Federal Budget Bill: Complex Outlook for Connecticut’s Economy

The recently passed federal budget reconciliation bill has been and will continue to be analyzed in the months ahead to determine its full impact on the nation and Connecticut.

The bill features sweeping changes to the federal tax code, restructures discretionary and entitlement spending, and raises the debt ceiling by $5 trillion.

While there are important facets of the bill to discuss with respect to its impact on social services, this preliminary analysis focuses on the economic implications for Connecticut.

Overall, the picture is complex.

There are elements that represent significant opportunities for individuals and industry, but the bill also introduces considerable fiscal pressures and creates potential economic headwinds.

In terms of the Connecticut economy, provisions in the bill provide a mix of industry investment, direct stimulus, and policy changes that will disproportionately impact our state in the years ahead—for better and for worse. 

The Good: Stimulus, Investments in Innovation 

The budget bill contains several provisions that will positively impact workers and businesses in Connecticut, including several that will be specifically advantageous. 

Arguably, the most substantial impact for business will be the continuation and expansion of tax advantages for investment and research.

The bill allows businesses to once again immediately and fully deduct domestic research and development expenditures and makes the 100% bonus depreciation provision permanent for qualified business properties.

Arguably, the most substantial impact for business will be the continuation and expansion of tax advantages.

These two provisions make investment more attractive for business and should drive growth and innovation.

Additionally, the bill expands the Advanced Manufacturing Investment Credit and the New Markets Tax Credit and renews the Qualified Opportunity Zone Program, which all incentivize investment and economic growth.

Finally, certain tax provisions create a preferred status for small businesses, which represent a disproportionate share of Connecticut companies overall. 

Workforce 

The legislation incentivizes certain employer behavior that should have a positive impact on the workforce.

The bill enhances tax credits for employers that support their workers, increasing the credit for employer-provided childcare to 40% (50% for small businesses) and expanding it to cover contracts with third-party providers.

The bill increases the tax credit for employer-provided childcare to 40% (50% for small businesses).

Similarly, the credit for providing paid family and medical leave is increased, giving businesses new tools to attract and retain talent.

While state-mandated leave is not eligible for this credit, contributions that employers make to supplement state FMLA will be eligible. 

Shipbuilding 

Connecticut is one of the most important states for shipbuilding in the nation—ranked number two in shipbuilding GDP—and the bill invests in programs that support these industries.

This includes $250 million for the expansion of the Training in Defense Manufacturing program, $450 million for additional maritime industrial workforce development programs, and $1 billion for additional advanced manufacturing process improvement and supplier development across the naval shipbuilding industrial base. 

Individual Tax Changes 

Beyond business specific changes, changes to individual taxation should provide a stimulus.

Connecticut, which has some of the highest state and local taxes in the country, stands to benefit from the increase in the state and local tax deduction cap from $10,000 to $40,000, although this is only a temporary change.

With some of the country’s highest state and local taxes, Connecticut stands to benefit from the increase in the SALT deduction cap.

Overall, a significant share of tax changes skew benefits toward high income earners, of which Connecticut has a disproportionate share.

We therefore might expect these changes to provide a larger stimulus to Connecticut compared to other states. 

The Bad: Spending Cuts, Deficits, Benefit Losses 

While the bill will certainly provide a boost to the economy, other elements of the law will act as a drag on future growth.  

Some of the stimulus created by tax cuts will ultimately be offset by a reduction in benefits paid.

The Congressional Budget Office estimates that up to 138,000 Medicaid recipients in Connecticut may lose coverage, while the Kaiser Family Foundation projects federal Medicaid funding will be reduced by an average of $1.3 billion annually over the next decade.

Federal Medicaid funding will be reduced by an average of $1.3 billion annually over the next decade.

The burden of these costs, besides being borne by those losing coverage, will also be borne by hospitals and health insurance plans as costs get passed on to insured care recipients.

The magnitude of that impact remains to be seen, but Medicaid expansion during the last decade tended to improve the fiscal condition of hospital systems, thus a reversal may create the opposite effect.

Healthcare is projected to be the fastest growing job market in the state over the next two years, although the fiscal condition of health systems could impact the pace of growth. 

Headwinds for Green Energy, Higher Ed 

Connecticut’s and New England’s energy strategy relies heavily on the deployment of green technologies, and the bill reduces or eliminates many of the tax credits or rebates that are leveraged to support that strategy.

Tax credits for wind, solar, and other renewable energy investments were removed and the bill eliminates the Energy Efficient Commercial Building Deduction.

