SB 358 Senate Bill - Bill Analysis

BILL ANALYSIS Ó

SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair

BILL NO: SB 358 HEARING: 7/6/2011
AUTHOR: Cannella FISCAL: Yes
VERSION: 5/23/11 TAX LEVY: Yes
CONSULTANT: Faulkner

GROSS INCOME: EXCLUSION FOR AIR QUALITY FUNDS

Excludes air quality funds from gross income and reduces
the basis of property to the extent it was acquired with
these funds.

Background and Existing Law

Existing federal and state laws provide that gross income
includes all income, from whatever source derived,
including compensation for services, business income, gains
from property, interest, dividends, rents, and royalties
unless specifically excluded. Exclusions are generally
enacted to change behavior, encourage growth in the
economy, or for other stated policy objectives. California
typically conforms to federal law for exclusions to gross
income for ease of administration.
In 2010, the state conformed to federal law to exclude the
American Recovery and Reinvestment Tax Act of 2009 grants
for renewable energy from gross income (SB 401, Wolk).

The California Air Resources Board (CARB) is responsible
for a number of air pollution incentives, grants, and
credit programs to reduce air pollution. While CARB has
program oversight, some programs are implemented as a
partnership with local air districts.

Funds received from CARB or local air districts for the
purpose of air pollution reduction are includable in gross
income.

Proposed Law

Senate Bill 358 excludes from gross income any amount
provided to a person by CARB, an air pollution control
district, or an air quality management district for the

SB 358 -- 5/23/11 -- Page 2

purpose of air pollution reduction. The basis of property
for determining gain or loss on the sale or disposition, as
well as for determining depreciation, would be reduced to
the extent the property was acquired with any amount
excluded from gross income under this bill.

State Revenue Impact

The Franchise Tax Board (FTB) estimates this bill will
result in the following revenue losses:2011-12: $8.2
million
2012-13: $3.3 million
2013-14: $1.3 million
2014-15: $0.2 million

Comments

1. Purpose of the bill . The author states, "California has
some of the toughest air quality standards in the nation
and compliance with regulations has proven to be a
challenging task for some businesses and individuals.
California's business community has strived to comply with
regulations and some have undertaken the herculean task of
exceeding rigorous standards or achieving early compliance.

Because grants are taxable, an individual or business
entity will never receive the full grant amount. For
example, many businesses in the San Joaquin Valley have
worked to comply with regulations by either purchasing new
vehicle fleets or upgrading their equipment to more
efficient models that produce fewer emissions. Not only
can purchases end up costing businesses extra money but
under current law, they do not receive the full grant award
because it is fully taxed. Therefore, the benefit of
receiving grant moneys is diminished.

SB 358 will eliminate the penalty that individuals and
businesses incur when they choose to comply early or elect
to meet and exceed CARB regulations. SB 358 will exempt
any grant funding provided by CARB or local air districts
for the purposes of air mitigation from state income tax.
Full grants will then be available to businesses and
individuals to help purchase cleaner technologies. This
bill seeks to fulfill California's commitment to cleaner
air while also supporting jobs and the business community."

SB 358 -- 5/23/11 -- Page 3

2. Programs, programs, and more programs . There are
approximately a dozen incentive and grant programs offered
through CARB to reduce air pollution. Some of these
programs are in conjunction with California's 35 local air
districts. For example:

The Carl Moyer Program provides monetary grants for
cleaner-than required engines and emission control
devices that reduce toxic particles and smog-forming
gases through retrofitting, repowering or replacing
equipment. The Carl Moyer Program was established in
1998 (AB 1368, Villaraigosa) and received $25 million
in funding its first year. Since its inception, it
has provided over $680 million in incentive funding.
Local air districts administer the programs for their
areas.
The Air Quality Improvement Program (AQIP),
established by the California Alternative and
Renewable Fuel, Vehicle Technology, Clean Air, and
Carbon Reduction Act of 2007 (AB 118, Nuñez), is a
voluntary incentive program to fund clean vehicle and
equipment projects, research on biofuels production
and the air quality impacts of alternative fuels, and
workforce training. AB 118 provided approximately
$200 million annually through 2015 for three new
programs. AQIP, one of the three programs, receives
$30-$40 million per year depending on revenues. The
bill created a dedicated revenue stream for the
programs through smog abatement, vehicle registration,
and vessel registration fees. This program is
administered exclusively by CARB.

Goods Movement Emission Reduction Program and
Lower-Emission School Bus Program. These programs
focus on near-term emission reductions from fully
commercialized emission control technologies.

Local air districts also oversee programs developed
at the local level including the Clean Green Yard
Machine Program. Air districts receive funding at the
state level from CARB, at the local level through
business permits and DMV fees, and at the federal
level. The San Joaquin Valley Air Control District,
the bill's sponsor, received $112,103,821 in incentive
grants in 2010. Approximately 90% of the funds were

SB 358 -- 5/23/11 -- Page 4

from the state and local level.

