Next challenge for Malloy: Can he hang on to his fiscal cushion?

Now that Gov. Dannel P. Malloy stands on the brink of a union concession deal to overcome most of the state’s budget deficit in the short term, his next challenge is to protect a $1 billion pool of money he wants to use to address longer-term financial problems.

Though the deal would nearly close the record-setting deficit Malloy inherited for the upcoming fiscal year–a gap that once stood at $3.67 billion–challenges remain that are equally if not more daunting. They include a maxed-out state credit card, a severely underfunded state employee pension program and a pending conversion to generally accepted accounting principles that will help keep the state from the fiscal gimmickry of the past.

So even as administration worked with unions to secure $2 billion in wage and benefit givebacks over two years, the governor and the General Assembly adopted a $40.1 million budget for the next two fiscal years that is designed to run an unprecedented $1 billion in the black. The question is whether he can hold onto it.

“You can already smell it in the building,” Sen. Eileen Daily, D-Westbrook, veteran co-chairwoman of the Finance, Revenue and Bonding Committee, said Friday. “People already want to use that [planned surplus] to bring back programs that have been cut. I think we need to rely on Governor Malloy to be strong about this, because legislative history shows this money could quickly become low-hanging fruit.”

The tempting fruit Daily is talking about involves a $369 million General Fund surplus built into the $19.83 billion spending plan for the fiscal year that starts July 1, and a whopping $634 million cushion in the $20.29 billion plan for the 2012-13 fiscal year.

By comparison, the biennial budget adopted two years ago was designed to run $700,000 in the black in 2009-10, while the second year–the current budget–technically relied on more than $190 million carried forward from past surpluses just to remain in balance with no projected surplus.

And even when economic times were much better in the spring of 2007, the biennial plan adopted then designed a two-year surplus that totaled just under $8.5 million.

So how has Malloy justified a two-year budget that is supposed to finish with $1 billion left over?

The governor has said that if concession talks failed, he’d need $2 billion to get through the next two years. While specific details weren’t released Friday, the tentative concession agreement Malloy announced is reportedly worth $1.6 billion.

But Malloy for the most part has defended the cushion by citing not the uncertainty of labor talks, but the future need to address other huge fiscal messes he inherited.

With over $19 billion in bonded debt, Connecticut ranks among the top three states in the nation in terms of debt per capita, and debt as a percentage of the taxpayers’ personal income.

The state’s received an actuarial report last November showing its employee pension fund in its worst shape since the state began saving for pension obligations in the mid-1980s. That account held less than 45 percent of the funds needed to meet its obligation to workers.

Further complicating matters, Connecticut shifted the pension contribution system in 1995 from a level-funded 30 year schedule to a backloaded system that will force dramatic increases over the next few decades. The required annual contribution is projected to grow by 50 percent by 2017, double by 2026 and triple by 2038.

And Malloy has pledged to begin transferring state finances to generally accepted accounting principles. That means following a series of common financial guidelines that emphasize transparency. Under GAAP, expenses must be promptly assigned to the year in which they were incurred. Similarly, revenues are counted in most situations in the year in which they were received.

Connecticut’s finances, under GAAP rules, are somewhere between $1 billion and $1.5 billion in the red, a margin Malloy would presumably set the state on a schedule to close gradually over 10 or 15 years.

Taking those challenges into account, Malloy has argued, a $1 billion cushion could be put to good use in future years once the current budget is stabilized.

Earlier this spring the governor took a hard line, vowing that if concession talks didn’t produce sufficient savings, he would make up the difference with cuts.

As late as last week, Malloy’s budget office prepared nearly $1.7 billion in alternative spending cuts. Besides more than 4,700 layoffs – a move Malloy insists no longer is in the works – there also were deep cuts to social services and a host of other programs.

But he softened that approach somewhat Friday, conceding that the $400 million shortfall between his concessions savings target and the amount projected in the tentative deal could be covered by “a mix of additional spending cuts and existing budgeted revenues.”

A former mayor of Stamford, Malloy also had frequently cited municipal aid reductions as a possibility if concession talks turned sour. He ruled nothing out Friday, but when asked if that might be one of the “additional spending cuts” he might seek from the legislature, the governor called it one of the “least favorite” options he would consider.

Former Democratic State Chairman John F. Droney said Friday that Malloy successfully campaigned on a pledge to address Connecticut’s fiscal problems in a transparent and honest manner with an emphasis on long-term solutions, not short-term gimmicks. He has maintained that approach since taking office in January, Droney said.

“He has gone around this state and put his reputation on the line, projecting himself – correctly – as a person who is facing reality,” Droney said, adding he doesn’t believe Malloy will deviate from his fiscal plans now to avoid friction with his fellow Democrats in the legislature over the need for more spending cuts.

“He doesn’t want to handicap himself or get a black eye,” if the economy slips and those other fiscal challenges remain unaddressed over the next three years, Droney added.

Malloy also could face pressure from minority Republicans, who object already have blasted the governor for signing nearly $1.47 billion in state tax hikes into law, and another $50 million in additional taxing powers for cities and towns.

The governor said he won’t raise taxes any further to make up for concession differential, but House Minority Leader Lawrence F. Cafero, R-Norwalk, said Malloy needs to think about disassembling that built-in surplus and using those dollars to cancel some of the tax hikes.

“What I’m hearing from the public is, he hasn’t cut spending enough,” Cafero said. “How can you turn to the most overtaxed population in America and say you haven’t suffered enough–that’s part of the anger we’re hearing out there every day.”