BILL ANALYSIS Ó AB 32 Page 1 Date of Hearing: May 13, 2013 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Raul Bocanegra, Chair AB 32 (Pérez) - As Amended: April 17, 2013 SUSPENSE REVISED Majority vote. Tax levy. Fiscal committee. SUBJECT : Insurance taxes: income taxes: credits: community development financial institution investments. SUMMARY : Increases from $10 million to $50 million the annual aggregate amount of qualified investments eligible for the Community Development Financial Institution (CDFI) tax credit under the Insurance Gross Premiums Tax (IT), Personal Income Tax (PIT) and Corporation Tax (CT) Laws, as provided. Specifically, this bill : 1)Increases the $10 million annual limitation on the aggregate amount of qualified investments eligible for the DCFI tax credit to $50 million. 2)Prohibits the total amount of investments certified by the California Organized Investment Network (COIN) in a calendar year to any one CDFI, together with its affiliates, from exceeding 30% of the annual aggregate amount of qualified investment, except as provided. 3)Requires that each year 10% of the annual aggregate amount of qualified investments be reserved for investment amounts of less than or equal to $200,000, except as specified. 4)Allows COIN to certify investments for the CDFI tax credit until January 1, 2017. 5)Revises the order of priority that must be used in granting applications for the CDFI tax credit. 6)Takes effect immediately as a tax levy. AB 32 Page 2 EXISTING LAW : 1)Authorizes a credit against the IT, PIT or CT, in an amount equal to 20% of a qualified investment made by a taxpayer into a CDFI. 2)Limits the annual certification of total qualified investments made by all taxpayers to all CDFIs to $10 million for each calendar year, but if the qualified investments are less than that amount in one calendar year, the difference may be carried over to future years and added to the aggregate amount authorized for those years. 3)Defines "qualified investment" as an investment that is a deposit or loan that does not earn interest, or an equity investment, or an equity-like debt instrument meeting federal or state agency standards. The duration of the investment must be for 60 months or more and the amount must equal $50,000 or more. 4)Defines a "community development financial institution" as a private financial institution located in California that is certified by the COIN Office of the Department of Insurance, that has community development as its primary mission, and that lends in urban, rural, or reservation communities in this state. The term "CDFI" includes a community development bank, a community development loan fund, a community development credit union, a microenterprise fund, a community development corporation-based lender, and a community development venture fund. 5)Provides that, in the event the total amount of qualified investments exceeds $10 million in a calendar year, priority shall be granted to those applications that meet any or all of the following: a) Directly benefit low-income persons. b) Prioritize rental housing, mortgages for community-based residential programs, and self-help housing ahead of single-family owned housing. c) Represent investments from insurance companies subject to tax under Section 12201 of the Revenue and Taxation Code (R&TC) or under Section 28 of Article XIII of the AB 32 Page 3 California Constitution. 6)Allows a carryforward of the unused CDFI credit up to four taxable years, or until the credit has been exhausted, whichever occurs first. 7)Authorizes COIN to certify investments for the credit on or before January 1, 2015. 8)Provides that the CDFI tax credit is effective until December 31, 2017, and as of that date is repealed. FISCAL EFFECT : The Franchise Tax Board (FTB) staff estimates that the PIT and CT tax provisions of this bill will result in an annual revenue loss of $1.2 million in fiscal year (FY) 2013-14, $1.2 million in FY 2014-15, and $1.5 million in FY 2015-16. These estimates do not include the revenue impact of the tax credit allowed against the insurance gross premiums tax. COMMENTS : 1)Author's Statement . The author states that, "Community development investments make sound business sense and provide solid returns while bringing much needed capital to low-income communities. These investments are leveraged to provide loans such as small business loans, mortgage loans, and construction loans. From 1997 through 2012 more than $135 million has been invested into some of California's most underserved communities through the COIN program. "In the recent past, CDFIs across the state have made notable investments, including: A mortgage loan for a nonprofit residential alcohol treatment facility Micro-loans of $500 to $5,000 to self-employed business owners Loan for six childcare centers to serve 500 low-income children Pre-development loans to Habitat for Humanity to construct affordable homes A loan to a church to build a child care center for low income residents A loan for 953 water hook ups in two small, rural AB 32 Page 4 communities A short-term loan to close escrow on housing for low-income foster youth. "The annually allocated tax credit has remained at $2 million since 1997. "Insurer demand for COIN CDFI tax credits continues to increase due to the reinvigoration of COIN. Unmet insurer appetite and underutilized CDFI capacity means the state could gain significantly more insurer investment if the amount of available COIN CDFI tax credits was increased. COIN staff estimates a $98 million peak demand for COIN CDFI tax credits." 