ARIZONA

MONTHLY FISCAL HIGHLIGHTS
May 2005
Summary
May General Fund revenue collections were $663.5 million, which was an increase of 30.7% above May 2004. May collections are
$99.5 million above the forecast for the month from the recently enacted state budget. Combined with the April variance, we are
now a total of $252.1 million above the forecast.
Most of this gain was again due to increased individual income tax collections in May compared to a year ago. While May is not as
large a collection month as April, May individual income tax collections were almost 70% above last year. As we saw last month,
final payments associated with the 2004 tax year filing remained especially strong.
Along with real estate and stock market capital gains, increased small business profitability is thought to be a driving factor in this
recent growth. The greater role of small businesses in individual income tax collections is discussed in more detail on page 7 of this
issue. If small businesses are experiencing the same growth as corporations, they could account for 48% of the increase in final
payments over the last 2 months.
The 2 other largest revenue categories, corporate income tax and sales tax, also grew significantly. As with individual taxes, May is
a smaller month for corporate collections. Nonetheless, the $68 million in May receipts was 79% higher than last year. Sales tax
collections grew by 13.8% in May. The contracting sector of sales tax was once again particularly strong, and was up 22.5% over
last year.
While General Fund revenues are running substantially ahead of forecast, this does not mean necessarily that there will be surplus
revenues from the perspective of future budgets. As enacted, the FY 2006 budget had only a small surplus. With the recent
April/May revenue surge, those extra monies will carry over into the next fiscal year and could result in a FY 2006 ending balance
of $250 million. Revenue collections during the course of FY2006 could also exceed the forecast, but those monies are already
statutorily dedicated to the Budget Stabilization Fund.
In developing a FY 2007 General Fund budget, the State will first need to replace $345 million in one-time monies used to balance
the FY 2006 budget. As a result, any FY 2006 “surplus” will first go for this purpose. As FY 2006 progresses, we will need to
monitor revenue collections and possible supplementals so as to refine our FY 2007 estimates further.
The May Monthly Fiscal Highlights also includes a summary of recent reports submitted to the JLBC and a summary of the June
28th JLBC meeting. The recent reports included:
• An update on a corrective action plan at the Arizona State Hospital to address deficiencies uncovered by a federal audit.
Through the end of May, DHS has expended 60% of their supplemental appropriation.
• The Department of Revenue’s report on their Revenue Generating Program, which is running $20 million behind
projections through March.
• The Arizona Department of Education’s projected surplus estimate of $35 million for FY 2005, which has already been
factored into the budget.

Table of Contents
Page #
May Revenues..........................................................................2
Recent Economic Indicators ....................................................4
Summary of Recent Agency Reports
- Corp. Commission – Report on Corporations Div. Filings....5
- Economic Estimates Comm. – Report on the BSF ................5
- ADE – Update on Projected Surplus of FY 05 .....................5
- DHS – Report on ASH Corrective Action Plan .....................5

Page #
Summary of Recent Agency Reports (cont..)
- DOR – Report on Revenue Generation Program .................... 6
- ADOT – Report on Parker MVD Field Office........................ 6
Other Issues
- Individual Income Taxes Paid by Business............................. 7
- June 28th JLBC Meeting Summary ......................................... 8

JLBC
This report has been prepared for the Arizona Legislature by the Joint Legislative Budget Committee Staff June 29, 2005. This report can also be
found on our Website at http://www.azleg.state.az.us/jlbc.htm
Page 1

Joint Legislative Budget Committee

Monthly Fiscal Highlights – May 2005

MAY REVENUES
Sales Tax revenue increased by 13.8% on a year-over-year
basis in May and was $12.3 million above the forecast for the
month. Year-to-date collections are 10.6% over last fiscal
year. The following is based on year-to-date collections
through May:
• Retail sales tax receipts have increased by 9.0%.
• Contracting continues to exhibit the large increases begun
last year, with a year-to-date increase of 19.8%.
• Restaurants and bars collections are up 9.8%.
• Use tax receipts (all of which are retained by the state) are
up 12.7%.
Individual Income Tax collections for May were 69.4%
above last year, due largely to growth in final payments from
the April 15th tax filings. The May results were comparable to
April’s 57.4% growth over the prior year. This strong showing
may be a combination of real estate capital gains, stock market
profits, and increased small business profitability. The role of
small business in individual income tax actions is discussed in
more detail at the end of this report.
It is also believed that the large surge in tax payments can be
partially attributed to other factors, such as the state’s
decoupling of the federal bonus depreciation provision that
expired last year, increases in year-end bonuses by employers,
and Microsoft’s $32 billion one-time dividend distribution in
December 2004.

