With the deficit now mainly gone and the state with a small surplus for the coming year after having to cut more than $1 billion to balance the current year’s budget, Democratic Gov. Katie Hobbs says she’s willing to negotiate on tax relief measures.
What she’s not interested in doing is signing off on one big cut passed by the Senate last week that would automatically cut income tax rates anytime the state has a structural surplus. Those cuts would essentially be locked in because, while cutting taxes takes only a majority vote, lawmakers must approve increases by a two-thirds vote.
“I’m not interested in tying our hands like that. No,” she said Feb. 28 of the proposal that is similar to a Colorado system known as TABOR. “Not like TABOR. No. That’s not tax relief. That is tying the hands of future administrations.”
TABOR, or Colorado’s Taxpayer’s Bill of Rights, was enacted by that state’s voters in 1992. It limits growth in spending by state and local governments, including schools, and requires voters to OK any tax increases.
The current Arizona proposal, dubbed TABOR-light, only affects state income taxes, 18% of which is shared with cities and towns.
Under the plan, the Legislature’s budget analysts would do an annual calculation. And if there’s a “structural surplus” — meaning more money than needed for ongoing programs — trigger the automatic cut in income tax rates for the next year.
Hobbs may not have a say in the matter, though.
That’s because Sen. J.D. Mesnard’s proposal is accompanied by a companion piece of legislation that, if the House and Senate approve it, would go directly to the voters for approval.
That increases the pressure on Hobbs to accept something or have voters — who tend to vote for measures cutting their own taxes — do it on their own.
The proposal from Mesnard, R-Chandler, involves some math.
It starts with the 2.5% flat personal income tax rate enacted under former Gov. Doug Ducey in 2021.
Then, each year, when the state collects more money than it is set to spend, the calculation would include annual adjustments for inflation and population growth.
All that would lead to a figure of how many millions of dollars of extra money is being generated. Then half of that would be used to cut the tax rate from the current 2.5%.
What alarms some is that this would be a one-way ratchet: Once the rate went down, it would not go back up, even in lean years, unless lawmakers gathered the necessary two-thirds vote, something that is considered politically impossible in the Legislature.
Democratic senators said during hearings on SB1318 and the accompanying ballot referral, SCR 1014, that automatic income tax cuts would tie the hands of future legislatures and governors when they negotiate on future budgets.
“What we’re trying to do here is handcuff us so we can’t make decisions during a budget (negotiation),” Sen. Brian Fernandez, D-Yuma, said during a Feb. 10 committee hearing on the measures.
“So, ‘handcuff’; is an interesting choice of words,” Mesnard responded.
“We can put parameters on ourselves,” he said. “The voters put parameters on increasing taxes back in the 90s and also, more recently, when they’re on the ballot.”
That refers to the need for a two-thirds margin for legislative tax hikes; under a measure voters approved in 2022, an initiative to increase taxes would have to pass by a 60% margin to take effect.
“This is a proposal to essentially strike a balance,” Mesnard said. “When you have a surplus, let’s split it between giving money to taxpayers and the other half allocating towards whatever you want.”
Fernandez said it is more than just a proposal—it limits the Legislature’s and the governor’s ability to raise the money needed to address important issues.
“It’s putting parameters on the future of our state, on what we can do in the next 30, 40, 50 years as a state in terms of being able to invest in education, invest in breaks for companies that come here,” Fernandez said. “There’s a whole host of things that we could be doing as a state that would actually move us as a state further that I think restricting this kind of revenue could stop us from doing.”
If the House approves the tax law changes in Mesnard’s SB1318, it would take effect in the 2026 tax year. The Legislature’s budget analysts expect it to reduce the current 2.5% flat tax rate to 2.42%, cutting $175 million in tax revenue, half the expected $350 million structural surplus in the 2027 fiscal year.
If Hobbs rejects that and the companion ballot referral, SCR1014, is approved by voters next year, it would lead to a tax rate cut to 2.39% based on half of the expected 2029 budget year surplus, leading to $291 million in tax cuts.
The current budget is just over $16 billion, with nearly half funding K-12 schools. The next highest spending is on the state’s Medicaid insurance plan for low-income residents, followed by prisons, human services, universities, and child safety.
Mesnard has two other tax cut bills on the table.
One was originally crafted to eliminate all income taxes on pensions and withdrawals from 401(k), Roth and other retirement accounts for anyone over age 59 1/2, and allow tax deductions for contributions to individual retirement plans known as IRAs. It had no limits and was expected to cut more than $913 million in state revenue.
Mesnard tweaked the plan to eliminate withdrawals from Roth plans, raise the age limit to 67 and set a cap on tax deductions at the standard federal deduction, now $14,600 for an individual and $29,200 for married couples filing together.
“The idea behind this is to try to incentivize saving,” Mesnard said. “We want to treat all retirement income … like we do Social Security. Arizona does not assess an income tax on Social Security.”
Fernandez also had some thoughts on this Mesnard plan.
“So, last week we had TABOR-light, which would cut our tax rate … after a couple years of surpluses,” Hernandez said. “And now you want to cut between $300 (million) and $900 million a year.”
“I really like you and, respectfully, I just don’t know where you think you’re going to get this money,” he continued. “I appreciate that you want to cut the size of state government, I get that. But I just think our state has certain obligations and these kind of things will not let us meet them.”
Sen. Mitzi Epstein, D-Tempe, said the Finance Committee Mesnard chairs should be renamed the “more money you have, the more tax breaks you get” committee.
That drew a rebuke from Mesnard.
He said he didn’t expect Democratic support. But that is because it is capped at the standard deduction amount and lower income Arizonans would end up paying no taxes on retirement income while those earning more would still have to pay. He thought they’d understand it was not targeted to benefit the wealthy.
“The idea that the more money you (make) the bigger your tax break is absolutely ridiculous,” Mesnard said of SB1371, which awaits a Senate vote.
According to the Legislature’s budget analysts, another Mesnard tax cut bill, SB1331, would eliminate capital gains taxes, costing the state between $40 million and $60 million a year. It passed the Senate on a 17-12 vote last week and now heads to the House for consideration.
The House also passed a tax cut last week, a measure by Rep. Justin Olson, R-Mesa, which would spread $200 million in tax cuts across sales, property and income taxes.
“I think that every session we’re down here we should evaluate how much of a tax relief package we can return to the taxpayers, the hardworking Arizonans,” Olson said.
Rep. Nancy Gutierrez, D-Tucson, said she was concerned about any more tax cuts in Arizona.
“It is extremely difficult to raise taxes in Arizona, and we already lowered many, many taxes,” Gutierrez said.
She noted that Olson’s HB2918 was opposed by cities and towns that would absorb some of the cuts, and by groups like Save Our Schools Arizona and the Arizona Center for Economic Progress, which advocates for fairer tax codes and investment in things like education, affordable housing and health care.
“We have a budget crisis,” Gutierrez said, “We have to make money to spend it. This will further reduce what we make in our state.”
Olson noted that the state doesn’t “make money.”
“This is not the state government’s money,” he said. “This is the hardworking Arizonans’ money, and this is leaving more of their hardworking resources with them.
He called his measure a “placeholder” tax cut that will go into the state budget conversation, as is the case with virtually all revenue and spending bills.
