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New York Supplemental Report

Tax Environment

New York stands out in the fifty states in the responsibility that it puts on local governments to fund basic services. In no state is the proportion of tax money provided by local governments higher or the proportion provided by the state lower. The effect of this situation is that New York State’s tax burden ranks eighth when measured per capita and 27th when measured as a percent of personal income. But when both state and local revenues are combined and compared to the combined totals in other states, the tax burden in New York is third per capita and it’s the highest in the country in the percentage it takes out of a resident’s income.

There is a good deal of ongoing tension regarding the fiscal responsibilities of the state and localities in New York. The major political divide between New York City and the rest of the state is certainly one factor. But there also have been longstanding tensions in regard to the way money is raised and divvied up. Revenue sharing is a fraction of what it once was and although there is a revenue sharing agreement that was reached in the 1970s and which is still on the books, it has not been adhered to for decades.

New York State cut taxes significantly in the 1990s. Even in fiscal year 2003, tax reductions continued, including a hike in the tuition tax credit, in the standard deduction for married couples, and in the increased earned income tax credit. However, the state’s dire financial situation led to a number of tax increases for fiscal year 2004.

Some specific taxes are very high in New York. State and local income taxes combined are 70 percent above the national average as a share of personal income. The tax on cell phone users is the fourth highest in the nation, after California, Florida and Virginia. The tax on cigarettes is tied with New Jersey for the nation’s highest. Liquor excise taxes are second highest after Florida (though the tax on wine is among the lowest).

Recent Tax Developments

• In early 2002, New York Gov. George Pataki (R) signed a 39-cents-per-pack cigarette tax increase, which brought the per-pack tax from $1.11 to $1.50

• New York reduced the small business tax and corporation franchise tax in FY2002.

• A tax amnesty program was held from November 18, 2002 to January 31, 2003.

• Tax cuts enacted for FY2003 included hikes in the tuition tax credit, in the standard deductions for married couples and in the earned income tax credit. A long-term care insurance credit was also adopted.

• In an effort to balance the FY2004 budget, the state legislature increased the sales tax a quarter of one percent and increased the income tax on people who make more than $100,000. It also took away the exemption on clothing and shoes that cost under $110. (To provide temporary relief, the legislature also gave citizens two weeklong sales tax holidays during the fiscal year — for the last weeks of August and January.)

Budget Information

At the close of fiscal year 2002, New York appeared to be in better condition than many other states. In fact, it was one of seven states listed by the National Conference of State Legislatures as not experiencing a budget gap for that year. However, this was largely due to the unique nature of New York’s fiscal year, which ends March 31. (Forty-six states use a fiscal year that ends June 30th). This meant that fiscal year 2002 for New York did not include the extremely weak second calendar quarter of that year when New York state tax collections dropped 19.4 percent, according to the Rockefeller Institute State Fiscal News.

In all, state tax collections were down 8.2 percent in the first six months of the 2003 fiscal year, with general fund revenue down 14.2 percent and spending up 2 percent from the previous year, according to a report issued by the New York Comptroller’s office. But New York’s fiscal crisis was largely downplayed prior to the 2002 election. Revenue shortfalls were handled through use of the rainy day fund and it wasn’t until late November that the Governor’s budget director asked agencies to cut their budgets by five percent for the remaining four months of the fiscal year, as well as to cut their budget requests for FY2004 by 5 percent.

A large budget gap was initially projected for the FY2004 budget, but a combination of tax increases, additional federal aid, about $4.2 billion in borrowing and the use of a number of one-time measures helped to close the gap. The budget was passed 40 days after the FY2004 fiscal year began and only after the legislature had overridden more than 100 vetoes of its spending plan by Governor George Pataki. Despite the increase in some taxes — notably a hike in the income tax for wealthy New Yorkers and a quarter percent rise in the sales tax — the state is still in a precarious fiscal situation. The gap between spending and revenue for FY2005 is now projected to be at least $5.3 billion on a $92.8 billion budget.

