Issues

Manufacturing a (Tax) Problem

Take a moment and look over this graph of effective tax rates in Hawaii, divided by industry. No points for guessing what type of business the government is currently trying to lure into the state. It’s almost startling. In every category except Research & Development, the effective tax rate is at least 12% and goes as high as 26%. In the category of R&D, however, a refundable tax credit can actually drop the rate to -0.6%.  This is what all the political eloquence about economic development in our state has wrought–a great tax rate for R&D operations. Too bad that the costs on nearly every other industry continue to make Hawaii an expensive place to do business. The information comes courtesy of the Tax Foundation, which compared data across states and ranked them based on effective tax rates. The point of the survey was to understand the state tax costs that are faced by real-world businesses. Unsurprisingly, the excise tax and  its multiple layers of taxation had a big impact–especially on manufacturing: More than in other states, Hawaii’s sales tax (called the General Excise Tax) applies to sales between businesses rather than just to the end consumer. As such, manufacturing machinery is taxed in Hawaii, so the cost of equipment and other inputs for manufacturing firms is significantly higher in Hawaii than in other states.   Hawaii imposes some of the highest tax costs in the nation on both new and mature labor-intensive manufacturing, with effective tax rates of 16.9 and 14.8 percent respectively, both over 60 percent above the median rates nationwide. The sales tax on manufacturing machinery is a...

The Clouded Judgment of Tax Authorities

The greed of tax authorities seems limitless. Revenue agencies will often seek to extend taxes well beyond what was contemplated when legislation was enacted, in the name of securing ever more money for government. Some even go so far as to extend taxes to services even in the absence of a tax that actually includes the item or service at issue. For example, Chicago recently instituted a “cloud tax,” a new extension of the existing “amusement tax,” and “personal property lease transaction tax” that will apply to streaming and cloud-based services. At a whopping 9 percent, the tax is expected to generate $12 million in revenue per year–or rather, innovative companies and consumers will lose $12 million every year. The Windy City’s tech community has complained loudly about the impact this discriminatory tax will have on the city’s innovation economy. Streaming customers and cloud-dependent technology companies have effectively been told that they are not wanted. What is the “the cloud”? Cloud computing is the storage and access of data with multiple redundant systems to ensure that the data is not lost, and access to programs over the Internet rather than on a local hard drive. In other words, the cloud is remote access and storage, and is simply a metaphor for the Internet. But why the seemingly sudden interest in taxing “the cloud”? As reported in the Wall Street Journal, “With sales of DVDs, video games and traditional packaged software slumping for years, more state and local governments are eyeing technologies such as streaming video subscriptions and cloud computing to help make up for hundreds of millions of dollars or...

You Can Have That Road, Alphonse … No! You Take It, Gaston!

CNBC’s recent rankings of “America’s Top States for Business” pegged Hawaii at #50 overall, despite a #1 rating for quality of life. One factor that led to Hawaii’s rock-bottom position was the condition of its roads and bridges. A big contributor to this state of affairs is that the State and counties aren’t clear on which roads they own, they don’t want to maintain them if they don’t know that they own them, and so there are a number of roads that are not getting maintained. Welcome to “Roads in Limbo.” When Hawaii was a kingdom, there were no counties; all roads belonged to the people through the sovereign. The counties were established in 1905, and while the counties were given certain rights and duties with respect to the roads in the following years, the division of roads into territorial and county highways did not happen until 1947. The law now defining state versus county highways, which dates back to 1963, refers to state highways as those acquired by or under jurisdiction of the Department of Transportation, and county highways as all other public highways. The law also mentions private roads that are surrendered or dedicated to the government and clearly says that in that context the government’s legislative body (such as the county council) needs to accept the dedication before the government takes over the road. The big question left open by these provisions is what happens to roads that were never private, but were originally government roads. Is the State allowed to say, “Hey, county, this road is in miserable, substandard condition so it’s now yours, you...

