Suppose you're a governor and your staff has just informed you that most of the biggest corporations doing business in your state have cooked their books so severely that they pay virtually nothing in state income taxes. Do you holler, "Hallelujah! Hunt 'em up and have 'em over for a campaign fundraiser!"? Well, that would be one common reaction. But it's not how newly elected New Jersey Gov. Jim McGreevey responded this year.
Like just about every state in the country, New Jersey has been struggling with huge revenue shortfalls lately. Unlike almost every other state, however, New Jersey has a governor brave enough to successfully take on the corporate tax dodgers. As the economy soared in the second half of the 1990s, most governors and state legislators watched idly -- or acted complicitly -- as their corporate income taxes were eroded by aggressive tax-sheltering schemes promoted by the major accounting firms. State treasuries have been victimized not only by the infamous offshore tax dodges that bedevil the federal government, but also by interstate shenanigans designed to move profits, on paper, into the handful of states that don't tax them.
The full extent of state corporate tax dodging was masked for a while by the fast growth in state personal income taxes. Thanks to expanding employment and a booming stock market, these jumped by 15 percent as a share of the economy from 1995 to 2000. But by the same measure, state corporate income taxes fell by 14 percent.
Of course, since Bush v. Gore was decided, the economy and the stock market have turned sour. As a result, over the past 12 months, state personal income taxes fell some $26 billion, or 12 percent, short of what collections would have been at their fiscal 2000 share of the economy. Meanwhile, state corporate taxes fell by $10 billion, a 27 percent drop from their 2000 level.
In New Jersey, the corporate tax decline was more like a collapse. Indeed, without reform, New Jersey tax officials predicted that in the upcoming fiscal year, companies would pay lower taxes in nominal dollars than they paid way back in 1982 -- unadjusted for inflation, economic growth or anything.
Even before the recession, 30 of the 50 companies with the largest payrolls in New Jersey paid only the state's token $200 minimum tax, despite billions in profits. Tax-avoidance schemes abounded. Under one, a New Jersey company sets up a shell subsidiary in Delaware, a state that doesn't tax royalty income. The subsidiary assumes ownership of the corporate trademark and charges the New Jersey company a royalty for its use. That generates a big New Jersey tax deduction. In another self-dealing ruse, a company makes big interest payments to its subsidiary in a no-tax state in order to slash its New Jersey taxable income.
Facing a $6 billion shortfall in his $23 billion budget for fiscal 2003, Gov. McGreevey decided to take on these and similar corporate tax dodges. His plan, just approved by the state Legislature, disallows the self-dealing deductions, institutes a real minimum tax (unlike the silly $200 minimum) that companies must pay no matter how many loopholes they claim, and institutes a number of other reforms.
So how does McGreevey's approach to the fiscal crisis compare to what his fellow governors have done? Well, like most governors, he papered over a big chunk of the problem -- covering up a quarter of the $6 billion shortfall by borrowing and shifting money from other state funds. He raised some regressive taxes and fees by about $400 million. And he scaled back his spending wish list by about $3 billion.
But on corporate taxes, McGreevey stands almost alone in the tax-reform hall of fame. According to the National Conference of State Legislatures, only nine states boosted corporate taxes for 2003, while eight states actually cut them, for a net increase of $1 billion. Of that net corporate tax increase, some $900 million was in New Jersey.
McGreevey promises that his labor-supported corporate reforms will "ensure corporations pay their fair share, just as every New Jersey family must do ... by eliminating the loopholes and gimmicks that have allowed companies to shirk their responsibilities." In contrast, antireform business lobbyists criticize McGreevey's bill as a "radical departure" that could embolden governors in other cash-strapped states to follow suit.
Let's hope they're both right.