New York Budget Gap Narrows, but No Long-Term Solution in Sight

New York cannot taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. itself toward a balanced budget.

The recently released FY 2025 budget for New York State signals a degree of optimism, with caveats. The budget reports that the state's financial situation is not as dire as the comptroller predicted just last year. However, revised expectations of accelerated economic growth, even combined with stop-gap tax policies that could potentially raise far more tax revenues, still fail to eliminate the budget gap.

Against a cumulative deficit of $27.1 billion predicted in the previous year's Enacted Budget Mid-Year Financial Plan Update (released in October 2023, for the three-year period of SFY 2025-26 through SFY 2027-28), the FY 2025 budget predicts a $13.9 billion gap, a substantial reduction. This assumes a strong economy that is expected to grow at 2.4 percent from 2024 to 2025, leading to job growth of 1.7 percent and an optimistic wage growth of 3.7 percent (nominal). This growth, combined with temporary tax increases on the highest earners in the state, has led to an optimistic projection of $236 billion dollars of increased tax revenue this year, compared to the $222.4 billion FY 2024 forecast from last year. Notably, the previous year's enacted budget assumed a GDP growth rate of 0.9 percent for 2024.

In its FY 2022 budget, New York codified temporary increases to its personal income tax (PIT) and corporate franchise tax (CFT) rates. PIT rates were raised for people with more than $1 million in annual income, and new brackets were created for filers with incomes over $5 million and $25 million. The CFT rate for businesses with over $5 million in annual profits was raised from 6.5 percent to a "cliff rate" of 7.25 percent, wherein the entire net income faces that tax rate rather than just the incremental value above $5 million. (Similar tax cliffs exist within the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , with the value of lower rates being phased out for high earners.) The franchise tax provision expires on December 31, 2026, while the increased PIT rates expire on December 31, 2027.

These extraordinary measures have still not led to a balanced budget for the state, with the situation expected to worsen in the coming years as these measures sunset. In 2024, the state is now projected to face a deficit of $2.4 billion, a figure that will expand to $7 billion the following year and soar further as these extra taxes are phased out.

One obvious solution that some legislators may consider would be to extend these high taxes further or codify them into law permanently. Caution, however, is important. Beyond a certain point, higher tax rates may reduce overall revenue due to behavioral changes, and increasing taxes excessively can hinder economic growth. For long-term viability, it is in New York's interest to reverse its reputation as a business-unfriendly state, as evidenced by its 49^th ranking in Tax Foundation's State Business Tax Climate Index. Higher taxes on businesses and capital owners also percolate down to the middle and lower classes in the form of higher prices, making life in the state increasingly unaffordable even for those that do not directly write a check to the state and local governments. Taxpayers gradually vote with their feet, and US Census data shows that New York lost the greatest share of its population to other states in the past year (latest data, July 2022 to July 2023). At the end of 2023, the number of workers was down 185,600 from pre-pandemic levels. Further, New York's labor participation rate of 61.3 percent is lower than the national average of 62.5 percent. Clearly, this is not conducive to a broad tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. and long-term economic and tax revenue growth in the state.

Importantly, had policymakers limited FY 2025 spending to what was forecasted in the still generous FY 2024 budget, the state would have seen a surplus for the ongoing year and may have been able to either stash more money into its rainy day fund for any future economic shocks, like the COVID lockdowns, or lower taxes to attract more business. In the FY 2024 budget, the state expected to spend a total of $231.6 billion in 2024-25, which would have led to a surplus of approximately $5 billion, if revenue projections hold. Instead, the state now expects to spend $239.1 billion. Even this lofty figure is not set in stone, and we may see it increase further as the fiscal year progresses.

Therefore, it seems like revenues are not the issue here. Instead, policymakers in New York should take a hard look at the state's spending situation, which seems to be spiraling out of control, especially its main drivers-public education and Medicaid. Medicaid spending is expected to be over $100 billion this fiscal year, a figure that is projected to grow to a statutorily nominally hard-capped $109.6 billion in 2027-2028, an increase of 9 percent. Not included in this, however, are some items such as funding for distressed hospitals, the Healthcare Safety Net Transformation Program, etc., which are funded via other budget mechanisms. This obviously comes at the expense of transparency and accuracy of the health care budget for the state, as well as subsequent overspending. The capped portion of the state share of Medicaid for 2024-25 comes to approximately $31.3 billion, against the previous year's estimate of $30.1 billion.

Further, public schooling, which consumes roughly 28 percent of the state budget, is expected to cost the state $30.2 billion, an increase of 5 percent over the previous fiscal year. This is despite the fact that school enrollment has actually fallen by 231,000 students since 2014, when the school budget was $21 billion. This is arguably not sustainable and puts growing pressure on state finances.

What is more worrying is that the state's reliance on federal funds for its spending has grown to 40 percent of its budget since the pandemic. In 2024-25, the state expects to receive $94.2 billion from the federal administration. While, as of now, such large receipts are expected to continue for the next few years, due to the Infrastructure Investment and Jobs Act (IIJA) and the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a "hidden tax," as it leaves taxpayers less well-off due to higher costs and "bracket creep," while increasing the government's spending power. Reduction Act (IRA), it is perilous to expect federal funding to remain this high in perpetuity. Things could change very quickly, potentially leaving the state in the lurch. The potential end of the federal SALT deduction limits and the sunsetting of the higher PIT and CFT also lend uncertainty to tax revenue collections, depending on the degree to which taxpayers shift their income reporting year to year and the degree to which the state conforms to federal tax law. Therefore, if a balanced budget is the goal, policymakers in New York will have to address the dramatic increase in spending, particularly against the backdrop of an uncertain fiscal environment.

Good tax policy is obviously important. For New York, it just may not be enough. And, absent a plan, there's always the risk that the state's already uncompetitive taxes could get even worse.

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