by Lowell L. Kalapa, Tax Foundation of Hawaii

As you begin to gather together your receipts, pay stubs and other income tax related materials, readers may want to take note of how their legislature targeted the “rich” in Hawaii to come up with more tax dollars to close the budget gap during the past two years.

Unfortunately, while it may have been a deft political move, the unintended consequences are that some of those changes may end up hurting the very people lawmakers thought they were protecting. Under Act 97 individuals with higher incomes will be limited in how much in itemized deductions they can use to reduce their adjusted gross income. Those individuals with federal adjusted gross income of more than $100,000 will be able to deduct up to only $25,000 of itemized deductions while couples with more than $100,000 of federal adjusted gross income will be able to take only a maximum of $50,000 in deductions. Heads of household earning $150,000 of federal adjusted gross income will be able to deduct a maximum of $37,500 in itemized deductions.

However, lawmakers also seemed to contradict themselves as they also prohibited all income taxpayers from deducting state income and sales taxes. Because of Hawaii’s income tax rates, this deduction for state income taxes tended to inflate the amount of itemized deductions for residents along with the mortgage interest deduction which is also substantial because of Hawaii’s high housing prices. Thus, while the mortgage interest deduction will continue to inflate the itemized deductions for taxpayers, the limit on itemized deductions may have little impact on most taxpayers because the amount of itemized deductions will be reduced with the loss of the ability to deduct state income and sales taxes.

On the other hand, the limit on itemized deductions of the “rich” could actually have unintended consequences for the poor. When one looks at the public thank-yous to donors of this or that charity ball or fund-raising events, they will see heading those lists are the so-called rich who just happen to have the ability to write a ten thousand-dollar check or one for fifty thousand dollars. While most of those contributions are made solely because individuals want to support those charities, there is also the tax benefit of being able to use those gifts to charities as an itemized deduction. Thus, placing a limit on those itemized deductions of the “rich” may, in fact, change the behavioral habits insofar as charitable giving. With the “rich” less likely to make charitable gifts because of the limitation on itemized deductions, those charities that serve the poor may have to cut back on the services they provide to the poor.

This is, in fact, what Congress learned when they imposed a similar limitation on itemized deductions a few years ago. That limit did, in fact, limit the philanthropic generosity of the “rich” who have the ability to make those large charitable gifts. As a result, Congress allowed the limit at the federal level to quietly expire at the end of 2009. Thus, a limit on itemized deductions based on one’s income in this case did have an unintended consequence that really hurt those who needed the services of the health and human service organizations who depended on those contributions.

An earlier attempt by Congress to slap higher taxes on “luxuries” that only the so-called “rich” could afford also had unintended consequences. In this case during the early 1990’s Congress took aim at luxuries like the yachts of the “rich” and attempted to impose higher taxes on those purchases. While the tax did hit the “rich,” many of those so-called “rich” people chose to avoid purchasing those goods that were subject to the surtaxes. Thus, in the case of the yachts of the “rich,” it was the hard-working stiff who sanded the teak decks of those yachts who eventually lost his job because yacht sales and ownership plummeted.

Locally, lawmakers also adopted an increase in income tax rates that puts the top tax rate at 11% and will be effective through the 2015 tax year to raise more revenues. While they may have thought they were going to raise additional income with these higher rates on “rich” individuals, what they failed to realize is that these are the very people who probably took advantage of the very generous high technology tax credits and they will have little, or no, tax liability as a result of the offset of the tax credits.

The point of the matter is that while taxing the “rich” may make good political rhetoric, in the long run there are unintended consequences that ultimately hurt all taxpayers.

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