Joint Select Committee on State Revenues and Expenditures: final report

              Arizona Joint Select Committee

on State Revenues and Expenditures

November 1989

Final Report

Volume 1

CONTENTS

VOLUME I

Acknowledgments

Committee Members and Staff

Transmittal Letter to Governor and Legislature

v

vii

ix

Part I: Findings and Recommendations

1. Findings and Recommendations

Part 11: Economic and Institutional Setting

2. The Arizona Economy: Cycles, Longterm Economic Growth 63

and Government Fiscal Behavior

3. Revenue Forecasting and Expenditure Budgeting 87

4. Improving the Budget Process 101

Part 111: Revenues

Overview

5. Arizona's Personal Income Tax

6. Arizona's Corporation Income Tax

7. Arizona's Taxation of the Insurance Industry

8. Taxation of Financial Industries in an Era of Change

9. The Arizona General Sales Tax

10. Selective Sales Taxes in Arizona

11. User Charges and Fees

Part IV: Expenditures

Overview

12. Higher Education In Arizona

13. Health Care Expenditures by Arizona's Governments

VOLUME I1

14. Financing K- 12 Education in Arizona

15. Arizona Welfare Expenditures

16. Expenditures on Natural Resources and Environmental

Quality

17. Public Safety Expenditures in Arizona

18. Arizona Highway Expenditures and Revenues

19. The Private Delivery of Public Services

Part V: Local Government Finances

Overview

20. Sales Taxes as a Revenue Source for Arizona Local

Governments

21. State Assistance to Local Governments in Arizona

22. A Laymans's Guide to the Theory of Local Property

Taxation

23. Arizona's Property Classification System

24. Fiscal Limits

25. Property Tax Relief Mechanisms

26. General Fund Revenues and Expenditures: History and

Projections

ACKNOWLEDGEMENTS

The success of a massive project such as an in- depth

evaluation of the fiscal system of Arizona depends on the

cooperation and assistance of many experts and dedicated

individuals. We were fortunate to have the assistance and

involvement of numerous knowledgeable individuals in state

government, of local experts in the private sector, of dedicated

individuals working for local governments, and of first- rate

academic economists in Arizona and across the country.

For their patience with our requests and the information and

data that they supplied, we thank the following state employees:

Peter Burns, Executive Budget Office; Ted Ferris, Richard

Stavneak, Cy Blanton, Mark Flanders, Richard Morris, Jack

Neisent, Steve Miller, Brian McNeil, Stephanie Hernandez, and

Jayne Burgess, Joint Legislative Budget Committee; Cathy Eden and

Wayne Casper, Department of Administration; Doug Norton, Linda

Blessing, and Bill Thompson, Auditor General's Office; Craig

Cornier, Candy Cooley, Georganna Meyer, Jane McVey, Rob Robinson,

Steve Shiffrin, Larry Thompson, Jerry Wallen, Elaine Johnson, and

Howard Boice, Department of Revenue; Susan Gallinger, Gay Anne

Williams, and Kelly McKay, Department of Insurance; Ian

Macpherson, Office of the Attorney General; Allan Price, Arizona

State University; Lisa Montoya, Board of Regents; Leonard

Kirschner and Fred Teitelbaum, AHCCCS; Ted Williams and Boyd

Dover, Department of Health Services; Judy Richardson and Gene

Gardner, Department of Education; Andy Genualdi, Department of

Economic Security; Bethany Miller, Ken Travous, and Courtland

Nelson, State Parks Board; Fran Gonzalo, Department of

Environmental Quality; Herb Dishlip, Department of Water

Resources; Tom Ohmart, Game and Fish Department; Dave Pilcher,

Department of Public Safety; Suzanne Sale, Herb Uphoff, and John

McGee, Department of Transportation; Don Horne and Stan Bates,

Department of Corrections; Brian Okesson, Office of the

Treasurer; Bill McDonald and Gary Graham, Administrative Office

of the Courts; Mark Bogart, Kitty Decker, Rick Collins, Michelle

Farren, Jeff Grant, and especially, Bob Lockwood of the House

Staff; and Kim Baker, Kevin DeMenna, Kevin Kinsall, Mike Martin,

Randie Stein, Christopher Smith, Rich Bitner, Louann Bierlein,

Senate Staff. A special note of thanks to Harold Scott of the

Governor's Office, who put out many fires, of varying sizes.

Several local government officials provided information and

invaluable institutional perspective. We thank Jack DeBolske,

Kent Fairbairn, and, especially, Cathy Connolly of the League of

Arizona Cities and Towns; Charles Hill, Kevin Keogh, Ceil Pettle,

Tim Everill, Tarnmy Perkins, and Ronald Jensen, City of Phoenix;

Carder Hunt, City of Scottsdale; Arnold Jeffers and Ken Bauer,

Pima County; Jim Holst, Yavapai County; Scott Lazenby, City of

Glendale; Donna Schober, Arizona Community College Association;

Chuck Essigs, Mesa Public Schools; William Horie, Santa Cruz

Valley Unified School District; Hardy Childers, Casa Grande

Schools; Barbara Robey, Arizona School Boards Association;

and Jim Shipman, Ed Ricketts and Kaaren Iverson, County

Supervisors Association.

Many individuals in the private sector provided perspectives

and information of great value. We thank Terry Trost, Phoenix

Chamber of Commerce; Neil ~ hristianson, Valley National Bank;

Gordon Murphy and Howard McCready, Arizona Bankers Association;

Eileen Nader and Marty Schultz, Arizona Public Service; Russell

Smolden, Salt River Project; Jim Bush, Fennemore Craig; Alan

Maguire, Rauscher, Pierce Refsnes; Alan Stanton, Phoenix; John

Swain, Streich, Lang, Weeks & Cardon; Kevin McCarthy, Arizona Tax

Research Association; Chuck Shipley, Arizona Chamber of Commerce;

Bob Dahlgren, Ciber, Inc.; Bill Jamieson, Jamieson and Gutierrez;

and the individuals at Rural/ Metro Corporation.

Carol Cohen, Bob Ebel, Clay Dursthoff, and Bob Rafuse of the

U. S. Advisory Commission on Intergovernmental Relations, and Bill

Kehm of the Governments Division of the U. S. Bureau of the Census

provided invaluable data sets and information. The School of

Public Affairs at Arizona State University conducted federal

revenue sharing surveys for the U. S. Census Bureau over a number

of years. These surveys provided the basis for a data set,

compiled and adjusted by Billie Etchells and Sue Kufahl, for

Arizona cities and counties in 1982 and 1987.

The basic research for the Final Report was performed by

professors and economic consultants from across the country. For

their careful analyses and substantial involvement we thank Mike

Bell, Johns Hopkins University; Bruce Billings, University of

Arizona; John Bowman, Virginia Commonwealth University; Alberta

Charney and Craig Horn; University of Arizona; Jon Christianson,

University of Minnesota; Steve Craig, University of Houston; Mark

Day, Tucson; Tom Downes, Northwestern University; Bob Ebel and

Carol Cohen, U. S. Advisory Commission on Intergovernmental

Relations; Roger Faith, Arizona State University; Dan Feenberg,

National Bureau of Economic Research; Ron Fisher, Michigan State

University; Bill Fox, University of Tennessee; Mary Gade,

Oklahoma State University; J. Fred Giertz, University of

Illinois; Robert Gloudemans, Phoenix; John Hall, Arizona State

University; Reka Hoff, University of Arizona; Dennis Hoffman,

Arizona State University; Tim Hogan, Arizona State University;

Doug Holtz- Eakin, Columbia University; Helen Ladd, Duke

University; Rob Melnick, Arizona State University; Wally Oates,

University of Maryland; Mike Ormiston, Arizona State University;

Tom Pogue, University of Iowa; Tom Rex, Arizona State University;

Harvey Rosen, Princeton University; Don Schlagenhauf, Arizona

State University; Mike Wasylenko, Syracuse University; and Mark

Watson, Northwestern University.

For their special skills and knowledge from day one to the

end, we thank Tracy Clark, Arizona State University, and Billie

Etchells, Phoenix.

A special thanks to Dana Weist, Pennsylvania Economy League,

whose enthusiasm, good sense, and economic skills were

invaluable.

COMMITTEE MEMBERS AND STAFF

COMMITTEE MEMBERS

Chairperson

Sharon B. Megdal

Megecon Consulting Group

C. Diane Bishop Jeffrey J. Hill

Superintendent of Public Instruction Arizona State Senator

Donald A. Bliss

U. S. West

Wayne Brown

R. R. & R. R. Evans

Leonard R. Judd

Phelps Dodge Corporation

Mark Killian

Arizona State Representative

Jose A. Cardenas John Mawhinney

Lewis & Roca Arizona State Senator

Jaime P. Gutierrez

Arizona State Senator

Chris Herstam

Arizona State Representative

Armando Ruiz

Arizona State Representative

Richard Snell

Ramada, Inc.

J. Elliott Hibbs John Stiteler

Arizona Tax Research Association Stiteler Investment, Inc.

COMMITTEE STAFF

Director

Therese J. McGuire

Dana Wolfe Naimark, Project Manager

Susanne M. Kufahl, Office Manager

Carol J. Mickey, Secretary

Mary D. Gibson, Typist

Arizona Joint Select Committee

on State Revenues and Expenditures

1700 West Washington, Room 310

Phoenix, Arizona 85007

( 602) 542- 1934

October 31, 1989

Governor Mofford and Members of the 39th Legislature

1700 West Washington

Phoenix, Arizona 85007

Dear Governor Mofford and Members of the 39th Legislature:

On behalf of the Members of the Arizona Joint Select

Committee on State Revenues and Expenditures, it is with great

pleasure that I submit the Final Report of the Committee. The

charge of the Committee was to identify structural weaknesses in

Arizona's current fiscal structure and to recommend a fairer,

simpler, more predictable fiscal system. The Final Report, a

reflection of the accumulated knowledge and fiscal policy

conclusions of the Committee, provides recommendations for a

sound fiscal system.

Chapter One provides a summary of the Committee's research

and presents the Committee's recommendations. The twenty- five

research chapters that follow provide a sound objective basis for

these recommendations. The research was conducted by fiscal

policy experts both within and outside Arizona. The study

process was open and thorough.

The Committee addressed important fiscal policy issues that

will affect all residents of Arizona. The Final Report of the

Committee can be used to design a fiscal system that will well

serve Arizonans into the 21st century.

Respectfully submitted,

Sharon B. Megdal, Chair

PART I

FINDINGS AND RECOMMENDATIONS

CHAPTER 1

FINDINGS AND RECOMMENDATIONS

CHAIRWW'S FOREWORD TO CHAPTER ONE

Chapter One of this Report presents the findings and

recommendations voted on by the Committee. The Chapter includes

29 recommendations that provide major structural improvements to

Arizona's fiscal system. The recommended changes greatly

simplify the fiscal system. The recommended shift away from

sales taxes toward personal income taxes will provide for a

fairer fiscal system to meet the needs of our growing state. The

Committee's intention with its recommendations was to develop an

overall system in which the major components, functioning

together, produce a balanced and rational system.

One of the 29 recommendations offers three integrated

revenue packages that indicate how Arizona's revenue system can

be restructured for the 1991 fiscal year. These packages close

the projected 1991 deficit and address, in part, the long- term

structural deficit. The packages focus on major changes to the

fiscal system, some of which might well occur over a phase- in

period rather than in a single step.

On the expenditure side, the Committee did not attempt a

detailed program or efficiency review. The Committee studied

major expenditure areas by comparing Arizona to other states, by

evaluating trends in spending, and by projecting expenditures to

the year 2000. As charged, the Committee examined the Cost

Efficiency Commission report and recommended that the Legislature

continue to evaluate and implement the Commission's

recommendations. The Committee also recommended reforms of the

budget process, the audit process, and the personnel system to

improve the efficiency and productivity of state government.

In developing their recommendations, committee members

wrestled with difficult policy trade- offs and the benefits and

costs of potential reforms. While the Committee did not

unanimously support each individual component of the

recommendations, committee members recognize that restructuring

Arizona's fiscal system will assist the State in more effectively

meeting the needs of its citizens.

I INTRODUCTION

The State of Arizona is facing a structural deficit.

Projected revenues do not support projected expenditures, and

without structural changes, the gap will widen over time. The

costs of the services that we have chosen to provide are higher

and growing faster than our current revenue collections.

Addressing the problem requires examining both the expenditure

side of the ledger, as well as the revenue side. We cannot

afford merely to increase the amount of revenues collected

without justifying the type and levels of expenditures being

made.

In recent years, the pressures resulting from the gap

between revenues collected and planned expenditures have led to

ad hoc short- term adjustments to both revenues and expenditures.

Due to these piece- meal adjustments, our fiscal system is now

extremely complex. We lack an overall fiscal policy framework,

thereby making the system susceptible to band- aid changes and

erosion of our tax bases.

