When policymakers say they have enacted “historic” legislation, they are usually accused of hyperbole. And, in many cases, that is a fair criticism. But in the case of Governor Brewer’s signing of HB 2815, it isn’t a big stretch to say that the action did make one historic move in regard to tax policy. It made Arizona the ninth state in the U.S. to effectively cut its capital gains tax. When the tax cut is phased in completely by 2016, the effective tax rate on capital gains will be 3.4%, instead of the current rate of 4.54%.
This is a very important step in making Arizona a more attractive place to do business and create jobs. And while we still have a ways to go to be really competitive with states that have no income tax, this move makes us more competitive with our neighbor, New Mexico, which in 2003 became the eighth state to cut its capital gains tax. New Mexico cut its capital gains tax in half, which put their rate at around 2.4 percent – a full percentage point lower than Arizona’s new rate. That tax cut precipitated a venture capital boom in New Mexico and translated to substantial job growth. To beat New Mexico at the capital gains tax cut game, we should lower our rate by another 25 percent. That would make Arizona’s capital gains tax rate the lowest in the nation.
There were some other important elements in this bill, too. It brought Arizona’s tax code up to par with most other states by increasing the number of years that corporations can carry business losses into the future. And it finally conformed the Arizona tax code to the federal code by allowing businesses to write off a larger share of the new capital investments they make by allowing what is called “bonus depreciation.” This is something that economists have long advocated as a job creator and something that the Goldwater Institute has been encouraging the Legislature to do since 2002.
Unfortunately, every rose has its thorns. The bill took a step in the wrong direction by creating a new tax credit that subsidizes a company for opening a new facility in Arizona or expanding an existing one. It’s not at all clear that credits like these actually encourage activity that would not have occurred in the absence of the subsidy. And, to make matters worse, the tax credit is "refundable." That means if a company has zero tax liability, they can still receive the subsidy in the form of a check from the government.
In the end, the Legislature and Governor Brewer are to be congratulated for this bill and moving Arizona toward a future in which venture capital and job growth return to the state and stay for the long term. But Arizona needs to go further, not just in reducing capital gains tax rates but in fundamentally reforming the tax system so that it doesn’t punish the creation of wealth, the starting of businesses, and real long-term job growth. So, who’s ready for round two?
Governor of Arizona: Press Release on Signing of HB 2815 (PDF)
Goldwater Institute: Investing in Arizona
Goldwater Institute: Don’t Repeat Jimmy Carter’s Failed Policies in Special Session Jobs Bill