Living in a state with some of the highest overall tax burdens in the country, New Jerseyans are used to heated arguments over tax policy. We’ve all seen the movie before. On one side, fiscal conservatives argue that lowering taxes is critical to keeping wealth and “job creators” in New Jersey. On the other, fiscal liberals argue that raising taxes on the most affluent is “fair” and necessary to support critical public services and has little, if any, impact on interstate migration and economic investment. Most of us in the middle are either confused or suspect that both sides may have a point.
Unfortunately, the traditional tax policy debate throws off plenty of political heat but sheds little light. One reason is that both extremes misunderstand or misrepresent the role of competition.
It’s all about competition, but not all the competition is about taxes. Like it or not, states compete for jobs and economic development. Each state faces a unique competitive environment made up of many components. Tax policy is important, but it is just one component among many such as location, climate, educational quality, density, regulatory requirements, cultural amenities, recreational resources, and infrastructure.
Yes, taxes matter, but not always in the way people assume. Clearly taxes matter, but how?
Given the ample statistical data that correlates New Jersey’s high taxes and net outmigration of both income and wealth from the state, many assume New Jersey’s “problem” is high taxes in general. Probably true to an extent, but there’s more to it.
Like many New Jerseyans, I have watched with alarm as a steady stream of friends, colleagues, and business firms decamp from New Jersey due, at least in part, to high taxes. Interestingly, although most complained about overall tax burdens, many specifically identified a “tipping point” issue such as crushing local property taxes, high marginal income-tax rates, low thresholds for taxing retirement income, the lack of any exemption for capital gains on the sale of a business, or the fact that New Jersey imposes a complicated mix of two death taxes. This concern for tax impacts at the important margins of firm- and individual-level financial decisions has important implications for how New Jersey should manage tax policies in a competitive environment.
In the competition for business and jobs, don’t oversell the benefits of lowering taxes. Yes, lowering business taxes can stimulate investment and job creation, but policymakers would do well to keep in mind that the reality of competition limits the long-term impact.
For example, despite the sturm und drang, many businesses’ state-tax burdens are relatively small compared with their federal tax obligations and other costs, so the comparative advantage that a state like New Jersey might derive from reducing taxes or even eliminating any specific tax is likewise relatively small.
Moreover, comparative tax advantages tend to be temporary. New Jersey is located in a highly competitive region, and our neighboring jurisdictions such as New York state and New York City have repeatedly demonstrated their willingness to counter New Jersey’s business-oriented tax and development incentives. The plain fact is, with an economy and budget more than twice the size, New York State will always be in a position to out-bid New Jersey.
Know your competition. Hint: it’s not Manhattan. There is a tendency in New Jersey policy circles to think of New York City, specifically Manhattan, as our main competitor. This focus is somewhat misplaced. In reality, outside of Newark and Hudson County’s “Gold Coast,” our northern counties’ most direct competition is from New York’s Orange, Rockland, Westchester, and Nassau, with whom they share many demographic and economic characteristics. New Jersey’s policymakers should therefore be careful to evaluate tax-policy proposals in terms of their relative impact on a target audience in substantially similar circumstances — for example, suburban office parks or commuting homeowners — rather than solely the apples-versus-oranges comparison between Manhattan and northern New Jersey.
Tax migration is not necessarily about moving. One of the most incendiary arguments in state tax policy today is over whether or not high income taxes actually encourage taxpayers to move from a high-tax jurisdiction such as New Jersey to a low-tax jurisdiction such as Florida. The answer, supported by research, is a resounding “yes, but.” Yes, we can document a small but consequential increase in “net outmigration” due to high marginal rates. The “but” is that the public dialogue typically assumes that “outmigration” means “moving,” whereas the reality is much more nuanced. Although it’s true that some fed-up wealthy taxpayers move or accelerate existing retirement relocation plans to escape New Jersey’s taxes, particularly when contemplating the sale of a closely held business, many others accomplish much the same goal by following their tax professional’s advice to establish tax residency outside New Jersey through relatively small lifestyle adjustments.
The simple fact is that a wealthy taxpayer with more than one residence who travels a bit can easily establish tax residency outside New Jersey while continuing to live in and enjoy property in New Jersey for almost half of every year. In other words, you can avoid a 9 percent tax on your income but still entertain family and friends at your beach house down the Shore for the entire summer season. Not a difficult decision. Not coincidentally, nonresidents are making up a larger fraction of total New Jersey tax returns filed by wealthy households. Since 1996, the percentage of total New Jersey returns reporting over $500,000 in income filed by nonresidents has increased from 5.9 percent to 7.9 percent. This is hugely consequential given the concentration of our income tax base at the high end (for instance, in 2012, the top 10 percent paid over 72 percent of all state income tax) and the fact that former residents filing as nonresidents typically slash their tax payments to New Jersey.
New Jersey doesn’t have to win on taxes; it just has to avoiding losing. For a host of physical, historic, and political reasons, New Jersey will never be the lowest-taxed state in the region let alone in the nation. And given the competitive environment we’re in, we’d be fools to try.
Yet we should do everything we can to avoid to compounding our losses. We must avoid policies that position New Jersey as a notorious and negative “outlier” in the region and among its economic peers.
Avoiding outlier status means rejecting proposals to boost our top marginal income tax rate far beyond New York State’s level (we are already higher) and filing down obnoxious policy splinters like an inheritance tax that applies to transfers as small as $500. It also means that when we raise taxes — as we almost certainly will — we should do it in ways that don’t aggravate our existing competitive disadvantages. That’s why, for example, it may make sense to combine a possible increase in motor-fuels taxes (which are relatively low) with phased-in reform of our death taxes (which are relatively high), even if the result is a net increase in revenue.
The bottom line is this: New Jersey’s best bet lies in maintaining a thoroughly unremarkable state tax-policy profile that frees our businesses and job creators to compete on other factors in which New Jersey may actually enjoy a significant and unassailable competitive advantage.