In other individual categories, withholding tax was up 12.7%
and refunds were (7.1)% less than May of last year. Overall,
May collections were $59.0 million above forecast.
In terms of total liability (withholding, payments, refunds),
individual income tax collections are up 30.2% for the fiscal
year to date.
Corporate Income Tax revenue of $68.0 million was 79.1%
over May 2004 collections. While May is not a large
collection month, this increase was $26.4 million over the
forecast for the month. Year-to-date corporate collections are
49.8% over the previous year.
The General Fund portion of Luxury Tax collections for May
was 9.7% greater than last May, increasing the year-to-date
total to 2.9% over the first 11 months of last year. The liquor
categories of the luxury tax increased by 11.9% compared to
May of last year. The tobacco tax component was up by 8.1%
for the month. Year-to-date, tobacco tax collections are up
3.7% over the prior year.
It also believed that the large surge in tax payments can be
attributed to other factors, such as the state’s decoupling of the
federal bonus depreciation provision that expired last year,
increases in year-end bonuses by employers, and Microsoft’s
$32 billion one-time dividend distribution in December 2004.

Table 1

April
Year-to Date
____________

General Fund Revenues
Compared to Adopted Forecast and FY 2004 Collections
($ in Millions)
FY 2005
Difference From
Difference From
Collections
May 2004 Forecast 1/
May 2005 Forecast 2/
$ 1,015.9
$ 189.5
$ 160.8
$ 6,336.0
$ 602.5
$ 160.8

Difference
From FY 2004
$ 255.1
$ 1,004.9 3/

1/ Originally enacted FY 2005 budget (May 2004).
2/ May 2005 Enacted Budget.
3/ Including the receipt of $87.2 million federal cash assistance grant in October, 2003.

Page 2

State of Arizona

General Fund Revenue: Change from Previous Year and May Forecast
May 2005

Current Month

FY 2005 YTD (Eleven Months)

Change From
Actual

May 2004

May 2005

Amount

Change from
Actual

Revised Forecast
Percent

Amount

Percent

May 2004

May 2005

Amount

Revised Forecast
Percent

Amount

Percent

Taxes
Sales and Use

$315,664,510

$38,295,266

$3,329,166,186

$320,406,251

10.6 %

$17,430,683

Income - Individual

229,122,033

93,843,969

13.8 %
69.4

58,955,367

34.6

2,691,036,902

624,344,577

30.2

225,006,268

9.1

- Corporate

68,048,720

30,050,203

79.1

26,372,601

63.3

604,455,760

200,981,199

49.8

17,411,198

3.0

1,136,506

27.4

22,029,510

(8,054,770)

(26.8)

1,288,085

6.2

12,872

0.2

57,894,764

1,627,572

2.9

(1,076,953)

(1.8)

Property

5,286,836

(916,386)

(14.8)

Luxury

5,846,293

518,055

9.7

Insurance Premium
Estate
Other Taxes

0.5 %

4,865,466

18.3

0.0

293,731,183

44,838,393

18.0

(1)

(0.0)

1,626,355

(2,887,501)

(64.0)

(398,645)

(19.7)

29,933,699

(6,753,090)

(18.4)

(1,099,406)

(3.5)

0.6

(51,846)

(51.8)

2,532,078

(202,927)

(7.4)

(51,959)

(2.0)

282

$657,149,160

$163,769,354

Lottery

3,140,400

3,140,400

License, Fees and Permits

2,381,686

684,403

40.3

1,702,919

126.7

0

4.1 %

31,506,259
48,154

Sub-Total Taxes

$12,304,983

33.2 %

$98,331,838

17.6 %

$7,030,780,082

$1,177,187,205

20.1 %

$258,907,915

3.8 %

Other Revenue
--

Interest

3,046,735

Sales and Services

3,464,094

(5,041)

(0.1)

Other Miscellaneous

3,145,233

(2,759,871)

(46.7)

Disproportionate Share
Transfers and Reimbursements
Sub-Total Other Revenue
TOTAL BASE REVENUE

40,400

1.3

27,411,600

(3,588,400)

(11.6)

(18,230)

(0.8)

26,193,918

3,208,208

14.0

2,818,559
(2,020,101)
259,079

0

0

1,188,862

1,030,270

--

0

16,367,010

3,793,080

30.2 %

1,192,369

$673,516,170

$167,562,434

33.1 %

$99,524,207

649.6

112,662

(1,116,800)

