Report :: New Jersey's Income Tax: How Progressive? by John W. Zerillo

When it comes to providing services to residents-and paying for them-states are more important today than they were 25-30 years ago. The primary reasons for this come from above and below. On one hand, states have assumed a larger portion of many costs that previously were borne at the local level, especially with regard to primary and secondary public education. On the other hand, the federal government has devolved more responsibilities to states, like welfare.

With the increased burdens for state government comes the task of figuring out how to raise the necessary money. And of course that involves taxation. So, governments wrestle with the issue of how to develop and maintain tax structures that meet residents' needs and do so in an equitable manner. In 41 states this includes a tax on personal income. On average, personal income taxes make up the second largest source of state revenues (behind sales taxes).

In 36 of those states-including New Jersey-the income tax is "graduated" or "progressive." The two words describe the same thing: a tax system in which not only the amount paid rises as a taxpayer's income goes up, but the rate at which the tax is levied goes up as well.

Progressive income taxes are considered equitable by the two important measures of the concept: vertical and horizontal. Vertical equity means that the tax burden is distributed differently among people of differing economic circumstances. In a system with vertical equity the share of income paid in taxes rises as income rises. Horizontal equity means that taxpayers in similar economic circumstances share similar tax burdens. By contrast a tax that fares poorly on the horizontal equity scale is the local property tax. Two homeowners in different towns could well pay very different percentages of their income in the form of property tax because of such variables as the value at which their municipality assesses their house and the rate of tax the municipality charges its residents.

Progressive taxation also is logical because upper income citizens have a great deal more disposable income than their lower income counterparts; they can generally "afford" the higher rates. Progressive taxes, particularly at the state level, can also partially mitigate the burden of sales and property taxes that are "regressive," which means the lower someone's income is, the higher percentage of that income they pay in the form of those taxes.

New Jersey's overall system of taxation is highly regressive. As reported in the NJPP report Upside Down and Backwards: Taxes in New Jerseyin February 2003, the poorest people in the state pay more than twice the percentage of their income in the form of state sales, state income and local property taxes than the wealthiest, when the full value of upper-income taxpayers' ability to deduct some state and local taxes from their federal obligation is considered.

So the income tax in New Jersey is asked to do two things: raise money to pay for important services and, through its progressivity, help combat the regressive effects of the rest of the tax system.

New Jersey's income tax has been in effect since its adoption in 1976 in response to a State Supreme Court ruling ordering the state to pay a higher percentage of the cost of K-12 public education. The original tax levied rates of 2% on the first $20,000 of family income and 2.5% on everything above $20,000.

Since then there have been several changes in the rates and income levels at which they take effect.

1990: 2% on income up to $20,000; 2.5%, $20,001 to $50,000; 3.5%, $50,001 to $70,000; 5%, $70,001 to $80,000; 6.5% $80,001 to $150,000; 7% over $150,000.

1994: 1.9% on income up to $20,000; 2.375%, $20,001 to $50,000; 3.325%, $50,0001 to $70,000; 4.75%, $70,001 to $80,000; 6.175%, $80,001 to $150,000; 6.65% over $150,000.

1995: 1.7% on income up to $20,000; 2.125%, $20,001 to $50,000; 2.975%, $50,001 to $70,000; 4.25%, $70,001 to $80,000; 6.013%, $80,001 to $150,000; 6.58% over $150,000.

1996: 1.4% on income up to $20,000; 1.75%, $20,001 to $50,000; 2.45%, $50,001 to $70,000; 3.5%, $70,001 to $80,000; 5.525%, $80,001 to $150,000; 6.37% over $150,000.

For single people each rate takes effect at half the income level as for married filers.

While this quick look at state income tax rates in New Jersey shows apparent progressivity, looks can be deceiving. Yes, the rates do increase-if modestly-as income rises. But tax rates are not the only way-and not necessarily the best way-to analyze a tax. A more reasonable standard of measurement to determine a state income tax's progressivity is the actual tax burden people face by income level. Put in other terms, are upper income New Jersey residents paying their fair share of taxes, at least compared to upper income residents from other states across the country?

A detailed look at New Jersey's income tax burden compared to that of other states shows surprising results that call into question the notion of just how progressive it is. This is a particularly pertinent issue during times of budgetary distress, the situation in which New Jersey finds itself today and for the foreseeable future.

To gauge income tax burden in New Jersey versus other states, we will engage in a series of comparisons. We will look at states in close geographic proximity to New Jersey, states that share with New Jersey high population density, states where there is thought to be less of a progressive taxation tradition than New Jersey and a final comparison of the Garden State to national averages.

