How is Hawaii’s general excise tax different from a sales tax?

If you have ever looked at a list ranking the states by sales tax rate, you may have noticed that Hawaii ranks surprisingly low, at a mere 4.0%. What you may not know is that the tax used to calculate this rank is not a general sales tax.

Hawaii Has No Sales Tax

Strictly speaking, Hawaii has no sales tax. Instead, there is a general excise tax, or GET, also known as the GE tax. No other state has a similar tax.

A lot of people from the mainland make the mistake of thinking the GE tax is a sales tax. If they look at receipts for purchases in Hawaii, they will see a line for an “excise tax.” This only adds to the confusion, because these lines make it look like a charge the customer pays, which is exactly how sales taxes work.

A general excise tax is a tax on gross revenue, charged to businesses at every stage in the chain of production of goods.

With a normal sales tax, the shoppers pay it at retail. The store keeps that money separate from its revenue, then usually sends the funds to the state on a monthly or quarterly basis.

California’s state sales tax rate is 7.25%. A customer’s $100 purchase carries $7.25 in tax. The store keeps $100 in revenue and forwards $7.25 to the state.

In Hawaii, the tax rate is 4 percent, except for three of the state’s four counties where local surcharges of 0.5 percent apply, at least at the time of this writing.

At retail, goods are subject to the full GE tax rate. A wholesaler or manufacturer pays at a reduced GE tax rate of 0.5 percent. The GE tax still raises prices for Hawaii shoppers, as it’s imposed at all steps of manufacturing.

If you look at a receipt for a purchase in Hawaii, you may see a 4.712% GE tax charged. In most counties the rate is 4.5%, but what about the extra 0.212%?

Here is the confusing part: A general excise tax is essentially a tax on receipts, including the amount that is passed on. In effect, Hawaii charges a little bit of GE tax on the tax.

When the GE tax rate is 4.5%, a $100 sale carries $4.50 of tax. Pass that on to the customer and the receipt totals $104.50. As 4.5% of $104.50 is about $4.70, the general excise tax increases by about $0.20.

Charging 4.712% for the GE tax covers the liability exactly. A customer pays $104.71 for the $100 item. The tax on that is $4.71. The business keeps $100 and sends $4.71 to the state, so the books balance perfectly.

GET applies to most purchases, even those for necessities such as fuel, clothing, and food. More than 50 goods and services are exempt from the general excise tax.

Insurance producers pay a 0.15% tax on their commissions. Shipyard operators pay no GET on work done on federally owned ships in interstate or international commerce, and some nursing home income is exempt.

Legally the GET is a tax on a business’s gross income, not the customer’s. On a practical level, however, businesses usually try to shift some or all of this tax onto the buyers.

On the surface, Hawaii’s 4 percent rate looks low compared to a sales tax of 7.25 percent in California. In most states, only retailers such as Costco or a local market pay the sales tax. At every stage, from production to retail, every business pays the GET.

A general excise tax is a pyramiding tax. The price of goods increases at each stage from manufacturing to retail. As Hawaii’s GET compounds at each level, the final price for consumers is higher than one may expect. In the end, the effective rate a consumer pays can be, by some estimates, anywhere from 4.32 percent to 13 percent, depending on the number of steps a product goes through in Hawaii on a 4% base.

Roots in Hawaii’s History

So why does only Hawaii have this tax?

The GET has its roots in Hawaii’s history. It came into existence in 1935, in the depths of the Great Depression. It’s been a good source of revenue for the state since its inception.

At the time, real estate values had dropped, reducing revenue from the territorial tax on land. In the midst of this, the Territorial Legislature created the GET to shore up the budget.

The original rates were 0.25% to 1.25%, depending on the industry, and most businesses paid the higher one.

The general excise tax rates have risen steadily over time. After World War II, the rate for most sales was 1.5%. By 1957, the general rate was 3.5%.

It rose to 4 percent in 1965. In 2005 the legislature allowed counties to add half a percent as a surcharge.

Tax Reform

Proponents of tax reform have called for changes to the general excise tax. In 2018, Beth Geisting of the Hawaii Budget and Policy Center argued that the GET is regressive and falling hardest on low-income households.

Geisting thinks that reforming Hawaii’s tax code could help, especially the GET. Her vision would try to spread the impact more fairly.

On the other side of the issue are the people who want to leave the general excise tax alone. James Mak, a retired University of Hawaii economics professor, favors the GET. His argument, made in August 2022, is that a balance of taxes is ideal. Every tax has flaws, so finding a mix that keeps the economy healthy is best for everyone.

As the GET is an important source of revenue for the state government, Hawaiian lawmakers are reluctant to make any drastic changes to it. It usually provides 40% to 50% of general fund revenue each year.

Still, new Governor Josh Green and some lawmakers see it as one way to help Hawaiians with high living costs. They have suggested removing food and medicine from the list of taxable items.

The Grassroot Institute of Hawaii campaigns for exempting medical care from the general excise tax. The group argued this would encourage new doctors to locate in Hawaii, adding much-needed medical care. Another argument was that it would lower medical costs for residents.

Whether these proposals pass remains unclear at the time of this writing. The debate on ways to make Hawaii more affordable will likely continue, as long as Hawaii remains one of the most expensive states in the nation.