Balancing the Budget

On Jan. 4, state lawmakers return to Hartford with a big problem waiting for them.
They’ll need to propose a balanced biennial budget covering fiscal 2018 and 2019 in the face of a two-headed fiscal monster—sharply rising fixed costs and lower-than-expected tax revenue.
And due to a law passed last spring that changes the way budget projections are reported, getting a clear picture of the problem may be a bit tougher than usual.
On Nov. 15 the legislature’s nonpartisan Office of Fiscal Analysis and Gov. Malloy’s budget office, the Office of Policy and Management, released separate fiscal reports with very similar conclusions: the state has to find over $1 billion in savings to end up with a balanced budget for next fiscal year.
Both reports reflect the new law, which eliminated the “current services” approach to budget prognostication, where the goal is to determine the amount of funding required to provide the same level of services in the succeeding fiscal years plus any scheduled or required changes.
The new methodology seeks to determine how much “nonfixed” spending can increase or must be cut based on a comparison of annual consensus revenue estimates with the previous year’s budget expenditures plus the annual growth in “fixed costs.”
Fixed costs are debt service, contributions to the state employee and teacher pension funds, payments toward state employee retiree healthcare benefits, entitlement programs (such as Medicaid), and federal mandates.
Focusing on projecting the growth of fixed costs, however, leaves out potential cost increases in other parts of the budget, which can give an incomplete picture of how much red ink there really is.

Fixed Costs Climbing

Following the new reporting parameters, OFA estimates that fixed costs will increase by $898.7 million in fiscal 2018.
When combined with expected declines in revenue growth, the state is left with the task of reducing nonfixed costs (which will total $9.1 billion in 2018) by
$1.2 billion, or 13%.
OFA’s projection of fixed cost growth is driven primarily by increases in debt service payments (up by $244.6 million), Teachers’ Retirement System contributions (up $297.4 million), and pension contributions and retiree health benefits for state employees (up $192.3 million).
The increases in fixed costs predicted for fiscal 2018 come as no surprise given the trend over the last decade, which has seen those costs go from 37% of the state budget in 2006 to an estimated 53% in 2018.
According to the OFA report, almost $10 billion will be spent on fixed costs in 2018, and another $5 billion on Education Cost Sharing (education funding for cities and towns) and state employee wages.
All told, fixed costs, ECS, and wages add up to 78% of the budget, in effect leaving only 22% from which to find savings.
The OPM report tells a similar story: fixed costs will increase by nearly $1.1 billion—growth that exceeds estimated (negative) revenue growth for fiscal 2018 by $1.3 billion.

Major Adjustments

“Clearly the state has gigantic challenges with respect to state employee pensions, teacher pensions, and other obligations that have not been funded [by prior administrations],” said Gov. Malloy, speaking to reporters at the State Capitol on Nov. 15.
Despite steps taken by the governor and legislature in the last few years to reduce Connecticut’s long-term debt, the state remains saddled by $74.3 billion in unfunded liabilities, including obligations for state employee pension and post-retirement health benefits.
That’s up 5% from last year’s reported amount of $70.7 billion.
“As in every budget I’ve put forward, we will have a payment plan to honor our obligations,” said the governor. “That will require adjustments to be made in other parts of the budget.”
Those adjustments may have to be more dramatic than indicated by the OFA and OPM reports.

Just days after those documents were released, the Connecticut Mirror reported that OFA issued another budget forecast—this time taking into account potential spending growth beyond the fixed costs used in the initial reports.
The new projection puts the fiscal 2018 deficit at nearly $1.5 billion, and the following year’s shortfall at more than $1.6 billion.
Previous estimates had put the deficits at $1.3 billion and $1.4 billion, respectively.

The Monster Rears Its Other Head

Rising fixed costs wouldn’t necessarily be a problem if state tax receipts were keeping up with them—but they’re not.
New consensus revenue projections released on Nov. 10 by OFA and OPM estimate a decline of $189.7 million in General Fund revenue from fiscal 2017 to fiscal 2018.
The projected average tax growth rate was reduced from 3.4% to 2.8%, based on current economic and collection trends, with the most significant downgrades anticipated for state income tax and sales tax collections.
According to the consensus revenue estimates, state income and sales taxes account for $13.7 billion in fiscal 2018, or 77% of total General Fund revenue, and they’re projected to decrease by $188 million in 2018 and $270 million in 2019.

What’s Causing Revenue to Falter?

