BILL ANALYSIS Ó AB 624 Page 1 Date of Hearing: May 2, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair AB 624 (John A. Perez) - As Amended: March 31, 2011 VOTE ONLY Majority vote. Fiscal committee. SUBJECT : California Organized Investment Network: tax credit program. SUMMARY : Extends the operation of the Community Development Financial Institution (CDFI) tax credit program for qualified investments made by insurance companies, corporations, or other taxpayers into a CDFI, as provided. Specifically, this bill : 1)Extends the existing CDFI tax credit provisions, from January 1, 2012 until January 1, 2017, that allow a credit to a taxpayer against the insurance gross premiums tax, personal income or corporation tax, in an amount equal to 20% of each qualified investment made by the taxpayer during the taxable year in a CDFI that is certified by the California Organized Investment Network (COIN) of the Department of Insurance. 2)Requires the Insurance Commissioner to create and appoint a COIN Advisory Board with the duty to advise on the best methods to increase the level of insurance industry capital in safe and sound investments while providing fair returns to investors and social benefits to underserved communities. EXISTING LAW: 1)Authorizes a credit against the insurance gross premiums tax, personal income or corporation tax, in an amount equal to 20% of a qualified investment made into a CDFI, not to exceed in the aggregate amount $10 million per calendar year. 2)Defines "qualified investment" as an investment that is a deposit or loan that does not earn interest, or an equity investment, or an equity-like debt instrument meeting federal or state agency standards. The duration of the investment must be for 60 months or more and the amount must equal AB 624 Page 2 $50,000 or more. 3)Defines a "community development financial institution" as a private financial institution located in California that is certified by the COIN Office of the Department of Insurance, that has community development as its primary mission, and that lends in urban, rural, or reservation communities in this state. The term "CDFI" includes a community development bank, a community development loan fund, a community development credit union, a microenterprise fund, a community development corporation-based lender, and a community development venture fund. 4)Limits the annual certification of total qualified investments made by all taxpayers to all CDFIs to $10 million for each calendar year, but if the qualified investments are less than that amount in one year, the difference may be carried over to future years. 5)Provides that the amount of total qualified investments certified in any calendar year from any one CDFI cannot exceed the lesser of $10 million or 40% of the aggregate qualified investments authorized. 6)Requires that, until July 1 of each year, 25% of the aggregate qualified investment amount be reserved for investments by admitted insurers, but permits the Insurance Commissioner to announce a different amount via regulations. 7)Requires that, until July 1 of each year, $3 million of the aggregate qualified investment be reserved for investments by individuals in amounts not to exceed $300,000, but permits the Insurance Commissioner to announce a different amount via regulations. 8)Allows a carryforward of the unused credit up to four taxable years. 9)Requires the Legislative Analyst, on or before December 31, 2010, to prepare an analysis of the tax credits investments made, including the credits' fiscal impact, the explanation of programs, projects, and other uses funded or carried out by CDFIs and supported, in whole or in part, by the tax credit investments, and the resulting benefits to economically disadvantaged communities. AB 624 Page 3 10) Repeals the CDFI tax credit effective January 1, 2012. FISCAL EFFECT : The staff at the Franchise Tax Board (FTB) estimates that the income tax provisions of this bill will result in an annual revenue loss of $200,000 in fiscal year (FY) 2011-12, $420,000 in FY 2012-13, $450,000 in FY 2013-14, and $450,000 in FY 2014-15. These estimates do not include the revenue impact of the tax credit allowed against the insurance gross premiums tax. COMMENTS : 1)Author's Statement . The author states that, "Community development investments make sound business sense and provide solid returns while bringing much needed capital to low-income communities. These investments are leveraged to provide loans such as small business loans, mortgage loans, and construction loans. More than $100 million has been invested into some of California's most under-served communities from 1997 through 2009." 2)Arguments in Support . The sponsor of this bill states that, "COIN's goal is to help address unmet capital needs supporting economic development and affordable housing in or benefitting low-income urban and rural people or communities in California, either directly, or through fiscal intermediaries," and that, through the CDFI tax credit program, more than $100 million has been invested into some of California's most under-served communities. The proponents of this bill give an example of a Los Angeles-based financial development corporation that "received a $500,000 COIN investment from a bank and was able to leverage that investment into $3.9 million in small business loans to 40 borrowers, 60% of whom are located in low-moderate income communities." The proponents also assert that, "Ýt]he state's small investment in this program helps leverage far more for our state," promotes development projects of special benefit to seniors and assists "persons in low income communities to secure financing for economic development and affordable housing." 