🔒A tax reform blueprint for Connecticut

These days, it may seem like Connecticut is the land of unsteady habits. As Gov. Malloy says, sometimes it just feels like we always see the glass half empty.

For example, those of us in the capital area get a steady stream of bad news about our Capital City in crisis.

Yet, right next door, there's West Hartford where our state's eighth largest municipality exemplifies diversity, good governance, fiscal sustainability and continuous economic re-invention.

So let's not waste time obsessing about Aetna's headquarters move, like we did with General Electric. Neither move is about competitiveness in taxes or cost of living. Both are more about the beggar-thy-neighbor bidding war among the states for public subsidies.

Besides, it wasn't that long ago that our corporate leaders led the way in fleeing cities and relocating their headquarters to the countryside.

Make no mistake, our rhetoric — especially our political rhetoric — influences how we see ourselves and how others see us. No democracy or economy, national or state, can thrive by looking backwards, devaluing our shared assets or chasing short-term satisfactions. So stow the political back-biting and skip the pity party. Let's get back to work.

I am a realist, but not a pessimist. Being a realist means building from our strengths, facing our weaknesses, embracing our challenges and creating new opportunities. Right now is the best opportunity we have to get it right. That starts by understanding there is no magic — just smart decisions, hard work and a vision that's fiscally sustainable and economically nimble.

With long years of service in the state legislature behind me, I see so many things we did right but also many that we did wrong or just ignored. Now, as Revenue Services Commissioner, I get to have a new window on the state economy every day. So what do I see?

Prior to the Great Recession, Connecticut experienced one of the strongest and longest runs of economic growth in the nation. Then, in the hard times that followed, we failed to see that a very long and very deep recession also masked tectonic economic shifts. We have been struggling ever since just to understand that this time it's not about recovery — it's about renewal.

Under Republicans and Democrats, state spending has outpaced economic growth and personal income growth for the past 20 years. Worse still, most of the growth and most of every state budget is fixed costs — unfunded liabilities that no one before Gov. Malloy has challenged.

No wonder, under Republican and Democratic governors, three major tax increases in the past 20 years have now reached a point of diminishing return.

The $1-billion-a-year, long-term concessions negotiated by Malloy and our state employee unions — when no one said it could be done — are real, lasting and a turning point.

As for taxes, we also have structural challenges. We rely more and more on income taxes — well over half the state's revenue stream. At the grassroots, new jobs that replace lost jobs pay a lot less on average. New employment is not in entrepreneurial or high value-added sectors while overall employment has yet to reach pre-recession levels. Net migration lowers average income while overall population continues to decline as our state gets disproportionately older.

Post-retirement income lags pre-retirement income while many retirees chase the sun for at least enough of the year to pay no Connecticut income tax. Far too many of our youngest and best educated — especially among Millennials — are choosing not to stay. Multiply that by tens of thousands of dollars for each of those net reductions and the tax losses really add up.

Connecticut's income tax is the third most progressive in the nation. It includes an earned income credit that helps working families and puts money back into the economy. Income taxes should be progressive. But overreliance on a highly progressive income tax and a relatively small segment of very high income taxpayers produces big revenue volatility.

The 45 percent drop in 2017 tax season payments by Connecticut's top 100 taxpayers could only have come as a surprise to someone not watching an already established trend. At the economic treetops, hedge fund management incomes are hugely important to Connecticut and New York. Risk tolerance among now mostly institutional hedge fund investors is far more conservative and, consequently, so are rates of return and fees earned.

Among our highest taxpayers, mobility is a concern. Our state lead in resident millionaires continues, routinely refreshed by in-migration from New York.

But the loss of any single one of our top wealthiest residents has a material impact on state revenue. Add to that, all the assets that have simply been parked in investments since the November election in hopes of a federal tax cut.

So, what about sales taxes and business taxes? Obviously, available disposable income is key to the business investments and consumer purchases that drive sales. But here there are also opportunities to tax smarter and reduce an estimated sales tax gap of around $300 million.

