Sales tax rate cut in 2 states bucks trend

Lawmakers in New Mexico and South Dakota cut sales tax rates this year, an unusual move compared with other states’ recent tax policy decisions.

It is more common for lawmakers seeking to make daily purchases more affordable to exempt or lower taxes on certain products. In Oklahoma, Gov. Kevin Stitt (R) is calling for an exemption on groceries, while Kansas Gov. Laura Kelly (D) is seeking them for groceries, diapers and feminine hygiene products.

South Dakota Gov. Kristi Noem (R) also pushed to eliminate taxes on groceries, but state lawmakers opted to reduce the overall sales tax rate from 4.5% to 4.2%.

“We wanted to cut taxes on things like diapers, and toothpaste, and haircuts, and all sorts of things people need in order to live,” South Dakota House Majority Leader Will Mortenson (R) said.

New Mexico and South Dakota are two of only five states that have lowered their sales tax rate over the last decade, according to the Tax Foundation, a conservative-leaning think tank.

Across-the-board sales tax cuts are less politically popular than exemptions and income tax cuts, tax policy analysts say. Sales tax revenues have also weakened over time as state leaders create exemptions and people spend less money on goods and more on services, including services states don’t tax. That creates pressure to raise sales tax rates, rather than lower them, analysts say.

“The sales tax is applying to a smaller share of personal consumption,” said Jared Walczak, vice president of state projects at the Tax Foundation. His team calculates that the sales tax base has shrunk by 40% over the last two decades.

Both sales and income tax collections have boomed since 2020 because of economic growth, massive federal Covid-19 relief, and inflation. New Mexico in December had a whopping $5 billion surplus, and South Dakota ended fiscal 2022 with $115 million extra to spend.

That growth is not likely to last, however. “We cannot expect to see the same growth as we have seen in fiscal 2022,” said Lucy Dadayan, a principal research associate at the Urban-Brookings Tax Policy Center, a joint venture between two think tanks in Washington, D.C. “In fact, a lot of states are forecasting much weaker revenues for fiscal 2024 as well as for the current fiscal year.”

South Dakota does not have an income tax. The state sales tax is its main source of revenue. The tax cut will cost the state about $105 million next fiscal year, Mortenson said.

Lawmakers decided an across-the-board cut would help keep revenues predictable, he said. “We need our sales tax collections to remain consistent and steady.”

The South Dakota tax cut will sunset in four years unless lawmakers decide to extend it.

New Mexico lawmakers voted last month to cut the 5% state gross receipts tax, which functions like a sales tax, by 0.5% over four years. Gov. Michelle Lujan Grisham (D) approved a 0.25% rate reduction last year.

New Mexico’s gross receipts tax covers most direct household spending and has among the broadest bases of any state sales tax, according to a 2021 report from the Urban-Brookings Tax Policy Center. Sixty-six percent of New Mexico household spending is taxable, compared to 34% nationally and about 47% in South Dakota, the report found.

This year’s gross receipts tax cut was part of a $1.1 billion tax cut bill that Grisham (D) has yet to sign. The bill would also authorize rebates, increase child tax credits, restructure income tax brackets, increase film tax credits and raise taxes on liquor and tobacco, among other changes.

The state’s Democratic leaders want to make the tax code more progressive, said Rep. Derrick Lente (D), chair of the House Taxation and Revenue Committee. Reducing the gross receipts tax rate is part of their strategy.

“That’s a huge benefit, especially for families and seniors that are on a fixed budget,” he said of the tax cut. New Mexico already exempts groceries from the tax, he noted.