This is the 10th and final instalment in a series outlining New Jersey’s fiscal fundamentals. The goal is to demystify some of the state’s financial challenges, and put them in context of the broader issues New Jersey faces. This series is also intended as a way to underscore the importance of state government in a year that will see a new governor and a new Legislature chosen by voters. Follow this link to see the other stories in this series.
In the previous nine Budget Basics, I discussed major fiscal topics, including revenues and expenditures, debt, retirement costs, property taxes, and surplus and deficits. Principally, the series was fact-based. My intent was to inform. I conclude with summary observations about the state’s fiscal future and a specific process that the new governor needs to take to address our problems.
The fiscal future of New Jersey is bleak. It has struggled to balance its budget for the past two decades. In the early 1990s the state’s credit was AAA by all three rating agencies. In subsequent years, the credit rating was reduced — during the past eight years it was reduced seven times. It is now the lowest in the country, except for Illinois. A recent report by George Mason University echoes the conclusion of the rating agencies and ranks New Jersey last in overall fiscal condition. A report by the PEW Foundation draws similar conclusions.
While New Jersey has never technically ended the fiscal year in a deficit — based on a modified accrual basis of accounting (the accepted criteria for all state and local governments), it has done so with gimmicks and underfunding education aid and the pension systems.
Some organizations have argued for large tax increases — as high as $5 billion. The business community has argued for tax cuts, even though taxes in the general fund were reduced in 2016 and will have a negative budgetary impact of $1.3 billion by next year compared to prior years.
I believe the state needs more revenues, but the decision on how to tweak the tax code needs to be carefully decided. Let’s summarize the situation.
In fiscal 1998 the state expended $17 billion — 20 years later we spent $34.7 billion. Fifty percent of that increase is accounted for by simple inflation as calculated by the consumer price index (CPI). Depending on one’s viewpoint, a compound rate of growth of 3.5 percent is not excessive, especially given constitutional requirements for education spending and rising healthcare costs. Others would say it is too much.
Two programs dominated state spending — K-12 education, and Medicaid. These programs are almost 60 percent of spending and are arguably difficult to reduce given the nature of the recipients. Furthermore, it is generally agreed the K-12 schools are underfunded by at least $1.2 billion-plus, based on the current formula. And as far back as the 1980s, Gov. Tom Kean termed Medicaid the “Pac-Man” of the budget, and it still is.
However, the largest albatross is retirement costs (pension and health benefits) for state employees and K-12 teachers (the state pays the school district share for both). The current budget underfunds pensions by more than $2.5 billion and any realistic projection suggests this shortfall will increase. The net liability is $115 billion.
The teachers pension fund will be depleted in the year 2029; the judges fund by 2022; other systems have similar depletion dates. The same problem exists with retirement health benefits that are funded on “a pay-as-you-go-basis” and whose unfunded liability is $69 billion and growing. This total $184 billion unfunded liability is more than five times the state’s bonded debt of $35 billion.
If one considers K-12 shortfalls, the underfunding of retirement costs, and the inevitable increases for Medicaid; transportation; public safety; existing debt payments; and institutional care for prisoners, veterans, people with developmental disabilities and mental health issues, one quickly concludes that future budgetary growth is inevitable. Over the past 11 years the workforce was reduced by 15,000 employees. It is not reasonable to expect more personnel reductions will solve the problem.
Finally, our state has a D+ rating from the American Society of Engineers regarding the condition of its infrastructure, with an estimated investment needed of over $145 billion during the next 10 years.
I conclude it is difficult to arrive at a solution by reducing costs. My realistic bet is to contain growth, but that too will be very challenging and certainly not without negative implications. Those who argue for large-scale reductions are not realistic in assessing state responsibilities — albeit reviews are always warranted.
Tax and revenue issues
Seventy percent of all state revenue comes from the personal income tax and sales tax, another seven percent from the corporate income tax. But growth has been tempered.
Over the past 10 years, the average growth for these three taxes was only 1.4 percent. In the year just ended the overall revenue growth was 1.9 percent. During the recent recession, revenues decreased 11 percent. Revenue growth will be less in subsequent years because of the phase-in of $1.3 billion in tax reductions implemented last year. Moreover, tax credits provided for corporations over the past 10 years reduced revenues by $1 billion — and more is projected. Corporate tax collections are 30 percent less today than 10 years ago.
Further, numerous one-time gimmicks were used as revenue items — which either cannot be repeated or should be discontinued, such as using capital funds at New Jersey Transit for operations, and using telephone taxes intended to upgrade 911 services.
