Strategic Imperatives for Hawaii’s Economic Future: Resolving the Sunset Uncertainty of the Research and Development Tax Credit for Small and Medium Businesses

1. Executive Summary

The State of Hawaii stands at a critical and precarious juncture in its long-term economic development trajectory. For decades, the structural foundation of the Hawaiian economy has been overwhelmingly dependent on tourism, real estate, and federal defense spending. In 2025, Hawaii’s Gross State Product (GSP) reached $91.9 billion, yet the state continues to suffer from slow annualized growth and a highly vulnerable economic composition.¹ This inherent structural fragility has been repeatedly and starkly exposed by macroeconomic shocks, global pandemics, and catastrophic natural disasters. Most recently, the devastating 2023 Maui wildfires triggered not only immense human tragedy but also severe economic contraction, leading to increased out-migration and a doubling of the number of local households living below the poverty line within the affected regions.² To forge a resilient, diversified, and shock-resistant economy, Hawaii has actively sought to cultivate a robust technology, bioscience, and innovation sector.⁴

A central cornerstone of this strategic economic pivot is the Hawaii Tax Credit for Research Activities (TCRA), codified under Hawaii Revised Statutes (HRS) § 235-110.91.⁵ This policy instrument is expressly designed to incentivize local Small and Medium Businesses (SMBs) to conduct high-value, high-wage research and development (R&D) within the state boundaries.⁵ However, the efficacy, reliability, and ultimate success of this vital economic catalyst are fundamentally undermined by a severe, self-inflicted policy defect: “Sunset Uncertainty.”

Currently, the TCRA is subject to a hard statutory sunset date of December 31, 2029, after which the credit will be entirely repealed from the state statute.⁵ Because institutional research and development is inherently a multi-year, highly iterative, and capital-intensive endeavor, the looming expiration of the credit actively discourages Hawaii’s SMBs from committing to the long-term technological investments that the policy was created to stimulate.⁹ This expiration date does not exist in a vacuum; it is compounded by structural rigidities within the current law—specifically, a severely constrained $5 million annual cap that is distributed on an arbitrary, first-come, first-served basis, and recent legislative changes that have drastically reduced the accessible value of the credit for established local innovators.⁷ Together, these factors render the TCRA an unreliable, volatile element in corporate financial modeling, diluting its power to attract and retain high-technology enterprises.

This exhaustive policy whitepaper is intended for distribution to the Government of the State of Hawaii. It provides a comprehensive analysis of the TCRA within the specific context of Hawaii’s SMB ecosystem. It dissects the macroeconomic implications of legislative uncertainty on corporate capital allocation, deeply evaluates the empirical impacts of recent legislative changes under Act 139 (2024), and proposes a suite of practical, actionable solutions for the Hawaii State Legislature. Furthermore, it outlines a rigorous implementation framework that balances the urgent need to aggressively incentivize SMB innovation with the paramount fiduciary imperative to prevent fraud, waste, and abuse.¹⁴ Finally, a detailed cost-benefit analysis demonstrates unequivocally that the immediate fiscal outlay required to stabilize and expand the R&D credit will yield compounding, long-term economic dividends—in the form of high-wage job creation, expanded tax bases, and intellectual property generation—that will far exceed the program’s initial costs over time.¹³

2. Contextualizing Hawaii’s R&D Tax Credit Framework

To fully comprehend the destructive nature of the current sunset uncertainty, one must first dissect the statutory mechanics, the legislative history, and the administrative realities of the Hawaii Tax Credit for Research Activities (TCRA). The credit is not merely a passive tax deduction; it is an active, structural mechanism intended to alter the behavioral economics of firm-level capital deployment.

2.1 The Mechanics and Intent of HRS § 235-110.91

The TCRA is a refundable income tax credit specifically designed to support Qualified High Technology Businesses (QHTBs) operating within the state.⁶ The distinction between a non-refundable and a refundable tax credit is of paramount importance in the context of innovation economics. For many SMBs, particularly early-stage technology startups, biotechnology firms engaged in prolonged clinical trials, and software developers building complex enterprise architectures, the initial years of operation are characterized by massive capital expenditures and nominal, if any, net taxable income.² A non-refundable credit would be entirely useless to these entities. The refundable nature of the TCRA dictates that if a company’s tax liability is less than the calculated credit amount, the State of Hawaii refunds the excess difference in cash.² This mechanism provides critical, non-dilutive liquidity that allows early-stage firms to sustain their cash burn rates while developing novel intellectual property.

