Pew study: States’ reserves left them only half prepared for Great Recession

CTMIRROR File Photo

State Comptroller Kevin P. Lembo (file photo)

Connecticut was far from the only state whose fiscal reserves weren’t enough to withstand The Great Recession, according to a new report from the Pew Charitable Trusts.

The new study recommends several steps to help states better prepare for economic downturns – including proposals Connecticut’s legislature has resisted in the past.

“Over the past decade, dramatic swings in revenue have become more common for state governments,” Pew staff write in a report titled Building State Rainy Day Funds. “Shifts in personal income patterns – particularly from traditional wages and salaries to investment income – made income tax collections harder to predict.”

According to the study, all 50 states had a combined $60 billion in emergency reserves  set aside by the summer of 2008, just before the last recession began. But within a year they faced a combined shortfall of $117 billion.

Connecticut’s tax revenue stream is particularly volatile, largely due to its proximity to Wall Street and the large financial services sector located in the state’s southwestern corner.

When Connecticut established a state income tax, less than 30 percent of its income tax receipts came from quarterly filings — with most of those stemming from capital gains, dividends and other investment-related income.

And while more traditional income tax revenues from paycheck withholding normally vary by only a few percentage points year-to-year, receipts from quarterly filings typically surge by double-digits in either direction.

Yet Connecticut is one of 38 states that do not mandate any deposit into their reserve when tax receipts achieve certain peak levels.

Two of the Pew report’s chief recommendations are centered on revenue volatility.

One is that states facing significant volatility allow for larger reserves. The second involves mandating deposits into the rainy day fund during periods when tax receipts exceed expectations.

State Comptroller Kevin P. Lembo, one of Connecticut’s most vocal advocates for budget reform, said the report highlights a problem that has become increasingly problematic for the state with each successive recession.

State law currently limits governors and legislatures from amassing a reserve greater than 10 percent of annual operating expenses. Lembo wants to raise the limit to 15 percent.

Connecticut officials had amassed a Rainy Day Fund of just under $1.4 billion – an amount that represented only about 8 percent of annual operating expenses – by mid-2008.

Yet even after borrowing $1 billion to close an operating deficit in the 2008-09 fiscal year, and expending the entire $1.4 billion reserve to help balance finances in 2009-10 and 2010-11, Gov. M. Jodi Rell and the 2010 legislature left a record-setting deficit of almost $3.7 billion – or about 18 percent – built into the 2011-12 budget.

Gov. Dannel P. Malloy and the legislature closed that deficit in 2011 with labor concessions and more than $1.8 billion in tax hikes.

While Lembo called raising the Rainy Day Fund limit to 15 percent “a good start,” he said officials also have to find a way to ensure Connecticut actually saves the money, particularly during good times.

“I think we have a very simplistic scheme to capture money at the end of the fiscal year,” he said. “It’s not bad on its face, but its proven to be inadequate. As long as setting aside money in reserve is the last step, by virtue of the process, and the lowest priority, we are never going to get where we need to be.”

Lembo added he would like to see the 2015 legislature debate some form of mid-fiscal-year deposit rule triggered whenever revenues exceed projections by sufficient levels.

The comptroller also suggested legislators consider a requirement that major, one-time payments to the state in connection with lawsuit settlements also go automatically into the reserve.

The Pew report also recommends that states regularly study their tax systems – a proposal that Connecticut already is following.

The legislature and Malloy agreed in May to launch a two-year study of the state’s tax system to analyze: tax fairness and volatility; how the system affects the state’s economic competitiveness; and whether Connecticut relies too heavily on local property taxes.

Connecticut currently has $270.7 million in its reserve. And the Malloy administration estimated last week that the state closed the 2013-14 fiscal year with a$121.3 million surplus. Once that surplus is deposited, the total reserve would reach $392 million, which represents about 2 percent of annual operating expenses.

“Before the governor took office, Connecticut’s Rainy Day Fund was empty,” said Gian-Carl Casa, spokesman for Malloy’s budget agency. “Every penny had been spent. Under Governor Malloy we have made deposits into the Rainy Day Fund for three consecutive years and it has grown to nearly $400 million. It’s an important protection in case of an economic downturn.”