BILL ANALYSIS Ó AB 2389 Page A ( Without Reference to File ) CONCURRENCE IN SENATE AMENDMENTS AB 2389 (Fox) As Amended July 2, 2014 2/3 vote. Urgency ----------------------------------------------------------------- |ASSEMBLY: |72-2 |(June 26, 2014) |SENATE: | | | ----------------------------------------------------------------- (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 AB 2389 Page B 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. AB 2389 Page C 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. AB 2389 Page D 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 AB 2389 Page E 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 AB 2389 Page F 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 AB 2389 Page G 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 AB 2389 Page H 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 AB 2389 Page I 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. AB 2389 Page J 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 AB 2389 Page K 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