BILL ANALYSIS SENATE REVENUE & TAXATION COMMITTEE Senator Lois Wolk, Chair SB 445 - Ashburn Introduced: February 26, 2009 Hearing: May 13, 2009 Tax Levy Fiscal: Yes SUMMARY: Enacts an Tax Credit of 6% of the Cost of Qualified Property EXISTING LAW provides various tax credits designed to provide incentives for taxpayers that incur certain expenses, such as child adoption, or to influence behavior, including business practices and decisions, such as research and development credits and Geographically Targeted Economic Development Area credits. The Legislature typically enacts such tax incentives to encourage taxpayers to do something but for the tax credit, they would otherwise not do. California allowed a Manufacturers' Investment Credit (MIC) equal to 6% of the amount paid or incurred for qualified property put in service in the State (SB 671, Alquist, 1994). Taxpayers engaged in enumerated industries could claim the credit and could only take the credit for costs incurred purchasing specified property. Part of the enabling statute enacted targets for California manufacturing jobs that must be met for the MIC to continue; however, the number of manufacturing jobs fell short of the targets, and the MIC was repealed in 2004. THIS BILL allows a tax credit of 6% of the cost of qualified property placed in service in this state. The SB 445 - Ashburn Page 5 tax credit is based on costs paid for constructing, renovating, or acquiring property on or after January 1, 2009, must be properly chargeable to the taxpayer's capital account, including sales and use taxes paid as a separately stated contract amount, provisions very similar to the MIC. Qualified taxpayers include businesses described in Codes 2011 to 3999, inclusive, of the North American Industrial Classification Manual, 2007 edition. Taxpayers may take the credit for purchases of qualified property, which is: 1. Defined by the Internal Revenue Code as subject to Section 167 depreciation, and must also be used: In manufacturing, processing, refining, fabricating, or recycling of property at some point in the manufacturing process. In research and development To maintain, repair, test, or measure any Section 167 eligible property As pollution control that meets or exceeds standards established by state or local agencies. In Recycling 2. Computers and computer peripheral equipment primarily used to develop or manufacture prepackaged or custom software. 3. Value of capitalized labor costs subject to specified requirements 4. In the case of a biotech manufacturer, activities related to biotechnology establishment, activities related to space vehicles and parts, and activities related to space satellites and communication satellites, Special purpose buildings and SB 445 - Ashburn Page 5 foundations constructed for use by the qualified taxpayer in a manufacturing, processing, refining, or fabricating process or as a research and storage facility, Capitalized labor costs for these special purpose buildings and foundations, subject to specific restrictions. THIS BILL provides that computer software primarily used in manufacturing, processing, refining, fabricating, or recycling of property, or used to develop or manufacture prepackaged or custom software are also eligible for the credit. The bill excludes furniture, facilities used in warehouses, inventory, equipment used in the extractive process, equipment used to store finished products, and any tangible personal property used in administrative, marketing, or management. THIS BILL also allows the credit for qualified property acquired by or subject to lease by a qualified taxpayer. The lessor must provide a statement to the lessee that includes the lessor's original cost for the qualified property and the amount of the cost of sales and use tax paid, and make the statement available to FTB. FTB may disallow the credit if the qualified property is subsequently leased to another taxpayer. THIS BILL provides the credit may be carried over for seven years, or in the case of a small business, nine years. A small business must have less than $50 million in gross receipts, $50 million in assets, less than $1 million in credits, or is engaged in biopharmaceutical activities and the U.S. Food and Drug Administration has not yet approved one of its products. THIS BILL provides that if the property is removed from the state, disposed of to an unrelated party by the taxpayer, or used for any purpose contrary to the requirements of the bill, no credit is allowed, and the FTB will add the amount of the already claimed credit to tax. THIS BILL provides that any determination of whether a pass-through entity is a qualified taxpayer be made at the SB 445 - Ashburn Page 5 entity level. THIS BILL provides definitions of its terms, and grants Franchise Tax Board (FTB) the authority to proscribe regulations to implement the measure. FISCAL EFFECT: According to FTB, SB 445 results in revenue losses of $285 million in 2009-10, $425 million in 2010-11, $455 million in 2011-12, and $495 million in 2012-13. COMMENTS: A. Purpose of the Bill According to the Author, "this bill would reinstate the Manufacturing Investment Tax Incentive which expired in 2004. Given the condition of our economy we must do everything we can to improve California's business environment and keep jobs and revenues in the State. The MIC provides a 6% tax benefit for the purchase of equipment used primarily in manufacturing and research and development. Such purchases are essential to the growth of businesses and the creation of new jobs. This legislation was advised by "Aerospace: States' Incentives to Attract the Industry", a report by the California Research Bureau. The bill applies to all industries. The reinstatement of a manufacturing investment tax incentive will advance the competitiveness of California's business environment. Previous state law allowed qualified taxpayers a Manufacturers' Investment Credit (MIC) equal to six percent of qualified costs. These costs included equipment used primarily in manufacturing, refining, processing, or recycling, as well as equipment used for SB 445 - Ashburn Page 5 research and development, maintenance and repair. The credit expired in January 2004. The MIC will