The revolutionary income-tax budget that Connecticut adopted last week left municipal analysts and other market players in a quandary over the consequences for the state's bonds.

On the one hand, the state no longer has the stigma of operating without a budget for the current fiscal year, or of relying on a sales tax-based revenue system that bloated budget deficits when the economy went bad. That change has positive implications for the bonds' credit quality, analysts say.

But on the other hand, the budget signed by Gov. Lowell P. Weicker Jr. on Thursday could hurt Connecticut paper. Investors had flocked to Connecticut bonds to escape a tax on interest income that ranged to 14%; now they will have less incentive to buy the state's bonds. Their taxable investment earnings will now be taxed at the same rate as their income. After deducting federal tax liability from the new 4.5% rate, that tax would equal about 3.1% for filers with itemized deductions.

John Pinkham, a fund manager for the Franklin Group of Funds in Norwalk, Conn., speculated last week before the budget passed that an income tax could threaten the state's municipal bond market.

"If there is an income tax, and interest and dividends are taxed at the income tax level, that would take some of the attractiveness away for the very wealthy," Mr. Pinkman said.

Peter J. Allegrini, a portfolio manager at Fidelity Investments, said Friday that as a result of the new tax, the after-tax yield advantage on Connecticut bonds compared with taxable bonds will drop by roughly 150 basis points as a result of the lower levies on taxable investment earnings.

But even so, Mr. Allegrini, whose $310 million Fidelity Spartan Connecticut High-Yield fund is 19% invested in the state's general obligation bonds, said he does not expect the loss of after-tax yield advantage to affect the market for Connecticut bonds.

"Even with the new tax, Connecticut tax-free investments remain attractive relative to Treasuries, corporate bonds, and mortgage securities," Mr. Allegrini said.

The taxable equivalent yield to Connecticut investors has been above 12%. The same equivalent will fall to somewhere above 10.5%, still a handsome return.

And, Mr. Allegrini said, demand for the securities will continue to outstrip supply, keeping Connecticut bond prices firm. "The net net of this whole thing is really going to be neutral," he predicted.

For the dynamics of supply and demand, lowering the state's lid on indebtedness -- a major part of the new budget -- will also help bolster the market for the state's debt.

The budget brought the state's debt ceiling down from 4.5 times annual tax revenues to 1.6 times the previous fiscal year's tax receipts, and the ceiling now applies to debt that has been authorized but not issued, as well as outstanding bonds.

Will that curtail issuance and drive up demand for Connecticut paper?

"That's going to significantly reduce supply," Mr. Allegrini said. "That to me is further evidence" that supply of the state's bonds will continue to lag behind demand.

Mr. Pinkman, who manages several funds including a $64 million tax-free Connecticut bond fund, foresees another factor that should keep the market for Connecticut debt strong: less affluent citizens seeking relief from the new income tax.

"It will be a transfer from the very wealthy to the middle-income earner. Connecticut paper, over all, might get a little bit cheaper and trade more in line with the national market."

Unlike some municipal bond analysts who have said the state's credit quality could improve because of the more reliable revenue generated by a tax on wages and salaries, Mr. Pinkman said he was not so sure that Connecticut general obligation bonds would be worth more than they used to be just because they were backed by an income tax-based system rather than by a mixture of sales, corporate, and investment tax.

"I don't think it will enhance the creditworthiness of the GOs necessarily," Mr. Pinkman said, "My feeling is that more people will seek Connecticut municipal bonds to avoid that income tax, which they've never had before."

As fo rhow the new budget will affect the state's fiscal imbalances, answering that question will take time, analysts say. But so far, the auguries of the state's first major income tax and the mere existence of a fiscal accord are auspicious.

"Clearly, one is glad they finally got a budget," said Claire G. Cohen, an executive managing director at Fitch Investors Service. "Beyond that, I think it'll be a while before anyone will really know anything about it. It will take time to figure out what they really did pass." Fitch rates the state's general obligation bonds AA-plus.

Richard Marino, a Standard & Poor's Corp. vice president, said Friday that he and other analysts from the agency will meet with representatives from Connecticut this week to discuss the state's new revenue system. In February, the agency placed Connecticut's outstanding AA-rated general obligation bonds on CreditWatch with negative implications. At the time they totaled $3.4 billion, but have since grown to $3.95 billion.

One state official said the budget includes spending cuts of about $1.2 billion. It also increases an array of levies on such items as cigarettes and tobacco products, and it lowers the sales tax 6% from 8%, broadening it slightly.

One question answered last week by the adoption of the state budget was how Connecticut intends to finance an accumulated deficit of nearly $1 billion. The budget provides for a serial bond financing over five years, rather than the three-year period originally proposed by Gov. Weicker when he unveiled his income tax proposal in February.

Benson R. Cohn, the state's assistant treasurer for debt management, said the deficit bonding is slated for sometime next month. In addition, he said that the state could decide to issue bonds rather than $233 million of bond anticipation notes for its Special Tax Obligation transportation program, following an announcement Friday by the Internal Revenue Service that it will delay the implementation of new rules for tax-free bond reimbursements. But doing that, he said, could interfere with the deficit bonding by glutting the Connecticut bond market in September.

Connecticut's budget also calls for biennial budgeting, forecasting for revenues and spending in the three years following each biennium. And the plan imposes a cap on most state spending besides that for debt service. The cap would limit annual budgetary growth to the rate of Connecticut's personal income growth or consumer prices.

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