On March 31, 2020, the Navajo Tax Commission (“NTC”) passed two resolutions that proposed a number of amendments and changes to the Navajo Tax Code. One resolution pertains to the sales tax provisions. It proposes raising the maximum sales tax rate from 6% to 10%. Currently, the NTC is limited to imposing a sales tax rate between 2-6%. It has chosen to impose the maximum rate, and so businesses that are subject to paying sales tax must pay 6% on sales that they make. If the resolution passes, the NTC could possibly choose to impose a 10% sales tax. 

The other resolution pertains to the Uniform Tax Administration Statutes (“UTAS”), which in its most basic sense, establishes NTC’s administrative authority, tax filings, penalties, and hearings. The resolution recommends increasing the late penalties from $50 to $200. If the resolution is passed, it would allow the NTC to keep all the revenues it collects from late penalties and also a percentage of other tax revenues.

Regardless of the motives behind these tax resolutions, the negative impact on the Navajo economy and small businesses outweighs any benefits to the NTC. In fact, the NTC is the only entity that benefits from the proposed amendments to the Tax Code. This tax study highlights the issues with the resolutions and proposes alternative solutions.

  • Taxation on reservations is complex because often times it involves competing interests of states and tribes regarding who has the authority to tax and who they can tax. During the second half of the 20th century, the U.S. Supreme Court decided a number of cases involving taxation on reservations. However, rather than drawing clear lines between state and tribal taxing authority, the U.S. Supreme Court ended up creating a complex tax scheme in Indian Country.

    One of the earlier tribal taxation cases to go before the U.S. Supreme Court was McClanahan v. Arizona State Tax Comm’n in 1973. In that case, the Court held that states could not impose income taxes on tribal members whose income was earned on a reservation. McClanahan, 411 U.S. 164 (1973). In 1980, the same court decided a case called Washington v. Confederated Tribes of the Colville Indian Reservation. In that case, the Court recognized that the power to tax is an essential attribute of tribal sovereignty, self-governance, and territorial management. Washington, 447 U.S. 134 (1980). Therefore, tribes could tax transactions of its members and even transactions of non-Indians doing business on the reservation. Two years later, in Merrion v. Jicarilla Apache Tribe, 455 U.S. 130 (1982), the Court addressed whether tribes could tax companies who extracted oil and gas from reservation lands. The Court held that indeed tribes could impose a severance tax on oil and gas companies.

    The aforementioned cases recognized and solidified the taxing powers of tribes. However, things were thrown into chaos when the U.S. Supreme Court allowed for dual taxation on reservations, meaning that both the tribe and the surrounding state could collect taxes for certain transactions. For instance, in Cotton Petroleum Corp. v. N.M., the Court held that non-Indian companies that extracted oil and natural gas from reservation lands may be subject to both tribal and state severance taxes. 490 U.S. 163 (1989). Likewise, in Okla. Tax Comm’n v. Citizen Band of Potawatomi Indian Tribe, the Court held that states could impose sales tax on non-Indians purchasing cigarettes from retailers on a reservation. 498 U.S. 505 (1991).

    This new string of taxation cases created an odd dual taxation scheme on reservations. In some reservations, retailers would have to keep track of cigarettes sold to tribal members and non-Indians. Retailers were not obligated to charge sales tax to tribal members under tribal law; however, pursuant to state law, they had to charge state sales tax to non-Indian buyers and pay those taxes to the state. If the retailers failed to pay taxes to the state, the state could enforce its tax laws by seizing products destined for retailers on the reservation. Unfortunately, dual taxation did not stop at oil, natural gas, and cigarettes. The Court also allowed dual taxation for fuel. See Wagnon v. Prairie Band Potawatomi Nation, 546 U.S. 95 (2005) (holding that states can impose fuel taxes on fuel purchased by a tribe from an off-reservation distributor).

    To determine whether a state can tax sales that occur on a reservation, the U.S. Supreme Court created the following rule: if the tax falls on the tribe or its members, the state cannot impose its sales tax on the transaction. Okla. Tax Comm’n v. Chickasaw Nation, 515 U.S. 450 (1995). However, if the tax falls on non-Indians, then the state can collect sales taxes from the transaction. Id. This is known as the legal incidence of the tax. The ironic part about dual taxation is that it only goes one way, meaning that the state can tax non-Indians on a reservation, but a tribe cannot tax Indians outside the reservation. If states are allowed to tax their citizens on a reservation, should not a tribe be allowed to tax its citizens in the state and have the state remit sales tax to the tribe?

