OSC Letterhead

September 28, 2018 

The Honorable Dannel P. Malloy
Governor of the State of Connecticut
State Capitol
Hartford, Connecticut 

Dear Governor Malloy: 

I write to provide you with the legal financial statements for Fiscal Year 2018. These statements have been prepared in accordance with statutory provisions designed to incorporate designated expenditure accruals of Generally Accepted Accounting Principles (GAAP) into the budget process. It is important to recognize that these statements have not been fully audited at this writing. The figures are subject to final audit adjustment and should be viewed as preliminary results. Final audited statements will be released on or before December 31, 2018.   

 The General Fund ended Fiscal Year 2018 with a deficit of $482,860,543. A transfer from the Budget Reserve Fund will eliminate the shortfall returning the unappropriated balance of the fund to zero. The Transportation Fund had an operating surplus of $148,105,872, which left a positive fund balance of $245,720,926 at the close of Fiscal Year 2018.

Despite the deficit in the General Fund, there was a vast improvement in the balance of the Budget Reserve Fund at the close of FY 2018.  The reserves at the beginning of Fiscal Year 2018 were $212,886,689.  However, a new revenue volatility provision, contained in Public Act 17-2, June Special Session, required that any estimated and final income tax payments above a threshold of $3.15 billion be transferred to the Budget Reserve Fund (BRF).  For a number of reasons discussed below, estimated and final income tax collections totaled $4,621,333,283 in FY 2018, which resulted in a revenue volatility deposit of $1,471,333,283 to the BRF.  After the transfer to the General Fund is made to close the FY 2018 deficit, the BRF will have a balance of $1,201,359,429 as of June 30, 2018.

 An additional transfer of $16.1 million from the BRF to the Retired Teachersí Health Service Fund, as required by Public Act 18-81, will bring the BRF balance to $1,185,259,429, or approximately 6.2 percent of FY 2019 General Fund budgeted appropriations.  While this represents significant progress, my office has traditionally recommended that the BRF reach a level of 15 percent of General Fund expenditures to protect against a future economic downturn.

 Fiscal Year 2018 began with considerable uncertainty as the state entered the year without an approved budget.  The first four months of operations were conducted under an interim spending plan issued by your office under Executive Order 58.  Moreover, just prior to the fiscal year, your administration signed a preliminary agreement with the state employee labor unions (known as the State Employees Bargaining Agent Coalition or SEBAC) that would lower wage and benefit costs in FY 2018 and subsequent years.  As the year started, however, the SEBAC 2017 agreement had not yet been ratified by the union membership or the Connecticut General Assembly.  Both approvals would follow by the end of July 2017. 

In late October 2017, the 2018-2019 biennial budget was passed by the Connecticut General Assembly and signed into law.  The budget plan for FY 2018 had net General Fund appropriations of $18.690 billion which represented growth of 4.6 percent over FY 2017 appropriation levels. Other statutory revisions during the fiscal year later brought FY 2018 net General Fund appropriations to $18.674 billion.

 In the end General Fund FY 2018 expenditures totaled $18,610,709,202.  This represented growth of 4.8 percent over actual FY 2017 spending levels, a net increase of $847.7 million.  Further analysis indicates that spending growth was concentrated in specific areas for FY 2018.  For example, a significant portion of the net increase was related to higher Supplemental Hospital Payments ($562 million above FY 2017 levels) that were part of the FY 2018 budget plan.  It should be noted that the increases in these supplemental payments will be offset in part by higher Federal Medicaid reimbursements.  Other significant areas of expenditure growth included several fixed cost categories such as higher contributions for teachersí retirement (+$258.9 million or 25.6 percent more than FY 2017); increased debt service payments (+$182.3 million or 10.3 percent above the prior year); higher Medicaid spending (+$105.9 million or growth of 4.4 percent); and $91.2 million in new other post-employment benefit (OPEB) contributions, which are set aside for future state employee retirement health costs.

