Earlier this week, Rhode Island Governor Donald Carcieri signed legislation that significantly reforms the state’s personal income tax structure. An ITEP analysis found that the bottom 95% of Rhode Islanders will see a net tax cut from the revenue-neutral reform, while the richest 5% will pay a slightly higher percentage of their income than under previous law. The problem is that this tax reform generates no new revenue to address the state's budget hole.
Rhode Island lawmakers and the business community championed the reform as a means to make the state more competitive, convinced that lowering the marginal top rate will make the state more attractive to businesses. While some of the motivations behind the reform are misguided, the end product has a lot to be said for it. Starting on January 1, 2011, Rhode Island’s personal income tax will be simpler, more sustainable, and somewhat fairer as a result of the reform passed this week.
Elements of the Rhode Island Reform Package
Perhaps the most significant aspect of Rhode Island’s personal income tax reform is the full repeal of all itemized deductions coupled with a substantial increase in the standard deduction. Itemized deductions are costly, “upside-down” subsidies with the greatest benefit going to the best-off taxpayers, offering little or no benefit for many middle- and low-income families. The increased standard deduction along with the state’s personal exemption will phase out for taxpayers with taxable income between $175,000 and $195,000 and will not be available for those with taxable income above $195,000. These changes alone will make Rhode Island’s income tax fairer and more sustainable over time.
To achieve their "competiveness" goal, lawmakers reduced the number of income tax brackets from five to three and lowered the top marginal rate from 9.9 percent to 5.99 percent. They also eliminated the alternative flat tax method for calculating the income tax, which had been a windfall for the wealthiest residents in the state.
Dozens of special tax breaks and credits were also eliminated. Only eight credits remain under the new law, including the state Earned Income Tax Credit and credits for child care and statewide property tax relief. Much to the chagrin of many advocates, the movie and TV production, scholarship, and historic structure rehabilitation credits also remained intact.
Victory for Fairness and Simplicity, But What about Revenue?
Some proponents of tax reform argue that it should be done in a revenue-neutral manner, meaning it does not result in a net gain or loss of tax revenue. This is how Rhode Island's tax reform works. The cost of rate reductions is offset by reducing credits, deductions and loopholes. This will make the state’s income tax simpler, fairer and more predictable.
Given the state's current budget difficulties, however, revenue-neutrality is an odd goal. By not taking the opportunity through restructuring the income tax to raise additional state revenue, state lawmakers passed the tax-raising buck to local lawmakers. This is particularly true in light of a $165 million cut to school districts and municipal governments that will surely force tax increases at the local level in order to preserve investments in public education and other programs.
In fact, the state budget cut to local governments all but ends the long-standing local car tax exemption program for low-valued cars. In exchange for the cuts, the budget included a measure allowing municipalities to tax all but the first $500 in value of cars, whereas previous law had exempted the first $6,000 in value.
This means that while low-income Rhode Islanders may see a slight decrease in their income tax from their state leaders’ reform efforts, they will likely also be paying more in local car taxes. And, due to the sleight of hand state lawmakers pulled by ending their support for the exemption for low-valued cars, one could argue that on a whole, their tax reform “package” was not revenue neutral at all.