Lembo warns CT is not guaranteed another April tax bonanza

After years of watching state tax receipts fall short of expectations, Connecticut officials have enjoyed the last 12 months as they’ve amassed a $1.2 billion budget reserve — with the potential to sock away another $1 billion before the fall.

But for the last two months, Connecticut’s chief fiscal watchdog has been trying to temper expectations through his monthly budget forecasts.

And while Comptroller Kevin P. Lembo has not forecasted gloom-and-doom, he has warned it’s premature to say the bonanza will continue in the next forecast — due shortly after the April 15 income tax filing deadline.

Major changes in federal tax policy and a dangerous national trend in household debt are wild cards that cannot be ignored, the comptroller told CT Mirror this week.

“These items give me pause, but I am not in red light territory,” Lembo said, adding that his office “generally has a lot of agreement with the governor and the legislature on the strengthening of Connecticut’s economy and its balance sheet.”

At first glance, the state’s finances are looking up.

Connecticut has $1.2 billion in its budget reserve and Lembo estimates it could grow to $2.24 billion by the time he completes his audit of the 2018-19 fiscal year in late September.

That’s a potential rainy day fund equal to 12 percent of state finances, which would be the largest in state history — but still below the 15 percent reserve Lembo’s office recommends.

More importantly, all of this fiscal good news has sprung up over the last year, and neither economists nor state officials are entirely sure about the reasons for it.

Did many Connecticut households maximize the earnings they reported — and the taxes they paid — in federal and state income tax returns they filed last year? If they did so, presumably to take advantage of favorable-but-expiring federal income tax rules, that was a one-time bump Connecticut won’t enjoy again.

Similarly, a federal tax loophole that for years allowed hedge fund managers to accumulate offshore gains without paying federal and state income taxes closed last year. If that was a big factor behind last year’s bump in state income tax receipts, it also won’t happen again.

And then there’s the new cap on state and local tax payments that can be claimed as a deduction against federal income taxes.

This shouldn’t affect Connecticut’s income tax because the state levies its tax against federally adjusted gross income, which involves earnings before deductions are applied. But if this new federal limit led Connecticut households to make other choices, it could drive state tax receipts in one direction or another.

Factor in the stock market’s decline in the second half of 2018 and the picture grows murkier.

“Some of this is really uncharted territory,” Lembo said.

Further complicating matters, the comptroller added, is a new report questioning whether Americans are prepared for the next economic downturn — whenever it occurs.

The Federal Reserve Bank of New York recently reported that household debt has grown for 18 consecutive months. As of December 31, Americans owed a record-setting $13.54 trillion on mortgages, auto loans, student loans, credit cards and other debt.

This trend is starting to resemble a debt problem that existed prior to the last recession, Lembo said. “We know what followed,” he said, “and we know that we want to be careful about the ability of Connecticut households being capable of surviving another recession.”

Lembo added that “Connecticut’s overall budget results are ultimately dependent upon the performance of the national and state economies.”