February 15, 2006. Testimony of Frank J. Mauro, Executive Director, Fiscal Policy Institute, presented to the Joint Budget Hearing on Economic Development and Taxes before the Assembly Ways and Means and Senate Finance Committees.
The centerpiece of the 2006-07 Executive Budget is a return to the pre-2001 practice of enacting large multi-year, backloaded tax cuts. The myriad of tax reductions being proposed by the Governor would reduce state revenues by about $1 billion in 2006-07. But because the proposed tax reductions would take effect in stages over the course of the next five years, they are projected to reduce state revenues by $5 billion when fully implemented in 2011-12.
A tax cut proposal of this magnitude, if enacted by the State Legislature, would put a substantial lien on future year resources and greatly limit the ability of the state to balance competing priorities in the annual budget process. To fully understand the impact of a $5 billion, multi-year, backloaded tax reduction commitment of this type on the rest of the state budget, it is important to keep several factors in mind.
(1) The estimates of the cost of the Governor’s proposed tax cuts in future years are based on estimates of the size of the economy, the distribution of income and other variables as of this year and next year. This means that the growth in the cost of the tax reduction program over time is not the result of growth in the economy or changes in the distribution of income or changes in other economic variables. This in turn means that unless underlying revenues grow faster than underlying expenditures, the implementation of a backloaded tax reduction program of this size will require large service reductions. If underlying revenues and underlying expenditures were to grow at the same rates over the next several years, tax cuts of the magnitude being proposed by the Governor would require $4 billion more in annual service cuts in the future than they are requiring this year. It also means that if the state could cut its revenues by $5 billion a year without jeopardizing other important state priorities, it could do it this year. But it cannot.
(2) The $2 billion budget surplus being projected by the Governor would not exist if it were not for the $2.2 billion in revenue that the state is receiving during 2005-06 from the temporary tax increases enacted in 2003. Since these tax increases have either expired or will be expiring in the near future, this surplus is not a recurring, annual surplus. This means that the current year surplus will not cover the cost of $2 billion of annual, recurring tax cuts, let alone the cost of the Governor’s tax cut program which will cost $4 billion a year by 2008-09 and $5 billion a year by 2011-12.
(3) President Bush’s recently released federal budget contains many proposals that, if adopted, would reduce federal revenues to the states. The President’s FY 2007 budget, proposes substantial reductions in federal spending on Medicaid. While some of these changes would lower both federal and state expenditures, the overwhelming majority of the President’s Medicaid proposals would lower federal funding to the states without reducing Medicaid costs and thereby shift costs to the states. Many of the changes in the latter category are proposed to be done administratively rather than through Congressional action and they are targeted at aspects of the Medicaid program where New York accounts for a greater than average percentage of total federal expenditures (e.g., New York’s system of providing high quality services to the mentally ill, the mentally retarded and the developmentally disabled). The President’s recent budget proposal also targets grants-in-aid to the states for 55% of the proposed reductions in discretionary spending even though such grants account for only about one-third of federal discretionary spending. Compared to last year’s levels adjusted for inflation, the Presidents proposal would reduce grant-in-aid to New York State by over $600 million next year and substantially more in future years. A state-by-state breakdown of the proposed Medicaid cuts is not available but given the nature of the President’s proposals, New York is likely to absorb a significant share of the federal cuts if those proposals are adopted.
In order to mask the full size of the budget gaps that his multi-year tax cuts would create, the Governor is proposing large service reductions, growing in value from close to $2 billion in 2006-07 to over $3 billion the following year. In addition, the Governor is proposing the use of over $1 billion of its most flexible rainy day funds in each of the two succeeding fiscal years. Even with these big service cuts and even with the use of all of the state’s flexible reserves for “non-rainy-day” purposes, the Governor’s budget would still leave the Legislature and the next Governor with budget gaps of $2 billion in 2007-08 and $4 billion in 2008-09.
The service reductions being proposed by the Governor include $1.3 billion in Medicaid cuts in 2006-07 and $2.3 billion in the following year. When federal matching funds are taken into consideration, this amounts to the removal of $2.6 billion from the health care system in 2006-07 and $4.6 billion in 2008-09. In a similarly misdirected move, the Governor’s second biggest target after health care is higher education, where he is proposing to cut $247 million in 2006-07 and $331 million in 2007-08.
In education, the increase in state aid to public schools that the Governor is proposing is far from sufficient to maintain the current level of educational quality without shifting a greater share of the costs to local property taxes. And, even though the Governor has said that he wants a statewide solution to the Court of Appeals’ decision in the Campaign for Fiscal Equity, his budget does not propose such a solution – – not even the inadequate plan that he has presented to the courts as the state’s position.
