The Cloud Behind the Silver Lining
“Brighter days are here,” Mayor Michael Bloomberg declared in presenting a fiscal 2005 budget proposal buoyed by rising city tax revenues.
But as Bloomberg acknowledged in his budget presentation, a dark and growing fiscal cloud looms on New York’s horizon. Even assuming a continuing economic recovery, the mayor is forecasting a $3.8 billion budget gap for the 2006 fiscal year, which begins July 1, 2005.
While “out-year” gaps are a perennial feature of the New York City budget, the projected year-after-next shortfall in Bloomberg’s latest financial plan is the largest on record. The city’s fiscal outlook is grimmer than it was just a year ago, despite improving economic conditions, because expenditures are growing faster than revenues.
Not including state and federal categorical grants, city spending in Bloomberg’s proposed 2005 budget is up 8.4 percent over the previous year—nearly four times the projected inflation rate. And the budget is on track to grow another 5 percent in 2006.
This memo explains how the future budget gap developed and why it needs to be taken seriously.
The gap in historical context
Under the City Charter, the mayor’s annual budget message must include a financial plan of revenues and expenditures “for the ensuing fiscal year and the three succeeding fiscal years.” These four-year financial plan projections are updated after every fiscal quarter.
State law requires New York City’s financial plan to be balanced in the current fiscal year. However, the city has never managed to achieve recurring balance of its revenues and expenditures across an entire four-year fiscal planning period. To varying degrees, expenditures have exceeded revenues in the three “succeeding years” of every four-year financial plan issued by the city since the post-fiscal crisis budget system took effect more than 20 years ago.
Fiscal monitors customarily have assessed the city’s progress towards meeting the elusive goal of structural budget balance based on the relative size of future budget gaps and the growth trends in revenue and spending. Out-year budget gaps are expected to shrink when the economy is growing; when this doesn’t happen, it is considered a sign of trouble and of a need for corrective action.
The chart below shows the budget gaps projected in the city’s April financial plans since fiscal 1982. The gaps are depicted both in absolute terms and as a percentage of projected expenditures.
As shown, the $3.8 billion out-year gap in Bloomberg’s proposed 2005 budget—that is, the projected difference between revenues and spending in 2006—amounts to 7.5 percent of projected expenditures for the same year. In both absolute and relative terms, this is larger than previous gaps.
To be sure, financial plan projections have not been made on a strictly consistent basis over the past 23 years. Depending on political and economic conditions, some mayors have constructed their plans more realistically than others. For example, former Mayor Rudolph Giuliani was frequently criticized by fiscal monitors for under-estimating expenditures. (At the same time, however, he also tended to severely under-estimate revenues.)
Even allowing for differing mayoral approaches to the financial forecasting game, Bloomberg’s projected 2006 gap would have to rank among New York’ biggest ever. In relative terms, the gap is more than twice the 24-year average of 3.7 percent of expenditures, and considerably greater than Giuliani’s eight-year average of 5 percent. In previous years, gaps exceeding 5 percent have nearly always been harbingers of serious fiscal trouble. The lone exception to this rule was in the late 1990s—when unanticipated revenues at the peak of a historic boom pumped billions of new dollars into the city’s coffers.
But as Bloomberg has pointed out, the city cannot count on economic growth alone to wipe out the projected 2006 budget gap. The proposed budget is already based on fairly optimistic economic projections, reflecting the recent resurgence of securities industry profits and the turnaround in other key city industries such as tourism. Even if the economy grows fast enough to generate new revenues at the same record pace New York last experienced in the late 1990s, the mayor noted, the city budget’s net gain would be another $1 billion—enough to erase just a quarter of the deficit.
What’s driving up the gap?
The city’s projected 2006 budget gap increased sharply between January and April (the third fiscal quarter of 2004), as shown below.
What explains such a large change in the fiscal projections in just three months? The simple answer: Projected revenues continued to increase—but projected spending increased even faster.
City revenues in 2005 and 2006 will be $1 billion higher than Bloomberg had projected in January, according to the mayor’s April plan. But spending during the same two-year period will be $3 billion higher than the January projection. This includes $475 million in additional Medicaid costs, $174 million in higher debt service, and a write-off of $300 million in added federal aid the city previously had budgeted but now admits it won’t receive. Medicaid and debt service are defined by the mayor as “non-discretionary” costs that the city can’t reduce on its own.
But most of the remaining spending additions for fiscal years 2004-05 and 2005-06 reflect the city’s own management and policy decisions, including:
In his January preliminary budget, Bloomberg forecast a $1.39 billion budget surplus for fiscal 2004. At that point, the mayor intended to roll the surplus forward into the next two fiscal years, in even increments of $695 million. But by April, the surplus had shrunk slightly, to $1.3 billion, and the significant increase in projected spending over the next two years had forced Bloomberg to say he would apply the entire amount to help balance the 2005 budget.
Without the prior-year surplus, in other words, the city would have a $1.3 billion operating deficit in 2005. That amount creates a hole the city needs to close before it can even begin to balance its 2006 budget.
Under the right economic conditions—a much stronger-than-expected recovery in every sector of the city’s economy, including a return of security industry profitability to the record levels of 2000—the city could gain another $750 million or so in recurring revenues over the next two years. Assume, further, that the city receives an added $1 billion a year in currently unanticipated state aid or mandate relief by 2005-06. That would still leave a 2006 city budget gap of roughly $2 billion. Given the normal delay between implementing cuts and realizing actual budget savings, Bloomberg will need to unveil a so-called PEG (Program to Eliminate the Gap) immediately after the 2005 budget is adopted.
On the other hand, other factors could make the budget outlook far worse. For example, unions representing police officers, firefighters and teachers all insist they will not settle on terms as modest as those agreed to by DC 37. Each added percentage point in annual wages for these unions would have a recurring budget impact of more than $100 million a year, according to OMB estimates. Economic growth could fall short of the budgeted projection—which will be more likely if supposedly temporary state and city taxes do not phase out on schedule.
In sum, despite the short-term improvement, New York City’s budget in the year ahead will be as vulnerable to external shocks as it was in the spring and summer of 2001, when then-Mayor Giuliani was already forecasting a sizeable budget gap for his successor’s first year in office. After 9/11, of course, the outlook instantly became much grimmer.
To reduce that vulnerability, the mayor and the City Council need to work much harder to reduce spending.