Citizens Budget Commission Citizens Budget Commission



March 6, 1998

TO: MEMBERS OF THE STATE FINANCES COMMITTEE

FROM: ANDREW REIN, SENIOR RESEARCH ASSOCIATE
CYNTHIA GREEN, VICE PRESIDENT FOR STATE STUDIES

RE: REVIEW OF THE STATE OF NEW YORK FISCAL YEAR 1999 EXECUTIVE BUDGET

On January 20, 1998 Governor George E. Pataki presented the fiscal year 1999 Executive Budget, and updated it on February 13 with the 30-day amendments. This memo reviews the proposed plan. The first section provides an overview of the budget. The second section identifies components of the proposal that are consistent with the Citizens Budget Commission's (CBC) values and previous positions and, accordingly, should receive our support. The final section identifies elements of the Executive Budget which conflict with CBC values and positions and which CBC should advocate changing.

Fiscal Overview

This overview analyzes how the Executive Budget would close the gap identified in CBC's baseline analysis, the multi-year consequences of policy decisions in the Executive Budget, and the five-year capital program presented along with the Executive Budget.

Closing the baseline budget gap

In December 1997 the CBC estimated that under current laws and policies the State faced a $1.1 billion general fund budget gap.[1] (See Table 1.) The Governor's Executive Budget would close that gap, provide new tax cuts, increase some spending, and leave an $85 million surplus.

The resources that make these initiatives possible would come from two sources. First, over $1.1 billion of the State's $1.8 billion fiscal year 1998 cash surplus would be "rolled" forward to fiscal year 1999. (See Table 2.) Second, nearly $1.1 billion would come from higher receipts estimates than in the CBC baseline. Almost all the increased receipts are from the personal income tax. This difference is attributable to updated current-year collections, less conservative economic assumptions and higher estimates of the receipts those economic assumptions will generate. For example, the Executive Budget receipts estimates are based on a 4.7 percent increase in New York State personal income in 1998, while the CBC's estimates are based on a 4.1 percent increase.

The Governor's budget also would increase spending beyond the CBC baseline. In contrast to 3.9 percent baseline growth, the Executive Budget would increase general fund disbursements 4.5 percent. When all State funds are included, disbursements would increase 7.9 percent.[2] (See Table 3.)

The largest single source of new spending growth beyond the CBC baseline would be the acceleration of STAR ($537 million), a program enacted in fiscal year 1998 that expands State school aid to fund local tax cuts. In addition, the Executive Budget's estimates of baseline spending growth combined with proposed spending increases expand the gap $313 million. For example, the Executive Budget's estimate of Medicaid is $170 million higher than the baseline and $29 million of new spending is proposed for the Roswell Park Cancer Institute.

The new resources also would be used to fund tax and fee cuts valued at $181 million. Reduced motor vehicle registration fees would cost $49 million and an additional week of exemption from the State sales tax on clothing would reduce collections $25 million. Proposed accelerations of unspecified, but already-enacted, tax cuts would lower receipts another $103 million.[3]

Fiscal implications

In addition to the cash-based financial plan described above, the Governor also presented his proposal in accordance with Generally Accepted Accounting Principles (GAAP)--the most accurate representation of an entity's finances. Under GAAP, the proposal to shift over $1.1 billion of this year's cash surplus into fiscal year 1999 creates a deficit because the "rolled" cash does not count as a fiscal year 1999 revenue. This would leave fiscal year 1999 with a $1.2 billion deficit in accordance with GAAP. (See Table 4.) As a result, the general fund accumulated deficit would grow from $864 million at the end of fiscal year 1998 to $2,069 million at the end of fiscal year 1999. (See Table 5.)

The Governor also projects that adopting the fiscal year 1999 Executive Budget would result in sizable future deficits. In fiscal year 1998, the State enacted phased-in, multi-year tax cuts and spending programs whose costs were projected to grow to almost $6.0 billion in fiscal year 2002. The Governor's current proposal would accelerate certain enacted tax cuts and spending programs and add new ones. The result would be a multi-year program whose $1.2 billion cost in fiscal year 1999 would rise to almost $6.2 billion in fiscal year 2002. (See Table 6.) These programs would drive large out-year deficits. The Governor projects that enactment of his budget would produce deficits of $2.7 billion in fiscal year 2000 and $5.1 billion in fiscal year 2001. (See Table 7.)

Capital and debt service spending

The Governor proposes a five-year, $21 billion capital plan. (See Table 8.) Annual capital spending would increase 22 percent from $3.9 billion in fiscal year 1998 to $4.8 billion in fiscal year 1999, and then decline to under $3.9 billion in fiscal years 2002 and 2003.

