Economic Effects of an Employer Compensation Expense Tax on New York Small Businesses

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1 Economic Effects of an Employer Compensation Expense Tax on New York Small Businesses Michael J. Chow and Paul S. Bettencourt NFIB Research Center Washington, DC March 26, 2018 Executive Summary The Tax Cuts and Jobs Act of 2017 represents the most significant reform to the U.S. tax system since the Tax Reform Act of Among the key provisions of the law are the modification of marginal tax rates for both single and joint filers, the rough doubling of the standard deduction, the repeal of personal and dependent exemptions, an increase in the child tax credit, a change in the mortgage ceiling for homes eligible for the mortgage interest deduction, and the introduction of annual limits of $10,000 to itemized deductions of state and local taxes (socalled SALT deductions) including state income taxes, sales taxes, and property taxes. Much of the discussion surrounding this major reform effort has focused on making the U.S. tax system more competitive on the global stage. While there is general agreement that the Tax Cuts and Jobs Act was successful in this regard and will overall be a boon to both U.S. businesses and individual taxpayers, there are concerns at the state level that certain aspects of the new law will change the relative competitiveness of states when it comes to attracting employers and residents. Limits on SALT deductions are one such provision in the new law and raises fears among political leadership in New York that the limits will make New York a less attractive place to do business, work, and live. In response to these concerns, state policymakers recently introduced 1

2 legislation to establish a new employer compensation expense tax that would ostensibly improve New York s relative competitiveness post-federal tax reform. The compensation expense tax would allow employers to elect to participate in a new tax program that would apply a fully deductible payroll tax on employees earning more than $40,000 per year in annual wages and compensation 1 ( covered employees ). The proposed tax would be phased in over a three-year period beginning in 2019 with a tax rate of 1.5 percent being applied to wage and compensation in excess of $40,000 for covered employees. The rate would rise to three percent in 2020 and to five percent for years 2021 and beyond. Covered employees whose employers elect to participate in the tax program would be eligible to receive an employee tax credit equal to a fraction of the compensation expense tax paid by their employers. This report presents an economic impact analysis of this proposed employer compensation expense tax on the New York economy with a particular focus on the small business sector of the economy. Using the Business Size Insight Module (BSIM), a dynamic, multi-region model based on the Regional Economic Models, Inc. (REMI) structural economic forecasting and policy analysis model, the NFIB Research Center estimates that, by the end of a ten-year period beginning in 2019, the proposed employer compensation expense tax would reduce private sector employment in New York by nearly 98,000 workers, reduce total employment in the state by nearly 107,000 workers, reduce the state labor force by almost 99,000 individuals, and lead over 172,000 people to leave the state. Real output in New York is also forecast to fall by $13.9 billion by 2028, with the cumulative loss in real output from 2019 to 2028 totaling $75.2 billion. Sixtytwo percent of the forecast job losses are jobs that would have been in the small business sector. 1 The legislation uses the language wages and compensation. We interpreted this to strictly mean wages and salaries and exclude from our interpretation other nonpecuniary forms compensation such as non-wage benefits like health insurance and paid leave, which are typically not subject to payroll taxes. 2

