CT tax revenue in free fall, adding $1.1B in red ink for next 2 years

Plummeting state income tax collections are experiencing their worst decline since the last recession, falling $450 million below anticipated levels for April — one-and-a-half times the free fall projected just one day ago.

More importantly, the escalating erosion means income tax projections for the next two fiscal years must be downgraded by $500 million and $600 million, respectively, Gov. Dannel P. Malloy’s administration said Thursday.

That adds $1.1 billion to an already daunting $3.6 billion deficit forecast, all but shattering hopes of avoiding tax increases or big municipal aid reductions in the next budget.

The new trend also means the state probably will:

• Close its third successive fiscal year in deficit;
• And deplete its $235.6 million emergency budget reserve.

It increases the risk that state government might have to borrow to cover operating costs for the first time in eight years — even though it still hasn’t paid off nearly $1 billion in operating debt from the last recession.

It also means all budget proposals for the next two fiscal years — including a plan Republican lawmakers expect to release later today — already are significantly out of balance. That’s because all plans were based largely on the last official revenue forecast, which was released back in mid-January.

Malloy’s administration, which already has scheduled a meeting Monday with legislative leaders to tackle the income tax problem, ordered an Executive Branch hiring freeze and warned department heads by memo to brace for layoffs.

“The drop in income tax revenue that we have experienced this April creates some major challenges for state government,” said Office of Policy and Management Secretary Ben Barnes, Malloy’s budget director. “First, we need to take every action available to us to reduce spending between now and June 30 to reduce our current year deficit as much as possible.  We are doing this now.  Second, we need to develop new approaches to further reduce spending in order to balance the budget for the years ahead.  Our budget, which already demanded painful choices, has just become $500 million worse.  We cannot afford to stay on our current course.”

State officials were stunned Monday when they learned income tax collections were running $267 million below anticipated levels for April. By Wednesday, the erosion had appeared to stabilize at $293 million.

But that was just a tune-up for the problem the administration reported Thursday.

The governor’s budget office indicated that tax collections for April now are running 30 percent below anticipated levels. And the bulk of that shortfall stems not from paycheck withholding, but from quarterly income tax returns — the chief means of reporting capital gains, dividends and other investment-related earnings.

Long recognized as the most volatile component of the income tax, capital gains and dividends traditionally drop sharply, pulling overall income tax receipts down with them, during economic slumps.

A comprehensive estimate of all state revenues is due to legislators from the Malloy administration and from the General Assembly’s nonpartisan Office of Fiscal Analysis on Monday.

But total income tax receipts now are expected to finish this fiscal year, which ends June 30, at just under $9 billion, down from $9.43 billion last fiscal year, a loss of 4.7 percent.

That marks the first time income tax revenues decline from the prior year since 2009, though Connecticut did order tax  hikes that took effect in 2010, 2012 and 2016.

Worst fiscal crisis since the last recession?

The outlook for the next state budget now represents the most dire forecast since Gov. M. Jodi Rell left office in 2010.

Nonpartisan analysts at that time warned that the first two-year budget of the new administration, unless adjusted, would spend a whopping $7.2 billion more than it would take in — a gap of more than 17 percent.

Malloy warned legislators back in February that his staff projected potential gaps of $1.7 billion next fiscal year and $1.9 billion in 2018-19, or $3.6 billion for the biennium.

Lopping another $1 billion off of anticipated income tax receipts in each of the next two fiscal years would push that shortfall to $4.7 billion, a shortfall equal to 12 percent of operating expenses.

Further complicating matters, Connecticut probably would enter the next fiscal year with no reserves.

The Rainy Day Fund currently holds $235.6 million, according to Comptroller Kevin P. Lembo’s office. That modest amount is equal to only 1.3 percent of annual operating costs. It is well below the 15 percent level the comptroller recommends as well as the $1.4 billion mark, or 8 percent, Connecticut held in 2008, just before the last recession.

Even though revenue from federal grants is running $30 million ahead of expectations, that bonus and the $236 million Rainy Day Fund fall far short of the projected income tax gap of $450 million for the current fiscal year.

Hiring freeze and layoffs in the works

Whether Connecticut can avoid borrowing largely will hinge on whether the administration can reduce spending quickly over the remaining nine weeks of the fiscal year.

Besides the hiring freeze, the administration also is looking at downsizing the workforce further.

Malloy, who has been in talks with state employee unions since November, is seeking concessions worth $700 million next fiscal year and $869 million in 2018-19.

The governor expressed disappointment earlier this month that the talks hadn’t produced a deal yet. Last week he took the first in a series of procedural steps to begin another round of state worker layoffs.

The administration specifically notified bargaining units that 11 departments and agencies had crafted plans that could affect close to 1,100 workers and also lead to elimination of about 120 unionized positions that are vacant.

The governor already has reduced the Executive Branch workforce, excluding public colleges and universities, by more than 9 percent since he took office in 2011.

CT still paying off debt from last recession

And Connecticut still hasn’t cleaned up all of its fiscal mess from that last economic downturn.

In late June 2009, Rell and the legislature faced a nearly $950 million deficit as the fiscal year wound to a close.

They opted to borrow nearly $1 billion — about $950 million to close the deficit and nearly $50 million more to cover borrowing costs and the first two years of payments on that debt.

This enabled Rell and the 2009 legislature to ensure their successors would have to oversee repayment of the entire debt starting in 2011.

Connecticut still owes more than $200 million on that debt and is scheduled to complete repayment on it next fiscal year.