Governor Rowland’s

Governor Rowland’s Budget Proposal FY 2003-2005 Biennium March 4, 2003

Back to Basics Budgeting • States are facing the worst budget crisis since WWII • Drastic changes in the stock market—unprecedented growth in the ‘90s followed by a dramatic drop off beginning in 2001 • 9/11, its fallout, & the anticipation of war may forestall the nascent recovery • Expansion and creation of new programs in the ‘90s • Spiraling health care inflation • Quick fixes and one time revenues have not provided a remedy • In 2001 and 2002, states generally failed to make the fundamental choices necessary to adapt to the changing economy • Instead, quick fixes, one time revenues and gimmicks were used to fill the gaps as they surfaced, only the holes reappeared • A structural and balanced solution is overdue • Tempered spending accompanied by modest tax increases, shared by all, will provide a basic, balanced solution

From Boom to Bust • CT enjoyed unprecedented surpluses in the mid and late ‘90s • From 1995 to 2001, the surpluses were between $81M and $700M per year • But in 2002, the state registered an $800M plus gross deficit • The deficit would have exceeded $1.2B if not for actions taken in Special Session

From Boom to Bust • During the Boom of the ‘90s, capital gains realizations drove much of the surpluses we saw in the mid to late ‘90s and into 2001 • In the years of the greatest surpluses, anywhere between 1/3 and 70% of each fiscal year’s surplus was tied to the stock market gains • For six years in a row, CT residents’ capital gains increased by booming double-digit growth • From 1994-2000, CT capital gains realizations grew by more than 500%

From Boom to Bust • The rising stock market meant healthy increases in other tax revenues as well • Withholding taxes grew between 7.5% and 15.1% annually • Sales taxes went up 3.6% to 8.6% annually • The estimates and finals category of the state income tax rose between 14% and 32% annually

From Boom to Bust • But a series of major market corrections occurred • IT & Telecom bubble burst • Corporate fraud and abuse scandals • 9/11 tragedy • The major stock indices are still down between 30% and 75% • With the stock fall came a precipitous fall in state tax revenue

From Boom to Bust • In the current fiscal year the state is looking at the second year in a row of negative withholding performance because of poor bonuses and stock options • Estimates and finals are estimated to be about 10% below last fiscal year • This equates to yet another drop in capital gains realizations of between 20%-25% on an already pitiful FY 02 base • The sales tax is expected to post a gain of just 0.9%, after performing barely above that last fiscal year

From Boom to Bust • How bad was the stock crash on state revenue? • Wealthy states like Connecticut saw their revenues drop more than the national average of 6% • In Connecticut, “so-called” economic growth of general fund revenues was down 7.5% in FY 02 • In the current fiscal year, a meager rebound from FY 02 of 1.6% is expected

Putting the Deficit and State Fiscal Crisis in Context

Thank Goodness for the Spending Cap • Clearly the spending cap isn’t perfect since we do have a deficit • But the spending cap did what it was supposed to do • Held growth rates between 2.1% and 6.4% over the past 8 years • Spending growth stayed down under the cap, in spite of several years of robust revenue growth • In FY 00 and 01, actual GF revenue grew almost 16%, but the budget grew over 12% • If not for the constitutional spending cap, our problems would clearly be much worse—our structural gap would be billions more • Consequently, CT’s fiscal situation is less severe than many other states

Both a Spending and a Revenue Problem • If the revenue side is a problem, so is the spending side • Even if the revenue base had stayed artificially high for the foreseeable future, we still could not afford the services our current laws call for • State employees and retiree health care are expected to grow over 20% in FY 04 • Medicaid is growing at about 9% • Overall growth in the GF is 12.3% • Even if revenues were still growing at 7%-9%, there would still be a substantial structural gap

And a Spending Cap Problem Too! • The spending cap demands that spending be reduced from current services by at least $1B over the next two fiscal years • The FY 04 current services gap is about $2B • The cap will only allow a blended capped and uncapped growth of just over 6% • But current services growth is about 12.3%, outpacing allowable growth in expenditures for FY 04 by $763M