Instead, the Governor has proposed continuing the first $325 million installment in Sound Basic Education aid that was adopted last year and putting an additional $375 million into a reserve fund for this purpose. The Governor is proposing that the $325 million be distributed in the same manner as it is being distributed this year (which is far less targeted to needy districts than the plan that the Governor presented to the courts) and that the additional $375 million be distributed pursuant to an allocation plan to be adopted by his Budget Director with no statutory standards or safeguards. Even if these resources were allocated in accordance with the standards adopted by the court, increasing spending at this rate would mean that the state government would not meet its reasonable share of the costs of a Sound Basic Education for all of the state’s children until sometime around 2022.
The temporary tax increases enacted in 2003 allowed New York State to deal with the recent recession in a much more effective manner than it dealt with the recession of the early 1990s.
While the $11.5 billion 15-month budget gap that New York State faced in January 2003 and the current $2+ billion surplus are not exactly comparable, the turnaround in the state’s finances in significant. This turnaround is particularly noteworthy given Governor Pataki’s claims in May 2003 that the Legislature’s balanced approach to dealing with the $11.5 billion budget gap was going to do great damage to the economy and produce large recurring budget gaps. In 2003, over the Governor’s vetoes, the Legislature closed the state’s budget gap in a much more balanced manner than New York State had pursued in the early 1990s, and the state is now enjoying the benefits of those choices.
Seven Years of Overly Ambitious Tax Cuts
In retrospect, it is clear that the large multi-year tax cuts enacted in Governor Cuomo’s last year in office and Governor Pataki’s first six years, when taken together, were overly ambitious. The Division of the Budget estimates that these tax cuts are reducing state tax revenues by about $15.4 billion this year and an estimated $15.8 billion next year.
Governor Pataki has described this effort as the largest multi-year tax reduction ever undertaken by any state. In terms of balancing this objective with prudent fiscal planning, however, a tax reduction plan half this size would have still been the largest state tax reduction in history but New York would have been much better positioned to weather the fiscal storms of the last several years and to meet the state’s priority investment needs.
Analysts and commentators who concluded that these tax reduction plans could not be sustained in the event of a downturn in the economy or a downturn on Wall Street, without significant backtracking on either the revenue and/or the expenditure sides of the budget, were dismissed as “naysayers.” Unfortunately, during the first several years of this decade, New York had to deal with both of those developments simultaneously and with the aftermath of September 11th as well.
Avoiding the Problem in 2001 and 2002 and Facing the Music in 2003
In 2001 and 2002, New York avoided significant tax increases and service cuts through the use of one-shots and the various reserves that the state had accumulated during the earlier boom times, and, as it turned out, an overestimation of the its 2002-2003 revenues. In January 2003, however, the Governor acknowledged that the state government faced an unprecedented 15-month, $11.5 billion deficit. This consisted of a $2.2 billion gap for the 2002-03 fiscal year that was then coming to a close and a projected $9.3 billion gap between revenues and expenditures for 2003-04.
On January 29, 2003, Governor Pataki proposed a multi-year plan for bringing the state’s finances back into some semblance of structural balance. The Governor’s multi-year strategy was not an illogical or inappropriate given that the projected $9.3 billion budget gap represented almost 25 % of the state’s General Fund budget at that time. Implementing $11.5 billion in service cuts and/or revenue increases during a 15-month period could very well have caused substantial harm to the state’s economy. The Legislature ultimately went along with the Governor’s proposal to reduce this gap to manageable proportions primarily through the use of a $4 billion one shot – the securitization (or bonding out) of the revenues that the state would be receiving over time pursuant to the settlement of the multi-state lawsuit against the major tobacco companies.
But when it came to the more difficult challenge of closing the remaining gap, the Governor leaned heavily toward spending cuts and increases in fees and regressive taxes and heavily against increases in progressive taxes. He proposed closing the remaining $700 million gap for 2002-03 entirely on the spending side of the ledge and covering the remaining 2003-04 gap with $5.2 billion in spending cuts and $1.3 billion in revenue increases, or about $4 of cuts (in state services and aid to localities) for every $1 of revenue increases. Moreover, the revenue increases that the Governor did propose were overwhelmingly increases in consumption and other regressive taxes and fees. The largest single revenue increase proposed by the Governor, for example, involved eliminating the State’s relatively new $110 clothing sales tax exemption and the replacing it with four one-week exempt periods. Moreover, as the Governor’s budget was reviewed by the Legislature and outside observers it became clear that many of the proposed cuts in aid to localities would have to be made up, at least in part, by property tax increases.
At the time, the Governor attempted to justify these policy choices by asserting a relationship among taxes, government spending and the economy that is inconsistent with basic economic principles, and by presenting an incorrect rendition of New York State’s economic history.
