Fiscal Year-End Letter to the Governor dated September 30, 2021

September 30, 2021

The Honorable Ned Lamont
Governor of the State of Connecticut
State Capitol
Hartford, Connecticut

Dear Governor Lamont:

I write to provide you with the legal financial statements for Fiscal Year 2021. 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, 2021.

The General Fund ended Fiscal Year 2021 with a surplus of $480,895,567. In a typical year, once the audit is completed, the surplus would be transferred to the Budget Reserve Fund (BRF). However, the balance in the BRF has reached the statutory limit of 15 percent of current year net General Fund appropriations. Therefore, a separate provision of the Connecticut General Statutes (CGS) will apply as described below. The Transportation Fund had an operating surplus of $72,703,313, which left a positive fund balance of $241,133,676 at the close of Fiscal Year 2021.

In FY 2021, for the fourth consecutive year, significant progress was made toward building the balance of the BRF. This was primarily due to the revenue volatility cap, first implemented in FY 2018. This statutory provision requires revenues above a certain threshold to be transferred to the BRF. For FY 2021, the cap was just over $3.4 billion for estimated and final income tax payments and revenue from the Pass-through Entity tax. At year-end, a volatility transfer of $1.24 billion was made to the BRF.

Prior to the close of FY 2021, the balance of the BRF was just over $3.03 billion. Adding the $1.24 billion volatility transfer brought the BRF total to $4.25 billion, or 20.5 percent of net General Fund appropriations for FY 2022. As a result, the BRF is currently $1.14 billion above the statutory 15 percent cap. According to CGS Section 4-30a (c)(1)(A), no further transfers will be made to BRF. Instead, the State Treasurer decides what is in the best interest of the state, whether to transfer the balance above the 15 percent threshold as an additional contribution to the State Employee Retirement Fund (SERF) or to the Teachers' Retirement System (TRS). Earlier this week the State Treasurer elected to transfer $903.6 million to TRS to reduce unfunded pension liability, with the remaining balance of $238.8 million going to SERF.

In addition, once the audit of FY 2021 operations is complete and the General Fund surplus is confirmed, the $480.9 million surplus will be transferred to SERF to reduce unfunded service liability. Achieving and surpassing the 15 percent threshold represents an important benchmark for Connecticut. Due to fiscal discipline and hard work, our state is in a much stronger position to provide critical services to those in need and to weather the public health and fiscal crisis brought on by the COVID-19 pandemic.

Similar to the pattern in the prior fiscal year, the General Fund budget projections varied widely throughout FY 2021 resulting from the COVID-19 pandemic and its anticipated impact on the state�s economy. The FY 2021 budget plan as initially formulated included a built-in General Fund surplus of $166.2 million. However, revenue estimates were revised significantly downward shortly after the start of the year. This reflected the results of the previous quarter when U.S. economic activity saw its largest drop on record due to COVID-related lock downs and job losses. Amid the uncertainty of the pandemic, the revised revenue schedule reflected a worst-case scenario for the General Fund and a deficit of over $2.0 billion (or 10.3 percent) was projected at the beginning of the year.

With each passing month, however, the revenue forecasts improved as the economy recovered, supported by significant Federal relief efforts. At the same time, General Fund spending growth was largely held in check. One of the main factors for this was the enhanced Federal Medical Assistance Percentage (FMAP), or matching rate for Medicaid expenditures. As a high-income state, Connecticut�s FMAP is typically 50 percent, with the General Fund and Federal funding sources each covering half of the costs. In FY 2021 due to pandemic-related relief provisions, the state received an enhanced Federal reimbursement rate of 56.2 percent, which reduced pressure on the General Fund Medicaid appropriation, the single largest line item in the state budget. In addition, the state began recovering jobs over the course of FY 2021 and the stock market continued its strong performance in the second half of calendar 2020. After the release of the January 15th consensus revenue forecast reached by OPM and the Office of Fiscal Analysis, a modest surplus was reported for the General Fund for the first time in FY 2021.