(3.9)

(356,736)

(1.3)

--

22,485,198

(913,286)

(3.9)

5,329,391

(36.8)

39,580,858

(3,604,313)

(8.3)

(3,404,482)

(7.9)

9.0

20,015,696

(19,267,689)

(49.0)

(3,360,399)

(14.4)

--

0

(5,625,187)

(100.0)

37,230,847

(64,449,162)

(63.4)

(3,871,656)

(9.4)

7.9 %

172,918,117

(94,239,829)

(35.3) %

(6,780,682)

(3.8) %

17.3 %

$7,203,698,199

10.5

$1,082,947,376

17.7 %

0

31.1

$252,127,233

--

3.6 %

One-Time Revenue
Urban Revenue Sharing
Budget Balancing Transfers
VLT Transfer

(31,089,382)

0

0.0

(341,983,197)

(7,340,130)

15,493,300

15,493,300

--

0

0.0

15,493,300

15,493,300

--

0

0.0

5,500,888

5,500,888

--

0

0.0

117,825,282

117,825,282

--

0

0.0

(100.0)

0

--

0

0.0

%

0

0.0 %

30.7 %

$99,524,207

17.6 %

Tax Amnesty
Judicial Enhancement
Sub-Total Transfers In
TOTAL REVENUE

0
87,000
(10,008,194)
$663,507,976

(667,285)

(32,043,121)

2.2

87,000
(11,629,218) -$155,933,216

--

2.2

0

0.0

0

(47,123,527)

(100.0)

0

2,496,600

(2,892,700)

(53.7)

0

0.0

75,962,225

(26.9) %

0

0.0 %

$1,158,909,601

19.8 %

$252,127,233

3.7 %

(206,168,015)
$6,997,530,184

--

VP% = Percent change from comparable period in prior year
VF% = Variance from forecast
F% = Forecast percent change for the fiscal year.
R% = Average percent change from comparable period in prior year which must be attained over remaining months to realize the forecast for year.

Table 2

Joint Legislative Budget Committee

Monthly Fiscal Highlights – May 2005

Arizona’s job market showed steady improvement. Statewide
non-farm employment advanced 3.9% during the last 12
months, a net gain of 92,300 jobs, with the goods-producing
sectors – manufacturing, mining and construction – all
reporting increases. The unemployment rate dropped (0.2)%
to 4.8% in May.

RECENT ECONOMIC INDICATORS
The nation’s economic indicators produced mixed results in
May. The U.S. Index of Leading Economic Indicators
decreased (0.5)% from the prior month. Although the stock
prices component made a positive contribution, the remaining
indicators were negative. However, consumer sentiment
rebounded in May. The Conference Board’s Consumer
Confidence Index jumped 4.8% from April’s reading,
bolstered by an improving job market and better expectations
for the economy’s short-term outlook.

Arizona personal income reflected the strength in the regional
economy, with a year-over-year increase of 8.5% posted in
2005’s first quarter. The state’s 1.4% growth from the
previous quarter ranked 7th in the nation.

The Semiconductor Industry Association’s latest forecast,
which was released in early June, predicted worldwide sales
would grow by 6% in 2005 and by a compound annual growth
rate of 9.8% through 2008. The previous forecast from
November 2004 expected sales to be flat this year. While the
forecast is positive for all regional markets, Asia is anticipated
to have the fastest growth. Domestically, U.S. semiconductor
billings (three-month moving average) dipped (0.7)% in April
but remained 1.1% above the level from a year ago.

The Arizona Business Conditions Index, derived from a
statewide survey of supply-chain managers, declined (5.8)% in
May. However, the latest reading of 62.8 remained well above
the level (50) associated with a growing economy.

The U.S. Consumer Price Index (CPI) declined (0.1)% in
May as gasoline prices eased from record levels. The index’s
three-month moving average increased 0.4% and stood 3.2%
higher than a year ago. Excluding food and energy prices, the
core CPI increased 0.1% in May.

The Department of Corrections’ inmate population
increased by an average of 85 inmates per month from March
trough May. The total population increased by 791 inmates
from a year ago.

The number of TANF recipients decreased to 99,430 in
April, a (1.6%) decline from March and a (15.0)% drop from
April 2004. The AHCCCS caseload increased in April.
Enrollment was 0.6%, or 4,485 more than March and stood
11.8% above the level from one year ago.

