BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: SB 508 HEARING: 3/30/11 AUTHOR: Wolk FISCAL: Yes VERSION: 2/17/11 TAX LEVY: No CONSULTANT: Grinnell TAX PREFERENCE ACCOUNTABILITY Requires bills enacting tax preferences to include specified information and a seven-year sunset. Background and Existing Law California law allows various income tax credits, deductions, and sales and use tax exemptions to provide incentives to compensate taxpayers that incur certain expenses, such as child adoption, or to influence behavior, including business practices and decisions, such as research and development credits and geo-graphically targeted economic development area credits. The Legislature typically enacts such tax incentives to encourage taxpayers to do something that but for the tax credit, they would not do. The Department of Finance is required to annually publish a list of tax expenditures. Proposed Law Senate Bill 508 provides that any bill that enacts a credit against the Personal Income Tax Law or Corporation Tax Law for taxable years beginning on or after January 1, 2012, contain: Specific goals, purposes, and objectives that the tax credit will achieve. Detailed performance indicators for the Legislature to use when measuring whether the tax credit met its specific goals, purposes, and objectives. Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding its goals, purposes, and objectives. The requirements shall include specific data and baseline data to be collected and remitted in each year the credit is effective, and the specific taxpayers, state agencies, SB 508 -- 02/17/11 -- Page 2 or other entities required to collect and remit data. A seven-year sunset. The measure also makes findings regarding tax preferences generally and their current fiscal impact on federal and state governments. State Revenue Impact According to FTB, an identical bill last year did not impact state revenues (SB 1272, 2010). Comments 1. Purpose of the bill . According to the Author, "Today's public finance system in California requires major reform. While I have pursued changing our budgeting system to apply performance measurements for spending programs, I am trying to do the same with SB 508, which applies a performance-based methodology to future tax expenditures enacted by the state. There is no good reason not to evaluate tax expenditure programs with the same rigor that we use when judging spending decisions, especially when California's tax preference portfolio now exceeds $47 billion, equal to half of our total revenue. While we cannot change existing tax preferences, we can at least start keeping better track of future ones." 2. Don't Count on It ? Currently, California's two business tax incentives, the Research and Development Tax Credit and Geographically Targeted Economic Development Area credits, do not have sunsets. Firms have certainty that they can claim these credits so long as they qualify, and make long-term investment decisions accordingly. Some opponents to SB 508 state that mandatory sunsets for tax expenditures are inappropriate and unfair when similar requirements do not apply to spending programs. Others state that the seven year standard is arbitrary; while sunset provisions and performance review are important, a firm's investment horizon and the tax credits themselves vary from case to case, and the same, fixed sunset period should not apply to tax incentives which may require different periods of time to accomplish its purposes. 3. A Bill About Bills . SB 508 applies to legislative bills introduced on or after January 1, 2012 that provide SB 508 -- 02/17/11 -- Page 3 new tax expenditures enacted by applying specified requirements, including a mandatory seven-year sunset. Future authors would have to put considerable thought into a bill adding a tax expenditure prior to introduction, like find indicators that they expect to change as a result of the tax expenditure, identify data that they expect to measure the change in the indicator, and select an entity to collect data. The Legislature would use this information when considering whether to reauthorize, expand, or limit the tax expenditure before the mandatory sunset. SB 508 could apply these requirements to existing tax preferences, but doing so in a way that would restrict the eligibility of a taxpayer to claim a credit would trigger the 2/3 vote requirement under Section 3 of Article XIIA of the California Constitution. Additionally, SB 508 applies only contingently to forthcoming measures; a future Legislature could waive the section of law put in place by SB 508, as this Legislature cannot affirmatively bind future ones under County of Los Angeles v. State of California (1984) 153 Cal.App.3d 568, 573. Future authors could simply add a "notwithstanding clause" to future measures to nullify the bill's requirement. Similarly, authors could choose to add a tax expenditure as an amendment to evade the requirement. 