    It is important for tribes to understand taxation in Indian Country because it helps tribes implement tax codes that would benefit the tribal economy and negotiate tax compacts with the states to get around dual taxation. Dual taxation causes significant harm to tribal economies because tribes are essentially losing tax revenue to the states. When states choose to collect taxes on business transactions on a reservation, “tribes are effectively barred from assessing taxes on the transactions because a tribal tax on top of the state’s would make the transaction more expensive.” The impact to the community manifests as underfunded services and deteriorating infrastructure which are paid for using tax revenue. Tax revenue allows a government to support essential government programs, police, courts and health care, to name a few.

  • Title 2 of the Navajo Nation Code (“NNC”) established the Office of the Navajo Tax Commission (“NTC”). The NTC is under the Executive Branch of the Navajo Nation and “is empowered to administer, and delegate the administration of, all Navajo taxes.” The NTC was therefore created to collect taxes and enforce the Tax Code. The Tax Code can be found in Title 24 of the NNC and consists of multiple chapters that address different areas. Chapter 1 of the Tax Code, also called the Uniform Tax Administration Statutes or “UTAS,” sets forth the general authority of the NTC and includes provisions on who the NTC can assess taxes against, the forms that individuals must submit to the NTC each year, when the NTC can impose interest, the type of penalties the NTC can assess for failing to pay taxes etc.

    Subsequent chapters address specific areas of taxes such as the possessory interest tax (Ch. 3), oil and gas severance tax (Ch. 4), business activity tax (Ch. 5), sales tax (Ch. 6), hotel occupancy tax (Ch. 7), and tobacco tax (Ch. 8). The NTC has the authority to collect these taxes pursuant to the Tax Code. It also has the power, under Title 2 sections 3351 and 3353, to adopt rules and regulations that it deems necessary to facilitate the collection of those taxes. Accordingly, the NTC has its own set of regulations separate and in addition to the Tax Code. The NTC’s regulations and the Tax Code can be found on the NTC’s website: https://www.tax.navajo-nsn.gov/.

    It is important to note that the Navajo Nation is unable to assess property taxes because Navajo lands are held in trust by the United States. Therefore, Navajo lands cannot be taxed, sold, or transferred without approval from the federal government. Moreover, the Navajo Nation does not tax the income of its members because such taxes would only add to the financial hardships that many members already experience. The average income on reservations is multiple times less than the average income off the reservation. Therefore, the Navajo Nation is limited in the type of taxes it can impose and collect.

    This is vastly different than taxation within states where individuals pay property and income taxes. Property and income taxes comprise a large portion of the total tax revenue that states collect. Meanwhile, the Navajo Nation is limited to imposing those taxes listed in the Tax Code, and even then, many of the taxes that the Navajo Nation collects are subject to dual taxation by the states.

  • The NTC was established to administer and enforce the provisions of the Tax Code. While it has the authority to create its own regulations that govern how it will administer and enforce the provisions of the Tax Code, it cannot amend, repeal, or add provisions of the Tax Code. It must follow a legislative process to do that.

    The process begins by the NTC passing a tax resolution that recommends changes to the Tax Code. Attached to the tax resolution is usually a copy of the laws that the NTC seeks to change. The proposed amendments, deletions, and additions are presented in an underline-strikeout format. After the NTC passes the resolution, it forwards the resolution to Office of Legislative Counsel for review to determine if the proposed amendments are “legally sufficient.” If they are, then it is assigned a legislation number and declared ready for consideration by the relevant committees: the Resources and Development Committee, Law and order Committee, Budget and Finance Committee, and Naabik’iyati’ Committee.

    Each committee will review the proposed legislation and then vote on whether to recommend that the Navajo Nation Council pass the proposed legislation. Typically, the public can submit comments regarding the proposed legislation which are forwarded to the committees. The Navajo Nation Council is the last to review the proposed legislation and ultimately determines whether it will become law or not. If the Council decides to pass the proposed legislation, then it will forward it to the President for his signature or veto. If the President signs the legislation, then it takes effect on the date the President signs the legislation unless otherwise stated.

    Keep in mind that the NNC can be found on the Navajo Nation Council’s website: https://www.navajonationcouncil.org/code/. All the titles, including Title 24 which is the Tax Code, are available in a searchable PDF format. However, the PDF’s do not include amendments enacted from December 2014 to present day. Accordingly, when reading the NNC, you should also check for any amendments. The Navajo Nation Council’s website also has amendments organized by title number.

