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The Honolulu Advertiser
Posted on: Sunday, April 6, 2003

High-tech sector fears for Act 221

By John Duchemin
Advertiser Staff Writer

As the election campaign came to a head last fall, Linda Lingle promised the Hawai'i technology community that as governor she would protect Act 221, the high-tech tax incentive, from modification.

Present policy, proposal compared

The current situation:

Act 221 now allows technology companies to claim a 20 percent refundable credit for research expenses. A refundable credit means the state cuts a check for the credit amount even if the claimant has no tax liability.

In other words, if a company spends $10 million on qualified research every year, it can get a $2 million check from the state government every year.

The proposed change:

Gov. Lingle wants the tax credit to apply only to additional research spending, and to be nonrefundable. So someone with no tax liability would get nothing.

In that case, if a company spends $10 million on qualified research every year, it would get no tax credit, because its research spending is constant.

If the company increases research to $11 million, it would qualify for a $200,000 tax credit ($11 million — $10 million = an increase of $1 million; $1 million x 20 percent = $200,000).

And that credit would only apply against tax liability, meaning the company would not actually get a check in the mail for that amount.

Six months later, as governor, Lingle is attempting to change the law to such an extent that some high-tech advocates are afraid Act 221, designed to attract high-tech investors and employers to Hawai'i, will cease to exist as a useful incentive.

Starting in late March, Lingle administration officials have lobbied legislators to introduce changes to Act 221 that would largely eliminate one of the act's half-dozen tax credits, a 20 percent refundable credit on all research-and-development expenses. Lingle proposes a slimmed-down, non-refundable R&D credit, which would be applicable only to increases in research spending.

The proposed amendment has been rejected by legislators in both the House and the Senate, but Lingle administration officials promise to revisit the issue as negotiations continue on several tax bills.

The administration argues that the change would save tens of millions of dollars, instead of losing revenue, and help balance the state budget, which faces a significant revenue shortfall over the upcoming two-year fiscal period. Randall Roth, Lingle's senior policy adviser, argues that Act 221 will remain one of the most generous incentives in the nation.

"Even after the proposed changes are taken into account, Act 221 continues to be a very powerful tool to attract investment to the tech sector," Roth said Friday. "Reducing the credit is a very responsible way to deal with the budget shortfall."

But many Hawai'i technology investors, employers and entrepreneurs say the governor's proposal not only breaks her promise to leave Act 221 alone, but also strips local high-tech companies of cash and fund-raising ability.

"If I can go to a venture capitalist and say, 'Look, I get 20 percent on my R&D,' that's a very real dollar amount. They buy that," said David Watumull, president and chief executive officer of Hawaii Biotech, an 'Aiea research company.

A surprise to everyone

Even proponents of changes to the law, which became a focal point of controversy soon after its passage in 2001, were surprised by Lingle's decision to target the research tax credit. That section of the law was widely considered beneficial and not controversial, with debate instead revolving around a 100 percent credit on investments into high-tech companies.

Critics of Act 221 have argued that its language is too loose and liberal, and decried a lack of clear Tax Department rules. Under Lingle, the department introduced tighter rules intended to stamp out abuses of the investment tax credit.

But influential critics including venture capitalist Barry Weinman and local entrepreneur Tareq Hoque have called for actual amendments to the law.

Many high-technology industry advocates, including the lobbying group Hawaii Technology Trade Association, oppose this stance, arguing that the new rules will eliminate abuses and that changing the law could scare away investors.

Dim forecast changed it all

None of this debate, however, applied to the research tax credit. Only after the state Council on Revenues, an appointed board of economists attached to the Tax Department, worsened its forecasts for state budget revenues did the R&D credit become a major issue.

The council on March 12 reduced its fiscal-year 2003 revenue forecast by $56.4 million, blaming tens of millions of dollars in expected research tax credits. Though less than $10 million in Act 221 research tax credits were claimed in 2001, the council forecast that the amount would more than double in ensuing years as more companies took advantage of the act.

Lingle administration officials say the governor decided to seek changes to Act 221 only after considering the council's forecast. Tax Director Kurt Kawafuchi estimated that the proposed change would save $68 million over the next three fiscal years.

Nonetheless, high-tech advocates were shocked by the sudden shift in strategy. In an October campaign debate, Lingle said: "Act 221 should be allowed to run its course."

"If there's one thing investors don't like, it's uncertainty, and to give the impression that we are going to start tinkering with Act 221 this soon after its enactment would send the exact wrong message to investors," Lingle said then.

The governor's latest proposal would not just tinker, it would gut one of the most important parts of the act, said Ann Chung, executive director of the Hawaii Technology Trade Association. She said she has received "at least 50" e-mails from company executives opposing Lingle's act, and not one in favor.

"If we make this change, we'll be sending the wrong message to investors," Chung said. "We would just be reinforcing the message that Hawai'i is fickle, and is not committed to technology."

Roth said Lingle is being flexible and practical in the face of a different reality.

"The question is: What does a leader do when she is given new, important, convincing evidence about an important issue?" Roth said. "We don't elect leaders to ignore all new evidence and etch in stone what was said in the campaign."

Bill Spencer, president of the Hawaii Venture Capital Association, said the administration is only looking at the short-term costs of the research credit, and not considering the long-term benefits. Companies using the credit will be able to generate jobs and profits — leading to increased tax revenues that will outweigh the drain caused by the credits, Spencer argued.

"Their primary goal is to balance the budget; they're not looking at what's more important in the long term," Spencer said.

Not everyone agrees that the research tax credit is the difference between the long-run success and failure of the high-tech community. Hoque, the chief executive of wireless equipment maker Landmark Technologies and former president of HTTA, said that larger, established companies with big research budgets are likely to benefit from a generous research tax credit — but that the greater mass of smaller Hawai'i startups have little need for the credit.

"The administration is obviously under pressure to balance the budget, so we've got to be willing to have a little give and take, in order to hold on to what we have," Hoque said. "Even if you get rid of the R&D credit, we're still saddled with the most lucrative tax credit in the country."

Reach John Duchemin at jduchemin@honoluluadvertiser.com or 525-8062.