 Talking tax with Tom here on a given Thursday at 10 a.m. This is Think Tech. I'm Jay Fidel. Tom Yamachika and Catherine Lohad join us. We're going to talk about the 2022 State Business Tax Climate Index for Hawaii. That may sound boring, but it's not. It affects all of us. It affects our business and the future of our state. It affects our brain drain. It affects the kids leaving. You care. You care about the business climate in this state, and you care about the tax climate. Welcome to the show, Tom, Catherine. Morning, Jay. How are you doing? Today we've got you with introducing Catherine and your job is to try to be nice. Oh, thank you very much. So our guest this morning, actually not morning her time, is Catherine Lohad from Washington, D.C. She is a senior research analyst. Did I get that right from the Tax Foundation in Washington, D.C. Their organization has a similar name to ours, but we're not related. But they do a lot more consequential work in our nation's capital. And one of the things that they do is they focus a lot on state taxation as well as federal. One of their best sellers, if you want to call it that, is the State Business Tax Climate Index. They have been doing it for several years. And I'll turn it over to Catherine so she can describe exactly what it is and why it's so consequential. Well, thanks, Tom. Okay, Catherine, we're all ears. You're talking about our future here, so be tender with us. Well, thanks, Jay. And thanks, Tom. And the Tax Foundation of Hawaii has been such a good partner to the Tax Foundation in Washington, D.C. over the years and working to advance sound tax policy in Hawaii. Like Tom said, the Tax Foundation in Washington, D.C. works on state tax policy issues in all 50 states and also federal tax policy issues. We have an economic model at the federal level. And recently, we delved into global tax issues as well. So we've been around for over 83 years now, and we work to advance sound tax policy. And so one of the ways we do that is through a tool called the State Business Tax Climate Index. It's a report we've published for almost two decades now that compares states according to the competitiveness of their tax structures. And so we have five major metrics, the five major taxes that all the states, or most of the states, levy corporate taxes, individual taxes, sales taxes, property taxes, and unemployment insurance taxes. And so I'm here today to talk more about how Hawaii stacks up compared to other states in terms of the competitiveness of its tax structure. I will note that this is primarily a study of tax structure, not of tax burdens, not of tax rates. Rates and burdens play into it a little bit more, but we also look at just the way the tax base is structured and whether or not that is economically competitive and makes the state a good environment for businesses and taxpayers. Well, let me just ask you about this tax climate and competitiveness. So are you talking about a climate to encourage business? Are you talking about a climate to encourage people to stay in that state rather than leave and go to another state where they feel the taxes are easier on them? Or are you really just simply comparing each state against all states and making a comparison about how that climate relates, compares with the average climate elsewhere. Where do you want to go on this? Is it business, is it individual, or is it just a comparison? You know, it's a little bit of both. It's more heavily weighted toward tax structure issues that would impact businesses' willingness to locate in a certain state. But the index does talk a lot about taxes that impact individuals as well. So when we first made this product and formulated the index almost 20 years ago, it was primarily about trying to compare business environments when you specifically look at tax structure. Now, there's a lot of other things that make a state good or bad for business, things like infrastructure and workforce and, you know, even the climate, the geographic climate, all kinds of other things can help make a state a good place for business or maybe struggle a little bit more for business. But this is specifically looking at the tax code. And if all other things were equal, would the tax code in a state make the state business friendly or would it not? Suppose I had a state with zero taxes, would they be at the very top of the list? If it had no taxes at all, I don't know how they'd operate any kind of government, but states do, I think, to answer your underlying question there, if a state doesn't have one of the major taxes, like no income tax, that state will be number one on that component of the index. So like I said, there's five major components. So if you don't have an individual income tax, you tie for first place on that component or if you don't have a sales tax, you tie for first place on that component. But then tax policy is all about trade-offs, right? So usually, if you don't have an income tax, you rely more on sales and property taxes. So you might not score as high on those components, but your overall score will still be more competitive because you're not relying on that. For example, in the individual income tax category, Alaska and Florida, are they tied at number one? Because of course, they don't have individual income taxes. New Hampshire is number one in sales tax because they don't have a sales tax. We are significant because we have broken into the bottom 10. We are 41st out of 50, we have for several years kind of hovered around the 20s and 30s. But this year, we kind of really made it to the bottom. And then Catherine's going to help tell us how we got there and why. Yeah, the bottom means we're in the 10 worst, I want to be clear. We're in the 10 worst in terms of the competitiveness of our tax