Nebraska Property Tax Relief Plan: Details & Analysis
Should the Nebraska Unicameral convene in special session in the coming days, it will do so to consider the furthest-reaching overhaul of the state 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.
code since 1967—and it doesn’t even have a full proposal in front of it yet.
Spurred by legitimate discontent over rising property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services.
burdens, Gov. Jim Pillen (R) is searching for bold solutions. But the plan, which reportedly involves a two-tiered 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.
and the state’s assumption of most school funding responsibility, would have profound implications that even those most convinced of the urgency of property tax relief may find unworkable and unpalatable.
Based on documents circulated to members of the governor’s property tax working group, the sales tax baseThe 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.
would expand to cover an additional $28 billion in currently exempt transactions, most of which were exempted to avoid double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.
. The expansion functions mainly as a tax on production, not consumption, resulting in higher prices for consumers, higher production costs for farms and businesses, and an incentive structure that drives jobs and economic activity out of state.
While the full details of Gov. Pillen’s plan are not yet available, he has outlined the contours of his approach, and the Nebraska Examiner obtained a draft document identifying the sales tax exemptions the governor intends to axe to raise an estimated $1.3 billion. (The Tax Foundation has relied upon this document for calculations included here, adjusting the rate on machinery and energy as subsequently reported.) The plan would entail using the revenue from an expanded sales tax to fund K-12 operating expenses—which constitute the overwhelming majority of school costs—at the state level, thus eliminating local property taxes for school operating costs over the course of a three-year phasedown.
The proposal also calls for a hard cap on city and county property tax collections, limiting revenue growth to the rate of 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.
under most circumstances. Both school districts and local governments would, however, have recourse to voters to override these restrictions, with school districts permitted to levy new property taxes for voter-approved bonds and raise rates with the approval of 60 percent of voters in a statewide primary or general election. Local governments, too, could exceed their caps with 60 percent voter approval. (School districts could also raise taxes with a simple majority if the state failed to live up to its new school spending obligations.)
Lawmakers will have to grapple with all of this: whether it is desirable for the state to assume so much responsibility for local education; how strictly local tax authority should be curtailed; whether jettisoning participation in multistate efforts to ease sales tax compliance is an acceptable price to pay; and, perhaps most importantly, whether the proposed sales tax pay-fors are too economically damaging.
Governor Pillen and aligned members of the Unicameral are right to scrutinize the list of current sales tax exemptions as potential ways to raise revenue to offset taxes elsewhere. There is nothing sacrosanct about the current sales tax base, which—like all states’ sales taxes—improperly taxes some transactions that virtually the entire public finance community believes should be exempt, but also exempts many goods and services without much justification for doing so.
The governor’s plan would apply sales tax to barber shops and salons, pet care, e-books and digital music downloads, parking garages, tennis lessons, zoo admission, and burial services, for instance. From a purely economic perspective, there are no compelling arguments for these exemptions, which largely arose through inertia. Sales taxes were historically imposed primarily on the sale of tangible goods, so when e-books began to compete with physical books, Nebraska’s tax code wasn’t equipped to respond to the transition, even though e-books are clearly a substitute for an existing taxable product. Services were only included on a limited basis, so a tennis racket is taxable, but tennis lessons are not—a distinction that may not make much policy sense. Meanwhile, things like burial services may have initially been exempt for broad categorical reasons (a narrow taxability of services) but remained exempt for policy, or at least political, reasons, i.e., the optics of making a funeral a taxable event.
However policymakers landed on taxing the above transactions or others like them, few economists would voice concern, and many would applaud an effort to better align the sales tax with the realities of personal consumption in a modern, more service-oriented economy. Unfortunately, when the goal is to raise an additional $1.3 billion from a sales tax that currently generates $2.6 billion (a 50 percent revenue increase), taxing e-books and haircuts barely makes a dent. Most of the additional revenue, therefore, has to come from taxing business inputs, things like agricultural machinery and equipment, manufacturing machinery, engineering, energy used in agriculture and industry, data centers and data processing services, and more.
Roughly 76 percent of the revenue from sales tax base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability.
would be generated from businesses, according to Tax Foundation calculations. About 64 percent of the proposed expansion is to goods and services that are almost exclusively purchased by businesses, while 14 percent of the expansion is to categories that are predominantly personal consumption, with another 22 percent that include both business-to-business purchases and final consumption.
