Office of the State Treasurer

TRENTON - State Treasurer John E. McCormac delivered the following testimony today before the Assembly Budget Committee. The remarks detail revenue estimates for the current and next fiscal year and Governor McGreevey's proposal to close loopholes in the Corporate Business Tax, provide a tax credit to small companies and achieve fairness and equity in business taxation.

Good morning Mr. Chairman and distinguished members of the Assembly Budget Committee. I welcome the opportunity to once again appear before you and bring this committee up to date on recent changes in the revenue picture for Fiscal Years 2002 and 2003.

I also am prepared to provide the Legislature with a detailed description of the Governor's plan to restore the Corporation Business Tax to a viable and reliable revenue source for the State. In partnership with the business community and leading economic experts, we have crafted a plan that is true to the principles of fairness and equity to the New Jersey businesses that are the lifeblood of our dynamic state economy.

Our changes will yield the recurring revenue goals that New Jersey must achieve to bring long-term structural balance to state finances. The problems we are experiencing today will repeat - year after year - if we do not repair a business taxation system that is broken. That is why it is critical for us to take a multi-year approach to our major solutions.

Before I speak in detail about the updated revenue estimates, I would first like to comment about this budget hearing process. I speak on behalf of all my fellow cabinet officers in stating that we are encouraged and heartened by the spirit of goodwill and cooperation that has been evident throughout the departmental presentations.

I believe that we all have the best interests of the State in mind; we share a common understanding of the challenges before us; and we look forward to working with you to address the priorities of our citizens with a budget that is fiscally sound and responsive to New Jersey's needs.

Revenues

The revised revenue estimates I am presenting today underscore the continued weakness in collections from the Gross Income Tax and the Corporate Business Tax for FY 2002, and the effect of this revenue deterioration on the FY 2003 projected revenues.

Simply put, a bad fiscal situation has grown much worse. April income tax collections fell $233.3 million below the most recently revised targets for the month, and were more than $750 million below projections for April that were made when the FY 2002 budget was adopted last June.

As a result of disappointing April income tax collections, and deteriorating Corporate Business Tax collections, we have no choice but to again revisit the FY 2002 problem, and to revise our revenue projections downward. We estimate that revenues for FY 2002 will be $589 million less than the revised revenue projections we made in March.

We also have had to revise our revenue projections downward for FY 2003. We estimate that for the coming fiscal year, revenues will be $628 million less than anticipated in the budget proposed by the Governor in March.

This means that we are confronting a combined total revenue shortfall of $1.217 billion in this fiscal year and the next.

The shortfall of $589 million below revised projections in the current budget year, which ends in less than five weeks, will result in $20.268 billion in revenue collections by the end of June. This is $2.605 billion less than the revenue projections contained in the budget that was enacted under the previous administration in June of last year.

When additional revenues approved since the adoption of the budget last June are factored in, the revenue targets established 11 months ago for the FY 2002 budget are off by nearly $3.1 billion, or 14 percent.

In fact, we now expect FY 2002 revenues to be $700 million less than the actual amount of revenue collected in the prior year, FY 2001.

These revised estimates for FY '02 have required us to reevaluate projected revenues for the fiscal year that begins July 1. We are reducing our projected revenues for FY 2003, from $23.7 billion to $23.1 billion.

This decline in revenue for the State is alarming, particularly when you consider that there are built-in costs that drive New Jersey's budget higher from one year to the next. And as I indicated in my testimony last month, had we taken our hands off the wheel and done nothing to stop the structural growth in state spending, we would have faced a shortfall problem in excess of $6 billion coming into a new fiscal year.

Earlier today you heard the Office of Legislative Services update its projections for FY '02 and '03. The Administration and OLS are virtually in agreement on the revenues for '02 and '03. We are committed to working with you to arrive at responsible revenue estimates for FY 2003 and beyond.

