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While Mayor Michael Bloomberg has belatedly proposed a tax package to help close the City’s $6+ billion deficit, Governor George Pataki continues to oppose raising taxes despite a State budget deficit that could reach $10 billion next year. To avoid devastating government services reductions on a scale not seen since the 1970s, substantial City and State tax hikes are inescapable even with new spending cuts. No one likes to impose or pay higher taxes, but we must do so if they’re the price of avoiding radical service cuts that do serious harm to our way of life, exacerbate the recession, and make New York City and State less attractive to business.
The question of which taxes to increase and by how much depends on two major considerations. The Governor, Mayor and lawmakers will need to take into account a) whether the added burden would be apportioned fairly among all taxpayers and those who work in New York City and benefit from city services and b) the potential for proposed tax hikes to prompt businesses and residents to relocate to lower-tax locales.
Based on these considerations, New York State should raise personal and corporate income taxes and the City should look to a mix of personal, property and corporate income taxes together with the commuter tax. These increases should be part of a long-term reform plan – including ending the utility gross receipts tax and restructuring the unfair property tax system -- to make the City and State tax and fiscal systems simpler, more predictable and more progressive. Since New York is one of only two states in which less than half the state and local tax revenue is generated by state taxes, another key goal should be for the State to become fiscally capable of taking over the local share of Medicaid and to provide adequate funding for education.
The additional taxes currently proposed by the Mayor would not be apportioned fairly. While a commuter tax is necessary and justified, a cut in the top personal income tax rate would greatly accelerate the recent trend toward personal income tax regressiveness among New York City payers. It will be hard to argue for the Mayor’s plan under which a suburban commuter earning $60,000 would pay $1,600 while a Manhattan resident with an income of $1 million saves $30,000. Since residential property taxes have a more regressive impact than personal income taxes, the proposal for the City to rely more on property taxes and less on the personal income tax would further burden those who are already having difficulty paying their bills; in 1999, 37% of the households in owner-occupied housing units in New York City had incomes of less than $40,000.
The Mayor now appears to appreciate that moderate tax increases that protect vital services are important to maintain New York’s competitiveness. The Governor still needs convincing that equitable, moderate tax increases would not harm the City and State economies. He should understand that the conventional wisdom that tax increases will necessarily lead to job losses is overstated, for several reasons:
• State and local taxes are only one of the costs of doing business and typically not one of the larger ones. Major factors other than the level of taxation that determine where businesses invests are a) occupancy costs including rent and utilities, b) the educational level and skills of the labor pool, and c) the capacity of the local transportation network to efficiently move commuters and goods. Many intangible factors, from the quality of the cultural life to the availability of recreational facilities, are of particular importance to the creative, information-based, high value-added industries that are becoming increasingly important in today’s economy.
Every legitimate study on the issue conducted since the 1950s has found at best a tenuous connection between the level of state and local taxes and economic performance. In 1997, for instance, Michael Wasylenko’s review in the New England Economic Review of studies on this issue concluded, “[T]axes do not appear to have a substantial effect on economic activity among the states.” Recent studies that purport to prove a direct connection between local tax burdens and economic performance are flawed because they confuse correlation and causation and give short shrift to the many other factors that lead to changes in employment levels.
• The fairness, simplicity and predictability of a location’s tax and fiscal systems are also an important business location decision factor. Reform that makes tax systems fairer and simpler and that ensures adequate government resources to meet important needs even during a recession can improve competitiveness. Closing unfair tax loopholes and eliminating ineffective special exemptions, ending certain taxes unique to New York, and phasing out regressive taxes such as the City’s utility gross receipts tax, together with comprehensive property tax restructuring, should all be part of a long-term comprehensive tax and fiscal system reform program.
• Most of New York’s economic competitors also face large budget deficits and some are raising taxes or delaying enacted tax cuts. Last month the Wall Street Journal reported that 46 states “struggled” to close a combined budget gap of $37 billion last fiscal year and by October the combined deficit had ballooned to $58 billion. Among recent tax increases are a New Jersey measure enacted this summer that will increase corporate tax collections from $800 million in 2002 to an estimated $1.8 billion in 2003.
Therefore, New York State should raise from $3 billion to $4 billion per year by:
• Progressively increasing the personal income tax. The share of total tax revenue generated by the personal income tax grew from 40% in 1972 to 58% in 2001. At the same time, the reduction in the top rate from a high of 15% in the 1970s to 6.85% today substantially lessened the relative contribution of the most wealthy households toward running State government.
The Fiscal Policy Institute proposes raising at least $3 billion annually through a temporary surcharge of seven tenths of one percent on the portions of a taxpayer’s New York Adjusted Gross Income above $100,000 and another .007 on the portions above $200,000. Considering that New York was the state with the greatest increase in income inequality during the 1980s and 1990s, the Fiscal Policy Institute proposal would be an equitable way to raise some of the revenue the State requires to help close its deficit.
