BHI
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New
Jersey's 1994 and 1995 Personal Income Tax Cuts led to 25,000 new jobs
and $2.1 billion in new capital
In 1994 and again in 1995, New Jersey cut
its graduated personal income tax rates, which ranged from 2%  7% in
1993, to 1.9%  6.65% in 1994 and further to 1.7%  5.68% by 1995. In
1997 the effective average state tax on personal income is 2.71%, but
would have been 3.08% without the tax reductions.
According to an econometric analysis performed
by the Beacon Hill Institute, the tax reductions have resulted in the
creation of 25,000 additional jobs and $2.1 billion in new capital stock.
These increases are over and above any changes that may have occurred
as a result of the upswing in the business cycle.
Economic Effects of New
Jersey Personal Income Tax Cuts, 19941997
Year

Cumulative
Change in Payroll

Cumulative
Change in Jobs

Cumulative
Change in Capital Stock

Cumulative
"Static" Tax Revenue Effect

Cumulative
"Dynamic" Tax Revenue Effect

Cumulative
Net Tax Revenue Effect

1994 
$383
million 
11,667 
$0.9
billion 
$194
million 
$10
million 
$183
million 
1995 
$814
million 
23,997 
$1.9
billion 
$469
million 
$21
million 
$448
million 
1996 
$861
million 
24,500 
$2.0
billion 
$499
million 
$23
million 
$476
million 
1997 
$929
million 
25,017 
$2.1
billion 
$539
million 
$25
million 
$514
million 
The tax cuts have boosted the annual payroll
in New Jersey by $930 million and raised employment by 0.7%, helping
bring the state’s unemployment rate down from 7.1% in January 1994,
when it was well above the national average, to 5.2% in August 1997
(very close to the national average). With the exception of April of
this year (when it was also 5.2%), this is the lowest rate in seven
years.
The tax reductions produced a net revenue
loss of about $514 million in 1997. This is the net result of two effects:
(1) the “static” revenue loss of $539 million (the loss computed on
the assumption that the tax cuts had no effect on the New Jersey economy)
and (2) the “dynamic” revenue gain of $25 million (the revenue gained
as a result of the increased production and personal income brought
about by the tax cuts).
Despite the job growth New Jersey has enjoyed,
critics of the tax cuts say that the new jobs being created have mostly
been lowwage service sector jobs and that highpaying industrial jobs
have decreased. It is true that most of the increase in jobs has been
in the service sector, in line with the longrun trend in the structure
of New Jersey’s economy. But it is not correct that the new jobs pay
low wages, given that the average annual wage in the state rose from
$32,815 in 1994 to $37,115 by 1997, significantly faster than the inflation
rate. The BHI tax model confirms this: The relevant structural equation
shows that a change in the state personal income tax rate does not alter
the wage rate, implying that the jobs induced by a tax cut must pay
at least as well as the average job does today.
______________________________________________________________________________
Methodology
Two steps are needed in order to measure
the effect of the tax cuts on the variables of interest – these variables
being the number of jobs (L), the wage rate (w), the capital stock (K)
and state tax revenue (TR). First we must establish baseline values
for the variables, projecting them out through the end of 1997. Then
we use the Beacon Hill Institute’s State Tax Analysis Modeling Program
(STAMP) to estimate and project employment, wages and the capital stock
in the absence of the tax cuts. These projections may then be compared
with the baseline values in order to isolate the effects of the tax
cuts.
A. Baseline Projections of Wages,
Jobs and Capital
The baseline projections are shown in the
table below, and were constructed as follows. Information on the number
of jobs is available for 1994 and 1995, and information on the number
of workers is available through June 1997. We suppose that the growth
rate of jobs is the same as the growth rate of the number of workers
for 1996 (1.65%) and assume that the number of jobs in 1997 grows at
the same rate as the number of workers did for the first half of 1997
relative to the first half of 1996 (1.67%).
The value of the total payroll is
known for 19941996, and we assume that it will continue to grow (in
nominal dollars) at the same speed as it did between the first quarter
of 1996 and the first quarter of 1997, which is by 7.43% per year. We
also assume that the capital stock grows at the same speed as
the total payroll, so that the capital to labor ratio does not change.
Since information on the capital stock in New Jersey is available for
1994, we use the historical growth rates of payroll to generate capital
stock values for 1995 and 1996, and the projected growth of payroll
to arrive at the capital stock for 1997. The average wage is simply
the total value of payroll divided by the number of jobs.
B. Applying the Tax Analysis Model
A fuller description of the tax analysis
model is given in An Application of the BHI Tax Analysis Model to
the Massachusetts Mutual Fund Industry (Beacon Hill Institute, October
1996); the basic model has been modified and reestimated so that it
is applicable to New Jersey. The model is designed to allow the analyst
to trace the effects of changes in state tax rates on employment, wages
and the stock of capital. It begins with a series of structural equations
that aim to capture the behavior of firms and households, and then rearranges
