A special legislative panel voted Thursday to reduce the number of state income tax brackets from five to three, with an eye on eventually creating a single tax rate.
The vote, which occurred over the objection of the two Democratic lawmakers, also includes a recommendation that, as long as the state has tax brackets, that they be indexed to account for inflation. In essence, if someone's income rose no faster than the cost of living, there would be no danger of being thrown into a higher tax bracket.
Sen. Steve Yarbrough, R-Chandler, said that's only fair.
“People should not see this ‘bracket creep’ purely as a result of inflation,” he said.
But the biggest debate was over that long-range goal by Rep. J.D. Mesnard, R-Chandler, to have a single tax rate rather than the five Arizona has now or even the three that are being proposed.
Mesnard insisted he is not proposing a flat income tax, where Arizonans would all pay a set percentage of their income. He conceded that would mean higher taxes for those at the bottom of the income scale — and even some in the middle class — a move that would be politically unacceptable.
Instead, he said there could be a single rate, but with built-in provisions for certain deductions and credits to ensure that the system maintains some form of progressivity, with a higher proportional burden on those making the most.
That raised questions from Sen. Steve Farley, D-Tucson, about why go through what could be convoluted changes in the tax system if the result effectively would be the same, both for individual taxpayers and the state as a whole.
Steve Slivinski, an economist with the Goldwater Institute who also serves on the panel, insisted that the change would have positive economic development effects. In essence, he said, it would allow Arizona to advertise to the world that it has a simple income tax system, with a single rate, even if the details of how that works are more complex.
All that goes to the goals of the Joint Task Force on Income Tax Reform. These include making the system as simple as possible while trying to make it both fair and stable, but without increasing the overall amount of taxes collected.
The easiest change goes to that question of indexing.
Under current law, for example, a single person who makes between $25,000 and $49,999 a year pays a top tax rate of 2.88 percent. But every dollar over $50,000 is taxed at 3.36 percent — even if that increase simply matches inflation.
The difference to individual taxpayers right at that line is minimal, with perhaps an additional $1 a year for a $100 raise.
But all that indexing adds up as a windfall for the state: Legislative budget analysts estimate that this bracket creep brings in an extra $10.9 million a year.
The idea was so popular it was approved unanimously earlier this year. But the plan was quashed in a veto by Gov. Jan Brewer.
Brewer, in her veto, said she supports “appropriate adjustments” to relieve individual income tax burdens. And the governor said adjusting brackets for inflation is one way to deal with that.
“However, such action should not occur automatically,” Brewer wrote. “Instead the Legislature should make those adjustments after careful consideration and in relation to other tax and expenditure decisions.”
The plan could meet the same fate this time around.
Gubernatorial press aide Andrew Wilder was noncommittal about what his boss would do, but he said that Brewer, in her veto letter “makes a convincing case against automatic versus carefully considered adjustments.”
The plan to reduce the number of tax brackets keeps both the top rate of 4.54 percent and the bottom rate of 2.59 percent. But the three middle rates which now range from 2.88 percent to 4.24 percent would be compressed to a single 3.90 percent rate.
Mesnard said, though it is structured so that virtually no one making less than $100,000 a year would pay more. That's because the bottom rate, which now covers income up to $10,000, would apply to the first $25,000 worth of earnings.
The possibility of higher taxes on top-income earners, though, drew concerns from Rep. Debbie Lesko, R-Glendale. So she got the panel to agree to delay the change to three brackets for at least a year under the premise that any higher taxes would be offset by inflation indexing — assuming that happens.
Farley said he's not sure what is the benefit of going from five brackets to three. He said the current system is “already working pretty well.”
Farley said his big concern is the desire to go to that single tax rate. He worried openly this was just an interim step toward a true flat tax, with every Arizonan paying the same percentage of his or her income.
Mesnard assured him that was not the ultimate goal. But Farley said any steps in that direction are bad ones.
“Why should we move toward that direction if the pure version of going toward that direction is so reprehensible?” he asked. And Farley told panel members that if they're interested in jump-starting the economy they should be looking at tax relief for those in the lower half of the income scale who are more likely to go out and spend what they have “instead of tank it away in a New York investment bank.”
Farley said he is not convinced that a single-rate tax can be done in a way that does not hurt those least able to afford more taxes.