Accounting for the intermediate transactions already in the existing sales tax base, this proposed expansion would lead to a majority (55 percent) of all Nebraska sales tax revenue coming from taxes on business inputs. The sales tax, intended as a consumption tax, would have more than half of its base functioning as a production tax.
Nebraskans might reasonably wonder why they should pay sales tax on their purchases, but businesses shouldn’t pay it on theirs. The reason is not to give businesses a special break. Instead, it’s to avoid taxing the same final transaction multiple times, a process known as tax pyramidingTax 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.
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To understand the implications of tax pyramiding, consider the sale of a loaf of bread. Like most states, Nebraska does not tax groceries, so the final transaction is actually untaxed. But imagine if the farmer had to pay sales tax on all business inputs—on seed, tractors, plows, irrigation systems, and combine harvesters; and then a miller paid sales tax on the wheat purchased from the farm, along with the purchase of a roller mill and bran finisher, plus on all the professional services they purchase so they can focus on their core competency—making flour—without setting up an in-house accounting, legal, tax, maintenance, or janitorial division; and then a bakery paid sales tax on the flour purchased from the miller, along with ovens and the electricity to run them, plus packaging materials and distribution services and much more; only after which a loaf of bread arrived at the grocery store, where it was sold “tax-free.” How much of the final price would be pyramiding sales tax at that point? (For many purchases, of course, the final transaction would also be subject to tax.)
Any such taxed intermediate transaction has the potential to be embedded in the final price of a good or service. But that is only half the story. Taxing business inputs also transforms the sales tax from a tax on consumption to, at least in part, a tax on capital. It takes a tax that is generally neutral with regard to in-state investment and turns it into a discriminatory tax on a state’s own businesses, disproportionately affecting smaller firms with less capacity to vertically integrate services.
Nebraska’s sales tax (like most sales taxes) is destination-sourced, meaning it is imposed where the product is purchased or used, rather than at the location of the producer or seller. This means that when Nebraska businesses sell in a multi-state market, they aren’t at a competitive disadvantage even if another state has a lower rate, because the purchaser always pays their own state’s sales tax. But as soon as taxes are imposed on a business’s own purchases, businesses in that jurisdiction are placed at a disadvantage against competitors not subject to such taxes in their own states. These taxes represent an additional cost of production that is not borne by their competitors based elsewhere, even if they sell into the same markets.
Depending on the market for a given product, the result of taxes on business inputs is either to (1) increase consumer prices or (2) reduce the profitability of the taxed business activity—or both. Whether, and how much, this raises the final price of the product (rather than cutting into profitability, reducing wages, or eliminating the production activity entirely or moving it across state lines) will depend on whether regionality is integral to the product.
Milk, for instance, is almost always sourced within a few hundred miles of the grocery stores in which it is sold to consumers, due to the costs of transporting it and the rate of spoilage, whereas cereal crops can be sourced from and processed anywhere in the country, and it is often cheaper to ship produce across oceans than across a few hundred miles of road.
If multiple layers of sales tax were imposed on the dairy industry by applying the tax to milking machines, the services of milk processing plants, and the services of milk distributors, then much of the additional tax would likely be borne by consumers, at least in some parts of the state, as milk from Idaho is not a competitive economic substitute for milk from Nebraska for a family living in North Platte. Milk from Iowa being stocked in stores in Omaha, though? That’s another matter entirely.
And what of, say, the sale of corn? The market for corn is international. You can catch the latest corn future prices on RFD-TV morning programming. If Nebraska farmers suddenly experience higher production costs due to a sales tax on their agricultural inputs, they can’t pass much of that cost along to consumers, because, as big as Nebraska’s corn production is, there’s plenty of other corn being grown across the world, and that competition will keep prices in check. Nebraska farmers, then, have no choice but to accept lower profit margins. For some businesses, of course, the additional tax on business inputs could make the difference between profitability and posting losses.
Some farms might come out ahead due to property tax relief. Other farms, and many other businesses, however, could find themselves in a much tougher spot as doing business in Nebraska becomes more expensive. To the extent that businesses can move some of their operations out of state, they will be incentivized to do so, taking jobs with them.