these equations to arrive at a set of reduced form equations which are
both theoretically consistent and may be estimated econometrically.
The equations are estimated using data from 19701994. In simplified
form, the two that are relevant here are the labor equation and the
capital equation.
The labor equation shows how changes
in state tax rates (and other variables) affect the number of jobs in
New Jersey. The estimated equation is of the form
(1) ln(L) = 0.0142 t + other terms
where ln(L) is the natural log of the number
of jobs, and t is the average marginal state tax rate on earned income
(i.e. the marginal tax rate faced by New Jersey taxpayers, on average).
The coefficient 0.0142 is statistically significant, and measures the
effect of a change in the tax rate (t) on ln(L); in other words ln(L)/t
= 0.0142.
The capital equation is similar,
except that the dependent variable is capital rather than labor. Specifically
the estimated equation is of the form
(2) ln(K) = 0.0173t + other terms
where ln(K) is the change in the natural
log of the value of the capital stock from one year to the next. The
coefficient 0.0173 is statistically significant.
In order to estimate the impact of the
income tax cuts, we first have to compare the average marginal tax rate
under the tax cuts, t_{c}, with the rate under
the hypothetical case of no tax cuts, i.e., under the 1993 tax systems,
t_{h}.
The latest data available for New Jersey
tax returns by income group are for 1994. Using the 1994 data, we first
calculate t_{c,94}. We compute the t that
would have prevailed if there were no tax cut in 1994, t_{h,94},
by applying the 1993 tax schedule to the 1994 taxable income. The results
are: t_{c,94} = 3.490% and t_{h,94}
= 3.713%. Therefore, the 1994 tax cut reduces the t by 0.223
percentage points. Since state tax return data are not available for
1995, we use the 1995 data on gross income by income group obtained
from the federal income tax returns. The estimated t_{c,95}
is 3.376% and t_{h,95} is 3.831%, resulting in
a reduction of 0.455 percentage points. Using a similar method, the
reductions of t for 1996 and 1997 are estimated to be 0.457 percentage
points and 0.459 percentage points respectively.
C1. Projecting the Effects of the
Tax Cuts: Employment
We project the employment that would not
have been created in the absence of a tax cut. In 1994, t would have
been 3.713% rather than 3.490%, so t = 0.223. Thus from equation (1)
we have
(3) ln(L) = (0.0142)t = (0.0142)(0.223)
= 0.00317.
The baseline value of ln(L) [=15.1212 =
ln(3,690,289)] now falls by 0.00317 to 15.118; taking the antilog gives
the number of jobs with the tax cut, which is 3,678,622, or an decrease
of 11,667 under the baseline case.
An essentially similar procedure is applied
for the three subsequent years. The detailed results are shown in the
table below, and indicate that by 1997, an estimated 25,017 jobs
have been created which would not have existed in the absence of the
cuts in the state tax on earned income.
C2. Projecting the Effects of the
Tax Cuts: Capital
The effects of the tax cuts on the stock
of capital are estimated in the same manner as for employment. Thus
from equation (2) we have for 1994
(4) ln(K) = (0.0173)t = (0.0173)(0.223)
= 0.00386.
The baseline value of ln(K) [=12.313 =
ln($222,674 million)] now falls by 0.00398 to 12.309; taking the antilog
gives a new capital stock, after the tax cut, of $221,790 million, or
an increase of $884 million over the baseline case. Then, by subtracting
this growth rate from the actual growth rate, we obtain the growth rate
of K caused by factors other than tax cuts, which is then used to project
the capital stock under no tax cut for 1995. This same approach is used
for estimating 1996 and 1997 levels.
C3. Projecting the Effects of the
Tax Cuts: Wages
The estimated reduced form equations of
the tax analysis model show that the state tax rate on unearned income
does not have a statistically significant effect on the wage rate in
New Jersey. Wages are thus assumed to follow the baseline projections
both with, and without, the tax cut. The total value of the payroll,
in the presence of the tax cuts, is calculated by multiplying these
average wage rates by the number of people employed.
C4. Projecting the Effects of the
Tax Cuts: Tax Revenue
What effect did the cuts in the tax rate
have on state tax revenue? First there is a “static” revenue loss, which
is measured as the reduction in the average tax rate (ATR) times the
tax base, which we take to be the baseline payroll. For instance, the
static revenue loss in 1994 was $194 million (=0.160%*$121,098 million).
But this overstates the true revenue loss, because there is also a “dynamic”
revenue effect: The tax cuts lead to an increase in the number of jobs
and hence the total payroll, and therefore to some offsetting increase
in revenue. For instance, in 1994 the dynamic revenue gain was $10 million
(=2.70%*$383 million).
D. The Total Effect
According to BHI estimations, as of 1997,
the number of new jobs created by the tax cuts was 25,017, raising employment
by 0.7% above the level it would otherwise have achieved. The capital
stock was $2.1 billion (almost 0.8%) higher than it would otherwise
have been. Annual state tax revenue was $514 million lower than it would
otherwise have been; this total consists of a static revenue loss of
$539 million, offset by higher revenue of $25 million generated by taxes
on the additional payroll resulting from the tax cuts.

