Though Connecticut’s gubernatorial contenders spent more time this fall talking about tax cuts than state budget deficits, the red ink awaiting the winner of Tuesday’s contest is very real – and can’t be wiped away without tough choices.

Neither Democratic Gov. Dannel P. Malloy nor GOP challenger Tom Foley have addressed the deficits head-on.

But those shortfalls – leftovers from the cavernous deficit that plagued state finances four years ago – threaten more than the tax relief both candidates have promised. They also could limit future efforts to improve transportation, education and economic development.

‘There won’t be a deficit’

Malloy insists “there won’t be a deficit” when the next fiscal year begins in eight months – a form of budget semantics. The state Constitution requires the governor and legislature to adopt a balanced budget. But that doesn’t mean they won’t have to cut spending and/or find more revenue, before the task is done.

For Foley, the projected deficits are very real – when it comes to assigning Malloy blame for them. But the deficits seemingly pose no obstacle to the Greenwich businessman’s plans to cut sales and car taxes, even though he has provided almost no details how he will close the shortfalls, or how he will pay for the tax relief.

According to the legislature’s nonpartisan Office of Fiscal Analysis, the next two-year budget – which is due to the legislature in February – has a built-in hole of $1.37 billion, or about 7 percent of annual operating expenses in year one, and a $1.58 billion gap, or 8 percent, in year two.

“We have a systemic problem in the state of Connecticut: We have a budget that is not structured to sustain itself,” said Rep. Vincent Candelora, R-North Branford, a veteran member of the legislature’s Finance, Revenue and Bonding Committee.

State budgets have been plagued by frequent deficit projections since Connecticut emerged from the Great Recession and faced a recovery that lagged even the nation’s sluggish economic comeback.

But Sen. Beth Bye, D-West Hartford, said perspective is crucial in this case.

The deficits projected for the next two years are only about 40 percent of the size of the record-setting $3.7 billion gap Malloy inherited when he took office four years ago.

“I don’t think you can have that kind of deep, deep recession without it having an impact,” Bye said. “We had so many people with needs. It was a time when things had to get re-prioritized.”

To help close that gap, Malloy and his fellow Democrats in the legislature’s majority adopted more than $1.8 billion in tax hikes, approved the largest state employee concession program in modern history, and dramatically reduced the state’s workforce.

In addition, Malloy also refused to cut aid to cities and towns, and he reformed the state employee pension system to end almost two decades of under-funding.

Repeating past fiscal gimmicks

Malloy has expressed surprise that nonpartisan “number crunchers” have said spending is on pace to exceed revenues next year by 7 percent, adding he has kept annual spending growth closer to 3 percent.

But the governor doesn’t mention that, after the difficult political choices of 2011 failed to stabilize the budget entirely, he employed some of the same fiscal gimmicks – albeit in smaller doses – that he criticized his Republican predecessor, Gov. M. Jodi Rell, for using.

These include:

Refinancing debt: General fund debt payments need to grow almost 20 percent next year just to meet existing obligations. Malloy and the legislature refinanced debt to push more than $390 million in payments owed this year and last until after the election, with interest.

Gov. Dannel P. Malloy
Gov. Dannel P. Malloy

Putting operating expenses on the credit card: This year’s budget includes $80 million in new municipal aid that was financed with bonding rather than paid for with cash. Another $19 million in spending for stem cell research and pollution abatement was taken out of the budget and put on the credit card.

Malloy and lawmakers borrowed $560 million two years ago to bolster the state’s cash flow. But at the same time they borrowed another $38 million to support general operations. Lastly, they borrowed $39 million to cover their first two years of debt payments on the original $560 million – effectively incurring interest on interest to postpone any debt costs until after the election.

The first payment on that debt, $58 million, comes due starting in the next budget.

Shifting Funds from Transportation: The governor and legislature reduced a planned transfer of general fund money to the Special Transportation Fund by almost $171 million this fiscal year. A transfer of $152.8 million is scheduled to resume in the next budget.

Expanding deficits with tax cuts: Even after analysts had begun projecting a deficit in the first state budget after the election, Malloy and the legislature approved about $225 million in tax cuts that take effect next year, worsening the shortfall.

Possible solutions to the deficits

Still, there are some steps that either Malloy or Foley can take to mitigate the deficit that are easier than typical tax hikes or spending cuts – yet still not without pain.

According to Comptroller Kevin P. Lembo’s office, Connecticut has $519 million in its emergency budget reserve – a level equal to 3 percent of annual operating costs.

Malloy or Foley could apply portions of the reserve to lower each of the next two annual deficits to about $1.2 billion.

But that would leave state government with no fiscal cushion heading into another four year term. Malloy has complained frequently that Governor Rell and the 2009-10 state legislature, burned through a $1.4 billion reserve, leaving him nothing to help tackle a nearly $3.7 billion deficit when he took office four years ago.

