In 2013, Rhode Island Governor Lincoln Chafee introduced a plan to lower the state’s corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rate from 9 percent to 7 percent over three years, making the state’s tax climate more competitive with its New England neighbors. Currently, Rhode Island ranks 46th in our 2014 State Business Climate Index. Its flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. rate on corporations, 9 percent, ranks 6th highest in the country.
The plan introduced by Governor Chafee would have offset the projected loss in tax revenue by reducing targeted tax breaks currently offered to corporations—namely, the Jobs Development Act. The Jobs Development Act, an initiative designed to reduce the tax burden for companies creating jobs within the state, gave $16.4 million in tax cuts to just eight firms in 2012. The proposed reduction in both the flat corporate tax rate and the targeted tax incentive for job creation via the Jobs Development Act meant a simpler, broader tax code in Rhode Island that would help it compete with the rest of New England.
State tax competitiveness is essential. As noted in the 2014 Index, competition among states is efficient: states can offer low, stable tax rates and businesses can choose to site in those states. Rhode Island continues to do itself a disservice by not passing reforms that broaden the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. while reducing targeted tax incentives for particular companies, which Governor Chafee’s plan would have done.
The good news is that Rhode Island is continuing to push for reform on corporate taxes. On May 7, Senate Finance Committee Chairman Daniel Da Ponte again introduced legislation that would reduce the flat Rhode Island corporate tax rate from 9 percent to 7 percent. Chairman Da Ponte cited an improving business climate as the primary reason for the cut, saying, “A two percentage point reduction in the corporate tax dramatically improves Rhode Island’s competitive position nationally and regionally.” The tax rate reduction would go into effect January 1, 2015, improve Rhode Island’s Index ranking, and position the state to have the lowest corporate tax in New England.
The bill also contains another important piece of tax reform. Rhode Island presently taxes corporations based on a three-factor apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. formula. The three factors—sales activity, property, and payroll—are weighted equally. The new proposal would change Rhode Island to a single-sales factor apportionment formula, meaning that corporations are taxed only on sales in Rhode Island as opposed to total sales, while also eliminating the tax burden on payroll and property. The Division of Taxation estimates this would mean a decrease in corporate taxation of $4.4 million.
However, Chairman Da Ponte is also advocating a move to combined reporting—meaning that corporations within the state cannot move sales in Rhode Island to states with lower taxation. Depending on the method used, combined reporting is estimated to raise additional corporate tax revenue anywhere from $38.6 to $44.4 million, and according to Chairman Da Ponte, would allow the state to roughly break even on the budget even with tax cuts.
Both the reduction in the corporate rate and the use of the Jobs Development Act carve-out are steps toward broadening Rhode Island’s tax base, and the movement to a single-sales apportionment formula creates a simpler tax code. Both would put the state on a path to economic growth. However, implementing combined reporting to ensure the state maintains its spending levels may offset the positive impact of these reforms. It is crucial that the state not take one step forward while taking one step back.
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