The state made a promise to investors.

Then when the going got tough — a $1.2 billion deficit — lawmakers decided that they did not mean what they said.

Now, with a controversial bill on Gov. Linda Lingle‘s desk that would save the state hundreds of millions over the next three years, a number of questions hang in the balance:

  • Is it legal for a government to renege on its word when it comes to a promise to investors?
  • If it is, what are the ramifications for future administrations — and taxpayers — if this one decides to do just that?
  • If the answer to the first question is in doubt, is the cost of deferring the credits more burdensome than paying up now?

And those, in many ways, are the easy questions.

The larger question, one that isn’t even on the table at this point, is whether the state of Hawaii gave away too much in 2001 when it promised investors 100 percent tax credits on investments in new tech companies. A tax credit allows investors to charge their investments in certain companies against income taxes they would otherwise owe the state.

“If you’re a bond rating agency, how are you going to look at this?” asked Jeff Au, managing director and general counsel of PacifiCap Group, a Honolulu venture capital firm. “How financially responsible is the state acting? My concern is that some companies are going to run out of money. And it’s going to cement this perception that Hawaii is a bad place to invest.”

This story started in the 1999, when Hawaii hungered to diversify its economy. The answer: Lure investors with lucrative tax benefits. But the initial offering limited the tax credit to 10 percent of the investment. By 2001, an amended law allowed investors to claim 100 percent of an investment — up to $2 million — in a high technology firm over five years (35 percent the first year, 25 percent the second year, 20 percent the third and 10 percent in the fourth and fifth years). In 2009, the law was amended again to limit credits to 80 percent of the tax liability.

The original intent of the refined Act 221, also known as the high-tech tax credit, was to ignite investments in high-technology companies. These include development and design of computer software, biotechnology, performing arts products (i.e. movie or television productions) and non-fossil fuel energy-related technology, among others. More than 4,000 investors helped fund 203 Qualified High Tech Businesses (QHTB) through 2008. These companies created 1,619 jobs, and employed 2,840 independent contractors, according to the state Department of Taxation.

The total cost in lost tax revenue to the state through 2008 was about $776 million, and the number of additional credits that could still be claimed amounts to $593 million.

Act 221 faced enough controversy in its first few years to compel the state Department of Taxation to defend it in a 2003 press release.

Then this year the Legislature decided the program had to end — and that it couldn’t make good on its part of the deal until 2013, delaying the benefits it had promised for three years.

“The Legislature finds that due to the dismal state budget situation, there is a compelling public interest for the early termination of tax credits that result in significant tax expenditures,” reads Senate Bill 2001. It repeals the tax credits prior to the original sunset date of Dec. 31, 2010, effective May 1, 2011. And people who invested in recent years under the belief that they would receive tax breaks every year must wait three years, until 2013, to receive their credits.

The response from investors? Threats of lawsuits. Au said his company already has hired a Washington, D.C. law firm to pursue litigation.

That’s where the news gets worse for the state. The prospect of lawsuits could become a fiscal burden in itself. Under the Hawaii Revised Statutes, the state must respond to such action by segregating the funds originally intended for tax credits. Instead of going into the General Fund to pay for the state’s operating costs, they must go into a “litigated claims fund,” and can’t be withdrawn until the lawsuit is settled, making the money unavailable, essentially, to both parties.

Gov. Linda Lingle‘s office said she was in the process of “reviewing bills and getting public input.” She has until July 6 to veto the proposals.

The state’s reversal of its promise to honor the tax credits is far more damaging than the economy itself, said Dew-Anne Langcaon, president and co-founder of Hookele Health Technologies, a company with five employees that is developing touchscreen wireless technology to aid senior citizens and decrease eldercare expenses. “The uncertainty which this bill has caused is making it impossible for our current and potential new investors to make an informed investment decision.”

About the Author