Even though its finances have stabilized, Connecticut’s “fiscal guardrails” have evolved beyond their stated purpose, channeling billions to cover pension debt in recent years while spending on core programs lags that of most states of comparable wealth, according to a new report to be released Wednesday from the Connecticut Project and researchers at Yale University.
The nonprofit groups also offered several reform options, including redesigning a controversial program to save volatile revenues and expanding allowable spending cap growth.
A series of budget controls enacted or renewed with bipartisan support in 2017 helped Connecticut build reserves, pay down unfunded pension obligations and avoid the operating deficits that plagued much of the 2010s, researchers wrote.
But caps on spending and borrowing and other savings programs also “have imposed increasingly stringent limits on the state’s ability to use existing revenues to meet current needs or make future-oriented investments,” they added. “The guardrails have placed billions of dollars of revenue ‘out of reach’ for the General Assembly as legislators confront demands for additional investment in a number of areas.”
Lawmakers, advocacy groups and others are anticipating an aggressive debate in the next General Assembly session, which convenes Jan. 8.
Leaders of the House and Senate Democratic majorities, backed by progressives and others in their caucuses, argue that Connecticut can invest more in education, health care, social services and town aid while still achieving surpluses — albeit more modest ones — that can be used to whittle down pension debt.
State analysts recently warned that rising Medicaid, debt payments and other fixed costs will consume most allowable spending growth in the next budget cycle, and Gov. Ned Lamont’s administration must negotiate new wage agreements with all major state employee unions.
Meanwhile, the billions of dollars in temporary federal pandemic aid that helped offset restrictions on spending state tax receipts have been all but exhausted.
But Lamont, other moderate Democratic legislators and minority Republicans all have argued to date that savings programs and spending controls shouldn’t be pared back, which could trigger a return to the deficits and tax hikes of the 2010s.
“As a state, we want to strike the right balance between a number of really important goals, and that includes paying for the mistakes of the past, building stable budgets, meeting the needs of families and communities in Connecticut, and making long-term investments that we need to make,” former Hartford Mayor Luke Bronin, one of four researchers on the report, told The Connecticut Mirror.
“What we try to show in these papers is that there’s a number of sensible options to consider,” Bronin added, “and that doing exactly what we’ve done isn’t the only choice available.”
Professor Zachary Liscow from the Yale Law School and researchers Nathanael McLaughlin and Mohit Agrawal, from Yale’s Tobin Center for Economic Policy, also contributed to the report.
CT’s ‘volatile’ revenues have been fairly reliable
Neither The Connecticut Project, a policy think-tank, nor Yale University advocate for specific reforms in the report. And while it offers potential adjustments to the system of caps and other budget controls that have dominated state finances for the past eight years, the report recognizes these “guardrails” — as advocates call them — have been beneficial in several ways.
A 2017 budget reserve of $212 million now stands at $4.1 billion. In other words, a rainy day fund once equal to roughly 1% of the General Fund now is at its record-setting, legal maximum of 18%.
And since 2020, Lamont and legislators have used another $8.6 billion in surpluses to reduce Connecticut’s pension debt, a huge mess created by decades of underfunding between 1939 and 2010.
Researchers also acknowledged that legacy of debt isn’t fully solved. Connecticut entered this year with more than $35 billion in unfunded pension liabilities. That burden, coupled with a hefty bonded debt and red ink in its health care benefit for retired state employees, makes Connecticut one of the most indebted states, per capita, in the nation.
But the budget controls were pitched in 2017 to balance budgets first and foremost. Paying down extra debt would happen occasionally when revenues boomed.
That hasn’t been the experience, though, researchers noted.
One program, labeled the volatility adjustment, is designed to capture a portion of quarterly income and business tax receipts that historically fluctuate greatly from year to year.
In concept, the program would capture big dollars some years, less in others, and sometimes nothing.
Instead, it has captured close to $1 billion or more in six of its first seven years. The only year it collected less was 2020 — when the coronavirus pandemic began — and it still grabbed $530 million.
It’s taken in an annual average of $1.4 billion, an amount that exceeds 6% of this fiscal year’s entire General Fund, since 2017. And state analysts project it will grab $1.4 billion again this year and close to $1.3 billion in each of the next three.
“Connecticut’s volatility cap is doing more than protecting against volatility,” the report states. “Rather, it has worked to compel substantial annual transfers into pension funds and other long-term liabilities, beyond what is budgeted and required by the actuarially required contributions to the pension funds.”
Researchers also noted that the volatility adjustment wasn’t crafted after an exhaustive study of state revenue trends. Legislators developed it in hurried fashion at the tail end of a nine-month budget debate that ended in October 2017.
