Public Policy. THIS REPORT RECOMMENDS that the State of Hawai i adopt two tax measures to address the

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1 RECOMMENDATIONS TO THE HAWAI I STATE LEGISLATURE January 2013 Public Policy HAWAI I APPLESEED CENTER Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families EXECUTIVE SUMMARY THIS REPORT RECOMMENDS that the State of Hawai i adopt two tax measures to address the needs of low income individuals and families: 1. A refundable Hawai i Earned Income Tax Credit. We propose the Hawai i EITC be fixed at 20 percent of the taxpayer s federal refundable earned income tax credit. 2. A non-refundable Hawai i Poverty Tax Credit to eliminate income tax on the poor. The Hawai i Poverty Tax Credit would: a. eliminate state income taxes on families whose adjusted gross income is below the applicable federal poverty guidelines for Hawai i; and b. reduce by 50 percent the state income tax on families whose adjusted gross income is between 100 and 125 percent of the applicable federal poverty guidelines for Hawai i. This non-refundable credit should adjust annually based on adjustments in the federal poverty guidelines for Hawai i. This report also briefly discusses five possible tax policy modifications that could equitably generate significant additional tax revenues that would more than pay for the costs of enacting the Hawai i EITC and the Hawai i Poverty Tax Credit. Residents in Hawai i are faced with a number of severe economic challenges to attaining and maintaining self-sufficiency. Our residents earn the lowest average-adjusted income in the country. 1 Yet, our state has the highest cost of living in the United States. 2 The monthly food cost alone for a family of four in Hawai i is more than 60 percent higher than on the mainland. 3 The cost for shelter in Hawai i is also the highest in the nation, with 75 percent of those living at or below the poverty level spending more than 50 percent of their incomes on housing. 4 Hawai i also leads the nation with 28.2% of households being shared in With the ever-rising costs in Hawai i of food and shelter, low-income citizens are facing a daunting struggle to escape poverty. This dilemma is often called the Price of Paradise but it has a particularly harsh effect on those living in poverty. While state tax policy should be designed to address this situation, it instead exacerbates it. The aggregate state and local tax rate for our low income population is the sixth highest in the nation. 6 In other words, Hawai i requires its poorest taxpayers to spend more of their household budgets on state and local taxes than the vast majority of states. LAW AND ECONOMIC JUSTICE 1 Moneyrates.com. 2 Hawai i Appleseed Center, The State of Poverty in Hawai i, April Alternative Hawai i, Cost of Living Price of Paradise, 4 National Low Income Housing Coalition, State Housing Profile: Hawaii, July Available at SHP-HI.pdf. 5 U.S. Census Bureau, Poverty and Shared Households by State: 2011, page 2. Shared households are those where at least one additional adult is in residence a person 18 or older who is not the householder, the householder s spouse or co-habiting partner or students 18 to 24 years old who are enrolled in school. 6

2 According to a 2009 analysis by the Institute on Taxation and Economic Policy, the poorest 20 percent of Hawai i taxpayers spent an average of 12.2 percent of their incomes on state and local taxes each year, while the state s middle-income taxpayers spent an average of 11.2 percent and the state s top 1 percent of taxpayers those earning more than $400,000 paid just 6.3 percent of their incomes on state and local taxes. 7 The Hawai i general excise tax is particularly regressive. Hawai i s poorest taxpayers pay 10 percent of their incomes in GET and other state and local consumption taxes, while the richest pay less than 2 percent. 