Wealthy Connecticut Takes Hard Look at Tax Code Fairness

Back • Publication Date: July 21, 2023 • Fiscal & Economics

• State requires rigorous biennial tax incidence reports
• Top earners had 6.64% effective rate

Connecticut is embarking on a first-in-the-nation tax transparency initiative that could answer
questions—shrouded in mystery in most states—about tax fairness and tax avoidance.
A little-noticed feature of the state’s 2024-25 biennial budget (HB 6941) requires the Department of
Revenue Services to issue comprehensive reports every two years analyzing several qualities of the
revenue system. The exercise will display new data about the revenue collected under a half-dozen
state tax programs, but it will also offer critical insights on two important fronts: the tax code’s impact
on different socioeconomic groups, and the billions of tax dollars that go uncollected each year due to
noncompliance—the so-called “tax gap.”

An additional feature of the new transparency regime requires the department to publish an annual
plan with measurable goals and specific strategies for closing the tax gap—a figure that Connecticut
Voices for Children, a progressive advocacy group, estimates at 19%, or $2.6 billion, for the personal
income tax alone.

While other states, including California, Minnesota, and Texas, have pursued similar examinations of
their tax codes, Connecticut is the first to require a holistic and continuous analysis of both the equity
and the effectiveness of its tax system. Policy makers believe this two-track analysis will be an
important tool for injecting fairness into the budget process.

“For both the legislature and the governor to make strategic decisions around budgeting and taxes,
you gotta have data,” revenue Commissioner Mark D. Boughton told Bloomberg Tax. “The perfect
scenario would be a 10-year window of data to be able to understand the trend lines and who is
impacted by tax. Then you could make decisions about the things you tax and the things you don’t
tax.”

Progressive lawmakers hope the transparency initiatives will help them assess and address
perceived tax regressivity in Connecticut, a state that routinely ranks in the top five nationally for income inequality.
“As one of the wealthiest states in the country we really have a duty to make sure we’re looking
closely at our tax system and creating a fair system where everyone is really paying what they owe,”
said Rep. Kate Farrar (D), vice chair of the Connecticut House Finance, Revenue and Bonding
Committee.

Tax Incidence Reports
Connecticut isn’t a newcomer to tax transparency, but its previous efforts have been inconsistent.
The legislature in 2014 required the department to issue its first “tax incidence” report, an estimate of
the total tax burden as imposed on all classifications of personal and business tax filers. The report
also intended to portray “economic incidence,” the indirect tax burden on households after businesses
shift their own tax liabilities to consumers and workers.

The legislature required the report to be issued every two years, but then waived the requirement for
several years. The second incidence report wasn’t filed until 2022 and raised questions about the
fairness of Connecticut’s system. The economic incidence analysis of the full burden for personal
income taxes, property taxes, sales and use taxes, excise taxes and corporate business taxes across
10 income categories, or deciles, revealed patterns of inequity and regressivity, said Patrick O’Brien,
research and policy director at Connecticut Voices for Children.

For instance, Connecticut taxpayers in the lowest economic decile, whose adjusted gross incomes
are below $44,758, paid an effective tax rate of nearly 26%. Taxpayers firmly in the middle class, the
third decile, and earning between $74,688 and $107,823, paid an effective rate of 15.5%. Highincome
taxpayers fared even better. Those in the ninth decile, earning between $1.6 million and $8.2
million, paid an effective rate of 7.08%. And people in the top decile, earning north of $8.2 million,
paid an effective tax rate of 6.64%.

Farrar said the 2022 report helped mobilize support for formalizing and broadening the scope of the
tax incidence analysis. Lawmakers added language to the budget requiring the revenue department
to issue its next report by Dec. 15, and biennially thereafter. The budget also requires a rigorous
analysis of the income and population distribution of the personal income tax, all business entity
taxes, sales and excise taxes, corporation business taxes, property taxes, and any other revenue
program generating at least $100 million.
The legislature tasked the department with presenting new information including: taxes paid by the
top 0.5% of all taxpayers; the percentage for each income class of taxpayers who are homeowners,
households with children, senior citizens, married and single; and information on the distribution of tax
credits and other exemptions resulting in a revenue loss to the state.
Farrar and Boughton said the new tax incidence framework embedded in the budget reflects
standards pioneered by the Minnesota Department of Revenue, often considered the “gold standard”
for such analysis.

Promoting Tax Compliance
A separate section of Connecticut’s 2024-2025 budget requires the department to “estimate the state
tax gap and develop an overall strategy to promote compliance and discourage tax avoidance.” As
part of the analysis, the legislature charged the department with evaluating its own staffing needs for
closing the tax gap.

The first such analysis is required by Dec. 15, 2024, and annually thereafter. In addition, the
legislature required the department to publish a plan for addressing the tax gap by July 1, 2025. The
plan must include specific strategies, goals, and “a timetable to measure progress towards closing the
tax gap.”

“These two things, taken together, would essentially be the highest level of tax transparency in the
country as this gets implemented,” O’Brien said.

O’Brien said he’s particularly interested in the forthcoming tax gap report, noting that no states
perform routine or robust analyses of tax compliance disparities. Connecticut Voices for Children
published a report last year estimating a state gap of $2.6 billion, but he believes the number is much
higher.

The report evaluated only the personal income tax and likely undercounted tax revenue that should
be flowing to the state from wealthy residents with opaque sources of revenue. Moreover, the report
fails to fully reflect the impact of a 10-year slide in audits of high-income households by both the IRS
and the state revenue department. Both problems, O’Brien said, contribute to the regressivity already
found in Connecticut’s tax code.

“The interaction of these two things means the income tax gap overwhelmingly goes to high income
earners,” O’Brien said. “The best data we have estimated that the top 5% account for about 53% of
the income tax gap, and 28% goes to the top 1%.”

Sales Tax Skimming
Boughton didn’t dispute the $2.6 billion estimate, but suggested Connecticut has bigger problems
with cash-based businesses, such as retailers, restaurants, and service companies, that underreport
their sales to the state.

“The biggest area where we don’t get full payment is the sales and use tax, not necessarily the
personal income tax. You see it in stores where customers pay with cash and the store doesn’t remit
the sales tax.”

Richard Pomp, a professor of state and local tax law at the University of Connecticut Law School,
questioned the wisdom of the state’s new transparency initiatives when officials could be devoting
more resources to auditing.

Tax system impacts and the machinations of the underground economy are notoriously difficult to
decipher, Pomp said. As a result, tax incidence reports and tax gap analyses require sophisticated
methodologies, cash, time, and analytical resources generally unavailable in state revenue agencies.
He suggested his state would be better off beefing up its audit department.

“Instead of tilting at windmills for political purposes, they ought to hire more auditors,” he said. “We all
know for every dollar we pay an auditor you get X dollars back.”

To contact the reporter on this story: Michael J. Bologna in Chicago at
mbologna@bloombergindustry.com

To contact the editors responsible for this story: Benjamin Freed at bfreed@bloombergindustry.com;
Kathy Larsen at klarsen@bloombergtax.com
©

Authors: Michael J. Bologna •  Source: Bloomberg News • View