BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 2389 HEARING: 7/1/14
AUTHOR: Fox FISCAL: Yes
VERSION: 6/25/14 TAX LEVY: Yes
CONSULTANT: Grinnell
CAPITAL INVESTMENT INCENTIVE PROGRAM: CORPORATION TAX
CREDIT: NEW ADVANCED STRATEGIC AIRCRAFT PROGRAM (URGENCY)
Enacts two tax credits for subcontractors performing
contracts for new advanced strategic aircraft programs.
Background and Existing Law
The aerospace industry in California began with a few
aircraft builders during World War I, and then vastly
expanded in the mobilization for World War II. The
industry steadily grew during the cold war, encompassing a
wide range of activities, including military and civilian
aircraft, reconnaissance and communications satellites,
strategic missiles, and space exploration. By the 1980s,
about 40 percent of the aerospace business nationwide
resided in southern California, and the industry employed
close to a half-million people. One of the region's
strongest selling points for aerospace was its environment:
the clear blue skies and ample open spaces were ideal for
testing new aircraft. California also was home to a variety
of related industries, particularly petroleum, as well as
to top-notch research universities and a large labor pool.
Defense spending peaked at $557 billion in 1985 (in
constant fiscal 2009 dollars) and then began a downward
trend. The Soviet Union collapsed in December 1991, ending
the Cold War: in the next decade, more than 50 major
defense companies consolidated into only six. According to
the Employment Development Department's Labor Market
Information Division, California employment in the
Aerospace Production and Manufacturing sector declined
almost by half from 139,300 in 1993 to 70,800 in 2013,
although almost all of the decline occurred before 2004.
Additionally, defense spending is expected to fall due to
the implementation of federal budget cuts.
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I. Capital Investment Incentive Program. Counties and
cities can pay a "capital investment incentive amount" for
15 years to attract qualified manufacturing facilities. A
proponent pays property taxes on no less than the first
$150 million of the facility's value, and then receives a
property tax rebate for the taxes paid on the facility's
value above that amount.
In return for this property tax rebate, the proponent must
pay a community service fee equal to 25% of the capital
incentive amount, up to $2 million a year. The proponent
must sign a community services agreement that spells out
the fee, payment conditions, a job creation plan, and
provisions to recapture the incentive payments if the
proponent fails to run the facility as agreed.
A city or special district may pay the county or city an
amount equal to the amount of property tax revenue that the
local government receives from the facility's property
taxes paid on the facility's value over $150 million.
To qualify for this tax rebate program, a qualified
manufacturing facility must:
Have an initial investment in real and personal property
over $150 million, certified by the Business,
Transportation, and Housing Agency.
Be within the county or city offering the capital
incentive program.
Be operated by a business within specified Standard
Industrial Classification Codes or a business that
recovers minerals from geothermal resources.
Be engaged in commercial production or manufacture of
products.
The Legislature originally passed the tax rebate program to
help Placer County officials attract an Intel plant, but
they never use d the law (SB 566, Thompson, 1997).
Legislators expanded the definition of a qualified
manufacturing facility to include CalEnergy Company's plan
to extract minerals from geothermal brine (SB 133, Kelley,
1999.) In 2009, the Legislature expanded the program to
include manufacturers that produce of electricity using
solar, wind, biomass, hydropower, or geothermal resources,
shifted the program to the Trade and Commerce Agency's
successor, the Business, Transportation and Housing Agency,
and chose to sunset the program entirely in 2017 (AB 904,
V.M Perez, 2009). In 2012, the Legislature expanded the
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program to include research and development facilities as
defined, raised the threshold amount to $250 million, and
shifted program administration from the now-defunct
Business, Transportation, and Housing Agency to the
Governor's Office of Business and Economic Development
(GO-Biz), which successfully enticed the Samsung
Corporation to expand a facility in San Jose (SB 1006,
Committee on Budget and Fiscal Review). However, the bill
repealed all of its changes on June 30, 2013.
