Report :: YOU'RE 40; NOW GET TO WORK: Making the State Sales Tax Pull its Weight by Mary E. Forsberg

In many ways, modern New Jersey first started to take shape in 1966-and it took a tax to make things happen. The state sales tax as it exists today began in that year, giving New Jersey for the first time enough resources to help make a truly positive difference in the lives of its citizens. One of the initial impacts of the new revenue stream was expansion of the state college system, opening the doors of in-state higher education to many more New Jerseyans than ever had the chance before.

Before 1966, the only taxes that individuals in New Jersey paid to the state were on the purchase of gasoline, tobacco products and alcoholic beverages. Yes, it was cheaper. But, arguably, people got what they paid for. New Jersey today is a different place, a better place. Now, as the sales tax marks its 40th birthday, it is time to ask some important questions of this levy. Is it doing all it can to support the needs of 21st century New Jersey? Is it in step with the times or stuck in the past? Is the tax as fair as it could be?

This report addresses those and other questions. It offers a contemporary look at a middle-aged tax, in the larger context of how New Jersey can meet its short- and long- term revenue needs and serve the people who live and work in the state.

In most of the United States, when someone buys something, a few cents per dollar are added to the price and sent to the government to pay for various programs and services. This is a sales tax: a tax on a transaction. In many instances, the tax is hardly noticed, if at all. Other times it can be the focus of considerable resentment. But, over the years, sales taxes have come to be hardy, reliable-and crucial-sources of revenue for the jurisdictions that levy them.

And almost every state does levy them. The five exceptions are Alaska, Delaware, Montana, New Hampshire and Oregon. Additionally, in 35 states, counties and municipalities can levy sales taxes. New Jersey is not one of them.

There are two types of sales taxes: general and excise. The general sales tax applies to a broadly-defined base: consumer purchases of goods and also services-like buying a television or renting a car-at the retail level. Excise taxes are imposed on specific items, usually gasoline, alcohol and tobacco (giving them the nickname of "sin taxes"). While people with no or very little income pay no income tax, it can safely be said that everyone pays sales taxes.

Of the $650 billion that state governments collected last year from all sources, 34 percent came from personal income taxes, 33 percent from sales taxes and 15 percent from excise taxes. (See Table 1.) As a percent of total taxes, Vermont relied least (14 percent) on sales taxes while Washington relied most (62 percent). Of the states that levy little or no income tax, six (Florida, Nevada, South Dakota, Tennessee, Texas and Washington) collect more than 75 percent of their revenue from a combination of sales and excise taxes.

New Jersey's reliance on general sales taxes is, at 29 percent of total revenue, below the national average. The state is, at 16 percent, slightly above the national average for excise taxation.

The sales tax may be calculated as a percentage of sales price (say 6 percent on a $10 purchase) or on a fixed amount per unit of product (6 percent on a gallon of gasoline or $2.05 on a pack of cigarettes). The first is a tax on value; the second is a tax on quantity.

The rate of tax that states levy on purchases varies considerably. (See Table 2.) Among the 45 states with a general sales tax, Colorado's is lowest at 2.9 percent. The highest, 7 percent, is in Mississippi, Rhode Island and Tennessee. However, with local rates that range from 0.25 percent to 8 percent on top of the state sales tax, the total sales tax in Alabama can be as high as 12 percent, tops in the US. Though New York State levies a 4 percent sales tax, county and city rates add from 3 percent to 5.5 percent. So the total sales tax levy ranges from 7 percent to 9.5 percent, depending on where a transaction occurs. In New York State, 79 counties and cities levy sales taxes.

But, knowing the sales tax rate is not enough to compare the tax burden from place to place because there also are wide variances in what is taxed. For example, 20 states levy sales tax on food purchased in a grocery store. (See Table 3.) In some states, food is taxed at a lower rate than other purchases. In others, it is subject only to a local sales tax. Only Illinois taxes prescription drugs, but 37 states tax non-prescription drugs. There are 22 states that tax residential natural gas; 23 tax home heating oil; 24 tax residential electricity; 12 tax water; and 10 tax sewer services. Minnesota and Wisconsin exempt purchases of oil and natural gas in the winter months. Maine exempts a portion of electricity purchased. Tennessee and Utah charge sales tax on utility bills, but at a lower rate than other purchases.

Every state but seven taxes at least some clothing purchases. The exceptions are Delaware, Minnesota, New Hampshire, New Jersey, Pennsylvania, Rhode Island and Vermont.

The first taxes widely levied by states on commodities were excise taxes on gasoline and tobacco products. Oregon imposed the first gasoline tax in 1919 (but interestingly has never imposed a general sales tax). By 1929, every state had recognized the revenue potential of taxing gasoline and enacted a gas tax. During the 1930s and 1940s the gas tax was the most important funding source for state governments, yielding one quarter or more of their revenue.

