I hope you are looking forward to Super Sunday (or, for those of you who are not football fans, to this year’s Puppy Bowl). In this week’s letter, I will discuss proposals to revise the state’s sales and use tax.
A. Rhode Island’s Current Sales And Use Tax
Our current sales and use tax rate is 7% for most purchases. (We pay use tax of 7% for out of state purchases, minus a credit for the sales tax paid to the foreign state.) Over time, the General Assembly has reduced the size of the sales tax base by enacting 68 exemptions, which range from such basic items as food and clothing to specific sectors such as horse food products and dietary supplements. This year the sales and use tax is projected to raise $1.46 billion, or approximately one-third of the State’s total revenues.
B. The Governor’s Budget Proposal
The Governor’s budget proposes reducing the sales tax to 6.85%. The administration projects this change will reduce general revenues by approximately $35 million per year, generating savings for households of approximately $39 annually (with other savings going to businesses). The governor’s budget anticipates future reductions to bring our sales tax rate down to the 6.25% charged in Massachusetts. Other Senators have proposed more immediate relief. One proposal would reduce the sales tax rate next year to 6%, while a second proposal would reduce the rate to 5%.
C. Placing Rhode Island’s Sales Tax Rate in Context
The Governor’s budget frames the proposed sales tax reduction in the context of the New England states, among whom our rate is highest, especially when compared to Massachusetts (6.25%) and Connecticut (6.35%). This comparison is incomplete however, because Rhode Island’s sales tax is different from theirs, and because we have made other tax choices that differ from our neighbors.
Rhode Island’s sales tax has 68 exemptions, many of which are unique. If we truly wish to match our neighbors in a fiscally responsible way, we would reduce our exemptions to match theirs while also reducing our overall rate. The Governor has not proposed this, perhaps because each exemption (such as the one for flags) has its own constituency that would oppose such a change.
2. Other Taxes
There are other ways in which our State’s tax system differs from our neighbors. For example, we do not pay any annual property tax on their automobiles, thanks to a $230 million State program. In contrast, taxpayers in Massachusetts and Connecticut both pay annual property tax on their cars. The revenue Rhode Islanders allocate to reimburse cities and towns for lost car tax revenues is $230 million, which roughly matches the revenue lost from a 1% reduction in the sales tax from 7% to 6%.
D. Tax Policy Goals
As I hope this discussion shows, interstate comparisons of sales tax policy must go beyond a simple comparison of rates. If we want to increase business for Rhode Island merchants who are located near our borders with Massachusetts and Connecticut, then (as Senator Felag pointed out), a 0.15% reduction in the rate is unlikely to make a difference; instead, Rhode Island might consider holding one or more “sales tax holidays” on selected weekends. If our goal is to increase the incomes of Rhode Islanders by reducing their tax burden, we should study which Rhode Islanders would benefit the most from this type of tax relief, and whether the Governor’s proposed $39 in household tax relief (and a similar amount in relief to businesses) is sufficiently meaningful to make a difference to Rhode Islanders, or whether there is another form of a $35 million tax expenditure that would be more effective.
Of course, greater relief is possible through a larger reduction in the sales tax rate, but the cost in lost revenue becomes more significant. On a purely “static” basis, the administration calculated a 0.75% reduction in the tax rate (to 6.25%) to cost $174 million in lost revenue, a 1% reduction (to 6%) to cost $225 million and a 2% reduction (to 5%) to cost $450 million. These losses may be mitigated through secondary or “dynamic” effects, as lower sales tax rates could provide incentive for more residents on either side of Rhode Island’s borders to buy in Rhode Island, increasing both business revenues and sales tax revenues. These secondary effects are difficult to model, however, as we learned when Congress passed the Reagan, George W. Bush and Trump tax cuts promising that they would be “paid for” with greater revenue from greater economic activity, only to find that their “dynamic” tax model was seriously flawed.
E. Fiscal Policy Goals
We must also consider the impact a significant reduction in tax revenues could have on the amount of government services Rhode Island can afford to provide. Last year, the General Assembly appropriated tens of millions of dollars of federal funds to pay for a two-year “patch” on holes in our “safety net” due to inadequate reimbursements for doctors and caring professionals, while also establishing a commission to review reimbursement rates going forward. That commission’s recommendations could reveal a funding need in the tens of millions of dollars. Also, a federal court ordered the termination of the truck toll program, that helped fund our roads. The Governor’s budget includes a $70 million “patch” of surplus funds for this revenue loss, but absent a successful appeal, we will have this hole in the budget going forward.
To conclude, the Governor’s proposal to reduce the sales tax has the surface appeal of bringing our rate closer to that of our neighbors and putting more money into Rhode Islanders’ pockets. With that said, I believe we must think about this proposal in a broader context, including (1) how our sales tax program (with its many exemptions) currently works in comparison to our neighbors, (2) who will benefit from the proposed reduction and in what amount and (3) what impact the reduction will have on our State government’s ability to provide needed services both now and in the future.