TCS Daily


Coring the Apple

By Megan McArdle - May 19, 2003 12:00 AM

New York City and New York State seem to have something against the financial industry. Of course, we all do. One look at our stock portfolio, and there's a strong urge to round a up a posse and take care of the folks who promised us that Yahoo was undervalued at 200. Nonetheless, the animus of the state and local governments towards the state's main industry seems to be something special. Especially since today's investment banker or equity analyst is a changed, chastened creature, made newly fearful by lawsuits, layoffs, and the knowledge that their city of residence seems to be Terrorist Target #1.

It's easy to forget, amid all the hype, that 99.9% of the folks in the financial services industry weren't doing anything criminal. Like many of us, they spent the boom years hunched over spreadsheets and mollifying their bosses. Certainly, during that time they generated an enormous amount of money - but then, they dropped an enormous amount of it into the coffers of their city, state, and federal governments. The 13,000 New Yorkers with incomes over $1 million currently account for more than a third of personal income tax revenues. High earners are disproportionately connected to the securities industry: in July, Crain's reported that the industry generated 21% of wages in New York, even though it accounted for only 5% of employment. Since the top 20% of the income distribution pays more than half of the property and income taxes, and more than a third of total tax revenue, you'd think that said officials would be interested in holding on to those people and the businesses that employ them. You'd think they'd make it a priority, in fact, since key firms seem to be taking a long, hard look at the astronomical price they're paying for their Manhattan address.

Yet rather than cosset our beleaguered bankers, the city and state governments almost seem to be trying to push them out of the nest.

Consider the reconstruction of the World Trade Center, which housed a large number of financial services firms. The Lower Manhattan Development Corporation, in the name of creating an "open and inclusive public process", seems ready to spend the next ten years letting every three-member community group with access to a mimeograph machine have its say about the final design. Meanwhile, companies are going elsewhere. TenantWise, a New York City commercial real estate site, reports that 20 companies, including big names like Citigroup, Morgan Stanley, and Lehman Brothers, have relocated at least part of their WTC operation out of Manhattan, resulting in a net loss of 25,000 jobs. Once they've signed long term leases, and their employees have relocated, it's going to be hard to lure them back into Manhattan no matter how open and inclusive the new design is.

Meanwhile, New York's Attorney General Eliot Spitzer has been hounding Wall Street firms with vague complaints about impropriety that seem best designed to pander to voters angry about the sorry state of their portfolios, rather than curb the very real abuses of the late 1990's. Though he makes noises about criminal wrongdoing, the criminal investigations seem to be happening at the federal level, where former CSFB golden boy Frank Quattrone has been indicted for witness tampering and obstruction of justice. Eliot Spitzer successes so far: various investment banks produced a chunk of cash for state coffers; Philip Anschutz paid $4.4 million in "fines" directed to his favored private charities; and notorious equity analysts Henry Blodget and Jack Grubman agreed to a lifetime ban from the securities industry - hardly a concession, considering that revelations about their tainted touts have ensured that most investors would sooner change their money into singles and use it to economize on Kleenex than invest it in any stock recommended by those two. The net result is a little money for the treasury, a lot of favorable publicity for Eliot Spitzer, and all the banks and bankers freshly reminded that their government views them as both scapegoat and cash cow. As if to reinforce this, Eliot Spitzer has filed new complaints, this time targeted at the investment banking side of the business.

If these things don't chase the financial sector out of the city, there's still a good shot that the record tax increases proposed by the legislature and the city council will. The largest component of these is a big increase in the personal income tax, which, as we have already seen, is disproportionately paid by high income types in the securities industry. When the Legislature and the Council are through, New York's top earners will be paying a combined state and local income tax of over 12%, plus sales taxes of over 9%. Meanwhile, the city's innovative "tax benefit recapture" will retroactively apply top-bracket rates to the first dollar of income, making the tax truly an economist's nightmare. Compare that with rates just across the river in New Jersey, where income taxes top out at 6.35%, and the sales tax is only 6%: a high income New Yorker could save himself nearly 10% of his annual income just by putting a short bridge between his house and the New York City Council. Because such a few high earners pay such a large chunk of the city's tax revenues, even a relatively low number of defections could deepen today's deficits into a permanent chasm. Particularly if businesses decide to follow their executives over the bridge.

Just as the broadband revolution is making it easier than ever for individuals and firms to relocate anywhere in the country, and security concerns are making it more attractive to do so, our state and local governments seem to have made it official policy to kick them while they're down. Why are our officials risking our fiscal future with these punitive measures?

For the same reason the rest of us resort to unsustainable short term measures in order to live beyond our means. They can't bring themselves to cut spending.

And spending, like taxes, is at record levels. When Wall Street was flush, legislators spent the tax dollars as fast as they came in. The Manhattan Institute's E.J. McMahon reports that inflation-adjusted state funds spending has grown at least 15% since 1994, and is set to grow by $2.8 billion this year despite a gargantuan deficit. Over the same period, New York City's budget grew from $22 billion to $30 billion. Even discounting a big jump in 2001, that means that in an era of prosperity, city spending grew an astonishing $5.6 billion, or 25% - right up to the capacity of record capital gains income and Wall Street bonuses to sustain it. Now that the money is gone, politicians are still spending as if nothing has changed, even though the speculative stock valuations that fueled the lion's share of the growth are hardly likely to return. If a family member or friend were still spending money based on the value of his stock portfolio in February of 2000, we'd step in to stop it. Yet who will stage an intervention with our politicians?

The city's Independent Budget Office has tried. As early as 1998, the IBO was predicting deficits as the Council's appetite for spending outstripped even the outsized gains in the NASDAQ. The deficits materialized on schedule, and the IBO has offered tough talk on the necessary measures to keep the city from bankruptcy. Private watchdog groups, from the Business Council to McMahon's New York Fiscal Watch, have made similar efforts. But the politicians refuse to hear it. Rather than opt to roll back some of that unsustainable spending, they're turning the screws tighter on the very people who made it possible. Why should they pay less in taxes just because they're making less money?

This is the political equivalent of eating the seed corn. And though the politicians claim they're doing it to help ordinary New Yorkers, in the long run, it's those of us who aren't wealthy investment bankers who are likely to pay the cost of all this grandstanding.
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