BILL ANALYSIS                                                                                                                                                                                                    




            SENATE REVENUE & TAXATION COMMITTEE

            Senator Lois Wolk, Chair

                                                     SB 1053 - Runner

                                        As Introduced February 16, 2010

                                                                       

            Hearing: April 28, 2010    Tax Levy         Fiscal: Yes




            SUMMARY:  Enacts a State Sales and Use Tax (SUT) Exemption  
                      for Manufacturing and Software Production  
                      Equipment

            

                        EXISTING LAW provides no special tax treatment  
            to entities engaged in manufacturing or software production  
            for purchases of equipment and other supplies. Business  
            entities engaged in manufacturing, research and  
            development, and software producing activities that make  
            purchases of equipment and supplies for use in the conduct  
            of their manufacturing and related activities are required  
            to pay tax on their purchases to the same extent as any  
            other person either engaged in business in California. 

                        THIS BILL would provide a partial exemption  
            (General Fund only) from the SUT rate of 6% (5% on and  
            after July 1, 2011) for the following purchases made by a  
            "qualified person":

             Tangible personal property to be used 50 percent or more  
              in any stage of manufacturing, processing, refining,  
              fabricating, or recycling of property (i.e., machinery,  
              equipment belts, shafts, computers, software, pollution  
              control equipment, buildings and foundations), as  
              specified.

             Tangible personal property to be used 50 percent or more  








                                                        SB 1053 - Runner

                                                                  Page 5
            

              in research and development. 

             Tangible personal property to be used 50 percent or more  
              in maintaining, repairing, measuring, or testing any  
              qualifying equipment. 

             Tangible personal property purchased for use by a  
              contractor, as specified, for use in the performance of a  
              construction contract for the qualified persons who will  
              use the property as an integral part of any  
              manufacturing, processing, refining, fabricating, or  
              recycling process or as a research or storage facility in  
              connection with the manufacturing process.

                        Defines a "qualified person" to mean either of  
            the following: a person engaged in those lines of business  
            described in Codes 3111 to 3399, inclusive, or 5112 of the  
            North American Industry Classification System (NAICS), 2007  
            edition; or an affiliate of such a person, provided the  
            affiliate is a member of the qualified person's unitary  
            group for which a combined report is required to be filed,  
            as provided.

                       Specifies that the proposed exemption would not  
            include (1) any tangible personal property that is used  
            primarily in administration, general management, or  
            marketing, (2) consumables with a normal useful life of  
            less than one year, except for fuels used in the  
            manufacturing process, and (3) furniture, inventory,  
            equipment used in the extraction process, or equipment used  
            to store finished products that have completed the  
            manufacturing process.


            FISCAL EFFECT: 

                 The BOE states that it would incur costs to administer  
            this bill.  These costs would be attributable to, among  
            other things, identifying and notifying qualifying  
            entities, auditing claimed amounts, revising sales tax  
            returns, reviewing returns with claimed exemptions, and  
            programming.  An estimate of these costs is pending








                                                        SB 1053 - Runner

                                                                  Page 5
            


                 BOE estimates that this bill will result in a revenue  
            loss of $600 million in fiscal year (FY) 2010-11, and $1  
            billion in FY 2011-12. 


            COMMENTS:

                 A.     Purpose of Bill
                 According to the author, "it is important that  
            California stimulate job creation and retention across all  
            areas of the manufacturing sector, not just green jobs.  As  
            proven with prior legislation of this nature, the  
            multiplier effect of SB 1053 will stimulate growth of both  
            the manufacturing and research and development sectors,  
            which is essential to reviving California's economy."

                 "Over the previous year, the manufacturing sector lost  
            106,200 jobs and on a seasonally adjusted basis, the sector  
            lost 7,200 jobs in December 2009.  Unfortunately for  
            California's manufacturers, our state is only one of three  
            states that tax manufacturing equipment purchases with no  
            credit or exemption.  Most other states recognize that  
            taxing input as well as the final manufactured product is  
            double taxation and discourages investment.  Manufacturing  
            jobs are critical to the overall health of our economy and  
            taxing manufacturing equipment is poor tax policy that only  
            hinders growth."



