Representative Tax System

Originally developed by the now-defunct United States Advisory Commission on Intergovernmental Relations (ACIR), the Representative Tax System (RTS) evaluates a state’s tax capacity by estimating the per capita yield that a hypothetical, uniform, representative tax system would produce in each state. For each of 26 individual taxes, a uniform tax rate is levied on an ideal comprehensive base. The RTS is the only fiscal capacity methodology that takes into account the mix of economic flows and stocks characterizing a state's economy. In establishing the "ideal comprehensive base," RTS makes certain assumptions concerning the definition of the tax base if it were devoid of all tax incentives or tax breaks, including exclusions, deductions and exemptions intended to encourage certain forms of behavior or to relieve the tax burden on certain groups or individuals. For example, the general sales tax, under the RTS system, ideally applies to all goods and services at the retail level, including such frequently excluded items as food and clothing, both of which are excluded from Rhode Island's general sales tax. From this ideal base, RTS removes items that are almost never taxed because of administrative or political constraints, such as business services. In developing the ideal comprehensive base, by necessity, certain assumptions are made regarding the application of the tax.

The hypothetical tax rate is determined by calculating the ratio of actual nationwide collections from the tax to the value of the nationwide standard base, as defined by RTS. For example, in FY 1996 the estimated nationwide standard retail sales tax base was $2.536 trillion. Nationwide collections from the retail sales tax were $169.0 billion, which results in an RTS standard sales tax rate of 6.67% (i.e., $169.1 billion/$2.536 trillion).

After the characteristics of each tax are determined, RTS distributes each base among the states on a per capita basis and applies the standard rate to each state’s base to estimate the state’s capacity to raise tax revenues. The U.S. average is set equal to 100. States with a tax capacity index above 100 are considered to have an ability to raise tax revenues that is greater than the national average, while states with an index below 100 are considered to have less ability to raise revenues.

Originally developed by the now-defunct United States Advisory Commission on Intergovernmental Relations (ACIR), the Representative Tax System (RTS) evaluates a state’s tax capacity by estimating the per capita yield that a hypothetical, uniform, representative tax system would produce in each state. For each of 26 individual taxes, a uniform tax rate is levied on an ideal comprehensive base. The RTS is the only fiscal capacity methodology that takes into account the mix of economic flows and stocks characterizing a state's economy. In establishing the "ideal comprehensive base," RTS makes certain assumptions concerning the definition of the tax base if it were devoid of all tax incentives or tax breaks, including exclusions, deductions and exemptions intended to encourage certain forms of behavior or to relieve the tax burden on certain groups or individuals. For example, the general sales tax, under the RTS system, ideally applies to all goods and services at the retail level, including such frequently excluded items as food and clothing, both of which are excluded from Rhode Island's general sales tax. From this ideal base, RTS removes items that are almost never taxed because of administrative or political constraints, such as business services. In developing the ideal comprehensive base, by necessity, certain assumptions are made regarding the application of the tax.

The hypothetical tax rate is determined by calculating the ratio of actual nationwide collections from the tax to the value of the nationwide standard base, as defined by RTS. For example, in FY 1996 the estimated nationwide standard retail sales tax base was $2.536 trillion. Nationwide collections from the retail sales tax were $169.0 billion, which results in an RTS standard sales tax rate of 6.67% (i.e., $169.1 billion/$2.536 trillion).

After the characteristics of each tax are determined, RTS distributes each base among the states on a per capita basis and applies the standard rate to each state’s base to estimate the state’s capacity to raise tax revenues. The U.S. average is set equal to 100. States with a tax capacity index above 100 are considered to have an ability to raise tax revenues that is greater than the national average, while states with an index below 100 are considered to have less ability to raise revenues.

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Appendix Table 1 shows the index of tax capacity for Fiscal Years 1996, 1994 and 1991. In each of these years, Rhode Island’s tax capacity was consistently below the National average and significantly less than almost all other northeastern States. In FY 1996 and FY 1994 Rhode Island had a tax capacity index of 91 (ranked 38th and 37th, respectively), compared to Connecticut’s second-ranked index score of 129 and Massachusetts’s 8th place tax capacity index score of 116. In FY 1991 the Ocean State’s tax capacity index score was 89, while both Connecticut and Massachusetts placed among the top ten states.

Tax Effort — While the tax capacity index measures a state’s ability to raise revenues, the tax effort index compares the actual revenue raised by state and local governments against the hypothetical, uniform representative tax system discussed above. In short, tax effort measures the extent to which a state utilizes its available tax base.

Using this index, as shown in Appendix Table 2, Rhode Island’s State and local tax effort in FY 1996 was 17% greater than the national average. The Ocean State’s index of 117 was second highest in the country and the highest in New England. The index score for FY 1994 shows similar results for the Ocean State. Across New England, with the notable exception of New Hampshire, all states exhibited relatively high tax effort. Rhode Island’s FY 1991 tax effort index of 115 placed the State 4th in the U.S.

Analysis — All else being equal, the ideal situation is to have a high tax capacity and a low tax effort, or at least a positive differential between tax capacity and tax effort. States with a relatively high tax capacity in relation to tax effort include: Nevada (+68), due in large part to the exporting of taxes through its tourism industry, Wyoming (+53), due to heavy dependence on natural resource extraction-based tax revenues, New Hampshire (+44), Colorado (+32) and Delaware (+31).

On the other hand, state and local governments with relatively low tax capacity in relation to tax effort need to be mindful of the resource constraints they face. Those states with relatively low tax capacity in relation to tax effort include New York (-32), Mississippi (-30), Rhode Island (-26), Maine (-24) and West Virginia (-21).

Appendix Table 3 provides additional details for FY 1996 RTS calculations of tax capacity and tax effort for each of the three main state and local tax sources - property, personal income and sales. Rhode Island ranks relatively low in terms of tax capacity for all three categories, while its 4th place property tax effort ranking (63.5% greater than the National average) reveals the Ocean State’s well-known over-reliance on property taxes. The Ocean State’s personal income tax effort is 16.7% above the National average, which placed the State 19th overall. The State’s general sales tax effort is low compared to other states — 19.5% below the U.S. average (ranked 35th) — due to the narrow base upon which Rhode Island’s sales tax rate is applied.

