Posted on: Sunday, January 26, 2003

COMMENTARY
Tech industry needs to reclaim benefits of Act 221

By Tareq Hoque

Over the past weeks, local investors put money into several of Hawai'i's premier high-tech companies — HotU, Hawaii Biotech, Hoana Medical and Landmark Networks (of which I am CEO), to mention a few. We should celebrate these investments as evidence that the state's high-tech economic incentive policy — Act 221 — is nurturing our tech industry.

A strong tech industry will have a meaningful impact on our state's economy through diversification and by creating lasting jobs that pay high wages. Yet, as the state struggles with a budget shortfall and difficult spending decisions, we need to remain vigilant to the misuses of Act 221 that are exacerbating our state's fiscal condition.

The intent of Act 221 is to promote business creation and economic development in the high-tech industry by encouraging local investment. The act reduces the financial risk to investors through a 100 percent state tax credit equal to their equity investment in qualified technology companies. The sustained economic output and job creation of these newly created technology companies is supposed to more than compensate the state for these initial tax credits to investors.

However, Act 221's dirty little secret is that most of its tax credits have nothing to do with high tech, nothing to do with investment, and nothing to do with starting local ventures.

Most of the $80 million-plus in Act 221 tax credits, perhaps more than 80 percent, have been exploited to benefit out-of-state movie producers who use the tax credits to subsidize their one-time filming projects. The state essentially has given these out-of-state movie producers a blank check into its tax revenues, with no oversight mechanism and no cost-benefit determination process.

As chairman of the Hawaii Technology Trade Association, I can tell you we worked hard with our legislators to pass Act 221 in 2001. We are disturbed by the growing trend of misuses and abuses of Act 221 in ways that we and most legislators never intended.

The inclusion of performing arts under Act 221 was supposed to help pioneering new-media companies in Hawai'i.

Square USA, for example, employed more than 150 professionals to develop new software and graphic techniques. They rendered one of the world's first virtual movies, "The Final Fantasy," on their massive computer server farm in Honolulu.

The Ohana Foundation also employed dozens of programmers to create interactive education software that was distributed globally.

By contrast, with the film project "The Big Bounce," Hawai'i taxpayers provided $50 million in tax credits, but the producers reportedly spent only $13 million locally during filming. The other $37 million in tax credits were sold at very low cost to a number of wealthy local "investors" and institutions who are using them to dodge their taxes during the next five years. The state has nothing lasting to show for its $50 million in tax credits.

So far, only a small portion of the producer's activities are performed in Hawai'i. Of the activities that have taken place here, there is only a short-term spurt of economic spending activity. There is no investment to produce sustained economic benefit for the state.

There is a world of difference between spending money on a project and investing money for the creation of a lasting enterprise. After leaving the state, these film producers furloughed all the temporary local hires; all the production equipment and vehicles sit idle or are returned to California. There is little or no investment, no creation of an industry and no economic development.

Controversial film projects such as "Blue Crush" and "The Big Bounce" cost the state treasury tens of millions of dollars in tax revenue. The amount rivals the entire annual marketing budget of the Hawai'i Tourism Authority, which promotes the state's crucial tourism and travel industry. These films generated fleeting economic activity in the state, but the payback to the state is minimal in relation to the enormous costs in lost revenue.

These generous incentives give insight into why the state's film commissioner "is dealing with an onslaught of calls — Hollywood is showing tremendous interest in Hawai'i." Where else can any producer get a blank check for tens of millions from the state's coffers, with no oversight, no cost-benefit justification and no requirement to leave lasting improvement? The size of the subsidy is limited only by the producer's ability to sell excess tax credits to people wishing to avoid paying their taxes.

Before Act 221, movie producers negotiated their deals directly with the state and had to justify their incentives with a suitable return for the public. Contrast the "Lilo & Stitch" deal, done before Act 221, that cost the state only $1 million yet gave it three years of marketing tie-in, promotion and oversight, to a fleeting project such as "The Big Bounce."

The tech industry is also troubled that the flood of excess tax credits from some film projects has greatly reduced the ability of local high-tech companies to gain the attention of local investors. The movie projects have kept the high-tech industry from reaping the full benefits of Act 221. The tech industry has the greatest stake in seeing the misuses curtailed and the mission of Act 221 — to build a quality high-tech industry — re-established.

The Hawaii Technology Trade Association would like to see the state Department of Taxation create guidelines to ensure Act 221's appropriate application with adequate oversight. However, if administrative action is not forthcoming or sufficient, the Legislature and administration should try to close the abusive and costly policies and loopholes.

Deals should be structured as true investments and not as spending projects. Entities should be structured as ongoing concerns rather than one-time projects, with financial risks and rewards, and true equity participation.

Opposition to these changes will surely come from the lawyers and accountants who generated considerable fees structuring these tax schemes, from so-called investors who received tens of millions of dollars of tax credits for pennies on the dollar, and from stakeholders in the out-of-state film industry who have enriched themselves at considerable expense to Hawai'i taxpayers.

Some may argue that fixing Act 221 will scare away potential investors in legitimate deals. However, sophisticated investors would likely be sympathetic to changes if the effort is intended to curtail abusive or unintended practices. One easily could argue that clearing the cloud of scandal and abuses would go a long way toward attracting new investors.

Act 221 is a fabulous law that is already having a positive impact on the state's high-tech industry. But it is broken and needs to be fixed. We cannot fault the movie companies for exploiting the loopholes. But we can fault our government leaders if they fail to curb these continued abuses.

Hawai'i needs a strong movie and television industry in addition to a high-technology industry. But building the industry by endangering the fiscal condition of the state and outraging the taxpayers with abusive practices is not a constructive approach.

Tareq Hoque is chief executive of Landmark Networks and chairman of the Hawaii Technology Trade Association. This is his personal viewpoint and does not necessarily constitute the views of either organization.