FY 2002 - Income Tax

New Jersey's April Gross Income Tax revenues mirrored a national trend of declining collections. We now estimate the State will receive $6.78 billion from the Income Tax in FY '02. That is $1.7 billion less than what was certified last June when the budget was adopted, and $511 million below the revised projections made in March. In fact, these newly revised projections are $425 million less than income tax collections in FY 2000, and nearly $1.2 billion below FY '01 collections.

Last June, the previous administration anticipated that total income for tax year 2001, including capital gains and stock options, would grow by 3 percent. We now recognize that in tax year 2001, total income actually declined by 5.5 percent.

Final income tax payments in April and May are now estimated at $890 million, or $476 million below last year's numbers.

FY 2002 Corporate Tax

The administration's revised estimate for the Corporate Business Tax is $1.028 billion. This represents a decrease of $84 million from the March revisions and is nearly $800 million less than the amount certified last June. That's nearly a 45 percent shortfall in one of the three largest revenue sources for the State.

Now that most of the payments have been received and processed, we are estimating that the LLC loophole changes that were enacted last year will generate only $71 million. This is approximately $350 million below the $420 million that was projected when this budget was adopted last June and $150 million less than the $220 million anticipated in our revised revenue projections in March.

The FY 2002 Budget Solution

Of immediate concern is the $589 million revenue shortfall in the current fiscal year. We are faced with the urgent task of identifying another $589 million in solutions between now and June 30. By doing so, we would meet our constitutional responsibility for a balanced budget for FY '02 and close the year with a surplus.

Prior to discussing FY 2003 revenues and proposed CBT reforms, I would like to present the administration's proposal for dealing with the FY 2002 revenue shortfall.

As I have indicated, we need to find at least $589 million in solutions to meet our constitutional obligation for a balanced budget.

With such little time to act and with our situation so severe, we are forced to rely upon $400 million from our restored surplus. This will leave us with a surplus of approximately $100 million at the end of the current fiscal year, and will provide $400 million of the $589 million needed to solve our fiscal 2002 problem.

While this amount is not a satisfactory surplus balance to project for the end of any fiscal year, with 11 months gone in the 2002 fiscal year and with only 31 days to close an unprecedented shortfall, we cannot maintain a $500 million surplus balance.

The remaining $100 million will be sufficient to cover any projected shortfall in the tax amnesty program, which as we know will not be fully measurable until the days just before and just after the deadline of June 10. Current collections are encouraging, but we must be conservative in our forecasting.

After the depth of our continuing problem became evident with the release of disappointing revenue collections for April, the Governor directed me to begin working with all cabinet officers to determine what spending could be frozen, what funds could be lapsed and how to extract the maximum amount of savings from budgets over the last two months of the fiscal year. Through this process, we have identified approximately $64 million in additional spending constraints from funds that are not scheduled to be expended prior to June 30th.

Since most of the expenditures during the balance of the fiscal year are payroll expenses, school aid payments or entitlement payments, we simply cannot solve our problem without additional FY 2002 revenue.

We therefore are requesting that the Legislature approve the diversion of an additional $125 million from surplus monies in the Unemployment Insurance Trust Fund. We have been assured by Labor Commissioner Kroll that the Fund can safely absorb this diversion.

The combination of the $64 million in additional spending constraints and the $125 million in UI funds will provide us with a surplus of approximately $100 million. My staff and OMB will continue to look for additional spending constraints to increase this surplus above $100 million.

FY 2003 - Total Revenue

As I stated earlier, we also have lowered our revenue expectations for FY '03 by $628 million.

As a first step in this balancing effort, the Governor has directed me to work with every department to prepare plans for reducing their operating budgets even further from the adjusted FY 2003 levels submitted just two months ago.

The Governor has made it clear that his objective is to deal aggressively with this problem by holding the line on spending. At his direction, I will again go line by line, division by division, and department by department to identify savings.

