BILL ANALYSIS Ó SB 508 Page 1 Date of Hearing: June 13, 2011 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Henry T. Perea, Chair SB 508 (Wolk) - As Amended: February 17, 2011 Majority vote. Fiscal committee. SENATE VOTE: 23-17 SUBJECT : Income and corporation taxes: credits: information and operative limitations. SUMMARY : Provides that a new tax credit, enacted by a bill introduced on or after January 1, 2012, shall be operative for a period of seven years and shall include specified goals, objectives, and purposes, as well as other detailed information relating to the credit's effectiveness. Specifically, this bill : 1)Requires any bill that would authorize a new credit under either the Personal Income Tax (PIT) Law or the Corporation Tax (CT) Law to state all of the following: a) Specific goals, purposes, and objectives that the tax credit will achieve. b) Detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives stated in the bill. c) Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding those specific goals, purposes, and objectives. d) A requirement that the tax credit shall cease to be operative seven years after its enactment date. 1)Makes legislative findings and declarations regarding the need for review of tax preference programs, including tax credits. 2)Applies to bills introduced on or after January 1, 2012. SB 508 Page 2 EXISTING LAW : 1)Provides various tax credits, deductions, exclusions, and exemptions. Some of these tax expenditures are designed to provide relief to taxpayers who incur specified expenses, such as, for example, costs incurred in adopting a child. Other tax expenditures are designed to encourage socially or economically beneficial behavior. 2)Requires, under Government Code (GC) Section 13305, the Department of Finance (DOF) to provide an annual report to the Legislature on tax expenditures by no later than September 15 of each year. The report must contain each of the following: a) A list of all tax expenditures exceeding $5 million in annual cost; b) The statutory authority for each tax expenditure; c) A description of any legislative intent articulated for each tax expenditure; d) The sunset date of each tax expenditure, if applicable; e) Identification of the beneficiaries of each tax expenditure; f) An estimate or range of estimates for the state and local revenue loss for the current fiscal year (FY) and the two subsequent FYs; g) For PIT expenditures, the number of affected taxpayers; h) For CT and sales and use tax (SUT) expenditures, the number of returns filed or businesses affected; i) Identification of any comparable federal tax expenditure; and, j) A description of any tax expenditure evaluation completed by any stage agency since the last report made. 1)Defines a tax expenditure as "a credit, deduction, exclusion, exemption, or any other tax benefit as provided for by the state." SB 508 Page 3 FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates that this bill would not impact General Fund revenue. COMMENTS : 1)Author's Statement . The author states, "Today's public finance system in California requires major reform. While I have pushed 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)Arguments in Support . According to the proponents of this bill, California spends about $41 billion annually in tax expenditures and despite this large amount, the necessary evaluation requirements used to assess the effectiveness of tax expenditures are nonexistent. The proponents assert that "tax expenditures have limited legislative review, no cap on the amount of money spent and a vote requirement of a simple majority." Once created, "tax expenditures could go on in perpetuity, giving away billions of dollars without any way for the public to know if that spending has any public benefits whatsoever." The proponents argue that SB 508 brings much needed performance review and oversight to tax expenditure programs in order to make those programs more transparent and effective. 3)Arguments in Opposition . The opponents, in contrast, argue that this bill would create uncertainty regarding long-term tax planning. The opponents state that, "When businesses choose to locate in a state, factors such as the availability of a skilled workforce, infrastructure, regulatory environment, and tax structure all play a significant role, and businesses evaluate whether they can rely on these factors to remain relatively stable and consistent in the long term." The opponents contend that the imposition of a mandated seven-year sunset on all future tax credits will have an adverse effect on businesses because it would create SB 508 Page 4 uncertainty with respect to the future of the state's tax structure. For example, in the life science industry, 5- and 10-year business plans are the norm and more effective, so enacting a seven-year sunset will be disruptive to this industry. The opponents assert that SB 508 "would eliminate vital tax credits just as a product comes to market after years of development and millions of dollars spent." While many of the opponents recognize that the state needs to analyze the effectiveness of tax policies and make sure that they are sensible for the future of California's economy, they stand firm in believing that this bill will negate that purpose. The opponents suggest amending SB 508 to eliminate the seven-year sunset. 