City Journal

William J. Stern
Kamikaze Budgeting
How much economic damage will the city’s bad budget and the state’s worse one inflict?
Spring 1998

New Yorkers have seen it all before: a Wall Street boom sends tax dollars cascading into the state and city treasuries . . . budget-writing politicians throw taxpayers' money around as if the happy days will last forever. . . the boom ends (as in a cyclical industry it always must) . . . and city and state both wake up with an even worse economic hangover than they've been nursing for most of the last 30 years. And here we go again. Governor George Pataki has issued a 1998-99 budget that vies for honors as the most fiscally irresponsible in the state's history. And Mayor Rudy Giuliani's 1998 budget, while a model of rectitude when compared with his recent predecessors' budgets and with the governor's profligacy, still fails to come to grips with the deep, structural economic problems that have bedeviled the city for half a century.

For both the city's and the state's economies, the problem has long been chronic overspending that in turn requires high levels of taxation way out of line with the rest of the country, in an age when businesses can move anywhere in search of low-cost, low-tax environments. In New York State, state and local taxes—averaging $4,671 per taxpayer last year—amounted to 15.3 percent of the average taxpayer's income, compared with 10.7 percent in business-friendly Texas, 10.8 percent in Georgia, and, across the river in New Jersey, still only 11 percent. As for local taxes alone, New York City dwellers paid 2.75 times more than the residents of the average northeastern or midwestern city and an amazing 4.36 times more than taxpayers in the new, expanding cities of the West and Southwest in 1994.

The result of such unwillingness to exercise real fiscal restraint is a persistently sluggish economy that for decades has started losing jobs well before national recessions begin and has stopped losing them well after the rest of the country, that gains jobs wanly when the rest of the nation is ebulliently churning them out, and that consequently ends up with proportionally fewer jobs overall than competing states and cities. Had New York State kept pace with the rest of the nation between 1982 and 1994, its total number of jobs would be 1.4 million higher than its actual total, according to Change New York, a fiscal watchdog group. While the rest of the country churned out employment between 1990 and 1996, New York State lost almost 332,000 jobs, and last year, when employment in the U.S. grew by an estimated 2.7 percent, New York State—even with money raining down on Wall Street—saw job growth at less than half that rate, a plodding 1.3 percent. And that's the state's best performance in 14 years. As for New York City, a recent study in these pages—completed before flush times both on Wall Street and in the tourism industry produced 54,800 new jobs—showed that, had Gotham's economy just kept up with the average big city of the Northeast or Midwest for the last 35 years, the five boroughs would have 750,000 more jobs than they have now. Had the city retained the job-creating power that it had in 1962, it would have 1 million more jobs than it has today ("New York's Million Missing Jobs," Autumn 1997).

How profligate is Governor Pataki's budget? Calling for $71.9 billion in spending, it is—in real terms, given lower inflation rates—more spendthrift than any of Mario Cuomo's porcine budgets. It fattens state-funded spending (the part of the budget the federal government doesn't finance) by an artery-clogging 8.5 percent over the preceding year. And just like Cuomo's lethal mid-eighties' budgets, it doesn't make any real use of its $1.8 billion surplus to help get the state's fiscal affairs in order so that it won't face a crisis when the next downturn inevitably arrives.

That's why it's hard to be enthusiastic even about the eventual 20 percent reduction in the state's income tax promised in the governor's grab bag of spending hikes and tax cuts. It may never happen. After all, Mario Cuomo canceled promised tax cuts in 1988, after the 1987 stock market crash slowed the torrent of tax revenues. Since both parties in the state legislature hate spending cuts, any drop in revenues is likely to produce either tax increases or the suspension of promised tax cuts—not belt tightening. Reneging on promised tax cuts, of course, is worse than never promising them at all. It produces bedlam. Businesses then see New York as not only the most costly place for commerce in the U.S. but the most unpredictable. Uncertainty, which makes planning nearly impossible, threatens businesses just as much as high tax costs, and it causes them to cancel their expansion plans or simply pack up and leave.

As for the surplus, New York State could spend it usefully. Above all, Governor Pataki could use it to help finance a state takeover of Medicaid, a huge expense that strangles the state's municipalities. Every state but Arizona and New York splits the enormous cost of Medicaid 50-50 with the federal government; local governments pay nothing. New York forces its municipalities to pick up 50 percent of the non-federal share, which for New York City comes to 15 percent of its local revenues, a crippling amount that about equals the city's structural deficit and that will total some $2.7 billion in fiscal 1998.

