State of the State Budget 2018: The Revenue System is Broken

January 8, 2018

State of the State Budget 2018:

The Revenue System is Broken

Dave Wells, Research Director

Executive Summary

Governor Doug Ducey will introduce yet another austerity budget that is in deficit without calling it so on Monday, January 8.  The Joint Legislative Budget Committee (JLBC) reports that the state has a net deficit a year after it increased spending by less than inflation plus population growth. The state’s revenue system is broken.  A prime culprit has been the failure of the 2011 “Jobs Bill” (HB2001) which put forward a series of corporate tax reductions amounting to more than half a billion dollars each year by FY2018.  Analysis of the New Employment Tax Credit portion of that legislation shows significant shortfalls in the state’s economic performance compared to anticipated growth rates.   Arizona’s employment growth from 2010-2017 has resulted in 70,000 less jobs than the average growth rate of neighboring states of California, Nevada and Colorado applied to Arizona (high state-Utah and low state-New Mexico excluded).  Consequently, no evidence supports claims that the Jobs Bill helped spur the state’s recovery

However, the large cost of the Jobs Bill has had fiscal consequences.  State revenue growth in Arizona during the current expansion has lagged significantly behind all neighboring states except New Mexico.  If the temporary revenue gains of the one cent three-year sales tax of Prop. 100 are removed then Arizona has fallen short of inflation, much less population growth.

Compared to FY2007 after adjusting for population growth, inflation, and continued use of accounting maneuvers, Arizona faces nearly a $5 billion deficit relative to state revenue at that time. Effectively, the state has about $3 for every $4 it had in FY2007 when adjusting for both inflation and population growth.

Given the state’s modest growth, the fiscal consequences of the Jobs Bill legislation on top of $4 billion in prior tax cuts since 1994 and more than half a billion dollars in tax credits is a state that is unable to meet its statutory and constitutional obligations.

While the budget is claimed to be in balance, the JLBC indicates a net deficit for this year that becomes far worse once one-time spending is added.  In addition, for a decade the state has rolled over its final K-12 payment to the next fiscal year, an amount that is twice the  budget stabilization fund balance ($930 million compared to $460 million).   This portion of expenditures being rolled over, nearly 10 percent, is about three times greater than at the end of the last expansion.  The lack of revenue resources means the state will likely enter the next recession with this rollover still on the books.


Funding Shortfalls:

  • 123 has helped address the legislature’s violation of base education funding that led to a lawsuit, but the state continues to shortchange K-12 education in building and renewal funds and soft capital. Consequently, school districts have filed a lawsuit against the legislature for violating the Roosevelt v. Bishop case, which declared Arizona’s system of school capital finance unconstitutional.  The legislature can fight providing sufficient resources to public education, but, ultimately, they will likely be found violating the state constitution.  This will require about $750 million above current K-12 funding.  Restoring all-day Kindergarten raises the total to $1 billion. This ought to be a top priority for the legislature in this session.
  • In the past decade, per student funding to universities has been cut by more than half. The state’s high school graduation rate is below the national average and its overall college attainment rate for adults 25-64 is also below the national average. The Arizona Board of Regents has called on the state to commit to funding half the cost of Arizona resident undergraduate education.  To do so would cost the state about $240 million.
  • The number of children in foster care appears to have peaked, but it is still far higher than it was a decade ago. The recent decrease may be more due to lower unemployment than anything the agency has accomplished. Turnover rates for specialists who work closely with vulnerable children and families remains very high, nearly 40 percent per year.  Raising starting pay and reducing workloads should be a top priority but is impossible to do when the state lacks the revenues to do so.  Investments in this critical area can help boost high school graduation rates, reduce crime, reduce future use of welfare and social services, and improve income equality.  $15 million would raise the salaries of specialists by $10,000, a first step before then engaging in reducing caseloads by hiring additional specialists.


Improving Use of Resources:

  • Eliminate or cap private school tax credits. Tax credits now take up more than half a billion dollars of state revenue. One of the largest areas has been to subsidize private school enrollment which in FY2017 amounted to $150 million. Despite a significant increase in taxpayer funds, private school enrollment over the last 20 years has been flat. In 2016, the Grand Canyon Institute estimated that these tax credit programs (excluding those for students with disabilities) cost the state around $10,000 from the General Fund for each new private school student who would not have otherwise enrolled.  This amount far exceeds the amount allocated from the General Fund per student to public schools.  In 2018 a new census of private school enrollment will be published at which time the Grand Canyon Institute will update its estimate.  The last legislative session saw another attempt to expand public monies to private schools.  Unless the legislature repeals this legislation, voters will have the final word in a referendum in November 2018.
  • Perhaps around $50 million could be better allocated if Charter Schools were subject to procurement laws. Charter Schools receive more than $1 billion a year from the General Fund. Every charter school is fully funded by the General Fund as compared to public district schools which, depending on their local property-base, receive funding from the General Fund and/or local property taxes.  Charter school enrollment has continued to grow compared to district schools which places additional pressure on the state General Fund.  However, the state laws on charter school finances are quite lax, allowing three-quarters of charter school operators to engage in questionable financial transactions with related-parties (usually the charter holder’s own for-profit business) to provide school services outside of the competitive procurement process required of district schools.  To provide better financial accountability and assure better returns to tax dollars, the legislature needs to subject charter schools to a similar procurement requirement.  If lack of oversight is leading to expenditures being 10 percent too high, about $50 million could be better allocated to improve student achievement.
  • $80 million could be raised by improving tax code enforcement. The state claims to now have 11 corporate auditors, up from 4 in October of 2016, but down from 30 in May of 2016. Overall audit income fell by $80 million from FY2016 to FY2017.  This outcome was predicted by experts, including the Grand Canyon Institute, yet budget amendments proposed to add auditors were voted down by the legislature.  Will the legislature continue to allow a few corporations to avoid paying their legally obliged share of taxes?

$55 million could be saved by moving to an Earned Release system for nonviolent offenders who are incarcerated. Arizona, while making some small efforts to reduce recidivism, continues to be the only state in the country to require all nonviolent offenders to serve 85 percent of their sentence behind bars regardless of behavior.  In 2012, the Grand Canyon Institute recommended transitioning to an earned release program that would maintain public safety.  This enables inmates who comply with their program for rehabilitation to be released earlier into community supervision and frees up more resources to make sure they have treatment for drug issues which often contribute to recidivism.