Forum

Stephen Kagann
Scarcity by Design: New York’s Vanishing Supply Side
Mr. Kagann, an economist with the New York City Council President's Office, discussed his view of the city's economy with city officials, opinion leaders, and journalists at a recent City Journal forum.
Winter 1993

Stephen Kagann’s article “New York’s Vanishing Supply Side,” which appeared in the Autumn 1992 issue of the City Journal, stirred more interest than virtually any other article about New York City published in the past few years, sparking discussion in the Wall Street Journal, The Economist, Newsday, and the Forward. Mr. Kagann, an economist with the New York City Council President’s Office, discussed his view of the city’s economy with city officials, opinion leaders, and journalists at a recent City Journal forum.

STEPHEN KAGANN: As a teenager in the 1950s, I would walk the streets of Manhattan, reading the corporate names on the buildings and marveling that I could make a career in virtually any industry right here. New York was the unquestioned center of international business, finance, manufacturing, shipping, transportation, pharmaceuticals, merchandising, fashion, publishing, broadcasting, telecommunications, art, and culture. The city was a magnet for the ambitious, the bright, and the talented.

But in the 1960s the city’s economy began to unravel. Manufacturing, which had employed 1.1 million people in the 1950s, began to leave town. The decline in industrial production was accompanied by a decline in rail transportation, shipping, and wholesaling. Yet no one seemed to notice. One reason was that the loss in manufacturing jobs was more than offset by an expansion in government employment. Government became an exciting new growth industry: From 1967 to 1975, 100,000 jobs were added to the city bureaucracy.

But beginning in 1969, the losses in the city’s private sector turned into a rout: From 1969 to 1977, 550,000 private-sector jobs disappeared. The decline amounted to 17 percent of the job base. Yet during those same years, nationwide private employment swelled by nine million jobs, an increase of nearly 16 percent, despite two national recessions. Manufacturing led the city’s decline, but there were also substantial job losses in construction, financial services, wholesale and retail trade, transportation, and public utilities.

Why did the business capital of the world undergo an economic collapse comparable to the Great Depression while the national economy prospered? I argue that the responsibility rested with Albany and city hall.

In the 1960s, city and state fiscal policies spun out of control. The combined burden of city and state taxes rose from 8.5 percent of gross city product in the 1950s to 12.4 percent by 1969. Even as the private sector was collapsing from 1969 to 1974, government employment continued to grow, and so did the city’s tax rates. By 1977, at the worst point in the city’s economy, the tax burden was 16.8 percent of gross city product. But even the annual ritual of raising taxes did not provide enough revenue to feed the voracious appetite of government. The city sold billions of dollars in bonds while dissembling about the use of the funds.

By 1974, however, investors regarded New York City as a bad risk and were no longer willing to buy its bonds. This created the fiscal crisis of 1974-77. Although the crisis led to a new tax increase, it also temporarily halted city spending. Fifty thousand city government jobs were eliminated virtually overnight, and some tax rates actually declined after 1977. Then, in 1978, the city economy began to expand, driven by the growth of financial services and, after the 1982 recession, the media sector. The flow of money into the city created a real estate boom, and by 1984 the city government was growing quickly again. By the end of the 1980s, city employment had expanded by nearly sixty thousand people. New real estate taxes were created and property taxes were raised, leaving the city’s fiscal fortunes dependent on an extraordinarily speculative bubble.

Not many noticed that throughout the 1980s corporate headquarters and manufacturing, wholesaling, trucking, and shipping concerns continued to leave, or that retailing never recovered. The expansion of the 1980s had a narrow base and the stock market crash in 1987 signaled another downturn. Yet city government employment continued to rise for another three years, and so did taxes. Although the city’s recession began months before the new administration took over in January 1990, the new mayor raised government employment levels during his first year—repeating the post-1969 pattern. A new fiscal crisis in October 1990 finally froze city employment levels, but to avoid cuts the administration piled on three major tax increases between July 1990 and July 1991. Albany raised taxes also. In 18 months, the combined city and state tax hikes increased the total tax burden on city residents by between $2.5 and $3 billion. The tax burden, which surpassed its 1977 record of 16.8 percent of gross city product in 1990, now stands at 17.8 percent. This figure compares with an average of 9.5 percent for the rest of the nation.

Imagine for a moment that there is a severe national recession in which employment levels have dropped by more than 10 percent. Further imagine that a federal administration proposes huge tax increases during this recession. With no debate, and with minimal press coverage, the tax hikes pass virtually without dissent. This would never happen in Washington—but it is how fiscal policy is made in New York City and State.

At the time the city’s tax hikes were proposed, Zheng Gu and I produced a study for the City Comptroller’s Office that examined how the city’s private-sector employment is affected by the tax burden, inflation rate relative to the rest of the nation, quality of life, and national economic conditions.

