Modernizing the Innovation Engine: Resolving Narrow Industry Definitions in the Hawaii Research and Development Tax Credit Framework

Executive Summary

The State of Hawaii faces a critical inflection point in its macroeconomic trajectory. For decades, the state’s geographic isolation, heavy reliance on imported goods, and overwhelming dependence on the tourism and hospitality sectors have created structural vulnerabilities within the local economy. In response to these enduring challenges, policymakers, industry advocates, and business leaders have championed the absolute necessity of economic diversification. This strategic imperative is comprehensively articulated in the Chamber of Commerce Hawaii’s 2030 Blueprint for Hawaii, which emphasizes the necessity of strengthening local industry clusters, cultivating emerging sectors, reversing youth outmigration, and building long-term economic resilience.¹ A cornerstone of this statewide diversification strategy is the incentivization of private-sector innovation through the state’s Tax Credit for Research Activities, codified under Hawaii Revised Statutes (HRS) §235-110.91.³

However, a fundamental statutory misalignment currently threatens to undermine the efficacy of this vital policy instrument. The existing legislative framework relies upon a highly prescriptive, exclusionary, and narrow definition of a “Qualified High Technology Business” (QHTB). By design, the statute heavily favors specific, enumerated sectors such as software development, biotechnology, and ocean sciences.⁵ This rigid, categorical approach inadvertently locks out a vast swath of innovative small to medium-sized businesses (SMBs) operating in traditional, yet highly critical, sectors such as agriculture and advanced manufacturing. While these traditional SMBs routinely engage in complex, technical research and development (R&D) to overcome Hawaii’s unique logistical, climatic, and supply chain challenges, they are effectively excluded from participating in the state’s primary innovation subsidy.

This whitepaper provides an exhaustive, expert-level policy analysis of this statutory bottleneck, tailored specifically for the consideration of the Hawaii State Government and the Hawaii State Legislature. It contextualizes the current R&D tax credit framework within Hawaii’s broader economic landscape and legislative history, tracing the evolution of the credit from its inception through the profound transformations enacted by Act 139 in 2024. The report extensively contrasts the state’s narrow industry definitions with the technology-neutral standards employed by the federal government under Internal Revenue Code (IRC) §41 ⁷, demonstrating the profound economic necessity of extending R&D incentives to agricultural and manufacturing SMBs.

Furthermore, the report delineates practical, implementable legislative solutions to resolve this policy issue, specifically advocating for the adoption of statutory technology neutrality and the implementation of a tiered tax credit allocation framework or proportional distribution model as contemplated in recent legislative sessions. Recognizing the fiduciary responsibility of the state, this report also details a rigorous implementation strategy designed to prevent fraud, eliminate wastage, and safeguard the integrity of the tax base through synchronized audit workflows, contemporaneous documentation mandates, and strict adherence to the federal four-part test for qualified research.

Finally, a comprehensive economic cost-benefit analysis demonstrates that the initial expenditure required to expand the credit to traditional SMBs operates not as a sunk cost, but as a high-yield macroeconomic investment. Driven by robust input-output economic multipliers identified by local economic research institutions ⁹, the expansion of the R&D tax credit will generate cascading future benefits, expanding the General Excise Tax (GET) base, elevating wage premiums, and ultimately paying for the program over time. The consequences of inaction—manifesting as continued youth outmigration, stagnant agricultural productivity, and an uncompetitive manufacturing base—render this policy modernization an urgent imperative for the future prosperity of Hawaii.

The Evolution and Context of the Hawaii R&D Tax Credit Framework

To fully understand the policy failure generated by narrow industry definitions, it is essential to first trace the legislative, economic, and functional architecture of Hawaii’s R&D tax credit. The Tax Credit for Research Activities was conceived to incentivize businesses to invest in localized, high-value technological development, effectively attempting to bridge the geographic disadvantages inherent to an island economy.

Historical Legislative Trajectory: From Act 178 to Act 139

Hawaii’s legislative efforts to stimulate a high-technology sector date back several decades, characterized by periods of extreme generosity followed by necessary fiscal retrenchment. In 1999, the state enacted Act 178, which established early iterations of high-technology business investment credits, though the strict rules resulted in minimal utilization, with merely twenty-three claims totaling approximately $162,000.¹¹ Recognizing the need for a stronger catalyst, the legislature passed Act 297 in 2000 and the highly consequential Act 221 in 2001. Act 221 dramatically increased the generosity of the investment tax credit, raising it to a 100 percent non-refundable credit claimed over five years, temporarily giving Hawaii the nation’s most aggressive business investment tax credit program.¹¹

Over the subsequent two decades, the state continuously refined its approach to balance the stimulation of the technology sector with the preservation of the state general fund. The modern iteration of the Tax Credit for Research Activities, codified under HRS §235-110.91, offers a refundable income tax credit to QHTBs that conduct qualified research within the State of Hawaii.³ Administered jointly by the Department of Business, Economic Development, and Tourism (DBEDT) and the Department of Taxation (DOTAX), the credit serves as a direct offset against corporate or personal income tax liabilities for expenses incurred in localized research activities.¹²

The regulatory landscape of this credit underwent a profound transformation during the 2024 legislative session with the passage of Act 139, derived from Senate Bill 2497.¹³ Prior to Act 139, the state allowed businesses to claim credits on their total qualified research expenses without regard to the federal base amount calculations. This made the credit exceptionally lucrative for claimants but created significant volatility and unpredictability regarding the fiscal impact on the state budget.¹⁴