Bond Rating at Risk • The gaps in our budget clearly put our state’s bond rating at risk • “Any significant revenue deterioration not offset by expenditure adjustments or revenue enhancements could cause a change in the rating…achieving structural budget balance in FY 04 and beyond will be necessary to maintain the current rating.” –Standard and Poor’s • “Adoption of balancing plans with recurring benefits is critical to the rating.” –Fitch Ratings • “The basic message here is that there is a growing negative number with no solution and there remains a structural imbalance.” –Moody’s upon putting Connecticut on its watch list for possible downgrade • A lower bond rating could mean tens of millions of dollars in increased debt costs decades into the future, meaning less will go to programs, services or other expenditures • Because of the deficit mitigation plan, the rating should be held

Changing the Entitlement Culture • The recent fiscal crises have forced states to rein in burgeoning entitlement programs • At least 40 states, including CT, have enacted significant Medicaid reforms • At least 22 states have restricted Medicaid eligibility • At least 16 states have established or increased co-payments • At least 29 states will implement reductions or freezes in provider payments • Given the spiraling health care inflation in the nation, state governments have had to realize that either benefits must be reduced or service populations must be restricted—you can’t have it both ways anymore

Where Does All the Money Go? • Any discussion of the equity of spending cuts must begin with an understanding of where the money currently goes • Total personnel costs make up about 30% of GF spending • Debt service accounts for about 8% of GF spending • Various entitlements amount to about 25% of GF spending • Local aid is about 17% of GF spending • Is there any doubt, then, that labor cost must be part of the solution

The Economic Outlook • What Does the Future Hold? • From a national perspective, the recession and sluggish recovery appear to be longer than the early ‘90s downturn • Recovery over the next several years appears moderate and prolonged • Consumer moderation in spending prevails over the next several years • “Jobless Recovery” Phenomenon --Productivity gains rather than job growth will drive the economy • Job, personal income and GSP growth will lag the nation • Connecticut tends to lead nation into recession, lags by two quarters in coming out • A Slew of Uncertainties • Economic recovery or continued recession rests on two main factors (1) the performance of the equity markets and (2) the outcome of the threat of war with Iraq

Liquidating the FY 2002 – 03 Deficit • How did the deficit come about? • Total revenues are down by $388M below budgeted amounts for FY 03 • Personal income taxes are down $421M because of reduced corporate bonuses and a downturn in capital gains revenue due to deterioration of the market • Sales and use tax revenues are down $82M • On the positive side, corporate tax revenue is up by $40M due to corporate downsizing in the private sector

Liquidating the FY 2002-03 Deficit • On the spending side, the state is expecting that expenditures will exceed budgeted appropriations by about $140M • Medicaid is anticipated to be over budget by almost $100M caused by the softened economy, liberal eligibility rules and health care inflation. Specific areas of deficiency include HUSKY enrollment for both adults and children, pharmacy expenditures and healthy home care enrollment • Major workers’ compensation deficiencies totalling about $17M • State employee and retiree health accounts have a deficiency of about $16M due to heavier than anticipated enrollment activity

Liquidating the FY 2002-03 Deficit • When the FY 03 budget adjustments were passed last year, the legislature cut $94M in anticipation that the administration would receive savings from union concessions for the current year • As no concessions were forthcoming, a portion of that $94M will be made up through savings from layoffs of nearly 3,000 state employees and savings from an early retirement plan. (Even with these measures we are still short by $50M)

Liquidating the FY 2002-03 Deficit • Deficit mitigation plan to close entirety of $638.3M gross deficit and deposit $47.8 million into Budget Reserve Fund. Combination of measures taken by Governor already, the legislative deficit mitigation bill, and future steps to be taken by the Governor within his own authority • November allotment rescissions of $27.9M in addition to $35M in Section 52 extraordinary rescissions already accounted for in the FY 03 adjusted budget passed last year (these Section 52 cuts do not reduce the deficit) • January allotment rescissions and agency forced lapses of $9.1M after duplication with legislative deficit mitigation plan is taken out.The legislature’s deficit plan also enacted some of the Governor’s forced lapses. Because the budget is balanced, the remaining forced lapses will not be taken and will be available for expenditure.