The consequence of raising taxes

 

Why Tax Rates Matter – Balancing Tax Revenue with Promoting Local Growth

First and foremost, the amount of tax that businesses pay matters in terms of investment and growth. Evidence shows that higher tax rates are associated with fewer formal businesses and lower private investment, meaning that in places with high tax rates there are fewer businesses and investment in the community. In one study of over 85 countries, a 10% increase in the corporate income tax rate resulted in a 17.5% decrease in the average rate of new business registrations and a 10% reduction in the investment rate. Lower investment rates and a low rate of new business registrations have long-term, negative effects on an economy. One study showed that a tax increase equivalent to 1% of GDP reduces output over the next three years by nearly 3%. Creating an environment that incentivizes entrepreneurship and fosters business growth is an important tool for creating a sustainable economy and alleviating poverty. Consequently, it is important to consider the impact that increased tax rates can have on businesses within the Navajo Nation.

Burdens of Tax Increases are not Equal, particularly for Small Businesses

It setting tax rates, it is important to consider small businesses. Small businesses are the backbone of an economy. The cost of taxes, both in the amount paid and the amount of time and resources required to remain compliant, makes up a larger share of revenue for small businesses compared to larger companies and corporations. Small businesses are also less likely to have the resources to file and pay taxes efficiently like larger companies and corporations. Because small businesses are more sensitive to tax increases, they are more likely to move to or remain part of the informal sector (e.g., flea markets) or, even worse, cease operations. Taxation of small businesses is especially important in Navajo Nation because the economy is comprised of thousands of micro and small businesses and many more that operate in the informal sector.

Regressive Nature of Sales Taxes

Sales taxes can either be paid for using the profits of the business or the business can pass the taxes on to the consumer in the form of higher prices. Even if the business passes the tax on to its consumers, it must consider that higher prices mean less demand and fewer customers.

Moreover, sales tax has an inherently regressive nature, meaning that low- and middle-income families feel the effect of sales tax more than rich families. A family with an annual income of $200,000 is less likely to feel the effect of a 6% sales tax on products than a family with an annual income of $40,000. Since high earners are able to save a much larger share of their incomes than middle-income families—and since the poor can rarely save at all—the tax is inherently regressive. Furthermore, according to Consumer Expenditure Survey data, ITEP estimates that when it comes to purchasing sales-taxable items, low-income families spend three-quarters of their income, middle-income families spend about half their income, and upper-income families spend roughly one sixth of their income. This has particularly far reaching implications for Navajo Nation, where the average annual income is substantially low and a majority of the population falls into the category of consumers that will be strongly affected by the regressive nature of the tax.

Arguments against the tax amendments

 

On March 31, 2020, the NTC passed two resolutions that propose a number of amendments to Chapter 1 (the UTAS) and Chapter 6 (sales tax) of the Tax Code. The resolution which seeks to amend Chapter 1 is Legislation 0111-21, and the resolution which seeks to amend Chapter 6 is Legislation 0112-21.

Legislation 0111-21: Amendments to the Sales Tax Provisions

Legislation 0111-21 proposes, among other things, to amend the maximum sales tax rate. Currently, under section 605, the NTC is authorized to impose a sales tax rate between 2-6%; the NTC set the sales tax rate at 6% which is the maximum rate. Legislation 0111-21 proposes increasing the sales tax range to 10%. Some would argue that 10% is merely the maximum rate or the cap on sales tax, and it is possible that the NTC can impose any sales tax rate between 2-10%. The problem with that argument is that the NTC must have the intention to raise sales tax beyond the current 6% rate. Otherwise, there would be no need for an amendment. Some would also argue that the NTC might charge a rate between 6-10% like 7% or 8%. However, if that were the case then the NTC would have proposed raising the sales tax range to 7 or 8%, not 10%. It is doubtful that the NTC would go through all the legislative trouble to increase the maximum sales tax range just so it has the option to raise the sales tax rate in the future. Clearly, NTC has the intention to raise the sales tax rate beyond 6%. It already charges the maximum sales tax rate, why would it not continue to do so if it has the power?

Many businesses have taken issue with the NTC proposing to increase the sales tax range to 10% and they have every right to be concerned. Currently, the NTC has chosen to impose the maximum rate of sales tax (6%). If the maximum sales tax range increases to 10%, the NTC would most likely increase the sales tax to 10% whether it happens suddenly or gradually. It cannot be emphasized enough that any increase in sales tax would be detrimental to the Navajo economy and small businesses. Moreover, it puts a financial burden on all businesses and forces them to make a difficult decision: do they pass the increased tax on to their customers via price increases or do they continue to charge a 6% sales tax and allow the remaining tax to eat into their profits? It should also be noted that the surrounding states have lower sales tax rates than Navajo Nation: Arizona’s sales tax rate is 5.6%, New Mexico’s is 5.125%, and Utah’s is 4.7%.

