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Winter 1993
   
City Taxes: Where to Start Cutting
Stephen Kagann
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New York City’s singularly high tax burden is the greatest peril to its economy: As I pointed out in the Autumn 1992 issue of the City Journal, each $100 million in new taxes levied during a recession leads to the loss of some 11,400 private-sector jobs, as businesses cut back or leave the city to escape the growing tax burden.

Fortunately, this effect works in reverse as well. According to my projections, a $4 billion reduction in taxes over four years would generate enough economic activity to create 600,000 new private-sector jobs in six years-240,000 more than have been lost during the current recession. This growth would cause the city’s revenues to reach a break-even point after four years. Even a less ambitious tax-cutting program could substantially improve the city’s economy.

Which of the city’s dozens of taxes cost the most jobs? Which would be the best ones to cut as part of an economic growth strategy? A City Comptroller’s Office study I conducted with senior economist Zheng Gu (“Jobs on the Run: Corporate Headquarters, State and Local Taxes, and the Economy of New York City”) helps answer these questions.

Our study examined the changes in the number of major corporate headquarters in New York City during the period 1956-91. Our sample included 650 companies: the five hundred largest industrial and the fifty largest transportation, merchandising, and utility companies listed in the Fortune directories. In 1956, 178 (or 27 percent) of these companies were headquartered in New York City. By 1991, the number had dwindled to 46 (or 7 percent).

We conducted a regression analysis to determine which variables were most important in influencing companies to move their headquarters out of the city. We found that a $1 billion increase in the overall tax burden leads, on average, to the loss of 0.8 corporate headquarters. (Each headquarters departure leads to the loss of an estimated 4,600 private-sector jobs, both from the corporation itself and from other companies that lose business because of the departure of the headquarters and its employees.) Other variables—the crime rate, inflation in the city relative to the nation, and nationwide economic growth—also have a measurable impact on the number of headquarters in New York. But the impact of taxes is large and unmistakable.

The most important finding of our study concerned the effects of two particular taxes: the personal income tax and the commercial rent tax. A $1 billion combined increase in these two taxes, we found, leads to the loss of an average of 5.4 headquarters. In other words, these two taxes are roughly seven times as important as others in driving large corporations from the city. One reason for this may be that the burden of these two taxes is unique to New York City, and therefore can be escaped by moving almost anywhere else.

The commercial rent tax adds 6 percent to the already high cost of office space in New York. Any company that spends more than $11,000 per year on rent ($15,700 in upper Manhattan or the outer boroughs) must pay this tax. No other city taxes commercial rents.

Likewise, New York is the only U.S. city to levy a progressive tax on personal income. (Washington, D.C., is an exception, but its residents pay no state taxes.) Some other cities have flat-rate income taxes, but only Detroit and Philadelphia—both of which have severe economic and fiscal problems—take 3 percent or more of their residents’ income. New York City’s top rate was 3.4 percent in June 1990, but the city has since raised the rate twice. It now stands at 4.46 percent. This, of course, is in addition to the state income tax, one of the highest in the country at 7.875 percent.

Not surprisingly, the corporate headquarters study found that among the most popular destinations for companies leaving New York are states with no personal income tax, state or local: Texas, Florida, and Connecticut, which had no income tax before 1991.

High corporate taxes are also cause for concern, though our study was unable to account for their effect because corporate profits, and the revenues from corporate taxes, vary widely from year to year. The state levies a 10.35 percent tax on corporate profits, but the rate is about 12.1 percent in the city and suburbs because of a surcharge that goes to the Metropolitan Transportation Authority. In addition, the city has its own corporate income tax of 8.85 percent—America’s only municipal corporate income tax. Thus, a city-based corporation can expect to pay a total of at least 21 percent of its profits in taxes. By comparison, Connecticut’s corporate tax rate, one of the highest in the country, is 13.8 percent, and is scheduled to drop to 11.5 percent in 1993. Moreover, unlike the state and federal governments, the city does not allow corporations to deduct as expenses any compensation paid to officers or major shareholders. Their income is taxed twice—first as corporate profits, then as personal income.

City officials have consistently denied that taxes are an important factor influencing businesses to leave the city. Yet the city’s actions belie these denials. Central to its economic strategy has been the practice of offering targeted tax breaks to large companies to induce them to remain in the city. Most recently, Morgan Stanley received $40 million in concessions in exchange for a promise not to move to Stamford, Connecticut.

But while these breaks may keep a few big companies from leaving the city, such a defensive strategy cannot revitalize New York’s economy in the long run. It does nothing to encourage new companies to start up in New York City rather than someplace else, or to prevent the departure of small businesses.

In fact, the city’s regime of double-taxation provides small businesses with a special reason to leave. Taxing executive salaries twice hits small corporations hardest, since a higher proportion of their income goes to their owners. In addition, sole proprietors and partners in firms (known as “subchapter S corporations” for federal and state tax purposes) must pay an unincorporated business tax of 4 percent of their earnings in addition to the personal income tax.

Small business owners can escape the bulk of the city’s personal income tax by living outside the city. Many eventually move their companies out as well, avoiding a long commute and the city’s business taxes. The economic effect of individual small business departures is incremental, but no one can doubt that they add up, doing significant damage to the city’s economy.

The Dinkins administration, in an effort to improve the city’s business climate, has promised not to increase corporate income taxes for the next four years. This is largely a symbolic action, however, since the rates are already so high that increasing them would be politically impossible. What the city really needs is an aggressive tax-cutting program. Since the commercial rent tax and the personal income tax (which together raise close to $4 billion a year) have a demonstrably severe effect on the city’s economy, they seem the likeliest candidates for reduction or elimination.

In the short term, this tax-reduction program would reduce the city’s revenues, but by no more than $1.1 billion in a given year. To cushion itself against these revenue losses, the city would have to cut spending by a modest 3 to 4 percent. Such cuts might entail some pain, but far less in the long run than the continuing decline of the city’s economy.

 

 

 
New York City’s singularly high tax burden is the greatest peril to its economy.
City Journal Winter 1993.
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