In addition to continued weakness in revenues, New York faces some major spending pressures: The state pension fund lost 25 percent of its value since 2000, according to the New York Comptroller’s Office, which will likely necessitate a substantial increase in pension contributions. As in most states, Medicaid costs are rising as well.

Fitch Ratings dropped the state’s bond ratings to AA- from AA in early June 2003. In May, Standard & Poor’s shifted its outlook on New York State bonds from stable to negative.

Adequacy

New York has an extremely volatile tax structure, largely because of its high dependence on the income tax and the extraordinary importance of a relatively small number of high-income taxpayers to state income tax revenue. The income tax, which boomed during the prosperous 1990s, delivering greater than expected revenues to the state has been severely impacted in the last two years by stock market declines, rising unemployment, falling salaries and the disappearance of opulent bonuses. In fact, personal income tax collections were down 23 percent in the first six months of the 2003 fiscal year. Although New York’s tax structure is much less progressive than it used to be, it is still relatively progressive and that also heightens revenue volatility. The more progressive an income tax is, the more elastic it is, which means that it reacts more strongly to times of economic boom and economic bust.

Other issues have resulted in lower revenues in the state. With income tax revenues high in the 1990s, the state was able to make substantial tax cuts — a reduction in tax receipts of $67.3 billion over seven years. In addition, the state has followed the pattern of many others in seeing a steep drop in the corporate tax base. This is partly due to the proliferation of corporate tax incentives, which has had substantial revenue consequences. Just between 2001 and 2002, the take from corporate taxes dropped from 7.1 percent of total state tax revenues to 5.2 percent

Fairness

New York does fairly well in terms of progressivity issues. Although its income tax is less progressive than it used to be, it still stands up quite well compared with most other states. It has a strong earned income credit and generous dependent care credits.

The state has a circuit breaker program that provides property tax relief to low income families. A state-financed property tax homestead exemption, granted in recent years through the STAR program provides additional relief to those who are 65 year olds and have a household income lower than $60,000, as well as lesser relief to younger taxpayers. (This program was started in the 1998-99 school year)

More property tax relief was granted across the board through the STAR program, starting in the 1999-2000 school years. This homestead exemption, available to all residential property owners, was phased in over years, and currently allows for the exemption of $30,000 from the value of eligible property for the calculation of school district taxes. One fairness issue that has been raised is that this benefit is only available in owner occupied dwellings, creating potential inequities for renters. (This problem was addressed in New York City through a STAR supplement that is provided to renters. But this has not been provided elsewhere in the state) Some advocates of a more progressive tax system, like the Fiscal Policy Institute, argue that this property tax relief is wasteful in that it is provided to people regardless of income.

New York has many tax incentives — as one observer noted, “One person’s loophole is another person’s economic development tool.” These tax incentives and credits have proliferated, making the system more complex and less fair. The investment tax credit has been used to drive tax liability down to near zero for some corporations. There are also research and development tax credits, solar and wind power credits, and many other ways for individuals and companies to chip away at their taxes.

One issue that’s ripe for more study is the impact of industrial development agencies, which have debt issuing power and can end up holding title to commercial enterprises like shopping malls. These malls, in turn become exempt from property taxes, because the title-holder is a quasi-governmental agency, although they may make some payments in lieu of taxes.

An alternative minimum tax does act as a cap on the amount of credits used by a company in any one year. Advocates of this believe that it is a good leveling device, but it has not been a popular tax with business.

New York’s sales tax includes some services, but there are many services that are not taxed, including all professional services and most personal services. Since the Federation of Tax Administrators surveyed states in 1996, the few changes to New York’s policies on service taxation has moved toward more exemptions rather than more services taxed. http://www.taxadmin.org/fta/pub/services/services.html

Many of its sales tax exemptions on goods have been put in place in an effort to make that tax less regressive. In trying to draw a line on what’s taxable and what’s not, it faces the usual array of knotty questions. A video rented from a video store is taxed, but one that is rented through a TV cable company is not. If you eat out (considered a luxury) food is taxed. If you buy food to prepare at home, it’s not. So, half a pound of roast beef from a deli counter is not taxed, but if you stick that roast beef between two slices of bread, the resulting take-out sandwich would be taxed.

