AP NEWS

Payroll tax would replace state income tax under radical new plan

May 9, 2019

Democrats including Gov. Ned Lamont are preparing to replace most of the state income tax with a payroll tax, a new scheme 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 payroll tax of 5 percent on all wages and salaries would save residents and businesses about $1.5 billion from what they’re paying now, and the state would take in an extra $400 million.

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 save money even as the state gained a new source of added revenue.

How’s that possible? The answer is that every employer in the state, now owing a 5 percent tax on wages and salaries, would cut employees’ pay by 5 percent. That means taxpayers would owe the federal government less than they do now, and most would owe the state nothing in income taxes.

Connecticut as a whole — workers, the state government and businesses — would share in the bounty.

“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.

The stumbling block is in the many complications that arise — not politics or ideology.

It’s not an easy switch. For example, anyone now paying less than 5 percent in state income tax would need to collect a refund from the state, and anyone paying more than 5 percent would continue to pay the difference in state income taxes. Setting that up is an administrative headache — easily worth the $1.5 billion, but a headache nonetheless.

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.

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.”

The ideas 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.

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, adding, “Any headway is good.”

dhaar@hearstmediact.com