3 Impact of Changes to State and Local Tax Deductions to New York A consensus among tax experts is that limiting SALT deductions increases overall federal tax revenues. This view is held by both experts working for the government as well as experts at nonpartisan, nonprofit think tanks. Prior to the Tax Cuts and Jobs Act becoming law, the Congressional Budget Office proposed limiting the deduction for state and local taxes as one of a number of options for reducing the deficit, citing figures from the Joint Committee on Taxation that estimated that the change in revenue over a ten-year period spanning 2017 to 2026 from capping SALT deduction at two percent of adjusted gross income would equal $955.4 billion. 2 Likewise, the Committee for a Responsible Federal Budget viewed the SALT deduction as an expensive tax expenditure that merited elimination or scaling back due to its regressivity and the desirability of single taxation of income. At the same time, many experts contend that taxpayers in states with a greater density of high-income taxpayers than in other states will, in the aggregate, pay more in taxes due to the new limitations on SALT deductions. According to recent analysis by the Tax Foundation, 88 percent of the benefits of the state and local tax deduction benefit taxpayers with incomes exceeding $100,000. Furthermore, the Foundation finds that six states (California, New York, New Jersey, Illinois, Texas, and Pennsylvania) claim more than half of the value of the deduction. New York alone accounts for 13.3 percent of benefits from the state and local tax deduction to the entire country, ranked second behind only California which accounts for 19.6 percent of total benefits. 3 The increased individual income tax burden on higher-income states has raised concerns among some lawmakers from these states that their states have been made less competitive due to the Tax Cuts and Jobs Act, which, they believe, creates risks of out-state migration by taxpayers seeking a lower tax burden and making companies less likely to locate in states due to the talent drain associated with out-state migration. According to New York s Department of Taxation and Finance, absent any changes to New York s tax code, the limitations on SALT deductions contained in the Tax Cuts and Jobs Act will cost New York taxpayers an additional $14.3 billion per year. 4 In New York Governor Andrew M. Cuomo s view, the elimination of full state and 2 Options for Reducing the Deficit: 2017 to 2026, Congressional Budget Office, December Walczak, Jared, The State and Local Tax Deduction: A Primer, The Tax Foundation, Tax Foundation Fiscal Fact No. 545, March Preliminary Report on the Federal Tax Cuts and Jobs Act, New York State Department of Taxation and Finance, Presented to Governor Andrew M. Cuomo during January

4 local deductibility provides grounds for New York to consider adjusting its own tax structure since state tax laws interact with the federal tax system, and what may have been a previously optimal state-federal tax arrangement may no longer be optimal following federal tax reform. On January 3 rd during his State of the State address, Governor Cuomo announced his ambition to investigate the feasibility of restructuring New York s tax code in significant ways. To this end, New York s Department of Taxation and Finance issued a report in January recommending three state-level tax reform proposals for consideration. These proposals are: 1. The creation of additional opportunities for New Yorkers to benefit from charitable contributions 2. Shifting from a tax system that relies heavily on income taxes for revenue to one that relies on a statewide employer compensation expense tax 3. The creation of a new statewide unincorporated business tax The second of these three recommendations constitutes a major shift in the burden of tax compliance away from individuals and employees toward employers, and it is this recommendation that is the focus of the remainder of this report. A detailed proposal for a new employer compensation expense tax was recently introduced as an amendment to this year s state budget bill. Passage of this amendment and implementation of this new tax would create a major new burden on employers seeking to do business in New York and would have considerable negative consequences for the state s economy. These consequences are discussed in detail below and are quantified using the NFIB Business Size Insight Module (BSIM), a dynamic, multi-region model based on the Regional Economic Models, Inc. (REMI) structural economic forecasting and policy analysis model which integrates input-output, computable general equilibrium, econometric, and economic geography methodologies. The underlying mechanics of the REMI model are based on decades of peer-reviewed literature. 5 The model is used by numerous clients in both the private and public sectors. 6 The 5 A list of the peer-reviewed literature is available at The list of references includes articles published in the American Economic Review and The Review of Economics and Statistics. 6 The REMI model is used by a diverse group of clients spanning academia, private consulting firms, local and regional governments, and nonprofits, to name a few categories. A list of clients that use the REMI model is available at The list has included consultancies like Boston Consulting Group and Ernst and Young, educational institutions like the Massachusetts Institute of Technology, nonprofit institutions like AARP and the Urban Institute, and federal, regional, and local government agencies. 4

