New Mexico Tax Increase Package Advances

Under New Mexico’s last two governors, the state cut both individual and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rates. Legislation backed by Gov. Michelle Lujan Grisham (D) would not only reverse course but make New Mexico a regional outlier, with higher and more progressive income taxes than any of its neighboring states. It’s part of a broader package that also includes:

• an expansion of the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. to capture remote sellers;
• a cigarette taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increase, from $1.62 to $2 per pack;
• an increase in the tobacco products tax, from 25 to 45 percent, with the definition of taxable tobacco products expanded to include e-cigarettes and other vapor products;
• an increase in the motor vehicle excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. to 4 percent; and
• a new tax on nonprofit hospitals.

Notably, it comes as the state is running a large surplus.

House Bill 6 passed that chamber on a 40-25 vote and is now pending in the Senate. If enacted, it would raise taxes by $580 million a year. The state is currently projecting a $1.1 billion surplus, but proponents see the bill as an opportunity to increase the share of tax collections from sources other than the state’s energy industry, which can be volatile and unpredictable. New Mexico is eighth in the nation in energy production, and generated $2.2 billion in government revenue from fossil fuel production in fiscal year 2018. The state’s current energy boom is welcome news to budget writers but adding it all to the baseline can be risky, as there is no guarantee that oil and gas prices (or in-state production) will be as strong in future years.

That’s a strong case for enhancing the state’s rainy day and other funds, setting more money aside in good years to provide a cushion in leaner ones. To proponents of H.B. 6, the volatility of energy markets is also a reason for New Mexico to chart a different course than its neighbors—many of which are also major energy-producing states. (Texas, Oklahoma, and Colorado rank 1st, 4th, and 7th, respectively on that measure.)

In 2003, New Mexico’s top individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate was 8.2 percent, and newly-elected Gov. Bill Richardson (D) set out to change that in an attempt to put the state on a more competitive footing with its peers. A five-year individual income tax cut package, with implementation beginning the next year, ultimately transformed a seven-bracket tax with a top rate of 8.2 percent into a four-bracket tax with a top rate of 4.9 percent. A decade later, Richardson’s successor, Gov. Susana Martinez (R), embarked on a similar phased reduction in the corporate income tax, reducing the top rate from 7.6 percent in 2013 to 5.9 percent by 2018.

Individual Income Tax				Corporate Income Tax
Year	Brackets	Top Rate		Year	Brackets	Top Rate
2003	7	8.2%		2013	2	7.6%
2004	6	7.7%		2014	2	7.3%
2005	5	6.8%		2015	2	6.9%
2006	4	5.7%		2016	2	6.6%
2007	4	5.3%		2017	2	6.2%
2008	4	4.9%		2018	2	5.9%

Neighboring states cut taxes too. Arizona adopted seven income tax rate reductions between 1990 and 2007, lowering its top rate from 7 to 4.54 percent. Colorado abandoned its graduated-rate income tax structure, with a top rate of 8 percent, in 1987, replacing it with a flat rate tax that was cut to 4.75 percent in 1999 and to its current rate of 4.63 percent in 2000. Oklahoma phased its top rate down from 6.65 to 5.25 percent between 2004 and 2007 and adopted another reduction—to 5 percent—in 2014. And in Utah, a 2007 tax overhaul scrapped a six-bracket system with a top rate of 7 percent for a flat 5 percent rate, trimmed to 4.95 percent in 2018. Texas and Nevada both forgo individual income taxes altogether. For the past five years, neither New Mexico nor any of its neighbors have imposed an income tax rate of more than 5 percent.

That would change under H.B. 6, which returns to a seven-bracket individual income tax structure with a top rate of 6.5 percent. Moreover, while that top rate would not kick in until $200,000 in taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. for single filers ($300,000 for joint filers), it would increase income tax burdens for many New Mexicans. Overall tax liability is almost identical for the lowest-income taxpayers; between about $10,000 and $23,500 in taxable income, it represents annual tax savings of about two dollars per taxpayer. (Some filers would, however, benefit from other provisions.) Above $30,000 in taxable income, it represents a tax increase. That increase grows rapidly. Take, for instance, a single individual earning the state’s average household income of $46,744, with taxable income of $34,544 after taking the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. . Under H.B. 6, her income taxes go up by more than a third, from $1,070 to $1,429. Someone with $50,000 in taxable income would experience a 61 percent increase in tax liability, from $1,387 to $2,233.