And state officials may need some of that reserve to keep the current $19 billion budget in balance. Though Malloy projected a $300,000 surplus on Oct. 20, nonpartisan analysts are tracking more than $80 million in potential cost-overruns in different state agencies. Lembo said last May that the budget was $52 million short of what it needed to cover retired state employee health care costs. And the governor and legislature built a controversial $75 million in “miscellaneous revenues” into this year’s plan.

The deficit-mitigating measure Malloy most often cites involves taking paths his predecessors have frequently trod.

The first involves removing inflationary increases built into cost estimates.

The second is to waive statutorily mandated increases in certain municipal aid programs. For example, legislatures and governors for years have suspended a requirement that they fully fund a grant program that reimburses communities for lost revenue tied to property-tax-exempt properties, such as colleges, hospitals or state-owned land.

Tom Foley

But neither of these options – which together save $400 million to $450 million – is entirely painless.

Municipalities have argued that non-education grants have not kept pace with rising local costs for years.

And backing inflation out of state finances places pressure on departmental budgets, which in turn usually leads to hiring freezes. But certain agencies, such as the Department of Transportation, generally are recognized as being significantly understaffed.

Will tax breaks be put on hold?

Another option for dealing with the deficit would be to delay the new tax breaks that start next year. These breaks include: a corporation tax surcharge set to expire; a new income tax credit for retired teachers; sales tax exemptions on clothing and non-prescription medications; and an increase in the Earned Income Tax Credit for the working poor.

Canceling or delaying all of these would save about $225 million – which represents one sixth of the projected deficit in 2015-16, and one-seventh of the shortfall the year after that.

But Malloy not only dismissed that option, he has proposed further tax cuts. The tax breaks he wants for college graduates with student loan debt and for urban businesses that add jobs would worsen next year’s deficit by $40 million.

Foley declined to say whether he would try to delay or cancel the tax cuts already in statute. But his proposals to cut the sales tax and cap local property taxes on cars would grow next year’s deficit by more than $350 million.

Everyone’s banking on an economic boom

Both Malloy’s and Foley’s election promises hinge on Connecticut’s economy coming back in a big way next year.

There are some positive signs. A recent report from the New England Economic Partnership predicted Connecticut could add up to 25,000 new jobs next year, driven by a large jump in the national economy.

And despite recent fluctuations, the markets on Wall Street have grown tremendously in value over the last three years, increasing wealth.

But one of the biggest misconceptions about state deficit forecasting is that it doesn’t assume any economic growth.

In fact, nonpartisan analysts already are counting on general fund tax receipts to grow by $375 million in the next budget, and by a further $733 million the year after that because of an improving economy. In other words, Connecticut needs those receipts just to keep the deficits from getting any worse.

And even a dramatic surge in the state’s Wall Street-related revenues wouldn’t make all of the projected deficits go away.

Even if Connecticut’s income tax receipts from capital gains, dividends and other investment related income were to grow twice as fast as assumed next year, that would mean an extra $300 million above the growth analysts are counting on.

Deficit, campaign pledges, threaten future initiatives

Even if Malloy or Foley erases the deficit and delivers on some promised tax cuts, the real danger is there’ll be nothing left for long-overdue investments in information technology and transportation infrastructure, as well as education, said University of Connecticut economist Fred V. Carstensen.

“Making the strategic investments now are vastly more important than delivering tax cuts, Carstensen said. “Connecticut is still way behind most states on the quality of infrastructure, especially its broadband capacity.”

Several of Connecticut’s top business leaders said in March – after hearing the governor express optimism that taxes could be cut in 2015 – that other priorities than tax cuts rank higher with some companies.

“It’s clear that the issue of taxes and spending is front-and-center, and that there is a feeling we are taxed too heavily and spend too much – I get it,” Joseph McGee, vice president of public policy for the Stamford-based Business Council of Fairfield County, said at that time. “But there needs to be a real conversation in Connecticut about an investment strategy for the future.”

McGee’s group has been pushing for the state to develop high-speed commuter rail between Hartford, New Haven and New York City.

State officials also head to court next January as a long-awaited trial begins to determine whether Connecticut children have the right to an “adequate education” and, in turn, whether the state adequately funds its schools.

Some legislators have speculated that this case, brought nine years ago by a coalition of municipal leaders and private citizens, could result in a dramatic increase in the state budget’s Education Cost Sharing grant program.

“It’s a no brainer,” Carstensen added last week. “You don’t cut taxes, you don’t cut your revenue stream when you are imposing a tax on your economy every day because you have poor infrastructure, because you have other needs.”

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Keith M. PhaneufState Budget Reporter

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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