structure and why. How did we achieve this remarkable distinction? Well, yep, you do currently rank 41st overall, and that has dropped slightly from last year. Last year, you were 39th overall. And one of the major driving factors for that is because on individual income taxes, you're actually in the bottom five. As you know, you have the second highest top marginal individual income tax rate in the nation of 11% after only California at 13.3%. And in Hawaii though, that 11% top rate kicks in at only $200,000 of taxable income for a single person and $400,000 for a married couple. And so that kick in is lower than in any other state. So you have very high income taxes. The brackets are an index for inflation. So in a year like this, where we've seen more inflation than we have in 40 years, you might fall into a higher bracket and you might not normally get hit by that top 11% rate, but this year you might because your nominal wages could have grown, but your actual purchasing power might not have grown along with it. So that's one of the things we'd really recommend Hawaii look at changing. But ideally, yeah, it is that individual tax component where the state struggles the most. You're kind of more in the middle of the pack on the other components like corporate income taxes and sales taxes, property, not quite as bad there. But one of the reasons you've dropped a little bit is because other states have gotten a lot more competitive. Last year alone, we saw 16 states either enact or implement individual income tax cuts. Whereas I know Hawaii had been talking about the idea of an increase, but really only two states, well, New York and DC were the only ones to enact individual income tax rate increases last year. And so the trend is toward more competitiveness and Hawaii by staying still has kind of fallen. And then you did see your unemployment insurance tax rates rise a little bit last year. Now I know they were scheduled to rise more. They would have gone all the way to schedule H, which is the highest they could possibly be. Legislature froze that at a slightly elevated level but prevented major tax increases, which is good, but they still went up. So that's one of the things that hurt you on the unemployment insurance tax component and then hurt you overall. How should we feel about this, Heather? I think just a sense of urgency that other states are trying to get more competitive. Hawaii had some unique challenges just being not in the mainland. So you don't have quite the same situation as a lot of other states and you have kind of unique hurdles to get over. And so I think using that as even more reason to say, look, people are going to be less likely to come here and more and more people might leave if we don't make it more of a taxpayer friendly place. I know a lot of people feel like they have been priced out of living in Hawaii and they've had to find other places to live and work because it's just not affordable anymore. And I know that's not what the state wants. And obviously you depend quite a bit on your tourism sector. So finding ways to support those businesses who have struggled over the past couple of years with the pandemic and the drops in tourism. I think just anything you can do to make your tax code more friendly so that when things kind of get back to normal, you won't be making things harder than they need to be for businesses as individuals. One of the things that has been notable is that the census has not been our friend. We have seen people kind of flock to the exits where that's not true for most of the mainland U.S. We're losing people. We're losing the tax base. And in order to maintain the same cost of government that's more per person because the base is small. It's an odd irony that you lose people and then you keep on pushing the taxes up, making it more unfriendly still and then you lose more people. It's a spiral, isn't it? Very vicious. We've seen in the states that raise their top rates, that's the states we see the most out migration from. Whereas in the states that have no individual income tax or have low flat individual income taxes, they've become a lot more likely to see waves of people moving in. States like Florida and Texas and Tennessee that now doesn't have an individual income tax have really benefited from that and people have been moving there. It's just getting more and more difficult for people to live in states where income tax burdens are so astronomically high. With us, it's not just a tax. We have limited land and therefore the cost of occupancy is higher than most places, almost as high as New York, although New York I think has the highest cost of occupancy anywhere. So the tax also, in my view, you can correct me, falls second to the cost of occupancy and the cost of living. It takes more to buy a loaf of bread and so forth. So the price of living in paradise taxes only one of the elements that is forcing people to leave. Comments? That's absolutely right. We're seeing high levels of inflation, high costs of goods and services as it is. So that's a major component. Cost of living in places like Hawaii is very high and some of that is difficult to get around because of your unique situation, but the tax code is making it worse. And even just simple things like failure to inflation index your brackets and standard deduction and personal exemption. That's pushing people into higher rates just because of inflation and those values of the standard deduction and personal exemption have been eroded over time because they don't increase from year to year with inflation. They stay the same. So people are getting less and less benefit and that's really an unlegislated tax increase that's happening and people often don't realize it, but it's definitely something that the state