Governor Spitzer’s first Executive Budget would raise state spending by up to three times the projected rate of inflation in the fiscal year that begins April 1.

The “state funds” share of the governor’s $120 billion total budget (excluding federal aid) would rise from $77.5 billion to $83.6 billion. That’s a growth rate of 7.8 percent, during a period when the Division of the Budget projects inflation at 2.6 percent. Spitzer is calling for the largest proposed state-funded spending hike since the nearly 9 percent growth rate in then-Governor Pataki’s 1998-99 Executive Budget, as illustrated below.

As noted in previous NYFiscalWatch memos concerning the annual Executive Budget, the spending figures in the Governor’s proposal traditionally are viewed as the floor for further negotiations with the Legislature, which invariably wants to spend more on nearly everything.

Proposed and Enacted State Funds Spending Increases Fiscal Years Ending March 31, 1996-2008

Source: Executive Budget, Division of the Budget. Enacted budget increase based on final close-out figures for all years except FY 2006-07, which is preliminary.

As shown in the chart, the Legislature added spending to Pataki’s proposal almost every fiscal year. The rare exceptions included:

• 1998-99, when Pataki proposed an exceptionally big spending increase of nearly 9 percent – and then succeeded in vetoing many legislative additions.
• 2001-02, when the Legislature’s spending demands were necessarily tempered by the revenue downturn in the wake of the 9/11 attacks.
• 2002-03, when further sharp drops in revenue forced the governor to make significant mid-year adjustments in enacted spending.

In his last four years as governor, the cumulative total of Pataki’s proposed hikes in state-funds spending was 17 percent. But the budgets enacted over this period—including many legislative add-ons that Pataki agreed to, and others he unsuccessfully tried to veto—raised spending by 35 percent. When Pataki proposed a 7 percent state funds spending hike for fiscal year 2006-07, the result was a net increase of more than 11 percent—the biggest surge in state spending since Cuomo’s heyday in the 1980s.

Dealing with shortfalls

As of October, Pataki’s final mid-year financial plan had projected a budget gap of $2.4 billion for 2007-08; that is, baseline spending was on track to exceed revenues by that amount. Thanks to higher-than-expected revenues and lower-than-expected spending, the gap confronting Spitzer when he took office last month had shrunk to $1.6 billion, according to the new governor’s first set of fiscal projections. Spitzer proposes closing nearly two-thirds of the gap with one-shot measures, including $600 million in surplus funds from prior years.

Looking ahead, assuming his budget is adopted with no changes, Spitzer projects future budget shortfalls of $2.7 billion in 2008-09, $4.9 billion in 2009-10, and $6.7 billion in 2010-11. He proposes using $1.2 billion in surplus funds to reduce these future gaps in even increments of $400 million a year.

Chronic projected shortfalls in the “out years” of the state financial plan reflect a continuing imbalance between recurring revenues and recurring expenditures. Stronger-than-expected economic growth made it possible for the Pataki administration to close similarly large projected gaps over the past three years. However, especially in light of Spitzer’s significant new spending commitments, the gaps mean the state remains vulnerable to any downturn in securities industry profits, capital gains and real estate profits, which have accounted for most of the state’s marginal revenue gains since 2003.

Tax Shifts, Loopholes and Increases

One of the largest new items in the budget is an expansion of the existing School Tax Relief (STAR) program, through which the state finances a partial school property tax exemption on owner-occupied homes. Spitzer would increase existing STAR exemptions by up to 100 percent over the next three years for qualified “middle-class” homeowners. A Jan. 8 NYFiscalWatch Memo explains and dissects the STAR proposal and its impact in further detail. STAR tax breaks flow as aid to school districts, which in turn must distribute the money to homeowners according to a set formula.

The governor also has proposed $449 million in what he calls “revenue loophole closures.” However, at least half of this money would be raised through material changes in tax law that could be more accurately described as tax increases for the affected payers.

In addition, the governor has proposed fee increases including $75 million from increasing the “covered lives assessment” paid by health insurance companies (and effectively passed along through insurance premiums) and $25 million—rising to $100 million when fully implemented in 2008-09—to come from unclaimed 5-cent beverage deposits, which bottlers now use to cover costs of handling containers.

What’s driving state funds spending?

As shown in the following table, virtually all of the $6 billion state funds increase is distributed among a dozen spending categories. These include additional STAR payments, which are properly accounted for in the governor’s budget as a spending item. Fully half of all new spending, including STAR and funding for the State University and City University systems, falls into the education category.

Outlook

Pataki set relatively high spending floors in each of his last three budget plans. The predictable result: the budget increased more in his last three years than in any comparable period since former Governor Cuomo’s second term.

As a new governor, Spitzer clearly believes he can be more successful in curbing legislative demands for higher spending-with vetoes if necessary. His success will hinge on his ability to minimize changes to his education and health care proposals. If he fails, spending in the next state budget will once again approach or exceed double-digits—a trend that, given New York’s population losses and sluggish economic growth, clearly will be unsustainable in the long term.

Notes

1. See p. 168 of the 2007-08 Executive Budget, Economic and Revenue Outlook.
   
2. A loophole is customarily defined as a provision of tax law that a taxpayer can circumvent without actually breaking the law. However, the largest of Spitzer’s changes would raise $200 million in state funds from requiring “combined reporting” of subsidiary income on corporate tax returns. This changes a 62-year-old provision of state law designed to encourage companies to locate headquarters in New York. And the impact on New York City-based companies is effectively doubled, since the budget also would change the city’s tax code to conform with state law.

Originally Published: FISCALWATCH MEMO February 2, 2007