Overview of New Mexico’s Tax System and Issues Before the 2009 Legislature

1. Overview of New Mexico’s Tax Systemand Issues Before the 2009 Legislature February 17, 2009 Richard Anklam, Executive Director Thomas Clifford, PhD, Research Director Richard.Anklam@nmtri.org

2. NMTRI Principles of Good Tax Policy N.M. Tax Research Institute is a non-profit, non-partisan member-supported organization dedicated to advancing the following principles of good tax policy in New Mexico. • Adequacy • Revenues should be sufficient to fund needed services • Efficiency • Interference with the private economy should be minimized • Equity • Taxpayers should be treated fairly • Simplicity • Laws, regulations, forms and procedures should be as simple as possible • Comprehensiveness • All taxes should be considered when evaluating the system • Accountability • Exceptions should be rare and should be carefully evaluated and justified

3. FY 2007 State & Local Tax Collections: $7.9 Billion • High reliance on general sales taxes • Low reliance on property taxes • High reliance on severance taxes • About half of selective sales taxes are road fund revenues.

4. FY 2007 Tax Revenue Distributions: $7.9 Billion • Just over half of all tax revenue goes to the state’s General Fund • Local governments receive about one-third of all tax collections. • The state road fund receives about 5%, and the Severance Tax Bonding Fund about 6%.

5. Trends in Tax Collections • GRT has increased – primarily due to local tax rate increases • Property tax has increased due to assessed value growth • Income tax collections have decreased due to tax rate reductions. • Severance taxes increased sharply due to higher product prices.

6. Multistate Comparisons: FY 2002 • New Mexico’s state & local sector uses a relatively large proportion of total personal income. • N.M. relies heavily on sales tax, lightly on property tax and below average on Income tax. • Taxes imposed directly on businesses – rather than on households – are relatively high. Source: Congressional Quarterly, State Fact Finder. Except *COST, Annual Business Tax Study excluding severance taxes.

7. GRT base is much broader than retail sales • Hybrid between Retail Sales Tax (high rate) and Business Privilege Tax (broad base) • Large parts of household consumption are exempt – food, medical services • Reducing the base puts upward pressure on rates

8. Pyramiding of the GRT • Deductions for Business-to-business transactions are limited to resale and targeted industry-specific deductions. • Estimates of pyramided share of tax base range from 1/3 to 50% -- currently over $1 billion per year. • Pyramiding creates inefficiency and inequity in the tax system: • In-state companies face higher overhead than out-of-state competitors • Small businesses – which have to purchase more of their inputs from other firms – face higher overhead than large firms

9. Other GRT Issues • Regressivity • NM’s heavy reliance on sales taxes increases regressivity of the system • Reliance on services, b-t-b taxation reduces regressivity • Food, medical deductions and Income tax credits reduce regressivity • Base erosion due to remote commerce • Broad base makes GRT less vulnerable to base erosion • Statute limits the Compensating Tax, which otherwise would apply to remote sales • NM could join the Streamlined Sales Tax Project to encourage remote sellers to collect GRT • Political base erosion • Narrower base, higher rates increase pyramiding • Hold harmless provisions are increasing complexity and cost

10. 2008 Property Tax Revenue Collections: Total $1.39 billion • About 1/3 of revenue goes to schools, mostly for capital outlay • 1/4 goes to Counties, mostly for operating expenditures • About 1/6 goes to municipalities. • About 10% each goes to hospitals (primarily UNMH) and higher education and • Slightly less than 5% goes to the state for GO bonds

11. Growth of Property Tax Obligations Since 2000 • Residential obligations have almost doubled – mainly due to assessed value growth. • Residential obligations have increased by 1/3 more than personal income. • Non-residential obligations are consistent with personal income growth.

12. Property Tax: Key Issues • Valuation limits create large disparities between taxpayers • Value limits and yield control have not prevented residential liabilities from growing much faster than income • Tax rates have not adjusted downward despite rapidly rising values: • Yield control does not include new construction • Voters are given an “all or nothing” option, either approving the amount of debt that can be financed by existing rates or none at all • Uneven administration creates wide disparities

13. Income Tax Issues • Adequacy: • Progressive rates cause “bracket creep” so revenue grows more quickly than income • Re-distribution: • Progressive rates shift burden from poor to rich • Efficiency • Recent rate decrease has brought rates into line with other states • Not yet clear how changes will affect revenue growth over time • Reduced progressivity is offset for low-income households by new tax credits and exemptions • Exemptions/Credits/Deductions: • Tax base is being eroded for non-tax policy goals • Threat to adequacy and efficiency

14. Corporate Income Tax Issues • A hard tax to justify: • Selective application – “C-corp.’s” only • Net income base is highly volatile • Incidence of tax burden is uncertain • Current law is a mixed bag for taxpayers: • Cons: Tax rates are high, and other provisions increase taxable income • Pros: Election to file as a separate, consolidated or combined gives taxpayers flexibility; Adhesion to federal tax base provides simplicity. • Combined reporting requirement would increase complexity • Definition of “unitary” is uncertain, would lead to litigation • Revenue impacts are highly unpredictable • NM has already succeeded in blocking abusive transactions

15. Road Fund Revenues • NM DoT reports being pinched by high costs, lower federal funding and aggressive expansion • NM and federal highway officials point out that revenues based on cents-per gallon fuels taxes and dollars-per-registration do not increase with inflation over time • Local officials complain about poor compliance with taxes on commercial trucking • Motor vehicle excise tax rate is relatively low, and revenue is distributed to General Fund – a 1% rate increase would generate $30 to $40 million

16. Taxes and Economic Development • Most economists agree that taxes negatively affect state economic development • NM’s GRT on business purchases puts the state at a disadvantage, even after allowing for low property taxes

17. Tax Incentives • Pros: • Incentives can offset other problems for firms seeking to locate here • Targeting can hold down cost, maximize “bang for the buck” • Cons: • Inequity creates tension between new and existing businesses • State-to-state tax differences are probably too small to have a major impact • Economic models can’t tell who really benefits – firm owners, workers, landowners or consumers • Can never know for certain the answer to the “but for” question • Non-economic development incentives: • How much subsidy is the right amount? • Tax Dept. cannot provide follow up, accountability • Increased complexity and cost • Direct appropriations are easier to track and make accountable

18. Revenue Raisers • GRT rate is too high given the breadth of the tax base – should also avoid “minimum tax” based on firms’ gross revenue • Oil and gas taxes are high enough – as a gross revenue tax, imposes a higher burden on the rate of return when prices decline • Eliminating state & local tax deduction for income tax purposes will increase complexity, increase disparities between NM and other states • Corporate income tax combined reporting is highly unpredictable • Cigarette taxes will not reduce consumption as long as tribal and internet sales are tax free -- revenue gain is much smaller than otherwise • Motor vehicle excise tax and insurance premiums tax rates are relatively low compared to other taxes – revenue would be more predictable • Re-visit more recently enacted tax preferences (review credits/exemptions/deductions for necessity ) • Streamlined Sales Tax Project will bolster the GRT in the long run