A stormy tax season

During an uncharacteristically gloomy afternoon at the Arizona Capitol this week, House Speaker Steve Montenegro battled gusts of wind that sent his notes flapping across the podium as he laid out Republicans’ latest position in the political battle over Donald Trump’s tax cuts.

Montenegro, flanked by about 20 other legislative Republicans, announced the House and Senate GOP caucuses sent Gov. Katie Hobbs a letter warning that “any outcome that forces Arizonans to refile their taxes is a non-starter.”

It was a fittingly dramatic backdrop for what has become an unusually dramatic fight over something that is typically anything but: adopting Arizona’s tax code.

So far, Hobbs has vetoed two Republican plans outlining how the state should conform to Trump’s tax cuts. She insists lawmakers instead pass the narrower, slightly less Trump-aligned package she rolled out in November under the banner of her “Middle Class Tax Cuts.”

Republicans, meanwhile, have repeatedly pointed to what they’ve framed as an unthinkable administrative failure: The Arizona Department of Revenue has already issued tax forms assuming federal tax conformity, so any deviation could force taxpayers who’ve already filed to amend their returns.

Every year, ADOR issues tax forms assuming the Legislature will match federal tax changes — because it usually does.

This year is not so typical: H.R.1, or Trump’s “Big Beautiful Bill,” rewrote major parts of the federal tax code that states like Arizona use as the foundation for their own systems. H.R.1’s changes cut into state revenue streams while shifting more public service costs onto state governments.

Add in an election year, and the fight isn’t just about tax policy. It’s about who voters hold responsible for the fallout.

Republicans want to make sure it’s not them.

After previously warning Arizona taxpayers to hold off on filing their state tax returns until politicians sorted out the tax code, Republicans issued new guidance Wednesday telling taxpayers to go ahead and file — and promised they’d make sure nothing changes.

The Executive Tower — headquarters of the “other side” — stands directly across the House and Senate on the Capitol plaza. But despite the short walk, neither Republican lawmakers nor the governor’s staff seems to have made the trip to negotiate in person.

Instead, the Governor’s Office and legislative Republicans have blamed one another for failing to negotiate. They’ve conducted the tax code fight through press releases, dramatic press conferences and veto letters.

And with taxes due in less than two months, tax preparers are desperate for some clarity.

Now, the standoff has landed on the outcome worst for Hobbs, and the most punishing for the state’s bottom line: full adoption of the Trump tax cuts.

It’s now a question of who blinks first.

Hobbs could still back down and adopt the full H.R.1 tax package, even after painting herself into a corner by blasting the extra corporate tax cuts baked into it. Or she could stick to her position, but that would force some who already filed to amend their tax returns.

Republicans have now drawn their own hard line, saying they’ll only pass a tax code with the business tax cuts — but if that doesn't happen in the next few weeks, taxpayers will reach the April 15 deadline filing returns that technically don’t comply with state law.

That scenario would be uncharted territory, even for Kevin McCarthy, the longtime Arizona Tax Research Association president who’s been with the group since 1986.

In addition to opposing what they’ve framed as corporate tax cuts, Democrats have repeatedly emphasized the need to know what programs Republicans plan to cut before agreeing to a new tax code.

Last year, during a similarly communication-starved budget standoff that nearly shut down state government, Hobbs secured funding for several priorities that require ongoing money, such as child care, public university scholarships and new school construction.

It would look really bad for her reelection bid if those programs were lost to Trump’s tax cuts.

At Wednesday’s press conference, Montenegro said Arizona has “sufficient cash balances to cover the impact this year” without making major cuts.

Still, Democrats argue tax changes belong in broader budget talks, pointing to the 2019 fight under Republican Gov. Doug Ducey, when the state tax code was folded into end-of-session negotiations.

The difference then, McCarthy explained, was that Arizona’s tax forms were already largely consistent with state law, because lawmakers had adopted most federal tax changes the year before.

The Legislature’s tax standoff has been brewing since last year.

Republicans asked Hobbs to call a special session in November after she announced her tax plan. She declined.

The governor promoted her tax proposal in her State of the State address and urged lawmakers to send it to her desk.

Instead, Republicans advanced their own conformity plan that adopted some provisions of H.R.1 — including the corporate tax changes — while omitting others.

Knowing the governor’s veto was coming, Republicans held a dramatic press conference where Montenegro spoke directly to the governor, who wasn’t there.

In her veto letter of that initial GOP tax plan, Hobbs said Republicans were holding taxpayers “hostage” to “force through tax breaks for special interests.” The GOP proposal carried a $441 million revenue hit this fiscal year — $147 million of it tied to business tax breaks.

Republicans then sent Hobbs a plan for full adoption of the Trump tax changes. She vetoed it with a firm tone:

But behind the scenes, there were mixed signals.

After the first veto in January, Montenegro and Petersen sent Hobbs a letter asking for guidance, noting the tax forms already in circulation didn’t match her preferred plan, and some taxpayers who had already filed could be forced to amend their returns.

Eleven days later, Hobbs’ budget director, Ben Henderson, responded.

Instead, the administration proposed passing the individual income tax pieces now and negotiating the business tax cuts later as part of budget talks.

Which is where things get circular: Full conformity — the very concept Henderson said the governor isn’t opposed to — would, by definition, include those same business tax cuts.

Ultimately, any tax plan that removes the business tax provisions already built into Arizona’s current filing forms would likely force some filers to amend their returns.

And the political optics go beyond bureaucratic hassle — some taxpayers could end up owing the state more money.

For now, both sides are dug in. Hobbs refuses to sign off without clarity on how Republicans would protect her priorities while giving up hundreds of millions in state revenues. Republicans are stuck on full adoption of the federal tax cuts.

We’ll see who makes the trip across the Capitol plaza first.