HARTFORD, CT — The idea of implementing a payroll tax and reducing Connecticut’s personal income tax was too complicated and too new to get approved in the last few weeks of the legislative session.
However, the idea was intriguing enough for lawmakers to create a bipartisan commission that got to work on exploring the payroll tax concept this week.
Essentially, the idea is to replace a portion of the Connecticut income tax with a payroll tax. The payroll tax would be paid by the employer, who could decide to reduce an employee’s wages to recoup the amount of money they would end up paying in taxes. At the same time, the employee would still realize an increase in income through a reduced income tax liability.
Lisa Hammersley, deputy executive director of the Connecticut School Finance Project, said this model of taxation could help Connecticut reclaim $2 billion of the $2.8 billion it lost under the 2018 Tax Cuts and Jobs Act.
She said businesses also benefit from the system because it has the potential to reduce taxes that businesses pay to the federal government by reducing the amount of FICA tax paid on employee wages. Also, the payroll tax is fully deductible to businesses.
Hammersley, the former budget director for the Senate Republican caucus, said it also has the potential to raise significant revenues for the state by as much as $300 million annually.
Under the model proposed by the Connecticut School Finance Project, taxpayers paying 5% or less could see their Connecticut income tax eliminated with the new payroll tax. About a million Connecticut taxpayers would no longer be subject to the personal income tax.
Currently, a married couple earning $100,000 a year would be taking home about $79,103 while paying $16,389 in federal income taxes and another $4,508 in Connecticut income taxes. Under the payroll tax model, the same couple would have their adjusted gross income lowered by $5,000 to $95,000, pay no state income tax, $15,407 in federal taxes, and increase their take-home pay by $491.
Department of Revenue Services Commissioner Scott Jackson pointed out that Connecticut’s tax code would treat this as a “tax on employers,” which is an important distinction moving forward.
Hammersley said that small, medium and large businesses would also benefit from this tax proposal.
Under modeling done by Roy’s organization, a small business with 10 employees and $250,000 in payroll expenses would have an additional savings of $1,581. A medium business with 150 employees and $9 million in payroll would see a savings of $56,925. A large business with 5,000 employees and $400 million in payroll would see a savings of $2.53 million.
The savings to businesses come from a reduction in payments to Medicare and Social Security.
Jeffrey Beckham, deputy undersecretary at the Office of Policy and Management, wondered how much of an impact that could have on a person’s Social Security upon retirement.
Katie Roy, executive director of the Connecticut School Finance Project, said it could have an impact but they don’t have access to individual tax data so it’s hard to say exactly how many people may ultimately be disadvantaged by this change, and by how much.
“Medicare and Social Security will receive less money if Connecticut employers pay less into them,” Roy said.
Lawmakers also wanted to know what the federal government would think about this proposal since previous “workarounds” to the 2018 tax law changes have been squashed by the IRS.
Roy said the proposal is different because it’s not a tax credit. Rather, she said it’s a “payroll tax,” which is “fundamentally allowed by the Internal Revenue Code.”
She said the proposal also requires the state to reduce the personal income tax and the federal government can’t tell a state how to set their tax rates.
“There isn’t a provision that allows the federal government to come in and say you can’t lower your personal income tax rates,” Roy said. “The reason we have not used a credit against the personal income tax is because of the possibility that the federal government could come in and disallow that credit against the income tax.”
Hammersley said they also have met with the attorney general to discuss the issue.
The payroll tax would apply to all wage earners. The state would still need to figure out how to treat state employees, tribal employees, and federal employees.