A huge tax cut with bipartisan support? It almost happened — and is a stark contrast to AZ's new flat tax

The pitch was enticing: Shrink Arizona's tax code from five rates to two. Cut taxes for nearly everyone. And make it so simple an Arizona tax return could fit on one page.

While streamlining the state's income tax is an effort championed today by Gov. Doug Ducey, it almost happened 35 years ago. 

The Income Tax Act of 1987 had many features similar to the major tax policy that lawmakers approved last year, which will give the state one lower, flat rate for income taxes. Ducey announced last week the single 2.5% rate will take effect in January, a year earlier than anticipated.

But there are also striking differences between the two proposals, separated by more than three decades.

The contrast illustrates how an issue as wonky as tax rates can reveal shifts in who state leaders think should benefit most from a booming economy. It also shows there is more than one way to get to a flat tax rate, with different winners and losers and variable consequences for state programs.

For example, the 2021 plan cuts taxes for all, but gives the biggest savings to the highest income earners. Legislative budget staffers estimate it will permanently remove $1.5 billion from the state's accounts. In contrast, the 1987 plan would have actually raised taxes on the top 2% of income earners and would have kept the state budget level by eliminating deductions. 

In 1987, the plan had bipartisan support — passing the House of Representatives with only one dissenting vote — compared to last year, where the flat rate was ushered into law on the strength of Republican votes and over the warnings of Democrats who warned it would jeopardize the state budget and risk program cuts when the economy enters a down cycle.

Property tax exemptions: What Arizona voters need to know

The 1987 plan was a reaction to federal income-tax changes in 1986 that, if not addressed at the state level, would have raised state income taxes.

The 2021 legislation was a response to a state surplus estimated between $2 billion and $4 billion, some of it buoyed by one-time federal COVID-19 relief dollars.

One plan had the enthusiastic support of a Republican governor; the other was disdained by a GOP governor, despite strong bipartisan support.

There was another critical difference: The 2021 plan passed and is now law. The 1987 proposal foundered in the state Senate.

Then-Gov. Evan Mecham, a Republican, was key to the original flat tax plan's demise. He told Senate leaders he did not want to see the bill, preferring his own tax proposal, said former Rep. Chris Herstam, who was the bill's sponsor and the chairman of the House Ways and Means Committee at the time.

Herstam, who was then a fellow Republican, was also a prominent Mecham critic. The governor was intent on delivering on a key campaign promise: To roll back a 1-cent increase in the state sales tax that was introduced as a "temporary" tax but morphed into a permanent increase. Mecham was unsuccessful in that quest.

Legislative records show the Senate in 1987 struck the tax language out of the bill and sent it back to the House for agreement. With no compromise, the bill died.

What happened with the 1987 tax cut

Herstam, now a registered Democrat, is among the detractors of the new tax plan, which ranks as the biggest income tax cut in state history.

While the flat rate gives every Arizona taxpayer a break, the biggest reduction goes to the highest earners. A filer with an adjusted income ranging from $1 million to $5 million was estimated to get a break of $44,762, according to legislative figures issued when the plan was debated last year.

For taxpayers who earn up to $40,000, the Joint Legislative Budget Committee projected a savings ranging from $2 to $8.

In contrast, the 1980s-era plan cut taxes for about 70% of Arizona taxpayers, and would have kept taxes the same for 28% of filers. But it would have raised taxes for the 2% of taxpayers whose adjusted income in 1987 was $75,000 or above, a move to keep the state revenues neutral. 

Herstam said the intent was to shift to a flatter income tax without some of the collateral risks of a steep cut to state coffers, such as cuts to local governments or big tax breaks for the wealthy. It proposed a 3% rate on taxable income up to $5,000, and 4% on income earned above $5,000.

"My reform effort was based on the desire for a more fair, simple, nonpartisan tax code that was free of special interest deductions and and credits, and did not hurt local government that shared revenue with the state," he said recently.

