The kindest cost Although tax hikes are seen as political poison, raising the state income tax would have a modest impact on most taxpayers — 67 cents a week — and represents the most equitable way of solving Rhode Island’s $225 million deficit BY BRIAN C. JONES
	Have-not and have less The Ocean State ranks high when it comes to squeezing the poor WHEN IT COMES to taxing the poor, Rhode Island is the fifth meanest state in the country. This is the assessment of the Institute on Taxation and Economic Policy, a Washington, DC, research organization that looks at federal and state tax issues. In Rhode Island, the institute says, families farthest down the economic ladder pay a bigger portion of their already-meager incomes in state and local taxes than similar taxpayers in most other states. According to a report that the group issued in January, families with an average $8400 income — and who make up the poorest one-fifth of all taxpayers — turned over 13 percent of their incomes to pay sales, property, and state incomes taxes. But the top one percent of taxpayers — with average earnings of $757,400 — spent just 8.6 percent of their income for the three taxes. Only four other states had higher rates of taxpaying by the poor, led by Washington state, which charged the bottom fifth of the economic ladder nearly 18 percent of their incomes for state and local taxes. The reason for Rhode Island’s ranking, according to the economic institute, is the state’s heavy reliance on sales and property taxes, which are considered "regressive," since they take a higher toll on the incomes of the poor than the rich. The bite is higher on the middle class, too. For example, a family earning an average of $36,000, paid 10.7 percent of its income for the three state and local tax categories, while those with incomes averaging $189,000 paid nine percent. However, Rhode Island did not make a related top 10 rating — in which the tax institute estimated how "regressive" states are when they treat the poor harshly, but go light on the rich. Presumably, the state’s progressive income tax, which hits the wealthy harder — plus the wide variety of essential goods not subject to the sales tax, such as clothing and food — evens out the tax fairness equation. — B.C.J.

RAISE THE state income tax?

The very suggestion is likely to result in howls from Woonsocket to Westerly, from college campuses in Smithfield to neighborhood bars in Silver Lake and from one end of the State House to the other.

"Completely unacceptable," Governor Donald L. Carcieri thundered last week in announcing that the state’s red-ink problem is $50 million worse than originally thought.

"It will be a drag on the economy; it will slow the economy down," says William B. Sweeney, a Bryant College economist. "I’d be opposed."

And Senate President William V. Irons warns, "Don’t send the wrong signal to people locating jobs here."

Yet one of the least understood aspects of the state income tax is how relatively little it takes out of the pockets of most Rhode Islanders. That’s because it’s designed to put a heavier burden on wealthier taxpayers.

At the request of the Phoenix, the Institute on Taxation and Economic Policy, a Washington research group, analyzed the impact of a potential one-time 10 percent increase in the state income tax. The institute’s computer simulation found that such a hike would be minimal for a majority of Rhode Islanders — just $35 a year. This works out to 67 cents a week.

How could such a big-sounding hike be so cheap?

It’s because 305,505 taxpayers — who earn $50,000 or less a year and who represent 61 percent of all Rhode Island taxpayers — pay the state’s lowest income tax rates. This year, they will pay an average sum of $339. After a 10 percent hike, their tax bill would be $374.

Here’s how higher-income families and individuals would be affected by the hypothetical tax hike:

• Another big group of taxpayers — 133,960, or 27 percent — would see a relatively modest boost of $186 dollars a year. These taxpayers earn $50,000 to $100,000 a year. Right now, their average tax bill is $1821.

• The biggest bite — an average of $609 more a year — would be felt by the 12 percent of taxpayers who are the state’s wealthiest. There are 58,330 people or families in this crowd, with incomes of $100,000 or more. At the present time, their average state income tax bill is $9365.

What this means is that for 88 percent of Rhode Island taxpayers, a major boost in the income tax would leave them relatively unscathed. It’s doubtful that on a week-to-week basis, most would even notice the change. Meanwhile, the Institute on Taxation and Economic Policy’s micro-simulation model predicts that a 10 percent increase in the income tax might raise at least $70 million.

This is much more money than the extra $23 million state shortfall for 2004, identified by state budget experts this month, which will require either spending cuts or increases in revenue. The same experts predicted that money for the current financial year, which ends in June, will fall short by nearly $14 million, and that welfare spending is up $12 million. This extra $50 million is in addition to a $175 million deficit that Carcieri claims he closed in his proposed 2004 budget — which remains to be adopted by the legislature.