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Critics of the RTS note the arbitrary choice of a standard tax rate, which may overestimate the taxing capacity of low-income states. In addition, the RTS assumes that a state’s ability to tax one set of economic transactions is independent of the intensity with which it taxes other bases. While RTS is far from a definitive measure of a state’s fiscal health, it is viewed as a decent indicator of overall state fiscal comfort and is a valuable tool in measuring aggregate tax capacity and the overall tax burden or effort imposed on a state’s taxpayers.

Personal Income Tax

Taxpayer Profiles - Assumptions and Methodology

RIPEC calculated the income tax burden for tax year 1999, using a set of assumptions concerning types of income (e.g., salary, capital gains, dividends, interest), deductions, credits and other relevant tax provisions. As discussed further in the body of this report (pages 31 through 34), taxpayer profiles were developed by RIPEC for families earning $500,000 and $1.0 million in annual income gain a better understanding of Rhode Island's personal income tax liability for upper-income tax filers and how Rhode Island's tax liability compares to other states. Tax returns were produced for a hypothetical family of four (two adults and two children).

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Types of Income - Due to Internal Revenue Service data limitations, a number of assumptions pertaining to types of income were developed by RIPEC. Tax professionals (i.e., tax attorneys and certified public accountants) reviewed these income assumptions to ensure some level of reasonableness. The following table provides information on the assumed income distribution for these two income groups.

Deductions - For families with $500,000 of income, a medical and dental deduction of $500 and charitable contributions of $10,000 were assumed. For families with $1.0 million of income, a medical and dental deduction of $500 and charitable contributions of $20,000 were assumed. Mortgage interest was assumed to be $25,000 for families with $500,000 of income and $50,000 for families with $1.0 million of income.

The deduction for state and local taxes paid was determined individually for each state. Using IRS data for the $500,000 income level, RIPEC calculated the average amount of state and local taxes deducted for this income level in each state. RIPEC then calculated an estimated state income tax liability for each state. This state income tax estimate was then compared to the estimated total state and local tax deduction reported by IRS. The difference in the two estimates was assumed to be real estate and personal property taxes.

In order to arrive at a total state and local tax deduction amount, RIPEC then recalculated the state tax return using the initial estimated state and local income tax amount and the estimated real estate and personal property tax amount. For example, the estimated amount of Rhode Island state and local income taxes paid was $37,848 and the real estate and personal property tax was assumed to be $10,902 for families with $500,000 of income. For Massachusetts, it was estimated that state and local income taxes paid were $32,893 and real estate and personal property taxes paid were $6,107.

For families with $1.0 million of income, the estimated real estate and personal property tax was estimated to be 133% of the amount reported for each state for families with $500,000 of income. The state and local income tax amount was first calculated and then re-calculated, adding back the estimated real estate and personal property taxes applicable for each state.

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Property Taxes

Property Value Per Pupil: Appendix Table 4 shows full property value for each community (adjusted for inflation), student enrollment and property value per pupil from 1978 to 1998. Using full value eliminates the effect that property revaluations, exemptions, credits and other circumstances may have on the analysis.

The Statewide full property value in FY 1978 totaled $35.1 billion. Statewide property value increased to $53.4 billion by FY 1988, representing an increase of 52.2%. During this ten-year period the ten urban communities’ property value increased 40.3% while the 29 non-urban communities’ property value increased 67.8%.

From FY 1988 to FY 1998 the statewide adjusted property tax base declined 1.3%, dropping from $53.4 billion in FY 1988 to $52.8 billion in FY 1998. During this period, the ten urban communities’ property tax base decreased by 16.9% while the non-urban communities’ property tax base increased by 15.9%.

If one looks at the change in property value over the 20-year period from FY 1978 — FY 1998, the adjusted full value of property for the ten urban communities increased by 16.6% ($3.4 billion). The remaining communities’ adjusted full value increased by 94.5% ($14.3 billion). The 12.2% decline in the City of Providence played a significant role in driving down the overall growth during this period.

Student Enrollment: From 1978 to 1988 statewide enrollment decreased by nearly 20%. Nearly 60.0% of the enrollment decline occurred in the urban communities. However, from 1988 to 1998 enrollment increased by 14% (18,234 students). The urban communities had 55.4% of the Statewide increase (10,111 students) and the non-urban communities had 44.6% (8,123 students) of the increase over this ten-year period. The net effect from 1978 to 1998 was a decrease in enrollment of approximately 8.5%.

However, enrollment changes among districts varied significantly during this period. While several districts lost enrollment during this ten-year period, the City of Providence experienced the greatest change in terms of total numbers. From 1988 to 1998, the City of Providence’s student enrollment increased by 6,172 students (31.8%).

Property Value Per Pupil: Using community property values adjusted for inflation, the average property value per pupil in Rhode Island increased from $210,721 in 1978 to $398,409 in 1988 to $346,268 in 1998. In 1978, the property value per pupil in the ten urban districts was 1.0% higher than the State average and 2.4% higher than the non-urban average. In 1998 the property value per pupil in the ten urban communities was 20.8% below the State average and 37.2% below the non-urban average ($436,618 per pupil).

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Revaluation Cycle: Legislation enacted in 1997 established a nine-year revaluation cycle, requiring two statistical updates during each nine-year cycle in lieu of the requirement to perform a revaluation once every ten years. The law defines what constitutes a statistical update and outlines appropriate update methods. Appendix Table 5 outlines the schedule of revaluations and statistical updates included in the 1997 reform legislation.

To ensure a smooth transition to the new revaluation schedule, the legislation outlines a schedule for the nine-year revaluation. Those communities that conducted a revaluation after 1992 must conduct a statistical update prior to their next scheduled revaluation. Once these communities conduct their scheduled revaluation, they will be required to begin the nine-year revaluation cycle from that point forward. Those communities that conducted a revaluation in 1992 or before will not be required to conduct a statistical update prior to their next scheduled full revaluation.