In the last quarter of the fiscal year, the projected surplus grew as revenue growth continued to exceed expectations in both the April 30th consensus revenue forecast and in the statutory tax accruals. In the end, the General Fund surplus was reduced due to significant carry-forward amounts totaling $758.4 million that were included in the budget plan for 2022-2023. In other words, amounts that would have lapsed at year-end were instead continued into FY 2022 and 2023 and earmarked for specific purposes.

In FY 2021, General Fund expenditures totaled $19,431,173,037. This represented an increase of $242.5 million, or 1.3 percent above FY 2020 spending levels. As noted, one of the primary reasons for the modest growth was a $119.7 million reduction in General Fund Medicaid spending, a decrease of 4.7 percent compared with the prior year that was largely due to the enhanced FMAP. There was also $19.7 million (-40.9%) in lower spending from the non-appropriated Adjudicated Claims account, which pays claims against the state. The primary reason was lower payments associated with the SEBAC v. Rowland settlement in FY 2021 compared with FY 2020.

There were significant reductions in several other General Fund accounts in FY 2021. Spending for the General Fund portion of Temporary Assistance to Needy Families (TANF) was lower by $12.7 million (-22.7%) due to a longer-term trend of caseload decreases that carried into FY 2021. The Care4Kids childcare portion of TANF was lower by $22.9 million (-29.4%), but this partly reflected a change from gross to net budgeting, where a portion of these expenditures were moved from the General Fund to a Federal grant account. Expenditures for the Board and Care for Children � Foster Care account decreased by $26.1 million (-19.1%), which reflected pandemic-related spending reductions. For example, due to the COVID-19, fewer children went to day care due to closures or stayed in home settings to reduce the risk of infection. Furthermore, Foster Care transportation costs were lower since many schools went to full time remote learning for significant portions of the year.

Other appropriations saw large spending increases that accounted for much of the growth in FY 2021. The General Fund employer contribution to the State Employee Retirement System (SERS) increased by a net $119.9 million or 10.0 percent driven entirely by an increase in payments toward unfunded pension liability. This was followed by a $66.2 million increase in higher education operating expenditures and a $50.2 million increase in education cost sharing grants to Connecticut cities and towns. The employer contribution to the Teachers� Retirement System grew by $41 million.

Overall, employee salaries grew modestly in FY 2021. General Fund salary and wage costs (from all appropriations) totaled $2.83 billion in FY 2021. This represented an increase of $66.6 million or growth of 2.4 percent compared with FY 2020. The full FY 2020 General Fund statement of appropriations and expenditures by line item is presented in Schedule B-3.

Despite pessimistic projections early in the fiscal year, General Fund revenues finished the year by outperforming their targets. Realized revenues totaled $20,531,418,459 and came in a net $278.9 million or 1.4 percent above the FY 2021 budget plan. When compared with the FY 2020�s realized amounts, revenues performed even better, finishing $1.3 billion or 7.0 percent above the prior year�s levels.

For FY 2021, collections in the six largest tax categories all ended the year above their budget targets. The strongest performer was the Pass-Through Entity Tax (PET) which is levied on Partnerships and S-Corporations. PET receipts ended the year $699.7 million or 45.2 percent above the budget plan. Due to the strong results in the financial markets, estimated and final income tax collections finished $259.7 million or 8.4 percent over target. Despite the pandemic and its impact on households, the Sales and Use Tax came in $204.3 million or 4.3 percent above the budget plan. This was partly the result of significant Federal relief efforts, including several rounds of direct relief payments to households that helped stimulate the economy after the pandemic induced recession hit. The Corporations Tax outperformed its target by $70.6 million or 6.1 percent and the Health Provider Tax came in slightly ahead of budget by $4.1 million or 0.4 percent.

