BILL ANALYSIS Ó
SENATE COMMITTEE ON BUDGET AND FISCAL REVIEW
Mark Leno, Chair
Bill No: AB 93
Author: Committee on Budget
As Amended: June 24, 2013
Consultant: Mark Ibele
Fiscal: Yes
Hearing Date: June 24, 2013
Subject: This is an Economic Development bill that makes
various changes in the state tax system beginning in
2013-14. The proposed statutory changes are related to the
Governor's Budget proposal to address budgetary aspects of
one of the state's largest and fastest growing tax
expenditure programs, and provide additional tax incentive
programs to encourage economic development.
Summary: This bill makes substantial changes to the state
tax system, relating to the personal income tax (PIT),
corporation tax (CT), and sales and use tax (SUT). The
bill would result in phasing-out and ending certain tax
provisions relating to taxpayers located in Enterprise
Zones (EZs) and similar tax incentive areas, ending the
current New Jobs Credit tax incentive program, and
instituting two major tax programs-a SUT exemption for
equipment and similar purchases, and a hiring tax credit
under the PIT and CT for employment in specified geographic
areas. The bill would also provide for allocating income
tax credits through the Governor's Office of Business and
Economic Development (GO-Biz) to assist in retaining
existing and attracting new business activity in the state.
Background: The state imposes a tax on the sale and use of
tangible personal property, a tax on personal income, and a
corporation tax based on income. For each tax, there are
various special tax expenditure programs designed to
encourage or reward particular economic activities. The
state's taxes and tax expenditure programs affected by this
bill are outlined below:
1. Sales and Use Tax. California's sales and use tax
law imposes the sales tax on the sale of tangible
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personal property in the state and the use tax on the
storage, use, or other consumption of tangible
personal property in the state, except where a
specific exemption is provided. Generally, the SUT
applies to the purchase or use of tangible personal
property, such as equipment, that is used to
manufacture, produce or process tangible personal
property. Thus, the tax is generally imposed on
equipment used in manufacturing and research and
development. The tax is not applied to sales of
tangible personal property when it is physically
incorporated in a manufactured item that will be sold.
The current statewide SUT rate is 7.25 percent and
includes rates for the state General Fund, various
special funds, and local governments. In addition,
local governments may impose voter-approved add-on
rates. An allocated exclusion from this tax is
provided by the California Alternative Energy and
Advanced Transportation Financing Authority (CAEATFA)
for purchases of tangible personal property for
approved manufacturing projects. The Board of
Equalization (BOE) administers the SUT.
2. Enterprise Zone Programs. California levies the
PIT on all California-sourced income. The PIT is paid
by all California residents and nonresidents who
receive income from sources in the state, unless such
income is specifically excluded from taxation. The
state also imposes the CT based on all income derived
from or attributable to California, and levies the SUT
on the sale of use of tangible personal property in
the state.
The Department of Housing and Community Development
(HCD) may designate certain geographic areas as EZs,
thus providing access to tax incentives for businesses
that conduct activities in these zones. Cities and
counties may apply to HCD for zone designation based
on unemployment rates, residents' participation in
subsidized meal programs, median resident income,
recent experience with plant closures, and certain
other socio-economic characteristics. Statutory
authority allows for the creation by HCD of up to 42
zones, each for a 15-year period. Currently, the
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state has 40 designated zones; two zones were allowed
to expire in 2012. EZs are widespread throughout the
state and result in potential tax benefits for
virtually all types of industries. With exceptions
for certain tax programs, these tax incentives are
generally available for certain other designated
geographic areas, comprising Local Area Military Base
Recovery Areas, Targeted Tax Areas, Manufacturing
Enhancement Areas, and the Los Angeles Revitalization
Zone. These later areas constitute a minor portion of
the geographically-based tax incentive program.
Taxpayers with business activities located in an EZ
can claim various tax incentives through both the PIT
and CT. The available tax incentive programs include
tax credits for hiring certain qualified individuals,
sales taxes paid on equipment purchases, and net
interest deductions for banks making loans to an EZ
business. In addition, EZ businesses may benefit from
accelerated depreciation of equipment and the
carry-over of 100 percent of business losses to future
tax years. The specific programs are:
a. EZ Hiring Credit. The largest EZ-related
incentive is the hiring credit. California law
provides a credit to taxpayers that employ
qualified employees in an EZ during the taxable
year equal to: (1) 50 percent of qualified wages
in the first year of employment; (2) 40 percent
of qualified wages in the second year of
employment; (3) 30 percent of qualified wages in
the third year of employment; (4) 20 percent of
qualified wages in the fourth year of employment;
and, (5) 10 percent of qualified wages in the
fifth year of employment. In general, qualified
wages means wages that do not exceed 150 percent
of the minimum wage. Such wages must be paid to
a qualified employee who works at least 90
percent of the time on activities directly
related to the business located in an EZ and
whose services must be at least 50 percent
performed within the boundaries of an EZ.