The legislation also outlined a State-local cost-sharing program for statistical updates. The first statistical update for each municipality will be fully funded by the State, up to $15.00 per parcel. The second statistical update for each municipality will be 80% funded by the State, up to $10.00 per parcel, based on an average cost per parcel of $12.00. Local communities would make up the balance. The third statistical update and those thereafter will be 60% funded by the State, up to $6.00 per parcel, based on an average cost per parcel of $10.00. Again, local communities would make up the balance. Communities that qualify as distressed communities (under R.I.G.L. 45-13-12) will receive from the State 80% of the cost to conduct statistical updates the third time and thereafter (no more than $8.00 per parcel).

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National Governors' Association

Streamlined Sales Tax System for the 21st Century

The current system of state and local sales tax administration is complex and burdensome. Differences in tax law among the states, coupled with the extensive use of the tax by local governments in many states, impose a significant compliance burden on multistate sellers, a burden for which they are not compensated in many instances. The tax system has not kept pace with changes in the U.S. and global economy and is particularly out of step with electronic commerce. Moreover, current legal rules are such that some types of retailers are treated differentially for the same items depending on the form of selling in which they engage and their contacts with the different states.

Substantial changes are necessary if the sales tax is to continue as an integral part of the state and local revenue system. Sales tax laws must be made significantly more uniform across the states, and the administration of the tax must be substantially overhauled and simplified. The goal of this proposal is to develop a more simple, uniform, and fair system of state sales and use taxation that significantly reduces the burden imposed on retailers, preserves state and local sovereignty, and enhances the ability of U.S. firms to compete in the global and information economy. The proposal is voluntary, retaining current law with regard to nexus, and moves to a uniform system over the longer-term. The proposal has both short-term and long-term components.

Step 1 - Create a zero burden system over the next 2-5 years.

The short-term goal is to create a burdenless system of collecting sales and use taxes that are owed by purchasers. The system will be simple, streamlined, and voluntary to both sellers and to states. The proposal’s key tenet is to achieve significant simplification of sales tax systems to match the rapid evolution of the information economy and global trade. The system will incorporate advanced information processing technologies and strategic simplifications of the sales tax system. State and local governments will also be responsible for paying all costs associated with the system so that costs and burdens will not be imposed on participating sellers.

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The Streamlined Sales Tax System for the 21st Century will be designed to achieve these goals for participating sellers. The key characteristics of this system will:

Eliminate the burden for firms to collect state and local sales taxes.

Maintain the current definitions of nexus for all state and local governments (i.e., there is no intent to expand or contract the definition of nexus).

Simplify the current system of exemption administration through a combination of changes in state laws, standardized administrative procedures, and technology.

Enact this system by the states and not request any action by the federal government to compel sellers to collect.

Offer this system in a phased-in approach to all sellers on a voluntary basis.

Eliminate costs of compliance, tax returns and payments, and tax audits.

Eliminate tax rate monitoring and implementation, and eliminate record-keeping requirements for sellers.

Eliminate any requirement for sellers to police the intent or status of purchasers asserting special exemptions.

Eliminate risks (bad debts, audit liabilities, etc.) for seller exercising reasonable care (no negligence or fraud).

These goals are the design requirements for the Streamlined Sales Tax System for the 21st Century. The states will implement uniform laws, administrative practices, third-party technology, and collection systems as necessary to achieve these results. The system will be developed within 18 months and the precise combination of uniform laws and technology may be adjusted in that time period to achieve these goals. States and local governments will work cooperatively with the business community to design the system.

Software that facilitates collection of state and local sales taxes comprises an essential element of this proposal, although it does not constitute a panacea. States must undertake substantial simplification and reforms of their existing tax systems to implement a viable software-based solution that dramatically reduces the tax collection burden not only for remote sellers but for all merchants, regardless of whether they sell goods in brick-and-mortar stores, through mail-order catalogs, or through the Internet. The goal is for states to develop and implement a uniform approach to the collection and imposition of sales and use taxes on remote sales.

Step 2 - Adopt a completely unified system over the 6-8 year time period.

While the first step will simplify and streamline the current system, the second step, or ultimate goal, is for all state and local governments to adopt the same classification systems, definitions, and audits.

Ultimately the voluntary system will be extended to all states and localities as well as for all remote sellers, ending the inequity of the current system. In order to collect sales and use taxes, states will have to conform to the uniform, nationwide system. States that do not adopt this approach and mechanism by a fixed date will be denied the ability to collect taxes on remote sales until they adopt the uniform system. This system could eventually be extended to all merchants and all types of transactions, regardless of whether they occur in a store, through a catalog, or via the Internet. All merchants should reap the benefits of a uniform, simple, and fair system that eliminates the burdens that have historically been associated with tax collection responsibilities.

Necessary State Simplifications:

The Short-Run Goal — Creating a Streamlined Sales Tax System

General Approach

The general approach of the streamlined sales tax system is to reduce the costs and burden of sales tax compliance for participating sellers to as close as possible to zero through a combination of:

Shifting sales tax administration to a technology-oriented business model in which primary responsibility for calculating, collecting, reporting, and paying the tax is lodged with "Trusted Third Parties" (TTPs) instead of the seller.

Simplifying sales and use tax laws and administrative practices in key areas necessary to enable the technology and new business model to operate properly.

States assuming responsibility for the costs of the system by reimbursing TTPs for their costs and for the costs of integrating their systems with those of participating sellers sufficiently to allow the seller to participate in the system. A participating seller will not be charged for participation in the streamlined system.

Plan Details

Participation in the System

Participation in the system will be voluntary to sellers and to participating states. There will be no change in current legal standards regarding the imposition of a use tax collection obligation on interstate sellers. Participating vendors would be free to engage in such business activities in those states as they desire without incurring additional sales and use tax obligations. The key characteristic is that the remote or interstate seller must be technologically capable of participating in the system by being able to transmit and receive information regarding transactions to a "Trusted Third Party." As the system succeeds and is refined, states will be in a position to expand its use, on a phased basis, to all retail stores.

Trusted Third Party

A central element in the proposed, new system is the "Trusted Third Party." [See attached chart.] Participating states and local governments will enter into contracts with one or more TTPs to operate the tax administration system. The TTP will be responsible for receiving required information on transactions from a seller and providing software for determining the taxability of a transaction, the appropriate state and local tax rate, and the tax due. The TTP will also provide tax information to sellers at the time of the sale, so that information on tax due is available to a customer before completion of the transaction. TTPs will also enter into arrangements with credit card and other electronic payment processors so that tax(es) owed the state or local government may be remitted directly to the TTP for transmittal to the state. The TTP will also be responsible for providing all transaction and return information to the states (and local governments where appropriate) along with the tax remittance.