Act 139 reined in this structural generosity by strictly realigning the state calculation with the federal IRC §41 incremental base amount rules.¹³ Under this updated framework, only new, incremental R&D spending that exceeds a historical baseline qualifies for the state credit, mirroring the federal methodology designed to reward the expansion of research rather than subsidizing a stagnant baseline of ongoing operations.⁴ Crucially, Act 139 also introduced precise demographic and geographic restrictions, explicitly limiting the credit to SMBs by defining eligible entities as those with no more than 500 employees.¹⁴ Furthermore, the statute mandated that more than 50% of the firm’s qualified research activities must be physically conducted within the State of Hawaii, and the business must be formally registered to operate within the state.⁴ The overarching legislative intent of the 2024 reforms was to optimize the state’s return on investment, ensuring that taxpayer funds heavily subsidized localized, small-business innovation rather than out-of-state corporate expenditures. The legislative extension of the credit through December 31, 2029, signaled the government’s long-term strategic commitment to utilizing the tax code as an instrument of economic development.⁴

Utilization Dynamics and Sectoral Concentration

Despite the stabilizing intent of Act 139, empirical utilization data provided by the DBEDT reveals a highly skewed and structurally constricted distribution of the tax credit. Under the current statutory framework, the maximum credit available per year is capped at an aggregate $5 million, and DBEDT is mandated to provide certifications on a first-come, first-served basis until this cap is exhausted.⁴

An analysis of the DBEDT Hawaii Research Tax Credit Report for the 2024 Tax Year illustrates the immediate impact of the Act 139 revisions. During the 2024 tax year application window, a total of twenty-three companies applied for the credit. Following the rigorous DBEDT review process, five entities were disqualified, resulting in eighteen formally certified QHTBs.¹⁵ The financial aggregates from this cohort reveal that these eighteen companies spent a combined total of $29.5 million on qualified research expenses within Hawaii.¹⁵ However, the total tax credits certified by DBEDT amounted to only $2.6 million, falling significantly under the state’s $5 million annual cap.¹⁵ This underutilization allowed all qualified and timely applicants to receive their full certified amount, but it also resulted in a sharp decrease in the average credit claimed per QHTB, which fell to approximately $0.15 million, down from averages of $0.45 million to $0.56 million observed in the preceding years under the pre-Act 139 “total amount” rules.¹⁵

The data further reveals an overwhelming concentration of credit utilization within very specific industry verticals. Among the eighteen certified QHTBs in 2024, the “Information and Communication Technology” sector was the most prevalent, representing the primary business area for a significant plurality of the firms.¹⁵ When defining their targeted research areas, companies overwhelmingly cited “Computer software” and “Biotechnology” as their primary fields of technical activity.¹⁵

This profound sectoral concentration is not indicative of a lack of innovation within Hawaii’s broader economy. Rather, it highlights an artificial constriction created by the statutory definition of a QHTB. The state’s strict definitional gates have successfully incubated an ecosystem of software developers and biotech firms but have systematically disenfranchised other vital sectors. The expenditure profile of the certified claims—where human capital in the form of wages accounted for an overwhelming 80.9% of all qualified research expenses ¹⁵—demonstrates that the credit effectively operates as a high-wage job subsidy. By restricting this subsidy to specific high-tech silos, the state is inadvertently depriving its traditional industries of the financial leverage required to hire advanced technical personnel.

To synthesize the operational impact of the current framework, the following table outlines the key parameters governing the Tax Credit for Research Activities post-Act 139:

Table 1: Operational Impact of the Act 139 R&D Framework

The Policy Issue: The Constraints of Narrow Industry Definitions

The core friction in Hawaii’s innovation policy lies precisely within the text of HRS §235-7.3, which establishes the definitional parameters for a Qualified High Technology Business. To legally claim the R&D tax credit, a business must definitively prove that it conducts more than fifty percent of its activities in “qualified research”.⁶ However, the statute limits the definition of “qualified research” to a restrictive, highly prescriptive eight-item list.

The Prescriptive Eight-Sector List and the “Picking Winners” Fallacy

Under current Hawaii law, qualified research is strictly confined to the following domains:

1. The same as in Section 41(d) of the Internal Revenue Code (though subject to state-level entity restrictions).
2. The development and design of computer software for ultimate commercial sale, lease, license or to be otherwise marketed, for economic consideration.
3. Biotechnology.
4. Performing arts products.
5. Sensor and optic technologies.
6. Ocean sciences.
7. Astronomy.
8. Nonfossil fuel energy-related technology.⁵

This highly prescriptive legislative approach creates a severe definitional straitjacket for local entrepreneurs. By explicitly naming favored sectors, the statute embodies a “picking winners” economic philosophy, an approach widely critiqued in modern economic development theory for its inability to adapt to rapidly evolving technological paradigms. While fields like ocean sciences, nonfossil fuel energy, and astronomy are undeniably relevant to Hawaii’s unique geographic and climatological endowments, the explicit enumeration of these fields establishes an exclusionary boundary that stifles cross-sectoral innovation.

Consider the practical implications of this framework. If a local Hawaii food manufacturing firm develops a novel, proprietary dehydration and thermal-processing methodology to dramatically extend the shelf life of locally grown breadfruit (ulu)—a process involving extensive engineering, thermodynamic modeling, food chemistry, and iterative testing—the firm struggles immensely to qualify for the tax credit. The activity is undeniably highly technical and seeks to resolve complex supply-chain uncertainties, but it is neither strictly “biotechnology” nor “computer software.” Because the firm is classified primarily as a manufacturer or food processor, it cannot meet the rigid threshold of conducting more than fifty percent of its activities within the enumerated high-tech list, rendering it ineligible for certification by DBEDT.