Who’s the Boss, Anyway? (Part 2)

In November of last year, I wrote about a Colorado case that was before the U.S. Supreme Court. Colorado voters had limited the power of its legislature to enact taxing and spending bills, and some of its legislators sued, saying that the power of the legislature was being throttled unconstitutionally. The federal district court and the Tenth Circuit allowed the suit to go forward, and the governor appealed. At the time, I said that the underlying question is: Who’s the Boss? Does the government exist to serve the people, or do the people exist to serve the government? The Supreme Court has now weighed in on the issue. To explain what happened I’ll need to review another case in Arizona. In Arizona, the question was how to draw representative district boundaries. Over the years, the legislature had drawn the districts several times, lawsuits were filed claiming irregularities including Voting Rights Act violations, and the courts had to redraw the districts several times. Finally the voters were fed up and added a provision to the Arizona Constitution cutting the legislature out of the process entirely and leaving the process of district drawing to an independent commission. Not surprisingly, the legislature filed suit alleging that tasking the commission with redistricting was unconstitutional. On June 29, the U.S. Supreme Court upheld Arizona’s process by a 5-4 decision. The Court’s majority opinion written by Justice Ginsburg quoted James Madison saying, “The genius of republican liberty seems to demand . . . not only that all power should be derived from the people, but that those intrusted with it should be kept in dependence...

Third Greek Bailout Is Not the Charm

Nearly a month ago Greek voters rejected more economic austerity as a condition of another European bailout. Today Athens is implementing an even more severe austerity program. Few expect Greece to pay back the hundreds of billions of dollars it owes. Which means another economic crisis is inevitable, with possible Greek exit (“Grexit”) from the Eurozone. Blame for the ongoing crisis is widely shared. Greece has created one of Europe’s most sclerotic economies. The Eurocrats, an elite including politicians, journalists, businessmen, and academics, determined to create a United States of Europe irrespective of the wishes of European peoples. European leaders welcomed Athens into the Eurozone in 2001 even though everyone knew the Greek authorities were lying about the health of their economy. Economics was secondary. Unfortunately, equalizing exchange rates cemented Greece’s lack of international competitiveness. Enjoying an inflated credit rating, Greece borrowed wildly and spent equally promiscuously on consumption. Greece could have simply defaulted on its debts. However, Paris and Berlin, in particular, wanted to rescue their improvident banks which held Athens’ debt. Thus, in return for tough loan conditions most of the Greek debt was shifted onto European taxpayers through two bail-outs costing roughly $265 billion. Greece’s economy has suffered, and the leftwing coalition party Syriza won Greece’s January election. Impasse resulted at the end of June as the second bailout expired. Athens denounced its creditors for insisting on repayment. Prime Minister Alexis Tsipras criticized “ultimatums, blackmail and fearmongering.” But writing off Greek debt would require European governments to confess their financial folly to their taxpayers. Restructuring Greek debt also would set off similar demands from other heavily...

Clean Energy Equals $418M Tax Hike?

Hawaii’s clean energy goals are the most aggressive in the nation, according to the home page of the Hawaii Clean Energy Initiative (HCEI). Let’s find out just how aggressive some of these goals are. Who is HCEI? It might sound like an independent nonprofit but it’s not; it’s actually a state government program under DBEDT. It’s been in the news recently because it released a draft report (written with the help of the International Council on Clean Transportation, an independent nonprofit that was awarded a $100,000 contract by DBEDT in April 2014). This 173-page report, all paid for with tax dollars, has a lot of recommendations, but we will concentrate on one of them for now. The draft report notes that Hawaii’s fuel taxes are low compared to gasoline taxes in the European Union. (Ours were fourth highest among the U.S. states in 2014, but apparently that doesn’t matter.) The report says that using gasoline for motor vehicles has “substantial externalities” including energy security, air pollution, traffic accidents, and traffic congestion. So the State could increase the tax rate to account for the social costs and increase the cost competitiveness of technologies that use alternative fuels. It also says that because demand for gasoline is relatively inelastic in the short term, economists tend to regard gasoline taxes as an economically efficient means of raising tax revenue. It recommends that the state tax on gasoline be hoisted by up to 400%, for an additional 85 cents a gallon, which, it says, would bring in an additional $418 million per year. Translation: Motor vehicles use fossil fuel, which is not a...

