Noting a reported increase in wealthy households in the New York City metropolitan area, Robert Frank of the Wall Street Journal is mystified that “New York still has huge budget problems given the wealth surge in 2009 and much-publicized tax burden of the wealthy.”

In other words, if we’re so wealthy, why does Albany still have a budget deficit?  Well, aside from the state’s lamentable failure to, you know, actually reduce spending from boom-time levels, the answer is simple.

Frank’s hook was a reported rebound in the number of “high net worth individuals,” or HNWI’s, in the New York metropolitan area.  HNWIs are further defined as “those having investable assets of $1 million or more, excluding primary residence, collectibles, consumables, and consumer durables.”  In other words, stocks, bonds, certificates of deposit, money-market funds, and cash sitting in the bank or stuffed in the mattress.

New York HNWIs

New York State does not tax financial assets, per se.  It taxes interest income, dividends and capital gains derived from those assets by state residents.  However, some New Yorkers with $1 million or more in financial assets are nonetheless living on modest incomes, and thus pay little or nothing in taxes.  This is especially true for retirees who have much of their net worth invested in low-risk assets now yielding very low returns.  If you have $1 million or more invested entirely in tax-free municipal bonds, you pay zero in state taxes.  If you’re heavily into stocks and have been lucky enough to match or even beat the market during its recent recovery period, you also may still have a backlog of capital losses from the 2007-08 bear market, which can be used to offset your taxable income.

Consider the example of a wealthy retired federal government employee living in Chappaqua.  The stocks he owns may have been worth $1.2 million in 2007, dipped in value to $900,000 in 2008, and rose back over $1 million in 2009.  However, his 2009 state tax bill wouldn’t necessarily have been any higher unless he cashed in some of last year’s market gains to meet higher expenses — say, the down payment on a lavish wedding for his daughter.  And even then, he might still be able to offset his tax bill with capital losses he experienced in the 2007 market downturn.  Indeed, if his capital losses were big enough and his income from other sources hasn’t grown, he may not be paying more for a few years to come (although, to be sure, he’s still paying a much higher effective rate than, say, the guy who picks up his garbage).

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Despite growing signs that Congress is finding it harder to spend with reckless abandon, New York State budget negotiators were counting on getting $1 billion in added Federal Medicaid Reimbursement Percentage (FMAP) aid under the so-called “jobs bill” expected to move through the U.S. Senate today.  Thursday.  Except … the bill didn’t move.  It was withdrawn, by Majority Leader Harry Reid (D-Nevada) before coming to a vote, once it became apparent that it wouldn’t garner enough votes to pass on its third try.

From Politico:

In stepping back now and pulling the bill, Reid made clear that he isn’t expecting a quick return.

The Senate will go home at the end of next week for the July Fourth recess and then return to what many expect will be a debate on energy policy. The long August recess follows, and, absent some breakthrough, Reid seems prepared to wait until after Labor Day before trying again.

By the way, the latest version of the bill the one Reid withdrew called for less FMAP money than the original.  In an effort to attract support from Republican moderates like Sen. Susan Collins of Maine, “$24 billion in new state assistance to pay Medicaid bills was scaled back to $16 billion and then phased out, as Collins had suggested, and fully paid for with offsets,” Politico noted.

In other words, the $1 billion originally expected by New York was really going to be more like $660 million.  And now, it may be three months before it’s clear that any of the dough will ever materialize.   Chalk it up as another example of why the entire Obama-era approach of providing temporary aid to states (on the Keynesian grounds that austerity measures will strangle the recovery) has actually tended to make a bad situation worse in places like Albany, where avoiding tough budget decisions is an art form.

Someone might want to convey this news to Governor Paterson and Democratic legislative leaders, who claim they are within striking distance of a budget deal to beat Paterson’s Monday deadline.

By the way, the newly agreed-upon New York City budget also assumes an increase in FMAP from the same federal legislation.  But the city budgeted its share much more conservatively, spreading a projected $600 million in added FMAP over three years, with $279 million included in the notional 2011 fiscal plan.  Mayor Bloomberg still has billions in reserve; for the city, unlike the state, a reduction in federal aid won’t spell the difference between red ink and redder ink.

