Property Tax Reform In New Jersey: What's In It (Or Not In It) For Business?

Tuesday, August 1, 2006 - 00:00

The Governor addressed a joint session of the state legislature on July 28, 2006 in order to inaugurate a special legislative session on cutting New Jersey's draconian property tax. Several legislative committees were charged with dealing with the seminal issues which will come to the fore during the session, namely, school spending, costs of public employee benefits, consolidation of local governments, and whether or not a citizens' tax convention is appropriate. It is anticipated that hearings will go on for two months, and the committees will draft bills which the full legislature can consider before year's end. The legislature is expected to also move to place a referendum on the ballot in November for New Jersey residents to approve a dedication of half of the State's recent sales tax increase to property tax relief.

The property tax as it currently exists and is imposed permits certain exemptions, rebates and abatements. The report of Governor Corzine's Tax Reform Transition Policy Group suggested an interim step in increasing property tax rebates, which would average $165 for renters, $1,320 for certain seniors, with most taxpayers seeing modest rebates of $500, and upper income taxpayers getting no rebate at all. However, with the average homeowner paying $5,269 per year for property taxes, a modest rebate of $500 seems trivial. The report identified the following options, among others, for property tax reform as including limiting property taxes to a percentage of a household's income, and limiting future tax increases.

One thing is clear, no matter how the process ultimately works itself out, to be successful, the property tax must be reduced for a majority of New Jersey residents. The ultimate question becomes, of course, how can this be done? The penultimate question for purposes of this commentary is how will it affect the business community in New Jersey? It only makes rational sense if certain residents, say a majority, are given property tax breaks; that revenue will have to be made up from somewhere, either from cuts or from other revenue sources. Let's start with cuts. Cuts mean that taxpayers will have to do without local control of services, and decentralized control means a loss of "home rule." New Jersey has 566 municipalities and 616 school districts, many with duplicative services. Is it possible that consolidated services and schools will save money and reduce the property tax? Answer: Possibly. Is it possible that such restructuring alone can result in meaningful property tax reduction state-wide? Answer: Unlikely. Left out of this calculus will be many suburban and rural municipalities which already provide minimal services, and which already have regional school districts. Since the political power of the exurbs has waned, residents of those areas may be left out in the cold. In short, the cities and inner suburbs will see property tax relief, and the outer suburbs and rural areas, absent a significant increase in state aid, probably will not. If consolidation alone is the sole solution offered, business interests in the inner suburbs and cities, where arguably there is the most waste and duplication of services, would likely see their property tax burden eased. However, that is a big "if."

Consolidation of schools will likely meet with opposition from the powerful teacher's union (truth be told the teacher's union also collectively bargains for some non-teaching school workers, as well as teachers). Consolidation of municipal services will likely meet with opposition from unions representing municipal workers, as well as the League of Municipalities, the influential association of municipal governments of New Jersey. Moreover, some municipal employees such as tax assessors and collectors, prime targets for consolidation, like teachers, are tenured. (Most states, unlike New Jersey, perform assessing and collection functions at the county, rather than the municipal, level). It is important to note that many legislators cut their teeth at the local level, and in some instances, are still serving as local elected officials. The support networks for these legislators are in the wards and districts of the local communities, and they dare not alienate those interests. Now this insalubrious scenario may not play out. In the ideal world, the legislature will act in the best interests of all the citizens, regardless of special and political interests, and enact structural reform which results in meaningful property tax reductions for all New Jersey citizens. Moreover, in the ideal world the legislature would not want to make the business environment in New Jersey any less friendly than it already is. In the unlikely event that structural reform resulting in property tax reductions does not, or cannot, happen, there will have to be an alternative revenue source (or sources) to subsidize what will have to effectively be gargantuan cuts in property taxes.