At DRS, we believe no one should pay more taxes because others do not pay their share. That's why we have increased fraud interception every year. It's why I stopped the practice of routinely renewing sales tax permits to tax delinquent and deficient businesses.

Connecticut's business community has as much at stake as the rest of us in changing the winking culture of cash, other off-the-books sales and diverting payment of trust taxes to prop up a failing business or cash in on unearned gains. That's not fair competition. It's theft.

Then there's e-commerce. No other marketplace continues to grow as fast. Yet no other sector is so federally protected from fair interstate competition. The U.S. Supreme Court punted to Congress on state taxation of remote sales. Twenty-five years later, Congress has done nothing.

Like Amazon, more and more online marketers have decided to collect and remit sales tax. But despite substantial economic presences in strong-market states like Connecticut, many others do not. The resulting tax gap is effectively paid for everyday by the rest of us — including Connecticut businesses competing to sell the same goods and services while absorbing the cost of tax collection and the disadvantage of cost-plus-tax pricing.

Connecticut must more aggressively pursue sales tax compliance by every major seller, no matter where based, that has any form of substantial economic presence in Connecticut.

There is another question of overall sales tax policy. Should our sales tax laws continue to be honeycombed with special interest exclusions and exemptions? These tax expenditures are off budget and — not even including food — cost us $3.6 billion annually. That's $3.6 billion paid by everyone so that some pay nothing. If ever there was a case for a broader base and lower rate, this is it.

What about Connecticut business taxes? While our rates are comparatively high, the business-backed national Council on State Taxation continues to rank Connecticut among the lowest total effective tax burden states. But that does not mean we cannot do better.

Led by DRS, supported by Gov. Malloy and working with the business community, we have already achieved a trifecta of corporate tax reforms. With conversion to a unitary, single-factor, destination-sourced approach, we have ended a tax regime that used to favor out-of-state businesses while burdening Connecticut-based businesses.

Whether corporate income or pass-through income, DRS is also stepping up in audit to challenge those who tilt the playing field through off-shoring and transfer pricing schemes that are tax evasion by any other name.

However, fewer and fewer businesses are organized as corporations. Personal taxation of pass-through business income now drives state business tax revenue. It's different taxes and different rules for businesses that differ in form only.

There are also many other types of Connecticut business taxes determined solely by the nature of the product or service provided. Add to that the irritant of Connecticut's so-called business entity tax, a fee that is often the first tax slap experienced by new enterprises well before turning even a first dollar of profit. As other states have done, it's time to at least consider rationalizing this mess with a single receipts-based tax that includes meaningful startup and reinvestment credits.

In fact, there are so many ways to use smart revenue policy as an economic driver. With transportation gridlock and aged infrastructure ham-stringing growth, we need a modern toll system that generates essential reinvestment.

Let's ramp-up tax credits for R&D, job creation, training for new workers, retraining for displaced workers and business reinvestment. We can even pay for it by getting rid of the remaining mishmash of tax credits and abatements that make no appreciable economic difference at all.

Rather than pile on more loans, let's drag antiquated systems of public and private higher education into the 21st century and then use tax policy to provide incentives for graduates to stay in Connecticut as next-generation entrepreneurs and skilled workers.

In exchange for real political and structural reform, we can also use tax policy — rather than bailouts, bankruptcies or yet another layer of government — to re-invent livability and economic viability in our struggling cities.

Of course, economic renewal will also depend on a renewed business paradigm. For too long, America has celebrated profitability over productivity and sustainability. There's a good lesson in the past recession and the “too big to fail” melt down that followed. Under-investing and short-selling, commoditizing businesses and employees, and short-term profits at any long-term cost never grow a business or an economy.

And let's be clear: Legislators debating pot and slots will not get us there either.

Finally, Connecticut's economic strengths need to be the basis of any diagnostic for improved competitiveness. A long and strong run of economic performance still leaves us a great state to live and work.

Connecticut may not economically be what it was, but there is no good reason why we cannot be what we want to be now and into the future. 

Kevin Sullivan is the commissioner of the Department of Revenue Services. This column was part of a speech Sullivan made recently at Hartford Business Journal's “CFO of the Year” awards luncheon.