Arizona Supreme Court sets the stage to overturn Prop 208 tax increase for school funding

The Arizona Supreme Court refused to block a voter-approved tax hike on the state’s top earners, rejecting a challenge brought by Republican lawmakers and a local business, who argued that the tax violated the state constitution.

But the victory for public school advocates is likely only temporary, as the court ruled that Proposition 208’s spending on teachers and school operations is subject to constitutional restrictions on spending — and said it’s very likely that the spending will far exceed the constitutional limits.

Because there was no evidence that the spending will exceed those restrictions, they ordered the lawsuit return to the trial court to determine whether it does. If the trial court determines it does, the ballot measure would be gutted and unable to direct money to public schools.

Prop. 208 imposes an additional 3.5% income tax surcharge on individuals who earn more than $250,000 per year or couples who earn at least a half million. The additional money, which legislative budget staff estimated to be about $827 million annually, is earmarked for K-12 education spending.

Opponents of the law argued in court that the Arizona Constitution prohibits voters from imposing new taxes on themselves, as voters did with the approval of Prop. 208 in November. They also argued that a constitutional provision requiring a two-thirds vote of the legislature to raise taxes applies to any voter-approved tax, and that the law infringes on lawmakers’ spending authority by dictating how the additional funding must be spent.

Maricopa County Superior Court Judge John Hannah rejected those claims in June. 

But on appeal, Prop. 208’s opponents argued that the money the ballot measure would send to schools violate a constitutional restriction on how much they can spend. The initiative’s authors attempted to circumvent the constitutional cap by calling the money as “grants” to schools to increase salaries for teachers and support staff — which are explicitly exempted from the spending limits — but the Supreme Court rejected that characterization.

Because the “grants” in Prop. 208 are derived from a tax increase on wealth Arizonans, and not voluntary gifts from private people or non-governmental entities, they are subject to the local spending limits, the court ruled.

By the court’s analysis, roughly $600 million of the estimated Prop. 208 funding is subject to the constitutional spending limits. And because the aggregate school spending statewide was only $144 million under the collective spending limit in the last fiscal year, the new education spending “will far outpace (the) permissible spending” and be unconstitutional.

And beyond that, the court ruled that the spending language can’t be severed from the rest of the voter-approved measure — meaning that if the spending violates the constitutional limits, the entire school funding scheme will be struck down.

During the 2021 legislative session, Republican lawmakers and Gov. Doug Ducey took actions to negate the effects of Prop. 208. The income tax cut they approved created a 4.5% cap on income taxes, effectively reducing the underlying tax rate for those who are subject to Prop. 208 to 1.5%, though they’ll still pay the full amount of the surcharge from the voter-approved tax and that money must still be used for the educational purposes laid out in the ballot measure. 

A separate law enacted by Ducey and the legislature exempts businesses that file income taxes under individual tax rates from the effects of Prop. 208.

DEVELOPING: This story will be updated throughout the day.