Questions and Answers

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1 UPDATE July 2015 Questions and Answers About Arizona s State Budget and Taxes What Every Legislator and Taxpayer Wants to Know

2 CHILDREN S ACTION ALLIANCE Children s Action Alliance is an independent voice for Arizona children at the state capitol and in the community. CAA works to improve children s health, education, and security through information and action. As a member of the State Priorities Partnership, Children s Action Alliance translates the complex world of state fiscal policy into credible and timely information that is used by policy makers, community organizations and the media. ACKNOWLEDGEMENTS This research was funded by the Annie E. Casey Foundation, the Ford Foundation, and the McMiles Donor Advised Fund held by the Arizona Community Foundation. We thank them for their support and acknowledge that the findings and conclusions presented in this report are those of the authors alone, and do not necessarily reflect the opinions of these foundations.

3 Questions and Answers About Arizona s State Budget and Taxes What Every Legislator and Taxpayer Wants to know July 2015

4 A GUIDE TO ARIZONA S BUDGET AND TAXES State budgets and taxes are tools to reach our common goals for health, education, security and a vibrant, prosperous future. This publication provides information and analysis to help policymakers, community leaders, and community-based organizations make good decisions about Arizona s state budget and taxes to reach those goals. These questions and answers highlight key facts and trends about past policies, current challenges, and future opportunities. Together, Arizonans can craft budgets and tax policies that help families and our state grow stronger. Budget and Taxes R R R What does the state budget look like this fiscal year?... 1 Each year the state legislature and governor adopt spending and revenue policies that balance the budget with general fund expenditures below available revenues. To close a projected $1 billion gap between revenues and expenditures, this year s budget includes $500 million in cost shifts to local governments and spending cuts to education, health care, and families. Additional tax cuts were passed that will shrink available revenues for the coming years. Why does state spending grow faster than the... 4 general population and inflation? The populations and costs that shape state priorities are significantly different from the general population or general inflation. Any law or constitutional amendment that ties the complex state budget to a mathematical formula based on general population and inflation is like ordering pizza for five teenage boys based on the appetite of a senior citizen couple living in Sun City. Does Arizona have limits on taxes and spending?... 6 Yes. Arizona has a number of constitutional provisions that limit spending and revenue increases. l July 2015

5 Tax Cuts and Tax Credits R R R R R R Do low-income families pay their share of taxes?... 8 Yes. All families in Arizona help pay for health, education, and public safety through state and local taxes. Low-income families pay a larger portion of their income in taxes than do wealthier families. Who doesn t pay state income taxes? Surprisingly, corporations and individuals at all income levels can end up paying little or no state income taxes. Has Arizona been cutting taxes? Yes. With the exception of 2003, the Arizona legislature has reduced tax rates and/or increased exemptions and credits in every year since By fiscal year 2017, the cumulative impact of this steady stream of tax cuts enacted since 1990 will reach $1.8 billion less in general fund revenues more than double that when you adjust for inflation. What are tax credits doing to the state budget? Tax credits cost the state budget $311 million in 2012 and have been growing fast. They compete with state agency budgets for the same pot of funding, but state lawmakers have virtually no accountability or control over tax credits once they are in state law. What would happen if Arizona eliminated the income tax? State income taxes for individuals and corporations make up nearly half of all revenue to the state general fund. Eliminating these taxes would have a dramatic impact on Arizona families including a potentially huge loss of state services or huge shifts in taxes from wealthier Arizonans to middle and lower income families. Should Arizona cut more taxes now to spur job growth? No. The link between tax cuts and economic growth is unproven and inconsistent. Arizona s economy has had both ups and downs during our 25 years of tax cuts. Given our current fiscal conditions, more tax cuts will mean more spending cuts that weaken our economic infrastructure and dampen job growth. July 2015 l Children s Action Alliance

6 Budget Trends R R R Has Arizona recovered from the recession? No. Arizona still has not regained all of the jobs lost during the Great Recession. Neither state revenues nor spending have returned to pre- Recession levels. What stands out in K-12 public education funding? Despite the intent of the temporary sales tax to shield education from budget cuts, state funding per student has dropped 24 percent since fiscal year Lawmakers have raised expectations for student success at the same time that many students are experiencing crowed classrooms with too few desks and supplies, outdated textbooks and technology, building problems due to deferred maintenance, and severe teacher shortages. What are the budget trends for the safety net? Arizona has a history of bipartisan support for policies that provide temporary help to prevent hunger, homelessness, illness, abuse and neglect. All of these can have lifelong consequences for children and high costs for taxpayers. Budget cuts have weakened the safety net and resulted in expensive emergencies for the state to handle. Challenges Ahead l July 2015

