Labor costs, tax receipts, threaten new CT budget before it starts

With Connecticut’s new fiscal year set to begin Friday, serious issues — involving both spending and revenue — have arisen in recent weeks that challenge state government’s new spending plan before it’s even begun.

And a major Wall Street credit rating agency questioned Monday whether Connecticut’s fiscal house is in order, If not, the state could face its third consecutive year of deficits.

“With weak tax collections likely to carry over into fiscal 2017, the state has limited flexibility to maintain a balanced budget,” Moody’s Investors Service wrote in its latest Credit Outlook newsletter. “Budget reductions are especially challenging to achieve in Connecticut, where fixed costs — the sum of pension contributions, retiree health contributions and debt service payments — claimed more than 25 percent of the state’s own-source governmental revenue in fiscal 2014.”

The state’s huge long-term liabilities, involving both unfunded retirement benefits and bonded debt, have made balancing the budget increasingly difficult for the governor and legislature in recent years. Costs tied to retirement benefits in particular are entering a cycle where they are projected to grow annually at a rapid pace for the next two decades as Connecticut compensates for past decades of inadequate savings.

“As the governor has said repeatedly, we must align spending with revenue,” Chris McClure, a spokesman for Gov. Dannel P. Malloy, said Monday in response to the analysis from Moody’s. “We’re in a new economic reality, and because personal income tax receipts are simply not meeting projections, we plan to take all necessary steps to balance the budget. We have been, and will continue to be, proactive about limiting spending to what we take in – just like the households we represent.”

After taking considerable heat 12 months ago for enacting a biennial budget that increased taxes by $1.3 billion and canceled more than $400 million in previously approved tax cuts, Malloy and his fellow Democrats in the legislature’s majority resolved this spring to avoid further tax hikes.

They closed a nearly $1 billion hole in the second year of that biennial plan, 2016-17, largely with cuts.

The revised budget does rely on some temporary revenues and other one-time sources. About $53 million in total would be swept from 14 smaller funds or off-budget accounts. Another $10.5 million hinges on enhanced tax collections and payoffs from lottery marketing.

Labor savings come up short so far

What was more controversial were nearly $325 million in labor-related savings built into the plan: $255 million in reductions to agency salary accounts and $69 million in extra “general employee” savings to be found by the Malloy administration after the fiscal year begins.

The governor announced in April he expected to eliminate 2,500 state jobs by mid-June. The bulk, about 1,900 to 2,000 would come from layoffs, and the remainder from retirements in the final three months of the 2015-16 fiscal year.

A mid-June deadline was set, Malloy said, to ensure the state could reap the savings from these job cuts both during the last two pay periods of the outgoing fiscal year and during all of 2016-17.

But through Monday, the administration had announced just 724 Executive Branch layoffs. Combined with 239 layoffs ordered by the Judicial Branch, 962 permanent positions — about half of what the governor projected — have been eliminated.

Spring retirements compensated for some of that shortfall. According to Comptroller Kevin P. Lembo’s office, 947 retirement requests have been filed since April 1.

Still, that means 1,909 jobs have been eliminated to date, about three-quarters of the 2,500 Malloy anticipated.

Further complicating matters, legislators acknowledged they had budgeted for more labor savings than would be achieved if Malloy carries out all of the layoffs he has planned.

The administration has not commented on the reasons why downsizing efforts are progressing more slowly than planned, other than to say those efforts are continuing.

As of the end of May, there were 23,866 full-time executive branch employees — excluding those in higher education — paid for from the General Fund. That’s down 2.8 percent from one year ago and 6.3 percent from December 2010, just before Malloy’s administration began.

Negative revenue trends continue

Connecticut’s finances also face problems on the revenue side of the ledger.

Malloy’s budget office announced last week that the deficit for the outgoing fiscal year had grown by about 20 percent, stretching to $316 million.

The main reason for that negative trend was eroding tax receipts. Specifically, the administration downgraded expected income tax receipts by $75 million, and sales tax revenues by $28 million.

And since prior year’s tax receipts are a crucial factor used to project likely revenues in the following year, the new forecast probably lowers analysts’ expectations for the 2016-17 fiscal year.

Much of the state’s income tax woes reflect lower-than-anticipated revenues tied to capital gains, dividends and other investment-related income.

Moody’s noted in its analysis that while other Northeastern states are faced with weakening income tax receipts, Connecticut’s chief revenue engine also is plagued by modest job growth.

“Connecticut’s weakness in PIT (personal income tax) withheld from paychecks indicates that the source of the underperfomance is more deep-seated than a shortfall in capital gains,” the analysis states. “In calendar 2015, the state’s job count grew by 0.7 percent, less than half the nation’s pace, and state job growth continued to lag the nation through May 2016.”

All General Fund tax revenues combined in the outgoing fiscal year are on pace to finish $600 million below original projections.

Moody’s also noted that the outgoing year’s deficit would further drain Connecticut’s modest emergency reserve, commonly known as the Rainy Day Fund. After the red ink in 2015-16 is covered, the state is expected to have just $90 million in reserve, an amount equal to roughly one-half of 1 percent of annual operating costs. Lembo recommends a reserve of 15 percent.

State law gives the governor limited authority to reduce spending without requiring legislative approval.

This unilateral rescissionary authority, which is restricted to no more than 5 percent from any line item and cannot reduce municipal aid, traditionally is rarely used before the second quarter of the fiscal year — particularly in a state election year.

Gian-Carl Casa, spokesman for the governor’s budget office, said last week only that administration officials “don’t have any plans to implement rescissions at this time.” But he also did not rule out the prospect that this could change.

Rep. Toni E. Walker, D-New Haven, co-chair of the Appropriations Committee, said she is wary of possible budget cutbacks, but stopped short of predicting them.

Walker said she would like the administration to brief her committee early this summer on the changing budget dynamics. “We need to get an honest review of where we are financially,” she said, adding that lawmakers aren’t done safeguarding the state’s finances just because the regular 2016 legislative session is over. “Our responsibility continues right into the beginning of the next session.”

But the top Republicans in the Democrat-controlled legislature said Monday that the Wall Street rating agency’s cautious statements about Connecticut are not surprising.

“The moment we start the new fiscal year July 1 we are automatically walking into another potentially huge deficit, based on the most recent figures,” said House Minority Leader Themis Klarides of Derby. “The promised savings in personnel costs: layoffs, retirements, unfilled vacancies and healthcare, are not going to be achieved. Again.

“We fixed nothing in the budget,’’ Klarides added. “The rating agencies understand this.’’

“I always believed that this budget was a budget that was doomed,” said Senate Minority Leader Len Fasano of North Haven.

GOP leaders insisted that major concessions from labor unions are needed to reduce costs over the long-term. Union leaders have said that workers, who granted concessions in 2009 and 2011, would not do so again, and that legislators should raise taxes on wealthy households and corporations.

Fasano said he believes this new budget is designed to “push away” the long-term fiscal challenges temporarily until after the November elections, after which Democrats would support another tax increase.