Tax cut and school vouchers are not causing Arizona's budget shortfall, analysts say

[Leroy N. Soetoro]

https://www.azcentral.com/story/news/politics/arizona/2024/01/12/lack-of-
tax-revenue-led-to-arizona-budget-shortfall-analysts-say/72193503007/

Arizona's budget went from flush to broke in just a few months, forcing
lawmakers to start the new year's session by clawing back previous
expenditures and preparing for more painful cuts ahead.

Democratic Gov. Katie Hobbs signed the bipartisan, $17.8 billion balanced
budget in May after negotiating with Republican leaders. The state's 90
lawmakers were playing with a roughly $2 billion surplus back then that
included leftover federal pandemic money, and each was given tens of
millions of dollars to spend as they saw fit.

The surplus party ended in October, according to the state's Joint
Legislative Budget Committee, which makes the revenue predictions.
Smaller-than-expected collections of tax revenue unbalanced it, leaving
the state with a likely $835 million deficit this fiscal year, which began
July 1, and an estimated $879 million deficit for next year, according to
numbers released Friday. The new numbers reflect a deficit that's about
twice as large as a previous estimate from October.

Hobbs' office released more optimistic numbers Friday in her new budget
proposal, showing deficits of $464 million in this year's budget and $890
million in fiscal year 2025.

Why does the state budget have a deficit?
Part of the recipe for the yearly state budget includes a heap of
predictions for how much money the state will make in tax collections. The
money needed for the desired expenditures wasn't all there in May, when
Hobbs signed the budget, but was expected to come in. Hobbs and lawmakers
spent all but $10 million of what they thought they had, which was $17.8
billion.

Actual tax collections and new forecasts show much smaller revenues.
Overall, revenues for fiscal year 2024 are down 9.3% as of November
compared with last year, according to a December report by JLBC.

Income tax collections declined the most, plummeting to about 28% less
than collected by the same time last year fiscal year, JLBC data shows.
Capital gains taxes were down, sales tax collection was slower than
anticipated and corporate income taxes started off the year strong but
have declined.

How did forecasters get it so wrong?
Predicting a state's fiscal future isn't easy, especially when a new tax
rate emerges.

To make the forecast, JLBC takes in data from an 11-member advisory
committee, two predictive models from the University of Arizona, and input
from JLBC staff, then averages the totals to come up with the numbers
lawmakers use to plan the budget.

The process grew more complicated last year. Then-Gov. Doug Ducey, a
Republican, signed a tax cut into law in 2021 that gave most taxpayers a
single, 2.5% flat tax rate. The tax rates previously ranged from 2.59% to
8%. The cut went into full effect in 2023.

The state-based revenue forecasts for the cut on Department of Revenue tax
returns from 2019 were "extrapolated forward," Richard Stavneak, JLBC
director, said at the Arizona Tax Research Association presentation in
October.

The current fiscal "bleeding" seems partly due to many residents delaying
when they filed their taxes, he said.

Forecasters were also looking at slightly better economic conditions back
in May, when general fund revenue was up nearly 2% over the previous year.
They at the time gave overly rosy predictions of future available funds
that lawmakers used to create the 2024 state budget.

By July, a JLBC report shows, state analysts realized they had
"significantly" understated the expected decline in income tax revenue due
to "lower payments and more refunds issues."

Is the state's 2021 tax cut responsible?
Pew Charitable Trusts, which published the 2023 report “Tools for
Sustainable State Budgeting” this year, said in a Jan. 11 news release
that the deficit in Arizona is "mainly due to the increased costs of
expanding a voucher program and a tax cut that took effect last year." The
Associated Press published an article on Jan. 5 with a similar headline,
blaming vouchers and the tax cut for the shortfall.

Josh Goodman, who researches fiscal management and long-term budget
sustainability for Pew, acknowledged in a Jan. 11 interview that Pew
didn't analyze the shortfall's cause. But it's clear Arizona is one of
several states that made policy decisions such as reducing taxes and
increasing spending based on the surplus of pandemic money, he said.

While the tax cut reduced the income tax revenue the state could collect,
the JLBC incorporated that lesser amount into its budget forecasts, and
lawmakers set their spending policy based on how much money JLBC said was
available.

Had the state not enacted the tax cut, it probably would still be seeing a
budget shortfall because the Legislature typically spends all of the money
it has in its yearly budget, said local economist Alan Maguire.

Are private school vouchers breaking the budget?
Not for this fiscal year. The cost of the newly expanded Empowerment
Scholarship Accounts was higher than expected by about $78-100 million in
this year's budget, the JLBC and Hobbs' office reported Friday. The extra
money isn't part of the budget shortfall but will be absorbed in the
overall K-12 budget.

The number of students in the program is currently 73,200. But for fiscal
year 2025, the number of students in the program will rise to at least
82,000, meaning the program will cost an additional $100 million or more.

But ESA costs for this year and next aren't solid because analysts don't
know how many students will sign up and where the students are coming
from. Each participating student gets an average tuition reimbursement of
$7,000 per year, which in theory can result in savings when students
switch from a public to a private school.

But as a July Arizona Republic article reported, the savings may only be
realized if a student moves to a private school from a charter school.
Some Democrats who opposed the expansion, which made all Arizona students
eligible for the vouchers, said it would soon lead to a runaway budget
crisis.

When will Arizona get back on the right fiscal track?
JLBC's updated forecast on Friday showed that if current predictions are
correct, the deficit will shrink in fiscal years 2026 and 2027, to $420
million and $187 million, respectively. Its October forecast showed a
surplus in 2027.

The update warns that forecasts will change again as more actual revenue
trickles in. The projections could change based on the spring 2024 income
tax-return season, updated ESA estimates, and "revised Medicaid enrollment
as individuals lose eligibility under the pandemic rules."

Republican leaders say the shortfall will be manageable. Maguire agreed,
saying that it's a relatively small percentage of the entire state budget
and that Arizona is in better shape than many states.

Where will Hobbs cut?Arizona governor will roll out her second budget

Lawmakers are currently working to find cuts to the budget, Senate
President Warren Petersen said. Details of what legislators are cutting
are still under wraps, though lawmakers have said roadwork projects not
begun yet are likely to be delayed.

Neither Hobbs nor Petersen believe the state should cover the shortfall by
tapping into its rainy day fund, which has about $1.5 billion in reserves.

To Petersen and other conservatives, cutting the size of government is "a
good and healthy thing to do," he said.

"We can make government more efficient and lean," he said, adding that he
hopes to protect education, public safety and transportation.

Hobbs' proposed budget suggests the state balance spending over the next
few years by eliminating planned road, capital and computer projects, and
by transferring funds from various state boards to the general fund.

She also hopes to save nearly half a billion dollars by restricting
participation in the ESA program and eliminating tax credits for public
school tuition, two programs that Republicans are not likely to yield on.

Can bipartisanship happen?Hobbs, Republican majority must coexist for one
more session

Reach the reporter at rst...@arizonarepublic.com or 480-276-3237. Follow
him on X @raystern.


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