Earlier in this decade, the last major change in federal tax policy helped bail New York out of its last Wall Street downturn.

Will Washington help or hurt the city this time around?

John McCain and Barack Obama have laid out strikingly divergent tax agendas. And ironically, Obama’s tax plan would do much more economic harm to New York City – whose voters support him enthusiastically – than would McCain’s.

Taxpayers at every income level benefited when Congress and President Bush agreed in 2001 to reduce income tax rates across the board. Still more important from New York’s standpoint, the Bush tax cuts were accelerated and expanded in the spring of 2003 to include lower rates on capital gains and dividends. This cut was a strong and timely economic boost for the Big Apple – helping to ignite the market’s recovery from the doldrums it had entered with the bursting of the tech bubble in 2000.

Under current law, however, virtually all of the Bush income tax cuts will expire at the end of 2010 – leading to an enormous and automatic tax hike. Resolving the uncertainty over future tax policy is among the most important challenges facing our next President.

Emphasizing economic growth as his goal, McCain would extend all the Bush cuts, including the current 15% top rate on capital gains and dividends.

Obama is focused on “fairness” – which is another way of saying income redistribution. He would preserve the Bush tax cuts in low- and middle-income households while restoring the top-bracket rates to their pre-2001 levels. And he would raise capital gains and dividends rates in the top two brackets by a full one-third, to 20%. Obama would use the added revenue – and then some – to finance new and expanded tax credits to households in lower brackets. The largest of these would be a “Making Work Pay” credit of $500 per worker, or $1,000 per couple.

Carrying those plans forward into the first two years of their administrations, we at the Empire Center have crunched the numbers to determine the New York impacts of the candidates’ plans:

McCain’s plan would save New York State residents a combined total of about $675 million in federal taxes in 2009 and 2010, mainly as a result of his plan to begin raising the tax break for couples with children.

Obama would give $13 billion in new tax credits to New York residents – including “refunds” to millions who already pay no taxes – while raising taxes on high-income New Yorkers by at least $16 billion. The result: a net tax increase of $3 billion in New York over the two-year period.

That’s not the end of the comparison. Higher rates on top brackets generally cause taxpayers to earn less, invest in tax-free shelters and engage in other legal strategies for reducing their taxable incomes. This would have a ripple effect on the city and state, which draw their income taxes from the same well. As a result, we estimate that adoption of Obama’s proposed individual income tax hikes would blow an added hole of at least $800 million in New York’s state tax receipts over the next two years, while reducing city revenues by at least $144 million over the two-year period.

Even before the events of the past few days, it was becoming obvious that marginal tax hikes couldn’t come at a worse time for the economy. Obama himself apparently recognizes this, since he suggested in a recent interview that he might delay his tax increases if a recession is underway next January.

For every dollar in taxes New Yorkers paid in 2005, the state got back 79 cents in spending. That means no amount of added spending will close our “balance of payments deficit” with Washington.

New York’s best economic hope from the federal government is for a tax policy that avoids direct hits on its tax base and promotes renewed investment by reassuring investors that capital gains and dividends rates won’t rise.

About the Author

E.J. McMahon

Edmund J. McMahon is Empire Center's founder and a senior fellow.

Read more by E.J. McMahon

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