Lawmakers last year eventually agreed to remove a provision that would have forced a cut in the income-tax revenue the state shares with cities and counties. That move solidified support for the tax package.

News accounts from 1987 showed the flat tax plan had scant opposition. It passed the Ways and Means Committee unanimously. No one testified at the hearing in February 1987, legislative records show, even though the bill would eliminate deductions and exemptions that lower a person's tax liability.

When the bill came before the full House, it won on a 54-1 vote. 

The only "no" vote came from Rep. Jack Brown, a Democrat from St. Johns. A member of the LDS Church, Brown opposed the elimination of the tax write-off for charitable contributions, which extends to churches, Herstam said. Brown is deceased.

The current tax policy keeps the charitable deduction, whose limit was raised in 2021, as well as numerous other write-offs in the state's tax code.  That's why some critics say Arizona's 2.5% rate is not a true flat tax because it lacks simplicity. The state's menu of deductions and tax credits requires a tax form larger than the flat tax ideal of a single postcard return for all filers.

Some states with a flat rate eliminated deductions and in other cases, personal exemptions, in the trade off to get to a lower, single rate. Arizona chose to keep those write-offs, which will reduce a taxpayer's tax obligation, in addition to shifting to a flat rate.

Although his plan is decades old, Herstam argues it's still a valid approach.

“It’s an example of how you can do meaningful tax reform in a nonpartisan, intellectual way," he said.

Hopes were high as the bill moved through the state House. Rep. John Wettaw, R-Flagstaff, called it “the most sweeping tax bill in decades.” 

How the current tax cut came together

It took three and a half decades before Wettaw's accolade could again apply to tax code changes in Arizona. The 2.5% rate coming in January is the lowest in the nation, not counting the eight states with no personal income tax, and the largest income-tax reduction in state history, according to the legislative budget office. 

A number of factors converged to create the climate for such a major step: From restrained state spending during the first year of the COVID-19 pandemic to a surprising economic bounce back once the state reopened, which left the state flush with cash.

State Rep. Ben Toma led the drive to shift Arizona to a flat rate. The policy built on tax changes made in 2019 that eliminated one of the state's five tax brackets, increased the personal exemption to $12,400 for single filers ($24,800 for married filing jointly) and levied sales tax on online sales from companies that didn't have a physical presence in Arizona. That increased sales tax collections, adding to the surplus.

Those conditions set the groundwork for 2021's massive tax cut. Toma said lawmakers had enough money to keep government funded, make some important ongoing increases, and still afford an income-tax cut that would permanently reduce state revenues.

There are significant differences from 35 years ago, Toma, R-Peoria, said.

Flat tax rates were almost non-existent then; Colorado was the only state to adopt such a policy, according to the Tax Foundation, enacting it in 1987, at the same time Arizona was considering such a move.

In the 21st century, more states moved to flat rates, while other states challenged Arizona's economic attractiveness by touting the fact they had no income tax at all.

"The political environment is different now, the budget is different and our needs are different," Toma said. "Our tax environment was just not attractive prior to this."

Plus, Toma and other Republicans argued, state coffers were awash in cash. It made sense to return some of that to taxpayers, creating a permanent cut in the state budget.

Unlike three decades ago, the perception of the state's needs last year were starkly different across party lines. Where Republicans argued lower taxes would attract more business and economic activity, Democrats saw an opening to address needs that were neglected due to years of budget shortfalls. This resulted in an unbridgeable partisan divide.

The major objection to the 1987 plan appeared to be a personality conflict between the bill's sponsor and Mecham, as well as Mecham's focus on reducing the sales tax.

The objection in 2021, Toma said at the time, was more philosophical, rooted in a fear of what might happen in the future with such a steep cut.

With Republicans in the majority, and Ducey eager for a cut that would advance his ambitions to get the income tax rate "as close to zero as possible," those fears were swept aside.

Reach the reporter at maryjo.pitzl@arizonarepublic.com and follow her on Twitter @maryjpitzl.