BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: AB 32 HEARING: 8/14/13 AUTHOR: J. Pérez FISCAL: Yes VERSION: 4/17/13 TAX LEVY: Yes CONSULTANT: Grinnell COMMUNITY DEVELOPMENT FINANCIAL INSTITUTION TAX CREDIT Extends and expands the Community Development Financial Institution credit. Background and Existing Law Federal law allows a new markets tax credit for taxpayer's qualified equity investments in community development entities, the primary mission of which must be serving or providing investment capital for low-income communities or low-income persons, as certified by the Secretary of the Treasury. The federal credit is equal to 39% of the qualified equity investment and is spread over seven years. State law does not conform to the federal new markets credit, but instead allows the Community Development Financial Institution credit (CDFI), administered by the Department of Insurance (DOI) (AB 1520, Vincent, 1997). Taxpayers may claim a credit against the Gross Premiums Tax, Personal Income Tax, or Corporation Tax equal to 20% of qualified investments in the form of non-interest bearing deposits, loans, or equity investments of at least $50,000 held for at least 60 months. Taxpayers can carry over the credit for four years. The credit was initially used only to reduce Personal Income Tax, or Corporation Tax liabilities, but the Legislature added a credit against the Gross Premiums Tax in 1999, also administered by DOI (AB 157, Vincent). In 2002, the Legislature extended the credit until 2007 (SB 409, Vincent), again until 2012 (AB 2831, Ridley-Thomas, 2006), and once more until 2017, but only allowed DOI to certify new deposits for credits until January 1, 2015 (AB 624, J. Pérez, 2011). AB 32 - 4/17/13 -- Page 2 For deposits to generate credits, CDFI must be certified by the California Organized Investment Network (COIN), an office in DOI, by demonstrating that it is a private financial institution located in California, its primary mission is community development, and that it lends in urban, rural or reservation-based communities in California. CDFIs may be banks, credit unions, or non-regulated non-profit institutions organized to provide private capital for community development or investing. There are currently 27 CDFIs in California, down from 50 in 2011. CDFIs must use the proceeds of the investment for a purpose that is consistent with its community development mission and for the benefit of economically disadvantaged communities and low-income people in California. CDFIs must apply to COIN on behalf of the taxpayer. COIN certifies the amount of the investment and the credit, which is capped at a total of $10 million each year, but any unused amount from past years may be carried over to future ones. COIN generally allocates the credits on a first-come, first-served basis; however, if COIN determines that the total amount of investment will exceed the cap, it can prioritize applications with investments that directly benefit low-income persons, or prioritize rental housing, mortgages for community-based residential housing, and self-help housing ahead of single-family housing. DOI or the Franchise Tax Board (FTB) may recapture the credit within the 60 month period if the taxpayer reduces or withdraws the investment. Proposed Law Assembly Bill 32 increases from $10 million to $50 million the amount of investments COIN can certify for CDFI credits each year. The measure restricts the amount of investments COIN can certify for any one CDFI, combined with its affiliates to 30% of the annual total, unless COIN determines after October 1 that the supply of credits exceeds demand. Additionally, the measure sets aside 10% of the annual total for investments of less than $200,000, again unless COIN determines after October 1 that the supply of credits exceed demand. The measure also modifies the requirement for COIN to prioritize applications when credit demand exceeds supply AB 32 - 4/17/13 -- Page 3 to place priority on affordable rental housing, housing for veterans, and self-help housing ahead of single-family homes. The bill also extends the date before which COIN can certify investments from January 1, 2015 to January 1, 2017. State Revenue Impact According to FTB, AB 32 results in revenue losses of $1.2 million in 2013-14 and 2014-15, and $1.5 million in 2015-16. This estimate does not include revenue losses due to credits applied against the Gross Premiums Tax. Comments 1. Purpose of the bill . According to the author, "From 1997-2012 the CDFI Tax Credit and Certification Program has leveraged $27 million in tax credits to generate $135 million in CDFI deposits in California's most underserved communities. Over the last several years, the COIN program has been oversubscribed and with a cap on the amount of investments it has been unable to meet the demand for capital. The increase in the investment amount proposed under AB 32 as well as the other programmatic changes will allow for more COIN capital to be deployed, more projects to be built, more jobs to be created and more investors to participate. Community development investments make sound business sense and provide solid returns while bringing much needed capital to low-income communities." 