BILL ANALYSIS AND FISCAL IMPACT REPORT	Page 1 of  4

DATE:  March 9, 2001	Submitted by: TAXATION AND REVENUE DEPT.
	T. GLENN ELLINGTON, SECRETARY
BILL NUMBER: SB – 739 as amended on Senate Floor (#1 - #4)

SPONSOR: Senator Adair

BILL SHORT TITLE: Tax Incentives for Construction and Operation of an Electrical Generating Plant Located in Designated Counties.

DESCRIPTION: This bill “sweetens” the pot for an investor owned utility, working in concert with a sponsoring government entity, that builds and operates an electrical generating plant in Lea, Eddy or Chavez Counties or per Senate Floor amendments, Luna, Roosevelt, Curry or Hidalgo Counties. The tax incentives included in the bill include: (1) considering any electrical generating plant built a manufacturing plant for the purpose of double-weighted sales factor for corporate income tax; (2) specifically exempting from gross receipts tax the tangible personal property, including that required for construction of the plant, incorporated in an electricity generating facility financed by industrial revenue bonds (however, this may not be effective; see Technical Issue #1 below); (3) creating a technical extension of the use of NTTCs for construction tangibles, since the tangible property, separately purchased, is intended not to be subsequently taxable; and (4) making such projects eligible for the manufacturer’s investment credit of 5% whether financed by IRBs or not. Also, Senate floor amendment #4 intends to provide a “safe harbor” for a construction contractor that accepts an NTTC from the sponsoring government in good faith (but this is unlikely to be effective; see Technical Issue#3 below). 

EFFECTIVE DATE: July 1, 2001

FISCAL IMPACT (Thousands of dollars):  		Note: Parenthesis ( ) indicate a revenue loss:
		Recurring or		
Estimated Impact on Revenues	Nonrecurring	Funds 	
	 FY 2002 	Full Year	     Impact     t     	             Affected          .             	
	(Millions)	(Millions)	Recurring	General Fund	
	(Millions)	(Millions)	Recurring	Local Governments	

	Assuming a 1,000 MW facility were built, total plant cost would be in the neighborhood of $300 million. The gross receipts tax deduction on construction materials would be about $5 million (mostly state cost), and the investment credit would be about $5 million (all state cost). These tax incentives would be worth about 3% of the total cost of the plant. The property tax exemption – the plant would be “owned” for the purpose of property tax by the county – might be worth on the order of $1.5 million a year.
	The precedential impact of this bill, however, is much more substantial.  The first obvious extension is to all power plants.  Current sales from the two large and 18 smaller generating stations would quickly – either through subsequent legislation or, more likely, litigation – become eligible for double-weighted sales. The Four Corners Power Plant and San Juan Generating Stations sell substantial amounts of power outside the state and the owners would benefit significantly from double-weighted sales for corporate income tax purposes. There has been some talk of an additional coal-fired base unit or two at Four Corners or San Juan Generating plants. The tax relief for construction materials and expansion of investment credit is virtually certain, again, through subsequent legislation or, more likely, litigation.
	A less apparent but potentially larger impact will come from the reaction of the federal government. New Mexico has been successful, even in the U.S. Supreme Court, in defending the imposition of its gross receipts tax on government contractors because it treats those contractors no differently than other contractors. Enactment of this bill will mean that federal government construction contractors will be treated less favorably than other contractors. It is not unlikely that federal courts would find an impermissible discrimination and bar New Mexico from taxing any federal construction contract. On an annual basis, that is something like $9 million in state and local gross receipts tax. If federal contractors become exempt, how long will the state continue to tax its own projects and those of local governments?

ADMINISTRATIVE IMPACT: Since this is designed to be effective for fewer than six companies and plants, virtually all the regulatory and processing issues could be handled manually, with minimal expenditure of resource. The true cost, however, would be defending against the lawsuits sure to be brought against the state seeking to extend the benefits of this bill to a large number of other projects and circumstances. Litigation expenses incurred in defending these cases could exceed $1,000,000 in the aggregate. 

