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Need To Heed Tax Review Commission

posted in: Weekly Commentary 0
 By Lowell L. Kalapa

(Released on 02/11/07)

The state constitution requires that a commission be convened every five years to conduct a systematic review of the tax structure and recommend tax and revenue policies after evaluating the state’s tax structure using such standards as equity and efficiency.

The deadline for each commission’s work is 30 days prior to the convening of the second regular session of the legislature after the appointment of the commission. Members of the commission are subject to the advise and consent of the state senate.

Added by the 1978 constitutional convention, the first commission appointed in 1980 resigned after they were unable to secure funding for the commission’s work. Another commission was appointed in 1983 and, with a shoestring for funding, completed its work in 1984 for submission to the 1985 legislature. Among the most controversial of that commission’s recommendations was a proposal to tax pension income. Having been exempt for decades, the idea of taxing the income of retirees hit a brick wall. But to that commission’s credit, the recommendation to tax pension income was combined with a recommendation that called for adjustment of the net income tax rates and brackets. In their view, the combined recommendation would “be able to provide substantial income tax relief to many low-to-middle income elderly.”

The taxation of pension income was considered by two other past commissions while the current commission appears to have arrived at a compromise position. The current commission considered taxing all pension income when it was recognized that how people saved for their retirement years had evolved over the last 20 years. In fact, it is now not uncommon to read about how companies have ditched the traditional “defined benefit” pension plans in favor of 401(k) or deferred compensation plans. These latter vehicles for retirement savings do not qualify for the exemption of pension income as in many cases it represents income that the employee has chosen not to take at the time it was earned.

As a result, the current commission is recommending that in order to be fair to those who will use these savings accounts for their retirement income and those who, because their employers continue to offer defined benefit plans, is to tax all pension income over an initial threshold of income. In the case of the commission’s recommendation, that threshold would be set at $50,000. That number is arbitrary and could be set at any amount. What is more important is that all retirement income be treated alike regardless of the form it takes and setting a high enough floor so that every retiree will enjoy the same tax break would be the most equitable approach to dealing with this type of income.

Another issue the commission took a look at is the general excise tax. The consultant’s review was based on either broadening the base of this tax or reducing it by providing additional exemptions from the tax. To broaden the base, the consultant recommended eliminating the exemption for not-for-profit organizations with respect to the goods and services they sell. The consultant noted that the broad exemption for nonprofits amounts to a subsidy for those organizations that distorts the allocation of resources, unduly encouraging consumption of their output especially when they compete directly with for-profit entities.

The consultant estimated that the exemption for nonprofit organizations costs the state $168.7 million in lost revenues for the tax year 2006 or about 6.5% of total general excise tax collections. If the exemption were eliminated, the consultant noted that it would be possible to drop the general excise tax rate from 4% to 3.7%. Elimination of the exemption would not affect the exemption for charitable donations, gifts or bequests.

Another commission recommendation based on the consultant’s study advises that “proposals to exempt transactions from the general excise tax should be weighed carefully. In general, exemption of transactions primarily affecting consumers is undesirable.” As a result the commission “cautions against approving proposals to exempt health care services, food, apparel, or shelter.”

The commission went on to offer that if it is “desirable to grant 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.”

There are an awful lot of bills this session that would do just that, exempt a variety of consumer transactions such as the exemption of food and health care services. Hopefully, lawmakers will heed the advice of the Tax Review Commission and tread carefully in considering such exemptions. After all, we taxpayers paid for that advice, let’s hope lawmakers listen to it.

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