Just a quarter of the way into the biennium, and the state budget approved in June is already awash in red ink.

In bipartisan budget talks on Nov. 4, Gov. Malloy and state legislative leaders agreed on an estimated state budget deficit of $350 to $370 million.

Nine days later, the legislature’s nonpartisan Office of Fiscal Analysis issued a firmer number, pegging the current fiscal year shortfall at $254.4 million, or 1.4% of total estimated expenditures.

OFA projected even uglier numbers for subsequent years—gaps of $552 million (2.9%), $1.72 billion (8.5%), $1.87 billion (8.9%), and $2.21 billion (10.1%) for fiscal years 2017, 2018, 2019, and 2020 respectively.

For the same four years, the governor’s budget office, the Office of Policy and Management, is projecting deficits of $508.1 million, $1.3 billion, $1.2 billion, and $1.4 billion.

The state’s short-term budget troubles are being blamed on overly optimistic revenue estimates in the biennial budget approved in late June. As of Nov. 10, revenues were running about $218 million behind and are projected to be more than $400 million short in FY 2017.

Wealth has moved out of the state, and we're seeing the effects of that.
— CBIA economist Pete Gioia
“Two factors are contributing to current revenue shortfalls,” says Pete Gioia, CBIA vice president and economist.

“One is that the architects of the budget based revenue projections on extremely rosy assumptions about personal income growth. They were expecting 5.2%, but we’re getting 3.2%.

“The other factor is that wealth has moved out of the state, and we’re seeing the effects of that.”

‘I Want to Spend Less Money’

The bipartisan budget negotiations between the administration and legislative leadership, which began in late October, were called by the governor to generate ideas from Democrats and Republicans for closing the budget deficit and positioning the state for future fiscal stability and economic growth.

“I want to spend less money,” said the governor at CBIA’s 200th Annual Meeting and Reception on Oct. 29 in Hartford.

“That’s why I’ve called everyone [legislative leaders from both parties] to my office to have a reasonable discussion about how to move Connecticut into the future. Let’s cut spending and get our long-term and short-term obligations under control.”

He added that we need to set a goal of making Connecticut the most competitive state in the region.

If an agreement between the governor and legislative leaders can be reached, the General Assembly would likely go into special session prior to the Feb. 3 start of the regular session.

“By linking fiscal stability with economic growth, Gov. Malloy has set the negotiations on the right path,” says CBIA President and CEO Joe Brennan.

“He has also taken the positive and important step of making budget talks bipartisan, seeking out the best ideas from both sides of the aisle. It’s clear that they all recognize that our recurring budget deficits and recent tax increases have a chilling effect on business investment and job growth in the state.

Starting the Discussion

The connection between fiscal stability and economic competitiveness is the cornerstone of a broad proposal the governor presented to state commissioners on
Oct. 28 in a cabinet meeting in East Hartford.

The plan offers an overview of the administration’s approach to meeting short- and long-term fiscal realities and putting Connecticut’s budget and economy on a more stable, sustainable path.

By linking fiscal stability with economic growth, Gov. Malloy has set negotiations on the right path.
— Joe Brennan, CBIA president and CEO
According to the proposal, the big question confronting the state is, “How do we position Connecticut for long-term economic growth, align our policies to encourage business growth, and fix the immediate [budget] shortfall while preserving core services?”

The solution?

“Address the shortfall and the long-term obstacles simultaneously so that we can have a healthy, sustainable economy and thus a healthy, sustainable budget.”

Putting the situation in those terms is a good sign for CBIA and the business community, who for years have worked to convince policymakers that responsible budgets and a strong economy go hand-in-hand.

“We need to encourage legislative leaders to take the connection between fiscal stability and economic growth seriously,” says Brennan. “We’re not going to get fiscal stability without economic growth.”

