The state auditor says because of a weak law, the state doesn’t know the impact of $1 billion spent in tax credits to boost the high-tech industry in Hawaii in areas such as biotechnology, software and alternative energy.
State Auditor Marion Higa, whose office compiled the report, added that the state Department of Taxation audited only about 3 percent of the tax credit claims, meaning businesses or individuals may have received tax credits for which they were unqualified. The department released the 45-page audit Tuesday.
The report said tax credits, a type of state expenditure that reduces revenue, are less likely to be scrutinized because they do not appear in the state budget. Since they don’t appear in the budget, they can grow without the Legislature’s knowledge, so requiring measurement and reporting of credits would improve accountability, the audit said.
According to the audit, the Legislature created the tax credit in 1999 to develop a high-technology industry in Hawaii. The law, which sunset in 2010, was "silent as to the expectations of the Department of Taxation" with no goals or performance measures for determining the effectiveness of the tax credit, the report said.
"No one knows whether the tax credits were successful or met their purpose," the audit said.
The audit also criticized the law for not lifting taxpayer confidentiality requirements, which were state law for tax returns. The confidentiality requirement was lifted in 2007, but only for the names of businesses benefiting from the credit and not for the amount of tax credits issued to the businesses.
Looking at other states, the audit found similar tax credits that require the disclosure of taxpayer information, such as the names of businesses, the amounts of investments and the tax credits. It also said other states have departments outside the taxation departments issuing the credits.
Compared with 25 other states with similar high-tech tax credits, Hawaii was one of the most generous with the tax credit while demanding fewer reporting requirements. Hawaii offered a 100 percent tax credit, well above the 60 percent offered by Maine, and capped the individual tax credit at $2 million, compared with $500,000 for the next-highest state.
When the tax credit first was created, it was for only 10 percent of an investment with a $500,000 cap. It wasn’t popular at the time, with only about 125 claims in the first two years.
In 2001 the credit was expanded to 100 percent of an investment with a maximum of $2 million claimable over five years per investment. The number of credits received doubled that year and later grew to 2,488 credits in 2008.
The audit mostly blamed the law for being deficient but also criticized the poor implementation of the law by the Taxation Department, saying it was inadequate, unreliable and lacked transparency in monitoring the business tax credits.
It said the department was flooded with additional responsibilities as the tax grew more popular. The report also blamed the Department of Taxation for not verifying the accuracy or completeness of information submitted by taxpayers claiming the credit.
It said the Department of Taxation did not provide reliable data and tax credit information to policymakers, which may have misled them in decision-making.
State Sen. Carol Fukunaga, chairwoman of the Economic Development and Technology Committee, said the executive branch is responsible for executing the law and should have proposed plans to fix the problem.
"The people who run government operations, they are in the best position to determine what’s the best solution," she said.
Fukunaga, who was co-chairwoman of the Senate Ways and Means Committee at the time the tax credit was passed in 1999, said it was originally a much different tax credit with only 10 percent and a cap of $500,000.
"(The original law) was a very modest attempt to say we think encouraging technology business to locate in Hawaii is going to be important," she said, adding that the plan was to generate businesses to create more tax revenue.
The law was based on the same model as a successful low-income housing tax credit, and there initially were no problems with it. In 2001, when Fukunaga was no longer heading the Ways and Means committee, the credit was expanded to the $2 million cap and covering 100 percent of the investment.
In 2007, legislators tightened up the reporting and accountability requirements to address concerns about reporting requirements for the tax by the Linda Lingle administration, Fukunaga said.
"At that time, the data that they did have was so incomplete, and that was why we wanted the reporting requirements," said Fukunaga, who was chairwoman of the Economic Development and Technology Committee at the time. "Everything that people told us would enhance the quality of the reporting was what we included."
In a response to the audit, Frederick Pablo, director of the Department of Taxation, said three tax directors led the department at the time of the credit. He was appointed in December 2010. He said the volume of credits increased each year, but office resources did not and the office was dealing with frozen positions and two years of furloughs.
He said in the past year the office has been recruiting to fill vacant positions and requested funding for a statistician to address the problems in the report.
