New Jersey's Suicidal Tax Policies

Alan Reynolds
After campaigning on a promise of no new taxes, Governor Jim
Florio doubled New Jersey income tax rates in June 1990 C from
3.5% to 7% on families earning more than $75,000 and from 2.5% to
5% above $50,000, effective in 1991. These increases were even
more onerous than those proposed in the deeply flawed 1988 report
of the State and Local Expenditure and Revenue Policy Commission
(SLERPC), which advocated a 4% rate at $50,000 and a 4.5% rate
for the 6.1% of taxpayers then earning more than $100,000.i
About one-third of New Jersey taxpayers, including more than half
of all two-earner or middle-aged families, suddenly found
themselves facing tax rates that were twice as high as before on
any increases in their gross income. That meant the income of
most secondary workers was subject to new taxes, as was income
from promotions, second jobs, overtime work or investments. By
thus penalizing added income, the state has effectively
discouraged and repelled the increased effort and investment
required to increase income C that is, New Jersey legislators
have quite successfully punished the source of economic growth,
with predictably disastrous results.
Sales taxes were also increased from 6% to 7% on July 1990,
and the base was considerably broadened to include
telecommunications services, janitorial services, alcoholic
beverages, cigarettes, household soaps and detergents.
Disposable paper products and heavy trucks were briefly included,
but later exempted again. An odd element of New Jersey's sales
tax is that clothing has always been exempted, requiring a higher
tax rate on big ticket items. This is to placate New Jersey
retailers, since the exemption lures shoppers from New York City.
The resulting fury of taxpayers was promptly reflected in
sizable Republican majorities in both state legislative bodies.
The sales tax rate (which was 5% until 1983) was thus rolled back
to 6% over Governor Florio's veto in July 1992. But the higher
income tax rates, which are even more damaging to the state's
economy, have been left in place.
The controversy over New Jersey tax policy has attracted
considerable attention. Even the London Economist took notice,
dubbing New Jersey's new taxes "the self-inflicted knockout" on
March 2, 1992, and noting, on June 21, 1991, that "Jim Florio of
New Jersey is probably the country's most reviled governor, after
pushing through $2.8 billion in taxes." The higher and broader
sales and excise taxes were supposed to bring in an extra $1.5
billion, while doubling the upper income tax brackets was
supposed to bring in $1.3 billion. Yet the problem is not that
these new taxes raised anything remotely approaching $2.8

billion. They most certainly did not. Individual income tax

receipts rose only $320 million in 1991 C a billion dollars short
of the original static revenue estimate (which assumed higher tax
rates would have no bad effects on anything). Sales tax receipts
rose $455 million in 1991, also a billion short. As a March 17,
1992 memo from the state's Office of Legislative Services put it,
in a massive understatement, "income tax revenues in FY 1991 were
well below estimates," and "sales tax revenues have been in
almost continual decline" since the first half of 1990. Indeed,
we will later question whether the higher tax rates C
particularly the doubling of income tax rates C raised even as
much money as the previous tax code would have, given the severe
damage they unquestionably inflicted on the state economy. The
distinction between tax rates and revenues is crucial, because it
is the totally erroneous belief that higher income tax rates have
yielded or will ever yield substantial revenue that prevents the
state legislature from responding to the public's quite
legitimate plea for repeal. Because the higher income tax rates
shrunk the growth of taxable payrolls, profits, property and
sales (and thus require higher welfare-related spending) they
have been and will continue to be self-defeating.
The source of discontent among New Jersey taxpayers is not
that high tax rates were successful, in the narrow sense of
raising $2.8 billion in added revenue without "killing the
goose." Instead, the anger of state taxpayers reflects their
intuitive understanding that punitive tax rates have contributed
to the state's disprortionately huge loss of both workers and
jobs, with private employment falling by more than 9% in the two
years after the tax increase was passed. The effect of the
destructive tax increases has been all pain and no gain.
New Jersey's new tax rate of 7% on individual incomes above
$75,000 (and 5% on incomes above $50,000) is much worse than it
looks. There are 15 states that may appear to have even higher
tax rates, but all of those states, unlike New Jersey, allow many
large deductions. New Jersey's unique tax on gross income, by
contrast, is inherently unfair. Many costs of earning income
(such as interest paid on stock margin accounts) are counted as
taxable income even though they are actually expenses. Those
living outside of New Jersey can grasp the impact by looking at
the usually substantial difference between their own "taxable
income" and gross income on federal tax returns.
Since the income thresholds at which the 5-7% tax rates
apply are defined in terms of gross income, they affect a
majority of two-earner families in New Jersey. Nationwide, the
median income of two-earner families was $46,777 in 1990 C
meaning half earned more than that. Since income typically peaks
at ages 45-54 (median income of $47,165 in 1990), mature
families, often with children in college, were also the main

