BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SB 1239 - Wyland
Amended: March 25, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Enacts Six Business Tax Benefits.
I. Sales Tax Exemption for Manufacturing Equipment
EXISTING LAW provides no special tax treatment to
entities engaged in manufacturing production for purchases
of equipment and other supplies. Business entities engaged
in manufacturing and research and development 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 engaged in business in
California.
THIS BILL, beginning January 1, 2011, provides a
state (General Fund only) sales and use tax exemption for
purchases of qualifying tangible personal property by
persons engaged in manufacturing, as defined.
II. Enhances Research and Development Tax Credit
EXISTING FEDERAL LAW provides research and development
tax credits to encourage companies to increase their
research and development (R & D) activities. Research
expenses must qualify as an expense, be incurred in the
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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.
THIS BILL, under the Personal Income Tax Law and the
Corporation Tax law, would, for taxable years beginning on
or after January 1, 2010:
1. Increase the credit for increasing qualified
research expenses from 15 percent to 20 percent, and
2. Increase the state's Alternative Incremental
Research Credit (AIRC) percentages to equal the
federal percentages in effect on January 1, 2005.
Thus, the former federal percentages of 2.65 percent,
3.20 percent, and 3.75 percent, would apply for state
purposes.
III. Tax Credit for Hiring Qualified Persons
EXISTING LAW allows a New Jobs credit enacted in 2009
to qualified employers equal to $3000 for each net increase
in qualified full-time employees hired during the taxable
year. The credit is limited to small businesses, as
defined, and is capped at roughly $400 million for all
taxable years.
EXISTING FEDERAL LAW, under the Work Opportunity
Credit program, provides that an employer may qualify for a
tax credit of up to $9,000 if the employee is a member of a
designated target group including qualified veterans
receiving Food Stamps or qualified veterans with a service
connected disability, as specified.
THIS BILL enacts a new tax credit for taxpayers for
hiring a qualified employee beginning in the 2010 tax year.
Taxpayers inside or outside a geographically targeted
economic development area may claim the credit. A
qualified employee is a CalWORKs recipient, a parolee, a
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person on probation, a veteran, or a person who previously
received unemployment benefits. The taxpayer may claim a
credit equal to:
25% of wages paid or incurred by the
taxpayer during the taxable year for each
qualified employee who worked between 120 and 400
hours during the taxable year.
40% of wages paid or incurred by the
taxpayer during the taxable year for each
qualified employee who worked at least 400 hours
in the taxable year.
IV. Accelerated Depreciation
EXISTING LAW authorizes, under the personal income tax
law and corporation tax law, a taxpayer to depreciate
property, determined by an applicable depreciation schedule
and method and an applicable recovery period.
THIS BILL would reduce the recovery period for
depreciating property to one- half of the period authorized
under existing law, thereby accelerating a business'
depreciation schedule for its tangible property, as
specified.
V. Five-Year Net Operating Loss Carryback
EXISTING LAW allows net operating loss (NOL)
carrybacks to the preceding two taxable years to be allowed
for operating losses attributable to 2010 and later.
EXISTING FEDERAL LAW provides, in general, that an NOL
can be carried back 2 years and forward 20 years and
deducted. Special rules are provided for the carryback of
NOLs relating to issues such as specified liability losses,
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casualty or theft losses, disaster losses of a small
business, and farming losses.
Recent changes in federal law extend the carryback
period up to five years for specified losses. The American
Recovery and Reinvestment Act (ARRA) allows certain
taxpayers to make an irrevocable election to carry back
applicable 2008 losses for up to 5 years. The Worker,
Homeownership, and Business Assistance Act of 2009 allows
taxpayers, other than taxpayers that received benefits
under the Troubled Asset Relief Program, with business
losses to make an irrevocable election to carry back losses
incurred in one year (ending after 2007 and beginning
before 2010) for up to 5 years.
THIS BILL conforms to federal law under the Worker,
Homeownership, and Business Assistance Act of 2009 which
allows businesses to carryback NOLs for 5 years. This bill
authorizes 50% of loss deductions by 2011, and for
subsequent years authorizes 100% of loss deductions for the
extended 5 year carryback.
VI. Eliminates Capital Gains Taxes
EXISTING LAW generally follows the federal rules for
defining capital assets, identifying holding periods, and
determining the gain or loss from the sale or exchange of a
capital asset, except capital gains are taxed at ordinary
income tax rates under the personal income tax law and
ordinary franchise/income tax rates under the corporate tax
law.
THIS BILL provides, under the personal income tax law
and the corporation tax law, that gross income shall not
include any gain from the sale or exchange of any capital
asset, thereby eliminating the state tax on capital gains.