The Governor is taking the lead in this regard by authorizing a reduction in spending on his new initiatives by approximately 50 percent. He has also made it clear that our budget reductions must not have an impact on staffing at State institutions that serve at risk populations. Adequate staffing levels at these facilities are essential to maintaining federal accreditation and protecting tens of millions of dollars in federal funds.

FY 2003 - Income Tax

Due to continued declines in actual FY 2002 income tax collections, we have reduced estimates for the GIT in the next fiscal year from $7.78 billion to $7.26 billion, a reduction of approximately $517 million.

It is important to note that New Jersey's property tax relief programs are paid through the income tax. But while revenues from the income tax have declined in FY '02 and FY '03, we continue to increase our commitment to property tax relief.

Although FY '02 income tax revenues were nearly $1.8 billion below the projections made when the budget was adopted, Governor McGreevey maintained funding for all of the property tax relief programs that were included in that budget.

When the budget was adopted last June, only $1.3 billion in General Fund revenue was set aside for property tax relief programs. The adjusted FY '02 budget now provides $3 billion in General Fund support for property tax relief programs.

Likewise, the governor has made it clear that despite the state's serious fiscal problems in the coming year, he will protect property tax relief for New Jersey citizens.

In FY '03, the $7.26 billion in income tax revenue will need to be supplemented with $3.36 billion million in General Fund revenue to insure that State aid for property tax relief and property tax relief programs is sustained.

FY 2003 - Sales Tax

Based on a re-evaluation of the projected growth in the Sales Tax, the FY '03 estimate has been decreased from $6.227 billion to $6.19 billion, a decrease of approximately $37 million.

The last five weeks of this budget year will be no less challenging than the first five months of this administration. We are committed to working with you on getting New Jersey on the right fiscal track for FY '02 and making this administration's first budget a prudent spending plan that brings true balance between revenues and expenditures.

As you know, these ongoing revenue problems compound a budget crisis that was already quite serious.

Immediately upon taking office, Governor McGreevey identified a $2.9 billion shortfall in the current year budget. Working together with you, we addressed that shortfall and restored balance to our budget.

In March, in his budget address to you, the Governor outlined a $5.3 billion shortfall in next year's budget, and his proposals for balancing New Jersey's budget.

A few minutes ago, I briefed you on the continued deterioration of revenues. Once again, we have been forced to make significant downward revisions in our revenue projections, both for the remaining five weeks of this year and for the coming fiscal year. And once again, we are forced to drive our government to greater efficiency, and we are forced to make difficult choices.

The Governor has made it clear that there are certain principles that have guided us in this budget process.

First, like any family, New Jersey must live within its means. Unfortunately, New Jersey has not been living within its means. Spending has grown 54 percent in the past 10 years, but our revenues this fiscal year are expected to be $700 million less than those collected last year. New Jersey has also greatly increased its borrowing in recent years, and the state's debt tripled between 1992 and 2002.

Second, while we have taken action to rein in the cost of government, and tackle waste and mismanagement, we also have identified those programs that must remain priorities, even in tough times. We must ensure our people are safe in their homes and on our streets. We must build the best educational system in the nation.

Third, the Governor made it clear that despite the enormous pressure of this fiscal crisis, we will not balance the budget on the backs of the working people of this state:

	The Governor refused to increase the income tax.
	The Governor refused to increase the sales tax.
	The Governor refused to cut aid to our schools or municipalities.
	The Governor refused to cut funding for direct property tax relief programs, such as NJ Saver, Homestead Rebates and the program that freezes senior property taxes.
	Combined, direct and indirect property tax relief comprise more than 50 percent of our state budget, and Governor McGreevey has not wavered in his commitment deliver this property tax relief to New Jersey's hardworking families.

REFORMING THE CORPORATE BUSINESS TAX

Mister Chairmen, after many weeks of refining the details of draft legislation to restructure our broken corporation business tax, I am pleased to announce that we expect the Administration's plan to be formally introduced today. I would like to give the committee a clear outline of this plan's components, and what the reforms mean for FY '03 and beyond.