5 BSIM is a customized version of the REMI model that has the unique ability to forecast the economic impact of public policy and proposed legislation on different categories of U.S. businesses differentiated by employee-size-of-firm. Forecast variables include levels of private sector employment and real output. By comparing simulation results for scenarios which include proposed or yet-to-be-implemented policy changes with the model s baseline forecast, the BSIM is able to obtain estimates of how these policy changes would impact employer firms and their employees. Modeling a Statewide Employer Compensation Expense Tax The proposed employer compensation expense tax would be phased in over a three-year period beginning in 2019 with a tax equal to 1.5 percent of the payroll expense paid by electing employers to covered employees. In 2020 and 2021, the tax increases to three percent and five percent, respectively, of payroll expense paid to covered employees. The tax rate would remain at five percent for years beyond In the context of the bill, a covered employee is an employee of an electing employer who is required to have withheld wage and salary for payroll tax purposes and receives annual wages and compensation from his or her employer of more than $40,000 per year. An electing employer is any employer who employs covered employees in New York and chooses to pay the new employer compensation expense tax. 7 Although Governor Cuomo s remarks concerning state tax reform suggest a desire to switch from a system reliant on income tax for revenue to one that relies on taxes imposed on employers, the amendment language does not in fact statutorily impose such a replacement. In other words, there is no language in the bill that indicates that an employer compensation expense tax may be paid by an employer and, in so doing, covered employees on behalf of which employers pay this tax would no longer need to pay income tax as individuals. Notable, too, is the language concerning a statewide employer compensation expense tax contained in the preliminary report issued by the New York Department of Taxation and Finance, which states: 7 Election by the employer to be thus taxed must be made by (1) unanimous consent of all owners of the employer at the time the election is made if the employer is not a corporation, (2) by an officer or manager of the employer who is authorized under law of the state where the corporation is incorporated or under the employer s organizational documents to make the election and who represents to having such authorization under penalty of perjury (if the employer is a for-profit or not-for-profit corporation), (3) by unanimous consent of all trustees if the employer is a trust, or (4) in the case where the employer is a governmental entity, by the chief executive officer of the governmental entity. 5

6 Under this model, New York State would enact a new constructed progressive employer compensation expense tax, which could either complement or replace the current income tax and withholding system on wages. Under any version of this model (including those that eliminate the personal income tax on wages), the personal income tax would be maintained for non-wage income. In short, nowhere in the Governor s remarks concerning reform of the New York tax system nor anywhere in the budget bill language detailing the makeup of the employer compensation expense tax does it stipulate that any existing taxes will be eliminated to offset the new tax. It is merely mentioned that replacement of certain current taxes with the new employer compensation expense tax might constitute part of the broad tax reform envisioned by the governor (and this reference was made in the report from the New York Department of Taxation and Finance not in the budget amendment language). Such circumstances allow for considerable latitude for economic modelers seeking to estimate the economic impact of the employer compensation expense tax. Specifically, the question of whether to assume the simultaneous replacement or elimination of existing taxes that coincide with the imposition of the employer compensation expense tax is an open one and must be addressed. The approach taken in this analysis is to evaluate the implementation of the statewide employer compensation expense tax as a standalone policy change and to not consider any revenue offsets that might arise from the replacement or elimination of existing taxes. This assumption was made due to the fact that the budget amendment language contains no explicit stipulations for tax replacements or eliminations. Calculating the amount of new taxes paid by employers under an employer compensation expense tax program naturally requires knowledge of wages and compensation earned by employees in New York. We relied upon data from the Census Bureau s Current Population Survey (CPS) March Supplement to obtain estimates of the amount of wage and salary earned by workers that exceed $40,000 per worker. Our analysis of the data indicates that in 2016, some 4.3 million New Yorkers making more than $40,000 per year collective earned $237.7 billion in wage and salary income. The average worker in this category took home just over $55,000 in annual wage and salary in These estimates provide a foundation from which we can extrapolate equivalently defined wage and salary earned by New Yorkers in years beyond To extrapolate compensation 6

7 earned in years beyond 2016, we assumed that wages and salaries in New York would continue to increase at their historical rate of growth since the third quarter of 2009 when the Great Recession ended and the current business cycle began. The compensation data used to estimate the growth rate was the time series for wages and salaries for private industry workers in the Northeast Census Region (which includes New York) provided by the Bureau of Labor Statistics. Using this data series, we calculate that wages and salaries for this region increased year-over-year by an average of 2.1 percent between 2009Q3 and 2017Q3. Applying this compensation growth rate to the estimated $237.7 billion in New York wage and salary income allows us to obtain estimates for the aggregate amounts of wage and salary earned by New York workers who earn more than $40,000 per year. Two important features of this compensation extrapolation bear mentioning here. First, our approach does not explicitly account for workers who currently earn below the $40,000 per year threshold but, through wage growth, may see their wages and salary transition from below or equal to the $40,000 per year threshold to above $40,000 per year. An assumption of 2.1 percent wage and salary growth over a decade means that a worker earning slightly under $33,000 per year in 2019 will see their wage and salary compensation grow to above $40,000 by The CPS data indicate that in 2016, some 19.8 percent of the workers who earned wage and salary in 2016 in excess of $33,000 per year earned wage and salary somewhere between $33,000 and $40,000. By not explicitly taking into account this class of workers, we may therefore be underestimating the total amount of wage and salary eligible for the employer compensation expense tax in future years. Table 1: Wage and Salary Income Distribution of New Yorkers Earning at Least $33,000 per Year in 2016 Percentile Annual Wage and Salary Income Percentile Annual Wage and Salary Income $60,000 5 $35, $62, $37, $67, $40, $72, $40, $79, $44, $85, $46, $97, $50, $108,490 8 With a historical compensation growth rate of 2.12 percent, a worker currently earning $40,000 per year would have made $32,437 ten years previous. 7

