Should We Be Willingly Fooled by the Tax Overhaul?

I'll tell you the honest truth: I really desire to play along and cheer the proclaimed income tax revision just passed by the General Assembly, but that "revenue neutral" thing gives the whole endeavor the feeling of a scam. Consider:

An analysis of the plan by Paul L. Dion, chief of the state Office of Revenue Analysis, showed the following:

• About 60 percent of resident taxpayers — 297,489 — will see a tax decrease, averaging $226 apiece.
• About 21 percent — 103,434 — will see no change.
• About 19 percent — 96,461 — will see a tax increase, averaging $654 apiece.

In the past decade, Rhode Island's flat tax reduction and (since-abandoned) capital gains tax phase-out have helped to maintain our base of wealthy taxpayers, but we've been bleeding what I've called "the productive class": motivated, upwardly mobile folks in the working and middle class range. So, the question of how many people will gain or lose according to the new policy is less important than the matter of which people will gain and lose. I lack the time for an analysis of my own, but the General Assembly's press release provides some clues:

The legislation would lower tax rates, simplify the system by reducing the number of tax brackets, exemptions and credits, eliminate itemizing and increase the size of standard deductions. It would go into effect Jan. 1, 2011, and it is estimated that it would save taxpayers whose adjusted gross income is less than $175,000 a total of about $4 million in 2011.

It would eliminate the flat-tax option for the highest earners, instead reducing the top marginal income tax rate from 9.9 percent to 5.99 percent. That amount would still make Rhode Island more competitive with neighboring states in terms of attracting high-earning taxpayers and help shake the state’s reputation as being unfriendly to high earners, but would not give the highest earners as low a rate as the flat tax would have eventually become if it were to continue being reduced, as it would under current law.

Notwithstanding the proclamations of folks (like Gary Sasse) whom one expects to be on the right side of such issues, it looks like the state government has mainly orchestrated a freeze of the flat tax with a positive spin. In other words, they've made the tax code more progressive.

And it may be somewhat worse than that. I'd be in favor of a flat, percentage-based tax that everybody pays and can figure out in minutes with a calculator, but disfavoring those who itemize, in favor of a standard deduction, would seem to turn against economic activity. At least to my experience, the years that I've itemized have all, first, been years during which I carried a mortgage (i.e., invested in the state by buying a house) and, second, made significant investments in the work that I do (i.e., buying tools for carpentry and equipment for writing).

The basic problem with focusing on the visible tax rates — as this legislation does as its central premise and objective — is that the families that can help to pull Rhode Island out of its death spiral will also be disproportionately likely to look past the headlines. To the extent that taxation makes a difference (and it isn't all-determining, to be sure), those who are wealthy and those who are most motivated to build wealth will take a moment to figure out whether they're among the 19% whose taxes are going up.