Get the truth. Much has been written about how the Legislature and Governor have cut income tax rates over the past two years. Yet other prosperity reducing tax rates have either remained too high or gone up. Tax rate increases outweigh tax rate decreases. In fact, the net estimate of all tax rate changes is revenue increases: $70 million in FY2004, $124 million in FY2005 and $106 million in FY2006. New Mexico is not on a path to prosperity.
Understanding Tax Policy
Taxation has a profound effect on the state’s economic well-being. Most people, however, are too busy making a living to keep tabs on everything the taxman is up to. That’s why the Rio Grande Foundation is pleased to announce the release of its first comprehensive guide to New Mexico tax policy: 2003 & 2004 Tax Legislation Guide. In this Guide, we have summarized the most significant tax and revenue legislation enacted in the last two legislative sessions. More importantly, we have translated these bills from the inscrutable language of legislative-ese into plain and simple English.
The Big Picture
For years, tax revenue as a share of personal income has steadily increased. But in the late 1990s, with no new taxes in nearly a decade, the state’s economic growth began to outpace its tax revenue growth. Taxes as a share personal income finally began to decline. It looked as if this trend would be accelerated when, in 2003, the State Legislature enacted historic reductions in income tax rates. Unfortunately, in that same legislative session and in the subsequent session, some other tax rates were increased. By the Rio Grande Foundation’s accounting, tax increases raised state revenues by $70 million in 2004, $124 million in 2005 and $106 million in 2006. On top of this, the state government authorized up to $170 million in new local tax revenue.
Of course it is tax rates that do the real harm. And notwithstanding the planned reductions in income tax rates, other tax rates in New Mexico remain unnecessarily high or are increasing. In 2005 the gross receipts tax rate will go up 0.5 percentage points in municipalities statewide; and additional rate increases are allowed in local jurisdictions. Also, excise taxes are up significantly. Other tax rates and fees are up; and additional money is being taken from the state’s permanent funds.
Principles of Sound Taxation
Principles of sound tax policy are fairly simple. They have emerged from two and half centuries of economic research and are widely accepted among academic economists. According to these principles:
- Taxes should be low: High marginal tax rates discourage economic activity, and therefore discourage wealth creation.
- The tax base should be broad: No exemption should be made for politically popular activities or for politically powerful interest groups.
- Taxes should be fair: No one should get special breaks on their tax rates and no one should be singled out to pay more.
- Taxes should be simple: Every “targeted” tax or tax exemption entails both unintended consequences and more red tape for the taxpayer.
Overview of Tax Policy in New Mexico
Regrettably, the legislative process in New Mexico pays little heed to these principles. In the last two legislative sessions, forty-six bills affecting tax and revenue policy were signed into law (how’s that for simple?). Only one of these bills lowered tax rates: the much-welcomed income tax reductions of 2003. Five laws sort-of lowered taxes by creating or expanding tax credits (these credits can be claimed against your tax liability, but only if you do what the legislature wants you to). In contrast, the legislature passed and the governor signed fully eighteen laws that increased taxes (usually under the guise of “fee” increases). Three more laws permitted local jurisdictions to increase taxes. Six laws narrowed the tax base, compared with only two which expanded it. Twelve laws “earmarked” money from the General Fund and two laws allowed money in “permanent funds” to be used by the General Fund.
The most conspicuous change in tax law from the past two legislative sessions was the income tax cut passed in 2003. Though not fully phased in until 2007, this bill represented a dramatic shift in New Mexico income tax policy. It reduced the number of tax brackets from seven to four. It also lowered tax rates-bringing the top rate from 8.2 percent to 4.9 percent. The bill will reduce revenue by $167 million over fiscal years 2004-2006.
Unfortunately, a string of tax increases more than made up for the income tax reductions. The single largest tax increase of the past two sessions was the cigarette tax increase, passed in 2003. This bill increased the per-pack cigarette tax by 329 percent. The bill is expected to raise $137 million for the state over the fiscal years 2004-2006.
Another giant tax increase came in a bill ironically called “Tax Relief and Highway Projects”. This inappropriately titled bill increases several taxes, some by as much as 38 percent. Every New Mexican with a vehicle is affected by the bill. Taxes are increased on everything from small cars to tractor-trailers. The bill is expected to increase tax revenue by $120 million over fiscal years 2004-2006.
Senate Bill 331, passed during the 2003 session is also expected to raise revenue: $96 million over 2004-2006. This bill, however, follows the principles of sound tax policy. Its revenue enhancements come entirely from a broadening of the tax base, rather than rate increases.
One of the more nefarious bills passed in the last two years is Senate Bill 385 from the 2004 session. This bill is a clever scam on federal taxpayers. Taking advantage of the federal government’s promise to match every dollar New Mexico spends on Medicaid with three more federal dollars, the bill artificially increases the cost of Medicaid by imposing a tax of $8.82 on hospital beds for every day they are occupied. Another bill, Senate Bill 436 is supposed to offset the “bed tax” with a $10 credit against individual tax liability. The credit can only be taken by individuals, however. Insurance companies see no relief from the tax. They, no doubt, will pass much of the cost off on consumers in the form of higher premiums. In any case, the tax credit does little to offset the “bed tax.” The tax increases government revenues by $45 million over three years. The credit offsets only $4.3 million of this new taxpayer cost.
Another noteworthy tax increase is embodied in Senate Bill 502 from the 2004 session. This bill raises net taxes on insurance premiums from 3 percent to 4.003 percent. It is projected to raise $32 million over three years.
Finally, House Bill 625 from the 2004 session is a prominent offender of the principles of sound tax policy. This bill not only narrows the Gross Receipts Tax base by exempting food and managed care medical and dental services, but it pays for these exemptions with an increase in the rates for everyone else, raising the state’s portion of the GRT in cities from 4.5 to 5 percent (counties and municipalities impose their own rates on top of that).
Tax Reform without Spending Reform
For more than a decade now, politicians of all political stripes have been talking earnestly about tax reform and tax reduction. Unfortunately, a slow but relentless climb in state and local spending has hampered their efforts. In 1992, state and local expenditures were 26 percent of state personal income. By 2002, state and local expenditures were 27.6 percent of personal income. Some of this spending is financed through fees, some through interest on state assets and some through taxes. Ultimately, however, all of the spending comes at a cost to the average New Mexican’s wallet. As long as state spending continues to claim an ever larger portion of state income, real tax reform will be nothing but a chimera. The New Mexico state government’s inability to commit to meaningful tax reform indicates the need for greater citizen control over tax policy. Over the next few months, the Rio Grande Foundation will launch a series of papers and initiatives profiling the ways the citizens of other states like Colorado have reclaimed control over run-away fiscal policy.
Authored by Matt Mitchell and Harry Messenheimer, Ph.D.