The economic impact of four fiscal alternatives

              THE ECONOMIC 1MPACT OF FOUR FISCAL ALTERNATIVES
Prepared by
Professors Dennis Hoffman, Lee McPheters, and
Michael Ormiston
Department of Economics
Arizona State University
Tempe, Arizona 85237
January
1989-
Typography: Jim Dodson
PREFACE
In early December of 1988, Governor Mofford and her staff sought an independent
analysis of four alternative fiscal plans. The charge was to measure the impact of each
proposal on the Arizona economy. Impacts of expenditures and tax changes on
employment and income were to be quantified and the net economic impact computed.
In addition, the implication of each alternative for Arizona's business climate was to be
examined, including effects on Arizona's ranking relative to other states on levels of
taxation.
The Governor's staff offered assistance by encouraging the cooperation of the
Department of Revenue in answering questions developed during the background
research. After completion of background research, the study proceeded without further
involvement from the Governor's staff. The fundamental assumptions concerning tax
incidence, tax shifting, and multiplier effects as well as all subsequent analyses were
based on established economic principles. This methodology was applied uniformly and
consistently to the four fiscal alternatives without adjustments or alteration to favor any
particular plan.
Preliminary results were to be delivered to the Governor's office on or before
December 28, 1988. It was understood that decisions on the fiscal year 1989 - 1990
budget proposals would not be made final until after receipt of the study findings, since
the Governor wished to be aware of the impacts on the Arizona economy associated
with each alternative plan.
The final report was presented on January 5, 1989. The researchers believe the
study is an accurate analysis of the economic impact of these alternative tax and
expenditure proposals. Realistically, because of the magnitude of the task and
restrictive time constraint, isolated ambiguities and typographical errors may remain.
The research assistance contributions of Mr. Dan Whalen, Mr. Tracy Clark, and Ms.
Aileen Bengston are gratefully acknowledged, as well as the invaluable typography
talents of Mr. Jim Dodson. Neither Arizona State University nor any agency of Arizona
government is responsible for or necessarily endorses the study findings. The analysis
and conclusions of the report, as well as all errors and omissions, are the sole
responsibility of the authors.
TABLE OF CONTENTS
Executive Summary
Project Overview and Primary Results
Introduction ...............................................................................................
The Economic Impact of Four Fiscal Alternatives ....................................
Methodology .............................................................................................
Tax Shifting .........................................................................................
Multipliers ............................................................................................
A Hypothetical Example .....................................................................
Expenditures ............................................................................................
Tax Plan A ...............................................................................................
Minimum School Tax ...........................................................................
General Property Tax ..........................................................................
Luxury Taxes: Cigarettes and Beer ...................................................
Corporate Income Tax ........................................................................
Mining Severance Tax ........................................................................
Tax Plan B ...............................................................................................
Individual Income Tax .........................................................................
General Property Tax ..........................................................................
Tax Plan C ...............................................................................................
Sales Tax on Food .............................................................................
Service Taxes .....................................................................................
Tax Plan D ...............................................................................................
Appendix A: The Arizona Economy: Structure. Performance. Outlook
Appendix B: The Business Climate Impact of Proposed Tax Changes
Bibliography: Statistical Studies of Business Climate Variables
and Economic Growth
EXECUTIVE SUMMARY
A weakening Arizona economy has brought slower growth of revenues to state
government. While the economy is performing sluggishly, the population of Arizona
continues to expand at a rate approximately double that of the nation as a whole and
projected expenses in critical areas such as education, health care, and corrections
continue to grow. Government revenues are not anticipated to increase sufficiently in
the coming fiscal year to adequately serve projected needs.
This report analyses the economic impact on the Arizona economy of each of four
alternative fiscal plans designed to meet the increased funding requirements projected
for the 1 989 - 1 990 fiscal year.
Methodology
*
Four plans are reviewed. Each has a common component - government
expenditures totalling $255 million. The four plans differ in the revenue proposals
included to increase revenues by $255 million.
The economic impact of expenditures and the tax plans is analyzed through
examination of three indicators -demand, earnings, and employment. The economic
impact consists of direct effects, multiplier effects, and long run incidence effects.
The direct effects are the immediate effects of a change in fiscal policy on final
demand for goods and services, earnings, and employment in Arizona. The multiplier
effects are the effects of a change in fiscal policy as it works its way through the
economy. Multipliers for each industry examined in this study were computed for
Arizona by the Bureau of Economic Analysis of the the U. S. Department of Commerce.
Long run incidence refers to the effects of a change in fiscal policy due to owners of
firms shifting their share of the tax burden to other resource owners, particularly workers.
The burden of any tax is often different from the legal impact of the tax due to
shifting. The personal income tax, sales taxes, and residential property taxes are born
by individual consumers. The corporate income tax is shared between owners of capital
and consumers. The severance tax is assumed to be born entirely by producers.
Property taxes on utilities are assumed to be shifted 50 percent to consumers, while
property taxes imposed on commercial property are shifted 67 percent to consumers.
The fiscal alternatives here are all "balanced budget" measures. Funds received
from the public as tax revenues are returned to the economy through government
spending, creating demand, earnings, and jobs. However, government spends on a
different mix of goods and services than does the taxpaying public. As government
spending replaces taxpayer spending, demand for certain types of goods and services
falls, while other types of goods and semices are increased in the economy.
The economic benefits of the expenditures programs are compared with the
economic costs - lost jobs, earnings, and reduced demand - associated with each of the
tax plans. The result is a computed net economic impact based on the net change in
demand, earnings, and employment in the Arizona economy as a result of $255 million
in expenditures paid for with $255 million in new tax revenues.
Overview of the Fiscal Alternatives
Each of the four alternative plans contains an identical increase in government
expenditures of $255 million. The expenditure categories are education ($1 11 million),
indigent health care ($78 million), behavioral health care ($25 million), and prison
operation ($41 million).
The government expenditures create demand for materials, supplies, equipment,
services, and structures, as well as employment for teachers, doctors and other health
professionals, corrections employees, and other workers. Funds injected into the
economy are spent and respent, creating final demand of $484.8 million, earnings of
$374.7 million, and 22,788 jobs.
While each of the four plans is designed to raise $255 million in revenues, the
impacts of the plans vary due to differences in the types of taxes included, the incidence
of the taxes, and the types of industries affected.
The plan with the most favorable economic impact on Arizona is Plan A (Table I).
This plan also has the most diversity in its mix of taxes, including a minimum school tax
($1 25 million), increased property tax revenues ($58 million), new cigarette and beer
taxes ($40 million), additional corporate income tax revenues ($1 0 million) and an
increase in the mining severance tax ($22 million).
The revenue proposals of Plan A reduce demand by $340.9 million in the Arizona
economy as revenues are transferred to government by business and consumers who
decrease their private spending. Earnings in affected industries fall by $296.3 million
and 17,297 jobs are lost.
The net economic impact of Plan A - combining the jobs and income created with the
jobs and income lost through taxation is $1 43.9 million in demand, $78.4 million in
earnings, and 5,491 net increase in jobs. The favorable impact on the economy is
obtained because (a) a substantial portion of the minimum school tax is paid by out-of-state
utilities, and (b) cigarette and beer customers continue to consume these products
and pay tax because of "inelastic demand."
Plan B has the second most favorable economic impact, with $36.1 million additional
final demand and $20.7 million added to earnings in the state. However, Plan B would
produce a net loss of 2,545 jobs. Since Plan B relies heavily on a personal income tax
increase of $1 45 million, the result is that consumers reduce their purchases in the retail
products and personal services sectors, both major employment sectors in Arizona. In
effect, retail and service workers would be replaced by a smaller number of workers in
education, health, corrections, and the industries which serve these sectors.
TABLE l
SUMMARY: ECONOMIC IMPACTS OF FOUR FISCAL ALTERNATIVES
FISCAL CHANGE ECONOMIC IMPACTS
Amount
Expenditures (millions)
Education $111
Health Care 103
Corrections 41
Total: 255
Demand Earnings Employment
(millions) (millions) (number of jobs)
206.3 136.2 8,934
202.6 180.7 9,662
3 . 9 4.192
484.8 374.7 22,788
Revenues
Plan ATaxes , (millions)
-Minimum School 1 is* - $125
. / General Property 58
40
Corporate Income 10
Mining Severance -22
255
Demand
(miillons)
$134.2
94.9
82.1
9.3
2QA
Earnings
(millions)
$1 16.4
78.9
62.5
12.0
3 i . S
Employment
(number of jobs)
5,236
5,925
4,501
51 1
1.124
Total Economic Costs:
Net Economlc Impact:
Revenues Demand Earnings Employment
Plan B Taxes (millions) (millions) (millions) (number of jobs)
Personal Income, $1 45 $268.6 $204.3 14,825
General Property I3.Q U S L J IiELZ 10.508
*
" 't \
255
,, >' 2'
96 y$i . Total Economlc Costs: 448.7 354.0 25,333
Net Economic Impact: +36.1 +20.7 -2,545
Plan C Taxes
Food Sales
Service Sales
Revenues Demand Earnings Employment
(millions) (millions) (millions) (number of jobs)
$1 27 $235.2 $1 78.9 12,984
128 w lZZS 14.972
255
Total Economic Costs: 465.6 351.7 27,956
Net Economic Impact: +19.2 +23.0 -5,168
Revenues Demand Earnings Employment
Plan D Taxes (millions) (millions) (millions) (number of jobs)
Sales
8
$255 $472.3 $359.2 26,072
;.;" ';
14 ;. r ,s., Total Economic Costs: 472.3 359.2 26,072
Net Economic Impact: +12.5 +15.5 -3,284
Plan C restores the sales tax on food (raising revenues of $1 27 million) and imposes
a tax on selected services ($1 28 million revenue ). Because consumers respond to
higher sales taxes by reducing purchases of food and services, the jobs loss under plan
C would be the greatest of the four alternatives. The greatest impact on employment is
due to the loss of service sector jobs as consumers reduce spending. This is because
the service sector is the most labor intensive - and the largest employment sector - of
the Arizona economy.
Plan D involves an increase in sales taxes sufficient to raise $255 million in
revenues. This tax has effects similar to Plan C in that it is also paid primarily by
consumers and impacts demand, earnings, and employment in the retail and wholesale
trade sectors. Final demand is reduced by the greatest amount ($472.3 million) under
this plan. This plan also affects the retail sector heavily, causing a loss of 26,072 jobs in
the Arizona economy. Similar to Plan C, the net job impact is negative for Plan D, with
3,284 jobs lost.
In summary, the most favorable economic impacts are obtained from Tax Plan A.
Because of the mix of tax options in the plan and the taxpayers affected, this plan yields
a positive net economic impact of $1 43.9 million in final demand, $78.4 million in
additional earnings, and 5,491 net new jobs created.
With the slowing Arizona economy attracting attention from the national media, it is
appropriate to briefly examine the impacts of tax increases on the Arizona business
climate. The question at hand is whether increases in taxes will affect corporate
relocations and economic development in the state.
In surveys of corporate executives regarding the importance of taxes vs. other
factors in determining relocation decisions, a quality labor force and access to markets
are the dominant factors mentioned first. In a survey conducted by the prestigious
Conference Board, executives responsible for site location decisions for research and
development facilities rated taxes the 18th most important factor to be considered. The
level of taxes was not mentioned at all in a University of Missouri survey of high
technology firms producing innovative products. Quality of life was the number one
determinant of relocation in a survey of Fortune 500 chief executives. Those employers
most likely to be concerned about taxes are firms in the later stage of the product cycle,
facing competitive markets for a standardized product, where small cost differences are
critical. But even these firms rate labor productivity, transportation, and access to
markets more highly than business taxes.
In the closely-followed Grant Thornton rankings, the highest rated factors include
wages, availability of workforce, and unionization. Tax levels rank 9th on the latest
Grant Thornton study, and change in taxes ranks 17th. Education, however, ranks 15th
on the Grant Thornton list (which focuses primarily on manufacturing plant
requirements), ahead of change in taxes. Arizona's lowest ratings in the current Grant
Thornton study are found in the areas of education (31 st), health care (32nd), and
transportation (40th).
Analysis of the available business climate surveys shows that tax increases will have
the smallest effect on high technology, research and development, and corporate
headquarters relocations. In addition, these are the types of employers most interested
in quality of life and public infrastnrcture, including education, health care, transportation,
and public safety. If the assumption may be made that these are the most desirable
types of relocations sought, then the conclusion is clear that Arizona's business climate
will be unharmed, and perhaps even helped, by the proposed fiscal changes.
It would be incorrect to assume that a fiscal program pursued on a massive scale
would yield similar positive benefits. The benefits of Plan A accrue largely due to the
relatively high proportion of the tax that is shifted to out-of-state utilities. In general,
modest balanced budget proposals like the ones examined in this study will essentially
be neutral -the benefits of expenditures essentially offsetting the costs of taxes. This is
no longer the case when programs become so large as to "crowd out" private sector
endeavors or create tax burdens that choke off business expansion. Our analysis
reveals that the current proposals are simply not large enough to have an adverse effect
on Arizona's economy.
PROJECT OVERVIEW AND PRIMARY RESULTS
During 1987, new wage and salary jobs in the Arizona economy increased at
a rate of growth of 3.4 percent. In 1988, the expansion of the Arizona economy
slowed until, by year end, new jobs creation was taking place at a rate of less
than one percent (Figure 0-1). While the overall Arizona economy is not in
recession (defined as a negative rate of growth in total employment), industries
linked to real estate and construction have experienced job losses and weakness
has spread from these sectors to other parts of the general economy.