Under the current statutory framework, the qualifying criteria for the TCRA are exceptionally stringent. A QHTB is narrowly defined as a small business that employs no more than 500 individuals.⁵ Furthermore, the enterprise must conduct more than 50% of its total qualified research activities physically within the State of Hawaii, and it must be formally registered to do business in the state.⁵ These geographic and size constraints were explicitly designed by the legislature to ensure that the economic benefits of the subsidy—namely, job creation and localized spending—accrue directly to the Hawaiian economy, rather than subsidizing the offshore or mainland operations of massive multinational conglomerates.¹²

The foundation of the Hawaii credit is strictly tethered to the federal provisions outlined in Internal Revenue Code (IRC) § 41.⁷ This alignment creates a baseline of compliance, meaning that expenses can only be claimed in Hawaii if they meet the rigorous federal definitions for Qualified Research Expenses (QREs).² To operationalize the credit, taxpayers must navigate a complex, dual-agency administrative labyrinth. First, an applicant must submit a comprehensive application and an exhaustive survey to the Department of Business, Economic Development, and Tourism (DBEDT) by March 31 of the year immediately following the taxable year in which the research was conducted.⁷ This survey mandates the disclosure of granular financial data, including specific qualifying expenditures, revenue generation, operational expense data, intellectual property filings, and payroll documentation.⁷ Only after DBEDT reviews and verifies this extensive data cache does it certify the claim and issue an approved Form N-346A.⁵ The taxpayer is then responsible for attaching this DBEDT-certified Form N-346A, alongside federal Form 6765, to their Hawaii income tax return filed with the Department of Taxation (DOTAX).⁷

2.2 Legislative Evolution: The Impact of Act 139 (2024)

The trajectory of the TCRA has been marked by frequent, highly disruptive legislative tinkering, culminating most recently in the passage of Act 139 (originating from Senate Bill 2497) in 2024.⁸ Prior to the enactment of Act 139, the state allowed taxpayers to calculate their credit based on the total amount of all qualified research expenses incurred within the taxable year, explicitly disregarding the restrictive “base amount” calculations mandated by IRC § 41.⁵ This “total amount” methodology was highly lucrative and broadly utilized by the local tech sector.

Act 139 fundamentally altered this calculation paradigm. It repealed the provision that made the federal base amount inapplicable, thereby forcibly reinstating the IRC § 41 standard for Hawaii state claims.⁵ Consequently, credit for qualified research expenses could no longer be taken without regard to the amount of expenses incurred in previous years.⁵ In practical terms, this shifted the TCRA from a subsidy on total R&D spending to a subsidy solely on the incremental increase in R&D spending over a historically established baseline.¹² While Act 139 succeeded in extending the program’s absolute sunset date from December 31, 2024, out to December 31, 2029 ⁵, its structural mathematical changes inadvertently hollowed out the immediate utility of the credit for the state’s most established, consistent innovators.

The empirical impact of Act 139 was immediate, chilling, and heavily documented in DBEDT’s summary findings for the 2024 tax year.¹² Under the new incremental calculation, the average tax credit claimed per certified QHTB plummeted drastically. During the 2020–2023 tax years under the “total amount” rules, the average credit ranged from $450,000 to $560,000 per company.¹² In 2024, under the Act 139 incremental rules, the average credit collapsed to a mere $150,000—a nearly 70% decline in financial support.¹² Furthermore, because the credit was now so mathematically restrictive, the state failed to disburse its entire allocation. Out of the $5 million annual cap available, only $2.6 million was certified in 2024, leaving $2.4 million entirely unclaimed by the market.¹² This demonstrates that the state collected less revenue from a weakened credit framework, because the incentive was no longer robust enough to drive the targeted economic behaviors.¹³

2.3 The Restrictive Cap and the First-Come, First-Served Lottery

Beyond the incremental calculation issues, the TCRA remains crippled by an artificially low statutory cap of $5 million per year for the entire state economy.⁵ To manage this severe limitation, the statute dictates that DBEDT must certify credits on a strict, chronological first-come, first-served basis.⁵