During the plan period, the mix of financing sources would change significantly. Most investments would be financed by appropriation-backed debt, known as back-door borrowing, rather than by the less expensive voter-approved, general obligation debt or pay-as-you-go resources.

Primarily because the plan does not include placing any general obligation bond issues on the ballot between fiscal years 1999 and 2003, investments financed by general obligation debt would decline significantly from $493 million to $176 million, or from 11 percent to 5 percent of total annual capital spending. During this period, the portion of investments supported by pay-as-you-go resources would decline from 28 percent to 10 percent. By contrast, the use of appropriation-backed debt--bonds issued by public authorities--would practically double, from 33 percent to 59 percent.

These new investments would increase the State's outstanding debt from $36.1 billion in fiscal year 1999 to $41.4 billion in fiscal year 2003. As a result, annual debt service would grow during this period from $3.5 billion to $4.4 billion, or 6.3 percent annually.

The Governor proposes to use $425 million of the fiscal year 1998 cash surplus to convert the Community Enhancement Facilities Assistance Program--enacted in the current fiscal year to finance projects to be chosen by the legislative and executive leadership--from a bonded program to pay-as-you-go. This initiative would produce annual debt service savings in excess of $50 million.[4] In order to reduce local governments' capital costs, the Governor also proposes to exempt low-cost local construction from the Wicks Law, which requires multiple contracts on construction projects.

Actions in the Governor's Budget Consistent with CBC Policy

The Executive Budget contains several initiatives that should be endorsed by the CBC because they are fiscally prudent or they improve services.

1. Convert a bonded program to pay-as-you-go

The Governor proposes to use $425 million of the fiscal year 1998 cash surplus to convert the Community Enhancement Facilities Assistance Program from a bonded program to pay-as-you-go. This is fiscally prudent because it would save recurring debt service costs, thus decreasing future deficits. However, controversy has surrounded this program, because it is the result of the State's flawed capital planning process that permits lump sum appropriations that could be distributed in a political fashion. As with all capital programs, these projects should be specified in the State's capital plan.

2. Change the Wicks Law

The CBC has long been a proponent of repealing the Wicks Law because it needlessly drives up the cost of construction.[5] The Governor proposes to increase the cost threshold--to $1 million in New York City and $500,000 in other localities--for projects required by the Wicks Law to have multiple contractors. In 2002, the threshold again would be increased, to $1.5 million and $750,000 for New York City and other localities, respectively. This is a step in the right direction.

3. Enhance the Tax Stabilization Reserve Fund

The Executive Budget proposes to enhance the Tax Stabilization Reserve Fund (TSRF). During times of economic prosperity it is prudent to put money aside in the event it is needed during an economic downturn.

The TSRF is established in the State Constitution, and its provisions are defined in statute. Annual deposits to the TSRF are capped at 0.2 percent of general fund disbursements, and the TSRF's total balance cannot exceed 2 percent of general fund disbursements. Withdrawals from the TSRF can be made if there is a mid-year, general fund imbalance, and withdrawals must be repaid in no less than three equal installments over the next six years. Under the current constraints, it would take six years for the TSRF to reach its limit (approximately $850 million), which could be an insufficient cushion.

The Governor plans to deposit $68 million of the fiscal year 1998 cash surplus into the TSRF--a prudent use of surplus moneys. This would increase the TSRF balance to $400 million, or 1.1 percent of general fund disbursements. The Governor also proposes to increase the annual deposit cap to 0.5 percent of general fund disbursements and the total balance cap to 5 percent. Increasing the total size and annual contributions would further enhance the TSRF.

Even with these actions, the TSRF still would not be a rainy day fund adequate to meet the State's needs. Other measures would further enhance the TSRF.

To promote fiscal stability, use of the TSRF should be counter-cyclical--TSRF withdrawals should be permitted only during an economic downturn. Since withdrawals are presently triggered by midyear imbalances rather than economic circumstances, TSRF use is not restricted to poor economic times. In fact, withdrawals may be made during an economic expansion. For example, if receipts estimates prove overly optimistic or spending is higher than anticipated, a resulting imbalance would allow a withdrawal. The use of TSRF resources should be tied to an indicator of economic contraction, not to general fund cash performance.

The State also should consider allowing prospective use of TSRF balances in the budget itself, rather than limiting use to mid-year infusions. During a recession, the State might appropriately use TSRF funds to support the new budget.