On August 10, 2021, Navajo Agricultural Products Industry (“NAPI”), the largest agricultural producer in the Navajo Nation, submitted public comments to the Committees in charge of reviewing Legislation 0111-21. In their comments, NAPI took note not only of the inevitable increase in sales tax, but also the changes to section 609(C) which exempts certain transactions and businesses from having to pay sales tax. 

Currently, section 609(C) exempts from sales tax, sales by producers that engage in agricultural, farming, or livestock activities within the Navajo Nation such as NAPI. The NTC seeks to amend this provision to exempt only “Sales of Agricultural Products by Agricultural Producers engaged in Traditional Navajo agricultural, farming, and livestock activities conducted within the Navajo Nation.” The amendment specifically states, “This exemption shall not apply to sales by commercial Agricultural Producers” (emphasis added). The NTC narrowed the exemption to apply only to agricultural producers engaged in “Traditional Navajo” agriculture. This begs the question of how many producers are actually engaged in “Traditional Navajo” agriculture and what does “Traditional Navajo” agriculture mean? 

The interesting thing about the amendment to section 609(C) is that it is so specific that it must be targeting NAPI. It takes away the sales tax exemption that NAPI relied on for years and subjects them to sales tax. If the Navajo Nation Council passes Legislation 0111-21, this would mean that NAPI would not only have to pay sales tax but most likely a sales tax rate of 10%. This is astounding considering the amount of sales revenue that NAPI generates each year. 

In their comments, NAPI noted that for the fiscal year 2020, it generated sales revenues totaling $41,136,743. If they were required to pay 10% in sales tax, that would mean that their customers, i.e. the Navajo Nation, the Navajo people, and Navajo businesses, would collectively pay $4,113,674 in taxes for the year. NAPI also stated, “Subjecting NAPI to a 10% sales tax will have significant impact on NAPI’s overall revenues, which will eliminate NAPI’s ability to pay dividends to the Navajo Nation each year and will lead to price increases for NAPI’s products to consumers effectively passing the tax onto consumers.” If NAPI is claiming that it will be overburdened by the imposition and increase in sales tax, imagine the burden placed on small businesses.

NAPI also illustrated the difficult position it would be put in: “If Legislation No. 0111-21 is enacted in its present form, NAPI will be left with two undesirable choices: (1) they can either absorb the tax cost so their pricing in the marketplace will remain competitive, which will impair their overall profitability, or (2) increase the price of their crops, which will make them uncompetitive in the global marketplace.” As an example, NAPI mentioned its relationship with Wilbur-Ellis, a company that sells fertilizers, pesticides, and seeds to NAPI. If Wilbur-Ellis were required to tax the sale of products to NAPI, NAPI would pay over $750,000 each year in sales tax. NAPI can either swallow the costs or increase the price of their products to make up for the loss.

From the consumer perspective, an increase in sales tax is also detrimental. On August 16, 2021, the Becenti Chapter passed a resolution opposing Legislation 0111-21 and submitted it to the Committees as public comments. In its resolution, the Becenti Chapter stated its concern that a sales tax increase will negatively impact their community members. The Becenti Chapter noted the low income of its community members and the fixed income for elders. Like many other communities across Navajo Nation, the pandemic is putting a strain on households and a sales tax increase would only exacerbate the financial burden.

Legislation 0112-21: Amendments to the UTAS Pertaining to Late Fees and Penalties

Legislation 0112-21 proposes to amend, among other things, the late penalties. If passed, the amendments would include raising the late penalties from $50 to $200 and allow the NTC to keep all the revenues it collects from late penalties. The NTC claims that the amendments are necessary to clarify certain provisions so that the NTC can properly administer taxes on the Navajo Nation. Martin Ashley, the Executive Director of NTC, wrote a letter to the Budget and Finance Committee on June 25, 2021, in which he explained, “One of the main purposes of the amendment is to provide clarification in the Administration, Definition, and other clarification to assist [NTC] in the proper administration of all Navajo Nation taxes.” 

Contrary to NTC’s claims, the language of the proposed amendments indicates that NTC stands to gain quite a bit in revenue by assessing higher fees, penalties, and sales taxes. While NTC benefits from the amendments, businesses will bear the financial burden and take the hit. 

