 Welcome back to Think Tech. We're doing talking tax with Tom Yumajika this morning here on the 11th day of March, 2021. There's the year advances and the legislature also advances. Welcome to the show, Tom, nice to see your smile and face. Thank you, Jay, it's great to be back. Well, talk about smiles, you know. There are some tricks. I'm just sort of setting the stage for you, Tom. There are tricks and traps in the tax world. And one has to be careful because sometimes things are not exactly as they seem to be. And there's some tax laws that have discontinuities. Got to watch out for that. Or clips that have, you know, $1 more in income value or whatever is taxed, part of the formula, but it results in hundreds of thousands of the tax increase for the public. We should look at that. We should look at the net income tax proposed by the Senate Bill 56 and the income tax as it now exists and a real chakaroo increases in the conveyance tax. You know, they're coming in the windows, Tom. Can we talk about some of these tricks? Sure, what I thought we'd talk about today is a number of these, all of which are included in what I call the Enola Gay Bill, which we were talking about last time, Senate Bill 56. Why in the world would it be called Enola Gay? Wasn't that the bomber that dropped the atomic bomb? On Hiroshima, yes, it was. That's exactly why I call it that. Because if that bill unleashes its payload, we're all in trouble. Okay. Okay, because we have all kinds of things. We have an income tax hike. We have a corporate income tax hike. We have a capital gains tax hike. We have a suspension of general excise tax exemptions for a couple of years, and we have increases in the conveyance tax. Oh my God, OMG. Now, and the reason why I bring up cliffhangers, cliffhangers sounds like a very interesting catty title. That's kind of why I picked it, but there actually are cliffhangers in the tax world. And let me tell you what these are and where we find them. Tax cliffs happen when if you make a dollar more in tax where you have a dollar more in income or a dollar more of whatever the tax law is catching, and then the tax jumps, not one dollar, not two, maybe a hundred, maybe a thousand dollars, that's when you have a tax cliff. And the higher the cliff, the more people want to tiptoe around it. And so that creates an atmosphere when the economic transaction is not really real because they're kind of motivated by people tiptoeing away from the tax cliff. Especially if they know about it. One implication of a cliffhanger, I think it goes back to the movies, early, early movies, where they wanted to keep your attention so they had somebody hanging on a cliff and everybody wanted to know what happened. Did he fall or did he get hurt? What happened? And so it's the same thing here. Like sometimes we do breaks in our shows. We like to leave them with a cliffhanger so they don't go away. Well, nobody's going away on this. They all want to know, Tom. Well, let's take a look at a typical cliffhanger and I'll show you what I mean. Okay. Let me start by kind of contrasting the kinds of tax systems we have now. Okay. General excise tax, that's pretty simple. It's 4%, right? If the sale price goes up or the transaction price goes up, it's 4% of whatever it is. The Connie surcharge is half a percent. Then you add a little bit to make up for the fact that if you add the tax to the bill, that gets taxed too. So here in Honolulu, we add 4.712 but it's still a linear function. Yes, but we ought to mention though that over the years, the Hawaii gross excise tax has become plenary. It's on everything. And although from time to time there have been bills that would excuse it from certain purchases, that hasn't really happened. So it attaches to everything. I don't think there's any place in the country where a sales tax is on everything, am I right? Yes, we have the broadest tax base in the country, bar none. So when you have in New York, you have a pretty high rate, I don't know, 7%, 8% but it's not on everything. So the net effect is- Right, typically in sales tax states, you'll have the sales tax fall on the prices of goods. Not so much services, but tangible goods. You go to the supermarket, you go to the drug store, that's where they're imposed. And it's really too bad because it becomes even more regressive. If I need to buy drugs, I gotta pay a tax on that. In so many other states, it's exempt. Should be exempt here. Well, prescription drugs are exempt here. The non-prescription drugs are taxable. Okay, got it. Okay, but the GE tax is basically linear function. So the more transaction prices, you know how much more tax you're getting. And that doesn't vary. The income tax as currently structured is the same way. The income tax is different brackets, but the tax in bracket number two starts where the tax on bracket number one left off. So you have like a line and then a steeper line, then a steeper line, and then a steeper line, but they all connect. So under the income tax system as it's constituted now, you get no discontinuities, you see. Every time you make one more dollar in income, you have a little bit more in tax, not more than dollar in tax when you increase income by one. So that's kind of progressive, isn't it? Because you're taxing people in higher income and higher rate. Yeah, that's exactly how you