The Legislature’s Better Budget Choices
Fortunately, for the state’s economy and for the economic well being of New York residents, the Legislature did not go along with the Governor’s recommendations. Instead, the Legislature adopted a much more balanced approach to balancing the state budget, relying more heavily on revenue increases than the Governor had originally recommended and reducing many of the spending cuts that had been recommended by the Governor. The Legislature appropriately enacted a series of temporary tax increases – some for two years and some for three years – that would allow the state to weather the downturn in the economy in a way that would not prolong or exacerbate that downturn, the way that the budget choices of the early 1990s had done.
Most significantly – and most at odds with the Governor’s rhetoric – the Legislature understood that during a recession, neither tax increases nor service cuts are desirable. But that in such a difficult situation, the least damaging approach to budget balancing involves increasing taxes on the portion of income that is least likely to be spent in the local economy; in other words, increases in the portion of household incomes over some relatively high level. Putting this economic reasoning into practice, the Legislature enacted the first increase in the state’s top income tax rate since 1972. Between the late 1970s and 2003, the state had reduced the state’s top income tax rate from 15% to 6.85%, with that top rate of 6.85% applying to taxable incomes over $40,000 for married couples and over $20,000 for single individuals. In 2003, the Legislature moved in the opposite direction – establishing two temporary higher brackets for the 2003, 2004 and 2005 tax years. The Legislature set a temporary top rate of 7.7% for taxpayers with taxable incomes over $500,000 for all three years, and a temporary second rate of 7.5% (declining to 7.375% in 2004 and 7.25% in 2005) on the portions of taxable income over $150,000 for married couples and $100,000 for single individuals.
Ten days after the original legislative passage of its budget package, the Governor vetoed the Legislature’s bill to raise state taxes, authorize transitional borrowing and allocate school aid and line-item vetoed 118 spending additions. Within 20 hours, the Legislature overrode every one of the Governor’s vetoes on a bipartisan basis.
Rhetoric vs. Reality
At the time, the Governor argued that the Legislature’s approach to balancing the state budget would have terrible economic consequences. On May 6, 2003, for example, the Governor issued a press release with the following lead paragraph: “Governor George E. Pataki today announced that the fiscally irresponsible budget passed by the State Legislature will harm New Yorkers by imposing the largest tax increase in the history of the State — a tax increase that will lead to massive job losses and a projected $13 billion budget shortfall in the upcoming two years.”
As we now know, the Legislature’s approach to closing the unprecedented $11.5 billion budget gap has proven to be much more economically sensible than either the approach taken by the state during the early 1990s or the approach (which would have been, in large part, a re-run of the choices of the early 1990s) recommended by the Governor in the early 1990s.
In January 2004 and January 2005, the state faced projected budget gaps, but those gaps were the result of the multi-year approach that the Governor had recommended (and that the Legislature had agreed to) for addressing the $11.5 billion budget gap that it faced in early 2003. In each of these years, the state faced the loss of the various one-time actions that had been used to balance the prior year’s budget. By January 2005, it was clear that underlying revenue growth and underlying expenditure growth were coming back into balance. And, during the course of the 2005-06 fiscal year, economic and revenue growth accelerated to the point that the state is now projected to end the fiscal year with a surplus of at least $2 billion. Without the temporary tax increases, New York would still be ending the current fiscal year with a balanced budget – which means that the state has achieved structural balance.
In discussing the current budget surplus, the Governor said, “This is a dramatic turnaround from last year when we were looking at a $4 billion deficit. It just shows that good government policies like reforming and controlling the cost of Medicaid and putting in place economic policies where our economy is expanding and growing have led to higher revenues and lower costs.” In listing the policies that contributed to the surplus, the Governor leaves out the most tangible factor – the temporary tax increases that were enacted (over his veto) in 2003. These tax increases prevented counterproductive service cuts and they clearly did not have the negative economic consequences that the Governor predicted in 2003. Over the course of the last three fiscal years, the temporary tax increases raised a total of almost $7 billion, with $2.2 billion of that total coming into the state treasury in 2005-06 alone. If it were not for this $2.2 billion in tax revenue, the state would not be ending the current fiscal year with a $2 billion surplus.
The 2006-07 Executive Budget proposes to put New York State back on the multi-year tax cut treadmill
The 2006-07 Executive Budget includes tax cut proposals that take effect over the course of the next six years and which would put a significant lien on future resources. The Governor’s plan calls for the enactment this year of a series of tax cuts that he estimates would reduce state revenue by $927 million in 2006-07 and by $4.5 billion in 2010-11, the fourth year of the next Governor’s term. But the full impact of some of these tax cuts would not be felt until even later. For example, the fully-implemented $1 billion annual cost of the proposed repeal of the state estate tax would not be realized until a year or two after 2010-11.
