Gov. Dannel P. Malloy intends to propose one of the largest tax increases in state history Wednesday, seeking $1.5 billion in new annual revenue from income tax hikes on the wealthy and middle classes, and new sales taxes on clothing and other long-exempt products and services.

In a plan outlined Monday to The Mirror by his senior staff, Malloy also would extend the corporate tax surcharge for another two years and restrict tax credits for the motion picture industry, while modestly increasing incentives for research and development.

The sales tax rate would change for the first time in 20 years, from 6 percent to 6.25 percent, and it would be applied to now-exempt items such as pet grooming, hair cuts, car washes, boat services, non-prescription drugs and cosmetic surgery. Taxes also would rise on tobacco, alcohol and luxury goods.

Legal, accounting, consulting and other professional services would remain exempt.

Malloy at UConn

Malloy: ‘Pass this as quickly as possible and then blame me.’

The General Fund tax increases, which will be accompanied by $2 billion in spending cuts in his budget proposal on Wednesday to close a $3.2 billion deficit, were crafted with an eye toward spreading the pain, keeping Connecticut’s tax structure competitive with neighboring states, and improving the state’s climate for job creation, his staff said.

“The governor was very clear that we could not do anything that could get in the way of his No. 1 goal, which is to create jobs,” said Roy Occhiogrosso, the governor’s senior adviser for politics and media.

Occhiogrosso and Benjamin Barnes, who oversees the budget as the secretary of policy and management, said they believe the administration’s plan meets all of Malloy’s goals, but neither they or the governor are under the illusion the package will be an easy sell. In staff meetings, Barnes said, each time an aide raised an objection to a particular element, he held up a sign with the deficit.

Though nonpartisan legislative analysts projected the 2011-12 shortfall at $3.67 billion, or about $470 million higher than the administration, the two numbers are more closely related than at first glance. The administration plan assumes that legally-required increases in certain municipal grants — which have been waived frequently in recent years by the legislature — will be waived again. The smaller deficit target also recognizes two recently developed estimates: $119 million in projected revenue growth, and about $60 million in reduced cost projections.

In a brief interview before a ribbon-cutting at a new science facility at the University of Connecticut Health Center, Malloy said it will be hard for the legislature to make major changes without the plan imploding. Only half-joking, Malloy said, “The smartest thing that the legislature can do is pass this as quickly as possible and then blame me.”

Malloy’s expansion of the sales tax would be partially offset by an earned-income tax credit for the state’s poorest wage earners, but he knows he can expect opposition from some fellow Democrats over the sales tax increase and the elimination of two tax brackets for lower-wage taxpayers.

Plans to cancel two popular income tax breaks for the working class, to maintain some of the lowest marginal income tax rates on the wealthy in the Northeast, and to tax all clothing, could be particularly problematic based on recent history.

The Democratic governor spent much of last fall’s campaign pledging to follow a philosophy of “shared sacrifice” in solving what effectively amounts to the largest budget deficit in Connecticut history. And Occhiogrosso added that “the revenue increases are spread out. There is not one group that bears a disproportionate burden.”

The chief engine in Malloy’s revenue-raising plan involves overhauling the largely flat state income tax, replacing its three rates with eight.

Currently, most filers pay 3 percent on the first $10,000 earned for singles and $20,000 for couples. Nearly all income above that is taxed at 5 percent, though earnings above $500,000 for singles and $1 million for adults started facing a 6.5 percent rate last year.

Malloy’s plan sets a new top rate of 6.7 percent at the same parameters for the top earners.

But most of the changes, in terms of detail, occur at the middle-income levels.

  • The 3 percent rate on initial earnings is gradually phased out, beginning with individuals earning more than $56,500 and couples topping $100,500. Those who don’t qualify for the 3 percent rate would face a 5 percent tax on initial earnings.
  • The three existing tax brackets would be expanded to eight. Marginal rates for singles/couples would be 3 percent on earnings below $10,000/$20,000; 5 percent above $10,000/$20,000; 5.5 percent above $50,000/$100,000; 5.75 percent above $100,000/$200,000; 6 percent above $200,000/$400,000; 6.25 percent above $300,000/$600,000; 6.5 percent above $400,000/$800,000; and 6.7 percent above $500,000/$1 million.
  • A middle-class property tax credit worth up to $500 would be eliminated.

