Tax Reform

Income Tax Increase Threatens Arizona’s Economic Competitiveness

This November, Arizona voters will decide one of the most important income tax issues to face their state in recent memory. Proposition 208 would increase  Arizona’s top personal income tax rate from 4.5% to 8% — an increase of 78% — and give Arizona the ninth highest top personal income tax rate in the nation. This would raise taxes by nearly $1 billion, which supporters believe will be spent on the state public school system.

Such a tax increase threatens to slow Arizona’s new growth and investment following the 2008 recession. Arizona currently has the lowest personal income tax rate of any surrounding state except Nevada, and this competitive edge is responsible for bringing in Arizona’s new-found wealth. If the top income tax rate becomes 8%, Arizona’s economic growth hangs in the balance.

While all taxes harm growth, personal income taxes are among the most pernicious forms of taxation. According to studies that differentiate between various forms of taxation, personal and corporate income taxes are the most harmful to long-term economic growth. In fact, Organization for Economic Cooperation and Development (OECD) scholars found a 1% decrease in income tax burden led to an expected 0.25% to 1% increase in gross domestic product (GDP) per capita between 1971 and 2004. This increase in economic growth from cutting income taxes holds true conversely – raising income taxes hurts economic growth.

The OECD study examined the damage caused by income taxes in national economies, but the negative effects of income taxes become more pronounced in an open system like the 50 state economies. Taxpayers increasingly move between states to avoid anti-growth economic policies like a high personal income tax.

The Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index measures how competitive state economies are relative to each other in 15 policy variables proven to generate economic growth. The report’s co-author and ALEC Chief Economist Jonathan Williams had this to say about nearly doubling Arizona’s top income tax rate:

“Increasing the personal income tax rate in Arizona would take a devastating toll on economic health. Imposing the $1 billion income tax increase on individual and small business taxpayers would lead to a shocking erosion in Arizona’s Economic Outlook; from 10th best today all the way down to 20th. Americans continue to vote with their feet across state lines, and they are voting strongly in favor of low-tax states creating a free market environment conducive to economic growth and opportunity. A massive increase in income tax burdens would significantly erode Arizona’s economic competitiveness.”

In context, Utah, Nevada, Texas and Colorado, ranked 1st, 4th, 15th and 18th, respectively, would each have a more competitive economy than Arizona. An 8% top personal income tax rate would make Arizona less competitive than nearly every state in its region for new investment and job creation.

California, with the highest top personal income tax rate of any state at 13.3%, has seen over 810,000 residents leave for other states on net over the past decade according to the ALEC Rich States, Poor States report. University of California, Berkeley polling finds more than half of California voters polled had thought about leaving California for another state. Of the voters polled, 58% cited high taxes as their motivation for wanting to move.

Arizona has been the third largest recipient of former Californians, behind Nevada and Texas, with nearly $12 billion in annual adjusted gross income (AGI) coming to Arizona from California since 1992. Nevada, Texas and Washington (the fifth largest destination of Californian expats) all have no personal income tax. Arizona’s current rate of 4.5% is one of the clearest arguments in favor of relocation from a high-tax state to Arizona. In addition to California, Arizona has seen a combined $7.2 billion in annual AGI flow in from New York and New Jersey, states with the second and third highest top personal income tax rates, respectively.

If Arizona enacts the income tax increases in Proposition 208, Arizona will lose its competitive edge to these high tax states. With a top income tax rate of 8%, Arizona would have a higher top personal income tax rate than 41 other states and the second highest top rate in the region, behind California.

Proponents of Proposition 208 claim this tax increase all goes to education, but education spending is already reaching record levels in Arizona. Due to economic growth, Arizona’s tax receipts have increased by over 40% during the last five fiscal years, leading to increased funding for schools. Adjusted for inflation, the state’s portion of education funding has increased every year. For the first time ever, Arizona is expected to spend over $10,000 per pupil, more than the 50 state average. Increased education funding, despite its dubious effect on student achievement, has already been accomplished through a pro-growth, competitive economic policy and without tax increases.

All taxes have consequences for economic growth, but income taxes have the greatest consequences. Arizona is in a perfect position to continue its recent record of vigorous economic growth. With the 10th most competitive state economy and its adjacency to California’s hemorrhaging tax base, Arizona has experienced a steady stream of new investment and jobs.  If this initiative passes and Arizona’s income taxes increases, other states may begin to see benefits at Arizona’s expense.

In Depth: Tax Reform

Mainstream economists, small business owners and taxpayers across the country understand that growth-oriented reforms mean increased opportunity for all. As demonstrated by the annual Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index, sound tax and fiscal policies are critical to economic health, allowing businesses and households to flourish. A…

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