targets of the tax increase.ii Because both living costs and

nominal incomes in New Jersey are significantly higher than the
national average, more than half of all two-earner or mature
families surely face demoralizing extra taxes of 5-7% on incomes
of secondary workers, as well as on added income from promotions,
second jobs and investments. And since the thresholds are not
indexed for inflation, they will affect a larger proportion of
families over time, as incomes rise with inflation.
At the previous maximum tax rate of 3.5%, disallowing
legitimate deductions was not too serious a problem. But a 5%
tax on all income above the median for two-earner or mature
families, and a 7% tax on gross income above $75,000, is quite
probably the highest in the nation for many taxpayers.
By also eliminating the deductibility of notoriously high
property taxes, the state's new tax scheme compounds the inequity
though an additional layer of double-taxation (since federal
income tax is not deductible, unlike some states, New Jersey
taxpayers also pay state tax on their federal income and Social
Security taxes). The removal of deductibility of property taxes
means New Jersey homeowners are now expected to pay income taxes
on what their income would have been if they hadn't already paid
thousands of dollars in property taxes. This reduced the
attractiveness of homeownership, and contributed, along with the
exodus of overtaxed suburbanites, to a deep decline in New Jersey
real estate values, thus shrinking the property tax base. With
the moving vans heading out, construction ground to a stop.
Building permits for multifamily housing dropped from 637 in
January 1990 to 12 in January 1991. Total housing permits
dropped from 2,235 to 872 in the same period.
State taxes are not at all like federal taxes -- they are
much easier to avoid by moving out of the state or, even more
important, by not moving in. The main issue is not whether high
tax rates will discourage big businesses from locating in New
Jersey, but whether they will discourage high-income families
from living in New Jersey. At the level of corporate taxes, New
Jersey is still competitive with the combined state and city
taxes of Manhattan, though not with many states.iii
However, as
the SLERPC report put it, "personal taxes may indirectly
influence firm location by affecting household location and
therefore labor availability."iv The most promising businesses
in today's high-tech information economy are critically dependent
on an adequate supply of well-trained experts and well-paid
entrepreneurs. If such people would rather live in places with
little or no income tax, such as Las Vegas, Orlando or Austin,
then businesses will move to wherever skilled people choose to
live, not the other way around. Businesses in states with little
or no personal income tax, for example, now find it much easier
to recruit skilled professionals and managers out of New Jersey.

Even if jobs in, say, Nevada merely offered the same salaries as
New Jersey, that would mean a 7% increase in after-tax pay, not
even counting lower property and sales taxes in many other
states.
In a June 11, 1991 editorial entitled "Fleeing Tax
Fairness," The Wall Street Journal cited figures from the Cato
Institute to show that the ten states with highest tax rates on
high incomes had experienced a relative decline in population of
2.4 percentage points in the 1980s, compared with the national
average, while the ten states least inclined toward "soak the
rich" policies had population growth 9 percentage points higher
than average. Graph 1 shows that New Jersey population growth
was already 5 percentage points below the national average in the
Eighties, even though state tax rates were then low enough to
attract a lot of people and many business away from New York City
(where population grew only 2.5% from 1980 to 1990, compared with
4.9% in New Jersey and 9.8% for the nation).
As Graph 1 shows, New Jersey's population virtually stopped
growing since 1990 C the year the tax hikes were announced. The
state's population growth from 1989-91 has remained far below
that of the nation. Since the people of New Jersey have not
suddenly started dying faster than elsewhere in the U.S., or
having fewer babies, the relative drop in population means there
are more moving vans heading out of the state than heading in.
Without new births, this would result in an outright population
decline. But since babies can't work, it may well result in a
drop in the working-age population. It is reasonable to assume
that this startlingly sudden exodus of taxpayers "voting with
their feet" was most dramatic among high-income households, who
are (1) most motivated to escape punitive taxation, and (2) most
easily able to relocate thanks to the occupational mobility of
those with superior training and skills. In California, similar
efforts to soak the rich have already led to "a net migration
from the state of high-earning (and highly taxed) people aged 45
to 64."v This means more of the tax burden in states such as New
Jersey and California, which are deliberately exporting affluent
taxpayers, must then be shifted to the remaining taxpayers with
relatively modest incomes. If New Jersey income tax rates stay
as punitive as they are, couples capable of earning more than
$50-75,000 will continue to move elsewhere at a much faster pace
than in the Eighties, rapidly eroding the state's income,
property and sales tax base. New Jersey may soon run out of
"rich" people to tax. And when high-income engineers,
scientists, physicians, accountants, advertising executives,
managers and entrepreneurs leave a state, they invariably take a
lot of other jobs with them.
As suggested in Table 1, before-tax personal income has
generally grown more rapidly in low-tax states than high-tax

