TAKING SOME OF THE BITE OUT OF COMPLIANCE

by Lowell L. Kalapa, Tax Foundation of Hawaii

One of the standards of good tax policy is that a tax system is efficient, taking few resources and effort to administer the tax imposed and taking little effort with which to comply with the law. Directions and information should be convenient and understandable to the average taxpayer, encouraging compliance and insuring that both the administrator and the taxpayer clearly understand how the law is applied.

When laws are so vague and poorly written, all sorts of problems can and do occur. Such was the case with what has become known as the Act 221 credits for investments and research in high technology. The drafter of the legislation deliberately inserted terms and actions on the behalf of the taxpayer that literally allowed all sorts of interpretation. With that intent in mind, the author of the legislation directed that the law be liberally interpreted, basically meaning “anything goes” in order to qualify for the credit. As a result, in the initial years following the adoption of the credit, anything and everything seemed to qualify as a claim for the credit.

More recently, a rewrite of the tax credit for alternate energy was intended to broaden the application of what was the old solar hot water heater credit to encourage the development of even more advanced technology for the use of non-fossil fuels to power the state. However, in the rush to encourage all sorts of new technologies, the legislation left the “barn door” wide open to interpretation and application that it appears to have opened the flood gates in allowing all sorts of claims to be filed and awarded.

Then there is the uninformed action to make simple things hard. Nearly 40 years ago the legislature decided that if the differences between the state income tax law and the federal income tax law could be minimized, there would be few differences between the two laws and it would make it much easier for the taxpayer to comply with the state law. Mistakes would also be reduced. The first step lawmakers took was to make sure that as many of the state provisions as possible mirrored the federal provisions when it came to the definition of taxable income. The result was that they adopted a new approach to insuring that the state law conformed to the federal law by listing those sections of the federal law that were not operative for state income tax purposes and which sections of the federal law were operative but differed in the amount of income recognized by that section. Lawmakers also committed to adopting provisions of the federal law regardless of the revenue impact - either plus or minus - in the pursuit of insuring simplicity for not only the taxpayer but also for the tax department.

One of the benefits of maintaining close conformity with the federal law is that state administrators could then rely on federal audits and examinations of federal returns to trigger an alert for state auditors to select the state returns where questionable information had been provided. This allowed state tax auditors to concentrate on the state’s largest source of tax income, the general excise tax. Some may question that if the state strives to maintain a close similarity to the federal definition of income, how come taxpayers cannot claim items such as the same standard deduction as provided by the federal law or tax credits like the earned income tax credit. That is because these provisions do not define taxable income or the dollar amount at the federal is irrelevant to the state tax rates which are substantially lower than federal tax rates.

In recent years both policymakers, as well as administrators, seem to have lost institutional memory when conforming the state income tax with the federal law. As a result, the number of differences between the federal and state laws has grown and where a few years ago Hawaii was able to boast that it had a single page income tax return, that has now grown to four pages and multiple worksheets that don’t even get turned into the tax department.

This past session had probably the most marked digression from conformity to the federal law. As a result of legislative action, some taxpayers will no longer be able to take all of the deductions they will be able to take on their federal tax return and all taxpayers will not be able to deduct their state income or general excise taxes on their income tax return.

Not only will taxpayers have to figure out different deductible amounts for their state return from their federal return, but they will also have to be aware of those changes and make the required recalculations of their taxable income. More work and more paper to be filed. Ease and efficiency are quickly disappearing and make compliance even more difficult.

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