 In part due to SEBAC 2017, there were reductions in a number of areas that helped mitigate spending growth in FY 2018.  For example, General Fund salaries were $119.4 million lower in FY 2018 than in FY 2017, a reduction of 4.4 percent.  The General Fundís pension contribution to the State Employee Retirement System (SERS) was approximately $73 million lower than the prior year, a decline of 6.5 percent.  Spending was reduced for other employee benefit categories including active employee medical insurance (-$36.2 million, down 5.6 percent) and employer Social Security payments (-$11.2 million, down 5.2 percent).  Continuing a trend from the previous year, General Fund block grant support for the higher education units fell by $64.0 million or 10.4 percent compared with FY 2017.  The complete statement of General Fund appropriations and expenditures is presented in Schedule B-3.

 Overall, factoring in the $1.47 billion revenue volatility transfer out to the Budget Reserve Fund, General Fund revenue collections fell below the budget plan for FY 2018 by $558.5 million, or approximately 3.0 percent.  Without the new volatility transfer, General Fund revenues would have exceeded the budget plan by $912.8 or 4.9 percent.  The complete statement of estimated and realized revenue is presented in Schedule B-2.

 The most notable revenue category in FY 2018 was the Personal Income Tax, which came in nearly $1.59 billion above its budget target.  It should be noted, however, the components of the income tax out-performed the budget plan at different growth rates.  The withholding portion of the income tax came in about 1.8 percent above the budget plan while the estimated and finals portion ended the year approximately 47.2 percent over the budget target.  Over the course of the fiscal year, several Federal tax provisions had a significant impact on collections in this latter category. 

 The first related to the Federal tax changes that took effect at the beginning of calendar 2018.  Some analysts noted that higher income taxpayers may have been holding off selling investments in recent years in anticipation of lower Federal tax rates.  However, after the Federal tax changes became effective on January 1, 2018, more investors began selling assets held during the stock market run up, which increased estimated quarterly or final payments made during the second half of FY 2018.

Another key factor was related to an October 2008 Federal law that eliminated a common mechanism used by hedge fund managers that enabled them to defer receipt of incentive or management fees earned by charging them to an offshore fund.  Under the new rules (Internal Revenue Code Section 475A) hedge fund managers had to recognize these profits, earned prior to January 1, 2009, as income before December 31, 2017.  As a result, a significant amount of the estimated payments collected during FY 2018 were related to hedge fund managers bringing these profits back to the United States from overseas.  As my office noted at the time, these revenue windfalls should be considered one-time in nature and not used to expand ongoing program expenditures that may not be sustainable.

 The positive performance in the Personal Income Tax was offset in part by weakness in other tax categories that came in below their FY 2018 budget targets.  These tax categories included Sales and Use (-$18.3 million), Corporations (-$12.5 million), Public Service Corporations (-$34.3 million), Cigarettes and Tobacco (-$17.8 million), Real Estate Conveyance (-$13.1 million), Admissions, Dues and Cabaret (-$1.2 million) and Miscellaneous taxes (-$12.8 million).  In contrast, the Inheritance and Estate Tax over-performed budget expectations by $43.7 million or 24.3 percent.  Finally, General Fund Federal grant revenue came in $623.2 million below the budget plan, partly due to a delay in Federal approval for Medicaid reimbursements related to the supplemental hospital payments.  These reimbursements are expected to be received in FY 2019.

 The Transportation Fund had revenue of $1,630.1 million in FY 2018, which exceeded the budget plan by $37.5 million. The strongest performing revenue category was the Oil Companies tax, which benefitted from higher oil prices and finished the year $40.7 million above target.  Transportation Fund spending of $1,483.7 million grew by $51.9 million or 3.6 percent from the prior fiscal year.  The largest programmatic spending increases were for public transportation initiatives including rail operations, which grew $36.9 million or 23.1 percent, and bus operations, which increased $13.5 million or 8.9 percent.  In addition, debt service costs rose by $31.8 million or 5.9 percent over FY 2017 levels.  These increases were offset in part by lower salary costs, which declined by $7.3 million or 3.3 percent and lower spending on employee benefits, which decreased by a net $8.9 million or 4.6 percent.