Learning from the experiences of the late mid to late 1990s
The Governor’s justification for these tax reductions is that past tax reductions explain the state’s current economic recovery and its current budget surplus. This, however, is a false and misleading rendition of the state’s recent economic history. The large tax reductions of the late 1990s did not inoculate New York from the economic downturn at the beginning of this decade, and the recent economic rebound and the current surplus have both come to pass in the face of tax increases that the Governor, in 2003, claimed would destroy the state’s economy. Moreover, the large multi-year tax reductions of the late 1990s made it much more difficult for New York to deal with the challenges it faced in 2001, 2002 and 2003 than would have been the case if New York had been more realistic in its enactment of multi-year tax cut promises.
Taken together, the tax cuts enacted in Governor Cuomo’s last year in office and in Governor Pataki’s first six years are reducing state revenues by about $15.4 billion during the current fiscal year alone. Cumulatively, to date, these tax cuts have reduced state revenues by $108 billion, and they are estimated by the Governor to reduce state revenues by a cumulative $196 billion by the end of the 2010-11 fiscal year. While the Governor takes great pride in these tax cuts, he never mentions the services that were cut, the human needs that weren’t met, and the investments that weren’t made in order to accommodate the billions in revenues that have been foregone over the last 12 years. The Governor likes to say that this was the largest multi-year tax reduction program ever undertaken by any state in the history of our country. That is true; but if the state had cut taxes by half the amount that it actually did, it would have still been the biggest tax cut in the history of this or any other state and it would have meant less deferred maintenance of the state’s physical and human infrastructure.
What the Governor also says, which unfortunately is not correct, is that “on a cumulative basis, when all enacted tax cuts are fully phased in, New Yorkers will have realized a savings of more than $167 billion.” While state revenues will have been reduced by $167 billion, a much smaller amount will have gone into the pockets of New Yorkers or even into the state’s economy. Approximately one third of this $167 billion will have gone to the federal treasury (since personal income taxes, property taxes and all business taxes are deductible on taxpayers’ federal tax returns), while large portions will have gone to nonresident individuals and out-of-state and foreign corporations. Thus, the Governor’s tax cuts are actually taking more money out of the state’s economy than they are pumping back in. This helps to explain the stagnancy of those parts of the state that did not benefit during the 1990s from forces like the boom on Wall Street or the growth of entertainment and “new media” businesses.
Almost all of the state’s job growth, before the declines that began in 2001, occurred in the New York City metropolitan area and this growth was overwhelmingly related to the good times enjoyed, during the mid and late 1990s, by the financial services, professional business services, entertainment and media industries. The huge tax cuts did virtually nothing to stimulate growth in the parts of the state that did not benefit from the growth of these industries.
For example, the Governor’s “supply-side” cuts in the top rates on the personal income tax, which are now reducing state revenues by over $7 billion per year, did not come close to generating the number of additional jobs that the Governor and his advisors promised. If those tax cuts had delivered the promised job growth, New York State would now have 200,000 more jobs than it actually has. Moreover, if employment had grown as fast in the first six and a half years of the Pataki administration as it had grown in the first six and a half years of the Cuomo administration, New York in August of 2001, right before the September 11th disaster, would have had 185,000 more jobs that it actually had.
Despite this record of non-accomplishment, the Governor argues that the additional tax cuts that he is proposing are just what are necessary to stimulate the Upstate economy. If $108 billion in tax cuts have not had the magical effect that the Governor promised, why does he expect New Yorkers believe that additional tax cuts will now do the trick?
While the boom on Wall Street allowed New York State to implement these massive tax cuts without even deeper service cuts than we have experienced and without even less investment in the state’s human and physical infrastructure, New York State tax policy, quite simply, had nothing to do with what happened or is happening in national and international financial markets. If New York State tax policy had anything to do with what goes on in the financial markets, the financial press would pay a lot more attention to what goes on in Albany and a lot less to the thoughts of former Federal Reserve Bank chairman Alan Greenspan and his recently-appointed successor, Ben Bernanke.
The relationship of the Governor’s 2006-07 budget proposals and the state’s fiscal situation
New York State’s budget situation is improving but substantial challenges remain. State revenues are growing fast enough to cover the growth in state expenditures but they are not growing fast enough to make up for the loss of the nonrecurring resources that were used to balance the state’s 2005-06 budget and to cover the cost of the new multi-year tax cuts being proposed by the Governor in conjunction with his 2006-07 Executive Budget.
In the current context, it makes no sense for the Governor to be proposing actions that make the state’s projected budget gaps larger; and then proposing to address those gaps through large and counterproductive service cuts and through the use of all of the state’s most flexible rainy-day reserves for what is clearly a “non-rainy-day” purpose. And all while failing to honor his promise to the courts and to the children of this state to implement a legitimate statewide solution to the Court of Appeals decision in the Campaign for Fiscal Equity case. Instead, at the first glimmer of budget balance since 2000, the Governor is proposing to create a series of projected budget gaps for future years.
