#1Hawaii Tax System: Income Tax Tax Review Commission TAX RESEARCH & PLANNING, DOTAX SETH COLBY JAN 20TH, 2021 1#2An income tax is a tax on an economic input Taxes on outputs are less likely to distort economic behavior than taxes on inputs Input Labor о Labor and capital are inputs ⚫ The is one rationale behind consumption о taxes Taxing income may lead to inefficient outcomes о ⚫ Taxing income discourages work. Less labor leads to a decline in economic output 。 Income tax is a disincentive to save because income tax penalizes consumption and savings IIT: 6.4%-11.0% Output GET 4.0% Firms Goods Capital Capital gains 7.25% 2#3Capital is mobile whereas labor is more domiciled Why do most governments tax labor inputs more than capital? Capital accumulation is strongly correlated with growth (promote investment) Most governments tax capital (capital gains and corporate income) less than labor However, labor more mobile between states than internationally, especially with the e- economy 3#4What is the optimal rate of taxation? Economic literature is divided on the optimal marginal rate of taxation о Range is somewhere between 0 and 100% 。 As income taxes get higher, more likely that people leave the work force or leave the tax jurisdiction Consideration: as you raise income tax, people may substitute labor with capital о о Receive equity compensation (taxed at capital gains) Increase use of C and S corporations (Gordon and Slemrod '00) There is a trade off between equity and efficiency 4#5Income tax is favored for its ability to redistribute Income tax allows authorities to apply different rates according "ability to pay" Graduated tax schedules help reduce inequality However, Income is not wealth. Wealth inequality tends to be more severe than income inequality It is possible to "hide" income, especially for wealthy individuals that receive most of their income for capital and engage in tax planning 5#6Income Tax vs. Consumption Tax Equity Efficiency Administrative Burden Avoidance Individual Income Tax Tend to be more progressive (using graduated rates) Moderate to high: Taxation of input reduces work, depends a lot on rates. Discourages Consumption Tax Regressive (less in life cycle terms) Minimal: If applied equally to all consumption goods Easy savings Easy to moderate Moderate to high Low 6#7A digression on inequality in the US and Hawaii 7#80.450 0.400 0.350 0.300 0.250 0.200 0.150 0.100 0.050 0.000 T Iceland Norway Denmark Finland The United States is one of the most unequal OECD countries Ineqaulity (Gini coefficient) After taxes and transfers Czech Republic Belgium Slovak Republic Austria Sweden Luxembourg Netherlands Germany France Switzerland OECD-24 Poland Korea Ireland Canada Italy Japan New Zealand Australia United Kingdom Source: OECD (2015) In it Together: Why Less Inequality Benefits All 8 United States#950 45 40 35 30 25 20 15 10 5 0 Poland Switzerland The US has one of the most progressive tax systems in the OECD Wealth Redistribution of Tax System Iceland Belgium Norway Sweden Japan Denmark Germany Share of taxes of richest decile Austria France OECD-24 Slovak Republic Luxembourg Share of market riches decile Czech Republic Korea Italy New Zealand United Kingdom Finland Source: OECD (2008) Growing Unequal? Income Distribution and Poverty in OECD countries Ratio of shares for riches decile Canada Ireland Netherlands Australia United States 9 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00#10United States redistributes less than most other developed countries Figure 4.4. Differences in inequality before and after taxes and transfers in OECD countries Difference in concentration coefficients around 2005 People ranked by disposable income People ranked by market and disposable income Percentage reduction 0.6 0.5 0.4 0.3 0.2 0.1 0 KOR ISL CHE JPN POL FRA AUT USA CAN LUX FIN OECD-24 NZL NOR Source: OECD (2008) How much redistribution do governments achieve? ITA NLD SVK GBR DEU IRL AUS CZE SWE BEL DNK 10#11The US relies on taxes to redistribute, which is less effective than cash transfers The impact of taxes and transfers on income inequality in 25 countries 