BILL ANALYSIS Ó AB 894 Page A Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 894 (Patterson) - As Introduced February 26, 2015 Majority vote. Tax levy. Fiscal Committee SUBJECT: Personal income taxes: credit: education expenses SUMMARY: Allows, for each taxable year beginning on or after January 1, 2016, a credit in an amount equal to 15% of the tuition paid or incurred by a taxpayer for education and training obtained by the taxpayer or the taxpayer's dependent at a vocational institution, as defined. Specifically, this bill: 1)Allows a credit, under the Personal Income Tax (PIT) Law, in an amount equal to 15% of the tuition paid or incurred by a taxpayer during the taxable year for education and training obtained by the taxpayer or the taxpayer's dependent at a AB 894 Page B vocational institution. 2)Limits the amount of the credit allowed to be claimed to $2,500 per taxable year. 3)Defines a "vocational institution" as a private, postsecondary institution that grants only certificates or associate degrees. 4)Authorizes the taxpayer to carry forward the tax credit to the following tax year, and succeeding seven years, if necessary, until the credit is exhausted. 5)Disallows the credit if the tuition costs are claimed by the taxpayer as an ordinary and necessary business expense. 6)Disallows the credit to a taxpayer who pays for the tuition at a vocational institution with distributions from the taxpayer's Golden State Scholarshare College Savings Account. 7)Contains legislative findings and declarations regarding the goals, purposes and objectives of this credit as well as the performance indicators, data collection requirements and baseline measurements, as required by Revenue and Taxation Code (R&TC) Section 41. 8)Takes effect immediately as a tax levy. EXISTING LAW: AB 894 Page C 1)Allows a tax credit, called the Lifetime Learning Credit, of up to $2,000 for qualified educational expenses, which include tuition and certain related expenses required for enrollment in a course at an eligible educational institution. The course must either be part of a post-secondary degree program or taken by the student to acquire or improve job skills. This tax credit is phased out if the taxpayer's modified adjusted gross income (AGI) is between $53,000 and $63,000 ($107,000 and $127,000 for taxpayers filing a joint return). 2)Allows a tax credit, called the American Opportunity Credit, of up to $2,000 for the first $2,000 of qualified tuition and related expenses, and a 25% credit for the next $2,000 of qualifying expenses, for a total tax credit of $2,500 each year per student. Up to 40% of the tax credit is refundable. This tax credit is phased out if the taxpayer's modified AGI is between $80,000 and $90,000 ($160,000 and $180,000 for taxpayers filing a joint return). This credit is limited to an eligible student's first four years of postsecondary education. 3)Excludes from the taxpayer's gross income payments received by the taxpayer from his/her employer, up to $5,250, for tuition, fees, books, supplies, and equipment under the employer's educational assistance program. Educational assistance does not include a) tools or supplies retained by the employee after completion of the instruction; b) meals, lodging or transportation; or c) courses involving sports, games, or hobbies. The term "education" includes any form of instruction or training that improves or develops the capabilities of an individual. Education may be furnished directly by the employer, or through a third party such as an educational institution. Education is not limited to courses that are job related or part of a degree program. EXISTING STATE LAW: AB 894 Page D 1)Provides various tax credits designed to provide tax relief for taxpayers who incur certain expenses or to influence taxpayers' behavior. 2)Does not conform to the federal Lifetime Learning Credit law, nor does it provide for a comparable tax credit. 3)Does not conform to the American Opportunity Credit, nor does it provide for a comparable tax credit. 4)Conforms, in general, to the exclusion of up to $5,250 of employer-provided educational assistance benefits from an employee's gross income. FISCAL EFFECT: The Franchise Tax Board's (FTB) staff estimates that this bill will result in an annual loss of $30 million in the fiscal year (FY) 2015-16, $75 million in FY 2016-17, and $110 million in FY 2017-18. COMMENTS: 1)Author's Statement . The author has provided the following statement in support of this bill: "As California emerges from the recent recession, the need for skilled labor is on the rise. Our UCs and CSUs are severely impacted despite the fact that many of the state's current labor demands do not necessarily require a Bachelor's Degree. "Certificates and Associate's Degrees obtained at vocational institutions serve just as well, if not better, than traditional higher education for jobs in many of California's AB 894 Page E most in-demand professions such as auto mechanics, vocational nurses and pharmacy technicians. "California needs to incentivize attendance at these types of institutions in order to meet current demands of the job market and to help students obtain a fast and affordable education. "Instituting a state tax credit to help offset the costs of attending a vocational school, will incentivize people to attend these types of institutions and gain the skills necessary to obtain gainful employment.' "By lowering the cost of attendance at one of these institutions, California will encourage its residents who may be looking to earn a certificate or license in a high-demand job field to attend these schools and gain these certifications that will make them career-ready and sought-after by employers in the state." 