In light of the slowing of the Arizona economy and recent comparisons drawn
by national media between the Arizona experience and downturns in Texas, it is
appropriate to examine the potential impact of a $255 million balanced budget tax
and expenditure proposal on the Arizona business climate and economy. The
question is how tax and spending changes of the magnitude and composition
proposed effect (a) Arizona's business climate as measured by various rankings
and surveys and (b) actual economic growth and development in the state.
After a review of factors influencing business climate rankings, an analysis
of surveys of business executives with responsibility for corporate relocations,
and an assessment of academic articles on the subject, the conclusion is clear
that the proposed tax and expenditure increases will not result in a significant
change in Arizona's business climate. The major findings of the business climate
research are as follows:
1. The taxes and expenditures proposed will have offsetting effects in the
annual Grant Thornton report, the most closely followed business climate ranking.
Three factors -tax effort, change in tax effort, and change in government
expenditures vs. change in state personal income -will be influenced in a
FIGURE 0-1
MONTHLY CHANGE IN ARIZONA EMPLOYMENT
(Percent Change from Same Month, Previous Year)
1986-88
Percent
7 -
6 -
5 -
4 -
3 -
2 -
1 -
0 - ~ ~ ~ 1 ~ 1 ~ 1 1 1 ~ ~ ~ 1 ~ 1 1 1 J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N
1986 1987 1988
Source: Arizona Department of Economic Security
negative direction. However, the expenditures undertaken will impact positively
on two other factors - education and health care - which are among Arizona's
lowest rated factors. Education has a higher weight in :he Grant Thornton system
than change in tax effort.
2. Any changes which do occur in the Grant Thornton rankings will not be
evident for several years, since the rankings are based on taxes and
expenditures made two to three years before. One variable, change in tax effort,
is calculated over five years. Meanwhile, other states will undoubtedly be raising
their taxes. Arizona's relative ranking in the Grant Thornton report is not
expected to be significantly influenced by the tax increases proposed.
Consequently, Arizona's business climate as measured by the well-known Grant
Thornton study will not be substantially changed.
3. Arizona ranked number one in both 1987 and 1988 on another closely-
. watched business climate ranking, that produced by Inc. magazine. Since the
Inc. ranking is based on (a) job growth (b) new business births and (c) number of
"high growth" businesses, the change in taxes proposed will have no impact on
Arizona's position in the Inc. ranking system.
4. In surveys of corporate executives regarding the importance of taxes and
other factors in determining relocation, a significant pattern emerges. Labor force
and access to markets are the two dominant factors considered first by most
corporate executives contemplating relocation (Table 0-1). Depending upon the
type of facility, taxes can be ranked as high as fourth (for a manufacturing plant),
as low as 18th (for a research and development facility) or not mentioned at all
(for high technology firms with innovative products in the early stages of
development).
5. The proposed tax increase will have the greatest potential impact on plant
relocations, especially for firms producing goods in the later stages of the product
TABLE 0-1
CORPORATE RELOCATION SURVEY RESULTS
Business
Survey Source Type of Facility Top Rated Factors Tax Rank
Fortune 500 Corporate Headquarters Quality of Life 6/24
Personal Preference
Fortune 500 Next Mainland Plant Worker Productivity 4/26
Transportation
Fortune 500 Previous Mainland Plant Worker Productivity 6/26
Markets
Executives R & D Facilities
High Tech
Managers High Tech Firms
Executives Office Facilities
Near Headquarters 18/20
Technical Personnel
Technical Personnel 019
Financial Community
Domestic Markets 417
Labor Market
Executives Manufacturing, Warehouse Domestic Markets 518
Distribution Facilities Site Availability
Sources: 1. Nhv Cowate America Move.-. . Fortune, New York, 1982
2. Locatina C~1~9ra5te8 9 Fad&& The Conference Board, New York, 1986
3. University of Missouri Survey, 1984
4-. BAusiness M O WC ushman & Wakefield, Chicago, 1988
cycle. During this stage of the product cycle, output technology is standardized,
markets are very competitive, and cost considerations at the margin are
paramount. However,the implication is clear that labor force and market
conditions are viewed first. If Arizona and another state are competitive on these
two factors, then taxes will be considered as a "tie breaker." With higher taxes,
Arizona will win some of these ties and will lose some of these ties, depending on
the competing states (i. e. California or Nevada).
6. Analysis of executive surveys shows that the proposed tax increases will
have the smallest effect on high technology firms, research and development
facilities, and corporate headquarters relocations. If the assumption may be
made that these are the most desirable types of relocations sought, then it is
concluded that Arizona's business climate will be virtually unharmed by the
proposed tax increases.
7. Most analysts of regional economic growth and development seem to agree
with Roger Vaughn (1 979) that "the level of business taxes has little impact on the
local growth rate or on the interstate location decisions of firms." Seventeen
statistical studies were reviewed relating economic growth to taxes and other
business climate variables. In seven of these studies, no statistical correlation
was found between taxes and economic growth variables. In 9 studies, mixed
relationships were found, with taxes affecting some variables, but generally
having little impact. In one study, a significant relationship was found between
taxes and economic measures.
One final point must be addressed. If taxes are secondary to labor force
variables and market considerations in determining business climate, wily is so
much emphasis placed on taxes in discussions of business relocation?
The answer lies in an understanding of business firm relocation dynamics. A
study by James Miller shows that, during the six year period 1969 - 1975, only
two percent of all manufacturing firms relocated, and only one half of one percent
of all firms relocated across state lines. Three fourths of all manufacturing
relocations involved movements to nearby counties in the same state.
This tendency of firms to relocate nearby their current site explains why
property and other taxes are considered by some to be crucial in the relocation
decision. By moving to a neighboring locality, a firm may retain its current
markets, suppliers, and labor force, but possibly lower its taxes. Thus, taxes are
the "swing factor" because other key determinants of costs and revenues stay
unchanged after most relocations.
The implications for Arizona are worth noting. in seeking corporate relocations
as a major source of new employment, the state is asking firms to make the
extremely risky decision of abandoning workers, markets, suppliers, and lines of
credit in exchange for what Arizona can offer in replacement. Thus, to assess the
role of taxes in business climate, it must be recognized that the attractions
Arizona offers in its business climate package must be competitive on a broader
range of fronts than states in the East who are only seeking to lure firms a short
distance. In brief, low taxes may be crucial in luring a firm across the river but
may not be particularly important in luring that same firm across the country.
Methodology
Four plans are reviewed. Each has a common component - government
expenditures totalling $255 million. The four plans differ in the revenue proposals
included to increase revenues by $255 million.
The economic impact of expenditures and the tax plans is analyzed through
examination of three indicators - demand, earnings, and employment. The
economic impact consists of direct effects, multiplier effects, and long run
incidence effects.
The direct effects are the immediate effects of a change in fiscal policy on final
demand for goods and services, earnings, and employment in Arizona. The
multiplier effects are the effects of a change in fiscal policy as it works its way
through the economy. Multipliers for each industry examined in this study were
computed for Arizona by the Bureau of Economic Analysis of the U.S.
Department of Commerce. Long run incidence refers to the effects of a change in
fiscal policy due to owners of firms shifting their share of the tax burden to other
resource owners, particularly workers. The burden of any tax is often different
from the legal impact of the tax due to shifting.
The personal income tax, sales taxes, and residential property taxes are
borne by individual consumers. The corporate income tax is shared between
owners of capital and consumers. The severance tax is assumed to be borne
entirely by producers. Property taxes on utilities are assumed to be shifted 50
percent to consumers, while property taxes imposed on commercial property are
shifted 67 percent to consumers.
The fiscal alternatives here are all "balanced budget" measures. Funds
received from the public as tax revenues are returned to the economy through
government spending, creating demand, earnings, and jobs. However,
government spends on a different mix of goods and services than does the
taxpaying public. As government spending replaces taxpayer spending, demand
for certain types of goods and services falls, while other types of goods and
services are increased in the economy.
The economic benefits of the expenditures programs are compared with the
economic costs - lost jobs, earnings, and reduced demand - associated with
each of the tax plans. The result is a computed net economic impact based on
the net change in demand, earnings, and employment in the Arizona economy as
a result of $255 million in expenditures paid for with $255 million in new tax
revenues.
Primary Results
Each of the four alternative plans contains an identical increase in government
expenditures of $255 million. The expenditure categories are education ($1 11
million), indigent health care ($78 million), behavioral health care ($25 million),
and prison operations ($41 million).
The government expenditures create demand for materials, supplies,
equipment, services, and structures, as well as employment for teachers, doctors
and other health professionals, corrections employees, and construction workers.
As shown in Table 0-2, funds injected into the economy are spent and respent,
creating final demand of $484.8 million, earnings of $374.7 million, and 22,788
jobs.
While each of the four plans is designed to raise $255 million in revenues, the
impacts of the plans vary due to differences in the types of taxes included, the
incidence of the taxes, and the types of industries affected. The economic costs
and benefits of each proposed tax plan are summarized below.
Tax Plan A
The plan with the most favorable economic impact on Arizona is Plan A. This
plan also has the most diversity in its mix of taxes, including a minimum school
tax ($1 25 million), increased property tax revenues ($58 millkon), new cigarette
Direct
Multiplier
Total
TABLE 0-2
THE ECONOMIC IMPACT OF
A $255,000,000 INCREASE IN STATE EXPENDITURES
lncrease in
Final Demand for Increase in Increase in
Goods & Services Earnings Employment
(millions) (millions) (number of jobs)
and beer taxes ($40 million), additional corporate income tax revenues ($1 0
million) and an increase in the mining severance tax ($22 million).
The proposed minimum school tax is to levy a tax equal to the appropriate
qualifying tax rate on all properties located in school districts that do not currently
qualify for state assistance. The economic impact of this tax is based on an
estimate of $1 25 million in additional tax revenues.
The proposed property tax increase is to increase the state's general
property tax rate to yield an additional 58 million dollars. Using 1988 rates and
assuming a 5% appreciation in net assessed value for 1989, this would require
the state to increase the rate from 4-7 p~er $1 00.00 net assessed value to 76$ per
$1 00.00 net assessed value. Accordingly, the average primary rate for combined
state and local property taxes - based on 1988 rates - would increase from $7.84
per $1 00.00 net assessed value to $8.1 3. Thus, property tax payers would
experience a 3.7% increase in overall property tax rates as a result sf the
proposal.
The proposed increase in luxury taxes is: (i) to increase the tax rate per pack
of cigarettes from $.I5 to $.25; and (ii) to increase the tax rate per gallon of malt
liquor from $.I6 to $.26. No change in the method of administering these taxes is
offered in the current proposal. The economic impact of the cigarette tax is based
on projections of 350 million packs sold in 1989190 at current tax rates. Only 30
million dollars additional revenue will accrue due to the tax after market demand
adjustments and up to 5 million additional Indian reservation sales. The
economic effect of the beer tax is based on projections of 104 million gallons sold
in 1989190 at current tax rates. The net revenue after minor demand adjustments
is expected to be 10 million dollars.
The proposed change in the corporate income tax code is to remove the
80120 exclusion, the Possessions exclusion and the Foreign Tax Credit from the
Arizona Corporate Income Tax Code. The economic impact of these taxes
assumes that the current provisions yield 10 million dollars in FY 89/90 corporate
liability.
The proposed change in the mining severance tax is to raise the rate on the
severance tax and alter the distribution formula so that proceeds from the
increased tax accrue entirely to the General Fund. The rate increase examined in
this report is from 2-1/2°/0 to 5% on the "net severance base." The actual
proposal may contain a provision that ties the tax rate to the price of copper. This
would help alleviate the burden of this tax on the mining firms during cyclical
downturns in copper demand. The economic impact of this proposal is based on
estimates of the N 89/90 net severance base of 880 million dollars so the
additional tax would raise 22 million in revenue.
The economic impact of Tax Plan A is summarized in Table 0-3. The revenue
proposals of Plan A reduce demand by $340.9 million in the Arizona economy as
revenues are transferred to government by business and consumers who
decrease their private spending. Earnings in affected industries fall by $296.3
million and 17,297 jobs are lost.
The net economic impact of Plan A - combining the jobs and income created
with the jobs and income lost through taxation is $1 43.9 million in demand, $78.4
million in earnings, and 5,491 net increase in jobs. The favorable impact on the
economy is obtained because (a) a substantial portion of the minimum school tax
is paid by out-of-state utilities, and (b) cigarette and beer customers continue to
consume these products and pay tax because of "inelastic demand."
We also examined Plan A using the assumption that owners of firms passed
100% of their own tax burdens directly to employees. This reduced the net gain
in earnings to $37.9 million and employment to 2,092 jobs. This scenario is less
TABLE 0-3
THE ECONOMIC IMPACT OF TAX PLAN A
Proposed Tax Changes and Revenues:
Minimum school tax
An increase in general property tax rates
Increases in luxury goods tax rates
Adjustments in corporate income tax deductions and credits
An increase in the mining severance tax rate
Total Revenues Generated:
Total Economic Benefits:
lncrease in final demand for goods and services
lncrease in earnings
lncrease in employment
Total Economic Costs:
Decrease in final demand for goods and services
Decrease in earnings
Decrease in employment
Net Economic Benefits:
Net increase in final demand for goods and services
Net increase in earnings
Net increase in employment
$484,817,000
374,673,000
22,788 jobs
$340,880,000
296,335,000
1 7,297 jobs
$1 43,937,000
78,338,000
5,491 jobs
likely in our opinion but it establishes a lower bound to the net
employment/earnings gains of Plan A.