In the 1980s, Arizona's economy has grown much faster than

the U. S. economy, although we have experienced our share of

downturns. During this period, Arizona has been an average-taxing

and average- spending state overall. Thus, it is clear

that tax burdens and spending patterns have not driven the growth

or cycles of Arizona's economy.

While Arizona's total state and local government spending

has been average, expenditures in specific categories have varied

significantly from the average state. Arizona expenditures per

capita are substantially above national averages for: highways - - due in part to catching up for past inadequacies; higher

education -- due in part to higher per capita student enrollment;

and public safety -- due in part to higher crime and

incarceration rates. On the other hand, Arizona's expenditures

per capita are below average for welfare and health care. These

differences from the national average result from policy choices.

Many of the major spending categories have been greatly affected

by Arizona's rapid population growth.

Much of the complexity of our fiscal system is manifested in

the relationship between the state and local governments. The

distribution of state aid to counties and cities, the homeowner's

rebate, and the current levy and expenditure limits on local

governments are not well designed to accomplish policy goals.

Many of these state policies are directed toward reducing

reliance on local property taxes.

This chapter presents the findings and recommendations

adopted by the Committee. The first part of the chapter consists

of findings and implications that evolved as the Committee's work

progressed. The second part of the chapter consists of Committee

recommendations that are based on the findings and implications,

Committee research reports, subcommittee analysis, additional

topics and information covered in staff memos, and public input.

These recommendations involve structural changes that improve

Arizona's fiscal system.

11. CRITERIA FOR JUDGING A STATE 2WD LOCAL FISCAL SYSTEM

The purpose of defining a set of criteria for evaluating a

fiscal system is to provide a common, general framework that

policymakers can refer to when policy options are considered.

Ideally, any potential change to the fiscal system should be

judged against these criteria, and policy choices should be made

based on how they fit into the overall fiscal framework rather

than on an ad hoc basis to meet short term needs.

The Committee used the following criteria in evaluating

Arizona's current fiscal system and considering potential

changes. Each criterion listed represents a desirable

characteristic of a good fiscal system. Because these

characteristics are often in conflict, it is impossible to design

a system that excels in every category. Using these criteria,

the Committee identified weaknesses in our current system and

adopted recommendations for structural changes to strengthen and

improve the system.

PREDICTABILITY: Avoid frequent ad hoc changes to the fiscal

system. A certain, predictable fiscal system benefits both

taxpayers and policy makers.

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: Impose higher taxes on individuals with greater

ability to pay, or provide these individuals with fewer

public services.

EFFICIENCY: Avoid causing changes in economic behavior by

keeping tax bases broad and marginal tax rates low. Tax

individuals and businesses in relation to public services

received, where appropriate.

NEUTRALITY: Avoid differential treatment of like economic

activities -- keep the playing field level.

STABILITY: Employ a system that does not produce wide swings in

expenditures or revenues in response to economic cycles.

RESPONSIVENESS: Employ a system that adequately tracks the long-term

growth 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 authority, so that voters can

hold elected officials responsible for both revenue and

spending decisions.

111. FINDINGS AND IMPLICATIONS - A SUMMARY OF THE COMMITTEE

RESEARCH REPORTS

STRUCTURAL DEFICIT*

FINDING IMPLICATION

1) Under the current revenue 1) The Arizona fiscal system has

structure and the expenditure a structural deficit that is

system resulting from current estimated to reach $ 932 million

programs and policies, real in 2000, which represents

general fund revenues are 23 percent of total revenues in

expected to increase by that year.

60 percent from 1988 to 2000,

while real general fund

expenditures are expected to

increase by 93 percent over the

same twelve year period.

2) Real general fund revenues

increased at an average annual

rate of 2.6 percent over the

last decade, while real general

fund expenditures increased by

an average of 3.8 percent per

year over the same period.

FISCAL COMPARISONS AND THE ARIZONA ECONOMY*

3) In 1987, Arizona state and 3) The overall level of** taxes in

local own- source revenues per Arizona is competitive.

capita were 98 percent of the

average for all states.

* See Appendix I for charts and graphs that illustrate many of the

findings contained herein.

**

For the purposes of these findings and implications, we have

assumed that the competitiveness criterion is met by keeping

revenues and expenditures from becoming far out of line with the

national average or neighboring states.

FINDING

4) Per capita income in Arizona

is approximately 95 percent of

the average for all states.

Arizona tax base capacity -- a

measure of ability to tax that

incorporates actual tax bases,

such as sales, property and

income -- is 99 percent of the

average for all states.

5) From 1980 to 1987, total

state and local revenues per

capita grew 75 percent in

Arizona and 78 percent

nationally.

6) In 1987, total Arizona state

and local spending per capita

( including capital expenditures)

was about the average for all

states. State and local

spending per capita was: about

average for K- 12 education;

significantly above average for

higher education, highways, and

public safety; and significantly

lower than average for welfare

and health care.

7 ) Arizona's tax effort on the

sales tax base is significantly

above the average for all

states, while its tax effort on

personal income, corporate

income, property, and user

charge bases is below average.

8) The techniques used to

develop revenue forecasts in

Arizona are generally sound.

9) Reasonable margins of error

inherent in forecasting suggest

that general fund surpluses or

deficits of 3 to 4 percent are

not unusual.

IMPLICATION

4) To have an average level of

state and local expenditures per

capita, Arizonans must spend a

slightly higher share of their

income on public programs than

average. However, Arizona has

the tax base capacity to spend

and tax at an average level.

5) Revenue raising by Arizona

governments has been in line

with state and local revenue

raising throughout the country

in the 1980s.

7) The mix of revenues and taxes

in Arizona may not be

competitive.

8) Recent budgetary problems are

not attributable to forecasting

deficiencies.

9) To inject predictability into

the budget process, a specific,

enforceable, constitutional or

statutory mechanism could be

developed to manage unexpected

deficits or surpluses of 3 to

4 percent.

FINDING

10) The state aid link between

state and local governments is

strong in Arizona.

11) Since 1970, ~ rizona's

economic cycles have been

roughly synchronized with

national economic cycles.

IMPLICATION

10) Because of fiscal

interrelationships between the

state and local governments,

changes to the State's fiscal

system cannot be thoroughly

evaluated without examining

potential impacts on local

government operations.

11) National economic cycles

affect the Arizona economy.

12) The magnitude of Arizona's 12) The need for a stable fiscal

economic cycles has been system is greater in Arizona

approximately one third greater than in the average state -- in

than the magnitude of U. S. fact, Arizona's fiscal system is

cycles. more stable than average.

13) Fiscal factors do not

explain state economic growth or

decline in the 1980s. A state's

fiscal system must be far out of

line from other states before it

has a noticeable impact on

economic growth.

REVENUE SOURCES

Personal Income Taxes

14) In 1987 Arizona relied on

the personal income tax for 18

percent of state own- source

revenues compared to an average

of 24 percent for all states.

15) The total state and local

personal income tax burden in

Arizona was $ 225 per capita in

1987 compared to an average of

$ 344 per capita for all states.

14) Because personal income

taxes track the cycles and long-term

growth of the economy,

Arizona's current state tax mix,

which has a light reliance on

personal income taxes, is less

responsive and more stable than

the average state tax system.

15) The personal income tax

burden in Arizona is very

competitive, and the burden can

be reasonably increased without

jeopardizing economic growth.

FINDING

16) The current personal income

tax structure is remarkably

complex.

17) The Arizona personal income

tax distributes the burden

across income classes in a

progressive way.

Business Income Taxes

18) Arizona is one of only seven

states to allow a deduction for

federal taxes paid from the base

of the corporation income tax.

Because of this deduction, the

top statutory rate is

approximately two percentage

points higher than it would need

to be without the deduction,

while still raising the same

amount of revenue.

19) In 1987, the state and local

corporation income tax burden

was low relative to other

states, $ 59 per capita in

Arizona compared to an average

of $ 93 per capita for all

states.

20) Corporation income taxes

raise relatively little revenue

for state governments in Arizona

and across the country ( less

than 7 percent of state own-source

revenues nationally and

less than 5 percent in Arizona

in 1987).

21) It is impossible to

determine with accuracy who

bears the burden of the

corporation income tax.

IMPLICATION

16) Unnecessary administrative

and compliance costs result from

a complex personal income tax

structure.

17) The personal income tax is

an instrument for progressivity

in the state and local revenue

system.

20) Reasonable changes in the

level of the corporation income

tax will not have a major impact

on the overall state revenue

picture.

21) The corporation income tax

cannot be used as a tool for

fair or equitable taxation.

FINDING

22) Currently reinsurers are

substantially free from taxation

in Arizona. They are not

subject to the corporation

income tax, and because they

seldom receive premiums, they do

not usually pay premium taxes.

23) The premium tax imposed on

insurance companies doing

business in Arizona is in line

with the practices in most

states, both in terms of

structure and rate.

24) ~ rizona is one of 17 states

that tax financial firms under

the general corporation income

tax.

25) ~ hirty- four states tax their

financial corporations with a

franchise tax, and the base of

the franchise tax is often net

income, defined in the same

manner as the corporation income

tax.

IMPLICATION

22) To improve neutrality,

reinsurers could be made subject

to the corporation income tax.

This. is likely to have little

impact on the reinsurer business

in Arizona, because Arizona's

primary attraction to them is

generous capital requirements.

23) No serious problems of anti-competitiveness

or complexity

exist with the premium tax.

24) This treatment is non-neutral

because financial

corporations differ from other

corporations in the way they

earn their income. Replacing

the corporation income tax with

a franchise tax based on net

income would result in more

neutral treatment.

25) Employing a franchise tax

would not be anti- competitive.

Sales Taxes

26) In 1987, state and local 26) The sales tax burden in

general sales tax collections Arizona may be placing the State

were $ 554 per capita in Arizona at a competitive disadvantage.

compared to an average of $ 398

per capita for all states.

27) Arizona collects a 27) The Arizona revenue system

relatively large share of its is both more stable and less

revenues from the general sales responsive than the average

tax -- 37 percent of own- source state revenue system.

state revenues in 1987 compared

to the average for all states of

25 percent.

FINDING

28) The Arizona transaction

privilege tax is more

complicated than a consumption

tax on final sales. The sales

tax code appears to have evolved

in a piecemeal fashion, lacking

an overall conceptual framework.

29) The broad base of the

Arizona sales tax includes many

business purchases.

30) Despite exemptions intended

to reduce regressivity ( such as

the exemption for food for home

consumption), the Arizona sales

tax, like sales taxes

everywhere, is regressive. That

is, tax burdens as a share of

income fall as income rises.

31) Food for home consumption

and personal services are exempt

from the sales tax, regardless

of income level.

32) Sales taxes are a major

direct conduit for non- resident

visitors to compensate state and

local governments for public

services they consume.

IMPLICATION

28) The resulting ad hoc

revisions diminish the

simplicity and predictability of

the tax, and the frequency of

revisions leads to fluctuations

in revenue.

29) The sales tax treatment of

business purchases results in

nonneutralities and

inefficiencies.

30) Heavy reliance on sales

taxes makes for a more

regressive tax system.

31) Exempting food narrows the

sales tax base dramatically

without targeting relief to low-income

individuals. Including

food in the sales tax base would

make the tax more regressive,

more stable, and less

responsive. Including personal

services in the sales tax base

would make the tax more

efficient, more responsive,

simpler, and only very slightly

more regressive.

FINDING

33) The tax rate on cigarettes

in Arizona is approximately

25 percent below the average for

all states. The tax rate on

distilled spirits is slightly

above average, the tax rate on

wine is significantly above

average, and the tax rate on

beer is somewhat below average.

34) The burden of taxes on

cigarettes and alcohol is highly

regressive.

35) Unlike the general sales

tax, cigarette and alcohol taxes

are collected on a per- unit

basis in Arizona and other

states.

36) Total state and local bed

tax rates in Arizona are in line

with the total rates in

neighboring states and other

states with large tourism

industries.

Property Taxes

37) In 1987, Arizona's state and

local property tax burden was

$ 462 per capita, 93 percent of

the per capita average for all

states.

38) In 1987, property taxes

accounted for less than

3 percent of state own- source

revenues in ~ rizona and less

than 2 percent of state

own- source revenues nationally.

IMPLICATION

34) A heavier reliance on either

of these taxes would make for a

more regressive tax system.

35) Without frequent rate

increases, revenue from these

two taxes does not keep pace

with inflation.

36) The taxes imposed on hotel

and motel rooms are competitive.

38) Reasonable changes in the

level of state property taxes

will not have a major impact on

the overall state revenue

picture.

Other Revenue Sources

FINDING IMPLICATION

39) Arizona's 2.5 percent 39) These higher taxes may place

severance tax on mining is mineral production in Arizona at

higher than the average for all a competitive disadvantage

states, and Arizona's mineral compared to other states.

tax base is also defined more

broadly than that of most other

states.

