Opinion: Trenton’s Circular Firing Squad

Andrew Sidamon-Eristoff | March 12, 2018 | Opinion
Democratic leaders compete to harm New Jersey's tax competitiveness

Andrew Sidamon-Eristoff
After years of championing New Jersey’s generous corporate tax incentives for job creation and economic development, and just one week before Gov. Phil Murphy delivers a budget address that will undoubtedly include a new millionaires tax, Senate President Stephen M. Sweeney has proposed a dramatic increase in New Jersey’s corporate income tax to support increased education-related spending.

Sweeney claims that hiking the corporate tax rate from 9 percent to 12 percent on earnings above $1 million would raise $657 million, which just happens to match roughly the amount that Murphy expects to raise by imposing a tax of 10.75 percent on incomes above $1 million. Notwithstanding this apparent coincidence, Sweeney says his proposal is not an “alternative” to Murphy’s millionaires tax, which he has nonetheless criticized as a “last resort” in the wake of the recent federal tax changes that will hit many wealthy New Jerseyans. Meanwhile, the governor has portentously welcomed the corporate tax-surcharge idea “as an additional weapon at our disposal,” presumably to help fund his expansive campaign spending commitments.

Whether Sweeney intends his proposal as an alternative to Murphy’s millionaires tax or not, it’s clear that New Jersey’s beleaguered taxpayers can look forward to months of ill-informed debate over which tax to raise. Let me go out on a limb: We’re highly likely to wind up with a version of both tax hikes, because both Democratic leaders desperately need revenue to satisfy their somewhat distinct core constituencies’ swelling demands for spending. Sadly, when the two leaders set aside their rhetorical jousting and jointly declare “victory” in reaching a compromise sometime in late June, the loser will be New Jersey’s long-term competitiveness.

At first glance, a corporate-tax surcharge seems qualitatively different from a millionaires tax. As Sweeney has pointed out, the former would impact inanimate legal entities that are benefitting from recent federal corporate-tax reductions, while the latter would target individuals who are already facing the loss of federal deductions for New Jersey’s high state and local taxes. True enough, but as tax hikes, the two proposals nonetheless share a defining negative characteristic: In the special context of state tax policy, they are both notably more anticompetitive than many of the available alternatives.

Moving the macro-economic needle

State tax policy is about competition, not macro-economics. With utmost respect, politicians’ assertions that state-level tax cuts can directly stimulate investment and job growth are mostly nonsense; the amounts involved are generally too small to move the macro-economic needle. Nonetheless, state and local taxes are clearly an important if not exclusive factor in the competition between states for investment and economic growth, particularly within regions.

What role do taxes play in this competition? Contrary to standard belief, I would argue that within the context of our relatively high-tax/high-service region – Connecticut, Delaware, Pennsylvania, New Jersey, New York, and Maryland – taxes are much more consequential as a negative than as a positive factor. In other words, avoiding exceptionally high taxes is much more important (and sustainable) than protecting exceptionally low taxes. The goal of New Jersey’s tax policy should be to achieve a balance that raises sufficient revenue to support our desired high service levels while assiduously avoiding negative outlier status within our region. At a minimum, we should avoid raising taxes where New Jersey is already a negative outlier.

As it happens, New Jersey is a negative outlier with respect to both the gross income tax and the corporation tax. Our income tax is the most progressive, and our top marginal rate of 8.97 percent is the highest, among the states in our region. At 9 percent, our top corporate rate is substantially higher than New York’s 7.1 percent and second highest to Pennsylvania’s 9.99 percent within the region.

Competitive implications

The competitive implications of a millionaires tax should be obvious. Apart from drastically increasing the allure of moving one’s tax residency (and tax dollars) to a state with no or limited income taxes, hiking the top rate to 10.75 percent will inevitably lead at least some high-income job holders in New York City to choose Fairfield County (6.7 percent) or Westchester (8.82 percent) over northern New Jersey when it comes time to move out of the city to accommodate a growing family. Similarly, it would be an act of irrational civic devotion and self-sacrifice for an executive assuming a new high-paying job in New Brunswick or South Jersey to choose Princeton or Haddonfield Borough rather than somewhere equally nice in nearby eastern Pennsylvania (a flat 3.07 percent plus 0.5 percent to 1.0 percent on “earned income” in some towns). In these and many other cases, the long-term impact on property values and hence property taxes will not be a happy one for New Jersey residents.

