On July 10, Hawaii Governor David Ige (D) signed a bill that significantly changes Hawaii’s tax code. The law project, HB 209, has two main provisions. Together, the provisions implement a state-level earned income tax credit and reinstate the top marginal personal income tax rates that had been allowed to expire. Although the tax credit is widely supported, it may affect only a small portion of eligible residents. On the other hand, increasing the maximum personal income tax rate could increase costs for local businesses.
State income tax credit
At the federal level, the Earned Income Tax Credit (EITC) is a tax credit for low-income workers. Taxpayers who receive the credit can use it to directly offset their tax payable and receive different amounts of credit depending on their income and the number of children they have. The credit is also refundable, that is, if the credit granted is greater than the tax liability, the taxpayer can receive a cash refund.
The state-level EITC adopted in Hawaii is based on federal credit, with state credit allocating 20% of the value of the federal credit the taxpayer receives. For example, if a single mother received a credit of $ 3,000 at the federal level, she would receive a credit of $ 600 on her Hawaii state income tax.
Unlike the federal EITC, the Hawaiian credit is non-refundable, which means that credit in excess of tax payable cannot be exchanged for cash. However, taxpayers can carry over the remaining credit value to subsequent years without any limitation.
In 2014, 16.7% of Hawaiians received a federal income tax credit, according to the IRS. For taxpayers subject to state income tax, Hawaii’s new EITC could offer significant relief. The Hawaii Department of Taxation projects a loss of revenue of $ 16.7 million in 2018 to grant state credit. However, the state EITC would not reach everyone who benefits from the federal EITC.
For some low-income families, the standard deduction and other tax provisions may already eliminate any state income tax liability. Due to the non-refundable structure of the credit, these families would not benefit from the legislation, which would reduce its scope. In fact, some believe that two-thirds of Hawaiian families eligible for the EITC would not benefit from the new law.
Reinstatement of the highest marginal income tax rates
In 2009, Hawaii adopted a temporary increase in taxes on high incomes, which expired in December 2015. HB 209 reinstates these rates permanently. The hike is expected to bring in $ 51 million in additional tax revenue in 2018. The EITC is expected to cost $ 16.7 million, the state predicts that the rate adjustment will result in a $ 20 to $ 40 million more in annual tax revenue, after taking into account a separate refundable tax credit / excise tax for low income families which is now made permanent.
Currently Hawaii has a marginal income tax rate of 8.25% for a single filer earning more than $ 48,000. HB 209 will create three new bands with corresponding new tariffs. In the highest bracket, sole filers will be subject to an 11% tax rate on all income over $ 200,000.
This has serious economic implications for Hawaiian businesses. In particular, the application of the new maximum rate to pass-through companies is worrying. These businesses report their income on an individual’s personal income tax return rather than on a separate business return, and are therefore taxed at the individual rates.
According to the latest available IRS data, approximately 8,000 Hawaiians earning more than $ 200,000 in income from middleman businesses on their tax returns. These declarants represented only 22.9% of intermediary companies, but contributed 84.5% of the net income passed on in 2014.
With the new law in place, Hawaii will levy the second highest rate in the country on these businesses. Such a high top marginal rate could discourage business investment in Hawaii, especially among small businesses. In 2013, small enterprises accounted for 96.2 percent of Hawaiian employers and employed more than half of the state’s workforce. While not all small businesses are flow-through entities, the impact on those that are could be enormous.
Given the impact of the 2008 recession on businesses, it is difficult to measure the impact of the temporary rate hikes from 2009 to 2015 in Hawaii. However, theory suggests that implementing such a high top marginal rate will have a negative impact on businesses.
Raising tax rates on flow-through entities will not only slow down the growth small businesses, but it will also discourage new business investment in Hawaii. Higher tax rates leave small businesses with less after-tax money to reinvest in their businesses, which translates into less growth at the business level. Likewise, high tax rates can prove prohibitive for new investments as they represent an additional cost to do business.
Although HB 209 was adopted with good intentions, it could have unintended economic consequences. Given the structure of the credit as non-repayable, it is not known how many Hawaiians will actually benefit from the expansion. Given the likely effects of the rate hike on job creation, the new policy may well prove to be counterproductive.
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