II. Tax Credits. California law allows various income tax
credits, deductions, and sales and use tax exemptions to
provide incentives to compensate taxpayers that incur
certain expenses, such as child adoption, or to influence
behavior, including business practices and decisions, such
as research and development credits. The Legislature
typically enacts such tax incentives to encourage taxpayers
to do something that but for the tax credit, they would not
do. The Department of Finance is required to annually
publish a list of tax expenditures, currently totaling
around $50 billion per year.
In 1998, the Legislature enacted two tax credits which led
to some work on the Joint Strike Fighter (JSF) being
performed in California (AB 2797, Machado, 1998).
Taxpayers that were contractors or subcontractors that
manufacture property for ultimate use in a JSF could claim:
The wage credit is equal to 50% of wages paid up to
150% of the minimum wage, not to exceed $10,000 per
year, per employee, that are direct costs allocable to
property manufactured in this state for ultimate use
in a JSF, with certain limitations.
The property credit, equal to 10% of the cost of
qualified property used by a taxpayer primarily in
qualified activities to manufacture a product for
ultimate use in a JSF, with certain exceptions.
Taxpayers could carry forward credits for eight years, but
the credit expired in 2006. Estimates vary for number of
taxpayers claiming the credit, and its fiscal effect: FTB
projected revenue losses between $10 million to $35 million
in 2003 and 2004 from the credits, with 15 taxpayers
claiming them, but stated no credit had been claimed before
2002. However, the Department of Finance indicated a
first-year cost of $60 million for 1998.
A recent Congressional Research Service report indicates
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that the United States' existing long-range bomber fleet is
reaching a critical point at its operational life span, and
states "military analysts are beginning to question just
how long these aircraft can last and continue to be
credible weapons systems." A recent news report indicates
that the Unites States Air Force's five-year spending plan
includes funds to develop a new long-range bomber, and a
congressional press release indicates funding for a new
bomber program. Other news reports state that the United
States Air Force will issue a request for proposals, and
that Northrop Grumman may compete against a joint bid from
Boeing and Lockheed Martin to build it. The author wants
to reenact the Joint Strike Fighter credits, and expand the
Capital Investment Incentive Program in the hopes that
future "advanced strategic aircraft programs" will be
constructed in California.
Proposed Law
Assembly Bill 2389 enacts two tax incentives:
I. Capital Investment Incentive Program. AB 2389 changes
the program to:
Lower the threshold of annual property tax revenues
the taxpayer must pay to be eligible for an incentive
from $150 million to $25 million,
Changes the codes for business eligible for the
program from any business within 3500 to 3899 of the
Standard Industrial Classification to companies within
3359 or 3364 of the North American Industrial
Classification System Codes,
The measure also makes conforming changes, and
provides that specified events constitute good cause
for the purpose of waiving recapture for failure to
perform,
Shifts program administration to GO-Biz, and
Repeals these changes as of January 1, 2016, but
provides that any incentive program established before
that date remains in effect for its full term.
Extends the sunset on the entire program from 2017
to 2018, and again clarifies that any incentive
program established before that date remains in effect
for its full term.
II. Wage and Property Credit. AB 2389 enacts a tax credit
equal to 17.5% of wages paid during the taxable year to
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qualified employees, on a full-time equivalent basis. To
qualify, taxpayers must be major, first-tier subcontractors
awarded a subcontract to manufacture property for ultimate
use in or as a component of advanced strategic aircraft,
and pay wages to employees:
Where at least 80% of his or her services are
directly related to the taxpayer's subcontract work on
new advanced strategic aircraft for the United States
Air Force, and
Paid for services not less than an average of 35
hours a week, or is a salaried employee, as defined.
The credit lasts from the 2015 taxable year until the 2029
taxable year, and is subject to an annual cap for all
taxpayers set at $25 million annually for the first five
years, $28 million for the five years after that, and $31
million for the last five years. FTB must allocate the
credit on a first-come, first-served basis, and taxpayers
may only claim credits on original, timely-filed returns.
Taxpayers can carry forward the credit for seven years.
