A society sinks into economic stagnation and decline gradually and slowly, but it usually only changes course through decisive and dramatic actions. Rhode Island's economy continues to drag behind with the second worst unemployment rate in the nation. Last month, in his State of the State address, Governor Lincoln Chafee hoped to spur Rhode Island's economy by proposing a reduction in Rhode Island's corporate income tax rate from 9 percent to 7 percent. He noted that this would put Rhode Island's corporate income tax rate "below that of both our neighboring states." While any reduction in the tax burden for business will help the economy to some extent, this incremental change in the corporate income tax rate to bring it below Connecticut and Massachusetts will not transform Rhode Island's economy. To make Rhode Island's economy prosperous and grow, Rhode Island must dramatically improve its business climate rating through a larger corporate income tax reduction.
A reduction in Rhode Island's corporate income tax rate in order to bring it just below the corporate income tax rates of Connecticut and Massachusetts will prove to be insufficient. In recent decades, Rhode Island has, on occasion, had a corporate income tax rate below that of its two neighboring states, but Rhode Island's economy still lagged behind its neighbors. For example, during the recession in the early 1980s, Rhode Island had a lower corporate income tax rate than both Connecticut and Massachusetts, and yet Rhode Island had a higher unemployment rate than both Connecticut and Massachusetts. Rhode Island must aim not only to have a lower corporate income tax rate than Connecticut and Massachusetts, which have high corporate income tax rates, but to move Rhode Island into the top 10 states with the best corporate tax climate in the nation.
In his State of the State address, Chafee indicated he was "skeptical of the myriad rankings and reports that place Rhode Island at the bottom of the barrel in terms of business climate." This is not surprising. Since at least the early 1980s, Rhode Island public officials have tried to dispute or discount Rhode Island's poor business climate rankings. While the governor can remain skeptical and in denial, the reality is that business leaders take these rankings and reports seriously in deciding where to locate business operations. To bring new businesses to Rhode Island, our state needs to dramatically improve its business climate rating.
At 9 percent, Rhode Island has one of the highest corporate income tax rates in the nation. As a result, Rhode Island is ranked 42nd in the nation by the Tax Foundation for its corporate tax climate. Half of the states that are in the top 10 for best corporate tax climate either have no corporate income tax or have a corporate income tax rate of 5 percent. Therefore, Rhode Island should reduce its corporate income tax rate from 9 percent to 5 percent. A 5 percent corporate income tax rate would be much lower than any other New England state and clearly the lowest in the entire Northeast.
Low corporate taxation should lead to long-term economic growth and higher employment levels for Rhode Island. The American Legislative Exchange Council, an organization which promotes free-market ideas to state legislators, annually produces a study entitled "Rich States, Poor States," which shows that historically states with the low corporate income tax rates have above-average rates of economic growth while states with the high corporate income tax rates have below-average rates of economic growth.
In addition to lowering the corporate income tax rate, Rhode Island needs to bring its law on corporate tax deductions into line with the federal government and other states. Currently, Rhode Island only allows the net operating losses for corporations to be carried forward and deducted from taxable income for five years. However, the federal government and a majority of other states allow net operating losses to be carried forward and deducted from taxable income for 20 years. Furthermore, the federal government and a number of other states allow net operating losses to be carried back and deducted from taxable income for two prior years. In 1974, Rhode Island had enacted legislation, which adopted the federal government approach in allowing the deduction of net operating losses from taxable income for prior and subsequent years. The legislation had been recommended in a study published in 1972 by a group, consisting primarily of business leaders, called Project Rhode Island. Unfortunately, in 1992, in the middle of yet another state budget crisis and after prior efforts by organized labor to dilute this tax provision, Rhode Island enacted legislation that dramatically limited the numbers of years that net-operating losses could be carried forward and deducted from taxable income. Today, Rhode Island needs to revisit this issue and enact legislation that will make Rhode Island tax law for net operating losses consistent with the federal government.
This corporate tax rate reduction and this change in the tax law regarding net operating losses may reduce government revenues. Assuming a completely static economy, a rough estimate of the reduction in government revenues from these tax reductions could be as much as $90 million. However, these changes in corporate taxes will generate tax revenues when corporations move to Rhode Island. Furthermore, Rhode Island can pay for these broad-based corporate tax reductions by eliminating the various corporate tax breaks that have developed in Rhode Island for specific businesses or industries over the years.
Corporations are mobile. Capital can be invested anywhere. Businesses compete with one another to make a profit. Likewise, states must compete with another to attract business. To be successful, public officials must remember the basic principle that business tends to invest in states with the lowest tax burdens. It is not enough for Rhode Island to have slightly lower tax rates than neighboring states that have high tax rates. To attract business and prosper, Rhode Island must aim to be among the states with the best tax climate in the nation.