BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
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Amended: May 5, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Conforms to the federal credit percentage
(20%) for increasing research activities and to
the federal alternative incremental research
credit (AIRC) percentages in effect on January 1,
2005.
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 FEDERAL LAW allows taxpayers a research
credit that is combined with several other credits to form
the general business credit. The research 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:
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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
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 allows taxpayers to
elect an AIRC regime, in which case the taxpayer is
assigned a three-tiered fixed-base percentage and the
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 AIRC rates are
1.49%, 1.98%, and 2.48%, respectively. The federal AIRC,
unlike the California AIRC, does not apply to any expenses
paid or incurred after December 31, 2009.
THIS BILL, under the Personal Income Tax Law and the
Corporation Tax law, would, for taxable years beginning on
or after January 1, 2010:
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1. Increase the credit for increasing qualified
research expenses from 15 percent to 20 percent, and
2. Increase the state's AIRC percentages to equal the
federal percentages in effect of 3 percent, 4 percent,
and 5 percent, as set forth in the Tax Relief and
Health Care Act of 2006.
FISCAL EFFECT:
The Franchise Tax Board (FTB) estimates that this bill
would result in revenue loss of $90 million in fiscal year
(FY) 2010-11, $80 million in FY 2011-12, $75 million in
2012-13 and $75 million in 2013-14.
COMMENTS:
A. Purpose of Bill
The author provides the following statement:
"Increasing the state's Research & Development (R &D)
tax credit would help California retain existing
high-paying research-oriented jobs and create new jobs.
A study by Dr. Daniel Wilson from the Federal Reserve
Bank in San Francisco shows that companies move mobile R&D
to the states with the lowest after-tax cost for conducting
research and development. For instance, after Arizona,
Hawaii and Rhode Island increased their R&D tax credits,
they realized increased amounts of R&D. California must
increase its R&D tax credit to ensure that it remains the
preeminent place to conduct R&D."
B. Background
California's research and development tax credit (RDC)
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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 take 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 both be used
to 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.
C. Arguments For Research Development Credits
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,
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
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world-class public higher education system. In 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.
D. Arguments Against Research Development Credits
California conforms to many aspects of the federal
research credit, albeit at lower percentages and with a few
more rules. Additionally, California recently allowed
taxpayers to assign R&D credits within the unitary group
(AB 1452, Committee on Budget, 2008). 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 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 reducing state funding for public services as a
result of revenue loss. 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.
E. Policy Concern
FTB points out the following policy concern: "Under
federal law, the AIC was terminated at the federal level
for taxable years beginning after December 31, 2008. The
federal change creates additional differences between
federal and California tax law, thereby increasing the
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complexity of California tax return preparation. If
conformity with federal law is the author's intent, the
author may wish to consider amending this bill to eliminate
the AIC election and allow the alternative simplified
credit."
Support and Opposition
Support:TechAmerica
Oppose:California Tax Reform Association
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Consultant: Meg Svoboda