Mayor Bloomberg’s “draconian” service-cutting contingency plan dominated the headlines when he unveiled his fiscal 2004 city budget proposal last week. But the real news is that the budget has brought the city a big step closer to another massive tax hike, posing a grave new threat to New York’s still-shrinking economy.

Having already raised city taxes and fees by nearly $2.5 billion in the last two years, Mr. Bloomberg is now seeking $1.4 billion in new tax revenues – up from the $1 billion increase proposed in his January plan. This would effectively wipe out all the tax cutting progress made in the Giuliani era.

To be sure, this is not the way the tax issue was portrayed in the mayor’s budget presentation. Instead, Mr. Bloomberg continued to maintain the pretense that Governor Pataki and New York’s Legislature might yet approve a “restructuring” of the city income tax under which commuters to New York would pay roughly $2.4 billion in new taxes to finance a $1 billion tax cut for Gotham’s own residents.

But to absolutely no one’s surprise, Mr. Bloomberg’s blockbuster commuter tax proposal was a non-starter at Albany. At this point, the most the mayor can hope for is the re-imposition of the old commuter tax, repealed in 1999, which would still leave him nearly $1 billion short of the revenue target in his newly released budget plan.

So where will the additional new tax revenue come from? Another property tax hike certainly is possible – but given the political blowback from last fall’s record 18.5% hike, it’s the last thing the City Council wants to do. In all likelihood, the focus will remain on the city resident income tax.

New York City’s current income tax tops out at 3.65% – a quarter-percent higher than when Ed Koch left the mayor’s office, 14 years ago. This means the combined non-federal income tax rate within the city is 10.5% – considerably higher than the rates in New Jersey at 6.35%, Connecticut at 5%, Pennsylvania at 2.8%, and the rest of New York State at 6.85%.

Options for increasing the city income tax range from bad to worse. For example, an across-the-board surcharge sufficient to raise $1 billion would return the top marginal rate to its pre-1999 level of 4.46% and cost median-income households nearly $300.

The City Council, however, would probably be much more inclined to adopt a soak-the-rich approach.

Last year, a majority of the current council members endorsed a plan to raise over $1 billion by hiking the income tax a full percentage point for New Yorkers with incomes between $200,000 and $250,000, and by two full points – to 5.65% – for all New Yorkers earning more than $250,000. The Manhattan Institute’s NYC-Stamp model estimates such an increase would result in the net loss of nearly 48,000 private sector jobs, on top of an estimated 62,000 job losses predicted to follow the property tax increase enacted by the City Council last November.

Advocates of stiff marginal surcharges in upper brackets ignore the fact that taxpayers with incomes above $200,000 tend to have more discretion than most New Yorkers over how – and where – they earn their money. These filers include a larger proportion of business proprietors, investors, and entrepreneurs, who customarily plow a portion of their disposable incomes back into their own firms and the stock market. Faced with a significant rate increase, some will move their businesses or primary residences to lower-taxed jurisdictions, or steer their money to tax-free investments – which, in either case, will undercut anticipated revenues.

Supporters of income tax hikes also falsely assume that the deductibility of local taxes on federal tax returns will significantly lower the net cost of such an increase for most taxpayers. In fact, a growing number of New York households – particularly in the brackets already targeted by the council – are subject to the federal alternative minimum tax, which allows no deduction for state and local taxes. Moreover, deductibility itself means far less now than it did two decades ago, when federal rates were nearly twice as high.

In general, a significant city income tax increase will slow economic growth and reduce employment by making New York a less attractive place to live and work, and by reducing the amount of money affected taxpayers spend and invest in the city. The resulting weakness in the local economy will ensure persistent budget gaps despite higher tax rates.

This is just what happened in the early 1990s, when Mayor Dinkins imposed in quick succession a big property tax increase along with two surcharges that represented a total income tax increase of more than 28%. These steps fed a downward economic spiral in which the city lost more than 300,000 private sector jobs, one-tenth of its employment base.

Despite the evidence provided by New York’s past experience and the continued shakiness of the local economy, Mr. Bloomberg continues to insist that higher city taxes will do less damage than reduced city spending. It still might not come to this if Albany approves virtually every non-tax item on Mr. Bloomberg’s wish list, and if labor unions suddenly reverse course and agree to productivity concessions. Otherwise, the question won’t be whether the mayor seeks to increase taxes, but how he seeks to do it.