Qualified employees include economically
disadvantaged individuals, dislocated workers,
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disabled individuals, ex-offenders, recipients of
certain federal or state aid, members of a
federally-recognized Indian tribes, or residents
of a defined "targeted employment area" (TEA),
where more than 50 percent of the residents are
low- and moderate-income. To qualify for the
hiring credit, the taxpayer must obtain a
certification, or voucher, indicating that the
employee meets the eligibility criteria specified
above. Taxpayers are required to retain a copy of
this voucher and provide it upon request to the
Franchise Tax Board (FTB), the state agency
charged with administering the CT and the PIT.
b. Sales or Use Tax Credit. Taxpayers
engaged in a trade or business within an EZ may
take a credit equal to the SUT paid during the
taxable year in connection with the purchase of
qualified property. Qualified property includes
specified machinery and machinery parts, data
processing and communications equipment, and
motion picture manufacturing equipment central to
production and postproduction. The total cost of
qualified property permitted for purposes of
claiming this credit may not exceed $1 million
for PIT filers and $20 million for CT filers.
Moreover, the qualified property must be used by
the taxpayer exclusively in an EZ.
c. Net Interest Deduction. California law
provides for the deduction of net interest income
on loans made to a trade or business located
solely within an EZ. For purposes of the EZ net
interest deduction, a qualified taxpayer
(creditor) is defined as an entity that loans
funds on or after the designation date of the EZ
to a qualified business (debtor) and receives
interest payments thereon. The taxpayer
(creditor) does not have to be located in the EZ
to take advantage of the net interest deduction;
only the debtor needs to operate within the EZ.
d. Accelerated Depreciation. Existing law
allows EZ taxpayers to treat 40 percent of the
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cost of specified property as an expense not
chargeable to the taxpayer's capital account.
Any such cost may be allowed as a deduction for
the taxable year in which the taxpayer places the
property in service. Such property must be for
exclusive use in a trade or business conducted
within an EZ.
e. Employee Tax Credit. Existing law allows
a PIT or CT credit equal to five percent of
qualified wages, as defined, received by a
qualified EZ employee during the taxable year.
However, for each dollar of income received by
the employee in excess of qualified wages, the
credit is reduced by nine cents.
1. New Jobs Credit. Under the PIT and the CT, a tax
credit of up to $3,000 for each additional full-time
employee hired is available to small businesses with
20 or fewer employees, beginning January 1, 2009. The
credit is prorated on an annual full-time equivalent
basis for employees employed less than a full year.
To qualify, each qualified full-time hourly employee
must be paid wages for not less than an average of 35
hours per week and each qualified full-time employee
that is a salaried employee must be paid compensation
during the year for full-time employment.
Generally, an employer may not claim the credit for
those employees who are certified as a qualified
employee in an EZ or similar incentive area, or for an
employee whose wages are included in calculating any
other credit allowed. In addition, there must be a
net increase in qualified full-time employees compared
to the number of full-time employees employed in the
preceding taxable year. For taxpayers who first
commence doing business in California during the
taxable year, the number of qualified full-time
employees considered employed in the preceding year
would be generally be zero, unless certain special
rules apply.
The credit is an allocated credit and the total amount
of credit available to be claimed by all taxpayers is
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capped at $400 million. The credit must be claimed on
a timely filed original return received by the FTB on
or before a cut-off date specified by the FTB.
2. Governor's Office of Business and Economic
Development. The Governor's Office of Business and
Economic Development (GO-Biz) was created to serve as
a single point of contact for economic development and
job creation efforts. The office offers a range of
services to businesses including: business attraction,
retention and expansion services; site location
selection; permit assistance; regulatory filing and
approval assistance; small business assistance;
international trade development; and assistance with
state government. Under the Governor's Reorganization
Plan No. 2 (GRP 2), the Infrastructure Development
Bank, the California Film Commission, the Office of
Tourism, and the Small Business Loan Guarantee Program
will be transitioned from the Business, Transportation
and Housing Agency (BT&H) to GO-Biz, effective July 1,
2013.
Proposed Law: The proposed law institutes several new tax
programs that will result in tax reductions for certain
purchases of tangible personal property and for increasing
employment in specific designated areas. In addition, the
law would provide for the allocation of tax credits in
exchange for investments and employment in California. The
law would also result in the elimination of EZ and related
area tax incentives and the New Jobs Credit.