The Tangled Web Woven

Not long ago, the technology industry kept Washington, DC, at arms-length, believing that the industry simply needed to keep innovating, and that Washington simply needed to stay out of the way. Books were written and congressional testimony given that repeated the thought over and over. T.J. Rodgers, founder, president, CEO, and a director of Cypress Semiconductor Corporation, argued in 2000, “We CEOs are constantly told to stop sitting on the political sidelines; recognize the value of ‘industry-government partnerships’; and become donors, lobbyists, and recipients of subsidies. We could make no bigger mistake than to ‘normalize relations with Congress and the White House.’”  Fifteen years ago, to the extent there was interaction between the tech industry and policymakers, it was largely via pan-technology sector industry trade associations. What a difference a few years can make. As new technologies develop—or even just “new” concepts, such as the “Internet of Things”—government has been eager to jump in and start “watching with interest” or outright regulating. Instead of letting innovation flourish, addressing real concerns only as they actually happen, government has increasingly designed solutions for which there are still no problems. By the time “solutions” are proposed, technology has moved on to its next innovation. But bureaucratic hubris imposes the new rules anyway. Government continued its predictable, if wrong-headed path, but the IT industry changed. Broad-based IT trade associations looking out for the entire technology ecosystem and representing both large and small companies have dwindled. Niche representation is the new normal. At the same time various technology companies began to ask the government for favors, seeking advantages in the marketplace and erecting barriers...

And the Lowsman Trophy Goes to … Hawaii!!

You may have heard about Marcus Mariota, the “favorite son” from Hawaii who went on to win the Heisman Trophy and was then picked in the first round of the NFL draft. What you might not know is that there’s also a Lowsman Trophy, for the pro football player who is picked dead last in the draft. The player winning that trophy also gets the coveted title of “Mr. Irrelevant.” CNBC, the business news network, recently published its rankings of “America’s Top States for Business.” They score the 50 states on more than 60 measures of competitiveness, separated into 10 broad categories and then weighted based on how frequently each is used as a selling point when the states market themselves. This year the categories were workforce, cost of doing business, infrastructure, economy, quality of life, technology and innovation, education, business friendliness, cost of living, and access to capital. Hawaii was ranked #1 in quality of life. However, its scores in the nine other categories were either miserable or abominable, leading to an overall finish at #50, dropping one place from last year. We were ranked #50 in cost of living and cost of doing business, and #49 in infrastructure (just behind Rhode Island, last year’s Lowsman winner). Our highest rank in categories other than the one we aced was #36, for technology and innovation. One of the report’s authors observed that part of the problem is unavoidable. We are in the middle of the ocean, more than 2,000 miles away from the mainland and the bulk of U.S. resources. The same factors that make us an expensive place...

Close the Export-Import Bank to Cut Federal Liabilities and Promote Economic Fairness

The Export-Import Bank’s charter expired on June 30. What is commonly known as “Boeing’s Bank” is headed toward Washington’s trash bin. When Congress returns, it could revive Ex-Im, which primarily subsidizes big business. But a proper burial for what candidate Barack Obama called “corporate welfare” would save Americans money, reduce economic injustice, and promote economic growth. ExIm exists to borrow at government rates to provide credit at less than market rates for select exporters, mostly corporate behemoths. The bank claims to be friendly to small business, but cherchez the money: it goes to Big Business. According to Veronique de Rugy of the Mercatus Center, the bank subsidized $66.7 billion in sales by Boeing between 2007 and 2013. In 2013, the top ten ExIm beneficiaries accounted for two-thirds of the bank’s total activities. The bank charges fees and interest and claims to make a “profit”—more than $1.6 billion since 2008. But economists Jason Delisle and Christopher Papagianis explained that the bank’s “profits are almost surely an accounting illusion.” Most important, there is no calculation for market risk. CBO figures real losses over the coming decade are likely to exceed $2 billion. Taxpayers also could get hit with a big default bill. Total outstanding credit is $110 billion, yet the agency’s own inspector general warned that bank practices create the risk of “severe portfolio losses.” The agency is supposed to create jobs by throwing cheap money at purchasers of American products. However, the bank backs only about two percent of U.S. exports. There is plenty of private money available for such deals. No one knows which contracts are sealed only with...

