Joint Task Force on Income Tax Reform

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ARIZONA STATE LEGISLATURE

Fifty-first Legislature – First Regular Session

JOINT TASK FORCE ON INCOME TAX REFORM

Minutes of Interim Meeting

Wednesday, August 21, 2013

House Hearing Room 1 – 1:30 p.m.

Co-Chairman Mesnard called the meeting to order at 1:39 p.m. and attendance was noted by the secretary.

Members Present

Senator Steve Yarbrough, Co-Chairman	Representative Javan D. Mesnard, Co-Chairman
Senator Kelli Ward (by phone)	Representative Debbie Lesko
Barry Broome	Representative Bruce Wheeler
Kevin McCarthy	Jim Rounds
Farrell Quinlin	Steven Slivinski
Aimee Rigler	Peggy Ullmann

Members Absent

Senator Steve Farley (excused)

Co-Chairman Mesnard stated that Arizona has made a lot of changes over the last few years regarding tax reform. The scope of changes included transaction privilege tax (TPT), capital gains, corporate income taxes and property taxes. In order to make Arizona as “business friendly” as possible, the goal of the Committee is to review the personal income tax system, under which most small business owners file. The Committee is made up of small business owners, economists, tax experts and elected officials. Co-Chairman Mesnard cited that other states have changed their personal income tax systems to make them simple, more transparent, consistent and predictable. The Committee will meet every other week through December 2013 with public testimony taken at the end of every meeting.

Co-Chairman Yarbrough explained that he has been in office for 11 years and has seen many accomplishments in the advancement of Arizona’s business climate. He highlighted major changes in the Arizona tax system and stated that to reform the personal income tax system and still create appropriate revenue for the legitimate role of government without sacrificing other goals, will be a challenge.

INTRODUCTION OF MEMBERS

Representative Debbie Lesko, Chairman, Ways and Means Committee, stated that she is interested in hearing the pros and cons of this issue.

Representative Bruce Wheeler, representing District 10 in Tucson, expressed the intent to develop a fair outcome that will not result in tax increases.

Jim Rounds, Senior Vice President, Elliott D. Pollack and Company, communicated that he has been working with different groups on economic development and reform, including tax policy, and he is looking forward to working on final tax issues that have not yet been addressed, like the individual income tax.

Stephen Slivinski, Senior Economist, Goldwater Institute, stated he is looking forward to working on this last piece of the tax puzzle.

Kevin McCarthy, President, Arizona Tax Research Association (ATRA), commented that he has been involved in many of the previous tax reforms and looks forward to working on this issue.

Aimee Rigler, Executive Director, Small Business Alliance AZ, stated her organization represents over 600 members.

Peggy Ullmann, Arizona Society of Certified Public Accountants (CPAs), stated that she represents CPAs who assist businesses and individuals in filing returns. She added that CPAs promote tax simplification and good tax policy.

Farrell Quinlan, State Director, National Federation of Independent Business, noted that there are 7,500 small business members in the state, the vast majority of which file as individuals, partnerships, limited liability companies (LLC) and S Corporations, so this is an important topic.

Barry Broome, President and CEO, Greater Phoenix Economic Council, stated that he worked on two major jobs packages with the Governor and Legislature and he is interested in improving Arizona’s competitive position.

Senator Kelli Ward (appearing by phone) stated she looks forward to working on the Committee.

PRESENTATIONS

History of Arizona’s Individual Income Tax System

Jon Stall, Joint Legislative Budget Committee (JLBC), explained that the individual income tax (IIT) is a substantial source of income to the General Fund (GF). It provided over $3.4 billion in Fiscal Year (FY) 2013, which made up over one-third of the total amount of the GF’s base revenue. He defined who pays the taxes: individuals, fiduciaries of estates, trusts, owners of pass-through entities, sole proprietorships, partnerships, LLCs and S Corporations
(Attachment 1). Mr. Stall continued with the overview relating to calculating Arizona’s IIT, legislative milestones, history of the IIT system and IIT revenue reliability.

