Faltering income tax widens deficit, threatens Malloy’s budget for coming year

Faltering state income tax revenues left Gov. Dannel P. Malloy reporting his largest budget deficit to date on Friday.

And unless tax receipts reported this week by nonpartisan legislative analysts improve, Malloy's budget plan for next year -- including a state employee pension fund fix and increased education aid to towns -- could be out of balance now and headed for more than $500 million in red ink by 2013-14.

The governor's budget agency, the Office of Policy and Management, reported that the general fund in this year's $20.14 billion budget is $66.9 million in deficit. Malloy needs to finish $75 million in surplus this year to maintain the ongoing conversion of state finances to Generally Accepted Accounting Principles, and the administration now faces a $142 million hole.

"The state is in the middle of the year's busiest two weeks for tax collection," OPM Secretary Benjamin Barnes said Friday, referring to the rush of income tax filings the state has been receiving in the days before and after the April 17 deadline. "While early receipts are below targets, it is too soon to draw any firm conclusions about our income tax results for the year."

Barnes also warned of an "emerging shortfall" in the Medicaid program that could involve more than $90 million in cost overruns.

But it's the income tax -- and particularly its most volatile component, that was threatening not only the current budget, but Malloy's plans for next year.

The $20.7 billion plan the governor offered in February for the fiscal year that starts July 1 was balanced -- but only for 12 months. According to the administration's own numbers, that plan would slip $424 million into deficit by 2013-14.

More than half of the new spending in that budget was dedicated to shoring up the state employee pension fund and increasing education cost-sharing grants to cities and towns by $50 million. And while Republican legislators argued the proposed new spending was not sustainable, administration officials defended the plan, noting they still had time during the 2013 General Assembly session to deal with the projected shortfall.

But key lawmakers from both parties on the Finance, Revenue and Bonding Committee said the state can't afford to take a wait-and-see approach any longer.

"We have no fiscal cushion. We have cash flow problems. The governor wants more spending and we're slipping into deficits," Rep. Vincent Candelora, R-North Branford, a veteran member of the Finance panel, said. "There was no room for error when he proposed his budget" in February, "and now we're seeing more problems with our revenues."

According to memos prepared by the nonpartisan Office of Fiscal Analysis and released by Candelora, receipts for capital gains, dividends and other earnings paid quarterly are running more than $116 million below expectations for April.

Income tax receipts from investment earnings are very volatile and can fluctuate by tens of millions of dollars from day to day at the tax filing deadline.

But if this year's income tax receipts remain more than $100 million below expectations -- and if projections for future years are downgraded in similar fashion -- the Democratic governor's new plan isn't balanced even for one year.

And Candelora said he fears that Malloy and the legislature's Democratic majority will try to solve it next January -- after the November legislative elections -- with more tax increases.

Malloy and the legislature ordered $1.6 billion in state and municipal tax hikes one year ago to close a huge budget deficit.

"I don't think you're going to find much appetite for any new revenue legislation, either this year or looking ahead to next year's session," Rep. Patricia Widlitz, D-Guilford, co-chairwoman of the committee, said. "We were very aggressive about raising new revenue last year."

Barnes said, "OPM continues to take every available step to end the year in balance and may take additional steps after consensus revenue is complete as warranted."

Friday's deficit forecast marks the first time that the Democratic governor reported a deficit. Last month the administration reported the general fund still to be $12.4 million in surplus.

Comptroller Kevin P. Lembo projected budget deficits in each of his past two monthly reports, including a $45.8 million shortfall announced on April 1. The Office of Fiscal Analysis has been tracking state finances in the red largely since the calendar year began, and reported a $124.4 million deficit on March 26.

And neither of those gaps, $45.8 million or $124.4 million, reflect the additional $75 million needed to fulfill Malloy's GAAP pledge.

The governor repeatedly has promised to maintain his planned conversion to a series of common financial guidelines established by the Government Accounting Standards Board to emphasize transparency. Unlike the modified cash basis state government has long used, GAAP rules require that funds be on hand to cover expenses as they are incurred.

State government would need another $1.7 billion in its coffers to cover all its obligations under GAAP rules. And that differential grows annually with inflation.

The $75 million surplus Malloy needs this year would be used only to cover that inflationary cost and stop the GAAP differential from growing.