The Ethics Commission Needs Ethics!

The Honolulu City Ethics Commission has just adopted a new policy that minimizes government transparency. The staff are now mandated to go through a cumbersome approval process before speaking to the media: “Additionally, any written media communications put out by the commission now needs to be sent to, in order, commission members, complainants and respondents (when applicable), the mayor and his Cabinet, City Council members, and then [emphasis added] media and members of the general public who have asked to see commission news releases.” An internal staff recommendation, ignored by the Commission, states that the new policy ” …will be counterproductive to the goals of ethics education and transparency.” Could this be old-boy politics? See this excellent editorial in the Star-Advertiser by Gordon...

Friends Don’t Let Friends Pay Higher Taxes?

“Friends Don’t Let Friends Pay Higher Taxes.” Sounds like a great marketing slogan, right? So just who do you think is doing the marketing? A conservative think tank? The Tax Foundation of Hawaii? A taxpayer advocacy group? Actually, it comes from the State of Indiana. Recently, the General Assembly of Connecticut, a state with Democratic political leadership just like ours, passed a $40 billion state budget that includes raising nearly $2 billion over two years by raising some taxes and cancelling previously approved tax cuts before they become effective. And it’s not the first time Connecticut jacked up their tax rates either. In 2011, they passed another $2 billion hike that drew considerable press attention. Anyway, Connecticut’s current budget bill prompted a firestorm of reaction from high-profile executives such as General Electric’s CEO Jeff Immelt, who emailed employees that he has assembled an exploratory group to “look into the company’s options to relocate corporate HQ to another state with a more business friendly climate.” Connecticut Governor, Dannel Malloy, who previously was expected to just sign the bill, quickly shifted to backpedaling mode. According to the Hartford Courant, he has not yet signed the bill, leaving open the possibility of revisiting the tax hikes in a legislative special session to be held this summer. So on June 10th, the State of Indiana took out a full-page ad in the Wall Street Journal that took aim, in not-so-subtle fashion, at three large companies that are headquartered in Connecticut – for now. It said: “GE, Aetna, and Travelers: We offer our support in the wake of Connecticut’s looming tax increase, because friends...

Where’s the Tax Stamp on that Eggplant?

Being a lawmaker is never easy. Not only do you have to deal with throngs of agitated constituents on a daily basis, but often you are asked to give your stamp of approval to things you might not know about completely. This past session gives us one interesting example. Health advocates approached a number of lawmakers about “e-cigarettes.” An e-cigarette is also known as a personal vaporizer (PV) or electronic nicotine delivery system (ENDS). It is a battery-powered vaporizer that is supposed to give a user a feel similar to tobacco smoking. Some e-cigarettes look like traditional cigarettes, but others do not. There are disposable and reusable versions. Typically the user inhales an aerosol, commonly called vapor, rather than cigarette smoke. This aerosol is generated when the device heats and atomizes a liquid solution known as e-liquid. E-liquids usually contain propylene glycol, glycerin, nicotine, and flavorings, but some e-liquids are sold without propylene glycol, without nicotine, or without flavors. In any event, some people got the idea that e-cigarettes should be treated the same as regular cigarettes, and therefore should be taxed under our tobacco tax the same as regular cigarettes. Bills were introduced in the Legislature to accomplish this, such as SB 1032 and HB 145, which had gotten all the way to conference committee (but didn’t make it out). SB 1032 would have added the following definition to “tobacco products”: “Any product containing nicotine, but not containing tobacco, that is intended for human consumption, whether chewed, smoked, absorbed, dissolved, inhaled, snorted, sniffed, or ingested by any other means, and that has not been approved by the United...

