Eliot Spitzer was swept into office by a record plurality, surrounded by impossibly high expectations that have already begun to deflate. As if that weren’t enough, he was also the first New York governor since Franklin D. Roosevelt in 1929 to take office at the peak of an economic expansion – which creates some heightened expectations of its own.
This is a decidedly mixed blessing for Spitzer, as the turmoil in world financial markets is now demonstrating. The economic trends driving state revenues over the last four years couldn’t get much better from Albany’s perspective. On the other hand, they could easily take a sudden turn for the worse – and may already have.
Wall Street has accounted for an outsized share of New York’s recent economic growth, and the governor is banking on continued strength in the financial sector to help underwrite his spending plans through 2010. But as Spitzer’s executive budget noted, “New York state revenues are profoundly affected by the fortunes of the financial markets.”
The state treasury is more dependent than ever on capital-gains and income taxes generated by the sort of high-flying investors, brokers and bankers who have the most to lose if market jitters over sub-prime mortgages lead to a prolonged shakeout.
Last year, financial and insurance firms accounted for nearly half of all private-sector wage increases and a third of overall private-sector economic growth in New York. The growth has been even more striking when viewed over the long term. In 1980, for example, the financial sector accounted for less than 10 percent of wages in the state. By 1990, the figure had climbed to about 12 percent. In 2006, it exceeded 20 percent.
Yes, the global economy remains strong, and the nervousness on Wall Street doesn’t necessarily point to a general economic downturn. As economic commentator Larry Kudlow pointed out last week, “While the subprime mortgage virus has temporarily infected banks, hedge funds, insurance companies and other institutions, most of Middle America is doing just fine, thank you very much.”
But the same doesn’t hold true in New York, where non-finance industries grew more slowly than the national average last year. The state’s once mighty manufacturing sector is especially troubled: Since 2000, it has shed a quarter of its jobs while increasing its output at barely half the national rate. Meanwhile, the boom in housing prices is over. Can commercial real estate be far behind?
While the risks were clear when Spitzer took office, his first budget has led the state further out on a fiscal limb. He increased state-funded spending by more than 8 percent, triple the inflation rate. He has committed himself to a record expansion of school spending over his first four years in office. He will add 2,800 employees to state agency payrolls this year. And his declared commitment to some form of state-sponsored universal health care has dollar signs written all over it.
The officially forecast state budget gap of $3.6 billion next year, growing to $6.7 billion by 2011, is relatively small by historical standards. Proportionately similar out-year shortfalls were charted during the mid-1980s and ’90s, only to disappear under a wave of unanticipated tax receipts. But in 2007, unlike 1987 or 1997, it’s difficult to see much more upside potential on the revenue side of the budget. Indeed, the cumulative gap would be even larger if Spitzer’s Budget Division hadn’t just added over $1 billion to its personal income-tax projections for the next three years.
A full-blown recession isn’t necessary to make the gap bigger in a hurry. All it will take is a bad year for a few thousand of the state’s highest-earning households, which already bear a disproportionately large share of the tax burden. It’s already happened once in this decade. Between 2001 and 2003, a sharp drop in state revenues could be traced primarily to a decrease in the incomes of New Yorkers earning more than $200,000.
The latest financial market gyrations could be just a blip, allowing state politicians a few more years of smooth sailing without tough decisions. But another day of fiscal reckoning for Spitzer is just a few years down the road. President Bush’s federal tax cuts played a crucial role in lifting New York’s economy out of the ashes of 9/11 and the last stock market downturn. Bush’s lower tax rates are set to expire in 2010 – and Democrats in Congress are clearly willing to let it happen, at least in the highest brackets.
An increase in marginal federal tax rates on high earners and investors will prompt them to minimize their taxable incomes, which in turn will suppress revenue growth in New York state. It happened in the early 1990s – and it will surely happen again if Bush’s cuts are undone.
And so, even if the current storm blows over and the stock market indexes resume their happy march upward, the end of the decade could witness an ironic spectacle: Eliot Spitzer celebrating the arrival in the White House of a fellow Democrat whose economic program blows a hole in New York’s tax base – just in time for the state’s next gubernatorial election in 2010.