Characteristics of a High-Quality Revenue System

Public finance experts generally believe that state and local revenue systems should be based on a "three-legged stool" approach, with personal income, sales and property taxes generating the majority of revenues, supplemented by excise taxes, business taxes, severance taxes and user charges.

The state-local revenue system should be marked by revenue diversification - fairly equal reliance on the big three (income, property and sales), with user charges and "all other" revenue sources rounding out this picture…The more intensively a jurisdiction makes use of any one of these revenue sources, the less obvious become its unique advantages and the more apparent its unique disadvantages.

Despite this public finance tenet, local circumstances, social and economic considerations, and political predilections determine how closely this guideline is followed. New Hampshire, for example, relies almost entirely on local property taxes as its main source of revenue, and Alaska depends heavily on tax revenues received from the extraction of natural resources. It should be noted that both of these states are currently under pressure to restructure their revenue systems.

What are the attributes of a high-quality revenue system?

A panel of public and private sector tax officials, convened in the early 1990s by the Foundation for State Legislatures (a group affiliated with the National Conference of State Legislatures), highlighted the major characteristics of a high-quality state revenue system. This group put forward nine principles, which are restated below as a guide to evaluate Rhode Island's current revenue system and as a means by which one can measure proposed changes to the system.

A high-quality state revenue system:
1. Comprises elements that are complementary, including the finances of both state and local governments;
2. Produces revenue in a reliable manner. Reliability involves stability, certainty and sufficiency;
3. Relies on a balanced variety of revenue sources;
4. Treats individuals equitably. Minimum requirements of an equitable system are that it imposes similar tax burdens on people in similar circumstances, that it minimizes regressivity, and that it minimizes taxes on low-income individuals;
5. Facilitates taxpayer compliance. It is easy to understand and minimizes compliance costs;
6. Promotes fair, efficient and effective administration. It is simply and professionally administered, raises revenue efficiently, and is applied uniformly;
7. Is responsive to interstate and international economic competition;
8. Minimizes its involvement in spending decisions and makes any such involvement explicit; and
9. Is accountable to taxpayers.

These principles apply more easily to revenue "systems" than they do to individual components of the system. RIPEC believes that it is the State's overall revenue system - made up of a number of taxes - that requires the attention of the Ocean State's leaders, those from the public sector as well as the private sector. Changing one tax in isolation may result in unintended consequences for other taxes, and adversely impact both individual taxpayers and the government's fiscal health.

If one were able to start with a clean slate, it would be much easier to construct a state and local tax system that reflects the benchmarks of a high-quality system that are detailed above. However, Rhode Island, like all other states, already has in place a tax system that has been fashioned and refashioned over the course of many decades. This report recognizes the current fiscal landscape and attempts to map out a series of steps that will be productive in moving the State toward a more responsive and responsible tax system that incorporates the principles of a high-quality revenue system.

In reviewing this document, the reader should keep in mind the components of the high-quality revenue system, and also be mindful of the relationship between State taxes and local taxes. In particular, the following questions might be asked:

• Does the State rely too heavily on one type of tax - personal income, property or consumption taxes - to fund government services?
• Are tax revenues produced in a reliable and stable manner or are they subject to extreme highs and lows?
• Is the overall tax system progressive, or does it impose a larger burden on lower-income individuals than the burden placed on middle-income and upper-income individuals?
• Is the system easy to understand and are compliance costs minimal?
• Does the tax system encourage or discourage job creation and does it compare favorably to tax systems in neighboring and competitor states?
• Is the tax burden on people in similar circumstances equitable, or does the tax burden vary significantly depending on one's place of residence or type of income?
• Is the system administered fairly and efficiently?

For some of these questions the answers seem obvious. Others, however, may require a more careful review of the tax system. By stepping back and looking at the total tax structure and identifying its strengths and weaknesses, RIPEC believes the State can establish a high-quality revenue system that reflects the needs of all Rhode Islanders, that fosters economic growth, and that is fair, equitable and efficient.