Budget hovers on brink of deficit as Malloy’s fiscal cushion erodes quickly

Gov. Dannel P. Malloy’s vaunted fiscal cushion has begun to erode quickly, and an underperforming state income tax is the chief culprit.

Fiscal analysts for the executive and legislative branches agreed on a consensus revenue report late Tuesday that pushes the current budget to the brink of a deficit — or possibly over it.

More importantly, the controversial half-a-billion-dollar surplus Malloy and the legislature built into next year’s budget — after a record-setting tax increase — has been chopped in half in less than seven months.

And the worsening fiscal picture also creates one more problem for Malloy, or more specifically for one of his major campaign promises. The first $75 million of this year’s projected surplus is supposed to be used to begin the conversion of state finances to generally accepted accounting principles.

But on Tuesday evening, the governor’s office was simply talking about keeping state government in the black.

“All today’s announcement means is that, as is the case in other states with high wage earners, fourth-quarter revenue is coming up short of expectations,” Malloy said, adding that he has directed Office of Policy and Management Secretary Benjamin Barnes “to pare back on current year expenses. But let there be no confusion — we will end the current fiscal year in the black, and in a more stable fashion than this state has seen in many years.”

The governor and his fellow Democrats in the legislature’s majority took considerable heat from the GOP after adopting a biennial budget last June with nearly $600 million in projected operating surpluses.

The $20.14 billion plan approved for the current fiscal year was projected to finish with a general fund surplus of $88 million.

But that was mild compared with the $496 million cushion built into the $20.4 billion preliminary budget approved for 2012-13. Malloy and lawmakers will consider revisions to that plan when the next regular legislative session begins Feb. 8.

Those unprecedented fiscal cushions were particularly controversial given that Malloy and his fellow Democrats enacted more than $1.5 billion in new state taxes to help balance state finances coming out of the recession.

But since June, revenue forecasts for the new budget have begun to fray.

The latest consensus numbers adopted by Barnes’ office and by the legislature’s nonpartisan Office of Fiscal Analysis now show general fund revenues down nearly $95 million this fiscal year from the level anticipated in the adopted budget. And that overall drop would be much greater had not a $169 million shortfall in income tax revenues been partially offset by gains in sales and wholesale fuel tax receipts.

Before this latest revenue change, the administration and OFA had estimated small surpluses of $83 million and $101 million, respectively, in this year’s budget. After the new revenue numbers are considered, the forecasts drop to either a $12 million deficit or a $6 million surplus.

And for 2012-13, revenues now are down $139 million from the level anticipated in the adopted budget. Combine that with administration estimates released in mid-November that showed spending on pace to run $104 million above forecast, and a built-in surplus of $496 million has been cut in half.

“Our fiscal situation is tenuous at best,” House Minority Leader Lawrence F. Cafero, R-Norwalk, one of the chief critics of Malloy’s fiscal policy, said Tuesday night.

Republicans had argued that a $1.5 billion tax hike would dampen the state’s economy, Cafero said. He added that he remains doubtful that the union concessions deal Malloy also relied upon to balance finances will produce the savings it’s supposed to.

“This is why the public scratches their heads and says ‘a pox on all of your houses, politicians,'” Cafero said, noting that the concessions deal bars Malloy from ordering any layoffs in most agencies. “That is a very, very bad situation to be in when you have an unstable fiscal environment.”

“This is more proof that Governor Malloy’s over reliance on tax increases was a failed approach to balancing the state budget in a responsible way,” said Senate Minority Leader John McKinney, R-Fairfield. “When the largest tax increase in state history isn’t enough to pay the bills, I hope everyone can agree that a significant reduction in the size and cost of government is in order.”

Malloy also finds himself in a difficult environment when it comes to his campaign pledge to immediately begin to convert state finances to GAAP rules, a series of common financial guidelines established by the Government Accounting Standards Board to emphasize transparency.

Unlike the modified cash basis currently used, GAAP rules require that funds be on hand to cover expenses as they are incurred. Similarly, revenues are counted in most situations in the year in which they are received.

In the context of the state budget, that ends an array of accounting gimmicks that has pushed current expenses into future years and, similarly, used revenues received in one year to balance the books of the prior year.

According to legislative analysts, state government would need an extra $1.7 billion on hand to fully follow GAAP principles. And that GAAP differential grows each year because of inflation.

When the budget was adopted in June, Malloy signed language that allowed him to delay the first of 15 annual payments to cover that $1.7 billion differential until 2014.

Instead the governor and legislature agreed to at least dedicate some of the projected surplus to stop the GAAP differential from growing.

That meant dedicating $75 million this year and $50 million in 2012-13 to to cover the inflationary growth — but only if there is any surplus to provide those funds.

Based on current projections, that no longer is the case this year.