1)Arguments in Support . The sponsor of this bill states that COIN's goal is "to help address unmet capital needs by supporting economic development, affordable housing and other such investments that benefit low-income and rural communities in California." The COIN received a record number of CDFI tax credit applications in 2011 and 2012, which required the COIN to allocate unused tax credits from prior years. Furthermore, according to the sponsor, within days of opening the first 2013 CDFI tax credit application cycle, "investors and CDFIs reported their intended community investment to be nearly $80 million on $16 million of tax credits." Due to this increased demand for tax credits, potential investors are turned away and community-based projects are not receiving the full benefit of this community investment. The sponsor argues that AB 32 is necessary to meet the large demand for CDFI tax credit in order to increase community development investment in programs and projects serving rural and underserved areas, such as, for example, low-income investment fund, Clearinghouse CDFI, and the Pacific Coast Regional Small Business Development Corporation. The proponents of this bill assert that community development investments "make sound business sense and provide solid returns while bringing much needed capital to low-income communities." These investments are leveraged "to provide ? small business loans, mortgage loans, and construction loans" and to secure additional sources of matching funds for projects such as, for example, construction of affordable housing or extension of health clinic services to the uninsured. AB 32 Page 5 The proponents state that California's underserved communities "are in desperate need of community development investment" and that investment "in low income communities has been insufficient, resulting in a low level of economic vitality, underperforming schools substandard housing, and a decline in the quality of life in many rural and urban areas." The proponents argue that the COIN program is "one way to improve the quality of life for Californians in the State's most underserved neighborhoods." 2)Background: The COIN Program . The COIN program was created in 1996 as a public-private partnership by the Department of Insurance, the insurance industry, state government leaders, and community development organizations with the goal of helping to address the unmet capital needs for economic development and affordable housing in low-income urban and rural communities throughout California. This voluntary program was established at the request of the insurance industry, "as an alternative to state legislation that would have required insurance companies to invest in low-income urban and rural communities, similar to the federal Community Reinvestment Act (CRA) that applies to the banking industry." (Insurance Commissioner Urges California Insurers to Invest in Low-Income Communities, Press Release, August 6, 2001). The COIN program serves as a liaison between insurers that are seeking investment opportunities and the community organizations that are seeking investment capital for projects. CDFIs work with COIN - an office within the California Department of Insurance - as financial intermediaries providing access to credit, loans, and investments to small businesses and non-profits that serve economically disadvantaged communities. CDFIs also offer administrative and technical assistance in these low-income communities. Generally, CDFIs lend to borrowers that do not satisfy the criteria for conventional lenders and focus on a particular community or certain groups of people. 3)The CDFI Tax Credit Program . In 1997, the COIN CDFI Tax Credit program was created to attract and leverage private capital to fund investments into CDFIs that yield economic and social benefits for California's underserved markets, as well as investments that yield environmental benefits. The program was set to expire at the end of 2011, but was extended until January 1, 2017. The amount of the credit is equal to 20% of AB 32 Page 6 each qualified investment of $50,000 or more made in a specified private financial institution located in California - a CDFI - that has been certified by the COIN as eligible. The COIN must certify each CDFI and each qualified investment. A CDFI, among other requirements, must apply to COIN for certification of its status and, on behalf of a taxpayer, for certification