To perform this analysis of state tax burdens by income category requires some reasonable standard of measurement. Such a standard of measurement is derived by utilizing data from a US Census Bureau survey taken in March 2002 that divides household incomes into five categories, each with the same number of families. In this manner we can, for example, determine what a New Jersey family in the second highest income category pays compared to families in the second highest income category in other states across the nation.

The five income categories that emerge from taking all states together are classified as follows: lowest from $0 to $24,999; second lowest from $25,000 to $44,999; middle from $45,000 to $64,999; second highest from $65,000 to 94,999; and highest above $95,000.

The data comparing New Jersey state income taxes by income category to taxes of its neighbors identifies significant differences. The analysis shows that the gap between the geographic average income tax burden and New Jersey actually widens as income climbs from $0 to $100,000, while in most other states the gap either narrows or upper income taxpayers exceed the geographic averages.

Even though the $100,000 income level represents the "lower" end of the highest income category, it is also a fact that New Jersey has a great deal of "making up" to do if it wants its upper income citizens to pay approximately what other upper income citizens pay in neighboring states. A notable statistic is that there is a $1,584 difference between the geographic average and New Jersey, or 1.58%, at the $100,000 level. Married taxpayers earning $100,000 in neighboring states pay a 60% greater tax burden than their income counterparts in New Jersey. This implies that additional moderate tax rate increases, particularly somewhere beyond $100,000, would not jeopardize New Jersey's standing as a low income tax state relative to its neighbors.

	Lowest (20K)	Second Lowest	Middle	Second Highest	Highest (100K)
New Jersey	$0	$508	$892	$1,659	$2,641
Pennsylvania	$560	$980	$1,540	$2,240	$2,800
Connecticut	$0	$225	$1,276	$2,917	$4,115
Maryland	$562	$1,236	$2,194	$3,394	$4,354
Delaware	$210	$983	$2,087	$3,528	$4,717
New York	$190	$910	$2,080	$3,769	$5,138
State Averages*	$304	$867	$1,835	$3,170	$4,225

Lower income category assumes an income of $20,000,
while highest income category is calculated on an income of $100,000.
The income categories are for married taxpayers.
* Excluding New Jersey.

It is obvious that New Jersey has a low state income tax structure compared to its neighbors. This is especially true in view of some of New Jersey's neighbors being generally thought of as "tax friendly" states when it comes to the levy on incomes-making the actual differences even more pronounced by national standards. Pennsylvania, for example, has one of the lowest state income taxes in the country, while none of the other states in the geographic analysis are among the top 15 highest state income tax structures in the country. In summary, though New Jersey's income tax is technically progressive, upper income married taxpayers, at least at levels of $100,000, pay significantly less than their income counterparts in neighboring states.

An interesting component of the analysis of the New Jersey income tax involves comparing tax burdens by income category to states that might arguably be considered to have less of a tradition of progressive taxation. We might expect that upper-middle- and upper-income earners in states with flat or regressive traditions paid less of a tax burden than equivalent income earners in states with more progressive tax structures. However, comparing the New Jersey income tax to these states shows just the opposite.

	Lowest (20K)	Second Lowest	Middle	Second Highest	Highest (100K)
New Jersey	$0	$508	$892	$1,659	$2,641
Louisiana	$203	$695	$1,365	$2,112	$2,695
Alabama	$523	$1,159	$1,999	$2,937	$3,663
Mississippi	$102	$663	$1,620	$2,870	$3,870
Georgia	$439	$1,339	$2,539	$4,039	$5,239
S. Carolina	$135	$1,046	$2,379	$4,108	$5,508
State Averages*	$280	$980	$1,980	$3,213	$4,195

It is important to note that there is essentially no difference between upper income tax burdens of these flat tax structure states versus New Jersey's neighbors in the northeast. The geographic averages for these states is $4,195, while New Jersey's neighbors average $4,225-only a $30 difference. Additionally, tax burdens for the second highest and highest group of taxpayers are 94% and 59%, respectively, above equivalent income categories in New Jersey.

One might have thought that a comparison with less tax-progressive states should place New Jersey in a more favorable light for two reasons. First, regressive or flat taxes are more favorable to higher income earners. Secondly, Mississippi and Alabama are among the 10 lowest income tax structures in the nation. Instead, though, the comparison shows that many New Jersey upper income earners shoulder significantly less of a tax burden than their income counterparts in less tax progressive states. The comparison simply serves to reemphasize the fact that New Jersey has room to increase its tax rates at higher income levels and still not unduly burden its upper income earners.

