Opinion: On Governing New Jersey — The Legend of State Property Tax Relief

Andrew Sidamon-Eristoff | February 18, 2016 | Opinion
We dissipate too much of our political energy arguing over funding levels for local aid and popular direct-benefit programs that have no real impact on property taxes.

Andrew Sidamon-Eristoff
One of the most enduring legends of New Jersey politics is that so-called property tax relief actually reduces local property taxes. Like most legends, this one combines an element of truth based on historical facts with more than a measure of myth.

Let’s review some history. Beginning in the 1970s, lawsuits in New Jersey and elsewhere began to challenge the traditional reliance on local property taxes for the support of public education, which had resulted in wide disparities in per-capita education spending between affluent and less affluent communities. Courts duly obliged state governments to redress the disparity. Some states, including New Jersey, chose to broaden the revenue base for local education by adopting a state income tax.

Although the obvious practical objective in enacting an income tax was to support a significant increase in state education aid, the contemporary political rhetoric assured skeptical suburban communities that the new revenue would “reduce” or “offset” property taxes.

And so it came to be that Article VIII of the New Jersey State Constitution, adopted in conjunction with the new Gross Income Tax in 1975, provides that the “entire net receipts” from any tax on personal income and a small amount from the sales tax shall be “appropriated … [to the Property Tax Relief Fund] … exclusively for the purpose of reducing or offsetting property taxes.” The general idea was that state aid to local governments and school districts would offset burdens on the local property tax base, while state-funded direct benefits such as the property tax deduction, the Senior Freeze, and the Homestead Rebate would reduce “effective” tax burdens for individual property taxpayers.

The problem then and now is that the twin policy goals of providing extra resources for poorer districts and offsetting or reducing property taxes are not always compatible. Paring them together set up a smoldering political tension that has arguably defined New Jersey’s politics ever since.

Moreover, it’s hard to claim progress on either goal. Even as the gross income tax has grown from 12.8 percent of the fiscal 1977 budget’s revenues to 40 percent in fiscal 2016, and the top marginal rate has climbed from 2.5 percent to 8.97 percent, we still have litigation over funding disparities (see Abbott v. Burke, I – XXI). Meanwhile, the constitutionally dedicated Property Tax Relief Fund supports approximately 42 percent of the state’s spending yet New Jersey’s homeowners still pay among the highest property taxes in the nation.

The bald truth is that the constitutional dedication of state tax revenues to “property tax relief” was and remains political cover for a fundamental restructuring of the state-local fiscal relationship. At its core, that restructuring has involved using the state’s tax base to redistribute resources from affluent communities to less affluent communities, particularly urban school districts. This redistribution may have been necessary and appropriate — let’s leave that question to another day — but after 40 years it should be obvious that increasing state property-tax relief, whether as state aid to school districts and local governments (together, local units) or direct benefits to taxpayers, has done nothing lasting to control or offset property taxes in most areas of the state.

Understanding what happened, why it happened, and why it’s relevant to today’s debate requires a review of several factors.
First, the expansion of the state revenue base was “successful” in that state income tax revenues have grown in both absolute and relative terms and the growth has, in turn, fueled an increase in state aid to localities, mostly to school districts. The hitch, however, is that this increase in state aid has for a variety of reasons favored poorer communities. In and of itself, this is not a “bad” thing, but it does mean there has been relatively less available for much-heralded property tax relief.

Second, given equivalent marginal rates, New Jersey’s income tax base does not reflect its status as one of the nation’s wealthiest states, with the consequence that our income tax yields less revenue per dollar of resident income than income taxes in many other states. This is because many of our state’s highest wage earners work in New York City and pay the bulk of their state income taxes to New York State rather than New Jersey while, under a 1977 bi-state compact, highly paid Pennsylvania residents working in New Jersey pay tax to Pennsylvania rather than New Jersey.

All this translates into a loss of approximately $2.2 billion in annual revenue, a significant amount compared with the state’s projected $13.7 billion from the gross income tax in fiscal 2016. It is important to note in this context that New Jersey’s marginal income tax rates are already the highest in the region, suggesting that there is little if any capacity to increase marginal rates without incurring substantial harm to New Jersey’s competitive position.

Third, revenues from the federal government account for a smaller share of total state and local revenues in New Jersey than the national average: 14.3 percent in New Jersey compared with 17.1 percent for the nation, according to U.S. Census Bureau data compiled for 2013 (latest available). Although it is hard to normalize and compare figures for strictly local revenue because states have different governmental structures, the census figures indicate that federal sources accounted for 2.1 percent of total local revenues in New Jersey versus 4.2 percent nationwide. Although they reference revenue rather than spending, these statistics generally dovetail with the accepted wisdom that, as a relatively high-income state, New Jersey gets less “return” on its federal tax dollars than many other states.

Finally, and most important, the last 40 years have seen an increase in local government and school district spending in New Jersey that has far outstripped the state’s capacity to increase offsetting property-tax relief in any form. Although it’s tempting to over-generalize and blame local leaders for a lack of spending discipline, I would argue that the fraught fiscal and legal relationship between the state and local units of government in New Jersey drives a political dynamic that makes it exceedingly difficult to restrain local spending.

Despite the “State Mandate, State Pay” amendment of 1995, the state has placed new mandates and burdens on local units. Meanwhile, the state has resisted efforts to expand localities’ tax base and indeed arguably narrowed it by capping the amount of revenue it returns to localities in replacement of former local public-utility gross receipts and franchise taxes.

Over time, the increase in state aid tended to supplant rather than supplement reliance on local property taxes in urban areas, to the point that local tax levies now support only a small fraction of the cost of public education in many of our urban centers. One consequence is that, everything else being equal, elected leaders in those localities have been less accountable to local property-tax-paying voters for their spending decisions.

Meanwhile, New Jersey’s strong political commitment to its version of home rule has buttressed jurisdictions’ resistance to consolidation and shared services. I would argue further that the tradition of home rule and the continued existence of a large number of bargaining units has in turn increased the relative political influence and negotiating leverage of unions representing local government and school district employees. In many localities, public employee unions are far and away the most powerful — and sometimes the only — organized political force. In the absence of an effective property-tax cap or limits on interest arbitration awards (until 2011), few local elected leaders could resist the tide. It is hardly a coincidence that some parts of New Jersey now have among the highest local public salary and benefit levels in the nation.

How do these various factors knit together? At the risk of gross oversimplification, the sum and substance is this: Given New Jersey’s relatively high state and local spending (the latest census figures) suggest that New Jersey’s state and local unit direct spending is approximately 11 percent higher than the national average), the limited revenue-generating capacity of our income tax base, the relative lack of federal revenue supporting local spending, and the fact that fiscal redistribution will always be a higher legal if not political priority, it is highly unlikely that New Jersey’s state government will ever have the discretionary fiscal capacity to meet the rising cost of education and local government, let alone offset the related heavy reliance on property taxes, on anything other than a temporary and unsustainable basis.

Why does this matter? The systemic overselling of “property tax relief” distorts the public policy debate. We dissipate too much of our political energy arguing over funding levels for local aid and popular direct-benefit programs that have no real impact on property taxes as such, leaving our long-suffering taxpaying public disillusioned and cynical. After decades of hackneyed bipartisan dogma, perhaps it’s time to focus on the only thing that will actually make a real difference to property taxes over time: controlling the cost of education and local government in New Jersey.