Candice Horbacz
Katherine Loughead, Director of State Projects at the Tax Foundation, delivered a stark warning to the Rhode Island House Committee on Finance on May 7, 2026, outlining the severe economic ramifications of House Bill 7313 (H 7313). The proposed legislation, set to take effect on January 1, 2027, aims to implement a three-percentage-point surtax on individual taxable income exceeding $640,000, a threshold annually adjusted for inflation. This measure would elevate Rhode Island’s top marginal individual income tax rate from 5.99 percent to a substantial 8.99 percent, effectively creating a four-bracket tax structure despite the bill’s formal retention of a three-bracket system. The non-profit, non-partisan tax policy research organization emphasized that while it does not take a position on specific legislation, it felt compelled to provide expert analysis on the negative economic implications inherent in such a significant income tax increase.
The Proposed Surtax: Mechanics and Intent
House Bill 7313 introduces a new layer of taxation for high-income earners in the Ocean State. The proposed surtax targets individuals whose taxable income surpasses $640,000, a figure established in 2026 dollars and slated for annual adjustment to account for inflation. This additional three-percentage-point levy would push the state’s highest marginal income tax rate to 8.99 percent. For context, Rhode Island currently operates with a top marginal rate of 5.99 percent. While the bill technically maintains a three-bracket structure on paper, the imposition of this surtax at a specific income threshold fundamentally creates a fourth effective bracket for those falling into the targeted high-income category.
The legislative intent behind such proposals often centers on generating increased state revenue, addressing perceived income inequality, or funding specific public programs. Proponents of H 7313 would likely frame it as a means to ensure that the wealthiest residents contribute a larger share to the state’s fiscal health, potentially citing needs in education, infrastructure, or social services. However, the Tax Foundation’s testimony underscored that the method of achieving these goals carries significant economic risks that could undermine the state’s long-term prosperity. The debate surrounding H 7313, therefore, encapsulates a fundamental tension between immediate revenue generation and the broader economic health and competitiveness of the state.
A Deeper Dive into Competitiveness: National and Regional Standing
One of the most immediate and quantifiable impacts highlighted by the Tax Foundation is the dramatic shift in Rhode Island’s tax competitiveness. If H 7313 were enacted, Rhode Island would ascend from holding the 15th-highest top marginal state individual income tax rate in the country to the 10th-highest, excluding the District of Columbia. This move would place it among a select group of states with the most aggressive income tax policies.
The Tax Foundation’s widely respected State Tax Competitiveness Index, which provides a comprehensive snapshot of states’ tax systems based on their structural neutrality and competitiveness, projects a significant decline for Rhode Island. Using a hypothetical scenario where H 7313’s policies were active on July 1, 2025 (the snapshot date for the 2026 Index), Rhode Island’s overall ranking would fall from its current 40th position to 41st. More critically, its individual income tax component ranking would plummet from 30th to 40th. This indicates a substantial erosion of the state’s appeal for individuals and businesses subject to this tax. The Index evaluates how well a state’s tax system adheres to principles of sound tax policy: simplicity, neutrality, transparency, and stability. A lower ranking suggests a less competitive and more economically distortive tax environment.
Regionally, the proposed surtax would fundamentally alter Rhode Island’s standing. Currently, the state benefits from having the third-lowest individual income tax rate in the Northeast, trailing only New Hampshire (which has no individual income tax) and Pennsylvania (with a low, flat statewide rate, though offset by local income taxes). This position has allowed Rhode Island to present itself as a comparatively more attractive alternative to high-tax neighbors like New York, New Jersey, and Massachusetts. However, H 7313 would erase much of this competitive advantage.
For instance, Massachusetts imposes a 9 percent rate, but it only applies to income exceeding nearly $1.1 million, with income below that threshold taxed at a more competitive 5 percent. Under H 7313, Rhode Island’s marginal rate of 8.99 percent would kick in at $640,000, making it less attractive than Massachusetts for a significant band of high-income earners. Furthermore, at the $640,000 taxable income level, Rhode Island’s proposed marginal rate would surpass those of several neighboring states: New Jersey (8.97 percent), Vermont (8.75 percent), Maine (7.15 percent), New York (6.85 percent), and Massachusetts (5 percent). This regional comparison underscores a critical threat: the ease with which businesses and high-income individuals in Rhode Island could relocate just across state lines to a more favorable tax climate, particularly given the state’s small geographic footprint.
