Flexibility Lost, Tax Increases Guaranteed with Earmarking

by Lowell L. Kalapa, Tax Foundation of Hawaii

Lawmakers and special interest groups believe that if they could secure a guaranteed source of funding for their pet project or program from state government, they won’t have to worry about their funding needs in the future.

Earmarking of revenue sources comes at a very high price for all programs and projects as well as for taxpayers who have to fork over the dollars to keep state or local government operating. Because earmarking takes funds away for the general pot of money that is used to fund the operations of state and local government, legislators or council members must either cut those programs or services that would otherwise be deemed essential to the health and safety of the community or, in the alternative, raise taxes to make up for those revenues that are earmarked for a specific program or project.

The practice dates back at least twenty plus years when state lawmakers first used the device as a way to hide surpluses in the state general fund. When the general fund balance or surplus at the end of the 1980’s mushroomed to more than a half billion dollars, lawmakers “earmarked” $90 million of general excise tax collections for an “educational facilities” fund because of the huge back log of school maintenance projects. Few, if any, opposed the idea for after all, the idea of repairing the badly dilapidated school plant was high on everyone’s priority list. As one senator put it in passing the bill out of committee, “This is our commitment to education.”

However, soon after adopting this earmarking, the financial picture of the state went south and lawmakers turned to this earmarked-financed special fund to raid it to pay for operating costs and changed the financing mechanism to bonds or debt. That same downturn spurred efforts to earmark other general fund tax resources for various programs.

Such was the effort to earmark the conveyance tax which is imposed on the transfer of real property. The rate was initially doubled in the early 1990’s and earmarked for affordable housing and funding the state trails program. Again, who could oppose the building of affordable housing or maintaining the state’s parks?

So earmarking resources not only hides the true cost of government, but it also reduces the flexibility that policymakers need to address changing needs. That is why a proposed amendment to the Honolulu City Charter to earmark one-half of one percent of all general fund revenues each year for a grants-in-aid program for nonprofits would seriously impair the ability of future county officials to address the changing needs of the City and holds the potential for guaranteed increases in taxes, in particular the real property tax.

Several years ago amendments to all four county charters were proposed that earmarked one percent of real property tax revenues for the purpose of funding affordable housing programs and for the protection of conservation lands. For the past fiscal year, that meant $8 million was earmarked for these programs, or looking at it in another light, it was $8 million that was not spent on essential City services such as police and fire protection or sewers or garbage collection. If cuts are not made to these essential services, then the council will have to raise another $8 million in real property taxes.

Thus, the charter proposal to earmark one-half of one percent for grants-in-aid to nonprofits would tie up another approximately $5 million that will either have to be cut from other programs or could result in an increase in real property taxes by another $5 million. Not only would cuts have to be made or additional taxes raised, but the earmarked funds could be used only for the grants-in-aid program. This would preclude the council from utilizing this amount for programs that might be considered of a higher priority should a need arise.

Given that this grants-in-aid program could only be used to fund nonprofit agencies who currently enjoy complete exemption from the real property tax, should the amendment gain approval there would be even more reason to consider charging nonprofit organizations for the City services they use as the new grants-in-aid program would reflect a double subsidy by City & County taxpayers for these tax-exempt organizations - one as a subsidy in the form of a grant-in-aid paid for by City taxpayers, and another subsidy in the form of the exemptions from the real property tax.

The proposal to earmark yet another source of revenues for the City & County should be soundly rejected.

--- 30 ---