 During FY 2018 Connecticutís economy experienced moderate growth, with some improvements toward the end of the year.  Nevertheless, Connecticut continues to lag behind the nationís economic recovery in several key areas.  A decade after its onset and despite progress on a number of fronts, Connecticut has yet to fully recover from the effects of the Great Recession.

 According to U.S. Bureau of Labor Statistics data reported by the state Department of Labor (DOL), Connecticut gained 14,100 nonfarm seasonally-adjusted payroll jobs over the course of FY 2018 and had a total of 1,698,000 employed residents as of June 2018.  As the fiscal year closed, Connecticut's unemployment rate stood at 4.4 percent in June, down one-tenth of a point from May 2018 and down three-tenths of point from a year earlier when it was 4.7 percent.  Nationally, the unemployment rate was 4.0 percent in June 2018, up two-tenths of a point from May 2018 and down three-tenths of point from the prior year when it stood at 4.3 percent.

 For July 2018, DOL reported that Connecticut had recovered 86.1 percent (102,600 jobs) of the 119,100 seasonally adjusted jobs lost in the Great Recession (March 2008 to February 2010). At that point the job recovery was into its 101st month and the state needed an additional 16,500 jobs to reach an overall employment expansion.  Looking at year-over-year job growth, construction and manufacturing were the fastest growing sectors of the state labor market on a percentage basis.

 The Connecticut housing marketís results were mixed for FY 2018.  An August 23rd release by the Federal Housing Finance Agency (FHFA) reported housing price appreciation statistics by state for the period ending June 30, 2018.  FHFAís Housing Price Index (HPI) tracks changes in home values for individual properties owned or guaranteed by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac).  Over the past year, Connecticut home prices continued to grow more slowly than most of the nation.  Connecticut homes appreciated only 2.38 percent for the year, which ranked 48th in the nation overall.  The U.S. average appreciation for the period was 6.49 percent.  A comparison of five-year housing prices showed similar results:  Single family houses in Connecticut appreciated 6.69 percent for the period versus a 33.09 percent increase for the nation as a whole.

A separate measure of by Berkshire Hathaway HomeServices reported results for the Connecticut housing market for June 2018 compared with June 2017.  Sales of single family homes fell 7.99 percent, while the median sale price rose 4.69 percent.  New listings decreased by 5.57 percent in Connecticut and the median list price increased by 6.82 percent to $299,000.  Average days on the market grew 20.29 percent in June 2018 compared to the same month in the previous year (83 days on average, up from 69 days). 

 In a July 24th report, the Bureau of Economic Analysis (BEA) released Real Gross Domestic Product (GDP) results by state for the first quarter of 2018.  Connecticut experienced a seasonally adjusted annual growth rate of 1.6 percent, which ranked 23rd in the nation overall.  This growth rate was somewhat slower than the national average of 1.8 percent.  However, Connecticut was second only to Vermont in growth among the New England states for the period.  State GDP results for the second quarter of 2018 will be reported in November.

 On September 25th, the Bureau of Economic Analysis reported that Connecticutís personal income grew by a 4.2 percent annual rate between the first and second quarters of 2018.  Based on this result, Connecticut ranked 22nd in the nation for second quarter income growth.  While this growth rate was equal to the national average, it represented the strongest performance in the New England region for the period.  The percent change in personal income across all states ranged from 6.0 percent in Texas to 1.6 percent in Washington.

 My office also issues a Comprehensive Annual Financial Report (CAFR) as an accounting supplement to the budgetary report. The CAFR includes financial statements for all state funds and component units prepared in accordance with Generally Accepted Accounting Principles (GAAP). From a balance sheet perspective, the GAAP unassigned fund balance in the General Fund was a negative $821.1 million as of June 30, 2017.  I will report the new unassigned fund balance figure for Fiscal Year 2018 no later than February of 2019 in accordance with U.S. Securities and Exchange Commission (SEC) requirements. 

 If you have any questions on this report, please do not hesitate to contact me.

 

Sincerely,

  

Kevin Lembo
State Comptroller

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