TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. competition has been a major state policy focus in the past few years, and, although New Jersey did not initially hop on this trend, both the governor and those in the legislature (through Assembly Bill 5323) now have tax policy on the mind. Of the ideas on the table, allowing the corporate surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. to expire and removing global intangible low-taxed income (GILTI)Global Intangible Low-Taxed Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage. from taxation would make New Jersey more competitive. Although extending the net interest limitation to all members of unitary groups is normal for a Finnigan rule state, doing so without adopting full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. would perpetuate a burdensome part of the corporate tax code.
When it comes to tax competition, New Jersey has historically been at the back of the pack. Since 2014, the Garden State has ranked last on the State Business Tax Climate Index—a measure of the competitiveness of state tax codes—seven times, and ranked 49th in the years it didn’t rank 50th. While 24 states adopted permanent tax relief in 2021 or 2022 by cutting individual or corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rates, New Jersey has offered only one-time tax rebates and sales tax holidaySales tax holidays are periods of time when selected goods are exempted from state (and sometimes local) sales taxes. Such holidays have become an annual event in many states, with exemptions for such targeted products as back-to-school supplies, clothing, computers, hurricane preparedness supplies, and more. s. But this pattern does not have to continue. Policymakers should use current discussions as an opportunity to improve New Jersey’s tax code to make the state a true contender.
The Corporate Income Surtax
New Jersey’s corporate income tax is an outlier among states, in both rates and structure. The Garden State’s corporate income tax rate of 11.5 percent has been the highest in the nation since 2021, when Iowa reduced its top rate from 12 percent to 9.8 percent. Additionally, New Jersey’s bracket structure differs from other states because the rates apply to a corporation’s entire net income, rather than just income above each rate threshold.
In 2018, the New Jersey legislature instated a temporary surtax of 2.5 percent on businesses (not including partnerships or S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s), which raised the rate from 9 to 11.5 percent for businesses with income above $1 million. The surtax was set to expire at the end of tax year 2021. However, in late 2020, the legislature decided to extend the surtax until the end of tax year 2023, citing concerns about revenues coming out of the pandemic.
Gov. Murphy has expressed a desire to let the surtax expire at the end of 2023. If he gets his wish, New Jersey’s top corporate income tax rate would fall to 9 percent, putting the state below Alaska, Illinois, and Minnesota. Although the rate is still high compared to the rest of the states, following through on the promised surtax expiration would be a step in a more competitive direction.
Elimination of GILTI Taxation
After the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. , many states unintentionally included GILTI in their tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s by conforming with the federal tax code. Excluding GILTI is an important move, however, as such income is beyond the traditional scope of state taxation and discourages multinational businesses from working in the state.
A tax on GILTI is essentially a tax on supernormal returnSupernormal returns are payoffs to investment greater than the typical market rate of return. They are often approximated as company profits that exceed 10 percent. This additional return on capital or labor is above breaking even on an investment relative to the amount of risk and time that investment required. s overseas, which is designed to be a proxy for a tax on intellectual property or other intangible business assets. At the federal level, these taxes are designed to minimize tax avoidance and profit-shifting, and there is a 50 percent deduction under IRC section 250 and further credits for foreign taxes paid in order to bring down the tax on such income. States like New Jersey, however, which begin their corporate income tax calculations with federal taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. before special deductions (line 28 of the corporate income tax form) generally forgo the corresponding 50 percent deduction, inadvertently taxing this income more aggressively than the federal government does.
Under A5323, New Jersey would treat GILTI as a dividend beginning on August 1, and would consequently allow businesses to exempt it from income. Kansas most recently joined the 26 other states that either do not include GILTI in the corporate tax base or do not impose a corporate income tax. If New Jersey followed suit, it would begin to chip away at its anomalously large tax burden on businesses.
Net Interest Deduction Limitation and Full Expensing
The creation of the net interest deduction limitation—found in Section 163(j)—on the federal level was intended to help pay for costs from the implementation of full expensing under Section 168(k). Notably, while New Jersey does not conform to the pro-investment expensing provisions, the state does conform to the revenue-raising Section 163(j). Through the process of switching from Joyce to Finnigan rules for combined reporting, Assembly Bill 5323 would extend this limitation to combined groups as a whole.
This tax treatment is not new in Finnigan rule states. However, if New Jersey continues to conform to Section 163(j), the state should also allow businesses to fully expense capital investments in the year they occur, adopting the original pro-growth policy that motivated the net interest limitation in the first place.
Generally, when businesses calculate their income for tax purposes, they subtract business costs. This is fitting, as the corporate income tax is meant to be a tax on business profits—in general, revenues minus costs. Requiring these deductions to be spread out over a number of years—as is the case in New Jersey—changes the nature of the tax.
Due to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and the time value of money, a dollar in the future is always worth less than a dollar today. Delaying deductions for the cost of business investments means that the real value of the deductions will always be less than the original cost. Ultimately, this treatment means the corporate income tax is biased against investment in capital assets, as other business expenses (e.g., labor, advertising, and supplies) can be written off in the first year. This is especially harmful to businesses in equipment-intensive manufacturing industries.
Although 18 states currently conform to the federal treatment of capital investment, the impact begins to erode this year with the federal phaseout of full expensing and its eventual sunset. Last year, Oklahoma became the first state to make full expensing permanent, and Mississippi followed suit this year. Policymakers in other states have expressed interest in permanence as well, raising hopes that many more states could follow suit next year. New Jersey should consider getting ahead of its peers by not only adopting this pro-growth policy but making it permanent.
Lessons and Solutions
In a time when businesses and residents are more mobile than ever, New Jersey is not stacking up well against the competition. The Garden State has been plagued with outmigration in recent years, with many residents in 2019 packing up to head to nearby states like Pennsylvania and New York, but also to lower-tax states that are farther away, like Florida and North Carolina.
As the saying goes, the best time to plant a tree is 20 years ago, but the second-best time is today. Just because New Jersey has had a burdensome tax code for many years does not mean that it’s too late to improve. The last two years have shown that state tax reform is both possible and important; New Jersey can embrace this possibility too. By letting the corporate surtax expire, eliminating taxes on GILTI, and embracing full expensing, New Jersey would take important steps toward creating a more welcoming and competitive tax environment.Share