Deconstructing the tax cap’s Silver lining

by E.J. McMahon |  | NY Torch

A important breakthrough on the property tax cap issue came last week when Assembly Speaker Sheldon Silver introduced a bill that conforms in key respects to Governor Andrew Cuomo’s original proposal.

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Unlike Cuomo’s tax cap bill, Silver’s would allow some room for tax increases due to rising pension costs — but, as explained below, the exception is a partially limited one that would only temporarily increase the cap. It also would exclude added taxes generated by new construction, providing a continuing incentive for economic development.

Most importantly, like Cuomo’s original proposal, Silver’s bill would give local voters an avenue for freezing their local school taxes.  This would be a truly game-changing reform in itself, quite apart from the cap.

To download a table comparing the two bills, click on the image at left.

The “control” lever

Why did the speaker–normally a close ally of teacher unions strongly opposed to the cap — make these concessions? The answer can be found in the final clause of the 18-page bill. As summarized in the Assembly sponsor’s memo:

This bill would take effect immediately and apply to the 2012-13 school year, provided that section 1, dealing with local governments, would first apply to the fiscal year that begins in 2012 provided further that the act would remain in full force and effect only so long as the laws providing for rent regulation and control remain in effect. [emphasis added]

The approaching June 15 expiration of the state’s current “laws providing for rent regulation and control,” which were last renewed in 2003, is what brought the Assembly speaker to the bargaining table on the tax cap.  To be sure, the vast majority of economists of every stripe believe rent control is massively destructive.  (Paul Krugman, for one, notes the problem is obvious)  But its renewal is nonetheless a top priority of the state Assembly, dominated by members from New York City, with the tacit support of Cuomo.

While key details have yet to be settled, no one doubts that the rent laws ultimately will be extended, probably for eight years, continuing a “housing emergency” that began in FDR’s third term.  Barring a collapse of New York City political influence in both houses of the Legislature, the rent laws also will be extended in some form when they come due again in (probably) 2019.  And when that happens, the tax cap will be automatically extended with them.

Could a future legislative leader pull a fast one and kill the tax cap by allowing rent laws to “expire” for a few minutes before quickly renewing them in a slightly modified form?  No — because the final clause of Silver’s bill stipulates that the tax cap shall endure as long as specific sections of law regulating rents are in effect, “as amended from time to time.”  Thus, the tax cap would be New York’s nearest equivalent to a permanent law.

The pension piece

New York’s public pension systems are supported primarily by tax-funded annual contributions from public employers — the state, local governments and school districts.  The contributions are calculated as a percentage of the wages and salaries of employees who belong to the respective pension systems.  Contribution rates vary from year to year, based on actuarial calculations that reflect pension fund investment returns as “smoothed” over the previous five years.

New York’s public pension contribution rates have begun to skyrocket as a result of investment losses sustained by the public pension funds in the wake of the recent financial crisis.  Although the stock market has turned around in the last two years, the pension funds still have a lot of lost ground to make up.  (See this report for more background on the issue.)

Last year, employer contribution rates to the pension funds covering most local government employees, the New York State and Local Employee Retirement System (ERS) and the Police and Fire Retirement System (PFRS), rose by four percentage points and three percentage points, respectively.  They are projected to rise by another two to three percentage points a year between now and 2016.  Employer contribution rates to the New York State Teachers’ Retirement System decreased to 6 percent for the 2008-09 school year, have risen to 8.62 percent for 2011-12, and are expected to keep rising for five more years.

Silver’s bill would exclude a portion of these pension increases.  Here’s how the provision is worded:

“Tax levy limit” means the amount of taxes authorized to be levied by or on behalf of a local government pursuant to this section, provided, however, that the levy shall not include any of the following:

[snip]

In years in which the system average actuarial contribution rate of the New York State and Local Employees Retirement System increases by more than two percentage points from the previous year, a tax levy necessary for expenditures for the coming fiscal year for local government employer contributions to the New York State and Local Employees Retirement System caused by growth in the system average actuarial contribution rate minus two percentage points.

Identical provisions apply to the PFRS and the TRS.

What this means, in practice, is that if the pension contribution rate rises by three percentage points, and if the tax cap is 2 percent, the costs attributed to a one-percentage point rise in pension contributions — that is, one percentage point of the covered payroll base for members of the pension system — can be excluded from the cap. This is much more restrictive than the property tax cap adopted last year in New Jersey, which effectively allows localities to pass along 98 percent of pension cost increases to taxpayers, along with a significant share of rising employee health insurance costs.

Inflation is currently running at a 1.7 percent annual rate, as calculated under both the Cuomo and Silver bills. In “New York’s Exploding Pension Costs,” released last December, Josh Barro and I estimated that the TRS employer contribution rate for fiscal 2012-13 will be approximately three percentage points higher than the rate for 2011-12.  Based on these figures, the partial pension exclusion will boost the average 2012-13 school tax cap from 1.7 percent to 2.7 percent, before counting any taxes generated by new construction.  If inflation ends up at 2 percent or more, the cap including the pension exclusion will average 3 percent.

