The Cloud Behind the Silver Lining
FISCALWATCH MEMO May 5, 2004

“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.[1]

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,[2] 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.[3]

State law[4] 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.[5] The gaps are depicted both in absolute terms and as a percentage of projected expenditures.

Next Year's Headache?
2005-06 City Budget Gap, in Millions of Dollars
As Projected in Mayor's Financial Plans

Source: Mayor's Budget Message, City Comptrollers Office

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.[6]

“Out-Year” Gaps in Mayors’ April Budget Plans, Since FY 1982
2005-06 City Budget Gap, in Millions of Dollars
As Projected in Mayor's Financial Plans

Source: New York City Office of Management and Budget

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:

  • $1.2 billion in collective bargaining costs, reflecting the assumption that all city unions accept terms similar to those in Bloomberg’s agreement with the largest municipal union, District Council 37 of the American Federation of State, County and Municipal Workers.
  • $316 million in subsidies for the operation of privately franchised bus lines which the city had unrealistically expected the Metropolitan Transportation Authority to absorb as part of a takeover deal.
  • $561 million in new agency spending (not including added wages and salaries), including such items as $105 million over the next two years to implement the ban on “social promotion” of third graders, and $175 million to administer and comply with a draconian lead paint abatement law approved by the City Council over Bloomberg’s veto.

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.

The outlook

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.

Notes

  1. Spending growth rates are from the Mayor’s Budget Summary for Fiscal Year 2005, p. 12. The economic projections in the Mayor’s Budget Message forecasts a consumer price index of 2.1 percent in 2005 and 2.3 percent in 2006 (p. 29).
  2. Chapter 10, Section 250.
  3. In addition to the annual budget message, which appears in April, updated financial projections are presented with the preliminary budget in January and the adopted budget in July. Updates also are issued in October or November of each year.
  4. Specifically, the New York State Financial Emergency Act for the City of New York (Ch. 868 of 1975).
  5. The fiscal 1982 financial plan was issued by then-Mayor Edward Koch in the year the city finally balanced its budget and emerged from the fiscal crisis control period imposed by the state after the 1970s fiscal crisis.
  6. There were also wide swings in the gap projection in the previous two quarters. The fiscal 2006 shortfall was pegged at $1.4 billion in Bloomberg’s April 2003 financial plan, but increased to over $3.2 billion in the plan based on the budget adopted in June 2003—and, during the same period, the projected 2005 gap increased from $750 million to $2 billion. These changes reflected the state Legislature’s approval of a city tax increase and state aid plan that was much smaller in succeeding years than Bloomberg had anticipated in his budget proposal. Strong revenue growth and continuing efforts to restrain discretionary spending in the first half of fiscal 2004 (June-December) helped Bloomberg shrink the gaps by the time he issued his January preliminary budget.

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