Each year the state forgoes about $835 million in revenue by giving companies and individuals a break on the general excise tax, exempting everything from aircraft engines to shipbuilding.

There are more than 50 classes of transactions not subject to the state's 4.71 percent (4.17 percent on the Neighbor Islands) excise tax. The exemptions were created over several decades, often to incentivize social and economic behavior or to conform Hawai'i tax codes with federal laws.

Now lawmakers are considering eliminating many of those exemptions to help close the state's $1.2 billion revenue shortfall through June 2011.

Some exemptions, such as a $230,000-a-year tax break for foreign diplomats and consular officials, are relatively small. Others, such as a prescription drug exemption that costs $22.5 million a year in lost tax revenue, are big.

House Bill 2877, which was passed by the Finance Committee this week, would suspend 39 tax breaks — including exemptions affecting nonprofits, airlines, hotel operators and labor groups — and replace them with a 1 percent tax.

A host of nonprofits, trade groups and others oppose eliminating many of the exemptions.

Another bill, HB 2878, would have suspended tax breaks for prescription drugs, insurance proceeds and tort awards. That bill was deferred.

Cutting exemptions won't alone solve the state's budget woes but could help, said Lowell Kalapa, head of the Tax Foundation of Hawaii.

"Yes, that is an option — to suspend or get rid of some of those exemptions," Kalapa said.

Among the exemptions that lawmakers have discussed eliminating are those for affordable housing projects and death and accident benefits.

Removing an excise exemption on banks' income also is under consideration. The Hawaii Bankers Association is opposing that move. Banks currently pay franchise taxes, which the state also is considering raising.

"The impact of passage of this provision would put Hawai'i banks in a quandary of absorbing the tax increase, which could mean the difference between profit and loss for some banks, or passing on the tax to its customers which would be devastating to our customers," Neal Okabayashi, the group's legislative committee chair, said in written testimony.

INCENTIVE INTENT

While state lawmakers consider eliminating some excise tax breaks, they're also considering creating new ones. Bills have been introduced to create new excise tax exemptions for food and over-the-counter drugs, sales of electric vehicles and sales of renewable energy systems.

Many excise tax breaks were created to spur economic activity. Some of that activity occurred, some did not.

For example, among the incentives is a general excise tax exemption for construction of an aircraft maintenance facility and for revenues derived from aircraft service and maintenance. That open-ended tax break was created in 1997 to encourage Continental Airlines to build a $24 million maintenance facility at Ho-no--lulu International Airport.

The tax break, at the time estimated at $1.2 million, was expected to create 110 permanent jobs with salaries averaging between $50,000 and $55,000. The state has never tracked the number of jobs created and maintained by the facility. However, that tax break, which was later expanded to cover other carriers, costs the state more than $7 million a year in tax revenue, according to the state Department of Taxation.

Separately , the state created an exemption for call centers in 2000 as part of an effort to stimulate that industry. The state has yet to become a haven for call centers and that exemption cost the state $50,000 a year in excise tax revenues.

SHIPS, CEMETERIES

Other exemptions that could be cut include those for shipbuilding and ship repair, air pollution facilities and receipts from leases of aircraft and engines used for interstate transport.

Tax exemptions for people with Hansen's disease, for nonprofit cemeteries , for state payments to foster parents and for foreign dignitaries also could be eliminated.

Consulate officials aren't likely to refuse to come to Hawai'i if their tax break is eliminated, said the Tax Foundation's Kalapa.

"I don't think (foreign diplomats ) ... are going to avoid hulas in Hawai'i where it's nice and warm," he said. "They're still going to come here. They're here because they enjoy it."

According to the state Department of Taxation analysis, one of the House bills could generate an estimated $314 million in added revenues during the next five years.

Removal of exemptions will likely be fought by the people taking advantage of the tax breaks.

"Each current beneficiary would like to protect their own kuleana, but my job is to look at the larger picture and address the unmet needs and the entire budget," said state Rep. Marcus Oshiro, D-39th (Wahiawā), chairman of the House Finance Committee. "This is giving us as many tools and choices as possible as we deliberate on both the budget program cuts and sources of additional revenues."

Many excise tax breaks cannot be eliminated without violating interstate commerce and other laws, Kalapa said. Those likely include about $70 million in excise tax breaks on sales of tangible personal property and services exported out of the state. There's also $41 million in excise tax breaks on the sales of liquor, tobacco and other items to the federal government .