Taxes: Should Connecticut keep down with the neighbors?

When Connecticut officials debate taxes, particularly the income tax, the arguments inevitably lead to comparisons with border states.

Anticipating a watershed debate in the 2011 legislative session as Connecticut confronts a mammoth, $3.4 billion budget deficit, legislators and gubernatorial candidates have stressed the importance of matching the neighbors. In other words, if taxes have to go up, make sure they stay below those in Massachusetts, New Jersey, New York and Rhode Island.

But if last week’s income tax overhaul in Rhode Island is any indication, Connecticut officials have been reminded that just as they watch their neighbors, their neighbors are watching them.

“We were definitely looking at Connecticut and Massachusetts when we addressed those rates,” Fred Sneesby, spokesman and policy analyst for Rhode Island Gov. Donald Carcieri said Tuesday. “The governor believes this will make it much easier to attract businesses to Rhode Island, and for them to find people who want to come here to be employed.”

Sneesby is referring to a bill Carcieri signed June 9 that replaces Rhode Island’s five-tiered income tax system with just three rates, and lowers the top rate from 9.9 to just under 6 percent. The low rate remains at 3.75 percent.

Equally important, Sneesby added, the legislation pares back a maze of more than 45 tax credits and exemptions down to about a half dozen.

Though Rhode Island fiscal analysts estimate the changes, effective Jan. 1, 2011, will largely be revenue neutral with a lower rate but fewer exemptions, the perception – high rates and a “Byzantine collection” of confusing exemptions – will change, Sneesby said.

“To some degree, perception is as bad as reality,” he said, adding that while the old system’s tax breaks spared many residents from paying the top rate, officials there believe the new systems message is clear: “It makes Rhode Island more competitive and more attractive.”

Carcieri’s official Web site includes a new analysis promoting the tax advantages of Rhode Island over its neighbors. The Web page shows five sample households, covering a range of incomes from minimum wage earners to single and married professionals to small business owners – all paying less in Rhode Island income taxes than they would in Connecticut or Massachusetts.

Reactions here to that message were mixed Tuesday.

“I’m not at all surprised Rhode Island is comparing itself to Connecticut,” Rep. Vincent J. Candelora of North Branford, ranking House Republican on the Connecticut legislature’s Finance, Revenue and Bonding Committee said. “We should be paying significant attention to neighboring tax policies because we know they are watching us.”

Candelora noted that officials from Starwood Hotels and Resorts Worldwide testified before the finance committee in March that their plan to move 813 jobs from offices in Westchester County into Stamford was driven, in part, by Connecticut’s more favorable income tax rates compared with those in New York.

Connecticut levies a rate of 5 percent on most income, though it charges 3 percent the first $10,000.  That change, combined with a small series of standard deductions and a credit of up to $500 to offset municipal property tax payments helps ensure most individuals earning less than $100,000 pay an effective rate between 4 and 4.5 percent.

A new top rate of 6.5 percent was added in 2009 for income above $500,000.

For now, Connecticut still offers the lowest rates in the region, though it will lose that spot to Rhode Island in January.

Massachusetts levies a flat 5.3 percent rate on income, though its 12 percent tax on interest and dividends forces most of its high-end earners to pay more there than they would in Connecticut.

New Jersey’s top rate hits 10.75 percent. New York’s state income tax tops out at 8.97 percent, according to the national Federation of Tax Administrators. But New York City residents also face a municipal income tax with rates between 2.91 and 3.65 percent.

Sen. Andrew W. Roraback of Goshen, the ranking Republican senator on the finance panel, said Connecticut no longer has to worry about tax competition just from border states, adding he believes residents and businesses are leaving for more favorable conditions in many southern states along the East Coast, including Florida, South Carolina and North Carolina.

High taxes, Roraback added, are just part of Connecticut’s problems that also include excessive state spending. “People can see the unsustainability of the status quo,” he said. “I think they can’t help but understand that Connecticut’s glide path is not unlike a 747 heading for a mountainside.”

Keeping tax rates in line with neighbors is nothing new.

Massachusetts’ sales tax on liquor is slated to rise from 5 to 6.25 percent on Aug. 1, coming closer to but still below the Rhode Island rate of 7 percent. Connecticut levies an excise tax on distributors of beer, wine and other liquor, depending on the product, but consumers pay the standard 6 percent sales tax on their alcohol purchases.

Rep. Cameron C. Staples, D-New Haven, co-chairman of the Connecticut’ legislature’s finance committee, said Connecticut’s concern lies more with what’s happening in New York, New Jersey and Massachusetts, and even then, tax rates are just part of a larger competition.

“I think it is just one item on a long list of things that businesses look at when they decide where to locate,” Staples said. “If there’s a substantial difference, there’s a problem. You don’t want to be way out of line.”

But Staples added it would be a mistake for Connecticut to reject tax increases to the detriment of the state’s school systems, its colleges and universities, or its transportation network.

University of Connecticut economist Fred V. Carstensen, head of the Connecticut Center for Economic Analysis, agreed.

“Businesses look at the quality of the workforce, the transportation system and the information technology network,” he said. “Usually taxes come in fifth or sixth.”

Carstensen also questioned whether Rhode Island’s income tax strategy would be a major draw for workers either.

“There’s virtually no evidence that I’m aware of that shows employees are influenced by the tax environment,” he said. “I’m deeply skeptical that this will lead to a significant payoff.”