State Comptroller Thomas DiNapoli yesterday issued a happy talk news release touting the state retirement system’s 26 percent return on investments in fiscal 2009-10, which ended March 31.

“The Fund remains one of the strongest in the U.S.,” DiNapoli said. “We’ve come through one of the toughest recessions in modern times, and now the Fund is well positioned to benefit from the national economic recovery we hope is taking hold. We’re not all the way back yet, and as we’ve seen in recent weeks, there are still challenges in the marketplace. But our foundation is strong. We’re moving in the right direction.”

In fact, even after that gain, the pension fund as of March 31 was nearly $56 billion below the level it would have attained if it had achieved its 8 percent target rate of return for the past five years.  The blue line in the chart below shows returns at the targeted rate; the red line shows actual returns, including the fiscal 2009-10 gain the comptroller is boasting about.

As for those marketplace “challenges” DiNapoli mentioned: since March 31, the Dow Jones Industrial average is down 8 percent, while the S&P 500 has dropped 8.6 percent.

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The Greek debt crisis has inspired economist Michael Boskin to lay out some fundamental lessons that are equally applicable to our own federal and state governments.

Quoting directly from this article by Boskin, the lessons are:

1. elected officials systematically ignore long-run costs to achieve short-run benefits;
2. they wait to act until they are forced;
3. government policies cannot circumvent the laws of economics;
4. governments cannot revoke the laws of arithmetic; and
5. budget policy is not merely accounting.

The challenge is to devise fiscal reforms that limit these tendencies.  That’s why, for example, it’s so important to replace the traditional defined-benefit (DB) pension plan in the public sector with defined-contribution (DC) plans.   Because DB plans are based on complex actuarial calculations, they are inherently opaque and have proven to be easy to manipulate.   By contrast, any change in a DC plan has an immediate and visible budgetary impact.

Lesson #5 is especially relevant to debate over Lt. Gov. Richard Ravitch’s long-term financial reform proposal for New York State, which is designed to promote budgetary balance (an accounting concept) rather than spending control (a meaningful policy goal).

As reported in today’s Wall Street Journal, the state may re-enter the short-term credit markets for the first time in two decades in order to cover a cash shortfall in June.

The possibility was first raised in a forum at the Rockefeller Institute last week by Assemblyman Herman “Denny” Farrell, chairman of the Ways and Means Committee. “We are going to have to borrow, and we’re going to have to borrow in the next couple of weeks in my opinion,” Farrell said.  Even if a budget is adopted in the meantime, the state is expected to have roughly $1 billion less than the cash it needs to pay its bills in June, including a large school aid payment.

But short-term borrowing by the state is restricted under the 20-year old statute creating the Local Government Assistance Corp. (LGAC), which effectively converted the state’s rolling short-term “spring borrowing” into long-term debt.  Here’s the relevant language from the Public Authorities Law (Article 10-B, Title IV, Section 3241-A, Subdivision 2):

The state may issue in any fiscal year tax and revenue anticipation notes in an aggregate principal amount in excess of the limit on issuance set forth in subdivision one of this section [the $4.7 billion in long-term borrowing originally authorized for LGAC], if and only if there shall have first been executed in such fiscal year a written certificate signed by the governor, the temporary president of the senate and the speaker of the assembly, which shall set forth:

(a) the emergency or extraordinary factors or factors unanticipated at the time of adoption of the budget for the fiscal year in which such borrowing is to be made that gave rise to the need for the issuance of tax and revenue anticipation notes in excess of such limit, and

(b) the amount of tax and revenue anticipation notes projected to be issued in each of the three fiscal years commencing subsequent to the fiscal year in which such limit was originally exceeded, which will result in the elimination of such excess as soon as practicable but in no event later than by the end of the third fiscal year commencing subsequent to the fiscal year in which such limit was originally exceeded. [emphasis added]

In addition, that emergency certification can’t be issued for more than four consecutive years.