To ensure that this budget is fair and equitable, we must make some fundamental reforms to our business tax structure.

We are here today because we have to be here. We have no other choice. Our Corporate Business Tax is broken.

Twenty years ago, the CBT raised $838 million - about 15 percent of the state's total tax revenue. Just five years ago, this proportion had dropped to 8 percent. By Fiscal Year 2001, it stood at 6.6 percent.

If we fail to reverse this erosion, we will see the CBT drop to just 4 percent of total state revenue in fiscal year 2003. Despite two decades of unprecedented economic expansion and growth in corporate profits, CBT revenues would be less next year than in 1982. In fact, in FY 2002 we anticipate collecting only 1.02 in CBT revenues, 44 percent less than the $1.8 billion projected in the original FY 2002 budget.

This is largely the result of proliferating loopholes that have permitted many profitable companies to avoid paying virtually any corporate tax.

In 1999, the last tax year for which statistics are available, nearly 77 percent of all companies paid only the statutory minimum tax of $200.

Of the 50 companies with the largest payrolls in New Jersey, 30 paid only the $200 minimum. That's less tax than would be paid by a single parent with a child earning $25,000 a year. That's not fair and that's not equitable.

Let me be clear, the problems with our CBT are not because these corporations are unprofitable. Treasury took an even closer at ten of these large corporations. These are some of the largest companies in the state, and some of them are headquartered here.

	These ten companies had an aggregate payroll of $3.5 billion;
	They told their shareholders they had $13.3 billion in profits;
	$2 billion of these profits would have been attributed to New Jersey profits, and subject to our CBT, based on how these companies apportion their income among various states;
	Those $2 billion in profits would have generated $177 million in CBT revenues.

But not one of those 10 companies paid more than the $200 minimum in corporate taxes in 2000.

Clearly, we must reform our corporate business tax. Let me begin by stating clearly that this proposal fully addresses the reasons why the CBT has collapsed as a viable revenue source for the State.

We have worked in consultation with many of the nation's leading tax experts and economists to clearly identify the reasons for this collapse.

We know that CBT loopholes allow multi-state corporations to transfer their profits to related out-of-state and offshore companies. We know that many of these companies utilize these loopholes to reduce their net income to little or nothing, thus avoiding the New Jersey Corporate tax.

We know that the CBT does not reach out-of-state companies that do business here. Instead, these companies are able to take advantage of the state's lucrative market, skilled workforce, and geographic prominence, while paying no corporate taxes to New Jersey.

We know what happens to New Jersey's business climate when some companies exploit loopholes and avoid paying their fair share: Corporate citizens who pay their fair share are put at a competitive economic disadvantage with companies that evade or exploit the system.

We have an obligation to provide a level playing field for all businesses, large and small, that invest in New Jersey, employ our citizens and do business here.

Our reforms correct these core problems with the tax structure in three ways.

	First, we are closing numerous loopholes which allow profitable companies to reduce their net New Jersey income on paper and avoid their true tax liability and avoid paying their fair share.
	Second, we are proposing an Alternative Minimum Assessment that will accurately measure a company's economic presence in New Jersey. Companies would assess their tax liability with a formula that uses either reported gross receipts or gross profits as a determining factor. Companies would then pay this alternative assessment, instead of the CBT, if it is larger than the CBT liability.
	And third, we will be establishing a revenue stream that captures enforcement and processing costs that New Jersey incurs from processing the vast network of limited liability companies and partnerships.

At the same time, we are taking affirmative steps to protect small businesses. Our proposed legislation will call for a reduction of more than 13 percent in the rate at which small businesses are taxed under the CBT, resulting in a tax decrease for approximately 20,000 small businesses.

