Constrained by guardrails, legislative session looms

Back • Publication Date: January 30, 2024 • Fiscal & Economics

Part 1: Since 2020, state government has deposited $1 out of every $5 into its pension funds, relying on a hastily crafted savings program that declares hundreds of millions of dollars annually too volatile to spend on anything else. Read Part 1 here.

Part 2: Even as Connecticut’s pension assets and fiscal reserves grow, health care, social services and higher education programs continue to erode. Read Part 2 here.

Part 3: Legislators agreed to leave the fiscal guardrails in place until mid-2028, but those controls could push state finances into crisis this spring.

As legislators were putting the finishing touches on the state budget last June, leaders of the House and Senate issued a warning.

Connecticut’s fiscal guardrails — its spending and borrowing caps complemented by two other savings mechanisms — had been very successful at building reserves and reducing debt.

But House Speaker Matt Ritter and Senate President Pro Tem Martin M. Looney both saw complications coming that would force painfully deep programmatic cuts, even as healthy surpluses kept rolling in.

Their admonition was simple: Be flexible, or the system could be changed, or removed.

“If you become too much of a straitjacket … then I worry about [fiscal guardrails] in the long term,” Ritter said seven months ago. “So, my response for the people who are so pure about that: Be careful, because they will go away in five years if you do that.”

The showdown foreseen by leaders of the Democratic majority could begin Feb. 7, when Gov. Ned Lamont proposes adjustments to the preliminary $26 billion budget adopted last June for the 2024-25 fiscal year.

Gov. Ned Lamont, delivering his budget address on Feb. 8, 2023, at the state Capitol. STEPHEN BUSEMEYER / CT MIRROR

Both Ritter and Looney acknowledge this system has captured nearly $11 billion in surpluses since 2017 but fear these guardrails could be out of balance, damaging education, health care and social services if not carefully monitored.

“I just think that’s an unnecessary approach,” Ritter told The Connecticut Mirror in a late December interview, referring to the prospect of chopping into a preliminary 2024-25 budget already projected to run hundreds of millions of dollars in the black. “It’s only going to set the stage for a difficult short session that doesn’t need to be difficult.”

Looney called it “something I’m gravely concerned about,” adding he believes most legislators share those concerns.

How the system breaks down in the next budget

Here’s where the problem starts.

The preliminary budget for next fiscal year increases General Fund spending 3.5%. The General Fund covers almost 90% of the state’s operating expenses.

Many legislators wanted to spend more on higher education, social services, nursing homes and federally qualified health centers, but the 2024-25 budget initially fit under the spending cap by $11.6 million, a razor-thin margin equal to roughly 1/20 of 1% of the General Fund, when adopted last June.

But Connecticut has been following two-year budget cycles since 1993. The traditional approach has been: Don’t hold up the package because of Year 2 problems. Get it passed and adjust the following spring, before the budget’s second year takes effect.

But since then, the spending cap challenge has gotten worse. The Lamont administration recalculated the cap in November and concluded next year’s budget already exceeds the limit by nearly $30 million.

Further complicating matters, state agencies are expected to overspend their budgets this year by about $285 million. Thanks to healthy revenues, though, the current budget still is on pace to finish more than $645 million in the black, according to Lamont’s budget office.

Still, analysts warn many of this year’s cost overruns could occur again in 2024-25. And if tacked onto the next budget’s bottom line, total spending then shatters the spending cap by a wide margin — closer to $300 million than to $30 million.

In other words, as soon as legislators reopen the preliminary budget for 2024-25, their task won’t be to add spending but rather to make big cuts — albeit not because of a shortage of funds.

“The spending cap, for me, is the main event,” said Lamont’s budget director, Office of Policy and Management Secretary Jeffrey Beckham.

And while he added the plan Lamont will propose to legislators on Feb. 7 “won’t be an austere budget,” Beckham’s office already has warned state agencies to temper their expectations.

Many advocates for core programs fear the worst, since the administration is holding its cards close to the chest.

During former Gov. Dannel P. Malloy’s administration, and during Lamont’s first three years in office under his former budget director, Melissa McCaw, the CT Mirror was able to view budget requests from various state agencies.

But Beckham declined to disclose them this year, insisting — despite the office’s past practices — that these budget documents were technically drafts and therefore exempt from disclosure.

Does the second ‘guardrail’ cause savings overkill?

The spending cap isn’t the only guardrail potentially pushing lawmakers to cut spending in the next budget. The “revenue cap” also complicates matters.

This provision requires lawmakers to adopt a budget with a significant built-in surplus. Call it insurance against cost overruns.