states, thanks to net immigration of productive people from other

states, and faster economic growth. Exceptions are rare and
easily explained, such as the impact of collapsing oil prices on
Texas and Alaska after 1986, or the recent loss of defense orders
in New Hampshire. Even in states with no income tax at all, the
relatively rapid growth of personal income creates rapid growth
of revenues from sales and property taxes, while slow growth in
the high-tax states has the opposite effect. Numerous studies
have documented in considerable detail, and over many years, the
fact that states with high tax rates do not grow as rapidly as
those with reasonable tax rates. Among the most recent of many
such studies, for example, are How State and Local Taxes Affect
Economic Growth by Gerald Scully of the University of Texas, and
several studies conducted for both the Joint Economic Committee
and American Legislative Exchange Council by Richard Vedder of
Ohio University.
Table 1
Growth of Before-Tax Personal Income, 1985-90
High-tax states:
Low-tax states:
New Jersey
44.7 %
Nevada
68.8 %
California
46.6
New Hampshire 50.9
New York 41.9
Florida
56.4
What may be even more important than immediate outmigration, of the sort New Jersey has already seen, is what steep
taxes do to in-migration over decades. New Jersey businesses
that rely on well-paid experts will have to offer much better
salaries in order to recruit such specialists out of businesses
and universities located in other states. In order to compete
for high-salary employees, New Jersey business will have to bribe
them with higher salaries and perks, to help cover the cost of
higher income taxes. That means most of "the rich" (a curious
description of two-earner couples earning more than $50,000) do
not really pay this tax -- it is shifted forward into higher
prices for consumers, or shifted backwards into lower profits for
business. In either case, New Jersey employers will find
themselves less competitive with businesses in other states, due
to higher labor costs and/or prices, which largely reflect higher
taxes on labor. Sales and profits will be lower throughout the
state economy, and therefore taxes actually collected on those
dwindling sales and profits will be lower.
Much of the outright exodus of business from New Jersey will
come later, when leases run out, as state employers find it
increasingly difficult to attract and retain high-income
employees. The most promising enterprises, with the best paid
jobs, have no choice but to locate where the skilled workforce
chooses to live. And mature, skilled employees and professionals
are extremely mobile C they cannot be forced to pay thousands

more in taxes simply for the dubious privilege of living in New

Jersey. Unless individual income tax rates become far more
competitive, New Jersey will find it increasingly difficult to
retain the businesses it has, much less to attract or build new
ones.
With the difficulty of attracting new high-income families
into New Jersey, and the greater ease with which other states can
recruit existing residents, most of the moving vans will continue
heading out. Since New Jersey stopped allowing its high property
taxes to be deducted from doubled tax rates on gross income,
living in a New Jersey home has suddenly become a luxury that
many will choose to avoid. That means even more homes for sale
in the already glutted New Jersey suburbs, and more failures of
New Jersey banks and thrifts that loaned money against New Jersey
real estate. As home prices fall, there will be continued
pressure to adjust appraisals downward for tax purposes.
Property taxes, like sales and corporate profits taxes, will be
depressed. Even if taxpayers were so docile as to permit
property tax rates to be raised to compensate for falling
property values, which is quite unlikely, such higher tax rates
on homeowners would make New Jersey living costs even less
competitive C accelerating the exodus of high-income
professionals and managers, and sinking home prices even faster.
Dropping Out of the Labor Force
The adverse impact of high income and sales tax rates is not
simply on the location of employers and employees, but also on
the incentives of those who remain in the state. As marginal tax
rates were reduced at the federal level in the 1980s, this had a
particularly strong impact on labor force participation rates in
states like New Jersey, with high nominal incomes (which are
partly offset by high living costs, including taxes). At the
national level, the percentage of working-age population that was
either working or looking for a job averaged only 58% during the
Seventies, but rose to 63% by 1989 (and was still 61.5% by mid1992). In New Jersey, labor force participation in the mid and
late 1980s jumped to 67.5% from July to November, 1990, up from
about 61% in the Seventies.
Labor force participation rates in New Jersey began falling
starting in December 1990 (the month before income tax rates went
up), and dropped from 67.6% in November 1990 to 65.3% by August
1992. In that period, the seasonally adjusted state labor force
had fallen by 141,000, or 3.5%, which means there were that many
fewer state residents who were willing to work. For any given
output per worker, that means potential state output fell by
3.5%, but the actual drop was probably twice that large, since
the most productive workers were the most likely to have left the
state. In a perverse sense, it is almost a blessing in disguise

