Why Do We Tax Shipping?

by Tom Yamachika, President, Tax Foundation Hawaii

Many of the studies that have compared Hawaii against the rest of the country have focused on our insanely high cost of living. Much of the latter is caused by geography. We’re on islands in the middle of the Pacific, and if we want goods that have been made elsewhere, they need to be transported here. But what many of us might not know is that we tax the transportation, making the shipping more expensive and thereby directly adding to the cost of living.

Take, for example, transportation of goods by air. We used to expose air carriers to the public service company tax, which is something like the General Excise Tax but with a higher rate. In 1978, the federal government passed a law preventing states from taxing air transportation of passengers and cargo. We nevertheless continued taxing our air carriers, saying that our public service company tax was a property tax rather than a tax on transportation. It took a trip to the U.S. Supreme Court and an 8-0 vote against the Department of Taxation in 1983 for the State to realize that it had to lay off the air carriers. But the State wasn’t finished. Many of the transportation service providers such as FedEx and UPS ship items from door to door, meaning that a parcel being shipped travels some distance on the ground in Hawaii to or from the airport. The State concluded that the local travel of the package could be taxed, and in 1998 won two cases in the Hawaii Supreme Court saying so.

What about transportation of goods by sea? There is no similar federal statute preventing states from taxing water transportation of passengers and cargo. There is a statute saying that no taxes by a non-federal interest shall be imposed on a vessel or its passengers for operating upon the navigable waters of the United States, but, according to a Hawaii appeals court decision in 2010, this law doesn’t apply because we aren’t taxing the passengers or cargo, but the business conducted by the vessel operator. The taxpayer in that case tried to get the U.S. Supreme Court to step in, but the Court denied review. Thus, it’s likely that Hawaii taxes apply to charges for shipping goods by sea. But Hawaii probably won’t have the right to tax all of the charges, at least when the goods are transported from another jurisdiction, because that other jurisdiction would have a right to tax the same charges as well.

At this point, you might be wondering what Hawaii taxes apply to interstate trucking, which is the third major way that goods can travel between states. We have three “interstate highways,” but we have no interstate trucking and never will – at least until they figure out how to put water wings on an 18-wheeler. Funny how that works.

Can we beat the system by having a business outside of Hawaii that does not pay Hawaii tax ship the goods to us? Lawmakers already have addressed this. Hawaii has a “Use Tax” that is imposed on someone who imports tangible property into Hawaii. If you buy a product, you have a choice between buying it from a local seller or from a “remote seller,” namely someone who isn’t subject to Hawaii tax laws. If the local seller would have had to pay General Excise Tax and you buy the product from the remote seller instead, you, as the buyer, are generally subject to Use Tax at the same rate. This system protects the local sellers, and a comparable provision is in place in all states that impose a retail sales tax. The Use Tax is paid on all costs necessary to bring the product onto Hawaiian soil, including the freight charges. No escape there.

So here is a radical idea: What if we turned off the General Excise Tax and Use Tax on shipping charges? That way we could do something about our cost of living while avoiding the complexities that are inherent in applying our taxes to the income or costs of transportation.

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