The New York City Guie to Destroying an Economy; R. Keating

What brought about the demise of this once great city? The answer lies on both sides of the big-government coin: an enor mous welfare state and the implementation of some of the most burdensome taxes ever known to man. Indeed, New York City serves as a "how to" guide for destroying an economy. Mind you, wrecking an economy such as New York City's was no simple feat. New York stood as an economic powerhouse for decades, a wellspring of risk-taking, invention, and creativity in a wide array of industries. City-economics guru Jane Ja cobs observed: "Beginning in about 1800, New York enjoyed tremendously high rates of development for twelve or thirteen de cades. "1 Later, Jacobs noted that the New York City economy "has been declining since at least the 1940s."2 Mr. Keating is Guest Editor of this issue of The Freeman. He serves as chief economist with the Small Business Survival Foundation, co-authored D.C. By The Numbers: A State of Failure, andjust completed hisforthcoming book tentatively titled New York By The Numbers: State and City in Perpetual Crisis.

Of course, New York City government lays claim to a long history of excessive expenditures and problems paying its bills. In 1907,for example, New York City Mayor George B. McClellan, Jr., son of the Civil War general, sought a bailout from private bankers-namely J.P. Morgan-when the city could not place its warrants} But the fiscalcrisis of the early 1930swas the turning point for the entire New York City econ omy. As the nation sank into depression between 1930and 1932,the city raised taxes inflicting further economic harm. Indeed, during this period of tax hikes, the city's general revenues declined by $47 million while expenditures grew by almost $100 million. Eventually, bankers stepped in once again to the rescue, virtually running the city from 1934to 1938.4 Counterproduc tive tax hikes still continued, though, in cluding the imposition of a city sales tax at 2 percent and a business gross receipts tax of less than 1 percent.

It was during the early Depression that New York City greatly expanded its public welfare web. Public assistance, along with widespread patronage and rising debt ser vice tied to public works projects, pushed city expenditures skyward. A troubled economy ensured that city revenues failed to reach expectations. While the immediate threat of the early 1930s fiscal crisis eventually was resolved, the fate of the city's economy was sealed. 540 Higher city spending and taxes became the officialgoverning model in New York City. The pattern of over-spending and a stagnant or declining economy would come to plague New York City time and time again. Indeed, city government expanded relent lessly for decades. Between 1930 and 1965, for example, real per capita city spending increased by almost 350 percent. Recipients of public assistance in New York City in creased from about 300,000 at the end of World War II to over 500,000 in 1965-a two-thirds jump while the city's population hardly grew at all. At the same time, prop erty taxes-the city's prime source of rev enues-doubled in real terms.

Albany's Share of the Blame All of the blame for this expanding levia than cannot be placed solely with New York City elected officials, however. State poli ticians played their parts as well. In addition to rubber stamping each city tax increase arriving at the Capitol in Albany (beyond property taxes, all general tax increases at the local level must be approved by the state), the state added its own burdens upon the city. New York was one of the first seven states to levy a personal income tax. In 1919, state legislators claimed that the loss of liquor tax revenues due to Prohibition required the state to impose a tax on personal in come. This was done over the protestations of the state's comptroller at the time, Eu gene Travis, who saw the new tax as un necessary. 5 The personal income tax was imposed in 1919with a top rate of 3 percent. In the 1930s, the top rate hit 8 percent-7 percent plus a separate 1percent income tax designed to "help" the state through the Depression (again, in reality only making matters worse). Some temporary state per sonal income tax relief was provided in the 1940s, but the top rate stood at 7 percent once again by 1954.

An additional tax measure, seemingly specifically designed to further extinguish entrepreneurial activity in New York, was imposed in February 1935. New York insti541 tuted a state unincorporated business tax i.e., an income tax on income from unin corporated enterprises, in addition to the personal income tax-along with an "emer gency" tax on capital gains. A glimpse of sanity could be briefly detected in 1938, however, when state officials at least saw that capital gains were being taxed too heavily, and provided for a 50 percent ex clusion from taxation. Therefore, by 1954, the effective top capital gains tax on indi viduals registered 3.5 percent. New York State levied its own corporate income tax in 1917. In the late 1950s, the corporate tax rate stood at 5.5 percent. All of these state income-based levies certainly took a toll on New York City, considerably hiking costs on the private sector.

