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CT’s government was once broke. Is it now holding too much cash?

Legislative leaders in 2017, from left: Senate President Pro Tem Martin M. Looney, House Speaker Joe Aresimowicz, House Minority Leader Themis Klarides and Senate Republican leader Len Fasano, before they reached an agreement in 2017 on a "volatility adjustment" that would be key to the state's now-burgeoning rainy day fund.
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CTMIRROR.ORG
Legislative leaders in 2017, from left: Senate President Pro Tem Martin M. Looney, House Speaker Joe Aresimowicz, House Minority Leader Themis Klarides and Senate Republican leader Len Fasano, before they reached an agreement in 2017 on a "volatility adjustment" that would be key to the state's now-burgeoning rainy day fund.

Editors’ note: In January and February 2017, the Connecticut Mirror published “A Legacy of Debt,” a five-part series analyzing how one of the wealthiest states in the nation had accumulated massive debt that placed unprecedented pressure on taxpayers.

The Connecticut Mirror published the second of a two-part update of this series, examining how the state’s revitalized savings habits have some worried it’s not investing enough in core programs.

Just 13 days after Dannel P. Malloy had been reelected as governor in 2014, his budget director, Ben Barnes, boldly declared Connecticut had entered a “permanent state of fiscal crisis.”

After a campaign in which Malloy pledged state government’s five-year-stretch of repeated deficits — including two major tax hikes — was over, Barnes abruptly rebooted the conversation as legislators and taxpayers braced for more fiscal pain.

Now, just eight years later, state officials are grappling with questions neither Malloy nor Barnes could have imagined.

Simply put, is state government too flush with cash? And after two years of a coronavirus pandemic that battered educational and health care systems, businesses and households, should the state be spending more to help?

For one of the most indebted states in the nation, the question might seem risible, even given the enormous wealth of Connecticut’s average household. With $95 billion in long-term bonded debt and unfunded retirement benefit obligations, state government finances are projected to be under significant pressure well into the 2040s.

But as advocates for everything from labor to business and education to health care will note, high debt is far from the only problem that could use some extra funding. And if Connecticut hopes to keep making money, they add, the government will have to hold on to less.

“However bad the pension debt is going to weigh on future generations, property tax over-reliance is weighing just as much on them right now,” said Susan Merrow, co-chairwoman of 1,000 Friends of Connecticut, a progressive group seeking more tax cuts for the low- and middle-income households and more aid for poor communities.

“Our inaction is actively limiting choices for future generations,” said Emily Byrne, executive director for Connecticut Voices for Children. “This is bad for Connecticut. We’re better than this.”

Connecticut Voices, also a progressive policy think tank, asserts education, health care and other programs impacting children have been getting squeezed in the state budget for 30 years as officials try to minimize tax hikes and still meet rising debt payments.

And with the coronavirus only exacerbating longstanding inequalities in wealth and opportunity in Connecticut — particularly along racial lines — Voices’ analysts argue the state’s economy is on a trajectory for collapse if it doesn’t invest now in programs and tax relief to narrow the gap.

But it’s not only the political left questioning whether state government is sitting on too much cash.

Gov. Ned Lamont has joined legislators from both parties in calling for some immediate tax relief — though each has different ideas about what form it should take.

And business leaders are pressing lawmakers hard to avert a huge, impending tax hike on nearly all companies involving Connecticut’s massive unemployment trust debt.

A new savings plan after a decade of red ink

Few legislators were thinking about tax cuts in October 2017 when a nine-month budget debate ended — already four months into the new fiscal year — with a bipartisan plan to stabilize state finances.

Connecticut had been on a fiscal roller coaster for decades since enacting a state income tax in 1991.

The state’s affluent suburbs, particularly in Fairfield County, often amassed huge earnings, particularly when the stock market was booming.

For example, state government ran up $6.1 billion in budget surpluses between 2000 and 2009, according to nonpartisan analysts. Only one-third of it, $2.1 billion, was placed in the budget reserve. The rest was spent.

