The two-year, $40.11 billion state budget includes changes to a variety of taxes, but perhaps the one that engenders the most debate, according to University of Connecticut Economic Steve Lanza, is the income tax.
Connecticut has this sort of “grudging acceptance” of the income tax, Lanza told a small group at the Connecticut Economic Resource Center Monday.
“It was never something that was popular. We kind of found ourselves forced into adopting a tax on income 20 years ago when we faced the same kinds of problems we found ourselves facing in the last few years,” Lanza said.
And immediately upon passage the income tax was already providing the state with about a third of its revenues and through the 1990s and 2000s it climbed to 50 percent of the state‘s general revenue. Lanza said it’s since declined, but he estimated it would begin to climb again in the future back toward 50 percent.
The state budget is now reliant on revenue from the income tax, but Lanza pointed out that it’s a very volatile tax. So when the economy is good, revenue is up, but when the economy declines, so does the amount of income tax the state can collect.
“We have to be careful about becoming reliant on it,” Lanza said. But it doesn‘t seem to be going away anytime soon. “That means this is probably not the last time we’re going to be on this budget roller coaster.”
Joachim Hero, a senior policy fellow at CT Voices for Children, said it just means the state needs to do more planning when times are good.
Income broadly decreases as the economy goes down and in order to avoid cuts that will make the economy worse, the state must plan ahead and create a Rainy Day Fund it can tap into when the economy gets rough, Hero said.
This year the Rainy Day Fund was already depleted before Gov. Dannel P. Malloy took office. The $1.5 billion fund was used to balance the 2010 and 2011 fiscal year budgets before Malloy came to office.
Speaking of Lanza’s report which found the wealthy pay a larger share of their income in income taxes, Hero said the wealthy pay more in income taxes by design because it corrects for the regressivity of the other taxes. He said when taken collectively the bottom 20 percent of income earners pay a higher percentage of their income in taxes than the upper 20 percent.
Lanza, who only looked at the income tax in the latest report of The Connecticut Economy, said the myth that Fairfield County pays most of the state’s taxes is true. He said Fairfield County accounts for 25 percent of the population in Connecticut and pays 42 percent of its taxes.
“Is it because of this progressivity of the tax? No, not directly,” Lanza said. He said Fairfield County earns 41 percent of the state’s income so the ratio of income to taxes is about one. He said towns with a high burden of taxes relative to income are located in Southern Litchfield County, southwestern New London County, and most of Middlesex County.
Lanza also sought to answer the question about whether the state’s adoption of the first income tax in the 1990s led to the state’s 20 year slump in job growth.
Arthur Laffer lodged that charge against the income tax in an October 5, 2010, op-ed in the Wall Street Journal. For the 11 states that have instituted an income tax over the last 50 years, Laffer compared state income and GDP relative to the U.S. in the year before the tax was adopted with their levels today, claiming to find a pattern of erosion in economic performance, and inferring a causal link, according to Lanza’s report.
Lanza called Laffer’s calculation “suspect.”
“A better approach would be to compare long term growth trends across all states—those with income taxes, those without, and those adopting the levy along the way—to see whether the tax is associated with a statistically significant differential in economic performance. My own analysis, based on a 55-year panel data study of all 50 states, using nonfarm job growth as the performance yardstick, suggests that it is not,” Lanza concluded.
But while income tax does not impact job growth Lanza said it could impact the state budget.
“Income tax progressivity does, however, make the state budget more sensitive to the vicissitudes of the business cycle—a problem that is likely to get worse as reliance on the tax grows,” Lanza concluded. “But whatever its faults, it’s hard to blame the income tax for having derailed any state engines of economic development, in Connecticut or elsewhere.”