8 40 $51, $128, $55, $165,000 Source: Current Population Survey Second, our methodology also does not explicitly account for changes in the workforce due to the entry of new young workers and the retirement of elderly workers. Recent estimates place the average retirement age for U.S. workers at about According to estimates obtained using CPS data, some 30 percent of New Yorkers earning at least $33,000 in wage and salary per year will reach this average retirement age by 2028 (Table 2). As economic modelers, we perhaps ought to be concerned about the impact this potential outflow of older workers might have on the wage and salary base for the employer compensation expense tax. However, recent demographic trends give us reason to believe that the net effect on the tax base due to the ageing out of older workers and the ageing in of new workers may be negligible. Table 2: Age Distribution of New Yorkers Earning at Least $33,000 in Wage and Salary per Year in 2016 Percentile Age Percentile Age Source: Current Population Survey The first of these trends is the continued stability of New York s population (and, hence, its potential resident labor force). Table 3 shows Census Bureau estimates of the resident population in New York from 2010 to Although population growth in New York has slowed in the past three years compared to the early 2010s, the Census data rebut assertions made 9 For example, see: Riffkin, Rebecca, Average U.S. Retirement Age Rises to 62, Gallup, April 28, Annual Estimates of the Resident Population for the United States, Regions, States, and Puerto Rico: April 1, 2010 to July 1, 2017, Census Bureau, downloaded March 27, 2018, 8

9 in popular media that New York s population has actually been declining in recent years. 11 Lacking convincing reason to do otherwise, we utilize the baseline population estimates in the REMI model which assume that New York experiences continued measured population growth through Table 3: Population Estimates of New York State: 2010 to NY Population Source: Census Bureau 19,405,185 19,526,372 19,625,409 19,712,514 19,773,580 19,819,347 19,836,286 19,849,399 Turning to our assumptions concerning New York s labor force, we must again address two key issues. The first issue is the relative competitiveness of New York compared to other states in a post-federal tax reform world (the principal concern of the New York Department of Taxation and Finance and the state s political leadership). A less competitive New York would in principal lead to out-migration of working age individuals who would relocate to other states where job prospects are better. For this analysis, we assume that any perceived deleterious effects on New York s competitiveness resulting from the Tax Cuts and Jobs Act will be sufficiently addressed at the state level (such as through this reform of the state tax code) so that New York remains competitive in its ability to attract employers, workers, and residents. The second issue is the impact of inflows and outflows to the labor force due to young workers entering the workforce and older workers choosing to retire. CPS data allow for a case that the potential tax base will not decrease due to these flows in and out of the workforce. Using the CPS March Supplement data, we calculate that in 2016 there were 2.83 million New Yorkers between the ages of 12 and 22 compared to 2.87 million New Yorkers between the ages of 52 and 62. The first group represents a pool of individuals with high probability of entering the New York labor force within a ten-year time frame (if they are not already part of the labor force). Assuming the current labor force participation rate of 63 percent is applicable for these future eligible workers, we can expect approximately 1.78 million new entrants into the labor force in the next ten years. 12 The second group is a class of individuals that includes a subset of New Yorkers who 11 See, for example, Winslow, Olivia, U.S. Census estimate: New York see population decline, Newsday, December 20, The labor force participation rate in the U.S., currently 63.0 percent, has remained in a range of +/- 0.4 percentage points of 63.0 percent since February