help to increase investment in California by reducing the net cost of new investment. The credit will also help California to compete with incentives offered by other states (most states provide a manufacturing investment or similar tax credit). The aerospace industry contributes significantly to the economy of the state. The industry provides a number of well-paid jobs and is a spring board of innovation for other sectors. Historically, California has had a significant share of the U.S. American aerospace industry. While California still has the largest share of U.S. aerospace employment, that share has been steadily declining. California has been losing aerospace jobs to other states. In the 1990s, the state lost about 166,300 aerospace jobs. By 1999, California employment in the aerospace industry was less than half of what it was in 1986. In 1986 California had almost one third of U.S. aerospace jobs, in 1990 it was 29 percent, reducing to 22 percent by 1998. In 2006 this share was 19 percent, but still above the California's share of U.S. average manufacturing employment (11 percent). Between 1998 and 2006, the aerospace industry in the rest of the country lost 12 percent of its workforce, but California lost more than twice this amount. Most of the losses took place in aircraft and components manufacturing. During this period, Washington State's share of U.S. aerospace employment also decreased, while the number of U.S. aerospace workers increased for Texas, Arizona, Georgia, Ohio, and Illinois. It is evident that California must do more to attract and keep businesses given the increasingly competitive domestic market. The business impediments faced by the aerospace industry have similarly been felt by the broad array of California's Manufacturing industries. The reinstatement of the MIC incentive is an important step to helping California to stop the exodus of important industry and remain the golden state for the businesses of today and tomorrow." SB 445 - Ashburn Page 5 B. Tax Expenditures California foregoes nearly $50 billion in revenue each year due to tax expenditures. While some are as American as apple pie, such as the exclusion from income for pension contributions and social security benefits, others are subsidies for other types of economic behavior deemed preferable by the Legislature, such as the mortgage interest deduction to spur homeownership, the research and development credit to stimulate high-paying jobs and new exciting consumer products and services, and Geographically Targeted Economic Development Area credits to help hard-to-hire employees and businesses in economically distressed areas. Tax expenditures evoke passionate and complicated debates, chiefly regarding whether state legislative action to forego tax revenues from specified taxpayers provides superior benefits than commensurate direct spending programs or general tax reductions. One of America's top state and local tax scholars, Richard Pomp, suggests evaluating tax expenditures as such, stating: "A tax expenditure can be viewed as if the taxpayer actually paid the full amount of tax owed in the absence of the special provision and simultaneously had received a grant equal to the savings provided by the special provision ? a tax expenditure is just one of a number of ways of providing governmental assistance and should be reexamined periodically using traditional budgetary and funding criteria"<1> SB 445 seeks to lower the cost of capital goods for California firms involved in manufacturing, research and development, and computer software development, among others. Quite different from direct spending measures, the Legislature may only limit, reduce, or eliminate tax credits by 2/3 vote of each house of the Legislature, the Committee may wish to consider a sunset provision for SB 508 should the measure advance from the Committee's ------------------------ <1> Pomp, Richard D. "Rethinking State Tax Expenditure Budgets," in Public Budgeting and Financial Management 5(2), 337-351 (1993). SB 445 - Ashburn Page 5 suspense file. C. Rinse and Repeat Tax incentives to aid manufacturing and research and development evoke heated debates. Many argue that tax credits lower the cost of capital, thereby leading to increased investments in the state in people and productive infrastructure. Critics assert that investment credits reward investments that would've occurred anyway, and drain the state budget at a time of fiscal calamity. Tax credits for manufacturing equipment reduce taxes for businesses that purchase more advanced machinery, which increases productivity and likely profitability. However, productivity increases are a double-edged sword: by making firms more productive with better machinery, businesses need fewer and fewer people to do the work now done by machines. California's MIC expired after falling short in 2003 of its statutorily required target, that California exceed by 100,000 jobs in each year the number of jobs the total employment in California in 1994. Perhaps failure to meet the target was enhanced productivity, but could also be attributable to larger changes in manufacturing job trends that show manufacturing jobs leaving higher-cost, higher-tax jurisdictions for areas with much lower labor costs and substantial capital grants. Given that California's previous experiment with the MIC failed to yield increased jobs despite its significant fiscal cost (generally between $300 and $450 million per year), why should the Legislature reenact the MIC? What is different about today's economy that will cause a MIC to have a more significant impact that the last go-around. Additionally, given the numerous tax incentives granted by the Legislature in the last seven months, including credit sharing, net operating cost carrybacks, homebuyer and motion picture production tax credits, and sales-factory only apportionment, what is the marginal impact a MIC would make to a company's citing or hiring decisions? SB 445 - Ashburn Page 5 Support and Opposition Support:Lockheed Martin Corporation California Taxpayers' Association BIOCOM Oppose:California School Employees Association California Tax Reform Association --------------------------------- Consultant: Colin Grinnell