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In 2016, lawmakers came up with a law requiring the State Auditor to review exemptions, exclusions, and credits in the general excise, public service company, and insurance premium taxes. Under the terms of the law, HRS section 23-71, the existing tax benefits on the books were divided into ten chunks, with each chunk to be reviewed every ten years. The Auditor was supposed to figure out how much each tax benefit costs in terms of lost revenue and determine whether the tax benefit has achieved and continues to achieve the purpose for which it was enacted by the legislature. The Auditor was supposed to start on the first chunk last year and finish the report before the start of the 2020 legislature, but there was a delay.
HRS section 23-91, also enacted in 2016, requires the Auditor to review tax credits, exclusions, and deductions in our net income-based taxes, namely the income tax and the financial institutions franchise tax. Those tax benefits were divided into five chunks with each chunk to be reviewed every five years, and the Auditor is supposed to start on those chunks this year.
Auditor’s Report No. 20-09, issued on June 25, was the first of these reports. It reviewed six exemptions and seven exclusions.
“Exclusions,” the report stated, “remove revenues from certain activities that were never intended to be part of a broadly defined tax base. Excluded amounts generally are not included in a taxpayer’s reported revenues and are therefore not taxed.” Examples are the exclusion for dividends and for income from the sales of securities, commodity futures, evidence of debt, real estate in fee simple. The report observed that the Department of Taxation does not require that any of these amounts be reported on a tax return (and never did). That makes it tough to estimate the revenue impact of the exclusion.
Here, the Auditor’s key finding is that the exclusions reviewed described kinds of income that were never supposed to be taxed in the first place. We agree with the finding. The tax is supposed to be on the privilege of doing business, so excluding income not from business activity makes sense. The Auditor requested that it be spared from reviewing these exclusions again, which also makes sense.
For the exemptions, the Auditor was only able to find out in general what the exemptions were designed to do. To find the rationale for the subcontract deduction, for example, the Auditor unearthed a conference committee report from 1970 saying that the committee hoped the exemption would result in a reduction in the cost of housing. For this as well as most of the other exemptions, the Auditor concluded that there was insufficient data to determine if the exemption was achieving the policy goal that the Legislature intended it to achieve, and asked that the Legislature do a better job of spelling out what it is trying to accomplish. Getting lawmakers to do that is a noble goal but may not be easy to accomplish.
The Auditor did pass judgment on one exemption. An exemption for income from the operation of a stock exchange was enacted in 1988, apparently designed to attract a stock exchange to Hawaii to replace the Honolulu Stock Exchange that closed its doors in 1978. But no replacement stock exchange ever appeared. Yet there were one or two handfuls of taxpayers who were claiming the exemption on their GET returns anyway (which doesn’t necessarily mean that the claimants belong in the hoosegow; they might have confused this exemption with the exclusion for stock market gains). Maybe it is time to clean up and repeal this provision.
We also have one interesting fact to share regarding this report. The Tax Foundation of Hawaii was the only non-government organization that the Auditor recognized (in the Foreword section of the report) as providing cooperation and assistance. We are honored by the inclusion but wonder whether other stakeholders, such as taxpayers and trade organizations, should have been consulted as well. More feedback probably would have resulted in a more useful report, with suggestions for improving the exemptions that are now on the books.
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Tom Yamachika is the President of the Tax Foundation of Hawaii, a private, nonprofit educational organization dedicated to informing the taxpaying public about the finances of our state and local governments in Hawaii. Tom is also a tax attorney in solo practice and has been since early 2013. Prior to 2013, he was with the accounting firm Accuity LLP, which was formed in 2006 from the Honolulu office of Coopers & Lybrand (which later became PricewaterhouseCoopers). Before that, he served as an Administrative Rules Specialist in the State of Hawaii Department of Taxation from 1994 to 1996, where he drafted rules, interpretive releases, and legislation on several different state taxes. Prior to that, he practiced litigation and tax law with Cades Schutte Fleming & Wright in Honolulu.