10 are in the workforce and earn wage and salary income (and therefore might currently contribute toward the hypothetical employer compensation expense tax base). Of this group, some 1.95 million individuals earned any wage and salary income with 1.15 million of these workers earning at least $40,000 per year in wage and salary. In total, these 1.15 million workers earned $237.7 billion in wage and salary income in Taken alone, the above statistics suggest that the coming years will witness a net outflow of workers from the New York labor force. However, it is critical to take into account an additional trend when evaluating the nature of New York s future labor force namely, the overall ageing of workforce in the U.S. According to Gallup, the average retirement age has increased from 59 years old in 2010 to 62 years old in Americans currently in the workforce also expect to retire at a meaningfully older age of 66 compared to the current actual average retirement age of We assume that retirement ages will in fact continue to increase, as the Gallup data suggest. Higher retirement ages mean that one can expect somewhat fewer than 1.95 million individuals who are between the ages of 52 and 62 and who also receive wage and salary income to actually exit the workforce, on average, at age 62. It is impossible to say with certainty, but rising retirement ages could lead net outflows from the labor force due to retirement to roughly equal net inflows into the labor force due to younger workers joining the ranks of the employed. We deem this a reasonable possibility and adopt this scenario as our assumption regarding age-related inflows and outflows of the labor force. The practical implication of this assumption is that a reasonable approach to estimating the future employer compensation expense tax base is to start with the estimated aggregate amount of wage and salary income currently received by workers earning more than $40,000 per year in such compensation and apply the historical 2.1 percent growth rate to obtain aggregate wage and salary amounts for future years. Our estimates of the tax base during a ten-year forecast window beginning in 2019 an assumption based on the proposition that a budget bill including this amendment passes in a timely fashion, is signed into law by the governor, and is implemented beginning next year are provided in Table Riffkin. 10

11 Table 4: Estimated Aggregate Wage and Salary Income Exceeding $40,000 per Person Earned by New York Workers Making at Least $40,000 per Year (per Person): 2019 to Est. Tax Base $253.2B $258.5B $264.0B $269.6B $275.3B $281.2B $287.1B $293.2B $299.4B $305.8B We move now to the important question of how many employers elect to participate in the employer compensation expense tax program, a critical determinant in how large the new tax burden will be on New York employers. While some observers of this tax program raise skepticism concerning the efficacy of the program to engender a healthy take up rate by employers, we reserve judgment about the incentive structure of the program and, giving the benefit of the doubt to policymakers who formulated the new tax program, assume that the program functions optimally in engendering 100 percent of eligible employers to elect into the tax program. Applying the aforementioned compensation growth rate of 2.1 percent to the 2016 aggregate wage and salary estimate and incorporating the above assumptions, we arrive at the following estimates for aggregate employer compensation expense tax paid for 2019 through 2028, the ten-year forecast window we investigate (Table 5). In 2019, we estimate that the initial 1.5 percent tax rate will yield approximately $3.8 billion in tax revenue for New York. As the tax is phased in, more tax revenue is received by the state treasury. We estimate that the three percent rate in 2020 will yield revenue of just under $7.8 billion and that the final tax rate of five percent will bring in $13.2 billion in 2021, with this figure increasing in future years due to wage growth. Table 5: Estimated New York Tax Revenue and Employer Deductions from a New Statewide Employer Compensation Expense Tax: 2019 to Est. Tax Revenue Est. Employer Tax Deduction $3.797B $7.776B $13.200B $13.480B $13.766B $14.058B $14.356B $14.660B $14.971B $15.288B $949M $1.939B $3.300B $3.370B $3.441B $3.514B $3.589B $3.665B $3.743B $3.822B As a practical matter, these revenue estimates represent a flow of resources from employers to the state treasury. As such, they were input twice into the BSIM once as a cost to firms, and then once again as added revenue to the state subsequently distributed to non-government agents. The BSIM employer cost variable utilized in this analysis was the non-compensation labor cost variable that impacts firms. This modeling choice recognizes the fact that while new costs to 11