that so many workers either left the state or dropped out of the
job market, since private employment fell even faster, as shown
in Graph 2. Payroll employment in the private sector fell
steadily by nearly 10% from January 1990 to August 1992 C a
staggering loss of 308,000 jobs, which continued to fall even in
the third quarter of 1992, when national GDP rose at a brisk 3.9%
pace. By July 1992, New Jersey was about tied with Alaska for
the second highest unemployment rate in the nation C 9.8% C
behind only West Virginia.vi Subsequent improvement in New
Jersey unemployment was a statistical illusion, mainly due to
even more people dropping out of the labor force. The U.S.
Bureau of Labor Statistics actually estimates that state
employment fell by another 6,000 jobs from July to October.
Government jobs keep growing, but not enough to offset losses in
the private sector. As the state Department of Labor noted,
though, "nonfarm wage and salary employment actually edged down
again in September, dropping by 6,800 on a seasonally adjusted
basis....Retail sales in the state turned in a weak performance
in July and August, with auto sales particularly sluggish. Also,
the volume of construction contracts was still headed downward as
of September and there is no indication of a strengthening of
industrial activity."vii
Aside from New Jersey's most productive people moving out of
the state, the dramatic drop in the labor force also reflects a
rational decision on the part of secondary workers (spouses) to
stay home rather than pay marginal taxes on relatively low wages
at the steep rate now facing New Jersey's primary workers (a
combined federal state rate of 39% plus Social Security tax).
Many secondary workers (spouses) are not all that eager to work
simply for the privilege of paying more taxes, and they will not
do so if the after-tax rewards are insufficient. Not all of the
drop outs showed up immediately when tax rates went up in January
1991, since secondary workers who could arrange to be laid off
went through the motions of "looking for work" until unemployment
benefits ran out. In January 1991 alone C a single month C
first-time claims for unemployment insurance jumped by 9.3% on a
seasonally adjusted basis.
I estimate that the higher state income tax rates will
permanently lower New Jersey labor force participation by about
2-3 percentage points, with the loss concentrated among secondary
workers in what would otherwise be two-earner households subject
to 5-7% state income tax (on top of 28-31% federal tax).
Population growth will also remain at least one percentage point
slower than it would be with the previous income tax structure.
This means the high state unemployment rate in New Jersey,
greatly understates the impact, because (1) those who drop out of
labor force or retire early are not counted as unemployed, and
(2) secondary workers who switch from full-time to part-time work
to reduce taxable income do not add to the unemployment rate

(even in manufacturing, weekly hours immediately fell in early

1991).
The unemployment rate would have looked much worse than 9.4%
by August 1992 were it not for (1) the dramatic slowdown of
population growth starting in 1990, and (2) the drop in the
percentage of the remaining population that is still willing to
work and pay higher taxes. The state labor force grew by 1.3%
per year from 1981 to 1990, but then fell by 3.8% by August 1992.
Had the labor force continued to grow at a 1.3% pace, and
employment fallen exactly as it did, then the unemployment rate
in August 1992 would have been 13.8! The impact of higher tax
rates in inducing more dropouts from the job market, as well as
shrinking the number of jobs offered due to the high "tax
premium" in labor costs, are obvious reason why the state's
brutally high marginal tax rates yield no revenue. Instead of
collecting 3.5% of the income of secondary workers, as before,
the state government now tries to collect 7% of zero. And the
loss of second incomes in many families further reduces revenue
because the working husband or wife's income is now taxed at a
lower rate than the previous tax on the combined income of both
spouses. The higher income tax rates also increase tax
avoidance, both through working "off the books," such as doing
home repair for cash, and through perfectly legal devices such as
replacing taxable investments with municipal bonds.
Average incomes in New Jersey, which have been about a third
above the national level, are already being reduced by the
state's self-inflicted inability to attract and retain highincome families, and to keep secondary workers in the job market.
Moreover, as shown in Table 4 below, much of the growth of the
personal income has been in government salaries and welfare
payments, with jobs and incomes rapidly declining in
manufacturing and construction. The state's below-average 2%
rise in per capita income in 1991 is also misleading because (1)
the cost of living rose more than 3% in New Jersey, thanks in
part to higher sales taxes, making real incomes fall; and (2)
exporting high-income families is a dangerous way to raise income
per person remaining. When couples with children leave the
state, for example, that may well raise apparent per capita
income, because children don't earn any income. An overtaxed
family of four earning $100,000 has a lower per capita income
($25,000 apiece) than a retired widow with a $26,000 annual
pension. But such "rich" families would have been a much better
source of state and local tax revenue than young singles and
retired people, had they remained in New Jersey. With fewer
mature, college educated, two-earner couples left to tax, and
fewer profitable businesses, the ironic result will be that a
greater share of New Jersey's tax burden will have to fall on
those with low or moderate incomes.