Mr. Broome asked the definition of a capital gains tax. Mr. Stall answered that it is the sale of an asset and any gain over the original purchase price of that asset is subject to a capital gains tax. Beginning in 2013, it only applies to assets purchased after 2011, such as securities, real estate and a personal home. Mr. Broome then stated that there seems to be a lot of volatility in tax income and questioned if it is tied to the type of tax or the type of economy and whether tax trends in other states are as volatile as in Arizona. Mr. Stall responded that he has not conducted a state-by-state analysis, which can be done.

Co-Chairman Mesnard indicated that Mr. Broome’s query as to whether volatility in tax income is tied to the type of tax or the type of economy can possibly be reviewed in a future meeting.

Sean Laux, Chief Liaison and Public Information Officer, Arizona Department of Revenue (ADOR), clarified that the sale of a personal home is not a capital gain, it is treated as a gain. Capital gain is income derived from the sale of a non-depreciable asset, with some exceptions.

Arizona Individual Income Tax Returns

Sean Laux, Chief Liaison and Public Information Officer, Arizona Department of Revenue (ADOR), reviewed Arizona IIT returns (over 2.5 million filed per year) and IIT enforcement efforts, which in FY 2013 involved 65,000 audits and $30 million in audit assessments, and resulted in $21 million in collections (Attachment 2, Pages 1-2).

Karen Jacobs, Economist, Arizona Department of Revenue (ADOR), gave an overview of state and federal data obtained from IIT tax returns (Attachment 2, Pages 3-4).

Ms. Jacobs answered Co-Chairman Mesnard’s questions relating to the use of federal data by stating that state and federal data is used to simulate changes in state tax law, state tax liability and federal tax law and for providing a total overall impact for Arizona taxpayers and the Federal Adjusted Gross Income (FAGI) bracket impact level. If something other than FAGI is used as a starting point to define income, she said she does not know what kind of data could be obtained from the Internal Revenue Service (IRS). An advantage of having FAGI as a starting point is that an additional data set can be used to deal with compliance for the Arizona state tax.

Mr. Laux added that even if ADOR did not use FAGI as the starting point, taxpayers would still have to calculate that number, so decoupling would have that disadvantage. Also, Title 43, Arizona Revised Statutes, would have to be rewritten to provide definitions.

Ms. Jacobs continued with the overview relating to the IIT model, noting that tax credits are not included, and a summary of state and federal IIT data and sources (Attachment 2, Page 6).

Mr. Rounds questioned, if Arizona is looking at other states and competitors, whether only nominal rates can be obtained or if effective rates can also be obtained. He said every state is different and wondered if it is possible to develop effective rates and whether documents are available to compare apples to apples. Mr. Rounds added that, given the limited data that is available due to the different tax laws, it may be helpful to develop a checklist of what would be optimal and check off what ADOR has and does not have. Ms. Jacobs replied that ADOR has a few reports from which she can provide summary information on effective tax rates, whether it is based off the FAGI or taxable income.

Mr. McCarthy advised the Committee of a national study composed by the Minnesota Center for Fiscal Excellence that addresses various income levels and filers with effective tax rates that he can provide. When asked if the study delineated individual components versus small business, Mr. McCarthy responded that he does not believe it did.

Ms. Jacobs completed the overview relating to federal source of income (SOI) data and ADOR reports (Attachment 2, Pages 6-8). She referenced a handout that summarizes the types of information collected by ADOR from IIT tax statistics from Arizona residents in Tax Year 2011, and information from ADOR’s Tax Expenditure Report, including tax credits for Tax Year 2010 (Attachment 3). She added that ADOR also compiles a more detailed tax credit report.

Co-Chairman Mesnard stated, after reviewing the first page of the handout (Attachment 3), that the information pertaining to income level could be useful in deciding how any changes that are contemplated may impact the first few categories.

Co-Chairman Mesnard recognized Secretary of State Ken Bennett in the audience.

The Process of Filing Your Personal Income Taxes in Arizona

Peggy Ullmann, CPA, Ullmann & Company, commented that while a flat tax is simplistic, it often creates economic results that could be less than desirable. Compared to other states, Arizona’s IIT collections are pretty favorable; corporate rates are average, IIT rates are a bit lower and the sales tax is higher. Ms. Ullmann gave an overview of a federal Form 1040 with six common types of income and typical itemized deductions (Attachment 4).