In addition, as a result of the tax changes embodied in Plan A, consumers of
electricity will pay about $.00153 more per kilowatt hour or, for an Arizona
household consuming 1,000 kilowatt hours per month, about $1.50 more per
month; residential property owners will pay, on average, $1 8 more per year;
consumers of cigarettes will pay $.I0 more per pack or, for a 1 -pack per day
smoker, $36.50 per year; and consumers of beer will pay slightly less than $.01
per can of beer or for ari individual consuming two 6-packs per week, about $5.85
per year.
Tax Plan B
The proposed tax changes for Plan B are to eliminate the special subtraction
designed originally to "avoid" any windfall that might have accrued to the state
due to the Federal Tax Reform Act of 1986 and to increase the state's general
property tax. The economic analysis of the special subtraction assumes that
about $1 45 million will be raised. The economic analysis of the general property
tax assumes an increase in the state's general property tax rate to yield an
additional 1 10 million dollars. Using 1988 rates and projecting a 5% increase in
net assessed value for 1989, this would require the state to increase the rate from
47$ per $1 00.00 net assessed value to $1.02 per $1 00.00 net assessed value.
Accordingly, the average primary rate for combined state and local property taxes
- based on 1988 rates - would increase from $7.84 per $1 00.00 net assessed
value to $8.39. Thus, property tax payers would experience a 7.0% increase in
overall property tax rates as a result of the proposal.
The economic impact of Tax Plan B is summarized in Table 0-4. Plan B has
the second most favorable economic impact, with $36.1 million additional final
demand and $20.7 million added to earnings in the state. However, Plan B would
produce a net loss of 2,545 jobs. Since Plan B relies heavily on a personal
income tax increase of $1 45 million, the result is that consumers reduce their
purchases in the retail products and personal services sectors, both major
employment sectors in Arizona. In effect, retail and service workers would be
replaced by a smaller number of higher paid workers in education, health,
corrections, and the private sector industries which serve these agencies.
In addition, as a result of these tax changes, residential property owners will
pay, on average, $35 more per month.
Tax Plan C
Plan C restores the sales tax on food (raising revenues of $1 27 million) and
imposes a tax on selected services ($1 28 million revenue). Because consumers
respond to higher sales taxes by reducing purchases of food and services, the
jobs loss under Plan C would be the greatest of the four alternatives. The
greatest impact on employment is due to the loss of service sector jobs as
consumers reduce spending. This is because the service sector is the most labor
intensive - and the largest employment sector - of the Arizona economy. The
economic impact of Tax Plan C is summarized in Table 0-5.
Tax Plan D
Plan D involves an increase in sales taxes sufficient to raise $255 million in
revenues. This tax has effects similar to Plan C in that it is also paid primarily by
TABLE 0-4
THE ECONOMIC IMPACT OF TAX PLAN B
Proposed Tax Changes:
Eliminate the windfall tax credit
An increase in general property tax rates
Total Revenues Generated: $255,000,000
Total Economic Benefits:
Increase in final demand for goods and services $484,817,000
Increase in earnings 374,673,000
Increase in employment 22,788 jobs
Total Economic Costs:
Decrease in final demand for goods and services $448,682,000
Decrease in earnings 354,020,000
Decrease in employment 25,333 jobs
Net Economic Benefits:
Net increase in final demand for goods and services
Net increase in earnings
Net increase in employment
$36,135,000
20,653,000
-2,545 jobs
TABLE 0-5
THE ECONOMIC IMPACT OF TAX PLAN C
Proposed Tax Changes:
Levy a 5% sales tax on food for at home consumption $1 27,000,000
Levy a 5% sales tax on selected services 128,000,000
Total Revenues Generated: $255,000,000
Total Economic Benefits:
Increase in final demand for goods and services $484,817,000
Increase in earnings 374,673,000
Increase in employment 22,788 jobs
Total Economic Costs:
Decrease in final demand for goods and services $465,629,000
Decrease in earnings 351,715,000
Decrease in employment 27,956 jobs
Net Economic Benefits:
Net increase in final demand for goods and services $1 9,188,000
Net increase in earnings 22,958,000
Net increase in employment -5,168 jobs
consumers and impacts demand, earnings, and employment in the retail and
wholesale trade sectors. Table 0-6 summarizes the economic effects of Tax Plan
D. Final demand is reduced by the greatest amount ($472.3 million) under this
plan. This plan also affects the retail sector heavily, causing a loss of 26,072 jobs
in the Arizona economy. Similar to Plan C, the net job impact is negative for Plan
Dl with 3,284 jobs lost.
Impact on Arizona's Relative Tax Burden
The proposed taxes will generally have little impact on Arizona's tax burden
per capita when compared with other states. Using data compiled in the 1987
AClR comparison of Fiscal Federalism, Arizona's relative burden increases from
26th highest to 23rd highest among all states due to the additional 183 million
(1 25 + 58) in property taxes proposed in Plan A. The tobacco and alcohol
burdens per capita increase from 37th to 22nd and 21st to 18th respectively. The
corporate tax burden per capita ranking is not affected by the 10 million dollar
increase in Plan A.
The increased burdens induced by the Plan B proposals increase Arizona's
ranking from the 33rd highest individual income tax per capita to 29th and the
26th highest general property tax to 24th. The sales tax proposals in Plans C and
D each result in an increase in Arizona's sales tax per capita burden from 6th to
3rd.
Interestingly, Arizona would remain one of the lowest ranking residential
property tax states even after the proposals. The Plan A $58 million general
property tax would increase the residential burden from 45th highest to 43rd
highest. The Plan B proposal would increase the residential burden to the 42nd
highest among all states.
TABLE 0-6
THE ECONOMIC IMPACT OF TAX PLAN D
Proposed Tax Changes:
An increase in the general sales tax
Total Revenues Generated:
Total Economic Benefits:
lncrease in final demand for goods and services
lncrease in earnings
lncrease in employment
Total Economic Costs:
Decrease in final demand for goods and services
Decrease in earnings
Decrease in employment
Net Economic Benefits:
Net increase in final demand for goods and services
Net increase in earnings
Net increase in employment
$484,817,000
374,673,000
22,788 jobs
$472,311,000
359,240,000
26,072 jobs
$1 2,506,000
15,433,000
-3,284 jobs
Summary
In summary, the most favorable economic impacts are obtained from Tax Plan
A. Because of the mix of tax options in the plan and the taxpayers affected, this
plan yields a positive net economic impact of $1 43.9 million in final demand,
$78.4 million in additional earnings, and 5,491 net new jobs created.
With the slowing Arizona economy attracting attention from the national
media, it is appropriate to briefly examine the impacts of tax increases on the
Arizona business climate. The question at hand is whether increases in taxes will
affect corporate relocations and economic development in the state.
In surveys of corporate executives regarding the importance of taxes vs. other
factors in determining relocation decisions, a quality labor force and access to
markets are the dominant factors mentioned first. In a survey conducted by {he
prestigious Conference Board, executives responsible for site location decisions
for research and development facilities rated taxes the 18th most important factor
to be considered. The level of taxes was not mentioned at all in a University of
Missouri survey of high technology firms producing innovative products. Quality
of life was the number one determinant of relocation in a survey of Fortune 500
chief executives. Those employers most likely to be concerned about taxes are
firms in the later stage of the product cycle, facing competitive markets for a
standardized product, where small cost differences are critical. But even these
firms rate labor productivity, transportation, and access to markets more highly
than business taxes.
In the closely-followed Grant Thornton rankings, the highest rated factors
include wages, availability of workforce, and unionization. Tax levels rank 9th on
the latest Grant Thornton study, and change in taxes ranks 17th. Education,
however, ranks 15th on the Grant Thornton list (which focuses primarily on
manufacturing plant requirements), ahead of change in taxes. Arizona's lowest
ratings in the current Grant Thornton study are found in the areas of education
(31 st), health care (32nd), and transportation (40th).
Analysis of the available business climate surveys shows that tax increases
will have the smallest effect on high technology, research and development, and
corporate headquarters relocations. In addition, these are the types of employers
most interested in quality of life and public infrastructure, including education,
health care, transportation, and public safety. If the assumption may be made
that these are the most desirable types of relocations sought, then the conclusion
is clear that Arizona's business climate will be unharmed, and perhaps even
helped, by the proposed fiscal changes.
It would be incorrect to assume that a fiscal program pursued on a massive
scale would yield similar positive benefits. The benefits of Plan A accrue largely
due to the relatively high proportion of the tax that is shifted to out-of-state utilities.
In general, modest balanced budget proposals like the ones examined in this
study will essentially be neutral -the benefits of expenditures essentially
offsetting the costs of taxes. This is no longer the case when programs become
so large as to "crowd out" private sector endeavors or create tax burdens that
choke off business expansion. Our analysis reveals that the current proposals
are simply not large enough to have an adverse effect on Arizona's economy.
INTRODUCTION
The Arizona economy expanded vigorously from 1983 through 1987, adding
more than 320,000 workers to Arizona payrolls. During this period, the state
ranked among the national leaders in the rate of economic growth. These were
years of strong net inmigration and record levels of building in multifamily,
industrial, and commercial structures.
As newly built inventory began to accumulate, growth in construction
employment peaked in 1986. By December of 1988, the industry experienced a
string of 25 unbroken months of job losses relative to year-ago employment
levels. Weakness in construction gradually spread through the economy. By the
end of 1988, total Arizona nonagricultural employment was growing at a rate of
less than one percent (Figure I), and Arizona ranked among the slowest growing
states.
The current weakness in the Arizona economy has caused some to question
whether the downturn is a a cyclical reaction to overbuilding that will soon be
reversed or an ominous signal of a significant change in the vitality of the Arizona
economy. Items in the national press have suggested that unusual elements are
present which will impact the future potential growth of Arizona.
The widely held view of economists in both the private and public sectors is
that the current ailments of the Arizona economy can be attributed to (a)
overbuilding, which led to reduced construction and real estate activity and (b) the
relative good economic health of competing states and the Midwest, usual
suppliers of jobseekers for Arizona. In retrospect, the vigorous population flows
and rapid rates of job growth of the recent past were not sustainable. Arizona
businesses accustomed to rapidly-growing customer bases have postponed
expansion plans and reduced employee rolls, further reducing local job gains.
The prognosis among economists is that - in the absence of a national
recession - a return to levels of growth approximating the long term Arizona
average will be experienced within 18-24 months. The current outlook for 1989
calls for the coming year to be very similar to 1988 in terms of overall growth.
The annualized rate of job creation is expected to be in the range of 3 percent,
about one half that of the long run Arizona average rate of job growth.
In light of the slowing of the Arizona economy and recent comparisons drawn
by national media between the Arizona experience and downturns in Texas, it is
appropriate to examine the potential impact of a $255 million balanced budget tax
and expenditure proposal on the Arizona business climate and economy. The
essential question at hand is how tax increases and government expenditures of
the magnitude proposed will effect (a) Arizona's business climate as measured by
various rankings and surveys and (b) actual economic growth and development in
the state.
After a review of factors influencing business climate rankings, an analysis of
surveys of business executives with responsibility for corporate relocations, and
an assessment of academic articles on the subject, the conclusion is clear that
the proposed tax increase and expenditures will not result in a significant change
in Arizona's business climate. The major findings of the business climate
research are as follows:
1. The taxes and expenditures proposed will have offsetting effects in the
annual Grant Thornton report, the most closely followed business climate ranking.
Three factors - tax effort, change in tax effort, and change in government
expenditures vs. change in state personal income -will be influenced in a
negative direction. However, the expenditures undertaken will impact positively
on two other factors - education and health care - which are among Arizona's
lowest rated factors. Education has a higher weight in the Grant Thornton system
than change in tax effort.
2. Any changes which do occur in the Grant Thornton rankings will not be
evident for several years, since the rankings are based on taxes and
expenditures made two to three years before. One variable, change in tax effort,
is calculated over five years. Meanwhile, other states will undoubtedly be raising
their taxes. Arizona's relative ranking in the Grant Thornton report is not
expected to be significantly influenced by the tax increases proposed.
Consequently, Arizona's business climate as measured by the well-known Grant
Thornton study will not be substantially changed.
3. Arizona ranked number one in both 1987 and 1988 on another closely-watched
business climate ranking, that produced by Inc. magazine. Since the
Inc. ranking is based on (a) job growth (b) new business births and (c) number of
"high growth" businesses, the change in taxes proposed will have no impact on
Arizona's position in the Inc. ranking system.
4. In surveys of corporate executives regarding the importance of taxes and
other factors in determining relocation, a significant pattern emerges. Labor force
and access to markets are the two dominant factors considered first by most
corporate executives contemplating relocation (Table 1). Depending upon the
type of facility, taxes can be ranked as high as fourth (for a manufacturing plant),
as low as 18th (for a research and development facility) or not mentioned at all
(for high technology firms with innovative products in the early stages of
development).
