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Necessary to Balance Good of Taxpayer and State

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By Lowell L. Kalapa

An advocate of the much touted Act 221 high technology tax credits admonished the criticism that the tax incentives continue to grow as astute taxpayers find ways to claim the credit.
In the advocate’s mind, the more tax credits claimed means the tax credits are working because it is bringing in new investment money. And if there is new investment that must mean there are new jobs and more income and therefore more taxes.
That logic might work if, in fact, more money was coming into the state than the tax credit was giving out. But that is not the case with the high technology business investment tax credit. Investors who take advantage of this credit invest $2 million in a qualified high technology business and over the next five years they can claim a tax credit equal to $2 million. As a result, they get all their money back. Now you have to ask yourself, from where does that $2 million in tax credit come? Well, it is coming out of the pockets of all the other taxpayers in the state who can’t avail themselves of the credit.
What is wrong with the high technology business investment tax credit is that it is 100% of the amount invested. In other words, the state is replacing every single dollar that an investor puts into a venture. In other words, there is no element of risk on the part of the investor because the investor is made whole even if the business fails. If the business succeeds, the investor will have an equity position in the business which in the long run may prove to be very profitable for the investor. And the investor might be subject to state income taxes on that profit, or maybe that investor has moved on to another state at which point the state doesn’t realize anything from that profit especially if the company is no longer based in Hawaii.
Regardless, the weakness of the high technology business investment tax credit is that there is no leverage. At least when the federal investment tax credit was around, the return on the investment was 10% of the amount invested. At least the federal credit leveraged the 90% out of the investor. With the 100% tax credit, one has to ask why does one need the investor? Why not just send the check from the state to the qualifying business?
Speaking of “qualifying business,” the definition of a qualifying business is a major contributing source for abuse of the credits. A qualified business must have more than 50% of its activities in qualifying research with more than 75% of the qualified research done in the state OR more than 75% of it gross income is derived from qualified research where the income is received from products sold, manufactured in or produced in the state or that its services are performed in the state. The hook is what constitutes “qualified research.”
To understand what “qualified research” means, one has to go to another part of the law where it starts out saying that the definition is the same as that found in the federal Code. But then a litany of other types of activities goes on to include things like the development of computer software using fourth generation or higher software, biotechnology, performing arts products, sensor and optic technologies, ocean sciences, astronomy, OR nonfossil fuel energy-related technology. Note well that the use of OR makes each of those categories exclusive so that they do not have to be included within the federal definition.
Of particular interest is the category of performing arts products. This is probably the category under which the surfer movie was able to collect on the high technology business investment tax credit. Whether or not it created more jobs or added income to the tax base is debatable. But what we do know is that it is just one of the many claims that has had a negative effect on tax collections.
As lawmakers struggle to balance the state’s biennial budget, it is that dour outlook on collections that just may lead them to pass a tax increase so they can balance the budget. Thus, what was touted as the savior of the state’s economy may just do all other taxpayers in should a tax increase be necessary.
Some may argue that the principal of tax credits is sound in encouraging economic activity; however, when the measure is so poorly drafted that it “gives away the store,” then all the income and all the new jobs that these credits are supposed to create are not worth a plug nickel if it results in an even higher tax burden on all other taxpayers.
So, if taxes have to be raised to balance the state budget, you might want to say mahalo to your high technology tax credit beneficiary.

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