Photo: Emily Metcalf
Photo: Emily Metcalf

By Lowell L. Kalapa – Hawaii’s general excise tax is the envy of every other state that imposes a retail sales tax because of its broad base, that is, it is applied to nearly every transaction that takes place in Hawaii.

Such is not the case of the retail sales taxes found in more than forty other states. Unlike the retail sales tax, which is usually imposed only on goods and then only on the end-user or consumer of the goods, Hawaii’s general excise tax is imposed not only on goods or things, but also on services and it is imposed even when the goods or services purchased will eventually be resold to someone else.

The other significant feature that differentiates the general excise tax from the retail sales tax is that it is a liability of the business selling those goods or services “for the privilege” of doing business in Hawaii whereas a retail sales tax is the liability of the customer. In those states that have a retail sales tax, the business is merely a collection agent for the city, county, or state government that levies the tax. In some cases, the business collecting the retail sales tax for the state or county is compensated for that chore by being able to retain a portion of what is collected as the sales tax. With the general excise tax, the amount paid over to the state tax collector is a percentage of what the business puts into the cash drawer, including the amount sometimes shown out as the general excise tax. The state rate, of course, is 4%, but in Honolulu the additional 0.5% for the rail system is tacked onto the basic 4% state rate.

Since the amount “passed on” to the customer as the general excise tax becomes a part of what the business collects and puts into the cash drawer, when it comes time to pay the tax collector his due, the business must pay 4% on that amount that has been passed on to the customer. As a result, that is why consumers see a rate of either 4.16% on the Neighbor Islands or 4.712% for those who live in Honolulu. Some may argue that businesses should charge only the statutory rate of $5 or 4.5%. The department of taxation is only interested in the amount being remitted to the state. However, it is against the law for a business to state that there is no general excise tax being imposed on a transaction.

Thus, while a business can show the amount of the tax out separately, that is not a requirement under the law. In fact, before the changes made to the Internal Revenue Code in 1957, businesses did not show the tax out separately because it was viewed as a tax on the gross income of the business. Only when the deduction for state sales taxes was added to the Code did the retail community pursue the IRS recognition of the tax as a “retail sales tax” for federal purposes and so the tax was shown out separately.

Today, because of price competition among businesses, nearly all businesses show the general excise tax out as a separate line item. Showing out the tax separately also helps to shift the blame to government for the added cost to the price of a product or service. However, it should be noted that merely charging the tax separately does not relieve the business of the burden of the tax. Because the 4% tax is levied on everything in the cash drawer including the amount of the tax passed on, the business must pay for a part of the general excise tax due out of his mark up or margin. When it is a business that operates on a slim profit margin, like a grocery store, the amount of the general excise tax paid out of the margin means a make-it or break-it point.

For the customer, the general excise tax is just another charge added to the bill, but for a business, the tax can determine whether or not it can stay in business. One might say, well, the tax is being passed on to the customer, so the business should be able to pay the tax and stay in business. That might be true for a business that can charge whatever it wants because the demand is high for the product or service being sold, but where there is intense price competition, the profit margin for goods or a service may not be sufficient to cover the cost of the tax that is paid out of the mark up. If that business cannot charge enough for the product or service to cover the general excise tax obligation that can’t be passed on, that business will soon be out of business.

And that is the point to underscore, because the general excise tax is a tax on gross income, it is due whether or not a business is profitable. Take, for example, a business that is having a fire sale or is going out of business sale and is selling everything below cost, the business is making no profit on those sales yet the general excise tax will still be due on the amount taken in from the fire sale.

For the average taxpayer who believes the cost of the tax can just be passed on to the customer, they don’t see that the business must still take something out of its mark up to pay the tax over and above what was passed on.

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui NewsWest Hawaii TodayGarden Isle News, and the HawaiiReporter.com.

© 2013 Tax Foundation of Hawaii

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