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

January 28, 2011

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, 2010, 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, we hope we have designed it to help readers, without a specialized financial background, gain a reasonable understanding of the State's financial activities.

The State's largest governmental fund is the General Fund. This is the fund most often referred to in media reports about the Connecticut's fiscal health. 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 beginning in March 2008. These job losses persisted until the start of calendar year 2010 and claimed 103,400 payroll positions. During calendar year 2010, Connecticut regained a modest 5,300 jobs. The stagnant employment conditions resulted in lackluster growth in tax revenues despite a number of tax increases totaling over $800 million in Fiscal Year 2010. General Fund tax revenues grew by just 1.7 percent in Fiscal Year 2010 on the budgetary basis of accounting. This was well below the historical growth rate of over 5 percent annually. General Fund spending in Fiscal Year 2010 remained relatively flat in comparison to the prior year.

On the budgetary or modified cash basis of accounting, in Fiscal Year 2010 operating outlays exceeded annual operating revenues by $843,1 million. The operating shortfall in the General Fund was more than offset by net transfers of $1,323.6 million. Budget Reserve Fund transfers represented $1,278,5 million of the total Fiscal Year 2010 transfer activity. After adjusting for transfers and other miscellaneous activity, the General Fund ended Fiscal Year 2010 with a surplus of $449,9 million, The surplus was reserved for Fiscal Year 2011.

On a GAAP or modified accrual accounting basis, the Fiscal Year 2010 General Fund budgetary surplus of $449,9 million became an operating deficit of $172.8 million. The adjustment from surplus to deficit is explained in large part by the fact that on the GAAP accounting basis revenue accruals were reduced by $155.7 million and additional payables and other liabilities were increased by $168.7 million. CAFR- Note 2, Budgetary vs. GAAP Basis of Accounting details the major adjustments in the conversion of the budgetary basis of accounting to GAAP's modified accrual basis.

In recent years when the State realized a revenue windfall, over half of that amount was reserved for future year spending and the remainder was deposited to the Rainy Day Fund, Between Fiscal Years 2004 and 2008, revenues exceeded budget expectations by approximately $3 billion, During this period, $1.4 billion was deposited to the Rainy Day Fund (8 percent of net General Fund appropriations).

To the extent that windfall revenue was used for debt reduction, debt avoidance or one-time items it did not create structural budget imbalances; however, a large share of the windfall in revenue realized in recent years was used to support ongoing operating expenditures in the General Fund. 'This windfall spending exacerbated recessionary challenges that the State faced and destabilized the budget.

Fiscal Initiatives

In order to partially address a $1.6 billion decline in General Fund tax revenues between Fiscal Years 2008 and 2010, a series of tax increases were passed into law effective for receipts of Fiscal Year 2010 and beyond. These tax changes included an increase in the personal income tax rate from 5.0 percent to 6.5 percent on taxable income over $1 million for Joint Filers, $800,000 for Head of Household, and $500,000 for Singles and Married Filing Separately. This was expected to result in a revenue gain of $594 million in Fiscal Year 2010 and approximately $400 million in Fiscal Year 2011. A corporation tax surcharge of 10 percent was levied in Fiscal Years 2009 thru 2011 for businesses with over $100 million in adjusted federal gross income. This was expected to raise $74,1 million in Fiscal Year 2010, $41,1 million in Fiscal Year 2011 and S22.1 million in Fiscal Year 2012, The cigarette tax was increased from $2.00 to $3.00 per pack, effective October 1, 2009. This was expected to produce a revenue gain of $99.3 million in FY 10 and $117.6 million in FY 11.

In addition to tax increases, transfers of $1,323.6 million - which contained largely non-recurring items - were made to the General Fund in Fiscal Year 2010. Budget Reserve Fund transfers represented $1,278.5 million of the total Fiscal Year 2010 transfer activity. The policy decision to utilize the Budget Reserve Fund in this way left the Fund with a small balance of $103.3 million, This balance was committed to the General Fund in Fiscal Year 2011. Cash balances in non-General Fund categories are being closely monitored on a monthly basis for possible transfer to the General Fund.

Public Act 10-175 authorized programs and policies designed to establish or expand business and create Connecticut jobs, The act authorized bonds for the development of new business concepts. It also authorized tax credits for certain technology-based emerging businesses and for businesses hiring employees with disabilities. It provided loan reimbursement grants to Connecticut students taking jobs related to alternative energy technology and related fields. The act also established a task force to examine ways of increasing state government's efficiency.

In a step toward making the State's budgetary, modified cash basis of accounting more consistent with Generally Accepted Accounting Principles, an appropriation account will be established in Fiscal Year 2012 to prefund an additional day of State employee payroll accrual. This appropriation was established through Public Act 10-173. The additional accrual results in an extra biweekly payroll check once every ten years.

Independent Auditor Opinions

As a Connecticut Constitutional Officer, the State Comptroller is responsible for setting statewide 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 failure 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

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 3,518,288 in 2009 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 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 two-year 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

As detailed in the text above, Connecticut is slowly emerging from a severe national recession. Modest but sporadic job gains are beginning to appear. The State added 5,300 payroll jobs in calendar year 2010, The strongest job gains occurred in the professional and business service sector with solid 4.2 percent year to year growth. This sector includes highly skilled occupations such as engineering, research and development positions, architectural services and information technology. The leisure and hospitality sector also posted gains of 2 percent. The most significant job losses were in the construction sector where payroll jobs declined by 6.6 percent during 2010. Connecticut's unemployment rate hovered at an unacceptably high level of 9 percent for most of the year.

Connecticut is a wealthy state, with large regional income disparities. Connecticut continues to lead the nation with per capita income of $55,063, which is almost 40 percent above the national level. Twenty percent of Connecticut's personal income is derived from dividends, interest and rent, which is two percent above the national average. Over the past ten years the percent of personal income derived from earnings has declined while the share of derived from dividends, interest and rent has increased. In the past decade, State personal income has grown at an average annual rate of 4 percent, which is below -the national growth rate of 4,4 percent, Eliminating recessionary periods, State personal income decline growth averaged over 6 percent annually.

Connecticut's housing market is expected to improve in 2011 after several difficult years. Connecticut housing prices were among the top five states for appreciation, rising 2,5 percent through the third quarter of 2010. However Connecticut single family median home prices are still well off of their 2007 peak price of $326,800 falling to S260,300 in the latest quarter of
2010.

Connecticut's economy is expected to experience modest economic growth in calendar year 2011. Connecticut's real state gross domestic product (SGDP), the broadest measure of the state's economic health, declined 11% in 2009 and is expected to show small positive growth for 2010 when figures are finalized. Projections for Fiscal Year 2011 show SGDP growth of over 3 percent.

Like other states, Connecticut is projecting significant declines in state revenues over the next year due to the lingering impact of the recession and its heavy reliance on one-time revenue sources to balance the state budget. The budget imbalance is estimated to exceed $3.5 billion for Fiscal Year 2012. A significant realignment of state spending and revenue will be required to avert this budget shortfall.

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

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