There may be another budgetary hit coming to New York City and New York State. Government officials don’t appear to have it on their radar, let alone have a plan to respond.
Mar. 19, 2026 — New York City is contending with its largest deficit since the Great Recession, the result, Mayor Zohran Mamdani says, of years of underestimating expenses and funding programs with one-time sources.
Mamdani has asked Governor Kathy Hochul and the state legislature to contribute more state tax revenue to the city and to increase taxes on high earners. If they don’t deliver, he has threatened a broad-based property tax hike.
However this year’s budget drama is resolved, these fights could become more difficult in the coming years — not because of economic conditions or changes in city or state policy, but because of cuts to federal tax enforcement.
What happens in DC doesn’t stay in DC
Federal, state, and local tax collection are intimately linked, particularly for localities like New York City that rely on business and personal income taxes. That means recent Internal Revenue Service staffing and budget cuts could have an impact on revenues flowing into City Hall and Albany.
“The details are complicated, but I think the big picture is pretty clear. If folks are getting away with cheating on their federal taxes more frequently, then they’re also going to get away with cheating on their state taxes more frequently,” said Carl Davis, research director at the non-partisan Institute on Taxation and Economic Policy. “People don’t fill out a dishonest return federally and then an honest return at the state level. That’s not the way it works.”
There’s a clear causal chain as to how this process could play out. Most states, including New York, base taxable income for both individuals and corporations on federal tax returns. New York City does the same. (See excerpt of the New York State and City tax return instructions, below.) The city and state then tack on various exemptions and additions. If filers declare a lower federal adjusted gross income than they actually earned, or claim deductions that they’re not qualified for, state and local income filings would almost certainly reflect those under-reported figures.
Hobbling the IRS
Ever since the Inflation Reduction Act led to a brief surge in IRS funding and staffing, Republicans have been chipping away at the agency. In 2024, the GOP-controlled Congress reduced the IRS’s long-term funding by $40 billion. After President Donald Trump took office, DOGE made significant cuts to the agency’s workforce. Between January and December of 2025, the agency shed about 28,000 workers, or roughly 27 percent of its staff, according to data from the National Taxpayer Advocate. Administration officials have previously discussed slashing the agency’s workforce by as much as 50 percent.
The 2026 tax filing season is the first administered by an IRS that reflects these cuts, which means the actual effects are not yet visible in government data. However, there have been warning signs. Last year, the Washington Post reported that the IRS has observed an increase in online chatter among would-be tax cheats looking to take advantage of diminished auditing capacity at the agency.
Researchers have modeled the revenue impacts of IRS cuts. The Yale Budget Lab found that if the agency’s workforce were cut by 50 percent from 2024 levels, federal tax revenues could decline by between $350 billion and $2.4 trillion over the next decade. The severity of the impact would largely depend on the opportunism of tax cheats.
There’s also a wealth of data on the inverse effect: How auditors increase tax revenue. A 2023 National Bureau of Economics working paper found that every dollar spent on federal audits yields more than $2 in additional tax revenue on average. It also found that the return on investment grows as auditors focus on higher earners. Federal audits of earners in the highest decile return $12 for every $1 spent.
Knock-on effects
That study focused on federal tax revenues, but the effect it measured should also be relevant to state or local tax revenues. “There is a kind of mechanical component in which, if you have unpaid tax obligations at the federal level, it is likely that you have unpaid tax obligations at the state or local level,” said Ben Sprung-Keyser, a professor of economics and public policy at the University of Pennsylvania and a co-author of the study.
Cole Rakow, assistant director for economics at the New York City-based Independent Budget Office, echoed that view. “If there is less enforcement, less auditing, and the potential for maybe misrepresenting sources of income, and if it’s easier to get away with that at the federal level, certainly that could have an impact on how income is being reported to the state and the city.”
Davis, the ITEP tax policy expert, has been ringing the alarm about the potential state-level impacts of the Trump administration’s IRS cuts for the past year. He’s been on the conference circuit speaking with state budget and taxation officials. He’s also working on a quantitative analysis on this issue that should be published in a few months. “If the IRS isn’t able to enforce the law robustly, states should be worried,” he said.
Not only would cheating on federal taxes carry through to income reported on state and local returns, but fewer federal audits would likely translate to fewer state and city audits: auditors at these different levels of government often share information about their investigations. New York State, for instance, requires filers to disclose any change in reported income due to federal audits within 90 days.
“There’s a lot of information sharing that goes on,” Davis said. “The states can gain access to their taxpayers’ federal returns. And usually, when the IRS finds an issue on the federal return, that information is communicated to the state.”
These impacts could compound over time, as more companies and individuals realize they can get away with under-reporting. Sprung-Keyser’s study found that three-quarters of the return on investment attributable to auditing high earners is from the deterrence effect.
See no evil?
So far, this issue doesn’t appear to be on the radar of state and local officials. A representative for the National Association of State Budget Officers said, “We have not heard from our members about this issue.”
