Alia Beard Rau

The Republic | azcentral.com

State leaders blame lingering effects of the Great Recession for the state's sluggish tax revenues and flat budgets. But economists say the real culprit is the cumulative impact of two decades of Arizona governors and lawmakers chipping away at the state's bottom line.

Tax cuts over that period will cost the state's fiscal 2016 general fund $4 billion in revenue, according to an analysis by economists with Arizona State University's W.P. Carey School of Business.

The impact is expected to grow as already-passed corporate tax cuts continue to be phased in through 2019.

It leaves little room to reconcile Gov. Doug Ducey’s promise for more cuts this year with public demand for more school funding and Republican legislative leaders' push for a structurally balanced budget.

That didn’t stop Ducey, however, from sounding an optimistic tone on the matter in his State of the State address.

“Together, we will lower taxes this year. Next year. And the year after. And at the same time we will invest in education this year, next year and the year after,” he said. “It doesn’t have to be an either-or. We can be responsible with our budget, invest in the future, and allow the people to keep more of the dollars they earn.”

But that investment won’t restore school spending to pre-recession levels.

Because of the cumulative effect of the cuts, even if Ducey and the Legislature wanted to return the state to pre-recession funding for things such as education and health care, it would be nearly impossible.

Arizonans paid 30 percent less in general-fund taxes in 2015 than they did in 1992, according to the analysis by economists Dennis Hoffman and Tom Rex.

"More than 90 percent of the decline in revenue resulted from tax reductions ... the remainder is due to the incomplete economic recovery from the last recession," the economists wrote.

"That's where all the money has gone," said Children's Action Alliance President and CEO Dana Wolfe Naimark, whose advocacy organization is pushing for more funds for social services and education. "People say the Great Recession ruined us and we have to live life as it is now. But we kept passing tax cuts even during the Great Recession. We, ourselves, have shrunk the tax base."

Have cuts stimulated the economy?

Beginning with former Gov. Fife Symington's push in the 1990s to reduce the state income tax, every governor since has signed off on a tax cut of some sort — Republicans and Democrats. The argument has consistently been that it makes Arizona more attractive to businesses and will bring more jobs and eventually more money into the state.

Arizona taxpayers contribute a smaller portion of their income to running state government than they did 35 years ago, even though the state has taken on greater responsibility for health care for low-income residents, raised education standards and expanded its scope of services. Arizona overall ranks among the bottom third of states in terms of tax rates. For example, 13 states have a corporate income tax lower than Arizona's 5.5 percent, including six states that have no corporate income tax, according to the independent Tax Foundation research organization. Arizona ranks higher, at 17th in the nation, for the combined cost of state and local sales taxes. It ranks 20th in the nation for property taxes.

For some, Arizona Gov. Ducey's rhetoric not matched by his budget

Arizona's overall tax revenue is below what it was in 2007, and the state's spending remains below pre-recession levels as well.

In 2006, former Democratic Gov. Janet Napolitano supported a $500 million tax cut. In 2011, former Republican Gov. Jan Brewer supported a $538 million phased-in corporate tax cut.

Ducey's $31 million tax reduction last year came despite the belief at the time that the state would have to dip into its "rainy-day fund" to pay the bills. An unexpected spike in revenue allowed the state to avoid that.

The explanations behind these cuts have varied.

"One was a hope that cutting taxes would spur economic development. Two, there was a very strong philosophical preference among many legislators over the years for smaller government. Three, voters like the sound of it," Wolfe Naimark said.

Even when Arizona struggled to find enough money to pay its bills during the recession, state leaders refused to slow or reverse tax cuts.

'“Once you pass any kind of a tax cut in Arizona, it doesn’t come back,” Hoffman said. “In 2006, Napolitano and legislative leadership cut a deal on a budget. Napolitano got all-day kindergarten and legislative leadership got a 10 percent cut in individual income tax. Ten years down the road, where’s all-day K? We still have the 10 percent reduction in income taxes."

Senate President Andy Biggs, R-Gilbert, said he believes the recent corporate tax cuts have helped Arizona’s economy. Without it, he said, the recession would have been worse. Specifically, he said, cutting taxes helped businesses survive the recession, protecting jobs and salaries, though some take issue with that notion.

Biggs said tax cuts were not to blame for budget shortfalls and program cuts in recent years.

“People who like high taxes are arguing we had this horrible revenue downturn and it was partly due to our tax reductions,” he said. “That’s simplistic and naive. We had a national recession. If we’d maintained all the high taxes, would we be where we are today, or would we have lost even more than the 300,000 jobs? Would we have lost 450,000 jobs?"

