Thank you for the opportunity to appear before you to present the views of the New York City Independent Budget Office (IBO) on the Mayor’s preliminary budget for 1998 and financial plan through 2001. As you know, IBO was established last year pursuant to the New York City Charter to provide expert, nonpartisan analysis to both elected officials and the public on relevant fiscal and budgetary issues facing the City.

The Charter requires IBO to publish two reports in response to the Mayor’s preliminary budget. First, IBO must issue a report each February discussing the expected levels of revenues and expenditures anticipated for the City in the coming fiscal year. On February 14, 1997, IBO met this requirement by releasing New York City’s Fiscal Outlook, providing a projection of baseline revenues and expenditures assuming existing spending policies and tax laws are allowed to run their present course. Second, IBO is required to issue an analysis of the Mayor’s preliminary budget (due March 22nd). This testimony includes a preview of that report.

Fiscal Outlook

IBO’s Fiscal Outlook report provided an independent City revenue and expenditure estimate for fiscal years 1998-2001. IBO is the only entity in City government, other than the Mayor, required to issue a revenue projection. Highlights include:

• IBO’s forecast of tax revenues.

• A new approach in New York City municipal budgeting was introduced: a current services baseline projection of revenues and expenditures. The current services concept, used extensively by the federal government and various states, is designed to project spending and revenues into the future assuming continuation of inflation-adjusted current spending levels and no changes to existing tax laws. Such a policy-neutral baseline provides a meaningful starting point for analysis of the City’s fiscal condition as the annual budget process gets underway.

• Based on new research reconstructing the history of tax policy changes and tax revenues, IBO found that City baseline revenue growth has lagged behind local economic growth over most of the past two decades. IBO’s analysis showed that this structural lag has played a much larger role than tax policies in influencing the overall size of the City tax burden and the mix of City revenue sources.

• The report concluded with an analysis of fiscal issues likely to become increasingly important in the months and years ahead. These include closure of the Fresh Kills landfill on Staten Island, reauthorization of the federal ISTEA transportation aid program, and implementation of recent major changes to federal welfare programs.

Analysis of the Mayor’s Budgetary Proposals

The primary reason for constructing a baseline in Fiscal Outlook that keeps current laws and policies unchanged was to provide a meaningful alternative reference point for elected officials, the public, and IBO to consider the Mayor’s preliminary budget as the annual budget adoption process gets underway. With such a base now established, IBO has turned its attention to an analysis of the Mayor’s preliminary budget. A report focusing on IBO’s re-pricing (also referred to as our “reestimate”) of the Mayor’s budgetary proposals will be issued later this week.

In our reestimate of the Mayor’s budget, IBO estimates that gaps would occur in each year of the financial plan ranging from $701 million in 1998 to $3.8 billion in 2001. Our gap projections are higher than the Mayor’s forecast by $701 million in 1998 rising to $1.3 billion by 2001. While the precise reasons for these higher gap estimates are detailed below, they result, more generally, from varying policy, economic, and technical assumptions that IBO has used to score the Mayor’s proposals.

IBO’s scoring of the preliminary budget suggests that the Mayor’s policies would modestly change the projected gaps that would occur under existing laws and policies. Compared with IBO’s baseline projections of revenues and spending, which assume current laws and policies remain unchanged, IBO’s reestimate of the Mayor’s budget shows that gaps would be $387 million lower in 1998, but higher by $183 million in 1999, $349 million in 2000, and $383 million in 2001.

Although IBO shows a gap of $87 million for 1997, we do not expect one to occur. A gap is shown because we have assumed $391 million in excess 1997 funds will be used to prepay certain 1998 expenses; an assumption necessary to establish a consistent starting point with the Mayor's budget. If IBO's spending and revenue forecasts for 1997 prove correct, the effect would be to reduce the expected rollover from $391 million to $304 million and to increase our 1998 gap estimate by $87 million.

