From New York’s standpoint, the best that can be said of last week’s federal tax hike is that it could’ve been worse.

Taxes on the wealthy went up, but “wealthy” was defined as an adjusted gross income starting around $500,000 for married couples, instead of at the $250,000 level favored by President Obama. At least 150,000 New York state households, including small business owners, were thus let off the rate-hike hook — for now, at least.

Congress also rejected Obama’s proposal to disallow a significant chunk of itemized deductions in the top bracket, which would’ve hit New York’s tax base harder than any state’s. But the last-minute tax deal reimposed a less stringent limit on tax deductions, the so-called “Pease” provision, which was phased out under the Bush tax-cut law between 2006 and 2010.

 

This limit hits couples with gross incomes starting at $300,000 — although New Yorkers with incomes just above that level will hardly notice the difference, since most of them are also hit by the Alternative Minimum Tax, which doesn’t allow anydeduction for state and local taxes.

A small bit of good news in the deal is that it permanently linked the obnoxious AMT to inflation, which at least will prevent it from hitting any more people than it already does.

Meanwhile, the president clearly isn’t done pushing for higher taxes as part of future federal deficit-reduction packages. After the deal was sealed, Obama said he’d only agree to spending cuts that “go hand-in-hand with further reforms to our tax code so that the wealthiest corporations and individuals can’t take advantage of loopholes and deductions that aren’t available to most Americans.”

In other words, he’ll continue to target tax breaks most heavily used by high-income New Yorkers — even though he just agreed to a tax bill that renewed several highly questionable loopholes, including a motion-picture-production tax credit and full deductibility of gambling losses.

The tax-hike deal reportedly will raise about $600 billion over 10 years. That’s barely half the amount Obama had sought to raise in added taxes — but still plenty big enough to perceptibly squeeze the relatively small number of high-income households that generate an outsized chunk of New York’s state and city revenues.

Although the Empire State is home to just over 6 percent of the nation’s federal-income-tax filers, it appears that about 16 percent of the revenue raised by the feds’ tax-rate hike in the top bracket will come from New York’s tax base, including nonresident commuters who work here.

By contrast, New Yorkers will pay their proportionate share of the revenue from the expiration of the temporary 2 percentage-point cut in the federal payroll tax, which applies to the first $113,700 of all wages and salaries.

For taxpayers in New York state’s own temporary “millionaire tax” bracket, the new federal tax law will drive the combined federal and state marginal tax rate to within a percentage point of 50 percent — its highest level in 27 years.

And for New York City’s highest earning residents, the combined federal-state-local income-tax bite will now consume more than half of every added dollar of income for the first time since the mid 1990s.

Only million-dollar earners in California will now face a higher combined marginal tax rate than New York City’s 51.7 percent — including a newly increased federal Medicare tax, as well as the impact of the Pease deduction limit plus state and local taxes.

As their financial advisers will undoubtedly remind them, high-income New Yorkers who don’t like the idea of paying more than half their total income in federal, state and local taxes have no shortage of options for reducing their tax bills going forward.

They can, for example, rely more on income from long-term capital gains and dividends, which will now be taxed at a federal rate of up to 23.8 percent — 1 1/2 times the prior rate, but still considerably less than the new federal marginal rate of more than 40 percent on wages and income from self-employment.

They might also shelter more of their earnings in tax-free municipal bonds, or plow it into other tax-preferred investments like movies — which offer the added advantage of skirting or minimizing state and city tax.

Last but not least, the richest New Yorkers can always move to a place with lower state and local taxes — of which there are plenty of choices.

That’s something state and city officials ought to keep in mind as they weigh their own fiscal options in the new year.

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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