Despite historic job losses at the start of the pandemic, the withholding portion of the income tax still finished the year $75.3 million or 1.0 percent above its budget target. Compared with prior year realized amounts, FY 2021 withholding receipts increased by $428.6 million or 6.3 percent. Growth in withholding reflected several factors, including the concentration of employment losses in the lower wage service sector, the economy regaining jobs throughout the year and having income tax withheld on enhanced unemployment benefits, including the additional $600 per week that was part of the Federal pandemic relief efforts. The complete statement of estimated and realized revenue for FY 2021 is presented in Schedule B-2.

Special Transportation Fund (STF) spending totaled $1,698,510,251 in FY 2021, increasing by $28.7 million or 1.7 percent compared with the prior fiscal year. In aggregate expenditure growth was quite modest, but there were significant shifts between line items. The three appropriations with the highest dollar increases were Personal Services, the primary account for salaries, which grew by $18.3 million (+8.6%); debt service on Special Transportation Obligation bonds, which increased $13.4 million (+2.1%); and the STF employer contribution for SERS retirement, which rose a net $9.2 million (6.2%) driven by the unfunded liability portion of the payment. Salary increases were caused by a combination of a higher position count in the Transportation Fund, employee wage increases as well as higher overtime costs for snow removal and clean-up activities related to Tropical Storm Isaias in August 2020. Two public transportation-related appropriations had significant spending decreases in FY 2021 due to COVID-19 related reductions in ridership. These included Rail Operations, which dropped by $15.1 million (-6.5%) and the ADA Para-Transit Program, which decreased by $7.3 million (-17.8%). In addition, the pandemic slowed the pace of maintenance projects funded by the Pay-As-You-Go Transportation line item, which saw a decline of $4.5 million or 24.4 percent.

The Transportation Fund had revenue of $ $1,777,716,829, which was $103.1 million or 5.5 percent below the budget plan for FY 2021. Both the Motor Fuel Tax (-$29.9 million) and the Oil Companies Tax (-$101.1 million) came in significantly below their budget targets based on a combination of lower oil prices for portions of the year and less consumption due to pandemic-related shutdowns. By contrast, the Sales and Use Tax and Sales Tax - DMV categories each over-perform the budget plan by $28.8 million and $31.1 million, respectively. The complete statement of Transportation Fund estimated and realized revenue for FY 2021 is presented in Schedule C-2.

Connecticut�s budget results are ultimately dependent upon the performance of the national and state economies. Overall, FY 2021 was characterized by the continued recovery from the recession caused by the COVID-19 pandemic. However, the recovery remains uneven with analysts describing it as K-shaped. This unequal nature of the recovery can be seen by its impact on different industry sectors and various income groups�some recovering quickly while others lag. Individuals and households that were able to work from home, typically white-collar workers, fared much better than lower wage service sector employees who lost jobs due to business closures. While millions remain unemployed nationally, a strong stock market has bolstered wealthier households. As the fiscal year ended, a pattern emerged with regards to the health of our economy: economic progress remains largely reliant on the course of the virus.

In the beginning of the fiscal year, Connecticut�s unemployment rate stood at 11.3 percent. This was among the highest unemployment rates in more than 40 years. Nonfarm payroll employment totaled 1,525,000, while 213,900 residents were unemployed according the Connecticut Department of Labor. Weekly initial unemployment claims averaged 10,794 and continued claims increased to 251,926. These economic circumstances were unlike anything Connecticut had seen in decades. By historical standards this recession was extremely impactful, yet conditions rebounded faster than normal. By the third quarter of 2020, conditions were improving more rapidly.

As the fiscal year closed, Connecticut�s unemployment rate dropped to 7.7 percent. Nonfarm payroll employment reached 1,590,900, but 139,000 residents remained unemployed. Weekly initial unemployment claims dropped to an average of 4,524 while continued claims fell to 59,763. By June of 2021, the state recovered 64.6 percent of the 292,400 jobs lost in March and April of 2020. Six industry sectors experienced growth while four declined over the same period. Leisure and hospitality, the industry most affected by the pandemic, had the greatest net change in employment. While labor market conditions have improved, Connecticut still has work to do to reach pre-pandemic levels of employment.