Liberation from this burden would be a huge plus for Gotham's economy. And once the state had to pay for all of Medicaid's non-federal share, legislators would have an incentive to control its runaway costs. Since they can now give away $1 in benefits at a cost of 25 cents to the state budget, legislators have loaded on every optional benefit to Medicaid, from artificial insemination to false teeth, to gain the gratitude of constituents, health-care providers, and health-care unions, while the localities have to raise taxes to pay their share of the cost. Reining in these costs, which taxpayers pay whether out of their state or their local pocket, would prove a boon to the state's fiscal health. (See "Medicaid's Fatal Attraction," Winter 1996.) The governor would have picked up political chits from hard-pressed mayors and county executives from Long Island Sound to Lake Erie.

But the Pataki budget lavishes funds on highly questionable projects. One egregious example: the $45 million that Pataki plans for the Empire State Economic Development Fund, a two-year-old program that subsidizes businesses and various local development agencies. Managing the fund is the state's $168 million-a-year Empire State Development Agency, which, among other projects, recently paid $6 million for a practice field for the Buffalo Bills football team. This kind of state-directed capitalism, in which government substitutes its bureaucratic thinking for the market's invisible hand, results in poor investment decisions and widespread corruption, with politicians and businessmen exchanging favors rather than pursuing market efficiencies. The IMF is currently insisting that Asian countries end just this sort of crony capitalism. New York has pursued state-directed capital investment since the late seventies, and it has done nothing for the economy, which ranks near the bottom in job creation, 48th of the 50 states.

New York's brand of state capitalism goes even further in the new budget, since the state will spend nearly half a billion dollars—a large percentage of the surplus—on the Community Enhancement Facilities Program, essentially a special-interest welfare program for sports and arts lovers. Two sports projects have made the most news, and both are bad ideas. The state plans a $63 million renovation of Rich Stadium, home of the Buffalo Bills, as part of a lucrative lease package to keep the team in western New York, and Albany will fork over $14 million for a minor league baseball park for Suffolk County. The justification for these big sums is that stadiums produce jobs, profits for businesses, and tax revenues for governments. They call it the "multiplex effect." But studies by the Federal Reserve Bank of Atlanta and economist Edward Mills of Northwestern University have clearly shown that sports facilities contribute nothing to economic development. What they really do is line the pockets of political insiders. The sports industry isn't the only special interest the new budget rewards. Arts funding, "upper-income welfare," as Raymond J. Keating of the Small Business Survival Committee correctly puts it, has increased a frothy 20.5 percent.

The Pataki budget's biggest failing, however, is to misspend vast amounts on primary and secondary education. The governor proposes an increase of $518 million—a 4.7 percent hike—for New York State's public schools, following a similar increase last year. But greater school funding hasn't improved the schools: SAT scores stagnate well below the U.S. average, while more than 20 percent of the state's public school students fail minimum reading requirements and do even worse in math. Shoveling money to the dysfunctional education industry without tying funds to better results implicates Pataki in the ongoing disaster. Moreover, Change New York complains that money being sent to school districts through the STAR (School Tax Relief) program—supposedly a dollar-for-dollar offset against local property taxes—shows up as unrestricted school aid in Pataki's budget, without an accompanying mandatory school-tax cap. Without a cap, school districts are more likely to waste the STAR money than to use it to reduce property taxes.

When we move to higher education, matters don't improve: here, too, Pataki squanders money without demanding accountability. He budgets an additional $118 million on the State University of New York and the City University of New York, without discussing the need for reform—such as means-testing tuition—or even what the state is trying to accomplish in financing its enormous university system. In fact, SUNY has long been a patronage mill for politicians. More troubling still, Pataki wants to plow $3 billion over the next five years into SUNY construction projects, including a $10 million, 7,500-seat sports stadium at Stony Brook—all paid for with borrowed money for future New York taxpayers to repay.

The Pataki budget's profligacy threatens to bury New York under a towering mountain of debt. Comptroller Carl McCall, nobody's idea of a fiscal conservative, expressed grave reservations about the debt level the 1998-99 budget contains. McCall warns that the governor's five-year capital plan will ratchet up debt service 40 percent, to $4.5 billion, and will reduce pay-as-you-go financing of non-federal capital projects to 14 percent, down from 37 percent today. By the end of the five-year capital plan, total state-supported debt per person will have increased 22 percent, from $1,860 to $2,270. Pataki's spending plan promises gigantic out-year budget deficits. The projected gap for 1999-2000 runs to $2 billion, and that figure presupposes—dubiously—that the state will receive $250 million in tobacco-company settlements. Deficit estimates for the following year run as high as a disabling $4.8 billion.