Do You Have a Spare 5000 Hours For a Little Light Reading?

We criticize legislators–and rightly so–for not fully reading the legislation they’re asked to vote on and for crafting such lengthy and tortuous bills in the first place. However, there’s another, more obscure repository of lengthy law–the Code of Federal Regulations. The Mercatus Center has calculated just how long it would take an average adult to the CFR and came up with a figure of 5727  hours. That means that if it was your full-time job to read it (and allowing two weeks of vacation per year), it would take three years to make your way through the whole thing. During which time, there would be even more added to it, so good luck with that. There’s a good reason for our reliance on computers to search and parse our regulations, as it’s beyond the ability of a normal person to carefully read and track all of the rules and their changes. (According to Mercatus, if you laid the pages of the CFR end-to-end, they would stretch 25 miles–almost a marathon.) The question of course, is what it says about the scope of the government’s regulatory powers that this is the...

Whither the Resort Fee?

This week we will be talking about “resort fees.” In recent years, a number of hotels, including many in Hawaii, have been adding them to hotel bills. The hotels say that it’s for access to the gym, pool, or Wi-Fi network, for example. But the fee is charged whether or not the guest uses the gym, pool, or Internet. By adding a resort fee of $25 to a room rate of $125, the hotel brings in $150 per night but it can advertise a $125 room rate. Whether or not this is truth in advertising — the consumer protection people can sort that one out — this also creates tax issues. Our state imposes a general excise tax on pretty much every kind of income. But an extra 9.25% is slapped on the charge for a hotel room. This is called the transient accommodations tax, or TAT. The hotels say that the resort fee is not for accommodations, as mentioned above, but the Department of Taxation has stated that a mandatory resort fee looks and walks like a room charge, so by golly they’re going to apply the TAT to the fee as well. The Department’s view of the world might make sense at first glance. After all, if I show up at a hotel without a car and they charge me a per-night parking fee anyway, then it’s tough for the hotel to say that what they are calling a parking fee isn’t just another piece of the room charge. But the Department’s own regulations add a wrinkle. The regulation gives the example of a guest who pays...

Digital Discrimination

As Benjamin Franklin famously wrote, “… in this world nothing can be said to be certain, except death and taxes.”  Technology has had an impact on both, providing us with longer life expectancies and a better quality of life, while tax authorities find technology too tempting to resist as the target for more taxes, even if those taxes discriminate against digital goods or services. Digital goods are those delivered completely electronically, such as music or videos, downloaded books or video games, as are digital services, such as job searching or resume preparation and editing. At one level, one might ask why digital goods are taxed at all. After all, digital goods and services do not tax state or local infrastructure. They don’t produce trash or require the burning of fuel or put wear and tear on roads for delivery by truck. But not only are states taxing digital goods and service—in some cases they are giving them discriminatory tax treatment, or even subjecting digital goods to duplicative and redundant taxes. Currently, one purchase could easily be taxed by the jurisdiction where the good is purchased, again where the merchant is located, and yet again in the jurisdiction where the wireless bill for the user’s account is sent. One purchase with sales tax applied three times, a delightful result for those whose only job it is to increase government spending by finding new ways to increase the tax money taken from citizens. Even though Congress has had legislation before it since 2010, it again wants to hear more. So today the Subcommittee on Regulatory Reform, Commercial and Antitrust Law of...

Unfunded Liabilities – Smoke and Mirrors?

