New York is just beginning to emerge from a two-year local recession compounded by 9/11 and lingering security concerns – but the city budget is growing at a pace more commonly associated with peak economic boom times.

City-funded operating expenditures[1] under the newly adopted 2005 budget were slated to increase by a record $3.1 billion, or nearly 10 percent, according to projections in the June financial plan. Excluding federal and state grants, the cost of running city government is growing from $31.9 billion to $35 billion.

If this trend remains unchanged, the overall increase in city-funded expenses during Michael Bloomberg’s first three years as mayor will reach 21 percent – more than double the inflation rate. Relative to New Yorkers’ personal income, this measure of spending will reach its highest level in more than a decade.

The budget’s financing structure sets the stage for bigger fiscal troubles ahead. Roughly $3.5 billion in planned city expenditures in fiscal 2005[2] will be paid for with a combination of surplus funds rolled over from 2004 and one-shot cash infusions from a handful of sources.[3] At the same time, however, recurring city revenues are growing at barely one third the rate of operating expenses. This explains why the city’s 2006 budget gap projection has grown from $1.4 billion to $3.7 billion in the space of just a year, despite the stronger-than-expected economic rebound.[4]

Stacking up the historical pattern

New York City’s fiscal 2003 budget – the first of Bloomberg’s mayoralty – resulted in the smallest annual increase in city-funded expenses (and the first sub-inflation increase) since fiscal 1995, which was Rudolph Giuliani’s second year as mayor. But as shown in the chart below, Bloomberg’s second budget led to one of the biggest spending increases in the last 20 years – and the projected growth in 2005 is even higher.

Annual Increase in City-Funded Operating Expenses* Compared to Inflation * excludes interfund capital transfers and federal, state and other categorical grants; includes debt service for Transitional Finance Authority bonds and “TSASC” tobacco bonds ** projection as of June 2004 adopted budgetSources: Mayor’s Executive Budget and City Comptroller’s Comprehensive Annual Financial report; inflation changes are annual as of June, based on consumer price index for northeast urban consumers from Bureau of Labor Statistics, except 2005 projection is derived from Executive Budget projections.

Over the last 20 fiscal years, only the 10 percent spending increases of fiscal 1985 and 2001 exceeded the projected 9.8 percent city-funded growth rate for 2005. But these surface similarities mask important differences in the forces driving the budgets in those years.

Running in place

The big budget increases of the mid-1980s and late 1990s through 2001 reflected expanding city payrolls and wage increases for city workers. Under Bloomberg, in contrast, a larger portion of the growth in the budget can be attributed to increases in the cost of maintaining existing programs and services.

As shown, more than two-thirds of the $3.1 billion city-funded budget increase for 2005 can be attributed to four spending categories:

After rising steeply in previous years, net city-funded debt service costs in 2005 will essentially show no increase over the prior year, mainly because the state’s highest court has approved a financing scheme that will eliminate the city’s remaining payments to the Municipal Assistance Corp. (MAC). Excluding MAC, however, all other city debt service is up about $500 million in 2005.

Outrunning the economy

An examination of spending trends under Bloomberg inevitably prompts comparisons with the budgets of his predecessor. As shown in the chart above, Giuliani allowed spending to increase significantly faster than inflation during four of his last five years in office – and another big increase was in store for fiscal 2002 before the World Trade Center attack forced the city into an austerity mode.

Yet, at the same time, Giuliani’s budgets did not grow faster than the economy that was supporting them; several, in fact, reduced the cost of government relative to the underlying tax base. This was possible in part because city tax cuts enacted during his tenure, along with the general improvement in the city’s quality of life, contributed to some of the strongest economic growth New York has experienced over the last 54 years. The culmination of this positive trend came in 1999 and 2000, when New York City outpaced the nation’s private sector job growth rate for two consecutive years – the first time that ever happened in a post-World War II economic expansion.

Bloomberg’s last two budgets, however, have grown considerably faster than the economy, as reflected when city-funded operating expenses are measured as a percentage of personal income (below).

