Payroll tax reform moves forward

The radical idea of replacing most of the state income tax with a payroll tax paid by employers has bubbled quietly among a handful of policymakers for much of this year, and some had hoped it would come to a vote before the General Assembly ends its regular session June 5.

That won’t happen. But even as lawmakers and Gov. Ned Lamont lurch toward a new state budget, some are still hard at work on the payroll tax concept — with an eye toward bringing a massive tax reform bill in 2020 that could save taxpayers and employers $1.6 billion a year and still net the state more than it takes in now.

“What we’re doing right now is doing a lot of the information gathering,” said Rep. Jason Rojas, DEast Hartford, co-chairman of the General Assembly’s tax-writing finance committee.

The Lamont administration is actively exploring whether the state can, indeed, transform billions of dollars of the state’s revenue stream into a 5 percent payroll deduction that employers pay to the state, eliminating the personal income tax for most residents.

Economists, accountants, lawyers and administrators in the governor’s budget office and the state Department of Revenue Services are all looking at the plan. It was first presented to Rojas and others in government earlier this year by a nonprofit, nonpartisan policy group, the Connecticut School Finance Project.

“All of us are intrigued by the concept and the administration has, I think, shown as much interest in it as we have,” Rojas said, referring to leaders of the finance committee.

Rojas and co-chairman Sen. John Fonfara, D-Hartford, have held out hope that some legislation would happen this year, though clearly it wouldn’t be the whole reform.

“That could be some kind of initial implementation of a piece,” Rojas said, or perhaps creation of a task force — though many think that’s how to kill an idea. Or it could be marching orders for the administration to study it, which is happening with or without a formal bill

“The payroll tax is a complex idea that merits further evaluation,” Lamont spokeswoman Maribel La Luz said in an emailed statement. “It is not feasible for this legislative session but we are continuing to have discussions with our colleagues in the legislature and bringing in other individuals with expertise in this area.”

Simple idea, complex problems

The idea behind a payroll tax is simple enough, but the problems it raises are complex. Employers that pay 5 percent of their employees’ wages to the state will expect to pay 5 percent less, so that they’re made whole. Workers, paid 5 percent less, would not have to pay 5 percentage points of the state personal income tax.

Here’s where the savings comes: Because employees and employers all pay federal payroll taxes amounting to 6.2 percent, they’d save on that cost because wages and salaries would be lower. And everyone would also pay federal income taxes on a lower base, saving money that way as well.

Anyone who pays less than 5 percent in state income taxes would receive a rebate. Anyone who pays more — the top rate is currently 6.99 percent — would pay the difference in state income taxes.

In all, the Connecticut School Finance Project, which devised the

plan, estimates that households would see a benefit estimated at about $1 billion. Employers would benefit by $600 million as their Social Security and Medicaid taxes would fall.

And the state would add an estimated $400 million a year to its coffers even after spending money to make lower-income people whole. That’s because it would eliminate certain exemptions in addition to raising overall tax rates for highend earners.

I went into more detail in a recent column about the idea. What’s happening now is the state is figuring out what the actual numbers would be, based on tax records rather than theory. But the bedrock principle is that everyone, rich, poor, middle class and employers, ends up ahead — because we all would pay less in taxes to the federal government.

Making it work

The problems aren’t small. They fall into four main areas: First, cutting salaries even to save workers’ money is not easy or smooth. Unions have contracts, big companies have national scales, homebuyers need to show income to qualify for mortgages.

The latest thinking as the planning moves forward is that the pay cuts, and the income tax reductions, and the payroll tax payments, would all be phased in over several years.

“Rather than actually having to go and reduce people’s wages by 5 percent, what you are doing is you are saying ... instead of a (cost of living) adjustment ... it’s going to be a tax-free raise,” Roy said.

In other words, instead of collecting a 2 percent raise in a year of the phase-in, an employee would get a 1 percent raise with a reduction in his or her state income tax rate.

Second, a lower salary with lower payments for Social Security and Medicaid means lower payments in retirement. There’s no basic formula for how much less retirees would get, but staff at the project, including Katie Roy, the founder and executive director, estimate the maximum loss would be 2.4 percent of benefits, perhaps slightly more, for someone who works under a payroll tax for his or her entire career.

That translates to about $480 a year for a retiree receiving $1,700 a month in Social Security. And while that’s not trivial, that person would more than likely see at least that much savings every year he or she worked — compared with the current system.

If that money were invested, it would far outweigh the lost retirement income. And anyone far along toward retirement could see almost no reduction in benefits at all.

Third problem: It’s possible the Internal Revenue Service would disallow it. I don’t have any new intel on this, but Roy believes there’s nothing to prohibit. Payroll taxes are legal.

It’s financial justice to make up for the Trump tax reform, which lowers deductible tax payments in Connecticut by an estimated $10 billion, costing residents $2.9 billion. The benefits in the payroll tax would not depend on the federal reform remaining in place, but they would be larger as a result of it, as taxpayers would lose fewer deductions.

The fourth major hurdle is lack of trust. Skeptics have said, since the idea surfaced in my May 10 column, that the state can’t be trusted to eliminate the right portion of the income tax, or that employees simply won’t agree to see their wages pared back for a promised reform that might go away, or never happen in the first place.

“I can’t resolve the trust in government issue,” Roy said, perhaps stating the obvious.

Bipartisan curiosity

Liberals and conservatives, Democrats and Republicans, have all said the idea might make sense if the problems can be resolved.

“Conceptually I like it,” said Sen. Kevin Witkos, R-Canton, ranking Republican on the finance committee. We definitely need to see it play out. It’s time we started thinking outside the box.”

Witkos said he would even agree to see the state increase its take from the system, by raising the total net taxes collected, if the extra money were used to pay down liabilities. That could even avert the need to refinance the teachers’ pension fund, he said — a plan he and other Republicans oppose.

Tom Swan, director of the Connecticut Citizen Action Group, said he participated in a conference call with two Washington, D.C.-based tax and policy groups, and everyone had a lot of questions.

“In principle I like the idea of figuring out ways to make Connecticut whole from the Trump tax scam,” Swan said, “but for me that includes recovering some of the $2 billion from the 1 percent.”

He was referring to the tax savings for the very wealthy in the federal reform. That’s part of the whole idea — total state taxes from that group would rise even as they saved money.