City Journal

Stephen Kagann
New York's Vanishing Supply Side
New York City's tax-and-spend policies are the primary cause of the local recession.
Autumn 1992

Two crucial facts have been all but ignored by policymakers and analysts responding to the current recession in New York City. First, the city’s economic crisis is more serious than is generally recognized, and far worse than in the rest of the country. Second, the bulk of the blame for New York’s sour economy rests not with the national economy or the Federal Government, but with the fiscal policies of the city and state. Over the past thirty years, New York officials have shown an appalling lack of interest in the city’s economy, except when the situation has become so bad that tax revenues decline precipitously. This trend has continued under the present administration, despite the severity of the current recession.

How severe is the recession? Figure I compares the changes in employment in New York with the nationwide rate between April 1989, when employment in the city began to decline, and June 1992. During that period, employment in the city fell by 370,000 jobs, or 10.2 percent. Employment in the nation reached a pre-recession peak of 110.3 million in June 1990, then dropped by 1.8 million jobs—a mere 1.6 percent—by May 1992. To put it another way, New York City accounted for nearly one in five jobs lost nationwide during the current recession, though only about one in 35 Americans works in the city.

Grim as these figures are, they do not tell the full story. While total employment is down by 10.2 percent, employment in the city’s private sector is down even more sharply: by 11.4 percent. As the proportion of workers employed by the government continues to increase, the tax burden on New Yorkers grows heavier. As we shall see, this damages the private economy still further, particularly in recessionary times.

There remain two private-sector growth industries: social services and health care. These industries are in good measure supported by public policies and paid for by tax dollars. When these fields are omitted from the calculation, the remaining private-sector job rolls are down nearly 15 percent—almost one in seven jobs—since April 1989.

The city’s economy is in deep trouble. Yet Albany and city hall have been reluctant even to admit there is a serious problem. They have tried to pin the blame on external forces—first the stock market crash, then the national recession. They have repeatedly insisted that a local recovery was just around the corner. And they have tried mightily to put the best face on the bad news. The mayor’s fiscal 1993 Executive Budget, for example, plays down the decline in employment while stressing the “strong growth” in the average wages of those who have jobs. The budget attributes this growth to “the continual movement of New York City’s economy towards internationally competitive high-wage service jobs.” But if wage rates are rising while employment is failing, the most reasonable conclusion is that low-income New Yorkers are bearing the brunt of the recession. (Large bonuses on Wall Street, the result of a rising stock market, are also contributing to the growth in wage rates.)

Taxing the Economy

It is not surprising that New York’s officials aid acknowledging the city’s deep economic problems, for the current crisis—and the long-term decline in the city’s economy—are largely the result of the tax-and-spend policies of New York City and State. As Steven Craig has pointed out in this journal, the city and state governments spend far more, on a per capita basis, than their counterparts anywhere else in the country.

The result is a singularly high state and local tax burden. The state levies 24 different taxes, the city 23. Some of these taxes are unique: New York City, for example, is the only municipality in the country that taxes the rental of commercial real estate or assesses a progressive personal income tax.

In New York City, state and local taxes consume 17.8 percent of the gross city product (abbreviated GCP, this is a measure of all goods and services produced in the city). For the rest of the nation, the state and local tax burden is only 9.5 percent of gross product. The high tax burden is a drain on the local economy: Even if a business is profitable enough to pay New York’s high taxes and survive, the tax advantages offered by other regions provide an incentive for it to leave. This is particularly true for highly competitive industries with low profit margins, such as manufacturing.

Despite the recession, the Dinkins administration and the state have continued to raise taxes, to the tune of $2.5 billion, in order to close the budget gap created by the stagnant economy. Two new surcharges on the city’s personal income tax raised the top marginal rate from 3.4 to 4.46 percent. The city also imposed several hundred million dollars in new property taxes, and did not implement some promised tax cuts.

In April 1991, when I was chief economist for the Office of the City Comptroller, my colleague Zheng Gu and I studied the economic consequences of new taxes as well as several other factors. Using a statistical technique known as regression analysis, we examined the effects of several variables—inflation, U.S. consumer spending, and changes in the state and local tax burden—on the number of private-sector Jobs in the city between 1950 and the present.

