Thank you for the opportunity to submit this commentary about the Regular Session of 2011.

My discussion focuses on the difficult decisions made by the Legislature to balance the state budget. I attempt to explain and defend the actions of the Legislature, particularly the House of Representatives.

Comprehensive Public Employees’ Retirement System Reform

Before proceeding with the main substance, I would like to offer my prediction of what will ultimately be deemed the most important measure passed by the 2011 Legislature. This measure received relatively little publicity or media coverage during the session. Consequently, my emphasis on it may be surprising, a departure from conventional commentaries that trumpet more tangible, publicly appealing, and media friendly accomplishments. Yet, this measure in my estimation represents a significant pivot point in the future of Hawaii.

House Bill No. 1038 comprehensively reforms the public employees’ retirement system benefit, contribution, and service provisions for public employees hired after June 30, 2012. HB 1038 has immediate beneficial impacts, resulting in cost savings to public employers of $54 million in fiscal year 2011-12 and $92 million in fiscal year 2012-13. More importantly, HB 1038 is intended to limit future increases of public employer contributions for the system and prevent such contributions from assuming greater and greater portions of the State’s and counties’ operating budgets. Because of the bill, Hawaii should be able to avoid public employee pension crises such as those currently experienced by California and other states. Future taxpayers will gain the most benefit from HB 1038, a far reaching piece of legislation.

The most credit for passage of HB 1038 should go to the Employees’ Retirement System Board of Trustees and Executive Director, who initiated the measure, and Governor Abercrombie who fully supported it.

Beginning Co-Equal Priorities

The main substance of this commentary is the Legislature’s actions toward achieving the two co-equal priorities I had submitted to you before the 2011 session convened.

One priority is to maintain the economic recovery and job growth. The other priority is to pass a balanced state budget that funds essential public health, safety, and education services without a general excise tax increase and without another mass state employee layoff. As of this writing, the State faces a budget gap of between $800 and $900 million over this and the next two fiscal years.

The Legislature was successful in achieving the latter priority, but less so regarding the first. The primary reason for the difference in success was the reality of the state budget crisis, which worsened as the session progressed. The lack of available revenues prevented the Legislature from funding tax credits or employment programs needed for immediate job opportunities.1

Balancing the Budget — Balanced Approach

After session began, the commonly acknowledged general fund budget shortfall was estimated to be a little more than $800 million over three years. The shortfall was based on the Council on Revenues general revenue projection of December 29, 2010. Subsequent projections, however, substantially lowered the anticipated revenue, resulting in an exacerbation of the shortfall by another $500+ million.2

Faced with a $1.3 billion general fund shortfall in late March/early April, the Legislature took a balanced approach to resolving the problem.

First, to address the immediate shortfall of about $200 million in this current fiscal year 2010-11, the Legislature transferred $16 million from non-general funds to the general fund, appropriated $40 million in rainy day funds and $42 million in hurricane relief funds, and authorized the Governor to utilize another $75 in hurricane relief funds if necessary. Those legislative actions, along with restrictions and contract cancellations by the Administration, were deemed sufficient to resolve the problem for this current fiscal year.

Next, for the fiscal biennium 2011-13, the Legislature both reduced appropriations and raised revenues, the same balanced approach taken during the past two years. Requested appropriations were reduced by about $618 million. Revenue enhancements, such as tax exemption suspensions, tax deduction limitations, fee increases, and non-general fund transfers, totaled about $660 million.3 In general, the revenue enhancement measures were focused on generating revenue from higher-income persons, visitors, and special interests.

The Legislature acted responsibly, avoiding the positions advocated by extremists on both ends of the political spectrum. Contrary to what some may believe, the Legislature did not solely raise taxes to balance the budget. Nor did the Legislature rely solely on spending cuts that would have decimated public services. Neither did the Legislature resort to tax refund delays to “kick the budget can” down the road as was done by the past Administration.

I am confident that the state budget passed by the Legislature does indeed fund essential public health, safety, and education services.

Obviously, the Legislature would have liked to appropriate more funds for lower and higher education, social services, economic development, and other worthwhile public services. Doing so, however, would have required the raising of substantial taxes, resulting in diverting more capital from the private sector than conducive to economic recovery.

Absence of General Excise Tax Rate Increase/Suspension of Certain General Excise Tax Exemptions

Very important from my perspective, the Legislature was able to balance the state budget without a general excise tax rate increase.

As the major revenue generating alternative to such a rate increase, the Legislature passed SB 754. The bill suspends the general excise tax exemptions for certain persons and activities for two years. Basically, SB 754 promotes fairness and raises revenue in a manner less detrimental to the economy than a general excise tax rate increase.4

Absence of Pension Tax

The state budget also was balanced without imposing a tax on pensions, one of the revenue enhancement options initially proposed by the Administration.

The House did pass a bill imposing a tax on the pensions of higher-income taxpayers exclusively. It, however, failed in the Senate. Under the bill, the pension of only the following would have been taxed:

(1) A married person filing jointly with an income of $200,000 or more;

(2) A head of household with an income of $150,000 or more; or

(3) A person filing an individual return with an income of $100,000 or more.

