Changes in tax policies and a little bit of luck have helped state finances in recent years
Since he took office 2 1/2 years ago, Gov. Ned Lamont has watched the cash pour into Connecticut’s coffers. Even a coronavirus-induced recession couldn’t stop analysts from forecasting big surpluses for the next two years.
But much of that good fortune is due to a tax system and other policies Lamont inherited.
Now, as another gubernatorial election cycle nears, the question looms: Who is responsible for Connecticut’s recent, relative budget prosperity?
“I didn’t expect that,” Lamont said of the billions of extra tax receipts that have poured in since he became governor. “I just knew that economic growth was the key.”
According to the Department of Labor, Connecticut is still down about 100,000 jobs from pre-pandemic levels, but state tax receipts have boomed regardless for two other reasons:
First, the stock market has largely defied the pandemic. The Dow Jones Industrial Average opened this week 35% higher than it stood on March 4, 2020, just before COVID-19 struck Connecticut.
Second, massive supplemental federal unemployment benefits left many jobless residents with more money over the past year than when they were working. And since much of those benefits are taxable, state income tax receipts remained strong as well.
That’s not to say Lamont has played no role in keeping finances in line. Pushing legislators to adhere to spending and borrowing caps, he has refused to tap state reserves during his first 30 months on the job. The rainy day fund has more than doubled and now exceeds $3 billion under Lamont, who also has channeled more than $1.4 billion in surpluses into the cash-starved pension funds.
And he’s frequently reminded lawmakers that the stock market, which has contributed greatly to the recent budget success, can turn on a dime.
“Bull markets, I guarantee you, always come to an end,” he said. “And this has been a long one.”
Malloy’s budgetary luck was the opposite of Lamont’s
But his good fortune — as far as state government finances are concerned — is undisputed, and pretty much the opposite of his predecessor, Gov. Dannel P. Malloy.
A Fairfield County Democrat like Lamont, Malloy came into office in 2011 with a state budget on pace for an unprecedented 18% deficit.
Put another way, a General Fund of about $18 billion — without adjustments — was projected to run more than $3.6 billion in the red.
And while Lamont started with $1.2 billion in the rainy day fund, Malloy began with an empty reserve, $1 billion in operating debt (left by Gov. M. Jodi Rell and the 2010 legislature ) and 9% unemployment — courtesy of the Great Recession.
Malloy took massive heat when he and the legislature enacted more than $1.8 billion in annual tax increases in his first year, one of the single-largest revenue bumps in state history.
This was compounded by the fact that actual tax receipts didn’t meet nonpartisan analysts’ projections during five of Malloy’s first six years in office as Connecticut muddled through one of the slowest recoveries in state history, according to records from the state comptroller’s office.
“It became somewhat of a shock to all of us,” said Hamden Democrat J. Brendan Sharkey, who was House majority leader and later speaker between 2011 and 2016. “There was a slow-moving realization that the Great Recession was like no other.”
The state’s unemployment rate wouldn’t dip below 5% until 2016 — a problem Malloy’s critics blamed on the taxes. But Connecticut hadn’t experienced any net new job gains since the 1980s, having failed for decades before to invest heavily in transportation, information technology infrastructure or cutting-edge industries.
“Complacency was the name of the game from 1990 until 2008” and the Great Recession, said University of Connecticut economist Fred V. Carstensen. “We were coming off this period when we were fat and lazy and didn’t need to do anything. … We were The Land of Steady Habits, but a lot of them were bad habits.”
“I understood how bad things were,” Malloy said. “It was not a normal recovery. But did I expect it to take six years? No.” (After losing 120,000 jobs in the Great Recession, Connecticut had regained only about 90,000 by the time the pandemic struck in March 2020.)
A second round of major tax hikes was ordered in 2015 — despite campaign pledges from Malloy and from his GOP challenger Tom Foley that the budget could be balanced without more revenue from households and businesses.
Income tax hikes of 2011, 2015 pay big dividends now
“Who wouldn’t want an easy solution? But the reality is our problems are too big for easy solutions,” Malloy said. “I knew people weren’t happy. I didn’t run for office to make people happy.”