40) The State government in 40) The State may be losing

Arizona relies less on charges opportunities to link benefits

than the average for all received to charges paid.

states -- current charges

accounted for 8 percent of state

own- source revenues in Arizona

in 1987, compared to 10 percent

nationally. I,

41) Thirty states have a realty 41) Because 30 other states

transfer tax with rates ranging impose a realty transfer tax,

from 0.01 percent to 3 percent imposing such a tax in Arizona

of property value. would not put the State at a

competitive disadvantage. The

tax would make the system more

responsive to growth, but would

add to the instability of the

tax system.

EXPENDITURE PROGRAMS

Higher Education

42) Per capita full time student

equivalent enrollment in

universities and community

colleges is 20 percent higher in

Arizona than the average for all

states. Because of this above

average enrollment and below

average per capita income,

Arizona is above the average for

all states in per capita

expenditures and expenditures

per $ 1,000 of personal income.

Arizona is below average in

expenditures per full time

student equivalent.

42) Quality does not depend on

effort relative to population or

personal income. To stay

competitive Arizona needs to

spend an above average amount

relative to population. Arizona

could reduce the number of

students enrolled in public

institutions of higher

education, but because Arizona

has few private institutions of

higher education, enrollment

cutbacks at the public

institutions will make higher

education less accessible.

FINDING

43) In the 1980s, state support

per community college student

has not grown as fast as

expenditures. At the same time,

community colleges have

increased their reliance on

local sources of revenue and on

tuition and fees, and community

college expenditures per student

have fallen in real terms.

44) At Arizona universities,

both in- state and out- of- state

tuition are somewhat below the

average for all states.

Health Care

45) Current evidence suggests

that the Arizona Health Care

Cost Containment System ( AHCCCS)

has contained costs when

compared to a traditional

Medicaid program, though not by

a large amount.

46) A combination of factors

outside of state control -- such

as medical price inflation,

technological changes, and

demographic shifts -- has caused

increased health care

expenditures.

47) In 1987, Arizona state

health care spending per capita,

including mental health care,

was far below the average for

all states.

IMPLICATION

43) The State could enhance

community college education

services by increasing state aid

or by granting greater revenue

raising authority to community

college districts.

44) slight increases in

university tuition would bring

Arizona in line with tuition

rates elsewhere, but may

preclude access to higher

education. Policy

considerations may warrant

different changes to in- state

and out- of- state tuition.

45) Changing to Medicaid is not

likely to alter indigent health

care costs significantly.

46) The State can reduce health

care costs significantly only by

eliminating programs, making

eligibility requirements more

restrictive, or reducing the

level of service.

47) The State can spend more on

health care without exceeding

the average for all states.

K- 12 Education

FINDING

48) Local school districts have

varying fiscal capacities and

face varying educational costs.

49) Arizona state and local

school expenditures per pupil

( including capital and current

spending) were above the average

for all states in 1987.

Arizona's greater- than- average

growth in student population

resulted in capital spending per

pupil roughly three times higher

than the average for all states.

50) Despite the equalizing

effect of the basic state aid

formula, significant variation

remains in both school tax

burdens and expenditures per

pupil. This variation reflects

different local fiscal choices

involving expenditure limit

overrides, expenditures allowed

outside the equalization base

limit, and other fiscal

decisions.

51) Current state and local

education expenditures per pupil

in Arizona were 3 percent below

the average for all states in

1987. When the Advisory

Commission on Intergovernmental

Relationsr ( ACIR) Representative

Expenditure System ( RES) is used

to account for the higher costs

of educating high school

students and low income

students, Arizona's current

expenditures per pupil on K- 12

education were 11 percent below

the average for all states in

1987.

IMPLICATION

48) Without state aid to these

districts, the variation in

school tax burdens and

educational services would

increase considerably.

50) The state aid formula could

be revised to address these

differences more directly.

51) To achieve an average RES

level of current spending per

pupil that reflects the higher

cost of educating high school

students and low income

students, Arizona would have had

to spend $ 231 million more on

K- 12 education in 1987. There

is no evidence, however, that

this additional spending would

necessarily improve educational

performance.

Welfare

FINDING

52) The characteristics of the

Arizona population do not

explain the low level of welfare

expenditures relative to the

average for all states.

53) The federal Family Support

Act mandates several changes to

state welfare programs that

expand benefits for welfare

recipients and alleviate some of

the harmful incentives built

into the current system.

Natural Resources

54) The groundwater withdrawal

fee of $ 1.00 per acre foot is

low relative to the cost of

other sources of water.

55) Compared to other state park

systems, Arizona's system has

relatively few sites and

visitors, and operating

expenditures per capita are much

lower than other western states

and the average for all states.

56) The Game and Fish Department

is financed solely by federal

monies and licenses and fees.

Federal monies comprise about

25 percent of total revenues.

Public Safety

57) Despite the fact that real

expenditures per inmate have

fallen during the 1980s,

increases in the inmate

population have caused dramatic

increases in total corrections

expenditures.

IMPLICATION

52) Increased spending on

welfare would require a

realignment of policy

priorities.

53) To meet these mandates, the

State either must spend more

money or reduce the scope of

current programs provided.

54) Increases in this fee could

encourage the conservation of

groundwater and provide an

offset to general fund revenues

for the Department of Water

Resources.

55) If the State decides that

preservation of and access to

sites of natural beauty are

important state

responsibilities, then more

sites will have to be acquired

and more resources committed.

56) If federal funding is

insufficient, license and fee

revenue cannot fund both game

and non- game programs

adequately.

57) Corrections expenditures can

be decreased significantly by

reducing the number of people in

prison -- through alternatives

to incarceration or changes in

policies defining crimes and

criminal sentences.

FINDING

58) In 1987, per capita state

and local expenditures on public

safety were significantly higher

in Arizona than the average for

all states, due in part to

Arizona's higher than average

crime and incarceration rates.

Highways

59) In 1987, Arizona's total

state and local highway

expenditures were nearly

70 percent higher than the

average for all states and

nearly 25 percent higher than

the average of eleven other

western states. Evidence

suggests, however, that Arizona

under- invested in highways

relative to other states in the

decade prior to 1987.

60) Arizona's current highway

fees and taxes are not

structured to keep pace with the

costs of highway construction

and maintenance.

Privatization

61) Competitive forces in the

private sector provide

incentives for minimizing costs

and enhancing productivity.

62) Arizona has been a national

leader in the privatization of

public services. Most

privatization arrangements, both

in Arizona and other states, are

contracts with private firms

that require financing from

pub1 ic funds .

IMPLICATION

59) To accommodate population

growth and to maintain parity

with other western states,

Arizona may need to continue to

spend a higher than average

amount on highways.

60) Indexing highway fees and

tax rates to a highway cost

price index would allow revenues

to keep pace with highway costs

without frequent statutory

changes in rates, although it

will not prevent shortfalls due

to unanticipated costs.

61) Privatizing the delivery of

public services has the

potential for cost savings.

62) Privatization offers limited

solutions to significant budget

deficits because much

privatization requires public

funding .

FINDING

63) ~ rizona's municipal sales

taxes are unusual in that cities

have complete authority to set

their own tax rates and define

their own tax bases.

64) Arizona local government

sales tax collections per capita

were nearly twice as high as the

average for all states in 1987.

65) Approximately 85 percent of

state assistance to cities and

counties in Arizona is not

appropriated, but rather is a

pre- determined share of

specified revenue collections.

66) The State of Arizona devotes

a larger share of its revenues

to local assistance than the

average for all states --

41 percent of state revenues in

Arizona compared to 33 percent

nationally in 1987. This

greater- than- average

distribution reflects the

greater decentralization of

expenditures in Arizona.

67) Since 1986, the State has

not met its statutory funding

commitments to community college

districts.

IMPLICATION

63) This arrangement is

advantageous to city governments

because it allows them to tailor

their sales tax bases to their

particular circumstances and

preferences, and insulates them

from state tax changes enacted

by the Legislature. The

multiplicity of tax bases and

rates, however, greatly

complicates tax compliance,

collections, and enforcement.

64) The exceptionally high sales

tax reliance of Arizona local

governments magnifies the

advantages and disadvantages of

sales taxes relative to

alternative sources of local

revenues.

65) This pre- determined level of

aid limits legislative

flexibility on fiscal decisions

from year to year. At the same

time, the certainty of the pre-determined

allocation

facilitates fiscal planning on

the part of recipient local

governments.

66) This greater distribution of

state aid weakens the

accountability in the fiscal

system by displacing the link.

between revenue- raising

responsibility and spending

authority.

67) To meet the statutory

formula, the State would have

had to allocate an additional

$ 9.9 million in aid to community

colleges in 1988.

FINDING

68) Much state aid in Arizona is

allocated based on population.

69) Property taxes are slightly

progressive and efficient

sources of revenue that are not

heavily utilized by states or

the federal government.

70) Property classification

systems are costly to administer

and comply with. The tax

differentials arising from

classification distort

investorst decisions regarding

property ownership. Because

Arizona's system defines an

unusually high number of

classes, these disadvantages are

acute.

71) Despite the general

advantages of local property

taxes, their use is limited by

the Arizona Constitution. It is

unclear whether these limits

have constrained property tax

levies in the 1980s, but they

may become constraining in the

future as the rate of new

construction declines.

72) The homeowner's rebate

offsets 56 percent of most

homeowner primary property taxes

for school districts, up to a

maximum of $ 500.

IMPLICATION

68) State aid programs are not

designed to equalize fiscal

disparities across local

jurisdictions.

70) Economic criteria support

the elimination of property

classification systems. Because

the tax is a tax on property

value, there is no economic

justification for different

rates on different types of

property.

71) The property tax levy limits

may prevent local governments

from gaining the full advantages

of property taxes.

72) The large rate of the rebate

and the fact that very few

taxpayers currently reach the

maximum suggest that an

incentive exists for increasing

school primary taxes and

spending. Because voters do not

pay the full cost of additional

education services and school

districts do not have to raise

their full revenues from local

taxpayers, the homeowner's

rebate diminishes accountability

and efficiency.

IV. COMMITTEE RECO~ ENDATIONS

The recommendations of the Committee are based on the

Committee research reports, findings and implications,

subcommittee analysis, additional topics and information covered

in staff memos, and public input. ( See Appendices I1 and I11 for

a complete listing and abbreviated descriptions of all policy

options considered by the Committee.) The recommendations

address structural deficiencies in Arizona's fiscal system, and

improve the simplicity, neutrality, predictability,

competitiveness, accountability, responsiveness, efficiency and

fairness of the system.

REVENUES

Personal Income Taxes

To reduce administration and compliance costs greatly and to

base tax liability more accurately on ability to pay, the

Committee recommends that the Arizona personal income tax

system start with a federal definition of the tax base, and

make a minimal number of adjustments to that base. The

broader base results in lower statutory tax rates and less

interference with private economic activity. ( An

illustrative sample tax form that achieves simplicity and

fairness by employing Federal Adjusted Gross Income as the

tax base is contained as Appendix IV.)

2. To improve the responsiveness and progressivity of the

Arizona tax system, the Committee recommends a heavier

reliance on the personal income tax.

Sales Taxes

3. To design a more effective sales tax, the Committee

recommends that the base be broadened to include a wider

array of consumer purchases of goods and services. The

Committee also recommends that the structure for determining

the base to be shared with cities and counties be

simplified, and the number of separate taxable categories be

reduced. These changes result in lower statutory rates and

reduced administration and compliance costs.

4. To improve neutrality and enhance the competitive position

of the state, the Committee recommends that used

agricultural equipment, expendable materials used in

processing and the commercial rental of real property be

exempted from the sales tax.

Property Taxes

5. To improve the neutrality and simplicity of the property

tax, the Committee recommends that the nine classes of

property be collapsed into three classes, one for

residential property ( currently classes 5, 6 and 8 ) , one for

vacant land and agricultural property ( currently class 4 ) ,

and the other for commercial and industrial property

( currently classes 1, 2, 3, 7 and C). This change improves

fairness by making the tax better reflect property value.

6. To improve neutrality and the fairness of the property tax

system, the Committee recommends that the highest assessment

ratio be no more than twice the lowest assessment ratio.

The classification commercial/ industrial should have the

highest assessment ratio, the classification

agricultural/ vacant land should have a middle assessment

ratio, and the classification residential ( including home

owners and rental property) should have the lowest

assessment ratio.

7. To simplify the property tax system, the Committee

recommends that the distinction between full cash value and

limited property value be eliminated. Property tax rates,

levy limits and voter- approved spending would all apply to

one measure of property wealth -- the full cash value.

