Gotham's spending continues to outpace inflation, economy—and sure deficits loom
FISCALWATCH MEMO July 25, 2005
By Nicole Gelinas

New York City's economy is slowly recovering from the bursting of the tech bubble in 2000 and from 9/11. But growth in the city's $51.8 billion municipal budget continues to significantly outpace inflation and economic growth in the city.[1]

New York will spend $37.4 billion in local resources[2] during fiscal year 2006 (which began July 1), up 7.5 percent from last year.[3] This means that over the course of Michael Bloomberg's first term as mayor, which began with the fiscal year 2003 budget and ends with the current budget, city spending will have risen 29 percent. At an average increases of nearly 6.9 percent each year, this is more than double the city's 3.1 percent average annual inflation rate.[4]

City spending under Bloomberg has vastly outgrown New York's "gross city product," which shrunk during 2002 and 2003 and has grown at an average 2.6 percent annually since then.[5] The growth in the municipal budget is also outpacing growth in personal income. City-funded spending now represents 10.7 percent of New York residents' personal income. This is up from 10.4 percent last year, and nearly 13 percent higher than the average during the eight years of former mayor Rudolph W. Giuliani.

Annual Increase in City-Funded Operating Expenses* Compared to Inflation

city fiscal years

* excludes federal, state and other categorical grants; includes debt service for Transitional Finance Authority bonds and "TSASC" tobacco bonds ** projection as of June 2005 adopted budget

Sources: Mayor's Executive Budget and City Comptroller's Comprehensive Annual Financial report; inflation changes are calendar-year, based on consumer price index for New York region urban consumers from Bureau of Labor Statistics.

While tax receipts have rebounded from the slump of 2001-02, the increase has been driven in part by temporary factors—especially the resurgence of securities industry profits and the stock market boom. Because recurring revenues have not kept pace with the budget's growth, the city faced a $3.7 billion shortfall for fiscal 2006. Bloomberg plugged this deficit with surplus tax revenues generated in late 2004 and early 2005. But the mayor's financial plan acknowledges that the city's structural budget imbalance is worse now than it was four years ago.

Under the new city budget, spending will continue to grow at a faster clip than the tax revenues needed to fund that growth. That's why New York faces budget gaps of $4.5 billion for fiscal 2007, $4.5 billion for 2008, and $3.9 billion for 2009. The 2008 and 2009 figures are actually 6 percent larger than those projected by the mayor when he first presented his Executive Budget in late spring. The city does not have any more "extra" funds (from prior-year surpluses) with which to close these widening gaps.

City-Funded Operating Expenditures As a Share of Personal Income in New York*

* Basis of comparison is personal income for calendar year in which budget was adopted.

Source: Personal income data from U.S. Bureau of Economic Affairs (through 2003) and New York City Office of Management and Budget (OMB) (2004-2005); city expenditure data from New York City Comptroller's office and OMB; author's calculations.

The past four years

Bloomberg spent $29.5 billion in city funds during his first fiscal year, not a significant increase over the $29 billion spent by Giuliani in his last year in office. But since then, spending has ballooned. Outsized growth in spending, not the drop in tax revenues after 9/11, was the primary reason behind the multi-billion budget deficits since 2003. In fact, 70 percent of new spending—or virtually all new spending above the normal rate of inflation—can be traced to the following three culprits:

• Pensions and benefits for city workers. In 2003, the city spent just $6.4 billion to fund pensions and benefits for public-sector workers. That figure has grown to $10.3 billion for 2006, in large part due to retirement benefit sweeteners enacted in 2000 and the need to make up for massive losses the pension fund sustained in the stock market slump of 2001-02. While pension costs stemming from those losses will peak next year (until the next stock-market crash), the increase in retirement benefits is permanent.[6] Moreover, health-insurance costs for employees are projected to continue increasing at 10.2 percent each year.[7]
• Medicaid. In 2003, city taxpayers spent $3.9 billion on medical care for the poor and on public hospitals; this year, the city will spend $5 billion. Albany has recently agreed to take over much of the future growth in the city's Medicaid program, in response to intense lobbying by Bloomberg and the representatives of other counties. But under the agreement, the city still must fund growth in Medicaid of up to 3.25 percent in 2007 and 3 percent each following year; the state will fund the balance. Current and future tax revenues cannot support the current level of Medicaid spending, or that predicted level of growth.
• Debt service. Taxpayers will spend $3.3 billion in interest on $49 billion in outstanding debt in 2006, up from $2.1 billion in 2003. Debt service costs have risen despite the refinancing of billions in debt to take advantage of sustained record-low interest rates, and the elimination of $500 million in Municipal Assistance Corp. (MAC) debt under a state refinancing scheme. The city has less flexibility to refinance debt in the future as interest rates inevitably rise. The city also will likely incur new debt in the coming years at higher interest rates.

