Posted on: Sunday, April 13, 2003

COMMENTARY
Hotel tax credits generate reliable revenue for state economy

By Joseph Toy and James Mak

The value of tax credits to our economy dominates much discussion at the Legislature and in the media.

Given the public trust placed on our state lawmakers, it is perfectly reasonable that hard questions be asked whether such tax incentives do indeed produce the intended benefits to the state.

In answering these questions, however, we need to be careful not to jump to conclusions or rely on incomplete information lest we risk eliminating incentives that clearly provide long-term benefits to our economy that well exceed the cost of any tax credit.

Such is the case with the existing hotel renovation tax credit, which the Legislature is now considering extending beyond its June 30 expiration.

There are several important reasons why deciding not to extend the hotel tax credit would be a mistake.

First, the hotel tax credit produces positive income for the state — it generates more money than it costs — and can continue to be an important contributor to our state's economy.

In estimating the cost of the hotel tax credit to the state, the Department of Taxation assumed hotel and related construction expenditures of $392 million per year for each of the five years of the proposed extension, with a resulting $39.2 million in annual hotel tax credits (or lost tax revenue). However, these estimates did not consider the substantial new tax revenues that would result from the construction itself, as well as increased tax revenues from renovated hotels being able to attract higher-spending guests and achieving higher room rates on an ongoing basis.

Given the assumption that $392 million in new hotel renovation and construction is being pumped into the economy every year, isn't it logical to expect increases in tax revenues after all of this investment? Clearly, the answer is yes.

When we consider that construction also creates increased sales from numerous suppliers and other businesses that support construction, we find that after applying economic multipliers prepared by the Department of Business, Economic Development and Tourism, the estimated additional state tax revenue generated from the construction within the same year is $45.2 million, or $6.1 million higher than the credit.

This does not take into account additional state tax revenues that will continue to be paid in subsequent years because of the higher room rates and higher-spending guests that result from renovated and repositioned hotels. When all of this is considered, the new tax revenues to the state both during and after the year of construction clearly far exceed the cost of a one-time credit.

Second, these positive tax revenues accrue immediately to the state. There is no revenue loss by the state at any time. This results from when the construction work is done and when the tax credits are given. The construction work is started and the money is spent in Year 1. Construction materials and wages are paid in Year 1. General excise taxes and income tax withholdings occur in Year 1, producing immediate revenue to the state.

Yet no tax credits can be taken in Year 1 — these can only be taken in Year 2 when tax returns are filed, based on expenditures made in Year 1, so the state is always ahead of the game. This is a very important consideration given the state's current economic condition.

Third, the hotel tax credit has done exactly what it was intended to do — spur construction. State tax data indicate that when the tax credit was introduced in 1997, the level of hotel construction was at least $23.2 million. This increased to $177.5 million in 2000 and to at least $159 million in 2001 as the effect of the tax credit took hold. These numbers indicate that once the tax credit was passed, a start-up time for planning and design work commenced and a ramp-up of actual construction followed.

Also, revoking the hotel tax credit could cost the state thousands of jobs. How can this be? The answer lies in what economists call the "multiplier effect." Each dollar spent on construction multiplies its impact throughout our economy as construction workers spend paychecks at Longs Drugs or Foodland, making it possible for those companies to keep paying their employees.

Not only do those employees spend their paychecks in turn, keeping the cycle going, all these employees pay taxes, further benefiting the state's bottom line.

Historically, for every $1 million spent by the hotel industry on construction, about 19 jobs are created. In 2001 alone, hotel construction work created more than 3,000 jobs. Between 6,900 and 7,300 jobs would be created each year through 2008 as a result of the construction spending estimated by the Department of Taxation. These jobs enable a lot of local families to support themselves, pay taxes and not burden our social services system.

Some have argued that tax credits don't matter, that this level of construction would have occurred without the tax credits. The available evidence tells us otherwise.

A recent case study was completed on nine hotels that spent $233 million in construction and remodeling since the hotel tax credits have been in effect. Owners of these hotels were interviewed, and all stated that the tax credits were an important consideration in the investment decision.

Several owners stated that the tax credit was a factor in reallocating construction budgets from Mainland projects to Hawai'i, while others stated that the renovation might have been postponed, scaled back or not pursued had it not been for the tax credits. Nearly all the owners reinvested the credit back into the hotel, further benefiting Hawai'i's visitor industry.

The case study estimated that the construction done by the nine hotels gave rise to a total of $5.8 million in tax credits. However, according to DBEDT estimates, this construction also resulted in $16.7 million in additional taxes to the state, or nearly three times the cost of the credit.

One must consider the condition of the Marriott Waikiki Beach Hotel and the Aston Waikiki Beach Hotel before the renovation that was needed to restore them to first-class hotels. Now these hotels are able to improve their revenue substantially, leading to higher tax revenues for both the state and counties and providing more stable employment.

It has not been easy for the hotel industry over the past decade. As a result of the Gulf War in 1991, the bursting of the Japanese investment bubble, and the shock of 9/11, some hotels have struggled to maintain their properties. Hotel tax credits are helping turn this around and keeping Hawai'i competitive as a tourist destination.

Joseph Toy is president of Hospitality Advisors LLC, a Hawai'i-based tourism and real-estate consulting firm. James Mak is a professor at the University of Hawai'i-Manoa, specializing in the economics of travel and tourism, and public finance.