The Path Not Taken: How New York State has Increased the Tax Burden on the Middle Class and Cut Taxes for its Highest Income Taxpayers by Over $8 Billion a Year

June 4, 2005. A little bit of tax history by Fiscal Policy Institute Executive Director Frank Mauro.

In 1972, New York State had a personal income tax with 14 brackets, ranging from a low of 2% to a high of 15%.

Since that time the state government has significantly restructured the state personal income tax in a variety of ways. Among the changes that have been made since 1972 has been a move to something that is much closer to a flat tax. This has been done by eliminating brackets from both the bottom and the top of the old structure.

For example, the lowest rate in the old structure was 2%. But the 2% and 3% brackets have been eliminated, so the lowest rate is now 4%.

At the other end of the spectrum, even more brackets have been eliminated. The 15%, 14%, 13%, 12%, 11%, 10% 9%, 8%, and 7% brackets are all gone.

New York now has a 5-bracket/5-rate system, with both the 5 rates and the 5 brackets in very tight ranges.

All five of New York’s current rates are between 4% (the current lowest rate) and 6.85% (the current highest rate).

And the brackets are just as compressed. A single person reaches the top 6.85% rate once his or her taxable income reaches $20,000. A married couple is in the top bracket when their taxable income is $40,000 or more.

For three years (2003, 2004, and 2005), New York State has had two temporary brackets on people with higher incomes. This year, for example, the state has a temporary top rate of 7.25% for single individuals with taxable income above $100,000. For married couples, this temporary top rate applies if their taxable income is above $150,000. The second temporary rate is 7.7% and it applies to all taxpayers with taxable income above $500,000.

To address the impact on eliminating the bottom two brackets (the 2% and 3% brackets) on low income working families, the state has adopted two income-based credits – the household credit and the state earned income tax credit. Those credits help people at the low end of the income distribution, which is good; but, they do not blunt the impact on middle income families of the state’s move to a relatively flat rate income tax structure.

Rather than eliminating so many rates from the top of the bracket structure, New York State could have helped middle income families much more if it had kept its old tax structure but stretched out the brackets each year to reflect the effects of inflation and indexed the state’s personal exemption as well. New York State, in fact, no longer has a personal exemption for taxpayers and their spouses, and the exemption for dependents has been set at $1,000 since 1988. Over this same period, the federal government’s personal exemption has been increased from $1,950 to $3,200. That means that a married couple with two children gets exemptions of $12,800 when calculating their federal income tax but only $2,000 when calculating their state income tax.

If New York State had pursued this alternative approach, lets call it Plan B – of indexing its tax brackets and its personal exemption for inflation, rather than cutting brackets from the top, 95% of New Yorkers would be paying less in state income taxes than they pay under the current law but (and this is a very big but) the state would be collecting $7.7 billion more in tax revenue each year. And, if it had been collecting that additional income tax revenue, the state would not have had to cut and freeze state revenue sharing with local governments as it has on so many occasions; and it would have been able to increase the share of school budgets covered by state aid. What we actually got instead were cuts in revenue sharing and smaller increases in school aid than would otherwise have been possible. And this meant bigger increases than necessary in local property taxes and school taxes – again hitting middle income families very hard.

So, how can it be that New York State could have pursued a policy that would have meant lower income taxes for 95% of taxpayers but more revenue for the state treasury? It sounds impossible but it’s true, and the reason why it is true is because so much of the income growth in New York State and in the United States over the past 20 years has been concentrated at the top end of the income distribution.

Instead, since the late 1970s, New York State has pursued an income tax policy that has meant higher than necessary income taxes for middle income families and huge tax cuts for the best-off 5% of state taxpayers – many of whom are actually residents of other states (primarily Connecticut and New Jersey) who commute into New York City to work.

Here are some examples. Because New York State cut income tax rates from the top rather than implementing Plan B, a family of 4 with income of $50,000 is paying about $1,000 more in income taxes than it would have if New York had pursued Plan B. For a family with income of $100,000 that tax difference is $2,000. The biggest losers are families earning about $150,000, who are paying about $2,500 more under the current 5-bracket, 6.85% plan than they would be paying under Plan B with 14 brackets and a top rate of 15%.

At the other end of the spectrum are the big winners. A family earning $500,000 is now paying $22,000 a year less than they would be paying if Plan B had been implemented. At the $1 million level, this savings is about $63,000 and at $2 million, it is about $145,000.

Why has New York State pursued such an attack on the middle class just to provide huge benefits to those who have the least difficulty in making ends meet? Has this been a conscious effort at class warfare? or, Have our policymakers just been oblivious to the impact of the state’s misguided tax policies?

A few states have taken steps to ensure that legislators no longer have to make such decisions in the dark. They have done this by requiring independent nonpartisan analysis of the impact of proposed tax changes on people at different income levels. New York should follow suit. But even, if this approach is successful, it will just prevent us from going further in the wrong direction.

What New York state needs to do now is to undo some of the damage of the last 25 years. It needs to move in the opposite direction to make the tax system fairer and to generate the revenue necessary to fund a statewide solution to the Campaign for Fiscal Equity lawsuit and to reduce the pressure that we are now placing on the property and sales tax bases.