BILL ANALYSIS                                                                                                                                                                                                    




                                                                  AB 2389
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          (  Without Reference to File  )

          CONCURRENCE IN SENATE AMENDMENTS
          AB 2389 (Fox)
          As Amended  July 2, 2014
          2/3 vote.  Urgency
           
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          |ASSEMBLY:  |72-2 |(June 26, 2014) |SENATE: |     |               |
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                                                  (vote not available)
           
           Original Committee Reference:    TRANS.  

           SUMMARY  :  Modifies the current capital investment incentive  
          program for local governments and allows a tax credit under the  
          Corporation Tax (CT) Law to a qualified taxpayer in an amount  
          equal to 17.5% of qualified wages paid by the taxpayer during  
          the taxable year to qualified full-time employees, as specified.  
           

           The Senate amendments  :

          1)Reduce the aggregate amount of the California Competes Tax  
            Credit that may be allocated to taxpayers in the 2015-16  
            fiscal (FY) year, and each FY thereafter, by the amount of the  
            CT credit allowed by this bill to all qualified taxpayers, as  
            specified. 

          2)Provide that if the amount available under the California  
            Competes Tax Credit program (Program) is less than the  
            aggregate amount of the credit allowed to qualified taxpayers  
            pursuant to this bill, then the California Competes Tax Credit  
            amount allowed for the next FY shall be reduced by the amount  
            of that deficit. 

          3)State legislative intent that the reductions of the aggregate  
            amount of the California Competes Tax Credit shall continue if  
            the credit program is extended beyond its existing repeal  
            date.  

           AS PASSED BY THE ASSEMBLY  , this bill:

          1)Amended, in several respects, Government Code (GC) Section  
            51298, which authorizes specified local governments to  









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            establish a "capital investment incentive program", whereby a  
            "capital investment incentive amount" is paid to the proponent  
            of a "qualified manufacturing facility" for up to 15  
            consecutive fiscal years. Specifically, the amendments:

             a)   Transfer responsibility for certifying the proponent's  
               initial investment from the Business, Transportation and  
               Housing Agency to the Governor's Office of Business and  
               Economic Development (GO-Biz). 

             b)   Modify the definition of a "qualified manufacturing  
               facility" to apply to businesses described within Code  
               3359<1> or 3364<2> of the 2012 North American Industry  
               Classification System (NAICS) Manual. 

             c)   Modify the definition of a "capital investment incentive  
               amount" as an amount up to or equal to the amount of ad  
               valorem property tax revenue derived by the participating  
               local agency from the taxation of that portion of the total  
               assessed value of the facility's real and personal property  
               that exceeds $25 million (instead of $150 million per  
               current law).

             d)   Expand the definition of "good cause" authorizing a  
               local government to waive a recapture of any capital  
               investment incentive amount for nonperformance.  

             e)   Make other conforming changes. 

          2)Provided that GC Section 51298, as newly amended, shall become  
            inoperative on July 1, 2015, and shall be repealed on January  
            1, 2016.  

          3)Provided that a capital investment incentive program  
            established before the effective date of this bill may remain  
            in effect for the full term of that program.

          4)Enacted a new GC Section 51298 that shall become operative on  
            July 1, 2015.  This version is similar to existing law, with  
          ---------------------------
          <1> Refers to establishments manufacturing electrical equipment  
          and components (except electric lighting equipment,  
          household-type appliances, transformers, switchgears, relays,  
          motors, and generators).  
          <2> Refers to establishments engaged in aerospace product and  
          parts manufacturing.  








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            the following key modifications:

             a)   Responsibility for certifying the proponent's initial  
               investment will be transferred to GO-Biz.

             b)   A qualified manufacturing facility will include a  
               business described in Codes 3321 to 3399<3>, inclusive, or  
               Codes 541711<4> or 541712<5> of the 2012 NAICS Manual.

             c)   The section will include the expanded definition of  
               "good cause" authorizing a local government to waive  
               recapture of a capital investment incentive amount for  
               nonperformance.

          5)Extended the sunset date for the entire capital investment  
            incentive program from January 1, 2017, to January 1, 2018.     
                

          6)Allowed a tax credit under the CT Law to a qualified taxpayer  
            in an amount equal to 17.5% of qualified wages paid by the  
            taxpayer during the taxable year to qualified full-time  
            employees, multiplied by the annual full-time equivalent  
            ratio.

          7)Provided that the credit is authorized for each taxable year  
            beginning on or after January 1, 2015, and before 1, 2030.

