By Lowell L. Kalapa
The current Tax Review Commission is poised to submit its report to the 2007 legislature and it appears that there will be some interesting recommendations made concerning issues pursued by prior legislatures.
One that is sure to put a damper on some legislative proposals is a caution against adopting additional exemptions from the general excise tax. In its report to the legislature the Tax Review Commission recommends that:
“Proposals to exempt transactions from the general excise tax should be weighed carefully. In general exemption of transactions primarily affecting consumers is undesirable. The Commission therefore cautions against approving proposals to exempt health care services, food, apparel, or shelter, for example. The Commission suggests that if the Legislature finds it desirable to grant such tax relief on equity grounds, that it should pursue those goals either through low-income credits against income taxes or through the appropriation and expenditure process, which enhances transparency and accountability.”
The Commission goes on to point out that based on its research, the exemption of food, health care, clothes and shelter from the general excise tax would have cost the state treasury more than a half billion dollars for tax year 2006 or nearly a quarter of what would have been generated by the tax. In the Commission’s estimation, taking this course of action to reduce the regressivity of the tax would instead cause the tax to become more inefficient and incur additional costs in administering and complying with the tax.
What is interesting is that the study upon which the Commission based this recommendation identified 29 states which exempt food for consumption off premises while 11 states exempt non-prescription drugs. Few states tax services like Hawaii and the states that tax a number of services are only three – Washington, New Mexico, and South Dakota.
The study looked at potential candidates for exemptions as identified as exempt in other states which levy a retail sales tax. These included, utility services, construction, health care, professional services such as legal and accounting services, food, shelter (as in the case of rental housing), and clothing. The study reported that depending on who are the consumers of these goods and services, exemptions from the tax will have differing effects. Where the consumer is a business, such exemptions will be beneficial to business buyers as the exemption would reduce, if not eliminate, the cascading effect of the tax otherwise known as pyramiding. Because the exemption of business-to-business transactions would not change the goods and services businesses purchase, there would be little, if no, distortion in the consumption patterns of a business as those goods and services are necessary for the production of whatever goods or services are made or provided by the business.
On the other hand, the report noted that the exemption of these goods or services when purchased by final consumers, individuals, will create distortions in how people behave. For example, because there would be no tax on the purchase of food at the grocery store as opposed going out to eat at a restaurant, consumers would tend to reduce the number of times they would go out to eat as opposed to buying groceries for home consumption. The same would be true of making a choice between buying clothes if those purchases are exempt as opposed to buying toys or stationary which would not be exempt.
More importantly, because adopting exemptions of these goods and services reduces the tax base and therefore tax collections, the rate on all other goods and services would have to be increased to make up the lost revenues. This would distort consumer behavior even more as those non-exempt items would be that much more expensive because of a higher tax rate imposed on the non-exempt items.
Probably the most interesting finding of the report is the impact that the exemption of these goods or services would have on employment. With the combination of narrowing the tax base and increasing the tax rate on non-exempt purchases that would distort consumer behavior, the study found that there would be a substantial loss of jobs with each exemption. Nearly 4,000 jobs would be lost if utility services were exempt while there would be a loss of 2,200 plus jobs lost if food were exempt.
Thus, while such proposals to exempt food, non-prescription drugs and other “necessities” may be well intended, the adoption of those exemptions will have a substantial adverse impact on the economy. For more details of the report as well as the Tax Review Commission’s report, go to the tax department’s website: www.state.hi.us/tax/tax.html