Business Income Taxes

8. To simplify the corporation income tax, the Committee

recommends that the deduction for federal taxes be

eliminated. The change reduces compliance and enforcement

costs because it eliminates the need to apportion federal

taxes among states. This change also lowers the statutory

tax rates, causing fewer distortions to economic decisions.

To improve neutrality, the Committee recommends that the

Legislature consider replacing the corporation income tax

with a franchise tax based on net income.

9. To improve the responsiveness of the Arizona tax system and

to tax corporations competitively with other statesf tax

systems, the Committee recommends that the reliance on

corporation income taxes be increased.

10. To improve competitiveness and horizontal equity between

corporations incorporated in Arizona and corporations

incorporated elsewhere, the Committee recommends that the

corporation income tax be changed to provide equitable

treatment of dividends received from controlled

corporations. The Committee further recommends that net

operating losses be treated the same in Arizona as for

federal tax purposes.

Other Revenue Sources

11. To improve the responsiveness of the revenue system and to

minimize the need for periodic changes to fee structures and

per- unit taxes, the Committee recommends that user charges,

license fees, and luxury taxes be indexed to relevant

measures of inflation. Without indexation or frequent

changes, the real value of charges, fees, and luxury taxes

falls over time.

To make product prices reflect the costs their use imposes

on society, the Committee recommends the creation of a

selective tax on hazardous products that can cause

pollution. Revenues collected should be kept in a special

fund for clean- up programs. After the fund has reached a

level deemed appropriate to cover potential losses, the

revenues may be used for other costs within the Department

of Environmental Quality. This would improve efficiency by

linking pollution- generating activities to pollution-abatement

expenditures.

EXPENDITURES

K- 12 Education

To enhance the equalization function of the K- 12 state aid

program, the Committee recommends that spending items

currently allowed outside the expenditure limits ( financed

by primary property tax levies) be prohibited or included as

cost factors in the equalization aid formula. Currently,

districts have varying capacities to support expenditures on

these items. By disallowing the irrelevant items and

including the valid cost differences in the formula,

districts' capacities will be equalized.

14. To ensure that state equalization assistance to school

districts accurately accounts for differences in school

costs, the Committee recommends that the state implement

routine evaluation of formula factors. Current factors

reflect differences across districts in student populations,

teacher experience, and transportation costs. As priorities

and circumstances change, new factors may need to be added

and weights may need to be changed.

15. To improve horizontal equity in the funding of K- 12 school

districts in Arizona, the Committee recommends a minimum

primary school property tax rate be required to be levied on

all property over and above the 50- cent county equalization

rate and the state education rate ( currently 47 cents), and

that this be phased in.

16. To improve the accountability and simplicity of the fiscal

system and provide more targeted benefits to low- wealth,

high- cost school districts, the Committee recommends that

the homeowner's rebate be phased out and that a portion of

the savings to the state be targeted to increasing state

equalization aid. This change improves the fairness of the

system by treating owner- occupied residential property li'ke

other property. The change also removes distortions by

having taxpayers/ voters face the true costs of increased

education spending. Unlike the rebate, state equalization

aid targets state assistance to low- wealth, high- cost

districts.

To improve equity for taxpayers in school districts, the

Committee recommends a funding system be developed to

equalize access to voter- approved spending overrides.

Currently, districts have varying capacities to fund

spending above expenditure limits. Fairness could be

increased by establishing a state program to supplement the

override tax levies collected by districts with low property

wealth. Districts would be able to finance overrides up to

a limit with more similar tax rates.

Higher Education

18. To make tuition better reflect the cost of education at the

universities, the Committee recommends that both in- state

and out- of- state tuition be increased, but not necessarily

in the same proportions. To preserve access to higher

education for people at all income levels, financial need-based

scholarship programs should be expanded.

We1 f are

19. To assist low income families and to establish a welfare

system that provides not only support, but work incentives,

the Committee recommends implementation of those programs in

the federal Family Support Act that address these goals.

The Committee encourages the Legislature to develop further

incentives to help people out of poverty in order to hold

down future welfare costs. The Committee also recommends

that Aid to Families with Dependent Children ( AFDC) benefits

be increased. Arizona's benefits are low relative to the

national average. In addition, the Committee recommends

that the Department of Economic Security take steps to

reduce the error rates in eligibility determination in the

AFDC and Food Stamp programs.

Budget and Audit Process

To prevent the occurrence of mid- year budget crises and to

improve the predictability of the fiscal system, the

committee recommends that the state establish a specific,

enforceable, constitutional or statutory mechanism to

accommodate budgeting and forecasting errors. Even with

solid forecasting and budgeting techniques, margins of error

of 3 to 4 percent are common. One possible mechanism would

be a contingency fund from which monies would be transferred

to the general fund whenever actual revenues fell short of

projected revenues or actual expenditures exceeded projected

expenditures.

21. To improve the budget process, the Committee recommends that

long- term strategic planning to meet established objectives

be incorporated into the budget process. This could be

facilitated by requiring agencies to submit prioritized

budget requests at several different expenditure levels.

The budget process could also be improved by implementing

budgets biennially for the smaller state agencies

To encourage higher productivity and more effective

management, the Committee recommends that the personnel

system be modified to allow for greater monetary incentives

through merit pay and bonuses. Currently, the framework

exists for merit pay, but there has not been a great

financial commitment by the state to the program. In

conjunction with the greater opportunities for reward for

state employees, the Committee believes that there should be

greater accountability for job performance.

To improve the effectiveness and efficiency of state

programs, the Committee recommends increasing the frequency

of performance audits of major agencies and implementing

follow- up actions to audit findings. Currently, sunset

performance audits are scheduled only once every ten years

and there are no formal follow- up procedures to ensure that

problems identified by the audits are addressed. The

Committee also recommends that the private sector loan

executives to the Auditor General to increase audit

resources. To increase the usefulness of both financial and

performance audits, the Committee recommends greater

interaction between the audit and budget processes. The

Committee also recommends the initiation of audits of

statewide functions, such as the use of motor vehicles or

consultants, and recommends the creation of an audit

function within the Executive branch.

24. The Arizona Cost Efficiency Commission ( Mini- Grace)

identified several areas in state government for potential

cost savings and cost avoidance. The Committee recommends

that the Legislature specify procedures for obtaining

closure on each of the Mini- Grace recommendations.

LOCAL GOVERNMENT FINANCE

25. To provide greater fiscal equalization across cities and

counties, the Committee recommends that per capita income be

one of the factors used to allocate state aid.

Jurisdictions with higher per capita income have lower need

and higher capacity, and, therefore, need less state aid.

26. To provide local autonomy and voter approval of local fiscal

decisions, the Committee recommends that voter- approved

permanent changes be allowed to the bases of both levy and

expenditure limits for cities, counties and community

college districts. This change, while maintaining

constraints on local fiscal behavior, allows for flexibility

to address changing circumstances.

To provide counties with more revenue flexibility to meet

their expenditure needs, the Committee recommends that

counties be granted authority to impose sales taxes by a

vote of the people. The current state sales tax

distribution to the counties could then be reduced or

eliminated. County sales taxes are common nationally and

regionally. Because many counties are at their property tax

levy limits, this authority would provide greater own- source

revenue capacity. To facilitate administration and uniform

enforcement, the authority granted should be restricted to a

uniform code imposed by the state on the counties.

STRUCTURAL DEFICIT

28. Our research report of August 23 illustrated that general

fund current- program expenditures are projected to grow much

faster than general fund current- program revenues between

now and the year 2000: 5.6 percent a year for expenditures

compared to 4.0 percent a year for revenues. The Committee

has provided a set of recommendations on revenues and

expenditures to serve as a foundation for a good fiscal

system. This foundation provides a more responsive revenue

system than the current revenue system and, therefore,

addresses the structural deficit, in part. Because the

growth rate of expenditures will remain above the growth

rate of revenues, there will be a need for future revenue

increases or expenditure decreases. To address the

structural deficit further, the Committee recommends that

the Legislature re- evaluate the fastest growing components

of total expenditures to identify ways to decrease the

growth rates of those components.

29. To improve the responsiveness, fairness, simplicity,

neutrality and predictability of the revenue system, the

Committee recommends that Packages A, B and C be given

consideration by the Legislature and the Governor. Each of

these packages addressesathe structural deficit recognized

by the Committee. However, Package B best represents the

preferences of the Committee. ( These packages and the

rationale underlying this recommendation of the Committee

are described in the next section.)

V. REVENUE PACKAGES THAT ADDRESS THE STRUCTURAL DEFICIT

Frequent, ad hoc changes to ~ rizona's revenue system enacted

to address short- term needs have resulted in a revenue system

that is unnecessarily complex, imposes non- neutral treatment on

taxpayers, and is unpredictable. The system lacks accountability

and fails to track growth in the state's economy at a pace

sufficient to cover expenditures. Sales and income tax bases

have been eroded over the years, resulting in high statutory tax

rates and inefficiencies.

The Arizona revenue system can be simpler, fairer, more

predictable, more responsive, and more accountable. An improved

revenue system includes a broader, simpler base for income taxes;

a broader base of consumer purchases for sales taxes; and a more

rational intergovernmental system. Appendix V presents three

revenue packages, each of which raises the same revenue as

projected for the current system in 1991. Each would result in

an improved fiscal system for Arizona.

Our research has found that the Arizona fiscal system does

indeed have a structural deficit: under the current system,

revenues are projected to grow more slowly than expenditures. As

time goes on, the gap between expenditures for current programs

and revenues raised under the current structure will widen.

Adjusted projections indicate that the deficit is estimated to be

$ 340 million in 1991. This estimate for the 1991 deficit is

based on staff long- term projections adjusted for short- term

changes in the economy and fiscal policies. The exact amount of

the 1991 deficit will vary from this amount due to outside

forces, such as changes in federal law, and to policy choices not

reflected in these projections. Changes to the levels of

expenditures and revenues to close the projected 1991 deficit

will not solve the long- term structural deficit. To eliminate

the structural deficit, not only must the levels of revenues and

expenditures be equal, but the future growth rates of

expenditures and revenues must be brought closer in line.

Because the magnitude of the deficit is large, minor

adjustments to revenues or expenditures will not eliminate it.

Significant expenditure cuts or revenue increases or a

combination of the two are required.

Expenditures

For example, if the Legislature chooses to address the

problem solely through expenditure cuts, it could do so by

freezing real expenditures for corrections, health care and

welfare at their 1988 levels. No increases for population growth

would be affordable. Alternatively, the future growth rates of

major expenditures could be cut in half. This would result in

major reductions in public services. For example, there would be

60,000 fewer AFDC recipients and 5,000 fewer prison inmates by

the year 2000 ( i. e., a 28 percent and 22 percent reduction,

respectively, from the projected caseloads in the year 2000.)

Our research has shown that Arizona is an average spender

overall. While there exist areas for cost efficiencies, we have

found no evidence of areas where the state is clearly over-spending

relative to identified needs. Policy choices have

resulted in higher than average spending in some areas and lower

than average spending in others.

Revenues

If the Legislature chooses to address the structural deficit

problem solely through revenues, it could do so along the lines

of one of the following three revenue packages for 1991. These

revenue packages are not meant to be a reflection of the other

Committee recommendations, but rather are illustrations of

possible integrated revenue packages that improve upon the

current system. These packages focus on major components that

together result in a well- balanced system. Although the

Committee did not vote on individual components of these

packages, the Committee forwards these packages to the Governor

and Legislature as illustrations of revenue systems that close

the 1991 projected gap and address, in part, the long- term

structural deficit. Of the three, Package B best represents the

preferences of the Committee.

These packages address the structural deficit with changes

to the two major sources of revenue for the state, the personal

income tax and the sales tax, and with certain other taxes or

structural changes that have major general fund revenue

implications. The personal income tax and sales tax provide

complementary components to the system. The sales tax brings

stability and contributes to the regressivity of the system. The

personal income tax is responsive to economic growth and

contributes to the progressivity of the system.

Changes to other taxes have much smaller impacts on the

overall revenue system. Adjustments to the system using minor

revenue sources may be desirable if they contribute to a rational

revenue system, but they should not be used simply to raise

revenue. The danger of relying on minor adjustments to meet

revenue needs is that they often consist of ad hoc band- aid

solutions that make the system more complex, less neutral and

less predictable.

All three packages use federal adjusted gross income ( FAGI)

as a base for the personal income tax, with no itemized

deductions or deductions for federal taxes paid. This broad base

for the personal income tax results in a greatly simplified

structure, allows for lower statutory tax rates, and provides an

income base that better reflects ability to pay. By adopting

FAGI as the base with a minimal number of adjustments, Arizona

will be affected very little by tax changes at the federal level.

The percentage share of total sales tax collections retained

by the state is assumed to be constant and equal to the current

share of 78 percent. The share of income taxes retained by the

state is assumed to be 87 percent, equal to the current share.