8 Even Hawai i s most progressive tax the personal income tax contributes to this problem. The Center on Budget and Policy Priorities found that, in 2011, Hawai i was one of only 15 states that taxed its working-poor families deeper into poverty via the state income tax. According to the CBPP, in 2011 Hawai i charged families of four with incomes at the poverty line $331 in income taxes, higher than in all but two other states. The state was one of only 15 to tax such families at all. Hawai i also was only one of 10 states that taxed families of three living at or below the federal poverty level, with such families earning at the poverty line being taxed $258 in income tax in HAWAI I CAN AND SHOULD act to address the inequities in its tax system, which are adversely affecting our state s most vulnerable residents. The proposed Hawai i EITC and the Poverty Tax Credit are designed with this goal in mind. Both programs will put money directly back in to the pockets of those low income wage earners who need it most. To the extent it is refunded, the Hawai i EITC will not only reduce the tax-burden on the low-income population, but also act as a wage supplement and an incentive for employment while reducing the significant income disparity between the wealthy and less fortunate. Similarly, the Poverty Tax Credit will eliminate the anomaly of taxing further into poverty those individuals and families who are earning the state s lowest incomes. The Hawai i EITC and Hawai i Poverty Tax Credit will also increase the prospects for asset building in the low income community. Asset building is an anti-poverty strategy designed to increase self-sufficiency of the low-income population through savings and the purchase of long-term assets. The Hawai i EITC and Poverty Tax Credit should be made part of a comprehensive public policy to help Hawai i s people build assets. This policy package should include a package of programs to help people earn more, save more, protect hard earned assets, start businesses and become homeowners. POVERTY BY THE NUMBERS Hawai i has the highest cost of living in the United States. Nearly 35 percent of single adults, 18.5 percent of two-adult, two-children families and 67 percent of single adult families with one or two children have earnings below the self-sufficiency standard. 75 percent of those living at or below the poverty level in Hawai i spend more than 50 percent of their income on housing. One in five households in Hawai i have zero or negative net worth, the sixth worst ranking among the states. One in four households in Hawai i do not have enough assets to subsist at the poverty level for three months if their income were disrupted. Hawai i is one of only 15 states that levy an income tax on families earning minimum wage and living below the federal poverty threshold. 7 An updated edition of ITEP s study is forthcoming. While recent changes in the personal income tax, such as the additional of three new top rates and new limitations on itemized deductions, have raised the tax rate paid by the state s highest-income residents somewhat, those changes are temporary in nature and have done nothing to reduce the high taxes paid by those at the bottom levels of income distribution Hawai i Appleseed Center for Law and Economic Justice Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families

3 Tax Relief Proposals for Low-Income Wage Earners and Families 1 ENACT A REFUNDABLE HAWAI I EARNED INCOME TAX CREDIT BACKGROUND In 1975, the federal government implemented the federal Earned Income Tax Credit program to reduce poverty and create a financial incentive to encourage work among lowincome families. 10 The credit has proved to be particularly effective at achieving both of these goals and has historically garnered support among both Democrat and Republican lawmakers in Congress. During the 37 years since its inception, the federal EITC has helped millions of families escape the crushing reality of poverty in our country. In 2009 alone, the federal EITC helped raise more than three million children in six million families from poverty. 11 The federal EITC has been expanded several times since 1975 by both Republican and Democratic presidents to provide additional support to low-income families and to encourage work over welfare. 12 A refundable EITC puts money directly back into the pockets of those who need it most. It not only reduces the tax burden of the low-income population, but also acts as a wage supplement and an incentive for employment. The federal EITC has been so popular that twenty-five states and the District of Columbia have followed the federal government s lead by enacting their own state EITCs, all calculated as a fixed percentage of the federal credit. 