7 BUDGET AND TAXES What does the state budget look like this fiscal year? Each year the state legislature and governor adopt spending and revenue policies that balance the budget with general fund expenditures below available revenues. To close a projected $1 billion gap between revenues and expenditures, this year s budget includes $500 million in cost shifts to local governments and spending cuts to education, health care, and families. Additional tax cuts were passed that will shrink available revenues for the coming years. The Arizona budget reflects the state priorities of education, health care, and public safety. K-12 education, AHCCCS (Arizona s Medicaid program), and the Department of Corrections make up two-thirds of the $9.2 billion appropriated from the state general fund for this fiscal year. The Departments of Health Services, Child Safety, and Economic Security along with the community colleges and universities make up another 24 percent. The last 9 percent of the budget goes to more than 50 agencies that receive some or all of their funding from the general fund. Most of these services involve consumer protection, including the Department of Financial Institutions and the Department of Veterans Services. The Department of Transportation and all spending for state highways comes from the state gas tax and is not part of the general fund budget. How the General Fund Is Spent - FY 2016 (Dollars in Millions) Child Safety $ % Economic Security $ % Health Services $ % K-12 Education $3, % Community Colleges/ Universities $ % All Other Agencies $ % AHCCCS $1, % Corrections $1, % Source: Joint Legislative Budget Committee Staff, Appropriations Report FY July 2015 l Children s Action Alliance 1

8 At the time the budget was passed on March 7, 2015, Governor Ducey proclaimed that it put Arizona on a path toward structural balance for the first time since But projections showed that ongoing revenues would not exceed ongoing expenditures until FY Less than a month after he signed the budget, Governor Ducey signed legislation that cut state revenues by $31 million annually effective immediately with other tax cuts to phase in over the next few years, unbalancing the budget that had been so precariously balanced. Community colleges $16 million Universities $99 million FY 2016 General Fund Spending Cuts in Arizona Total $497 Million Education and Health Among the Hardest Hit K-12 district & chart schools $146 million All other $73 million Shift to local governments $60 million Child safety $4 million DES child care & operating $6 million Medicaid provider rates* $37 million Medicaid enrollment reduction $40 million Ambulance rates $6 million Courts $10 million * Since the budget was passed, AHCCCS (the Medicaid agency) has determined that it can absorb the $37 million cut without having to reduce provider rates. Source: Joint Legislative Budget Committee Staff, March Plan as Engrossed, March 9, Since the legislature adjourned in April, state revenues have picked up, with general fund collections through May being $257 million higher than had been forecast. This means that the planned withdrawal from the Rainy Day Fund will not be needed to finish fiscal year 2015 with a positive ending balance. The state begins the new fiscal year with a much larger beginning balance than had been expected, and the Rainy Day Fund balance remains at about $460 million. If revenues continue to come in above forecast, our elected leaders will be debating how to best allocate the unexpected funds and whether to consider them a one-time windfall or an ongoing boost. While they debate saving larger amounts in the rainy day fund, paying off debt, enacting additional permanent tax cuts, or investing in state needs, increased revenues may be needed to offset budget shortfalls in other areas. New fraud detection and tax amnesty efforts, for example, may not produce the $57 million in revenues that was assumed in the budget. And spending amounts may be higher than budgeted in certain areas, like foster care, where growing needs were not factored into the budget. In addition, the adopted budget fails to fully address the lawsuit regarding K-12 education funding, providing $74 million for this year s inflation factor instead of the $337 million ordered by the court. 2 l July 2015

9 In addition to the potential gap between projected revenues and spending this year, Arizona has other debt and unfunded obligations. The state has built up $3 billion in general fund debt with annual payments of principal and interest that must be funded every year like paying a mortgage. The annual debt payments combined are $366 million just larger than the $356 million general fund appropriated to the new Department of Child Safety. Arizona also has $1.8 billion in unfunded obligations, equal to 20 percent of total general fund appropriations. These include delayed payments, an accounting gimmick, known as rollovers, that push the payment of certain bills into the following fiscal Arizona has $1.8 billion in unfunded obligations. year. They can continue year after year until enough funds are available to reverse them. In addition, a number of budget formulas in state law are unfunded. These formulas are put into state law to automatically adjust specific types of spending for certain factors every year, such as inflation or growth in people needing the service. The legislature has eliminated some of these formulas from state law (and they are not included in the $1.8 billion unfunded obligations). Others remain in state law but go without funding in the budget. Arizona s Budget Leaves Out $1.8 Billion in Payment Obligations and Formulas $232 million Deferred payments $9.2 billion Total FY 2016 appropriations $1.8 billion shorfall $931 million $637 million K-12 rollover Suspended formulas Sources: Joint Legislative Budget Committee, Appropriations Report FY 2016, and Annual Report on State Debt and Obligations, January July 2015 l Children s Action Alliance 3

10 Why does state spending grow faster than the general population and inflation? The populations and costs that shape state priorities are significantly different from the general population or general inflation. Any law or constitutional amendment that ties the complex state budget to a mathematical formula based on general population and inflation is like ordering pizza for five teenage boys based on the appetite of a senior citizen couple living in Sun City. Over 20 states, including Arizona, have considered and rejected putting these TABOR formulas into their budget process. Only Colorado has adopted this so-called taxpayer bill of rights. It was such a disaster for the economy, schools, roads, healthcare, and public safety that Colorado voted to suspend it. State business leaders agree that TABOR led to slower job growth and delayed recovery from recessions. Population: Many of the groups that drive the state budget grow far faster than the statewide population, including prison inmates, community college and university students, children in foster care, and children and adults participating in services for developmental disabilities. Statewide Population Growth vs. Program Population Growth, % 160% 167% 140% 120% 124% 100% 80% 60% 40% 31% 37% 48% 59% 20% 0% Statewide Community Prison Inmate University People Kids in Population College Population Enrollment Receiving Foster Growth Enrollment Growth Developmental Care Disability Services 4 l July 2015