4. A Rose By Any Other Name . The terms "tax expenditures" and "tax preferences" have caused considerable strife in debates before the Revenue and Taxation Committee in the past. One school of thought states that tax revenue inherently belongs to taxpayers, and laws allowing them to keep more of it for performing a specific activity cannot appropriately be called or compared to direct spending as the money involved never flows to the State's treasury. Others disagree, indicating that laws allowing taxpayers to reduce tax by engaging in specific behavior is indistinguishable from spending except on a balance sheet. To illustrate the point, the late economist David Bradford stated that instead of purchasing weapons systems from defense contractors, Congress could instead provide a Weapons Supply Tax Credit for defense contractors equal to the cost of goods sold. Defense spending would then vanish from the spending side of the federal government's accounting ledger, and revenues would concomitantly decline by an equal amount. SB 508 -- 02/17/11 -- Page 4 The Congressional Budget Office (CBO) defines tax expenditures as "revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability." CBO states that tax expenditures may be considered analogous to direct outlay programs, and the two can be considered as alternative means of accomplishing similar budget policy objectives. The Department of Finance defines tax expenditures as "any special provision in the tax law that results in the collection of fewer tax revenues than would be collected under the basic tax structure." The semantic distinction is politically important. While tax expenditures are parts of current federal and state law, and need not be authorized as part of the federal budget process, both Congress and the Legislature must authorize spending programs by legislative appropriation or in the State Budget with the notable exception of spending mandated by initiative. In Congress, legislation authorizing tax expenditures and direct spending programs are treated identically. In California, unless the tax expenditure is subject to a sunset provision, the Legislature can only reduce or limit tax expenditure programs by 2/3 vote of each house of the Legislature, as they are considered tax increases for the purposes of Section 3 of Article XIIA of the California Constitution. Despite cuts in programmatic spending this year, the Legislature has not yet repealed tax expenditures in recent years, although Governor Brown proposed ending tax credits in Geographically Targeted Economic Development Areas such as enterprise zones. Past tax expenditures such as the Rice Straw Credit have sunset in recent years, although the Legislature reauthorized the Child Care Facilities Credit (AB 1282, Mullin, 2007) and the Community Development Financial Institutions credit (AB 2831, Ridley-Thomas, 2006) in recent years, although both credits are due to expire after the 2011 taxable year. 5. Plus Çe Change, Plus C'est La Même Chose. According to Stanley Surrey and Paul McDaniel's seminal book, "Tax Expenditures," the United States Department of the Treasury first published a tax expenditure budget in 1968. The Congressional Budget Act of 1974 required that all future SB 508 -- 02/17/11 -- Page 5 budgets detail the tax expenditure concept and providing a detailed accounting of federal tax expenditures in the federal budget where it has appeared ever since, although the amounts are not part of the budget table. In 1976, Congress reduced tax expenditures as part of the Tax Reform Act that year. Soon after, President Jimmy Carter urged Treasury to recommend whether tax expenditures could be repealed to reduce taxes overall, and Congress considered sunset reviews and statutory caps on federal spending during that time. Currently, federal tax expenditures result in $1.2 trillion in foregone revenue (half of total revenues), and 8% of U.S. Gross Domestic Product, and exceed any category of federal spending. This year, the President's National Commission on Fiscal Responsibility and Reform stated that eliminating all tax expenditures allows Congress to cut income tax rates by half without significant change to overall revenues, and called for eliminating or limiting many tax expenditures as part of its plan. California does not include tax expenditures as part of the budget, instead choosing to publish two excellent reports on the subject. First, the Department of Finance's "Tax Expenditure Report" serves as a listing of all tax expenditures ( http://www.dof.ca.gov/research/economic-financial/#anchorTa xExpenditureReports ) and Franchise Tax Board's "California Income Tax Expenditures: Compendium of Individual Provisions," ( http://ftb.ca.gov/aboutftb/plans_reports.shtml ) describes and discusses each item in addition to providing foregone revenue totals and number of returns affected. Finance's report shows that tax expenditures resulted in revenue foregone in 2002-03 of $24.2 billion, which roughly doubled to $47 billion in 2010-11 - an amount equal to about half of total revenues and the same share of total federal revenues. 6. Back Again . SB 508 is identical to SB 1272 (Wolk, 2010) which Governor Schwarzenegger vetoed, stating: To the Members of the California State Senate: I am returning Senate Bill 1272 without my signature. While the sponsors seem intent on eliminating measures that will generate jobs and stimulate the SB 508 -- 02/17/11 -- Page 6 economy, the average California taxpayer would probably be better served if the Legislature were willing to automatically sunset every new spending entitlement, program expansion and business mandate after 7 years. For this reason, I am unable to sign this bill. Sincerely, Arnold Schwarzenegger Support and Opposition (03/24/11) Support : California Labor Federation Opposition : California Bankers Association, California Taxpayers Association, California Aerospace Technology Association, California Manufacturers Association, and TechAmerica