High income tax may aggravate Connecticut's budget problems

The city of Hartford, Conn., the capital of America's richest state, may be headed for bankruptcy. And one reason is that it can't count on seeing the money it needs from a state government that has stomach-churning budget problems of its own.

The state's budget hole is at least $2.3 billion for the fiscal year that's already begun.

It's a curious story of grinding financial problems in a state that leads the nation in per capita personal income. And financial problems aren't the only bad news. The state has been losing population, and even giant insurer Aetna just decided to pick up and move, quitting a state that's been its home for 164 years.

Aetna didn't bother sugarcoating it, either. In a nutshell, Aetna's CEO said the employees it needs to attract to succeed are just the kind of people who would never want to live in a place like Connecticut.

There's a usual-suspects list of explanations for how the state got itself into a financial bind, including a whopping public employee pension shortfall that took years of mismanagement to create.

Yet it's hard to miss one fact — Connecticut's individual income tax collections have slid, recently coming in far below what had been forecast and lower than had been collected last year.

You may have already guessed that Connecticut has raised its personal income tax rates for higher income taxpayers, most recently about two years ago. That's what makes what is happening in places like Connecticut well worth studying here in Minnesota, which now has the most progressive individual income tax system in the country, according to the Minnesota Center for Fiscal Excellence.

No two states are alike, of course, and one thing that's striking about Connecticut is how much it depends on income tax revenue from a relatively small number of people. The top 1 percent of income earners usually pay 30 percent or more of individual income taxes. In one telling detail, the state disclosed in the spring that its 100 largest individual taxpayers paid about 45 percent less in taxes than they did the year before.

It may be just a coincidence that taxes collected from the highest earning taxpayers declined right after the state raised its top marginal tax rate to 6.99 percent for the highest income taxpayers.

It's a left-leaning state with a Democrat serving as governor, yet income tax rates were raised on top earners during the term of the prior governor, Republican M. Jodi Rell. As for what she really thought of this tax policy, maybe it's enough to note that she later said the state was "in a downward spiral" and left, relocating her primary residence to low-tax Florida.

It actually would be pretty easy to make a political case, if looking for votes in the Connecticut legislature, for balancing the books by raising taxes on higher income families. That's because to call Connecticut America's richest state doesn't provide nearly a complete picture of who actually lives there.

It's certainly true affluent people live there, but so do a lot more people who are barely getting by. Connecticut generally shows up near the top of any list of the widest disparity in household income between the relative few who make an awful lot of money and everybody else.

In the metropolitan area of Fairfield County, home to poor neighborhoods as well as communities filled with hedge fund managers and commuters to New York City, the top 1 percent of families in 2013 earned on average more than $6 million each. That was nearly 74 times the average income for everybody else in Fairfield County.

So you can imagine why one of the ideas to raise revenue that pops up all the time in Connecticut is to slap some kind of tax on the state's large hedge fund industry with roughly 450 firms as of last count. Asset management, as it turns out, is one of the state's most important industries. In 2016, according to the state, securities and investments accounted for just 1.5 percent of the jobs but more than 7 percent of wages.

One of the ironies of the whole debate about taxing hedge funds is that the main reason a big asset management cluster developed in Connecticut in the first place is that Connecticut was at one time a low-tax place to live and work. The state didn't even have a personal income tax until 1991. Investment fund managers could remain part of the greater New York City swirl and yet live a far lower-cost life across the state line in southwest Connecticut.

The reason a surcharge on hedge funds hasn't been adopted yet is that it would be so obviously counterproductive.

The hedge fund industry is so important to the state that there have even been taxpayer subsidies for it in a way that seems simply unimaginable here in Minnesota. That included taxpayer money granted to Bridgewater Associates of Westport, a firm routinely described as the world's biggest hedge fund manager.

Hedge funds generally had a so-so year in 2016, according to the annual compensation list in Institutional Investor's Alpha magazine, so Bridgewater founder Ray Dalio, recipient of taxpayer subsidies, personally made only $1.4 billion.

The state officials who made that call aren't stupid. They knew it looked terrible to shovel taxpayer money into a billionaire's firm.

Maybe what this state's complex approach to its hedge fund managers — subsidizing them and taxing them — shows is how little headroom is left in a policy of raising taxes on upper income taxpayers. Everybody understands that the physical assets of a hedge fund manager are basically only their computers — which are obviously portable.

If the state raises taxes again on upper income taxpayers, at least a few of those hedge fund managers may just make a reservation with the same moving company that's going to be trucking out the household belongings of the Aetna executive team.