BILL ANALYSIS
SB 1391
Page 1
Date of Hearing: June 28, 2010
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Anthony J. Portantino, Chair
SB 1391 (Yee) - As Amended: May 19, 2010
Majority vote. Tax levy. Fiscal committee.
SENATE VOTE : 22-11
SUBJECT : Tax credits: reporting and recapture.
SUMMARY : Requires a taxpayer claiming a business tax credit to
report annually the number of employees employed by the taxpayer
in the state for the current and preceding taxable years as well
as the number of jobs created by those credits. Provides that
the entire amount of new business credits claimed by the
taxpayer will be recaptured by the state if the taxpayer has a
"net decrease" in the number of full-time equivalent employees,
as specified. Specifically, this bill :
1)Requires a taxpayer doing business in the state that claims
any business tax credit under either the Personal Income Tax
(PIT) Law or the Corporation Tax (CT) Law to include annually
on the timely filed original return all the following
information, in the form and manner prescribed by the
Franchise Tax Board (FTB):
a) The number of full-time employees, part-time employees,
and temporary employees, as defined, employed by the
taxpayer in the state for the current and preceding taxable
years.
b) The number of full-time jobs, part-time jobs, and
temporary jobs created by the credit.
2)Provides that, in the case of any business tax credit enacted
on or after January 1, 2011 and claimed by a taxpayer, the
entire amount of the credit will be disallowed for all taxable
years and any previously allowed amounts shall be recaptured
if the taxpayer has a "net decrease" in the number of
full-time equivalent employees.
3)Specifies that the "net decrease" in full-time equivalent
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employees shall be determined, on and after January 1, 2014,
by subtracting the total number of full-time equivalent
employees employed by the taxpayer in the current taxable year
from the average number of full-time equivalent employees
employed by the taxpayer during the three preceding taxable
years. The average number is calculated by dividing the total
number of full-time equivalent employees in the three
preceding taxable years by three.
4)Defines "full-time equivalent" as either of the following:
a) In the case of a full-time employee paid hourly
qualified wages, "full-time equivalent" means the total
number of hours worked for the taxpayer by the employee
(not to exceed 2,000 hours per employee) divided by 2,000.
b) In the case of a salaried full-time employee, "full-time
equivalent" means the total number of weeks worked for the
taxpayer by the employee divided by 52.
5)Specifies that all employees of the trades or businesses that
are treated as related under either Internal Revenue Code
(IRC) Section 267, 318, or 707 shall be treated as employed by
a single taxpayer.
6)Provides that the amount of business tax credits recaptured
shall include the credits reported by the taxpayer on previous
tax returns and interest computed using the adjusted annual
rate, as specified.
7)Defines "business credit" as a credit added to either Part 10
or Part 11 of the Revenue and Taxation Code (R&TC) on or after
January 1, 2011, and allowed to taxpayers engaged in or
carrying on any trade, business, profession, vocation or
calling, or commercial activity in the state, including
activities in the state that benefit an affiliated entity of
the taxpayer.
8)Defines "full-time employee" as an employee who works an
average of 35 hours in a week, calculated monthly.
9)Defines "part-time employee" as an employee who works less
than an average of 35 hours in a week, calculated monthly.
10)Defines "temporary employee" as an employee who works less
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than 120 days per year.
11)Declares that this bill does not limit FTB's authority to
audit the information reported by taxpayers on their tax
returns.
12)Provides that Government Code (GC) Chapter 3.5 (commencing
with Section 11340) of Part 1 of Division 3 of Title 2 does
not apply to any standard, criterion, procedure,
determination, rule, notice, or guideline established or
issued by the FTB pursuant to the provisions of this bill.
13)Takes effect immediately as a tax levy.
EXISTING LAW :
1)Provides various tax credits, deductions, exclusions, and
exemptions. Some of these tax expenditures are designed to
provide relief to taxpayers who incur specified expenses
(e.g., costs incurred in adopting a child). Other tax
expenditures are designed to encourage socially or
economically beneficial behavior.
