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TAB A: Minutes of the January 11, 1989 Meeting 0 T-B: Research Paper: Criteria for Evaluating Fiscal Systems
TAB C: Research paper: 'Interstate Fiscal Comparisons
TAB D: Models and Methodology
TAB E: Recent Correspondence
1. Call to Order, 4:00 p.m.
Hearing Room 2, House of Representatives
2. Approval of January 11, 1989 Minutes
3. Presentation of Research Paper (Tab B):
criteria for Evaluating Fiscal Systems
4. Presentation of Research Paper (Tab C):
Interstate Fiscal Comparisons
5. Other Business
6. ~djournment, 7: 00 p.m. (estimated)
Minutes of Meeting
Wednesday, January 11, 1989
A meeting of the Joint Select Committee on State Revenues and Expenditures was
held in Hearing Room 2 of the House of Representatives, a t 4:00 p.m. on
Wednesday, January 11, 1989, with Chairman J. E l l i o t t Hibbs presiding.
Jose Cardenas
Don B l i s s
Sharon Medgal
Sen. Jeffrey H i l l
John S t i t e l e r
Members Present
Sen. Jaime Gutierrez Rep. A r t Hamilton
Leonard Judd J. E l l i o t t Hibbs
Rep. Mark Killian Richard Snell
Rep, Chris Herstam Sen. Robert Usdane
Wayne Brown
Also present a t the meeting was Staff Director Dr. Therese J. McGuire.
Members Absent
Hon. C. Diane Bishop
By a motion made by M r . B l i s s , seconded by Mr. Snell, the minutes of the @ October 17th meeting were approved.
Chairman Hibbs, welcomed Representative Mark Killian to the Committee. He
replaces Representative John King, who did not win re-election.
Dr. McGuire highlighted several issues that were brought up during the four
public hearings held in Flagstaff, Yuma, Phoenix and Tucson. She also stated
that each of these issues w i l l be addressed by the consultants in one or more
of the research reports prepared for the committee. Dr. McGuire confirmed
that the public hearings were very useful in identifying issues and
information available. Chairman Hibbs directed staff to distribute to
committee members a summary list of the issues and concerns identified during
those hearings.
Mr. B l i s s questioned whether or not the Committee would go back to the public
l a t e r in the process and especially a t the end when considering policy
recommendations. Chairman Hibbs stated t h a t t h a t question would be addressed
l a t e r in the agenda.
Dr. Megdal added that she would also like to see any correspondence that staff
received as a result of the hearings. Dr. McGuire noted that the docket book
for t h i s meeting only contained the actual transcripts of the hearings.
Correspondence would be included in future docket books according to their
relationship to topics on the Calendar.
Page 2
Referencing the Committee's calendar, Dr. McGuire stated that research reports
were being conducted on each of the topics that will be addressed. The
reports were being done by some of the best public finance economists in
Arizona and throughout the country.
She stated that the research process for each topic report consists of a
series of steps:
Step 1. Identify the issues and the availability of information and
data and other relevant reports and studies through meetings
with local experts.
Step 2. Outline the study so that it addresses issues identified
using methodology that employs the available information.
Step 3. Do the research as outlined.
Step 4. Written and oral presentations of the analysis.
@ Dr. McGuire continued to illustrate the process by reviewing outlines of two
studies currently underway. One, on the general sales tax, which really is a
transactions privilege tax, consisted of four areas:
1. The description of the structure, its rationale and role and
interstate comparisons.
2. Evaluate the current structure, in terms of stability and
responsiveness, and the distribution of the burden.
3. Consideration of changes to structure, including base broadening,
and evaluation of stability and burden.
4. Look at the cost of compliance and administration involved, and
state and local differences in tax base definition.
The other study, on the Arizona economy and business climate, was outlined as
1. Describe industrial mix of Arizona today and in the past and
compare it to other states.
2. Compare Arizona job growth rate with other states.
3. Ask why the differences in job growth rates. What factors across
the states help to explain the differences in unemployment growth
rates? An econometric model will determine correlations.
4. Compare Arizona with other states on the factors identified by the
Page 3
Attached to each research report will be an executive summary and a set of
findings or policy options, whichever is relevant. Twenty to twenty-five
reports will cover all areas listed on the calendar. These reports are being
prepared by some of the best public fiance economics in the country and the
state. Dana Naimark, Project Manager and Dr. McGuire will be heavily involved
in each & step of the process on each report. Deadlines have been set for
each researcher that are consistent with the scheduled Committee meetings.
Many of the reports are well underway. Topics such as K-12 and property taxes
have been placed later in the calendar to allow enough time for a high quality
job on these areas.
Dr. McGuire proceeded to report on the Committee's part in the process. She
explained that approximately one week prior to each meeting, Committee members
will receive a docket book containing relevant research reports and summaries
to review. Brief presentations on the reports will be given at the meeting
followed by a question and answer period and discussion of the information and
options presented. No votes will be taken until all the reports and
information have been presented. The rationale for this procedure is to
insure that the Committee meetings are devoted to fact-finding and information
gathering, and since many components of the fiscal system are intimately
' @ linked to one another, component by component recommendations are not likely
to be consistent.
After all the research is completed and presented, the Committee will meet to
make policy recommendations on the final package. Staff will be able to pull
together various policy options for consideration by the Committee. Any
recommendations made will be based on nine months of fact finding and
analytical evaluations.
Over the last few months researchers have been identified for all the topics.
Half a dozen of the researchers are on Step 3 of the process with research
well underway. Another half a dozen are on Step 2, outlining methodology.
The remaining dozen or so are on Step 1--identifying issues, data and
The January 25 meeting will cover two reports on background-- Criteria for
Evaluating Fiscal Systems and Fiscal Comparisons with Other States.
The Criteria report is a conceptual report--no data gathering or analysis is
involved. It defines principles or criteria to be used in evaluating
components of the fiscal system. The report will define and discuss criteria
such as equity, efficiency, simplicity, stability, accountability, neutrality
and competitiveness (economic development). The Committee may want to
formally adopt or chose a set of criteria at the January 25th meeting to
provide a framework for the research meetings to follow.
Questions turned again to the subject of public input. Dr. McGuire stated
that interested parties may provide input by submitting any information or
reports to staff. Local experts will also provide input through meetings with
Page 4
Once all the reports are completed and prior to the policy recommendations,
the public may provide input by submitting five-page typewritten documents
stating their reactions to the reports. These documents will then be reviewed
by staff and distributed to Committee members.
Concerns were then expressed on the notification and the advertising of the
Committee's process to the public. Many people do not know who or what we are
and more needs to be done to ensure that everyone receives a chance to give
input. It was suggested that the media be utilized more through press
releases and interviews in order to make the public more aware of the
Committee's work.
Discussions then turned to the qualifications and the expertise of the
consultants. Dr. McGuire noted that all the consultants have prior experience
and expertise in their area of study. They are all Ph. D. economists from
academic institutions and are experts in state and local finance. They have
met with local experts pertaining to their area. For instance, the sales tax
consultants are meeting with representatives from the League of Cities and
Towns and County Supervisors and Department of Revenue. Concerns were
expressed on the lack of input that the Committee felt they had in the @ selection of these consultants. Chairman Hibbs interjected that the Committee
agreed to give Dr. McGuire the authority to pick the consultants. He went on
to explain that she went to great efforts to meet with potential consultants
at ASU and UofA as well as out-of-state. Following further discussion,
Chairman Hibbs directed staff to provide copies of each consultant's resume to
Committee members. Chairman Hibbs reiterated what Dr. McGuire said earlier
that the consultants were only to provide information and the pros and cons of
the problems identified by the Committee members. It is up to Committee
members to make the final recommendations based on the information.
Discussion then turned to modeling and its capabilities and time factors.
Senator Hill expressed concerns regarding the use of models in the past and
the amount of time that it took to get results based on different factors. He
also wanted to know when these models would be available, if not already. Dr.
McGuire explained that a set of models would be available as the reports were
available along the lines of the Calendar. Dr. Megdal questioned the
availability of current econometric models. Dr. McGuire and Chairman Hibbs
explained that several forecasting models are available from the Universities
and other sources and the Department of Revenue has an income tax model but it
is not up yet. Senator Hill requested that modeling and its process be
addressed at the next meeting.
Other Business
Representative Herstam distributed copies of a revised version of the * Committee's Calendar. He explained that he changed the calendar by speeding
up the process by eliminating the Executive Summary meeting, reducing the
discussion of final recommendations from four days to two days and setting the
delivery of the final report 20 days earlier.
Page 5
In doing this, he hoped that the Legislature would be able to address the
final recommendations of the Committee during a special session slightly
earlier than originally anticipated. Representative Herstam made the motion
that the revised Calendar, dated January 11, 1989, be adopted by the
Committee. The motion was seconded by Representative Killian.
Senator Hill made the motion to further amend the Calendar by moving the
property tax area up. Following discussion on the process and the time needed
to study this area, the motion failed due to the lack of a second on the
Discussion then turned to the Calendar. Dr. McGuire stated that speeding up
the process by three weeks would not affect the quality of the research and it
was satisfactory to do so. By a roll-call vote of 14-0 in favor, the motion
passed urianimously.
Senator Usdane apologized for being late. He wanted to notify the Committee
that he was taking himself off of the Committee due to time constraints
associated with his position as President of the Senate. He has asked Senator
John Mawhinney to take his place and stated that Senator Mawhinney had indeed @ sat through the Committee's meeting as an observer. Senator Usdane also
wanted to emphasize the importance of the Committee and that the Legislature
had high expectations of the group. He hoped that the final report would come
out in a timely basis and that it would allow the Legislature to address the
current problems that the Szate faces and wished the Committee well in its
process. Chairman Hibbs thanked Senator Usdane and welcomed Senator Mawhinney
to the Committee.
With no further business, the meeting was adjourned.
Respectfully Submitted,
'./ LOQ%.J~A IAkd
Susanne M. Kufahl Ci
- Preliminary Draft -
January 25, 1989
- Preliminary Draft -
Executive Summary
State and local fiscal systems seem to be riddled with
complexities, inefficiencies and inequities. Complexity is a
problem because a misunderstood system does not well address the
needs of the people the system was devised to serve. Inefficiency
is related to waste - the size of the economic pie is smaller than
perhaps it need be. Inequity can arise from unequal treatment or
from treatment that does not adequately account for differences in
economic circumstances.
Several criteria for evaluating a fiscal system can be
identified. Below nine potentially useful criteria are briefly
defined. The purpose of attempting to define a set of criteria is
to provide a common, general framework that policymakers can refer
to when policy options are considered. It is legitimate to ask of
any potential aspect of the current fiscal system or any change to
the system, what the effect is on the overall simplicity, fairness,
equity, stability, efficiency, responsiveness, competitiveness,
neutrality, and accountability of the system.
