How Did America's Richest State Become Such a Fiscal Mess?

Connecticut is home to many wealthy residents. Its state government, on the other hand, is feeling the consequences of what some call "two decades of bad decisions."
by | September 2017

Connecticut may be too rich for its own good. Long blessed with a disproportionate number of high-income residents, the state has entertained lavish spending habits for decades. Lawmakers have acted as if they were on a shopping spree at Christmas, confident that the money to pay off the credit cards would somehow be found in the new year. Meanwhile, they have avoided many of their less glamorous responsibilities -- depositing money into pension accounts and other retirement benefits, and paying for adequate infrastructure maintenance. Now, all those bills are coming due, and the money isn’t there to pay them.

Budget problems have become chronic in Connecticut. This year, they got worse. Faced with a projected $5 billion shortfall over the state’s two-year budget period, the legislature blew well past the July 1 budget deadline. (There was still no agreement on a budget as of mid-August.) “People have come to expect a very high level of services, while keeping taxes low,” says state Rep. William Tong. “That math doesn’t work. People are facing two decades of bad decisions and we’re having to reckon with that new reality.” In May, the three major credit rating agencies all downgraded the state, citing weak revenues. Continuing budget fights and tax increases have driven down business confidence.

Connecticut’s economic problems extend well beyond the budget. The state prospered in the 1970s and 1980s, when nearby New York City was dangerous and Connecticut’s suburban landscape was welcoming. Corporations were eager to resettle there. But fashions have changed. Millennials and corporations have developed a hankering for urban life. That urge has robbed Connecticut’s suburban landscape of its appeal. This was demonstrated starkly by the decisions of two of its marquee employers, General Electric and Aetna, to move their headquarters to Boston and Manhattan, respectively. That bad news has fed a broader negative narrative about the state, with damning coverage in outlets such as Slate, The Atlantic and The Wall Street Journal.

Connecticut has five cities with populations above 100,000, but each is below 150,000. While some of the cities are doing better than others, they all have more than their share of concentrated poverty, bad schools and unemployment. In short, Connecticut lacks a city that can take advantage of the newfound cachet of urban life. Instead, the state has had to take over the financial reins of several of its troubled smaller cities over the past two decades. Hartford, the capital, has its own chronic budget problems and has hired attorneys to explore the possibility of bankruptcy. “At a time when other states were reinvesting in cities, Connecticut was not, and certainly the state itself was not,” says Gov. Dannel Malloy. “Now, when millennials and people 50-plus want to live in urban environments, our urban environments are not up to snuff.”

The state still has the nation’s highest per capita income, but over the past 20 years, its job creation numbers have ranked in the bottom five among the 50 states. Essentially, it has created no new net employment for decades. It was only this past June that Connecticut finally managed to claim the same number of private-sector jobs that it had before the 2008 recession. Many of the jobs in finance that were lost with that year’s market crash have never returned. A disproportionate number of positions created since are low-wage jobs in the service sector. And people have begun to vote with their feet. The state has lost population for three years running. Last year, Greater Hartford ranked fourth and New Haven fifth in population loss among the nation’s 100 largest metro areas. “We’re a wealthy state,” says Oz Griebel, president of the MetroHartford Alliance, the region’s chamber of commerce, “but we’re not growing with the national economy.”

Connecticut is now at a crossroads. A model that worked for years -- safe suburbs offering good schools for the children of hedge fund managers and insurance agents -- is no longer as compelling. Mansion-size houses in the toniest precincts of the richest suburbs aren’t emptying out yet, but they are getting hard to sell.

Over the course of its long history, Connecticut has successfully reinvented itself several times, changing specialties from agriculture to manufacturing to financial services. Today, unlike other states and cities that have run into serious financial difficulties, Connecticut clearly has the means to change course. Not only is its median income still high, but the state boasts assets such as proximity to Boston and New York, amiable coastlines and river valleys, and notable institutions of higher education. In addition to the continuing presence of a thriving financial sector, Connecticut is home to aerospace and defense contractors and other advanced manufacturers who can’t hire help fast enough, as well as a growing medical and life sciences sector.