13 These are both blue and red states, including Colorado, Connecticut, Delaware, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Nebraska, New Jersey, New Mexico, New York, North Carolina, Oklahoma, Oregon, Rhode Island, Vermont, Virginia, Washington and Wisconsin. BENEFITS AND ADVANTAGES OF A HAWAI I EITC It is specifically aimed at families with children All low-income wage earners may claim the federal EITC, and therefore the proposed Hawai i EITC, but the credit is much larger for taxpayers with children. The federal EITC lifts more children out of poverty than any other government program. If we supplement it with a Hawai i state EITC, we can better address child poverty in Hawai i. 14 The amount of the Hawai i EITC is meaningful The amount of credit depends on how much income a family has and how many children are in the family. The chart on the next page shows the amounts for different family sizes using IRS criteria for tax year Institute on Taxation and Economic Policy, Rewarding Work Through Earned Income Tax Credits, Sept Center on Budget and Policy Priorities, A Hand Up: How State Earned Income Tax Credits Help Working Families Escape Poverty in 2011, April Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families Hawai i Appleseed Center for Law and Economic Justice 3

4 Family type Maximum income for eligibility Maximum federal credit Maximum state credit if EITC is 20% Single, 1 Child $36,920 $3,169 $634 Married, 1 Child $42,130 $3,169 $634 Single, 2 Children $41,952 $5,236 $1,047 Married, 2 Chldren $47,162 $5,236 $1,047 Single, 3 or More Children $45,060 $5,891 $1,178 Married, 3 or More Children $50,270 $5,891 $1,178 Single, No Children $13,980 $475 $95 Married, No Children $19,190 $475 $95 The Hawai i EITC will be utilized People who are eligible utilize the federal EITC. In the U.S. in 2002, about 83 percent of eligible people claimed the federal EITC, compared to about 67 percent for food stamps and 48 percent for Temporary Assistance for Needy Families or Aid to Families with Dependent Children. In 2006, about 80 percent of eligible people claimed the federal EITC and food stamps and about 40 percent claimed TANF or AFDC. 15 In Hawai i, 108,000 of our poorest wage earners claimed the federal EITC for the 2011 tax year according to the IRS. 16 The amount of the credit adjusts to encourage work The amount of the federal EITC one gets gradually rises as one earns more income until income reaches a specific level: $6,210 for childless taxpayers; $9,320 for families with one child; and $13,090 for families with two or more children. The credit then remains at the maximum amount throughout a certain income range before eventually being phased out slowly. Once certain income levels based on family size are reached, no federal EITC credit is available because the taxpayer s income is closer to providing a livable wage. 17 This unique structure is designed to create work incentives for people at the lowest income levels to allow them to economically choose work over welfare. A Hawai i EITC can enhance efforts to help families build assets EITC refunds can be used to promote asset building in low-income families. One study found that 33 percent of 650 EITC recipients surveyed planned to save a portion of their tax refunds. Another found that half of EITC recipients use their refunds to make critical investments such as paying off high-interest debt, upgrading housing or paying for education. A state EITC program could be linked effectively to a variety of asset-building initiatives. The Hawai i EITC will be easy to apply for and administer Since it simply piggybacks on the federal EITC, calculating the state credit is simple. A taxpayer takes a set percentage of whatever was claimed for the federal EITC. We propose that the percentage be 20 percent. Thus, if the federal EITC for a family were $2,500, the Hawai i EITC would amount to $500 $2,500 x 20% = 500. Refunded credits can help low-income communities Most low-income wage earners who receive EITC refunds put them immediately back into the economy by spending on day-to-day survival needs such as food and shelter. In this manner, the Hawai i EITC will inject money directly back into the local economy. A 20 percent state EITC would add roughly $36 million to more than $200 million in federal credits invested into communities throughout Hawai i Tax Policy Center, EITC, TANF and Food Stamp Participation Rates, , June 30, See 17 See Tax Policy Center, Briefing Book, Taxation and the Family: What is the Earned Income Tax Credit. 18 Internal Revenue Service. 4 Hawai i Appleseed Center for Law and Economic Justice Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families

