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Rio Grande Foundation
P.O. Box 2015 Tijeras, NM 87059

505-286-2030

New Mexico-STAMP

Measuring the Effects of
Tax Changes in New Mexico Using the
New Mexico State Tax Analysis
Modeling Program

With a Forward by
Harry Messenheimer, Ph.D.
Senior Fellow, Rio Grande Foundation

The following study of potential tax reforms in New Mexico is best understood as a complement to Rio Grande Foundation's study last fall: New Mexico 2000: A Study of Its Policies and Economic Health (that study may be found on our web site www.riograndefoundation.org). That study examined the relationship between economic freedom and prosperity by interstate comparisons over 20 years. The findings were not happy for New Mexico: If New Mexico now had state and local governments that were only slightly more coercive than the lower 48 average, then the median income for 4-person families is estimated to be $8,303 higher and per capita income is estimated to be $5,476 higher than they are today. In addition, measures of income growth over the last 20 years indicate that New Mexico is last.

As part of last fall's study I examined one of the high visibility constraints on economic freedom: taxes, and that part is summarized herein to set the stage for Beacon Hill's tax model. How does New Mexico compare to other states with respect to taxes? Because of the bewildering array of tax rates, bases, exemptions and deductions that question is difficult to answer. One intuitively appealing answer (because it gives some sense of the ability to pay) is total tax revenue collected as a percentage of income. Figure one displays New Mexico's position in 1998 relative to the U.S. average and states in the region.

Figure 1: Comparison of state and local taxes collected per $1000 of income

Tax rates modify behavior, so it is also important to compare rates for major sources of tax revenue. Figure 2 compares state-component rates (and revenue collected) for sales and gross receipts taxes for states in the region:

Figure 2: Regional comparison of tax rates and revenue collected for gross receipts and sales taxes: 1995

The top two panels picture alternative tax rates among states in the region for the sales and gross receipts tax for services and goods. New Mexico taxes services, and other states do not. So, the relevant tax rate shown in the upper left panel is 5% for New Mexico and zero for all others. New Mexico and the other states tax goods, so the relevant tax rate shown in the upper right panel is 5% for New Mexico and ranges from 3 to 6.2% for the others. New Mexico taxes goods at a rate a little above average for the region. Texas is often cited as having a very high sales tax rate compared to New Mexico. Notice that is not really true: Texas may exceed New Mexico for the state-wide-tax on goods (6.2% to 5%), but New Mexico far exceeds Texas for the tax on services (5% to zero).

The other major source of revenue is the individual income tax. Figure 3 compares New Mexico's top tax rate (and revenue collected) to that of regional states. Notice that New Mexico has the highest rate in the region.

With that summary of how New Mexico's major taxes compare to other states, it is worth pointing out an important difference in interpretation between my earlier study and the one that follows. My earlier study was concerned with long run adjustments: how outcomes in states are affected by major differences in economic freedom (taxes included). The study that follows derives its estimates of tax reform consequences from a shorter run look at how New Mexico has adjusted year-to-year to relatively small changes in tax rates given overall differences in economic freedom across states.

Figure 3: Regional comparison of income tax margins and revenue collected: 1995

With that in mind, the reader should recognize that any one of the major kinds of tax reforms assessed by Beacon Hill Institute would have an effect on expectations about the economic climate in New Mexico. As long as major tax reform is credible enough to be considered durable, so that New Mexico would not be expected to renege on it, then entrepreneurs and risk takers would be attracted to our state. And in that sense, Beacon Hill's estimates of tax reforms' revenue impacts are way too low. The problem is that we do not know how rapidly the revenue increasing, longer run adjustments would take place. The actual pace of adjustment would be dependent on the credibility of lasting reform. One way to provide additional credibility would be to make it more difficult for the legislature to increase taxes, say by imposing a supermajority requirement. Regulatory and spending reform also would go a long way toward reinforcing credibility that New Mexico intends to be a state where people can flourish. Note that most of the tax reforms assessed below could easily be implemented with spending restraint ($500 million in lost revenue represents about five percent of spending). Maybe New Mexico could stop increasing spending for a year or two, or impose some constitutional restraints on spending growth.

Now for some thoughts about the following study: the alternative reforms of interest to people around the state were given to Beacon Hill so that policy makers would have a sense of some major tax reform options. We are not locked into any of the particular reforms assessed. In fact, Beacon Hill has provided us with a spreadsheet that will allow Rio Grande Foundation to assess any reform suggested in similar fashion.

The Beacon Hill Model was unable to tease out the separate dynamic effects of removing the gross receipts tax on services, since New Mexico has had the broader based tax over the period of study. The estimate is derived by treating removal of services from the tax base as a proportionate reduction in the tax rate. By removing the tax on services, however, the cascading effect of business-to-business taxes would also be removed. The dynamic revenue increase of removing the tax on services would therefore be much higher than indicated, and the economic benefits would be greater than indicated.

The reader may wonder why one alternative "reform" looks at halving extractive taxes, since there is no major push politically for such a reduction. The first reason we do so is for completeness. Extractive taxes constitute almost 10 percent of revenue for New Mexico on average. The second, and more important, reason is that extractive taxes cause harm to New Mexico's economy just as do other taxes. Extractive taxes are not a free lunch for New Mexico. And they are not all exported to other states as was demonstrated in my tax exporting study of natural gas in 1996 (copy may be found on our web site www.riograndefoundation.org).

The purpose of the Rio Grande Foundation is to suggest scholarly ideas to improve the economy and quality of life in New Mexico. We are pleased to offer this report and tax model, New Mexico STAMP, for consideration of those who share our goals.

Download Adobe Acrobat document of full report