And after the Great Recession of 2007-09, state finances were plagued with red ink as Connecticut’s economy lagged the nation.

Legislators and Gov. M. Jodi Rell agreed in 2009 on tax hikes worth about $875 million per year. Rell negotiated the increase with legislative leaders, then used a legal technicality to let the tax hikes become law without her signature.

Malloy approved $1.8 billion in tax increases in 2011 and an additional $895 million in 2015.

Despite all of those increases, the state’s reserves in 2017 totaled $213 million, enough to cover roughly 1% of annual operating costs, and a fraction of the 15% cushion endorsed by the comptroller’s office and Wall Street credit rating agencies.

When lawmakers struck a bipartisan budget deal in October 2017, they sought to change all of this.

Though no one knew when the state’s income tax would boom again, lawmakers vowed to be ready whenever it did.

They created something called “the volatility adjustment,” which is designed to force state officials to save money when times are good. It focuses on two areas.

The income tax generates between $10 billion and $11 billion annually, and while most comes from paycheck withholding, about 30% comes from quarterly returns — which are dominated by capital gains and other investment earnings.

The pass-through entity tax, a levy on many businesses not subject to the corporation tax, had been part of the income tax until recently and generates another $1.5 billion per year, also through quarterly filings.

Quarterly income and pass-through entity tax filings that collectively exceed $3.1 billion are caught in this volatility adjustment system and must go into the state’s rainy day fund. Once the fund hits its legal limit at 15% of annual operating expenses, the dollars are used to pay down pension debt.

Was savings requirement based on study, or a hunch?

No one expected much from this system right away. Initial projections were that it would capture $13 million, an amount equal to 1/14th of 1% of the budget, and that it would take two years to do it.

It captured just shy of $1.5 billion in the first year. In its four-year history, it has averaged $1.05 billion per year and never raked in less than $530 million.

The stock market — with a few exceptions that include a poor first month of 2022 — has boomed consistently since 2018, turning a $213 million rainy day fund into a record-setting $3.1 billion pile of cash.

The reserve hit the 15%-of-annual-operating-expenses cap last year, and an additional $1.7 billion in surpluses since then have spilled into the pension funds.

Still, Connecticut has more than $40 billion in pension debt. And while the extra payments chip away at that total, officials concede it will be decades before Connecticut is on equal debt footing with most other states.

More important, some advocates ask, how can officials be sure all of the funds captured by the volatility deposit actually are, well, volatile?

Connecticut has had big surpluses four years in a row, and analysts project this fiscal year and next will be two of the largest bounties yet.

The threshold level for the volatility adjustment — all quarterly tax receipts in excess of $3.1 billion — wasn’t set based on any study or analysis. It was simply the total those sources had produced in the 2016-17 fiscal year, the one just before the volatility adjustment was created.

Senate President Pro Tem Martin M. Looney, D-New Haven, conceded the savings target was selected quickly as lawmakers tried to wrap a marathon budget debate.

But he also predicted many would be wary of changing the threshold, even after four good years in succession.

“Before that, we got burned three or four years in a row,” Looney added.

Carstensen: ‘Economy … is going to be a nightmare’

Still, others argue state officials should be more open-minded about putting some of these surplus dollars to work. That’s because, while state government’s coffers have swelled, the economy hasn’t been as robust, especially since the coronavirus arrived in March 2020.

Connecticut lost 292,000 jobs during the worst of the pandemic in 2020 and still hasn’t recovered 25% of them.

More important, the damage has been focused on the state’s poorest communities, which have always suffered much higher unemployment than their affluent suburban neighbors.

For example, Hartford’s jobless rate was 6.3% in 2019, one year before COVID struck, then ballooned to 13.3% in 2020, according to state Department of Labor statistics. Farmington’s unemployment stood at 3.2% two years ago and grew to 5.8% in the worst of the pandemic.

And though 2021 year-end statistics haven’t been calculated, monthly unemployment rates showed many suburbs nearly back to pre-pandemic employment levels, while cities are much slower to recover.

“It’s going to be a nightmare if the economy continues on its current trajectory, which is flat or negative,” said University of Connecticut economist Fred V. Carstensen.

