To Tax or Not to Tax Sale of Food and Medicine

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By James Mak

Inflation is soaring at the highest rate since the early 1980s.  Not surprisingly, many Hawaii residents are struggling financially today. Sadly, this has been true long before the pandemic and the recent spike in prices.  In 2018,  42% of Hawaii households struggled to make ends meet; 33% were ALICE households, households that earn above the federal minimum wage but not enough to afford basic household necessities.  (ALICE stands for asset limited, income constrained, employed).  The number of ALICE households has been rising for quite some time.

Some people are calling for the elimination of the State’s general excise tax (GET) on food and medicine because they are necessities, correctly noting that taxes on the purchases of those expenditures disproportionately hurt low income households because low income households spend a larger percentage of their incomes on consumption than those in the middle and high income households.  In the language of economists, the GET is a “regressive” tax.

In defense of Hawaii’s GET,  State Tax Director Isaac Choy (July 24th issue of the Honolulu Star Advertiser) argued that the GET should not be evaluated by itself because it is part of a balanced revenue system comprising of taxes and non-taxes that work together to raise revenue to fund government services we desire.  And the added cost of the GET levied on food purchased by lower income families is offset by income tax credits currently valued at nearly $29 million.  Moreover, the Federal Government does not permit food purchased with food stamps to be taxed.   Exempting food purchases would primarily benefit higher income households and affluent tourists and would not produce a more equitable tax system.  It would also cost the State nearly $270 million in lost tax revenue.  Choy also explained that Hawaii does not currently tax prescription medicine.  Tax department data show that, in tax year 2020, the total value of exemptions claimed for prescription drugs and prosthetic devices was $1.8 billion; the estimated tax revenue lost (referred to as “tax expenditures”) was $72.7 million.  Hawaii does tax the sale of nonprescription drugs.

Keli’i Akina (Grassroot Institute of Hawaii) disagrees with Choy.  In an August 3 Star Advertiser essay, Akina argued that food purchases in Hawaii should be exempt from the GET to benefit all Hawaii residents and not just low income households because Hawaii households spend a much higher percentage of their budgets on food than the U.S. average—16.5% vs 12.5%.  He further argued that the prescription drug exemption should be broadened to include medical and dental services to alleviate the state’s severe doctor shortage.  To gain full benefit of the tax exemptions, “policymakers could resist the urge ‘to make up the difference’ with more taxes elsewhere.”

This essay explains why Hawaii should not exempt food and nonprescription drugs from the GET.

Taxing (or Not Taxing) Food and Drugs in Other States

Hawaii is not the only state that taxes the sale of food and non-prescription drugs but does not tax the sale of prescription drugs. Data compiled by the Federation of Tax Administrators show that (as of January 1, 2022) 10 other states  do the same as Hawaii.  In a number of these states (but not in Hawaii), food is taxed at a lower rate than the state’s general sales tax rate. (Hawaii’s GET is not a sales tax since it is a “privilege” tax levied on businesses and not on consumers.  As the GET is intended as a tax on consumption, it is treated as a sales tax for comparison purposes with sales taxes in other states.)

Twenty-three states do not tax sale of food and prescription drugs but do tax nonprescription drugs.  In some of these states local governments add their own sales tax on food sales  (More commonly, local governments exempt food from sales taxation if food is exempt at the state level.).

Only Illinois taxes all three. The State of Illinois levies a 6.25% sales tax on “general merchandise” but levies a lower 1% sales tax on “qualifying foods, drugs, and medical appliances.” (Beginning July 1, 2022 Illinois enacted a one-year tax holiday on groceries under the state’s Family Relief Plan.  The 1% sales tax on groceries will resume on July 1, 2023.) 

By contrast, 8 states (plus the District of Columbia) exempt all three. And five states have no general sales tax.

Taxing Food and Drugs in a High Quality Tax System

In an earlier UHERO blog, it was noted that there is substantial agreement on what constitutes a high quality tax/revenue system at state and local governments. Thus, one might think that state tax systems across the country would be very similar.  Actually, there are vast differences in the states’ tax systems. As seen here, it is also true when it comes to taxing sale of food and medicine. 

History plays an important role in shaping the structure of a state’s tax system.  Hawaii’s GET was enacted in 1935 in the middle of the Great Depression when the territorial government was looking for revenue to maintain its services. A tax commission was appointed to come up with solutions.  The commission recommended a gross income tax levied on vendors (not consumers). To spread the burden of the tax “equitably”, the original GET had an extremely broad base.  It taxed everything—goods and services, intermediate and final sales. So prolific has been the GET’s ability to generate revenue that, since its adoption, state lawmakers have been reluctant to shrink its tax base (e.g. by granting numerous exemptions) out of concern for revenue loss to the government treasury.   

