Governor Napolitano’s Citizens Finance Review Commission gave preliminary approval Sept. 9 to a series of income-tax proposals that would have a mixed impact on state revenues.

It was the first time the commission indicated approval of any of the proposals its research groups have presented. Commissioners will be meeting over the next few weeks to review proposals on sales tax, property tax and other revenue sources.

The net effect on state revenue of the income-tax proposals that got the commission’s tentative nod was not immediately known. In any case all proposals on all tax types can be revisited at any time up to the report deadline under an informal agreement by which the commission will not make any final decision until all its recommendations have been reviewed.

“The commissioners are wary of making final recommendations serially because all these subjects are inter-related,” commission director Leezie Kim said. “What for example would happen if an early approval of an income tax proposal conflicted with later approval of a property tax change?” She said the commission is taking an approach by which proposals are determined to be “on the table, off the table or in the middle.”

Non-Resident Withholding

Members had no objection to recommending that the state impose withholding taxes on the Arizona income of non-residents as long as the rate was in line with what other competing states are doing. In most other states that collect such taxes on non-residents, three specific types of transactions are targeted: non-wage income, income distributed by pass-through entities, and real estate sales. Estimates of the additional revenue that could be generated by this expansion of income tax range as high as $113 million.

Corporate Minimum Tax

Members agreed that the state could derive additional revenue from a minimum charge on corporations and partnerships, but there was no agreement on whether to levy it as a fee or a tax. Competitor states currently collect $10 to $800 per year on each entity. Commissioners said their concerns were both administrative and policy-driven.

A minimum income tax would be collected by the Department of Revenue, while an annual fee would be collected by a different agency.

Member David Smith, the Maricopa County manager, said that if the charge is called a fee then the entities should be entitled to some state service in return, either regulatory or oversight. Otherwise, he said, it should be called a tax.

Member Tom Franz, general manager of Intel’s Advanced Development Group, said that regardless of whether the levy is called a tax or fee, it should be administratively simple for the taxpayer to calculate and pay. Co-chairman Bill Post, the chief executive officer of Pinnacle West, directed the authors of the proposal to revisit the issue and make more specific recommendations.

Interstate Companies

A proposal that would alter how Arizona treats corporate income earned out of state received mixed reaction. Currently, Arizona calculates interstate-company income by a formula that includes elements of property value, payroll and value of sales.

The proposal before the commission would replace the formula with a single-factor calculation: a company’s Arizona sales as a proportion of its total sales. In almost all cases, commissioners were told, the result would be a reduction in companies’ tax liability. The authors of the proposal, however, say it would stimulate economic development by attracting other such companies and their taxable income to the state, with the result that overall state revenue would increase. Members said they wanted more information on the revenue impact and quantification of the predicted economic growth.

Estate Tax

The Arizona tax code defines “gross estate” for purposes of Arizona taxation, as “gross estate” as defined in the federal internal revenue code. Therefore the continuing expansion of federal estate-tax exemption creates an exemption in Arizona and reduces Arizona state government’s revenue from this tax source.

There was no support on the commission for de-coupling Arizona’s estate tax law from federal law. The commissioners indicated they feel that any state revenue that might be preserved by de-coupling would be realized at the expense of greater Arizona tax code complexity, which is something the commission hopes to avoid.

Tax Credit Reduction

The commission’s goal of tax-code simplification also was the principal reason behind a proposal to reduce the number of tax credits available to individual and corporate taxpayers.

There was considerable discussion about the income-tax credit given for donations to public schools and charter schools. Some members wanted to change it from a direct credit against tax to a deduction against taxable income, which would be a smaller deduction and therefore more money for the state. Members did agree that any change in the list of tax credits should be phased in over time to reduce the impact in any one fiscal year. Certain credits, for example property tax credits that were the basis for a development, might have to be grandfathered in to cover the lifetime of the claim. And still other credits cannot be touched at all, the commission agreed, either for legal reasons (for example the Clean Elections donation credit, which cannot be changed except by popular vote) or for political reasons (for example a credit given for development of housing for the disabled poor). The Department of Revenue was asked to provide more information before the commission takes any action.

The commission is charged with presenting a list of recommendations to the governor to simplify and modernize the state’s tax structure. Proposals on the transaction privilege tax also were presented at the Sept. 9 meeting and will be discussed at the commission’s next meeting Sept. 25. At that time proposals on property tax also will be presented. The commission’s final meeting is scheduled for Oct. 22, and its report to the governor is due on Oct. 31. —