3. Double dip . SB 358 provides an income exclusion for
clean air awards. If the state's stated goals are to
encourage cleaner air and business expansion, the existing
awards already meet those objectives. In addition to the
monetary awards, the organizations that receive these funds
will get a double benefit of the exclusion. Was this the
intent of the original legislation? Did the legislature
intend to provide public money grants to private entities
and exclude the funds from taxation? The Committee may
wish to consider if these organizations should receive a
double benefit or if one monetary benefit award is enough.

4. Why and why now ? All programs are voluntary incentive
programs and fund air pollution reductions that are in
excess of what is already required by legislation. By most
accounts, the pollution reduction programs operated by CARB
and local air districts are successful. For example, CARB
is required to report to the Legislature biennially on its
implementation of AQIP. The 2010 Biennial Report to the
Legislature states: "With the success and popularity of
AQIP to date, ARB does not recommend any Legislative
changes to the program at this time."

Funds offered by these programs are in demand. A news
release from the San Joaquin Valley Air Pollution Control
District announcing a new round of incentive funding ($60
million) to replace, repower and retrofit heavy-duty,
diesel-powered trucks, stated; "Initial funds were quickly
exhausted, signaling a critical need for fresh funds by
heavy-duty truck owners." (March 7, 2011)

The bill's sponsor agrees that grant funds are popular.
However, the sponsor states that they cannot always reach
all the areas they need such as small businesses and
individuals. There is concern that this problem will only
grow and become more complex in the future. They state
that many small businesses and individuals cannot afford
the taxes owed on grants and the cost can preclude
participation by these groups.

5. Reverse non-conformity . California typically conforms
to federal law for income tax purposes to allow for
substantial simplification of state tax forms. For federal
purposes, air quality funds are taxable and will continue

SB 358 -- 5/23/11 -- Page 5

to be taxed into the foreseeable future. Any changes to
the computation of gross income for state purposes,
different from federal law, could potentially be burdensome
for taxpayers and FTB.

Proponents of SB 358 purport that the elimination of state
income tax on air quality funds will enable more small
businesses and individuals to participate in air quality
programs. However, by comparison, the federal portion of
the tax bill associated with these grants is much higher
than the state portion. State personal income tax rates
range from 1 to 9.3 percent with an addition 1 percent
surcharge for taxpayers making more than $1 million.
Federal personal income tax rates range from 10 to 35
percent. Federal tax rates on corporate taxable income
vary from 15 to 35 percent; the state rate is 8.84 percent.
If small businesses and individuals cannot afford to
accept an air quality grant because of state income taxes,
more than likely, the continued existence of federal income
tax on air quality funds will still preclude participation
in the programs.

6. Show me the money . SB 358 provides an income exclusion
for various awards in order to meet and exceed the state's
existing clean air laws. In order to absorb the General
Fund costs, the Committee may wish to require local air
districts to reimburse the General Fund for funds lost by
the provisions of this bill.

7. Making it work . In its analysis of SB 358, FTB states
that the bill fails to specify how the FTB would determine
or verify whether payments provided by the CARB were for
the purposes of air pollution reduction. To reduce
disputes between FTB and taxpayers, as well as to ease
administration of SB 358, FTB staff recommends the bill be
amended to (1) require CARB to provide certification to
taxpayers that a payment is for air pollution reduction,
(2) require taxpayers to submit such certification to the
FTB upon request and (3) require CARB to provide the FTB a
data file annually containing information relating to the
payments and the recipients.

In addition, the FTB states the bill lacks a definition for
"air pollution control district" and "air quality
management district." As written, the exclusion from gross
income and basis adjustment would apply to payments from

SB 358 -- 5/23/11 -- Page 6

such a district whether the district is located in
California or otherwise. It is unclear if it is the
author's intent to exclude from gross income payments from
out-of-state air quality entities.

Finally, the FTB states, the provisions of the bill that
would require a basis adjustment for property acquired with
any amount provided by CARB, air pollution control
districts, and air quality management districts for the
purpose of air pollution reduction are not statutorily
linked with the provisions of the bill that would provide
an exclusion from gross income for such amounts. To
prevent disputes between taxpayers and the department, the
author may wish to amend the bill to link by statute the
provisions that would require a basis adjustment with the
provisions that would provide an exclusion from gross
income.

The Committee may wish to consider amending the bill to
address these implementation concerns.

Support and Opposition (6/30/11)

Support : San Joaquin Valley Air Pollution Control District
(Sponsor); California Air Pollution Control Officers;
California Cotton Ginners and Growers Associations;
California Partnership for the San Joaquin Valley;
California Taxpayers Association; Engineering and Utility
Contractors Association; South Coast Air Quality Management
District; Western Agricultural Processors Association.

Opposition : Unknown.