Graph 3 shows that disposable (after-tax) income grew more

rapidly than in the U.S. as a whole before the 1990-91 tax
increases, but has grown far more slowly since. The fact that
New Jersey's economy continues to perform far below that of other
states, indeed near the very bottom in terms of jobs, cannot be
explained by a general nationwide recession from about August of
1990 to May of 1991, since the state economy was much worse than
most, even in third quarter of 1992. The state's plight cannot
be blamed on defense cutbacks, as would be reasonable in
Connecticut, since New Jersey ranks in the bottom half of the
states in terms of defense industry employment as a share of
total employment. Nor can it be blamed on disproportionate
reliance on cyclical industries, such as automobiles, since New
Jersey's economy is quite diversified. There is really no other
plausible explanation except that the New Jersey government has
taxed the economy into chronic stagnation or worse.
Shrinking the Tax Base: The Mythical $2.8 Billion
It is a bad habit to describe higher tax rates by the amount
of money they hope to raise, since such hopes are invariably
disappointed. Discussions of the increase in New Jersey's sales
tax in mid-1990, and higher income tax in 1991, thus speak of the
increase in dollar terms C as an increase of $2.8 billion. Yet
this is wildly inaccurate. In reality, the higher income and
sales tax rates yielded little or nothing in added revenue C
certainly less than typical yearly gains before tax rates were
increased. It is by no means clear that the huge increase in
individual income tax rates, or even the smaller hike in sales
taxes, raised any revenue at all, even in the short run. And
steep tax rates will raise less and less new revenue over time,
since they will continue to keep the growth of income, sales,
employment and population in New Jersey significantly lower than
otherwise.
In a memorandum of March 17, 1992, the Office of Legislative
Services noted that sales tax revenues had been improving in the
first half of 1990, before the higher tax rates were imposed, but
that "for all of FY 1991 and the first two quarters of FY 1992,
sales tax revenues have been in almost continual decline..."
Sales were probably pushed forward in early 1990, as people
bought big ticket items early to avoid the extra 1% tax (e.g.,
$200 on a $20,000 car). What little revenue increases have
occurred since then have been from applying the tax to more goods
and services, the OLS suggests, not from the higher rate. This
means bringing the sales tax back down to 6%, from 7%, is quite
unlikely to lose even a significant fraction of the $608 million
static estimate, since it will result in more sales to tax.
When counting the revenue from any higher tax rate, it is
essential to look at adverse secondary effects on other taxes.

Higher tax rates on sales and/or individual income can be

expected to reduce taxable business profits, for example, since
they reduce sales and increase costs. A very large portion of
sales tax in New Jersey, possibly as much as half, is paid by
businesses (e.g., on materials, gasoline and telephone calls),
since many consumer purchases, such as clothing, remain taxexempt. Moreover, sales tax on what businesses sell must, like
any other price increase, reduce their sales volume. Sales of
big ticket items, like cars and appliances, are quite sensitive
to price, which is why auto producers are more cautious than
governments about increasing prices. Businesses know that higher
prices can result in lower revenues, due to depressed sales, but
governments should know that the same is true of prices that rise
because of higher sales taxes.
As explained above, higher
marginal tax rates on employees tend to be compensated by higher
before-tax salaries, at least for skilled and mobile employees,
resulting in higher labor costs, smaller taxable profits, and
fewer jobs. Such secondary effects mean the resulting loss of
tax revenues from corporations has to be balanced against shortterm gains C if any C from the increased tax on their sales, or
on their employees' salaries. New Jersey's corporate tax
receipts fell by $234 million from 1989 to 1991, and are
correctly expected to fall again in 1992-93.
Since doubling the tax rate on relatively high-income
families causes more such families to leave the state than to
enter, that also created a glut of unsold housing and thus
depressed property values and property tax receipts. This may
require greater state support of local government functions that
would otherwise have been supported from higher property values.
In considering how much revenue is raised by an increase in
marginal tax rates, it is essential to look at both individual
and corporate income tax receipts. This is necessary not only to
account for spillover effects of one tax on the other (e.g., high
corporate taxes reduce employment, while high personal or sales
taxes reduce business sales), but also because it is often fairly
easy to convert individual income to corporate income, or viceversa, if there are tax advantages in doing so. Professionals
and small businesses can and do create corporations to allow them
to take more deductions; corporate managers can avoid the 7%
marginal tax on salaries by switching compensation packages
toward larger perks and profit sharing, and so on. Without
understanding that higher personal tax rates provided a powerful
incentive to switch from "Schedule C" (business and selfemployment income on the personal tax) to the corporate tax form,
the state Labor Department simply notes that "the number of new
business incorporations...have been increasing since the start of
1991" [when personal tax rates were doubled]. This most
certainly does not mean that there are new businesses being
created in New Jersey C the collapse in private jobs in Graph 2