The following tables show how rates and brackets change for single filers under the proposal.

Current Law				H.B. 6 Proposal
1.7%	>	$0		1.7%	>	$0
3.2%	>	$5,500		3.2%	>	$6,650
4.7%	>	$11,000		4.7%	>	$10,000
4.9%	>	$16,000		5.2%	>	$23,500
				5.5%	>	$50,000
				5.8%	>	$100,000
				6.5%	>	$200,000

These aren’t just tax increases on high earners; they would have a dramatic impact on middle-class New Mexicans. However, increases are ameliorated for some filers by various changes. The state’s standard deduction and personal exemption conform to those offered by the federal government, and under the new federal tax law, the standard deduction almost doubled (to $12,200 for 2019) but the personal exemption has been suspended. The proposal, while retaining the higher standard deduction, creates a state-specific dependent deduction worth $4,000 for their second and subsequent dependents. (No deduction is available for the first dependent claimed.) This depended deduction would be available so long as the federal personal exemption is suspended. The Working Families Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. , moreover, increases from 10 to 20 percent of the value of the federal Earned Income Tax Credit (EITC).

New Mexico’s income tax has long included a marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. , meaning that in many cases, married two-earner households pay more in taxes than they would if they were filing separately. (States can avoid a marriage penalty by doubling bracket widths for joint filers, but while joint filer brackets are wider than single filer brackets in New Mexico, they aren’t twice as wide.) Under the current tax code, however, the impact is modest: the most a couple could pay in marriage penalties is $151. Under H.B. 6, that would soar to a maximum of $1,111.

Under current law, the first $1,000 in capital gains are excluded from taxation, and a 50 percent deduction is available for remaining capital gains income, consistent with the federal policy of preferential rates for capital gains. Such a policy favors investment but is also intended to compensate for the degree to which inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. erodes the value of capital gains. Imagine, for instance, a $10,000 investment made twenty years ago and sold for $20,000 in 2019. This represents a nominal gain of $10,000, but about $5,110 of that is a phantom gain; it’s just the effects of inflation. In real terms, the investment returned $4,890. Absent any preferential rate for capital gains income, however, the entire $10,000 “gain” would be taxed. A preferential rate or deduction is a crude way to address this issue, but nevertheless serves a valuable purpose. Under H.B. 6, the $1,000 exclusion is maintained, but the 50 percent deduction would be repealed.

The bill would also tax internet sales beginning July 1 of this year, and ultimately change how the state imposes its sales tax. New Mexico’s sales tax—confusingly termed a “gross receipts taxA gross receipts tax, also known as a turnover tax, is applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. ,” even though it is not structured like the gross receipts taxes that exist in certain other states—is origin- rather than destination-sourced, meaning that the tax is levied at the seller’s location, not the buyer’s, and is subject to the local rate in the seller’s jurisdiction. For remote transactions already subject to tax due to the seller’s physical presence in the state, the state sales tax is destination-sourced, but the remote seller does not owe local sales taxes. Under H.B. 6, the state would begin a two-year transition, ultimately resulting in destination-sourced local sales taxes for remote sales. In the interim, the bill provides for transfers to local governments to allow them to share in the new revenue.

Notably, New Mexico does not adhere to the uniformity and simplification rules provided for in the Streamlined Sales and Use Tax Agreement (SSUTA). It has not adopted the common definitions employed in member states, nor does it provide rate and base lookup software for the sales tax as it exists statewide and in the state’s 144 local taxing jurisdictions. Taking these modest steps would help ensure that the state’s remote sales tax regime is consistent with the standards praised by the U.S. Supreme Court in Wayfair v. South Dakota, and thus likely to survive any legal challenge.

Historically, New Mexico has lagged its peers in gross state product and job growth, with spurts in both when energy markets are particularly strong. Taxes are only one of many considerations for individuals and businesses, but for a state surrounded by faster-growing peers, a package of significant tax hikes poses real risks.

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