The dramatic and often tragic events unfolding in Greece have highlighted that the current debt crisis is not isolated to the world’s private borrowers. In Europe and in the United States, governments at all levels are having to grapple with the consequences of long-standing fiscal mismanagement just as households and commercial real estate investors are adjusting their own balance sheets.
While recent weeks’ attention has been focused on Europe and the potential for the Olive Belt’s crisis to spill over into global financial markets, our own fiscal challenges have been coming to a head on a smaller scale here at home. In the shadows of Greek protests and the stock market roller-coaster ride, the budgetary hurdles still facing New York City were made apparent last week, when the mayor kicked off the next fiscal year’s budget debate.
Our city faces a deficit for the upcoming fiscal year, and our elected officials must determine how to close the gap. And so the mayor’s $62.9 billion fiscal year 2011 budget proposal, unveiled May 6, includes myriad cuts to city services and higher fees for a host of public services. The city’s teaching rolls may lose as many as 6,400 educators through a combination of attrition and layoffs. In sum total, the budget proposal reduces city expenditures by just over $600 million, or 1 percent of current spending.
As the mayor’s office has been quick to point out, the city’s predicament follows in part from even deeper cuts in Albany. Grappling with a gaping $9 billion budget shortfall, the governor has proposed a $1.3 billion reduction in state support for the city. The state’s new fiscal year began on April 1, but disagreements in the state capital have precluded passage of a budget in the Legislature. The state has been operating under emergency spending bills since the March 31 deadline for a formal budget. Governor Paterson has threatened to furlough state employees.
Governor Paterson’s office has questioned whether the mayor’s proposed cutbacks are necessary. Hard hit by the downturn on Wall Street, and as a result of the proposed state funding cut, the city would face an even larger spending pullback were it not for its relatively more disciplined management of the public finances to date. In 2008, the city had a cumulative surplus of $8 billion, built up during six years when city operations were in the black.
Although not meeting the requests of every constituency, the mayor has been a very able steward of our public purse when few others can say the same. And he has remained prudent through the downturn: Total city expenses for the current year are projected to be $523 million lower than forecast in January. The city is in immeasurably better health than during the fiscal crisis of 1975 and the creation of the Municipal Finance Assistance Corporation (MAC).
TO ENSURE THAT THE city can ultimately return to fiscal balance, the mayor has had to embrace politically unpalatable reductions in services, including the aforementioned pruning of the teaching ranks. And while cuts to libraries, seniors centers and fire companies have served to contain the city’s shortfall, they have not been matched with corresponding tax increases.
Given the current political climate, the absence of targeted tax increases for high-income earners and profitable financial-services firms has prompted suggestions of bias. On Friday, The Wall Street Journal quoted City Councilman Brad Lander as saying that “the mayor is asking children, seniors and families to do all the sacrificing. … The only people the mayor is not asking to share in the sacrifice are the Wall Street banks and hedge funds that cause[d] the economic mess to begin with-he’s taking great pains to defend them.”
Mr. Lander’s viewpoint is not unique to this cycle. In his treatise on local public finance, “How to Have a Fiscal Crisis,” eminent Wharton finance professor Robert Inman described a recurring theme in the life of our nation’s most venerable cities: “Stagnant or declining private economies create unique pressures on local public officials: hard-pressed taxpayers, concerned investors, worried public employees, and needy residents each make their claim to a share of the shrinking real resource base.”
But the mayor is right to avoid seeking an increase in taxes on the city’s highest income earners. While it may seem intuitive that our most well-heeled citizens should contribute even more to the public purse, economics and history show us that following this intuition will undermine the city and its tax base. Even when imperfectly mobile, households and firms respond to increases in local taxes by locating to other jurisdictions. Redistributive taxes cannot be implemented at the local level without some loss of the tax base. Mayor Bloomberg describes this readily observable economic phenomenon in clear terms: “At some point, you drive them out.”
The New York Fed’s Andrew Haughwout, along with Professor Inman and other colleagues, describes the need for forethought in considering tax increases for high income earners, pointing out that “… elected state and city officials must recognize the reality of city revenue constraints. A city’s revenue capacity is limited by the mobility of its residents and firms.”
In New York City, the mobility of wealthy households is very high given a plethora of options-from Westchester to Connecticut to New Jersey-where the tax-for-service trade-off may be more favorable given any family’s particular circumstances.
And so in their analysis of the relationship between taxes and revenues in New York City, Philadelphia, Houston and Minneapolis, Mr. Haughwout and his colleagues conclude that “tax increases unmatched by tax-financed, compensating service benefits for taxpayers-whether property owners, consumers, or firms-will drive those taxpayers from the city. Property values fall, business sales decline and the city’s job base shrinks. To protect city economies, a dollar of taxes paid must be matched by a compensating dollar of public services received.”
At least at the local level, taking from Peter to give to Paul may leave us all wanting.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.