2)Arguments in Support . The proponents of this bill note that "[v]ocational school students are typically working parents tasked with supporting a family and completing their education." They argue that this bill is "California's opportunity to support hard-working students who are getting back into the classroom to get hands-on job training." 3)Arguments in Opposition . The opponents state that when "the for-profit private education setting has been objectively studied, the default rates, graduation rates, and job placement rates have all consistently lagged far behind the value of less expensive alternatives; alternatives that do not require the student to incur as much debt." They argue that this bill "would misdirect tax dollars without accountability" and that the "substantial revenue loss from this program could?be far better directed in terms of directly paying for job training and upgrading of skills" rather than tax credits. AB 894 Page F 4)For-Profit Career Schools . State support for higher education has been dramatically reduced because of budget crises over the last 10 years, impacting not only the University of California and California State University, but also the state's Community College system. Many potential students had no other option but to enroll in for-profit vocational schools that offered certificates and associate degrees in various fields, including health, accounting, and computer services, among others. These schools promised practical training, professional certification, and placement at high-paying jobs after graduation. Some vocational schools, however, have been criticized for misrepresenting job placement rates to students and investors, leaving former students jobless and in debt, and violating California's false advertising and unfair competition laws. In fact, the California Attorney General recently filed a lawsuit alleging that Corinthian Colleges, which is a for-profit company offering postsecondary education, violated consumer protection and securities laws, misrepresented job placement rates to students and investors, advertised for programs that it did not offer, and subjected AB 894 Page G students to unlawful debt collection practices.<1> On April 26, 2015, Corinthian Colleges, Inc., announced that it has "ceased substantially all operations and discontinued instruction" at several campuses and filed for bankruptcy on May 4, 2015 .<2> A few other for-profit career schools are currently under investigation by state attorneys' general in --------------------------- <1> Corinthian Colleges, Inc. (CCI) owned Heald, Everest, and WyoTech campuses in California. CCI institutions offered a range of programs, including 8- to 12-month certificate programs, with tuition and fees that ranged from $13,100 to $21,338, 24-month associate's degree programs with tuition and fees that ranged from $33,120 and $42,820; and bachelor's degree programs that were between $60,096 and $75,384. According to a 2014 complaint filed by the Consumer Financial Protection Bureau (CFPB), most students attending CCI were low-income, or the first in their families to seek an education beyond high school. In 2012, CCI reported that 85% of its students had family incomes of less than $45,000 per year. An estimated 57% of CCI students had household incomes of $19,000 or less, and 35% of CCI students had a household income of less than $10,000. Most students attending CCI received federal financial aid; according to CCI's filing with the Securities and Exchange Commission, CCI received 84.8% of their net revenue from federal financial aid (Title IV: Pell Grants and Federal Loans). <2> According to the California Attorney's General Office, the closure follows oversight and enforcement actions by state and federal agencies, including the California Department of Justice, the U.S. Department of Education, the U.S. Consumer Financial Protection Bureau, the California Student Aid Commission, the California Bureau of Private Postsecondary Education, and several other state attorney generals. AB 894 Page H various states.