Tech-biz tax breaks changes shelved

By Sean Hao
Advertiser Staff Writer

A proposal to scale back the state's technology tax credits will likely have to wait until next year, but several other states are still considering similar moves as they face burgeoning budget deficits.

House members balked at Lingle's proposed changes last week, contending that it is the wrong time to curtail economic diversification efforts by pulling back on credits for the high-tech industry. The plan now is to discuss Act 221 issues over the summer.

But severe budget shortfalls in other states, including California, Illinois, Ohio and New Jersey, are continuing to force debates over cuts in high-tech tax incentives.

"A lot of states are looking at doing something about erosion of their corporate income taxes," said Bob McIntyre, director of nonpartisan watchdog group Citizens for Tax Justice.

Created in mid-2001, Hawai'i's tax credits for technology investment as well as research and development are considered especially generous, but they are not unique. Many other states compete for high-tech, high-wage jobs with similar incentives.

Proponents of Act 221 say Hawai'i stands out because of the size of its tax credits: a 100 percent nonrefundable income-tax credit for technology investments and a 20 percent refundable corporate income-tax credit for qualifying research costs. Because the credit is refundable, businesses do not need a tax bill for the state to pay them one-fifth of their research costs.

The two incentives combined trump the offerings of most other states, including those with lower business costs, said Dan Berglund, president for industry consultant the State Science & Technology Institute in Westerville, Ohio.

"It would be very safe to say that what Hawai'i has is one of the most, if not the most, generous tax credits," he said. "Hawai'i faces a real set of unique challenges given the geography, (and) given the nature of the economy and how dependent it is on tourism. In a way, it really takes something unique and dramatic for Hawai'i to move forward significantly in growing a technology base."

Lingle has been proposing changing language in Act 221 requiring the Department of Taxation to liberally interpret Act 221. She also wants to amend the research tax credit so it applies only to the increased research costs of a company rather than its entire research budget.

Under Lingle's plan, the research credit also would no longer be refundable — so companies could only benefit if they generate profits.

That could save the state tens of millions of dollars, but it also would make Hawai'i's technology tax incentives less attractive compared to other states', Berglund said. It also would send technology investors and companies conflicting signals about Hawai'i's receptiveness to high-tech business.

"If you change it, it would remove its uniqueness," Berglund said.

Many states offer research tax credits but most model the credits after a federal program that provides a 20 percent nonrefundable credit only on increased research costs.

Exceptions include California, where companies can claim a 15 percent nonrefundable tax credit against total research costs, and Maryland, where companies can claim a nonrefundable 3 percent credit against their base research costs and a 10 percent credit against any increases in research spending.

Several states, including California and Ohio, also provide investment tax credits, although neither offers credits as large as Hawai'i's. Administration officials have blamed Act 221 for a drain on state tax collections.

During the first nine months of the fiscal year, Hawai'i companies paid an estimated $26.4 million in corporate income taxes but claimed $40.8 million in refunds, representing a decline of 109 percent in income for the state from the previous year.

The tax department blames the loss in corporate taxes on Act 221 because, unlike other business incentives, the research tax credit is refundable. For example, a company that spends $1 million on research but does not post a profit can still claim a $200,000 refund from the state.

Act 221 cost the state $23.6 million in 2001, including $14 million in research tax credits. But the total future cost after one year is estimated at $60 million because only a portion of investment tax credits can be claimed each year. In 2002, Act 221 is expected to cost another $45 million, according to tax department estimates.

Just what Hawai'i is getting for its money is a subject of debate.

A tax department analysis of the act's first two years showed negligible job growth while a survey by industry trade group Hawai'i Technology Trade Association reported about 2,000 jobs directly created by Act 221 and another 2,000 jobs generated indirectly.

But concerns about Act 221 extend beyond its cost and benefits.

Lingle has expressed concerns that many tax credits are being claimed to avoid taxes rather than spur industry growth. The abuses cited include research tax credits claimed by ineligible tax-exempt organizations and by financial institutions applying the credits against franchise taxes instead of income taxes. Other companies have artificially inflated their research spending figures, the administration contends.

There also is inappropriate use of the technology investment tax credits, such as those used for one-shot movie deals that don't create permanent jobs or contribute to the economy on an ongoing basis. The tax credits also have been claimed for investments that are repaid for services rendered, among other things.

As a result, the administration doubts whether the technology industry has been the main beneficiary of Act 221.

"The intent of this law is so good and so important but with many laws, especially as it related to taxes and tax credit and tax deductions and so on, sometimes there are unintended consequences and there were major unintended consequences with Act 221," Lingle said.

Controversy surrounding the act is "creating a reputation for us as a place to go to a tax shelter, not a place to be taken seriously in technology, and that will hurt us over the long term," she said. "And we need to really turn around that reputation as a place where there is serious investment."

Mike Fitzgerald, president and chief executive of Enterprise Ho-nolulu, says it is too early for Hawai'i to opt for changes to Act 221.

"We're going to do more damage to the economy by changing that," he said. "I think it's too early to make an up or down decision on it right now."

While Hawai'i lawmakers appear likely to shelve changes to Act 221 this year, other states struggling with budget shortfalls are reconsidering their technology incentives:

• California is weighing whether to extend a manufacturing investment tax credit amid a decline in manufacturing jobs.

• Illinois is considering repealing a 6.5 percent research credit, which applies only to increased research and development costs.

• New Jersey suspended net-operating-loss carryovers for technology companies for 2002 and 2003, but extended the program's duration from 15 years to 17 years. That means a company cannot use prior-year losses to lower its tax bill for two years.

• Ohio is debating whether to reauthorize and possibly increase a technology investment tax credit.

Some states are debating alternatives to incentives or are increasing technology incentives. Ohio and Pennsylvania are considering selling bonds to finance economic development programs and Washington recently passed a technology research tax credit.

Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.