The impact of the exclusion will vary by school district; the tax cap exclusion will be larger, relative to the local tax levy, in districts that are less reliant on local property taxes and more heavily dependent on state aid.  Notably, it may also increase in the near future if pension costs spike at a faster rate.  Assuming the TRS hits its investment earnings targets over the next five years, Barro and I estimated last fall that  pension contribution rate increases would spike by four percentage points in 2013-14, by six percentage points in 2014-15, and by three percentage points in 2015-16, declining thereafter.  The governor’s office, in announcing support for Silver’s bill, has estimated smaller increases in TRS pension rates during the same period.

The stock market’s performance has exceeded expectations since our estimate was completed, but as the TRS noted in a February administrative bulletin to employers: “Although recent capital market returns continue to be encouraging, it is likely that (the contribution rate reflected in 2013-14 budgets) will again represent a significant increase.”

If our peak estimates are correct, and if the base cap throughout this period is 2 percent, the net school tax limit could range from nearly 4 percent in 2013-14 to 6 percent in 2014-15,  before dropping back to the statutory minimum during the second half of the decade.  In our worst-case investment scenario, pension costs will not continue rising indefinitely, but will ultimately level off at a much higher level without continuing to drive up the cap.  (As it happens, the estimated statewide TRS base payroll of $17 billion is not far below the $19 billion in total school tax levies proposed for 2011-12.  Thus, every average percentage point increase in pension contributions equates to about 0.9 percent of the tax levy.  That number will be lower — i.e., thus adding less to the tax cap — in wealthy “low need” districts, and higher in poorer “high need” districts.)

The possibility that the pension exclusion could temporarily double the average cap level in a couple of upcoming years is all the more reason why it is essential to avoid attaching a sunset date to the law, which would further limit the time period in which it can have a dampening effect on long-term tax hikes.

However, the cap alone is not the only significant change that would affect school property taxes.  Even if the pension exclusion temporarily pushes the effective tax cap well above its 2 percent maximum face value, voters in school districts throughout the state (outside New York City) for the first time will have the power to freeze school tax levies if that’s what a majority (a simple majority) desires.

Overriding the contingency budget

Under current law, school boards concerned about the outcome of a budget vote have a comforting fallback option. If a budget proposition fails twice, boards can then adopt a “contingency budget” without voter approval.  Total contingency spending can increase by 4 percent or 120 percent of the rate of inflation — which, this year, would have been far more than the average spending growth actually proposed by most districts.

Cuomo’s original tax cap would have eliminated the contingency budget language.  Silver’s bill retains the contingency budget provision, but allows it to be trumped by the tax cap.  If a budget fails to win approval twice, or if a board decides not to resubmit a rejected budget for a second vote, the board can levy a tax “no greater than the tax that was levied for the prior school year.”  To repeat: if local taxpayers reject a budget twice — even if it calls for a tax hike within the limit — the allowable increase will be zero.

The message to school boards: two strikes and you’re out.

More taxpayer power = undemocratic?

Opponents have claimed the tax cap will undercut democracy – but the real impact will, if anything, be quite the opposite.  After all, school districts could no longer impose state-mandated minimum budgets and tax hikes without voter consent.  School officials would have to work harder to persuade a larger number of taxpayers to accept spending increases.  That’s conducive to more civic engagement and a more democratic process.

For other types of localities, the effects of the cap will be more muted, especially after Silver’s changes.  Cuomo’s bill would have allowed for override of the tax cap by a two-thirds majority of the governing board in jurisdictions other than school districts. Silver’s bill aligns the super-majority provision to the same 60 percent level in all types of local governments.

For local governments with five-, seven- or nine-member boards — including nearly all towns and many villages and cities — a 60 percent majority requires the same number of votes as the simple majority already needed to pass any law.  In most other local legislative bodies, a 60 percent majority will require one to two added votes, or three votes in the largest (such as Albany County’s 39-member Legislature).

Counties, towns and municipal governing bodies seeking to raise taxes above the cap limit will have to do so pursuant to a separate local law following a public hearing, in addition to the normal budget adoption process.  Therefore, while the cap is easier to override, it sets a higher political bar for local officials to clear.  As for the pension exclusion, the estimated increase for ERS and PFRS over the next five years is not expected to exceed three percentage points in any given years, and thus the impact of the exclusion on the local cap will be relatively small.

If the tax cap makes just a small difference in annual tax levy increases, this could add up to a big savings for taxpayers.  For example, from 1999 through 2009, school tax levies rose by an annual average of 6.3 percent.  If the average had been 5.3 percent–just a single percentage point lower–property owners by 2009 would have been saving $2 billion a year.

Conclusion

Under the circumstances, given the Assembly’s strident opposition to any kind of limit on property tax levies, Silver bill can be seen as an acceptable compromise — barely acceptable, that is.  Ideally, it would have no added exclusions other than new construction growth.   Any further weakening of the governor’s bill, through the addition of an expiration date or of further expense exclusions, would make this a cap that is not worth the effort.

- E.J. McMahon is the President at the Empire Center for Public Policy.