BILL ANALYSIS                                                                                                                                                                                                    Ó




                                                                  AB 305
                                                                  Page A
          Date of Hearing:  May 13, 2013

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Raul Bocanegra, Chair

                AB 305 (V. Manuel Pérez) - As Amended:  April 16, 2013

          2/3 vote.  Tax levy.  Fiscal committee.  
           
          SUBJECT  :  California New Markets Tax Credit Program

           SUMMARY  :  Establishes the California New Markets Tax Credit  
          Program (Program), with the stated purpose of stimulating  
          economic development and hastening California's economic  
          recovery by authorizing tax credits for investment in  
          California.  Specifically,  this bill  : 

          1)Contains the following legislative findings:

             a)   California is entering the sixth year of the worst  
               economic recession since the Great Depression. 

             b)   Due to a systemic budget problem, the state is suffering  
               from chronic revenue shortfalls based in part on increasing  
               reliance on revenues from personal income tax rolls. 

             c)   Investment in small business ventures is a proven method  
               of stimulating economic activity, creating new jobs, and  
               generating revenue by expanding the tax base. 

             d)   The federal New Markets Tax Credit (NMTC) Program,  
               created in 2000 with bipartisan support, has been an  
               effective means of stimulating state and regional economies  
               due to its ability to leverage federal funds to drive  
               private investment in communities that would otherwise not  
               have had access to capital.  These investments accrue to  
               small businesses, schools, and other business-related real  
               estate projects.  

             e)   As of 2010, nine states (Connecticut, Florida, Illinois,  
               Kentucky, Louisiana, Mississippi, Missouri, Ohio, and  
               Oklahoma) had enacted matching state programs.  On average,  
               these states successfully leveraged $13 in federal NMTC for  
               every dollar of state credits initially allocated for the  
               state program.  









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             f)   As of December 29, 2012, $261.5 million of California's  
               small business hiring tax credit are still available.

             g)   Given the current economic climate and the lack of use  
               of the state hiring tax credit, it is reasonable for the  
               Legislature to search for and consider other alternatives  
               to stimulate hiring and generate economic activity to  
               shorten the current recession and promote permanent  
               economic recovery.

             h)   There are low-income communities in the state that face  
               multiple challenges in attracting private investment,  
               including developing and maintaining a workforce that meets  
               the skill needs of local employers, an infrastructure that  
               connects local businesses to external markets, and  
               neighborhoods that are not disproportionately burdened with  
               environmental pollutants, including air, soil, and water  
               contamination.  

             i)   Given the Program's ability to stimulate private  
               investment activity in areas that would otherwise not have  
               access to investment capital, it is appropriate that the  
               state consider prioritizing a portion of the Program to  
               encourage private investment in areas that face multiple  
               challenges in attracting investment capital.  

          2)Requires the California Tax Credit Allocation Committee  
            (Allocation Committee) to administer the Program. 

          3)Allows, for taxable years beginning on or after January 1,  
            2013, and before January 1, 2020, a credit in an amount  
            determined in accordance with Internal Revenue Code (IRC)  
            Section 45D, as modified.  For a taxpayer holding a "qualified  
            equity investment" on that investment's "credit allowance  
            date", the credit shall equal a percentage of the amount paid  
            to a "qualified community development entity" for such  
            investment at its original issue.  The applicable percentage  
            shall be:

             a)   0% with respect to the first two "credit allowance  
               dates";

             b)   7% with respect to the third "credit allowance date";  
               and, 









                                                                  AB 305
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             c)   8% with respect to the remainder of the "credit  
               allowance dates".  

          4)Provides that the credit shall be allowed only if the taxpayer  
            holds the "qualified equity investment" on the "credit  
            allowance date" and each of the six following anniversary  
            dates of that date.

          5)Defines a "qualified equity investment" as any "equity  
            investment" in a "qualified community development entity" if  
            all the following conditions are met:

             a)   The taxpayer acquires the investment at its original  
               issue, directly or through an underwriter, solely in  
               exchange for cash; 

             b)   Substantially all of the cash is used by the "qualified  
               community development entity" to make "qualified low-income  
               community investments"; and, 

             c)   The investment is designated by the "qualified community  
               development entity."  

