Connecticut Voices for Children Reality Check Report

8/7/2019 Connecticut Voices for Children Reality Check Report

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33 Whitney Avenue New Haven, CT 06510 Phone 203-498-4240 Fax 203-498-4242 Web Site: www.ctkidslink.org53 Oak Street, Suite 15 Hartford, CT 06106 Phone 860-548-1661 Fax 860-548-1783 E-mail:[email protected]

Reality Check: Connecticuts Public Revenues and Spending Have RemainedLean and Stable for Decades

February 2011

Introduction

Just how big is Connecticuts government? Has it grown at the same rate as Connecticuts economy andpopulation, or has it lagged or exceeded that growth?

Contrary to some common misconceptions, Connecticut has a lean public sector relative to other states. As thisreport explains, publicly available data show that state and local government in Connecticut account for a smallportion of the state economy and that Connecticut raises and spends revenue well below its means. Moreover, thesize of Connecticuts state and local government has remained stable for the past forty yearsranging betweenseven and eight percent of the state economy.

By collecting and spending revenue, our state and local governments carry out the roles we expect of them,including educating our children, building and maintaining roads and public transit, maintaining police andfirefighting services, helping our most vulnerable residents, supporting our businesses, protecting our environmentand operating our courts, prisons, public libraries, and parks. In creating and maintaining these public structures,Connecticuts state and local governments are asking for no more of a total financial contribution from Connecticutresidents and businesses today than in the 1970s, for as a share of personal income and state Gross State Product(GSP), both revenue and spending have been holding steady for decades.

This report measures state and local government in Connecticut along three dimensions. The first dimension isstate and local government as a proportion of GSP, which shows the value of government services relative to thetotal value of the Connecticut economy. The second dimension is state and local revenue relative to state income, ameasure of the financial responsibilities state and local governments place on their residents and businesses. Thefinal dimension is expenditures by function, a measure of the amount that state and local governments spenddelivering specific categories of public goods and services. Using these three dimensions, we find that Connecticutstate and local government is lean compared with other states and that growth has been stable in recent decades.

State and Local Government Relative to the Economy

Connecticut state and local government is the 5th smallest in the country relative to the size of its economyIn 2008, state and local government in Connecticut was equal to 7.8% of Gross State Product (GSP), the officialmeasure of Connecticuts economy.1 This placed Connecticut among the most frugal of all states, with itsgovernment a smaller share of its economy than states commonly thought of as exemplars of small governmentsuch as Texas and New Hampshire.


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State and local government in Connecticut has not grown as a share of the economy since 1970.2The mostwidely accepted method of determining government growth tracks the size of government over time relative to theeconomy. In Connecticut, state and local government has maintained roughly the same relative size for about fortyyears (Figure 1, below).

Data show that the proportion of Connecticuts GSP devoted to state and local spending has not changedsignificantly in recent years, and is in fact lower now (at 7.8%) than it was in the early 1970s. This challenges acommon misperception that growth in Connecticuts state and local government has outstripped growth in its

economy, or that the root of Connecticuts current deficit is out-of-control growth in the state and localgovernment sector. State and local government in Connecticut has not only been a relatively small part of itseconomy compared to other states, but has remained between 7 and 8 percent of the state economy since at least1970.

Revenue

State and local governments finance the provision of public goods and services through multiple sources ofrevenue. While some revenue sources come from outside the state (i.e., revenue from the federal government, orfrom the states return on its investments), the largest sources come from taxes and fees collected on assets andeconomic activities that exist within the state (e.g., revenue from the personal income and sales taxes). The CensusBureau uses the term own-source revenue to describe all taxes, charges, and other miscellaneous fees collected bya government.3 This section focuses on Connecticuts own-source revenue, as it is the category of revenues overwhich state and local government has the most control. This report combines revenue raised at both the state andlocal levels to make valid state comparisons since states differ in which government functions are assigned to whichlevels of government (e.g., states transfer varying degrees of taxing and spending authority to local governments,including county goverments). Figure 2, below shows Connecticuts state and local revenues in FY2008 grouped incategories used by the United States Census Bureau.

4%

5%

6%

7%

8%

9%

10%

11%

1970 1975 1980 1985 1990 1995 2000 2005

Figure1.Connecticutstateandlocalgovernmenthasremainedastable

shareofGrossStateProduct

State and Local Government

Share of GSP

Percentof ConnecticutGSP


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Figure3:Connecticutownsourcerevenuehasbecomelessreliantonsales

andcorporateincometaxandmorereliantonthepersonalincometax.

