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. AB 305 Page B 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 Page C 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 AB 305 Page D 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. AB 305 Page E 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 AB 305 Page F 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 AB 305 Page G 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 AB 305 Page H 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 AB 305 Page I 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 AB 305 Page J "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 AB 305 Page K 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. AB 305 Page L 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. AB 305 Page M 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 AB 305 Page N 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"; AB 305 Page O 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