 Yeah, it's reflexive whether a state can tax itself. It's a very interesting question that Tom Yamachika brings up and he is our regular contributor, co-host on talking tax with Tom, Tom Yamachika. Let's move right along here. What is this with the state taxing itself? How does that work? Well, okay, here's the deal. In this past legislative session, lawmakers passed Senate Bill 3201. And what that would have done is it would have changed the kinds of activities that are taxable for nonprofits, okay? For most of the country and for income tax purposes, the Internal Revenue Code tells us that nonprofits are normally tax exempt. I mean, if you get the proper tax exempt classification, you're exempt on almost all of your activities except those that constitute what we call an unrelated trade or business. And what that means is it's got to be a business activity, not just a one-off, but regularly carried on. And it needs to be unrelated to the purpose for which your organization was granted a tax exemption. So for example, if you have a school, you charge tuition, you can say, yeah, the tuition is a business, but it's related to the exemption that the organization has. I mean, it's a school, getting students educated is their taxes and purpose. So it's related and therefore not taxable. Now in Hawaii, GET goes by a different set of rules. And we tax nonprofits, if they have any activity, the primary purpose of which is to produce income. Okay, related or not. I think that doesn't include fundraising though. It does, that's the point. If somebody gives me $10, they help support my nonprofit fund drive, that's. That's a donation and they can get a deduction for tax purposes, you're exempt for GE purposes, except if you give that person something back, like a ticket to a dinner. In that case, it becomes a fundraising activity, not related to the nonprofit's purpose and it's 100% taxable. Okay, so I mean, as if it were a regular business. Right, so the bill would have changed it so that the nonprofit would be taxable for GE purposes only on unrelated business activity as well with some exceptions. But it would have been a great step forward for nonprofits who have been struggling with this dichotomy for years, if not decades. Okay, let me go back for a minute. This is 3201 is about for sexized tax, it's not about income tax. Right, it doesn't affect income tax. You started out with discussing the federal system and unrelated business income in the federal system. This does not affect unrelated business income or state income tax, right? That's correct, this is the same standard. Same standard, let me go back to that for a minute. So if you have unrelated business income either in the federal or the state, does that jeopardize your exemption from tax? It does if you make too much. Because- How much is too much, Tom? Well, if it's the primary purpose of your organization, then you're not entitled to exemption. But that's pretty much the, yeah, it's subjective and it's kind of the atomic bomb that the IRS can drop on an organization that it feels makes too much money. And they've tried that with the mega churches and some other organizations like EST, for example. I don't know if you remember EST, but those are organizations that come to mind. But I am aware of educational institutions that own and operate businesses like regular businesses. And that doesn't actually disqualify them from their 501C3 or whatever it is. Yeah, as long as the businesses are put in for-profit entities. I mean, the for-profit entities are there to make a profit. I mean, that's fine. Right, okay. So that would be taxable both federal and state. Now let's move to the gross sex tax. Before, sounds like before this bill came up or would have passed, it didn't, but if you had an event, say, and you charged people and you gave them food and all this then theoretically, you would have to pay gross sex tax on the admission fee. Yeah, the gross ticket price. The gross ticket price. It doesn't matter what the food cost. And so now this bill would have changed that. Can you give us the dimensions of the bill? I mean, what would it have done? And then we'll examine, you know, why it was introduced. Well, okay, let's say somebody gives a fundraising party at the end of the year, like let's say think tech. And a donor comes in and says, oh, hey, I wanna be a major sponsor of the event. So I'll give you $100,000, but give me 10 tickets. So I can put some people there at the celebration for you. Under the GE tax law as it's currently worded, $100,000 is subject to tax. You don't get any deduction whatsoever, even though it looks like mostly a donation. So same situation, same scenario, $100,000, but no free ticket. Yeah, if the donor gets nothing in exchange, then there's a different exemption that kicks in and says it's a donation. Donations aren't income and not some tax. Yeah, so a donor is always wanna, the donor is going to want, and don't need for that matter, is going to want to make it clear that there's no consideration passing back to the donor. Yeah, that's current law, that's not changed by this bill. But it's those situations where you have like a ticket price that's disproportionate to what the donor gets back in return, those are the things that would be changed. Right now it really doesn't matter what the donor gets in return for the ticket as long as it's something, then it's not a donation. Okay, that could be very unfair in the sense that, would you say 10 tickets for $100,000 would make the whole thing subject to tax? Even under, well, under existing law, that just seems inequitable, doesn't it? Yeah, and that's one of the reasons why this bill was introduced. Now, as it went through the legislative process, okay, everybody, everybody kind of thought it was a good idea, legislators thought it was a good idea, the charities thought it was a good idea, even the department thought, oh, we're not gonna oppose it, we're just gonna give some comments on it. And it went all the way to the end. Okay, then stuff happened. The tax director