But some economists rebut that.

According to Rex, economic growth can be stimulated by tax cuts, but only under certain conditions. Even then, only in the most extreme cases will increased economic growth generate enough tax revenue to offset the loss from a tax reduction.

Typically, those conditions occur when tax rates are significantly above the national average or there are underused resources reflected in a high unemployment rate or empty commercial buildings. However, those conditions weren't present during the tax cuts of the 1990s and 2000s, Rex wrote in a July 2015 report.

"Even in the early 1990s when the tax reductions began, the overall state and local government tax burden was not higher than average," Rex wrote. "No positive economic response to the tax reductions can be perceived."

According to Rex's analysis, Arizona has performed worse than the national average since the tax cuts were implemented.

Hoffman said it’s difficult to determine the impact of a tax cut among so many variables, but there are some indicators.

“We grew very rapidly as a state from 1950 until arguably the last six years, and yet during those early years we had higher individual and corporate tax rates,” he said. “State and local taxes tend to be a small piece of the pie. And Arizona already has a very favorable tax and regulatory environment."

He said that while the economy is more or less back to where it was before the collapse, tax collections continue to lag when you account for population growth.

“Tax-rate reductions have played a role,” he said.

According to the Joint Legislative Budget Committee, corporate income-tax revenue was down 45 percent in December compared with December 2014, indicating the corporate tax-cut package is kicking in. According to the committee's January report, tax credit "refunds increased from $19.4 million in December 2014 to $50 million in December 2015."

Finding the sweet spot

Ducey released his budget proposal in mid-January, but provided no details on his promised tax cut plan.

When asked in late January, he declined to provide details but repeated his campaign promise of driving the income tax to as close to zero as possible. He also said a structurally balanced budget — in which ongoing revenue matches ongoing expenses — is a priority.

“I want to be responsible in our current situation,” he said. “So, you’re going to see something similar to what you saw last year that will be incremental and responsible."

Ducey administration officials maintain the tax cut will help Arizona in the long run, allowing it to better compete with other states to attract and retain businesses and residents.

Gov. Ducey's budget plan: Modest increases to education, child safety; no tax cuts - yet

Greater Phoenix Chamber of Commerce Vice President of Public Affairs Mike Huckins said attracting and keeping business in Arizona requires a balance between tax rates and quality of life.

"The tax structure is an important part of what businesses focus on when looking to relocate here or expand, but so is the education status of the state," Huckins said. "If there's room in the budget to do both, then let's have a conversation. But we don't want to hurt one to do the other."

His members successfully lobbied for the corporate tax cuts in recent years, and he said they are starting to see some economic benefits from them. But he said his members are pushing a "steady as we go" approach to taxes this year.

"Let's not do anything too drastic," he said. "Let's take a year and see how the revenues really are balancing out."

He said he believes Arizona's current tax rates have put Arizona in a "very competitive" position nationally.

Ducey spokesman Daniel Scarpinato said neighboring states are constantly tweaking their tax structures to be more attractive. "It's a big piece, if not the biggest piece when people and businesses decide where to locate," Scarpinato said. "He (Ducey) believes everyday Arizonans need to keep the money they earn and he believes that will make our state a better, more attractive, more prosperous place."

Recent polling indicates Arizona has reached a point where most voters and taxpayers are no longer pushing for tax cuts. In a November poll from Arizona State University's Morrison Institute for Public Policy and the Walter Cronkite School of Journalism and Mass Communication, 66 percent of individuals questioned indicated they would be willing to pay higher taxes to improve the state's education system.

Longtime pollster Mike O'Neil said people generally like tax cuts but really hate education cuts. He said sometimes it takes a while for people to connect the two, but polling is starting to reflect the connection. He said he started seeing education spike as a priority last year.

"When we were charting the most important issue, education funding started to go off the charts," he said. "We had big enough cuts for long enough that I think it started to hit home. It got felt."

Hoffman said the call for tax cuts in Arizona does appear to be fading.

“What I’m hearing less and less of in this state is the ideological cry that low taxes will guarantee prosperity,” he said. “It seems like what we need to do as a state is figure out what level of public service we need — universities, prisons, health care, whatever — and then be willing to pay for it. It’s arithmetic."

Scarpinato said Ducey feels his job as governor is to grow the economy, not grow government.