Making New York’s state-local tax system more regressive
In addition to the limitations that the Governor’s proposals would place on the Legislature in balancing future budgets in a manner that is fiscally, economically and socially sensible, his proposals would make changes in the tax system that, despite his rhetoric, would make New York’s state-local tax system less fair than it already is.
For example, the Governor is proposing to eliminate the New York State Estate Tax, something that his supposed idol Theodore Roosevelt fought for as a means of limiting the creation of great concentrations of wealth. The Governor claims that he is just conforming to the changes at the federal level that are increasing the value of estates that are exempt from taxation and then repealing the tax completely in 2010. But those changes were enacted in 2001, and the Governor said absolutely nothing about conforming to them in 2002 or 2003 or 2004, when doing so would have affected the budgets that he was responsible for balancing. Now, in his last year in office, the Governor is proposing to address this “problem” in a way that will first affect the state treasury in 2007-08 and then grow rapidly to a fully-implemented annual revenue loss of $1 billion per year beginning in 2011-12.
The Governor is also attempting to mislead the public when he says that he is just proposing to conform to the federal law. While the federal estate tax (along with the full credit for state estate taxes paid) is scheduled to come back into operation in 2011, the Governor is proposing that the New York State Legislature fully and permanently repeal New York State’s Estate Tax in 2010. In the name of federal conformity, the Governor is moving to prejudge the debate that is going on at the national level as to the future of the Estate Tax. This might just be grandstanding but, if adopted, it would represent a substantial increase in the regressivity of New York’s tax system.
Here is what the New York Daily News had to say about this proposal in a January 29, 2006, editorial entitled Pataki does a job on the working class:
While denying New York City its fair share of school aid in disregard of a court order, Pataki wants to eliminate over 10 years the tax that New York imposes on the estates of the wealthy after they have died. A bad idea in general, getting rid of this tax is monstrous when you consider how much money is at stake and how few people would benefit.
Pataki’s plan would siphon $900 million a year out of the treasury and give $600 million of the money to the beneficiaries of roughly 200 estates. That’s $600 million for a very rich and very lucky 200 instead of $600 million to improve the education of 1.1 million children. Pataki says this makes sense because he wants to keep rich taxpayers in New York, and we’re not making that up.
The $900 million dollar figure cited by the Daily News comes from the Budget Division’s estimate of the cost of this proposal in 2010-11 but the full impact of this proposal (an estimated $1 billion per year) would not be felt until 2011-12 at the earliest because of the lag time involved in the settling of estates and the grace period for the filing of estate tax returns. And, once again, all of these estimates are based on the current value of the dollar and of other economic variables. The estimate of $600 million of the benefit going to some 200 very wealthy families is based on estate tax receipts for the 2004-05 state fiscal year when 216 estates of $6 million or more paid estate taxes of $591 million on estates valued, in the aggregate, at about $4.5 billion. Of that $591 million, about $378 million was paid by 25 estates valued at more than $28 million each.
The Governor’s proposal to repeal the state Estate Tax might explain why he and his staff have embarked on an effort to convince New Yorkers that the wealthiest one percent of New York families carry an inordinate share of the tax burden. They have attempted to do this by pointing out that the wealthiest one percent of New York families pays about 35% of the state Personal Income Tax. But the Governor’s disinformation campaign ignores both the distributional impact of other state and local taxes and the wealthiest one percent’s share of the income of all families.
As the following table (from a study that applied 2002 tax law to 2000 incomes) indicates, because of the regressivity of sales and property taxes, the wealthiest one percent pay about 20% of all taxes, a share that is reduced to 17% when the deductibility of state and local taxes on federal income taxes is taken into consideration. And while they represent only one percent of all families, they have 25% of the income of all families, and 37% of the income not necessary for meeting the basic necessities of life.
Wealthiest 1% of Families Next 4% of Families Wealthiest 5 % of Families Average Income $1,663,000 $250,200 Share of All Family Income 25.2% 15.1% 40.3% Share of All Family Income Above $27,000 37.2% 20.3% 57.5% Share of Personal Income Taxes 35.4% 18.2% 53.6% Share of Sales & Excise Taxes 8.3% 9.5% 17.8% Share of Residential Property Taxes 7.3% 15.9% 23.2% Share of Total Taxes (including those not shown individually) 20.8% 14.6% 35.4% Share of Total Taxes After Federal Offset 17.3% 13.4% 30.7%
Eliminating the state Estate Tax, one of the state’s most progressive taxes would serve to make New York’s overall state-local tax system even more regressive than it already is.