who cured of four had not been kind of significantly in the loop on this, he took a look at it and says, what is, what's going on with this thing? And that's when the fund started. So- Can I stop you there for a minute? Where does this thing come from? I mean, it's a tax bill, all tax bills have all these technical implications. It never really stands alone, it always has an implication on state revenue and where it's reported elsewhere and so forth. Doesn't the tax office look at these bills at the time they're introduced? Doesn't the tax office introduce these bills? Doesn't the legislator who submits the bill confer with the tax office, see if it's a legitimate positive change in some way? Yeah, they don't have to. They don't, I guess. They typically don't, they wait for the tax environment to testify in the bill. Okay, so who submitted it? I guess it was not the tax office. It wasn't the tax office. All right. I mean, what interest group would have submitted it? The nonprofits? The nonprofits, I would imagine. Yeah. Okay, so I interrupted you, go on, please continue. Okay, sure. So we get to the end of session and the tax director kind of gets excited over this bill because he's kind of thinking, well, how does this fucker work? And then he starts getting people involved for, in my own mind, spurious reasons. So what the bill contained was language that said that if, you know, that there are some get out of free cards in the internal revenue code. It says if you earn certain types of income, then it won't be considered unrelated business taxable income, even though it might be, you know, regular and continuous, like if you get rents or if you get to capital gains, because there are some get out of jail free cards in what we call 512B. Let's say we really don't care about the underlying business that got you this rent or this interest or capital gains. We're gonna say it's not unrelated business taxable income. Okay. And for GE purposes, we didn't adopt those. So we had a proviso that says that these 512B get out of jail free cards don't apply. And so somebody at the tax office kind of thought about that and said, well, okay, that means that anything that's in the get out of jail free provisions is automatically taxed, which is not what it says. Okay. But there was an understanding that, okay, I mean, there are some charitable organizations that do make a lot of money off of rents. And we have some, you know, very large land trusts, for example, and they didn't wanna change that because that would distort the revenue picture. I mean, it would cost too much. And so this is where the question, you know, whether the state tax itself rears its ugly head. So the tax office then went to the University of Hawaii and they said, look, in 512B, there are these get out of jail free cards for research grants. This bill is gonna make those taxable. Is that what you want? And of course, you said, no, no, no, no, we don't want that. This is okay then. Recommend veto of this bill and they did. But it wasn't true. Yeah, I think it's not true for several reasons. Number one, governments don't pay taxes. Tax payers pay taxes. What sense would there be? Are you saying that the University of Hawaii is government? Yeah, it's a government, isn't it? It's a government agency. I think that should be, you know, a basic understanding of all of us. It's not separate from government. The University of Hawaii is a government agency. And that has implications all across the board and so many things. What about other institutions? What about private colleges? They're not government agencies then. That's right, they're not. But DOE and its public schools are and there is some guidance from the Department of Tax saying, and I guess they were asked about fundraisers being carried on by school groups, classes, PTAs and stuff like that. And they said that, oh, the DOE and its public schools are not considered taxable entities for GET purposes. So, you know, if it's another entity that's conducting this fundraising like the PTA, for example, then yeah, there may be some tax implications, but if it's the school itself, no. Okay, and the question that I wanted to put is, all right, what's so different between K-12 public schools and the university? They're institutions of higher learning. They're state agencies. So if the department's saying that the schools are all exempt from tax, why is the university exposed to any kind of tax at all? Right. As you just said, there's no difference. They're both government agencies. Could there be any legitimate distinction? I don't think so, but they still got the university scared and the university came in with a veto recommendation as well as the tax department. And that led to Senate Bill 321 being placed on the intent to veto a list. And then now, as we found out just a couple of days ago, it did get vetoed. How do you know this was the reason it got placed on the veto list and was vetoed? I mean, is this stated in the veto list? No, no, I had some inside information. Okay, well, it seems to me that, I would like to know that too. I would like to know if the governor and the people who are trying to influence him are wrong about their interpretation and a state agency is wrong about their interpretation of the existing state law. Do you think the veto list, do you give his reasons or do you express who is asking? No, I mean, the current veto message and the intent to veto recommendation, you know, it just said that the governor was concerned about unintended consequences. That's pretty vague. And then the actual veto message kind of said, well, and it's gonna cost a lot. It's gonna cost basically three and a half million dollars a year in revenues. Is that a legitimate reason to veto this bill that would forgive non-profits a certain amount of gross excess tax? Well, that's debatable. You know, certainly anytime you enact a credit or incentive, it's gonna have a revenue cost. Some have more revenue cost than others. Anytime you enact an exemption, it has a revenue cost. Let's go back to the bill