2. Policy Questions . Taxpayers claiming the CDFI include some of the world's largest financial institutions and insurance companies, including Pacific Life Insurance Company, JP Morgan Chase, and Blue Shield of California. These firms are highly sophisticated investors, and allocate billions of dollars daily in various asset classes. The credit AB 32 seeks to extend and expand AB 32 - 4/17/13 -- Page 4 subsidizes these firms' investment in CDFIs with the intent that capital will flow to productive uses in low-income communities in California. As such, AB 32 poses three major policy questions: First, is it the proper role of the state to use tax credits to direct private investment decisions? These firms are successful because of their expertise in intermediating capital, and would deposit funds in CDFIs if it made sense from an asset allocation perspective. Because tax credits are funded by forgoing revenue that could be used for other government services or tax reductions, is increasing and extending the CDFI credit both appropriate and worth the cost? Second, if the state wants to direct investment into low-income areas, the CDFI credit is a tool that serves as a carrot, not a stick. Federal law's Community Reinvestment Act (CRA) provides considerable regulatory encouragement for federally-regulated banks to invest in low-income areas. Instead of tax credits, California could adopt its own CRA and require banks and insurance companies to invest in specified areas as a condition of doing business in the state. Lastly, is the CDFI scalable? Simply because taxpayers are claiming more tax credits today than in previous years doesn't necessarily mean that it's successful, as evidenced by now-repealed Enterprise Zone tax credits, in which credit usage grew as the economies within the zones stagnated. AB 32's quintupling of the credit amount is an affirmative statement that the credit is highly successful, and more is better. What evidence indicates that increasing CDFI credits will lead to more economic growth in these areas? 3. Growing appetite . After many years of lack of demand for CDFI credits, efforts by Insurance Commissioner Dave Jones have increased demand for the credits. Because of this increase, the Commissioner argues that AB 32's increase in the cap is necessary as many taxpayers want to make investments, but this year's allocation plus carryover amounts from previous years have already been claimed. According to DOI, insurance companies generally make investments in the third and fourth quarters of the year, and, CDFIs will make deposits and put them to work this AB 32 - 4/17/13 -- Page 5 year should AB 32 be enacted. However, is this problem more a result of the first-come, first-served methodology for allocating credits? The law directs COIN to certify investments that qualify when they come in the door - only later in the year can COIN prioritize some applications over others (See Comment #7). The Committee may wish to consider whether the CDFI credit should be expanded as AB 32 calls for, or whether it should delete the first-come, first-served method in favor of an allocation system that identifies stronger applications. 4. Measuring performance . CDFIs apply to COIN to certify the amount of the investment eligible for the credit; however, the CDFI isn't required to state the projects it funds using the increment of investment proceeds that generate credits for investors. While COIN reviews a CDFI's general lending practices, collects and publishes information about investors, the amount of the investment, and the CDFI receiving it, no information exists about the specific projects that happen due to the credit that wouldn't without it. Without information showing the specific things the state bought with the foregone revenue that funds the tax credit, how can the Legislature accurately measure the CDFI credit's performance? Additionally, COIN's records generally list the identity of the investor, but not always, sometimes listing "private investor." The Committee may wish to consider requiring CDFIs to specify the projects that will be funded using the deposits that give rise to tax credits, and identify the taxpayers that receive the credits. 