          6)A "qualified equity investment" shall not include any "equity  
            investment" issued by a "qualified community development  
            entity" more than one year after the date that such entity  
            receives an allocation.   

          7)Defines "credit allowance date" to mean, with respect to any  
            qualified equity investment, the date on which the investment  
            is initially made, and each of the six anniversary dates of  
            such date thereafter.

          8)Defines "equity investment" as any:

             a)   Stock, other than nonqualified preferred stock as  
               defined in IRC Section 351(g)(2), in a corporation; or, 

             b)   Capital interest in a partnership. 

          9)Defines a "qualified community development entity" as a  
            domestic corporation or partnership that:

             a)   Has a primary mission of serving, or providing  









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               investment capital for, low-income communities or  
               low-income persons;

             b)   Maintains accountability to residents of low-income  
               communities through their representation on any governing  
               board of the entity or on any advisory board to the entity;  
               and, 

             c)   Is certified by the Allocation Committee.  

          10)Defines a "qualified low-income community investment" as any  
            of the following:

             a)   Any capital or equity investment in, or loan to, a  
               qualified active low-income community business, as defined,  
               or any real estate project or any operating business that,  
               at the time the initial investment is made, has 250 or less  
               employees and is located in a low-income community;

             b)   The purchase from another qualified community  
               development entity of any loan made by that entity, which  
               is a qualified low-income community investment;

             c)   Financial counseling and other services to businesses  
               located in, and residents of, low-income communities; or, 

             d)   Any equity investment in, or loan to, a qualified  
               community development entity. 

          11)Requires the Allocation Committee to adopt guidelines to  
            carry out the Program's purposes.  The guidelines shall not  
            disqualify a low-income community investment for the single  
            reason that public or private incentives, loans, equity  
            investments, technical assistance, or other forms of support  
            have been or continue to be provided.

          12)Provides that the adoption of these guidelines shall not be  
            subject to the rulemaking provisions of the Administrative  
            Procedure Act (Government Code Section 11340 et seq.).  

          13)Requires the Allocation Committee to establish and impose  
            reasonable fees upon entities that apply for a credit  
            allocation, with revenues used to defray administrative costs.  
             










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          14)Caps the aggregate amount of credit that may be allowed [sic]  
            in any calendar year at $40 million.  However, the Allocation  
            Committee must limit the cumulative allocation of credits to  
            no more than $200 million.     


          15)Requires the Allocation Committee to reserve annually at  
            least:

             a)   15% of the tax credits for community development  
               entities that target businesses located in low-income  
               communities facing disproportionate environmental  
               pollution;

             b)   15% of the tax credits for community development  
               entities that target rural areas, including businesses  
               providing equipment or supplies to agricultural producers,  
               packers, handlers, and processors; and, 

             c)   20% of the tax credits for community development  
               entities that target businesses in inner-city areas.  

          16)Reduces the credit allocation for the existing New Jobs Tax  
            Credit from roughly $400 million to roughly $200 million.   
            Provides that the "cut-off date" for the New Jobs Tax Credit  
            shall be the last day of the calendar quarter within which the  
            Franchise Tax Board (FTB) estimates that it will have received  
            returns claiming credits that cumulatively total $200 million  
            (instead of $400 million) for all taxable years.  

          17)Deletes duplicative sections of the Revenue and Taxation Code  
            as a housekeeping matter.

          18)Sunsets the Program provisions on December 1, 2020.  

          19)Appropriates $150,000 from the Tax Credit Allocation Fee  
            Account to the Allocation Committee for purposes of  
            implementing the Program.  

          20)Takes immediate effect as a tax levy.  

           EXISTING LAW  :

          1)Allows various tax credits under both the Personal Income Tax  
            Law and the Corporation Tax Law.  These credits are generally  









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            designed to encourage socially beneficial behavior or to  
            provide relief to taxpayers who incur specified expenses.     

          2)Provides for the following geographically-targeted economic  
            development areas (G-TEDAs):  Enterprise Zones, Manufacturing  
            Enhancement Areas, Targeted Tax Areas, and Local Agency  
            Military Base Recovery Areas.  Special tax incentives are  
            provided to taxpayers conducting business activities within a  
            G-TEDA.  These incentives include a hiring credit equal to a  
            percentage of wages paid to qualified employees.