Divergence from Federal Technology-Neutrality

The restrictive nature of the Hawaii framework stands in stark contrast to the federal R&D tax credit administered under IRC §41. The federal statute is fundamentally technology-neutral and industry-agnostic.¹⁹ Congress designed the federal credit with the understanding that innovation does not exclusively reside in cleanrooms or coding environments; it occurs on factory floors, in agricultural fields, and within complex logistical networks. The federal code does not mandate that a firm operate within a recognized “high-tech” industry to receive benefits. Instead, it focuses entirely on the underlying nature of the activity itself.

Under federal law, any business—whether it is a row-crop farm on the Big Island, a heavy machinery manufacturer in Kapolei, or an aerospace contractor—can claim the credit if its specific developmental activities successfully pass the rigorous, four-pronged statutory criteria known as the “Four-Part Test”.⁸ This test mandates that the research must adhere to the following principles:

• Permitted Purpose: The research must be undertaken to create a new or improved business component, resulting in enhanced function, performance, reliability, or quality.²¹
• Technological in Nature: The activity must fundamentally rely upon the principles of the hard sciences, such as engineering, physics, biology, or computer science.²¹
• Elimination of Uncertainty: The research must be designed to discover information to eliminate technical uncertainty concerning the capability or method for developing the business component, or the appropriate design of the component.²²
• Process of Experimentation: The taxpayer must engage in a systematic process of experimentation, involving the formulation of hypotheses, modeling, simulation, or systematic trial and error to overcome the identified uncertainty.²¹

Because Hawaii mandates that a firm first qualify as a QHTB (categorically restricted by the eight sectors in HRS §235-7.3) before it can fully apply the federal IRC §41 rules at the state level, traditional Hawaiian SMBs find themselves trapped in a statutory paradox. These firms may meticulously document their engineering efforts, easily pass the federal Four-Part Test, and successfully claim the federal R&D tax credit for optimizing an irrigation system or developing a new milling process. Yet, they remain entirely barred from claiming the Hawaii counterpart for the exact same localized, job-creating expenditures simply due to their North American Industry Classification System (NAICS) code or primary business designation.²³

The Market Failure of Exclusion

This narrow definitional framework actively induces a market failure within the state economy. Innovation does not occur in isolated, “high-tech” silos; in the modern economy, it increasingly occurs at the intersection of traditional industries and applied science. When the state tax code heavily subsidizes software development but taxes agricultural engineering at the standard, unmitigated rate, it artificially skews capital allocation away from the physical industries that the state desperately needs to stabilize its supply chains.

Traditional SMBs in Hawaii already operate under extreme margin pressures. They face some of the highest commercial energy costs in the nation, severe skilled labor shortages, and exorbitant trans-Pacific shipping rates that erode profitability.²⁴ By denying these physical-sector firms access to R&D subsidies, the state exacerbates the so-called “Valley of Death”—the perilous phase in commercialization where a business possesses a viable, highly technical concept but lacks the necessary risk capital to systematically test, iterate, and scale it into a market-ready product.

To illustrate the stark divergence between the state and federal approaches, the following comparison table highlights the structural inequities faced by traditional Hawaiian SMBs:

Table 2: Comparison of State vs. Federal Definitions

The Imperative for Inclusion: The Agricultural Sector

The exclusion of agriculture from the state’s premier innovation incentive is not merely a technical oversight; it represents a profound strategic vulnerability. To comprehend the urgency of broadening the R&D definitions, policymakers must examine the critical role this sector plays in Hawaii’s economic survival and the specific, highly technical hurdles local food producers currently face.

The Food Security Crisis and Demographic Realities

The State of Hawaii currently imports approximately ninety percent of the food consumed within its borders.²⁸ This staggering reliance on complex, long-haul maritime and aviation supply chains leaves the state’s population acutely vulnerable to external macroeconomic shocks, ranging from global pandemics and geopolitical conflicts to port strikes and natural disasters. Furthermore, the agricultural sector faces an imminent demographic collapse. According to industry advocates, including the Hawaii Agricultural Foundation, the average age of a farmer in Hawaii—and indeed across the nation—is roughly sixty years old.²⁴ Younger generations are increasingly abandoning traditional agrarian careers, opting instead for less physically demanding, higher-paying roles within the service, tourism, or technology sectors.

The mathematical reality is stark: the only viable solution to increasing local food production while the available agricultural labor pool simultaneously shrinks is the aggressive, widespread adoption of Agricultural Technology (AgTech). Modern farming, particularly in an environment as challenging as Hawaii, is no longer solely about manual labor; it is a highly technical, data-driven discipline.²⁹

The R&D Realities of Modern Hawaiian Agriculture

Hawaiian agricultural SMBs are currently attempting to innovate across a variety of complex vectors, all of which require significant R&D expenditures that fit the spirit—but not the state statutory definition—of high technology. Examples of this essential innovation include:

