The governors tax hike will harm New Yorks competitiveness.
Why did New York governor Andrew Cuomo, the first-term Democrat who had pledged no new taxes—period, suddenly reverse himself and engineer a December special session of the state legislature to impose higher taxes on New Yorks top earners? Occupy Wall Street and other tax-the-rich advocates probably had less to do with Cuomos turnabout than the state governments growing gap between spending and revenues. Last spring, the governor closed a $10 billion budget gap for fiscal 201112 without a tax increase but left an imbalance, initially estimated at $2.4 billion, for 201213. Following the summers stock-market decline and eurozone chaos, Cuomos November budget update estimated that the gap had grown by $1 billion. Moreover, after slashing school aid and freezing Medicaid spending in his first budget, Cuomo had promised to boost spending for both by 4 percent the following year. This effectively locked in 40 percent of the 201213 budget, narrowing options for balancing it.
After rejecting tax hikes so strongly for most of his first year in office, Cuomo didnt want to be perceived as reversing himself for the sake of a sheer revenue grab. So on the eve of the special session, he declared the states income-tax system to be unfair, implying that it extracted the same percentage of income from the middle class as from the wealthy. In fact, while New Yorks previous top rate of 6.85 percent applied to taxable incomes as low as $40,000 for married couples, an array of credits and a large standard deduction ensured that middle-class households actually paid a much smaller percentage than those higher on the income scale. Thanks to this progressive structure, the share of income taxes paid by New Yorks highest-earning 1 percent rose from 25 percent in 1994—Governor Mario Cuomos last year in office—to a peak of 43 percent in 2007.
This made New Yorks revenue base inherently unstable, the state assemblys Ways and Means Committee staff pointed out. Sure enough, when incomes at the top plummeted in the wake of the 2008 financial crisis and recession, so did the states tax receipts. To help fill the gap, Governor David Paterson agreed in 2009 to a temporary, three-year tax increase, creating two new income-tax brackets: 7.85 percent on incomes as low as $200,000 for individuals and $300,000 for married couples; and 8.97 percent on households with taxable incomes of $500,000 or more. The temporary increase, set to expire at the end of 2011, became widely known as the millionaire tax, though 80 percent of the households paying it earned less than $1 million.
Cuomo resisted demands that he extend the entire temporary tax. Instead, he persuaded the legislature to join him in artfully reshuffling the tax deck. The resulting deal establishes a new top rate of 8.82 percent on taxable incomes of $1 million for individuals and $2 million for married couples—effectively, a 29 percent hike over the pre-Paterson top rate. The old rate of 6.85 percent was restored for married couples earning more than $300,000 but less than $2 million annually. Taxpayers lower on the income scale received a small cut in their rates—down to 6.45 percent for couples earning up to $150,000 and 6.65 percent for couples earning between $150,000 and $300,000.
The new top rate is now set to expire at the end of 2014—the next gubernatorial election year, as it happens. Until then, and perhaps indefinitely, New York will continue to impose one of the nations heaviest income-tax burdens on top earners. Only two of the Empire States economic peers tax at higher statewide rates: California (9.3 percent) and New Jersey (8.97 percent). For New York City residents, the combined state-local top rate will be 12.7 percent, the highest in the country.
What Senate Republicans trumpeted as a tax cut and job creation plan actually amounts to a $2.6 billion tax increase for targeted high earners, compared with what they would have paid under the permanent, pre-2009 law. Out of that amount, $690 million paid for the tax cuts in lower brackets; $250 million was earmarked to the Metropolitan Transportation Authority to offset sharp reductions in its regional payroll tax on small firms and private schools; and $150 million went to upstate flood relief and an array of small-business tax credits whose likely impact was overstated by all concerned. This leaves Cuomo with a net $1.5 billion to help fill his next budget hole.
Cuomos move deals another blow to New Yorks economic competitiveness without addressing the causes of higher spending at the state and local level. The state tax code is now even more steeply progressive, meaning that revenues will be more volatile than ever, and less sustainable. Advocates of a millionaire tax will keep pressing for higher rates. The governor has bought himself a little breathing room with his end-of-year tax bargain but has created some bigger problems for the future.