Figure2:SourcesofConnecticutTotalRevenue,FY2008($millions)


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less than the 50-state average. Put another way, if Connecticuts total general revenue were the same share of itspersonal income as the 50-state average, Connecticuts state and local governments would notbe in deficit now, asthey would have $10.2 billion in additional funds to invest in the services and programs that serve us all and keepConnecticut competitive.

Connecticut raises relatively more revenue from its poor and middle-class residents than it does from itshighest income residents. In 2007, Connecticut was among the top ten states with the highest state and localtaxes on the poor, who paid an average of 12.0% of their incomes in state and local taxes.9 Middle-income taxpayerspaid close to 10.0% of their incomes in state and local taxes. At the same time, the wealthiest 1% in Connecticutpaid 4.9% of their incomes on state and local taxes, which was less than half the share paid by lower- and middle-income taxpayers. This sort of tax structureone that places heavier tax responsibilities on those with lowerincomesis referred to as regressive.

While high-income earners in Connecticut pay the lowest effective state and local tax rates, they also make a verylarge proportion of total income in the state. Connecticut tax records show that 26% of all income in Connecticut

was reported by the wealthiest 1% of residents filing personal income tax returns in 2008 (the roughly 10,000taxpayers with Connecticut adjusted gross income of $1 million or more).10 So while total personal income in thestate is very high, much of that income is held by a relatively small group of taxpayers who pay a relatively smallshare of their income in state and local taxes. Connecticuts highly skewed distribution of income paired with a taxstructure that demands less from those who earn the most leads to revenue that is modest compared to the statesmeans.11-12 Indeed, in 2006, the Federal Reserve Bank of Boston reported that Connecticut was top in the nation inits revenue capacity but among the bottom five states in its revenue effortdefined as actual revenue raisedrelative to a states capacity to raise revenue.13

Why compare combined state and local revenues to total state personal incomerather than use per-capita measures?

State and local revenue as a share of a states personal income is a standard metric in public financeanalysis when seeking to analyze the size of the government sector. It is preferable to per capitarankings (i.e., spending per person) in state-by-state comparisons because it:

Takes into account the differing fiscal capacities among states to raise revenue, as well as thediffering needs for public services related to the size of the states economy,

Better captures the relative effort states are making to fund public services ,

Better measures the relative impact of state and local taxes on state taxpayers, and

Accounts for cost-of-living differences among states, including those that stem from varyinglabor costs.

In Connecticut, a high ranking in per capita state and local revenue often leads people to drawimproper conclusions about the size of state and local government. Costs are inflated in Connecticutrelative to other states due in part to higher incomes, which means that Connecticut pays more forinputs than other states. By measuring government costs relative to income, one reduces the impactof such price differences.

In summary, per capita measures of revenue or spending that fail to account for differences in stateincome do not say anything meaningful about tax/revenue burdens for the same reason that thevolume of water in a bucket tells us nothing about how full the bucket is unless we know the size ofthe bucket. Connecticuts bucket is less full than all but four states.


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Through tax reform, Connecticut could increase revenue while at the same time lowering taxes for many of itsresidents. Other states with high per capita incomes, such as New Jersey, New York, California, and Minnesota,have a larger share of their total personal income financing state and local government. Yet the share of incomepaid in state and local tax by most residents in these states is actually less than or equal to similarly-situatedConnecticut residents. For example, in New Jersey, the bottom 95% of non-elderly taxpayers pay a smallerproportion of their incomes in state and local taxes than the bottom 95% in Connecticut, yet New Jerseys state andlocal own-source revenues are a larger share of its total personal income (15.8% in New Jersey as compared to13.9% in Connecticut). Table 2, below, compares tax rates in Connecticut and New Jersey. If Connecticuts own-

source revenues equaled the 15.8% of total personal income of New Jersey, Connecticut would have collected over$500 million dollars in extra revenue in 2008. The example of New Jersey suggests that Connecticut could improveits fiscal health while conceivably lowering taxes for the majority of its taxpayers.

Wealthy states with more progressive state and local tax structures can raise significantly higher revenue with lowertax burdens for most residents, which means a better ability to make the needed public investments in highpriorities such as education, economic development and improved infrastructure that would benefit allConnecticutresidents and businesses.