3)Background: The COIN Program . The COIN Program was created in 1996 as a public-private partnership by the Department of Insurance, the insurance industry, state government leaders, AB 624 Page 4 and community development organizations with the goal of helping to address the unmet capital needs for economic development and affordable housing in low-income urban and rural communities throughout California. This voluntary program was established at the request of the insurance industry, "as an alternative to state legislation that would have required insurance companies to invest in low-income urban and rural communities, similar to the federal Community Reinvestment Act (CRA) that applies to the banking industry." (Insurance Commissioner Urges California Insurers to Invest in Low-Income Communities, Press Release, August 6, 2001). The COIN program serves as a liaison between insurers that are seeking investment opportunities and the community organizations that are seeking investment capital for projects. CDFIs work with COIN - an office within the California Department of Insurance - as financial intermediaries providing access to credit, loans, and investments to small businesses and non-profits that serve economically disadvantaged communities. CDFIs also offer administrative and technical assistance in these low-income communities. Generally, CDFIs lend to borrowers that do not satisfy the criteria for conventional lenders and focus on a particular community or certain groups of people. 4)The CDFI Tax Credit Program . The existing state law provides, until January 1, 2012, for the CDFI tax credit, which allows taxpayers to claim a credit equal to 20% of each qualified investment made in a specified private financial institution located in California - a CDFI - that has been certified by the COIN as eligible. The COIN must certify each CDFI and each qualified investment. A CDFI, among other requirements, must apply to COIN for certification of its status and, on behalf of a taxpayer, for certification of the credit amount allocated to the taxpayer. The COIN office generally approves applications on a first-come, first-served basis, although it has some discretion in certifying CDFIs. Currently, 81 CDFIs are certified by COIN as eligible to participate in the tax credit program. The COIN is required to provide the FTB, which is charged with administering the state income tax laws, with an annual list of taxpayers, their identification numbers, the amount of their investments and the total amount of all qualified investments. The goal of the CDFI tax credit program is to provide incentives to attract private capital investments that otherwise would AB 624 Page 5 not be available to CDFIs. This tax credit may be claimed by taxpayers against the insurance gross premium tax, the state corporation tax, or the state personal income tax. The statewide amount of the credit for all recipients is capped at $2 million per year for the three taxes combined. Thus, each year qualified investments up to $10 million are eligible to receive the tax credits. However, if less than $10 million is invested in qualified CDFIs in any calendar year, the remaining amount may be carried over to the next year and any succeeding year during which the credit remains in effect. The credit is subject to a 60-month recapture period if the investment is reduced or withdrawn. According to the FTB's tax expenditure report, the total amount of credit claimed under the Corporation Tax (CT) and the Personal Income Tax (PIT) Laws in 2007 was $52,000, and was allowed on 48 PIT and 3 CT tax returns. As stated in the COIN report dated January 10, 2011, approximately $1.65 million in qualified investments have been approved by the COIN and $330,000 of the tax credits have been certified for the 2010 calendar year. The total remaining amount of investment still available for 2010 calendar year is $13.7 million, which translates into over $2.75 million of tax credits available for certification. Most investments that qualify for the CDFI tax credit also qualify for the federal New Markets tax credit. Furthermore, those investments may also qualify for the low-income housing tax credit and/or the enterprise zones (EZs) and targeted tax areas deductions. The low-income housing tax credit and EZ zone programs are state tax programs that are also intended to generate new investment and economic activity in targeted communities. 5)Federal "New Markets" Tax Credit Program . Existing federal law provides for a "new markets" tax credit that permits individuals and corporate taxpayers to receive a credit against their federal income taxes for making equity investments in investment vehicles known as Community Development Entities (CDEs). The primary mission of a CDE is to serve, or provide investment capital for, low-income communities or low-income persons, as specified. The federal credit amount is equal to 39% of the qualified equity investment, and is spread over seven years. Thus, in each of the first three years, the federal credit amount is equal to 5% of qualified contributions and, in each of the remaining four years, the amount of credit is increased to 6% of AB 624 Page 6 qualified contributions. The Department of the Treasury administers the program and provides allocations of the federal credits to eligible community development entities through a competitive grant process when Congress makes the credits available. The federal limit of the total qualified investments from all taxpayers for 2010 was $3.5 billion, of which $901 million were allocated to California companies. 6)Gross Premiums Tax . Unlike the federal "New Markets" tax credit, the CDFI tax credit is also available to insurers that are subject to the gross premiums tax pursuant to the California Constitution (Section 28, Article. XIII, California Constitution). The gross premiums tax is an excise tax on insurers for the privilege of transacting insurance in this state. The statutory provisions relating to the assessment and collection of the tax are contained in Part 7 (commencing with Section 12001) of Division 2 of the Revenue and Taxation Code. This tax is imposed in lieu of other state and local taxes and fees, making an insurer exempt from paying those charges, other than real property and motor vehicle taxes and fees. The economics of the insurance industry provide a key reason for the special treatment of insurance companies. Most corporate taxpayers calculate their income by subtracting costs incurred in the production of goods or services from the revenues received from their sale. Insurance companies, by contrast, collect their revenues up front, then make payments to policyholders based on contingent events that occur many months or years later. Thus, it can be difficult to "match up" revenues to related expenses. In an income tax framework, insurers ideally would be allowed to deduct the current value of all future obligations (claims) covered by the insurance policies they have written when calculating their taxable income for a given year. Because the actual amount of these obligations is uncertain, as are the amount of investment earnings on accumulated premiums received during the intervening period, an accurate determination of the theoretically appropriate amount of taxable income proves very difficult to achieve in practice. Insurers subject to the gross premiums tax do not pay tax on other forms of income, such as investment income, or income earned from other trades or businesses. 