Imposing a 33.33 percent surcharge on corporate earnings above $1 million would also make New Jersey less competitive. At the headline level, of course, joining Iowa as one of only two states that impose a 12 percent marginal rate will place New Jersey near the top of any site-selection consultant’s pro forma “naughty, not nice” list. New Jersey won’t even make it to the conversation stage. Sorry Newark: say “good-bye” to Amazon. Sweeney’s observation that corporations are receiving a big federal tax break is accurate but totally irrelevant since we are concerned with New Jersey’s relative competitiveness.

We should also consider the asymmetric impact of a surcharge on our existing businesses. Once a fair proxy for business taxation in New Jersey, the corporation business tax is now an increasingly volatile and fragile instrument for raising a relatively small portion of overall state revenue (at a budgeted $2.6 billion, just over 7 percent in fiscal 2018). Consolidations in key industries, escalating corporate tax incentives, and the rise of passthrough entities such as LLCs as the preferred choice for new business formations have steadily eroded the traditional “C” corporation base. That means, in turn, that the burden of our corporate income tax is increasingly borne by a dwindling number of legacy companies that lack the sophistication to access tax incentives or, for regulatory or other reasons, are unable to leave New Jersey or reorganize as a passthrough. Would imposing a massive surcharge on a small number of unlucky New Jersey corporate taxpayers really be fair? What message would this treatment of our existing corporate taxpayers send to those who are organizing new businesses or contemplating an expansion into the Northeast?

If both the millionaires tax and corporate-tax surcharge are particularly bad ideas from the standpoint of protecting New Jersey’s competitive position, are there “better” alternatives? Setting aside the question as to whether we really need more revenue – I am not convinced – the answer is “yes,” there are indeed several ways that New Jersey could raise more revenue without accentuating its negative outlier status within the region. Specifically:

Sales Tax: The 2016 reduction in New Jersey’s sales from 7.0 percent to 6.625 percent costs the state an estimated $575 million or more a year without, in my opinion, delivering any substantial benefit to our competitive position. Comparable rates were already higher in Philadelphia and New York State which, unlike New Jersey, taxes clothing sales of $110 or more. Reversing this tax cut would have minimal negative impact.

UEZs: Here’s one of Trenton’s worst-kept secrets: Since its creation as a “temporary” initiative back in 1983, the expensive Urban Enterprise Zone program has generated far more political currency than lasting economic growth in our state’s struggling urban communities. A progressive new Democratic administration just might have the political courage and flexibility to put this well-intentioned but failed experiment out of its misery, saving taxpayers approximately $380 million a year in tax expenditures. Just repealing the reduced sales tax rate within UEZs, which simply pushes existing retail activity across municipal boundaries, would raise almost $150 million a year.

Death Taxes: In 2016, New Jersey’s Legislature voted to eliminate the estate tax, thereby taking New Jersey from having the most to the least burdensome death-tax regime in the region. Despite the bipartisan self-congratulation, however, the inconvenient truth is that New Jersey didn’t need to eliminate its estate tax to be competitive. It would have been more than sufficient, and much less expensive, to repeal the unusual transfer-inheritance tax and join New York in matching the federal estate-tax exemption amount. Once again, New Jersey could revisit this change with minimal impact.

Income Tax Rate Recapture: One important difference between New Jersey’s and New York State’s income tax is that the latter includes a controversial and little-understood “rate recapture” provision that denies taxpayers the benefit of lower marginal rates as they move up in income. In other words, New York taxpayers are obliged to pay the highest marginal rate applicable to their income on all their taxable income, not just the portion above a given tax bracket level. Although tax policy purists would absolutely hate the idea, adopting a similar rate-recapture provision in New Jersey would raise substantial revenue from relatively affluent taxpayers without the need to increase our top marginal rate. Sneaky, yes, but an effective way to avoid damaging “New Jersey = Tax Hell” headlines.

Gas Tax: After much public lamentation, New Jersey in 2016 finally raised its gas tax from the second-lowest in the country to a level that, while 8th highest in the nation, is still lower than Connecticut, Pennsylvania, and New York. We’ve still got some competitive room for a modest additional increase. Not everyone’s ideal, granted, but still an option.