Gotham Gazette

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2008: The Year the Good Times Ended?

As the new year begins, recent reports suggest that economic prospects for 2008 look rather bleak, but that fiscal prospects, at least in the short run, look manageable. The city projects a yawning $6.5 billion budget gap for fiscal year 2011. But mayors and city councils tend not to worry that far into the future. In the shorter term, while the city anticipates a decline in revenues, money from last year's budget surplus and Mayor Michael Bloomberg's October directives calling for immediate cutbacks in city spending seem to provide a cushion.

The economic slowdown and its effect on city coffers are likely to rule out any major new spending initiatives in the mayor's preliminary budget for next year, which will be released shortly. The city's capital budget, though, continues to climb. The economic uncertainly also raises questions about whether city can continue to cut its property tax rates and still maintain services.

Feeling Wall Street's Pain

The city's reliance on tax revenues from Wall Street bonuses and profits explains the glum forecasts for 2009 and beyond. "The ongoing turmoil in the credit and housing markets will have serious implications for the city's economy.... The greatest risks ... are a sustained downturn on Wall Street and a housing-induced recession," according to the state deputy comptroller's December report on the city's October budget modification.

While the city's forecasters do not anticipate a recession, in October they project a slowing economy and a decline in job growth from 62,200 new jobs in calendar year 2006 to only 12,100 in calendar 2008. The city does not, however, anticipate a recession.

The city comptroller's December report on the city's economy and finances notes that "the unfolding sub-prime mortgage debacle and its collateral effects on credit marketsâ threaten both the national and local economies. The resulting financial losses and layoffs, however, are likely to fall disproportionately on New York firms and workers.

The mortgage crisis has already had a significant impact on Wall Street profits. As a result, the earnings of the city's financial firms are likely to be down significantly from 2006 levels -- along with the associated bonuses, which last year reached a record $34 billion."

The state Financial Control Board's December report notes that worries about the city's financial services industry led the city in its October modification to reduce projections of revenues from sources other than the property tax by $576 million in the current budget year, including a reduction of $207 million in the personal income tax and $256 million in property transfer and mortgage recording taxes.

The city also cut back its estimates of non-property tax revenues for fiscal years 2009, 2010 and 2011 by $1.1 billion, $1.2 billion, and $1.5 billion, respectively.

The control board sees an additional concern: inflation. The city projects that inflation will drop from 3.2 percent in 2006 to less than 2 percent a year from 2009 to 2011. The board, though, points to higher gasoline, other energy and food prices that make it "difficult to see how an acceleration of inflation could be avoided without a recession."

Endangered Tax Cuts?

All of this could affect taxes. Will the city continue its program to cut property tax cuts? The cuts -- a 7 percent reduction in the property tax rate (costing about $750 million) and a $400 rebate for residential homeowners (costing $250 million) -- are built into each of the next three years of the city's financial plan, contributing to the projected deficits. The mayor has said that maintaining the cut wills depend on economic and fiscal conditions.

The importance of the tax-cut question is highlighted by the state deputy comptroller's report. It pointed out that the city will spend $3.3 billion more this fiscal year than it will take in in revenue. It will bridge the gap, though, with funds from last year's budget surplus. That money is paying for the $1.3 billion in tax cuts and $2 billion in new expenditures this fiscal year.

Since the projected budget gap for 2009, which the preliminary budget will have to fill, has grown from $1.55 billion to $2.7 billion since June, the extension of tax cuts as well as new expenditure cuts should become part of next year's budget discussion.

Not only will the mayor and council have to review the arguments for continuing the property tax rate cut and rebate, but they will also have to push the state legislature to keep the current city sales tax rate at 4 percent. The city sales tax rate falls to 3 percent in July with the demise of the Municipal Assistance Corp.

MAC was created in 1975 by the state to create a bonding entity that raised the money to bail the city out of its near-bankruptcy. As part of that state legislation, the city sales tax was raised from 3 percent to 4 percent to assure the payment of debt service on the MAC bonds. Those bonds have now been paid off.

The city's financial plan assumes the sales tax will remain at 4 percent, but the state will have to pass legislation authorizing that rate. Well over $1 billion in city sales tax revenue is at stake.

Expense Budget Trends

The monitors highlight several interesting trends regarding city spending. Expenditures grew an average of 10 percent a year in 2004 and 2005 and 8.6 percent a year in 2006 and in 2007, according to the state deputy comptroller. (The rate for the latter two years includes $2.5 billion that was placed in a reserve fund, the Retiree Health Benefits Trust Fund.) This was well above the rate of inflation.

In 2008 the same report projects an increase of 5.6 percent in spending, and, from 2009 to 2011, an increase of 4.8 percent annually. This is lower than in the earlier years but still more than twice the projected inflation rate.

The expenditures are dominated by so-called non-discretionary spending: debt service, Medicaid, pensions and other benefits for city employees. These are expenses the mayor has little or no control over because of debt obligations, labor contract agreements, and federal/state mandates.

In fact, non-discretionary expenditures account for most of the expenditure growth. And, most importantly, their share of all expenditures has been growing rapidly. In FY 2003, 37 percent of city-funded expenditures were non-discretionary; in 2011 an estimated 49 percent will be non-discretionary. Growth in debt service is a big part of this increase, up 26 percent between 2008 and 2011, to $6.1 billion in 2011.

Where the Growth Is

The big increase in the capital budget may eventually define Bloomberg's fiscal legacy. As the state deputy comptroller notes, city-funded capital budget commitments will increase by 71 percent this fiscal year alone, to an all-time high of $8.3 billion. For the next four years, city-funded capital commitments will total $27.1 billion.

The rapidly growing capital budget means more new schools, more mass transit, more affordable housing, more environmental protection, etc. But, as the city comptroller's December report shows, the debt service that pays for the capital budget is part of the city's operating budget and will eat up an increasing percentage of city revenues -- from 11.8 percent in 2007 to 15.4 percent in 2011. That means there will be less funding available for discretionary services, such as education, housing, libraries, parks, and youth, senior, health and other social services.

In his October modification, the mayor began planning his first cutbacks in expenditures, by setting a hiring freeze in most agencies and asking all city agencies to find 2.5 percent in cuts this fiscal year and 5 percent next year. That would save $500 million and $1 billion, respectively.

We will soon see if these actions, in response to the bleak revenue prospects, keep the current financial plan manageable. If it does not, the city may have to revisit its long-term commitment to tax cuts and its very ambitious capital program.

Glenn Pasanen, who teaches political science at Lehman College, has been in charge of Gotham Gazette's finance topic page since 2001. 

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