HI. TECH
Questionable logic undermines Lingle's call for reforms of Act 221

By John Duchemin
Advertiser Staff Writer

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According to this logic, reining in the act will not only help save the state from this budgetary crisis (tens of millions of dollars in shortfalls) but help keep our kids in school.

Lingle administration officials claim that curtailing the section of Act 221 that lets companies take a 20 percent refundable credit on high-tech research expenses will add $68 million to tax revenues over the next three fiscal years, wiping out a sizable part of the projected shortfalls.

This argument, however, is not only ironic — six months ago, Lingle vowed to protect Act 221 from changes — but also based on questionable math.

Administration officials project that high-tech companies would claim at least $26 million in research tax credits in fiscal year 2004 and $20 million the next year.

Officials base this projection on 2001, when companies claimed $9.8 million of the credits. Since that was the act's first year, the administration assumes the amount of tax credits would increase in subsequent years. By 2004, Lingle officials predict, the amount of research tax credits claimed under Act 221 will be almost triple the amount claimed that first year.

If that's the case, then Hawai'i has a far larger research community than anyone realizes. To walk through the math: Lingle expects Act 221 will generate at least $26 million in research tax credits in fiscal 2004. Because those are 20 percent tax credits, at least $130 million of research will have to be done in 2004 to generate that much money ($130 million times 20 percent = $26 million).

Where is this money going to come from? The Hawai'i high-tech community would be hard-pressed to find five companies whose total revenues add up to $130 million, let alone produce $130 million in R&D.

What's more, the Act 221 research tax credits can only be claimed on "qualified" research expenses, a strictly demarcated definition that even excludes many types of scientific expenses. Hawai'i Biotech president David Watumull asserts that if the Hawai'i economy is producing $130 million in qualified research per year, the actual amount of research could be nearly double that — about $250 million per year.

If the high-tech community in Hawai'i was investing $250 million in research and development per year, we wouldn't be having this discussion. There would be no need for Act 221.

"If we had that kind of money we'd be dancing in the streets," says Ann Chung, executive director of the Hawai'i Technology Trade Association.

Another problem with the governor's argument is that it looks only at the costs of the research tax credit.

Lingle is accurate in arguing that Act 221 is extremely generous — and possibly excessively so — to R&D companies. Because the credit is refundable, businesses don't even need a tax bill for the government to pay them one-fifth of their research costs.

But the governor hasn't made a public attempt to weigh the benefits of trying to stimulate high-tech research. Tech advocates argue — with some logic on their side — that the money the government pays out in R&D credits could help generate additional high-tech jobs, therefore generating more income and general excise taxes — possibly enough to "break even" on the research tax credit.

This may not be the case — but how can anyone know without a thorough study? Again, irony lurks close to hand; a recent special commission on taxation reported that Act 221 should have been subjected to a cost-benefit study before its passage in 2001. Now, Lingle wants to torpedo a key part of the act — without weighing the costs and benefits of doing so.

This is not to say that Lingle is wrong to try to balance the budget, or to take a hard look at Act 221, which according to the Tax Department has been subject to abusive usage that undermines its credibility and drains the state coffers. Indeed, other proposed changes to the act intended to tighten the law are supported by several influential members of the high-tech community.

But by using questionable logic to push for changes to the R&D credit, the governor has not made a convincing case. It's the type of argument that could not only undermine her credibility with the high-tech community, but also produce greater resistance to other proposed changes to Act 221 that are based on better logic.