0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 Brazil (2006) Poland (2004) Guatemala (2006) Ireland (2004) Colombia (2004) Estonia (2004) Israel (2005) United Kingdom (2004) Germany (2004) France (1994) Finland (2004) Belgium (1997) Australia (2003) Netherlands (2004) United States (2004) Czech Republic (2004) Reduction of inequality through transfers Reduction of inequality through taxes ■Gini coefficient for disposable incomes Austria (2004) Sweden (2005) Canada (2004) Norway (2004) Denmark (2004) Switzerland (2004) Romania (1997) Republic of Korea (2006) Taiwan, China (2005) Note: The total height of the column corresponds to the Gini coefficient for market incomes (ie. before taxes and transfers). Source: Luxembourg Income Study (US) Database, http://www.lisproject.org/techdoc.htm (multiple countries, analysis of micro-date). 11#12Gini Coefficient Hawaii is one of the most equal states in the country Hawaii is the third most equal state in the country according to GINI Coefficient Hawaii is the second most equal state based on the ration of top1% to bottom 99% of income Global economic forces have led to outsized economic gains for top income earners since the 1970s but the gains have been less dramatic in Hawaii relative to other states. о о 0.55 Hawaii: +54% Income change for top 1 percent of household since 1979. All others saw -9% New York: +273 Income change for top 1 percent of households since 1979. All others saw +5% increase Income Equality by State 0.5 0.45 0.4 0.35 0.3 0.25 0.2 T T Utah Alaska Hawaii Iowa Wyoming New Hampshire Wisconsin Vermont Nebraska Indiana Minnesota Maine Delaware Idaho Nevada Washington South Dakota Maryland Ohio Colorado Kansas Oregon Montana West Virginia Missouri Michigan Virginia North Dakota Arizona Pennsylvania South Carolina Oklahoma Rhode Island Texas Mississippi Arkansas Illinois Georgia Alabama Kentucky Tennessee New Mexico North Carolina New Jersey Massachusetts Florida California Louisiana Connecticut New York Source: American Community Survey (2015) Includes all cash income 12 12#13Income gains in the top 1% have been modest compared to other states The top 1% takes home 11.9% of all the income in Hawaii, compared to an average of 20% In the US Share of income captured by the top 1%, 1917-2012 25 20 15 10. United States I 1920 1940 1960 1980 2000 Hawall Source: Economic Policy Institute 13#14The median Hawaiian household reports above average income but residents in top 1.0% report below average income compared to other states Income threshold of top 1% of filers by state $80,108 Median HH income in Rank State Income threshold of top 1.0% Share of Income earned by to 1.0% Hawaii (5th highest in 1 Connecticut $827,194 27% nation) 2 Massachusetts $728,272 23.7% 3 New York $702,559 29.3% $140,990 4 New Jersey $701,005 19.6% Income threshold of top 5 California $659,503 23.0% 10% of filers in Hawaii 6 Washington $585,748 18.7% 7 Florida $581,682 28.4% Avg United States $538,926 28.4% Source: American Community Survey and 38 Hawaii $414,599 14.1% DOTOX Source: IRS 2017 14#15Hawaii's Individual Income Tax 15#16At a Glance: Hawaii tax system Hawaii revenue share of individual income tax is close to the national average Composition of state and local taxes Corporate Income 2% Hawaii Property 17% Other Taxes 22% Individual Income 21% General Sales 38% U.S. Avg Other Taxes 19% Corporate Income Property 31% 4% Individual Income 23% General Sales 23% Source: Tax Foundation 16#17Roughly 31% of total collections derive from individual income taxes 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Composition of State Revenues CY 2010 CY 2011 CY 2012 CY 2013 CY 2014 CY 2015 CY 2016 CY 2017 CY 2018 CY 2019 CY 2020 Other Corporate Income Tax Unemployment Insurance Tax Public Service Companies Tax Cigarette & Tobacco Tax Motor Vechicle Taxes & Fees Fuel Tax Transient Accommodations Tax Individual Income Tax General Excise and Use Taxes 17#18The GET is a more stable revenue source than the Individual Income Tax Tax Revenue and Economic Performance (Normalized) 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1 0.9 0.8 CY 2007 CY 2008 