In September, the Colorado Office of the State Auditor (OSA) released its first evaluation of the state’s tax expenditures—deductions, exclusions, and other preferences in the tax code. Under legislation enacted in 2016, OSA is reviewing all of the state’s tax expenditures on a five-year schedule to assess their effectiveness and whether they are meeting their intended purpose. Despite some data limitations, the study included background information and analyses of 15 tax expenditures, including several sales tax exemptions and others related to agriculture. Similar evaluations have led to changes in other states that helped programs better meet their aims and stem revenue losses.
This analysis by The Pew Charitable Trusts of OSA’s study is intended to help Colorado lawmakers as they consider its policy implications. The tax expenditures OSA studied this year fall into three broad categories: those with limited or no use, structural components of the tax code, and regularly used discretionary tax expenditures. For each category, we present questions designed to help lawmakers gauge the value of specific programs.
Tax expenditures with limited or no use
- Agricultural Lease Deduction.
- Crop Hail Insurance Premium Tax Exemption.
- Farm Close-Out Sales Tax Exemption.*
- Hunger Relief Income Tax Credit.
- Crop and Livestock Contribution Corporate Income Tax Credit.
- Occasional Sale of Liquor by Public Auction Exemption.
- Sacramental Wines Excise Tax Exemption.
- Sales to Residents of Bordering States Exemption.
* OSA lacked data to estimate the revenue impact of the Farm Close-Out Sales Tax Exemption.
None of these programs is widely used. To determine whether they should continue and in what form, lawmakers need to consider why participation is low. Several possible explanations are discussed below.
Is the program designed to achieve its intended purpose?
In 1961, the Colorado General Assembly enacted the Crop Hail Insurance Premium Tax Credit. While not explicitly stated, OSA inferred from the tax credit’s statutory language that its aim was to help farmers obtain insurance for crop damage through mutual protective associations. But OSA’s evaluation revealed that the credit cannot be used because no such associations exist in Colorado. Moreover, OSA estimated that as of 2017, 67 percent of the state’s cropland was covered by federal crop insurance, so the program’s purpose is probably being fulfilled.
Does the program duplicate another in the state?
OSA evaluated whether the Farm Close-Out Sales Tax Exemption cuts the cost of purchasing agricultural equipment and supplies through farm closeout sales. It found that other, broader tax expenditures exempt sales and use taxes on most farm equipment and supplies, regardless of whether they are sold at a closeout sale. Specifically, OSA noted five additional sales and use tax exemptions that could apply to property sold at these sales, duplicating the exemption’s intended benefits.
Are those eligible for the program aware that it exists?
The Agricultural Lease Deduction has been available since 2016, but no claims have been filed. The program aims to encourage farmers nearing retirement to lease assets to people who are beginning to farm or ranch. To determine the tax expenditure’s potential effectiveness, OSA surveyed older farmers and ranchers. Respondents indicated that while they may find the exemption beneficial, many were already seeking parties to lease to in the interest of continuing their operations. And only 27 percent of those surveyed were familiar with the deduction.
Is the program’s original purpose still relevant?
The Sales to Residents of Bordering States Exemption, created in 1963, exempts the sales tax for residents of bordering states that do not impose a retail sales tax. It applies specifically to purchases made within 20 miles of the Colorado border by nontourists. While its purpose was not explicitly stated, OSA determined by researching retail sales taxes in bordering states that it was created for merchants near the Colorado-Nebraska line, because Nebraska did not have a sales tax when the expenditure was enacted. Since all bordering states now impose sales taxes, OSA could not identify a rationale for continuing the program.
Structural components of the tax code
- Credit for Taxes Paid to Other States.
- Wholesales Tax Exemption.
These types of tax expenditures are generally created to serve principles of sound tax policy such as treating similar taxpayers equally or increasing the efficiency of tax collections, but policymakers still should examine whether they are accomplishing these goals.
Are these programs offered in other states and at what level?
OSA’s analysis of the Credit for Taxes Paid to Other States found that 42 of the 43 states that impose income taxes offer a credit for income taxes paid to another state, with some variation in how they calculate the amount of the credit. In addition, some states allow the credit only if the state where the other income was earned also provides a credit. OSA also noted that other states have different residency requirements, which may affect eligibility for the credit.
What are the consequences if the program is modified?
