Surpluses... but not for taxpayers, unless Bloomberg acts
FISCALWATCH MEMO July, 2006

By Nicole Gelinas

New York City's current budget is an object lesson in why too much money is just as serious a problem as too little.

New York ended the last fiscal year with $3.8 billion more than it expected to spend, despite the creation of a $2 billion health care "trust fund" for retiring city workers as well as a projected spending increase that once again exceeds the rate of inflation.

But while taxpayers historically have borne tax-rate hikes to fund the city's predictable cyclical deficits, they will not see tax cuts due to the current record surplus, unless Mayor Bloomberg takes advantage of this temporary boom time to spearhead permanent rollbacks of New York's uncompetitive business and income taxes.

Budget basics

New York will spend $56.4 billion in fiscal year 2007, which began July 1. Of that total, $40.5 billion will come from city funds, mostly from city property taxes, sales taxes, business taxes, income taxes, and the balance of last year's surplus.[1] City-funded spending will increase by about 6.8 percent from last year, roughly in line with average annual spending increases during the Bloomberg administration and more than double the 2.9 percent projected inflation rate.[2] Over Bloomberg's first five years' worth of budgets, city-funded spending is up nearly 40 percent, while inflation is up about 17 percent.[3]

Annual Increase in City-Funded Operating Expenses* Compared to Inflation * excludes federal, state and other categorical grants; includes debt service for Transitional Finance Authority bonds and "TSASC" tobacco bonds ** projection as of July 2006 adopted budget Sources: Adopted budget, July 2006; inflation changes are calendar-year, based on consumer price index for New York region urban consumers from Bureau of Labor Statistics.

Under Mayor Bloomberg, city-funded spending also continues to hover near a record percentage of the city's total personal income, a measure that had declined markedly during the two Giuliani administrations.

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: Author's calculations; personal income data from the U.S. Bureau of Economic Affairs (through 2003) and from the New York City Office of Management and Budget (OMB); city expenditure data from OMB.

What drives this year's spending increase?

Notably, Medicaid spending, responsible for much of the growth in recent years' budgets, was flat, as New York State took over much of the responsibility for that program's growing costs under a deal inked last summer.

Headcount

After declining by about 5 percent during Bloomberg's first five years, the number of city and city-subsidized employees will rise by less than half a percent this year, from 300,767 to 301,845, with the net gains led largely by 800 net new police officers, 771 net new social-services workers, 804 workers at the Administration for Children's Services, 826 health and mental hygiene workers, and 145 Housing Preservation and Development workers.[4]

Why the surplus?

But despite continued spending increases and slight increases in headcount, the most obvious feature of this year's budget is the surplus; even after removing the effects of previous year-to-year surpluses for a one-year picture, the city's one-year operating surplus was about $1.5 billion.[5]

New York boasts this surplus in part because tax revenues exceeded previous expectations last year by nearly $4 billion. In fact, about 5 percent of taxes collected could have remained in taxpayers' pockets in the first place, and be put to better use in the private economy.[6] Why the wild forecasting mistake?

It is not because New York's economy is growing at a torrid pace; local economic growth was about 3.2 percent last year and will be about 2.4 percent this year.[7] Nor is it due to new tax increases; temporary income—and sales-tax hikes enacted in the second year of the Bloomberg administration expired in full in the middle of the last fiscal year as promised.

Rather, the surplus is a hazard of New York's cyclical tax structure. Unlike most cities, New York reaps a significant share of its revenue—about 20 percent of total taxes collected in recent years—from a municipal personal-income tax, and reaps another 12 percent from three similarly economically sensitive business taxes (taxes each on general corporations, banks, and business partnerships & sole proprietorships). Moreover, two once-minor and stable sources of tax revenue - the mortgage-recording tax and the property-transfer tax - have behaved like cyclical taxes over the past few years, due to the city's unsustainably torrid real-estate market.

Indeed, these six economically sensitive taxes exceeded their projections by more than 32 percent, or nearly $3.3 billion, last year, and were thus responsible for much of the one-year surplus. By contrast, property-tax collections exceeded last year's projections by less than one percent.[8]

The personal-income tax, in particular, is subject to predictable wild swings from year to year because taxpayers reporting income of $1 million and above - only half a percent of tax filers - pay about one-third of city income taxes.[9] Thus, large swings in volatile measures like Wall Street bonuses, capital gains and dividend income, and real-estate investments mean large swings for New York City's budget.

