Riding out the storm: tiny Rhode Island has been buffeted by a huge fiscal hurricane that's far from over.

• Author: Downing, Neil

In the summer of 2006, Rhode Island's Republican governor and the state's Democratically controlled General Assembly teamed up to deliver a basketful of tax breaks.

They expanded a statewide property-tax relief program, shielded more cars from local excise taxes, and broadened the state's earned income credit.

But the most publicized piece was a new flat-tax option for calculating Rhode Island's personal income tax, an attempt to make the state more appealing for business owners.

"The very blue state of Rhode Island adopted one of the most sweeping pro-growth tax reforms in any state," The Wall Street Journal said at the time.

Three years later, in a rare personal appearance before the House Finance Committee, Governor Donald L. Carcieri proposed a broader list of tax cuts, including a phase-out of the state's 9 percent corporate income tax.

But gone was the bipartisan back-slapping of 2006. In its place were sharp-pointed comments from Democratic legislators and social service advocates who had had enough tax breaks passed in the name of economic development.

"Have we any guarantee that this will help raise jobs that help those who need it most?" asked Representative Thomas C. Slater.

The problem was that this very blue state was very deep in the red.

DEVASTATING RECESSION

Well before Carcieri proposed his plan in May, a full-blown recession had swept through Rhode Island like an ocean-churned hurricane. It had raised unemployment to levels not seen in decades, eroded tax revenue and made budget deficits balloon.

A key factor was the housing market.

Throughout much of the 1990s, the median price of a single-family home generally followed national trends. But with the new century came double-digit percentage increases in housing prices--each year, for four straight years. From 2000 to 2005, for example, the median price of a single-family home in Rhode Island more than doubled, from $145,000 to $293,400.

Some lenders, chasing fees, made loans to people who would not otherwise qualify, the so-called subprime loans that swept the country.

"It's clear the underwriting standards that the mortgage bankers were using were egregious," says Carcieri, a former banker, during an interview at his State House office in Providence.

"There were no appraisals going on, and on top of that, no money down" in many cases, he says. "And it was all predicated on this notion that real estate prices, residential prices, were just going to keep going up forever."

All the while, a state tax credit gave developers incentive to rehabilitate rundown historic buildings. New hotels and high-end condominium projects went...