itself. I mean, we're a non-profit, you're a non-profit. We care about these things because we know how hard it is, especially in this environment, to raise funds. I include COVID, I include, you know, the economy in general, and I include those things that are undermining our society these days. It's hard to raise funds. And so non-profits do a lot of work that the government would otherwise have to do itself. Or that the government cannot do itself and can only be done by non-profits. I mean, the government, for example, is not gonna have a tax foundation like yours. And I'm not sure the government would ever have in organization like ThinkTech, a media organization. So these organizations and lots of other non-profits, including social safety net non-profits, perform valuable services in our community. We need to keep them alive. We need to incentivize contributions. Therefore, it seems to me that this bill was a good idea, three and a half million dollar reduction in collections or not. And, you know, tax is all of our priorities, right? You wanna prioritize a public policy point on this and maybe not on that. And so you can't just make a flat tax. You have to think about what the state as a matter of public policy wants to do. And clearly what it should be wanting to do is incentivize non-profits who do important work in our communities. Well, I mean, that's the reason why non-profits get its tax exemption in the first place. But the problem over the years has been that, you know, most of the people who are Shanghai into performing financial work for non-profit organizations. And I say Shanghai because most of them just don't do that voluntarily. They need to be asked. A lot of them come from backgrounds where they know what the federal tax law says but they have no idea what GE law says for non-profits. I mean, it's kind of, you know, unrelated business income is a concept that's taught in school, okay? You learned in accounting school, you learned in law school. If you take tax classes, you know, stuff like that. But GE, not a chance, okay? I mean, that is something that is kind of too specific. When you're in Hawaii, you either need to find out about it through your own research or you find out about it the hard way defending an audit. Well, GE is draconian. I mean, George Freitas spent his career at the tax office crying to expand the gross exercise tax into everything and he succeeded. It's plenary. It covers everything you can think of. There are really no significant exemptions. It's all over the economy. And other states which have, you know, similar taxes, designated sales taxes have all kinds of exemptions and deductions and you know, try to make it more just, if you will. Our gross exercise tax is not just and it's regressive and come to find that, you know, the rules of application are different for the gross exercise tax as they would be for the federal unrelated business income standard. It's troubling and there should be reform, don't you think? This was a reform, right? Yeah, it was an attempted reform. But it failed. But it failed. So my question to you is, is this gonna come back? Will there be, should there be other reforms in the gross exercise tax? Should there be exemptions? You know, like we talked about for years for drugs and the like. That actually affect the disadvantaged people, the lower economic groups, lower income groups. So it's not so regressive. We need the reform but is there an appetite for reform? It doesn't sound like it. No, no, well, I don't think so. I mean, I think one of the problems is that the way our GET works, it's so different from how it works in every other state that people get confused and, you know, they leave themselves wide open for the Department of Tax to come in and do it, gotcha. Okay. Which is exactly what happens. That's absolutely right. And so I think there should be, you know, greater efforts to achieve a greater understanding with the public about what this sucker does, how it acts. And that way, I think at least it'll be more fair in that, you know, with people knowing, you know, how it works and guessing in the appropriate circumstances would be right most of the time. Then, you know, you have, you know, less of a chance for the gotcha moments and the instances where the tax could get really unfair. Now, I do think that GET is more fair than a sales tax in that if you wanna spread the cost of doing business, you have all the businesses participate, not just the retail stores who sell tangible personal property. Why do you let one sector or another skate as the case in most states? Most states completely exempt the service sector. But... You're right, there's no good distinction for that. Yeah. It's retail revenue, whether you're selling widgets or services, yep. Yeah. So in that event or in that manner, I think the GET is like perversely more fair. It's regressive, yes. But that's one reason why we can keep it at like 4% or 4.5% as opposed to like 9% in the state like California. Let me just ask about that half percent. You know, back in the lingual days, somehow that got adopted point, what is it, 712 additional percent on gross excise. So in the old days, when things were simpler, you paid 4%. Yeah, it was 4.167. Yeah, to cover the... Cover the tax on the tax. Tax on the tax. I love when they have tax on the tax. But now it's not that anymore, it's 4.0712. And I thought that was kind of like for a period of time, not forever. Can you give us a little thumbnail about what happened there and why it's still in place? Because of rail. I mean, the half percent surcharge was a means to get more money to the Honolulu rail project. And that happened, I think, in 2006, 2007. And it's kind of been there ever since. I mean, a lot of things start off as a good idea with a temporary duration, but it gets extended and extended and extended. Like, the transient accommodations tax was originally enacted at 5% to build a convention center. Well, now our convention center is built and our transient accommodations tax is at 10.25%. Plus 3% more