TECHNICAL ISSUES: 
1.	The amendment to Section 7-9-54 NMSA 1978 apparently intends to allow (encourage) the sponsoring governmental entity to separately contract for construction materials for the proposed electrical generating project, thus rendering the materials portion of the project free of gross receipts tax. Allowing this practice to take root would be make a serious reform of the state’s tax system inevitable by undermining one of the few remaining pillars of the existing tax. The definition of “construction” and “service” in Section 7-9-3 NMSA 1978, however, are unchanged. Thus the construction contractor is still providing a service and the taxable value of that service will encompass the whole project, including the materials. The Department will have no choice but to insist on tax with respect to the whole project. This no doubt will engender litigation. If the courts decide that the amendment to Section 7-9-54 NMSA 1978 trumps the rest of the Gross Receipts and Compensating Tax, the practice of allowing the separation of labor and materials for these projects will rapidly spread to all construction projects. This will have a substantial fiscal impact on both state and local governments.
2.	If the Department’s position that receipts from the property components of a construction project remain taxable, despite Section 4 of the bill, Sections 2 and 3 of the bill appear to be unnecessary. Section 7-9-51 NMSA 1978 allows a contractor  to issue an NTTC to a construction material vendor. Nothing in this proposal changes the taxability of construction – a service.  Receipts from a construction project are taxable, even when the customer is a government or is financed with industrial revenue bonds or if the materials are separately stated or separately purchased. Similarly Section 7-9-52 NMSA 1978 allows a contractor to issue an NTTC to a construction service subcontractor. Since the real property construction portion of the project will be taxable, the existing provisions of GRT cover this situation. 
3.	If a contractor accepts an NTTC from the sponsoring government and asserts his right to deduct the construction tangible personal property, the Department will probably strategically and equitably assert that the contractor did not accept the NTTC in good faith. The “safe harbor” amended into the bill (Senate Floor amendment #4) will probably not protect the contractor. Mere allegations by the contractor of having received oral assurances from the local government will be given little credence.
4.	Suit could be brought on equal protection grounds and on the prohibition expressed in Article IV, Section 24 of the New Mexico Constitution, “the legislature shall not pass local or special laws … [relating to] the assessment or collection of taxes; … [or] exempting property from taxation. In every other case where a general law can be made applicable, no special law shall be enacted.”  Although this provision has not been tested in depth, it is likely that the Constitution anticipated this precise type of breach. What is interesting is that the Constitution anticipates that the resolution of a Constitutional challenge on the grounds of local or special law will be to expand the concept to general applicability. Thus, the restriction to particular counties will be resolved to allow an electrical generating plant located anywhere in the state to partake of the benefits of this bill. The restriction to construction of an electrical generating plant financed by IRBs is likely to be resolved in favor of deduction of materials for all government construction projects.

OTHER IMPACTS AND ISSUES:
1.	Data from the 1997 IMPLAN data set show the following (millions of dollars):
		Tangible Portion	State Gross Receipts Tax	Local Gross Receipts Tax	
State and Local Construction	 1,037	 415	18.9	8.4	
Federal Construction Demand	 364	 145	6.1	2.9	
IRB financed construction	 200	 80	3.4	1.6	
					
    Total construction	 1,600	 640	26.4	12.9	

2.	The following counties are class B counties with 1990 population of over 47,000 and less than 60,000, and with 1999 property tax valuation of over $550,000,000.

County	1990 Population	1999 Property Tax Valuation	
Chaves	57,849	555,000,000	
Eddy	48,605	1,088,000,000	
Lea	55,765	1,021,000,000	

3.	Luna County, with $238M in assessed valuation and 18,100 population is the county identified as “a population of less than 20,000 and with a net property tax value of $210 million to $400 million.”

4.	Luna County and Roosevelt County, with $181 million and 16,702 population, are counties identified as “a population of over 15,000 but less than 19,000 and assessed value of more than $180 million but less than $240 million.”  This double inclusion of Luna County should not be a problem.

5.	Curry County, with $374 million in assessed valuation and 42,207 is the county identified as “a population of more than 42,000 and a net taxable value of more than $300 million but less than $400 million.”

6.	Hidalgo County, with $102 million in assessed value and 5,958 population is the county identified as “a population of less than 6,000 and an assessed valuation of more than $100 million.”

7.	Ultimately, the question is one of risk and priorities. The state must determine if the risk to future revenues (on the order of $30 million a year) is sufficiently weak to allow betting $8 to $10 million one-time, and $2 to $3 million a year on an investment in a plant that might generate $250 to $300 million in sales a year, with purchases of Eddy, Lea and Chavez natural gas on the order of $100+ million per year. The gas burned in the plant would be subject to the gross receipts tax. Electricity generated in the plant that is sold within the state will be taxable. The plant would become property taxable after 20 or 30 years, when the industrial revenue bonds are retired. If the state does move forward with this proposal, the most likely effect will be that the state and all cities and counties will forego tax revenue, while the host county of the plant and the natural gas producing areas of the state – principally in the Permian basin – will reap the benefits.

8.	The conventional economic development argument for tax incentives is always trotted out in the debate on these and similar projects. “If the project is not built, the governments (and the people) will not get any tax revenue at all, so foregoing nothing costs nothing.” There are a number of fallacies in this reasoning. First, a high-dollar project will not live or die on a “discount” of 3% of the capital cost of the project. 3% is the kind of post-decision sweetener that many companies have learned to extract from governments. Second, we choose to allocate total government expenditures for public schools, higher education, courts and corrections, health, safety and welfare and general government by imposing taxes shared among businesses and individuals. To treat taxes as going into a “black hole” completely misses the point of community and the uses of the tax revenue. A third fallacy is that the gross receipts tax from economic development projects is not in the revenue estimates, therefore, the state and local governments are not foregoing revenue that they had counted on. In fact, the revenue estimates at all levels assume economic growth. It is not necessary to identify the exact nature or location of economic growth, but to use historical precedent to link predicted real growth of the national economy to predicted real growth of the state economy and therefore to nominal growth in revenues. Thus, the growth from this electrical generating project is effectively in the revenue estimates and in the tax base.

9.	Obviously, extending “manufacturing” to cover this one (or a small number of) specially-favored plant(s) is but the first step to including all power plants within “manufacturing.”  If that is the decision the Legislature wants to make, a direct approach is clearer and fairer than pretending to carve out special, one-time exceptions. Simply delete the existing specific exclusion of electricity generating plants. 

10.	This is good example of what happens when the State lacks a coherent tax policy.