11 Inflation: The mix of costs that go into measuring inflation is far different from the mix of costs that affect state spending. For instance, education from kindergarten through postsecondary education makes up 51 percent of Arizona s budget, while education is only 3 percent of the cost that goes into determining the Consumer Price Index (CPI). Medical costs make up only 8 percent of the CPI, while AHCCCS/Medicaid health care costs make up 13 percent of state spending. On the other hand, food and beverages make up 15 percent of the CPI, while only a handful of state agencies, such as the prisons and the Arizona Pioneers Home, have food costs in their budget. What Makes Up the Consumer Price Index Education 3% Recreation 6% Other 4% Communication 4% Medical Care 8% Food and Beverages 15% Transportation 15% Apparel 3% Housing 42% Source: Bureau of Labor Statistics, CPI Detailed Report, January How the General Fund Is Spent Corrections 11% AHCCCS 13% Higher Education 8% All Other Agencies 9% K-12 Education 43% Health Services 7% Economic Security 5% Child Safety 4% Source: Joint Legislative Budget Committee Staff, Appropriations Report FY July 2015 l Children s Action Alliance 5

12 Does Arizona have limits on taxes and spending? Yes. Arizona has a number of constitutional provisions that limit spending and revenue increases. The Arizona constitution contains a limit on state spending that applies to all appropriated funds, not just the state s general fund. This limit is based on the size of the overall state economy. Currently the limit is 7.41 percent of total state personal income. Arizona s Appropriations Have Remained Well Below the Constitutional Limit 8% 7% Constitutional Limit 7.41% 6% 5% 5.56% 4% 3% 2% 1% 0% Actual Appropriations as Percentage of Personal Income Source: Joint Legislative Budget Committee Staff, State Appropriations Limit, February 12, NOTE: The statutory limit is adjusted whenever government functions or funding responsibilities transfer between levels of government. 6 l July 2015

13 The Arizona constitution also requires that any legislation that would increase net state revenues must be approved by a two-thirds majority in the state House and Senate. This encompasses adopting new taxes or increasing rates on existing taxes. It also includes any reduction or elimination of tax deductions, credits, exemptions or exclusions. (Fees and assessments that are authorized by statute and are set by a state officer or agency do not require a two-thirds vote.) Unlike revenue increases, passing tax cuts, adopting or expanding new credits, or any other action that reduces state revenues requires only a simple majority vote. Article 9, Section 3 of the Arizona constitution requires the legislature to provide sufficient sources of revenues to defray the ordinary expenses of the state for each fiscal year. In other words, the state budget must be balanced every year. The state constitution also includes limits on expenditures from school districts and community college districts and limits on property taxes levied by counties, cities, towns, and community college districts. July 2015 l Children s Action Alliance 7

14 Do low-income families pay their share of taxes? Yes. All families in Arizona help pay for health, education, and public safety through state and local taxes. Low-income families pay a larger portion of their income in taxes than do wealthier families. When all types of state and local taxes are combined income, sales and property families with incomes in the bottom fifth pay nearly three times what families in the top 1 percent do $12.50 for every $100 of income compared to $4.58 for the highest income families. Sales taxes make up the largest portion of the taxes paid by those with the lowest incomes. Families with the lowest incomes in Arizona also pay more of their income in state and local taxes than do the lowest income families in neighboring states. Arizona Families with Lowest Incomes Pay a Higher Portion of Their Income in State and Local Taxes than Taxpayers with Higher Income $12.50 $11.19 State and Local Taxes Paid per $100 of Income $9.15 $8.20 $6.93 $5.73 $4.58 Bottom 5th Second Middle 5th Second Top 5-15% Top 2-5% Top 1% Lowest 5th Highest 5th Portion of Total Household Incomes Source: Institute on Taxation & Economic Policy, Who Pays?, January l July 2015

15 Who doesn t pay state income taxes? Surprisingly, corporations and individuals at all income levels can end up paying little or no state income taxes. Three out of four corporations that filed income taxes in Arizona in 2011 had the minimum tax liability of $50. Fewer than one in ten corporations paid $5,000 or more in income taxes. Like individual taxpayers, corporations can significantly reduce or eliminate entirely their income tax bill through the use of tax credits. In 2011, corporations reduced their tax liability by $119.6 million through the use of tax credits and carried another $1 billion over to be used in future years. Only One-Fourth of Arizona Corporations Owed More than the $50 Minimum Corporate Income Tax in 2011 $50-$5,000 $5,000-$100,000 $100,000-$1 million Over $1 million $50 minimum Note: Amounts shown before tax credits. Source: Arizona Department of Revenue, Corporate Taxpayer by Size of Tax Liability, Tax Year July 2015 l Children s Action Alliance 9