4)What is a "Tax Expenditure "? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. According to legislative analyses prepared for prior related measures, United State Treasury officials and some Congressional tax staff began arguing in the late 1960s 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). A recent report by the Legislative Analyst's office (LAO) shows that tax expenditure programs cost the state nearly $50 billion in FY 2008-09. The LAO report noted that resources are allocated to a new tax expenditure program automatically each year, with limited, if any, legislative review, and there is no limit or control over the amount of money forgone since the Legislature does not appropriate funds for tax expenditure programs. The LAO report also stated that the tax expenditure programs offer many opportunities for tax evasion, given the relatively low level of audits. 5)Current Review of Tax Expenditures . Although there is no requirement for the Legislature itself to review existing tax expenditures, several state agencies are required to issue annual tax expenditures reports. In 1985, the Legislature passed ACR 17 (Bates), which called upon the LAO to prepare a biennial "tax expenditure" report. Additionally, the DOF currently publishes an annual report on tax expenditures, pursuant to GC Section 13305, and provides it to the Legislature by no later than September 15 of each year. The DOF report includes a list of tax expenditures exceeding $5 SB 508 Page 5 million in annual cost. Finally, since 2007, the FTB is required to prepare an annual report, "California Income Tax Expenditures," describing tax expenditures found in the PIT and the CT Laws. 6)How is a Tax Expenditure Different from a Direct Expenditure ? As the DOF 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 then direct expenditures once they are put in place. While infrequent legislative review offers taxpayers greater certainty, it also results in tax expenditures remaining a part of the tax code in perpetuity without demonstrating any public benefit. Secondly, there is generally no control over the amount of revenue losses associated with any given tax expenditure. Finally, the vote requirements for direct expenditures and tax expenditures are different. While it takes a two-thirds vote to make a budgetary appropriation, a tax expenditure measure can be enacted by a simple majority vote. It should also be noted that, once enacted, it generally takes a two-thirds vote to rescind an existing tax expenditure. This effectively results in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of the efficacy, without a supermajority vote. 7)How Much Do Tax Expenditures "Cost" the State ? According to the DOF, the vast majority of tax expenditures are included in the PIT Law. To this end, the DOF estimates that tax expenditures reduced PIT revenues by roughly $31 billion in FY 2010-11. The SUT Law, in turn, contains identifiable state tax expenditures worth about $11 billion annually. For FY 2010-11, corporate tax expenditures amounted to roughly $5 billion. 8)What Does This Bill Do ? SB 508 is intended to create a mechanism for the legislative review of certain tax expenditures for the purpose of evaluating their effectiveness and compatibility with present day state policy objectives. Specifically, it requires each bill enacting a new tax credit to describe the goals, purposes, and objectives for authorizing such a credit, to specify detailed performance indicators intended to measure the effectiveness of the credit, and to mandate an automatic seven-year sunset for the operation of the credit. This bill is narrowly tailored to SB 508 Page 6 apply only to tax credits, as opposed to all tax expenditures. Furthermore, it would only apply to new tax credits, i.e. tax credits that are enacted by bills introduced on or after January 1, 2012. 9)The Seven-Year Sunset . This bill limits the operation of every new tax credit to a seven-year period, as long as it is enacted by a bill introduced on or after January 1, 2012. Business representatives often argue that companies need predictability, and that a short-term business tax credit would not be of any particular benefit to a taxpayer whose business projections span over decades. However, this sunset date may be easily extended by a subsequent statute enacting or re-enacting a tax expenditure. 