Rhode Island tax reform: Less bold than it looks?

University of St. Thomas finance professor John Spry asks whether Minnesota should follow Rhode Island's "bold" tax reform.

Perhaps the real question is whether a bill that unanimously passes both houses is as bold as it looks.

The reforms include cutting the state's top marginal income tax rate from 9.9 percent to 5.99 percent, reducing the number of tax brackets from 5 to 3, and raising the personal income tax standard deduction while eliminating many other tax credits and itemized deductions. Overall, the bill was revenue-neutral and may end up being slightly progressive.

Significantly, Rhode Island has a Republican governor and Democratic majorities in both houses. The tax reforms passed unanimously. Spry says:

this shows how a coalition can be assembled to lower tax rates by widening tax bases. Every Democrat in the Rhode Island legislature was willing to support significant pro-growth reduction in tax rates because he or she recognized the benefits of lower tax rates in today's competitive economy."

It may also show that tax reform is easier when the governor is engaged and the changes don't increase taxes overall or require new program cuts. However, this "reform" does not actually address the state's revenue shortfalls. (Rhode Island's FY11 budget was balanced in part by cutting aid to local governments and paring back some state employee retiree payouts.)

The bill was based on proposals from a 2009 tax reform panel appointed by Governor Donald Carcieri. Prof. Spry served on Gov. Tim Pawlenty's so-called 21st Century Tax Reform Commission, which focused primarily on business tax reform and also called for broadening the sales tax base while lowering rates. But its proposals never got much support from the governor.

We agree with Spry that the changes are positive because they are somewhat simpler and eliminate preferences to make the system fairer. Growth & Justice has long advocated lowering sales tax rates and broadening the base as one reform in Minnesota's tax system.

But will cutting the top marginal tax rates and most of the breaks that lowered the effective rate do anything for substantive for business growth?

We side with the Citizens  for Tax Justice assessment that the economic growth rationale for this bill is misguided. Especially since research is silent on whether revenue-neutral changes in tax rates and tax bases have any impact on growth.  

San Jose State tax professor Annette Nellen says, as we do, that what matters is whether changes in business activity and start-ups actually occur after the change takes place. Before Minnesota drinks this Rhode Island flavor of the tax reform Kool-Aid, we might want to see some evidence that the effects are as advertised.

Prof. Nellen notes another wrinkle in the simplification effect of the reforms - namely, that most tax payers

are likely still itemizing for federal income tax purposes. Also, the number of tax brackets doesn't tie to simplification (unless is it just one bracket) because people use tax tables and tax preparation software to apply the tax brackets.

Fairness and simplicity are relatively easy to measure; economic impact is beyond complicated.

So voters may be best served by frank discussion about how any tax reforms will adequately fund the programs and services citizens want from state government. In Rhode Island, as in Minnesota, that issue has still not been addressed head on, with state lawmakers passing that buck to local governments.