It is not surprising that there has been a great deal of interest in cutting taxes lately given continuing U.S. economic expansion, shrinking federal budget deficits, and near record levels of budget surpluses for both New York State and New York City. The interest in cutting taxes here in the City has been further stimulated by the claim that tax cuts return money to the City treasury, perhaps even pay for themselves over time, by boosting economic activity and thus government revenues. The surge in tourism and hotel occupancy tax revenues that accompanied the City's cut in its hotel occupancy tax in 1994 has been used to make the case for cuts in other taxes, including a recent proposal to eliminate the sales tax on clothing items priced under $500. But is the claim that tax cuts pay for themselves realistic?

• There has been a great deal of uncertainty regarding the extent to which the surge in New York City's hotel tax receipts can be attributed to the reduction in the City's hotel occupancy tax rate.
• It is also unclear whether a reduction in the clothing sales tax would generate similar results.

The New York City Independent Budget Office (IBO) has recently completed two studies to address these issues. This document summarizes Reductions in the City's Hotel Occupancy Tax Rate: The Impact on Revenues (July 1997) and highlights main findings of Would Clothing Sales Tax Cuts Pay for Themselves? (June 1997). Both of these reports can be obtained by contacting IBO or by accessing our web site.

Hotel rooms located in New York City are subject to occupancy taxes in addition to sales taxes. In 1990, a series of tax increases by both the City and State increased the overall tax rate on rooms costing $100 a night from about 15 percent to more than 21 percent-the highest rate in the country and over twice the average rate for major U.S. cities. These high tax rates fueled resentment among tourists and convention planners, who unofficially boycotted New York City as a location for their events.

Pressure to reduce these taxes led the State to eliminate its 5 percent hotel occupancy tax in 1994, with the City following suit by cutting the variable component of its rate from 6 percent to 5 percent. These cuts had the effect of improving the hotel business climate and the unofficial convention boycott ended. But how much did New York City's tax cut cost the City treasury?

All else being equal, a decline in the hotel occupancy tax rate would be accompanied by a reduction in taxes collected. But all else is rarely equal. Despite the tax cut, total City hotel occupancy tax receipts actually increased substantially in the subsequent three fiscal years, as increases in hotel occupancy and pre-tax room rates boosted tax receipts by more than enough to compensate for the loss of revenues directly attributable to the tax cut. (See figure on next page.)

It is one thing to note that collections rose following the tax cuts and quite another to conclude that the tax cuts are solely responsible for the increased economic activity that resulted in the surge in receipts. In fact, both hotel occupancy and pre-tax room rates began to increase well before the tax cut, suggesting that demand for hotel rooms by vacation and business travelers was already rising due to factors other than the reduction in the tax rate. These other factors behind the increase in demand for hotel rooms include the Northeast's expanding regional economy and rising consumer confidence, stronger foreign economic growth, and declines in the City's crime rate.

All of this leads us to the question at hand. With so many factors contributing to the increase in hotel occupancy tax collections, how much of the rise is attributable to the reduction in the City's tax rates? Unfortunately, there is no simple way to examine the data to answer this question. Through the use of sophisticated statistical techniques, however, we are able to provide an answer.

Our analysis seeks to determine the degree to which the City's 1994 tax reduction stimulated increases in hotel occupancy and room rates, thereby boosting tax revenues so as to offset the revenue loss due to the tax cut. The results of the model indicate that lower hotel taxes lead to higher hotel occupancy and pre-tax room prices, but other factors also are significant. Strong domestic and foreign economic growth leads to increases in tourism and higher hotel occupancy. Decreases in crime are shown to increase hotel occupancy as predicted, and decreases in employee payroll costs-the measure of hotel owners' costs of doing business-are shown to increase occupancy.

More specifically, the model indicates that a 1 percent decline in the tax rate generates an increase of 0.34 percent in the hotel occupancy rate and a smaller increase in inflation-adjusted room rates. While these effects may appear modest, their impact on City revenue is substantial because the combined State and City cuts decreased taxes on hotel rooms by over 20 percent-although less than a quarter of the revenues generated by the tax reductions can be attributed to the decline in the City's tax rate.

With this information in hand, we are able to estimate how much of the $16 million price tag (fiscal year 1994) of cutting the tax was directly offset by increases in hotel occupancy and room rates. The City's tax cut led to a $2.0 million increase in hotel occupancy tax revenue and a $1.2 million increase in general sales tax revenue. Thus, $3.2 million, or 20 percent of the $16 million cost, was directly offset by tax revenue from increased hotel business.