for the county surcharges on it. So, I mean, things just have a way of spiraling out of control. And I think that that's what happened to the half percent when it first got adopted. The other counties were saying, well, we should have this right too. And the constitution, I think, does say that. Initially, most of the counties wanted hands off and they didn't think that adopting half percent in their respective counties would do them any good, but they kind of got into the realization that they had to do that to stay alive economically. And so they did. Why if the county needed the money, why don't they just raise the real property tax? That's a very good question. But it seems that property taxes, are visible and associated with the counties. So if they did that, the voters would know who to boot. With the GE tax, there's a little bit more confusion and a little bit more, I think, deniability. Yeah, if you can slip it by the taxpayer, then it's a great source of additional funds, I guess. And that's what it is. It's confusion, as you've said. The other thing is that, in the case of Act 221 and many other incentive provisions legislature has adopted, there were, and there are specific sunset date. But there's no sunset date on that half percent, is there? There is. When is it? I think it's, now it's up to, I think, 2033. That's 11 years from now, Tom. Yeah, it was supposed to be, I think, this year or next year, but it got extended a few times. Okay. So the Tax Foundation of Hawaii looks at all these things. And I mean, you're talking about things that really do need to be rationalized and reformed. So you're not just interested in reducing taxes, for that matter, in making sure that the spending of the money is legitimate and fair and rational and all that. You're interested in looking at the whole system then. Give me your mission on that. Our mission is to help people create a rational and fair tax system. And we have different criteria on our website that we used to evaluate this, like the proportionality of burden, the regressivity, for example, transparency. Are you able to do that? Because you don't actually submit bills. That I know of. Who is submitting bills that seek reform? I mean, everybody is self-interested. And if there's nobody who comes by and says, oh, this is really wrong. This is unfair. This is disproportionate. This is regressive. We can't do this. What an interest group, what organization submits bills to do that? It's a very good question. I don't think there is one. So that's, and yeah, I mean, you have incentive proposals being put forth by lawmakers. You have increased proposals being put forth by lawmakers. You have, once in a while, some technical reform proposals being put up by the department, but it's usually ways to spread the pain rather than relieve people of it. You know, to circle back to our original discussion, Tom, the general rule is, the two general rules is no man or woman's life and property is safe while the legislature is in session. But that's kind of a joke. We do need them to consider public policy and to adopt reasonable, helpful, community beneficial legislation. The other rule is the taxes never go down. They go up, but they never, ever go down. And yet here we are on talking tax with Tom and we find this bill 3201, which effectively does, it does reduce and reform the gross exercise as it applies to non-profits, which as we have discussed is a valuable statement of priority and public policy. And yet this bill fails. Where do you put that in the general rule, the taxes never go down. This one would have reduced tax, at least on some taxpayers, ostensible taxpayers, nonprofit taxpayers, but it was vetoed. Where are we on this? Where are we on reform and rational inquiry into our tax system? Well, I don't know if we have any, you know? I mean, we have tax provisions that are supposed to be reviewed. We have reports coming out. We have our elected politicians looking at this stuff with at least some degree of understanding. They probably should give a little bit more time to understanding this stuff more because that's really what helps feed the engine. Of course the engine, the engine is the financial engine. It's the fiscal engine that you and I talk about, the ability to pay bills and all that. And I think, you know, if you take a look at it over the last 20 years, what you don't see is an improvement of the engine by diversifying the economy, by incentivizing new businesses and all that. We haven't really spent time or legislative effort doing that. And the other thing, you know, and it's all around, you know, kids leaving the brain drain, which is ultimately gonna make us a backwater sooner than later, is this, it's public confidence. If I give you a reform bill and I say, we are going to make this rational, we are going to reform parts of it, which we don't consider fair or appropriate to raise money. We're gonna have a comprehensive view of our tax system. What I do is I engender public confidence. The veto of this bill, 3201, at least to me does not engender public confidence. Where are we going on public confidence, Tom? Yeah, that's a very good point, Jay. This bill obviously got scuttled in back room dealings after the legislature had finished after the chance to submit public input had come and gone. We need to do better. Yeah, we need to do better. And the remarkable thing, as you discussed early on in the show is that the basis on which the bill was scuttled was wrong. It was a mistake. It was a mistake as in the interpretation of the existing law. So there you have it. What an interesting discussion. What an interesting scenario. Thank you very much, Tom. Tom Yamachika, president of the Tax Foundation of Hawaii, here on Talking Tax with Tom. Thanks so much. Aloha. Thank you so much for watching Think Tech Hawaii. If you like what we do, please like us and click the subscribe button on YouTube and the follow button on Vimeo. You can also follow us on Facebook, Instagram, Twitter and LinkedIn and donate to us at thinktechawaii.com. Mahalo.