The Covid pandemic imposed enormous economic and policy uncertainty on New York State. This uncertainty has continued into the current fiscal year. The economic recovery from the Covid shock far exceeded initial expectations. As a result, financial plans preceding fiscal years 2022 and 2023 significantly underestimated those years’ actual revenue. The same projections underestimated spending to a lesser extent, leading to large fiscal surpluses amassed in the last two years (see figure 5).
Recent higher-than-expected revenue was driven by uncertainty around the state’s economy and around a recent change in the state’s tax law: the pass-through entity tax (PTET). The PTET, which was enacted in fiscal year 2021, allows recipients of pass-through entity income — which includes income from partnerships, LLCs, and S-corporations — to sidestep a cap on state and local tax deductions from federal tax liabilities imposed by the 2017 Tax Cuts and Jobs Act. Taxpayers with pass-through income can opt to pay the PTET and receive an equal credit against their personal income taxes (under federal rules, state and local taxes can be deducted from business taxes, but not personal income taxes).
While PTET is revenue-neutral for New York State across the life of the program, it is not neutral in any given year: taxpayers rushed to opt in the business tax in 2022 and carried their personal income tax credits into following years. This timing misalignment has imposed volatility on the state’s finances. PTET’s fiscal impact is unbudgeted until fiscal year 2022, in which it was sharply positive, raising tax receipts by $16 billion. PTET also had a positive revenue impact the following year, fiscal year 2023, with PTET-related taxes and credits coming in $8 billion higher than initially forecast. DOB now expects PTET to be more negative than initially forecast in fiscal years 2024 through 2027. Predicting the timing of PTET’s fiscal impact, however, has proven difficult and the tax is likely to be a continued source of fiscal volatility.
Economic uncertainty also drove substantial forecast error in recent years. In the year prior to Covid, DOB economic projections generally predicted the state’s economic trajectory well. In fiscal years 2021 and 2022, however, DOB significantly underestimated wage and personal income growth (see figure 6). While these are the most recent fiscal years for which data is fully available, the most recent economic indicators continue to show resilience.