16 Households might pay no state income taxes for one of two reasons: Their incomes fall below $11,000 the threshold set in state law for filing a state income tax return, or They have higher incomes, but their tax liability is erased through the use of exemptions, deductions, and tax credits. For example, a family with income that falls within the second highest tax bracket (between $100,001 and $300,000) can end up owing no income taxes through common deductions and credits. Arizona Income Tax Return for Family of Four Federal adjusted gross income $134,000 Subtractions Standard deduction -10,010 Personal exemptions -6,300 Dependents (2) -4,600 Taxable Income 113,090 Tax (Income x.0424 less $1,178) 3,617 Credits Student Tuition Organization -1,056 Student Tuition Organization - switcher -1,050 Qualifying charitable organization -800 Public schools extracurricular activities -400 Military Family Relief fund* -311 Subtotal - Credits -3,617 Taxes Owed 0 *A maximum of $400 could be claimed; however, only $311 was needed to eliminate tax liability l July 2015

17 TAX CUTS AND TAX CREDITS Has Arizona been cutting taxes? Yes. With the exception of 2003, the Arizona legislature has reduced tax rates and/ or increased exemptions and credits in every year since By fiscal year 2017, the cumulative impact of this steady stream of tax cuts enacted since 1990 will reach $1.8 billion less in general fund revenues more than double that when you adjust for inflation. Even during the Great Recession when drastic spending cuts were made to keep the budget balanced, hundreds of millions of dollars in tax cuts were passed. In 2015, state general fund revenues were $32.36 per $1,000 of income one-third lower than in 1990 and 17 percent lower than right before the Great Recession. State General Fund Revenue as a Share of Personal Income Has Dropped Significantly Since the Early 1990s General Fund Revenue Per $1,000 of Personal Income $55 $50 $45 $40 $35 $ $ $ $32.36 $ Fiscal Year Source: Tabulations prepared by Tom Rex, Associate Director, Center for Competitiveness and Prosperity Research, Arizona State University, based on data from Joint Legislative Budget Committee Staff, Appropriations Report, and the U.S. Bureau of Economic Analysis. July 2015 l Children s Action Alliance 11

18 All types of taxes have been cut since Examples include: Both the corporate and individual income tax rates have been cut 5 times at a total annual cost to the general fund of $1.2 billion, not adjusted for inflation. Today, the individual income tax rate for the highest income bracket is less than two-thirds of what it was in 1990, while the corporate income tax rate is currently in a four-year phase down. In tax year 2017, the corporate income tax will be just over half (52 percent) of what it was in individual income tax credits have been adopted, with 27 of them still being in place. The total annual cost of these credits, excluding any carry forward amounts, is approximately $202 million. 26 corporate income tax credits have been adopted, with 21 of them still being in effect. The annual cost of these credits, excluding any carry forward amounts, is approximately $129 million. New exemptions and increased deductions for both corporate and individual income taxes amount to $210.8 million annually, not adjusted for inflation. Allowing multistate corporations to choose their preferred method for determining their taxable income, called single sales factor, means $122 million less per year in state revenues. Many of the tax cuts passed since the Great Recession began are phasing in over a number of years, starting out relatively small but growing into the future. In particular, the so-called Jobs bill passed in 2011 was estimated to cost the general fund $38.2 million in fiscal year 2012 but has an estimated $538 million impact by the time it is completely phased in fiscal year The phased provisions include reducing the corporate income tax rate, reducing the commercial property tax assessment, and reducing the corporate sales factor, which affects multistate corporations. The most recent legislature continued this practice of passing tax cuts that have little impact now but will grow over time. A reduction in the insurance premium tax rate is estimated to cost the general fund $1.3 million in fiscal year 2017, but will grow to $35.2 million annually over 10 years. The assumption behind this phasing in of tax cuts is that the economy will improve over time so that the revenues lost due to the tax cuts will be made up by growth in the overall economy. Unfortunately, this has not worked out over one-third of the $1 billion deficit for fiscal year 2016 is attributable to tax cuts passed since l July 2015

19 What are tax credits doing to the state budget? Tax credits cost the state budget $311 million in 2012 and have been growing fast. They compete with state agency budgets for the same pot of funding, but state lawmakers have virtually no accountability or control over tax credits once they are in state law. A tax credit reduces the amount of taxes owed on a dollar-for-dollar basis a $400 tax credit can wipe out a $400 tax bill. The dollar value of tax credits claimed is growing at a much faster rate than state revenues, the state s economy, or state spending on K-12 education. Each legislative session since 2005, at least one new tax credit has been added or expanded. Between 2010 and 2013, even as state revenues were plummeting due to the recession, eight new credits were created. Today there are 27 credits available to individuals and 22 available to corporations. Tax Credits Are Growing Fast - Percent of Growth 1999 to % 56% 74% 56% General Fund State GDP K-12 Education State Tax Revenues State Appropriation Credits Source: Joint Legislative Budget Committee Staff, Appropriations Reports for FY 1999, FY 2000, FY 2012 and FY 2013; Arizona Department of Revenue, Arizona Income Tax Credits, November 2014; U.S. Bureau of Economic Analysis, Gross Domestic Product by State. Tax credits lack the basic accountability and control that state spending has. Unlike agency budgets that must be approved by the state legislature every year, tax credits are reviewed only once every five years. Even after a review that shows questionable results, tax credits continue forever unless a bill to repeal them passes with a twothirds vote in both the house and the senate. While state agency spending is capped at the appropriated amount, only 10 out of the 49 credits have an aggregate cap. State legislators don t know what the fiscal impact of any tax credit will be in any particular year until after the credit has already been taken. July 2015 l Children s Action Alliance 13

