With state surpluses continuing, lawmakers debated Monday the best way to deliver financial relief: cutting the state income tax or boosting child tax credits.

State budget director Jeffrey Beckham pushed Gov. Ned Lamont’s plan framing it as a progressive move to grant relief to the most taxpayers.

Beckham, who will help negotiate the final details with legislators over the next two months, said the state is financially prepared to enact large tax cuts after depositing $7.2 billion into the rainy day fund since the 2018 fiscal year, largely from capital gains profits on Wall Street. In addition, he said the top 1% of Connecticut taxpayers pay 34% of the state income tax and the top 25% of filers pay 83.6% of the total.

“By targeting relief toward working families and the middle class, these tax cuts should enhance the equity already inherent in Connecticut’s progressive tax code,” Beckham told the legislature’s tax-writing finance committee.

If the measure is approved by the Democratic-controlled legislature in the coming months, a family of four with two children earning under $50,000 per year and qualifying for the earned income tax credit would pay no state income tax. Families earning under $40,000 could receive a rebate.

Couples filing jointly would save a maximum of nearly $600 per year if they earn about $100,000 per year, and single filers earning about $65,000 would save a maximum of nearly $300 per year. The cuts would reach 63% of income tax filers and would start with the new tax year on January 1, 2024.

But Democrats and advocates say that looking at the state income tax alone does not tell the whole story because lower-income residents pay sales, gasoline, and other taxes that disproportionately impact their income.

A key priority for some Democrats is creating a permanent state child tax credit — which is not part of Lamont’s package.

Sana Shah, advocacy director for New Haven-based Connecticut Voices for Children, says Lamont’s overall tax package would cost $557 million per year, adding that revisions should be made to create a fully refundable child tax credit of $250 per child for a maximum of three children. That would cost an estimated $125 million a year, she said, if the credit is limited to single tax filers earning up to $100,000 and joint tax filers earning up to $200,000 per year.

Patrick O’Brien, research and policy director for Voices, said Connecticut is the only high cost-of-living state with an income tax that does not adjust taxes for the number of children. Families earning $100,000 per year with no children have a far different economic picture than families with two children who need about $17,000 per year to raise each child, he said. New York, by contrast, adjusts in three different ways, including relief for child care, he said.

Sen. John Fonfara, a Hartford Democrat who co-chairs the tax committee, said that Voices should be supporting more policies to grow the economic pie instead of looking for ways to redistribute wealth.

“We want higher-income earners here,” Fonfara told O’Brien. “I don’t see too many cranes in Connecticut. Go to Boston, and you see a lot of cranes. We can’t do much with finance if we don’t have revenue.”

But O’Brien, who holds a Ph.D. in political science from Yale University, said that 70% of economic growth is related to consumer spending — and giving credits and tax cuts to lower-income residents would spur economic growth and help businesses.

“Our tax system is exacerbating … income inequality,” O’Brien said.

But Rep. Lezlye Zupkus, a Prospect Republican, said blue-collar families in her district are having a hard time paying their bills.

“I see your comments as just tax the rich,” Zupkus told O’Brien. “When those people leave, who pays the boat?”

O’Brien responded that the poor have a higher effective tax rate, based on a percentage of their overall income, than wealthier families.

The finance committee is expected to make recommendations by April 21, and then top legislative leaders are hoping to reach the final deal with Lamont before the session ends on June 7.

Bipartisan support for income tax

Lamont’s tax cuts would be accomplished by reducing the current 5% rate to 4.5%, which represents a 10% rate cut. The current 3% rate would be reduced to 2%, which amounts to a 33% cut in taxes paid. The rate cuts would show up automatically in paychecks, rather than having taxpayers fill out any forms or applications.

Rep. Maria Horn, a Litchfield County Democrat who co-chairs the committee, said it is “refreshing” for the legislature to be debating about how to cut taxes, rather than raising them.

Unlike some past issues that have been split along partisan lines, Republicans have voiced general support for the plan by Lamont, a fiscally conservative Democrat.