A competitive bid and negotiation process will be used to select the TTPs. It is expected that multiple TTPs will be selected. The selection process will include a certification of the software used by the TTP to make taxability determinations and to apply the appropriate state and local tax rate. Transactions sent through the system will be presumed to have had the correct tax calculated and paid by the purchaser.

Costs of the System

Trusted Third Parties will be paid by states and localities on a "per transaction" basis (either a flat per transaction rate, percentage rate, or combination) based on negotiated rates. The fee paid to TTPs will be used to pay all costs associated with the system, including the costs of integrating seller systems with those of the TTP, the costs of payment processors, and the costs of the TTP itself. All participating TTPs will be paid the same rate.

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Burdens and Incentives for Sellers

The only obligation imposed on a participating seller will be to integrate its business system with that of the TTP so that information required for tax determinations can be made available to and received from the TTP at the time of the transaction. Costs of this integration will be reimbursed by the TTP through the transaction fee paid by the states. The seller will not be responsible for making taxability determinations or handling state tax money. Consequently, the seller will not be subject to tax audits by the states. The vendor will be subject only to a periodic "system check," sufficient to ensure that the appropriate information is passed to and received from the TTP. A single, centralized check will be performed on behalf of all states.

It is expected that TTPs will provide financial incentives for sellers to enter the system and to sign up with a particular TTP. The fee to the TTP will be structured by participating states to provide a bonus incentive in the early months of participation. As an additional incentive, the proposal would not subject remote sellers to examination or review for any tax liabilities they may have incurred by inadvertent nexus-creating contacts prior to entering the system, provided they have not been contacted by a state for such purposes. Participation in the system will not, however, be considered a factor in determining potential liability for any other tax imposed by a participating state.

Privacy Issues

The proposal will be constructed to ensure privacy. A TTP will not be in possession of personal identifying information for an individual buyer paying taxes at the time of sale. Individual names, street addresses, and buyer credit card information will not be transmitted to the TTP. While the tax rate assignment will be made based on an individual street address, the address will be converted to a "geo-code" (i.e., taxing district identifier) by the seller before information is transmitted to the TTP.

Administrative Simplifications

The proposed tax-collection system would eliminate costs and inconveniences to the merchant. From the merchants’ and their customers’ perspectives, the tax collection system is intended to operate seamlessly with the credit card processing system, so they effectively do not even know it is there. The biggest benefit, however, is that migration to this tax collection system would end discrimination based on the way an item is purchased. Under this system, goods are treated equally from a tax perspective regardless of whether they are bought in a store, from a catalog, or via the Internet, and the tax system will no longer build in a competitive advantage or disadvantage to one class of merchants at the expense of their competitors. The system will be accompanied by certain strategic simplifications. These include:

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Uniform product codes;

Uniform sourcing rules;

Uniform procedures for the administration of exempt transactions (to include changes in the "good faith" standard for acceptance of exemption certificates);

Initiating the development of uniform definitions for use in state tax laws;

Limits on the frequency with which local government tax rate changes (including from annexations) may be made; and

Required advance notice of such changes.

The Long-Run Goal — Adopt a Completely Unified System

While simplifying and streamlining the existing state sales tax systems will reduce the burden on the private sector to collect taxes, additional efficiencies can only be attained by creating a uniform system. The goal will be achieving one classification system for products, one set of definitions on exemptions, and a one-stop audit process for all state and local governments. Financial incentives and penalties would be adopted to ensure that all states participate in the uniform system. Such a system would also include uniform sourcing rules and limitations on the extent and frequency of state and local tax law changes. Specifically, states would not be able to unilaterally make changes in the product classification, exemption definitions, or sourcing rules. Instead a system would be in place where changes would be determined by a "consensus board" made up of representatives of participating states. States would be obligated to follow the consensus rules. These consensus changes could only be made once a year. States that fail to adopt the changes would not be allowed to utilize the uniform system. Eventually all states would enact conforming legislation so that the "consensus board" changes would be automatically adopted by the states.

Although state and local governments would be allowed to change tax rates on specific goods and also change exemptions, they could only make changes within the uniform system. In addition, states would only be allowed one "change window" per year. This uniform system would utilize the "Trusted Third Party" mechanism to collect and remit tax revenues, and would maintain the existing nexus rules. Specifically, no federal legislation to compel interstate sellers to collect taxes would be required.

Implementation

The streamlined system will be implemented through a combination of uniform legislation and multistate agreements among participating states. The uniform legislation will cover a variety of items, including authority to participate in and help finance the system, as well as the required administrative simplifications regarding exemptions, rate changes, etc. The multistate agreement will provide the details for developing, operating, and governing the system. It is anticipated that the system can be implemented in the initial states by July 2001.

Evaluation of Voluntary Zero Burden System

Description of Rhode Island's Business Taxes

Business Corporation (R.I.G.L. Title 44, Chapter 11)

Corporations and businesses, wherever incorporated, deriving any income from sources within Rhode Island or engaging in any activities or transactions within the State for purposes of profit or gain are subject to a tax of 9.0% of net income, as reported to the Federal government on U.S. Form 1120, line 28. The formula for apportioning income to Rhode Island is the mean of the Rhode Island shares of company assets (property), income and payroll — referred to as an equally-weighted three factor formula. The minimum business tax is $250.00. In FY 2000 the State estimates that it will receive $67.6 million from this tax.

"Net Income" includes the following deductions and additions:

Deductions
Net operating loss
Special deductions (same as US Form 1120)
Rhode Island exempt dividends and interest
Gross-up of foreign dividends

Additions
Interest not included on US Form 1120
Rhode Island corporation taxes deducted on US Form 1120.

Franchise (R.I.G.L. Title 44, Chapter 12)

Every corporation chartered in Rhode Island or qualified to do business here must pay a tax of $2.50 for each $10,000 of authorized capital stock. No par stock is valued at $100 per share. The minimum franchise tax is $250. Inactive corporations and those not engaged in business here during the taxable year are taxed: $250 where such stock does not exceed $1.0 million; and $12.50 per additional $1.0 million or part. This tax is payable only when it is more than the business corporation tax. This tax is not applicable to special types of insurance companies, loan and investment companies, banking institutions, and credit unions. In FY 2000 the State estimates that it will receive $7.9 million from this tax.

