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New Jersey Supplemental Report

Tax Environment

New Jersey stands out among the fifty states for its heavy dependence on the property tax in terms of combined local and state tax burden. The only state that depends more on the property tax in terms of local and school funding is New Hampshire, which has no income tax except on dividends and interest and no general sales tax. New Jersey established its sale tax in 1965 and its income tax 11 years later. Currently, New Jersey’s overall tax burden is high. In terms of state taxes alone, it ranks 10th in per capita taxes; for local and state taxes it ranks 4th. When tax burden is calculated as a percentage of personal income, the state tax load looks much lighter — due to the high personal income there (third in the nation in per capita personal income).

In contrast to most other states, New Jersey’s gubernatorial election was held in 2001, not 2002. This made tax reform more feasible in 2002, since it was the administration’s first year in office.

There is currently a good deal of talk about a constitutional convention to consider property tax reform, but the state’s leaders have yet to reach an agreement about whether this will take place.

Recent Tax Developments

• In an initial phase of corporate tax reform in 2001, New Jersey required out of state limited liability companies to pay corporate income tax.

• A tax amnesty program for the state ended June 10, 2002 raising about $277 million. Fines and penalties for tax avoiders were waived.

• On July 1, 2002, Lawmakers approved the $23.4 billion state budget, including a 70-cents per pack cigarette tax increase and a number of fee hikes, they held off on approving proposed corporate tax changes until the next day.

• On July 2, 2002, Governor Jim McGreevey won approval of his business tax plan. The plan imposed an “alternative minimum” tax that is figured on the basis of gross receipts or gross profits. The plan also taxes out-of-state sales that are not already taxed by the other states, tightens up some other business loopholes and creates a Corporate Business Tax Reform Commission (a joint executive and legislative panel) to study the impact of the new taxes.

• Tolls on the New Jersey turnpike escalated by as much as 17 percent New Years Day, 2003 — based on a plan approved nearly three years before.

• On July 1 2003, the $24 billion FY2004 budget was signed into law, with a number of new tax revenues in place. These included a 7 percent state hotel tax, which allows municipalities to tack on another 1 percent tax for themselves, an additional 55-cents per pack cigarette tax (bringing the total to $2.05 cents, the highest in the country, except for New York City), and an assortment of additional taxes on casinos, including a temporary profits tax.

Budget Information

Gov. James McGreevey took office in January 2002, immediately facing a $3.5 billion budget gap, partly due to unrealistic revenue estimates that had been made in an election year. He ordered $1.7 billion in cuts from the $23.3 billion budget; increases in the costs of other programs put final spending for the year around $22.7 billion and a sizeable hunk of the state’s general fund balances were eaten down. A tax amnesty program, which ended in June, brought in an estimated $277 million.

The FY2003 budget was about 3.1 percent higher than FY2002. The state initially faced a $6 billion hole in the FY2003 fiscal year, which ended June 30th. This was addressed through changes to the corporate tax structure, increases in cigarette taxes and fees, as well as program cuts, and a freeze of state aid to schools. One-time budgetary actions were also used to achieve balance — for example, New Jersey was one of the states that sold off part of its future income from the national tobacco settlement to raise money to pay current bills. In other cost saving measures, the state froze payments in its 3-year-old NJ Saver property rebate program to $500, rather than bringing the average payment up to $600 as originally planned. (It has subsequently reduced those checks even further.) It also eliminated the rebates for homeowners with income in excess of $200,000. Revenues came in fairly close to estimates through the first four months of the current year — in contrast to many other states, but fell off at year’s end.

At the end of calendar 2002 and the beginning of 2003, the projected gap in the FY2004 budget was estimated between $3.7 and $5 billion and there was a good deal of talk about cutbacks to state services. Cuts were not nearly as dramatic as initially feared, however — possibly because all legislators will be running for re-election in November. On July 1, 2003, the Governor signed into law a $24 billion budget that included about $600 million in new taxes and fees. The budget was once again supported by a number of one-time revenues

On the spending side, New Jersey faces major increase in pension costs, due to stock market declines.

Adequacy

One of the major tax issues for New Jersey has been its dependence on the income tax in terms of state tax revenues. This has made the state vulnerable to major revenue fluctuations, due to the vagaries of the stock market and wild fluctuations of personal income, particularly for those involved in financial markets. As is common in many states, New Jersey’s reliance on corporate taxes diminished considerably over the last twenty years. With its tax reform actions of 2002, it took a major step in the opposite direction, imposing an alternative minimum tax on corporations and continuing an ongoing effort to close loopholes that allow companies to avoid taxes by shifting money out of state. The state sales tax is narrow and no general local option sales taxes are permitted; Historically, New Jersey has dealt with its revenue fluctuations by utilizing one-time methods of solving budget shortfalls — an unfortunate tradition that has often left budgeters in a state of crisis management.

