Rhode Island Budget Includes Tax Amnesty, Cigarette Tax Increase

June 14, 2012

The Rhode Island legislature recently approved the state's 2013 budget. The bill’s sponsor in the House, Representative Helio Melo, says they "were able to prevent several tax and fee increases,” although the budget still includes some tax increases. The bill, H7323, which gives the state an $8.1 billion spending plan for 2013, passed in the House with a vote of 57 to 15 and the Senate with a vote of 30-7. The plan includes several tax changes including:

  • Increasing the cigarette tax from $3.46 to $3.50 per pack
  • Granting a 75-day tax amnesty period including a waiver of penalties and  a 25 percent reduction in interest payments
  • Making theater and musical touring productions eligible for the state’s film tax credit
  • Extending the sales tax to clothing costing more than $250, limousine and taxi rides, and pet services (not including veterinary costs)

Several of Governor Lincoln Chafee’s proposals were not included in the final bill such as an immediate increase in Division of Motor Vehicles fees which were not set to increase until 2014, an increase in the tax on restaurant meals, and an expansion of the hotel tax.

Though the state was able to avoid some of the tax increases recommended by the governor, their budget does not follow all of the principles for sound tax policy. Rhode Island already has the second highest cigarette excise tax in the country of $3.46 per pack. The national average is $1.46. Cigarette smuggling, driven by high tax rates, is already a significant problem in Rhode Island. A study by the Mackinac Center estimated that 41% of all cigarettes smoked in the state in 2009 were brought into Rhode Island illegally, either through organized commercial smuggling or casual smuggling for personal consumption. This is the third highest smuggling rate in the nation. Any new increases to their already high tax will only further encourage this activity. Thus, Rhode Island may not receive the $1.8 million they expect from the increase.

Tax amnesty is a temporary reduction in interest and penalties for delinquent taxpayers who come forward to pay their tax liabilities. Amnesty is meant to help recoup unpaid tax liabilities and get noncompliant back on the tax rolls. The state’s 75-day tax amnesty program will allow for delinquent taxpayers to pay back taxes along with a 25 percent reduction in the interest they owe and no penalties. While tax amnesties can net the state revenue in the short term, there are potential drawbacks. Tax amnesties may send the message to taxpayers that they can evade taxes without fear of criminal prosecution and even receive a discount on interest or penalties. This may degrade respect for the system, and hence compliance. More importantly, if people believe that amnesty may occur again in the future then amnesty creates a moral hazard because people believe they will never have to face the legal and financial consequences of their noncompliance. This could lead to a growing problem in which more and more people fail to pay and attempt to wait until another amnesty period is offered.

The state also expanded eligibility for its film tax credit. The academic research is not kind to film tax incentives. While the Rhode Island film incentive is scheduled to end in 2019, they will be continuing to throw good money after bad by allowing these credits to continue for 7 more years. Many states including Arizona, Kansas and New Jersey, among others, have recently defunded or ended their film incentive programs after research showed that they only recouped between 7 and 28 cents in tax revenue for every one dollar they spent on the incentives. Creating a state budget means lawmakers must balance different priorities. Giving tax incentives to productions that may be just passing through the state should not be a priority.

Rhode Island lawmakers seem to realize that broadening the sales tax base is a move towards smart tax policy. However, the changes are minor: expanding the base to clothing worth more than $250, limousine and taxi services, and pet services. According to John Mikesell, a professor of Public Finance at Indiana University “a true sales tax would impose a uniform tax only on final consumption — all goods and services sold to households….”(page 5 of this report). Broadening the sales tax base allows for lower rates to be used so all citizens can pay lower rates on all their purchases.  Though the state has extended the sales tax base to some services, the budget also removes tourism services, which included taxes on sightseeing tours and transportation services, from the tax base at the same time. These services were added to the tax base in 2012. Ultimately these are marginal changes to Rhode Island’s sales tax that do not address the larger tax base issues.

More on Rhode Island here.

The bill can be read here.

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