Two new reports on the cost of changing how construction activity is taxed could torpedo the sales tax simplification plan being pushed by Gov. Jan Brewer.

One study by legislative budget staffers say what Brewer wants could slash state revenues by $137 million a year. That alone could give lawmakers reason for pause.

But that's not all.

Another report by the Grand Canyon Institute concludes that if Brewer gets the changes she wants it would leave the state's more than 90 cities with $10 million less overall.

The reports come as the governor's staff is trying to line up votes for Brewer's broader plan to simplify how sales taxes and collected and audited.

Brewer wants to limit the ability of cities to tax items and services beyond what the state itself taxes. And it would ensure businesses that they are subject to only a single audit of their books versus the current situation that 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 if questions about changing the tax on contracting taxes cannot be resolved, that 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 the 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. 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, Olofsson said the loss could be $137 million.

Hunter pointed out that even Olofsson's analysis says 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. It puts the net negative effect on state revenues at $125 million.

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

"There are serious question 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.

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

But gubernatorial 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 revenues. But if the tax is levied when and where supplies are purchased, the dollars flow to where that store is located.

It also is not a zero-sum gain, as the change in methodology -- going from a percentage of total construction price to simply a sales tax on materials themselves -- could also mean less overall dollars.

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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