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By James Mak
In the recently-concluded thirty-first legislature (2021), Hawaii state lawmakers passed HB 862 CD1 which would divert to the state government’s general fund (GF) $103 million from the state’s transient accommodation tax collections (TAT) that otherwise would have gone to the counties. In exchange, state lawmakers gave each of the four counties the authority to levy its own transient accommodations tax by ordinance; the maximum tax rate would be capped at 3%.  The county transient accommodation tax (CTAT) “shall be in addition to any state transient accommodation tax,” which currently is at 10.25%. In FY2019, the TAT generated $600.3 million in revenues; of that amount $103 million were allocated to the counties and $340 million were allocated to the general fund.  The counties’ annual allotment of $103 million remained unchanged between FY2015 and FY2019 even as total TAT collections rose from $421 million to $600.3 million. As a result, the counties’ share of TAT fell from 24.5% in FY2015 to 17.2% in FY2019. Governor Ige’s Sixth Supplementary Proclamation during the COVID-19 pandemic suspended the distribution of TAT revenues to the counties (and other special funds, e.g. funding for the Hawaii Tourism Authority); all of the revenues collected subsequent to the proclamation (except that earmarked for the Honolulu rail project) went into the general fund.  HB 862 CD1 proposes to take the counties’ share of TAT revenues by statute so that the counties would not receive the annual $103 million allocation even after the governor’s emergency proclamation is lifted.
The Legislature’s decision to strip the county’s share of TAT revenues is certainly a stark change from just a few years ago, when, in 2014, a blue-ribbon 13-member State-County Functions Working Group (WG) appointed by the Governor, county mayors, the President of the Senate, the Speaker of the House and the Chief Justice of the Hawaii Supreme Court, was asked to “…submit a recommendation to the Legislature on the appropriate allocation of the transient accommodation tax revenues between the State and counties that properly reflects the division of duties and responsibilities relating to the provision of public services.”  In 2016, state lawmakers rejected the recommendation from the working group—which was based on flawed methodology—but Senate and House members could not independently agree on how much to increase the counties’ share of the TAT revenues and for how long and decided to keep the status quo. The message to the counties was clear: no additional money for the counties. But lawmakers didn’t deny any money from TAT revenues for the counties either. The Legislature has the power to set county allocations on a year-by-year basis, a process that created a fiscally undesirable element of uncertainty for county budgeting. As creatures of the State, Hawaii’s counties are at the mercy of the state government.
State aid to local governments is an important feature of state-local public finance in the U.S.  Most of the state aid to local governments is conditional/restricted aid with local school districts being the largest recipients of state aid, but not in Hawaii, where the provision of K-12 public education is a state (and not a local) responsibility unlike in the other 49 states. By contrast, unrestricted aid is money given to the local governments with no strings attached. The U.S. Advisory Commission on Intergovernmental Relations (ACIR) defines unrestricted grant-in-aid as “revenue sharing.” 
The Hawaii state government has had a long history of sharing revenues with its counties because of the vertical fiscal imbalance created by the extreme centralization of the state’s government structure. According to the ACIR, “The fiscal system of a state is vertically balanced when the costs of the expenditure responsibilities assigned to the state government, on one hand, and to local governments as a group, on the other, are roughly commensurate with the potential productivity at reasonable rates of the revenue sources available to each level of government.”  Counties in Hawaii have less revenue raising authority than local governments in most states. (However, Hawaii’s constitution allows only the counties to levy the real property tax.) With the state guarding its taxing powers jealously, the ACIR observed in a report to the 1988 Hawaii Tax Review Commission that, “Consequently, [Hawaii’s] counties are limited in their ability to initiate new functions.”  It hasn’t gotten much better for the counties. From 1977 to 2017, federal and state governments in the U.S. have substantially reduced aid to counties, cities and townships.  In 2005, the Legislature passed Act 247 authorizing the counties to adopt a surcharge by ordinance on the general excise tax that applies to transactions taxed at the 4% rate; money raised must be spent only on the rail project in Honolulu and “public transportation systems” in the neighbor island counties.  The surcharge is capped at 0.5%. Honolulu County began to impose its surcharge beginning January 1, 2007 (ending in 2030); Kauai and Hawaii Counties imposed theirs on January 1, 2019; only Maui County has declined to impose a surcharge.