The State should consider requiring deposits during strong economic periods and rescinding the repayment requirement. The current deposit provisions can be easily circumvented under the State's cash accounting provisions that allow a surplus to be eliminated, in effect, by rolling it into the subsequent year. Furthermore, if the TSRF is to be built up in good times and drawn down in bad, it would be appropriate to modify the current repayment requirements.

4. Use Executive Budget receipts estimates as the basis for the adopted budget

The estimates of receipts in the Executive Budget are prudent and based on reasonable economic assumptions; therefore, they should be the basis for the adopted budget. For example, the Executive Budget projects the growth in wages, personal income and capital gains to slow from their rapid pace in 1997; thus personal income tax liability growth is expected to slow from 12 percent in 1997 to 6.5 percent 1998.[6] This is higher than CBC's baseline estimate of 5.2 percent in 1998, but it is reasonable and prudent. Receipts estimates should not be increased above these levels unless data from more recent months indicate better economic performance.

5. Sustain and accelerate tax cuts that promote economic competitiveness

The Governor proposes to continue and accelerate tax cuts enacted in prior years, including cuts in the estate tax and the utility gross receipts tax. Also, $100 million is set aside for accelerating any of the already-enacted tax cuts. The CBC's Budget 2000 Project evaluated New York's State and local tax system and concluded that cuts in the personal income, business income, real estate transaction, utility gross receipts and estate and gift taxes would most effectively improve New York's competitiveness.[7]

6. Pursue elementary and secondary education reforms

Three of the Governor's education initiatives follow policy prescriptions previously recommended by the CBC.[8]

  • Allow year-round education. Current State law does not allow local school districts the option of utilizing year-round schooling to improve education and relieve crowding. The Governor proposes to "authorize school districts to adopt a more flexible school calendar with a portion of the required 180 days of session to be in July and August without triggering a reduction in State aid. The assignment of students ... would be made on a voluntary basis by school districts and parents would be afforded the right to opt out of any such assignment."[9] CBC research has shown that year-round education is critical to relieving overcrowding in New York City. Adopting this proposal would provide the City and all localities flexibility to meet their needs.

  • Reform special education funding. The current aid formula has driven up costs by providing financial incentives for districts to place children with varying degrees of specialized needs in costly special education initially and in highly restrictive environments within the special education curriculum thereafter. The Governor proposes to join the Board of Regents in urging reform of special education funding.

  • Allow the creation of charter schools. Charter schools would increase experimentation and the educational options open to parents and students. Furthermore, competition from successful charter schools would provide an incentive for other public schools to improve.

7. Pursue STAR's goal of enhanced State financing of elementary and secondary education

The STAR program will reduce local school property taxes (and personal income taxes in New York City) while concurrently increasing State education aid to school districts to fund their revenue loss. When fully phased-in in fiscal year 2002, the result will be a $2.7 billion shift in education funding from the local tax base to the State. This is desirable because the State's broader tax base makes it possible to overcome existing disparities in school funding.

In the 1994-95 school year, the wealthiest 10 percent of the school districts spent 77 percent more per pupil than the poorest 10 percent.[10] As currently structured, STAR will not reduce these disparities. The size of the local tax cut varies among localities, because in all areas except New York City the cut is a property tax exemption tied to property values; owners of higher value property will receive larger cuts.[11] Duncombe and Yinger estimated that the basic exemption in Westchester will be $72,000, compared to $30,000 in most of the state.[12] Therefore, the new State aid that will be substituted for local resources will be distributed based on regional variation in property values. This will result in increasing the share of State school aid to wealthy districts and decreasing the share provided to needy districts. Calculations using the Duncombe and Yinger analysis reveal that downstate suburban districts, the wealthiest in the state, have 18 percent of the state's students but will receive 25 percent of the STAR funds.

Available data identify the impact of the program on New York City. The Governor's budget proposes to provide New York City with 35.4 percent of the standard (non-STAR) school aid in school year 1998-99. However, when STAR is fully implemented in fiscal year 2002, the City's share of total State education funding (including STAR) will drop to 34.1 percent.[13] This represents a loss to the City of $227 million. It is probable that similar losses will be incurred in other needy districts with low property values. Conversely, wealthy districts' share of State aid will increase.

Recommended Changes to the Executive Budget

While the Executive Budget contains important elements that CBC supports, it also contains proposals that are inconsistent with CBC's values and principles. Thus, the CBC should recommend the following changes to the plan.

1. Use the entire surplus in a fiscally prudent manner

The State should use the entire fiscal year 1998 cash surplus, projected to be $1.8 billion, in ways that promote long-run fiscal stability. The Governor proposes to use $493 million, or 28 percent, in such fiscally prudent ways.[14] The rest would be used to support the State's baseline operations and new spending or tax-cut programs.

