Sen. Len Fasano watches Sens. John Fonfara and Scott Frantz, the Democratic and Republican finance co-chairs, celebrate the landmark budget vote in 2017 that led to the state's record-setting rainy day fund. mark pazniokas / ctmirror.org

Throughout this election season, candidates have sparred over whether state government is hoarding money against the next recession while taxpayers flounder amid sky-high inflation.

There’s $3.3 billion in the rainy day fund. Another $1.4 billion in federal pandemic relief — originally earmarked for the current biennial budget cycle — is being kept back to prop up state finances in 2024 and 2025. 

And earlier this week, Gov. Ned Lamont’s administration projected the current fiscal year will close next June with more than $2.3 billion remaining — potentially the second-largest surplus ever, topped only by last June’s $4.3 billion cushion.

But one legislator is asking a different question: Is government saving enough?

Sen. John Fonfara, D-Hartford, the architect of the savings program that helped create the unprecedented reserves, says that if the next recession matches the economic slide of 2007-09, the answer likely is “no.” 

Though current law caps budget reserves at 15% of the General Fund, Fonfara wants to begin a discussion next year on a 20% limit. Based on the current state budget, that would allow the state to hold roughly $4.4 billion in reserve.

Historically, when Connecticut slides into recession, “we don’t just raise taxes, we don’t just cut services,” said Fonfara, who co-chairs the Finance, Revenue and Bonding Committee. “We generally do both.”

“And when we cut services, we cut them for the neediest among us,” he said, adding that lawmakers often view it as “a perverse response but a necessary response.”

But is it? 

If reserves are sufficient, Connecticut not only could avoid tax hikes and program cuts but could invest more in programs to pull families and businesses out of trouble, Fonfara said.

Fonfara isn’t alone in suggesting Connecticut should have a larger reserve.

The Government Finance Officers Association now recommends a minimum reserve of 16% of annual operating expenses, but only five states currently top that standard.

All states have some form of reserve to stabilize their budgets, according to the Tax Policy Center at the Urban Institute & Brookings Institution. Connecticut, 40 other states and the District of Columbia cap those rainy day funds.

But while reserve caps of 5% or less used to be more common, many states reconsidered them after the last recession, and only nine states and D.C. still use that limit, according to the tax center.

State finances were unprepared for the last recession

Economists are mixed on how bad the next recession will be. And Fonfara concedes that most downturns aren’t as severe as the plunge experienced from late 2007 through early 2010, which economists dubbed the Great Recession.

But he argues that if the intensity of the next downturn is close to that of the last one, a 15% reserve wouldn’t stop things from getting ugly at the state Capitol.

And the historical data supports Fonfara’s point.

By June 2009, a weak economy and eroding revenues left the state with nearly $1 billion in operating debt just as the fiscal year was coming to a close.

Republican Gov. M. Jodi Rell and a Democrat-controlled General Assembly borrowed money to solve that problem and dedicated the entire $1.4 billion rainy day fund and $540 million in emergency federal aid to keep the 2009-10 and 2010-11 fiscal years afloat. They also ordered about $870 million in new taxes, including a new 6.5% income tax rate on wealthy households and increases in corporation, cigarette and estate taxes. 

All of the non-tax measures to balance finances — the borrowing, exhausting of reserves and utilizing of emergency federal aid — collectively represented 17% of the General Fund. And they still weren’t even close to enough to prevent more pain.

By 2012, those maneuvers were exhausted, and tax receipts hadn’t rebounded. Analysts warned state spending, unless adjusted, would exceed revenues by $3.7 billion, a deficit of more than 18%.

New Gov. Dannel P. Malloy and the legislature would order nearly $1.9 billion in new taxes, negotiate major concessions with state employee unions and begin a downsizing effort that would shrink Executive Branch staff by 10% over the next eight years.

More importantly, said University of Connecticut economist Fred Carstensen, the state too often failed to invest sufficiently in expanded access to health care and job training that could have accelerated its recovery. More funding for transportation, IT infrastructure, higher education and cutting-edge industries — which would have strengthened the economy over the long haul — also was limited.

“I think it’s a really valuable conversation to have,” Carstensen said of Fonfara’s proposal. “If we get into deep [trouble], not only do we not want to cut budgets, we want to take new initiatives. That’s when it’s cheapest.”

CT’s revenues are extremely volatile

Connecticut’s fiscal cushion is even bigger now than it was in 2009. But it might not be as large as it seems.

The $3.3 billion rainy day fund and $1.4 billion in uncommitted federal pandemic relief, together, represent 21% of the General Fund.

On paper, that’s easily enough to keep state finances balanced for the next few years.  But it’s not that simple.

The emergency federal aid is gone after 2025.

Connecticut’s massive pension debt — which exceeds $40 billion and is expected to remain a problem until the 2040s — has first claim on the annual budget surpluses unless the rainy day fund is increased. That means this fiscal year’s projected surplus, and any after that, would go toward the pension problem, not to shield against the next recession.

Connecticut still hasn’t regained all of the nearly 120,000 jobs lost in the 2007-09 downturn. And what if the state’s economy never fully recovers from the next recession?

Connecticut has one of the most volatile tax streams in the country. With its proximity to Wall Street and considerable financial services sector, it relies heavily on income taxes tied to capital gains, dividends and other investment earnings.

Since 2001, year-over-year, economic growth rates for quarterly income tax filings — which reflect investment earnings — range from 46% to -27%, according to the state Office of Policy and Management. When Wall Street surges, state coffers get fat. And when the markets shrink, state finances go into convulsions.