This administrative mechanism creates extreme structural unpredictability. Historically, prior to the dampening effect of Act 139, the $5 million limit was so inadequate relative to the volume of local R&D activity that the cap was exhausted almost instantly. As noted by industry consultants, the cap was routinely reached “almost as soon as the online applications were opened” on March 1st.² This framework transforms a vital economic policy into an administrative lottery. For an SMB executive, meeting all the stringent qualifications of a QHTB, executing millions of dollars of research within Hawaii, and meticulously documenting every expense does not guarantee the receipt of the credit.⁷ If a company’s administrative staff experiences a minor technical delay and submits their N-346A application a few hours after the $5 million threshold has been breached by competing firms, that company receives zero state support for that tax year.¹²

Academic studies evaluating the efficacy of state-level tax incentives routinely heavily criticize first-come, first-served rationing mechanisms. Such frameworks fail entirely to align the financial subsidy with optimal economic outcomes; instead, they reward mere administrative speed.¹⁴ An enterprise cannot responsibly base long-term, multi-million dollar capital expenditure decisions on a tax credit that behaves with the unpredictability of a sweepstakes. Therefore, sophisticated SMBs systematically discount the perceived value of the Hawaii TCRA when projecting their future cash flows, severely diluting the policy’s intended macro-level incentive effect.¹⁴

3. The Economic Profile of Hawaii’s QHTB Sector: What is at Stake?

To accurately assess the urgency of resolving the sunset and structural uncertainties, the Hawaii State Legislature must understand the precise economic profile of the businesses utilizing the TCRA. These are not standard service-sector enterprises; they represent the pinnacle of high-value, exportable knowledge work. DBEDT data from the 2024 tax year provides an exhaustive, granular illustration of a highly valuable—albeit artificially constrained—economic cohort.¹²

In 2024, a total of 23 entities applied for the credit, of which 18 QHTBs were fully certified (five were disqualified for exceeding the employee limit, failing the 50% in-state research requirement, or lacking proper documentation).¹² These 18 certified firms spent a combined $29.5 million on qualified research expenses strictly within the borders of Hawaii.¹² The composition of these expenditures is highly localized; over 80% of all research expenses were allocated directly to employee wages, with ten of the companies reporting that wages accounted for 90% to 100% of their total research spending.¹²

The revenue generation of these firms is substantial. The 18 QHTBs generated $233.4 million in total revenue in 2024.¹² While this revenue was highly concentrated—with five companies earning over $10 million each and three earning less than $150,000—it highlights the presence of both mature, highly successful anchor firms and aggressive, early-stage startups within the local ecosystem.¹² Notably, nearly 20% of this revenue was derived directly from the commercialization of intellectual property (IP), demonstrating that these firms are actively exporting knowledge-based products to global markets, thereby drawing external capital into the isolated Hawaiian economy.¹² Collectively, this small cohort owned or had pending 138 patents, with all but one originating directly from research conducted in Hawaii.¹²

However, the most critical metric for state policymakers is the employment impact. As of December 2024, the certified QHTBs employed 879 people in regular positions, the vast majority (88.6%) of which were full-time roles.¹² This workforce is deeply rooted in the local community; an overwhelming 97.4% of these employees were verified Hawaii residents.¹² The compensation for these roles vastly outpaces the broader state economy. The weighted average annual wage for full-time staff across all roles was $88,557.¹² For those specifically engaged in full-time research activities, the weighted average annual wage surged to $117,972, with over a third of all full-time employees earning in excess of $100,000 annually.¹²

Furthermore, these businesses act as localized economic multipliers. Beyond internal payroll, twelve of the QHTBs spent a combined $3.8 million on 110 independent contractors and external technical services for jobs performed explicitly within Hawaii.¹² The dominant sectors driving this activity are Information and Communication Technology, Computer Software, and Biotechnology—industries universally recognized as the foundation of the 21st-century global economy.¹²

The following table synthesizes the empirical economic impact of the 18 certified QHTBs in the 2024 tax year, clearly illustrating the high-leverage nature of the state’s investment:

Table 1: Empirical Impact of the QHTB Cohort (2024)

This data paints an undeniable picture: QHTBs represent the exact demographic and economic profile that Hawaii must actively cultivate to ensure future prosperity. However, their continued presence and expansion are directly threatened by the instability of the current tax code.

