By Lowell L. Kalapa
The legislative session will be soon upon us and with many new faces there is no doubt that freshmen legislators will want to conquer the world during their first term in office including overhauling the tax laws of the state.
While the tax burden is indeed high in Hawaii, garnering the fourth or fifth highest spot among the 50 states, it does not mean that the tax system is out of whack. Indeed, Hawaii is recognized as having a well-balanced tax structure utilizing the net income tax, a general excise tax mistakenly called a sales tax, and the real property tax. Now the first two taxes are resources of the state while the latter is a county resource. While all states levy some kind of real property tax, only 39 states levy both a net income tax and a general sales tax. However, only five states do not levy a sales tax but one does allow its local governments to levy a tax on sales.
On the other hand, seven states do not impose a personal income tax on their citizens, choosing instead other ways to fund state programs and services. These states include: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Some elected officials have suggested that perhaps doing away with the personal income tax would reward workers who earn and save while imposing a higher sales tax would discourage excessive spending.
The problem with the heavy reliance on sales taxes to fund state government is that depending on what is included in the sales tax base – that is, what is taxed and what is exempt – could make the sales tax a very volatile resource for state government. For example, when such necessities as food and drugs are exempt or removed from the tax base, the remaining transactions determine how much will be generated from the sales tax. If these types of purchases are discretionary, then sales tax collections will be fraught with peaks and valleys as consumers either accelerate, defer, or do not make discretionary purchases.
Even if such necessities are removed from the sales tax base, the tax continues to be regressive, that is taking a greater chunk of the low-income family’s budget than that of a higher income family budget. Although exempting necessity purchases, such as food, from the base would mitigate some of the regressivity, the problem of volatility noted above would make the dependence on the sales tax questionable for state government.
What is even more interesting is that Hawaii’s general excise tax is so much more comprehensive that when compared to other states, the breadth of the base of the general excise tax is 109%, that means that many of the goods or services that are subject to the tax are taxed more than once. No other state has such a broad base to which their sales taxes are applied. The next largest base subject to the sales tax is Wyoming with 64.6% followed by New Mexico that taxes about 62% of the goods and services sold in that state.
What is more disturbing about replacing the net income tax with the general excise tax at a higher rate is the fact that the structure of the general excise tax allows it to take more per dollar of income than the nominal rate of 4%. In fact, a recent article by one of the national experts in the area of sales taxation reports that Hawaii’s general excise tax takes 4.39 cents of every dollar of personal income. Not only is this more than the nominal rate of 4%, but it is also the most pennies per dollar of personal income taken by any state’s sales tax even though many of those states impose a nominal rate higher than 4%.
On the other hand, because Hawaii lowered its personal income tax rates a few years ago, it is no longer in the top in the maximum tax rates although the top tax rate of 8.25% is far higher than many of the other states with personal income taxes. However, because Hawaii has not increased its standard deduction in more than a decade, the very poor still end up paying some amount of personal income taxes on their meager incomes.
Because Hawaii’s personal income tax has a graduated scale of rates, rising with each bracket to the maximum of 8.25%, the personal income tax system is deemed progressive, that is those with higher incomes pay a larger percentage than those at the bottom of the income scale.
The personal income tax also allows the system to provide tax relief for other taxes like the general excise tax because it measures the taxpayer’s income or ability to pay those other taxes. And because the state income tax largely conforms to the federal definitions of income, it is easy with which to comply and administer.
Next week we will look at where the real property tax contributes to the balanced tax system in Hawaii.