Education spending also deserves attention. City-funded spending on schools will reach $8.4 billion this year, up from $6.3 billion in 2003. This vast increase drives some of the above costs, as higher education spending means higher salaries for more teachers and higher debt for ambitious capital projects.

Where the money to pay for outsized spending growth has come from

While the mayor frequently cites $3 billion in "cuts" from the budget baseline, New York has avoided budget deficits since 2002 largely through reliance on tax increases, including a $1.42-per-pack cigarette tax increase enacted with Bloomberg's first budget in the spring of 2002, a record 18 percent property tax hike enacted at the end of 2002, and "temporary" sales and income tax rate hikes approved in the spring of 2003. Extra revenues from those tax hikes—a total of nearly $8 billion over three years—have helped to close each year's deficit since then.[8]

The city has also had an unexpected savior: At virtually the same moment that higher city taxes were taking effect in 2003, Congress and President George W. Bush were enacting accelerated federal income tax cuts that were especially beneficial to investors and the stock market. Since late 2004, the private-sector economy, particularly the frothy real-estate sector, has sent extra billions gushing into the city's coffers above projected revenues from the temporary and permanent tax hikes.

The city has reaped $1.2 billion more than it had projected last year in taxes on real-estate transactions since July 2004, due to record-high level of real-estate purchases, sales and refinancings during the continuing boom in that sector. The city has also reaped nearly $1.5 billion in extra income and business taxes, as brisk Wall Street merger and acquisitions activity has buoyed that sector in recent months.

These extra tax dollars from higher tax rates and from increased economic activity, not spending cuts, closed the budget gap for the new fiscal year. While Bloomberg did cut about a half-billion dollars from projected agency spending last year, those cuts were nearly exactly offset by unexpected growth in Medicaid, education and overtime spending.[9]

What does the future hold?

On top of this year's 7.5 percent increase, the city's financial plan forecasts further spending growth of at least 3.7 percent in fiscal year 2007. According to the mayor's projections for the next three years, total city-funded spending will increase by 9 percent by 2009 and tax revenues will increase by nearly 15 percent during the same period.

However, these rosy numbers don't tell the whole story. Even if the economy and tax revenues continue to expand each year as projected, and even if the mayor can keep spending increases far below his own historical pattern of increases, the projected growth in tax revenues over spending growth is not enough to pare back the projected built-in deficits by even one dollar. As noted, the mayor already faces serial deficits in 2007, 2008 and 2009, beginning with the $4.5 billion in 2007. The city, by law, must balance its budget every year—but tax revenues must grow robustly just to keep these deficits from widening further.

And as the mayor noted in January, public-employee benefits and debt-service costs, in particular, will continue to grow for the foreseeable future. Between now and 2009, for example, interest and amortization costs on debt will likely rise another 45 percent. Pension and fringe benefits for public employees will likely grow by an additional 10 percent.

The risk factors

This year, the city expects to spend $18.2 billion on salaries and wages for its public-sector work force. This figure is about $890 million above what the city had expected to spend at this time about a year ago; Bloomberg adjusted the figure twice to take into account ongoing negotiations that will likely result in wage hikes for municipal employees.

But he likely has not hiked future spending projects enough to fund those wage hikes. In late June, for example, an independent arbitration panel awarded city police officers a cumulative, retroactive 10.25 percent raise for the two years that ended in July 2004. The city's Independent Budget Office estimates that the hike will cost $490 million over three years, including money for higher pensions. Firefighters and teachers are also working under expired contracts; similar raises for all city workers could represent about $1 billion in additional annual spending by 2009, in addition to $2.3 billion upfront to fund retroactive payments. Moreover, the arbitration panel said that the city will finance part of the cost of the police officers' raise by slashing salaries for rookie cops by 32 percent, from $36,878 to $25,100 a year, for the first six months of work. This option likely won't be available to the city to finance raises for teachers, as the city and the teachers' union agreed three years ago to raise starting salaries in an effort to recruit more and better rookie teachers. The IBO notes that the city has set aside money for these labor settlements, but that "these funds may not be enough." The state comptroller agrees. The risk is clear: The $3.9 billion budget gap for 2009 could be a minimum $4.9 billion deficit.[10]