The success of excise taxes held back development of general retail sales taxes in the 1920s. Like today, states worried that consumers would take their business across the border to tax-free states elsewhere, and they were conscious of the US Supreme Court's concern about taxes inhibiting interstate commerce. The Depression changed things. General sales taxes were seen as a revenue source that could hold up in bad times, unlike income and property taxes-which tend to fluctuate more widely with economic conditions. Mississippi was first to enact a sales tax. Desperate for additional revenue, the state converted its business occupation levy into a 2 percent tax on retail sales. By 1938, 29 states-including New Jersey-had adopted a general tax on retail sales. By 1944 the general retail sales tax was state government's most important revenue source.

Like many states suffering from the effects of the Depression, New Jersey imposed a 2 percent general sales tax in 1935. All sales tax revenues were appropriated "for the relief of unemployed and dependent persons, to reduce general property taxes, for the expenses of administering the act and for refunds due any person under the provisions of the act."

Because other excise taxes already were levied on them, New Jersey (and most other states) exempted motor fuels, alcoholic beverages, gas, electricity, water, fertilizer and commercial feed from the sales tax. Also exempt were magazines and newspapers and transactions made by the state and federal government. The sales tax lapsed June 13, 1938. New Jersey would not enact a sales tax again until 1966, making it one of the most recent six states to do so.

Forty years ago, Gov. Richard J. Hughes tried unsuccessfully to get the Legislature to adopt a state income tax, primarily to expand the state's higher education system. Legislators balked (it would be 1976 before the income tax came), and Hughes had to settle for a 3 percent sales tax in 1966. New Jersey's sales tax rate rose to 5 percent in 1970 and remained unchanged for more than a decade until 1983. The table below details the history of sales tax rates in New Jersey.

Over the course of 40 years, New Jersey has not undertaken a comprehensive assessment of what should and should not be taxed. Though the state's sales tax law has been amended frequently since 1966, most changes have been relatively small. In many cases, revisions were aimed at promoting or discouraging particular behavior or in response to the desires of specific businesses or industries. Some examples:

Although New Jersey does not allow local governments to levy general sales taxes, it does allow them to tax certain things for local benefit. Among the taxes permitted in New Jersey:

It is less common in the Northeast for local governments to levy sales taxes than it is in other parts of the country. For some local governments, sales taxes represent significant tax revenues. Several cities-including Tucson, Denver, Omaha and Tulsa-have collected 20 percent of their tax revenue from the sales tax.¹

With a state tax rate of 6 percent and no local sales taxes, New Jersey is slightly above the national 5.32 percent state-only average, but below the combined 7.48 percent state-local rate. (See Table 2.)

Another way to measure sales tax burden is on a per capita basis, dividing the revenue raised in a state by the number of people that live there. (See Table 4.) For general sales tax, this ranges from a low of $408.84 per year in Virginia to a high of $1,675.77 in Hawaii. New Jersey's general sales tax per capita ranks 20th in the nation at $751.57. Excise taxes per capita range from $182.63 in Georgia to $750.08 in Vermont. New Jersey's excise tax per capita is $415.21, 17th in the nation. Combining the general and excise tax burdens yields a low of $192.07 per capita in Oregon and a high of $2,155.78 in Hawaii. New Jersey's combined general and excise sales tax per capita is $1,166.78, 14th in the nation.

Since these data include only state-level collections, states where county and municipal governments levy sales tax show a lower burden than they would if those taxes were included in the totals. In New York, for instance, the state collected $10.6 billion in sales and use taxes but local governments took in $10.8 billion in Fiscal Year 2004-2005.² When these local sales taxes are counted, per capita collections in New York more than double on a per capita basis. When state and local sales tax combined are measured as a percentage of income, New Jersey ranks 43rd, at 2.7 percent. Hawaii and Louisiana are highest at 6.4 percent; Oregon is lowest among states with any sales tax, at 0.9 percent.³

Operating a sales tax system is not as easy or straightforward as it might sound. As a practical matter, there are decisions to make that have economic, societal and political ramifications-all of which shape the process.

One of the most fundamental questions is what to tax. The answer varies considerably from state to state. Then there is the matter of what the tax rate should be-what percentage tax is levied on each transaction. The answer to the first question has a lot to do with the answer to the second: the more items that are exempt from sales tax, the higher the rate needs to be on what is taxed in order to bring in the same amount of revenue. In other words, the broader the base, the lower the rate can be. If all consumption were taxed, one of two outcomes would result: either the state would collect twice the revenue it collects without changing the tax rate (since about half of the economy is exempt from sales taxes); or the rate could be lowered but the revenue from the tax would be the same. For example, food purchased in grocery stores for consumption alone constitutes about 20 percent of the sales tax base in the United States. More than half of states do not tax food.⁴ While there may be good reasons not to tax food, the policy has an impact on state revenue.

