STOP DESTROYING ECONOMIC GROWTH

by Lowell L. Kalapa, Tax Foundation of Hawaii

At its latest meeting, the State Council on Revenues amended its forecast of the growth rate in general fund tax revenues from 11.0% to 14.5% for the current fiscal year.

Woo-hoo, you would think elected officials would be dancing in the streets! But a closer examination of how the Council got to that stunning forecast is a bit more sobering. First of all there is an artificial bump in the growth rate caused by the fact that the previous state administration stalled income tax refunds two years ago so that more revenues could be counted in the fiscal year while delaying the pay out of tax refunds until the next fiscal year. This had the effect on the following fiscal year that made revenue growth look like it was in the dumps. And then this year when refunds were paid on a timely basis, it will make tax revenues look like they are soaring because on a year-to-year basis this year will look good against a year when there was an outflow of cash due to refunds from the last year. The result is that, of the 14.5% increase, about 4.3% of the change in the growth rate will be due to the effect of holding back income tax refunds two years ago.

The second component of the Council’s latest forecast will be due to changes in the tax law the legislature adopted this year due to the suspension of certain general excise tax exemptions including the exemption for stevedoring activities and for contractors and subcontractors. Increases in tax revenues are also projected as a result of changes made to the income tax law that will restrict certain itemized deductions and delay the increase in the standard deduction that had been planned for this coming year. For the average taxpayer many of these increases won’t be apparent until they file their income tax returns next year or will result in subtle increases in the cost of goods and services.

Although the tax department had estimated these changes would result in more than $300 million in new revenue for each of the next two years, the Council had reservations about those estimates and instead adopted only a portion of the department’s estimate that will result in a 5% growth in tax revenues this year.

Much of the Council’s skepticism of the department’s estimate was based on the reasoning that either taxpayers will find ways to avoid paying the tax by restructuring transactions or, in the case of the subcontractor deduction, taxpayers will do the work themselves without subcontracting the work to another taxpayer. In the case of sales to certain tax-exempt entities like the federal government, the Council noted that many vendors rewrote their contracts that allowed them to be grandfathered into the exemption.

Thus, with 4.3% of the growth rate attributable to the shift in income tax refunds and 5% due to the tax law changes, only 5.2% of the forecasted growth in general fund tax revenues will be due to economic growth. Although this forecasted growth in the economy is better than what appears to be happening on the mainland where the unemployment rate hovers just over 9%, the Council’s forecast is based on a number of assumptions that could change overnight depending on what happens in the national and global economy.

As one Council member noted, should government leaders, either nationally or globally, drop the ball in healing the economic woes, those actions could affect the Council’s forecast. He pointed out how Japan actually made substantial gains in the last decade only to have government leaders dash those gains with a round of higher taxes and new government regulations in that country.

And that’s what is holding back any euphoria about the Council’s latest forecast. As Congress and the administration await the deliberations of the new “super” committee that has been charged with coming up with the new game plan to right-size the federal government, will Congress undertake its own plan to right the nation’s fiscal ship? Will those plans involve judicious reductions in the size of the federal government or will tax increases be the solution that elected officials choose?

And what about our local political leaders? Should the additional revenues expected from the tax law changes adopted this past legislative session not materialize, will elected officials once more resort to tax increases to balance the budget or will they find ways to reduce government expenditures to match what the economy is able to produce? What will be fascinating to watch is how the economy reacts to the tax increases lawmakers adopted. Will those tax increases slow economic growth and drive taxpayers out of business and kill the jobs Hawaii workers need?

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