"Our success in building our economy is not based on how large our infrastructure is, or how much we are spending on government programs," he said. "It's going to be, 'Is the unemployment rate moving in the right direction? Are we attracting new businesses? Are entrepreneurs able to get their business moving without a lot of red tape?' "

Bruce Merrill, a veteran pollster and political scientist, said tax cuts remains a key piece of the conservative, Republican agenda.

"Look at what the governor is doing," he said. "Some of his opponents are going to say he's cutting social services or he hasn't done what he should on education, but supporters will say he's doing exactly what he said he would do when he was elected. It's all about elections and whether someone might like it or not."

But even among conservative Republicans, support for tax cuts appears to have its limits.

"We really need to concentrate on having a structurally balanced budget, just like I do in my household — I have to live within my means," said Sen. Debbie Lesko, R-Peoria, who serves on the Senate Appropriations Committee. "I think the state has to live within its means and so before we do any major changes or spending or tax reductions, we need to take a close look at it."

Lesko said some are floating the idea of cutting the individual income tax but adding a new sales tax on services to compensate for the revenue loss. No such legislation has been introduced, but there is still time.

Biggs said his focus is also on structural balance, and paying down debt.

“People are broadly content with all the business tax reductions that we’ve instituted over time. I think they want to let those take effect,” he said. “I’m not saying everybody’s saying take a breath, but people would like to see what’s going on before we do more. And I think there is a concern overall with the direction the economy is going."

At the same time, Biggs is not outright dismissing whatever Ducey may propose.

“We want to see what the tax package would look like,” he said. “If it seems sound, I think there will be support for it."

Biggs said he believes Arizona’s current tax base is large enough to assure government is doing its job.

“It isn’t like we are starving state government,” he said. “You are looking for the sweet spot where you can take care of your constitutionally-mandated functions, which are education, public safety, roads and infrastructure. You want to take care of that and keep the burden low on your citizens."

He said the sweet spot for him would be cut social-welfare spending and spend that money instead on education, public safety, roads and infrastructure.

The goal as a legislative leader, he said, is to find the “political sweet spot."

“Find what is necessary to balance your budget, not place an overburden of taxes and regulations on our citizens and still produce enough funding to pay for our fundamental needs,” he said. “I think we’re close.”

Arizona's tax history

1988: State raises taxes by $179 million and makes various cuts to cover a more than $300 million shortfall blamed on tax cuts passed during the previous decade.

1992: State has a budget surplus of $11 million; passes more than $20 million in tax cuts. A decade of tax cuts follows, including seven different income-tax cuts between 1994 and 2007.

1996: State eliminates the state property tax.

2000: Voters pass Prop. 301, which provided an additional 0.6 percent in sales taxes for education through 2021. The education tax generated $626.4 million in fiscal year 2015.

2003: Housing boom officially begins, increasing revenue.

2006: State has a $1.5 billion budget surplus. Gov. Janet Napolitano, a Democrat, works with a GOP-led Legislature to expand or create a number of state programs, including all-day kindergarten. They also pass $500 million in tax cuts.

2006: State repeals the estate tax.

2007: Housing boom begins to go bust. National recession officially begins.

2009: Gov. Jan Brewer signs a budget package that cuts $144 million from K-12 schools and $155 million from the state Department of Economic Security. For the first time, the state exceeds its threshold of $500 million in IOUs backed by state-held accounts and must turn to institutional lenders.

2010: State for the first time goes to the public bond market to sell 14 state buildings, including the tower that houses the Governor's Office, for $735.4 million. The state retains control of the buildings and leases them back at an interest rate of 4 percent. State ends funding for all-day kindergarten, saving the state $218 million.

2010: Voters approve a three-year 1-cent-per-dollar increase in the state sales tax. It brought the state nearly $1 billion a year during those three years for education, human services and public safety.

2011: The Legislature and Gov. Jan Brewer approve a tax package to cut corporate taxes by 30 percent from 2014 to 2019, costing the state an estimated $538 million. It also included phasing down the flat corporate income tax rate from 6.9 percent in fiscal 2015 to 4.9 percent in fiscal 2018.

2012: The Legislature and Gov. Jan Brewer approve a tax-cut package that includes a 25 percent reduction in individual income taxes paid on capital gains over the next three years.

2015: The Legislature and Gov. Doug Ducey approve legislation to adjust the state's income-tax brackets with inflation every year. It is estimated to cut tax revenue by $30 million in fiscal year 2016.

Reach the reporter at alia.rau@arizonarepublic.com or on Twitter @aliarau. Republic reporter Yvonne Wingett Sanchez contributed to this article.