• Precision Irrigation and Fluid Dynamics: Farmers operating in drought-prone microclimates, particularly on the leeward coasts of the islands, are designing custom fluid-dynamics systems utilizing sensor networks to optimize water usage down to the individual plant level.⁸
• Controlled Environment Agriculture (CEA): To combat extreme weather events and maximize yields on limited acreage, agricultural SMBs are engineering specialized greenhouse environments. This involves thermodynamic modeling, automated harvesting robotics, and the development of highly calibrated hydroponic and aeroponic nutrient delivery systems.⁸
• Soil Chemistry and Crop Optimization: Given the unique volcanic soil profiles of the islands, local producers are developing new, proprietary soil amendments utilizing indigenous microorganisms to enhance crop diversity and combat invasive tropical pests, thereby reducing reliance on imported, restricted-use chemical pesticides.⁸
• Value-Added Food Processing: To stabilize revenues, agricultural entities are venturing into complex food science, developing proprietary extraction methods for essential oils, or creating fruit powder production techniques to extend the shelf life of highly perishable tropical fruits.³³

These activities require immense upfront risk capital, involve significant technical uncertainty, and rely heavily on the hard sciences of biology, chemistry, fluid mechanics, and engineering. They perfectly encapsulate the fundamental purpose of an R&D tax credit. Yet, because these businesses are classified broadly under agricultural NAICS codes rather than as pure “biotechnology” or “software” firms, they are largely excluded from the QHTB framework. Organizations such as the Thrive Hawaii Agrifood Summit and initiatives like the WOCAN agricultural hub on the Big Island are striving to integrate traditional Hawaiian practices with modern, climate-smart technologies.²⁴ However, achieving the state’s ambitious food security mandates requires aligning tax incentives to subsidize the immense developmental costs these organizations bear.

The Imperative for Inclusion: The Advanced Manufacturing Sector

Similarly, Hawaii’s manufacturing sector operates at a severe, inherent geographic disadvantage. The exorbitant cost of importing raw materials across the Pacific, combined with the costs of exporting finished goods to mainland or international markets, creates a structural barrier to achieving economies of scale. However, the paradigm of “Advanced Manufacturing”—which involves the deep integration of innovative technologies, robotics, and optimized methodologies to transform the industrial value chain—offers a viable pathway to local profitability and systemic resilience.³⁴

Establishing Industrial Resilience Through Innovation

While Hawaii will never compete with mainland mega-factories in low-cost, high-volume mass production, the state is home to highly specialized, niche, and high-value manufacturing ecosystems. These include aerospace component fabrication, precision naval shipbuilding support, specialized consumer food processing, and advanced materials engineering.³⁶ For instance, the recent launch of Hawaii’s first advanced manufacturing training center at Honolulu Community College, designed to support the Pearl Harbor Naval Shipyard and private ship repair facilities, vividly highlights the state’s critical need for industrial innovation to build resilience amidst geographic isolation.³⁶ Researchers and manufacturers are actively integrating materials characterization, mechanical design, and advanced fabrication to create structures capable of withstanding Hawaii’s highly corrosive maritime environments.³⁶

When a local food processor invests millions of dollars and thousands of man-hours into experimenting with new flash-freezing technologies or thermodynamic dehydration processes to create shelf-stable, exportable products from local produce, they are performing rigorous R&D.³³ When a specialized manufacturer designs nanometer-thin sensors or resilient aerospace assemblies, requiring iterative physical testing and metallurgical analysis, they are performing R&D.³⁶ Excluding these manufacturers from the state’s R&D tax credit suppresses the very economic diversification that the DBEDT and the architects of the Hawaii 2030 Blueprint are explicitly tasked with promoting.¹ Modernizing the manufacturing base is not a luxury; it is a necessity for reducing the state’s dependence on fragile external supply lines.

Proposed Legislative Solutions to Modernize the Framework

To rectify the systemic exclusion of innovative SMBs in traditional sectors, the Hawaii State Legislature must act decisively during the current and upcoming legislative sessions. The primary objective is to modernize the statutory definitions within the HRS to align with federal best practices, thereby democratizing access to innovation capital without compromising the fiscal stability of the state budget. This report proposes two synergistic, highly practical legislative solutions.

Solution 1: Implement Statutory Technology Neutrality

The most direct, elegant, and economically sound remedy is to amend HRS §235-7.3 to entirely eliminate the prescriptive, eight-sector list and replace it with a robust, technology-neutral definition of “Qualified Research.”

The legislature should decouple the Tax Credit for Research Activities from the outdated, restrictive concept of a “Qualified High Technology Business” (QHTB) and instead base eligibility entirely on the nature of the technical activity performed. By amending the statute to define “Qualified Research” simply as “the same as defined in Section 41(d) of the Internal Revenue Code,” the state would immediately, and comprehensively, harmonize its tax code with federal standards. This action would allow any Hawaii SMB that passes the rigorous federal Four-Part Test to claim the state credit for its localized expenditures.

If political constraints or concerns regarding statutory interpretation require maintaining specific categorical definitions within the law, the legislature must, at an absolute minimum, explicitly expand the existing list to include “Advanced Manufacturing” and “Agricultural Technology.” To prevent bureaucratic ambiguity, the state can draw upon highly effective legislative precedents from other jurisdictions. For example, the State of Illinois formally defines “Advanced Manufacturing” within its tax code as the practice of using innovative technologies and methods to optimize the value chain, specifically including critical sub-sectors such as food manufacturing, fabricated metal manufacturing, clean energy ecosystems, and robotics.³⁴ By adopting a similarly broad, activity-based definition, Hawaii will open the doors for its farmers and manufacturers to legally claim the R&D expenditures they are already conducting, instantly leveling the playing field.

