New tax proposals are brought to the legislature every year, and in this session tax policy deserves closer scrutiny than ever before.
In the last 12 months, COVID-19 has transformed work, school, home and our entire economy. Rebuilding Hawaii into a place where local people can live and thrive requires a review of many state policies, including the fundamental fairness and adequacy of our tax system.
Local economists point to the following as foundations for a healthy and vibrant Hawaii future: efficient transportation, good public schools and universities, affordable and available housing, and effective government. None of this is possible without collective investment – through taxes – in government spending and regulation.
For most years, half of the state’s operating budget (now about $16 billion) is funded by taxes, another 23% by extrabudgetary funds (such as UH tuition), and 20% by the federal government. In 2020, our General Excise Tax produced $3.5 billion, income taxes totaled $2.4 billion, and the Temporary Accommodation Tax added $564 million. Together, these three accounted for 81% of state taxes.
So-called “sin taxes” on tobacco products and alcohol play a minor role in government revenue, accounting for just 2% of total revenue in 2020. Although alcohol tax revenue has remained fairly stable over the past decade (around $50 million per year). tobacco taxes ($112 million in 2020) are in decline. That’s because sin taxes are tools to change behavior, not just collect revenue. Hawaii’s progressive tobacco taxes are designed to both help meet the public cost of smoking and reduce consumption. The 2021 bills introducing taxes on sugar-sweetened beverages have the same rationale.
That year, lawmakers considered proposals that would fundamentally change Hawaii’s tax system by raising property tax rates and eliminating income taxes. Uniquely, the Hawaiian Constitution gives counties sole authority to tax real estate while barring them from collecting most other taxes. County governments rely on property taxes as their primary source of revenue, which is expected to bring in $2.2 billion in 2020.
Hawaii has the lowest homeownership tax rates in the country, and the amounts paid by homeowners are low, even considering the high cost of houses here. Our low property taxes are cited as one of the reasons foreign investors are able to buy up Hawaii’s homes, resulting in lower housing stocks and higher prices for local residents. One of the bills targeting property tax increases would encourage counties to raise rates by taking away their share of the TAT. Another would require a constitutional amendment to allow the state to tax real estate again.
Raising property taxes is good tax policy when accompanied by increased homestead tax exemptions. Boroughs can and should be moving in this direction anyway to pay for critical infrastructure and other priorities for the Borough’s residents. But these bills would also eliminate income taxes on individuals and corporations, a trade that would seriously degrade Hawaii’s tax system and undermine the adequacy of state revenues.
A regressive tax system is one in which lower-income households pay a larger percentage of their income in taxes than wealthier ones. The most regressive states have little or no income taxes, relying instead on property taxes and sales/excise taxes.
Income taxes are progressive because tax rates increase as income increases. In Hawaii, income taxes take just 0.6% of the income of the lowest-income households, while the top 1% pay 6.2% of their income.
Any bill that would eliminate our income tax would instead make Hawaii more dependent on the regressive GET, which captures a far larger percentage of low- and middle-income earners. GET revenue would not adequately support decent public education (including the much-needed expansion of public preschools), affordable and available housing, efficient transportation, and effective government — the things Hawaii needs to have a healthy, expanding economy.
Given the wide and growing gap between low-income and high-income residents, lawmakers should consider different tax laws to make our tax system fairer and more equitable. For example, it is high time to raise the tax rate on long-term capital gains income, which is currently capped at 7.25%, far less than we pay on income from our wages. Capital gains benefits go almost exclusively to the wealthy. Lawmakers should also increase inheritance taxes by reducing the allowance for high-value estates. Now, a couple’s $11 million estate isn’t taxed at all.
In 2021 and every year, proposals to change our tax system are important. Tax policy must ensure that the burden of funding our society — generating the revenue we need to provide Hawaii residents with the best possible and brightest future — is shared fairly.
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