BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 718 HEARING: 8/12/14
AUTHOR: Roth FISCAL: Yes
VERSION: 8/7/14 TAX LEVY: No
CONSULTANT: Grinnell
PURSUANT TO SENATE RULE 29.10(d)
ECONOMIC DEVELOPMENT (URGENCY)
Expands recently enacted aerospace tax credit to include
prime contractors.
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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A recent Congressional Research Service report indicates
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." According to news reports
citing a United States Air Force (USAF) press release, USAF
released a request for proposals on July 9th for the "Long
Range Strike Bomber" to replace potentially outdated
predecessors. News reports state that the project is one
of USAF's top priorities, and that the Northrop Grumman
Corporation will compete against a joint bid from the
Boeing Company and Lockheed Martin Corporation to build
between 80 and 100 aircraft with a targeted average
procurement cost of $550 million each. The contract should
be awarded next spring, but additional details remain
confidential. Seeking to steer economic activity
associated with performing the contract, the Legislature
revised an existing local tax incentive program, and
enacted a new corporation tax credit last month (AB 2389,
Fox):
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:
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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 used 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 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 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.
AB 2389 (Fox, 2014) changed 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,
Change 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,
Make conforming changes, and provided that
specified events constitute good cause for the purpose
of waiving recapture for failure to perform,
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Shift program administration to GO-Biz, and
Repeal these changes as of January 1, 2016, but
ensured that any incentive program established before
that date remains in effect for its full term.
Extend the sunset on the entire program from 2017
to 2018, and again guaranteed that any incentive
program established before that date remains in effect
for its full term.
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 the 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.
AB 2389 enacted a tax credit equal to 17.5% of wages paid
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during the taxable year to 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 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.
AB 2389 only allowed "major, first-tier subcontractors" to
claim the credit, with the only firm meeting that
definition is Lockheed Martin. Northrop Grumman as a prime
contractor wants AB 2389 changed to allow it to claim the
same tax benefits that the Legislature granted Lockheed
Martin. Additionally, some technical changes are needed to
AB 2389.
Proposed Law
Senate Bill 718 amends the corporation tax credit recently
enacted by AB 2389 to:
Allow a prime contractor awarded a prime contract,
SB 718 - 8/7/14 -- Page 6
as defined, to claim AB 2389's credit,
Specifies that the credit is allowed only for
contracts awarded after August 1, 2014, and does not
include upgrading, modernizing, sustaining, or
otherwise modifying other bomber programs, and
Makes technical and conforming changes to ensure
that the Franchise Tax Board (FTB) can implement the
credit effectively.
SB 718 modifies the Capital Investment Incentive Program
to:
Change the definition of "proponent" to include
parties that lease or occupy a government-owned
qualified manufacturing facility under a lease
agreement, as Northrop Grumman would use its currently
leased facilities near Edwards Air Force Base to
perform any contract eligible for benefits under the
bill, and
Clarifies that capital investment incentive amounts
allocated back to taxpayers must be calculated after
the county auditor makes Education Revenue
Augmentation Fund (ERAF) shifts.
State Revenue Impact
Pending.
Comments
1. Purpose of the bill . According to the author, "The
aerospace industry in Southern California began roughly 100
years ago. Over the last century, early aviation pioneers
in the region transitioned from small workshops to large
factories that produced bombers and fighters and employed
tens of thousands of Southern Californians. However, with
the end of the Cold War in the late 1980s came defense
budget cuts and military base closures. In response, the
industry's largest firms contracted in a wave of
consolidations and, as a result, many smaller, second and
third tier contractors were forced to close their doors.
This bill has the potential to be of significant benefit to
California. The size of this incentive program, $25
million to $31 million per year for 15 years, and its focus
on aerospace is seen as an opportunity to position
California once again as a national leader in supporting
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the aerospace industry by growing the industry by
approximately 1,100 direct jobs, [and] 5,500 indirect and
induced jobs."
