BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 939 - aanestad
Introduced: February 3, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Allows Taxpayers within the Oroville Enterprise
Zone to Sell Enterprise Zone Hiring Credits to
Unrelated Parties.
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 LAW provides special tax incentives for
businesses located in enterprise zones (including
accelerated depreciation, 100% net operating loss
carryover, wage credits, and credits for sales tax on
equipment purchased for use in the zone). The law allows
the governing body of a city or county to request the
Department of Housing and Community Development (HCD) to
designate qualified areas as enterprise zones from
applications received from the governing bodies. Zones are
designated for 15 years with the exception of zones
designated prior to 1990 that may have their designation
period extended to 20 years.
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EXISTING LAW allows four kinds of Geographically
Targeted Economic Development Areas: 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
LAMBRAs, two MEAs, and one TTA, all of which are
designated.
EXISTING LAW allows employers inside an enterprise
zone to claim a tax credit of 50% of the wages paid to a
qualified employee in the first year, 40% in the second
year, 30% in the third year, 20% in the fourth year, and
10% in the fifth year, up to 150% of the minimum wage.
Qualified employees include individuals:
Eligible for job training programs
Eligible for most social welfare programs
Economically disadvantaged
A "dislocated worker," as defined
A disabled individual who is eligible or
enrolled in a state rehabilitation plan
Service connected veteran
Ex-offender
Member of a federally recognized Indian tribe
Residents of a Targeted Employment Area
EXISTING LAW requires the California Film Commission
to allocate $100 million in tax credits for film production
each year for five years (ABx3 15, Krekorian and SBx3 15,
Calderon, 2009). Eligible taxpayers may assign the credit
to other subsidiaries and affiliated within the unitary
group, who can also apply the credit to any sales tax
obligations incurred as a result of retail business.
Credits attributable to independent films may be sold to
other investors.
THIS BILL allows taxpayers that derive enterprise zone
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hiring credits under the Personal Income Tax or the
Corporation Tax to sell the credit to an unrelated party.
The taxpayer must report the sale to the Franchise Tax
Board (FTB) with all required information regarding the
purchase and sale of the credit, including the social
security number or other taxpayer identification number of
the unrelated party acquiring the credit, and the sale
price or other consideration received for the credit.
Taxpayers may only sell the credit once, and cannot claim
on its return any sold tax credit Should the taxpayer
generating the credit and the firm acquiring the credit
both claim the same credit, FTB may disallow the credit of
either taxpayer, but only if the statute of limitations
still apply, which is generally four years. The measure
also states legislative intent that the proceeds of any tax
credit sales authorized by the bill be used for the
expansion of business activities, the hiring of staff, the
purchase of capital, or for any other business operational
expense related to maintaining the business within the
Oroville enterprise zone.
FISCAL EFFECT:
According to the FTB, SB 939 results in revenue losses
to the state of $1.5 million in 2011-12, $1.6 million in
2012-12, and $1.7 million in 2012-13.
COMMENTS:
A. Purpose of the Bill
SB 939 would authorize the sale of an unused hiring
tax credit by a business in the Oroville Enterprise Zone to
an unrelated party. The proposal originates from an
independent analysis prepared by the City of Oroville that
explored ways to improve the business attractiveness of the
City and its Enterprise Zone. The analysis concluded, in
part, that allowing the sale of these unused credits would
be a significant economic attraction for businesses.
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There is precedent for the sale of unused tax credits.
In 2009 the legislature passed ABx3 15 to allow businesses
associated with the entertainment industry to sell credits
to an unrelated party (Revenue and Taxation Code Section
17053.85 (c)).
B. Not so EZ.
California's enterprise zone program, the result of
collaboration between former Assemblymembers Pat Nolan and
Maxine Waters (AB 40 and 514, 1984, respectively), has
evolved from a well-intentioned legislative effort to use
tax credits to draw investment into depressed rural and
urban areas into an almost half-billion tax credit program
referred to as California's best economic development
program. Passionately defended by business interests and
local administrators as the state's best tool for economic
development, the program is not without detractors who
state that the program offers a poor return on the state's
investment due to its statutory design. Administered by
the Department of Housing and Community Develop (HCD),
which took over responsibility for the EZ Program from the
now-defunct Trade and Commerce Agency in 2003, the program
allows five different tax benefits for taxpayers doing
business in one of the state's 42 zones.
For many years, the program resulted in revenue losses
of less than $10 million. However, beginning in 1998, the
program began to significantly grow in cost, due largely to
an industrious cottage industry of accounting firms and tax
credit consultants that found the program could be marketed
under contingency arrangements to taxpayers who were
unaware of its generous benefits, especially the hiring
credit, which can be worth up to $37,444 to an employer
over five years if qualified wages reach the cap of 150% of
the minimum wage. Additionally, some of these accounting
firms and tax credit consultants pushed local zone
administrators to issue certifications qualifying employees
for the hiring credit using questionable interpretations of
statute and scant documentation, including
"cross-jurisdictional vouchering," where an enterprise zone
manager for one zone would certify employees employed in a
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different zone, among others.
HCD's vouchering regulations eliminated or limited
many sources of abuse in 2007; however, accounting firms
and tax credit consultants unsuccessfully brought suit to
enjoin the regulations (Cyntron Payroll Solutions v.
Department of Housing and Community Development), and
attempted to disqualify the Franchise Tax Board from
auditing enterprise zone tax credits at all, arguing that
the Government Code placed local zone administrators as the
sole arbiters of whether an employee is qualified under
criteria in the Revenue and Taxation Code. The BOE
affirmed FTB's role in The Appeal of Deluxe (Dec. 12, 2006,
No. 297128) 2006 Cal. Tax Lexis 432, but FTB's authority
was subsequently weakened by the Second Court of Appeal in
Dicon Fiberoptics v. Franchise Tax Board (Case B202997,
2009) by stating that while FTB is legally authorized to
audit EZ credits, the voucher constitutes prima facie
evidence that the taxpayer is entitled to the credit.
