Gov. Hochul makes a budget presentation (photo: Mike Groll/Governor's Office)

When Governor Kathy Hochul delivered her State of the State address in January, she promised to keep income taxes flat this year while identifying other revenue sources to pay for major funding needs.

"A majority of economists are predicting a recession," she said. "And it's also one of the reasons why we will not be raising income taxes this year."

The Legislature is now putting that promise to the test, seeking to increase taxes on the state’s highest individual and corporate earners as the legislative and executive branches negotiate a roughly $230 billion state budget.

Hochul, a Democrat, and the two Democratic supermajorities in the Legislature are divided over how to fund critical state functions and new priorities as pandemic-era federal aid dries up. A two-year boom in tax revenues due to a prior tax increase on top incomes combined with higher-than-anticipated earnings during the covid recovery is expected to yield to slower growth driven by high inflation and fears over a possible recession.

But the state currently remains flush with cash – entering the fiscal year with a $8.7 billion surplus – as leaders decide on a spending plan while putting billions more into reserves. Budget gaps in the outyears – fiscal years 2025, 2026, and 2027 – are expected to total $22 billion, primarily due to a drop in projected tax receipts and high ongoing levels of spending. The state budget has increased from $175.5 billion in fiscal year 2020 (the last pre-pandemic deal, struck in April 2019) to the expected roughly $230 billion budget for this fiscal year.

Hochul, Senate Majority Leader Andrea Stewart-Cousins, and Assembly Speaker Carl Heastie have been nearly deadlocked over the budget, now three weeks late, with discussions dominated by bail and housing policy. Looming behind them is a long list of other policy and fiscal decisions, with how much the state will raise and spend underpinning much of it. Part of that is a debate over raising taxes on the state's highest earners to pay for mass transit, healthcare, and a menu of other priorities held by various stakeholders.

Roughly a third of state revenue comes from personal income and corporate franchise taxes. Those funding streams account for about two-thirds of the revenue the state can raise directly without federal sources. Income taxes, the single largest non-federal funding source for the state government, fell steeply to $58 billion in Fiscal Year 2023, after reaching a peak of more than $70 billion the year before — though the projected income tax receipts this year are still higher than fiscal years 2019, 2020, and 2022. The expected drop this year is largely due to a so-called Pass-through Entity Tax, which gives certain corporations the option to pay an additional tax in exchange for personal income tax credits for their shareholders and other affiliates.

Proponents of higher taxes on the rich argue the boost could raise hundreds of millions to tens of billions of dollars to support programs for struggling New Yorkers like child care, affordable housing, health care, and education. Opponents, including Hochul, argue that already-high tax rates are responsible for an exodus of some high-income earners and going further could jeopardize the state's economic competitiveness.

Lawmakers are seeking new revenue in the face of concerns over the MTA's solvency, now with a $4.6 billion four-year shortfall, stress on the health care system, the costs associated with an influx of asylum-seekers to New York City, and other challenges and opportunities.

To fund those and other priorities, Hochul is looking to extend a 2021 tax increase on the most profitable companies. But she has resisted calls from Democratic lawmakers to raise personal income taxes on top individual earners while keeping in place increases passed in 2020 and also moving ahead with the next step in a modest, multi-year middle-class income tax cut.

The funding from the corporate tax increase extension, along with an additional payroll tax on downstate businesses to support the MTA, is expected to raise close to $2 billion in additional annual revenue, according to the governor's projections.

Both houses of the Legislature proposed higher corporate tax rates while rejecting Hochul's "payroll mobility tax" increase in their one-house budget resolutions, passed in mid-March. The chambers also both backed income tax increases on individuals in the top two brackets, those making more than $5 million and $25 million annually.

The different revenue and spending plans were followed by the launch of more intensive budget negotiations among the three Democrats, who have been meeting regularly behind closed doors over the past month with little to show for it.

On Wednesday of this past week, Stewart-Cousins told reporters she hoped negotiations were "at the beginning of the end" but that no agreement on taxation had been made.

"We haven't had a discussion about that," she said of proposals to raise taxes on the very wealthy. "We, in our one-house [budget resolution], talked about that possibility but it's not at the table right now."

On Monday, State Comptroller Thomas DiNapoli released a report showing tax collections in the last fiscal year exceeded the governor's amended executive budget forecast by $2.9 billion but were still $9.5 billion lower than the year before. In total, the state collected $111.7 billion in fiscal year 2023, which ended March 31.

"We are obviously taking a look at what is going on and the Comptroller's report certainly is informative," Stewart-Cousins said on Wednesday.

The fight over tax rates is playing out in the hallways of the State Capitol where advocates for and against increases are making their positions known. On Tuesday, a coalition of Democratic legislators and advocates supportive of the "Invest in Our New York" package of major tax increases and additional spending called on Hochul to accept tax hikes on New York's millionaires and billionaires.

"We must create a fairer, more inclusive society by investing in essential services, raising the minimum wage, and ensuring that the wealthiest contribute their fair share," said Assembly Member Michaelle Solages, a Nassau County Democrat, in a statement.

Nathan Gusdorf, executive director of the Fiscal Policy Institute, a nonprofit focused on state economic and fiscal trends, supports the tax increases proposed by the Legislature and has been calling for them to be made permanent. "The budgets only increase taxes on the top 0.2 percent of taxpayers, and only on a temporary basis," he said in a recent statement. "The state's fiscal stability would be better served by broadly increasing the progressivity of our tax system for all high earners on a permanent basis."

The Empire Center, a nonprofit think tank, has argued New York's relatively high personal income tax for top earners led to an outmigration of millionaires, citing data showing the state's share of millionaire earners nationwide decreased between 2010 and 2020. But while the number of millionaire filers leaving the state rose most years between 2016 and 2021, according to state tax data, the exodus shrank by roughly a quarter in 2021, the same year income taxes were raised on the highest earners. Overall, the total number of millionaires in New York continued to rise.