          8)Defined a "qualified full-time employee" as an individual that  
            is employed in this state by the qualified taxpayer and  
            satisfies both of the following:

             a)   The individual's services for the qualified taxpayer are  
               at least 80% directly related to the qualified taxpayer's  
               subcontract to design, test, manufacture property, or  
               otherwise support production of property for ultimate use  
               in, or as a component of, a new advanced strategic aircraft  
               for the United States (U.S.) Air Force; and,

             b)   The individual is paid compensation by the qualified  
               taxpayer that satisfies either of the following conditions:

             --------------------------
          <3> Refers to a wide array of manufacturing activities.  
          <4> Refers to research and development in biotechnology.  
          <5> Refers to research and development in the physical,  
          engineering, and life sciences.








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               i)     Is qualified wages paid by the qualified taxpayer  
                 for services not less than an average of 35 hours per  
                 week.

               ii)    Is a salary paid by the qualified taxpayer as  
                 compensation during the taxable year for full-time  
                 employment, within the meaning of Labor Code Section 515.

          9)Defined "qualified taxpayer" as any taxpayer that is a major  
            first-tier subcontractor awarded a subcontract to manufacture  
            property for ultimate use in, or as a component of, a new  
            advanced strategic aircraft for the U.S. Air Force. 

          10)Defined "major first-tier subcontractor" as a subcontractor  
            that was awarded a subcontract in an amount of least 35% of  
            the amount of the initial prime contract awarded for the  
            manufacturing of a new advanced strategic aircraft for the  
            U.S. Air Force. 

          11)Defined "qualified wages" as wages paid or incurred by the  
            qualified taxpayer during the taxable year with respect to  
            qualified full-time employees that are direct labor costs,  
            within the meaning of Internal Revenue Code (IRC) Section  
            263A, relating to capitalization and inclusion in inventory  
            costs of certain expenses, allocable to property manufactured  
            in California by the qualified taxpayer for ultimate use in,  
            or as a component of, a new advanced strategic aircraft for  
            the U.S. Air Force. 

          12)Defined an "advanced strategic aircraft for the U.S. Air  
            Force" as a new advanced strategic aircraft developed and  
            produced for the U.S. Air Force under the New Advanced  
            Strategic Aircraft Program.

          13)Defined "New Advanced Strategic Aircraft Program" as the  
            project to design, test, manufacture, or otherwise support  
            production of a new advanced strategic aircraft for the U.S.  
            Air Force under a contract that is expected to be awarded in  
            the first or second calendar quarter of 2015. 

          14)Defined "annual full-time equivalent" as either of the  
            following:

             a)   In the case of a qualified full-time employee paid  
               hourly qualified wages, the total number of hours worked  









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               for the qualified taxpayer by the qualified full-time  
               employee, not to exceed 2,000 hours per employee, divided  
               by 2,000.

             b)   In the case of a salaried qualified full-time employee,  
               the total number of weeks worked for the qualified taxpayer  
               by the qualified employee divided by 52.

          15)Defined "annual full-time equivalent ratio" as a ratio, the  
            numerator of which is 1,100 and the denominator of which is  
            the number of qualified full-time employees computed on an  
            annual full-time equivalent basis for the taxable year.  The  
            ratio may not be greater than one. 

          16)Limited the total aggregate amount of the credit as follows:

             a)   To $25 million, per calendar year, for years one through  
               five;

             b)   To $28 million, per calendar year, for years six through  
               10; and,

             c)   To $31 million, per calendar year, for years 11 through  
               15.

          17)Prohibited a qualified taxpayer from claiming the credit  
            unless the credit was reflected within the bid, upon which the  
            taxpayer's subcontract is based, by reducing the bid amount by  
            a good faith estimate of the allowable credit amount. 

          18)Required a qualified taxpayer to report to the Franchise Tax  
            Board (FTB), upon request, all references to the credit and  
            ultimate cost reductions incorporated into any successful bid  
            that awarded a subcontract for which the taxpayer is making a  
            claim. 

          19)Provided that, if a qualified taxpayer is eligible to claim  
            other tax credits for qualified wages, then only one credit  
            shall be allowed to the taxpayer with respect to any wage  
            consisting in whole or in part of those qualified wages. 

          20)Required the FTB to allocate the credit on a  
            first-come-first-served basis.

          21)Allowed the FTB to prescribe necessary or appropriate  









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            regulations, rules, guidelines, or procedures to implement the  
            credit program.

          22)Required the credit to be claimed on a timely filed original  
            tax return.

          23)Allowed a qualified taxpayer, in the case where the credit  
            allowed exceeds the tax liability, to carry the excess forward  
            to reduce the tax in the following year, and the seven  
            succeeding years, if necessary, until the credit is exhausted.  


          24)Repealed the credit on December 1, 2030.

          25)Takes immediate effect as an urgency statute necessary for  
            the immediate preservation of the public peace, health, or  
            safety.  