2)Requires, under GC Section 13305, the Department of Finance
(DOF) to provide an annual report to the Legislature on tax
expenditures by no later than September 15 of each year.
FISCAL EFFECT : According to the FTB staff, this bill does not
affect state revenue because it does not apply to any currently
authorized tax credits.
COMMENTS :
1)Author's Statement . The author states, "SB 1391 brings much
needed transparency and accountability to corporate tax
expenditures. This bill will allow the state to recoup, or
"clawback," any future tax expenditures given to a corporation
that fails to meet employment or investment commitments.
"Clawback provisions make tax expenditures more effective,
transparent, and accountable. This bill will set clear
expectations for corporations and guarantee that the state's
investment will yield measurable results in the form of job
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retention and creation.
"California taxpayers should not annually provide upwards of $14
billion in corporate tax credits without transparency and
accountability. It is unconscionable to devastate social
services and education while big corporations are getting
billions of dollars in tax breaks without creating jobs or
even staying within California.
"Such information allows citizens to become more knowledgeable
about how their government works. A democracy depends upon an
informed citizenry to function properly."
2)Arguments in Support . The proponents of this bill argue that,
while currently corporations receive "an estimated $14.5
billion in tax expenditures annually with little to no
accountability," it is nearly impossible to track if those
subsidies contribute to the creation of jobs in California.
The proponents also note that, as dollars flow out to
corporations without oversight, the state is facing a jobs
crisis and "public services are being devastated by budget
cuts that touch every sector from education to health care."
The proponents state that beneficiaries of state programs,
such as CalWORKS, are required to provide fingerprints,
"report their income every three months, be checked
continuously for fraud, and prove that they found work for
thirty-two hours per week to keep their grants and
assistance." In contrast, "corporations receive billions of
state subsidies in the form of tax expenditures [but] are not
required to demonstrate any measurable results." The
proponents assert that clawback provisions "make tax
expenditures more effective, transparent and accountable" and
would "guarantee that the state's investment will yield
measurable results in the form of job retention and creation."
Finally, they observe that 20 other states have enacted
similar "clawback" provisions in tax expenditures, loan, grant
and other business subsidy programs.
3)Arguments in Opposition . The opponents state that, while they
do not, in principle, disagree that "the legislature should
evaluate the effectiveness of investment incentives, the
approach used by SB 1391 fails to consider numerous other
factors that demonstrate their effectiveness, and would
undermine the incentive effect of future enacted investment
credits by creating uncertainty for employers who might wish
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to take advantage of them." They argue that many "investment
credits work over a period of time, and ? result in higher
employment as a secondary benefit that may or may not happen
fast enough to evade the claw-back provision of SB 1391." The
opponents also assert that, even if this bill provides for "an
effective analysis of investment incentives, the reclamation
provision is still problematic because it creates uncertainty
for employers, and the reliability of the investment credits
is what encourages [employers] to make decisions that help the
state in the long run."
4)"Clawback" Provisions in Other States . Currently, some 20
states and dozens of cities use "clawback" provisions in one
or more of their subsidy programs. (Reform #2: Clawbacks, or
Money-Back Guarantees, www.goodjobsfirst.org ). For example,
the State of Arizona requires recipients of the economic
development assistance above $1 million, including loans,
grants, tax credits, job training and improvements, to enter
into a memorandum of understanding with the state containing
performance standards the company is expected to meet within
the first five years after the assistance is received. If the
company fails to comply with the terms of the agreement, the
state can stop, readjust, or recapture all or part of the
assistance. Similarly, in Georgia, if a taxpayer fails to
meet minimum job creation requirements of the Business
Expansion Tax Credit program, the state may recapture the
subsidy. The State of Connecticut authorizes a recapture of
the full value of any financial assistance given to a company
by the state's department of economic development, development
authority, or Connecticut Innovations, Inc., if the company
relocates outside the state within 10 years or during the term
of the aid, whichever is longer. In Nevada, a company that
ceases to operate or fails to meet investment, employment,
wage, or health benefits requirements under the Business Tax
Abatement program is subject to the recapture provisions. In
Ohio, the Corporate Franchise and State Income Tax credits are
subject to recapture if a taxpayer that claimed any of those
credits fails to maintain operations at the project location
for at least twice the number of years as the term of the tax
credit. Finally, the State of Virginia enacted the Major
Business Facility Job Tax credit program that requires
taxpayers to maintain a certain number of qualified full-time
employees every year, and, if the number drops below the
average number employed during the first year of the credit,
the state will recalculate the original credit and will either
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increase the tax or recapture the credit.
