Lessons from New York’s financial mess

It has been a tough week for the State of New York. First came the news that the state will be facing a $2.3 billion budget shortfall. Then came the news that Amazon is cancelling its plans to build a second headquarters in Queens, NY citing opposition from state and local politicians, taking with it 25,000 jobs with an average pay of $150,000 and $2.5 billion in investment.

Let’s start with the budget shortfall. New York has the highest tax rate in the entire country according to CNBC. If you live in New York City, they have an additional income tax. The total state and local income tax in NYC could climb up to 12.6%. Add in federal income taxes and high-income earners will pay a marginal income tax of 50%.  We haven’t even started talking about property tax, sales tax (8.88%), estate tax (16%), etc. Prior to the federal tax reform of 2017, residents of high tax states like New York could deduct their state and local taxes from their federal tax return. The tax reform of 2017 capped such deductions at $10,000. This brought into focus the underlying structural problem which New York had created for itself over a long period of time resulting in the current shortfall.

New York’s progressive system has resulted in half the income tax revenues being paid by the top 1% of filers. A significant portion of these high-income people have their compensation tied to stock market performance either through direct investments or Wall Street bonuses. This makes their incomes, and in turn, the state’s revenues, highly volatile and susceptible to short term market fluctuations. Such dependency on the top 1% is a significant structural issue. As I opined in my Laying out the broad principles of tax reform column in November 2017, an effective system of taxation should have three components: It should have a broad base, a low rate, and should be easy to administer. New York’s tax structure of taxing just 1% of its filers with a confiscatory rate is in clear violation of at least the first two of those three components. This, in no small measure, has contributed to the problems of the state.

The problem doesn’t end there. In this day and age, capital and people are mobile. As Governor Cuomo accurately pointed out last week, “Tax the rich. Tax the rich. Tax the rich. We did that. God forbid the rich leave”. “This is not an academic discussion…People are mobile, and they will go to a better tax environment”, continued Cuomo. As more people leave, states like NY are left with fewer people shouldering the tax burden, further deepening the crisis. Add to it activists who drive companies like Amazon out of the state, then you have an economy that is sliding backwards.

One final point: Supreme Court Justice Louis Brandeis once wrote, “a state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.” The laboratory experiment of taxing the top 1% to the hilt along with a poor business climate has resulted in New York losing the rich to other low tax states. Just imagine the impact of proposals from the likes of Congresswoman Ocasio-Cortez, who wants a federal tax rate of 70%. How long before America’s rich find their homes in a low-tax country if such policies were implemented?