The governor’s plan suggests the following principles, or goals, as a guide to future budget decisions:

  • Maintain a sustainable, balanced budget that does not rely on phantom savings.
  • Set clear priorities in order to increase state government productivity while controlling costs.
  • Provide predictability for business, nonprofits, and families.
  • Increase Connecticut’s competitiveness with a goal of making Connecticut the most competitive state in the region.

Proposed Budget Cuts: Details Emerge

In his presentation to state commissioners, the governor offered several tactics for addressing short-term budget concerns, including making targeted cuts.

Although his plan offered few specifics on what those cuts would be, the administration provided a very detailed 36-page list of proposed budget reductions on Nov. 13, the day after the governor held the third round of negotiations with legislative leaders.

The reductions, which total more than $330 million and target numerous departments and services, include closing the State Police Barracks in Bethany, the Enfield Correctional Institution, and two courthouses; eliminating six state commissions; eliminating or reducing state funding for several social services and workforce development programs and for numerous museums and other cultural nonprofit organizations.

We have a fiscal crisis, and we need a new direction.
— CBIA economist Pete Gioia
The governor also plans to continue cutting the state workforce through attrition and other means besides layoffs, setting a target of 500 jobs for this fiscal year.

“We have a fiscal crisis, and we need a new direction,” says Gioia.

“We’re encouraged to see that Gov. Malloy is looking for consolidations in areas such as corrections and other state services and that he’s looking to move some direct services to the private sector, where they can be delivered more efficiently and less expensively.

“But in many cases, while these are good moves, they are still only first steps.”

GOP Proposal

Republican legislative leaders released a budget reductions list of their own on Nov. 13, consisting of short- and long-term proposals.

Their plan would cut more than $370 million from the current year’s budget and allow for the restoration of the cuts to hospitals and social services made by the governor’s September rescissions.

Among their suggestions are offering retirement incentives to senior state employees (estimated to save $79.9 million in the FY 2016 budget); cancelling a $94.6 million payment into the Municipal Revenue Sharing Account (the current level of funding to cities and towns would not be reduced); and authorizing the governor to hold back $93 million that is currently designated to cover potential agency overspending.

The GOP’s long-term proposals include lowering the state debt by limiting how much Connecticut can borrow and getting concessions from state employee unions.

Labor concessions to consider, say Republicans, include eliminating overtime pay from pension calculations, increasing current employees’ pension contributions, increasing prescription drug co-payments, ending longevity payments starting in April 2016, and implementing a new retirement plan that includes a defined contribution component.

Legislative Democrats Weigh In

On Nov. 16, Democratic legislative leadership released a plan that would cut $350 million from the current budget, restore just over half of the $63.5 million in budget cuts already made to hospitals, and provide modest tax relief for businesses.

The greatest savings in their plan—$105.3 million—would be achieved through wide-ranging cuts to numerous agencies and programs, including education, social services, job training, the Judicial Branch, public safety, and corrections.

They also want to delay a $35 million sales tax transfer to fund the governor’s long-range transportation initiative.

Democrats said in a media release that they support long-term negotiated savings from state employees, but stopped short of recommending an early retirement incentive plan, arguing that such plans add to the financial stress on the pension system.

They did, however, join the GOP in calling for $10 million in overtime savings and creating a state office to oversee overtime administration.

“It’s important for the governor and Democratic and Republican legislative leaders to work together to reach an agreement,” says Gioia. “There are very good elements in all their plans.”

Public Employee Pensions

One of the state’s most serious fiscal problems is its massive unfunded liabilities for state employee and teacher pensions and post-employment health benefits.

According to the latest (Nov. 13) OFA numbers, the unfunded liability in the State Employee Retirement System stands at $14.9 billion, a $1.6 billion increase over last year.

The state owes the Teachers’ Retirement System $10.8 billion, unchanged from 2014.

We need to bring public employee benefits more in line with those offered in the private sector
— Joe Brennan, CBIA president and CEO
The liability for state employee post-retirement health and life insurance benefits is a whopping $19.5 billion, also unchanged from last year.

