A 21st Century Sales Tax: Why Governor Chafee’s plan to modernize the sales tax is necessary

March 11, 2011

Rhode Island must modernize its antiquated sales tax in order to maintain investments in public services that improve our quality of life, protect our families and businesses, and help grow our economy. Today, we have one of the most narrow sales tax bases in the country, and our collections from this important source of revenue are well below the national average.

The Governor’s proposal to broaden the sales tax base and lower the rate is a logical and necessary response to a changing economy and shifting consumption patterns. When Rhode Island’s sales tax law was passed in 1947, the drafters could have never foreseen how our economy would change over time. Back then, people bought more goods than services and they bought those goods at local stores. Today, we consume more services than goods and we buy more things online, where purchases can escape taxation.

Consider these examples. When you purchase a lawnmower you pay sales tax, but your neighbor who hires a landscaper to cut her grass does not. When you buy ant traps or Raid at the grocery store, you will pay a sales tax, but you won’t if you hire an exterminator or pest control service.

Then there are the digital products that are commonly purchased through the internet today and can escape taxation. If you download music you don’t pay sales tax but you do if you walk into a music store and purchase a CD. The same is true of books, computer programs, and other “digital goods.”

The failure of our sales tax to keep pace with these changes in consumption is part of the reason that we do not have the resources we need. Because we have exempted many goods and not taxed many services Rhode Island has the sixth most narrow sales tax base in the country. Not surprisingly our sales tax collections are well below the national average. The Ocean State had the 38th lowest sales collections as a share of personal income of the 46 states that had a sales tax in Fiscal Year 2008.

Broadening the sales tax base can help generate much needed revenue and improve the adequacy of our sales tax for the long-term. Furthermore, it can reduce the short-term volatility of this important source of revenue during economic downturns, for example, when consumers forgo purchasing big ticket items like cars, computers, and appliances. Finally, expanding the base to services can make this tax more equitable by treating equally those consumers who choose to purchase goods and those who choose to spend money on services.

The Institute on Taxation and Economic Policy in Washington, D. C. has performed an incidence analysis to determine how much more, or less, different income groups would pay if the Governor’s sales tax proposal is enacted. They found that the poorest 20 percent of households that have annual income of less than $18,000 would pay $83 more a year in sales tax; the second lowest 20 percent of households with incomes between $18,000 and $32,000 would pay $163 more in sales tax. The impact for all income groups is shown in Table 1.

INCOME
GROUP
AVERAGE TAX CHANGE PER YEAR TAX CHANGES AS PERCENT OF
INCOME
Lowest 20%
(Less than $18,000)
$83 +0.8%
Second 20%
($18,000-$32,000)
$163 +0.7%
Middle 20%
(32,000-$57,000)
$224 +0.5%
Fourth 20%
($57,000-$90,000)
$341 +0.5%
Next 15%
($90,000-$169,000)
$413 +0.3%
Next 4%
($169,000-$396,00)
$546 +0.2%
Top 1%
(More than $396,000)
$1,732 +0.2%

For low and modest-income households, the increase in sales tax payments can be offset through a strengthened state refundable Earned Income Tax Credit (EITC). Close to half of the states offer a state Earned Income Tax Credit, and most of those credits are fully refundable. Rhode Island’s EITC is only partially refundable, leaving much room for improvement to boost the incomes of low-wage families and offset the more regressive sales and property taxes. The Institute on Taxation and Economic Policy found that a fully refundable state EITC in Rhode Island would offset the impact of expanding the sales tax base for the poorest families in the state.

The Governor’s balanced approach to balancing the budget avoids even deeper spending cuts that would hurt struggling families, damage our state’s fragile economy and jeopardize our recovery.

A majority of Rhode Islanders agree with this balanced approach. A Brown University poll conducted in March found that close to 68 percent of Rhode Islanders believe it is necessary to use a combination of spending cuts and tax increases to balance the state’s budget.

Rhode Islanders understand we cannot cut our way to prosperity. Crumbling bridges, tuition hikes, and waiting lists for workforce development training will not help our economy grow. We need to invest in our current and future workforce and infrastructure in order to get our economy back on track. Modernizing the sales tax is critical to ensure that our state has the revenue we need on an on-going basis to provide critical public services.

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