We found that during a local recession, if the tax burden is already high, each $100 million in new taxes will lead to the loss of approximately 11,400 private-sector jobs citywide. Other factors affect employment as well. For example, if New York’s inflation rate exceeds the national average by 1 percent over four years, some 13,000 jobs are lost. For each $1 billion increase in nationwide consumer spending on durable goods, the city gains about 2,100 jobs. We also found that private employment is declining by an estimated 8,400 jobs a year for reasons not specifically considered in the study—including the city’s quality of life and of government services.

Figure 2 shows what this all means in the current recession. In 1991, we made two forecasts of what would happen to private-sector employment in New York City between 1991 and 1994. If the tax burden had remained constant, the recession would have been brief and only slightly worse than the national recession: Employment could have been expected to decline slowly through 1992, then recover in 1993 and 1994. With the new taxes that were enacted, we expected employment to drop dramatically in 1990-92 and not begin to stabilize until 1994.

What actually happened—shown through 1992—was that employment declined even more than we projected. The job losses beyond our projections cannot be attributed to the tax hikes, but a majority of lost jobs can be: 209,000 out of the 349,000 total private-sector jobs lost during 1990-92. By 1993, we expect an additional 56,000 jobs to be lost as a direct consequence of these new taxes.

Not surprisingly, the report was dismissed by the Dinkins administration. “Studies suggest that local business and employment relocation is determined by a host of economic and social factors,” wrote Philip Michael, director of the Mayor’s Office of Management and Budget. “Most surveys cite the local tax burden as only one of these factors and generally not a significant one.” The studies to which Michael refers, however, do not claim to measure the same things as ours. They do not focus on New York City, but rather compare many metropolitan regions, nearly all of which have tax burdens within a narrow range far below New York’s. These studies examine only manufacturing employment, not total private-sector employment. And they tend to focus on specific taxes or incentives, not on the total tax burden. Moreover, despite these differences, some of these studies do in fact show, contrary to Michael, that taxes have a significant influence on employment.

Ignoring the impact of taxes on the economy causes the city to overestimate its ability to raise revenues through tax hikes. In a June 1991 follow-up to our study, we predicted that the economic decline caused by the huge tax increases would lead to a $1.142 billion loss in city revenues during fiscal 1991-93. Based on the results for fiscal 1991 and 1992 and the city’s current forecast for 1993, the actual revenue shortfall is $1.158 billion—and this assumes no new taxes in 1993. The Mayor’s Office, however, has put forth a program calling for even more tax increases for fiscal years 1993-96.

How We Got Here

Although the Dinkins administration has worsened the city’s current predicament, it can hardly be blamed for creating the problem. Over the last three decades, through successive administrations in Albany and city hall, the city’s private economy has undergone fundamental structural changes. The city government, in its effort to maximize tax revenues in the short run, has steadily increased taxes, weakening the city’s economy in the long run. Albany must bear part of the blame as well, for the state government has also grown substantially, much of what the city spends is mandated by the state, and the city’s taxing authority (except property taxes) must be approved by the State Legislature.

Figure 3 illustrates how private-sector employment in New York City has changed since 1950. In the immediate postwar years, New York was an economic colossus, with 3.1 million private jobs in 1950. One out of every 14 American workers earned a living within the five boroughs. In subsequent years, particularly during the late 1960s, private employment continued to grow slowly, peaking at more than 3.2 million in 1969.

Although the national economy grew more quickly, New York City’s economy remained strong. The city easily weathered the national recessions of 1953-54, 1958, and 1961. The local economy was diverse. One-third of private sector employment was in manufacturing industries. New York’s financial services sector dominated domestic and international finance. The city was home to nearly half of the fifty largest U.S. industrial companies and about one in four of the largest merchandising, transportation, and utility companies. In addition, the city had a large concentration of communications companies—telephone, broadcasting, and publishing firms.