5. The proposed tax increase will have the greatest potential impact on plant
relocations, especially for firms producing goods in the later stages of the product
cycle. During this stage of the product cycle, output technology is standardized,
markets are very competitive, and cost considerations at the margin are
TABLE 1
CORPORATE RELOCATION SURVEY RESULTS
Business
Survey Source Type of Facility Top Rated Factors Tax Rank
Fortune 500 Corporate Headquarters Quality of Life 6/24
Personal Preference
Fortune 500 Next Mainland Plant Worker Productivity 4/26
Transportation
Fortune 500 Previous Mainland Plant Worker Productivity 6/26
Markets
Executives R & D Facilities
High Tech
Managers High Tech Firms
Executives Off ice Facilities
Near Headquarters 18/20
Technical Personnel
Technical Personnel 019
Financial Community
Domestic Markets
Labor Market
Executives Manufacturing, Warehouse Domestic Markets 518
Distribution Facilities Site Availability
Sources: 1. mv Co- America Mov.e.s . W here, Fortune, New York, 1982
2. Locatina-ate R&n Facllltles. The Conference Board, New York, 1986
3. University of Missouri Survey, 1984
4. BuSiness America Real Estate M o w Cushman & Wakefield, Chicago, 1988
paramount. However,the implication is clear that labor force and market
conditions are viewed first. If Arizona and another state are competitive on these
two factors, then taxes will be considered as a "tie breaker." With higher taxes,
Arizona will win some of these ties and will lose some of these ties, depending on
the competing states (i. e. California or Nevada).
6. Analysis of executive surveys shows that the proposed tax increases will
have the smallest effect on high technology firms, research and development
facilities, and corporate headquarters relocations. If the assumption may be
made that these are the most desirable types of relocations sought, then it is
concluded that Arizona's business climate will be virtually unharmed by the
proposed tax increases.
7. Most analysts of regional economic growth and development seem to
agree with Roger Vaughn (1 979) that "the level of business taxes has little impact
on the local growth rate or on the interstate location decisions of firms."
Seventeen statistical studies were reviewed relating economic growth to taxes
and other business climate variables. In seven of these studies, no statistical
correlation was found between taxes and economic growth variables. In 9
studies, mixed relationships were found, with taxes affecting some variables, but
generally having little impact. In one study, a significant relationship was found
between taxes and economic measures.
One final point must be addressed. If taxes are secondary to labor force
variables and market considerations in determining business climate, why is so
much emphasis placed on taxes in discussions of business relocation?
The answer lies in an understanding of business firm relocation dynamics. A
study by James Miller shows that, during the six year period 1969 - 1975, only
two percent of all manufacturing firms relocated, and only one half of one percent
of all firms relocated across state lines. Three fourths of all manufacturing
relocations involved movements to nearby counties in the same state.
This tendency of firms to relocate nearby their current site explains why
property and other taxes are considered by some to be crucial in the relocation
decision. By moving to a neighboring locality, a firm may retain its current
markets, suppliers, and labor force, but possibly lower its taxes. Thus, taxes are
the "swing factor" because other key determinants of costs and revenues stay
unchanged after most relocations.
The implications for Arizona are worth noting. In see king corporate relocations
as a major source of new employment, the state is asking firms to make the
extremely risky decision of abandoning workers, markets, suppliers, and lines of
credit in exchange for what Arizona can offer in replacement. Thus, to assess the
role of taxes in business climate, it must be recognized that the attractions
Arizona offers in its business climate package must be competitive on a broader
range of fronts than states in the East who are only seeking to lure firms a short
distance. In brief, low taxes may be crucial in luring a firm across the river but
may not be particularly important in luring that same firm across the country.
THE ECONOMIC IMPACT OF FOUR FISCAL ALTERNATIVES
The economic impact on the Arizona economy of each of four alternative
tax/expenditure plans is analyzed in this report. The four alternative tax plans are
revenue neutral in that each is designed to raise approximately $255,000,000 in
additional revenues for Arizona's General Fund. The four expenditure proposals
are identical.
The analysis begins by describing the methodology used to evaluate each of
four proposed tax plans which is followed by a discussion of the economic
implications of a specific $255,000,000 in State expenditures. Next a detailed
analysis of the economic impact of each proposed plan is undertaken. The
analysis consists of a discussion of current tax rates as well as the business
activity that serves as the base for each proposed tax change, a quantitative
analysis of the direct and indirect economic effects of the proposed tax or
expenditure changes, and a summary that includes a discussion of any relevant
administrative issues regarding collection of the taxes as well as a discussion of
how the proposed tax changes may affect Arizona's position relative to other
states.
METHODOLOGY
The economic impact of a change in state fiscal policy consists of direct
effects, multiplier effects, and long run incidence effects. The direct effects
are the immediate effects of a change in fiscal policy on final demand for goods
and services, earnings of Arizona workers, employment in Arizona, and retained
earnings of Arizona firms. The multiplier effects are the effects of a change in
fiscal policy as it works its way through the economy. The long run incidence
effects are the effects of a change in fiscal policy due to owners of firms shifting
their share of the tax burden to other resource owners, in particular, to workers.
Tax Shifting
The degree to which a tax can be shifted from the point of legal impact to its
final resting place on those who bear the economic costs is crucial to determining
the burden of the tax. Whether a tax is borne by producers or consumers makes
a difference. Table 2 gives the tax shifting assumptions used in this report.
These assumptions are the standards currently used by economists to evaluate
fiscal policy changes.
The traditional view of tax shifting for both general and selected sales taxes is
that they are fully shifted to consumers. The individual income tax can not be
shifted, in general, and is borne by taxpayers. The corporate income tax, on the
other hand, is assumed to be borne by the owners of capital.
State severance tax revenues are derived from the extraction of natural
resources, primarily copper in Arizona. The standard assumption is that this tax
is shifted 1 00 percent to consumers; however, since copper producers in Arizona
are essentially world price takers, in this report the mining severance tax is
assumed to be borne entirely by producers. This, of course, increases the
burden the tax places on the Arizona economy.
Property taxes are divided into three categories: public utilities, residential
property, and all other property. Fifty percent of property taxes imposed on
utilities are assumed to be shifted to consumers. While the precise degree to
which this tax can be shifted depends on the extent to which the Corporation
Commission allows rate increases, an equal sharing of the tax between producers
and consumers is standard. Property taxes imposed on residential property
TABLE 2
INCIDENCE ASSUMPTIONS
State Tax
General Sales Taxes
Selective Sales Taxes:
Tobacco
Alcohol
Individual Income Tax
Corporation Income Tax
Mining Severance Tax
Property Tax:
Public utilities
Residential property
CommercialIlndustriaI property
Incidence
Consumers of taxed items
Consumers of tobacco products
Consumers of alcoholic beverages
Taxpayers
Owners of capital
Owners of capital
112 consumers, 112 owners of capital
Households
213 consumers, 113 owners of capital
Source: Phares, Donald, Who Pays State and Local Taxes?, Cambridge:
Velgeschlayer, Gunn and Hain, Publishers, Inc., 1980.
owners is borne completely by households while 67 percent of property taxes
imposed on all other property owners is shifted to consumers of goods and
services (the assumed shifting by all other property owners .is an average of the
individual components).
Multipliers
In order to track the economic impact of a policy change as it ripples through
the State's economy, some assumption must be made concerning how a change
in final demand for goods and services affect earnings and employment in the
economy. Table 3 gives the multipliers for Arizona that have been calculated by
the Bureau of Economic Analysis, U.S. Department of Commerce. Column one
gives the output multiplier. Each entry in column one represents the total dollar
change in production that occurs in all Arizona industries for each dollar change in
final demand for the goods or services produced by the industry corresponding to
the entry. Column two gives the earnings multiplier. Each entry in column two
represents the total dollar change in earnings of households employed by all
Arizona industries for each dollar change in final demand for the goods or
services produced by the industry corresponding to the entry. Column three
gives the employment multiplier. Each entry in column three represents the
total change in number of jobs in all Arizona industries for each one million dollars
in final demand for the goods or services produced by the industry corresponding
to the entry.
For example, consider the mining industry. The output multiplier is ,8047
which means that a one million dollar increase in demand for copper produced in
Arizona will generate an additional $804,700 increase in final demand for goods
and services throughout the State's economy. The earnings and employment
Mining
Retail Trade
TABLE 3
MULTIPLIERS FOR ARIZONA
Output
(dollars)
Wholesale Trade .8068
Health Services .9665
Other Services .8000
Education ,8588
Utilities .4808
Earnings Employment
(dollars) (number of jobs)
Source: Regional Input and Output Modeling system, Regional Economic
Analysis Division, Bureau of Economic Analysis.
*Each entry in column one represents the total dollar change in production that occurs
in all Arizona industries for each dollar change in final demand for the goods or
services produced by the industry corresponding to the entry. Each entry in column two
represents the total dollar change in earnings of households employed by all Arizona
industries for each dollar change in final demand for the goods or services produced by
the industry corresponding to the entry. Each entry in column three represents the total
change in number of jobs in all Arizona industries for each one million dollars in final
demand for the goods or services produced by the industry corresponding to the entry.
multipliers for the mining industry are ,5399 and 24.7 respectively. Thus, the
$804,700 increase in final demand will generate additional incomes equal to
3399 X 804,700 = $434,457 for Arizona workers as well as an increase in
employment equal to 24.7 X .8047 = 20 jobs.
A Hypothetical Example
The best way to illustrate the methodology used in this report to determine the
economic impact of a change in fiscal policy, is to consider a hypothetical
example. Suppose the State increases the property tax on all other property
enough to raise one million dollars in additional revenues for the State's General
Fund. What will be the economic impact of this tax change?
First consider the direct effects of the tax. Table 2 indicates that 67 percent of
this property tax will be shifted to consumers of goods in Arizona which means
that consumers have .67 X 1,000,000 = $670,000 less to spend on goods. Thus,
the first direct effect is a reduction in final demand for goods produced in Arizona
by $670,000.
This reduction in final demand will also have an impact on earnings of Arizona
workers as well as employment. Column two of Table 3 indicates that for the
retail trade industry, a $670,000 reduction in final demand for goods will generate
a .7606 X 670,000 = $509,602 reduction in incomes of those employed in the
retail trade sector of the Arizona economy. Column three of Table 3, on the other
hand, indicates that for the retail trade industry a $670,000 reduction in final
demand for goods will lead to a reduction in the number of jobs available in
Arizona of 55.2 X .670 = 37.
Another direct effect of the tax is the reduction in retained earnings of firms
affected by the tax. In this example, firms pay an additional $330,000 in taxes.
However, some of this tax burden may be shifted from owners of capital to other
resource owners employed by the firm; in particular, labor. While there is no
general consensus as to how much of the firms' burden can be shifted, a
reasonable estimate is that a maximum of 50 percent can be shifted to workers.
Thus, of the $330,000, retained earnings will fall by $1 65,000.
Next, consider the multiplier effects. As the initial $670,000 reduction in final
demand filters through the economy, Table 3 indicates that there will be an
additional .8522 X 670,000 = $570,974 reduction in final demand for goods. This
is the output multiplier effect. Further, both earnings and employment will be
affected by this second round change in demand. When consumers spend
$570,974 less for goods, production falls which leads to a .7606 X 570,975 =
$434,283 reduction in earnings (the earnings multiplier effect) and a 55.2 X
.570975 = 32 reduction in the number of jobs available in Arizona (the
employment multiplier effect).
Finally, consider the long run incidence effect. In the long run owners of firms,
owners of capital, may shift some of their tax burden to other resource owners
employed by the firm; in particular, to labor. As noted above, in this report it is
assumed that 50 percent can be shifted to workers. This being the case, in this
hypothetical example 50 percent of $330,000 original borne by firms is shifted to
workers. Thus, incomes of workers are reduced by an additional $1 65,000.
This reduction in workers' incomes leads to a $1 65,000 reduction in final
demand and the long run incidence effect is determine in the same way we
determined the direct and multiplier effects above. Using Table 3, a $165,000
reduction in final demand for goods leads to an additional .8522 X 165,000 =
$1 40,613 reduction in final demand which means that as a result of this further
shifting of the tax burden the dollar value of production in Arizona falls a total of
165,000 + 140,613 = $305,613. In addition, worker's incomes fall an additional
.7606 X 305,613 = $232,449 and employment fall by 17 jobs.
The total economic impact of a hypothetical increase in property taxes that
generate one million dollars in revenues is the sum of the direct, multiplier, and
long run incidence effects: final demand for goods and services falls by
$1,546,487; workers' earnings fall by $1,249,498; the number of jobs available to
Arizona workers falls by 86; and retained earnings of firms falls by $330,000.
These calculations are summarized in Table 4.
EXPENDITURES
Each of the proposed tax plans discussed in this report are revenue neutral in
that each is designed to generate approximately $255,000,000 in additional
revenues for the State of Arizona; thus, a choice between tax plans could be
made simply by determining which plan will impose the smallest total economic
cost on the State's economy. However, to fully understand the impact of each
fiscal proposal on the Arizona economy, it it useful to determine not only the costs
associated with each tax plan but also the benefits associated with the increase in
State expenditures made possible by the tax. Comparing economic costs and
benefits provides a clear picture of the net impact of any particular policy change
on the State's economy.
The following analysis assumes that the additional revenues generated by any
one of the proposed tax plans is to be expended as follows: $78,000,000 on
indigent health care, $25,000,000 on behavioral health care, $41,000,000 for
prison operations, and $1 11,000,000 on education.