5)Is Accountability Needed for Tax Expenditures in California ?
Existing law provides various credits, deductions, exclusions,
and exemptions for particular taxpayer groups. Although there
is no requirement for the Legislature itself to review
existing tax expenditures, several state agencies are required
to issue annual tax expenditure reports. In 1985, the
Legislature passed Assembly Concurrent Resolution 17 (Bates),
which called upon the Legislative Analyst Office (LAO) to
prepare a biennial "tax expenditure" report. A recent report
by LAO shows that tax expenditure programs cost the state
nearly $50 billion in fiscal year 2008-09. The LAO report
noted that resources are allocated to a new tax expenditure
program automatically each year, with limited, if any,
legislative review, and there is no limit or control over the
amount of money forgone since the Legislature does not
appropriate funds for tax expenditure programs. The LAO
report also stated that the tax expenditure programs offer
many opportunities for tax evasion, given the relatively low
level of audits.
Additionally, the DOF currently publishes an annual report on
tax expenditures, pursuant to GC Section 13305, and provides
it to the Legislature by no later than September 15 of each
year. The DOF report includes a list of tax expenditures
exceeding $5 million in annual cost.
As DOF notes in its annual Tax Expenditure Report, there are
several key differences between tax expenditures and direct
expenditures. First, tax expenditures are reviewed less
frequently than direct expenditures once they are put in
place. This can offer taxpayers greater certainty, but it can
also result in tax expenditures remaining a part of the tax
code in perpetuity without demonstrating any public benefit.
Secondly, there is generally no control over the amount of
revenue losses associated with any given tax expenditure.
Finally, the vote requirements for direct expenditures and tax
expenditures are different. While it takes a two-thirds vote
to make a budgetary appropriation, a tax expenditure measure
can be enacted by a simple majority vote. It should also be
noted that, once enacted, it generally takes a two-thirds vote
to rescind an existing tax expenditure, which effectively
results in a "one-way ratchet" whereby tax expenditures can be
conferred by majority vote, but cannot be rescinded,
irrespective of their efficacy, without a supermajority vote.
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Finally, since 2007, the FTB is required to prepare an annual
report, "California Income Tax Expenditures," describing tax
expenditures found in the PIT and the CT laws.
Tax expenditures in California are designed to provide relief to
taxpayers who incur specified expenses or to encourage
socially or economically beneficial behavior. But, while
those tax expenditures are enacted with a view of achieving a
certain set of public benefits, a taxpayer's eligibility for
claiming those expenditures is not contingent upon the
taxpayer's future behavior. In contrast to a direct subsidy,
be it in the form of a grant or a loan, most tax expenditures
are broad-based and do not require a taxpayer to sign a
contract with the state, create a certain number of new jobs
or meet any other target as a condition of the taxpayer's
eligibility to claim a tax expenditure. Nor does the state
currently have a right to recapture any of the tax
expenditures claimed by the taxpayers even if those taxpayers
have created no new jobs or provided no other anticipated
benefits to the state. Indeed, once a tax expenditure is
enacted, the state does not have any control over the annual
amount of foregone revenue, regardless of whether or not the
taxpayers have changed their behavior. Thus, it is nearly
impossible to quantify the public benefits, if any, created by
most state tax expenditures.