5. LAO's take . AB 2831 (Ridley-Thomas) required the LAO to prepare an analysis of the CDFI credit. LAO's April 14, 2011 letter to the Chair of the relevant committees in the Assembly and Senate included four conclusions, among them: Economic Impact. It is very difficult to estimate the impact of the tax credits, although we suspect that in many cases investments in the CDFIs would not have been made in the credit's absence. It is true that 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. Even in these cases it seems likely that the tax credits helped generate investment activity that otherwise might AB 32 - 4/17/13 -- Page 6 not have been funded. Credit Percentage Seems Reasonable. This credit is set up like most in-vestment credits in that it refunds a percentage of the invested amount, and 20 percent is the equivalent of about 2.5 to 3 percentage points on a ten-year loan at prevailing interest rates. This is about one-half of the interest rate spread between a fairly safe investment and a very risky one. For example, recently, the difference between the rates on a BBB (low investment-grade) bond and a CCC ("junk") bond was about 6 percent. While we have no reason to believe that a 20 percent subsidy is too high or too low, it is possible that changing conditions in financial markets in the future could warrant a different subsidy percentage for this credit. Owned Versus Rental Housing. The CDFIs have supported both rental and owner-occupied housing, including both construction and mortgage loans. Credit standards for home purchase loans have increased markedly since the collapse of the housing market. In order to benefit lower-income individuals, it may make sense for housing development efforts to focus more on rental housing at least in the near future. Accordingly, the Legislature may wish to consider focusing the tax credit more on CDFI investments in rental housing opportunities to benefit low-income populations. NOTE - AB 624 allows DOI to prioritize rental housing and other use over single-family homes if total investments exceed the legal cap. First-Come, First-Served Tax Credits Can Be Problematic. In some prior years, the program has hit its annual cap. If the credit is retained in its current form, it may be advisable to authorize COIN or some other entity to award the credits competitively instead of on a first-come, first-served basis. This might allow the state to prioritize CDFI investments that best fit desired policy objectives-for example, by directly benefiting lower-income people instead of benefiting projects that merely are located in lower-income areas AB 32 - 4/17/13 -- Page 7 6. Recent history . In 2011, the Committee heard AB 624 (J. Perez), which would have doubled the amount of the CDFI credit and extended the authorization for DOI to certify investments for the credit until January 1, 2017. The Committee approved the bill with amendments that deleted the doubling of the investment amount, extended the ability for taxpayers to claim the CDFI credit until 2017, but didn't allow DOI to certify new investments after January 1, 2015. 7. Amendment Options . Should the Committee want to approve AB 624, but make changes to the CDFI credit program, it could amend the bill to: Prohibit or lower the priority for credit allocations those investments by banks and financial institutions required by CRA, thereby ensuring that California isn't subsidizing compliance with existing federal law; Grant regulatory authority to COIN to adopt a scoring process that allows it to set goals and evaluate applications to direct available resources toward the best projects; In combination with requiring CDFIs to disclose specific projects and taxpayers as suggested in Comment #3, change the bill's prioritization of rental housing projects being affordable to a requirement, similar to state and federal low-income housing tax credits; and Delete or reduce the bill's expansion of the annual amount of investment that generates a credit from $10 million to $50 million. Defer action on the measure, as the CDFI credit does not sunset until January 1, 2015. Assembly Actions Assembly Revenue and Taxation 9-0 Assembly Appropriations 16-0 Assembly Floor 77-1 Support and Opposition (08/08/13) Support : 3CORE Financial Mentoring Perspective; American AB 32 - 4/17/13 -- Page 8 Federation of State, County and Municipal Employees; Association of California Life and Health Insurance Companies; California Department of Insurance (sponsor); California United Bank; Century Housing Corporation; Clearinghouse Community Development Financial Institution; Corporation for Supportive Housing; Enterprise Community Investments, Inc.; Farmers Insurance Group; Grossman Financial Management; InSight at Pacific Community Ventures; Karuk Community Loan Fund, Inc.; Los Angeles LDC; Northeast Community Federal Credit Union; Northern California Community Loan Fund; Opportunity Fund Northern California; Pacific Coast Regional Small Business Development Corporation; Personal Insurance Federation of California; Rural Community Assistance Corporation; Roxborough, Pomerance, Nye and Adreani, LLP; San Luis Obispo Housing Trust Fund; Self-Help Federal Credit Union; The Association of Financial Development Corporation. Opposition : Unknown.