Cut to tax credit could open debate on property tax reform

Though many middle-class Connecticut households will lose $200 next spring when a popular credit on their state income tax return shrinks, there is a silver lining: Those same filers will get nearly one-third of that cut back from the federal government.

And the head of an economic think-tank at the University of Connecticut says that win-lose arrangement is just one of the factors that underscores the ineffectiveness of a state property tax credit that has enjoyed tremendous popularity since it helped resolve a partisan tax battle in Hartford 16 years ago.

Professor Fred Carstensen, head of the Connecticut Center for Economic Analysis, also said his unit recently launched a new research project into a potential alternative to the  credit. He said the new cut offers an opportunity for policy-makers to re-examine a regressive property levy that still dominates Connecticut’s tax network.

“As I took a comprehensive look, I couldn’t identify any significant economic benefit to the property tax credit,” Carstensen said during an interview last week.

That credit, which allowed state income tax filers to reduce their liability by as much as $500 — provided they paid that much in municipal property taxes — will fall to $300 on returns filed next spring. The change, which nonpartisan legislative analysts project will save state government just over $150 million per year, was one component employed by Gov. Dannel P. Malloy and the General Assembly to close a $3.67 billion deficit built into 2011-12 finances.

“What value does that deliver?” Carstensen said.

For poor working families renting apartments in Connecticut’s urban centers — where rental costs are highest — the only relief they can expect is to recoup the property taxes paid on a car, he said. And if it is an older, used car of minimal value, that typically amounts to less than $100.

Most of those who receive the full $500 benefit own a home, or at least two cars. “At that point their income level suggests they don’t need this help the most,” Carstensen said.

Individuals earning less than $56,500 per year and couples making less than $100,500 can claim the credit with no restrictions, provided they paid property taxes. The credit is gradually reduced for households earning above these threshold amounts. Individuals whose incomes exceed $100,500, and couples topping $160,500, are ineligible.

Those most likely to pump the $500 back into the economy, poorer urban residents, rarely receive the full benefit.

Further complicating matters, he said, most Connecticut households effectively forfeit about 30 percent of the credit to the federal government.

That’s because the property tax credit directly reduces a filer’s state income tax liability on a dollar-for-dollar basis. That means a filer receiving a $500 credit owes $500 less in state taxes.

According to a center study conducted four years ago, about 80 percent of federal income tax filers here itemize their federal income tax returns. And since state taxes paid can be reported as an itemized federal tax deduction, that $500 credit reduces reportable income.

Assuming most households face an average federal income tax rate of nearly 30 percent, the result of a household claiming a $500 credit on a state return, Carstensen said, is a $150 increase in federal taxes owed.

Conversely, if state government will pay out $151 million less next spring in property tax credits, Connecticut households will save about $45 million on their federal income taxes.

Still, even with the new $300 limit, the property tax credit program is expected to cost state government more than $220 million next spring.

The credit, which was launched at $100 in 1996 and then gradually increased over time, was the product of a 1995 compromise between then-Gov. John G. Rowland, a Republican, and a Democrat-controlled House of Representatives.

Rowland, who had campaigned on a pledge to phase out the income tax, favored a relatively flat levy while Democrats pressed for a more graduated system. The credit compromise lowered the effective rate modestly for the middle class while leaving upper-middle and wealthy households still taxed at the same percentage.

Carstensen said the center has just begun researching what he believes would be a more effective alternative to the property tax credit and would close a significant loophole in the tax system.

It involves levying a new statewide property tax on wealthy residents who own significant property here, but also spend enough time out of state to avoid legal residency–and therefore avoid paying state income taxes.

“I believe we have a significant number of residents who claim they are not legal residents, yet still leave here close to six months out of the year, use our services, use our highways–and don’t share fully in the tax burden,” Carstensen said.

Though the center expects to spend at least the next three months researching this proposal, Carstensen added he believes a statewide rate of 1.5 mills — or $1.50 for every $1,000 of assessed property value — would net the state several hundred millions of dollars.

This, coupled with the $220 million spent annually on property tax credits, could instead by used to dramatically expand Connecticut’s $2.8 billion annual municipal grant system, he said.

Though that concept hasn’t generated any ripples of support at the Capitol, the sluggish economy has intensified policy-makers’ focus on the property tax.

Malloy, a former Stamford mayor who has been one of the most vocal critics of Connecticut’s reliance on property taxes for more than a decade, refused to support any cuts to the town aid package this past spring as the state budget deficit was closed.

Malloy and his fellow Democrats in the legislature also created small new revenue-sharing programs to give local governments a portion of state sales and real estate conveyance tax collections.

“We clearly thought that reducing aid to municipal governments in this climate was going to result in property tax increases,” said Malloy’s budget director, Office of Policy and Management Secretary Benjamin Barnes, who added that shielding the grant system was cuts was one of the best ways to provide effective property tax relief. “We clearly think that the direct approach works well.”

Sen. Steven T. Cassano, D-Manchester, who like Malloy is both a former mayor and a former president of the Connecticut Conference of Municipalities, agreed that maintaining town aid was more important this year than shielding the property tax credit.

One of the leading advocates for regionalizing services, Cassano predicted that communities will have to look more closely at jointly purchasing equipment, insurance, and other necessities, as well as sharing school administration and other services, in the coming years.

Though sparing municipal aid from this year’s state budget crisis was a huge accomplishment, “growth in town aid has been bare bones for several years now and you can’t continue to operate at zero. We are going to have to face some major decisions in the next few years.”

For example, Cassano said, Connecticut districts could dramatically reduce costs by sharing superintendents, principals and other educational administrators — provided communities can rethink longstanding views about local autonomy.

“That’s the real noose around Connecticut’s neck,” he said. “But we’re doing things backwards and it’s the property tax bill that bears the burden.”