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Indirect Benefits Sometimes Difficult to Understand

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By Lowell L. Kalapa

An idea that continues to float around Capitol Hill with little success is the bill to restore the business entertainment deduction to 100% of the cost of the entertainment expense.

Reduced to 50% of the cost of the business entertainment expense nearly a decade ago, congressional officials have continually attempted to restore such expenses to full deductibility. Part of the problem is the perception that this was a deduction that benefited the rich business person who was wining and dining some prospective client. And certainly this was perhaps engendered by the abuse of the deduction with horror stories of millions of dollars spent on sports game boxes, limousines, and lavish dinners.

However, just like the luxury tax that federal officials slapped on yachts a couple of years before, the people who were really hurt by the change in the deductibility of business entertainment expenses were the people who provided the services – from limousine drivers to waiters in restaurants. The original logic for allowing business entertainment expenses to be deductible was that this was a cost of doing business and the production of income for the business, much like the machinery or labor that was necessary to produce the goods or services sold.

Here in Hawaii where the hospitality industry is the largest component of the economic base, business entertainment expenses provide a stabilizing force that evens out the peaks and valleys of the seasonal demand of visitors. Making business entertainment expenses fully deductible would be an added incentive for business people to entertain clients. More importantly, it would insure that there would be a demand for the services utilized in entertaining clients.

While it would allow a business to reduce taxable income and therefore potential liability, it would also mean that persons providing entertainment services, such as the waiters and waitresses in the restaurant, would have jobs and income on which taxes would be due.

So instead of viewing the business entertainment deduction as merely giving “fat cat” businesses another tax break, it should really be viewed as a mechanism to encourage consumption of services upon which many depend for their livelihood. The same misdirected logic also led to the adoption and then the repeal of the luxury tax on yachts and cars.

Believing that a surtax on the purchase of luxury goods, such as yachts and planes, would soak those who could afford to pay the tax, lawmakers were convinced that this would be a progressive way to make the rich pay for their indulgences. What federal lawmakers learned was that instead of forcing the rich to pay the tax, the rich just decided not to make these purchases. The result was that hundreds, if not thousands, of workers who built yachts or airplanes were put out of work. Again, instead of achieving the desired result, a change in the tax law had an adverse impact on those people lawmakers had no intention of affecting.

Here in Hawaii, lawmakers have had fantasies of adopting laws that would impose stiff tariffs on certain activities or discourage or encourage certain behavior. Luckily, many of them were stopped before becoming law. Among the most notorious was the idea of taxing the speculation in land during the early 1990’s when foreign investors flocked to Hawaii and bought up real estate driving land valuations through the roof.

Lawmakers thought that if there was a heavy penalty for speculating in real estate where land was acquired literally over night and turned over and sold within a short period of time, say within a year, that this heavy surcharge would discourage that activity. Little did they realize that often times just common folks get caught in circumstances where they purchase and sell a property within a short period of time with no intent of speculation.

But lawmakers were convinced that a heavy club would stop this type of activity. Well, they didn’t even have to adopt the tax before investors became wary of the potential penalty if real estate was purchased and sold within a short period of time. That contemplation along with a number of other “anti-business” actions contributed to the perception of a draconian business climate that Hawaii is still battling to shake-off.

So well intended as laws and lawmakers may be, such bad ideas may just engender the opposite reaction from the one intended. That’s why care must be taken to insure lawmakers understand both the upside and downside of their proposals.

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