BILL ANALYSIS Ó AB 1069 Page 1 Date of Hearing: May 16, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair AB 1069 (Fuentes) - As Introduced: February 18, 2011 Majority vote. Tax levy. Fiscal committee. SUBJECT : Income taxes: extension of the motion picture tax credit program. SUMMARY : Extends the operation of the California Motion Picture Tax Credit for five additional years, from July 1, 2014 until July 1, 2019. Specifically, this bill : 1)Authorizes the California Film Commission (CFC) to allocate annually the motion picture tax credits, under both the Personal Income Tax (PIT) and the Corporation Tax (CT) Laws, to qualified applicants for five additional fiscal years (FYs), from July 1, 2014 until July 1, 2019. 2)Specifies that the aggregate amount of motion picture tax credits that may be allocated by the CFC in any FYis limited to $100 million, through and including the 2018-19 FY. 3)Deletes duplicative sections of the Revenue and Taxation Code (R&TC). 4)Takes effect immediately as a tax levy. EXISTING FEDERAL LAW : 1)Allows a taxpayer to recover the cost of motion picture films, sound recordings, copyrights, books and patents using the income forecast method of depreciation. As an alternative, taxpayers may elect to deduct up to $15 million ($20 million if the production expenses are incurred in certain distressed areas) of the cost of any qualifying film and television production, commencing prior to January 1, 2012, in the year in which the expenditure is incurred. 2)Provides that "qualified film" productions are eligible for the domestic production activities deduction equal to a 9% deduction of so-called "qualifying production activities AB 1069 Page 2 income" (QPAI). The deduction was phased in at 3% in 2005 and 2006, 6% in 2007 through 2009, and 9% in 2010 and thereafter. QPAI refers to the net income from the license, sale, exchange, or other disposition of any qualified film produced by the taxpayer. The deduction is limited to 50% of the W-2 wages paid by the taxpayer with respect to domestic production activities during the taxable year, and is generally allowed for purposes of the Alternative Minimum Tax (AMT). A "qualified film" is defined as any motion picture film or video tape, excluding sexually explicit films as defined in 18 United States (U.S.) Code Section 2257, if at least 50% of the total production compensation constitutes compensation for services performed in the U.S. by actors, production personnel, directors, and producers. 3)Does not allow any income tax credit for motion picture production activities. EXISTING STATE LAW : 1)Conforms to the use of the federal income forecast method of depreciation for the recovery of costs of motion picture films, sound recordings, copyrights, books, and patents, with modifications. 2)Does not conform to the federal expensing provision for film and television production. 3)Does not conform to the federal domestic production activities deduction. 4)Allows a qualified taxpayer, for taxable years beginning on or after January 1, 2011, a motion picture production tax credit, under either the PIT or CT Law. 5)Specifies that the amount of the tax credit is equal to either: a) 20% of the qualified expenditures attributable to the production of a qualified motion picture, or; b) 25% of the qualified expenditures attributable to the production of a television series that relocated to California, or an independent film. AB 1069 Page 3 6)Defines "independent film" as a film with a budget between $1 million and $10 million produced by a non-publicly traded company that is not more than 25% owned by publicly traded companies. 7)Requires the CFC to administer a motion picture production tax credit allocation and certification program, as follows: a) Taxpayers will first apply to the CFC for a credit allocation, based on a projected project budget. b) Upon receiving an allocation, the project must be completed within 30 months. c) The taxpayer must then provide the CFC with verification of completion and documentation of actual qualifying expenditures. d) Based on that information, the CFC will issue the taxpayer a credit certificate up to the amount of the original allocation. 8)Defines "qualified motion pictures" as one produced for general distribution to the public, and include feature films with budgets between $1 million and $75 million, movies of the week with a minimum budget of $500,000, and new television series with a minimum production budget of $1 million. 9)Requires that 75% of the production days take place within California or 75% of the production budget be incurred for payment for services performed within the state and the purchase or rental of property used within the state. In addition, requires that the production of the qualified motion picture be completed within 30 months from the date on which the qualified taxpayer's application is approved by the CFC. 10)Declares that the credit is not available for commercial advertising, music videos, motion pictures for non-commercial use, news and public events programs, talk shows, game shows, reality programming, documentaries, and pornographic films. 