10

proves that C but rather than individuals with self-employment

income are forming corporations to gain access to deductions not
allowed under the brutal 7% personal tax. Indeed, such "new
incorporations" jumped 20.6% in January 1991 alone (the beginning
of the tax year), and by another 17.6% in January 1992!
Moreover, both business profits and sales must be adversely
affected by excessive taxation of salaries and purchases, so one
consequence of higher taxes on the customers, workers and
stockholders of corporations is to lower taxable profits for
corporations.
If we look at corporate and individual tax receipts
together, as we obviously must, it might appear that the big
increase in income tax occurred in 1987 or 1989, not 1991, since
revenue gains were often larger under the previous, lower tax
rates. Of course, the economy was in better shape in the late
1980s than in 1990-91, but that begs the question of the adverse
impact of higher tax rates on economic growth. As we will see
later, the 1990-91 drop in taxable income and sales in New Jersey
was far greater than for the country as a whole, and cannot be
simply dismissed as a consequence of national economic trends.
With the doubling of state personal income tax rates in
1991, revenues from that source rose by only $320 million C less
than the $338 million increase in 1989, when tax rates were left
unchanged (and, of course, 1989 dollars were worth more than 1991
dollars). As Table 2 shows, the modest 1991 gain in taxes
collected from "individuals" was more than offset by a deep
decline in "corporations" (a legal distinction at best). On
balance, the growth of income tax receipts since tax rates went
up has been no faster than before tax rates went up, even in
nominal terms.
Table 2
Annual Changes in Individual and Corporate Income Tax
Receipts
Before and After Individual Tax Rates Were Increased
($ millions)
After: 1991
Before: 1986-89

Individual
$ 320
247

Corporate
- 30
38

Total
290 mn.
285

Far from raising the mythical "$2.8 billion," the growth of

total revenues in New Jersey (even including lotteries, casinos
and numerous fees) barely kept pace with inflation after 1989.
Measured in constant 1990 dollars, total revenues in 1991 were
$11.8 billion, barely changed from the already depressed $11.4
billion figure of 1990.viii Such stagnation in real tax receipts
is a typical, not paradoxical, result of higher tax rates,
reflecting the related stagnation of overtaxed economies. The
same thing recently happened in California, for example, where

11

seemingly huge "tax increases" has reportedly been yielding about

$2 billion less than expected, thanks to a highly publicized
exodus of overtaxed employers. Conversely, after a reduction of
tax rates in Oregon at the end of 1990, the Wall Street Journal
(May 23, 1991) reported that "for the second time this year,
state officials have revised upward their tax revenue estimates."
Similarly, whole countries that imposed increased income and
sales tax rates in 1989-91, including the United States, Canada,
Germany, and Japan, were likewise promptly surprised by falling
real revenues.ix Real, inflation-adjusted U.S. federal revenues
declined by 1% with the infamous 1990 tax hikes, and revenues
from the increased 1987 capital gains tax have fallen steadily,
injuring state revenues as well. Countries that instead reduced
marginal income tax rates since the late 1980s had relatively
strong economic growth and superior growth of real revenues.
Mexico, for example, cut income tax rates from over 55% to 35%,
and tax revenues grew in real terms (adjusted for inflation) by
14.7% in 1989 and 18% in 1990. Singapore cut its top tax to 33%
at around $250,000, and real tax receipts subsequently grew by 9%
a year.
Tax revenue, after all, depends on two components C the
average tax rate (not the marginal rate) times the tax base.
The base of the sales tax is the dollar value of sales, the base
of the income tax is the amount of income in each tax bracket,
and the base of the corporate profits tax is earnings less
deductible expenses. We know with some certainty that any higher
tax rate can be expected to have an adverse impact on the tax
base. After all, one rationale for high tax rates on liquor on
tobacco, for example, is to discourage purchases of those
products C i.e., to deliberately shrink the tax base. However,
such "sin taxes" are popular revenue sources precisely because
large price increases bring only small reductions in sales (and
also a switch to cheaper brands). This is not the case with many
other taxes, where a higher tax rate may dramatically slow the
growth of the tax base, or even produce a real (inflationadjusted) decline, so that the higher tax rate ends up yielding
less real revenue than a lower rate after only a few years. A
familiar example is "prohibitive" tariffs, which so discourage
imports that revenues fall. But there can be prohibitive taxes
too, particularly at the state level.
State sales taxes on big-ticket items, such as new cars,
appliances and furniture, significantly raise the price. By no
coincidence, new passenger car registrations in New Jersey peaked
at 41,333 in June 1990, the month before the sales tax went up,
plummeting to 25,225 in August 1992.x It is basic economics that
less can be sold at a higher price C demand falls as prices rise
C and the price, of course, includes sales tax. But this effect
is particularly pronounced at the state level, because sales