Liquidating the FY 2002-03 Deficit • $107.6 million in attainable spending reductions in legislative deficit mitigation plan out of $222.5 million reported in bill. Included in the attainable cuts is $4.65 million FY 2000-01 surplus. Included here is $21 million for layoffs and $23 million for the early retirement that was passed • Within existing authority, Governor and the Secretary of OPM can choose to lapse salary reserve monies of $29.5 million • Within existing executive authority, the Governor and the Secretary of OPM can choose to lapse $18.7M in collective bargaining monies that were set aside for unsettled contracts

Liquidating the FY 2002-03 Deficit • According to OPM’s analysis, the legislative deficit mitigation plan will infuse $485.2M into the general fund revenue stream. Pure tax increases amount to about $296M, with an additional temporary corporate surcharge raising $46M. Other transfers and accrual changes make up rest • New additional tax increases in this budget proposal that raise $8.1M in FY 03

Liquidating the FY 2002-03 Deficit • About $350M in ongoing and temporary tax increases, or about 50% • About $223M in spending cuts, or one-third • It’s fair. It’s equitable. The plan should preserve the state’s bond rating • Final estimated FY 03 spending in the general fund will be about $28M higher than what the Governor was going to initially propose ($12.112B versus $12.140B) • It balances the state budget and reduces next fiscal year’s hole by more than one half. Total FY 04 mitigation is $1.118B, dropping gap from over $2B to just below $900M • Mitigation because of plan in FY 05 is $1.146B, dropping gap from over $2.5B to below $1.4B

The FY 2003-05 Biennial Budget • The Spending Plan • Governor Rowland continues his record of fiscal prudence • The proposed FY 04 budget is $333M below the cap and for FY 05 $65.6M below the cap • GF current services reduced by $1.16B in year one and $1.59B in year two • GF net revenues increased $852M in FY 04 and $950M in FY 05

The FY 2003-05 Biennial Budget Revenue Forecasts • Revenue assumptions are based upon the most prudent and realistic forecasts currently available

The FY 2003-05 Biennial Budget Revenue Forecasts • For the state income tax, modest growth is predicted for the withholding side and even more modest growth is predicted in the estimates and finals component. It will raise $4.75B in FY 04 and over $5B in FY 05

The FY 2003-05 Biennial Budget Revenue Forecasts • The Sales and Use Tax, the state’s second largest tax generator, will rebound during the FY2003-05 biennium and will raise almost $3.3B in the first year and $3.46B in the second year

The FY 2003-05 Biennial Budget Limiting the use of one-time revenues • Many states have used one-time revenues as a “quick fix” in order to avoid the necessity of making significant structural changes to both the expenditure and revenue sides of the budget. Poor fiscal practice will impact our bond ratings if no structural changes to state budgets are made • Connecticut has used one-time revenues of $656.3M as well to adjust and balance the FY 03 budget as follows • $475M in the FY 03 budget adjustment plan of last year including $85M in additional tax amnesty monies over what was budgeted • $181M under House Bill 6495 • The use of one time revenues drops from approximately 5.4% in FY 03 to 1.7% in FY 04 and to 1.3% in FY 05. Total “one-times” $207M and $172M in each each year. Included are sweeps of ECLM, CEF, CHFA, CDA, and CII

Tax Changes and Revenue Enhancements • Taxes were already increased $250M last year

Tax Changes and Revenue Enhancements

Tax Changes and Revenue Enhancements • Legislative deficit mitigation plan increased income tax rate • Effective with income year 2003, increase the 4.5% to 5% only; 3% rate unchanged • 0.5 percentage point across-the-board rate increase for all filers • Raises $231M in FY 03, $428M in FY 04, and $446M in FY 05