The economic impact of these expenditures prior to the consideration of
financing costs is shown in Table 5. The methodology discussed above is used
Direct
Multiplier
Long Run Incidence
Total
TABLE 4
THE ECONOMIC IMPACT OF A HYPOTHETICAL PROPERTY TAX
THAT GENERATES $1,000,000 IN ADDITIONAL REVENUES
Decrease in
Final Demand for
Goods 8a Services
(millions)
Decreast in
Decrease in Decrease in Retained
Earnings Employment Earnings
(millions) (number of jobs) (millions)
.510 37 165,000
Direct
Multiplier
Total
TABLE 5
THE ECONOMIC IMPACT OF
A $255,000,000 INCREASE IN STATE EXPENDITURES
lncrease in
Final Demand for Increase in Increase in
Goods & Services Earnings Employment
(millions) (millions) (number of jobs)
to calculate each of the entries in this table. Column one gives the increase in
final demand for goods and services, measured in millions of dollars, that arises
because of increased spending. The total effect associated with a $255,000,000
increase in government expenditures on health care, prisons, and education is an
increase in final demand for goods and services of $484,8 1 7,000. That is, every
dollar spent on health care, prisons, and education generates, on average, a
$1.89 increase in final demand. For example, a dollar spent on health care
increases the demand for physician's services by $1.96; a dollar spent on prisons
increases the demand for operations supplies by $1.85; and a dollar spent on
education increases the demand for educational services by $1.86.
Column two gives the increase in earnings of those workers employed in
businesses affected by the increase in final demand (the entries in this column
are calculated using the earnings multipliers for other services, retail trade, and
education shown in Table 3). In this instance, a $484.81 7 million increase in final
demand for goods and services will generate $374,673,000 in additional incomes
for Arizona workers. This means that, on average, every dollar spent by the state
generates a $1.47 increase in income.
Finally, column three gives the increase in employment associated with the
increase in final demand (the entries in this column are calculated using the
employment multipliers for services, construction, and education shown in Table
3). This expenditure program will generate approximately 22,788 new jobs for
Arizona workers.
TAX PLAN A
Tax Plan A consists of five proposed changes in the existing tax code for
Arizona: a minimum school tax, increasing the state wide property tax, an
increase in luxury taxes, eliminating or reducing certain corporate income tax
credits and deductions, and increasing the mining severance tax. Table 6(a)
summarizes the results of the economic analysis described below. The net
economic benefits of Tax Plan A are: an increase in final demand for goods and
services of $1 43,937,000; an increase in earnings of Arizona workers of
$78,388,000; and the addition of 5,491 jobs for Arizona workers.
As is discussed below, the entries in this table reflect the assumption that 50%
of the tax burden is borne by customers, 25% by owners of firms, and 25% by the
firms' employees, the most reasonable case. Table 6(b), on the other hand,
reflects the most severe case. The entries in this table reflect the assumption that
50% of the tax is borne by customers and, ultimately, 50% by the firms'
employees. This has essentially the same aggregate income and employment
impact as if the tax was entirely passed through to utility customers.
Plan A - Minimum School Tax
Background - Minimum School Tax (Plan A)
Under the current Arizona State School Assistance Program, a school district
qualifies for state aid only after levying property taxes at the minimum qualifying
tax rate. At present, the minimum qualifying rate is $2.36 per $1 00 assessed
valuation for elementary or high school districts and $4.72 per $1 00 assessed
valuation for unified districts or districts without both elementary and secondary
schools. State aid is then set equal to any shortfall that exists between each
TABLE 6(a)
THE ECONOMIC IMPACT OF TAX PLAN A
Proposed Tax Changes and Revenues:
Minimum school tax
An increase in general property tax rates
Increases in luxury goods tax rates
Adjustments in corporate income tax deductions and credits
An increase in the mining severance tax rate
Total Revenues Generated:
Total Economic Benefits:
lncrease in final demand for goods and services
lncrease in earnings
lncrease in employment
Total Economic Costs:
Decrease in final demand for goods and services
Decrease in earnings
Decrease in employment
Net Economic Benefits:
Net increase in final demand for goods and services
Net increase in earnings
Net increase in employment
$484,817,000
374,673,000
22,788 jobs
$340,880,000
296,335,000
17,297 jobs
$1 43,937,000
78,338,000
5,491 jobs
TABLE 6(b)
THE ECONOMIC IMPACT OF TAX PLAN A:
TAX BURDEN SHIFTED 100% TO WORKERS AND CONSUMERS
Proposed Tax Changes:
Minimum school tax
An increase in general property tax rates
Increases in luxury goods tax rates
Adjustments in corporate income tax deductions and credits
An increase in the mining severance tax rate
Total Revenues Generated: $255,000,000
Total Economic Benefits:
Increase in final demand for goods and services $484,817,000
Increase in earnings 374,673,000
Increase in employment 22,788 jobs
Total Economic Costs:
Decrease in final demand for goods and services $444,837,000
Decrease in earnings 336,802,000
Decrease in employment 20,696 jobs
Net Ekonomic Benefits:
Net increase in final demand for goods and services $39,980,000
Net increase in earnings 37,871,000
Net increase in employment 2,092 jobs
district's school budget limit and property taxes available at the qualifying rate in
each school district.
While most school districts in Arizona levy property taxes equal to or greater
than the minimum qualifying tax rate, a number of school districts are able to
meet their school spending budgets by taxing property at rates far below the
minimum qualifying rate and, thus, do not receive state assistance. These
districts are "property rich" in the sense that the net assessed values per student
are extremely high compared to districts throughout the rest of the state.
Typically, the reason for high net assessed values per student is that large
commercial or industrial parcels are located within the school district. For
example, the Ruth Fisher Elementary School District contains the Palo Verde
Nuclear Generation Station. This district currently levies a primary property tax of
only $.04 per $1 00 assessed valuation. This low rate is sufficient to attain the
school budget requirements in the district.
Tax Proposal - Minimum School Tax (Plan A)
Levy a minimum school tax equal to the appropriate qualifying tax rate, $2.36
or $4.72 per $1 00 assessed value, on properties located in school districts that
do not currently qualify for state assistance. The districts that would be affected
by this tax, along with their 1988 property tax rates and their qualifying tax rates,
are shown in Table 7. The economic impact of this tax is based on an estimate of
125 million dollars that would be raised by increasing the tax rates in these
districts to the qualifying tax rate.
Economic Impact - Minimum School Tax (Plan A)
In order to determine the economic impact of the minimum school tax,
property owners in the school districts affected by the tax are divided into three
TABLE 7
CURRENT TAX RATES FOR DISTRICTS THAT DO NOT RECEIVE
SCHOOL ASSISTANCE FROM THE STATE
District
1988 "Primary" Minimum Qualifying
Tax Rate Tax Rate
Round Valley Unified
St. Johns Unified
Cochise Elementary
Chevron Butte Unified
Young Elementary
Ruth Fisher Elementary
Riverside Elementary
Phoenix Union High School
Madison Elementary
Arlington Elementary
Joseph City Unified
Vail Elementary
Continental Elementary
Red Rock Elementary
Champie Elementary
Bouse Elementary
Bicentennial Union High School
categories: utilities, residential, and ail other. As is shown in Table 8, of the $1 25
million in new tax revenues approximately $1 16 million will be paid by public
utilities, $1 million by residential property owners, and $8.1 million by all other
property owners.
First consider the economic effects of the tax on producers and consumers of
electricity. As a result of the minimum school tax, utilities pay $1 16,039,000
additional tax revenues per year to the State of Arizona. Of this $1 16 million
approximately $94,276,000 will be paid by the owners of the Palo Verde Nuclear
Generation Station. Since 53.41 percent of Palo Verde is owned by out-of-state
firms, 5341 X 94,276,000 = $50,353,000 in tax burden will be exported out of the
state. Thus, Arizona utilities will pay a total of $65,686,000 in additional tax
revenues.
While the point of legal impact of the additional $65 million in tax payments is
on the utilities, 50 percent of these additional taxes will be shifted to consumers of
electricity (see Table 2). This being the case, consumers of electricity will pay
$32,843,000 more per year for electricity, about $.00153 more per kilowatt hour
(KWH), which is an average increase of 2.1 percent increase in the cost of
electricity. For an Arizona household consuming 1,000 KWH of electricity per
month, the cost of using electricity will increase by $1.53 per month. If all of the
tax is shifted to consumers, the burdens would be twice as great.
As a result of the increase in the cost of consuming electricity, demand for
electricity will fall. How much demand falls depends on the price elasticity of
demand which measures the relative responsiveness of quantity demanded to
changes in price. As shown in Table 9, the price elasticity of demand for
electricity is .l. This means that a one percent increase in the cost of electricity
will cause a .I percent fall in demand for electricity.
TABLE 8
MINIMUM SCHOOL TAX REVENUES
BY TYPE OF PROPERTY OWNER
Tax Revenues
(millions)
Utilities
Residential Property Owners
Commercial/lndustriaI Property Owners
TOTAL
Source: Arizona Department of Revenue.
TABLE 9
ELASTICITY ESTIMATES
Item Elasticity
Bee+ ...... .. . ........... .. ..... ... .......... ........... . . .............. ........ . .70
Electricity+ ................................................................................... .10
Food*. . . . .. . . . . . . . .. . . .. . . . . .. . . .. . . . .. . . . .. . . .. . . . .. . . . . . . . .. . . . .. . . .. . . .. . . . .. . . . .. . . . .. . . . . . . . .. . . .. .21
+ Source: Browning, Edgar K. and Browning, Jacquelene M., Microeconomic
Theory and Applications, 3rd. ed., Glenview, Illinois: Scott, Freeman and Co.,
1989.
* Source: Nicholson, Walter, Intermediate Microeconomics and Its Application,
3rd ed., chicago, Illinois; The Dryden Press, 1987.
Given a demand elasticity of .I, if the cost of electricity increases 2.1 percent
then demand will fall by .21 percent. Currently, Arizona industrial, commercial,
and residential consumers of electricity purchase 4,180 million KWH, 8,850
million KWH, and 10,790 million KWH per year respectively. Residential
consumers pay an average price of .09277 per KWH, commercial consumers pay
an average price of .08602 per KWH, and industrial consumers pay an average
price of .09277 per KWH. As a result of the minimum school tax, the price of
electricity purchased by residential, commercial, and industrial buyers will
increase by 1.7 percent, 1.8 percent, and 2.7 percent respectively. Thus, final
demand for electricity will fall by $3.679 million per year.
Since consumers of electricity pay an additional $32.843 million in taxes,
disposable income falls by this amount and not only will final demand for
electricity fall but so too will final demand for other goods traded in Arizona. Table
10 shows the reduction of final demand of goods and services other than
'electricity. Column one gives additional taxes paid by type of consumer. Column
two gives the reduction in final demand for electricity by type of consumer.
Column three gives the difference between Columns one and two and represents
the reduction in final demand for other goods and services due to the fall in
disposable income. That is, final demand falls by a total of $29.1 64 million.
The $3.679 million reduction in final demand for electricity and the $29.1 64
reduction in final demand for other goods and services yields a direct output effect
of $32.843 million. This, in turn, generates the direct earnings and employment
effects; in particular, earnings of Arizona workers will fall by $21.698 million and
1,553 jobs will be lost (these numbers are calculated using the retail trade,
wholesale trade, and utilities multipliers for the changes in final demand attributed
to residential consumers, all other consumers, and consumers of electricity
respectively).
TABLE 10
REDUCTION IN FINAL DEMAND OF GOODS AND SERVICES
AS A RESULT OF AN INCREASE IN THE COST OF ELECTRICITY
Reduction in Reduction in
Additional Tax Expenditures Final Demand for
Revenues Paid on Electrlcity Goods & Services
(millions) (millions) (millions)
Residential Consumers $1 6.41 5 $1.670 $1 4.745
Commercial Consumers 12.484 1.376 11.108
Industrial Consumers 3.944 0.633 3.31 1
Total 32.843 3.679 29.164
Another direct effect of the tax is a reduction in retained earnings of firms
affected by the tax equal to .5 X 32,843,000 = $1 6.422 million.
In addition to the direct effect of the tax increase, there will be multiplier and
long run incidence effects. The multiplier effects are calculated using the
multipliers given in Table 3. Final demand for goods and services in all industries
will fall by $25.968 million, earnings will fall by $1 7.689 million, and 1,225 jobs will
be lost.
The long run incidence effects are calculated assuming that utility owners shift
50 percent of their tax burden to workers. This being the case, disposable
incomes of workers employed by the utility industry fall by .5 X 32,843,000 =
$1 6.421 million. Using the retail trade multipliers in Table 3, this reduction in
disposable income causes final demand for goods sold in Arizona to fall by
$30.41 5 million, earnings to fall by $23.1 34 million, and employment to fall by
1,679 jobs.
Next consider residential property owners in the school districts affected by
the minimum school tax. Residential property owners pay an additional $1.1 37
million in property taxes as a result of the tax which is, on average, a $61 .I 1 per
parcel increase in taxes. This means that disposable incomes of residential
property owners falls by $1 .I 37 million which, in turn, leads to a direct output
effect equal to a $1.1 37 reduction in final demand for goods.
The $1 .I37 million reduction in final demand will also generate a direct
earnings effect equal to a .7606 X 1 ,I 37,000 = $364 million fall in earnings and a
direct employment effect equal to 55.2 X 1 .I 37 = 63 lost jobs (see Table 3 for
relevant multipliers).
In addition to the direct effect of the tax increase, there will be a multiplier
effect (there is no long run incidence effect since the tax falls on residential
property owners rather than firms). Using the retail trade multipliers given in
Table 3, final demand for goods will fall by another .a522 X 1,137,000 = $969
million, earnings will fall by .7606 X 969,000 = $737 million, and 55.2 X .969 = 53
jobs will be lost.
