Civil Service Enforcement/Research Department

TO:                 Executive Board Members, Statewide Labor Management Chairs, and Council Leaders

FROM:           Frank Mauro, Executive Director, Fiscal Policy Institute

                        Thomas E. Cetrino, Director of Civil Service Enforcement/Research

DATE:            December 20, 2002 (includes minor revisions from the December 6, 2002 memo)

RE:                 Revenue Options to Help Reduce the State’s Projected Deficit of

                        $8 to $10 Billion Over the Next 17 Months

Note:  Minor revisions were made to sections C and D of the December 6, 2002 memo on the same topic

            Two weeks ago the Civil Service Enforcement/Research Department forwarded you a memo that outlined the extent of the State’s serious fiscal problems and detailed the reasons why the State will run a deficit of $1.5 to $2 billion in this fiscal year and another $6 to $8 billion in SFY2003-04. That memo also discussed a few one-shots that the State may use to close both this year’s and next year’s budget gaps.  However, to close a budget deficit this large the State must raise revenue at least for the next two years, the time period that our budget deficit problems are likely to continue. 

            While there are ways to raise revenue that do not involve increases or surcharges on current broad-base taxes like the personal income tax or corporate franchise tax, the best way to raise revenue fairly is through broad-based taxes.  Groups like the New York State Business Council claim that tax increases during a recession are bad economic policy that will result in fewer private sector jobs.  Their view is contradicted by many mainstream economists including Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics, and Peter Orszag of the Brookings Institution.  In several publications, Stigliz and Orszag have stated, “If anything, tax increases on higher income households are the least damaging mechanism for closing state fiscal deficits in the short run.  Reductions in government spending on goods and services, or reductions in transfer payments to lower-income families, are likely to be more damaging to the economy than tax increases focused on higher-income families.”

            The model the Business Council and its business-funded “think-tanks” use to project job losses from certain tax increases is not considered credible by most mainstream economists.  It also neglects to factor in the direct public sector and health care sector job losses created by their alternative proposals to close the State budget deficit.  Nor does it acknowledge the negative multiplier effect of such job losses.  Their proposals call for:

1.      a 20,000 employee reduction in the State workforce,

2.      a 1,000 employee reduction in the State Court system workforce,

3.      no contractual increases for the next three-year contracts for State employees,

4.      give-backs on State employee health benefits,

5.      privatization of services currently provided exclusively by State employees, and

6.      significant cuts in Medicaid and education aid.

These proposals will result in the loss of at least 60,000 jobs while the State income tax surcharge proposal supported by the AFL-CIO would, according to the discredited model used by the business community, allegedly result in the loss of 46,000 jobs.  The following is a list of options that will raise revenue and reduce the amount of spending cuts needed to close the impending State deficit.

A.  Federal Help - Direct and Indirect

1.   Reimbursement for all or some of NYS and NYC tax revenue losses directly attributable to the World Trade Center disaster.  This can be done with federal legislation that deals specifically with New York or federal legislation that amends the federal Stafford Act to address this issue more generally in a way that helps New York but which would also help any other areas of the country that may suffer huge revenue losses in the future as a result of terrorist attacks.  Members of the New York congressional delegation, led by U.S. Representative Carolyn Maloney, and Senators Schumer and Clinton, have recently introduced legislation (HR 5523 and S 3055) that would repeal a $5 million limit that was placed on the loans that FEMA can make to local governments for this and other disaster-related purposes, and make states eligible for such assistance.  Under current law, only local governments are eligible for such assistance. The bill would also not require repayment of the loan when the revenue loss is caused by a terrorist attack.

2.   Federal fiscal relief to the states.  In late July, the Senate adopted an 18-month “state fiscal relief” measure as an amendment to the Schumer-McCain Prescription Drug Reform Bill.  While this amendment passed by an overwhelming bi-partisan majority (75-24), neither the House of Representatives nor the President have gotten on board.  This proposal would have provided the states with $7 billion of fiscal relief over the next 18 months.  New York would have received about $1.1 billion of that assistance.

B.  Reestablishing a Fair Personal Income Tax System.  

It is important to note that any increase in the State personal income tax would be offset by the Federal income tax reductions that all taxpayers received in their 2002 returns and will receive in their 2003 and subsequent years’ returns.