In the 1960s, the structure of the city’s economy began to change. While the city shared in the decade’s prosperity, it lost 121,000 manufacturing jobs. At the same time, 138,000 new public-sector jobs were created. To pay for the growing government, both the city and state raised taxes.

The nation had a minor recession in 1969-70. But in the city, the downturn was severe and prolonged. From 1969 to 1977, employment in the city’s private sector fell by 17.6 percent while the nation’s private payrolls rose by 15.7 percent.

The recovery of 1978-88 was led by financial services, and the strong growth in consumer spending after 1982 stimulated the city’s broadcasting, printing, publishing, and advertising sectors.

But the recovery was only partial. In 1987, the city’s private sector jobs numbered just over three million, 240,000 below the 1969, peak. While FIRE (finance, insurance, and real estate), construction, and services experienced dramatic recoveries, other industries did poorly. Wholesale and retail trade did not recover. Nor did transportation and public utilities. Manufacturing, a major employer of low-skill and entry-level labor, continued to decline. The city lost more corporate headquarters.

In the wake of the October 1987 stock market crash, the securities industry began to cut back on employment in the city. Total private-sector employment began falling in April 1989. At less than 2.7 million, it is now below the level of 1977.

In some respects, the current decline is worse than the 1969-77 episode, because the economic base was stronger and more diverse in 1969 than in 1989. While manufacturing led the earlier decline, a number of the high-skill, high-wage service industries have contracted sharply since April 1989. Employment has dropped by 25 percent in business services—accounting, advertising, computer, credit, and personnel services. In engineering and management services, employment is off by 16 percent.

The long-range picture is equally bleak. Manufacturing and corporate headquarters were once pillars of the local economy. Since the late 1950s, 800,000 manufacturing jobs have left the city. In addition, the city roll of corporate headquarters on the Fortune lists fell by 130 firms from 1958 to 1992, costing the city more than 500,000 jobs. The loss of manufacturing and corporate headquarters has redefined the local economy, reduced the range of opportunities for New Yorkers, led to dependence on a narrower base of industry, and made the city more vulnerable to dramatic downturns.

The Public Sector Explodes

As the private sector in New York declined, the public sector grew. Figure 4 shows the ratio of city government jobs to private jobs in the city from 1950 to 1992. During the 1950s, local government employment fluctuated between 8.7 and 9.4 percent of private-sector employment. In the 1960s, local government became a growth industry, and the percentage rose continuously, peaking at 16 percent in 1975. City taxes were raised every year from 1963 to 1976-even as private employment in the city collapsed after 1969-to pay for the burgeoning public sector. The city ignored the economic crisis until it became a fiscal crisis—that is, until the economy had declined so much that tax revenues were insufficient to pay for expenditures.

The fiscal crisis forced cuts in government employment and the realization that the economic base had been ruptured. A few taxes were reduced beginning in 1977, and the ratio of public to private jobs declined, reaching 13.4 percent in 1981. But the economic recovery generated more revenues, spurring new growth in public employment. The ratio of public to private employment began rising once more, and the city started increasing taxes again in 1984.

The 1987 stock market crash forewarned the current recession. Yet in spite of the experience of 1969-77, local government employment continued to grow. By 1992, it had expanded to a record 17 percent of private employment. Taxes continued to rise accordingly.

Figure 5 shows how the tax burden has grown over the years. In 1951, 8.3 percent of the GCP went for state and local taxes; the nationwide average was 5.9 percent of gross product. That means economic activity in New York City carried an extra tax burden of 2.4 percent of all production. Forty years later, New York’s state and local tax burden had grown to 17.1 percent, while the nation- wide figure had grown to 9.5 percent. New York’s extra tax burden had risen to 7.6 percent—more than triple its 1951 level.

The actual effect of this increase has been even more pronounced because of changes in federal income tax rates. Both individuals and corporations are allowed to deduct state and local taxes from their federal taxable income. This deduction mitigates the high tax burden in states such as New York, but the value of the deduction goes down as federal tax rates are decreased. From 1950 to 1990, as the city’s tax burden rose, the federal rate on the top personal income bracket fell from 92 to 28 percent (rising to 31 percent in 1991) and the top corporate income tax rate dropped from 52 to 34 percent. In addition, federal deductibility for sales taxes was eliminated in 1987 and the allowable deduction for upper-income taxpayers was reduced by 3 percent in 1991. These measures further reduced the value of the federal deduction.

