Construction sales-tax change eyed

The Arizona Republic
Saturday, December 22, 2012
Beth Duckett

Arizona municipalities are on edge about a proposal to change the way Arizona taxes construction materials, saying it poses a threat to city revenue.

The reform would charge sales tax on raw materials that contractors purchase at checkout rather than the existing system, which allows the state and cities to tax the final price of the project.

For cities and towns where construction activity is on the rebound, the reform could mean a shift in revenue to areas where contracting suppliers are abundant, instead of where the actual construction occurs.

The League of Arizona Cities and Towns has estimated Arizona cities could lose $168million a year if there is a shift to paying for construction materials at the point of sales.

The potential revenue from construction-related taxes helps pay for crucial city services.

“In Scottsdale, we don’t have a lot of places where they purchase these materials,” said Brad Lundahl, Scottsdale government-relations director. “We would lose out on those taxes.”

The reform was outlined in a final report from a task force established by Gov. Jan Brewer to simplify the state’s sales-tax system, which is often criticized as one of the most complicated in the nation.

The report includes a long list of concerns from the cities about the construction sales-tax change. Any change in the tax would require the state Legislature’s action.

For many cities and towns, construction is picking up after the recession but continues to lag behind levels achieved during the boom years.

Scottsdale took in nearly $14million last fiscal year in construction sales taxes, down from $32million in fiscal 2007-08, according to figures from budget manager Judy McIlroy.

The city issued 79percent more building permits for single-family homes through November, compared with the previous year, according to the Home Builders Association of Central Arizona.

Among Valley cities, Gilbert came out ahead, issuing more than 2,330 new-home permits.

As the town continues to expand, “the proposed changes to the construction sales tax would significantly affect our community,” said Mayor John Lewis.

Gilbert officials told area lawmakers that eliminating the construction sales tax could create a budget “quandary” for Gilbert and other municipalities.

Town Manager Patrick Banger estimated that the change could impact Gilbert’s annual budget by $7.5million to $10million a year.

In Goodyear, construction sales taxes have dropped to roughly $7million or so a year, from a high of around $20million, said Romina Khananisho, intergovernmental programs manager.

“Construction sales tax is not something we can give up right now,” Khananisho said.

Under the current proposed scenario, Lundahl said the tax would be collected and remain in the cities that have the largest amount of contractor-material vendors.

“We obviously said that’s unfair,” he said. “We’ve heard legislators say the simple solution is just to do revenue sharing, even though they don’t understand how complex it would be and it would still be very unfair to cities.”

City officials say a shift to paying for construction materials sounds simpler on its face.

But large contractors, such as homebuilders or firms that put up industrial properties, don’t buy their major materials at local outlets such as Lowe’s or Home Depot, said Ken Strobeck, executive director of the League of Arizona Cities and Towns.

Many of those materials come from out of state, so contractors would not be paying Arizona sales tax on those large transactions.

“This is not an easier way for them to pay taxes,” Strobeck said. “It’s a tax cut.”

League officials acknowledge that the system is complex for small contractors and that an ideal solution has not yet been worked out.

The proposed reform has many supporters, including the small contractors who stress that the lack of tax uniformity causes confusion, resulting in millions of dollars of lost sales-tax revenue a year.

“If I work in 10 different cities, I would have 10 different forms come to my home every month,” said Scottsdale City Councilman-elect Guy Phillips, a self-employed air-conditioning contractor.

“It’s a pain in the butt,” Phillips said. “A lot of guys don’t do it.”

Currently, contractors in Arizona rely on exemption certificates so they don’t pay sales taxes on materials at checkout.

The final report of the task force said abuse of the system is “easy to hide and audits are rare.”

Moreover, contractors have different licensing requirements and are subject to audits from a variety of cities and jurisdictions, said Spencer Kamps, vice president of legislative affairs at Home Builders Association of Central Arizona.

“The prime contracting system in Arizona is the most complex system in the nation,” Kamps said.

“A materials tax would essentially put everybody on the retail rate,” he said.

Kamps stressed that streamlining would make it easier for Arizona to join a national effort to tax online sales.

Kevin McCarthy, president of the Arizona Tax Research Association, said sales-tax reform is a long-standing issue that the business community has tried to address for decades “with little or no progress.”

The prime contracting tax has been a considerable focus at the state Capitol, he said.

Under the existing system, the state and cities charge tax on 65percent of the final amount charged to the customer.

One scenario outlined in the report estimated the change would decrease state general-fund revenue by $64million, but increase county and city distributions by $41million and $25million, respectively.

Total revenue collected would jump by $2million, the estimates show.

Phoenix disputes the analysis, saying the state’s largest city would experience negative impact on revenue of $9million to $26million a year, said Karen Peters, senior executive assistant to Phoenix’s city manager.

Phoenix had a representative appointed to the task force.

During deliberations, “we did express concerns,” she said.

Tom Belshe, deputy director of the League of Arizona Cities and Towns, said the construction sales tax “is tied to services that have to be provided.”

Belshe said cities and towns are being asked to accept a change “with very little or no information on what the impacts to budgets could be.”

“We have no way of knowing where those retailers that would be collecting the tax are at or how much we would get in new retail money,” he said.

Scottsdale Mayor Jim Lane said he supports the overall idea of simplifying the tax code but is concerned about what formula the state could use to distribute the revenue to cities.

“The state would have ultimate and complete control over it, which means we would have to have reasonable assurances it wouldn’t be swept or things wouldn’t change politically.”