12

taxes are so easy to evade (except for new cars). Nearly

everything can be purchased by mail order from other states,
including furniture, jewelry and valuable electronic products.
Sales taxes are virtually impossible to collect from "flea
markets," such as the one in Chester, New Jersey, where many new
as well as used products are sold for cash.
Table 3 shows the relative growth of three tax bases in New
Jersey, compared with that of the U.S. as a whole. Before 198990, New Jersey typically experienced far more rapid growth of
personal income and retail sales than the rest of the nation.
With the higher tax rates on individual incomes and sales,
though, New Jersey has slipped far behind. It is noteworthy that
the base of the only tax that was not increased C corporate tax C
has not slowed more than elsewhere, suggesting the problem of
personal incomes and sales is not simply a consequence of
cyclical business losses. Indeed, the relative drop in the
growth of personal income and sales in New Jersey in 1990-91 is
so dramatic, relative to the rest of the country, that it can
only reflect huge losses of high-income taxpayers and sales to
other states. This makes the revenue estimates for 1992-93 look
absurdly optimistic, once again, since they are based on a rosy
scenario about the state's disappearing labor force and customers
somehow reappearing.
Table 3
Annual Growth Rates in the Tax Base:
New Jersey versus The United States
SALES
INCOME
CORPORATION
Year
N.J.
U.S.
N.J.
U.S.
N.J.
U.S.
1980
7.5%
6.8%
15.5%
11.4%
NA
12.5%
1981
6.2%
8.5%
14.1%
11.9%
0.8%
2.4%
1982
8.6%
3.0%
13.9%
6.2%
0.3%
16.8%
1983
10.3%
9.5%
8.9%
6.4%
1.9%
40.4%
1984
10.6%
1.0%
17.5%
10.2%
22.4%
24.2%
1985
14.5%
6.8%
14.5%
7.1%
19.8%
6.3%
1986
11.9%
5.4%
13.0%
6.2%
12.0%
-3.3%
1987
11.6%
6.3%
12.4%
5.9%
0.5%
17.7%
1988
6.9%
7.1%
10.2%
7.2%
9.5%
14.1%
1989
1.1%
5.5%
12.8%
7.5%
12.3%
-3.6%
1990
1.7%
3.8%
2.1%
6.8%
-11.1%
-9.3%
1991
-8.0%
0.9%
2.3%
3.3%
-10.1%
-10.3%
1992 e
3.8%
4.5%
2.7%
4.1%
NA
NA
New Jersey Budget 1992-93, Survey of Current Business
(for
U.S.)
& NJ Economic Indicators, Aug. 1992 for 1992 year-to-year
data at that time.
The 1991 estimates (e), from the Budget, reveal a tendency

13

toward wishful thinking.

The notion that higher tax rates on incomes and sales raised
any significant sum in New Jersey, much less $2.8 billion, is
simply a myth C based on the naive hope that the tax base would
grow just as fast with higher tax rates as it did with lower tax
rates. It follows that reversing the unproductive tax hikes of
1990-91 cannot possibly result in significant revenue losses, but
are instead likely to raise more money over a few years by
improving the state's growth of taxable incomes, sales, property
and profits.
Spending
A growing economy can support a growing government sector,
but government in New Jersey has grown so rapidly as to shrink
the taxable private sector on which it depends. The mandate
behind the 1988 SLERPC report was to "pay particular attention to
the relationship of the tax system...[and] state expenditures to
the vitality of the economy of the state," but the report
actually did neither. Instead, the report endorsed massive
redistribution of income from suburbs to cities, and simply
ignored all logic and evidence that taxation affects human
behavior and therefore the state's prosperity. It noted that
state spending and average salaries had both increased by an
average of 10.5% a year from 1980 to 1988, far beyond the growth
of taxpayer's ability to pay, but had nothing critical to say
about that unsustainable explosion.
From 1980 to 1990, state spending per capita increased by
139%, the third largest increase in the nation, behind only
Massachusetts and Connecticut. The level of state spending, at
$2,775 in 1990, was 20.4% above the national average.xi Although
there was some restrain on hiring from March to August of 1991,
it didn't last. From January 1989 to August 1992, government
employment rose by 20,100 or 3.6%, with about half of that
occuring between August of 1991 and 1992. As Table 4 shows, from
1989 to 1991, a rising share of personal income in New Jersey
came from government salaries and government transfer payments
(mainly "welfare" of various sorts), while a shrinking share came
from manufacturing. Transfer payments are now substantially
larger than all wages and salaries in manufacturing C that is, an
important group of New Jersey producers and taxpayers now collect
less pre-tax income than nonproducers, and even less after taxes.
It continues to be difficult for private employers to
compete with the generosity of political employers, when trying
to recruit people to work despite the higher taxes. In 1991,
average wages in government in New Jersey increased by 6.4%,
while those in private service rose by only 5.1%.xii This
suggests that government workers have been more successful than