It specifically says planned spending can’t exceed 98.75% of projected revenues — or there must be a cushion of 1.25%. Analysts earlier this month projected General Fund revenues next fiscal year would approach $23.2 billion, which means spending can’t top slightly less than $22.9 billion.

At first glance, that poses no problems.

The preliminary 2024-25 budget adopted last June includes a General Fund that spends slightly more than $22.8 billion and would need at least a built-in surplus of $290 million to comply with the revenue cap. It currently has a cushion topping $350 million under the latest revenue projections.

But if most of this year’s $285 million in agency cost overruns also must be added to next year’s bottom line, it would still be in balance. But the roughly $70 million operating surplus left after compensating for those cost overruns would be way below the $290 million cushion required by the revenue cap. It would take roughly $220 million in cuts to fix this problem.

Meanwhile, thanks to a third guardrail, the next state budget has another big pile of untouched money — but those dollars also can’t be spent.

Known as the volatility adjustment, it targets quarterly income and business tax receipts, two sources that vary greatly from year to year. Any receipts above a predetermined annual limit are deemed “volatile” and cannot easily be spent.

The volatility adjustment has saved an average of almost $1.3 billion during its first seven years in existence and is scheduled to save another $452 million in 2024-25.

Therein lies the huge logic hurdle legislative leaders don’t know how to clear.

How do they dash lawmakers’ hopes of adding dollars to core programs in the next budget, and then convince them to cut about $220 million — just so the final plan has a $290 million built-in operating surplus and leaves another $452 million untouched via the volatility savings program?

“It’s completely untenable,” Looney said, “It would be impossible to build consensus around that dynamic.”

When you have healthy surpluses, “the first thing you have to do is protect the budget you have and make investments,” Ritter said.

One option around that is simply to remove the revenue cap. Ritter, Looney and other legislators have questioned publicly whether it’s redundant.

House Speaker Matt Ritter, right, and Senate President Pro Tem Martin Looney welcoming Gov. Ned Lamont as he prepared to present his budget on Feb. 8. MARK PAZNIOKAS / CTMIRROR.ORG

Another is to hope the revenue cap problem in the next budget simply will go away — and there’s a chance it will for a while.

If revenue projections for next fiscal year were to surge dramatically, so would the spending level allowed under the revenue cap system. Analysts are scheduled to adjust their revenue forecasts once more on April 30, one week before the regular legislative session ends.

The late April test often triggers the biggest revenue changes, if any are forthcoming, since it is based on updated income tax data following the annual April 15 filing deadline.

But even if leaders get lucky and revenue projections surge in April, the spending cap requirement still leaves them with the same problem. How do they convince rank-and-file lawmakers to make hundreds of millions of dollars in programmatic cuts when even larger, seemingly available piles of cash remain untouched?

Do guardrails reflect what taxpayers can afford?

Beckham cautioned legislators to remember the guardrails ensure that state government remains affordable. The spending cap allows growth to match increases in household income or inflation, whichever is larger in a given year.

“For those who want to push past that limit,” Beckham added, “you’re saying, ‘I want to spend money faster than our people are making it.’”

“I think we are much better off when we keep our word,” Lamont said, noting legislators have endorsed these guardrails twice, including last year’s unanimous vote.

Tampering with controls that have stabilized debt costs and enabled tax cuts could harm Connecticut’s prosperity, the governor added. “Those guardrails are facilitating economic growth in the state,” he said. “You can’t have opportunity without growth. And even with those guardrails, we’re making historic investments.”

But critics of that system counter that Connecticut has some of the most extreme income and wealth inequality in the nation. In other words, some folks are making that money much faster than others — and don’t always have to work for it — while others struggle greatly.

Data from nonpartisan fiscal analysts last October found that households earning more than $2 million annually paid nearly 80% of their 2021 Connecticut income taxes, on average, through the quarterly filings used chiefly to report capital gains, dividends, and other investment income.

By comparison, a household earning the statewide median — which was $83,572 according to the U.S. Census Bureau — paid 82% by paycheck withholding. All households earning less than $250,000 per year paid, on average, at least 82% of their state income taxes through paycheck withholding.

Connecticut Voices for Children, a progressive policy think tank based in New Haven, has argued repeatedly in recent years for a more progressive income tax system to help fuel greater investments in education, health care and social services.

Lamont, a fiscal moderate and Greenwich businessman, counters that this approach would prompt Connecticut’s richest, and largest, taxpayers to flee the state.

