BILL ANALYSIS Ó
Senate Appropriations Committee Fiscal Summary
Senator Kevin de León, Chair
AB 2389 (Fox) - Capital Investment Incentive Program and
Corporation Tax Credit
Amended: July 2, 2014 Policy Vote: G&F 4-2
Urgency: Yes Mandate: No
Hearing Date: July 3, 2014 Consultant: Robert Ingenito
This bill meets the criteria for referral to the Suspense File.
Bill Summary: AB 2389, an urgency measure, would (1) modify the
Capital Investment Incentive Program (CIIP), and (2) allow a tax
credit under the Corporation Tax (CT) Law to a qualified
taxpayer in an amount equal to 17.5 percent of qualified wages
paid by the taxpayer during the taxable year to qualified
full-time employees, as specified.
Fiscal Impact:
The bill would lead to up to $420 million in direct
costs to the General Fund in forgone tax revenue over 15
years. However, under the current version of the bill, the
first three years would be funded from an existing credit
(up to $25 million per year). Consequently, relative to
current law, the bill would reduce revenues by up to by
$345 million. Credits claimed in the initial year could be
lower than the cap due to the pace of initial hiring.
To the extent that tax credits under this bill "crowd
out" tax credits available to other employers during the
first three years, a cost pressure of up to $75 million
could result (see Staff Comments).
The Franchise Tax Board (FTB) indicates that it would
incur a one-time implementation cost of $82,000 (General
Fund), related to IT changes.
The Governor's Office of Business and Economic
Development (GO-Biz) indicates that it would incur minor
and absorbable administration costs.
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Potential General Fund revenue (resulting from the
production of the aircraft in California and subsequent
taxable economic activity) that would not have occurred
absent the enactment of the tax credits. However, the
amount is unknown, and the extent to which the tax credits
would result in economic activity in California that would
not have otherwise occurred is unclear (see Staff
Comments).
Background: The aircraft industry grew more rapidly over the
first half of the twentieth century than any other segment of
the California economy. In 1910, William Randolph Hearst
offered $50,000 to the first pilot who could fly from California
to the East Coast in thirty days or less; however, no one
claimed the prize. That same year saw the nation's first public
aviation meet, which occurred on Dominguez Ranch near Los
Angeles. This event drew over 200,000 people, and the meet
established initial aviation speed and endurance records. After
World War I, Southern California's airplane designers and
manufacturers began to construct a variety of aircraft. By 1935,
the output of California's aircraft industry totaled $20 million
annually ($340 million in 2013 dollars).
The industry steadily grew through World War II and during the
Cold War, encompassing a wide range of activities, including
military and civilian aircraft, reconnaissance and
communications satellites, strategic missiles, and space
exploration. Sonic booms and test-rocket firings that flashed
and echoed in the foothills became common occurrences in
Southern California, and the region's economy became linked to
the ebbs and flows of defense spending. By the early 1960s,
roughly 40 percent of the $6.1 billion U.S. Department of
Defense prime contracts for development, test and research work
went to California. That proportion continued into the 1980s,
and the industry employed roughly 500,000. 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 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
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collapse of the Soviet Union and the end the Cold War led to
more than 50 major defense companies consolidating into only
six. Employment Development Department (EDD) employment data
indicate that the Aerospace Production and Manufacturing sector
declined from 214,200 in 1990 to 71,900 in 2013, an average
annual decline of 8.7 percent; Los Angeles County's aerospace
employment comprises roughly 60 percent of the statewide total,
and shrank proportionately over the same time period. Most of
the declines occurred before 2004. However, further job decline
is possible because defense spending is expected to fall due to
the implementation of federal budget cuts.
I. Origin of the California Competes Tax Credit. The California
Competes Tax Credit is an income tax credit available to
businesses that seek either to come to California or grow
existing operations in the State. Tax credit agreements are
negotiated by GO-Biz and approved by a newly created "California
Competes Tax Credit Committee," consisting of the State
Treasurer, the Director of the Department of Finance (DOF), the
Director of GO-Biz, one appointee each by the Speaker of the
Assembly and Senate Committee on Rules.