Nor has the mayor budgeted extra money for city spending under the Campaign for Fiscal Equity lawsuit (CFE), under which Supreme Court Justice Leland Degrasse has ordered a $5.6 billion increase in the annual operating budget for city schools. If the lawsuit ultimately results in any above-normal increase in schools spending—which remains open to question—the city inevitably will be required to foot at least part of the bill.

On the revenue side, the city faces the perennial peril of being too tightly wedded to Wall Street. Interest rates have remained at record lows, contributing to a surge in Wall Street activity and profits. However, that happy circumstance will not continue indefinitely. The city has already projected slower economic growth through 2007, but the city's dependence on personal-income taxes from wealthy earners mean that it is particularly vulnerable to another slowdown.

Moreover, if interest rates rise, the city will face added costs in its own borrowing as well, just at it is constrained by lower tax revenues.

Upside potential

The city has already hiked its tax-revenue estimates by nearly $2 billion next year and by $1.2 billion in 2008, due to higher projected property valuations amidst a continued real-estate boom, and higher projected income taxes due to healthy Wall Street activity. If the real-estate market continues to expand at its torrid pace, the city will reap even higher revenues from even higher valuations, and will continue to reap extra taxes from the real-estate transaction taxes as well.

Likewise, the city could also experience higher tax-revenue growth if the equity market perks up next year, supplementing this year's income- and business-tax revenues. While the equity market has recovered from its post-9/11 lows, it has not returned to the consistent double-digit growth experienced during the late 1990s, growth that paid for much of the city's spending during the Giuliani years. Indeed, Wall Street is projected to add only 3,400 jobs this year, not much more than last year's 3,200 jobs.

The outlook for taxpayers

The 2006 budget assumes that the higher personal income tax rates on upper-income earners will expire December 31—the middle of the fiscal year. But absent a sustained economic miracle, it will take an enormous commitment from Bloomberg and from the City Council to pare back projected spending to keep that "temporary" tax from crawling out of its fresh grave next year to fund the post-election deficit.[11]

Notes

1. The $51.8 billion figure is adjusted from the city's official $50.2 billion figure to account for about $900 million in private-sector and other categorical grants. It is also adjusted for the rollover of temporary surpluses from one year to the next, spending should be recorded in the year it occurs, not in the year in which funds are available.
2. This figures excludes federal, state and private-sector grants.
3. The city receives an additional roughly $14.4 billion from the federal and state governments each year, much of that earmarked for medical and education spending.
4. Inflation in New York City and the surrounding region has averaged 3.1 percent since January 2002, according to the federal Bureau of Labor Statistics. The estimate for 2005 inflation is from the state comptroller's office.
5. "The State of the City's Economy and Finances," New York City Comptroller, 2003 and 2004 reports.
6. Albany continues to add to the city's pension expenses—most recently with a law creating a presumption that city workers who come down with lung ailments are entitled to generous disability benefits if they happened to work on the post-9/11 clean-up at the World Trade Center site. Mayor Bloomberg estimates this law (Ch. 93) will add another $53 million a year to the city's pension costs.
7. "Review of the Financial Plan of the City of New York," New York State Comptroller, June 2005.
8. According to the city budget office, New York has reaped about $1.2 billion in three years from temporary income- and sales-tax increases, and nearly $2 billion each year from the permanent property-tax hike.
9. "Review of the Financial Plan of the City of New York," New York State Comptroller, June 2005.
10. "Analysis of the Mayor 's Executive Budget for 2006," New York City Independent Budget Office, May 2006; "Review of the Financial Plan of the City of New York," New York State Comptroller, June 2005. (Adjusted for changes to the executive budget between May and July.)
11. The mayor reportedly told members of the left-leaning Working Families Party that he might well turn to wealthy taxpayers again to plug the city's "enormous deficit" so that he does not have to resort to budget cuts. See "3 Democrats and the Mayor Vie for Third Party's Nod," The New York Times, May 12, 2005.