A longtime advocate of increased saving for pensions, Carstensen said Connecticut has enough resources to cover its debt and invest — heavily — in an economy that is not growing high-paying jobs. That means more funding for transportation, research and development, higher education and IT infrastructure.

The surpluses Connecticut enjoys now will vanish quickly, Carstensen added, if the state’s professionals must move elsewhere to secure top salaries.

Business leaders also are warning that the state’s economy is at risk unless Lamont and legislators do more to fend off a potentially massive tax hike.

They’re referring to the state’s unemployment trust, which needed to borrow roughly $1 billion from the federal government to keep jobless benefits flowing during the last two years amid the pandemic.

Businesses are on the hook to repay that debt and replenish the fund, and they are facing a huge special assessment starting later this year.

State officials already have pledged to use $155 million of federal grant funds to help pay down that debt.

Connecticut Business and Industry Association President and CEO Chris DiPentima said many companies, though appreciative, have responded with the same message.

“That’s not enough to spur the economy. That’s not enough to get us going in the near term,” he said, adding that businesses want Connecticut to tap its own considerable coffers to provide more relief.

Similarly, labor leaders say the state must provide hazard compensation and affordable health care for workers at grocery stores, social service agencies, nursing homes and other essential front-line jobs that pay too little and are becoming too dangerous in the age of COVID-19.

“Let’s be honest, it’s not a labor shortage,” said Rep. Robyn Porter, D-New Haven, co-chairwoman of the legislature’s Labor and Public Employees Committee. “It’s a wage shortage. … It’s a health insurance shortage.”

The dozens of nonprofit agencies that deliver the bulk of state-sponsored social services say the pandemic has pushed them into staffing and fiscal crises.

According to a survey by the CT Community Nonprofit Alliance, 91% of agencies that responded find it difficult to recruit staff while facing an average vacancy rate of 18%.

And just like the pension system, the nonprofits say their problem — little growth in state funding — has persisted for decades.

The alliance is seeking an additional $461 million per year in funding to close what it projects its members have lost to inflation over the last decade alone.

“We have always said that we valued our nonprofits, and we need to show that value, not just by thanking them,” said Sen. Cathy Osten, D-Sprague, co-chairwoman of the Appropriations Committee. “We have to start funding the services at a level that allows them to more than exist.”

Towns: If CT can’t afford to keep its promises now, when?

Many Connecticut municipalities say they’ve been barely existing for decades as growing property tax burdens, stagnant state aid and slow economic growth have taken a huge toll.

Cities and towns here received more than $1.5 billion in direct federal pandemic relief last year, but they also reported losing hundreds of millions of dollars in revenue during the worst of the coronavirus.

Municipal leaders were somewhat surprised in mid-January when they received a letter from Lamont’s budget office reminding them they wouldn’t receive a share of state sales tax receipts as once promised by law.

The legislature’s decision to suspend the revenue-sharing program in 2018, just three years after its creation and before it had been fully implemented, had been well publicized.

Towns leaders also had followed closely last spring, when Lamont and lawmakers chose to keep the program in political limbo.

What surprised them was when Lamont’s budget office wrote that “no payments will be possible” because other obligations set by the legislature had not been met.

Back in 2015, towns were promised that, within three years, the state would share as much as $360 million annually in sales tax receipts.

Majority Democratic legislators centered their 2016 campaigns on this pledge. And they confidently boasted the aid would be delivered — even though nonpartisan analysts were warning that the 2018 budget faced a built-in deficit two-and-a-half times the size of the promised relief.

But after four years of robust surpluses and another $4.4 billion surplus projected for this year and next, how is the revenue-sharing still “not possible,” as Lamont’s budget office wrote?

The official answer is the legislature used about $120 million of those funds to boost grants to cities and towns and assigned the rest to cover state expenses.

“This just reminded us: When the state promises revenue, we can’t rely on that,” said Elizabeth Gara, executive director of the Connecticut Council of Small Towns.

