I’m a small business owner. I offer accounting, CFO and CPA services to my clients, many of whom are other small businesses. I provide strategic and financial expertise to avoid risk, leverage opportunity, and maximize returns. In other words, I know good investments from bad ones.
The proponents of the “Invest in Education” initiative may have a laudable goal – improving our education system through providing additional revenues. However, I believe they have made several dire miscalculations. Arizonans should beware: This is a bad investment. The costs will far outweigh any potential gains.
Currently, Arizona has five income tax brackets, starting at 2.59 percent and topping off at 4.54 percent. With less than 2 percent separating the bottom from the top brackets, our state does not disincentivize individuals from working hard to make more money. This is especially true for the thousands of small businesses in our state.
The majority of small businesses in Arizona are S-corps and LLCs. One main difference between their organizational structure compared to large businesses (mostly formed as C-corps) is how they are taxed. Small businesses’ income is “passed through” to the individual side, meaning they pay personal income taxes on their small business profits.
The “Invest in Education” initiative proposes a complicated and confusing new income tax system in our state. It increases our five brackets to seven, and instead of each bracket applying one tax rate, each bracket is taxed two separate rates – a minimum tax liability based upon the upper threshold of the previous bracket plus a higher rate on the excess income over that threshold. Based on this added complexity alone, it will cost people more to do their taxes as well as cost them more in taxes.
Doubling the top two rates is incredibly unfair to the little business that pays personal income taxes on business profits. It will severely limit their ability to reinvest in their operations, hire people and expand. It also puts them at a competitive disadvantage to larger corporations that are taxed at a flat 4.9 percent.
Ultimately, if passed, this proposition will drive start-ups, small businesses and entrepreneurs to other states with a more competitive, less-burdensome tax system that doesn’t punish their success.
Voters also should be aware that Arizona has what is called the Voter Protection Act. This locks in any initiative passed at the ballot box and precludes the elected Legislature from making any changes to the law unless it has a three-quarter majority vote and it furthers the intent of the proposition. Effectively, this will make the new income tax system permanent and make it impossible to tweak in the future.
I know the complexity of taxes, and I know the best way to debate and craft a modern, simple and effective tax system is not at the ballot box.
As has occurred in California, other high-tax states and at the federal level, those who choose to stay in Arizona and who have the most resources and influence will find ways to shelter their hard-earned income.
My clients, the small business owner, will have no such advantage. Because the Legislature will be unable to make requisite fixes to the brackets and rates, tax credit programs and carve-outs will be the go-to mechanism. This will only further complicate our tax code as well as create greater inequities.
-Ronald Elwood is a certified public accountant.