could work toward fixing in order to make the state a little more business and taxpayer friendly. One other thing is that you mentioned en passant, you mentioned about COVID and COVID has undoubtedly had, COVID has had an effect on everything, everything. So the question is what effect does COVID have on this competition among states on the mainland? What effect does it have here in terms of the tax burden and the drivers that drive people away? One of the really neat things right now is that people are working remotely and a lot of jobs are going to be permanently hybrid or permanently flexible and I know a lot of people would love to move to Hawaii, take their New York City-based job and move to paradise. That sounds so appealing and I know a lot of people would try to do that if they could, but if there are barriers in place that are keeping people from being able to live where they want to, related to the tax code or things like that, it's not going to be something they're able to do. If they say, oh, you know what, I wouldn't get as much bang for my buck, I'd be subject to a lot higher tax rates as much as I'd like to do that, it's just not feasible. And so I think states like Hawaii have a really good opportunity to attract more residents to try to reverse the net out migration problem and just to try to spur more entrepreneurship, but unless some things change, it's going to be more difficult. You know, Tom, you follow this in great detail here and I wonder if I could ask you, is there any real chance that Hawaii in this session is going to ease up on these tax burdens? You might as well talk in front of Catherine, she needs to know because she's going to have to evaluate this next year as well. Well, one I think bad habit that our legislators have is rather than, you know, look at broad based tax relief, they look at targeted tax credits. And so there's a mountain of proposals in our current legislature to give tax credits to this, tax credits to that, cesspool conversion, feminine hygiene products, food, you name it, there's a proposed reduction or credit that corresponds to it. On the opposite end, we have the Department of Taxation trying to clamp down everything. They proposed legislation to say, well, if you're going to enact a tax expenditure of any kind, the legislation needs to have a full blown economic analysis, which most of these things don't have and will never have. And at the same time, they are proposing to jack up the tax penalties to confiscatory levels even worse than we have now. So we're hoping that due to the upcoming elections or otherwise, people will have some sense of realism and they'll shy away from the stuff that's really terrible and there's a lot of it. So hopefully we can get... Catherine, Tom's comments suggest two things I'd like to acquire with you about. One is it's not a metric, it's more of a qualitative thing, but if you get to feeling that state government is being mean, confiscatory, for example, on penalties and raising penalties to astronomical rates, rates higher than anywhere else, you get a kind of feeling about the attitude that we have. That means the legislature, the tax office, governor, whoever is involved. I know that's a qualitative rather than quantitative thing, but does that play into how well a state performs under your kind of analysis? Because frankly, if I were in Tennessee and I saw this sort of thing happen, I said, were they crazy? The tripling the penalties, this is not a friendly state. They want to send me away. They're creating barriers and shedding this nastiness. Why would I subject myself to that? How does this affect the competition? That's a really good point, Jay. And I think that definitely plays into taxpayer sense of whether their office of taxation, their department of revenue is looking out for their best interests and playing fair and being reasonable. And while that's not a factor on our index, it's certainly a factor in how people view the government and how they view the state and those in leadership there. And so I think we're seeing a lot of good measures have been taken over the past couple years to provide leniency to taxpayers, given all that's happened with the pandemic. And that's reasonable to just make some of those temporary changes to provide a little more relief and make life a little bit easier at a time when life is pretty hard for most people. It's something states to all work toward is making their administration more efficient, making it less of a burden for taxpayers. One little piece of goodwill goes such a long way, really. If you see the state doing something kind and gentle and understanding and sympathetic to your plight, and these days people have lots of plights, you feel really good about it, even if it doesn't cost them that much, even if it's just a statement of caring. I think we've lost that. Hawaii has lost that, as Tom said, and other states probably too. The other thing I was going to ask that came out of Tom's points is tax credits. I'm kind of on a permanent concern about tax credits to incentivize critical industries. And in this case, for Hawaii, we have very limited number of sectors that drive the economy. One of the sectors they've been talking about since state is trying to create a technology sector. Every governor talks about it, and so many people in the legislature talk about it. But nothing really happens. We had a tax credit for tech investment back for about 10 years in 2010, and it sunsetted early. They killed it. I personally believe that when you have a targeted tax credit towards something that builds the economy, you're actually creating a greater tax base, and therefore that should be a positive. How does the tax foundation feel about that? Yeah, that's a really interesting point you