Tax Changes and Revenue Enhancements • To ensure that the current fiscal year deficit is closed • New tax tables will be in force by April 1 • Increase withholding so as to collect a full six months worth of increases in the three remaining months of the fiscal year • In effect, taxpayers would be asked to double up • April, May and June make up for January, February and March • New tax tables would be issued again for implementation in July, which would be the permanent ones

Tax Changes and Revenue Enhancements • Reducing the property tax credit on all filers • Reduce the $500 property tax credit to no more than $400 and remove the minimum $100 credit for higher income filers • Phase out the minimum $100 property tax credit, even at higher income levels • The property tax credit begins to be phased down beginning at $54,500 for singles and $100,500 for joint filers. The current $100 minimum begins at $144,500 for singles and $190,500 for joint filers

Tax Changes and Revenue Enhancements • What The Property Tax Credit Change Will Mean? • All who pay at least $500 in property taxes and file for the credit will see the $100 loss. Those who pay and claim less than $500 in property taxes will see a reduction of up to $100 and those whose claim is less than $400 will have no reduction • Increase revenue in FY 04 by $68M and by $69.4M in FY 05 • Property tax minimum phase-out saves $12M in FY 04 and FY 05

Tax Changes and Revenue Enhancements • Elimination of phase-in of higher singles exemption • Last session, the legislature suspended the phase-in for two years effective January 1, 2002. The 2001 exemption level of $12,500 remains in effect until January 1, 2004 • The Governor proposes to permanently repeal any further changes to the singles exemptions. The exemption and phase-out threshold will stay at the January 2001 levels permanently. Will save $7M in the FY 05

Tax Changes and Revenue Enhancements • Summary of Income Tax Increases • Total income tax increases or repeal of past reductions amount to $231M in FY 03, $508M in FY 04 and $535M in FY 05 • On the property tax credit, no filer gets hit with more than a $100 loss. Every filer is paying 0.5 percentage points more on all taxable income – period • Families earning less than $100K pay less than $500 more than they did before – about $10 per week • The filer earning $500K will pay up to $2,550 more. The filer earning $1M will pay up to $5,050 more • About three quarters of the tax hike will be borne by those earning more than $100K • Since the beginning of the Rowland administration, families earning less than $125K still enjoy an overall income tax decrease

Tax Changes and Revenue Enhancements • Lowering sales tax exemption on clothing and footwear • Accomplished in the legislative deficit mitigation plan • Return to the $50 threshold per item effective April 1 • Increased revenue to the general fund of $8.2M in the current fiscal year, $33.6M in FY 04 and $35.3M in FY 05 • New proposal: Eliminate sales-tax free week to save $3M in FY 04 and $3M in FY 05

Tax Changes and Revenue Enhancements • Sales on business computer services • Repeal the phase-down • The Governor is proposing a permanent rate of 1%. This change would raise about $10.8M in FY 05

Tax Changes and Revenue Enhancements • Corporate tax surcharge • 20% surcharge in income year, falling to 10% in income year 2004. Surcharge will be gone by income year 2005 • Businesses will pay in estimated taxes what would have been owed if the tax were in place as of January 1 • Last session, two major changes increased corporate expenses by at least $60M. Total of $105M in new temporary surcharges in the two income years

Tax Changes and Revenue Enhancements • Increasing the Cable TV Gross Receipts Tax • Increase cable gross receipts tax portion of the public service tax from 5% to 6% to raise $6.3M in FY 04 and $6.7M in FY 05 • The Hospital Sales Tax • Permanently rescind the 5.75% hospital sales tax • Cigarette Tax Increase • Increase the cigarette tax rate to $1.51, effective March 15 to raise $31M in FY 03, $78M in FY 04, and $76M in FY 05