By comparison, when the Democrat-controlled Finance, Revenue and Bonding Committee tackled an imposing deficit two years ago, the panel recommended three new marginal rates — all aimed at incomes above $500,000 and topping out at 7 percent.

income tax rates

Democratic lawmakers also largely have resisted efforts to reduce the property tax credit since it was launched at $100 in 1996. It was seen as a compromise between then-Gov. John G. Rowland, a Republican who favored a flat income tax, and Democratic lawmakers who argued that the income tax system overly burdens the middle class.

The last time the credit was reduced, from $500 to $350 back in 2003, it was restored to its top level just two years later.

But Occhiogrosso noted that Malloy’s overall plan would collect an estimated 38 percent of its revenue from households that earn more than $250,000 annually. That includes lowering the minimum value for estates subjected to the inheritance tax from $3.5 to $2 million.

Equally important, he added, it would keep the state’s top tax rates below those in Massachusetts, New York and New Jersey — key jurisdictions that Connecticut competes with for wealthy residents tied to Wall Street.

“The governor does not believe in punishing wealth or success,” he said. “Nor does he want to drive people out of the state.”

The governor’s plan also reaches out to his own party by creating a state earned income tax credit to help poor households save more, a goal Republican governors have thwarted progressive Democrats from achieving for more than a decade.

Malloy’s proposal would allow state income tax filers who qualify for the federal EITC to claim a state credit equal to 30 percent of their federal credit. The Connecticut Association for Human Services, a nonprofit social service advocacy group, estimated that the average federal credit for an Connecticut family would amount to $2,000.

Malloy’s income tax changes would be retroactive to Jan. 1, but would not affect paycheck withholding until July 1. But the new withholding rates, if adopted, would not be pro-rated in July to compensate for the six missed months of collections. That means that unless filers voluntarily increased their state withholding levels, the additional taxes would be paid through diminished refunds or increased payments included with tax filings in spring of 2012.

The income tax changes, worth nearly $880 million next fiscal year and $700 million in 2012-13, would be supplemented by the largest overhaul of Connecticut’s sales tax since the chief rate was reduced from 8 to 6 percent in 1991 as part of the compromise that created the state income tax.

Reactions to the governor’s tax plan were guarded Monday, as both legislators and interest groups waited to see Malloy’s proposals for the spending side of the budget.

Both House Speaker Christopher G. Donovan, D-Meriden, and the State Employees Bargaining Agent Coalition declined to comment, while Senate President Pro Tem Donald E. Williams Jr., D-Brooklyn, said, “We respect the difficult challenge facing Governor Malloy, and we stand ready to work with him to pass a budget that is tough, fair, and helps Connecticut grow jobs.”

Sen. Andrew W. Roraback of Goshen, ranking Senate Republican on the Finance committee, said, “I appreciate that the governor has to offer a balanced budget, but I don’t want to even contemplate taxes unless, and until, meaningful spending reform has been achieved. Otherwise I believe it’s a recipe for too many taxes.”

Sen. Eileen Daily, D-Westbrook, veteran chairwoman of the Finance committee, said Malloy’s decision to keep proposed income tax rates below those in competing jurisdictions “shows a very thoughtful approach.”

And given the high stakes involved with a $3 billion-plus deficit, Daily added, Democrats hoping for even higher tax rates for the wealthy might be wary to reject Malloy’s proposal out-of-hand. “I’m thrilled to be getting a budget that’s actually balanced,” she said. “And with a deficit this big, every revenue thread you pull out of this means you have to cut something else out of the package.”

The state’s chief business lobby, the Connecticut Business and Industry Association, also praised Malloy for keeping a watchful eye on other states while crafting his plan.

“I think the governor attempted to minimize the damage somewhat” of imposing $1.5 billion in new taxes, Joseph F. Brennan, the CBIA’s executive vice president, said Monday, adding it will be equally crucial when the full budget is presented Wednesday “to see how he’s going to reform government spending over the long haul.”

Republican State Chairman Chris Healy saw no need to withhold his judgment of the revenue plan offered by the state’s first Democratic governor in 20 years.

“This is a disaster for the Middle Class, small business owners, investors and a pay day for the government,” Healy said in an emailed statement. “At long last we see what many privately feared, that Governor Malloy is more interested in rewarding those who feed off government rather than those who produce wealth and opportunity.”