4. The Core Policy Issue: The Macroeconomics of Sunset Uncertainty

The foundational threat to Hawaii’s innovation pipeline is the statutorily mandated sunset date of December 31, 2029.⁵ While the legislative extension granted by Act 139 in 2024 provided brief, temporary relief from an impending fiscal cliff, establishing a hard sunset at the end of the current decade reveals a fundamental misunderstanding of the chronological realities of corporate research and development. Innovation is not a short-term, discrete annual event; it is a sprawling, multi-year, and highly iterative process subject to extreme technical risk.¹³

4.1 The Chronological Disconnect Between Policy and Science

The development lifecycle for deep technology is notoriously long. The engineering of new climate-resilient nanomaterials, the rigorous clinical trials required for a novel biotechnology therapeutic, or the complex architecture and security hardening of enterprise-scale software platforms generally operate on a five- to ten-year timeline from basic foundational research to viable market commercialization.¹³

When the executive team or board of directors of a Hawaiian SMB evaluates a new, capital-intensive research initiative in the year 2026, their financial forecasting models must project costs, capital requirements, and potential subsidies through 2031, 2033, or beyond. Because the Hawaii TCRA is legally scheduled to expire in 2029, the firm’s Chief Financial Officer cannot, under any responsible fiduciary standard, factor state-level tax subsidies into the latter half of their discounted cash flow models.⁵ This arbitrary legislative disruption in the financial modeling drastically inflates the perceived risk and the net present cost of the project. Consequently, projects that would be highly viable and economically beneficial under a permanent tax regime are deemed too financially hazardous to initiate.

4.2 Real Options Theory and the “Caution Effect”

The negative correlation between policy uncertainty and corporate capital investment is not merely anecdotal; it is deeply embedded in robust macroeconomic literature. The behavior of firms facing sunset uncertainty can be best understood through the lens of “real options theory”.¹⁰ In corporate finance, strategic investment opportunities are viewed analogously to financial options. Because R&D investments involve massive “sunk costs”—expenses for specialized equipment, highly specific laboratory testing, and bespoke software coding that cannot be easily recovered or liquidated if the project is subsequently abandoned—firms hold a highly valuable “call option”.¹¹ This is the option to delay their investment until external uncertainty is resolved.

When a government institutes an arbitrary sunset clause on a vital subsidy, it actively and deliberately injects severe legislative uncertainty into the market. A seminal macroeconomic study by Nicholas Bloom (2007) demonstrates that higher uncertainty generates a powerful “caution effect” among executives.¹¹ This caution effect makes R&D spending significantly less responsive to favorable business conditions, causing firms to hoard cash, delay hiring, and postpone capital deployment until the political landscape stabilizes.¹¹ The data indicates that uncertainty fluctuations can account for roughly a third of the fall in capital investment and hiring during economic contractions.²⁶

Furthermore, research indicates that macroeconomic and monetary policy uncertainty critically tightens financial constraints, particularly for SMBs that do not possess the massive cash reserves of multinational corporations.¹⁰ High uncertainty raises the cost of external financing, thereby heavily increasing the opportunity cost of dedicating limited internal funds to speculative R&D.¹⁰ Empirical, cross-country studies unequivocally show that high uncertainty depresses the aggregate number of R&D personnel hired by private enterprises and the total volume of patent applications filed.⁹ By maintaining the 2029 sunset date, the Hawaii State Legislature is inadvertently acting as a depressant on its own high-tech sector, creating an environment where rational firms will invariably choose to exercise their “real option” to delay or downsize operations rather than commit capital to an unpredictable jurisdiction.

5. The Consequences of Inaction: Capital Flight and Brain Drain

The failure to swiftly and permanently resolve the TCRA’s sunset and structural uncertainties carries profound, long-lasting negative consequences for the economic viability of the State of Hawaii.

