Gov. Dannel P. Malloy took a political blow this April when plunging income tax receipts nixed his plans for an election-year rebate.
But according to a new report from a nationally recognized public-policy think-tank, Connecticut officials had lots of company dealing with tax deadline chaos.
The new report from the Nelson A. Rockefeller Institute of Government found 33 out of 38 states that impose a broad-based personal income tax saw their 2014 first quarter receipts drop compared with the prior year. And while Connecticut lost ground, it fared better than the national average.
The institute, the public policy research arm of the State University of New York, also found that it was income tied to capital gains, dividends and other investment earnings – rather than traditional paycheck withholding – that really drove the revenue decline.
“The April 15 deadline for personal income tax returns brought bad news for nearly every state that has a broad-based income tax,” the report states. “While the direction of the April surprise was anticipated, the magnitude was underestimated in many states.”
The institute examined 38 of the 41 states that levy a broad-based personal income tax, comparing tax receipts for January through April in 2014 and 2013. It did not obtain data for Hawaii, Minnesota and New Mexico.
For the 33 states that experienced revenue declines, the average loss was 7.1 percent. Losses ranged from 31.1 percent in Ohio to 0.6 percent in Pennsylvania.
Connecticut faced a 6.9 percent drop. That meant a projected surplus of nearly $500 million for the fiscal year that ends June 30 was scaled back to less than $45 million.
The governor, who wanted to give a $55-per-person rebate to middle-income taxpayers, dropped that plan, along with a proposal to deposit an extra $100 million in the state employees’ pension fund.
The situation was very different one year ago when states were enjoying a rare post-recession surge in income tax revenues. Receipts in the first four months of 2013 were up almost 24 percent nationally over the same period in 2012.
But that raised a big question that wouldn’t be answered until this year.
Officials in most states predicted the expiration of the President-Bush era federal income tax breaks would spur a December 2012 surge of stock sales. The wealthy would take capital gains while they could still pay taxes at the lower federal rate for one last time in the spring of 2013.
But states also assumed some of that extra revenue one year ago was tied to a general improvement in the economy that would continue into 2014. The key question, though, was how much?
The answer came this spring, when states learned nearly all of last year’s growth was a one-time phenomenon.
“The declines in income tax collections appear to have been driven mostly by behavior of taxpayers who shifted income … to minimize federal tax liability,” the institute reported.
“It is primarily the echo of the fiscal cliff,” state Revenue Services Commissioner Kevin B. Sullivan said, referring to the federal budget talks that led to the expiration of the Bush tax rates.
Gian-Carl Casa, spokesman for Malloy’s budget office, said the institute’s report confirms what the administration reported last April – “that the drop in revenues from (quarterly filings) was a national phenomenon and that our methods of estimating returns are similar to what is done in the rest of the country.”
Revenue roller coaster
But state Sen. L. Scott Frantz of Greenwich, the ranking GOP senator on the Finance, Revenue and Bonding Committee, said the study also contains a valuable lesson Connecticut must learn.
Income tax receipts tied to investment earnings are among the most volatile sources of revenue states can tap – and Connecticut relies on them more than nearly all other states.
Almost 40 percent of Connecticut income tax receipts come from quarterly filings – most of which involve capital gains and dividends – as opposed to traditional paycheck withholding. But while revenues from the latter typically vary by 1 to 5 percentage points in any given year, quarterly filings typically move in double-digit percentage shifts, sometimes topping 30 percent.
And given that almost half of the revenue needed to support the new, $19.1 billion state budget that begins July 1 comes from the income tax, critics say Connecticut’s finances are at the mercy of a revenue roller-coaster.
“We can’t afford to continue with the status quo,” Frantz said. “Otherwise it’s going to drive everyone crazy.”
The state legislature enacted a finance committee proposal to launch a multi-year study of the Connecticut tax system, and Frantz said he expects finding ways to stabilize revenues will be a top priority.