“Hartford’s fiscal challenges were decades in the making,” says Mayor Luke Bronin, blaming parochialism and a finance system that favors suburban neighbors.

 

But the same sense of general prosperity that allowed the state easy access to credit in the past has left much of Connecticut feeling complacent, even as it faces clear challenges. In many parts of the state, life is still good. The loss of GE and Aetna has served as a wakeup call for public officials, but not everyone feels the same sense of urgency. Unsurprisingly, not many politicians are interested in amplifying the message in the national media that something has gone seriously wrong. “The vast majority of people in Connecticut, unless they were literally trying to sell their home to a GE executive, are not feeling the pain yet,” says Matthew Nemerson, New Haven’s economic development director.

There are a couple of practical reasons why the state may have a hard time changing course, though. To start, its political culture is highly parochial, with strong home rule protecting the interests of 169 cities and towns and nearly as many school districts. Connecticut has the nation’s second-highest rate of income inequality, after New York, but there isn’t a sense in the smaller communities that their future is tied to improving the health of those less fortunate. “More than anything, we suffer from a lack of common identity and the sense of a common future,” says Hartford Mayor Luke Bronin.

The other roadblock is partisanship. As fiscal problems have grown entrenched, it’s become more difficult to find political consensus. Democrats say the state can’t solve its problems with massive spending cuts, and favor both a state sales tax hike and a change in law to allow cities to raise sales taxes on their own. But Republicans blame the state’s woes on decisions in 2011 and 2015 to address shortfalls by bumping up tax rates. They have no appetite for more. “Companies aren’t going to stay here,” says Themis Klarides, the GOP leader in the state House, if taxes keep going up. “They certainly have no reason to come here.”

Complaining about tax hikes has been a winning message for Republicans. At the start of the Obama presidency, Democrats enjoyed a 114-37 majority in the state House and a 24-12 advantage in the state Senate. Now, the state Senate is tied, although the Democratic lieutenant governor can cast tie-breaking votes. Last fall, Republicans came within four seats of taking over the House. Malloy, who has the lowest approval rating of any Democratic governor in the country, admits he was lucky to win re-election in 2014. He isn’t seeking another term next year. It’s not hard to imagine that Connecticut, long dominated by Democrats and still one of the bluest states in presidential voting, could fall under complete Republican control in 2018. That would cause a huge shift in direction.

For Connecticut as a whole to thrive, however, there has to be not only broad agreement about the need to shake things up, but something like consensus about what changes the state should make. Connecticut has not reached that stage yet. “What was once our strength has now become, in my opinion, our weakness,” says state House Speaker Joe Aresimowicz. “We are the land of steady habits and the world has changed around us.”

 

Connecticut can’t say it wasn’t warned. Back in 1999, a report by a consultant named Michael Gallis identified the state’s aging transportation network, its “fragmented political structure” and the lack of a metropolitan center or strategy as glaring weaknesses. The report was widely discussed and still gets talked about in planning circles, but it didn’t convince policymakers or the public that the state needed to change its ways. A sense of isolation -- that Connecticut benefited from not having the same problems as New York or Boston -- kept residents thinking of their state as its own little pocket of prosperity, rather than as part of a bigger region in which it must compete.

At the start of the new century, Connecticut still prospered, its economic growth outpacing the country’s as a whole. That allowed it to issue income tax rebate checks to residents -- $50 to individuals and $100 to couples. These added up to $100 million that, in hindsight, many analysts wish had been devoted to paying down state pension debt, which the Malloy administration puts at $22 billion, although private estimates count it much higher. Instead of making regular pension fund contributions, Gov. John Rowland made a deal with labor unions a decade ago that allowed the state to defer paying them. “My predecessors lived in good times and didn’t spend any of that good-time revenue to attack the state’s long-term problems,” Malloy complains. “I’m living in slow growth and I’m putting every dollar into retiring long-term obligations.”

