Seven years after Mayor Giuliani led New York out of its last fiscal crisis, the city’s budget has now come almost full circle.

Giuliani took office declaring that city government was too big and taxes were too high. His first two budgets cut the headcount of city employees and reduced spending, setting the stage for both tax cuts and a series of surpluses.

But that fiscal discipline had begun to unravel by the middle of the mayor’s first term. Over the past four years, the city’s spending on operations has risen so fast that it has now caught up with and surpassed the revenue bulge accumulated during the 1996-2000 economic boom.

* The latest adopted budget, which Giuliani has submitted to the state Financial Control Board (FCB) for certification this week, will raise the city’s employee headcount to a new high and increase city spending at nearly twice the inflation rate.

* Worse, for all intents and purposes, it contains an operating deficit of more than $2 billion. Prior year surpluses are being used to keep the budget in balance. But bigger gaps are projected for the future—up to $5 billion by 2005, according to some fiscal monitors.

In the kindest light, Giuliani’s last budget might be viewed as a deliberate ploy to make it harder for his successor to increase spending—”Rudy’s revenge,” as Cooper Union Professor Fred Siegel puts it. Unfortunately, at a time of economic uncertainty, the budget also effectively forecloses the single most effective tool for promoting continued economic growth—broad-based tax cuts.

To their credit, Speaker Peter Vallone and the City Council went along with Giuliani’s plan to shave a bit more off the surviving Dinkins-era income-tax surcharge this year. But council members used projected budget gaps as an excuse to back away from Giuliani’s proposal to finally eliminate the Commercial Rent Tax (CRT), an early-’60s relic unique to New York. They opted, instead, for a small re- duction in the tax.

The continued survival of the utterly indefensible CRT broadcasts a dangerously negative signal to a business community worried that, for all the shortcomings of Giuliani’s tax program, the next few years could be worse.

Given what passes for “economic development” policy in New York, the council sent a truly schizophrenic message to the business community: We’ll continue to hit you with this extraordinary, costly tax if you employ a lot of people in expensive space below 96th Street Manhattan. If this makes you angry enough to publicly threaten a move to Jersey City, we’ll offer tax abatements to change your mind.

New York remains, by far, the most heavily taxed big city in America. Reductions in this tax burden would provide essential fuel for renewed economic growth over the next few years. Unfortunately, the city’s tax-cutting program has sputtered almost to a halt.

Of course, this would have required a fresh commitment to curbing spending—something the city hasn’t seen since Giuliani’s second year in office.

Personnel costs consume more than half the budget, so efforts to save money have to focus on the workforce. Giuliani has added a net 4,000 workers to the payroll since taking office, but his 1993 campaign platform suggested that 35,000 positions could be eliminated. This was by no means an outrageous idea. For example, an advisory panel appointed by Mayor Dinkins concluded in late 1993 that the headcount could be reduced by 25,000.

Achieving the less ambitious goal of eliminating 20,000 full-time positions—bringing the headcount back to 1996 levels—would generate $1.15 billion a year in budget savings. A good starting point would be the staffs of city elected officials, which have expanded by some 2,000 employees in the past 20 years.

Another $1 billion in savings could be realized over the next few years by reforming the city’s employee health-benefits coverage, scaling back the city’s overly ambitious capital program, freezing non-personal service costs and making targeted cuts in non-essential spending programs. One of the more obvious cutback candidates is the $130 million budget of the city Department of Cultural Affairs—now twice the size of the New York State Council on the Arts and significantly better funded than the National Endowment for the Arts.

Added together, these suggestions would amount to $2.8 billion—equal to the largest gap Giuliani projected in his last four-year fiscal plan. That’s just a down payment on what is needed to give New York City the tax climate it needs to generate sustained economic growth.

Since the city’s tax burden falls most heavily on businesses and on a relatively small number of wealthy residents, the political course of least resistance for any New York mayor is to continue expanding public spending—a tendency already on vivid display in the early stages of the mayoral campaign.

But in the long run, New York’s own recent history shows the best prescription for political and economic success is to get the budget under control—before it’s too late.