define, that's how you define progressive. Progressive is where you tax the people who can pay it more heavily than the people who can't. The only tax we have that is progressive is the income tax or the income-based taxes. We have the income tax and the bank franchise tax, which are both based on their income. And it's more progressive the way we have it than if you simply attach a percentage and you let that fly at any rate of income. That wouldn't be as progressive as if you had what we have. Right, that's exactly right. And that's why Hawaii is known to have a regressive tax system. And the reason why is because we depend on our GET so much. The GET produces roughly half of our general fund revenue and it doesn't discriminate against high earners or lower earners, it's just based on the price you pay. So that is considered to be regressive because it bites people more. Effectively it does discriminate against low wage earners. If you don't have money, you pay the same rate of tax as the guy who has lots of money. Yeah, that's the complaint about a regressive tax system like the one we have, okay. But then you have even more anomalies where the end points don't connect. And let me show you one example. Let's put on a slide that I made for conveyance tax. So if we can have the slide, please, there it is. You can see in this chart over here and it's kind of squished down for a reason because I'm gonna show you what it's being proposed to become in the Enoligay bill next. But we're not there yet. But what this is, it shows the conveyance tax we have now and you see that at certain break points, I think it's 600,000, 1 million, 2 million, 4 million, 6 million, then 10 million, the next bracket kicks in. Okay, but when the brackets kick in, they don't start where the other one left off. Okay, because the way that the conveyance tax structure is like let's say you start off with the first million being, one bracket is the first million and you have your tax rate at 0.1%. Okay, so the first million is taxed to 0.1%. And then when you pass 1 million and get to the next bracket from one to two, the tax is 0.2%. But the tax is 0.2% on everything, including the first million. So whereas before you were taxing the million at 0.1%, now you're taxing it at 0.2%. So that gives you a discontinuity in the way the tax is applied. So you look at the next dollar between a million and a million, one, right? And the difference is 0.1% on the million dollars, which I think is what, $100? Yeah. Okay, so $1 more in consideration, $100 more in tax. Now that doesn't sound so bad. Okay, so let's bring up that first chart again. Okay, and let's contrast it with something. The second chart I'm gonna bring up is the same conveyance tax, but as proposed by the Enola Gay Bill in its current form. So let's go to slide two. Okay, a couple of thoughts now. Number one is, yes, it's not that much money if you have a property that's within, that's a middle-class property, can't put it that way. But I think it's worth mentioning that when you and I started practicing back when it was peanuts, the conveyance tax was really peanuts. And it was intended, I think originally, and the effect that it was to pay the administrative costs of the Bureau of Conveyances or the stick tax office in making a record of the transaction. It was not intended to raise revenue. But then somewhere along the way, you probably know better than me, there was this dramatic leap in the rate of tax. But all of a sudden, it was no longer intended to simply pay the expenses of the transfer. Now it was a real tax. You remember that? Well, we're talking about a dramatic leap again. You're right in that the conveyance tax started off not as a means of raising money, but as a means of getting people to write down how much they were paying in transactions. So the real property tax office, which at that time was controlled by the state, this was like a long, long time ago, when the state did have the property tax, okay? And you see a conveyance tax stamp, maybe it's still this way, a conveyance tax stamp on the document that was being recorded. And you can take the conveyance tax and reverse the math and figure out what the purchase price was by looking at the conveyance tax stamp. Is that still the case? Actually, no, the conveyance tax stamps are not put on the document anymore. It's just the recordation information. So... Interesting, interesting. Sometimes you really can't tell what they paid for it. Yeah, it's public records. So sites like Zillow and other real estate sites can figure out how much was paid for the transaction. You can't find it from the document itself. But it's not stated on the document itself. Yeah, yeah. Okay, so let's go back to our graph. This is, let's go back to graph number one and contrast with graph number two. Now in graph number two, as you can see, the lines have gone up quite a bit. And that's because they're proposing four times the conveyance tax on the highest bracket, which is on $10 million or more. So instead of $1.25, which is per $100 of consideration, which it is now, it would go to $5 or 5%. Now, when you contrast that with the previous bracket, the previous bracket is like 375 or something like that. And you get to the point between $10 million and $10 million one. You have a huge difference, let's go to slide two. The