Public Utilities Gross Earnings (R.I.G.L. Title 44, Chapter 13)

Public utilities in Rhode Island are taxed on their gross earnings in lieu of the business corporation tax. Rates vary by industry, and are detailed on the following page. In FY 2000 the State estimates that it will receive $66.3 million from this tax.

Financial Institutions (R.I.G.L. Title 44, Chapter 14)

Financial institutions pay a 9.0% tax on net income or $2.50 per $10,000 of authorized capital stock. Banks having a regular place of business outside Rhode Island are entitled to apportion net income using a three-factor formula similar to that used for the corporate income tax. In FY 2000 this tax is projected to generate $4.9 million.

Bank Deposits (R.I.G.L. Title 44, Chapter 15.1)

Eliminated for banks in 1998, this tax remains in effect for credit unions. Credit unions are charged a fee of $0.0695 per $100.00 of the daily average of the deposits with the banking institution during the calendar year for institutions with total deposits in excess of $150.0 million, and $0.0625 for those with total deposits of $150.0 million or less. Deposits include deposits, time deposits, certificates of deposits, savings plans and share of stock. In FY 2000 this tax is projected to generate $900,000.

Insurance Premiums (R.I.G.L. Title 44, Chapter 17)

Every domestic, foreign, or alien insurance company, mutual association, organization, or other insurer, except marine companies and fraternal organizations, transacting business in Rhode Island is assessed a tax of 2.0% of gross premiums on contracts of insurance, except ocean marine insurance, written during the year. The State expects to receive $33.5 million from the tax on insurance companies in FY 2000.

Health Care Provider Assessment (R.I.G.L. Title 44, Chapters 50 and 51)

Residential care facilities for the mentally retarded are taxed on 6.0% of gross patient revenue, nursing facilities are assessed a tax of 3.75% and hospitals are charged a fee of 2.0% of gross patient revenues. These taxes were enacted by the 1992 General Assembly to maximize Medicaid revenues under allowable Federal rules. While the owners of the facilities, including State government, pay the taxes, the assessments are built into the rate structures. Since a substantial portion of the patients are Medicaid eligible, significant shares of the assessments are actually paid by the Federal government. In FY 2000 collections from this tax are projected to be $25.1 million.

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Overview of Major Business-Related Tax and

Unemployment Insurance Changes in Rhode Island

1993 - 1999

Listed below are the major business-related tax and unemployment insurance changes enacted by the General Assembly from 1993 through the 1999 legislative session. These changes have been grouped into nine categories and listed chronologically within each category:

General Business, Job Development and Small Business

Investment Tax Credits and Research and Development Tax Credits

Property Tax

Unemployment Insurance

Enterprise Zones and Urban Reinvestment

Financial Services, Banking and Insurance

Manufacturing

Software

Company-Specific Tax Changes

This list is not intended to represent all business-related policies enacted over the past seven years. Information contained in this report was gleaned from material provided by the Economic Development Corporation (EDC), the Economic Policy Council (EPC) and the Senate Policy Office.

General Business, Job Development and Small Business

1993 - Business Corporation Tax - accelerated the repeal of the corporate surtax of 10% of the corporate income tax thereby reducing the effective tax rate from 9.9% to 9.0% three years earlier than planned.

1994 - Job Development Act - granted incremental income tax rate reductions to companies that create new employment in Rhode Island between July 1, 1994 and December 31, 1997. For every 50 jobs created during that period employers were entitled to one quarter of one percent (0.25%) reductions in their otherwise applicable tax rate. In 1996 this act was extended through 1999.

1994 - Small Business Tax Credit - provided a tax credit to small businesses equal to any guaranty fee they pay to the Small Business Administration pursuant to obtaining SBA financing.

1996 - Job Training Credits - allowed credit against the corporate, public service gross earnings, bank excise, gross premiums insurance and personal income taxes for the qualifying expenses of offering training and/or retraining to qualifying employees.

1998 - Credit for ISO Certification Expenses - Effective July 3, 1998, any taxpayer receiving a quality standard certificate from the International Standard Organization is entitled to a tax credit equal to the cost incurred to obtain the quality standard certificate.

1998 - SBA Guarantee Fee Tax Credit Carry-Forward - small businesses are allowed a credit against the tax imposed by chapters 11, 17 and 30 equal to the amount paid to the SBA as a guaranty fee for obtaining SBA guaranteed financing. Beginning in tax years commencing after December 31, 1997 unused portions of the credit may be carried forward for a maximum of four (4) subsequent tax years.

1998 - Jobs Development Act - extended Jobs Development Act to allow corporate income tax rate reductions for jobs created before July 2001. The rate reduction is based on job growth within a three-year period. Manufacturers who have lost 60% or more of their facilities due to a natural disaster resulting in the inability of active employees to continue production may qualify for corporate income tax rate reductions under the Jobs Development Act for jobs retained or added. Damaged businesses may also qualify for a sales tax exemption on reconstruction materials that are not reimbursed by insurance.

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Investment Tax Credits and Research and Development Tax Credits

Investment Tax Credit

1993 - Investment Tax Credit increased from 2.0% to 4.0%.

1997 - Investment Tax Credit increased to 10% on buildings and equipment purchased or leased for firms in targeted industries that meet certain median wage or training performance criteria. Legislation also expanded the credit for manufacturing firms to leased equipment and machinery.

Research and Development Tax Credit

1994 - Credit for Research and Development Property - provided tax credits for research and development facilities and expenditures, effective for facilities acquired, constructed, reconstructed or erected and expenses paid or incurred after July 1, 1994.

1996 - Sales and Use Tax for Research and Development - broadened the application of the sales and use tax exemption for equipment and related items used in research and development by replacing the words "used predominantly" with "to the extent used."

1997 - Research and Development Tax Credit - raised the R&D tax credit to 22.5% for companies increasing research and development expenditures, making Rhode Island the most aggressive R&D Tax Credit in the nation, according to EDC.

