Because the legislature does not have the authority to repeal or undermine a voter-approved ballot issue, majority Republicans used other strategies to circumvent Prop. 208’s effect, implementing a 4.5% cap on the maximum combined tax rate. The provision has the effect of reducing the regular income tax rate on that income to 1%, which also reduces revenue from the regular income tax.
Changes in Tax Rates.
Key provisions of the tax cut package, contained largely in Senate Bill 1828, includes shifting the graduated tax on personal income to a flat tax over several years. This will begin by eliminating the four current tax rates, which range from 2.59% for single filers with income up to $26,500 to 4.5% on income over $159,000. The thresholds are doubled for joint filers.
The new rates start at 2.55% for single filers with income up to $27,272, and increase to 2.98% for income over that amount starting on January 1, 2022. Those rates would be lowered to 2.53% and 2.75%, respectively, upon confirmation that the state’s General Fund revenue for the previous year is at least $12.78 billion. If revenue equals or exceeds the higher level of $12.98 billion, the rate would become a flat 2.5% tax on all individual income. This provision was included to win support from legislators who expressed concern about the tax cuts’ effect on state revenue.
Other Prop. 208 Relief.
On July 9, Ducey signed another piece of legislation (Senate Bill 1783) that gives passthrough business owners the option to pay a special business tax on passthrough income and avoid Proposition 208’s 3.5% tax. This passthrough income would be subtracted from their state personal income so that this part of their earnings would not be subject to the tax.
Supporters of S.B. 1783 claimed that Prop. 208 is detrimental to the owners of successful small businesses that are organized as passthrough entities, and they note that, last fall, Prop. 208’s supporters campaigned that the tax was not designed to target small businesses.
However, S.B. 1783’s opponents argue that the new law allows wealthy business owners to bypass the tax and frustrate the will of the voters.
Additional Tax Savings.
The tax legislation also reduces property taxes paid by businesses by cutting the commercial/industrial property tax ratio from 18% to 16% over the next three years. Lawmakers expect the change to prompt local jurisdictions to increase property tax rates, and therefore, the package raises the homeowner rebate from 47.19% to 50%.
In addition, military veterans’ benefits become exempt from state income tax, and the state’s 25% charitable deduction is indexed for inflation for taxpayers who do not itemize deductions.
Other Provisions.
The amount of income tax revenue shared by the state with local governments will increase from 15% to 18%, which will provide assurance to localities concerned that the income tax cut will decrease their share of that revenue.
There is also an increase in the amount of state debt to be paid down, aimed to satisfy legislators who were worried about the state’s debt picture.