The study showed that if the city raises taxes by $100 million during an expansion period, about 5,000 private-sector jobs will be lost. If, on the other hand, the city is in a 1970s-style recession, as it was in 1990 and 1991, every $100 million in new taxes will cause some 11,400 New Yorkers to lose their jobs in the private sector.

Our study was denounced by certain folks in the city government. Everyone knows, they said, that taxes are not a determinant of business location decisions, or certainly not an important one. But based on our model, we forecast in early 1991 that the tax increases of 1990 and 1991 would lead directly to the loss of between 250,000 and 260,000 jobs.

What actually happened? Since April 1989 the city’s private sector has been collapsing even faster than in the 1970s. In little more than three years, the private sector has lost 360,000 jobs, a decline of about 12 percent. If we exclude private-sector industries that are largely supported by public tax revenues—health care and social services, both of which have been growing quickly—the job loss figure is even higher: more than 400,000, or between 15 and 16 percent.

Can we blame New York’s job losses on the national economy? During this recession nationwide private-sector employment went down by 1.6 percent at most. Our losses are vastly disproportionate.

What about Reagan-Bush cuts in urban aid? In fact, cutbacks in federal spending for cities began under the Carter administration. It wasn’t until 1990 and 1991, however, when city officials needed someone to blame for the local recession, that they noticed there had been cutbacks in aid to cities. In fact, during the 1980s, New York, unlike other cities, had continued to expand public-sector employment despite the federal cutbacks.

What about the communications revolution, which makes it easier for corporations to leave town? Other business capitals such as Tokyo and London have the same technology yet there is no impetus to move. In fact, Japanese government officials tell me they can’t get people to leave Tokyo.

What is responsible for New York’s massive economic failure? Simply put, a government whose employment level is far too high extracts a burden that makes it very costly to do business here. Only firms with very high profit margins can afford to remain in the city. Moreover, the large tax burden diminishes New Yorkers’ standard of living by reducing after-tax income and increasing the cost of everything we buy.

By making it more difficult for businesses to stay, the city has increased the probability that any given citizen will join the ranks of the unemployed. Our government claims to represent the interests of the poor. But who is most likely to become unemployed? Among the hardest-hit industries are retailing and manufacturing. The marginal workers—immigrants, minorities, teenagers—are disproportionately represented in these industries and are losing jobs at a sickening pace. Teenage employment has nearly ceased to exist in New York and the end result is what you see out in the streets. It’s a sad story.

DAVID RUBENSTEIN, City Office of Management and Budget: I think your model grossly misrepresents the city’s tax burden. You rely on the gross city product, a statistic prepared by the State Comptroller’s Office. But the Comptroller’s Office acknowledges that its numbers underestimate the city’s total production. Your use of this statistic, therefore, tends to overestimate the tax burden.

The way the tax burden is usually measured is as a percentage of personal income. When you use that measure, you’ll find that the tax burden is not double the national average and that it has not been climbing that rapidly.

STEPHEN KAGANN: We considered measuring the tax burden as a percentage of personal income. We rejected that approach because personal income includes transfer payments such as welfare and Social Security. We were interested in measuring the burden of taxes on productive economic activity.

The State Comptroller’s Office does say its gross city product figure is probably too low, but for statistical purposes the important thing is that it accurately reflects the changes from year to year.

I understand, by the way, that OMB has put out its own gross city product measure, and my friends in the City Comptroller’s Office tell me it’s too large.

MICHAEL BROOKS, Sanford C. Bernstein & Co.: I used to be with the State Comptroller’s Office, and I helped prepare the gross city product figure. I agree with a lot of what you say, but I think you have a tendency to overstate the issue. Your article says that in New York City, state and local taxes consume 17.8 percent of the gross city product. For the rest of the nation, the tax burden is only 9.5 percent of gross product. But the State Comptroller’s Office told you that gross city product is an excellent way to measure change over time but it is not an accurate measure of the economy at any particular point in time. It is erroneous, based on this measure, to compare the tax burden in New York City with the national tax burden at the same time.

STEPHEN KAGANN: Suppose my numbers do overstate the difference. Suppose New York’s tax burden isn’t 17.8 percent, but 16 or 16.5 percent. Our tax burden is still clearly out of line, enough to hurt us in the competition with other parts of the country.

There’s another way to look at the tax burden: the relationship between city government employment and private-sector employment. During the 1950s, city government employment was about 9 percent of private-sector employment. In the mid-1970s, it peaked at 16 percent. City government employment is now around 17 percent of private employment. If city government employment is higher now, relative to its tax base, than it was in 1977, the money must come from higher taxes. This is a particularly important point given the cuts in federal aid during the Carter, Reagan, and Bush years. Less federal money means a larger proportion of city spending is paid for by state and local taxes.