SIMPLICITY: Minimize fiscal compliance and administration costs.
The system should be easily understood by affected individuals and
businesses, and easily implemented by government agencies.
@ HORIZONTAL EQUITY: Treat individuals of equal means equally under
the fiscal system.
VERTICAL EQUITY: Tax individuals with greater means or ability to
pay more, or provide these individuals with fewer benefits from
publicly provided goods and services.
EFFICIENCY: Employ benefit taxation where appropriate, and tax
activity with relatively inelastic supply or demand relatively
NEUTRALITY: Avoid differential treatment of like economic
STABILITY: Employ a system that does not produce wide cyclical
swings in expenditures or revenues.
RESPONSIVENESS: Employ a system that adequately tracks the secular
changes in the State's economy and population.
COMPETITIVENESS: Design the fiscal system so that it does not deter
economic growth and prosperity.
ACCOUNTABILITY: Provide links between revenue raising
responsibility and spending requirements and authority.
The purpose of defining a set of criteria for the Committee
is to provide a common, general framework that members can refer
to when policy options are considered. In general, criteria are
used to evaluate revenue-neutral and expenditure-neutral changes
to the fiscal system. criteria aid in identifying structural
deficiencies of the system such as unresponsiveness, unfair
treatment, high costs of compliance, and detrimental effects on
economic growth.
With its fiscal system, a state attempts to provide a desired
level of goods and services and to finance adequately that chosen
level. Economics can provide some guidance in the choice over the
. set and level of goods and services to provide. Three commonly
accepted justifications for government provision of goods and
services are (1) benefits being realized by those other than the
individuals immediately involved (e.g., primary and secondary
schooling), (2) nonrival and nonexclusionary consumption (e.g., a
street light) , and (3) a community's desires for some
redistribution of resources. But these guidelines can take
policymakers only so far. It is difficult to quantify the extent
of external benefits and nonrival, nonexclusionary consumption, and
preferences over redistribution are difficult to aggregate. At the
margin the extent or size of government is a political decision
that in a well-working democracy reflects the desires of the
@ electorate.
However, three important criteria - simplicity, equity, and
efficiency - do provide much guidance for evaluation and reform of
a fiscal system. Efficiency has at least three aspects relevant
for fiscal system evaluation. One aspect recognizes the fact that
when individuals decrease their consumption of a good or cut back
production in response to a tax, the associated consumer benefits
and/or economic profits are lost. This is inefficient, since,
without the tax, consumers were willing to pay at least the cost
of producing those units and thus the exchange of units results in
a net gain to society.
This discussion suggests that goods with unresponsive demands
or supplies should be disproportionately taxed while those with
very elastic demands or supplies should be taxed relatively
lightly. This efficiency argument applies to taxing cigarettes,
for example, since the demand for cigarettes is relatively price
unresponsive. (Note that this rationale for taxing cigarettes
differs from a commonly heard, and inconsistent rationale that
cigarettes are demerit goods, the consumption of which should be
discouraged, possibly through heavy taxation.) Of course, other
less common taxes are also justified under this argument, such as
a tax beyond a license fee on marriage, a consumer service that is
likely to be quite price inelastic. To achieve efficiency, the
simple rule of thumb is, when possible, to tax relatively lightly
those economic activities that are relatively price responsive, and
tax relatively heavily those economic activities that are price
A third example will illustrate an important tradeoff that
@ confronts tax policymakers over- and over. One good with a very
inelastic demand, and thus one that by the efficiency criterion
should be taxed relatively heavily, is the drug insulin. However,
a high tax and resulting high price for insulin strikes most people
as a very unfair policy. This is a relatively easy
efficiency/equity tradeoff to resolve, but others, with more
problematic solutions, often arise in the design of an acceptable
fiscal system.
A second, slightly different twist on the same efficiency
concept is that, in an economy characterized by competitive markets
and no market failures, taxes should be chosen to minimize
distortions to economic behavior. As an example, when business
taxes are designed to treat different types of inputs or different
forms of capital differentially, decisions about the mix of inputs
are distorted from their cost minimizing mix, that is, an
inefficiency is generated. Sometimes this distortionary treatment
can be justified as serving some other goal, such as encouraging
a particular local or ailing industry, but the efficiency loss to
society needs to be recognized.
The assumption that markets are perfectly competitive and
without failure is critical to the above. If, for example, the
use of one type of input, an input deemed the most cost effective
by the business, imposes costs on other businesses or consumers
not borne by the original business, then a tax on the use of the
externality-generating input is efficient.
A final efficiency concept that provides an important link
between taxes and the goods and services provided by government is
the concept of benefit taxation. Under benefit taxation (also
known as user charges) an individual must pay a price or tax per
unit of the good or service consumed. Thus, individuals will
choose not to use the publicly provided good or service if the
benefits are less than the cost of getting access, and only those
who benefit at least as much as the cost will use the good or
service. This is an efficient allocation of the scarce resource.
For benefit taxation to be viable, certain characteristics
must exist. It must be relatively inexpensive to exclude those who
do not pay from the benefits of using the publicly provided good.
So, for example, toll bridges are common whereas tolls to enter a
Central Business District (CBD) network are not common, because the
cost of monitoring every entrance to the CBD is prohibitively
costly. Secondly, the good being provided cannot be of a
redistributive nature or a good deemed necessary, regardless of
ability to pay for the good. In these situations, the efficiency
argument is at odds with equity considerations, illustrating the
equity/efficiency tradeoff once again.
In summary, the efficiency criterion argues for taxing
relatively inelastic goods and services relatively heavily, for
using the fiscal system to distort economic decisions only when
market failures are identified, and for using benefit taxation
where appropriate. Several conflicts with a second important
criterion, equity or fairness, have already been identified. There
are two commonly used concepts of equity - horizontal equity and
vertical equity.
Horizontal euuity refers simply to the equal treatment of
equals. If two individuals of equal income or wealth are treated
differentially by the fiscal system, in terms of tax liability or
services received, the system is characterized by horizontal
inequity. his concept was one of the more important driving
forces for tax reform at the federal level. There was a strong
perception backed by reasonably strong evidence that taxpayers of
equal tax paying ability were given differential treatment under
the law based on how they earned or spent their income. While
intuitively appealing, the concept of horizontal equity is
surprisingly difficult to define accurately or to make operational.
For example, one could argue that although different forms of
income or consumption may be treated differentially under an income
tax, each taxpayer is subject to the same tax svstem and is free
to take advantage of as many loopholes and special treatments as
the next taxpayer. In reality, the frustration with the federal
income tax was more that certain forms of preferential treatment
were only available to the wealthy, which brings us to the second
form of equity.
Vertical eauity refers to tax liability and expenditure
benefits being related to economic well being or ability to pay.
The idea is that those with a greater ability to pay taxes should
pay more, and those with lesser ability to obtain necessary goods
and services should receive more via public programs. Like
* horizontal equity, this concept is more subtle than it first appears. Although we may a11 agree that individuals of greater
ability to pay should pay more in taxes and that individuals with
less income or wealth should receive more in publicly provided
goods and services, how much more is difficult to answer.
Economics does not provide much guidance on this all important
One guideline for tax policymakers that comes from this
discussion of equity and efficiency is to employ benefit taxation
where the circumstances warrant, and to employ ability-to-pay
taxation for redistribution and for financing general government
expenditures or government expenditures where it is difficult or
undesirable to ration the scarce good or service via a tax price
\a system.
.-- Sim~licitv in a fiscal system requires more than ease of
compliance and administration. When it is difficult to determine
one's own tax liability or eligibility and benefits of a government
program, confidence and trust in public officials and the "system"
erodes. Government that obfuscates, that ignores real costs
associated with unnecessary complexity, is an unresponsive
Some aspects of a state and local fiscal system are inherently
complex. The complexity is a necessary evil of performing an
otherwise worthy function. Yet, it is often the case that many
goals of complex programs can be achieved through simpler means.
For example, state personal income taxes are a common method of a 6
raising general revenue on an ability-to-pay basis. Attempts are
often made to use the personal income tax to accomplish many more
goals than equitable revenue raising. When special provisions are
put into a state tax code to encourage certain types of economic
behavior, they are likely to be ineffective (because state marginal
tax rates are low relative to federal marginal tax rates) and to
create complexity and costs of compliance and administration. A
strong simplicity argument can be made for tying a state income tax
base closely to the federal income tax base, and allowing for
differing state preferences over vertical equity to be reflected
in tax rates which are simple to implement and comply with.
Transfer payment programs are also often exceedingly complex.
Again, the complexity may be inherent to a properly designed
program. But a search for simpler yet equally effective programs
can make for a more acceptable fiscal system.
Simplicity, equity and efficiency are three important criteria
for evaluating fiscal systems. Several other criteria are also
important to consider. stability of the fiscal system is
particularly important at the state level where constitutional or
statutorial requirements for balanced budgets are ubiquitous. This
concept, like the others, is more subtle than first appearances
would lead one to believe. For example, a system that is stable
over the business cycle may also be unresponsive to secular growth
of the economy, which may or may not be desirable. Stability and
res~onsiveness of the system to economic growth are related
concepts that provide different attributes to a fiscal system.
Neutrality in a fiscal system can be confused with horizontal
equity, but it is closer to an efficiency concept. Neutrality
refers to an equal playing field, not giving an unfair advantage
to one particular industry, firm, or activity. It can be invoked
when discussing the property tax treatment of different types of
commercial/industrial property, when discussing the sales tax
treatment of different types of retail sales activity, and when
discussing eligibility requirements for government programs that
treat seemingly similar situations differentially.
A concept very closely related to efficiency and that links
taxes and expenditures is accountabilitv. Accountability refers
to tying revenue raising responsibility to spending authority. A
state and local fiscal system often scores poorly on this criterion
when the state government becomes heavily involved financially or
statutorily in the fiscal affairs of its local governments. The
state involvement is often motivated by equity concerns and thus
we have another illustration of the tradeoff between equity and
efficiency. comparative economic analysis can provide some
guidance on preferred methods of intergovernmental fiscal
Another concept also related to one aspect of efficiency is
com~etitiveness or concern about economic development. State
economies are open economies and if a state and local fiscal system
is deficient in significant ways, from either the revenue or
expenditure side, then people and businesses may feel compelled to
move out of the state, or if choosing among several states for a
desirable living and working environment, may choose another state.
Many other characteristics about states are likely to be more
powerful factors in these location decisions, but a fiscal system
far out of line can make a difference.
