Governor Paterson and state legislative leaders announced today that they’ve agreed to use most of New York’s unfettered federal stimulus money to restore spending to the governor’s budget and to avoid any further spending cuts.  The result will be to partially re-inflate an unsustainable budgetary baseline and to expand the budget gap in future years.

Of course, that’s not the way they put it.  Instead, the governor’s press release headlined an “agreement to eliminate $1.3 billion in planned tax increases,” which was his focus at a Capitol news conference.  And Paterson used the occasion to warn again that “we cannot treat a temporary windfall from Washington as an excuse to avoid the tough choices we must inevitably make to get our fiscal house in order.”

But do the math: Paterson’s proposed tax and fee increases came to over $4 billion.  Today’s deal affects only one-third of that amount.

Meanwhile, Albany’s share of the so-called “State Fiscal Stabilization” portion of the stimulus–a virtual block grant from Washington, funneled mainly through the federal Medicaid reimbursement formula–apparently will approach $5 billion for 2009-10 alone.  Paterson, Assembly Speaker Sheldon Silver and Senate Majority Leader Malcolm Smith have agreed to use just over one-quarter of that amount to avoid higher taxes and fees.

So, what what will the Governor and Legislature do with the remaining three-quarters of the money?  Well, they’ll need $370 million to fill a hole left by the collapse of the Aqueduct casino deal.  And their recent consensus revenue agreement indicates they’ll need to cover another $1 billion in falling tax receipts. That still leaves more than $2 billion for other purposes.

Now consider this: not counting the governor’s baseline reduction in school aid, which will be largely restored by separately targeted provisions of the federal stimulus bill, the actual cost-containment actions and baseline spending reductions in Paterson’s budget (mainly avoided increases, rather than actual “cuts”) came to about $3.7 billion.  So, at their joint appearance today, the governor took a giant step towards conceding that he will allow Senate and Assembly Democrats to use the stimulus money to reverse more than half of the non-education spending restraint he originally proposed–while leaving two-thirds of his original tax and fee hikes on the table.  And Assembly Speaker Sheldon Silver is still widely expected to propose some form of “millionaire tax” on top of that (although Paterson, as of today at least, is still rejecting it).

It doesn’t have to be this way.  State Senate Republicans last week proposed an alternative budget plan that, by their description, would have accepted many of the governor’s spending recommendations while using the stimulus money to avoid any tax or fee increase.  Assume, for the sake the argument, that the GOP plan relies on creative accounting and is not solidly balanced enough to withstand further revenue erosion.   Still, all you need to do is drop the Senate’s ill-advised restoration of the STAR property tax rebate, and you’ve got another $1.7 billion in breathing room.

Since the federal stimulus package only extends through fiscal 2010-11, why is it preferable to use stimulus funding to hold the line on taxes rather than increase spending?  Because further annual spending increases will only compound the structural budget gap, making the future problem bigger.  A dollar in avoided tax hikes will add less to future gaps than a dollar of added spending–and it will help avoid further suppression of economic activity at the worst possible time.  (Of course, the ideal course would entail larger spending reductions for the future, but no one in Albany is currently headed that way.)

As the Senate Republicans have shown, a balanced 2009-10 state budget without tax hikes is feasible.  So why won’t the Democrats who now control both houses of the Legislature join their governor in doing just that?  Because their aim is not restore only some of the spending removed by Paterson.  Their apparent goal–notwithstanding Silver’s assertion today that the Assembly knows “deep cuts have to be made”–is to loosen the budget belt a lot more.   Meanwhile, perhaps Silver will juxtapose an income tax hike for high-income households against some of the Paterson tax and fee proposals still on the table.

At this rate, next year’s State Funds spending increase (counting the stimulus as a temporary “special revenue-other” replacement, rather than as a permanent federal aid formula increase) will come to 4 percent.  It could be considerably more, depending on whether the Legislature is able to roll Paterson on the income tax issue, and on how they use the money.  In a deflationary environment characterized by sharply falling employment and personal income–indeed, the worst economic conditions most of us have ever seen, with the Wall Street heart of the state’s revenue base in a shambles–that would be incredible.