By Dallas Fox.
Arizona’s Past and Current Income Tax System
Long is the debate on whether state income tax should be split into different tax brackets, kept at a single flat rate, or eliminated entirely. Prior to former Arizona Governor Doug Ducey signing Senate Bill 1828 into law on June 30, 2021, the Arizona state income tax consisted of four distinct tax brackets. The lowest bracket taxed individuals at 2.59% of income below $27,808 and hit a maximum tax of 4.5% on every dollar beyond $166,844. This progressive tax structure had the effect of taxing Arizonans at an increasingly punitive rate as they earned larger taxable incomes.
Immediately after SB 1828’s passage into law, Arizona’s income taxation shrunk to two brackets only, where all income up to $27,808 was taxed at 2.55%, with any income in excess of that dollar amount taxed at 2.98%. This change effectively condensed the three former highest tax brackets into a single bracket, taxed at 2.98%. The shift toward a flat income tax system was imminent. In fact, SB 1828 itself had provisions that would converge the two remaining tax brackets into a single flat tax rate of 2.5% if Arizona met certain revenue triggers. Well, in September 2022, such triggers were met. In turn, all Arizonans, regardless of income level, will be taxed at 2.5% at the state level moving forward.
Arizona isn’t the only state with a flat income tax. As of 2021, nine other states have adopted a flat state income tax rate. Moreover, Mississippi joined the ranks alongside Arizona this year and Iowa will follow suit in 2026. On the flip side, the vast majority of states still maintain a multi-bracketed income tax system. With all this said, the question that remains is whether Arizona’s new income tax system will serve its citizens better than its former tax system.
Progressive vs. Flat Income Tax
Progressive tax systems, by their very definition, impose progressively higher tax rates on individuals as their income level rises. As a result, such systems collect less income from the poorest households, making up the revenue difference by taxing high earners more harshly. This kind of income taxation is based on the concept of the ability to pay. Many argue that progressive tax systems provide low-income households the breathing room necessary to ensure that all people have the opportunity to reach their full potential despite their tax burdens.
A flat income tax system, on the other hand, demands that each taxpayer relinquish the same percentage of their income to the hands of the government, regardless of their income level. In turn, the poorest and wealthiest taxpayers alike pay the same tax rate on every dollar earned, eliminating any structural wealth redistribution.
The federal government has been collecting income tax through a progressive system since 1862. Today, the lowest and highest federal tax rates range from 10% to 37% respectively, with the goal of ensuring that the burden of funding rests on the Americans with the most disposable income. However, the federal code also provides for flat taxes, such as payroll taxes. Even if we assume that these systems work well at the federal level, they may not provide the same benefits at the state level.
Which System Works Best for Arizona?
The average income among the top 20% earning taxpayers in Arizona is roughly $210,000. By contrast, the average income among the bottom 20% earning Arizonans is roughly $15,000. Even assuming healthy margins of safety under these statistics, there is a high degree of income inequality in the state of Arizona. A progressive income tax system can be used to mitigate such income inequality. As such, Arizona’s former tax system was designed to ensure adequate state funding with the burden of such funding falling on Arizonans with the most disposable income.
Under Arizona’s former system, an individual earning $210,000 would pay roughly $8,300 in state income tax, excluding all deductions, whereas an individual earning $15,000 would only pay around $400. Under the current flat tax system, wealthier and poorer individuals would instead pay $5,250 and $375 respectively. With the numbers laid out, the progressive tax has almost no effect on the taxation of low-income taxpayers; however, it offers such individuals relief by collecting much more from high-income earners to eventually be redistributed in benefits to the poorest families.
However, despite the tangible wealth redistribution that Arizona’s former progressive tax system caused, it also brought plenty of downsides that the new flat tax system alleviates. To start, the old progressive system worked in contrast to the benefit theory, which states that individuals should pay taxes in proportion to the benefits they receive from the state government. Assuming that low-income earners benefit the most from state-administered benefits, it seems unfair that those who contribute the most to state funding under a progressive tax system are the same individuals who receive hardly any state government relief. A flat tax system, while still favoring low-income earners in this regard, reduces the magnitude of such favor.
Moreover, because the highest marginal tax rate under Arizona’s former progressive system was almost twice as large as the lowest income bracket, the former system provided natural disincentives to continue earning income at and beyond the highest marginal rate. In turn, taxpayers would reach a point of diminishing returns on their efforts to earn income. When applied at a state-wide scale, the reduction in work effort at the highest income rates inhibited overall economic growth. With the new implementation of a flat tax system, all Arizonans are equally incentivized to produce at every income level since their average tax rate will always remain at 2.5%.
Lastly, Arizona’s flat tax system is undoubtedly simpler than its former progressive system. Many taxpayers do not understand how a marginal progressive tax system works. Therefore, when calculating their expected state tax liability, many Arizonans likely calculated such figure incorrectly under the former system. On the other hand, the imposition of a flat 2.5% tax rate on every dollar earned is exceedingly simple and can hardly be calculated incorrectly. Not only is a flat tax system easier to understand, it also makes forecasting tax liability easier throughout the year while an individual’s final taxable income at year’s end is still unknown.
No matter what happens, whether it’s inside or outside of Arizona, the flat versus progressive state income tax debate will never end. While a progressive state income tax undoubtedly helps decrease income inequality, it provides natural disincentives to earn income at high levels and is much more complicated for laypeople to understand, among other things. These issues are alleviated by a flat state income tax system. Whether Arizona’s flat tax system will serve its citizens right in the long run is a question only answered by time. All we know now is that more and more states are beginning to tax their citizens using a single flat rate.
By Dallas fox
J.D. Candidate, 2024
Dallas is currently a 2L from Cave Creek, Arizona, interested in trusts & estates law. Prior to law school, he received a Bachelor of Arts degree in Business Law from Arizona State University. In his spare time, Dallas enjoys watching Cardinals and Suns games, playing soccer with his little brother, and watching reality television with his fiancée.