           FISCAL EFFECT  :  Unknown

           COMMENTS  :   

          1)Proponents of this bill note the following:

               As you know, the aerospace industry has a long and  
               rich history in Southern California.  This extremely  
               diversified industry is comprised of small, medium and  
               large enterprises that manufacture aircraft (civil and  
               military), missiles, satellites and other space  
               vehicles, as well as the businesses that manufacture  
               and distribute parts and components.  The state's  
               aerospace industry directly supports about 140,000  
               high-paying, high-skill jobs.  More than 88,000 of  
               those jobs are located in Southern California.  

               However, we must always remember that in today's  
               global economy, location is not permanent, but by  
               choice.  Companies - especially those that would avail  
               themselves of the benefits offered in AB 2389 - have  
               many opportunities to locate outside of California.   
               We have to be ready as a region and as a state to make  
               that choice easier for them to locate their business,  
               suppliers, contract, and/or product or research and  
               development investment here.  We see AB 2389 as an  
               action policymakers can - and must - take.  And while  









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               we fully understand that one program is in no way a  
               panacea to save an industry, it is a small step in the  
               right direction to help us attract new companies as  
               well as grow next-generation aerospace businesses.  

          2)Assembly Revenue and Taxation Committee comments:

             a)   Background:  The aerospace industry began in California  
               with a few aircraft builders around 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% of the aerospace business 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 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 collapse of the Soviet Union and the end the  
               Cold War led to more than 50 major defense companies  
               consolidating into only six.  According to the Employment  
               Development Department's Labor Market Information Division,  
               employment in the Aerospace Production and Manufacturing  
               sector declined from 139,300 in 1993 to 70,800 in 2013.   
               Most of the decline occurred before 2004.  However, further  
               job decline is likely because defense spending is expected  
               to fall due to the implementation of federal budget cuts.
                                         
             b)   The capital investment incentive program:  As noted  
               above, current law authorizes specified local governments  
               to establish a capital investment incentive program,  
               whereby a "capital investment incentive amount" is paid to  
               the proponent of a qualified manufacturing facility for up  
               to 15 consecutive fiscal years.  This bill would, among  
               other things, modify the definition of a "qualified  
               manufacturing facility" to apply to businesses described  
               within Code 3359 or 3364 of the 2012 NAICS Manual.  These  
               sections, in turn, refer to establishments manufacturing  









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               electrical equipment and components, and establishments  
               engaged in aerospace product and part manufacturing.  This  
               bill also temporarily modifies the definition of a "capital  
               investment incentive amount."  Under the existing  
               definition, 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 above that amount.  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).  These  
               modifications to the capital investment incentive program  
               will cease to be operative on July 1, 2015.  Thereafter,  
               the capital investment incentive program will revert to its  
               current form, with certain modifications, and will remain  
               in effect until January 1, 2018.  

             c)   The proposed income tax credit program:  This bill  
               creates a corporation tax credit program for the aerospace  
               industry.  The proposed credit amount is equal to 17.5% of  
               the wages paid to employees of a taxpayer engaged in  
               manufacturing of property for ultimate use in, or as a  
               component of, a new advanced strategic aircraft for the  
               U.S. Air Force.  The annual amount of the credit is limited  
               to $25 million for the first five years, $28 million during  
               the next five years and $31 million for the remaining five  
               years.  The credit program includes a 15-year sunset  
               provision, and it is allowed only for wages paid to  
               individuals employed in California.  

             d)   The existing hiring tax credit program:  Last year, the  
               Legislature substantially revised California's tax  
               incentive programs for economic development.  A new hiring  
               tax credit was established under the Personal Income Tax  
               and CT laws, from January 1, 2014 to January 1, 2021, for  
               additional hiring of employees in defined geographic areas  
               of the state.  The hiring credit is available in the  
               geographic areas largely covered by the former enterprise  
               zones (EZs) (except certain census tracts with low  
               unemployment), two recently expired EZs, and in designated  
               census tracts that have a civilian unemployment rate and a  
               poverty rate in the top 25% of all census tracts in the  
               state.  The credit is available for full-time employees who  
               perform at least 50% of their activities in the designated  
               areas.  To qualify for any credit, the taxpayer must have  









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               experienced an increase in total jobs throughout the state  
               from one year to the next.  Taxpayers are only allowed the  
               credit for the number of new jobs provided in the state.