Table 3
RECENT ECONOMIC INDICATORS
Indicator
Arizona
- Unemployment Rate
- Jobs
- Contracting Tax Receipts (3-month average)
- Retail Sales Tax Receipts (3-month average)
- Residential Building Permits - (3-month moving average)
Single-unit
Multi-unit
- Arizona Tourism Barometer
- Phoenix Sky Harbor Air Passengers
- Arizona Average Natural Gas Price
($ per thousand cubic feet)
- Leading Indicators Index
- Business Conditions Index
(>50 signifies expansion)
- Consumer Confidence Index
- Business Leaders Confidence Index
- Arizona Personal Income
- Arizona Population
- AHCCCS Recipients
- TANF Recipients
- DOC Inmate Growth (3-month average)
United States
Gross Domestic Product
- (seasonally adjusted annual growth rate)
- Consumer Confidence Index
- Leading Indicators Index
- U.S. Semiconductor Billings -(3-month moving average)
- Consumer Price Index - (3-month moving average)

Change From
Prior Period

Change From
Prior Year

Time Period

Current Value

May
May
Mar-May
Mar-May

4.8%
2.47 million
$59.6 million
$147.5 million

(0.2)%
0.1%
6.1%
(2.9)%

(0.3)%
3.9%
23.2%
10.6%

Feb-Apr
Feb-Apr
January
April
March

6,574
1,206
100.7
3.64 million
$6.05

8.6%
33.6%
1.4%
(4.1)%
(2.1)%

4.4%
31.2%
6.4%
9.0%
13.1%

(0.8)%
(5.8)%

0.7%
(2.3)%

April
May

119.7
62.8

2nd Quarter 2005
2nd Quarter 2005
1st Quarter 2005
July 1, 2004
April
April
Mar-May

97.4
62.8
$172.5 billion
5.74 million
816,141
99,430
32,621

1st Quarter 2005

$11.1 trillion

3.5%

3.7%

May
May
Feb-Apr
Mar-May

102.2
114.1
$3.3 billion
194.1

4.8%
(0.5)%
(0.7)%
0.4%

9.8%
(1.9)%
1.1%
3.2%

(6.6)%
0.8%
1.4%
3.0%
0.6%
(1.6)%
85 inmates

8.1%
(7.2)%
8.5%
3.0%
11.8%
(15.0)%
791 inmates

Page 4

Joint Legislative Budget Committee

SUMMARY OF RECENT AGENCY REPORTS
Corporation Commission - Report on Corporations Division
Filings – Pursuant to Laws 2005, Chapter 4, the Corporation
Commission was appropriated $456,206 as a FY 2005
supplemental and is required to report monthly on the total
number of filings received by the Corporations Division, the
total number of filings processed by the Corporations Division,
and the amount of time to process the filings. The commission
submitted its 2nd report on June 8, 2005.
Between March 25, 2005 and May 31, 2005, a total of 18,547
filings were received by the Corporations Division, and 22,853
were processed. Over the same time period, the amount of time
required to process the filings fell from an average of 63 days
to 31 days for expedited filings and an average of 164 days to
142 days for regular filings.
The commission submitted a plan to resolve the filings backlog
along with its 1st report on May 6, 2005. The plan consists of:
•

•

•
•

Using the supplemental funds for overtime and temporary
staff rather than new staff, until they had clear direction
from the Legislature for hiring new staff in FY 2006. The
Legislature subsequently approved this FY 2006 funding.
The implementation of the Initial Processing System (IPS)
– IPS involves bar coding and scanning every LLC filing
so that an electronic copy of the file is made. This creates
efficiencies both during the processing of the document
and for inquiries made after the document has been
processed.
Re-deploying staff who worked on the name availability
phone line to examine filings instead.
Beginning development of E-government for services such
as filing LLC articles of organization online.

Economic Estimates Commission - Report on the Budget
Stabilization Fund – Pursuant to A.R.S. § 35-144(F), the
Economic Estimates Commission (EEC) is annually required
to calculate the amount of monies that may be deposited to or
withdrawn from the Budget Stabilization Fund (BSF). The
EEC estimate is calculated using a formula based on historical
Arizona personal income growth and the Gross Domestic
Product (GDP) deflator. On May 20, 2005, the EEC reported
that the formula would have called for a $56.8 million deposit
into the BSF in FY 2005. Statute does not automatically
appropriate this amount to the BSF but rather allows the
Legislature to include the amount in that year’s General
Appropriation Act.
The FY 2005 budget did not include an appropriation of these
monies into the BSF. However, as part of the 2004 General
Appropriation Act, the Legislature adopted certain conditional
FY 2005 appropriations (otherwise known as “triggers”) that
would be enacted if revenues exceeded the budgeted forecast
for FY 2004 and the first 6 months of FY 2005. These triggers
resulted in a total deposit of $156.5 million to the BSF in FY
2005.