And while that second tax increase pushed Malloy’s limited popularity to a new low, it also completed the budgetary foundation that had been laid in 2010.
Since its inception in 1991, Connecticut’s income tax had largely been flat, taxing most earnings at 4.5% and then later at 5%. The legislature and Rell would tax earnings above $500,000 for singles and $1 million for couples at 6.5% starting in 2009 — but only for income above that threshold.
In other words, a couple earning $2 million per year only would pay 6.5% on the second million. The first million would still be taxed at lower rates.
Under Malloy, the income tax would become significantly more progressive.
It was expanded to include seven marginal rates, topping out at 6.99%.
More importantly, it included a “recapture” provision that ensures the wealthiest households pay the top income tax rate on all of their earnings — not on just a portion.
And when Wall Street began to finally rebound in a big way in 2018, the new rate structure pushed income tax receipts up quickly — even with sluggish job growth. That’s because nearly one-third of Connecticut’s income tax revenues come not from paycheck withholding but from quarterly returns — which are dominated by capital gains and other investment earnings.
The state income tax and pass-through entity levy — an income tax on small business owners — generated $11.7 billion last fiscal year, 30% more than they did just four years ago.
That’s enabled Lamont to amass the maximum-allowed rainy day fund — a little more than $3 billion or 15% of annual operating expenses — and generally avoid major tax hikes during his first three budgets.
Did the GOP create CT’s current budgetary success?
But Republicans say those who focus closely on Malloy or Lamont to explain the currently flush budget situation are wrong.
“The [good] fortune has nothing to do with either one of the them,” said Liz Kurantowicz, a Republican political strategist.
Simply voting for tax increases or generating big tax receipts does not translate into budget success, she and other Republicans argue.
In fact, Connecticut’s history throughout the 1990s and 2000s is littered with fiscal problems despite many years of robust tax receipts.
State government ran up $6.1 billion in budget surpluses between 2000 and 2014, according to nonpartisan analysts. Only one-third of it, $2.1 billion, was placed in the budget reserve. The rest was spent — and none of those expenditures involved deposits into the pension funds to reduce debt in this area.
Why haven’t the recent surpluses been spent on new programs and on pet projects in lawmakers’ home districts? Republicans say the answer can be found four years ago.
The GOP hasn’t controlled the state House or Senate since 1996, but it had narrowed the Democrats’ lead significantly heading into the 2017 session.
And as liberal and moderate Democrats struggled for months — unsuccessfully — to reach a budget deal with Malloy, or amongst themselves, in 2017, the Republicans were brought in to craft a bipartisan package.
The GOP agreed, but also insisted that Malloy — whose popularity was waning — be excluded from the negotiations.
The longest-running budget debate in modern state history would wrap in late October with both parties backing a new budget — and a provision that’s become known as the “volatility adjustment.”
This mechanism forces the state to save a significant portion of income tax receipts tied to investments earnings, which can fluctuate greatly from year to year. Since its enactment, that volatility adjustment has taken $4.1 billion in potential spending out of the legislature’s hands.
“We were taking the good times for granted,” said House Minority Leader Vincent J. Candelora, R-North Branford. “Very frankly, Gov. Lamont has been the beneficiary of that bipartisan budget.”
Sen. John Fonfara, a Hartford Democrat, spearheaded the push for the volatility adjustment.
But North Haven Republican Len Fasano, who was Senate Minority Leader in 2017, said it was the GOP that used its leverage to ensure not only the savings provision, but newer-and-tougher caps on spending and borrowing were enacted.
“It’s amazing what it has done for the state,” Fasano said. “It’s very satisfying to see that, because it shows, with a bipartisan deal, what can happen.”
New Britain Democrat Joe Aresimowicz, who was House speaker from 2017 through 2020, said Republican recollections are skewed, and many from both parties fought for the fiscal reforms that made a big difference in 2017.
“We [all] made the tough choices and it was always while hoping we would come out on the better side,” he said. “It was the most challenging, frustrating but rewarding and satisfying thing I’ve ever done in my entire life.”