/ Modified jan 19, 2024 7:58 a.m.

The Buzz: How the state went from a surplus to a deficit

Two economists walk through how the state is facing a projected $1.7 billion deficit by the end of FY 25 after starting last year with a $2.5 billion surplus.

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The Buzz

The Buzz for January 19, 2024

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The Joint Legislative Budget Committee is projecting a $1.7 billion deficit in Arizona’s budget by the end of fiscal year 2025. But just last year the state was in a multi-billion dollar surplus.

The JLBC pointed to declining revenues as the cause of Arizona’s shortfall, specifically pointing out the individual income tax as the “primary underperformer” when looking at fiscal year 2024’s general fund revenues. Collections dropped by 27.7% when compared to last year and the JLBC says the implementation of a flat income tax rate is one of the reasons why.

President of Rounds Consulting Jim Rounds says that while he is in favor of having as low of an income tax rate as possible, he believed that moving to a 2.5% flat income tax rate was not the right move.

“I think they were a little too aggressive with the flat tax,” Rounds said. “I would rather have used some of that extra money on some other one time items and then we wouldn't be having as many fiscal problems right now.”

In mid-2021, when the flat income tax rate was still being debated, Rounds wrote a paper detailing the benefits and drawbacks of a flat rate on future state income taxes. He said a flat tax of 3% or 3.5% would be more responsible.

“You have to be able to generate enough revenue to pay for all the other things that make an economy tick,” Rounds said. “It's not just about having the lowest income tax rate.”

At the time, his firm strongly supported putting an extra half a billion dollars of the surplus to the state’s rainy day fund for when there are fiscal issues. The state was not sure how a surplus came to be but many believed it had to do with the influx of federal pandemic funding.

“There were a lot of unknowns related to the tax cut,” Rounds said. “There were a lot of unknowns related to exactly what part of the stimulus money was in our general fund base that's going to be going away…So the extra money into the Rainy Day Fund was our hedge against maybe having problems like we're seeing right now.”

Instead of placing even more funding than what would normally be allocated into a reserve, lawmakers created a pool of funding that each legislator was allowed to use for a project of their choice.

Arizona’s financial issues are forcing the state to reconsider how it handles funding certain areas like education. Governor Katie Hobbs proposed a $16 billion budget that some Republican lawmakers feel only target GOP initiatives.

KJZZ Political Correspondent Wayne Schutsky has been reporting on the financial issues within the capital. He says that some Republican lawmakers, like Chair of the House Appropriations Committee Representative David Livingston, could get on board with proposed cuts to projects like transportation.

“He was concerned that the list the governor put forward was mostly Republican projects, so that could be a little hiccup there,” Schutsky said. “But he's generally supportive of that idea of pausing some of these construction projects.”

However, as Schutsky said, not all cuts are being welcomed with open arms. One of Hobbs’ biggest areas to rein in is Empowerment Scholarship Accounts–better known as universal school vouchers.

“That's obviously a no go with Republicans who are all very supportive of the voucher program, so it's kind of a non-starter,” Schutsky said.

The program is already exceeding its allocated money halfway through the fiscal year by more than $40 million and is expected to overspend by $78 million at the end of the fiscal year.

Grand Canyon Institute’s Research Director Dave Wells says the state is essentially subsidizing private schools or paying for it entirely.

“The state didn't used to pay it, meaning that if these kids were not otherwise going to be in public schools or charter schools that the state would have been paying for, then this is costing the state money,” Wells said.

From his perspective, the voucher expansion and flat income tax rate are the top two causes of Arizona’s fiscal challenges.

In her proposed budget, Hobbs’ is suggesting the legislature increase regulations in regard to who can qualify for a universal voucher, backtracking from her previous calls to repeal the program.

“She's taking a little bit more of a measured approach to it and I think that is being done with the campaign in mind, so that they can go to voters and say, ‘We think these are common sense reforms. We're not trying to get rid of the program altogether. We're just trying to make sure the money is spent wisely.,’” Schutsky said.

The additional regulations include requiring a student to be in public school for at least 100 days before they become eligible for vouchers, transparency requirements for private schools, expanding the state auditor general’s authority to review how ESA money is spent, and more. However, getting Republican support for such a change would be difficult.

“Republicans aren't going for it and without those cuts, the governor is not going to be able to close the budget deficit even with her more beneficial projections,” Schutsky said.

Wells says that Arizona’s longtime issues with education funding will not be helped with the current fiscal crisis.

“The monies that are going to support kids going to private schools is also draining from the Department of Education's ability to be properly funded for all the district schools and charter schools.”

For years, the state has consistently ranked among the lowest across the nation when it comes to per-pupil funding in K-12 schools. Those who oppose universal school vouchers say that the program takes aways funding that would otherwise go to district and charter schools. The JLBC projects that a drop in public school enrollment will offset the ESA shortfall.

There is some common ground that both Democrats and Republicans agree to when it comes to the budget, like increased funding for the border to address the fentanyl crisis and better equip local law enforcement agencies.

Republican lawmakers have not yet put out their proposed budget, but Schutsky says Livingston indicated they had ideas for cuts that were not included in Hobbs’ budget.

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