Reforming the tax law to recognize new efficiencies


More than a decade ago, lawmakers and tax department officials realized it was possible to purchase a service for resale and that the person making the purchase did not necessarily have to consume the services.

The idea of selling goods for resale dates back to the late 1960s when the state hired a consultant to look at the structure and performance of the state’s unique general excise tax. While the state wanted to know about the many idiosyncrasies of the tax, it was also keenly aware that the GET imposed a heavy burden on taxpayers, especially after the rate was increased in 1965 from 3.5 percent to 4 percent to generate revenues the fledgling state needed to build necessary infrastructure as the jet age of visitor travel dawned in Hawaii. It had last been increased in 1957 from 2.5 percent, a rate in effect since the end of World War II.

The retail rate of 4 percent was imposed on all transactions, except for agriculture, manufacturing and wholesaling. The consultant found the high retail rate caused the cost of the tax to pyramid, because the 4 percent was often imposed on transactions which had already been levied with a 4 percent tax. The consultant recommended that purchases of goods or services to be resold should be taxed at a lesser rate to mitigate the pyramiding effect.

While the rate on the purchase of goods for resale was eventually reduced to 0.5 percent, lawmakers found it difficult to conceive of a service that might be purchased for resale to a subsequent customer. After all, once a service is performed, it is hard to imagine that it could be performed for a subsequent customer.

It was not until the late 1990s that examples of how a service could be resold became apparent. The first example came with subleasing real estate, office or store space. Inasmuch as leasing or rental of real property is considered a service, this particular transaction was very much a tangible example of a service that can be resold. As the small business community flourished, smaller spaces increased in demand allowing a master lessee to carve up a rented space to be subleased to smaller businesses. However, as each lease and sublease was considered a retail transaction in the belief that a sublessee would be the consumer of the reduced floor space, the full retail rate of 4 percent was imposed on that sublease.

As businesses leased space to other businesses or sublessees, lawmakers eventually devised a formula to determine a lesser rate of tax on each subsequent sublease. While that action got closer to imposing a lesser rate that would be the equivalent of the 0.5 percent on the purchase of goods for resale, it did not address other types of services or clearly identify that the resale rate for services is an explicit 0.5 percent.

As part of a push to secure re-election, the governor established a task force to come up with ideas to revitalize the state’s flagging economy. Among the many recommendations was one to address this issue of the pyramiding of the GET on services. A year later, the de-pyramiding solution was adopted.

Even though the purchase of services for resale has been on the books for more than a decade, there are some specific provisions of the GET that were adopted prior to the enactment of the de-pyramiding statute that probably should be repealed as those provisions represent attempts to address the de-pyramiding of specific types of services.

Repealing some of these provisions and bringing these transactions under the de-pyramiding provisions would ensure all sales of services for resale are treated alike. Among these provisions is the contractor-subcontractor deduction, the division of income of tourism-related activities, and sales of printing to a publisher for resale to advertisers.

Lowell L. Kalapa is president of the Tax Foundation of Hawaii.