Tuesday, January 28, 2014

What Interest Does a State Have in Limiting How Much Its Subdivisions May Tax?

By Mike Dorf

An interesting intra-Democratic disagreement is currently playing out between New York City Democratic Mayor Bill de Blasio and New York State Democratic Governor Andrew Cuomo.  Among de Blasio's more popular campaign promises was the proposed establishment of universal pre-K in NYC, to be funded by a dedicated fund from taxes on the wealthiest city residents.  But recently, Governor Cuomo announced that he wants to create a state program of universal pre-K that would render the de Blasio plan unnecessary.  Rather than treat Cuomo's announcement as the highest form of flattery, de Blasio is (for now) pushing ahead with his plans.

In a nutshell, de Blasio argues that his approach is still needed even if the state funds pre-K for (at least) the following reasons.  First, the city program would be up and running this year, whereas Cuomo plans to take five years to phase in the state program.  Second, de Blasio envisions a higher quality, and thus costlier, program, for which the city's pro rata share of the state funds would be inadequate.  Indeed, Cuomo proposes spending less money statewide ($2.2 billion) than de Blasio proposes to spend just in NYC ($2.5 billion).  Third,  even apart from total cost, de Blasio worries that state funding from general revenues would make the state program vulnerable to cuts or cancellation in Albany's political process, whereas a city program with a dedicated revenue source would be less vulnerable.  (This argument is undercut by de Blasio's proposal to have the new tax expire after five years.)

I don't have a view on the relative merits of the proposals (or of universal pre-K more generally), but I do want to use this dispute to raise a question about the relation between political units and their sub-units with respect to taxation.  Under New York law, the city cannot impose the proposed tax without permission from the state, which is why de Blasio was in Albany yesterday pleading his case to the legislature.

The question I want to raise here is this: What sorts of grounds would justify a state in denying to a subdivision the power to raise taxes?  I raise the question because, prima facie, one might think that it's better to let the smaller geographic units make these decisions for themselves.  de Blasio made just this point in talking about his proposal as an exercise in "self determination."  And there's certainly something to that.  The people within the geographic sub-unit already have an incentive to resist taxes they regard as too high, and so decision making at the level closer to the people has the advantage, other things being equal, of being more democratic.  Below I'll discuss three ways in which other things might not be equal.

(1) Tax Base.  State officials sometimes complain that federal taxes effectively crowd out state taxes.  In principle, states can set their tax rates at whatever they want, but as a practical matter, people in each state will think about total taxes when deciding how they feel about state taxes.  Thus, the lower the federal tax rate, the more room the state has to impose its taxes.  In general, the same phenomenon occurs from states to local governments--with state tax rates operating as a kind of baseline and local taxes acting on top of that.  With most local governments, the relevant kind of tax is on real estate but in NYC and some other local governments, there is also a separate income tax.  Now the key point is that if a local government is big enough--as NYC is relative to NYS--then state taxes not only constrain how much revenue the local government can raise; the local taxes can constrain the state as well.

(2) Distribution.  Closely connected are questions of distribution.  Again, assuming as a practical matter that voters care about their total rate of taxation, raising local taxes for local purposes constrains how much money can be raised statewide for statewide purposes.  So, if a particular locality is rich relative to the rest of the state, the state may not want the locality to use its wealth only for local purposes.  This dynamic is clearly in play in the de Blasio/Cuomo disagreement.  NYC is home to the wealthiest residents of the state as well as some of the poorest.  The question here is whether the money that can be extracted from those wealthy city residents should be used to benefit schoolchildren statewide or just within NYC.  There's no clearly "right" answer to that question, but it's hardly surprising that each jurisdiction would want the resource spent within its jurisdiction.

(3) Policy.  We can imagine circumstances in which a locality seeks authority to impose a new tax that, as a practical matter, wouldn't seriously constrain the ability of the state to impose other taxes. Nonetheless, the state might object on policy grounds.  Suppose that a municipality wants to implement a tax on large sugary drinks.  (Just saying.)  For reasons of principle (libertarianism, here) or politics (the power of "Big Sugar" in the state capital), the state might refuse permission (assuming this were the sort of tax that required state approval).  Or state legislators might take a different view of the likely impact of a tax.  de Blasio might think that upper east side investment bankers will grumble into their brandy snifters while pining for the good old days when a billionaire ran the city but that they will ultimately just fall into line and pay his new tax.  Meanwhile, a state legislator might disagree, thinking that de Blasio's pre-K tax will be the straw that breaks the banker's back, leading him to pack his bags for Jersey City or Greenwich.  (There was a suggestion along these lines yesterday.)  Even though the state legislators are not necessarily better positioned than the local officials are to calibrate the tax to raise revenue without inducing flight, such flight, if it occurred, would have an impact on the state too, and so state legislators will indeed vote on such matters.

Note that the considerations I've discussed are all connected to what we might think of as ideology, but they're not simply about the role of government.  Nonetheless, we can expect that much of the news coverage--and some of the actual grounds for disagreement--will focus on the supposed battle for control of the Democratic Party, pitting de Blasio the progressive against Cuomo the Clintonian pragmatist.