Update and FAQs on CT's Fiscal Crisis

By Katie Roy, director & founder of the Connecticut School Finance Project

Connecticut entered this legislative session with a significant hole in the State's next two year budget and the situation has gotten dramatically worse over the past week. We have just received the final Consensus Revenue numbers from OPM and OFA, and CT's income tax collections are down $413 million for the current fiscal year.

This post is in response to the many questions we have received asking us about what is happening and its impact on the state budget, and is intended to provide a basic overview of the state's fiscal situation and briefly describe its impact on the FY'18-FY'19 biennium budget. Please note this post is intended to be explanatory in nature, and it is not intended to be an expression of support or opposition for any particular policy or solution. 

In putting this FAQ together, I have taken information directly from many articles written by CT Mirror reporter Keith Phaneuf (for brevity, I did not include citations throughout, except where I have directly quoted, but I have provided links to the articles at the end of this email). I would also like to thank Kathy Guay for her assistance in updating the data in the Office of Fiscal Analysis's Fiscal Accountability Report. 

What changed during the past week that made the fiscal picture so much worse than expected?
As everyone knows, April 15 (or this year, April 18) is Tax Day. In CT this isn't only the day that annual income tax returns are due, it is also the date when first quarter returns for quarterly tax filers are due. As a result, late April is when the State finds out what their tax receipts for the year actually look like.

On Monday, April 24, the State announced that income tax collections were running $267 million below the January 2017 Consensus Revenue* estimates. On Thursday, April 27, the State announced that income tax collections had fallen precipitously from Monday's estimate and were running more than $400 million below anticipated tax revenues. Today, Monday, May 1st, the final Consensus Revenue numbers put CT's tax collections for this year $413 million below projections. This means tax collections for April are running nearly 30 percent below anticipated levels

Because income tax collections are far lower than what was projected for this year, it has created an immediate hole in this year's state budget. Connecticut's budget for this year is anticipated to be $380 million in the red, which would fully deplete the State's "Rainy Day Fund," which currently contains $236 million (note: the current Rainy Day Fund level is well below the 15 percent of annual operating costs that the comptroller recommends the fund contain). This means the State must take immediate steps to close the hole in this year's state budget between now and June 30th (when the fiscal year ends). If it is unable to find enough cost savings, the State would need to borrow money just to finish the fiscal year. (The last time the state had to do this was in June 2009, when the state borrowed nearly $1 billion to close a budget hole of nearly $950 million. Connecticut still hasn't finished paying that money back—they still owe about $200 million on that loan.)

*The Consensus Revenues are revenue estimates that have been agreed upon by the Governor's Office of Policy and Management (OPM) and the General Assembly's Office of Fiscal Analysis (OFA). 

What does this mean for the state budget over the next two years?
The potential decline in income tax collections isn't only a problem for this year—it also impacts the projected income tax collections for the next two years. Due to the decline in this year's income tax projections, the projected income tax receipts for FY'18 and FY'19 have been reduced by $600 million and $865 million, respectively. 

Prior to this unexpected decline in income tax revenues, CT was already facing a difficult fiscal picture for the next two fiscal years. Based on the January 2017 estimates, a deficit of $1.7 billion was expected for FY'18 and $1.9 billion for FY'18, for a total of $3.6 billion over the two-year biennium. These reduced income tax estimates would increase those deficit amounts to $2.2 billion for FY'18 and $2.7 billion for FY'19, resulting in a total shortfall of nearly $5 billion.

Note: Fiscal Year 2018 (FY'18) begins on July 1, 2017 and Fiscal Year 2019 (FY'19) begins on July 1, 2018. Connecticut has a biennium budget cycle, which means the State budgets for the next two fiscal years during odd-numbered years.

How large is the Connecticut budget? What does it mean to need to reduce spending by $5 billion?
Connecticut's estimated total General Fund expenditures for this year (FY'17) are $17.88 billion. 