Finally, consider all other property owners in the affected school districts. As
a result of the minimum school tax, all other property owners pay $8.1 million
additional tax revenues per year to the State of Arizona. While the point of legal
impact of this additional $8.1 million in tax payments is on firms, 67 percent of
these additional taxes are shifted to consumers (see Table 1). This being the
case, all other property owners will pay .33 X 8,100,000 = $2.7 million of the tax
(about $1 07 per parcel), while consumers in general will pay .67 X 8,100,000 =
$5.4 million more per year for goods and services or about $3.49 more per wage
earner employed in the retail trade sector.
As a result of the increase in the cost of consuming goods and services, final
demand for goods and services will fall. Since many goods and services are
affected simultaneously, the standard assumption is that, on average, final
demand will fall by the full amount of the tax burden borne by consumers. In this
instance, final demand will fall by $5.4 million per year which is the direct output
effect of the tax. The $5.4 million reduction in final demand will also generate
direct earnings and employment effects; in particular, earnings of Arizona workers
employed will fall by .7606 X 5,400,000 = $4.1 07 million and 55.2 X 5.400 = 298
jobs will be lost (see Table 3 for relevant multipliers).
Another direct effect of the tax is a reduction in retained earnings of firms
affected by the tax equal to .5 X 2,700,000 = $1.350 million.
In addition to the direct effect of the tax increase, there will be multiplier and
long run incidence effects. The multiplier effects are calculated using the
multipliers given in Table 3 for retail trade. Final demand for goods and services
will fall by .a522 X 5,400,000 = $4.602 million, earnings will fall by .7606 X
4,602,000 = $3.500 million, and 55.2 X 4.602 = 254 jobs will be lost.
The long run incidence effects are calculated assuming that owners firms shift
50 percent of their tax burden to workers. This being the case, disposable
incomes of workers employed in the retail trade sector falls by .5 X 2,700,000 =
$1.350 million which causes final demand for goods sold in Arizona to fall by
$2.500 million, earnings to fall by $1.902 million, and employment to fall by 138
jobs.
Table 11 contains a summary of the economic impact on Arizona workers of a
minimum school tax designed to generate $1 25 million of additional revenues for
the State. As a result of levying this tax, final demand for goods and services will
be reduced by $1 34.249 million, earnings will be reduced by $282 per worker
employed in the utility and retail trade sectors, and employment in these sectors
will fall 1.51 percent.
TABLE 11
THE ECONOMIC IMPACT OF A MINIMUM SCHOOL TAX
THAT GENERATES $1 25,000,000 IN ADDITIONAL REVENUES
Reduction in
Final Demand for Reduction in Reduction in
Goods & Services Earnings Employment
(millions) (per worker) (% of wage earners)
Direct $39.380 $76 .55%
Multiplier
Long Run Incidence "
Total 134.249 282 1.51
Plan A - General Property Tax
Background: General Property Tax (Plan A)
The State currently taxes property at a primary rate of 47@ per $1 00 net
assessed valuation. Rates from 1985 through 1987 averaged 39.3@ per $1 00 net
assessed value.
Tax Proposal - General Property (Plan A)
Increase the state's general property tax rate to yield an additional 58 million
dollars. Using 1988 rates and assuming a 5% appreciation in net assessed value
for 1989, this would require the state to increase the rate from 47@ per $1 00.00
net assessed value to 76@ per $1 00.00 net assessed value. Accordingly, the
average primary rate for combined state and local property taxes - based on
1988 rates - would increase from $7.84 per $1 00.00 net assessed value to $8.1 3.
Thus, property tax payers would experience a 3.7% increase in overall property
tax rates as a result of the proposal.
Economic Impact - General Property Tax (Plan A)
In order to determine the economic impact of a general property tax increase,
property owners are divided into two categories: residential and all other. Of the
$58 million in new tax revenues approximately $1 7.1 85 million will be paid by
residential property owners, or $1 8.31 per parcel, and $40.815 million by all other
property owners, or $39.08 per parcel.
First consider residential property owners. As a result of the tax, the
disposable incomes of residential property owners falls by $1 7.1 85 million which,
in turn, leads to a direct output effect equal to a $1 7.1 85 reduction in final demand
for goods. This, in turn, generates a direct earnings effect equal to a .7606 X
17,185,000 = $1 3.071 million fall in earnings and a direct employment effect
equal to 55.2 X 17.1 85 = 949 lost jobs (see Table 3 for relevant multipliers).
In addition to the direct effect of the tax increase, there will be a multiplier
effect (there is no long run incidence effect since the tax falls on residential
property owners rather than firms). Using the retail trade multipliers given in
Table 3, final demand for goods will fall by another .8522 X 17,185,000 = $14.645
million, earnings will fall by .7606 X 14,645,000 = $1 1 .I39 million, and 55.2 X
14.645 = 808 jobs will be lost.
Next, consider all other property owners. As a result of the property tax
increase, all other property owners pay $40.81 5 million additional tax revenues
per year to the State of Arizona. While the point of legal impact of this tax is on
firms, 67 percent of these additional taxes are shifted to consumers (see Table 2).
This being the case, all other property owners will pay .33 X 40,815,000 =
$1 3.469 million of the tax (about $1 2.89 per parcel), while consumers in general
will pay .67 X 40,815,000 = $27.346 million more per year for goods and services
or about $1 7.69 more per wage earner.
As a result of the increase in the cost of consuming goods and services, final
demand for goods and services will fall. Since many goods and services are
affected simultaneously, the standard assumption is that, on average, final
demand will fall by the full amount of the tax burden borne by consumers. In this
instance, final demand will fall by $27.346 million per year which is the direct
output effect of the tax. The $27.346 million reduction in final demand will also
generate direct earnings and employment effects; in particular, earnings of
Arizona workers employed will Call by '7606 X 27,346,000 = $20.799 million and
55.2 X 27.346 = 1,509 jobs will be lost (see Table 2 for relevant multipliers).
Another direct effect of the tax is a reduction in retained earnings of firms
affected by the tax equal to .5 X 13,469,000 = $6.734 million.
In addition to the direct effect of the tax increase, there will be multiplier and
long run incidence effects. The multiplier effects are calculated using the
multipliers given in Table 3 for retail trade. Final demand for goods and services
will fall by ,8522 X 27,346,000 = $23.21 9 million, earnings will fall by .7606 X
23,219,000 = $1 7.660 million, and 55.2 X 23.21 9 = 1,281 jobs will be lost.
The long run incidence effects are calculated assuming that owners firms shift
50 percent of their tax burden to workers. This being the case, disposable
incomes of workers employed in the retail trade sector falls by .5 X 13,469,000 =
$6.734 million which causes final demand for goods sold in Arizona to fall by
$1 2.474 million, earnings to fall by $9.488 million, and employment to fall by 689
jobs.
Table 12 contains a summary of the economic impact of a property tax
increase designed to generate $58 million of additional revenues for the State.
As a result of levying this tax, final demand for goods and services will be
reduced by $94.869 million, earnings will be reduced by $261 per worker
employed in the utility and retail trade sectors, and employment in these sectors
will fall 1.90 percent.
Comparison with Other States - Property Tax (Plan A)
A ranking of state and local property tax revenue burdens expressed on a per
capita basis and as a percentage of personal income appears in Table 13. In
1986 Arizona ranked 26th in property tax per capita burden and 24th in burden as
a percent of personal income. After expressing the additional property taxes of
183 million dollars outlined in Plan A in comparable terms and discounting to
1986 dollars, the Arizona property tax burden would increase to 23rd on a per
capita basis and 20th as a percent of personal income.
TABLE 12
THE ECONOMIC IMPACT OF A GENERAL PROPERTY TAX
THAT GENERATES $58,000,000 IN ADDITIONAL REVENUES
Reduction in
Final Demand for Reduction in Reduction in
Goods & Services Earnings Employment
(mllllons) (per worker) (% of wage earners)
Direct
Multiplier
Long Run Incidence
Total
TABLE 13
STATE RANKINGS FOR
STATEANDLOCALPROPERTYTAXREVENUES
Rank State
1 WY
2 AK
3 NJ
4 NY
5 NH
6 CT
7 OR
8 MT
9 MI
10 RI
11 MA
12 WI
13 N E
14 VT
15 I A
16 I L
17 KS
18 MN
19 CO
20 TX
21 ME
22 SD
23 C A
24 WA
25 MD
26 A2
27 FL
28 V A
29 OH
30 IN
3 1 PA
32 UT
33 ND
34 NV
35 GA
36 HI
37 ID
38 NC
39 SC
40 MO
41 TN
42 OK
43 DE
44 MS
45 wv
46 KY
47 LA
48 AR
49 NM
50 AL
US
1986
Per Capita
Revenue
$1,173
1,084
757
748
738
731
651
650
650
624
601
600
579
556
544
539
533
529
521
51 7
478
477
451
442
438
422
41 1
396
394
393
388
366
364
340
329
31 4
299
265
260
243
235
234
223
221
203
1 95
189
182
143
118
$463
State
WY
AK
MT
OR
N H
MI
NY
VT
WI
RI
NJ
N E
S
I A
CT
ME
TX
KS
MN
MA
IL
CO
UT
BZ
WA
IN
FL
ND
OH
PA
C A
MD
V A
ID
G A
SC
MS
NV
NC
HI
TN
wv
OK
MO
KY
AR
LA
DE
NM
AL
US
1986
Revenue1
Personal
Income
8.83%
6.1 1
5.88
5.1 7
5.08
4.81
4.66
4.64
4.57
4.52
4.43
4.34
4.28
4.27
4.06
4.05
3.90
3.88
3.77
3.68
3.66
3.56
3.54
2333
3.22
3.1 6
3.07
3.00
2.98
2.90
2.87
2.81
2.76
2.69
2.68
2.48
2.42
2.41
2.30
2.29
2.1 1
1.98
1.91
1.85
1.80
1.74
1.69
1.59
1.33
1.12
3.37%
State
WY
AK
N J
NY
N H
CT
OR
MT
MI
RI
MA
WI
N E
VT
I A
IL
KS
MN
CO
TX
ME
SD
BZ
C A
WA
MD
FL
V A
OH
IN
PA
UT
ND
NV
GA
HI
ID
NC
SC
MO
TN
OK
DE
MS
wv
KY
LA
AR
NM
AL
US
Tax Plan A*
Per Capita
Revenue
$1,173
1,084
757
748
738
73 1
65 1
650
650
624
60 1
600
579
556
544
539
533
529
521
51 7
478
477
464
45 1
442
438
41 1
396
394
393
388
366
364
340
329
31 4
299
265
260
243
235
234
223
221
203
1 95
189
182
1 43
118
$463
State
WY
AK
MT
OR
NH
MI
NY
VT
WI
RI
NJ
NE
S
I A
CT
ME
TX
KS
MN
Az
MA
Tax Plan A*
Revenue/
Personal
Income
8.83%
6.1 1
5.88
5.17
5.08
4.81
4.66
4.64
4.57
4.52
4.43
4.34
4.28
4.27
4.06
4.05
3.90
3.88
3.77
;tZP
3.68
3.66
3.56
3.54
3.22
3.1 6
3.07
3.00
2.98
2.90
2.87
2.81
2.76
2.69
2.68
2.48
2.42
2.41
2.30
2.29
2.1 1
1.98
1.91
1.85
1.80
1.74
1.69
1.59
1.33
1.12
3.37%
*Assumes property tax increase of $125,000,000 (Qtr.) plus $58,000,000 general.
Another way of gauging the additional property tax burden embodied by Plan
A would be to compare its impact on the average residential property owner with
the burdens maintained by residential property owners in other states. Table 14
presents average effective property tax rates for all states in 1986. Arizona
maintained the 45th highest rate in 1986. Expressing the additional property tax
burden proposed by the 58 million dollar General Property Tax Plan A in 1986
dollars would result in a movement in Arizona's ranking to the 43rd position.
General Arguments - Property Tax (Plan A)
As indicated by Table 7 certain residential, commercial and industrial property
owners will realize a substantial increase in property tax rates as a result of the
property taxes proposed in Plan A. However, it is clear that properties throughout
the state would be taxed equally after this provision is imposed. That is, no
property tax advantages would exist due to the relatively arbitrary location of
school district boundaries.
Attempts to extend the minimum school tax provision statewide to all districts
would pose difficulties for some districts. A number of districts can justify state
assistance based on established budget formulae and available net assessed
value. Once the aid formula is established, however, these districts can seek
local property tax relief by undertaking cost saving measures designed to reduce
school budgets. With a statewide minimum qualifying tax rate, there would be no
incentive for local districts to economize in this fashion. Indeed, the tax structure
would encourage local school districts to overstate school budgets as much as
possible since monies not spent on local schools will flow out of the district and
into the State's general fund.
Finally, the state should also consider what types of resources will be required
to administer this tax. Presumably, the tax will be collected in the same fashion
TABLE 14
AVERAGE EFFECTIVE PROPERTY TAX RATES.
EXISTING SINGLE FAMILY HOMES WITH FHA INSURED MORTGAGES.
BY STATE AND REGION. 1986
State and Reaiory
U.S. Totals. ......................................................................
New England
Connecticut ...............................................................
Maine .........................................................................
Massachusetts. .........................................................
New Hampshire ........................................................
Rhode Island .............................................................
Vermont .....................................................................
Mideast
Delaware ...................................................................
Washington. DC ........................................................
Maryland ....................................................................
New Jersey ................................................................
New York ...................................................................
Pennsylvania .............................................................
Great Lakes
Illinois .......................................................................
Indiana ......................................................................
Michigan ....................................................................
Ohio ..........................................................................
Wisconsin ..................................................................
