by Lowell L. Kalapa, Tax Foundation of Hawaii

As the largest source of general fund tax revenues, it is crucial that administrators, as well as practitioners, understand the underlying philosophy of the general excise tax in order for the tax to make sense.

Much as some reject the notion that the general excise tax is imposed for "the privilege of doing business in the state," the 4% tax that everyone likes to call the state sales tax is just that, a privilege tax. As a result, the sale of anything, be it goods or services, is subject to the tax because the seller has the "privilege" of making that sale in the state.

And that last phrase - "in the state" - is also crucial to the imposition of the tax. When a business locates in the state and begins selling goods or services in the state, then that business becomes subject to the tax because the business has now "requested" to do business in the state. If a business outside the state that has no physical presence in the state of Hawaii sells a product or service to a person in the state, the law attempts to level the playing field by imposing a complementary tax called the "use" tax on the person making the purchase. If the purchaser is going to consume the product or service, then the use tax is paid at a rate of 4% which is the same rate imposed on retail sales under the general excise tax. If the purchaser has purchased the product or service with the intent of reselling the product or service, then the use tax is due at the rate of 0.5% which is the same as the wholesale rate under the general excise tax.

The word "attempts" used above is probably an accurate description of what happens when most consumers make a purchase from an out-of-state vendor. The average "joe" probably is unaware that the "use" tax is due on that purchase, while businesses more than likely will pay the tax as they are more likely to be audited. Also larger and more visible purchases, such as an automobile, will be caught in the system, as those purchases will have to be registered in the state for use on the roadways.

When an out-of-state vendor decides to locate a place of business in the state or for that matter just have a representative of the product or service in the state, the vendor gains "nexus" or presence in the state and, therefore, becomes subject to the general excise tax on all sales be it onsite in the state or by way of mail or INTERNET. Again, this is because the vendor has asked for the privilege to do business in the state. Thus, it is "where" the business or vendor is located that determines whether the general excise tax or the use tax is imposed.

The idea of requesting the privilege for doing business in the state applies across the board to all sellers of products or services. This is why many nonprofit organizations that believe that they are "tax exempt" protest when told that they must pay the 4% general excise tax on fund raising income from the sale of this or that product. Inasmuch as the sale of this or that product or service as a way to raise money for the organization probably is in direct competition with a for-profit business selling the same product or service, they are seeking the same privilege as the for-profit vendor.

Supporters of the nonprofit might argue that the price at which they sell their sausage or candy is typically higher than what a for-profit vendor might sell the same product because it includes a higher mark up in order to raise funds for the nonprofit. However, the fact of the matter is that the purchaser does not need to buy another sausage or box of candy from the for-profit vendor. Thus, the "privilege" to sell that sausage or box of candy requires the payment of the general excise tax.

Every year lawmakers throw bills in the legislative hopper to exempt the sale of a variety of goods or services from the general excise tax like the purchase of food or healthcare services with the well-intended hope of not taxing the poor or the sick. And each year, they need to be reminded that the general excise tax is imposed for the "privilege" of doing business and exempting certain products or services discriminates against those who may be selling other goods or services.

For example, a grocer selling food would be exempt whereas the retailer next-door selling clothes would not be exempt. Another example is the doctor who would be exempt but the mechanic who works on the doctor’s car would not be exempt. Such exemptions merely erode the tax base and unless lawmakers are willing to have less money to spend, the rate on all other vendors would have to go up to compensate for the lost revenues.

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Lowell L. Kalapa is the president of the Tax Foundation of Hawaii.

© 2011 Tax Foundation of Hawaii