Rhode Island High-Earner Surtax Would Hurt Small Businesses

Chairman Abney and Members of the House Finance Committee:

My name is Katherine Loughead, and I am the Director of State TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Projects at the Tax Foundation. The Tax Foundation is a nonprofit, nonpartisan tax policy research organization that analyzes tax policy issues at the state, federal, and international levels.

I appreciate the opportunity to submit written testimony regarding House Bill 7313. The Tax Foundation does not take a position on legislation, but I am eager to provide information on the negative economic implications of income tax increases like the one proposed in H 7313.

Beginning January 1, 2027, H 7313 would impose a three-percentage-point surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. on Rhode Island taxable income exceeding $640,000 (in 2026 dollars), with that amount adjusted annually for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spendin. This would raise the top marginal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source rate in Rhode Island to 8.99 percent and would effectively create a four-bracket individual income tax structure (even though the bill states that the three-bracket structure would remain in place on paper).

If this tax increase were enacted, Rhode Island would go from having the 15th-highest top marginal state individual income tax rate in the country to having the 10th-highest (not including the District of Columbia). If the tax policy changes contained in H 7313 had been in effect as of July 1, 2025, the snapshot date for the 2026 State Tax Competitiveness Index,[1] Rhode Island would have ranked 41st overall and 40th on the individual income tax component, representing a decrease in competitiveness compared to its current ranks of 40th overall and 30th on individual taxes.

The economic literature overwhelmingly finds that an income tax increase of this magnitude would negatively affect economic growth and opportunity in Rhode Island. Studies show that higher marginal income tax rates reduce gross state product, investment, and in-state employment mobility, while encouraging outmigration.[2] Notably, research finds a negative relationship between changes in income tax rates and the wages of both higher-income and lower-income workers.[3] As such, the proposed tax increase would reduce economic opportunity even for those Rhode Island residents who would not owe the surtax directly.

Much of this negative effect on economic growth would come from the proposal’s harmful impact on businesses. According to the US Small Business Administration, Rhode Island’s 116,149 small businesses employ approximately 51.1 percent of the state’s workers.[4] The vast majority of small businesses are pass-through businesses (S corporations, LLCs, partnerships, and sole proprietorships), meaning business income is taxed on the owners’ individual income tax returns. IRS data show that 55.6 percent of Rhode Island individual income tax filers with more than $500,000 in adjusted gross incomeFor individuals, gross income is the total of all income received from any source before taxes or deductions. It includes wages, salaries, tips, interest, dividends, capital gains, rental income, alimony, pensions, and other forms of income.
For businesses, gross income (or gross profit) is the sum of total receipts or sales minus the cost of goods sold (COGS)—the direct costs of producing goods (AGI) had income from pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. ownership on their returns, and approximately 75 percent of Rhode Island’s pass-through business income was earned by filers with $500,000 or more in AGI.[5]

In other words, a surtax on $640,000 or more in income—framed as a tax on the “top one percent” of income earners—would be, to a sizeable degree, a tax increase on small businesses. This surtax would make it harder for Rhode Island’s small businesses to stay afloat, leading to higher prices for consumers, lower wages, fewer new job opportunities, and even business closures.

The proposed tax increase would also make Rhode Island’s tax climate substantially less competitive both regionally and nationally. Despite its relatively high top marginal rate nationally, Rhode Island has the third-lowest individual income tax rate in the northeast after only New Hampshire, which forgoes an individual income tax altogether, and Pennsylvania, which has a low, flat statewide rate of 3.07 percent but imposes relatively high local income tax rates.

Currently, Rhode Island is a more competitive alternative to high-income-tax New York, New Jersey, and Massachusetts. However, if this proposal were adopted, the Ocean State would become less attractive to high earners than even Massachusetts, since Massachusetts’s 9 percent rate kicks in at a much higher income level of nearly $1.1 million, with income below that threshold taxed at a much more competitive rate of 5 percent. If Rhode Island were to adopt a tax rate of 8.99 percent on income exceeding $640,000, Rhode Island’s marginal rate on $640,000 in taxable income would be higher than the marginal rates on that level of income in New Jersey (8.97 percent), Vermont (8.75 percent), Maine (7.15 percent), New York (6.85 percent), and Massachusetts (5 percent).[6]

Since 2020, 23 states have reduced their top marginal individual income tax rates, with many doing so on more than one occasion, bringing the national median top marginal rate from 5.4 percent in 2020 to 4.7 percent in 2026. Until recently, Rhode Island’s top marginal rate of 5.99 percent was not much higher than the national median, but as the median top marginal rate has continued to drop, states like Rhode Island that have not reduced their income tax rates have quickly fallen further behind. In that 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.

Joining the ranks of Massachusetts and other high-income-tax states would harm Rhode Island’s competitiveness. The negative outcomes—including outmigration of entrepreneurs and job creators and reduced job growth, wage growth, and in-state investment—would likely be even more pronounced in Rhode Island, given the state’s small geographic footprint and the ease with which Rhode Islanders could move elsewhere while staying relatively close by. Policymakers should take full stock of all these likely negative outcomes before adopting income tax increase proposals such as the one contained in H 7313.

I appreciate your consideration of this statement and respectfully request the inclusion of this letter as part of the public hearing record.

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 TaxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or income taxes where all savings are tax-deductible. Changes,” American Economic Journal: Economic Policy 13:2 (2021); Karel Mertens and Morten O. Ravn, “The Dynamic Effects of Personal and Corporate Income TaxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual 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/.