Another problem for the state, in terms of fairness, has been the fragmented nature of property tax assessment. There are more than 4000 local governments in New York, including school districts and special districts, leading to a complicated system of local assessment and tax collection. Many overlapping governmental borders complicate this issue, as does the wide latitude given towns — which levy property taxes on behalf of themselves as well as schools — to determine what the taxable value of property is. Different towns and cities are permitted to assess at different percentages of full value. The lack of any enforced requirement for periodic assessment deals another blow to the fairness of the system. As one official in the Office of Real Property Services says: One town can be assessing property at 100 percent of market value. And another town may not have done a reassessment in 50 years and may be at 2 percent of market value. And these two towns could both be in the same school district.

Although there is no enforced requirement to reassess property at set intervals, there has been a trend to do this more regularly than in the past and the accuracy of assessment rolls has been improving. The state also steps in with equalization adjustments to help determine a town’s fair contribution to a school district. This process is complex, however, and while it may ensure that towns pay their due, despite their assessment practices, it does not increase fairness for individual taxpayers. In general the property tax system is still described by observers as arcane and complicated — an inequitable system in which equals are not treated equally.

Management

New York State has one of the best tax websites in the country, according to an analysis of all 50 sites by Governing magazine. Standard government web-site features are all there and e-mail service is available to those who want to keep track of what’s new. Refund, appeal, amnesty, deduction/credit information are all relatively easy to find, and good summaries of collections are available.

New York State provides an online service allowing taxpayers to check the status of their income tax refund. Taxpayers who register for secure Internet access can check their account balance for the current and previous tax year and can electronically send a request to the department for reconciliation. New York State does not have electronic sales tax filing or free Internet tax filing for individuals or other direct online filing programs. It allows for electronic income tax filing through practitioners and is starting an alliance program with tax preparers to provide free electronic filing to certain groups — for example, veterans or college students. It also instituted the use of 2d bar codes in January, 2003. As many of its returns are still received in paper form, it has outsourced data entry of tax returns to several banks and receives information electronically from them. The state does have electronic payment systems. Officials estimate that 70 percent of funds from income and sales tax are received electronically, which represents about 15 percent of filers.

The state does not yet have an integrated tax system, but it is developing one, which will be web-based. This is currently in the design phase. Development of the income tax and corporate tax components are expected first, with implementation in Summer 2004. It’s hoped that this will cut down on substantial maintenance costs, provide more time for analysis, and give managers better ability to interact with the system without the need of a technician to rewrite codes, etc. The current corporate tax and income tax technology are 30 years old and 25 years old respectively. Prior to the re-design, the department has been using two different mainframes and has three different major database systems. Each of the nearly three dozen taxes administered has its own application codes. The integrated system will result in one platform, one common data base, and one common code. This will mean that a tax manager could access all the information about a taxpayer using two or three screens of data, compared to up to 70 different screens that might need to be accessed now.

Reporting and analysis is generally very good. The state prepares a tax expenditure report, which totes up the cost of tax breaks. This is available on the web at http://www.budget.state.ny.us/pubs/supporting/supporting.html. It also has the capacity to determine the impact of tax changes on different income groups, according to the Corporation for Enterprise Development’s State Assets Development Report Card.

A tax amnesty program was held in FY2003. It started in mid-November and lasted until January 31. It was expected to bring in $175 million. A number of new technological applications were developed for the amnesty program, which will be useful for administering taxes generally. The Department of Taxation and Finance says that it used 325 people to run its last amnesty program in 1996-97, but only needed to devote 20 people full-time to this year’s effort due to the improved technology and the ability to integrate the amnesty effort into its normal operations.

In an effort to collect on some $200 million owed to the state by non-residents and out of state corporations, the New York State Department of Taxation and Finance hired an outside firm (Allied Interstate Inc. of Minneapolis).

In compliance, one of the areas in which New York State is most aggressive is in establishing the issue of residency. Especially for wealthy individuals, it keeps an extremely close watch on people who live part of the year in New York yet claim to have residency in another state.

