The Rental Car ‘Loophole’

by Tom Yamachika, President, Tax Foundation Hawaii

There are a number of bills in this year’s Legislature that seek to raise revenue by closing a “loophole” in our General Excise Tax Law.  But is it really a loophole?

When a wholesaler sells tangible personal property to a retailer and that retailer resells it, the wholesaler is taxed at 0.5% and the retailer is taxed at 4.5%.  Under a law that has been on the books since 1971, the same thing happens when the wholesaler sells to someone who rents out the property as a service to others.  The theory expressed at that time was that the State will get its 4.5% tax on the rental income, whether the property is a car, boat, or backhoe.

The bills in the Legislature propose to require car rental companies to pay 4.5% when they buy or import cars.  HB 1937 / SB 2394 would use the additional money for teacher temporary hazard pay.  HB 2575 / SB 2594 would fund an additional position in the Department of Taxation.  HB 2586 / SB 2784 would funnel the money to the Department of Hawaiian Home Lands.

Some op-ed pieces that ran in the Star-Advertiser argued that allowing car rental companies the 0.5% rate is a loophole that needs to be closed.  On February 27, the Star-Advertiser published an editorial agreeing with that proposition.  They even had a few things to say about us…but I’ll get to that later.

We aren’t convinced that there is a loophole in the current law.

The bill proponents and the editorial complain that car rental businesses use the cars here just for a few years and then ship them off to the mainland where car sales aren’t subject to GET, so there is only a short period when 4.5% GET is imposed.  But if a retailer imports an article and then sells it immediately to an out-of-state buyer, the 0.5% rate still applies to the retailer’s purchase, even though no 4.5% GET is captured anywhere in the economic stream.  In response to our observation that car rental companies are no different from renters of industrial equipment or farm machinery, the editorial argues that “industry equipment rentals are typically closer to the production stage of a business operation, where taxation can be traced directly to a cost of doing business; for car-rental companies, however, vehicles are the business.”  But what does that even mean?  If I am going to an equipment rental company to rent a backhoe for a construction project, isn’t that backhoe the business?

The editorial also says, “the reliably anti-tax Tax Foundation of Hawaii warns of potential litigation.  The Tax Foundation’s argument that this tax would be ‘selective application’ of the law doesn’t hold, however, if the Legislature modifies tax law.”  But that’s not what we said, and we certainly didn’t threaten litigation.  We certainly recognize that the Legislature has the right to muck up the General Excise Tax law if it wants to, so we suggested that if it wants to raise taxes on this industry only, it could do so by hiking the Motor Vehicle and Tour Vehicle Surcharge Tax.

The editorial does say something with which we strongly agree:  “To preserve maximum flexibility, the [Legislature] must first rule out any advance earmarking of revenues.  In today’s shaky political and economic reality, potential crises loom on a daily basis, and it would be foolish to channel all new revenues to one cause.”  Nevertheless, we always seem to be knee-deep in bills suggesting or demanding tax earmarks, with their proponents clamoring for a “dedicated funding source.”  Those are the real loopholes in our public finance system, and it is our hope that the Legislature recognizes them as such and begins to get rid of them instead of made-up ones touted by partisan proponents.