Connecticut’s low- and middle-income households could pay tens of millions of dollars less in federal taxes each year while state officials simultaneously gain access to a wealth of new economic data.
But for that to happen, according to one of the state’s leading economists, Connecticut officials must first take a fiscal leap of faith – and repeal arguably the state’s most popular tax break.
Officials have an opportunity “to make the tax system simple, more progressive, vastly less expensive – and you force everybody to be transparent at the same time,” said economist Fred V. Carstensen, who heads the Connecticut Center for Economic Analysis at the University of Connecticut.
Step One: Replace income tax credit with sales tax rebate
Carstensen is urging a legislative study panel to investigate eliminating a state income tax credit that reimburses households up to $300 to offset their municipal property tax bills.
Without that credit, nearly 900,000 state income tax filers would pay an extra $214 million in total to the state.
But that’s just the first step.
The next, Carstensen says, is to send that same $214 million back to Connecticut families – but as sales tax rebates, and not as income tax refunds.
What’s the difference?
A refund involves the state’s returning to the taxpayer collected money that the taxpayer didn’t owe in the first place.
A rebate – in this case a small fraction of the $4.2 billion in sales tax receipts Connecticut collects each year – simply involves the state’s choosing to share a portion of its revenues with taxpayers.
Why is that important? The answer lies within two components of the federal income tax.
First, state income tax payments can be deducted on federal income tax returns.
So if a Connecticut household pays $300 more in state income taxes, annual income on its federal return drops by $300. And – assuming a federal income tax rate of about 30 percent – that hypothetical household’s federal refund would grow by about $90.
Second, a state sales tax rebate does not count as income that a household must report to Washington.
So once the switch is done, Carstensen says, Connecticut taxpayers still receive the $214 million they get each year from the state Capitol, and tens of millions of dollars more from Washington.
The exact amount from the last source is hard to calculate precisely.
That’s because fewer than 40 percent of households nationally itemize deductions on their federal income tax return.
According to a 2014 study by the Brookings Institute that examined tax data county-by-county, the share of households itemizing in Connecticut ranges from a low of 35 percent in Windham County to a high of 48 percent in Fairfield.
Connecticut targets the middle class to receive the property tax credit. It is gradually reduced for individual filers earning more than $56,500 per year and for couples topping $100,500. Individuals earning more than $100,500 and couples exceeding $160,500 are ineligible entirely.
But Carstensen said the state can set similar criteria for sales tax rebates.
And Connecticut would be better served, he said, by complementing the sales tax rebates with a reform and streamlining of its sales tax system.
The state currently has almost $3.9 billion worth of exemptions to its sales tax.
Many officials have argued that a significant portion of those exemptions stem from political influence rather than a compelling economic benefit.
If Connecticut were to repeal most or all of those sales tax breaks, it could lower the overall rate and use additional revenues to expand sales tax rebates even further, Carstensen said.
“Getting rid of the Swiss cheese sales tax would put everybody on equal footing,” he said. It particularly would be beneficial to Connecticut’s poorest households – most of which already pay little or no state income tax.
A final selling point, Carstensen added, is that Connecticut could tie eligibility for sales tax rebates to data collection.
To receive a rebate, households might have to provide data on the occupations of its members, for example. A nonprofit business, which benefits from various sales tax exemptions, could be asked to show what items it purchased sales-tax-free.
“Connecticut has a data desert,” he said, adding that other states, such as Wisconsin, have used rebates to enhance tax research and analysis.
New Haven Democrat William Dyson, a retired lawmaker who led the legislature’s Appropriations Committee for 16 years (under four governors) through 2004, now co-chairs the tax study panel.
Dyson, whose group will begin reviewing different tax proposals in late January, said the political hurdle facing any concept that would end the property tax credit is huge.
“Oooh, that’s a biggie,” Dyson said, adding its fate would hinge on Carstensen and others convincing lawmakers that a change enhances both fairness and tax efficiency. “Fairness in my head is not fairness in another person’s head. I learned that in this building [the state Capitol] a long time ago,” Dyson said.
When Quinnipiac University’s Polling Institute last surveyed voters about the property tax credit in March 2011 – as Gov. Dannel P. Malloy and legislators grappled with a record-setting, $3.7 billion budget deficit – nearly three-quarters of residents opposed eliminating the property tax credit.
Among seven potential tax hikes, only one – a 3 cents-per-gallon increase in gasoline taxes – drew more opposition.
Former Sen. William Nickerson of Greenwich, the study panel’s other co-chairman, said it would be premature to form conclusions on any proposal early in a study process, which is expected to continue for the next two years.
But Nickerson said Carstensen’s criticism of the dozens of sales tax exemptions on the books is valid.
Sales tax breaks “really have proliferated,” said Nickerson, who was the ranking GOP senator on the legislature’s tax-writing Finance, Revenue and Bonding Committee for much of the 1990s and 2000s. “And once it is in place, it does not get the same scrutiny that [the budget] receives. It does not receive sunlight. It lives on in its own little box, out of sight.”
And the state’s top tax official, Department of Revenue Services Commissioner Kevin B. Sullivan, noted that “the majority of necessities already are sales tax exempt or are about to be.”
Roughly one-third of the $3.9 billion in sales tax exemptions applies to groceries, gasoline, prescription medications, medical equipment and certain utility sales. And another third applies to raw materials and services tied to business production.
Exemptions for non-prescription medications and for clothing costing less than $50 are scheduled to be restored next year.