It’s not clear that the General Assembly will propose a 10 percent hike in the income tax — or even a more modest increase — because income tax hikes are always controversial.

Some liberal groups and politicians, however, have at least started discussing an income tax increase as an alternative to cutting programs they support, such as RIte Care, the state’s heralded medical insurance program for low-income families, and the state’s unique brand of welfare reform. Marti Rosenberg, executive director of Ocean State Action, a policy group of labor unions and community organizations, says social advocates and some legislators are weighing the pros and cons of a tax hike.

And the Rhode Island League of Cities and Towns has proposed that the General Assembly conduct an independent poll of Rhode Islanders, asking whether they would prefer a hike in the statewide income and sales taxes to higher local property taxes. Executive director Daniel L. Beardsley Jr. says the league is not pushing an increase in the income tax over the sales tax, or visa versa. But the group thinks the public should be asked whether it wants some state tax hike, rather than a town-by-town increase in local property taxes.

Local officials contend that the limits on state aid to cities and towns — proposed by Carcieri earlier this year — may force local property tax hikes to pay for increased school, police, and other municipal costs.

The Poverty Institute at the Rhode Island College School of Social Work has also included a theoretical income tax increase in a "laundry list" of possible budget moves that, it says, could reduce the state deficit while preserving key social programs. The list includes closing what it contends are "loopholes" in business tax breaks (saving up to $8 million a year), and imposing a new "land speculation tax" on profits when someone rapidly buys, then sells land ($15 million).

But the Poverty Institute says the biggest gains would be through a 10 percent increase in the state income tax, which it estimates would bring in as much as $85 million. (It also calculates smaller income tax rate increases, with skimpier revenue yields).

For all the political toxicity associated with tax hikes, there are indications that many Americans appreciate the importance of fairness on tax issues. Even though President George W. Bush maintains enviable popularity ratings, a recent New York Times poll revealed a high degree of public skepticism, for example, about Bush’s ongoing pursuit of tax cuts that primarily benefit the wealthy.

Yet state leaders, even those who stress the importance of a progressive approach to taxation, remain steadfast in their opposition to an income tax hike. During an appearance last week on WRNI-AM’s Focus: Rhode Island, Irons indicated he’d rather support an additional "luxury" sales tax on such items as suits that cost more than $500.

WHY IS 10 percent a target for a tax hike?

That’s what it would take to restore tax rates to what they were before a cut enacted in the boom years of the 1990s.

Don’t remember the income tax cut?

For the same reason that a boost in rates might escape the notice of most people, the major cut in the income tax in the 1990s was not noticed either — because, once again, only well-heeled residents were substantially affected.

At the time, the Institute on Taxation and Economic Policy estimated that between federal and state income tax breaks, the richest one percent of Rhode Islanders would average $5200 in savings, but everyone else would average less than $100.

There are two reasons to discuss restoring the old level.

One is that the income tax collects the most money — the latest estimate is that it will bring in $853 million next year. The sales tax raises nearly as much. The third largest source of statewide revenue is gambling, at about $340 million a year.

The other reason a hike is attractive to some experts is that they consider the income tax much fairer than the sales tax. They believe the sales tax hits the poor much harder than the rich. This might not seem obvious, since the rich have more money to spend and thus pay more in sales taxes.

But another way of looking at the fairness of taxes is to measure the percent of someone’s overall income that’s needed to pay the taxman.

The tax institute says the sales tax in Rhode Island takes more than eight percent of the income of the state’s poorest citizens — those with incomes less than $15,000. But taxpayers with incomes of $272,000 pay 0.8 percent of their income in sales taxes. Here’s why: With a sales tax, rich and poor pay sales tax at exactly the same rate — seven percent. And one-rate taxes take a bigger bite from the little guy.

For example, a family with a $50,000 income buys a $20,000 car, which requires sales tax of $1400. That’s 2.8 percent of the family’s overall income. But if a $100,000-income family buys the car, the tax is 1.4 percent of its income.

The same thing happens with local property taxes. Because rich people have more money, they end up devoting a smaller portion of their total income to property taxes — despite generally living in pricier houses.

So why is an income tax hike usually so unpopular?

Norton Francis, the senior policy analyst who calculated the impact of a hypothetical Rhode Island income tax hike, says one issue may be perception.

The sales tax is paid a little at a time, so except for when someone buys a car or another big-ticket item, the yearly bite isn’t felt as much. But with the income tax, Francis says, people see black and white results every year when they tally up their federal and state returns.