By exempting some items from the sales tax, governments decide to take in less money in return for what is seen as a public benefit-such as not taxing items considered to be necessities. But these exemptions add another dimension to sales tax considerations: how stable a source of revenue the tax will be. The reality is that the more goods and services taxed, the more stable the revenue during economic downturns and the lower the tax rate that can be levied. To use an extreme example, if a state only taxes car sales and fewer cars are sold, revenue from the tax would drop. But if a state taxes expenditures on food and clothing, for which demand is high in good and bad economic times, the tax collected will be less subject to fluctuations-much like an investor diversifying his or her portfolio.

Discussions of the sales tax do not go on very long without the important concern of fairness being raised. Indeed, the sales tax involves the need to weigh the trade-offs of collecting substantial revenue against over-burdening segments of the population. Fairness in taxation requires that people in similar financial circumstances be treated equally and that people who are better off contribute more than those who are less well off.

On one level, taxing more things makes a sales tax more fair. Using examples found in New Jersey's sales tax, why tax natural gas and electricity used to heat a home but not home heating oil? Why tax broadband access to television but not cable access or satellite TV? Why tax the person who rents a movie at a video store but not the person who watches a pay-per-view movie on cable TV? In each case, taxing one but not the other creates inequity among consumers. It also makes administration more complicated and increases the likelihood that some tax will not be collected because merchants will not realize it is supposed to be.

Perhaps the main issue of fairness that arises over sales taxes is the regressive nature of the levy. The term refers to a tax where the lower someone's income is, the higher the percentage of that income he or she pays in tax. While it is true that a wealthy person is likely to spend more than a low-income person and thus pay more in sales tax, higher-income taxpayers do not consume their entire incomes and the portion they save is not subject to sales or consumption taxes. Another way to look at this is with a hypothetical comparison of purchases. Someone making $500,000 a year buys a $60,000 car and pays $3,600 in sales tax. Someone making $30,000 a year buys a car for $8,000 and pays $480 in sales tax. Clearly, the higher income person pays more tax. But, for the person making $500,000 the tax amounts to 0.0072 of total income. For the person making $30,000, the tax comes to 0.016 of income. When the full range of transactions is taken into consideration, the sales tax ends up being a bigger burden as a percentage of income for a lower income person than it does for a higher income person.

But, not everyone buys everything. There are many items that rich people are far more likely to buy than are poor people. Sometimes the decision on what to tax or not tax adds to regressivity. For example, hiring a limousine with a driver is not taxed in New Jersey, but renting a car is. Laundry detergent is taxed but having clothes cleaned at a laundry is not. Tickets to a sporting event are taxed, but the $30,000 membership fee to a golf club is not. In all three cases, the activity most likely to be undertaken by a lower or middle income person is taxed and that most likely for a higher income person is not.

Sales taxes are the most regressive when basics such as food, clothing and prescription drugs are included in the tax base. New Jersey and many other states have decided to minimize the regressive aspect of sales taxes simply by exempting certain purchases from the tax.

But the argument can be made that this practice costs the state much-needed revenue that could be raised relatively painlessly from some of the population. A case in point: exempting clothes means a low-income family pays no tax on their baby's winter snowsuit; but it also means a billionaire who buys a $3,000 fur coat, and could easily afford the $180 sales tax on it, is let off.

Five states address the issue of regressivity a different way, by offering a credit to the elderly, poor and disabled that represents a portion of the sales tax paid for necessities. (See Table 3.) This involves a yearly refund based on the amount of sales tax it is estimated that someone at a particular income is likely to pay. In Kansas, for example, taxpayers over 55, taxpayers with children under 18 and disabled taxpayers receive $72 per person if their family income is below $13,450 and $36 per person if it is below $26,900. Of course, the tax relief is not as immediate as it would be if items were exempted from the tax in the first place. And tax credits require people to fill out paperwork, raising the possibility that some who are eligible for credits will fail to seek them. On the other hand, under such a system the state collects considerable sales tax revenue from those who are not eligible for a credit because, arguably, they can afford the tax.

Another way to offset the negative impact of sales taxes is to introduce progressive elements elsewhere in the tax system. One method is to have a graduated state income tax structure. Another is to increase the amount of money a person or family is allowed to make before having to pay state income tax. Gov. Jon S. Corzine has proposed such a measure. A third way is to increase assistance for low-income working poor families through programs like the Earned Income Tax Credit.

The nature of the US economy has changed dramatically since sales taxes first were imposed. What we have come to call services-as opposed to tangible goods-were a much smaller segment of all transactions than they are today. The Internet, cell phones, dating services, tanning salons, cable TV, health clubs-those are just a few examples of things people pay for today that did not exist when sales taxes were conceived.

