Unscrambling Ominous Signs 

Economic slowdown is suspect in mystery of missing sales tax

March 13, 1989, Monday, ALL EDITIONS; BUSINESS; Pg. 01

By Al Gordon 

NEW YORK GOVERNMENT officials were stunned when their prize goose, the sales tax, suddenly stopped laying golden eggs about a year ago.

After almost a decade of high single-digit and even double-digit growth in revenue from the levy, New York State, New York City and Nassau and Suffolk Counties saw their sales-tax receipts turn nearly flat. And with government figures indicating robust retail sales in the region, officials fretted about the mechanics of tax collections and the possibilities of tax cheating.

But, some economic analysts warn, policymakers also should be worrying about Dennis McGrath’s pickup truck.

The 34-year-old contractor is co-owner of Sullivan & McGrath Corp., a Long Beach-based company that specializes in home improvements. And not your run-of-the-mill new kitchen or bathroom job, either: His market is “large-ticket” custom renovations of expensive homes in exclusive neighborhoods. 

Since the company was launched in 1980, McGrath said, it has had about 20 such jobs per year, and usually there have been 10 more proposals “we can’t get to.” But there’s no backlog now. “We only have three active jobs,” he said. “I hope I’m wrong, but this is not a promising year.”

It isn’t just McGrath’s upscale market that has been hit; middle-income renovations are hurting, too. Contractors are scrambling everywhere to find business.

As a result, McGrath canceled his order for a new company truck. “There’s no reason to put it on the road. There’s no work for it.”

Joseph H. Clinard Jr., who heads the DESCAP financial planning firm in Hauppauge, said consumers “have become very conservative” about all big-ticket purchases. One reason is the steady climb in interest rates. People may not understand all the economic ins and outs of high interest rates, he said, “but they know instinctively that this is not a good thing.”

And less buying means lower sales-tax collections. While home renovations themselves aren’t covered by the sales tax, the building materials, appliances and whatnot that go into a renovation and the new home furnishings that typically accompany such a job are a big source of tax revenue. So are cars and trucks.

Although U.S. Commerce Department data show that retail sales are strong - up by more than 9 percent in the city and state and up nearly 8 percent on Long Island during 1988 - independent measures of housing activity and car sales are pointing down. Further, the government’s data show relatively little growth in department store sales, which is consistent with reports from the retailers themselves.

To many analysts, the signs are ominous.

“There has been a major shift in the economic environment, not just a little blip,” said Samuel Ehrenhalt, regional commissioner of the U.S. Bureau of Labor Statistics. As detailed data on the region’s economic performance last year become available, most measures - including such crucial indicators as job growth and real incomes - are proving to have been virtually flat or even to have declined. The 1980s were “a period of remarkable growth” for metropolitan New York, Ehrenhalt said, “but that period now is over.”

Rosemary Scanlon, chief economist of the Port Authority of New York and New Jersey, gives more credence to the retail numbers and cautions that it is too soon to determine that an economic slowdown is at hand. But, she adds, “We may look back on this and conclude that this is when we really began to feel the effects of the stock market crash” of 1987.

While there is substantial agreement among economists and public officials that economic weakness is an important contributing factor to the sales-tax slowdown, few suggest it is the only one.

Questions are being raised about the tax collection and distribution mechanism - questions that have a high level of political sensitivity in light of the fact that the failure of sales-tax revenues to match budget projections has contributed to a fiscal crunch for governments in New York.

The state and city, also hit by serious shortfalls in income taxes and other revenues, are weighing major budget cuts. On Long Island, county property taxes went up an average of 12 percent in Nassau, 39 percent to 49 percent in western Suffolk towns and 135 percent to 160 percent on the East End.

The state collects all sales taxes from New York’s 450,000 merchants and then distributes the cities’ and counties’ share of the proceeds. The 20,000 biggest merchants (who represent about 70 percent of the revenues) report monthly; the rest, quarterly. The state Department of Taxation and Finance says it takes at least six months to complete its processing and auditing work, integrate the quarterly receipts with the monthly proceeds and adjust the payments to localities accordingly.

But when all that is done, the only thing the cities and counties get are checks on the 4th and 12th of each month, with no detail of the underlying sales activity.

Nassau County Comptroller Peter King points to the unexplained discrepancy between the sales-tax and retail-sales figures and to the fact that state sales-tax revenues are growing faster than Nassau’s. King charges that Albany has been unfairly distributing the proceeds, diverting funds from the Island to boost less-prosperous counties. “My main concern,” he said, “is that our allocation is going elsewhere.”

