How not to reform RI's taxes

Tom Sgouros

23 April 2001

Submitted to Providence Journal, but to no effect. Delivered in testimony to House Finance Committee, 21 May, 2001

The cry of "tax reform" is again ringing throughout the halls of state. Last year RIPEC [Rhode Island Public Expenditure Council, a business-led lobby group] published a call for tax reform, and this is the effect of their rash act. But opportunists at the state house have seized the chance to ignore all that is useful and good about that report in favor of one minor element, and now the state is poised to eliminate the capital gains tax.

For the purposes of this discussion, let's not even consider the state's social services. We can argue about whether these services are generous or stingy, but let's save those arguments for another day, and just pretend to have hard noses or hard hearts and assume them to be funded adequately at current levels.

The real evil of our tax system, identified correctly in the RIPEC report, is our property tax system. Property taxes -- and how they're administered -- create inequities in school funding, incentives for urban flight, invitations to suburban sprawl, and obstacles to affordable housing, open space, and farming. Property taxes are the single heaviest tax burden on most businesses, and on many individuals, too. They are difficult to budget for, with frequent rate changes and occasional breathtaking revaluations. Most important, property taxes are levied without regard for ability to pay. The income tax cannot drive a business into bankruptcy: no income means no tax. But property taxes do so every day.

So if property taxes are the problem, why are we going to cut the capital gains tax instead? Which problem does this solve? Already there are those in the legislature who see this as a choice between cutting capital gains and phasing out the car tax, part of the property tax. That is, the choice is between fixing the system that isn't broken and fixing the system that is.

How much will it cost? Proponents say around $20 million, a figure obtained by projecting from current collections. But they claim these cuts will change people's behavior, so these projections can't be correct. So either they're right about the cost, in which case nothing will change except that the rich will get richer, or they're right about the effects, in which case this could cost us a bundle. They can't be right about both. (Some will say that the cost isn't money that we could have. But this isn't right, either. Any decent accountant can come up with ways to convert income into capital gains.)

In the meantime, while we debate whether we'd be cutting $20 or $50 million from RI's tax rolls, the state continues its wasteful borrowing. The Department of Transportation, for example, plans to borrow $30 million a year for the next decade, at least.

Borrowing is generally done for one of two reasons: either to amortize some large lump sum over several years, or because there will be income earned from some investment made with borrowed funds. Someone might borrow to buy a house because her annual budget *for that year* couldn't fit the extra cost, but it could fit the cost of the payments over many years. A jewelry company might borrow to buy a lump of gold, but the profit from the jewelry they make will pay back the debt service. State roads fall into neither category. If we're borrowing $30 million *every* year, then there's no need to amortize, it's already amortized, at $30 million a year, and we should just budget for that. And roads won't earn back their investment -- especially not roads built to replace existing ones, which is what most of the next decade's cost is for. Any credit counselor can tell you this is a perfectly common financial strategy, but one that often ends in bankruptcy court.

So we have a real tax problem in property taxes. And we have a financial travesty in the making: DOT. Neither of these problems is solved by cutting capital gains taxes. On the contrary, cutting capital gains will make solving them difficult or impossible.

It is said that cutting capital gains taxes will "send a signal." I ask to whom? Cutting capital gains taxes only to bankrupt the state government and forestall real reform will send a signal only to people who can't count -- or who don't care. These are not the business owners who will make our future. These are the people who will take advantage of us in the short term, and leave us with an empty future and emptier pockets.

Rhode Island's fiscal problem is not that taxes are too high, but that when people go to tot up the ledger, there isn't enough on the positive side to outweigh the taxes. Were we to invest what money we have to make sure that every child, *in every community*, got a first-class education, to help provide recreational, cultural, and educational opportunities to all our citizens, and to ensure quality health services to everyone, we'd have no trouble at all attracting and retaining the businesses we want to have here.

But this is not what we do. We squander our tax money on hare-brained "development" schemes, unnecessary and destructive road projects, and wasteful borrowing. This is not to mention our waste of energy resources, poor maintenance of our buildings and roads, and redundant bureaucracies. (Why do we have two state TV stations? Two environmental agencies? Two election agencies?) Our search for the big fix has distracted us from the real problems that government can -- and should -- take care of.

The currently happy state of Rhode Island's finances have given us an opportunity. We can choose to use it to reform our finances in a way that will allow us to invest for the future. Or we can choose to blow it on a tax giveaway that may cost us the opportunity to fix what is really broken. You choose.