Budget director Benjamin Barnes at the forum mark pazniokas / ctmirror.org file photo
State budget director Ben BarnesUpdated at 3 p.m.} mark pazniokas / ctmirror.org file photo

Updated at 3 p.m.

Connecticut’s latest budget nightmare became reality Monday.

Analysts for Gov. Dannel P. Malloy’s adminstration and the legislature’s nonpartisan Office of Fiscal Analysis downgraded anticipated revenues for the next two fiscal years by $1.46 billion — nearly $600 million next fiscal year and $865 million in 2018-19 — largely because of eroding income tax receipts.

Projected revenues now fall $2.2 billion, or 11.3 percent, short of the funding needed to maintain current services in 2017-18. And with the potential deficit swelling to $2.7 billion, or 13.6 percent, in 2018-19, the biennial shortfall approaches $5 billion.

Further complicating matters, revenues for the current fiscal year are $413 million below anticipated levels. This pushes state finances more than $380 million in the red and threatens to deplete the $236 million in the emergency budget reserve with less than nine weeks remaining before June 30.

“The precipitous drop in revenue we experienced in late April creates major challenges for the state throughout the remainder of this fiscal year and into the next biennial budget we are currently working on,” Office of Policy and Management Secretary Ben Barnes, Malloy’s budget chief, said Monday. “We need to take immediate action to reduce spending between now and June 30 to reduce our current-year deficit as much as possible to prevent the need to borrow to meet expenses. We also need to develop new, additional approaches to further reduce spending in order to balance the budget for the years ahead.”

Barnes added that, “We cannot afford business as usual. Our current economic environment compels action and compromise.”

“Today is a devastating day for the state of Connecticut,” Sens. Len Fasano of North Haven and Kevin Witkos of Canton, the two highest-ranking GOP senators, said. “A nearly $5 billion historic deficit over a two-year period is staggering. For the past six years, Republicans have sounded the alarm. What we have to do now is change the state’s failing policies. Tomorrow the work begins.”

Income tax took the biggest hit

The income tax, the state’s largest revenue engine, saw the most erosion by far.

According to analysts, income tax receipts this fiscal year now are expected to total just under $9 billion. Not only is that well below the $9.44 billion analysts were anticipating just four months ago, but it falls short of the $9.2 billion collected last fiscal year.

Malloy noted Monday this report comes with some dangerous signs.

Income tax receipts are eperiencing their first major decline since 2009 — just as Connecticut fell into The Great Recession.

And the bulk of the latest income tax erosion was tied not to paycheck withholding but to quarterly filings, most of which involves capital gains, dividends and other investment-related earnings.

According to the governor’s budget office, the state’s 100 largest-income taxpayers paid 45 percent less this year than last.

Malloy: Stop targeting hedge funds for tax hikes

With Connecticut’s economy — and the state budget — heavily reliant upon the financial services sector, and hedge funds in particular, Malloy called for legislators to resist discussing boosting taxes on this group.

The governor asked legislators “to be careful what you’re saying about them. This is an important industry.”

And some ideas should not be discussed at all, the governor added.

For example, labor advocates and other progressives have suggested that Connecticut respond to the “carried interest” loophole within the federal income tax system by imposing a surcharge close to 20 percent on the earnings of hedge fund managers.

The “carried interest” provision in the federal tax allows hedge fund managers to pay a 20 percent capital gains rate on their income rather than the top marginal rate for earnings in the federal system, which is 39.6 percent.

“We should stop that kind of discussion, quite frankly,” Malloy said.

But while the proposed “hedge fund” tax increase has very little support in the General Assembly, it remains unclear whether lawmakers will turn to another increase in the top marginal rate within the state income tax — a solution they employed in 2011 and again in 2015.

And the last time Connecticut faced a potential deficit in the upcoming fiscal year in double-digit percentages, in 2011, an income tax increase aimed at both wealthy and middle-income households was the single-largest means used to close that gap.

The Finance, Revenue and Bonding Committee conducted a public hearing last week on a proposal to increase the top marginal rate on the income tax from 6.99 to 7.49 percent. But the panel did not recommend that hike, which would have applied to households earning more than $500,000 per year.

Sales tax slips, but estate tax revenues grow

The second-largest source of tax revenue, the sales tax, declined slightly in the new forecast.

Analysts already had been warning that sales tax receipts should drop from about $4.2 billion this fiscal year to just under $3.9 billion in 2017-18.

Now they project next fiscal year’s receipts at $3.84 billion, downgrading their 2017-18 estimate by a fraction of 1 percent.

Legislators also have considered proposals to increase the sales tax rate from 6.35 to 6.99 percent, and to broaden the base to include sales to nonprofit entities.

But the finance committee did not recommend either of these changes as well.

Malloy and several legislators have argued that Connecticut’s inheritance and estate taxes are driving the wealthy out of the state, and have proposed reducing these burdens.

But the new consensus forecast upgrades expected receipts from these taxes from $175 million to $186 million for the current fiscal year.

The report also predicts such receipts will remain above $180 million for each of the next two fiscal years.

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Keith M. PhaneufState Budget Reporter

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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