Karl Felsen, spokesman for the state tax department, denies that any funds have been diverted. Other parts of the state have been experiencing stronger growth in their sales taxes than the city and Long Island, he said.

City and Suffolk officials aren’t quite as critical of Albany as Nassau officials are. But they, too, would like a better explanation of what’s going on.

“The state has been reluctant to give us information,” said Robert Kurtter, Suffolk’s deputy administrator for finance.

Another contributing factor to the fall-off in sales tax may be increased tax avoidance, possibly motivated by the fact that the federal income-tax deduction for sales levies ended in 1986.

Sales taxes can be reduced legally through lease deals, which stretch out the tax payments; semi-legally through mail-order or out-of-state shopping (on which taxes are supposed to be paid later, but enforcement is virtually nonexistent) and illegally through such means as unreported cash deals.

The trend toward more mail-order shopping and more car leasing predates the tax-law changes and it’s a subject of debate whether they have accelerated much.

Kurt Barnard, a Manhattan-based marketing consultant, said, “Mail-order sales have steadily increased in size” in recent years and he expects the growth to continue. When New Yorkers buy from an out-of-state mail-order house, that cuts into sales-tax revenues.

Car leasing cuts into sales-tax revenues, too, because the tax payments are spread out over the life of a lease rather than paid at once.

Carmakers say there is little evidence of a surge in leasing; it accounts for about 8 percent of cars sold nationally and continues to grow slowly. “I wouldn’t attribute it [the growth] to the effect of the tax law,” said William Lovejoy, group vice president of marketing for General Motors Acceptance Corp.

Local officials, however, wonder whether the prevalence of leasing here might be higher than the national norm. For example, at Penn Toyota Ltd. in Roslyn, Robert Penn reports that leases now account for about one-fourth of the deals.

On the illegal tax-avoidance front, Thomas Conoscenti, an economics professor at Polytechnic University in Farmingdale who has been looking into the so-called “underground economy” on Long Island, calculates that in the past two years the amount of business done “off the books” may have increased to as much as 38 percent of economic activity, from 30 percent before the tax law changed. The city long has had a vast underground economy, the dimensions of which are unknown.

Considerable areas of the economy, such as repair work or the dealings of small stores, lend themselves to cash transactions that can be hidden from tax authorities, experts say. In addition, some tax officials suspect there may be abuse of the sales-tax-exempt status granted nonprofit organizations, governments, diplomats and retailers buying wholesale.

Still, said one city official, “a sudden increase in tax evasion just doesn’t happen.”

Analysts point out that tax evasion may itself be a sign of stress facing the regional economy. “When people are squeezed, they find things to cut,” said Glenn Yago, a Manhattan-based economist who has done major studies on the future of the Long Island and state economies. Tax avoidance may help make ends meet, he said.

“People make rational economic decisions,” the Port Authority’s Scanlon said, “not always legal ones.”

And the signs of stress continue to mount.

The Bureau of Labor Statistics reported last month that private-industry job growth in New York City came to a halt in 1988, with the number of jobs holding virtually unchanged at 3 million. Manufacturing lost 13,000 jobs and financial services - which accounted for two-thirds of the city’s job growth in the 1980s - lost 14,000, as the after-effects of the October, 1987, stock market crash intensified.

Ehrenhalt said that on Long Island, private jobs were up 1.2 percent to 1.14 million in 1988, a growth half that of the year before and far below the pace of the early 1980s. Moreover, manufacturing jobs - largely reflecting cutbacks at Grumman Corp. and other defense contractors and subcontractors - fell by 6,000, on top of a 4,700 decline in 1987.

Equally important, Ehrenhalt said, after running well ahead of national averages for most of the decade, the New York area now has fallen behind the rest of the nation in job growth. Last year’s national average was 3.6 percent.

Robert Dye, an economist with the WEFA Group, a Philadelphia-area forecasting firm, said the New York area jobs being lost are higher paying than those being added, which tend to be in the service sector. “If Grumman shuts down an assembly line, it’s not very likely that anyone will come in and install new manufacturing production to replace it,” he said.

The lost jobs come on top of an already high cost of living in the area. While earnings continue to rise, real incomes - wages adjusted for inflation - were essentially flat in the Northeast last year.

Yago said the high cost of housing in the region is leaving families increasingly strapped for cash, thereby cutting discretionary spending.

Moreover, some experts say, the discrepancies between sales-tax receipts and retail-sales figures may not be as great as they appear.