The remaining $1.3 billion of the surplus also should be used in fiscally prudent ways. These include the following possibilities:

  • Pay-off outstanding debt. This would reduce recurring debt service expenses and out-year budget gaps. It would be especially appropriate to pay off debt that was issued to support operations rather than capital projects. Between the Local Government Assistance Corporation, the Attica Prison sale, and a pension refunding, the State has approximately $6 billion of debt that was not issued to build capital projects.

  • Fund one-time commitments that provide multi-year benefits. It also would be prudent to fund non-recurring initiatives that help balance future budgets by reducing future operating expenses. This could include spending--some of which is already in the budget--to upgrade computer systems to address the "year 2000 problem."

  • Reduce the accumulated deficit and other long-term liabilities. The proposed budget would increase the State's general fund accumulated deficit to $2.2 billion, including funds owed to local governments, vendors and school districts. For example, the State could pay the almost $1.2 billion it owes school districts from prior years.[15]

2. Balance the budget by returning spending control to a top priority

The Executive Budget proposes a 5.4 percent real (inflation adjusted) increase in State funds spending--a stark contrast to the 4.6 percent real decrease in the Governor's first two years. The fiscal year 1999 budget should be balanced with recurring spending reductions, rather than relying primarily on $1.1 billion rolled from the fiscal year 1998 cash surplus. This roll would use non-recurring resources to support recurring and rapidly growing spending programs and tax cuts, leaving large future deficits.

Restructuring State operations would reduce the recurring costs of government. Although the State reduced its workforce over 18,000 positions during fiscal years 1996 and 1997, little additional reduction has taken place. In most agencies State workers have not been subjected to competitive pressures. Many other jurisdictions have lowered costs significantly by requiring government workers to compete with private and non-profit firms for the right to provide services. Also, large savings and improved services would result from reengineering service delivery through the introduction of new technology, work processes, work rules and compensation packages.[16]

The State also should take action to further reduce the cost of Medicaid long-term care services. Progress has been made in reducing acute care costs with the approval of the Medicaid managed care waiver. To reduce New York's long-term care Medicaid costs, the State has introduced incentives for individuals to purchase long-term care insurance. Still, New York has generous eligibility rules, particularly the limits on retention of assets. These should be tightened to target Medicaid benefits to the indigent.[17]

3. Reduce reliance on appropriation-backed debt

The proposed capital program would increase the State's reliance on appropriation-backed debt, which typically is more costly than general obligation debt and does not require voter approval.[18] In light of the strict constitutional constraints on general obligation debt and the failure in 1995 of the debt reform constitutional amendment, reliance on appropriation-backed debt is not surprising. However, no general obligation debt issue is proposed for the ballot; thus, the opportunity to reduce reliance on appropriation-backed debt would be missed.

Converting a portion of the proposed capital plan's appropriation-backed debt to general obligation debt would save money and increase accountability. Any of the planned $10.3 billion of authority borrowings could be placed on the ballot. Since propositions are not always approved by voters, there is a reluctance among politicians to placing bond issues on the ballot. Historically, however, voters have tended to approve transportation bond issues. The $6.3 billion for transportation is the largest portion of authority borrowing in the plan. If it were funded with general obligation instead of authority bonds, the share of the total capital program funded by general obligation bonds would increase from 8 percent to 38 percent, and the percent funded by authority bonds would decrease from 49 percent to 19 percent.

4. Reconsider the cut in the sales tax

Following a one-week "experiment" in January, 1997, the State enacted legislation to exempt clothing under $100 from the State sales tax for three separate weeks, and then make the exemption permanent on December 1, 1998. While this enjoys a great deal of popular support and may be an attractive political choice, the economic development benefits of this cut appear to be very limited and other tax cuts would do more to improve the State's competitiveness.