                 B.     Background
                 For a ten-year period ending December 31, 2003,  
            California law provided a partial (General Fund only) sales  
            and use tax exemption for purchases of equipment and  
            machinery by new manufacturers, and income and corporation  
            tax credits for existing manufacturers' investments (MIC)  
            in equipment (SB 671, Alquist, 1993).  Manufacturers were  
            defined in terms of specific federal "Standard Industrial  
            Classification" (SIC) codes.  The bill provided an  
            exemption from the state tax portion for sales and  
            purchases of qualifying property, and the income tax credit  








                                                        SB 1053 - Runner

                                                                  Page 5
            

            was equal to six percent of the amount paid for qualified  
            property placed in service in California.  Qualified  
            property was similar to the property described in this bill  
            -depreciable equipment used primarily for manufacturing,  
            refining, processing, fabricating or recycling; for  
            research and development; for maintenance, repair,  
            measurement or testing of qualified property; and for  
            pollution control meeting state or federal standards.   
            Qualified property also included tangible personal property  
            purchased by a contractor, as specified, for use in the  
            performance of a construction contract for the qualified  
            person who would use that property as an integral part of  
            the manufacturing process, as described.  Certain special  
            purpose buildings were included as "qualified property," as  
            this bill proposes.  New manufacturers could either receive  
            the benefit of the exemption, or claim the income tax  
            credit.  However, existing manufacturers could only receive  
            the benefit of the income tax credit.

                 This sales and use tax exemption and income tax credit  
            had a conditional sunset date.  They were to sunset in any  
            year following a year when manufacturing employment (as  
            determined by the Employment Development Department) did  
            not exceed January 1, 1994 manufacturing employment by more  
            than 100,000.  On January 1, 2003, manufacturing employment  
            (less aerospace) did not exceed the 1994 employment number  
            by more than 100,000 (it was less than the 1994 number by  
            over 10,000), and therefore the MIC and partial sales tax  
            exemption sunsetted at the end of 2003.

                 Since the expiration of the partial exemption of  
            manufacturing equipment, numerous bills have been  
            introduced to either reinstate or to expand or modify the  
            exemption, but have failed to pass.  



                 C.     Arguments For and Against  the MIC
                 SB 1053 provides a sales and use tax exemption for  
            manufacturing equipment that qualified taxpayers for the  
            now-defunct Manufacturers' Investment Credit.  Tax credits  
            provide a dollar-for-dollar reduction in tax, which is  








                                                        SB 1053 - Runner

                                                                  Page 5
            

            based on a firm's net income, so only firms that generate  
            profits may make use of tax credits.  Additionally, tax  
            credits may exceed tax due for the year in which the firm  
            generates the credit, but can often carry the credit  
            forward to future years.  Even then, the Legislature can  
            limit the use of tax credits, as it did for the 2008 and  
            2009 tax years, when it capped the use of credits and Net  
            Operating Loss deductions to 50% of a taxpayer's liability  
            (AB 1452, Committee on Budget, 2008).  Sales tax exemptions  
            are superior to tax credits because it benefits all  
            companies that purchase qualified equipment, regardless of  
            whether the firm is profitable.  

                 It has been argued that there is no way to directly or  
            even indirectly measure the effect of the MIC on jobs  
            because the connection is so tenuous.  Also, it has been  
            argued that there is no way to tell whether equipment was  
            purchased in response to the MIC or whether it would have  
            been bought anyhow without the credit.   

                 In an October 2002 report put out by the Legislative  
            Analyst's Office, An Overview of California's  
            Manufacturers' Investment Credit, the following arguments  
            against and in support of these tax incentives were  
            presented:

            

      Arguments In Support of the MIC

              Investment Incentive-The MIC effectively reduces the  
              price of new capital, and leads to greater investment.   
              Adherents of this view suggest that a firm considering a  
              capital investment is much more likely to undertake such  
              investment with the MIC in place.  Proponents argue that  
              this marginal cost reduction can have a significant  
              positive impact on investment decisions.
             Relocation Incentive-California has become a more  
              attractive place relative to other states for business  
              since the credit has been in place.  The argument here is  
              that tax credits do influence corporate location  
              decisions and dissuade businesses from moving their  








                                                        SB 1053 - Runner

                                                                  Page 5
            

              activities out of California. Manufacturing industry  
              representatives stated and continue to state that the MIC  
              plays an important role in both expansion and business  
              location decisions.

