Will a higher threshold make the pension tax palatable?

It’ll be interesting to see if the proposal in the Legislature to tax pensions continues to draw the political ire of seniors now that the House has set the income threshold at nearly three times higher than originally proposed by Gov. Neil Abercrombie.

Hawai‘i  is one of only 10 states that don’t tax employer-provided pensions, and Abercrombie raised a fair point about whether that should change given the state’s precarious financial situation.

But he set the income threshold way too low at $37,500 for singles and $75,000 for married couples, which would have taken a big chunk out of the anticipated retirement income of middle-class citizens who could ill afford the loss.

The governor also failed to properly index the tax, which would have placed an unfair burden on those who fell just over the limit.

The House removed a lot of the immediate sting by raising the income threshold to $100,000 for singles and $200,000 for marrieds.

Rep. Isaac Choy, an accountant who is respected for his facility with numbers, estimated the tax will apply at this point to only 3,000 high-income taxpayers who can afford it, and the rest will have 15 to 20 years to prepare before inflation pulls them into the grip of the tax.

What remains to be seen as the measure moves to the Senate is whether nervous retirees and those soon to retire — a politically potent bunch — will be relieved by the reprieve or if they’ll continue to view any new tax on pension income as an ominous threat.

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18 Comments on “Will a higher threshold make the pension tax palatable?”

  1. Richard Gozinya Says:

    As presently proposed, how much additional tax revenue would this bill generate?

  2. David Shapiro Says:

    $17 million. Original proposal would have raised $112 million.

  3. Kolea Says:

    My attitude towards the bill has evolved as I have heard arguments from different quarters. I believe several things simultaneously, and each is pushing in a slightly different direction.

    I agree there is no inherent logical reason why pension income should be exempt from taxation. Imagine two seventy year old people. Both with the same income. One retired with a pension. The other does not. The person without a pension may have to work until “the day they die,” with no opportunity to retire.

    Let’s assume both are kindly, elderly, grandparently type of people who we adore and admire for their wisdom.

    Why should the person who continues to work have to pay taxes, further eroding their ability to pay their bills?

    The answer which JUMPS out is that the one person planned well and the other did not. But we do not know the person without a pension did not “plan well.” Suppose they worked for a company which went bankrupt and lost their retirement? Suppose they invested the wages of their earlier career into a small business which provided employment to others for years before a giant “big box” store moved in next door and wiped them out? Maybe they had prudently put their earnings into buying a home, secure in their belief that investment could be sold to finance their final years?

    I appreciate Isaac Choy’s argument that this should be phased in slowly, to allow people to factor it into their planning and avoiding a sudden shock to retirees. He proposes to allow inflation to deliver an ever-growing group of people subject to the tax. Right now, it applies to something like 0.7% of Hawaii tax filers. With inflation, it would apply to 1% in a few years. In a decade, it might hit 4 or 5% of Hawaii taxpayers.

    I see two problems with the proposal. First, it does not generate enough revenue. (I will ignore those who think the state has enough revenue to meet all reasonable needs.) $17 million will scarcely make a dent in the budget deficit. Yes, it will produce more income as inflation pushes more taxpayers past the threshold income, but the budget crisis is NOW. And it is real.

    Second, once the Adjusted Gross Income (AGI) rises above the trigger point, all the pension, including that below the threshold, will be subject to the income tax. This strikes me as absurd. It is certainly inconsistent with the way most the tax code works, where taxes are applied at the margin. Meaning once a threshold is reached, only income above that point is subject to taxation.

    Imagine to taxpayers, living side by side. One’s AGI is $100,001, the other’s is $99,999. Although one income is only $2 more than the other, the first person will pay thousands of dollars more. This violates a core principle of tax fairness: people will comparable incomes, from the same sources, should be comparable taxes.

    I believe there should be a tax on pensions. That it should be phased in to reduce its disruption to the lives of taxpayers. That it should be GRADUATED, with the first income threshold significantly lower than $100K, but only income OVER the threshold should be taxed.

    The easiest way to do this would be to exempt a set dollar amount of pension from taxes, perhaps the first $20K would be tax free.

    Under Abercrombie’s original plan, a retiree with an AGI of $37,500 would pay a tax of $2,249. Under the current House version, with the $100K threshold, that person would pay $0.

    If we exempted the first $20K of pension income, an elderly person with an AGI of $37,500 would pay $895.

    AB 1 : $2,383
    HB : $0
    Kolea: $ 895

    For comparison, an elderly person with an AGI of $37,500 without a tax-exempt pension pays the same as under Neil’s original plan: $2,383. (The AARP is willing to protect higher income pensioners, but seems to be overlooking how unfair this might be to the working elderly.)

    How much revenue this proposal would raise, I will leave to brilliant number crunchers like Isaac Choy and Marcus Oshiro. The concept I am advancing has the advantage of being more graduated than either of the two other proposals, and when it kicks in, it kicks in AT THE MARGIN, which is much fairer.