difference there is, what is it, $100,000 or more? It's a big jump. It's a very big jump. And that's really where we're going to have all kinds of interesting consequences. As you said before, the new rate after the jump applies to the entire value. Same way as in the first chart. That's right, the same way as in the first chart. It's a really deep breathing exercise all of a sudden. Now you have a higher rate, all of the value of the property. And it's much more revenue for the state. Yeah, and you'll notice that the, in the last bracket, you're not only talking about applying the $5 tax rate to the, let's go to the previous chart, please. You're not talking only about applying the $5 tax rate to the, what's over $10 million. But you apply it to all the brackets before. So you apply the $5 to the first million, the second million, the fourth and fifth million, the sixth through tenth million. You apply it to all of that. That's why you have this huge jump at the end. Is that why you call it the Enola Gay tax? That's one reason. There's more. And P.S., if you didn't know, Enola Gay was the U.S. bomber that bombed her eschema with the atomic bomb. So this is a sort of nuclear tax increase. They were going to apply it to income tax as well. And let me show that to you. The third chart, let's bring that up right now. This is the proposed income tax in the previous version of the bill, in Senate Bill 56 as it was originally introduced. It was designed to phase out the effects of the higher, higher of the lower brackets when you get to somebody in the higher bracket. So for example, you have somebody in the 11% bracket. Previously, because the dots all connected, they were getting the benefits of the lower brackets for the income that they made, the lower amounts of income that they made. And then you can still see that in the chart on the very left side, because they didn't mess with those brackets. So up to like about maybe 50 or 60,000, you see that all the lines connect. That's the same as it is under the current income tax, all the lines connect. But once you reach that break point, then they started to twist the lines a little bit so that the effects of the lower brackets would be phased out in the higher income taxpayers. At least that's what they're trying to do. And they didn't do that good a job. So you still had discontinuities in the income tax. The tax in the second bracket, for example, does not apply to the income in the first bracket, right? The income in the first bracket is paying at the original rate, not at the increased rate. Right, at least that's for the first few brackets. But for the later ones, they started to kind of go back on that. Such that the highest bracket was a 13% bracket, and it would have applied to everything. So I remember reading recently that our existing marginal rate income tax in Hawaii is like 11%. And the new rates under the bills that have been introduced is more like 15% or 16%, am I right? Yeah, the current version of Senate Bill 56 basically has all the dots connected. But once you hit 200,000 for individual and 400,000 for married filing joint, it takes off. Because the rate goes from 11% to 16%. You know, I remember that Hawaii income tax rates were among the highest in the nation before at 11%. That's right. Now, if we go up to 16%, we're going to be significantly higher than that higher maybe than any other state, am I right? Well, that's definitely true. Right now, the top is California with 13.3. And their highest tax bracket only kicks in for, then it can come over a million. And they even don't phrase it in terms of, they say, well, the top rate is 12.3, but then they have some kind of surcharge of 1% that kicks in at a million dollars. But we all know what that means. We can do the math. So just take a look at the capital gain rate that is within the income tax. So you have a capital gain tax on the sale of that same property you were talking about a minute ago. And effectively, you have an increase in the rate that is charged. That's a capital gain tax for income resulting from the sale of capital asset, like property. And the other hand, you also have a significant increase in the conveyance tax, right? Which is also taxing the gross value of the property being transferred. So somebody who's selling property gets an increase both ways, though. That's true. So you really have to watch out for the double whammy in this respect, because that is going to happen. Now, the good news is that the Senate Bill 56 is still a bill. It's not law yet. It still has quite a ways to go before becoming law and has to go through the House. And in the House, everybody's up for election every other year. So it's much more accountable to the people, I think, than the Senate is, because you only have half the senators up for reelection every two years. They have four-year terms. So the House will all be up for reelection next year, 2022. That's correct. So they should be concerned, because taxpayers do not like, you can quote me on this, tax players do not like tax increases. You get that right? I think you got that right. One of the truisms in the tax world. I mean, maybe you'll find the occasional person who considers it their patriotic duty to give taxes to the government. That's always a way to do that. Yeah. And then some people think they're not paying