12 employers from the compensation expense tax are intrinsically tied to payroll, the costs do not take the form of additional compensation paid to employees (which would have feedback effects in the model due to additional consumption from workers with more take-home pay to spend). Since the compensation expense tax applies to all industries, the employer costs were distributed across all firms in all industries according to weights derived from REMI baseline projections of pre-tax reform employment figures. As for our modeling of the state treasury s handling of this new tax revenue, there are obviously multiple ways that this money could be used by the state. First, the state could choose to spend the money directly on various initiatives, increasing state demand for goods and services and recycling the money directly into the economy through payments to providers of these goods and services. Second, the state may elect to save the tax revenue for use at a future date, whether it be for specific projects already approved but which have a start date beyond 2019 or, alternatively, for setting aside in a rainy day fund (or other savings account) that is not attached to any preexisting spending plans. Third, the state government can choose to help offset the new tax burden on employers by recycling the new revenue to other economic agents vis-à-vis the tax system. In fact, the budget amendment contains such a measure in the form of tax credits available to covered employees whose employers elect to participate in the compensation expense tax program. We assume that all revenue collected by the state from the compensation expense tax is subsequently distributed to covered workers in the form of a tax credit (discussed later in greater detail). This aspect of the modeling is important because it means that our modeling approach is revenue neutral. Another important feature of the proposed employer compensation expense tax is that any such tax payments are tax deductible to employers for income tax purposes. The value of a tax deduction to a taxpayer depends on two criteria. The first is the taxpayer s revenue or gross income. For the deduction of the employer compensation expense tax to have value to an employer, revenue must be sufficiently high that revenue less all other business deductions (prior to deducting any portion of the paid employer compensation expense tax) is positive. If not, then the deductibility of the employer compensation expense tax is financially meaningless. We assumed that all employers electing to participate in the employer compensation expense tax program have sufficient annual revenue to fully deduct this new tax payment from their regular taxable income. 12

13 The second criterion is the marginal tax rate faced by the taxpayer. Given the brief amount of time since the Tax Cuts and Jobs Act became law and the lack of post-tax reform business tax data, measures of effective tax rates paid by U.S. businesses are understandably scarce. However, given the reaction of economists and business leaders to the new law, it seems fair to assume that effective tax rates paid by firms will be lower post-tax reform compared to the rates firms paid pre-reform. Numerous studies have been completed which discuss the pre-tax reform effective business tax rate in the U.S. A 2011 report on these studies published by the Tax Foundation notes that such studies placed the pre-reform tax rate somewhere between 23 percent and 35 percent, with an aggregate average of 27.9 percent. 14 For our analysis, we assume that the aggregate average effective tax rate for firms is 25.0 percent. This assumption is arbitrary, but it is one that we consider reasonable (and possibly even conservative) given the reduction in the corporate tax rate from 35 percent to 21 percent as well as the new deduction of up to 20 percent of business income available to pass-through businesses. Our estimates of the value of these tax deductions to New York employers throughout our forecast window are given above in Table 5. Concerning how this tax deduction was inputted into the BSIM, the deduction of 25 percent of paid employer compensation expense taxes was modeled as a cut in production costs. A key feature of the production cost variable in the BSIM is that changes to this variable do not affect the relative costs of factor inputs (e.g., labor, capital, or fuel). This modeling choice reflects the principle of cost neutrality that appears fundamental to the new tax: despite the compensation expense tax being an explicit tax on labor, this new cost on labor for employers ought to be offset through the tax code vis-à-vis the deductibility of the compensation expense tax for income tax purposes. Hence, even though the compensation expense tax is definitionally a payroll tax, in our modeling we avoid explicitly changing the relative cost of labor to the costs of other factors of production. Another important feature of the compensation expense tax is that employers may not pass on the burden of the tax to employees by reducing employee wages or compensation by any amount that represents all or any portion of the tax imposed on the employer, meaning that the full burden of the tax is shouldered by employers (although in theory this burden is offset through the tax deductions employers may take). This means that covered workers wage bills may not be cut 14 Dittmer, Philip, U.S. Corporations Suffer High Effective Tax Rates by International Standards, Tax Foundation, Tax Foundation Special Report No. 195, September