bring up, and we actually have a study that looks at exactly what you're saying. It's called Location Matters, and it basically takes eight different model firms across eight different industries and plants them in different states and shows about the effective tax rate they would have in each state. And so you can see that some industries are very heavily incentivized and have negative effective tax rates because Hawaii's really trying to lure them with credits. Meanwhile, your manufacturing sector is hit the hardest, and you unfortunately have the worst environment for labor intensive manufacturers. Capital intensive manufacturers really struggle there because of the underlying tax code, because of things like sales taxes, the general excise tax applies to machinery and equipment and office furniture, all kinds of things. And so more than incentives, a much better incentive to do business in Hawaii would be to just have a tax code that doesn't penalize some businesses so much more than others and having a good broad base, a base that makes sense and lower rates, and just a more reasonable environment. So no matter if you're a tech startup or a manufacturer or a data center, that you have a good chance to succeed in Hawaii. One last point on that though, Catherine, is now you're looking at all 50 states, and you see them compete on this, whatever they do to be kinder, gentler, and more caring concern about business and individual quality of life. So if I have a state which is that way, which is kinder and gentler, does it work? Does it work? Does it really incentivize people to come to that state? Does it really incentivize businesses to move and invest into that state? Do you have a handle on that? Do you have a metric on whether it really works? You know, we see immigration into states with competitive tax codes. Every year, the states that perform well on our index are states that enjoy plenty of new residents, new business startups. We see GDP growth in those states. And so having a competitive underlying tax code is one of the best things a state can do to say that we are welcoming to businesses. We want people here. We want entrepreneurship and we want, you know, to better the quality of life here and the standard of living for everyone. And so there are simple things the state can do. Little structural provisions we point out in the index that are working against the state. For instance, Hawaii has a really complex but really uncompetitive corporate tax provision called the throwback rule, which basically says if another state doesn't have jurisdiction to tax a corporation's income, they'll throw it back into the Hawaii corporate tax base and, you know, capture more taxes from them or things like the sales tax applying to every business input pretty much under the sun. That really makes it difficult for businesses that rely heavily and that have on inputs and that have low profit margins. So there are reasonable things that the state could do to level the playing field and make the code more neutral. And that would really, I think, make investment in Hawaii continue to grow and state would see growth over time. Yeah, Tom, you've got to get Catherine in front of the legislature and she can do that by Zoom. I'm sorry, you can't come out here. It's just not feasible, but you could talk to them. Well, that and the legislature just closed anyway to the public. Yeah, there's no point. But maybe you could talk to them by Zoom and give them some hints on this because I think this is really critical. I mean, Tom and I were talking before about how the state is like throwing away money right now in so many projects that are not worthy. They really got to straighten that out and find a way to be more amenable to bring competitive businesses out here even in the time of COVID. So would it help, for example, is somebody like Catherine testified, Tom? Oh, I'm sure it would. We got to find a good measure for her to testify on and hopefully her schedule can allow for that. I would love to do that. Yeah, that would be important. Can you just so that people can see the perspective here? Can you name the bottom 10, the ones where Hawaii is at, and the top 10, the ones who have successfully created kinder and gentler tax codes? Yeah, the top 10 and bottom 10 states on the index. Is that what you're asking? Yeah. Yeah, so the top 10 are states like, let's see, I don't have a list in front of me right the second, but I think Wyoming, South Dakota, Alaska, Florida, Montana, New Hampshire, Nevada, Tennessee, Indiana, and Utah. And the 10 bottom are in order of nastiness, Hawaii, Louisiana, Vermont, Arkansas, Minnesota, Maryland, Connecticut, California, New York, and less New Jersey. Thank you, Tom. Well, let me ask you an overarching question because right now it seems to me that a lot of the fundamental principles of our country are in discussion and may change in political or social transformation. Do you think the federal, in a perfect world, Catherine, do you think the federal government could step in and even the score? Could the federal government have an effect on all of this and do things to avoid the disparity? That's a really interesting question. I think it's rightly up to states in our system of federalism to design the state government that they want and to have little experiments in governing and that fosters competition. And I think overall, we don't want a uniform system with a lot of mandates coming down from the federal government. But I will say the federal government provided states tons of money in the American Rescue Pan Act, the CARES Act, other federal aid. And so it's really up to states to use that money wisely and to use that in ways that will benefit states for the long term. One way Hawaii could use it would be to