City-Funded Operating Expenditures As a Share of Personal Income in New York* * Basis of comparison is personal income for calendar year in which budget was adopted. ** Budget data for 2004 is estimated; 2005 is a projection based on the June 2004 financial plan.Source: Personal income data from U.S. Bureau of Economic Affairs (through 2002) and New York City Office of Management and Budget (OMB) (2003-2004); city expenditure data from New York City Comptroller’s office and OMB; author’s calculations

After trailing far behind the rest of the nation, New York experienced the beginning of a fairly strong economic rebound in 2003 – but the city budget adopted that year grew even faster. City-funded operating expenses in fiscal 2004 rose above 10 percent of personal income for the first time in nine years. And in fiscal 2005, spending is on track to continue rising to 10.5 percent of personal income, highest since 1994.

Upside potential?

The trend line could turn around if economic growth in the city accelerates beyond current projections. However, several of the factors that contributed to New York’s stronger-than-expected growth in 2003 won’t be replicated in the near future. Accelerated cuts in federal marginal income tax rates were particularly beneficial to New York residents – more than offsetting a virtually simultaneous, temporary increase in state and city income tax rates, as well as providing a major boost to the entire national economy. Cuts in federal taxes on dividends and capital gains also contributed to a strong recovery in the stock market – boosting securities industry profits and bonuses, which in turn pumped up income tax receipts.

Since the start of 2004, stock market indexes have moved mostly sideways, and few analysts see another 90s-style boom in equity values on the near horizon. Bottom line: Wall Street is unlikely to provide another big burst of unanticipated tax receipts in fiscal 2005.

Meanwhile, other economic and fiscal data for the first six months of 2004 indicate that private sector employment and wages in New York are growing again – but not faster than anticipated. As of June, private sector employment in the city remained 156,000 jobs below the mid-2001 level.

It’s no more likely that the expense trends driving the growth in the budget will reverse themselves. Pension costs are projected to increase another $1.1 billion by 2007 and then level off. Another surge in stock prices – which, as noted, is unlikely in any event – would only modestly suppress this increase, which is due in large part to past benefit enhancements, wage increases and early retirements.[5] Employee salary and benefits cost projections are, if anything, on the low side (see next section). The increase in city Medicaid costs assumes the state will adopt cost-containment measures backed by Governor George Pataki but resisted by some in the state Legislature; otherwise, the city’s Medicaid caseload continues to rise, as does underlying health care inflation. Debt service – which is largely a product of previous borrowing decisions – is on track to continue rising by another $750 million between 2006 and 2008, and rising interest rates make further refinancing savings unlikely.

Downside risks

If the upside potential is small, the risks are considerable. For example, the pending resolution of the Campaign for Fiscal Equity[6] lawsuit could force the city to increase its own annual school funding by amounts ranging from $83 million in 2005 to $791 million by 2008, according to the state comptroller’s office.[7]

A second wild card is collective bargaining. The budget assumes that all of the city’s bargaining units will agree to three-year contracts modeled after the one ratified earlier this year by members of the city’s largest union, District Council 37 of the American Federation of State, County and Municipal Employees. The contract covers fiscal 2003 through 2005.

Members of D.C. 37 and several smaller unions that have ratified similar deals will get a $1,000 up-front cash bonus and permanent wage increases of 3 percent for the second year and 2 percent for the third and final year of the agreement. The pay hike in the third year will be at least partially subsidized by a 15 percent pay cut and reduced benefits for newly hired union members during their first two years on the payroll. An added 1 percent pay hike will hinge on the union’s agreement to additional productivity enhancements. But there will be no change in current work rules affecting any current union member.

While modest by municipal collective bargaining standards, the D.C. deal represented a significant retreat from Bloomberg’s previous insistence that any wage increases be entirely paid for by concessions. In any event, both the United Federation of Teachers and Patrolmen’s Benevolent Association (PBA) have rejected a contract based on the D.C. 37 agreement and are demanding far richer deals. In the case of the PBA, such a contract could ultimately be forced on the city through binding arbitration.

Even assuming that the D.C. pattern holds for all unions, the city budget includes no new money to cover additional labor costs starting in 2006, when yet another round of new labor contracts will be due to take effect.

A final risk concerns possible changes in federal tax policy. Democratic presidential candidate John Kerry has pledged that, if elected, he will roll back recent federal income tax cuts for high-income households, which would have a disproportionately negative impact on individuals and firms in New York City. Even if President Bush is re-elected, his efforts to make federal tax changes permanent will require much greater spending discipline than he and Congress have exhibited over the past four years.