What's the surplus good for?

Bloomberg rightly noted in his budget presentation that the surplus is not sustainable. In fact, New York faces a deficit of another $3.8 billion next year (although, of course, that's another forecast that could be wildly off the mark either way). Thus, Bloomberg dedicated much of the surplus toward creating the $2 billion fund to pay for the healthcare costs of future city retirees.

While it is certainly more prudent to put money aside rather than to increase unsustainable year-to-year spending, the trust fund does not address the underlying problem it was created to solve: the fact that the city continues to contract with its unions to offer healthcare benefits that are unsustainable over the long term.

Rather than save New Yorkers' tax money in city coffers, Bloomberg should use the time afforded by the surplus to reform the city's most pernicious taxes, to put the city's budget on a more sound fiscal footing as well as to improve New York's competitive position relative to other American cities.

How does New York stack up compared to other American cities?

New York City's tax burden for both businesses and residents is prohibitive. On the business side, consider: in one widely recognized study, New York State ranks dead last in terms of its overall business climate[10], due in large part to its 8.775 corporate-franchise tax.

But compounding the burden in New York City are three city-specific business taxes: a general 8.85 business tax, which is the highest municipal business tax in the nation (and is slightly higher than New York State's similar tax), its tax on banks (whose rates vary), and its 4 percent tax on unincorporated-business profits, which falls on partnerships and sole proprietorships on top of the personal-income tax for partners' salaries and bonuses.[11] Besides Gotham, of the top 10 cities in terms of population, only three have an urban business tax, and of the 10 fastest-growing cities, none does.[12]

And while it almost goes without saying that New York's tax burden for businesses is heavy, much of the city's future job growth won't be through growth at large corporations, but through entrepreneurial growth: that is, individuals deciding to stay in or come to New York City and start their own businesses. In an economy dependent on entrepreneurial growth, tax burdens on individuals, including New York City's personal-income tax and property tax, become ever more important, because mobile individuals can easily choose another city; they are not wedded to Gotham due to their jobs.

In this regard, New York is also behind. Of the top 10 cities in America in terms of population, seven have no personal income taxes.[13] Of the top 10 fastest-growing cities, none of them has a personal-income tax. Compounding the heavy local income-tax burden here is the fact that many of New York's competitor cites are in states that do not levy personal-income taxes, including Florida, Nevada, and Texas.

New York City officials often point out that the city's property-tax burden on owner-occupied homes is lower than that of the surrounding suburbs. But the city closes this gap with the personal-income tax. In fact, as the chart below illustrates, New York's total tax burden, including income and property taxes, is higher than that of its peers for middle-income and upper-middle income residents, particularly for the higher-income residents who drive an entrepreneurial economy.[14]

Real tax reform

Mayor Bloomberg should use the breathing room provided by this year's cyclical surplus to work with Albany and the City Council on real tax reform.

The mayor could start by pushing for the repeal of a "temporary" 14-percent surcharge on the city's personal-income tax, which has been on the books for 16 years. In the hands of the private economy rather than in the city's accounts, this money would represent a significant boon to New York: an analysis by the Empire Center for New York State Policy has shown that the elimination of the income-tax surcharge would create 26,300 net new jobs in the city.[15] The mayor also could begin to pare back the city's three major business taxes.

Moreover, as this year's operating surplus shows, a repeal of the surplus is certainly "affordable" for the city budget. A full repeal of the personal income tax surcharge, for example, retroactive to July 1 would save taxpayers $825 million during this fiscal year, increasing to $856 million in 2008 and nearly $1 billion by 2010.[16]

But what about future deficits?

Mayor Bloomberg might argue that the city cannot responsibly cut taxes because it will only be forced to raise them in a year or two or a few, when the city once again predictably plunges into budget deficits.

But, in fact, New York has ample room to cut spending. Of the ten largest American cities, New York spends nearly twice as much per-capita as the average of the nine runner-ups, and about two-thirds more than the second-largest city, Los Angeles.