Solution 2: Establish a Tiered Allocation Framework and Expand the Cap

A primary, and highly valid, concern among state fiscal policymakers is that expanding the definition of eligible industries will result in a massive flood of new applicants. Under the current $5 million absolute cap, a surge in applicants could rapidly deplete the available funds, effectively diluting the financial benefit for the existing cohort of software and biotech firms that have come to rely on the credit. It is highly relevant that current proposed legislation, specifically House Bill 2546 (H.D. 1) moving through the 2026 legislative session, contemplates addressing this by raising the annual aggregate cap from $5 million to $15 million, and shifting the allocation method from a first-come, first-served basis to a proportional distribution model if the cap is reached.³⁹

Regardless of whether the final statutory cap remains at $5 million or is elevated to $15 million, the government can effectively manage expanded eligibility and protect strategic industries by implementing a Tiered Allocation Framework within the statute. Under this sophisticated system, the aggregate statutory cap would be subdivided into dedicated, protected tranches based on overarching state economic goals.

Table 3: Proposed Tiered Allocation Model

This tiered solution guarantees that traditional SMBs receive the catalytic capital they desperately need without threatening the established funding pipelines of the software and biotech industries. Furthermore, it provides DBEDT with precise, legislative control over economic development targets, allowing the state to actively cultivate its food security and manufacturing resilience objectives without micromanaging individual corporate applications.

Implementation Strategy: Safeguarding Against Fraud and Wastage

The expansion of tax credit eligibility inevitably introduces heightened concerns regarding compliance, potential fraud, and the misallocation of public funds. R&D tax credits, particularly at the federal level, have historically faced intense scrutiny from the IRS due to aggressive corporate accounting practices where routine, day-to-day operational expenses are falsely masqueraded as qualified “research”.⁴¹ To ensure that Hawaii’s taxpayer dollars are utilized efficiently and exclusively for genuine innovation, the statutory expansion must be coupled with an ironclad, modernized implementation and audit framework overseen by DOTAX and DBEDT.

Strict Enforcement of the Federal Four-Part Test

The bedrock of fraud prevention in an expanded system is the rigorous, uncompromising enforcement of the federal Four-Part Test.²¹ Under a modernized, technology-neutral policy, DOTAX and DBEDT must require traditional SMBs to definitively prove that their claimed activities transcend standard business operations and represent genuine technical risk.

For example, an agricultural entity attempting to claim the credit for the routine expenses of simply planting a new, commercially available seed variety would definitively fail the test, as there is no technical uncertainty involved, nor is there a true process of scientific experimentation.²⁶ Conversely, if that same farmer designs a novel, proprietary sensor array to monitor sub-soil hydrology, writes custom code to analyze the resulting data, and uses that data to systematically iterate a custom nutrient-delivery algorithm, the activity cleanly passes all four parts of the test. By publishing clear, sector-specific regulatory guidance and hypothetical examples—similar to the comprehensive Audit Techniques Guide (ATG) published by the IRS—DBEDT and DOTAX can establish unambiguous boundaries between routine farming/manufacturing and genuine, subsidizable R&D.⁴³

Digital Compliance and Contemporaneous Documentation

The vast majority of abusive or non-compliant R&D claims rely on retrospective estimations—situations where accountants attempt to guess how much time employees spent on research projects months or even years after the fact. To combat this pervasive issue, Hawaii must mandate contemporaneous documentation as a strict, non-negotiable prerequisite for certification by DBEDT.⁴¹

Applicants must be legally required to maintain a centralized credit register that tracks project timelines, scientific hypothesis formulations, iterative testing logs, and specific employee wage allocations in real-time.⁴⁴ DBEDT’s newly updated N-346A online application portal ⁴ should be deeply integrated with an automated documentation submission protocol. Businesses would be required to upload digital project plans, laboratory notes, and expense logs that cleanly and indisputably link every single dollar claimed to a specific, qualified business component.²²

Strengthening Audit Capabilities and Pre-Filing Agreements

Expanding the credit necessitates empowering the Department of Taxation to conduct rigorous oversight. DOTAX must be adequately resourced to audit highly technical claims, potentially utilizing third-party engineering or agricultural subject-matter experts to verify the scientific validity of advanced manufacturing and ag-tech applications during the audit process.

Furthermore, to reduce friction for SMBs while maintaining compliance, DBEDT should implement a Pre-Filing Agreement (PFA) program.⁴¹ A PFA allows a business to submit its proposed R&D project scope to the state for preliminary qualification review before the tax season begins. This provides the SMB with the regulatory certainty required to make large capital investments, while simultaneously reducing the downstream administrative and audit burden on DOTAX. Finally, the legislature must ensure that statutory penalties for fraudulent or deeply negligent claims—such as those strengthened under recent acts like Act 76 ⁴⁵—are robust and strictly enforced, serving as a powerful deterrent against aggressive tax avoidance strategies.

Cost-Benefit Analysis and Economic Multipliers

A common, and highly predictable, fiscal objection to expanding tax credits is the focus on the immediate reduction in state tax revenues. However, analyzing the R&D tax credit strictly as a static, line-item cost on the state ledger fundamentally misunderstands the complex mechanics of innovation economics. The initial outlay of tax credits serves as catalytic capital that yields profound, compounding macroeconomic returns for the state. To frame this policy accurately, legislators must evaluate the proposal through the sophisticated lens of economic multipliers, supply chain resilience, and long-term fiscal recapture.