5 According to a 2009 study in Michigan by the Anderson Economic Group, for every dollar of federal EITC received by Michigan taxpayers an additional $1.67 was generated in new earnings for Michigan residents. The study found that households receiving an EITC used most of their money on durable goods such as appliances or vehicles. This spending increases activity in the local economy directly and indirectly as it is re-spent. 19 A study on the impact of EITC dollars on the city of Fresno, Calif. further reinforced the economic viability of state EITC spending: For every EITC dollar claimed, a further $1.40 was generated in local economic activity; for every $100,000 claimed, an additional permanent job was generated. 20 COSTS TO THE STATE BASED ON 2012 RATES The figures below show the impact on all Hawaii taxpayers of adopting a Hawaii EITC calculated at either 10 percent or 20 percent of the federal EITC, as well as the estimated revenue cost to the state if such a credit had been implemented for tax year 2012: COST OF HAWAI I EARNED INCOME TAX CREDIT TO STATE BASED ON 2012 TAX RATES 2012 Income Group Lowest 20% Second 20% Middle 20% Fourth 20% Next 15% Next 4% Top 1% Income range Less than $19,000 $19,000 to $37,000 $37,000 to $53,000 $53,000 to $90,000 $90,000 to $174,000 $174,000 to or more Average income in group $12,000 $28,000 $44,000 $70,000 $123,000 $234,000 $813,000 Example 1 10% Refundable EITC, State Cost: $18 Million Tax cut as a % of income (0.5%) (0.2%) (0.1%) 0% 0% 0% 0% Average tax cut $53 $62 $26 $ Share of total cut 37% 44% 18% 1% 0% 0% 0% Average cut for those with cut $171 $258 $176 $ Percent receiving a tax cut 31% 24% 15% 1% 0% 0% 0% Example 2 20% Refundable EITC, State Cost: $36 Million Tax cut as a % of income (0.9%) (0.4%) (0.1%) 0% 0% 0% 0% Average tax cut $105 $124 $53 $ Share of total cut 37% 44% 18% 1% 0% 0% 0% Average cut for those with cut $342 $517 $352 $ Percent receiving a tax cut 31% 24% 15% 1% 0% 0% 0% NOTE: The baseline against which each of these options is analyzed is 2012 Hawai i income tax law, adjusted to reflect the larger standard deduction and personal exemptions taking effect in SOURCE: Institute on Taxation and Economic Policy, November See footnote 6 for more detail. Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families Hawai i Appleseed Center for Law and Economic Justice 5

6 2 ENACT A HAWAI I POVERTY TAX CREDIT THAT ELIMINATES INCOME TAXES FOR FAMILIES IN POVERTY BACKGROUND Hawai i s personal income tax is a progressive tax. Unlike general excise and property taxes, which require the state s poorest residents to devote a greater portion of their household budgets to paying tax than any other group, the state s personal income tax actually requires more of the state s wealthiest residents. However, even this tax falls short of the ideal in some regards. For example, the lack of adequate credits and exemptions means that some low-income working families are actually pushed deeper into poverty by the personal income tax. PROPOSED HAWAI I POVERTY TAX CREDIT One way to address this inequity is to establish a tax credit that eliminates personal income tax liability entirely for any family in poverty, while also reducing tax liability for families just above the poverty line. Using the 2012 federal poverty guidelines for Hawai i, this would involve eliminating any income tax on single individuals earning less than $12,860 or married couples earning below $17,410. A single parent with two kids would see the family s income tax liability eliminated if the parent earned less than $21,960 in 2012, and a two parent family with two children would pay no income tax if their combined income was below $26, Larger families would be eligible for the credit at higher income levels, and the cut-offs would change each year as new poverty data for Hawai i are released. Finally, in order to avoid a cliff in tax liability where taxpayers above the poverty line lose their entire Hawai i Poverty Tax Credit, it is proposed that those families with incomes between 100 and 125 percent of the applicable poverty guideline would receive a credit cutting their tax liability in half. WHERE HAWAI I RANKS For many of the same reasons that favor adopting the Hawai i EITC, exempting low income workers from paying state income taxes will help reduce poverty and the tax burden on those least able to afford it. As cited previously, Hawai i s working-poor families pay higher tax bills than those in all but five other states. The Center on Budget and Policy Priorities reported in 2011 that Hawai i is one of only 15 states that levy an income tax on full-time workers in families of three making the minimum wage of $15,080. The federal poverty threshold for a family of three was $17,922 in 2011 and such a family earning at that level would owe $258 in income taxes. In fact, the poorest taxpayers in Hawai i pay an average tax rate of more than 12 percent of their income, partially because of the regressive nature of the general excise tax, while those earning more than $400,000 pay closer to 6 percent of their earnings. 