I argue the existing tax structure will not produce sufficient growth to cover projected budgetary needs.
Some revenue options
Some suggest a “millionaires tax” could generate $600 million. This might be an option but hardly enough for all the needs and always a risk as to what the impact might be on the “rich” who are mobile and could leave the state permanently or for enough days to have no tax liability.
Other options: Restore some or all of the tax reductions made last year ($1.3 billion); increase the sales tax rate (a 1 cent increase generates $1.3 billion); eliminate some of the many “tax expenditures” (credits and deductions) in the tax code. For example, if the state taxed food (many states do) $1.5 billion would be generated; a certain percentage could be refunded to people below a specific income to lessen the impact of the regressive nature of taxing food.
Examples of other tax-expenditure options: Eliminate the property tax exemption on income tax filings ($426 million) or eliminate the net operating-loss deduction for corporations ($550 million). There are many exemptions in the tax code adding up to $28 billion in potential revenue. Obviously, each of these credits/deductions benefits some segment of the public and is difficult to change, but must be carefully analyzed as to impact and benefit.
The state should press our congressional delegation to insist that federal law be changed to allow all Internet transactions to be subject to sales tax. This would bring needed revenue and would be fair to neighborhood businesses. But prior attempts by national state-tax associations have not been successful.
Some people want to reduce the property tax and offset the decrease by increasing the income tax or initiating a circuit-breaker concept. In my view, such solutions are not feasible. The state’s revenue problems are such that any increase in taxes cannot be used to reduce the property tax. Further, 43 percent of all state revenue is already sent to local units for property-tax relief.
The property tax is unpopular, but it is dependable and, unlike the income tax, is not volatile. Moreover, remember that local costs are driven by local decision-makers.
The cap on local property taxes and arbitration settlements must be maintained — as these tools have substantially lowered property tax growth — from prior year growth patterns of 6.8 percent to 2.1 percent. My Budget Basics on property taxes discussed a range of policy choices that could be implemented to reduce property taxes, but such options affect a whole range of “sacred” items that are difficult to alter — but the issues need to be discussed.
Some organizations argue that a “growth-tax” policy is needed — translate that to mean tax cuts. One could write a thesis on the pros and cons of tax cuts and if it really spurs growth and increases revenue. I observe that our New Jersey tax base, unlike the federal tax base, is relatively small, and reducing taxes has a limited impact on spurring growth — or for that matter reducing inequality. Furthermore, reports and analyses are mixed as to its value, and states like Kansas that did cut taxes found the reverse effect, and subsequently increased the same taxes when revenues significantly decreased.
On the other edge of the spectrum, others suggest specific taxes be increased to levels exceeding $5 billion. In my view, this also is not possible, as such large tax increases are politically doubtful and certainly not what taxpayers would deem acceptable.
I could continue but you get my drift. The projected ongoing costs of basic state government programs, plus the need to address the extensive underfunding of the retirement systems, school aid, and infrastructure, require more revenues and possibly additional changes to the retirement systems, especially for new employees — and quite possibly constitutional or legislative changes.
I have discussed some options, but eventually a political decision will be necessary — and it will be painful. Further, we cannot realistically argue that “just cutting the budget” will solve the problem or is even a viable option.
The new governor needs to address the “budget problem” as the highest priority. Based on my experience and my tax-policy philosophy I could recommend a series of solutions — and so could a bunch of other folks. But we ultimately need to develop specific tax actions not broad philosophy, and I think a bipartisan and objective blue-ribbon tax policy commission is the best method.
The new governor should in quick fashion appoint leaders from all segments of our community to review spending and most importantly the state’s tax structure. We have not thoroughly examined our tax system for 30 years; it is sorely overdue and needed. Since 73 percent of total state-wide spending is at the local level — especially school districts — spending habits and overall organization of our local governments must be considered. Spending at the local level competes for the same tax dollar that the state relies on to address our statewide problems. The solution can’t just focus on state spending and revenues.
The goal of the commission cannot be revenue-neutral; that is, reduce some taxes and increase others. The state needs more revenue: The question is how much is feasible and from where? Respected commission members can discuss and recommend a viable set of tax proposals that can be acceptable to the Legislature and the governor — and most importantly — properly explained to the public.
The problems have been mounting for over 20 years and will not be solved with short-term gimmicks or tentative partial solutions. We must have serious and thoughtful solutions. Continuing to delay only increases the problem and makes the eventual solution much more painful and difficult.