By Lowell L. Kalapa
Although there appears to be a lot of the “politics of blame” to go around. Hopefully, personalities and hard feelings won’t get in the way of enacting one of the most important products of the 1999 legislative session – de-pyramiding of the general excise tax.
If you think you are confused and befuddled because you don’t understand “pyramiding,” join the crowd. The “mysterious” phenomenon stumps reporters and lawmakers and even some accountants who are unfamiliar with the general excise tax, and it is the stealthy culprit that increases the cost of living in Hawaii.
Tax pyramiding occurs when the general excise tax is imposed on a good or service at more than one stage of the production process such that when you add up the amounts of the tax imposed at each turnover of the good or service, the amount represents a percentage of the final selling price that is greater than the statutory 4% rate.
This phenomenon was criticized nearly 35 years ago when an independent consultant reviewed the general excise tax. While the rate for the sale of goods sold for resale was reduced to 0.5% to mitigate the pyramiding of the tax, it seems policymakers in the old days couldn’t imagine services sold for resale. In their logic, when a service was rendered it was immediately consumed and therefore subject to the full 4% rate.
After the consultant’s study was submitted, the legislature provided for a narrow application of the lesser 0.5% rate for certain types of situations where services are secured upon the request of a customer. This “intermediary services” provision was so narrowly interpreted and applied that few service providers qualified for the provision.
As a result, the cost of the 4% tax becomes imbedded in the cost of the service if the service is resold. If the service is resold as part of another service or combined with goods, the selling price will then include the cost of the original service, the 4% tax on that cost, the cost of the service or goods with which it is being combined and the mark-up of the seller. This sales price, including the amount of the 4% tax imposed on the previous transaction, is again subject to the 4% tax rate.
Let’s look at an example of how pyramiding affects the cost of services. Say, a hotel decides that it wants to provide its guests an authentic Hawaiian luau experience. However, the hotel chefs are unable to cook Hawaiian fare. So they contract with a caterer known for its Hawaiian food, but the hotel wants the caterer to provide everything that goes along with a luau including the entertainment, flowers, and decorations.
The caterer only knows how to prepare the food. So the caterer secures the services of a Hawaiian music trio to perform at the luau. They contract with a local florist to arrange the flowers at the luau site. They contract with a local theater supply company to set up the decorations and props once a week.
Each of these services is currently subject to the full retail rate of 4% on the amount they receive from the caterer. The caterer, in turn, includes the cost of the entertainers, the florist, and the theater supply company in his charge to the hotel. The caterer must pay the 4% tax rate on the entire amount received from the hotel. The hotel, in turn, must pay 4% on the tickets they sell to their guests who choose to attend the luau.
Under the bill approved by the 1999 legislature, the entertainers, the florist, and the theater supply company would now only pay the 0.5% rate as the services they provide will be resold by first the caterer and then by the hotel. Only the tickets sold to the hotel guest will be subject to the 4% tax rate as it is the guest who will “consume” all of these services.
There are countless examples of situations where services are purchased for resale by the subsequent business. Although some would like the 0.5% rate to apply to all their purchases, the lesser rate will not apply to services that are actually consumed by the business. This is because the bill attempts only to put services on par with goods which are still subject to the 4% rate if they are used by the business.
The de-pyramiding of the general excise tax on services will take a major step toward reducing the cost of living and doing business in Hawaii.