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The Honolulu Advertiser
Posted on: Friday, November 27, 2009

UH analysis calls Act 221 a 'mistake'

BY Greg Wiles
Advertiser Staff Writer

Hawaii news photo - The Honolulu Advertiser

Christy Romano and Josh Keaton shoot a scene from a Disney Channel film at the Ko Olina Resort. A UH analysis says it is hard to tell whether the state has benefited from generous tax credits intended to lure such ventures to Hawai'i.

Advertiser library photos

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Hawaii news photo - The Honolulu Advertiser

The film "Blue Crush" received more than $15 million in Act 221 credits, but generated few permanent jobs.

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An analysis of Hawai'i's high-technology tax credits done by three University of Hawai'i economists has found the credits were poorly designed and that it is difficult to quantify their benefit to the state in terms of jobs and bringing in out-of-state investors.

The study looked at what are considered the most generous technology tax credits of any state and found it was difficult to determine whether the state achieved the desired goals of the tax credit, which can return 100 percent of investments to investors.

"We conclude that it was a mistake to initiate a generous tax credit program without adequate monitoring by public agencies or disclosures of how public funds are being used by recipients," wrote Andrew Kato, Sumner LaCroix and James Mak, economists from the University of Hawai'i Economic Research Organization.

The authors noted it is difficult to determine how much out-of-state investment was attracted into local high technology firms, or how many jobs were created by an estimated $657.5 million of tax credits. The research is to be published in State Tax Notes, a national tax journal.

"Do we know how much additional capital Hawaii's high technology tax credit program attracted to Hawaii relative to the amount that would have occurred without the nation's most generous tax incentive program? The answer is 'no,' " the paper said.

"Do we know how many additional high technology jobs were created by the tax credit program? Again the answer is 'no.' "

Proponents of the tax credits say the incentive helps bring in money and create jobs in keeping with a decades-old state goal of building a high-technology industry to wean the state off its dependency on tourism. The industry is seen as an environmentally friendly business that pays high wages. The tax credits also are available to filmmakers and other firms that specialize in the performing arts.


Efforts to foster growth in the high-tech industry began in the 1980s as use of personal computers ramped up and continued into the 1990s as the Internet took hold. The study noted the efforts were mixed, with the state unable to attract a sizable company in the early 1990s and that some startups relocating to the Mainland once they were successful.

But in 1999 the state began a new strategy that involved offering investment tax credits for investments in select high-technology industries. The study noted at least 18 states had established such credits to boost either high-technology companies, venture capital investment or other types of investment in fledgling companies.

The study said academics criticize such investments as violating principles of sound tax policy and good government, but lawmakers perceive them as an expedient way to induce growth when they haven't been able to tempt high-technology formation with lower overall tax rates or quality public services.

Hawai'i's incentives have gone through several iterations and eventually became known as Act 221, which allowed investors to claim 100 percent of their investment against what they owed in Hawai'i taxes over a five-year period.

"The 100 percent credit attracts high-quality ventures with considerable chance of success, but also induces entrance of low-quality ventures with little chance of success," the paper said.

Moreover, the program allowed people to sell credits, so an out-of-state investor could assign credits to a Hawai'i investor. The non-resident would get a greater ownership stake, while the Hawai'i resident could claim greater credits than what they had invested.

LaCroix, who also is a UH-Mänoa economics professor, said this feature was a "toxic combination" that resulted in some people investing to get tax credits and not because they believed the startup company might enjoy success.


He said no other state has credits higher than 50 percent. Moreover, it contributed to control of some of the companies being transfered out of state and companies moving to the Mainland, the paper said.

"Prior to 2009, the program may have just been providing highly subsidized incubator services to firms that will ultimately generate jobs for workers in other states," the paper said.

The tax credit was revised earlier this year to disallow the claiming of credits that are larger than their share of ownership in the company. It now only allows residents to claim credits up to 80 percent of their total state tax liability in any one year.

Proponents of the credits had argued vociferously against the changes and noted the program had been successful in jump-starting Hawai'i's high-technology industry when other efforts had failed.

A report released last year and sponsored by the industry and others found public and private technology activities accounted for $3 billion, or about 5 percent of the state's economy. Where there were little in the way of successful software, biotechnology and Web-related companies here two decades ago, there is now a community of such firms.

But the program has also had its share of setbacks, such as a disclosure the 2002 movie "Blue Crush" had garnered more than $15 million of Act 221 credits while creating little in the way of permanent jobs.

Such uses of the credit are no longer allowed, but LaCroix said there still is too little information about the effectiveness of the incentives.

While the state Department of Taxation has tried to institute means of tracking and evaluating the incentives' effectiveness, the effort is short of where it needs to be, the authors noted.

They said there's little way to compare year-over-year data and that the tax department has not done enough to pursue people who don't fill out required reports on investment made into the businesses and the number of jobs created.

LaCroix said there needs to be intensive monitoring of who gets the credits and what they are doing with the money in terms of companies and jobs.

He noted some companies receiving credits don't even maintain a Web site, while others are subsidiaries of existing corporations that house technology departments and claim the credits.

"There is no reasonable estimate of what the taxpayers of Hawaii gained in return," the report said.

The paper concludes by saying a smaller, targeted investment tax credit may be one way of increasing new and innovative businesses, but that it shouldn't be relied upon to carry the full burden of growing an industry.