Can Connecticut Achieve Fiscal Sustainability?

State’s competitiveness, place in national economic rankings

depend on it

On Feb. 6, after a one-day weather-related delay, Gov. Dannel Malloy opened the 2014 Connecticut General Assembly session with an address to legislators featuring several proposed revisions to the $19 billion state budget ($22 billion including Medicaid spending) for the second year of the biennium.

The governor’s budget proposal increases state spending by $37.2 million (2.7%) for the fiscal year that ends June 30, 2015, keeping total expenditures under the state’s constitutional spending cap by $8.1 million.

With a projected budget surplus of $506.1 million for FY 2014, announced by Comptroller Kevin Lembo on Feb. 3, Gov. Malloy proposed a three-way distribution of the surplus funds:

• $250 million to the state’s Budget Reserve Fund (Rainy Day Fund), which would increase it from $270.7 million as of June 30, 2013, to $520.7 million, or just over 3% of planned spending. (Lembo has been advocating for a level of 15% of spending.)
• $155 million in gasoline tax and sales tax refunds ($110 to families, and $55 to individuals).
• $100 million to pay down the state’s unfunded obligations for state employee pensions. According to the legislature’s nonpartisan Office of Fiscal Analysis (OFA), that debt totaled $13.3 billion as of Nov. 2013.

‘Spectacular Performance’

Connecticut’s budget surplus is just an estimate, says CBIA Vice President and Economist Pete Gioia, who believes that there’s a good chance it will grow. He notes that much of the surplus has come from income tax revenue generated by big gains in the financial markets since the end of the recession.

“Wall Street performance was spectacular in 2013. Any losses incurred during the recession have for the most part been offset, and there’s been some significant bonus performance in the financial sector.”

Indeed, the current state budget surplus stems largely from higher revenue from two sources: a one-time tax amnesty program and big gains in the financial markets: a notoriously unreliable source of revenue, but one that Connecticut has increasingly depended on.

According to a Jan. 27 OFA report, the state’s tax amnesty program generated $50 million more than budgeted in sales and use tax revenue and $19.3 million more than budgeted in personal income tax receipts. In addition, corporation business tax revenue was up by $61.9 million due to higher-than-budgeted tax amnesty collections.

More significantly, personal income tax receipts overall increased by a net $213.1 million, “likely due to strong performance in equity markets,” states the OFA report.

Likewise, in his Feb. 3 release, Comptroller Lembo said, “”_the majority of the surplus dollars in Fiscal Year 2014 result[s] from a one-time tax amnesty program and from the most volatile component of the income tax, which relies on strong stock market performance.”

Curb Your Enthusiasm

That last point is a red flag for CBIA President and CEO John Rathgeber.<

“We shouldn’t rely on that performance repeating itself, which is why we must continue to lean government services and find ways to make our tax structure more competitive and less volatile.”

Rathgeber adds that it’s not just the vagaries of Wall Street that make Connecticut’s revenue stream so unstable; it’s also the fact that the taxpayers supplying the lion’s share of tax revenue from financial sector gains are also the most mobile portion of our population. They’re the people “with the wherewithal to freely choose their domiciles if economic or fiscal conditions in Connecticut become too unfavorable.”

CBIA’s senior vice president of public policy, Joe Brennan, agrees.

“In Connecticut, you really have to look at what’s generating the revenue driving a budget

surplus before you’re lulled into thinking that everything is fine,” he says. “The state income tax was adopted in 1991 in part to create a more stable, predictable source of revenue. Over time, however, policy decisions have concentrated the tax burden on a smaller group of high-income taxpayers, making it much more reliant on income from capital gains and financial-sector bonus payments: politically popular but also very unreliable sources, because they fluctuate with Wall Street’s ups and downs, which in recent years have been quite dramatic.”

Out-Year Deficits

Another reason not to get too giddy about the current year’s surplus is that beyond FY 2015, OFA is forecasting sizeable state budget deficits. In its Fiscal Accountability Report released last November, the agency projected that the state will face budget shortfalls of $1.1 billion in FY 2016, $1.2 billion in FY 2017, and $1.4 billion in FY 2018.

