 Aloha everyone and welcome to another episode of Hawaii Together on Think Tech Hawaii. I'm your host Kelea Akina, president of the Grassroot Institute. If you live in Hawaii then you know that everything is expensive here. Everything costs so very much and there are many many reasons for this but one of the reasons that residents mention most often is the high taxation rate here in the state for people who live here and many people are actually shocked when they find out how much we pay in taxes. It's often one of the reasons why Hawaii has trouble attracting and retaining certain professions and industries and that's especially difficult for us now in the aftermath of the Lahaina fires where we absolutely have taken a huge hit in terms of the personal toll of the fire and not only that the economy. So taxes is something that is all the more relevant to us today. For that reason I've gone to a gentleman on the mainland to ask for his expertise in this matter, Andrei Yushkov. He is my guest today and he covers tax policy in his role as a senior policy analyst at the Tax Foundation Center for State Tax Policy. We've done a lot of work with the Tax Foundation at least the national organization and I'm so glad that Andrei can join us today. Welcome to the program Andrei. Thank you Kaylee for having me and I would be happy to answer any questions about tax policy in Hawaii. Well Andrei my colleagues are quite impressed with you. They met you at a recent conference and said I definitely need to talk with you about our tax policy. You're in an interesting position from Washington DC. One of your jobs is to actually study the tax policies of the state of Hawaii. But first before we get started tell me how you got into this line of work. Did you just grow up as a little boy and say when I grow up I want to be a tax policy analyst. Well not quite like that but still well I was born in Russia and then I studied in many different places in Russia in Germany in the United States of America where I got my PhD from Indiana University. But well before I came to the United States I was doing some policy work. I participated in several international development projects and they were all on public financial management at the state and local level. So I was doing research policy expertise in a variety of different in several different countries and I love working with the state and local governments exploring their tax policies and I think the United States is an excellent place for that because again you have a very competitive version of federalism here so states compete among each other and they have a completely different tax regimes. So it's quite interesting for me to to be in this role and to analyze to compare different states to study best practices worst practices and make some policy recommendations to the states. Well that's a fascinating background you have your perspective from the international level to the Hawaii level as well as you study the tax systems of the different states. So let me just ask you this right at the start. What did you mean when you talked about federalism that that's a very interesting word and it's a very important word when it comes to understanding how taxes and people work in their relationship with the government. When you talked about that what did you mean. So to me as a public finance analyst federalism of course means fiscal federalism. So by fiscal federalism I mean this complex assignment of different functions to different levels of government and also horizontally. So how different states and localities structure their tax policies how they interact with federal government and also how they decide what to spend on. So it's again this complex public financial issue and in America well the system is much more competitive than for instance in Germany or in Russia because there they do have a version of corporate federation where the federal government's role is much more important in price to equalize fiscal capacity across different regions or states and in the United States it is not the case. So states actually compete for human capital they compete for physical capital money resources etc and they do it in a very expert fashion. As I understand it our constitution of the United States protects the rights of states in terms of what is meant by federalism that certain powers and only that certain powers and only those powers are delegated to the federal government and the others are actually left with the states themselves. In terms of tax policy it looks sometimes as though we've reversed that direction and in many cases it feels that the federal government is getting the lion's share of the benefit of tax policy here in the United States. But we'll move on from that and let me ask you a bit about Hawaii. You look at states across the nation how would you compare Hawaii's tax policy in a general sense to the tax policies of other states in the United States? So Hawaii of course is a little different from all other states because it is not a mainland state. Still there are some similarities and some differences between Hawaii and many other states. Of course one of the most important taxes everywhere is the individual income tax and unfortunately Hawaii is not very competitive from that front specifically because many states have recently implemented policies to lower tax rates and to improve the tax structure with respect to the individual income tax. And Hawaii right now it has one of the highest top marginal income tax rates in the country. It's actually second to to California. Andrea if I might interrupt just briefly I just want to make sure that our audience is following us. When you talk about the top marginal income tax rate with respect to our tax rates in Hawaii and the brackets that we're in could you pause for a moment and explain how that's determined. What do we mean by that? So the top marginal income tax rate applies to the last dollar of your income. So basically if you earn if you are a single individual who files a single tax return then if you earn more than $200,000 then in Hawaii actually 11% is applied to the last dollar of your income. So this is the top marginal tax rate and actually this rate the top marginal tax rate is one of the highest in the country at 11%. So again in California it's 13.3 but it applies well it doesn't well sort of it doesn't apply to to income of say $200,000. It applies to only incomes above $1 million. So again with respect to the tax bracket system in general Hawaii is less competitive than many other states because Hawaii has 12 brackets and this is quite unique and it creates of course complications and well the tax code in Hawaii is pretty complex and this is this is one of the problems that definitely needs attention. Well I often hear the complexity of our tax code from two different audiences. One audience is those who are coming to Hawaii and discovering particularly those of higher income and the other audiences those who are leaving Hawaii over the last several years we've had a large exodus of our people one of the highest rates in the nation and when we interview them one of the most common reasons they give second or third to the cost of housing is the high tax burden. Now is this something that you hear commonly across the country or is this unique to Hawaii? Absolutely and we have done some research on