Email  Print  Feed

Subscribe to From the Founder : fromfounder

The State of the State’s Economy

Protagonists in the annual battle of the budget usually fold their tents by June and return to their various hometowns to explain what they won, or failed to win, for their constituents. With the precipitous decline in state income, the battle this year over the 2009–2010 budget is especially agonizing and protracted. As of this writing, six months into the fiscal year, the budget had yet to be finalized, and a special session was called for mid-December.

We are all painfully aware that Fairfield County pays nearly half of state income taxes, mostly from towns in lower Fairfield County. And these towns receive, on average, a far smaller percentage of state aid in return than towns in other parts of the state. In 2006, for example, Greenwich contributed $658,232,747 in income and sales taxes to the state and received just $6,406,787 in state municipal aid, a return of one cent on the dollar, not untypical of some of its neighbors. While the high average income in our area is cited to justify a progressive tax policy, this golden egg known as Fairfield County has served to encourage a lack of budgetary restraint by representatives from other areas. According to former state senator Bill Nickerson, who fought the budgetary battle in the Senate for twenty-two years, there has always been an attitude of, “Those wealthy towns in lower Fairfield County can afford it.”

The severity of the recession and the super-majority that Democrats now enjoy in both houses of the legislature have made it all the more difficult to achieve an agreement on steps needed to balance the budget as required by the Connecticut State Constitution. For the Democratic majority, it seems to be business as usual, and rather than cutting spending on marginal programs and eliminating duplication of services, the Democrats have insisted on raising taxes in a state that already ranks first in the country with a state and local per capita tax burden of $7,000. This is 64 percent higher than the national average. In addition, Connecticut ranks fourth in the country in per capita debt, at $6,830 for every man, woman and child. It should be obvious that raising taxes is no longer an option. We cannot afford business as usual.

Not surprisingly, on October 26 an analysis by Moody’s reduced the fiscal outlook for the state from stable to negative and lowered the rating on our general obligation bonds. The report pointed to Connecticut’s debt ratios as among the highest in the nation, pension funding levels that are among the lowest in the country, and unfunded postemployment benefits that are larger than the state’s operating budget. It was also concerned by the state’s inordinate dependency on high-earning taxpayers.

Soaking the rich is always popular among the general populace. However, it is not a viable approach for two reasons. In an excellent op-ed piece on the budget process that appeared in the Hartford Courant, Bill Nickerson disposes of a number of myths, among them that the rich aren’t paying their fair share of taxes. At one end of the spectrum, he cites a typical home-owning family of four with an income of $53,000 that pays little or no state income tax. At the other end, according to the Yankee Institute for Public Policy, the top 1.3 percent of taxpayers, those with incomes of $1 million or more, are responsible for 35 percent of the state’s entire income tax revenue. But because their earnings include capital gains and bonuses, the number of this small group of high earners has been further diminished. Republican Senator Scott Frantz has also pointed out to Democrats on the opposite side of the aisle that because IRS provisions for accumulated tax loss carry forward, future growth in taxable income from this group cannot be counted on. The argument tends to fall on deaf ears.

The Moody’s report supports Bill Nickerson’s claim that raising taxes on so few will do little to close the budget gap, and that depending more on this small group simply makes the revenue stream more volatile, as witnessed by greatly reduced income tax collections in the current recession. A joint release by Livvy Floren, Lile Gibbons and Fred Camillo, representing Greenwich and part of Stamford, echoed the folly of increasing the tax burden on upper incomes. Yet rather than cut expenses, the Democratic majority is intent on raising taxes on this small cadre of wealthy taxpayers.

The second reason raising taxes on high earners is counterproductive is that when taxes reach an onerous level, people simply leave the state for more economically friendly climes. According to the Yankee Institute, between 1991 and 2008, Connecticut lost a net 325,526 residents to other states, mostly to Florida (with no income or inheritance tax), followed by Georgia, Virginia and the Carolinas. Between 1995 and 2006, the net income leaving the state was nearly $5 billion, which translates into a loss of state and local tax revenue due to out-migration of over $566 million. But that is only for the year they leave; compounded over the twelve years of the Yankee Institute study, the loss in state revenue comes to $31.2 billion and for localities, $3.7 billion. In 2005, the year the estate tax was reintroduced, 12,800 residents left the state, and three out of four of them cited income and estate taxes as their reason. Worrisome also is a poll by the institute last August that found that 45 percent of our residents have considered moving out of state due to high taxes.

