If you are a New Jersey resident or business owner, this statement will not surprise you — the New Jersey state tax system is broken. The state’s personal income tax burden is the third highest in the country and its corporate income tax system is ranked the worst in the nation. On top of income taxes, there are a myriad of other taxes — New Jersey’s property tax is the most burdensome in the country; the state’s gas tax ranks eighth among all 50 states in the amount of revenue the state collects; its sales tax ranks 16th; and its cigarette tax ranks 10th . Taken together, it quickly becomes apparent why thousands of New Jersey residents are fleeing the state every year — the tax burden is just too high.
The broken tax system has a significant impact on New Jersey’s ability to serve its citizens and make itself appealing to businesses the state and its municipalities want to attract. What are the root causes that made New Jersey’s tax system so burdensome and ineffective? What parts of the tax code are not working and should be changed? What can we learn from other states efforts to reform their own tax systems?
How We Got Here
Remarkably, for most of the 1990s and early 2000s New Jersey brought in more revenues than it spent and — in stark comparison to other states — the state budget was relatively stable and significant tax increases were infrequent. From FY 1995 to 2004, state expenditures grew on average by 4.2 percent annually — but revenue growth averaged 5.5 percent. However, strong economic forecasts and robust revenue growth spurred the state to dramatically increase spending: From FY 2000 to 2002 total state spending increased 21 percent. Unfortunately, the economy began to slump in mid-2000 and with unemployment nearing 6 percent in mid-2002, state revenues actually declined by 23 percent. The dramatic revenue shortfall sent shockwaves through the state capital where the immediate response from lawmakers was to raise taxes — and over a decade later they continue to do so.
The tax and fee increases enacted in the mid-2000s were not paired with spending restraint. From FY 2003 to FY 2005, New Jersey state government enacted substantial increases in personal and corporate income taxes, tobacco taxes, Internet taxes, and other miscellaneous taxes and fees that extracted over $5 billion in new revenue from taxpayers. However, during this same period new state spending increased at nearly double the rate of new tax revenues — along with an increase in the state’s indebtedness which reached $30 billion in 2005. (Spending increases were fueled in part by skyrocketing costs and commitments tied to public employee pensions and healthcare.) New Jersey was not a microcosm for what was occurring in other states. During this same period, 10 states managed to trim general fund spending and one — Oregon — managed to make spending cuts of as much as 13 percent while holding the line on major tax increases.
Shortcomings in the New Jersey Tax Code
New Jersey’s current tax rates are too burdensome for most corporate and individual taxpayers. The state’s tax code was built to serve a state economy rooted in the manufacturing era and a tax base that is too narrow. If New Jersey is to remain competitive vis-à-vis other states in the 21st century economy, major revisions to the state’s tax code are required. In determining what to do, legislators should first look for remedies to several major state law deficiencies, including:
- Modernizing the sales tax laws. Sales tax revenues in New Jersey top $9 billion annually, or nearly 25 percent of the state revenue base. However, nearly 150 items are exempt from the state sales tax, including clothes, groceries, and professional services. While manufacturers and consumers of these goods will argue these exemptions are warranted, the state stands to lose millions in revenue this year from these exemptions. Finally, in 2017-2018 the state incrementally reduced the sales tax rate from 7 percent to 6.625 percent which is estimated to cost the state nearly $700 Million per year by 2020. However, the net savings from the sales tax rate cut to New Jersey taxpayers earning less than $25,000/year is less than $1 per week while high income earners only net a savings of $14 per week.If there is one bit of good news, on June 21, 2018 the U.S. Supreme Court ruled that states have the right to collect sales taxes on online purchases, a move that could net New Jersey an additional $200 Million annually.
- Taking a closer look at deductions, exemptions, and credits. Like the sales tax, New Jersey’s personal and corporate income tax statutes are riddled with deductions, exemptions and credits. Some of these exceptions are recent additions to the tax code, but many have been in place for decades absent recent examination of their effectiveness. Numerous existing business income exemptions and credits (particularly those applying to small businesses as well as those impacting research and development and manufacturing) could be amended to make them more efficient and attractive to existing businesses who may contemplate leaving the state as well as to new businesses wishing to locate in New Jersey.
- Rethinking the Property Tax. A New Jersey family living on the state’s median income of $68,000 per year pays a median property tax bill of $7,410, or nearly 11 percent of their total income. Thus, there is little debate why the property tax burden is the biggest reason residents are fleeing the state in record numbers for lower tax jurisdictions. As the primary revenue source for public education in New Jersey, property tax rates and revenues have continued to escalate as the demand for education funding increases. In addition to a top-to-bottom review of assessment and valuation formulas to insure all types of property are correctly valued and taxed, the state could also investigate ways to inject more local participation in the property tax system, which could lead to stricter and more evenly distributed school funding.
