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February 1, 2017

Whether by taxing or cuts, CT faces painful fiscal future

There is no shortage of ideas on how Connecticut should not solve the fiscal crisis caused by its massively unfunded retirement benefit programs.

There are plenty who say state government cannot tax its way out of a problem expected to last 15 years or more, and to attempt to do so would cripple an already weakened economy.

This camp places most of its hope in slashing labor costs. Unfortunately, the fastest growing expenses in the current budget have nothing to do with present-day workers, whose benefits are very close to the national average. And even reducing expenses tied to present-day workers comes with plenty of complications.

A second approach holds some reductions must be made but there’s no hope deep spending cuts can do it all and that major tax increases are unavoidable. Too much of the budget is tied up in fixed costs, and a slash-and-burn approach only would destroy the state’s quality of life while still failing to balance the books.

Labor leaders add that the focus on worker concessions amounts to scapegoating that not only weakens the economy, but delays the search for a real solution.

The problem is that none of these approaches alone even claims to resolve the problem over the long term.

With retirement benefit and debt costs already consuming close to one-third of revenues, and likely to absorb a much greater share in the coming decade-and-a-half, Connecticut may need a multi-faceted solution that will spark fierce opposition among all constituent groups.

Connecticut has taken some steps

“They took a long time for these problems to develop and we can take a long time to solve them,” said Gov. Dannel P. Malloy’s budget director, Office of Policy and Management Secretary Ben Barnes. “But you can’t take a long time to start solving them.”

Connecticut has taken some steps under Malloy’s administration to mitigate the anticipated explosion of retirement benefit costs in the coming years.

The 2011 union concessions deal would eliminate nearly 30 percent of the liabilities in the retiree health care program — provided Connecticut increases its savings in this area starting in 2018 by about $120 million annually for the next three decades. Unfortunately that still leaves this as the worst-funded — by far — of all state retirement benefit programs.

The Executive Branch workforce, excluding public colleges and universities, has shrunk more than 9 percent during the governor’s first six years in office.

And annual contributions to the state employees’ and teachers’ pensions both are more than double the 2010 payment.

“We are paying a lot more” to save for benefits than past governors and legislatures did, Barnes said. “We’re making big sacrifices at a time when the economy has not produced big revenue growth to make that easy.”

In addition, a deal Malloy recently struck with unions would allow Connecticut to avoid the worst upcoming spikes in state employee pension contributions — while still making hefty payments between now and 2032. But to do so, Connecticut would shift an estimated $14 billion to $21 billion in contributions onto taxpayers between 2033 and 2047. The plan is expected to be voted on today by the legislature.

Connecticut also has been relying on tax increases with greater frequency.

After enacting the income tax in 1991, the General Assembly waited 12 years before increasing that levy.

The next income tax hike came more quickly, in 2009, part of a $1 billion overall state tax increase. Just two years later, in 2011, Malloy signed a record-setting package of tax increases projected at more than $1.8 billion per year.

In 2015, the governor and lawmakers simultaneously ordered more than $675 million in tax increases while reneging on more than $230 million in previously approved tax cuts — a $900 million swing.

“I think we’ve got to realize what choices we have, and increasing taxes is not one of them,” said Connecticut Business and Industry Association economist Peter Gioia, who added that any more increases in the near future would have a chilling effect on economic growth.

‘The goose might not stick around’

And that effort to avoid tax hikes must extend to Connecticut’s wealthiest households and to its financial services sector, Barnes said.

“We became this Mecca for affluent people and well-educated people … partly because we were a tax haven,” he said. “People came to Greenwich because it was cheaper than living in New York or in Rye, and we may have lost some of that. It’s hard to argue that that didn’t serve us very well, and I’m a liberal Democrat.”

There is some evidence to support Barnes’ assertions.

A new study of the financial services sector released this week by a New England coalition of business, academic and health institutions found the industry contributed 22 percent of all wages paid in Connecticut in 2015 — more than $35 billion — while generating 20 percent of the gross state product.

“The goose might not stick around and continue laying golden eggs if we don’t give it a nice, hospitable place to be,” Barnes said.

“There is no appetite for anybody to increase taxes,” Senate Republican President Pro Tem Len Fasano of North Haven said, charging that too many at the Capitol don’t want to recognize the full extent of Connecticut’s problems. “First we have to get the Democrats to agree that the current structure of the state has to significantly change, now and in the future.”

Few states can match Connecticut’s debt

According to a January 2016 analysis by CNBC — based on data from Moody’s Financial Services running through the 2014 fiscal year — Connecticut had state pension debt equal to $14,769 per person.

That’s second-worst among all states, topped only by Illinois’ debt. More importantly, Connecticut and Illinois are national outliers. The next closest state is New Jersey at $9,520, and the national average is just $4,383.  

