By Natalie Packard.
On August 19, 2021, the Arizona Supreme Court in Fann v. Arizona allowed the Invest in Education tax initiative to stand while the lower state court decides if the tax revenue will surpass the state constitutional limit. While this may seem like a victory for Invest in Ed, the Supreme Court’s decision held that the tax initiative’s characterization of the revenue as “grants” was unconstitutional and may lead to the initiative being struck down by the lower court.
The Tax Initiative – Proposition 208
Invest in Education filed an initiative on February 14, 2020 called the “Invest in Education Act” (“Act”) that was placed on the ballot as Arizona Proposition 208 (“Prop. 208”). Prop. 208’s purpose is to raise revenue for schools by imposing an income tax surcharge on “high-income” taxpayers in Arizona. Specifically, individuals earning more than $250,000 incur a 3.5% tax that would be used for education initiatives and teacher salaries. Ultimately, the Act was expected to raise over $800 million every year.
Arizona education advocates tried to bring a version of this initiative to voters in 2018, but the Arizona Supreme Court threw it off the ballot. Education advocates also tried to receive more funding through a 2018 teacher strike that ended in increased salaries for public school teachers but did not result in other funding boosts. Even after the salary raise, Arizona was ranked 48th nationally in school spending. The 2020 initiative was a response to these events.
Arizona voters passed Prop. 208 with a 51.7% majority vote in November 2020, and it became law in January 2021.
The Lawsuit That Ensued
Opponents of the Act sued that same month to strike down Prop. 208. The initiative’s supporters argued in front of the Arizona Supreme Court that the estimated $827 million raised per year is a “grant” to schools. This classification is important because if the funding is a “grant,” then it is exempt from the Education Expenditure Clause in the Arizona Constitution which places limits on overall spending on education. Unfortunately for the supporters of the initiative, the justices rejected this argument in a 6-1 opinion and held that the money is not a “grant” to schools and is therefore subject to the spending limitations.
Yet, the initiative will remain for now because the justices stated that they “cannot determine at this preliminary stage of the case the extent to which, if any, such funding will exceed the constitutional expenditure limitation.” Subsequently, the Court handed the case back to the trial court to determine if the revenue will surpass the spending limit.
Would the Taxpayers Have Voted for the Initiative?
The Arizona Supreme Court had to determine whether certain provisions in the Act could be saved or if the unconstitutionality of one provision applied to the whole Act. Part of this determination required an analysis on whether taxpayers would have logically voted for the Act knowing that about $600 million of the generated tax revenue could not be spent without legislative authorization. Opponents argued that voters would not have approved Prop. 208 with such knowledge, but proponents argued that hopeful voters could have been willing to approve of the Act, counting on the legislature to authorize spending beyond the limit to avoid accumulating “hundreds of millions of dollars in unspent revenues.”
The Court stated that “[c]ollecting taxes that cannot be spent does little or nothing to provide increased support for school districts” and held that it would be “so irrational or absurd” to conclude that an informed electorate would have adopted the tax provision while knowing most of the money would be sitting around.
Now What?
Justice Timmer said in her dissenting opinion that the majority’s framework used to analyze the constitutional spending limit “almost certainly” destroys the initiative. Arizona Governor Doug Ducey was happy about the ruling, stating that “it’s only a matter of time” before Prop. 208 is “knocked down entirely.” The Arizona Free Enterprise Club President celebrated the decision, saying, “We are looking forward to the trial court determining that the law exceeds the constitutional expenditure limitation and officially strik[ing] down the measure.”
Supporters said the decision was “an affront to our right to self-governance” and that their efforts to stop the legislature from undoing Prop. 208 are crucial to avoid “the twin blows” of the loss at the Supreme Court and potential loss at the trial court. The President of the state teacher’s union said the ruling makes it even more important for voters to sign petitions to block a large income tax cut the legislature passed this year.
These proponents plan to argue in the trial court that the constitutional spending cap is currently set artificially low and should be reset to allow all of the initiative’s generated tax revenue to be spent.
However, the legislature just enacted the Arizona Small Business Income Tax Referendum, which creates a new small business tax category that would not apply to Prop. 208. In other words, small business owners may be able to avoid the Prop. 208 tax surcharge. According to legislative budget analysts, this could cut about $292 million from the funding schools would otherwise receive under the initiative.
These factors will likely be considered as the trial court takes back the case. Regardless of these considerations, however, the Arizona Supreme Court has set clear guidelines for the trial court to follow, and there is seemingly little wiggle room.