that and it turns out that of course when people make those relocation decisions in a high mobile economy which we have right now well they have a variety of factors right that factor. So one of these factors is of course taxes in particular income taxes also property taxes sometimes sales taxes but in general income taxes are very important and we see this recent trend that people tend to relocate to those states which do not impose income taxes at all states like Florida, Texas, Tennessee, Washington state or to those states where they do have a flat income tax and where they have pretty simple income tax systems. So I would say that of course there are many other factors that affect those systems including the cost of living in general including the cost of housing and many tears right so the tax benefits package but taxes are quite important and you see that people move away from California, from New York, from Illinois even though Illinois has a pre-competitive tax system compared to New York but they move to Florida, Texas, Tennessee and other states with simpler tax systems. Often in some of the states you mentioned the discussion of taxes the relative benefits in some states and the burdens in other states is discussion amongst those who are partisan in nature Republican versus Democrat sometimes states are called blue states or red states with respect to their tax policies or the friendliness of their policies. That discussion generally doesn't take place in a large way here in the state of Hawaii because we are predominantly of a single party yet during the last legislative session our governor Josh Green proposed a sweeping tax plan and I take my hat off to him for some of the recommendations he made. They weren't all accepted and one of those items that wasn't accepted was quite revolutionary for Hawaii and that would be to have indexed states' tax brackets personal exemption and standard deduction to changes in inflation. That may be a best practice in some states but it's just unheard of here. Our legislature was not in favor of that. What would be the pros you'd say of that? What would be the benefits to Hawaii of inflation indexing and tell me whether there are some other states that have experienced benefits from doing that? Yes absolutely this is a very important recent trend as well so many states now well states that do have do impose taxes on wage income most of them now index different tax provisions including tax brackets the standard deduction personal exemption index them for inflation and this has a reason behind that because what you want to prevent in this case you want to prevent unlegislated changes and unlegislated tax increases for those people right so I did some simple analysis for Hawaii I did some tax simulation for our discussion today and it turns out that well the median household income is quite it remained pretty constant over the last five years right so from 2016 to 2021 in nominal terms the median household income increased from $72,000 to about $82,000 in real terms right in inflation adjusted terms it was pretty costly so of course well working families working individuals they increased they had those raises say color adjustments right so their wage was adjusted for inflation but as a result they experienced now higher effective tax rates so at the median again working family of two they now well say inflation 21 they paid $700 more in state income taxes than they did in 2016 so it's quite a significant change right because there were no legislated changes in those tax schedules in those tax brackets in the standard deduction or personal exemption right but still they do have to pay more now than they did five or seven years ago so this is one reason why we encourage states to index tax brackets as well as the standard deduction personal exemption for inflation because in this situation can be harmful situation can be prevented what is the trend among states how many have started to index according to inflation so right now again it's important to understand that 11 states they have a flat income tax rate right so they have well a single tax rate and it is a very simple tax system that kicks and nine states do not tax wage income at all among other states 14 states do have well two index either tax brackets or tax brackets and standard deductions for personal exemptions for inflation and you see that in total it's already 34 states and in that case Hawaii is very far behind most of those states and again states that have a flat income tax system they do not have to index tax brackets for inflation because they technically do not have tax breaks right they apply a single tax rate to all in right or most most well I certainly I certainly hope the awareness in our Hawaii population of growing inflation particularly for housing and for food actually for everything that matter I hope that that growing awareness will make people all the more open to the idea of indexing for inflation but at the same time there are some criticisms that have been raised to this and as I mentioned before the governor's bold proposal did not pass well what is your response to some of the critics who feel that this would not be a good move for Hawaii well I believe this move does not have many cons of course if your GDP is not growing right if your personal income in the state is not growing then adjusting those tax brackets for inflation will lead to lower tax revenues but of course tax revenues need to be a function of economic growth right as your economy grows and you can expect to to benefit from it as a state in that case I mean if your economy is growing if personal income is growing and if that is your target then adjusting for inflation will not well complicate the the system right so your revenues will still stay constant or will even slightly increase as a result so I guess the focus here should be on improving the prospects of economic growth by maybe lowering some taxes including the immediate tax and then thinking about inflation indexing because because it will help working panelists and many other families in that case as well but then I mean tax revenues can steal the relative profit even to adjust for inflation well Andre I couldn't agree with you more it just does not make sense to punish people for not earning the money they need to earn in order to get government more tax dollars what we really need to focus on is stimulating the economy we need economic growth we need higher revenues those higher revenues will logically produce higher tax returns for the government and that should be the aim of all of us instead of working counter productively toward that now let's talk a little bit about the impact of federal tax policy on Hawaii there's a term that is used frequently that I would appreciate you explaining to our audience called full expensing and how how in the world does that work in Hawaii so full expensing again now we talk about corporate taxes right so we are very much in paper of full expensing because when a particular term invests in well physical capital it proves it's well capital something to produce their goods and services right in the current system well again the current system has changed with the tax cuts and jobs act this act of 2017 and allowed full expensing right and some states conform with the federal legislation in that in that respect