1. Sales and Use Tax Exemption. The proposed law
would allow for an exemption from the state portion of
the SUT, beginning January 1, 2014 and before January
1, 2019, for certain purchases by qualified purchasers
that are used in designated activities. The exemption
would be limited annually to the first $200 million of
otherwise eligible purchases by a qualified purchaser.
Qualified purchasers that would be eligible for the
SUT exemption are identified by designated codes of
the North American Industry Classification System
(NAICS), but excluding extractive industries:
a. NAICS Codes 3111 through 3399 include all
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establishments primarily engaged in manufacturing
activities. This encompasses manufacturers in
the aerospace sector, textiles, pharmaceuticals,
printing, food and others.
b. NAICS Code 541711 includes establishments
primarily engaged in conducting biotechnology
research and experimental development. This
encompasses industries using microorganisms and
cellular and bio-molecular processes to develop
or alter materials.
c. NAICS Code 541712 includes establishments
primarily engaged in conducting research and
experimental development in the physical,
engineering and life sciences. This encompasses
activities in agriculture, electronics,
environmental biology, botany, computers,
chemistry, food, fisheries, forest, geology,
health, mathematics, medicine, oceanography,
pharmacy, physics, veterinary and other allied
fields.
Qualified tangible personal property must be used at
least 50 percent of the time by the qualified
purchaser in any stage of manufacturing, processing,
refining, fabricating, or recycling of tangible
personal property; for purposes of research and
development; to maintain, repair, measure, or test
tangible personal property; and, if purchased by a
contractor, used as an integral part of the
manufacturing, processing, refining, fabricating, or
recycling process, or as a research and storage
facility for use in connection with those processes.
Qualified tangible personal property eligible for the
exemptions would include: machinery and equipment,
including component parts such as belts, shafts,
moving parts and operating structures; equipment or
devices used or required to operate and control
machinery such as computers, data processing
equipment, software; pollution control equipment that
meets state and federal standards; and special purpose
buildings used as an integral part of manufacturing,
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processing, refining, fabricating or recycling
process, not including storage. Eligible property
must have a useful life in excess of one year and
excludes items such as furniture, equipment used for
extraction or storage, or property used for
administration, management or marketing.
The SUT exemption would be provided if the purchaser
furnishes a seller with an exemption certificate,
which would be kept by the seller and furnished to the
BOE upon request. Qualifying purchases that are
removed from the state, or used for unqualified
activities, within one year of the purchase would be
subject to a 'claw-back' equal to the value of the SUT
exemption. The purchaser of the property would be
liable for the payment of the sales or use tax that
would otherwise have been collected from the seller
absent the provision of the exemption.
2. Hiring Credit. The proposed legislation would
initiate a new hiring tax credit under the PIT and CT,
from January 1, 2014 to January 1, 2019, for
additional hiring of employees in defined geographic
areas of the state. The hiring credit would be
available in the geographic areas largely covered by
the existing EZs (except certain census tracts with
low unemployment), two recently expired EZs located in
Antelope Valley and Watsonville, and in designated
census tracts that have a civilian unemployment rate
and a poverty rate in the top 25 percent of all census
tracts in the state. The credit percentages for all
hiring credits are 35 percent per year for five years
for wages between 150 percent and 350 percent of the
minimum wage (currently between $12 and $28 per hour).
The credit is available for full-time employees who
perform at least 50 percent of their activities in the
designated areas. Generally, (except for small
businesses that claim the credit), the following
apply: (1) taxpayers from a temporary agency,
retailer, restaurant or drinking establishment, as
defined by the NAICS codes are prohibited from
receiving the hiring credit; and (2) taxpayers that
move into an EZ are required to provide an "offer of
transfer" to its employees with comparable
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compensation. Important features of the Hiring Credit
include the following:
a. Employee Characteristics. Employees
would have to meet one of the following
characteristics: (1) have been previously
unemployed for six months; (2) received the
Earned Income Tax Credit (EITC); or (3) have
served in the United States Military.
b. Net New Jobs. The bill requires that in
order to qualify for any credit, the taxpayer
must have experienced an increase in total jobs
throughout the state from one year to the next.
Taxpayers are only allowed the credit for the
number of new jobs provided in the state. For
example, if a company shows it has hired 100
employees statewide, the company may receive
total credits for up to 100 employees.
