General excise tax needs a few tweaks
Despite being referred to as Hawaii’s sales tax, the general excise tax is better described as a multirate, multistage tax imposed on wholesaling, retailing and services, as well as goods.
A couple of years ago, the state Legislature decided the budget shortfall was far too great to be dealt with solely by spending reductions. On the other hand, with elected officials under the gun insofar as re-election, legislators shied away from direct increases in taxes on residents. Instead, they resorted to hiking the hotel room tax, taking money from a fee that was supposed to fund the building of a dedicated rental car facility, increasing income tax rates on higher income individuals and suspending many time-honored exemptions from the general excise tax.
Because the general excise tax is levied on people who want the privilege of doing business in the state, lawmakers figured the public would not notice exemptions were temporarily suspended. However, many of those exemptions have a direct impact on all taxpayers, such as the exemption for stevedoring activities that affects nearly 100 percent of items shipped from out of state or interisland. Others, such as the exemption from the general excise tax on the sale of agricultural products to interstate carriers, highlighted the anomaly that perhaps the exemption was not necessary. The original exemption applied to only locally grown agricultural products. However, when the exemption was declared unconstitutional, since it discriminated against the sale of agricultural products that weren’t locally grown, the condition that the products be locally grown was deleted. As a result, there was little reason to exempt those products sold to interstate carriers from the general excise tax since it did not and could not help local agricultural products. It is one exemption that lawmakers may want to permanently repeal.
The exemption known as the contractor and subcontractor deduction raised questions of whether that treatment of income is appropriate. Under the contractor and subcontractor deduction, a general contractor may be asked by a client or homeowner to build or install a certain type of material for which the general contractor does not have the expertise. The contractor will subcontract that work out to a craftsman with the needed skills. When it comes time to pay the general contractor, the general contractor keeps only the amount of the payment that is for his work and deducts the amount due the subcontractor and pays the general excise tax only on the amount the general contractor kept. The subcontractor pays the 4 percent tax on the full amount received from the general contractor. Thus, there is only one excise tax on the amount paid for the job by the client or homeowner.
This provision dates back to the original adoption of the general excise tax in the 1930s. Back then, few people could imagine a service would be resold to someone else, because a service is provided in the here and now; it was difficult to imagine someone could turn around and resell a service. Special treatment of gross income was adopted to ensure the full 4 percent was not paid twice on the same amount.
Since that time, practitioners and administrators have come to realize that other services can be resold. As a result, about a decade ago the general excise tax law was amended to recognize that not only can goods be purchased for resale, but services can also be purchased for resale. To ensure services purchased for resale were not subject to being taxed twice at the full retail rate, the law was amended to impose the lesser 0.5 percent rate on those services the purchaser intended to resell to his client or customer.
When the suspension of the contractor and subcontractor deduction expires next June, lawmakers should consider putting contractors and contracting work under the provision that recognizes the purchase of services for resale.
There are other unique provisions of the general excise law to which this treatment should be applied, including tourism-related activities.
Lowell L. Kalapa is president of the Tax Foundation of Hawaii.