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Economists Send Up Red Flags On Dems' Tax Plan

LYNN DOAN

April 16, 2009

With the state's three-year budget deficit forecast hovering between $6 billion and $9 billion, Democrats are pushing a tax plan that economists warn will wipe out thousands of jobs both in old-line and emerging Connecticut industries.

The tax package unveiled by the state legislature's Democratic majority earlier this month includes three main hits to business: a 30 percent surcharge on the corporate earnings tax; an end to sales tax exemptions on some key purchases such as computer services; and stricter limits on tax credits, including the lucrative research and development credits that keep many startup businesses afloat.

While the higher taxes would help keep the state above water and could avert public employee job cuts, economists and business executives say the plan would also exacerbate mounting layoffs in a deep recession and drive out companies that many see as the future of Connecticut's economy.

"I don't have numbers in my computer that are going to tell me what this is going to do to jobs, but I know it's not good," said Nicholas S. Perna, economic adviser for Webster Bank and a lecturer at Yale University. "You're either going to discourage companies from staying in Connecticut by putting a surcharge on them when profits are very hard to come by, or you're going to discourage them from relocating here."

No one, in fact, has complete numbers on estimated job losses or even on exactly how much the Democrats' proposal would raise in new revenue from business.

The state is expected to collect $315 million in the next three years from the corporate earnings surcharge and $79.5 million annually from the 54 tax exemptions that would be repealed — although some of those exemptions apply to consumers.

Calculating the effect on the tighter R&D credit policy is harder because that depends heavily on company decisions that are colored by state policy. Tax reformers in Connecticut have long argued that it's impossible to gauge the effectiveness of the state's many exemptions and credits because it isn't known what a company does with the money.

"There are some sales tax exemptions, and there are some tax credits that have been there for many years for no reason except that some lobbyist is pushing for it to be there," said state Rep. Demetrios S. Giannaros, D- Farmington, an economics professor at the University of Hartford. "Really, we should let businesses compete fairly and more jobs will be created."

As proposals wend though the Capitol, debate rages over whether the money collected, which many say represents a fair share from business, would outweigh job losses in the state's private sector. Companies' decisions on hiring are impossible to predict, as they depend not only on finances but attitudes, many executives say.

But by most accounts, hundreds of millions of dollars in higher business taxes, part of the Democrats' overall plan to increase state taxes by $3 billion over the next two years, would exact a significant cost to the state's economy.

Biotech, Fuel Cells

The 30 percent surcharge on corporate taxes alone would purge 470 Connecticut jobs a year for the next 10 years, according to an analysis done by Stan McMillen, chief economist for the state Department of Economic and Community Development.

McMillen said just one of the sales tax exemptions on the chopping block — for computer and data processing services — would result in another 2,200 job losses annually for the next 10 years. He estimated that, together, the surcharge and the repeal of the computer services exemption would result in a $344 million decline in the size of the state's economy each year for the next 10 years.

"And this is just a very small part of the entire package," he said.

Business advocates say Connecticut's stalwart manufacturing sector and two key growth industries — biotech and fuel cell technology — would particularly suffer from the tax proposals. Among the sales tax exemptions to be repealed are three that allow these businesses to buy equipment, fuel and tools tax-free or at a discounted tax rate.

"Isn't that madness? We're one of the leading states in the country on fuel cell technology and they're going to increase their costs by 6 percent," said University of Connecticut economist Fred V. Carstensen. "That strikes me as being bizarre, just bizarre."

Carstensen, director of UConn's Connecticut Center for Economic Analysis, said "there is no question" that the repeals would prompt job losses and "venue shopping" among Connecticut's businesses.

But Carstensen said the Democrats' proposal to impose a 30 percent tax surcharge would cause less damage to the state economy than the spending cuts laid out in the governor's budget because it would preserve a higher level of public services and thus preserve jobs.

"Government spending generates the largest economic benefit," he said. "If the choice is between raising taxes and laying people off, then you want to raise taxes."

He added that a surcharge poses no threat to Connecticut businesses because they've become "very, very skillful at manipulating tax codes."

"There's a whole cadre of lawyers and accountants who track all these things and that's a lot easier than relocating your business," he said.

'A Chilling Effect'

Economists and executives warn about decisions companies make based on their perceptions of the state's policies — although in this recession, unlike in the past, virtually every state faces a similar bind and many are increasing taxes.

In Danbury, companies are already "acting defensively," instituting four-day work weeks and furloughs, said Stephen A. Bull, president of the Greater Danbury Chamber of Commerce. There isn't much left for these businesses to do, Bull said, but to cut jobs, relocate or simply shut down.

"They are positioning themselves," he said, "for what could transpire on the state level."

Companies currently use the tax credits to reduce their corporate earnings tax liability by up to 70 percent — but that would shrink to 50 percent for most companies over the next two years under the proposal.

This reduction would equate to millions of dollars in lost investment in Connecticut's bio-pharmaceutical industry alone, said Paul Pescatello, president and CEO of Connecticut United for Research Excellence, a trade group for the state's bio-pharmaceutical and life science companies.

"This is the most innovative industry, arguably, we've got in this country," he said. "The biotech-pharmaceutical industry spends more than any other industry on research and development, so these research and development tax credits are critical."

Pfizer Inc. is an especially sensitive example. The company employs 5,000 people at its global research headquarters in Groton and New London, and is buying and merging with a competitor, Wyeth — a merger that will lead to job reductions in places now being determined.

In a statement released Wednesday, Pfizer said it was "concerned with any proposal that may stifle innovation."

Pescatello said he is still polling his members to determine exactly how much less they would be able to invest in research under the Democrats' tax proposal.

Even without solid numbers, he said Wednesday, "it's going to have a chilling effect on how their future stands in Connecticut."