In summary, several criteria for evaluating a fiscal system
have been identified and discussed. The purpose of attempting to
define a set of criteria is to provide a common, general framework
that policymakers can refer to when policy options are considered.
It is legitimate to ask of any potential aspect of the current
fiscal system or any change to the system, what the effect is on
the overall simplicity, fairness, efficiency, neutrality,
stability, responsiveness, competitiveness, and accountability of
the system.
0 SIMPLICITY: Minimize fiscal compliance and administration costs.
The system should be easily Lnderstood by affected individuals
and businesses, and easily implemented by government agencies.
HORIZONTAL EQUITY: Treat individuals of equal means equally under
the fiscal system.
VERTICAL EQUITY: Tax individuals with greater means or ability to
pay more, or provide these individuals with fewer benefits
from publicly provided goods and services.
EFFICIENCY: Employ benefit taxation where appropriate, and tax
activity with relatively inelastic supply or demand relatively
NEUTRALITY: Avoid differential treatment of like economic
STABILITY: Employ a system that does not produce wide cyclical
swings in expenditures or revenues.
RESPONSIVENESS: Employ a system that adequately tracks the secular
changes in the State's economy and population.
COMPETITIVENESS: Design the fiscal system so that it does not deter
economic growth and prosperity.
ACCOUNTABILITY: Provide links between revenue raising
responsibility and spending requirements and authority.
- Preliminary Draft -
January 25, 1989
- Preliminary Draft -
Executive Summary
The public budget--the total set of state and local government
tax and expenditure policies--forms a primary tool for
accomplishing governmental goals. Since states operate in open
economies that are affected by external policies and circumstances,
it is useful to compare Arizona's fiscal system with the systems
in other states.
Such comparisons highlight Arizona's basic fiscal structure
in the context of the larger regional and national economies, and
may provide initial indicators of fiscal imbalances. Interstate
fiscal comparisons do not, however, illustrate whether revenue and
expenditure levels are too high or too low, since states differ
greatly in demographic characteristics and in political
preferences. Likewise, interstate comparisons alone can not
measure a state's economic competitiveness because many factors
other than taxes and spending may be related to economic growth.
This research paper relies on U.S. Census data for the period
between 1975 and 1987. Comparisons are made between Arizona, the
national average, and ten other states selected for their economic
competition with Arizona or their similarities or qreat differences
with Arizona s fiscal system. All figures include aggregates of
; @ state and local data.
Arizona expenditures as a percentage of state personal income
have remained nearly constant over the period reviewed, while the
expenditure to personal income ratios of most of the comparison
states, and the national average, have fallen slightly. In FY
1986, Arizona's ratio of expenditures to personal income was
20.7 percent, 13 percent above the U.S. average of 18.3 percent,
and Arizona ranked fifth among the eleven comparison states.
For FY 1986, Arizona's per capita expenditures were about
average for elementary and secondary education, above average for
higher education, highways and police and fire, and lower than
average for public welfare and health and hospitals. Using a
representative expenditure system index for FY 1987, which takes
account of the underlying need for certain types of expenditures,
Arizona spent over 40 percent less than its representative need
level for welfare and health, and over 35 percent more than its
representative need for higher education, highways, and police and
Taking account of changes in population and personal income, * Arizona's revenues grew at about the national average rate between
1975 and 1987. since 1975, Arizona's revenues per capita have
remained slightly below the national average (98 percent of average
in FY 1987) . During that same period, Arizona's revenues relative
to personal income ranged from seven to eleven percent above the
national average, and, in 1987, Arizona ranked fifth among the
comparison states.
Using FY 1987 data, Arizona's state/local breakdown of total
revenue was about average. However, Arizona raised 24 percent of
total revenues through state and local general sales taxes,
compared to a national average of 17 percent, and raised 12 percent
of its revenues from income taxes compared to a 17 percent average.
Using a representative tax system index, ~rizona's total tax
base capacity increased from 92 percent of average to 99 percent
of average between 1975 and 1986, and Arizona ranked eighth among
the comparison states in 1986.
In FY 1986, Arizona's tax effort relative to capacity varied
tax by tax. The tax effort on the sales tax base was 53 percent
above average, ranking second in the nation. Tax efforts on
selective sales and license fees were about average, whereas the
efforts on the individual income tax, property tax, corporate
income tax, mineral tax and user charge bases were below average.
In summary, Arizona is an average state in many fiscal
respects. Despite rapid population growth, Arizona has remained
very close to the national average in revenue growth per capita and
per dollar personal income and in overall tax capacity and tax
effort. Arizona is somewhat above the national average in
expenditures as a percentage of personal income and in revenue as
a percentage of personal income. Arizona also differs from the
national average in its mix of taxes and its composition of
expenditures. As the Committee proceeds with its study of specific
taxes and spending programs, the interaction of economic
competitiveness and fiscal efficiency, equity, simplicity and
accountability will be explored in greater depth.
Purpose and Scope
Like the other forty-nine states and the ~istricto f Columbia,
Arizona operates in an "open economy.It That is, it is generally
not free to establish any legal or institutional barriers to the
movement of commodities and/or resources (e.g., labor, capital)
across its borders. Thus, for example, Arizona cannot establish
tariff barriers or migration controls in order to shape its
economic, social, and demographic environment.
What Arizonans can do, however, is to influence the character
of the State by establishing state and local government programs.
And the primary (though by no means the only) tool for
accomplishing governmental goals is the public budget--that is, the
set of state and local government tax and expenditure policies.
But, because of the openness of the U.S. economy, even these
vfowns tate" tax and expenditure arrangements cannot be made without
regard to the nature of the budget policies of the other states.
As a result, a question that inevitably arises with respect to
state and local fiscal policies is: How does our state (e.g.,
Arizona) compare with the others--in terms of the mix and level of
public goods and services provided and the tools that are used to
@ pay for those activities.
The question of how Arizona compares is useful for describing
the State's basic fiscal structure and for viewing that structure
in the context of the larger regional and national economies.
Interstate comparisons are also useful for taking a first slance
at the issue of economic competitiveness.
The relevance of interstate fiscal comparisons to Arizona's
economic competitiveness derives from the openness of state
economies--the budget is one of the few economic development
factors over which policy makers have significant policy control.
Thus, for example, although there may be little (if anything)
legislators can do about Phoenix's hot summers to expand the local
employment base, they may be able to directly influence certain job
creation decisions (negatively as well as positively) through their
budget actions. Accordingly, policy-makers will often want to know
if tax burdens are higher or lower in this State than in others,
or if government spending on certain programs is higher or lower,
or if other of the State's policies are "out of lineH with those
of competing jurisdictions. The interstate comparison is one way
to besin to address that question. And fiscal comparisons have,
in fact, become increasingly important during the 1980's. Federal
grants in aid to states and localities have diminished, and the
federal deductibility of state and local taxes has been reduced,
both decreasing the fiscal equalization effect across states and
highlighting state-to-state differences.
In short, interstate fiscal comparisons are an appropriate
element of the study and understanding of the ~rizona fiscal
system. But it is important to note that fiscal comparisons form
only the first step in evaluating any state's economic
competitiveness. Interstate differences in demographic
characteristics or industrial structure may make it perfectly
logical and beneficial for -one state to set fiscal policies that
are very different from another state's. So, while significant
interstate differences may be initial indicators of a fiscal
imbalance, additional information and evidence about economic
competitiveness are needed before conclusions and policy decisions
are made.
It is important to explore economic competitiveness in more
depth since it is often the case that below-average taxes and
spending are presented as 81evidencen of a state's favorable
"business climate.'' Indeed, such numbers mav reveal just the
opposite: that public services are inadequate for attracting
business to an area. Similarly, a state ranking above other states
in its spending/taxing record does not necessarily show that its
services are being provided in a manner that effectively makes a
location favorable to job development and/or the in-migration of
skilled laborers.
The Data e
The methodology used in fiscal comparisons involves selecting
a set of indicators that are common to the all the states and then
comparing their levels and trends for a set of years. It is also
useful to relate these indicators for one state (e.g., Arizona) to
a group of other states in order to illustrate relative
Indicators In order to make meaningful interstate fiscal
comparisons, it is essential to apply consistent definitions and
measurements across all states. Accordingly, one must rely on
information compiled by the U.S. Bureau of the Census, which
collects and then reports data in uniform fashion with the express
purpose of facilitating comparisons across jurisdictions. One
cannot rely directly on internal state budget documents or other
financial reports for deriving interstate comparisons, because the
definition of taxes and expenditures will vary across the states.
On the expenditure side of the budget, for example, medical
aid to the poor may be categorized as spending on ffhealthfsfer vices
in one state but as a component of "welfaren in another. Similar
types of discrepancies occur on the receipts side of the budget.
Some states that impose gross receipts taxes on business activities
may consider the tax to be in the nature of an income tax levy,
while others treat it as part of their sales tax collections.
The same type of problem arises with respect to what is a
state versus a local tax and/or expenditure. Different states
allocate structurally similar taxes (and non-tax revenues) and
expenditures to different levels of government. Thus, what Arizona
may consider a local responsibility in its highway or education
system may be treated as a state function in Texas. And in some
places the sales tax may be only available for state use (e.g,
Hawaii), whereas in other states the tax may be considered
primarily a source of local revenues (Nevada). Again it is
necessary to use a consistent frame of reference for making fiscal
comparisons. Consistency requires both utilizing Census data and
also reporting comparisons in terms of the sum of state and local
asqresates. To do otherwise could lead one to draw conclusions
0 about incomparable numbers.
Years Because of the need to adjust data to ensure
consistency, the published Census data lags the end of the fiscal
year by about eighteen months. Thus, the most recent data
available for most of the discussion that follows is for 1986. This
data lag does not present a major problem when one is interested
in comparing expenditure and tax levels among the states. In
making interstate comparisons one wants to learn about gradual
and/or continuous changes over time--not the single snapshot
situations that may reflect actions designed to meet unusual or
unexpected one-time budgetary requirements. Accordingly, much of
the following data is presented over an eleven to twelve year
period beginning in 1975 (representative of the end of the era of
@ rising federal aid flows to the states), continuing with 1980
(which generally dates the period of the state "tax revoltsw), and
then 1985 and 1986 or 1987 (the most recent years for which data
are available).
The Com~arison States In order to highlight certain aspects
of Arizona's fiscal place among the states, comparisons are made
between Arizona, the U.S. average, and ten other states. Colorado,
California, Nevada, New Mexico and Utah are included because they
are geographically neighboring states which are seen to compete
with Arizona for residents and/or jobs. Florida and Texas are
included because their economies also compete with ~rizona for
industry-specific resources (tourism in Florida and high-technology
in Texas). ~llinois, and New York--although having fiscal
structures very different from Arizona's--also compete with Arizona
for residents (in the late 1970's the greatest percentages of
migrants to ~rizona came from these two states and California).