22 Exempting those living in poverty from paying income tax not only will make the tax system fairer, it will help them meet the many economic challenges to their basic survival. COST TO THE STATE OF IMPLEMENTATING THE POVERTY TAX CREDIT The following chart shows the estimated impact on state tax revenues of adopting the Hawaii Poverty Tax Credit: See footnote 6 for more detail. 6 Hawai i Appleseed Center for Law and Economic Justice Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families

7 ESTIMATED IMPACT ON STATE REVENUES OF THE HAWAII POVERTY TAX CREDIT 2012 Income Group Lowest 20% Second 20% Middle 20% Fourth 20% Next 15% Next 4% Top 1% Income range Less than $19,000 $19,000 to $37,000 $37,000 to $53,000 $53,000 to $90,000 $90,000 to $174,000 $174,000 to or more Average income in group $12,000 $28,000 $44,000 $70,000 $123,000 $234,000 $813,000 Eliminate Income Tax for Families in Poverty; Halve Tax for Families up to 125% of Poverty Line State Cost: $19 Million Tax cut as a % of income (0.7%) (0.2%) 0% 0% 0% 0% 0% Average tax cut $77 $44 $21 $ Share of total cut 53% 31% 14% 2% 0% 0% 0% Average cut for qualifying $293 $377 $564 $ Percent receiving a tax cut 26% 12% 4% 1% 0% 0% 0% BENEFITS AND EFFECTS OF ENACTING BOTH PROGRAMS SOURCE: Institute on Taxation and Economic Policy, November 2012 The Hawai i EITC and Hawai i Poverty Tax Credit programs are designed to accomplish different goals, and could sensibly be paired together to improve the fairness of Hawai i s tax system. The EITC is designed to incentivize work, and its refundable nature means that it can be used not only to offset personal income taxes, but to mitigate the regressive impact of both the general excise and property tax systems. However, an EITC by itself cannot guarantee that all of Hawai i s poor will have their tax liability eliminated. Particularly for families without children for whom the EITC is least generous the Poverty Tax Credit provides an important backstop to prevent the poor from being taxed deeper into poverty by the income tax. The following chart shows the impact of coupling a 10 percent Hawai i EITC with a Poverty Tax Credit and the impact of coupling a 20 percent EITC with a Poverty Tax Credit. These data take into account the interaction effect between these two policies most notably, the fact that the Hawai i EITC will eliminate tax liability for some families, thereby reducing the additional cost to the state of providing the proposed Hawai i Poverty Tax Credit. COST OF A HAWAI I EITC PLUS A POVERTY TAX CREDIT TO THE STATE BASED ON 2012 TAX RATES 2012 Income Group Lowest 20% Second 20% Middle 20% Fourth 20% Next 15% Next 4% Top 1% Income range Less than $19,000 $19,000 to $37,000 $37,000 to $53,000 $53,000 to $90,000 $90,000 to $174,000 $174,000 to or more Average income in group $12,000 $28,000 $44,000 $70,000 $123,000 $234,000 $813,000 10% Refundable EITC Paired with Full or Partial Elimination of Tax for Families under 100% or 125% of Poverty 18% of Hawaii Residents Receive a Cut State Cost: $32 Million Tax cut as a % of income (1.0%) (0.3%) (0.1%) 0% 0% 0% 0% Average tax cut $121 $80 $42 $ Share of total tax cut 49% 33% 17% 2% 0% 0% 0% Average cut for with cut $255 $297 $259 $ Percent receiving a tax cut 47% 27% 16% 1% 0% 0% 0% 20% Refundable EITC Paired with Full or Partial Elimination of Tax for Families under 100% or 125% of Poverty 18% of Hawaii Residents Receive a Cut State Cost: $47 Million Tax cut as a % of income (1.4%) (0.5%) (0.1%) 0% 0% 0% 0% Average tax cut $167 $133 $63 $ Share of total cut 45% 36% 17% 2% 0% 0`% 0% Average cut for those with cut $353 $490 $389 $ Percent receiving a tax cut 47% 27% 16% 1% 0% 0% 0% NOTE: The baseline against which each of these options are analyzed is 2012 Hawaii income tax law, adjusted to reflect the larger standard deduction and personal exemptions taking effect in SOURCE: Institute on Taxation and Economic Policy, November 2012 Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families Hawai i Appleseed Center for Law and Economic Justice 7

