Income Tax Reform

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An Arizona legislative committee started meeting this week on ideas to reform the state’s income tax system. Representative J.D. Mesnard, the vice-chair of the committee, Economist Jim Rounds, who is a committee member, and House Minority leader Chad Campbell will talk about the committee’s goals.

Ted Simons: An Arizona legislative committee is looking at ideas on how best to reform the state's income tax system. For more we welcome Representative J.D. Mesnard, the vice-chair of the committee, economist Jim Rounds who is also on the committee, and house minority leader Chad Campbell. Good to have you all here, thanks for joining us. J.D., we'll start with you. What exactly is this panel charged to do?

J.D. Mesnard: The goal of the task force is really to look at ways where we can simplify our personal income tax system. It's really part of what's been a comprehensive approach to how we can spur economic development in the state, create a healthy economy and it's really the last piece. Over the last few years we've looked at corporate income tax, property tax, capital gains tax. This session we did a major sales tax reform and this is the last piece and we're going to look at ways where we can make it a little easier on the people of Arizona when they file their taxes.

Ted Simons: Is simplification needed? Is it too labyrinthine out there?

Jim Rounds: Well I think this is what we have to find out because we've looked at all these other taxes, we've implemented new economic development programs, and we've seen Arizona move up in rankings in terms of being more competitive much more quickly than the other states over the years. We improved our rankings in four years. Other states, it's been taking about a decade and this is the last piece. And things that I would like to learn are where do we stand in terms of small business taxation? That hasn't been looked at enough. I think it's valid to look at some of these things. I would rather look at them and make some intelligent decisions than to just ignore them completely.

Ted Simons: Is reform necessary as far as individual income taxes?

Chad Campbell: I don't know what reform means in this case. So if reform means a flat tax then no, we should not be going down that road. If there's some simplification measures we can take with the income tax, possibly that's something we should look at. My bigger concern has always been the sales tax, TPT. We took a large step forward this last session with the reform bill that J.D. just mentioned, which we supported I think unanimously. I would like to see more done with the sales tax still, which is the most burdensome tax I think in the state, especially with small businesses. That's where we should focus our efforts. I think our income tax is fine. I'm a little worried about where this conversation may go.

Ted Simons: Do you think Arizona's income tax is fine? Because there are some who say it needs to be lowered and others who say it's already too low.

J.D. Mesnard: Well, that's the million dollar question and that's what we're going to be spending the next few months here taking a look at. The income tax hasn't been looked at in 20 or 30 years so I think it makes sense for a group of professionals, small business owners, tax experts, to take a look and see if there's ways we can improve our income tax system. I'm not against continuing the improvements on the sales tax. I think we'll see that next session but in the meantime, we can, in fact, multitask and hopefully, this task force will do just that.

Ted Simons: The argument that Arizona's income tax is too low or has been traditionally, historically low compared to other states, valid?

Jim Rounds: Well, we don't know exactly what those comparisons are because a lot of the comparisons look at nominal rates, they don't look at the actual effective rates and that's something that was introduced in the first meeting. And I think that's the way to go. Actually take a look at how the tax structure impacts individuals and businesses and see if there's anything that we need to do to tweak it. It doesn't necessarily mean lowering it and impacting revenues. In fact, that's one of the questions. I'm more concerned about is there anything we can do to continue to build our economy? And I think that's what most of the volunteers are looking at, as well.

Ted Simons: It's somewhat of a rule here: lower the taxes, build the economy. We've heard that from a variety of sources in a variety of ways. Your thoughts on that idea.

Chad Campbell: You can only go so far. We have over $4 billion right now in unpaid obligations in the state of Arizona. We're not living up to our end of the bargain with many people we've taken money from out there or taken services from. We have schools that are underfunded. We have an infrastructure that needs a lot of work. You can only go so far. The sales tax is I think one of the most unstable forms of taxation yet we rely on it heavily for our general fund. The income tax which we're talking about today, we've gutted that really for the past 17 or 20 years. Since 1990 through 2007, we cut it by over three to four percent depending on which bracket you're talking about, and it is low. The highest income tax bracket in the state of Arizona is the fourth lowest one in the country. I'm not saying we should raise it, I just think it's fine where it is but again, we have to be cautious where we're talking about lowering tax rates because if you lower the income tax rates, do you know who's going to end up picking up that slack? Middle class families. If you flatten out the income tax rate in the state, probably 80 percent of people under $80,000, are going to get a tax increase.

Jim Rounds: We've had one meeting. We've had one out of many meetings.

Chad Campbell: But I've been in the legislature for many years and I've seen these proposals. I know where they go, and I'm just a little worried.

Jim Rounds: I don't mind you guys beating each other up over the head as much as needed. You're in politics and that's part of your job, but I think the volunteers on this committee deserve a little more respect in terms of coming into this in an honest way.

Chad Campbell: I agree.