Monthly Fiscal Highlights – May 2005

Arizona Department of Education - Update on Projected
Surplus for FY 2005 – Pursuant to A.R.S. § 35-131(D), the
Arizona Department of Education (ADE) recently submitted an
updated estimate of its projected FY 2005 surplus. As of June
14, 2005, ADE projects that it will have a $35,084,900 surplus
for FY 2005. This amount is $(6,849,600) less than its most
recent prior estimate dated March 15, 2005.
ADE’s FY 2006 appropriation includes a $(41,851,700) base
adjustment for a projected FY 2005 surplus. This amount is
$(6,766,800) more than ADE’s current surplus estimate.
ADE’s June and March estimates, however, both reflect a
$(10,000,000) transfer of surplus FY 2005 monies from the
Homeowner’s Rebate program to Achievement Testing for
expanded AIMS tutoring for FY 2005. Most of those
transferred monies now are expected to revert, however, which
could increase the final surplus to an amount higher than the
assumed $(41,851,700) FY 2006 base adjustment.
ADE’s current FY 2005 surplus estimate includes a
$29,583,800 surplus for Basic State Aid, a $6,851,700 surplus
for the Homeowner’s Rebate (not including the $10,000,000 in
transferred AIMS tutoring monies), and a $(1,823,100)
shortfall for Achievement Testing (again not including
transferred monies). The remaining surplus of $472,500 is for
other miscellaneous programs. The department’s June 14th
report does not indicate how it plans to address the projected
$(1,832,100) shortfall for Achievement Testing for FY 2005.
Department of Health Services - Report on Arizona State
Hospital Corrective Action Plan – Pursuant to Laws 2005,
Chapter 5, the Department of Health Services (DHS) has
submitted a report on the status of the State Hospital’s
Corrective Action Plan. The State Hospital’s Corrective
Action Plan was instituted in order to address deficiencies cited
by the federal government in the Hospital’s operation.
Supplemental funding was added in order to assist hiring and
retaining nurses and other staff, to pay for increased drug costs
as well as to make improvements to the facility.
According to the report, the department has expended
$771,200, or 60% of the FY 2005 supplemental funding
amount of $1,281,400, as of May 31. The Hospital has hired 5
Registered Nurses and expects to hire 3 additional Registered
Nurses that will start in June. Additionally, the Hospital has
hired one Social Worker that will start on May 31 and is in the
process of interviewing for additional Social Workers. Three
Recreational Therapists have been hired and will begin work in
June and the process of interviewing for a fourth Recreational
Therapist and a Psychologist II position.
Maintenance
contracts for housekeeping and other facility maintenance are
in effect and the Hospital has recently awarded the contract to
repair the mall concrete surface. Table 4 below updates the
progress of the State Hospital’s Corrective Action Plan.

Page 5

Joint Legislative Budget Committee

Monthly Fiscal Highlights – May 2005

Table 4
Arizona State Hospital
Status of FY 2005 Corrective Action Plan
As of May 31, 2005

Action Plan Initiative
Fill Vacant RN Positions
Critical Positions to be Funded
Fund 4 Social Workers
Restore Maintenance Contracts
Repair Mall Concrete Surface
Increased Drug Costs
Total

FY 2005 Plan
$487,400
55,900
37,600
209,200
49,800
441,500
$1,281,400

Department of Revenue - Report on Revenue Generating
Program – A footnote in the General Appropriation Act
requires the Department of Revenue (DOR) to report quarterly
to the Committee on the effectiveness of the revenue
generating program and the department’s overall enforcement
and collections program, including a comparison of projected
and actual revenue enforcement collections for FY 2005. The
revenue generating program was expected to produce $75.1
million of gross additional enforcement revenue, including a
net increase of $53.2 million to the State General Fund.
DOR has reported their General Fund enforcement revenue,
which includes both their baseline and revenue generating
program monies. They did not separate out the enforcement
monies attributed to the revenue generating program. DOR
had General Fund enforcement revenues of $214.6 million
through the 3rd quarter of FY 2005, which was $(20) million
below their goal of $234.6 million. There were shortfalls of
$(24.8) million in collections, $(1.3) million in transaction
privilege tax audit and $(1.1) million in accounts receivable,
which DOR attributes in part to the conversion of the
transaction privilege tax system to the Business ReEngineering/Integrated Tax System (BRITS) in January 2004.
DOR reports that the BRITS transaction privilege tax system is