enough. I think Warren Buffett said that once. This is going to, if these things get adopted, they get adopted by the legislature to sign into law, we are going to be really, really high among the states. And as a matter of policy, we'll be number one. Number one. Great to be number one in something. But you know, as a matter of policy, of course, we have to pay our debts and we have to keep on providing government services and the like and supporting all those government union members that are in there that need. But you know, the bottom line is if I'm a young person, graduating school, looking around for my career, my future, my house and car and wife and child and what have you. And I make a comparison. Hawaii is not farewell on the comparison. And I may vote with my feet. Yeah. You may go with the farewell route. The farewell route. A lot of people do this population. Right. You do this sort of thing at a huge social expense and an economic ultimately an economic expense. It's a short term view in the sense that if people leave and take a powder, then the tax base shrinks. Next time around, you can't raise as much money on even the same rates. Yeah. And the people who are left going to have to pay more and more because there's the same expense with, you know, a few less, you know, a few fewer shoulders to bear it. Yeah. That's Randy Roth used to call it the price of paradise and it is an increasingly burdensome. Yeah. So I think, you know, the, I mean, maybe the right solution is one that's more balanced. I mean, it's really hard in my mind to justify any kind of tax increase, you know, on business when you've got a pandemic going on because you have, you know, the businesses packing up and leaving, you know, laying off people, shuttering their stores, creating lots of, you know, vacant office space and retail space. Yeah. And this is not only a time where we don't want to put a burden on existing businesses or businesses that are teetottering. We want to use the tax law as a way to incentivize new business. You know, when in other states you find they give tax credits, they give tax holidays to say, if you come to our state and open your doors here, we'll give you a tax holiday of a year or two. You don't have to pay any taxes. In that way, they hope to attract new businesses to the state. Right. And here's the rub. Okay. 75% of all businesses are not corporate. Okay. They're conducted in LLC form partnership form. Forms in which the tax of the business is not paid at a corporate rate. It's paid by the individuals who own it at the individual rate. So if you are going to tax individuals, you are taxing these businesses as well. So 75% of the businesses. Now, it's no accident that the second most productive tax that we have in our arsenal here behind the GT is the individual income tax. Okay. The state GT produces what? Three and a half billion dollars state individual income tax produces two and a half billion. And then everything else combined is maybe another two to two and a half billion. Everything else combined. So that's that's how big it is property tax. Oh, no, that's that's at the county level. So, so the counties do their own thing. Well, I take your point about the fact is in Hawaii, most businesses are individual businesses. People don't incorporate. They don't create LLCs and all that. Even if they do create LLCs. It's a pass. If it's a pass through for tax purposes, the tax on the business is paid by the individuals. Yeah, thank you. But, but you know what? It's, it's the thing about the mom and pops. You know, if you want to rebuild the economy or build it as in Hawaii, you know, the whole experience has been mom and pops, small businesses of millions in small businesses, and they grow and they combine and they consolidate. And all of a sudden you have medium sized businesses and so forth. If you wanted to incentivize or re incentivize, you know, an economy, you would start there small, encourage people, young people to start small businesses. And if you have a tax increase, like the ones we're talking about, that is a disincentive to starting small businesses. Right. Oh yeah. And you would be surprised. There are some, you know, big to very, very big businesses that are not in corporate form. Like the large accounting firms, for example, they're all limited liability partnerships. I knew a guy who owned a downtown office building as a sole proprietor. I like that. Yeah. That's, that's done. Big law firms. I'm sure you're familiar with those. None of those are in corporate form. So where is this taking us, Tom? You know, because frankly it sounds like you haven't said, but I'd like to know your view that these, these tax bills will, at least the number of them will be passed. And we will have significantly increased taxes this year coming up probably effective the end of the year or sooner. And it's troublesome because it's a short term view and we haven't managed our money very well up to this point. And it's a sort of catch up ball game. And you know, I'm wondering where it all goes from here. How many, how many times can you raise a tax like this before you blow up the economy? You blow up the next generation. Well, I think that's, that's one reason why the legislators are taking a step back and they're trying to reorganize their schedule to at least digest the huge