CT has a surplus – for now

State government’s new budget year is off to a healthy start, but there’s good news and bad news in the numbers.

Gov. Dannel P. Malloy’s administration announced Monday that state finances have been running almost $138 million in the black since the fiscal year began on July 1.

But because of a new provision in state law designed to encourage savings, one key component of surging state income tax receipts tied to capital gains and dividends won’t be available to avert a much larger looming budgetary crisis.

“It is important to note that this represents the first projection of the state’s budget outlook for FY 2019,” Malloy’s budget director, Office of Policy and Management Secretary Ben Barnes, wrote in his monthly analysis to Comptroller Kevin P. Lembo. “As the year progresses, these estimates will undoubtedly be revised to reflect the impact of changes in the economy, expenditure patterns, and/or other factors.”

Still, the General Fund, which covers the bulk of operating costs and represents $19 billion out of the total $20.85 billion state budget, is on pace for a surplus just shy of three-quarters of 1 percent.

Though modest, this is a departure for the Malloy administration, which has struggled for the better part of the past seven-and-a-half years with deficits. The red ink has piled up as Connecticut has tried to catch up on more than seven decades of inadequate savings for pensions and other retirement benefits pledged to state employees and municipal teachers.

The new surplus projection is tied largely to income tax receipts, which are running $97 million ahead of projections. The sales tax is outperforming expectations by $58 million.

These revenue gains are offset somewhat, though, by about $36 million in cost overruns, focused chiefly on the prison system and the Department of Children and Families.

The income tax surge follows a pattern that began last April, when spring tax receipts finished a whopping $1.5 billion above original projections.

Administration officials and many economists warned that much of last fiscal year’s bonanza might be a one-time event, for two reasons.

One, many households inflated their quarterly state income tax payment last December to take advantage of favorable federal income tax rules that expired after the 2017 calendar year.

And, two, a federal income tax loophole that for years allowed hedge-fund managers to accumulate offshore gains without paying federal and and state income taxes closed last year, leading to a one-time surge in tax payments.

Still, that left Connecticut’s emergency budget reserve — commonly known as the rainy day fund — at its highest level since before the last recession. The reserve currently holds about $1.1 billion, which is equal to 6 percent of the General Fund.

Lembo recommends a reserve of 15 percent.

To put it in further perspective, the legislature’s nonpartisan Office of Fiscal Analysis projects state finances — unless adjusted — will run $2 billion in deficit in the first fiscal year after the November elections, a potential gap of 10 percent. And the projected shortfall grows to $2.6 billion, or 13 percent, by the 2020-21 fiscal year.

Much of those deficit forecasts are driven by skyrocketing retirement benefit costs and other debt expenses.

Further complicating matters is a new “volatility cap” that lawmakers enacted last November to force the state to do a better job saving money.

The cap specifically forces the state to save income tax receipts related chiefly to capital gains and other investment earnings — which are highly volatile — whenever Connecticut’s annual tax clears a threshold level. This fiscal year that mark is about $3.1 billion.

So while the extra $97 million in income tax receipts tied to paycheck withholding are driving the latest surplus forecast, another $85 million in unanticipated receipts — this amount tied to capital gains and dividends — is subject to the volatility cap.

In fact, Barnes’ office estimates as much as $448 million in extra income tax receipts could come in — and fall subject to the volatility cap — before the fiscal year ends on June 30.

But that also means the next governor and legislature could touch none of those capped income tax receipts next spring when they must adopt the next biennial budget — and close those $2 billion-plus deficit projections.

State officials also don’t have the option of repealing the volatility cap until 2023.

To make sure this cap, and other new spending and borrowing constraints, stay in place, the legislature mandated the state must pledge not to alter these caps for five years in the covenants accompanying bonds issued earlier this summer. 

The state sells bonds on Wall Street to finance various capital projects. The covenant essentially is a contract between the state and the investors that buy those bonds.