Before the TAT was imposed in 1987, Hawaii’s county governments received a share of the state’s general excise tax (GET) between 1948 and 1965. Beginning in 1965, GET revenue-sharing was replaced by a system of grant-in-aid (Act 155), compelling a parade of county mayors trekking to the Legislature each year to lobby for more state aid. For the counties, uncertainty over the amount of aid complicated budget planning. Act 155 grant-in-aid was terminated at about the same time the federal government’s general revenue sharing program with the state and local governments (in place since 1972) ended in 1986. When the TAT was first imposed (at a modest rate of 5%) in January 1987, revenues from the tax were distributed to the state’s general fund; the Legislature then appropriated money to the counties for “infrastructure/or tourism related activities.” In 1989 ACIR recommended that the TAT be transferred from the state to the counties because the counties provide most of the public services consumed by tourists. The Legislature did not act on ACIR’s recommendation. Instead, it opted to give the counties a share of the TAT revenues. In 1990, the Legislature decided to allocate 90% of the revenues from the TAT to the counties, retaining the remaining 5% to defray “TAT-related administrative purposes.”  Between 2001 and 2009, the counties received 44.8% of total TAT revenues collected each year; thereafter, its share declined steadily as more and more of the TAT revenues were allocated into the general fund. Now, the Legislature wants to eliminate the annual county allocations altogether and give the counties the authority to levy their own transient accommodation tax. Is the decision good or bad policy?
A memo from one member of the blue-ribbon State-County Functions Working Group summarized the advantages and disadvantages of granting the counties the authority to levy their own TAT: “The primary strengths of the approach are that it fosters a greater sense of ‘home rule’ and that it removes the annual petitioning by the Counties to the Legislature. The primary weaknesses are that the industry will have five legislative bodies with which to deal on TAT matters and the tax can be applied inconsistently, leading to confusion.”  The perceived weaknesses are not very persuasive. For example, in California, the Revenue and Taxation Code section 7280 authorizes the legislative body of any city, county, or city and county to impose a transient occupancy tax (TOT) on tourist lodgings. 
There has also been concern that adding (possibly) another 3% on top of the existing 10.25% TAT rate would greatly increase the cost of travel to Hawaii and result in less tourist travel to the state at a time when the state’s economy is still trying to recover from COVID-19.  There is further concern that illegal vacation rentals that have not been paying the TAT might enjoy an even greater price advantage over hotels and other legal visitor accommodations. However, that should induce the counties to tighten regulation of vacation rentals and vigorously go after tax cheats.
Economists agree that a benefit from allowing local governments to raise their own revenues derives from the notion that, with fiscal decentralization, decisions on local public expenditures—and simultaneously revenues levied locally—should be made by the level of government that is closer to the local population and, thus, more reflective of their demand for local government services than decisions made by a distant central government.  Thus, allowing the counties to levy their own TAT is consistent with promoting greater (economic) efficiency.
For state lawmakers, the decision to strip the TAT money from the counties was not about raising economic efficiency; it was political. In the short run, it was a politically expedient way to solve the state’s fiscal crisis during the pandemic without raising state taxes.  That rationale is weakened when the Biden administration came along with a federal rescue package that plugged the fiscal holes in most state and local government budgets around the country. The rationale is further weakened when the Council on Revenues (COR), in its latest forecast, predicted a strong tax revenue bounce back for FY2021. Nevertheless, (and whether state lawmakers realized it or not during their deliberations) within the next 25+ years, Hawaii’s state government faces daunting fiscal challenges due to climate change, an aging and slower growing population and slower tourism and economic growth.  Thus, in the long run, the State may have a stronger case for diverting earmarked county TAT revenues for its own use. But, as demonstrated by a recent UHERO research brief,  it doesn’t make fiscal sense to try to solve the state government’s long run fiscal gap by focusing on a single tax, the TAT.
