Connecticut tax revenue is likely to plunge in the last four months of the current fiscal year, taking annual tax revenue down about $1.1 billion below the official forecast, according to a new study by The Townsend Group which I head. That’s a big miss in a state with total annual tax revenue of about $22 billion. It is a huge miss, given that we already know how much taxes have been collected for two-thirds of the year.

The miss derives exclusively from tax revenue derived largely from investment activities. In 2021, the stock market boomed and capital gains skyrocketed, taking this revenue from $4.7 billion in fiscal 2021 to $6.6 billion in fiscal 2022.

In 2022, the stock market plunged and capital gains turned mostly into losses. Nevertheless, the state’s official forecast is for $5.5 billion of this type of revenue in this fiscal year 2023 ending in about three months on June 30th. That is a mere 16% decline from the record-breaking prior fiscal year. The Townsend study projects revenue of $4.4 billion, or a 32% decline.

The Townsend study caps off what has been a six-months-long public debate between state officials and me.

The state adopted its official forecast for this type of tax revenue in April of 2022 and reconfirmed it as recently as last month. I began questioning state officials in early autumn, suggesting that the April-to-September decline in the stock market might warrant an adjustment downward. The official spokesman for the Office of Policy and Analysis (OPM) replied saying that OPM is data-dependent and that receipts in the first three months of the fiscal year (July through September) were “coming in above target.”

In November, I challenged OPM and the Office of Fiscal Analysis in the General Assembly (OFA), which, together, are required by state law to issue official consensus revenue forecasts (CRF) periodically. Their November CRF forecast left the original April forecast unchanged, to which I replied in a column “their projections of tax revenue from investment income for the current fiscal year (FY2023) are way too high.” When OPM and OFA reconfirmed the April forecast again in their January 17, 2023 CRF, I wrote another column criticizing these agencies, saying their stance reflected the limitation of a data-dependent approach when faced with a lack of data. Every year, about three-quarters of stock market related individual income taxes are paid in January through June. In April every year, roughly one-third arrives. Clearly, the first six months of the fiscal year provide little data upon which to adjust a forecast, so their data-dependency locked them into their original forecast.

The column concluded “budget officials should not waste time tracking the numbers before April. They should make a broad judgment. If the stock market was up for the prior year, they should expect robust revenue; if it was down, a significant decline should be expected.”

So why does this debate matter? As my January column stated “In about two weeks, Governor Lamont will release his budget for the next biennium. If based upon the Consensus Forecast, it will be based upon a highly uncertain foundation.”

The column continued “In all probability, the whole budget process will have to undergo massive – and confusing – revisions as a result of the likely overestimation of this revenue source. Lamont should ignore his budget officials and base his budget proposal on more conservative numbers.” Just weeks ago in mid-March when OPM reconfirmed the official forecast of $5.5 billion of this type of revenue – that is the combination of “Estimates and Finals (E&F)” and the “Pass-through Entity Tax (PET),” it stated that “Any negative deviation in collections of either the PET or E&F would impact the volatility cap deposit and not budgetary balance…”

This statement appears to be an attempt to minimize the significance of the potential revenue shortfall by saying it would not impact the budget. To this, I would say that a revenue shortfall is a revenue shortfall, no matter what part of state operations it impacts. Townsend’s projection of a $1.1 billion shortfall signifies a big impact.

Since the January CRF was issued, the state has posted data for two more months of E&F and PET receipts – for January and February 2023, for which combined receipts are down 23% from 2022. Factoring in a $57 million increase in refunds of these taxes in the two months, the two-month net receipts are down 43% year over year.

The shortfall that Townsend projects would not impact the current budget ending in June 2023, but rather would reduce funds in the state’s two big public pension funds, which are severely underfunded.

The next few weeks will tell whether the official forecast or the Townsend projection is closer to the mark. For the sake of Connecticut – and retirees receiving benefits from the pension funds, I hope the official forecast is more accurate.