New Jersey Income Tax Cut Led to Savings, Not Rise in Local Taxes

Introduction

Governor Christine Todd Whitman instituted cuts in the state income tax beginning in fiscal year l995.  This has direct implications for local financing decisions because revenue from the New Jersey income tax is, by law, dedicated solely to relief of local property taxes, to which New Jerseyans are also subject and which are levied by both municipalities and local school districts.  No revenue from the state income tax is allocated to general funds.  This connection has led to some fear that the state income tax cuts would simply lead to dollar-for-dollar increases in local property taxes.  The evidence suggests that this has not been the case so far, and is not likely to be the case in the future.

First, historically, there has been little or no relationship between changes in the state income tax and local property taxes.  They simply do not seem to be connected.  For instance, during the period from 1985-1990, property taxes increased steadily in real terms (at about 7 percent per year) while income tax revenue was extremely variable (real income tax revenue increased by over 20 percent in 1987 and decreased by over 5 percent in 1988).

Second, an examination of data for 1995, the first year of the Whitman tax cuts, shows virtually no change in real property taxes relative to 1994, further bearing out the fact that the two taxes are not related.

Third, an empirical phenomenon observed in previous studies indicates that lump sum grants from higher levels of government lead to higher levels of spending than if the funds are collected locally.  This study finds that this phenomenon holds for New Jersey as well.  In other words, localities are found to spend more money when funds come from the state than if taxes are collected and spent directly by the school district.

Since 83 percent of local property taxes go to school districts, the study examined school district taxation and expenditure policy in detail.  (In New Jersey, both school districts and municipalities have the power to levy taxes.)  An econometric model was developed to look at the relationship between school district property taxes and changes in the state income tax.  According to the model, New Jersey taxpayers have saved 78 cents for each dollar decrease in state income tax.  The model, which takes into account how school districts have historically reacted, predicts that relationship will continue to hold.  Based on that prediction, New Jerseyans will save approximately $895 million over the five-year period from 1994 to 1998.

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