BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 1053 - Runner
As Introduced February 16, 2010
Hearing: April 28, 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 states that it would incur costs to administer
this bill. 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
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BOE estimates that this bill will result in a revenue
loss of $600 million in fiscal year (FY) 2010-11, and $1
billion in FY 2011-12.
COMMENTS:
A. Purpose of Bill
According to the author, "it is important that
California stimulate job creation and retention across all
areas of the manufacturing sector, not just green jobs. As
proven with prior legislation of this nature, the
multiplier effect of SB 1053 will stimulate growth of both
the manufacturing and research and development sectors,
which is essential to reviving California's economy."
"Over the previous year, the manufacturing sector lost
106,200 jobs and on a seasonally adjusted basis, the sector
lost 7,200 jobs in December 2009. Unfortunately for
California's manufacturers, our state is only one of three
states that tax manufacturing equipment purchases with no
credit or exemption. Most other states recognize that
taxing input as well as the final manufactured product is
double taxation and discourages investment. Manufacturing
jobs are critical to the overall health of our economy and
taxing manufacturing equipment is poor tax policy that only
hinders growth."
B. Background
For a ten-year period ending December 31, 2003,
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 from the state tax portion for sales and
purchases of qualifying property, and the income tax credit
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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.
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
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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, 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
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
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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.
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
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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.
D. Administrative and technical concerns
Should the measure advance from the Committee's suspense
file, the Committee should amend the measure to address the
following administrative and technical concerns:
In defining "qualified person," it is recommended
that the bill require that the qualifying entity be
primarily engaged in the activities described in the
referenced codes. This is an important issue and one
that generated many disputes when the Board of
Equalization (BOE) administered Section 6377
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previously.
Another issue relates to the proposed definitions
for the types of property included and excluded from
the proposed exemption. For example, on page 4, lines
20 and 37, the bill refers to the items having a
useful life of one year or more (or less than one
year). In order to lessen potential audit disputes,
the bill should contain some mechanism for determining
the useful life. Perhaps some reference to the
provision in the California income tax laws for
depreciating assets should be incorporated into the
bill.
Subdivision (g) of proposed Section 6377 (see page
6, line 3) provides for an exemption from tax for
specified leases of qualified property and limits this
exemption for a six-year period. This limitation is
modeled after a provision in former Section 6377 that
provided a state tax exemption solely to new
manufacturers' leases of equipment. Since this bill
would provide the exemption for all qualifying
persons, it appears the limitation in subdivision (g)
is unnecessary and should be stricken. Otherwise,
long-term leases of qualifying property would not
enjoy the same tax privileges that the bill would
provide to actual purchases of the same property.
Support and Opposition
Support:Cal-Tax, BayBio
Oppose:American Federation of State, County ad
Municipal Employees,
AFL-CIO, California Tax Reform Association
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Consultant: Meg Svoboda