5.1 Interstate Competition and Capital Flight

Capital in the 21st century is highly mobile, and R&D activities are uniquely geographically agnostic. A software engineer or a computational biologist can perform their duties almost anywhere, provided the supporting infrastructure and financial incentives exist. As of 2025, the competitive landscape for innovation has intensified dramatically, with 36 U.S. states and Puerto Rico currently offering their own state-level R&D tax credits to stimulate and attract high-tech enterprise.²⁸

States such as Texas, Arizona, and Massachusetts have aggressively optimized their tax codes to serve as magnets for high-tech SMBs, often featuring permanent, uncapped credits, and enhanced payout rates for private collaboration with academic institutions.²⁸ These states actively court the very companies Hawaii is currently frustrating. If Hawaii allows the TCRA to remain shadowed by a 2029 sunset, or allows its administration to remain a structurally unreliable lottery, SMBs will simply relocate their research operations to jurisdictions that provide fiscal certainty.

This is not a theoretical risk; it is a stated intention. A 2024 self-reported survey of certified QHTBs in Hawaii revealed a stark reality: 50% of the companies explicitly stated that they would have significantly reduced or entirely ceased their research spending within the state without the support of the TCRA.¹² Allowing the credit to sunset, or allowing it to remain practically inaccessible due to low caps and incremental constraints, is tantamount to actively exporting Hawaii’s homegrown innovation economy to the mainland.²⁹

5.2 Exacerbating the Brain Drain and Stifling Diversification

Hawaii has struggled for decades with a chronic “brain drain”—the continuous, demoralizing exodus of its brightest high school and university STEM (Science, Technology, Engineering, and Mathematics) graduates to the mainland due to a severe lack of high-paying, career-track local opportunities.³⁰ The 879 personnel employed by QHTBs in 2024, earning an average of $117,972, represent the exact demographic that the state must desperately retain to secure its future civic vitality and expand its tax base.¹²

If legislative uncertainty forces Hawaii’s QHTBs to scale back their multi-year projects, freeze hiring, or relocate operations to the mainland, the immediate and most painful casualty will be these highly skilled, high-wage jobs. The loss of these individuals removes top-tier taxpayers from the state’s revenue streams, diminishes the localized consumer base that supports the broader service and retail economy, and deepens the state’s dangerous over-reliance on the low-wage tourism sector.¹³ Without a reliable, long-term incentive structure, Hawaii will perpetually fail to reach the critical mass of human capital and physical infrastructure necessary to establish a self-sustaining, globally competitive technology cluster.

6. Practical Solutions for the Hawaii State Legislature

To aggressively address the sunset uncertainty and optimize the TCRA for the maximum benefit of SMBs and the state economy, the Hawaii State Legislature must adopt comprehensive statutory reforms. Piecemeal extensions are no longer sufficient. The following proposed solutions are designed to transition the framework from an unpredictable, short-term subsidy into a permanent, structural economic driver.

Solution 1: Permanent Codification with Rigorous “Dynamic Performance Triggers”

The most direct, effective, and economically sound method to eliminate sunset uncertainty is to formally repeal the December 31, 2029 expiration date, thereby making HRS § 235-110.91 a permanent fixture of the Hawaii tax code. This action would mirror the stabilization of the federal R&D credit (IRC § 41), which was made permanent under the PATH Act after decades of damaging, temporary extensions.⁵

However, permanent tax expenditures often draw valid political and economic criticism for lacking ongoing accountability, transparency, and responsiveness to changing fiscal realities.³¹ To balance the absolute necessity of predictability for SMBs with the fiduciary responsibility required by state budgeting, the legislature should replace the hard sunset clause with a sophisticated Dynamic Performance Review Trigger.

Under this modernized system, the TCRA is legally permanent, providing the long-term horizon SMBs require. However, the statute would legally mandate that the Department of Business, Economic Development, and Tourism (DBEDT) conduct a rigorous, highly publicized biennial economic impact analysis of the program.¹² The revised statute must codify specific Key Performance Indicators (KPIs) that the QHTB cohort is expected to meet in aggregate. These KPIs should include the creation of net-new STEM jobs, the aggregate volume of out-of-state export revenue generated by QHTBs ³³, and the state’s calculated Return on Investment (ROI) measured via expanded corporate income and General Excise Tax (GET) bases.¹³

If the aggregate economic performance of the QHTB cohort falls below these statutory thresholds for two consecutive review cycles, a legislative review is automatically triggered, forcing the legislature to actively debate, reform, or pause the credit. This mechanism provides SMBs with the vital baseline certainty they need to initiate 10-year research projects, secure in the knowledge that the credit will persist indefinitely so long as the high-tech sector continues to deliver the promised, quantifiable economic benefits to the state.

