The search for a tax unicorn

The Arizona Republic
Wednesday, April 15, 2009
Robert Robb

Arizona leaders are doing a lot of looking for unicorns these days.

The one they are in particularly hot pursuit of is a state tax structure that isn't so subject to cyclical fluctuations.

The universities sent out a scouting party for this particular unicorn, called the Fiscal Alternative Choices Team. It recently released a field report.

According to the FACT report, one of the major problems is that Arizona is too reliant on the sales tax. "Collections from the sales tax are volatile across the economic cycle," the report claimed, "and do not keep pace with economic growth."

This is a widely held view. It is also manifestly false.

From 1993, when state revenues stabilized from the recession in the early 1990s, until 2007, when state revenues peaked before the current downturn, state sales tax collections grew by 177 percent. State personal income during the same period grew by 180 percent. From 2000 to 2007, sales tax collections actually grew faster than personal income.

The staff of the Joint Legislative Budget Committee, who unlike academics have to live with the consequences of their misjudgments, reached the opposite conclusion. According to its review of the historical record, "Changes in base sales tax collections generally track Arizona personal income."

Sales taxes have also generally held up better than other sources during recessions. In the recession of the early 1990s, state collections of both individual and corporate income taxes experienced a one-year decline. Sales tax collections never dipped into the red.

Nor did they the last time state revenues declined in 2002. Individual income tax collections, by contrast, declined over 9 percent. Corporate income taxes fell 36 percent.

This recession has been different. Last year, state sales tax collections declined over 3 percent. This year, so far, they are down by more than 11 percent.

This, however, is an unusual recession. And collections from individual and corporate income taxes are also hugely off, even after adjusting for the effect of the individual rate cut that was partially implement during the period.

Many suggest that revenues would be more stable if the state got back into the property tax business. The FACT report suggests imposing one for the school construction obligations the state took over from local school districts.

That would raise more money. But it wouldn't make state revenues less volatile. After the commercial real estate depression in the late 1980s, the Arizona property tax base actually shrunk. That's probably going to happen again with the dramatic decrease in residential property values the state has experienced.

The notion that greater reliance on real estate values would reduce state revenue volatility would seem self-evidently silly. But it persists.

To reduce volatility, the FACT report recommends that the sales and individual income tax bases be expanded and the rates reduced. There are many reasons why that could be a good idea. But reducing cyclical volatility isn't one of them.

Take one of the recommended sales tax base expansions, commercial real estate leases, as an example. In the first place, such a tax is highly unfair, which is why it was repealed. Commercial office buildings already pay high property taxes, which are passed on to lessees. Then subjecting the lease to a sales tax is piling on.

Regardless, such a tax would be more volatile, not less. In a downturn, commercial lease space contracts and rates go down.

There is simply no evidence that broadening the bases of the sales and individual income tax would reduce their volatility, and the FACT report offers none.

If stability is the goal, then reducing reliance on the two most volatile revenue sources, taxes on corporate income and capital gains, would be the way to go. But the gains in stability would be minor.

There are improvements that can be made in Arizona's tax structure that would enhance the prospects for long-term economic growth, which in turn could increase state revenues. But they would not do much to reduce the cyclical fluctuations in such revenues.

As I've written before, and will undoubtedly write many more times so long as the newspaper gives me this forum, there are no countercyclical tax sources. In an economic downturn, they all go down.

There are no unicorns.