New Jersey: Why the Garden
State is Under Scrutiny
Market Commentary
December 2016
THE STATE OF NEW JERSEY HAS BEEN UNDER SCRUTINY FOR SOME TIME due to fiscal
challenges, and current events continue to validate the market’s concern.
Recently it was reported that the state has the lowest pension funding ratio of
any state, with pension assets equal to just 37% of the benefits owed. Shortly
thereafter, the state legislature and governor agreed on its transportation
funding: the gas tax will increase but the state sales tax will be reduced.
Subsequently, New Jersey voters decided to segregate transportation revenues solely for
the use of financing transportation-related projects, compounding the limitations on
state revenues. Due to the various budget pressures, Standard & Poor’s downgraded the
state’s rating, to A- with a negative outlook, cementing New Jersey’s rank as the second
lowest-rated state after Illinois. Moody’s and Fitch’s ratings of A2 and A, respectively,
also place New Jersey as second lowest among the 50 states. While none of these events
is surprising, they underscore the need to monitor the state closely.
Reduced State Sales Tax Endangers Annual Pension
Funding Gains
In January 2017, the sales tax will decline from 7% to 6.875% and will be further
reduced in January 2018 to 6.625%. Additionally, the estate tax will be phased out
over two years and certain changes to income tax exemptions will be phased in. This
is a direct result of a deal brokered between the legislative branch and the governor to
finance the state’s transportation fund.
New Jersey relies heavily on sales tax revenues to finance its general operations. The
effect on the current budget will actually be mildly positive, but it will reduce the
state’s operating revenues significantly in the long run. The state has estimated that by
fiscal year (FY) 2021 its general fund will receive $1 billion less in revenues due to the
reduction. This will present a high hurdle in continuing the pension funding plan as laid
out by Governor Christie. The administration plans to increase funding by 1/10 of the
actuarially required contribution each year. In FY17, the budget includes a $1.9 billion
payment, equal to 4/10th of the total payment.
Full funding of the pension payments at $6.3 billion is scheduled for FY23; as a
point of comparison, this is a sizable payment relative to the current year’s budget of
$34.5 billion.
NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE
Kristen DeJong
Vice President, Research Analyst
Nuveen Asset Management, LLC
Beth Dougherty
Vice President, Portfolio Manager
Nuveen Asset Management, LLC
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New Jersey: Why the Garden State is Under Scrutiny
December 2016
The reduction to the state’s sales tax clearly threatens its ability to continue the funding
plan. As state revenues decline, there will be greater competition for funding among
those payments and money for education, public safety, and health and human services.
Furthermore, continued underfunding of pension payments through 2022 will drive
down the pension funds’ already low funded ratios. As of June 30, 2015, funding ratios
for the state’s open pension plans range from just 22% to 53%, and the total net pension
liability is $135.7 billion. That’s nearly four times the state’s operating budget.
Notably, a new governor will take office in 2018. That administration will face difficult
decisions, including raising revenues, reducing other expenditures or reducing the
pension payment as was done in FY14 (the pension payment was just $699 million that
year, less than 20% of the ARC).
Transportation Trust Fund Benefits from Gas Tax Increase
While New Jersey’s general operating revenues are expected to decline, resources
dedicated to transportation funding are set to increase. The transportation trust fund
(TTF) is responsible for maintaining and constructing the state’s transportation
infrastructure. To address the dire need to finance infrastructure projects, the New
Jersey legislature voted to raise the per-gallon tax on gas and diesel. Prior to this, all the
revenues coming into the TTF were needed to cover debt service. Effective November
1, the state’s gas tax increased by 23 cents and the tax on diesel fuel increased by 4 cents,
to a rate of 37.5 cents per gallon. This puts the state’s gas tax at seventh highest in the
nation. Previously, it was the second lowest, only after Alaska. The higher gas tax is
expected to increase the TTF’s revenues by $1.23 billion each year after FY17.
In November, New Jersey voters approved a constitutional amendment dedicating
the state’s gas and petroleum taxes to the TTF. The new amendment restricts all gas,
diesel and petroleum taxes, along with any future increases, to finance transportation
projects. This will reduce the funds available for general state purposes, but also alleviates
the state’s need to transfer sales tax revenues to the TTF to cover debt service on
transportation bonds as the state had been doing. Passage of the amendment greenlights
legislation for the state to issue up to $12 billion of transportation bonds through FY24.
However, the state does not intend to tap this authority over the next two years due to
the recent issuance of approximately $3 billion in Federal Highway Reimbursement
Revenue Notes that will finance transportation projects for FY17 and FY18. With
near-term transportation funding resolved, state leaders may refocus attention on other
budget issues such as pension and health care.
Health Care Costs: Another Pressure on Sluggish Revenues
Although pensions and transportation funding have been in the news lately, New Jersey’s
budget faces numerous challenges. Revenues have been underperforming for years and
health care expenditures have been increasing faster than pensions. New Jersey relies
primarily on revenues generated from personal income and sales tax collections to
finance its general operations. The health of these revenue streams are dependent upon
the health of the state’s economy but the state’s recovery from the great recession lagged
its neighbors.
