BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 1565 - Buchanan
Amended: June 16, 2010
Hearing: June 23, 2010 Tax Levy Fiscal: Yes
SUMMARY: Provides a 20% Research and Development Tax
Credit for Alternative Energy and Advanced
Transportation Technology Costs in Newly
Designated Research and Development Tax Credit
Areas Located Within an Innovation Hub or City,
as Defined.
EXISTING LAW, at the state and federal levels,
provides various tax credits designed to provide tax relief
for taxpayers who incur certain expenses (e.g., child
adoption) or to influence behavior, including business
practices and decisions (e.g., research credits or economic
development area hiring credits). These credits generally
are designed to provide incentives for taxpayers to perform
various actions or activities that they may not otherwise
undertake.
EXISTING LAW allows four kinds of Geographically
Targeted Economic Development Areas (GTEDA): Enterprise
Zones, Local Agency Military Base Recovery Areas (LAMBRAs),
Manufacturing Enhancement Areas (MEAs), and Targeted Tax
Areas (TTAs). While some differences exist among the tax
incentives for each, taxpayers generally have access to
each form of preferable tax treatment. The law currently
limits the number of enterprise zones that may be
designated to 42 and HCD has currently designated either
conditionally or finally 40 zones. State law allows eight
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LAMBRAs, two MEAs, and one TTA, all of which are
designated.
EXISTING LAW, under SB 71 (Padilla), Chapter 10,
Statutes of 2010 (signed by the Governor on March 24, 2010
and effective immediately), certain "projects" may be
approved for a state and local sales and use tax exclusion
by the California Alternative Energy and Advanced
Transportation Financing Authority (CAEATFA). SB 71
amended Public Resources Code (PRC) Section 26003 and added
PRC Section 26011.8 to include within the definition of
"project" equipment used to manufacture products that
produce energy from alternative sources such as solar,
wind, and biomass. SB 71 allows the CAEATFA to authorize a
sales and use tax exclusion for purchases of tangible
personal property utilized for the design, manufacture,
production, or assembly of advanced transportation
technologies or alternative source products, components, or
systems, which includes renewable energy equipment,
combined heat and power equipment, and alternative
transportation equipment in California.
EXISTING FEDERAL LAW allows taxpayers a research
credit that is combined with several other credits to form
the general business credit. The research and development
(R & D) tax credit is designed to encourage companies to
increase their research and development activities.
The research credit for personal income tax taxpayers is
determined as the sum of:
1. 20 percent of the qualified research expenses
incurred during the taxable year that exceeds the base
amount, as defined, and
2. 20 percent of the amount paid or incurred during
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the taxable year on research undertaken by an energy
research consortium.
In addition to the two components listed above, corporate
taxpayers are allowed a credit of 20 percent of expenses
paid to fund basic research at universities and certain
nonprofit scientific research organizations.
EXISTING FEDERAL and STATE LAW allow taxpayers to
elect an Alternative Incremental Credit (AIC) regime, in
which case the taxpayer is assigned a three-tiered
fixed-base percentage and the R & D credit rate, likewise,
is reduced. Under federal law, for amounts paid after
2006, a credit rate of 3% applies to the extent that a
taxpayer's current-year research expenses exceed a base
amount computed by using a fixed-base percentage of 1%
(i.e., the base amount equals 1% of the taxpayer's average
gross receipts for the four preceding years) but do not
exceed a base amount computed by using a fixed-base
percentage of 1.5%. The other two applicable tier
percentages are 4% (of expenses between 1.5% and 2% of the
base amount) and 5% (of expenses exceeding 2% of the base
amount). In California, the applicable AIC rates are
1.49%, 1.98%, and 2.48%, respectively. The federal AIC,
unlike the California AIC, does not apply to any expenses
paid or incurred after December 31, 2009.
THIS BILL authorizes, until January 1, 2016, the
Department of Housing and Community Development (HCD) to
designate, based on specific factors, a Research and
Development Tax Credit Area (RDTCA) located within and
Innovation Hub (iHub) or a city, defined as follows:
A city incorporated on or after July 1,
2000.
"iHub" means an Innovation Hub designated
by the Business Transportation and Housing
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Agency.
Research and Development Tax Credit Area
or "area" means a geographical region designated
by the HCD and must be located entirely within a
jurisdiction or a city or iHub and shall be
smaller in size than the city or iHub.
Provides that proposals from an iHub or City to have
the HCD designate an RDTCA must include the geographical
boundaries of the proposed area and the targeted number of
new, permanent jobs expected to be created by the new
proposed area.
Specifies that designations of RDTCAs by the HCD
must be based on specific criteria, including, but not
limited to, the following:
The extent to which the anticipated benefit to the
state from projects or products produced within the
area equals or exceeds the anticipated benefit to
entities
The extent to which the proposed area will create
new, permanent jobs in the state.
