Procrastinators may hope for big refunds and scramble to beat Tuesday’s tax-filing deadline, but the person with the most riding on those returns is Gov. Dannel P. Malloy.
If household and business earnings are on the rapid rise, Malloy could watch the budget woes that dogged his first term vanish in the blink of an eye.
If those returns show no growth, Malloy will struggle for the next seven months to distract voters from a major deficit in post-election state finances.
And if results fall somewhere in the middle, the battle to define Connecticut’s economic future should dominate the 2014 election season, just as it did four years ago.
“I think we’re on a positive glide path,” Sen. John Fonfara, D-Hartford, co-chairman of the tax-writing Finance, Revenue and Bonding Committee, said last week. “I am cautiously optimistic. If you look at our history, once the revenues started to pick up, they just built on themselves.”
State government’s single-largest source of revenue is income tax, which provides about $9 billion, or half of its annual operating budget. While most of its income tax receipts come from regular withholdings from residents’ paychecks, nearly 40 percent comes from capital gains, dividends and other investment earnings.
Between 2004 and 2008, Connecticut’s income tax receipts from investments grew an average of 20 percent each year. Over those five years combined, Wall Street’s contribution to the state’s coffers jumped by almost $2 billion.
In the 1980s and 1990s, state government enjoyed similar boom times.
But that hasn’t been the case since the last recession. And since Malloy became governor in January 2011, Connecticut has muddled through one of its slowest and most sluggish recoveries.
That’s not to say the economy began to roar three months ago.
But after years of watching tax revenues come in below or just barely at budgeted levels, state officials saw significant improvement.
Nonpartisan analysts and Malloy’s budget office signed a consensus report concluding that taxes would yield $360 million more than planned this year. Perhaps more importantly, they also increased expectations for future tax receipts by about $150 million in each of the next two years.
That last bit of news was tempered by a nonpartisan projection that – even with this growth – a $1 billion hole is built into state finances for the budget that Malloy, or his successor, must present to the legislature next February.
But what happens if Connecticut gets even better news when analysts test revenues later this month – the last time they’ll do so until after the election?
Income tax receipts alone jumped by more than $500 million between 2000 and 2001, despite no changes in tax rates.
If analysts project that type of future growth in April, a $1 billion post-election deficit is chopped in half. And Malloy, who already is expected to have deposited $500 million into the emergency budget reserve by this fall, could build that cushion even more. This could all but neutralize any talk of a fiscal crisis after the election.
Malloy frequently reminds reporters and voters that he inherited an unprecedented $3.7 billion budget deficit – almost 20 percent of annual operating costs – when he took office three years ago.
His Republican critics have argued that the tax increases he approved to help close that gap weakened Connecticut’s economy, while others in labor say the governor and legislature didn’t raise enough revenue to stabilize the budget.
Republicans also say the post-election deficit is largely because Malloy and his fellow Democrats have used borrowing and other gimmicks to push hundreds of millions of dollars of current expenses off until next year.
Malloy responds that Connecticut’s finances are much more stable than what he inherited, that fund raids and other practices used frequently to balance the budget are being phased out, and that his administration has begun to reverse decades of underfunding for state workers’ pensions and retirement health care.
And the governor told more than 200 business leaders at the Capitol last month that even if a deficit develops after the election, he’s confident the economy will have rebounded enough to allow his administration to close the gap without more tax hikes.
“Even if we did have a deficit, we’re not going to raise taxes,” he said. “We’re done.”
But Malloy will have a much easier time selling that message if tax receipts explode – not just improve – in the next few weeks.
So far no one has predicted anything quite that optimistic – but neither has anyone ruled it out.
“Anyone who says the outlook is disastrous is wrong, and anyone who says it’s completely rosy is wrong,” said Comptroller Kevin P. Lembo, a Democrat from Guilford. “We are still going through the process of recovery. It is not complete.”
The comptroller added that all of the state’s major taxes, including income, sales and corporation, finally are matching or exceeding projections. “You can see the beginnings of some real growth,” he said. “So we’ll see.”
Sen. L. Scott Frantz of Greenwich, the ranking GOP senator on the finance panel, offered a similar assessment.
“I think we can expect signs of a healthy recovery” with the April forecast, he said. “But not one that’s knocking the cover off the ball.”
Lembo and Frantz also agreed that the top priority at the Capitol has to be depositing as much as possible into the reserve, commonly known as the Rainy Day Fund, to ensure budget stability in the next term.
The head of the University of Connecticut’s economic think-tank, professor Fred V. Carstensen, outlined a slightly different scenario, but still emphasized the need for state government to exercise caution with its budget.
Carstensen, head of the Connecticut Center for Economic Analysis, said corporate profits have outpaced the national economy in the opening quarter of 2014. This trend could lead to a healthy amount of capital gains – which in turn could boost state revenues significantly – but it might not be sustainable.
In other words, even if the April revenue numbers spike upward, a correction shortly after that, back to steadier growth, is likely, he said.
“There is nothing in the cards right now that suggests we’re going to see any kind of sustained economic surge,” Carstensen said.