Democrats including Gov. Ned Lamont are preparing to replace most of the state income tax with a payroll tax, a new way to raise cash for the state that would mark the most radical change in Connecticut finances since the income tax started 28 years ago.
The plan would mean a tax cut for every person who works in Connecticut, at least in theory.
At it’s heart, it’s a simple idea: Employers would pay a payroll tax of 5 percent on all wages and salaries. They would, presumably, cut employees’ pay by 5 percent to make themselves whole.
The key is that employees would make 5 percent less, reducing federal income taxes as well as Social Security and Medicaid taxes for them and their employers. Most would be free of the state income tax, and those who now pay more than 5 percent would see their state income taxes drop sharply.
Those who pay less than 5 percent would receive a rebate from the state.
If it’s crafted right, according to documents top leaders are using as a blueprint, every taxpayer — rich, poor, middle-class, small business owners — would all save money even as the state gained a new source of added revenue.
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Dan writes about the intersection of business, public policy and politics and how the issues affect the people of Connecticut.
Savings would amount to at least $1.5 billion, and the state would take in an extra $400 million by raising tax rates in people making more than $200,000 — even as those people paid less money overall.
“Everybody gets a tax break, from EITC to millionaires,” said Sen. John Fonfara, D-Hartford, co-chairman of the General Assembly’s finance committee, referring to low-income workers who receive the earned income tax credit. “Everybody will come out ahead.”
The stumbling block is in the many complications that arise — not politics or ideology.
It’s not an easy switch. For example, unions have negotiated pay levels that would need to change; self-employed epople would act as both employer and employee, with complications; big companies with national pay systems would need to do some local tailoring; people who work in Connecticut but live elsewhere may have new filings to make.
And of course, employers would need to remit the new payroll tax to the state, replacing or augmenting withholding, depending on each employee’s salary.
The list of stumbling blocks continues. Setting all that up would present an administrative headache. But as far as I can tell, there’s no deal-killer as long as the IRS approves. The $2 billion or so in savings easily make the headaches worthwhile.
No other state has launched a mandatory payroll tax to replace the income tax. New York created an optional version of it last year but only a few hundred companies have taken up the idea.
But with the federal cap on deductions for state and local taxes, the payroll tax idea takes on new urgency for high-cost states such as Connecticut that have an income tax.
“We will not need a capital gains tax,” Fonfara said.
In other words, if it works — a big if — the payroll tax would eliminate the issue that’s dividing Democrats most sharply: Whether to raise an estimated $260 million a year by creating a surrcharge on capital gains income for wealthy taxpayers in the highest income-tax bracket.
Lamont has said that won’t happen, though he has not threatened a veto outright. Democrats in the General Assembly want the capital gains tax and a standoff has seemed unavoidable.
A rush to deadline
As of this week, Lamont’s top aides, including Chief of Staff Ryan Drajewicz and Melissa McCaw, the policy and budget chief, are working on the payroll tax along with key agencies, chiefly the Department of Revenue Services, Fonfara and Rep. Jason Rojas, D-East Hartford, co-chairman of the finance committee, both said.
The idea came from the Connecticut School Finance Project, a nonprofit, nonpartisan group based in New Haven that works on public finance issues. Rojas had a series of talks with people from the project and others, and thought the plan required months of planning — take the summer and work through it, he figured.
Once the finance committee finished its work, Fonfara turned to the payroll tax idea. “When I found out how many boxes it checks, I said, ‘We need to do this,’” he told me in the crazy hours Wednesday night into Thursday morning, as the House debated a minimum wage increase.
“It’s certainly possible,” Rojas said. “There’s just a lot of details we have to work out.”
On the Republican side, Gail Lavielle, R-Wilton, ranking member of the appropriations commitee, said it may be part of the answer to the state’s fiscal crisis.
“Will it solve everything? No way,” Lavielle said early Thursday, but she added, “Any headway is good.”
How much wll I save?
Documents prepared by the Connecticut School Finance Project give examples. A married couple making $100,000, for example, now pays $5,172 in state income taxes. The couple’s combined state income tax and payroll deduction would total slightly more, $5,250, but its federal tax bill (based on a standard deduction) would drop by $982, for a total savings of $904.
The couple’s employers would see a benefit, albeit a small one, because they would pay Medicare and Social Security taxes based on $95,000, not $100,000.
A single person making $40,000 a year would see his or her total state tax go up — in the form of a employer payroll levy — from $1,395 to $2,000. That worker would owe the federal government $393 less, for a net increase of $212. The state would make that up, perhaps with a kicker.
A couple earning $1 million would see a net reduction of $19,675 because their taxable income would drop by $50,000. If the state were to hike their Connecticut taxes by 1 percentage point, to a total of 7.99 percent from the current 6.99 percent, they’d still come out ahead by nearly $10,000 — and the state would pocket an extra $10,000.
The state would also benefit because it would eliminate certain exemptions in addition to raising overall tax rates for high-end earners. Even with those tax increases, every person in every income group would still see an overall tax cut because their reportable federal income would be lower, the documents show.
The idea is similar in many ways to the employer tax on so-called pass-though income that’s earned by partnerships such as law firms. Rather than pay out income, the partnerships tax themselves at the business level, thereby reducing each partner’s income.
Will the federal government allow this? In some ways it’s a workaround to reduce the sting of the state and local tax deductions, which is costing the state an estimated $2.9 billion.
The irony lost on no on is that the payroll tax would eliminate the state income tax for most residents, which was the centerpiece of Republican Bob Stefanowski’s campaign against Lamont for governor — though, of course, Stefanowski proposed to do it without adding a different tax.
“Stefanowski ran on it,” Fonfara said, “but the crazy thing is that it’s Lamont that could make it happen.”