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Nebraska Supplemental Report

Tax Environment

Nebraska is an agricultural state, with one in four jobs still related to farming.

In the past, the state was heavily dependent on its property tax, which has been a source of agitation to its citizens. But in the 1990s, the legislature imposed levy limits on property taxes and restructured revenue sources somewhat to limit increases in property taxes. The amount of revenue generated from the property tax has gone down relative to other taxes and the state now has a relatively balanced tax system. Still, many Nebraskans still perceive the property tax as too high.

The three states that share the largest borders with Nebraska — Iowa, South Dakota and Kansas — are all heavy users of the sales tax and this is sometimes a benefit to Nebraska. For example, Iowa and South Dakota both charge tax on food, but Nebraska doesn’t, so residents close to the border travel over to Nebraska to shop. On the other hand, complaints come from southern counties, which complain that repair parts for the repair of farm machinery are not taxable in Kansas or Missouri, but are in Nebraska, causing problems for Nebraska businesses.

In general, the anti-tax movement in Nebraska has been less fevered than in many other states. A strict property tax limitation measure failed at the polls in 1996. Another ballot measure that attempted to cap state spending failed in 1998.

The state has the only unicameral legislature in the country. The legislature has lost a good deal of institutional knowledge in the tax arena in the last year, and will continue to lose more — a result of a successful ballot initiative to term limit Senators.

Recent Tax Developments

• In Spring, 2002, the legislature overrode Governor Mike Johanns veto of a temporary increase in taxes that included a 30-cents-a-pack cigarette tax boost, a 0.5-point sales tax hike, a hike in personal income tax rates in all brackets, and an expansion of the sales tax base to include 10 new services.

• In May 2003, the legislature made a variety of temporary taxes that were imposed in 2002 permanent and increased the state’s alcohol taxes. Tax increases also included a further expansion of the sales tax base, which was projected to bring in $43.5 million per year in new revenue.

Budget Information

Nebraska reacted more quickly than many states to the economic downturn. Leaders made significant budget cuts in FY2002 and temporary taxes were passed in Spring 2002 and were expected to raise $117 million to deal with budget shortfalls and another $24.5 million that was allotted to the cash reserve fund. The sales tax base was also expanded, with an additional 10 services added to those that are taxed. A special session in August was held to deal with a $233 gap between spending and projected revenue that remained in the FY2003 fiscal year. The unicameral legislature made $71 million in cuts, transferred almost $40 million and shrunk projected spending growth for the year from a planned 4.3 percent to 1.5 percent. Some accounting maneuvers and cash transfers were also used. In mid-November, the budget gap over the next two-year cycle was reported to be $673 million. In addition to the weakness in revenues from the poor economy, Nebraska was one of the states most severely impacted by the drought of 2002. Meanwhile, spending pressures were particularly acute in social services and corrections.

In May 2003, the legislature passed its two-year budget, dealing with a gap between spending desires and projected revenues that had grown to $750 million. This was closed — after the legislature again overrode Gov. Mike Johanns’ veto — through $345 million of tax increases and the remainder in spending cuts. This included a decision to make a variety of temporary taxes that were imposed in 2002 permanent, as well as an increase in alcohol taxes. It also expanded the sales tax base once again, adding six new services — including most repair labor and some construction labor — to the list that are now taxed. Nebraska will also receive $108 million of the $20 billion in federal money that is being divided up among the states to help them deal with their budget problems. The general purposes part of this money was to be deposited in the state’s cash reserve.

Revenues continued to come in less than anticipated through the spring. General fund revenues for May, for example, were about $17.6 million or 8.2 percent less than forecast in February.

Adequacy

Until the last several years, Nebraska’s sales tax base had been narrowing. But in 2002, the legislature expanded the 5.5 percent tax to cover about 10 new services. This year, it was further expanded to cover some home remodeling jobs and some previously exempt goods.

Even so, Tax Commissioner Mary Jane Egr is concerned that the sales tax, as it currently operates in Nebraska, is out of step with the current economy. If this situation isn’t addressed, the state will likely become more reliant on the income tax. Corporate tax revenue also hasn’t grown nearly as fast as other tax sources. There are several reasons for the decrease in its importance. First, Nebraska is a heavy user of tax incentives. Second, although it is a combined reporting state, which limits the ability to shift income to separate subsidiaries, it has made several important legal changes that help corporations avoid income tax. The state repealed the “throw-back” rule and was one of the first five states to shift to a single sales factor apportionment formula. A company’s taxable income is determined only by the ratio of its sales within Nebraska to its total sales nationwide. Assets and payroll do not enter into the calculation

Fairness

Over the years, tax observers have complained that Nebraska has a narrow sales tax base and that the number of exemptions has grown. The taxation of services has been about average for the nation, but lags for Nebraska’s regional area. The state has been making clear efforts to broaden the sales tax base, however. In the last five years, the revenue committee in the legislature has tried to stop more holes from being poked in the tax base and starting in October, 2002, the legislature added 10 services to the 49 services that had been taxed up to that point (out of potential total of 164, according to a 1996 survey by the Federation of Tax Administrators, http://www.taxadmin.org/fta/pub/services/services.html). The tax was broadened to cover about six more services in 2003.

The state generally gets high marks for a lack of regressivity in its tax structure. Up until 1987, Nebraska’s individual income tax was calculated simply as a percentage of federal liability. At that point it decoupled from the feds and adopted four brackets.