Its origins stem from the 2013-14 budget negotiations. In June
2013, the Legislature enacted AB 93 (Committee on Budget), which
reformed California's economic development policies by
eliminating enterprise zones (EZs) 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 EZs, and other areas that suffer
from high levels of poverty and unemployment. The credit
lasts from 2014 until 2019.
A sales and use tax exemption on purchases of
manufacturing equipment made by taxpayers within specific
North American Industrial Classification System (NAICS)
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
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2013-14, $150 million in 2014-15, and $200 million for the
2015-16, 2016-17, and 2017-18 fiscal years, subject to
adjustments.
II. Capital Investment Incentive Program. Counties and cities
can choose to 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 percent of the capital
incentive amount, up to $2 million annually. 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.
III. Tax Credits. Current 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, in the
absence of the tax credit, they would not do. DOF is required
to annually publish a list of tax expenditures, which currently
total around $50 billion per year.
Proposed Law: This bill would enact the following two tax
incentives:
Capital Investment Incentive Program. This bill would,
among other things, modify the definition of a "qualified
manufacturing facility" such that it would apply to
businesses described within Code 3359 or 3364 of the 2012
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North American Industrial Classification System (NAICS)
Manual. These NAICS Codes contain firms manufacturing
electrical equipment and components, and establishments
engaged in aerospace product and part manufacturing. This
bill would also temporarily modify the definition of a
"capital investment incentive amount". Currently, as noted
above, a proponent pays property taxes on no less than the
first $150 million of the facility's assessed value and
then may receive a property tax rebate for the taxes paid
on the facility's value in excess of $150 million. This
bill would authorize a local government to rebate property
tax revenues paid on the facility's assessed value above
$25 million (instead of $150 million per current law).
Program administration would be shifted to GO-Biz.
These modifications would cease to be operative on July 1,
2015. Thereafter, the capital investment incentive program
would revert to its current form, with certain
modifications, and will remain in effect until January 1,
2018. However, incentive programs established before these
dates would be effective for their full term.
Wage and Property Credit. AB 2389 would enact a tax
credit equal to 17.5 percent of wages paid during the
taxable year to qualified employees, on a full-time
equivalent basis. To qualify, taxpayers must be major,
first-tier subcontractors (as defined) awarded a
subcontract to manufacture property for ultimate use in or
as a component of advanced strategic aircraft, and pay
wages to employees (1) such that at least 80 percent 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 (2) that average a minimum 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. The cap is set at $25 million annually for the
first five years, $28 million annually for the middle five
years, and $31 million annually for the final five years
(for a 15-year total of $420 million). FTB must allocate
the credit on a first-come, first-served basis, and
taxpayers can carry forward the credit for seven years.
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Staff Comments: This bill is the result of negotiations between
the Administration and Lockheed Martin (LM) in support of LM's
efforts to win the bidding for the Advanced Strategic Aircraft
Program (ASAP). According to the author, the State would receive
a significant net benefit from enacting the bill. Specifically,
the result would be an increase of 750 aerospace jobs (and the
retention of another 350 existing jobs), roughly 4,800 indirect
jobs, and additional jobs created by smaller suppliers. One
study concludes that each aerospace job created would lead to an
additional 3.8 jobs in the State, and that the bill would
generate $1.2 billion in net state and local tax revenue over
the 15-year period. However, these job and revenue estimates are
likely overstated; if this bill is not enacted, the $420 million
over 15 years would be available for other purposes, such as
broader-based tax reductions, or investments in education or
infrastructure. These potential alternative uses of the $420
million would also increase economic activity and revenues,
albeit by an unspecified amount. Thus, the net impact from this
bill would likely be less than $1.2 billion.
The view that this tax program could pay for itself was echoed
by DOF staff testifying before the Senate Governance and Finance
Committee on July 1, 2014. The representative indicated that it
is the Administration's expectation that the amount of the tax
credits used will be completely offset by higher income tax,
corporation tax and property tax revenues spurred by subsequent
increases in economic activity.
However, the DOF testimony is a departure from current practice,
and raises key process questions for the Committee: will DOF
routinely apply the revenue estimation methodology it used on
this bill to other tax legislation, and will it make this
methodology available to the public?
