Among the studies done for the current Tax Review Commission is one that is almost mandatory as the constitution provides that the Commission judge whether or not the tax structure produces adequate revenues.
This particular study was done internally by the department of taxation staff which looked back some 30 years to evaluate the adequacy of the state tax structure as it generates revenues for the state general fund. As the report notes, researchers were confronted with the proverbial “chicken and egg” problem of asking themselves “how much revenue is needed” only to be answered with the proverbial response, “enough to run government.” That response begged the question of, “how much government service is required?”
While one could go around and around on that latter question, the researchers decided that the state’s tax structure could be deemed as producing adequate revenues if “the revenue it produces grows as fast as personal income.” The focus of revenue adequacy centers on the general fund because it is the general fund that is called upon to pay for the general operations of government. However, the researchers also noted that because the tendency over recent years has been to shift some of the operations of state government to special funds, they also examined special funds.
The researchers identified two types of adequacy – one where the tax revenues paid in the general fund tend to automatically grow as fast as personal income provided the tax law and that portion of each tax source remains the same. The second type is whether or not tax revenues paid into the general fund grow as fast as personal income despite changes in the tax law or if the portion of the tax source is changed over time.
The researchers found that the current tax structure meets both types of adequacy. Under the test for adequacy that assumes that changes in the tax law are made and the portion of the tax source that goes into the general fund does not change, researchers found that general fund tax revenues tended to grow at a rate about 5% greater than the growth in personal income since 1972. On the other hand, actual revenues paid into the general fund, taking into account the changes that have been made to the tax code over the years and the earmarking of revenues that formerly went to the general fund, indicated that revenues grew at a rate about 3% greater than the growth in personal income.
What is interesting is that the study also looked at the growth rate of revenues going into the general fund had the receipts of the tax sources not been earmarked for special funds, but took into account changes in the tax code, and found that the growth rate would have been 4% faster than the growth in personal income.
As the study notes, the legislature has taken two types of action to reduce the automatic growth in general fund tax revenues. One course of action has been to reduce statutory tax rates or reduce the tax base by providing exemptions and credits. For example, the legislature reduced the top income tax rate and broadened the income tax brackets in 1998 as part of the Economic Revitalization effort of the administration. Specific exemptions were increased, such as the increase in the amount of income of national guard personnel that is exempt from income taxes.
The second strategy has been to shift tax revenues from the general fund to special funds such as the earmarking of the transient accommodations tax (TAT) for the convention center and visitor promotion and the earmarking of the conveyance tax for affordable housing and land conservation.
In both cases, the effect has been to reduce the growth of revenues with respect to the growth rate in personal income by about one percent. While it is comforting to know that the tax structure produces sufficient revenues to fund general fund programs, one has to raise the question about the overall growth in state government when expenditures that were formerly general fund financed are now being financed through special funds.
One also has to question whether or not adjustments to the tax code that resemble expenditures rather than tax relief, such as the targeted business tax credits, can be justified. If indeed the tax law had not been changed or the amount of money generated by the tax structure was not siphoned off into special funds, could the legislature have provided more tax relief for Hawaii’s residents? Juxtaposed to the spending limit discussed earlier this month, the unadulterated tax structure would have funded general fund spending growth 5% greater than total state personal income, contrary to the intent of the constitutional spending limit.
That’s the reason earmarking of general revenues is not in the best interest of the taxpayer.