Every four years, like a scene from “Groundhog Day,” candidates for New Jersey governor serve up a warmed-over menu of policy platitudes. My favorites concern taxes. No issue that touches so many people invites more political obfuscation, misrepresentation, and outright nonsense.
Here are a few observations to help you make sense of it all:
Everyone is a tax expert. Over the course of my 25 years in public life, I have never met anyone in or out of government who is not a tax policy expert. After all, everyone pays taxes. This wealth of expertise helps explain why it is almost impossible to have a rational conversation about tax policy.
We’re talking about state tax policy. On taxes, most state candidates make arguments that are more appropriate to a discussion of national tax policy than state tax policy. Right-wing candidates argue that cutting state taxes will spur growth, while left-wing candidates believe that we should use the state tax system to reduce income and wealth inequality. Sorry, but both sides are guilty of overselling. It’s a question of scale or lack thereof. As a practical matter, the relatively small size of the state budget and revenue base compared to their federal counterparts means that cutting or raising state taxes has a relatively limited impact in spurring growth or reducing inequality, respectively.
It’s all relative. Whether we like it or not. New Jersey competes for investment and jobs with its regional neighbors. Yes, other factors like education and infrastructure are important, but state tax policies play a critical role in both the perception and reality of regional competitiveness. In this context, it is more important to focus on relative rather than absolute tax burdens.
Tax policy is a lousy offensive weapon. Do tax cuts and tax incentives “work”? Maybe, but only some of the time and, even then, for a limited time. New Jersey’s various efforts to gain a competitive advantage through tax cuts and tax incentives hardly qualify as an unmitigated long-term success. Apart from unresolvable questions about what would have happened in the absence of a tax cut or particular incentive, history suggests that employers are skilled in playing jurisdictions off against each other and that our competitors, particularly New York City and New York State, have the will and capacity to counter New Jersey’s every move. The resulting “race to the bottom” starves the state of needed revenue and leaves an uneven and unfair distribution of tax burdens, even within industries, as some firms qualify for incentives and others don’t.
The bottom line: tax incentives are a necessary evil. New Jersey can’t afford to disarm unilaterally, but we should abandon the bipartisan fantasy that we can use incentives to secure a sustained advantage. As someone who has worked in both New York State and New York City government, I can assure you that New Jersey, with its relatively small tax base and budget, not to mention crushing legacy pension obligations, will never be able outbid its competitors across the Hudson.
Avoid Self-Inflected Injury
First, do no harm. If cutting taxes and deep incentives aren’t the Yellow Brick Road to lasting prosperity, what kind of tax policy should New Jersey pursue? My answer is simple: first, do no harm. The focus of New Jersey’s tax policy should be to avoid being notably uncompetitive, particularly within our region. That means keeping New Jersey firmly within the regional mainstream and avoiding negative outlier status. For instance, it made sense to raise the gas tax to fund the Transportation Trust Fund because we still compare favorably to our neighbors. Similarly, raising the estate tax exemption from a totally uncompetitive $675,000 to match some of our competitor states was important, but eliminating it completely wasn’t necessary to shed our negative outlier status within the region, and I fear that the competitive advantage gained will prove temporary as a function of other states’ countermoves or backsliding in the face of ongoing fiscal pressures. Finally, since New Jersey already has the highest marginal income tax rate in the region, imposing a new millionaires’ tax may be great politics — who cares about a tax that someone else pays? — but it will also increase the volatility of our revenue base and push wealthy New Jerseyans into the arms of tax advisors.
Millionaires and moving. Will imposing a new top income-tax rate result in a flood of millionaires picking up and moving to Florida or some other tax-friendly state? Probably not. Will it push taxable income and thus revenue out of New Jersey? Probably yes.
If you’re confused, it’s undoubtedly because the usual debate over a millionaires’ tax ignores the underlying mechanics of residency and state income taxation.
Under general state-income tax laws, state residents pay state income tax on all their income from whatever source while nonresidents pay tax only on the income they derive from the taxing state. To eliminate double-taxation, resident taxpayers receive a credit against their resident income tax for the taxes they pay as a nonresident to another state.
So far so good, until you consider the circumstances of wealthier taxpayers who may have more than one residence and who derive income from many jurisdictions. In these circumstances, state statutes typically impose resident taxpayer requirements on anyone who maintains a “permanent place of abode” in a state and spends all or part of 183 days a year there.
