What Will It Take to Grow GDP? (Part 2)

by Tom Yamachika, President, Tax Foundation Hawaii

Last week we suggested that we look at growing our state’s economic position by concentrating on areas of our economy that we can control, like our tax rates. We examined the business tax climate rating the national Tax Foundation gave our state, and reviewed the areas where Hawaii received good ratings, namely corporate income tax, sales tax, and property taxes.

Hawaii really got zinged in the areas of individual income tax and unemployment tax. Perhaps these two areas present the best opportunities to change the perception of our state as, well, something other than tax heaven.

This week we’ll look at individual income tax where the study placed us at #35. Our high income tax rate cost us lots of points in our rating. As of June 30, 2013, Hawaii’s 11% top individual rate was second only to California (which, incidentally, took the #50 spot in the individual income tax category). You may remember that our 9%, 10%, and 11% rates were enacted in 2009 and are supposed to expire at the end of 2015. The enactment itself was something of a drama because then-Governor Lingle vetoed the bill and our House and Senate held special votes to override the veto. During that tumultuous time, proponents often pointed out that the tax increases were temporary and would go away at the end of 2015. Will our lawmakers keep their promises and let the high rates expire? Stay tuned to our next legislative session where all will be revealed!

Another issue that hurt our rating is indexation. States commonly index the standard deduction, personal exemption, or the bracket amounts for inflation, which means that when it takes more dollars to buy the same goods and services, the brackets, for example, are adjusted to account for that lost purchasing power. Twenty states index all three items. Twenty more states, and the District of Columbia, index one or two of them. We are one of ten states that index none of them. Failure to index results in something called "bracket creep," which I have written about before. Bracket creep causes numbers that were meaningful when enacted to become much less meaningful over time.

We also got dinged for having 13 brackets in our income tax code, the most in the nation. Brackets add complexity, and for what reason? Someone at the federal poverty line is already in the fourth bracket with a tax rate of 6.4%. That is no surprise because our brackets date from the 1960's and were not adjusted for inflation. A prime example of bracket creep. If you want progressivity where people with more net income pay a higher rate, this can be easily accomplished with far fewer brackets.

On the bright side, we scored points since we have no alternative minimum tax. AMT is a completely separate tax system under the federal code designed to take back some of the deductions and other tax breaks. The study argues that it adds needless complexity. As of the study date, eight states, including California, had AMT.

Another couple of features where Hawaii scored points: our tax has no marriage penalty and we recognize LLC’s and S Corporations the same as the federal authorities do.

That’s how our individual income tax scored. We will break down how our unemployment tax scored in our third and final installment next week.

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LINK: Part 1