1.   A Modest Temporary Personal Income Tax Surcharge for the Wealthiest New Yorkers.  The AFL-CIO has endorsed a plan that would add for two years a surcharge of seven tenths of one percent (.007) on the portions of a taxpayer’s New York Adjusted Gross Income above $100,000 and another seven tenths of one percent (.007) on the portions above $200,000.  It is estimated that this approach would generate between $2.7 and $3 billion per year.  This proposal would raise New York State’s top income tax rate from the current 6.85% to 8.25%, the same top rate that North Carolina has adopted for the 2001, 2002 and 2003 tax years (up from its permanent top rate of 7.75%).  Appendix 1 contains a chart that details how much the federal income tax will decrease for a family of four and how much of this tax cut they would retain under this State surcharge proposal. 

2.   A Temporary 1% Increase in the Top Income Tax Bracket. The Schuyler Center for Analysis and Advocacy (SCAA) has developed a plan for adding a temporary additional one percent tax on the portion of taxable income over $100,000 for individuals, over $200,000 for married couples, and over $150,000 for heads of households.  This change is estimated to increase revenues by approximately $1.6 billion per year.  SCAA has advocated that such a tax increase be part of broader tax reform that also decreases taxes for the working poor by developing and expanding a number of New York tax credits such as the Earned Income Tax Credit (EITC) and the Child and Dependent Care Credit.  Full enactment of these tax credits would reduce the net gain of this proposal to $1.1 billion.

3.   Adopt Another So-Called “Business Friendly” State’s Income Tax Structure.  The Institute for Taxation and Economic Policy has estimated, for example, that New York State would collect an additional $4 billion per year if it replaced its entire bracket structure with the North Carolina bracket structure.

4.   Defer all, some, or none of the tax cuts scheduled to take effect during 2002 or on or after July 1, 2002, or on or after January 1, 2003.  Appendix 2 contains a complete list of future major tax cuts.  Many believe that that it would be unwise to fight for a postponement of the scheduled personal income tax cuts because these changes benefit many low-income, working families and families with children attending college. The corporate tax cuts if rescinded will not raise a significant amount of revenue.

C. Eliminate Corporate Tax Loopholes So All Corporations Pay Their Fair Share Of Taxes

It is important to note that some of these options, if adopted, would subsume savings from other options.  We will note that when we estimated the revenue generated with each option. Overall, when we include the savings from decoupling from the federal bonus depreciation tax credit discussed in section E we believe the State can generate $1.5 billion annually by closing corporate loopholes discussed in sections C, D, and E.

1.   Adopt Combined Reporting.  New York should join California, Colorado, Illinois, New Hampshire and the 12 other states that use a reform called “combined reporting” to prevent profitable multi-state and multi-national corporations from avoiding state corporate income taxes through something called “transfer pricing.”  Through the aggressive use of “transfer pricing,” such corporations can shift income and expenses among their numerous (sometimes in the hundreds or thousands) subsidiary corporations in order to reduce their overall tax liability by having inordinately large portions of their income show up in subsidiaries that are only taxable in so‑called offshore tax havens where tax rates are inordinately low, or in states that do not have corporate income taxes, or in states (like Delaware) that have corporate income taxes but which do not tax the income from trademarks and other intangibles.  (Note: as with other corporate tax reforms, this would help NYC and the MTA as well as NYS since NYC also has a corporate income tax and the MTA receives the proceeds from a 17% surcharge on the portions of State corporate income tax revenues that are attributable to the MTA region.)  Based on estimates of the impact of a proposal by Wisconsin’s former Governor Tommy Thompson to adopt combined reporting in that state, this could raise New York State’s corporate tax revenues by 13 to 15%.  This would raise between $340 and $392 million annually.

2.   Reform or Replace NY’s Current Alternate Minimum Tax.  New York’s current Corporate Alternate Minimum Tax (AMT) was enacted in 1987 as part of a general corporate tax reform.  The AMT was intended to curb the impact of specific loopholes by not allowing their use to cut a corporation's franchise tax below a certain level.  Beginning in 1994, however, the state began to add loopholes to the AMT itself and then, in 1999, it cut the AMT rate from 3.5% to 2.5%. 

a.   Fix the current Corporate AMT.  New York State should eliminate all of the loopholes that have been added to the AMT and restore the AMT rate to 3.5% from the current 2.5%.

b.   Adopt a new State Corporate AMT based on the model of the federal government’s Corporate AMT.  The federal corporate alternate minimum tax requires corporations to use the same financial accounting they use to report to their shareholders to calculate an alternative minimum tax.  If New York adopted such an approach, it would improve the odds that a profitable corporation would pay at least some tax. 