Enterprise zone advocates cite accounts from taxpayers
who state that they locate in California largely because of
enterprise zone program 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.
At the Committee's Enterprise Zone Oversight Hearing
on March 10, 2010, the Committee from proponents and
opponents of the program. The Committee also received oral
and written testimony from several academic experts on the
subject:
Dr. Charles Swenson, whose work shows
that enterprise zones have decreased unemployment
and poverty rates in California census tracts
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within zones<1>
David Neumark, whose paper states that
California's enterprise zones have no effect upon
employment and business formation in zones,<2>
zones which have lower share of manufacturing and
where managers perform more marketing activities
have more favorable effects on employment, and
zones that devote more time to helping firms
claim tax credits eliminate any positive
benefit.<3>
Eileen Norcross of the Mercatus Center at
George Mason University, who stated that
enterprise zones have failed to produce the hoped
for benefits of economic revitalization and
robust economic growth because the policy is
discriminatory and introduces complexity and
gamesmanship into the tax code and business
decisions. Norcross recommends that the state
should instead set rules that encourage
entrepreneurship without regard to firm size or
business activity.
The Legislative Analysts' Office, which
recommends the program be eliminated or
restructured.
While SB 939 would grant flexibility for the
enterprise zone in Oroville by allowing firms that cannot
use hiring tax credits because of insufficient tax
liability, should a program with such questionable return
---------------------
<1> "Government Programs Can Improve Local Labor Markets:
Evidence from State Enterprise Zones, Federal Empowerment
Zones, and Federal Enterprise Communities," by John Ham,
Ayse Imrohoroglu, and Charles Swenson, February 2009.
<2> "Do Enterprise Zones Create Jobs?" by David Neumark and
Jed Kolko, Journal of Urban Economics, June 2010
<3> "Do Some Enterprise Zones Create Jobs?" by Jed Kolko
and David Neumark. Journal of Policy Analysis and
Entrepreneurship, Vol 29, No. 1, 5-38 (2010).
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on investment to the state be expanded in any way before a
comprehensive reform effort is enacted? The Committee may
wish to consider whether selling credits begs the question
of a program this is poorly designed to achieve the state's
economic development needs, especially in rural areas
during economically trying times when taxpayers lack
sufficient net income to offset with tax credits.
C. The Right Tool for the Job?
Tax credits directly reduce taxes due, which is
determined by multiplying adjusted income by the
appropriate marginal rate. Tax credits are either
non-refundable and enacted by a majority vote of each house
of the Legislature, meaning that the value of the credit
reduces tax due until equal to zero, or, refundable and
enacted by a 2/3 vote, which requires the state to refund
the remaining value of the credit after tax due is reduced
to zero. Because the enterprise zone hiring credits are
nonrefundable, a firm must have positive net income in a
tax year to make use of the credit, although a firm may
carry over an enterprise zone hiring credit infinitely
until exhausted; LAO calculates that $595 million in
enterprise zone hiring credits have been generated but not
yet used through 2007.
SB 939 highlights the limitations of using the
enterprise zone hiring credit, showing the inefficiency of
using the tax code to create economic development
incentives: eligible firms in the Oroville Enterprise Zone
lack sufficient tax liability to use the full value of the
credit (or use it at all), so the Zone would like the state
to grant firms within the zone the ability to sell the
credit. Firms are engaging in the activity the state
wants them to - ostensibly hiring hard-to-hire individuals
within economically depressed areas - but get little
benefit. Selling credits is one tool that can offer
taxpayers an alternative to monetize behavior deemed
beneficial by the Legislature.
Additionally, selling credits afford taxpayers with
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unrelated income a tax shelter. Firms that avail
themselves of California's markets, and marshal land,
labor, and capital to make a profit, pay taxes in exchange
for making use of public services and infrastructure.
Buying a tax credit disconnects these "dues of a civilized
society," by allowing firms to buy its way out of taxation.
With that said, SB 939 is not without precedent: the state
afforded movie producers similar credit selling ability
when it enacted the movie credit because entertainment
companies often form Limited Liability Companies to produce
movies, which pay little to no tax at the entity level
because the firm passes through income to its partners
(ABx3 15, Krekorian, and SBx3 15, Calderon, 2009).
Additionally, firms with subsidiaries and affiliates may
assign tax credits, including enterprise zone hiring
credits, to firms within the unitary group, but can only
offset apportioned zone income (AB 1452, Committee on
Budget, 2008).
D. Think Globally, Act Locally
SB 939 only allows firms within the Oroville
Enterprise Zone to sell credits to unrelated parties.
However, with 39 other enterprise zones in California, and
HCD opening an application round for two more, how soon
before other zones, or all zones, come knocking for the
same benefit, especially if economic activity, and
therefore tax liability, remains tepid? The Committee may
wish to consider the likelihood of future requests should
it choose to grant Oroville's.
Support and Opposition
Support:Oroville Area Chamber of Commerce, City of
Oroville, Butte County Economic Development Corporation,
The Austin Company, Tracy and Associates, Inc., Pacific
Coast Producers, Marsha Edwards, Real Estate Investor,
Roplast Industries, Inc., Private Industry Council of Butte
County, Sierra Pacific Packaging, Inc., IAMED Commercial
Real Estate and Care Facilities, Rodriguez Landscapes
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Oppose:None received.
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Consultant: Colin Grinnell