Just since 1979, services as a share of personal consumption have increased from 47 percent to 58 percent: less than half of Americans' consumer spending is now on tangible goods. To varying degrees, states have broadened their sales tax bases to include more services, yet only three states-Hawaii, New Mexico and South Dakota-get a significant portion of their revenue from services. Many activities that would yield the most revenue (including such professional services as consulting, lobbying and legal) remain largely untaxed. As consumption patterns have changed, the decision not to tax services has contributed to the need over time to increase sales tax rates in order to maintain revenue from the tax.

As services become an ever-more important part of the consumer economy, a strong case can be made for taxing more of them. Doing so can help make a tax system fairer, more stable and easier to administer. And, after all, the sales tax is intended to be a tax on general consumption.

The Center on Budget and Policy Priorities has estimated that the annual nationwide revenue yield from taxing all services purchased by households except health care, education, housing and a few others would be on the order of $57 billion. Actual new revenue would be less, since most states already do tax some services. Extrapolating from the national estimate, taxing all services in New Jersey could provide up to $2.6 billion annually in state tax revenues (some of which already is being collected).⁶

All 50 states exempt some or all of a host of services: housing, health and medical, personal, legal and business. To catalog states' experiences, the Federation of Tax Administrators (FTA) surveyed states in 1990 and regularly updates its findings to add new services. The most recent update, in 2004, included for the first time dial-up and broadband Internet access, direct satellite TV and architectural services-bringing the total services surveyed to 168. (See Appendix for the table comparing the taxation of services in New Jersey, New York, Pennsylvania and Connecticut and summarizing the number of states that tax each service.)

In recent years, states have made only minor changes in the types and number of services they tax. For example, four states in 1990 taxed barber and beauty services; in 2004 seven did. In 1990, accounting, engineering, architectural and legal services were each taxed in three states. In 2004, five taxed them. Nor has any state undertaken a broad expansion of its tax base since budget problems led Florida to do so in 1987 and Massachusetts in 1990. The Massachusetts sales tax was expanded to include luxury services such as athletic club fees and landscaping services over a certain amount, and the professional services of lawyers, architects, engineers and accountants. Both states subsequently repealed the taxes. More recently, Florida Senate President John McKay proposed a plan he said would save the average household more than $100 annually by lowering the sales tax rate from 6 percent to 4.5 percent and taxing architectural services, attorney's fees, consultants, accounting and freight delivery. The plan went nowhere.⁷

Hawaii and New Mexico, with state sales tax rates of 4 percent and 5 percent respectively, tax more of the 168 services surveyed by the Federation of Tax Administrators than any other states (160 and 156 respectively). Only seven states (Delaware, Hawaii, Iowa, New Mexico, South Dakota, Washington and West Virginia) tax more than 50 percent of the services surveyed. The ranking for Delaware, which does not levy a sales tax, is attributable to the broad-based gross receipts and occupational taxes it levies on most businesses. The FTA decided to include these taxes in its survey because it believes they are most likely paid by consumers, making them substantially like sales taxes.

At the other end of the spectrum are Alaska, Colorado, Illinois, Massachusetts, Montana, Nevada, New Hampshire and Virginia-each of which taxes fewer than 20 services. Oregon taxes none. New Jersey taxes 65 of the services on the list, or just under 40 percent of all that are surveyed.

In addition to what things people buy, another huge change in the national economy concerns where they buy them. Sales from catalogs and, increasingly, from vendors on the Internet are becoming commonplace for many consumers. It has been estimated that between 2001 and 2011, state and local governments will lose $400 million in sales tax revenue because of remote purchases from out-of-state vendors who sell things to that state's customers but have no physical presence in a state and do not collect the tax. In many cases these are items that would be taxed if bought by a New Jersey resident in New Jersey. If a merchant has actual stores in New Jersey, consumers from New Jersey who buy from that merchant online or by mail order do have to pay sales tax.

Congress has failed to require sellers of all types of commerce to collect sales and use taxes, creating a situation many say puts local businesses at an unfair disadvantage against online retailers that can, in effect, charge less. Absent Congressional action, sellers without a physical presence can volunteer but have not been required to collect the tax. The US Supreme Court has determined it is unconstitutional under the Commerce Clause to require sellers with minimal presence in a state, such as catalog sellers, to collect sales tax. Information provided to the New Jersey Sales and Use Tax Review Commission indicates that more than 15 national retailers with dot-com and/or catalog companies voluntarily agreed to collect sales taxes on remote sales and remitted approximately $10 million over the 18-month period surveyed.⁸

One of the most significant changes in New Jersey's sales tax rules in recent years came when the state agreed to participate in the national Streamlined Sales Tax Project.⁹ The project began in 2000 as a cooperative effort of the National Conference of State Legislatures, the National Governors Association, the Federation of Tax Administrators and state governments to simplify and modernize sales and use tax laws in order to make multi-state tax administration and compliance easier. Collecting sales taxes on transactions is complex for vendors that make sales throughout the US and are responsible for complying with roughly 7,500 state and local tax jurisdictions that charge sales tax on different items and at different rates. It is clear that sales tax administration can be simplified if every jurisdiction uses a common definition, taxes are remitted to fewer administrative locations and information on all state and local tax rates is easily available.