Solution 2: Structural Redesign – Proportional Distribution and Cap Modernization

Even if the sunset date is addressed, the secondary layer of uncertainty—the annual, instantaneous exhaustion of the $5 million cap—must be resolved. The legislature must fundamentally reform the rationing mechanism. Pending legislative proposals, such as HB 2546 and SB 3213, have correctly identified this critical necessity by proposing a shift away from the chaotic first-come, first-served model to an equitable Proportional Distribution system.¹³

The following table contrasts the catastrophic inefficiencies of the current system against the stabilizing mechanics of the proposed proportional model:

Table 2: Allocation Mechanism Comparison

Concurrently, the legislature must aggressively expand the annual statewide cap. The $5 million limit is a relic of a much smaller economy. As championed by local technology advocates and organizations like Oceanit Laboratories, expanding the cap to a minimum of $15 million is essential.¹³ Expanding the cap and instituting proportional distribution entirely removes the administrative volatility of the program, transitioning it into a reliable pillar for SMB growth.

Furthermore, as strongly suggested by industry stakeholder testimony, the legislature should repeal the restrictive “incremental only” limitation imposed by Act 139 in 2024. By allowing taxpayers to once again claim all qualified research expenses without regard to prior-year historical bases, the state will immediately revitalize the credit’s utility for established local firms that maintain consistently high levels of innovation spending.¹³

Solution 3: The “Safe Harbor” Project Lifecycle Exemption

If the legislature finds itself politically constrained from making the credit broadly permanent across the entire tax code, a highly effective alternative approach is to implement a targeted “Safe Harbor” cohort model, designed specifically to accommodate the realities of long-term R&D.

In this hybrid model, the broader statutory sunset date of 2029 could remain in place for the initiation of entirely new enterprise claims. However, the legislature would amend HRS § 235-110.91 to guarantee that any QHTB that successfully registers a qualified, multi-year research project with DBEDT prior to the sunset date is legally “grandfathered” into the program.⁵ These firms would be statutorily entitled to claim the TCRA for the specific, predefined life cycle of that registered project (e.g., capped at a maximum of 7 to 10 years), regardless of the broader sunset date occurring in 2029.

This approach surgically targets the core behavioral issue—protecting ongoing, highly vulnerable multi-year investments from sudden legislative disruption—while still allowing the state government to close the program to new entrants in 2029 if severe macroeconomic fiscal conditions demand a reduction in tax expenditures. This ensures that SMBs can accurately model their capital outlays without the paralyzing fear that the regulatory rug will be pulled out from under them mid-development.

7. Implementation Strategy: Maximizing Benefit While Eliminating Fraud and Wastage

Expanding the cap and stabilizing the TCRA requires a concurrent, aggressive strengthening of the state’s compliance and oversight mechanisms. Hawaii’s history with technology tax incentives—most notably the widespread controversies and perceived abuses surrounding Act 221 in the early 2000s—highlights the severe dangers of combining lucrative tax credits with lax regulatory oversight.¹⁴ Between 2001 and 2018, the Department of Taxation (DOTAX) rarely audited R&D claims, leading to instances of highly inflated expenses and state capital being inappropriately diverted to non-research, operational activities.¹⁴

To implement the proposed policy changes safely, the Hawaii government must deploy a modernized, multi-layered defense system against fraud, waste, and abuse.

7.1 Strict Adherence to IRC § 41 and IRS Audit Alignment

The most effective, cost-efficient safeguard against state-level fraud is maintaining strict, unyielding statutory alignment with the federal definitions of Qualified Research Expenses (QREs) under Internal Revenue Code Section 41.⁵ By legally mandating that a Hawaii small business must also successfully claim the federal R&D tax credit for the exact same expenses in order to be eligible for the state credit, Hawaii effectively leverages the massive enforcement apparatus and jurisprudence of the Internal Revenue Service (IRS).²

If a company’s research activities satisfy the federal “Four-Part Test”—specifically requiring a Permitted Purpose, the activity being Technological in Nature, the Elimination of Technical Uncertainty, and a rigorous Process of Experimentation—they possess a highly verifiable foundation of scientific legitimacy.²⁴ However, recognizing that federal IRS budgets have fluctuated over the past decade and overall corporate audit rates have declined ¹⁴, Hawaii cannot simply abdicate responsibility to the federal government. DOTAX must be properly funded and specifically directed to conduct localized, secondary audits. These audits should not attempt to re-litigate the federal Four-Part Test, but rather specifically target the Hawaii statutory requirement that more than 50% of the activities occurred physically within the state.⁵

7.2 Mandatory DBEDT Pre-Certification and Geographic Tracking

The current administrative process requires DBEDT pre-certification and the completion of a detailed online questionnaire before tax credits are authorized.⁵ This is a powerful best practice that must be maintained and strengthened.