6)This Bill's Approach to Measure and Enforce the Effectiveness
of Tax Credits . SB 1391 establishes very specific criteria to
measure the effectiveness of future business tax credits by
reference to a number of new jobs created by taxpayers in the
state. Thus, it requires a taxpayer claiming an existing
business tax credit on its tax return to also report the
number of taxpayer's full-time employees in California for the
current and preceding taxable years and the number of jobs
created by the tax credit. In addition, this bill provides
that, in the case of a new business tax credit, the taxpayer
will be required to repay the entire amount of the tax credit
if the taxpayer's employment declines in subsequent years.
The "net decrease" in employment in a particular tax year is
measured by comparing the total number of the taxpayer's
full-time equivalent employees during a three-year period
immediately preceding the tax year in question, divided by
three, with the total number of the employees in the current
tax year. The total number of the taxpayer's full-time
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equivalent employees also includes employees of any trade or
business acquired by the taxpayer during the tax year. The
recapture provisions apply to tax years beginning with the
2014 tax year, after three years of reporting following this
bill's effective date (2011, 2012, and 2013 tax years). Thus,
SB 1391 is intended to recapture only those business tax
credits that are enacted after the effective date of this
bill.
7)The Difference Between This Bill and "Clawback" Provisions in
Other States .
The approach taken by this bill is somewhat different from the
"clawback" provisions enacted in other states. A brief
overview of other states' similar programs indicates that
those provisions are either included in subsidy contracts
negotiated and signed by governments and taxpayers, or added,
via legislation, to targeted development subsidy programs. As
discussed earlier, the subsidy programs encompass all sorts of
economic development assistance, including loans, grants, loan
guarantees, targeted tax credits, job training, and interest
rate subsidies. In the case of a subsidy program that
requires a formal agreement signed by a taxpayer and the
government, the taxpayer agrees to abide by the terms of the
contract to qualify for the subsidy. If a subsidy does not
require a formal contract, such as, for example, corporate tax
credits or targeted jobs development credits, the statute
authorizing the subsidy expressly sets forth the requirements
and goals that must be met by the taxpayer in order to qualify
for the subsidy.
In contrast, while SB 1391 attempts to create an accountability
mechanism for tax credits claimed by businesses in California,
it assumes that the effectiveness of all new business credits
may be measured only by (a) the number of new jobs created in
the state, and, (b) without taking into account the quality of
those jobs. However, not every credit is enacted for the
purpose of creating jobs. For example, a low-income housing
tax credit is intended to increase the supply of affordable
rental housing units available to low-income California
households. Similarly, the California research and
development (R&D) credit was implemented to encourage
companies to conduct R&D in California, rather than in other
states. Secondly, some jobs, e.g., high paying jobs, with
good benefits, are more attractive to the states than others.
Thus, a high-tech company that lays off two minimum-wage
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workers and, instead, hires one highly-skilled engineer would
be subject to the recapture provision under this bill, even
though the company has created a more valuable job in the
state.
Furthermore, SB 1391 only requires a recapture of business
credits under the CT or PIT law and does not apply to other
tax expenditures, such as tax exemptions, exclusions,
deferrals, elections, or deductions. For example, the FTB
included a "water's-edge" election on the list of tax
expenditures that cost the state $700 million in the 2006 tax
year. The "water's-edge" election is an alternative to the
worldwide unitary method of calculating California income for
multinational corporations. It allows corporations to reduce
their tax liability and/or filing complexity and to avoid
providing financial details of their foreign operations.
However, under this bill, the state is not required to
recapture the amount of tax savings due to the "water's-edge"
election. In addition, businesses often receive tax
exemptions and exclusions from their sales and use taxes as
well as property taxes, not just income taxes. And,
sometimes, the value of direct expenditures, such as grants,
loans, or other subsidies may be greater than that of a tax
incentive. But, if this bill's intent is to require the
recapture of only those tax incentives that are expressly
created by the Legislature in the future for the principal
purpose of encouraging businesses to create new jobs in
California, then Committee staff suggests that this bill be
amended to limit the application of the recapture provisions
only to those tax expenditures.