The Streamlined Sales and Use Tax Agreement (SSUTA) established common definitions across states, providing for uniform determinations of what is and is not subject to sales tax. For example, if a state chooses to tax candy and is part of the SSUTA, it will define candy in the same way as every other member state. Although each taxing jurisdiction must use the same definition, it retains the right to decide whether or not to tax the item being defined.

On October 1, 2005, New Jersey adopted the provisions of the Streamlined Sales Agreement. It has made for some interesting changes in what the state now taxes because the state must conform to common definitions. Generally, New Jersey does not tax food but does tax soft drinks and candy. Under the Streamlined Sales Agreement, candy is defined as a preparation of sugar, honey or other sweeteners in combination with chocolate, fruits, nuts or other ingredients in the form of bars, drops or pieces. But if that product contains flour or requires refrigeration, it does not fall into the category of "candy" and is not taxable unless the state taxes non-candy foods. Because of this, Kit Kats, Twix, Nestle Crunch, Milky Way and some licorice now are not taxable as candy because they contain flour. For New Jersey to tax these candies, all states would have to agree to amend the definition of candy under the Streamlined Sales Agreement, or New Jersey would have to tax food in general.

The Streamlined Sales Agreement also changed New Jersey's definition of a soft drink. Previously, carbonated drinks were subject to sales tax and non-carbonated drinks were not. Coke and club soda were taxed; Kool-Aid and Gatorade were not. Under the new definition, non-alcoholic soft drinks are taxed if they contain sweeteners. Designer water, sweetened ice tea, sodas and Gatorade are now taxed whether carbonated or not. But any drink containing milk or milk products, soy or other milk substitutes or more than 50 percent fruit or vegetable juice is not taxed. Not taxed are unsweetened water regardless of carbonation, fruit or vegetable drinks containing more than 50 percent juice by volume, nutritional drinks that contain soy (Ensure, Boost), apple cider, beverage powders (Kool-Aid, lemonade, sweetened ice tea) and frozen fruit juice concentrates regardless of percentage of juice.

Even with its general exemption for clothing, New Jersey had always taxed furs. But under the Streamlined Sales Agreement, fur is defined as clothing and so cannot be taxed by a state that exempts clothing. Only storing a fur is taxable now in New Jersey.

The sales tax in New Jersey is a generally stable source of revenue for the state that in most years has grown at a steady rate. The tax has consistently produced between 20 percent and 30 percent of state government resources. But, as can be seen in Table 5, the 59 percent growth in sales tax revenue since 1995 seriously lags behind the growth in collections from the state's gross income tax (110 percent) and corporate business tax (118 percent)-and behind overall state revenue growth (88 percent).

In other words, the sales tax in New Jersey is not living up to its potential as a revenue source.

In 1990, New Jersey's large budget shortfall and growing concern over property tax increases led to a short-lived increase in the sales tax rate from 6 percent to 7 percent and expansion of the tax base to cover more goods and services. The fundamental basis for these changes came from the bipartisan State and Local Expenditure and Revenue Policy Commission (SLERP), created in 1984 under Gov. Thomas Kean. The SLERP Commission was asked to study a range of issues, including the effects of mandated spending and such aspects of New Jersey's tax system as its impact on the state's economic vitality, long-term adequacy for funding major state services, equity and efficiency.

The Commission, which finished its work in 1988, made many recommendations. And while it did not call for increasing the sales tax rate, SLERP did investigate and explain the impact of broadening the sales tax base by extending sales taxes to items that, at that time, were exempt. Its research showed that broadening the tax base would allow the state to more than double sales tax collections or, alternatively, lower the tax rate. (See Table 6.)

In Fiscal Year 1986, on which the commission based its findings, New Jersey collected $2.529 billion in sales tax revenue. The state instead could have collected $5.524 billion from the sales tax, or lowered the tax rate from 6 percent to 2.7 percent if all current exemptions-including food, clothing, newspapers and magazines, professional services, drugs and medical supplies-had been eliminated.

More specifically, the Commission said that taxing utility bills would increase sales tax revenues by 26 percent or, alternatively, permit a statutory tax rate cut to 4.7 percent. Other base-broadening options included taxing food, which would increase sales tax revenues by 21 percent or allow a tax rate cut to 5 percent; clothing, which would increase revenues by 12 percent or allow a rate cut to 5.3 percent; services to individuals, which would increase revenues by 4 percent or allow a rate cut to 5.8 percent; and professional services, which would increase revenues by 20.9 percent or allow a rate cut to 5 percent.

