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Evolution Of The Tax System In Hawaii

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By Lowell L. Kalapa

After last week’s column about the origins of the public service company tax and why utilities enjoy an exemption from the real property tax, several readers pondered the evolution of the tax system in Hawaii.

First of all, readers should know that Hawaii has always had a very highly centralized form of government. From pre-western contact days, when the alii ruled supreme, power was concentrated in the alii who provided protection for his subjects and order to the system of governance. In return, his loyal subjects provided the fruits of their labor in the taro patches from the mountains and the seas.

Although Hawaii’s first attempt at a modern day tax, the income tax of 1896, was found to be unconstitutional under the Republic, the power to tax was clearly centralized. With the passage of the Organic Act and the annexation of Hawaii as a territory of the United States, the responsibility for collecting taxes and other revenues was placed under the Territorial Treasurer. The bulk of the Territory’s revenues was realized from real and personal property taxes.

By the time the 20th century dawned in Hawaii, some of the deficiencies of the earlier law were corrected imposing a tax of 2% on the income of all individuals in excess of $1,000 and 2% on corporate income net profits. Hawaii was way ahead of its time with this flat tax on income. The flat tax was modified in 1921 to provide graduated rates ranging from 2% to 5% on individual income and the corporate tax rate was increased to 5%.

In the mean time, an inheritance tax on property received from an estate was added in 1905. Aside from the graduated income tax rates and the increase in the corporate tax rate in 1921, no other major changes were made to the tax system until 1929 when the Territorial Tax Board was formed. As the effects of the Great Depression reached the island shores, the search for a new form of taxation began in earnest as neither the property tax nor the income tax were producing sufficient revenues for the Territory.

The Territorial Tax Board took a bold step in 1932 and established a new business excise tax, a public utilities tax, and a bank excise tax. On top of that, a specific tax on fuel was adopted to begin to build a modern roadway infrastructure and a poll tax on employees was also approved. This latter tax, which was set at $5 per employee, consolidated school, road and poll fees that had been imposed as far back as the days of the kingdom. Although called a poll tax, it was never a qualification to participate in the election process. In turn, the real property tax was revised to lower the burden of that tax on Hawaii’s people and the personal property tax was repealed.

However, within a couple of years it became evident that this new tax structure was not producing the revenues that had been anticipated. So in 1934, Governor Poindexter appointed a thirteen-member committee to review and analyze the tax system and develop an equitable and adequate system that would provide sufficient revenues for the Territory.

Upon the completion of their review, this committee recommended a package that included, the repeal of the bank excise tax to be replaced with a tax on bank shares, elimination of the exemption of dividend income under the income tax, repeal of the personal property tax, and last but not least, the replacement of the business excise tax with a “broader-based” gross income tax. This latter recommendation was the birth of what we know today as the general excise tax.

This new tax on gross income represented a redistribution of the tax burden between consumers and businesses. In contrast to the old business excise tax which focused primarily on taxing businesses, the general excise tax encompassed all activities of financial gain and economic benefit for both businesses and consumers.

While the rate of the general excise tax has been increased from the initial rate of 1.25% on retail activities to the current 4%, the nominal rate remains well below the average “retail sales tax” rates found on the mainland.

The compensating “use tax” was enacted in 1945 after Hawaii emerged from martial law and sales from out-of-state unlicensed sellers took an upward swing in the postwar era. Imposed on purchases of tangible personal property made from sellers not located in the Territory, it was the first effort to put businesses, not subject to the general excise tax, on equal footing with Hawaii businesses.

Next week we will look at the effort to persuade Congress that Hawaii was qualified to become a state with the ability to be financially self-sufficient.  

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