20 The expansion of the private school tuition tax credits in particular is having a significant impact on state revenues. Arizona now has two individual and two corporate tax credits for contributions to student tuition organizations that use the funding to grant scholarships for private school tuition. Combined, the amount claimed for these four credits rose from under $14 million in 1999 to $108 million in The largest of the corporate tax credits (shown below) has an aggregate cap that grows by 20 percent each year and has been maxed out the last several years. Corporate Private School Tuition Tax Credit Cap Doubles Every Four Years Corporations Now Maxing Out Their Contributions Every Year Millions of Dollars $51.6 $50 $45 $43.1 $40 $35 $30 $25 $20 $15 $10 $10.1 $5 $ Contribution Cap Actual Contributions Source: Arizona Department of Revenue, Arizona Income Tax Credits, November 2013; calculations by Children s Action Alliance. Another feature that puts tax credits outside legislative budget control is the carry forward balance that taxpayers are allowed to accumulate and use in future years. For most tax credits, if taxpayers don t owe enough income taxes to use the whole credit, they are allowed to save the unused portion of the credit and apply it against future tax liability. For instance, if a taxpayer owes $300 in taxes and has contributed $400 to the qualifying charitable organizations tax credit, the $100 unused portion of the credit can be carried forward and used on the next year s tax return. The number of years a credit can be carried forward ranges from 5 to 15 years l July 2015

21 Today, individuals and corporations are carrying forward a combined $1 billion balance in tax credits that can hit the state budget at any time. This carry-forward amount is three times greater than the credits claimed in any single year. The carry forward balance for corporations is expected to grow because the amount of corporate taxes due will decrease with the phasing down of the corporate tax rate. Millions of Dollars Arizona Taxpayers Have Built Up Over $1 Billion in Tax Credits That Carry Forward to Future Years Combined Individual and Corporate Income Taxes $1,400 $1,200 $1 Billion $1,000 $800 $600 $400 $200 $311 Million $ Credits used Credits carried forward to future years Source: Arizona Department of Revenue, Tax Credit Report, November July 2015 l Children s Action Alliance 15

22 What would happen if Arizona eliminated the income tax? State income taxes for individuals and corporations make up nearly half of all revenue to the state general fund. Eliminating these taxes would have a dramatic impact on Arizona families including a potentially huge loss of state services or huge shifts in taxes from wealthier Arizonans to middle and lower income families. If Arizona were to eliminate the income tax and increase the sales tax to make up for the revenue loss, Arizona s sales tax rate would grow from the current 5.6 percent to about 10.6 percent. Arizona s rate would become the highest in the nation, significantly higher than the current top spot of California at 7.5 percent. Replacing income taxes with sales taxes would also shift tax responsibility away from higher income Arizonans to those earning middle and low incomes. Under this approach, 80 percent of Arizonans would see their state taxes go up, while the wealthiest 20 percent would see a tax cut. Sources for General Fund, FY 2016 (Dollars in Billions) Sales/Use Tax $4.3 45% Other $0.9 10% Individual Income Tax $3.7 39% Corporate Income Tax $0.6 6% Source: Joint Legislative Budget Committee Staff, Appropriations Report FY Total $9.5 Billion Alternatively, trying to cut spending to make up for the lost income tax revenue would drastically disrupt basic state priorities. Would the legislature simply cut all state agency budgets in half, regardless of the impact? Would the general fund cover just K-12 education and Child Safety with zero funding for prisons, universities, health care, and the Department of Public Safety? Would the group homes and services for people with developmental disabilities be closed? Would the 1.6 million Arizonans who depend on AHCCCS for health care suddenly be without any coverage, disrupting the health care system statewide? 16 l July 2015