c.   Adopt a new State Corporate AMT similar to the new Corporate Alternate Minimum Assessment (AMA) enacted earlier this year by New Jersey.  The reformed New Jersey AMA applies to businesses with gross profits of $1 million or more, with those businesses subject to a new low rate assessment on either the portion of their gross profits over $1 million or the portion of their gross receipts over $2 million.  This new assessment is estimated to raise between $202 and $234 million per year in New Jersey.  In New York, a similar assessment would probably raise at least between $400 and $460 million per year.

3.  Enact a Corporate Disclosure Law.  New York State should require every publicly-traded corporation that does business in the State to report its gross and net income, deductions and credits, and the amount of New York state taxes paid, much as corporations already do at the federal level.  This would allow taxpayers and policy makers to identify companies in the State that may be making profits but, through the use of clever business structures and tax expenditures, are paying little or no New York taxes.  Only with that information can the State truly know how well its tax policies are working. 

D.  Eliminate Specific Corporate Loopholes That Don’t Create Jobs.   

1.   Repeal the Investment Tax Credit ($163 million) or reform it by tying this credit to the actual number of jobs created and retained.  Most of this revenue would be offset by the revenue generated by adopting a new corporate Alternative Minimum Tax since most corporations reduce their State tax by using the Investment Tax Credit.

2.   Reduce the exclusion of subsidiary income ($100 million).  Most of this revenue would be offset by the revenue generated by adopting a new combined reporting law.

3.   Reduce the exclusion of investment income ($140 million).

4.   Limit Industrial Development Agency's ability to abate State taxes ($60 million).

5.   Reduce abuse of point‑of‑service exceptions ($75 million).

6.   Recover subsidies from firms that do not live up to the conditions of tax abatements ($15 million).

7.   Eliminate last step of corporate surcharge reduction ($250 million). This last step of this surcharge reduction has already been implemented so to achieve this revenue we would have to reinstitute the last phase of the surcharge.

E.   Ensure Federal Tax Cuts Do Not Further Erode New York State Revenues

1.      Decouple from Federal Bonus Depreciation Tax Cut.   From the late 1980s until 2001, nearly all states used the federal definition of taxable business income — including the federal allowance for depreciation — as the basis for their own tax calculations.  A federal tax law enacted March 9, 2002, however, created a new tax deduction for "bonus depreciation" that will cost states very large amounts of revenue.  This tax reduction gives corporations a reduction in their federal and NY State corporate franchise tax for investing in new equipment no matter where those investments are made (including foreign investments).  The revenue loss to New York State from this tax cut will be between $270 and $545 million in SFY2003-04. New York City would also lose substantial revenue due to this tax cut.

      Thirty states plus the District of Columbia that previously followed federal depreciation   rules are now decoupled from federal tax law — in effect, disallowing the new bonus             depreciation provision in their states.   Last year, the New York State legislature, with the           Governor’s support, elected not to decouple from this federal tax cut. They should        reconsider this decision in light of the current deficit and the fact that New York is giving a          tax cut it cannot afford to businesses that make investments outside of NY or the country.

2.   Remain Decoupled from the Federal Estate Tax Cut.  Last summer's federal tax legislation includes a phase-out of the federal estate tax, culminating in full repeal in 2010. On a much faster track, the legislation repeals over the next four years the federal estate tax credit to which state estate taxes are tied.  Currently under New York’s law the elimination of the           state estate tax credit in federal law does not automatically eliminate or reduce the amount of estate tax due to the State.  Unless the Governor and Legislature act to conform to the             federal changes, the State’s revenue will be retained.  The amount of revenue at stake is substantial, about $2.7 billion for SFY2003-04 through SFY2007-08.  In SFY2003-04 alone the adoption of the federal law would cost New York State $118.5 million, which would          grow to close to $1 billion in SFY2007-08.

E.     Reform the STAR Property Tax Relief Plan

To ensure fairness, property tax relief should not discriminate on the basis of geography or on the basis of whether someone is a renter or a homeowner.  STAR fails on both of these counts.  Enriching the state's real property tax circuit breaker credit would provide a more targeted, cost-effective means of providing property tax relief to those who are truly overburdened by the current system.  Such a reform would provide more relief to those who are truly overburdened by their property tax bills while saving $1 billion or more per year relative to the cost of the STAR program.