State income tax receipts plunged 15% or $1.1 billion in one year between 2008 and 2009 A 15% drop in state income tax receipts now would cost Connecticut almost $1.8 billion. Over a two-year budget cycle, that hypothetical income tax erosion alone would exhaust the rainy day fund.

Fonfara acknowledged a 20% reserve also might not be enough to solve all problems in the worst of recessions. And he also conceded that politically, it would be a hard sell to convince many legislators to let government save even more money.

That’s because state government isn’t the only entity suffering during a recession. In fact, families and businesses often start hurting well before government feels the fiscal pain.

Would a large budget reserve come at the expense of taxpayers and services?

Republican gubernatorial candidate Bob Stefanowski says the $660 million tax relief program that Lamont touts as one of the largest in state history is actually modest in proper context.

The Consumer Price Index leapt from 1.4% in 2020 to 7% in 2021. It currently stands at 8.2%, though it topped 9% earlier this year.

Gasoline prices peaked in Connecticut in mid-June at $4.98 per gallon, despite Lamont and lawmakers waiving the 25-cents-per-gallon retail gasoline tax between April 1 and Nov. 30. And the $3.56 per gallon price the AAA reported Thursday is still up 4 cents from one year ago.

“If the state of Connecticut was a bank, which it’s not, how much would you trust it to hold onto your money for you?” said Stefanowski, who pitched a nearly $2 billion tax cut package earlier this year centered on an expanded income tax relief program to offset municipal property tax burdens. “This surplus is your over-collected tax dollars.”

Democrats have fired back by calling Stefanowski’s tax-cutting plan reckless, potentially leaving state finances at risk as the possibility of a global recession looms large.

But it’s not just Republicans who have grumbled about the state’s swelling reserves.

Labor groups have pointed to the rainy day fund as they protest minimal funding for bonuses for workers who manned health care and other essential services during the pandemic.

The community-based nonprofits that deliver the bulk of state-sponsored social services repeatedly cited the growing surplus in recent years when complaining about their lack of state funding.

In 2020, the CT Community Nonprofit Alliance pitched a plan to shave $460 million off the surplus over five years to enhance services for people with disabilities.

Still, Tolland Democrat Nancy Wyman, Connecticut’s lieutenant governor from 2011-2018 and state comptroller for 16 years before that, thinks reevaluating state reserves could be beneficial. She spent much of the late 1990s urging lawmakers and then-Gov. John G. Rowland to strengthen the state’s financial safety net.

The law back then capped the rainy day fund at just 5% of the General Fund. That not only left finances largely unprepared for recessions, but it also prompted governors and legislatures to spend large surpluses, rather than pay down debt, when the reserve had reached its 5% cap.

State government ran up $6.1 billion in budget surpluses between 2000 and 2014, according to nonpartisan analysts. Only one-third of it, $2.1 billion, was placed in the budget reserve. The rest was spent.

Just as families need to have funds socked away to handle emergencies, Wyman said, government needs reserves to tackle recessions as well as unexpected crises like the coronavirus pandemic and the recent crumbling foundations dilemma in eastern Connecticut. 

“A lot of people could understand it that way because this was like their own [family] savings account,” she said.

But the late 1990s were not far removed from the 1991 session that adopted the state income tax — and sparked a storm of outrage. Many lawmakers feared government saving more money would just be salt in the wound, Wyman said.

But the income tax now has been around for 31 years, she noted, adding the issue shouldn’t be as sensitive now.

Without ‘a true picture of the budget, … it’s not going to help us.’

But some state leaders are ready to hear more from Fonfara, even if they aren’t ready to endorse expanded reserves just yet.

Chris Collibee, spokesman for Lamont’s budget office, was guarded in his comments but made it clear the governor gives high priority to a sound fiscal safety net.

“As Gov. Lamont has made clear on numerous occasions, protecting the Rainy Day Fund is essential with ongoing concerns about how the current global economic situation will potentially impact our state’s financial position,” Collibee said. “Our historic level of budget reserves, along with the volatility and revenue cap provisions, provide substantially more insulation for the state budget.”

Fonfara’s co-chair on the finance committee, Rep. Sean Scanlon, D-Guilford, is running for state comptroller this fall.

“Sen. Fonfara is right to start this conversation,” Scanlon said. “The average Connecticut family doesn’t have a cap on their savings account.”

But Scanlon, who also has pushed for the state to expand income tax relief to low- and middle-income households with children, says expanded reserves can’t come at the expense of helping working families survive high inflation now.

“That is the balance,” Scanlon said. “Doing some tax-cutting, protecting services and protecting the integrity” of state finances.

The top Republican in the state House of Representatives, Minority Leader Vincent J. Candelora of North Branford, also said he’s open to exploring a larger reserve — provided the discussion is based in policy, not politics.

Under Rell, a Republican governor, a Democrat-controlled legislature ordered nonpartisan analysts to review the revenue projections of the governor’s staff to ensure estimates weren’t overly rosy. There would be three “consensus” reports each year, the first starting in October. But after Malloy, a Democrat, became governor, the first report was shifted until after the November elections.

And in June 2019, Lamont and Democratic lawmakers reinterpreted the “consensus” projection law, adopting a new budget that assumed $180 million more in state income tax receipts than nonpartisan analysts projected for the coming year. 

Income tax receipts fell $490 million short of projections in 2019-20. The last four months of that fiscal year were marred by the coronavirus’ arrival in Connecticut.

Fonfara’s proposal “is worthy of a conversation,” Candelora said, but the process has to be insulated from these types of partisan gimmicks. “We can have the largest rainy day fund in the world, but if we don’t have a true picture of the budget, it’s not going to help us.”

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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.