In all three revenue packages and the amounts shown for the

current system, the miscellaneous category includes severance

taxes, property taxes, luxury taxes, licenses, charges and fees,

lottery revenues, insurance premium taxes, and other

miscellaneous revenues. Also included under miscellaneous is the

revenue currently collected from minimum property tax payments

required from school districts not receiving state aid ( based on

one- quarter of the qualifying tax rate). Changes to the system

that raise the required minimum tax are labeled as " additional

minimum school tax rate. I1 Finally, the amount shown under the

homeowner's rebate represents a reduction in state spending and

thus a savings to the general fund.

As recognized in Committee Recommendation # 28, these

potential changes to the level and structure of state revenues do

not provide a complete solution to the structural deficit. Even

these three more responsive revenue systems are not projected to

grow as fast as expenditures to the year 2000. Arizona will

continue to face deficits, although less severe deficits if the

Legislature acts upon these recommended packages, throughout the

next decade unless the growth rate of expenditures is decreased

through: a) a strong economy, b) the maturation of state

policies, c) a change in state policies in fast- growth areas such

as corrections, health and welfare, or d) a combination of all

three.

Package A

This package simplifies the personal income tax, broadens

the sales tax base to include personal services and repair,

casual auto sales, and interstate telephone calls; narrows the

sales tax base to exclude commercial rent; and lowers the sales

tax rate to 4.5 percent. The package includes a real estate

transfer tax at a 0.5 percent rate, requires school districts not

receiving state aid to levy a primary school tax rate equal to

the qualifying tax rate, and eliminates the homeownerrs rebate.

This package decreases the reliance on the sales tax and

increases the reliance on the personal income tax and on other

sources, primarily property taxes.

Current

System Packase A

Sales Tax

Personal Income Tax

Corporation Income Tax

Other:

Real Estate Transfer 75

Additional Minimum

School Tax Rate 92

Homeownerrs Rebate 177

Miscellaneous 648 648

Total Other 648 992

TOTAL $ 3,288 $ 3,628

By changing the sales tax base, this system is more neutral

than the current system, and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is not altered significantly by this package.

Including a real estate transfer tax increases responsiveness of

the system, and brings our tax structure in line with 30 other

states. Raising the minimum school tax rate improves the

fairness of the system. Eliminating the homeowner's rebate

improves fairness and removes distortions: the current

homeownerrs rebate does not target needy school districts or

needy taxpayers/ voters; this change makes the local price to

taxpayers/ voters better reflect the costs of K- 12 education.

This package improves the overall responsiveness of the

system and reduces the regressivity. The package increases the

property tax burden on homeowners and on property taxpayers in

wealthy school districts.

Package B

This package simplifies the personal income tax, changes the

sales tax base to include personal services and repair and to

exclude commercial rent, and lowers the sales tax rate to

4.8 percent. The package includes a real estate transfer tax at

a 0.3 percent rate, requires school districts not receiving state

aid to levy a primary school tax rate equal to 75 percent of the

qualifying tax rate, and reduces the homeowner's rebate subsidy

from 56 percent to 25 percent. This package decreases the

reliance on the sales tax, increases the reliance on the personal

income tax and increases reliance on other taxes, primarily

property taxes.

Current

Svstem Packase B

Sales Tax

Personal Income Tax

Corporation Income Tax

Other:

Real Estate Transfer 45

Additional Minimum

School Tax Rate 62

Homeowner8s Rebate 88

Miscellaneous 648 - 648

Total Other 648 843

TOTAL $ 3,288 $ 3,628

By changing the sales tax base, this system is more neutral

than the current system, and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is not altered significantly by this package.

Including a real estate transfer tax increases responsiveness of

the system, and brings our tax structure in line with 30 other

states; imposing the tax at a low rate causes little interference

in the private market. Raising the minimum school tax rate

improves the fairness of the system. Reducing the homeowner's

rebate subsidy improves fairness and reduces distortions: the

current homeowner's rebate does not target needy school districts

or needy taxpayers/ voters; this change makes the local price to

taxpayers/ voters better reflect the costs of K- 12 education.

This package increases the overall responsiveness of the

system, and increases the overall progressivity of the system.

The package increases the property tax burden on homeowners and

property taxpayers in wealthy school districts.

Package C

This package simplifies the personal income tax, broadens

the sales tax base to include food for home consumption and

consumer purchases of gasoline, and lowers the sales tax rate to

4.6 percent. To direct the revenues from a sales tax on gasoline

to the general fund, as shown below, would require a

constitutional change. This package replaces the homeowner's

rebate with a homeowner's exemption at an equal cost to the

state. This package increases sales tax revenues and increases

personal income tax revenues, while all other sources remain the

same as in the current system.

Current

Svstem Packase C

Sales Tax $ 1,465 $ 1,515

Personal Income Tax 1,003 1,293

Corporation Income Tax 172 172

Total Other 648 648

TOTAL $ 3,288 $ 3,628

By expanding the sales tax base, this system is more neutral

than the current system and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is increased by this change. The change to a

homeowner's exemption provides more targeted and less

distortionary property tax relief.

Relative to the current system, Package C relies slightly

less on the sales tax and more on the personal income tax as a

share of total revenue. The changed reliance on sales, personal

income and other taxes is not likely to affect overall

regressivity or responsiveness relative to the current system.

APPENDIX I

CHARTS AND GRAPHS

General Fund Revenue and Expenditure Projections

I1Best Estimatew

( Current Programs)

Revenues + Expenditures

MIX OF STATE OWN- SOURCE REEYLIE

PWS- INCOME ( i El=)

MIX OF STATE OWN- SOURCE E5mUE

SOURCE: U. S. 32s- 3,--.. L - L

33

DOLLARS PER CA? lTA

COM l') Ali IS0N OIT S- rAIE& 1- OCAI- EX I3- I-- N DIIUR ES

PER CAPITA. 1987

K- 12 EDUC. HIGIiER ED PUB. WELFAREt1EALTH& IiOSP HIGHWAYS POLICE/ FIRE CORRECTIONS

] U. S. Average

SOIJRCE : U . S . Cens~ 1s nureau

m A Arizona

POLICY OPTIONS INVENTORY

The committee has considered over one hundred miscellaneous

policy options dealing with revenues and expenditures. Most of

these options derive from committee research reports. Several,

however, were generated from public input or by individual

Committee members. The policy options are listed here as an

inventory.

The options are not numbered or arranged on the basis of any

priority. Nor should the fact that some options are followed by

pro or con remarks or comments and others are not be construed to

mean that either the Committee or staff intend that such options

are entitled to greater or less weight than others. In some

cases, options may overlap. In others, there may be conflicts.

The intent of this appendix is only to present the broad array of

options that have been considered. The exact wording of this

appendix has not been voted upon by the Committee.

OPT ION

1. Simplify the personal

income tax.

a. Adopt federal

adjusted gross

income ( FAGI) as the

base.

b. Adopt federal

taxable income as

the base.

c. Apply Arizona

percentage to

federal tax

l i a b i l i t y .

Increase reliance on the

personal income tax.

PRO'S

Greatly reduces administration and

compliance costs.

a. Provides for the most

broadly defined base,

enhancing efficiency.

Provides for more responsive and

equitable tax system. State income

taxes are deductible at the federal

level.

3. Eliminate deduction for Simplifies the system and improves

federal taxes paid on the efficiency by reducing the marginal

corporation income tax. rate.

4. Impose a franchise tax Improves neutrality, because income

based on net income on: earned on federal obligations may

be included i n the base. Such

income may be more s i g n i f i c a n t f o r

financial institutions than for

other corporations.

CON S COMMENTS

Reduces opportunity for state- Policy goals that d i f f e r from

specific adjustments. federal tax policy goals are

not effectively pursued

through the income tax due to

Low marginal rates at the

state Level relative to

federal income tax rates.

b. The narrower base ( r e l a t i v e b. This option

to FAGI) requires higher incorporates federal

rates, diminishing itemized deductions.

efficiency.

l-c.

Uould require change m

i n Arizona rate i n

response to any change

i n federal tax to

maintain revenue.

Adds i n s t a b i l i t y . Income taxes The personal income tax

are not exportable. burden and reliance i n

Arizona are Lou. Personal

income tax revenues could be

increased substantially and

Arizona would s t i l l be below

the US average burden.

Federal Law prohibits states

from taxing federal

obligations under a

corporation income tax, but

not under a franchise tax.

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s. , 2. z- h ID

0 oT" a - oI

OPT I ON

e. interstate phone

calls.

PRO'S

e. Improves responsiveness,

neutrality, and efficiency.

6. Remove selected business Simplifies the tax, improves

purchases from the sales neutrality, and potentially

tax base: enhances the competitive position

of the state.

a. equipment.

b. expendable

materials.

c. comnercial rent. c. Improves state's

competitiveness, and

provides for neutral

treatment of businesses

whether they own or rent

property.

7. Require conformity of Greatly reduces complexity and

state and Local sales tax administration and compliance

bases. costs.

8. Change alcohol and Improves responsiveness and

tobacco taxes from per p r e d i c t a b i l i t y by minimizing the

unit to ad valorem need for statutory changes i n

structure. rates.

CON'S COMMENTS

e. May hurt Arizona's e. Revenue estimates

competitiveness, i n i t i a l l y . include tax on

business calls, which

should be exempt

according to theory

that tax should apply

only to f i n a l sales to

consumers.

Would result i n large revenue Generally, should not exempt

l osses . business purchases of items

or services which are

comnonl y purchased by

individual consuners due to

administrative problems and

potential for tax evasion.

a. Much equipment i s

already exempt.

Revenue estimates are

not available.

( r\

b. Revenue estimates are

not available.

c. Arizona i s one of f i v e

states that tax

rentals of real

property.

Diminishes local control and Policy decision must be made

f l e x i b i l i t y , Local governments on which base to use as a

are not insulated from state standard.

policy choices.

Could increase regressivity of This would be easy to achieve

the f i s c a l system. by adding a rate at the

r e t a i l Level and eliminating

the tax at the wholesale

level.

OPT ION

9. Impose a real estate

transfer tax.

10. Determine whether state

higher education

resources should be

concentrated on one or

two major research

universities.

11. Limit enrollment at

universities and

accomnodate more students

at comrmnity colleges.

12. Increase university

tuition.

13. Alter e l i g i b i l i t y or

service coverage under

AHCCCS.

14. Reform K- 12 financing by:

a. requiring a minimum

primary school

property tax.

PRO IS

Increases responsiveness.

Supporting two research oriented

universities could help economic

development.

Allows the state to concentrate

university resources on upper

division courses and on research-related

a c t i v i t i e s .

Reduces subsidy to out- of- state

students and makes t u i t i o n better

r e f l e c t cost of education.

Increasing e l i g i b i l i t y or service

coverage provides greater benefits

for low- income individuals.

a. Improves horizontal equity

for taxpayers.

CON I S COMMENTS

Increases i n s t a b i l i t y . 30 states impose the tax at

rates from 0.01% to 3%.

Dividing support between two Very few states have more

major universities could Lead to than one outstanding research

Lower quality overall. university. There are no

major private universities i n

Arizona as there are i n many

other states.

Limits opportunity for university Might involve more state aid

education. to comnunity colleges or

higher comnunity college

property taxes or tuition.

Limits access to university

education.

Could be accompanied by more

need- based scholarship

funding.

0

Increasing e l i g i b i l i t y or service Arizona spends far below the

coverage requires a larger average on health care per

comnitment of resources. capita.

a. Increases property tax a. Could be implemented

burden i n wealthy i n revenue/ expenditure

d i s t r i c t s . neutral way for the

state by towering QTR,

or could provide

additional revenues

for state general

fund. The closer the

minimum rate i s to the

QTR, the greater the

improvement i n

horizontal equity.

OPT I ON PRO'S

b. equalizing access to b. Improves horizontal equity

overrides. for taxpayers.

c. prohibiting spending c. Improves horizontal equity

outside the for taxpayers and students.

equalization base

limits.

d. implementing routine d. Ensures that formula cost

evaluation of factors accurately r e f l e c t

formula factors. actual service costs.

e. taxing certain e. Improves horizontal equity

industrial for taxpayers.

/ u t i l i t y property at

state level only.

f. increasing state

share of school

financing.

f. Improves horizontal equity

for taxpayers.

g. requiring minimum g. Could improve horizontal

level of school equity i n services received

d i s t r i c t by students.

expenditures.

CON ' S COMMENTS

b. Increases complexity. b. Could be expenditure

neutral for state by

increasing QTR, and

thus substituting

override aid for some

portion o f

equalization aid.

c. Spending items currently

allowed outside the Limits

could be prohibited or

incorporated i n t o the

equalization base as cost

factors.

d. Evaluation requires

resources.

e. Local governments would e.

bear the costs of providing

services to these

properties without

receiving property tax

revenues from them.

f. Diminishes accountability. f.

g. Conflicts with local

choice.