7)The CDFI Tax Credit Program Utilization. As stated in the AB 624 Page 7 letter sent by the Insurance Commissioner to insurance company executives on February 17, 2011, the CDFI tax credit has been underutilized in recent years and, currently, $4.75 million in tax credits are available for investments in underserved communities. In 2009, the COIN certified 23 CDFI qualified investments, but 22 of those investments were made by banks and one or more individuals and the single largest investment - a $5 million investment resulting in a $1 million tax credit - was made by Metropolitan Life Insurance, the only insurance company that applied and received the credit. AB 41 (Solorio), Chapter 340, Statutes of 2010, requires insurance companies to develop and file with the Insurance Commissioner a policy statement on community development investment and community development infrastructure investments by July 1, 2011. The goal of this new law is to increase the number and amount of community development investments by requiring the adoption of Community investment policy statements. 8)The Report by the Legislative Analyst's Office (LAO). As required by existing law, on April 14, 2011, the LAO issued an analysis of the CDFI tax credit, discussing the credits' fiscal impact and the resulting benefits to economically disadvantaged communities and low-income people in California. The LAO report noted all the following: a) Economic Impact. While the LAO was unable to estimate the economic impact of the tax credits, it states that "in many cases investments in the CDFIs would not have been made in the credit's absence." The report admits that "some of the credits have benefited larger CDFIs that are capable of raising funds in other ways and for which the credit-funded investments represent a smaller portion of their total assets." However, the LAO found that, even in those cases, the tax credits "helped generate investment activity that otherwise might not have been funded." b) Credit Percentage Seems Reasonable . The credit refunds a percentage of the invested amount, which translates into approximately "2.5 to 3 percentage points on a ten-year loan at prevailing interest rates," which is "about one-half of the interest spread between a fairly safe investment and a very risky one." While the LAO did not find a 20% subsidy to be too high or too low, it noted that "changing conditions in financial markets in the future could warrant a different subsidy percentage for this AB 624 Page 8 credit." c) Owned Versus Rental Housing . In light of the higher credit standards for home purchase loans since the collapse of the housing market, the LAO suggests that, in order to benefit low-income individuals, the CDFI tax credit program should focus on investments in rental housing, at least in the near future. d) First-Come, First-Served Tax Credits Can Be Problematic . Even though the tax credit is currently underutilized, at some point in prior years, it was fully used. The LAO advises to authorize COIN or some other entity to award the credits competitively, instead of a first-come, first-served basis, to allow the state to prioritize CDFI investment, if there is more demand for the credit in the future. 9)Tax Credit Versus Grant . A disadvantage of using tax credits as a means of encouraging or rewarding particular behavior is that they could only be utilized by taxpayers with a tax liability. For example, charities or other tax-exempt organizations have very little use for a tax credit; nor does a tax credit have any immediate value to a business that has losses. The CDFI tax credit has been largely underutilized in recent years. While it leverages billions of dollars of investment into businesses and real estate projects in communities with high rates of poverty and unemployment, it appears that a stand-alone tax credit may not be sufficient to attract enough of those investments. An alternative way of encouraging investment in CDFIs and increasing the CDFI tax credit program's utilization rate would be to temporarily convert the program into a partial grant program, similarly to a temporary federal tax credit for qualified investments in solar, wind or other qualified projects. Under the federal grant program, a qualified taxpayer may elect to receive a grant - in lieu of the tax credit - for a qualified project placed in service either in 2009 or 2010. The ability to choose whether to receive the credit or grant helps owners in financing the solar, wind, or other qualified project. The Committee may wish to consider whether a temporary grant program would be a better vehicle in achieving the goal of encouraging investments in underserved communities and of allocating a fixed, budgeted amount among the most worthy depositors or the most necessary projects. The Committee may AB 624 Page 9 also wish to consider amending the bill to authorize COIN to award grants, in addition to allocating tax credits, subject to the total aggregate amount of $2 million, and to allow a qualified taxpayer to make an irrevocable election to choose either the tax credit or a grant in lieu of the credit. 10)Double-referral . This bill was doubled-referred with the Assembly Committee on Insurance, and passed out of that Committee with a 10-0 vote on March 30, 2011. For additional discussion of this bill, please refer to that committee's analysis. REGISTERED SUPPORT / OPPOSITION : Support California Department of Insurance (sponsor) Association of Financial Development Corporations Local Initiatives Support Corporation Rural Community Assistance Corporation Opposition None on file Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098