Explainer: Why NJ may lower its sales tax rate

New Jersey’s sales tax may drop under a plan being debated in the Legislature. 

What it is: At the heart of a new bill that was abruptly passed by the state Assembly early yesterday amid a flurry of backroom negotiations between Gov. Chris Christie and Assembly leaders is a proposed 1 percent reduction of New Jersey’s 7 percent sales tax.

The cut would be phased in, starting at 0.5 percent next year and reaching the full 1 percent in 2018. It would come as part of a broader deal to renew the state Transportation Trust Fund (TTF) for another 8 years with a 23-cent gas tax hike.

What it means: The Senate has yet to consider the proposal, but if it were to be enacted, the sales-tax cut would represent New Jersey’s first reduction of a broad-based tax since 1994. It would also come at a time when the state has been experiencing revenue problems, including a $600 million budget hole that had to be closed with a series of cuts and other adjustments just last month.

The budget impact of the proposed sales-tax cut would start out modestly at $376 million during the 2017 fiscal year. And because it is part of a broader plan that involves the gas-tax increase to shore up the TTF, the cut would initially free up roughly $350 million in sales-tax revenue that’s currently being used to prop up the deeply indebted trust fund.

Going forward, the impact of the sales-tax cut on the budget would rise to an estimated $1.6 billion once fully phased in during the 2019 fiscal year, according to the nonpartisan Office of Legislative Services. Because all of the more than $1 billion in annual revenue that would come in from the 23-cent gas-tax hike would be constitutionally dedicated to funding transportation projects, the hit from the sales tax cut on the state budget would not be offset, leaving a wide gap.

Christie and other supporters predict that gap would be closed by economic growth, but if that growth doesn’t materialize, the hole would have to be filled with spending cuts or other tax hikes since the state constitution requires a balanced budget.

Complicating the issue even further is a planned constitutional amendment, backed by Democratic legislative leaders and public-worker unions, that calls for revenue growth to help fund a series of ramped-up state contributions to the grossly underfunded public-employee pension system. If voters approve the amendment this fall, it would mandate spending on the pension payments to increase from $1.3 billion this fiscal year to over $3 billion just as the full impact of the sales tax-cut would take effect.

History of the sales tax: New Jersey’s sales tax is rooted in a 1966 law that established a 3 percent rate. That was increased to 5 percent in 1970, and to 6 percent in 1983. The rate was lifted to 7 percent in 1990 under then-Democratic Gov. Jim Florio, only to be reversed in a backlash in 1992.

Another increase restored the rate to 7 percent in 2006 under then-Democratic Gov. Jon Corzine, but only after a six-day shutdown of state government. At the same time, the range of services that are subject to the sales tax was expanded, though New Jersey still offers exemptions for clothing, groceries and necessities, maintaining the progressive nature of the tax.

Unlike many other states, New Jersey doesn’t allow sales taxes to be levied at the local level. In fact, specially designated Urban Enterprise Zones allow many struggling downtowns to charge a lesser rate of 3.5 percent.

Sales tax collections have been on the rise: While income tax is subject to significant volatility, the sales tax has been a steady performer for the state budget over the last several years. It generated $7.5 billion in revenue during the 2010 fiscal year, and $7.8 billion during the 2011 fiscal year. Sales tax collections then steadily improved from $8 billion during the 2012 fiscal year to $8.8 billion through the 2015 fiscal year. The latest projection for the current fiscal year, which ends at midnight tomorrow, is for $9.3 billion, and Christie’s administration is forecasting a $9.6 billion haul during the 2017 fiscal year.

An alternative tax cut: The proposal featuring the sales-tax cut that has emerged this week actually is an alternative to another bipartisan plan that came out of the state Senate earlier this month.

That plan, sponsored by Sens. Paul Sarlo (D-Bergen) and Steve Oroho (R-Sussex), also features a 23-cent gas-tax hike, but instead of a sales-tax cut it calls for phasing out New Jersey’s estate tax and making a series of other tax cuts. They include lifting state income-tax exemptions on pensions, 401(k) plans, and other sources of retirement income over the course of several years. The Sarlo-Oroho plan would cost an estimated $870 million once all the cuts were fully implemented.

The new proposal, backed by Christie and Assembly Speaker Vince Prieto (D-Hudson), scraps most of the tax cuts that are included in the Sarlo-Oroho plan in exchange for the sales-tax reduction. It does, however, keep changes to retirement-income exemptions that the two senators proposed, adding another $200 million to the potential cost of the Christie-Prieto plan.

What advocates on both sides are saying: Republican lawmakers are lauding what they say would be a tax cut for all residents, and a full reversal of the Corzine sales-tax increase from 10 years ago. Christie made a pitch for the latest plan during a public event on school funding that he held in Wall yesterday. He said the gas-tax hike would cost the average motorist about $200 more a year, while the sales-tax cut would save the average consumer $465.

“You all deserve to have your expenses lowered a little bit,” Christie said.

Alarms are being sounded, however, about the proposed sales-tax cut by New Jersey Policy Perspective, a liberal think tank based in Trenton. A joint analysis by NJPP and the Institute on Taxation and Economic Policy determined the sales-tax cut combined with the proposed tax-policy changes to sources of retirement income would give 74 percent of the proceeds of the cuts to the top 40 percent on the income scale. The bottom 40 percent would get just 9.5 percent, according to the analysis, which is scheduled to be released today.

What happens next: The Senate adjourned on Monday before considering any proposals related to renewing transportation funding or cutting taxes. But the Senate is back in session tomorrow, setting the stage for what is expected to be another long day of nip-and-tuck negotiations.

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John Mooney contributed to this story. NJ Spotlight, an independent online news service on issues critical to New Jersey, makes its in-depth reporting available to NewsWorks.