Although the City has managed to balance its books in each of the past 17 years, these large out-year gaps could portend the need to cut services or raise taxes in the years ahead, particularly in the event of an economic downturn. It is important to note that the Mayor’s out-year financial plan assumes continued growth in the local economy. In the event of an economic downturn, however, spending needs would likely increase— particularly for social programs—at a time when revenues would likely be decreasing, making future budget gaps substantially larger than projected above. If this were to occur, whoever is Mayor would likely face the unenviable choice between increasing taxes in a slow economy or reducing spending when it is needed most.

Absent a significant downturn, if history is any guide these out-year gap projections will get smaller as a result of changes to the Mayor’s financial plan as each new fiscal year approaches. The negative consequences of last minute, incremental service reductions, tax increases, or an over-reliance on non-recurring revenues (of which there are a finite number) to pay for ongoing expenses, however, highlight the need for the City to adequately plan for its financial future now. While the Mayor’s budget contains an out-year gap closing plan, details are very sketchy. A more articulated systematic, long-term plan to close projected gaps would help eliminate budget year balancing scrambles, improve the City’s bond rating, and instill confidence in the citizenry that its government is behaving in a fiscally responsible manner.

Budget Summary

The preliminary budget reflects an improving local economy which has allowed the Mayor to propose fewer spending reductions than in recent years coupled with a reduction of certain taxes paid by New Yorkers. IBO projects that both City-funded and overall spending for 1998 would remain roughly at current year levels if the Mayor’s budget was adopted in its entirety. As shown in Figure 2, beyond 1998 we expect expenditures to grow at a substantially faster pace than revenues, leading to the large budget gaps illustrated in Figure 1 above.

The Mayor’s plan for 1998 benefits from increasing revenues, a carryover of surplus 1997 funds, savings assumed from reforms to entitlement programs, bond refundings from the Municipal Assistance Corporation, and increased unrestricted intergovernmental aid. These items account for an additional $1.5 billion not assumed in earlier financial plan projections. Nevertheless, the budget does propose to reduce agency programs by $558 million in 1998.

Further, the Mayor proposes to reduce the sales tax, the tax on unincorporated businesses, and the commercial rent tax. The fiscal prudence of cutting taxes depends on anticipated spending requirements, the specific taxes under consideration, and on the sustainability of recently strong revenue growth. Although the chosen tax cuts are primarily targeted to stimulate growth, the larger question is whether the City will ultimately be able to afford them. The magnitude of projected out-year gaps calls into question the sustainability of any tax cuts.

Figure 3. IBO’s Budgetary Estimate Under the Mayor’s Policies (In millions of dollars)
	1997	1998	1999	2000	2001
Revenues:
Taxes	18,806	18,684	19,065	19,714	20,341
Micellaneous Revenues	3,454	2,967	2,486	2,256	2,246
State/Federal Categorical Aid	10,473	10,622	10,728	10,942	11,243
Other	1,174	1,170	1,032	1,029	1,029
Total Revenue	33,907	33,443	33,311	33,941	34,859
Expenditures:
City-Funded	23,521	23,522	25,314	26,608	27,437
State/Federal Categorical Funded	10,473	10,622	10,728	10,942	11,243
Total Expenditures	33,994	34,144	36,042	37,550	38,680
IBO Surplus/(Gap) Estimate (Revenues-Expenditures)	(87)	(701)	(2,731)	(3,609)	(3,821)
SOURCE:	Independent Budget Office.
NOTES:	All amounts are before out-year gap closing intitiatives. Figures do not include intra-city revenues and expenditures.

IBO Reestimates

Figures 4 and 5 summarize significant estimating differences between IBO’s reestimated projections and the projections contained in the Mayor’s preliminary budget. It must be emphasized that differing estimates of City revenues and City-funded spending have a direct impact on projected gaps, while varying estimates of State and federal aid have no net budgetary impact because such grants are fully expended.

