Raising Property Taxes to Improve Public Schools

by James Mak and Carl Bonham, UHERO, February 3, 2017

Hawaii’s public school teachers’ union (HSTA) is back at the State Legislature this session to ask lawmakers to help find more money to pay teachers and other education expenses. HSTA was at the Legislature last year to lobby for a 1% increase in the State’s 4% general excise and use tax (GET) to fund K-12 public education. That effort failed. HSTA is back again with a new plan. The plan calls for an amendment to the State’s Constitution that would allow the State to impose an “education surcharge” on the counties’ real property taxes on residential “investment property”. Hawaii’s Constitution currently only allows the counties to levy a property tax. The proposed amendment includes a daily room tax on tourist accommodations which State lawmakers can enact without a constitutional amendment.

The proposed amendment (SB 683) reads as follows: “Shall the Legislature fund a quality public education for all of Hawaii’s children, including the recruitment and retention of teachers; lower class sizes; special education program; and career and technical education, art, music, Hawaiian studies, and Hawaiian language instruction by establishing a surcharge on residential investment property and visitor accommodations?” HSTA estimates that the two taxes would generate $500 million in revenues each year. (By comparison, data from the State’s Comprehensive Annual Financial Report for fiscal year 2016 show State tax revenues collected from all sources totaled $6.454 billion and expenditures on lower education was $2.522 billion.) That money would be set aside in a special fund for education. The real intent is to generate more money to pay teachers in order to address a teacher shortage crisis, which HSTA President Corey Rosenlee said is “…going to make it very difficult to attack a lot of those other problems that are affecting education.” The proposed amendment requires the approval of voters; thus, lawmakers can escape blame for raising taxes. Pretty clever. But lawmakers will still be on the hook for passing bills to implement the proposed amendment. Senate bill SB 686 specifies what will be taxed and at what rates. It is a highly discriminatory bill.

Unfortunately, the current proposal put forth by HSTA to tax investment properties and visitor accommodations is seriously flawed. Consider the property tax surcharge proposal. What are residential “investment properties”? HSTA defines residential investment property as any residence that doesn’t have a homeowner exemption. To qualify for a homeowner exemption, the residence must be its owner’s principal residence. U.S. Census data (American Community Survey) show that in 2015, 56.9% of the 450,572 occupied housing units in Hawaii were owner-occupied, and 43.1% (181,028 units) were occupied by renters. The average household size in occupied rental units was 2.83. Thus, there are a lot of renters living in HSTA’s “investment properties.” A property tax surcharge on investment property is also a tax on renters in Hawaii.

Authors of SB 686 recognized the potential negative impact of their plan on renters. SB 686 states: “This part shall not apply to property rented for an amount no greater than $1,500 per month, not including any applicable maintenance fees, utility fees, and services charges.”

U.S. Census data show that in 2015, the median monthly gross rent in Hawaii was $1,438. Forty-seven percent of the occupied rental units, or 84,562, had a gross monthly rent of $1,500 or more; those units housed about 240,000 people. However, property values and rents vary among the counties, with Honolulu at the top. Home ownership is also lower on Oahu compared to the Neighbor Islands. Thus, the education surcharge will have a disproportionate impact on Oahu renters.

There’s more. The tax on rental properties priced above $1,500 per month will drive up their monthly rents; but it may also drive up the rents of exempt units as some renters switch out of the higher priced units into the lower priced units.

SB 686 requires the counties to administer and collect the education property surcharge. It won’t be easy for the counties to sort out which properties qualify for this exemption. Counties don’t have information on which properties without homeowner exemptions are rented and for how much. And rents also can change periodically requiring constant adjustment to the $1,500 exemption threshold.

The education surcharge tax rates, set on a sliding scale, are not modest. For example, for FY 2016 to FY2017, the Honolulu County property tax rate for “residential” properties is $3.50 per $1,000 net taxable property for all properties except Residential A properties (valued at $1 million and above) which are taxed at a higher rate of $6 per $1,000 net taxable property. In SB 686, the lowest property tax rate is $3.50 per $1,000 for properties valued at below $500,000. Thus, an owner of an investment property in Honolulu worth less than half a million dollars can expect to see his (her) combined City and State property tax bill double. For an investment property valued between $500,000 and under $750,000, the combined property tax bill will be 2.29 times the previous County-only tax bill. SB 686 is also silent on whether the valuation thresholds will be properly indexed to allow for changes in housing prices. In the absence of indexing, more and more investment property owners will be pushed into higher tax rates as housing prices rise.

Taxes are sometimes levied to discourage certain kinds of behavior—e.g. smoking and drinking. We call them “sin taxes.” But the most important reason to levy taxes is to raise revenue to pay for public services that we desire. The tax is the price of the services consumed. Households whether they own or rent and send their children to our public schools consume a public service that is not produced at zero cost. HSTA’s education tax surcharge proposal gives homeowners with exemptions a discount on the consumption of public education services. What is the rationale for that? Is it because owner-occupants can less afford the additional tax than renters? A good tax system should be equitable as well as pay for public services that we collectively value the most. The HTSA proposal is patently unfair.

The education surcharge on visitor accommodations is arguably even more bizarre than the property tax surcharge. SB 686 states: “The education surcharge on visitor accommodations shall be imposed statewide on all visitor accommodations, regardless of occupancy.” In other words, it is also levied on vacant units. Rates are set at $3 per day for units that rent for less than $150 per day, and $5 per day for units that rent for $150 per day or more. Thus, the visitor accommodation tax is not an occupancy tax like the State’s transient accommodation tax (TAT); it is essentially a property tax.

Hawaii’s TAT is a tax on consumption even though it is levied on sellers (hoteliers); the TAT is passed on to consumers/tourists. A property tax is a tax on capital (including land). In my own research on the distribution of the burden of the hotel property tax, I came to the conclusion, that an increase in hotel property taxes in Hawaii cannot be fully passed on to hotel guests. With the TAT, hotel guest bills include a separate line item stating the amount of TAT payable by the guest. If hoteliers wish to visibly pass on the visitor accommodation tax to guests in the same way, what is the appropriate amount to list on the guest bill since the tax levied per occupied room varies from hotel to hotel depending on the hotel occupancy rate?

Finally, HSTA’s plan puts the cart before the horse. Ideally, one should first have a detailed implementation plan for what is needed to create a “quality” state-wide public education system then figure out how best to fund it. HSTA’s current proposal seems to say, “Give us more money and we’ll figure out how best to spend it.” Apparently, HSTA is hoping that voters will be more willing to raise taxes that appear to target tourists and wealthy property investors. Hawaii’s public schools may need more money, but HSTA’s plan is not the way to raise it.

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SB686: Text, Status

HB180: Text, Status