The Mechanics of the Economic Multiplier

When an agricultural or manufacturing SMB receives an R&D tax credit, the capital does not sit idle in a corporate treasury; it is immediately deployed into the local island economy. Empirical economic research indicates that R&D spending, particularly when directed toward “low-tech,” capital-constrained, or traditional sectors, exhibits a very high elasticity of demand. This means that every dollar of public tax subsidy generates a disproportionately large, multiplicative increase in private R&D investment, often far exceeding the baseline expectations of policymakers.⁴⁶

In Hawaii, DBEDT, alongside academic partners such as the University of Hawaii Economic Research Organization (UHERO), frequently utilizes input-output economic models to track how distinct spending injections cascade through the local economy. For instance, recent UHERO analyses of investments in Hawaii’s environmental and industrial infrastructure demonstrate a total economic multiplier of approximately 2.03. In that specific study, $461 million in direct operational expenditures generated an astonishing $937 million in aggregate statewide output of goods and services.⁹ Similarly, production and manufacturing-related expenditures carry estimated aggregate multipliers of at least 1.73.¹⁰ Furthermore, an analysis using the Dynamic Deterministic Shift-Share (DDSS) framework confirms that the technology sector, while moderately sized, anchors long-run diversification strategies due to its exceptionally high wage levels and subsequent induced spending impacts.⁴⁸

If the state allocates $5 million in R&D tax credits to traditional SMBs under an expanded framework, the direct, indirect, and induced economic impacts are profound. The SMB utilizes the $5 million to hire local agricultural engineers, food scientists, or advanced manufacturing technicians. Those new employees spend their high STEM-level wages on local housing, food, and retail services, generating massive “induced” economic impact.⁴⁹ Simultaneously, the SMB purchases specialized testing equipment, raw materials, and fabrication tools from local downstream vendors, generating significant “indirect” impact.⁴⁹ Applying a conservative 1.73 multiplier ¹⁰, a $5 million state tax credit investment reliably generates at least $8.65 million in aggregate economic activity across the islands.

Fiscal Recapture and Long-Term Return on Investment

This robust multiplier effect directly and reliably translates into fiscal recapture for the state government. Hawaii levies a broad General Excise Tax (GET) of approximately 4.0% to 4.5% on nearly all business transactions at every stage of production.⁵⁰ The state also relies on a graduated individual income tax featuring a top marginal rate of 11.0%, and a corporate income tax ranging from 4.4% to 6.4%.⁵⁰

As the $8.65 million in generated economic activity rapidly cycles through the state economy, it is repeatedly subjected to the GET. Furthermore, the high-paying STEM jobs created by these rigorous R&D efforts yield substantial, recurring state income tax revenues.⁵¹ Studies by UHERO on high-multiplier local spending demonstrate that these activities heavily bolster state tax revenues across multiple vectors, effectively offsetting the initial public subsidy over a multi-year horizon.⁹

Beyond the immediate tax recapture, the successful commercialization of R&D leads to highly profitable, exportable intellectual property (IP) and value-added goods that permanently elevate the state’s economic baseline.²⁴ If a local manufacturing firm successfully utilizes the credit to develop a proprietary robotic assembly process or a highly efficient material fabrication technique, that firm fundamentally increases its long-term corporate profitability. This permanently expands Hawaii’s corporate income tax base. The initial cost outlay of the tax credit is therefore not a loss; it is fully amortized over the lifespan of the resulting commercial innovations, transforming the state from a passive tax collector into an active venture partner in its own economic survival.

Consequences of Inaction and Conclusion

The decision to maintain the legislative status quo—preserving the narrow, exclusionary industry definitions that currently govern HRS §235-7.3—carries severe, compounding negative consequences for Hawaii’s long-term economic viability.

First, the state will continue to suffer from an accelerating “brain drain.” Hawaii’s excellent university systems produce highly capable mechanical engineers, agricultural scientists, software developers, and industrial designers. If local SMBs in the agricultural and manufacturing sectors are financially prohibited from engaging in cutting-edge R&D because they are denied state subsidies, they simply will not be able to afford to hire these graduates. Consequently, this highly educated demographic will continue their outmigration to states like California, Illinois, or Texas, where robust, technology-neutral R&D subsidies allow traditional physical industries to aggressively hire and retain elite technical talent.¹

Second, the structural vulnerabilities of the island economy will deepen. If the local agricultural sector cannot afford the immense R&D capital required to transition to climate-smart, automated, and high-yield technological farming, the state will never break its precarious 90% reliance on imported food.²⁸ The next major geopolitical shock or maritime disruption will expose the fragility of this system. Similarly, without advanced manufacturing capabilities, Hawaii will remain entirely dependent on maritime supply chains for basic industrial goods, construction materials, and processed foods, leaving it perilously exposed to global logistics crises.²⁵

Finally, failing to broaden the R&D framework fundamentally undermines the state’s own strategic vision. The Chamber of Commerce’s 2030 Blueprint explicitly calls for the urgent diversification of the economy beyond tourism and hospitality, demanding massive investments in agriculture, sustainability, and resilient manufacturing.² By keeping the R&D tax credit locked behind narrow, exclusionary definitions that favor only a handful of specific high-tech silos, the legislature is effectively starving its most critical, legacy industries of the catalytic capital required to modernize.

Modernizing the Tax Credit for Research Activities to embrace true technology neutrality is not a concession; it is an essential evolution. By aligning state policy with established federal standards, implementing robust digital fraud-prevention frameworks, and acknowledging the profound macroeconomic multipliers of traditional sector innovation, the State of Hawaii can transform its R&D tax credit from a niche subsidy into a truly comprehensive, powerful engine for state-wide economic resilience and enduring prosperity.

