Gov. Dannel P. Malloy set off a feud with lobbying groups for Connecticut towns and cities last week following his release of a report that indicates a steady increase in municipal aid and a call for “modernizing” the relationship between state and local governments.

The 176-page report shows that over the last five years, while government has cut billions of dollars in state agencies, aid has gone up $1 billion, to over $5 billion a year for the state’s 169 towns and cities.

“As a former mayor, former member of local boards of finance and education, and as a father who raised three children here, I know just how important state funding is for every city and town in Connecticut,” Malloy said in a statement. “That’s why my administration has been highly protective of municipal aid over the past six years, as this report makes clear. Unfortunately, holding towns harmless and even increasing aid while we make excruciating cuts across state government is not sustainable in the long term.”

Since the General Assembly failed to enact a budget in time for the start of the fiscal year, Malloy has controlled state purse strings through executive order. If the Capitol impasse continues into October, billions of dollars in aid will dry up under his plans.

Malloy said he would try to retain levels of education funding, but he is more concerned about the troubled urban areas with under-achieving schools, including Hartford, Bridgeport and New Haven, than suburban school districts, particularly those with declining enrollments.

“It has always been my priority to shield education funding from the difficult choices we have had to make,” Malloy said. “At the same time, we are forced to make nearly impossible decisions and we must now prioritize safeguarding funding to the greatest extent possible in communities with concentrated pockets of poverty and the highest student needs.”

Release of the report prompted criticism from both the Connecticut Conference of Municipalities and the Connecticut Council of Small Towns.

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City, town aid

Municipal aid is the largest category of state spending, totaling nearly $5.1 billion in the fiscal year that ended June 30. It included:

More than $3 billion a year in legally mandated grants, including payments in lieu of taxes for state-owned property as well as colleges and hospitals; revenue from the Mashantucket Pequot and Mohegan casinos; the Regional Performance Incentive; grants for municipal projects, the Municipal Revenue Sharing Account, adult education, and Education Cost Sharing (ECS).

Capital programs including local school construction that can range between $600 million and $850 million annually. Also local capital improvements, town aid for road and Small Town Economic Assistance Program.

Over $1.2 billion in the state’s share of contributions to the Teachers Retirement System, retiree health service cost, and debt service on the pension obligation bonds.

Joe DeLong, CCM executive director, said that in fact, the payments towns and cities receive in lieu of taxes for hosting tax-exempt properties including colleges and hospitals has been declining in recent years. And school funding, under the state’s own formula, falls short by about $600 million a year, he said.

“And there are over 1,300 state mandates on towns that dictate nearly 50 percent of municipal spending,” said DeLong. “The state sets up the arbitration system that sets teacher salaries and then when the system the state forms becomes unsustainable, the solution is to push the problem they created off onto those who had nothing to do with it.”

Betsy Gara, executive director of COST, said the organization understands the state’s fiscal challenges, but is worried that Malloy’s report “is setting the stage to penalize towns that have done everything right — maintained healthy fund balances, controlled property tax levels, and grown their grand lists.

“By continuing to look for ways to funnel a greater share of our taxpayer dollars from small towns to the cities, the state is imposing a crushing burden on property taxpayers in our small towns,” Gara added.

A day before the report was released, House Democrats offered a budget compromise proposal that would include more state aid than Malloy’s executive order, but party leaders said it would merely become a further basis of discussions while Connecticut finishes its second straight month without a new budget.

The Democrats’ tentative budget plan would increase the state’s 6.35 percent sales tax to 6.85 percent.

House leaders said raising the tax by a little over one-twelfth would be a good way to avoid some of the major cuts to school and municipal aid Malloy ordered in July.

The governor was underwhelmed.

“My view is that we shouldn’t raise the sales tax to 6.85 percent,” Malloy said. “I think we should stop leading the discussion with revenue. I don’t know how they bring it into balance. They’re certainly not doing it with the $325 million that they say they would get from raising the sales tax. My fear is this is a billion dollars in additional revenue, and we have to analyze it.”

Republicans immediately criticized the plan.

“It took the House Democrats eight months to come up with another $1 billion tax hike as the only means to solve the state’s financial crisis,” said House Minority Leader Themis Klarides, R-Derby. “The Democrats want to continue down the path that has led us to the precipice of fiscal ruin.’’