Sales Tax Or Not? General Excise Tax, That Is A Beautiful Beast
by Lowell L. Kalapa, Tax Foundation of Hawaii
Last week we raised the question of whether or not the latest Tax Review Commission has really had the opportunity to understand the current tax system before embarking on the quest to create the tax system of the “21st Century.”
One of the most misunderstood of Hawaii’s taxes is the general excise tax which is often referred to as a “sales tax” as consumers usually see it tacked onto their bill or grocery receipt as “tax” on the transaction as they would see it added to their bill in other states where there is a sales tax.
But a “sales tax” the general excise tax is not. Unlike a sales tax, the general excise tax is actually a tax on the business making the sale as opposed to a retail sales tax which is a tax on the consumer making the purchase. Thus, if a customer walked out the door in a retail sales tax state, refusing to pay the retail sales tax, the authorities could go after the customer and collect the tax or throw the customer in jail. In Hawaii, if the tax is not collected from the customer, the business would still be responsible for filing a general excise tax return and paying the amount of the tax. Again, this is because the tax is on the business.
And unlike the retail sales tax where the business is merely the “tax collector,” the general excise tax is imposed on the gross income of the business including any amount that the business ends up passing on to the customer as the amount of the tax. That’s why where the tax rate is 4%, the business charges 4.16% which is the amount of the tax and the pass on. And where the amount is 4.5%, the business charges 4.712% which includes the tax on the amount passed on to the customer.
So why is the general excise tax so different from the retail sales tax? Well, at one point in time Hawaii did attempt to adopt a retail sales tax. The general excise tax is actually the second run at Hawaii’s effort to emulate a retail sales tax. The first attempt occurred in 1931 and indeed looked very similar to the retail sales taxes found on the U.S. mainland. However, it failed because the retail base was rather small in those days of the Great Depression. People grew their own food or bartered and what was needed for clothing and other apparel was provided by the plantation stores. The bulk of the population worked on the plantations and most of their needs were provided by the plantations.
As a result, the first tax was a failure and was repealed. In its place a tax on businesses was adopted measured by the gross proceeds of the business. And unlike the retail sales tax, the tax was imposed on all transactions including services, as a good part of the tax base was pineapple canning and sugar processing albeit at a lesser rate than what was imposed on retail sales. Some may say that the production of sugar and pineapple was the production of product so why were those activities considered a service. One has to remember that most of the production of those two commodities was for export out of state and, therefore, little, if any, of it was consumed at retail. Yet those two industries were the largest portion of the economic base. Thus, the tax was constructed to capture these service activities, while at a lesser rate, and the base was a substantial portion of the tax base.
Initially set at a rate of 1.5%, it rose to a rate of 2% during the war years, and then just prior to statehood in 1959 to a retail rate of 3.5%. Following statehood with the obvious need for infrastructure to accommodate the fledgling visitor industry, the retail rate was increased in 4% in 1965 to produce the needed resources to modernize Hawaii. At about the same time the consulting firm of Arthur D. Little was commissioned to do a study of the general excise tax. One of the recommendations made was that taxing goods purchased for resale exacerbated the final cost of goods sold for retail or consumption. Thus, it was recommended that those transactions be taxed a lesser rate which was set by the 1969 legislature at 0.5%. Note well that the lesser rate applied only to the purchase of goods for resale. It would take 30 years before the taxation of services purchased for resale was accorded the same lesser rate of 0.5%.
Finally, it should be understood that because the general excise tax base includes nearly every transaction that takes place in the state, the rate can remain rather low at 4% (4.5% in Honolulu) yet continually produce more than half the general fund tax revenues for the state. This is very different from the retail sales taxes found on the mainland where the base includes only retail sales and then only goods and not services. This is just a limited facet of the general excise tax with much more to learn and understand.
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