Report: State debt costs likely to grow faster than revenues

Despite a 12-month surge in state tax receipts, Gov. Dannel P. Malloy’s budget office warned Thursday that Connecticut’s pension obligations and other debt will grow faster than revenues in the coming years.

The administration’s Fiscal Accountability Report — a mandated annual assessment of a wide array of fiscal health indicators — also repeated its call for a longterm strategy to deal with teachers’ pension contributions, one of the fastest-growing segment of the state budget.

“Absent any recession, the (tax revenue) growth rates remain conservative and well below growth experienced in prior recoveries,” the Office of Policy and Management wrote in its report.

At first glance this seems counter to recent evidence.

Connecticut boosted its budget reserves from $212 million to almost $1.2 billion over the past fiscal year, driven largely by spiking state income tax receipts.

Initial projections show the state could deposit another $900 million in the rainy day fund after this fiscal year ends on June 30 — with the income tax again a major factor.

But the administration warns there are several reasons to be cautious.

The state income tax gets about twothirds of its receipts from paycheck withholding and the rest from quarterly filings — which largely reflect capital gains, dividends and other investment earnings.

Traditionally this has been one of the most volatile components of the state tax system, experiencing double-digit percentage growth or shrinkage depending on the economy.

But since the last recession ended in early 2010, Connecticut’s goose that lays golden eggs has grown more conservatively.

And while there are positive economic signs, including job growth and extra receipts from paycheck withholdings, the latest surge is partly “an outlier,” the report states.

Why? There are two reasons, and neither is likely to generate a long-term trend.

Many households inflated their quarterly state income tax payments this past winter to take advantage of favorable federal income tax rules that expired after the 2017 calendar year.

And a federal income tax loophole that for years allowed hedge-fund managers to accumulate offshore gains without paying federal and and state income taxes closed last year, leading to a short-term surge in payments.

By 2021 and 2022, the administration predicts, the capital gains and dividends portion of the income tax should be growing at a modest 2 percent a year — provided Connecticut and the nation are not in a recession.

And there’s another reason to be cautious, according to the governor’s budget office. What are commonly called “fixed costs” are not staying fixed.

Required contributions to pension funds, a retirement health care program for state employees, Medicaid and other federal entitlements already approach 45 percent of the budget. They are deemed “fixed” costs not because they can’t rise, but rather because it is difficult for state government to reduce them.

And this report doesn’t even address two other major “fixed” costs in state government, salaries and non-retirement benefits for employees.

Still, the governor’s budget office warns that the fixed costs that were analyzed will grow $620 million next fiscal year, or roughly 8 percent. There will be similar growth for the next two years after that as they jump $569 million and $552 million, respectively.

Republican gubernatorial candidate Bob Stefanowski, who lost the 2018 campaign to Democrat Ned Lamont, repeatedly pledged to take a “zero-based” approach to state finances, making no assumptions about expenditures when preparing his own budget. That claim was highly contentious during the race largely because Connecticut carries a larger share of fixed costs on its budget than do most other states.

Perhaps the largest fixed cost involves the $1.39 billion contribution Connecticut must make next fiscal year to its pension fund for municipal teachers.

Like the pension fund for state employees, Connecticut routinely short-changed contributions to the pension fund for teachers between 1939 and 2010, leading analysts to project a massive surge in costs between now and the mid-2030s.

Connecticut and state employee unions agreed last year to restructure payments into the employees’ pension fund, shifting billions of dollars of expenses onto taxpayers after 2032.

But the state borrowed $2 billion in 2008 to shore up the pension fund and pledged in its covenant with investors not to tamper with contributions until the bonds are paid off.