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A Lower Corporate Tax or Lower Sales Tax: What Does RI Need More?

Monday, March 11, 2013

 

The choice between lowering the state's corporate tax rate and the state's sales tax isn't "black and white," says former Rhode Island Public Expenditure Council (RIPEC) director Gary Sasse.

Last week’s news that the state’s unemployment rate had dropped to 9.8 percent in January of this year sparked a lot of debate over what Rhode Island could do to further pull its economic and job climate out of the bottom of national rankings.

But that topic has been discussed in detail ever since the recession began and now, as the General Assembly begins to analyze and scrutinize Governor Chafee’s proposed fiscal year 2014 budget, two potentially dramatic shifts in Rhode Island’s tax structure have been heralded as the end-all, be-all cures for the state’s woes.

The question is, however, which proposal should lawmakers focus their efforts on this legislative session: Reducing the corporate tax rate from nine percent to seven percent, as Governor Chafee advocated in his State of the State address, or reducing/eliminating the state’s sales tax, an idea backed by a number of lawmakers in the House of Representatives?

Not Just a Hypothetical

The idea of pitting the lower corporate tax rate against the lowered sales tax rate is not just a hypothetical meant to spark workplace conversations around a water-cooler, it’s been one of the leading topics of discussion for the Rhode Island Center for Freedom and Prosperity (RICFP), a group that argues only one of the two proposals would have an immediate, lasting impact.

In an analysis done earlier this year, and promoted heavily on social media by the group last week, the organization says the true impact of the lowered corporate tax rate would be about 144 private sector jobs and local receipts of roughly four million dollars.

By contrast, the group says, eliminating the state’s sales tax would create 23,873 jobs and be bring in $157.7 million locally.

Does that mean the state would be better served focusing on lowering its sales tax rate, which the non-profit organization the Tax Foundation says is the second-worst in the country, or reducing its corporate tax rate, which many economists argue is a leading roadblock to attracting new businesses?

It depends whom you ask.

Pros and Cons of Chafee’s Corporate Tax Proposal

The concept of a lower corporate tax rate has been floating around the Rhode Island State House for years but it wasn’t until Governor Chafee’s State of the State speech that it truly picked up steam.

Experts on the state’s economy all say the benefit of such a move is crystal clear and would go a long way in the state’s efforts to create a business-friendly environment that could potentially attract a rash of new companies who otherwise would never have considered making Rhode Island their home.

Even the majority of the state’s political leaders couldn’t find fault with the concept.

But some question just how big the immediate impact would be as the proposal, as currently outlined, would not be revenue-neutral and would still leave some loopholes that could have a devastating impact on the state’s efforts to turn itself around.

Gary Sasse, former Rhode Island Public Expenditure Council (RIPEC) director, called Chafee’s plan a “step in the right direction,” but stopped short of fully endorsing it for this very reason.

As chair of the Governor’s Tax Policy Strategy Group, Sasse helped write a report back in 2009 that concluded that the “modest changes in the Corporate Income Tax might be insufficient” and recommended “taking a more dramatic step” that would place Rhode Island in “the horizon of companies as they look toward economic recovery and renewed business activity."

The group said it favored a phased-in elimination of the corporate income tax outright and felt it would “distinguish Rhode Island from other states as being business friendly” and would be “striking enough to alter the negative perception of taxes in Rhode Island."

Sasse said the group concluded that eliminating the corporate income tax and replacing it with a franchise tax system featuring a tiered system based on a corporate net income would be the best result going forward but that’s not the plan in place and one of the primary issues Sasse takes with the governor’s current initiative.

“Lowering the corporate tax rate is a step in the right direction, it’s not a negative thing, it’s a positive thing,” he said. “But then the question you have to ask is how are you going to pay for it and what impact do you think it will have on your competitive position? Those are the two questions.”

The Sales Tax Issue

The effect of a reduced or eliminates sales tax has spurred a lot of debate in terms of how much revenue Rhode Island would really stand to lose each year.

Not surprisingly, the biggest resistance toward a lower sales tax is also the idea of the revenue the state would lose by reducing its current rate.

Opponents to a bill introduced by Representative Jan Malik and cosigned by Reps Brian Newberry, Joseph McNamara, Samuel Azzinaro, and Arthur Corvese that would completely eliminate the tax say it would leave the Ocean State with a $887 million hole to fill each year.

Supporters, meanwhile, say that the immediate impact would be felt as it would spur economic development by way of shopping and redirect money currently leaving to businesses in Massachusetts and Connecticut back into the Ocean State.

To this end, the RICFP says the budget gap is more in the $105 million range.

And that’s why Malik, a liquor store owner, believes having the state legislature address the issue of Rhode Island’s sales tax would go a lot further than any potential corporate tax reduction.

“I honestly think if you talk to any business that’s affected by the state’s sales tax issue, that is at a disadvantage to neighboring states, they will tell you and I will tell you, that we would rather see the sales tax lowered than the corporate tax go down,” he said.

Sasse says reducing the state’s sales tax is a more complicated issue than just dropping a number. He argues that the way to analyze what impact a change in the sales tax would have is through “dynamic forecasting,” and even that strategy is troubled.

