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, 




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               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 





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          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.  





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          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 





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          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 





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               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