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Efforts To Gain Statehood Drive Tax Reform

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By Lowell L. Kalapa

After years of trying to gain equal footing as a full-fledged state, backers of the statehood cause realized that they had to prove that Hawaii was ready to stand on its own financially. 

With renewed efforts to seek statehood for Hawaii underway in earnest following the end of the World War, 1957 proved to be a landmark year for the Territorial tax system. After an initial attempt to reform the Territorial tax system was rejected during the regular session of the legislature that year, a special session of the legislature was called. The 2% Compensation and Dividends tax which had been adopted in the middle of World War II was tossed out in favor of a graduated income tax law that drew heavily on the federal income tax Code which had been basically rewritten in 1954.

At the same time, changes were made to the rates imposed under the general excise tax law with the retail rate rising from 2.5% to 3.5% while the rate on producing, manufacturing, wholesaling, canning and intermediary services was reduced. On the other hand, rates were increased for liquor, tobacco, public utilities, and insurance premiums taxes. A cap that had been imposed on the amount that could be raised from the real property tax – which at the time was $2 million – was removed and lawmakers instead specified a maximum tax rate that could be imposed on real property tax assessments.

All of these efforts of the 1957 session were focused on positioning the Territorial tax system for the coming of statehood, a goal that was achieved two years later. However, statehood not only brought taxation with representation in the national arena, but it also raised interest in Hawaii and spurred growth in the state as visitors began to arrive in droves. Fueled by the commercial jet age, the visitor industry responded by making the state bird the construction crane as a new visitor plant began to grow in Waikiki. All of this growth created increased pressure on the public infrastructure and the public services demanded by this growth.

Just six years after attaining statehood, a gubernatorial commission presented a list of recommendations to the 1965 legislature. The primary recommendation was an across-the-board increase in tax rates – with the exception of fuel taxes and the state’s inheritance tax. The rates enacted in 1965 are basically the rates that taxpayers must pay today with the exception of the net income tax where rates were adjusted to compensate for the base-broadening effect of the 1986 federal tax reform act and those of the 1998 Economic Revitalization Task Force.

The consumption and compensating taxes were repealed and replaced with today’s use tax law which is imposed on purchases of goods and services from vendors who are not licensed under the general excise tax law – sellers from outside the state. This use tax law is intended to put those unlicensed sellers on equal footing with local sellers who must pay the general excise tax.

The tax reform of 1965 was also marked by a sharing of the general excise tax collections with the counties which was allocated on a county’s “relative fiscal capacity and its relative fiscal need.” Readers should also know that until 1978 policies with respect to the real property tax was set by the state legislature. So the amount of the home exemption or how agricultural land was assessed was dictated by state law. Thus, a sharing of the general excise tax collections was a means by which the state subsidized county functions. However, the most the counties ever received from this sharing of general excise tax revenues was about $19 million.

This ceiling came about in response to the federal revenue sharing program which allowed the state to get some of those funds provided that the state did not reduce grants-in-aid to counties and municipalities. As a result, the 1973 legislature figured if they had to promise not to reduce grants to the counties, they would just freeze this grant-in-aid program or as one lawmaker commented, the sword cuts both ways.

A near-miss to raise taxes by $200 million in 1973 led then Governor Ariyoshi to convene an ad hoc commission on operations, revenues, and expenditures. While the commission found no pressing need to raise taxes, it noted that should the state be faced with a similar crisis in the future, consideration might be given to imposing a tax on the rental of hotel rooms.

Next week, we will pick up this fascinating history of Hawaii’s tax system on the adoption of the tax on hotel rooms.  

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