Furthermore, our proposed legislation will include provisions designed to encourage job creation by doubling the new jobs factor and expanding the eligibility for midsized businesses through an expanded jobs credit incentive program.

I would like to share details of the tenets of these reforms with you now and answer whatever questions I can following my prepared testimony.

Prominent among our proposals are loophole closers that end companies' ability to export their earnings and import expenses to minimize their tax liability to New Jersey.

Royalties

Our loophole closure solutions cover an import/export paper trail that cries out for reform. We will disallow royalty payments to be taken as a deduction from New Jersey's CBT, when those royalty payments are made to a parent or affiliated company.

New Jersey is home to multi-state companies that have considerable assets, including intellectual property assets such as trademarks. As a tax avoidance strategy, some companies have created business affiliates in other states - Delaware in particular - that do not tax royalty income.

Then, the out-of-state affiliate charges the New Jersey company a licensing fee for the use of the trademark. This allows the New Jersey company to write off the royalties as a business expense, thus lowering it profits and reducing or eliminating its CBT liability. In a very real sense, they pay themselves, write it off as a business expense, then use the transaction to lower their tax liability in New Jersey.

The transaction becomes even more troubling when one considers that the royalty income claimed in another state gets imported back to New Jersey as a dividend, which is not subject to the CBT.

Legally, we take the position that when an out-of-state company claims to "sell" trademarks or other creations to affiliated companies in New Jersey, that out-of-state company has a clear nexus to New Jersey and should be paying its fair share of taxes already, without the need for CBT reform. Unfortunately, these disputes become tangled in years of litigation. We propose making the law clear by affirmatively closing this major loophole and recouping between $25 million and $40 million due to New Jersey each year.

Dividend Exclusion

New Jersey's CBT currently excludes certain dividends in the determination of a company's net income. Specifically, dividends received from an 80 percent-owned subsidiary are 100 percent excludable, as in the case I just described, while all other dividends are excludable at the rate of 50 percent.

Through tax planning practices, companies are able to convert taxable income into untaxed dividends by transferring income earned by one subsidiary or affiliate to another.

We are closing this loophole by electing to tax 100 percent of these dividends as net income subject to the CBT.

By closing this loophole, New Jersey projects to recoup between $50 and $70 million in CBT revenue due to our State.

Interest Exclusion

Interest expenses are currently deductible from the net income reported to New Jersey under the CBT. Corporations can shelter taxable profit by sending it to subsidiaries or affiliated companies in other states that have less tax or no tax. This is done under the guise of "interest" being paid by the New Jersey company on a "loan" from an out-of-state affiliate.

We are seeking to close this loophole, yet maintain the deduction for legitimate cases in which an interest-paying corporation is a guarantor of a loan to a third party.

Under our reforms, 100 percent of the interest paid to affiliate entities would be added back into net income reported to the CBT. By disallowing this interest deduction, New Jersey would restore $25 million to $40 million to our CBT collections.

Throwout Rule

Another needed reform is enactment of a so-called "throwout rule."

As you know, the CBT is calculated on a three-factor formula that encompasses property, receipts and payroll. Multi-state corporations are effectively able to minimize the receipts portion of that formula by claiming significant sales in states where they are exempt from taxation.

These sales are typically referred to as "nowhere sales" that yield "nowhere income," which cannot be factored into New Jersey's CBT.

We are closing a loophole that currently allows companies that do business
in more than one state to artificially lower their taxable profits by factoring in these untaxed profits from states outside of New Jersey.

The new formula for apportioning a company's taxable profits in New Jersey will require that companies factor in only the income that is subject to taxation in this or another jurisdiction.

As a result, our corporate tax formula will more accurately measure a company's taxable profits that should be subject to our corporate tax because those profits are generated here.

We have rejected an option that is used by 24 other states where they tax
income that is earned in non-taxing states as if it were earned in their states. We believe that is unfair to business and we rejected that option.