That leads us to other potential revenue sources. Already the sales tax was increased by 17% (from 6% to 7%), and we are told that half of that increase (estimated revenue of $600 million) will be dedicated to property tax relief. It is unlikely that the legislature is prepared to increase taxes again (except perhaps on high income residents) any time soon. New Jersey's current property tax system is based, among other things, on two fundamental precepts: (1) that all property be taxed uniformly, and (2) that all property be taxed at fair market value. This formula insures that businesses and residents alike are taxed on the same basis, and on the same rate. However, it doesn't have to be that way. One way to increase property tax relief is to cease taxing on a uniform basis, and cease taxing at fair market value. Assuming the residents, i.e ., the voters, are the intended beneficiaries of property tax reductions, how might the system be fiddled with to generate property tax reductions for residents, while at the same time maintaining or increasing current funding levels with minimal cuts in services?

One good guess is that the legislature could propose an amendment to the State Constitution which would permit non-uniform and non-fair market value assessments. What is the import of this concept? New Jersey could adopt a system which permits residences to be assessed at fair market value only when sold, and that assessment would be maintained until the next sale (the so-called "welcome stranger" pattern). That option would result in artificially lower assessments for residences over the short term, thereby insulating residents from tax increases over the period of their ownership of their home. As for other classes of property, such as commercial, industrial and rental properties, assessments could be mandated to be maintained at fair market value year in, year out, resulting in higher assessments for those properties, and therefore, theoretically, higher taxes on those properties. This idea is not so far fetched. In California residences are assessed at fair market value only when they are sold or newly constructed. If an owner does not change residences for a substantial period of time, the assessment will remain at an artificially lower level.

Alternatively, properties of business or commercial properties (even high income taxpayers) could be taxed at a higher rate than residential properties. In such a case, businesses would be subsidizing lower property taxes for residences. Indeed, increasing assessments upon the sale or construction of residential real estate would burden residential developers because new homes would be automatically subject to higher taxes, potentially making them less desirable than existing homes, or homes out of state. It has been reported that since 2000 New Jersey has lost nearly 20,000 residents to northeastern Pennsylvania. Look for this population drain to accelerate if taxes are increased on new homes.

Another option would be the taxation of business personal property. New Jersey used to have a business personal property tax, but it was repealed in 1993. Any personal property that is still taxed is taxed as real property, but in the vast majority of cases the taxed property is arguably a fixture. New Jersey could enact a new tax on business personal property which would include everything from vehicles used for business purposes, to desks, chairs, telecommunications equipment, computers, et cetera . Many states have substantial personal property taxes, but intangibles are typically excluded. Connecticut even has a personal property tax on residents' vehicles. Such a tax on business personal property would raise substantial revenue with little notice from the populace. It would also increase costs of record keeping, auditing and payment functions for businesses in the State, particularly for small businesses that are not accustomed to such a tax.

The corporate franchise tax or other fees could also be increased to pay for a property tax reduction. Indeed, taxes on (perish the thought) legal services have already been proposed, but not enacted. As part of the package to plug the $4 billion budget deficit (New Jersey was one of a handful of states running a budget deficit this year) the legislature already enacted, effective August 1, 2006, a real estate transfer tax on conveyances of commercial property. The tax of 1% would apply to all transactions if the consideration exceeds $1 million, and commercial property would include income producing (rental) properties. That tax would also apply to sales of controlling interests of such commercial properties. Another option would be the institution of a new local income tax on all residents, with the tax rate being set at the local level, and the tax administered by the State. There is precedent for this in other states where some large cities levy income taxes which are collected and administered by the State. The revenue from such a tax would theoretically be used to reduce the property tax.

The bottom line is that business interests might end up being in the proverbial bull's eye, in terms of revenue generation to offset property tax reductions and/or reform. There are strong public interests which favor maintaining the status quo of home rule. Moreover, many residents when faced with the prospect of accepting tax cuts coupled with fewer local services and regionalization of schools, may choose the status quo . If New Jerseyans are one thing, they are not stupid. It is a better guess that the electorate will want their cake and eat it too - i.e. , maintain the status quo on services, home rule, education, and still cut property taxes. Will Governor Corzine and the legislature need magic to make this happen? No, but the million dollar question (literally) is in who's backyard will they look for the pot of gold at the end of the rainbow? It just might be in yours.

Christopher John Stracco is a Partner at Pitney Hardin LLP. His practice is focused on commercial litigation, specializing in real property litigation, including real property taxation, zoning and real property disputes and landlord tenant litigation.

Please email the author at cstracco@daypitney.com with questions about this article.