Making New York’s Corporate Income Tax more porous
New York State’s corporate income taxes have become more and more like “Swiss cheese.” General business corporations for example, have gone from carrying over 10% of New York State’s tax load in the late 1970s to less than 4% this year. And, for this year and last year, corporate income tax revenues are up substantially from the level of the previous several years. This is due to a number of factors including significant growth in receipts from “audit and compliance” activities. This growth, in turn, is attributable in large part to the closing of some corporate tax loopholes.
The Governor’s 2006-07 budget proposals, however, move in the opposite direction by proposing to eliminate the state’s corporate Alternate Minimum Tax (AMT) which was enacted in 1987 to make sure that profitable firms paid some minimum amount in state taxes and to add a very risky provision for the “expensing” (i.e., writing off in one year) of capital investments.
The Business Council has been lobbying for the repeal of the corporate AMT for several years. It argues that the AMT prevents firms from being able to use all of the Investment Tax Credits (ITC) that they earn. That was the very purpose of the corporate AMT, which was established by a comprehensive corporate tax reform law, which was enacted in 1987 with the active support of the Business Council. That 1987 law reduced the corporate income tax rate from 10% to 9% (and
Impact of Alternative Combinations of Corporate Income Tax rates and Investment Tax Credit rates 2000 2003 Capital Investment* 215,000 149,000 Corporate Profits** 153,317 75,478 Federal ITC and Corp. Income Tax Rates before 1986 Tax Reform Act 10% of Corporate Investment 21,500 14,900 46% of Corporate Profits 70,526 34,720 ITC as a % of tax due before credits 30% 43% NYS ITC and Corp. Income Tax Rates before 1987 Tax Reform Act 6% of Corporate Investment 12,900 8,940 10% of Corporate Profits 15,332 7,548 ITC as a % of tax due before credits 84% 118% Current NYS ITC and Corp. Income Tax Rates 5% of Corporate Investment 10,750 7,450 7.5% of Corporate Profits 11,499 5,661 ITC as a % of tax due before credits 93% 132% * From Table 760, Statistical Abstract of the United States: 2006 ** From Table 767, Statistical Abstract of the United States: 2006
to a lower level for small businesses) and it eliminated and/or limited a number of corporate tax preferences. The ITC was reduced from 6% to 5% rather than being eliminated but the AMT was established at a 3.5% rate. The intended purpose of this set of changes was to provide that a firm would pay state taxes on its income at 9% with preferences or 3.5% without preferences such as the ITC. Since 1987, the state’s main corporate income tax rate has been reduced to 7.5% and the AMT rate has been reduced to 2.5%. The problem with this system is that the ITC rate (5%) is set too high relative to the tax rate (7.5%). With this combination of tax and ITC rates, a firm that is simply making the investments necessary to not run its plant and equipment into the ground can generate enough ITCs to reduce their tax liability to zero or close to zero. The corporate AMT was intended to prevent such a situation for firms with profits.
The Governor’s proposal is to allow the “expensing” (i.e., writing off in one year) of capital investments in New York State. This change has a very high price tag (an estimated $560 million per year) but there is a clear risk that the cost will end up being much higher and not have the in-state economic benefit that is being advertised. The reason for this risk is that such an approach is clearly in violation of the Commerce Clause of the United States Constitution under current court interpretations. In the 1980s, New York purported to allow a form of accelerated depreciation (the so-called ACRS, later MACRS) for in-state property but not for out-of-state property. But, in the 1990s, this venture into mercantilism was found to violate the U.S. Constitution in the 1990s and New York State changed its laws to allow ACRS for all property. The Pataki Administration apparently thinks that if the U.S. Supreme Court strikes down a decision by the Sixth Circuit Court of Appeals involving Ohio’s Investment tax Credit that a state would then be free to adopt differential depreciation schedules. All parts of this reasoning are extremely speculative and place the state at great financial risk, given the enormous cost of “expensing” relative to other forms of accelerated depreciation.
A Better Choice on Tax Policy
Rather than moving in the direction recommended by the Governor in the 2006-07 Executive Budget, the Legislature should move to close loopholes in the state’s corporate taxes and provide the revenue necessary for implementing a legitimate statewide solution to the Campaign for Fiscal Equity decision without making counterproductive cuts in other parts of the state budget.
Eliminate Tax Breaks that Don’t Create Jobs. New York State’s annual Tax Expenditure Report shows that business corporations receive over $2.5 billion in tax breaks each year. The Pataki Administration has attempted to solve this “problem” by dropping many of the state’s corporate loopholes from this annual accounting. In addition, untold millions more are lost via transfer pricing and other techniques used by large, multi-national corporations to avoid paying their fair share of taxes. New York could reduce leakage from these tax preferences if it were to adopt “combined reporting” and eliminate the loopholes that were added to its Corporate Alternative Minimum Tax in 1994.