Over the years, Hawaii state lawmakers have preserved the GET’s broad base and its low rate (currently at 4%).  A 2021 study by Nikhita Airi and Frank Sammartino (“How Broad Are State Sales Tax Bases,” Tax Policy Center, Urban Institute and Brookings Institute) finds that, in 2018, Hawaii’s sales tax base as a percentage of direct household spending was 88%; the national average was 34%. (Direct household spending excludes spending by nonprofits and imputed personal consumption expenditures such as the rental equivalent of owner occupied homes.) Differences among states were primarily due to differences in the tax treatment of services.  Explanation for the reluctance of states to tax services stems from history.  Historically, sales taxes rules were written primarily to tax “tangible goods” (most of the rules were written in the 1930s) and must be changed by legislation, which is a difficult hurdle.

The Situation in Hawaii

During the 2021 state legislative session, a bill was introduced (Senate Bill SB 608) that would have exempted groceries (i.e. food consumed at home) and nonprescription drugs from the GET.  The bill died in committee.  Another bill (SB849) proposed to exempt food, medical services, and feminine hygiene products.  That bill also failed to pass.  If food, health care, and shelter are deemed necessities, why not exempt rents?  

This leads to the big question: Why do we tax?  The most important reason we tax is to generate revenue to pay for government services we desire.  The GET is part of a Hawaii state and local tax/revenue system to raise the required revenue.  It is the largest revenue generator for the State.  Taxes in this system interact with each other to work together to raise the desired revenue as efficiently and as equitably as possible.  Since every tax in that system has shortcomings, it is a good idea to have a balanced mix of revenue sources.  Hawaii has both income and sales taxes partly because sales taxes are regressive and income taxes are progressive. [1] Having both balances each other.  It also allows lower rates for both than if the State relied only on one of them.  This suggests that some components of a balanced revenue system will be regressive and others will be progressive.  The fact that sales taxes are regressive is not a good reason for not using them. The challenge is:  How to have the GET work within a revenue system that generates adequate amount of revenue at the same time is fair and minimizes the negative impacts of the GET on lower income households?  Should GET exemptions be favored over income tax credits?

Exemptions have several disadvantages that are well known.  They employ a shot-gun instead of a targeted approach to solve a problem.  Tax exemptions shrink the tax base and potentially produce large revenue losses that have to be made up by raising tax rates on other purchases.  This leads to the distortion of consumer spending by unintentionally influencing how consumers spend their budgets. A quality revenue system should aim for a broad tax base and low rates.  Then there is the additional cost of compliance and administration.

The 2005-2007 Hawaii Tax Review Commission (TRC) came to the same conclusion. The TRC warned that proposals to exempt transactions affecting consumers (as opposed to businesses) such as health care, food, clothing or shelter should be evaluated carefully. Exempting these purchases from the GET would have cost the state treasury $501 million or about 22.3% of total GET receipts. To compensate for the loss, the GET rate on the remaining tax base would have to be raised from the current 4% to 5.1%. 

Hawaii is one of five states that employs the income tax credit (or rebate) approach to lower the negative impacts of sales taxes on low income residents. In 2019, Hawaii’s Refundable Food/Excise Tax Credit refunded $28.4 million to low-income residents (240,158 claims with an average value of $118 per claim).  The complicated Credit for Low Income Household Renters distributed a paltry $2 million (20,530 claims with an average value of $99 per claim). [2] (The Tax Department processes nearly 650,000 resident individual income tax returns each year.) 

Neither credit is without flaws.  Their biggest shortcoming is that benefits and income eligibility thresholds are not automatically adjusted (“indexed”) yearly for inflation.  Indexing makes good sense; so the Legislature should move on this quickly if the credits are to achieve their intended goal of helping Hawaii’s low income households.

Finally, while the purpose of this essay is to shed light on the merits of sales tax exemptions versus income tax credits, there are echoes of larger issues that Hawaii needs to address going forward.  Taxes are levied on income, consumption and wealth.  Hawaii’s tax system taxes income (income tax) and consumption (GET) heavily, but taxes wealth (e.g. property tax) lightly.   What should be their appropriate balance?  That will be the topic of a future essay.


Acknowledgements: Mahalo to Bob Ebel and Bill Fox for sharing their expertise on state and local government finance with me as I was crafting this essay. Thanks also go to Sumner La Croix, Kimberly Burnett and Carl Bonham for useful comments on an earlier version of this essay. Remaining errors, if any, are mine.


[1] One shortcoming of Hawaii’s personal income tax is that it exempts defined pensions—e.g. pensions received by state and local government employees—from the income tax.  401k distributions are taxed.

[2] Rent is subject to the GET and passed on to renters but the imputed rental value of owner-occupied housing is not taxed so that people who occupy their own homes enjoy preferential tax treatment. In comparison, the $2 million distributed to renters is surely too little.


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