Whether we actually see those deficits depends to a great extent on U.S. economic growth, says Gioia, pointing out that Connecticut benefits a lot when the U.S. economy experiences robust growth.

“If the economy on the national level continues at a pace of approximately 3% GDP, then we should be in good shape,” says Gioia.

He also points out that if the state maintains the governor’s proposed 2.8% spending increases over the next several years, expenses will come in under revenue projections, “and we’ll set ourselves up for repeated surpluses: maybe not near the size of what we’re seeing now, but at least there won’t be the threat of tax increases or having to tap the Rainy Day Fund.

“But,” Gioia cautions, “there are threats.”

He cites the possibility that a terrorist attack or other international incident, while remote, could pose a risk to continued growth.

“A more likely threat internationally is that major trading partners could have economic problems. Probably the most worrisome is China and, to a lesser extent, the possibility that the European financial situation could deteriorate.”

Another serious concern, he says, comes from within.

“The bigger threat is that the Federal Reserve moves too aggressively in tapering off its economic stimulus program: purchasing federal bonds: and pushes interest rates up too high. That would threaten the U.S. economy and have a particularly acute effect on Connecticut, as our housing recovery is only beginning. Growth in long-term mortgage rates could totally torpedo that. So the kicker is that Fed actions could begin to cool the economy before Connecticut has fully recovered.”

Fiscal Issues First and Foremost

Of course, Connecticut can’t control Fed decisions, but policymakers can act to keep the state’s economy moving forward and move Connecticut into the top 20 states in national business climate rankings by 2017: a goal that CBIA and other business organizations will be emphasizing over the next three years.

“It’s critical that all of us: elected officials, businesses, employees, and residents: come together and embrace the goal of moving the state into the top 20 across a number of national economic rankings by 2017,” said Rathgeber in a Feb. 10 statement announcing the release of CBIA’s legislative priorities for 2014.

“Those rankings highlight Connecticut’s competitive weaknesses and contribute to an overall negative perception of the state, making it very difficult to attract the types of private sector investments we need to build a strong, vibrant economy.”

Rathgeber noted that the state has had a poor showing in many nationally recognized independent business climate indexes, including CNBC’s Top States for Business and Forbes Best States for Business.

In most such cases, fiscal issues weigh heavily on a state’s place in the rankings. Among the criteria CNBC’s index employs, for example, is a state’s economic condition, which includes fiscal health as determined by credit ratings and outlook, as well as state revenues as compared to budget projections. (Connecticut ranked 45th in CNBC’s Top States for Business index in 2013.)

Although Connecticut’s elected officials won’t be crafting a new biennial state budget until next year, lawmakers and the administration can work together and use the 2014 General Assembly session as a foundation for boosting the state’s national economic rankings.

The job starts with continuing and expanding efforts to rein in state spending, pay down the state’s unfunded liabilities, and make state government less costly and more efficient.

“In the longer term, we really need to continue to make progress in our management of state finances to ensure that we end the cycle of budget deficits and the threat of new rounds of tax increases resulting from the state’s unfunded liabilities,” says Rathgeber. “Those two items have had the most significant impact on the unwillingness of the private sector: inside and outside the state: to make the kind of investments necessary to accelerate our economic recovery.”

Long-Term Obligations

According to OFA’s Nov. 2013 Fiscal Accountability Report the state’s unfunded liabilities: legal commitments incurred during the current year or a prior year that must be paid at some time in the future but for which no reserves have been set aside: add up to $65.2 billion,

$5 billion less than the total in Nov. 2010. They include state employee pensions and post-retirement benefits, teachers’ pensions and post retirement benefits, bonded debt, and the GAAP deficit.

In a report released on Jan. 8, 2014, the Office of Policy and Management (the governor’s budget office) set the state’s total unfunded liabilities slightly lower, at $64.6 billion, representing, says the report, a 15.2% ($11.6 billion) reduction over the last three years.

The report attributes the reduction to the administration’s “disciplined approach to funding all our long-term obligations,” increased payments in priority areas such as pensions and the GAAP deficit, and having “negotiated significant benefit changes and cost-sharing arrangements with our employees that have made our future pension and retiree benefit programs vastly more affordable.”

