In Arizona, budget cuts alone won’t cut it, economists say

By the time Arizona legislators finally balance this year’s budget, they could be meeting in a building not technically theirs.

Losing outright ownership of the state legislative buildings would not be among the most severe or personal consequences of the so-called “Great Recession,” but perhaps among the most symbolic. For some lawmakers, the sale and leaseback of the Capitol is desperation embodied, but balancing the budget will likely get even harder.

With the state at least $1.4 billion in the red and spending at almost twice the rate of money coming in, there’s no hedging room left for the legislature when it resumes meeting Jan. 11.

Arizona’s most prominent economist has announced that by his tally, it’s impossible to balance the $10.1 billion budget without new revenue – read: taxes – which the Republican-dominated legislature has fought for months.

Lawmakers refused even the Republican governor’s proposal to let voters approve or reject a temporary one-cent sales tax increase. Gov. Jan Brewer had to sue legislators to get them to send her budget bills last year. And under the state’s super-majority rule, it takes only 11 legislators to kill a tax bill.

Even so, a tax increase is possible because Arizona’s situation is so desperate, second only to California’s in severity, said Marshall Vest, an economist at the University of Arizona with 30 years experience observing the state legislature.

“I’ve learned that you just cannot predict what is going to happen,” he said. “Just about everything on the table is a kind of last resort.”

The Arizona constitution requires a balanced budget, but the funding from which legislators can cut is limited by federal and voter-approved mandates.

“The bottom line is, you could lay off every state employee and not begin to balance the budget,” Vest wrote in a December report. “You could entirely eliminate higher education and not come close. Ditto for welfare programs . . . and programs for children . . .”

Thirty-seven states have raised taxes since 2008, according to the National Association of State Budget Officers, and Arizonans are among those with the lightest tax burden.

By Jan. 7, five months into the budget-balancing debacle, Republican organizers had begun to hint that a tax hike might be unavoidable.

“There has to be some kind of revenue,” said Paul Boyer, the communications director for state House Speaker Kirk Adams. Boyer was reluctant, however, to link “revenue” explicitly with “taxes,” saying that there was more debt refinancing that could be done.

According to the Joint Legislative Budget Committee, which reviews state finances for the state House and Senate, Arizona government has already borrowed as much as it can internally and has an average daily balance of $747 million in outside borrowing.

That borrowing got more expensive when two rating agencies downgraded the state’s credit rating Dec. 23. Moody’s cited “revenue raising requirements” among the reasons for the rating change, and Standard & Poor’s noted the “state’s structurally imbalanced budgets, which are partly due to what we consider a lack of significant budget action.”

But the first order of business scheduled for the legislature’s Jan. 11 session is not tax increases. Rather, the focus will be a job creation package with embedded tax cuts.

“More than anything, we need job creation,” the Republican Party spokesman said. “Tax relief is an important part of that.”

The idea is to increase state revenue through economic development targeting the mining, manufacturing, and research and development industries.

The legislation, named the Arizona Economic and Job Recovery Bill, is based on a report compiled by Elliott Pollack, a prominent Phoenix economist who states explicitly that his recommendations should not be understood as a solution to the state’s budget deficit because benefits would be mostly long term.

Despite Pollack’s warning, lawmakers have already begun releasing statements linking job creation with a balanced budget and tax increases.

“As Commerce chair, I believe this bill can do more for Arizona’s short and long term economic outlook due to its comprehensive approach than any tax increase ever could,” Phoenix Rep. Michelle Reagan wrote in an early January statement.

The bill would reinstate a job training program suspended last year, reduce taxes for businesses and homeowners and create a fund to entice businesses considering relocation to the state.

If the bill passes as written, business property taxes would drop five percentage points to 20 percent, the corporate income tax would drop from 7 percent to 4.5 percent, a tax due to be reinstated this year would be repealed and small businesses would get an income tax break.

“As a result of the income tax relief, every single taxpayer in Arizona will receive a rate reduction,” a fact sheet released by the office of the House speaker states.

How to fill the hole left in the state budget as a result of lower tax rates? “That should be addressed by job creation as a result,” Boyer said.

The state is running out of options. If lawmakers are unable to agree on more cuts or new revenue and the economic development package doesn’t work as planned, Arizona will be issuing IOUs by March, Vest said.

The sale and leaseback of state-owned properties won’t solve the problem. The $735 million expected from the Jan. 12 sale is enough, probably, to cover the state’s February bills.

Over the 20-year term of the property sale and leaseback, Arizona will spend about $1.2 billion to lease property it now owns outright, the Treasury Department estimates. After 20 years, the title will be transferred back to the state, according to the standard contract.

It’s still unclear exactly how the IOUs, if needed, would be structured, but state Treasurer Dean Martin has suggested an interest rate of about 0.5 percent, far less than the 3 percent interest offered during the five months California offered the warrant notes.

“That’s a lot less incentive to buy,” Vest said.