Works Cited

1. 2030 Blueprint – Chamber of Commerce Hawaii, accessed March 23, 2026, https://www.cochawaii.org/2030-blueprint/
2. Blueprint 2030: An Economic Action Plan for Hawaii Report, accessed March 23, 2026, https://www.cochawaii.org/wp-content/uploads/2024/10/COCH-40740_BlueprintReport_Spreads-compressed.pdf
3. accessed March 23, 2026, https://www.striketax.com/state-rd-credits/hawaii-r-d-tax-credits#:~:text=The%20Hawaii%20R%26D%20Tax%20Credit,%2C%20Economic%20Development%2C%20and%20Tourism%20(
4. Tax Credit for Research Activities (TCRA) & Hawaii Film Tax Credit, accessed March 23, 2026, https://dbedt.hawaii.gov/taxcredits/
5. Hawaii R&D Tax Credits – Endeavor Advisors, accessed March 23, 2026, https://www.endeavoradvisors.com/hawaii-rd-tax-credit/
6. Hawaii Revised Statutes Division 1. Government § 235-7.3 – Codes – FindLaw, accessed March 23, 2026, https://codes.findlaw.com/hi/division-1-government/hi-rev-st-sect-235-7-3/
7. Row Crop Agriculture & the R&D Tax Credit – Adams Brown, accessed March 23, 2026, https://www.adamsbrowncpa.com/blog/row-crop-agriculture-the-rd-tax-credit/
8. R&D Tax Credits: Agricultural and Farming Industries – Acena Consulting, accessed March 23, 2026, https://www.acenaconsulting.com/blog/rd-tax-credit-industry-spotlight-farming-agriculture
9. Economic Impact of the City and County of Honolulu’s Department of Environmental Services on the State of Hawai’i in Fiscal – UHERO Hawaii, accessed March 23, 2026, https://uhero.hawaii.edu/wp-content/uploads/2025/10/EconomicImpactOfTheCityAndCountyOfHonolulusDepartmentOfEnvironmentalServices.pdf
10. Economic Development FY 24 and FY 25 Variance Report, accessed March 23, 2026, https://budget.hawaii.gov/wp-content/uploads/2024/12/05-Economic-Development-FY-24-and-FY-25.7Lt.pdf
11. Small State, Giant Tax Credit: Hawaii’s Leap into High Technology Development, accessed March 23, 2026, https://uhero.hawaii.edu/wp-content/uploads/2019/08/UHERO_WP2009-03.pdf
12. Hawaiʻi Tax Credit for Research Activities – Hawaii Technology Development Corporation, accessed March 23, 2026, https://www.htdc.org/programs/hawai%CA%BBi-tax-credit-for-research-activities/
13. Hawaii R&D Tax Credits – Strike Tax Advisory, accessed March 23, 2026, https://www.striketax.com/state-rd-credits/hawaii-r-d-tax-credits
14. HI SB2497 – BillTrack50, accessed March 23, 2026, https://www.billtrack50.com/billdetail/1682020
15. Report on Hawaiʻi Tax Credit for Research Activities for the 2024 Tax Year – Hawaii.gov, accessed March 23, 2026, https://files.hawaii.gov/dbedt/economic/data_reports/HawaiiResearchTaxCredit_TaxYear2024.pdf
16. Report on Hawaii Tax Credit for Research Activities for Tax Year 2022, accessed March 23, 2026, https://files.hawaii.gov/dbedt/economic/data_reports/HawaiiResearchTaxCredit_TaxYear2022.pdf
17. Hawaii’s Refundable R&D Tax Credit: The CPA’s Comprehensive Guide for 2025, accessed March 23, 2026, https://www.acenaconsulting.com/blog/hawaiicredit
18. The Hawaii Guide to State Tax Incentives – Gusto, accessed March 23, 2026, https://gusto.com/resources/states/hawaii/hi-tax-incentives
19. How Tech Neutral Tax Credits Ensure American Energy Leadership, accessed March 23, 2026, https://bipartisanpolicy.org/article/how-tech-neutral-tax-credits-ensure-american-energy-leadership/
20. The potential benefits of the R&D tax credit – CohnReznick, accessed March 23, 2026, https://www.cohnreznick.com/insights/potential-benefits-of-r-and-d-tax-credit
21. California State Research & Development Tax Credit, accessed March 23, 2026, https://beaumontcabusiness.gov/businesses/incentives/california-state-research-and-development-tax-credit
22. 4 Step Guide to Secure R&D Tax Credits – MGO CPA, accessed March 23, 2026, https://www.mgocpa.com/perspective/4-step-guide-to-securing-rd-tax-credits-for-your-company/
23. Hawaii – Research Credits–Expenditures on Research Activities – Income Taxes, Corporate – Explanations – CCH AnswerConnect | Wolters Kluwer, accessed March 23, 2026, https://answerconnect.cch.com/document/jhi0109013e2c83aa0eb8/state/explanations/hawaii/research-credits-expenditures-on-research-activities
24. How Ag Tech Is Helping Hawai’i Farmers Grow More Food – Hawaii Business Magazine, accessed March 23, 2026, https://www.hawaiibusiness.com/ag-tech-helps-hawaii-farmers-grow-more-food/
25. Performance of the Manufacturing Industries in Hawaii and the U.S., accessed March 23, 2026, https://files.hawaii.gov/dbedt/economic/archive/reports/Manufacture%20_Report_11_21_16.pdf
26. Section 41 tax credit benefits farmers engaging in research activities – Farm Progress, accessed March 23, 2026, https://www.farmprogress.com/farm-business-planning/section-41-tax-credit-benefits-farmers-engaging-in-research-activities