Recently, I was on a television program with two very prominent local politicians, and the subject of unfunded liabilities came up. We know that actuaries have looked at the Employer-Union Health Benefits Trust Fund, or EUTF, and have found that the plan is “unfunded” by a staggering amount, as in over $18 billion. One of the politicians spoke of the unfunded liability dismissively, like it was an imaginary number. Smoke and mirrors. So I thought I would spend some time talking about what actually goes into this “unfunded liability” calculation. Pension funds and benefit plans have income and expenses, like most of us. We gather the bills on our desk that we happen to have, take out our checkbook to pay them with the money we have at the moment, and then, hopefully, we have money that is left over. This is called a “pay as you go” system, and the money left over is our “cash balance.” The problem with this system is that it only considers what is due, or on hand, at the moment and does not consider the future. To get a better picture of financial condition, benefit funds, insurance companies, and others with large obligations payable in the future try to predict the future. A benefit fund, for example, might not have to pay anything out currently, but if people have been promised health care benefits between the time they retire and the time they die, then it’s possible to estimate who is likely to retire, who is going to draw benefits, how much benefits are going to be drawn, when the benefits are...

Patients and Doctors, not the FDA, Should Choose Right Medicine

Good ideas in Congress rarely have a chance. Rep. Fred Upton (R-Mich.) is sponsoring legislation to speed drug approvals, but his initial plan was largely gutted before he introduced it last month. Drug discovery is an uncertain process. Companies consider between 5,000 and 10,000 substances for every one that ends up in the pharmacy. Of those, only one-fifth actually makes money—and must pay for everything. As a result, the average per drug cost exceeds $1 billion, most often thought to be between $1.2 and $1.5 billion. Some estimates run more. Naturally, the Food and Drug Administration insists that its expensive regulations are worth it. Unfortunately, while the agency undoubtedly prevents some bad pharmaceuticals from getting to market, it delays or blocks far more good products. The average delay in winning approval of a new drug rose from seven months in 1962, when the FDA’s power was dramatically increased, to 30 months in 1967. Approval time now is estimated to run as much as 20 years. Economist Sam Peltzman found no evidence that changing the law reduced the introduction of ineffective or unsafe pharmaceuticals. After all, companies don’t make money selling medicines that don’t work. And putting out something dangerous is a fiscal disaster. Observed Peltzman:  the “penalties imposed by the marketplace on sellers of ineffective drugs prior to 1962 seem to have been enough of a deterrent to have left little room for improvement by a regulatory agency.” Alas, the FDA increases the cost of all medicines, delays the introduction of most pharmaceuticals, and prevents some from reaching the market. That means patients suffer and even die needlessly. Congress...

Whose Tax is It, Anyway? (Part 2)

Last week we spent some time on business-related income taxes paid and the question of who may deduct them. Some 77% of small businesses are organized as “pass-through entities,” such as partnerships, LLCs, or S corporations, where the business entity doesn’t pay income taxes but its owners do. If the taxes belong to the business, they may be deductible against the business income; if they belong to the individual owners, then there are provisions that either limit the deductibility or disallow it altogether. A Temporary Treasury Regulation from 1986 says that the taxes belong to the owners, not the businesses. In Hawaii, if the owner has adjusted gross income of at least $100,000 (single) or $200,000 (married filing jointly), and then state taxes are not deductible at all. But there is a wrinkle. The same Hawaii law that disallows the deduction for state tax to individuals with higher adjusted gross income also disallows the deduction for corporations. Furthermore, it disallows the deduction to all corporations, large or small, whether they make or lose money. (For the curious, the law involved is Hawaii Revised Statutes section 235-2.4(i)(2).) But the Department of Taxation is allowing corporations to deduct state tax anyway. Why? The Department, in Announcement 2011-20, explained: “[C]orporate taxpayers will no longer be able to deduct state income tax paid under Internal Revenue Code (IRC) § 164(a)(3), nor will they be able to deduct general excise tax paid in lieu of state income tax under IRC § 164(b)(5). However, this bill has no effect on a corporate taxpayer’s ability to deduct income tax or general excise tax as an ordinary...