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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Governor Paterson has sent the Legislature a chapter amendment that would delete a proposed new hedge fund tax from the state’s pending 2010-11 revenue bill.   By approving the chapter amendment, which is expected to happen today, the state Assembly can erase the tax without voting all over again on the revenue measure it passed July 1.  The state Senate would have to approve the entire bill and the amendment before the revenue package could go to Paterson for his signature.

A new tax on the carried interest income of hedge fund partners who live in other states was approved as part of the revenue bill passed in the Assembly last month.   In addition to removing the hedge fund tax, the chapter amendment would clarify a tax on the incomes of non-resident partners in New York Subchapter S firms, and make a technical change to a provision allocating the state film credit.

The submission of the amendment deleting the hedge fund tax comes a day after Connecticut Gov. Jodi Rell hosted a dinner for leaders of the New York Hedge Fund Roundtable, and a week after Speaker Sheldon Silver first indicated he would rethink the tax.

** P.S. — The hedge fund tax was supposed to raise $50 million in the coming year.   There was no immediate indication of whether the Governor or Legislature have an alternative spending cut or revenue raiser in mind to cover that amount.  But when you’re talking about a $134 billion budget that’s probably way out of balance even assuming passage of the entire revenue bill, what’s another $50 million?

Governor Paterson has dropped a proposal to impose New York State’s personal income tax on the interest income of non-resident hedge fund managers from his latest preferred list of revenue-raisers to help pay for the 2010-11 budget appropriations the Legislature finished enacting two weeks ago.

The governor’s move is only symbolic, however. A package of tax and fee hikes including the hedge fund tax was passed by the state Assembly on July 1 and is the only live revenue bill pending in the state Senate. Moreover, the Assembly and Senate have refused to accept delivery of the program bill he sent up to them today.

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Governor David Paterson and the Democratic leaders of the New York State Legislature have agreed to impose $50 million in new taxes on non-resident partners in New York-based hedge funds.

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Local media has picked up on the NYC Independent Budget Office’s blog post on the precipitous drop in wages in New York’s securities industry in 2009. The get-it-over-with-fast drop mightn’t have been such a bad thing for the city — if local, state, and federal government had responded appropriately. (more…)

The Senate passed financial industry “reform” yesterday. But one important amendment failed earlier this week: New Hampshire Senator Judd Gregg’s proposal to prohibit federal bailouts of state and local governments.

The Judd amendment would have instructed Washington not to purchase state or local bonds to help out distressed municipal governments, unless the state or local entity in question was suffering through a catastrophe akin to Hurricane Katrina.

This amendment was not a small irrelevancy tacked on to an important matter. The financial industry cannot reform itself unless investors, including many big financial institutions themselves, realize that they face the risk of losses if they lend unwisely to any sector of the economy. (more…)

e21 has a good staff editorial up on the now-tragic Greek crisis, with possible implications for New York and California.

The plan for Greece, of course, is for Europe and the IMF to bail out the debt-drenched nation’s bondholders, by imposing austerity measures on everyone else. These measures must be draconian enough “to attenuate the anger of German voters.”

But the Greeks, or at least the most vocal and violent of them, are not cooperating. As the editorial notes:

Whether the Greek unions succeed in quashing the deal, eventually the strings attached to the aid will impose costs on an interest group with sufficient clout to make the interests of creditors [bondholders] seem less compelling. At some point, taxpayers in the “parent” will demand concessions that the bailed out entity will not abide. At this point, the bailouts will finally end.

Here at home, bondholders lend money to states like NY and CA largely because they think that the feds will bail them out in a crisis (I think).

President Obama’s “Build America Bonds” program has solidified this expectation. After all, international bondholders are buying muni bonds labeled “America” itself, giving them extra confidence if they don’t know very much about individual state credits and don’t care to learn.

But what if, when the time for an explicit bailout of American states is at hand, whoever is in charge in DC must make New York and/or California make tough-minded public-sector concessions to get the rest of the nation on board? Then, it may not be worth it, politically, for state governments to serve as the conduits for bailouts of their bondholders.

In that case, bondholders, at the very least, would have to take some losses along with other big creditors, including pensioners — and quite possibly have to take even bigger losses than the better-connected parties.

America may not have to confront such issues this year or this half-decade. But unless heavily obliged American states start to pare back their long-term obligations, the question likely will arise someday.

Please read more on this topic here, too …

Arkansas Sen. Blanche Lincoln released her bill for derivatives reform last week. It contains a nugget of good news for state and local taxpayers. The bill would require dealers in the oft-complex business of interest rate and other “swaps,” largely big banks like JPMorgan Chase, to hold themselves to a fiduciary standard in designing such swaps for municipalities. That is, they would have to determine that a particular customized deal is good for the client — the taxpayer — when compared to other alternatives, not just good for the bank’s bottom line.

Maybe it would prevent stuff like this.

[In case you are wondering why an Arkansas senator has the derivatives portfolio: Sen Lincoln chairs the agriculture committee, where regulation of derivatives -- cattle futures, etc. -- originated.]

The lead business section story in today’s New York Times profiles the 10 highest-earning hedge fund managers.  A quick Google search indicates that only three of the firms run by these superstars — Soros Fund Management, Paulson & Co., and Harbinger Capital Partners — are based in New York City.

Two others — Renaissance Technologies and Icahn Capital — are based in East Setauket, Long Island and White Plains, respectively.  The remaining five can be found in Connecticut (SAC Capital Advisors of Stamford and ESL Investments of Greenwich); Chatham, New Jersey (Appaloosa Management); Chicago, Illinois (Citadel Investment Group); and Houston, Texas (Centaurus Partners).

To be sure, most of these guys either have trading rooms or a personal pied-a-terre in Manhattan.  So they don’t totally escape New York taxes, but are certainly in a position to minimize them based on how much time they spend in the city.

Memo to tax-hungry New York lawmakers: a fabulously successful hedge fund can be anywhere.  Even Houston, Texas.

Senator Chris Dodd’s financial-regulatory bill includes some of what the press calls the “Volcker Rule” (p478): banning FDIC-insured banks and their affiliates or parent companies from what’s known as “proprietary trading” or betting supposedly safe banking deposits on speculative market activities.

Except! Dodd includes a huge loophole for state and local governments. (more…)