Earlier this year, the City & County of Honolulu tinkered with its real property tax system.  People who aren’t aware of what happened may find themselves with property tax bills many times what they are now.

In Honolulu, as in most other counties here and in many jurisdictions on the Mainland, there are several property tax classifications.  For example, there is residential use that is taxed at $3.50 per $1,000 of assessed value; commercial use, taxed at $12.40; and hotel/resort, taxed at $12.90.  The classification that you fall in is determined by the “highest and best use” of your property.

Highest and best use has nothing to do with how you are actually using your property.  It means the most productive use that your property could be put to, if it is legal under applicable law and zoning.  So, for example, a person who owns industrial zoned land next to a shopping mall can build a farm on it and grow vegetables, but the property tax rate that will be applied won’t be the agricultural rate, it will be the higher commercial rate.

For most people, qualifying for the residential rate, the county’s lowest, is not a problem.  Much of the land that people build houses on is zoned for residential use, which means it’s not legal to run businesses or resorts on that land.  The highest and best use is residential, and that’s what determines the tax classification.  However, some properties in the Honolulu urban core are given “mixed use” designations, which means it is legal to build a house on the property or to have a shop there.

This is where the problem arises.  Currently, the tax ordinances allow condominium units to be classified based on actual use, not highest and best use.  Thus, people who live in condominium units were allowed the residential rate if they said they were actually living in them, even though the zoning allowed commercial use.  Some complained that the system was inconsistent:  if the farmer in the example above had to pay at the commercial rate, why does the person living in the condominium unit get to qualify for residential?  Ordinance 17-13, enacted earlier this year, took away the actual use “loophole,” bringing back the highest and best use rule for condominium units.

To get around the highest and best use rule, the ordinances allow property owners to make a “dedication.”  A dedication is a contract with the county that says the use of your property will be restricted to a particular use even though the zoning allows something else.  With the dedication in place, commercial or hotel uses become illegal even though the zoning may allow them, so those uses cannot be considered highest and best.

Ordinance 17-13, mentioned earlier, also allows for those living in mixed use areas to make a dedication to residential use.  A property owner who makes one will be allowed the residential tax classification.  A property owner who doesn’t may well be reclassified to commercial or hotel/resort, with severe financial consequences.

To make a dedication, the appropriate form needs to be filed by September 1.  It’s referred to as Form BFS-RP-P-41E, Petition to Dedicate Certain Property for Residential Use (5 Year Dedication).  Don’t be late!

We continue our discussion about the 5% charge assessed against special funds in Hawaii government, also known as the “Central Services Skim.”  Last week, we examined the exemptions from the skim and the danger that the funds who are paying the assessments can claim that they are being gouged.  This week, we look at the one State department that has funds with no exemption, and refuses to pay it:  the Department of Hawaiian Home Lands (DHHL).

When the State Auditor published recommendations in 1994 relating to the Central Services Skim, it included one saying that DHHL wasn’t paying it but should.  DHHL published a rebuttal arguing that the Central Services Skim assessments violated the Hawaii Constitution, the Hawaiian Homes Commission Act of 1920 (HHCA), and our Admission Act; and that the funds were trust funds to be used exclusively for the benefit of native Hawaiians.  DHHL’s most recent audited financial statements, for the fiscal year ended June 30, 2016, indicates that it still doesn’t believe it has to pay.  The financial statements estimate that the cumulative total assessments that it has refused to pay is about $24 million.

With that, we examine the arguments DHHL has made.

Concerned about the condition of the native Hawaiian people, Congress enacted the HHCA to set aside about 203,500 acres of ceded lands for native Hawaiian homesteads.  Section 213 of the HHCA established several funds, including the Hawaiian home administration account, the Hawaiian home operating fund, the Hawaiian home receipts fund, the Hawaiian home trust fund, and the native Hawaiian rehabilitation fund.  As originally enacted, all five were special funds.  Act 27 of 1998 purported to reclassify four of them as trust funds.

When the State of Hawaii was admitted to the United States in 1959, section 4 of the Admission Act provided that the HHCA would be adopted as a provision of the Hawaii Constitution, provided “that all proceeds and income from the ‘available lands’, as defined by said Act, shall be used only in carrying out the provisions of said Act.”

In 1978, the Hawaii Constitutional Convention, worried about the chronic underfunding that the Hawaii Legislature had given DHHL for many years, recommended a constitutional amendment that required state government to appropriate “sufficient sums” to fund it.  The effect of that constitutional provision is now being litigated in the court system in a case named Nelson v. Hawaiian Homes Commission.  The court decisions so far have indicated some willingness to force the Legislature to appropriate more money to DHHL than it historically had received.

DHHL’s arguments appear to be both textual and practical.  It first argues that the texts of the HHCA, Hawaii Constitution, and laws prevent the diversion of HHCA assets to purposes other than those authorized by those laws.  It then says that DHHL has been fighting for years to have the Legislature fund it adequately as the Hawaii Constitution requires, and the Central Services Skim would force many more dollars to go in the wrong direction.

The textual arguments do not seem to be airtight.  Section 213(f) of the HHCA expressly allows the Hawaiian home administration account money to pay for “salaries and other administration expenses of the department in conformity with general law applicable to all departments of the State.”  If DHHL is deriving benefits from central services provided by other state departments, that language would allow the account to pay for them.  The more general argument about the funds being bound to a specific purpose doesn’t seem to hold up; the funds need to continue to exist, the programs they support need to employ people, and the people need to be hired and paid.  If the funds are accepting benefits from State central services, it is fair that those benefits be paid for.  Even the federal agencies administering the transportation-related funds allow their funds to pay for central state government expenses for this reason.