The bill prohibits taxpayers from claiming the credit
unless the taxpayer reduces the bid made to subcontract
work by an amount that reflects a good faith estimate of
the credit. All references to the credit and ultimate cost
reductions must be made available by the taxpayer to the
Franchise Tax Board (FTB) upon request.
The bill sets forth provisions to determine full-time
equivalents, allows FTB to issue regulations exempt from
the Administrative Procedures Act necessary to implement
the bill, and contains an urgency clause.
State Revenue Impact
Pending.
Comments
1. Purpose of the bill . According to the author, "AB 2389
is an economic incentive package that will support the
aerospace industry, specifically an "advanced strategic
aircraft program." Specifically this bill creates a tax
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credit program for the aerospace industry which would total
on average $25 million to $31 million per year for 15
years. Under this bill, there are no unaccountable tax
giveaways. The credits sunset, are subject to annual caps,
and only are provided based on jobs that will be created to
work on the advanced strategic aircraft program.
Specifically,
Credits sunset after 15 years.
Credits are capped at:
o $25 million for five years;
o $28 million for the next five years; and
o $31 million for next five years.
Credits provided only on a qualified employee basis where
that employee is spending 80% of their time working on the
advanced strategic aircraft program.
AB 2389 expands the ability of a local government to pay an
investment incentive, to include qualified aerospace
facilities and other specified manufacturing facilities
until July 1, 2015. Capital investment incentives are
amounts up to the amount of ad valorem property taxes paid
by the qualified facility, less 25%.
The urgency clause is needed because the Department of
Defense (DoD) is currently evaluating several programs to
recapitalize its military assets and initiatives. Proposal
deadlines require legislation to be finalized prior to the
July recess."
2. Process . The Senate Governance and Finance Committee
is hearing AB 2389 only five days after the bill's
provisions went into print last Thursday, June 26th. The
author indicates that the Legislature must enact AB 2389
immediately for any of the advanced strategic aircraft
program work to take place in California, because potential
subcontractors must submit information to DOD to evaluate
in July. However, because DOD programs are confidential
due to national security concerns, no independent
information exists to verify the deadlines for DOD review
compelling legislative action, or that AB 2389's package of
tax incentives are the right amount, but not too much, to
steer the work to California. Instead, the Committee can
only rely on statements from parties involved in recent
confidential negotiations between the Governor's Office and
Lockheed Martin Aeronautics Company. In May, when the
Committee considered SB 998 (Knight), which granted tax
benefits to aerospace companies, no mention was made of the
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necessity of these tax benefits, or the incipient need to
enact them before July. Should the Committee approve $420
million in corporation tax credits over 15 years without
complete and verified information? If so, it should expect
other firms to threaten to shift employment out of
California unless the Legislature grants them significant
tax benefits outside the usual process for considering
legislative bills. The Committee may wish to consider
whether it has the information necessary to approve AB
2389, and the precedent it sets if it does so.
3. Good model . While AB 2389 requires a significant leap
of faith, the taxpayer doesn't claim any credits unless
they win the subcontract, and employ individuals in the
state to perform the subcontract, similar to the JSF
credit. Additionally, the measure requires the taxpayer to
reflect the credit's value as part of the subcontract bid,
although it's unclear how many potential taxpayers are
bidding for the subcontract. However, one drawback of AB
2389's credit is that taxpayers can claim it using the same
costs that they can deduct as ordinary business expenses.
The committee may wish to consider whether the taxpayer
should get only the credit in addition to the deduction.
4. Single industry . The Committee considers many
proposals for tax incentives similar to AB 2389's tax
incentives for aerospace companies. When considering
competing claims for finite tax benefits, one way to assess
each proposal is to consider what the state is buying with
the foregone revenue of tax credits. The state's
low-income housing tax credit buys needed housing that must
be affordable for up to 50 years. Research and development
tax credits can lead to superior consumer products, or
cures and remedies for illnesses. Manufacturing incentives
like advanced strategic aircraft programs can result in
factories and other forms of capital stock, while
incentives for movie production may lead to additional
employment in the state, but movie productions set up,
shoot, and leave quickly. Incentives for aerospace firms
will likely lead to increases in human capital, as skilled
engineers and technicians are necessary to work on these
highly complex projects, with positive spillovers to areas
around the locations where they perform the work. The
Committee may wish to consider the merits of subsidizing
aerospace companies instead of competing claims.
