(Released on 12/16/07)
Until very recently, one could say that the overall structure of the tax system reflected good tax policy because it contained elements that treated all taxpayers fairly and equitably.
But in recent years policymakers and certain taxpayers have decided that the tax system in Hawaii should be more fair for certain taxpayers as opposed to all taxpayers. One of the basic elements of a good tax system should be that it treats all taxpayers fairly and equitably. Where taxpayers are in different situations, the system should recognize the unique situations and treat those taxpayers differently based on the taxpayers’ capacity to pay the tax.
For example, while the general excise tax applies to nearly all transactions or sales of goods and services, it would create difficulties for those taxpayers whose “gross income” doesn’t really belong to them. This is the case with the corporate income tax and the general excise tax for financial institutions where the money they “take-in” every day is not income to the financial institution. They are deposits that belong to their customers. Thus, instead of paying the corporate income tax and the general excise tax, as other businesses do, financial institutions pay what is known as the financial institutions franchise tax. It might be considered a hybrid that recognizes that not all of the income of the financial institution belongs to that business.
Just as much as a good tax system should be fair and equitable, it should also be efficient in that it should not be so difficult with which to comply and administer that it costs the taxpayer or the tax department more than what that tax can raise. Good tax policy in this area dictates that a tax should cost little to administer in proportion to the revenue it produces.
An example of an inefficient tax is the motor vehicle tax that California attempted to levy a few years ago where a personal property tax was applied to vehicles. This meant that the amount of tax due was based on the estimated value of the vehicle. Because there are many permutations of the same vehicle, this created a nightmare for tax assessors as they tried to value the vehicle. Two vehicles of the same make and model could have two different values depending, say, on whether one had been in an accident or perhaps had a more powerful engine or more accessories. Assessors would have to spend an inordinate amount of time (not to mention money) trying to determine the differing values that this made the California motor vehicle tax inefficient. It was ultimately one of the factors that drove Governor Gray Davis from office.
Good tax policy also dictates that a tax should affect the economic system as little as possible, that is it should be neutral and not cause people to stop working or investing or saving or to make other basic changes in their economic lives. While not a tax per se, the golf course exactions that county policymakers levied on developers during the 1980’s can be viewed as a “tax” that caused developers to re-think the cost of their projects and ultimately drove those investors from the state.
Another example of how the tax system affects how taxpayers make economic choices is when the state income tax rates and brackets were so narrow that earning another few dollars put a worker into the next higher bracket. Not that taxpayers made the deliberate decision NOT to work, but it forced taxpayers to think twice about how they could avoid having to pay more just because they earned a few more dollars.
A good tax system also means that there should be certainty as to what is being taxed and how it is being taxed so that the taxpayer knows what tax is owed and for what reason. If the law is vague as to how a tax is being administered, taxpayers (and their accountants) will spend hours trying to figure out how that tax law applies to their income, creating anxiety because the taxpayer is not sure he or she has filed his or her return correctly. Such is the case with the high technology tax credits where the law was specifically written with such vagueness that the law itself initially provided that the terms of the credit were to be loosely interpreted. The result is that there is a long line of taxpayers who applied for the credits who are now standing in line for “comfort” letters from the tax department while the tax department tries to figure out how the law applies.
Next week we will look at how the legislature has strayed from good tax policy and created a tax system that only favors a few while continuing to impose a heavy burden of taxes on others.