The showdown between Gov. Ned Lamont and the General Assembly over the budgetary spending cap seemingly sprang up in the last two weeks around a growing crisis in special education.

But the seeds of that conflict were planted at least four years ago when officials, flush with federal COVID grants and record-setting surpluses, began dedicating hundreds of millions annually to circumvent the cap.

And now, with pandemic aid nearly exhausted and Congress weighing cuts that could take hundreds of millions more in federal aid away from Connecticut, state officials’ efforts to re-embrace the cap is coming at the worst possible time for many politicians.

“We can criticize what’s going on at the federal level, but I think Connecticut is being forced to reconcile with its bloated government,” said House Minority Leader Vincent J. Candelora, R-North Branford.

“It’s not just one category that’s touched by an austere budget” and at risk of deep cuts unless the cap dilemma is addressed, countered Sen. Cathy Osten, D-Sprague, co-chairwoman of the Appropriations Committee. “It’s every single category.”

Did CT misuse emergency COVID aid?

At first glance, Connecticut isn’t in that much trouble with the cap, which keeps roughly three-quarters of the current $26 billion budget in line with household income and inflation. The remaining areas — payments on bonded debt, certain pension contributions, federal funds spent by state agencies, and programs ordered by courts or the federal government — are exempt.

Lamont warned legislators about one week ago that cost overruns and agency overspending have Connecticut on pace to close the fiscal year $61.5 million above the cap.

Legislators responded last week, in overwhelmingly bipartisan fashion, to order another $40 million in emergency spending to address a special education funding crisis in local schools. Lamont, who hinted he would veto the appropriation next week, told business leaders in January that the spending cap is “sacrosanct.”

Still, the potential overage is only one quarter of 1% of the General Fund.

The larger problem involves the next fiscal year, which begins July 1.

The $27 billion plan Lamont offered on Feb. 5 falls a razor-thin $1.8 million under the cap, despite leaving higher education and social services with hundreds of millions less and delaying any extra special education aid until 2027.

The common thread running through the spending cap woes of this year and next is $2.8 billion in emergency federal pandemic grants.

Through the American Rescue Plan Act of 2021, Congress awarded Connecticut that money with few strings. It could be used for almost any program, excluding large-scale tax reductions, and already was exempt from the cap under existing state rules.

Besides arriving one year after COVID struck the state, the timing of these ARPA dollars was perfect for another reason.

A series of other state savings programs created in 2017 to complement the spending cap was beginning to generate massive surpluses, raising concerns among some that too many tax dollars were being leached from education, health care, town aid and other core programs.

Over the past seven years, those surpluses have averaged $1.8 billion and represent 8% to 9% of the General Fund.

But even as the spending cap and other so-called “fiscal guardrails” were extracting huge sums from programs, legislators and Lamont used cap-exempt ARPA dollars to put much of that money back.

According to the governor’s budget office, an average of $703 million in ARPA funds has been allocated annually over the past four years. More than half of those funds went to ongoing efforts including higher education, early childhood development and children’s mental health, K-12 school air quality, student meals and school-based health centers, nonprofit social service providers, and services for crime victims and people experiencing homelessness.

And a second accounting maneuver helped state officials work even further around the cap.

Because Connecticut was running up record-setting surpluses, legislators and the governor chose to transfer some of those unspent dollars forward from one fiscal year to the next. 

And because those “carry-forward” dollars technically were appropriated in a prior year, they didn’t count against cap limits in the subsequent year, when they were actually spent.

According to state budget records, the governor and legislature have ordered an average of $259 million in “carry-forwards” per year since 2022.

But now, Connecticut has exhausted its ARPA funds. And with more than a dozen state agencies struggling with overspending this year, options for “carry-forwards” are limited.

The spending cap has plagued CT officials for decades

So, with hundreds of millions of cap-workaround dollars off the books, state officials’ choices are either to comply with the spending limit or revise it, replacing vanishing ARPA and “carry-forward” dollars with more traditional state funds.

Neither would be easy politically.

The Hartford-based Yankee Institute, a conservative public policy group, is urging officials to abide strictly by the spending cap. It believes Connecticut can save big dollars by cutting human services programs for undocumented residents and freezing wages for state employees.

Carol Platt Liebau, the group’s president, said delaying necessary spending cuts only leads to greater pain.

“Voters understand that the longer we push this choice down the road, the more we face the prospect of having tougher choices,” she said, adding that eventually translates into “massive” tax increases and service cuts.