2
A BRIEF HISTORY OF
NEW JERSEY’S PENSIONS
As recently as FY02, the state’s pension
plans were fully funded, with the assistance
of $2.8 billion in pension obligation
bonds (POBs) issued in 1997. Following
the issuance of the POBs, the state began
to underfund, or in some cases entirely
skip, its actuarially required contribution
to the funds. The state also increased
benefits. It was FY07 before the state made
a meaningful contribution again. But once
the recession hit, pension payments were
cut back, investment returns were dragged
into negative territory and funding ratios
plummeted.
In 2011, the state passed pension reforms
that called for increased employee
contributions, a higher retirement age and
elimination of cost of living adjustments
(COLAs) among many other employee
concessions. In return, the state agreed
to make pension payments a legal
requirement and phase in full funding
of the actuarially required contribution
(ARC) over seven years. Many aspects of
the pension reform have been litigated,
including the state’s ability to reduce the
contractual payments and whether freezing
the COLAs is constitutional; both were ruled
in favor of the state by the New Jersey State
Supreme Court.
New Jersey: Why the Garden State is Under Scrutiny
December 2016
Although the state has made recent gains in employment and resident wealth indices
remain strong, the sluggish economic recovery has directly resulted in weak revenue
growth over the past several years. Combine this effect with the upcoming reduction
in the state’s sales tax and other revenues, and the forecast for the state’s budget is
very concerning.
On the expenditure side, the fiscal strain is not only due to increasing pension
contributions. Expenditures for other post-employment health care benefits (OPEB)
exceed pension payments by $68 million in the FY17 budget. This payment equals 5.6%
of FY17 budgeted operating funds revenues, excluding federal grants, and combined
with pension payments constitute $3.8 billion, or 11% of the budget. In FY16 the
combined benefits accounted for 9.4% of the budget.
These obligations are growing faster than the state’s revenues. As a result, other more
easily cut expenditures are crowded out as costs for pension and health care grow.
A February 2016 report from the New Jersey Pension and Health Benefit Study
Commission stated when these combined expenditures exceed 15% of the budget, the
state will be facing financial jeopardy and will likely see additional downgrades to its
public credit ratings.
Pension and OPEB Costs Consume a Larger Share of Budget
Pension and OPEB Contributions as % of Operating Funds Revenues
Operating Funds Revenue ($ millions)
Contribution as a % of Operating Funds Revenues
 Operating Funds Revenue
$35
12%
$30
$25
9%
$20
6%
$15
$10
3%
$5
$0
2010
2011
2012
2013
2014
2015
2016
2017
0%
Data source: New Jersey Economic Development Authority Official Statements, 2016 Series AAA, 2015 Series WW, 2014 Series PP,
2012 Series II and 2011 Series GG.
State Debt Expected to Remain High
The state’s debt burden has increased substantially in the past decade, and is high by
many measurements. In 2015, the state ranked fourth in total net tax-supported debt
outstanding, according to Moody’s. Residents shoulder $4,141 of per capita net taxsupported debt, ranking fourth and compared to an average of $1,431. It also ranks fourth
among states in terms of tax-supported debt as a percent of income at 7.3%, more than
double the average of 3.0%, and as a percent of state GDP at 6.7% (the mean is 2.7%).
Debt service on the state’s general obligation (GO) and appropriation-backed bonds is
$3.7 billion in FY17, equal to 11% of the budget. Combine this with pension and OPEB
expenditures and the state’s fixed costs exceed 20% of anticipated FY17 revenues.
3
DEBT SERVICE COMBINED with
pension and OPEB expenditures
exceed 20% of anticipated FY17
revenues.
New Jersey: Why the Garden State is Under Scrutiny
December 2016
The state has almost $37 billion of debt outstanding, although less than 6% is GO bonds.
The rest is subject to annual appropriation, although about half is backed by dedicated
revenues, either per state statute or bond indentures. The state’s ability to issue additional
bonds is somewhat limited, as voters must authorize both GO and appropriation-backed
bonds. However, this excludes debt backed by constitutionally dedicated revenues, such as
bonds issued by the TTF.
Despite Progress, New Jersey Faces Long-Term Hurdles
The state has made progress in both funding of pensions and transportation, but recently
passed legislation will reduce operating revenues over the next two years and certainly
endanger the plan of fully funding pension payments by FY23.
The New Jersey Supreme Court ruling allowing the state to reduce pension contributions
provides the state some short-term financial flexibility, but each year of insufficient
funding compounds the long-term pension funding challenges. Future revenues will
undoubtedly be needed to sustain expenditures in the absence of further pension and
healthcare reform. The state’s large economic base and high resident wealth levels remain
positive credit factors but fiscal challenges, led by a growing pension burden, are likely to
continue over the long term. ▪
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SOURCES
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Truth and Consequence, Status Report of the New Jersey Pension and Health Benefit Study
Commission, September 25, 2014
Supplemental Report on Health Benefits, New Jersey Pension and Health Benefit Study Commission, February 11, 2016
“New Jersey Tops Illinois as State With Worst-Off Pension System,” Bloomberg, November 2,
2016
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GPE-STNJ-1216P 21439-INV-AN-12/17
New Jersey Educational Facilities Authority Official Statement, Series 2016, October 31, 2016
State of New Jersey 2015 Audit
State of New Jersey 2017 Budget Summary
State of New Jersey Division of Pensions and Benefits Financial Statements and Supplementary Schedules, June 30, 2014