A recent Fiscal Policy Institute report shows that half of New Yorkers who left the state went to neighboring high-tax states. The report suggests a greater concern is an outmigration of middle class residents driven by New York's high cost of living, especially housing.

Patrick Orecki, the director of state studies at Citizens Budget Commission (CBC), a nonprofit fiscal watchdog, said the state should be seeking other revenue sources without relying so heavily on the wealthiest residents.

"The tax environment, especially being so top heavy, can and does have a negative impact on the state's competitiveness," he told Gotham Gazette. "There are plenty of opportunities for the state to, instead of increasing taxes, find savings elsewhere in the budget."

Also at stake in budget negotiations are billions of dollars in tax breaks for a range of industries, which the governor and Legislature have each included in their spending proposals. This year, Hochul proposed increasing the state's Film Tax Credit from $420 million to $700 million a year for media productions in New York. Both chambers included the increase, along with a $100 million boost in what’s now a $200 million a year credit for Broadway theaters that Hochul also backed. Some budget watchdogs, including CBC, have argued these types of subsidies have little proven impact on job creation or economic development.

Orecki suggested the state eliminate the Film Tax Credit and similar subsidies, and seek efficiencies in other areas like the state's School Aid and Medicaid formulas — the two biggest areas of spending in the budget each year. CBC is also opposed to proposed corporate tax hikes to fund the MTA, which Orecki noted also has room for savings. "Providing just new recurring revenue we don't think is a sustainable or reasonable option," he said.

Personal Income Tax
In April 2021, the final state budget deal raised personal income taxes on three groups: individuals making over $1 million a year or married couples making over $2 million a year; anybody making over $5 million annually, regardless of filing status; and anybody making over $25 million annually.

Both legislative one-house budgets this year propose .5% rate increases on the top two income brackets for tax years 2023 through 2027. That means for people making over $5 million a year, their state income tax rate would rise from 10.3% to 10.8%. For people earning over $25 million, their state income tax rate would increase from 10.9% to 11.4%.

The Assembly projects those rate increases to raise $717 million in the current fiscal year that just began (FY 2024) and $3.5 billion total through FY 2027. According to an analysis from Citizens Budget Commission, the rate hike would impact about 22,000 individuals, based on 2020 tax data. That year, people earning over $5 million annually made up .2% of filers and shouldered roughly a quarter of the state's personal income tax liability.

Corporate Tax Rates
In 2021, New York State raised both the personal income tax and the corporate tax rates on a temporary basis. The corporate tax rate hike – from 6.5% to 7.25% on corporations with over $5 million in annual profits – was authorized for three years, from 2021 to 2023.

This is the last year for which the 7.25% rate remains in effect. Without action in Albany, the rate will revert to 6.5%. A three-year extension would raise an estimated $2.9 billion through 2026, according to the executive budget.

Hochul and both houses agree on extending the hike through 2026. But factoring into the debate over the corporate tax rate is how to pay for the MTA, with its significant operating deficit of $4.6 billion. The transportation authority is funded in part by a surcharge on large downstate businesses. Hochul and each house of the Legislature each put forward a different plan to shore up the authority’s finances.

Hochul's Payroll Mobility Tax
Hochul's executive budget proposes an increase in the "Payroll Mobility Tax" – a separate tax on businesses based on a percentage of their employees' salaries that applies to downstate beneficiaries of the MTA, including New York City subways and buses, MetroNorth, and Long Island Rail Road. The state Division of the Budget projects the tax would raise an additional $800 million annually for the MTA.

The funding would help cover the authority's operating shortfall, which has been exacerbated by low ridership during the pandemic.

The payroll tax is considered a deductible expense, outside of a corporation's taxable profits, that is borne by the employer. It is debated whether the cost of payroll taxes like these are eventually passed on to employees in the form of lower wage increases as companies seek to maximize their profits over time. Democratic lawmakers are opposing this approach in favor of bigger hikes on corporations’ taxable profits.

Hochul's plan has New York City chip in an additional $500 million per year for the MTA, which Mayor Eric Adams and legislators have opposed. In their alternative plans, the Legislature removed that potential cost shift to city as well as the slight fare increase, from $2.75 to $3, Hochul wants the MTA to move ahead with after a pandemic-era pause.

The MTA Surcharge
To pay for the MTA, both the Senate and Assembly one-house budgets rejected the payroll mobility tax, each choosing to further increase the corporate tax rate, albeit in different ways that would need to be reconciled before a budget deal is reached.

For businesses making over $5 million in profits in the downstate counties serviced by the MTA railroads, an additional surcharge on the corporate tax rate exists, specifically earmarked for mass transit. For these businesses in the so-called Metropolitan Commuter Transportation District (MCTD), that surcharge currently adds 30% of the corporate tax rate on top of the base rate. That is a roughly 2.2 point addition to the base rate of 7.25% for a total corporate tax rate of 9.425%.

The Senate proposal raises the MTA surcharge from 30% to 45%, meaning an additional 3.26 points for a total tax rate of 10.5% for businesses in the MCTD.

The Senate has not released an exact estimate for how much money the change would raise, but experts believe the increase would total close to $1 billion of additional MTA funding each year.

The Assembly proposes to fund the MTA with an across-the-board 2 point corporate tax increase to 9.25%, with the caveat that proceeds of that increase from within the MCTD catchment area would go toward the MTA. Revenue generated by the increase from businesses in the rest of the state would support transit systems in their regions.

The Assembly estimates the additional increase would generate for the MTA and other transit systems $1 billion a year on average over the next four years. Under the Assembly plan, the MTA surcharge would remain at 30% of the corporate tax rate.