Finally, Minnesota is included because its economy and fiscal
structure are quite different from Arizona's, and these differences
can provide interesting perspectives and insights.
It is appropriate to begin the examination of the Arizona
fiscal system by first taking a look at the expenditure side of
the budget.
There are two reasons for doing so. First, and fundamentally,
governments tax to spend. - That is, over time, the level of
revenues will reflect the desired level of spending. Second, the
very structure of the revenue system may reflect spending behavior
as well as taxing philosophies. If government expenditures rise
and fall at erratic rates, for example, the legislature may resort
to a series of uncoordinated revenue adjustments to address short-term
financial needs rather than the long-run fiscal goals of the
state. Thus, spending patterns may provide insight about the
revenue-raising structure.
Level and Com~osition of Expenditures
Two conventional measures of interstate spending comparisons
are presented below. Table 1 compares Arizona's direct
expenditures (all spending other than intergovernmental, utility,
and insurance trust spending) both in dollars and as a percent of
personal income. By dividing spending by a readily available
common denominator such as state personal income, one can make both
intertemporal and interjurisdictional comparisons.
As the data shows, Arizona's expenditures as a percent of
@ personal income have remained relatively constant over time; but
relative to the national average of the fifty states and the
District of Columbia, Arizona's expenditures have been slowly and
steadily rising. This has occurred because the national average
expenditures have been falling. The record of the comparison
states is mixed: California and Nevada have exhibited declines in
the relative level of direct expenditures to state personal income
between 1975 and 1986, while Utah, New Mexico, Minnesota, and New
York have maintained a relatively high level of spending activity.
Florida, Colorado, and Illinois have exhibited little change in
their expenditure to personal income ratios. And the Texas ratio,
while still below average in 1986, has steadily increased relative
to the U.S. average.
Table 2 presents information regarding a second measure of
expenditures, per capita expenditures and state and local
government expenditures broken out by functional composition. As
that table shows, in per capita terms Arizona is about average in
total spending and spending on elementary and secondary education;
above average for higher education, highways, and police and fire;
and well below the national norm for expenditures on welfare and
health and hospitals. It is important to note that while per
capita terms are used for consistent comparisons here, other ratios
may be more relevant for certain types of spending. Expenditures
per pupil, for example, may reveal more about the true level of
education spending than per capita measures.
Table 2
mI'NRE FWCITCNS, SELEClED SUITS, 1986
1 986
State (a) Other (a) Per Capita M d b )
onited States - $604,455 $602 24.0% $235 9.4% $310 l2.3 $222 8.s $205 8.2% $134 5.3% $ 8 ~ ) 31.Z $2,507 100
Calif omia
k k i c o
0 NaJ York
Scurce: ACIR staff ccnqutations using ACIR Stat-1 Gowmmmt Finance Dislcettes, EY86.
(a) Figures in these c o l ir~dic ate percatage of direct total expeulibxe
(b) 100 = U.S. Average > C k - I -
Many quick comparisons among the selected states can be made. 0 For example, most of the comparison states are at or near the
average level of education spending (with only California and
Nevada being noticeably below average). Six of the ten comparison
states are, like Arizona, well below the U.S. average for welfare
spending. Arizona had the second highest expenditure percentage
on highways of the illustrated states, and the lowest percentage
of the eleven for health and hospitals.
Table 2A shows the functional distribution of per capita
Arizona expenditures between 1980 and 1987. Over that time period,
the percentage of total dollars spent on education, health, and
administration decreased, while the percentage spent on highways,
welfare and interest increased.
What can one conclude from these data? The answer is: not a
whole lot. As noted above, there is nothing in these comparisons
that tells us whether ~rizona is spending at "too high" or "too
lowl1 a level, either as measured by changes in the level of
expenditures over time or in terms of their composition. The
numbers do, however, suggest some interesting questions for further
examination in the remainder of the Committee's work: What
explains the relatively high and rising level of expenditures over
time? Are Arizonansg preferences for public goods and services
increasing as their incomes increase? Does the growth in
expenditure levels over the past decade reflect a need for Arizona
governments to increase public services in order to accommodate the
State's rapid economic growth over the same time period? If so, is
Table 3
S t a t e
Education Health Police A l l ------------------- and and Other
Primary & Pub1 i c Hospi- Correc- Expendi-
Total Secondary Higher Welfare t a l a Highways t i o n s t u r e s
United S t a t e s lOO.O$ lOO.O$ lOO.O$ 100.Ol lOO.O$ 100.0s 100.0$ 100.0s
C a l i f o r n i a
F l o r i d a
I l l i n o i s
New York
Sources: U.S. Bureau of the Census, Government Finances i n 1986-87, GF-87-5 (November
1988), Table 29; unpublished e s t i m a t e s by Robert W. Rafuse, J r . , V i s i t i n g Senior Fellow, A C I R (1989).
there reason to expect the Arizona to U.S. ratio (Table 1) to
converge rather than to widen as the State's economy enters the
next decade? What explains the unusually low amount of public
resources being allocated to welfare and health? Is this because
Arizona policy-makers are reflecting a voter preference against
resource redistribution? Or, might these numbers be explained by
the fact that Arizona is not as densely populated as much of the
rest of the country, and/or that people who live and work here are
healthier and simply better able to care for their own social
needs? Why are per capita expenditures on education and highways
on the high end of the spectrum? Is the school-aged population as
a percentage of total population high relative to other states,
requiring more education spending? Have our highway expenditures
lagged behind other states, with construction programs peaking in
@ the mid-1980's? These types of questions can be explored as the
Committee continues its work throughout the spring and summer.
The Representative State Expenditure System
A new approach to the comparative analysis of state and local
government expenditures offers some insights into these questions
about Arizona's spending for specific types of programs. The
approach involvesthe calculation of "representative expenditures."
A state's representative expenditure for a program function is the
level it would have to undertake in order to match the national
* averase level of spendins in relation to the underlvins need for the service.
The representative expenditure approach was developed during
the U.S. Treasury Department's studies of federal-state-local
fiscal relations several years ago. Estimates of representative
expenditures for eight major categories of public spending
originally published in the-Treasury report for 1984 have recently
been refined and updated to 1987.
The essential idea behind the representative expenditure
calculation is that the I1need" for spending on a particular
function in a state can be related to a wworkloadw measure. The
workload measure is a simple index comparing the level of some
relevant characteristics in a state to the level in the nation as
a whole. In the case of public welfare, for example, the workload
measure is a statels proportion of the total U.S. population living
in households with incomes below the poverty line. In the case of
higher education, the workload measure is more complicated: it is
the weighted sum of a state's proportion of total U.S. population
in various age groups. Given these workload measures, which all
are expressed as proportions of a U.S. total, a statels
representative expenditure for a function is the equivalent
proportion of the actual total spending for the function by all
state and local governments in the country.
For example, because Arizona contained a greater than average
proportion of low income population in 1987, the representative per
capita welfare expenditure is greater than the U.S. average. In
actuality, Arizona spent a below-average amount per capita on
il) welfare. The actual per capita expenditures were only 58.8 percent
of the representative need for expenditures. In the case of higher
education, Arizona's representative level of need is slightly lower
per capita than the U.S. average, while actual 1987 per capita
expenditures were higher than average. Arizona actual per capita
expenditures on higher education were 39.2 percent above the
representative need.
The results in Table 3 show that Arizona's total expenditures
were approximately equal to its total representative expenditures.
The general picture repeats the results of Table 2, showing Arizona
with relatively low expenditures relative to need on welfare and
health and hospitals, and relatively high expenditures on
0 education, highways, and police protection. The percentage
comparisons, however, differ from the results in Table 2 that do
not consider a measure of need. When need is included, the
magnitudes change so that Arizona's high levels of spending appear
even higher, and the low levels appear lower. The results
illustrate dramatic differences between actual expenditures and
representative expenditures for most of the expenditure categories-.
The rank order among the illustrated states shifts somewhat as
Table 2A
Arizona Per Capita State and Local, Direct General Expenditures
and Percent Distribution by Functional Category, Selected Years
Function 1980 1985 1987
Per Capita Percent Per Capita Percent Per Capita Percent
Education $673 43.5% $872 37.8% 11,071 38.2%
Highways 157 10.2 243 10.5 364 13.0
Pub1 ic Yelfare 68 4.4 181 7.9 215 7.7
Health & Hospital 110 7.1 109 4.7 126 4.5
Police & Fire 102 6.6 150 6.5 172 6.1
Sewerage & Sanitation 54 3.5 86 3.7 78 2.8
Local Parks & Recreations 70 4.5 98 4.3 122 4.4
Financial Administration 78 5: 0 96 4.2 117 4.2
and General Control
Interest on General Debt 45 2.9 163 7.1 196 7.0
Other Expenditure 191 12.3 307 13.3 342 12.2
Total 1547 100.0 2305 100.0 2803 100.0
Source: U.S. Bureau of the Census, Governmental ~inances, various years.
Note: Expenditures are in current dollars; percent details may not add to 100.0
due to rounding.
*For 1985 and 1987, Local Parks and Recreation adds in spending for
natural resources."
Economists use several tax and tax-related measures as
indicators of fiscal performance. In general, these indicators
rely on four basic estimates: population, personal income, size of
tax base, and tax and revenue collections. The first three of
these indicators provide common denominators for comparison. The
tax and revenue aggregates serve as numerators.
As with any aggregate measure of fiscal performance, the tax
and revenue indicators discussed here have advantages and
disadvantages, and the significance of these merits and
shortcomings varies depending on the specific indicator being used.
However, at least two observations pertain to all of the following
The first is that their usefulness derives largely from the
fact that they provide a quick and consistent method for
comparison. In practice, there is much more consistency across
states as to what constitutes a given tax or tax. base than there
is regarding what is an appropriate public expenditure.
A second and equally important merit of aggregate indicators
of interstate fiscal variation is their ease of calculation and,
thus, their familiarity to a wide range of citizen groups.
At the same time, however, such interstate tax and revenue
comparisons are characterized by several inherent limitations and
therefore should be interpreted with care:
A. Interstate comparisons based on collections do not take
into account variation in the scope, quality, or cost of
public services p-rovided in each state. It may be that
differences in tax burdens across states represent
varying levels of services provided, not only varying tax
B. The estimates on which the measures are based are assumed
to be independent of each other, ignoring the possibility
that they may interact. For example, tax rates may
influence the size of the tax base, or some of the income
being taxed may itself have been created by the public
C. The use of aggregate measures gives no indication of the
incidence of tax burdens--how the tax burden is
distributed among, for example, income classes or
different types of taxpayers such as residents and
D. The estimates for any particular year may not be
representative. For example, a state's tax revenues in
a particular year could reflect a revenue windfall or
shortfall, or a temporary tax surcharge.