of the credit amount allocated to the taxpayer. The COIN office generally approves applications on a first-come, first-served basis, although it has some discretion in certifying CDFIs. If however, the COIN determines that total qualified investments will exceeds $10 million, then priority must be granted to those applications that (a) directly benefit low-income persons, (b) prioritize rental housing, mortgages for community-based residential programs, and self-help housing ahead of single-family owned housing, or (c) represent investments from insurance companies. The COIN is required to provide the State Board of Equalization or the FTB, whichever is applicable, with an annual list of the names and identification numbers of any taxpayers who make any withdrawal or partial withdrawal of a qualified investment before the expiration of 60 months from the date of the qualified investment. The goal of the CDFI tax credit program is to provide incentives to attract private capital investments that otherwise would not be available to CDFIs. This tax credit may be claimed by taxpayers against the insurance gross premium tax, the state CT, or the state PIT. The statewide amount of the credit for all recipients is capped at $2 million per year for the three taxes combined. Every $1 of the tax credit yields $5 of private investment, with the total tax credit allocation of $2 million generating up to $10 million of private investments in COIN-certified CDFIs. However, if less than $10 million is invested in qualified CDFIs in any calendar year, the remaining amount may be carried over to the next year and any succeeding year during which the credit remains in effect. Private investments have a minimum term of 60 months, and the tax credit is allocated in year one of the five-year investment period. The credit is subject to a 60-month recapture period if the investment is reduced or withdrawn. According to the FTB's tax expenditure report, the total amount of credit claimed under the CT and the PIT Laws in 2009 was $250,000, and was allowed on 89 PIT and an unknown number AB 32 Page 7 of CT returns. As stated in the COIN report dated January 10, 2011, approximately $1.65 million in qualified investments were approved by the COIN and $330,000 of the tax credits were certified for the 2010 calendar year. The total remaining amount of investment still available for 2010 calendar year was $13.7 million. However, by July 2011, the COIN had allocated $6.75 million in tax credits to insurance companies and other investors, which included $2 million for 2011 and $4.75 million of unused credit from prior years. The allocation translated into $33.75 million of qualified community investments. Most investments that qualify for the CDFI tax credit may also qualify for the federal New Markets tax credit. Furthermore, those investments may also qualify for the low-income housing tax credit and/or the enterprise zones (EZs) and targeted tax areas deductions. The low-income housing tax credit and EZ programs are state tax programs that are also intended to generate new investment and economic activity in targeted communities. 4)Federal "New Markets" Tax Credit Program . Existing federal law provides for a "new markets" tax credit that permits individuals and corporate taxpayers to receive a credit against their federal income taxes for making equity investments in investment vehicles known as Community Development Entities (CDEs). The primary mission of a CDE is to serve, or provide investment capital for, low-income communities or low-income persons, as specified. The federal credit amount is equal to 39% of the value of the qualified equity investment, and is spread over seven years. Thus, in each of the first three years, the federal credit amount is equal to 5% of qualified contributions and in each of the remaining four years the amount of credit is increased to 6% of qualified contributions. The Department of the Treasury administers the program and provides allocations of the federal credits to eligible community development entities through a competitive grant process when Congress makes the credits available. The federal limit of the total qualified investments from all taxpayers for 2011 was $3.5 billion, of which $1.210 billion were allocated to California companies. 