Gov. Dannel P. Malloy has asked state legislators to scale back a new tax credit for the working poor–but not to help close the $700 million shortfall in the next state budget.

The administration proposal to reduce the maximum new state earned income tax credit by one-sixth instead would boost projected reserves for the next two annual budgets by $18 million each.

Malloy already has proposed $704 million in savings to re-balance the budget through a combination of layoffs, municipal aid reductions and other spending cuts–more than enough to offset the $700 million savings originally projected to come from concessions next fiscal year.

And the administration couldn’t spend the new revenue obtained by reducing the earned income tax credit in the coming fiscal year without exceeding the constitutional spending cap–something it has said it will not do.

Malloy’s budget director, Office of Policy and Management Secretary Benjamin Barnes, said the reduction is fair given other sacrifices state government would have to impose now that state employee unions have rejected a concessions package.

But Jim Horan, executive director of the nonprofit Connecticut Association for Human Services, was critical ofthe cut. “This credit is a vital tool for economic stimulus” and a way to help poor families living paycheck-to-paycheck to save more money, he said.

The federal government has offered an EITC, a refundable tax credit primarily for poor working individuals and couples with children, since 1975.

The new budget adopted during the regular legislative session creates a new state income tax credit worth a maximum of 30 percent of the federal credit. The program would help qualifying households save an estimated $110 million next fiscal year, according to the legislature’s nonpartisan Office of Fiscal Analysis.

For a single parent with two children, an annual income of $14,500 would yield a maximum credit of $1,511. That same parent could qualify for a credit of up to $306 with an annual income of no more than $35,550.

The governor’s proposal would reduce the maximum state credit to 25 percent of the federal benefit. The administration estimates this change would save the state $18 million per year.

But unless Malloy is willing to exceed the constitutional spending cap, none of that added revenue would be used to offset the failed concession deal. That’s because the adopted $20.14 billion budget for 2011-12 falls a razor-thin $1 million under the cap.

The concession deal was supposed to save $1.6 billion over the next two years–including $700 million in 2011-12. If Malloy and the legislature replace more than $1 million of that $700 million in rejected concession savings with new spending–using new revenue from the EITC adjustment or some of the built-in surplus–the plan would violate the spending cap.

The legislature made final adjustments to the revenue portion of the new budget on June 7, the second-to-the-last day of the regular legislative session, but didn’t make any changes to the EITC then.

So why is the issue being raised in a session Malloy called to compensate for the failed concession deal?

“This was the one proposal I wasn’t ready for,” Rep. Toni Walker, D-New Haven, co-chairwoman of the Appropriations Committee and a strong advocate for the EITC, said Thursday. “The whole purpose of the EITC is to help the populace which is being affected by the social services that we are cutting back. I’m trying to find out why we’re looking at this now.”

“I’m very concerned that the governor put this on the table at this point,” Horan said. “It gives the appearance that it’s necessary to balance the budget and it’s not.”

The only immediate effect of the change, if approved by the legislature, would be to increase the fiscal cushions already built into the next two state budgets.

Barnes said the primary reason for making the change is to improve fairness in the new budget. “We think it is equitable that we restrain the EITC a little given the changes that we have to make,” he said, particularly citing nearly 5,500 recommended layoffs.

There is a second advantage to paring back the tax break, Barnes added.

Because most state spending is contained in the General Fund, and because it would face the bulk of the cuts under the governor’s plan, the administration recommended reducing the share of General Fund tax revenue it would transfer into the Transportation Fund from $85 to $41 million next fiscal year. That transfer would shrink to $23 million were it not for the added revenue from the EITC, Barnes said. And even though that extra $18 million can’t be spent in the Transportation Fund next year without blowing the spending cap, it can remain in the fund’s reserve and be available for use one year down the road, he said.

The 2011-12 budget originally was designed to run $88.9 million in the black across all funds. In 2012-13 the fiscal cushion is significantly larger at $554.9 million or 27 percent of the entire $20.4 billion budget.

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.

Republican legislators have criticized Malloy and his fellow Democrats in the legislative majority for approving over $1.5 billion in tax hikes for the coming fiscal year yet still crafting budgets with hundreds of millions of dollars left over.

Malloy has defended the surpluses on several occasions by citing the future need to address huge fiscal problems 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.

And Malloy and the legislature have begun 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 more than $1.5 billion in the red. The legislature adopted a 10-year schedule to pay off that debt starting in 2013-14.

The governor has said he needs to use portions of those projected surpluses–$75 million in 2011-12 and $50 million in 2012-13–simply to offset inflation and keep that $1.5 billion differential from growing.

And Senate Majority Leader Martin Looney, one of the legislature’s most vocal advocates for a state EITC, said even a credit equal to 25 percent of the federal tax benefit would give Connecticut one of the largest state credits in the nation. “I think we still would have one of the more substantial credits,”he said.

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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