seal of comptroller's office, state of connecticut
STATE OF CONNECTICUT
OFFICE OF THE STATE COMPTROLLER
Kevin Lembo
State Comptroller
55 ELM STREET
HARTFORD, CONNECTICUT
06106-1775
Martha Carlson
Deputy Comptroller

February 28, 2012

To the Citizens, Constitutional Executive Officers, and Members of the Legislative General Assembly of the State of Connecticut:

It is a privilege to present the State of Connecticut Comprehensive Annual Financial Report (CAFR) for the fiscal year ended June 30, 2011. This report was prepared in accordance with Generally Accepted Accounting Principles (GAAP) as prescribed by the Governmental Accounting Standards Board.

Even though much of this report must be written in a rather formal and technical manner, my office has endeavored to present the information in a way that will help readers without a financial background to understand the State's overall fiscal position.

The State's largest governmental fund is the General Fund. This is the fund most often referred to in media reports about Connecticut's finances. Over three-quarters of all governmental financial transactions relating to the cost of providing State services and the collection of revenues to pay for those services occur within the General Fund.

A national recession that officially commenced in December 2007 produced a pattern of job losses in Connecticut that began in the first half of 2008. These job losses persisted until the start of 2010 and claimed almost 120,000 payroll positions. By the close of Fiscal Year 2011, the state had regained 30,000 jobs, or 25 percent of the total loss.

On a budgetary basis of accounting, which has a cash based focus, the General Fund ended Fiscal Year 2011 with a surplus of $236.9 million. However in order to attain that surplus, the state drained reserves, and relied on one-time revenues and transfers. If this funding had not been available, a deficit of just over $1 billion would have occurred. On a GAAP basis of accounting, the General Fund posted a deficit for Fiscal Year 2011 of $350.8 million. The differences between budgetary accounting and GAAP that creates the different operating results for the General Fund are detailed in Note 2 of this publication.

In reviewing Connecticut's fiscal history, it is important to understand how surpluses generated in good economic times have been distributed. The majority of surplus dollars have been generated on the revenue side of the budget equation, not through spending constraints. In past years when the State realized a revenue windfall, over half of that unexpected revenue was reserved for future year spending initiatives. What remained was deposited to the Rainy Day Fund. Between Fiscal Years 2004 and 2008, revenues exceeded budget expectations by over $3 billion. During this period $1.4 billion was deposited to the Rainy Day Fund (8 percent of net General Fund appropriations). With the onset of the recent recession, the Rainy Day Fund was completely drained to support General Fund programs. Had additional windfall revenue been set-aside, various tax increases may have been averted. A well funded reserve promotes a stable tax system; and a stable tax system is vital to economic growth.

It is also important to note that the use of windfall revenue for ongoing spending initiatives created significant structural budget problems. When windfall revenue is used for debt reduction, debt avoidance or other one-time outlays it does not create future year budget imbalances; however, a large share of the windfall revenue that was collected in recent years went to ongoing programs in the General Fund. Once that excess revenue was gone, structural problems emerged. The out-year deficit projections for the 2012-2013 biennium were in excess of $3 billion in each year. The imbalances were remedied through significant tax increases, labor concessions and other spending cuts.

Major Policy Initiatives and Priorities

Recognizing Generally Accepted Accounting Principles (GAAP) within the State Budget

With the implementation of the budget for the 2012-2013 biennium, Connecticut began a transition to GAAP budgeting. Historically, the State budget has been developed on a modified version of cash accounting. This accounting method does not recognize expenditures when a liability for goods and services is incurred. The expenditure is not counted until the bill is actually paid. Likewise, revenue is not posted, in most cases, when it is earned. Instead revenue is counted when the cash payment is recorded.

The annual process of converting financial transactions from budgetary accounting to GAAP has resulted in large accrued liabilities over time. These liabilities have been growing due to inflationary factors and other required adjustments. In Fiscal Year 2001, the GAAP shortfall in the General Fund was $782 million. By Fiscal Year 2011, the shortfall had grown to almost $1.8 billion.

The budget plan for 2012-2013 was formulated to freeze the GAAP deficit by setting aside additional revenue to offset the growth in GAAP accruals. In future fiscal years, the remaining accumulated GAAP deficit will be systematically reduced.

Revenue Enhancements and Labor Concessions

A slow growing national economy and structural budget imbalances resulted in historically large budget deficit projections for Fiscal Year 2012 and beyond. Increasing revenue and reducing labor costs became two major components in the effort to ameliorate the State's immediate and long-term budget problems.

