Most Hawaii taxpayers are sighing with relief now that they have dropped their federal tax returns in the mailbox. At the same time, the madness of completing their state tax returns is just around the corner.
It used to be a slam dunk for most taxpayers as they merely had to copy numbers from their federal returns. Except for some obvious differences, such as tax exempt interest on federal savings bonds, cost-of-living allowance payments, and exempt pay for National Guard service, the definition of income for federal and state tax purposes was the same. That is until the state ran into a bump in the road a couple of years ago and decided to raise revenues to fill a budget shortfall. Lawmakers took aim at the most obvious target — Hawaii’s visitors — and raised the hotel room tax, or transient accommodations tax, and took all of the proceeds from the higher rate.
The higher rate — 9.25 percent — was phased in over a couple of years and is set to sunset or expire in 2015. The current administration would like to either make that rate permanent or, as it suggested this year, increase it to 11.25 percent. Given the deal to raise the TAT rate was cut between the Legislature and the hotel industry, it seems lawmakers don’t want to be accused of not keeping their word and the bills to either make the higher rate permanent or raise the rate even higher have hit the legislative graveyard.
In fact, lawmakers have taken the administration’s bill and moved up the sunset date for the higher rate from 2015 to July 1, 2013. With the state revenue picture improving, an earlier sunset date for the higher rate seems almost imperative.
Lawmakers made some changes to the way taxpayers figure taxable income a few years ago to help raise money to fill the budget shortfall. Apparently, one of the changes which elicited a sharp outcry was a limitation on itemized deductions for high-income earners. Those single taxpayers with federal adjusted gross income of $100,000 or $200,000 for joint filers can only deduct the first $25,000 of their itemized deductions — $50,000 for joint returns.
While limiting the amount one can deduct will, no doubt, increase the amount of one’s income exposed to the state income tax, the idea had unintended consequences. High-income earners are in a financial position to make substantial and generous charitable gifts to the community nonprofits or charities. Those charities and nonprofits besieged the Legislature last year, pointing out that the limitation on itemized deductions had discouraged many of their major donors from making substantial.
When the measure to repeal the limitation on charitable deductions did not pass last year, those same organizations made their concerns known to the administration and this year the governor’s office submitted a proposal to exempt charitable contributions from the limitation on itemized deductions. The proposal was incorporated into a legislative proposal and will be considered by a legislative conference committee. The limit on all itemized deductions is scheduled to sunset at the end of 2015.
Then there is the loss of being able to deduct state income taxes as an itemized deduction if taxpayers fall over the above thresholds specified for the limitation of itemized deductions. Proposed by the state administration two years ago, the argument made was that taxpayers don’t deduct federal income taxes on their federal returns so the state should not allow taxpayers to deduct state income taxes on their state returns.
The move was intended to generate more income, but it deviated from the state’s intent to minimize the differences in the definition of income for state and federal tax purposes. Not only that, but the deduction for state income taxes paid recognizes that the use of the money represented by the state income taxes paid — either in withholding or as a result of paying estimated taxes — was lost when paid to state government and the taxpayer had no economic benefit of the withheld tax amount. This change was made permanent but it should be reconsidered because it represents one more difference between the state and federal definitions of income.
Lowell L. Kalapa is the president of the Tax Foundation of Hawaii.
