BILL ANALYSIS Ó AB 2026 Page 1 Date of Hearing: May 14, 2012 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair AB 2026 (Fuentes) - As Introduced: February 23, 2012 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, 2015 until July 1, 2020. 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, 2015 until July 1, 2020. 2)Extend the existing $100 million-per-FY limitation on the aggregate amount of motion picture tax credits that may be allocated by the CFC in any FY, through and including the 2019-20 FY. 3)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. The amount of the deduction is equal to a 9% deduction of so-called "qualifying production activities 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 AB 2026 Page 2 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. 6)Defines "independent film" as a film with a budget between $1 million and $10 million produced by a non-publicly traded AB 2026 Page 3 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 a "qualified motion picture" as one produced for general distribution to the public, regardless of the medium that, that is one of the following: a) A feature film with budgets between $1 million and $75 million; b) A movie of the week with a minimum budget of $500,000; c) A new television series produced in California with a minimum production budget of $1 million licensed for original distribution on basic cable; d) An independent film; or, e) A television series that relocated to California. 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. AB 2026 Page 4 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 2014-15 FYs on a first-come, first-served basis, with 10% of the allocation reserved for independent films. 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, or; c) Elect to apply the credit against their sales and use tax liability. 15)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. 16)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. 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. AB 2026 Page 5 FISCAL EFFECT : The FTB staff estimates that this bill will result in an annual revenue loss of $5.1 million in FY 2014-15, $22 million in FY 2015-16, with the estimated total revenue loss of $473 million for the following FYs. COMMENTS : 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 2026, 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." AB 2026 Page 6 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 the program." 3)Arguments in Opposition . The opponents state that "the non-partisan Legislative Analyst Office has found this program to be ineffective" and argue that "extending the credit by an additional five years means that other vital state programs like education, public safety, or other health and human service programs would have to be reduced." The opponents also assert that "California's film tax credit program should not conflict with the public health priorities of our state and nation" and urge the author to amend this bill to implement "the CDC and WHO recommendations by limiting subsidies for movies to only those that do not have tobacco-related imagery." 4)How is a Tax Expenditure Different from a Direct Expenditure? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, 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). 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 AB 2026 Page 7 rescinded, irrespective of their efficacy, without a supermajority vote. 5)Tax Incentives: Do They Work? 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, assert 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 California's tax structure and other policies. Additionally, critics argue that industry-specific tax incentives do not 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)]. As noted by the Legislative Analyst Office (LAO) in the presentation at this Committee's hearing "Assessing Tax Expenditure Programs in Light of California's Fiscal Challenges" on February 22, 2012, "policymakers should regard many TEPs Ýtax expenditure programs] evaluations with AB 2026 Page 8 skepticism." It was further explained that, "Analysis of alternative uses of public funds is difficult and often omitted entirely from? studies Ýof TEPs]. These studies also usually rely on extensive and sometimes subjective assumptions which, if changed, can produce very different results? It is rare that the value of TEPs can be demonstrated conclusively compared to these alternate uses of tax dollars. If the Legislature wishes to use TEPs, despite these challenges, it is important that TEPs be used cautiously, structured carefully, and reviewed regularly to consider if they operate in an effective and cost-efficient manner." 6)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. Originally, the program was scheduled to sunset in 2013-14 FY, but was extended by the Legislature in 2011 for one additional year - until FY 2014-15. ÝAB 1069 (Fuentes) Chapter 731, Statutes of 2011]. 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 FYs, from FY 2009-10 until FY 2014-15, 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. 7)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 Film Tax Credit Program is a relatively new program, and AB 2026 Page 9 whether the Program has been successful in achieving its main goal is up for debate. a) Maybe 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 revenues to the state as well as an increase in jobs. As AB 2026 Page 10 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, as of last year, $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 to keep production in California because of the various AB 2026 Page 11 other benefits connected with filming in California. b) Maybe 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 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 rather than be a deciding factor for otherwise-undecided producers." (2009-10 Budget Analysis AB 2026 Page 12 Series, Film Production Credit, February 5, 2009). As noted by Mr. 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 television 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, it 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. 8)What is the Urgency ? This bill proposes to extend the existing film tax credit program for an additional four years, from FY 2015-16 until FY 2019-20. In light of the fact that the existing Program is not due to expire for another three years, and the fact that it is uncertain whether the existing AB 2026 Page 13 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. Furthermore, the Committee may wish to consider requiring the LAO to conduct a study to determine the program's efficacy. 9)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. 10)Related Legislation . AB 1069 (Fuentes), Chapter 731, Statutes of 2011, extended the film production tax credit program for one year, until July 1, 2015. SB 1197 (Calderon), of the 2009-10 Legislative Session, would have deleted sunset date of the film tax credit program. SB 1197 was held under submission in Senate Revenue & Taxation Committee. SBx8 55 (Calderon), of the 2009-10 Legislative Session, would have deleted the sunset date of the film tax credit program. SBx8 55 was held under submission in Senate Rules Committee. ABx3 15 (Krekorian), Chapter 10, Statutes of the 2009-10 Third Extraordinary Session, established the Film Tax Credit Program. AB 855 (Krekorian), of the 2009-10 Legislative Session, would have established a film production tax credit. AB 855 was held at the Assembly Desk. AB 1696 (Bass), of the 2007-08 Legislative Session, would have established a financial assistance program within the CFC to encourage filming motion pictures and commercials in California and requires the Business, Transportation & Housing Agency to report the economic impact of this program by December, 2011. AB 1696 failed passage on the Senate Floor. SB 359 (Runner), of the 2007-08 Legislative Session, mega tax credit bill would have created a credit for a percentage of the wages paid of amounts paid to purchase or lease tangible AB 2026 Page 14 personal property in conjunction with the production of a qualified motion picture. SB 359 was held under submission in the Senate Revenue and Taxation Committee. AB 832 (Bass), of the 2007-08 Legislative Session, would have created unfunded grant program administered by the CFC to encourage filming motion pictures and commercials in California. AB 832 was held under submission by the Assembly Appropriations Committee. SB 740 (Calderon), of the 2007-08 Legislative Session, would have created a film production credit equal to 100% of the direct revenues attributable to the production or 125% of the revenues of the productions in a television series that relocated to California or an independent film as defined. SB 740 was held under submission in Senate Revenue & Taxation Committee. AB 777 (Nunez), of the 2005-06 Legislative Session, would have authorized qualified motion picture tax credit in an amount equal to 12% of the qualified production for qualified wages paid with an additional 3% for qualified motion pictures. AB 777 was held under submission in the Senate Revenue & Taxation Committee. SB 58 (Murray), of the 2005-06 Legislative Session, would have created a refundable income and a corporation tax credit equal to 15% of the amount of qualified wages paid and qualified property purchased in the production of a qualified motion picture. SB 58 was held under submission in the Senate Revenue & Taxation Committee. Support The California Labor Federation California Chamber of Commerce California Taxpayers Association California Teamsters Public Affairs Council Chamber of Commerce, Los Angeles Area Film Liaisons in California Statewide (FLICS) Motion Picture Association of America, Inc. Jess Talamantes, Mayor of Burbank SAG-AFTRA Opposition AB 2026 Page 15 California School Employees Association The American heart Association (oppose unless amended) The American Cancer Society (oppose unless amended) Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098