Current
Expenditures
$181,000
--148,700
-41,500

Funding Yet to
be Expended
$306,400
55,900
37,600
60,500
49,800
--

$771,200

$510,200

still not fully functional, and that they continue to manually
review all transaction privilege tax audit bills prior to mailing.
The total shortfall of $(20) million includes results which
exceeded the goals by $278,700 in corporate tax audit,
$760,000 in individual tax audit and $6.3 million in license
compliance. Table 5 summarizes these results.
Arizona Department of Transportation - Report on Parker
MVD Field Office – Laws 2004, Chapter 276 appropriated
$500,000 from the State Highway Fund to the Arizona
Department of Transportation (ADOT) to relocate the Parker
Motor Vehicle Division (MVD) field office. In October 2004,
ADOT estimated a total cost of $500,000, including a
contingency set aside of $39,000. All costs were ADOT
estimates, with no contracts yet in place. ADOT reported that
the new office is to be located on 3 acres leased from the
Colorado River Indian Tribe. At its October 14, 2004 meeting,
the Joint Committee on Capital Review gave a favorable
review to the Parker MVD Field Office relocation with the
provision that ADOT report back to the Committee with
updated expenditure estimates once construction contracts had
been signed.
On May 25, 2005 ADOT reported a total cost of $540,100,
citing $54,900 of additional unanticipated costs not included in

Table 5
DOR’s General Fund Enforcement Revenue Through the 3rd Quarter of FY 2005 (Net of Duplications)

Corporate Tax Audit
Individual Tax Audit
Transaction Privilege Tax Audit
License Compliance
Collections
Accounts Receivable 1/
Total

FY 2005 Through 3/31/05
Goal
Actual
$40,105,700
$ 40,384,400
6,187,800
6,947,800
11,835,500
10,516,600
9,075,300
15,349,300
140,503,500
115,690,500
26,855,600
25,712,400
$234,563,400
$214,601,000

Over/(Under)
$ 278,700
760,000
(1,318,900)
6,274,000
(24,813,000)
(1,143,200)
$(19,962,400)

___________
1/ Taxpayer accounts paid before they would have been moved to Collections, which allows collectors to work on
other accounts.
Page 6

Joint Legislative Budget Committee

Monthly Fiscal Highlights – May 2005

their October 2004 estimate. The $54,900 includes $49,000 to
stabilize loose sandy soil at the site. ADOT reports that they
are paying for the $40,100 of expenditures which exceed the
appropriation from MVD’s operating budget. ADOT reports
that the work will be done June 17, 2005 and the Parker MVD
Field Office will be relocated June 20, 2005. Table 6 shows
ADOT’s 2 cost estimates.
Table 6
ADOT’s Expenditure Estimates
Architectural &
Engineering
Site Development
Utility Connection
Modular Building
Telecommunications
Furniture
Contingency
Total

October 2004
$ 12,000

June 2005
$ 38,000

75,000
50,000
216,000
54,000
54,000
39,000
$500,000

237,500
5,900
232,900
7,300
18,500
0
$540,100

OTHER ISSUES
Individual Income Taxes Paid By Business – Individual
income tax collections for the April/May period increased
almost 75% compared to the previous year. The large surge in
individual income tax collections in the current fiscal year is
not a phenomenon that is unique to Arizona. Reports from
many other states show revenue collections far in excess of
earlier projections, although Arizona’s growth was one of the
nation’s highest.
The current lack of detailed Arizona income tax data makes it
difficult to explain the April/May revenue growth with any
certainty. Based on general economic trends, the JLBC Staff
speculates that the large increase in income tax revenues is
spurred by capital gains from real estate investments and stock
market appreciation. Higher profitability of small businesses
(which often pay individual rather than corporate income
taxes) is another likely factor.
There has not been significant attention paid to the role of
small businesses in individual income tax collections.
According to the Internal Revenue Service (IRS), the majority
of businesses operating in the U.S. are subject to individual
rather than corporate income taxes. A business that is subject
to individual income taxes is referred to as “pass-through
entity” since its income (and thus resulting income tax
liability) passes or flows through the business to the individual
owners or members of that business. In other words, the
business itself is not a tax-paying entity. Instead, the
individual owners or members of that business include their
pro rata share of the business net income (or loss) on their
personal tax return.

