Summary of Findings

This analysis considers the costs of three different options for federal tax conformity with HR1 by the state of Arizona. Findings include:

• Not conforming would fund up to $300 million in minimal agency priorities.
• Significant conformity (excluding SALT and auto interest deduction) would generate more than a $300 million deficit and not fund any minimal agency priorities.
• Minimal conformity (broad change to standard deduction, tips, overtime and opportunity zones only) but not funding minimal agency priorities leaves a small surplus.

Introduction

The unfunded tax changes Congress approved in HR1 (a.k.a. The One Big Beautiful Bill Act) are expected to increase the federal government’s budget deficit by $600 billion in FY2027. Arizona, however, must have a balanced budget, so conforming to HR1’s tax elements comes at a significant cost to the state.

The Arizona Legislature’s Joint Appropriations Committee hearing last week made clear that the Republicans have no interest in any revenue enhancements (beyond Prop. 123) to make up for the projected loss in income that will result from conforming to HR1. If that’s the case, there is a contradiction between their stated desire to conform to the federal tax code (except for on the State and Local Tax deductibility issues) and their constitutional responsibilities to fund critical aspects of the state.

Assumptions

This analysis assumes the legislature comes to a bipartisan agreement on renewing Prop.123 without going to voters to increase distributions from the State Land Trust to fund K-12 education,  which would generate $300 million in FY2027. Another piece of legislation proposes a ballot referral to renew Prop. 123, but it would cut revenue in half since it would not go into effect until January 2027; something the state cannot afford.

Even with a Prop 123 renewal, the state can only afford minimal conformity with HR1 and still have the resources to meet critical new expenditures. A better option might be to forgo conformity. The tax benefits of HR1 are not well distributed, e.g., if you don’t earn tips or work overtime, you don’t gain anything. The cost of conforming prohibits meeting minimal agency priorities, such as continuing funding for childcare or preventing a 4% salary reduction for Department of Corrections staff.

Analysis

This report uses the latest revenue estimates and ongoing expenditures for FY2027 from the Joint Legislative Budget Committee (JLBC) and examines three budget scenarios:

1. No Conformity
2. Significant Conformity (excludes SALT and auto interest deduction)
3. Minimal Conformity (broad change to standard deduction, tips, overtime and opportunity zones only)

Only the No Conformity and Minimal Conformity options are fiscally viable unless revenue sources are added or significant budget cuts from ongoing expenditures are made. Since the No Conformity option leaves a slight negative balance, about one-fourth of the minimal desired agency priorities would have to be forgone; these priorities are entirely cut from the Significant and Minimal Conformity options. Significant Conformity leaves a deficit of more than $300 million.

About

Dave Wells holds a Ph.D. in Political Economy and Public Policy and is the Research Director of the Grand Canyon Institute. He can be reached at dwells@azgci.org or (602) 595-1025 ext. 2.

The Grand Canyon Institute (GCI) is a nonpartisan, nonprofit organization dedicated to informing and improving public policy in Arizona through evidence-based, independent, objective, nonpartisan research. GCI makes a good faith effort to ensure that findings are reliable, accurate, and based on reputable sources. While publications reflect the view of the Institute, they may not reflect the view of individual members of the Board.

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