Connecticut’s record-setting rainy day fund is running on borrowed time
Gov. Ned Lamont spent his first year in office trying to keep legislators from spending a $2 billion-plus rainy day fund.
By the end of his second year — in December — that likely won’t be an issue any more.
Though little is certain amidst unprecedented economic chaos and partisan feuding over federal relief for states, Connecticut’s fiscal leaders agree on one thing: The worst-case scenario — no fiscal cushion and a revenue base down $1 billion or more — could be facing Lamont and state lawmakers as early as February when they start crafting Connecticut’s next budget.
And the best-case scenario isn’t much better.
“To be blunt,” Lamont said Monday as he teased the upcoming revenue forecast, “the numbers are not very pretty.”
The governor’s budget agency and the legislature’s Office of Fiscal Analysis will take their first stab at charting the chaos later today when they project revenues for the fiscal year that begins July 1.
Lamont’s predecessor, Dannel P. Malloy, struggled for seven of his eight years in office with little or no reserves because he inherited an empty rainy day fund and more than $1 billion in operating debt when he took office in 2011. And while he didn’t foresee the pandemic, Lamont spent much of his first year in office urging legislators to leave the reserves alone, assuring them they would, inevitably, be needed for one crisis or another.
That crisis has arrived, and not just in Connecticut.
The Center on Budget and Policy Priorities, a Washington, D.C.-based fiscal think-tank, estimated Wednesday that state budget shortfalls nationally will total an unprecedented $650 billion across this fiscal year and the next two — upping by 30% the nightmare scenario it released just two weeks ago.
Only $65 billion in federal stimulus has been provided to date to narrow those shortfalls. After states drain their cumulative $75 billion in reserves, there’s another $510 billion shortfall that must be dealt with through tax hikes, spending cuts, borrowing — or all of the above.
“Without substantial federal help, [states] very likely will deeply cut areas such as education and health care, lay off teachers and other workers, and cancel contracts with businesses,” wrote Michael Leachman, the center’s senior director of state fiscal research. “That would worsen the recession, delay recovery, and hurt families and communities.”
Far too many unknowns
Just how ugly things will get in Connecticut is expected to remain a mystery for many months, because too many unknowns remain.
First, no one knows how many jobs the state really has lost.
Through Tuesday, the Department of Labor had received an astronomical 427,000 applications for unemployment benefits dating back to mid-March. That’s three-and-a-half times larger than all jobs lost in the last recession.
State officials hope most of those jobs will return when shuttered or scaled-back businesses reopen or expand service later this spring or summer. But economists also insist many of those jobs are lost for good.
And it’s not just retail, restaurant and hospitality jobs directly affected by the shutdowns that are vulnerable.
The Dow Jones Industry Average through mid-week had plunged almost 20% since mid-February. Barring an immediate and pronounced rebound, state analysts expect that to take a toll on Connecticut’s income tax revenues, which rely heavily on nearby Wall Street.
One-quarter of all tax receipts, about $2.5 billion this fiscal year, were expected to come from quarterly filings — most of which involve capital gains and other investment-related earnings.
New York State Comptroller Thomas DiNapoli projected in late March a sharp drop in Wall Street bonuses in 2020, and a need for governments to prepare for the “severe budgetary implications of the coronavirus crisis.”
“All of the economic inputs, without exception, are not operating in their normal way,” said Connecticut Comptroller Kevin P. Lembo. This extends not just to financial services, but also the housing and job markets and consumer spending, he said.
The report due Thursday from Connecticut fiscal analysts will assess damage only to the revenue side of the budget — but all the parties involved concede that the analysis can offer only minimal guidance.
That’s because the state has very little tax data on which to base its findings. To provide relief from the coronavirus pandemic, Lamont delayed most household and business tax filings from April 15 until mid-July.
Melissa McCaw, Lamont’s budget director, warned two weeks ago that if tax revenues erode in this recession like they did in the last one, Connecticut stands to lose roughly $1.4 billion next fiscal year. That’s significant, but it’s a manageable problem given the $2.5 billion the state currently holds in its rainy day fund.
But McCaw also said there’s absolutely no guarantee that this downturn won’t be more severe than The Great Recession, which officially ran from December 2007 through mid-2009 in the United States. Some economists insist it continued in Connecticut through early 2010.
Consumer confidence headed for a new low?
During the last recession, it was the state income tax that eroded the worst. This time around, Connecticut’s sales tax — traditionally a very reliable revenue source — is at risk as well.
What happens when consumers are still reeling from the discovery that shopping can be dangerous — literally — to their health? If community spread and months of lost wages haven’t put enough of a damper on shoppers, disappearing nest eggs should finish the job, said Don Klepper-Smith, an economist with DataCore Partners.
“Wait until people realize this summer that their 401(k)s have been turned into 201(k)s,” quipped Klepper-Smith. New metrics already show consumer confidence in New England already has plunged to an all-time low, he said. “As goes the consumer, so goes the general economy.”
“It’s a tsunami — a hard stop,” Mark Zandi, chief economist for Moody’s Analytics, said of the pandemic’s economic impact during a webinar earlier this month.
And if the first economic shock wave was the business closures, “wave Number Two of the tsunami is going to occur relatively quickly — when people start realizing they are worth a lot less than they thought,” Zandi added. “Household wealth is evaporating very quickly.”
Both Lembo and McCaw said it’s certainly possible the entire rainy day fund will be exhausted by the close of the next fiscal year 14 months from now.
And while Connecticut’s hefty reserves and overall strong cash position leave it better suited — relative to other states — to handle short-term fiscal problems, McCaw said, the state’s fate over the long haul could hinge on the next round of stimulus.
“While I am comforted by a record-high rainy day fund, we also know those funds could be quickly utilized,” she said, adding Connecticut also has many stakeholders that need relief, including healthcare providers, businesses and municipalities. “The needs are vast.”
State Medicaid spending rose roughly $130 million in the final quarter of this fiscal year. At that pace, the state could be facing a $500 million-plus increase in health care spending next fiscal year.
Pension costs expected to surge yet again
And then there’s the big thorn in Connecticut’s budget: pension costs.
Between 2010 and 2018, as Connecticut recovered from the last recession more slowly than nearly all other states, required annual contributions to cash-starved pension funds more than doubled to $2.5 billion, devouring 13% of the state’s budget. And despite efforts to stabilize them through costly refinancing efforts in 2017 and 2019, they’re likely to grow again.
As the stock market falls and public-sector pension fund investments lose value, required government contributions to these funds traditionally surge.
The Pew Charitable Trusts released an analysis last week that projects states’ collective pension debt could reach an all-time high of $1.7 trillion unless the markets rebound over the next three months.
Cities and towns, many of which already are bracing for higher property tax delinquency rates this summer, also face rising pension contributions.
Given all of these challenges in Connecticut’s fiscal future, forecasters have to strike the right balance, Lembo said.
Panicking and overreacting is bad. Failing to plan until it’s too late can be fatal.
“You want to give an accurate picture from where you are, but at the same time you don’t want to unnecessarily scare everyone or go too far down the rabbit hole without sufficient information to back it up,” he said. “It’s the difference between hitting the brakes — or hitting the brakes and going through the windshield.”
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