History has shown us that the act of increasing taxes in difficult times stifles economic recovery and exacerbates problems. The Great Depression consisted of a major recession that began in the early 1930s and a second recession caused by a relapse in 1937. The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime. From 1932 through 1936, legislators passed enormous federal and state tax increases, which led to the relapse in 1937.
The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. Notwithstanding this truth, U.S. federal and state tax policies are on an economic-crash trajectory today, just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1 percent nationally, their highest level in decades. The Bush tax cuts are set to expire in 2011, and additional taxes to pay for health care and the proposed cap-and-trade proposal are on the horizon.
The courage to meaningfully reduce spending has proven too difficult for elected officials to muster. There is far more political careerism and dodging of real solutions than the intestinal fortitude to do what is necessary. Unfortunately, in the battle between cutting spending and increasing taxes, tax increases are winning.
There is a groundswell of “tax the rich” rhetoric coming out of Washington as well as from state capitals. Taxing the rich may be a political solution because it affects only 1 percent of voters, but it is not a sustainable economic solution. States that have built their enormous public burdens by focusing on the wealthy will hit the wall first and hardest. Look at California, which extracts more than half of its income taxes from less than 1 percent of its citizens. This example is extreme, but California is hardly alone in its overreliance on a few highly mobile taxpayers. New York is right up there, with the wealthiest 1 percent paying more than 41 percent of all state income taxes. Individuals and businesses are fleeing soak-the-rich states already. New York and Connecticut are currently tied for having the highest state and local tax burden in the nation.
OUR REAL ESTATE TAXES, including transactional taxes and fees, will also be a politically easy target. An additional real estate tax burden now would only add to the distress that is so tangibly imbedded into so many New York City properties. Cash flows are already under tremendous pressure. Real estate taxes already provide a significant percentage of our state revenue. Based upon the way values have fallen across all property types, tax assessments should be decreasing; but because of the way they are calculated, they are, unfairly, continuing to increase, creating even more stress in the marketplace.
Remarkably, at an event last week, I overheard politicians speculating that the disastrous New York real property capital-gains tax—a.k.a., the “Cuomo tax”—may be revived. This was a 10 percent state capital-gains tax on any real estate transaction over $1 million; it was enacted by Governor Mario Cuomo and the State Legislature in 1983. The tax had a tremendous chilling effect on development and investment in New York. It caused severe reductions in transaction volume, as the costs of selling were too onerous. During this period, real estate investment trusts were emerging as dominant players nationwide, but New York was the last city on their list of targets due to our tax structure.
Because the legislation was drafted by politicians without input from the business community, there were deficiencies that forced some developers to pay the “gains tax” even when they lost money on a transaction. Additionally, every project required an audit that was costly and inefficient for the government to oversee. The fact is that there was a sharp rise in transfer taxes collected after the repeal of the law, in 1996, as transaction volume increased. REITS began to invest in New York City, and the market began an unprecedented run.