To prevent systemic wastage, DBEDT must enforce rigorous, granular reporting on the ultimate end-uses of the qualified research expenses. Specifically, DBEDT must actively track the legal residency status of claimed employees and the physical execution location of independent contractors.¹² The 2024 DBEDT data, which successfully verified that 97.4% of regular employees of certified QHTBs were Hawaii residents ¹², proves that strict adherence to geographic constraints is highly effective when monitored. DBEDT should be granted the explicit statutory authority to immediately disqualify any applicant attempting to claim expenses for out-of-state shadow payrolls, remote mainland contractors, or corporate shell companies.¹²

7.3 Regulating the R&D Tax Consulting Industry

A significant driver of fraudulent or aggressively inflated R&D claims nationwide is the unchecked proliferation of “boutique” tax consulting firms that operate heavily on contingency fee models.³⁶ These consultants charge the SMB a high percentage (often 20% to 30%) of the total tax credit successfully recovered. This compensation structure creates a massive, perverse incentive for the consultant to maximize the claim amount by artificially stretching the definition of QREs to include wholly unqualified marketing, routine maintenance, or standard operational costs.³⁶

The Hawaii legislature should introduce specific regulatory constraints on third-party consultants preparing TCRA claims within the state. The state could legally require explicit disclosures of fee structures directly on Form N-346A. Submissions prepared under contingency models could be automatically flagged by algorithmic systems for much higher scrutiny by DOTAX auditors.¹⁶ Encouraging standard fixed-fee or hourly billing practices among preparers organically aligns the financial incentives of the consultant toward strict legal compliance and risk mitigation for the SMB, rather than artificial claim inflation.³⁶

7.4 Utilizing Statutory Penalties for Negligence and Fraud

To create a powerful deterrent effect against bad actors, DOTAX must aggressively and visibly utilize its existing statutory authority under HRS § 231-39.¹⁶ The law clearly delineates the consequences of abuse, imposing a severe penalty of up to 25% for tax underpayments resulting from negligence (defined as the failure to keep adequate records or make a reasonable, good-faith attempt to comply with the law) and a massive 50% penalty for underpayments resulting from outright fraud (the intentional falsification, evasion, or concealment of facts).¹⁵

DOTAX must draw a sharp, enforced line between aggressive but legal tax planning and illegal tax evasion.¹⁵ Publicizing civil enforcement actions and financial penalties against entities that abuse the TCRA will establish a strong, market-wide deterrent effect. This ensures that the state’s limited capital is exclusively reserved for legitimate SMBs pursuing genuine, high-risk scientific and technological advancements.

8. Cost-Benefit Analysis: Framing the Initial Outlay as a High-Yield Investment

In debating the expansion and stabilization of the TCRA, policymakers must fundamentally pivot away from viewing the R&D tax credit purely as an unrecoverable “cost” or a static drain on the state’s General Fund. Instead, sound economic analysis requires framing the proposed $15 million annual cap as a highly leveraged, strategic state investment that will reliably generate future, compounding tax revenues and socio-economic benefits that easily pay for the program’s initial outlay over time.

8.1 The Sprawling Differential Between Social and Private Returns

Economic literature provides overwhelming, empirical evidence for the outsized returns generated by research and development within a localized economy. Rigorous studies utilizing comprehensive data from U.S. firms over three decades estimate that the marginal social return on R&D spending is a staggering 58%, compared to a much lower marginal private return of only 14%.¹⁴

This massive 44% differential exists because the knowledge, technologies, advanced processes, and intense workforce training generated by R&D inevitably spill over into the broader local economy, permanently raising productivity and capability across adjacent, non-tech sectors.¹⁴ By subsidizing this activity, the State of Hawaii is essentially purchasing an economic asset with a 58% rate of return. Without the state subsidy, local SMBs will chronically underinvest in R&D because their corporate balance sheets can only capture the 14% private return, leaving the state starved of the broader, transformative economic spillovers.³²

