The Governor’s Executive Budget proposes to divert to the State $600 million of New York City’s sales tax revenue on the grounds that the City misused that amount of State sales tax revenue. The controversy involves debt of a specially created local authority, the Sales Tax Asset Receivable Corporation (STARC). The best outcome of this dispute would be to return the contested money to City and State taxpayers in the form of long-term savings.

The Creation of STARC

STARC was created in 2003 as part of budget legislation for State fiscal year 2003-2004.¹ In the aftermath of a national recession and the 2001 terrorist attacks, the budget was unusually tight. The Governor proposed reductions in aid to New Yok City, as well as other cuts. In response, legislative leaders came up with a scheme to provide aid to New York City at relatively little initial cost to the State.

At the time the Municipal Assistance Corporation (MAC), the entity created in 1975 to borrow on behalf of the City when it had lost access to credit markets, still had $2.5 billion in debt outstanding. The bonds were scheduled to be paid off over the next five years from City sales tax revenue. Once the debt was paid off, MAC would go out of business, a symbolic marker of the City’s full recovery from the fiscal crisis of the 1970s.

Under the legislative proposal, a new entity, STARC, was created to borrow a sum equal to the outstanding amount of MAC bonds. The money would pay off the remaining MAC debt in 2003 rather than in 2008. This would eliminate the City’s annual debt service burden of $500 million over the next five years, a substantial savings for the City.

The State legislature agreed to pay the debt service on the $2.5 billion in new STARC bonds with State sales tax revenue; the annual cost was far less than that of the remaining MAC bonds because STARC payments were stretched over 30 years rather than the 5 remaining years for MAC bonds. The State guaranteed $170 million annually to repay the debt.  In effect, the State borrowed to pay for $2.5 billion of operating aid to the City, with State taxpayers picking up the tab for 30 years. 

Governor George Pataki opposed the STARC deal and sued to prevent its implementation on grounds the legislature did not have authority to dedicate the sales tax in this manner.² The suit was not successful, but delayed the issuance of STARC bonds until October 2004.³ Nearly $2.7 billion was borrowed in order to repay the City for MAC debt service it paid in the interim, to pay off the remaining MAC bonds, to pay the first year’s interest, to create a debt service reserve, and to cover underwriting fees. Thus, as a consequence of the delay, the State’s costs in fiscal years 2004 and 2005 were less than initially planned and more of the total cost was borrowed.

STARC Refunding

The STARC arrangement remained mutually satisfactory for the State and City for the next 10 years. The disruptive event was a decision by the City in the fall of 2014 to refund the STARC bonds. Refunding made good sense because interest rates had fallen since 2005, and many of the bonds were now about to be callable at par.

The controversial aspect of the refunding was the City’s decision to borrow $637 million more than was needed to pay off the outstanding bonds.⁴ It was able to do this because, thanks to the lower interest rate, the State guarantee of $170 million annually supported debt service on the larger amount.  Thus, instead of receiving “excess” State sales tax revenue the City had available an extra $637 million in upfront cash.⁵

The STARC refunding was good for the City’s current financial plan, but repeated the fiscal error of borrowing for operating purposes. The City used STARC to borrow more than $600 million to support its operating budget in fiscal years 2015 to 2018, and the money is being repaid by future taxpayers over the next 18 years. Taxpayers in 2033 will still be paying for services delivered to New Yorkers in 2014 to 2017.

State officials and fiscal monitors did not initially object to the STARC refunding or Transitional Finance Authority (TFA) transactions. Then in January 2016, about 14 months after the transaction, the Governor in his Executive Budget proposed withholding $600 million in City sales tax revenue. Since withholding State sales tax revenue from STARC would jeopardize the security of the bonds, he proposed “claiming” the funds from the excess refunding directly from City taxes, which the State collects on the City’s behalf.⁶

The City contends that since the State obligated itself to pay the City $170 million for 30 years it has done nothing wrong and should not have any of its sales tax withheld. However, to the extent the refunding could have reduced annual debt service costs due to lower interest rates, it might have been reasonable to share those savings with the State because its sales tax pays the debt service. While the City argues that the deal guaranteed $170 million annually, it was predicated on level debt service over 30 years and did not anticipate the lower interest rates now available.

A Resolution that Benefits Taxpayers

The resolution of the current controversy should be neither in favor of State’s or City’s claim to the contested $600 million, nor a “splitting of the baby” to give half to each. Instead the money should be put to a use that yields longer term savings for taxpayers, an appropriate goal of a bond refunding. This can be achieved by paying off outstanding debt that requires debt service payments over a period longer than three years and closer to the duration of the STARC bonds. Both the City and State (including their borrowing authorities) have an abundance of such debt. A negotiated division between the City and State should be reached, to give relief to city and state taxpayers over the longer term.