The possible issuance of short-term revenue anticipation notes is not to be confused with the possibility of longer-term “transitional” deficit financing, as proposed by Lt. Gov. Richard Ravitch’s long-term fiscal reform plan.  Gov. Paterson has reacted coolly to the Ravitch plan; in fact, in what surely be a first for the Empire State, the plan has inspired the governor to publish a New York Times op-ed critical of an idea floated by his own appointed lieutenant.

As its 2009-10 fiscal year draws to a close, New York is on track to collect roughly $500 million less than originally projected from last year’s temporary “millionaire tax,” which raised the marginal income tax rate by up to 31 percent on taxpayers with incomes as low as $200,000.  The state’s official bean-counters (you know who you are!) may be inclined to blame this entirely on “timing issues,” or the shift of banker bonuses to stock options, or capital loss carry-forwards.  Think twice, folks, and lower your sights for the long haul:  Impending federal tax increases will suppress the growth in New York’s income tax base for years to come, complicating efforts to dig out of a deepening budget hole.  An op-ed in yesterday’s Wall Street Journal explains why.

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Lt. Gov. Richard Ravitch still hasn’t publicly released his long-term plan to restore structural balance to New York’s state budget, including a rumored proposal to bond out a portion of the state’s budget shortfall.   But the details emerging so far from officials with some knowledge of the plan make this sound like a dubious proposition, to say the least.

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“Changes in the timing and structure of financial services sector compensation, which have resulted in lower than expected personal income tax [PIT] revenues” led to a $1 billion state PIT shortfall in January, which in turn has helped add $750 million to the projected state budget gap for fiscal 2010-11, Governor David Paterson announced today.

In other words, Wall Street has not come to Albany’s rescue.

Opponents of Governor Paterson’s proposed mid-year budget cuts last fall were buoyed by hopes that financial sector bonuses would prop up the state’s finances for at least a while longer.  They were wrong.  Firms like Goldman Sachs decided to award some bonuses this year in the form of stock options, which won’t be fully exercised (and thus taxed by Albany) for years.

Paterson was already planning to push $500 million of the current year deficit into next year, contributing to a $7.4 billion budget gap that his 2010-11 Executive Budget was designed to close with a mix of spending restraint and tax increases.  Now that gap has grown to $8.2 billion.  Paterson said his 21-day budget amendments, to be released next Tursday, will include proposals for closing the additional hole.

The net added 2010-11 shortfall of $750 million consists of these elements:

• A revenue drop of $550 million through the end of 2010-11, including the recurring elements of a $1 billion shortfall in PIT collections in January, which was expected to be the biggest bonus payment month.
• Additional Medicaid expenditures of $400 million due to higher-than-expected Medicaid enrollments.
• Offsetting savings of $200 million in “areas outside Medicaid.”

Nicole dissects Mayor Bloomberg’s preliminary 2011 budget in a Post op-ed today.   Her key point: while news coverage of what the Times headlined as a “grim budget” has concentrated heavily on the mayor’s proposed cuts, Bloomberg actually is relying much more heavily on a $2.9 billion revenue surplus created by the latest Wall Street bubble (call it the post-bubble bubble) to close a projected $4.1 billion budget gap.

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Some thoughts on Governor Paterson’s announcement today that he expects his forthcoming 2010-11 Executive Budget to result in a 2011-12 “surplus” of $1 billion that he will propose using for “property tax relief” in the form of a new “circuit-breaker” income tax credit:

1. The state’s 2011-12 General Fund budget gap was last projected at $14.3 billion.  This reflects, in part, the scheduled expiration of some $5.7 billion in temporary federal stimulus aid that will be used to help balance the state’s 2010-11 budget.  If the governor is saying that the four-year financial plan to be issued with his 2010-11 Executive Budget next week will make up for lost stimulus money, wipe out the entire projected gap and hold recurring spending a full $1 billion below recurring revenues in 2011-12, that’s really something to celebrate.  Applause should be held, though, until we know whether he intends to achieve structural balance solely through recurring savings and spending reductions, and not through another round of increases in state taxes and fees. (more…)