It is important to keep these warnings in mind when making
interstate comparisons of the sort presented here. Such tax burden
measures do not tell the whole storv about such concerns as
taxpayer equity and business climate. However, because the same
limitations apply to the data for each state, when viewed over time
the comparisons can present a useful picture of how a specific
state compares with others.
Overall Revenue Growth
Between 1975 and 1987, Arizona state an'd local government
experienced extraordinary revenue growth. As shown in Table 4,
Arizona's state-local own-source general revenues in 1987 were over
four times their 1975 level. While Arizona's total revenue growth
during this period was greater than that of any of the comparison
states, several of the other states (including Utah, Florida,
Texas, and New Mexico) also experienced high levels of revenue
growth compared to the national average.
Knowing that a state's revenues have grown rapidly tells us
little about the reasons for such growth or about the change in
tax burdens in the state, however. Revenue increases may be due
to changes in demographics, tax policy, economic conditions, or
other factors which interact to affect tax yields.
(in $millions) % Change % Change in
Change in Per Capita
% Chan e as %of Population Personal Income
1975 1980 1985 1987 1975-87 US Ave. 1975-1987 1974-1986
Neighborin States
calif ornya 22,687 36,577 60,016 75,620
Colorado 2,215 4,066 7,003 8,145
Nevada 627 1.147 2.097 2.414
New Mexico
Other Comparison States
Florida 6,016
Illinois 9,821
Minnesota 3,909
New York 22,886
Texas 8,413
Source: Compilation based on U.S. Bureau of the Census, Government
Finances, various issues.
Two obvious factors that affect overall revenue increases are
population growth and personal income growth. A growing population
will lead to increased tax revenues to the extent the newcomers are
subject to taxes already in place. An increasing population will
also require that a higher level of services be provided if per
capita service levels are to be maintained; this increased demand
for services will also necessitate higher revenues. Higher per
capita personal income levels will increase revenues to the extent
taxes are levied on income or uses of income, i. e. consumption.
As income increases, demand for public goods and services may also
increase, requiring higher revenues to support their provision.
The last two columns of Table 4 show how the two factors of
population and income growth relate to the statesf revenue growth.
Arizona's population grew by 52 percent between 1975 and 1987,
faster than any of the comparison states except Nevada, and almost
four times faster than the national average of 14 percent. Per
capita personal income, meanwhile, grew somewhat more slowly than
the national average, changing 263 percent compared to the national
average of 269 percent. Arizona's growth in personal income per
capita was less than the growth in seven of the ten comparison
states. While this lower-than-average per capita personal income
growth would tend to reduce revenue growth over time, it appears
that the dramatic increase in population overwhelmed the personal
income effect and led to the relatively high level of revenue
growth in Arizona.
Revenue Growth Per Cawita and Per $1,000 Income e
Tables 5 and 6 show revenue levels and growth on the basis of
population and income, respectively. Putting the revenue data on
a per capita basis allows more meaningful comparisons of states
with differing population levels and rates of population growth.
Adjusting for income also nets out effects of state size and
Tables 5 and 6 show that when population and income growth are
accounted for, Arizona's revenue growth was about average for the
period between 1975 and 1987. The State's revenue per capita grew
275 percent over this period, just about the national average of
276 percent. The state's revenue per $1,000 income grew by the \. national average of three percent.
Level of Revenues
If Arizona's rate of revenue srowth (accounting for population
and income growth) is about average, how does its level of
collections compare? Tables 5 and 6 also permit interstate
comparison of revenue levels.
Revenues per capita One measure widely used to make
interstate tax burden comparisons is the level of revenues per
capita. By dividing collections by population, such measures
provide a common denominator among states and account for different
population levels. Per capita measures are easily computed and
$ of U.S. 5 of U.S. 5 of U.S. % of U.S. $ Change Change as $
1975 Average 1980 Average 1985 Average 1987 Average 1975-87 of U . S. Ave.
Neighboring S t a t e s
C a l i f o r n i a 1071 126.0 1545 117.0 2276 110.6 2697 115.0 252 9 1
Colorado 874 102.9 1407 1 06.5 2167 105.3 247 1 105.3 2 83 102
Nevada 1060 124.7 1436 108.7 224 1 108.8 2397 102.1 226 8 2
New Mexico 80 4 94.6 1508 114.1 2370 115.1 2449 104.3 3 05 110
Utah 694 81.7 1166 88.2 2052 99.7 2066 88.1 298 108
Other Comparison S t a t e s
F l o r i d a 7 20 84.7 1077 81.5 1772 86 .O 2072 88.3 288 104
I l l i n o i s 881 103.7 1341 101.5 1944 94.4 2 16 9 92.4 246 8 9
Minnesota 996 117.1 1582 119.7 2608 126.7 29071 123.9 292 106
New York 1263 148.6 1843 139.4 2987 145.1 3542 151.0 2 80 102
Texas 6 88 80.9 1161 87 - 8 1875 91.1 2024 86.3 294 107
Source: Compilation based on U.S. Bureau of t h e Census, Government
Finances, v a r i o u s i s s u e s .
* m M C A t cMN-smcE (;ENFRAI; IlEvmlE
PER $1,000 F%RXNAL INCm, 1975-1987
% of U.S.
1975 Average
Neighboring States
California 180 114.4
Colorado 161 102.3
Nevada 182 115.7
New Mexico 199 126.2
Utah 160 101.5
Otha Cauparison States
Florida 137 87.3
Illinois 142 90.0
Minnesota 184 117.0
New York 205 130.4
Texas 141 89.6
% of U.S.
1983 Average
% of U.S.
1905 Average
% of U.S. X Change Change as %
1981 Average 1975-87 of U.S. Ave.
h x e : Ccnpilation based on U.S. Weau of the Census, Govennrent
Fhaxes, various issues.
have an intuitive appeal; they are, however, weak measures of tax
@ burden.
Per capita measures treat all residents identically,
regardless of their age, degree of economic dependence, taxpaying
capability, or need for public services. For example, two states
with the same level of collections and same number .of residents
but different mixes of retirees and workers would be measured as
having the same tax burden, even though the states could be
expected to have differing aggregate taxpaying capabilities and
differing needs for public services. By dividing by the number of
state residents, per capita measures also fail to account for the
tax burden effects of revenue collections from non-residents (such
as out-of-state workers, visitors, and consumers).
The data in Table 5 show that since 1975, Arizona has
consistently been slightly below the national average (97 percent
to 99 percent of the average) in collections per capita. In
contrast, all of the state's geographical neighbors except Utah
have been somewhat above average in total collections per capita.
The two "economic neighbortt states of Florida and Texas have
remained consistently below the U.S. average. And two of the
comparison states, Minnesota and New York, show per capita
collections well above average (24 percent and 51 percent above
average, respectively, in 1987) .
Revenues per $1,000 income State and local revenue in
relation to personal income is a somewhat better measure of
interstate burden variation than revenues per capita, because it
captures an element of differential taxpaying ability among states.
By focusing on resident income, however, this measure (like
revenues per capita) ignores tax exporting, the ability of a state
to collect taxes from nonresidents. By failing to account for non-resident
taxes, the ratio of revenues to income overstates the tax
burden on the residents of energy-rich states such as Texas, or
tourist-rich states, such as Nevada, that can significantly export
taxes. By focusing on income, this measure also distorts the tax
burden where various tax bases are changing at rates different from
income. This is true, for example, in states experiencing economic
decline reflected in declining property or sales tax bases. Since
these sort of distortions apply to all states' revenue-income
ratios to varying degrees, one should be cautious in drawing
conclusions about tax burdens from the ratios shown.
Table 6 shows that Arizona's revenues per $1,000 personal
income were between seven percent and 11 percent above the national
average between 1975 and 1987. In 1987, three of the comparison
states--California, Colorado, and Nevada--were within one percent
of the national average on this measure, while Utah, New Mexico,
Minnesota and New York were well above average. Considering that
New Mexico and Utah have significant mineral wealth, their high
ratios are probably due, at least in part, to tax exportation.
And note the data for Texas, another state with significant tax
exportation potential. Even though that state's revenue-income
ratio is shown to be seven percent to 10 percent below average,
this measure probably overstates the resident tax burden in Texas.
The above-average ratio for Arizona probably also overstates the @ resident burden, since Arizona can export some portion of the tax
burden to non-residents through the mining and tourism industries.
Tax Mix
What is the relative contribution of various revenue sources
to overall tax burdens? Table 7 presents data on how Arizona's
revenue system compares with that of other states by showing the
percentage composition of total state-local own-source revenues by
ma j or revenue source.
Table 7 presents a complicated picture. On the one hand, it
shows the diversity of state-local tax systems, reflecting
differing economic bases and political preferences. Nevada and
Florida, for example, have very low or no state income taxes
compared with most other states, but rely more heavily on sales
taxes. Texas and New Mexico both have substantial severance tax
revenues and low (or no) income taxes, but Texas relies more
heavily than average on the local property tax whereas the opposite
is true for New Mexico. New York, California, and Minnesota all
rely heavily on the income tax.
On the other hand, the table shows considerable agreement
among states in how they structure their intergovernmental tax
systems. For example, in all of the comparison states except New
Mexico, the state share of total state-local revenues is between
FlBcmnm COsITIm OF STATEim cxa-m -, ma7
t7lmlE- -=KEV BJUES - --- --
All All Charges & AZ1 A l l Charges & ~~E
State General Incane Severance Other Miscell. Local Property General Other Miscell. STAEAOUL
Revewes Sales Tax Taxes Taxes Taxes Reveries Revenues Taxes Sales Tax Taxes Revenues REVENUES
Neigkboring States
california 57.9% 14.7% 25.0% 0.0% 83% 9.9% 42.1% 16.1% 3.7% 3.62 187% 100.0%
colorado 45.2% aa 14.2% 0.1% 83% 13.7% 54.a 23.1~ 8.5% 1.9% 21.4% 100.0%
Nevada 56.1% 22.9% 0.0% 0.0% 24.0% 9.2% 43.9% 13.4% 0.2% 7.1% 23.1% 100.0%
a ~ e ~w i c o 72.6% 19.0% 9.3% 6.4% ai% 29.7% 27.4% 6.1% 3 1.2% 16.9% 100.0~
Utah 57.7% 16.1% 17.1% 0.6% 7.6% 16.3% 42.3% 19.0% 3.6% 1 17.9% 100.0%
Other Canparison States
Florida 46.3% 22.0% 2.4% 0.3% 14.a 6.a 53.7% 21.0% 0.1% 5.2% 27.3% 100.0%
Illinois 52.4% 13.6% 15.R 0.0% 12.2% 10.9% 47.6% 25.4% 4.a 4.3% 13.0% 100.0%
Minnesota 55.4% 11.9% 22.2% 0.1% 1o.a 10.5% 44.6% 19.6% 0.1% 0.a 24.0% 100.0%
New Yo& 47.4% a.l% 23.2% 0.0% 7.9% 8.3% 52.6% 22.6% 6.9% 9.7% 13.4% 100.0%
Texas 44.4% 13.5% 0.0% 3.5% 16.0% 11.3% 55.6% 27.1% 3.3% 2.2% 23.0% 100.0%
U.S. A-Same:
Canpilation based on U.S. Bureau of the Census, Goverrrnent
Finances in 1986-87, and State Government Tax Collections in 1987.