What is needed right now is to find answers to the broader question: What should be the fiscal relationship between the state and the counties? The last time the question was asked, and studied thoroughly, was more than 30 years ago. The task of coming up with answers/options could be assigned to the current Tax Review Commission. In the past, the Tax Review Commission tended to focus narrowly on the soundness of the state’s revenue system. A high quality state revenue system must take into consideration both state and local governments because the two are complementary. 
 https://www.capitol.hawaii.gov/session2021/bills/HB862_CD1_.pdf (visited June 9, 2021)
 State of Hawaii, Department of Taxation (DOTAX), Annual Report, 2018-2019, at https://files.hawaii.gov/tax/stats/stats/annual/19annrpt.pdf (visited June 9, 2021)
 By then the counties had received $85.8 million for FY2020; TAT revenues collected for the entire fiscal year 2020 totaled $564.3 million and the counties’ share fell to 15.2%. State of Hawaii, Department of Taxation (DOTAX), Annual Report, 2019-2020 at https://files.hawaii.gov/tax/stats/stats/annual/20annrpt.pdf (visited June 9, 2021)
 James Mak, How Hawaii’s State Government Shares Transient Accommodation Tax Revenues with Its Local Governments,” UHERO Working Paper No. 2016-4, May 12, 2016 at https://uhero.hawaii.edu/wp-content/uploads/2019/08/WP_2016-4.pdf (visited June 9, 2021).ERH
 There is also federal aid to state and local governments. See Congressional Research Service, Federal Grants to State and Local Governments: A Historical Perspective on Contemporary Issues, May 22, 2019 at https://fas.org/sgp/crs/misc/R40638.pdf (visited June 10, 2021).
 U.S. Advisory Commission on Intergovernmental Relations (ACIR). The State of State-Local Revenue Sharing, M-121. Washington D.C.: USGPO, 1980, at https://library.unt.edu/gpo/acir/Reports/information/M-121.pdf (visited June 12, 2021)
 U.S. Advisory Commission on Intergovernmental Relations (ACIR). “Intergovernmental Fiscal Relations in Hawaii,” Tax Review Commission Working Papers and Consultant Studies,” Volume 2, Honolulu: Tax Review Commission, December, 1989, pp. 192-193. At https://files.hawaii.gov/tax/stats/trc/docs1989/TRC_Work_Papers_and_Consultant_Studies_1989.PDF (visited June 10, 2021)
 ACIR (1989), p. 7.
 Megan Randall, Census of Governments Illustrate Declining Aid to Localities, Other Trends in State and Local Finance, Tax Policy Center, Urban Institute and Brookings Institution, April 21, 2020 at https://www.taxpolicycenter.org/taxvox/census-governments-illustrates-declining-aid-localities-other-trends-state-and-local-finance (visited June 10, 2021).
 Mak (2016), p 14.
 Mak (2016), footnote #25, p. 11.
 https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=RTC§ionNum=7280. (visited June 12, 2021)
 Maui County’s mayor is the first mayor to announce that his county will set its TAT rate at the cap if the Governor signs HB 862 CD1 into law. Allison Schaefers, “Maui County plans 30% rise in visitor tax if Gov. David Ige signs bill,” Honolulu Star Advertiser, April 28, 2021 at https://www.staradvertiser.com/2021/04/28/breaking-news/maui-county-plans-30-increase-in-visitor-tax-if-gov-ige-signs-legislation/ (visited June 12, 2021).
 http://www.ciesin.org/decentralization/English/General/Rational.html (visited June 11, 2021) In the language employed by economists, decentralization promotes “allocative efficiency.”
 James Mak, Robert D. Ebel and Carl Bonham, “How Can the State Government Restore Fiscal Balance?” UHERO Brief, June 18, 2020 at https://uhero.hawaii.edu/wp-content/uploads/2020/06/HowCanTheStateGovernmentRestoreFiscalBalance3.pdf (visited June 11, 2021).
 James Mak and Robert D. Ebel, “Charting a New Fiscal Course for Hawaii: Fiscal Architecture Approach,” UHERO Brief, January 29, 2020 at https://uhero.hawaii.edu/wp-content/uploads/2020/03/ChartingANewFiscalApproach.pdf (visited June 11, 2021).
 Mak and Ebel (January 29, 2020).
 James Mak, “To Tax or Not to Tax: Making a High Quality State Revenue/Tax System,” UHERO blog, March 6, 2020 at https://uhero.hawaii.edu/to-tax-or-not-to-tax-making-a-high-quality-state-revenue-tax-system/ (visited June 11, 2021).