Where Have Other States Succeeded and Failed in Tax Reform? Nearly every state has attempted — or at least considered — overhauling their tax code in the past two decades in order to improve efficiency, increase revenues, or attract new business to their state. Many states have succeeded in their efforts, but some have failed miserably, driving business from their state, and damaging their state’s credit rating. New Jersey legislators have plenty of examples to look to if they decide to undertake a similar effort in Trenton.
- Indiana. Indiana’s tax reform process can be viewed as the “slow and steady” approach—the state took almost six years over two state administrations to complete the process. The primary tenets of Indiana’s efforts focused on gradual reductions in the state’s corporate tax rate, which were paired with reductions in the state’s personal income tax rate. Once completed, the state’s income tax rates are now near the lowest in the country. To pay for the tax reductions, the state eliminated numerous exemptions, deductions, and credits and raised some taxes (like the gas tax). However, the state also instituted new measures to tie gas tax revenues to funding for infrastructure projects. Finally, the state instituted a broad-based tax incentive review process that requires all tax incentives to undergo an ongoing five-year review and if cost-benefit analyses prove incentives are ineffective, the legislature has the power to immediately repeal them.
- District of Columbia. The nation’s capital has a unique economy — its main drivers are work associated with the federal government and tourism and it faces stiff competition on both fronts from the neighboring states of Maryland and Virginia. To make its tax code more competitive with those in neighboring states and to better protect the District’s revenue base, the Tax Revision Commission made a series of tax code recommendations that were implemented over a three-year period. These changes included: 1) expanding the sales tax base to include some services; 2) reconfiguring and lowering personal income tax rates while preserving the current level of revenue collected from the tax; and 3) implementing a series of tax triggers that ensured that approved tax changes were not put into effect until sufficient revenues were accumulated to cushion the blow from potential revenue losses. The tax code changes — accompanied by prudent fiscal management — have worked. While overall revenues generated under the new tax code initially decreased by $67 million in 2016, business is booming in the District and from 2009 to 2017 the city’s fund balance improved from $1 billion to $2.7 billion.
- Kansas. Unfortunately, the tax reform experiment in Kansas is a prime example of the impact of poorly developed policies and economic implications outside the control of the governor and legislators. The strength of the Kansas economy is built on agriculture, and the timing of the Kansas tax reform debate coincided with a massive reduction in commodity prices resulting in plummeting state revenues. However, in 2012 Governor Brownback proposed a 25-percent reduction in the personal income tax rate, with offsetting revenues achieved by eliminating numerous deductions, including the state deduction for home mortgage interest. Non-wage income for pass-through businesses was also exempted from income tax under the plan. The pass-through exemption created a firestorm in the state due to its potential for tax-avoidance. Many of the proposed revenue offsets upset state legislators who eventually deleted them from the legislative proposal. Caught in a political bind, Brownback signed the revised legislation into law with the promise to revisit several issues and correct the missteps. But that promise was never kept. The governor and legislature remained at loggerheads and a net tax cut of $500 million went into effect in 2014. The estimated price tag of the legislation is expected to balloon to $900 million in 2018 or 15 percent of the state’s general revenue budget. Unlike other states that have successfully overhauled their tax codes, at no time did Kansas take steps to broaden its tax base to generate new revenue, and it failed to heed warnings to proceed with caution. Instead the state quickly drafted, debated, and passed legislation without assuring that offsetting revenues would be available to cover unintended losses due to economic downturns.
Where Do We Go From Here?
A strong economy and a robust state tax code can set New Jersey back on the path to prosperity. To jumpstart New Jersey’s economic engine, legislators would be wise to first focus on making the state’s tax code more efficient and adaptable to the state’s residents and businesses. This should not be a rushed process but a deliberate review and reconstruction that is implemented over several years and creates a tax base that accurately reflects today’s economy and promotes equal tax treatment of taxpayers, income, and assets. Ensuring that adequate revenues are available to fund state operations is central to tax reform discussions: It is essential for New Jersey to control state spending so that efforts to reform the tax code do not fall victim to unsustainable revenue outlays, which would only force the state to increase taxes again down the road. This will not be an easy undertaking, but it must be done to secure the future and prosperity of our home state.