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John Spry: Can Minnesota learn from Rhode Island’s bold tax reform?

By John Spry

St. Paul Pioneer Press (MN) – Sunday June 20, 2010

Rhode Island is passing Minnesota in the race for mobile workers, entrepreneurs, and job-creating investments. Its decision to do so could provide a roadmap for a major tax reform in Minnesota.

Rhode Island’s legislature unanimously voted to reduce its highest income tax rate from 9.9 percent to only 5.99 percent. That’s a 40 percent reduction. It will move Rhode Island from the nation’s fourth-highest income tax rate this year down to 25th place next year. Policy-makers believe it will help make Rhode Island much more competitive in attracting businesses — and jobs.

Rhode Island’s reasoning and the structure of its reforms could be instructive for Minnesota, which currently has the ninth-highest personal income-tax rate in the nation (7.85 percent).

The new Rhode Island tax code has a larger standard deduction of $7,500 for individuals, $15,000 for married couples; a $3,500 personal and dependent exemption; and three tax brackets: below $55,000, 3.75 percent; $55,000 to $125,000, 4.75 percent; over $125,000, 5.99 percent. It eliminates the state alternative minimum tax. The deduction and exemptions are phased out for higher income taxpayers.

Rhode Island pays for the reduction in tax rates and increase in the standard deductions by widening the income tax base. Rhode Island’s reform eliminates itemized deductions and limits tax credits. It keeps only eight tax credits, including a property tax credit and the earned income tax credit for lower income families. The number of tax brackets is reduced from five higher tax brackets to three lower brackets.

Eliminating itemized deductions makes the tax code more “transparent, easier to administer, and easier for taxpayers to understand,” according to Rhode Island Senate President M. Teresa Paiva Weed, a Democrat.

Many itemized deductions, like the home-mortgage interest deduction, seem politically popular. However, Rhode Island’s 68-to-0 House vote and 35-to-0 Senate vote demonstrate that lower tax rates can be more important than maintaining tax preferences.

Rhode Island’s unanimous tax reform shows how a coalition can be assembled to lower tax rates by widening tax bases. Every Democrat in the Rhode Island legislature was willing to support significant pro-growth reduction in tax rates because he or she recognized the benefits of lower tax rates in today’s competitive economy. “We are living in a mobile global economy. There are those people who will embark upon entrepreneurship … and they will shop around,” said Democratic State Sen. Daniel DaPonte.

House Speaker Gordon Fox, also a Democrat, commented, “This significant tax-reform legislation sends a loud and clear message to all other states that Rhode Island is aggressively seeking to attract business, create new job opportunities and ensure that our economy is moving in a positive direction. Combined with other bills we have passed this session to streamline our regulatory and permitting process, we have taken major steps toward becoming a business-friendly state.”

Republican Gov. Donald Carcieri and every Republican in the legislature were willing to end tax deductions in order to achieve significant reductions in tax rates. Gov. Carcieri called it “a clear message to our citizens, businesses, and neighbors that we are serious about improving our tax competitiveness.”

Will Minnesota follow Rhode Island’s lead by cutting our tax rates while simplifying the tax code by eliminating tax preferences?

Minnesotans face a choice about taxes in the fall election campaigns. The decision involves both tax rates and tax bases. Are Minnesota’s tax rates too high or not high enough? Are lower tax rates worth eliminating tax deductions? Or should we raise tax rates and create new tax loopholes? Is it better to pick winners and losers through the tax code or follow the example of Rhode Island’s tax reform?

Candidates should clearly explain their position on these issues. They should also explain how their tax policies would create an environment for job creation and economic growth.

Perhaps Minnesotans will agree with Democratic Rhode Island State Rep. Steven Costantino: “This is the moment that we can change our reputation” as a high-tax state. “Let’s tell our neighbors, ‘We are ready to do business.'”

John Spry of St. Paul is an associate professor in the department of finance at the University of St. Thomas.