44 percent and 58 percent. Arizona is close to the national
average with 54 percent of its revenues accruing to the state
government and 46 percent being raised by local governments. On
average, state-local revenue systems are fairly evenly diversified,
relying nearly equally on income, sales, and property taxes. With
the exceptions of New Mexico and Texas, for example, all of the
comparison states are within seven percentage points of the average
property tax reliance of 20 percent.
While Arizona's overall revenue mix does not look extremely
different fromthe national average, the Arizona system does differ
from the average in two notable respects: Arizona derives a larger
part of its revenues from state and local general sales taxes (24
percent vs. a 17 percent average) and a smaller portion of its
revenues from income taxes (12 percent vs. a 17 percent average).
Note that the Arizona sales tax proportion is slightly overstated
here, since the state severance taxes are included in the State's
general sales tax category. It is also interesting to note that
while Arizona ranks eighth among the eleven compared states for
reliance on the property tax, the Arizona proportion is only 1.5
percent below the national average.
Tax Capacity and Tax Effort
A state's tax mix is a flawed indicator of tax burden
resulting from particular revenue sources because it fails to take
into account states' varying capacities to raise revenues from
particular sources. Tax capacity depends on the underlying
economic bases in a jurisdiction, such as mineral wealth,
consumption of particular goods or services, income levels, and
property values. For example, two states that raise the same
amount of revenue through the property tax but have differing
aggregate property tax values do not place the same burden on that
tax base.
The Advisory Commission on Intergovernmental Relations (ACIR)
has developed a methodology that measures each state's tax capacity
on an aggregate and tax-by-tax basis. The ~epresentative Tax
System (RTS) approach calculates tax capacity in each state by
applying national average tax rates to a uniformly defined set of
commonly used state and local tax bases. The resulting tax yields,
or capacity, in each state thus reflect differences in the
underlying tax bases and do not depend on whether or at what level
a state actually taxes a particular base. Once capacity is
calculated, the tax burden, or effort, placed on each base is
computed by dividing actual collections in the state by its
hypothetical capacity.
Tax Capacity RTS tax capacity and tax effort data for Arizona
and comparison states are presented in Table 8 and Chart 1. The
data show that between 1975 and 1986, Arizona's total tax capacity
increased from around 92 percent of average to just about average
(99 percent of average) . In 1986, Arizona ranked 20th out of 50
states and the District of Columbia in total tax capacity. Except
for Utah, most of the comparison states have shown relatively high
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1986 RTS Tax Capacity = 99 1986 RTS Tax Effort = 99
Total RTS Tax Capacity and Tax Effort, 1975-86
- Tax Capacity
1975 1977 1979 1981 1983 1985 1987
1986 Capacity and Revenue
Selected Revenue Bases
General Selective Ucenses Personal Corporate Property Mineral User
Sales Sales Income Net Income Revenues Charges
capacity over this period: Nevada, largely because of its tourism
and gaming industries, ranks third in the nation in capacity.
~alifornia and Colorado also show relatively strong and consistent
tax capacities, and New ~exicoh ad above-average capacity for three
of the five years shown.
Note that tax capacity in both New Mexico and Texas increased
through 1982, then decreased. This pattern reflects the effect of
fluctuating energy prices during this period, which strongly
affected the fiscal environments of these states. Other regional
economic trends are also reflected in these numbers: the decline
in the older industrial states (Illinois and New York),
particularly during the recession in the early 1980's; the
subsequent recovery of the Northeast (New York); and the decline
in the economic strength of the farm states (Utah). These results
illustrate the sensitivity of the RTS tax capacity measure to the
varied and changing economic bases of each state.
The bar graph on Chart 1 shows Arizona's tax capacity relative
to the U.S. average for different types of tax bases in 1986.
Arizona's capacity was significantly above average for property
taxes, and below or near average for all other tax bases.
Tax Effort As shown in Table 8 and Chart 1, Arizona's overall
tax effort (collections relative to capacity) dropped sharply
between 1980 and 1982 (from 117 percent of average to 92 percent).
As of 1986, Arizona's tax effort was just about average (99 percent
of average), and ranked 21st among all the states. This indicates
that given its underlying economic bases, the state was placing an
overall burden on those bases approximately equal to the national
average burden.
Arizona, however, has a higher tax effort than most of its
neighboring states. Five of the comparison states--Nevada,
Colorado, New Mexico, Florida, and Texas--are among the 12 lowest
tax burden states in the nation. The effort indices for these
states range from 35 percent below average for Nevada to 12 percent
below for New Mexico in 1986. Four of the other comparison states
show a significantly different pattern, however: New York,
Minnesota, Utah and Illinois all ranked in the top 12 tax burden
states in 1986.
Tax Effort by Revenue Source Even though Arizona's overall
tax effort is about average, it does not follow that the tax burden
placed on each revenue base is also near average. Table 9 presents
1986 tax effort indices for eight selected revenue bases to
illustrate that, indeed, this is not the case.
For example, the data show that (relative to capacity)
Arizona's tax effort for the general sales tax is 53 percent above
average, making it the state with the second highest sales tax
burden in the country (after Washington, which had a sales tax
effort over twice the national average). Conversely, the tax
burdens placed on the individual income and property tax bases are
less than 80 percent of average, ranking the state 35th in effort
in both cases. The state's effort is also below average to varying
degrees for the corporate income tax, mineral revenues, and user
Policy Im~lications Table 9 is particularly useful for
comparing Arizonats tax burdens on specific taxes with those of
other states. Because the effort indices for each state are
calculated relative to a standardized capacity, the table presents
a picture of how intensively each state taxes its potential bases
compared to all other states. A state may then be seen to be
underutilizing or overworking a particular tax--relative to the
national average.
There may be good reasons for a particular state to differ in
some respects from the national average. Arizona, for example, may
choose to impose a heavy sales tax burden because some of the costs
will be borne by non-resident tourists. However, since all types
of taxes contain some inherent structural deficiencies and
inequities, states have tended to seek diversity and balance in
their revenue sources in order to minimize economic problems.
Thus, the committee may wish to consider altering the mix of
~rizonals tax burden to bring tax effort for specific tax bases
closer to the national average (decreasing the effort on general
sales taxes and increasing the effort on income taxes, property
taxes, severance taxes, and user charges). The Committee may
decide, however, that there are other tax characteristics more
important than interstate comparisons, and may conclude that
certain Himbalancesw are appropriate and beneficial.
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Summarv of Emenditure and Revenue Com~arisons
Interstate tax comparisons, despite their limitations, provide
useful information pertaining to relative tax burdens and
expenditure patterns. According to the tax comparison measures
examined above, Arizona is an average state in many respects.
Despite rapid population growth, Arizona has remained very close
to the national average in revenue growth per capita and per unit
income, and in overall tax capacity and tax effort. Arizona is
somewhat above the national average in expenditures as a percentage
of personal income and in revenues as a percentage of personal
income. This may be due to the exporting of taxes through the
mineral and tourism industries. Arizona also differs from the
national average in its mix of taxes and composition of
expenditures. As the Committee proceeds with its study of specific
taxes and spending programs, the interaction of economic
competitiveness and fiscal efficiency, equity, simplicity and
accountability will be explored in more depth.
Arizona Joint Select Committee on State Revenues and ~xpenditures
Fiscal 2000 Study Committee
Models and Methodology Generated by Fiscal 2000
The Final Report of the Fiscal 2000 Study Committee will
include twenty to twenty-five research studies, which jointly
provide the background for the committee's recommendations. The
purpose of each study is- to analyze and evaluate structural
features of Arizona's fiscal system, and to determine relationships
between population and economic changes and expenditures and
revenues. The primary concern of staff is to provide the committee
with the information and analysis needed to make informed
recommendations about the structure of the entire fiscal system.
There is concern that the information and analysis provided
to the Committee will not be readily adaptable for future use by
the Legislature. Although it is not the purpose of this committee
to provide the Legislature with econometric or revenue models, many
of the research studies generated for the work of the committee
will involve the use of specific models or methodologies. These
tools will be well documented and can be employed on standard
statistical or spread sheet computer programs. The ~ommittee's * Final Report will be a living document, which, with updated data,
can be used by the Legislature to replicate any of the analysis
deemed relevant.
What follows is a brief description of some of the methods
and data that will be employed for the work of the Committee.
1. The Property Tax
With the cooperation of DOR, staff will obtain property tax
data files on assessed valuations and other relevant property tax
data for all counties in the state. These data will be loaded,
cleaned and assembled by Tracy Clark on the ASU mainframe computer
under the supervision of committee staff. Through September 1989,
the Committee staff will use these data to analyze the impact of
various potential changes to the structure of the property tax.
At the end of the Committee's process, it will be a relatively
simple task to transfer the data to other computers. To keep this
a "livingw data set, the property valuations need to be updated
annually. Models or methods developed by staff to perform policy
option analysis on these property data will be documented and made
available to all interested agencies. e
m 2. The Sales Tax (Transactions Privilege Tax)
The methodology employed to evaluate structural changes in the
sales tax involves matching sales tax revenue data with consumer
expenditure data. We will be collecting the most recent figures
and historical figures to evaluate various policy options. The
methodology used and data employed will be clearly explained and
stored on floppy disks.
As with the property tax, future use of this methodology will
require updating the underlying data, but the basic sources are
publicly available.
3. The Personal Income Tax (PIT)
The background report prepared by the research consultants for
staff use will discuss a variety of structural and policy issues
related to the personal income tax. Because the updated DOR income
tax model will not be operational before they begin their work on
analyzing PIT structural issues, the research consultants will be
relying on the output of a proprietary tax simulation model at the
National Bureau of Economic Research, cambridge, Massachusetts.