             e)   Wage subsidy:  Unlike the existing hiring tax credit,  
               which attempts to encourage taxpayers to hire new  
               employees, the proposed tax credit appears to be simply a  
               state subsidy for wages paid by a qualified taxpayer  
               engaged in manufacturing of new advanced strategic  
               aircraft.  At the same time, this bill seems to encourage a  
               qualified taxpayer to increase employee wages over time.   
               After reaching the 1,100 employee threshold, a qualified  
               taxpayer would only be able to increase an allowable credit  
               amount by increasing employee wages.<6>  

             f)   Supply-side economics:  Generally, advocates for tax  
               incentives, such as Arthur Laffer and N. Gregory Mankiw,  
               argue that reduced taxes allow taxpayers to invest money  
               that would otherwise be paid in taxes, thereby creating  
               additional economic activity.  "Supply-siders" posit that  
               higher taxes do not result in more government revenue;  
               instead, they suppress additional innovation and investment  
               that would have led to more economic activity and,  
               therefore, healthier public treasuries, under lower  
               marginal tax rates.  Critics, however, assert that tax  
               incentives rarely result in additional economic activity.   
               Companies do business in California because of its  
               competitive advantages, namely its environment,  
               transportation infrastructure, access to ports, highways,  
               and railroads, as well as its highly skilled workforce and  
               world class higher education system.  
             --------------------------
          <6> For example, a qualified taxpayer with 1,100 employees, each  
          earning $130,000 a year, would qualify for a $25,025,000 tax  
          credit.  [$143,000,000 total wages x (1,100/1,100 employees) =  
          $143,000,000x17.5% = a tax credit of $25,025,000].  However, if  
          the qualified taxpayer were to hire one additional employee, the  
          taxpayer would again only qualify for a tax credit of  
          $25,025,000.  [$143,130,000 total wages x (1,100/1,101  
          employees) = $143,000,000x17.5% = a tax credit of $25,025,000].   
          Therefore, in order to receive a larger credit, the qualified  
          taxpayer would have to increase wages for each of its 1,100  
          full-time equivalent employees beyond $130,000 a year.  Hiring  
          additional employees beyond the 1,100 employee limitation would  
          make no difference.









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             The budgets for defense projects are predetermined by the  
               federal government, and any increase in aggregate economic  
               activity would be dependent on additional federal defense  
               spending.  One might argue that this bill subsidizes work  
               that has already been committed to by the federal  
               government.  However, this bill has less to do with  
               increasing economic activity nationwide and more to do with  
               ensuring that such activity occurs in California. 

             g)   Specific industry:  In general, tax credits and other  
               tax incentives are used to encourage certain behavior, not  
               to necessarily aid a specific industry.  For example, the  
               Research and Development Credit provides a credit for  
               qualified research, but the research can be accomplished in  
               a number of industries:  computer and peripheral equipment  
               manufacturing, communications equipment manufacturing,  
               semiconductor and other electronic component manufacturing,  
               pharmaceuticals and medicine manufacturing, and software  
               publishing.  In contrast, tax incentives provided to  
               specific industries are intended to retain or attract  
               certain industries to the state.  Subsidizing certain  
               industries, not just certain behavior, may be more  
               beneficial in that targeted subsidies could provide the  
               state with a larger return on investment, both financially  
               and socially.  However, as with other industry-specific  
               credit programs, providing subsidies to a single industry  
               could unintentionally cause aggressive competition among  
               various states, leading to what is known as a "race to the  
               bottom."  

             h)   Double-dipping:  This bill provides that a qualified  
               taxpayer may claim only one tax credit for qualified wages,  
               if other tax credits are available.  However, the exclusion  
               of other credits does not prevent the use of a deduction  
                                          for ordinary and necessary business expenses, which  
               includes wages paid to an employee.  This bill would allow  
               a qualified taxpayer a double benefit:  first, a deduction,  
               and then a credit calculated based on the same wages paid  
               by a qualified taxpayer for qualified full-time employees.   
               Generally, a credit is allowed in lieu of a deduction in  
               order to eliminate multiple tax benefits for the same item  
               or expense.

             i)   Fiscal vs. calendar years:  The Senate amendments  









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               provide that, beginning with the 2015-16 FY, the total  
               amount of credits that may be allocated under the Program  
               must be reduced by the amount of credit allowed to all  
               qualified taxpayers under this bill.  Specifically, the  
               amendments provide that the aggregate amount of Program  
               credits must be reduced by the amount of credit allowed  
               under "subparagraph (A) or subparagraph (B) of paragraph  
               (1) of subdivision (c)" of the new credit.  Subparagraph  
               (A), in turn, provides that in years one through five of  
               the new credit, the total amount of credits is capped at  
               $25 million "per calendar year."  It is unclear to the  
               Assembly Revenue and Taxation Committee how the FY  
               provisions of the Program credit are to be reconciled with  
               the calendar year limitations of the tax credit created by  
               this bill.
           
          Analysis Prepared by  :  Oksana Jaffe, M. David Ruff, and Carlos  
          Anguiano / REV. & TAX. / 
                          (916) 319-2098 

                                                               FN: 0004250