Legislators simply identified the “volatile” revenue categories, set a $3.15 billion threshold based on the receipts those categories had generated the prior year and declared anything that exceeded this level was unsafe to spend. They allowed the threshold to be increased annually based on statewide growth in personal income, but everything hinges on that initial threshold of $3.15 billion.
Was it a typical year?
A January 2024 CT Mirror series showed 2017 was one of the weakest years for state tax receipts in recent history. Specifically, revenues from these volatile sources, after adjustments for inflation, were the third-lowest between 2010 and 2024.
And if the initial threshold was atypically low, could Connecticut be treating millions of stable, recurring tax dollars as too volatile to spend?
“There was no magic, and arguably, little science, behind the guardrails’ initial design,” researchers wrote, adding that the current system “appears to cast too wide a net” in declaring revenues too volatile to spend.
Researchers suggested lawmakers consider several changes to this system, including:
- Reconsidering which taxes it considers “volatile,” especially given that the system identifies huge sums that must be saved year after year.
- Changing the annual growth rate, possibly considering inflation as well as growth in household income.
- And abandoning 2017 as a typical year for tax receipts, instead considering revenues over a rolling five- or 10-year average.
Researchers also noted that the volatility adjustment isn’t the only safety net lawmakers built into the budget to guard against deficits.
They also mandated that planned spending can’t exceed 98.75% of available revenues. This 1.25% cushion, which represents about $300 million this fiscal year, helps Lamont and legislators deal with unexpected cost overruns.
CT spending on programs lags investments in comparable states
As year after year of big budget surpluses have bolstered pension funds, critics of this system say other core programs have suffered.
Connecticut spending on retirement benefits grew 20.3% between 2016 and 2023, once adjusted for inflation, while spending outside of pensions fell 2.5%, the report states.
Lamont and legislators might have had this debate early, but state government received roughly $3 billion from Congress through the American Rescue Plan Act of 2021. And about $2.8 billion of those funds were highly flexible and could be spent on most programs, without being subject to limits imposed by the guardrails system.
But those ARPA funds, which legislators used to bolster programs when traditional tax revenues were captured by savings programs, have been largely exhausted.
And researchers noted in the new report that leaves sizeable gaps in the budget.
This fiscal year, ARPA funds are supporting about $510 million in services, and another $184 million is backed by another temporary resource: surplus funds carried forward from previous fiscal years.
The state’s public colleges and universities have been one of the chief recipients of this one-time money and are particularly at risk of cuts in the next budget, researchers noted.
The report also states that total inflation-adjusted spending in Connecticut has grown more slowly than other northeastern states of comparable size and wealth.
Spending per capita has grown by just 0.74% here between 2015 and 2021, compared with 1.2% in New Jersey and 2.65% in Massachusetts.
Spending cap changes are OK, gimmicks are not
Even if Lamont and legislators agreed to revise the volatility adjustment and dedicate more dollars to core programs, another budget control stands in the way.
The state spending cap, which has existed in various forms since 1991, tries to keep growth in most segments of the budget in line with household income and inflation.
Researchers suggested that the spending cap could be more generous than current rules allow.
Currently, the system takes the prior year’s spending and applies a growth factor: inflation or increases in household income, whichever is larger. But rather than just counting the prior year’s spending, researchers asked, why not also consider the spending that might have been?
In some years, legislators don’t spend the full amount allowed under the cap system, even if inflation is high, usually because revenues don’t support it. Under those circumstances, this allowable growth is forfeited, rather than built into the system and carried forward into future years.
But if such an adjustment were made, researchers wrote, the present spending cap limits might better reflect the costs facing state government.
Rather than debate spending cap reforms, legislators and governors for a decade and a half have instead looked for options to work around the cap. These generally involve fiscal maneuvers that, while legal, are blasted by critics are contrary to the spirit of the spending cap.
Revenues are “intercepted” and programs are funded in off-budget accounts that are outside of the cap. Because payments on bonded debt long have been exempt from cap limits, policymakers sometimes borrow — and pay interest — on programs normally paid for with cash.
For example, Connecticut borrows tens of millions of dollars annually to make payments on borrowing.
Researchers for The Connecticut Project and Yale wrote these methods “risk decreasing budget transparency and increasing inefficiency. To the extent that policymakers find themselves routinely structuring around the existing cap, more direct and transparent changes to the spending cap’s design may be warranted.”
Note: The Connecticut Project is a donor to The Connecticut Mirror.
This story was originally published in the Connecticut Mirror Dec. 11, 2024.
