Running on Empty: Federal Tax Package Conformity Leaves $1 Billion State Budget Deficit
Summary of Findings
Federal HR1, also known as the One Big Beautiful Bill Act, made significant changes to federal tax law. Now it is up to states to decide whether to align their tax laws to conform with the federal changes. States are not required to, but it’s generally easier for taxpayers if their state returns rules are similar to the federal government. Regulatory provisions related to government programs that were part of HR1 states must comply with.

Because HR1 was retroactive to Jan. 1, 2025, if Arizona conformed its tax laws, it would impact the already-ended FY2025 as well as FY2026. The costs of the related tax cuts would get rolled into FY2026. FY2027 would also bear significant costs. If Arizona fully conforms to HR1, it could cost a total of $800 million in tax revenue.

The Grand Canyon Institute (GCI) uses estimates from the Joint Legislative Budget Committee (JLBC) as well as identifying critical or required spending from the JLBC’s summary of budget requests from agencies. The table below leaves out many spending areas–so it’s a fairly bare bones budget.

But between lost revenues from Prop. 123, the 2.5% Flat Tax passed in 2021 as well as the added net cost of Empowerment Scholarship Account (ESA) vouchers, the state confronts a more than $1 billion deficit starting the legislative session for FY2027 if the state fully conforms with HR1. 

The state has revenue options that total more than $2 billion to cover this deficit. 

Reintroduce a Progressive Income Tax on Wealthier Taxpayers ($1 Billion+): The Flat Tax costs the state more than $2 billion annually and 80% of the benefit goes to households with incomes above $200,000. Reintroducing some version of a progressive income tax on higher-earning households could raise at least $1 billion.

Renew Prop. 123 ($300 million): In 2025, the General Fund absorbed the cost created by the expiration of Prop 123 in June 2025 and the failure of the legislature to renew it.  This meant backfilling an allocation from the State Land Trust that was reduced from 6.9% to  2.5% with the expiration of the proposition. 

Sweep Unspent ESA voucher accounts ($440 million): Each year a significant portion of ESA voucher amounts are not spent and accumulate in accounts. The legislature could sweep these funds to recover almost a half a billion dollars.

Limit ESA vouchers for homeschooling and non-accredited schools to $2,000 ($290 million): When Texas passed its universal voucher program, it limited awards for homeschooling to $2,000. This is the area that has been abused the most. GCI estimates one-third of recipients are homeschooling. Limiting their vouchers to $2,000 would save an estimated $290 million in FY2027.

Eliminate Sales Tax Exemption for Data Centers ($60 million): Data centers are already profitable, are not particularly strong providers of jobs, and are not effectively lured by incentives. Arizona has a sales and use tax exemption that was specifically created for data centers. Its cost has exploded from $1.4 million in 2020 to $19 million in 2024 and $38.5 million in 2025. GCI estimates the FY2027 cost to be at least $60 million, if not higher.

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.

Grand Canyon Institute 

P.O. Box 1008 

Phoenix, Arizona 85001-1008 

GrandCanyonInsitute.org