De Blasio’s awful tax hike timing

by E.J. McMahon |  | NY Torch

Mayor Bill de Blasio says the wealthiest New Yorkers should “chip in a little extra”—a mere $800 million in higher income taxes, or an average of $25,000 per affected household—to pay for subway improvements and transit fare subsidies.

But given Washington’s tax reform agenda, de Blasio’s latest soak-the-rich tax hike proposal is badly timed. It’s hardly a secret that the Trump administration and Republican congressional leaders want to repeal itemized deductions for state and local taxes—which would significantly raise the net cost of living, working and doing business in New York, especially for those with the highest incomes.

De Blasio’s proposal, which would require state legislative approval, would boost the city’s top rate from 3.88 percent to 4.41 percent on individuals earning over $500,000 and couples with taxable income over $1 million. He pushed the same idea during his first mayoral campaign in 2013 for the purpose of funding universal prekindergarten programs.

Governor Andrew Cuomo rejected that proposal and instead launched a statewide universal pre-K expansion funded out of the state budget. To pay for it, Cuomo effectively skimmed more off the top of the state’s own technically temporary but repeatedly extended “millionaire tax”—which now imposes an 8.82 percent flat tax (about two percentage points higher than the permanent rate) on individual filers with taxable incomes above $1 million and married-joint filers with incomes of $2 million.

The combined state and local income tax bite on New York City’s highest earners now comes to 12.7 percent, second in the nation’s to California’s 13.3 percent, as shown below. De Blasio’s proposed tax increase would further raise the rate to 13.2 percent, almost equal to California’s.

For New York City residents with seven-figure incomes, the federal itemized deduction slices 3.9 percentage points off the combined state and local income tax rate (after adjusting for the impact of the deduction-capping Pease limitation).

As shown below, the top effective state-local rate in the city has generally ranged from roughly 8 percent to 10 percent over the past 30 years. But under Trump’s proposed tax plan, the effective rate would shoot up to its full statutory level of 12.7 percent, as shown by the more darkly shaded column on the right side of the chart.

 

The impact of tax deductibility is further illustrated by New York City’s Marginal Effective Tax Rate, or METR, a measure of the combined federal-state-local income tax on the highest earners fleshed out in this 2013 paper by Gerald Prante and Austin John, of Lynchburg College in Pennsylvania.

The following table adapts the Prante-John methodology to compare the METR under current law with the projected rate under the reform plan outlined by Trump administration officials in April.

New York’s current combined marginal rate comes to 51.84 percent on salaries and bonuses, and 35.14 percent on income from dividends and long-term capital gains. Both METRs are significantly higher than comparable rates in jurisdictions with no state or local income tax, such as Florida.

Of course, high-income earners also would benefit from Trump’s proposal to reduce the top rate from 39.6 percent to 35 percent. However, for New York City residents in the top state bracket, the federal tax savings from that rate cut would be almost totally offset by the loss of the state and local tax deduction.  In fact, as shown in the table, the net marginal tax on salary and bonus income for the wealthiest filers would drop only slightly, from 51.84 percent to 51.09 percent. In other words, for these taxpayers, the loss of the deduction would consume 84 percent of the marginal cut in the top federal rate.

Trump did not propose any cut in capital gains tax rates, and U.S. Senate Republican leaders dropped their attempt to repeal the added 3.8 percent Obamacare tax on investment income.  Assuming no further tax cut proposals in this area, the loss of deductibility will produce a net increase in Marginal Effective Tax Rate on investment income of New York residents.

These changes would widen the tax divide between New York City and jurisdictions levying no income tax. As shown in the Florida example, the tax premium paid by a New York City resident would increase from roughly 9 percent to roughly 13 percent on income from labor, and from 12.34 percent to 12.8 percent on investment income.

At first glance, this issue might seem remote from the concerns of middle-income upstaters.  However, residents of other New York regions should keep in mind that their state government has become disproportionately dependent on taxes paid by the same high-income city residents targeted by de Blasio’s tax hike proposal.

A further increase in tax rates, aggravated by the loss of deductibility, could accelerate a recent trend that has seen a growing share of New York income millionaires change their domiciles to other, lower-taxed statesThat would erode the state’s tax base, with ripple effects that would felt across New York.

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