The clean-up of the corporate income tax code and the rate reductions that should result from it are just the first steps toward fundamental reform of the overall business tax regime in Arizona. The following is a menu of policy prescriptions, each of which will make Arizona's business tax climate more competitive in the region and the nation. The reforms are listed in order from least to most aggressive. Each of these proposals is designed to be enacted in single year: a multiple year phase-in of any tax cut delays and hinders the economic growth potential of the cut. Table 7 (click on the PDF button below) shows the one-year economic and revenue effects of each proposal. Additionally, spending cuts should be seriously considered to offset any revenue declines that might result from these reforms. For footnotes on the projections, refer to the full study.
1) Equalize the state's income tax rates.
Arizona has a higher statutory tax rate on corporate income than its northern neighbors, Utah and Colorado. Arizona also imposes a higher top tax rate on corporate income than it does on personal income. If the state wants to have an efficient income tax system, there is no reason to tax a different type of income with a higher rate, as doing so creates economic distortions. To become more competitive in the region, Arizona should keep the corporate income tax rate no higher than 5.04 percent. This would equalize the top taxation rates between personal and corporate income, creating an estimated 10,000 new jobs as a result. Although there would be a static loss of around $96 million in corporate income tax revenue from the baseline, the increase in economic growth would offset this by increasing personal and sales tax revenue, so that general tax revenue would decrease only by a net of $74 million.
2) Cut the corporate income tax rate to a regionally competitive level.
Lowering the state corporate income tax rate to 5.04 percent would make Arizona's corporate tax code competitive with Utah, but Colorado's flat corporate tax rate would still be lower. Therefore, legislators should seriously consider lowering the corporate tax rate to 4.63 percent. Again, the economic effects would be substantial: 12,000 new jobs could be created, with a net revenue decline of only $89 million (which includes a $27 million increase in personal income and sales tax revenue).
3) Suspend the unemployment tax rate for at least a year, and lower the rate thereafter.
The unemployment insurance fund has a substantial surplus, and even in the unlikely event that unemployment claims double in the next two years, the fund would have more than enough to cover mandated benefits. Suspending the unemployment insurance tax rate would give businesses and workers some breathing room in the tight economic climate we have been experiencing. The most important effect of a temporary suspension of the unemployment tax would be a large increase in new job and payroll growth. On its own, without any corresponding decrease in the corporate income tax rate, this action could create 116,000 jobs and generate a $4 billion increase in real payroll-in a single year. This effect is driven by the fact that the unemployment tax is primarily a tax on labor. Cutting that tax would help the worker most, and help businesses by lowering the cost of hiring labor. A suspension of the unemployment tax for a year would spur a net increase in sales and income tax revenue to the tune of $268 million.
4) Suspend the unemployment tax and cut the corporate income tax rate to a regionally competitive level.
If the unemployment insurance tax is suspended in conjunction with a decrease in the corporate income tax rate to 4.63%, the number of new jobs created would leap to over 128,500, real payroll would grow by $4.6 billion, and the state would experience a revenue spurt of $179 million. That revenue boost would likely continue in future years as a result of the new stock of jobs in the state. A permanent reduction of the unemployment insurance rate to 0.5%, or even a halving of the state unemployment insurance rates after 2003, would sustain the job and revenue growth, keeping the rate of expansion between 5 and 10 percent above current trends.
5) Eliminate the corporate income tax.
Eliminating the corporate income tax is one of the best steps that the legislature can take to spur economic growth. It would increase Arizona's tax competitiveness by substantially lowering both the overall tax burden and by making the state comparatively friendlier to business. Perhaps most importantly, it would bring the state closer to a tax system based on consumption, which would be more economically efficient and more favorable to growth. The economic growth resulting from the elimination of the corporate income tax would be substantial. While payroll would grow $1.2 billion-not as much as if the state suspended the unemployment insurance tax-the number of new jobs would exceed 35,300. Net general revenue would fall by $266 million-once again, cushioned by an increase in sales and personal income tax revenue-but this shortfall could be made up by substantial cuts in the general fund budget.
6) Eliminate the corporate income tax and suspend the unemployment tax.
Suspending the unemployment insurance tax for a year would make abolition of the corporate income tax revenue-neutral. This reform would create roughly 150,000 jobs, and boost payrolls by $5.4 billion. Lowering the future rate to 0.5 percent for all businesses would preserve revenue-neutrality for the foreseeable future.