Is an increase in the sales tax a dagger aimed at the heart of Rhode Island’s economy? A prudent way to raise tax revenue and pay for other priorities? Neither? Both? How much would a $165 million tax increase actually affect the state’s $45 billion economy?
To get some answers, I gave a call to Andres Carbacho-Burgos, an economist with Moody’s Economy.com who has been tracking Rhode Island’s economy for years and whose forecasts are used by state budget officials. The transcript has been lightly edited for clarity.
I know it’s not your job to recommend specific policies, but it is your job to understand them. So I wanted to ask, what sort of economic impact would your models expect from a $165 million increase in state sales tax revenue? How big a deal would it be?
You need to look at more dimensions than just simply the volume of revenue received.
The theory behind Governor Chafee’s plan and some other proposals is that you try to lower the overall sales tax rate but you make up for the lower rate by broadening the base, by including services and possibly some Internet sales as well. So everything depends — well, I wouldn’t say everything — but a lot depends on how exactly you increase sales tax revenues.
I would say for Rhode Island households at the median income or below, something which substantially reduces sales tax rates would of course be beneficial to them. It would leave them with somewhat larger real income, and so that would help them out. The overall effect on total spending depends on the overall redistribution of the sales tax burden over the entire population of households in Rhode Island.
Now, have you done any modeling, or were you asked by the state to do anything, at Moody’s Economy.com on how this would impact our somewhat slow recovery here in Rhode Island?
No, we have not been asked by the state of Rhode Island to do any modeling on alternative sales tax proposals. What we do for them is we provide a semiannual estimate of income growth based on no major changes to tax policy.
I was reading your chief economist Mark Zandi recently explaining how in some cases cutting spending is worse than raising taxes because the multiplier on spending does more for the economy than the lower tax rates do. How should people be looking at that – the question of weighing those alternatives – in terms of the economy?
That’s a complicated question, but a brief shorthand is whenever you raise taxes or cut spending, you should look at the multiplier effect, in terms of figuring out who bears the brunt of those higher taxes or reduced spending and what is their tendency to spend over the economy.
The theory is that if you raise taxes on, say, the top 1% of income earners – either at the national level or at the state level – the impact on the economy will be less because the top 1% spend a much smaller share of their total income, and they save and invest the rest. So by raising taxes on the top 1%, the theory is you would cut more into savings, which don’t matter immediately in the short term, but you would cut less into private spending.
When you’re looking at the different ways for increasing tax revenue, though, the sales tax is actually fairly regressive, and it hits households across the board. What about that aspect of it?
Other things being equal, if you raise the effective sales tax rate – and by effective I mean not just the nominal sales tax rate, but the fraction of sales tax payments out of total personal income – then, because it’s regressive, that will have a more serious effect on spending than if you raised income taxes on the top income brackets.
And, just to be clear, that is what was going to happen here, although the politics is in flux. Although the nominal rate was going down, the governor wanted to add a 1% tax and more items at the standard rate to net $165 million more in revenue out of the sales tax. So would he be talking about taking more out of spending then?
Yeah, but again – just to hedge my position here – a lot of that depends on where the additional broadening of the sales tax base would take place – if it would be a broadening into services which the average household never uses. For example, if you impose a sales tax on large-scale financial services, then the burden on spending for that particular broadening would be very small as far as households in Rhode Island are concerned.
So yes, it’s true that other things being equal, an increase in the effective sales tax rate is more regressive and therefore hits spending harder than income tax rates. But you also have to be careful to look at what the structure of the change in the sales tax looks like.
So it sounds like the bottom line is it’s very important to look at the domino effect and the way all these ideas impact each other. You can’t just say raising the sales tax is bad or raising the sales tax is good – you have to look at which sales tax and who it’s on and who’s paying and all that.
In other words, you have to look at what economists look at – the incidence of the sales tax – and what changes.
Anything else I should ask you on this to help people understand the sales tax debate?
That’s about it. One thing I would add – there has been a lot of talk about competitiveness. In terms of sales taxes, Rhode Island already had rough parity and maybe even a slight advantage compared to Massachusetts and Connecticut because even though the current state sales tax rate is higher for Rhode Island than for Massachusetts and Connecticut, Massachusetts and Connecticut generally tend to have higher local sales taxes, and so overall the effective rates even out.
So if you can get a lowering of the nominal tax rate by broadening the base, then that might actually help Rhode Island’s competitiveness and might actually draw in some shoppers from Massachusetts and Connecticut. So it’s also another issue to consider.
On that point, though, I’ve heard a lot of skepticism here – understandably, people aren’t economists, and they wonder, would having Rhode Island at 6% versus Massachusetts at 6.25% really have that big an impact on consumer habits and where people go to spend their money?
If you look at just the state sales tax rates, no. What you have to remember is that most Massachusetts counties add a lot of additional sales tax rates, more than Rhode Island does. So once you add together the state and local tax rates, a reduction in the Rhode Island state rate to 6% would have a significant difference, assuming of course that local governments in Rhode Island didn’t raise their own rates.
Correction: Andres writes in to note that commenter Mario is correct in pointing out Massachusetts and Connecticut do not have local sales taxes.
(photo: Seeking Alpha)
WPRI.com intern Claire Peracchio contributed research.