BILL ANALYSIS
RECONSIDERATION - FOR VOTE ONLY
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SBX6 8 - Dutton
As Introduced February 24, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Enacts a State Sales and Use Tax (SUT) Exemption
for Manufacturing and Software Production
Equipment.
EXISTING LAW provides no special tax treatment
to entities engaged in manufacturing or software production
for purchases of equipment and other supplies. Business
entities engaged in manufacturing, research and
development, and software producing activities that make
purchases of equipment and supplies for use in the conduct
of their manufacturing and related activities are required
to pay tax on their purchases to the same extent as any
other person either engaged in business in California.
THIS BILL would provide a partial exemption
(General Fund only) from the SUT rate of 6% (5% on and
after July 1, 2011) for the following purchases made by a
"qualified person":
Tangible personal property to be used 50 percent or more
in any stage of manufacturing, processing, refining,
fabricating, or recycling of property (i.e., machinery,
equipment belts, shafts, computers, software, pollution
control equipment, buildings and foundations), as
specified.
Tangible personal property to be used 50 percent or more
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in research and development.
Tangible personal property to be used 50 percent or more
in maintaining, repairing, measuring, or testing any
qualifying equipment.
Tangible personal property purchased for use by a
contractor, as specified, for use in the performance of a
construction contract for the qualified persons who will
use the property as an integral part of any
manufacturing, processing, refining, fabricating, or
recycling process or as a research or storage facility in
connection with the manufacturing process.
Defines a "qualified person" to mean either
of the following: a person engaged in those lines of
business described in Codes 3111 to 3399, inclusive, or
5112 of the North American Industry Classification System
(NAICS), 2007 edition; or an affiliate of such a person,
provided the affiliate is a member of the qualified
person's unitary group for which a combined report is
required to be filed, as provided.
Specifies that the proposed exemption would
not include (1) any tangible personal property that is used
primarily in administration, general management, or
marketing, (2) consumables with a normal useful life of
less than one year, except for fuels used in the
manufacturing process, and (3) furniture, inventory,
equipment used in the extraction process, or equipment used
to store finished products that have completed the
manufacturing process.
FISCAL EFFECT:
The BOE has not yet completed its analysis of SBX6 8.
However, because this bill is substantially similar to SB
1053, the fiscal effect is the same, which BOE estimates to
be losses of $600 million in fiscal year (FY) 2010-11, and
$1 billion in FY 2011-12.
The BOE would incur costs to administer this bill.
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These costs would be attributable to, among other things,
identifying and notifying qualifying entities, auditing
claimed amounts, revising sales tax returns, reviewing
returns with claimed exemptions, and programming. An
estimate of these costs is pending.
COMMENTS:
A. Purpose of Bill
According to the Author,
"California is only 1 of 3 states in the US that taxes
manufacturing equipment purchases with no credit or
exemption. Most states recognize that taxing the input as
well as the final manufactured product is double taxation
and discourages investment.
Current policy will mean even less production in
California -- out-of-state companies will elect to grow
elsewhere and in-state companies will shift workers or
facilities to other regions that do not burden capital
investments with excess taxation. Since 2000, California
has lost over 600,000 manufacturing jobs. These jobs
represent quality middle class careers that have an average
wage of sixty thousand dollars, provide for upward mobility
and typically include health benefits. Manufacturers have
the highest multiplier of any industry with networks of
suppliers whose economic vitality have a direct and
positive impact on the state's revenue.
Forbes Magazine ranks California as the most costly
state to do business, while the Chief Executive Magazine
finds California's business climate as the worst in the
nation for the 4th year in a row. With California's
unemployment rate at 12.4%, 5th worst in the nation, it is
vital that the Legislature enact meaningful reforms to help
California's economy grow."
B. Background
For a ten-year period ending December 31, 2003,
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California law provided a partial (General Fund only) sales
and use tax exemption for purchases of equipment and
machinery by new manufacturers, and income and corporation
tax credits for existing manufacturers' investments (MIC)
in equipment (SB 671, Alquist, 1993). Manufacturers were
defined in terms of specific federal "Standard Industrial
Classification" (SIC) codes. The bill provided an
exemption to the state tax portion for sales and purchases
of qualifying property, and the income tax credit was equal
to six percent of the amount paid for qualified property
placed in service in California. Qualified property was
similar to the property described in this bill -depreciable
equipment used primarily for manufacturing, refining,
processing, fabricating or recycling; for research and
development; for maintenance, repair, measurement or
testing of qualified property; and for pollution control
meeting state or federal standards. Qualified property
also included tangible personal property purchased by a
contractor, as specified, for use in the performance of a
construction contract for the qualified person who would
use that property as an integral part of the manufacturing
process, as described. Certain special purpose buildings
were included as "qualified property," as this bill
proposes. New manufacturers could either receive the
benefit of the exemption, or claim the income tax credit.
However, existing manufacturers could only receive the
benefit of the income tax credit.
