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Hawaiʻi’s state and county governments seem to be doing a reasonable job of getting businesses to pay their appropriate share of the cost of government services through taxes, according to a new blog by the University of Hawaiʻi Economic Research Organization (UHERO). Its author, UHERO Research Fellow James Mak, cautions that there are many factors that contribute to business taxation, and more research should be done on the government expenditure side to allow more precise assignment of expenditures that benefit businesses versus households.

Mak’s blog is in response to a recent report published by Ernst & Young LLP (PDF) and others that presents detailed state-by-state estimates of state and local taxes paid by businesses in fiscal year 2021.

According to the report, in FY21, firms doing business in Hawaiʻi paid $4.5 billion in state and county taxes, accounting for 38.1% of the $11.8 billion total tax revenues collected by Hawaiʻi’s state and county governments from all taxpayers. The 38.1% figure is below the national average of 43.6%. For Hawaiʻi businesses, property taxes ($1.5 billion) and general sales taxes on the purchases of intermediate inputs and capital expenditures ($1.3 billion) were at the top of their state and local tax liabilities.

To compare each state’s effort to raise taxes, the Ernst & Young report calculated an effective business tax rate (TEBTR) for each state. TEBTR is derived by dividing the sum of total (state and local) tax revenues collected from businesses by the relevant tax base. A proxy for the relevant tax base is the private sector share of gross state product, which measures the total value of a state’s annual output of goods and services (net of intermediate inputs) produced by the private sector.

In FY21, Hawaiʻi’s effective business tax rate was 6.6%, compared with the average rate across the country of 4.9%. Compared with other states, Hawaiʻi’s high TEBTR suggests that Hawaiʻi taxes its businesses more heavily than most other states. That conclusion, Mak said, would be premature. As the Ernst & Young report notes, the TEBTR does not take into account that some of the taxes paid by businesses are not actually paid by businesses because they are passed on to consumers.

Recovering costs of public services

Mak asks the question if state and local governments around the country recover the cost of public services they provide to businesses through business taxes. The Ernst & Young report attempts to answer that question by computing a “business tax-to-benefit ratio” for each state. The ratio is calculated by “dividing the amount of business taxes in each state by the estimated amount of government expenditures that benefits businesses.” It is not an easy calculation as many government expenditures benefit both businesses and households. A good example is education.

By far, the largest category of state and local government spending is on education. Businesses value an educated workforce. So, it is undeniable that businesses benefit from government spending on education, but there is uncertainty over how much. For the Ernst & Young report, researchers calculated business tax-to-benefit ratios assuming that the share of government spending on education that benefits businesses is either 0%, 25% or 50%. Zero percent and 50% are clearly unreasonable, Mak said. Focusing on 25%, in FY21 Hawaiʻi’s business tax-to-benefit ratio was 1.1, meaning that businesses in Hawaiʻi paid $1.10 in state and county taxes to receive in return $1 in government spending that benefits them. The national average ratio was 1.5.

“Despite the wide range of education benefit assumptions (from 0% to 50%), Hawaiʻi’s tax-to-benefit ratio is in the neighborhood of 1.0,” the blog said. “That suggests that Hawaiʻi’s state and county governments (collectively) seem to be doing a reasonable job of getting businesses to pay their appropriate (i.e. not too much or too little) share of the cost of government services. If cost recovery is the main purpose of business taxation, Hawaiʻi’s current (general) business tax structure appears not to be in desperate need of major reform.”

One note of caution Mak wrote is that the Ernst & Young’s business tax-to benefit ratios don’t inform whether or not taxpayers get their money’s worth. The “benefit” in the tax-to-benefit calculations is the amount the government spends to provide services intended to benefit businesses and not how much benefit businesses actually derive from the expenditures.

For the entire blog, visit UHERO’s website.

UHERO is housed in UH Mānoa’s College of Social Sciences.

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