A Fair Tax

by Tom Yamachika, President, Tax Foundation Hawaii 

Every so often, I’m asked what kind of things we should be looking for, as a society, when the legislature is in session and is considering different ways to beat money out of us.

So, here is what I think.

Taxation is, primarily, a means of spreading the cost of a civilized society, namely the cost of our government, among the people who benefit from that government.

It’s easy to say that this cost should be spread fairly.  It is a much harder task to define what “fairly” is.

Some think that fairness means applying the same tax to everyone, everywhere, and to everything.  This comes close to describing our General Excise Tax.  Yes, it has exemptions and exclusions and reduced rates, but it comes far closer to pervasive fairness than most tax systems here or elsewhere.  The tax rate of 4.5% applies to most retail transactions, and it does not depend on anyone’s ability to pay the tax.  For that reason it is called a “regressive” tax, leading many to say that it is not fair.  Sales taxes, which most states impose, are the classic regressive taxes.

Some think that fairness means a tax that depends on ability to pay.  If you can pay more, then your fair share is more.  Our Net Income Tax, with several different tax brackets that apply higher rates to income over increasing thresholds, accomplishes this.  It’s called a “progressive” tax for that reason.  Most states have progressive income taxes, but most have fewer brackets (some have a “flat tax” with one bracket).  All have continuing political debate over what is a “fair share” to make people pay.

Most tax systems, including ours, also include items that detract from fairness.  There are two kinds.  Credits and incentives are typically given to encourage or reward social behavior that is seen as beneficial to society.  Clean energy credits, credits to encourage capital investment, and enterprise zone incentives are just a few examples.  The other kind works the opposite way.  Think of penalties and sin taxes, such as tobacco taxes or liquor taxes.  They are there either to penalize detrimental behavior or to pay for incremental costs that are associated with that behavior.  Credits and incentives, as well as penalties and sin taxes, are by definition unfair, but we as a society justify the unfairness by saying that it will accomplish a greater good.

So, what should we be looking for at our Legislature to be sure that lawmakers are focused on making taxes fair?

First, we need taxes and regulations that focus on real fairness and are not simply a manifestation of other motives such as envy, of which we have written before.  If there are going to be credits and incentives, we need to monitor the societal effects and sunset them when the desired results are achieved.  The same goes for the penalties and sin taxes, which are the other side of the same coin.

There are some taxes that we now have in place that do not fit the traditional mold of the sin tax.  Take the transient accommodations tax and the rental motor vehicle and tour vehicle tax, for example.  Do we have them for reasons other than “Because we can”?  Are there incremental social costs associated with hotel and rental vehicle activity that the taxes pay for?  Are the social costs and the taxes in alignment?

The same analysis should be done for social welfare programs administered through the tax system, such as the food/excise credit and the credit for dependent care services.  Are they properly and efficiently administered through the tax system, or should they be housed in, say, the Department of Human Services, our department that is specially equipped to deal with the downtrodden?

As of this writing, government agencies and legislators are hard at work drafting legislative proposals.  We hope that they will go through these analyses to better understand their proposals.