First of all, they are based on different things. More than 20 percent of the retail-sales figures come from groceries and drugs, which aren’t taxed, while about 10 percent of sales taxes come from services, mainly repair work, that aren’t counted in the retail-sales figures. So if food prices are up sharply, as they are currently, that would show up as an increase in retail sales but such increases would cut into disposable income available for taxable items.

Second, for department stores there is no discrepancy. Area department stores have reported generally lackluster sales in the past year, although the crucial Christmas season was strong. And that’s what the federal data show. For the first 11 months of 1988, the Commerce Department said department store sales were up a fraction of a percent in the city and down a fraction on Long Island.

William Ruben, vice chairman of Bonwit Teller, said that “the whole fashion business fell off in the spring,” largely due to consumer resistance to the season’s women’s wear. He attributes whatever gains the stores registered through the year to shopping by tourists rather than New Yorkers, with upscale merchants outperforming the retailers who aim at a middle-income clientele.

The Port Authority estimates that the number of foreign visitors reached a record 3.5 million last year. Domestic tourism also was up, helped by the city’s convention center. The decline in the dollar, Scanlon said, made New York attractive territory for international shoppers, with the bulk of those dollars being spent in the city rather than in the suburbs.

Ruben noted that sales at Bonwit’s Manhattan store were “much stronger” than those at its Manhasset outlet.

Tourists shipping their purchases home, sales-tax-free, would be one possible way that retail sales could have grown without sales-tax revenues rising accordingly.

Another factor, notes Kurtter, is that the quarterly sales-tax receipts that come from smaller merchants are showing more weakness than the monthly collections from big stores.

On Long Island, this could reflect the damage to boutiques, restaurants and other small businesses from last summer’s beach pollution, he said. But regionwide, it may mean that in a tough retailing environment, “the big stores are better able to fight hard for consumer dollars” than mom-and-pop operators, he said.

The one divergence in data that none of the experts can readily explain, other than to suggest the possibility of statistical error, involves the purchases of cars, appliances and other big-ticket items. Those items were the strongest part of retail sales, according to the federal figures.

Cars account for about 20 percent of the sales-tax revenues on Long Island (about 5 percent in the city). According to auto registration figures - the best available indicator of sales at the local level - compiled by R.L. Polk & Co. in Detroit, car sales were off 8.6 percent in Nassau County in 1988 compared with the previous year and were down just over 4 percent in Suffolk. Statewide, car sales were off 2 percent, and in New York City they were down about 1.75 percent.

Further magnifying the impact of the slump is the fact that luxury-car sales - BMWs, Jaguars and the like - were especially hard hit.

Similarly, after several boom years, home building and home sales have slowed in the metropolitan area. Sales of existing homes were flat last year, and in the first six months of 1988 permits for new housing units tumbled 23.9 percent from the year-earlier period in the city and 17.3 percent on Long Island, according to the National Association of Home Builders.

Jerry Houseman, an economics professor at Massachusetts Institute of Technology who has looked into the effects of a similar situation in that state, said, “When people buy homes, they often buy ‘white goods’ “ - appliances. As a result, he said, “the very large slowdown in the housing market” that’s occurring throughout the Northeast will depress the sales of big-ticket retail items.

Significantly, the sales-tax downturn is a northeastern phenomenon, hitting New Jersey, Connecticut and Massachusetts as well as New York.

California also has a budget crisis and is experiencing a shortfall in income-tax revenues akin to that of its eastern counterparts. But, said John Vickerman, deputy director of California’s nonpartisan legislative analyst’s office, “sales-tax revenues have been coming in on schedule.” California projects 7.6-percent sales-tax growth in the fiscal year that began July 1 and “through January, we are right on target,” he said.

Looking at the factors behind the possible slump here, Irwin Kellner, chief economist of Manufacturers Hanover Trust, said, “The major sources of economic strength on Long Island are dissipating.” In the city, he sees “stagnation” as the financial industry continues to retrench and construction slumps.

“The 1987 stock market crash took a lot of steam out of the economy,” Kellner said, while the defense industry is likely to bear the brunt of budget-cutting in Washington. And all of this, he said, “is not counting the possibility of recession” due to national trends.

The WEFA Group’s forecasts call for continued erosion in the metropolitan area’s economic position due to high labor and energy costs as well as “tremendously high real estate costs.”

Dye said early indications were that a revised WEFA forecast due out this spring would be more optimistic. But recent indications of an inflationary spurt and the Federal Reserve’s moves to slow the economy through higher interest rates, he said, “are the type of thing that can lead to recession.”

Copyright 1989, Newsday Inc.