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Property Tax

1995 - Cities and towns allowed to exempt office equipment, such as computers and telephone equipment, used by commercial or manufacturing businesses from the local property tax. The bill also allowed cities and towns to exempt leasehold improvements made by commercial or manufacturing businesses from the local property tax.

1998 - Wholesale and Retail Inventory tax phase out - required every municipality shall phase-out the property tax on wholesale and retail inventories over a ten-year period

1998 - Motor Vehicles tax phase out - phased-out local property tax on motor vehicles over seven years, with the tax scheduled to be fully phased-out in FY 2006.

Unemployment Insurance

1994 - Temporary Disability Insurance Contributions - established a formula for automatically determining the Temporary Disability Insurance employee contributions rate each year, beginning January 1, 1995. It also allowed the current taxable wage base to rise above the current $38,000 level as the TDI maximum weekly benefits increase.

1997 - Made several changes in the contribution and benefit provisions of the Employment Security Act (i.e., unemployment insurance). This Act revised the new employer rate calculation, expanded the range of employer tax rates in each of the nine tax schedules, raised the re-qualification requirements from 4 to 8 weeks, and changed the rules regarding which employer’s account is charged for an unemployed individual with multiple recent employers. Together these changes reduced costs by limiting the unemployment roles and charging employers rates that are more consistent with the burdens they place on the system.

1998 - Eliminated ability of an employee to collect unemployment compensation benefits if he/she leaves work to follow a spouse who retires from his/her job and moves out of Rhode Island. In 1998 Rhode Island taxed employers on the first $18,200 of an employee’s salary. The 1998 base is equal to 70 percent of the statewide average weekly wage and was designed to rise each year as wages rose. The state’s Unemployment Insurance System was amended so that, Beginning in 1999, the wage base will be tied to the levels in the Employment Security Fund on September 30 of each year. That taxable wage base shall be effective for the tax year immediately following the determination date. The higher the reserve level, the lower the wage base. The wage base can vary from a low of $12,000 to a high of $19,000.

Enterprise Zones and Urban Reinvestment

1993 - Allowed the Enterprise Zone Council to designate a total of seven enterprise zones, where the previous limit had been five. In 1994 the General Assembly increased this limit to nine.

1994 - Required qualified business to create a minimum of 5.0% new or additional jobs, as well as obtaining a certificate of good standing from the Division of Taxation and the Corporation Division of the Secretary of State’s office before it can be qualified to receive tax credits. Act also allowed banks and insurance companies to participate in the enterprise zone program and created an income level of $30,000 for employees to be eligible for tax modification benefits.

1997 - Reauthorized Enterprise Zones - allowed all tax credits associated with Enterprise Zones to continue to be available to enterprise zone firms. The law originally limited credits to the first five years after zone designation. Now, any enterprise zone firm may qualify for incentives for 5 years after the firm is certified as an enterprise zone firm regardless of when the zone was designated.

1998 - Incentive to Employ Enterprise Zone Residents - provided a tax credit for qualified enterprise zone businesses for employing persons domiciled in an enterprise zone. Firms qualifying for enterprise zone tax credits by increasing total company employment by 5.0% within a Rhode Island enterprise zone may take a credit equal to 75.0% of the total wages paid to enterprise job employees living in an enterprise zone. The maximum credit is $15,000 per employee.

1999 - Enterprise Zone Carry-Forward - Starting with firms receiving year 2000 certification for job creation, this law allows unused enterprise zone wage tax credits to be carried-forward for three years.

Financial Services, Banks and Insurance

Financial Services

1994 - Rhode Island Passive Investment Company Act - exempted from State taxation intangible investment income earned through the maintenance and management of passive investment portfolios in Rhode Island. To be eligible for the tax exemptions, the investment company must (1) confine its activity to the maintenance and management of its passive intangible assets, (2) employ no less than five persons in Rhode Island and (3) maintain an office in Rhode Island.

1995 - Allocation of Income for Selected Financial Service Companies - allowed regulated investment companies and brokerage firms to subject to Rhode Island taxation only that income which is paid to the Rhode Island owners of that investment company or paid to customers of that company who live in Rhode Island. Companies, which choose this type of income allocation, must do so for at least five years.

1996 - Allocation of Income - Pension Fund Service Firms - entitled pension fund service firms to apportion income to Rhode Island using a one-factor formula based on the ratio of income of Rhode Island receipts from such services during the taxable year to total receipts everywhere from such services for the same taxable year. Companies, which choose this type of income allocation, must do so for a successive period of five years.

1996 - Financial Institutions Sales and Use Tax on Certain Telecommunication Services - allowed regulated investment companies a gross receipts exemption from sales and use tax imposed on toll-free terminating telecommunication service, provided that the eligible company employs no less than 500 full-time equivalent employees.

Banks

1995 - Bank Modernization Act - allowed banks to take a $1 credit against their franchise tax for every dollar they pay under the deposit tax and allowed banks to file consolidated tax returns.

1995 - Apportionment of Income for Banks - Banks with operations in Rhode Island are only taxed on income derived from Rhode Island sources and operations. Banks having a regular place of business outside Rhode Island are entitled to apportion net income using a three-factor formula similar to that used for the corporate income tax.

1996 - Allocation and Apportionment of Income for Credit Card Banks - Banking institutions which engage only in credit card business are entitled to apportion net income using a one-factor formula based on the ratio of income derived from accounts owned by customers domiciled in Rhode Island to income derived from accounts owned by all of the banking institution’s customers.

Captive Insurance

1999 - Captive Insurance Rate Lowered - tax rate on premiums collected by captive insurance companies reduced from a flat 1.0% rate imposed on all premiums collected or contracted for, to a sliding scale for direct premiums and assumed reinsurance premiums. The tax on direct premiums range from 0.002% on the first $20.0 million of premiums to 0.000375% on each dollar of premiums over $60.0 million. The tax on assumed reinsurance premiums range from 0.001125% on the first $20.0 million of assumed premiums to 0.000125% on each dollar of assumed premiums over $60.0 million. The tax rate deduction was retroactive to December 1, 1998.

Insurance

1997 - Alien Insurance Act - allowed insurance companies incorporated or organized under the laws of any country other than the United States to be treated as a domestic Rhode Island insurance company, provided they meet the usual requirements of RI’s insurance regulations, and locate here.

