STATE OF CONNECTICUT OFFICE OF THE STATE COMPTROLLER
Kevin Lembo State Comptroller	55 ELM STREET HARTFORD, CONNECTICUT 06106-1775	Martha Carlson Deputy Comptroller

January 29, 2016

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, 2015. 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.

Between 2008 and 2010, Connecticut lost 119,000 payroll jobs or about 6 percent of the State's labor force due to the "Great Recession". Connecticut's employment recovery began in 2010, but it was volatile with months of gains partially offset by subsequent losses. Connecticut did not experience a consistent pattern of monthly growth in payroll employment until the final months of Fiscal Year 2014. During Fiscal Year 2015, Connecticut continued the pattern of sustained monthly job additions resulting in a gain of twenty-seven thousand payroll positions over the course of the fiscal year. That rate of job growth is fairly typical for the State during periods of moderate economic expansion, and it approximated the national rate of employment growth. By the end of Fiscal Year 2015, Connecticut had recovered almost 98,000 jobs or over 82 percent of the recessionary job loss. The State's unemployment rate fell from 9.5 percent in October of 2010 to 5.7 percent by the close of Fiscal Year 2015.

While Connecticut has been adding jobs, worker's wages have continued to stagnate during the recovery. This trend is not unique to Connecticut. Nationally, this recovery has been defined by sluggish wage gains. In Connecticut, wages were growing at a twelve-month rate of below 2 percent at the end of Fiscal Year 2015. This compares to wage gains as high as 7 percent going into the recession. Rising wages are an essential component of economic growth and, consequently, State revenue growth. The structural growth in State General Fund revenue in 2015 was just 1.6 percent. This is well below the average annual 5 percent growth that would be anticipated during a normal economic recovery period.

The slow pace of structural revenue growth after the 2008 recession has held the average annual General Fund spending increases over the past five fiscal years to 2.5 percent. Prior to the recession, General Fund spending was growing at an average annual rate of 7.3 percent. In order to sustain the modest rate of budget growth, tax increases and other revenue enhancements were implemented.

Both nationally and in Connecticut, economic growth has been moderating over the past several decades. From the 1950's to the mid-1980s, there were numerous periods of double-digit growth in Gross Domestic Product (GDP). Since that time, there has been a gradual downward slope in the GDP rate of growth. This corresponds to a reduction in the percentage of U.S. adults that are middle income. According to the Pew Research Center, the percentage of middle income adults has dropped from 61 percent in 1971 to 50 percent in 2015. The largest share of GDP, about two-thirds, is based on personal consumption expenditures. Middle income individuals have been a driving force in expanding the growth in consumer spending. Therefore, it is not surprising that the erosion of the middle income segment has contributed to slower economic growth and slower revenue growth.

This report devotes significant attention to the State's General Fund. The General Fund is the largest single governmental fund. It is the fund most often referred to in media reports about Connecticut's finances. About 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.

Despite the implementation of three deficit mitigation initiatives and other cost cutting measures utilized in Fiscal Year 2015, the General Fund closed the fiscal year with a budgetary deficit of $113,168,010, which represents six-tenths of one percent of Fiscal Year 2015 budgeted spending. The deficit was eliminated through a transfer from the State's Budget Reserve Fund. As a result of this transfer, the balance in reserve was reduced from a level of $519,169,363 to $406,001,353. The new Budget Reserve Fund balance is equal to 2.2 percent of net General Fund appropriations for Fiscal Year 2016. That level of reserves is insufficient. I proposed legislation that was passed into law as Public Act 15-244 that provides a methodology for increasing the balance in the Budget Reserve Fund systematically over time. That new law is described in detail in the Major Policy Initiatives section below.

A complete discussion of Fiscal Year 2015 budget and fiscal trends is contained in the MDA section of this report.

Major Policy Initiatives

Budget Stabilization: The purpose of the State's Budget Reserve Fund is to create budget stability during periods of economic decline. Increasing taxes or cutting spending as the economy contacts in order to balance the State budget places additional downward pressure on economic growth. A sufficiently funded budget reserve can mitigate or completely eliminate the need for budget policies that worsen an economic downturn. Public Act 15-244 implements a systematic process to guarantee that major revenue windfalls are deposited to the Budget Reserve Fund before they can be diverted to other purposes. Since 1990, Connecticut has realized over $5 billion in windfall revenue, yet the Budget Reserve Fund never exceeded $1.4 billion.