Chris Collibee, the administration’s budget spokesman, said, “Gov. Lamont has been clear that the constitutional spending cap is an important limitation on state budgeting.”

Lamont has warned that adherence to the cap is particularly important now, given that President Donald J. Trump and the new Congress are proceeding with plans to cut Medicaid and other programs that send huge dollars to the states. Connecticut receives more than $6 billion in Medicaid alone from Washington each year. A cut of even 4% would translate into hundreds of millions in lost revenue.

“If an exigent situation presents itself that requires consideration of whether to exceed the spending cap, the governor will engage the public and the legislature,” Collibee added.

But no one in state government has felt safe doing that for almost two decades.

The spending cap was enacted in statute in 1991, and voters overwhelmingly approved a constitutional amendment one year later making the cap a necessity.

But from the late 1990s through 2007, Republican Govs. John G. Rowland and M. Jodi Rell would team with Democratic-controlled legislatures to legally exceed the cap seven times.

This requires a three-fifths vote of the legislature and the governor’s written permission.

But after the Great Recession and a sluggish recovery contributed to three major tax hikes between 2009 and 2015, tolerance for openly exceeding the cap vanished.

Gov. Dannel P. Malloy, who inherited a record-setting deficit from Rell and who approved two of the three big tax increases during that period, also sparred with the cap.

And while he never asked lawmakers to surpass the limit, he also sought to circumvent it at times.

For example, he redirected tens of millions owed to charter schools to cities and towns, which then gave the money right back to the charters. But because it had touched the accounts of “distressed” municipalities — and because aid to poor communities was cap-exempt at the time — the spending was allowed.

Malloy and legislators also revised cap exemptions in 2015 to exclude certain pension contributions.

And Lamont, even with his vocal support for the spending cap, signed ARPA allocation measures that pumped hundreds of millions of temporary cap-exempt dollars into ongoing programs.

His new budget also recommends creating a $300 million endowment, also outside of the cap, to expand child care and early childhood development initiatives.

And while minority Republicans in the legislature insist they support strict adherence to the cap, they took a different approach this week. The GOP overwhelmingly backed the extra $40 million in spending for special education and tried, unsuccessfully, to boost it to $108 million.

“That was a political statement that we made to the Democrats,” Candelora said, adding that since the majority already was pushing past the cap, Republicans figured it was time to give local schools all the funding they sought.

Several Democrats suggested it was evidence that the GOP struggles with the cap as much as does the rest of state government.

Has CT learned from its past fiscal mistakes?

There are some policy groups that have suggested it’s time for Connecticut take a fresh look at its budget limit.

Connecticut Voices for Children and a second group composed of The Connecticut Project and researchers from Yale University’s Tobin Center for Economic Policy have offered suggestions in recent months.

Currently, the system takes the prior year’s spending and applies a growth factor: inflation or increases in household income, whichever is larger. But rather than just counting the prior year’s spending, researchers on both studies asked, why not also consider the spending that might have been?

In some years, legislators don’t spend the full amount allowed under the cap system. Under those circumstances, this allowable growth is forfeited, rather than built into the system and carried forward into future years.

In 2016, the Washington, D.C.-based Center on Budget and Policy Priorities told a legislative panel that Connecticut’s spending cap growth formula ignores a big chunk of household income in one of the richest states in the nation.

In most years, growth in allowable spending is driven by increases in household income in Connecticut.

But the existing system doesn’t consider earnings from capital gains — a huge omission. With a huge financial services sector and its proximity to Wall Street, Connecticut gains billions of tax dollars annually from investment earnings.

Analysts say the state income tax — the single-largest source of revenue in Connecticut’s budget — will generate $12.2 billion this fiscal year. And 27% or almost $3.3 billion of that comes from quarterly tax receipts, most of which involve capital gains and other investment earnings.

“Sometimes the cap can be too onerous,” House Speaker Matt Ritter, D-Hartford, told The Connecticut Mirror this week.

And though he didn’t suggest any specific reforms, the speaker said suggestions that state officials haven’t learned from the mistakes of prior decades aren’t based in fact.

Since 2017, officials have built a $212 million rainy day fund into a record-setting $4.1 billion reserve equal to 18% of annual operating expenses, one of the largest in the nation. Over the same period, another $8.6 billion in surpluses has been deposited into the pension funds.

“The fiscal success of the state in the last eight years is a credit to both the legislature and the governor,” he said. “It has involved discipline.”

To those who suggest officials can’t be trusted even to review the spending cap and other budget controls without risking Connecticut’s fiscal stability, Ritter added, some “people are scared of their political shadows.”