10) How Effective is This Bill ? Both this Committee and its Senate counterpart already require the vast majority of tax expenditure measures they pass out to contain a built-in repeal date. However, while the Committee routinely requires sunset dates to be added to tax expenditure measures, there is nothing in existing law that would require them to do so in the future. Moreover, in the past few years, some of the most dramatic changes to our tax code have been enacted as part of the budgetary process beyond the review of this Committee. However, even if a general sunset requirement were included in statute, there would be nothing to prevent a future Legislature from enacting an open-ended tax expenditure "notwithstanding" the statutory prohibition. Indeed, there is considerable question as to whether such a prohibition would have any binding effect. ÝSee e.g., United Milk Producers of California v. Cecil (1941) 47 Cal.App.2d 758, 764-65, noting that the Legislature cannot declare in advance the intent of a future Legislature]. Courts have long held that one legislative body may not limit or restrict its own power or that of subsequent legislatures, and the act of one Legislature may not bind its successors ÝCounty of Los Angeles v. State of California (1984) 153 Cal.App.3d 568, 573]. In practical terms, it means that subsequent Legislatures are under no legal obligation to comply with the provisions of this bill. Furthermore, since this bill is a statutory, and not a constitutional, measure, any subsequent Legislature could easily dispense with this requirement by simply including a provision in a statute that would override Revenue and Taxation Code Section 40. SB 508 Page 7 11)Suggested Technical Amendment . Committee staff suggests the following technical amendment: On page 2, line 8, delete "$41 billion" and insert "$47 billion" 12)Related Legislation: a) SB 1272 (Wolk), introduced in the 2009-10 legislative session, was identical to this bill. Governor Schwarzenegger vetoed SB 1272 stating that "While the sponsors seem intent on eliminating measures that will generate jobs and stimulate the 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." b) AB 2171 (Charles Calderon), introduced in the 2009-10 legislative session, would have conditioned the allowance of a tax benefit on the passage of a separate statute. AB 2171 was held under submission by the Assembly Committee on Appropriations. c) AB 2641 (Arambula), introduced in the 2009-10 legislative session, would have required the Legislature to review, before January 1, 2014, and every fifth year thereafter, each tax expenditure, as specified, and provided that every new tax expenditure that is enacted after the effective date of AB 2461 shall be repealed automatically on January 1, 2015, and on January 1 of every fifth year thereafter, unless otherwise provided. AB 2641 was held under submission by the Assembly Committee on Appropriations. d) ACA 6 (Charles Calderon), introduced in the 2009-10 legislative session, would have amended the State's Constitution to, among other things, limit the operative period to seven years from the date of the enactment of a new or amended tax credit. ACA 6 died on the Assembly Floor. e) AB 831 (Parra), introduced in the 2007-08 legislative session, would have required any legislation creating a new tax expenditure, or extending the operation of an existing tax expenditure, to include a sunset provision. AB 831 SB 508 Page 8 failed to pass out of the Senate Committee on Revenue and Taxation. f) AB 1933 (Coto), introduced in the 2005-06 legislative session, would have required any legislative measure creating a new tax expenditure, or extending the operation of an existing tax expenditure, to include legislative findings regarding the purpose of the tax expenditure, an estimate of the attributable revenue losses, a specific methodology for measuring the anticipated benefits, and a sunset date no later than five years in the future. AB 1933 failed to pass out of the Senate Committee on Revenue and Taxation. g) AB 2199 (Brown), introduced in the 1995-96 legislative session, would have required all tax expenditures to be authorized via an appropriation in the annual Budget Act. AB 2199 failed to pass out of this Committee. h) AB 2884 (Villaraigosa), introduced in the 1995-96 legislative session, would have required the LAO, together with the DOF, FTB, and the Board of Equalization, to conduct an evaluation of all tax expenditures, as defined. AB 2884 failed to pass out of this Committee. i) SB 1233 (Hayden), introduced in the 1993-94 legislative session, would have required the LAO to review each tax expenditure program, as directed by this Committee and its Senate counterpart, to determine if its objectives are being realized, whether its benefits exceeded its revenue costs, and whether there is a less costly way of providing the same benefits. Governor Wilson vetoed SB 1233. REGISTERED SUPPORT / OPPOSITION : Support California Labor Federation Opposition BIOCOM California Aerospace Technology Association California Bankers Association California Manufacturers and Technology Association SB 508 Page 9 California Taxpayers' Association Tech America Analysis Prepared by : Jeremy Ghassemi & Oksana Jaffe / REV. & TAX. / (916) 319-2098, ext. 3978