14

their private sector counterparts in being compensated for the

higher taxes, which means some of the income tax burden on public
employees is at least partly shifted to private taxpayers.
Table 4
Select Sources of Personal Income in New Jersey
($ billions)
GOVERNMENT
TRANSFERS
MANUFACTURING
1989
$ 16.5
$ 20.4
$ 24.2
1990
17.9
22.5
23.9
1991
19.0
25.8
23.8
Survey of Current Business, August 1992
Some of the continued growth of government employment and
salaries in New Jersey may be at the local level, where there
were 5,600 employees added in the year ended September 1992
(compared with 2,700 more state workers). But this distinction
does not absolve the state, since much county and city government
employment is funded by state taxes and debt. The harsh reality
is that government employment and salaries cannot keep rising as
private employment falls, because it is private employees and
employers, and related retail sales, that provide the tax
revenues to meet government payrolls. Government can't grow by
simply taxing more and more government workers, since they seem
able to pass their taxes along in above-average wage hikes.
Government employment must be curbed in order to alleviate tax
burdens that are strangling the private sector.
A Star Ledger/ Eagleton poll was reported in the Trenton
Times (February 9, 1992) as suggesting that "most New Jersey
residents oppose a proposed 1 percent rollback of the state sales
tax if it means a cut in state services." Actually, 34% strongly
disapproved and 25% mildly disapproved of that particular tax cut
if it had the assumed effect of cutting "services," but 69%
really favored the lower sales tax. If you ask people if they
would rather see poor children starving on the streets than pay
taxes, you get a quite different answer than if you ask them if
they think they are getting a dollar's worth of "services" for
each dollar they pay in taxes. The same poll showed that 70% of
New Jersey voters would rather cut spending (29% wanted to cut
state employment), while only 22% supported higher taxes. And
the poll did not ask a single question about income taxes.
New Jersey had a law in effect from 1976 to 1988 that at
least tried to keep increases in state spending in line with
increases in per capita income.xiii It would seem highly
desirable to restore something of that sort, with some sort of
sanctions for failure, since the recent pattern of growing
government and a shrinking private work force is simply not
sustainable. Taxing successful families and enterprises into

15

oblivion is not a viable solution.

Conclusion
Doubling New Jersey's income tax rates on families with
above-average incomes virtually stopped the growth of population,
as the most productive families moved out, and it also reduced
the willingness of spouses to remain in the labor force. The
resulting reduction in taxable real personal incomes, corporate
profits, retail sales, and property values far exceeded
comparable national trends, depressing tax receipts by shrinking
the tax base. Increasing the sales tax, from July 1990 to July
1992, likewise depressed sales in New Jersey establishments.
These effects nullified even short-term revenue gains and surely
pushed longer-term state and municipal tax collections, including
property tax receipts, far below what they would otherwise have
been. Rolling-back the sales tax in mid-1992 will help a bit,
but carries a greater risk of revenue loss than would returning
to the previous income tax rates and is, in any case, not
sufficient to remedy the damage the income taxes cause. Even New
Jersey will benefit to some extent as the overall national
economy expands, but it will nonetheless underperform most other
states, particularly those with low income tax rates, until the
state's uniquely oppressive tax structure is repaired. New
Jersey's punitive personal income tax rates will continue to
leave the state economy (and therefore real tax receipts)
relatively depressed C forever C until those tax rates are
brought back down to a reasonably competitive level.
*

Alan Reynolds is Director of Economic Research with the Hudson

Institute in Indianapolis.

16

i. State and Local Expenditure and Revenue Policy Commission, Final Report, 1988, p. 66. The rationale for higher
income tax rates was some absurd estimates (on page 97), claiming those earning less than $10,000 paid 33.9% of their
income in state and local taxes. This required that poor people somehow devote far more than 6% of the their income to a
6% sales tax that excludes clothing and many other goods. One error here is that income in any given year may be lower
than normal, so spending by those in the bottom 20% of the nation's income distribution appears to be twice as large as
what they earn. Another dubious assumption is that property taxes are borne by renters rather than by capitalists.
ii. U.S. Bureau of the Census, Money Income of Households, Families, and Persons in the United States: 1990, D.C.,
p.52-53.
iii. A few non-manufacturing companies were still moving their offices from New York to New Jersey, even after 1991.
Stephen Kagann, "New York's Incentives, the Wrong Incentives," The Wall Street Journal, October 6, 1992.
iv. SLERPC, op. cit., p. 50.
v. George Will, "California: A Lesson for the Candidates," Hartford Courant, September 24, 1992.
vi. U.S. Department of Labor, "State and Metropolitan Area Employment and Unemployment: July 1992," News,
September 16, 1992.
vii. New Jersey Department of Labor, New Jersey Economic Indicators, October 1992, p. 4.
viii. Stephen Moore, "A Fiscal Report Card on America's Governors," Policy Analysis, January 30, 1992, p. 62.
ix. For a statistical survey of how and why high tax rates often lead to weak or falling real revenues see Gerald W. Scully,
Tax Rates, Tax Revenues and Economic Growth, Dallas, National Center for Policy Analysis, 1991. Also, Alan Reynolds,
The IMF's Destructive Recipe of Devaluation and Austerity, Hudson Institute, 1992.
x. New Jersey Economic Indicators, October 1992, Table X, p. S-22. Even on a seasonally adjusted basis, which obscures
the tax timing a bit, the drop was 27% from June 1990 to August 1992.
xi. American Legislative Exchange Council, FYI, January 21, 1992.
xii. New Jersey Economic Indicators, October 1992, Table 2, p. 16.
xiii. Duane A. Pard, "Fiscal Discipline Mechanisms," in Tex Lezar, ed., Making Government Work, San Antonio, Texas
Public Policy Foundation, 1992, pp. 341-47.

17