State income tax receipts surge but can’t be used to plug deficit

The new budget adopted with bipartisan support last fall establishes a new “volatility” cap to force Connecticut to save more when the income tax performs well.

Legislators got some good news and some bad news Monday about the state budget.

The good news: State income tax receipts from December and January are running $900 million more than expected — driven largely by one-time decisions by taxpayers here prepping for major changes to federal income tax policies.

The bad news: Legislators can use only about $10 million of those funds to mitigate the $224 million budget deficit projected for the current fiscal year.

Why? Because the new budget adopted with bipartisan support last fall establishes a new “volatility” cap to force Connecticut to save more when the income tax performs well.

The new cap stipulates that when revenues from quarterly income tax filings — which largely involve capital gains and other investment-related income — exceed $3.15 billion in a fiscal year, the excess must be deposited into the emergency reserve, commonly known as the Rainy Day Fund.

The budget currently assumes about $3.14 billion in income tax receipts from quarterly filings.

Gov. Dannel P. Malloy called the surging tax receipts “very promising news for the state. And while I have been critical of many parts of the bipartisan budget, the legislature deserves praise for implementing the new volatility cap. Because of this new law, we know that any unexpected revenue will be set aside to meet future needs in a responsible way.”

The governor added that, “We still need to take steps to close the deficit this year and to avoid one in the year that starts in July. If we take those steps and use these one-time revenues to rebuild our rainy day fund, we will give Connecticut residents and businesses the fiscal responsibility they have been demanding.”

The legislature’s nonpartisan Office of Fiscal Analysis and the Malloy administration are expected to confirm this surge in income tax receipts in a joint revenue projection due to lawmakers on Jan. 15.

There still are ways legislators could use more than $10 million from the projected surge in revenues to mitigate the entire deficit:

Repeal the volatility cap: The new budget states that the treasurer’s office, when it issues bonds to finance various capital projects, must write a pledge that the state will adhere to this cap into the bond covenant — effectively a contract between Connecticut and it’s investors.

But the budget also stipulates this pledge doesn’t have to be written into bond covenants until May 15 — giving the legislature time to repeal or delay the cap restrictions now.

Ignore the deficit until September: The legislature also could allow the state to close the fiscal year in deficit. Though the budget year ends on June 30, the comptroller doesn’t officially close the books until late September.

If Comptroller Kevin P. Lembo certifies a deficit at that point, any funds needed to cover that shortfall would automatically be drawn from the Rainy Day Fund.

But that approach is risky because there is a chance that at least some of the projected January surge in income tax receipts will erode.

The Malloy administration warned legislators earlier this winter Connecticut could experience a “bubble” in state income tax receipts in January because taxpayers here are taking one-time measures to prepare themselves for federal tax changes.

Congress recently enacted stricter limits on how much state and local tax payments can be deducted for the 2018 federal tax year — which means on income tax returns filed in the spring of 2019.

Connecticut residents hoping to get one more good deduction on the federal returns they file this coming April could take advantage of certain pre-payment rules now — and make larger state tax payments now.

Similarly, many businesses pay their state taxes through Connecticut income tax rather than its corporation levy. Some of those companies also are looking for ways to report earnings now — and pay more to Connecticut now — while the more favorable federal tax deductions still are available.

Meanwhile, the withholding portion of the state income tax — which provides about two-thirds of the total tax revenues — has grown very sluggishly since last recession ended.

It only grew by 1.3 percent last fiscal year. And it’s unclear whether Connecticut will achieve the 2.1 percent growth projected for this fiscal year, according to the Malloy administration.

Legislative leaders said Monday that they are focused now on mitigating the state deficit — without relying on most of the projected surge in income tax receipts.

“We just passed it, so I would suspect we would keep it,” Senate Republican leader Len Fasano of North Haven said of the volatility cap.

Keith M. Phaneuf is a reporter for The Connecticut Mirror (www. ctmirror.org). Copyright 2018 © The Connecticut Mirror. kphaneuf@ctmirror.org