That’s why — among other reasons — some say today’s workers have to sacrifice, regardless of how far back the mistakes go.

“This is not a situation where we’re simply going to tax our way out of it,” said Carol Platt-Liebau, president of the Yankee Institute, a Hartford-based, conservative public policy group. “I don’t think people realize the spine-tingling, blood-chilling extent of the problem.”

Yankee Institute officials note that Connecticut still is promising benefits to today’s workers without saving enough to pay for them.

When it comes to retirement health care, state government is setting aside less than one-quarter of the money it should right now to cover the benefits it is promising to present-day workers.

According to both the Malloy administration and Comptroller Kevin P. Lembo’s office, Connecticut would need to set aside an amount equal to 14 percent of payroll each year to cover this benefit.

After decades of saving nothing, state government started requiring workers — between 2009 and 2012 — to contribute 3 percent of their pay toward this cost.

Retirement health care benefits need to be cut dramatically — possibly eliminated — and today’s workers given only a 401(k)-style, defined contribution retirement plan, maybe with no state match, said Suzanne Bates, the institute’s director of policy and legislative outreach.

But even eliminating pensions for new state workers would mitigate — and not solve — the overall problem facing Connecticut between now and the early 2030s, and in one respect it would make things worse.

For example, the state employee pension fund has cash flow issues because of its extremely poor funding ratio, and state officials concede that without the pension contributions from present-day workers, government would have to contribute more to meet the benefits owed to retirees. After the 2030s, of course, things would become much less costly.

Besides cutting labor costs through concessions and workforce reductions, the CBIA says the state could reduce its operating costs by more than hundreds of millions of dollars annually by:

Accelerating the transition of elderly residents from nursing-home to home-based care;

Increasing use of technology to deliver services more efficiently;

And rehabilitating more nonviolent offenders in the community rather than in prison.

“This is where the state has to play hardball,” Bates said. “We’ve got to get scared about this and do something, or nothing’s ever going to change.”

The biggest myth in state government

But labor leaders counter that the biggest myth in state government is that the salaries and benefits provided present-day employees are sinking state government’s finances.

According to Malloy’s budget agency and the legislature’s nonpartisan Office of Fiscal Analysis, more than 80 percent of the required pension payments are to compensate for contributions not made or investment returns not achieved in the past. 

Less than 20 percent of the contribution is needed to cover the benefit promised to current workers.

Some hope that federal court intervention in the undetermined future will somehow allow one of the wealthiest states in the wealthiest nation off the hook and cut its benefits to those already retired.

But Malloy said those who hope Connecticut will be excused from contractual obligations are fooling themselves.

“The law on that is quite clear on what you can and cannot do,” he said while briefing Capitol reporters in early December on the state employees’ pension fund. “And we don’t elect people to be magicians in the legislature. We have to deal with legal realities.”

According to analyses of the state employees’ and municipal teachers’ pension systems prepared by Center for Retirement Research at Boston College, the pension costs tied to current Connecticut employees and teachers both are below the national average.

And Connecticut has saved less than 1 percent of the money necessary to fund its long-term retirement health care obligations. The bills left by past legislatures and governors are larger than the cost of fully saving for present-day workers.  

Pension contributions and retiree health care costs in the state budget have grown, and are projected to continue growing, much faster than wages and benefits for present-day workers.

Concessions, layoffs have limited value

Labor leaders note workers approved concession packages in 2009 and 2011 that froze wages, restricted pension benefits, increased health cost-sharing and added an employee wellness plan — complete with financial penalties for those who don’t participate.

State Comptroller Kevin P. Lembo, who has taken a lead in urging officials to take the longer view of fixing Connecticut’s finances, said government is not done streamlining labor costs.

But Lembo also said Connecticut has had its biggest successes working with its employees.

While wage freezes and pension restrictions got the headlines from the 2011 concessions deal, Lembo predicted an employee wellness program may prove to be the most vital component in the years to come.

“This stuff is working,” he said. “It’s not going to fix everything by itself, and not right away, but it is a piece of the solution.”

Labor leaders also say those who argue further concessions would substantially mitigate Connecticut’s impending budget woes simply don’t understand the math.

Students and faculty rally outside the state Capitol against potential budget cuts to public colleges and universities last week

According to nonpartisan analysts, a wage freeze across all of state government would save less than $200 million per year. The projected savings from laying off 2,000 state employees is about $130 million.

The savings from both combined, represents less than one-quarter of the projected $1.4 deficit in the upcoming fiscal year, and would be an even smaller share set against the billions of dollars in projected long-term increases in benefit costs.

A Republican proposal last spring to require all state employees to contribute 4 percent of their pay toward pensions would have increased pension fund resources by $74 million per year — and produced an even smaller savings in the state budget.

Income inequality, $85 million for hedge funds

And state government is making plenty of mistakes, labor leaders say, that would make it hard to convince workers to give another time.