replenish the unemployment compensation trust fund to try to save off further UI tax increases in 2023. There are things states should do to use what the federal government has done to make their environment more pro-growth and better. And I think we see a lot of states kind of trying to throw up their hands and not knowing what to do with this money. And it's really important that states use it wisely. It's not always going to be there. And we're not always going to be in this place where there's a huge federal handout. So I think it's important for states to take that and make it work to their benefit. You know, as we go down the path here, the federal government collects more taxes relative to the entire national tax burden. And the states seems to me collect less taxes, less a portion of the pie. So then the federal government winds up giving all this money back to the states, you know, hundreds of millions, billions back to the states. And then it falls on the states to distribute that money. It's sort of like, you know, the federal government is collecting it for you and then returning it to you so you can distribute it just as if you had collected it in the first place. But the problem is that some states don't do a good job at distributing it. You know, Tom and I have talked about this in the past. So you get hundreds of millions of dollars and you leave it on the shelf. You don't spend it at all. You spend it on the wrong things. You spend it slowly. You know, you have a bad tax policy and you're distributing a lot of money that comes from the Fed or you're not distributing at all. And therefore, you know, subverting a Fed policy on that. So my question is, can you, should you, will you include a metric in this examination about how well a given state does in distributing federal funds? You know, that's something we have looked at and analyzed in different blog posts that we've written on our website. So you can go to taxfoundation.org to talk about or to see how we recommend states use that money. One of the top being to replenish unemployment trust funds and pay out current benefits because those are allowable uses that will prevent future tax increases. But the index is mostly something that wants, is tries to be consistent from year to year. And so we do try to keep it on basic structural things that states will either do well or poorly from year to year. And so we don't change it for any given situation necessarily. You know, we update it as the landscape changes. For instance, when the wayfarer decision came down on remote sales taxes, we updated the index to account for that and for how states handle that. And this year, I think it was convenience rules. One of the uncompetitive tax provisions some states have that is making things especially bad during the pandemic. But overall, it's supposed to be kind of a consistent metric. So you can see how you've gotten better or worse from year to year. Okay, there's a viewer question that came in. And the viewer question is, why does Hawaii choose not to be competitive? Let me kind of react to that first and then maybe the two of you can jump in. I don't think it's so much a choice not to be competitive. But I think we care about other things. And we don't care so much about the competitiveness of business so much as we care about paying for this thing or that thing, this program or that program, and we're horrible at it. As evidenced by maintenance backlogs at several of our schools, our university system, our other state facilities, our airport has drawn lots of criticism. We in this space talked a couple of weeks ago about pots of money that the federal government has made available to us as a state that we've just left on the shelf. This was a big problem also about five or six years ago with transportation funding, you know, Clean Water Act funding and other things. And also with the Department of Education not spending the effort to pull in special education monies that are available. We've got a lot of things going on where we're just not using the money we have properly and legislators are trying to keep up with that as opposed to, choosing to be uncompetitive. Yeah, maybe it's just they're just not aware of the issue and not focusing on the issue. Well, we're about done out of time, Catherine, but I just want to distill something that I think I've learned from this discussion. And that is unless our legislature and unless our state government take some steps to make us friendlier, your next report looking to next year will move us further down on the chart because other states are doing better. And so if we don't pay attention, we're going to be less competitive and lower on the scale. Am I right? That's right, Jay. Yep. We expect to see more states enact new income tax cuts this year. And I also know that the unemployment insurance tax increase that's pending for 2023 is a big threat in Hawaii. And if nothing is done, that would probably reduce your rankings even further, just as more states are trying to get more competitive. So I don't want to see Hawaii drop any further. But unless something is done this year, I wouldn't be surprised if that does happen. Thank you, Catherine. Time is up to you to summarize, close, and provide an effusive thanks to Catherine. We would like to thank Catherine and the Tax Foundation for all the work that they do in monitoring the tax climate in not only here, but all of the 50 states. Catherine has had the good fortune of being assigned to Hawaii among her portfolio of states. And we really thank her for appearing on Think Tech Hawaii today on the Talking Tax Show to share her wisdom and that of her organization. Well, thank you, Tom. And thank you, Jay. It's been great to be with you. Thank you, Catherine. Thank you, Tom. Aloha.