Policy changes to General Fund revenue were expected to generate approximately $1.4 billion in additional receipts for Fiscal Year 2012. These changes included a restructuring of the personal income tax that expanded the number of tax brackets from three to six. The top income tax rate was increased from 6.5 percent to 6.7 percent. The sales tax rate was increased from 6 percent to 6.35 percent with 0.1 percent reserved for municipal revenue sharing. Many products and services previously exempt from the sales tax became taxable. A 20 percent corporate surcharge was imposed on businesses with annual gross income of $100 million or more and a tax liability in excess of $250. The inheritance and estate tax exemption was lowered from $3.5 million to $2 million with an expansion of the 7.2 percent rate. Many other adjustments were also passed into law. The changes were implemented with special attention to keeping Connecticut's tax structure competitive with the tax provisions found in other states in the region.

One of the most significant cost cutting initiatives implemented to close the budget gap was the renegotiation of salary, health, pension and other related compensation with state employees. The administration estimated that total saving in excess of $700 million would be achieved in Fiscal Year 2012 with savings growing and accumulating in the out years. The agreement imposed a wage freeze for two years, capped the salary level used to calculate pensions, increased the pension reduction for early retirement, imposed a 3 percent contribution rate on active employees to fund retiree health care, lowered the minimum cost of living pension adjustment and implemented a Health Enhancement Program designed to reduce health care costs by promoting preventative care and by more appropriately directing points of service delivery. Many other changes were included in the agreement. In addition to lowering annual budget costs, this agreement is expected to reduce long-term liabilities.

Job Growth Legislation

A special legislative session was convened in October, 2011 that was dedicated to job creation in Connecticut. The result of the session was a $626 million bipartisan jobs bill and a $291 million investment to leverage genetic research activities at the University of Connecticut Health Center.

The $626 million in new bonding authorization over two years featured an array of economic development initiatives including new job creation credits and related employment credit programs, new public-private investment initiatives, additional infrastructure investments, new funding for start-up technology companies, funding for brownfield remediation, expanded loan programs, investor tax credits and many other specific initiatives. This effort represents a historic level of public investment in private job creation within the State.

Independent Auditor Opinions

As a Connecticut Constitutional Officer, the State Comptroller is responsible for setting state-wide accounting practices. Ultimate responsibility for the accuracy, completeness, and fairness of data presented in this CAFR, including all disclosures, rests with the State of Connecticut and my office. Connecticut statutes require an annual audit of the State's basic financial statements. These include statements prepared on the budgetary basis of accounting as well as statements prepared using GAAP -the basis of accounting that is generally accepted throughout the United States. The State is also required to undergo an annual "single audit" for reporting to the Federal government. To meet all of these requirements, the State Auditors of Public Accounts have examined our financial statements and the appropriate supporting documentation.

With the exception of the State's inability to update its OPEB liability and ARC in accordance with the requirements of GASB Statement 45, the State auditors gave the CAFR for the State of Connecticut a "clean" opinion indicating they can state, without reservation, that the financial statements are fairly presented in all material respects in conformity with GAAP.

Profile of the Government and its Safeguards

The Nutmeg State

Connecticut became the fifth state of the United States on January 9, 1788. Its borders encompass 5,009 square miles. Within its compact borders, Connecticut has forested hills, urban skylines, shoreline beaches, and historic village greens. Connecticut is a thriving center of business as well as a vacation location. It is both a New England State, and suburban to New York City. The population of Connecticut was 3,580,709 in 2011 according to U.S. Census estimates. Five large cities, Bridgeport, New Haven, Hartford (the State Capitol since 1875), Stamford and Waterbury, have populations in excess of 100,000 residents.

State Government

Separation-of-Powers provisions of the State Constitution established the three branches of State government: executive, legislative and judicial. The executive branch, which is responsible for enforcing state laws, consists of six state executive officers: Governor, Lieutenant Governor, Treasurer, Comptroller, Secretary of State and Attorney General. All are elected to four-year terms.

Connecticut's General Assembly or legislative branch is responsible for creating new laws and consists of a Senate and a House of Representatives. There are currently 36 State Senators and 151 State Representatives. Members of the General Assembly are elected to two-year terms. Connecticut also elects two U.S. Senators and five U.S. Representatives.

The Judicial Branch is responsible for interpreting and upholding our laws as consistent with the State Constitution and legal precedence. The Judicial Branch consists of three levels: The Supreme Court, the Appellate Court and, at the lowest level, the Superior Court which is further divided by state law into Civil, Criminal, Housing and Family Divisions. Judges of the Supreme Court, the Appellate Court and the Superior Court are nominated by the Governor from a list of candidates submitted by the Judicial Selection Commission and are confirmed by the General Assembly. They serve eight-year terms and are eligible for reappointment.