5)Gross Premiums Tax . Unlike the federal "New Markets" tax AB 32 Page 8 credit, the CDFI tax credit is also available to insurers that are subject to the gross premiums tax pursuant to the California Constitution (Section 28, Article. XIII, California Constitution). The gross premiums tax is an excise tax on insurers for the privilege of transacting insurance in this state. The statutory provisions relating to the assessment and collection of the tax are contained in Part 7 (commencing with Section 12001) of Division 2 of the R&TC. This tax is imposed in lieu of other state and local taxes and fees, making an insurer exempt from paying those charges, other than real property and motor vehicle taxes and fees. The economics of the insurance industry provide a key reason for the special treatment of insurance companies. Most corporate taxpayers calculate their income by subtracting costs incurred in the production of goods or services from the revenues received from their sale. Insurance companies, by contrast, collect their revenues up front, then make payments to policyholders based on contingent events that occur many months or years later. Thus, it can be difficult to "match up" revenues to related expenses. In an income tax framework, insurers ideally would be allowed to deduct the current value of all future obligations (claims) covered by the insurance policies they have written when calculating their taxable income for a given year. Because the actual amount of these obligations is uncertain, as are the amount of investment earnings on accumulated premiums received during the intervening period, an accurate determination of the theoretically appropriate amount of taxable income proves very difficult to achieve in practice. Insurers subject to the gross premiums tax do not pay tax on other forms of income, such as investment income, or income earned from other trades or businesses. 6)The Report by the Legislative Analyst's Office (LAO) . As required by existing law, on April 14, 2011, the LAO issued an analysis of the CDFI tax credit, discussing the credits' fiscal impact and the resulting benefits to economically disadvantaged communities and low-income people in California. The LAO report noted all the following: a) Economic Impact . While the LAO was unable to estimate the economic impact of the tax credits, it states that "in many cases investments in the CDFIs would not have been made in the credit's absence." The report admits that AB 32 Page 9 "some of the credits have benefited larger CDFIs that are capable of raising funds in other ways and for which the credit-funded investments represent a smaller portion of their total assets." However, the LAO found that, even in those cases, the tax credits "helped generate investment activity that otherwise might not have been funded." b) Credit Percentage Seems Reasonable . The credit refunds a percentage of the invested amount, which translates into approximately "2.5 to 3 percentage points on a ten-year loan at prevailing interest rates," which is "about one-half of the interest spread between a fairly safe investment and a very risky one." While the LAO did not find a 20% subsidy to be too high or too low, it noted that "changing conditions in financial markets in the future could warrant a different subsidy percentage for this credit." c) Owned Versus Rental Housing . In light of the higher credit standards for home purchase loans since the collapse of the housing market, the LAO suggests that, in order to benefit low-income individuals, the CDFI tax credit program should focus on investments in rental housing, at least in the near future. d) First-Come, First-Served Tax Credits Can Be Problematic . Even though the tax credit is currently underutilized, at some point in prior years, it was fully used. The LAO advises to authorize COIN or some other entity to award the credits competitively, instead of a first-come, first-served basis, to allow the state to prioritize CDFI investment, if there is more demand for the credit in the future. 7)Related Legislation . AB 624 (Pérez), Chapter 436, Statutes of 2011, extended the CDFI tax credit program from January 1, 2012 until January 1, 2017. AB 2832 (Ridley-Thomas), Chapter 580, Statutes of 2006, extended the operation of the CDFI tax credit program from January 1, 2007, until January 1, 2012. SB 409 (Vincent), Chapter 535, Statutes of 2001, extended the AB 32 Page 10 operation of the CDFI tax credit program from January 1, 2002 until January 1, 2007. AB 1520 (Vincent), Chapter 947, Statutes of 1997, established the CDFI tax credit program until January 1, 2002. REGISTERED SUPPORT / OPPOSITION : Support 3CORE Association of California Insurance Companies Association of California Life and Health Insurance Companies California Department of Insurance (sponsor) California State University California United Bank Century Housing Community Loan Fund Diana Singleton (individual) Donald Stone (individual) Enterprise Community Investments, Inc. FAME Assistance Corporation Farmers Insurance Group Grossman Financial Management Los Angeles LDC National Association of Mutual Insurance Companies Nehemiah Community Reinvestment Fund Northeast Community Federal Credit Union Northern California Community Loan Fund Opportunity Fund Pacific Association of Domestic Insurance Companies Pacific Coast Regional Pacific Community Ventures Pacific Life Insurance Company Personal Insurance Federation of California ProAmerica Bank Roxborough, Pomerance, Nye & Adreani, LLP Rural Community Assistance Corporation Self-Help Federal Credit Union The Association of Financial Development Corporations Opposition None on file AB 32 Page 11 Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098