Rep. Holly Cheeseman, the committee’s ranking House Republican, said that her caucus favors the income tax cut over a child tax credit. She said that about 30% of families have children, while 70% do not.

Lamont has proposed increasing the Earned Income Tax Credit, aimed chiefly at working families. The increase would give an additional $211 to the average household, but could give a couple with two children an extra $585, according to the administration.

“The EITC is effectively a child tax credit,” Beckham told Cheeseman, adding that 90% of the beneficiaries at the federal level are families with children. “We just think we should have a broad-based relief that everyone participates in.”

Lisa Tepper Bates, president of the United Way of Connecticut, said that families seeking to qualify for the earned income tax credit must earn less than $56,000 per year.

“Raising a child in Connecticut is more expensive than almost anywhere in the country,” Tepper Bates said, calling for the credit to become permanent.

The enhanced federal child tax credit of $3,600, which was boosted for one year during the coronavirus pandemic, has been dropped back to its original level of $2,000 per child. The credit could fall further to $1,000 when former President Donald Trump’s tax cuts expire in 2025.

Rep. John Piscopo, a fiscally conservative Republican who has voted against many Democratic budgets in his long career, said he was among the first to stand and applaud Lamont’s plan. He said he is “really supportive of that middle-class tax cut.”

State Rep. Joe Polletta, a Watertown Republican, agreed.

“The states that are growing are the ones that are more tax friendly,” he said.

Pass-through entity tax

Besides the income tax, Lamont is also calling this year for cuts in the pass-through entity tax, which was created in 2018 as a workaround for taxpayers snagged by the maximum federal deduction of $10,000 in their state and local taxes, known as SALT.

In the latest proposal by Lamont to restore a credit, about 123,000 small businesses would receive combined tax relief of about $60 million in a move pushed by the Connecticut Business and Industry Association.

The pass-through entity tax now ranks as the third-highest tax generator in Connecticut at a projected $2 billion for the current fiscal year — behind only the state income tax at $11.8 billion and the state sales tax at $5 billion.

While small retail shops and struggling businesses operate under limited liability companies that qualify for the pass-through entity tax, the lion’s share of the money is paid by wealthy small business owners. State statistics show that 80% of the tax is paid by entities that are earning more than $500,000 per year. The entities might have two or 10 partners, for example. In addition, nearly half the businesses filing under that category in 2019 owed no tax at all, according to state records.

“You shouldn’t have to pay on that entity twice,” Beckham told the committee Monday. “It represents a kind of double taxation.”

Fonfara said that Connecticut residents had fared well due to the creation of the workaround for federal taxes.

“The legislature chose to provide a benefit,” Fonfara said, adding that businesses saved $270 million in the past. “I think most businesses would say ‘I’ll take that deal.”’

House Republican leader Vincent Candelora of North Branford said the middle-class tax cut is important because many residents have not yet benefitted from the state surpluses.

“It was put in place when the SALT tax was put in place,” Candelora said. “It’s preventing them from paying more tax revenue to the federal government. We should be returning it to 93%. Corporations aren’t subject to the SALT tax, so they get to deduct all their taxes. It’s protecting our businesses from the federal tax. … The SALT tax is going to expire in 2025, so this may all be moot.”

Sen. Norm Needleman, an Essex Democrat who is a wealthy business owner, said he personally benefitted “from Connecticut’s creative thinking” five years ago.

“People like me, who own pass-through entities, benefitted,” Needleman said. “Generally speaking, this is a good proposal. It’s what other states are doing. We want to make sure that people don’t get hurt by legislation that was originally intended to help people.”

The proposal by Lamont would mark the first reduction in the income tax rate since 1996. In that year, the legislature created the 3% rate, which was a reduction from the previous 4.5% rate. But the rates and credits were also baked into the income tax tables, meaning that low-income couples earning less than $24,000 per year never paid the 4.5% rate. Instead, they owed no income tax at all at the time.

Christopher Keating can be reached at ckeating@courant.com