The still-missing link: Tax cuts

While city officials obviously can’t control macroeconomic effects or the gyrations of the stock market, they can try to make New York more competitive with the rest of the country by reducing the city’s extraordinarily high cost of living and doing business. The place to start is by attacking the city’s heavy and cumbersome tax structure.

So far, though, city policies under Bloomberg have moved in precisely the opposite direction. City taxes have been increased by up to $3 billion a year, including “temporary” income and sales tax increases due to expire at the end of 2005.[8] The mayor has rolled back a small portion of the record 2002 property tax hike in the form of a targeted $400 rebate for homeowners only – leaving commercial, utility and multi-family properties to continue paying the full, higher tax bill. Otherwise, in contrast to Giuliani, Bloomberg has not identified broad-based tax reduction as a short- or long-term priority of his administration.

Constricted vision

In presenting his 2005 budget to the state Financial Control Board, Bloomberg said the city was entering the new fiscal year “with a new mood of measured optimism about our financial future.”[9]

It’s hard to see the justification for such optimism, “measured” or otherwise. To be sure, the situation has improved since the fall of 2002, when the city budget gap had swelled to more than $6 billion. However, while the initial 2005 budget is balanced, it calls for a rate of spending growth that is simply unsustainable. The mayor will need to start addressing the city’s projected future shortfalls with a new round of gap-closing measures well before the fiscal year is over.

Simply balancing the budget – difficult as that will be – is not enough. New York City imposed the heaviest personal and business income taxes of any major city in America even before Bloomberg’s tax hikes were enacted. Gotham’s future growth prospects will depend in large part on the mayor’s ability not only to close future gaps but reduce the scope and expense of city government.

Originally Published: FISCALWATCH MEMO

Notes

1. The measure of spending used throughout this analysis is based on a methodology used by the state comptroller’s office in its regular analyses of city budgets (see http://www.osc.state.ny.us/osdc/). It excludes federal, state and other “categorical” grants – money, such as school aid and federal Medicaid reimbursements, that that must be spent for a specific purpose. It also adjusts for the city’s technique of using surplus funds in one year to pre-pay expenses in the next. The resulting figure, which properly attributes expenses to the year in which they are encumbered, provides the most consistent basis for evaluating what New York City needs to raise from its own resources in order to finance its budget on an annual basis. This method differs slightly from the definition of “city-funded” spending used in previous FiscalWatch memos on this subject, but the resulting percentage changes are very similar.
2. City fiscal years run from July 1 through June 30.
3. Specifically, the 2005 budget relies on $1.7 billion in surplus funds rolled over from 2004 and $1.8 billion in one-shots, including back rent from the Port Authority for city-owned airports.
4. For more background on the projected gap and how it stacks up in a historical context, see the May 5, 2004, FiscalWatch memo, “The Cloud Behind the Silver Lining,” at https://empirecenter.org/publications/the-cloud-behind-the-silver-lining.
5. City pension contributions could still be lowered in the short term through a change in actuarial assumptions or a further “stretch out” of costs related to benefit enhancements, as is already being proposed by Governor Pataki for the separate state retirement system. This would not actually reduce pension obligations but push the costs off into the future.
6. Campaign for Fiscal Equity v. State of New York, http://www.nycourts.gov/ctapps/decisions/Jun03/74opn03.pdf, New York State Court of Appeals, No. 74, June 26, 2003, p. 15. For more on the court decision and its implications, see the recent Manhattan Institute Center for Civic Innovation study “No Strings Attached? Ensuring That CFE Funds Are Spent Effectively,” by Raymond Domanico, at http://www.manhattan-institute.org/pdf/cr_42.pdf.
7. “Review of New York City’s Financial Plan for Fiscal Years 2005 Through 2008,” July 2004, Report 5-2005, p. 39 (http://www.osc.state.ny.us/osdc/rpt5-2005.pdf).
8. For more details on the 2003 income tax hike, see the June 9, 2003 FiscalWatch memo, “New York’s Ugly Stealth Tax Hikes,” at https://empirecenter.org/publications/new-yorks-ugly-stealth-tax-hikes.
9. The full text of Mayor’s remarks can be found at http://www.nyc.gov/html/om/html/2004b/pr197-04.html.