2. Competitive neutrality . SB 718 first came into print
on Thursday, August 7, 2014. The Assembly Committee on
Revenue and Taxation and the Assembly Floor approved the
bill on Monday, August 11th, and the Committee is hearing
the bill today despite it having been in print for only
five days. Normally, legislation authorizing significant
tax benefits would advance according to normal legislative
timelines to enable policy review and public input;
however, the Legislature enacted and the Governor signed AB
2389 under a similarly accelerated timeline, and SB 718's
only ensures competitive neutrality between the two
competing bidders for the same project. Similar to AB
2389, SB 718 proponents justify the accelerated process by
indicating that the Legislature must approve SB 718 quickly
before USAF's deadline to enable them to represent the tax
credit's value in its bid, and without the measure, state
law grants a preference to its sole competitor by allowing
only subcontractors to claim $450 million in tax credits
over 15 years. With AB 2389, the Legislature indicated
that the foregone revenue in tax credits is justified by
the positive economic effects resulting from performing the
aircraft contract in California. SB 718 merely extends
this policy to ensure that the state isn't tipping the
scales in favor of one firm over another.
3. Good model . While AB 2389 and SB 718's tax credits
require a 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 sub-contract bid. However, one drawback of the
aerospace 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. Tradeoffs . Generally, there are two sides to any
debate about bills that grant tax credits for economic
development. One side argues that tax credits reward
behavior that would have occurred without the subsidy,
SB 718 - 8/7/14 -- Page 8
so-called "deadweight loss," while the other asserts that
they generate additional employment, wage payments, and
other economic activity by lowering production costs at
the margin in amounts necessary for firms to engage in
economic activity in California instead of somewhere else.
With SB 718, this debate overlays a unique set of
circumstances:
First, news reports indicate that only two bidders
will compete for the advanced strategic aircraft
project: a joint bid by Boeing and Lockheed Martin,
and another from Northrop Grumman. The two firms
often compete with each other to perform aerospace
contracts.
Both Lockheed Martin and Northrop Grumman have
long-established presences in California, owning
property and employing thousands of individuals. The
two firms have facilities adjacent to each other near
Palmdale, California. Both firms argue that winning
the contract will lead to direct investment and
increased employment in the state, as well as
additional positive economic effects resulting from a
chain of suppliers that would perform tasks necessary
to complete the contract.
AB 2389 only allowed subcontractors, as defined, to
claim a credit for wages paid to individuals who would
work on the contracts that give rise to the credit.
Northrop Grumman could win the contract without the tax
credit, thereby employing more persons, and making the
investments in the physical infrastructure necessary in
California to perform the contract, meaning that SB 718
would provide a windfall benefit for something the firm
would've done anyway. In this case, AB 2389 would be moot
as Lockheed Martin won't be performing the contract.
Another possibility is that Northrop Grumman wins the
contract, but chooses to perform it in another state. Both
bills would then be irrelevant because only wages paid to
employees in California performing the contract generate
credits.
5. Urgency . SB 718 is an urgency measure that would take
effect upon the Governor's signature, and must be approved
by 2/3 vote of the Legislature.
6. 29.10 . The Senate Rules Committee has referred SB 718
to the Committee under Senate Rule 29.10. As such, the
SB 718 - 8/7/14 -- Page 9
Committee may (1) hold the bill, or (2) return the bill to
the Senate Floor.
Assembly Actions
Assembly Revenue and Taxation: 7-0
Assembly Floor: 73-0
Support and Opposition (08/11/14)
Support : San Diego Mayor Kevin L. Faulconer; Antelope
Valley Board of Trade, Azusa Chamber of Commerce,
California Chamber of Commerce, CONNECT, City of El
Segundo, El Segundo Chamber of Commerce, Irwindale Chamber
of Commerce, City of Lancaster, Lancaster Chamber of
Commerce, Los Angeles Area Chamber of Commerce, Los Angeles
Economic Development Corporation, Manhattan Beach Chamber
of Commerce, Northrop Grumman, City of Palmdale, City of
Redondo Beach, Redondo Beach Chamber of Commerce, San Diego
Regional Chamber of Commerce, San Diego Regional Economic
Development Corporation, San Gabriel Valley Chambers of
Commerce, San Gabriel Valley Economic Partnership, South
Bay Association Chambers of Commerce, Southwest Defense
Alliance, West Valley-Warner Center Chamber of Commerce,
Yuba-Sutter Chamber of Commerce.
Opposition : None known.