Updated at 7:10 p.m. with comments from legislative leaders.

New reports show dramatically eroding state income tax receipts that could expand the deficit in the next two-year budget by more than $500 million while depleting existing reserves.

Although six more days remain before analysts complete their review of April income tax receipts, the new numbers also raise the prospect state government may have to borrow to balance the current budget — the first time Connecticut has had to do so in eight years.

And these reports come as Gov. Dannel P. Malloy and legislators are scrambling to avoid raising income tax rates for the third time since 2011.

The legislature’s nonpartisan Office of Fiscal Analysis notified the Finance, Revenue and Bonding Committee on Monday that April receipts are running $267 million below the level anticipated in this fiscal year’s adopted budget.

April income tax returns are crucial because they also are one of the prime factors used to project likely tax revenues for the next two fiscal years.

In other words, if the early returns hold, and if April receipts are down 20 percent or $267 million, that probably would prompt analysts to reduce expected revenues for each of the next two fiscal years by a similar amount, or more than $500 million for the upcoming biennium.

In a rare commentary included with Monday’s report, nonpartisan analysts said it appears that a “pessimistic scenario” that is related to the last state budget is playing out.

“Under this scenario, the decline in revenue experienced in FY 16 leads to individuals spending and investing less in Connecticut, resulting in a potential ‘echo’ effect similar to what happens after a recession,” the office wrote. “This results in a decline in aggregate economic activity which impacts a large group of taxpayers, but to varying degrees.”

Gov. Dannel P. Malloy mark pazniokas / ctmirror.org

When Malloy spoke with Capitol reporters last Thursday, he warned that “the next 72 hours” would be crucial for determining the revenue outlook for the next state budget.

“We are tracking revenue very closely as we are in the middle of our highest collection period,” Chris McClure, spokesman for the governor’s budget office, said Monday. “We will hold off from drawing any conclusions until later this week when we will have a clearer picture.”

State finances already are expected to be in dire straits over the next two fiscal years unless significant changes are made.

Finances, unless adjusted, are on pace to run $1.7 billion in deficit in 2017-18, and $1.9 billion in the red in 2018-19, according to Malloy’s administration, for a combined biennial shortfall of $3.6 billion.

Nonpartisan analysts last projected the potential, two-year deficit at $3 billion, including $1.4 billion in the first year and $1.6 billion in the second.

If the April income tax estimates hold, the worst-case deficit forecast from the Malloy administration would approach $2 billion in 2017-18 and $2.2 billion in 2018-19.

These represent potential gaps of 10 percent and 11 percent, respectively.

Eroding receipts compound challenges

This threatened erosion of income tax receipts could complicate two other aspects of the next state budget debate: tax increases and worker concessions.

Malloy has urged legislators to close the majority of the upcoming budget deficits with spending cuts rather than tax hikes.

The Democratic governor and some legislators — particularly Republicans — argue that diminishing tax returns are a sign that Connecticut must resist another rate increase for its income tax and other major levies.

But the other side of that coin involves a sizeable, growing projected deficit driven largely by surging retirement benefit costs.

As the deficit grows larger, the state has fewer options capable of raising enough revenue or reducing expenditures sufficiently to close a gap of that size.

AFSCME Council 4 spokesman Larry Dorman CTMirror.org

Malloy is seeking major concessions — worth $700 million next fiscal year and $869 million in 2018-19 — from state employee unions.

But unions, which granted concessions in 2009 and 2011 and also agreed this year to allow Connecticut to defer some payments into the employee pension fund, have argued the state must increase taxes on wealthy households and on major corporations.

“It is apparent from the ongoing revenue shortfalls and the continuing struggle of the middle and working class that our current tax structure is inadequate in ways other state like Minnesota – which raised taxes on the wealthy – have overcome,” said Larry Dorman, spokesman for Council 4 of the American Federation of State, County and Municipal Employees, one of the largest state employee unions.

