Now that the 2025 legislative session has come to an end, there remains one issue that has unfortunately been left unresolved once again: economic diversification.

The need to diversify the local economy couldn’t be a more pressing issue. As the Covid-19 pandemic showed, Hawaiʻi’s reliance on tourism is simply unsustainable.

As much as lawmakers and economists like to discuss this crucial issue, there can be no real progress toward diversifying the economy until certain incentives are arranged so as to encourage entrepreneurship and private enterprise.

Therefore, Hawaiʻi must take significant steps to become a pro-business state by substantially reducing state income and corporate taxes across-the-board, as well as slashing burdensome regulations that hinder economic growth.

According to a report by CNBC, Hawaiʻi was ranked “the worst state for business in America in 2024.”

Among the numerous reasons for this, high tax rates and obstructive regulations were the central reasons behind this. In fact, according to the state Department of Taxation, the top individual state income tax rate is 11% for those making $200,000 or more, making it one of the highest rates in the country.

Similarly, as a report by the University of Hawaiʻi Economic Research Organization states, in 2021 local businesses faced an effective corporate tax rate of 6.6%, which is higher than the national average of 4.9%.

Blame The GET

But perhaps the most damaging of our local taxes is the general excise tax. On the surface, its 4.5% rate seems insignificant. However, a deeper examination of it reveals an almost surreptitious effect. That 4.5% rate is charged on the gross income of a business.

For example, take a business that makes, say, $10,000 in a month but pays $12,000 in expenses. This leaves them with a loss of $2,000. Here’s the catch: that business still has to pay the 4.5% tax on the original $10,000, meaning that they are being taxed on money they don’t have. In other words, it’s a phantom tax.

Hawaiʻi’s regulatory structure isn’t any better. When it comes to affordable housing, for example, it can take months if not years to obtain the necessary permits. This is due to the fact that the Department of Planning and Permitting constantly faces backlogs that stem from bureaucratic inefficiencies and excessive regulations.

So how does all of this affect the local economy? It discourages the establishment of businesses in Hawaiʻi, raises costs for local business owners, and disincentivizes important investments in our state.

Not only this, but when individuals face such financial impediments, it reduces consumer spending, thereby slowing down economic growth.

Hawaiʻi cannot expect to diversify the economy when the conditions for business are nearly punitive. There needs to be an environment in which businesses are able to grow and prosper. Reducing tax rates and regulations are a critical first step in achieving this goal.

Naturally, one may ask how much the government will need to cut spending to account for the tax cuts. This is a valid question, but there is a fundamental misconception in it. It is not necessarily the case that with a 10% tax cut, for instance, that a 10% spending cut must be enacted; it isn’t a zero-sum matter.

In economics, there is something called the Laffer Curve, which demonstrates the relationship between tax rates and government revenues. According to this model, as tax rates increase, there comes a certain point when government revenues decrease.

This is because high taxes gradually diminish the incentive to work and invest, shrinking the total pool of taxable income from which the government can extract.

As counterintuitive as it sounds, low taxes actually increase government revenues over time because it spurs investment and consumer spending.

In fact, according to the Tax Foundation, states that cut tax rates saw a 9.8% increase in tax revenues between 2019 and 2023, while states that didn’t cut tax rates saw only a 6.2% increase in revenues.

It’s no surprise that many local businesses struggle to survive in Hawaiʻi. An enormous tax burden and overbearing regulations sap the vigor and competitiveness out of the local economy.

We’d be wise to heed the words of Adam Smith, the father of modern capitalism, “After all the proper subjects of taxation have been exhausted, if the exigencies of the state still continue to require new taxes, they must be imposed upon improper ones.”

Until Hawaiʻi allows for the ingenuity of the free market to thrive, economic diversification will remain nothing but a dream.