by Lowell L. Kalapa, Tax Foundation of Hawaii

Across the nation it has become increasingly apparent that state and local governments are also struggling in these difficult economic times as taxpayers are laid off and real estate values plummet.

As a result, elected officials are turning every stone and looking under every leaf for potential revenues to shore up sagging budgets. Local officials have also been beating the bushes searching for additional revenues without having to adopt an explicit increase in tax rates.

At the state level, lawmakers have resorted to suspending certain exemptions under the general excise tax while increasing income tax rates on the “rich” and limiting itemized deductions and redirecting revenues from special funds to the general fund. While lawmakers claim they have already cut state government to the bone, how much more can the taxpayer and the state economy be expected to kick in to keep government open?

Perhaps the other question that should be asked is whether or not everyone is paying his or her fair share for government. Last session the administration proposed taxing traditional defined benefit pensions. Although the major reason behind the proposal was to raise more funds for the state general fund, the proposal raised the question as to whether or not such a broad exemption insured that those who receive a pension are paying for the government services they use.

Currently, income from a traditional defined benefit pension fund is totally exempt from state income taxes. While some argue that seniors live on a fixed income and after all those years of paying taxes, they deserve to be exempt. The problem is that even as seniors they continue to use public services and public facilities. Someone has to pay for those services or to maintain those facilities. Completely exempting pension income shifts the burden of providing those services and facilities to someone else.

The administration’s proposal failed to gain legislative approval and was left on the cutting room floor largely because of the emotionalism, but also because it was convoluted making the application of the tax less than understandable. The proposal relied on federal adjusted gross income that already includes pension income and some Social Security benefits. It set a threshold that exposed all pension income to taxation should a taxpayer’s income go just one dollar over that threshold.

Had the proposal just exempted a base of pension income with which seniors could easily identify, the proposal might have had more consideration. While most seniors today are beneficiaries of these defined benefit pensions, fewer retirees in the future will enjoy that benefit as more and more employers shift to 401(k) plans whose benefits are entirely taxable. Those seniors who currently receive benefits from a 401(k), therefore, are subject to income taxes while defined benefit pensioners are not.

Because such exemptions make the tax base all that smaller, the rates imposed on those not so favored are higher than they have to be. As noted in an earlier Commentary, a broad base, such as that for the general excise tax, allows a tax rate to remain relatively low.

In Honolulu, the review panel that has been asked to look at the real property tax is also faced with a similar problem. Over the years the real property tax has been riddled with all kinds of exemptions and dedication provisions which have taken some taxpayers off the hook insofar as paying for important county services such as police and fire protection. As a result, the burden of paying for those county services falls to those who are not so favored with an exemption, and the rates imposed on those taxpayers are higher than they really have to be because those who are taxed have to make up the loss of revenues for those who are not taxed. The problem for elected officials is that many of these exemptions have constituencies, the largest being homeowners who regard their home exemption as being sacrosanct, and nonprofit organizations that generally do not pay income taxes. In a state where nearly half of the population rents shelter, the home exemption actually discriminates against those renters. And for nonprofits, they avail themselves of many of those vital county services such as police and fire protection.

So while we would all like to believe that the best tax is the tax that someone else pays, it sooner or later comes back to haunt us all. For years, the real property burden was shifted to businesses, but businesses have to pass the costs onto their customers. When it comes to paying for government, there is no free lunch.

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