Adoption of heat pumps and electric vehicles in the state relies on government incentives to help offset high electricity costs, and these changes inhibit those efforts. 

Tax credits for wind, solar, and other renewable energy investments were removed.

Furthermore, the bill institutes a new excise tax structure on university endowments.

Large endowments, like Yale University’s, face significantly higher tax rates as a result. The disbursements from these endowments provide significant funding to local research, therefore we may see reduced investment over the long run as a result.

University-spawned companies have attracted billions in investment in recent years, and this change likely creates headwinds for the future creation of those companies. 

State Budget Pressure 

Benefit cuts and changes to funding methodologies will create state budget pressure in future years, although many of the largest impacts won’t come into play until the next biennium.

For example, changes to SNAP reimbursement rates that scale federal cost sharing based on payment error rates could cause Connecticut to be responsible for 15% of the program cost.

Other changes, like removing federal taxes on tips and overtime and the vehicle interest deduction provision, will result in lost revenue.

Other changes, like removing federal taxes on tips and overtime and the vehicle interest deduction provision, will result in lost revenue to the state.

The Office of the Comptroller, reporting on Office of Fiscal Analysis estimates, suggested that the House version of the bill would cost the state $191.5 million across these three provisions.

However, the Senate version of the bill put caps on the provisions, such as limiting the car interest deduction to new vehicles only, that should reduce that gap significantly. 

Medicaid

Changes in Medicaid policy are harder to estimate with respect to the impact on the state’s budget.

While on one hand the state is losing federal dollars, this is largely due to the exclusion of individuals from eligibility.

Since the overall number insured by Medicaid will decline, savings will be experienced in the Connecticut budget as well.

Other changes in reimbursement methods will ultimately increase the state’s share of Medicaid spending.

Meanwhile, other changes in reimbursement methods will ultimately increase the state’s share of Medicaid spending.

Further analysis will be required for a full picture of the impact the Medicaid changes will have on the budget. 

How the state responds to these budget pressures, whether through tax increases, spending cuts, or savings drawdowns, will contribute to overall economic competitiveness. 

Deficits, Interest Rates 

Estimates for the ultimate price tag for the federal tax and spending bill vary based on source, but it is expected to be substantial even under the rosiest of assumptions.

The primary concern with respect to these increased deficits is the extent to which they drive up interest rates and crowd out private investment.

Higher borrowing costs will further exacerbate budget challenges associated with Connecticut’s high levels of debt.

CBO estimates for the bill suggest that the crowding-out effect will reduce long-term GDP, but these findings are controversial.

The economic and interest rate environment today is very different from the past 15 years or so, but it is worth monitoring how the increase in U.S. debt impacts long-run borrowing costs.

For Connecticut, higher borrowing costs will further exacerbate budget challenges associated with the state’s high levels of debt. 

Conclusion: Waters Further Muddied 

This year has been defined by increasing economic uncertainty brought on by federal policy changes, and the budget reconciliation bill only adds to that uncertainty.

Even as we evaluate the economic impact of these budget changes, it is worth remembering that this policy does not happen in a vacuum, but should be evaluated in step with other changes such as trade policy.

For example, analysts at the Tax Foundation estimate that tariff proposals would offset much of the economic stimulus of the budget bill, while revenues from tariffs may offset some of the deficit concerns previously discussed.

It is important that businesses and policymakers prepare options for limiting the impact of the negative aspects of policy changes.

While there was hope that trade deals would arrive sooner to soften the blow from tariffs, recent news suggests tariff rates will remain high, absent some other intervention outside of the administration. 

As we await further guidance on benefits and tax changes, it is important that businesses and policymakers prepare options for limiting the impact of the negative aspects of policy changes.

While certain changes to policy will be a boon to the state, others will require careful implementation.

State Policy Recommendations

State policymakers can help reduce uncertainty by: 

• Reducing payment error rates for SNAP to limit state share of SNAP costs 

• Leveraging existing shipbuilding efforts to maximize new funding availability for Connecticut companies in the shipbuilding supply chain 

• Continued expansion of the R&D tax credit to blunt the impact of science funding cuts and enhance new federal tax policy 

• Continue paying down high interest pension debt to offset impacts of increased interest rates on bonded debt 

• Emphasizing energy affordability to offset impacts of reduced renewable and energy efficiency credits/rebates 

• Streamlining work requirement reporting to limit the number of Medicaid recipients who lose coverage thus maximizing federal contributions 

Much is still to be seen and understood about this new law, but pragmatic leadership can help maximize outcomes for Connecticut and its residents. 

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About the author: Dustin Nord is director of the CBIA Foundation for Economic Growth & Opportunity.