October 11, 2006

Tuning-Up Rhode Island’s Business Tax Climate

(The following article originally appeared in the October 20, 2006 edition of the Providence Journal.)

Pundits bemoan the outsourcing of jobs to India and China, but the facts suggest a menace closer to home. Jobs leaving Rhode Island are less likely to cross the ocean than they are to end up in neighboring New Hampshire or down south, as companies run for cover from punitive tax climates.

State taxes matter a lot, and in today’s increasingly mobile world, low-tax states are lining up to poach companies away from high-tax states.

In recent years, Rhode Island stood out as a state that ignored the writing on the wall. It entered this 2007 fiscal year with heavy taxes in every major area, according to the Tax Foundation’s new State Business Tax Climate Index. The index measures each state’s rates, brackets, credits, exemptions, etc., and produces a ranking of “business-friendliness” — on which Rhode Island is dead last.

This 50th-place finish combines rankings on five major taxes. Rhode Island’s sales-tax system and corporate-income tax both rank 35th best. The personal-income tax ranks 48th, and both the unemployment-insurance tax and property tax rank 50th.

No other state’s tax systems are so consistently poor. Ohio, New Jersey, New York and Vermont are the other four states in the bottom five overall, but each of them has at least one tax that is average or above nationwide.

A major part of the problem is plain to see: high tax rates all around:

• Only one state has an income-tax rate on the books that’s higher than Rhode Island’s 9.9 percent top rate: California’s “millionaire’s tax” of 10.3 percent.

• In corporate taxation, only eight states have a higher rate than Rhode Island’s 9 percent.

• In unemployment-insurance taxes, the federal government sets permissible minimums and maximums, and Rhode Island levies the highest allowed.

• In property taxes, Rhode Island’s collections are sixth highest per capita and fifth highest as a percentage of income. Plus there’s the dreaded capital-stock tax, a punitive tax on business property that 27 states do without entirely.

• The state sales-tax rate of 7 percent is tied for highest nationwide.

Here’s the silver lining. Rhode Island’s economy has dragged this anchor further than one would expect. Population growth and economic growth are steady — they both rank in the middle of the pack nationwide over the last five years.

And amazing to tax pundits nationwide, Rhode Island became a flat-tax pioneer when it passed an optional flat income tax this year. The 8-percent rate for 2006 won’t rattle any cages nearby, but if the state can keep or accelerate the schedule it has set for lowering the rate, it will soon make a dent in the state’s heavy tax armor.

Unfortunately when it comes to tax competition, most states get it wrong. The temptation is to lure big-name employers with such short-term tax bonanzas as property-tax abatements, tax credits for research and development, and other special tax preferences. But this strategy almost always backfires.

Short-term tax lures appear to “create jobs,” but those tax giveaways are a face-slap to existing companies, treating a state’s economic base of companies as dupes who’ll pick up the tab for newcomers.

Companies can’t be blamed for accepting special tax handouts rather than demanding broad-based tax reform. Uncle Sam taxes our corporations at the highest rate in the world — higher than Sweden, Germany and France — so it’s no surprise companies take any tax break they can get.

Instead, the blame falls on lawmakers who relish the photo-ops and headlines that come with handing out high-profile tax benefits, rather than fixing deep-seated problems in their state tax codes.

Rhode Island has doled out its share of these, on top of the usual corporate giveaways through the tax code: job credits, research-and-development credits, investment credits and so forth. But by enacting the new flat tax, the state has shown the first sign that it will preserve jobs the right way: by identifying and fixing complex and punitive parts of state tax codes, leveling the economic playing field for both new and existing Rhode Island companies.

Massachusetts overcame its “Taxachusetts” label long ago and has the region’s second-best tax system, after New Hampshire. Its constitutionally mandated single-rate personal-income tax and reasonable sales tax are pluses, but bad business taxes drag it down to 36th best overall in the State Business Tax Climate Index, within striking distance if Rhode Island continues taking tax reform seriously.

Connecticut’s 37th best tax climate features high property taxes, a fair-to-poor sales-tax system and numerous asset-based taxes, such as estate and gift taxes. A recent study out of the University of Connecticut found that a simple rate cut in the corporate-income tax created far more jobs than did packages of special credits and exemptions.

Rhode Island can compete with its border states and beyond, and it has recently shown the political will to do so. On the tax front, there’s nowhere to go but up.

William Ahern is communications director at the Tax Foundation.