This “statutory residency” concept is central to state tax planning and has important but largely under-appreciated practical consequences. For instance, a wealthy New Jersey resident taxpayer with a house in Florida doesn’t have to sell out and physically move to Florida to be treated as a tax resident of Florida. She or he only need establish domicile in Florida (no minimum stay required) and be very careful to stay out of New Jersey for 183 days during the year. She or he might even consider buying a pied-à-terre apartment in Manhattan. None of this would constitute a hardship or a major change in lifestyle for someone who already has a house in Florida, routinely spends a few nights a month in Manhattan, and likes to travel. She or he can still enjoy the warm weather months and major holidays at her or his beach house down the Shore with the grandkids without becoming a New Jersey resident taxpayer. She or he may still pay some nonresident tax to New Jersey, but it will be minimal because, as a wealthy individual, the likelihood is that most of her or his income is from investments not subject to nonresident income tax. Tax advisors would be committing malpractice not to point these facts out, especially if their client is planning the sale of a business or another transaction likely to generate large capital gains.
What does all this have to do with the millionaire’s tax debate? We need to recalibrate how we model and measure the impact of high rates on our state’s competitive position. Although analysis of historic data backs up the general assertion that comparatively high marginal income-tax rates contribute to net outmigration of wealthy taxpayers over time, high rates may be a more significant factor in the steady increase in the proportion of wealthy New Jersey taxpayers who are filing as nonresidents. Between 2012 and 2015, for example, the proportion of New Jersey taxpayers reporting more than $500,000 in gross income who filed as nonresidents increased from 38.2 percent to 41.0 percent. This apparently small change is ominous when one considers New Jersey’s heavy reliance on high-income taxpayers with large amounts of investment income, and the fact that former resident taxpayers typically pay a fraction of what they used to pay to New Jersey.
New Jersey’s low-yield income tax. Thanks largely to the fact that thousands of New Jerseyans commute to high-paying jobs in New York City, New Jersey grants about $3.5 billion a year in credits for taxes that our residents pay to other jurisdictions. After offsetting credits for taxpayers who commute to New Jersey, approximately $2.2 billion a year flows out of New Jersey to other states, mostly New York. This is a huge amount compared to the $13.9 billion that the income tax is expected to raise in fiscal 2017. In addition to serving as a bizarre backdoor subsidy to New York, the credit mechanism means that, for any given marginal tax rate, New Jersey’s income tax yields less net revenue in relation to taxable income than that of other states.
State property-tax relief doesn’t work. It is an article of faith among New Jersey politicians that more state-level property-tax relief, funded mainly with income tax receipts, will somehow reduce local property-tax burdens. Sorry, but history suggests otherwise. The state adopted the income tax in 1976 specifically to provide property-tax relief. Four decades later, notwithstanding an income tax that has grown from about 13 percent to over 40 percent of state revenue, New Jersey retains a firm grip on the No. 1 spot in residential property tax burdens.
Why? I would suggest three major factors. First, New Jersey state and local government spending is about 11 percent higher than the national average, while federal assistance to our local governments is about half the average. Second, the New Jersey Supreme Court has diverted the bulk of income tax-funded state school aid toward low-income districts instead of broad-based property-tax relief. Third, and most significantly, the regional competitive dynamic combined with our comparatively low income-tax yield limits the state’s practical and political ability to increase income tax rates to provide meaningful property-tax relief. Imagine what we could do if we didn’t have to send $2.2 billion a year to New York!
There are no loopholes, just policy choices. Politicians often advocate closing tax loopholes as a painless way to raise boatloads of money. Beware false advertising. For starters, what exactly is a “loophole”? Is it an unintended or inadvertent flaw in the tax law that allows some taxpayers to pay less than they should? Or is it a tax break that the Legislature deliberately created or has declined to change in the face of changing economic circumstances? If the former, how do we determine the amount that “should” be paid? If the latter, do we know why the Legislature acted or failed to act? The tax law may have plenty of flaws but few, if any, are truly unintended and inadvertent. Characterizing a feature of the tax law as a “loophole” is an easy way to obscure political accountability and ignores the fact the entire tax law reflects policy choices.
Taking people off the tax rolls is a mistake. Politicians love to take credit for raising income thresholds for the requirement to file a tax return. Although this may sound like a good idea, it’s not. First, this rhetoric confuses the fact that low-income people need to file a return to qualify for valuable tax credits such as the Earned Income Tax Credit. Second, exempting people from the task of filing a return undermines the culture of voluntary compliance that is the cornerstone of our tax system. This is no small matter. A series of federal government surveys have documented a two percent increase in the “tax gap” (noncompliance) since 2001.
Tax dedications: a metric of democratic failure. In recent decades, it’s rare to see a major tax increase proposal that doesn’t feature some sort of voter-approved dedication to a favored cause such as education or transportation. Politicians know that voters distrust them to spend their money wisely, so they sweeten the pot with a dollop of direct democracy. Trouble is, dedications decrease fiscal flexibility and make our elected representatives less accountable for setting and managing priorities with limited resources. Over time, we’ll wind up with more dedications and less accountability, a recipe for continuing democratic frustration and alienation.