Plains
Iowa ..........................................................................
Kansas ......................................................................
Minnesota .................................................................
Missouri .....................................................................
Nebraska ...................................................................
North Dakota .............................................................
South Dakota. ............................................................
Southeast
Alabama .................. .................................................
Arkansas ...................................................................
Florida .......................................................................
Georgia .....................................................................
Kentucky ...................................................................
Louisiana ...................................................................
Mississippi .................................................................
North Carolina ........................................................... South Carolina ..........................................................
Tennessee .................................................................
Virginia ......................................................................
West Virginia .............................................................
Southwest
Arizona .....................................................................
New Mexico ...............................................................
Oklahoma ..................................................................
Texas .........................................................................
Rocky Mountain
Colorado ....................................................................
Idaho .........................................................................
Montana ....................................................................
Utah ..........................................................................
Wyoming ...................................................................
Far West
California ...................................................................
Nevada ......................................................................
Oregon ......................................................................
Washington ...............................................................
Alaska .......................................................................
Hawaii ........................................................................
Effective Property
Tax Rate . 1986
1.16%
.R.a nk mlah . 1 . Low = 50)
Source: Computed by AClR staff from data contained in U.S. Department of Housing and Urban Development.
Housing.FHA. Management Information Systems Division. Single Family Insured Branch. Data for States and
Selected Areas on Characteristics of FHA Operations Under Section 203(b). various years .
as the current general property tax. However, the state must investigate whether
additional administrative difficulties might arise when some districts are assessed
at the minimum qualifying tax rate while others establish their rates in the
conventional fashion.
Plan A - Luxury Taxes: Cigarettes and Beer
Background - The Cigarette Tax (Plan A)
At present the Arizona state tax rate per pack of twenty cigarettes is $.l 5 per
pack (this is in addition to the federal excise tax of $.l 6 per pack). The tax is
levied on distributors of cigarettes and is administered by requiring cigarettes sold
at retail outlets in the state to carry stamps issued by the Arizona Department of
Revenue upon payment of the tax. The rate may, in fact, be slightly less than
$.I 5 per pack since stamps purchased in amounts greater than $30,000 are sold
at a 3-4% discount.
Tax Proposal - The Cigarette Tax (Plan A):
Increase the tax rate per pack of cigarettes from $.l 5 to $.25. No change in
the method of administering the tax is offered in the current proposal. The
economic impact of this tax is based on projections.of 350 million packs sold in
1989190 at current tax rates. The tax would conceivably raise $35 million dollars
based on anticipated FY 89190 consumption levels. However, we estimate that
minor demand reduction and increased incentive for Indian reservation purchases
will result in approximately $300 million in taxable cigarette pack sales - or $30
million in additional revenues.
Economic Impact - The Cigarette Tax (Plan A)
While the point of legal impact of the additional $.I0 per pack tax payment is
on the owners of firms selling cigarettes, 100 percent of the tax increase is shifted
to cigarette consumers (see Table 2) in the form of higher prices for cigarettes.
This means that consumers of cigarettes will pay, on average, 7.7 percent more
for a pack of cigarettes. For a smoker consuming one pack of cigarettes per day,
the annual cost of purchasing cigarettes will increase by $36.50.
As a result of the increase in the cost of consuming cigarettes, demand for
cigarettes will fall. Table 8 indicates that the price elasticity of demand for
cigarettes is -35. This means that a 7.7 percent increase in the price of cigarettes
will cause a .35 X 7.7 = 2.695 percent fall in demand for cigarettes. Currently,
Arizona consumers purchase 350 million packs of cigarettes per year at an
average cost of $1.30 per pack. Thus, consumers will purchase .02695 X
350,000,000 = 9.432 million fewer packs of cigarettes per year and revenues
generated by the tax will be .1 X 340,568,000 = $34.057 million (as noted above,
up to $5 million of these revenues will be lost because of increased purchases
from Indians).
As a result of the tax increase, final demand for cigarettes will fall by 1.30 X
9,432,000 = $1 2.262 million. In addition, since consumers of cigarettes pay an
additional $34.057 million in taxes, final demand for other goods and services
traded in Arizona falls by $21.795 million. Since retail trade multipliers are used
for both the cigarette industry and other goods, final demand for goods and
services falls by $34.057 million, which is the direct output effect. This reduction
in final demand generates direct earnings and employment effects equal to a
$25.903 million reduction in earnings of Arizona workers and a job loss of 1,847
jobs (see Table 3 for relevant multipliers).
In addition to the direct effect of the tax increase, there will be multiplier effects
(since the tax is shifted 100 percent to consumers, there are no long run
incidence effects). The multiplier effects are calculated using the multipliers given
in Table 3 for retail trade. Final demand for goods and services in all industries
will fall by 3522 X 34,057,000 = $29.024 million, earnings will fall by .7606 X
29,024,000 = $22.075 million, and 55.2 X 29.024 = 1,602 jobs will be lost.
The total effect of the tax on cigarettes will be to raise approximately $30
million in additional revenues, to reduce final demand for goods and services by
$63.081 million, to reduce earnings by $47.978 million ($1 74 per worker), and to
reduce employment by 3,449 jobs (1.25 percent).
Background - The Beer Tax (Plan A)
At present the State of Arizona levies a $.I6 per gallon tax on malt liquor (this
is in addition to the federal tax of $.29 per gallon). The tax is paid by wholesalers
of malt liquor and administered by the Arizona Department of Revenue.
Tax Proposal - The Beer Tax (Plan A)
Increase the tax rate per gallon of malt liquor from $.I6 to $.26. No change in
the method of administering the tax is offered in the current proposal. The
economic impact of this tax is based on projections of 104 million gallons sold in
1989190 at current tax rates. The net revenue after minor demand adjustments is
expected to be 10.3 million dollars.
Economic Impact - The Beer Tax (Plan A)
As was the case for cigarettes, even though the point of legal impact of the
additional $.I0 per gallon tax payment is on the owners of firms selling beer, 100
percent of the tax increase is shifted to beer consumers (see Table 2) in the form
of higher prices for beer. This means that consumers of beer will pay, on
average, 1.62 percent more for a gallon of beer or slightly less than $.01 more per
can of beer. For a beer drinker consuming two six-packs of beer per week, the
annual cost of purchasing beer will increase by $5.85.
As a result of the increase in the cost of consuming beer, demand for beer will
fall. Table 8 indicates that the price elasticity of demand for beer is .70. This
means that a 1.6 percent increase in the price of beer will cause a .70 X 1.62 =
1.13 percent fall in demand for beer. Currently, Arizona consumers purchase 104
million gallons of beer per year at an average cost of $6.1 9 per gallon. Thus,
consumers will purchase .0113 X 104,000,000 = 1.1 75 million fewer gallons of
beer per year and revenues generated by the tax will be $1 0,283 million.
As a result of the tax increase, final demand for beer will fall by $6.995 million.
In addition, final demand for other goods and services will fall by (1 0.283 - 6.995)
= $3.288 million. Since retail trade multipliers are used for both the beer industry
and other goods, final demand for goods and services falls by $1 0.283 million,
which is the direct output effect. This, in turn, leads to a $7.821 reduction in
earnings of Arizona workers and a job loss of 1.052 jobs (see Table 3 for the
relevant multipliers).
In addition to the direct effect of the tax increase,'there will be multiplier effects
(since the tax is shifted 100 percent to consumers, there are no long run
incidence effects). The multiplier effects are calculated using the multipliers given
in Table 3 for retail trade. Final demand for goods and services in all industries
related to the beer industry will fall by .8522 X 10,283,000 = $8.763 million,
earnings will fall by .7606 X 8,763,000 = $6.665 million, and 55.2 X 8.763 = 484
jobs will be lost.
The total effect of the tax on beer will be to raise ap9rsximately $1 0 million in
additional revenues, to reduce final demand for goods and services by $1 9.046
million, to reduce earnings by $1 4.486 million ($52 per worker), and to reduce
employment by 1,052 jobs (.386 percent).
Table 15 contains a summary of the economic impact of increases in luxury
goods taxes designed to generate $40 million of additional revenues for the State.
As a result of levying these taxes, final demand for goods and services will be
reduced by $82.1 27 million, earnings will be reduced by $226 per worker, and
employment will fall 1.63 percent.
Comparison with Other States - Luxury Taxes (Plan A)
Table 16 presents a ranking of the total state and local alcohol products tax
revenue burdens expressed on a per capita basis and as a percent of personal
income. In 1986 Arizona ranked 21st on a per capita basis and 14th as a percent
of personal income. After expressing the additional beer taxes of 10 million in
comparable ierms and discounting to 1986 dollars, the Arizona alcohol products
tax would increase to 18th on a per capita basis and 10th as a percent of
personal income.
Table 17 presents a 1988 state-by-state comparison that separates beer tax
rates from other alcohol tax rates. With the proposed tax on beer the Arizona rate
would be 26@, the 17th highest tax rate among all states.
A ranking of state and local tobacco products tax burdens expressed on a per
capita basis and as a percent of personal income appears in Table 18. In 1986
Arizona ranked 37th in Tobacco products tax burden per capita and 36th as a
percent of personal income. After expressing the additional cigarette taxes in
Plan A on comparable terms and discounting to 1986 dollars, the Arizona tobacco
products tax burden would increase to 22nd on a per capita basis and 19th as a
percent of personal income.
TABLE 15
THE ECONOMIC IMPACT OF INCREASES IN LUXURY GOODS TAX RATES
THAT GENERATE $40,000,000 IN ADDITIONAL REVENUES
Direct
Multiplier
Total
Reduction in
Final Demand for Reduction in Reduction in
Goods & Services Earnings Employment
(millions) (per worker) (% of wage earners)
$44.340 $1 22 38%
37.787 104 .75
82.1 27 226 1.63
TABLE 16
STATE RANKINGS FOR
ALCOHOL PRODUCTS TAX REVENUES
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
State
FL
AL
GA
SC
HI
VT
ME
TN
AK
WA
NC
TX
KS
MT
VA
OK
NV
LA
MS
1986
Per Capita
Revenue
$37.28
34.38
31.99
30.64
28.11
27.37
26.86
25.92
25.42
21.78
21.29
20.93
18.20
17.27
16.89
15.73
14.66
13.91
13.48
State
AK
SD
GA
HI
TX
V A
MD
ID
ND
WV
UT
NE
MO
BZ
KY
OR
ME
LA
WA
1986
Revenue/
Personal
lncome
0.32%
0.29
0.28
0.26
0.23
0.23
0.23
0.21
0.1 9
0.1 6
0.1 6
0.1 6
0.15
p34
0.13
0.13
0.12
0.1 2
0.12
State
FL
AL
G A
SC
HI
VT
ME
TN
AK
WA
NC
TX
KS
MT
V A
OK
NV
Az
LA
MS
KY
MN
SO
MA
NM
PA
NH
AR
NY
MI
UT
CT
ID
NE
ND
WI
IL
D E
RI
N J
CO
IN
OH
MD
wv
I A
C A
MO
OR
WY
US
Tax Plan A*
Per Capita
Revenue
$37.28
34.38
31.99
30.64
28.1 1
27.37
26.86
25.92
25.42
21.78
21.29
20.93
18.20
17.27
16.89
15.73
14.66
Ms!u
13.91
13.48
13.01
12.19
12.16
12.13
12.01
1 1.36
10.73
10.56
10.50
10.32
10.03
10.03
9.56
9.14
8.56
8.32
7.98
7.95
7.91
7.69
7.29
6.62
6.49
6.29
5.67
5.20
4.96
4.90
4.01
2.82
$1 3.78
Tax Plan A*
Revenue1
Personal
State Income
AK 0.32%
SD 0.29
GA 0.28
HI 0.26
TX 0.23
V A 0.23
MD 0.23
ID 0.21
ND 0.19
BZ u
WV 0.1 6
UT 0.1 6
N E 0.1 6
MO 0.1 5
KY 0.13
OR 0.13
ME 0.12
LA 0.12
WA 0.12
NY 0.1 1
TN 0.1 1
NH 0.1 0
C A 0.1 0
AL 0.1 0
AR 0.10
VT 0.10
MS 0.09
IL 0.09
RI 0.08
MN 0.08
MI 0.07
NJ 0.07
OH 0.07
NV 0.07
NC 0.07
WY 0.06
FL 0.06
SC 0.06
D E 0.06
WI 0.06
IN 0.05
I A 0.05
CT 0.05
OK 0.05
NM 0.04
KS 0.04
MA 0.04
MT 0.04
PA 0.03
CO 0.03
US 0.1 0%
'Note: Assumes increase in beer tax of 1 Oelgallon.