The state has greatly improved its audit selection processes, according to a series of audits conducted by the State Comptroller’s office in the mid to late 1990s. Improved technology has also helped it do a better job in making sure that collections were deposited in a timely and accurate fashion. The department has a number of joint programs with the IRS, which shares its interest in cracking down on the over aggressive use of tax planning devices in flow-through entities. It was also one of the first states to sign a memorandum of understanding with the IRS to facilitate joint agreements that satisfy both federal and state liabilities if a business owes money.

Improved technology will be a major boon to the auditing area. A data warehouse that was started three years ago has been quite successful, but it can only be used in a limited way. Otherwise, data matching efforts can be crude and error-prone when they involve legacy systems, multiple codes and databases. A fairly large number of taxpayers are currently contacted because the computers have targeted a data mismatch, which turns out to be inconsequential or erroneous. With improved technology the state will be able to reduce the relatively large number of taxpayers who are contacted in error and the number of “no change” audits (those that don’t yield results) will go down.

Some interesting innovations that are already in place include an audit case management system, which has allowed the state to trace revenues from a business down to it’s partners, whether they are residents or non-residents.

During the Pataki administration, the Department of Taxation and Finance has made a substantial effort to become much more customer focused and “taxpayer friendly”. Many individuals outside the department report that the “character” of the department has changed and that its past reputation of being arrogant and contemptuous of taxpayers has evaporated. In making these changes, employees were tapped for their input. Complaints of a lack of training, poor technology, deterioriating working conditions and a “command and control” environment provided the catalyst for improvements. At the same time, there was a tremendous outreach to external stakeholders. Task forces from various business or industry groups and advisory councils were set up to provide input. A good deal of effort has also gone into making sure that the 12 district offices involved in audits all follow the same guidelines and procedures so that taxpayers are treated in a like manner across the state.

The current administration maintains that a friendlier tax department that is sensitive to economic development issues does not conflict with a tough stand on compliance. Some critics worry, however, that the state hasn’t “pushed the envelope” in cracking down on business tax planning abuses and that it has been reluctant to take aggressive legal positions. Observers note that there is an inherent tension that results when a tax department is focused on economic development, yet still is responsible for the administration of tax laws.

An independent tax court, removed from the judicial system, appears to work well. It provides taxpayers, though not the state, with the right to appeal to an exterior court. This tends to encourage the state itself toward settlements.

Note: Forty employees from the Department of Taxation and Finance, which had offices on the 86th and 87th floor of the South Tower of the World Trade Center, were killed on September 11.

Local Issues

Although the general U.S. trend has shown an increase in state aid to local governments, some states, including New York have gone in the opposite direction. According to a study by Robert Tannenwald, entitled “Are State and Local Revenue Systems Becoming Obsolete?”, between the late 1970s and late 1990s, state aid as a percentage of local general revenues fell from 40 percent to 30 percent in New York.

The fact that New York services are so dependent on locally raised revenues raises a number of issues. According to a study entitled “The Funding Gap” by the Education Trust, New York is the state with the largest gap — a difference of $2,152 per student — between per student funding in poor and wealthy school districts. This is way more than the average gap nationally, which was pegged at $966. http://www.edtrust.org/main/main/reports.asp

In fact, New York State’s method of providing aid to the New York City School District, and of overseeing education in the city, recently was found constitutionally inadequate by the state’s highest court. The court gave the state until July 3, 2004 to craft a solution. While the solution need not be statewide to satisfy the court’s directive, many observers believe an overhaul of the entire system of financing schools is likely.

One of the major differences between New York and other states is that the responsibility for Medicaid funding falls heavily on local governments. Unlike the vast majority of other states, New York requires its county governments and New York City to pay half of non-federal Medicaid dollars. Medicaid costs have skyrocketed in the last several years and this has resulted in major tax increases, or proposed increases in New York State counties.

