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Eating Away at the Tax Base Creates Revenue Shortfall

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By Lowell L. Kalapa

Tax credits continue to attract the fancy of lawmakers who believe they are the elixir of whatever ails you, the economy, a specific project, or a specific industry.
They have become more popular than exemptions and deductions because lawmakers can see how much they’ll be used to entice the taxpayer. At least they think they know how much will be given away. Yes, they know how much will be given to a specific taxpayer for installing a solar water heater, or they know what percent of the cost of the project will be given to a qualifying taxpayer.
However, what lawmakers have discovered is what they don’t know about tax credits. They don’t know how much the credits will cost the state treasury over the life of the credit. As a result, while lawmakers can make projections, there isn’t any certainty that the projections will be met. The result is that when a tax credit exceeds projections a huge black hole appears on the state’s revenue ledger. And that is what has happened to the state’s revenue machine over the past six years.
Despite the fact that the economy is improving, at least that is what economists tell the public, the state’s revenue picture lumbers along and lawmakers try to make ends meet by raiding special funds or resorting to in-lieu tax increases called user fees and charges. The problem wouldn’t be so bad if lawmakers enacted reductions in state spending at the same time they adopt these tax incentives, but by chipping away at the tax base without commensurate reductions in program spending, lawmakers are faced with regular shortfalls.
Apparently lawmakers also fail to recognize the other consequence of eroding the tax base and that is, everyone else who is not favored by a tax credit or exemption continues to pay the high level of taxes for which Hawaii has a notorious reputation. It is that heavy tax burden that makes it difficult to survive in Hawaii either as a family or as a business. And because lawmakers believe that businesses can pass along the cost of the tax or fees like the real property tax or business registration fees, the cost of these taxes and fees are buried in the cost of the goods and services we as consumers purchase.
Lawmakers would like their constituents to believe that adoption of these targeted tax credits or incentives will help to improve the economy. One has to ask whether or not the money spent by way of the tax credits and incentives actually improves the economic outlook for Hawaii. This was one of the major points made by the most recent Tax Review Commission.
The Commission noted that previous Commissions did not have to deal with the issue of targeted business tax credits as targeted business tax credits are a relatively new phenomenon, developed in the past six years as the economy treaded water in the economic doldrums. The Commission recommended that before any targeted tax incentive is adopted lawmakers need to undertake a cost benefit analysis, that is to analyze whether or not a tax incentive proposal will cost the state more than the estimated economic and tax benefits expected to be realized.
The Commission also noted how unlimited or open-ended tax credits lack oversight and control. Specifically, once enacted neither lawmakers nor administrators have any control on how much will be claimed. Thus, if the tax incentive is very attractive, it may generate more interest than first envisioned. And if the law is poorly written, such a tax incentive can be ripe for abuse.
But more importantly, if the tax incentive generates more losses than increased revenues from the particular activity, then it becomes nothing more than a subsidy for that particular activity at the expense of all other taxpayers. It is an erosion of the tax base.
If lawmakers want to subsidize a certain activity, then they should hand the money out the front door with an appropriation. An appropriation is precise. Lawmakers and taxpayers know how much the subsidy will cost and can weigh that subsidy against all of the other competing programs for the tax dollar. If such a subsidy can’t pass muster, then it probably should not have been considered for a tax credit as an appropriation of general funds is the same thing as handing out a tax credit.
Finally, eroding the tax base narrows the field that can be taxed which means that tax rates have to be maintained at a higher rate in order to produce the revenues that lawmakers like to spend. Thus, these tax incentives should be viewed as nothing more than indirect tax increases on all taxpayers.

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