1994 
1995 
1996 
1997 
Baselines 




A 
Employment

3,690,289

3,726,170

3,787,588

3,850,841

B 
Payroll
($mill) 
121,098 
126,412 
133,038

142,924 
C 
Average
wage ($ p.a.) (=B/A) 
32,815 
33,925 
35,125

37,115 
D 
Capital
Stock ($ mill) 
222,674 
232,445

244,629

262,807







Effects
with Tax Cuts 










E 
Effective
AMTR with tax cuts^{a} 
3.49% 
3.38% 
3.44% 
3.50% 
F 
Effective
AMTR without tax cuts 
3.71% 
3.83% 
3.90% 
3.96% 
G 
Effective
cut in AMTR 
0.223% 
0.455% 
0.457%

0.459% 






H 
Effective
ATR with tax cuts^{b} 
2.70% 
2.61% 
2.66% 
2.71% 
I 
Effective
ATR without tax cuts 
2.86% 
2.98% 
3.03% 
3.09% 
J 
Effective
cut in ATR 
0.160% 
0.371% 
0.375%

0.377% 






K 
Employment
in absence of tax cuts 
3,678,622

3,702,173

3,763,088

3,825,823

L 
Cumulative
job increase with tax cuts (=AK) 
11,667

23,997

24,500

25,017

M 
Annual
job increase due to tax cuts 
11,667

12,330

502 
518 






N 
Capital
stock in absence of tax cuts ($ mill) 
221,790

230,567

242,644

260,665

O 
Cumulative
extra capital due to tax cuts ($ mill) (=DN) 
884 
1,878 
1,985 
2,142 
P 
Annual
capital increment due to tax cuts ($ mill) 
884 
995 
107 
157 






Q 
Payroll
in absence of tax cuts ($ mill) 
120,715

125,598

132,177

141,995

R 
Cumulative
extra payroll due to tax cuts ($ mill) (=BQ) 
383 
814 
861 
929 
S 
Annual
payroll increment due to tax cuts ($ mill) 
383 
431 
46 
68 






T 
"Static"
tax revenue effect: cumulative ($ mill) (=B*J) 
194 
469 
499 
539 
U 
"Static"
tax revenue effect: annual ($ mill) 
194 
275 
30 
40 
V 
"Dynamic"
tax revenue effect: cumulative ($ mill) (=H*R) 
10 
21 
23 
25 
W 
"Dynamic"
tax revenue effect: annual ($ mill) 
10 
11 
2 
2 
X 
Net tax
revenue effect: cumulative ($ mill) (=T+V) 
183 
448 
476 
514 
Y 
Net tax
revenue effect: annual ($ mill) (=U+W) 
183 
264 
28 
38 
Appendix Table: Effect of New Jersey Tax Cuts on Employment,
Capital Stock and Tax Revenue
Notes: Slight rounding
errors may occur. a: AMTR, Average Marginal Tax Rate, is the marginal
state tax rate on earned income faced, on average, by taxpayers in New
Jersey. b: ATR, Average Tax Rate, is total state tax revenue on earned
income divided by earned income (payroll).
Revised
on 06/27/2002: HTML
format revised on
12Jul2007 9:55 AM