23 Should Arizona cut more taxes now to spur job growth? No. The link between tax cuts and economic growth is unproven and inconsistent. Arizona s economy has had both ups and downs during our 25 years of tax cuts. Given our current fiscal conditions, more tax cuts will mean more spending cuts that weaken our economic infrastructure and dampen job growth. Arizona has been cutting taxes consistently for 25 years. We kept cutting taxes right through the Great Recession and beyond and some of those tax cuts are still phasing in. Despite the continuous tax cuts and the accompanying promises that they would supercharge our state economy, recovery from the recession remains painfully slow. The fact is that the link between tax cuts and economic growth is a messy business. There is no clear consensus and no consistent research results to prove the argument that tax cuts grow jobs. One thing is clear. Cutting taxes means cutting revenues. Even Alan Viard from the famously conservative American Enterprise Institute says that s obvious. In an October 7, 2012, C-Span interview he said: It is correct of course that tax cuts are not revenue increasing. The incentive effects are not big enough so that you actually will raise more revenue. Tax Cuts Passed Since the Recession Account for More Than One-Third of the FY 2016 $1 Billion Revenue Deficit 38% 38% of projected budget deficits are due to tax cuts passed since 2009 And what happens when we reduce revenues? We have to cut spending. Source: Joint Legislative Budget Committee Staff, Finance Advisory Committee Presentation, January 22, 2015; 2014 Tax Handbook. The tax cuts passed by the state legislature just since the recession in 2009 account for more than onethird of the projected budget shortfall in fiscal year If we hadn t wiped out that $383 million in revenues, we could have avoided all of the new budget cuts this year to K-12 and higher education, the cuts to child safety and economic security, and the cuts to our health care system. July 2015 l Children s Action Alliance 17

24 The spending cuts following a tax cut can cause economic damage themselves, running directly counter to the intent. As described by the WP Carey School of Business at Arizona State University: Empirical evidence exists that public infrastructure plays a role in increasing business investment, job creation and economic growth. Similarly, tax reductions financed by cutting education, infrastructure spending, and other services valued by businesses will have a negative effect on economic performance (A Summary of the Arizona State Government Fiscal Situation, March 2009). In recent years, some Arizona leaders have pronounced that Arizona should be less like California and more like Kansas when it comes to taxes. But the real life results don t back up the pronouncements. In the fall of 2012 California voted to increase the state sales tax as well as income taxes for the wealthiest Californians. One executive there predicted that this temporary rate increase would cause his state s economy to self-destruct and that more companies would be motivated to find greener pastures. The Greater Phoenix Economic Council announced it would offer free airfare and hotel rooms to the first 100 California CEOs and high-tech, highwage business owners who wanted to look at moving to Arizona. So, did the predictions of California s demise come true? Not at all. According to the U.S. Bureau of Labor Statistics, Arizona has added 130,300 new jobs since December 2012 a 5.2 percent increase. But California grew far more jobs than Arizona adding over 1 million jobs with a 7.1 percent increase. Jobs Gained (December 2012 to March 2015) Percent Increase Arizona 130, % California 1,054, % Kansas 42, % U.S. 6,090, % While California raised taxes, Kansas went in the opposite direction. Governor Brownback and the Kansas state legislature cut personal income tax rates significantly and made some other tax changes to replace some of that revenue in 2012 and They said the tax cuts would grow the economy, bringing prosperity to Kansans. But these two rounds of tax changes have left a large and growing hole in the state s budget shrinking school funding and other public services. At the same time, Kansas job growth of 3.1 percent since December 2012 has lagged behind the national average of 4.5 percent. It s clear that there is no automatic, guaranteed link between tax cuts and job growth. It all depends on where you start and what you do with both sides of the ledger. Whether it s a business or an individual, economic decisions about relocation and investment depend on many factors and taxes are far from the top of the list l July 2015

25 BUDGET TRENDS Has Arizona recovered from the recession? No. Arizona still has not regained all of the jobs lost during the Great Recession. Neither state revenues nor spending have returned to pre-recession levels. As of June 2014, the nation had recovered all the jobs it had lost during the Great Recession. Almost a year later, Arizona has regained only 78 percent of the jobs that were lost. The impact of the recession on state revenues has been severe and long-lasting. Recent projections are that revenues will not return to pre-recession levels until after fiscal year Percent of Jobs Recovered Arizona 78% U.S. 132% Maine (lowest) 50% North Dakota (highest) 1,723% Calculated from Bureau of Labor Statistics State and Area Employment, Hours and Earnings, seasonally adjusted nonfarm data, 2007 to March Arizona General Fund Revenues Are Not Expected to Recover Until After FY 2018 Billions of Dollars $9.26 $9.62 $8.76 Temporary Sales Tax $8.05 $8.71 $9.11 $8.36 $8.56 $8.85 $9.14 $9.51 $6.97 $6.29 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15* FY 16* FY 17* FY 18* * Projections Source: Joint Legislative Budget Committee Staff, Finance Advisory Committee Presentation, January 22, 2015 and Appropriations Report FY July 2015 l Children s Action Alliance 19

26 Despite higher costs, more prisoners, more students, and more children in foster care, the fiscal year 2016 state budget is smaller than the budget in fiscal year In total the budget is 86 percent of what it was right before the Great Recession. But the differences vary widely across state agencies and services. The Department of Corrections budget is 14 percent higher than it was before the recession, while funding for community colleges is 67 percent lower. 69% Change in State Agency Budgets General Fund Dollars, FY 2008 to % 3% -5% -11% -15% -41% -28% -59% -67% Child Corrections Health AHCCCS K-12 Economic Universities School Community All Other Safety Services Education Security Facilities Bd Colleges Agencies Source: Joint Legislative Budget Committee Staff, Appropriations Report FY 2008 and FY Most budget cuts to state services have not been restored since the recession. Examples include: Eliminating $4 million in state funding for child care assistance for low-income working families. Cutting in half the job training funds for parents trying to move from welfare to work. Phasing out KidsCare health coverage for children in low-income, working families. Reducing by 20 percent the amount families can receive in TANF cash assistance. Eliminating the building renewal formula for public school building maintenance and repair and replacing it with a small grants program that is 80 percent lower than the funding provided in fiscal year Suspending statutory funding formulas for K-12 education and university financial aid, and statutorily eliminating all state funding for Pima and Maricopa community colleges l July 2015

