Taxes aren’t just a means to collect revenue; they’re also a tool that can be leveraged to obtain positive social outcomes. Taxing cigarettes and alcohol discourages their consumption, and we use the tax proceeds from these sources to cope with the poor effects of smoking and alcoholism on public health. Similarly, there exists an opportunity to use different taxes to encourage positive trends, while also making adjustments to where the burden of these taxes fall, creating new opportunity for Hawaiʻi residents to thrive.
[Related: “What makes a good tax system?”]
Hawaiʻi’s general excise tax (GET) is not only our state’s largest source of tax revenue (Fig 4.3), but also the primary reason Hawaiʻi’s lowest income earners have the second highest tax burden in the United States. Adjusting our tax system to rely less on the GET could free up room to make further changes to lessen that burden, like exempting food and other essential goods from the excise tax the way most states exempt these essentials from sales tax. However, there is opportunity to be found in other sources of tax revenue as well.
Individual Income Tax
While Hawai‘i’s GET tax is considered regressive—i.e., it collects a larger share of the income of low- to moderate-income residents—Hawai‘i’s income tax is progressive, with higher income households paying a greater share of income in taxes. Hawaiʻi adopted an income tax in 1901, before it even became a state. In FY2017, Hawaiʻi’s individual income tax produced $2.2 billion, or 30 percent of all tax revenue.
According to the Department of Taxation, “Hawai‘i’s individual income tax generally follows the federal definitions for determining net taxable income but has its own exemptions, tax credits, and tax rates.” Individual tax rates are arranged in 12 brackets. The lowest tax rate is 1.40 percent and, effective January 1, 2018, the percentages paid by the top three brackets are 9 percent, 10 percent, and 11 percent, respectively. Hawai‘i’s individual income taxes are distinguished by having the largest number of brackets of any state, and the 11 percent paid at the top of the scale is the second highest in the nation.
The 2017 law that added the three top tax brackets did so to offset a new non-refundable earned income tax credit (EITC) to start benefiting lower income wage earners in 2018. Income taxes are imposed on virtually all earners, but some low-income residents can erase their tax debt with credits for food/excise tax, low-income renters, child and dependent care, and earned income. All, except the earned income tax credit, are refundable.
The federal EITC or EIC, which has been around since 1975, provides a subsidy for low-income working families. The federal EITC is a refundable credit, which means that it can reduce tax liability to below zero and pay out the remaining amount as a tax refund. The EITC, in combination with the refundable portion of the Child Tax Credit, lifts more people out of poverty than any other program, according to the Center on Budget and Policy Priorities. Hawaiʻi should take the next step after implementing its state version, and convert the Hawaiʻi credit into a refundable tax credit.
According to the U.S. Census, Hawaiʻi’s counties spend less per person on average than similar jurisdictions in any other state. Hawai‘i has the fifth lowest local taxes (which are county taxes in Hawai‘i) as a share of total state funding. Ours is the lowest effective property taxes in the country at $2.80 per $1,000 in net value. New Jersey’s rate is the highest at $23.8 per $1,000—8.5 times more than Hawaiʻi’s rate.
Theoretically, Hawaiʻi’s county tax rates do not need to be as high to cover essential functions because most services that are funded at the local level in other states are state functions here: the prime example is Hawai‘i’s public school system. Hawaiʻi is the only state with a single school district system funded and operated by the state. In other states, public education is supported at the county or municipal level, often relying on property taxes for funding.
In Hawai‘i, only the counties have constitutional authority to levy property taxes, which are used for county services unrelated to education. (A ballot initiative was proposed for the 2018 election that would allow property tax collection at the state level to support certain educational costs, but it was invalidated by the Hawaiʻi Supreme Court shortly before the election.) But even without making investments in schools, Hawaiʻi’s counties should take the opportunity to re-examine their property rates to address the long lists of projects that could move forward with more funding. These include supporting truly affordable rental properties, improving infrastructure or working on a host of other local needs that local government can best address.
