New Jersey’s economic decline is contained in its de jure fiscal institutions—the rules under which the state’s elected officials budget—and the way they are interpreted and enforced—the de facto rules. These institutions and their interpretation—the state’s constitution, its laws, policy legislation, court rulings, state and federal mandates—have helped to create the present crisis. This crisis stems both from years of institutional and policy neglect that has turned a once well-managed state into a rent-seeking society, and a growing gap between the de jure and the de facto rules that check government’s activity.
Perennial budget shortfalls, a symptom of the state’s growing fiscal instability, have occurred for several reasons—growing spending in times of high revenues, and significantly, an activist state Supreme Court’s mandates on school funding and rulings permitting the state to avoid and bend constitutional prohibitions on the usage of debt. Unions have left a strong mark on New Jersey’s budget, increasing the size of salaries, pensions, and health benefits, which ultimately function as mandates on lower levels of government, driving up property taxes to the second-highest per capita in the nation.
Aid (state and federal) constitutes 75 percent of New Jersey’s budget. Medicaid, along with dozens of other grant-in-aid programs, occupies a sizable and growing portion of the state’s budget. The effect of the federal stimulus package will postpone needed reforms while permanently growing the size and scope of government spending and passing those costs along to state and local governments as future taxes. Aid transfers have also altered budgeting in New Jersey’s 566 municipalities and 611 school districts, creating dependencies on aid streams while eroding control over local tax rates and the level and amount of spending on local services. The expansion of intergovernmental aid has centralized the provision of services and eroded local competition. By fracturing the relationship between those who benefit (e.g., local school districts) and those who pay (e.g., state income taxpayers), the incentive to control costs and accountability for spending has been systematically weakened through fiscal illusion.
Increased taxation is meant to support the steady growth of public spending. Growth in New Jersey’s budget is driven, in theory, by citizen preference for a certain level of government services, and the taxation necessary to support it. However, the government of New Jersey has resorted to fiscal evasion—avoiding the rules meant to constrain spending—and has sustained spending growth through fiscal illusion, obscuring the full costs of policies by relying on intergovernmental aid and debt to achieve the current level of spending.
Over a period of years, New Jersey lost control over its budget. While the state gained more control over local budgets, it lessened the ability of local governments to set their own fiscal course. In combination, the effect of increased spending, taxation, debt, and the costs of regulatory compliance—on all levels of government—has compromised the state’s fiscal framework and made its economy less resilient to downturns, driving businesses and people out of a once-thriving state.
For New Jersey to regain its former position, the state must implement institutional reforms. These include moving the tax system to one that is broad-based and low-rate. This will enable the state to raise the revenues necessary to fund its operations while reducing the current system’s negative impact on economic activity. At the same time, the state should introduce competition in the provision of schooling through the use of vouchers, particularly in the Abbott districts, which will encourage schools to improve performance and lower costs. State aid streams, including the Property Tax Relief Fund, and municipal aid programs should be reduced and eventually eliminated as budgetary mechanisms for transferring resources. To date, the effect of these intergovernmental aid streams has been to erode local control while stimulating spending on the local level, helping to drive up property taxes in many communities. Along with this, state mandates should be reviewed and rolled back on the local level. This will help to restore competition between municipal governments for citizens and businesses, encouraging local governments to provide the mix of goods and taxes that citizens want.
Spending on the state level can only be reigned in though rules that bind elected officials from spending beyond what is fiscally sustainable. New Jersey should adopt TABOR-type legislation, setting annual spending growth to the rate of population growth plus inflation. Anything beyond this amount should be approved by voters.
To reduce current spending, New Jersey should review the state’s budget (and municipalities should review local budgets) in terms of who is the best provider of goods and services. Many items currently funded by public dollars may be provided by the private sector or partially privatized.
Short of these kinds of institutional reforms, New Jersey will continue on its present course. The current system has created strong constituencies, such as public sector and teachers unions, which benefit from the status quo and current revenue redistribution streams. Reforms must confront what is perceived as politically unpopular and avoid the temptation to tinker with the present framework with marginal changes such as increasing property tax rebates, offering tax breaks, finessing current aid formulas, or relying on federal bailouts. These actions will only mask, if not deepen, the distortions and inefficiencies in New Jersey’s state and many local budgets.
Consistent and binding institutional reforms that encourage fiscal prudence will not only address the many (and interlocking) causes of New Jersey’s fiscal crisis and decline, but will also send a powerful signal to citizens, businesses, and outside investors that New Jersey is committed over the long-run to returning to the guiding fiscal and economic principles which made it an economic leader.
 New Jersey FY 2008 Budget in Brief, http://www.nj.gov/treasury/omb/publications/09bib/BIB.pdf.