11)Requires the CFC to allocate $100 million of credit authorizations each year during the period 2009-10 through 2013-14 on a first-come, first-served basis, with 10% of the allocation reserved for independent films. AB 1069 Page 4 12)Declares that any unallocated amounts and any allocation amounts in excess of certified credits may be carried over and reallocated by the CFC. 13)Provides that qualifying taxpayers could claim the credit on their tax return filed with the Franchise Tax Board (FTB) under either PIT or CT. 14)Provides that taxpayers may use certified credits as follows; a) Claim it directly; b) Assign it to another member of their unitary group; c) Sell the credits to other taxpayers, or; d) Elect to apply the credit against their sales and use tax liability. 15)Specifies that any unused credit may be carried forward to each of the following six taxable years or until the credit is exhausted, whichever occurs first. In the case where the credit exceeds a qualified corporate taxpayer's liability, it may elect to assign any portion of the credit to one or more affiliated corporations for each tax year in which the credit is allowed. 16)In the case of credits attributable to an independent film, the qualified taxpayer is allowed to sell a credit to an unrelated party but is required to report to the FTB prior to the sale of the credit all required information in the form and manner specified by the FTB. 17)Requires the CFC to provide the FTB with a list of qualified taxpayers and the tax credit amounts allocated to each qualified taxpayer by the CFC. FISCAL EFFECT : The FTB staff estimates that this bill will result in an annual revenue loss of $11 million in FY 2013-13, $49 million in FY 2014-2015, and $83 million in FY 2015-16, with the estimated total revenue loss of $357 million for the following FYs. COMMENTS : AB 1069 Page 5 1)Author's Statement . The author provides the following statement in support of this bill: "California suffered both job and financial losses as hundreds of productions have left the state to seek incentives offered elsewhere. A phenomenon commonly referred to 'run-away production.' In addition to the international competition from Canada, Australia and most EU nations, over 40 U.S. states offer meaningful financial incentives to the film industry successfully luring production and post-production jobs and spending away from California. "In February 2009, the California Film & Television Tax Credit Program was enacted as part of a targeted economic stimulus package to increase production spending, jobs and tax revenues in California. AB 1069, in seeking a five-year extension to the existing law, acknowledges that the Program has been successful in its goal to retain and increase film and television production occurring in California." 2)Arguments in Support . The proponents state that the film production tax credit has been successful in its goal to retain and increase film and television production occurring in California. Thus, since "its inception, the program has generated 41,000 new jobs and $2.2 billion ? in direct spending." It helps California to stay competitive because, when productions leave the state, only top tier talent is flown to work on location. As a result, many well-paying production jobs with good benefits are lost and ancillary businesses such as caterers, dry cleaners and restaurants are negatively impacted. The proponents assert that, given that 40 other states and many foreign countries are promoting aggressive programs to attract motion picture production to their jurisdictions, it is vital for California "to retain this important engine that contributes ingenuity, talent, and creativity to our economy." The proponents also emphasize that the film tax credit is "one of few tax breaks in California that has the appropriate accountability measures to make sure it is effective." The program includes a five-year sunset, an annual cap of $100 million and is targeted. The proponents conclude that this bill "gives California the needed competitive edge to keep its heritage industry and will continue the successful momentum of AB 1069 Page 6 the program." 3)Tax Credits: Do They Work? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960's, U.S. Treasury officials began arguing that these features of the tax law should be referred to as "expenditures," since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues). Generally, advocates for tax incentives, such as Arthur Laffer and N. Gregory Mankiw, argue that reduced taxes allow taxpayers to invest money that would otherwise be paid in taxes to better use, thereby, creating additional economic activity. "Supply-siders" posit that higher taxes do not result in more government revenue; instead, they suppress additional innovation and investment that would have led to more economic activity and, therefore healthier public treasuries, under lower marginal tax rates. Industry-specific credits complement this theory by lowering tax costs for industries that provide positive multiplier effects, such as stimulating economic activity among suppliers and increasing economy-wide purchasing power resulting from hiring additional employees. Critics, however, state that tax incentives rarely result in additional economic activity. Companies locate in California because of its competitive advantages, namely its environment, weather, transportation infrastructure, access to ports, highways, and railroads, as well as its highly skilled workforce and world class higher education system. These advantages trump perceived disadvantages resulting from its tax structure and other policies. Additionally, critics argue that industry-specific tax incentives do actually effect business decisions; instead, enhanced credits and deductions reward firms for investments they would have made anyway. ÝSee, e.g., D. Neumark, J. Zhang, and J. Kolko, Are Businesses Fleeing the State? Interstate Business Location and Employment Change in California, (a PPIC report showing that, while California loses jobs due to firms leaving the state, these losses have a minimal effect on the economy); D. Neumark and J. Kolko, Are California Companies Shifting Their Employment to Other States? (finding that, while California companies have shifted jobs to other states, out-of-state firms have offset these losses by hiring more in California)]. AB 1069 Page 7 4)How is a Tax Expenditure Different from a Direct Expenditure? As the Department of Finance notes in its annual Tax Expenditure Report, there are several key differences between tax expenditures and direct expenditures. First, tax expenditures are reviewed less frequently than direct expenditures once they are put in place. This can offer taxpayers greater certainty, but it can also result in tax expenditures remaining a part of the tax code without demonstrating any public benefit. Secondly, there is generally no control over the amount of revenue losses associated with any given tax expenditure. Finally, it should also be noted that, once enacted, it generally takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date. This effectively results in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their efficacy, without a supermajority vote. 5)California Motion Picture Tax Credit Program: Background . In February 2009, the California Film & Television Tax Credit Program (Film Tax Credit Program) was enacted as a part of an economic stimulus plan to promote production spending, jobs, and tax revenues in California. Although a bill creating some sort of a tax incentive for the motion picture and television production in California had been introduced almost every legislative session long prior to 2009, the existing film tax credit program was initially recommended by then Governor Schwarzenegger in his 2009-10 budget proposal. Unlike other proposals in the past, the existing film tax credit is targeted, capped and allocated. In many respects, it is similar to a grant program. It is effective only for five fiscal years, from FY 2009-10 until FY 2013-14, and only $500 million total is allocated to this credit over the life of the program. The CFC is required to allocate and certify the credit on the first-come first-serve basis, up to $100 million every FY. The credit cannot be used until January 1, 2011, and is not refundable. 6)Is the Film Tax Credit Program Effective in Achieving the Stated Goal ? With the current financial state of the California economy, all state programs affecting the General Fund are under scrutiny to ensure that the programs are effectively achieving desired results. The main goal of the Film Tax Credit Program is to prevent runaway production and retain production already being filmed in California. The AB 1069 Page 8 Film Tax Credit Program is a relatively new program, and whether the program has been successful in achieving its main goal is up for debate. a) May be it is. Undoubtedly, California companies face higher costs of doing business - land, labor, and capital are generally more expensive here. Furthermore, other states and foreign countries have been fiercely competing with California to lure motion picture and television series production away from California. The high costs of doing business in California, coupled with very generous tax incentives provided elsewhere, force many motion picture companies - that would otherwise seek to locate in California - to lower-cost and lower-tax jurisdictions. According to the CFC, in 2003, "66% of studio feature films were filmed in California." In 2009, however, only 38% of studio films were filmed in the state, and San Francisco film and TV production employment dropped 43% between 2001 and 2006. The recent report released by the Milken Institute states that, although "it is still too early to know the