Overhauling the Sales and Admissions Tax

Another key component of Malloy’s plan involves raising an $461 million in sales tax revenues next year and $941 million extra over the next two combined.

sales tax

Besides boosting the rate from for the first time in 20 years from 6 to 6.25 percent, Malloy reassessed — as he promised during the fall campaign — nearly $3 billion in sales tax exemptions, some of which date back than three decades.

“There is absolutely no rhyme or reason for what we found,” Occhiogrosso said, adding that “one would think it’s an example of how special interests have affected the process over the years.”

Malloy canceled the exemptions on a wide array of services, covering pet grooming, boat storage and repair, car washes, manicures, haircuts, yoga studio programs, non-prescription drugs and limousine services. Exemptions to the state’s sales tax on admissions that had been granted to more than a dozen select tourist attractions also would be repealed.

The state’s sales tax on hotel stays, which currently stands at 12 percent, would rise to 14.

Though many Democratic lawmakers suggested a similar tightening on sales tax exemptions, Malloy also appeared to break ranks with his own party when he suggested canceling arguably one of the most popular sales tax break — an exemption on clothing valued at less than $50, which goes back to 1985.

Barnes said the administration realizes sales taxes are somewhat regressive. But he also noted that the governor wanted to avoid repealing exemptions that are helping businesses grow and maintain jobs, adding that the public may not realize that high-priced items also benefit from the sales tax structure.

“We have tax-free caviar,” Barnes said, adding the governor also proposed a 3 percent sales tax surcharge on luxury purchases, covering prices above: $100,000 for boats, $50,000 for vehicles; $5,000 for jewelry and $1,000 for clothing.

Barnes added that for a few “select” retail products or services — which won’t be disclosed until Wednesday — the Malloy budget calls for a 6.35 percent sales tax. The revenue from this added 0.10 rate component, estimated at $24 million per year, would be returned to cities and towns to help offset reductions in municipal aid.

Businesses Face Extended Surcharge, Fuel Tax Overhaul Begins

The administration proposed retaining the 10 percent surcharge on the corporation tax, which expires after this calendar year, for another two.

A new “throw-back” rule similar to those imposed by other states would collect an extra $20 million annually from companies with a significant presence in Connecticut, but who also generate major income in states with no corporation tax.

And another $18.8 million would be saved over the next two years combined by dramatically reducing the ability of film companies to transfer the tax credit they receive for operating in Connecticut.

Former House Speaker James A. Amann, D-Milford, who spearheaded the push to create the film tax credit program five years ago, predicted restrictions on transferring tax credits would discourage film companies from considering locating in Connecticut. “It’s making revenue for the state and it’s creating jobs,” he said. “We shouldn’t try to change the game on something that’s working.”

Barnes said the administration had considered further business tax hikes, but noted companies already are facing a new $40 million levy this September as Connecticut begins paying off the interest on borrowing needed to stabilize the unemployment compensation fund.

The governor also would provide $17.5 million in expanded credits to reward businesses that create new jobs over the next two years.

Malloy also took the first steps toward overhauling a financing system that critics argue has helped leave Connecticut with an aging, congested transportation network incapable of supporting economic development.

Hoping to end nearly a decade of raids on fuel tax revenues to support day-to-day government operations, Malloy proposed devoting at least 70 percent of revenues from the state’s wholesale fuel tax to the Special Transportation Fund. That means stripping $73 million total away from the General Fund over the next two fiscal years.

The governor also proposed adding 3 cents to the 25-cents-per-gallon retail tax on gasoline and 2 cents per gallon to the diesel tax, which currently stands at just under 40 cents per gallon. These transportation fund tax increases would be worth about $51 million per year

Other components of the Malloy revenue plan include:

  • Adding 40 cents per pack to the cigarette tax and ordering comparable hikes to the levies on snuff and other tobacco products.
  • And increasing the tax on electricity generation by 2/10th of one cent per kilowatt hour.

The tax increase on electric generation would not affect Connecticut consumers, since the neither Connecticut Light & Power or United Illuminating, the two utilities that transmit power to to consumers, purchase their power from generating plants in the state, Barnes said.

Since deregulation, CL&P and UI contract to buy their power on the open market. Some industry representatives, who declined to be quoted by name, said the electric-generation tax could eventually hit Connecticut consumers by driving up the regional cost of electricty.

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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