          3)Allows a credit for taxable years beginning on or after  
            January 1, 2009, to qualified employers equal to $3,000 for  
            each net increase in qualified full-time employees hired  
            during the taxable year.  The credit is limited to small  
            businesses (i.e., taxpayers with 20 or fewer employees as of  
            the last day of the preceding taxable year).  The credit is  
            capped at roughly $400 million for all taxable years.  

          4)Allows a credit equal to 20% of each qualified investment into  
            a Community Development Financial Institution (CDFI) that is  
            certified by the California Organized Investment Network  
            (COIN).  The aggregate amount of qualified investments is  
            generally capped at $10 million for each calendar year.  Thus,  
            the statewide total for all credits allowed under the program  
            is capped at $2 million per year (i.e., 20% of $10 million).

           FISCAL EFFECT  :  The FTB estimates that this bill would result in  
          General Fund (GF) revenue gains of $42 million in fiscal year  
          (FY) 2013-14, $31 million in FY 2014-15, and $12.5 million in FY  
          2015-16.  

           COMMENTS  :

          1)The author has provided the following statement in support of  
            this bill:

               California can no longer afford to leave millions in  
               federal money on the table, year after year, by failing to  
               implement a state New Markets Tax Credit Program to  
               jump-start economic productivity in our low-income areas.   
               Such a program will enable us to leverage many times more  
               in federal funds than it would cost the state to implement,  
               and lead directly to capital investment in small  
               businesses, a proven model for helping to end an economic  









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               recession.  At least nine other states have successfully  
               implemented such a program already, on average leveraging  
               13 times more in federal monies than they allocated in  
               planned revenue to fund the tax credit.  This bill means  
               community empowerment because the program in question has a  
               proven track record of job creation.    

          2)Proponents of this bill state:

               Over the last several years, while other states have  
               focused on attracting new businesses and creating jobs,  
               California has dismantled one economic development program  
               and placed another under attack.  With the enterprise zone  
               program capped and currently on hold pending new  
               regulations, California has few tools with which to focus  
               on job creation, especially in low-income areas.  These tax  
               credits will provide significant incentives for additional  
               private investment in our communities.  

          3)The FTB notes certain implementation concerns in its staff  
            analysis of this bill, including the following:

             a)   "This bill uses terms that are undefined, e.g., "real  
               estate project" and "time of initial investment."  The  
               absence of definitions to clarify these terms could lead to  
               disputes with taxpayers and would complicate the  
               administration of this credit.  The author may wish to  
               amend this bill for clarity."  

             b)   "The bill requires that if an investment is made in an  
               operating business, the business must have 250 or less  
               employees.  The language is silent as to the timing and  
               method of determining the number of employees, (e.g., Head  
               count at year end?  Full-time equivalents?).  The author  
               may wish to amend the bill to clarify this issue." 

             c)   "The California New Markets Tax Credit section would be  
               in effect only until 
               December 1, 2020, and would be repealed as of that date.   
               The result would be that the credit could not be taken  
               after that date.  Investors making an investment might be  
               barred from utilizing the full amount of their credit.  For  
               example, an investor making a qualified investment in 2018  
               would have zero credit allowable for the first two years  
               because the allowed percentage is zero for the first two  









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               years.  The credit would repeal as of December 1, 2020, and  
               with the investor filing their return in 2021 for the 2020  
               taxable year no credit would be allowed because of the  
               repeal of this section.  If this is contrary to the  
               author's intent, the author may wish to amend the bill."