The first two comparisons illustrate the lower comparative tax burdens for upper middle and upper income New Jersey residents. The two comparisons, however, did not include any of the "Top 10" highest income tax structures, but did include Pennsylvania, Mississippi and Alabama-all in the bottom 10. The chart below shows New Jersey's tax structure next to the 10 highest state income taxes in the country.

	Lowest (20K)	Second Lowest	Middle	Second Highest	Highest (100K)
New Jersey	$0	$508	$892	$1,659	$2,641
Kentucky	$727	$1,743	$2,955	$4,455	$5,655
Wisconsin	$0	$885	$2,428	$4,314	$5,690
Oklahoma	$457	$1,432	$2,781	$4,488	$5,818
Idaho	$157	$1,140	$2,623	$4,556	$6,116
N. Carolina	$602	$1,554	$2,939	$4,688	$6,158
Maine	$135	$928	$2,439	$4,560	$6,260
Hawaii	$722	$1,796	$3,336	$5,366	$7,046
Iowa	$504	$1,607	$3,150	$5,351	$7,146
Montana	$477	$1,395	$3,132	$5,631	$7,757
Oregon	$809	$2,010	$3,777	$6,024	$7,824
State Averages*	$459	$1,449	$2,956	$4,943	$6,547

The comparison between New Jersey and what might be considered the 10 most aggressive state income tax structures obviously highlights significant differences in the way upper income citizens are taxed. Married taxpayers from these states pay on average 148% more in taxes at $100,000, or a significant difference of $3,906 per year. While the substantial differences are not surprising, the analysis shows that modest increases in upper income tax rates in New Jersey would still not closely approximate equivalent tax burdens in many other states.

New Jersey is the most densely populated state in the nation. So there might be validity in looking at New Jersey in relation to other states that have a lot of people per square mile. It could be argued that such states have in common similar service needs and problems other states are less likely to experience.

A potentially higher level of service needs can also contribute to higher local property taxes, increasing the pressure for a progressive income tax to help relieve the local tax burden. Indeed, that is the constitutional purpose of New Jersey's income tax. By calling upon upper income citizens to contribute more to state funding of schools and other services, a broad-based income tax can help to spread the burden more fairly. So it would seem reasonable to compare New Jersey with the five other most densely populated states in the nation to determine relative upper income tax burdens.

	Lowest (20K)	Second Lowest	Middle	Second Highest	Highest (100K)
New Jersey	$0	$508	$892	$1,659	$2,641
Connecticut	$0	$225	$1,276	$2,917	$4,115
Maryland	$322	$1,236	$2,194	$3,394	$4,354
Rhode Island	$253	$827	$1,644	$3,259	$4,687
Delaware	$210	$983	$2,087	$3,528	$4,717
Massachusetts	$360	$1,317	$2,371	$3,762	$4,883
State Averages*	$229	$917	$1,914	$3,372	$4,551

Information on most densely populated states comes from the World Almanac, 2003.
Income categories are for married taxpayers.
* Excluding New Jersey.

The information gathered from this comparative income tax analysis highlights to an even greater degree the differences between New Jersey and other states. It turns out that densely populated states do seem to have something in common-with the notable exception of New Jersey. First, each state at the $100,000 level has a tax burden of somewhere between $4,115 and $4,883-a small range and substantially above New Jersey's $2,641. Secondly, the average tax burden for these states at the $100,000 income level is $4,551, significantly higher than the average of neighboring states, states with less progressive tax structures, and national averages.

A reasonable conclusion is that other densely populated states are doing a better job of spreading the tax burden via the state income tax than New Jersey. It is simply hard to ignore that taxpayers in other densely populated states have, on average, a 72% higher tax burden than they have in New Jersey at the $100,000 level.

While comparing New Jersey to other states by geographic region or by density reveals interesting information, an analysis of the New Jersey tax structure should also contain comparisons to national averages. This type of analysis, however, can be clouded by the fact that nine states (Wyoming, Alaska, Washington, Florida, New Hampshire, Nevada, South Dakota, Texas, and Tennessee) do not have state income taxes. These states obviously must generate revenue in other ways, often leading to higher property taxes, which would not be included in the comparison. For informational purposes, it is therefore useful to compare New Jersey in two different ways: first, with all states, and then with only those states with income taxes.