A closer inspection of Legislation 0112-21, which pertains to the UTAS, reveals that clarification of the Tax Code may not be the primary purpose behind the proposed amendments. For instance, section 103(c) allows the NTC to retain 5% “of all tax revenues, penalties, interest, and tax settlement amounts it collects on behalf of the Navajo Nation.” Section 103(d) allows the NTC to retain 100% “of all fees it collects.” Section 115(b) allows the NTC to charge $50 for a taxpayer conference, and section 115(d) allows the NTC to charge an administrative fee to issue refunds, at a rate of 5% with a minimum floor of $200. Section 129(a) increases the statute of limitations from 4 years to 6 years, meaning that the NTC can collect delinquent taxes from businesses going back 6 years rather than 4 years. This provision is interesting because one can only wonder if the NTC is planning to conduct a widespread investigation into businesses that failed to pay taxes within the past 6 years.

When Legislation 0112-21 is read in its entirety it becomes obvious that the NTC’s stated purpose of clarification is disguising the actual purpose which is to increase NTC’s revenues. If NTC’s purpose is to increase revenues then there are better ways to achieve that purpose than to drain the current tax base with sales tax, fees, and penalties. The NTC’s proposed amendments are similar to the old monarchies that require the working families to pay taxes or food to the palace. When the palace wants to have more wealth and food, it simply takes more from the working families, and if a family cannot give more, it gets punished. The palace obviously does not see the hardship that the working families endure because they are behind palace walls and do not work the fields.

Policy solutions

While the imposition of an increased sales tax may lead to increased revenue for the Navajo Nation and NTC in the short term, the research conducted here signals the needs to long term impact on the Navajo economy and small businesses. While sales tax may offer one avenue for generating much needed revenue for government services and tax administration, there are other solutions available that should be discussed and explored by the Navajo Nation. For instance, investing in a streamlined, digital, and modernized tax system would make it easier for businesses to maintain compliance with tax laws and reduce costs to the NTC by eliminating paper trails and physical filing. The following examples show instances where streamlining the tax system has achieved many benefits without impacting the economy.

 

Improved tax administration

Efficient tax administration can help encourage businesses to become formally registered, thereby expanding the tax base and increasing tax revenues without increasing rates. The research shows that when companies decide whether to enter a certain market, the ease of paying taxes is an important factor, regardless of the corporate tax rate. A study of 118 economies over six years found that when the administrative burden was reduced by 10%—as measured by the number of tax payments per year and the time required to pay taxes—it led to a 3% increase in annual business registrations.

Making it easier to pay taxes is especially important for the growth of small businesses. In Brazil, the government created Simples Nacional, a tax regime designed to simplify the collection of taxes for micro and small businesses. The program reduced overall tax costs by 8% which led to an increase in the business licensing rate by 11.6%, an increase in the registration of microenterprises by 6.3%, and an increase in the number of business registrations by 7.2%. Revenue collections rose by 7.4% because of increased tax payments.

 

Introduce electronic filing and e-payment systems

Introducing an electronic filing and payment system has the potential to drastically improve compliance and tax revenues, without the need to raise tax rates. Additionally, they can lower administrative costs associated with processing tax filings. Further, an electronic system has repeatedly been shown to improve compliance in jurisdictions with similar infrastructure and economic statistics as the Navajo Nation. For example, in Tajikistan, the introduction of an electronic filing and payment system reduced the time for a firm to comply with taxes by 24%. As a result, the number of businesses filing taxes doubled and revenue collections rose strongly.

In the first five years on implementing a similar electronic system in Malaysia, the percentage of individuals and businesses filing increased from 5% to 34%. At the same time, tax collections increased from 14.5% of GDP to 15.3%. Also, the time spent taxpayers spent maintaining compliance with tax laws decreased by over 12% for small and medium-size companies.

 

Tribal-State tax revenue sharing agreements

Tax compacts between tribes and states have the potential to eliminate dual taxation and lower administrative costs of tax collection for the Navajo Nation. The tribe and the state can share collection costs and tax revenues in areas where dual taxation is permitted. For example, the state of North Dakota and the Standing Rock Tribe have an agreement that provides an 80/20 tribal/state split of tax collections for sales and use taxes. The have similar agreements that pay a 87/13 tribal/state split for cigarette and tobacco excise taxes and for fuel taxes.

Navajo Nation has some existing tax agreements for tobacco and fuel taxes, but none for sales taxes. This solution has the benefit of reducing tax incidence on businesses, which can lead to increased business activity and compliance, but also lower administrative costs for collecting taxes.