Over the past two decades, the SLERP options for possible base expansion largely have been ignored. But, though they were based on 1986 collections, these projections can be applied to more recent collections to come up with a workable estimate of possible additional revenues or tax rate reductions. If similar a analysis were applied to the $6.552 billion in sales taxes collected in Fiscal Year 2005-taking into account methodological issues from changes in relative consumption, cost of goods and services evaluated by the SLERP Commission and the base expansions that have occurred-New Jersey could still nearly double the amount it collects and have one of the broadest tax bases in the nation.

More recently, in April 2004, an analysis by the state Division of Taxation prepared for The Star-Ledger¹⁰ found that New Jersey could raise up to $2.2 billion if sales taxes were levied on just seven services the state currently does not tax. The estimates were that a sales tax on consulting would raise $462 million; legal services $449 million; computer systems design $381 million; architectural, engineering and related services $379 million, accounting $297 million; advertising $146 million; and data processing $128 million.

These services are used more by businesses than households, creating a potential problem. Some analysts worry that certain necessities, such as food, can end up being more expensive as businesses each step of the way add in the sales taxes they must pay (e.g. the farmer, the processor, the trucker and then the market). Another is that these taxes can distort the allocation of economic resources, as large businesses, wherever possible, would internalize these services by hiring their own advertising, data processing, security and commercial art staffs to avoid the tax.

The most recent attempt to get more from sales taxes came when Gov. Richard J. Codey in 2005 proposed an initiative he said would raise $275 million by expanding the sales tax base to more services. None of the proposed changes were enacted and they have resurfaced in the Fiscal Year 2007 budget proposed by Governor Corzine in March 2006. His budget predicts annual revenue gains of $330.6 million. Corzine also has proposed increasing the sales tax rate to 7 percent to raise an additional $1.085 billion in the next fiscal year. The proposed base-broadening is detailed in Table 7.

Over the last five years, more than 100 pieces of legislation have been introduced to change the terms of New Jersey's sales tax. Under law, since 2000, all such legislation must be reviewed by the state Sales and Use Tax Review Commission. It makes recommendations based on such considerations as whether the tax burden is fairly shared among taxpayers, retailers can figure out the rules without interpretive regulations, the impact on economic and financial decisions in order to minimize its impact on the marketplace and keeping administrative costs borne by the state and retailers as low as possible.

Many of the Commission's comments are insightful with regard to concerns about shrinking the sales tax base and creating disparities in coverage. For example, in 2002 the Commission argued against a "sales tax holiday" popular in many states, where certain items are removed for a week or so from taxation. It said such an exemption would:

further alter the broad-based nature of the sales and use tax. A broad-based tax, imposed with limited exemptions on a wide range of transactions, is easy to understand and administer, and is generally perceived as economically neutral and 'fair.' When imposed at a fairly low rate, the burden, per transaction, on the individual taxpayer, is relatively small, but the cumulative revenue generated can be enormous. [A(n) exemption or a sales tax holiday] would save an individual purchaser a fairly insignificant sum. However, the cumulative loss of revenue, some of it unintended, to the state could be substantial. This leaves the state to find other means of generating the moneys lost as a result of an expanded exemption that has little to recommend it as a matter of tax policy.¹¹

Much of the legislation the Commission has reviewed would have extended to more parts of the state the Urban Enterprise Zone program, under which businesses are exempt from sales tax and consumers pay 3 percent instead of 6. On this, the Commission was equally direct:

This legislation exacerbates the ongoing problem created by the increasing number of communities that have been designated urban enterprise zones under the UEZ program. As more zones are authorized, surrounding communities claim a negative economic impact that causes them to seek similar tax advantages... A destructive cycle of economic cannibalization is inevitable when government creates a favorable tax situation in multiple districts scattered across a densely populated state like New Jersey. Assuming a somewhat inelastic level of retail purchases, as the number of zones increase, so does the negative impact of shifting economic growth from one municipality to another.¹²

It is time to revisit New Jersey's sales tax in a clear-headed and thorough manner. There needs to be broader discussion about what this tax can be called on to do for the public good. What follows are some ideas as to where that discussion could go.

Review all current exemptions from the sales tax to see if some should be eliminated.

Table 8 estimates the revenue New Jersey would collect by eliminating the exempt status of various goods and services and broadening the base. For example, revenues from imposing the sales tax on motor fuels sales in New Jersey would add $928 million in sales tax revenue to the $6.6 billion in sales taxes collected in Fiscal Year 2005. The state could also choose to tax services listed below. Taxing all of them would raise an additional $2.8 billion. If it chose to enact every base-broadening suggestion in the table, New Jersey would expand the sales tax base by 85 percent and, by doing so, could raise an additional $5.6 billion.

Alternatively, if the state decided it could afford to forego the revenue, it could choose to lower the tax rate instead of collecting the additional revenue. If the state chose to enact every base-broadening suggestion in the table, the overall sales tax rate could be reduced to 3.2 percent with the same amount of revenue being collected.

Levy the 6 percent sales tax on motor fuels: On the sale of gasoline alone, this could generate up to $723 million based on $3.00 a gallon gas prices.