This option i s

irrelevant for school

d i s t r i c t s , i f Option rl

No. 14a i s adopted.

Increasing the state

share increases the

portion o f K- 12

expenditures funded by

sales and income

taxes, decreases the

portion funded by

local property taxes.

The rationale for

minimum expenditures

rests on a l i n k

between education

spending and service

levels that i s

d i f f i c u l t t o document.

OPT I ON PRO'S CON'S COMMENTS

h. merging Low

enrollment d i s t r i c t s

with neighboring

d i s t r i c t s .

h. Could improve horizontal

equity for taxpayers and

students, could reduce costs

per student through

economies of scale.

h. Conflicts with Local

choice.

i. applying spending

Limits to small

d i s t r i c t s .

i. Promotes equal treatment of

school d i s t r i c t s regardless

of size.

i. Conflicts with local

choice.

i. Couldreduce

expenditures i n small

d i s t r i c t s .

j. appropriating funds

to d i s t r i c t s for

strategic planning

to meet educational

j. Could promote better Local

decision- making and improved

services.

j. Would require additional

state expenditures.

goals.

15. Increase AFDC benefit

payments . Benefits low- income mothers and

children and may provide welfare

recipients with the means to become

financially independent.

Requires Large comnitment of Arizona spends far below the

resources. average on welfare per

capita.

16. Earmark additional gas

tax revenues for

pollution programs ( to

DEQ).

Provides a l i n k between pollution

generating a c t i v i t i e s and spending

on pollution abatement.

Higher gas taxes may hurt

competitiveness.

Would require a

constitutional change.

17. Assume f u l l state funding

of the judicial system.

Improves horizontal equity i n tax

burdens and services received

across local jurisdictions, may

achieve economies of scale.

May create unwieldy state

bureaucracy.

Could be revenue neutral by

decreasing state shared

revenues.

18. Alter sentencing

policies, both Length and

nature of sentence.

Alternatives to incarceration could

be cost effective, shorter

sentences put Less demand on

pr i sons.

Using alternatives to prison or Arizona has a high crime rate

shorter sentences could result i n and high incarceration rate.

increased crime and less security

for the public.

19. Impose a selective sales

tax on polluting

household products.

Improves efficiency by making the

tax reflect the costs imposed on

society.

May be costly to administer, Revenues could be earmarked

would be regressive. to pollution clean- up

programs.

20. Index a l l user charges

and license fees.

Improves responsiveness, minimizes

the need for periodic rate changes.

Set- up costs may be high and

a decision must be made as to

the appropriate index.

8 T 5.

t- 5. o5ar, = t - ID ID -.

I" ln 3.

3 r t

- 0 ln

7 r t - h - o

I D 7 0 7

c n m - r o

- 0 3 < 0 l n - - . $,! $

- w. em - r t

- r t * - I

d. d. 0 a,

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- . 3 m V)

$ : i B x6 .3 ; z :

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5 O l

OPTION

a. one class ( complete

uniformity).

b. two classes:

residential and

comnercial/

industrial.

c. three classes:

residential,

agricultural,

comnercial/

industrial.

PRO'S

29. Allow permanent voter- Allows voter- approved f l e x i b i l i t y

approved changes to the to respond to changing

base of Levy and circunstances.

expenditure Limits.

30. Eliminate homeowner's Improves accountability and

rebate. simplicity.

31. Implement structural

changes to the

homeowner's rebate.

a. Reduce the rate.

b. Replace with

homeowner exemption

or credit.

c. Target rebate to low

income or Low wealth

individuals.

a. The perceived cost of

education i s closer to the

actual cost.

b. A t the margin, increased

spending i s financed t o t a l l y

by Local taxpayers, results

i n lower effective tax rates

for lower valued homes.

c. Provides r e l i e f where it i s

needed.

CON'S COMMENTS

Currently c i t i e s and counties

can change the base of their

expenditure limits.

Increases homeowner property tax As a school aid program, the

burden, could result i n homeowner's rebate i s not

unintended ( by the state) well targeted. As a property *

decreases i n school spending. tax r e l i e f mechanism, it *

provides perverse incentives

to homeowners.

c. May be more complex.

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m -.* la

03011,

rtln ln rt

d. d.

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OPT I ON

38. Impose sales tax on

transfers of securities.

39. Tax amount of power

generated rather than

receipts of in- state

power sales.

40. Repeal the vendor

allowance.

41. Repeal the sales tax

exemption for

advertising.

42. Extend sales tax to

employee meals.

43. Extend sales tax to

carbonated drinks.

PRO'S CON'S COMMENTS

Taxing transfers of

securities i s

administratively feasible

only i n states with stock

market exchanges. A proper

method of taxing income

generated by such transfers

i s through capital gains

taxation.

Simplifies the tax and exports some Could lead to retaliatory tax Arizona exports more energy

burden to out- of- state residents. increases on Arizona fuel than i t imports.

purchased out of state.

Improves simplicity.

Could improve responsiveness.

Could increase costs of goods. Arizona's current vendor

allowance i s low compared to

other states.

Diminishes neutrality and

simplicity.

Improves n e u t r a l i t y and efficiency. Might increase Labor costs.

44. Exempt purchases of used Improves neutrality.

agricultural equipnent

from the sales tax.

45. Increase severance tax Burden Likely exported to other

rate on mining and states and introduces few

timbering. behavioral distortions.

46. Extend sales tax to cable Improves efficiency.

T. V.

47. Increase sales tax rate

on wholesale feed.

Distorts consumer decisions

between carbonated and non-carbonated

beverages.

Carbonated drinks are now

included i n exemption for

food for home consumption.

May diminish competitiveness of Severance tax base for mining

Arizona's mining industry. d i f f e r s from transaction

privilege tax base so

equivalent rates do not

ensure neutrality.

Lower rate at wholesale i s

equivalent to higher rate at

r e t a i l .

OPT ION

48. Extend sales tax to

mining and d r i l l i n g

equ i p e n t .

49. Require remittance of

sales tax collections

over 81 m i l l i o n twice

monthly.

50. Treat corporations

incorporated i n Arizona

l i k e corporations

incorporated elsewhere

with respect to dividends

received from controlled

corporations.

51. Conform with federal Law

on the Length of carry-back

and carry- forward

periods for net operating

losses for corporation

income tax.

PRO'S

Increases tax revenue at any given

rate.

Improves neutrality.

Simplifies the corporation income

tax.

CON'S

May harm competitiveness and

neutrality and may diminish

simplicity.

Increases compliance costs.

Would result

the state or

some Arizona

COMMENTS

i n revenue loss to Current Law exempts dividends

tax increase for from subsidiaries of Arizona

corporations. domiciled corporations and

discriminates against firms

domiciled elsewhere.

Attention should be paid to

transition rules.

52. Eliminate gradations in the rate structure of the

corporation income tax.

Change the weights in the corporation income tax

apportionment formula to favor the sales factor.

Impose the corporation income tax on reinsurers with a

credit for premium taxes paid.

Broaden the premium tax to cover untaxed insurance forms

such as self insurance and fraternal insurance.

Include premiums paid by government agencies in the tax base

for Health Care Service Corporations.

Eliminate the tax credits allowed for insurance examination

fees and assessments.

Adjust the apportionment formula for multistate financial

institutions to:

a) add intangibles to the property factor,

b) eliminate the property factor,

c) use a receipts factor only.

Base nexus rules on solicitation rather than physical

presence for financial institutions.

In determining the appropriate severance tax rate, compare

Arizona's severance tax to other states' severance taxes

rather than to sales tax rates.

Develop indigent behavioral health care as part of the

AHCCCS program, part of the Department of Health Services,

or an independent entity.

Develop a centralized, coordinated data base for state and

local health care spending.

Implement provisions of the federal Family Support Act prior

to the required deadline.

Establish poverty prevention programs.

Strengthen child support enforcement policies.

Raise the groundwater withdrawal fee.

Release State Park entrance fees and concessions revenues

for use on current operations.

68. Fund non- game and wildlife habitat programs in the Game and

Fish Department with General Fund monies.

Implement new law enforcement technologies.

Enhance court charge and fee revenues.

Determine funding, allocation, and appropriate use of

Criminal Justice Enhancement Fund monies.

Conduct a statewide inventory of potential fees and charges.

Establish greater fee flexibility.

Evaluate earmarking more fees into special funds.

Establish congestion tolls for highway travel.

Conduct a cost allocation study of Arizona's highway

structure.

Evaluate the potential for privately operated prisons.

Evaluate current privatization in behavioral health service

delivery.

Evaluate privatization of government support services.

Utilize alternative, private mechanisms to resolve disputes.

Privatize inspection and regulation activities.

Increase privatization in areas where feasible.

Insert matching requirements to categorical state aid

programs.

Adjust fiscal limits for changes in intergovernmental aid.

Allow cities to pass temporary overrides of levy limits.

Change state budget process to operate biennially.

Alter the level of centralization in state government

operations.

Establish central data base on Arizona local governments.

Establish state body to collect and analyze local government

data and act as liaison between local governments and the

State.

90. Equalize the effective tax rates on the different types of

alcohol.

91. Conduct a study to estimate the revenue losses associated

with exempting business purchases from the sales tax base.

92. Reserve mid- year budget adjustment procedures for truly

unforeseen emergency situations; a formal mechanism should

be established to address such situations.

93. Combine small state agencies.

94. Invest resources in establishing a thorough, well- documented

data base on state revenues.

95. Reduce jet fuel taxes in Arizona.

96. Charge a graduated co- payment fee for AHCCCS benefits.

97. Extend sales tax base to include business services and non-health

professional services.

98. Prohibit state or local discriminatory rates on products

and/ or services within the same industry.

99. Eliminate duplication of programs within the university

system.

100. Revise residency requirements to reserve in- state tuition

rates for bona- fide Arizona residents.

101. Create cooperative venture teams with public/ private

partnerships utilizing loaned executives to supplement the

budget process.

102. Shorten time between sunset reviews.

103. Encourage private sector loaned executives to the Auditor

General to increase audit resources.

104. Allow reverted monies to be used for employee rewards.

105. Amend Constitution to allow general obligation bonding for

capital outlay for prison construction.

106. Require privatization bidding before general obligation

bonding can be undertaken.

107. Limit state bonded indebtedness to a percentage of state

personal income.

108. Require that bonds be voter- approved.

109. Increase support for community colleges and raise the

admission standards at all four- year universities.

110. Increase out- of- state tuition to cover the actual costs of

providing services to those students and increase in- state

tuition to the national average.

111. Define a NbasicllK - 12 education in terms of specific dollar

funding and commit state resources to fund that level in

each district.

112. Allow local residents the opportunity to increase education

funding beyond the basic level through the local property

tax.

113. Authorize open enrollment in K- 12 school districts to foster

competition and accountability.

APPENDIX I11

FISCAL OPTIONS GROUPED BY CRITERIA

There is no perfect revenue source to finance state

government expenditures. Different sources of revenue serve

different policy goals. These goals are often in conflict so

that designing a fiscal system involves policy tradeoffs. while

a single revenue source may have undesirable characteristics, it

may fit effectively into an overall revenue system. It is

important then, to evaluate a revenue system on its merits as a

whole: do the component parts, functioning together, meet the

state's goals for equity, simplicity, responsiveness, stability,

competitiveness, predictability, efficiency, accountability, and

neutrality? In reality, it is desirable to design a system that

meets all of these goals to some degree, a system that is well-balanced.

For discussion purposes, it is useful to examine the

extremes.

Displayed below are three packages composed by staff, each

of which emphasizes a different fiscal criterion. The purpose of

these packages is to illustrate which elements of a revenue

system best address equity, efficiency and responsiveness. Each

package includes only those components that meet these specific

goals. All three packages strive for simplicity, where

simplicity can be gained without diminishing some other goal.

Package X. ~ fficiency\~ eutrality\~ ccountability

To improve efficiency, Package X broadens the sales and

income tax bases so that statutory rates can be reduced.

~ roadening the sales tax base to include all consumer purchases,

while narrowing it to exclude all business purchases, simplifies

the tax. It also provides for more neutral treatment of

different types of business. Accountability is improved by

having taxpayers and consumers face the true cost of the benefits

they receive, and by forcing the jurisdiction that spends tax

dollars to be responsible for collecting them.

o Base the personal income tax on federal adjusted gross

income ( FAGI)

o Impose a franchise tax rather than an income tax on all

corporations

o Do not allow a deduction for federal taxes paid on the

corporation income tax

o Remove all business purchases from the sales tax base

o Expand the sales tax base to include all consumer purchases

o Require conformity between local and state sales tax bases

o Increase university tuition

o Impose a selective sales tax on polluting products

o Permit local option fuel and vehicle taxes

o Reduce state aid to local governments

o Appropriate state aid annually, rather than setting a pre-determined

share

o Establish uniform classification of property with uniform

assessment ratios

o Eliminate the homeowner's rebate

o Remove local property tax and expenditure limits or expand

allowance of overrides

o Increase user charges and license fees to reflect actual

benefits, and earmark more fees into special funds

Package Y. Equity

Package Y emphasizes both horizontal and vertical equity.

