State Fiscal Policy

The most immediate fiscal policy problem also is the most critical: the huge gap between what the state sets aside for pensions and health care for retired government employees and how much those obligations will cost. When states pay less into the retirement systems each year than what will be needed to meet future demands, a fiscal time bomb is created. Each year of inadequate funding compounds the difficulty.

If New Jersey does not ramp up its contributions, the pension funds will run dry shortly. The projected depletion dates – when a plan’s assets cannot cover obligations to retirees – are uncomfortably near. Although estimates vary (based on differing assumptions about the state’s future contributions, the yield of the investments, and the value of payments to retirees), one projection is that in five years, that is, 2022,¹ the pension plan for judges will run out of funds. According to Moody’s Investors Service, the teachers’ pension fund (TPAF) and the public employees’ retirement system (PERS) will run out of funds in 2027 or 2028.²  The state’s police pension fund (SPRS) is projected to hit zero in 2033.³

In all, more than 600,000 current and former public servants – including police officers, teachers, and social workers – could see their pension payments greatly reduced or stopped. And, because of the enormous sums needed to fill the pension gap, the crisis has implications beyond what retirees face. A cash-strapped state government cannot make necessary investments in schools and bridges, water systems, child welfare, or any of the other goods and services upon which the public depends. This is why the pension issue must be of immediate concern to everyone in New Jersey.

If the retirement plans were depleted, the state would need to devote more than $8 billion each year to pensions alone, which would displace spending in all other budget categories. Further, such pay-as-you-go spending is so fiscally unsound that it would result in continued downgrades of New Jersey’s once-stellar AAA credit rating and would increase the state's costs of any borrowing.  

There are those, including some experts who advised The Fund for New Jersey in the preparation of this report, who believe New Jersey is already past the point of no return — that years of missed or inadequate investment in employee pensions cannot be undone. New Jersey’s unfunded retirement obligations over the next 30 years are so enormous – the smallest estimate exceeds $66 billion⁴ – that replenishing might seem impossible.

New Jersey cannot hide from this threat. Unlike insolvent companies or people, states cannot file for bankruptcy protection. As long as states have the power to raise revenue, they must do so to meet their constitutional obligations. If the pension funds were depleted, it is likely that courts would be asked to decide whether retired workers’ pensions are constitutional obligations that must be paid.

No one knows which groups and interests would feel the pain of a court ruling, but all of the likely scenarios are costly. If the courts ruled against the retirees, thousands of people could lose their economic security, and the cascading effects would be felt throughout the state. If courts ruled that the state is obliged to pay the pensions, the rush to find cash to cover these annual bills could destabilize the entire state budget.

The problem grows more serious each day, and there are no pain-free solutions. Every fiscal decision the state makes in the coming years must advance the goal of setting New Jersey in a new, better direction.

Pensions are not the only daunting financial challenge. Others include:

• Retiree health care costs that steadily increase, putting pressure on annual budgets
• An inefficient and inequitable tax system that deprives the state of resources needed to adequately support key public investments
• Significant unmet infrastructure needs in transportation, energy, water supply, and other vital areas that have the potential to damage or disrupt future economic growth
• Public education investments that fall short of New Jersey’s constitutional obligation to remedy educational disparities, as well as under-investment in early childhood and higher education, which support economic growth
• A large and increasing number of residents, including children, who do not have enough resources to support their basic needs, including housing that is safe, healthy, and affordable

In sum, taken together, these challenges present a crisis requiring sober analysis, long-term solutions, and the determination by policymakers to act without delay.

Failure to confront these challenges will prevent public investment in the building blocks of a strong economy and thriving communities, as recommended in all the Crossroads NJ reports. Those recommendations include offering all students a quality education; rebuilding deteriorating public infrastructure for transportation, water supplies, energy, and waste disposal; helping all New Jerseyans afford a good home close to their work; and encouraging innovation and growth through support for business owners and workers.

These are among New Jersey’s many pressing, unmet needs — now and in the future — that we cannot afford to address.

By many conventional measures, New Jersey is among the nation’s most prosperous states. It has an ideal location, high average personal income and economic activity, a highly skilled work force, and many other physical, social, and economic assets. Given these strengths, the state should be on sound fiscal footing. The budget approved yearly ought to advance priorities for making public investments in New Jersey’s growth.

But that is not the case. Various fiscal health measures clearly demonstrate that the state’s finances are in significant distress. For example, New Jersey’s credit rating has been reduced several times by each of the major rating agencies over the past seven years,⁵  with the result that New Jersey has had higher borrowing costs for public improvements and prudent refinancing of existing debt. The state’s fiscal status has deteriorated over time; indeed, one recent study of states’ fiscal solvency ranked New Jersey 50^th in the nation.⁶

Despite the constitutional requirement of a balanced budget, year after year New Jersey has achieved the appearance of balance by jeopardizing its economic future – deferring billions in pension obligations, skipping needed infrastructure repairs, and shortchanging economic drivers such as higher education. 

It is simplistic to argue that a path forward for New Jersey can be built on spending reductions alone. In fact, most spending by New Jersey and other states is devoted to two areas in which the state's flexibility is limited: K-12 education and providing health coverage through Medicaid.

Reduction in Medicaid spending is limited because the federal government requires states to provide a basic set of benefits. Moreover, under the joint federal-state arrangement for funding Medicaid, each dollar that the state cuts would result in the loss of a dollar of federal assistance. Similarly, New Jersey Supreme Court decisions in the Abbott vs. Burke cases⁷ limit the state’s ability to significantly cut support for public schools. And, even if such reductions for K-12 education were possible, they would have adverse implications for the state’s future economic development and overall quality of life.

