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Lawmakers Must Alleviate Regressive 4% Tax

posted in: Weekly Commentary 0
By Lowell L. Kalapa

One of the drawbacks of any tax imposed on transactions is that the tax tends to be regressive, that is, the tax takes a larger percentage of a poor family’s income than it does of a higher-income family.
The result is that the poor family spends more of its limited income in the amount of the transaction tax. Such is the case with the general excise tax which is imposed on all transactions be it at the retail level or the wholesale level.
And unlike retail sales taxes found on the mainland, the 4 percent tax is imposed on services as well as on goods. The result is that the general excise tax has a much higher degree of regressivity than the retail sales taxes found on the mainland.
As a result, in addition to raising the standard deduction for the state income tax, the one other thing that lawmakers could do to ease the burden of taxes on the poor is to mitigate the imposition of the general excise tax on those families.
Efforts to lighten the burden of the 4 percent tax dates back to the late 1960s when credits were granted to all consumers. This credit, along with credits for other purchases, was consolidated into one credit in 1974 with the intent of reducing the regressive nature of the general excise tax.
The credit structure was designed to return more of the general excise tax paid to those at the very bottom of the income scale and lesser amounts to those who are considered lower middle-income. The credit amount was largest at the $5,000 and less level then gradually the amount of the credit was reduced as income rose to be eventually phased-out at first the $15,000 and then the $30,000 income level.
Through the years, the amount of the credit was increased continually until the general excise tax credit was joined by the food tax credit. Since the income tax base was substantially broadened as Congress eliminated tax preferences such as the deduction of credit card interest and sales taxes, federal income tax rates were lowered to compensate for the base broadening.
However, in Hawaii lawmakers were urged not to lower income tax rates at a commensurate rate because the impact of the base broadening was unknown. Instead, lawmakers were asked to adopt the food tax credit of $55 until the impact of the federal changes could be assessed over the following three years. Within two years the decision was made to make the food tax credit permanent and leave income tax rates with the minimal adjustment made in 1987. The food tax credit and excise tax credit were subsequently combined into a single credit in 1990.
Within a few years as tax revenues paled, lawmakers repealed what became the combined food tax credit and the general excise tax credit as they searched for money to balance the general fund budget. Although a low-income tax credit was adopted as part of the income tax rate cuts recommended by the Economic Revitalization Task Force (ERTF) in 1998, the amount was a minimal $30 per exemption which was also inversely graduated and phased-out for those with more than $30,000 in adjusted gross income.
Now that the state has an ebullient revenue outlook, calls are being made to reform the state tax system to provide tax cuts for the middle-class and for increases in the standard deduction. However, a restoration of the general excise tax credit in a similar structure that existed before 1987 would be a giant step toward restoring relief from the general excise tax for the poor.
However, as lawmakers work on restoring this relief mechanism, they might want to correct some of the shortcomings of the original statute. For example, the original law based the credit on the number of exemptions claimed. This allowed seniors, who are granted a double exemption due to age, to claim twice the amount of the credit as their counterparts in the same income category but who were less than age 65. For the purposes of claiming the credit, the double exemption for age should not be utilized.
To claim the credit, consideration should be given to using the number taxpayer’s bring over from the federal return as adjusted gross income as it captures some of the income that state law excludes from taxation such as pension income. Since the logic behind granting the credit is to return some of the 4 percent imposed on income spent for goods and services, all available income should be counted to measure the need for relief.
Finally, consideration should be given to setting a reasonable ceiling before the credit phases out. Thirty years ago, those with income of $15,000 or more did not receive the credit. Later it was raised to $30,000 at which point it was then repealed. Consideration should be given to raising that ceiling.

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