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Guaranteed Tax Increase If Earmarking Proposal Adopted

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By Lowell L. Kalapa

Nearly 20 years ago the legislature, flush with cash as a result of a booming economy, began a practice that has plagued the fiscal integrity of the state.

Not only has it jeopardized the fiscal integrity of the state, but it has also insured that taxpayers continue to bear a heavy tax burden in Hawaii. Embarrassed by riches that were accumulating in the state general fund – to the point where the surplus topped $650 million – lawmakers searched for ways to hide this fact from taxpayers. After all, lawmakers reasoned, it is much more difficult to raise taxes than it is to lower them. So why should they give any of that surplus back?

But the media, as well as legislative observers, kept on raising the issue of why the legislature had to hang on to all of that surplus while taxes continued at rates that had not been changed since the mid 1960’s. The ingenious policymakers looked for ways to hide their embarrassment of riches and came up with the strategy to earmark those surplus dollars into special funds.

Lawmakers figured that once the money was “out of sight,” it would also be “out of mind.” Their initial run at this strategy could not have been for a more worthy cause, that is, the repair and maintenance of school facilities. After all, education is near and dear to all taxpayers, especially parents of kids using those facilities.

The resulting legislation was to earmark $90 million of general excise tax collections for this new educational facilities special fund. The collections of the general excise tax have always been a receipt of the state general fund; however, since it was the collections of the tax that were being earmarked, the earmarked $90 million was never considered a part of the state general fund. Thus, these earmarked funds were never counted as part of the general fund surplus. The result is that lawmakers could “hide” this money from the eyes of the taxpayers because it would not show up as surplus general funds. 

Because the economy continued to boom in the late 1980’s and early 1990’s, lawmakers extended this strategy to numerous other special funds, many of which had absolutely no relationship to the revenues being earmarked.

However, the strategy did not go unnoticed and in 1989 the Tax Review Commission concurred that this practice distorts the financial picture of the state and recommended that the legislature should “avoid the creation of special funds that earmark general fund tax revenues as opposed to income from user related charges.” 

The Commission also noted that this strategy avoids the constitutional spending limitation. The Commission pointed out that special funds that “merely set aside general fund revenues for general fund expenditures cannot be justified; they restrict budget flexibility, create inefficiencies, and lessen accountability.” This assessment was reiterated by the State Auditor when she was directed to review the practice of earmarking former general fund revenues for special funds. 

However, public policymakers continue to ignore this criticism as evidenced by the earmarking of the tobacco tax increase by this year’s legislature for a variety of special funds. How soon they forget the dilemma they faced during the last decade when they had to raid many of these special funds to just keep the lights on in state buildings.  Lawmakers even took back the $90 million of general excise receipts that had been earmarked for educational facilities maintenance. So much for the “commitment” to education of which they proudly boasted when they adopted the initial legislation. 

As both the 1989 Tax Review Commission and the State Auditor noted, earmarking general fund revenues for a variety of purposes reduces the flexibility lawmakers need to address problems as they arise. Creating special funds with earmarked general fund revenue also creates the false illusion that a particular problem is being addressed. It also absolves lawmakers from the arduous task of setting priorities for general fund spending.

One of the side effects of this earmarking is that by clouding the true financial picture of the state, lawmakers can avoid the issue of the high tax burden in Hawaii as it creates the illusion that there are insufficient funds to run state government. Thus, it forecloses the opportunity to reduce the tax burden as a means of encouraging economic activity and attracting new businesses and the jobs they bring to Hawaii.

Next week we will look at a provision that some counties have adopted to earmark real property taxes in a very similar manner that will ultimately insure higher real property taxes in the future.

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