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NY's Road to Ruin


NY's Road to Ruin

March 16, 2005
Urban PolicyNYC

ONCE the Legislature adopted a "temporary" personal-income-tax increase in 2003, it was only a matter of time before someone in Albany moved to make the tax hike permanent.

Sure enough, the heavy-spending budget resolution approved by the state Assembly this week includes an open-ended extension of the state's 7.7 percent flat rate on taxpayers with incomes over $500,000. The proposal will now be on the table in budget negotiations between Assembly Democrats and Senate Republicans — who have their own big spending appetites, and who supported the temporary rate hike just two years ago.

If enacted, this would be New York's first permanent increase in the income-tax rate in more than 30 years. And it would send a troubling signal to investors and business decision-makers that the era of pro-growth tax reduction is over in the Empire State.

As the late Walter Wriston observed, "Capital goes where it's wanted and stays where it's well treated." In the 21st century economy, investment capital is more mobile than ever.

And high-income households are the most mobile of all taxpayers. Raise their taxes, and some top earners will inevitably choose to leave New York. Others will charge more for their services or look for ways to earn, spend and invest less in the state.

So, even if your taxes don't go up, the economy suffers and you do, too. Some will lose business; others will lose their jobs.

In this way, "soak the rich" ends up soaking everyone.

Not so long ago, the relationship between taxes and economic growth was better understood by Democrats as well as Republicans in Albany. In fact, over the past quarter-century, the greatest reductions in state income-tax rates have been signed into law by Democratic governors.

Hugh Carey cut the top rate from 15 percent to 10 percent during his last term in office. And Mario Cuomo saw the top rate decline further, to 7.875 percent. (Cuomo reneged on further, scheduled cuts.)

Pataki's 1995 tax-cut package brought the top rate down to 6.85 percent — lowest since the '50s. But even at that level, the vast majority of middle- and upper-income New Yorkers were subject to the heaviest state income-tax burden in the region.

And for New York City residents, the combined state and local income tax rate now tops out at over 12 percent — highest in the country.

Because many small, closely held firms and partnerships are subject to the state personal income tax rather than the corporate tax, what the Assembly is proposing is not just a higher permanent rate on individuals but a tax hike for employers.

The deductibility of state and local taxes on federal returns is often cited as an argument in favor of raising New York's income tax. But deductibility isn't what it used to be.

Thirty years ago, when the Empire State's top rate was 15 percent, the top federal rate was 70 percent. This meant the effective state-tax bite on the highest-earning households was only 4.5 percent. Today, with the federal top rate set at 35 percent, the post-deductibility cost of a 7.7 percent state rate is 5 percent.

Plus, many high-income New Yorkers are subject either to the Alternative Minimum Tax, which doesn't permit deductions, or to a cap on itemized deductions. Either way, the deduction is worth the least to those who send the most to Albany. (And deductibility itself may not survive the next round of tax reform in Washington.)

And it's not as if some of New York's wealthiest taxpayers lack any other reasons to leave. The phase-out of the federal estate tax is having the effect of making New York's state "death tax" exceptionally high. Lawyers and financial planners are already advising their New York clients to move to states such as Florida and South Carolina, which have no estate tax at all.

Even putting aside the economic considerations, the Empire State is dangerously over-reliant on its personal income from high-income households. In 2001, for example, state residents with incomes above $500,000 represented barely 1 percent of taxpayers but paid more than 30 percent of the taxes.

The downside of depending so heavily on such a small number of taxpayers should be obvious: It means that when the wealthiest New Yorkers have a bad year, the entire state suffers inordinate fiscal stress. This is precisely what happened between tax years 2000 and 2002 — when all of the decline in state income-tax revenues was concentrated in high-income households.

Financing popular programs with higher taxes on the wealthiest New Yorkers may be smart politics. But shifting even more of New York's steadily rising public sector burden to roughly 65,000 footloose tax filers with volatile incomes would make for truly dumb policy.