CBIA’s Joe Brennan applauds the administration’s efforts but urges more aggressive action.

“This is not just a business issue. If we’re going to add jobs, create more opportunities for people, and generate tax revenues to pay for necessary government programs, we must start laying the groundwork now. That starts with resolving the state’s long-term fiscal issues. We’ve made some progress; now it’s time to accelerate that progress.”

Leaning State Government

As has been reported in previous issues of CBIA News, a number of state agencies have become leaner, greener, more user-friendly, and more cost efficient: a culture change that promises to keep state government more responsive to business and more responsible to taxpayers.

An 84-page report from the governor’s office, Continuous Improvement in Connecticut State Government, outlines successful efforts to cut costs in several state agencies, in many cases by instituting lean practices.

Perhaps most notably, the Department of Energy and Environmental Protection (DEEP) implemented a lean process to break a logjam in industrial stormwater general permits and is saving $1.84 million per year through reduced state energy bills as result of energy retrofits via the Lead by Example program.

Modest strides have also been made at other agencies, including the Department of Labor through the newly created Unemployment Compensation Fraud Unit, which has recovered nearly half-a-million dollars in unemployment insurance overpayments and prevented about $100,000 weekly in fraudulent payments.

“We’re still tracking and still need to see comprehensive effects of implementing lean across all state agencies,” says Gioia. “Ultimately, the greater efficiencies and productivity in elimination of waste through lean is going to set the state up for better performance. But it has to be fully implemented across all state agencies. That will not only set the stage for cost savings in the future, but part of the savings will come sooner through running programs better and faster, and that’s going to be essential over the current budget period.”

Noting that the state has programs to lean processes in all major state agencies, Gioia cites the Department of Transportation (DOT) as an example of an agency where such efforts could have a big impact on the state’s finances and economic competitiveness.

“The governor has made a major effort to enhance infrastructure by transferring $380 million from the General Fund to the Special Transportation Fund and is hiring additional DOT staff to more rapidly implement shovel-ready projects. DOT also needs to maximize its ability to get projects done faster through lean initiatives because, ultimately, in anything to do with construction, delays cost money.”

New Program Series on Fiscal Sustainability

Putting Connecticut on a path toward long-term fiscal health is the subject of a new series of programs sponsored by Webster Bank and produced in partnership by the MetroHartford Alliance, Connecticut Institute for the 21st Century, Bridgeport Regional Business Council, Chamber of Commerce of Eastern Connecticut, Waterbury Regional Chamber, and The Connecticut Mirror.

The programs will take place throughout the year in locations across the state and will discuss Connecticut’s fiscal challenges and opportunities, with particular focus on the state’s long-term obligations and the crowding-out effect they have on investments in transportation, education, social services, and other parts of the state budget.

“Our strategic goal is to get more people in the state educated about our long-term fiscal issues, the theory being that as we get into the 2014 election cycle, voters will be trying to evaluate candidates’ positions on these issues,” says Oz Griebel, president and CEO of the MetroHartford Alliance.

The programs will emphasize that when it comes to the state’s unfunded liabilities and other long-term obligations: including Medicaid: the state can’t continue down the same road it’s been on, says Griebel.

“We want to educate voters so that they can ask their candidates, ‘What’s your solution to this?'”

The tactical goal of the program series, explains Griebel, is to get employers there so that they, in turn, will share the information with their employees.

“These programs are one more voice, one more spotlight on the issue to help more people become informed and engaged, at least in the sense that they’re better prepared to evaluate candidates.”

In addition, if primaries are held, Griebel plans to request that the party chairs ask their candidates to participate in a forum dedicated to budget problems, particularly in the context of the longer-term issues.

The first program in the series, “Fiscal Sustainability: Critical to Connecticut’s Growth,” was scheduled for Feb. 25 in Hartford and featured several prominent speakers, including OPM secretary Benjamin Barnes. Future programs will take place in Bridgeport, Waterbury, New London, and other cities.

For more information or to register for an upcoming program, visit the MetroHartford Alliance.

Bill DeRosa is editor of CBIA News. Contact him at bill.derosa@cbia.com.