The Committee regularly considers proposed legislation that
would change the base and/or the rate of a given tax. With
respect to determining the revenue impacts of such proposals,
debate exists over whether to use "static analysis" or "dynamic
analysis." The main difference between the two is that dynamic
revenue analysis attempts to take into account both the direct
behavioral effects and the broader economic feedback effects of
tax law changes on the amount of revenues collected. In
contrast, static analysis does not attempt to measure these
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dynamic effects. Rather, it assumes that such things as the size
of the tax base, and spending and other decisions by individuals
and businesses, are unaffected by tax law changes.
The Legislative Analyst's Office (LAO) has noted that, in
theory, revenue estimates should incorporate all dynamic effects
in order to accurately measure how actual tax collections will
be affected by law changes. In practice, however, the LAO notes
that a number of factors make this a challenge. First,
accurately modeling dynamic effects is inherently difficult.
This in part is due to data limitations and lack of knowledge
about exactly how taxpayers behave. Second, the way that tax
changes are financed matters. For example, does a tax reduction
result in lower governmental services of some sort or involve
backfilling lost revenues from another source? The dynamic
effect on revenues is affected by the specific answer. Third,
dynamic effects can be very complicated. They can involve a wide
range of considerations from spending and investment decisions,
to interstate migration flows, to decisions about working. In
addition, the timing of dynamic effects can be hard to pinpoint.
Given these and other issues, questions have been raised about
the reliability of dynamic estimates, whether or not they should
be used in budgetary calculations, and whether they make sense
from a cost/benefit perspective.
California had a dynamic revenue estimating requirement in place
for DOF from 1994 through 2000 under Chapter 393, Statutes of
1994 (SB 1893, Campbell). The State worked with University of
California economists to construct a large economic model
capable of looking at dynamic effects, and DOF was given
resources to provide
information on dynamic effects in its analyses of tax bills and
proposals. The legislation requiring dynamic analysis was
ultimately allowed to sunset. Despite not routinely doing
full-blown dynamic analysis for tax measures, current revenue
estimates for tax bills do often incorporate significant
assumptions about the direct behavioral responses of taxpayers
affected. As one example, proposals to increase cigarette taxes
incorporate research results about how higher cigarette prices
reduce consumption.
Because of the difficulties inherent in perform dynamic revenue
analysis, the fact that the implementing legislation sunset and
the model housed at DOF ceased to be used, this Committee relies
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on static analysis when scrutinizing revenue proposals. DOF
generally does as well. The Administration's public statement
that the tax credits under this bill would be offset by higher
future revenues is a major departure from the status quo.
Potential Cost Pressures. As noted previously, California
Competes is currently subject to annual caps. These caps are
intended to limit revenue losses to ensure that last year's
replacement of EZs with new tax reductions is revenue-neutral.
The Committee just made its first allocation of tax credits.
Specifically, 396 firms reportedly applied for credits totaling
over $500 million, well in excess of the $30 million first-year
cap.
The current version of this bill sets aside a portion of the
credits that would be available under California Competes and
reserves them for LM. Thus, firms will be competing for a
smaller amount of tax credits than would be the case absent this
bill, which could result in a cost pressure to restore the tax
credits available under California Competes to the original
amounts.
Setting a Precedent? As noted by staff from the Senate
Governance and Finance Committee, other firms could threaten to
move employment out of state unless they receive significant,
expedited tax benefits. To the extent that this occurs, future
revenues could be lower than what would occur on the natural,
and the net fiscal impact would be unclear.
NAICS Codes. Finally, under the provisions of the bill, certain
tax relief would be available to firms in two four-digit NAICS
Codes. One of them is NAICS 3364, "Aerospace Products and Parts
Manufacturing". The other NAICS category affected by the bill is
NAICS 3359, "Other Electrical Equipment and Component
Manufacturing". This industry group comprises establishments
manufacturing electrical equipment and components (except
electric lighting equipment, household-type appliances,
transformers, switchgear, relays, motors, and generators). The
primary subcomponents of this NAICS code are as follows:
33591 Battery Manufacturing
33592 Communication and Energy Wire and Cable Manufacturing
33593 Wiring Device Manufacturing
33599 All Other Electrical Equipment and Component
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Manufacturing
The publicly stated intent of the bill is to support the
aerospace industry; consequently, it is unclear why NAICS 3359
is also included.