Flat tax, school vouchers and slowing sales taxes driving $400 million budget shortfall

When Arizona lawmakers passed a budget in June, they expected to have a $10 million surplus by the end of the fiscal year. But just a few months later, the state now forecasts a $400 million deficit. 

That predicted deficit is driven by the state’s newly implemented flat income tax, a slowing in sales tax revenue and higher-than-expected spending on school vouchers. 

The new budget forecast, by the state’s Joint Legislative Budget Committee, was released Wednesday during a meeting of the Finance Advisory Committee, a panel made up of public and private sector economists that periodically evaluates the state’s financial status. 

While the 2024 budget was based on a projection of 1.9% revenue growth, so far this fiscal year — which began in July — revenues have declined by a whopping 6.2%. JLBC predicts that revenues will improve, but will still decline by a total of 0.6%. 

A major contributing factor to the decline is the full implementation of a flat income tax that GOP lawmakers and then-Gov. Doug Ducey championed. In January, the individual income tax rate was lowered to 2% from 2.7%, resulting in a 27% drop in income tax collections from the prior fiscal year. So far, that means $243 million less has been collected than was expected. 

The tax cut was the result of a package approved by legislative Republicans and Ducey in 2021, which changed Arizona law from a graduated income tax rate to a flat tax. Budget analysts at the time estimated the cuts would cost the state about $1 billion in revenue from 2021 levels when they were fully implemented.

JLBC Chief Economist Hans Olofsson explained that Arizona should expect to collect around $500 million less in income taxes this year than it originally predicted and around $240 million less than projected in sales tax income. 

On a more positive note, corporate sales taxes are expected to bring in around $146 million more than anticipated this fiscal year. 

The 2024 budget was based on an assumption that 68,380 students would take part in Arizona’s expanded ESA program that allows any K-12 student to receive a voucher to attend private school or to fund homeschooling, at a total cost of $625 million. 

But the program is already exceeding both of those figures. There are currently 68,455 students in the program and the cost is over budget at around $665 million. That added cost is due to more students with special needs, who receive larger voucher amounts, using the program than lawmakers budgeted for. 

JLBC Deputy Director Jack Brown explained during the Finance Advisory Committee meeting that the state won’t be able to determine the net impact of the voucher program until it can determine how many of those students switched from public to private schools — which would mean a simple movement of money — and how many of them never attended public schools, meaning their tuition is a new cost to the state. 

Brown told the committee that the state won’t have good public school enrollment data with which to determine those numbers until November at the earliest. Data on the ESA program is generally sparse, which has been a frustration for both critics and some backers.

The state still has around $1.5 billion in its rainy day fund that could be used to shore up the possible deficit, but Senate President Warren Petersen told the Arizona Mirror in a statement that he would only be willing to tap into the fund in the case of a deep recession, which the state is not currently experiencing. 

JLBC Director Richard Stavneak explained that the state should expect projected fund balances to change considerably through the year, partly because it’s always difficult to predict how the economy will fare, but also because Arizona doesn’t have a baseline for some of the changes happening this year. 

“When you do unique things, you don’t have a template for how to predict the future,” he said. 

Budget analysts had predicted that the state would see the majority of the income tax impact when it sends out refunds in the spring, but it seems to be seeing those impacts in real time instead. The state also doesn’t have a good baseline for ESA enrollment and costs and doesn’t have other states to look to, since Arizona’s program is unique. 

Both Republicans and Democrats pointed their fingers at one another when it comes to who is to blame for the shortfall. Petersen dismissed the impact of the flat income tax and exploding use of school vouchers and instead blamed President Joe Biden.

“Unfortunately, skyrocketing inflation, rising interest rates, crippling energy costs, and record-high gas prices caused by reckless policies being pushed by Democrats at the federal level are crushing Arizonans’ ability to have discretionary income,” Petersen said in a statement. 

That means people have less to spend beyond basic necessities, he said, driving down sales tax revenues. 

“We will evaluate a variety of ways to cut spending in order to accommodate this shortfall and return to a balanced budget,” Petersen added.

Gov. Katie Hobbs, a Democrat who negotiated the 2024 budget with Republican leaders in the legislature and later signed off on it, declined to comment on the shortfall. 

But on Tuesday, Hobbs put out a statement condemning the ESA program for going over budget and having more enrollees than expected, at 68,455. 

“The school voucher program is unaccountable and unsustainable,” Hobbs said in the statement. “It does not save taxpayers money, and it does not provide a better education for Arizona students. Instead, taxpayer dollars are funding ski resort passes, luxury car driving lessons, and pianos because partisan politicians refuse to place real limits on the program. Now, the runaway spending threatens funding for state troopers fighting drug trafficking, social workers protecting Arizona’s most vulnerable children, and doctors caring for Veterans who sacrificed their health to protect our country.” 

In her statement, Hobbs called on State Superintendent of Public Instruction Tom Horne, a Republican, along with Petersen and Republican House Speaker Ben Toma, to pass accountability and transparency measures for the program. 

In a response to Hobbs’ statement, Toma said that the ESA was not exceeding estimates, in contradiction to the JLBC’s report released on Wednesday. 

“We remind the Governor that she leads the entire state of Arizona, and if she seeks changes to the ESA program, she ought to propose serious policies, not tweet vague threats,” Toma said in the statement. “The State Legislature has yet to see any policy proposals from her office. Arizona will continue to responsibly fund students, not systems.”

Toma did not respond to a request for comment.