Because the tax reduction helped stimulate additional tourist spending and other economic activity in the City, it is also important to consider the indirect economic and fiscal benefits generated by the cut in hotel taxes. IBO's econometric estimates imply that after two years, revenues of City hotels increase by about $30 million annually in response to the City's share of the tax cut. This increase in spending on hotel rooms is accompanied by increases in visitor's spending in other areas of the City's economy. Using information reported by the New York Convention and Visitors Bureau (NYCVB), we find that hotel bills account for 36 percent of hotel guests' total spending in the City. By extension, the increase in hotel stays attributable to the City's tax cut generate an additional $53 million in non-hotel spending each year.

These increases in tourist spending translate into significant additional City revenues from sales, personal income, business income, and property taxes, though it takes years for the full increase in property taxes to be realized. The NYCVB estimates that each dollar of tourist spending in New York City ultimately yields 5.4 cents in City tax revenues. Thus, we expect increased non-hotel spending by the overnight visitors taking advantage of the City's tax cut to generate as much as $2.9 million of additional City tax revenues each year.

But the impact of tourism on New York City's economy (and tax revenues) goes well beyond spending by tourists themselves. Businesses that receive tourist dollars spend a portion of their receipts on locally produced goods and services. Similarly, their employees spend a portion of their earnings on local products. This spending in turn generates new but smaller rounds of spending in the City economy. The sum of all the rounds of additional spending induced by an initial infusion of dollars into the City's economy is known as the multiplier effect.

The NYCVB reports that the sales multiplier for New York City tourism is 1.48, meaning that every $100 spent by tourists generates an additional $48 in new spending in the local economy. Using this multiplier, the $83 million increase in visitor spending resulting from the City's hotel tax cut ($30 million on hotels and $53 million on other tourism-related purchases) is expected to generate an additional $40 million in spending and output in the City, in turn generating an increase of $2.1 million annually in City tax collections.

Adding together the direct ($3.2 million) and indirect ($2.9 million plus $2.1 million) impacts, IBO estimates that as much as $8.2 million or 51 percent of the annual revenue loss resulting from the rate reduction in the City's hotel occupancy tax is offset by increased tax collections due to the tax cut's stimulation of hotel occupancy, tourist spending, and general economic activity.

One of the arguments used to support the elimination of the City sales tax on under-$500 clothing is that the impact of this tax cut on retail trade would be comparable to the hotel tax cut's impact on tourism. According to some proponents, the increase in economic activity following a clothing tax reduction would be very significant, leading to overall increases in City tax revenues large enough to offset a substantial portion of the direct loss of clothing sales tax revenues.

IBO's study of the proposed clothing tax cut does not support this claim. We found that after a City clothing tax reduction, apparel sales would be fueled both by money formerly spent on sales taxes and by additional sales shifted into the City as a result of decreasing the tax advantage currently enjoyed by New Jersey clothing retailers. When all of the secondary revenue impacts of this increased activity are fully phased in, however, they would offset only 6.7 percent of the $352.6 million direct cost in 2005 of the City eliminating its 4 percent sales tax. If the State were also to eliminate its 4.25 percent sales tax, the combined economic impact of both the City and State tax cuts would generate a secondary tax revenue offset of about 14 percent of the direct cost-still far short of the 51 percent offset attributed to the reduction in the City's share of the hotel occupancy tax.

There are three main reasons why the secondary fiscal impact of a clothing sales tax cut would be relatively small. First, unlike the demand for hotel rooms, retail clothing sales are constrained by the amount of income in the local economy. Increased spending by hotel guests, in contrast, brings in dollars that would not otherwise have been spent in the metropolitan area. Second, spending on clothing is less discretionary and therefore less price-sensitive than hotel-related spending. Finally, while hotel stays are essentially a locally produced commodity, much of the clothing sold by City retailers is produced elsewhere. Therefore, additional retail sales following a tax cut would add comparatively little to the taxable output of the City.

As much as half of New York City's reduction in its hotel occupancy tax is offset by increases in other City revenues. But the City's experience in cutting its hotel tax cannot be generalized to cuts in other City taxes; the major factors contributing to these revenue offsets are specific to the tourism industry and to the unique structure of the City's hotel taxes. In contrast to the hotel occupancy tax cut, IBO projects that the revenues generated by the proposed elimination of the City sales tax on under-$500 clothing would pay for only a small share of the direct cost of the tax cut.

Tax cuts, however, do not necessarily have to pay for themselves to be desirable. They can serve many different purposes, from increasing economic competitiveness to making the tax system more equitable. As is the case with any other governmental decision, cost considerations are critically important, but they are just one of the many factors that should be considered in making sound public policy judgments.