New tax on the rich in New Jersey may give provincial governments something to think about: Don Pittis

As revenue-hungry Canadian provinces line up cap in hand for federal dollars, a new tax on wealthy residents of New Jersey that was approved last week offers food for thought.

Dubbed the millionaires tax, the new law is widely expected to pass through the Democratic-controlled state legislature now that its main opponent, New Jersey Senate President Steve Sweeney, has come on side.

Republican critics of the tax hike say it will lead to an exodus of the wealthy out of the state, and political analysts say the idea would have faced a veto from Gov. Phil Murphy's Republican predecessor, Chris Christie. Whether that exodus actually happens may serve as a lesson to other cash-deprived jurisdictions considering new taxes on high income earners.

Changing political mood

The mood appears to have changed in New Jersey amidst a collapse of state revenue in the wake of COVID-19. There are signs Washington is not bailing out state governments, and the state's poorest residents continue to suffer from the recession. Indeed, back in the spring, Canadian tax historians predicted a new willingness to accept tax increases.

If New Jersey's millionaires tax becomes law, the new rules will increase taxes collected by the state for those earning between $1 million and $5 million to 10.75 per cent from the current 8.97 per cent. Those earning more than $5 million already pay the higher rate.

"We do not hold any grudge at all at those who have been successful in life, but in this unprecedented time, when so many middle-class families and others have sacrificed so much, now is the time to ensure that the wealthiest among us are also called to sacrifice," Murphy said last week as he announced the deal with his former opponents to proceed with the tax.

Since the beginning of the coronavirus outbreak and the growing recession it has caused, Murphy's popularity has soared from the mid-40s to more than 70 per cent by April, according to public opinion surveys.

The new mood in favour of a millionaires tax comes as no surprise to Elsbeth Heaman, a tax historian at Montreal's McGill University and editor of the newly published book Who Pays for Canada?

"You get a better mandate to tax the rich in a crisis," she said by phone shortly after Murphy's announcement late last week that New Jersey would go ahead with the new tax.

The move confirms what she and others said in May about how the Canadian government would pay for the growing cost of helping the economy through the devastating effects of job losses and business failures.

"A catastrophe, a war, a famine, something like that creates a different kind of attitude toward taxation," Heaman said at the time.

Just as in Canada, individual states do not have the spending power of the national government. One reason is that states do not have the borrowing power implied by modern monetary theory because they don't control their own currencies. But for another, New Jersey was historically a leader in cutting business taxes.

New Jersey's great exemption

"It was in the 1890s that New Jersey began the great tax exemption," said Heaman.

The technique, she said, was to entice New York corporations to register within something called trusts — companies that held other companies — allowing them to pay lower New Jersey tax rates, but allowing the state to collect those taxes on companies that didn't physically operate within New Jersey. It became a huge competition between states in what Heaman calls "a geographic race to the bottom."

Now, as COVID-19 cuts into revenue in states and in Canadian provinces, regional governments are getting caught short, with some looking for ways to save. As the Wall Street Journal has reported, many are cutting back on schools, universities and other services, in spite of the danger of compounding the damage caused by a private-sector contraction.

Other states may be watching the New Jersey plan unfold, but the New York Times reports that despite many more high income earners in his jurisdiction, New York Gov. Andrew Cuomo continues to insist that Washington should bail out state and regional governments despite repeated failures by Congress to offer a new plan.

That battle for cash between levels of government has echoes in Ottawa this week as the federal Liberals decide how much of their deficit to spend on programs of their own and how much to offer to the provincial premiers who would prefer to dole out the money themselves.

So far, raising provincial taxes on the rich has got little attention. And there are good reasons for that, according to Stephen Gordon, economics professor at Quebec's Université Laval who specializes in taxation.

Political signalling

Previous U.S. research has shown that tax increases don't tend to cause mass migration across state lines. But Gordon said getting a reputation as a high-tax jurisdiction can prompt wealthy residents to go out of their ways looking for legal tax avoidance measures so the money will not show up as taxable income at the state level.

He suggested taxes at the federal level would be more effective because the U.S. remains a special place where people want to live. "They can't all go to Monaco," he quipped.

Critics like Gordon say that small state tax increases on such a rarified group of very high-income earners may be good political signalling, but it doesn't actually generate much revenue. That's why systems that tax the incomes of the broad middle class or use value added taxes that apply to everyone are better for raising money.

"This is more ceremonial than anything else," said Gordon. "It's less than one per cent of the budget, and it's not going to plug the big hole that COVID-19 has punched into state budgets."

But in a country where in recent decades talk of tax increases has almost always been political poison, the New Jersey tax hike may signal that in the current crisis, that hostility is wavering.

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