TESTIMONY OF E. MARTIN DAVIDOFF
BEFORE THE SENATE BUDGET & APPROPRIATIONS COMMITTEE
NEW JERSEY STATE LEGISLATURE - JUNE 17, 2002


WELCOME TO NEW JERSEY - THE "TAX IT IF IT MOVES" STATE!
 

    This is the headline which will appear if you enact S. 1556 and the Governor's Budget. The Governor's budget will encourage businesses to look elsewhere when deciding where to locate there businesses and is based upon the erroneous proposition that the CBT has grown too slowly.

    The Governor looks at the CBT and ponders why it is growing so slowly? It should not be surprising. Just ten years ago, there was no such thing as Limited Liability Companies and New Jersey S Corporations which provide businesses with single-level direct personal taxation of their business profits. Today, these benefits exist and have been an astounding success.
 

    How do we know of the astounding success? Just look at the growth of the personal income tax. In spite of the Whitman tax cuts of up to 30%, the revenues of the personal income tax have risen 92.5% during the nine-year period from FY'92 to FY'01 while the inflation rate has grown only 27.0%. During that time period, in spite of the Governor's impressions, the CBT collections increased 52.6%, nearly double the rate of inflation.

    Today, the Governor attempts to plug a one billion dollar deficit by doubling the taxes raised from business.


LIMIT SPENDING INCREASES TO INFLATION

    In his March 26th budget document, the Governor claims that this year's budget increases spending a
mere 1.5% by stating that FY'02 spending will end up at $23.320 billion dollars and that FY'03
spending will be only $343 million higher at a mere $23.663 billion. That is not true. Included
as a line item for Total Resources for FY'02 is an item identified as "Lapses". Simply, that is
money that is not going to be spent. Hence, at most, only $21.644 billion will be spent for
FY'02. Thus, the budgeted spending for FY'03 is 9.2% higher then the amount being spent for
FY'02.

    Furthermore, even if FY'02 is an aberration, the budget for FY'03 proposes to spend more then 11% of
the amount budgeted for FY'01, a pace more then DOUBLE the 4.7% inflation increase for the
past 2 years (about 2.3% per year). So, my first question to Governor McGreevey is why does
the State of New Jersey need to increase spending nearly 2-1/2 times faster then the rest of us?

    The answer is that it doesn't. Rather, during these lean years, we must limit the growth in government to inflation.

THE GOVERNOR'S NEW TAX PROPOSALS

    ELIMINATE LOOPHOLES

    The Governor attempts to eliminate loopholes available to New Jersey companies paying royalties to related Delaware holding companies. This is good tax policy and should be implemented. New Jersey should also implement other anti-abuse provisions, similar to other states, to fight tax evasion by certain businesses.


    NEW PROCESSING FEE ON PARTNERSHIPS

    However, the largest tax increase, introduced deceptively as a Processing Fee, is a brand new tax on entities treated for federal income tax purposes as partnerships. This includes partnerships, limited liability companies, and limited liability partnerships. Every such entity with more than two partners will be subject to a $150 per partner fee [S.1556, 21]. This is a new tax on people who already pay individually upon the profits of these entities. This is a tax in the vein of "if it moves, lets tax it" and disguised in the Treasurer's remarks as a processing fee. This has nothing to do with the abuses that were identified by the Governor of large corporations not paying taxes!

    Think of all the small investment clubs that will be paying this $150 per partner fee. Investment clubs of 10 or 20 people will now be paying thousands of dollars in these new fees when they are only passing through hundreds of dollars of interest and dividend income? How many small real estate investment Limited Liability Companies will now be subject to a tax they never anticipated? How many start-up businesses will abandon an attempt to commence their business due to the toll charge you place on them today through this tax or the increase in the corporate minimum tax being proposed by others?
 

    When the State of New Jersey set up LLCs and LLPs, there was an implicit understanding. That understanding was that these entities would pass through their profits and losses and the individual owners would be taxed at one level of taxation. There would be no entity level taxation. That is why our state's economy grew so rapidly in the 1990s. We offered a simplified set of tax rules, few tax traps, and a single level of taxation for most small businesses. Today, the Governor and S.1556 attempts to violate that agreement with a proposal first presented just a few weeks ago!

    Ten years ago this week, I was proud to support legislation which enacted the first steps in eliminating the double-taxation of S Corporations in New Jersey. As part of that bill, the requirement to file a form NJ-1065 was added to raise funds for New Jersey. Presumably, this would provide information to the Division of Taxation to find those, particularly nonresidents, who were failing to report partnership income to New Jersey. How ironic that this initial requirement is now used 10 years later as excuse put the government's hands in our pockets?

