New Arizona ban on taxing 'services' might wreck city budgets. So cities lawyer up

Prop. 126 bars new or increased taxes on services, but the voter-approved measure did not define "service"

Lauren Castle
The Republic | azcentral.com
A waitress retrieves dishes at Chase's Diner in Chandler. If restaurants and bars are considered a non-taxable service under a new Arizona law, city budgets could take a big hit.

Arizona cities are becoming the testing grounds to figure out how a statewide ballot proposition will affect their bottom lines. 

Some say Prop. 126 could dramatically reduce tax collections. Others say the worry is unfounded. 

Arizona voters in November overwhelmingly approved Prop. 126, which prohibits new or increased taxes on services.

At the same time:

  • Mesa voters increased the city's sales tax to bolster public safety.
  • Scottsdale voters agreed to a sales-tax hike to get better roads.
  • And Tempe voters renewed an arts sales tax. 

A study by the Grand Canyon Institute estimates Prop. 126 could wipe out millions of dollars from the newly passed local tax measures, and eventually reduce tax collections at other levels of government from renewal of regional transportation funding to statewide education funding.

No definition

A chief concern is that Prop. 126 did not define the services exempted from taxation.

The Grand Canyon Institute study estimates Mesa could lose 38 percent of its anticipated public-safety sales tax collections, depending on what gets lumped into the services category. That would leave the city unable to hire all 65 police officers and 45 firefighters promised.

If restaurants and bars are considered a non-taxable service, for instance, that alone would eliminate 10 percent of Mesa's anticipated sales-tax hauls.

Miguel Torres serves lunch to diners at Rosita's Place in Phoenix.

The Mesa City Council on Monday decided to challenge Prop. 126, seeking clarification from the courts. 

"Proposition 126 creates multiple issues and ambiguities that endanger the ability of the City of Mesa to collect and retain the public safety sales tax," a city statement said.

"We don’t take challenging this initiative lightly, but our commitment to Mesa voters to fund our Police and Fire & Medical Departments to ensure a safe community for our citizens makes it necessary," the statement said. 

A day later, the Scottsdale City Council voted to retain outside counsel to clarify the proposition's impact, through court proceedings if necessary. The Tempe City Council followed a similar path Thursday. 

Officials in Flagstaff, where voters also passed a tax measure last month, say they are still analyzing the proposition's effects.

Wes Gullett, a spokesman for proponents of Prop. 126, told The Arizona Republic on Thursday that he doesn't think cities have anything to worry about. "They have the right to do the tax. They've been doing the tax. Prop. 126 doesn't change that," he said. 

What is Proposition 126? 

The state Realtors association launched Prop. 126, which prevents taxes on real estate services. But it also prohibits any service-based taxes not in effect as of Dec. 31, 2017. 

The proponents spent more than $8 million on their effort, including an ad that showed a giant vacuum sucking money from the city of Phoenix. The ad raised the specter that government could begin to tax services such as health care, child care and veterinary services

Some 64 percent of voters approved the initiative, which amends the state Constitution.  

Broadly speaking, Arizona taxes goods and not services. However, there are taxes on such things as utilities, hotel rooms and restaurants that could be construed as "services," opponents cautioned. 

Groups on both sides of the political spectrum opposed the measure, in part because of the lack of clarity. 

Ken Strobeck, executive director of League of Arizona Cities and Towns, said this week that with no definition of services it could lead to broad interpretation and accusations of tax collections being unconstitutional. 

Big possible impact or nothing to worry about?

Dave Wells, research director at the Grand Canyon Institute, a nonpartisan organization that opposed the proposition, co-authored the report on the measure's potential impacts.

The report estimates Mesa could collect $15 million annually instead of the anticipated $25 million from its voter-approved sales tax increase for public safety. That assumes the city could not collect the tax in categories such as utilities and restaurants or bars. 

The report estimates Scottsdale could lose $90 million it expected to receive from its voter-approved sales-tax hike and matching regional transportation funding over 10 years.

A Scottsdale spokesman declined to comment on the report's findings. "Scottsdale is still working through its analysis of any potential impact given the uncertainties in the Proposition arising from, among other things, the absence of a definition of ‘services,'" city spokesman Kelly Corsette said. 

Tempe could lose a third of theanticipated $9 million in annual collections on a voter-approved sales tax for art and cultural amenities, according to the report.

The city said in a statement that it believes Prop. 126 "is flawed," poorly written and should not apply to the city's art and cultural tax. 

"The Tempe sales and use tax ... is not a tax on services or labor. It pertains mainly to things like goods sold at retail," a city statement said. "By contrast, services are typically actions such as salon services, pet grooming, real estate transitions and visits to health care providers."

Flagstaff similarly could see funding pared back on a voter-approved tax measure.

Gullett dismissed the report as "total exaggeration." In his opinion, service is incidental at a restaurant. The goods are the "onion rings and the beer" and tax collections at restaurants would continue. 

Strobeck sees it as a "giant open-door invitation" for lawsuits with people claiming things shouldn't be taxed. 

Republic reporter Paulina Pineda contributed to this article. 

Reach the reporter at Lauren.Castle@gannett.com. Follow her on Twitter: @Lauren_Castle.