Despite having a relatively modest emergency budget reserve right now, Connecticut’s savings strategy is better than those in most states, according to a new study by Pew Charitable Trusts.
Connecticut also is one of just five states nationally that tracks and projects radical shifts in its revenues — arguably the chief problem that leads states to build a budget reserve.
Of the 46 states with emergency budget reserves, more than half — 27 — “do not clearly express in state law what they are seeking to achieve with them.”
For example, New Mexico law says its rainy day fund should be tapped “if the governor declares that the expenditure is necessary for the public peace, health and safety.”
As a result, the report argues, many states grapple with a political debate that has dogged rainy day funds for decades: Are such reserves responsible planning for fiscal crises or unnecessary hoarding of taxpayers’ resources?
“In many states, reserves have proved inadequate during recessions, in part because no clear purpose guides rainy-day-fund policies,” the report says. “When a state’s reasons for saving are either unstated or poorly defined, policymakers lack the information necessary to match savings goals to needs.”
By comparison, Pew identifies 19 states, including Connecticut, that have a narrowly defined reserve system that identifies explicit purposes for using reserves, such as avoiding tax hikes and cuts to municipal aid, or to respond to weakening economic indicators.
Connecticut particularly stands out for two reasons.
Tracking volatility
The state is one of just five — along with Minnesota, Nebraska, Oregon and Utah — that require regular assessments of revenues to account for volatility.
Especially because of proximity to Wall Street, Connecticut’s income tax — which provides about half of the revenues for its nearly $20 billion annual budget — is subject to sharp swings.
While a majority of income tax receipts comes from regular withholdings from residents’ paychecks, nearly 40 percent comes from capital gains, dividends and other investment earnings.
And while withholdings are predictable and shift modestly by a few percentage points – in good and bad times – capital gains historically have been just the opposite.
For example, between 2004 and 2008, Connecticut’s income tax receipts from investments grew an average of 20 percent each year.
A New Savings Strategy.
Lost amid other details in the two-year state budget adopted last June was a new strategy to improve Connecticut’s savings habits.
Lawmakers and Gov. Dannel P. Malloy approved several aspects of a blueprint proposed by Comptroller Kevin P. Lembo, including language that requires automatic deposits into the emergency budget reserve whenever the state’s income or corporation taxes rake in far more dollars than expected.
The new system also increases the maximum amount the state can set aside from 10 to 15 percent of the general fund.
But legislators and the governor did postpone these changes for several years. They don’t take effect until 2020.
Still, the Pew report hails the overall package, saying Connecticut made “significant progress” by adopting “substantial reforms” to its reserve system.
These reforms also were praised by several Wall Street credit rating agencies. But those groups also noted that creating a new savings strategy is not the same as actually building up savings, and Connecticut officials postponed that challenge for several more years.
The state’s emergency reserve currently holds a relatively modest $406 million, which represents slightly more than 2 percent of annual operating expenses.
Lembo, who presented the new savings plan to legislators early in 2015, said the goal was to craft “a uniquely Connecticut solution” that recognizes the effect of Wall Street and other factors that play a much smaller role in other states.
“We really tried to demonstrate for lawmakers how the volatility of our revenue stream impacts this goal of setting aside money for a rainy day,” he said, adding Connecticut still must exercise fiscal discipline, but has a blueprint “to put the state in a more stable position going into the future.”