Tax Changes and Revenue Enhancements • Increases in the real estate conveyance tax • Effective April 1 • No increase in the real estate conveyance tax on homes valued at or under $300K or on the first $300K of a home’s value • The incremental portion of a home’s value between $300K and $800K will be taxed at .75% as opposed to 0.5% • The portion of a home over $800K will be taxed at an incremental rate of 1.5% as opposed to 1% • The commercial rate will increase from 1% to 1.5% • Will raise $5M in FY 03, $25M in FY 04, $25M in FY 05

Tax Changes and Revenue Enhancements • Tourism funding changes • Combine the Historical Commission, the Commission on the Arts, the Film Commission and the Tourism Office into a new commission, the Commission on the Arts, Culture, and Tourism • To bring greater oversight and accountability to the system, current tourism districts will be disbanded and the central commission will determine what local entities should be set up and the funding they should receive

Tax Changes and Revenue Enhancements • Escheating unclaimed bottle deposits to the State of Connecticut • The Governor again is proposing that unclaimed deposits on unreturned beverage containers be escheated to the state • Will raise $18M in year one and $20M in year two It’s Time!!

Tax Changes and Revenue Enhancements • Internet sales tax • Change Connecticut’s status on the Streamlined Sales Tax project from observer status to voting participant status • Connecticut is currently losing between $300-$400M • Governor Rowland now favors taxation of internet sales

Tax Changes and Revenue Enhancements • Governor Rowland is proposing ongoing tax increases, including the permanent freeze of the singles exemption at $12,500, of $214 million. Including the legislative deficit mitigation plan, total taxes will increase $851 million.

Tax Changes and Revenue Enhancements • Net tax decrease of $961M • Economic Competitiveness fundamentally safeguarded

Education: Developing the Next Generation • Reducing Racial Isolation and Improving Urban Education – Sheff Initiatives • Under Governor Rowland, spending on initiatives to improve urban education and reduce racial isolation has increased from $21M to $208M over the decade • Funding for Magnet Schools will increase from $45M in FY03 to $73M in FY05, the number of schools will increase from 31 to 48 and enrollment will go from 11,000 to 17,000 over the biennium • Funding for the OPEN Choice Program will increase $300K in FY 04 and $1.6M in FY05, with enrollment going from 1,600 to 2,000 in FY05 • Funding for Charter Schools will be $16M in FY04 and $16.8M in FY05 with 2,400 students participating in FY05 up by 150 students over the biennium • The Interdistrict Cooperation Grant, serving some 60,000 students, will be increased by $1.2M during the biennium

Education: Developing the Next Generation • Reducing Racial Isolation and Improving Urban Education – Sheff Initiatives

Education: Developing the Next Generation • School Choice • Governor proposes allowing parents of children in “failing” schools to take up to $3,000 in ECS funding to attend school of their choice including public, magnet, charter or private schools • Regional Vo-Tech Schools • Due to fiscal exigencies, institute a freeze in enrollment at current levels for FY04 • Educational Cost Sharing • To restrain growth but maintain equalized distribution: (a) keep ECS Cap in place but continue $50M subsidy for capped towns, (b) eliminate Density Supplement (c) institute 3% reduction in each town’s grant for the biennium and (d) calculate ECS grant only once for the biennium • These measures will save $170M over the biennium • The proposed $1.488B for ECS, although a $27M reduction from current year, is up $100M from FY 01 level

Education: Developing the Next Generation • Special Education Changes • Under current law, the threshold for state funding of per pupil costs would go from 5x to 4.5x costing $37.3M over the biennium. • The proposed budget maintains the current eligible costs over 5x the average per pupil cost funding level and caps the grant at FY03 level • Holding Other Grants to Level Funding • Because of the State’s fiscal condition, level funding is proposed for Public and Non-public School Transportation, Adult Education and Health and Welfare Services grants • RESC Subsidies • Reduce current operating subsidy grant by $1M and lease grant by $300K

Governor Rowland’s