Inadequate contributions over the years and lower-than-assumed investment returns have been key factors in making Connecticut one of the most indebted states in the country.

In addition, many believe that public employee pension and benefits packages that far outstrip those offered in the private sector and most other states must also be cited as a major reason for the state’s enormous unfunded liabilities.

State benefits packages are not up for renegotiation until 2022, but Gov. Malloy is proposing changes to the way the state employee pension fund is financed.
He recommended the following changes in his Oct. 28 cabinet meeting:

  • Split the SERS into two plans. One plan would be a pay-as-you-go system for Tier 1 retirees, which would take them out of the SERS altogether and simply pay their pensions each year out of the state budget. (Tier 1 workers and retirees are those hired before 1984; their benefits are more generous than those of workers hired subsequently and account for the lion’s share of the state’s unfunded SERS liability.) Benefits for Tier 2 and 3 retirees would be covered by the assets in the SERS fund.
  • Reduce the investment return assumptions for SERS and TRS. The state employee pension fund currently assumes an average 8% return; the teachers’ fund, 8.5%. The administration believes that an assumption of 5.5% is much more realistic. Of course, the lower the funds’ ROI, the more taxpayers have to cover to meet funding goals.
  • Control future benefit cost through collective bargaining, particularly by avoiding retirement incentives, contribution holidays, or other similar damaging practices. (Recall that a big part of the Republican’s reduction plan was offering retirement incentives to senior state employees, a potential area of contention as budget talks proceed.)

“We need to bring public employee benefits more in line with those offered in the private sector,” says Brennan. “There are things we can take from all the proposals that would get the state moving toward that goal.”

Correcting Mistakes

Recognizing the connection between fiscal responsibility and a strong economy, the governor’s broad plan includes several measures designed to boost economic growth and create jobs by creating a more hospitable business tax climate.

Several of his proposals would undo more of the damage created by the tax measures in the current budget, measures that House Speaker Brendan Sharkey (D-Hamden) admitted were “not well thought out and fully vetted” as Democratic legislators rushed to complete a budget by the end of the 2015 session.

“Oftentimes, that’s not a process that’s conducive to…good decision-making,” said Sharkey at the Nov. 5 meeting of the state Commission on Economic Competitiveness. (CBIA’s Joe Brennan is a member of that body.)

“I recognized after we passed this budget that we had made mistakes,” Sharkey added.

As an example, the Speaker mentioned not realizing the full impact of raising the data processing tax, which was eliminated from the budget during the special session in late June.

The governor’s tax proposals include:

  • Improving the new unitary combined reporting system (which requires multistate companies to pay Connecticut tax on income earned in other states) by capping the amount of any company’s additional tax owed due to the change to a unitary system
  • Restoring the 70% limit on business tax credits, including the R&D credit
  • Changing the tax on net operating losses to allow firms with significant prior-year losses to trade in 50% of those losses for an immediate exemption from the annual limit under the law, provided they continue to pay a minimum tax of $2.5 million
  • Providing a 15-day exemption from the personal income tax for employees coming into the state for business development activities (e.g., training) in the interest of making the state a more attractive destination for corporate meetings

‘We Can No Longer Avoid the Hard Choices’

Brennan is encouraged that Gov. Malloy and the legislative Democrats and Republicans have all proposed plans to address budget shortfalls without additional tax increases.

“It’s essential that the final package takes bold steps to restructure and reform state government in a way that allows for efficient and cost-effective delivery of state services without driving wealth and investment out of the state,” he says.

“We recognize that it’s an arduous task, but we can no longer avoid making the hard choices needed to spur economic growth in the state.

“Fiscal stability and predictability are critical to rebuilding the business confidence necessary for investment, economic growth, and job creation.”

That, in turn, says Brennan, will ensure that the state has the revenue it needs to deliver critical services and that our citizens have the educational and employment opportunities they need to better their lives.

For information about legislative issues and state fiscal policy, email or call CBIA’s Bonnie Stewart (860.244.1925 | @CBIAbonnie).