February 28th, 2007 11 Minute Read Public Filings

Testimony of Edmund J. McMahon Before the Joint Fiscal Committees of the New York State Legislature

I'd like to begin with two pointed observations about the 2007-08 Executive Budget and its impact on taxpayers and the economy:

The budget will raise state taxes, in several significant respects.

The budget will not provide lasting, broad-based relief from New York's sky-high local property taxes.

In each case, I will lay out some pro-growth policy alternatives that can affordably be implemented in the next budget.

BUSINESS TAXES

It is debatable whether all of Governor Spitzer's proposed changes in corporate, bank and insurance taxes can actually be considered "loophole closers." A loophole is a provision of tax law that is being exploited to produce a result the law never intended. It simply is not accurate to apply this description to some of the governor's proposals.

Semantics aside, there is no question that if you enact this budget as proposed, you will be imposing a significant tax increase on some of New York's largest and most valued employers.

To be sure, most firms will see little or no change in their state tax bills under this budget, and some may even pay less. But the net result, according to the Budget Division's conservative estimate, will be the equivalent of a 5 percent increase in Article 9a revenues alone. This would mark the first significant business tax increase at the state level since the early 1990s.

Fully implemented, the total revenue impact of all the tax increases in this budget will exceed $600 million, including the proposed $75 million increase in the "covered lives assessment." This is a hidden tax that already adds hundreds of dollars a year to health insurance premiums in the most expensive regions of our state. Surely the last proposal the Legislature ought to be considering is one that that will push health insurance costs in New York even higher.

Among the major business tax changes proposed in the budget, I would like to focus on a provision that will effectively force New York firms to file "combined reports" of income from out-of-state subsidiaries and related companies with which they have substantial inter-corporate transactions.

The Executive Budget characterizes this as one that will simply conform New York to the practice in 17 other states. Of course, this also means that New York will move further out of conformance with the general practice in the majority of states, including almost all of our neighboring states and our strongest competitors for corporate investment east of the Mississippi.

All businesses seek to minimize their taxes to the greatest possible extent allowable by law. The challenge for policymakers is craft a tax code that is fair, simple and economically competitive, while producing minimal incentives for economic distortion. The Legislature met this challenge effectively in 2003, when it amended the corporate tax law in a way that has effectively outlawed the use Delaware holding companies to shelter income through royalty payments for intellectual property-closing the so-called "Geoffrey the Giraffe" loophole.

There can be little doubt that some corporations are continuing to use aggressive tax planning to attempt to shift profits from New York to subsidiaries other states. But they do this at their own risk—because present New York law makes it clear that such transactions must be arms-length and that the pricing of goods and services must be fair. A parent company that attempts to artificially deflate its New York income by overpaying an out-of-state subsidiary for goods or services is begging for a bigger state tax bill after its next audit.

The governor's proposal to treat all inter-corporate transactions as potential tax avoidance schemes will penalize large, multi-state New York firms that have perfectly sound business reasons for integrating their productive activities among separately incorporated subsidiaries and related companies. Court rulings and tax tribunal decisions already provide such corporations with a roadmap for fairly pricing and allocating inter-corporate transactions within the meaning and intent of current law.

Forced combined reporting will move New York a giant step closer to the purely "unitary" approach-which, in the absence of broader restructuring and rate cuts, will inevitably be perceived by corporate America as a significant increase in our corporate taxes. It will raise taxes for both perceived corporate cheaters and for those firms that have been doing business in a perfectly legal manner. It will add to compliance costs for affected firms without necessarily simplifying enforcement for the state-since disputes will now shift from evaluating transactions to determining whether related companies are truly engaged in a unitary business. This "loophole closer" would reverse a consciously adopted policy aimed at encouraging headquarters companies to locate in New York.

Despite the negative impacts on some firms, it could be argued that a unitary tax would come closer to achieving the highly desirable policy goals of tax neutrality and equity. The governor might credibly have advanced such an argument if he had proposed the same tax changes in a revenue-neutral context-for example, by linking his combined reporting requirement to a reduction in business tax rates. Better yet, he might have proposed these changes in the context of a broader reduction in the state's overall corporate tax burden.

Unfortunately, he did neither of these things-because the prime motivation behind the business tax proposals in this Executive Budget is not to reform the tax code but to raise revenue.

This approach sends the wrong signal to firms that might otherwise consider investing or expanding in our state. After all, New York's overall business tax burden already is among the heaviest of any state's. Our business tax climate is ranked 47th out of 50, according to the Tax Foundation [1]. And according to the latest Ernst & Young study for the Committee on State Taxation, New York's overall business tax share of private-sector productivity is 15 percent above the national average, and above those of peer states [2].

The Legislature deserves credit for taking some important steps to improve the situation over the past 15 years. For example, New York's maximum corporation franchise tax rate on net income has fallen from 10.35 percent in the early 1990s to 7.5 percent today. However, it should also be noted that much of our corporate tax base is concentrated in the metropolitan transportation region, where the mass transit surcharge raises the marginal state rate to 8.75 percent. Only seven states now impose higher rates on corporate net income.

And the burden is heaviest of all in New York City, which is the only municipal government in the nation to impose its own business income tax. The city's top rate of 8.85 percent is higher than the New York State rate. Thus, the combined rate is a whopping 17.6 percent - easily the highest in the nation, fully double the tax imposed in the vast majority of states. Attached to my testimony is a chart showing how the New York State and City rates stack up to those in the rest of the nation.