The state is also struggling to fund its teachers’ retirement system. While it has been able to renegotiate benefit levels with its own employees, benefits for teachers are negotiated with local districts. If the state isn’t able to stretch out its payments to the teachers’ pension plan, as it did with the state workers’ fund, its mandated contributions are set to balloon from $1.2 billion this year to $6 billion in 2024. “We are faced with legacy problems that have finally caught up with us,” says Matt Ritter, the state House Democratic leader.

Longstanding debt isn’t Connecticut’s only financial problem. Back in 1992, shortly after the state imposed a personal income tax, voters overwhelmingly approved a spending cap. The constitutional amendment they voted for, however, didn’t define what the spending cap would be. The legislature has been able routinely to exceed the statutory cap by declaring spending “emergencies” or employing other gimmicks. In 2015, the state attorney general ruled that the spending cap as it stands is legally unenforceable.

 

The only upside of a new deal with labor unions, says House GOP Leader Themis Klarides, is that it will hand her party power “on a silver platter.”

 

When the income tax was created, Connecticut lost one of its regional advantages. Established during a budget crisis triggered by the early 1990s recession, it was not originally intended to become the primary source of income, yet it’s now the state’s single largest revenue source. It’s a progressive tax, so much of the money comes from a relatively small number of top earners. Half of a $400 million shortfall in income tax receipts projected this spring came from just 100 individuals. With uncertainty about whether the tax code will be changed at the federal level, a lot of hedge fund managers and other high fliers are holding off on selling their investments. But at least a few have moved their residency or their hedge funds down to Florida, which has no personal income tax. Conservatives can rattle off the names of individuals who took millions in tax revenue with them. “They’ve decided six months and a day in Florida solves the problem,” says Carol Platt Liebau, president of the Yankee Institute, a free market think tank in Hartford.

Malloy’s proposed budget this year would have raised taxes and fees, but he looked to spending cuts to close most of the shortfall. In May, he reached an agreement with public employee unions to restructure the state’s pension plan and other retirement obligations. The deal increases pension and insurance costs for workers, while freezing wages for three years and offering less generous retirement plans to future hires. The package is expected to save the state $1.5 billion during its current two-year budget cycle and $24 billion over the next 20 years. “State employees are basically saying one full year of the budget, $24 billion, that’s on us,” says Lori Pelletier, president of the AFL-CIO’s Connecticut branch. “There’s no sense in getting a raise if three months from now you’re going to be laid off.”

The deal echoed concessions Malloy had won from unions earlier in his term. But Republicans, while acknowledging that the package offers real savings, complain that it doesn’t go far enough. Connecticut is one of only four states that collectively bargain retirement benefits. The latest deal not only guarantees raises in the future and bars layoffs of state employees, but extends the life of underlying contractual benefits until 2027. “These union contracts effectively tie the hands of one or two governors and the legislature for the next 10 years,” Liebau says.

 

Connecticut has an intergovernmental setup unlike that of any other state. For all practical purposes, it has no counties. Services that in most states are financed and shared by multiple jurisdictions, such as courthouses and roads, are handled at the state level in Connecticut. A few city and town functions have been consolidated here and there-- back-office accounting for libraries, the occasional animal shelter. But regional consolidation of schools and public safety are considered third-rail issues. Connecticut, which is home to 3.6 million people, has 111 police dispatch centers. By comparison, Houston, which has 2.3 million residents, has just one emergency dispatch center, which handles fire as well as police. One Connecticut high school had a graduating class of 45 students this year. Rather than sending the kids somewhere else, its district is expanding and renovating the campus.

The only real source of revenue for local governments in Connecticut is the property tax. Since demand for services is often greatest in the bigger cities, their property tax rates end up being quite high -- often double the rate charged by neighboring towns. The problem is particularly acute in Hartford, where more than half the land is occupied by state facilities or other nontaxable entities. The city’s population doubles during working hours, but commuter taxes are illegal, so Hartford has no real way to reach beyond its own borders to get resources from neighboring towns whose residents benefit from city services. “The state of Connecticut owes the city of Hartford $50 million to $60 million a year in payments in lieu of taxes,” says Cynthia Jennings, a member of Hartford’s city council. “For almost 20 years, they have not paid what they owe us. Not even close.”

