This session has been rich with terrible tax policy ideas.  From tax increment financing to refundable tax credits – the legislature has considered several bills with proven track records of failure in other states.

One particular idea that has circulated this session and gained a level of undeserved traction is the Rural Tax Credit Program.   Proponents of the bill have sold the legislation as a way to jump-start the rural economy.

The legislation is complicated which aides in befuddling lawmakers into believing it must be brilliant.  Essentially the mechanism works as such: qualified Rural Investment Firms (of which there are only a few) are eligible for $30 million in salable tax credits upon raising $50 million in investible capital.  The tax credits may be utilized to offset corporate income, individual income, or premium insurance taxes.  Premium insurance taxes are paid by insurance companies on individual policies sold, and are assessed at 2 percent of total revenues.

 

The Rural Investment Firm then invests the capital into businesses located in rural Arizona, often as debt-financing, i.e. directs loans.  The money is essentially raised leveraging a tax payer-subsidized risk pool by the State foregoing future tax revenues.  Additionally, the insurance companies’ reward is also not directly tied to the investment in rural businesses; but in the purchase of the tax credits which reduce their liabilities.

 

This financing arrangement severely distorts the risk involved in traditional capital raising and investment.  And although the Investment Firm uses other people’s money, much like a bank does, they are not required to pay it back – not to the insurance companies, and not to the State.  In other words, state taxpayers are stuck subsidizing the risk under the plan while the investment firm gets to keep all of the reward.

 

Similar programs have been tried in other states over the past few decades, predominantly under the name CAPCO (Capital Companies,) with dismal results. CAPCO has been widely regarded as one of the most inefficient ways to raise capital, and ineffective ways to invest capital.    Because CAPCO has earned a terrible reputation for wasting tens and hundreds of millions of dollars, the program has been rebranded and repackaged several times. And while the Rural Tax Credit program does contain some modest improvements and is less lucrative compared to other failed CAPCO plans, it is still functionally the same deal.

Many states that have implemented similar programs have repealed them or let them sunset:

All of these CAPCO programs differ in detail.  Some allow their tax credits to be first collateralized into notes, before they are sold to insurance companies.  Some allow for a dollar-for-dollar tax credit.  Others allow for the tax credits to be used prior to the capital being invested.  And most allow Investment Firm to assess generous management and legal fees.  However, each of these variations are not very substantive.  The basic mechanism remains the same in all CAPCO programs, including in the Rural Tax Credit Program proposed in HB2530 and SB1212.

At the end of the day the Arizona Legislature should learn from other states’ that have bit on these investment models.  Given the information, analyses, and record of failure readily available to interested lawmakers, anything less than an emphatic rejection of HB 2530/SB 1212 is unacceptable.

As the budget battle heats up at the legislature, Governor Ducey and lawmakers are currently debating multiple proposals to increase funding for K-12 classrooms. With limited resources available to achieve many of these goals, it is important that policymakers prioritize where new dollars are spent and avoid proposals that do not improve outcomes or implement bad tax policy.

First, here are some of the ideas that should be avoided:

Expanding All Day Kindergarten: Though very politically popular, multiple studies show increasing funding for all-day kindergarten either results in no increase in achievement, or the gains are lost by the third grade. Until it is determined why all-day kindergarten is not improving student performance, lawmakers should not increase funding for the program.

Exempting Teachers from Paying Income Tax: Lawmakers want to provide a pay raise for teachers, and since everyone hates the income tax why don’t we do both at the same time? Of course, the problem with this tax carve-out is that it will spur other classes of government employees (police officers, firefighters, etc.) to ask for the same deal. Additionally, evidence shows that taxpayers who are exempted from paying the income tax (both businesses and individuals) are much more likely to support future income tax increases on everyone else who do pay. If lawmakers believe in paying government employees more, do it through a pay raise. And if they want to cut income taxes, do it for everyone, not for a select group.

Borrowing for School Construction: After the recession in 2008, much of the funding provided by the state for new school construction dried up. In some respects, the reduction made sense since population growth stopped and several districts actually experienced  enrollment decline. Now that population growth has rebounded, there is renewed need to provide dollars to the School Facilities Board. As an alternative to appropriating the funds, however, there are discussions to just borrow the money for the construction. This is the wrong approach that could wreck the structural balance of the budget and lead to more borrowing in the future.

Rather than spending funds on these options that are not outcome focused, lawmakers should instead focus on proposals that improve accountability, improve student performance and are based on results. The best proposal released so far to accomplish this goal is the Governor’s recommendation to provide additional funding to achievement schools that are high performing or demonstrate student improvement.

Under the plan, top-performing district and charter schools would receive additional funding, with low income schools getting a larger share. This approach makes sense as it ties funding to outcomes, which is what the priority should be.

As we near the conclusion of budget talks, let’s hope lawmakers choose the right policy path of funding K-12 outcomes, not the politically easy one of more money with no strings attached.

 

There has been a flurry of bills this session aimed at increasing funds for transportation – all have involved increasing taxes:

SB 1146 might be the worst of all.

The amended SB 1146, which was supported by all Democratic members and three Republicans in the Senate, gave carte blanche fee authority to the Director of the Arizona Department of Transportation (ADOT) to charge any Vehicle License Tax rate they desired.  For example, if the ADOT director decided to double the VLT tax or to assess a $10,000 VLT on gas-guzzling pick-up trucks to combat climate change, it would be lawful under SB 1146.

Why would anyone support giving unelected bureaucrats the power to charge whatever tax or fee they want with no legislative oversight? The answer is that this is an attempt to circumvent Proposition 108, a constitutional taxpayer protection that requires a 2/3 affirmative vote by the legislature to raise taxes.  By handing their taxing authority to the ADOT Director, the legislature can claim that this is an “administratively set fee” that is not subject to Prop 108.

This end-run on our constitutional requirement of a 2/3 vote is currently being litigated in court by the Goldwater Institute over Medicaid expansion. Under scrutiny is two parts – whether the Legislature voted to increase NEW revenues, and whether the Hospital Fee assessed by the Director of Arizona’s Medicaid system was indeed a “fee” or a “tax.”

If the courts side with allowing for this administrative tax increase loophole, lawmakers will have discovered a way to raise taxes that erodes separation of powers inherent to our system.  The legislature is supposed to be the purse strings; elected to do one job – pass a budget.  This means the levers to extract money from taxpayers lies at their feet.

Not only does SB1146 allow an unelected bureaucrat to unilaterally set tax rates for Arizona residents – but it allows politicians to dodge accountability for the tax hike.  It is almost difficult to comprehend why our elected representatives would even consider such a dangerous proposal except as a way to avoid any accountability for supporting a tax increase.

Fortunately for taxpayers, it appears that SB 1146 is no longer moving this session. But given the uncertainty of the Medicaid lawsuit and politicians insatiable appetite to capture as much money as possible without anyone noticing, we fully expect similar efforts to appear in the future.



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The Arizona Free Enterprise Club is a free market policy and advocacy group dedicated to promoting a strong and vibrant Arizona economy.