Rhode Island Officials Consider Income Tax Reform

Rhode Island’s top income tax rate of 9.9% is the fourth highest in the United States (after the Pacific Ocean states of California, Hawaii, and Oregon). Income over $34,000 faces at least a 7% income tax, higher than neighboring Connecticut and Massachusetts. Other state taxes are also burdensome and poorly structured, including a hefty 9% state corporate income tax.

In our State Business Tax Climate Index, Rhode Island has climbed a bit from being the worst business tax climate in the country in 2006 to merely the 7th worst in 2010. Part of that modest improvement comes from an optional flat income tax that imposes one rate on a broad definition of income, reducing distortions and burdens. The flat tax currently stands at 6% and will drop to 5.5% in 2011 and beyond.

The optional flat tax is a positive step for Rhode Island’s tax climate, so we’re a bit worried that House Finance Committee chairman Steven M. Costantino wants to get rid of it as part of a tax reform plan. But as details emerge about Costantino’s plan, it may also be a good beginning step for the Ocean State:

As currently designed, the plan would:

• Raise the amounts of the lump-sum standard deduction that most taxpayers claim, but eliminate the option to make a detailed list of deductions – a process known as itemizing.
• Allow only a handful of tax credits, including one for taxes paid to other states, the earned-income credit, the statewide property-tax relief credit and a credit for residential lead-paint abatement.
• Eliminate the optional flat-tax method of calculating one’s Rhode Island income tax.

Mark Higgins, dean of the University of Rhode Island’s College of Business Administration, said the changes, if adopted, would make Rhode Island’s tax system more predictable for tax-planning purposes, and easier to understand and administer.

Carcieri’s tax-reform panel last year recommended a top rate of 5.5 percent, but “that’s not practical today. . . not affordable,” Sasse said. “The top rate is going to have to be closer to 6.5 percent,” he said. John C. Simmons, executive director of the Rhode Island Public Expenditure Council, a business-backed group that monitors the state’s finances, said the new top rate should be no more than 6 percent.

Revenue-neutral broadening of the tax base and lowering the tax rate: classic good tax reform. I can’t wait to see the formal proposal.

More on Rhode Island here.