With this reform, we estimate that New Jersey will recoup between $50 million and $70 million in revenue that escapes through this loophole.

Also, as part of our effort to impose our CBT on all corporate income that is generated in New Jersey and legally attributable to New Jersey, we will amend our law to extend the reach of our CBT to any income derived from New Jersey sources. We will also attribute entirely to New Jersey the so-called non-business income earned by our domestic corporations that is not taxable elsewhere.

Like several other states, we will eliminate a deduction for foreign, non-U.S. taxes. And we will make minor modifications to the R&D tax credit, while preserving its essential role in encouraging and rewarding new research and development expenditures in New Jersey.

Ending Exclusions

Our CBT reforms also seek to level the playing field in New Jersey by ending special tax advantages enjoyed by select types of companies.

Investment companies enjoy a preferred tax status under the CBT. New Jersey defines an investment company as a business engaged in managing its own portfolio. The CBT defines the taxable income of such companies as just 25 percent of their entire net income. We believe it is fair to raise the taxable income to 60 percent of net income, which will net the state an additional $20 million to $30 million.

We also believe it is fair to subject Savings and Loan Associations to the Corporation Business Tax. Unlike most other financial institutions, S&Ls currently pay no CBT. Instead, they pay only an annual excise tax equal to 3 percent of net income. That tax was enacted in 1973. We believe the time is right to bring S&Ls in line with what other depositary institutions pay. This change will allow the State to realize $5 million to $10 million in CBT revenue.

Another group of taxpayers that enjoy preferential treatment are shareholders of Real Estate Investment Trusts.

REITs pay a 9 percent tax on only 4 percent of their net income. One of the main concerns about REIT income is that profits of non-resident shareholders can escape taxation under the CBT. Our reforms would amend New Jersey law to require the addback of dividends distributed to shareholders in the calculation of the entire net income of REIT.

By closing this loophole, New Jersey would recoup between $1 million and $3 million in revenue that would otherwise go unreported in New Jersey.

Consolidated Reporting

We also recognize that the sum total of all of our loopholes may negatively affect some transactions that business executives believe are legitimate. That is, frankly, the unavoidable consequence of being a so-called "separate entity" state. That is, New Jersey treats each subsidiary or affiliate of a corporation as if it stands alone, even though we know that in some of our multi-national corporations, they are all part of a commonly managed, integrated whole.

Economic experts say that the most efficient and fairest way to tax corporate income at the state level is to

We do not propose to mandate California-style "combined unitary" reporting, where the state requires a multi-state or multi-national firm with multiple subsidiaries to combine all those entities which are part of a "unitary" business in California. But we do propose to give corporations the option to pay tax based on their federal consolidated return. "Consolidated" is not the same as "combined unitary." Consolidated combines ALL of a corporation's entities, even those arguably not part of the unitary business.

Unlike combined unitary, piggy-backing on the federal consolidated return is not subject to disputes over what part of the business is unitary with the business in New Jersey. We do not open ourselves up to a new round of games, where corporations gladly include money-losing operations in their combined returns and try to exclude their money-making operations. Using the consolidated federal return is simpler; there are no disputes over what is unitary; we piggyback on the federal return. To avoid year-to-year gaming, the election would apply for five years, subject to change on two years' notice.

Consolidated reporting gives firms the option to present the total pie of corporate income; identify the fair slice apportioned to New Jersey; and then pay tax on that New Jersey apportioned income.

NOLS

These loophole closures represent long-term, sustained reforms to restore our CBT to its status as a viable revenue source for New Jersey. Currently, however, we are repairing a CBT that is in a free-fall, and we must take some other immediate steps to stop the rapid erosion of CBT revenues.

For this reason, while we assess the impact of our numerous loophole closers, we propose suspending the two-year carry-forward of net operating losses, or NOLs.

Net Operating Loss rules, allow companies to reduce their corporate business tax payments by deducting Net Operating Losses for a period of up to seven years. Our legislation will defer this accounting procedure for two years.