          4)Committee Staff Comments:

              a)   What is a "tax expenditure"?  :  Existing law provides  
               various credits, deductions, exclusions, and exemptions for  
               particular taxpayer groups.  In the late 1960s, United  
               States Treasury officials began arguing 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).  

              b)   How is a tax expenditure different from a direct  
               expenditure?  :  As the Department of Finance 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 than direct expenditures once they are put in  
               place.  This can offer taxpayers greater certainty, but it  
               can also result in tax expenditures remaining a part of the  
               tax code without demonstrating any public benefit.  Second,  
               there is generally no control over the amount of revenue  
               losses associated with any given tax expenditure. Finally,  
               it should also be noted that, once enacted, it takes a  
               two-thirds vote to rescind an existing tax expenditure  
               absent a sunset date.  This effectively results in a  
               "one-way ratchet" whereby tax expenditures can be conferred  
               by majority vote, but cannot be rescinded, irrespective of  
               their efficacy, without a supermajority vote.

              c)   This proposal  :  This bill would enact a new tax  
               expenditure program modeled after the federal NMTC, with  
               the stated purpose of stimulating economic development and  
               hastening California's economic recovery by authorizing tax  
               credits for investment in California.  The Program would be  
               "funded" by reducing the credit allocation for the existing  
               New Jobs Tax Credit by roughly $200 million.

              d)   The federal NMTC  :  Enacted in 2000, the federal NMTC is  
               a non-refundable tax credit designed to encourage capital  









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               investment in qualified low-income communities.   
               Specifically, federal law allows a NMTC for a taxpayer's  
               qualified equity investments (QEIs) in a community  
               development entity (CDE), which must be a corporation or  
               partnership.  The CDE's primary mission must be serving, or  
               providing investment capital for, low-income communities or  
               low-income persons, as certified by the Secretary of the  
               Treasury.  The taxpayer's federal NMTC totals 39% of the  
               QEI made in the CDE, but is spread over a seven-year period  
               as follows:

               i)     A 5% credit for the year the QEI is purchased and  
                 for the first two years thereafter (i.e., 15% for the  
                 first three years); and, 

               ii)    A 6% credit for years four through seven (i.e., 24%  
                 for the subsequent four years).  

               Before a CDE can sell QEIs eligible for the federal NMTC,  
               it must apply for and be granted an allocation from the  
               CDFI Fund through a competitive application and review  
               process.  Geographic diversity is not a consideration in  
               the evaluation process.   
                
              e)   How would the Program differ from the federal NMTC?  :   
               The Program would differ from the federal NMTC in numerous  
               respects, including the following:

                i)     Different credit percentages over the seven-year  
                 period  :  While the proposed state credit, like the  
                 federal credit, totals 39% of the taxpayer's investment  
                 in a qualified community development entity, the state  
                 credit would be spread out over the seven-year period as  
                 follows:

                  (1)       0% for the year the investment is purchased  
                    and the following year (i.e., 0% for the first two  
                    years); 

                  (2)       A 7% credit for the third year; and, 

                  (3)       An 8% credit for years four through seven  
                    (i.e., 32% for the subsequent four years).

                 It is Committee staff's understanding that this  









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                 "back-loading" of the credit percentages is designed to  
                 reduce the Program's upfront cost to the GF. 

                ii)    Expanded definition of a qualified low-income  
                 community investment  :  Federal law defines a qualified  
                 low-income community investment to include any capital or  
                 equity investment in, or loan to, a qualified active  
                 low-income community business, as specified.  This bill  
                 would expand the definition of a qualified low-income  
                 community investment, for state purposes, to include any  
                 capital or equity investment in, or loan to, "any real  
                 estate project or any operating business that, at the  
                 time the initial investment is made, has 250 or less  
                 employees and is located in a low-income community."

                 As presently drafted, this additional language is both  
                 vague and susceptible to multiple conflicting  
                 interpretations.  For example, what exactly is a "real  
                 estate project"?  Does the 250-employee limitation apply  
                 only to operating businesses or does it apply to real  
                 estate projects as well?  Must a real estate project be  
                 located in a low-income community to qualify?  One could  
                 argue that, as presently drafted, an investment in any  
                 real estate project could meet the definition of a  
                 qualified low-income community investment.  This  
                 expansive interpretation is only buttressed by additional  
                 language in the bill requiring operating businesses to  
                 meet the other conditions of a qualified active  
                 low-income community business, but making absolutely no  
                 reference to real estate projects.  
                  