New York's $68.5 billion debt burden dwarfs that of other large states, outweighing California's by 50 percent, for example, despite the Empire State's much smaller population. In fact, New York's debt far exceeds that of Texas and California combined and, as a percentage of personal income, surmounts Texas by 400 percent. Since 1985, New York State's debt has increased 241 percent, impelling Moody's Investor Services to lower the state's bond rating below any state's except Louisiana's. A poor bond rating increases borrowing costs, making debt financing ever more oppressive. To continue in this direction—when New York's debt service already gobbles up 10 percent of the budget—threatens to rob the state of whatever budget flexibility it still retains.

Along with piling up debt, the governor's budget expends the balance of the $530 million reserve fund the state set aside last year as insurance against economic downturn, as if good times were all that lie ahead. Of course, the reserve itself is symptomatic of what's wrong with the state's fiscal priorities: it is a way of piling up money to ensure that even when bad times arrive, the state won't have to cut excessive spending.

If Governor Pataki thinks New York has outgrown its economic quandaries, he's entertaining a dangerous fantasy. In New York City, home of the financial service industry, unemployment through the nineties has been closer to double-digit, continental-European levels than to those of the rest of America. Upper New York State continues to be an economic disaster area, untouched by the rust-belt boom. In many upstate communities, real recovery from the recession of the early nineties hasn't happened. During 1996, for example, upstate New York created a pitiful 1,800 jobs, while Massachusetts, with roughly the same population as upstate New York, launched 60,000. Ohio, similar demographically and industrially to western New York, created 48,000 jobs. Small wonder, then, that the educated young flee upstate New York for opportunities elsewhere. New York's budget surplus has created an illusion of a robust economy, but the reality is considerably less healthy.

Why did Governor Pataki propose so terrible a budget—after three relatively restrained earlier budgets and so much rhetoric of fiscal prudence? One explanation is narrowly political: the budget is Clinton-style triangulation, co-opting the opposing party's agenda, leaving them nothing to run against, while arrogantly assuming that your own party's supporters have nowhere to turn. The budget might be part of Pataki's effort to secure 60 percent of November's vote, sufficient to carry Senator D'Amato and the rest of the Republican ticket to victory with him and push the governor to national prominence. Currently riding high in the polls, Pataki might just pull it off. After all, the governor won 1994's race with an unenthusiastic 28 percent of the vote in New York City—where the popular New York City mayor opposed him—and with a strong third party candidate gaining 7 percent of the vote in some upstate communities. This year, Mayor Giuliani's support virtually ensures a stronger showing in the city, while the only possible third-party candidate on the horizon is Lieutenant Governor Betsy McCaughey Ross, who might run as a Liberal who will siphon votes from the Democrats.

There's another, perhaps deeper, explanation for Pataki's bad budget: the governor belongs to a political culture without true political convictions. The Reagan revolution, which discredited the ideal of big government throughout American politics during the eighties, never arrived in New York State. As a result, the Republican party maintains close ties with the construction industry, organized labor, the education cartel, and municipal labor unions—all supporters of the welfare-state idea of government. Seen in this light, Pataki's half-hearted effort to reform rent regulation last year, which succeeded only in killing the possibility of reform for a generation, was a clear precursor of his budget proposal.

Perhaps those interested in a real New York economic recovery, one that would provide widespread opportunity to all the state's citizens, look in the wrong direction. The state's Republican party has long been part of the problem of New York's spending addiction, not its solution. The only New York governor over the last 40 years who actually fought for spending restraints was a Democrat—Hugh Carey. When Pataki released his budget, the speaker of the New York City Council, Peter F. Vallone—like Carey, a centrist Democrat from the outer boroughs with a strong legislative background—bluntly told the truth: "George Pataki's proposed budget is the most fiscally irresponsible in history," he said. Vallone, a candidate for governor who has worked successfully with Mayor Giuliani over the past four years in the city, makes one wonder whether that partnership could work effectively for the state.

