Category Killer

by Tom Yamachika, President Tax Foundation Hawaii

We are now in the home stretch at the Legislature.  This is the time when conference committees meet to iron out differences between versions of legislation passed by the House and by the Senate. Unfortunately, all of the negotiations and conversations take place behind closed doors. We don’t get to see the results until agreement is reached and a public meeting is called to vote on the conference draft.

One of the bills still in play is what I call the Category Killer, House Bill 1369.  The bill as introduced took aim at more than a dozen different tax exemptions and credits.  Why?  Legislators are deeply concerned about fallout from the chainsaw-wielding cost cutters now running amok in Washington, DC, and are considering a special session later in the year to deal with anticipated slashes in federal dollars that have been coming to Hawaii and were relied upon in the budget.  So, legislators now are thinking about revenue enhancement.  Which means either raising taxes or pulling back on tax breaks.  The Category Killer bill delivers the latter in spades.

We at the Foundation always have supported treating taxpayers equally under the tax code, so we probably won’t be shedding too many tears if some exemptions or credits that were disrupting the free market went bye-bye.  But some of the provisions on the chopping block are more widely used and have become necessary for the tax system to operate as intended.

One example is what we call the “sublease deduction.”  Our general excise tax hits rents at the full retail rate.  So, people renting real estate to others can expect to pay GET on their rental income.  But what happens if that property is leasehold?  In the old days, the GET would apply with full force to both the lessor and the sublessor, bringing two layers of 4% tax (I’m not counting the county surcharge) to the ultimate lessee.  And it didn’t stop there:  If the property was subleased again, one more layer of 4% tax would be slapped on.  And so forth.

In 1997, the sublease deduction was enacted. It applied to whoever was both receiving and paying rent.  That person would be fully subject to tax on rent received but would get a deduction for 87.5% of rent paid, effectively dropping the ultimate lessor’s tax rate to 0.5%, the tax rate we charge to wholesalers, making the GET on rents economically similar to other instances where the GET is applied more than once in the chain from supplier to consumer. The Category Killer bill gets rid of the deduction entirely.

On the income tax side, the Capital Goods Excise Tax Credit was enacted in 1987 to give businesses relief from the GET that they paid on equipment, production machinery, computers, and other depreciable assets.  The individual purchases would not be exempt from GET or use tax, but the businesses were able to get back some of the cost through this refundable credit. The Category Killer bill eliminates the credit for all businesses except manufacturing and agriculture.

And then, for businesses of all kinds selling to the federal government, an exemption from the GET on sales of tangible property dates back to 1951.  Why is it there? Normally, people or businesses needing tangible personal property have a choice to buy from a local seller or to bring it in from outside. The local seller, however, has to pay GET while the outside seller, presumably outside the reach of Hawaii’s taxing jurisdiction, does not.  To level the playing field, Hawaii imposes a use tax on a customer bringing in tangible goods from outside the state in the same amount as the GET that the local seller would’ve paid. However, this doesn’t work when the federal government is the purchaser because it’s immune from use tax (and every other state tax).  Thus, this exemption is needed by businesses of all kinds who are selling to the federal government.  But the Category Killer bill wipes it out.

These three “tax benefits” are, again, just the tip of the iceberg.  House Bill 1369, the Category Killer bill, deserves your attention.  Hopefully we can avoid the “cut and oops” cycles that the federal government recently has been going through.