State Budget Tax Reform

Federal Tax Reform is Shaking Up New York’s Finances, but Flow of Bank Settlement Money is Bailing Out the State Budget

Jim Brennan The Federal tax law overhaul that took place at the end of 2017 capped state and local income and property tax deductions on Federal income tax returns at $10,000, damaging millions of New Yorkers’ (and tens of millions of other Americans’) ability to itemize deductions on their Federal tax returns. The change also resulted in sudden shifts in New Yorkers’ behavior toward their own New York tax payments. Over the past two budget cycles the changes have destabilized New York State’s tax revenue collection patterns and caused considerable uncertainty in the States’ budget and funding for the services New Yorkers rely upon.

A recent report by Moody’s Investors Service  indicates the fears of Governor Cuomo and other New York leaders that the Trump tax deductions cap will cause New Yorkers to flee the State may be exaggerated. But that report only reviewed New York outmigration patterns through 2017- this analysis focuses on immediate changes in New Yorkers’ behavior as New York taxpayers and how those changes have affected the past two budgets and the one just adopted. How many New Yorkers will leave the State remains unknown.

In December 2017, following Congress and Trump’s tax reform, the State government experienced a sudden spike in tax payments as New Yorkers chose to make tax payments in 2017 rather than 2018 so they could still deduct in excess of $10,000 in New York taxes from their Federal returns, and avoid the future limits on deductions to the extent that they could. According to a State Comptroller 2018 report, the State Division of the Budget estimated that $1.9 billion came into the New York treasury that represented an acceleration of 2018 tax payments into 2017 to take final advantage of deductibility. As a result, New York’s tax revenue rose more than 6% in 2017-18 over 2016-17. But, of course, it was anticipated that these 2017 payments would affect 2018 payments and that tax collections would correspondingly fall in 2018. At the time of budget adoption in 2018, the State predicted tax revenue would fall 2% in 2018.

In December 2018 and January 2019, however, tax collections fell precipitously, resulting in a $3 billion drop below estimates made at the time of the April 2018 budget enactment, for a total drop of $ 4.4 billion, or 6.4% below the 2017-2018 budget, not 2%. Many wealthier taxpayers, with large incomes from capital gains, pay significant portions of their New York State taxes in quarterly estimated payments, including a regular January quarterly payment, rather than in withholding taxes, which are usually related to wages and salaries. Before the Federal tax overhaul, New York taxpayers had an incentive to make their January estimated payment in December to assure they could take their tax deductions for that year on their Federal return. But with itemization nearly wiped out, the incentive to make the estimated tax quarterly payment early disappeared. The loss of this incentive is believed to be the main factor in the dramatic revenue declines this past December and January.

The State Division of the Budget believes that some of the money might be recouped in estimated payments in the quarter following this past January ( this current April 2019), but since the State adopted its budget April 1st, there was no way to know how much of the money might be recouped. Instead the Governor and the Legislature chose caution and limited spending increases this year. New York is not going broke, and the economy and tax revenue are still anticipated to grow, but the shock from the billions in lower revenue informed a cautious approach. The 2018 stock market decline also affected New York’s tax revenue from capital gains. For the first time in many years the Governor and the Legislature added to the Rainy-Day Reserve Funds rather than add a lot of new spending.

Shoring up the State’s financial situation has been an extraordinarily fortunate additional development over the past few years. Litigation against the financial industry for wrongdoing that occurred during the Great Recession has resulted in many banks and financial companies agreeing to settle lawsuits for fraud and other problems with New York State for almost $12 billion dollars since 2015!!! New York spent much of the first of these settlement dollars on economic development to help the stagnant economy in Upstate New York ( , but in 2017 and 2018 $2 billion more has come in from new financial settlements, and the State has simply used the money to bail out the State budget and fund the MTA.

In the 2017-18 budget year the State put $461 million from over $800 million in new settlement funds that year into the State budget, and set aside $155 million to cover future labor contract increases. In the adopted budget of 2018-19 ( a year ago last April), the State took another $383 million from financial settlement funds to put into the budget, and took $ 194 million of additional settlement funds to help pay for the one-time 2018 cost of the MTA Subway Action Plan ( 2019 and beyond was covered from a tax). But as 2018 progressed, an extra $1.2 billion more in Financial Settlement funds came into the State Treasury that had not been booked by the State in the April budget adoption ! In the budget just adopted a week ago, Governor and the Legislature took $336 million of the new money to cover the bills for the early 2019 winter shortfalls related to the apparent taxpayer behavior changes, and have set aside more than $ 600 million from the Financial Settlement Funds in Reserve Funds to reduce future risks in the case of economic downturn, Federal cutbacks, or other problems. The combination of Rainy-Day Funds and Financial Settlement Reserves now totals $ 5 billion for the 2019-2020 Fiscal Year.

In an important revenue action, the State renewed the higher rate for taxpayers with incomes over $2.2 million at 8.82%, yielding $ 770 million this year and an extra $4 billion next year, for five full years. School aid received a 3.7% increase (NYC got 3.4%). The Legislature restored $ 550 million for the Medicaid program that the Governor tried to cut after the shortfalls appeared. The minimum wage increase that took place on Jan. 1, 2019, to $15/hr., necessitated $700 million in additional Medicaid spending to cover the cost of raising the pay of workers in hospitals, nursing homes, and home care agencies who made less than $15 an hour in New York City, as well as somewhat lower raises outside the City. The State anticipates tax revenue will recover from the decline this past December and January, although overall it will be lower than had been hoped last year.

The challenges to fund the MTA will continue, since the tax and fee increases to assure $25 billion for its 2020-24 Capital Plan don’t approach the $40 billion estimated to be needed for that plan or the $7 billion for the current plan- 2015-2019- that remains unfunded. But don’t expect more tax increases for the MTA in an election year in 2020.

Jim Brennan was a member of the New York State Assembly for 32 years and retired at the end of 2016. He chaired four committees, including the Assembly Committee on Corporations, Authorities, and Commissions for six years, the Committee on Cities for five years, and the Committee on Mental Health and Developmental Disabilities for six years. There are 96 Brennan laws on the books of the State of New York and Jim won three national awards for his legislative work during his career.

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