<3> 5)Funding for Community Colleges . According to a study by the Public Policy Institute of California, in 2010-11 California spent $1.6 billion less in higher education than it did 10 years earlier, adjusted for inflation. (Hans Johnson, Defunding Higher Education: What are the Effects on College Enrollment, Public Policy Institute of California, May 2012.) However, with the passage of Proposition 30, General Fund (GF) revenue is estimated to increase by about $6 billion per year, which would primarily be used to restore funding to California's public school system. In January, Governor Brown proposed to allocate $7.3 billion to community colleges in FY 2015-16, an increase of 8% from the current year. The new funding will allow community colleges to enroll more students and offer more classes. This bill proposes to subsidize education and training obtained by taxpayers at vocational for-profit institutions. While a tax credit for educational expenses incurred at a private school may encourage students to get vocational -------------------------- <3> To date, 37 state attorney generals are participating in a joint working group examining for-profit colleges, according to the office of Kentucky Attorney General Jack Conway, and at least 24 state attorney generals are actively investigating specific for-profit colleges in their states. See, e.g., http://www.republicreport.org/2014/law-enforcement-for-profit-col leges/ AB 894 Page I training, it is questionable whether scarce GF moneys should be used to subsidize private schools, especially given that tax expenditure programs tend to decrease the amount of funds available for public education funding in the first instance. Instead of forgoing GF revenues, the Committee may wish to consider whether these funds may be better utilized if directly appropriated to the state's Community College system. 6)Existing Tax Incentives for Continuing Training and Education . Current California tax law provides for several tax incentives for individuals who invest in continuing education and training. The expenses incurred by employers in training employees are uniformly regarded as a business expenditure, which means that these expenses can be fully deducted from gross income as "ordinary and necessary" business expenses. The cost of continuing education provided to the employer - the business owner - is also deductible as a business expense as long as the education maintains or improves skills required in the employer's trade or business, or that is required by law or regulations for maintaining a license to practice, keep the salary, or hold a job. For example, a practicing attorney may deduct the cost of continuing legal education if the continuing legal education is a requirement for maintaining the membership in the State Bar Association. However, expenses for re-training for another position or expenses necessary to meet the minimum requirements for a position are not eligible for a deduction (e.g., a law student may not deduct the cost of a bar exam even if she/he working part-time at a law firm while studying the exam). An individual taxpayer may also deduct certain educational expenses, but only to the extent those expenses are work-related and they exceed 2% of the taxpayer's AGI. However, the costs of preparing for state credentialing (certification, licensing or registration) examinations that are required in order to practice certain professions are not currently deductible. In addition, an individual may exclude from his/her gross income payments up to $5,250 received from AB 894 Page J his/her employer for tuition, fees, books, supplies, or equipment under the employer's educational assistance program. Education under this program does not have to be job-related or be part of a degree program. 7)Credit and Deduction. Existing law already provides a tax incentive, in the form of a deduction, for certain education and training costs. This bill would allow a qualified taxpayer an alternative tax benefit, in lieu of a deduction. A tax credit is more valuable because it lowers the tax liability dollar-for-dollar. In contrast, a deduction decreases the taxable income so the deduction's value depends on one's tax bracket. For example, if a taxpayer is in the 25% bracket, a $1,000 deduction would lower the taxpayer's tax bill by $250. In contrast, a $1,000 credit decreases the tax liability by the full $1,000 regardless of the tax bracket. 8)529 Plans. Existing federal and state laws allow taxpayers to contribute to qualified tuition programs under the Internal Revenue Code Section 529, known in California as the "Golden State Scholarshare Trust" (ScholarShare). ScholarShare enables taxpayers to save for college by saving money in tax-advantaged investments. Neither earnings nor disbursements, when used for tuition and other qualified expenses, are subject to income taxes. This bill would disallow the credit to taxpayers who use the tax-deferred funds in a ScholarShare account to pay for tuition. However, this bill would not preclude taxpayers from claiming the credit for tuition paid with funds accumulated on a tax-free basis in other 529 plans. 