City Funds

Figure 4. IBO's Reestimate of the Mayor's Budgetary Proposals (In millions of dollars)
	1997	1998	1999	2000	2001
Gaps as estimated by the Mayor	-	-	(1,895)	(2,739)	(2,542)
IBO Reestimates:
Revenues:
Taxes:
Property	7	(12)	43	12	(68)
Personal Income	37	41	3	(42)	(170)
General Sales	(22)	(13)	(20)	(19)	(21)
Business Income	53	19	41	30	28
Real-estate Related	-	-	(5)	(6)	(2)
Tax Reduction Program	-	(3)	(14)	(14)	(15)
Miscellaneous Revenues:
Airport Rent	-	(270)	(215)	-	-
Collections Initiative	-	(20)	(20)	(20)	(20)
Total Revenue	75	(258)	(187)	(59)	(268)
Expenditures:
Public Assistance	(68)	(103)	(121)	(147)	(206)
Medical Assistance	(6)	(281)	(251)	(266)	(279)
Education	-	-	(111)	(111)	(237)
Overtime	(20)	(25)	(25)	(25)	(25)
Judgments and Claims	(33)	(34)	(37)	(38)	(33)
Transitional Labor Savings	(35)	-	-	-	-
Labor Reserve	-	-	(104)	(224)	(231)
Total Expenditures	(162)	(443)	(649)	(811)	(1,011)
Total Reestimates	(87)	(701)	(836)	(870)	(1,279)
Gaps Under the Mayor's Budgetary Proposals as Estimated by IBO	(87)	(701)	(2,731)	(3,609)	(3,821)
SOURCE:	Independent Budget Office.
NOTES:	Negative numbers indicate increases in the budget gap. All amounts are before out-year gap closing intitiatives. Figures do not include intra-city revenues and expenditures.

Over the 1998-2001 period, IBO projects higher gap estimates in its reestimate of the Mayor's budget than those forecasted by the Mayor. For 1998, IBO's gap estimate is $701 million higher than the Mayor’s budget—which predicts a balanced budget for the coming fiscal year. More specifically, IBO’s re-pricing of the Mayor’s budget yields $258 million in lower City revenues and $443 million in higher expenditures.

Much of the difference in revenues results from IBO's view that the City will be unable to realize all of the additional airport rent sought by the Mayor. Most of the difference in spending estimates—discussed in more detail below—can be found in projections for public and medical assistance.

For 2001, IBO’s gap estimate under the Mayor’s policies is $1.3 billion higher than amounts projected in the Mayor’s budget. Our estimate of City revenues is $268 million lower due primarily to IBO's projection of slower growth in property and income taxes, while our spending estimates for public assistance, Medicaid, education, overtime, judgment and claims, and the City's labor reserve fund are $1.0 billion higher than forecasted by the Mayor.

Taxes. IBO’s forecast of City tax revenue is very similar to the Mayor’s budget for most of the financial plan period. In general, the revenue impact of our somewhat more pessimistic economic assumptions is offset by technical differences in forecast methods. IBO’s revenue forecast is slightly more optimistic over the near term, with $32 million of additional revenue in 1998 and $48 million in 1999; in both years, IBO’s estimates of higher tax revenues are partly offset by our projection that the Mayor’s tax reduction program will be somewhat more costly than forecast in the Mayor’s budget. In contrast, IBO’s forecast for City tax revenue is more pessimistic than the Mayor’s for the latter part of the plan period, with $39 million less revenue in 2000 and $248 million less in 2001.

Miscellaneous revenues. IBO forecasts miscellaneous revenues that are $290 million and $235 million lower than the Mayor’s budget in 1998 and 1999, respectively. In particular, IBO believes there is considerable risk both as to the size and the timing of airport rents, which is the topic of an ongoing dispute between the Port Authority and the City. IBO also questions the revenue projected by the Mayor for collections initiatives beginning in 1998. These initiatives are part of a long-delayed program to consolidate various activities within the Department of Finance.

Public assistance. IBO forecasts substantially higher spending on public assistance than amounts projected in the Mayor’s budget. The Mayor’s plan does not take into consideration the full effects of the new federal welfare law, and assumes that recent welfare caseload reductions will continue through June 1998, with no caseload changes thereafter through 2001.

