Late last month the national Tax Foundation, located in Washington, D.C., compiled its annual study of sales tax rates from around the country. This year it used a population-weighted rate that took into account local sales tax rates imposed in 38 of the states that allow their local governments to levy a county or city sales tax.
As expected, Hawaii came in almost dead last as one of the lowest combined state and local sales tax rates, outdone only by Alaska, which posted a 1.69 percent rate compared to Hawaii's 4.35 percent rate. Unfortunately, another think-tank organization called the National Center for Policy Analysis picked up the more sensational parts of the report, listing the states with the highest combined sales tax rates and the states with the lowest combined sales tax rates. Of course, Hawaii stood out like a sore thumb as being in the bottom five with a low combined rate.
Although the NCPA newsletter did note that some states relied on other taxes and, therefore, may not have as high a rate as those states that depend heavily on the sales tax as a major source of revenue, it failed to note that the other factor in determining the burden of the sales tax - or in the case of Hawaii, the general excise tax - is the base against which the rate is applied. Had the NCPA newsletter been more careful, it would have quoted Scott Drenkard of the Tax Foundation, who wrote:
"This report ranks states and cities based on tax rates and does not account for differences in tax bases (e.g., the structure of sales taxes, defining what is taxable and non-taxable). States can vary greatly in this regard. For instance, most states exempt groceries from the sales tax, others tax groceries at a limited rate and still others tax groceries at the same rate as all other products. Some states exempt clothing or tax it at a reduced rate.
"The taxation of services and business-to-business transactions also vary widely by state. Experts generally agree that Hawaii has the broadest sales tax in the United States, taxing many products multiple times and, by one estimate, ultimately taxing 99.21 percent of the state's personal income. The base is far wider than the national median, where the sales tax base applies to 34.46 percent of personal income."
In other words, unlike other states that have a retail sales tax structure, Hawaii's general excise tax focuses on the gross income received by a business located in the state. That means any and all of the gross income received by a business licensed to do business in Hawaii is subject to the state's general excise tax. This means that sales of both goods and services are subject to the state's 4 percent general excise tax. In addition, when goods and services are not sold for final consumption but are being purchased for resale to the customer of the purchasing business, the general excise tax is charged, albeit at the lesser 0.5 percent rate.
Where Drenkard failed to close the loop is that Hawaii's general excise tax is applied to services that in today's modern economy account for a much larger share of the tax base than the sale of goods. In fact, in Hawaii it is estimated that only 40 percent of retail transactions are for the sale of goods while the sales of services account for about 60 percent of the tax base. Thus, when folks ask what kind of rate would Hawaii need if it were to adopt a retail sales tax like those found on the Mainland, the response is something on the order of 10 to 11 percent in order to generate the same amount of revenue that the general excise tax rate at 4 percent now generates. This is because the service portion of the base is 1 times the size of the goods portion of the base. Thus, if the service portion of the base is not taxed, the current rate would have to be increased by a rate 1 times the rate applied to goods, or 6 percentage points, for a total of 10 percent.
That would make Hawaii's sales tax rate higher than the No. 1 state of Tennessee, which stands at 9.44 percent. Unfortunately, the readers of the NCPA newsletter did not have the opportunity to read the Tax Foundation's complete report and probably believe that Hawaii has a low sales tax rate in comparison to all the other states that impose a sales tax.
For those of us who have worked with the general excise tax, we can attest to the fact that the general excise tax is one of the reasons why it is so costly and difficult to do business in Hawaii. The tax extracts its due without regard to profitability or sustainability. It is as some have described, a beautiful beast, producing generous revenue with such a low rate.
* Lowell L. Kalapa is president of the Tax Foundation of Hawaii.