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April 13, 2020

CT’s unflappable sales tax faces unprecedented threat from coronavirus

HBJ Photo | Joe Cooper Downtown retailer Jody Morneault’s Stackpole Moore Tryon has pivoted to online sales since the pandemic.
By Keith M. Phaneuf, CT Mirror

With apologies to Yellowstone National Park, the sales tax has been Connecticut’s version of Old Faithful. 

For decades, the consumption tax on goods and services has pumped hundreds of millions of dollars into the state’s coffers with the highly predictable results of Wyoming’s famous conical geyser.

Even amidst The Great Recession of 2007-09 — as income tax revenues cratered — the sales tax rarely missed a beat.

Until now.

Though it may be months before Connecticut knows how much damage has actually been done to its revenue workhorse by thousands of businesses and millions of consumers remaining cloistered by the pandemic, officials — both public and private — fear something likely has changed for the worse, and for good.

“Floor traffic in stores will be down — permanently. People are getting accustomed to doing things differently,” said University of Connecticut economist Fred V. Carstensen.“People will probably do fewer shopping trips in general going forward.”

“Early indications are that consumers are cutting back or spending much less due to personal economic uncertainty,” analysts for the Washington, D.C.-based Institute on Taxation and Economic Policy [ITEP] wrote in a report predicting an unprecedented drop nationwide in states’ sales tax revenues. “Even people who still have jobs may substantially cut back their spending because there are limited ways for them to spend their money.”

Connecticut labor officials are struggling to process more than 300,000 unemployment claims filed since March 13. Connecticut lose just under 120,000 jobs in the entire previous recession, which ran from December 2007 through mid-2009.

ITEP analysts wrote that consumption always take a hit in a normal economic downturn. Getting furloughed or watching a business fail can make the prospect of shopping scary, even if surgical masks and rubber gloves aren’t necessary to safely enter a store.

“Of course, there’s nothing typical about our current situation,” the ITEP report added. “But there’s every reason to think this pattern will hold this time around—and may even be more pronounced than usual.”

“I can’t recall a time when I’ve seen greater economic uncertainty in my 40 years of doing this,” said DataCore Partners economist Don Klepper-Smith, who was the state’s chief economic adviser in the late 2000s.

“Before the coronavirus this was an economy based on consumption and more consumption,” he added. “All of that is going to be revamped now. People are going to take inventory of what’s important in life.”

A revenue stream that withstood recessions
Not long after its enactment in 1947, the sales tax became state government’s chief source of revenue. Even after the income tax usurped the top spot in 1991, the sales tax remained a strong second.

The $4.3 billion it generated last fiscal year paid for nearly one-quarter of General Fund spending and it’s delivered more than $4 billion every year since 2014.

And it’s far sturdier than the income tax in the face of economic shocks.

Over the last two decades the sales tax has rarely declined more than 5% in one year. Investment-related income tax receipts, by comparison, can vary year-to-year by 20% or more.

And in each of the last two recessions, sales tax revenues have shrunk at less than half the rate of the income tax.

In 2009, in the depths of The Great Recession, while income tax collections were down almost 15%, the sales tax was off just 7%, according to an analysis by the School + State Finance Project, a New Haven-based public policy think-tank.

The sales tax is not perfect. Connecticut, like other states, has watched revenue growth stagnate amidst a growing internet retail market. But officials here have resisted that more effectively than their counterparts in many other states, getting online giants like Amazon and eBay to collect and remit sales taxes.

Legislators also broadened the sales tax last year and imposed the full 6.35% rate on digital downloads, which had been taxed for years at just 1%.

Heading into the big unknown
At first glance, little has changed.

Both Gov. Ned Lamont’s administration and the legislature’s Office of Fiscal Analysis projected — as recently as three weeks ago — the sales tax still would produce the nearly $4.5 billion on which legislators were counting.

But that’s because of systemic lag time built into the sales tax system, and both agencies were relying on data through Feb. 29, eight days before the first Connecticut resident tested positive for COVID-19.

Businesses remit the sales taxes they collect from any given month — on the last day of the following month. Normally that means tax receipts for March are remitted on April 30, for example.

But things aren’t normal, nor will they be anytime soon.

Lamont postponed a host of business tax deadlines to ease the cash crunch so many companies are now facing. Businesses that remit less than $150,000 in sales tax receipts per year can defer their March 31 and April 30 payments to the state until May 31.