Still, Connecticut Voices’ executive director, Emily Byrne, says long-standing public under-investment in many programs serving the state’s poorest and most vulnerable residents hasn’t substantially grown since 2017, and in several cases has gotten worse.

“While the fiscal controls have certainly set the state in a good position to pay down unfunded liabilities, which is the right thing to do, it has done so at the expense of the current generation,” Byrne said.

“It’s not either-or. It’s got to be both,” she added. “The hope is that the legislature can figure out a way to create fiscal controls that serve all residents.”

In recent years, lawmakers have pursued loopholes around the spending cap rather than direct changes.

Surplus funds from an outgoing budget are carried forward into the next cycle. And since they already were counted against an earlier year’s spending cap, they don’t break the limit when they are spent later.

Lawmakers also have employed an accounting gimmick known as a “revenue intercept” to capture millions of dollars in tax receipts before they arrive in the General Fund and effectively spend them outside of the cap system.

Guardrails have strong supporters

But any effort

But any effort to change the revenue or spending caps — or any other guardrails — likely would face lots of opposition.

“We are absolutely committed to revenue cap compliance,” Beckham said, adding that applies to the spending cap as well.

House and Senate Republican leaders share the Democratic governor’s passion for preserving the guardrails, even though they and their colleagues have expressed disappointment about the recent lack of funding for certain programs, including winter heating assistance and other social service programs.

Rather, GOP leaders say, Democrats should be looking for options to cut spending where it is bloated and redirect those funds to services in need. Reforming the arbitration system could better control state employee raises, while smarter pension investments could yield higher earnings, Republicans say.

The Republican minority leaders, Sen. Kevin Kelly, left, and Rep. Vincent J. Candelora. MARK PAZNIOKAS / CTMIRROR.ORG

“These are choices that have to be made,” Senate Minority Leader Kevin Kelly, R-Stratford. “I think the guardrails have served the taxpayers very well.”

Others echo the mantra of “if it ain’t broke, don’t fix it.”

“The most progressive thing I think we can do is to stick with the guardrails and be fiscally cautious,” said state Comptroller Sean Scanlon, a moderate Democrat and former state representative who co-chaired the Finance, Revenue and Bonding Committee during much of the period when large budget surpluses were achieved.

Scanlon, who served in the House from 2015 through 2022, said the fiscal concerns now pale in comparison to those when he first joined the legislature and a huge budget deficit prompted one of the largest tax hikes in state history.

“Before you even have the discussion about changing any of the fiscal guardrails,” said Connecticut Business and Industry Association spokesman Chris Davis, a former five-term state legislator, “how do we bring down those costs of government?”

Davis, who served throughout the 2010s, says businesses haven’t forgotten the tax hikes and budget deficits of those times, even if some legislators have.

The recent years of budget surpluses, tax cuts and debt reduction have given many companies the confidence to add jobs, he said.

Tampering with the guardrails, Davis added, “sends the message to the business community that predictability and stability may not be here.”

Chris Davis, then a Republican state representative, speaks with the media in 2018. He is now the vice president of public policy at the Connecticut Business and Industry Association. KEITH M. PHANEUF / CTMIRROR.ORG

Leaders might pull the plug on budget adjustments

If no consensus is reached on how to deal with the upcoming guardrail issues this legislative session, Democratic legislative leaders have one more card to play.

Though Connecticut generally follows a two-year budget cycle — adopting a biennial plan in odd-numbered years — it’s not obligated to adjust the second half of that budget in even-numbered years.

As recently as 2020, when lawmakers closed the Capitol in March following the initial outbreak of COVID, they didn’t adjust the second year of a biennial budget before it took effect.

Both Ritter and Looney said that isn’t the optimal way to handle the budget. But if the only choices are leaving the preliminary $26 billion plan alone or making further cuts, they will choose the former.

Looney expressed hope that the governor and Republican legislators would be willing to reassess the 7-year-old guardrails and at least try to mitigate any negative side effects.

“I certainly believe that the world has not stood still since 2017, so I think it is entirely appropriate for us to assess where we are,” he said.

The legislature pledged in contracts with its bondholders to follow these guardrails at least until mid-2028. But changes can be made if the governor and three-fifths of both legislative chambers agree.

Ritter also was hopeful that some compromises, either through formal changes or with other workarounds, can be reached. But he also repeated his earlier warning that a strict adherence to these guidelines, without regard for any damage caused, won’t end well.

“They’re going to be picked apart if you don’t think, logically, what their purpose is,” he said. “If you are so rigid, … then they are going to go away.”

Authors: Keith M. Phaneuf •  Source: CT Mirror • View

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