This sales and use tax exemption and income tax credit
had a conditional sunset date. They were to sunset in any
year following a year when manufacturing employment (as
determined by the Employment Development Department) did
not exceed January 1, 1994 manufacturing employment by more
than 100,000. On January 1, 2003, manufacturing employment
(less aerospace) did not exceed the 1994 employment number
by more than 100,000 (it was less than the 1994 number by
over 10,000), and therefore the MIC and partial sales tax
exemption sunsetted at the end of 2003.
Since the expiration of the partial exemption of
manufacturing equipment, numerous bills have been
introduced to either reinstate or to expand or modify the
exemption, but have failed to pass.
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C. Arguments For and Against the MIC
SB 1053 provides a sales and use tax exemption for
manufacturing equipment that qualified taxpayers for the
now-defunct Manufacturers' Investment Credit. Tax credits
provide a dollar-for-dollar reduction in tax, which is
based on a firm's net income, so only firms that generate
profits may make use of tax credits. Additionally, tax
credits may exceed tax due for the year in which the firm
generates the credit, but can often carry the credit
forward to future years. Even then, the Legislature can
limit the use of tax credits, as it did for the 2008 and
2009 tax years, when it capped the use of credits and Net
Operating Loss deductions to 50% of a taxpayer's liability
(AB 1452, Committee on Budget, 2008). Sales tax exemptions
are superior to tax credits because it benefits all
companies that purchase qualified equipment, regardless of
whether the firm is profitable.
It has been argued that there is no way to directly or
even indirectly measure the effect of the MIC on jobs
because the connection is so tenuous. Also, it has been
argued that there is no way to tell whether equipment was
purchased in response to the MIC or whether it would have
been bought anyhow without the credit.
In an October 2002 report put out by the Legislative
Analyst's Office, An Overview of California's
Manufacturers' Investment Credit, and the following
arguments against and in support of these tax incentives
were presented:
Arguments In Support of the MIC
Investment Incentive-The MIC effectively reduces the
price of new capital, and leads to greater investment.
Adherents of this view suggest that a firm considering a
capital investment is much more likely to undertake such
investment with the MIC in place. Proponents argue that
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this marginal cost reduction can have a significant
positive impact on investment decisions.
Relocation Incentive-California has become a more
attractive place relative to other states for business
since the credit has been in place. The argument here is
that tax credits do influence corporate location
decisions and dissuade businesses from moving their
activities out of California. Manufacturing industry
representatives stated and continue to state that the MIC
plays an important role in both expansion and business
location decisions.
Efficient Job Allocator-Competition for business among
states is an efficient job allocator. This argument
holds that the nation benefits from the redistribution of
jobs that may occur due to the use of investment tax
credits. This is based on the notion that jobs are worth
more in areas with higher unemployment, and that such
areas are likely to have relatively aggressive tax credit
programs. These areas will be able to attract businesses
away from regions that do not value the jobs as highly.
Other Arguments. Advocates of the MIC also emphasize that
the MIC offers significant indirect benefits to the state
in terms of investment and job growth that result in
additional state revenues. They also point out the
importance of manufacturing to the overall state economy
in terms of economic stability and the high value-added
nature of the employment in this sector.
Arguments against the MIC
Inequitable Taxation-The MIC results in giving a tax
advantage to manufacturing over other business
activities, as well as providing an advantage to capital
investment over labor. This view holds that since only
one type of industry (and production factor) benefits
from the tax credit, the remaining industries face
relatively higher costs, and are therefore at a
competitive disadvantage. Such preferential treatment
can also result in inefficient resource allocation
according to this view.
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Relocation Rather Than Creation-The MIC results in few
new jobs, but rather pits states against each other in
competing for jobs. The argument here is that corporate
tax breaks are no more than a transfer of government
funds to private businesses, and in the end, the national
economy is unaffected. In this view the competition
among states in offering various tax incentives
represents a form of "prisoners' dilemma"-in which each
state would be better off if none offered such
incentives. If one state does offer them, however, it is
in the interest of other states to do the same.
Inefficient Development Policy-Tax incentives have a
negligible impact on economic growth, and any job
creation that does occur does so at a substantial cost
per job. Proponents of this view also hold that some of
the tax credits will go to companies which would have
made the same investments, regardless of the tax
incentive. That is, the tax credit did not induce the
investment, yet the company receives "windfall benefits"
in the form of reduced taxes.
Ineffective Development Policy-Taxes are a very small
percentage of overall business costs and thus have little
effect on business decisions. Labor, transportation,
land, and other factors typically constitute much more
significant proportions of total costs than do taxes.
Therefore, according to those who hold this view,
tinkering with this particular cost is unlikely to result
in a large shift or expansion of business compared to the
adverse fiscal effects that such measures can have on the
state.
Support and Opposition
Support:
California Manufacturers & Technology Association,
California Aerospace & Technology Association, California
Taxpayers Association, TechAmerica
Oppose:None received
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Consultant: Meg Svoboda