Historically, most of the revenue windfall has come from the estimated and final payments component of the income tax and from the corporation tax.

This law will allow revenue growth in these tax categories that exceeds a ten year growth average to be intercepted for deposit to the Budget Reserve Fund. This ensures that windfall receipts are intercepted and placed in reserve before they can be diverted for other uses. The threshold limits that determine revenue windfall amounts were first calculated and published by the Comptroller's Office in Fiscal Year 2015. The law takes effect in Fiscal Year 2021.

Office of Early Childhood: An Office of Early Childhood (OEC) education was established to become operational in Fiscal Year 2015. This office assumes the responsibility for administering the following major programs as of July 1, 2014: school readiness; the Children's Trust Fund; Connecticut Charts-a-Course; State and federally funded child day care subsidies; child day care services management, evaluation, and professional development; child day care facilities licensing and inspection, and youth camp oversight.

The same act that created the OEC makes several changes to school readiness program funding, which the state provides through various grants allowing towns to purchase seats for three-to five-year olds who are too young to attend kindergarten. It expands school readiness seats and who is eligible for them, and increases the cost per seat from a maximum of $8,346 to $8,670. The act also makes several other major substantive changes in the following ways: (1) requires OEC to make more frequent unannounced visits to all licensed day care centers, group day care homes, and family day care homes; (2) gives OEC more authority over school readiness staff qualification requirements; and (3) changes the organization and membership of certain councils, committees and cabinets.

Required Installation of Interlock Devices: A new law requires any driver convicted of an administrative per se violation to install an ignition interlock device (IID) in all owned and operated vehicles after the license suspension period. Each driver that is required to install an IID must pay an administrative fee of $100 to the Department of Motor Vehicles (DMV) prior to installation. This will result in a revenue gain to the Ignition Interlock Device Administration Account within DMV of up to $650,000 annually beginning in Fiscal Year 2016.

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 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.

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 3,590,886 in 2015 according to U.S. Census estimates. This is a population loss of 3,876. Connecticut was one of seven states to lose population between 2014 and 2015. 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. Note 1 of this report contains detailed information on the reporting entity.

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 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.

Economic Condition and Outlook

At this writing, Connecticut has recovered all of its private sector recessionary job losses and is continuing to add private sector employment. The State needs to reach the 1,713,000 job level to enter a full nonfarm employment expansionary phase. This will require an additional 13,300 nonfarm jobs. Connecticut's nonfarm jobs recovery is 69 months old and is averaging 1,532 new jobs per month since February 2010.

As is discussed above, Connecticut has been growing jobs at fairly typical recovery rate; however workers' wage growth has been below normal recovery levels. There are some early signs that wage increases may be accelerating slightly. Wages increased by less than 2 percent in Fiscal Year 2015. Current trends point to Connecticut wage growth of better than 3 percent. Wage Growth in the United States averaged 6.3 percent from 1960 until 2015, reaching an all-time high of 13.8 percent in January of 1979 and a record low of -5.77 percent in March of 2009. Historically, Connecticut wages have increased at a faster pace than the national average.

Connecticut, like most other states, has a revenue structure that is dependent on rising wages and the related increases in consumer spending. As wages have been slow to recover, Connecticut's revenue base has experienced lower than expected growth. As job expansion continues in the State and as wage acceleration takes hold, Connecticut's recent budget pressures will abate. Exactly when solid wage gains will emerge is as uncertain as it is vital to the State's budgetary health.

Looking forward it is also important to note that Connecticut's economy is dependent on the national economy, which is dependent on world events. Global economic activity has constrained domestic growth. China's economy (2nd largest in the world) has been slowing. In response, its central bank cut interest rates in hopes of boosting growth. Less oil demand from China as the economy slowed has produced a sharp drop in oil prices as well as coal and other commodities. These falling prices have negatively impacted the stock market.

The cheaper oil has damaged oil exporting economies such as Brazil and Russia, in addition to many Middle Eastern producers. The European economy has struggled to grow at all, advancing at an annual pace of less than 2 percent.

These events will also impact Connecticut's financial health in the coming years.

Acknowledgements
I want to thank my staff, the State Auditors, 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

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