Lembo proposes overhaul of state government’s savings habits
Still struggling to pay its debt from the last recession, Connecticut might have avoided that emergency borrowing – and have double its current reserves – had it followed a new savings strategy unveiled Tuesday by Comptroller Kevin P. Lembo.
But to beef up its bank account, Connecticut must recognize that some of its most lucrative taxes – levies on investment income and corporations – drop most quickly when times get tough.
Lembo’s plan would:
- Increase the maximum savings allowed;
- Trigger automatic deposits into the budget reserve, commonly known as the Rainy Day Fund;
- And waive savings requirements during economic slumps and initial periods of recovery.
“Had such a deposit formula been in place since the inception of the income tax, Connecticut would have more easily weathered the most recent recessions,” Lembo wrote in a position paper submitted Tuesday to the General Assembly.
Current law allows the legislature and governor to build reserves up to 10 percent of the general fund. Based on the current budget, that represents a limit of $1.75 billion.
But Connecticut has never amassed reserves greater than 8 percent of annual operating costs. And those reserves never matched the revenue losses sustained during the last two recessions as tax receipts plummeted.
For example, the state had $595 million in its Rainy Day Fund entering the recession of 2001-to-2003, yet faced a revenue shortfall of about $1.7 billion over that period.
Similarly, Connecticut had a record-setting $1.38 billion in reserve entering The Great Recession in 2009, then watched revenues plunge by more than $2.4 billion.
“The 2009 recession was historically severe and may not be an accurate representation of future recessions,” the comptroller wrote in his plan. “Nonetheless, had the 2009 recession merely been equivalent to the milder 2001 recession, the state’s reserves still would have been insufficient to make up for the decline in revenues.”
Not surprisingly, legislatures and governors raised taxes after both economic downturns.
And Gov. Dannel P. Malloy and the legislature have struggled to rebuild the reserve since the last recession. It currently holds $519 million, which is equal to about 3 percent of annual operating costs.
The first step, Lembo told The Mirror on Tuesday, is to raise the maximum reserve to 15 percent of annual operating expenses. That would represent about $2.63 billion based on the current budget.
States have very different reserve needs, and Connecticut needs a bigger cushion given its heavy reliance on the fiscal rollercoaster that is Wall Street and the financial services sector of the economy.
About 40 percent of the state’s largest revenue source, the personal income tax, comes from quarterly payments rather than paycheck withholding. And most of those quarterly payments involve income tied to capital gains and other investment earnings.
This income tends to “rise and fall with economic booms and busts,” the comptroller wrote.
Connecticut ranks first in the nation in per capita income, a rank driven largely by a concentration of wealthy households in Fairfield County.
In 2009, capital gains dropped 60 percent, leading to a $904 million decline in quarterly state income tax payments.
“The corporation tax is similarly volatile as corporate profits fluctuate with the economy,” Lembo added.
But raising the limit is just the first step, the comptroller said, noting that Connecticut has a history of not saving well when it had the chance.
Since 1990, the state has had over $5 billion in revenue windfalls, yet deposited less than half of that amount into the Rainy Day Fund.
“In essence, Connecticut has used temporary windfalls to fund both one-time and recurring state budget expenditures instead of putting them aside to cover inevitable revenue declines during economic downturns,” Lembo wrote.
In other to save more, the comptroller said, Connecticut needs to learn from other states – both their gains and their mistakes.
Virginia relies on historical averages when planning for its volatile taxes. When receipts in key taxes top that average, reserve funds automatically are deposited. But Virginia also placed a 5 percent cap on its budget reserve, preventing further deposits in the years leading up the last recession, and ultimately leaving the state with too little in the bank.
Tennessee uses a similar system but employs a larger cap, making it one of just a handful of states that had enough reserves to manage its budget through most of the last recession.
Virginia raised its cap after the last recession, earning praise from Moody’s Investors Service, a major Wall Street credit-rating agency.
Lembo proposed a formula that relies not only on average corporation and income tax receipts over the last 10 years, but also calculates average annual growth in these volatile taxes.
When receipts are projected to grow beyond the average for the previous decade, Connecticut would automatically save those funds.
In many past years those dollars were spent on recurring programs – on the assumption that the hefty revenue growth enjoyed for two or three years would continue indefinitely.
Had Connecticut followed this savings approach – and made the corresponding sacrifices in annual spending – its reserves before the last recession would have topped $3.4 billion. Instead, Connecticut exhausted its $1.38 billion Rainy Day Fund and still had to borrow another $1 billion to balance its books in 2009.
Lembo also estimated that Connecticut could have double its current reserve, about $1.1 billion, if it had followed this approach from 2011 onward.
But this doesn’t mean Connecticut must save every single year, the comptroller added.
If the goal of a budget reserve is to smooth out the economic highs and lows of a budget based on volatile taxes, then deposits sometimes must be waived when times are tough.
If the choice is to make deposits or to cut vital programs that eventually will be rebuilt when times are better, then deposits could be deferred, he said.
Lembo added that increasing government’s power to save money always is politically tricky, and will be challenged by some as evidence that taxes are too high.
What it does, he added, is take the state off of the fiscal equivalent of a binge-diet dynamic.
“This system preserves a progressive tax environment while putting some rational thinking on the budget-making process,” Lembo said, adding he’s optimistic that officials who recall the budgetary challenges of the last recession will consider his proposal.
“These concepts should be compelling for anyone who has had to sign, or cast a vote on, a budget in the last few years,” he said.
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