Two provisions of the new law—to increase work quotas for adult welfare recipients and to ban most legal immigrants from federal assistance programs—would likely have a particularly strong impact on future caseloads and expenditures. Work quota increases would require substantial new expenditures for workfare administration and associated child care, especially in the later years of the plan. The restrictions on federal assistance to legal aliens, especially those limiting eligibility for Supplemental Security Income, would significantly increase State- and City-funded Home Relief caseloads as low income elderly and disabled individuals move off federal welfare rolls. Overall, IBO projects additional City spending on public assistance (above the Mayor’s plan) of $103 million in 1998 growing to $206 million by 2001.

Medical assistance. Similarly, IBO projects significantly higher spending on medical assistance than levels reflected in the Mayor’s budget. The budget assumes adoption of measures in the Governor’s executive budget that would hold down costs of Medicaid by eliminating inflationary increases and taking other cost-saving actions. The Mayor’s budget also assumes little growth in overall Medicaid costs. The use of preliminary State estimates of decreased Medicaid costs has proven problematic for the City in recent years, as actual reductions adopted by the State legislature have been less than those proposed in the executive budget. In addition, the growth rates of Medicaid expenditures assumed in the Mayor’s budget are low compared to historical trends. Overall, IBO projects additional City spending on medical assistance of $281 million in 1998 and comparable amounts each year thereafter through 2001.

Education. Given that enrollment is a significant factor in determining education spending, IBO has developed a model to forecast Board of Education expenditures. Based on extensive econometric analysis, IBO forecasts that education spending would be $111 million higher than the Mayor’s budget in 1999 and 2000, and $237 million higher in 2001. In addition to enrollment, IBO’s estimate takes into consideration such factors as pupil-to-teacher ratio, the number of teachers system-wide, and inflation.

Labor reserve. Additional funding needs for the City’s labor reserve are forecast to be $104 million in 1999 growing to $231 million in 2001 over amounts assumed in the Mayor’s plan. The plan includes no collective bargaining increases for covered organizations beyond the annualized values of increases in 1997 and 1998. While it is the Mayor’s position that the covered organizations will have to pay for any additional increases themselves, the City has traditionally funded these collective bargaining increases.

Other spending. IBO also projects substantially higher spending in several other areas of the budget. Uniformed personnel overtime costs are forecast to be $25 million higher annually than the Mayor’s plan over the 1998-2001 period. While some of the City’s overtime control strategies have been successful, the City has not realized the full savings intended from these measures. Further, IBO forecasts additional spending on judgments and claims of $34 million in 1998 and similar amounts thereafter based on our analysis of expenditure growth showing higher than anticipated growth since 1990.

State and Federal Categorical Aid

IBO forecasts higher State and federal categorical aid over the 1997-2001 period compared with amounts estimated by the Mayor. For 1998, IBO's projection for State categorical aid is $219 million higher than the Mayor's. By 2001 this difference grows to $598 million. IBO's projections for public and medical assistance and education more than account for our higher projections. State categorical aid projections for all other agencies are slightly lower than the Mayor's by $16 million in 1998 decreasing to less than $1 million in 2001. Estimated federal categorical aid is $550 million higher than the Mayor's in 1998, a difference that increases to $741 million by 2001. IBO's projections for education and HPD account for about half of this difference for the period 1998-2001. IBO's categorical projections for health, social services, police, child services and transportation comprise another third of the difference. In the absence of contrary evidence, IBO projections assume the continuation of aid initiatives consistent with recent trends.

Figure 5. IBO's Reestimate of State and Federal Categorical Grants (In millions of dollars)
		1997	1998	1999	2000	2001
Mayor's Prliminary Budget		10,447	9,853	9,833	9,870	9,904
IBO Reestimate		10,473	10,622	10,728	10,942	11,243
Difference		26	769	895	1,072	1,339
SOURCE:	Independent Budget Office.
NOTE:	All amounts are before out-year gap closing initiatives.