27 Other state budget cuts have been funded by requiring counties, cities and towns to pay for what had previously been a state cost, including: Eliminating the $9 million in state funding for Maricopa County superior court judges. Reducing the Department of Juvenile Corrections budget by $12 million and requiring the counties to make up the difference. Requiring local governments to pay $21 million of the cost for operating the Department of Revenue. July 2015 l Children s Action Alliance 21

28 What stands out in K-12 public education funding? Despite the intent of the temporary sales tax to shield education from budget cuts, state investments in charter and district schools have been reduced in numerous ways. State funding per student has dropped 24 percent since fiscal year Many schools are experiencing crowded classrooms with too few desks and supplies, outdated textbooks and technology, and severe teacher shortages. By any measure, Arizona s K-12 education funding (adjusted for inflation) has dropped. Trends in funding from state, local and federal sources are shown below. Arizona s Education Funding Per Student Has Dropped (Adjusted for Inflation) $8,868 $7,712 $7,783 $7,799 $6,737 $6,754 $4,303 $4,654 State, Local, and Federal Funds State and Local Funds Only State Funds Only $3,512 $3,529 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 est. est. Note: State funds include the Permanent State School Fund and appropriated dollars in addition to the general fund. Source: Joint Legislative Budget Committee Staff, K-12 Funding (M&O, Capital and All Other), August 7, From a national perspective, U.S. Census data from 2013 ranks Arizona in the bottom five states for various measures of revenue and spending per student. Arizona also ranks third worst in the country in the depth of cuts to school funding since the start of the recession (Center on Budget and Policy Priorities, Most States Still Funding Schools Less than Before the Recession, October 2014 ). Arizona has cut investment in K-12 schools, per student adjusted for inflation, by 17.5 percent since 2008 putting us behind only Oklahoma and Alabama. Seventeen states have increased education funding since the recession l July 2015

29 The budget cuts to education come at the same time that lawmakers and taxpayers have been raising expectations for schools, teachers, and students. Examples of major cuts to K-12 education include: Lawmakers eliminated state funding for full-day kindergarten. Schools now receive funding for half-day kindergarten only; districts can offer full-day kindergarten but have to pay for it either by cutting spending somewhere else or charging tuition. The building renewal funding formula for schools to repair and maintain school buildings was repealed from state law as part of the fiscal year 2014 budget and replaced with a grants program that is less than one-tenth of what the formula had called for. The state budget suspends a portion of the additional assistance formulas that pay for textbooks, computers, technology, classroom supplies, etc. District schools will receive only $63 million instead of the full $445 million required by the formula. Charter schools will receive $291 million instead of $310 million. In a lawsuit called Cave Creek v. Ducey, the Arizona Supreme Court has ruled that the state legislature violated a voter mandate by only partially funding inflationary adjustments for K-12 funding for three years. The Superior Court has ordered the state to re-set the funding base to meet the voter mandate by adding $337 million to the K-12 budget every year starting now. The state legislature is appealing this ruling, arguing that their calculation would make the adjustment much smaller. Legal arguments are also ongoing about whether schools must be reimbursed for the missing funding during these three years a total of $1.2 billion. Policy and political discussion about education funding often center on whether school districts are spending tax dollars wisely and getting the money to where it matters most for children. In a February 2015 report, the Arizona Auditor General noted that on a statewide basis, administrative spending by school districts is low. Compared to national averages, Arizona districts spent 0.9 percentage points less on administration because they paid lower salaries to administrators and support staff and/or employed fewer of them. In fact, according to the U.S. Census Bureau, Arizona had the second lowest administrative spending per K-12 student in 2013, including both school and district administrative expenses. July 2015 l Children s Action Alliance 23

30 K-12 Administration Spending Per Pupil, 2013 District of Columbia $3,470 Alaska $2,037 Vermont $1,971 Wyoming $1,817 Connecticut $1,718 Delaware $1,668 New Jersey $1,662 New York $1,636 Illinois $1,627 Wisconsin $1,525 Ohio $1,522 Maryland $1,521 North Dakota $1,506 Rhode Island $1,500 Pennsylvania $1,411 New Hampshire $1,385 Oregon $1,365 Colorado $1,306 Michigan $1,262 Maine $1,261 Massachusetts $1,201 Nebraska $1,201 California $1,188 Louisiana $1,176 Montana $1,172 United States $1,166 Iowa $1,163 Hawaii $1,114 Missouri $1,107 Indiana $1,100 Washington $1,099 Minnesota $1,084 Kansas $1,080 Nevada $1,038 South Carolina $1,012 West Virginia $1,012 Kentucky $1,005 South Dakota $1,004 Virginia $992 Arkansas $969 Oklahoma $957 Georgia $952 New Mexico $951 Mississippi $934 Alabama $932 Texas $914 North Carolina $883 Tennessee $842 Florida $760 Idaho $706 Arizona $659 Utah $637 Arizona has the 2nd lowest spending on K-12 administration* $ and has the 7th lowest percentage of K-12 spending on administration costs 9.0% * Administrative includes school administration, general administration, other support, and non-specific support services. Source: Public Education Finances, 2013, issued June 2015, U.S. Census Bureau, Department of Commerce, Economics and Statistics Administration l July 2015