When compared with Governor Pataki's fiscal bacchanal, Mayor Giuliani's $34.3 billion 1998 spending plan for New York City seems a model of responsibility. But looked at more closely, it appears less restrained. The mayor claims that spending, excluding state and federal aid, will go up only six-tenths of 1 percent in the next fiscal year, less than the local inflation rate, which he anticipates will range from 2 to 2.5 percent. But under the city's accounting rules, the current-year surplus of $1.2 billion gets treated as if it were money spent in the 1997 fiscal year, though the mayor will use it to cover fiscal 1998's expenses. That is, the spending figure for 1998 gets artificially depressed, while the 1997 figure gets artificially elevated. When adjusted for this sleight of hand, the city's spending increase will be over 3 percent. The mayor also uses Consumer Price Index-based inflation rates, which a bipartisan commission concluded overstate inflation by at least 1 percent.

Even so, the Giuliani budget deserves some praise: it completely avoids the state budget's wild excesses, and it can claim a few real victories. Most notably, the mayor has reduced the public-assistance caseload faster than the city originally projected. By June the caseload will be lower than at any time over the last 30 years—below 800,000 from a 1995 peak of 1,151,000—realizing the city annual savings of nearly a half billion dollars. In addition, the mayor offers some sensible tax cuts—chiefly in the commercial rent tax and the sales tax for clothes and footwear—that will add up to $774 million returned to taxpayers by 2003. The mayor correctly points out, too, that he inherited an exceedingly difficult situation in 1994, that he is reserving 70 percent of the surplus for financing projected shortfalls over the next two years, and that, unlike Pataki, he proposes no major new programs that would burden the city's already fragile budgetary condition further.

But if the mayor is putting money aside for future shortfalls, he should ask another hard question: why does the city so regularly have budget shortfalls? Answer: its economy cannot support a government of the present mammoth size and scope. Though with his challenge to CUNY's costly remediation fiasco and his brave talk of the tragedy of illegitimacy in his 1998 State of the City address, the mayor has shown a willingness to begin asking hard questions about New York's municipal welfare state, he still needs to begin dismantling it.

After Medicaid, New York City's biggest budget buster is its municipal workforce. How can the city's economy grow if it supports a public workforce that receives incomparably more fringe benefits than most private-sector employees? City-funded personal service costs will total a jarring $12.1 billion in fiscal year 1998, a full 9 percent more than 1997. Half of this billion-dollar increase results from the city's new labor agreements, which will grant most city employees a 3 percent wage increase in 1998. In addition, the city's workforce, after three years of reduction, will grow to 205,600 employees by the middle of 1998, an increase of 5,000 over last year, mostly to staff the Board of Education's expanded literacy programs. Especially given the 35-hour workweeks, ample pensions (costing the city $1.3 billion in 1998), non-contributory health-care plans, and lavish vacation, sick-day, and holiday schedules, the last thing the city needs is more employees.

Mayor Giuliani has accomplished more than any other mayor in New York's postwar history, transforming assumptions about public safety in ways no one could have imagined four years ago. New York is now one of America's safest cities, a welcome change that is itself an economic boon to the city. But the mayor can afford a little humility when he discusses the city's economy. The budgetary surplus that Giuliani, like Pataki, enjoys, grows out of a Wall Street boom for which neither mayor nor governor can take credit. The truth remains: New York City has not created a single net new job in half a century.

New York's dependence on Wall Street has only grown: the financial services industry now employs 4.5 percent of the city's workers, but they're directly responsible for 17 percent of the city's wages, up from 11 percent just ten years ago. In addition, a significant number of jobs and wages in the city directly depend on Wall Street. The city's increasing reliance on Wall Street results in a steeply verticalized economy that poses three economic threats. First, the financial services industry is cyclical, and when it turns down, as it surely will, the city will suffer deeply, as it did during earlier downturns in the late eighties and early nineties. Second, technological change could soon transform financial services into a "virtual" industry that has no need to stay in Manhattan or any central city. If this happens, and if New York doesn't diversify its economic base, its preeminence will be over. Last, given that Wall Street leaders know their importance to the city, they will press for continued tax concessions, which they've already received in recent years. But tax breaks given to large financial institutions result in proportionally higher taxes on small businesses—the real engine of economic growth in the United States over the last three decades.

Since Wall Street-generated surpluses won't last forever, New York City, like New York State, needs to get its economic house in order. Unless government spending drops sharply, taxes will stay high, and new investment and job growth will remain a mirage. While Governor Pataki's budget suggests that he may be beyond salvation, Mayor Giuliani, by accomplishing so much in improving New Yorkers' quality of life, raises the hope that New York City has a future commensurate with its magnificent past—if only the mayor will broaden his innovative approach to urban policy to an area he has as yet only tentatively addressed: the city's economy.

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