In short, New Jersey has no choice but to confront each of its substantial financial problems head on, with a focus on what best serves the long-term public interest.

With or without the retiree benefit funding crisis, New Jersey’s state revenue system is in dire need of modernization if it is to maintain or increase the level of public investment in services and initiatives essential to economic growth. Every year, New Jersey’s anticipated expenses exceed its revenue, creating what is called a structural deficit. Lacking the resources to directly address the problem, policymakers instead have resorted to a patchwork of one-time gimmicks, unpaid or postponed bills, and raids on funds designated for specific purposes such as promoting energy efficiency and affordable homes. 

A reformed revenue system – updated to better reflect New Jersey’s demographic, economic, fiscal, and technological conditions – could produce more for public investment, reduce the structural imbalance, and mitigate some built-in inequity. Such reforms would not substitute for the significant shift in income and sales taxes required to address the pension crisis; they do offer additional opportunities to right the fiscal ship.

When the state sales tax was initiated in 1966, Americans were spending more on goods than on services. Today consuming patterns have reversed, and the sales tax is a less productive source of revenue for public investment because most services are not taxed.¹⁹ Many did not even exist 50 years ago, underscoring how out of date the state’s sales tax now is.

Further, revenue from the state’s corporate business tax is less robust than needed to support public investment because policies enable multi-state corporations to shift profits made in New Jersey. This is done by attributing profits to various subsidiaries located in other states, ones with lower or no business taxes. Often those subsidiaries are created solely to reduce a company’s tax obligation.²⁰

Another source of state revenue could come from marijuana. Across the nation, attitudes toward marijuana have changed dramatically in recent years. Amid growing evidence that its use poses no greater dangers to most people than alcohol does, policymakers are seeing the financial upsides of legalizing marijuana to reduce the number of incarcerated nonviolent offenders and reap revenue from the taxation that would accompany legalization. To date, eight states and Washington, D.C., have legalized recreational marijuana use. In many other states, including New Jersey, medicinal use is legal.

Collectively, states lose billions of dollars a year because they are unable to collect sales taxes on purchases made through the Internet or mail-order catalogs. The growing importance of such sales undermines the revenue productivity of the state’s general sales tax because, even though consumers are legally bound to pay it, sellers are not required to collect and remit sales taxes unless those sellers have a physical presence in the state. In addition to depriving the state of revenue, this puts local “brick and mortar” businesses, which must collect sales taxes, at a competitive disadvantage.

Although New Jersey is among the nation’s wealthiest states, with a median income at about $72,000 a year, the economic inequity among its residents is wide and growing. The 1% of New Jersey households that earn the most have seen their incomes increase by 190% since 1979, while the income of everyone else has risen by 20%. Only five states have a larger-percentage difference in average income between the wealthiest 5% of households and the least-wealthy 20%.²³

More than a third of New Jersey households earn too little to provide for necessities.²⁴  People at this income level struggle from paycheck to paycheck. A family of four in New Jersey needs $64,176 a year to afford a two-bedroom apartment at fair market rate and to cover the cost of maintaining one car, licensed in-home child care, food, out-of-pocket medical expenses, and taxes — plus an additional 10% of the total of all these items in case of overruns. These New Jersey families face fiscal crises as overwhelming as the state’s.

In relation to state fiscal policy, the burdens on the economically distressed result from both the erosion of public investment on their behalf and on the way New Jersey raises revenue at the state and local levels. Overall, New Jersey’s state and local tax system is what economists call “regressive”: The lower a household’s income, the higher share of that income it pays in taxes. For example, New Jersey families making less than $22,000 a year pay 10.7% of their income in state and local taxes; those making between $43,000 and $71,000 pay 9.1%; and those making more than $758,000 — the top 1% — pay 7.1%.²⁵

The inequity is compounded by the fact that, as an alternative to raising broad-based taxes, New Jersey makes extensive use of fees, user charges, lottery receipts, and other non-tax sources that cost low- and middle-class households a greater share of their income than they cost the most affluent. To an extent, New Jersey mitigates these disparities through a state income tax that has higher rates for higher income; the exemption of food and clothing from the state sales tax; a state Earned Income Tax Credit to boost low-paid working families, and some property tax relief for families struggling to get by. More is needed.

As noted previously, the scale of the employee retirement obligations confronting the state will make it difficult (if not impossible) to avoid increasing some taxes on all state residents and businesses, including those of modest means. Through an increased sales tax, most New Jerseyans will likely pay more. At the same time, changes to income tax should be adopted to mitigate the additional burden felt by the state’s least well-off residents.

Sometimes referred to as “back-door spending” because tax expenditures involve money given out through exemptions written into law rather than through budgeted appropriations, these exemptions increasingly are used to try to encourage businesses to move into the state or hire more people. In other cases, tax expenditures help struggling residents by, for example, exempting food and clothing from the sales tax or providing an Earned Income Tax Credit to working people who are paid too little to support their families. When taken together, New Jersey tax expenditures are substantial – in Fiscal Year 2017 alone they totaled $23.9 billion.²⁸

Tax expenditures have been proliferating rapidly, particularly the tax breaks offered to businesses to persuade them to come to, or stay in, New Jersey, since a 2013 law expanded use of this type of subsidy. At the same time, the effectiveness of this strategy is being questioned. At present, New Jersey does not monitor tax expenditures closely to control their growth and to determine whether they deliver their designed economic benefits.²⁹