The lure of taxing the wealthy has appeared to backfire in other states, including neighboring New York, where tax revenues from this source are reported to be running well below projections. It remains to be seen whether revenues from Connecticut’s increase from 6 to 6.5 percent on incomes over $1 million will meet expectations.

Equally important, Connecticut is ranked fifth among the most unfriendly states in the nation for business, and our tax burden, along with the cost of living and the effect of both private and municipal union contracts, has caused a loss of business and industry to other states. The current recession has amplified the long-term trend. Since January 2009 over 9,500 businesses have closed, and 90,000 jobs have been lost. Increasing business taxes and fees will do nothing to reverse this trend.

While Connecticut remains the wealthiest state per capita in the country, our revenues have shrunk in every category. The only things growing are our expenditures and our deficit. As of December 1, the budget gap for the current year stood at $467 million ($337 million if a proposed reduction of the sales tax is not approved), and that is after applying a one-time injection of federal stimulus funds and tapping the rainy-day fund for $1.04 billion. This leaves just $342 million in the emergency fund to apply to next year’s budget. With no rainy-day fund to draw upon, the picture for the following three fiscal years is less than rosy. Deficits of more than $3 billion are projected for each year, which Scott Frantz, for one, considers conservative. Former Stamford mayor (and gubernatorial candidate) Dan Malloy projects the shortfall three years from now at $7 billion.

Another myth Bill Nickerson ex-plodes is that the legislature is equipped to deal with current deficits because it has cut the budget before. In fact, he claims, the budget has never been cut. “The General Assembly uses the word ‘cut’ to mean only a reduction in the rate of expenditure growth.” Defenders of the budget process also claim that government programs are rigorously evaluated by the legislature each year and unworthy ones eliminated. “This has never happened in my twenty-two years in Hartford,” he says. Instead, the legislature takes a top-down approach starting with what it costs to carry forward all government programs and services from the previous year, which inevitably results in spending increases. In the past five years, these have averaged 6.1 percent annually, exceeding the rate of infla-tion in all but one. “The budget-making process is fundamentally flawed,” maintains Nickerson. What is needed is a zero-based budgeting process wherein each program “is subject to rigorous nonpolitical evaluation of what works … and what doesn’t.” He adds, however, that the legislature lacks an institutional framework for such a broad-based examination.

The problem facing legislators is that to balance the budget, further cuts must be made in social services, which at $3.9 billion including Medicaid is by far the largest single expense category in the General Fund. It is followed by municipal payroll at $2.7 billion, education at $1.9 billion and debt service at $1.6 billion.

The complete realm of social services is made up of a labyrinth of special-interest projects carried in different accounts. Some projects are overlapping, and all are dear to one constituency or another. Social Services has mushroomed over the years, and if all its components are assembled in one account, the total could reach as much as $5 billion. In these hard times, it is difficult to cut human services, but it is not too much to insist on greater efficiency and the elimination of duplication. A strong case can be made that greater economy can be achieved by outsourcing some services to private enterprise.

State employment, the second-largest expense category, has increased exponentially, resisting all attempts to contain it. Since 2005 the cost of state employee and retiree health and pension benefits is forecast to increase by 110 percent by 2014. This compares with projected increases of 59 percent for all budgeted funds and a consumer price index increase of just 25 percent. The reason is not hard to find. Chris Donovan, speaker of the house and former majority chairman, was once head of the state Municipal Workers Union, which we are told he ruled with an iron hand. (He still carries a union card.) Connecticut, with 55,000 employees, is the state’s single largest employer. And Senator Toni Boucher, representing Westport, says that Donovan has steadfastly refused to cut employee benefits or lay off workers. Unfortunately, he has an ally in Don Williams, president pro tem of the Senate. Rather than cut expenses, they have voted to increase various fees and issue bonds to cover budget shortfalls. To pay off the $2.3 billion in bonds issued just this year will cost taxpayers $3.75 billion over the next twenty years.

Finding a way out of Connecticut’s financial crisis requires reforming the budget-making process. It should be no consolation that other states, notably New York and California, face similar crises. We should remind ourselves that no goods or products of economic value are produced by government agencies. Their existence is dependent on the value of goods and services provided by private enterprise. As Senator Frantz simply puts it, “We can’t all work for the government, or there would be nobody making money to support it.” It’s a philosophy that legislatures here and everywhere would be well advised to adopt.