Opinion

NY’s stealth tax hike

Another Tax Day brings with it yet another unher alded and unlegislated inco me-tax increase for middle-income New Yorkers.

This may surprise anyone who’s paid cursory attention to the state’s tax policy. After all, Gov. George Pataki’s 1995 income-tax cut aimed its largest savings at middle-income families, who’ve also benefited from two later increases in the standard deduction and from the creation in 2006 of a child credit. While New York’s “millionaire tax” affects taxpayers with incomes above $200,000, the state’s tax rates on households earning less than $150,000 haven’t changed in more than a decade.

So, if anything, the income tax for a typical New York family should be lower than in the late 1990s, right?

Nope. Adjusting for changes in the cost of living, the 2010 state income-tax bite on middle-income New Yorkers is higher than it was 1997, when the Pataki tax cuts became fully effective.

That’s because New York — unlike the federal government — doesn’t “index” its tax code to adjust automatically to the rate of inflation. (Neither, by the way, do Connecticut, New Jersey and Pennsylvania.)

The difference this makes from one year to the next can be very small — a matter of perhaps $12 or so for a middle-income earner last year, for example. But over time, even in an era of low inflation, it adds up.

In 1997, for example, a family at the statewide median-income level earned $50,000 and sent 3.3 percent of its gross income to Albany. By 2010, median income had risen to $70,000 — essentially keeping pace with inflation — but under New York’s nonindexed tax code, the effective tax rate came to 3.8 percent. The difference translates into a hike of about $326 a year.

The difference for taxpayers is larger in higher-income downstate suburbs, where the cost of living is higher. In Long Island, where the median family income has risen to $103,000, state income taxes for 2010 are about $413 higher than they’d have been if the 1997 tax code had been linked to inflation.

New York’s largest stealth tax increases fall on those in the upper bands of the downstate middle class. For a family of four with income of $130,000 in 2010 dollars, the failure to link the 1997 tax code to inflation translates into an added tax bill of roughly $1,000.

Multiplied across the entire tax base, it all equates to hundreds of millions of dollars of unlegislated tax hikes for Albany.

The poorest one-fifth of tax filers aren’t affected by this syndrome. They pay no income tax to begin with, and the Earned Income Tax Credit they receive from the state is based on the federal EITC, which is adjusted to track inflation.

Nor does it slap the wealthiest taxpayers. That’s because they’ve already been gouged by a separate, uniquely pernicious feature of New York’s income tax code.

Under a standard graduated income tax, such as the federal one, a household in the highest bracket pays the top rate on just the portion of its income in that bracket, and then lower rates on the portions of income that fall into the lower brackets. But in New York, under a change first enacted in 1991, every household with an adjusted gross income above $150,000 has been paying the top rate of 6.85 percent on its entire income. No brackets means no bracket creep.

(On the other hand, if this so-called “benefit recapture” provision had been indexed to inflation 20 years ago, it wouldn’t fully kick in until income reached $244,000.)

If Gov. Cuomo and the Legislature continue to ignore this problem, they could be exposing New Yorkers to much larger tax hikes in the near future. Some economists predict the massive debt buildup and the Federal Reserve’s easy money policies will soon lead to a surge in inflation. If that happens — and when it comes to fuel prices, it’s already happening — many more New Yorkers will experience inflationary bracket creep, generating a windfall for Albany, but misery in family budgets.

The short-term fix is obvious: Index New York’s tax brackets, standard deductions and personal exemptions so they automatically rise with the Consumer Price Index every year. This could be done now, retroactive to the start of 2011, and the impact on state revenue will still be barely discernible in the year ahead.

In the long run, New York’s entire state personal income tax is overdue for an overhaul. The goal should be twofold — lower the tax rates and broaden the taxable income base through elimination of loopholes. And stop the stealth tax hikes, once and for all.

E.J. McMahon, a senior fellow at the Manhattan Institute’s Empire Center for New York State Policy, was an architect of the Pataki tax cuts.