1999 - Tax Credits Allowed for Insurance Carriers - The Investment Tax Credit, Research & Development Property Credit, and the Research & Development Expense Credit were expanded to apply to Rhode Island insurance carriers. Property and casualty insurance companies may receive the State’s investment tax credit for qualified tangible property including computers, software, and telecommunications hardware no matter how the property is acquired. The law allows both the R&D Property Credit and the R&D Expense Credit to be applied against the Gross Premium Tax.

Manufacturing

1994 - Gross Receipts Tax - phased-out gross receipts tax for manufacturing customers of electric and natural gas utilities by 1% annually over four and three year periods, respectively.

1996 - Sales and Use Tax for Manufacturing - made it easier for manufacturers to take advantage of the sales and use tax exemption by including all machinery and equipment used in the manufacturing process, excluding only the portion of those items used or consumed for administration and distribution. This legislation was later amended to include computer software.

Software

1997 - Software Stock Tax Exemption - granted complete personal income tax exemption for capital gains from qualified options or ordinary income from non-qualified options made on stock for employees in software industries (defined by SIC codes 7371, 7372, 7373). This tax incentive became effective January 1, 1998.

Company-Specific Tax Changes

1993 - For purposes of calculating the Rhode Island personal income tax, this legislation allowed employees of corporations to subtract from federal adjusted gross income any income resulting from the sale of stock, warrants, bonds or other interests of a corporation which: a) is traded publicly on a recognized exchange, b) has its headquarters in Rhode Island, and c) has at least 1,000 full-time employees in Rhode Island.

1994 - Business Corporation Tax - allowed certain qualified corporations which have produced over a period of five years annually goods worth at least $10,000,000 where on the average at least 80% of that production has been for sale to a branch of the United States Armed Services to accelerate the amortization of depreciation of its depreciable assets over a five year period.

Glossary of Terms

Charges comprise charges imposed for providing services or for the sale of products in connection with general government activities. Amounts designated as charges are reported on a gross basis without offsetting the cost to produce or buy the commodities or services sold. Utility service charges are excluded.

Expenditures include all amounts of money paid out by a government during its fiscal year--net of recoveries and other correcting transactions--other than for retirement of debt, purchase of investment securities, extension of loans, and agency or private trust transactions. Under this definition, expenditure relates to external payments of a government and excludes amounts transferred to funds or agencies of the same government.

Expenditures include payments from all sources of funds, including not only current revenues but also proceeds from borrowing and prior year fund balances. Amounts spent by all agencies, boards, commissions, or other organizations categorized as dependent on the government concerned are included. Expenditures of business-type activities of governments (utilities and other commercial or auxiliary enterprises) are reported on a gross basis. That is, related revenues are not deducted from their expenditures to derive net expenditure amounts.

Federal Government Grants and Payments represent actual cash outlays provided to a state or local government units directly from the Federal government. Grants to individuals and profit or nonprofit institutions are generally not included, nor are payments for services rendered.

General Revenue comprises all revenue except that classified as liquor store, utility, or insurance trust revenue. Generally, the basis for this distinction is not the fund or administrative unit established to account for and control a particular activity, but rather the nature of the revenue source involved.

General Sales Taxes are those sales or gross receipts taxes which are applicable with only specified exceptions to all types of goods and services, or all gross income, whether at a single rate or at classified rates. Taxes imposed distinctively on sales or gross receipts for selected commodities, services or businesses are reported separately (see discussion of "Selective Sales Taxes.")

Income Taxes are levied on the gross income of individuals or on the net income of corporations and businesses (i.e., after allowable deductions). Income taxes include:

Individual Income Taxes: Taxes on individuals measured by net income and taxes on special types of income (e.g., interest, dividends, income from intangible property, etc.). Excludes taxes using income from intangible property; income taxes on unincorporated businesses; payroll taxes to finance insurance trusts programs, such as Social Security taxes; and city gross earnings taxes.

Corporate Income Taxes: Taxes on corporations and unincorporated businesses (when taxed separately from individual income) measured by net income, whether on corporations in general or on specific kinds of corporations, such as financial institutions.

Miscellaneous General Revenue includes general revenue derived from a government’s own sources that are not otherwise expressly categorized (i.e., excluding all taxes, motor vehicle licenses, liquor store, utility, current charges, and insurance trust revenues).

Motor Fuel Sales include all taxes on gasoline, diesel oil, aviation fuel, "gasohol," and any other fuels used in motor vehicles or aircraft.

Motor Vehicle License Taxes are those fees imposed on owners or operators of motor vehicles for the right to use public highways, such as fees for title registration, license plates, vehicle inspection, vehicle mileage and weight taxes on motor carriers, highway use taxes, and off-highway fees. Excludes personal property taxes on motor vehicles; sales or gross receipts taxes on the sale of motor vehicles; taxes on motor carriers based on assessed value of property, gross receipts, net income, and other taxes on the business of motor transport.

Other Taxes include death and gift taxes, document and stock transfer taxes, severance taxes (i.e., taxes imposed distinctively on the removal of natural products such as gas, minerals, timber, for fish from land or water and based upon the value or quantity of products removed or sold).

Per Capita refers to the amount of state and local revenues (or expenditures) received (or expended) per the total number of residents in the state. This figure is calculated by dividing the revenue (expenditure) amount by the total number of residents.

Per $1,000 of Personal Income refers to the amount of state and local revenues (or expenditures) received (or expended) per every $1,000 of personal income generated by the state’s residents. This figure is calculated by first dividing the state’s total personal income by 1,000. This number is then used as the denominator when dividing the revenue (or expenditure) amount.

Property Taxes are taxes conditioned on ownership of property and measured by its value. They include general property taxes related to property as a whole, real and personal, tangible or intangible, whether taxed at a single rate or at classified rates, as well as taxes on selected types of property, such as motor vehicles, or on certain or all intangibles.

Revenues include all amounts of money received by a government from external sources during its fiscal year, net of refunds and other correcting transactions, other than issuance of debt, sale of investments, and agency or private trust transactions. Under this definition, revenue excludes amounts transferred from other funds or agencies of the same government.

