The analysis from Moody’s Investors Service also said Connecticut, New York and New Jersey — whose economies are tied most directly to the Wall Street-centered financial services sector — also could be headed for a clash with the IRS as they change state tax laws to mitigate these trends.
Meanwhile, the Connecticut Conference of Municipalities called this week on the General Assembly to enact legislation to shield communities’ emergency budget reserves from arbitrated labor contract settlements.
New federal tax laws limiting deductions for state and local tax payments and mortgage interest “will present a significant headwind” to Connecticut, New York and New Jersey “due to the region’s high state and local taxes and high home prices,” Moody’s wrote.
This analysis asserts this probably would dampen the growth in housing prices and lead to “tepid growth” in property valuations. As a result, property tax receipts could stagnate or decline except in communities that opt to increase local tax rates.
Connecticut, New Jersey and New York are particularly vulnerable because they feature relatively high taxes at both the state and local levels, according to Moody’s.
Connecticut Conference of Municipalities spokesman Kevin Maloney said this week that, “There is no way to sugarcoat the fact that the recently passed sweeping federal tax reform will adversely impact a majority of property taxpayers and town and city governments across Connecticut. Limiting the ability of Connecticut towns and cities to write off property tax paid annually will only place more pressure on the property tax in Connecticut, making Connecticut local economies and tax environment more uncompetitive and depressing the value of homeownership.”
Connecticut residents already take the second-highest average deduction for state and local taxes, Maloney said. More than 41 percent of Connecticut federal returns included a SALT deduction in 2014, with the average deduction close to $19,000 per filer.
Municipal governments with high fixed costs, such as significant bonded debt or poorly funded retirement benefit programs, will have less flexibility to respond, according to Moody’s.
Connecticut communities dodged a fiscal bullet in this area last year when the General Assembly refused to accept a proposal from Gov. Dannel P. Malloy to shift as much as one-third of the state’s required annual contribution to the teachers’ pension fund onto municipal budgets.
CCM, which fought the pension cost shift proposal last year, is pushing now for lawmakers to enact a measure that would prohibit an arbitration panel from considering a municipal fund balance of 15 percent or less when calculating the financial capability of a municipality to pay employee salaries and benefits.
“Connecticut faces an unprecedented credit-rating crisis, with Moody’s questioning the ratings of 26 additional cities and towns, adding to 25 already with negative outlooks,” said Joe DeLong, CCM executive director. The bill proposed this year “aims to protect the municipalities of Connecticut from passing the effects of these ratings down to the citizens of the state.”
Governor Malloy asked lawmakers this year to make two changes to state tax law to help mitigate the pain of federal tax restrictions on municipalities and businesses.
One proposal would allow municipalities to create charitable organizations to support local services, offering property tax credits in exchange. A second would help small businesses to reduce federal income tax liability through a change in how they pay taxes to the state — at no cost to Connecticut.
“This report from Moody’s echoes the warnings from the administration from the start of the negotiations on this terrible policy last year,” Chris McClure, spokesman for the governor’s budget office, said this week. “We have proposed changes to state law that we think can help ameliorate some of the potential harms to Connecticut taxpayers, our municipalities, and our state’s economy. … The simple truth is that the cap on SALT deductions is bad for these blue states because that is exactly what the Republican Congress intended.”
The governor also announced in late January that Connecticut would join New York and New Jersey in a lawsuit challenging the constitutionality of the new federal limits on state and local tax deductions, a change that primarily falls on a dozen states that voted against President Trump in 2016.
State Comptroller Kevin P. Lembo also has called for Connecticut to attempt to counter some of the federal tax policy changes.
“Connecticut cannot tolerate federal tax policies that impede economic growth in our state while asking Connecticut taxpayers to fund programs and services in debtor states like Mississippi, West Virginia and the Carolinas,” Lembo said. “This Moody’s report is an acknowledgement of what Connecticut already knows – that recent federal tax changes will have damaging consequences for Connecticut’s entire economy. It is no surprise that Moody’s recognizes the implications of federal tax policy for Connecticut in suppressed housing and revenue growth, and other consequences.”
Lembo added that Connecticut pays more federal taxes per capita than most other states, receiving back about 87 cents in federal assistance for every $1 Connecticut pays into Washington.