September, 2009

Institutions Matter: Can New Jersey Reverse Course?

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New Jersey entered the current recession in a weakened fiscal and economic condition. With the state's economy and revenues closely linked to Wall Street, the collapse of the financial sector and its aftershocks-rising unemployment and falling income-leave New Jersey facing "a historic revenue collapse, and the most significant downturn in its modern history," according to the state's treasurer. The current recession is severe, but this fiscal dilemma is not new. The state has experienced structural deficits regularly over the past 20 years.

Though the magnitude and depth of the current recession is unprecedented, New Jersey's perennial budget shortfalls and the growth in taxation on all levels are the result of years of poor fiscal choices which have gradually weakened the state's once strong economy. New Jersey is ranked 46th in economic freedom, with the highest state and local tax burden in the nation, at close to 12 percent of average income. New Jersey's income tax is highly progressive, with a top bracket of 10.75 percent on income over $1,000,000. The corporate tax is a flat rate of 9 percent-the sixth highest in the nation. The sales tax is exemption-laden, leading the state to raise rates, most recently in 2006, from 6 to 7 percent. In addition, New Jersey levies many smaller taxes on services and activities. Between 2002 and 2007, the state created 102 small taxes and fees, all of which combine to create a narrow base, high-rate system of tax. Property taxes have increased steadily over the past 30 years, averaging $6,787 per capita in 2008. Since 2000, New Jersey has lost technology and information sector jobs and gained low-wage service sector jobs and public sector jobs. New Jersey's population growth has slowed and out-migration has increased.

Increased taxation is meant to support public spending. Growth in New Jersey's budget is driven, in theory, by citizen preference for a certain level of government services and the taxation necessary to support it. However, the government of New Jersey has resorted to fiscal evasion-avoiding the rules meant to constrain spending-and has sustained spending growth through fiscal illusion, obscuring the full costs of policies by relying on intergovernmental aid and debt to achieve the current level of spending. The state has long emphasized current spending at the expense of higher taxes for future taxpayers. The costs of this approach are now coming due.

This paper presents a series of reforms based on the successful experience of other governments. It begins with a background discussion of the challenges New Jersey will face in implementing these reforms by reviewing the state of the state and the loss of the "Old-Time Fiscal Religion," the foundation of public finance until the Keynesian revolution of the 1940s. The paper explains the limits of public policy and government intervention and explores the importance of inter-jurisdictional competition and direct democracy, concluding with recommendations for institutional and policy reforms.

Citation (Chicago Style)

Norcross, Eileen and Frederic Sautet. "Institutions Matter: Can New Jersey Reverse Course?" Special Study. Arlington, VA: Mercatus Center at George Mason University, September, 2009.