The New Tax Scam

Yesterday, Marc highlighted the peculiarity of a tax reform that purports to lower most Rhode Islanders' taxes while increasing withholdings:

The point is to give workers "a little cushion so that when they get to the end of the year, they [won't] be in a situation where they'd owe money on their personal income tax," said state Tax Administrator David M. Sullivan.

As Marc points out, the effect of that "cushion" is to give the government a tax-free loan throughout the year courtesy Rhode Island's working population. Commenters to his post even go so far as to suggest the "cushion" might actually be to protect the state from the possibility that it won't be able to afford refunds when the tax year's over.

Such a prediction is a bit aggressive, for me, but the red flags of this scam are enough without them. For starters, consider this discordant note:

The changes make the state tax system easier to understand and calculate, said Michael F. Canole, the Rhode Island Division of Taxation's chief of examinations. "We've simplified our personal income tax," he said.

If the system is simpler, why is it necessary for the state to raise withholdings by so much? Typically, each exemption has taken $3,650 of income out of the withholding calculation; this year it will be $1,000. Seems to me that a simpler code would be easier to predict.

That leads to the obvious questions of for whom the tax code is easier and whom it will harm and help:

A report prepared by the Division of Taxation in September said that, as a result of the changes, 81 percent of Rhode Islanders "will either pay the same or less in personal income taxes going forward."

We know that the objective of the tax reform was to be "revenue neutral," meaning that it would create winners and losers. We've also read that the wealthiest will not be among the losers (although I can't find the link to that story, just now). And we know that the central change, beyond freezing the flat tax as the new highest bracket, is to eliminate itemized deductions.

So, the answer to my questions is that the loser 19% are going to be middle-income Rhode Islanders who, by their actions, have high deductions — people who've bought property with loans, who invest in businesses, and who have unreimbursed medical expenses for a few. Productive, advancing people. The sorts of people who have been leaving Rhode Island, but whom the state desperately needs if it is going to manage to pull out of its nosedive.

A look at the Dept. of Taxation's FAQ regarding the revised tax rates shows the standard deduction to which all "married filing jointly" taxpayers will be limited as $15,000. That's half of my itemizations, last year, meaning that my taxable income is going to more than double.

Frankly, although it feels odd to imagine such scheming, I can't help but wonder whether the just-in-case over-withholding — despite the simpler tax code — is actually meant to distract the losers until the tax year is over. After all, if the message is that "most Rhode Islanders" will actually pay lower taxes, but that everybody is going to have higher withholdings, then the average taxpayer won't figure out that he or she is in the negative 19 until it's too late.

(By the way, I don't have time to find the reports and dig into them, right now, but I can't help but wonder whether that 19% is measured by tax returns or actual taxpayers. If the former, then the number of losers is twice as high... and even that doesn't include their children.)