CY 2009 CY 2010 CY 2011 CY 2012 CY 2013 CY 2014 CY 2015 CY 2016 CY 2017 CY 2018 CY 2019 General Excise and Use Taxes Individual Income Tax Hawaii GDP 18#19Notable features of Hawaii individual income tax Very progressive relative to other states Many brackets Brackets not indexed to inflation (unlike federal rates) Relatively low standard exemption compared to federal (Federal $12,600, HI: $4,400) Refundable credits offset burden for lower income individuals The largest state specific exemption is pensions and social security, which is expected to grow with time 19#20Hawaii exempts 16% of income through pension disbursements Composition of federal Individual Income in Hawaii Captital gains 3% Social security 4% Self-employment income. 6% Interest & dividends 2% Pensions & IRA distributions 12% Income Source Rate Wage & Salaries Pensions & IRA distributions Self-employment income Social security Variable (See tax bracket) 0% (Employer contributions exempt) Variable (see tax bracket) 0%, (exempt) Capital Gains 7.25% Wages & salaries 73% Interest & Dividends Variable (see tax bracket) 20#21Hawaii has one of the highest marginal tax rates in the county 43 states levy individual incomes taxes 8 states have a single-rate structures Tax Bracket Highest Marginal 1 California 13.30% 2 Hawaii* 11.00% • Hawaii will have the most brackets in the country with 12. California and Missouri have the second most tax brackets with ten 3 Maine 10.15% 4 Oregon 9.90% 5 Minnesota 9.85% 6 Iowa 8.98% 7 New Jersey 8.97% Hawaii has the second highest income tax rates of any state 8 Vermont 8.95% 9 DC 8.95% 10 New York 8.82% 11 Wisconsin 7.65% 12 Idaho 7.40% 21#22Hawaii income brackets are steep on the extremes and relatively flat in the middle Tax brackets for Selected States (Joint Filers) Colorado 4.63% of federal taxable income Virginia Maryland California Hawaii* 2.00% > $0 2.00% > 3.00% > $3,000 3.00% > $0 $1,000 5.00% > $5,000 5.75% > $17,000 4.00% > $2,000 4.75% > $3,000 5.00% > $150,000 5.25% > $175,000 5.50% > $225,000 1.00% 2.00% > $16,030 4.00% > $38,002 6.00% > $0 1.40% 3.20% > $0 $4,800 5.50% > $9,600 $59,978 6.40% > $19,200 8.00% $83,258 6.80% $28,800 5.75% > $300,000 9.30% 10.30% > 11.30% > $644,998 12.30% > $1,074,996 13.30% $105,224 7.20% > $38,400 $537,500 7.60% > $48,000 7.90% > $72,000 8.25% > $96,000 > $1,074,996 9.00% > $300,000 10.00% > $350,000 11.00% > $400,000 22 22#23Hawaii's tax brackets are more progressive than most states Rates on Taxable Income for selected states (married, filed jointly) Adjusted Gross Income 50,000 75,000 100,000 150,000 350,000 Ratio 350,000/ Marginal Effective Marginal Effective Marginal Effective Marginal Effective Marginal Effective 50,000 Hawaii 7.60% 5.72% 7.90% 6.36% 8.25% 6.76% 8.25% 7.25% 8.25% 7.82% 137% California 4.00% 2.16% 6.00% 3.17% 8.00% 4.21% 9.30% 5.86% 9.30% 7.83% 363% Maryland 4.75% 4.64% 4.75% 4.68% 4.75% 4.70% 5.00% 4.71% 5.50% 5.13% 110% Colorado 4.63% 4.63% 4.63% 4.63% 4.63% 4.63% 4.63% 4.63% 4.63% 4.63% 100% Virginia 5.75% 5.23% 5.75% 5.41% 5.75% 5.49% 5.75% 5.58% 5.75% 5.68% 109% Year 2018 Using standard deduction and no dependents 23#24Most resident filers are in middle and upper-middle tax brackets 2018 Joint Filers by tax brackets (residents) Tax Bracket (by Taxable Returns with Taxable Income in the Tax Bracket Margina Number of % of Total No. Amount of | Tax of Joint Returns Taxable Income 1.40% Income) Returns $0 to $4,800 39,534 17.75% $15,808,333 $4,801 to $9,600 3.20% 6,473 2.91% $46,624,377 $9,601 to $19,200 5.50% 13,484 6.06% $194,770,639 $19,201 to $28,800 6.40% 14,073 6.32% $338,011,998 $28,801 to $38,400 6.80% 13,861 6.22% $464,810,868 $38,401 to $48,000 7.20% 13,498 6.06% $582,493,413 $48,001 to $72,000 7.60% 33,754 15.16% $2,024,126,504 $72,001 to $96,000 7.90% 29,027 13.04% $2,422,020,698 $96,001 to $300,000 8.25% 52,086 23.39% $7,628,200,519 $300,001 to $350,000 9.00% 1,616 0.73% $522,070,010 $350,001 to $400,001 $400,000 10.00% 1,120 0.50% $418,017,532 & Over 11.00% 4,155 1.87% $4,656,684,945 ALL 222,681 100.00% $19,313,639,836 24#25Tax Liability ($ Million) Tax liability is skewed to the center and upper end