             Efficient Job Allocator-Competition for business among  
              states is an efficient job allocator.  This argument  
              holds that the nation benefits from the redistribution of  
              jobs that may occur due to the use of investment tax  
              credits.  This is based on the notion that jobs are worth  
              more in areas with higher unemployment, and that such  
              areas are likely to have relatively aggressive tax credit  
              programs.  These areas will be able to attract businesses  
              away from regions that do not value the jobs as highly.

             Other Arguments. Advocates of the MIC also emphasize that  
              the MIC offers significant indirect benefits to the state  
              in terms of investment and job growth that result in  
              additional state revenues.  They also point out the  
              importance of manufacturing to the overall state economy  
              in terms of economic stability and the high value-added  
              nature of the employment in this sector.



             Arguments against the MIC 

              Inequitable Taxation-The MIC results in giving a tax  
              advantage to manufacturing over other business  
              activities, as well as providing an advantage to capital  
              investment over labor.  This view holds that since only  
              one type of industry (and production factor) benefits  
              from the tax credit, the remaining industries face  
              relatively higher costs, and are therefore at a  
              competitive disadvantage.  Such preferential treatment  
              can also result in inefficient resource allocation  
              according to this view. 
             Relocation Rather Than Creation-The MIC results in few  
              new jobs, but rather pits states against each other in  
              competing for jobs.  The argument here is that corporate  
              tax breaks are no more than a transfer of government  
              funds to private businesses, and in the end, the national  








                                                        SB 1053 - Runner

                                                                  Page 5
            

              economy is unaffected.  In this view the competition  
              among states in offering various tax incentives  
              represents a form of "prisoners' dilemma"-in which each  
              state would be better off if none offered such  
              incentives.  If one state does offer them, however, it is  
              in the interest of other states to do the same.

             Inefficient Development Policy-Tax incentives have a  
              negligible impact on economic growth, and any job  
              creation that does occur does so at a substantial cost  
              per job.  Proponents of this view also hold that some of  
              the tax credits will go to companies which would have  
              made the same investments, regardless of the tax  
              incentive.  That is, the tax credit did not induce the  
              investment, yet the company receives "windfall benefits"  
              in the form of reduced taxes.

             Ineffective Development Policy-Taxes are a very small  
              percentage of overall business costs and thus have little  
              effect on business decisions.  Labor, transportation,  
              land, and other factors typically constitute much more  
              significant proportions of total costs than do taxes.   
              Therefore, according to those who hold this view,  
              tinkering with this particular cost is unlikely to result  
              in a large shift or expansion of business compared to the  
              adverse fiscal effects that such measures can have on the  
              state.



            D. Administrative and technical concerns

            Should the measure advance from the Committee's suspense  
            file, the Committee should amend the measure to address the  
            following administrative and technical concerns:

                   In defining "qualified person," it is recommended  
                 that the bill require that the qualifying entity be  
                 primarily engaged in the activities described in the  
                 referenced codes.  This is an important issue and one  
                 that generated many disputes when the Board of  
                 Equalization (BOE) administered Section 6377  








                                                        SB 1053 - Runner

                                                                  Page 5
            

                 previously.   
                   Another issue relates to the proposed definitions  
                 for the types of property included and excluded from  
                 the proposed exemption.  For example, on page 4, lines  
                 20 and 37, the bill refers to the items having a  
                 useful life of one year or more (or less than one  
                 year).  In order to lessen potential audit disputes,  
                 the bill should contain some mechanism for determining  
                 the useful life.  Perhaps some reference to the  
                 provision in the California income tax laws for  
                 depreciating assets should be incorporated into the  
                 bill.  

                   Subdivision (g) of proposed Section 6377 (see page  
                 6, line 3) provides for an exemption from tax for  
                 specified leases of qualified property and limits this  
                 exemption for a six-year period.  This limitation is  
                 modeled after a provision in former Section 6377 that  
                 provided a state tax exemption solely to new  
                 manufacturers' leases of equipment.  Since this bill  
                 would provide the exemption for all qualifying  
                 persons, it appears the limitation in subdivision (g)  
                 is unnecessary and should be stricken.  Otherwise,  
                 long-term leases of qualifying property would not  
                 enjoy the same tax privileges that the bill would  
                 provide to actual purchases of the same property.




            Support and Opposition

                 Support:Cal-Tax, BayBio

                 Oppose:American Federation of State, County ad  
            Municipal Employees, 

                          AFL-CIO, California Tax Reform Association


            ---------------------------------









                                                        SB 1053 - Runner

                                                                  Page 5
            

            Consultant: Meg Svoboda