The state does redistribute wealth to some extent, in the form of direct aid to cities or investments in redevelopment projects. But municipal aid has been on the chopping block, given the state’s own budget woes. Residents of the more prosperous towns, as in most places, question why their tax dollars are being sent to support cities they don’t live in. That parochialism is reflected in the legislature, where lawmakers ask to be provided with “number runs” showing how budget decisions are going to affect their own districts. “We have extreme wealth in some places and extreme poverty in some places,” Ritter says. “The legislature reflects that at times.”

 

With a loss of population and more than half its land non-taxable, Hartford is facing possible bankruptcy.

 

As things stand, Connecticut is like a big city that has been zoned into 169 different districts, a few of which have to take on a huge burden of poverty. There is some rural poverty in the state, but most poor people live in the larger cities. Those living in suburbs enjoy good schools and public safety, and get a tax cut to boot, in the form of lower property tax rates. “Most of the social bads are concentrated in about 12 of the 169 towns,” says Nemerson, New Haven’s economic development director. “Any change to make it better will hurt large numbers of people.”

Still, the problems associated with pronounced inequality are becoming more apparent. Connecticut is 80 percent white, but its population of white children under the age of 10 is falling faster than in any other state. Racial and ethnic minorities already make up more than 50 percent of infants and toddlers and are about to become a majority of 3- and 4-year-olds. Connecticut’s kids score well on standardized tests overall, but there’s a pronounced achievement gap among racial groups and by geography. As is true almost everywhere, students in city schools are faring poorly. “We can’t leave students in nine cities behind -- that’s 30 to 40 percent of our future workforce,” says Lyle Wray, executive director of the Capitol Region Council of Governments in Hartford. “Fifteen percent proficiency scores in math -- that’s an economic death sentence.”

Malloy recognizes the need to invest in cities. He was once the mayor of Stamford, where new companies in fields such as biotech are moving in alongside the hedge funds, and thousands of new housing units have gone up. In July, the governor announced improvements in rail service and stations that will offer better connections between Hartford and New Haven to the south and Springfield, Mass., to the north. Through a quasi-public development authority, the state has helped build 1,600 new housing units in Hartford. The shift of a University of Connecticut campus from West Hartford to a former newspaper building across the street from the city hall will bring 2,000 undergraduates downtown. “The seeds of revitalization are there,” says Mayor Bronin. “If they’re going to grow, we have to clear away the fiscal crisis that the city faces.”

The same could be said about the state as a whole. Policymakers are facing up to the fact that it’s no longer enough to be the kid brother to Boston and New York. Connecticut has to think of itself as a set of small to midsize regions that need to compete within the Northeast and nationally in order to jump-start any sort of growth. It has the tools. When it comes to productivity or education levels of its workers, Connecticut ranks near the top. And lawmakers from Malloy on down who seek to downplay the practical damage of GE and Aetna shifting headquarters -- but not the bulk of their workforces -- have a point. More than 20 years after Travelers Insurance moved its headquarters to Manhattan, it remains the largest private employer in Hartford.

Connecticut is not in a death spiral, but it has failed to position itself to react to changing demographics and location preferences. There’s a lot of optimistic talk about how the pendulum may swing back, that when the millennials have kids they’ll look more kindly on the Connecticut suburbs. Expecting people to want what they’re currently rejecting is a big risk, however. In a system designed for inertia, changing course will be difficult, especially since most people are still comfortable. And state leaders have lost credibility with many voters about even the need to chart a different economic course, after telling them too often that things will work out all right if they just swallow one more bitter pill in the form of tax increases to get through the latest crisis.

Change is always difficult, especially in a place accustomed to success. But by this point it’s clear that what’s worked so well for Connecticut in the past isn’t working now. Maintaining the status quo doesn’t portend well for the future. “For a long time, Connecticut relied on a suburban strategy,” says Rep. Tong, “and the world has changed dramatically and very quickly.”