New York: Why the Math Is So Scary

Bloomberg has a $6.4 billion deficit--and little room to maneuver

When Michael R. Bloomberg took office as mayor of New York on Jan. 1, he aimed to work wonders on municipal government, just as he had in the business world. "We cannot raise taxes," he said in his inaugural address. "We will find another way."

Bloomberg has already changed his tune; running New York in an economic slump has proved tougher than the self-made billionaire imagined. On Nov. 23, he pushed through an 18% property tax increase as an aggressive step to closing budget gaps projected at $1.1 billion this fiscal year and $6.4 billion in the year beginning next July.

It's not just because of the terrorist attack on the World Trade Center. Bloomberg has also been forced to confront two dismaying facts: First, New York's economy is more cyclical than the nation's because it depends heavily on Wall Street, whose profits are highly volatile. Second, New York has high fixed costs, including more debt per dollar of property value than any major city except long-suffering Philadelphia and perhaps Detroit. That combination--a cyclical economy and high fixed costs--virtually guarantees a fiscal crisis during an economic slowdown.

That's not to say the mayor and the city are helpless. In the long term, New York's priorities are obvious: chisel high costs from municipal government, pay down the debt, and rejuvenate the infrastructure--from streets to schools--to attract residents and businesses.

Right now, though, there's a budget crisis to contend with. The property tax increase should bring in an extra $1.7 billion next year. Bloomberg also announced plans to seek a 2.7% levy on the incomes of suburban commuters--six times the size of the commuter tax that the New York state legislature repealed in 1999. He might get lawmakers to O.K. a 1% tax, which would raise close to $400 million. He's also aiming for budget cuts and labor givebacks to save $1.7 billion next year and wants an extra $600 million in state and federal aid--though he'll probably get only a fraction of that.

Bloomberg's critics are howling that by emphasizing tax hikes, he's going down the wrong path. "There's a simple rule of thumb: You don't raise taxes in the middle of a recession," says Fred Siegel, a senior fellow at the Progressive Policy Institute, a centrist think tank.

Indeed, tax increases carry plenty of risks. Leo F. Wells III, president of Wells Real Estate Funds in Norcross, Ga., says property tax hikes could tip him toward buying buildings across the Hudson River, in Jersey City, N.J., instead of in Manhattan. Says Wells: "People leave a lot quicker than they come back. You can kill yourself in the long run trying to take care of a short-term problem." The combination of increased taxes and improving communications could accelerate an exodus of brokerages and investment banks, says Alan Johnson, head of Wall Street compensation-consulting firm Johnson Associates Inc. He predicts that "in the next five years, probably one of the big firms will move out of town."

What Bloomberg has run up against is an extreme version of the distress that's afflicting most mayors and governors in America. Unlike Washington, most state and local governments maintain separate budgets for operations and capital spending, and they're required by state laws to balance their operating budgets every year, even in slumps.

New York's problems are among the worst. In part, that's because of its dependence on the securities industry. With average pay of over $200,000 a year, the finance sector supplies fully 20% of personal income in the city, up from 5% in 1980. While that was a plus in boom times, it's a minus now. Wall Street-related tax revenues--including those on individuals' capital gains--are down 40% this year from their 2000 peak. Employment is back to 1998 levels, a 10% decline, and falling.

What makes the Wall Street downturn harder to deal with is that almost two-thirds of New York's $42 billion budget goes for involuntary expenses. The cost of servicing debt--which rose under Mayor Rudolph Giuliani, despite the prosperous times--represents a big chunk. The city has accumulated about $5,000 in debt per person, which makes for an annual debt service bill of $2.3 billion. Pensions account for another $1.7 billion more, while welfare and Medicaid cost $4.5 billion a year. An additional $14 billion in spending on education, social services, and other functions is also considered non-discretionary, since it's funded with earmarked state and federal money. If the city cuts back on that spending, a big portion of the earmarked funds gets taken away.

That leaves only one-third of the budget, or $15 billion, fully under the city's control. The bulk of that spending goes towards essential services like police, fire, sanitation, corrections, and locally funded education. The bottom line: It will be almost impossible to quickly close a budget gap of $6.4 billion, through cuts in discretionary spending alone. Says William Cunningham, the mayor's chief spokesman: "I defy you to find any economist to make that math work."

Over time, of course, diligent cost-cutters can make city services cheaper to deliver. Bloomberg himself demonstrated his cost-cutting acumen at Bloomberg LP, where he once sent carpenters in on the weekend to trim the size of desks in order to cram in more workers. But for New York City, the only way to cut costs instantly is through reducing services, and Bloomberg badly wants to avoid a repeat of the 1970s, a decade remembered for crime and dirty streets. The risks to quality of life were brought home in mid-December as the city braced for a possible illegal strike by 34,000 bus and subway workers employed by the Metropolitan Transit Authority--a state-operated agency that's also strapped.

With the slump continuing, Bloomberg's dilemma isn't going away anytime soon. His staff predicted last month that the city's inflation-adjusted output will decline half a percent next year, on top of a 2.7% drop in 2001 and a projected 2.5% fall this year. Rae D. Rosen, senior economist at the Federal Reserve Bank of New York, warns that employment gains are likely to be concentrated in jobs such as restaurant and hospital work that generate less income tax than finance jobs. Says Rosen: "The fiscal picture is likely to remain difficult."

Still, there's much that the mayor can do besides plug holes in the budget. He can start by demonstrating his determination to attack spending. Local government jobs make up a fifth more of the local workforce in New York than in Philadelphia and about a third more than in Chicago. The business-funded Citizens Budget Commission estimates that New York's spending on police protection per capita is 46% above the big-city average. It recently proposed measures to save city agencies $1.2 billion a year, from lengthening workweeks to rearranging police schedules to cutting energy bills.

As businesses threaten to leave town, Bloomberg shouldn't respond in desperation. Bribing companies to stay with big tax breaks only saddles others with higher taxes. These days, much of his time is devoted to crisis management. The billionaire entrepreneur must long for the days when all he had to do to trim costs was to pull out the saw.

By Peter Coy, with Steve Rosenbush and Emily Thornton, in New York

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