Alternatively, if a taxpayer hires 50 new
employees in one area but laid-off 25 employees
in another part of the state, the taxpayer would
only be eligible for credits for 25 qualified
employees.
c. Small Business Provisions. The bill
requires that 25 percent of the hiring credits be
reserved for small business, defined as
businesses with annual gross receipts of under
$2.0 million. Small business must comply with
all requirements except the offer of transfer and
the industry limitations noted above.
d. Credit Administration. Taxpayers may
only qualify for the credit if it is on the
original filed timely return with the FTB; no
credit may be claimed on an amended return.
Taxpayers, with qualified employees that meet the
net new jobs test, must reserve a credit with the
FTB. The credit is then claimed on an original
filed timely return. The proposed statute
requires the FTB to compile a list of the hiring
credit vouchers claimed and number of new jobs
created for each taxable year.
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3. Governor's Office of Business and Economic
Development. The bill establishes the California
Competes Tax Credit Committee (CCTCC), consisting of
the State Treasurer, Director of Finance, the Director
of GO-Biz, and a representative of the Senate and
Assembly. The CCTCC would approve or reject written
agreements for the allocation of California Competes
tax credits under the PIT and the CT after the receipt
of fully executed written agreements between the
taxpayer and GO-Biz. Under the program, up to $30.0
million would be allocated in 2013-14, $150.0 million
in 2014-15 and $200.0 million from 2015-16 through
2018-19. The amounts actually allocated would be
subject to restrictions based on the total value of
SUT exemptions and Hiring Credits claimed relative to
the amount of $750.0 million. Twenty-five percent of
the credits would be reserved for small businesses and
priority would be given to projects proposed for
location in areas of high unemployment or poverty.
The agreement to award credits would take into
consideration, but not limited to: the number of jobs
created; the compensation paid to employees; amount of
investment by the taxpayer in the state; amount of
unemployment in the area; other incentive available to
the taxpayer in this state and other states; duration
of the project; overall economic impact of the
project; strategic importance of the project;
opportunity for future expansion in the state by the
taxpayer; and the extent to which state benefits
exceed state costs. In the event that a taxpayer
fails to perform under the written agreement, the
credit would be subject to recapture. The bill also
requires GO-Biz to provide information to FTB
regarding the effectiveness of the credits as measured
by job creation, additional investment and other
metrics.
4. Enterprise Zone Programs. Under the proposed
legislation, programs related to tax incentives for
activities in EZs and similar areas, would generally
no longer be effective beginning January 1, 2014.
However, with respect to the EZ hiring credit, for
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employees employed by the qualified taxpayer prior to
January 1, 2014, the wages paid with respect to those
employees would continue to qualify for the credit for
any remainder of the five-year period. In addition,
credits claimed, or earned, under the EZ program and
carried-over from prior years, could continue to be
applied to tax liabilities for up to five years, or
through December 2019.
5. New Jobs Credit. Under the proposed statute, the
2009 New Jobs Credit would cease to be operative for
taxable years beginning on or after January 1, 2014
and repealed.
6. Appropriation. An appropriation to the Department
of Finance and the CCTCC is provided for the costs of
administering the provisions of this act. The
allocation of funds under this appropriation would be
effective 30 days after the notification by the
Director of Finance to the Joint Legislative Budget
Committee (JLBC).
Proposed Amendments: Proposed committee amendments to AB
93 are the following:
1. Legislative Intent. The legislative intent
language amendment would indicate that the Legislature
finds and declares the goal of California's economic
development policy should be designed to: create good
jobs with middle class wages and benefits; target for
assistance individuals with barriers to employment;
and, encourage businesses to invest and create jobs in
California.
2. Targeted Employment Areas. There are three
categories of employees eligible for the hiring
credit: (1) individuals who have been unemployed for
six months; (2) veterans unemployed at discharge; and
(3) EITC recipients. The amendment would allow for
the expedited processing of credit reservation
requests from a qualified taxpayer who submits a
tentative tax credit reservation request for an
eligible employee (under of the three eligibility
categories) who also happens to reside in a TEA.
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3. Legislative Reporting. The proposed amendment
would require the following program evaluations be
provided to the JLBC annually. The reports would
include discrepancies between initial estimates and
actual credit or exemption usage under the programs
and identify options for program changes in the event
usage is below expectations. The evaluations
presented to the JLBC would be provided by: FTB for
the Hiring Credit; BOE for the SUT exemption; and
GO-Biz for the California Competes credits.
4. Severability. The bill amendments would provide a
severability clause that would allow for the continued
operation of other provisions of the statute in the
event that the establishment of the GO-Biz California
Competes credit is found to be an unlawful delegation
of legislative authority. In addition, the bill
amendments contain language that would preclude the
operation of the SUT exemption and the Hiring Credit
in the event the repeal of the EZ program and the New
Jobs Credit are overturned and instead remain
operative.
