Despite a 12-month surge in state tax receipts, Gov. Dannel P. Malloy’s budget office warned Thursday that Connecticut’s pension obligations and other debt will grow faster than revenues in the coming years.

The administration’s Fiscal Accountability Report — a mandated annual assessment of a wide array of fiscal health indicators — also repeated its call for a long-term strategy to deal with teachers’ pension contributions, one of the fastest-growing segment of the state budget.

“Absent any recession, the (tax revenue) growth rates remain conservative and well below growth experienced in prior recoveries,” the Office of Policy and Management wrote in its report.

At first glance this seems counter to recent evidence.

Connecticut boosted its budget reserves from $212 million to almost $1.2 billion over the past fiscal year, driven largely by spiking state income tax receipts.

And initial projections show the state could deposit another $900 million in the rainy day fund after this fiscal year ends on June 30 — with the income tax again a major factor.

But the administration warns there are several reasons to be cautious.

The state income tax gets about two-thirds of its receipts from paycheck withholding and the rest from quarterly filings — which largely reflect capital gains, dividends and other investment earnings.

Traditionally this has been one of the most volatile components of the entire state tax system, experiencing double-digit percentage growth or shrinkage depending on the economy.

But since the last recession ended in early 2010, Connecticut’s goose that lays golden eggs has grown more conservatively.

And while there are positive economic signs, including job growth and extra receipts from paycheck withholdings, the latest surge is partly “an outlier,” the report states.

Why? There are two reasons, and neither is likely to generate a long-term trend.

Many households inflated their quarterly state income tax payments this past winter to take advantage of favorable federal income tax rules that expired after the 2017 calendar year.

And 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 this past year, leading to a short-term surge in payments.

By 2021 and 2022, the administration predicts, the capital gains and dividends portion of the income tax should be growing at a modest 2 percent a year — provided Connecticut and the nation are not in a recession.

And there’s another reason to be cautious, according to the governor’s budget office. What are commonly called “fixed costs” are not staying fixed.

Required contributions to pension funds, a retirement health care program for state employees, Medicaid and other federal entitlements already approach 45 percent of the budget. They are deemed “fixed” costs not because they can’t rise, but rather because it is difficult for state government to reduce them.

And this report doesn’t even address two other major “fixed” costs in state government, salaries and non-retirement benefits for employees.

Still, the governor’s budget office warns that the fixed costs that were analyzed will grow $620 million next fiscal year, or roughly 8 percent. There will be similar growth for the next two years after that as they jump $569 million and $552 million, respectively.

Republican gubernatorial candidate Bob Stefanowski, who lost the 2018 campaign to Democrat Ned Lamont, repeatedly pledged to take a “zero-based” approach to state finances, making no assumptions about expenditures when preparing his own budget. That claim was highly contentious during the race largely because Connecticut carries a larger share of fixed costs on its budget than do most other states.

Perhaps the largest fixed cost involves the $1.39 billion contribution Connecticut must make next fiscal year to its pension fund for municipal teachers.

Like the pension fund for state employees, Connecticut routinely short-changed contributions to the pension fund for teachers between 1939 and 2010, leading analysts to project a massive surge in costs between now and the mid-2030s.

Connecticut and state employee unions agreed last year to restructure payments into the employees’ pension fund, shifting billions of dollars of expenses onto taxpayers after 2032.

But the state borrowed $2 billion in 2008 to shore up the teachers’ pension and pledged in its covenant with bond investors not to tamper with pension contributions until the bonds are paid off.

That isn’t scheduled to happen until 2032 and the earliest the state likely could pay off that debt is 2025.

“Failure to address the funding issues in TRS (Teachers Retirement System) leaves the state exposes to annual increases (in contributions) amounting to hundreds of millions of dollars each year throughout the coming decade,” the report states.

The governor has recommended that the state study an option raised earlier this year by the state Commission on Fiscal Stability and Economic Competitiveness.

It recommended that legislators consider dedicating an asset, such as the annual proceeds it receives from the quasi-public Connecticut Lottery Corporation, to a pension fund.

The lottery sent between $330 million and $338 million into the budget’s General Fund in each of the past two fiscal years. If this stream were pledged to the teachers’ pension for a decade — and if reasonable growth is assumed from the investment of those revenues — it could be worth $4.5 billion to $5.5 billion to the pension fund over this period.

This would raise the teachers’ pensions’ funded ratio beyond 70 percent. In other words, it would — with the lottery revenue stream — have enough assets to cover more than 70 percent of its long-term obligations.

The bond covenant does allow the legislature and governor to modify pension contributions modestly, provided the funded ratio is in excess of 70 percent.

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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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