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New guv’s first crisis: Dealing with school funding while trying to cut taxes

eThe tax-cutting stance embraced by several candidates for governor is heading straight into a collision course with the reality of a judge’s ruling on school funding.

Earlier this month, Maricopa County Superior Court Judge Katherine Cooper reset the inflationary funding for K-12 schools to what it would have been had the state kept up with the payments during the recession. As a result, the state may have to provide $1.6 billion in additional education funding within the next five years and pay back another $1.3 billion for the years lawmakers withheld full payments from the schools.

This looming fiscal crisis is threatening to stand in the way of the tax-cutting approach embraced by several candidates, some of whom are actively advocating the elimination of the state’s income taxes, which comprise roughly $4.4 billion of the state’s $9.5 billion budget. State treasurer Doug Ducey and Secretary of State Ken Bennett, in particular, favor doing away with the corporate and individual income tax rates, although both said they would be judicious in achieving this goal.

Other candidates have not been immune to proclaiming familiar promises and well-trodden policy positions like militarizing the border on the primary campaign trail, where they often appeal to their bases in a high-stakes gamble to secure votes. Christine Jones, for one, has talked about doing “more” to cut taxes on top of the hundreds of millions of dollars that already will be given away — mostly to companies — within the next three fiscal years alone.

Yet the recent court order potentially exposing the state to roughly $3 billion in obligations over the next five years is compelling candidates to confront what likely will become the first crisis the next governor will have to solve.

Former Arizona Sen. Rich Crandall, who briefly ran Wyoming’s schools, said this income tax cutting stance amid the state’s very real obligations is “ignoring the reality.”

“This is strictly campaign rhetoric,” Crandall said. “We’ve got some good people running for governor. They’re smart people, and they’re just saying things on the campaign trail that will get them elected, but they’re not realistic.”

Crandall said the experience of Kansas, which approved massive tax cuts two years ago, including a slew of individual income tax reductions, should be a cautionary tale for Arizona. Kansas’ revenues are now in a free fall, and the estimates say if the tax cuts aren’t reversed, the situation will only get worse.

For education advocates, the candidates’ tax-cutting stance is worrisome.

“No one has yet been able to explain to me how we would eliminate the income tax while still maintaining the obligations we have to our state budget priorities, including education,” said Pearl Chang Esau, president and CEO of Expect More Arizona.
Medicaid complicates matters

In fact, the $2.9 billion the state may be forced to find does not even count recurring obligations, such as the $931 million in deferred payments to schools that policymakers have chosen to disregard.

An equally big threat to the state’s budget is the pending court battle over Brewer’s decision to expand Medicaid. The expansion plan allows the state to draw down hundreds of millions of dollars in federal funding to pay for Arizona’s Medicaid program. If Brewer loses the legal fight, the state might have to find $3.6 billion between fiscal 2014 and fiscal 2015 to pay for the health insurance of a segment of Arizona’s population.

Professor Dennis Hoffman of Arizona State University’s W.P. Carey School of Business said any additional obligations the state must take on as a result of court rulings will only exacerbate problems in paying its bills.

Noting the state’s tepid revenue collections, he added, “So, a proposal to further recalibrate the state’s tax revenues or further change the tax base in a downward direction only makes the problem more challenging, clearly.”

Eliminating the income tax has been championed by the conservative think tank Goldwater Institute, which is advocating for a broad-based sales tax that captures more transactions.

In a policy paper, the think tank said a revenue-neutral restructuring of the tax base that eliminates the income tax could add 20,000 jobs in the first year.

“Arizona policymakers should set their sights on big ideas that move the state into a new era of economic growth,” the group said. “The faster policymakers can fundamentally reform the state’s tax system, the quicker we will reap the economic benefits.”

Sticking to tax cuts
Neither Bennett nor Ducey is backing out of their tax plans.

In fact, Bennett doubled down on his suggestion to replace the sales tax with a broad-based and lower-rate consumption tax and do away with income taxes.

He argued that the state would have had the money to pay back the schools over the last five years if it had been more proactive in restructuring its tax policy and transitioning into a consumption tax.

Bennett explained the nuances of his approach by noting the volatility of Arizona’s revenue base. In the good years, state revenues skyrocket, but during downturns, they fall much faster than the economy.

He argued that a broad-based consumption tax set at 3.5 percent would produce $9.8 billion out of Arizona’s $280 billion economy, and that will be sufficient to maintain current collection levels if income taxes are eliminated.

When pressed on how he would deal with the school payment issue, Bennett replied, “One bite at a time, one year at a time.” He said it took the state five years to get into the mess, and it shouldn’t expect to emerge out of it in a mere year.

Ducey, too, isn’t reconsidering his tax plan in the face of a potentially bank-breaking obligation. He reiterated his narrative that “reducing” the income tax would require up to two terms in office, a growing economy, and shrinking government.

“If the court determines $1.6 billion in back payments are required by the state, we will find a solution for the entire budget situation in a fiscally responsible way that doesn’t break the bank,” he said.

He noted that the court is yet to hash out the mechanics of paying back the schools.

A warning not to cut the income tax
The other candidates for governor all noted the gravity of the situation but provided few specifics to tackle the problem.

Jones said she hopes Brewer and the Legislature would hunker down to find a solution now, and looking ahead, she added the focus must be on growing the economy.

“A stronger economy generates more revenues without the need to raise taxes, which will help us solve problems of this nature,” she said, adding she will be “ready to take the appropriate measures in January when we must provide a 2015-16 balanced budget for the state, including these added costs.”

Fred Duval, the presumptive Democratic nominee, seized the moment to criticize his Republican foes.

“This is a warning to Doug Ducey and Ken Bennett that their plan to further cut income taxes on wealthy Arizonans is dead in the water. It’s time to restore funding to our kids’ schools,” he said. “As the economy grows, we’ll have the money to do just that, with help from the rainy day fund and finding efficiencies in other areas of state government.”

Former California congressman Frank Riggs said while he favors broad changes to the state’s tax policy, now is not the time to eliminate or shift to a flat income tax.

“I don’t want to raise taxes, but we have to look at a broader revenue base,” he said, adding it could be accomplished by “streamlining and reforming the tax code and getting rid of corporate tax breaks.”

Riggs also claimed that repealing Common Core could save the state $350 million, which could help pay back the schools.

Like Riggs, former Mesa mayor Scott Smith plans to tap into state trust lands and see how some funds can be further diverted to education.

Smith spokesman Drew Sexton also said dipping into the rainy day fund — as plaintiffs in the K-12 funding case have suggested — is a poor solution.

“That’s putting on a Band Aid when you need surgery,” Sexton said. “I don’t want to cut off any options here, but I don’t think that’s a long-term solution.”

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