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FISCAL EFFECT:
The Board of Equalization (BOE) estimates that this
bill's exemption of tangible personal property purchased by
manufacturers from the state sales and use tax will result
in a revenue loss of $0.6 billion in January -June 2011,
and $1 billion in fiscal year (FY) 2011-12.
The Franchise Tax Board (FTB) estimates that this bill
will result in a revenue loss of $16.1 billion in FY
2010-11, $11.5 billion in FY 2011-12 and $13.6 in FY
2012-13. These revenue losses are as follows:
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| For Tax Years Beginning On or After January 1, 2011 |
|--------------------------------------------------------------------|
| Assumed Enactment Date By September 30, 2010 |
|--------------------------------------------------------------------|
| ($ in Millions) |
--------------------------------------------------------------------
-------------------------------------------------------------------
| 2010-11 |2011-12 |2012-13 |
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|----------------+----------------+----------------+----------------|
|Research credit |-$175 |-$165 |-$155 |
| | | | |
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|Hiring credit |-$4,400 |-$5,000 |-$4,500 |
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|Accelerated |-$1,575 |-$1,150 |-$850 |
|depreciation | | | |
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|NOL |-$2 |-$9 |-$12 |
|----------------+----------------+----------------+----------------|
|C/G income |-$9,900 |-$5,200 |-$8,100 |
|exclusion | | | |
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COMMENTS:
A. Purpose of Bill
The author provides the following statement:
"California needs bold reforms to address the state's
looming unemployment and struggling economy. In order to
spur recovery, make California competitive for investment,
and provide incentives for job creation, the legislature
must act immediately to adopt policies to address these
important issues. California is desperate for measures that
will stem job loss and entice businesses to hire new
employees.
This legislation will encourage job creation and
bolster investment in California by enacting a sales and
use tax exemption for manufacturing equipment, eliminating
the state tax on capital gains, establishing hiring credits
for new employees, increasing the research and development
credit, shortening depreciation schedules and extending the
current net operating loss deduction rules."
B. Tax Expenditures
The Department of Finance defines a tax expenditure as
a "deduction, exclusion, exemption, credit, or any other
tax benefit as provided by the state." When policymakers
institute new tax expenditures, the state agrees to forego
tax revenues in the hopes of providing increased equity in
the tax system or seeking to change private investment
behavior. In addition to increasing the R & D credit and
providing a sales and use tax exemption for manufacturing,
SB 1239 would enact a tax expenditure in the form of a
hiring credit, designed to encourage the employment of new
employees.
As California faces another fiscal imbalance,
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policymakers are increasingly interested in the state's tax
expenditures, their goals and objectives as well as their
efficacy. California foregoes approximately $50 billion in
revenue each year due to tax expenditures. These range from
the exclusion from income for pension contributions and
social security benefits to subsidies for other types of
economic behavior deemed preferable by the Legislature,
such as the mortgage interest deduction to spur
homeownership, the research and development credit to
stimulate high-paying jobs and new exciting consumer
products and services. Tax expenditures evoke passionate
and complicated debates, chiefly regarding whether state
legislative action to forego tax revenues from specified
taxpayers provides superior benefits than commensurate
direct spending programs or general tax reductions
SB 1239 enacts various tax expenditures simultaneously
in attempt to spur job creation and business investment.
The Committee may wish to consider the efficacy and
efficiency of existing federal and state tax incentives
before straining the state's finances to allow SB 1239's
sweeping credits that may be duplicating current programs.
C. NOL Carrybacks
A net operating loss (NOL) is incurred when a business
taxpayer has negative taxable income. An NOL can be used to
obtain a refund for taxes paid in the past and/or to reduce
future tax obligations. The process of using an NOL to
refund previously paid taxes is known as an NOL carryback,
whereas the process of using an NOL to reduce future taxes
is known as a carryforward. Under federal law, nearly every
taxpayer is allowed to carry back an NOL from a trade or
business to apply as a deduction against income in prior
taxable years. Generally, NOLs can be carried back to the
two years preceding the loss year and then forward to the
20 years following the loss year. Recently, the federal
carryback period was extended from two to five years for
specified losses (as noted above.) SB 1239 conforms to
these recent changes in federal law and permits businesses
to carryback their NOL deductions for five years.
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The basic rationale for allowing losses to be carried
back flows from a recognition that businesses are
established with the goal of making a profit over a
business cycle rather than in any particular year.
