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In this article, we look under the hood to examine the legislative history of the budget cap system to demonstrate how it was transformed from a flexible mechanism designed primarily to refill the Rainy Day Fund and to manage volatile income streams into new interlocking restrictive caps. The new caps were designed to impose austerity budgeting as the primary method of elevating pension debt prepayment as a higher priority than fully funding property tax reduction grants and other spending programs.

  • The 2015 Lembo volatility cap

Connecticut finance experts in the early 2000’ were rightly concerned that the  Rainy Day Fund [RDF] was insufficient to protect taxpayers from unbearable tax increases in the event of a disastrous revenue shortfall caused by an economic recession. Indeed, the RDF balance in 2011 couldn’t have been worse– it was zero! Positive balances grew slowly but by 2015 another budget deficit required a withdrawal from the RDF to balance the budget.

Fiscal experts agreed that the practice of funding the RDF by depositing only the leftover surplus at the end of the fiscal year was at fault. They agreed that such an ad hoc system was not sustainable as a long-term policy.

In response, then-Comptroller Kevin Lembo spearheaded a successful effort in 2015 to jettison the old ad hoc system and to replace it with three significant fiscal reforms.

First, he proposed the creation of a growth-adjusted volatility cap to intercept the most volatile sources of revenue — the quarterly estimated and final payments portion of the personal income tax, and the corporation business tax—as revenue  sources to fund the RDF. Second, he proposed increasing the required level of the RDF to 15% of the appropriated General Fund budget instead of 10%. Third, the RDF would be modified to require that surplus funding derived from the Volatility Cap intercept would be used first to build up the RDF to its new statutory level of 15%  and thereafter be diverted to pay down unfunded pension debt.

At the April 2015 public hearing of the Finance Committee, these reforms were endorsed by fiscal experts. According to Robert Zahradnik, director of State and Local Policy at The Pew Charitable Trusts, “Pew’s research ranked Connecticut 13th highest in the nation on tax volatility with a volatility score of 6.5, which means that revenues typically fluctuated by 6.5 percentage points from the 19-year average in any given year. By comparison, [the] 50-state tax revenue had a volatility score of 5.0. Connecticut is among the 29 states with volatility higher than the national benchmark.”

Zahradnik recommended “that policymakers tie rainy day fund deposits to revenue volatility.” He noted that 13 states connected “the rules for when, how, and how much to deposit into their budget stabilization funds with underlying revenue or economic fluctuation.”

Lembo’s proposed reforms were adopted in 2015 as part of the 2016-17 budget bill with an  implementation date for the Volatility Cap intercepts set for 2019.

  • The 2017-18 Anti-Spending ‘Guardrails’

But a funny thing happened to the Lembo Volatility Cap between its approval in 2015 and its implementation in 2019: it was replaced in  2017 and 2018 by a different volatility cap and a much more severe set of anti-spending restrictions now known collectively as the ‘budget guardrails.’

The new controls transformed the volatility cap’s primary function from building up the RDF to interacting with the additional set of new caps to impose austerity budgeting on spending in order to generate more “surplus” funds. The new system would then automatically transfer the “excess surplus” funds to debt prepayment and away from programmatic budgeting, including property tax grants.

The anti-spending austerity budget ‘guardrails’ put in place in 2017-18 included:

  • A new “revenue cap” that imposed a limit on the amount of estimated revenues that could be spent in any year. The Cap ratcheted spending downward from 99.5% of revenue in FY 20 to 98.50 in FY 24 to 98% in FY 26;
  • A revised “volatility cap” that replaced Lembo’s flexible multi-year lookback to measure volatility with a “hard limit” of $3.15 billion for the appropriation of the personal income tax’s “quarterly estimates and finals” revenues (adjusted for inflation). All corporate tax revenue– the most volatile of all revenues– was excluded from the new cap. As we will discuss below, the changes to Lembo’s Volatility Cap played a major role in transforming the guardrails into an austerity budget device;
  • A revised “Rainy Day Fund” that mandates “surplus surplus” funds be used only to retire pension debt after the RDF has reached its maximum required size of 15% of the state operating budget;
  • A revised “spending cap” super majority law that further constricted state spending by eliminating the prior Spending Cap exemption of $1.611 billion in statutory grants to distressed municipalities;
  • A new “bond allotment cap” that restricts the amount of General Obligation bonds that the governor may approve in any fiscal year; and
  • An untested and bizarre “bond lock” law that requires the state treasurer to include a pledge to private bondholders who purchased state bonds between 2018 and 2020 that the state would not enact any laws taking effect between 2018 and 2028 that change any of the wording of the guardrails unless approved by a three-fifths legislative super-majority.

