One of state government’s most controversial taxes, a levy on large estates, has been the centerpiece of a decade-long, see-saw battle that last swung in favor of high-earners just one year ago.

But several forces, both political and fiscal, could tip the scales back in the other direction this legislative session. And while the income and sales taxes continue to garner most of the headlines, both sides of the estate debate are gearing up for another fight.

“I think we already have a very competitive tax structure with other states,” Senate Majority Leader Martin M. Looney, D-New Haven, said Friday. One of the legislature’s most vocal advocates for a state earned income tax credit to assist low-income working families, Looney said sparing wealthy estates from a return to tax levels they faced just two years ago should not be lawmakers’ top priority.

Senate Minority Leader John McKinney, R-Fairfield, also predicted there would be considerable pressure to increase the estate tax, but said those who believe it will boost the state’s coffers “are extremely short-sighted. There have been and there will be people of wealth with big estates who will choose to establish residency outside of Connecticut if we go back down this road.”

The last stop on this “road” involved an August 2009 compromise between then-Gov. M. Jodi Rell and the legislature’s Democratic majority. The Republican governor grudgingly accepted a new top rate on the income tax — 6.5 percent on annual income above $500,000 for singles and above $1 million for couples — in exchange for three key changes to the estate tax starting Jan. 1, 2010:

  • The threshold minimum value of estates subject to the tax rose from $2 million to $3.5 million.
  • Most of the marginal estate tax rates were reduced by one-quarter.
  • And the so-called “cliff” effect was eliminated. Previously, no tax was levied on any estate worth $2 million or less, while the full tax was imposed on any estate worth just $1 more. The new system applied a more graduated series of rates to ensure those with estates barely over the threshold paid a reduced tax.

Sharply differing philosophies on the pros and cons of taxing inheritances have kept the issue on the legislature’s bargaining table for more than a decade.

Throughout the 1990s, state government had two levies, a gift and a succession tax, that drew resources from estates.

The legislature enacted measures in the late 1990s and early 2000s to phase out both taxes. But the recession of 2001 through 2003 first delayed those phase-out efforts, and ultimately led to the adoption in 2005 of a uniform estate tax.

Not surprisingly, as state government’s fiscal outlook worsened in 2010, there were almost immediate efforts to reopen the compromise of 2009, with some legislators calling for the estate tax cut’s repeal even before it took effect.

The Democrat-controlled Senate adopted a deficit-mitigation measure in March that would have kept the “cliff” fix and the $3.5 million threshold,  but it imposed significantly higher rates. The House declined to take up the bill, despite strong support from the Democratic majority there, after Rell threatened to veto the measure and bog down efforts to close what was, at that time, a $518 million mid-year budget deficit.

One month later, the Finance Committee adopted a similar measure, but it also was left out of a final budget compromise negotiated by Democratic leaders and the Rell administration.

Now, for the first time since 1990, Democrats control the Executive Branch as well as the legislature.

Gov. Dannel P. Malloy’s administration has been cautious in its comments about the estate tax. Roy Occhiogrosso, Malloy’s senior advisor, said the governor does believe those who can afford to pay a little more should do so during a fiscal crisis. But Occhiogrosso also said the governor believes Connecticut shouldn’t “punish” successful households with excessive tax rates.

So where does that leave Malloy and the legislature this year?

The X-factor might rest with the largest projected budget deficit in Connecticut history, and a potential estate tax increase that already has the “yes” votes Malloy would need pretty much in place.

“I think it’s fair to say everybody saw the votes were there one year ago” to increase the tax, Sen. Eileen Daily, D-Westbrook, co-chairwoman of the Finance, Revenue and Bonding Committee, said. “It’s not that simple, but people remember that.”

But officials also know that the $3.67 billion deficit projection is built into the coming fiscal year is more than seven  times the shortfall in place during the last estate tax battle. The new deficit is equal to one-fifth of all current spending and more than half of all annual income tax receipts.

The estate tax also is one of the few taxes currently performing far ahead of expectations this fiscal year. Though $99 million in total receipts was built into this year’s $19.01 billion budget, the Jan. 14 revenue forecast issued by both the Malloy administration and nonpartisan legislative analysts was for $171.9 million.

“The estate tax provides a tremendous amount of revenue for Connecticut,” said Joachim Hero, a research analyst for Connecticut Voices for Children, a New Haven-based social services advocacy group and part of the Better Choices for Connecticut coalition pressing for a more progressive state tax system.

Hero said recent studies “really challenge the assumption that (taxpayer) migration is strongly affected” by increasing estate taxes, adding that proximity to family and quality of life concerns are the key factors.

The increases proposed last year basically would have restored about $70 million in estate tax burdens lifted in 2010, he added.

But McKinney said he believes those who favor higher estate taxes dramatically underestimate the fiscal toll they take on Connecticut.

Those wealthy individuals who do change their primary residency to another state don’t just deprive Connecticut of a one-time estate tax boost when they die. Each departure also potentially means 10 or 20 years of lost state income taxes, and lost charitable donations.

“Raising the inheritance tax is effectively playing a game of chicken with Connecticut’s most successful residents,” said Sen. Andrew Roraback of Goshen, ranking GOP senator on the Finance committee. “We are at risk of killing the goose that’s laying the golden eggs.”

Rep. Patricia Widlitz, D-Guilford, the new House chairwoman of the Finance Committee, said she has taken a position yet on any taxes yet, and won’t until after Democrats on the tax-writing panel hold their first caucus on the topic.

But like McKinney, Widlitz also said families don’t appreciate when rates see-saw back and forth year after year any more than businesses do.

“It’s very important that we fixed the cliffs and we have to balance raising the taxes to close the deficit against the impact on our economy,” she said. “But we also have to recognize that there is some uncertainty out there and people don’t like that.”

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Keith M. PhaneufState Budget Reporter

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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