BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 444 - Ashburn
As Introduced
Hearing: May 13, 2009 Tax Levy Fiscal: Yes
SUMMARY: Increases Research and Development Tax Credit
from 15% to 20%; Conforms to the Federal
Alternative Incremental Research Credit
EXISTING LAW provides various tax credits designed to
provide incentives for taxpayers that incur certain
expenses, such as child adoption, or to influence behavior,
including business practices and decisions, such as
research and development credits and Geographically
Targeted Economic Development Area credits. The
Legislature typically enacts such tax incentives to
encourage taxpayers to do something but for the tax credit,
they would otherwise not do.
EXISTING FEDERAL LAW provides research and development
tax credits to encourage companies to increase their
research and development activities. Research expenses
must qualify as an expense, be incurred in the United
States, and be paid by the taxpayer. Additionally,
research must discover information technological in nature,
involve experimentation, and intended to develop a new or
improved business component, among other requirements.
In December, 2006, Congress enacted the Tax Relief and
Health Care Act (TRHCA), which extended research and
development credits, created the alternative simplified
SB 444 - Ashburn
Page 5
credit, and increased the alternative incremental credit
rates. As amended, federal law provides three research and
development tax credits:
A research credit equal to 20% of the
incremental amount of qualified research and
development costs that exceed its base year
amount, a product of the taxpayer's fixed-base
percentage and average gross receipts for the
four years before the taxpayer takes the credit.
This credit rewards firms that increase their
research and development expenses over their
previous efforts. California conforms to this
credit for research conducted in California,
except at a lower percentage of 15%. California
also offers corporate taxpayers a basic research
payment credit, for university and hospital-based
research, of 24%.
A new alternative simplified credit equal
to 12% of research expenses that exceed 50% of
the average research costs for the three
preceding taxable years.
An alternative incremental credit equal
to the sum of an increasing percentage of the
amount of qualified research and development
costs in excess of a percentage of the base
amount, defined as the average gross receipts for
the last four years, divided into three tiers:
o 3% (formerly 2.65%) of expenses
between 1% and 1.5% over the base amount.
California allows a credit equal to 1.49% of
these research expenditures.
o 4% (formerly 3.2%) of expenses
between 1.5% and 2% of the base amount.
California's credit equals 1.98% of these
costs.
o 5% (formerly 3.75%) of expenses
exceeding 2% of the base amount.
California's credit equals 2.48% of these
SB 444 - Ashburn
Page 5
costs.
EXISTING STATE LAW mostly conforms to federal law,
except at the lower percentages listed above. California
research credits may not be combined with other credits,
although they may be shared with subsidiaries and
affiliates within the commonly controlled group for taxable
years beginning on and after July 1, 2008 (AB 1452,
Committee on Budget, 2008).
THIS BILL increases the amount of California's
research expense credit from 15% to 20% and increases the
amount of California's alternative incremental credit from
current state rates listed above to the recently increased
federal rates (3%, 4%, and 5%).
FISCAL EFFECT:
According to Franchise Tax Board (FTB), SB 444 results
in revenue losses of $40 million in 2009-10, $65 million in
2010-11, $57 million in 2011-12, and $60 million in
2012-13.
COMMENTS:
A. Purpose of the Bill
According to the Author, "This bill would increase
research and development tax credit from 15 to 20% of the
excess of the qualified research expenses. This bill would
also provide complete conformity to the alternative
incremental credit provided under federal income tax laws.
Increasing Rand D incentive will help California to improve
the domestic competitiveness of its business environment
become more competitive, thereby keeping jobs in the State
and encouraging the creation of new jobs through the
expansion of existing businesses.
SB 444 - Ashburn
Page 5
For many of California's most important industries,
research and development is an essential component to
maintaining competitiveness and allowing the growth of
business. Californian companies have long been on the
cutting edge of improving existing technologies as well as
creating new ones. Continued research and development is a
essential component to success and growth of major
industries in the State. Many companies, particularly small
and startup businesses rely on such tax incentives to allow
the companies to remain viable during years of costly
research that provide for future productivity.
The aerospace industry attracts the attention of
policy makers because it contributes significantly to the
economy of the state. The industry provides a number of
well-paid jobs and is a spring board of innovation for
other sectors. Historically, California has had a
significant share of the U.S. American aerospace industry.
Although this share has been declining, California still
has the largest share of U.S. aerospace employment.
California has been losing aerospace jobs to other
states. In the 1990s, the state lost about 166,300
aerospace jobs. By 1999, California employment in the
aerospace industry was less than half of what it was in
1986. In 1986 California had almost one third of U.S.
aerospace jobs, in 1990 it was 29 percent, reducing to 22
percent by 1998. In 2006 this share was 19 percent, but
still above the California's share of U.S. average
manufacturing employment (11 percent).
Between 1998 and 2006, the aerospace industry in the
rest of the country lost 12 percent of its workforce, but
California lost more than twice this amount. Most of the
losses took place in aircraft and components manufacturing.
During this period, Washington State's share of U.S.
aerospace employment also decreased, while the number of
U.S. aerospace workers increased for Texas, Arizona,
Georgia, Ohio, and Illinois.
It is evident that California must do more to attract
and keep businesses given the increasingly competitive
domestic market. The increase to the Research and
development tax incentive will help California to stop the
exodus of important industry and remain the golden state
for the businesses of today and tomorrow."
SB 444 - Ashburn
Page 5
B. Positive Externalities and California's Research and
Development 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,
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. Enacted in
1986 (AB 53, Klehs), and made permanent in 1988 (SB 671,
Alquist), 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.
C. Thinking at the Margin
Home to many of the world's most innovative firms,
California provides a research and development credit, much
like the federal credit, that provides incentives for
SB 444 - Ashburn
Page 5
incremental increases in research. A firm spending more
this year than last year on research claims a credit on
that increment of research costs; the credit does not serve
as a reward for past behavior, instead it's an incentive to
increase research activity on top of existing
infrastructure. The bigger the marginal increase in
research expenses, the bigger the credit.
California conforms too many aspects of the federal
research credit, albeit at lower percentages and with a few
more rules, and 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 result in a
substantive increase in research activities in the state,
or merely serves 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.
D. If it Ain't broke?
There is substantial evidence that the joint federal and
state effect of the R&D credit has created a multiplier of
positive benefits to the state and nation. Given the large
combined rate of the credit, it may be one of the most
significant government programs for new technologies. For
example:
A 1995 report from Congress's Office of Technology
Assessment found that the credit stimulated $1 of new
R&D for every $1 of revenue loss.
SB 444 - Ashburn
Page 5
A 1993 study by economist Bronwyn Hall of the
National Bureau of Economic Research found $2 of
additional R&D for every $1 of revenue loss.
A Coopers & Lybrand study finds that over a 12-year
period the credit stimulates additional productivity
and economic growth, raising federal revenue by almost
enough to pay for the credit -- that is, the dynamic
revenue loss is just 35 percent of its static loss.
Given the positive impact of the credit and the generous
federal credit, it is unclear whether an increase in the
state credit would produce any additional benefits. The
committee may wish to study the marginal effect of state
conformity to the federal credit.
E. Related Legislation
AB 765 (Caballero, 2009/2010) would increase the
credit for increasing qualified research expenses to 20
percent incrementally over a four year period beginning in
taxable year 2011.
Support and Opposition
Support:BIOCOM
Lockheed Martin Corporation
California Taxpayers' Association
SB 444 - Ashburn
Page 5
Oppose:California Tax Reform Association
---------------------------------
Consultant: Colin Grinnell