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NM’s tax code like ‘Swiss cheese’

SANTA FE – State Rep. Jason Harper compares it to “Swiss cheese.”

New Mexico’s gross receipts tax code is full of holes, the Rio Rancho Republican likes to say, making it difficult to understand and forcing the tax rate upward to compensate for the lost revenue.

But figuring out how to melt down that block of cheese is proving to be an incredibly complex task – and more than just the tax code is at stake.

A tax overhaul package, if Democrats and Republicans ever agree on one, could help break the budget impasse that’s dominated the Roundhouse for months – producing new revenue in the short term, as sought by the Legislature, and overhauling the tax code in the long run, a goal shared by the governor and lawmakers alike.

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“I think this reform is clearly the important starting piece,” Senate Majority Leader Peter Wirth, D-Santa Fe, said after meeting with Gov. Susana Martinez last week.

But a recent analysis by economists working for the Legislative Finance Committee outlines some of the uncertainty that’s made it so difficult to reach agreement.

In a seven-page memo, economists Jon Clark and Dawn Iglesias estimate that eliminating all those holes in the tax code – as proposed in legislation sponsored by Harper – would raise about $512 million a year.

That would be more than enough new revenue to cover the spending proposed in next year’s budget and boost cash reserves.

But it would also mean new taxes imposed on nonprofit groups, hospitals, schools, newspapers and others.

The goal, however, isn’t simply to raise revenue.

Harper, Martinez and other supporters want to eliminate the holes to produce a more level tax environment – one in which the health of an industry or company isn’t tied to its tax breaks.

“We’re open to generating some new revenue for the state,” Harper said, “only if it’s part of comprehensive reform that makes our state more competitive, doesn’t pick winners and losers, and helps us jump-start our economy.”

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The final version of Harper’s bill left intact some tax breaks. Food, for example, would have remained untaxed. The food tax had been part of his original proposal, but consideration for it was dropped earlier this year.

‘Pyramiding’

One key to Harper’s plan is addressing a quirk in New Mexico’s tax system: pyramiding, or the imposition of taxes on each step in a larger transaction, the result of which is an exponential increase in the overall taxes paid.

It’s a particular problem for small-business owners – who, say, have to pay taxes when they hire an accounting firm to do their taxes, pay another company to package their product and so on, all before they actually sell something to a customer.

The taxes stack up on top of one another and end up being passed onto the consumer.

Harper calls it the “black eye” of the gross receipts tax system – something that makes New Mexico stand out from other states that use a more simple sales tax on only the final product.

But pyramiding is tough to solve.

The LFC memo – written by economists who work for the Legislature as a whole, not one political party or the other – estimated that Harper’s proposal to eliminate the most egregious forms of pyramiding (sales from one business to another) could cost the state anywhere from $260 million to $490 million a year.

And those are just the reasonable estimates. A surprise could push it even higher, the memo said.

There simply isn’t much data for an estimate, the economists said, because taxpayers don’t have to report separately on each deduction they’re using in the detail needed for a more thorough analysis.

But the amount of lost revenue is critical.

If it’s near the $490 million estimate, it would almost entirely wipe out the $512 million gained from eliminating the other tax deductions, exemptions and credits.

That, in turn, means there’s almost no flexibility to reduce the overall tax rate. A critical goal of the tax overhaul is to lower the rate by broadening the base of things that are taxed – a move that supporters say would make New Mexico more attractive for business growth.

Harper, in any case, believes the LFC memo overstates the potential revenue loss from addressing pyramiding as proposed in his legislation, House Bill 412.

But Democrats in the Legislature say the memo supports their point: The state should move cautiously on the tax overhaul because of uncertainty over how each change would affect government revenue and the broader economy.

Sen. Carlos Cisneros, a Democrat from Questa and vice chairman of the influential Senate Finance Committee, said lawmakers approved a smaller tax overhaul package this year – less ambitious than Harper’s proposal – “to ensure we didn’t inadvertently create more problems.”

Martinez vetoed that proposal, House Bill 191.

The changes in the bill “are a false attempt at tax reform and fall embarrassingly short,” she said in a veto message.

Another option

The LFC economists suggest another option for overhauling the tax code: Eliminate the $512 million in tax exemptions, deductions and credits and then use all of that savings to reduce the overall tax rate.

That doesn’t directly address pyramiding, but a lower tax rate would at least help reduce the damage caused by pyramiding and dampen the burden on companies that are brought into the tax base.

“This is not a perfect option,” the economists wrote, “because no perfect option exists.”

Whether that idea would win support from either the Legislature or Martinez isn’t clear.

Harper said it isn’t the “meaningful reform” he proposed in his own bill, House Bill 412, which failed to advance through the Senate.

The option suggested by LFC economists has some merit, Harper said, but it’s better to address pyramiding directly, even if it means the overall tax rate can’t be reduced as much otherwise.

The LFC option “still hasn’t addressed the pyramiding left in the code,” Harper said.

Sen. John Arthur Smith, a Deming Democrat and chairman of the Senate Finance Committee, said he supports the push for a tax overhaul and has for a long time. But it cannot be done in one swoop – as proposed by Harper – because of the complexity and potential for unintended consequences, he said.

“I’m now convinced it’s going to have to be done in pieces,” Smith said.

Martinez and legislative leaders met privately last week to talk about how to negotiate a budget compromise and overhaul the tax system. They didn’t reach agreement but are open to further talks.

The solution, if they succeed in negotiating one, could be adopted in a special or extraordinary session later this month.

The new budget year starts July 1.

By the numbers
$512 million – Annual value of removing tax deductions, exemptions and credits in New Mexico’s gross receipts tax system. This would be new revenue for the state. It doesn’t include reimposition of the tax on food, which wasn’t part of the final proposal.
$260 million to $490 million – Estimate for value of removing business-to-business sales – a form of “pyramiding” – from the gross receipts tax code. This would be revenue lost for the state.
Source: Legislative staff analysis of House Bill 412, legislation proposed by Republican Rep. Jason Harper of Rio Rancho.

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