In July the New York State Comptroller reported that  tax collections for the first quarter of the fiscal year (April through June) came in $799 million higher than original projections and that disbursements came in $1.2 billion below  projections.[1] A more recent update covering July reported that receipts came in $351 million short for that month,[2] and the Comptroller implored the state to remain “vigilant to keep our finances on track.” Nonetheless, the hint of possible favorable developments over the course of the year has prompted calls from multiple quarters for increases in planned spending and possible new tax cuts thanks to an emerging “surplus.”

Talk of a surplus and using it for new initiatives should end immediately for two reasons. First, the likelihood of any surplus is remote; second, even if there were to be a “surplus,” it should be used for more prudent uses than new spending or tax cuts.

Prospects for a Surplus are Remote

The likelihood that New York State will have extra cash this fiscal year is reduced by these four considerations.

1. Cash received and disbursed in any given month is important, but potentially misleading, information.

Predicting the timing of certain cash receipts and disbursements is an even more imperfect science than forecasting annual totals. For example, general purpose spending was $890 million below projections in the month of June but $1 billion above projections for the month of July. Shifting payments from the end of one month to the beginning of the next has little impact on the recipient but big impacts on the monthly figures. Additionally, forecasting the level and precise timing of certain irregular revenues, such as business tax audits, is extremely challenging. The tax “surplus” for this year already fell from $799 million in June to $604 million in July. Therefore a few early months’ results are a poor guide to year-end totals.

2. All economic indicators point down.

July and August produced a string of bad economic news, from the European debt crisis to weak employment, consumption and housing numbers to the first-ever U.S. credit downgrade. The state’s budget assumes that national GDP will grow 2.9 percent this year and 3.6 percent next year. [3] The Bureau of Economic Analysis estimates that in the first quarter of 2011 the national economy grew only 0.4 percent, followed by 1.3 percent growth in the second quarter.[4] The Federal Reserve’s most recent GDP growth estimate for all of 2011 is 2.7 to 2.9 percent and 3.3 to 3.7 percent for 2012.[5] Since the state’s budget was finalized, the Dow Jones Industrial Average has fallen about 12 percent.[6] Because certain revenues, such as sales taxes and withheld income taxes, shift quickly with changing consumption and employment levels, if this negative turn is prolonged, state tax collections likely will come up short in the rest of the year.

3. The unexpected tax revenue is from volatile and hard-to-predict sources.

Much of the unexpected revenue has come from the personal income tax and specifically, from estimated payments. At the beginning of the year, the state budget office predicted that estimated income tax payments would increase 22 percent over last year. Through the first four months of the year, these payments were 35 percent above last year. Because estimated payments are based on taxpayers’ final returns, they tend to lag economic trends and they can rise and fall rapidly. For example, revenue from estimated payments continued to climb through fiscal year 2009, even though all other tax revenue fell 3 percent in that year.[7] In fiscal year 2010, these payments fell 29 percent in a single year. Business taxes, the second largest source of unexpected revenue this year, is another hard-to-predict source. Last fiscal year business taxes fell over $400 million short of initial estimates.

4. Federal deficit reduction will hurt the State in the short-term.

As the federal government moves to reduce its annual deficits, New York will be negatively impacted. On the spending side, federal aid pays for 33 percent of the state’s budget, mostly for the Medicaid program;[8] cuts in the federal budget are bound to lower the state’s revenues. On the revenue side, thanks to the concentration of high-income households, New Yorkers pay $174 billion in federal income taxes, the second highest of all the states.[9] In the short-term, any increase in federal taxes will reduce disposable income available for consumption and investment within New York. Additionally, through TARP and the stimulus program, the federal government provided enormous assistance to New York during the worst of the recession. Any further slippage in the economy is not expected to be met with such generosity.

Any surprise surplus is needed to cope with existing problems, not to fund new commitments

Even if an unlikely surplus emerges, it should not be thought of as available for new initiatives. The current budget already has serious problems that ought to be dealt with first, before new commitments make the fiscal situation even more problematic. Here are three looming issues. 

1. The Governor and the unions still need to finalize $377 million in savings from labor.

With the approval of the Civil Service Employees Association (CSEA) contract, the Governor achieved 16 percent of the $450 million target for savings from labor in the current budget. The remaining 84 percent must come from a combination of concessions from other unions, agency consolidations and restructuring, and, if need be, layoffs. In order to meet the year-end target, for the remainder of the fiscal year, state agency spending must be 12 percent below the prior year.[10] With only two-thirds of the fiscal year remaining, every passing day means that greater concessions or layoffs may be needed to achieve the year-end target.

2. The current-year budget has almost $2 billion of undesirable fiscal gimmicks; replacing them is more important than new spending.

To avoid further spending reductions or new revenues, the Governor and Legislature decided to continue two gimmicks enacted in prior years: the deferral of $970 million in business tax credits and the amortization of a $635 million payment to the pension system. The State also intercepted $200 million in revenues dedicated to the MTA and asked public authorities to contribute $150 million to general state spending. Before committing to any new spending or tax reductions, New York should reduce reliance on existing gimmicks, particularly ones that add to long-term costs.

3. The next fiscal year starts with at least a $2.4 billion gap.

In January, the Governor must submit a balanced budget for fiscal year 2012-13. After almost four years of large budget gaps that required increased revenues and lower spending, the Governor will be hard-pressed to find easy budget balancing actions. Moreover, the current budget projections assume that Medicaid and school aid spending is held to 4 percent growth next year and that all labor savings from this year continue into the next. Even a small budget gap will prove challenging to close; any surprise surplus should be used in ways that help lower the gap (like paying down debt or reversing deferrals), not in ways that make the gap grow (like tax cuts or spending restorations).

For all these reasons, the Governor and the Legislature should view any unexpected revenues as a temporary blessing and keep the lid on the piggy bank sealed shut.