Persons with less than those income levels would not have been taxed. This point was not adequately communicated by the media.

Despite unfair criticism, I believe that the House took the right course and displayed political courage in considering and fully discussing the issue.5

Economic Recovery and Jobs

To achieve the priority of immediate job growth, I had introduced bills to provide tax credits for new employees, curtail business tax deductions not directly related to employment, and utilize temporarily special funds for public service employment programs (such as using the legacy land special fund for conservation employment rather than property purchases). None of those bills passed, however, because the state funds necessary for the programs had to be channeled instead to balance the budget.

Nevertheless, the Legislature did lay the groundwork for continuing economic recovery.

At the initiation of the Governor, the Legislature in HB 200 appropriated $1.8 billion in fiscal year 2011-12 and $1.0 billion in fiscal year 2012-13 for capital improvement projects. The appropriations will serve the dual purposes of improving infrastructure and providing jobs.6

Much was accomplished for the promotion of renewable energy, an area promising for economic development and necessary for reducing the export of dollars for fossil fuel purchases.7 For example, SB 1347 permits the spreading of renewable energy costs among a public utility’s affiliates and ratepayers. Although the bill did not receive as much attention as SB 367, the undersea cable bill (which failed), SB 1347 has the potential for accelerating renewable energy development, particularly on the neighbor islands.

The Legislature also passed HB 1342, which provides for expediting of permits for broadband infrastructure, and HB 677, which requires the establishment of a food safety and security program for local farmers to enable sale of their produce. Both, hopefully, will set foundations for the telecommunication and agriculture industries to evolve and grow.

Governor Abercrombie’s Leadership

Finally, I would like to acknowledge Governor Abercrombie for his leadership during the session. He was in the forefront, leading the effort to resolve the budget crisis and enact structural fringe benefit and tax reforms. Although he has been criticized by some for lack of success, I would disagree. By personal example, he showed courage and fortitude in attempting to achieve an ambitious agenda. To me, there is much more worth in a person who tries to reach many difficult goals, thereby heightening the risk of failure, rather than one who espouses few “easy” goals, thereby ensuring a pale “success”. Governor Abercrombie, with his “New Day” leadership, is clearly the former.

About the Author: Representative Calvin K.Y. Say currently serves as the Speaker of the Hawaii State House of Representatives. Speaker Say is the first Chinese-American to serve as a Chamber Speaker.

Elected President of the National Speaker’s Conference by his House (Assembly) Speaker colleagues across the nation in 1999, Speaker Say is now a senior member of the organization, and is nationally recognized as an expert on State budget issues and fiscal challenges.


1 Conflict Between Balancing the Budget and Programs for Immediate Job Growth

In my pre-session commentary, I had foreseen the possibility of a conflict between balancing the budget and immediate job growth initiatives:

I, however, recognize that the priorities will compete for state funds. Promoting immediate private sector job growth may require the granting of tax credits of funding of employment programs. This will cost the State money that then cannot be used to balance the budget. Conversely, restoring funds for state services and employee compensation may leave little or no funds left for private sector job programs.

2 Council on Revenues’ Decreasing General Fund Tax Revenue Projections

The following displays the decrease of the Council on Revenues’ projections from December 29 to March 29, 2011 (after the earthquake, tsunami, and nuclear power plant disasters in Japan):

3 Major General Fund Revenue Measures

The following are the major general fund revenue measures passed for the fiscal biennium 2011-13.

One major point of emphasis is that the following total of $658.7 million is not generated solely from tax increases. Of the total, $559.2 million is generated from “tax or fee increases” (HB 1039, SB 570, HB 754) while $99.5 million is generated from non-general fund or other transfers (HB 775, SB 120, SB 1186).

4 General Excise Tax Exemption Suspension — SB 754

SB 754 suspends for two years (from July 1, 2011 to June 30, 2013) the general excise and use tax exemptions for certain persons and business activities. During the two-year suspension period, the formerly exempt persons and business activities will be subject to the four per cent general excise or use tax rate (but not the 0.5 per cent surcharge in Honolulu for the rail project).

Reasons for supporting passage of SB 754 are the following:

(1) The bill is the major revenue generator for resolving the $1.3 billion general fund shortfall over the next fiscal biennium.

SB 754 generates, for the general fund, $169.8 million in fiscal year 2011-12 and $216.0 million in fiscal year 2012-13. The general funds, along with other revenue enhancements/diversions and $618.0 million in budget cuts, are necessary to close the budget gap.

(2) The bill is supported by the Governor and part of the Administration’s financial plan.

(3) The bill promotes fairness.

Suspending the exemptions eliminates a preference for the formerly exempt persons that other businesses do not have. Many businesses, such as restaurants, supermarkets, accounting firms, etc., do not enjoy general excise tax exemptions. In effect, those businesses must make up for the tax revenues foregone through the exemptions.