Fairness

In lobbying for change in the corporate tax structure, the James McGreevey administration argued strongly that the situation as it existed was inequitable. The changes do appear to create a more even playing field for businesses — even if the businesses themselves don’t like it much. The Treasurer’s office argues that aggressively going after companies that do business in the state, but don’t pay taxes there, also makes good sense in terms of fairness. (Opponents to these changes argued that they would be burdensome to business and interfere with the state’s long-term policy objectives of developing new business.)

The sales tax is narrow, with food, clothing, footwear, prescription drugs and utilities all exempt. Revenue department managers believe that the state has granted fewer exemptions to special interests than many other states, though this is difficult to get a handle on since the state does not have a Tax Expenditure report. In terms of services, the state does not tax any professional services, or computer services and extremely few personal services. The tendency in the last six years has been to increase the number of exemptions rather than to cut back on them.

New Jersey has a mildly regressive tax structure. The 20 percent of the population with the lowest income pays 12.4% of its income in taxes, while the 20% of the population with the highest income pays about 9.5%, according to “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States,” 2nd edition. The range in what the rich and poor pay is less extreme than in many other states, but the fact that everyone pays a lot in New Jersey compounds the problem for those with little income. New Jersey Policy Perspectives (NJPP) notes that there are only six states where the poor pay a higher percentage of their income in taxes than they do in New Jersey. A 2002 report released by NJPP also criticized New Jersey’s relatively new earned-income tax credit program for being less generous in its tax credits to the working poor than most states that have such credits. The report noted that the state’s income eligibility level doesn’t keep pace with inflation. (http://www.njpp.org/pr — legup.html) In terms of positive features, New Jersey’s graduated rate income tax makes the state’s tax system less regressive. Exemptions on items that are thought of as necessities (like food and clothing) in the sales tax also tend to decrease regressivity there, while the several income-based rebate programs reduce the regressivity that stems from the state’s heavy reliance on the property tax.

Management

New Jersey is one of the states that stand out for not cutting back on its revenue department during tough budget times. Managers say that this area is regarded as a profit center, not a cost center.

Although there was an early retirement program; department leaders were allowed to replace employees who left, although there tended to be a shift in positions toward enforcement. Knowing that it faces the retirement of more than half of its workforce in the next ten years, the revenue department also has been one of the most proactive government agencies in workforce planning. This is guiding the department toward achieving a varied distribution of ages through its divisions.

The state is well known among tax experts for its compliance efforts. This past year, audit enforcement was beefed up with 50 additional employees. In addition, an agreement with the attorney general’s office in 2002 signals a new era of cooperation in which tax documents will be more readily available to criminal investigators and tax fraud cases will get more attention.

In general, the state has put a lot of effort into compliance over the last half dozen years: targeting industries where there have been problems in the past — like pizza parlors, dentists, bars or restaurants. The state also is aggressive about pursuing non-residents or out-of-state businesses that function in New Jersey without paying taxes. In spring 2002, notices went out to 11,000 out of state lawyers that did some business in New Jersey that they could be required to pay taxes. Tax investigators work with the state police in examining truck cargo manifests and visiting construction sites to ensure that all contractors are registered. The result of these efforts: the state’s nexus unit discovers and registers in excess of 1000 new businesses a year, managers say. Catching a non-filer has a particularly attractive payoff, since the state can often pick up back taxes as well. Other tools used by New Jersey: the printing of delinquent taxpayers names on the Internet, an amnesty program, and a crackdown on residents who buy cigarettes out of state without paying NJ taxes on them.

The state makes good use of data matching — for example, comparing the state’s records to IRS records to pick up those individuals who are filing federal returns but not state returns. An automated system also sends out delinquency notices in priority order. But New Jersey hasn’t yet moved as far as it would like into the more sophisticated technology of data-mining, in which intuitive software is used to look for aberrations or patterns in data that you can’t get out of a flat tape match. The Revenue Department is currently looking at companies to choose one that has a product of this kind that would work for the state.

New Jersey has good customer service initiatives. There are more than 1 million people who use its telephone systems each year to get pre-recorded tax information or check on refunds. There is a bimonthly newsletter and the website is very informative and increasingly interactive with the state providing citizens the ability to look up information on their own accounts — for example, checking on estimated payments for income tax. Taxpayer outreach includes a speaker’s bureau — with division of revenue speakers available to speak at organizations. Small business workshops are given. There are cooperative efforts to do tax returns free for people if they need help.

