WELL, what do you know? After raising taxes on high-income households by up to 31 percent, New York state is collecting far less income tax than it had anticipated just a few months ago. That drop in tax receipts is a major reason why a $2.1 billion hole has just opened in the state’s 2009-10 budget.
Gov. Paterson promises that by “early fall” — that is, after six more weeks of budgetary inaction by the Legislature — he will propose a deficit-closure plan including “substantial reductions in local assistance and State Operations spending, as well as other measures to achieve a balanced budget in the current year.”
Don’t be surprised if the state’s labor-dominated “fair share” groups respond to any threat of spending cuts by pushing for yet another soak-the-rich tax increase.
Here’s one argument they’ll use: New York’s temporary new top rate of just under 9 percent was calibrated to equal the maximum marginal rate adopted a few years ago by New Jersey. But the Garden State has since leapfrogged us, raising its top rate to 10.75 percent on households with incomes of more than $1 million.
So New York now has more room to raise its own taxes again. Get it?
Of course, this kind of logic requires turning a blind eye to lower income tax rates in neighboring Connecticut (5 percent), Massachusetts (5.3 percent) and Pennsylvania (3.07 percent) — not to mention Florida, New Hampshire and Texas (which have no income tax at all).
It also requires overlooking the impact of higher state income taxes in New York City, where the current combined state and local income tax rate of 12.62 percent is already the highest in the nation.
Meanwhile, back in the real world, Albany is now reaping the predictable consequences of Paterson’s cave-in to the Legislature’s demand for higher income taxes.
Since the mid ’90s, New York has become increasingly reliant on taxes generated by a small number of high-income households. By 2007, the top 1 percent of earners was generating 41 percent of the state’s income-tax receipts.
This tax structure was “inherently unstable,” “volatile” and “unsustainable,” as the state Assembly Majority Ways and Means Committee staff acknowledged in a report last February.
Yet, with a big push from Assembly Speaker Sheldon Silver, this year’s income-tax hike made the state’s revenue stream even more unstable, volatile and unsustainable — without even taking into account the dampening impact that higher taxes will have on New York’s economic-recovery prospects.
Under the circumstances, Paterson’s Division of the Budget can hardly be blamed for missing its revenue target. The risk is that it’s still guessing too high.
Despite the big rate increase, the state’s first-quarter income-tax receipts were down 31 percent from the same period the year before. In part, the drop reflects the lag effects of financial losses sustained by taxpayers last year. DOB’s updated financial plan forecasts that most of this shortfall will be made up over the next eight months.
Problem is, wealthy households now have a growing incentive to shelter, defer and move around income in anticipation of federal tax hikes that could raise the combined statewide marginal tax rate in New York to nearly 50 percent.
Because the city and the state tap the same pool of income as the federal government, any policy change affecting taxpayer behavior at one level ultimately affects revenues at all three levels. Thus, President Obama’s plan to significantly raise income tax rates no later than 2011 inevitably will shrink New York’s taxable income base.
And if Congress imposes a “millionaire tax” to pay for national health care, the local base will shrink even more.
In the shorter term, we’re likely to experience a whipsaw effect: Aware of what’s coming in 2011, high earners will do everything they can to accelerate capital gains and other income from 2011 into 2010, which in turn will pump up New York’s state and city income-tax collections next year. That temporary bump will be followed by another sickening drop the following year — when billions in federal stimulus aid is also set to expire, blowing open the biggest budget gaps in New York’s history.
Of course, all this focus on tax receipts obscures the main problem: spending. While revenues are dipping, New York’s state-funds budget is on track to grow 24 percent over the next three years.
Even assuming there is no further deterioration in revenues, DOB says it will need to tap the state’s remaining reserves to avoid running out of cash at the end of this year. If Paterson and the Legislature don’t plan on getting serious about this problem sooner rather than later, they might as well start printing IOUs right now.
E.J. McMahon is director of the Manhattan Institute’s Empire Center for New York State Policy. He blogs on budget issues at nyfiscalwatch.com.