Panel criticizes tax incentives to businesses

By Sean Hao
Advertiser Staff Writer

The way the state gives tax incentives to businesses lacks oversight and accountability and there is no way to determine whether the incentives actually benefit the economy, according to a new report by a state advisory panel.

The recommendations come at a critical time for state officials, including Gov. Linda Lingle and legislative leaders, who are facing a huge budget shortfall but also are considering new tax incentives aimed at energizing the economy.

Among the new incentives likely to come before legislators this year are tax rebates for a resort development at Ko Olina as well as possible tax breaks for commercial construction and additional incentives for the film industry.

Both the proposed Ko Olina tax break as well as Act 221, a high-technology investment rebate, have generated controversy over the past year. While supporters see the incentives as a positive way to generate jobs and economic development, critics see them as handouts that don't necessarily create long-term economic growth.

The Tax Review Commission, which is charged with reviewing the state tax structure and determining whether tax policies are sound, is appointed by the governor every five years. The most recent report is the work of members appointed in 2001.

In its report, the commission said there is a need to examine business tax incentives now because the number of such tax breaks has doubled since the commission's last report in 1996.

Marilyn Niwao, a commission member, acknowledged that the report is critical of the way incentives are created by lawmakers who don't have a firm idea of the tax revenue at stake.

"I think the state Legislature has been a little bit too free in creating overly generous credits without the ability to check on them," said Niwao, who is president of Niwao & Roberts Certified Public Accountants on Maui.

The report notes that between 1957 and 1969, the state had only three tax credit programs compared with 20 today. The programs in effect now cover activities as varied as ethanol production, high-technology, motion pictures and hotel remodeling, among others.

The commission said among the incentives of most concern is Act 221. Created in 2001 to encourage high-technology industries to establish operations in Hawai'i, the law has essentially become a general business tax credit with generous allowances and no accountability, the report states.

For example, the credit only requires that more than 50 percent of a businesses' activity be considered high-tech to qualify. That means that for every $200.01 invested in such a business, $100 can be spent on a non high-tech activity, yet investors in the company can deduct 200 percent of the amount invested in the non high-tech portion from their taxes.

Additionally, in certain cases the tax credit can be taken by someone who has not invested their own money in a qualifying company.

"As a practitioner, I see more and more of these credits coming through," Niwao said. "I'm not sure these programs are benefiting whom the Legislature wanted to benefit."

Act 221 has also been criticized for its use by the film industry, which has temporarily pumped some money into the local economy but has not created permanent jobs. In 2001, investors in the surfing movie "Blue Crush" received at least $18 million in tax rebates, more than all Hawai'i technology companies combined.

Supporters of Act 221 say the state benefits from the legislation as well. Excluding credits given to the film makers, Act 221 brought in an estimated $16 million in capital to Hawai'i technology companies in 2001 and more than $20 million in 2002, said John Chock, president of the Hawai'i Strategic Development Corp., the state's venture-financing arm.

Chock said it's difficult to estimate how much Act 221 will end up costing the state in tax revenue because it's unclear how many people will take advantage of it.

"Good tax attorneys will find ways to use the law for their clients," he said. "In the near-term there may be a shortfall in terms of tax revenues ... (but) over the long-term, companies receiving the rebate should generate a lot more tax revenues."

In addition to criticism of Act 221, the report said the state's ethanol production facility credit allows a large maximum tax credit of 240 percent for investments in an ethanol production facility. The tax credit was approved as an incentive to build such a facility, but no one has proposed one.

The Tax Review Commission recommends the Legislature conduct a cost-benefit analysis of each of the tax credit programs as well as the state's energy conservation credit, which provides a tax credit of up to 50 percent of the cost of installing energy conservation systems.

"We need to pay much more attention to recognizing what the effects are and predicting what will happen" when tax incentives are created, said James Moncur, a Tax Review Commission member and University of Hawai'i economics professor.

Lowell Kalapa, president of the Tax Foundation of Hawai'i, a public watchdog organization, said he agreed with much of the commission's recommendations. Unlike a bond issue, where the public knows in advance how much a particular project will cost, the costs of many tax credit programs remains unknown, he said.

"When money gets spent, it's either going out the front door, in the form of a bond issue, or through the back door, in the form of a tax credit," Kalapa said. "With the tax credit, there is no accountability."

The Legislature is expected to review the commission's recommendations. Kalapa said the Legislature has a history of eventually adopting the Tax Review Commission's proposals, though typically only after several years of discussion.

Lingle's spokesman, Russell Pang, said the commission's report is still under review and that the governor had no immediate comment.

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