Many states impose more than just a gas tax on the sale of motor fuels. Seven-California, Georgia, Illinois, Indiana, Michigan, New York and Virginia-levy the state sales tax in addition to the gas tax. Connecticut levies a 5 percent gross earnings tax on the sale of motor fuels. In addition to state taxes, 14 allow local governments to levy additional local option taxes on the sale of motor fuels. These taxes add an average of 14.0 cents to those states' gas tax.¹³

Since 2002, sales tax revenues on gas in California have grown annually by $300 million to $400 million to reach $2.8 billion in 2005, according to the California Board of Equalization.¹⁴ The higher cost of gasoline is one reason California has seen a sizeable revenue windfall this year.

At 10.5 cents per gallon, New Jersey's is the third lowest gas tax in the US after Georgia (7.5 cents per gallon) and Alaska (8 cents). While most gas taxes in New Jersey are dedicated for transportation funding, the sales tax would generate substantial revenue which could be used more generally. Unlike gas tax revenues, which only increase when rates increase or more gallons of gas are used, a sales tax is responsive to gas price changes.

Eliminate complicating exemptions: The amount of money this would generate is difficult to determine but the administration of the system would be simplified.

Many oddities exist in the current tax code where substantially similar products are taxed differently. For example, natural gas for home heat is taxed but oil is not; cloth and plastic bags, plastic placemats and plastic or foam dinnerware are taxed but paper bags, paper placemats and paper plates are not; rug cleaners and deodorizers and the equipment needed to do the job are taxed but hiring someone to do the job is not; pumpkins used for decoration are taxed but pumpkins for food are not; Snickers candy bars are subject to tax as candy but Milky Way candy bars are not as a result of the Streamlined Sales Tax Agreement. The state should review the tax status and eliminate such inconsistencies.

The only way to rectify the inconsistencies of taxing pumpkins and candy bars is to consider a sales tax on food. This should be considered only in combination with a credit system to offset the most regressive impact of such an expansion.

Raise the income tax threshold; create a sales tax credit and/or expand the Earned Income Tax Credit to offset the negative effects of increased consumption taxes on lower income residents.

In his Fiscal Year 2007 budget, Governor Corzine proposed eliminating the state income tax burden on married couples with incomes below $25,000 and singles with incomes below $15,000, and to reduce the burden on couples with incomes up to $30,000. His proposal would have the effect of being a 100 percent credit against sales tax increases that would be paid by New Jerseyans at those income levels, at the cost of $105 million in Fiscal Year 2007.

The federal government enacted a sales tax credit in 2004 allowing taxpayers to itemize deductions for either their state and local income taxes or their sales taxes. The credit allows New Jersey residents to deduct between $178 and $2,081, depending on their income exemptions-more if they can prove they paid above what the IRS table says is standard for that income level. A similar credit in New Jersey can help alleviate the negative effects of an expanded sales tax. The $178 deduction for New Jersey assumes a taxpayer spent $2,967 on goods or services that were subject to the state's 6 percent sales tax.

Among states with a state Earned Income Tax Credit, only New Jersey cuts off eligibility when a household reaches $20,000 in annual income-a figure that next year will be below the federal poverty line for families of some sizes. By increasing eligibility, based on family size, to as much as the $37,000 (for two or more children) allowed by the federal EITC and other states, New Jersey would provide the working poor with further relief from the regressivity of the sales tax, while also having available more sales tax revenue that could be used to expand health care coverage and other programs for low-income persons.

Expand the number of services taxed. The relatively modest additions proposed by Governor Corzine identify up to $330 million in new revenues; far more could potentially be raised.

Taxing certain services helps to mitigate the regressivity of sales taxes because higher income people are more likely to spend a greater percentage of their income on, for example, memberships to golf clubs, manicures, carpet cleaning and hiring cars with drivers. And it would put the sales tax much more in line with the consumption pattern of today's economy. Appendix A lists some options, shows how many states tax those services and whether Pennsylvania, New York and Connecticut tax them.

Impose a luxury tax on cars that either cost more than $35,000 or get less than 20 miles per gallon.

Governor Corzine's budget calls for a one-time registration fee of 0.4 percent on newly-registered vehicles with a sticker price of $45,000 or more and a fuel-efficiency rating of less than 15 miles per gallon. The budget proposal estimates the state would collect an additional $17 million from this initiative and that it would add only $180 to the cost of a new $45,000 car.

A luxury tax on cars that cost more than $35,000 and get less than 20 miles per gallon could raise even more than $17 million annually. Those who can afford the most expensive cars and those who choose to drive fuel inefficient cars would begin to pay their fair share.

Impose the sales tax on clothes above a certain value, allowing the state to again impose the tax on fur and some other clothing.

New Jersey taxed fur clothing until it accepted the provisions of the Streamlined Sales Tax Agreement, which defines furs as clothing. Since New Jersey exempts all clothing from sales tax, furs could no longer be taxed.