For decades, Connecticut has spent less of its total personal income on state and local government thanmost other states. Data back to 1980 show that the proportion of total personal income paid in state and localtaxes and fees in Connecticut has been consistently lower than the national average and the large majority of otherU.S. states (Figure 4). Through the 1980s and into the middle 1990s Connecticut generally followed the 50-statetrend of increasing state and local revenues as a proportion of state personal income from slightly over 11% in1980 to a high of just under 15% in 1997. While the reasons for state and local government growth over this periodare complex, many see this change as resulting in large part from the devolution policies begun in the Reaganadministration, which shifted increasing public responsibility and authority from the federal government to thestates.14 Starting in the late 1970s and through the 1980s, federal grants in aid to states were significantly cut at the

same time that states were increasingly empowered to adopt innovative policies. This shift put pressure on statesand localities to raise revenue to compensate for lost federal funds and finance new reforms, primarily ineducation.15 Throughout this period, Connecticut raised revenue well below its capacity relative to other states.

Table2.EffectiveTaxRates,CTvs.NJ,TaxYear

2007*

IncomeGroup CT NJ

Bottom20% 12.0% 10.7%

Second20% 9.7% 9.5%

Middle20% 9.9% 8.6%

Fourth20% 9.6% 8.1%

Next15% 8.5% 7.9%

Next4% 7.6% 8.6%

Top1% 4.9% 7.4%

*Chartusestaxcollectionsin2007butupdatestoaccountfortaxlaw

changesupthroughOctober2009

6%

7%

8%

9%

10%

11%

12%13%

Income

Averageeffectivetaxratesforincomesbelow

$225KarelowerinNJthaninCT

%ofincomepaidinstate&localtaxes


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*

S

10%

12%

14%

16%

18%

20%

22%

24%

1980

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15%

20%

25%

1992

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1984

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upward pressure on state and local expenditures, but in the last decade rising education costs have had an evenlarger impact despite declining enrollment. Nationally, education costs have risen 61% between 2000 and 2008,compared to a 40% increase in medical care, and a 25% average increase in the costs of all goods and services (therate of inflation since that time).17 Since education and health are such a large component of total state and localspending, changes in the cost of delivering these services can have a dramatic effect on total government costs. Theimpact of the recession on employment and the need for public services will likely cause state costs related to publicwelfare, health, and hospitals to grow significantly in the years following 2008.

As a proportion of total state income, total state and local direct general expenditures 18 in Connecticut

were the lowest of any state in the country. Part of the impact of Connecticut raising relatively little revenue as ashare of its total personal income is that Connecticut spends less on state and local services relative to its capacitythan most other states. Table 2 shows Connecticuts 50-state rank in state and local expenditures by severalcategories of expenditure. Connecticut was ranked in the bottom ten states in Education, Social Services,Transportation, Public Safety, and Environment and Housing expenditures. As the table shows, Connecticut spenta smaller proportion of its income on state and local goods and services than most states in practically everycategory, spending 5.2 percentage points less overall than the U.S. average.

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200820072006200520042003200220012000

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and

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even half of the projected 2012 deficit could [...] overwhelm private sector job growth, significantly raise theunemployment rate, reduce state revenues while raising public sector costs, and ultimately lead to [lower]population.20 Connecticuts economic future depends upon the choices we make today. Without implementingrevenue reforms that will leave needed public investments intact, all of Connecticuts residents will eventually feelthe consequences.

1 GDP at the state level is calculated as the sum of the total factor incomes and other costs of production in a state economy. Thisbroadly includes labor income, capital income, and business taxes. The state and local government component of GDP comprises wages +taxes on production and imports subsidies + gross operating surplus of sixteen different categories of government enterprises. Allestimates of GDP in this report come from the Bureau of Economic Analysis, Regional Economic Accounts. Available at:http://www.bea.gov/regional/index.htm2 The BEA changed its industry classification system in 1997 from the Standard Industrial Classification (SIC) to the North AmericanIndustry Classification System (NAICS) such that most sector-specific comparisons between years earlier than 1997 and those after are notcomparable; however, the classification for state and local government remained the same through these changes and can therefore becompared over this time. Because estimates of total GSP are slightly different under SIC accounting than they are under NAICSaccounting, the proportion of GSP accounted for by state and local government will vary, but the effects are small. In 1997, e.g., the BEAcalculated GSP for Connecticut using both SIC and NAICS and found the estimate of state and local government contribution to be7.14% using SIC and 7.28% using NAICS, a difference of 0.14%.3 State and local payroll tax contributions to insurance trusts, such as to pensions, are not included under own-source revenue. Also

