Preliminary Overview and Analysis

New York finally has a new state budget—more or less.

On Aug. 3, the state Senate passed a bill containing nearly $800 million in tax hikes and other provisions that represent the final piece of the budget for the fiscal year that began April.  Passage of the 2010-11 appropriation bills was completed by the Legislature June 28–after which Gov David Paterson vetoed thousands of line items, mainly legislative pork-barrel “member item” spending.  He also vetoed the Legislature’s attempt to restore $419 million in school aid reductions.  As first suggested here last spring, Paterson goaded a deadlocked Legislature into action by using his executive budget powers to craft spending “extender” bills that raised the specter of a government shutdown.

While total spending in the adopted budget does not appear to be much larger than Paterson originally proposed, it is likely to create much bigger problems down the road.  The budget gap for 2011-12, which the next governor elected in November will have to close, has been estimated at $7.5 billion.  But even before reaching that point, the state’s 2010-11 budget–like its deficit-ridden predecessor–shapes up as a flimsy house of cards that could begin to collapse before the year is out.

Spending

The “all funds” budget, including all federal aid, comes to $136.5 billion, up 5.7 percent from last year, according to the governor’s Division of the Budget (DOB).  However, DOB says this includes a $2.1 billion education aid payment that was deferred from the previous year due to the state’s cash shortage.  Adjusting for this change, and for accounting complexities related to temporary federal aid that is passed through to localities, DOB projects total spending is projected at $134.4 billion.  This is an increase of 2.4 percent over the adjusted figure for last year.  On the same adjusted basis, state operating funds spending is up 0.3 percent, the smallest increase since the mid-1990s.

But to get a clearer idea of the state’s recurring spending commitments, a further adjustment is necessary.  Adding back temporary federal stimulus funds used to supplement state funds in each of the last three years, state operating spending under the new budget is up a whopping 8.4 percent over 2007-08, although both personal income and private-sector economic activity in New York has dropped sharply during the Great Recession.

Including the DOB adjustment, this year’s budget will depend on at least $5.7 billion in temporary federal “stimulus” funding.  This equates to $5.7 billion in recurring state spending that must be permanently cut or funded with tax increases in order to balance the budget after the stimulus expires—which could be as soon as this year.

As usual, the Legislature failed to produce an updated financial plan clarifying expenditure totals before it voted on the budget.  Paterson’s DOB is not expected to release its own complete update until 30 days after the passage of the last budget bill—which will be around July 28.

Tax Increases

The 2010-11 budget will be financed in part by $1.2 billion in tax and fee increases, on top of a record $8 billion in statewide taxes and fee hikes adopted last year.  Most of this year’s new levies were included in a revenue bill passed by the Assembly in early July, which then stalled in the Senate for a month.

They include:

• Temporary reinstatement of sales tax on clothing purchases under $110, which is expected to raise $330 million.
• A restructuring of the state STAR tax credit program that will effectively boost New York City’s resident income tax by another 6 percent for high-income households.  This is expected to raise $120 million.
• A further reduction in allowable itemized deductions for taxpayers earning over $10 million a year.  The wealthiest taxpayers will now be able to claim deductions for only 25 percent of their contributions to charity.  The additional philanthropy tax will raise $100 million this year and $135 million thereafter.
• Deferral of tax credits earned by businesses that invest or create jobs in New York, which is expected to raise $100 million this year.  The deferred tax breaks—including investment, research and development, and brownfield development credits–will balloon to nearly $1.9 billion over the following two years, to be repaid (without interest) starting in 2013-14.
• An $1.60 increase in the state cigarette tax, raising the total to a prohibitive $3.40 per pack—highest in the nation.  The $290 million tax hike was adopted by both houses and signed into law as part of a separate bill in mid-June, was hailed by anti-smoking advocates.
• New taxes on “private label” credit cards issued by retail stores and on Internet hotel booking websites, such as Expedia, expected to raise $30 million.

The revenue bill passed by the Assembly originally included a provision designed to raise $50 million imposing state income tax on the investment income of nonresident partners in New York-based hedge funds—a move Mayor Michael Bloomberg called “the best thing that ever happened to Connecticut,”whose governor immediately invited New York firms to move to her state.  However, as part of the final action on Aug. 3, this tax was removed from the final version.

Borrowing

Paterson claimed that the budget contained “absolutely no borrowing.” This is true only in the narrowest technical sense, however.

Instead of selling deficit bonds to investors, the state will effectively borrow up to $2 billion from taxpayers over the next three years through the tax credit deferrals included in the revenue package. Another $1.5 billion will be borrowed during the same period by “amortizing” a portion of the state’s projected contributions to the state pension fund — a gimmick that theoretically could continue in perpetuity, if necessary.

The annual borrowing tab from these sources: $342 million in 2010-11, rising to $1.6 billion by 2012-13.

Risky Assumptions

The new budget also relies on a variety of assumptions that might not pan out, including:

• $250 million in “workforce savings” that have yet to materialize;
• a $300 million fee related to the installation of electronic slot machines at Aqueduct raceway, although a vendor has yet to be chosen;
• $70 million in savings attributed to renewed regulation of health insurance policies—an estimate that is dubious, to say the least;
• $220 million from more aggressive tax audits (as if state tax collectors were not already aggressive); and
• $150 million in taxes from sales to non-Indians on Indian reservations—an overdue move, but one that will be strenuously resisted by upstate tribes.

A solid preliminary rundown of the holes in the budget can be found in this preliminary analysis by the state comptroller’s office.

Another stimulus crutch

The 2010-11 state budget also assumes that Congress will extend “enhanced” Medicaid funding first made available under last year’s mammoth federal stimulus bill.  New York’s share would come to $1 billion in 2010-11, and another $1 billion in 2011-12.  However, the Medicaid funds were removed from the House version of the bill, and a measure including a reduced amount of Medicaid funding was recently stalled in the U.S. Senate.  As a result, Gov. Paterson successfully pressed the Legislature to adopt a contingency plan to cover the shortfall with reductions in local aid starting in mid September, if Congress doesn’t extend the funding.

The U.S. Senate took a big step towards approving the added Medicaid money in a key procedural vote on Aug. 4, the day after New York’s budget was finalized.  However, the bill also requires approval by the House, which might still reduce or eliminate the appropriation.   Even if Congress does clear more Medicaid money, it only postpones the inevitable day of reckoning for the state, which has failed to enact permanent structural reforms needed to bring the cost of government into line with economic reality.