real impacts of the Film Tax Credit Program, there are some encouraging signs" that the Film Tax Credit Program is working. (K. Klowden, A. Chatterjee, and C. Flor Hynek, Film Flight: Lost Production and Its Economic Impact on California, Milken Institute, July 2010). Thus, in January of 2010, the Los Angeles Economic Development Commission (LAEDC) projected that, as a result of the California incentive program, production in the state should have picked up in 2010. The projection by LAEDC was bolstered by Film L.A. (the permitting agency for Los Angeles) reports. Film L.A. reported that, in 2010, feature film production posted a 28.1% fourth quarter gain and a year-over-year gain of 8.1%. In Film L.A.'s January 11, 2011 release, it was reported that the increase can be wholly attributed to the Film Tax Credit Program. The Program attracted dozens of new feature film projects to Los Angeles, which was responsible for 26% of the local feature production for the year. The CFC stated that these numbers are an early indicator that the incentive program is having an immediate positive impact on production in California. The increase in production has resulted in increased AB 1069 Page 9 revenues to the state as well as an increase in jobs. As reported by the CFC, in FY 2009-10, $176 million in tax credits were allocated to 70 projects. The aggregate amount of direct spending by the 70 projects is estimated at $1.2 billion, of which $453 million is attributable to direct qualified wages (excluded any wages for actors, directors, writers, and producers), $430 million to qualified non-wage expenditures, and $346 million to non-qualified production expenditures (e.g. addition spending that does not qualify for tax credits). An estimated 18,200 crew and 4,000 cast members have been or will be hired by the approved projects and an additional 113,000 individuals will receive daily employment as background players. Further, in FY 2010-2011, $121 million in tax credits were allocated to 43 projects. The estimated aggregate direct spending by the 43 projects is $969 million. Over $275 million is directly attributed to qualified wages and $315 million to qualified non-wage expenditures. An estimated 7,500 crew and 2,100 cast members have been or will be hired by the approved projects and an additional 59,000 individuals will receive daily employment as background players. Thus, to date, $300 million in tax credits have been allocated which has resulted in a total aggregate of direct spending of $2.2 billion and total wages paid/to be paid of $728 million. It has been estimated, using generic multipliers for motion picture and video industries in California, that the broader economic impact of the Film Tax Credit Program has resulted in business revenues of $6.5 billion, full time equivalent jobs of 40,996, and earnings of $1.8 billion. California has a comparative advantage over other states because of the long established entertainment industry. The established industry has provided California with a skilled workforce and available infrastructure. It has been argued that the comparative advantage, when coupled with an incentive program, should be effective in keeping production in California, despite the fact that the California tax credit is not as generous as that of other states. In other words, an incentive program that is less costly than those provided in other states has the ability AB 1069 Page 10 to keep production in California because of the various other benefits connected with filming in California. b) May be it is not . Critics, however, argue that the economic benefits of film tax credits are often overstated "while their costs are underestimated or completely ignored." (M. Robyn, Tax Foundation, Film Production Incentives: a Game California Shouldn't Play, p. 1, A Report Presented at the Joint Oversight Hearing of the Committee on Revenue and Taxation and the Committee on Arts, Entertainment, Sports, Tourism, and Internet Media, March 21, 2011). Although "industry advocates long have argued that movie production in California was in danger of being poached by other states or countries through their use of Ýmotion picture tax incentives], employment and wage data for the motion picture industry do not provide clear evidence that any significant damage to the state's industry or economy has resulted from efforts by other states to draw movie production away from California in the past decade." (Brian R. Sala, Acting Director, California Research Bureau, Updated Information On Film Industry Incentives, a report presented on March 11, 2011, at the Joint Oversight Hearing of this Committee and Arts, Entertainment, Sports, Tourism, & Internet Media Committee). In fact, it appears that California's total film industry employment has grown since 2000, from 36% to 38%, though it has had its ups and downs. (M. Robyn's Testimony, p. 3). Secondly, opponents argue that subsidies to the film and television industry benefit production that