Proponents of the cut argue that it is economically beneficial because it would encourage New Yorkers and others to shift clothing purchases to New York from other states, thus increasing economic activity. Analyses of the impact of a cut for purchases under $500 by the New York City Independent Budget Office and by a private economics firm concluded that the economic stimulus generated would increase other State revenues enough to pay for only 14 percent and 22 percent of the revenue loss.[19] In addition, the New York State Department of Taxation and Finance analyzed the impact of the first week-long experiment and found that sales during the quarter increased only 2.9 percent, about the rate of inflation.[20] This is lower than expected and does not support the contention that sales increased due to the tax cut. The report states, "it seems likely that most of the 2.9 percent increase ... may be part of the larger national trend and may not be attributable to the temporary exemption."[21]

Furthermore, cuts in other taxes would be more beneficial to New York State's competitiveness. The CBC's Budget 2000 Project evaluated New York's State and local tax system and concluded that, in the aggregate, New York's State and local sales taxes were in line with national norms and that cuts in the personal income, business income, real estate transaction, and the estate and gift taxes would be most beneficial to improving New York's competitiveness.[22]

All Tables For Non-Javascript Browsers

NOTES
1. Andrew S. Rein, A Baseline Budget for the State of New York Fiscal Year 1999 (NY: Citizens Budget Commission, December 1997).
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    • 2. State funds include general, special revenue, debt service and capital funds not derived from federal assistance.
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    • 3. $3 million is due to the acceleration of an existing agricultural tax credit.
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    • 4. Debt service costs in fiscal years 2000 through 2002, reported in New York State, Capital Program and Financing Plan Update, November 1997.
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    • 5. This position was most recently reiterated in Charles Brecher and Dean M. Mead, Budget 2000 Project: Capital Investment and Debt Service (NY: Citizens Budget Commission, December 1996).
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    • 6. 1997 liability growth is on a constant-law basis.
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    • 7. See Charles Brecher, Budget 2000 Project: Tax Policy (NY: Citizens Budget Commission, December 1996).
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    • 8. See Richard Delaney, School Buildings for the Next Century: An Affordable Strategy for Repairing and Modernizing New York City's School Facilities (NY: Citizens Budget Commission, September 1996) and Richard Delaney, Budget 2000 Project: Public Education (NY: Citizens Budget Commission, December 1996).
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    • 9. 1998 Article VII # 2, "Memorandum of Support," January 1998.
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    • 10. CBC recommended increasing equity in school funding in Richard Delaney, Budget 2000 Project: Public Education (NY: Citizens Budget Commission, December 1996) and Charles Brecher, Budget 2000 Project: Final Report (NY: Citizens Budget Commission, December 1996). Data on spending provided by the New York State Education Department.
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    • 11. In New York City, residents will receive a credit against their personal income tax.
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    • 12. William Duncombe and John Yinger, "An Analysis of Two Educational Policy Changes in New York State: Performance Standards and Property Tax Relief," The Maxwell School, Syracuse University, 1998.
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    • 13. This assumes 1) annual baseline increases in the standard aid stream of 3 percent between fiscal years 1999 and 2002, 2) the City's share of the standard aid streams will stay at 35.4 percent, 3) the City will receive 40 percent of the multi-year education programs enacted in fiscal year 1998, and 4) the City will receive 25 percent of the total STAR funds, which includes the NYC PIT portion and 9.5 percent of the property tax reduction. New York City's share of the total property tax savings would have to double, to 19.6 percent, for its share of aid to stay constant.
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    • 14. This includes the $425 million for the Community Enhancement Facilities Assistance Program and the $68 million deposit to the TSRF.
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    • 15. This figure is the total of prior year school aid recorded in the general fund and the general long-term obligations account group as of March 31, 1997, reported in State of New York, Office of the State Comptroller, Comprehensive Annual Financial Report, for fiscal year ended March 31, 1997. If substantiated, other unaudited outstanding claims would increase this amount.
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    • 16. See Dean Michael Mead and Andrew S. Rein, Budget 2000 Project: Restructuring Government Services (NY: Citizens Budget Commission, December 1996).
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    • 17. See Charles Brecher and Sheila Spezio, Budget 2000 Project: Social Welfare Spending (NY: Citizens Budget Commission, December 1996).
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    • 18. For an analysis of the State's debt issuance practices see Cynthia B. Green, Guidelines for Debt Reform in New York State (NY: Citizens Budget Commission, January 1994).
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    • 19. David Belkin, Would Clothing Sales Tax Cuts Pay for Themselves? (NY: New York City Independent Budget Office, June 1997) and Thomas Conoscenti and Associates, Inc., Who Benefits? prepared for the New York State Association of Counties and New York State County Executives Association, May 1997. Who Benefits? includes an alternative scenario in which the economic stimulus would offset 33 percent of the revenue loss.
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    • 20. New York State Department of Taxation and Finance, Office of Tax Policy Analysis, The Temporary Clothing Exemption: Analysis of the Effects of the Exemption on Clothing Sales in New York State, November 1997.
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    • 21. Ibid, p. 22.
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    • 22. See Charles Brecher, Budget 2000 Project: Tax Policy (NY: Citizens Budget Commission, December 1996).
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