On a national level, over the course of FY 2021, the U.S. added 6.3 million jobs and the unemployment rate fell from 10.2 percent to 5.9 percent. The total number of unemployed persons fell from 16,308,000 to 9,484,000 according to the U.S. Bureau of Labor Statistics. Job growth over this period was strong but is still down by 6.8 million, or 4.4 percent, from pre-pandemic levels. All industry sectors grew over FY 2021, and notable job gains occurred in leisure and hospitality, professional and business services, and information.

As COVID-19 vaccines became available to the public in early 2021, fears of the virus eased and by June 2021 approximately 60 percent of Connecticut residents were fully vaccinated. The Conference Board reported the U.S. Consumer Confidence Index showed an upward trend during the year starting at 97.1 and ending at 128.9�the highest level since March of 2020. Consumers during this period were increasingly optimistic about business and labor market conditions. Since then, vaccination rates have continued to improve slowly (with Connecticut among the highest in the nation), but the emergence of the Delta variant of COVID-19 has caused confidence levels to drop amid the increased uncertainty.

In FY 2021, U.S. Gross Domestic Product (GDP) showed continued growth after falling significantly in the first and second quarters of 2020. The Bureau of Economic Analysis (BEA) reported real U.S. GDP increased at an annual rate of 33.8 percent in the third quarter and 4.5 percent in fourth quarter of 2020. In the first two quarters of 2021, U.S. GDP advanced at annual rates of 6.3 percent and 6.6 percent, respectively. Connecticut followed national GDP trends, growing 32.6 percent in the third quarter and 7 percent in the fourth quarter of 2020. In the first quarter of 2021, Connecticut�s growth rate of 6.0 percent ranked 34th in the nation according to BEA with durable goods manufacturing, finance and insurance, and retail trade contributing the most to GDP. These results reflect the continued economic recovery, reopening of establishments, and continued government response to the COVID-19 pandemic.

After a major plunge in March of 2020, the stock market rallied and shifted to a bull market, erasing most losses by August 2020. Expansionary fiscal policy in response to the pandemic encouraged spending and investing, while Federal Reserve monetary policy kept interest rates low, making it cheaper to borrow. Throughout the year, the stock market proved to be volatile, fluctuating as news of COVID-19 outbreaks and variants emerged. However, as the fiscal year closed, all three major market indices (S&P 500, NASDAQ, Dow Jones) had all reached historic highs.

During FY 2021, the housing market boomed due to work-from-home requirements, low-interest rates, and an exodus from cities to suburbs. In Connecticut, between June 2020 and June 2021, sales of all property types increased 32.44 percent, according to Berkshire Hathaway Home Services while the median sales price increased 21.79 percent. Average days on the market decreased over 50 percent to 37 days. At the same time, the average sales price of properties sold in Connecticut was higher than the list price. While this was good news for existing homeowners, rapidly increasing prices excluded many first-time homebuyers from the market.

Inflation ramped up in FY 2021, reaching highs last seen during the 2008 financial crisis. The consumer price index came in at an annual rate of one percent in July 2020 and grew to 5.4 percent by June 2021. Prices of automobiles (including new, used, and rental cars) gasoline, lumber, airfare, lodging, and food away from home all increased substantially in 2021. Price growth was due to increased demand coupled with supply-chain issues, scarcity of materials, and labor shortages.

The recent uptick in inflation has brought the long-term inflation average closer to the Federal Reserve�s two percent target since inflation has run well under that level over the last decade. The Federal Reserve, which is tasked with managing inflation while also promoting maximum employment and stable interest rates, labeled the increases to inflation transitory. As demand decreases, and supply-chain and shortage issues abate, inflation should recede. Recent data suggests this assessment is materializing.

My office also issues a Comprehensive Annual Financial Report as an accounting supplement to the budgetary report. This annual report 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 $1,072.2 million as of June 30, 2020. I will report the new unassigned fund balance figure for Fiscal Year 2021 no later than February of 2022 in accordance with U.S. Securities and Exchange Commission (SEC) requirements.