New York City can get away with imposing a sky-high marginal rate in large part because of state and city tax law provisions that are designed to narrow the definition of allocable corporate income-including the combined reporting rule this budget would change.

Because the governor's proposal would extend the forced combined reporting requirement to the city as well as the state, it effectively doubles the impact in the city, as Mayor Bloomberg pointed out in his testimony before you earlier this month. The closer you nudge the effective corporate tax burden closer to that 17.6 percent statutory level, the more reason you will give to some major employers to reconsider their continued presence in the city, if not the state.

In the short term, the best course available to the Legislature is the following:

Declare a moratorium on further tax increases of any kind, including the misleadingly labeled "covered lives assessment." Ideally, the next budget should include tax cuts-including some of the broad-based business tax cuts passed by the Senate two weeks ago, including further reduction of the corporate franchise tax rate and complete elimination of taxes on manufacturers. But such reductions should be financed with recurring savings on the expenditure side of the budget, not surplus revenues from volatile sources.

Join with the governor to appoint a blue-ribbon commission to recommend a comprehensive overhaul of New York's Corporation Franchise, Bank and Insurance Tax laws, whose core elements now date back to the mid-20th century. The goal should be to give New York a business tax code better suited to the global economy of the 21st century-a tax code that establishes sustainable economic growth and competitiveness as paramount goals.

Instead of worrying about the extent to which New York corporations are shifting profits to tax havens elsewhere in the country, we should be trying to figure out how we can turn New York itself into a tax haven. We should stop wondering how to force corporations to pay more taxes for the privilege of doing business in New York State. We should be looking for ways that will encourage more corporations to invest more money and to create more jobs in New York.

PROPERTY TAXES

One of the biggest new initiatives in Governor Spitzer's proposed budget is a major expansion of School Tax Relief (STAR) property tax exemptions for homeowners, ultimately adding $2.5 billion a year to what is now a $3.4 billion program.

To summarize the flaws and shortcomings of this proposal:

More than half the homeowners in at least 12 of our largest suburban counties earn to much to qualify for full "middle-class" tax relief [3].

The Middle Class STAR plan includes a built-in marriage penalty.

Increasing the existing STAR subsidy will give school districts a further incentive to accelerate their spending and tax levies. That's what happened during the implementation of the STAR's first stage, between 1998 and 2001.

The results: Housing costs will rise for young couples and low-income households, who tend to rent rather than own; and economic development will be further deterred by growing burden on commercial and industrial property.

Recent Census data confirm that our property taxes on owner-occupied homes are wildly out of line with national norms. In absolute terms, homeowners in New York City suburbs pay the highest property taxes in the country, rivaled only by their counterparts in New Jersey. When property taxes are measured relative to home value, nine of the 10 most heavily taxed counties in the country are in upstate New York.

But other data comparative indicate that New York's local property taxes on commercial properties, and on apartment buildings, are as far out of line as taxes on owner-occupied homes [4]. In some cases, the disparity between New York and other states is even worse in these categories. STAR provides no relief from these high taxes-and a STAR-like program to assist businesses or apartment dwellers would be at least as inequitable and administratively cumbersome as the homeowner model.

The ultimate problem is that STAR treats a symptom and not the disease. The "relief" is offers is temporar—a large dose of fiscal Novocain. And the pain is all the greater now that the original dose is wearing off. In fact, as if often the case, by masking the pain, it made things worse.

There is a better way. Before embarking on any increase in STAR, whether it is the Governor's plan or the Senate's, the Legislature should link this tax subsidy to a cap on property tax levies. The limit suggested a decade ago by Governor Pataki's original STAR bill-the greater of 4 percent, or inflation-is an appropriate starting point. Voters would be allowed to suspend the limit for one year at a time. The cap would be adjusted to reflect increases school enrollments, and to reflect the value of new construction and improvements.

Such a cap has been considered by this Legislature before. In 1995, for example, Assembly Speaker Silver proposed-and the Assembly passed—the "Real Property Tax Limitation Act," described as limiting all local revenues to the rate of inflation. The bill allowed for exceptions to the cap only in "extraordinary" circumstances, requiring a well-advertised public hearing and vote of the local governing body. A maintenance-of-effort obligation was imposed on the state itself, when it came to local assistance as part of the bargain.

In New Jersey, Governor Corzine has promised to sign a property tax relief measure that will reduce tax bills while capping property tax levies at 4 percent, with some exceptions.

The basic concept is already proven success for another of our neighbors. In the 1960s and 70s, Massachusetts was one of New York's perennial rivals for the title of most heavily taxed state. In 1980, voters there approved Proposition 2 1/2, limiting increases in their taxes in a manner similar to the approach I have outlined for New York. Within a decade, the combined tax burden in Massachusetts had subsided to the middle rankings among states. No one calls it "Taxachusetts" anymore.

CONCLUSION

In closing, the answer to the twin challenges of high taxes and sluggish economic growth in New York is not to create still more "targeted" forms of tax relief, grants and loans-but to firmly and finally limit growth in taxes, and to take those steps that are necessary to create a more hospitable climate for all forms of free enterprise. As Governor Spitzer himself observed in a speech to The Business Council last September:

"Too many companies today would say that they would not locate in New York because we are just not competitive. Our state has the highest combined state and local tax burden in the nation ... [W]e simply cannot raise taxes and keep New York competitive."

Thank you.

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