Albany, NY, USA. Governor Andrew Cuomo not only got New York's legislature to pass its budget on time but also changed spending assumptions in ways that nudge the budget closer to long-term structural balance.

Populist outrage at the big bonuses paid by Wall Street firms has mostly melted away since the peak of the financial crisis. But New York State will be feeling the effects of the bonus backlash for a long, long time.


Traditionally, Wall Street bonuses have been a huge source of income tax revenue for New York: Around 20 percent of the state’s wages are paid to people in finance and insurance. So the state budget office tracks bonuses closely. According to the latest estimates, finance and insurance bonuses have recovered some from a plunge in 2009, but the haul remains much lower than it used to be. Even in 2013, bonuses are expected to reach only $40 billion, compared with more than $50 billion in 2008. The drop may well be permanent.

The story of the bonuses is a microcosm of changes rippling through state government in New York. It now seems clear that the pain of the recession wasn’t just about suffering through a few years of tight state budgets. Rather, it was the culmination of years of practices that were unsustainable. For better or for worse, New York can’t keep financing government and spending on services the way it has in the past.

Andrew Cuomo, the new governor of New York, isn't the first person to figure that out. But in his first five months in office, he's been unusually effective at focusing the state legislature on the problem. Cuomo has taken to lecturing Albany on the need to reform a political culture that favors short-term dealmaking over long-term planning.

And he relentlessly talks about the need to rein in spending on New York’s two biggest budget drivers — health care and K-12 education. Cuomo, whose father Mario was an iconic liberal governor of New York, has described his political philosophy like this: “I am a progressive Democrat who’s broke.”

When this year began, New York faced a $10 billion shortfall in the upcoming fiscal year — a gap equivalent to 15 percent of the state’s general fund. But that was only the beginning of the problem. The next year's shortfall was projected to be $15 billion. The following year's was estimated at $17 billion. After that, it was $21 billion. Despite having passed sizable tax increases and unpleasant budget cuts during the recession, New York appeared headed toward a state of perpetual fiscal crisis.

Cuomo won approval of a budget that friends and foes alike describe as a radical departure from the way the state had been doing business. For one thing, it passed on time — the first time in five years that New York has had a budget in place by the April 1 start of its fiscal year. But it also changes assumptions about the way New York spends money on health care and schools in ways that nudge the budget closer to a long-term structural balance.

As a result of Cuomo's budget deal, New York’s 4-year shortfall projection fell from $63 billion to $10 billion. If the state simply extended an income tax increase on the rich that is set to expire on December 31 — something most New York Democrats support, but Cuomo opposes — those future budget gaps would vanish.

There's no guarantee that the savings Cuomo is counting on will materialize, however. It will require difficult and partially unspecified changes in the way New York provides health care to its most vulnerable residents. Local governments will have to go along with a controversial overhaul of their relationship with the state. And it will require the continued cooperation of interest groups that are accustomed to playing hardball politics but have decided to fall in line with Cuomo's vision of the future — for now, at least.

Two budget drivers

Cuomo had good reason to focus on Medicaid and education. Besides being programs on which the state spends most of its money, they’re also areas where New York spends more prolifically than other states do. For example, New York's Medicaid program is one of only a handful that provides full coverage to childless adults below the poverty line. And in the classroom, New York's per-pupil spending is tops in the nation. “Those two areas are the real drivers that will affect the future of New York,” says Stephen Acquario, executive director of the New York State Association of Counties. “Everything else is secondary.”

In New York, spending on Medicaid and education has been guided by funding formulas that, for the upcoming fiscal year, assumed spending increases of around 13 percent. Although the formulas are enshrined in state law, lawmakers have ignored them before. This year's budget goes even further. It throws out those formulas, replacing them with spending limits that cap their growth well into the future. Medicaid won't be allowed to grow faster than a key index of health care inflation that currently stands at 4 percent. And future education spending will be capped at New York's rate of growth in personal income.

On the health care side of the equation, one of the first things Cuomo did when he took office was to convene a Medicaid Redesign Team to help guide cuts to the program. This team was itself a dramatic break from New York’s past.

The previous three governors — two Democrats and a Republican — each tried to cut Medicaid at various times. All faced a barrage of ads from a powerful alliance between the state’s hospitals and its unionized health care workers, fights that left the governors badly bruised. Just last year, for example, the state hospital association conducted a media campaign featuring “Cutzilla,” a giant rampaging lizard meant to embody the potential harm of Medicaid cuts.

This time, though, Cuomo coopted his potential opposition. He made the unions and hospital groups part of his Redesign Team. He also supported the formation of an organization called the Committee to Save New York that has raised millions of dollars. If Cutzilla reared his head again, Cuomo’s allies would be ready to match any ad blitz dollar for dollar. As part of Cuomo's team, the hospitals and health care workers helped him design a package of cuts — more than $2 billion worth for this year alone.

The blueprint they came up with doesn't cut Medicaid enrollments — the federal health care overhaul generally wouldn't allow that. Nor does it make broad reductions in the kinds of services Medicaid provides. A big part of the savings comes from reducing payments to doctors and hospitals. Much of the rest is supposed to come from better coordination in the care of Medicaid's most challenging patients: nursing home residents, people with mental and physical disabilities and those with substance abuse problems.

