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Sunday, November 01, 2009

Cut Tax Credits, Not Just Budget

By Sergio Pareja
UNM School of Law
          New Mexico legislators are looking for long-term solutions to the state's budget situation. In their search, they should not only look at cutting direct expenditures. They also should consider tax expenditures.
        A direct expenditure occurs when money is appropriated to pay for something. A cut to a direct expenditure is what people picture when they demand spending cuts. A tax expenditure is a targeted tax break that deviates from the "norm" of a generally apportioned tax. A cut to a tax expenditure takes the form of a targeted tax increase.
        How are tax expenditures like direct expenditures? Suppose the federal government collects $100 in taxes from farmers and Congress decides it wants to give farmers $10. As a direct expenditure, the government cuts a check for $10 to farmers. As a tax expenditure, the government provides a $10 tax credit only to farmers.
        In both cases, government revenue from farmers is reduced from $100 to $90, and farmers keep the $10. Despite the similarity, those who support a $10 direct expenditure are "tax and spend liberals" while those who support a $10 tax expenditure are "tax-cutting conservatives."
        Both the federal government and states routinely use tax expenditures. In fact, legislators often use tax expenditures, with little notice by the public, to benefit campaign contributors. Partly because of this, the federal government and nearly all states regularly publish tax expenditure reports. The best of these reports are comprehensive, detailed and available on-line. Although it has issued one extremely-limited report, New Mexico is one of only nine states that do not regularly issue a tax expenditure report.
        State legislators should be concerned with both state and federal tax expenditures. New Mexico piggybacks on the federal computation of income. Because of this, federal tax law drastically affects state revenue. A good tax expenditure report will state how much key federal tax expenditures are costing the state.
        States don't need to accept federal tax expenditures. In fact, state legislators should decide whether the benefit of "administrative simplicity" is worth the revenue loss from significant federal tax expenditures. If it is not, state tax law can back that expenditure out of the state's tax computation.
        Tax expenditures can be extremely targeted, benefitting only one company, or broader. Broad federal tax expenditures generally have specific policy goals. These expenditures usually prohibit employers from providing the benefit solely to highly compensated employees. This makes sense. The government should not "spend" the money only to benefit the well-off.
        Tax law does occasionally allow tax expenditures to benefit only high-paid employees. For example, one code section (Section 106) gives tax-free treatment to health insurance policies even if they only are offered to top-level executives. This can be a "Cadillac health plan" subsidy for top executives.
        Qualified transportation fringe benefits also can be provided solely to top executives. Specifically, employers can allow only highly paid employees to reduce their taxable income by $2,760 a year for parking expenses. Is the policy goal for this tax break to encourage high-paid executives to drive to work?
        We also allow people to deduct interest on their home mortgage. Renters aren't so fortunate. The policy is to encourage widespread home ownership, but there is a $1 million purchase price cap on the deductible interest. New Mexico could cap that lower to end what some call the "McMansion in the burbs" subsidy. This interest deduction also includes vacation homes. Must tax law encourage vacation home ownership?
        We may ultimately decide that, for administrative simplicity, we do not want to subtract federal tax expenditures from the New Mexico state tax computation. We also may decide that there are good policy reasons for most of New Mexico's own tax expenditures. Nevertheless, legislators should be given the tools they need to decide this.
        In the special legislative session, legislators can't make tax expenditure cuts. This is not right. Tax expenditures usually benefit the well-to-do. Cuts to direct expenditures tend to hurt lower- and middle-income families. Legislators should be allowed to determine if the policy of encouraging vacation home ownership outweighs the full funding of public education.
        Looking forward to the next legislative session, New Mexico should join the majority of states and begin to regularly produce a comprehensive tax expenditure report. An occasional, limited tax expenditure analysis is no substitute. The report should cover all major taxes, and it should be available on-line to the general public. It also should evaluate if each tax expenditure is efficiently furthering a stated policy goal. If it is not, then legislators should cut the tax expenditure just the same as they currently are considering cutting direct expenditures.
        Sergio Pareja is a professor of tax law at the University of New Mexico School of Law.