For nearly thirty years, the taxing of services was treated differently then the taxing of goods or tangible personal property. However, beginning this year, services are now on an even playing field with goods.
When the firm of Arthur D. Little took a look at the general excise tax back in the mid-1960’s, it was noted that taxing goods and services that would eventually be resold to another person at the full retail rate would dramatically increase the cost of those goods and services to the final consumer.
Although the general excise tax had been established with a wholesale rate back in the 1930’s, the lesser rate applied only to goods. Originally set at 0.25%, the wholesale rate rose to a high of 1% when the retail rate stood at 2.5%, but again, the wholesale rate applied only to tangible personal property. When the Little study was presented to the legislature in 1968, a major recommendation was to lower the rate on services purchased for resale.
However, lawmakers, as they do today, had a difficult time conceptualizing that a service could be resold. Apparently when lawmakers looked at services they believed that when a service was performed, it was being performed for the final consumer and was being done at a specific moment in time. It was difficult for lawmakers to envision that a service done on Monday could be resold on Wednesday. So for nearly thirty years, services – with a few minor exceptions that qualified for what is known as intermediary services – were taxed at the full retail rate of 4%.
In the meantime, Hawaii’s economy transition from one based in agriculture to one based in the visitor industry where nearly all of the visitor experience is services. In fact, today more than 60% of the general excise tax base is transactions that involve the sale of services. While indeed many of these transactions involve the sale of services to the final consumer, to Hawaii’s visitors many involve services that are incorporated into another service that is then resold to the visitor.
So in 1999, lawmakers were finally convinced that there are services that could be and are being purchased for resale to a final consumer. Enacted as part of the effort to revitalize Hawaii’s economy, lawmakers approved Act 71 which phased-in a reduction of the general excise tax rate on services that are purchased for resale. Beginning this year, the rate on the wholesale sale of services is 0.5% just as it is on the wholesale sale of goods.
For example, a visitor decides to take an all day fishing excursion and charters a boat to go bill fishing. The boat owner probably will provide the visitor food for the all day excursion. The food is catered from a local restaurant and is sold to the boat owner. Although to the casual observer the food might be considered “goods” for the purpose of the general excise tax, the catering is actually a service.
Since the food is not for consumption by the boat owner, but the visitor, the service is actually being purchased by the boat owner for resale to the visitor who has chartered the fishing boat. Therefore, the caterer should be paying 0.5% on the sale of the food to the boat owner as the cost of the food will be recovered in what the boat owner will charge the visitor as the food is being resold to the visitor.
Another example of the resale of services is when an engineer is hired by an attorney who is filing a claim on behalf of a client for a defect in a building. The engineer is being hired to determine whether or not there is truly a defect in the building. Without this information, the attorney cannot argue the claim on behalf of his or her client. However, since the outcome of the claim will benefit the client, the engineer’s work is actually for consumption by the client. Thus, the attorney is purchasing the services of the engineer for resale to his client. This is a service that should be subject to the lesser 0.5% rate.
As both Hawaii’s economy and the national economy move toward one that is based on services, this change in the general excise tax law will become even more critical in insuring that costs to the final consumer are kept in check. As Arthur D. Little noted, the cost of the general excise tax on all the transactions prior to the final transaction can be more than the initial cost of the goods or services.
Indeed, the general excise tax and how it is imposed is a major contributor to Hawaii’s high cost of living. No doubt one of the hurdles to finally reducing the rate on the wholesale sale of services is the fact that without the reduction state government enjoyed the windfall of revenues this pyramiding of the tax produced.
If Hawaii’s economy is to grow and its residents are to survive, other ways to address the pyramiding of the tax need to be addressed.