27. Advanced Manufacturing Investment Credit | Internal Revenue Service, accessed March 23, 2026, https://www.irs.gov/credits-deductions/advanced-manufacturing-investment-credit
28. Climate Resilient & Agricultural Innovation Hub for Women Farmers of Hawai’i County, accessed March 23, 2026, https://www.wocan.org/projects/ag-hub-for-women/
29. Technology is Changing Agriculture, But is It For the Better? – Hawaii Farmers Union United, accessed March 23, 2026, https://hfuuhi.org/technology-is-changing-agriculture-but-is-it-for-the-better/
30. Business and Industry Development | Hawaii County, HI Research & Development, accessed March 23, 2026, https://www.rd.hawaiicounty.gov/economic-development/industry-development
31. Germinating UH agriculture tech innovation | University of Hawaiʻi System News, accessed March 23, 2026, https://www.hawaii.edu/news/2024/07/12/germinating-agtech-innovations/
32. 2023 Legislative Update — HAPA – Hawaii Alliance for Progressive Action, accessed March 23, 2026, https://www.hapahi.org/blog/2023-legislative-cross-over
33. AgFood System 2025 Report – HIAP, accessed March 23, 2026, https://www.hiagpartnership.org/agfood-2025-report
34. (35 ILCS 65/) Advancing Innovative Manufacturing for Illinois Tax Credit Act., accessed March 23, 2026, https://www.ilga.gov/Legislation/ILCS/Articles?ActID=4602&ChapterID=8&Chapter=REVENUE&MajorTopic=GOVERNMENT&Print=True
35. 003500650K77-10.html – ILGA.gov, accessed March 23, 2026, https://www.ilga.gov/ftp/ILCS/Ch%200035/Act%200065/003500650K77-10.html
36. UH’s advanced manufacturing initiative prepares workforce, strengthens economy | University of Hawaiʻi System News, accessed March 23, 2026, https://www.hawaii.edu/news/2025/10/02/advanced-manufacturing-initiative/
37. Hawaiʻi Primed to Revive Agriculture – Hawaii Business Magazine, accessed March 23, 2026, https://www.hawaiibusiness.com/hawaii-primed-to-revive-agriculture/
38. annual report 2025 – Hawaii.gov, accessed March 23, 2026, https://files.hawaii.gov/dbedt/annuals/2025/2025-dbedt.pdf
39. HI HB2546 – BillTrack50, accessed March 23, 2026, https://www.billtrack50.com/billdetail/1956144
40. H.B. No. 2546, H.D.1, Relating to Tax Cr – LegiScan, accessed March 23, 2026, https://legiscan.com/HI/supplement/HB2546/id/685875/Hawaii-2026-HB2546-HB2546_HD1_TESTIMONY_FIN_03-02-26_.pdf
41. IRS Scrutiny on R&D Tax Credits: How to Protect Your Claim in 2025, accessed March 23, 2026, https://massietaxcredits.com/resources/articles/irs-scrutiny-rd-tax-credits-2025/
42. Bad breaks: Why US tax policies put innovation at risk, accessed March 23, 2026, https://siepr.stanford.edu/publications/policy-brief/bad-breaks-why-us-tax-policies-put-innovation-risk
43. Audit techniques guide: Credit for increasing research activities (i.e. Research Tax Credit) IRC § 41 — Determining the scope – IRS, accessed March 23, 2026, https://www.irs.gov/businesses/audit-techniques-guide-credit-for-increasing-research-activities-ie-research-tax-credit-irc-ss-41-determining-the-scope
44. Audit-Proofing Your Tax Credit Claims: Best Practices and Red Flags for 2026 – HRlogics, accessed March 23, 2026, https://hrlogics.com/blog/audit-proofing-your-tax-credit-claims-best-practices-and-red-flags-for-2026
45. Tax Law Changes from the 2024 Regular Legislative Session – Hawaii.gov, accessed March 23, 2026, https://files.hawaii.gov/tax/news/announce/ann24-04.pdf
46. Unlocking Innovation: The Economic Impact of R&D Tax Credit Policies – IDEAS/RePEc, accessed March 23, 2026, https://ideas.repec.org/a/aiy/jnljtr/v11y2025i2p341-357.html
47. The Impact of Research and Development Tax Incentives on Colombia’s Manufacturing Sector: What Difference Do They Make? in – IMF eLibrary, accessed March 23, 2026, https://www.elibrary.imf.org/view/journals/001/2008/178/article-A001-en.xml
48. Hawai’i’s Targeted & Emerging Industries – Hawaii.gov, accessed March 23, 2026, https://files.hawaii.gov/dbedt/economic/data_reports/emerging-industries/Hawaii_Targeted_Emerging_Industries_2025_Update_Report.pdf
49. The Economic Impacts of Federal Government Contracts Awarded in Hawaii Fiscal Year 2018 – 2022, accessed March 23, 2026, https://files.hawaii.gov/dbedt/economic/archive/reports/Econ_Impact_Fed_Contracts_FY1822_Aug_2023_Final.pdf
50. Hawaii Tax Rates & Rankings – Tax Foundation, accessed March 23, 2026, https://taxfoundation.org/location/hawaii/
51. Annual Report 2023-2024 – Hawaii.gov, accessed March 23, 2026, https://files.hawaii.gov/tax/stats/stats/annual/24annrpt_2.pdf
52. Are R&D Tax Credits Available in California? | See if You Qualify – KBKG, accessed March 23, 2026, https://www.kbkg.com/research-tax-credit/california-rd-tax-credit