                iii)   Modified definition of a qualified active low-income  
                 community business  :  This bill modifies the definition of  
                 a qualified active low-income community business.   
                 Specifically, this bill deletes the requirement that a  
                 substantial portion of the services performed for the  
                 business by its employees are performed in a low-income  
                 community.  It is not entirely clear to Committee staff  
                 what this deletion is designed to accomplish.

                iv)    Requires that 50% of the tax credits be reserved  
                 annually for specified community development entities  :   
                 Specifically, this bill would require that at least:

                  (1)       15% of the credits be reserved for community  









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                    development entities that target businesses located in  
                    low-income communities facing disproportionate  
                    environmental pollution; 

                  (2)       15% of the credits be reserved for community  
                    development entities that target rural areas, as  
                    specified; and, 

                  (3)       20% of the credits be reserved for community  
                    development entities that target businesses in  
                                                 inner-city areas.               
                   
              f)   Does California have any similar tax credit programs?  :   
               While California does not conform to the federal NMTC,  
               state law does allow a 20% credit for each "qualified  
               investment" in a CDFI certified by COIN.  The aggregate  
               amount of qualified investments is generally capped at $10  
               million for each calendar year.<1>  Thus, the statewide  
               total for all credits allowed under the program is capped  
               at $2 million per year (i.e., 20% of $10 million).  Unlike  
               the federal NMTC, the "qualified investment" in the CDFI  
               must be at least $50,000, be for a minimum duration of 60  
               months, and may consist of either an equity investment or a  
               deposit or loan that does not earn interest.
               Existing law defines a CDFI, in turn, as a private  
               financial institution located in California that has  
               community development as its primary mission, and that  
               lends in urban, rural, or reservation communities in this  
               state.  Specifically, a "CDFI" may be a community  
               development bank, a community development loan fund, a  
               community development credit union, a microenterprise fund,  
               a community development corporation-based lender, or a  
               community development venture fund. 

               The existence of California's stand-alone CDFI tax credit  
               raises some interesting issues.  Namely, the state already  
               has a tax credit program specifically designed to encourage  
               private investment in underserved markets.  Given this  
               fact, does it makes sense to establish a second tax credit  
               program with the same goal?  If this bill were enacted in  
               -------------------------
          <1> State law provides that if the aggregate amount of qualified  
          investments made in a calendar year is less than $10 million,  
          the difference may be carried over to the next year, and any  
          succeeding year during which the credit remains in effect, and  
          added to the aggregate amount authorized for those years.  








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               its present form, we would have two similar tax credit  
               programs, administered by two separate entities, with an  
               unclear level of coordination between the two.  Moreover,  
               would it be possible for a CDFI to also be certified as a  
               qualified community development entity?  If so, could a  
               taxpayer potentially receive the benefit of both credits  
               for the same investment?  The author may wish to consider  
               amendments providing greater specificity on these issues.  

              g)   The Legislative Analyst's Office (LAO) Report  :  On April  
               14, 2011, the LAO issued an analysis of the CDFI tax  
               credit, discussing the credit's fiscal impact and the  
               resulting benefits to economically disadvantaged  
               communities and low-income individuals in California.  The  
               LAO report noted the following:

                 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 not have been funded.   
                  
              h)   Related legislation  :  Committee staff notes the  
               following related bills introduced in the 2011-12  
               Legislative Session:

               i)     AB 11 (Portantino) would have reduced the New Jobs  
                 Tax Credit allocation from roughly $400 million to  
                 roughly $200 million, and allowed a new credit equal to  
                 20% of annual workers' compensation premiums paid by  
                 qualified taxpayers.  The total amount of the new credit,  
                 in turn, would have been capped at roughly $200 million.   
                 AB 11 was held in this Committee.  

               ii)    AB 234 (Wieckowski) would have modified and expanded  
                 the existing New Jobs Tax Credit by, among other things,  
                 providing a credit of $9,100 for each net increase in  
                 qualified full-time employees paid more than $16 per  
                 hour.  AB 234 was held in this Committee.  