Delaying this rule means only that companies that earn a profit this year will pay tax this year and will not carry forward losses from as far back as seven years ago to reduce their tax this year.

Let me be clear. While we are deferring the NOL rule for two years, we are also adding two years at the back end of the existing seven-year period. Thus, ultimately no company will lose the opportunity to write off those losses from prior years.

We also include a provision to codify a recent Tax Court decision, applying Supreme Court precedent, which defines when NOLs can be used in the case of corporate mergers and changes in where a company is incorporated.

A two-year deferral of the NOL rule would boost revenues to the State by between $180 million and $200 million without causing any hardship to struggling businesses.

Alternative Minimum Assessment

As you will recall, the AMA proposed in budget documents released on March 26 provided for an alternative structure based on three measures of economic activity: corporate receipts, payroll and property, much like the factors used to apportion profits to New Jersey under the current CBT.

Under refinements that we incorporated following extensive meetings with members of the business community and state taxation experts, the AMA formula will quantify a company's economic activity in New Jersey by providing a choice of using gross receipts or gross profits to measure their economic presence in New Jersey. The AMA would be capped at $5 million per company, or $15 million for a corporation's entire group of affiliated companies.

Gross profits is gross receipts minus the cost of goods sold. By permitting companies to use their gross profits to calculate their AMA, we are protecting high volume, low margin industries such as retailers, food stores, car dealers and others who are so vital to our state's economy from bearing a disproportionate tax burden.

We are confident that this reform will effectively capture tax income due to New Jersey from out-of-state companies that currently pay no corporate taxes in New Jersey. These are companies that take advantage of our marketplace, and have a significant economic presence here, but do not have an actual physical presence in our state. Companies that ship their goods to customers in our state, and use our roads and bridges - but pay no corporate taxes here - put New Jersey companies at a competitive disadvantage. This reform will level the playing field for New Jersey companies.

The AMA will also prevent companies from devising new loopholes to avoid their New Jersey corporate taxes. We are confident that our proposals to close loopholes will show results. But at the same time, we cannot underestimate the ingenuity of corporate tax planners, and their ability to continue to invent new loopholes. This is why the CBT has deteriorated and if left unchanged, would produce less in revenues next year than in 1982.

The AMA will produce between $240 million and $275 million in revenues that are due New Jersey. A share of these revenues will come from out-of-state companies that currently pay no corporate business taxes in New Jersey.

This reform will ensure fairness. New Jersey companies that are already paying their fair share would not be subject to the AMA. Companies would be required to calculate their CBT tax liability, as well as their liability under the AMA, and would pay whichever is larger. Under the AMA, companies would choose whether to calculate its liability based on either gross profits, which would be subject to a .6 percent tax rate, or gross receipts, which would be taxed at .3 percent.

To protect small businesses, the first $1 million in gross receipts would be exempt from the AMA, and the first $500,000 in gross profits would also be exempt.

Furthermore, if a company's AMA exceeds its CBT in one year, the difference between the AMA and the CBT would count as a credit to reduce the company's CBT liability in a future year.

The AMA will sunset after December 31, 2006 because this is a transitional assessment intended to provide time for the loophole closers to generate the expected revenues.

Processing Fee

We are also introducing a reform that would institute a processing fee on individual owners of pass through entities, such as LLPs, LLCs and Partnerships. Members and partners in LLPs, LLCs and Partnerships must file a K-1 form with the state.

We estimate that half of K-1s filed in New Jersey come from out of state residents who are involved in New Jersey LLCs, LLPs and Partnerships. Enforcement is difficult in such cases. That is why we recently announced we would begin withholding in the case of business entities that have out of state partners, just as any wage earner currently has taxes withheld from their paycheck.

