On June 3, Gov. Josh Green signed House Bill 2404 into law, hailing the signing day as a “historic day” that would bring “much-needed tax relief to our residents.” Under the new law, standard deductions will be increased in 2024, 2026, 2028, 2030 and 2031; in 2025, 2027 and 2029 the lowest income tax brackets will be eliminated and tax rates on the remaining income brackets will be lowered.

The Hawaii Department of Taxation (DOTAX) estimates that by 2031, income taxes paid by working-class families will fall in steps by 10% to 72% depending on income. Forty percent of Hawaii households will no longer pay any Hawaii income tax by 2031, compared to 25% today. The cuts would provide an estimated $5.6 billion in total “savings” to taxpayers.

The changes to the tax code are long overdue.

Under the old tax code, inflation pushed more Hawaii households into higher income tax brackets each year, thereby generating higher tax liabilities, even when increases in their incomes may not have matched inflation. To address this problem of “bracket creep,” 17 of the 32 states with graduated tax rates adjust their income tax brackets annually for inflation (referred to as “indexing”). Twenty states (plus the District of Columbia) index their standard deductions. The Internal Revenue Service (IRS) adopted indexing in the 1980s.

With the passage of HB 2404, Hawaii’s income tax system will have made adjustments for its prior lack of indexing, but tax rates will still not be annually adjusted for inflation. Adding indexing to the tax code in the 2025 legislative session would help to make sure bracket creep is no longer an issue. All that said, the new tax code is a big improvement for working-class families.

For Gov. Green and the Legislature, the tax cuts come with a big loss in general fund tax revenue that rises sharply over time. DOTAX estimates that the first year (fiscal year 2025) loss in tax revenue will be $240 million, but losses will increase to $596.6 million in FY2026, $1.05 billion in FY2029, and $1.45 billion in FY2032.

DOTAX estimates already include “dynamic scoring effects” in which increases in state economic growth and additional spending by households with higher after-tax incomes generate additional tax revenues to offset some of the initial revenue losses. Empirical studies show that while these effects tend to be positive, they are typically relatively small, making up less than 20% of the revenue loss. When Kansas made drastic cuts in income and business taxes in 2012, big revenue losses resulted in cuts to vital government services, such as education and infrastructure.

During the signing ceremony for the bill, Gov. Green stated that the projected revenue decline will not be paid for by reducing government services. To us, this implies that the revenue gap will need to be closed by increasing other types of taxes. In this case, there is no reason to wait until the revenue gaps actually appear. If policymakers do this, then decision-making will be made in the crisis atmosphere of deep budget deficits.

Instead the Legislature should be proactive in the 2025 session in weighing the pros and cons of increasing different taxes. This would allow a public debate to happen in a less charged atmosphere. The alternative to cutting taxes is to cut services. Economic research shows that the most productive public investments are in infrastructure and “human capital” — medical care, early education, K-12 education, higher education and job training.

However the state responds, the Legislature and governor need to develop a baseline plan for adjusting taxes and expenditures well before serious deficits from the tax cuts start to appear.

James Mak and Sumner La Croix are senior research fellows at the University of Hawaii Economic Research Organization (UHERO).