Advocates of the misnamed “millionaire’s tax” enacted in New York state last year claimed that it would restore “fairness” to a tax code that favored the rich. But thanks to the complex interplay of federal and state tax rules, Albany’s share of all income taxes paid by New York’s wealthiest residents has actually been rising since the 1970s. And it will soon rise to its highest level ever — unless President Obama and congressional Democrats reverse course.

Obama won office on a promise to return the tax rates on the top two income-tax brackets (now 33 percent and 35 percent) to the levels in effect in 2000 (36 percent and 39.6 percent) — and his latest budget still promises to let those Bush-era tax cuts expire next year.

So the state couldn’t have picked a worse time to enact yet another “temporary” income-tax hike — yet that’s precisely what Gov. Paterson and the Legislature agreed to do last spring, as part of the 2009-10 state budget. This hike has raised the top state rate to 8.97 percent on filers with taxable incomes of more than $500,000 (and to 7.85 percent for those starting as low as $200,000).

It hasn’t raised as much money as they hoped for, though: Revenue from New York’s tax hike on high earners was coming in $400 million below the governor’s original estimate for this year even before he announced Wednesday that income-tax collections in January had fallen another $1 billion short of projections — a result, in part, of investment banks’ decision to shift some bonuses from cash to stock options. Simply squeezing harder on higher earners wasn’t such a smart strategy, it seems.

On the face of it, New York state’s top rate is still much lower than the all-time high of 15.35 percent reached in the mid-’70s. But, thanks to changes in federal deductibility, the effective rate is actually higher now than it was 35 years ago.

And current tax trends in Washington will push New York’s net income-tax cost — the difference between earning income here and in a no-tax state, such as Florida or Texas — further beyond ’70s levels, even if the higher state rate expires on schedule in two years.

The reasons lie in the complex way that the state tax code interacts with the federal one. Back in the ’70s, the top federal income-tax rate was 70 percent. But itemized deductions for all taxpayers — including deductions of state and local taxes — were unlimited, which effectively meant that those state and local taxes were discounted by 70 percent.

So, when New York’s top income-tax rate hit its 15.35 percent peak, the effective marginal rate after federal deductibility (that is, the rate of taxation that the feds didn’t shield taxpayers from) was a much lower 4.6 percent.

Thus, while the total tax burden was staggeringly high in the ’70s, federal deductibility gave high-tax states like New York some shelter against competition from low- or no-tax states like Florida and Texas.

The next two decades brought major changes. By 1997, after 20 years of tax cutting under both Democratic and Republican governors, New York’s top state income-tax rate had hit a 40-year low of 6.85 percent.

Federal rates also fell significantly. But, starting in 1990, the feds also introduced new limits on the deductibility of state and local taxes for top-bracket taxpayers.

The paradoxical result of all this was that New York’s effective top rate rose. In other words, the net-tax cost of living in New York compared with a state with no income tax is now higher than it was 30 years ago. As of 2010, the effective rate stands at 5.8 percent statewide.

And now the Bush tax cuts are due to expire at the end of this year. That includes Bush’s phase-out of the cap on state and local tax deductions. Indeed, Obama wants to further limit these deductions.

The result, we estimate, will be to push up New York’s effective tax rate to 7.3 percent — its highest level ever.

In New York City, the combined effective rate of state and city income taxes will be almost 10 percent — and the total federal, state and city income-tax bite will exceed 50 percent for the first time in more than a quarter-century.

Impending federal tax changes also are likely to shrink the pool of taxable income for both the state and city governments, since top-bracket earners faced with steep increases in federal tax rates will have more incentive to shelter some income or move to a state with lower taxes.

The specifics remain unsettled. But the trend in federal tax rates and rules is deeply unsettling for New York’s economic and fiscal outlook — and at the worst possible time for New York’s battered economy.

About the Author

E.J. McMahon

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

Read more by E.J. McMahon

You may also like

Hochul Tells It Like It Is

Presenting her budget this week in Albany, Gov. Kathy Hochul delivered more than just a financial plan. She gave the state a refreshing dose of fiscal honesty. “The truth is,” Hochul said, “we can’t spend like there’s no tomorrow, because tom Read More

Putting Hochul to the test: Will the governor use her budget powers to protect New York’s fiscal future?

“We will not be raising income taxes this year,” Gov. Hochul declared in January at the opening of New York’s 2023 legislative session. Read More

What Gov. Hochul must do to prevent a coming fiscal crash

The pandemic and its fiscal aftermath have given rise — temporarily — to a state budget trend unique in New York’s history. Read More

Bear market spells big trouble for NY state and city budgets

Wall Street generates an outsized share of New York’s tax revenue, so the recent drop in stock prices should worry both Gov. Kathy Hochul and Mayor Eric Adams. Read More

Calling Tax Cut “Theft,” Cuomo Continues to Push For Federal Bucks With Phony Math

The results of this week’s Georgia Senate runoffs, assuring Democrats will soon control both houses of Congress, as well as the White House, had to come as a huge relief to Gov. Andrew Cuomo. Read More

Students Need Reforms, Not HEROES

Families and businesses are watching their bottom lines and stretching each dollar. But House Democrats are pushing a plan to prevent America’s schools from doing the same thing. Read More

Washington shouldn’t fund NY’s “normal” budgets

With the coronavirus lockdown continuing to erode tax revenues, Gov. Andrew Cuomo has turned up the volume on his demands for a federal bailout of the New York state budget. In a weekend briefing, the governor repeated his estimate that the Empire State will need help closing a deficit of $10 billion to $15 billion. “I don’t have any funding to do what I normally do,” he said. Read More

Cuomo’s Plate Spinning

Governor Cuomo’s license plate design contest was a PR ploy masking a nickel-and-dime revenue raiser. Read More