Spokespeople for New York Governor Kathy Hochul, state Controller Thomas DiNapoli and the state Department of Finance and Taxation did not respond to questions about whether this is an issue that merits examination, what IRS cuts in enforcement might mean for state and local tax revenues, or about what could be done to ward off potential revenue loss.
Neither did spokespeople for Mayor Zohran Mamdani, the city’s Department of Finance, Comptroller Mark Levine, City Council Speaker Julie Menin, or City Council Finance Committee Chair Linda Lee.
City and state budget documents do not reference diminished federal auditing capacity or potential increases in tax evasion. However, both governments are reckoning with other federal tax changes in their budget processes, like how much to couple their tax regimes with new policies like “no tax on tips.” They’re also planning for reduced federal funding across a wide range of programs in the coming years, following Trump administration cuts.
For its part, the IRS maintains that things are going smoothly this tax season, even with a much smaller workforce. IRS CEO Frank Bisignano has said the agency is currently at the “perfect” staffing level, and that it will be able to do more with less using AI. “Remember, there was a lot of pundits out there saying IRS is going to fail,” Bisignano told Government Executive this month. “We’re 40% through the tax season, and we hear in every corner that it’s going well.”
Experts like Sprung-Keyser are skeptical. “If you have fewer auditors and audits, and you spend less money on those audits, you should expect to bring in less revenue.”
What to do about it?
Increasing the number of auditors at the city and state level is the most straightforward way to guard against the potential impacts of diminished federal auditing capacity. “There is no substitute for a robust federal tax enforcement program,” Davis said. “But even so, states should still do their best to fill the gaps that have been created by drastic cuts to IRS enforcement.”
In fact, Mamdani and Hochul have both called for hiring additional auditors in their budget proposals. In announcing his budget, Mamdani said the city would hire an additional 50 city tax auditors. However, it appears that, when comparing the Fiscal Year 2026 adopted budget (June 2025) with the preliminary FY 2027 Executive Budget (February 2026), neither the overall number of authorized positions in the Department of Finance’s audit “unit of appropriation,” nor the number of authorized employees in sub-categories of audit is proposed to be increased.
“At the release of the Financial Plan the Mayor referenced the hiring of additional auditors to increase audit revenues, but the Plan does not include any additional auditor headcount,” a New York City Council Finance Committee report on Mamdani’s proposed budget notes.
The New York state budget calls for a $2.4 million funding increase for the Department of Taxation and Finance to pay for 25 additional auditors.
Much of New York City and state’s auditing capacity currently focuses on residency. If an individual falsely claims residency in, say, Florida, then the city and state would receive no income tax at all from that person. “Residency audits are a really important part, and something that the city and the state are both very aggressive about,” said Ana Champeny, vice president for research at the Citizens Budget Commission.
However, if the IRS begins conducting fewer audits, city and state tax enforcement agencies may need to expand their purview to investigate matters usually handled by the feds, Davis said. “Typically, states will focus their auditing efforts on things that they don’t expect the IRS is checking for at all,” he said. “But there may also be instances where states will want to look at items being reported on the federal return.”
Picking up the IRS’s slack could become a bit easier as laid-off IRS alumni join the ranks of state tax agencies. Last August, Law 360 reported that more than 20 state revenue departments had hired former IRS agents that year. Among them were 35 former IRS employees hired by New York’s Department of Taxation and Finance.
The City Council report on the Mayor’s budget notes that audit revenues are up this year as compared to last, which it attributes to “hiring of new and more experienced auditors who are able to accomplish more and secure more revenue.” The average amount recouped from a closed tax audit increased from $67,000 last fiscal year to $96,000 this year.
Still, hiring and retaining experienced auditors remains an issue. “It is also maybe a challenge for government to hire auditors when they have more lucrative private sector options,” said Cole Rakow of the IBO. “There may be a staffing limitation there.”
It’s possible that technology can help auditors become more efficient, offering a counterbalance to staffing challenges. That’s the hope at the federal level. And it may play a role at the state and local level, as well. The Department of Finance has made incremental technological upgrades over the past decade that have improved its auditing capacities, Rakow said. The agency made a “big technology investment to use computing to better target where audits should go, and that was helping to increase the amount of revenue we could bring in,” he said.
The road ahead
Even the most proactive state and local efforts are unlikely to be enough to fill the gaps in tax enforcement left by a shrunken IRS. For one, their technological capabilities and investigative resources will never be able to match those of a federal agency. Moreover, grappling with the issue of reduced IRS enforcement is unusually difficult for state and local officials.
While the impacts of tax breaks or cuts to benefits programs can be modeled fairly easily, understanding the impact of, and developing a strategy to address, decreases in IRS enforcement requires gaming out second- and third-order consequences over an extended period of time. That’s not something local and state governments are set up to do. And, for now, it does not appear that they are doing it.
To head off a potential decline in tax revenue, cities and states may have to reexamine their entire auditing apparatus to ensure they’re able to collect all of the taxes they’re owed. New administrative and strategic policies may be needed to catch the evaders previously caught by the federal government.