but unfortunately the tax cuts and jobs act and unless some of these provisions are extended by Congress it will phase out in 2025 it actually hasn't really started phasing out and in this case we actually recommend the states to well to make full expensing permanent at the state level and this would allow companies that invest in technologies right invest in new machinery equipment to deduct those capital expenditures from their tax base full rate and this is quite important for businesses for companies in particular manufacturers Andre if Hawaii as a state adopted full expensing regardless of what the federal government does what benefit would it bring to our economy and to the businesses if we did again that's a great question again we expect that it will incentivize investment and investment as we know all economists know that investment is one of the primary drivers of economic growth so if you have a way to incentivize investment to incentivize investment in manufacturing then of course you can expect your future economic growth to excel so this would be one very important benefit of this particular provision one of the laws that was passed most recently in the recent legislative session had to do with allowing businesses in the state to lower their federal taxes by getting around state and local tax caps or deduction caps as we refer to them could you explain a little bit about this and in particular how that work around has benefited other states and how it might benefit Hawaii right so first of all I would like to advertise the Grasswood Institute because John Helton has a very nice piece about well this specific salt cap work around in Hawaii and those recent changes so I encourage everybody interested in tax policy in Hawaii to read his piece on that but in general the salt cap well is a very important federal provision right so people usually when they file their federal tax returns they have an option whether to use the standard deduction or to itemize their deduction right and typically when they itemize their deductions one of those itemized deductions is the state and local tax deduction so people who pay a lot in state and local taxes they can deduct a particular amount of money from their federal tax base right from their adjusted crossing the tax cuts and job tax again kept these salt deductions at $10,000 so this was an important change but the IRS nowadays it allows those states that have high state taxes to implement those work grounds and Hawaii was one of the states that implemented that so it is important for not for all business but specifically for past through entities right so past through entities including as corporations partnerships they definitely benefit from this work ground because they now need to pay less in federal taxes however we believe that this is well this violates the principle of neutrality unfortunately because it doesn't treat everybody as equals right it creates these preferential treatments for past through entities and it doesn't create the same preferential treatment for wage employees right wage earners and C corporation so again it may be beneficial for a subset of individuals but you need to understand who is included in this subset of individuals right and usually when we talk about itemizers well people for itemize those are people who earn relatively high weight or business income as well so this work around may be very helpful for as corporations partnerships etc but we need to understand the whole structure of your economy and if this is only say 15 percent of your well combined business in Hawaii then maybe it's it's good for them but but it's not good for all businesses and for all people who file their taxes right you know talking about the complications of the impact of tax policies on those at different levels of income raises a philosophical question and I'm wondering if I can just throw this out to you there are many here in Hawaii who are averse to any benefits that businesses or higher income individuals get in terms of tax reform and say that that does not benefit those at the lower income levels that it doesn't really trickle down it doesn't really help the populace but instead there's the robin hood effect that and in other words they propose the solution should be to take from the rich and give to the poor what are some general thoughts you may have about the the equity involved here and the issues that people address when they look at benefits that may occur to those at the higher income levels or at business levels so again I would say that the individual income tax system in Hawaii is progressing and maybe it is overly progressing again compared to some other states right and you have to compete for human capital and you mentioned that well people unfortunately leave Hawaii because of its tax policy in particular right so I would say that it's the tax system that you now have it is already progressing it already takes more from the rich than from the poor and you also have the standard deduction that unfortunately is not indexed for inflation and personal exemption and those provisions actually help well people who are relatively poor so I would say that from the perspective of equity well the state of Hawaii is actually very high on this rank but again if it comes at the cost of future investment then again it can be dangerous for future population growth for future economic growth and it can have many other detrimental effects unfortunately recently you wrote on throwback rules as we close quickly in the next moment would you care to say anything about that and how these may work in Hawaii so the throwback rule is an important provision again in the corporate income tax code and well those provisions are now frequently being repealed in many states and there is a reason for that again the corporate income tax system is very complicated so you need to make a small example here right so consider you have a firm in Hawaii and this firm sells goods and services not only to the residents of Hawaii but to other states as well and then the question is about the portion of corporate income of this particular firm right so you have a complicated different types of apportionment rules and some of them are more efficient than others and also you have these throwback rules so throwback rules were intended to tax nowhere in so for instance if a firm sells something to a particular state where this income is not taxable because the firm does not have a next in that state then the idea was to throw this income back to the tax base of Hawaii right and unfortunately these rules may lead to overtaxing corporate income so for some firms it may lead to taxing more than 100% of their corporate income and that is the reason why many states actually repeal those rules well thank you Andre this has been a fascinating conversation and I appreciate your work your expertise and what you do with the national tax foundation thank you for your consultation with us at grassroots institute good having you on board thank you very much and thank you for having me my guest today has been Andre Yushkoff who happens to be a tax policy specialist at foundation or at the tax foundation the national organization and we're just grateful for his work thank you for being with us today I'm Kili Akina you're watching think tech Hawaii's Hawaii together until next time