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Learning Curve Steep For New Leaders

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By Lowell L. Kalapa
(Released on 2/6/11)

The proverbial you know what hit the fan when the administration unveiled its plan to “balance” the state budget by raising taxes – uh, yes, raising taxes.

Probably the most controversial of these tax increase proposals is the one that would start taxing pension income. Hawaii is one among ten states that does not tax pension income, that is pension income received in the form of a defined benefit plan. While most businesses in the private sector have done away with the “defined benefit” type of pension plan as the costs became prohibitive, state and local governments continue to provide this benefit. Thus, the loudest protests will come from those who retired from public employment.

From a pure equity point of view, taxing pensions should not be any different from taxing the wages and salaries of a working person. Just because it takes the form called pension or retirement, it is income nonetheless. That said, one has to acknowledge that pension income is usually a fixed amount for the rest of the life of the retiree with no option for earning more next year than was realized this year. And this is the rub for retirees who continually point out that they are living on a “fixed” income. As the cost of living rises, these retirees must cope with those rising costs on an income that doesn’t increase from year to year.

The administration’s measure recognizes those who depend on that pension income for their basic needs by setting a floor before pension income is to be included in gross income for state income tax purposes. This “floor,” or threshold, is set at $37,500 of federal adjusted gross income for individuals, $56,250 for heads of households, and $75,000 for those filing a join return. The problem with using “federal adjusted gross income” is that not only does it already include pension income but it may also include one-half of the taxpayer’s Social Security benefits.

Thus, the administration’s proposal not only changes the policy regarding the taxation of pension income, but it also changes the policy with regard to the taxation of Social Security benefits. It is not that the state tax will be levied on Social Security benefits per se, but because federal adjusted gross income includes Social Security benefits which then define whether or not one’s pension becomes taxable for state income tax purposes, it has an indirect effect of taxing those benefits.

This approach also ignores the actual size of the retiree’s pension income as exceeding the threshold or floor and throws all of the retiree’s income on the table to be taxed. So, the retiree may have been employed at a business where the pension plan met the bare minimum requirements of the law and the contributions to the plan may have been relatively small in favor of paying more generous wages.

That retiree, being prudent, set aside some of those generous wages either in savings or purchased equities to provide for his or her retirement. As a result, the earnings of those savings and investments provide for the bulk of the retiree’s income. Because these sources of income are included along with what might be considered a pittance of pension income, the retiree exceeds the threshold subjecting all of the pension income to the state income tax. On the other hand, another retiree’s only source of income is his pension, but that pension falls just below the proposed threshold of federal adjusted gross income and thus escapes any state income tax.

It would seem fairer that if pension income is now to be taxable for state income tax purposes, the threshold be measured only against the form of income called pensions. Treatment of this form of income would be identical regardless of other sources of income and regardless of the federal definition of income.

That said, one has to ask why has it come to this point that the state has to tax a source of income that traditionally has been exempt? All taxpayers, both workers and retirees, must share the blame as few paid attention to how lawmakers frittered our tax dollars away on this or that program. Now that many of those programs and services lawmakers initiated in the last few years have constituencies, it has been difficult for lawmakers to rein in that spending.

The swift and vehement rejection of the proposal to tax pensions lies not so much in the fact that it will now tax income that was formerly exempt as much as it is the fact that taxpayers already reel under the heavy burden of taxes in Hawaii. As on senior noted, “What have lawmakers been doing with all the taxes we pay?”

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui News, West Hawaii Today, Garden Isle News, and the HawaiiReporter.com.


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