5. One company ? AB 2389 is intended to help the Lockheed
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Martin Aerospace Company increase employment in California.
While estimates show the state receiving a significant net
benefit from enacting the bill, should the state direct its
economic development programs to help individual firms?
Doing so gives the appearance of favoritism, and sets a
precedent for others to ask for similar treatment.
6. Or not ? Northrop Grumman has requested amendments to
AB 2389 to extend its tax benefits to prime contractors of
advanced strategic aircraft systems, similar to the JSF
credit. Northrop states that because AB 2389 is limited
only to subcontractors, including prime contractors allow
the state to benefit regardless of whoever ultimately wins
the contract. Northrop adds that it expects the contract
to only have two bidders, and it will bid as a prime
contractor.
7. Priorities. Last year, the Legislature enacted AB 93
(Committee on Budget), which reformed California's economic
development policies by eliminating enterprise zones and
other geographically-targeted economic development areas,
instead allowing three new tax benefits:
Tax credits for wages paid by taxpayers to
qualified employees within former enterprise zones,
and other areas that suffer from high levels of
poverty and unemployment. The credit lasts from the
2014 taxable year until the 2019 taxable year,
A sales and use tax exemption on purchases of
manufacturing equipment made by taxpayers within
specific North American Industrial Classification
System codes, capped at $200 million annually per
taxpayer, effective July 1, 2014, and ending July 1,
2022.
The California Competes Tax Credit, where the
California Competes Tax Credit Committee can award
various tax credits up to an annually capped amount to
taxpayers who apply. The Committee can grant $30
million in tax credits in 2013-14, $150 million in
2014-15, and $200 million for the 2015-16, 2016-17,
and 2017-18 fiscal years, subject to adjustments.
The credit sunsets in 2025.
Firms eligible for AB 2389's tax benefits can apply to the
Committee for California Competes Tax Credits; both the
bill and the program seek to increase employment in the
state by granting tax benefits. However, California
Competes is currently subject to caps intended to limit
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revenue losses to ensure that last year's reforms are
revenue-neutral, and the Committee just made its first
allocation of tax credits. One option to assist potential
contractors for advanced strategic aircraft systems while
limiting fiscal losses would be to deduct the value of AB
2389's tax credits from California Competes' total.
However, AB 2389's fixed dollar, fifteen year commitment
outlasts California Competes' current sunset and allocation
caps. A second option could split the difference by
deducting only AB 2389's costs in the first five years, but
grant the rest of the credit for years six through fifteen.
A final option is for California Competes to award Lockheed
Martin a credit based on its current statutory authority
since those credits are specifically meant for this type of
negotiation between the Governor's office and individual
companies. The Committee may wish to consider amending AB
2389 to account for its overlap with California Competes,
and limit the risk of revenue loss.
8. Take a walk on the supply side . Since 2008, the
Legislature has granted significant tax incentives to
reduce employers' costs in the hopes they will deploy
revenue that would have flowed to the state in taxes to
increase employment, often referred to as "supply-side
economics." AB 2389 offers another step in this direction,
despite academic research generally dispelling the
relationships between tax reductions and employment.
Among these:
Allowing corporations to share tax credits, and
taxpayers to carry forward net operating losses for 20
years, or carry them back three years with delayed
effect (AB 1452, Committee on Budget, 2008),
Elective sales-factor only apportionment (since
repealed by initiative, but an alternative may be
returning due to litigation), motion picture
production tax credits, and small business hiring
credits (ABx3 15 (Krekorian)/SBx3 15 (Calderon),
Sales and Use Tax Exclusions for renewable energy
manufacturing (SB 71, Padilla, 2010) and advanced
manufacturing (SB 1186, 2012),
Expanding the Community Development Financial
Institution credit from $10 million to $50 million (AB
32, J. Pérez, 2013).