The Bush federal tax cuts of 2001 would offset the additional cost to upper income taxpayers of a progressive increase in State tax rates. A family of four with an adjusted gross income of $500,000 saved approximately $5,000 on their federal taxes in 2002. According to a recent analysis of a similar progressive revenue raising proposal, if the State’s top rate had been increased from 6.85% to 8.85% in 2002, the State would have realized an additional $3.2 billion and this family would have paid an additional $5,600 in State taxes – for a net payment of only $600 when the federal tax cut and State tax increase are considered together. This gap entirely disappears when federal deductibility of state personal income taxes is considered. And the net savings will grow even more as additional scheduled cuts in the top federal top take effect in 2004 and later.
• Closing corporate tax loopholes and decoupling from federal “bonus depreciation.” Corporate income taxes now generate less than 10% of tax revenue, down from over 15% during the 1970s; the main income tax, the “corporate franchise tax,” is down to 5% from 10%. During the 1970s, the State personal income tax raised four times as much as the corporate franchise tax, in 1982 seven times as much and by 2001 eleven times as much. Corporate income taxes have fallen far behind personal income taxes because of large rate cuts, expanded business incentives, greater use of tax code loopholes, changes in the formula for allocating corporate income to New York, and increased utilization of limited liability corporations and other mechanisms that tax business income through the personal income tax yet can still result in a net revenue loss.
To raise several hundred million dollars annually, the State should close unfair and unproductive corporate income tax loopholes, restore the alternative minimum tax to its 3.5% rate of the 1980s, and rein in those business incentives that have not proven effective.
Since most states including New York use federal adjusted gross income as the base to compute corporate tax liability, changes in federal depreciation rules affect the level of state as well as federal tax revenue. In 2003 and 2004 the State will forgo several hundred million dollars in corporate income taxes because, unlike 30 other states including New Jersey, New York has not decoupled from the temporary 2002-2004 “bonus depreciation” allowance included in the 2001 federal economic stimulus package. New York should decouple from “bonus depreciation.”
The City should raise at least an additional $3.5 billion:
• Progressively raise the personal income tax to raise at least $1 billion additional per year and raise from $800 million to $1 billion a year by reinstating the commuter tax at double the rate of the tax that was eliminated in 1999. The personal income tax, which accounts for 24% of City tax revenue, has become less progressive in recent years. There should be a progressively structured increase in this federally deductible tax to raise at least $1 billion. The commuter tax should be reinstated at double the rate of the tax that was repealed in 1999, as opposed to six times the former rate as proposed by Mayor Bloomberg.
• Collect an additional $1.5 billion annually by increasing the property tax rate 15%, with a refundable enhanced circuit-breaker tax credit for lower-income homeowners, and ending to exemptions for non-resident homeowners. The City should concurrently reconstitute the Real Property Tax Reform Commission. The Commission’s final report in 1993 concluded that the real property tax “not only appears unfair, it is unfair.” It still is. If the tax is increased, then fundamental property tax reforms must be instituted.
Concerns expressed by the commercial real estate industry that a property tax hike would unfairly burden corporate tenants – most leases allow owners to pass tax hikes along to their tenants – are overstated. Since the mid-1990s, all commercial tenants except for large and mid-size tenants south of 96th Street have been exempted from the commercial rent tax. For businesses signing new leases, the impact of a property tax increase is tempered by the softening of the City’s commercial rental market. And because commercial assessment increases are phased in over five years, corporate tenants are now saving billions of dollars they would have paid had assessments during the recent commercial property boom became fully effective immediately.
• Close business tax loopholes to raise potentially tens of millions of dollars. Business taxes generate approximately 13% of City tax revenue, little changed since the 1970s. According to the New York City Independent Budget Office, the fact that the business income tax share has remained flat suggests “that the city needs to examine its business taxes in light of changing ownership structures and shifts in the amount of income multi-state and multinational firms apportion to the city.”
While it may seem counterproductive to raise taxes to pay for government spending in a weak economy, in the short run cutting government spending may be even more harmful than tax hikes, according to a recent analysis by Nobel Prize winner Joseph Stiglitz and Brookings Institution tax and fiscal policy expert Peter Orszag. They conclude that some portion of a tax increase results in reduced savings rather than reduced consumption whereas government spending reductions on goods, services and transfer payments to individuals tend on a dollar for dollar basis to reduce consumption and harm local economies.
Now is time to refocus government on making real improvements in the business climate. These include more efficient, “smarter” government that provides high-quality services, responds effectively to every day business needs, and makes investments in public infrastructure with high economic payoff.
An expanded Javits Convention center, biotech incubators, upgraded airport cargo facilities, and customized job training, are a few. Investment in infrastructure – human, technological, and physical – will be more important for growing our economy than keeping taxes at current levels.
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