Connecticut Legislature Sends Corporate Tax Hike to Governor
June 5, 2015
Earlier this week, the Connecticut Legislature adopted a $40.3 billion biennial budget that includes significant changes to the state’s tax structure. Facing a projected deficit of nearly $3 billion in FY 2016-17, legislators acted on a budget which raises approximately $2 billion in new tax revenues.
Nearly 25 percent of this new revenue comes from an increase in income taxes. Nearly $300 million will come from the addition of two income tax brackets above Connecticut’s current highest rate of 6.7 percent. Another approximately $200 million derives from the reduction of an income tax credit that middle- and lower-income households can claim as an offset against local property tax payments.
The new tax plan also increases corporate tax liability by nearly $500 million. Much of this revenue comes from a change in the way corporations report their income in Connecticut. The new plan moves the state to combined reporting, meaning that corporations will be required to include the income of out-of-state affiliates on their Connecticut corporate tax returns, even if those affiliates otherwise lack a taxable physical presence within the state. It also eliminates a number of corporate credits, expanding overall collections, and increases the sales tax rate on data processing services from one to three percent. Data processing is a business input, so including it in the sales tax base leads to tax pyramiding, with a single good or service being taxed at multiple points along the production chain. Since businesses across the spectrum—not just those in the technology sector—rely on data processing, this tax increase is potentially highly significant for Connecticut corporations as well.
Some of the budget’s most significant changes affect the collection and distribution of sales taxes. Connecticut’s official sales tax rate is 6.35%, but not all goods (and those few services subject to tax) are taxed at that rate; some items, like clothes and shoes under $50, are exempt from the sales tax, while many luxury goods are taxed at an even higher rate. The new budget eliminates exemptions on non-coin-operated car washes, non-metered parking, and clothing and shoes under $50, and raises the rate on luxury goods from 7 to 7.75 percent. It also increases the tax on cigarettes from $3.40 to $3.90.
A portion of the revenue from these new taxes is earmarked for the alleviation of other tax burdens. The budget allocates about $436 million in sales tax receipts to towns and cities to pay for reductions in local property taxes, though such policies can create perverse incentives to ramp up local taxes in other areas. Additional provisions limit the amount of tax that municipalities can levy on cars, hold localities harmless for revenues lost to this cap, provide additional funding for municipalities with many tax-exempt buildings, and restrict funding for municipalities that do not use some of the new revenue to lower local property taxes.
The plan has some appealing features. Although property tax offsets can create perverse incentives, Connecticut has the nation’s second-highest property taxes, and finding a way to reduce them is a worthy goal. Moreover, exemptions make sales taxes less efficient and necessitate a higher rate than would otherwise be necessary.
Unfortunately, on the whole, this budget dramatically increases tax liability and is likely to undercut Connecticut’s efforts to promote economic growth. The tax hike on data processing services and shift to unitary reporting make Connecticut’s already-dreary business climate even worse. Connecticut’s corporate tax rate of 9 percent, which consists of a 7.5 percent base rate and “temporary” 20 percent surcharge that was extended by the new budget, is the 5th highest in the country. The details of the new budget plan have caused Connecticut companies like General Electric, which employs over 5,000 people in Connecticut, to seriously consider relocating.
The new taxes included in the budget fall upon taxpayers across all income strata, particularly where new sales taxes and the diminution of the property tax credit are concerned. Connecticut’s income tax, which underperformed projections by $65.5 million earlier this year, could take a further hit if companies shed jobs or flee the state in response to the new taxes.
Connecticut can take steps to mitigate the damage caused by this budget. It can start by reducing or repealing its capital stock tax, a tax which falls directly on capital formation. It can also eliminate reliance on “temporary” surcharges and similar policies which create economic uncertainty. And above all, having adopted a $2 billion tax increase just a few years after raising taxes by $1.5 billion, the state might look to solutions beyond such a heavy reliance on tax hikes.
An earlier version of this post underreported Connecticut’s budget deficit to be $172.8 million. This was the deficit for the current fiscal year as projected by Comptroller Kevin Lembo on April 1, 2015. Before the budget’s passage, the projected deficits for FY 2016-17 were $1.28 billion and $1.55 billion, respectively, according to the Connecticut General Assembly’s Office for Fiscal Analysis. This earlier version also reported that the Connecticut income tax revenues were $67 million under projections. They were actually $65.5 million under projections as reported by the Office of Fiscal Analysis.
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