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Revenue comprises amounts received by all agencies, boards, commissions, or other organizations categorized as dependent on the government concerned. Revenue of business-type activities of governments (utilities and other commercial or auxiliary enterprises) is reported on a gross basis. That is, related expenditures are not deducted from their revenues to derive net revenue amounts.

Selective Sales Taxes are those taxes placed on specific commodities, businesses, or services not otherwise accounted for (e.g., alcoholic beverages, lodging, lubricating oil, fuels other than motor fuel, meals, soft drinks, tobacco products, etc.).

Tax Burden refers to a measure of taxes collected by state and local governments as a percentage of the total personal income generated by the state’s residents. Term can also refer to the measurement of taxes paid by particular income groups or individuals.

Taxes are compulsory contributions exacted by a government for public purposes, other than for employee and employer assessments and contributions to finance retirement and social insurance trust systems and for special assessments to pay capital improvements. Tax revenue comprises gross amounts collected (including interest and penalties) minus amounts paid under protest and amounts refunded during the same period. It consists of all taxes imposed by a government whether the government collects the taxes itself or relies on another government to act as its collection agent.

One important feature of tax revenue is the need to pass a "visibility test." That is, the tax levy must be visible to the taxpayer as being a tax and not buried under the guise of another revenue. Take, for instance, a tax on utility services provided by the government levying the tax. If the utility bill does not itemize the tax but incorporates it into its user charge rate (therefore being invisible to the customer as a tax), then that so-called "tax" is reported as a utility revenue for Census Bureau purposes.

Total State and Local Taxes include all taxes (as defined above) imposed by state and local governments.

Sources

Advisory Commission on Intergovernmental Relations. RTS 1991: State Revenue Capacity and Effort. Washington, D.C., September 1993.

Almy, Gloudemans and Jacobs. Toward a Fairer, More Understandable and Less Costly Property Tax for Rhode Island. Providence, August 1996.

Bartik,Timothy. Who Benefits from State and Local Economic Development Policies? W.E. Upjohn Institute for Employment Research. Kalamazoo, Michigan, 1991.

Besci, Zsolt. "Do State and Local Taxes Affect Relative Growth." Economic Review. Atlanta, March/April 1996.

CCH, Incorporated. 2000 State Tax Handbook. December 1999.

Citizens for Tax Justice. Who Pays? Washington, D.C., June 1996.

Delphi Survey and Forrester Research.

Federation of Tax Administrators.

House Fiscal Advisory Staff, Rhode Island General Assembly. Rhode Island Revenue Facts. Providence, 1998 and 1999.

Internal Revenue Service. Statistics of Income. Spring Bulletin. Washington, D.C., Spring 1999.

Klein, Robert J. and John Shannon. "Characteristics of a Balanced and Moderate State-Local Revenue System." Reforming State Tax Systems. National Conference of State Legislatures. Denver, 1986.

Minnesota Taxpayers Association and National Taxpayers Conference. "Comparison of 1997 Individual Income Tax Burdens by State." St. Paul, Minnesota, March 1999.

Minnesota Taxpayers Association and National Taxpayers Conference. "50-State Property Tax Comparison Study: Payable Year 1998." St. Paul, Minnesota, January 1999.

Narragansett Electric Company. Providence, 2000.

National Association of State Budget Officers. The Revenue Potential of Taxing Services. Washington, D.C., July 1991.

National Conference of State Legislatures. Financing State Government in the 1990s. Washington, D.C.

National Conference of State Legislatures. State Budget and Tax News. Denver.

National Conference of State Legislatures. State Policy Reports. Denver.

National Education Association. Ranking of the States. Washington, D.C.

Rhode Island Senate Select Commission on Tax Rate Competitiveness. November 1999.

Rhode Island Department of Administration. Analysis of Rhode Island State Tax Structure. Prepared by KPMG, Peat Marwick, Policy Economics Group. Providence, November 1, 1993.

Rhode Island Department of Administration, Budget Office.

Rhode Island Department of Administration, Division of Taxation. Tax Expenditures Report. Providence, 1998, 1999 and 2000.

Rhode Island Department of Administration, Office of Municipal Affairs.

Rhode Island Department of Education.

Rhode Island Department of Labor and Training.

Rhode Island State Budget, various years.

Sales Tax Institute/Yetter Consulting Services.

Tannenwald, Robert. "Fiscal Disparity Among the States Revisited." New England Economic Review. Federal Reserve Bank of Boston. Boston, July/August 1999.

Tannenwald, Robert. "State Business Tax Climate: How Should It Be Measured and How Important Is It?" New England Economic Review. Federal Reserve Bank of Boston. Boston, January/February 1996.

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Tax Foundation. Washington, D.C.

United States Congress. Congressional Research Service. Washington, D.C.

United States Department of Commerce, Bureau of the Census, State and Local Government Finances. Washington, D.C.

United States Department of Commerce, Bureau of Economic Analysis. Washington, D.C.

United States Department of Commerce, Bureau of Labor Statistics. Washington, D.C.

Wasylenko, Michael. "Taxation and Economic Development: The State of the Economic Literature." New England Economic Review. Federal Reserve Bank of Boston. Boston, March/April 1997.

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RIPEC Tax Strategy Task Force

Robert E. Liguori, Chair
Managing Partner
Adler, Pollock and Sheehan P.C.

Thomas J. Anton
Director
A. Alfred Taubman Center for Public
Policy and American Institutions
Brown University

Patrick J. Canning
Managing Partner
KPMG LLP

Stephen J. Carlotti
Partner
Hinckley, Allen and Snyder LLP

Donna C. Cupelo
President and CEO
Bell Atlantic - Rhode Island

James H. Hahn
Partner
Partridge Snow & Hahn LLP

Wayne W. Juchatz
Former Executive Vice President
and General Counsel
Textron Inc.

Howard M. Kilguss
President
Excell Manufacturing

Ronald K. Machtley
President
Bryant College

Albert W. Ondis
Chairman and CEO
Astro-Med, Inc.

Lawrence J. Reilly
President and CEO
Narragansett Electric

Alfred J. Verrecchia
Executive Vice President
of Global Operations and CFO
Hasbro Inc.

Joseph R. Paolino, Jr.
Partner
Paolino Properties

Norman Richter
Vice President - Taxes
Textron Inc.