The change in New York’s tax burden shows a pattern similar to that for public-sector employment: Taxes increased only slightly during the 19508, then began rising sharply during the 1960s, continuing unabated until 1977. They went down somewhat, leveled off during the early 1980s, and in 1984 began rising rapidly once again.

Economic and Fiscal Crises

These long-term patterns of tax increases, economic decline, and growth in the public sector tell us a great deal about the way the city does business. The primary role of local government, beyond providing basic municipal services, ought to be ensuring a favorable economic climate, one in which a city’s residents can secure good jobs and develop their careers, open and build businesses, support their families, and educate their children.

New York City’s goals, however, have been different. Since the 1960s, the city government has consistently acted as if its purpose were to maximize revenues and expand the public sector. Even during severe recessions, the city continues to raise taxes, relenting only when it is forced to do so by a still-worsening economy.

The effect of local tax increases is particularly destructive during a recession. A recent update of our study found that during periods when the economy is contracting and the local tax burden is high (as in 1970-78 and 1989 to the present), each $100 million in new taxes costs the city some 11,400 private-sector jobs. If the economy is expanding and the tax burden is high (as in 1979-88), $100 million in new taxes costs 5,100 private jobs. During the period before the late 1960s, when New York’s tax burden was closer to that of the rest of the nation, new taxes had a statistically insignificant effect on overall private-sector employment.

City officials have built a wall of denial around these facts. To this day, for example, the collapse of the city’s economy in the 1970s is understood to have been nothing more than a “fiscal crisis.” What actually happened, as we have seen, is that the growth in government and taxes during the 1960s set the stage for an economic crisis. When the economy began to falter in 1970, the city continued raising taxes. The additional tax burden worsened the economy, putting more people out of work. But the city continued raising taxes anyway, compounding the problem further. Finally, in 1974, the city experienced a shortfall in revenues—the fiscal crisis. But it was not until 1977—eight years after the economic downturn began—that the city stopped raising taxes. The economy partially recovered, but significant and permanent damage had been done.

The situation is disturbingly similar today. The prosperity of the 1980s, like that of the 1960s, was accompanied by sharp increases in taxes and public-sector employment. The recession began three years ago, but the problem was not publicly recognized until city tax revenues began to collapse toward the end of 1990. The city recognized a fiscal crisis and raised taxes to cover the shortfall. The result is a continuing, and worsening, recession.

In several respects, today’s economic crisis is worse than that of the 1970s. The rate of decline in private-sector employment has been greater than in the first three years of the 1969-77 episode. Going into this recession, the private-sector employment base was smaller and less diverse and the tax burden was considerably higher than in 1969.

The Need for Leadership

New York’s public officials have focused almost exclusively on current budgetary issues, avoiding any discussion of the destructive effects of a growing tax burden on a shrinking private economy. Instead, they have blamed New York’s economic troubles on a variety of external factors: Manufacturers prefer the larger and cheaper space available in less developed areas of the country. Cheap foreign labor is taking away New York jobs. The revolution in communications technology eliminated the need for a central urban location. The most recent excuse is that the Federal Government has diverted resources away from the cities.

Each of these explanations has a degree of truth. But as we have seen, the primary cause of New York’s economic decline is a fiscal policy out of control and the consequent crushing tax burden, which is far higher than virtually anywhere else in the country and which has not provided New Yorkers with a commensurate level of public services. External factors may worsen the situation, but that is all the more reason why New York needs to enact pro-growth policies—including lower taxes and a leaner, more efficient city government—that would allow the city to preserve its competitive advantages.

There may be hope. If New Yorkers created this mess, New Yorkers can clean it up. Only if New York’s leaders honestly confront our problems can we expect the City to prosper in the years ahead.

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