It increases reliance on the progressive personal income tax, and

decreases reliance on the regressive sales and tobacco and

alcohol taxes. The package targets state aid and other subsidies

to areas of greatest need, rather than providing broad tax relief

programs. It equalizes spending and tax burdens across all types

of local jurisdictions.

o Increase the reliance on personal income taxes

o Base the personal income tax on FAG1

o Make the personal income tax more progressive by increasing

marginal rates at higher income levels

o Reduce the reliance on sales taxes

o Reduce the reliance on tobacco and alcohol taxes

o Increase university tuition and provide more need- based

scholarships

o Impose a minimum school tax rate

o Equalize access to school spending overrides

o Prohibit school district spending outside equalization base

limits

o Tax some industrial/ commercial/ utility properties at state

level only -- remove them from local tax bases

o Add per capita income to state aid distribution formulas and

provide more aid to jurisdictions with lower per capita

income

o Alter the structure of the homeowner's rebate to target aid

to low income and low wealth homeowners or to low wealth and

high cost school districts

Package 8. Responsiveness

Package Z is designed to grow more quickly relative to

growth in the underlying economy. Reliance on the personal

income tax, a very responsive revenue source, is increased, and

other revenue sources are redesigned to be more responsive. Note

that responsiveness and stability are opposing goals so that a

package emphasizing stability would have the reverse of the

components in Package Z.

o Increase reliance on personal income taxes

o Decrease reliance on sales taxes

o Add personal services to the sales tax base

o Base tobacco and alcohol taxes on the dollar value of sales

rather than on the quantity purchased

o Impose a real estate transfer tax

o Index all charges and fees to keep pace with some measure of

inflation

o Make the personal income tax more responsive by including

brackets with higher marginal rates at higher income levels

APPENDIX IV

SAMPLE SIMPLIFIED PERSONAL INCOME TAX FORM

nrizona Form 140 Resident Personal Income Tax Tax Year 1989

Name

IIome Address

city State i~

Your Social Security Number

spouse's Social Security Number

Filinq Status d1;:.:; ;; 0

or Ilead of 2 . rnMarried or Single

household filing

joint return separately

-~.. x- - e - m p- tions Personal I> ependents Age 65 or over Dlind

Write 1. 2. 3. 4 .

number of

exemptions Total ( add lines 1 through 4)

claimed 5.

6. Federal Adjusted Gross Income ( U. S. form

1040, line 31 or U. S. form 1040A line 13

or U. S. form 1040 EZ line 3)

7. Interest or dividends earned on bonds of

another state or its governmental units

8 . Add lines 6 and 7 and enter total here

8-'

9. Interest received from U. S.

bot~ ds, Treasury notes, other U. S ,

certificates of indebtedness

lo. Multiply the number on line 5 by

$ X thousand

11. Add lines 9 and 10 and enter total here

I I I

12. Subtract line 11 from line 8. This is your

Arizona taxable income.

13. Tax from the table on page X of instructions

12- E I I l

14. Voluntary contributions for wildlife, child

abuse prevention, and political parties.

15. Add lines 13 and 14 and enter total here.

15- r----- n

16. Arizona income tax withheld

( from 1989 W- 2 forms)

17. Estimated tax paid in 1989, and

extension payments.

17. CIzu 18. Add lines 16 and 17, and enter total here

19. 1f line 18 exceeds line 15 enter your REFUND.

19. m

20. If line 15 exceeds line 18 enter your TAX DUE.

Your signature Spouse's Signature

20- n

Date

Paid Firm Is

Preparers Signature Name

Address Social Security #

APPENDIX V

REVENUE PACKAGES THAT ACCOMPLISH STRUCTURAL REFORM

Frequent, ad hoc changes to Arizona's revenue system enacted

to address short- term needs have resulted in a revenue system

that is unnecessarily complex, imposes non- neutral treatment on

taxpayers, and is unpredictable. The system lacks accountability

and fails to track growth in the state's economy at a pace

sufficient to cover expenditures. Sales and income tax bases

have been eroded over the years and inappropriately exclude

categories, resulting in high statutory tax rates and

inefficiencies.

The ~ rizona revenue system can be simpler, fairer, more

predictable, more responsive, and more accountable. An improved

revenue system includes a broader, simpler base for income taxes;

a broader base of consumer purchases for sales taxes; and a more

rational intergovernmental system. Each of the following three

revenue systems would result in an improved fiscal system for

Arizona.

Based on our research report of August 23, 1989 that

presented long- term revenue projections, and based on adjustments

for short- term variations ( including both structural changes and

economic changes), staff projects that 1991 general fund revenues

will be $ 3,288 million ( in 1991 dollars) under the current

system. The three potential revenue systems presented below each

raise $ 3,288 million. These packages combine major options that

represent improvements upon the current system. The packages

include only those options that affect general fund balances.

All three packages use federal adjusted gross income ( FAGI)

as a base for the personal income tax, with no itemized

deductions or deductions for federal taxes paid. This broad base

for the personal income tax results in a greatly simplified

structure, allows for lower statutory tax rates, and provides an

income base that better reflects ability to pay. By adopting

FAGI as the base with a minimal number of adjustments, Arizona

will be affected very little by tax changes at the federal level.

The percentage share of total sales tax collections retained

by the state is assumed to be constant and equal to the current

share of 78 percent. The share of income taxes retained by the

state is assumed to be 87 percent, equal to the current share.

In all three revenue packages and the amount shown for the

current system, the miscellaneous category includes severance

taxes, property taxes, luxury taxes, licenses, charges and fees,

lottery revenues, insurance premium taxes, and other

miscellaneous revenues. Also included under miscellaneous is the

revenue currently collected from minimum property tax payments

required from school districts not receiving state aid ( based on

one- quarter of the qualifying tax rate). Changes to the system

that raise the required minimum tax are labeled as '' additional

minimum school tax rate." Finally, the amount shown under the

homeowner's rebate represents a reduction in state spending and

thus a savings to the general fund.

Package At

This package simplifies the personal income tax, broadens

the sales tax base to include personal services and repair,

casual auto sales, and interstate telephone calls; narrows the

sales tax base to exclude commercial rent; and lowers the sales

tax rate to 4.1 percent. The package includes a real estate

transfer tax at a 0.5 percent rate, requires school districts not

receiving state aid to levy a primary school tax rate equal to

the qualifying tax rate, and eliminates the homeownerts rebate.

This package decreases the reliance on both the sales and

personal income taxes, and increases reliance on other sources,

primarily property taxes.

Sales Tax

Personal Income Tax

Corporation Income Tax

Other:

Real Estate Transfer

Additional Minimum

School Tax Rate

Homeownerts Rebate

Miscellaneous

Total Other

TOTAL

Current

System Packase At

By changing the sales tax base, this system is more neutral

than the current system, and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is not altered significantly by this package.

Including a real estate transfer tax increases responsiveness of

the system, and brings our tax structure in line with 30 other

states. Raising the minimum school tax rate improves the

fairness of the system. Eliminating the homeownerts rebate

improves fairness and removes distortions: the current

homeownerts rebate does not target needy school districts or

needy taxpayers/ voters; this change makes the local price to

taxpayers/ voters better reflect the costs of K- 12 education.

This package does not markedly change the overall

responsiveness of the system, nor does it change the overall

burden on low- income people relative to high- income people. The

package increases the property tax burden on homeowners and on

property taxpayers in wealthy school districts.

Package B1

This package simplifies the personal income tax, changes the

sales tax base to include personal services and repair and to

exclude commercial rent, and lowers the sales tax rate to

4.2 percent. The package includes a real estate transfer tax at

a 0.3 percent rate, requires school districts not receiving state

aid to levy a primary school tax rate equal to 75 percent of the

qualifying tax rate, and reduces the homeowner's rebate subsidy

from 56 percent to 25 percent. This package decreases the

reliance on the sales tax, slightly increases the reliance on the

personal income tax, and increases reliance on other taxes,

primarily property taxes.

Current

System Packase B1

Sales Tax

Personal Income Tax

Corporation Income Tax

Other:

Real Estate Transfer

Additional Minimum

School Tax Rate

Homeowner's Rebate

Miscellaneous

Total Other

TOTAL $ 3,288 $ 3,288

By changing the sales tax base, this system is more neutral

than the current system, and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is not altered significantly by this package.

Including a real estate transfer tax increases responsiveness of

the system, and brings our tax structure in line with 30 other

states. Imposing the tax at a low rate causes little

interference in the private market. Raising the minimum school

tax rate improves the fairness of the system. Reducing the

homeowner's rebate subsidy improves fairness and reduces

distortions: the current homeowner's rebate does not target

needy school districts or needy taxpayers/ voters; this change

makes the local price to taxpayers/ voter better reflect the costs

of K- 12 education.

This package increases the overall responsiveness of the

system, and increases the overall progressivity of the system.

The package increases the property tax burden on homeowners and

property taxpayers in wealthy school districts.

Package Ct

This package simplifies the personal income tax, greatly

broadens the sales tax base to include food for home consumption

and consumer purchases of gasoline, and lowers the sales tax rate

to 3.6 percent. To direct the revenues from a sales tax on

gasoline to the general fund, as shown below, would require a

constitutional change. This package replaces the homeowner's

rebate with a homeownerts exemption at an equal cost to the

state. This package decreases sales tax revenues by $ 290 million

and, correspondingly, increases personal income tax revenues by

$ 290 million, while all other sources remain the same as in the

current system.

Current

System Packase Ct

Sales Tax $ 1,465 $ 1,175

Personal Income Tax 1,003 1,293

Corporation Income Tax 172 172

Total Other 648 648

TOTAL $ 3,288 $ 3,288

By expanding the sales tax base, this system is more neutral

than the current system and the lower tax rate results in less

interference with private economic decisions. The regressivity

of the sales tax is increased by this change. The change to a

homeownerts exemption provides more targeted and less

distortionary relief.

This package markedly increases the overall responsiveness

of the system. The increased reliance on the personal income tax

and the decreased reliance on the sales tax likely offset the

increased regressivity of the expanded sales tax base.

PART I1

ECONOMIC AND INSTITUTIONAL SETTING

CHAPTER 2

THE ARIZONA ECONOMY: CYCLES, LONGTERM ECONOMIC GROWTH

AND GOVERNMENT FISCAL BEHAVIOR

I. INTRODUCTION

Economic growth benefits a state in many ways. Economic

growth results in jobs for the labor force, income, goods and

services for residents, and tax revenue for financing desired

government services. Policymakers attempt to encourage economic

growth through many means, including fiscal policy. These

decisions are often made with an insufficient amount of

information to guide effective policy. This chapter describes

empirical evidence regarding the effect of the fiscal system on

economic growth.

The methodology employed compares differences in states1

long run economic growth rates to differences across the states

in factors influencing business location decisions. The

methodology is not appropriate for explaining cyclical changes in

growth rates. Rather, the approach used here seeks to explain

what causes one state to have consistently lower or higher

economic growth than the average state. In particular, once we

have controlled for many business location factors, does the

level or nature of Arizona's fiscal system in the 1980s help to

explain its relatively high level of economic growth in the

1980s?

The chapter addresses and defines a competitiveness

criterion. Do Arizonals taxes and expenditures put it at a

competitive advantage or disadvantage vis- a- vis other states?

11. EMPLOYMENT AND OUTPUT GROWTH RATES: ARIZONA COMPARED

Employment Structure and Growth

The level and growth of economic activity often guide

policymakersl decisions on fiscal matters. In this section, we

examine states1 employment growth rates for two time periods:

1973 to 1981 and 1981 to 1987. All three years represent peaks

or near- peaks in the business cycle, and 1987 is the most recent

year for which Bureau of Economic Analysis data are available on

computer tape. Because 1973, 1981 and 1987 are comparable points

in the business cycle, the analysis focuses on secular or long-term

growth from 1973 to 1981 and 1981 to 1987. The selection of

the two time periods avoids confounding secular or long run

trends in employment growth with short run employment changes due

to business cycle fluctuations. This section employs earnings

employment data, which include employment in both wage and salary

jobs as well as proprietors1 categories. The source for the

employment data is the U. S. Department of Commerce, Bureau of

Economic Analysis.

