The Finance Committee budget- revenue and tax reform

Wednesday we talked about the spending side of the budget; where money is going and which programs were cut. Yesterday the Finance Committee released the other half, revenue, or where the money is coming from to pay for all those services.
For the second time in a row, we have a budget proposal that includes quite a bit of good news.

1. The budget: revenue overview
Let´s start with the obvious: new revenue means taxes. The Finance Committee budget brings in more money, so it is taxing more stuff, and they are doing this in a pretty smart way that deserves some attention.

First, let´s see where the new revenues are coming from (PDF):


If you look at this numbers, you will immediately see that this is a lot of money - more than the amount the Appropriations budget actually calls for. There are two main reasons for that.

First, some of the new revenue raised will not go to the state coffers, but to municipalities. Paired with the new revenue package, the Committee passed S.B. 1, a fairly ambitious property tax reform bill. This proposal includes some clever ideas on property taxes, and instructs that part of the sales tax money will go to municipalities. More on this below.

Second, because the sales tax will cover more services and products, the state will actually lower the rate.This will leave enough room to cover the additional spending on the Appropriations side while avoiding some of the impact from the tax increase.

To sum up, the total new revenues add up to just shy of one billion. Of that money, $294 million would go to municipalities, and $253 are used to lower the overall sales tax rate. With Appropriations adding $289 million in spending, the budget actually ends up having a small surplus.
Now let´s look at the numbers with some detail.
2. The budget: the sales tax

So let´s take a closer look at the sales tax: what are the exact changes included in the Finance proposal?

The Finance Committee proposal is based on broadening the tax base.

In non-jargon, the current sales tax is far from comprehensive: there are a lot of products that are not taxed (they are exempt), and services are only taxed if included explicitly in legislation. The Finance Committee´s plan eliminates quite a few exemptions (some of them were already included in the Governor´s budget proposal) and adds to the list of taxable services. This is similar to the recommendations offered by CT Voices in their March revenue proposal.

What exemptions are eliminated?

The two big items are clothing and footwear under $50 (raising $137 M) and computer and data processing (raising $162 M).

What services are now taxed?

The list is fairly long - you can find it here. The ones that raise the most revenue are engineering services, public accountants and consulting services. Most of the changes are items that really never made much sense to be tax exempt, like interior designers, golf courses, country clubs and direct mail advertising,

All in all, it does add up to a good amount of money: $322 Million.

What will be the sales tax rate now?

By the end of the year, 5.85% for the state portion of the sales tax; 0.5% for municipalities. The state rate would be reduced to 5.35% in 2016, leaving the combined rate at 5.85% next year.

Are these changes regressive?

The sales tax is indeed fairly regressive, however the slightly lower rate actually should favor lower income households. The services added and most exemptions do not affect poor families all that much, although the clothing exemption does. It is too early to tell how this will impact families without running some numbers.

The municipal .5%, however, will be used to lower another tax that it is really regressive: car taxes. More on that in a bit.
3. Other taxes: income and capital gains

The changes on income and capital gains are a bit more straightforward: just a slight increase in rates.

Income tax:

The top marginal rate (for individuals making more than $500,000 a year or couples filling jointly making more than $1,000,000) will go up from 6.7% to 6.99%. Note this is the marginal rate - that is, for each dollar that an individual makes over $500,000 he would pay about 6.99 cents instead of 6.7. The top tax rate will still be well below New York, New Jersey and Massachusetts, so we are still competitive in this regard.

Although small, the change raises significant amounts of money: $102.4 Million.

Capital gains:

Taxpayers in the highest income bracket (more than $500,000 for individuals, $1,000,000 for couples) will pay a 2% additional tax on all capital gains. This will put Connecticut in line with New York for top earners, and still below New Jersey.

The new supplemental tax would raise $167.6 million.
4. Other taxes: odds and ends

There are quite a few minor changes in the Finance proposal, the most relevant being tweaks on the hospital tax, closing some loopholes by introducing combined reporting for corporations (basically preventing businesses from claiming that they made profits in another state), the elimination of the business entity tax and Keno.

Yes, Keno again. It really does not raise that much revenue ($13.6 M in the first year, $30 M in the second), but it is again in there, somehow.
5. Property tax reform: S.B. 1 and the sales tax

We have been talking about property taxes quite a bit for the past few weeks. The current system is not only terribly regressive but steers investment away from poorer cities.This has been an area that the FESC wanted to address.

The Finance Committee is tackling this issue with S.B.1, adding a few very interesting tweaks. We mentioned that the sales tax now has a 0.5% portion that goes to municipalities; this bill actually details how the money would be used. It has four main components:

Motor vehicle tax changes:

The car tax is now capped at a mill rate of 29.36. There are 57 municipalities with taxes above that threshold - part of the money from the sales tax will be used to compensate them for the lost revenue.

This change would limit (but not close completely) the gigantic disparities in rates that the same car can pay if registered in a different town, a very positive reform.

Changes to PILOT grants:

PILOT stands for "payment in lieu of taxes". This is a grant that compensates towns with a lot of non-taxable property (state buildings, non profits hospitals, etc.) for the loss of revenue. S.B.1 tweaks the formula to give priority to the towns with the most non-taxable property. They also happen to be the poorest cities, so it is also a positive change.

Regional revenue sharing:

An idea we have described earlier, although with 20% of new commercial/industrial revenue growth shared instead of the 40% of the original bill. It is a bit less effective, but still a very good reform.

Regional program incentives:

About 10% of the funds coming from the sales tax would be used to establish cooperative regional programs to create efficiencies and reduce costs.

All in all, these are good changes - maybe a bit less ambitious than the bill that came out of the Planning Committee, but positive changes nonetheless. The car tax change will represent a hefty tax cut to city residents and many inner ring suburbs, PILOT will dedicate more resources to poor towns, the revenue sharing will help balance growth and regionalization incentives can help reduce the costs of providing municipal services.

The bill has strong support from the leadership, so it has a good chance to make it to the floor. If you have not talked with your legislators about property tax reform, it is time to start.
6. What´s next?

Still a long way to go until the budget is done. The Finance package includes quite a few big ideas, so once it gets to the floor, expect some back and forth discussion.

What it is important to do now is to contact your legislators in the Finance Committee and thank them for their efforts. This is a very difficult budget that needed some tough budget choices. The budget includes new revenue and some significant reforms on how we pay education (remember- that´s what property taxes are for!) in the state. Our legislators made the hard choices, and they deserve some recognition.

We had some very good news in the budget process this week. We are not done yet, but we are moving the needle - things are going in the right direction. Stay tuned, as there is more to come.

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