Still, many experts — including those who don’t bill themselves as apologists for the rich — say that income tax hikes can be counterproductive and end up hurting the state’s overall economy.

Leonard Lardaro, a University of Rhode Island economist, says an income tax hike could be damaging in the long run. Asked whether he favors a hike, Lardaro says: "There’s a huge reason not to. Rhode Island is a very high tax and high-cost state."

When companies consider locating in one state or another, Lardaro says, among the things they consider is the level of a state’s taxes. "I’m not saying you will have a big move out," should taxes be raised, he says. But he worries that other companies may not move in if Rhode Island has high income tax rates compared to other states.

Irons, the Senate president, say this is why he’s "totally against raising the income tax." He’s spoken to business executives who say they factor income tax rates when they explore setting up new business activities. In fact, Irons says, there’s even a term that companies use when they have to give their top executives raises, so they won’t lose income when moving to a higher-cost location: "grossing-up" pay levels.

Irons fears that if the income tax is raised, much of the work the state has done in making Rhode Island more attractive for business will be wrecked, and the state’s workers will lose the opportunity for new and higher-paying jobs.

Income tax advocates will argue that high-income executives can afford higher tax rates, Irons says, and he doesn’t disagree. But as a practical matter, anyone — of modest or high income — will seek to save money when they can. "If you don’t have to pay for something, you don’t," the Senate leader says, and thus the state might never see new businesses or jobs that might have come to Rhode Island.

A TAX HIKE would take money out of consumers’ pockets, says Sweeney, the Bryant College economist. In turn, this deprives the economy of the "multiplier effect" of one consumer’s spending fueling that of another. There’s also a "multiplier" effect in the economy when government collects taxes, Sweeney says. But he said the multiplier is higher for the private than the public sector.

Sweeney questions whether a tax hike is even needed. His economic forecast predicts the local economy will rebound in this fall. With increased jobs, the state will automatically get a boost in income tax revenue.

If budget changes are needed, Sweeney says, they should be made in reducing the size of the state payroll. He thinks this will happen when Carcieri’s "Big Audit," which will purportedly curb inefficiency in state government, is finished.

"You have to make a case for needing a hike in the state income tax," Sweeney says. "I don’t know [that] you can do that, particularly with the governor’s "Big Audit" — which I think will result in laying off maybe 500 employees — which is the only way to save money at the state level."

Carcieri himself has put the blame on "excessive spending," adding, "The costs of running state government have been increasing at an unsustainable rate for years."

But Nancy H. Gewirtz, head of the Poverty Institute, counters this assessment. She says an institute study found that government spending in Rhode Island has actually lagged behind the overall growth of the economy. She blames the deficit on the cost of the income tax cut, and a partial rollback of property car taxes — which, she says, is costing the state $100 million a year.

Those who favor the income tax (nobody claims to actually like it) argue that it’s simply a more even-handed way to support government. "It’s the most broadly-based, fairest tax," says Richard McIntyre, another URI economist.

McIntyre, who doesn’t believe a full restoration of the ’90s tax rate cut is needed, scoffs at arguments that a hike will make the state less welcoming to business. Forcing local communities to shoulder the burden of higher property taxes, he says, will be more devastating. "Saying raising [income] taxes will put us in a less competitive position — this is exactly backward," McIntyre says. "If you sacrifice a key portion of education and public safety, that does not put you in a competitive position."

In the end, raising one tax or another is not an academic discussion: It’s a political one.

On the surface, the politics of an income tax increase — which puts the least strain on the wallets of the most voters — would seem to argue for an income tax hike.

If 61 percent of taxpayer/voters were to pay an increase of less than a $1 per week, where would a massive outcry come from? On the other hand, there are passionate arguments on the other side.

So a side drama may take place at the General Assembly, as the legislature struggles with budget issues in the coming weeks.

If the debate hinges on the fairest way to raise the millions of dollars needed to pay the state’s bills, hiking the income tax seems a credible alternative. Most taxpayers wouldn’t feel the pinch; Those who would pay the most already enjoyed substantial tax breaks when times were better and are in the best financial position to pay more.

But even people who benefit from the income tax’s "progressive" structure tend to dislike this particular tax. Arguments that a tax hike will hinder an economic recovery that would create new jobs — and thus new income tax revenue — raise a potent counterpoint.

What is clear is that somebody will pay. The only uncertainty is whether the topic of fairness, especially for middle- and low-income Rhode Islanders, will be included in the discussion.

Brian C. Jones can be reached at brijudy@ids.net