Estate tax measure may preview 2017 state tax debate

Democrats and Republicans alike concede any proposal to raise state taxes has virtually no chance of passing at the Capitol this spring — even with huge budget deficits looming in the near future.

But the 2017 legislative session — which opens two months after the November legislative elections — is a different story.

And last Friday’s public hearing before the Finance, Revenue and Bonding Committee — and in particular competing testimony on the estate and gift taxes — offered a preview of the debate some expect to dominate the next session.

On one side, businesses and fiscal conservatives argued to eliminate the tax. The hundreds of millions of dollars it draws annually from the wealthiest families makes Connecticut a national outlier — goes one argument — and removing it will keep those families moving and paying taxes in another state.

On the other side, labor unions, social service advocates and other progressive groups charge that the tax is essential to redistribute wealth in a state whose tax network has favored — even shielded — the rich for more than two decades.

And the stakes in this battle, even though it probably won’t be fought for another year, are huge.

The legislature’s nonpartisan Office of Fiscal Analysis is projecting massive deficits, topping $2 billion, in both 2017-18 and 2018-19, the first two new fiscal years after the November elections.

In addition, economists, analysts, legislators and Gov. Dannel P. Malloy’s administration all have warned that eroding state tax revenues — which already have contributed largely to these projections — could worsen when revenues are re-assessed in late April or in mid-November.

“We don’t want to see a continued exodus of wealth from this state,” Bonnie Stewart, tax specialist for the Connecticut Business and Industry Association, told the finance committee last week.

“We risk being left behind,” said Zach Janowski, director of external affairs for the Yankee Institute, a conservative public policy group. “It hurts all of us who remain here and want to see Connecticut thrive. … We create millionaires in Connecticut and then they leave.”

And the tax isn’t just a problem for the wealthy, said Rep. Chris Davis of Ellington, ranking GOP representative on the finance committee.

Parents owning a particularly large farm might have to sell it simply because their children, who otherwise would inherit it and continue to work the land, can’t afford to pay the estate tax, he said.

Janowski and Stewart were referring to estate and gift taxes expected to collect $217 million this fiscal year.

Connecticut levies a tax on estates valued at more than $2 million, and the CBIA and Yankee Institute aren’t the only groups raising concerns about this tax.

The State Tax Panel, a group charged by the legislature over the last two years with studying state taxes, recommended in December that Connecticut look for ways to at least mitigate the estate levy.

It noted that the federal tax only targets estates valued at more than $5.4 million, and that most other states either don’t levy such a tax, or adhere to the federal threshold.

But that same panel also recommended no immediate changes to the estate and gift taxes. And with surging pension and other retirement benefit costs expected to burden the state budget for the better part of two decades, some argue that no state taxes will be dropping any time soon.

More importantly, according to Lindsay Farrell, director of the Connecticut Working Families Party, the estate tax is one of the few levies that tries to restore balance to a tax system that already overburdens the middle-class here.

In 1991, just before the state income tax was enacted, the state placed a 7 percent levy on capital gains, and a top rate of 14 percent on dividends.

But once the income tax was enacted, capital gains and dividends faced the same top rate as all other types of income at 4.5 percent.

While the top marginal rate has grown to 6.99 percent since then, rates have risen on the middle class as well. Most middle income families now face a top rate of 5.5 percent.

And research shows municipal property taxes continue to hit middle- and lower-income families the hardest. A state tax incidence report released in December found households earning less than $48,000 per year effectively pay nearly one-quarter of their annual income to cover state and local taxes — with the property tax taking the most. That study included families and individuals that rent their housing, and whose rental charges reflect the property taxes their landlord must pay.

Further complicating matters, a $500 state income tax credit offered to the middle class to offset property taxes has ben whittled down to $300 this year, and drops to $200 next year.

“The estate tax is one of our most sensible taxes,” Farrell said, adding that “we just simply cannot afford any cuts in revenue.”

Sheldon Toubman, an attorney with New Haven Legal Assistance Association and an advocate for social services recipients, asked the finance committee to do more than simply preserve the estate and gift taxes.

“The safety net is being threatened with decimation because of the huge budget deficit,” Toubman said. “If that should happen, my clients would go without critical services, imperiling their health and, in some cases, even their lives. In addition, the budget deficit is threatening massive layoffs of state employees, many of whom are involved in direct service to our low-income clients.”

Toubman’s solution is for Connecticut to embrace the proposal of two New York state legislators, and look to the financial services sector — and hedge funds in particular — to contribute more.

Assemblymen Jeffrion Aubry and Sean Ryan have proposed amending the New York state income tax to collect funds that they argue hedge funds should be paying through the federal income tax, but don’t.

At issue is “carried interest,” which refers to one type of compensation hedge fund managers receive in the form of a percentage of their funds’ profits.

The federal government treats this interest as a long-term capital gain, which is taxed at 20 percent, rather than at the top marginal rate for more traditional income, which is 39.6 million.

In other words, Toubman says, if Congress won’t collect this money through the federal tax, Connecticut should scoop it up with state taxes.

Hedge fund principals “are not putting anything at all of their own at risk; rather, they are simply taking chances with other people’s money,” Toubman said. “The only reason that the federal tax loophole has not been fixed at the federal law is that wealthy individuals have lobbied extensively to maintain this special tax break relative to other individuals at the same high income level.”

But Sen. L. Scott Frantz of Greenwich, ranking GOP senator on the finance committee, said that if the estate tax already gives Connecticut a national reputation for punishing wealth, singling out hedge funds would send a negative message that would decimate the financial services sector of the economy.

“You’re talking about going after very bright people with the ability to move very easily,” Frantz said. “Why would you give them a reason to locate somewhere else? We want them here paying taxes.”

Rep. Rick Lopes, a Democrat from the blue-collar city of New Britain, said he hasn’t seen any hard data showing Connecticut’s wealthiest are fleeing the state faster than any other groups, such as college graduates who are struggling to find work.

“There seems to be a lot more anecdotal information about (wealthy) people leaving than facts and figures,” he said.