OSC Letterhead

September 30, 2016

The Honorable Dannel P. Malloy
Governor of the State of Connecticut
State Capitol
Hartford, Connecticut

Dear Governor Malloy:

I write to provide you with the legal financial statements for Fiscal Year 2016. These statements have been prepared in accordance with statutory provisions that were designed to incorporate designated expenditure accruals of Generally Accepted Accounting Principles (GAAP) into the budget process. It is important to recognize that these statements have not been fully audited at this writing. The figures are subject to final audit adjustment and should be viewed as preliminary results. Final audited figures will be released on December 30, 2016.

The General Fund ended Fiscal Year 2016 with a deficit of $170,418,432. A transfer from the Budget Reserve Fund will eliminate the shortfall returning the unappropriated balance of the fund to zero. The Transportation Fund had an operating deficit of $37,205,802, which left a positive fund balance of $142,840,556 at the close of Fiscal Year 2016.

After the transfer to the General Fund, the Budget Reserve Fund will have a balance of $235,582,921. The reserves at the beginning of Fiscal Year 2016 were $406,001,353.

In evaluating the Fiscal Year 2016 General Fund deficit it is instructive to recall that as the fiscal year budget formulation process began, projections indicated that maintaining existing levels of programs and services would produce a deficit of $1.1 billion.

In order to pass a balanced budget for Fiscal Year 2016, policy changes were implemented to reduce current service spending in the General Fund by $519 million. The actual changes in spending between Fiscal Years 2015 and 2016 are discussed below. In addition to the spending changes, adjustments were enacted to generate an anticipated $802.1 million more in gross General Fund revenue. The largest revenue changes were to the income tax ($169.3 million), the corporation tax ($258.1 million), and the health provider tax ($224.8 million). The gain in the health provider tax was to be partially offset by higher payments to hospitals. Since the hospital tax (Public Act 11-6) was implemented in Fiscal Year 2012 as a method of maximizing federal reimbursements, redistribution of the tax back to hospitals has steadily declined.

Within the first two months of Fiscal Year 2016, it became clear that General Fund revenue would fall short of budget targets. A significant stock market correction in August of 2015 dampened hopes of meeting income tax estimates, especially with respect to the capital gains portion of the tax. By the time of the November 10, 2015 consensus revenue forecast, General Fund revenues were projected to be $217.5 million short of budget expectations and a Fiscal Year 2016 General Fund deficit emerged. In December, a deficit mitigation target of $350 million was negotiated and Public Act 15-1 was passed to rebalance the budget. Public Act 15-1 made line-item reductions to agency budgets and delayed revenue transfers to the Transportation Fund and to the Municipal Revenue Sharing Account, among other changes.

Revenue estimates continued to deteriorate throughout the fiscal year and on March 16, 2016 you issued budget rescissions totaling $78.7 million across all branches of government. At the end of Fiscal Year 2016, the General Fund deficit estimate was $279.4 million, which was prior to accrual activity. Positive accrual results have reduced the General Fund deficit number for Fiscal Year 2016 to $170.4 million as cited above.

General Fund spending of $17,921.3 million in Fiscal Year 2016 grew by $501.6 million or 2.9 percent over last fiscal year. Almost 80 percent of this spending increase was attributable to two appropriation line-items: Debt Service increased by $265.5 million or 18.7 percent and the State Employees’ Retirement System Contribution grew by $125.9 million or 13 percent. The functional program areas with the largest dollar reductions in spending from last fiscal year were general government administration (down $34 million or 5.1 percent), health and hospitals (down $19.4 million or 1.1 percent) and conservation and development (down $11 million or 5.3 percent). The largest functional program area increase was to education, which grew by $96.6 million or 1.9 percent. Education is the largest single program area accounting for almost 30 percent of General Fund expenditures.

In Fiscal Year 2016, General Fund revenue expanded by $498.8 million or 2.9 percent from the prior fiscal year. This gain was primarily due to the revenue policy changes discussed above, and it was well below initial budget expectations. The largest variance from the original budget estimates was in the income tax, which fell $652.8 million short of the target. Compared with the previous fiscal year, the payroll driven withholding portion of the income tax grew by 3.4 percent in Fiscal Year 2016. However, the estimated and final payments portions of the income tax, which are related to capital gains and bonus payments, dropped by 4.4 percent despite an increase in the upper bracket tax rate.

The disappointing revenue results for Fiscal Year 2016 were largely produced by an economy that has yet to reach past recovery growth levels, as well as considerable stock market volatility. Connecticut added 15,800 payroll jobs in Fiscal Year 2016. At fiscal year end the state had recovered approximately 80 percent of the jobs lost to the 2008 recession and the unemployment rate stood at 5.8 percent. Personal income was expanding in Connecticut at an annualized rate of just over 3 percent during Fiscal Year 2016. That was less than half the rate of income growth that was experienced after the 2001 recession.

Housing market sales volume was an economic bright spot in the state with double-digit growth during most of the fiscal year, but prices of those homes continued to decline.

The average annualized quarterly growth of the U.S. economy as measured by real GDP during Fiscal Year 2016 was 1.2 percent. Historically, real GDP has increased at a rate of just over 3 percent.

Transportation Fund revenue was constrained by lower fuel prices during Fiscal Year 2016. Total fund revenue fell $115.3 million below original budget expectations. Transportation Fund spending of $1,400.7 million grew by $78.1 million or 5.9 percent from the prior fiscal year. Revenues of the Transportation Fund totaled $1,352.8 million in Fiscal Year 2016, a decrease of $8.1 million or 0.6 percent.

My office also issues a Comprehensive Annual Financial Report (CAFR) that converts the GAAP budgetary basis to the GAAP financial reporting basis. The CAFR accounts for various non-budgetary financial transactions as well as the budgetary basis transactions. From a CAFR balance sheet perspective, the GAAP shortfall or unassigned fund balance in the General Fund was a negative $793.2 million as of June 30, 2015. I will report the new unassigned fund balance figure for Fiscal Year 2016 no later than February of 2017 in accordance with SEC requirements.

If you have any questions on this report, please do not hesitate to contact me.

Sincerely,

Kevin Lembo
State Comptroller

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