Transient Accommodations Tax
The transient accommodations tax (TAT) is imposed on income gathered from renting a hotel room, rental house or similar living accommodation to visitors. In 2017, Hawaiʻi brought in $508 million from this source, or 7 percent of all Hawai‘i’s tax revenue. In 2017’s special legislative session, the TAT was raised by 1 percent to 10.25 percent to fund Honolulu’s rail project. The distribution of TAT funds is shown in Figure 4.5.
Most TAT funds go into the general fund (57 percent), but also get distributed to support the counties (20 percent), tourism (16 percent), as well as land development, Turtle Bay preservation and the convention center (6 percent). The visitor industry is a mainstay of Hawaiʻi’s economy and needs to contribute its fair share of revenue. Given the increase in visitors seen in recent years and the growing propensity for them to rent accommodations outside of hotels, it is crucial for the state to enforce collection of TAT from nontraditional hosts who rent rooms or houses to tourists.
Opportunity in Other Taxes and Fees
Other smaller revenue sources from taxes demonstrate further imbalance in the tax system that could be adjusted to make sure the state is collecting additional revenue and from sources that can more easily bear the costs of such taxes.
In FY2017, Hawai‘i’s corporate income tax collected just $77 million, while its conveyance taxes on transferred properties produced $95 million. Both of these taxes are progressive because they impact wealthy residents and corporations, while leaving low-income earners out of the equation. However, the amount of revenue generated by each of these progressive taxes is quite small.
Hawaiʻi collects a state corporate income tax at a maximum rate of 6.4 percent, spread across three tax brackets. There are a total of 32 states with higher corporate income tax rates than Hawaiʻi. Another way to look at this is that Hawaiʻi ranks 41st in per capita corporate income taxes.
For comparison, the maximum personal income tax rate in Hawaiʻi was raised to 11 percent in 2017, on incomes over $400K (joint), $300K (head of household) and $200K (single). Even the wealthiest corporation that does business in Hawaiʻi will always pay a lower income tax rate than many of the state’s highest individual earners.
One reason that revenue from the corporate income tax is so low is that more and more businesses are being structured as pass-throughs (accounting for about half of private sector jobs in Hawaiʻi), in which corporate income is distributed to owners, who then pay individual income taxes on it. Additionally, the Tax Cuts and Jobs Act of 2017 created a new deduction of 20 percent on pass-through income, further limiting the amount of revenue collected from wealthy earners.
The conveyance tax, meanwhile, generates revenue from property transfers. The tax operates on a sliding scale and, for the majority of small-scale land owners who paid $600,000 or less for their property, the conveyance tax rate is set at $0.10 per $100. At $600K, the rate increases to $0.20. A $599.99K property, therefore, would incur a mere $600 tax upon transference to a designated inheritor.
At the same time, the real estate, rental and leasing sector has consistently accounted for the largest, non-governmental portion of the state’s GDP since the Department of Business, Economic Development and Tourism has been keeping records (back to 1997). Investment in land, therefore, is a huge money-maker for corporations and wealthy individuals alike, while failing to generate a proportional amount of revenue for the state.
By contrast, the collection of motor vehicle registration fees and taxes that automobile owners are required to pay each year, alone, generated $187 million—more than corporate income and conveyance taxes combined. However, these automobile taxes and fees are regressive: every car owner has to pay them, but they take up a larger percentage of low-income earners’ budgets. And people who earn lower incomes tend to live where rents are cheaper, in rural or other areas farther from urban areas and work, and are therefore more reliant on automobiles.
This tax should be examined to see if it is a disproportionate burden to lower income people living in rural areas who rely on cars to get to work. At the same time, it might be tailored to ensure that it collects an appropriate sum to cover the wear and tear on roads and highways attributed to tourism.
Other taxes that could provide an opportunity for adjustment include:
- Fuel and environmental response taxes (produced $195 million);
- Cigarette and tobacco taxes (totaled $124 million);
- Public service/utility company fees, in lieu of taxes (contributed $122 million); and
- Liquor taxes (yielded $51 million).