New York Is Headed for Dark Days Unless Bloomberg Changes Course
Last week, Mayor Mike Bloomberg announced a grim update to New York City's $60 billion budget. To meet falling revenues he proposes spending cuts and property-tax hikes, and he may increase income taxes by 15%.
The real risk to the city isn't a tough budget this year or next. It's that the mayor might be too optimistic in assuming the downturn in tax revenue will be short-lived.
In his budget announcement, Mr. Bloomberg told New Yorkers that "we're just not going to return to the dark old days of the '70s, when service cuts all but destroyed our quality of life."
The problem is that the "dark old days of the '70s" didn't start with cuts to vital services like police and sanitation. They started in the late 1960s, when the city had a chance to avoid its near bankruptcy a few years later. Instead it chose to raise taxes for new spending. It was in this period when the city enacted its first income tax as well as new business taxes. It kept raising taxes as it went on to lose half of its one million manufacturing jobs and half of its more than 100 Fortune-500 headquarters.
The city had made a near-fatal error by raising taxes and vastly increasing social spending without recognizing its economy was changing. As revenue began to slow in the 1970s, the new spending inexorably crowded out basic-services. The result was a deterioration of quality of life, including police cutbacks that allowed crime to spiral out of control.
New York nearly didn't recover from that error. It did get good mayors in Ed Koch and Rudy Giuliani, but it also got lucky. In the early 1980s, the financial industry started to grow at a spectacular rate relative to the rest of the nation's economy. The financial sector's profits as a percentage of the nation's income doubled twice from the early 1980s to 2006.
New York was a beneficiary of this breakout. It could suddenly have both guns, in the form of a bigger police force, and butter, in the form of social spending—social spending that never fell from its 1970s share of the budget.
Today, things are different. The financial-services industry could be at the beginning of a long-term correction that will leave profits much lower than they had been. Wall Street's business model—of taking ever bolder risks with shareholders' and lenders' money and reaping fees from ever-more-complicated proprietary financial products—now appears to be dead. Consequently, high finance may shrink as a share of the national economy and the city's economy, not just temporarily but for a decade or more.
To plan for this risk, the city needs to respond with structural spending reform and tax policies that create new revenue sources.
To understand just how dependent upon Wall Street New York City's budget has become, consider these facts. Two years ago, a third of all the wages and income in the city came from the finance, insurance and real-estate industries, up from just a quarter a decade earlier. The securities industry alone was responsible for a quarter of wages, up from 17% from a decade earlier.
The city also depends on its top 1% of earners—many of them tied to the financial industry—for nearly half of its personal-income tax revenue, up from 41% from last decade. The financial sector provides more than a third of business taxes. Last year, Wall Street bonuses alone comprised 8% of the city's personal income. In 2000, the peak year for tech-bubble bonuses, they comprised 6.6%.
Wall Street's boom, moreover, papered over the precarious structure of New York City's budget. Two years ago, New York took in 41% more in tax revenues than it had in 2000, after inflation. But the city's long-term, big-ticket budget items—pensions and health care for city workers, Medicaid and debt costs—had increased by more than half.
The mayor calls these costs "uncontrollable" because cutting them requires long-term planning. They now comprise more than half of the budget funded by city tax revenues, and will continue to grow if left unchecked. The budget in general is 22% bigger, after adjusting for population and inflation, than it was at the height of the 1970s fiscal crisis. Most of that growth came in the past seven years.
While the mayor has shown us that tax revenues are plummeting, he projects that the city's economy will start growing robustly in little more than two years, with tax revenues overtaking their bubble-era levels by 2011. So the city is cutting basic services—including cutting a class of 1,000 new police officers—today and planning to raise taxes to tide itself over until the good times return.
This approach worked in the early 1990s and in the early 2000s during cyclical slumps. Wall Street grew again so torridly that it didn't care about higher taxes.
But the city may not be so lucky this time. An indefinitely shrinking financial industry would seek to cut costs, including taxes. Companies like Merrill Lynch, merging with out-of-state institutions, could easily move jobs out of New York if taxes go up.
The mayor needs to turn his attention now to those "uncontrollable" costs—because controlling them will take time. Otherwise, within a few years the city will need to cut deeply into the basic-services portion of its budget, like police and fire, by 20% or more. That would risk repeating what happened to the city in 1970s, when the murder rate doubled in just five years.
One place Mr. Bloomberg could start is by asking public employees to contribute 10% to their own health-care premiums, and working with the state to wring 10% savings from the city's bloated, patronage-rich Medicaid program. Such savings, together, would net $1 billion annually, a significant help for future deficits. The city and state can also work with unions to rein in future pension benefits.
New York's next two decades can be brighter than the past two. Other industries, attracted by lower residential and commercial real-estate prices, will want to come here. But that will take time, and those industries won't generate Wall Street level profits and bonuses.
The city has to change. Right now, it can do so willingly. In two years, it may not have that luxury.
This piece originally appeared in Wall Street Journal
This piece originally appeared in The Wall Street Journal