8 Tax Proposals to Raise Additional State Revenues THE LOW-INCOME TAX RELIEF POLICIES suggested in this report will result in a loss of state tax revenue. To achieve a balanced budget, these revenue losses must be offset either by other revenue increases or by cuts in existing state government expenditures. Hawai i Appleseed supports cuts in spending that can be achieved through greater governmental efficiencies, but not cuts in the essential services that government should provide. Hawai i Appleseed recommends five tax policy modifications which, if adopted, would generate substantial additional revenues and at the same time improve the overall fairness of Hawai i s tax structure. 1 ELIMINATE THE TAX BREAK FOR CAPITAL GAINS INCOME PERHAPS THE MOST UNFAIR TAX BREAK offered under Hawai i s tax system is the preferential treatment given to capital gains income the profits one realizes from selling assets such as stocks, bonds, investment real estate, art or antiques. In Hawai i, unlike in most states, income from work is actually taxed at a higher rate than income from these types of investments. The special tax treatment given to capital gains income is estimated by the Institute on Taxation and Economic Policy to cost Hawai i s government $29 million in tax year 2012 alone, with 92 percent of that amount flowing to the richest 1 percent of Hawai i residents. While capital gains tax breaks are most often justified as a way to boost economic growth, there is little persuasive evidence that this is actually the case. Multiple national studies have shown capital gains breaks to be of little or no benefit to the economy. Hawai i s capital gains break is even less wellsuited for spurring in-state growth, since the same break is given to investors regardless of whether they invest in Hawai i, or California, New York or Arkansas. 23 Hawai i lawmakers could eliminate this break to ensure that families living off their investments pay the same amount in tax as those earning wages and salaries. Doing so would increase state tax revenues and improve the fairness and adequacy of the state s tax system overall. The following chart shows the likely impact of this reform based on 2012 tax rates: ELIMINATING SPECIAL TAX RATE FOR CAPITAL GAINS WOULD INCREASE STATE REVENUE BY $29 MILLION 2012 Income Group Lowest 20% Second 20% Middle 20% Fourth 20% Next 15% Next 4% Top 1% Income range Less than $19,000 $19,000 to $37,000 $37,000 to $53,000 $53,000 to $90,000 $90,000 to $174,000 $174,000 to or more Average income in group $12,000 $28,000 $44,000 $70,000 $123,000 $234,000 $813,000 Tax increase as a % of income 0% 0% 0% 0% 0% 0% 0.5% Average tax increase $1 $4 $68 $3,923 Share of total tax increase 0% 0% 0% 0% 1% 6% 92% Average increase if one is due 0 $3 $10 $16 $40 $214 $7,201 Percent facing tax increase 0% 0% 0% 5% 11% 32% 54% NOTE: The baseline against which each of these options is analyzed is 2012 Hawaii income tax law, adjusted to reflect the larger standard deduction and personal exemptions taking effect in SOURCE: Institute on Taxation and Economic Policy, November Hawai i Appleseed Center for Law and Economic Justice Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families

9 2 PREVENT HIGH-INCOME TAXPAYERS FROM BENEFITING FROM LOWER TAX BRACKETS HAWAI I HAS ALREADY ENACTED sensible limitations on the benefits our state s most affluent residents can receive from tax breaks such as itemized deductions and the personal exemption. However, the state still allows its wealthiest residents to benefit from the lower tax brackets designed to benefit middle- and lower-income Hawai i residents. While Hawai i s top tax rate of 11 percent kicks in at $400,000 of income, or $200,000 for single taxpayers, taxpayers earning above this level do not pay an 11 percent tax on all of their income. Even taxpayers earning $1 million or more benefit by having the first $400,000 they earn in any given year taxed at the state s lower tax rates ranging from 1.4 percent to 10 percent. While this system of marginal tax rates makes sense on the whole, three states Connecticut, Nebraska and New York have improved upon it by enacting measures that gradually phase out the benefits of these lower rates for the very richest taxpayers. Adopting a similar approach in Hawai i could raise millions of dollars in additional tax revenues and reduce the sharp regressivity of the state s overall tax system. 