New Mexico’s Omnibus Tax Bill

March 17, 2023

Timothy Vermeer

Timothy Vermeer

New Mexico was the ostensible setting of the 1966 film The Good, the Bad and the Ugly. This week, the New Mexico legislature is considering an omnibus tax bill that could make good use of the same title. House bill 547 includes some good, pro-growth tax reform, like reducing the gross receipts tax (GRT) rate. Unfortunately, this catch-all bill also misses opportunities, including lowering the top marginal individual income tax rate and reducing tax pyramiding. This analysis addresses the good (and the almost good), the bad, and the ugly of HB 547 and offers some potential improvements.

The Good (and the Almost Good)

Included in HB 547 is a reduction to the state’s GRT rate, which is good news for New Mexico’s economy. What the state calls a GRT is a hybrid between a sales tax and gross receipts tax. It doesn’t tax intermediate transactions as much as a pure gross receipts tax but still taxes enough of them that its sales tax-like rate is a significant impediment to in-state investment.

Currently, the rate is set at 5 percent through June 30 with a 0.125 percentage point reduction scheduled to take effect July 1. Under HB 547, a new rate of 4.5 percent would supersede the reduction planned for this July, with a further reduction to 4.375 percent on July 1, 2024. However, if GRT revenue in any fiscal year after 2025 and before 2030 is less than 95 percent of GRT revenue from the previous fiscal year, the rate would snap back to 4.75 percent, a flawed design: even if lawmakers wanted to shield against a downturn in revenues, this would mean that a really good revenue year followed by a pretty good revenue year could trigger a completely unnecessary higher rate.

The flattening of the CIT is a step in the right direction, but it falls short of being a truly good reform. As currently proposed, the two-bracket CIT would become a flat rate tax of 5.9 percent on January 1, 2024. The elimination of the lowest bracket would result in a more neutral treatment of income, which is desirable, but it would also result in an additional $5,000 tax on the first $500,000 in taxable corporate income. To truly qualify as a good reform and improve the state’s regional tax competitiveness, lawmakers should reduce the CIT rate, which is at least 1 percentage point higher than any of its neighbors. Workers and consumers would benefit from a CIT rate reduction through higher wages, additional job opportunities, and more competitive prices for finished goods.

Additionally, the proposal to add two new marginal tax brackets to the top of the individual income tax schedule has been removed from the bill, at least for now. It would be difficult to justify how such a proposal is in New Mexico’s economic interest when the state is projected to have a $3.6 billion budget surplus and already has a top marginal income tax rate 1.05 percentage points higher than its nearest neighbor. Instead of the additional two brackets, the bill was amended to add one new tax bracket at 4.3 percent, decrease the lowest marginal rate from 1.7 percent to 1.5 percent, and reconfigure the kick-in thresholds for all but the top rate. The largest change in effective tax rates would be for those earning less than $100,000 in taxable income. Lawmakers could enhance this reform as well if they reduced the top marginal rate and brought it more in line with the top rates of their neighbors.

The Bad and the Ugly

While the GRT would be reduced to 4.375 percent by July 1, 2024, that only addresses half the problem. The primary concern with the GRT is the tax pyramiding that occurs throughout the supply and production chains. This distorts the costs of goods and services and compounds the amount of tax paid by the consumer. The average state sales tax rate across all 50 states is 5.1 percent and the median rate is 6 percent. If the GRT was only assessed on the final consumption of goods and services, as an ideal sales tax should, the GRT could remain at its current 5 percent and be competitive with other states.  The lower rate in HB 547 is helpful, but the bill does not correct the GRT’s fundamental problem of tax pyramiding.

A currently tabled bill, HB 367, would create deductions a company could claim for the GRT paid on the majority of professional services used in business operations. That would be a significant step forward in right-sizing the GRT, which currently generates 60 percent of its revenue from business-to-business inputs and has a tax base broader than the state economy. If the Senate does not include an amendment to that effect, it will be a missed opportunity to enact a pro-growth structural tax reform that provides direct relief to resident consumers and businesses.

Another potential missed opportunity involves the indexation of the state’s individual income tax brackets for inflation. Within New Mexico’s tax code, the indexation of various credits and deductions abounds. In fact, no fewer than three additional provisions were indexed for inflation in the current omnibus bill. Lawmakers understand these provisions protect taxpayers from having the value of their credits and other provisions eroded by inflation. Yet, after nearly two years of inflation above 5 percent on an annualized basis (the longest such period since 1982), New Mexican taxpayers are still suffering from bracket creep, where inflation pushes people into higher tax brackets. To protect New Mexican taxpayers from this, lawmakers should index the state’s individual income tax brackets to the consumer price index. It is the single broadest protection they could offer and would be consistent with other parts of the state’s tax code.

A third provision of HB 547 that could hinder the New Mexican economy affects the tax treatment of capital gains income. Under the current system, New Mexico taxpayers with capital gains income are able to deduct 40 percent of their net gain from their New Mexico taxable income. This is a positive feature of the state’s tax code as it promotes the creation of capital, which has been in short supply in the Land of Enchantment. However, HB 547 would limit a taxpayer’s net capital gains deduction to $2,500 (for all types of investment gains), or 40 percent of up to a $300,000 net capital gain from the sale of a New Mexico-based business. According to the fiscal impact report, this would amount to a $57 million tax increase on those reporting capital gains income. Policymakers should consider how many of them would leave the state as a result.

When people think of the likely targets of the capital gains tax, they may think of wealthy day traders who professionally buy and sell stocks. But that is an increasingly outdated way of thinking of investors. Today, there are more retail investors than ever before. If the goal is to increase equity and generational wealth among lower-income earners, the legislature should avoid tapping capital gains income for additional revenue. This disproportionately affects lower-income investors—those who are trying to leverage a changing marketplace to move up the economic ladder.

Lastly, HB 547 would facilitate another round of tax rebates based on 2021 tax returns. A single filer would be eligible for a $500 rebate and married filers are eligible for a $1,000 rebate. The rebate would offset the taxpayer’s income tax liability in 2021 but it would also be refundable, which ensures all taxpayers receive the full amount of the rebate. There are worse things to do with surplus tax revenue than return it to taxpayers, but the same revenue could also go to paying down other major tax reforms, stabilizing the government’s revenue streams, and allowing taxpayers to keep more of their money from the start.

As New Mexico’s legislative session comes to a close, policymakers still have important decisions to make. There are several good tax provisions in HB 547 and others that could be improved. Whatever legislators decide, it is important to remember that states do not institute tax policy in a vacuum. Tax competition continues apace in neighboring states, including in Colorado where voters approved a tax decrease last fall, and in Arizona where legislators are working to establish a mechanism to phase out the individual income tax in coming years. As we’ve written before, taxes are not the only reason people choose to reside in a state, but every change to a state’s tax system makes its business tax climate more or less competitive compared to other states. Adopting the sound tax reforms still pending in Santa Fe is an opportunity for New Mexico to keep up with the pack or risk falling further behind.

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A 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.

Inflation 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.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat.

Tax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action.

A gross receipts tax is a tax 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.

A 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.

An 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.

A capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. Capital gains taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment.

Bracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation.

Taxable 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.