Economic theory demonstrates that a suitably long carryback
period for NOL deductions helps to smooth out income and
taxes paid over a business cycle, thereby allowing a
business to make efficient decisions regarding financing
and investment.
A 2009 Congressional Research Service (CRS) Report
entitled Net Operating Losses: Proposed Extension of
Carryback Period, indicates that the majority of the tax
burden falls on risky investments. As a way of easing this
burden, NOLs are allowed to be carried back, effectively
creating a partnership between the taxpayer and the
government. This allows the government to share both the
return on investment (tax revenue) and the risk of
investment (revenue loss). A refund, as a means of sharing
investment risk, provides a firm with cash flow, which
helps pay for business expenses during tough economic
times. The ability to carryback an NOL is particularly
important for businesses that have historically generated
taxable income, but may currently be experiencing losses.
Additionally, an NOL carryback may provide for a cheap
source of funds in an economy with restrictive credit.
A recent Assembly Revenue and Taxation analysis points
out that while there is strong justification for a
carryback provision as a method of averaging business
income over time and as a way of reducing investment risk,
there is disagreement over its ability to stimulate the
economy. In terms of economic stimulus, it is important to
understand the differences between the state and federal
governments. The federal government, unlike the state
government, is able to stimulate the economy because of its
ability to run deficits. Because of this, the federal
government is able to provide for a carryback deduction
without having to offset the cost. The state, on the other
hand, is required to fund a carryback deduction by
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eliminating government spending in other areas. The
ability to run deficits allows the federal government to
maintain or increase spending, whereas the state government
simply shifts funds from one program to another.
Therefore, the stimulating effect that a carryback
provision would have at the federal level does not apply at
the state level.
It has been argued that a business benefits from state
programs, infrastructure, protection of property and other
activities that facilitate the operation of business, and
therefore, should compensate the government for services
rendered. Allowing NOLs to be carried forward and
backwards may be good tax policy, but should unprofitable
businesses be able to enjoy the services without
compensating the state for, at least a portion of, those
services? The sharp drop in state tax revenue has made it
difficult for California to fund the programs and services
needed for the operation of business. Therefore it may be
impossible for the state to maintain basic government
services while providing refunds to businesses, especially
under SB 1239's extended NOL carryback provisions.
D. Taxing Capital Gains vs. Other Forms of Income
As has been described in past Senate Revenue and
Taxation committee analyses, the difference between capital
gains and other forms of income is like the difference
between Joey's lemonade stand and the lemonade he sells.
Suppose government imposes a 15-percent tax on each glass
of lemonade sold. Such a tax would be an income tax. Now,
suppose he wanted to sell his lemonade stand. The profits
from this sale would represent his capital gains; the value
of the lemonade stand may be hundreds, even thousands of
times greater, because of its ability to keep generating
profits.
Is there a value difference between the two items?
Opponents of lowering or eliminating capital gains tax
argue that the tax on capital gains (the lemonade stand)
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should be no different from that on normal income. In
fact, they argue that it makes sense to tax investment
income as the state shifts from wage earners (selling
lemonade) to investments (lemonade stands). This argument
states that there is no value difference between the
lemonade stand and the lemonade but that they are both
sales, like any other sale. Even if the lemonade stand is
1,000 times more valuable than the lemonade it sells, the
market forces should ostensibly engineer the correct sales
price for the stand.
Proponents of reducing or eliminating the capital
gains tax argue that the lemonade stand should be taxed at
preferential, lower rates or not at all because by making
lemonade stands more profitable than lemonade, investors
will want to invest in more lemonade stands thus increasing
the means of production and spurring economic growth.
The policy questions related to the taxation of
capital gains are: should we distinguish between various
types of income? The idea of a capital gains tax
elimination, as provided for under SB 1239, is to charge a
15-percent tax on a worker but no income tax on an owner,
for example. Economists would call this regressive tax
policy which creates inequalities in the system. The fact
that the lemonade stand is more valuable due to its ability
to keep generating profits should be factored into the
sales price instead of the tax rate being factored into how
much the investor makes. The second question is: why
should human capital be taxed and investment capital not
taxed? Workers can improve their worth through better
education just as an owner can improve his business through
modernization. Both will result in higher productivity and
income; yet only one is taxed under SB 1239 (the worker).
Finally, not all capital assets are as productive as
lemonade stands: from a production and job-creation point
of view, some assets such as art, wine, classic cars and
antiques do not produce the same number of jobs or increase
productivity in the same way as the lemonade stand or other
factory.
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Support and Opposition
Support:BayBio, California Small Business Association,
and National Tax Limitation Committee
Oppose:None received
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Consultant: Meg Svoboda