excluded are any earnings on investments made with these trusts.4 Although Connecticut did not have a personal income tax before 1992, it collected tax on capital gains and dividends, which explains whya small portion of Connecticut state revenue was still collected through personal income in 1988. The separate taxes on capital gains anddividends was repealed when the personal income tax went into effect in 1992.5 State personal income data come from the U.S. Bureau of Economic Analysis (BEA). BEA defines it as the sum of wage and salarydisbursements, supplements to wages and salaries, proprietors' income with inventory valuation adjustment (IVA) and private capitalconsumption adjustment (CCAdj), rental income of persons with CCAdj, personal dividend income, personal interest income, and personacurrent transfer receipts, less contributions for government social insurance. Note that state personal income does not include capitalgains.6 In reality, this proportion is lower than 13.9% because the Commerce Departments measure of state personal income does not includecapital gains income. In Connecticut, which in 2007 had the fifth highest proportion of capital gains income of any state (IRS, Statistics ofIncome Division), the burden of state and local taxes if capital gains were included in total income would be even lower relative to otherstates than it already is.7 Ryan McAuliffe, Sharon Langer. Connecticut Losing out on Federal Funds for Childrens Health Coverage. Connecticut Voices for

Children. February 2008.8 Additionally, Connecticuts budgeting practices combined with its budget cap provide a disincentive for the state to find ways to increaseits Medicaid and Title IV-E reimbursements. Because Connecticut gross budgets funds in these accounts, funds from the federalgovernment count against the state budget cap.9 Carl Davis, et al. Who Pays? A Distributional Analysis of the Tax Systems in All 50 States. 3rd ed. Institute for Taxation and EconomicPolicy. November 2009.10 Connecticut Voices for Children analysis of income data from the Connecticut Department of Revenue Services.11 Joachim Hero, Connecticut Leads the Nation in Multiple Measures of Income Inequality: 2007 Connecticut Voices for Children.September, 2009.12 Joachim Hero, Connecticuts Wealthy Pay Smaller Share of Income Than Most Residents in State and Local Taxes. ConnecticutVoices for Children. January 2010.13 Yesim Yilmaz, Sonya Hoo, Matthew Nagowski, Kim Rueben, and Robert Tannenwald. Measuring Fiscal Disparities Across the U.S.States: A Representative Revenue System/Representative Expenditure System Approach, Fiscal Year 2002. New England Public PolicyCenter. Working Paper 06-2. 2006. (Paper is part of the Urban InstitutesAssessing the New Federalismproject).14 The Reagan Administrations goal of decentralizing government authority and responsibility is a mater of historical record, though theintent was that increased dependency on state and local revenue streams would shrink government at that level, when in fact the oppositeoccurred. For a discussion of New Federalism in the Reagan era, see: Timothy Conlan, Federalism after Reagan. The Brookings Review.Vol. 6, No. 4. 1988; Peterson, George E. 1984. "Federalism and the States." In John L. Palmer and Isabel V. Sawhill, eds., The ReaganRecord. Cambridge, MA: Ballinger.15 Timothy Conlan, Federalism after Reagan. The Brookings Review. Vol. 6, No. 4. 1988; Peterson, George E. 1984.16Note that spending on public welfare consists in very large part of expenditures related to the state Medicaid program, which provideshealth insurance to low-income children and their families, pregnant women, and low-income elderly with long-term care needs.


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17Consumer Price Indices, U.S. Bureau of Labor Statistics, U.S. City Average. The index for education includes costs for child care, K-12,and higher education, as well as costs for some school supplies such as text books. The index for medical care includes the cost of drugs,supplies and all medical services.18 According to the Government Finance and Employment Classification Manual, Direct Expenditure is defined as all expenditure otherthan intergovernmental expenditure. (Chapter 5.2.2.1) General Expenditures comprise all expenditures except those expendituresclassified as utility, liquor store, or social insurance trust expenditures.19 E.g. Mark Zandi, of Moodys.com, noted in his July 1, 2010 testimony before the House Budget Committee that state and local budgetcuts would impede the broader recoverys prospects significantly absent increased federal aid. http://www.economy.com/mark-zandi/documents/Final-House-Budget-Committee-Perspectives-on-the-US-Economy-070110.pdf20 Peter Gunther and Fred Carstensen. A Very Deep Hole Indeed: The Connecticut Economic Outlook, November 2010. ConnecticutCenter of Economic Analysis, University of Connecticut. November, 2010. Pg. 1. Available at:http://ccea.uconn.edu/forecasts/CTOutlook_2010Nov.pdf

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