8)Other Potential Issues :
a) What is the methodology for determining the number of
jobs created? This bill requires taxpayers to report the
number of jobs created by the tax credits claimed by the
taxpayers. It is unclear what kind of methodology the
taxpayer is expected to use in calculating the number of
jobs created since this bill is silent on this issue.
b) How many taxpayers are going to be subject to the
recapture requirement ? The FTB currently receives over 17
million income tax returns each year. While the majority
of those returns contain no claims of business tax credits,
many of them do. The proposed recapture requirements will
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be burdensome not only for many small taxpayers but also
for the FTB since it will have to process millions of
additional statements and annually identify the taxpayers
that are subject to the recapture provisions. The author
may wish to consider limiting the application of this bill
only to businesses with a certain amount of net income in
California.
c) Binding Future Legislature ? This bill requires the
future Legislature to limit the availability and the
utilization of new tax credits. However, one legislative
body may not limit or restrict its own power or that of
subsequent legislatures, and the act of one Legislature may
not bind its successors [County of Los Angeles v. State of
California (1984) 153 Cal.App.3d 568, 573]. In practical
terms, it means that subsequent legislatures are under no
legal obligation to comply with the provisions of this
bill. Furthermore, since this bill is a statutory, and not
a constitutional, measure, any subsequent legislature could
easily dispense with this requirement by simply including a
provision in a statute that would override this bill's
provisions.
9)Suggested Technical Amendments .
a) California Jobs . It appears that the author's intent is
to create new jobs only in California, not elsewhere.
However, the proposed calculation for determining a "net
decrease" in the number of a taxpayer's full time employees
is not limited to those employees who are located in
California. Conceivably, the taxpayer may be able to
escape the recapture by decreasing the number of California
employees while increasing the overall number of jobs
elsewhere.
b) Definition of "Business Credit ." Committee staff
suggests that the definition of a "business credit" be
revised to specify that the credit must be allowed to a
taxpayer with respect to the income attributable to the
taxpayer's trade, business, profession, vocation, or
calling, or commercial activity.
10)Related Legislation.
AB 2666 (Skinner), introduced in the current legislative
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session, requires a taxpayer doing business in California to
submit to the FTB, under penalty of perjury, specified
information relating to the amount of tax credits claimed by
the taxpayer. Requires the State Chief Information Officer to
publish this information on the Reporting Transparency in
Government Internet Website. AB 2666 passed out of the
Senate Committee on Revenue and Taxation and is currently
pending in the Senate Appropriations Committee.
AB 2230 (Charles Calderon), introduced in the current
legislative session, requires FTB to post on its website, by
March 31, 2011, and annually thereafter, a list of the 100
largest publicly traded corporations disclosing certain
tax-related information reported by those corporations, as
specified. AB 2230 is pending on the Assembly floor.
SB 1272 (Wolk), introduced in the current legislative session,
requires any bill that creates a new tax credit to include
specific goals, purposes, and objectives of the credit,
performance measures for the credit within the language of the
bill, and repeal dates that are five years after the enactment
date of the bill. SB 1272 is currently pending in this
Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Labor Federation (sponsor)
The American Federation of State, County and Municipal Employees
(AFSCME), AFL-CIO
California Professional Firefighters
The Service Employees International Union (SEIU), Local 1000
The Service Employees International Union - California State
Council
California Nurses Association
The San Francisco Child Care Planning and Advisory Council
California Federation of Teachers, AFT, AFL-CIO
Opposition
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California Chamber of Commerce
BIOCOM
California Aerospace and Technology Association
California Bankers Association
California Grocers Association
California Manufacturers and Technology Association
California Taxpayers' Association
TechAmerica
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098