Connecticut has been in a fiscal crisis pretty much non-stop for the past eight years. It is likely that the state would have started looking at red ink before that, but the real estate and financial bubble of the 2000s masked the underlying reality. For close to a decade, and probably for longer, our state has been constantly on the edge of a fiscal chasm, with the General Assembly muddling through with a mix of tax increases and spending cuts.
The thing is, this is not really normal. Connecticut is one of the wealthiest states in the wealthiest country in the world. Even if the state´s economy hasn´t fully recovered, unemployment is relatively low, growth is weak but not anemic and labor productivity is still high. We have an economy in a mild slowdown enough to produce a shortfall that could be sorted out with some tweaks. Instead, we have a Groundhog Day of budget deficits.
For starters, it is not true that we have a state government we cannot afford. It is hard to stress enough the fact enough that Connecticut is really wealthy and we are not doing anything that other states aren't able to pay for, but it goes beyond that. Measured both in terms of state and local taxes as percentage of personal income and as size of state and local government as percentage of the state economy, we rank in the bottom half in terms of how much we tax and spend.
Of course, it is not that we have not raised taxes. The state, in fact, went through two rounds of pretty hefty tax increases, one just after Governor Malloy got elected, a second round last year. The Governor and legislature have been looking for money all over the place, and they have bitten the bullet (twice!) with unpopular tax increases. And yet, the budget hole does not get any smaller. Why?
The answer is a tad complicated, and requires having a closer look at how we tax and spend in the state. The main issue, however, is less that we spend too much or tax too little, but that we do both in really outdated, inefficient ways. We have a state budget based on 20th century assumptions, not 21st century realities. Let´s start today with taxes.
1. Taxing objects in the age of ideas
If we want to see how the Connecticut tax structure is designed for a 1960s style economy, look no further than the sales tax. About a quarter of the total tax revenue of the state comes from the sales and use tax, collecting a bit north of $4 billion a year. It is a fairly regressive tax, with families at the bottom of the income distribution paying much higher effective rates than anyone else.
This is due to the very nature of taxes on consumption (the poor dedicate a higher percentage of their income to it), but also because we happen to exclude a lot of things from it: primarily, many services. Connecticut´s tax code has a monumental amount of carve outs, exemptions, loopholes and special provisions that leave a huge and increasing percentage of our economy untaxed. This means that a diaper, sofa or cell phone has to pay sales tax, while things like repairing a boat, hiring an interior decorator or going to the gym are untaxed. In a sense, the state is raising money from tangible products in an economy that is more and more focused on services and ideas.
If we eliminated all the sales tax exemptions but the one for food purchases, Connecticut would be able to collect close to $2.5 billion in extra revenue a year at current rates – or it could cut the current rate by close to two points, giving a significant tax cut to low income families while still raising close to half a billion in additional revenue. To put it in one sentence, broadening and simplifying the sales tax makes sense.
The sales tax, however, is hardly unique. If we look at the state and local tax system as a whole, the property tax is by far the biggest source of funding for Connecticut´s public sector, with 45% of all tax revenue. Four or five decades ago, when Connecticut had a much more egalitarian income distribution and wealth was much less geographically segregated, it made sense: the core cities concentrated business, trade and industry and could raise revenue effectively. Today, cities have lost much of their former tax base, suffered years of underinvestment and concentrate most of the need, so they end up having higher mill rates. As a result, nearly 60% of Connecticut towns cannot cover the cost of their services on their own.
Things have changed in the past few years. Today, many business favor dense, vibrant urban areas instead of suburban campuses. GE left the state not looking for a low-tax haven, but for vibrant, urban Boston. Knowledge workers value active, diverse, lively, dense communities, and clustering creates strong network effects that promote innovation. In Connecticut, however, we are taxing those urban areas heavily, while leaving the most expensive suburban communities in the country paying much lower mill rates. Again, we have an outdated tax system, raising money in a way that doesn´t make much sense.
2. Giving tax breaks to fading industries
The rest of the state´s tax system is similarly geared to either raise money from a 1960s-style economy or promote growth like we used to have in last century. Connecticut´s business tax code heavily favors manufacturing over any other kind of industry: while the total effective tax rate for a factory (adding up business, property, sales and unemployment taxes) is 9.8%, a research facility or corporate headquarters ends up paying 22%.
This might have made sense decades ago, when manufacturing was both labor intensive and did not face international competition. Today 80% of the U.S. labor force is in the service sector, while manufacturing barely employs 8% of workers. Connecticut, even with all this help, barely looks any different, with less than 10% of the labor force in factories. Our business tax code is needlessly complicated for no good reason.
3.Taxing (some) income instead of wealth
Connecticut has the largest income gap of the nation. The state tax system takes this into account thanks to a progressive income tax that raises roughly 60% of its revenue. The income tax does its job in making those that have the most pay more, but not terribly so: the effective tax rate for households in the top income decile (4.52% in 2011) is only three and a half points higher than those at the bottom (1.11%). Trouble is, wealthy, affluent households tend to receive a very high percentage of their income from investments, and Connecticut is not taxing capital gains that much.