This collection of 2017-18 controls fundamentally altered the functioning of the 2015 Lembo volatility cap by creating an entirely new and untested state budget regimen.

How did the changes to Lembo’s volatility cap contribute to transforming the guardrails into a spending restricting device? The change occurred because the focus of this cap shifted away from the volatile character of the income stream in the Lembo cap to the fixed amount of the volatile income in the adopted cap. The Lembo cap required the intercept of revenue “whenever the most volatile tax revenue streams produce revenue above historic norms” measured by a long-term multi-year lookback. In short, Lembo proposed a variable cap on using revenue from volatile income streams.

But the volatility cap adopted in 2018 that repealed the 2015 Lembo cap enacted instead a hard limit of $3.15 billion of the quarterly and final payments from personal income tax filings that could be appropriated in the budget. The rest of such collected revenue is automatically deposited into the Rainy Day Fund. This dollar figure does not change except for an annual inflation adjustment.

The austerity budget function was implemented by the interlocking of the volatility cap’s hard limit on appropriations to no more than $3.15 billion in “volatile” estimates and finals revenue (as adjusted); the revenue cap’s limit on spending to no more than 98%-99% of the estimated annual revenue; the spending cap’s limit on annual state spending increases including aid to distressed municipalities; the Rainy Day Fund’s required transfer to debt retirement; and the bond lock, which promised bond holders that none of the caps can be altered by less than a supermajority three-fifths vote.

The guardrails function as an “austerity” device because they prevent state spending on “programs” such as property tax reduction grants but they don’t limit the amount of overall spending in the budget. Spending to reduce unfunded debt liability is still “spending” that is paid for by state taxes. But under the new regimen, debt prepayments are favored exclusively over property tax grants and other programs.

It is not irrelevant to inquire about the possible reasons why the fiscally flexible 2015 Lembo volatility cap was altered by the strict spending limits and inflexible ‘guardrails’ adopted in 2017 and 2018.

Concerns continued to grow about the state’s poor fiscal standing and underfunded RDF. But the biggest change that preceded the transformation of the caps was the 2016 state election that produced an unusual 18-18 partisan tie in the State Senate. It strengthened the hand of both Republican and Democratic budget hawks who felt the Lembo plan and Malloy administration budgets did not go far enough to rein in programmatic spending.

The usual budget process was further disrupted when then-Gov. Dannel Malloy vetoed the Republican-led state budget well after the start of the 2017 fiscal year. Coincidentally, the State Spending Cap Commission submitted it recommendations in 2017 to the General Assembly where the newly empowered bipartisan coalition of budget hawks adopted the Commission’s minority report urging aid to distressed municipalities be placed under the restrictive spending cap.

The conclusion seems inescapable that the new budget regimen that was defined by the imposition of inflexible guardrails was as much the product of a shift in political power as it was the outgrowth of attempts to better manage fluctuations in revenues. Regrettably, it does not appear that the consequences of each new guardrail or of their interaction were given appropriate legislative study, review, or expert analysis prior to the adoption in 2017-18 or their readoption in 2023.

Tomorrow: Dismantle CT’s undemocratic and extra-constitutional ‘bond lock’ guardrails.

Alex Knopp is the principal author of this analysis on behalf of the following members of the Property Tax Working Group of 1,000 Friends of Connecticut. (Knopp is a former State Representative, Mayor of Norwalk and Visiting Clinical Lecturer at Yale Law School.): 

  • Bill Cibes, former State Representative, Secretary of Office of Policy & Management and Chancellor of the Connecticut State University System
  • Michele Jacklin, former Hartford Courant Political Columnist, Trinity College Media Director and Co-Chair, CT Council on Freedom of Information.
  • Jefferson Davis, former State Representative and First Selectman of Pomfret.
  • Sue Merrow, former First Selectman of East Haddam and Chair, CT Council on Environmental Quality.
  • Albert Ilg, former Town Manager, City of  Windsor and Interim City Manager of Hartford.
  • Chip Beckett, former Glastonbury Town Council member.