This unfairness would have worsened if the general excise tax rate had been increased without suspending the exemptions. The businesses without exemptions would have had to pay more taxes while the exempt ones would still pay $0.

(4) The bill is the major alternative to an increase of the general excise tax rate.

The House position was that a general excise tax rate increase would have raised the cost of doing business and cost of consumer products and services much more than would have occurred under SB 754. Raising the cost of business and cost to consumers would have negatively impacted the economic recovery. Moreover, a general excise tax increase would have been regressive (although this effect could have been mitigated by tax credits for low-income persons).

Most of the general public mistakenly assumes that a one per cent general excise tax rate increase will require them to pay just one cent more on every dollar of purchase. This mistaken assumption ignores the pyramiding effect of a rate increase, an effect in which the taxes at previous transaction levels are hidden in the price of the final product or service.

(5) The bill is consistent with the way the general excise tax is supposed to work.

Opponents of SB 754 argue that the bill will force them to pass-on the newly imposed tax. The argument fails to recognize that the general excise tax is set up for the pass-on of the tax at every transaction level. That is why the general excise tax rate is so low compared to the sales tax rates of other states.

Moreover, this argument fails to recognize that the pass-on would have been much worse if the general excise tax rate had been increased.

In sum, suspending the general excise tax exemptions will have lesser detrimental impacts and be fairer than increasing the general excise tax rate.

5 Pension Tax — HB 1092/SB 570, HD 1

HB 1092/SB 570, HD 1, had proposed to tax the pensions of higher-income taxpayers only. A taxpayer’s pension would have been taxed if:

(1) The taxpayer files a joint return and earns more than $200,000 in federal adjusted gross income;

(2) The taxpayer is a head of household and earns more than $150,000 in federal adjusted gross income; or

(3) The taxpayer files a single return and earns more than $100,000 in federal adjusted gross income.

If a taxpayer has a federal adjusted gross income of less that the applicable trigger, the taxpayer’s pension would not have been taxed.

“Federal adjusted gross income” basically means income less certain adjustments and deductions. (See the first page of IRS Form 1040 for the manner in which “federal adjusted gross income” is calculated.)

Reasons for supporting the proposal were the following:

(1) The bill would have promoted fairness.

Other retirement income, such as 401(k)s, are already taxed by the State and federal governments. In the future, most private sector retirees probably will have 401(k)s that are taxed while public employees will still have traditional pensions. As the Director of Taxation testified: “It is a fair tax policy to treat the taxation of employer-funded retirement income similar to the self-funded retirement income.”

(2) The bill was narrowly focused on higher income taxpayers with pensions.

The State Tax Department estimated that less than one per cent (0.7%), or about 3,900 tax filers, would have been affected.

(3) The taxing of pensions was recommended by the Tax Review Commissions of 1995-97, 2001-03, and 2005-07.

(4) The bill would not have broken any promise.

Opponents claim that there was a “promise” that pensions would never be taxed. No document with such a “promise” has been produced.

6 Highway/Road Funding Bills

On the subject of infrastructure and jobs, the Legislature also passed bills to generate revenues for highway and road construction, maintenance, and improvement. SB 1328 raises the vehicle registration fee and SB 1329 raises the vehicle weight tax. Although the bills increase the tax and fee burden on drivers, the resultant revenues are intended to address a major constituent complaint: poor highways and roads. Constituents generally understand that, if they want better highways and roads, they will have to pay for the improvements. Expenditure on highway and road construction, maintenance, and improvement also will generate jobs.

After much contemplation, the Legislature chose not to pass a bill increasing the fuel tax. The Legislature felt that a fuel tax increase at this time would have compounded the gasoline price hikes currently faced by drivers.

7 Renewable Energy Bills

Renewable energy bills passed during the 2012 session included the following:

HB 1520 On-bill financing. Supports the State’s clean energy objectives by requiring the public utilities commission to investigate an on-bill financing program that would allow electric company (i.e. HECO) customers to purchase or acquire a renewable energy system or device, and provide for billing and payment through the customer’s electricity bill.

SB 1347 Achieving portfolio standard. An electric utility company and its affiliates may aggregate their renewable portfolios in order to achieve the renewable portfolio standard. This bill allows the spreading of renewable energy costs and expenses to a utility’s affiliates and their ratepayers, and to recover costs and expenses through a surcharge.

SB 1244 Biofuel facilities. Expands the renewable energy siting process to include biofuel production facilities with the capacity to produce and distribute 100,000 gallons or more of biofuel annually.

SB 631 Renewable energy systems on agricultural lands. Allows renewable energy systems on class B and C agricultural lands.

SB 704 On-site systems. Exempts certain third party owners or operators of renewable energy on-site systems from regulation by the public utilities commission.

SB 1482 CIP reasonableness. Requires the public utilities commission to consider certain fossil fuel factors when determining the reasonableness of a public utility’s proposed capital improvement projects.

SB 181 Photovoltaic for single family homes. Establishes a working group to determine the feasibility of requiring all new residential single family construction to incorporate the design and minimum installation equipment needed for future adoption of a photovoltaic system.