A Roadmap to a Better New York Budget

This month, New York's legislature will reconvene in Albany to once again face down a major budget gap. (Give it a couple more years, and New York will get to share in California's "permanent budget crisis" moniker.) Despite enactment of a major, "temporary" income tax increase last year, the state nonetheless expects a budget gap somewhere between $6 billion and $9 billion for the fiscal year beginning April 30.

A report out today from the Empire Center for New York State Policy provides a blueprint for beginning to close this gap (and even larger ones that loom in the following two years). The report, which I co-authored with the center's director, E.J. McMahon, also identifies steps to fix the state's budget process and reform the state's tax code for the long term.

New York's budget crisis is principally a problem of overspending. Because of an outsized budget, New York state and local taxes per capita are 160 percent of the national average. Of course, New York is a high-income state and could therefore be expected to have a relatively large government; but even calculated as a share of income, New York's state and local tax take is 133 percent of normal.

And the problem has been getting worse. Over the last decade, New York state spending grew by $35 billion to $85 billion in the current fiscal year. If spending growth had tracked inflation over this period, the rise would have been $21 billion less, or $17 billion less if it tracked personal income growth.

To get its budget gap under control, New York will have to make tough choices to contain spending growth. But even as the recession has battered New York tax revenues, lawmakers in Albany have so far been unwilling to exercise restraint. After adjusting to reflect ongoing programs funded by federal stimulus money, the 2009-10 budget contained an 8% increase in State Funds spending, a move The New York Times said "could hardly be called austere."

In recommending reforms of state spending, we were guided by three simple questions: Do we need this? Can we afford this? Is there a better way to do this? The answers led us to suggestions that could save the state $30 billion over the next three years.

Some of the moves we recommend will be painless -- New York's budget contains wasteful programs and unjustifiable spending that can simply be eliminated. Closing unneeded prisons, selling public golf courses and ski resorts, and eliminating frivolous tax credits (like one for rehab of historic barns) would help fix the budget gap without inflicting pain on the public.

But producing $30 billion in savings over three years will involve cutting programs that are not abjectly useless. And it will certainly require touching the two largest components of the state budget -- school aid and Medicaid. Fortunately, New York spends far above the national average in these areas already, meaning that plenty of savings opportunities are available before we cut "to the bone."

New York spends at 165 percent of the national per-pupil average on K-12 education, and is not getting good bang for its buck. By eliminating costly state mandates, raising the cap on charter schools, imposing a three year wage-freeze from the state level, and repealing laws that give excessive bargaining power to teachers' unions, New York can restrain the education spending beast without worsening outcomes.

Medicaid spending is even farther above normal, with payments per enrollee at 173 percent of the national average. Several avenues for Medicaid savings are available, including an introduction of managed care for Medicaid participants (a success in Florida) and a reduction in apparently excessive reimbursement rates to hospitals and nursing homes.

Many of our proposals couple spending reductions with the elimination of costly mandates and regulations. In many cases, these rules are unusual or unique to New York -- for example, a prohibition on design-build bid processes for public works projects. In areas from education to transportation to public safety, laws designed to enrich unionized employees drive costs skyward. Repealing these laws will minimize the impact of spending cuts on program beneficiaries.

This kind of spending austerity will not be popular in Albany. The alternative is further increases in taxation, an approach already favored by some liberals in the state legislature. However, New York already saw what happened when it walked down the road of unrestrained spending and spiraling tax rates -- the near fiscal collapse of the 1970s.

In 1976, New York City's state-local income tax rate peaked at over 19 percent. The current nominal rate, 12.62 percent, is not nearly as high. But in the 1970s, federal income taxes were much higher and state and local income taxes were fully deductible; as a result, most of the state tax bite was felt by the federal treasury, not the high-income taxpayer. After federal deductibility, New York's top state and local income tax rate is now higher than ever -- and balancing New York's budget with tax increases would involve going even higher.

Many politicians in Albany view soak-the-rich taxes as a spigot that can be turned on and off at will, with no effect on the tax base. This impression is reinforced by a temporary high-income tax hike from the beginning of this decade, imposed during the 2001 recession. Revenues rebounded quickly in the first half of the decade, and the tax hike expired on schedule as revenues rose briskly.

This time, the state will not be so lucky. New York's 2001 tax hike was only about half as big as the current one. It was accompanied by simultaneous federal tax relief, which grew New York's tax base. And it came in a shallow national recession, which was followed by a robust economic rebound, especially in the financial sector.

Last year's "Millionaire Tax" increase (which actually applied to taxable incomes as low as $200,000) is already bringing in revenue about 10% below projections. Meanwhile, coming federal tax increases will push the top federal-state-local income tax rate in New York City above 50% in 2011, for the first time since 1986 - this time, federal actions will compound the state tax hike's ill economic effects instead of offsetting them.

And while disaster has been averted, the financial sector will not come roaring back as New York's fiscal savior like it did in 2004. In short, New York is not currently in a position to grow its way out of fiscal crisis like it did the last time -- it must now restrain spending, while repositioning its tax code to foster future economic growth.

Our report provides a blueprint to do just this, and avoid a 1970s-style fiscal collapse. Now it's time for Albany legislators to take their heads out of the sand, realize the pickle they're in, and get to the business of fixing the mess they've made. Here's hoping they're ready to be serious.