New York Tax Hikes Could Prompt Wealthy Residents, Firms to Leave: Expert

If implemented, the tentative deal reached in New York to raise taxes on the state's wealthiest residents could prompt many of its most mobile executives and employees to move out of state, according to Jared Walczak, vice president of state projects at the Tax Foundation.

After all, the highest-earning New Yorkers tend to be people who can work remotely more easily than others, and some of these New Yorkers have already temporarily left New York during the pandemic, Walczak told ThinkAdvisor in a phone interview on Tuesday.

"Fortunately, New York has not seen a significant decline in revenues during the pandemic," he explained. "So this is about increasing revenue, not patching a hole" in the state budget, according to Walczak.

The tentative deal reached between Governor Andrew Cuomo and state legislators came about one week after budget director Robert Mujica said the state will have a hole of nearly $2.5 billion as New York will receive only $12.6 billion of the $15 billion in federal aid it had sought.

If the plan is implemented, income-tax rates would temporarily increase to 9.65% from 8.82% for single filers earning more than $1 million, according to a Bloomberg report. The deal would also create two new tax brackets: Those individuals with income between $5 million and $25 million would be taxed at 10.3%, and those with income over $25 million would be taxed at 10.9%.

What New York Should Do Instead

"New York's priority should be on bringing back those who have temporarily left the state during the pandemic, not giving them an excuse not to return," Walczak argued.

And "substantially raising taxes on businesses and high earners at a time of dramatically enhanced mobility could easily backfire," he warned.

"The pandemic has given us this forced experiment in remote work and, while many of us will go back to offices, it's clearly working" for many companies, Walczak said.

Therefore, "post-pandemic, far more people will work remotely or at least have significant remote work flexibility," he explained. "For some who currently live in major metropolitan areas like New York City, in particular, this may mean the flexibility to live in a lower-cost jurisdiction."

That will translate to lower cost of living overall and lower tax costs for those New Yorkers, he noted. While they may not have been willing to give up a job to move elsewhere, "if that job can follow them, you will see more migration" to other states.

"This is, therefore, a particularly bad time to be raising taxes on the most mobile New Yorkers, particularly when there's not a pressing revenue need," he said.

What Advisors Should Do

There are important discussions that advisors should have with their clients about the proposed tax hike, especially if it goes through.

For starters, "if financial advisors are talking to [clients] who are interested in remote work, there needs to be a discussion" about New York's convenience of the employer rule that dictates if your office is in New York, then you continue to owe income taxes to New York, even if you're both living and working elsewhere, Walczak said.

"There's a way around this if they're working remote" that advisors should know about and explain to these clients, he noted: "They would need to be assigned to their company's office in another state."

However, if they "only have a New York office, they may be hit with double taxation if they move elsewhere — obviously a huge impediment to remote work," he said.

This is another reason why we may see smaller firms relocate outside of New York, he warned.

A large financial services company will likely have offices around the country. If an employee decides to move to Virginia, they can assign them to a Virginia or Maryland office, for instance.

"But a company that only has one office and wants to provide remote work may find it conducive to move to New Jersey or Connecticut or really anywhere to avoid that particular penalty on its employees," Walczak explained.

That is because "there's not a lot that can be done to hedge against income tax increases unless you choose to change where you live or work," he said.

This may also result in changes to investment decisions so that's another area for advisors to explore with clients impacted by this, he said, adding: "It's particularly worrisome given how many people temporarily located out of New York."

Impact on Wall Street

The financial services sector has historically been "strongly tied to New York City," Walczak noted. "It's a global financial capital and that won't change overnight," he said. "But clearly many of those jobs can now be performed from anywhere, and some of them will be."

Wall Street has avoided one potentially devastating proposal, which was to impose a stock transfer tax in New York again, according to Walczak.

That posed an even "greater risk … because imposing a tax worth $12 billion a year could easily have driven the exchanges out of the city, not only losing those jobs and activity but also imperiling the many other financial sector jobs that no longer have as compelling of a reason to be located in New York," he explained.

However, "even without that, while certainly New York will remain a global financial capital, you will have plenty of people in the finance sector who have increased flexibility to work elsewhere and see taxes rising substantially and no longer find a compelling reason to stay" if the tentative deal as it stands is implemented, the tax expert said.

It is also possible that, in some cases, it won't only be employees who can work remotely who may flee the state, but the firms they work for also.

"Smaller hedge funds and smaller firms may have more flexibility to relocate than larger ones, but large ones can shift workforces around," Walczak said. They may not change their headquarters but more of their employees may be assigned to offices elsewhere in the country.

He conceded that, "to some degree, this was already coming" because "just the change in work culture" to more remote work "will drive some" of that to happen. "But it will impelled further by the fact that New York is a high cost of living and high tax jurisdiction and now it may be getting even more costly."

The proposed tax increase also stands to lead to even more New York companies downsizing their office spaces, he said: "It further increases the cost of doing business in New York and working in New York. And it sends a message that high earners aren't welcome, and this is a problem in a state that gets 42% of its income tax revenue from the top 1% and that drives more than 60% from the top 5%."

Although high earners tend to be an "obvious target for additional tax revenue," Walczak said, "they're also the most highly mobile individuals, and they are vital to New York's tax base." New York is a high-tax state but many people are still "willing to pay that premium because of what New York has to offer," he noted.

However, "post-pandemic, some of those offerings aren't as profound anymore because part of it's the work access and that's no longer going to be tied to exclusively" being in New York, he said.

Bad for State, Even Worse for City

"High earners are concentrated in New York City and the increased corporate income tax is also notable there because New York City is extremely rare" in that it "not only has a municipal-level corporate income tax, but an incredibly high one at a higher rate than the state rate," Walczak noted.

Only a certain amount of income "can be apportioned to New York City, so many firms are paying New York State taxes on a wider base of income," he said.

But the New York City rates are very high. Combined with the proposed corporate tax increase, businesses would pay about 16% rates on their New York City-based activity, he said, adding: "That is far and away the highest you can pay anywhere in the country."

Based on revenue data for the first 10 months of the just-concluded fiscal year, New York revenues were "completely flat," according to Walczak. The state will also be receiving over $10 billion in aid thanks to the American Rescue Plan Act and localities will receive another roughly $10 billion in aid, he said.

As a result, "there's no compelling need for a $4.3 billion tax increase right now," according to Walczak. "This isn't a question of which taxes should you raise," he explained.

"It's a question of why are you raising taxes when revenues are available, substantial federal aid is on the way. And the top priority should be ensuring that those who temporarily relocated elsewhere come back to New York," the tax expert noted.

Addressing the state budget director's argument, Walczak said: "New York has stuck with" its forecast of a $15 billion budget gap "for many months now despite [a] dramatically improving revenue picture."

New York revenues are not declining, according to Walczak. New York instead will likely close the past fiscal year with its "second-highest revenue ever in real inflation adjusted terms," he projected.

What it all boils down to is a simple fact: "There's no crisis" with New York's budget, he argued.

See: New York's Highests Earners Face Tax Hikes in Proposed Budget