of the income distribution $550 $500 $450 $400 $350 Before Credits $300 After Credits $250 $200 $150 $100 $50 $0 <10 10 <20 20 <30 30 <40 40 <50 50 <75 75 <100 100 <150 150 <200 200 <300 300 <400 >400 -$50 Hawaii AGI Class ($ Thousand) Source: 2018 Income Tax Returns 25#26The highest income earners pay a higher share in taxes than their share of income Ratio of the Share of Gross Tax Liability to Share of Taxable Income of Residents by Hawaii AGI Class 1.40 1.20 1.00 0.80 0.56 0.60 0.40 0.33 0.20 1.13 1.08 1.03 0.99 0.94 0.90 0.85 0.80 0.71 0.00 <10 10 <20 20 <30 30 <40 40 <50 50 <75 75 <100 1.26 100 <150 150 <200 200 <300 300 <400 >400 Hawaii AGI Class ($ Thousand) Source: 2018 Income Tax Returns 26#27Low-income filers have low tax liabilities and benefit from refundable credits 10.0% Average Effective Tax Rates by Income of Residents Before Credits After Credits 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% <10 >400 300 <400 200 <300 150 <200 100 <150 Source: 2018 Income Tax Returns 27 50 <75 40 <50 30 <40 Hawaii AGI Class ($ Thousand) 75 <100 20 <30 10 <20#28$ Million Residents pay 92% of all individual income tax $2,500 $180 $155 $2,000 $137 $148 $116 $106 $112 $1,500 $2,266 $2,109 $1,000 $1,937 $1,955 $1,786 $1,653 $1,632 $500 50 $0 2012 2013 2014 2015 2016 2017 2018 Residents ■Nonresidents 28#29The Exemption of Pension and Social Security are amongst the largest sources of untaxed income Taxable Returns Nontaxable Returns Total Returns Est. Rev Loss No. of Returns Amount No. of Returns Amount No. of Returns Amount Amount Total SS and Pension Exemption Exempt Pensions Social Security Benefits 133,668 $3,451 84,112 63,779 $2,212 49,399 69,889 $1,239 34,713 $2,278 217,780 $5,729 $382 $1,794 113,178 $4,006 $484 104,602 $1,723 Dollars (millions) The cost of exempting Social Security and Pensions is $382 million 29 29#30Assessing the individual income tax Economic Efficiency Fairness Administrative Burden Stability • Provides a disincentive to work ⚫ IIT penalizes savings in comparison to consumption tax (mitigated by tax breaks on retirement savings) • High rates (especially in higher incomes) may prompt tax avoidance and lower potential to generate revenue • Progressive, a common mechanism for redistribution. • Moderate compliance costs and moderate administrative costs by the government IIT revenue is more volatile than GET revenue 30#31Hawaii's Corporate Income Tax 31#32Corporations are taxed in ways that other businesses are not Corporates (C-corps) Revenues Pass-throughs (S-Corps, Partnerships, Sole Proprietorships) Revenues Revenue - Costs Revenue - Costs Taxed within entity Profits (6.4% Tax) Not Taxed within entity Distributed Profits Individual Income Rate Distributed Profits Individual Income Rate 32#33A lower corporate tax rate lowers ROI needed to invest Expected Value = Discounted Future Cash flow * (1- tax rate) In Corporate Finance, investments must meet or surpass a certain ROI (usually risk-adjusted Weighted Average Cost of Capital). When the tax rate decreases, more projects surpass the investment threshold → More investment (in theory) A higher corporate tax rate lowers the expected value of investment opportunities A lower corporate tax rate increases the in expected value of investment opportunities 33#34Features of Hawaii's Corporate Income Tax Generates a relatively small amount of revenue 。 Just 1.5% of total collections (2015-2020) Of the 44 states that collect corporate income tax, Hawaii ranks 44th in terms of collections per capita Hawaii's top corporate income tax rate of 6.4% falls in the middle of state corporate taxes nationally. о ⚫ Lowest Rate: 3.00% North Carolina о Highest Rate: 12.00% lowa 34#35Hawaii's Corporate Tax Rate Income Rate <=$25,000 4.40% $25,000+ 5.40% $100,000+ 6.40% Capital Gains: 4.0% 35#36Corporate Tax Rate Tax on corporations is passed to consumers, workers, and owners of capital Economic logic cautions against the use of graduated corporate tax systems since corporate earning is not indicative of "ability to pay" 。 Graduated rates incentivize firms to engage into economically wasteful tax planning 36#37Thank You 37