The state will soon have a flat 2.5% income tax, after flirting with 8%.
By The Editorial Board
Arizonans who fled California for sunnier tax climes can breathe easier after a court ruling that has saved the day from a punitive 8% top state tax rate.
A state judge on Friday struck down Arizona’s Proposition 208, which placed a 3.5% surtax on incomes above $250,000, or $500,000 for joint filers. The surtax passed narrowly in a 2020 referendum that sought to raise hundreds of millions of dollars for public schools. But the surtax would also have blown past the cap on education spending in the state constitution.
Nixing the surtax means Arizona will soon have a flat tax of 2.5% on individual incomes, the lowest flat rate among states with an income tax. Gov. Doug Ducey slashed the previous 4.5% top rate in his 2022 budget, and the flat 2.5% rate will phase in by 2024. If the 4.5% rate and the surtax had stayed in place, a combined 8% top rate would have given Arizona the 10th-highest state income tax rate.
Judge John Hannah hewed to the letter of the law in reviewing the surtax. “School district spending more likely than not will exceed the predicted spending limit in 2023,” he wrote. That’s an understatement. Invest in Arizona, the advocacy group behind the surtax, said its proposal would raise at least $253 million for schools that year, pushing spending far above the likely limit.
The state Supreme Court ruled last year that money raised by the tax couldn’t be rebranded as “grants” outside the spending cap, or be put aside to be spent later. It remanded the case for Judge Hannah to rule on the spending cap issue, and he said the constitution didn’t allow the surtax.
Arizona’s teachers union argued that ending the surtax would rob funding from hard-up school districts. State Superintendent Kathy Hoffman agreed after Friday’s ruling, asking “how will we remain competitive when our neighboring states have increased teacher pay?”
How many raises does she want? The courts held that the spending cap couldn’t be surpassed by referendum. But last month the Republican-controlled Legislature voted to suspend the cap temporarily, letting schools claim an extra $1.2 billion appropriated last year. Funding increases in recent years are on top of a 20% raise that Arizona teachers gained after striking in 2018.
Tax competition has helped Arizona draw residents and businesses from neighbors like California, but the surtax would have sent the Grand Canyon State down a Golden State path. The tax’s $250,000 income threshold made it a particular burden on small businesses that pay taxes under the individual code.
The episode is a reminder of the value of constitutional guardrails on state taxes and spending. Arizona voters in 1980 placed limits on school spending through a ballot initiative, preventing unrestrained budget bloat. Taxpayers in other states, take note.
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