Generally, all businesses except regular corporations are
considered pass-through entities. In Arizona, a pass-through
entity is either operating as a sole proprietorship, partnership,
limited liability company (LLC), or a Subchapter S
Corporation. These business structures differ legally most
notably with respect to ownership restrictions, filing
requirements, and personal liability for business debts and
court judgments. For example, sole proprietors and general
partners are personally liable for any debts incurred by their
business, whereas members of limited liability companies and
shareholders of S Corporations are not.
According to a recent report by the Council On State Taxation
(COST), a national nonprofit trade association, individual
income taxes paid by pass-through entities have increased
significantly over the last two decades. For example, at the
national level, COST estimates that the share of individual
income tax liability attributable to pass-through business
income has increased from 7.1% in 1980 to 13.1% in 2001.
The growing importance of pass-through business income
relative to corporate net income is highlighted in COST’s
report. For example, in the period from 1980 to 2001, business
income in the U.S. grew at an average annual rate of 8.8% for
pass-through entities compared to 5.9% for regular
corporations. For the nation as a whole, individual income
taxes paid by pass-through entities represented about half of
the amount of corporate income taxes paid by regular
corporations in FY 2004.
The rapid formation of pass-through entities in Arizona is
evidenced by statistics provided by the Arizona Corporation
Commission (ACC). According to ACC, the number of new
LLCs in the state has increased by 136% over the last 4 years.
In the same period, the number of new filings of corporations
decreased by 21%. LLCs comprise 43% of corporate filings
currently recorded by ACC.
According to the Department of Revenue (DOR), Arizona
income tax returns do not include the information that is
necessary for the department to calculate the amount of state
income tax attributable to pass-through entities. However,
COST estimates that Arizona collected about $200 million in
income taxes in FY 2004 from the net income generated by
pass-through entities. If this estimate is correct, income tax
from pass-through entities represented about 9% of total
individual income tax collections in FY 2004. This means that
individual income taxes attributable to Arizona pass-through
businesses constituted about 40% of corporate income taxes in
FY 2004.
COST’s estimate was based on Arizona’s assumed share of the
total U.S. pass-through business income as reported by the
IRS. To gauge the accuracy of COST’s estimate, the JLBC
Staff contacted the California Franchise Tax Board (FTB),
which provides its own independent estimate of California
income tax attributable to pass-through entities.
FTB
considered COST’s California estimate consistent with FTB’s.
This may arguably lend more credence to COST’s Arizona

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Joint Legislative Budget Committee

estimate since California tax returns (unlike Arizona tax
returns) include the information that is necessary to fairly
accurately calculate the amount of state income tax attributable
to pass-through entities.
The growing importance of pass-through business income in
Arizona can also be inferred from Arizona personal income
statistics. According to the Bureau of Economic Analysis
(BEA), the share of Arizona personal income attributable to
proprietorships has grown from 6% in 1990 to 9% in 2004.
This trend is due to the fact that while overall personal income
grew at an average annual rate of 7%, proprietorship income
(which is a component of personal income) grew at an even
faster annual rate of 10%.
The continued growth in business income from pass-through
entities is likely to further increase the volatility of the state’s
individual income tax collections. Generally, business income
tends to be more volatile than other personal income sources.
In addition, income generated by businesses (especially by
limited liability companies and S Corporations) is often taxed
at the top marginal tax rate. The trend of increased business
income from pass-through entities is thus likely to help explain
(at least in part) the increased revenue volatility observed
during economic upturns and downturns.
Efforts to monitor the growing importance of pass-through
entities in Arizona are hampered by a lack of state-specific
data. Furthermore, national data is typically released with a
lag of 2 or 3 years. For this reason, we do not expect the IRS
to release tax year 2004 national income data until the fall of
2006. At this time, we expect to be in better position to
account for the underlying sources of the FY 2005 revenue
windfall.
In lieu of “hard” data, however, the recent growth in corporate
income taxes may help to explain the simultaneous surge in
individual income tax collections. Year to date, corporate
income taxes have grown by 50%. If the same growth trend
applies to small businesses as well, their individual income tax
payments would have increased by about $100 million. (This
amount is derived by applying the 50% assumed growth rate to
the FY 2004 small business individual income tax base of $200
million reported by COST.) Since small business income is
typically not subject to withholding tax payments, the
increased tax liability generated by such businesses (estimated
to be $100 million) may have appeared as part of the $208
million increase in April/May final payments.
JLBC MEETING
At its June 28th meeting, the Joint Legislative Budget
Committee considered the following issues:
Arizona Health Care Cost Containment System – Review
of KidsCare Behavioral Health Capitation Rate Changes – The
Committee gave a favorable review to the Arizona Health Care
Cost Containment System (AHCCCS) Behavioral Health
capitation rates for the KidsCare (including parents) program.