TABLE 1

Employment Shares for Arizona, Six Comparison, States

and the United States, by Industry, 1987

United New

Industry - States - Arizona California Colorado Nevada Mexico Texas Utah

Total Earnings Employment 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00

Farm 2.55 1.24 1.62 2.32 0.84 2.75 2.80 2.41

Nonfarm 97.45 98.76 98.38 97.68 99.16 97.25 97.20 97.59

Agricultural Services, 0.96 1.45 1.76 0.97 0.70 0.87 0.87 0.62

Forestry & Fishery

Mining 0.75 0.76 0.36 1.56 1.43 2.42 3.07 1.09

Construction 5.36 7.33 5.08 5.57 6.12 6.16 6.10 5.05

Manufacturing 15.12 11.01 14.42 9.99 4.03 5.82 11.34 11.89

Nondurable 6.21 2.50 4.71 3.66 1.57 1.97 4.86 3.87

Durable Goods 8.91 8.51 9.71 6.33 2.47 3.85 6.49 8.01

Transportation, Comnunications & 4.73 4.08 4.25 5.09 4.94 4.72 5.14 5.03

Public U t i l i t i e s

Wholesale Trade 4.85 4.12 4.87 4.29 3.22 3.52 5.01 4.48

Retail Trade 16.40 17.44 15.63 16.42 15.33 17.54 16.72 16.65

Finance, Insurance & Real Estate 7.75 10.23 8.92 10.14 7.04 6.82 8.35 7.52

Services 26.06 26.84 28.11 26.70 43.45 25.91 24.64 25.63

Goverrment 15.47 15.50 14.98 16.95 12.89 23.46 15.95 19.62 . . . . . .*. . . . . . . . . . . . . . . . . . . . .

California, Colorado, Nevada, New Mexico end Utah were chosen as comparison states because they border

Arizona and are generally perceived as economic competitors. Texas i s included as a comparison state i n t h i s

section because it i s i n the Southwest region, broadly defined, and it, too, i s viewed as an economic

competitor.

SWRCE: U. S. Department of Comnerce, Bureau of Economic Analysis.

Tables 1 and 2 report annual employment growth rates and

levels of employment by major industry -- Farm; Agriculture,

Forestry and Fishery; Mining; Construction; Manufacturing ( with

separate categories for durable and nondurable manufacturing

industries); Transportation, Communications and Public Utilities;

Wholesale Trade; Retail Trade; Finance, Insurance and Real

Estate; Services; Government; and Total Earnings Employment --

for seven states and the U. S. in the two time periods. In

addition to Arizona, the comparison states include the

neighboring states of California, Colorado, Nevada, New Mexico,

and Utah, and the State of Texas. Table 1 presents the

distribution of total employment by industry in 1987. Table 2

displays the annual employment growth during the two time

periods.

When compared to the U. S. as a whole, Arizona has relatively

high concentrations of employment in Construction and Finance,

Insurance and Real Estate ( see Table 1). In 1987, about

5.4 percent of the U. S. workforce was employed in Construction

compared to 7.3 percent in Arizona, and about 7.8 percent of the

U. S. workforce was employed in Finance, Insurance and Real Estate

compared to 10.2 percent in Arizona. It is also notable that

Arizona had a greater concentration of its workforce in

Construction than any other state in the region in 1987.

Annual Rate of Employment Growth for Arizona, Six Cornparison, States

and the United States, by Industry, 1973- 81 and 1981- 87

( i n percentages)

Employment Growth, 1973- 81

United New

Industry - States - Arizona California Colorado Nevada Mexico Texas

Total Earnings Employment 1.98 4.55 3.54 4.19 6.84 3.54 4.34 3.70

Farm

Nonfarm

Agricultural Services, Forestry & Fishery

Mining

Construction

Manufacturing

Nondurable

Durable Goods

Transportation, Comnunications &

Public U t i l i t i e s

Wholesale Trade

Retail Trade

Finance, Insurance & Real Estate

Services

Government

Employment Growth, 1981- 87

Total Earnings Employment 2.24 5.15 3.04 2.09 3.50 2.33 1.50 2.72

Farm

Nonfarm

Agricultural Services, Forestry &

Mining

Construction

Manufacturing

Nondurable

Durable Goods

Transportation, Comnications &

Public U t i l i t i e s

Wholesale Trade

Retail Trade

Finance, Insurance & Real Estate

Services

Govermnt

- 1.82

2.36

Fishery 5.37

- 5.35 -

3.82

- 0.89

- 0.40

- 1 - 22

1.22

* ~ a l i f o r n i a , Colorado, Nevada, New Mexico and Utah were chosen as comparison states because they border Arizona and are

generally perceived as economic competitors. Texas i s included as a comparison state i n t h i s section because i t i s i n the

Southwest region, broadly defined, and it, too, i s viewed as an economic competitor.

SOURCE: U. S. Department of Comnerce, Bureau of Economic Analysis.

On the other hand, about 6.2 percent of the U. S. workforce was

employed in nondurable manufacturing, while only 2.5 percent of

the Arizona workforce was employed in nondurable manufacturing.

For other industries, Arizona's employment concentration does not

deviate greatly from the averages in the U. S. as a whole.

Arizona and its comparison states have service- based

economies, as all seven states in the region have a lower portion

of their workforce employed in manufacturing industries than the

U. S. as a whole. Of the neighboring states, ~ alifornia's

employment structure most resembles that of the U. S., while

Nevada's employment structure, with 43.5 percent of its workforce

employed in Services, departs the most from the U. S. employment

structure.

Employment growth rates for these states and for the U. S. as

a whole are displayed in Table 2. During the 1973 to 1981

period, employment growth rates in all seven states exceeded the

2.0 percent annual employment growth rate in the U. S. as a whole.

Moreover, in all seven states in the region, non- farm employment

in every sector except Mining grew faster than U. S. employment in

that sector during the 1973 to 1981 period. ~ ining employment in

Arizona declined at a 0.2 percent annual rate during the period,

compared to an 8.2 percent rate of growth for U. S. Mining.

Turning to the 1981 to 1987 period, employment in the U. S.

as a whole grew at an annual rate of 2.2 percent. Five of the

seven states in this region experienced higher employment growth

than the nation as a whole during this period. Arizona had

employment growth of 5.2 percent per annum, while employment grew

3.5 percent per annum in Nevada, 3.0 percent per annum in

California, 2.7 percent per annum in Utah and 2.3 percent per

annum in New Mexico. On the other hand, employment grew at only

2.1 percent per annum in Colorado and a sluggish 1.5 percent in

Texas. In the five rapidly growing states, employment in

individual industry sectors generally grew faster during the 1981

to 1987 period than the national averages in the corresponding

industry sectors during the same period. However, the dominance

of the region that is revealed in the 1973 to 1981 employment

data is not as evident in the 1981 to 1987 period.

Arizona experienced the most rapid employment growth rate of

the seven states during the 1981 to 1987 period. In addition,

Arizona's employment growth was more than double the national

average in both the 1981 to 1987 period and the 1973 to 1981

period. Employment growth well in excess of that in the nation

as a whole relies on a constantly expanding market share, on

labor force growth in excess of that for the national average,

and on the infrastructure expanding at a rate sufficient to

accommodate rapid growth. Such a high level of growth probably

cannot be sustained over the longer run. This observation does

not necessarily suggest that the Arizona economy will decline,

but its long- run growth rate is likely to slow down and approach

the average for the nation as a whole.

The most recent reports on Arizona's job growth relative to

the U. S. should not be viewed as evidence that long- run growth in

Arizona has fallen below the U. S. For example, from December

1987 to December 1988, total non- agricultural employment

increased only 0.9 percent in Arizona compared to 2.4 percent for

the U. S. It is likely that the recent figures represent short-term

business cycle responses, driven in this case by a downturn

in the construction industry, that occur periodically regardless

of the underlying factors that determine long- run growth. Recent

figures for one of those underlying growth factors, population

growth, indicate that Arizona is still likely to have an

advantage over the average state in long run growth ( although the

relative size of the advantage may be declining). From the

fourth quarter of 1987 to the fourth quarter of 1988, population

in Arizona increased 2.1 percent compared to an increase of

0.9 percent in the U. S.

Gross State Product Growth

Annual growth rates for Gross State Product for the seven

comparison states and the nation by industry sector are reported

in Table 3 for the 1973 to 1981 period and the 1981 to 1986

period. ( Data on Gross State Product are not available for

1987.) Gross State Product measures the sum of payroll plus

capital earnings ( or value added) in the industry. Conceivably,

the rankings and growth rates of states could differ from those

obtained using employment growth rates.

According to data in Table 3, Gross State Product for the

U. S. and for five of the seven comparison states -- New Mexico

and Utah being the exceptions -- grew slightly more slowly during

the 1973 to 1981 period than employment during the same period

( see Table 2). The relative ranking of the states changes very

little, however. Of the seven states, Nevada, Utah, and Arizona

were the fastest growing states when either Gross State Product

or employment are used to measure growth. But, during the 1973

to 1981 period Arizona had the second largest growth rate of

employment among the comparison states, while it had the third

largest growth rate of Gross State Product.

The reason for the discrepancy between the growth rates of

output and employment is difficult to determine without data on

the underlying components of Gross State Product. But one

explanation is that states with more manufacturing industries

will have higher Gross State Product growth than employment

growth as these industries are generally more capital intensive.

As a result Gross State Product in manufacturing industries will

grow when capital is added to the production process even though

labor is growing more slowly than capital. On the other hand,

service industries have less opportunity to add capital, and

Gross State Product growth in services may be more closely tied

to increases in employment.

Gross State Product grew more quickly than employment during

the 1981 to 1986 period, but the employment growth figures in

Table 2 are for the 1981 to 1987 period, and they are not

strictly comparable to the Gross State Product figures in

TABLE 3

Annual Rate of Gross State Product Growth for Arizona

Six Comparison States, and the Unitedstates

by Industry, 1973- 81 and 1981- 86

Gross State Product Growth. 1973- 81

United New

Industry - States - Arizona California Colorado Nevada Mexico Texas Utah

Total Earnings Employment 1.95 4.26 3.22 4.10 6.36 4.19 4.19 4.37

Farm

Nonfarm

Agricultural Services,

Forestry & Fishery

Mining

Construction

Manufacturing

Nondurable

Durable Goods

Transportation, Comnications &

Public U t i l i t i e s

Wholesale Trade

Retail Trade

Finance, Insurance & Real Estate

Services

Government

Gross State Product Growth, 1981- 86

Total Earnings Employment 3.06 5.50 4.19 2.99 2.30 0.86 1.64 3.21

Farm 2.27 0.36 1.28 5.54 2.28 4.97 3.71 4.74

Nonfarm 3.08 5.62 4.25 2.92 2.30 0.77 1.60 3.19

Agricultural Services, 5.00 5.63 4.11 4.63 6.05 3.71 1.93 4.24

Forestry & Fishery

Mining - 3.13 - 6.40 - 2.52 1.30 3.61 - 5.37 - 2.32 - 11.21

Construction 2.69 7.42 3.23 0.43 - 1.23 1.45 - 1.28 1- 10

Manufacturing 3.73 7.09 6.11 5.54 6.80 10.46 1.25 7.73

Nondurable 5.04 7.62 7.87 7.01 7.57 10.80 1.74 8.76

Durable Goods 1.66 4.50 2.13 2.44 5.36 10.02 0.61 5.05

Transportation, Comnunications &

Public U t i l i t i e s 2.08 2.31 2.97 2.54 2.55 1.46 2.51 2.73

Wholesale Trade 5.28 7.63 7.22 3.46 7.07 3.39 3.64 4.24

Retail Trade 4.63 7.05 5.06 4.04 2.99 4.69 3.92 4.97

Finance, Insurance & Real Estate 3.06 5.71 3.49 2.41 2.65 - 0.43 2.62 2.42

Services 4.08 7.24 4.72 3.67 1.95 4.08 3.55 4.35

. . . G. o. v.* e. . rn. m. . e. n. t. . . . . . . . 0.94 2.97 1.25 1.60 0.57 1.15 2.37 2.26

California, Colorado, Nevada, New Mexico and Utah were chosen as comparison states because they border

Arizona and are generally perceived as economic cmpetitors. Texas i s included as a comparison state i n this

section because it i s i n the Southwest region, broadly defined, and it, too, i s viewed as an economic

competitor.

SOURCE: U. S. Department of Comnerce, Bureau of Economic Analysis.

Table 3. During this latter period Arizona and California grew

faster than the U. S. as a whole when growth is measured using

Gross State Product. The main conclusion here is that the

results of the regional growth analysis, and of Arizona's

performance in particular, relative to these other states, are

altered only slightly when output instead of employment is used

as the basis of the analysis. Thus, the conclusion that Arizona

was a rapidly growing state during the 1973 to 1987 period

remains intact.

Shift- Share Analysis for Arizona

Another method for examining employment growth and economic

strength of an economy is shift- share analysis. The method

disaggregates employment growth into three components: a

national effect, an industry mix effect and a competitive effect.

The national effect estimates expected employment growth if

employment in each industry in the state gro