Ironing out the tax code, state House lawmakers want to suspend general excise tax exemptions for several business activities over the next few years to help reduce the budget deficit.

Tax purists contend that exemptions can distort the tax code by providing tax breaks for favored industries while others have to pay. But some of the state’s most influential business interests, including Hawaiian Airlines, Outrigger Enterprises Group and Alexander & Baldwin, defend the exemptions as a way to help offset the pyramid effect of the general excise tax.

The 4 percent general excise tax — 4.5 percent on Oahu because of a rail transit surcharge — is the state’s largest source of revenue. The broad-based tax is applied on most business transactions, but numerous exemptions have been carved out over the years.

The House would lift exemptions on several business activities and apply a GET of 2 percent, 3 percent and 4 percent on those activities over the next few years. The bill, HB 799, is the largest source of new revenue in the House’s deficit reduction plan. According to recently updated estimates, it would bring in $55.7 million in fiscal year 2012 and significantly more money in future years to stabilize the state’s financial plan.

House leaders were behind a similar bill last year, but it fell apart at the end of session after opposition from industry lobbyists and key state senators.

Senate leaders were again skeptical of the proposal this year, but attitudes have changed since the state Council on Revenues downgraded the state’s revenue forecast last week, increasing the projected two-year deficit to nearly $1 billion.

"I think we’ll consider everything, including that," said state Senate President Shan Tsu­tsui (D, Wai­luku-Kahu­lui).

While the House has approved nearly two dozen revenue-generating bills, suspending GET exemptions is by far the largest, and if the Senate does not go along, it would increase pressure to consider other big-ticket alternatives, such as swapping Hono­lulu rail tax revenue for general obligation bonds, scooping hotel room tax revenue from the counties or even raising the GET.

"Right now we give away close to probably a billion dollars in overall exemptions from GE. Now some of it makes sense because they are taxed in other parts of statute, but many of them are not, they are just given exemptions," said state Rep. Pono Chong (D, Mau­na­wili-Kane­ohe). "It’s kind of unfair that we exempt some types of businesses and not others."

Chong said lawmakers are considering cuts to state programs and targeted tax increases, so it is difficult to justify the exemptions.

"How do you raise taxes on people when there is a group of people who still don’t pay on their portion?" he asked.

State Sen. David Ige (D, Aiea-Pearl City), chairman of the Senate Ways and Means Committee, said lawmakers worked hard in the past to lessen the pyramid effect of the general excise tax through exemptions. (The pyramid effect refers to the same money or product being taxed multiple times.)

"Is it going to stifle the economy?" Ige asked of lifting the exemptions. "How does that show up? What impact does it have on the recovery?"

Many economists discourage exemptions and tax credits because they prefer minimal distortions in the tax code.

"Essentially you’re opening up all these areas where people are taxed differently. It creates a tax fairness problem, and it distorts behavior," said Carl Bonham, a University of Hawaii-Manoa economist who serves on the Council on Revenues.

Other tax policy analysts see potential risk in suspending the GET exemptions. Lowell Kalapa, president of the Tax Foundation of Hawaii, told House lawmakers they should evaluate state programs and serv­ices first and examine money tucked away in special funds.

Kalapa believes suspending the exemptions could come at a bad time for many businesses. In written testimony he said the proposal "underscores the depth and breadth of the financial crisis that the state faces."

"The point to be made here is that unless elected officials rein in the size and cost of running government in Hawaii, such desperate measures, as this bill represents, may have to be adopted and in doing so will destroy the economic base of the state.

"This is not a compromise situation, but an either-or situation; either expenditures are right-sized or the state’s economy is put out of business."

The House proposal touches so many business interests that several observers have dubbed it a full-employment bill for lobbyists. At one late-night hearing in February before the House Finance Committee, state House Speaker Calvin Say (D, St. Louis Heights-Wilhelmina Rise-Palolo Valley) called several lobbyists who testified against the bill back before the committee and lectured them about selfishness for not suggesting alternatives.

But several businesses could lose millions of dollars’ worth of exemptions and have naturally turned to lobbyists to help protect their interests.

Contractors face the deepest bite. The loss of a subcontractor deduction could increase their tax burden by $33.3 million in fiscal year 2012, $85.7 million in fiscal year 2013, $123.7 million in fiscal year 2014 and $145.6 million in fiscal year 2015.

The deduction allows primary contractors to deduct amounts paid to subcontractors from gross receipts when calculating their GET burden. If the deduction were removed, the GET would be applied to both the gross receipts of primary contractors and the amount paid to subcontractors working on proj­ects.

Tim Lyons, a lobbyist who serves as president of the Subcontractors Association of Hawaii, has called it "probably one of the truest forms of ‘taxing the tax.’ "

The Outrigger Enterprises Group has warned that the loss of a sublease deduction could hurt small businesses that sublease in places such as Waikiki.

Alexander & Baldwin told the House that lifting the exemption for the amounts received from the loading and unloading of ships could increase the cost of "virtually everything that is brought into or transported out of the state."

Hawaiian Airlines estimates that the loss of its exemptions — on the gross receipts from the rental or leasing of aircraft or aircraft engines and on the amounts received for aircraft serv­ice and maintenance — could cost up to $73 million in total through 2015.

Keoni Wagner, vice president for public affairs at Hawaiian Airlines, said the airline understands the severity of the state’s budget problem but believes the bill would undermine the state’s economic recovery and harm its business.

"The current exemptions that exist in the law are helping to promote this growth at Hawaiian," Wagner said in written testimony. "Elimination of the current tax exemptions which affect the airlines would have a disproportionate effect on Hawaiian versus its competitors. Competing airlines have little exposure to state taxes compared to Hawaiian, so the impact on Hawaiian is much larger."