G.  Broaden the Sales Tax. 

Over time, the sales tax has been capturing an increasingly smaller stream of State revenue.  Remote sales via the Internet or catalogs and a shift to a service driven economy are responsible.  According to a study by Minnesota’s revenue department, the sales tax captured about 60 percent of commerce in the early 1970s and now captures only 40 percent.  Although taxation of remote sales is likely off the table in the near term, barring a change of heart by Congress, a broadening of the tax base is essential if the sales tax is to retain its viability. Nebraska has begun to slowly broaden its sales tax base. Tennessee, Florida, Minnesota are other states that have considered this approach.

PEF is part of a informal coalition of unions, religious groups, and community groups that support a balanced approach towards closing the State budget deficit that includes raising State revenues.  The revenue coalition considered and rejected expanding the sales tax to professional services and premium cable services.  It did not discuss whether the sales tax should be expanded to computer and data processing services.  The State could gain considerable revenue if it significantly broadened it sales tax base.

The State AFL-CIO is also developing a strategy to raise State revenue that involves polling, message development, and the development of a media campaign.  It will work in concert with the revenue coalition.  We will update you on these groups’ progress as the State budget process proceeds.  We expect the Governor to release his Executive Budget the week of January 27, 2003, although it could be released as late as February 3, 2003.

APPENDIX 1

IMPACT OF .007 PERSONAL INCOME TAX SURCHARGE ON A FAMILY OF FOUR

Source: Fiscal Policy Institute December 2002

APPENDIX 2: TAX CUTS TAKING EFFECT IN 2002 AND BEYOND

(This list complied by the Fiscal Policy Institute does NOT include tax changes that apply to tax years beginning on or before January 1, 2001 or tax changes that apply to specific actions [such as the making of a purchase of a specified kind] taken on or after particular dates up to and including January 1, 2002.)

A.  Tax cuts that apply to tax years that have begun for most (but not

all) affected taxpayers but for which final returns will not be filed until 2003 or late 2002.

1.  Personal Income Tax - Increase in standard deduction for married couples filing joint returns, from $13,400 to $14,200, for tax years beginning on and after January 1, 2002. (2000 Part P)

2.  Personal Income Tax - Increase in State Earned Income Tax Credit from 25% to 27.5% of Federal Earned Income Tax Credit, for tax years beginning on and after January 1, 2002.  (2000 Part Q)

3.  Personal Income Tax - For tax years beginning on and after January 1, 2002, increases from $2,500 to $5,000 the maximum amount of allowable undergraduate higher education tuition expenses for which an itemized deduction or a 4% refundable credit can be taken by New York residents. (2000 Part DD)

4.  Insurance Tax - For tax years beginning on and after January 1, 2002, insurance companies can claim credits for 100% of any investments made on or after May 1, 2000, in CAPCOs (certified capital companies), up to a $150 million statewide cap.  (This is the state’s third round of CAPCO credits for insurance companies.) (2000 Part FF)

5. Bank Tax - For tax years beginning on and after July 1, 2001, reduces the tax rate from 8.5% to 8% of net income. (Note: For virtually all banks this applies to tax years beginning on January 1, 2002.) (1999 Part O)

6. Insurance Tax - For tax years beginning on and after July 1, 2001, reduces the tax rate from 8.5% to 8% of net income.  (Note: For virtually all insurance companies this applies to tax years beginning on January 1, 2002.)  (1999 Part O)

7.  Insurance Tax - For tax years beginning on and after July 1, 2001, reduces the Cap tax rate for non-life insurance companies from 2.4% to 2.2%. (Note: For virtually all insurance companies this applies to tax years beginning on January 1, 2002.)   (1999 Part O)

8.  Corporation and Utility Tax - For tax years beginning on and after January 1, 2002, eliminates the excess dividends tax (Section 183) for telecommunications companies principally engaged in local telephone with fewer than one million access lines. (1999 Part V)

9.  Corporate Franchise Tax - For tax years beginning on and after July 1, 2001, reduces the tax rate from 8% to 7.5% of net income.  (Note: Most corporations have calendar year fiscal years so that this reduction applies to tax years beginning on January 1, 2002.)  (1998 Section 9)