3 ELIMINATE TAX BREAKS FOR WEALTHY RETIREES BACKGROUND As Hawai i s population ages, the cost of exempting retirees pension income from tax will grow significantly. In 2011, Hawai i lawmakers considered putting Hawai i s tax system on a more sustainable footing by taxing the pension income earned by the state s upperincome residents. These proposals balanced the need to ensure the long-term adequacy of Hawai i s revenues with the desire not to raise taxes on less affluent members of the state s elderly population. Hawai i s lawmakers should strike this balance by gradually phasing out the pension exclusion for wealthy seniors. WHERE HAWAI I RANKS In providing this exemption for pensions, Hawai i is unfairly shifting the tax burden from wealthy retirees to working taxpayers, including working seniors. Providing a reasonable exemption can help protect low-income and middle-class seniors who are struggling economically. Currently, Hawai i is one of only 10 states to provide a blanket exemption for income received from government pensions by senior citizens, regardless of their income or wealth. It also offers one of the most generous private pension exemptions in the country. 24 A majority of states either cap each taxpayer s maximum pension exemption at some amount, limit the exemption to taxpayers below a specific income level, or offer no specific pension exemption at all. 25 By requiring wealthy retirees to shoulder their fair share of the tax burden, Hawai i would increase tax revenues while concurrently taking a step to reform the disparity inherent in providing special exemptions based exclusively on age rather than ability to pay. 24 State Personal Income Taxes on Pensions and Retirement Income: Tax Year 2010, NCSL, Feb State Personal Income Taxes on Pensions and Retirement Income: Tax Year 2010, NCSL, Feb Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families Hawai i Appleseed Center for Law and Economic Justice 9

10 REVENUES RAISED In April 2011, the Hawai i Department of Taxation analyzed two proposals to modify the existing tax policy on pensions. The first was the Abercrombie administration s proposal to eliminate the exemption for taxpayers earning more than $37,500 for a single taxpayer, $56,250 for a head of household, and $75,000 for a married couple filing jointly. The department projected this proposal to raise $112.3 million per year from 43,520 taxpayers, 8.1 percent of Hawai i resident taxpayers. The second was a legislative proposal to eliminate the exemption for taxpayers earning more than $100,000 for a single taxpayer, $150,000 for a head of household, and $200,000 for a married couple filing jointly. This proposal was projected to raise $17.2 million per year from 3,988 taxpayers, 0.7 percent of Hawai i resident taxpayers. Modifying current exemptions for pension income would not only generate significant immediate revenues, it would also provide a robust source of continued revenues for the state in future years. According to testimony given by the Abercrombie administration in 2011, estimates for revenue gains under the governor s previously proposed thresholds were approximately $176.0 million in fiscal year 2012, $191.3 million in fiscal year 2013, and $206.7 million for fiscal year 2014 and onwards. Overall, the department estimated that in any given year the pension exemption benefits 96,200 taxpayers, 18 percent of Hawai i resident taxpayers, and that $2.61 billion in Hawai i pensions are taxed at the federal level, but not the state level ELIMINATE THE STATE INCOME TAX DEDUCTION HAWAI I IS ONE OF JUST SEVEN states that allow taxpayers to deduct the state income taxes they have paid during the course of a year when calculating their final state income tax bill for that same year. This deduction serves no discernable purpose, and only exists because Hawai i has coupled its own income tax rules too closely to federal tax rules the deduction exists at the federal level as a form of revenue sharing with the states. In 2011, multiple Hawai i tax and budget experts urged that the deduction be repealed entirely, and testified that it was irrational and nonsensical and amounted to poor tax policy. 27 Hawai i legislators responded by preventing taxpayers earning over $100,000 per year, or $200,000 for married couples, from claiming the deduction. Lawmakers could build on this reform by implementing Gov. Neil Abercrombie s original recommendation to repeal the deduction entirely. 