Is New York prepared for a fiscal disaster?

Gov. Andrew Cuomo managed to close a projected $3.1 billion deficit in the executive budget he proposed on Jan. 15, but New York’s finances are still vulnerable to two potential disruptions beyond its control: a volatile economy and the whims of the Trump administration.

An economic downturn or cuts in federal aid to could dramatically upset the careful fiscal balance that Cuomo has pursued in his eight years in office, a tenure that began in 2011 with a $10 billion budget deficit. While the governor made some additional strides in his latest budget to keep spending in check, provisions that would go into effect if the state’s fiscal fortunes head south might not be enough to avoid painful budget cuts down the road.

A good firewall against draconian budget cuts is a robust reserve fund, experts say. Cuomo on Tuesday proposed that an additional $488 million be stowed away in the upcoming year, increasing the total amount of the rainy day fund to $2.28 billion, but that is still roughly half of what the state really needs, according to David Friedfel, director of state studies at the Citizens Budget Commission. Ideally, about 10 percent of general fund tax revenues – like California has – would be set aside, he said. “The reserves are simply not there,” he said. “We do not have a easy revenue source to tap into, particularly if it’s a severe recession. To keep spending flat would be an extreme challenge and the state simply hasn’t taken any steps to prepare.”

Other measures that the state should take to protect its fiscal health would be capping Medicare reimbursements for high-income people and changes to state employee and retirees health benefits, according to Friedfel. Notably, the Cuomo administration did include in its budget conservative estimates of revenues from legalized marijuana, and it is proactively reducing its fiscal forecasts sooner rather than later, Friedfel added.

The Cuomo administration also has to abide by its 2 percent cap on spending increases if it wants to keep the deficit from ballooning to $4.3 billion in fiscal year 2021. If the state stays under the cap, the budget gap that year would be reduced to $747 million and surpluses thereafter, but several variables can disrupt that equation. Changes to the federal tax plan have already upset revenue projections. Contingency plans in the budget proposal can only reduce spending by so much and it is hard for anyone to save when there are lots of reasons to spend.

So is New York state ready for a recession? “No,” said Friedfel. Here are are a few questions that reveal why.

How has the federal government upset New York’s finances?

“Now on the finances for the state, we start with the $3 billion hole, largely because of the federal policies,” Cuomo said during his address on Tuesday. “The revenues have slowed. We believe it's attributed to the federal SALT program which we all predicted was going to have a dramatic effect on New York.”

Indeed, the source of much of the fiscal uncertainty is the new $10,000 cap on federal tax deductions of state and local taxes, which had previously been unlimited. This change to the so-called SALT deduction means that New Yorkers have less incentive to pay their state taxes by the end of year, and that could be what is behind decreasing tax receipts that required state officials last month to reduce revenue projections by $400 million for this year and $1.5 billion for next year.

Changes to the federal tax code overall “injected volatility into taxpayer behavior, making it very difficult to identify the true underlying income and tax receipt trends,” Robert Mujica told reporters after the governor’s speech. But just as worrisome for state finances are ways that high-income earners might avoid paying taxes. “What else are they looking at?” said Mujica. “Are they looking at other tax avoidance strategies?”

For now, SALT is a top worry for state officials, but additional moves by the Trump administration could also throw the state budget into disarray. This includes cuts in federal aid to the state or the effects of federal policy on a stock market that has swung dramatically in recent weeks, affecting revenues from sources like capital gains and corporate bonuses.

Given these vulnerabilities, why is Cuomo proposing to limit taxes?

The proposed budget includes a number of measures aimed at limiting taxes. They include making the 2 percent cap on property taxes permanent and continuing to phases in certain middle-class tax cuts. Overall, the state has to strike a certain balance between taxing high-income earners enough to keep the state fiscally sounds while not depending on them so much that it incentivizes them to move out of state. The Citizens Budget Commission estimates that 0.6 percent of taxpayers pay 20 percent of state’s operating spending. If just 1 percent of these high earners left the state, they would take $200 million in revenues with them.

The latest budget proposal does not do enough to mitigate this vulnerability, according to E.J. McMahon, research director at the Empire Center for Public Policy. “We’re climbing further out on the limb of heavy dependance on high income taxpayers,” he said. Furthermore, budget manipulations present the budget proposal as having a 2 percent cap on spending, when McMahon’s analysis finds that state spending would rise by 3 percent were Cuomo’s budget proposal to pass.

What is the state’s current margin of error?

So what will the state do if fiscal disaster in one form or another strikes? The current budget proposals includes a few contingency plans. A 3 percent reduction in local assistance appropriations would go into effect if tax receipts drop by $500 million, with exceptions for school aid, Medicaid and public assistance. Another proposal would allow the state budget director to prepare a plan if and when the federal government reduces Medicaid funding by $850 million or more, or reduces state operating funds by the same amount. The state Legislature would have 90 days to reject such a plan, which would otherwise take effect automatically. A similar plan was agreed to in the 2017 session.