Economic Literature and Macroeconomic Impacts
The Tax Foundation’s testimony drew heavily on established economic literature, which, it asserts, "overwhelmingly finds that an income tax increase of this magnitude would negatively affect economic growth and opportunity in Rhode Island." Numerous studies consistently demonstrate that higher marginal income tax rates correlate with reduced gross state product (GSP), diminished investment, and decreased in-state employment mobility. These economic disincentives are rooted in basic principles of supply and demand: when the reward for earning more income is significantly reduced through taxation, individuals and businesses are less incentivized to produce, invest, and expand within that jurisdiction.
Specifically, higher marginal rates can discourage entrepreneurship and risk-taking, as the potential after-tax returns on successful ventures are curtailed. This can lead to a decrease in capital formation—the accumulation of financial assets available for investment—which is crucial for job creation and economic expansion. Moreover, research has identified a negative relationship between changes in income tax rates and the wages of both higher-income and lower-income workers. This counterintuitive finding suggests that the economic drag created by higher taxes on top earners isn’t confined to that group but ripples through the entire economy, affecting the broader labor market. For lower-income workers, this could manifest as slower wage growth or fewer entry-level job opportunities, as businesses facing higher costs or reduced investment capacity scale back. Consequently, the proposed surtax, while framed as targeting a specific segment of the population, is projected to reduce economic opportunity for all Rhode Island residents, irrespective of whether they directly owe the surtax.
Small Businesses at the Forefront of the Impact
A critical aspect of the testimony focused on the disproportionate impact of H 7313 on Rhode Island’s small business sector, which forms the backbone of the state’s economy. According to the U.S. Small Business Administration, Rhode Island’s 116,149 small businesses collectively employ approximately 51.1 percent of the state’s workforce. These businesses are not merely local shops; they are innovators, service providers, and major employers.
Crucially, the vast majority of small businesses operate as "pass-through entities." This includes S corporations, LLCs, partnerships, and sole proprietorships. Unlike traditional C corporations, these businesses do not pay corporate income tax. Instead, their business income "passes through" directly to the owners, who then report it on their individual income tax returns and are taxed at individual income tax rates.
IRS data illuminates the direct link between the proposed surtax and small business owners in Rhode Island. The data reveals that 55.6 percent of individual income tax filers in Rhode Island with more than $500,000 in adjusted gross income (AGI) derived income from pass-through business ownership. Furthermore, approximately 75 percent of all pass-through business income in Rhode Island was earned by filers with $500,000 or more in AGI. This statistical reality challenges the common perception that a surtax on income exceeding $640,000 exclusively targets the "top one percent" as purely passive investors or wage earners. Instead, to a "sizable degree," it would function as a significant tax increase on active small business owners and entrepreneurs.
For these pass-through business owners, a higher individual income tax rate directly translates into higher operational costs and reduced capital for reinvestment. This can force difficult decisions: raising prices for consumers, cutting wages, deferring expansion plans, or, in severe cases, leading to business closures. The ripple effects would be widespread, from stifled innovation and fewer new job opportunities to a diminished consumer base grappling with higher costs. The local business community, including organizations like the Rhode Island Chamber of Commerce and the National Federation of Independent Business (NFIB) Rhode Island, would likely echo these concerns, emphasizing the potential for reduced economic vitality and increased pressure on local enterprises.
Rhode Island’s Unique Vulnerability: Outmigration Risk
The Tax Foundation’s testimony underscored a particular vulnerability for Rhode Island: its small geographic footprint. While all states face the risk of outmigration due to unfavorable tax policies, this risk is exacerbated in a compact state like Rhode Island, where residents and businesses can easily relocate just a few miles away to a neighboring state with a more competitive tax climate. The ease with which Rhode Islanders could move elsewhere while remaining relatively close to their existing networks, customers, and communities makes the proposed surtax a particularly risky proposition.
The outmigration of entrepreneurs, high-income earners, and job creators would not merely result in a loss of tax revenue for the state. It would also lead to a brain drain, as skilled professionals and innovative business leaders seek environments where their economic contributions are not met with punitive taxation. This loss of human capital and entrepreneurial spirit could significantly hinder job growth, wage growth, and in-state investment, creating a self-reinforcing cycle of economic decline. The state’s ability to attract and retain talent and capital is paramount for its economic future, and a move that makes it less competitive regionally could have profound and lasting consequences.