The extent to which projects or products produced
within the area result in a reduction of greenhouse
gases, air or water pollution, and increase in energy
efficiency or a reduction in energy consumption, as
specified.
Provides for a research credit that would be
calculated as 20 percent of a qualified taxpayer's
research expenses that are in excess of the specified base
period amount. This credit shall be in effect from January
1, 2011 to January 1, 2016.
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Provides for an unlimited carryover period for credit
amounts generated in years 2011 through 2106.
Provides that a designated RDTCA is exclusive of any
area that is within an existing GTEDA.
Prohibits qualified taxpayers from assigning the
credit within a unitary group. Allows for a qualified
taxpayer to still elect the federal AIC credit.
Requires that the new, increased credit can be claimed
only by a qualified taxpayer operating within a RDTCA in
lieu of the existing California R & D credit.
Requires the Legislative Analyst's Office to report on
the effectiveness of the credit between January 1, 2016 and
December 31, 2016 by evaluating factors including but not
limited to:
The number of jobs created by the program in
this state.
The number of businesses that have remained
in this state or relocated to this state as a
result of the program.
The amount of state and local revenue and
economic activity generated by the program.
FISCAL EFFECT:
The Franchise Tax Board estimates that this bill would
result in a revenue loss of $2 million in fiscal year (FY)
2010-11, $9 million in 2011-12, and $ 20 million in fiscal
year 2012-13.
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COMMENTS:
A. Purpose of Bill
The author provides the following statement:
Assembly Bill 1565 creates targeted Research and
Development Tax Credit Areas with attractive R&D
credits to motivate green technology businesses to
stay in and move to California. AB 1565 will provide
an additional 5% R&D tax credit to businesses located
in an R&D tax area that conduct R&D in alternative
energy sources and advanced transportation
technologies. This incentive will encourage
businesses to remain in California and motivate new
businesses to locate here, retaining and creating
permanent jobs and helping to spur California's
economy. This concentration of green industry
knowledge will help create a strong foundation for
California to become the green industry leader.
Furthermore, encouraging the proliferation of a green
technology industry within California assists the
state in its goal of reducing greenhouse gas emissions
to 1990 levels by 2020, as established by AB 32.
B. Background
iHubs and New Cities
In March, 2010, the California Business,
Transportation and Housing Agency announced the
establishment of six inaugural designations of California's
iHub initiative.
The agency states that the goal of the initiative is to
"harness the creative and entrepreneurial spirit of the
state by encouraging regional collaboration between
research institutions, start-up technology companies, local
governments, venture capitalists, and economic development
organizations with the common goal of creating jobs." The
locations of the iHubs include Livermore, Orange County,
San Francisco, Sacramento, Sonoma County, and Coachella
Valley.
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In addition, there are 7 newly incorporated cities
that would qualify as RDTCAs under this bill: Aliso Viejo,
Elk Grove, Rancho Cordova, Goleta, Menifee, Wildomar and
Eastvale.
Tax Incentives
AB1565 increases the R & D credit but only in newly
designated RDTCAs, i.e. newly incorporated cities or iHubs,
thereby making the credit applicable in a kind of new
GTEDA. Background information on the R& D credit and
GTEDAs is provided below.
R&D Credit
California's research and development tax credit (RDC)
allows taxpayers filing under both the corporation tax (CT)
and in most cases, the personal income tax (PIT) to reduce
their tax liabilities to the extent that they engage in a
particular types of research and development activities.
The RDC was established in 1987, (Chapter 1138, Statutes of
1987, AB 53 Klehs), and is generally tailored after a
similar federal credit.
The RDC is available only for certain types of
qualified research activities that takes place in
California and exceed a certain base level of R&D
expenditures (as determined by the level of R&D
expenditures undertaken by the taxpayer in prior years).
The credit may be used to both offset current-year tax
liabilities and "carried forward" to offset tax liabilities
in future years, but may not be "carried back" to offset
past years' liabilities.
Enterprise Zones and Other GTEDAs
Existing law authorizes the HCD to designate up to 42
enterprise zones based on a statutory list of criteria
related to poverty and economic dislocation. In addition to
the Enterprise Zone Program, existing law also authorizes
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the establishment of two Manufacturing Enhancement Areas
(MEA), one Targeted Tax Area (TTA), and eight Local Agency
Military Base Recovery Areas (LAMBRA). Collectively, these
business incentive areas are referred to as GTDAs.
The GTEDA programs are based on the economic principle
that targeting significant incentives to lower income
communities allows these communities to more effectively
compete for new businesses and retain existing businesses,
which results in increased tax revenues, less reliance on
social services, and lower public safety costs. Residents
and businesses also directly benefit from these more
sustainable economic conditions through improved
neighborhoods, business expansion, and job creation.