TABLE 17
STATE EXCISE TAX RATES ON BEER AND CIGARETTES: 1988
Cigarette Rate* Beer Rate
SU.tSa.t eM aenddi aRne. ..g...M.... .......................................................... .$.I8 .$.I6
New England
Connecticut ............................................................... . 26 .10
Maine ......................................................................... . 28 .35 Massachusetts. ......................................................... .2 6 .1 1 New Hampshire ........................................................ .1 7 .30 Rhode Island ............................................................. .2 7 .06
Vermont ..................................................................... . 17 .265
Mideast
Delaware ................................................................... . 14 .06 Washington. DC ........................................................ .1 7 .08
Maryland .................................................................... . 13 .09
New Jersey ................................................................ . 27 .03 New York ................................................................... .2 1 .055 Pennsylvania. ............................................................ .1 8 .08
Great Lakes
Illinois ....................................................................... . 20 .07
Indiana ...................................................................... . 155 . 115
Michigan .................................................................... . 21 .20
Ohio .......................................................................... . 18 .08
Wisconsin .................................................................. . 30 .06
Plains
Iowa .......................................................................... . 34 .19
Kansas ...................................................................... . 24 .18
Minnesota ................................................................. . 38 .15
Missouri ..................................................................... . 13 .06
Nebraska ................................................................... . 27 .23 North Dakota. ............................................................ .2 7 .16 South Dakota. ............................................................ .2 3 .27
Southeast
Alabama ................................................................... 1 . 165 1.05
Arkansas ................................................................... . 21 .16
Florida ....................................................................... . 24 * .48
Georgia ...................................................................... . 12 .32 Kentucky ................................................................... .0 3 .08
Louisiana .................................................................. . 16 .32
Mississippi ................................................................. . 18 .43 North Carolina ........................................................... .0 2 .53 South Carolina .......................................................... .0 7 .7 7
Tennessee ................................................................. . 13 . 125
Virginia ...................................................................... . 025 .26 West Virginia. ............................................................ .1 8 .18
Southwest
Arizona ..................................................................... . 15 .16
New Mexico. .............................................................. .1 5 .18
Oklahoma .................................................................. . 25 .36
Texas ......................................................................... . 205 .19
Rocky Mountain
Colorado .................................................................... . 20 .08
Idaho ......................................................................... . 18 .15
Montana .................................................................... . 16 .14
Utah .......................................................................... . 23 .355
Wyoming ................................................................... . 08 .19
Far West
California ................................................................... -35 .04
Nevada ...................................................................... . 20 .09
Oregon ...................................................................... . 27 .085
Washington ............................................................... . 31 . 09
Alaska ....................................................................... . 16 .35
Hawaii ........................................................................ 40% .50
*Note: State tax rates are in addition to the federal tax of $.16.
Source: Cigarette data: AClR staff compilations from Commerce Clearing House. State Tax Review . Beer data:
AClR staff compilation from Public Revenues from Alcohol Beverages. 1986.87. Distilled Spirits Council of the United
States. Inc . . unpublished compilation from the Wine Institute. San Francisco; Commerce Clearinghouse. State Tax
Reporter. Sales Taxation: State and Local Structure and Administration. John F . Due and John L . Mikesell. Johns
Hopkins University Press. 1983 .
TABLE 18
STATE RANKINGS FOR
TOBACCO PRODUCTS TAX REVENUES
Rank State
1 ME
2 NH
3 RI
4 MA
5 NJ
6 CT
7 OR
8 NY
9 NV
10 AR
11 W1
12 I A
13 FL
14 KS
15 MN
16 WA
17 MI
18 Ib
19 OK
20 TX
2 1 VT
22 AL
23 SD
24 MS
25 MO
26 PA
27 DE
28 N E
29 HI
30 LA
31 WV
32 ND
33 TN
34 OH
35 MT
36 CO
37 A2
38 GA
39 MD
40 AK
41 IN
42 NM
43 ID
44 C A
45 WY
46 SC
47 UT
48 V A
49 KY
50 NC
US
1986
Per Capita
Revenue
$32.13
31.87
30.14
29.56
28.1 1
27.57
27.40
27.03
26.96
26.61
26.57
25.35
24.50
24.12
24.06
23.99
23.93
23.56
22.78
22.70
State
ME
AR
MS
NH
RI
OR
WI
AL
I A
NV
SD
OK
VT
FL
MA
WV
MI
KS
WA
MN
TX
NY
NJ
LA
IL
MO
TN
1986
Revenuel
Personal
Income
0.27%
0.26
0.23
0.22
0.22
0.22
0.20
0.20
0.20
0.19
0.1 9
0.1 9
0.1 9
0.1 8
0.1 8
0.1 8
0.1 8
0.1 8
0.17
0.1 7
0.1 7
0.1 7
0.1 6
0.1 6
0.1 6
0.1 6
0.15
0.15
0.15
0.14
0.14
0.14
0.1 4
0.14
0.13
Q,l2
0.1 2
0.1 1
0.1 1
0.1 0
0.09
0.09
0.08
0.08
0.08
0.07
0.06
0.05
0.04
0.02
0.1 4%
State
ME
NH
Ri
MA
NJ
Tax Plan A*
Per Capita
Revenue
$32.13
31.87
30.14
29.56
28.1 1
27.57
27.40
27.03
26.96
26.61
26.57
25.35
24.50
24.12
24.06
23.99
23.93
23.56
22.78
22.70
22.33 ais
21.21
21.14
20.67
20.43
19.64
19.42
19.31
18.59
18.44
18.42
17.51
17.1 0
17.03
16.04
15.59
15.1 1
15.00
14.55
13.75
9.98
9.87
9.62
9.35
8.88
7.91
6.36
4.91
2.62
$1 9.29
State
ME
AR
MS
NH
RI
OR
WI
AL
I A
NV
SD
OK
VT
FL
MA
WV
MI
KS
BZ
WA
MN
TX
NY
NJ
LA
IL
MO
TN
CT
PA
MT
N E
ND
D E
HI
OH
GA
IN
CO
MD
NM
ID
SC
AK
UT
WY
C A
KY
V A
NC
US
Tax Plan A*
Revenuel
Personal
Income
0.27%
0.26
0.23
0.22
0.22
0.22
0.20
0.20
0.20
0.1 9
0.1 9
0.1 9
0.19
0.1 8
0.1 8
0.1 8
0.1 8
0.1 8 Q,lz
0.1 7
0.17
0.17
0.17
0.1 6
0.1 6
0.16
0.1 6
0.15
0.1 5
0.15
0.14
0.1 4
0.14
0.14
0.14
0.13
0.12
0.1 1
0.1 1
0.1 0
0.09
0.09
0.08
0.08
0.08
0.07
0.06
0.05
0.04
0.02
0.14%
*Note: Assumes inc :rease in cigarette tax of I Otlpack.
Table 17 presents a 1988 comparison of cigarette tax rates across all states.
With a rate of 25@ per pack proposed in Plan A, Arizona would have the 17th
nighest tax rate on cigarettes.
General Issues - Luxury Tax (Plan A)
Most analyses of expenditure profiles reveal that cigarette and beer taxes are
regressive (lower income earners bear a higher burden - rate of tax as a percent
of income). At the same time, it is easy to demonstrate the high costs that
excessive consumption of beer and cigarettes can impose on society. Revenues
raised by taxing these items can help offset some of these higher costs.
Luxury taxes such as those proposed in Plan A provide an opportunity for
nonresident visitors to the State to pay for services provided by State
government. Unfortunately, no data on nonresident consumption of beer and
cigarettes is currently available. We have assumed in our analysis that the
burden of the tax is borne by Arizona residents -thus overstating the actual
resident burden of the luxury tax increase. Of course the employment effects that
occur as a result of the tax would not be affected by distinguishing resident and
nonresident consumers.
Plan A - Corporate Income Tax
Background - Water's Edge Definition
The provisions of the Arizona Tax Code that are to be affected by the
proposed change in the Arizona definition of "water's edge" for establishing
corporate liability are discussed in a recent memo drafted by an analyst of the
Arizona Department of Revenue:
80120 Corporation -A company incorporated in the United
States and taxed through the Internal Revenue Code. The
U.S. and most states also define it as a company with 80
percent or more of its property, payroll, and sales in foreign
countries. Arizona defines it as a company deriving 80
percent or more of its gross revenues from foreign countries.
"Possessions" Corporation - defined in IRC Section 936
as a company incorporated in the United States that derives
80% or more of its gross revenues from a U.S. Possession
(Puerto Rico, etc.). Arizona uses the IRC definition. This
corporation is taxed through the Internal Revenue Code.
Under Arizona law (ARS Section $43-1 132). A combined
return is a group of corporations that operate as a single,
unitary business. Since 80120 and Possessions corporations
are often part of a unitary business, their incomes are not
subject to Arizona tax. Therefore a business could legally
structure itself so that profits from foreign sales could escape
Arizona taxation, even though the sales force and a portion
of the sales offices are located in the US.
Further, the statutes require that any expenses attributable to
income from an 80120 or Possessions corporation that may
be in the remaining Arizona return must be removed (ARS
Section $43-1 132). Such expenses could include research
and development and accounting, legal, and pension
expenses. However, it presents a difficult audit situation to
determine the exact amount and is generally not being done
on the returns when filed.
The "water's edge" debate has raged at two levels among states that levy
corporate income taxes. The primary debate involves early 1980 attempts by
several states to require that combined "worldwide" income appear on the state
corporate return. Tax liability of a multi-national corporation in each state that
ad~piedsu ch a "worldwide" combination provision was established by comparing
the personnel, property and payroll that the firm maintained in the state with the
"worldwide" profits of all its affiliates. Originally twelve states - labeled the "dirty
dozen" by multi-national corporations - experimented with "worldwide" combining.
Arizona, along with the remaining states, "piggy-backs" the Federal Corporate tax
code and therefore does not allow "worldwide" combining. Recently, all but one
of the twelve states that originally experimented with "worldwide" combining of
corporate income have liberalized their corporate tax structure so as to define a
"water's edge" to the state tax liability of a multi-national corporation.
While the debate over worldwide combinations was underway, domestic
corporations sought an opportunity to reduce their state liabilities by seeking
exclusion of "80120 income" or "possession" income defined in the memo. Along
with this effort in 1985 the State of Arizona began exempting the net income of
"80120" or "possessions" corporations. This exemption places Arizona in a
position that is yggy favorable to large multi-national corporations that have the
capacity to benefit from "80120" exclusions. The best example of a firm that
enjoys the benefits of this statute is a "Fortune-500" conglomerate that operates
in Arizona. Foreign sales from this firm are channeled through a separate
corporation that is also typically a member of the conglomerate. Practical
examples of firms that fit this example in Arizona are "high-tech" multi-nationals
such as Motorola, Digital, Intel, etc. Due to confidentiality restrictions we are not
able to confirm that these types of conglomerates do indeed benefit from the
"80120" provision. However, it is common knowledge that IBM lobbied actively for
"80120" exclusions in 1985. Hence, we will presume that the affected firms are
mainly engaged in "high tech" or other forms of manufacturing. Financial service
firms would then typically be affected.
As the memo indicates, these firms benefit from the "80120" or "possessions"
provision since virtually all costs of production can be used to offset taxable
domestic profits while considerable net foreign income is exempted by the "80120"
or "possessions" provision. No assistance is provided by IRS corporate auditors
in clarifying this situation since the "80120" or "possessions" firm is treated as
"domestic" by the IRS and all income is subject to taxation.
The provision regarding the deduction of Foreign Tax Credits ARS $43-1 122.4
is discussed in a recent memo written by an analyst of the Department of
Revenue.
This Law allows a deduction on the Arizona return for that
portion of the federal Foreign Tax Credit used to offset the
federal income tax liability if the foreign income generating
the tax credit is taxed by Arizona.
Apparently this section was an attempt to incorporate the
Arizona Appeals Court's Anderson-Clayton Decision into the
Law. If so, it was inadequate and the federal tax deduction is
still computed under the guidelines of that case. The
Anderson-Clayton case required the amount of Foreign Tax
Credit used to reduce the federal income tax liability to be
added back to the net federal liability when computing the
federal tax deduction for Arizona income tax purposes. This
allows a portion of the Federal Foreign Tax Credit to flow
through as part of the federal tax deduction. The direct
deduction of Foreign Tax Credit provided in 943-1 122.4 is
also allowed, this provides a double deduction of the Foreign
Tax Credit if the intent was to compute the correct federal tax
deduction under the Anderson-Clayton Formula.
Another rationale of this section is that it provides a
deduction of related expenses if Arizona Taxes foreign
income.
Section $43-1 121.3 disallows the deduction of all income
taxes paid to other states or foreign countries based on the
premise that all income generating those taxes is
apportioned outside Arizona.
With the adoption of UDiTPA apportionment factors in 1984,
the foreign income generating the Federal Foreign Tax
Credits is effectively apportioned outside Arizona. With this
foreign income no longer taxed by Arizona, the deduction of
the related Foreign Tax Credits is not justified.
The "double-counting" referenced in the memo could occur in the following
manner. A multi-national firm can deduct a portion of the foreign credit (the
proportion determined by the multi-state apportionment formula) on Line B6 of the
corporate form. In addition the "Arizona portion" of Federal corporate income tax
is deducted on line 16. This Federal tax burden would typically not be "net" of
foreign credits obtained on the Federal form. Hence, a multinational corporation
may obtain a deduction twice - once directly via line B6 and second indirectly
through the Federal tax deduction.
As indicated above our access to detailed corporate data is restricted to
protect the confidentiality of each firm. However, it is obvious that the initial effect
of this tax will be felt by multinational corporations that file Arizona Corporate
lncome Tax returns.
Tax Proposal - Corporate lncome Tax (Plan A)
Remove the 80/20 exclusion, the Possessions exclusion and the Foreign Tax
Credit from the Arizona Corporate lncome Tax Code. The economic impact of
these taxes assumes that the current provisions yield 10 million dollars in FY
89/90 corporate liability.
Economic Impact - Corporate lncome Tax (Plan A)
As noted above, eliminating the 80/20 exclusion, the Possessions exclusion,
and the Foreign Tax Credit will generate $1 0 million in tax revenues which, in
turn, reduces corporate income by the same amount. As shown in Table 2, in this
report it is assumed that corporate income taxes are not shifted forward to
Arizona consumers. This assumption is