Eliminating Tax Liability for Workers in Poverty
Hawai‘i is one of only fifteen states that taxes the income of residents living at or below the poverty level, while most states either provide a refund or require no payment. In fact, Hawai‘i places the second highest tax burden in the nation on low-income families–our lowest income households pay over 13% of their income in taxes, while those at the top pay 8% or less. Combined with the highest cost of living in the nation, nearly half of our state’s residents live paycheck-to-paycheck.
We can restore some balance to our state’s tax system by providing targeted tax relief to those with the lowest incomes in the state. A first step would be to eliminate state income tax liability for workers in the lowest tax brackets.
Reinstating Upper-Level Income Tax Rates
From 2009 to 2015, Hawaiʻi’s highest-income residents paid higher tax rates than in prior years. These higher rates slightly narrowed the gap between the tax burdens of our high and low income neighbors. However, those rates were allowed to sunset at the end of 2015.
We reinstated those top tax rates as part of HB 209 in 2017. The increase in revenue provides more than enough to pay for needed tax relief for those most squeezed by Hawaiʻi’s high costs and low wages. The Institute for Taxation and Economic Policy estimated that reinstating these tax rates would raise over $75 million per year. About 90% of the revenues raised would be paid by the top 1% of Hawai‘i earners. For example, in the case of those making a million dollars in taxable income per year, the higher rates would mean paying an additional $17,750 for joint filers, $20,188 for heads of households, and $22,625 for single filers.
These higher tax rates apply only to taxable income earned above the highest tax bracket levels that were in effect from 2009 to 2015. Taxable income is often much lower than total income earned, because it is the amount AFTER a taxpayer has subtracted their exemptions and deductions, which can amount to tens of thousands or hundreds of thousands of dollars. These rates do NOT affect any of the income that these high earners make below these limits. In other words, the higher taxes would be paid only on any additional dollars earned above the bracket levels.
For a married couple filing jointly with a taxable income of $350,000, the higher tax rates only apply to the last $50,000 that they earn. That means they pay an extra $375 per year with the higher rates in effect.
For heads of households, the higher tax rates apply to taxable income above $225,000 per year. So with a taxable annual income of $250,000, a head of household pays higher taxes on only their last $25,000 of income, for an additional $188 per year.
For single filer with an annual taxable income of $175,000, the higher rates apply only to the last $25,000 that they earn. They pay an extra $188 per year under the higher rates.
Other Potential Revenue Raisers
Hawai‘i is one of only seven states in the U.S. that allows taxpayers to deduct state income taxes they have paid during the course of a year when calculating their final state income tax bill for that same year. This deduction is little more than an error in the tax code imported through an inartful copying of the federal tax system which allows the deduction of state income taxes paid. Hawai‘i’s failure to require itemizers to add back the deduction has been criticized by tax and budget experts as “irrational,” “nonsensical,” and “poor tax policy.” Were the state to take the sensible step of fully eliminating the state income tax deduction, the Department of Taxation estimates that Hawai‘i would collect approximately $63 million in new revenue.
Hawai‘i has one of the lowest property tax rates in the nation under almost any measure. In addition to these low rates, Hawai‘i follows the federal treatment of income by allowing a deduction for property taxes paid. Only those taxpayers who earn enough to benefit from itemizing deductions are able to benefit from the property tax deduction. Meanwhile, property taxes are passed to renters in the form of higher rents, but they do not receive a similar tax write-off. Simply removing the property tax deduction would generate $27.2 million in new revenue.
Hawai‘i is one of just eight states that provides a substantial tax break for capital gains income. The tax break given to capital gains is one of the most inequitable features of the Hawai‘i state tax system, with 92 percent of the benefit going to the richest one percent of Hawai‘i residents. It is even extended to non-residents who profit from trading investment assets, such as local real estate. If the state taxed capital gains at the same rate as income from other sources, it could generate up to $14.8 million in additional revenue.
Hawai‘i has already enacted some sensible limits on tax breaks that disproportionately benefit the state’s most affluent residents, such as capping the total value of itemized deductions and phasing out the personal exemption for high-income taxpayers. However, the state still allows its wealthiest households to benefit from the lower tax brackets designed to benefit middle and lower-income residents.