    The dollar amount of the exempt portion of pension income could be adjusted up or down, depending upon a consensus over what point is fair. And depending upon how much of the budget deficit we agree should be covered by this tax increase.

    Food for thought.

  4. Richard Gozinya Says:

    Thanks for the info,Dave. Sure seems like a lot of effort is being expended for only $17 million in near-term revenue. Pretty manini return on the investment of a lot of political capital.

  5. Kolea Says:

    I have already received an email pointing out a mistaken assumption in my proposal. If a person has an AGI of $37,000, a significant portion of that is probably non-pension income, already subject to taxation. So my sample numbers are off. Most of those people are already paying taxes on a portion of the AGI under either Abercrombie or the HB proposal. My numbers were assuming the entire AGI was derived from a pension, whcih is extremely unlikely.

    I accept that criticism, so the numbers need to be adjusted. But I believe the basic concept of exempting a set amount of pension income from taxation and then subjecting the income exceeding that exemption to the regular, graduated income tax, is a better approach than the income trigger being proposed by Abercrombie and the House and Senate versions.

    I look forward to more criticisms/refinements of the idea. Keep ’em coming.

  6. Michael Says:

    http://www.pbgc.gov/

    Savings Bonds.
    IRA.

    Like some individuals, our government works pay check to pay check with little or no savings. The more money one makes the more they spend. Taxes go up. Union dues go up. No one wins or balances.

    I learned from my mother who bought Savings Bonds and put aside pennies for IRA. 30 years at 100 dollars a bond goes a long ways. IRA of 2000 dollars a year helps. With a private retirement I will pay taxes as I cash in. A 100 dollar bond after 30 years matures around 500 each. Taxes taken out still around 350. Times this by 12 times 30 years plus worth. Yet my family did not starve. No such luxuries.
    Sad I did not listen and learn. Too American.

    You want to balance our Budget or retire. Get an elder Japanese woman to set the balance straight. Jokingly I say, making a dollar out of 15 cents.

  7. cloudia Says:

    EVERYTHING is being cut: basic mental health services,
    women infants & children, Head Start for heaven’s sake!

    EVERYONE must be glad to hold on to everything they can! Except of course the financial elite who (according to a fed member) “Have learned nothing, continue the party, who put us more at risk than ever.”
    But hey, let’s bicker over our crumbs and close another small school/ohana or two!

    Maybe the UH president might even have to move into her Manoa mansion!

  8. WooWoo Says:

    I agree with Kolea that there is no logical reason why a pension is not taxed, but logic and our tax code rarely intersect.

    This makes me think twice about my Roth IRA. I can see the day when I retire and they decide to tax it because they “need the money”

  9. Michael Says:

    What average retiree will make 37,500 gross a year pension? Maybe aiona? Maybe lingle? They are not average. Not the average person who worked for less. union or non-union. Maybe when a union member retires they will be paying union tax, so their reps can still drive their big suvs.

    Again I don’t see the worry about a Math Problem that does not exist except to those who gross before retiring 100 thousand or more a year.

  10. charles Says:

    “way to low ” or “way too low”?

    It’s the NRA argument, in a way. Once you tax pensions whether it’s $1 or $1,000,000, sooner or later, you’ll be taxing me.

    So, of course, I oppose it.

    Tax the other guy and I’m in full support.

  11. el guapo Says:

    At some point, higher income families should be taxed, but don’t forget that a lot of seniors prevent their children and grandchildren from becoming homeless families or a further case for DHS to deal with. In that way they are already saving the State a lot of money. I don’t have any hard facts to support this, but everyone knows someone who lives with their parents or whose children and grandchildren live with them.

  12. Kolea Says:

    I’ve gotten some feedback –that’s the polite word– to my proposal. It was pointed out that calling for an $895 tax hike on an AGI of $37,500 amounts to a 2.5% tax hike! And the tax hike would only hit retired State and county workers or retired military.

    I was asked why retired public employees and veterans should should be singled out to carry the load of balancing the state’s budget? Why not raise the income tax the amount necessary, with a renewed commitment to ensuring it was a progressive, graduated tax based upon “ability to pay”?

    One person called the plan to tax pensions a dishonest “gimmick,” an attempt by the state to renege on its earlier collective bargaining agreement with state employees and suggested future public sector negotiations will have to demand more wages and benefits upfront, if the state is going to reduce the value of deferred compensation in the form of pensions and Medicare reimbursements.

    So I have abandoned my proposal. I became distracted by the triggering mechanism in the Governor’s proposal and sought a better remedy to that problem, trying to come up with a better technical fix to what is a dumb and unjust idea in the first place. These pensions were agreed to in the understanding they would not be taxed. The state should honor that understanding. Or, if we are going to move away from it, the current Hoseproposal to set the threshold high and allow inflation to eventually, in the long run, make all pensions taxable in the distant future.