8.2 Direct and Indirect Tax Revenue Generation

The immediate fiscal outlay of the credit is rapidly offset by the massive tax footprint of the QHTB corporate structures and their highly compensated workforce. Utilizing DBEDT’s verified 2024 data as a baseline, the mechanics of this Return on Investment (ROI) become highly visible:

Table 3: Economic ROI Analysis

As succinctly noted in powerful stakeholder testimony submitted regarding HB 2546, these highly compensated employees “generate income tax revenue, pay GET on local purchases, and reduce demand for social services. A fully utilized $15 million credit supporting this level of economic activity is not a subsidy, it is an investment with measurable, compounding returns”.¹³

8.3 Signaling to Private Capital Markets

Beyond direct taxation, a permanent, robust R&D credit serves a vital, often overlooked signaling function to private capital markets. Sophisticated academic research demonstrates that firms utilizing rigorous R&D tax credits experience significant non-tax financial benefits, including vastly lower Initial Public Offering (IPO) underpricing and the enhanced ability to raise substantially more capital during funding rounds (averaging $7 million more in IPO proceeds for comparable firms).¹⁷

When Hawaii SMBs can point to a stable, permanent, and adequately funded state-level R&D credit, their underlying unit economics improve dramatically. Consequently, they become significantly more attractive to massive venture capital and private equity firms operating on the mainland. This dynamic effectively draws vast sums of external private capital into Hawaii, fueling further exponential growth, hiring, and taxable corporate activity without requiring an additional dollar of state public funds. In essence, the state’s initial, measured tax expenditure acts as a powerful magnet for private investment, multiplying the total financial impact on the local economy.⁴

9. Conclusion

The Hawaii Tax Credit for Research Activities represents the state’s single most potent policy lever for aggressively modernizing its economy, retaining its top-tier intellectual talent, and building a shock-resistant technology sector capable of weathering future global disruptions.⁴ However, the program’s immense potential is currently paralyzed by severe structural deficiencies—chiefly, the impending, arbitrary December 31, 2029 sunset date, the mathematically restrictive incremental limits imposed by Act 139, and the highly inefficient, unpredictable first-come, first-served rationing mechanism.⁵

Because research and development is an inherently long-term, capital-intensive process that relies heavily on predictable financial forecasting, SMBs simply cannot operate efficiently under the constant shadow of short-term policy expiration.⁹ This legislatively imposed uncertainty depresses hiring, delays critical capital investment, constricts cash flow, and ultimately forces Hawaii’s most innovative companies to strongly consider relocating to the dozens of other states that offer permanent, stable, and welcoming R&D incentives.¹⁰

The Hawaii State Legislature possesses clear, actionable, and proven pathways to resolve this crisis. By transitioning the TCRA into a permanent statutory fixture governed by rigorous biennial economic performance reviews, implementing a fair proportional distribution system to guarantee equity among applicants, repealing the restrictive base-amount requirements of Act 139, and raising the funding cap to $15 million to align with true market demand, the state can completely eliminate corporate uncertainty.¹³ Coupled with robust DOTAX auditing procedures, mandatory DBEDT geographic tracking, and strict alignment with IRS parameters to aggressively prevent historical abuses ¹⁴, these reforms will create an un-gamable, highly efficient incentive structure.

The fiscal outlay required to stabilize and expand this program is absolutely not a sunk cost, but rather a highly leveraged, high-yield public investment. The QHTBs nurtured by this policy generate exceptionally high-wage jobs, produce globally valuable intellectual property, and contribute aggressively to the state’s income and general excise tax bases.¹² To do nothing—to allow the sunset date to quietly approach and the credit to continue operating as an unpredictable, underfunded lottery—is to actively accept economic stagnation, systemic brain drain, and a dangerous, continued over-reliance on a fragile tourism economy that is wholly unsuited for the challenges of the 21st century.² Immediate legislative action is required to secure Hawaii’s technological and economic future.

Works Cited

1. Hawaii Economic Trends, Stats & Rankings | IBISWorld, accessed on March 23, 2026, https://www.ibisworld.com/united-states/economic-profiles/hawaii/
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