On January 15, the Institute on Taxation and Economic Policy (ITEP) released a report ranking the states in terms of how progressive their tax systems are. A “progressive” tax system is one that asks the wealthier taxpayers to pay more of their income than the poorer taxpayers. Most states rely upon some form of net income tax and some form of sales tax. Sales taxes tend to have flat rates and, therefore, are regressive. Income taxes tend to have brackets, with taxpayers with higher incomes exposed to higher tax rates and are progressive.
ITEP’s study concluded that virtually every state tax system is “fundamentally unfair,” in that it takes a much greater share of income from low- and middle-income families than from wealthy families. Combining all state and local income, property, sales and excise taxes that Americans pay, the nationwide average effective state and local tax rates by income group are 10.9% for the poorest 20% of individuals and families, 9.4% for the middle 20% and 5.4% for the top 1%.
The ten states with the most regressive tax structures, which they call “the Terrible 10,” the bottom 20% pay up to seven times as much of their income in taxes as their wealthy counterparts.
Hawaii didn’t make the Terrible Ten, but wasn’t that far behind: it was ranked #15 (from the bottom). One large contributor to Hawaii’s ranking is its high dependency on the regressive General Excise Tax. The study noted that six of the 10 most regressive states derive roughly half to two-thirds of their tax revenue from sales and excise taxes, compared to a national average of roughly one-third. Hawaii gets roughly half of its general fund revenue from the GET.
Hawaii was also singled out in the report for one other measure. The report measured which states imposed the greatest burden on the poorest 20% of the population. The poorest 20% of Hawaii’s non-elderly taxpayers paid 13.4% of their family income in state and local taxes, making it the second worst in the nation behind the state of Washington (which, by the way, topped the Terrible Ten).
The national Tax Foundation was very quick to publish a rebuttal to this report. One of its principal concerns was that progressive tax systems, such as those ITEP seems to be championing, would lead to volatile tax systems that dampen economic growth. To put it another way, governments need money even when times are bad. Income taxes can’t be expected to give them that revenue because people are either incurring losses or making less net income. Sales taxes and our GET, however, don’t care about profits so the tax money keeps coming in – or going out, depending on your perspective. Regarding economic growth, the Foundation points out that nearly every economic study of taxes and economic growth found that tax increases harm economic growth, with the most severe effects coming from corporate taxes, followed by personal income taxes, consumption taxes, and property taxes. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages.
For policy makers trying to figure out how best to steer Hawaii’s economy and to be fair to the taxpayers at the same time, these studies show us that these goals are not necessarily consistent; there’s a fair amount of pushing and pulling. Finding the right balance among these considerations is a tall order every year. For our lawmakers beginning Hawaii’s 2015 legislative session, it’s now up to you – whether you signed up for this part of the job or not.