These fees will ensure that partners and members of pass-through entities contribute toward our state's costs of administering and enforcing our tax laws. There would be no charge for the first two K-1s filed by any LLC, LLP or Limited Partnership. But for partnerships and LLCs with three or more members or partners, there would be a recording fee of $150 for the third and subsequent K-1 forms filed.

We anticipate collecting between $250 million and $300 million from this initiative.

PROTECTING SMALL BUSINESSES

We know that small businesses are the backbone of our economy, and are the primary source of new jobs. Our proposal includes several measures to protect small businesses.

As outlined above, the AMA would not apply to a company's first $1 million in sales, or to its first $500,000 in gross profits.

But we propose going even further to protect small businesses. Businesses currently pay 7.5 percent on net profits of up to $100,000. Companies that report more than $100,000 in net profits currently pay 9 percent on all profits.

To support small businesses, we propose lowering the CBT rate for companies with $50,000 or less in profits from 7.5 percent to 6.5 percent. This is tax reduction of more than 13 percent. Approximately 20,000 small businesses will see their taxes decrease as a result of this reform.

ENCOURAGING JOB GROWTH

We also have incorporated significant incentives to encourage larger employers to continue growing and creating jobs in New Jersey. We propose expanding the jobs credit by doubling the new jobs factor and expanding the eligibility for midsized businesses. This will make the credit more generous and more accessible to businesses that are investing and hiring in our state.

CONCLUSION

The changes to the CBT outlined above will ensure that New Jersey achieves the revenue collection target of $1.82 billion originally contained in the FY 2002 budget enacted nearly one year ago.

We have built the $1.82 billion into our '03 plan and we will achieve it. With no changes to the CBT, we would collect only $870 million from the CBT in FY 2003, nearly $1 billion less than the CBT revenues that were projected in the budget adopted by this Legislature nearly a year ago. That revenue of $870 million assumes that New Jersey will decouple from the depreciation changes enacted this spring at the federal level. We will need your continued help to enact decoupling legislation and to fix New Jersey's broken CBT. Otherwise, our CBT revenues would fall as low as $800 million, and possibly less.

We will achieve our target and we will do so with fairness and equity. We have consulted extensively with the business community throughout this process, and we have crafted our proposal with sensitivity to what these tax changes mean to our business community. We are balancing this sensitivity with our obligation to deliver services to all New Jersey citizens and provide an equitable system of business taxation.

We simply cannot stand by and do nothing to curb the runaway erosion of the CBT revenue base. We cannot stand by while some companies pay their fair share, and others avoid paying virtually anything at all.

We simply cannot afford a system in which 77 percent of businesses pay just the CBT minimum of $200. This is unfair to hardworking New Jersey families that pay considerably more than that in state taxes. We must not allow hardworking citizens to shoulder the burden, while their highly profitable employers use loopholes to escape paying their fair share.

We also must level the playing field so that businesses that do pay their fair share are not put at a competitive disadvantage against multi-state corporations that are able to export their profits to avoid paying their New Jersey taxes.

The Corporate Business Tax has become the Corporate Optional Tax. That must change, and it will change.

We have made every effort to be open and fair about the changes to the CBT tax structure. We have built flexibility into our plan to allow businesses to tailor the fairest plan for their needs.

For example, we modified the AMA to encompass either gross profits or gross sales.

We also are giving companies the right to elect to pay the state CBT based on the New Jersey share of income reported on the corporation's consolidated tax return. If they feel they would be unfairly burdened by our loophole closures, businesses are welcome to opt to pay the CBT based on the share of its consolidated income that is attributable to New Jersey.

Our plan is fair, it rebuilds the CBT and it levels the playing field for all businesses who make New Jersey's economy strong, dynamic and vibrant.

This, coupled with our other revenue proposals and spending constraints, will address New Jersey's need to put our fiscal house in order. Our changes will fortify the structural base of our budget, strengthen our commitment to deliver property tax relief to citizens, and meet the diverse budgetary challenges of our great state.