“What dynamic forecasting means is if I’m going to change the tax, I’m going to need to change behavior and that change in behavior and that change in behavior is going to make for more revenue to offset the price difference,” he said. “But the problem with forecasting that way is the timeline is for two-three years, even if the dynamic forecasting is right and there are no economic changes, it takes time to catch up so you have a hole in the budget for that period of time which is a problem.”

The second issue, Sasse says, is that the forecast is based on models and “those models are only as good as the assumptions that are put into them.”

“That’s a theoretical model that says if we do this, people’s behaviors will change and this will happen and it’s based on the lag period,” he said. “How do you make up the revenue you forgo until economic habits change? That’s the real issue with the sales tax proposal.”

The Small Business Connundrum

For Malik, the choice is clear. The corporate tax reduction, he says, will predominately affect only larger businesses. Trimming or eliminating the sales tax, he argues, would not only benefit the state’s small businesses but its residents as well.

Malik adds that, because the proposed lower corporate tax rate wouldn’t reduce or eliminate the minimum corporate tax of $500 that most small businesses pay now, it would only affect larger corporations that may or may not decide to locate in the state.

The Barrington/Warren State Rep argues that Rhode Island is at a real, competitive disadvantage with neighboring states like Massachusetts right now and needs to spend more time dealing with hard facts than hypothetical business models when deciding what policies to focus on.

“What happens is if I’m on an even playing field with my neighboring community or my neighboring state, you can be competitive,” he explains. “The tax on gas is 11 cents cheaper per gallon, there’s a seven-percent difference in sales tax on liquor from Rhode Island to Massachusetts. There’s a 0.75 percent sales tax from their 6.25 to our seven percent tax so people are shopping.”

A Matter of Choice

Sasse says choosing which tax reduction to target is a complicated issue.

“It depends on what kind of industries you want to attract,” he said. “If you want to attract manufacturing jobs, if you want to attract med/ed jobs, research jobs and you want to attract companies to produce, for example, medical devices, then you want to lower the corporate tax. That has a much more direct impact. If your objective is to try to attract more retail jobs, then it’s the sales tax.”

Sasse says he believes the tax choices a state makes have to be a part of a broader economic strategy.

“If you look at the jobs numbers, and this is pretty interesting, between the recession, and last month, we still have lost 22 percent of our manufacturing jobs, we’ve lost 35 percent of our construction jobs,” he said. “We’re gaining jobs in sectors that depend on government spending and we’re losing jobs in sectors that depend on private investment so you want to change tax policy to incentivize companies to make private investment here and … it really depends on the type of company and the type of business sectors that you’re trying to attract.”

URI economist Dr. Len Lardaro agrees and says the state has to “totally reinvent itself” if it really wants to make a change.

“Our tax and cost structure consists of our taxes, fees, regulations, electricity costs, and most importantly, the lack of skills of our state’s labor force,” he said. “Given our fees, regulations, and inappropriately skilled labor force, the overall impact of changes in any particular tax will be somewhat muted since the world is not linear.

The impact of a lower corporate tax rate, for example, depends among other things on whether firms who want to locate or expand here are able to secure enough adequately skilled labor to fulfill their needs. As that is problematic, the effect of lowering our corporate tax rate will therefore have some positive effects, but not as many as one would observe in a state with a more competitive economic climate.”

Something Must Be Done

Whether or not the General Assembly addresses either the corporate tax rate or sales tax rate this session remains to be seen.

Regardless of which tax reduction is more vital to Rhode Island’s economic future, lawmakers, economic experts and political leaders all agree the General Assembly can’t just sit on their hands this session and leave the status quo intact.

“A gradual reduction in the corporate tax rate and the sales tax rate would be beneficial to Rhode Island businesses and citizens,” said Dr. Edward M. Mazze, a professor of business administration at the University of Rhode Island. “The reductions would put the state in a better competitive position to attract and retain businesses. Our tax rates would then be competitive with the other New England states. This would a major boost to economic development in Rhode Island.”

“In one sense this is a false alternative,” said Susan Wynne, the President of the Rhode Island Tea Party. “Both reductions (or eliminations) are moral and just: they leave the money with the proper owners rather than ‘redistribute it,’ which means expropriate it. And both will help signal nationally that we are slowly opening the doors for free enterprise and capitalism to return to RI. Currently we are doing the opposite! We are running Hasbro, MetLife and possibly CVS jobs out of town with RI's notorious regulations and taxes.”

Representative Doreen Costa agrees the topics are worth discussion but says it’s entirely possible the General Assembly may not address either issue.

“Honestly the way things are going in this state it would be a small miracle if either were to happen,” Costa said. “Legislators are too busy making gun laws, putting camera's at traffic lights, revoking voter ID laws and submitting legislation that in no way will help the taxpayer from what I have seen in hearings so far.”

Mark Zaccaria, the head of the RI GOP, says Rhode Islanders should be clamoring for both proposals “given the long-term benefits,” and hopes the ideas don’t die out before getting serious consideration.

“Legislators are notorious for their short-term vision,” he said. “If I had to suggest which order these two taxes should be cut I’d probably opt for the Corporate Tax first then the Sales Tax second (but) these benefits might take a year or more to be felt, and legislators don’t have nerves of steel when it comes to waiting for results so nothing is easy.”

 

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