Contrasting National Tax Policy Trends
Rhode Island’s consideration of H 7313 stands in stark contrast to a prevailing national trend in state tax policy. Since 2020, a remarkable 23 states have actively reduced their top marginal individual income tax rates, with many implementing multiple reductions over this period. This widespread movement has seen the national median top marginal rate drop significantly, from 5.4 percent in 2020 to 4.7 percent in 2026. This trend reflects a growing consensus among state policymakers that lower income tax rates can enhance economic competitiveness, stimulate growth, and encourage investment.
During this same timeframe, only five states and the District of Columbia have implemented increases to their top marginal state individual income tax rates on ordinary income. This places Rhode Island’s proposed surtax as an outlier, moving against a strong national current of tax reduction. As the national median rate continues its downward trajectory, states like Rhode Island that maintain or increase their income tax rates risk falling further behind in the race for economic vitality and talent retention. The proposed policy could send a signal that Rhode Island is less committed to fostering a dynamic business environment compared to a majority of its peer states.
The Broader Legislative and Economic Landscape
The testimony by Katherine Loughead to the House Committee on Finance is a critical moment in Rhode Island’s legislative process. While the committee weighs the potential revenue benefits that proponents of H 7313 might emphasize, the Tax Foundation’s analysis provides a robust counter-argument centered on long-term economic sustainability. The debate extends beyond the immediate fiscal impact, delving into the very fabric of Rhode Island’s economic identity and its ability to compete in a dynamic national and regional marketplace.
Policymakers face the complex challenge of balancing the desire for increased state revenue with the imperative to maintain a competitive and attractive environment for businesses and individuals. The Tax Foundation’s analysis strongly suggests that adopting proposals like H 7313 would harm Rhode Island’s competitiveness, potentially leading to the outmigration of entrepreneurs and job creators, reduced job growth, suppressed wage growth, and diminished in-state investment. These negative outcomes would likely be particularly pronounced in Rhode Island due to its unique geographical characteristics and its proximity to other states with varying tax structures. The decision on H 7313 will therefore be a defining moment for Rhode Island’s economic future, influencing its appeal as a place to live, work, and invest for years to come.
Policymakers, including members of the House Finance Committee, are urged to take full stock of all these likely negative outcomes before adopting income tax increase proposals such as the one contained in H 7313. The Tax Foundation respectfully requested the inclusion of its comprehensive statement as part of the public hearing record, hoping to inform a decision that prioritizes the long-term economic health of the Ocean State.
References
[1] Janelle Fritts, Jared Walczak, Abir Mandal, and Katherine Loughead, 2026 State Tax Competitiveness Index, Tax Foundation, Oct. 30, 2025, https://taxfoundation.org/statetaxindex/.
[2] For a summary of the literature, see Timothy Vermeer, “The Impact of Individual Income Tax Changes on Economic Growth,” Tax Foundation, Jun. 14, 2022, https://taxfoundation.org/research/all/state/income-taxes-affect-economy/. See also Ann D.M. Nguyen et al., “The Macroeconomic Effects of Income and Consumption Tax Changes,” American Economic Journal: Economic Policy 13:2 (2021); Karel Mertens and Morten O. Ravn, “The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States: Reply,” American Economic Review 109:7 (2019); William M. Gentry and R. Glenn Hubbard, “The Effects Of Progressive Income Taxation On Job Turnover,” Journal of Public Economics 88:9 (2002); and John K. Mullen and Martin Williams, “Marginal Tax Rates and State Economic Growth,” Regional Science and Urban Economics 24:6 (December 1994).
[3] Karel Mertens and Jose L. Montiel Olea, “Marginal Tax Rates and Income: New Time Series Evidence,” Quarterly Journal of Economics 133:4 (2018): 1803-1884.
[4] US Small Business Administration Office of Advocacy, “2025 Small Business Profile: Rhode Island,” Jun. 30, 2025, https://advocacy.sba.gov/2025/06/30/2025-small-business-profiles-for-the-states-territories-and-nation/.
[5] Internal Revenue Service, “SOI Tax Stats – Historic Table 2,” https://www.irs.gov/statistics/soi-tax-stats-historic-table-2.
[6] Janelle Fritts and Katherine Loughead, “State Individual Income Tax Rates and Brackets, 2026,” Tax Foundation, Feb. 17, 2026, https://taxfoundation.org/data/all/state/state-income-tax-rates-2026/.