Ms. Ullmann reviewed income tax returns from four states; Arizona, Utah, North Carolina and California using an income figure of $77,000 (Attachment 5). She mentioned the recent change North Carolina made by reducing its state income tax rate to a flat rate of 5.8 percent in 2014 and 5.75 percent in 2015; however, that flat rate is higher than Arizona’s highest graduated rate that affects only income over $300,000. She continued with a review of IIT Common Arizona Adjustments (Attachment 6) and calculation of the numbers in the income tax forms for the four states (Attachment 7). She discussed the fact that North Carolina allows a deduction for business income up to $50,000, which is favorable to business and distinguishes a wage earner from a self-employed individual.

Discussion ensued on the health of Utah’s economy based on its flat tax rate.
Co-Chairman Mesnard clarified points of discussion that Utah is wealthier overall and the economy is doing better, while Representative Wheeler’s concern is not to use that as an excuse to raise taxes on lower-income individuals in Arizona. Mr. Broome maintained that a flat tax creates consistency.

Co-Chairman Mesnard questioned Mr. Laux about auditing and whether making Arizona’s tax code simpler will result in fewer audits and more compliance. Mr. Laux responded that audits are performed for many reasons, some of which are minor. He surmised that the complexity lies with federal versus state compliance since FAGI is the starting point and there are not a significant number of additions and subtractions in Arizona code to get to the state taxable income. There is some complexity with passed rules on special bonus depreciation and other expenses but, by and large, complying with Arizona’s income tax system is not more difficult than complying federally.

Tax Policy and Competitiveness

Stephen Slivinski, Senior Economist, Goldwater Institute, discussed Arizona’s economic growth potential of varying tax regimes and potential policy outcomes and routes in relation to other states (Attachment 8). He questioned whether to tax consumption or savings/investments, if the rate structure should be a flat or graduated tax and principles of tax policy (simplicity, fairness, neutrality and competitiveness). He said Arizona is in competition with Hong Kong, western states, Kansas and North Carolina. He continued with an overview of conclusions of economic literature, related studies and tax data for Arizona and other states. In conclusion, he communicated that income taxes inhibit economic growth and potential. Flat taxes are preferable to graduated-rate income taxes, but absence of an income tax is preferable to either. He added that other states are beginning to move faster on tax reform than Arizona.

COMMITTEE DISCUSSION

Mr. Rounds commented that the presentations touched on his questions about effective rates. For future meetings, he asked if documentation is available showing the impact of IIT rates on a small business, suggested a review of the current high consumption tax, discussion of the appropriate way of taxing, how to build the economy in terms of business development, what it is going to cost and what can be passed in the Legislature.

Co-Chairman Mesnard stated that the Members should have at least one more informational meeting before discussing goals.

Ms. Ullmann provided a handout for reference, State Business Tax Climate Index 2013, which lists ranking, by state, of five component taxes (Attachment 9).

Mr. McCarthy stated that much time could be spent comparing Arizona to other states but cautioned the Members about the information that is used. He indicated that he prefers the study on income taxes he mentioned earlier because it addresses effective tax rates.

Further ideas were discussed to address in future meetings such as tax volatility in relation to sustainability issues in the economy, like dependency on housing and construction, data on reducing the IIT for S Corporations, the role of the Marketplace Fairness Act, if passed, philosophy, implementation, definitional clarity, and the importance of IIT when attempting to attract businesses.

Co-Chairman Mesnard thanked the Committee Members for their time and stated his goal is to be revenue neutral. He said he is looking for practical, incremental ways to improve the income tax system. Co-Chairman Mesnard advocated not basing Committee decisions on whether the Marketplace Fairness Act is passed by Congress, although the Committee can evaluate its utility. He mentioned a position statement from Children’s Action Alliance (Attachment 10), noting that if the concern is that taxes will be increased for the poor, that is not the intent. He added that the next meeting is set for Wednesday, September 4, 2013, at which a guest from Utah will speak.

Without objection, the meeting was adjourned at 3:45 p.m.

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Tracey Gardner, Committee Secretary

August 28, 2013

(Original minutes, attachments and audio on file in the Office of the Chief Clerk; video archives available at http://www.azleg.gov)

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JOINT TASK FORCE ON INCOME TAX REFORM

August 21, 2013

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