federal tax bill that was just signed today. So that could change things. We hope that it will. Yeah. How would it, how would it change things? Well, if there's, if there's more money to go around to help the state, then there's less reason for lawmakers to go reach into our pockets. Okay. It's a one shot bill. It's not likely that it's going to happen again and again. Yeah, but then neither is the pandemic. Well, okay. It's an infusion bill. It infuses, you know, a lot of, a lot of money to individuals one time. And, you know, I'm thinking, okay, you can make the case if you're a legislator that, that's nice, but that, that is, that is not a long term view. It is not even a multi year view. And ultimately we do have to increase taxes. So why not do it now? Well, that's if you're, that assumes you're subscribing to the view that we need this size of government in the long term. And that might not be true. I haven't seen anybody move for a smaller government. Have you? Well, you know, at one point, you know, the governor was talking about some furloughs and program cuts. I think he, I think the discussion hasn't ended yet. We've been in the pandemic for a year time. Yeah. When does he finally get around to that? Supposedly this session. Okay, we'll see. Yeah. Certainly the legislative committees have been talking about it. And there's also another wrinkle that, that has kind of come in with the federal bill. And that is the federal bill has a provision that says to the states, if you're going to accept this, this wad of money that's being made available to the states, you cannot reduce taxes. You cannot, you cannot enact incentives until the money is either spent or returned to the treasury. Okay. And this is from, I believe March 3rd, 2021. Okay. Fortunately for us, we signed our unemployment tax relief bill. The day before on March 2nd. So, so we just barely made it under the buzzer. So we can keep our unemployment tax relief. But, but if people are worried or thinking that there's a chance that the legislature will pass, like for example, there's, there's a bill to provide tax forgiveness for unemployment benefits that are presently taxed. Okay. That really can't happen. So what about my $1,400 check? Is that taxable at the end of the year? Shouldn't be. Okay. Well, that gives it a, you know, a greater luster. But let me ask you this time. This is a one shot deal. It's not likely that Joe Biden can do this on a repeated basis. He's already having trouble on everything, you know, that follows in the legislative pipeline of his initiatives. So don't kind of this happening again in a perfect world. It could happen every month, you know, and it would be a smaller amounts and sort of tune up the economy. But you have to do, you have to quote, go big, because you may not have the chance again. So here we are. That plus, you know, the stimulus money has to come from somewhere. Well, okay. You know, we've paid it. We, the taxpayers have paid that money. So it's not that it's coming back. Or we'll have to pay, pay it back somehow. We'll have to pay it back in the future. Yeah. Yeah. But here, my question. Go ahead. Yeah. I mean, it doesn't, magically, the money doesn't magically appear out of anywhere. Okay. Right. It comes from there. There are costs in paying it back. There are costs. But let me ask you this. I think I'm right to say that we're in the first year of the two year biennium cycle of the legislature, right? That's correct. And we're considering all these bills. And if we get a big infusion of money, if things look better through the council on revenues, if it looks like we may not need as much as we thought when these bills were initiated or introduced a few weeks ago, then maybe we don't pass them. But since this is the first year of the biennium, we can sort of table them. We can leave them hanging until next year, whether they were automatically in the second year of the biennium, they're automatically alive and ready to come back. And since the federal infusion is only a one year deal, or less, wouldn't it be appropriate? Put them on the table to shelve them for a year, have them come back in the second year of the biennium and start the bubble machine up all over again. You're scaring me, Jay. You're scaring me. Because yeah, that is possible. And if you're right, this is the second, this is the first year of the legislative biennium. Bills that are dead can come back to life in the second half. That's very true. Okay, we're out of time, but can you sort of somehow summarize where we are on what you call the discontinuities, the cliffs, and there's another term, the cliff hangers. Yeah, we're talking about cliff hangers today. We just need to make sure that we know that they exist and where they are. We talked about the conveyance tax. They're in the conveyance tax now, as proposed, they'll be a lot worse in terms of the amount and the number of the discontinuities. So we need to keep an eye on what's going on. Hopefully cooler heads prevail and something reasonable passes or doesn't pass. Maybe that's even better. Those are the choices. Well, thank you, Tom. Tom Yamachika, President of the Tax Foundation of Hawaii, making great contributions to the public conversation, public awareness, and to the results in the legislature. Thank you so much. Thank you for having me on the show.