Some $640 million worth of cuts aren't specified. The state is counting on health care providers to find their own ways to reduce costs. Not everyone is convinced that will happen. “There’s a lot resting on this idea that there will be a provider-led effort to change utilization,” says Elizabeth Lynam, vice president and director of State Studies at the Citizens Budget Commission. “We don’t know how it’s going to happen yet. What are they going to do? What are the initiatives that will come forward to meet this target?”

If sufficient spending reductions don’t materialize, the state has the authority to order more cuts. The stakes are huge — and not just for the state budget. Medicaid covers nearly 5 million New Yorkers; the program pays for half of all births in New York and three-quarters of the days New Yorkers spend in nursing homes. Both the state’s poor residents and its health care economy depend on a well-functioning Medicaid program.

As the impact of these changes begin to be felt, the question is whether lawmakers will be willing to stick with the fragile truce that has made them possible. The federal health care law's mandate to enroll even more eligible people in Medicaid will further challenge Cuomo's spending cap in the coming years. “I prefer to call it a two-year experiment,” says Daniel Sisto, president of the Healthcare Association of New York State, “although I think the governor would prefer to think of it as an enduring legacy.”

A sound basic education?

On K-12 education, there is a similar new willingness in Albany to experiment with a new fiscal structure. But there are equally strong reasons to question whether the anticipated budget savings will stick.

For one thing, the education funding formulas tossed aside in this year's budget existed for a reason. They were the culmination of a lawsuit that argued that the state wasn’t ensuring a “sound basic education” in New York City, something courts had ruled the state constitution required. Parents and education activists may sue again.

“If we can find new ways to provide the constitutionally mandated services at a lower cost, I’m all for that,” says Michael Rebell, who led the 14-year legal battle that produced the funding formula. “Litigation is complicated. It takes time. One always wants to avoid it if possible. But if it’s necessary, it’s necessary. When push comes to shove, the kids are entitled to a sound basic education.”

The other risk in Cuomo's approach is that it shifts the financial burden for funding education to school districts. And New York’s school districts are not well positioned to handle that burden.

That’s because the property tax, the revenue source that the districts depend on, is at a breaking point. New York has some of the nation’s highest property taxes. This isn’t just a function of pricey real estate in places like Manhattan, Long Island and Westchester County. In fact, as a percentage of home value, the places with the highest property tax burdens in the whole country lie in Western New York: Orleans County, Niagara County and Monroe County. Nor are property taxes just a problem for homeowners — businesses cite them as a major impediment to economic growth.

Cuomo doesn’t want to see state education cuts simply result in even higher local property taxes. So he’s proposed another cap, one that would limit total local property tax increases to 2 percent or the rate of inflation, whichever is lower (New York City is exempt from the proposal). So far, Cuomo’s fellow Democrats in the State Assembly have balked at Cuomo’s version of the cap, although negotiations are ongoing.

The debate over the property tax cap highlights a fact of life in New York: Even more so than in most states, the fiscal fortunes of the state and its local governments are intertwined.

Nine out of ten dollars counties spend pay for state mandates. That includes an unusual arrangement where New York counties pay billions of dollars each year to help fund Medicaid. State collective bargaining rules also give unions at the local level substantial leverage in labor negotiations. Most local government representatives are skeptical of the property tax cap, saying they need to get rid of rules like these before they can curtail spending.

Cuomo thinks that logic is reversed. He believes the property tax cap is the best way to force localities to change how they operate. Cap supporters envision public employee unions making concessions once counties don’t have the taxing power to give them more generous deals.

The state teachers union says that schools eliminated 15,000 positions over the last two years, mostly through attrition. This year, it’s expecting more than 15,000 positions to disappear, largely through layoffs. Curtailing property taxes and state support for education without hurting school kids or other beneficiaries of local government services won’t be easy.

Optimism amidst difficulties

Of course, Medicaid and education are just the most immediate of New York's fiscal challenges. There are plenty of others. New York carries a heavier load of tax-supported debt than other large states do. The state hasn’t set aside money to pay for $56 billion worth of health care obligations promised to retired state workers. New York's population is older than the national median. The infrastructure is older than average, as well.

There are positive signs, too. Despite the bonus backlash and Wall Street's outsized role in the recession, New York's economy has held up fairly well. The unemployment rate, currently 8 percent, has trended below the national average. The state workforce is leaner than it used to be: Excluding higher education, New York has 50,000 fewer state agency employees than it did 20 years ago. And in 2009, lawmakers passed a pension overhaul for state, school and local government employees that is expected to save tens of billions of dollars in coming decades.

Cuomo has a long way to go before he can claim to have solved New York's fiscal problems. But longtime observers of the state's finances seem optimistic about the budget debate they've witnessed over the past five months, as Cuomo tries to change the political rules in New York by force. “This is a very big first step and probably even more than that,” says Robert Ward, deputy director of the Rockefeller Institute of Government in Albany. “But it’s not the entire journey.”

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