Gov. Paterson has withdrawn his support from a proposal to raise $50 million in taxes from partners in New York-based hedge funds who live in other states. His revised position on the tax became official Tuesday, when he excluded it from a new revenue-raising bill he sent up to the Legislature — which promptly refused to accept it.
Paterson began expressing second thoughts about the hedge-fund tax after Mayor Bloomberg pointed out it could be “the best thing that ever happened to Connecticut” — where Gov. Jodi Rell responded by rolling out the welcome mat for New York fund managers.
Too bad Paterson didn’t figure out that clipping the hedgies was a bad idea before he signed off on its inclusion in an $828 million revenue package that the state Assembly passed on July 1. Or, better yet, before he first floated the idea as part of a prior budget proposal, almost 18 months ago.
The hedge-fund tax is far from dead even now. The state Senate’s Democratic majority hasn’t expressed opposition in principle to any of the tax and fee hikes passed by the Assembly. (Senate leaders are holding Paterson’s revenue bill hostage over other issues.)
In short, New York’s future tax treatment of the participants in a multibillion-dollar industry remains up in the air. And even if the hedge-fund tax is ultimately killed, the proposal has created bad karma that will linger in a slow-growing economy.
The governor and Legislature keep inventing new ways to alienate the lucrative core of their tax base — the highly mobile, highest-earning 1 percent of taxpayers who generate more than 40 percent of the state’s income-tax revenues.
Last year, the state temporarily raised its top income-tax rate from 6.9 percent to just under 9 percent. Through 2011, at least, that rate is at its highest level since 1986, when it applied to a narrower base of taxable income.
Taxpayers with incomes between $200,000 and $500,000 are paying 15 percent more in New York state taxes than they did two years ago; for those above $500,000, the bite is 31 percent bigger.
The proposed hedge-fund tax is targeted at the “carried interest” profits that fund partners earn on successful investments. While there’s an unrelated drive in Congress to hike the federal tax here, the issue in New York comes down to an effort to pilfer taxes from Connecticut and New Jersey before the federal issue is resolved.
New York taxes residents of other states on the salaries, wages and bonuses they earn here. They get a dollar-for-dollar credit from their state of residence for every dollar they pay to New York. But income from dividends and investments is taxed only by a taxpayer’s state of residence. The hedge-fund-tax proposal aims to redefine carried interest as “ordinary” income that the Empire State would tax.
If New Jersey and Connecticut follow suit, they will be yielding tens of millions of dollars of revenue to Albany. If they don’t, investors could face double taxation.
If and when this happens, it will be retroactive to Jan. 1.
The revenue bill also includes another swipe at high-income taxpayers: a further reduction, from one-half to one-quarter, in the share of federally deductible charitable contributions that can be claimed on state returns by those earning over $1 million a year. This amounts to a $100 million tax on New York’s wealthiest and most generous philanthropists
Meanwhile, in the absence of a revenue bill, the $134 billion in spending bills finalized by the Legislature two weeks ago aren’t fully paid for. Further spending reductions are called for but unlikely; the Legislature and Paterson had enough trouble “cutting” the budget down to a small increase over last year.
So, if New York leaders agree to avoid the hedge-fund tax or remove other items from their revenue-raisers, the alternative will most likely be to pluck another goose.
Eventually, though, someone in Albany will have to notice that geese have wings.
E.J. McMahon directs the Man hattan Institute’s Empire Center for New York State Policy. ejm@empirecenter.org