  13. WooWoo Says:

    Kolea-

    Your original post was logically correct: there is no reason why pensions in the state of Hawaii should be tax-free. Your latest decision to succumb to those who cry foul illustrates why meaningful change in our tax and fiscal policies is so difficult.

    Pensions are not by definition tax free. Most other states tax them. If a Hawaii retiree moved to another state, it would be taxable.

    Making a retirement planning decision based on the assumption that tax laws will not change is a mistake – and public policy cannot be held hostage by an individuals’ mistake in assumptions.

    That bears repeating.

    Making a retirement planning decision based on the assumption that tax laws will not change is a mistake – and public policy cannot be held hostage by an individuals’ mistake in assumptions.

  14. Michael Says:

    People should save on their own. No retirment plan offered for any job. There was none offered before but some businesses found they could make money off of pension plans. Before Hawaii became a State people just saved for their future. Called a Savings Account. Even Savings Accounts were charged taxes upon withdrawl.

    One could save more if they did not have to pay union dues.

  15. Kolea Says:

    WooWoo,

    I agree tax policies change. But most of these pensions are an agreement between the state, the counties and the Federal government. In effect, the state is now changing the terms of its agreement. Had the public workers anticipated this, they would have demanded higher wages and benefits at the time of the negotiations.

    Second, if the principle which is supposed to be guiding the budget process is “Shared Sacrifice,” why single out state, county and federal retirees for carrying such a large portion of the burden rather than spread it out more broadly.

    I was not wed to my math, but when it was pointed out I was proposing a 2.5% tax hike on retirees making $37,500, without seeking comparable tax increases from others, particularly high earners, it was obvious I was off-track.

    We can only subscribe to the idea public sector retirees have been getting a “free ride” if we blind ourselves to the fact that the unions accepted a lower amount of pension because they were tax free. Without the tax-free understanding, the state would have had to pay them higher pensions or higher wages.

    I do not believe the state has a right to renege on its collective bargaining agreements any more than I believe parties in the private sector have that right. We can negotiate new contracts with different terms, but we cannot renege on older agreements once the employees have met their obligations. That’s a shady business practice.

    While the dominant narrative about the state’s budget crisis portrays the state’s budget crisis as caused by overly generous union contracts, the real reason was the collapse of the financial market and the resultant recession, which continues to suppress state revenues.

    Now that we are in this jam, we need to find the most equitable way of getting out of it. Scapegoating the public sector retirees seems like a particularly mean-spirited, and unfair, “solution.” Anti-union propaganda should not blind us to our ethical obligation to honor our contractual obligations.

    I am still looking for a plan based upon genuine “shared sacrifice.”

  16. WooWoo Says:

    Kolea-

    The collective bargaining agreement says that the state will pay pensions. The collective bargaining agreement, which is negotiated between the governor and the unions, cannot stipulate that the pensions will be tax-free. Tax policy is the purview of the legislative branch.

    If the state were to stop paying pensions, that would be breaking a contractual agreement.

    No agreement exists between the State of Hawaii and the unions that pensions will be forever tax-free.

    Your arguments about shared sacrifice are separate from the logical argument for taxing pensions. I repeat that you were right the first time – there is no logical reason why they should not be taxed.

    This illustrates why our tax code makes no sense. Once a benefit gets written in, it must stay in forever because if it is taken away the benefitting group cries foul.

    Like many other middle-class homeowners, I get a huge tax deduction every year for mortgage interest. It makes no sense, except for the fact that the real estate industry is always one of the top 3 lobbyists on both sides of the aisle. Promoting home ownership arguments are bunk; Canada has a similar home ownership rate with no tax deduction.

    Although it would cost me a huge amount more in taxes, I would willingly give up this deduction in the name of closing the deficit and restoring sanity to our tax code. Unfortunately, it’s probably me and 3 other people in this country.

  17. shaftalley Says:

    i don’t think there should be tax on any state employees’ pensions.no matter how much their retirement income is.it’s nobody’s business what people earn or how they earn it or how they spend it.we can’t tax our way to prosperity.leave all retirees in peace.i also agree that the tax code inhawaii should be simplified.too many special interests involved with our state legislators to get exemptions,deductions.all of these problems could be solved by eliminating taxes on income.or at least a flat tax.and as far as public service unions.i believe in freedom of association.as long as people have the right to join or not to join.they shouldn’t be forced to join or pay dues as a condition of employment.is the state workers and hawaii teachers pension plans unfunded liabilities?maybe the new generation of state employees should consider a 401Kwith joint employee/employer contributions.

  18. zzzzzz Says:

    Woowoo–now you just need to find the other two. I’d also prefer a more streamlined tax process. The current one is such a pain, as well as an economic anchor, as so many resources are spent doing something that generates no overall value to the economy.

    Kolea–how about increasing the barrel tax as a way to share the sacrifice? That touches everyone, including tourists, and would also help reduce our dependence on imported oil, make renewable projects pencil out more favorably, reduce $$ leaving the state, ……..


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