The response to electronic filing efforts has been somewhat disappointing to managers. At last count, between 20 to 25 percent of individual taxpayers filed electronically. Electronic filing is complicated by the presence of a lot of border employees — people who live in New Jersey but work in another state and are required to send in copies of other state tax returns. These requirements are going to be relaxed and the tax department expects to double the number of electronic filers in the near future. Another obstacle cited: Accountants are resistant because they need to have clients come back into the office to sign a return before its electronically sent out — whereas, otherwise they can send them their returns through the mail. Electronic filing is available for the sales tax but only a small percentage of businesses take advantage of it.

Following fiscal 2002, there was widespread concern about problems in revenue estimating. Income tax revenues in general, and particularly revenues from capital gains, were projected to be far greater than they actually were. The Assembly Task Force on Fiscal Responsibility issued a report in 2002 that recommended using external economic advisors to certify revenue estimates, as well as other suggestions designed to squeeze politics out of the revenue-estimating process. The Treasurer’s office believes that the revenue estimating issues were specific to FY 2002 and the impact of politics, and that they are not a systemic problem.

The state also has been criticized by the Corporation for Enterprise Development for not having a tax expenditure report, though managers maintain that this information is largely available in the state’s budget book.

New Jersey has substantially more oversight function in the administration of local property tax than Pennsylvania or New York. Local assessors report to a county tax administrator; all house sales are reported to the state so it can keep an eye on the deviation between assessed prices and true value. If there is too much of a deviation between assessments in an area (if one person’s house is assessed at 40 percent of its value and another is assessed at 80 percent, for example) then the state can call for a reassessment.

Local Issues

The major local tax issue in New Jersey is property taxes, which continue to be very high relative to other states. Although the state has put in place a number of rebate mechanisms, this has not appeared to alleviate taxpayer frustration. The Star Ledger reported in October 2002 that homeowners experienced an average $310 jump in their property tax bills in 2002. The 7 percent average rise in property tax was the highest in a decade, the newspaper reported.

In FY2002, the state froze local aid to municipalities. This was under consideration for the FY2003 fiscal year as well. The tightness of funding from the state will be very difficult for New Jersey’s many local governments to deal with given some built in spending pressures — notably steep increases in pension costs. This will put pressure on local governments to raise property tax rates even further.

One of the problems for local governments in New Jersey has been a lack of revenue-raising options. Local option sales taxes, for example, are not permitted. The legislature provided some relief in the 2003 session by permitting, for the first time, a 7 percent state tax on hotels, motels, campgrounds, and bed and breakfast establishments, giving municipalities the opportunity to tack on an additional 1 percent tax for themselves. In July 2004, the percentage that goes to the state drops to 5 percent, and locals will be allowed to add on 3 percent.

Noteworthy Programs

• Property tax rebate programs. New Jersey Saver was started as a telefile program, with individuals sent a worksheet and information they would need for applying for the rebate through a toll-free two-minute telephone call. Managers say the program has been exceptionally successful, with 98 percent of applications now filed electronically or by phone. Only taxpayers with unusual situations need to file on paper. The property tax rebate is available to homeowners with incomes of $200,000 or less. Checks averaged $500 in 2002, but effective with the new budget on July 1 2003, the average NJ Saver check has been reduced to $250. (The cost savings — $354 million — were shifted to state aid for education.) The state also has two other property tax rebate programs — the homestead rebate, which citizens apply for through a form that goes in with an income tax. Eligibility is dependent on income, age and disability. Another tool to lower property tax burdens is the Property Tax Reimbursement; it’s an income-based freeze on property taxes for senior citizens or the disabled. The first year of the program, 1998, serves as the base year. Applicants report the tax paid in that year. As long as their circumstances remain the same, the government funds any increase in property taxes from that year. To qualify, you have to be a state resident for ten years and in the house for three years. Funding for this program was kept level for FY2004 at $22 million. To prevent growth, some changes were made. The program will provide checks in FY2004 only to those filers who received checks last year and the checks are capped at last year’s amount.

• Unclaimed property. The state keeps ten years of information online on unclaimed property. This pertains to assets that have been turned over to the state — for example, the content of safety deposit boxes. An individual can type in his name and see if the state is holding any property belonging to him.

• Voluntary disclosure efforts. New Jersey is doing a lot to encourage taxpayers to voluntarily come forward if they discover that they have a tax liability that they haven’t been meeting. For example, the department will accept a list of facts about a taxpayer and negotiate an agreement for the payment of back taxes, without the taxpayer’s name. When the agreement has been reached, the name is then revealed. By coming forward voluntarily, the taxpayer often can get the department to agree not to pursue the debt back as many years — they may pursue it back four years rather than seven, for instance. One of the reasons the voluntary disclosure effort is effective, managers say, is that the state’s nexus unit has a strong reputation for being aggressive if it discovers on its own that a business has been avoiding taxes.

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