The more interesting question, however, is the practical one.  If the State ultimately is found to have been shortchanging DHHL unconstitutionally, then it will have to make things right.  Consideration for any central services benefits DHHL received would be proper, but the overall shortfall, which appears to be considerable, may be enough to justify, at least to some degree, DHHL’s refusal to fork over the ski

Last week, we began a discussion about the 5% charge that is assessed against the “special funds” in Hawaii government, which we called the “Central Services Skim.”  For the last few fiscal years, the Central Services Skim has redirected about $45 million a year from the special funds to the state general fund, ostensibly to pay for shared services such as human resources and administrative costs.

This week, we look at the exemptions and the danger they pose.

Not every pot of money in state government pays the Central Services Skim.  Special funds pay it, but “trust funds” and “revolving funds” don’t.  The distinction between the three types of funds can be subtle.  The State Auditor has described a special fund as one “used to account for revenues earmarked for particular purposes and from which expenditures are made for those purposes.”  A revolving fund is one “from which is paid the cost of goods and services” by a state agency, “and which is replenished through charges for those goods or services or through transfers from other accounts or funds.”  A trust fund is one that invokes “a fiduciary responsibility of state government to care for and use only for those designated to benefit from the funds.”

On top of that, state law exempts many special funds from the Central Services Skim.  When the State Auditor examined the issue in 1994, 21 different special funds were exempted.  The exemption list has grown to 36 today, with 35 exemptions in HRS section 36-27 and one in another law.  The exemption list doesn’t appear to have a common theme or thread.  It includes, for example, the Turtle Bay special fund, the civil monetary penalty special fund, the deposit beverage container special fund, the community medical centers special fund, the Aloha Tower fund, and the sport fish special fund.

With trust and revolving funds categorically exempt from the skim and many of the remaining funds covered by exemptions, we have a chance to get into some sky-high trouble.  Take the airports, for example.  In fiscal 2016, the Airport Revenue Fund, which is largely fed by aircraft landing fees, ponied up close to $15 million in Central Services Skim.  The FAA, which put out an Airport Compliance Manual in 2009 (also known as FAA Order 5190.6B), explains that airport revenue is supposed to be used for the benefit of the airport.  The laws do allow an airport sponsor (our Department of Transportation, for example) to apply some of that revenue toward the general costs of government, if the costs are allocated to the airport fairly.  Because Hawaii’s Central Services Skim law is older than the federal laws imposing restrictions on airport revenue, our 5% skim is grandfathered.  However, the FAA made it clear in the manual that it can retaliate, such as choking off the amount of Airport Improvement Program discretionary grants, if it finds that an airport sponsor has been diverting too much.

There, of course, is the danger.  There are more loopholes in Central Services Skim obligations than a Swiss cheese, there is no common thread between them, and the loopholes have been proliferating.  It was difficult in 1994 to find that central services expenses are being fairly allocated, and the facts have worsened over time.  The federal government might wake up one day and conclude that the airport fund, which now pays roughly a third of the Central Services Skim, has been gouged.  If it decides to act, you can be sure that the action won’t be pretty.  And then, if there is carnage over the airport fund, the highway fund and the harbors fund couldn’t be that far behind.

The underlying premise, that special funds should contribute to the costs of government because they are deriving benefits, is sound.  For some reason, however, our government finds it intolerably difficult to allocate those costs fairly.  If we can fix this situation, maybe we will come up with some good ways to fix our tax system, which is supposed to allocate the costs of government to the populace.

Next week, we examine the one department that has thumbed its nose at the Central Services Skim.

In this space, we have often spoken of funding government with “special funds.”  Special funds are pots of money dedicated to a specified purpose.  Money in the fund can be spent for the specified purpose without going through the general appropriation process at the Legislature.  Agencies love them because they can spend money without interference by meddlesome lawmakers.  Supporters of the programs and services that the fund is spent on like them too, because the fund is dedicated to their program or service.  Or so they think.

But there is some “skimming” going on.  A Hawaii law dating back to 1955, which now can be found at HRS section 36-27, says that 5% of any special fund’s income will be paid to the state general fund to pay “central service expenses,” which we assume are shared services costs such as payroll, accounting, compliance reporting, and other administrative costs.  HRS sections 36-28, 36-28.5, and 36-29 apply a similar skim to the highway, airport, and harbor funds respectively, except that the 5% applies to the fund’s income net of payments for principal and interest on bonds.

The same 1955 law contained another provision, now found at HRS section 36-30, which says that each special fund “shall be responsible for its pro rata share of the administrative expenses incurred by the department responsible for the operations supported by the special fund concerned.”  This law does not provide for a flat percentage, but instead requires the state department in charge of the special fund to figure out the proper administrative costs.

Reports to the Legislature by the Department of Budget and Finance show the amounts assessed in recent years:

Source:  Department of Budget and Finance, Budget, Program Planning and Management Division website

In 1994, the State Auditor, Marion Higa at the time, issued Report 94-17 on these assessments.  She concluded that it was appropriate for special funds to pay their fair share of administrative costs.  But she observed that a flat 5% seemed to be an arbitrary percentage and wondered whether it was a reasonable amount, observing that other states that charged central services expenses were charging quite a bit less in percentage terms.

To determine whether the 5% flat amount is fair, we need to know what costs this charge was meant to cover.  The State Auditor recommended that the Department of Budget and Finance put out some rules, which the statute authorizes explicitly, to add clarity and consistency.  It’s 23 years later and we’re still waiting for those rules.

In upcoming weeks, we will examine other issues relating to the Central Services Skim, as I call it, including the sheer number of funds that are exempt from it and how continued proliferation of the exemptions may get us in sky high trouble with the federal government, and the one department in state government that flatly refuses to pay a penny of the Central Services Skim.