LEGISLATIVE FISCAL ESTIMATE

ASSEMBLY, No. 3868

STATE OF NEW JERSEY

217th LEGISLATURE

 

DATED: NOVEMBER 7, 2016

 

 

SUMMARY

 

Synopsis:

Imposes corporate business tax and gross income tax on income attributable to certain investment management services that a corporate or individual partner provides on behalf of a partnership.

Type of Impact:

Potential annual State revenue gain for the General Fund and the Property Tax Relief Fund.

Agencies Affected:

Department of the Treasury.

 

 

Office of Legislative Services Estimate

Fiscal Impact

Annual

 

Potential State Revenue Gain

Indeterminate, Potentially Significant – See comments below

 

 

 

 

·         The Office of Legislative Services (OLS) believes there may be an indeterminate, but significant annual State revenue gain for the General Fund and the Property Tax Relief Fund under this bill, but only if certain conditions hold.

·         The implementation date for the tax provisions of this bill is unknown and dependent on actions by other states and by the federal government.  If the states of Connecticut, New York, and Massachusetts were to enact legislation of identical effect and if the federal government were to maintain current law regarding the taxation of carried interest, then the State would gain additional tax revenue in fiscal years in which the conditions are met.  As of October 2016, none of the other states has enacted legislation of identical effect.

 

BILL DESCRIPTION

 

      Assembly Bill No. 3868 of 2016 concerns the taxation of income attributable to certain “investment management services” that an individual partner or corporate partner provides on behalf of a partnership.  The intent of the bill is to ensure that a possible “carried interest loophole” is not used under New Jersey tax law.

      “Carried interest” is the term commonly used to describe an investment manager’s share in the net profits of an investment fund in excess of any amount contributed by the manager to such fund.  When an investment manager organizes a fund and provides management services to it, the manager usually receives a share of the fund’s future net profits (a “carried interest”), along with a fixed management fee.  The investors who provide most of the capital for the fund share the rest of the fund’s future profits.  Under current federal law, each investor’s share of the fund’s net profits, including the investment manager’s share, generally is taxed at the lower rate for capital gains (rather than at ordinary income tax rates).  The “carried interest loophole” has the effect of treating hedge fund and private equity fees as capital gains, rather than ordinary income.  Gains on investments held longer than one year receive preferential treatment in the federal income tax code, with the highest marginal rate on long-term capital gains set at 20 percent.  Thus, at the federal level this income is taxed at a 20 percent rate and not at the highest federal marginal rate of 39.6 percent, escaping a marginal tax rate of about 19.6 percent.

      The bill defines this source of income as investment management services income so that income that might be claimed by fund managers to be nontaxable income from intangibles, is clearly identified as taxable income for both corporate and nonresident and resident individual partners.

      The bill also implements a 19 percent surtax on income received from investment management services under the gross income tax and the corporation business tax.  This surtax aims to “repatriate” the federal income tax “lost” at the federal level back to the states.  However this 19 percent surtax will only remain in effect until such time as the Director of the Division of Taxation determines that the United States Congress has passed and the President of the United States has signed legislation having an identical effect with this act applicable to such income earned in all of the states and territories.  Thus, this state level effort will end if the “carried interest loophole” is closed at the federal level nationwide.

      In addition, the proposed changes under this bill would take effect only upon the enactment into law of legislation having an identical effect in the states of Connecticut, New York, and Massachusetts. 

 

 

FISCAL ANALYSIS

 

EXECUTIVE BRANCH

 

      None received.

 

OFFICE OF LEGISLATIVE SERVICES

 

      The OLS believes there may be an indeterminate, but significant annual State revenue gain for the General Fund and the Property Tax Relief Fund under this bill, but only if certain conditions hold.  Specifically, the implementation date for the tax provisions of this bill is dependent on actions by other states and by the federal government.  If the states of Connecticut, New York, and Massachusetts were to enact legislation of identical effect and if the federal government were to maintain current law regarding the taxation of carried interest, then the State would gain additional tax revenue in fiscal years in which the conditions are met.  As of October 2016, none of the other states has enacted legislation of identical effect.  

      Precise fiscal information on the impact of this bill is not available.  New Jersey does not produce State gross income tax and corporate tax data related to the sources of income targeted by this bill.  Nationally, there is a wide variance in estimates of the federal impact of the “carried interest loophole.”  Congressional Budget Office (CBO) estimates suggest that treating carried interest as ordinary income subject to ordinary federal income tax rates may raise about $2.0 billion annually.  The policy group Citizens for Tax Justice has also estimated that the 10-year federal revenue impact of closing this “loophole” would be about $21.0 billion, similar to the CBO’s forecast once annualized.  If New Jersey’s share of the $2.0 billion CBO estimated annual revenue gain matched New Jersey’s 4.0 percent share of federal adjusted gross income, the legislation has the potential to yield $80.0 million in additional State revenues attributable to New Jersey taxpayers. 

      In contrast, Victor Fleischer of the University of San Diego School of Law estimates that the federal tax revenue potential of closing the “carried interest loophole” may be almost 10 times greater than the CBO estimate.  Mr. Fleischer calculates that the total carried interest earned by general partners may equal about $200.0 billion annually in the U.S., half of which may be taxed at the lower capital gains rate.  He estimates further that the federal tax rate savings applied to $100.0 billion yields $18.0 billion in annual tax savings from the “carried interest loophole,” if adjusting for changes in tax behavior.  The Hedge Clippers, an advocacy group that cites the work of Victor Fleischer (Hedgepapers No. 27, March 7, 2016), estimates that states could raise significant tax revenue by taxing carried interest to “repatriate” the tax revenue “lost” at the federal level.  That analysis estimated New Jersey could raise $112.8 million annually through legislation that is conceptually similar to this legislation. 

      The OLS has no independent means to evaluate this group’s estimate or the estimates for total federal revenues made by the CBO.  However, while these estimates vary, the revenue potential is significant, if at some future date the other conditions of this bill were met.    

 

 

Section:

Revenue, Finance and Appropriations

Analyst:

Martin Poethke

Principal Revenue Analyst

Approved:

Frank W. Haines III

Legislative Budget and Finance Officer

 

 

This legislative fiscal estimate has been produced by the Office of Legislative Services due to the failure of the Executive Branch to respond to our request for a fiscal note.

 

This fiscal estimate has been prepared pursuant to P.L.1980, c.67 (C.52:13B-6 et seq.).