14 to financially offset the compensation expense tax, although employers still have recourse to raising prices for customers and workforce reductions. Given this explicit prohibition in the budget amendment, we make no effort to exogenously decrease the BSIM variable that represents employers wage bills in our modeling, thereby preserving the baseline consumption power of workers in the REMI model. An additional feature of the proposed tax is that on the employee side, the budget bill allows for tax credits for covered employees of employers who elect to pay employer compensation expense tax. The precise calculation of the tax credits is somewhat complex but essentially equals some fraction of the compensation expense tax that employers pay on a covered employee s wage and compensation in excess of $40,000 (per year). As with the tax itself, the employee credit is phased in over three years beginning in Detailed tax data at the state level is scarce, and there is a paucity of data sufficiently thorough that would allow us to perform this calculation for wage and salary workers in New York. This being the case along with the importance of the employee credit component of this tax program, we assumed that covered employees working for employers who elect into the program receive a tax credit equal to the full amount of compensation expense tax paid on their behalf by their employers. While we wish that we had data adequate to model employee credits with greater precision, this approach has the advantage of making any possible forecasts of job losses resulting from the analysis conservative. Finally, as for how we implemented the employee credit using the BSIM, we chose to model the employee credit as a direct increase in employee compensation. Our preference would have been to model the credit as a tax rebate perhaps by using a government transfer variable but, unfortunately, the REMI model does not permit the distribution of transfer payments strictly to workers earning wage and salary (the only class of individuals eligible for the credit). Such being the case, we instead increased aggregate employee compensation directly by an amount equal to the total amount of tax revenue that we estimated the state treasury would take in from the new tax. Doing so ensures that the modeling approach is revenue neutral and accounts for 15 The precise formula for the employee credit is as follows: In 2019, the credit equals the product of the (1) covered employee s wages and compensation in excess of $40,000 received during the tax year from the covered (and electing) employer and (2) 1.5 percent and (3) the results of 1 minus a fraction, the numerator of which shall be the tax imposed on the covered employee as determined pursuant to New York tax law before the application of any credits for the applicable tax year (2019) and the denominator of which shall be the covered employee s taxable income as determined pursuant to the budget bill for the applicable tax year (2019). The employee credit formulas for years 2020, 2021, and beyond are identical to the formula for 2019 save that the percentage in the product formula equals three percent for 2020 and five percent for 2021 and beyond. 14

15 additional spending on the part of workers who would see an increase in after-tax income because of tax reform. As with the compensation expense tax itself, the employee credits were distributed to all industries according to weights derived from REMI projections of pre-tax reform employment figures. Simulation Results BSIM simulation results for the modeled effects of New York s proposed employer compensation expense tax are provided below. All employment figures are expressed as number of employees while output figures are expressed as billions of 2015 dollars. Under the modeled assumptions: There would be more than 97,700 fewer jobs in New York in 2028 if the employer compensation expense tax is enacted. Small businesses would be particularly impacted. 16 o Businesses with fewer than 500 employees are forecast to experience 62 percent of job losses (over 60,100 lost jobs). o Businesses with fewer than 100 employees are forecast to lose over 45,600 jobs, about 47 percent of all jobs lost (Table 6). In addition to forecast reductions in employment, real output 17 is also forecast to decrease by approximately $13.9 billion by 2028 compared to the baseline forecast (Table 7). Over the ten-year forecast window, the cumulative real output lost is forecast to be $75.2 billion. New York s population is forecast to decrease by more than 172,000 residents by 2028 (Figure 5), and New York s labor force would decline by nearly 99,000 workers (Figure 6). 16 This analysis adopts the Small Business Administration s size-of-business threshold of 500 employees to distinguish between small businesses and large businesses. The 500-employee threshold is frequently used by researchers to delineate the small business sector when working with firm-size data. 17 The term output refers to the aggregate output of the New York economy (GDP). GDP has three possible definitions: (1) the value of final goods and services produced in an economy during a given period (as opposed to raw materials or intermediate goods which are produced or sourced earlier in the production process), (2) the sum of value added during a given period, or (3) the sum of incomes in the economy during a given period. It is a technical term whose significance may be better understood by the reader if she considers that because of the first definition, output serves as a rough proxy for sales. 15

