Tax plan called costly to state, cities

Losses up to $137M forecast under gov's simplified sales levy
2013-03-15T00:00:00Z Tax plan called costly to state, citiesHoward Fischer Capitol Media Services Arizona Daily Star
March 15, 2013 12:00 am  • 

PHOENIX - A controversial plan by Gov. Jan Brewer to change how construction activity is taxed could cost the state up to $137 million a year in revenue, according to a new legislative budget study. A separate report puts the loss at $125 million.

And that doesn't even count millions of dollars that cities could lose if the new tax-collection plan is approved, according to the second report.

The Grand Canyon Institute, a nonpartisan research center, concludes in its report that if Brewer gets the changes she wants, it would leave the state's more than 90 cities with a total of $10 million less in construction sales tax revenue.

The reports could undermine efforts by the governor's staff to line up votes for Brewer's broader plan to simplify how the state's sales taxes are collected and audited.

Brewer wants to limit the ability of cities to tax items and services beyond what the state taxes. And it would ensure businesses that they are subject to only a single audit of their books versus the current situation, which allows a review by not only the state but every city in which they do business.

Potentially more significant, Congress is considering the Marketplace Fairness Act, a measure to allow states to impose their sales taxes on Internet merchants. But the federal legislation makes that ability contingent on states having a simplified sales tax system, the kind of system Brewer is pushing here.

Local businesses are making that change a priority.

On Thursday, Michelle Ahlmer, executive director of the Arizona Retailers Association, urged the state's two U.S. senators to back that law.

"The status quo provides out-of-state online sellers with an unfair competitive advantage over traditional brick-and-mortar stores and robs state and local governments of vital revenues needed to maintain important services, including funding schools," she wrote.

Michael Hunter, the governor's chief tax adviser, said that simplification remains Brewer's top priority. And given that importance, he said that if questions about changing the rules on contracting taxes cannot be resolved, the issue might have to be jettisoned to salvage the rest of the simplification plan.

Under current Arizona law, contracting is taxed at the point of construction.

In essence, builders determine the price of the project and then pay tax on 65 percent of that figure, what is presumed to be the cost of materials. Labor is not subject to tax.

What Brewer wants is to have taxes paid by builders when they purchase the materials. The contention is that will result in less "leakage," where contractors buy supplies without paying taxes and then use them in projects where the taxes are not captured.

Hans Olofsson, chief economist for the Joint Legislative Budget Committee, said Brewer's plan is built on an assumption that this "leakage" - essentially a noncompliance rate - is 31 percent of all contracting sales tax. He said if that and other assumptions made by the administration are true, the change would boost state revenues by $19 million.

But Olofsson said he and his staff question that 31 percent figure.

"Given that the largest contracts are typically audited in some fashion, there are reasonable questions as to whether Arizona's 'underground' contracting economy is that large," he wrote in a memo.

Using a 20 percent noncompliance rate and some other different assumptions than the governor used, Olofsson said the loss could be $137 million.

Hunter pointed out that even Olofsson's analysis said the approaches are "speculative" and that both sets of assumptions are "plausible." And Hunter said there have been estimates that put the noncompliance rate as high as 41 percent.

But Olofsson's more dire revenue prediction, based on that 20 percent noncompliance, got a boost Thursday with a separate analysis of the change prepared by the Grand Canyon Institute, which put the net negative effect on state revenues at $125 million a year.

Dave Wells, the institute's research director, cited projections showing the state's revenues are expected to remain relatively unchanged, at about $9 billion, for the next few years.

"There are serious questions whether the state can afford this kind of lost revenue, especially as one considers the possibility of another economic slowdown before the end of the decade," he wrote in his center's report.

Any change that reduces state tax revenues is going to get a hard look from lawmakers.

But gubernatorial spokesman Matthew Benson said there are "flaws" in the Grand Canyon study.

Then there's the separate question of the financial hit to cities, many of which have their own local sales taxes on construction.

The current system ensures that if something is built in the community, that city gets the tax revenues from the construction contractors. But if the tax is levied when and where supplies are purchased, the dollars flow to where that store is located.

Because of the change in methodology - going from a percentage of total construction price to simply a sales tax on materials themselves - could also mean fewer overall dollars for cities.

Hunter said those objections could be resolved - if lawmakers allow cities to replace the contracting tax with something else.

State revenue questions aside, several legislators have made it clear they are not interested in pursuing any change in the law unless the cities' concerns can be satisfied. And that could force eliminating the change in contracting taxes from the plan to clear the way for the simplification.

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Brewer's plan

Gov. Jan Brewer is proposing an extensive revamp of how Arizona collects sales taxes.

In its simplest form, the legislation would limit the ability of individual cities to decide on their own what items are taxable.

It also would ensure that businesses would face only a single audit from the state to determine if they had paid the correct amount, eliminating separate reviews by each city.

The most controversial part would scrap the system in which taxes on construction and other kinds of contracting are collected where the work is done. As it is now, contractors determine the price of the job and then pay taxes on 65 percent of that, the part that is presumed to be for materials, with the beneficiary being the city where the work is done.

Under the proposed change, contractors would pay regular state and local sales taxes at the time of purchase on the items they buy - and to the retailer, who might be in another city entirely.

Opponents of the plan said the proposed changes would hurt cities, especially growing communities.

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