The Reporting Entity

The State of Connecticut financial reporting entity includes all of the funds of the primary government and of its component units. The primary government includes all funds, agencies, departments, bureaus, commissions, and component units that are considered an integral part of the State's legal entity. Component units are legally separate entities for which the primary government is financially accountable. Discretely presented component units are reported separately in the government-wide financial statements, to emphasize that they are legally separate from the primary government and to differentiate their financial position and results of operations from those of the primary government. Other component units, although legally separate entities have their financial position and operations blended with the primary government, essentially for technical reasons as explained more fully in the additional information on the reporting entity which is included in CAFR -Note 1, Summary of Significant Accounting Policies.

Internal Controls

Our State's internal control structure has been established to ensure that the assets of the government are protected from loss, theft, or misuse, and to ensure that adequate accounting data are compiled to allow for the preparation of financial statements in accordance with GAAP and State legal requirements. The internal control structure is designed to provide reasonable, but not absolute, assurance that these objectives are met. The concept of reasonable assurance recognizes that: (1) the cost of a control should not exceed the benefits likely to be derived, and (2) the valuation of costs and benefits requires estimates and judgments by management.

Budgetary Controls

The State Legislature prepares a bi-annual budget that contains estimates of revenues and expenditures for the ensuing two fiscal years. This budget is the result of negotiations between the Governor and the Legislature. Adjustments, in the form of budget revisions, executive orders, and financial legislation agreed to by the Governor and the Legislature, are made to the annual appropriations throughout the fiscal year. Budgetary controls are maintained at the individual appropriation account level by agency and fund as established in authorized appropriation bills. The objective of these controls is to ensure compliance with state laws embodied in the appropriations. The State Comptroller is statutorily responsible for control structures to safeguard revenues due the primary government, to determine the amount equitably due with respect to claims made and to ensure such expenditures are compliant with an appropriation contained in the budget for such purpose.

Budgeted appropriations are the expenditure authorizations that allow state agencies to purchase or create liabilities for goods and services. Before an agency can utilize funds appropriated for a particular purpose, such funds must be allotted for the specific purpose by the Governor and encumbered by the Comptroller upon request by the agency. Such funds can then be expended by the Treasurer only upon a warrant, draft or order of the Comptroller drawn at the request of the responsible agency. The allotment process, which includes limits on the power of the Governor to modify appropriations, preserves expenditure controls over special revenue, enterprise, and internal service funds and capital projects that are not budgeted as part of the annual appropriation act as revised.

The Spending Cap

In November 1992, electors approved an amendment to the State Constitution providing that the amount of budgeted expenditures authorized for any fiscal year shall not exceed the estimated amount of revenue for such fiscal year. This amendment thus provided a framework for placing a cap on budgeted appropriations.

Annual budgeted appropriations are capped at a percentage increase that is based on either the five-year average annual growth in the state's personal income or annual inflation, whichever is higher. Debt service payments, certain statutory grants to distressed municipalities, and appropriations required by federal mandate or court order are excluded from the limits of the cap.

The spending cap can be lifted if the Governor declares the existence of extraordinary circumstances and the General Assembly by three-fifths vote approves appropriations in excess of the cap. This has occurred in almost every year that the State has posted a budget surplus in the General Fund to enable the appropriation of surplus dollars that would have otherwise gone to reduce state debt and fill the rainy day fund.

Economic Condition and Outlook

The national economy as measured by real GDP grew at a moderate rate of just over 2 percent during the first two quarters of Fiscal Year 2011 before slowing sharply in the second half of the fiscal year. Second half growth was about half of the first half level. This is consistent with Connecticut's job performance, which expanded by 15,200 payroll jobs during Fiscal Year 2011 with most of the gain coming during the first six months of the fiscal year.

In Fiscal Year 2011, Connecticut weekly earnings increased at a 3.3 percent rate. The State's personal income has been growing at a rate in excess of 4 percent.

The stock market realized double digit gains over the course of the fiscal year. The Dow increased by 25 percent as recessionary pressures eased. Historic growth was posted in corporate profits in calendar year 2010 with solid results continuing into the first quarter of 2011.

Retail sales were strong throughout Fiscal Year 2011 growing by more than 8 percent. The personal savings rate declined steadily during most of the fiscal year. The higher store sales helped to boost Connecticut's Fiscal Year 2011 sales tax revenues by 4.7 percent from a year ago.

The State's housing sector continued to struggle in Fiscal Year 2011. New housing permits declined 5 percent from already depressed levels and existing home sales fell 19 percent during the fiscal year with quarterly sales at about half of the 2005 level.

After declining in 2009, Connecticut's export sector rebounded with solid growth in 2010 continuing into 2011 with double digit growth.

Acknowledgements

I want to thank my staff and all of the agency personnel and others who contributed to producing this report. I also want to thank its readers who bring meaning to the work that we do.

Sincerely,

Kevin Lembo
Connecticut State Comptroller