PIPER ARROW ACFT XPONDER MODE C ERRONEOUS ALT READOUT. ATC WAS READING 2500 FT WHEN ACFT WAS AT 1000 FT AND ATC THOUGHT RPTR PLT HAD ENTERED CLASS B AIRSPACE.

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DEPARTED 2N8; FLEW N UP THE HUDSON RIVER VFR CORRIDOR AT 1000 FT TO OWD. UPON ARRIVING AT OWD I WAS TOLD TO CALL THE RADAR SUPVR. HE ADVISED ME THAT THE RADAR SHOWED I WAS AT 2500 FT OVER THE RIVER. THEREFORE I ENTERED EWR'S AND LGA'S AIRSPACE. I EXPLAINED TO HIM I WAS DEFINITELY NOT OVER 1000 FT AND I HAD WORK DONE TO THE AVIONICS. HE THEN TOLD ME TO HAVE MY XPONDER AND ENCODER CHKED. UPON RETURNING TO 2N8 I CALLED LGA FOR A XPONDER CHK. I WAS TOLD AT 1000 FT THE XPONDER WAS RPTING 2500 FT. THEY ADVISED ME TO TURN OFF MODE C AND PROCEED S DOWN THE RIVER. ON MAY/XX/97 I TOOK THE ACFT TO FBO; WHERE THEY FOUND THE ENCODER TO READ WRONG. IN FURTHER TROUBLESHOOTING THEY FOUND THE B2 LINE FROM THE ENCODER WAS INOP. THIS CAUSES THE XPONDER TO READ 2500 FT WHEN THE ACFT IS ACTUALLY AT 1000 FT. THE EQUIP IS NOW BEING REPAIRED. I BELIEVE A REAL PROB EXISTS WITH MODE C. AT ANY TIME A MALFUNCTION MAY OCCUR AND RPT ERRONEOUS ALTS. THE PLT HAS NO WAY OF KNOWING WHEN THIS HAPPENS; AND THIS MAY CAUSE A VIOLATION. THAT NEVER REALLY OCCURRED.