This question applies to two programs in OSA’s evaluation: the Wholesales Tax Exemption and the Credit for Taxes Paid to Other States. These two programs have a large revenue impact--$4 billion and $185 million, respectively. OSA’s analysis provides a thorough explanation of possible effects if the state eliminated the tax expenditures. For example, if lawmakers ended the wholesales exemption, OSA estimates a 148 percent rise in the state’s sales tax revenue and a 35 percent gain in total state tax revenue, but retailers would probably offset the lost exemption by raising prices.
OSA notes that eliminating the Wholesales Tax Exemption would produce a ripple effect. Not only would wholesalers pay more sales tax, but distributors and retailers would, too. In this scenario, all entities making wholesale purchases would either pay the taxes themselves or pass on the additional cost to consumers. In addition, OSA points out that retailers would be at a competitive disadvantage to manufacturers that sell directly to consumers because a sales tax would be applied at each transaction.
Regularly used discretionary expenditures
- Long-Term Lodging Exemption.
- Newsprint and Printers Ink Sales Exemption.
- Newspapers Exemption.
- Sales to Charitable Organizations Exemption.
- Biogas Production Components Sales Tax Exemption.
OSA’s evaluation showed that although these programs are regularly used, they may not be working as intended. Lawmakers can examine these programs’ relevance, cost-effectiveness, design, and administration.
Is the program’s purpose still relevant and is the cost justified?
Using the legislative declaration for the 1943 bill that created the Newsprint and Printers Ink Exemption and the Newspapers Exemption, OSA inferred that the measure’s purpose was to clarify that these purchases were not intended to be taxed. Historical context also informed OSA’s conclusion: Many other states exempt newspapers from sales taxes due to their role in informing the public. The Department of Revenue offered insight on another reason for the Newspapers Exemption: It was difficult to collect sales tax on newspapers, particularly with coin-operated machines.
OSA estimates that the Newsprint and Printer’s Ink Exemption and the Newspapers Exemption resulted in about $500,000 and $2.7 million, respectively, in forgone state revenue in 2017. Because demand for newsprint is declining, OSA anticipates that the exemptions will have a diminishing impact on future state revenue. The office also noted that if the exemptions were eliminated, newspapers could face higher costs. The additional financial burden coupled with increasing difficulty in generating revenue could result in more layoffs and closures or passing on costs to consumers.
OSA notes that lawmakers could consider clarifying whether the Newspapers Exemption should also apply to newspapers’ digital editions.
Are program eligibility requirements appropriately defined?
OSA determined that the Long-Term Lodging Sales Tax Exemption aims to ensure that the sales tax is applied equally for those who purchase long-term housing from lodging providers and those who purchase it through traditional apartment leases. According to the statute, the exemption applies to occupants of a variety of types of lodgings, such as hotels, guesthouses, and mobile homes, for at least 30 consecutive days. While OSA determined that the tax exemption’s purpose is being met and continues to be applicable, the office highlighted that the program does not indicate whether the exemption also applies to situations in which a business pays for a room that is occupied by different employees—or to the emerging market of home-shares for private homes (e.g., Airbnb or HomeAway). If the exemption were allowed in these situations, the state probably would lose more tax revenue.
Similarly, OSA determined that the Biogas Production Components Sales Tax Exemption is meeting its goal of encouraging development of projects that produce biogas-derived energy in Colorado, but only to a limited extent. While the exemption may be promoting the development of biogas facilities in the state, it probably has not led to greater biogas production capacity. Stakeholders note that the components used to produce biogas are tax exempt if the electricity that is generated from the biogas is sold to a third party, such as a utility, but not if it is used on-site. However, expanding the program to include projects that use the electricity on-site could encourage more small-scale production facilities than was originally intended—meaning fewer tax dollars going to the state.
Is the program administered efficiently?
OSA’s analysis of the Sales to Charitable Organizations Exemption found that while the program is widely used, many of the groups it surveyed reported having difficulty claiming the exemption. In addition to complications related to Colorado’s local government tax laws, the survey identified various challenges that charitable organizations have accessing the exemption from retailers. It found that many retailers don’t know how the exemption works or who is eligible, have not adequately trained their staffs on how to apply the exemption, and find verifying eligibility a time-consuming process. If a retailer denies the exemption, a charitable organization may apply for a refund from the Department of Revenue. However, OSA points out that this is a burden to both the department and the charitable group. Refunds take up to nine months to process.
Answering these questions can help policymakers decide whether to eliminate a tax expenditure, modify it, promote its availability, or take no action. Before they act, policymakers should consider the effects on revenue and meeting the program’s intended purpose.