Under the governor’s proposal as outlined to the working group, some business inputs would be taxed at the ordinary rate of 5.5 percent. Others—those prone to pyramid the most—would be taxed at 4 percent (and not be subject to local sales tax), an implicit acknowledgment of the harm caused by taxing these inputs. But this creates an additional problem. Nebraska is a party to the Streamlined Sales and Use Tax Agreement (SSUTA), which standardizes definitions and requires a certain level of tax uniformity, simplifying compliance costs for sellers and providing software and tools to better facilitate remittance of sales tax on remote transactions. One requirement for member states is that they cannot impose different rates on different products, other than groceries. The Nebraska proposal would apply a different rate to an estimated $14.4 billion worth of transactions, all of which would pyramid.
On July 22, Gov. Pillen offered a new statement of principles setting parameters on sales tax base broadening, most notably promising “no sales tax on ag inputs or manufacturing materials (defined as physical economic resources used to create goods to be sold to an end user),” “no sales tax on services or items that are exempt in all surrounding states,” and “no double taxation.” At first blush, these principles may appear to pare back the proposed areas of expansion considerably. But while the limitations sound significant, they are not—mostly thanks to neighboring South Dakota.
The unusually broad base in neighboring South Dakota helps salvage some base broadening that might not otherwise be possible under the proviso that nothing can be taxed if not taxed in at least one neighboring state. Nebraska’s neighbor to the north, which foregoes both an 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.
, has an uncommonly broad sales tax, ranking with Hawaii and New Mexico as the most aggressive in taxing business inputs. (South Dakota, as it turns out, has relatively little business in many of the taxable categories, except agriculture.)
The prohibition on double taxation, meanwhile, is not a guard against tax pyramiding from taxing business inputs. Instead, it refers to a policy of exempting equipment from tangible personal property (TPP) taxation if it is subjected to sales tax upon purchase. Rolling back the TPP tax is good policy, but it doesn’t make up for taxing capital investment upon purchase.
Potentially significant, however, is the principle restricting sales tax on “ag inputs or manufacturing materials (defined as physical economic resources used to create goods to be sold to an end user).” How narrow or broad this may be interpreted remains to be seen. An appropriate understanding of resources used to create goods would exclude virtually all business inputs. However, the language of “ag inputs and manufacturing materials” (plus the requirement that they be physical) appears to be narrowly drawn to allow machinery, equipment, and energy to be taxed. Seed could not be taxed, but planters could. Iron ore could not be taxed, but the molds, casters, and rolling mills used in steel manufacturing could. The principles sound good, but arguably change nothing about the known proposal.
Nebraskans know that property tax relief is important. Nebraska has the 8th-highest residential property taxes in the country measured as a percentage of the market value of owner-occupied housing, and the 10th-highest overall property tax burden (for all classes of property) measured as a percentage of income. As assessed values have skyrocketed in recent years, millages (rates) have not always been adjusted appropriately to avoid large, unnecessary tax increases.
The state’s Truth in Taxation law, adopted in 2021, requires public notice and an affirmative vote by local government to allow collections to increase more than an “allowable growth percentage,” but there are many exemptions, and the limitation is not hard to override. Imposing binding levy limits that can only be overridden by a vote of the people—as the governor proposes, but perhaps still with some allowable growth percentage rather than the inflation-only approach being contemplated now—could be part of the solution.
Responsible sales tax base broadening could help offset property taxes as well, though policymakers would need to take considerable care in the design of such a policy to ensure that the offsets are “sticky” and that localities cannot simply revert to old tax rates while benefitting from state transfers, or even raise their rates in the confidence that the state will provide their taxpayers with an offsetting credit.
Unfortunately, while the proposal the Unicameral will take up in special session begins with some of the right ideas, it takes them to unworkable places. Instead of sales tax reform and modernization, Nebraskans would get an economically destructive new tax on in-state production. Instead of workable property tax limits, Nebraskans would get ones that are quite strict on paper, but so much so that overriding them could quickly become routine, or lead to demands for more state aid.
Nebraskans have suffered under high property taxes for a long time and may be in no mood to wait any longer for relief. But this is not the sort of problem that will be hashed out in special session without creating new problems worse than the ones the plan is intended to solve. Real reform and real relief are possible. It may not be as splashy, and it almost certainly won’t be done in a few weeks’ time, but tax reform for all Nebraskans is not just worth doing: it is worth doing right.
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