Rhode Island’s personal income tax system has evolved into such a complicated entity that one of the authors of a study on the state’s tax structure calls it “broken.”
“We feel we have a system that is essentially broken and getting more broken every year,” said Grafton H. Willey IV, one of the authors of a study released by the Rhode Island Society of CPAs and Rhode Island Public Expenditure Council. “It’s become a really complicated system.”
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So complicated, in fact, that there’s no clear tax rate.
“The way it’s set up now gives politicians a way to not tell us how we are being charged,” Willey said.
From 1971 to 2001, the state’s personal income tax rate was tied to the federal income tax liability, meaning taxpayers owed Rhode Island a percentage of what they paid in federal taxes. That return was very straightforward and was the size of a postcard, Willey said.
Now, the state return runs for 12 pages and has a set of rules completely different from those for the federal calculations. Rhode Island has more than 40 different tax credits, which adds to the confusion.
According to the study, the General Assembly could have reduced Rhode Island’s income tax proceeds.
“It’s evolved into an income tax structure geared toward protecting state revenue,” said Gary Sasse, one of the authors of the study and executive director of RIPEC. “It doesn’t account for fairness.”
After Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, additional federal changes could have lowered the income tax burden in Rhode Island by accelerating specific deductions by using a taxpayer’s federal taxable income as a base for determining state tax liability, the study says. By not allowing that to happen, the General Assembly allowed the state tax return to become more complex.
“In every case, the state opted not to change the 2001 system and it became more complicated,” Willey said.
The maze of tax regulations makes it more difficult for businesses to operate in Rhode Island, Willey said. The depreciation rules for Rhode Island are different from the federal regulations. Many small-business owners use depreciation as a way to offset the cost of buying new equipment.
“It creates a huge inequity for successful businesses,” Willey said.
Both Sasse and Willey said Rhode Island’s tax structure keeps it from being competitive with other states in attracting economic development. Rhode Island has to closely examine the personal income tax structure to see if it encourages or discourages economic expansion and job retention, the study found.
Sasse said Rhode Island has the highest marginal tax rate, 9.9 percent. By comparison, Massachusetts is 5.3 percent and Connecticut is 5 percent.
“It impacts the cost of doing business,” Sasse said.
The RISCPA said it collected anecdotal evidence that the state’s high marginal tax rate may be influencing wealth creation and retention. The survey found that retirees were moving to lower-taxing states; some companies were locating in lower-tax states and serving Rhode Island customers without creating a tax base within the Ocean State; and companies with more than one location were making inroads into Rhode Island but locating those with higher salaries outside the state.
In the study, RISCPA and RIPEC recommend that the General Assembly and other decision-makers work to improve the transparency, simplicity, economic competitiveness, equity and fairness of the income tax system.
“There hasn’t been a thorough analysis of how our income tax structure is working,” Sasse said. The group recommends a total overhaul of the current state income tax system.
To start the process, the governor and General Assembly should examine the feasibility of an income tax system based on adjusted gross income, he added. Such a system is used in 26 of the 41 states that charge income tax.