Combined reporting, as currently required by California, Colorado, Illinois, New Hampshire and the 13 other states, requires a business to file a single combined return for all of its business activities. This prevents profitable multi‑state and multi‑national corporations from avoiding state corporate income taxes through accounting trick that shift income and expenses among their numerous subsidiary corporations in order to reduce their overall tax liability by having inordinately large portions of their income show up in subsidiaries that are only taxable in so‑called offshore tax havens where tax rates are inordinately low, or in states that do not have corporate income taxes, or in states that have corporate income taxes but which do not tax certain kinds of income.
Enact a Corporate Disclosure Law. A growing number of corporations use transfer pricing and a variety of other subterfuges to minimize the percentage of their net income that is subject to tax by any state. New York State should require every publicly traded corporation that does business in the state to report its gross and net income, deductions and credits, and the amount of New York state taxes paid, much as corporations already do at the federal level. This would allow taxpayers and policy makers to identify companies in the state that may be making profits but, through the use of clever business structures and tax expenditures, are paying little or no New York taxes. Only with that information can the state truly know how well its tax policies are working. The Securities and Exchange Commission, as part of its response to the Enron scandal, should require every publicly-traded corporation to file, as a supplement to its annual report to stockholders, a 50-state spreadsheet that shows its allocation of property, payroll and sales among the states and its tax payments to each of the 50 states.
Crack down on schemes that create “Nowhere Income.” Multi-state corporations pay no taxes on profits attributable to sales made in states in which they do not have a physical presence. To address this situation, 28 of the 45 states with corporate income taxes, including California, Texas and Utah have enacted “throw-back” or “throw-out” rules to limit this drain on state revenues. New York State should also adopt such a safeguard.
Reform New York’s Corporate Alternate Minimum Tax (AMT). Several significant loopholes that favor multi-state corporations were added to New York’s Corporate AMT beginning in 1994 and the AMT rate was cut from 3.5% to 2.5% in 1999. These changes should be repealed or the AMT should be replaced with a variation of the Alternative Minimum Assessment (AMA) adopted by New Jersey in 2002. To ensure that such an assessment would not hurt small business, it should only be applied to businesses with annual gross profits of $5 million or more. In this year’s budget, the Governor is proposing that the state go in a totally opposite direction and repeal the corporate AMT. If this is done, it means that many large multi-state corporations will be able to use old carried-forward Investment Tax Credits to reduce their tax liability in New York State to zero even if they move jobs out of the state.
Make polluters pay for Governor Pataki’s plan to cap greenhouse gas emissions. The Legislature should ensure that the tradable emission permits under Governor Pataki’s proposed regional carbon cap are auctioned rather than given away. The proceeds from such an auction (estimated at about $500 million per year beginning when the program is implemented) could be used to mitigate the negative distributional effects on low and moderate-income households and to serve other economically and socially important purposes.
Create a fair and equitable personal income tax structure. A legitimate statewide solution to the Court of Appeals’ decision in the Campaign for Fiscal Equity case will require substantial additional revenues. The most economically sensible way to raise such revenues would involve reforming the NYS personal income tax structure in a way that ensures that the wealthiest New Yorkers pay their fair share in state and local taxes. The specific approach to be utilized will depend on a number of factors including the overall cost of the remedial plan and the portion of that plan to be financed through a reform of the personal income tax structure. Among the many options available for moving in this direction are the following: (a) continuing New York’s 2005 temporary surcharges on the portions of a family’s taxable income above $150,000 (7.25%) and above $500,000 (7.7%), (b) adopting the top brackets from New Jersey (8.97% on income above $500,000) or North Carolina (8.25% on income above $200,000); and (c) replacing New York’s current bracket structure with its 1972 brackets (2% through 15%) adjusted to reflect the changes in the cost of living over the past 30 years. Under this latter option, 95% of New Yorkers would pay less than under current law while the state would collect $7.7 billion more in revenue. This indicates how far and in what direction New York’s tax system has changed over the past 30 years.
Impact of Education Spending with Various Revenue Sources Gross Effects (percent change) Net Effects (percent change) Education Spending Personal Income Tax Property Tax General Sales Tax Personal Income Tax Property Tax General Sales Tax Impact of $6 Billion Total Employment +1.26 –0.78 –0.87 –0.94 +0.48 +0.38 +0.32 Gross State Product +1.10 –0.67 –0.75 –0.80 +0.44 +0.35 +0.30 Personal Income +0.78 –0.52 –0.58 –0.62 +0.27 +0.20 +0.16 Impact of $8 Billion Total Employment +1.67 –1.04 –1.17 –1.25 +0.64 +0.51 +0.43 Gross State Product +1.47 –0.89 –1.00 –1.07 +0.58 +0.47 +0.40 Personal Income +1.05 –0.69 –0.78 –0.83 +0.36 +0.27 +0.21 Source: Institute on Taxation and Economic Policy, Achieving Adequacy, April 2005, p. 53
Reform the STAR Property Tax Relief Plan. In 1997, Governor Pataki got the message that by cutting the top rate on the state’s progressive personal income tax, he was cutting the wrong tax, in the wrong way, at the wrong time. In his 1998 State of the State Address, he put a positive spin on this recognition of the fact that the income tax is a fair tax and that the overwhelming majority of New Yorkers do not feel oppressed by it. “Last year we knew it was time to build on the tax cuts of the first two years. From this podium, I told you that it was time to cut taxes again. Different taxes. Oppressive taxes. Property taxes.” It is, however, unfortunate that this focus on oppressive taxes did not take center stage until after the state had cut the income tax by over $4.5 billion a year (now $7 billion a year) with only half of this amount, at most, staying in the New York economy.