NBER, a privately funded research organization directed by Martin
Feldstein, has developed a tax simulation model that encodes the
specific instructions from states' personal income tax forms and
the data from a sample of federal tax forms by state. DOR has
@ provided staff with Arizona taxpayer information to use in the NBER model. When the Committee begins its policy options deliberations,
the Committee will be able to rely on the DOR model to obtain
simulation results.
4. Microeconomic Analysis of the Relationship of the Economy to
the Fiscal System
A methodology that attempts to determine the statistical
correlation between a variety of potential business location
factors and the employment growth rate of the economy will be
employed for the work of the Committee. Like the sales tax
methodology, this econometric methodology can be employed with
updated data to investigate similar issues in the future.
The data used in the report for the Committee will be the most
recent data available for this type of interstate comparative
analysis. These data can be made available on floppy disks, but
to determine whether the business location situation has changed
in years to come, new data (all available from public sources)
would need to be gathered.
4- H u m SERVICES
2555 E. First St., Suite 107 Ilrcson, AZ 85716 0323-l303
Arizona Joint Select Camnittee on State Revenues and Expenditures
E l l i o t Hibbs, Chairpersm
1700 W. Washington, Suite 370
Phoenix. Arizona 85007
k a r Mr. Hibbs and Camittss Memkre:
On behalf of the Arizma Coalition for Human Services, I wwld l i k e to take
this opportunity to respond to your request for information on state
revenues and expenditures. In regards to expenditures, I have enclosed a
copy of cur legislative agenda which clearly presents the areas of need i n
human services. Our c o a l i t i m has been actively advccating for human
services since i t s inception i n 1983.
While cur c o a l i t i m has been exploring the impartant issue of revenues, we
were not prepared to discuss r e c m d a t i o n s at the public hearing which was @ recently held in Pima W n t y . Notice of the hearing uas received two days
~ r i o tro the scheduled date.
The issue of state revenue i s certainly a complex one and we are pleased to
know that ywr ccxrmittee i s working m some solutims to the problem.
hr recomnendations at t h i s time wwld te t o look at a combination of reallo-cating
p r i o r i t i e s at the state level that wwld free m e y for other
needs, the closure of tax loopholes, and the possibility of increased taxes
if that i s the only way to fund an adequate h n s ervice system.
An examole of reallocating p r i o r i t i e s might be the criminal justice system.
We believe less expensive more effective w n s of handling pecp!e v;,% are
not a threat to society cwld be developed instead of adding expensive
prison beds.
We believe there may be tax loopholes i n cur revenue system which seriously
effects the financial h s e of the state. We mid strongly enccurage explo-ring
these loopholes with action being taken i n this legislative session.
Our ccmlition i s opposed to a food tax, but might support taxing c a r b a t e d
beverages as a swrce of additional revenue.
THE GOAL: An effective, economical human services system responsive to the rights and needs of citizens who.
through no fault of their own, are unable to obtain basic life support means for themselves and their dependents.
We w i l l be happy to forward any additional input to ywr c m i t t e e as cur
coalition explores t h i s area i n more depth. We wwld also be interested in
a fbolloewiung styoo uer pfrougresls and providing any data cn human services which might
cc Sharm Megdal
Jeff H i l l
To: The Arizona Joint Select Committee on State Revenues and
From: Ruth R. Houghton
2907 East air mount
Phoenix, Arizona 85016
Age: 68
Occupation: Executive Director, private non-profit social
service agency
Arizona's structure for collecting revenues for the support of
public institutions and programs is clearly in need of restruc-turing.
During five of the last six years, the revenues collec-ted
under the present system have been insufficient to cover the
budget adopted during the preceding legislative session.
The following facts need to be considered:
Property Tax
1. Only 17% of Arizona's total land area is privately owned.
(See attached statistical summary.)
This raises the question of whether the state can afford to
give tax exemptions to property taxpayers. It also indicates
the importance of having all private land included in school
district boundaries.
2. Arizona's property tax rate for homeowners is low. My own
annual property tax bill for 1988 is $88 less than my tax
bill in Los Angeles County forty years ago - for a single
family dwelling valued at one-tenth the value of my present
home in Phoenix.
Indiaent Health Care
According to published reports, recent growth in Arizona's
economy has occurred principally in service industries, which
employ workers at low rates of pay and provide no employee
1. Persons who earn minimum wage ($3.35/hour or $6,968/year
@40 hours per week) make too much money to qualify for care
under the Arizona Health Care Cost Containment System(AHCCCS).
In order to qualify for AHCCCS, a family of 6 must have an
annual income of no more than $6,442.(See attached AHCCCS
eligibility criteria.) *
2. Workers who work for low hourly pay without employee bene-fits
are forced to rely on public health care programs and
the public welfare system when they are confronted with
catastrophic illnesses or family emergencies. Emergencies
in such families are responsible for much of cost overruns
in the AHCCCS program and client increases in Department of
Economic Security assistance programs.
Personal Opinions
Sales Tax and Users Fees
1. I believe that the state cannot afford to continue to exempt
food from the sales tax,
2. Many other states operate toll roads rather than freeways.
It seems reasonable to consider tolls as a possible revenue
- DRACE IN ARIZONA RESERVOIRS AN EcONOM~C PROFILE OF
In Thousand Acre Feet - Storage
AS of 61-87 - 652
Avg. Storage'
Land - 113.508 square r n k . Water - 492 square mlies
ANOM.t he nabon s smh largest state IS located m me Southwest and also IS one of be Row Mountam Slates. D mIS th e key word In devnblng
Anzm ecommcaly ard gqraontcarlv The stale conra~nslh ree btsUnct topqraphe areas: a hqh Wteau r q mI ml n the norUEmeast mrnw of the
gate, a mountainous area runs a~agonallvln rougn the rnldsecnon to me nonhwestem hp: ard the southwestern d6tncl s d~ldedbe iween desen vallep
ard low rnoumn ranps %ese loflraunlc areas all have attierent cl~rnatesw, hd have dlsoncwe(y mnhenced devewrnent In each rqlon
m n t . . .
s e . . .
s e k . . ,
k.. k D am. W . . . .
: Apacne,
. . . . . . .
Government. . . . . .
Annual June
Avo. 1986 1987 Saguaro . . . . . . . . 1,710.0 1,248.8
ilorseshoe. . . . . . . . 310 .0 156.8 1,26923.16 1 3
Soil Conservation Service.
30.4 pmns p r square mile
ATER CONSUMPTION AND SUPPLY SOURCES LEADING CITIES - POPULA~ON - Normalized 1970 Conditions STATUS OF LAN0 OWNHWlP
U.S. Forest Se~ce. . . . . . . 15%
U.S. Bureau of Lard
MaMgement . . . . . . . .17
Indian Rese~amm . . . . . .28
State of Anzona . . . . . . . . 1 3
~ u a l o r C o r p o r i ~.. .. . 17
~ P u M i c l a n d s . . . . . . .10
Phoenix (State Caoltol). . . .
T u w h . . . . . . . .
Mesa . . . . . . . . . .
Tern*. . . . . . . . . .
Glendale . . . . . . . . .
Sconsdale . . . . . . . .
Chmler . . . . . . . . .
'Pwulaton as of July 1,1981
lwCe(ws . . . . . .1.392161
19x1 C e w . . . . . . 1.775399
1980 C e w . . . . . ,2718,425
1986 Estimate . . . . . .13 51.%
1987 Esbmale . . . . . .3.469.m
YO Change
+ 472% + 76.8 + 135.0 + 253.4 + 33.6
Po~uiabon. . . . . . . . .
Wage and Salay Employment .
Retal Sales . . . . . . . .
Bann Depowls . . . . . . . Vehtde Regtslfabons : . . . .
Mdor Fuei Consumpn
RACIAL BREAKDOWN - 1980 (gallons). . . . . . . . .
White . . . . . . . . . . 82.4%
$8 State Water Plan - Altsrnatin, Futures, February, 1977.
TOTAL. . . . . . . . .1 W.Ea
SpaMhHentage.. . . . 18.2%
Note: Prior to 1982 Retail Sales figures included food sales. Ke~fwe
o cuentas medicas que usted adquirid durante el
atlo pasado para ayudarle hacerse elegible. Usted
tiene que ser residente de Arizona.
Maximum Annual Income lngreso Mdximo Anual
Persons in Not More Personas en No MAS
Household Than Hogar de Casa
1 $3,200
2 4,266
3 4,810
4 5,354
5 5,898
6 6,442
$544 for each additional dependent.
For information on how to be determined Indigent Para informacidn para saber como puede ser
or Medically Needy, call: determinado lndigente o Necesitado Medicamente,
COUNTY CITY PHONE # AND EXT. CONDADO ClUDAD #de TELEFONO Y EXT.
Apache Springerville 333-51 63 Apache Springerville 333-5163
Cochise Bisbee 432-5703, X490 Cochise Bisbee 432-5703, X490
Coconino Flagstaff 779-6575 Coconino Flagstaff 779-6575
Gila Globe 425-5721, X380 or 381 Gila Globe 425-5721, X380 o 381
Graham Safford 428-6730 Graham Safford 428-6730
Greenlee Clifton 865-3322 Greenlee Clifton 865-3322
La Paz Parker 669-61 55 La Paz Parker 669-61 55
Maricopa Phoenix 244-021 0 -cC Maricopa Phoenix 244-02 1 0
Mohave Kingman 753-9141 Mohave Kingman 753-9141
Navajo Holbrook 524-231 5 Navajo Holbrook 524-231 5
Pi ma Tucson 746- 1073 Pi ma Tucson ' 746-1073
Pinal Florence 868-5801, X244 Pinal Florence 868-5801, X244
Santa Cruz Nogales 287-9284 Santa Cruz Nogales 287-9284
Yavapai Prescott 445-7450, X288 or 286 Yavapai Prescott 445-7450, X288 o 286
Cottonwood 634-2203 Cottonwood 634-2203
Yuma Yuma 782-651 6 Yurna Yurna 782-651 6
For referral to your local DES or SSA office call: Para referencia a su oficina local DES o SSA Ilame:
AZ DEPT. DEPT. de AZ DE
AFDC Eligibility 1-800-352-8401 Elegibilidad AFDC 1-800-352-8401
(toll free in AZ) (sin cobro en AZ)
Public Hearing
Phoenix, Arizona
December 5, 1988
The Arizona Chapter of Tax Executives Institute is pleased to
present these general comments to the Joint Select Committee on
State Revenues and Expenditures.
