Federal tax legislation adds revenue pressure to New Jersey localities

The federal tax overhaul will create a ripple effect for New Jersey local governments, according to S&P Global Ratings.

S&P credit analyst David Hitchcock wrote in a report Tuesday that capping deductions for state and local taxes at $10,000 and changes to mortgage interest deductions, along with lower homeownership incentives in the legislation, could lead to declining property values that weaken tax revenues for New Jersey municipalities. Hitchcock noted that municipalities will face this new revenue environment while also tackling increased costs from pension contributions as well as rising expenditures for police and firefighters after the expiration of the state’s 2% public safety arbitration cap.

“Overall, the combination of revenue-raising constraints and increasing costs will likely result in reserve spend-downs and weakened financial positions, potentially resulting in negative rating actions, particularly if budgets become structurally imbalanced,” said Hitchcock in the report.

At the state level, Hitchcock said New Jersey’s immediate revenue impact will not be felt as much since its itemized income tax deductions are largely decoupled from taxpayers' federal itemized deductions. Hitchcock said a rush of people paying their 2018 taxes by the end of December 2017 in response to the tax bill could cause a large temporary increase in tax collections for December and January. The opposite effect is likely for state corporate taxes since businesses will attempt to defer their payments from 2017 into the 2018 tax year because of the lower federal rates, according to Hitchcock.

“It might take time to determine what portion of the increased revenue is of a one-time versus an ongoing nature, which will increase forecasting uncertainty in the first half of fiscal 2018,” said Hithcock.

New Jersey also faces looming challenges in 2018 from new more conservative actuarial assumptions in the state's four major pension plans to 7.00% from 7.65%. Hitchcock noted in his report that lowering the return assumptions increased the New Jersey’s combined unfunded pension liability by $6.1 billion, to $45.4 billion, using state actuarial assumptions. The move also spiked the combined state and local actuarially determined contribution for fiscal 2019 by $813 million.

If paid fully, New Jersey's portion of ADC increases by $390 million in 2019, to $5.7 billion, or a $4.6 billion net from $1.1 billion of lottery proceeds dedicated to pension contributions. However, Hitchcock noted that state has historically paid far less with only half of its total $5 billion ADC budgeted for 2018 before excluding lottery payments.

“Assuming New Jersey continues to increase its pension contribution to 60% of ADC in fiscal 2019 as per current law, up from 50% in fiscal 2018, state pension payments would increase by $234 million in 2019, which we believe is relatively manageable compared to a total fiscal 2018 state operating budget of $35 billion,” said Hitchcock. “If the state increased pension contributions to 70% of ADC in fiscal 2020, it would contribute $3.0 billion, net of lottery proceeds.”

S&P rates New Jersey general obligation debt at A-minus, which is the lowest level of the 50 U.S. states with the exception of Illinois. The state will see a leadership change in Trenton Tuesday when Governor-Elect Phil Murphy replaces term-limited Gov. Chris Christie.