16 Despite arguments that the employer compensation expense tax would attract workers by making New York more economically competitive, the BSIM forecasts that the proposal would actually cause New Yorkers to move to other states in search of better opportunities. Table 6: Employment Difference from Baseline (Number of ) under the Forecast Scenario Firm Size Percent of Total (2028) ,887-3,534-4,606-5,663-6,619-7,470-8,204-8,796-9, % ,893-3,499-4,454-5,383-6,216-6,952-7,588-8,098-8, % ,934-3,643-4,772-5,867-6,850-7,717-8,462-9,060-9, % ,504-5,185-7,740-10,171-12,335-14,242-15,873-17,190-18, % ,482-4,900-6,843-8,636-10,208-11,589-12,774-13,734-14, % ,267-4,501-9,860-15,726-20,856-25,258-29,120-32,444-35,178-37, % < 20-2,421-5,714-10,676-13,832-16,913-19,684-22,139-24,254-25,953-27, % < 100-3,292-8,219-15,861-21,572-27,084-32,019-36,381-40,127-43,143-45, % < 500-4,231-10,701-20,761-28,415-35,719-42,228-47,970-52,901-56,877-60, % All Firms -5,498-15,201-30,621-44,142-56,575-67,486-77,091-85,345-92,056-97, % Table 7: Real Output Difference from Baseline (Billions of 2015 $s) under the Forecast Scenario Firm Size Percent of Total (2028) % % % % % % < % < % < % All Firms % 16

17 Jobs Lost (Employment Difference from Baseline) NY Private Nonfarm Employment: Difference From Baseline (in Number of ) in , <20 <100 <500 All Firms -20,000-30,000-40,000-50,000-60,000-70,000-80,000-90, ,000 Employee-Size-of-Firm Category Figure 1 17

18 Cumulative Real Ouput Lost (Billions of 2015 $s) $0 -$10 New York Real Output: Cumulative Difference From Baseline (in Billions of 2015 $s) by <20 <100 <500 All Firms -$20 -$30 -$40 -$50 -$60 -$70 -$80 Employee-Size-of-Firm Category Figure 2 18

19 Cumulative Real Output Lost (Billions of 2015 $s) $0 Cumulative Real Output Lost (All Firms) from 2019 to 2028 if New York Enacts an Employer Compensation Expense Tax $10 -$20 -$30 -$40 -$50 -$60 -$70 -$80 Figure 3 19

20 100% 90% Percentage Shares of Jobs Lost and Cumulative Real Output Lost if New York Enacts an Employer Compensation Expense Tax Percentage Share of Jobs Lost by 2028 Percentage Share of Cumulative Real Output Lost ( ) 80% 70% 60% 50% 40% 30% 20% 10% 0% Figure Employee-Size-of-Firm Category <20 <100 <500 All Firms 20

21 Population Change (Thousands) 150 Population Change as a Result of New York s Proposed Employer Compensation Expense Tax ( ) New York New Jersey California Illinois Pennsylvania Rest of US Figure 5 21

22 Labor Force Change (Thousands) Labor Force Change as a Result of New York s Proposed Employer Compensation Expense Tax ( ) New York New Jersey California Illinois Pennsylvania Rest of US Figure 6 22

23 Summary This report presents an economic impact analysis of a proposed employer compensation expense tax on the New York economy with a particular focus on the small business sector of the economy. In response to concerns that limits on SALT deductions will make New York a less attractive place to do business, work, and live, state policymakers recently introduced legislation to establish a new employer compensation expense tax that would ostensibly improve New York s relative competitiveness post-federal tax reform. The compensation expense tax would allow employers to elect to participate in a new tax program that would apply a fully deductible payroll tax on employees earning more than $40,000 per year in annual wages and compensation. The NFIB Research Center estimates that, by the end of a ten-year period beginning in 2019, the proposed employer compensation expense tax would reduce private sector employment in New York by nearly 98,000 workers, reduce total employment in the state by nearly 107,000 workers, reduce the state labor force by almost 99,000 individuals, and lead over 172,000 people to leave the state. Real output in New York is also forecast to fall by $13.9 billion by 2028, with the cumulative loss in real output from 2019 to 2028 totaling $75.2 billion. Sixty-two percent of the forecast job losses are jobs that would have been in the small business sector. 23