The state provides billions of dollars in tax breaks and subsidies each year.

Some of these tax breaks have strong support from most political circles and constituent groups, such as the sales tax exemption on groceries.

And some recent corporate assistance plans the Malloy administration pursued, such as the 2014 deal granting United Technologies Corp. $400 million in tax relief to expand facilities and preserve engineering and manufacturing jobs here, won praise from some labor groups.

But other tax exemptions and subsidies for businesses are never tested or reviewed to determine if they return any economic value, said Lori Pelletier, president of the Connecticut AFL-CIO.

Then there is “the shadow government — labor’s term for millions of public dollars spent on contracts for private services — legal, architectural, planning, media and others.

“I’m not saying they’re all bad,” said Salvatore Luciano, director of Council 4 of the American Federation of State, County and Municipal Employees. “I’m saying, ‘who reviews those contracts?’”

Further complicating matters, labor leaders say, is that state officials in general — and the Democrats who have been labor’s traditional ally — have not done enough to reverse income inequality here.

Why would workers want to grant another round of concessions, Pelletier asked, when state government has provided about $85 million in grants and tax breaks to two hedge funds over the past year?

“I don’t know how you reduce income inequality by giving a hedge fund manager millions of dollars,” Luciano said.

“Connecticut is probably one of the worst states in the country when it comes to income inequality and tax fairness. The people who are moving the most are the people who are having difficulty finding a job, not the millionaires.”

Malloy defended the assistance to hedge funds as vital to stop a key segment of Connecticut’s tax base from departing.

A new study released in December by the Center for Budget and Policy Priorities, a Washington, D.C.-based fiscal policy group, ranked Connecticut as the third-most unequal state in terms of income.

The richest 5 percent of households here receive 20 percent of the income.

For the top 5 percent, the average annual income is $444,303, which is 16.6 times the average earning of the lowest 5 percent at $26,764. The middle 20 percent in Connecticut, the report found, earn an average of $86,346 per year.

Since 1979, earnings for the top 1 percent of Connecticut households have grown by 291 percent, while those for the rest have averaged 15 percent growth over that same period.

A state tax incidence report released in December 2015 found households earning less than $48,000 per year effectively pay nearly one-quarter of their annual income to cover state and local taxes — with the property tax taking the most. That study included families and individuals that rent their housing, and whose rents reflect the property taxes their landlord must pay.

Malloy said in his 2011 budget address that “while I do believe in a progressive income tax, I do not believe that we should punish success, or wealth.”

Luciano said working class families may not have the earnings of more affluent households, but they nonetheless are successful.

“The paradigm of ‘let’s not punish wealth’ — well, you didn’t,” said Sal Luciano, executive director of one of the largest unions representing state workers, Council 4 of the American Federation of State, County and Municipal Employees. “You punished labor.”

Are tax hikes unavoidable?

Luciano and Pelletier say Connecticut is going to have to raise taxes to deal with a major portion of its unfunded liabilities.

They are not alone.

“This ‘austerity is the path to prosperity’ line is ridiculous,” said Fred Carstensen, director of the Connecticut Center for Economic Analysis, UConn’s economic think-tank. “It literally is dangerous to believe that is going to happen.”

Unless Connecticut increases investments in transportation, information technology infrastructure and education, it has little chance to grow its economy, Carstensen said, adding that has no chance of happening as debt costs eat up increasingly large shares of existing revenues.

Pointing to billions of dollars in delayed borrowing for transportation and other capital projects in Connecticut, the UConn economist said each $1 billion costs the state at least 10,000 jobs.

“To close disparities, create opportunity, and enable all residents to thrive, we need a new commitment to equitable economic development,” said Ellen Shemitz, executive director of Connecticut Voices for Children, a New Haven-based public policy group that advocates higher taxes on wealthy households and major corporations. “ … This means scrutinizing the combined effect of income and property taxes to fix an upside-down system which imposes a lower effective rate on those with the most resources.”

Students and faculty rally outside the state Capitol against potential budget cuts to public colleges and universities last week

Many in state government and in business also conveniently forget that the wealthy once faced much higher state tax rates than they do now, said New Haven Democrat William Dyson, a retired lawmaker who co-chaired the Appropriations Committee for 16 years (under four governors) through 2004.

Connecticut had imposed a tax on dividends and capital gains for two decades before it rolled that levy into the new state income tax in 1991.

In 1990 the state taxed capital gains at 7 percent and dividends at 14 percent. After the income tax’s enactment, the maximum tax on all earnings was 4.5 percent. Twenty-six years later the top rate on the income tax is 6.99 percent, Dyson noted, predicting Connecticut will soon have to revisit what amounted to one of the largest tax breaks on the wealthy in state history.

“It still rubs some people raw,” he said.

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