    Taxes should be assessed on some theory of ability to pay. This fee clearly violates that premise. If the Governor believes he needs more money, he should be brave enough to request an increase in major taxes and not disguise the increase through an unfair fee.

    I am one of 20,000 CPAs in New Jersey. I currently represent 19 companies that are required to file partnership returns. Only 4 of those entities represent active businesses. The remaining 15 represent are investment vehicles. Of those 15, 10 have more than two partners. If my firm is typical, there are 200,000 investment partnerships in New Jersey that will be impacted by the proposed user fee. What do you suppose will happen if you stifle 200,000 investment partnerships? How many new investment partnerships will look to do business in New Jersey when New Jersey is one of very few states (the only one I am aware of) to impose such a fee? The partnership and LLC business forms are simple and easy to work with. Yet, they provide great flexibility. Also, they have been inexpensive to operate because neither the federal or state governments place any taxes or fees upon them. By enacting this legislation, you are placing a new toll charge on investment and business startups in New Jersey. This can only slow our economic recovery.

    Last night I was at a restaurant in East Brunswick enjoying a Fathers' Day dinner with my family. I ran into an old friend of mine, a Milltown Jaycee. We chatted briefly about my testimony today. He nearly fell off his chair. His family has nine partnerships with ten partners each. Each partnership owns a single property to minimize their liability. The new tax on partnerships will cost this family $13,500 per year!

    DEPRECIATION DECOUPLING & RECOUPLING OF MEALS & ENTERTAINMENT

    The Governor and S. 1394 imposes greater complexity by decoupling the new federal depreciation incentives (which are designed to encourage post 9/11 investment) from New Jersey's tax rules. I do not believe that the legislation would save $150 million as estimated by the administration. As an advocate for simplification I would strongly oppose depreciation decoupling in any form. Rather, I would recommend that the 100% New Jersey allowance for meals and entertainment be re-coupled to follow the federal rules, in which meals and entertainment is only 50% allowable. Although I agree that as a necessary expense that meals and entertainment expenditures should be fully deductible, I would rather raise revenue through a process that simplifies New Jersey tax computations (by minimizing differences from the federal tax base) rather then adding greater complexity.
 

    OTHER REVENUE RAISERS

    Other revenue raisers proposed by the Governor, such as suspending net operating losses, disallowing interest deductions for interest paid to related parties (even if at arms-length rates), and the new Alternative Minimum Assessment are all unfair attempts to deal with the budget deficit on the backs of business.



SURTAX OFFERS SIMPLER, FAIRER SOLUTION

    Today, the governor wants to squeeze a billion dollars from New Jersey businesses, doubling their share of the tax burden. But if New Jersey needs more taxes as a result of the economic slowdown and 9/11, the Governor should have all residents share by broadening the tax base. One method is my surtax proposal, which could be shown as a separate line item on tax returns and phased-out as the economy recovers.

    Here's how the surtax would work. Let's assume that we need another $450 million to plug the hole in the budget. We have $9 billion expected to be raised from the individual gross income tax and the CBT. Simply add a 5% surtax computed on one's current tax. Thus, corporations will be taxed at an effective rate of 9.45%, instead of 9%, and individual rates will rise from the current rates of 1.4% through 6.37% to 1.47% through 6.6885%.

    Everyone does his or her share and pitches in. After all, isn't that what democracy is all about? But to really win the support of everyone, lets make sure that most people will actually pay less!

    New Jersey wage earners have up to $217 of unemployment and disability taxes withheld on the first $23,500 of income in their paychecks. We know these funds are over-funded because governors and lawmakers have been raiding them for years! I propose that we cut the employee share of these taxes by 0.1% That would save $23.50 per year for each employee making over $23,500 and $47 for each family with two wage-earners.

    A New Jersey family of four making $65,000 will have NJ taxable income of approximately $55,500, after taking deductions for exemptions, real estate taxes, medical expenses and so forth. The NJ Gross Income Tax on such a family is currently $940. The surtax, which would add $47, would be offset by the reduction in their unemployment and/or disability taxes. Hence, no net tax increase. And those beneath the $55,500 level of taxable income will actually pay less in overall taxes.

    I have here a reprint of my April 22nd article in Business News which describes the surtax proposal and ask that it be incorporated into the record.

    I would like to thank the Committee for holding these hearings to secure the public's input.