Under the GTEDA programs, businesses and other
entities located within the area are eligible for a variety
of local and state incentives. Local government incentives
can include subsidizing the cost of development, funding of
related infrastructure improvements, providing job training
to prospective employees, or establishing streamlined
processes for obtaining permits. The state also offers a
number of incentives, including tax credits, special tax
provisions, priority notification in the sale of state
surplus lands, access to certain Brownfield clean-up
programs, and preferential treatment for state contracts.
C. Arguments For and Against the R & D credit
Arguments for the R&D credit
Generally, research credits are enacted because of
positive externalities and spillovers from research
activity, such as reducing the costs for other firms'
activity, and providing, new, better, and less expensive
products for consumers, according to Bronwyn Hall and Marta
Wosinka, of the University of California at Berkeley, in
their paper, "The California R&D Tax Credit: Description,
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History, and Economic Analysis" (June 1999). However,
because all U.S. firms are eligible for the federal credit,
and research activities would result regardless of state
credits, California's high percentage credit seeks to
influence firm decision-making and confine more research
and development, as well as the positive spillover effects,
to this state. Additionally, research often leads to
production so a firm that takes a research credit may also
cite manufacturing in the same state that provides the
research incentive.
In a tax system often criticized as unfriendly to
business, California's research credit builds on its
competitive advantages of a highly educated workforce and a
world-class public higher education system. It can be
argued that California's research and development tax
credit provides a powerful incentive for firms to conduct
research and development in California, with high research
credit percentages that exceed other states' similar
credit. The credit is quite popular, with over 5,000
returns claiming more than $550 million in credits in 2003.
Arguments against the R&D credit
California conforms too many aspects of the federal
research credit, albeit at lower percentages and with a few
more rules. And, California recently allowed taxpayers to
assign R&D credits within the unitary group. However,
given the current high levels of investment in research and
development in California, its highly educated workforce,
and the research infrastructure currently operating in the
state, will increasing credit percentages-on a local,
specified basis- result in a substantive increase in
research activities in the state, or merely serve as a
reward for work companies are doing regardless? The
Committee may wish to consider what marginal increase in
research, and the commensurate positive spillovers, will
result from increasing research credit percentages,
especially when fiscal realities may necessitate reduced
state funding for public services resulting from the
revenue loss.
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Moreover, given the positive impact of the credit and
the generous federal credits, it is unclear whether an
increase in the state credit would produce any additional
benefits.
D. Arguments For and Against GTEDAs
Arguments for GTEDAs
Enterprise zone and other GTEDA advocates cite
accounts from taxpayers who state that they locate in
California largely because of GTEDA incentives, which
overcome disadvantages posed by California's tax and
regulatory system. Enterprise zone supporters state that
the incentives draw investment into economically distressed
communities and provide avenues for hard-to-hire
individuals to find employment.
Furthermore, in November 2008 and later revised and
re-released in March 2009, economists from the University
of Southern California (USC) released a report that
strongly supports the efficacy of GTEDAs as labor market
interventions. The USC study found that federal empowerment
zone, federal enterprise communities, and state enterprise
zones have "positive, statistically significant impacts on
local labor markets in terms of the unemployment rate, the
poverty rate, the fraction with wage and salary income, and
employment."
Arguments against GTEDAs
Detractors of GTEDA programs state that these programs
offer a poor return on the state's investment due to their
statutory design. Consider this argument in the context of
AB 1565. This bill could lead to certain businesses
leaving an older city, such as Stockton, and moving to a
newer, neighboring city, such as Elk Grove - where the
business could potentially qualify for the increased R&D
credit if Elk Grove is designated as a RDTCA. In this case,
one community wins, but another loses. The RDTCA can be
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viewed as an economic distortion, causing a mere transfer
of payments and tax advantage to the business without
attracting any new investment to California and leading
only to foregone revenue to the state. In addition,
qualifying incumbents of a newly designated RDTCA would
gain an added tax benefit, thereby awarding them for
something they were already planning to do. Thus, the tax
determinants were not factors in the business' location in
the first place.
Moreover, the Public Policy Institute of California's
(PPIC) main finding is that enterprise zones have no
overall effect on job growth. PPIC released a study in June
2009 which looked at whether the enterprise zone program
has been successful in creating more jobs than would have
otherwise been established without the zone. PPIC's report
concluded that "enterprise zones have no statistically
significant effect on either business creation or
employment growth rates."
Support and Opposition
Support:City of Elk Grove (sponsor), City of
Livermore, City of Palm Springs
Oppose:None on file
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Consultant: Meg Svoboda
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