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December 22, 2017

Federal tax changes further polarize debate over state income tax

By KEITH M. PHANEUF | CT MIRROR

Now that Congress has passed a massive federal tax overhaul, political observers here agree it could have a chilling effect on future proposals to raise the Connecticut income tax — even 14 months from now when a huge deficit looms in state finances.

But liberals and conservatives were split over whether this is a good thing, as huge pressures are projected to test state finances in unprecedented fashion in the coming years.

“I personally feel right now Connecticut is on the precipice of a recession,” said Don Klepper-Smith, chief economic adviser under Gov. M. Jodi Rell, who added it is not surprising state income tax receipts slumped over the past 18 months. “That says you have a problem with your largest generator of tax revenue, and this problem isn’t going to go away by raising taxes.”

“The federal tax changes are potentially a disaster for the state of Connecticut,” said Senate President Pro Tem Martin M. Looney, D-New Haven. “There are so many people, in the aggregate, who will pay more, and these are middle-income people.”

But while Looney said it is “unrealistic” and “indefensible” to argue this is a reason not to reshape the state income tax to provide middle class relief, he does expect many will use the federal tax changes as a reason to stand pat.

Deducting state and local taxes is key

Critics and supporters alike of the congressional plan concede it probably will draw dollars — in the aggregate — out of Connecticut.

The new plan nearly doubles the standard deductions within the federal income tax for individuals and married couples while boosting the child tax credit.

But it eliminates or shrinks many other popular deductions — including some big ones for Connecticut residents. Currently taxpayers can deduct what they pay in state income, sales or municipal property taxes from their federal returns. The new law caps the deduction at a total of $10,000.

According to IRS data, more than 700,000 taxpayers in Connecticut — which has one of the largest property tax burdens in the nation — claimed about $13.6 billion in state and property deductions on their 2014 federal returns. The average deduction nationwide in 2014 was $11,845.

And Connecticut’s chief tax official, Department of Revenue Services Commissioner Kevin Sullivan, said the aggregate claim here now is closer to $16 billion.

Gov. Dannel P. Malloy’s budget director, Office of Policy and Management Secretary Ben Barnes, said his agency still is analyzing the net impact of the complete federal tax plan. But he said it’s hard to envision any outcome that doesn’t drain resources from the state and shift burdens onto middle-income households.

Much of that is due to the capping of state and local tax deductions, Barnes said. As an example, a single homeowner with an annual income of $80,000 could be paying more than $10,000 in state and local taxes.

Malloy, a Democrat, has been highly critical of the plan, arguing its potential to drive down property values alone could push the nation toward recession.

Barnes, who called the tax plan “an abomination,” said he nonetheless believes Connecticut’s response should not be to restructure the state income tax.

“I do think our taxes are pretty progressive now,” he said, adding that the new federal cap on deductions “will serve as a mirror” to make Connecticut taxpayers — particularly wealthy ones — more aware of the state and local tax burdens they face.

Shifting burdens to the middle class

But some advocates for a more progressive state levy said the problems facing Connecticut’s poor and middle classes are getting worse — and not just because of federal tax changes.

Connecticut’s social services safety net has gone through significant contractions over the past two years, said Sheldon Toubman, an attorney for the past 26 years with the New Haven Legal Assistance Association. That group helps the poor, disabled and others in need secure housing, benefits, employment, and legal assistance with immigration and family matters.

More than 30,000 poor adults have lost state-funded health insurance under the Husky program.

Home health care and non-emergency dental services for the poor have been eliminated or cut.

Connecticut has reduced payments to some providers who treat low-income patients.

And lawmakers are scrambling to reverse cutbacks ordered in October to a Medicare Savings Program that uses Medicaid funds to pay medical expenses that Medicare doesn’t cover. Lawmakers from both parties have said they are responding to a major outcry from many of the 113,000 elderly and disabled affected by the reduction.

If these changes are causing friction, Toubman asks, what happens over the next two decades as Connecticut grapples with spiking costs tied to poorly funded state pension and retiree health benefit programs?

What happens if the projected worsening of the federal budget deficit — because of the new tax plan — leads to cutbacks in Medicaid and other assistance to states?

“Certainly we’ve never seen so extensive a savaging of social services over such a short period of time,” Toubman said.

“The people who are opposed to raising income taxes on those most able to pay are going to use whatever argument they can,” he added. “But every analysis says this is a huge tax break; even the Republicans don’t dispute that. The people who need the extra money don’t get this windfall.”

Elliot: ‘The system truly has to break’

Rep. Josh Elliott, D-Hamden, one of the legislature’s most vocal advocates for higher tax rates on Connecticut’s wealthiest households, conceded few state legislators are likely to press for tax hikes next spring, in a state election year.

But what about in January 2019, when the new governor and legislature take office — and face projected deficits of $1.9 billion in 2019-20 finances, and $2.7 billion in 2021-22?

“I still don’t know if there is going to be much debate” about reshaping the state income tax, Elliott said, saying the most recent state budget “was about punishing” the middle class, the poor, and public-sector employees.

Connecticut’s property tax was identified in the state’s 2014 tax incidence analysis as one of the chief culprits behind an effective state and local tax burden that falls most heavily on the poor.

The analysis — which looks not only at who pays taxes, but how those costs are passed onto others — concluded households earning less than $48,000 per year effectively lose 25 percent of their income to state and local taxes.

“We are tipping the scale and making it significantly more difficult to go from impoverished to middle class,” Elliott said. “ But I think there are a number of people out there who are just misinformed. I think the system truly has to break before we can build it back up.”

Bill Cibes, who served as budget director to Gov. Lowell P. Weicker Jr. in 1991 when the administration proposed and secured legislative approval of the new state income tax, is another longtime advocate for a more progressive state levy on earnings. (Editor’s note: Until recently Cibes was a longtime member of The Mirror’s Board of Directors.)

Cibes said one of the key selling points of a state income tax 26 years ago was Connecticut, through federal tax deductions, could leverage billions of dollars more from Washington.

“I used to call it unilateral federal revenue-sharing,” Cibes said. “This new national tax scam is going to have a severe impact on the Connecticut economy. We just don’t know what it is.”

Still, the former budget director said he also fears the federal changes will increase public pressure here to keep Connecticut’s income tax rates where they are.

“The case for progressivity is diminished,” he said.

The new federal tax law also creates a 20 percent deduction for limited liability corporations and other “pass-through” businesses.

In Connecticut these businesses pay their state taxes through the income tax rather than the corporation levy — one of the few state taxes that has seen receipts grow well in recent years.

Cibes said he suspects the new federal system will encourage more businesses to restructure as “pass-throughs” so they can take advantage of the credit — further shifting tax burdens from businesses to households.

Further complicating matters, the new federal tax system’s tax breaks for the middle class expire after 2025, but the business tax cut is permanent.

But Rep. Vincent J. Candelora, R-North Branford, a veteran member of the General Assembly’s tax-writing Finance, Revenue and Bonding Committee, said that while the federal changes may harm the state somewhat, recent history has shown boosting taxes here only would make things worse.

“Having a more progressive income tax in Connecticut could cause wealthier people to leave,” he said, adding that big state income tax hikes Malloy and a Democrat-controlled legislature ordered in 2011 and 2015 already have weakened the tax base.

“And now that there’s going to be a cap on your deductibility at the federal level,” Candelora added, “certainly anybody who can no longer itemize is going to think twice about continuing to pay higher Connecticut income taxes.”

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