High-tech tax credit gives too much, gets little in return
POSTED: Monday, January 12, 2009
Act 221 allows Hawaii taxpayers to invest in high-tech and entertainment companies rather than pay taxes. The total cost has reached $747 million and is likely to exceed $1 billion fairly soon.
The money is real. That the transfers are accomplished with journal entries at the Department of Taxation serves only to lessen the levels of transparency and accountability that normally accompany large government handouts. For example, the public will never know who actually receives the $1 billion. Any Department of Taxation employee who dared to release the name of an Act 221 investor could go to jail for doing so.
The goal of Act 221 is to create new industries with high-paying jobs. To qualify for Act 221 credits, however, investors need not create a single new or permanent job.
Act 221 is less demanding and far more generous than incentives offered by any other state (where credits rarely exceed 25 percent). Although usually described as a 100 percent credit, Act 221 actually permits some investors to claim credits that are significantly greater than the amounts they invest (150 percent is common; 200 percent to 400 percent is less common but possible).
Act 221 is riddled with loopholes. For example, some local companies simply drop ongoing activities into a new subsidiary and then claim a 100 percent credit. Except for the paper shuffling, nothing changes: the same workers continue to do the same thing in the same place. Yet the paper-shuffling "investor" qualifies for Act 221 credits.
There are many other "strategies" that defy common sense yet arguably satisfy all the statutory requirements of Act 221. The Department of Taxation tries to contain these abuses, but its resources are quite limited and Act 221 audits are exceptionally time-consuming. That's why the department's audit rate for tax returns claiming an Act 221 investment credit is only about 2 percent.
Investors in Act 221 companies are usually wealthy individuals and financial-services corporations that are attracted primarily by the prospect of a 100 percent to 200 percent credit. They usually lack experience in the underlying business activity, and tend to perform relatively little due diligence before investing. This is relevant because venture capital firms prefer to provide later-round financing to companies that initially attracted so-called "smart money."
Act 221 companies that achieve business success are able to relocate outside Hawaii with virtually no penalty for doing so. Unfortunately, that's exactly what some have done. Others have kept one or two employees in Hawaii but moved the bulk of their operations elsewhere.
The 2007 Hawaii Tax Review Commission described Act 221 as a fiscally unsound "black hole," and pointed out that this well-intentioned law appears not to have produced demonstrable growth in Hawaii's technology sector.
Especially in light of fiscal challenges facing this state, lawmakers need to revisit Act 221. There are much better ways to support the development of high-tech and entertainment industries in Hawaii.