would have occurred in absence of the incentive and "much of the subsidy represents a real loss of revenue with no net new jobs to offset the cost." (M. Robyn's Testimony, p. 2). In its 2009-10 Budget Analysis Series, the Legislative Analyst Office (LAO) noted that the credit is allocated on a first-come first-serve basis, which undercuts the program's incentive for production companies to change their location decisions. The firms that are "absolutely committed to producing in California would be among the first to apply for credits - before firms that are considering an out-of-state location," and as a result, the credit "may be even more likely that most similar programs to create a windfall for committed in-state producers AB 1069 Page 11 rather than be a deciding factor for otherwise-undecided producers." (2009-10 Budget Analysis Series, Film Production Credit, February 5, 2009). As noted by M. Robyn from Tax Foundation, in order for the film tax credit to be a revenue gain for the state, "any net new jobs, or net jobs saved, would have to generate enough tax revenue to outweigh the revenue wasted on productions that would have located in-state anyway." (M. Robyn's Testimony, p. 2). However, no data is yet available to determine the extent of the film and TV production that would have occurred in the state in the last two years in the absence of the film tax credit. The LAO was also concerned with a "horizontal inequity" created by this credit, meaning that similarly situated taxpayers are treated differently. The program is likely to create inequities in the way film companies are treated: some firms may be approved for credits while other equally qualified firms may be denied simply because they did not apply soon enough. Finally, the LAO report mentioned that it was unclear why "the film industry deserves special treatment" while other industries, for which production costs are higher in California than in some other locations, are left out. The LAO stated that the film tax credit, as proposed in 2009, would "arbitrarily favor some film producers over others" and that, rather than singling out individual industries, "the state should endeavor to create the conditions that permit all businesses to thrive." Even though film productions greatly impact the broader economy in California is not unique to the film industry; other industries have a similar effect. The film and television industry has been a large source of employment and revenue for the state and losing the industry could be detrimental to the California economy. However, the question remains as to whether the value of the benefits received by the state from providing the film tax credit outweighs the costs of the tax subsidy. 7)What is the Urgency ? This bill proposes to extend the existing film tax credit program for an additional five years, from FY 2013-14 until FY 2018-19. In light of the fact that the existing program is not due to expire for another two AB 1069 Page 12 years, and the fact that it is uncertain whether the existing tax credit is effective in achieving its goal, the Committee may wish to postpone the consideration of the extension until next year, once more data is available. 8)Double-referral . This bill is double-referred with the Assembly Committee on Arts, Entertainment, Sports, Tourism, and Internet Media and passed out of that Committee with a 9-0 vote. For a more comprehensive analysis of this bill, please refer to that Committee's analysis. REGISTERED SUPPORT / OPPOSITION : Support American Federation of Television and Radio Artists California Labor Federation California State Council of Laborers California Taxpayers Association California Teamsters Public Affairs Council Directors Guild of America Film Musicians Secondary Markets Fund IATSE Local 44 - Affiliated Property Craftpersons IATSE Local 80 - Motion Picture Studio Grips/Crafts Service IATSE Local 600 - International Cinematographers Guild IATSE Local 695 - Sound Technicians, Television Engineers, Video Assist Technicians, and Studio Projectionists IATSE Local 700 - Motion Picture Editors Guild IATSE Local 705 - Motion Picture Costumers IATSE Local 706 - Make Up Artists & Hair Stylists Guild IATSE Local 728 - Motion Picture Studio Electrical Lighting Technicians IATSE Local 729- Motion Picture Set Painters and Sign Writers IATSE Local 767 - Motion Picture Studio First Aid Employees IATSE Local 800 - Art Directors Guild and Scenic, Title, and Graphic Artists IATSE Local 871 - Script Supervisors/Continuity, Accountants and Allied Production Specialists Guild IATSE Local 884 - Motion Picture Studio Teachers and Welfare Workers IATSE Local 892 - Costume Designers Guild International Brotherhood of Teamsters, Local 399 AB 1069 Page 13 Motion Picture Association of America Professional Musicians - Local 47, American Federation of Musicians Recording Musicians Association Screen Actors Guild Unite Here Opposition None on file Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098