Income tax hike looming for NY?

| NY Torch

Today’s New York Times reports “a growing sense” in Albany that the Democrats who now control state government will seek to raise state income taxes on “the wealthiest New Yorkers” to help close a $15 billion budget gap.  The Times article quotes Sen. Eric Schneiderman, a Manhattan Democrat and likely sponsor of soak-the-rich tax hike, as saying: “There are a lot of us who feel that for the last 30 years we’ve been shifting the tax burden from the wealthy to middle-class families.”  In fact, there’s little evidence to support this view — and plenty of evidence to the contrary.

Consider, for example, the actual trend in the share of state income taxes paid by the highest-earning one percent (a group whose incomes began at roughly $750,000 as of 2007).  The data in this chart are from Table 6 on page 200 of the 2009-10 Executive Budget, Economic and Revenue Outlook.

As shown, the share paid by the wealthiest one percent peaked at 41 percent of all New York State income taxes in 2007.  The projected drop in the share starting in 2008 reflects the Budget Division’s expectation of a sharp, ongoing drop in incomes among the wealthiest New Yorkers.  But even with the steep downturn, the share of taxes paid by the wealthiest New Yorkers is expected to be higher than the 30 percent level of 1996 —when the top rate was higher.

Prior to the mid-1990s, New York State’s budget and tax agencies did not calculate the distribution of income tax burden among income percentiles.  However, since the mid-1990s, the distribution of New York state income taxes has closely tracked the distribution of federal income taxes among comparable high-income groups.  And on the federal level, there is no question that the wealthiest Americans have been paying a rising share of income taxes for most of the past 30 years, despite tax rate cuts during that period.   See the numbers in this study, for example.   And in this table.

This seeming paradox—lower tax rates resulting in larger tax shares for the wealthiest Americans—confirms one of the principal supply-side arguments advanced for President Ronald Reagan’s tax cut package in the early 1980s.  As Reagan expected, taxpayers in the highest brackets responded to lower tax rates by working more, taking more financial risks and sheltering less of their income.  Amid a general growth in affluence, the booming stock market, rising real estate values and rising compensation for corporate executives also gave an extra push to personal wealth in the top tax brackets.  And as incomes rose for the wealthiest one percent, so did their share of income tax payments, a trend that accelerated after the 1986 federal tax reform took the top rate to a 55-year low.  Meanwhile, between 1986 and 2005, both average tax rates and tax shares dropped for the remaining 99 percent — and the lowest-earning 50 percent realized the largest decreases, according to data compiled by the Tax Policy Center at the Urban Institute and Brookings Institution.

Making a bad situation worse

New York’s growing dependence on high-income taxpayers is a major reason why the Empire State is now in such big fiscal trouble.   Schneiderman and his fellow lawmakers budgeted huge, unsustainable spending increases when incomes among the wealthiest taxpayers were soaring, even though the trend clearly couldn’t go on forever.  As discussed more extensively in this City Journal article, a sizable chunk of the state’s revenue growth between 2003 and 2008 could be traced to a heavily leveraged bonus and profits boom on Wall Street.   By the same token, the decrease in projected state income tax receipts starting in 2008-09 can be traced to sharp losses (capital losses and job losses) in a now-shattered securities industry.

Yet the worse New York’s economy gets, the more strident have been the calls for a “millionaire tax” from a coalition of the state’s labor leaders and health-care industry advocates.  Their motivation is obvious: despite what Governor David Paterson rightly calls the most severe economic and crisis of our lifetimes, the unions don’t want the jobs, salaries and benefits of their members to be touched by budget cuts, and the hospitals don’t want to see the Medicaid gravy train derailed.  To justify their position, they invariably start by pointing to the long-term decline in the state’s top income tax rate, which at 6.85 percent is now less than half its 1977 peak of 15.375 percent.

In fact, however, once the interplay of state and federal tax rules is taken into consideration, the net impact of the state’s marginal rate has changed very little.  Keep in mind, that 15.375 percent top rate in 1977 was deductible against a top federal rate of 70 percent.   As a result, for those in the highest federal bracket, the state tax rate effectively cost 4.61 percent.   Both federal and state tax rates dropped sharply over the next 30 years.  Deducted against the current federal top rate of 35 percent, the marginal post-deduction cost of New York’s income tax rate is 4.45 percent — and that slightly lower rate applies to a broader base of income.

Proponents of higher income taxes on top earners also are fond of claiming that New York’s relatively flat graduated rate structure, under which the top rate applies to taxable incomes as low as $20,000, means that a middle-class working New Yorker is taxed as heavily as a millionaire.  But deductions, exemptions and tax credits—all of which are heavily tilted to low- and middle-income earners—also have a bearing on the final tax bill.

In fact, state tax statistics show that, in the most recent year for which comparable current-law data were available, the effective tax rate on New Yorkers earning more than $1 million was 6.1 percent—nearly twice the 3.1 percent effective rate on those earning between $25,000 and $50,000.   With the passage in 2006 of a new child tax credit, the effective rate for middle-class families has further decreased.  Low-income working people in New York generally pay no tax at all; instead, they receive a check from Albany, thanks to the nation’s most generous state earned income credit.

Rate comparisons

New York’s current statewide income tax rate is the second highest among major northeastern states.   Pennsylvania’s statewide income tax rate is only 3.07 percent, but it can rise as high as 6.98 percent due to local taxes in Philadelphia and other cities.   Since 2004, New Jersey has imposed the highest statewide marginal income tax rate in the region: 8.97 percent on incomes above $500,000 starting in 2004.   However, New York’s biggest concentration of wealthy taxpayers can be found in New York City—where the combined state and local income tax rate at the margin is 10.5 percent, the highest in the country.

$250,000-a-year “millionaires”?

Last March, Assembly Democrats approved a bill that would have established a new 7.7 percent rate on incomes over $1 million.  In August, the Assembly upped the ante, voting to raise the tax rate to 7.85 percent on incomes between $1 million and $5 million, and 8.6 percent on incomes above $5 million.  Senate Republicans and Governor Paterson opposed both tax increases.

The tax hike now being discussed in the Capitol would be much larger and further reaching, reportedly kicking in at taxable incomes as low as $250,000.  That would make even more damaging to the state’s long-term recovery prospects, especially given the likelihood that a state tax hike will be compounded, sooner or later, by a sharp increase in federal tax rates.

Governor Paterson repeatedly rejected last year’s proposals to raise the income tax.   But he has wavered repeatedly on the issue, and his budget falls well short of cutting spending by large enough amounts to close the budget gaps without raising revenues.  Instead, he has called for $4 billion in obnoxious nuisance tax and fee increases that have met with a predictably hostile reaction in the Legislature—begging the question of whether the governor is slyly inviting lawmakers (who aren’t known for their skill in coming up with spending cuts) to push the alternative of raising income taxes on New York’s (remaining) highly mobile economic decision-makers in the midst of a severe recession.

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