10.  S Corporation Differential - Reduces the S corporation differential rate from 0.825% to 0.65% for large S corporations for tax years beginning on and after July 1, 2001.  (Notes: 1. Most affected corporations have calendar year fiscal years so that this reduction applies to tax years beginning on January 1, 2002; 2. the differential rate for small S corporations was reduced previously from 0.125% to 0.05%.) (1998 Section 13)

B.  Tax Cuts that apply to tax years that have not begun for any affected taxpayers.

1.  Personal Income Tax - Increase in standard deduction for married couples filing joint returns, from $14,200 to $14,600, for tax years beginning on and after January 1, 2003.  (2000 Part P)

2.  Personal Income Tax - Increase in State Earned Income Tax Credit from 27.5% to 30% of Federal Earned Income Tax Credit, for tax years beginning on and after January 1, 2003.  (2000 Part Q)

3. Beer Tax -  Reduces beer excise tax rate from 12.5 cents to 11 cents per gallon effective September 1, 2003.  (2000 Part V)

4.  Petroleum Business Tax - Provides for a 33% rate reduction for both diesel motor fuel and residual oil used for non-residential heating purposes effective September 1, 2002.  (2000 Part X)

5.  Personal Income Tax - Creates new credit up to $1,500 for the cost of installing fuel cell electric generating equipment in taxpayer's residence, for tax years beginning on and after January 1, 2003. Excess may be carried over for 5 years. (2000 Part Z)

6. Personal Income Tax - For tax years beginning on and after January 1, 2003, increases from $5,000 to $7,500 the maximum amount of allowable undergraduate higher education tuition expenses for which an itemized deduction or a 4% refundable credit can be taken by New York residents. (2000 Part DD)

7.  Personal Income Tax - For tax years beginning on and after January 1, 2004, increases from $7,500 to $10,000 the maximum amount of allowable undergraduate higher education tuition expenses for which an itemized deduction or a 4% refundable credit can be taken by New York residents. (2000 Part DD)

8. Bank Tax - For tax years beginning on and after July 1, 2002, reduces the tax rate from 8% to 7.5% of net income. (1999 Part O)

9. Insurance Tax - For tax years beginning on and after July 1, 2002, reduces the tax rate from 8% to 7.5% of net income.  (1999 Part O)

10.  Insurance Tax - For tax years beginning on and after July 1, 2002, reduces the Cap tax rate for non-life insurance companies from 2.2% to 2%.    (1999 Part O)

11. Corporate Franchise Tax - For tax years beginning on and after July 1, 2003, reduces the tax rate on net income from 7.5% to 6.85% for businesses with net income of less than $200,000.  For businesses with net income between $200,000 and $290,000, the tax rate would range from 6.85% to 7.5%. (2000 Part A)

12.  S Corporation Differential - Reduces the S corporation differential rate by over 40% for tax years beginning on and after July 1, 2003.  For S corporations with net income of more than $290,000, this reduction is from 0.65% to 0.375%; for S corporations with net income of $200,000 or less, this reduction is from 0.05% to 0.0275%; for S corporations with net income between $2000,000 and $290,000, the differential rates are prorated between these two levels.  (2000 Part A)

13.  Personal and Corporate Taxes - Provides, for tax years beginning on and after January 1, 2002, a 10% credit for cost of purchasing long-term care insurance.  This credit applies to the corporation and utility tax, the corporate franchise tax, the personal income tax, the bank tax, and the insurance tax. Any unused portions of this credit can be carried over to future years.  (2000 Part E)

14.  Corporation and Utility Tax - Beginning on January 1, 2003, reduces the section 186-a gross receipts tax on gas and electricity and the section 189 gas import tax from 1.9% to 0.85%; beginning on January 1, 2004, reduces these taxes from 0.85% to 0.4%; and beginning on January 1, 2005, reduces these taxes from 0.4% to 0%. (2000 Part Y)

15.  Corporation and Utility Tax - Beginning on January 1, 2003, increases from 25% to 50% the portion of the section 186-a excise tax on the transmission and distribution component of gas and electric services for commercial, industrial and not-for-profit customers that is excluded from taxation; on January 1, 2004 this exclusion is increased to 75%; and on January 1, 2005, it is increased to 100%.  Beginning on January 1, 2003, reduces this tax on transmission and distribution services for other customers from 2.4% to 2.25%; beginning on January 1, 2004, reduces this tax from 2.25% to 2.125%; and beginning on January 1, 2005, reduces this tax from 2.125% to 2%. (2000 Part Y)