In other words, Connecticut may be well into the summer before it has any clue how bad the initial hit to its sales tax revenues actually was.

“We were prepared for a lot in this state, but nobody’s prepared for the scale of what we have been confronted [with] over the last few months and we can expect in the next few months,” Lamont said during an early April budget briefing.

The fiscal year wraps in less than three months on June 30th. And Lamont’s budget director, Melissa McCaw, recently projected the General Fund would finish about $500 million in deficit — a significant gap, but manageable given Connecticut’s $2.5 billion budget reserve.

How many businesses won’t recover from shutdown?
The real question is what happens in the new fiscal year starting July 1, particularly if additional waves of COVID-19 outbreaks bring more social distancing and business closures?

Business leaders already warn that many small businesses that shut their doors in March won’t reopen them, even if closure rules are lifted in May or June. That means many companies have stopped pumping sales tax receipts into Connecticut’s coffers permanently.

“Every day that goes by is make-or-break for some restaurants,” said Scott Dolch of the Connecticut Restaurant Association. “Unfortunately I can promise you a lot of them will not be able to reopen.”

The industry, which alone generated $400 million in sales tax revenue in 2019, asked Lamont to allow restaurants to keep three months of receipts this year.

Lamont denied that request, which would have amounted to a $100 million bailout — or more — to one industry. The governor did create a $50 million no-interest, loan program for small businesses, but it cashed out in just two days after receiving more than $200 million in requests for aid.

Connecticut Business and Industry Association President Joseph F. Brennan agreed that many small businesses, not just restaurants, won’t survive until the summer unless massive, government assistance — preferably grants and forgivable loans —  arrives soon.

“There are certainly some that are on the clock, especially those that were subject to shutdowns early on,” he said, adding the federal government must expand relief. “Anything that does not have to be paid back will help businesses survive.”

‘All of a sudden — bam — it stopped’

“There’s absolutely no question that the vast majority of traditional brick-and-mortar retailers … are under a tremendous amount of stress,” said Tim Phelan, president of the Connecticut Retailers Association. “Both chains and independents, they either shut down completely or they’ve had to make massive adjustments.”

Tile America, a New Haven-based family business begun 55 years ago, “was having a fantastic year, a tremendous first quarter,” until early March, said owner and president Brian Knies. “And all of a sudden — bam — it stopped.”

The importer and distributor of tile and stone products relies heavily on in-person visitors to its showrooms to drive business. The company, which employs 80 people, has avoided layoffs to date by adjusting on the fly.

A new virtual design service and website that allows browsers to envision a new kitchen or bathroom has helped stem the business loss at just 50%, Knies said, adding it’s not a long-term solution.“We’re trying to do the best for our employees and our customers and we’ve had to reinvent ourselves,” he said. “But really we’re just hoping we get past this peak and that things turn around quickly.

”Consumer confidence may be damaged for  years
But even once businesses reopen, experts say consumers likely won’t be ready to spend as they once did.

Carstensen said some consumers will no longer feel safe patronizing restaurants, movies, baseball games or other group settings until a coronavirus vaccine is available. And for some others, it will take even longer.

“Many people are getting extremely cautious about spending as they accumulate debt, run up their credit cards, can’t pay their mortgage,” Carstensen said. “And some people are getting accustomed to getting their groceries delivered. Things are changing.”

And while state government can’t automatically repair that confidence, it can rebuild its sales tax to better withstand future shocks, he said.

The first step is to broaden the tax — far more than Connecticut officials have dared, Carstensen said.

Connecticut has dozens of sales tax exemptions worth about $4.4 billion per year and the UConn economist long has advocated canceling most of them — including the break for groceries. The state then would use the revenue boost to lower the overall sales tax rate driving it down closer to 4%, Carstensen said.

But that doesn’t mean everyone would really pay sales taxes on groceries.

While everyone would be charged the tax when making a purchase, the state still could return sales tax receipts on groceries and other key items by providing an income tax rebate, he said.

Lamont had studied this option for a few weeks shortly after he took office in January 2019, but quickly scrapped it in the face of public criticism.

“We don’t have to have a sales tax that is vulnerable to shifts in consumption,” he said. “It’s a far more stable revenue stream if you’re taxing everything, not just discretionary stuff. It’s not going to collapse.”

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