A dumb state budget mess
Hobbs still hasn't learned how to play the budget game.
In the standoff between Gov. Katie Hobbs and GOP lawmakers over conforming to federal income tax changes, it’s hard to decide which is dumber: the substance or the timing.
I’d give a slight nod to the timing.
The budget reconciliation bill (big, but not beautiful) with the federal changes was signed into law in early July. That gave Arizona six months to decide whether to conform well in advance of the start of income tax filing season. Yet, tax filing season is upon us, and no one in Arizona can accurately calculate what is owed the state.
The blame for this inexcusable dilatoriness lies principally with Hobbs. She’s the governor. She should have been the one agitating for a special season to resolve the question well in advance, rather than waiting for the regular legislative season to begin in January. She didn’t even announce her position of opposing conformity for corporations until late November.
She’s also more in the wrong on substance. The primary purpose of conforming state income tax law with federal provisions is to ease the compliance burden for taxpayers. In this particular case, that’s a much more compelling consideration for corporate taxpayers than individual ones.
Overwhelmingly, the federal tax changes allow corporations to fully expense capital investments – in buildings, machinery, and R & D – in the year they occur, rather than being amortized over a period of years. By not conforming, Hobbs would put Arizona businesses in the position of, for the exact same capital investment, expensing it for federal tax purposes while amortizing it for state tax purposes.
Contrary to the rhetoric from Hobbs and legislative Democrats, these aren’t provisions limited to benefiting billionaires or large corporations. The compliance burden of treating capital investments differently for federal and state tax purposes would fall on all Arizona corporations – large, small, and in-between.
Fully complying with the federal changes would be costly to the state’s general fund, an estimated $440 million hit for the current fiscal year and a $340 million reduction for the 2027 fiscal year, the budget for which will be debated this session. The state’s general fund picture was already tight. It would have been reasonable for Hobbs to insist on some compensating measures if needed to maintain state programs – either dipping into the rainy day fund or enacting some of the cost saving or revenue enhancing ideas in her FY 2027 budget proposal.
But burdening Arizona businesses with maintaining two sets of tax books isn’t the right answer. Particularly since, unlike with the individual tax conformity provisions, the corporate ones don’t reduce tax liability over time. What is gained through expensing in the first year is lost in subsequent years from the lack of the amortization deduction.
GOP lawmakers aren’t all in the right about this either. They did not enact a full and clean conformity bill. Their bill didn’t include some of the federal changes and added provisions that weren’t part of the federal budget reconciliation legislation.
Most egregiously, the GOP bill vetoed by Hobbs didn’t include the additional $6,000 deduction in the federal legislation for seniors up to a certain level of income. Instead, the state GOP bill limited the additional deduction to withdrawals from retirement accounts. And added a $6,000 deduction for contributions to a Roth IRA. Hobbs rightly objected to the regressivity of these provisions. From a conformity standpoint, they add complexity rather than providing more simplicity.
In all her years as governor, Hobbs has yet to provide an initial budget proposal that could serve as a beginning point for negotiations.
In previous years, the irrelevancy of Hobbs’s initial budget proposal was political. Each year, she proposed significant cuts in the state’s voucher program, with the savings spent elsewhere. Since the GOP legislative majority was never going to go along with gutting the universal voucher program, where Hobbs wanted to spend that money wasn’t a starting point for negotiations.
This year, rather than propose gutting the voucher program, Hobbs called for capping eligibility at a family income of $250,000. I don’t favor that. But it isn’t such a large factor that the rest of Hobbs’s budget depends on its enactment. It doesn’t, in itself, render her budget irrelevant.
This year, her budget isn’t rendered irrelevant due to political infeasibility, but due to fiscal recklessness. Hobbs proposes that, in FY 2027, the state spend $925 million more than she projects the state collecting in general fund revenues that year, which includes several recommended tax and fee increases. Hobbs would cover up that deficit with a projected carryforward from this fiscal year, which she estimates at roughly $560 million (the legislature’s budget staff has it considerably higher), and $760 million in reimbursement from the federal government for state border enforcement costs.
The federal budget reconciliation bill included $10 billion for such reimbursements. The $760 million represents what Arizona has requested from the purse.
There is no federal timeline for the dispersal of this money. The law says that the funds are available through September of 2034. The Trump administration has a track record of shortchanging grants to states and localities headed up by Democrats. And it’s hard to believe that the Trump administration would disperse the money without some strings attached requiring the funds to be spent in some way on additional immigration enforcement.
In short, it would be imprudent beyond description to adopt, or even discuss, a budget today based upon the assumption that some time over the next year and a half the federal government is going to give the state $760 million in unrestricted funds. Without the unrestricted federal funds, Hobbs’s budget is more than $360 million in deficit, even with fully spending the carryforward surplus. Which renders her proposed spending proposals, at this point, irrelevant.
I’m not privy to the internal budget strategy sessions of the Hobbs administration. But she has not been served by sidelining herself from early budget deliberations by politically infeasible or fiscally imprudent initial offerings.
If politically feasible and fiscally prudent, her spending priorities would constrain the GOP budget considerations and put her in a stronger bargaining position when final and binding negotiations took place. But since her initial spending priorities are irrelevant, because dependent on gutting the voucher program or unrestricted and uncertain grants from the federal government, she’s relegated to tying up loose ends and asking for crumbs to avoid a government shutdown.
Hobbs is running for re-election. Her strongest argument is continuing to provide a check on the excesses of a MAGA legislature. And she’s done that. But, in four cycles, she still hasn’t learned how to play the biggest game of all, shaping what state government is and does through skillful participation in the budget process. Starting out with the politically infeasible or the fiscally reckless doesn’t get it done.
Reach Robb at robtrobb@gmail.com.