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This week, Rhode Island Governor Lincoln Chafee joined the very short list of governors supporting a balanced approach to addressing significant revenue shortfalls.  Like governors in Connecticut, Minnesota, Illinois, Hawaii, and North Carolina, Chafee included new revenue in his budget proposal, which will help mitigate the impact of otherwise devastating spending cuts. 

Significant changes to Rhode Island’s sales tax would raise enough revenue to close roughly half of the state’s $331 million budget gap.  Chafee proposes a two-tier sales tax rate structure, a 6 percent rate on most goods and some services and a 1 percent rate on certain additional items currently not taxed. 

The 6 percent sales tax would be a broader version of the existing tax. Chafee would expand the base of the sales tax to include an array of services currently not taxed as well as some goods that are legislatively exempt from the sales tax, including newspapers, live entertainment, car washes, and dry cleaning services.  The main sales tax rate would be lowered from 7 percent to 6 percent and the combined change would raise around $78 million for next fiscal year.

Chafee’s plan would also apply a new 1 percent sales tax to more than 40 goods currently exempt from the sales tax including clothing, boats, flags and farm equipment. 

Under the plan, food, prescription drugs, durable medical products and gasoline would continue to be exempt from state sales taxes. 

Chafee’s budget proposal also included an overhaul of business taxation, including enacting combined reporting, phasing down the corporate income tax rate from 9 to 7.5 percent, and restructuring the corporate minimum tax so that corporations pay differing amounts based on their total sales in Rhode Island.  These combined changes would result in a net revenue loss of $14.5 million once fully implemented in FY16, but Chafee champions the package as one that will make the state more business-friendly and competitive with neighboring states.

Kate Brewster, Executive Director of the Poverty Institute, commented on the governor’s budget proposal to GoLocalProv: “We are pleased that our Governor has taken a balanced approach to balancing the budget that includes revenue raising proposals rather than relying on a cuts-only strategy… His proposals to close corporate loopholes through combined reporting and bring our sales tax into the 21st century are responsible tax policies.”

While we agree Governor Chafee should be applauded for embracing a balanced approach to the budget that includes important tax modernization changes, relying solely on the sales tax to raise revenue inevitably means that the state’s poorest residents will shoulder the largest share of the tax increase.  An ITEP analysis found that the bottom 20 percent of taxpayers will pay on average an additional 0.8 percent of their incomes in sales taxes while the top 1 percent on average will only pay an additional 0.2 percent. 

In order to lessen the impact of the sales tax changes on low- and moderate-income households, Rhode Island lawmakers should consider increasing their state Earned Income Tax Credit (EITC).  Rhode Island currently allows for a 15 percent refundable EITC or an optional 25 percent non-refundable EITC.  According to ITEP analysis, eliminating the optional non-refundable EITC and increasing the refundable credit to 25 percent (in other words, all eligible taxpayers would receive a refundable EITC that is 25 percent of their federal credit), would offset the impact of the sales tax changes on the poorest 40 percent of households.  This change would cost an estimated $26 million, which could be paid for by scaling back the governor’s corporate income tax rate reduction.

It is also curious that Governor Chafee chose a two-tiered sales tax rate structure rather than simply applying his entire list of currently exempt items to the higher sales tax rate.  If Rhode Island had one sales tax base, the main sales tax rate could be reduced even lower than 6 percent while still raising a significant amount of revenue.