In 2018 Connecticut did launch an effort to beef up the Education Cost Sharing grant — the state’s chief program for funding local school districts — over 10 years.

But Lisa Hammersley, executive director of the School and State Finance Project, said Connecticut now needs to be more aggressive in bolstering its support for education.

"The pandemic has strained public school systems and has created new academic and social-emotional obstacles for Connecticut's students that cannot be overlooked,” she said. “With state revenues at record highs and an overflowing rainy day fund, it's time for Connecticut to fulfill its commitment by fully funding education and providing resources to all students according to their learning needs."

Officials will tap CT’s windfall for election-year tax cuts, but not for more spending

The state could fund the requests of towns, schools and other interest groups — but that would mean saving less than it does right now.

For many state officials, that’s just not an option at present.

"Increasing spending while simultaneously increasing risk would further the structural imbalance and enhance uncertainty right as our state is finally improving its financial standing,” Melissa McCaw, Lamont's former budget director, said last month, shortly before she resigned.

And even though the economy has improved from its mid-2020 pandemic low, the administration is not taking future stability for granted.

“We must not presume COVID-19 is a thing of the past, and we cannot plan on this business cycle lasting forever,” McCaw added.

But it may be up to Lamont and the General Assembly to say no to all requests for added spending, given that they also want to drain some of the dollars from the state’s coffers.

Both the governor’s office and the legislature are up for grabs this election year, and officials from both parties have put a myriad of tax cuts on the table.

Tax cuts cost the state government money — in this case, tens and even hundreds of millions of dollars per year.

Lamont wants to ease property tax burdens by expanding a middle-class state income tax credit and giving towns more funds to help them free car taxes.

Senate Republicans have proposed a temporary rollback of the sales tax, and their House counterparts are exploring even more aggressive state income tax relief than Lamont proposed.

“The family budgets are getting crushed,” said Senate Minority Leader Kevin Kelly, R-Stratford. “What we’re hearing from families across Connecticut is that they need help, they need relief, that the economy for Connecticut is not performing for them.”

Majority Democrats in the House and Senate also are expected to offer tax-cutting plans.

Rep. Sean Scanlon, D-Guilford, co-chairman of the Finance, Revenue and Bonding Committee, has again proposed a new $600-per-child state income-tax credit for low- and middle-income households.

Some say Connecticut could increase spending to meet its greatest needs, offer tax relief for the poor and middle class and maybe even save extra dollars for its pension funds.

The other co-chairman of the finance committee, Sen. John Fonfara, D-Hartford, tried that approach last spring but without success.

For the math to work, it involves major tax hikes on Connecticut’s wealthiest households and major corporations. Fonfara sought hundreds of millions of dollars in new revenue from these sources but ran into numerous roadblocks — chiefly, Gov. Lamont.

The Democratic governor, a Greenwich businessman, has argued that tax hikes on the wealthy would prompt them to flee Connecticut.

A frustrated Fonfara likened impacts of the state budget on the Black community to the police killing of George Floyd by Minneapolis police, the May 2020 crime that set off a national debate over criminal and economic justice.

“Our policies are a knee on the neck of the Black community and other underserved communities of our state,” Fonfara said last June as the Senate debated the budget. “We can do better, and we must do better.”

Fonfara, who was one of the chief architects of the 2017 savings program that helped Connecticut build its budget reserve, said there’s no reason to reverse this trend toward fiscal responsibility.

But even some of the tax cuts that have been proposed so far, he said, won’t be enough to reverse Connecticut’s massive inequalities in access to economic opportunity, education, health care and affordable housing.

"A property tax credit will not save our cities, will not help build generational and community wealth in poor Latino and Black communities,” he said, adding that can only be achieved by a much larger redistribution of tax burdens and years of sustained state investments in key programs.

“That means committing to not just saying that Black Lives Matter, that Latino lives matter,” Fonfara added. “That’s showing that to Connecticut, it [the status quo] is not acceptable.”

The first part of this series update, published March 13, examined how the state’s debt and savings habits have changed greatly in just five years, and how they will shape state finances for decades to come.