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January 2009 — Vol. 86, No. 11
State budget emergency
How will Connecticut
handle tough times?
Budget deficits will require fiscal discipline, policies that
encourage economic growth
By Steve Higgins
Connecticut is facing unprecedented budget deficits—estimated at a whopping $6 billion over the next two years—that will force major changes in the way the state conducts business. Legislators must ensure that Connecticut emerges from the turmoil in a position of strength, not in decline.
The severe economic crisis roiling the nation is hitting Connecticut hard as state income tax revenue, sales tax receipts, and casino profits plummet from prior anticipated levels. While the state enjoys a well-diversified economy, 45% of state income tax revenue is paid by Fairfield County residents, many of whom work in financial services and/or have significant investments tied to the stock market. That makes state coffers particularly vulnerable to downturns in the financial services industry and the stock market, both of which are being hit hard by the current crisis. From July 1 to December 1, the Dow Jones industrial average fell 28%. And looking ahead, as many as 200,000 Wall Street workers, some of whom live in Connecticut, are expected to lose their jobs in the next two years.
To add to the problem, economists estimate another 40,000 to 80,000 people in Connecticut will lose their jobs during the current recession, which will dampen revenue from income taxes, corporate taxes, sales taxes, and motor fuel taxes.
Gov. Rell has called this the greatest financial crisis since the Great Depression and said that significant spending cuts and structural changes in state government will be needed. She also said she opposes tax increases. Democratic legislators have pledged to work with Gov. Rell and Republican lawmakers.
Tax increases not the answer
John Rathgeber, CBIA president and CEO, urges legislators to follow the governor’s lead and keep the focus on spending cuts, resisting the temptation to try to tax their way out of the crisis.
“The state should position its response so that we can come out of this recession stronger and more quickly,” Rathgeber says. “During past recessions Connecticut lagged behind other states in terms of recovery. We need to reverse that trend by improving our competitive position.”
Rathgeber notes that when the severe recession of 1989–92 hit nationwide, Connecticut lost 160,000 jobs and took years to get them back. “In the late 1980s, as we were entering into the recession, the state raised the corporate tax rate to the highest in the country and increased other business taxes. Employers responded by reducing the workforce and, in some cases, leaving the state,” he points out.
On the bright side, Connecticut has a diversified economy and has set aside $1.4 billion in its Rainy Day Fund. However, Rathgeber believes using that fund should be the last resort and restricted to unique, one-time expenditures that arise in the biennium.
“The state must look hard at all expenses, recognizing that the need for public services will rise as cities continue to struggle due to the wave of home foreclosures,” he says. “The cities must change the way they do business as well. During a time of crisis you can make reforms, such as regionalization of services.”
Todd P. Martin, a Fairfield-based economic consultant, agrees. “The state needs to get a handle on spending,” he says. “Obviously they haven’t kept honest in terms of the spending caps. Real, inflation-adjusted spending at the state level has quadrupled since the mid-1980s.”
The housing bubble fueled spending, with residents, businesses, and governments alike skimping on savings and running up debt. During the credit boom, Connecticut went “along for the ride,” Martin says, and like many households, the state needs to go on a strict budget.
“Raising taxes is the worst way to go, and this is the worst time to do it,” since tax increases prolong economic downturns, he explains. “If you want less of something, tax it.”
Martin also called on Connecticut’s cities and towns to embrace regionalization and begin sharing the cost of services and other municipal expenses.
Estimated deficits keep rising
In mid-November, Gov. Rell released deficit projections of $2.6 billion in fiscal 2010, which starts July 1, 2009, and another $3.3 billion in fiscal 2011. Those numbers, which assume current state spending levels, are far higher than previous estimates.
“The forecast for our economy is indeed bleak,” the governor said at a press conference, adding that the latest projections are “absolutely astounding.”
Gov. Rell already had called for a special session Nov. 24 to deal with a $300 million deficit in fiscal 2009. Previously she had ordered $184 million in spending cuts toward balancing the state’s $18.4 billion budget. She is expected to release a new budget plan in February.
“It’s a scary time,” she said at a press conference. “And it’s a truly difficult time for our state and our nation.” She added that the state needs to return to its “core functions” and that “everything is on the table.”
CBIA economist Pete Gioia says the governor’s proactive stance is necessary given the rapidly deteriorating situation. “The numbers are bad, and they are going to get worse,” Gioia says. “The full effect will hit after April 15, because half the state’s income tax comes from 70,000 taxpayers, many of whom are in financial services or whose wealth is tied to financial services. The damage is enormous and widespread in that industry.”
Three million workers account for the other half of state income tax revenue, and some of those taxpayers will lose their jobs as well. “Consumer spending will drop, because people are going to feel poorer—and slow sales during the holiday season will affect state sales tax revenue,” Gioia says.
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