 25 percent five years ago.
Now Republicans want to slash it further. Senate Majority Whip Steve Pierce, a Prescott Republican, is eyeing a business property tax rate of 18 percent.
Pierce clarified that the tax cuts under his plan wouldn’t take effect right away. Last year, House Republicans contemplated lowering it to 16 percent eventually, although the plan would have applied only to voter-approved bonds and overrides beginning in 2012.
The approach is popular among economists, who have long argued that Arizona cannot continue to rely on a development strategy based on plenty of sunshine, good transportation and an affordable workforce. The strategy worked in the past but is now leaving the state behind the curve.
Last year, economist Elliott Pollack produced a report that argued for a competitive business tax structure as well as incentives to retain or attract companies.
One recommendation of the Pollack report is to create a new business classification with a 10 percent property tax assessment ratio — the same rate for homeowners. The report suggested limiting the new classification to “base” industries, which mean manufacturing companies and export-related business.
Actually, Gov. Jan Brewer and most lawmakers, including Democrats, agree that Arizona’s business property tax is far from ideal. California, Colorado, New Mexico and Nevada have far lower rates than Arizona. A report by ASU’s W.P. Carey School of Business last year noted that Arizona has one of the highest industrial property tax burdens in the nation.
But many also agree that without countering its impact, a reduction in business property taxes would result in an increase in residential taxes.
“Any time you decide to take money off of one category of taxpayers, you either have to lower the budget amount that you’re spending or shift that difference onto another category of taxpayers,” said Ken Strobeck, executive director of the League of Arizona Cities and Towns.
Of course, the impact of any tax policy would depend on several factors, including the actual tax rate change and local governments’ response, according to Strobeck.
George Cunningham, the budget director under former Gov. Janet Napolitano’s administration, said homeowners would feel its impact differently depending on where they live.
“Any jurisdiction that had a very high dependence on commercial and industrial property, with the reduction in the assessment ratio, they would have a much higher increase in the residential property tax than a district that didn’t have that kind of a mix,” he said.
But Pierce said if homeowners’ property taxes spiked, that’s because local taxing jurisdictions chose to do so, essentially putting blame on cities that would take action to stabilize their revenue streams after the state takes a bite out of the money they use to pay for police and other municipal services.
“If the property taxes on homes go up as a result of these ideas, it’s because local governments and those taxing jurisdictions have chosen to keep spending at levels that are unsustainable,” he said.
House Speaker Kirk Adams also said many factors contribute to what the actual tax bills become, such as the rise or fall in home values.
That’s why when people talk of shifting the burden to homeowners — the balloon analogy — Adams said his initial response is: “Show me the numbers and how that actually works and what that actually means.”
Here is the challenge that politicians face: Any tax decision is a political decision and politicians have a tendency to skewer a plan that makes economic sense if it resulted in higher tax bills for homeowners. Politicians would rather avoid difficult decisions than face voters’ wrath.
The low-point of a recession might not be the ideal time to increase homeowners’ tax bills. Previous tax cuts took place in good times, when the state had plenty of revenue and could absorb the lost revenue. In fact, the current reduction in the business assessment ratio was coupled with an increase in the homeowner’s tax rebate.
But many homeowners today are struggling to keep up with their mortgages. In the meantime, Arizona’s jobless rate remains high.
“I don’t see how that’s a good thing to do when you have the highest level of foreclosures you’ve ever seen in the state and people are walking away from their houses on a daily basis,” said incoming House Minority Leader Rep. Chad Campbell, who is arguing for an overhaul of the tax code, starting with eliminating certain sales tax exemptions.
On the most optimistic end, the plan to reduce business taxes is a win-win. A vibrant economy that attracts companies and drives population growth would minimize or totally offset any increase on residential property taxes.
But that’s also betting against the future. If companies don’t come, homeowners could be left holding the bag.
Three plans, several conflicts
Draft of Senate Republican tax plan:
• Bring down business assessment ratio to 18 percent from 21 percent.
• Reduce the agricultural property assessment ratio to 15 percent from 16 percent.
• Increase the exemption for business personal property taxes to $78,500 from $66,440.
• Phase out the state capital gains tax.
• Reduce corporate income tax rate to 5 percent from 6.968 percent.
• Adopt a 100 percent sales tax factor, which increases the sales tax exemption on goods manufactured in Arizona but sold elsewhere to 100 percent from the present 80 percent.
• Limit increases in assessment of property values at 5 percent annually, both for secondary and primary taxes.
Draft of Brewer’s plan:
• Reduce corporate income tax rate to about 5 percent from nearly 7 percent.
• Adopt a 100 percent sales factor, which increases the sales tax exemption on goods manufactured in Arizona but sold elsewhere to 100 percent from the present 80 percent.
• Reduce or eliminate capital gains taxes on small business investments.
• Reduce business property tax by expanding enterprise zones, impacting real and personal property.
• New tax credits for research and development, and “angel investors” who provide capital for small businesses.
Draft of House plan (2010’s H2250):
• State Equalization Property Tax — Phased out over 4 years (Tax Year ’14).
• Property Tax: Assessment Ratio Reduction — Reduce to 16 percent from 20 percent on secondary (TY ’12).
• Property Tax — Accelerated depreciation of personal property (TY ’11).
• Individual Income Tax — Small business capital gains subtraction (TY ’11).
• Corporate Income Tax — Reduce rate to 5 percent from 7 percent over 5 years (TY ’11).
• Corporate Sales Factor — Increase to 100 percent from 80 percent over 2 years, which increases the sales tax exemption on goods manufactured in Arizona but sold elsewhere to 100 percent from 80 percent. (TY ’15).
• Divert 100 percent of state withholding tax on wages of certain new jobs.
• Reduce assessment ratio for a qualifying business up to 10 Years (Enterprise Development Program).
• Create tax credits for new qualifying jobs (Enterprise Development Program).
Broad agreements among three plans:
• Phase out capital gains tax on small business investments.
• Reduce corporate income tax to 5 percent.
• 100 percent corporate sales factor, which increases the sales tax exemption on goods manufactured in Arizona but sold elsewhere to 100 percent from the present 80 percent.
• Enterprise zones — Governor and House only.
Potential clash points:
• Business assessment ratio. Governor is reluctant to push for an across-the-board tax cut and instead wants to expand enterprise zones, which would have limited impact on shift in tax burden to homeowners.
• Enterprise zones. Governor and the House agree on concept, but Senate resists it. Senate wants a broad-based, across-the-board cut in business property tax.