In addition, in a state with very high levels of concentrated wealth, our property taxes remain firmly local. As a result, the more expensive the average median price of a house is in a town, the lower the mill rates are. As most of household wealth in the state is tied to housing, we are again raising revenue the wrong way from the wrong places.
Fixing these imbalances and modernizing Connecticut´s tax system to make it more efficient, fair and predictable won´t be easy. Even a non-binding, non-partisan tax panel this year had trouble producing a revenue-neutral set of proposals, and sidestepped proposing significant changes to the property tax. We are at a point, however, where Connecticut can no longer afford standing still. Our state and local tax system is regressive, inefficient and often just raises insufficient funding from the wrong things and places. It is time for state and local leaders to step up and start thinking big, not just look at piecemeal reforms. The current tax system will never be able to raise enough revenue to fund our current needs on the long run, or to foster sustainable economic growth.
Not everything is taxes and taxation, however – Connecticut might not be the big spender that is often suggested, but we do manage to use our money in surprisingly inefficient ways sometimes. That, however, is for the next article. Stay tuned.
The Connecticut General Assembly is in session, and the budget hearings have begun. With the state facing a deficit north of $570 million in the coming fiscal year, legislators are again scrambling to find ways to balance the budget.
There seems to be very little appetite so far for any kind of tax increases, so Governor Malloy and legislators are talking about cuts - and these cuts are being discussed, right now, at multiple Appropriations Committee hearings at the Capitol. You can find the calendar here; today the committee will hear about higher education. Tomorrow at 4 pm they will host the hearing for human services which may be of most interest to you.
There are two things to bear in mind about the budget revisions proposed by Governor Malloy, one about process, one about where the cuts will fall. Both are important, and deserve some attention.
A. WHERE ARE THE CUTS?
The cuts for fiscal year 2017 add up to $570 million. The departments that are facing the worst cuts are the Department of Social Services ($61 million), Department of Developmental Services ($55 million) and from addiction and mental health services ($71 million).
This by itself would be worrisome, but it goes beyond that. According to the CT Community Nonprofit Alliance´s analysis, 72% of the cuts ($408 million) come from non-profit providers. Consequently, many core services offered by these providers will again face an uphill battle meeting the needs of low-income families in the state with diminishing resources.
The slow economic recovery has left many families behind. The budget is asking them again to bear the brunt of the state fiscal woes.
B. HOW ARE THE CUTS BEING INTRODUCED?
Governor Malloy has decided to consolidate most line items in the budget under a generic "agency operations" heading. After that, his proposal states that spending will be cut 5.75%, but without specifying exactly from where.
This is a problem. Instead of the traditional budget breakdown of proposed reductions with specific explanations of what line items are facing cuts, this proposal just offers an agency-wide spending level, and gives the authority to each agency head to decide where to cut. The result is a budget that imposes harsh spending cuts but is lacking in transparency, with no information on what programs will be eliminated.
This is not acceptable. Transparency is an essential for accountability. The Governor´s budget proposal shifts the responsibility and decision making for crucial spending decisions from an open, public process at the General Assembly towards one with no public participation, no open hearings and limited accountability. The only way to make those decisions and introduce real, needed changes to the state budget is through an open, accountable and transparent budget process, not by delegating authority to the executive branch.
WHAT IS NEXT? HOW CAN I GET INVOLVED?
Right now we encourage you to reach out to your legislators, even more so ifthey are on Appropriations. If you are able, we strongly encourage you to submit testimony to the committee, specially if you are involved in a program that is facing cuts. The message is simple:
Feel free to give us a call if you have questions or need a hand drafting testimony, setting up a meeting with a legislator or preparing talking points. We will be happy to help.
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.
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.
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.
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.
If you are looking for some effective policy proposals to help low income families thathappen to have broad bipartisan support, Washington has not been the best place to look of late. After the SNAP cuts approved last week in the House, it is hard to believe there is much interest in helping low income families in the short term.
There is one policy that it is both very effective and that has been receiving plaudits from both sides of the aisle of late, however: the Earned Income Tax Credit, or EITC. The Center on Budget and Policy Priorities has a great article about the EITC, a policy that both works and has some Republican Senators arguing that it need to be expanded. The data certainly shows its effectiveness:
Next to Social Security, the EITC combined with the refundable portion of the Child Tax Credit constitutes the nation’s most powerful anti-poverty program. These two credits lifted 10.1 million people out of poverty in 2012, including 5.3 million children (see chart). As AEI’s Michael Strain points out, the EITC “is a very effective anti-poverty tool because it supplements earnings and incentivizes employment. Expansions of the EITC have been very successful at encouraging work, particularly among single mothers during the 1990s.”
We were very vocal, in fact, arguing for a state EITC. The state tax credit was cut last year due to the tough budget situation from 30 to 25% of the federal refund. Governor Malloy has promised restoring the state EITC to 27.5% this budget year (and to 30% in 2015), and CAHS will work to ensure this program is restored.
CAHS, through our very successful VITA program, has also worked for years to make the help families get access to the program. You can learn more about our VITA program here - and get information on all sites in the state by calling 211.