Interestingly, despite facing higher sales and property taxes generally, voters outside the state’s major cities, were generous in late spring 2003 in approving school budgets (this approval is not required in New York’s large cities). According to the State Council of School Superintendents, following these school budget elections, school districts, on average, will raise their own local property taxes 7.4 percent this year.

The state gives local governments some freedom to impose taxes. Counties, for example, can use local option sales taxes as well as property taxes. They can opt to give or not to give certain exemptions — for example the exemption for low-cost clothing or the residential home energy exemption — and they can opt to participate or not to participate in sales tax holidays. They do need to ask the legislature for permission to add their own sales taxes to the state rate once they’ve hit 3 percent (in addition to the amount levied by the state itself) Since this takes time and effort, and inevitably becomes the victim of horse-trading in Albany, and since the legislature has not yet approved local sales taxes that exceed 4 percent, it tends to result in counties turning to property tax increases with greater frequency.

Cities have hotel taxes, utility taxes, property and sales taxes, and in the case of New York City and Yonkers, income taxes. New York City has a wide array of other taxes as well. But the state repealed the New York City commuter tax in 1999, over the loud protests of city officials. The city’s subsequent efforts to convince the state to reinstate the tax have been unsuccessful.

An effort to relieve the property tax burden has come in recent years through a new homestead exemption, affecting only school district property taxes. The exemption, called the STAR (or School Tax Relief) program, was phased in over three years and was available to any residential homeowner. In general, the program allowed for the exemption of $30,000 from the value of eligible property for the calculation of school district taxes. A school district tax exemption of $50,000 off of property value was available to property owners who were over 65 and had a household income lower than $60,000.

Noteworthy Programs

• The Data Warehouse Project. The state has made major strides in improving the quality of the data and the technology available to access it efficiently and effectively, Cleaner and more complete data in a single database allows the state to utilize matching techniques to check the returns from one type of tax against another (sales compared with income, for example) and match third party data against returns. One of the goals of these matches is improved audit selection. The state’s sales tax program was the first to extensively use third party data. This has resulted in a “no change” rate of 17 percent for audits, whereas a random selection of audits would generally have a 70 percent “no change” rate. The lower the no change rate, the more effectively audit candidates have been selected. This effort will be expanded with the development of the state’s integrated tax system

• Hiring reforms. As in other states, New York has often had a tough time filling auditor positions. Three years ago, it made a significant change in how it recruits staff, shucking a number of long-standing requirements that made it difficult for people to apply for auditor jobs. For example, in the past, an applicant was required to send in $25 with the application and then might have to wait three to six months to take the necessary exam. Now the state evaluates auditors based on education and experience and has reduced a 12 to 15 month recruiting and hiring process to a two-three month recruiting and hiring process.

• Call Center. The state has significantly transformed its call center in the last five years. In 1998, a customer service survey revealed that taxpayers had a very hard time reaching the New York State Department of Taxation and Finance. Performance measures showed that taxpayers received 3.4 million busy signals and that 2.3 million calls ultimately got through. It took an average speed of 2 minutes and 37 seconds to answer a call. To fix this problem, the automatic call distributing system was revamped with 96 additional lines. The state also upgraded its automated voice response system so that taxpayers could dial up and by entering their social security number, receive information on the status of their accounts. Other improvements included an increase in hours of operation and a revamping of automated voice response scripts to that they made more sense and were less confusing. More information was also made available on the Internet. In addition, tax department representatives were given the authority to deal with problems as they came in, including the ability to make online changes to an account.

In FY2002, the call center answered 4.2 million calls and the number of busy signals were down to 280,000. The average speed to answer a call was 42 seconds. The call center also provides assistance to other state agencies, such as the health department, the consumer protection board, and the state emergency management office. For example, the call center was very active in fielding calls during the September 11 crisis. There also is a tax practitioner hotline

• Taxpayer outreach. The New York State Department of Taxation and Finance does many small business workshops. It also sets up tax booths to provide voluntary tax assistance, and has a special program that trains volunteer CPAs and other accountants to prepare tax returns for the elderly. The department’s outreach activities increased from 174 in 1998 to 502 in FY2002.

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