During the heated debate over whether or not the general excise tax rate should be increased to fund mass transit for Honolulu, it became very clear that few, if any, lawmakers truly understand the general excise tax.
Even though the general excise tax is commonly referred to as a sales tax, it is far from a consumption type of tax found on the mainland as has been pointed out repeatedly. The general excise tax is a tax imposed for the privilege of doing business in Hawaii and is therefore levied against the business and not the customer. Yet because many businesses show out the tax separately, it is thought of as a tax on the customer.
Actually, the general excise tax, which was established in 1934, was never shown out separately until the mid 1950’s when the federal Code allowed state and local sales taxes to be deductible for federal income tax purposes. At that time the merchants in Hawaii asked the Internal Revenue Service to allow the general excise tax to be deductible like a sales tax if the tax was shown out separately. The IRS concurred and ever since then the general excise tax has been shown as a separate charge to the customer even though the deduction for sales taxes was repealed in 1986 and only recently has been allowed – temporarily – as a deduction for federal income tax purposes.
While businesses contended with the general excise tax for years and the initial rate was set relatively low at 1.25% for retail transactions, concern began to grow as the rate was continually increased after World War II. Rising first to 1.5% in the post war period, and then to 2.5%, businesses demanded that the tax be reviewed when the rate reached 3.5% in pre-Statehood days and finally went to 4% in the mid 1960’s.
At that point, the legislature contracted with the firm Arthur D. Little to take a look at the tax and make recommendations on how it could be improved. The study noted that while goods which were sold at wholesale, that is purchased for resale to another person, enjoyed a lower tax rate of 0.5% that was not the case with services. The study also noted that purchases made by businesses were also subject to the general excise tax at the full retail rate. This imposition of the tax contributed to the increase in the cost of goods and services passing through the system, thereby exacerbating the pyramiding of the tax.
While the business community complained for years about the pyramiding of the tax because of the imposition of the full retail rate on services that were purchased for retail and on business-to-business transactions, little was done other than to have various reviewers of the tax system, like the Tax Review Commissions, make the same observation again and again. That is until the economy went into a deep funk in the early part of the last decade.
Faced with a reelection bid in the next year, the previous state administration called together a task force that would make recommendations on how best to kick start the sluggish state economy. Among the many recommendations of the task force was the recommendation that the pyramiding of the general excise tax be eliminated. While primarily focused on creating equity between the treatment of goods and services, the task forced believed “that pyramiding of the general excise tax creates extra costs that appear in the form of higher prices to consumers and lower profits to businesses, especially when the tax is levied on inter business transactions in goods and services.”
The task force also noted that the “burden of pyramiding is likely to be higher for service businesses, small businesses, and entrepreneurs and a deterrent to outsourcing for large businesses, because current law taxes all Hawaii interbusiness purchases, with some exceptions.”
Two sessions after the report was submitted, the legislature reduced the rate on purchases of services for resale. However, they phased-in the reduction of the rate over a period of seven years. This was because lawmakers did not believe the state treasury could stand the revenue loss all at once. However, as we can see in hindsight, revenues actually improved over the period since 1999.
More importantly, lawmakers need to understand that the general excise tax is still fraught with pyramiding since inter-business transactions are still subject to the tax at the full retail rate of 4%, a burden that wheedles its way into the cost of all goods and services and is ultimately paid by the consumer in the form of higher prices. Ta-da! Hawaii’s high cost of living!