	Lowest (20K)	Second Lowest	Middle	Second Highest	Highest (100K)
Average of All states	$271	$850	$1,729	$2,949	$3,958
Average of States with Income Tax	$331	$1,036	$2,109	$3,596	$4,827
New Jersey	$0	$508	$892	$1,659	$2,641

From what we have seen so far, it comes as no surprise that New Jersey ranks well below the national average for states that administer some form of income tax. But what is even more striking is the fact that even when the nine states without income taxes are placed in the averages New Jersey is still considerably below the national norm. At an income of $100,000, for example, taxpayers across the country have an average tax burden that is 50% higher than their income equivalents in New Jersey. The numbers are even more daunting when non-income tax states are eliminated. In this circumstance residents of those states pay 83% more than their upper income counterparts in New Jersey.

While this analysis so far has shown the respective burdens of married New Jersey taxpayers, it should be noted that upper income, single New Jersey residents also have less of a tax burden. Using the same Census Bureau survey taken in March 2002, we can identify the number of singles and divide their respective incomes into five equal categories, thus allowing for a standard of measurement and comparison.

	Lowest (10K)	Second Lowest	Middle	Second Highest	Highest (70K)
Average of All states	$110	$483	$1,036	$2,014	$2,897
Average of States with Income Tax	$134	$589	$1,263	$2,456	$3,533
New Jersey	$0	$271	$499	$1,358	$2,321

The national average tax burden for upper income single taxpayers is 25% higher than in New Jersey. When non-income tax states are eliminated, the difference goes up to 46%. While the differences between national averages and New Jersey tax burdens are not as great for single taxpayers as they are for married residents at upper incomes, these differences are still statistically significant.

By using virtually any standard of comparative measurement it can be concluded that most upper income New Jersey residents pay significantly less than those making the same income across the country. Only when incomes start to reach the $250,000 vicinity does New Jersey's structure begin to tax a larger share of a taxpayer's income.

After reviewing tax rates and various comparisons, we are better able to answer the original question: do upper income New Jersey taxpayers pay their fair share of state income taxes?

To some extent this is a question of perspective. For example, a greater share of all the state income tax collected in New Jersey comes from upper income households than from elsewhere. But does this really answer the question?

The more practical answer is this: most upper income New Jersey residents, irrespective of their percentage of contribution to state revenues via the income tax, pay significantly less on average than income counterparts in other parts of the nation. In comparison, then, it could be reasonably argued that they are paying less than their fair share. With burgeoning property taxes, and significant increases likely to continue-given the federal government's steady pattern of tax cuts and devolution of responsibilities to states-there will be continued pressure on New Jersey to generate more tax revenues.

Clearly there is room for some, if not most, of those additional revenues to be generated from state income taxes rather than from increases in regressive state sales or local property taxes. New Jersey must face up to the reality that while its state income tax structure is technically progressive, most upper income citizens pay a lower percentage of their income toward the income tax than their counterparts in other states.

Some critics contend that increasing dependence on state income tax revenue is risky because this is a highly volatile revenue source subject to falloff in recessionary times such as these. But the corollary makes a compelling case: an increasingly progressive tax generally will allow a state's tax revenue to grow along with the economic growth of the state. Because New Jersey's economy grows on an annual basis far more often than it shrinks, the benefit in terms of state tax revenues is obvious. The burden would then be on state fiscal policymakers to husband increasing revenues during good times and avoid the soaring debt, cost shifting and other actions that helped make the transition from the prosperous 1990s to the present so traumatic.

In other words, rather than creating a tax system that does not fully get the benefit of economic upsurges, the state should opt for the money-but use it well.

A moderate, balanced restructuring of the New Jersey income tax need not be complicated. A reasonable recommendation would be to make multiple incremental increases in tax rates only at higher levels of income. This would have several benefits:

No tax plan is perfect, and it is always difficult to analyze one specific part of a state's tax structure without considering all the others, including local taxes. But the statistical evidence shows that modest increases in upper income tax rates would still keep the great majority of high-income New Jersey earners below nationwide state income tax averages. This is a strategy that would help correct the state's current financial deficiency and at the same time provide more substantive growth in state tax revenues as the economy grows.

John W. Zerillo is an Assistant Professor of Business Administration at St. Joseph's College in Standish, Maine. A graduate of Rutgers University, he runs a financial consulting firm and has written extensively about state income taxes. The information discussed in this report comes from a nationwide comparative state income tax analysis he co-wrote with Aaron Perkins.

Material on the expanding role of state income taxes and issues of equity relies heavily on an excellent publication by the National Conference of State Legislatures called Tax Policy Handbook for State Legislators.