PHOENIX — Business interests trying to quash a vote on higher taxes on the rich sought to convince a judge Wednesday that the extent and breadth of the proposed new levy is being purposely understated and misleading.
Attorneys for both the Invest in Education initiative and the Arizona Chamber of Commerce and Industry agree that the measure, if approved by voters, would create an effective income tax rate on earnings above $250,000 of 8.04 percent, up from 4.54 percent now.
Taxes on earnings below that would remain unchanged. And estimates are that only about 4 percent of all Arizona taxpayers would be affected.
The description provided to those signing the initiative — and in the initiative text itself — says the measure will impose “a surcharge at the rate of 3.5 percent.’’ That, the business group contends, misleads the public about the extent of the change that is designed to raise $940 million a year for K-12 education.
They contend what’s really at issue is a 77.7 percent increase in the top tax rate. They want Maricopa County Superior Court Judge Christopher Coury to declare that the failure to sufficiently explain the extent of what is being proposed means the petitions and the initiative wording are fatally flawed and cannot be put before voters.
At least part of the objection from the business foes goes to the use of the word “surcharge.’’
“What the initiative refers to as a ‘surcharge’ is a tax,’’ according to attorney Brett Johnson, who is representing the business interests trying to keep the measure off the ballot.
It’s not just the word “surcharge’’ that he says is misleading.
“When the petition’s 100-word description refers to ‘establishing a 3.5 percent surcharge’ on this income, it gives voters the misimpression that the income in questions is currently untaxed,’’ Johnson said. “After all, ‘establish’ refers to starting something that does not currently exist.’’
He said that is designed by proponents of the initiative to convince people to sign the petition and support the measure.
“Voters would find the distinction between a new tax and a tax increase material,’’ Johnson said. “Someone might be willing to tax their fellow citizens 3.5 percent but not 8 percent.’’
For Johnson to have the measure removed from the ballot he needs more than his own assessment. So the foes retained economist Jim Rounds.
“It would have been improper and possibly misleading to use the word ‘surcharge’ instead of ‘tax increase,’’ Rounds told Coury on Wednesday. He suggested words like ‘surcharge’ and ‘revenue enhancement’ are designed to hide the true nature of what is being proposed.
Attorney Marvin Ruth pointed out that Rounds, in submitting his own argument urging voters to reject the initiative, actually used the word “surcharge.’’
Rounds said he still considers it a tax hike, saying it would take the top tax rate up past 8 percent.
Ruth pointed out it’s not that simple.
He said the surcharge, if approved by voters, would exist independent of the income tax system. What that means, Ruth said, is the 3.5 percent levy would remain even if the legislature were to abolish the regular state income tax.
Ruth suggested that makes it a surcharge versus a simple tax increase.
Verbiage issues aside, Rounds also testified that there’s something else missing from the way the levy is described in the initiative: who it would affect.
It spells out that the levy would apply to incomes of more than $250,000 for individuals and $500,000 for couples. Rounds said what the initiative does not say is that it also would affect certain kinds of small businesses.
That includes not just sole proprietorships in which any business income is attributable to the individual owner, it also would affect businesses incorporated under Subchapter S of the Internal Revenue Code.
Traditional corporations pay taxes under the corporate name; all earnings of S corporations are considered the earnings of the owners of that company and taxed as individual income.
That, Rounds testified, means small businesses would be affected if the initiative is adopted, something not mentioned in either the description or the initiative itself.
David Lujan, director of the Arizona Center for Economic Progress, told Capitol Media Services that tells just half the story.
He said that these business owners, like any other business, do not pay taxes on their gross receipts. What is taxable is what remains after all expenses are deducted — essentially the individual’s take-home profits, much in the same way employees pay taxes on what they take home and is the bottom line of taxable income on individual tax returns.
Lujan said he doubted there were many business owners who had take-home profits, after expenses, in excess of $500,000.
Rounds, however, said that perhaps a quarter of those who would be affected by the initiative are business owners.
Ruth said that doesn’t add up.
Using some data that Rounds himself provided, he said that total taxable income of those earning more than $200,000 — the break point used by the state Department of Revenue — was $59.8 million. By contrast, Ruth said, the portion of that attributable to businesses was less than $1.8 million, or less than 3 percent of adjusted gross income
Ruth said that shows just a small portion of business filers would be affected.
“You’re doing the analysis improperly,’’ Rounds responded.
The hearing is expected to continue into Thursday, with Coury issuing a ruling on whether the measure can go on the ballot within days. Whichever side loses is virtually certain to seek Arizona Supreme Court review.
This trial is just the first of four which will determine what, if anything, will go before voters.
There are separate challenges to a campaign to legalize the recreational use of marijuana, a second to give judges more discretion in sentencing and a third to give pay raises to hospital workers and guarantee that people with pre-existing conditions can get affordable health insurance. Those trials begin this coming week.