A legal challenge to legislation that shielded small businesses from Prop. 208’s tax increase could end up barring the Arizona Legislature from ever cutting taxes again.

That’s the claim from the nonprofit Goldwater Institute, which filed to intervene in a challenge to Senate Bill 1783 by Invest in Arizona.

The legislation, enacted as part of a bundle of budgetary measures, allows S-corporations to file differently so their pass-through income isn’t subject to Prop. 208’s 3.5% tax on income over $250,000 for single filers.

Invest in Arizona filed the legal challenge to SB 1783 on Aug. 5. The group said the bill violates the Voter Protection Act by pulling revenue that would qualify under Prop. 208 out of that taxable income.

Goldwater filed to intervene Wednesday, along with the Arizona Free Enterprise Club.

The groups said if SB 1783 is struck down, as the plaintiff is asking it to be, any legislative cut to taxes would be subject to a legal challenge under the same argument.

“If, as Plaintiffs allege…, “exclud[ing] large categories of individual income from [a person’s] ‘taxable income’ violates Prop. 208, then the legislature is barred from ever creating new tax credits, or other tax cuts in the future,” Goldwater’s attorney said in the filing. “Were this Court to endorse it, the consequence would not only to be prohibit any reduction in Arizona income taxes going forward, but to effectively outlaw a significant part of FEC’s organizational mission.”

The reasoning behind this premise comes from how all tax exemptions and deductions are filed, said Timothy Sandefur, vice president of litigation for Goldwater.

“Under SB 1783, a business owner’s business income is subtracted from her personal income before it is counted as ‘taxable income’ (and the business income is taxed separately),” he said.

“But every tax deduction or exemption does the same thing: It is subtracted from a person’s income before the tax is imposed. That means that if Invest in Arizona is successful in this lawsuit, not only would the new small business tax be struck down, but the Legislature would be forever barred from reducing taxes.”

The ballot initiative’s fate is uncertain after the Arizona Supreme Court remanded a challenge to its legality back to a lower court with instructions to reconsider it under more restrictive pretense.

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This article was published on August 26, 2021 and is reproduced with permission from The Center Square.