Monthly Fiscal Highlights – May 2005

The approved rates are virtually identical to budgeted levels for
FY 2006.
Department of Economic Security – Review of Transfer of
Appropriations for TANF Cash Benefits and Child Care
Subsidy Line Items – The Committee gave a favorable review
to the Department of Economic Security’s (DES) request to
transfer $12.0 million from the TANF Cash benefits line item
in order to address shortfalls in the Operating budget of the
Division of Benefits and Medical Eligibility ($3.0 million) as
well as in the Adoption Services ($1.2 million) and Children
Services ($7.8 million) line items. The Committee also
discussed how DES planned to address the agency’s remaining
$9.4 million shortfall.
There was also concern that the transfers are replacing monies
that had been made available in FY 2004 through a veto of a
lump sum reduction. These monies were not replaced in the
original FY 2005 budget, as the Governor had directed DES to
find efficiencies. DES is now transferring TANF surplus
monies to resolve this issue. TANF monies are available
because of declining caseloads, resulting in the decline in
TANF cash assistance payments.
The Committee also favorably reviewed a transfer of $4
million from the Day Care Subsidy SLI to the Transitional
Child Care SLI. Growth in the Transitional Day Care
population has been higher than anticipated while caseloads in
the Day Care Program have declined by 3.7%. In addition to
the transfer, the Committee discussed the wait list that was
implemented in September 2004 in light of the fact that the
program is expected to have an estimated $4 million projected
surplus at the end of FY 2005.
Department of Economic Security – Review of Expenditure
Plan for Discretionary Workforce Investment Act Monies –
The Committee gave a favorable review of the Department of
Economic Security’s expenditure plan of $184,900 in
Workforce Investment Act (WIA) monies in order to provide
support to the Jobs for Arizona Graduates (JAG) Program.
The Committee stipulated that DES provide performance
measures for the JAG Program in order to measure the
program’s effectiveness.
Department of Health Services – Review of Children’s
Rehabilitative Services Capitation Rate Changes – The
Committee favorably reviewed the Department of Health
Service’s (DHS) capitation rate adjustments for the Children’s
Rehabilitative Services Program for FY 2006. The capitation
rate adjustments are within the agency’s FY 2006
appropriation levels for the program.
Department of Revenue – Review of Ladewig Expenditure
Plan – The Committee gave a favorable review to the
Department of Revenue’s estimated administrative expenditure
plan of $1.4 million for the Ladewig Project for FY 2006. As
part of the agency’s report, DOR indicated that FY 2005
refunds included over $6.3 million in overpayments to
taxpayers. The Committee directed DOR to report back to the
Committee after the taxpayer overpayment issue has been
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Joint Legislative Budget Committee

Monthly Fiscal Highlights – May 2005

resolved and to estimate the agency’s total cost of the Ladewig
project at that time.
Arizona State Retirement System – Review of FY 2006
Information Technology Expenditure Plan – The Committee
gave a favorable review to the Arizona State Retirement
System’s (ASRS) FY 2006 Information Technology (IT)
expenditure plan. The Government Information Technology
Agency (GITA), in its most recent monitoring report, changed
the project’s status from “green” to “red,” indicating a serious
risk to project completion by the planned date. The Committee
directed ASRS to provide an update by the end of each
calendar quarter as to the progress made towards bringing the
IT plan back to “green” status.
Arizona Department of Corrections – Report on Employee
Overtime Pay and the On-Call Pay Settlements – The Arizona
Department of Corrections submitted a report indicating that
all FY 2004 compensatory time has been paid and that all but 3
on-call claims were paid as of May 2005. The report further
stated that $7.8 million was spent on FY 2004 employee
compensatory time payments and $12.3 million was expended
for on-call claims.
The Committee also discussed a number of other items related
to ADC, including:
• The number of vacant positions and the dollar value of
vacancy savings in the department’s budget;
• ADC’s plan for expending its vacancy savings;
• The competitiveness of correctional officer pay;
• The resources currently in the department’s budget that can
be used to address compensation issues;
• Private prison contracts, particularly for a women’s only
facility.

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