Slow Capital Gains Worsen Deficit Projections [Courant]

Article as it appeared in the Hartford Courant
The Connecticut state deficit is now projected to be $101 million, comptroller says.

HARTFORD — With state income tax collections from Wall Street slower than expected, the comptroller is now projecting the state deficit at $101 million for the current fiscal year.

Comptroller Kevin Lembo, a Democrat, said Monday that the state had been expected to collect more money from capital gains taxes, which are paid through the personal income tax, from gains in stocks on Wall Street. That, however, is not happening at the pace that was expected — prompting Lembo’s deficit estimate to grow by $40 million.

The state’s fiscal fortunes have been directly affected in the past by trends on Wall Street and changes in federal tax law. A major change was the end of the Bush-era tax cuts on capital gains, which prompted wealthy investors to sell their stocks at certain times and not at others, officials said.

Connecticut multimillionaires and billionaires traditionally make estimated tax payments in January, and this year’s total grew by only 4.9 percent from last year. The money from massive gains or losses on Wall Street can fluctuate widely — leading either to deficits or surpluses in state coffers.

“In the past, these payments through January have provided an indication of the size of the estimated and final payment receipts that can be expected in April,” Lembo said.

Based on the numbers he has seen so far, Lembo is questioning whether Gov. Dannel P. Malloy’s budget office, known as the Office of Policy and Management, is being too optimistic about the money that will come flooding in from the annual April 15 tax deadline.

Malloy’s current projection of a 25 percent increase from last year in the estimated and final payments is at a level that “has not occurred in the last decade,” Lembo said.

Even though Wall Street has been setting records, the state receives capital gains taxes only when stocks are sold. So if a millionaire’s portfolio is now swelled with large gains, the state receives nothing unless trades are made.

“I am also concerned that since the stock market recovery began in 2009, trading volume that generates taxable receipts has been declining,” Lembo said. “It appears that one cause is an aging demographic that has shifted to lower-risk portfolios with less trading volume. Complicating matters further, volume has been heaviest at lower points in the market cycle, thus reducing the amount of taxable capital gains. For these reasons, I have reduced my income tax estimate by $40 million this month. I remain hopeful that April receipts will outpace my current projection, but I believe it is reasonable to lower expectations at this time.”

Lembo noted that the capital gains rates were lower during the state’s 2013 fiscal year, prompting investors to sell at that point — and boosting state revenues. The gains were thus shifted into the 2013 fiscal year instead of the 2014 fiscal year. As such, some state officials were surprised in April 2014 when tax collections were relatively anemic, and the state’s projected surplus of more than $500 million largely disappeared.

That prompted Malloy to abruptly drop his plans last year for tax rebates of $55 for individuals and $110 for couples because the state lacked the money.

Asked to comment on Lembo’s projections, a spokesman for Malloy said the administration is already working to control spending in the current year that includes closing the deficit partially with a settlement for $36 million that was negotiated by the state attorney general’s office.

That money represents Connecticut’s share of a $1.375 billion national settlement with Standard & Poor’s Financial Services LLC after then-Attorney General Richard Blumenthal filed a lawsuit in March 2010 that charged that S&P misled investors “when it rated structured finance securities in the lead-up to the 2008 financial crisis,” the attorney general’s office said.

Malloy “has already submitted legislation to the General Assembly to avoid a budget shortfall this year,” said GianCarl Casa, a budget office spokesman. “Comptroller Lembo has confirmed in his letter that our savings target is attainable and consistent with past performance. This is especially true as Connecticut’s economy continues its two-year period of steady economic growth.”

But Senate Republican leader Len Fasano of North Haven, who has been calling for bipartisan meetings on the state’s budget problems since before Christmas, said that more action is necessary.

“We have repeatedly seen revenues come in far below what the governor and other state officials have projected,” Fasano said. “Clearly, our economy remains in trouble, and a gaping hole remains in the budget. This is precisely why the governor needs to work together with legislators from both sides of the aisle to collectively identify a way to address these significant financial problems. … We cannot ignore that our deficit is widening yet again.”