The Scottish moral philosopher Adam Smith first published “;An Inquiry into the Nature and Causes of the Wealth of Nations”; on March 9, 1776. “;The Wealth of Nations,”; as it is usually abbreviated, is considered to be the first modern book on economics and as a result Smith is often referred to as the father of modern economics.

In “;The Wealth of Nations,”; Smith set forth four requirements for a good tax system. While many have posed other requirements and methods to evaluate a tax system, Smith's are still accepted as a valid basis for the discussion and assessment of a tax system. The four requirements are equality, certainty, convenience and an economy.

As a professor of accounting and an advocate for those living in poverty, I often lecture and testify on tax matters. I use Smith's four requirements to set the stage and always find that the most interesting discussions and debates are related to the requirement of equality.

According to Smith, equality means that “;A tax should be based on the taxpayer's ability to pay.”; The result of equality is that “;The payment of a tax in proportion to the taxpayer's level of income results in an equitable distribution of the cost of supporting the government.”; Basically, the more you make, the more you pay — a progressive tax rate system. This also seems to make sense from a spiritual perspective, as the good brothers I work with at the school on the slopes of Kalaepohaku often say, “;To those to whom much is given, much is expected.”;

So why in these hard economic times does Hawaii continue to be among the few states giving preferential tax treatment to capital gains income? Why does this tax break for those who possess the most continue when the financially marginalized are facing severe cuts in services due to the state's budget shortfall?

The state could raise significant income and cut into the budget deficit in order to help those in greatest need merely by taxing capital gains like all other income, just as the vast majority of states already do.

Capital gains are profits from the sale of assets, such as stocks, bonds, investment or vacation real estate, art or antiques. Capital gains are only taxed when they are realized; that means that the gains are only taxed when the asset is sold. Thus owners of real estate or stocks will not owe any income tax on the increase in the value of their property from year to year until that property is ultimately sold.

Economic theory and just plain old common sense tells us that when it comes to taxation, income from capital gains should be treated just like any other income. Taxes should really be imposed on capital gains just as they are imposed on wages and salaries, on interest earnings and the profits of small businesses and farms. For the reality is that a dollar is a dollar, regardless of how it is earned.

The Hawaii Alliance for Community Based Economic Development recently announced the release of a new report that finds Hawaii could save upwards of $21 million a year if it were to eliminate the special tax rates the state now offers to upper-income taxpayers for the capital gains income they receive. According to the report “;A Capital Idea,”; from the Institute on Taxation and Economic Policy, Hawaii is one of just nine states with lower tax rates for capital gains.

“;Hawaii's preferential rates for capital gains income deprive the state of millions of dollars in needed funds, benefit almost exclusively the very wealthiest members of our communities, and fail to promote economic growth,”; remarked Matt Gardner, ITEP's executive director.

In practice, very few working-class Hawaii residents have capital gains income that is subject to taxation. As the report notes, taxpayers with adjusted gross incomes of less than $50,000 comprised 67 percent of all federal returns filed by Hawaii residents in 2006, but constituted just 12 percent of returns with income from capital gains.

In fact, taxpayers in this income group received just 3 percent of total capital gains income reported by Hawaii residents on their federal tax returns that year.

In contrast, consider that the top 20 percent of Hawaii's taxpayers receive 99 percent of the actual tax benefits from the capital gains “;tax break”; with the top 1 percent, those with adjusted gross incomes in excess of $386,000, reaping 81 percent of the benefits.

This report highlights the need to review Hawaii's tax code comprehensively in light of our current fiscal challenges. It also reminds us that our state tax code benefits the wealthy and the capital gains treatment contributes to an unfair regressivity in our taxes. Eliminating or reducing this preference would move us to a more balanced and fair tax code and save the state badly needed revenue.

Right now, legislators from Rhode Island to Hawaii are searching for solutions to mounting budget deficits, solutions that will allow them to fund vital public services without placing additional responsibilities on those families struggling to make ends meet. Repealing costly, inequitable, and ineffective tax breaks like Hawaii's preferential rates are the first place our legislators should look.

———

Wayne M. Tanna is professor of accounting at Chaminade University and a member of the Board of Directors of the Hawaii Alliance for Community Based Economic Development.