State government continues to occasionally use money reserved for capital projects to cover operating bills, and then returns the funds later — a practice several critics acknowledged Wednesday isn’t illegal.

Neither, they conceded, is it costly. In fact, it effectively allows the state to borrow funds more cheaply than it could if officials sought a commercial loan.

But as it begins to happen more and more frequently, is it masking bigger problems with state finances?

Members of the legislature’s Finance, Revenue and Bonding Committee probed that issue Wednesday with Gov. Dannel P. Malloy’s budget director and a top official from state Treasurer Denise L. Nappier’s office.

“It’s not sending a great message to the market place,” said Sen. L. Scott Frantz, R-Greenwich, who said he fears Wall Street credit rating agencies likely would downgrade Connecticut’s bond rating — boosting interest costs on future borrowing — if the practice continues.

Why? Because it reflects a dangerous policy of procrastinating on finding real solutions to fiscal problems, Frantz said. “This is of great concern to all of us.”

That cash pool has been the source of controversy at the Capitol since January. That pool mingles tax revenues, federal grants and receipts from fees and licenses with borrowed funds. The treasurer’s office is allowed to transfer dollars — temporarily — between operating and capital programs. In the past it was done infrequently on occasions when bills exceeded tax and other operating fund receipts.

But according to monthly reports filed with the legislature, Nappier’s office has temporarily transferred funds away from capital project accounts at four different times this calendar year to help cover bills.

Office of Policy and Management Secretary Benjamin Barnes, Malloy’s budget chief, said all funds Connecticut borrows through bonding for the capital program are assigned to specific projects. But if those projects aren’t ready to start, those “idle” funds can be used to cover bills, and then reassigned to the capital program as revenues improve.

And the interest on capital borrowing is lower than what Connecticut would face borrowing directly for operating costs, Assistant Treasurer Lawrence Wilson told the committee.

These temporary transfers are “the most flexible and least costly approach to meet the state’s obligations,” he added.

And both Frantz and Rep. Vincent J. Candelora, R-North Branford, noted that this practice is just a symptom of bigger fiscal problems.

Traditionally the state’s income-tax revenues have swelled quickly during good fiscal times, pushed upward by Wall Street and the rest of the financial services sector. But Candelora said Connecticut has a habit of increasing its spending with the assumption that the good times will continue indefinitely.

“The minute there’s a hiccup” in the stock market, “it creates a disaster for Connecticut.”

“I think we should just try to have a more reasonable budget,” Frantz said.

Most of the criticism of the cash-flow system has come from the Republican minority in the legislature.

But Wednesday, Democrats on the finance panel also expressed concern about Connecticut’s increasing use of transfers.

“I think we need to have a budget that’s sustainable and takes into accounts the ups and downs” of the economy, said Rep. Edward Moukawsher, D-Groton.

Barnes said the Malloy administration has taken steps to address this problem. But Malloy took office in January 2011, and the problems that often leave the state strapped for operating cash can be traced back decades.

The chief problem, he said, has been the refusal of past administrations to embrace Generally Accepted Accounting Principles.

Unlike the modified cash-basis system currently used, under GAAP, expenses must be promptly assigned to the year in which they were incurred. In the context of the state budget, that would end an array of accounting gimmicks that have pushed current expenses into future years.

If GAAP standards are used, state finances are deep in the red. Fiscal analysts for the executive branch estimated last November that the state should have had another $1.7 billion on hand given all of its operating expenses and related obligations. And that margin grows annually due to inflation.

“I don’t think this is a good thing,” Barnes said. “This is a reflection of the situation that we’re in. … It is not ideal.”

Malloy’s first budget, signed in May 2011, set up a 15-year plan to pay off the GAAP differential, starting in the 2013-14 fiscal year. That plan also called for the administration to set aside surplus funds — $75 million this year and $50 million in 2012-13 — to cover inflation and keep the GAAP deficit at $1.7 billion.

But Barnes conceded that because state revenues have grown at a significantly slower pace than originally anticipated, it is unlikely those inflationary payments can be made.

The state’s fiscal challenges are “not of a scale that can be solved in a year,” Barnes said, adding that the solution applies in taking “a consistent, disciplined effort over time.”

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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