The Tax Executives Institute (TEI) is the principal association
of corporate tax executives in North America. The membership of
TEI is composed of more than 4000 members representing more than
2000 of the leading corporations in the United States and Canada.
TEI represents a cross-section of the business community and is
dedicated to the development and effective implementation of
sound tax policy, to the promotion of uniform and equitable
enforcement of tax laws, and to the reduction of the costs and
burdens of administration and compliance to the benefit of both
government and taxpayers alike. As a professional organization,
TEI is committed to maintaining a tax system that works - one
that is both administrable and can be complied with.
Members of TEI are responsible for managing the tax affairs of
their companies and must contend with the provisions of the tax
laws relating to the operation of business enterprises. We
believe that our diversity and professional training of our
members enable us to bring a balanced and practical perspective
to the issues to be addressed.
The Arizona Chapter of TEI was chartered in 1976 and holds
monthly meetings in the Phoenix area. The Arizona Chapter
consists of 28 members representing 23 companies doing business
in Arizona.
The purpose of these comments is to suggest a framework within
which the committee might examine the principal revenue sources
of the state - sales, property and income tax. These comments
are very limited in scope: they do not address taxes or revenue
sources other than those- mentioned above, do not comment on the
individual income tax and do not address any expenditure issues.
Moreover, we do not attempt to take a position on any of the
points raised herein. We intend to present a more detailed paper
with our specific suggestions on what, if any, changes should be
made to Arizona's tax laws in the future. Time constraints have
limited the scope of the present paper to outlining some of the
issues which should be considered in connection with an
examination of the sales, property and corporate income tax.
Arizona imposes a 5% transaction privilege tax on the privilege
of doing business in the state. The tax is imposed upon the
person or entity engaging in business, measured by sales volume.
The tax may be, and usually is, passed through to the ultimate
consumer and therefore acts in the same manner as a general sales
tax. It is supplemented by a compensating use tax and a 2%
rental occupancy tax. In addition to the state level tax, some
78 cities and towns in Arizona levy a tax in the nature of a
sales tax.
a A. Uniform State and Citv Tax Base
Ideally, a tax should be easily understood, simple to administer
and enforce and easy to comply with. We believe the ~oint Select
Committee should examine the existing system of state/city taxes
with this in mind.
Presently, the 78 cities and towns imposing a sales tax may adopt
the same base as the state tax but need not do so and, indeed,
many do not. Although most cities have now adopted the model
city tax code (MTCT), the wide range of options available under
the code results in a lack of conformity between cities as well
as lack of conformity with the state. For example, food, which
is exempt at the state level, may be taxable or exempt depending
on the option selected by each city.
There are also many problems in interpreting the various codes.
In the best case, terms such as "foodu under the MCTC is
identical to the state definition. Unfortunately, there are many
other definitions that are not consistent such as
I1manufa cturingtl, ttmanufacturing equipmenttt (income producing
capital equipment under the MCTC), "expendable itemstt,e tc.
The problem for business taxpayers is therefore twofold:
numerous separate bases upon which the tax is imposed and
differing definitions and interpretations of identical terms. We
believe consideration should be given to making a uniform sales
tax base mandatory throughout the State.
B. Exemptions
Apart from the question of multiplicity of bases is the question
of what a unified base should consist of. Put another way, what
business transactions should be exempted from the tax? The state
level tax presently has a number of exemptions, principal ones
being sales for resale, casual sales, most services, drugs and
medical devises, food, and gasoline. In addition, numerous
other, more limited exemptions exist. While few would argue over
the need for an exemption for sales for resale, the various other
exemptions should be examined closely. Important considerations,
in this regard are whether the exemption furthers a substantial
public interest (e.g., charitable organizations), eases
regressivity (e.g., food) or minimizes multiple taxation (e.g.,
manufacturing equipment) .
C. Unification of Audits- and Appeals
Under present law, taxpayers are subject to multiple audits on
sales tax questions from separate state and local auditors.
Often, these audits deal with identical issues and contain the
possibility of conflicting results at state and local levels.
Consideration should be given to unifying the audit function as
between the state and cities so as to assure that taxpayers are
called upon to defend their treatment of a particular item only
once, and that the appeals process is binding on both the
taxpayer and the government. Successful simplification of the
present sales/use tax system would mean that audits could be
centralized, most likely at the state level. A simplified system
would mean that audits could be conducted more quickly and
efficiently, resulting in more audit coverage by the audit
agency and less taxpayer time consumed in their individual audit.
Appeals (which should be minimized) would need to be heard only
once for the state and cities. Settlements would be expedited
and issues resolved quickly and at much less expense in time and
money for both the taxpayer and the tax jurisdictions.
Although present law (section 42-1451 A.R.S.) provides that the
~epartment of Revenue may collect and administer any transaction
privilege tax imposed by a local authority, and may enter into
agreements with such local authorities for coordinated collection
and audit functions, the statute is permissive, not mandatory,
and is not availed of by many municipalities. In practice, the
larger cities and towns in the state have opted not to
participate in the program, leaving only small municipalities,
which lack the budget and staff to undertake these functions
themselves, as participants.
Generally all tangible property in ~rizona is subject to an ad
valorem tax imposed by state, county and municipal authorities.
Various issues suggest themselves in this area.
A. Pro~ertv Classifications
Presently, eight separate classifications of property exist, each
with separate assessment ratios and some with special valuation
rules. In general, the more classifications there are, the less
uniform the impact of the tax is. Consideration should be given
to minimizing the number of classifications in order to promote
fairness and uniformity. Where special rates are desired to
encourage retention of land for specific use (such as native
desert of other natural, undeveloped condition; agricultural use,
etc.) special classes may be justified but statutory definitions
should be examined to define such special cases as specifically
as possible.
B. Assessment Ratios
There are assessment ratios for each of the present eight
classes of property. These vary from (Class 8) to 10% (Class
5) to 15% (Class 6) to 16% (Class 4) to 25% (Class 3) to 30%
(Classes 1 and 2) and an annual factored ratio for Class 7.
consideration should be given to narrowing the disparate range of
rates under current law.
C. Special Tax Districts
There are presently 23 Special Taxing Districts listed in 829
pages of A.R.S. - Title 48 - Special Taxing Districts! This
tends to create additional record keeping, disbursement of the
revenues generated and, a service fee to the county to do so.
The proliferation of special taxing districts creates enormous
e burdens on businesses to keep track of the physical location of
their property. Consideration should be given to reducing the
number of special tax districts and re-directing the revenues
generated from the fewer resulting authorities. Consideration
should also be given to increasing central state assessment, with
disbursement back to local authorities, in the case of large
industrial and commercial- facilities.
D. Primary and Secondary Values
Presently two separate values are calculated, a "primaryv1 value
and a llsecondaryvva lue. The dual system is confusing to
taxpayers and, while it serves an important function in imposing
0 the constitutionally-mandated limitation on growth of local
spending and taxing, ways should be explored to simplify the
methodology used.
111. Corporate Income Taxes
A. Federal Income Tax Deduction
Arizona along with six other states permit a deduction for
Federal income taxes.
The determination of the amount of the federal income tax
deduction is often difficult, complex and uncertain. This is
true not only because of the mathematics involved (one needs to
solve simultaneous equations to figure both a federal tax which
allows a state tax deduction and a state tax which allows the
federal tax as a deduction) but also because it is not clear how
the federal tax imposed on a multi-state non-unitary consolidated
group should be allocated to the Arizona jurisdiction of the
unitary filing entity. This complexity has spawned considerable
litigation. See, e.g., Arizona Department of Revenue v. Arizona
Sand & Rock Co., 745 p. 2d 116 (AZ. Sup. Ct., 1987) Motorola v.
Department of Revenue, 694 p. 2d 321 (AZ. Ct. App., 1984).
~bolishing the deduction coupled with a reduction of the
corporate rate appears to be a simple solution, but this would
pose other problems.
First, as a conceptual matter, a tax on corporate (as distinct
from individual) income is a business expense as valid as any
other. Denying deductions for costs of producing revenue depart
from the concept of a net income tax and convert it into a gross
receipts tax.
Second, the base upon which an income tax is imposed should
measure the ability to pay. Federal income tax is not
proportional to a corporation's taxable income. The allowance of
credits, exemptions and the alternative minimum tax cause the
proportionality to be broken and not to recognize the federal
tax as a deduction would therefore distort the tax base as a
measure of ability to pay.
An alternative to abolishing the federal tax deduction is to
enact new statutory provisions clarifying and providing
definitive guidelines to -be applied in determining the amount of
the federal tax deduction.
B. Minimum Tax
In 1988 a minimum ~rizona corporate income of $50.00 was
enacted. There are a number of alternatives to this choice.
First, the present concept could be retained with an increase or
decrease in the dollar amount. This statement itself points up
one problem with a dollar threshold, which is that whatever
level is chosen is inherently arbitrary and thus a change in the
amount is easily justified whenever revenue needs to be raised.
Second, a franchise-type minimum tax could be employed. Under
this concept, which is utilized by a few states, a corporation
would pay the larger of a tax on net inc~me or a tax based on the
value of the corporate franchise (e.g., stockholders1 equity plus
funded debt) .
Third, a comprehensive alternative tax base, such as is used in
the federal system, is possible. The problem here is the sheer
complexity of such a system and the severe paperwork burden on
both taxpayers and the Department of Revenue. Nor is an attempt
to "piggybackw on the federal system a viable alternative since
problems of allocation and apportionment would be very severe.
Current law is perhaps the lesser of evils in this area.
C. consolidated Return
Simplicity, clarity and certainty are virtues of a corporate
income tax system highly desired by the corporate taxpayer
The present unitary system of grouping affiliated corporations
for return filing purposes is quite to the contrary,complex,
uncertain and in some cases artificial.
A main problem is determining when are subsidiary's business is
unitary with another. Present DOR regulations are very
restrictive in this regard and often lead to a multiplicity of
Arizona returns being filed where only one federal return is
needed. Controversies over what is or is not part of a unitary
business are a natural consequence of this concept.
a Consideration should be given to allowing taxpayers an option to
file consolidated returns, utilizing federal definitions.
The Joint Select Committee has a difficult and important task.
We hope that outlining some of the issues which can be addressed
in sales, property and corporate income taxes will aid in an
examination of one area of the Committee's responsibilities. We
look forward to providing more in-depth comments once the
committee has decided on an agenda of areas in which to focus.
Respectfully submitted,
Arizona Chapter
Tax ~xecaives ~nstitute
-2 -
Robert E. Ciancola
Chapter Vice President
Tel. (602) 222-6915
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