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            short of the targets, and the MIC was repealed in 2004.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  








            


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            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  








            


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                         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  








            


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            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  








            


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            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."










            


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            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).







            


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            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?  










            


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            Support and Opposition

                 Support:Lockheed Martin Corporation

                        California Taxpayers' Association
                        BIOCOM


                 Oppose:California School Employees Association

                        California Tax Reform Association


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            Consultant: Colin Grinnell