Tragically, though, for all of New York City's tax and spending woes through the end of the 1950s,they soon would seem like child's play compared with the statist on slaught about to be unleashed. Liberal Re publicans Nelson Rockefeller (elected New York's governor in 1958) and John Lindsay (elected mayor of New York City in 1965) arguably would turn out to be the two biggest tax-and-spend elected officialsat the state and local level in our nation's history, following in the footsteps of another New Yorker, President Franklin Delano Roose velt, probably the nation's all-time leading taxer-and-spender at the federal level. In deed, New York carries considerable big government guilt. At the state level, spending during the Rockefeller era-essentially spanning 1959 to 1975-would rise by 210 percent in real per capita terms. Over this period, real per capita state public welfare spending jumped by an incredible 625 percent. Meanwhile, by the mid-1970s, the state's top personal in come tax rate reached 15.375 percent, the corporate tax rate hit a high of 12 percent, the capital gains tax rate topped 9 percent, and the state's unincorporated business tax registered 5.5 percent (a hike from 4 percent in 1968). In addition, Rockefeller imposed a state sales tax of 2 percent in 1965, which quickly jumped to 4 percent by 1971.

542 THE FREEMAN • AUGUST 1996 A Plague of Taxes As for the city, Mayor-elect John Lindsay stated in late November 1965 that the im position ofa city income tax was "definitely a last resort."6 A mere four months later, the income tax rested at the center of Lindsay's first budget proposal and was implemented by June 1966. The "last re sort" turned out to be the first resort. City and state elected officials signed off on myriad tax increases that year, including the imposition of a city personal income and capital gains tax with a top rate of 2 percent, a city corporate income tax of 5.5 percent, and a city unincorporated business tax of 4 percent! By the mid-1970s,New York City's personal income and capital gains tax rate had more than doubled to 4.3 percent and the corporate rate almost doubled to 10.05 percent. Just over the period of 1965 to 1976, on a real per capita basis, city total expenditures more than doubled and public welfare ex penditures increased by almost 335 percent.

The city's debt service climbed 287 percent. This great expansion of government spending and taxation led to New York City's great fiscal crisis of the mid-1970s. Sound economic incentives were obliter ated at all income levels. The city's lucrative welfare system made sloth and idleness pay, compared with hard work and human capital investment, fostering government depen dency. Indeed, by the mid-1970s,New York City's public welfare rolls topped 1.2million in a city whose population was declining from 7.9 million in 1970to just over 7 million in 1980. Meanwhile, the tax burden on productive individuals and economic activity was pro hibitive in New York City. The combined state and city marginal income tax rate equaled 19.675 percent in 1976, up by 181 percent from the 1959 rate of7 percent. For entrepreneurs operating enterprises not in corporated, the combined state and city unincorporated business tax of 9.5 percent had to be added-creating a top income tax rate on New York's entrepreneurs of just under 30 percent! The capital gains tax reached 13.525 percent-of course, not in dexed for inflation so the real rate was substantially higher. On the corporate side, the state and city tax rate topped 22 percent.

Plunder at Its Worst While all taxes raise costs and distort the economy, no tax does more damage than the income tax. New York City's sky-high tax rates destroyed incentives for working, investing, and entrepreneurship. Indeed, in dividuals and businesses were provided with every incentive to leave New York City, and that's exactly what they did. While the city's economy certainly was in decline from the Great Depression through the early 1960s, it went into outright free fall in the late 1960s through the 1970s. Despite the drunken frenzy favoring big ger government in New York City during this period, a few sober individuals could see the city was careening off the road. For example, as a candidate for mayor in 1965, William F. Buckley Jr. saw the city's woes quite clearly. In his 1966book, The Unmak ing of a Mayor, which chronicled his 1965 mayoral contest against Lindsay and Dem ocrat Abraham Beame, Buckley observed quite simply about New York City: "The taxes are high, and the means of collecting them barbarous .... Yet no matter how high the taxes soar, things somehow do not appear to improve." In fact, Buckley went on to note how much worse things got in New York as government's reach extended ever farther.

Again, Jane Jacobs writing in 1968 recog nized that New York's economic growth had come to a halt, citing many indicators: "absolute declines in the sheer number of enterprises in New York; persistent growth in the number of idle and underemployed poor; remarkable growth of unproductive makework in the city bureaucracies, make work which, more and more, is depended on to take up the slack of insufficient useful work for the city's high school and college graduates; piling up of undone work and unsolved practical problems; lack of new kinds of manufacturing work to compensate THE NEW YORK CITY GUIDE TO DESTROYING AN ECONOMY 543 for the losses of old; a seemingly compulsive repetition of existing ways of doing things even though it is evident that what are being compulsively repeated are mistakes; lack of local development capital for new goods and services, accompanied by a surfeit of capital for projects that destroy existing enterprises and jobs, and quantities of cap ital for export. "7 That is, the city suffered a dearth of creativity and entrepreneurship.