Tax receipts suffer without strong economic growth and the job creation it brings, and neither indicator has been kind to Connecticut since the Great Recession.
From 1997 to 2007, Connecticut saw 3% growth in real gross state product. From 2007 to 2015—a period that includes the recession—GSP dipped to -0.8%.
Since the recession, the state’s economy has improved, but our recovery has failed to keep pace with many of our neighboring states and the nation overall.
In 2015, Connecticut’s economy grew by just 0.6%, well below the regional and national averages.
In fact, the state’s post-recession economic growth has consistently trailed the region and the country, with a low point of -0.9% in 2011 and a high of 1.2% in 2014.
Meanwhile, New England’s economy grew by 1.3% in 2015, with Massachusetts (at 2%) the leader among the six states.
Since the official end of the recession in the second quarter of 2009, Connecticut’s economic growth has averaged 0.4% at an annual rate, compared with a national average of 1.9%.

Backsliding on Jobs

Although Connecticut has added jobs since the downturn, we’ve begun backsliding, losing 6,600 positions in September, 7,200 in October, and nearly 15,000 since June.
Earlier in the year, the state had recovered more than 80% of the 119,100 jobs lost in the recession; now we’re back to 69%, the worst recovery rate in New England.
Maine, at 75%, is the only other New England state that has not regained all lost jobs.
Massachusetts has recovered over 300% of jobs lost during the downturn and leads the region.
The United States, on average, has recovered 178%.
In addition to shaky job growth, another factor putting pressure on tax revenue is the fact that a disproportionate number of the jobs added in Connecticut have been low-wage.
The recession wiped out primarily high-wage jobs around the country, with Connecticut losing nearly 15,000 jobs in financial services alone.
During the recession, the Finance & Insurance industry—the single largest private industry sector in Connecticut—accounted for over 49% of all losses in salaries and wages.
In 2015, that sector accounted for 19% of all private-sector salaries and wages, down from a pre-recession peak of 21%.

Slaying the Monster

Is there a way out of the state’s fiscal mess and economic funk?
CBIA President and CEO Joe Brennan thinks so.
“As the governor said in his 2016 budget address, we can find a way out by, first and foremost, living within our means—finding out how much money our tax system is going to bring in and spending no more than that amount," Brennan says.
“As hard as it’s going to be to solve our budget problem, if we try to do it with tax increases, it’s only going to make the situation worse by driving more wealth, more businesses, and more jobs out of the state.

“Our opposition to tax increases doesn’t stem from simply not wanting to pay higher taxes; we’re opposed to tax hikes because they will make our fiscal troubles worse. You don’t want a solution that makes things worse; that’s not the definition of a solution.
“We need to focus on the core services of government and not try to be everything to everybody.”
CBIA Vice President and Economist Pete Gioia agrees.
“We’ve got to decide what our priorities are and make sure the priorities are funded, and then we can address other areas that aren’t as high on the list,” he said.
Gioia believes that the best way to determine those priorities is to adopt a true zero-based approach to the budget.
“No sacred cows; everything has to be on the table,” including, he says, contracts governing state employee pensions and benefits, which aren’t officially up for renegotiation until 2022—too far off, as far as Gioia is concerned.
“What we have is unsustainable state spending that requires major structural reform.”

Getting a Jump on the Budget

The governor’s budget office has already begun taking steps to pave the way for a balanced 2018–2019 budget without resorting to tax increases.
OPM has asked state agencies to provide options for cutting 10% from their budgets.
Proposals received so far include closing certain facilities, cutting staff, and scaling back or eliminating various services and programs.
Recommendations have also been made to generate revenue, including by increasing certain fees and fines, but the governor has indicated that tax increases are not something he’s looking at.
In response to a question at his Nov. 15 press conference about whether he will propose tax increases to help stem the tide of red ink, Gov. Malloy told reporters, “If you’re asking if I’m leading with the expectation that we’re going to raise a lot of additional dollars, the answer is no.”
In what could be good news for business investment in Connecticut, the governor did suggest that he would like to see tax measures implemented that would make the state more economically competitive.
“I think there are tax changes that I’d like to see that are beneficial to the business climate of the state,” he said.
“We have a lot of work to do on a budget that will be pressed by the unfunded obligations of the past and, at the same time, bring some stability to the state’s business community to meet some of the desires they and I have jointly and that I’ve attempted to do in the past.”
Brennan applauds the governor’s desire to continue the progress made during the last General Assembly session to close budget gaps without resorting to tax increases and urges the legislature to follow suit.
“I’m confident lawmakers will work together in a spirit of bipartisanship to not only solve our immediate budget challenges but take the necessary steps—including enacting a workable spending cap—to ensure fiscal stability in Connecticut for years to come,” he said.

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For more information, contact CBIA’s Louise DiCocco (203.589.6515) | @LouiseDiCocco