5. Sales and Use Tax Exemption Delay. The proposed
amendments would delay the implementation of the sales
and use tax exemption for equipment related to
manufacturing and research and development for six
months. Under the amendments, the exemption would be
available beginning July 1, 2014.
6. Technical Amendments. Legislative Counsel has
identified certain technical changes that relate to
cross-references, typographical errors, and
inadvertent minor inconsistencies that will be
clarified through the amendments.
Fiscal Effect: The bill contains measures that would
result in revenue increases and decreases. Revenue
decreases would result under the proposal from the sales
and use tax exemption, tax credits for additional hiring
created, and tax incentives provided by GO-Biz. Increases
in revenues would stem from the repeal of certain tax
credits and other tax incentives related to the enterprise
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zones and similar tax incentive areas, and cessation of the
2009 New Jobs Credit. The table below indicates the
revenue impacts of isolated components of the proposal and
the total impact of the measure over the next four years:
Revenue Impacts (In Millions $)
----------------------------------------------------------
| Tax Provision | 2013-14 |2014-15 |2015-16 |2016-17 |
|---------------------+---------+--------+--------+--------|
|Sales and Use Tax | -236| -486| -521| -531|
|Exemption | | | | |
|---------------------+---------+--------+--------+--------|
|Hiring Credit | -7| -34| -70| -110|
|---------------------+---------+--------+--------+--------|
|GO-Biz Incentives | 0| -32| -83| -134|
|---------------------+---------+--------+--------+--------|
|Enterprise Zone | 95| 375| 635| 805|
|Repeal | | | | |
|---------------------+---------+--------+--------+--------|
|New Jobs Credit | 75| 0| 0| 0|
|Repeal | | | | |
|---------------------+---------+--------+--------+--------|
| Total | -73| -177| -39|30 |
----------------------------------------------------------
Estimates from the Board of Equalization (BOE) and the
Franchise Tax Board (FTB) provide the basis for the revenue
estimates shown the table. The Department of Finance (DOF)
then made additional adjustments in these estimates to
account for specific policy design aspects of the proposal,
assumptions regarding behavioral shifts, and anticipated
future actions.
In particular, the BOE provided base estimates of the
revenue loss due to sales and use tax exemptions which do
not account for certain adjustments required to incorporate
behavioral changes, interactions with other programs, and
limitations on the availability of the exemption. DOF's
most significant adjustment to the BOE estimates is a
downward adjustment resulting from the $200 million
per-firm limitation. A review of California data indicates
that, while few firms exceed the $200 million threshold,
those that do contribute a disproportionate share of
capital purchases-almost 22 percent of equipment purchases
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are attributable to purchases in excess of $200 million by
firms with more than $200 million in purchases. This
adjustment results in a reduction in the revenue loss from
this component.
Similarly, the FTB provided base estimates for the
elimination of EZ credits and those for similar zones.
FTB's estimates did not account for anticipated revenue
impacts of regulatory decisions by the Administration,
through audit procedures or other administrative steps that
would, as a matter of course, work to reduce the impact of
the EZ tax incentive programs. Not accounting for these
anticipated actions would tend to overstate the positive
revenue implications in the bill attributable to ending EZ
tax incentive programs. Thus, the DOF adjustment results
in a reduction in the revenue gain associated with the
proposal.
DOF's revenue impact projections are based on available
California data and account for historical patterns of
equipment purchases for various firms. The available
state-level data used is based on a reasonable period from
which to sample. While there will always be variations
from estimated revenues due to changing circumstances and
events for which forecasting tools cannot account, the
revenue estimates seem reasonable.
Support: NA
Opposed: NA
Comments: From an economic perspective, the core of the
proposed policy changes would represent an improvement in
overall state tax policy. The SUT exemption, although
limited to particular industries, would represent a
fundamental policy improvement by addressing the phenomenon
of 'tax pyramiding'-that is, when inputs to production are
taxed as well as the outputs. While this aspect of the
proposal represents good tax policy, broad application
would result in significant revenue loses; however, this
possibility is dealt with by targeting the exemption to
particular industries. Regarding the EZ programs, the
general intent of the PIT and CT tax incentives in the EZ
program is to generate, in designated areas, economic
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activity-such as additional investment and employment-that
would otherwise not occur. However, the effectiveness of
the EZ program in this regard has been the subject of
substantial criticism. A broad body of economic and tax
research indicates that the program offers a poor return on
the state's sizable investment, largely as a consequence of
the ineffectiveness and inefficiencies inherent in tax
incentive programs of this type. On balance, the proposal
represents a significant step forward for state policy,
while still retaining certain incentive benefits for
disadvantaged areas of the state.
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