The root cause for this debilitating dearth in New York City was a massive public sector. A monstrosity that literally became impossible to finance. Far too burdensome taxes-not to mention regulations-fos tered an exodus of labor and capital. The city also could not float any short or long term debt as the bond market knew that both taxes and debt levels in New York were far too high. The marketplace signaled New York that government was just too big. Many people today, however, believe that New York City's great fiscal crisis ended when the city was able to return unassisted to the debt markets in 1979. And for a very brief period, some budget re straint was exhibited. From 1975-76 to 1980-81, for example, city spending de clined on a real per capita basis by almost 25 percent, and city gross debt dropped by almost 60 percent. Impressive, but it left New York's spending and debt levels at astronomical heights, still light years ahead of the average for large U.S. cities. And from 1981 into the early 1990s,city spending and debt levels resumed a rather steady and steep ascent. As of 1992 (last year with full comparative data), New York City per cap ita spending topped the large city (300,000+ population) average by 131 percent, public welfare spending by 353 percent, and debt outstanding by 65 percent.

As for taxes, the city's personal income and capital gains tax actually rose to 4.73 percent by 1983, slowly declined to 3.4 percent by 1989,but then increased again to 4.46 percent by 1991. A small decline in the city's corporate tax rate occurred, to 8.85 percent. The 4 percent unincorporated busi ness tax still hampers entrepreneurship. Some headway was made on the state tax front after the mid-1970s, but it has been a slow, arduous process riddled with set backs, such as a state capital gains tax hike of 62 percent in 1987. Tax reductions over these years, though, have brought the state's personal income and capital gains tax rate down to 6.85 percent (effective in 1997) and the state's corporate tax down to 10.53 percent in the New York City area and 9 percent elsewhere. In New York City today, a combined state and city income tax rate on entrepreneurs tops 15 percent and the combined corporate rate reaches higher than 19 percent. The capital gains tax exceeds 11 percent, and again, grows much higher when inflation is factored into the equation. And roughly 2 million New York City residents receive some kind of public assistance.

As a result, New York City's private sector remains moribund. For example, there were fewer small businesses in New York City in the early 1990sthan in 1969. In addition, between 1969 and 1995, total pri vate-sector employment in New York City declined by 15 percent. In order to place the city back on an economic growth track, New York must shed its most severe gov ernmental burdens-a massive welfare state paid for in part with high income taxes. Since taking office in 1994, Mayor Ru dolph Giuliani's spending proposals have only offered restraint or small cuts. For fiscal year 1996-97, he tepidly proposed allowing the city's personal income tax surcharge to expire-which would have dropped the tax rate from 4.46 percent to 3.91 percent. Even this minor step was opposed by the speaker of the New York City Council, and Giuliani actually retreated by the time he offered his final budget plan-instead pushing a four-year extension of the income tax surcharge! At the state level, Governor George Pataki has pushed for spending restraint and rather smallish tax cuts since his election in 1994.

Bolder actions must be taken. Recent New York history actually provides an ex ample. Hugh Carey served as New York governor from 1975 to 1982. He too offered a little spending restrainta brief respite 544 THE FREEMAN • AUGUST 1996 Looking down Wall Street at Broadway~'i Trinity Church-/866. between the big spending eras of Rock efeller and Mario Cuomo-and small cuts in personal and corporate income taxes. How ever, Carey also accomplished something monumental in New York. He actually got rid of a major tax. Under Carey's reign in the Governor's Mansion, the state eliminated its unincorporated business tax of 5.5 per cent. Indeed, "elimination" is the key to New York City's economic revitalization. Noth ing less will suffice. The city personal in come, capital gains, and corporate income taxes, and the distinctly anti-entrepreneur unincorporated business tax, must be elim inated. After all, few cities levy their own income taxes. And the cities imposing the most burdensome income levies possess dismal economic records. After New York City, Philadelphia and the District of Co lumbia stand out in this regard. Likewise, New York State should be moving to elim inate state personal income, capital gains, and corporate income taxes. Finally, of course, a state, city, and federal welfare system that destroys lives by fostering gov ernment dependency at the expense of in dividual responsibility also must be elimi nated.

New York City's only chance at regaining economic greatness lies with restoring in centives to live, work, invest, and take risks in the city. That means throwing away New York's long-held big-government philoso phy and opting instead for free markets, small government, and low taxes. D 1. Jane Jacobs, The Economy ofCities (New York: Vintage Books, 1970), original copyright 1960, p. 95. 2. Jane Jacobs, Cities and the Wealth ofNations: Principles of Economic Life (New York: Vintage Books, 1985), original copyright 1984, p. 179. 3. Ron Chernow, The House of Morgan: An American Banking Dynasty and the Rise ofModern Finance (New York: Atlantic Monthly Press, 1990), p. 126. 4. Ibid., p. 225. 5. Ray B. Smith, History of New York State: Political and Governmental, Volume IV, 1896-1920 (Syracuse; N.Y.: The Syracuse Press, Inc., 1922), p. 316. 6. The Wall Street Journal, "Personal Income Tax for New York City Called 'Last Resort,' " November 30, 1965.

7. The Economy of Cities, pp. 96-97.