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Industry Insights

It's the taxes, silly: How high taxes in New Jersey hurt the middle-class and small businesses the most

By ,
Khurram Dara
Khurram Dara

We still have five months to go in 2017 and New Jersey has already topped several lists this year we all wish it hadn't. With long-term liabilities mushrooming to 360 percent of total assets, New Jersey was ranked the state with the worst fiscal health in the country for the third consecutive year by the Mercatus Center at George Mason University.

For the fifth consecutive year, New Jersey saw more residents leave than any other state, with 63 percent more departures than arrivals.

According to recent McKinsey study, New Jersey has been among the worst states for economic growth, with GDP increasing an average of just 0.3 percent between 2005 and 2015 – nearly five times lower than national GDP growth over the same period.

There’s not one single explanation for all of these trends, but there is one particular list New Jersey sits atop that comes pretty close to providing an answer: our state has the worst business tax climate in the nation, according to the independent nonprofit Tax Foundation, an unfortunate distinction the state has had for the last three years.

High taxes make New Jersey less attractive to businesses and residents. Skeptics often claim this is an exaggeration and that few actually move just because of taxes. But even if we put aside departures like the high profile move made by fund manager David Tepper to Florida a few years ago, those opposed to lowering tax rates have to reckon with the fact that most people are leaving for new job opportunities. Why aren't these opportunities in our state? Perhaps it has something to do with the uninviting business environment created by unnecessarily high taxes.

The common refrain from opponents of tax cuts, especially cuts for businesses, is that they only benefit big corporations and the wealthy. But in many cases high taxes hurt the middle-class and small businesses more than the rich and powerful. Here are a few examples:

  • Property Taxes: New Jersey has the highest property tax burden in the country, with an effective rate (as a percent of income) of 5.41%. The high property tax burden makes the state less attractive to potential residents and new businesses. It also affects everyone, not just property owners, as the increased costs are passed through in the form of higher rents for property and higher prices for goods and services. So not only do we “price out” many in the middle-class from moving here, we make it harder for small and family businesses to compete with larger corporations and national or regional “chains” that can more easily bear the cost of higher taxes because of their scale. As a result, bigger businesses face less competition and increased market concentration, which can mean higher prices for consumers. Higher prices and higher rents hurt the middle-class and poor more than the wealthy because they eat up a bigger share of their incomes.
  • Individual Income Taxes: New Jersey has some of the highest individual income tax rates in the country. And despite the name, individual income taxes don’t just affect individuals, they affect small businesses too. That’s because most businesses in the US are actually subject to individual tax rates not the corporate tax rate; nearly 95% of businesses in America are “pass-through” entities, meaning their income passes through to their owners and is then taxed at the individual level. In this category you’ll find sole proprietorships, partnerships and LLCs – exactly the kinds of small and family-owned businesses you’d expect to find on Main Street. To make matters worse, New Jersey’s top tax bracket threshold is $500,000, which is among the highest in the nation. This means that once your income rises above $500,000, your tax rate jumps by 2.6% (the largest increase between any of the state’s tax brackets). So if you’re a small business owner with a pass-through entity, you’re subject to a reduced return on investment as your net income increases, which serves as a disincentive to grow. Because big corporations typically have net incomes far above this threshold, they avoid this problem. To add insult to injury, instead of simply using the IRS definition of “taxable income” (like nearly every state does), New Jersey has its own, separate definition which further increases compliance costs. Increased compliance costs generally hurt smaller businesses more than larger firms.
  • Inheritance and Estate Taxes: New Jersey is one of just two states that has both an inheritance tax and an estate tax (Maryland is the other). So the state will levy a tax on the estate first and then again on the heir who inherits it. While some may associate inheritance and estate taxes with the wealthy, in practice these taxes are most harmful to small, family-owned businesses where the owner passes away and leaves the business to his or her children. These businesses are not just gateways to the middle-class for many families, they can also serve as a nest egg of sorts, one they hope to pass down to their children. The double burden of inheritance and estate taxes can force heirs to family businesses to have to downsize or even sell off assets just to cover the tax bill.
  • Corporation Business Taxes: New Jersey’s corporate tax, known as the Corporation Business Tax (CBT), is among the highest in the country, with a top rate of 9%. Not only are we less competitive than our neighbors in New York, who have a corporate tax rate of 7.1%, we also lose out on some of the additional revenue because of the myriad of special deductions and credits the legislature has historically doled out to certain types of companies. All of this favors larger corporations, which have the resources to lobby in Trenton and more robust accounting departments (or access to pricey external accountants) to help massage their net income with creative accounting maneuvers so they can reduce their CBT burden.
  • Special Favors for Special Friends: According to the McKinsey study, over 80% of government incentives in New Jersey went to older domestic companies, despite the fact that younger and foreign companies invest more capital and create more jobs on average. The consequences of this are evident: New Jersey pays in incentives about 5x more for each job affected and 6x more per dollar of investment compared to peer states, according to the report. The average state spends roughly 40 cents in incentives for every dollar of corporate investment it brings in. From 2010 to 2016, New Jersey paid $1.80 in incentives for every dollar of corporate investment it induced.

New Jersey is a highly educated state with a prime location. It has a hardworking population that pays a lot in taxes. And still, the state has accumulated an offensive level of debt with little growth to show for its spending on incentives. Simply shifting dollars around through taxes and transfer payments won’t get us out of this hole, only economic growth that increases our tax base will. For the sake of New Jersey’s middle-class and small businesses, we need to reduce the tax burden now more than ever.

Khurram Dara, an attorney and author, is president of the Summit Taxpayers Association in Summit.

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