BILL #    HB 2236

TITLE:     military pensions; increase; tax subtraction

SPONSOR:    Livingston

STATUS:   As Introduced

PREPARED BY:    Jon Stall

 

 

 

REVISED

 

Description

 

The bill gradually increases the current $2,500 cap placed on the amount of military retirement pay that is exempt when calculating income for state income tax purposes to $15,000 in tax year (TY) 2029.  The bill would effectively lower military retirees’ income for purposes of calculating their income tax liability.

 

Estimated Impact

 

HB 2236 is estimated to reduce General Fund revenues by $(4.7) million in FY 2020.  The impact grows to $(26.7) million by FY 2030, once the 11-year phase-in of a $15,000 subtraction is complete.  Table 1 on the following page summarizes the estimated impacts of the bill from FY 2020 to FY 2030.  If more military retirees are attracted to the state as a result of the exemptions, however, the revenue reduction could be partially offset from additional tax collections to the General Fund.

 

The Department of Revenue (DOR) estimates that the bill would reduce revenues by $(4.9) million in FY 2020, an impact that grows to $(23.9) million by FY 2030.

 

Analysis

 

After 20 years of service, retired and retained members of the Army, Navy, Marine Corps, Air Force, and Coast Guard are eligible to receive pension payments from the federal government.  Current law includes a $2,500 cap on the amount of this pay that is exempt in calculating Arizona Adjusted Gross Income (AGI) for the 50,200 Arizona residents that receive non-disability military retirement pay (data is from FY 2016).

 

The U.S. Department of Defense (DOD) publishes data on total pension benefits received by Arizona military retirees, but only releases national data on the distribution of payment amounts.  In preparing this analysis, the JLBC Staff assumed that the distribution of pension payment amounts for Arizona military retirees is the same as that across all military retirees nationwide.  For example, DOD reports that 20.3% of all military retirees nationwide received annual pension income of $15,000 or less in FY 2016.  The JLBC Staff assumed similarly that 20.3% of Arizona military retirees received annual pensions of $15,000 or less in FY 2016.

 

The bill would gradually increase the current $2,500 cap placed on subtractions of military retirement pay to $15,000 by TY 2029 and later years.  Using FY 2016 data from DOD, the JLBC Staff estimated the amount of Arizona military retirement pay that would be subjected to state income tax between the current $2,500 cap and the different caps proposed in the bill.  Estimates excluded the portion for disability pension income (2.5% of DOD payments in FY 2016) that is not currently subject to federal or state income tax.  Levels of military pay were adjusted upward for inflation.  Between FY 2011 and FY 2016, total military retiree pay grew by 2.0% annually.  This same annual rate of growth was applied to FY 2016 salaries to produce military pay estimates in each year through FY 2030.

 

The bill's General Fund revenue reduction was estimated by applying a 3.4% average marginal individual income tax rate to the estimated reduction in taxable income.  This rate represents the average marginal individual income tax rate of all Arizona taxpayers.  Table 1 below summarizes the estimated impacts of the bill from FY 2020 to FY 2030.

 

(Continued)

Table 1

 

Summary of Estimates

 

 

 

 

 

Year

Subtraction
Cap

Increase in Subtractions

($ in Millions)

GF Revenue Reduction

($ in Millions)

 

FY 2020

$  5,000

    $ 137.7    

       $  (4.7)

 

FY 2021

  6,000

          196.1

          (6.7)

 

FY 2022

7,000

         255.9

         (8.7)

 

FY 2023

8,000

      317.1

      (10.8)

 

FY 2024

     9,000

        379.8

        (12.9)

 

FY 2025

       10,000

       443.9

       (15.1)

 

FY 2026

      11,000

         509.4

         (17.3)

 

FY 2027

     12,000

      576.3

      (19.6)

 

FY 2028

      13,000

      644.5

      (21.9)

 

FY 2029

      14,000

        713.8

        (24.3)

 

FY 2030

 $ 15,000

 $ 784.4

 $ (26.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DOR estimates that the bill would reduce revenues by $(4.9) million in FY 2020, an impact that grows to $(23.9) million by FY 2030.  DOR estimates do not reflect growth in military retiree pay in later years. 