31 There has been a lot of criticism of public schools for not spending more of their dollars on classroom instruction. It s true that Arizona s spending per student for classroom instruction is lower than the national average. And due to low state education budgets, Arizona s spending per student is lower than the national average in every category of school spending. In 2013, Arizona schools spent a total of $7,208 per student only two thirds of the national average of $10,700. Education Spending Per Pupil Transportation $485 $353 U.S. AZ Plant Operations $1,009 $818 U.S. AZ A narrow focus on classroom spending ignores budget areas that are directly linked to student success. For example, spending in student support services is not considered classroom spending, but it directly supports student learning and achievement. This spending pays for speech, audiology and occupational and physical therapy services for students as well as health, psychological services, attendance, social work and guidance. Spending needs for these services vary depending on the percentage of students who live in poverty or have special needs. Similarly, spending on instructional support is not counted as classroom spending but pays for teacher training, curriculum development, and library, media and technology services, all designed to improve classroom instruction. Other areas of the budget are equally vital to students daily learning, such as food services, transportation, and capital funding for school facilities, equipment, and technology. Instructional Support Student Support Classroom Instruction Administration Other $502 U.S. $601 U.S. $6,480 U.S. $1,166 U.S. $458 $410 AZ $567 AZ $4,016 AZ $659 AZ $385 Source for illustration: U.S. Census Bureau, Department of Commerce, Economics and Statistics Administration, Public Education Finances: 2013, issued June U.S. AZ July 2015 l Children s Action Alliance 25

32 The U.S. Chamber of Commerce draws a direct link from high-quality education for all students to global economic competitiveness, warning that even our most privileged students rank in the middle compared to international peers and disadvantaged students fall far behind. The Chamber concludes that no society or economy can afford for so many of its students to be left behind. (Leaders and Laggards, 2014) In their state-by-state report card on K-12 educational effectiveness, the Chamber gives Arizona a grade of D for both overall academic achievement and academic achievement for low-income and minority students. At the same time, the Chamber grades Arizona with a B for return on investment, noting that student achievement is high relative to the low level of state spending l July 2015

33 What are the budget trends for the safety net? Arizona has a history of bipartisan support for policies that provide temporary help to prevent hunger, homelessness, illness, abuse and neglect. All of these can have lifelong consequences for children and high costs for taxpayers. Budget cuts have weakened the safety net and resulted in expensive emergencies for the state to handle. Public funding for the safety net works together with private charitable efforts to help struggling families working to get back on their feet especially families with children. In fiscal year 2016, no state general fund money is appropriated for child care assistance for low-income working families and only a total of $5.7 million is appropriated for cash assistance, job training and services to address hunger, domestic violence, and homelessness less than 1 percent of the general fund budget. What is Cash Assistance? Cash assistance is a small monthly payment (not more than $278 per month for a family of three) to very poor qualified parents to help them pay for basic needs such as rent and clothing while they prepare to join the workforce. Before and during the Great Recession, many budget cuts to the safety net were passed with a short term goal of saving state spending. But the longer term results have been more families in crisis with nowhere to turn for help and expensive emergencies for the state to handle. An important part of the safety net is welfare for the poorest mothers and children also known as cash assistance or Temporary Assistance for Needy Families (TANF). Over the past few years, the monthly cash amount has been cut by 20 percent. The maximum life-time limit for participation, which was five years until 2009, will be only one year effective July 1, 2016 making Arizona the only state with a limit below 21 months. Other qualification rules narrowed eligibility and cut more than 14,000 children being raised by their grandparents. July 2015 l Children s Action Alliance 27

34 The combined result of these policy changes has been dramatic. At the beginning of welfare reform in 1996, cash assistance was reaching more than half of families with children in poverty in Arizona. By 2013, fewer than one in 10 poor families with children received cash assistance. Many More Families with Children in Poverty Fewer Families Receiving TANF Cash Assistance 181,700 33,800 17,300 17, TANF Cash Assistance Cases Families in Poverty Source: Center on Budget and Policy Priorities analysis of poverty data from the Current Population Survey and TANF caseload. Another part of the safety net, child care assistance, was also cut dramatically. All participating families have time limits on the assistance and all help pay for child care, with copayments based on their income. What is Child Care Assistance? Child care assistance is a voucher paid for with tax dollars to help qualified, working parents earning low incomes afford chld care of their choice in their community l July 2015