Jim Rounds: So we really want to look at that in a comprehensive way and I've done a couple of dozen of these types of committees. This was one of the more interesting first meetings that I've had so I'm a little more encouraged than normal. We'll see where things go and I'm sure you're going to be monitoring it closely but I'd rather think the best at least early on.

Chad Campbell: I've been in the legislature for eight years so I try to put it in perspective but anyways.

J.D. Mesnard: I do want to clarify one thing too. This is a common misconception about which revenue source is the most stable or the least stable. A lot of people believe sales tax is the least stable and the most volatile. It is, in fact, the most stable revenue source we have in this state. Our budget analyst posts online a report that looks at all of them, corporate income, sales, personal income and sales is the most stable, least fluctuating in those economic ups and downs of any revenue source.

Chad Campbell: Depends how you look at it. I know what you're saying, but it depends on how you look at it. But in terms of economic impact, I believe relying on the sales tax for the majority of your general fund dollars in Arizona is the least stable way to go about it. Talking about small businesses -- my wife is a small business owner -- the sales tax in this state is way too high, way too complicated. Hopefully, we simplified it last session but it is problematic for businesses where the income tax is not.

Ted Simons: Is it, to the point where the burden of shifting income tax onto maybe another revenue source can't go to a sales tax?

Chad Campbell: My point is and again, I'm not suggesting that the members of the committee have any preordained outcome of this but if we're talking about a flat tax, we're talking about lowering the income tax rate, you're going to shift that burden somewhere, be it within the income tax brackets themselves, probably to the middle class or lower income, or you're going to shift it over to the sales tax where the lower end again on the income spectrum is going to be taking up more of that burden from the sales tax.

Ted Simons: Shifting that burden is a major factor here isn't it?

Jim Rounds: Well I don't know. The devil's in the details. You can look at these tax policies in terms of how do you feel philosophically about a tax and I think that's fair. Is it building an economy? If you're going to change the tax code is there going to be a cost and is that the most efficient way of spending those dollars? But also you can craft a tax in a more efficient way as well where it's revenue neutral. I think all of these need to be addressed. While these arguments are fair, at least what we've been thinking about how we're going to approach this committee is to look at all of these in the aggregate and see if some good ideas can be brought up.

J.D. Mesnard: That's the commitment I've made as the co-chair and yesterday we had this discussion. And Jim brings up a great point. The reality is we're looking at something that's revenue neutral. We're going to be very sensitive to the whole winners losers aspect when we make any changes and we're trying to keep it revenue neutral. But we are not going to be increasing taxes on the poor. I mean, I realize others may have made suggestions in the past or offered proposals but it isn't fair to judge what this is going to do in the next several months on that basis.

Chad Campbell: And again, I'm not trying to say that you have some predetermined outcome but if you're talking about revenue neutral, revenue neutral in terms of the general fund. Saying you generate $4 billion with this tax plan, and you generate $4 billion with this new tax plan, that's revenue neutral but who is paying that $4 billion is the difference, and right now, in this state, the vast majority of our money coming from our taxes comes from the middle class and the lower income and shifting any type of burden onto them further is going to only hurt them more. The richest families in Arizona pay the least amount of taxes out of any state in the country and so if we're going to be talking about revenue neutral, you're going to shift that burden somewhere and my guess being at the legislature for eight years, is you're not going to shift it to higher income; you're going to continue to shift that burden onto lower and middle income families.

Ted Simons: So when you talk about simplifying the tax system here, are you talking about simplifying for everyone, simplifying for some at the expense of others, some more than others or all of the above?

J.D. Mesnard: At this point, we're just getting started. But I will just tell you my vision. We have umpteen deductions and subtractions and exemptions and tax credits and you have several different tax rates. We're going to be looking at all of these things and how we can craft a simple tax structure for the people and small businesses of Arizona in a revenue-neutral way, being sensitive to those on the lower end of the socio-economic spectrum and I think we can actually make some progress. I think the criticism up front is a little bit unwarranted. Certainly we can make sure we're going to be on the same page of protecting those we need to protect but let's give this a shot and see if we can do some good.

Ted Simons: I know that whenever a flat tax has been referred to a couple of times at the table here, whenever a flat tax is mentioned, the idea of losing deductions, especially that mortgage interest deduction almost is like a brick wall that stops everything. With that in mind, is a flat tax or a slightly bumpy tax, is it even viable?

J.D. Mesnard: A flat tax that is purely flat, no way, not going to happen. But if we look at ways we can simplify it where you probably do keep the mortgage interest deduction in place and some other deductions like for charity or others, it's not a pure flat tax. That's why we're not talking about a flat tax and everyone who tries to label it that is not fair. A single rate system, we're collapsing the rates a little bit. I think we'll take a look at doing that. We're not going to end up with a flat tax.