While Hawai‘i’s maximum marginal tax rate of 11 percent kicks in at $200,000 for a single taxpayer and $400,000 for married couples filing jointly, households above these income levels do not pay an 11 percent tax on all of their income. Even multimillionaires benefit by having the first $400,000 they earn in any given year taxed at the state’s lower marginal tax rates of 1.4 percent to 10 percent.
While this marginal tax rate structure may make sense for most taxpayers, three states— Connecticut, Nebraska, and New York—have made it more equitable by enacting measures that gradually phase out these lower rates for the very richest taxpayers. Adopting a similar approach in Hawai‘i would raise millions of dollars in additional tax revenues and reduce the intense regressivity of the state’s overall tax system.
During 2011–2012, Hawai‘i increased its surcharge on rental cars from $3.00 to $7.50 per day. That increase was allowed to sunset on July 1, 2012. In its report to the Tax Review Commission, the PFM Group recommended that this surcharge be restored to the 2012 rate, which would result in additional revenues of more than $65 million. This increase has the advantage that it would be borne almost entirely by out-of-state residents and likely would have only minimal impacts on the tourist industry as demonstrated by the levels of travel activity during the period of the increased surcharge.
Hawai‘i currently taxes corporate income at different rates based on income in tax brackets ranging from 4.4 to 6.4 percent. This tiered corporate tax structure is somewhat unique, as 31 other states have a single rate. A multi-bracket income tax structure makes sense for an individual income tax because residents with lower incomes are less able to afford a large tax burden. However, there is no such similar “ability to pay” concept for corporations. Our top corporate income tax rate is the 19th lowest in the nation, and our per-capita corporate tax collections are the 9th lowest. Consolidating our corporate income tax brackets and raising the net corporate income tax rate to 9 percent would generate approximately $27 million in new revenue.
As Hawai‘i’s population ages, the revenue lost by exempting retirees’ pension income from taxation will grow significantly. By completely exempting pensions from taxation, Hawai‘i is unfairly shifting the tax burden from wealthy retirees to working taxpayers, including working seniors. Providing a reasonable exemption would protect low-income and middle-class older adults who are struggling economically while also ensuring that everyone pays their fair share.
Hawai‘i is one of only ten states to provide a blanket exemption for government pensions, regardless of income or wealth. It also offers one of the most generous private pension exemptions in the country. A majority of states cap each taxpayer’s maximum pension exemption at some amount, limit the exemption to taxpayers below a specific income level, or offer no specific pension exemption at all.
By requiring wealthy retirees to shoulder their fair share of the tax burden, Hawai‘i would increase tax revenues while starting to reform the disparity inherent in special exemptions based exclusively on a taxpayer’s age, rather than ability to pay. Modifying current exemptions for pension income would not only generate significant revenue immediately, but it would also provide a robust source of continued revenues for the state in future years. Estimates for revenue gains were approximately $200 million.
Real estate investment trusts (REITs) are business entities developed in the mid-1960s to enable small investors to invest in income-producing real estate. A REIT is taxed as a corporation but allowed to deduct all of its dividend payments from its taxable income. This differs from most corporations, which have to pay corporate-level taxes on any dividends distributed to shareholders. While these shareholders must still pay income taxes on the dividends that they receive, the REIT itself is often able to avoid all corporate income tax liability.
This tax structure causes much of the income gained by local real estate companies to go untaxed in Hawai‘i. For example, a New York resident can buy shares in a REIT that has all of its property holdings in Honolulu. None of the REIT’s income will be subject to Hawai‘i state income tax as long as the REIT pays out any income produced to its shareholders as dividends. The shareholder then pays personal income taxes only in her home state of New York, where she is a resident. The net result: money made off of Hawai‘i’s land generates tax revenues in New York, while Hawai‘i receives nothing.
Because REITs are so common in Hawai‘i, and because the majority of REIT shareholders do not live in Hawai‘i, estimating the exact amount of revenue that the state loses from not taxing these properties is difficult. However, analysis of the larger REITs that own property in Hawai‘i suggest potential tax revenues of approximately $30 to $50 million.