“We’ve said it before, and we’ll keep saying it: the budget cannot be balanced on the backs of taxpaying public employees who provide vital services that make our state a better place to live, work and learn,” Dorman said. “Connecticut is the wealthiest state in the richest country on the planet, yet continues to tax labor before wealth. Restoring taxes on the ultra-wealthy and big corporations is not only fair, it’s a demonstration that sacrifice will truly be shared.”

GOP: Stop public hearing on income, sales tax hikes

Meanwhile, Senate Republican leaders urged their Democratic counterparts to scrap plans for a public hearing Tuesday on bills to raise income and sales taxes.

Senate Republican President Pro Tem Len Fasano of North Haven and Sen. L. Scott Frantz of Greenwich, the Senate GOP chair on the Finance, Revenue and Bonding Committee, said the conversations about three proposals could harm the economy. The measures would:

  • Raise the top marginal income tax rate from 6.99 to 7.49 percent;
  • Raise the base sales tax rate from 6.35 to 6.99 percent;
  • And broaden the sales tax base by ending the exemption on sales to nonprofit entities.

These proposals “are extremely concerning in light of” the eroding income tax projections, Fasano and Frantz wrote in a letter to the Democratic chairs on the finance committee, Sen. John Fonfara of Hartford and Rep. Jason Rojas of East Hartford.

“We urge you to stop further conversations about creating a budget that once again relies on closing a deficit with massive tax increases,” Fasano and Frantz added. “Just hearing these bills is detrimental to our state and sends a message to businesses and families about the direction our state is headed.”

But Democratic leaders have said they only are exploring tax increase concepts at this time.

“I can understand their (Republicans’) concern,” Rojas said. “But this is a public hearing.”

Rojas noted that the Connecticut Conference of Municipalities, working with Democratic and Republican municipal leaders, asked legislators to explore a sales tax increase as a means to protect local aid and to shield property taxpayers in tough fiscal times.

“I think every member of the legislature has run on property tax reform in at least one election cycle, and that’s what this is about,” he said.

Fonfara could not be reached for comment Monday afternoon.

The finance committee has scheduled Tuesday’s public hearing for 11:30 a.m. in the Legislative Office Building.

Will Connecticut deplete its reserves?

The eroding income tax receipts also threaten finances for the current fiscal year.

The $267 million potential income tax shortfall already exceeds the state’s modest $235.6 million emergency reserve, commonly known as the Rainy Day Fund.

Further compounding matters, nonpartisan analysts and Comptroller Kevin P. Lembo both said the current budget already is in deficit — before the latest income tax trends were reported.

The Office of Fiscal Analysis projected back on March 27 that Connecticut would finish the current fiscal year $45 million in deficit.

Lembo pegged the shortfall on April 3 at $44.6 million.

The Malloy administration generally has been more optimistic about tax revenues and still was projecting a small surplus — $19.7 million in an $18.1 billion General Fund — as late as April 20.

“At this rate, we will show a deficit at the end of the fiscal year June 30 which further complicates the task of getting our state’s finances back on solid ground,” House Minority Leader Themis Klarides, R-Derby, said. “However, Republicans are committed to doing just that.’’

Connecticut last had to borrow to balance its books eight years ago, during Gov. M. Jodi Rell’s administration, when it closed the 2008-09 fiscal year about $1 billion in the red.

State government had more than $500 million in its emergency reserve two years ago.

But state officials whittled down that cushion to cover deficits. The state finished the 2014-15 fiscal year with a $113 million deficit and 2015-16 with a $170 million shortfall.

Keith has spent most of his 31 years as a reporter specializing in state government finances, analyzing such topics as income tax equity, waste in government and the complex funding systems behind Connecticut’s transportation and social services networks. He has been the state finances reporter at CT Mirror since it launched in 2010. Prior to joining CT Mirror Keith was State Capitol bureau chief for The Journal Inquirer of Manchester, a reporter for the Day of New London, and a former contributing writer to The New York Times. Keith is a graduate of and a former journalism instructor at the University of Connecticut.

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