By Lowell L. Kalapa
One of the guest speakers invited to address the Taxation Working Group of the Economic Revitalization Task Force last week was flat tax “guru” Professor Alvin Rabushka of the Hoover Institution at Stanford University.
Although Rabushka’s forte is the flat tax approach to income taxation, he was asked to evaluate the Hawaii tax system and in particular the state’s net income tax. And what he had to say obviously was not well received by all in attendance, in fact, there seemed to be a sense of denial, especially among elected officials.
Rabushka labels Hawaii’s net income tax system as “one of the worst” income tax systems in the country with its high maximum tax rates and relatively low-income thresholds. He characterizes such a tax system as a “job killer” because it discourages businesses from creating new jobs because the low-threshold, high rate structure creates a pressure on payrolls to keep up with after-tax income that is eroded by a high maximum tax rate kicking in at such low levels of income.
However, what was most painful for elected officials was the point that Rabushka made about reforming Hawaii’s draconian income tax. He noted that if Hawaii wants to lower income taxes, elected officials will have to make a choice between revenue neutrality and taking a hit in revenue. He believes that given Hawaii’s high burden of taxes, revenue neutrality is out of the question. And as he pointed out, if policymakers can accept that premise, then it becomes quite evident that they will have to settle for a smaller sized government.
His recommendation to improve Hawaii’s income tax system boiled down to four words: low rate, broad base. Rabushka suggested that elected officials consider cutting the current tax rate in half or eliminating the net income tax altogether. He vehemently advised against merely raising the threshold where the maximum tax rate kicks in as he believes that Hawaii’s current maximum tax rate of 10% is among the highest net income tax rates in the nation.
He also noted that while there will be a temptation to utilize targeted tax incentives to attract various types of businesses to Hawaii, that approach is out-dated and probably would not work in an environment where the tax rates are high by comparison to other jurisdictions. He noted that while targeted tax incentives were the norm during the 1970’s and 1980’s, most of those countries which took that approach have now moved to broad-base, low-rate tax structures, doing away with the targeted tax incentives.
Coming full circle, Rabushka pointed out that there is substantial research which establishes a clear link between high tax burdens and low economic growth. He noted that during the past three decades, scholars from all over the country have analyzed the effects of state and local government taxation on business location and on economic growth. They have demonstrated statistically significant relationships between state and local taxation and economic activity. Among the findings are that: low tax states grow more rapidly than high tax states; higher marginal tax rates and greater progressivity of the personal income tax reduce employment in manufacturing and wholesale trade; and increases in effective tax rates on business reduce the number of new industrial firms.
Other findings also indicate that higher personal income, sales, and property taxes reduce new business starts while tax difference on capital between sites affects the geographical distribution of new manufacturing firms. On the other side of the coin, those studies indicate that reductions in personal income tax, property tax and sales taxes increase employment and capital investment in manufacturing facilities.
Based on what Professor Rabushka had to say, the solution is obvious, but the real question is whether or not elected officials will have the “political will” to make those changes, especially if it means down-sizing government and spending less.