Comparison with Current Services Projections

IBO estimates that enacting the Mayor’s budgetary proposals would modestly change projected gaps from the levels forecasted in our current services baseline. IBO’s reestimate of the Mayor’s tax reduction program projects lower tax revenues than current services by $253 million in 1998 and $553 million by 2001. Offsetting these reductions are increases in miscellaneous and other revenues totaling $353 million in 1998 decreasing to $25 million by 2001. IBO also estimates that agency spending under the Mayor’s proposals would be $287 million lower than current services projections falling to $145 million by 2001.

Figure 6. IBO's Current Services Baseline (In millions of dollars)
		1997	1998	1999	2000	2001
IBO's Current Services Baseline Gap		(87)	(1,088)	(2,548)	(3,260)	(3,438)
IBO's Scoring of the Mayor's Budgetary Proposals
Revenues Changes:
Tax Reduction Program		-	(253)	(477)	(532)	(553)
Miscellaneous Revenues		-	209	24	22	23
Other Revenue		-	144	2	2	2
Expenditure Changes:
Agency Changes		-	287	268	159	145
Total Changes		-	387	(183)	(349)	(383)
Gaps Under the Mayor's Budgetary Proposals as Estimated by IBO		(87)	(701)	(2,731)	(3,609)	(3,821)
SOURCE:	Independent Budget Office.
NOTES:	Negative numbers indicate increases in the budget gap. All amounts are before out-year gap closing intitiatives. Figures do not include intra-city revenues and expenditures.

City Funds

Revenues. The centerpiece of the Mayor’s tax reduction program is the proposed elimination of sales taxes on apparel items priced under $500. IBO estimates that the sales tax cut would decrease City fund revenue by $156 million in 1998 and by nearly twice as much in 2001. Two proposals for further reductions in the Commercial Rent Tax—an increase in the threshold exempting tenants from the tax and a 33 percent reduction in the effective tax rate for remaining non-exempt taxpayers—would decrease revenue by $30 million in 1998 and $173 million in 2001. Finally, the Mayor’s proposal to increase the credit for Unincorporated Business Tax filers with relatively small liabilities would cost $57 million in 1998 and $70 million in 2001.

Expenditures. Reductions in City-funded spending on police, cultural affairs activities, the Health and Hospitals Corporation, and certain actions anticipated from the State account for 81 percent of the $287 million in spending reductions below current services levels in 1998.

• Police Department funding would total $67 million less than current services projections. This is due in large part to the fact that the 1998 current services estimate assumes the continued funding of 1,841 uniformed and civilian positions slated for elimination in the Mayor’s budget.

• Cultural affairs activities would be about $18 million lower, due mainly to reduced funding to cultural institutions and program services in the Mayor’s budget.

• HHC funding would be $77 million lower. This is due to the State’s planned entitlement reductions, declining inpatient utilization at public health care facilities, and increasing use of voluntary hospitals by Medicaid beneficiaries.

• Anticipated State actions would yield savings of $68 million, from various proposals such as housing loan restructuring, a corrections reimbursement increase, State takeover of CUNY associate degree programs, and increased revenue sharing of the stock transfer tax.

State and Federal Categorical Aid

IBO’s projection of State and federal categorical aid, assuming enactment of the Mayor’s budget, provides our best estimate of grants to be received by the City. Our current services projection, however, is based on a simple assumption that most aid will be provided at 1997 levels, adjusted for inflation.

Figure 7. IBO's Current Services Baseline: State and Federal Categorical Grants (In millions of dollars)
		1997	1998	1999	2000	2001
Current Services Baseline		10,473	10,702	10,894	11,091	11,389
IBO Reestimate		10,473	10,622	10,728	10,942	11,243
Difference		-	80	166	149	146
SOURCE:	Independent Budget Office.
NOTE:	All amounts are before out-year gap closing initiatives.

Report Availability

IBO’s analysis of the Mayor’s preliminary budget will be published on March 21, 1997. Copies can be obtained by calling IBO at (212) 442-0632.