 

If more military retirees are attracted to the state as a result of the bill, however, the revenue reduction could be partially offset from additional tax collections to the General Fund.  The JLBC Staff previously analyzed potential revenue offsets of exempting military pension income under SB 1444 during the 2017 Legislative Session.  SB 1444 would have provided a 100% exemption, that, once fully implemented, would have reduced revenues by an estimated $(49.1) million a year.  The analysis of SB 1444 provided an illustrative example that exempting 100% of military pension income may generate $5.1 million in offsetting revenue from additional economic activity.  The revenue offset example was only estimated to occur under full implementation of a 100% exemption for military retirement pay.  Given the $(26.7) million revenue reduction estimated under HB 2236, the proportional revenue offset for the bill would be $2.8 million a year.  That amount may overstate the offsetting revenues, as HB 2236 provides a lower exemption of $15,000 in military retirement income.

 

We have included an excerpt of our fiscal note on SB 1444 below:

 

"If more military retirees are attracted to the state as a result of the bill, however, the revenue reduction could be partially offset from additional tax collections to the General Fund.  From 2010 to 2015, the number of military retirees residing in Arizona grew at roughly 0.7% a year.  This population grew at an average of 1.1% a year in the 23 states that did not tax military retirement pay during this time (in some states, just military retirement pay is specifically exempt, while other states have no income tax).

 

For illustrative purposes only, increasing the growth rate of military pensioners in Arizona (excluding those that already receive a full exemption of disability pension income) from 0.7% to 1.1% a year would cause their numbers to grow from the current 49,900 to 54,500 by FY 2023.  A total of 54,500 military retirees would represent an increase of 1,700 retirees compared to the 52,800 projected if growth instead continued at the historical 0.7% annual rate.

 

In FY 2016, Arizona collected an average of $2,500 in transaction privilege tax and individual income tax revenue to the General Fund per individual income taxpayer.  Between FY 2011 and FY 2016, revenues per taxpayer grew 2.7% annually.  Using this historical rate of growth, the amount of revenues per taxpayer is projected to grow 2.7% annually, to approximately $3,000 in FY 2023.  If 1,700 military retirees are attracted to the state as a result of the bill, and $3,000 in tax revenue is collected to the General Fund for each retiree, the bill would increase

 

(Continued)

revenues by $5.1 million in FY 2023.  The economic activity of military retirees that receive a full exemption under the bill may spur additional economic activity and result in a dynamic impact in the sense of further increasing revenues to the state.  The $5.1 million estimate for this hypothetical scenario does not incorporate dynamic impacts associated with that additional economic activity.

 

A 2016 study by a research economist at the University of South Carolina estimates the fiscal impact to South Carolina of a full exemption of military retiree pay.  South Carolina is gradually phasing in a full exemption of military retiree pay from TY 2016 to TY 2018.  The study projects that the exemption would be revenue neutral by TY 2024, if the exemption annually attracts an additional 5% in military retirees to the state.  This assumed rate of growth seems unlikely, given that the highest average annual rate of growth in military retirees in any of the 23 states that do not tax military retiree pay was 2.2% (South Dakota) from FY 2010 to FY 2015.

 

The extent that an income tax exemption impacts relocation decisions of military retirees is not well quantified in academic literature.  A research economist at the University of Utah concluded that "existing research is insufficient to predict the size of a possible migration response by military retirees due to an income tax policy change.""

 

Local Government Impact

 

Each year, incorporated cities and towns receive 15% of income tax collections from 2 years prior.  The bill would decrease local government distributions by $(702,500) in FY 2022.  The impact would grow to $(4.0) million by FY 2032, once the 11-year phase-in of a $15,000 subtraction is complete in FY 2030. 

 

These amounts exclude any possible gain from increased retirees.

 

1/29/18