Rhode Island Enacts Pro-Taxpayer Reform Package

Published August 1, 2006

Thanks to lawmakers who in June enacted a package of tax and spending reforms that were quickly signed into law by Gov. Donald L. Carcieri (R), Rhode Islanders now have an optional flat-rate income tax, tighter caps on property taxes, the eventual elimination of an automobile excise tax, lower capital gains taxes, and controls on growth in education spending.

“In many ways, this legislative session was a landmark, as far as tax initiatives were concerned,” said Gary Sasse, executive director of the Rhode Island Public Expenditure Council, a public policy organization that studies the state’s tax and spending practices. “This was the most pro-taxpayer session in more than a decade.”

Dems, GOP Work Together

The session saw Democrats, who control the legislature, join Republicans to push for the reforms.

“By increasing the phase-out of the car tax, by increasing property tax rebates for our most vulnerable citizens, by implementing a flat tax alternative, and by reducing the capital gains tax, this budget represents a major step towards my goal of reforming Rhode Island’s tax system,” Carcieri said in a statement announcing he had signed the budget.

Rhode Island employers have complained about being unable to attract top people to their firms because of the heavy income tax burden imposed on high-income earners. High-income earners in Rhode Island pay an income tax rate of 9.9 percent, one of the highest state income tax rates in the country.

Tax Competition Embraced

House Speaker William Murphy (D-West Warwick) and fellow Democratic leaders responded with a plan to allow high-income earners to pay taxes under the existing tax structure, with its multiple tax rates depending on income level, and income tax deductions and exemptions, or under a new flat-rate tax structure without deductions or exemptions. The tax rate will fall over several years, ending at 5.5 percent in 2011. Neighboring Massachusetts has a flat-rate income tax of 5.3 percent.

Though most Rhode Islanders would pay less tax by staying in the current income tax system, with its five tax brackets and exemptions and deductions, those who earn more than $250,000 might do better under the flat tax, depending on other factors such as whether they have large capital gains, according to Sasse.

“The real importance of this is perception,” Sasse said. “We need to be competitive” with neighboring states such as Massachusetts.

Sasse said lawmakers also strengthened the property tax cap. Over six years, the current 5.5 percent cap on annual increases in property tax levies would drop to 4 percent. A four-fifths vote of local governing bodies would be needed to exceed the tax cap limits.

The tax package also continues a phase-out of Rhode Island’s motor vehicle excise tax. The exemption (the amount of a car’s value that is not subject to the excise tax) this year will go from $5,000 to $6,000. The state last year restarted the phase-out, which lawmakers had stalled, by increasing the exemption from $4,500 to $5,000.

Spending Limit Proposed

Lawmakers also gave Rhode Island citizens the chance to vote on a constitutional amendment this November to limit state spending to 97 percent of the estimated revenues from all sources, with the balance to be deposited into a budget reserve account that can total no more than 5 percent of revenues. If the payment made to the budget reserve account would increase the amount beyond 5 percent, the excess would go to the Rhode Island Capital Fund for the funding of capital projects only, not to debt service as currently permitted.

If approved by the voters, the amendment would take effect in FY 2013.

Sasse said the Rhode Island constitution currently limits spending to 98 percent of the estimated revenues from all sources, including unencumbered general revenues for the new fiscal year remaining at the end of the previous fiscal year. The balance is deposited into a budget reserve account that can total no more than 3 percent of revenues.

“That money for debt service has been used to balance state budgets,” Sasse said, by moving debt service funds out of the Rhode Island Capital Fund and into the general revenue fund. “This year alone we have $40 million of debt service.”

Under the proposed amendment, those debt service transfers would no longer be allowed to pay for general fund spending. The state would have to cut general fund spending or boost revenues to make up for the loss of debt service money.

Steve Stanek ([email protected]) is managing editor of Budget & Tax News.