However, according to OFA's Fiscal Accountability Report, more than half of the state's budget is dedicated to "fixed" costs and that portion of the budget is growing. "Fixed" costs are costs related to pensions and other retirement benefits for public school teachers, pensions and other retirement benefits for state employees, and debt service on bonding for capital projects that the State has a legal obligation to pay. These four line items alone will take up more than 30 percent of next year's budget. Additionally, OFA classifies some entitlement grants (such as Medicaid) as "fixed"—these entitlement grants take up an additional 21 percent of the budget. The chart below shows the Baseline FY'18 budget breakdown between fixed and non-fixed costs:

This means the total Non-Fixed portion of the budget is 48.6% or $9.1 billion. With a FY'18 budget deficit of $2.2 billion, the State would need to cut ALL non-fixed expenditures by 24.2 percent to close the budget holeIf Education Cost Sharing funding is held harmless, then all other non-fixed expenditures would need to be reduced by 31 percent. (Note: ECS funding is not all of the education funding that goes to districts). 

Note: We have followed the lead of OFA in identifying which costs are considered "fixed." OFA's Fiscal Accountability Report lists specific accounts as "fixed" costs," as outlined in Section 78 of P.A. 16-3, MSS. This statutory language says that fixed costs are: debt service, pension obligations, entitlements, and retiree health care. The statutory definition does not include active state employee health insurance costs so I have not included those here (nor the Other Post Employment Benefits (OPEB) expenditures required from the 2011 SEBAC agreement).

How did Connecticut end up with so much unfunded retirement and bonded debt?
For many years, Connecticut failed to save for the retirement benefits it promised to public sector workers. According to Keith Phaneuf, "Connecticut saved nothing between 1939 and 1971 — and very little until the mid-1980s — to cover pensions promised to state employees and teachers. For example, between 1979 and 1988, the state never contributed more than 40 percent of the recommended payment for the teachers’ pension." As a result, Connecticut has run up about $50 billion in unfunded retirement obligations and about another $24 billion in bonded debt (for a total of $74 billion). 

A household equivalent to this would be charging more than 30 years worth of living expenses to your credit card and not making any payments toward the principal or interest. The result is that Connecticut's residents are now paying not only our own bills but also the bills of our grandparents, which have been badly inflated over time by interest. 

It is also important to note that Connecticut is in far worse fiscal shape than other states when it comes to debt. As Phaneuf wrote, "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 third-worst among all states, topped only by Illinois’ and Alaska’s debts. 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."

Is this problem going to get better or worse in future years?
Unfortunately, the State's budget challenges are expected to get worse before they get better. The share of the State's budget committed to costs related to pensions and other retirement benefits for public school teachers, pensions and other retirement benefits for state employees, and debt service on bonding for capital projects has grown steadily over the past 20 years from 12 percent of the General Fund to more than 30 percent of the General Fund, and are expected to continue to grow at a rapid rate until they peak in the 2030s—at that point, it is expected the State will have caught up on paying these unfunded liabilities, and many retirees from the period when state government didn’t save will have passed away.

As Phaneuf has explained, "According to a study by the Center for Retirement Research at Boston College, both annual contributions to state employees’ and teachers’ pensions are on pace to more than quadruple by the early 2030s, placing both above $6 billion per year. They are about $1.6 billion and $1.3 billion, respectively, next fiscal year. The teachers’ fund contribution potentially faces a 365 percent increase over 14 years, or an average annual jump of 26 percent." 

How do you expect this to impact school finance?
Given the fact that main formula aid for education (ECS funding plus general operating grants for choice programs) already makes up nearly 30 percent of the non-fixed cost portion of the State budget, it seems unrealistic to expect the State will be able to substantially increase education funding for the foreseeable future, and in fact, it is possible the State may be forced to make meaningful reductions to some education grants. However, the difficult budget situation does not preclude the State from adopting—and using—a formula to fund public schools, and in fact, the difficult budget situation is arguably an additional reason why it makes sense to distribute education funding equitably, using a transparent formula. 

What are your sources and where can I learn more?