Nebraska’s income tax is now among the most progressive in the United States, with income tax breaks phased out at high-income levels, according to the Institute on Taxation & Economic Policy. See “Who Pays? A Distributional Analysis of the Tax systems in All 50 States”, http://www.itepnet.org/whopays.htm

There is a good deal of controversy within the state over the issue of tax incentives, with questions arising as to their fairness and efficacy. When the tax credit program began in the late 1980s, 12 companies qualified for the credits. According to the Corporation for Enterprise Development, 114 companies now receive these tax breaks and another 118 are applying for the benefits. In 2001, more than $147 million was handed out in tax breaks to qualifying companies. This was down considerably in 2002 to $105 million. http://www.revenue.state.ne.us/incentiv/02an_rep/02_annrp.htm Renewed efforts are underway to require more public disclosure about the tax credit program, which currently releases limited company-specific information.

Management

The state has a very useful tax expenditure report published every two years that is available on the web, http://www.revenue.state.ne.us/tax — exp/2002/contents.htm. It’s also very good at analyzing tax data and has an ability to determine the impact of its tax changes on different segments of the population, according to the Corporation for Enterprise Development’s Asset Development Report Card, http://sadrc.cfed.org/states/ne.php. An annual report provides information on tax incentives in the aggregate, though without specific company information. The legislative branch developed a computer model to help the state better understand the costs and benefits of awarding tax incentives.

Nebraska has been in the front of the pack in terms of technology; it has good imaging capabilities and has made major inroads in getting tax money electronically. More work is needed in the area of data mining and data warehousing. Improvements are hindered by budget cutbacks. According to an August 2002 article published in State Tax Notes, Nebraska’s revenue department was cut by 9 percent in the eighteen previous months. Another problem on the horizon is the large number of employees in the revenue department who are headed for retirement — many employees started work at the same time, when the state instituted its income and sales tax in the late 1960s,

The state is trying to push a lot more decision making down the ranks. If a front line employee knows how to assist a taxpayer, for example, the tax department wants to empower that employee. It’s also trying to develop benchmarks to help measure its own performance and to strive for more input from taxpayers to help it better administer programs. In the area of compliance, tax department managers feel confident that they are doing a good job in collecting taxes from the companies that are located in Nebraska, but feel they could do more in pursuing taxes owed by companies that do business in Nebraska but don’t have a physical presence in the state.

The state has substantially improved the administration of the property tax system.

Local Issues

In the 2002 regular session, the legislature temporarily suspended requirements imposed by its school funding formula, allowing the state to pull back $22 million that it was supposed to provide to schools. At the same time, it allowed local school boards to exceed levy limits, an action that ordinarily requires a vote of the people. Having cut state aid for schools as well in 2003, the legislature again voted to allow local districts to hike property tax levvies up to 5 cents to make up for the loss of aid..

In general, Nebraska has one of the lower percentages of state aid for schools relative to local aid. According to the annual financial report of Nebraska schools, in 2001-2002 — the most recent audited figure — 45 percent of funding came from the state and 55 percent came from local sources. For the following year, the percentage that came from the state declined, though final figures aren’t yet available.

Nebraska’s dependence on property taxes has waned over the years. In 1980, net property taxes represented 45 percent of the total. In 2000, it had dropped to 31.1 percent of total state and local revenues, though Nebraskans still bear a greater burden from this tax relative to their other taxes and with the weakness in state dollars, local property taxes may be increasing again. According to a 50-state Property Tax Comparison Study published by the Minnesota Taxpayers Association in cooperation with the National Taxpayers Conference, residential property taxes were higher than the U.S. average for Nebraskans in 2000.

Local governments are sometimes blindsided by unexpected revenue losses due to tax credits given by the state. Governor Mike Johanns has said he believes that cities need a clearer idea of potential revenue losses they will suffer in the future because of tax incentives.

Another issue impacting the state/local revenue mix is school aid. A task force compiled a list of draft proposals in the fall, seeking to make the Nebraska School aid formula more equitable.

Noteworthy Programs

• Taxpayer Input. Nebraska is trying to develop a more customer-focused culture in the administration of its tax programs by seeking much more input from taxpayers. For example, in the state’s sales and use tax education campaign, it held focus groups with practitioners, regular taxpayers, small business owners and larger taxpayers — people who have to comply with the state’s sales and use tax form. The idea was to simplify the sales and use tax program to have as much voluntary compliance as possible. In doing so, it received very good recommendations for tweaking the system and making the regulations easier to find. One technique was to give the focus group a question about shipping and handling and then time them to see how long it took for them to find the right answer in the department’s literature. For some people, it took 5 minutes; others took 20 minutes and they still couldn’t find the right answer — showing the department that it needed to develop better indexing.

• Econometric Modeling Program. Nebraska has an econometric modeling program, which enables it to project out the costs and benefits of tax incentives and how tax structure changes in general will impact on, and be affected by, the Nebraska economy. The computer-based general equilibrium model was developed at the University of Nebraska Department of Economics and enables the legislative fiscal office to run simulations of the impact of proposed tax credits or other tax changes — not only on taxes collected, but also in terms of the impacts on personal income, wages and salaries. Observers also note that Nebraska is at the forefront of doing performance-based analysis on the tax incentive issue.

• Nebraska recently completed a successful electronic data conversion project so that 100 percent of the tax information received on gasoline, diesel, and aircraft fuels is reported electronically. In an article in State Tax Notes, Nebraska Tax Commissioner Mary Jane Egr wrote that the state’s data systems allow it to track motor fuel from the time it enters Nebraska until it is taxed, consumed, or exported. The state worked with a software vendor to develop a Windows-based program, then copied and distributed it for free (at first) on CD-ROMs. Return and payment due dates were extended as an inducement. The full mandate became effective January, 2002 and was preceded and supported by a marketing and education campaign.

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