Jim Rounds: We don't have to think about this binary where it goes to a pure flat tax definition or we keep the current system. There's probably something in place and since we're talking resumes, I've been an economist for 17 years and I'm thinking the people on the committee have a lot of experience as well based on what I know. We would like to look at this from an economist's perspective and I know that politics is always at play there and I completely appreciate your comments, but the volunteers on the committee are driving this. It's not the few policy makers that are on the committee. The volunteers are the ones that are going to be coming up with the different ideas and bringing the decisions to debate.

Ted Simons: What are the important factors for the volunteers on the committee? What are they looking for? What do they want to see done?

Jim Rounds: Well, we've heard some talk about how they would like to see some form of a flat tax at some point. We've seen some that would like to look at how it might impact small business and help build the economy. And we've heard some discussion about how maybe we might have a currently competitive system like you mentioned earlier. And so there's a lot of different opinions. Now, looking at the numbers is going to get to the bottom line and that's why I'm interested in helping to participate so what I'm hoping is even though politics will play a role in this, in the end I think the numbers are going to speak for themselves, at least to some extent, and then these guys can start their debate again.

Chad Campbell: Here's my concern with this, though. When you talk about all the factors here, you're talking about simplification, you're talking about collapsing the tax brackets, flat tax, helping out small businesses, which is something I'm completely supportive of and always have been. Most of these things out of those things I just named are already taking place with our current income tax. Our income tax is already pretty conducive to all of those things so the only big thing left is flat tax. And that's where this conversation always comes back from the conservative right is the flat tax.

Ted Simons: Is it a flat tax or as mentioned here a flatter tax?

Chad Campbell: Either way, if you're flattening out the income tax in this state, you're going to shift the burden to people making $80,000 and less. There's no way around that. They are the ones who pay the majority of the income tax right now, and if you're going to shift that burden it's going to shift to them because the wealthiest are going to get the largest tax break if you collapse that tax bracket structure as it is now or flatten it out, it is going to shift to middle and lower income families.

J.D. Mesnard: That makes a huge assumption that you don't give an exemption or some starting point. If you had a $20,000 starting point -- [ Overlapping Speakers ]

Chad Campbell: But then simplification goes out the window. Why make something more complicated that's already working?

J.D. Mesnard: If you collapsed it to two and the starting point is $20,000 -- We don't have a broken system.

Jim Rounds: This is why you need economists. Let the economists come in, analyze things properly, lay it out and then let a more thorough debate.

Chad Campbell: The problem is politicians get in the way, though [ Laughter ]

Jim Rounds: I won't disagree with that.

J.D. Mesnard: We have more nonpoliticians on this committee, it's a bipartisan committee, it's got two different small interest groups.

Ted Simons: Real quickly, the collection of Internet taxes and sales taxes and such, how does that play into all of this in terms of changing the entire dynamic?

J.D. Mesnard: That's a great question. It's been brought up a lot that what Congress does as far as internet sales tax could come into play here and maybe it does. It could come into play later on, assuming they even do this that you can utilize a new tax source to weather out the winners and losers problem. I don't want to be married to what Congress may or may not do when we're looking at reforms in this committee. Certainly, there's utility to what they may do. At the end of the day, there will be a policy debate as to whether or not to lower the sales tax or lower the income tax with such congressional legislation. It remains to be seen.

Ted Simons: Are Internet sales tax revenues such that they're high enough to where you can start lifting maybe some other columns there and even things out?

Jim Rounds: Some estimates are but I like the comment that J.D. brought up. If Congress were a baseball player, it would batting like 27 so we don't want to count our money before it actually comes in. But I think at some point the legislature will need to tackle that because if there's additional funds there and there's a reasonable argument that's actually crafted to have a more efficient system so we build our economy, it will be discussed but we don't want to bring that in too soon. It's a little bit early right now.

Ted Simons: Last question for our two legislators here. What can realistically and politically be accomplished here, regarding reform of the income tax?

Chad Campbell: I think that it's going to be a tough one politically. I think that we had a flat tax proposal two years ago and when the numbers came up from the JLBC, even the most conservative person down there ran away from that because you were going to raise taxes on about 80 percent of Arizonans. I applaud the efforts of J.D. I applaud the efforts of the volunteers even more so. I think politically it's going to be very tough. I want to go back -- I think we should focus our efforts on the sales tax and continue to figure out how to lower that sales tax, flatten out that sales tax and make it more competitive for businesses in the state, especially locally-owned and small ones. That's where we should focus our energy. I'm looking forward to seeing what comes out of this, but I'm not optimistic.

Ted Simons: Co-chair, what can be done here?

J.D. Mesnard: I think realistically we can do a whole lot or at least begin the dialogue over several years where we accomplish a whole lot. Call me the optimist, Mr. Campbell. But I think working together, bipartisanly in a broad way, bringing in the tax experts, the small business experts and the economists, I think we can give it our best shot. Might do some small things, might do some big things but I'm hoping for big things.

Ted Simons: Sounds good, sounds encouraging, gentlemen good to have you here, thanks for joining us.

J.D. Mesnard: Representative; Jim Rounds: Economist; Chad Campbell: House Minority Leader

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