While the Governor’s STAR plan was aimed at an important problem, it works in an inefficient and ham-handed manner. By allocating property tax relief in a way that is unrelated to the amount of a household’s property tax bill relative to its income, it delivers much less relief to those who are truly overburdened by property taxes than would a substantial expansion of the state’s circuit breaker tax credit – at one-half the current $3.2 billion annual price tag of the STAR program – and much more to homeowners for whom property taxes represent a very small percentage of their income. Under STAR, the amount of tax relief to which a homeowner is entitled can vary with the median home value in his or her county of residence, but not with the magnitude of that homeowner’s property tax burden relative to his or her income. The plan’s one income test (whether a senior homeowner’s income is above or below $60,000 a year, with that amount now adjusted annually to reflect changes in the cost of living) creates an illogical notch effect, while begging the question of a rational sliding scale based on income. While the Governor argued for STAR on the basis that some people were literally being taxed out of their homes, STAR does not target its relief to such households. In addition, two taxpayers with the same income and the same size property tax bill could get widely varying levels of relief depending on where they happen to live.
The STAR plan is also flawed in that it provides relief only to homeowners. This ignores the fact that tenants also pay property taxes. While homeowners pay property taxes directly, tenants, through their rental payments, carry a substantial portion (usually estimated as being more than one-half) of the property taxes paid by the owners of their buildings. But under STAR, neither tenants nor landlords receive any relief. Only the owners of owner-occupied dwellings are helped by STAR. The result is extreme racial disparities. Over 62% of white households live in owner-occupied dwellings, while the comparable figure for black households is 29%. Replacing STAR with an expanded circuit breaker credit would also eliminate such unequal treatment since it provides relief to renters as well as homeowners.
2000 Census: Occupied Housing Units by Tenure by School District Total Owner Occupied Renter Occupied Percent Owner Occupied New York City 3,021,590 912,135 2,109,455 30% Buffalo 122,720 53,340 69,380 43% Rochester 88,995 35,770 53,225 40% Yonkers 74,350 32,115 42,235 43% Syracuse 59,525 24,020 35,505 40% Albany 40,720 15,320 25,395 38% Schenectady 26,515 11,885 14,630 45% New Rochelle 26,190 13,175 13,015 50% Mount Vernon 25,730 9,400 16,325 37% Utica 25,095 12,270 12,825 49% Niagara Falls 24,100 13,900 10,200 58% Ithaca 23,150 9,935 13,215 43% Newburgh 22,180 12,675 9,510 57% Binghamton 21,390 9,335 12,060 44% Kingston 21,050 13,240 7,805 63% Subtotal – NYS’s 15 Largest City School Districts 3,623,300 1,178,515 2,444,780 33% Rest of State 3,433,560 2,560,732 872,833 75% New York State Total 7,056,860 3,739,247 3,317,613 53%
To ensure fairness, property tax relief should not discriminate on the basis of geography or on the basis of whether someone is a renter or a homeowner. STAR fails on both of these counts. Enriching the state’s real property tax circuit breaker credit would provide a more targeted, cost-effective means of providing property tax relief to those who are truly overburdened by the current system.
Instead of trying to trying to put much of future years’ budgets on auto-pilot through the enactment of tax cuts that will take effect gradually over the course of the next five years, and instead of trying to make it more difficult for the state to meet important human needs and important state investment priorities, and instead of engaging in a misinformation campaign intended to convince the taxpayers of this state that the wealthiest one percent of taxpayers carry an inordinate share of the tax burden, the Governor should be trying to leave the state on a sound financial footing. New York State is currently in a position to do just that, but it can not do so if it makes multi-billion dollar, multi-year tax cut promises that (1) require large service cuts and the use of all of the state’s most flexible rainy day funds and (2) leave that state with projected budget gaps of $2 billion for 2007-08 and $4 billion for 2008-08. A much better choice for the future would involve the establishment of a fair, adequate and economically sensible tax system.