Annual City Spending Per-Capita: NYC vs. Other Large Cities Source: Author's calculcations based on municipal budget documents. Note: NYC's figure does not include Medicaid spending, as Medicaid is a state responsibility in the comparison cities.

Further, of the ten fast-growing cities in America, New York eclipses the per-capita spending average by a similar margin.

Annual City Spending Per-Capita: NYC vs. Fastest-Growing Cities Source: Author's calculcations based on municipal budget documents. Note: NYC's figure does not include Medicaid spending, as Medicaid is a state responsibility in the comparison cities.

This extra spending makes the difference between reasonable, stable tax collections based on property assessments and retail sales, as most cities have, and wildly cyclical income-sensitive tax collections that hurt entrepreneurial job creation as well as make rational budgeting all but impossible, as New York has.

Of course, to cut both taxes and spending permanently, Mayor Bloomberg must tackle the city's intractable big-ticket items, including municipal pensions and healthcare benefits as well as a burdensome city debt load.

Without significant reform, these costs will continue to spiral: debt costs, for example, are projected to increase by 27 percent over the next three fiscal years, to more than $5 billion, or from 13 percent to 17 percent of local tax revenues within three years.[17] Pension costs, in turn, will increase by 17 percent over the next three years. And although New York State now shoulders more of the burden for local Medicaid cost increases, New York City's $4.9 billion annual Medicaid tab still will climb nearly 9 percent over the next three years, to $5.4 billion, a level that remains an unsustainable burden for taxpayers.[18]

If Mayor Bloomberg were to embark upon reforming these big-ticket items during the remainder of his second term and using the savings to work with the City Council and the State Legislature to enact permanent, rational tax cuts at the city level, the fiscal and economic rewards for New Yorkers would be great.

Notes

1. Author's calculations based on New York City adopted budget, July 2006; New York City financial plan, June 2006; and "Review of the Financial Plan of the City of New York," New York State Comptroller, June 2006. Author's figure differs from some reported figures due to the masking effects of surplus carryovers in reported figures.
2. The spending figures include $1 billion in each of fiscal years 2006 and 2007 for the new health benefits trust fund. While this is not strictly operational spending, New York will account for the new trust fund in a manner similar to the one in which it accounts for pension contributions, which budget observers have historically treated as operational spending.
3. For past spending figures, see "Gotham's spending continues to outpace inflation, economy-and sure deficits loom," Nicole Gelinas, www.nyfiscalwatch.com, July 2005. However, the revision to last year's budget to include the first $1 billion payment to the health care trust fund increases last year's spending over the previously reported figure.
4. New York City financial plan, January 2006.
5. "Review of the Financial Plan of the City of New York," New York State Comptroller, June 2006.
6. The city collected more than $33 billion in tax revenues for FY2006. Source: New York City financial plan, January 2006.
7. New York City financial plan, January 2006.
8. Author's comparison of FY2006 forecasts and outcomes, January 2005 vs. January 2006.
9. Source: "Inside the Budget," New York City Independent Budget Office, December 2000.
10. "State Business Tax Climate Index Rankings by State," Tax Foundation, February 2006.
11. For a full analysis of these taxes, see "Pricing the Luxury Product": New York City Taxes Under Mayor Bloomberg," E.J. McMahon, Manhattan Institute, November 2005.
12. Population information on the largest and fastest-growing cities is from the U.S. Census, July 2005.
13. Author's analysis of municipal budgets of large and growing cities, July 2006.
14. Property taxes on many New Yorkers who rent, rather than own, their own homes are actually much higher, as property taxes on an owner-occupied home is assessed on only 6 percent of that home's market value, while the property tax on a large residential rental building is assessed on 45 percent of that building's value; landlords of market-rate buildings pass that disproportionately high tax burden on to tenants.
15. "Taxes and Consequences: The Gotham STAMP 2006 Computable General Equilibrium Model," E.J. McMahon and David G. Tuerck, www.empirecenter.org, December 2005.
16. Source: Independent Budget Office, July 2006.
17. "The Comptroller's Comments on the Fiscal Year 2007 Executive Budget," City of New York, June 2006.
18. For an analysis of the growing cost of these items, see "Mayor Bloomberg and the Limits of Pragmatism," Nicole Gelinas, Manhattan Institute, November 2005.