Volatile personal income jumps, but economy slows

Personal income rose nearly 5 percent in the first quarter of 2011, but state officials need to beware that revenue from a just-increased income tax relies more than ever on volatile earnings tied to an uncertain stock market, according to the latest quarterly report from the University of Connecticut.

The warning about tax volatility was a key component of a sober assessment of a state economy that seems to be slowing, said economist Steven P. Lanza, executive editor of The Connecticut Economy.

Unemployment remained “stubbornly high” at 9.1 percent in the first quarter of this calendar year while the housing market appeared bleak, Lanza said.

“We’re seeing the economy shifting down a notch,” Lanza said Monday during a presentation of the university’s latest quarterly economic journal at the Connecticut Economic Resource Center offices in Rocky Hill. “It’s not the kind of growth we’d like to see, that we’d need to see to reduce the unemployment rate.”

The harsh winter, the tsunami and resulting nuclear plant crisis in Japan, and a steady rise in gas prices all contributed to slowing economic growth in the first quarter of 2011, Lanza said.

But perhaps the largest hazard for the state’s economy lies with its housing market. Home prices appeared to hit bottom during the second quarter of 2010, but they are down 7.5 percent in the first quarter of this year compared with a year ago, while new housing permits were down 20.8 percent.

The opening months of 2011 did offer some positive economic signs, Lanza said.

Professional and business service jobs rose by 4,500 and this sector now has regained about half of the jobs it lost in the last recession. And construction jobs rose by 2,500, or 44 percent, due largely to a 65-percent increase in construction activity over the prior quarter, according to the latest issue.

And personal income, which finished strongly on the rise last year, was up 4.7 percent between January and March compared with the same period one year ago.

But even that positive sign carries an element of risk as well, Lanza said.

The nearly $900-million state-income tax increase approved in the just-completed legislative session adds several new rates, including a new top rate of 6.7 percent on high-end earners, up from 6.5 percent.

Roughly one-third of the state’s annual income tax receipts are tied to quarterly tax payments — rather than paycheck withholding — and most of that income involves capital gains, dividends and other investment returns. This also is one of the most volatile components of the state’s overall tax picture, routinely growing, or shrinking, by double-digits each year.

Annual revenue from this component of the income tax alone plunged by more than $860 million between 2008 and 2009 alone as Connecticut sunk into the deepest part of the recession.

“We’re likely to find when the next recession arrives that income falls off a cliff again,” Lanza said, adding that state officials should consider budget safeguards now to prepare in the coming years for the next economic downtown.

And with the new top rate for the wealthiest households, plus rates of 6 and 6.5 percent applied to upper-middle-income family earnings previously taxes at 5 percent, state government could see revenue “evaporating” faster during the next economic slump than in 2009, Lanza warned.

“We have to become careful about relying on that,” he added. “That’s probably not the last time we’re going to be on that budget roller coaster.”