As if the massive deficit forecast for next year wasn’t enough, fiscal analysts issued a new warning on the state budget Tuesday, saying projected spending in 2011-2012 is on pace to exceed the constitutional cap by more than $1.1 billion.

Though the economic downturn that has gripped the state since early 2008 has restricted spending growth, it also has stifled personal income in Connecticut–one of the key sources of revenue that allows spending to increase under the cap system.

The cap problem detailed by nonpartisan legislative analysts and Gov. M. Jodi Rell’s budget staff creates a new quandary for Gov.-elect Dan Malloy, who may face pressure from his fellow Democrats in the General Assembly to exceed the cap while simultaneously trying to close the largest deficit in state history.

The Office of Policy and Management, the Executive Branch’s chief administrative and fiscal arm, estimated that the spending needed to maintain current services next fiscal year would exceed the cap by $1.34 billion. The legislature’s Office of Fiscal Analysis came to a relatively similar conclusion, projecting a $1.14 billion problem.

Further complicating matters, some rapidly growing segments of the state budget–such as Medicaid, other social services and fringe benefits for state employees–are eating up an increasingly larger share of the state’s resources.

“As these pieces of the pie are starting to grow, the other pieces are shrinking by necessity,” Michael J. Cicchetti, Rell’s deputy budget director, testified Tuesday at a hearing conducted by the Appropriations and Finance, Revenue & Bonding committees. “They are squeezing out the other pieces of the budget.”

In 2005, Medicaid, state welfare for single adults and state employee benefits represented 34 percent of annual spending. By next year, unless reductions are made, they will approach 40 percent, according to OPM. Over the same time, formula grants to cities and towns, through which the state provides the bulk of its municipal aid, will have dropped from 17 to 14 percent.

Malloy and the next legislature will have a tough time avoiding spending reductions across the board next fiscal year as they grapple with a built-in shortfall that executive and legislative branch analysts peg at $3.4 billion and $3.7 billion, respectively. Both represent nearly one-fifth of this year’s overall spending.

But the Democratic governor-elect pledged repeatedly on the campaign trail to impose no cuts on the $1.9 billion Education Cost Sharing grant to cities and towns, effectively taking 10 percent of the entire budget off the table.

Malloy also promised not to “shred the safety net” of social services, presumably guaranteeing these programs would not absorb any major cuts.

The new governor, who did not rule out tax increases during his campaign, was frequently accused by GOP opponent Tom Foley of seeking huge new revenue and being unwilling to impose deep cuts anywhere on the budget.

But if fiscal analysts are correct, Malloy either will have to cut significantly into state spending, or have to maneuver deftly around the spending cap’s tricky legal rules–an alternative that could pose political problems as well.

The 1991 General Assembly tried to temper outrage over enactment of the state income tax by drafting a statutory spending cap. Voters would add the cap requirement to the state Constitution one year later by adopting the 28th Amendment.

But the cap, which is supposed to keep spending increases in line with the annual growth in personal income, can be circumvented if the legislature and governor see eye-to-eye.

If the governor signs a declaration of fiscal “exigency,” effectively declaring a budgetary emergency, the legislature can expend dollars in excess of the cap with a 60 percent vote in both chambers.

Rell became the first governor to propose legally exceeding the spending cap before a fiscal year had begun when she offered a plan in February 2005 that went about $200 million over the cap. The governor defended her proposal, saying that it enabled the state to qualify for more than $100 million in added federal aid for nursing homes and other community based care providers.

The Democrat-controlled legislature eventually adopted a variation of that plan, and two years later combined with Rell to approve a new budget for 2007-08 that exceeded the cap by $690 million.

Many Democrats argue that the cap is problematic, discouraging the state from seeking and spending more federal aid.

“I think the way we define the cap is flawed,” Rep. John Geragosian, D-New Britain, said. “It doesn’t take into account that government spends its money differently” than the private sector does. For example, he said, demand for government social services rises significantly during tough economic times.

Sen. Donald J. DeFronzo, D-New Britain, who co-chairs a key Finance subcommittee on bonding, said the state does have some new room on its credit card since the legislature and Rell agreed last spring to defer over $400 million in planned borrowing. Using that bonding capacity to support strategic capital projects to spur economic development could boost job growth and subsequently state tax revenues, though DeFronzo noted this might be more of a long-term solution than a short-term assist to the budget deficit.

“This may be a way of generating new revenue without the painful effect of increasing taxes,” he added.

“I think the spending cap needs to be modified,” retiring Rep. Cameron C. Staples, D-New Haven, who has co-chaired the Finance Committee since 2005, said. “I think there is an opportunity now with the new administration coming in for a reasonable discussion.”

Malloy’s choice for budget director, Ben Barnes, said Tuesday that the deficit and spending cap projections are noteworthy, but it’s premature to speculate how the governor-elect’s first budget proposal, due in February, will deal with those challenges.

“We all agree the spending cap is something we need to pay attention to,” he said. “But there are enormous challenges in the budget that dwarf even the magnitude of the spending cap” calculation.

Republicans at Tuesday’s hearing predicted that if Malloy and the legislature don’t adhere to the current cap system in 2011, voters will take note.

“A change in the spending cap would translate into increased spending and I think that’s what the public would see,” Rep. Vincent J. Candelora of Branford, ranking House Republican on the finance panel, said.

The top House GOP lawmaker on the Appropriations Committee, Craig Miner of Litchfield, said tampering with or legally exceeding cap limits “will do nothing but exacerbate the problems we have now.”

Keith has spent most of his 31 years as a reporter specializing in state government finances, analyzing such topics as income tax equity, waste in government and the complex funding systems behind Connecticut’s transportation and social services networks. He has been the state finances reporter at CT Mirror since it launched in 2010. Prior to joining CT Mirror Keith was State Capitol bureau chief for The Journal Inquirer of Manchester, a reporter for the Day of New London, and a former contributing writer to The New York Times. Keith is a graduate of and a former journalism instructor at the University of Connecticut.

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