New Jersey Policy Perspective and Star-Ledger Forgot that Marginal Tax Rates Matter

December 3, 2010

[Note: and earlier version of this post stated that the author’s requests to NJPP for a copy of their report went unanswered. It was later learned that their response was actually mistakenly diverted into the author’s spam folder.]

On Monday ran a story in which New Jersey Policy Perspective (NJPP) is quoted in defense of the state’s income tax structure, using evidence from Governor Christie’s own tax return. The Star-Ledger (part of also ran an editorial the next day making essentially the same points. The Governor has been a critic of what he views as uncompetitive, high tax rates, and he vetoed an extension of the state’s “millionaire’s” tax in 2010.

NJPP’s comments and the editorial rely on the fact that Gov. Christie paid 6.1% of his income in New Jersey state income taxes in 2009, even though he and his wife were in the second highest income tax bracket in NJ, which has a rate of 10.25% (see the table below for NJ’s 2009 tax rates). Their NJ tax bill was $33,619 and their NJ adjusted gross income was $548,792 (NJPP used the slightly lower taxable income number).

The 6.1% is an effective tax rate (total taxes as a percent of total income), while the 10.25% is a statutory marginal tax rate, that is, the tax rate on the last dollar of income earned. Statutory tax rates increase as income increases, but only the income above the accompanying tax bracket is subject to the higher tax rates. (This should not be confused with an effective marginal tax rate, which includes the effects of phase-ins and phase-outs of tax credits and deductions). Both marginal and effective tax rates are important, and neither should be confused or ignored.

The Star-Ledger editorial board seems to want to characterize the marginal tax rate structure as some kind of loophole, calling it a “twist” and pointing out that “no one pays 10.75 percent on all their income”. But such a system is the norm for income taxes at the state and federal levels, and everyone benefits from a tax system structured this way. If you are going to have multiple tax rates, a marginal tax rate system, where only income above a given bracket threshold is subject to higher rates, is essential. Otherwise taxpayers will experience extreme jumps in tax liability from a small increase in income, potentially outweighing the increase in income. “Fair” is hard to define, but it would seem pretty unfair if a taxpayer’s increase in income was less than their resulting increase in taxes, no matter their income level (this would be an effective marginal tax rate over 100%).

The reason that Gov. Christie’s taxes would be higher in New York is that New York phases out their marginal tax rate system for high income earners (note that the news story uses New York state as a comparison, while the editorial uses New York City. The NJPP report is here). Through a complicated calculation, as a taxpayer’s income increases the state moves toward a single flat tax rate, eventually apply a rate of 8.97% on all income for taxpayers making over $550,000. The Philadelphia example is different, relying on the fact that the city has an income tax rate of 3.9296% on top of PA’s 3.07%. Most people in PA are not taxed at this level, and if Christie lived elsewhere in PA his taxes would be much lower, potentially less than half of what they are in Philly.

The point that the editorial glosses over or fails to understand is that marginal tax rates are important. For an illustrative example, imagine two simple tax systems, one with a flat 1% rate, and the other with a 0% tax rate on income up to $50,000 and a 51% tax rate on income above $50,000. For a taxpayer making $51,000 both systems result in a $510 tax liability, an effective tax rate of 1%. But the second, two rate system has a much higher disincentive to work because while the taxpayer is not taxed on her income up to $50,000, once she reaches the $50,000 mark the government begins taking more than half of each additional dollar of income. This system has a higher marginal tax rate for this person. This would obviously negatively affect her incentive to work harder and earn more income, especially when compared to the 1% flat rate. The two rate system above is less attractive for someone making over $50,000, and they may choose to locate in a jurisdiction with lower marginal rates. In economic speak, higher tax rates result in a greater “excess burden” of taxation, essentially the societal welfare cost of taxes, including behavioral effects, beyond simply the revenue raised.

It is a well-established principle that tax systems should be designed to minimize effects on behavior, and one important aspect of this is to keep tax rates as low as possible. The non-partisan Congressional Budget Office has a good paper on this issue at the federal level. The marginal tax rate system in New Jersey is obviously a result of a preference for a progressive income tax structure that places an increasingly higher burden on high-income taxpayers than low-income taxpayers. But progressivity can be attained with relatively lower income tax rates, avoiding the damaging effects of high marginal tax rates. New Jersey’s marginal tax rates, separate from its overall level of income taxation, are relatively high compared to other states.

New Jersey Income Tax Rates for a Married Couple, 2009*
For Income Over But NotOver Rate
$0 $20,000 1.40%
$20,000 $50,000 1.75%
$50,000 $70,000 2.45%
$70,000 $80,000 3.50%
$80,000 $150,000 5.53%
$150,000 $400,000 6.37%
$400,000 $500,000 8.00%
$500,000 $1,000,000 10.25%
$1,000,000 10.75%
*the top rate in 2010 is 8.97%. Click here for all the 2010 rates

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