9)The Costs of Training of Non-California Workforce Would Qualify for the Credit . Clearly, a highly educated workforce is one of the most important factors of sustaining a healthy and diversified economy in California. However, the application of this bill is not limited to California workforce and, arguably, would be extended to the tuition costs incurred by a taxpayer in paying for education and/or training of dependents based outside of California. The AB 894 Page K Committee may wish to limit this bill's application only to costs of tuition for education and training obtained by California-based workforce. 10)California Workforce Development Programs: Tax Credits vs. Grants . Although well intentioned, this bill represents an attempt to use the tax code to accomplish a public policy objective that would be more efficiently addressed through direct outlay of state funds. There are several workforce development programs in California; they are primarily administered through the Labor and Workforce Development Agency and the California Community College System. One of the largest programs of its kind in the nation is the Employment Training Panel (ETP), a business- and labor-supported state agency that funds job skill development initiatives that have good pay potential. The ETP provides customized training to new and current workers of California employers, particularly those facing out-of-state competition. One source of funding is provided by an assessment of one-tenth of 1% of unemployment insurance wages paid by every private, for-profit employer in California, as well as some non-profits amounting to no more than $7 per covered employee per year. In fiscal years (FY) 2010-11 and 2011-12, the ETP received alternative funding aimed at training workers for jobs emerging in the recovering economy. As noted by the California Budget Project, nearly two-thirds of the projected 2020 labor force is already past high-school age, and meeting the needs of working adults requires changes in the areas that include financial aid policies; supportive services, such as child care and transportation; new approaches to teaching and curriculum design; and flexibility in the scheduling of classes. (California Budget Project, Mapping California's Workforce Development System: A guide to Workforce Development Programs in California, 2009.) It was also suggested that one promising strategy for addressing both the needs of workers and employers is employment and training programs that target a specific industry and work to meet its AB 894 Page L local labor market needs. (Id.). It appears that a stand-alone tax credit is not sufficient to improve the state's workforce or to ensure that the state's workers have the skills needed to compete in the global marketplace. The Committee may wish to consider whether a direct grant program to cover tuition of individuals at vocational institutions would be a better vehicle to achieve these goals. 11)Sunset Date . This bill does not contain a sunset date. It should be noted that, once enacted, it takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date, effectively resulting in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their efficacy, without a supermajority vote. The Committee may wish to add a five-year sunset to this bill and require the Legislative Analyst to prepare a study regarding the impact of this tax credit on the California economy and to report back to the Legislature its findings prior to the sunset date. 12)Implementation Concerns . As noted in the analysis prepared by the Franchise Tax Board (FTB) staff, this bill would allow a credit to a taxpayer who pays for, or incurs, vocational school tuition for the taxpayer or his/her dependent. The term "taxpayer" may refer to one individual or a married couple. Furthermore, the term "dependent of the taxpayer" is an undefined phrase. The FTB staff recommends that this bill be amended to clarify these terms to avoid any disputes between taxpayers and the FTB. 13)Prior Legislation . a) AB 2519 (Patterson), of the 2013-14 Legislative Session, is substantially similar to this bill. AB 2519 was held on the Assembly Appropriations Committee's Suspense File. b) AB 1735 (Harkey), of the 2010-11 Legislative Session, AB 894 Page M would have allowed a credit, under both the Personal Income Tax Law and the Corporation Tax Law, in an amount equal to 50% of the costs paid or incurred by a taxpayer during the taxable year for education and training provided to either the taxpayer or its employees. AB 1735 was held on this Committee's Suspense File. c) SB 1163 (Vasconcellos), of the 2001-02 Legislative Session, would have allowed a 100% credit for amounts paid or incurred, not to exceed $1500, for information technology training for the taxpayer or any employee of the taxpayer. SB 1163 was never heard by the Senate Committee on Revenue and Taxation. REGISTERED SUPPORT / OPPOSITION: Support Valley Regional Occupational Program Clovis Unified School District Opposition American Federation of State, County and Municipal Employees (AFSCME), AFL-CIO AB 894 Page N California Tax Reform Association Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916) 319-2098