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DECLINE IN THE MAJOR TAXES: Neither Treasury Department officials nor the Office of Legislative Services were expecting a recession when they testified before the Legislature's budget committees last April, May and June. But with economists and business leaders projecting New Jersey likely to show negative growth for at least the last two quarters of 2001, an across-the-board drop in income, sales and corporate business tax revenues can be expected.

CALCULATING THE SALES TAX: The Treasury Department cut its projected income from the sales tax by $60 million last June, but still forecast a 6.0% increase. However, estimated sales tax collections dropped $22 million in September, the month of the Wrold Trade Center attack, and the state's auto dealer and retail merchant trade associations are not optimistic about the prospects for revenue growth.

September revenue numbers released by Treasury showed a $22 million (4.2%) drop in expected sales tax and a $44 million fall in corporate revenue that represented an 18.1 percent decline over the forecast. Lawrance said the corporate numbers might be due to companies projecting lower economic activity in the payments they filed September 15, four days after the World Trade Center attack, and that the October numbers he would be releasing in mid-November would be a more accurate harbinger.

Treasury's June budget forecast called for a $348 million (6.0% increase in sales tax receipts to $6.127 billion, and a $500 million (38.5%) increase in corporate tax revenues to $1.8 billion built primarily upon a change in the way the state taxes limited liability corporations.

The $420 million projection for the tax change is particularly questionable, since the Treasury Department originally estimated that the new tax would produce just $100 million; Democrats asserted that the revenue to be produced from closing the "loophole" rose in proportion to Treasury's need to fill the budget gap.

During most recessions, state revenues from sales, corporate and income taxes actually decline, raising serious questions about the projections.

"We are bound to see a decline in the corporate income tax as profits plummet," said Melanie Willoughby, executive director of the New Jersey Retail Merchants Association. She and James Appleton, who heads the New Jersey Coalition of Automobile Retailers, both noted that the only reason retail and auto sales were not down further in September was because of deep discounting by merchants and auto dealers that will cut into profits.

Appleton said motor vehicle sales, which are the best predictor of sales tax revenues, were expected to be down 5 percent before the World Trade Center attacks and before the economy was expected to be in a recession.

Willoughby added that sales of high-end luxury items sold by stores like Fortunoff, Tiffany', Sachs Fifth Avenue and Macy's have been especially hard hit. "When you lose those impulse sales, people don't go out the following month and buy two to make up for it," she noted.

Similarly, the airline, travel, hotel and restaurant industries that have lost business will not make up their losses.

"After the attack, there was a great consumer demand shock and nobody went shopping for a few days," Hughes said. "That alone had a significant economic impact and knocked all the third-quarter numbers into the negative. Then we had thousands of layoffs at Continental and other airlines, and all the secondary impacts in related fields."

The state Commerce and Economic Growth Commission found some travel agencies losing up to 90 percent of bookings for the next three months, and most limousine services, taxi companies, caterers and other businesses serving airlines and hotels were forced to implement at least short-term layoffs.

"People who are worried about their jobs are not going to spend money, and people who feel poorer because their stock portfolios are worth tens of thousands of dollars less aren't going to be in the mood to spend money either. It's not a great scenario," Willoughby said.

OLS was projecting lower increases in all the major taxes than Treasury before the World Trade Center attacks and the onset of what is expected to be at least a two-quarter recession. Based on past trends, New Jersey's state government will be lucky if sales, corporate and non-Wall Street-related income tax revenues equal last year's numbers. That would leave another $500 million or more to make up in the current-year budget.

THE DOUBLE HIT: What is not well-understood about state budgeting is the impact of current-year shortfalls on budget forecasts for the following year. If revenue falls short $1 billion, for example, in the budget for FY02, it produces a corresponding reduction in projected revenue for the following year, as Rosen explained in his testimony to the Legislature's joint budget committees last May.

If the new governor and Legislature were able to close, for example, a $1 billion deficit in the current-year budget by using up all of the surplus and by a series of fiscal gimmicks or one-shots, rather than by cutting programs that continue from year to year, they would then have to come up with $1 billion in additional revenue the following year to fund the programs they had managed to avoid cutting the year before. Some of this could come out of normal revenue growth from an economy bouncing back if the recession was over.

But any increase in revenue would almost certainly be eaten up immediately by the need to replenish the $1 billion surplus that had been eaten up to balance the previous year's budget.

Therefore, a $1 billion current-year budget deficit really is a $2 billion headache, and all of it has to be addressed before June 30.

HIDDEN LAND MINES: The dropoff in state revenue caused by the Wall Street-led recession would be difficult enough to resolve, but the FY02 budget contains several "hidden land mines," as budget experts often refer to revenue items expected to disappear the following year.

First, the current year budget contains $650 million in special federal Medicaid reimbursement for nursing homes and hospitals that New Jersey and other states have been taking advantage of for several years under an unintended loophole in the federal Medicaid program. New Jersey's share under this program is scheduled to drop to $150 million in next year's budget. This creates a $500 million shortfall in the general fund because the programs have to continue. New Jersey's Senate and congressional delegation have been lobbying to keep the special federal aid in place, but the Bush administration, understandably, is more focused on Afghanistan and its own fiscal needs.

Second, the Temporary Energy Facilities Assessment, a $216 million special tax that makes up for the difference between taxing energy under the Gross Utilities and Franchise Tax and under the lower 6% sales tax rate is scheduled to expire this year. There has been some discussion of reauthorizing the tax for a year during the lame duck session, but Republicans are unlikely to do Democrats this favor if they capture the governorship and Legislature.

Third, the $70 million to $80 million going to hospitals for charity care out of the Unemployment Insurance Fund will have to be picked up out of the general budget next year, particularly if unemployment claims rise as a result of the recession.

Together, this could add up to another $800 million in revenue the new governor and Legislature would need to identify by January.

THE PRICE OF ELECTION-YEAR SUCCESS: By continually extending the deadline for homeowners to sign up for the NJ SAVER property tax rebate and by aggressively advertising the program, the DiFrancesco administration managed to attract $100 million more in rebate applicants than they had budgeted, adding to the current-year deficit problem.

WHEN THE PENSION BUBBLE BURSTS: The biggest potential problem on the horizon is New Jersey's pension system. The boom on Wall Street over the past four years not only fueled state income tax revenue, but kept raising the value of New Jersey's pension stock portfolio so substantially that the state has not had to contribute a dime to the pension system for four years. It is possible, budget experts say, that New Jersey could squeak through one more fiscal year, FY03, without adding to the pension system. But starting in FY04, New Jersey will need to add an estimated $1 billion per year to the pension fund for government retirees. By itself, this could create a very difficult budget process in the spring of 2003 if it is not addressed sooner.

DEBT TO PAY: Finally, New Jersey's debt service, which costs taxpayers $1.35 billion in this year's budget, is likely to jump to at least $2.1 billion by FY05. So far, only about one-tenth of the $8.6 billion in school construction bonds authorized last year has been committed. And while contracts have been signed for land acquisition under Governor Whitman's $1 billion open space initiative, almost no money has come out of the Treasury yet. By delaying these commitments until after mid-year, Treasury officials may be able to delay increasing debt service payments appreciably in the FY03 budget.

THE BOTTOM LINE: While it is early in the budget year, the projected falloff in major tax revenues, particularly capital gains and other Wall Street-related income tax receipts, and the other budgetary problems described above add up to a potential shortfall of at least $3 billion for the new governor and Legislature.

However, the long-term prognosis for New Jersey's economy actually remains strong.

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Mark Magyar is president of the Public Policy Center of New Jersey and editor of New Jersey Reporter magazine.