THOMAS TISCH, FLF Associates: I have a question for David Rubenstein. Do I understand you to say that New York’s city and state tax burden is not higher than elsewhere in the country?

DAVID RUBENSTEIN: State and local taxes are higher in New York than nationwide—there’s no doubt about that. But that differential has probably remained about the same since 1980. I can back that up just by looking at the tax law. For example, the personal income tax rate is not as high as it was in 1983.

THOMAS TISCH: As a taxpayer in New York, I find that if you look at raw rates you’re often tremendously misled. The income tax rates may not be as high, for example, but New York State disallows a significant number of itemized deductions. What Stephen Kagann has done is show the cumulative effect of the taxes we actually pay.

MITCHELL MOSS, New York University: Firms have been leaving New York for 150 years. They left long before our taxes were higher than others. This has been a long-standing pattern that has nothing to do with taxes, but rather with a desire for low-density housing, more space, better services, and, in many cases, old-fashioned racial prejudice.

New York has always let firms leave if they cannot afford the city’s comparatively high costs. I don’t care who leaves New York; I’m worried about who moves in. The source of New York City’s success has always been that the city recreates itself periodically.

Manufacturing, for example, remains an important part of our economy, but no matter what we do to strengthen our manufacturing base, it will never be as big as in the old days. New York City lost its seaport decades ago when container ships made New Jersey a better location, but our airports have fifty thousand workers, far more than the seaport ever employed. Union Carbide’s headquarters left the city because a bomb blew up the building. The next day the CEO said, “We’re going to Connecticut.” These are some of the reasons that businesses leave New York; it isn’t just taxation.

STEPHEN KAGANN: I never said taxes were the only factor. But they are a very important factor. Many people want to deny that taxes make a difference at all.

My work does take into account the flow of businesses into as well as out of New York. The net number of private-sector jobs declined precipitously during the 1970s and has done so again—by 360,000—since April 1989.

The decline of New York’s private sector over the past few decades runs counter to the city’s history during the previous century. After the Civil War, during the period of greatest American industrialization, there was a surge, not of companies born in New York, but of companies that came here to make the city their headquarters, because New York was the headquarters city. Today, that trend has been reversed.

FRED SIEGEL, City Journal: I would add that New York missed the small-business revolution in the 1980s. There is no high-tech industry in New York, except companies that specialize in working for large corporations. Small software companies, for example, leave as fast as they start here.

DEREK JOHNSON, Deputy Manhattan Borough President: If you arc right, Mr. Kagann, what solution do you proffer? I would like you to speak to quality-of-life issues because I’m not sure how we can cut spending, and therefore taxes, without harming the quality of life. Indeed, I think that quality-of-life issues may be as significant, if not more so, than the tax burden in driving businesses out of New York.

STEPHEN KAGANN: Some of my work has examined quality-of-life issues, and we have found that they do indeed affect the city’s economy. And a lot of business people tell me, “Yeah, I hate the taxes, but I also hate walking the streets of New York.”

It may seem obvious that if you raise taxes that means you’re raising government services. But after being in city government for a couple of years, I don’t see a correlation between what the government spends and the benefit to the people. If there were such a correlation, New York would be the cleanest, best educated, most decent, and most civilized city in the country—but it’s not.

Yet all I’ve heard from those who insist that taxes don’t matter is a defense of the status quo. I don’t accept that. Is it written in stone that New York has to go downhill? I don’t think so. If we fundamentally change the way we view government in this city, there may be hope for a recovery and a better quality of life. If not, the best we can hope for is stability at a low level or a decline in the rate of decline.

DAVID SUTTON, Manhattan Borough President’s Office: I don’t think that there are any “taxes don’t matter” people in this room, and I really think this kind of polarization is unfortunate. The debate is really about the question of magnitude. It makes a large difference whether we’re talking about 11,400 jobs per $ 100 million in city taxes or 4,700 or 2,000 or some other number. And these technical issues like whether you’re using the right denominator really have an important effect on those outcomes.

STEPHEN KAGANN: One might debate my methodology, but I simply have not heard any public acknowledgment from city officials that taxes are crucially important. I would have been very happy to hear people question my methodology, but also say, “You may have a point there; what you say makes a certain amount of sense.” Instead, they simply reject my conclusions out of hand.

The private reactions I’ve had to my work are quite revealing. People in city and state government occasionally tell me, “I really appreciate what you’re doing and I’ll comment on your paper, but don’t give me any acknowledgment because I can’t be associated with what you’re doing.” I get the same response from private-sector economists who deal with city government—they get really uptight about being associated with my work. But the response is quite different when I talk to people in the private sector who are not involved with the government. I tell them we have a model that shows New York’s excessive tax burden leads to the loss of jobs, and people ask, “Where’s the punch line? Isn’t this obvious?” It’s obvious everywhere except city hall and Albany.

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