Almost every state taxes clothing on some level. Connecticut if a single item costs more than $75; New York taxes clothing if a single item costs more than $110; and Massachusetts if it is more than $175. By exempting clothing below these amounts, Connecticut estimates that it loses $120 million a year in revenue,¹⁵ New York about $600 million a year,¹⁶ and Massachusetts loses $214 million annually.¹⁷ Pennsylvania estimates that it loses nearly $900 million in sales taxes annually by exempting all clothing from the sales tax.¹⁸

Governor Corzine's proposal to broaden the sales tax base would be the biggest overhaul of the system in more than a decade and these changes help to erase the shortfall in next year's state budget. But as New Jersey goes beyond balancing the budget in the short term and moves toward creating an overall revenue structure that maximizes fairness and adequately funds the state's needs, an even more wide-ranging approach is needed.

Adopting all or many of these suggestions would raise much-needed revenue without increasing the sales tax rate above the current 6 percent. The present sales tax in New Jersey is so riddled with inconsistencies that raising the rate would only compound the existing unfairness. And while it may be tempting to broaden the base and lower the rate, the reality is that New Jersey's current financial situation and the need to address the state's longstanding structural deficit would make that unwise.

Over the long term, significantly broadening the sales tax base and maintaining the current rate at 6 percent is better policy for funding state services.

Source: Federation of Tax Administrators, 2004 Survey of State Taxation of Services, May 2005.
Note: New Jersey and Pennsylvania levy a flat 6 percent sales tax on all taxable services. With the exception of 900 number services and short and long term auto leases which are taxed at 9 percent, New York levies a 4 percent state sales tax on taxable services. Connecticut levies a 6 percent sales tax but taxes hotel rentals at 12 percent, certain admissions and amusement fees at 10 percent and certain computer services at 1 percent.

Raimondo, Henry. Economics of State and Local Government. Westport, CT: Praeger Publishers. 1992. p. 173.
http://publications.budget.state.ny.us/fy0607littlebook/TaxExpendures06Final.pdf
Hovey, Kendra A. and Harold A. Hovey. CQ's State Fact Finder 2005. p. 156.
Brunori, David. State Tax Policy: A Political Perspective. Washington, D.C.: The Urban Institute Press. 2001. p. 73.
Fox, William F. "Can the State Sales Tax Survive a Future Like its Past?" in The Future of State Taxation, David Brunori, editor. Washington D.C.: The Urban Institute Press. 1998. p. 35.
Mazerov, Michael, Expanding Sales Taxation of Services: Options and Issues, June 19, 2003. p. 7.
State Tax Notes, February 4, 2002. p. 325.
New Jersey Sales and Use Tax Review Commission recommendation Pursuant to P.L. 1999, c.416 on S-1958, November 12, 2004.
According to the Streamlined Sales Tax Governing Board, 13 states (Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota and West Virginia) have passed all of the provisions of the agreement and another 6 (Arkansas, Nevada, Ohio, Tennessee, Utah and Wyoming) have either passed most of the provisions or have passed them all with a delayed effective date.
"A tax fix for our times: New Jersey's perennially out-of-whack property taxes can be lowered - and here's how." The Star-Ledger, April 28, 2004.
New Jersey Sales and Use Tax Review Commission recommendation pursuant to P.L. 1999, c. 416 on S-1635, July 30, 2002 and S-1924, February 22, 2001.
New Jersey Sales and Use Tax Review Commission recommendation pursuant to P.L. 1999, c. 416 on A-2724, December 18, 2000.
Energy Information Administration, Petroleum Marketing Monthly May 2006, Table EN1.
Yi, Matthew, "Sales tax on gasoline a bonanza for state: local governments also are big gainers as price at the pump continues to rise." San Francisco Chronicle, May 11, 2006.
Connecticut Tax Expenditure Report, August 30, 2004. p. 25. http://www.cga.ct.gov/ofa/Documents/RevItems/TaxExp/TaxExp2004.pdf.
State of New York Tax Expenditure Budget, Fiscal Year 2007. p. 130. http://www.budget.state.ny.us/pubs/supporting/TaxExpenditureReport0506.pdf.
Tax Expenditure Budget, Fiscal Year 2007, Commonwealth of Massachusetts, Executive Office for Administration and Finance, January, 2007. p. 60. http://www.dor.state.ma.us/stats/teb/TEB2007.pdf.
Governor's Executive Budget 2006-07, Commonwealth of Pennsylvania. P. D34. http://www.budget.state.pa.us/budget/lib/budget/2006-2007/exec_budget/TaxExpenditures.pdf.

New Jersey Policy Perspective is a nonpartisan, nonprofit organization established in 1997 to conduct research and analysis on state issues. Our goal is a state where everyone can achieve to his or her full potential in an economy that offers a widely shared, rising standard of living.