28 Repealing the deduction for state income taxes paid could raise revenue. In March 2011, the Department of Taxation estimated that a full repeal of the deduction for state income taxes could raise $94.4 million. 29 The actual limitation of the deduction, as enacted in 2011, was estimated to raise $17.9 million per year. 30 Based on the original estimate, it would seem that approximately $70 million in additional revenue could be raised through full repeal of this deduction Pablo, Frederick D., Testimony of the Department of Taxation Regarding SB 570 SD1, delivered before the Senate Committee on Ways & Means, available at: See also Dean Hirata, deputy director of the Department of Budget and Finance, as quoted in DePledge, Derrick, Tax deduction repeal would pinch majority, Honolulu Star-Advertiser, Feb. 17, 2011, available at: Tax_deduction_repeal_would_pinch_majority.html. 29 Hawai i Governor Neil Abercrombie s 2011 State of the State Address, available at: Hawai i Appleseed Center for Law and Economic Justice Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families

11 5 REQUIRE ONLINE RETAILERS TO COLLECT HAWAII EXCISE TAX HAWAI I, like every other state with a sales tax, requires its residents to pay sales taxes on the items they purchase online, just as they are required to do when shopping in a brick and mortar store. Due to a 1992 U.S. Supreme Court ruling, however, the states ability to require that online retailers collect this tax on behalf of their customers has been greatly limited. Hawai i and other states have instead had to trust that online shoppers will remit the tax themselves. 31 Shoppers are rarely aware of this requirement, however, and often ignore it even when they are. In practice, online shopping tax evasion has become rife. Academics have estimated that Hawai i loses a total of $60 million in revenue per year on online shopping sales. 32 In 2009, the Hawai i Legislature tried to increase tax revenues from online purchases by passing what is known as a click-through nexus requirement. The bill required that major online retailers, the largest of which is Amazon, begin to collect the Hawai i sales taxes owed by their customers if the retailer partners with Hawai i businesses to solicit sales. Unfortunately, in 2009 Amazon temporarily terminated its relationship with Hawai i businesses to avoid having to collect the sales taxes owed by its customers. Governor Linda Lingle vetoed the bill as a result of Amazon s decision and Amazon eventually restored those relationships. In the years since, however, Amazon has significantly scaled back its efforts to avoid online sales tax compliance measures. As of late 2012, Amazon collects sales taxes in eight states which comprise up to 35 percent of the nation s population. The company also has committed to collecting sales taxes in five more states by 2014, increasing the percentage of the population living in states where Amazon will collect tax to 46 percent. Requiring online retailers such as Amazon to collect sales taxes owed under Hawai i law could be accomplished in several ways. In addition to the click-through nexus provision described above, Hawai i could also enact an affiliate nexus provision that would require retailers with subsidiaries or other affiliated companies in the state to collect tax. 33 In 2009, the Department of Taxation estimated that an Amazon nexus bill could raise $4 million per year. 34 If successfully implemented, the actual amount raised through a combination of click-through and affiliate nexus provisions could be in multiple millions of dollars generated through improved tax enforcement rather than a tax increase Tax Policies That Will Help End Poverty for Hawai i s Lowest-Income Families Hawai i Appleseed Center for Law and Economic Justice 11

12 HAWAI I APPLESEED CENTER LAW AND ECONOMIC JUSTICE P.O. Box Honolulu, Hawai i (808) BOARD OF DIRECTORS David Derauf, M.D. Marc Fleischaker, Esq. Naomi C. Fujimoto, Esq. Patrick Gardner, Esq. David J. Reber, Esq. EXECUTIVE DIRECTOR Victor Geminiani, Esq. Hawai i Appleseed Center for Law and Economic Justice is a nonprofit, 501(c)(3) law firm created to advocate on behalf of lowincome individuals and families in Hawai i on civil legal issues of statewide importance and to complement the assistance provided by other legal services providers in the state.