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               iii)   AB 236 (Swanson) would have reallocated $50 million  
                 from the New Jobs Tax Credit to establish a new credit  
                 designed to encourage the hiring of the chronically  
                 unemployed.  AB 236 was held in the Assembly  
                 Appropriations Committee.    

               iv)    AB 246 (Wieckowski) would have modified and expanded  
                 the existing New Jobs Tax Credit by, among other things,  
                 providing a credit of $9,100 for each net increase in  
                 qualified full-time employees paid more than $16 per  
                 hour.  AB 246 died in the Senate Committee on Governance  
                 and Finance.    

               v)     AB 248 (Perea) would have reallocated $150 million  
                 from the New Jobs Tax Credit to establish a credit equal  
                 to 25% of the value of qualified medical services  
                 personally provided by a physician during the taxable  
                 year.  AB 248 was held in the Assembly Appropriations  
                 Committee.  

               vi)    AB 304 (Knight) would have allowed a tax credit,  
                 under both the Personal Income Tax Law and the  
                 Corporation Tax Law, for each "qualified employee"  
                 employed by a "qualified employer," as specified.  AB 304  
                 was held in this Committee.  

               vii)   AB 643 (Davis) would have reallocated $300 million  
                 from the New Jobs Tax Credit to establish a state New  
                 Markets Tax Credit program designed to stimulate economic  
                 development.  AB 643 was held in the Assembly  
                 Appropriations Committee.

               viii)  AB 1009 (Wieckowski) would have recast the existing  
                 New Jobs Tax Credit by, among other things, modifying the  
                 definition of a "qualified full-time employee" to apply,  
                 for taxable years beginning on or after January 1, 2012,  
                 only to individuals who were unemployed for the 30 days  
                 immediately prior to being hired.  AB 1009 was held in  
                 this Committee.

               ix)    AB 1195 (Allen, Perea, and Wieckowski) would have  
                 expanded the New Jobs Tax Credit's definition of a  
                 "qualified employer" to include taxpayers that, as of the  
                 last day of the preceding taxable year, employed 50 or  
                 fewer employees (instead of 20 or fewer employees per  









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                 current law).  AB 1195 was held in the Senate  
                 Appropriations Committee. 

               x)     AB 1596 (Cook) would have modified the New Jobs Tax  
                 Credit by allowing the credit to employers with up to 50  
                 employees.  AB 1596 was held in this Committee.  

               xi)    AB 2037 (Davis) would have established the  
                 California New Markets Tax Credit Program.  AB 2037 was  
                 held in the Assembly Appropriations Committee.  

               xii)   SB 156 (Emmerson) would have modified the New Jobs  
                 Tax Credit by allowing the credit to employers with up to  
                 50 employees.  SB 156 failed passage out of the Senate by  
                 the constitutional deadline.

              i)   Double-referral  :  This bill was double-referred to the  
               Assembly Committee on Jobs, Economic Development and the  
               Economy, and passed out of that Committee on a 8-0 vote on  
               April 9, 2013.  For additional discussion of this bill's  
               provisions, please refer to that Committee's analysis.    

              j)   Suggested technical amendments  :  

               i)     On page 3, in line 24, strike "(I)" and insert  
                 "(i)";

               ii)    On page 8, in line 23, insert "community" after  
                 "low-income";

               iii)   On page 8, in line 34, strike "'Substantial portion'  
                 shall be defined as 40 percent or" and strike lines 35  
                 and 36;  

               iv)    On page 9, in line 18, strike "allowed" and insert  
                 "allocated";     

               v)     On page 10, in line 22, strike "commission's" and  
                 insert "committee's"; 

               vi)    On page 10, in line 34, strike "organization" and  
                 insert "entity";

               vii)   On page 12, in line 37, insert "community" after  
                 "low-income";









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               viii)  On page 13, in line 9, strike "'Substantial portion'  
                 shall be defined as 40 percent or" and strike lines 10  
                 and 11; and,       

               ix)    On page 13, in line 33, strike "allowed" and insert  
                 "allocated".  

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          California Banker's Association
          City of Roseville
          City of Sacramento 
          Enhanced Capital Partners, Inc. 
          Greenlining Institute
          Los Angeles County Division of the League of California Cities
          Valley Economic Development Center

           Opposition 
           
          None on file
           
          Analysis Prepared by  :  M. David Ruff / REV. & TAX. / (916)  
          319-2098