Specifically for aerospace, exempting property used
in space flight from the personal property tax (AB
777, Muratsuchi, 2014).
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9. Tradeoffs . Tax benefits directed at specific
industries do two things: First, they reward behavior that
would have occurred without the subsidy, so-called
"deadweight loss." Some firms won't employ more persons,
pay higher wages, or reimburse more tuition because of the
tax benefit, instead increasing returns to capital in
amount equal to the amount of the tax credit. In these
instances, the state receives no marginal benefit, and
transfers wealth from purposes it would otherwise spend
money on for government purposes to the firm. Second, the
bill may generate additional employment, wage payments, and
economic activity; the incentive will lower production
costs at the margin in amounts necessary for firms to
choose to make products in California instead of somewhere
else. A successful tax credit leads to more economic
activity at the margin than its deadweight loss, but no tax
credit has yet conclusively demonstrated that its benefits
outweigh its costs. The Committee may wish to consider how
much additional economic activity AB 2389 will spur versus
its deadweight loss.
Additionally, enacting a new tax benefit requires cuts in
spending or higher taxes to match the amount of foregone
revenue resulting from AB 2389. Tax credits do not pay for
themselves: the state's last effort of "dynamic revenue
analysis" indicates that while dynamic effects are
definitely present and visible, their effects are generally
relatively modest.<1> The Committee may wish to consider
whether the benefits resulting from this manufacturing
incentive are worth the tradeoff of cuts in spending or
taxes on other activities.
10. Tax competition . States often compete against each
other with grants, loans, regulatory incentives, and tax
benefits to attract firms to locate within its borders.
When successful, states can increase employment, but it's
not a free lunch. The Legislative Analyst's Office
recently stated:
"When government does not offer industry subsidies,
businesses in those industries generally locate their
economic activities where they would best be suited.
For example, agriculture generally plants crops where
----------------------
<1>
"Whatever Happened to Dynamic Revenue Analysis in
California?" John David Vasche, prepared for the
Federation of Tax Administrators, September, 2006.
AB 2389 - 6/25/14 -- PageK
they are most productive and manufacturing generally
locates where it has the best access to inputs, labor,
and markets. State film and television subsidies
shift activity from where it would otherwise locate to
somewhere else without necessarily improving the
output or yielding any greater social benefit. At the
same time, these subsidies reduce funds for other
state priorities, including spending on programs or
reductions in tax rates that would benefit all
taxpayers equally."
Engaging in tax competition is a dangerous game: should
California expand its incentives, it should expect other
states to follow, fueling a so-called "race to the bottom."
The Committee may wish to consider the merits and risks of
engaging in tax competition generally, and for defense
contractors specifically.
11. Back and forth . Enacted in 1850, the property tax has
long served as the foundational revenue source for local
agencies to fund services like public safety, health, and
education. Until 2011, the Community Redevelopment Law
allowed local officials to set up redevelopment agencies
(RDAs), prepare and adopt redevelopment plans, and finance
redevelopment activities; however, the Legislature
dissolved more than 400 redevelopment agencies in 2011 at
the request of the Governor, choosing to instead divert
these revenues from economic development back to core
public services. AB 2389 brings back the use of property
taxes for economic development by allowing local agencies
to rebate property taxes on property worth more than $25
million back to taxpayers. Are property taxes for public
services, or for economic development? The Committee may
wish to consider the criteria for allowing local agencies
to use property tax revenues for economic development
purposes.
12. Urgency . AB 2389 is an urgency measure that will take
effect immediately if it's enacted. As such, both houses
must approve the bill by 2/3 vote.
Assembly Actions
Assembly Floor 72-2
Assembly Revenue and Taxation 9-0
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Support and Opposition (06/30/14)
Support : California Conference of Machinists and Aerospace
Workers; LAEDC.
Opposition : None
received.