BILL ANALYSIS                                                                                                                                                                                                    �



                                                                  AB 2638
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          Date of Hearing:  April 23, 2012

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Henry T. Perea, Chair
                     AB 2638 (Eng) - As Amended:  April 17, 2012

          Majority vote.  Fiscal committee.

           SUBJECT  :  State government:  fiscal affairs.

           SUMMARY  :  Requires the Department of Finance (DOF) to include 
          additional information in its annual tax expenditure report and 
          to provide to the Legislature certain specified information, in 
          cooperation with the Franchise Tax Board (FTB) and the State 
          Board of Equalization (BOE), regarding tax expenditures at the 
          time of the submission of the Governor's Budget to the 
          Legislature.  Specifically,  this bill  :  

          1)Requires the DOF to do both of the following: 

             a)   Include in its annual tax expenditure report:

               i)     The year of enactment for each credit, deduction, 
                 exclusion, exemption, or any tax benefit exceeding $5 
                 million in annual cost. 

               ii)    Anticipated revenue loss, if available, pursuant to 
                 the final fiscal committee analysis of the act that 
                 established the tax expenditure, adjusted for inflation. 

             b)   Provide to the Legislature, at the time of the 
               submission of the Governor's Budget, an estimate of the 
               revenue loss in the upcoming fiscal year (FY) for each tax 
               expenditure exceeding $5 million in annual cost.  Defines 
               "tax expenditure" as a credit, deduction, exclusion, 
               exemption, or any other tax benefit provided by the state. 

          2)Requires the FTB and the BOE, at the time of the submission of 
            the Governor's Budget to the Legislature, to report to the DOF 
            and the Legislature on the fiscal and tax effect of tax 
            expenditures from sales and use tax (SUT), personal income tax 
            (PIT), and corporation tax (CT).  

          3)States that the BOE and FTB reports shall be limited to tax 
            expenditures with an annual revenue loss of at least $5 








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            million and shall include all of the following information:

             a)   The most recent data to characterize the economic, tax, 
               and demographic profile of claimants, including an estimate 
               for the state and local revenue loss for the current FY and 
               the two subsequent FYs. 

             b)   Anticipated revenue loss, if available, pursuant to the 
               final fiscal committee analysis of the act that established 
               the tax expenditure, adjusted for inflation. 

             c)   Citation of academic studies pertaining to the tax 
               expenditure or similar tax expenditures, where deemed 
               appropriate by the BOE or FTB, whichever is applicable.

             d)   Usage data, where available, for the same or similar tax 
               expenditures adopted by other states with similar 
               economics, business entity types, and tax laws, or the 
               federal government, if appropriate.

             e)   Any other distinguishing tax characteristic, including 
               other tax expenditures claimed.

          4)Provides that, for SUT expenditures, the BOE report shall also 
            include:

             a)   At a minimum, the revenue loss for each expenditure for 
               the most recent tax year for which full year data is 
               available and estimated revenue loss for the current FY and 
               subsequent FY by industry code. 

             b)   For the most recent taxable year for which a full year 
               of data is available, average, median, highest, and lowest 
               amounts claimed by taxpayer liability and the amounts 
               claimed and, as of the time report is prepared, amounts 
               disallowed. 

          5)Requires that, for PIT and corporate income and franchise tax 
            expenditures, the FTB report identify all of the following 
            information:

             a)   At a minimum, the revenue loss for each expenditure for 
               the most recent taxable year for which a full year of data 
               is available, the current FY, and the budget year, in the 
               following categories by:








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               i)     Adjusted gross income of the claimants.

               ii)    Tax liability of the taxpayer. 

               iii)   Region.

               iv)    Industry code.

             b)   For the most recent taxable year for which a full year 
               of data is available, average, median, highest, and lowest 
               amounts claimed by taxpayer bracket, and amounts claimed 
               and, as of the time the report is prepared, amounts 
               disallowed. 

          6)Specifies that the BOE and FTB shall provide sufficient data 
            to support a subsequent analysis of the revenue loss of the 
            tax expenditure. 

          7)Defines "tax expenditure" as a credit, deduction, exclusion, 
            exemption, or any other tax benefit provided by the state. 

           EXISTING LAW:

           1)Allows various tax credits and other tax benefits designed to 
            provide tax relief for taxpayers who incur certain expenses 
            (e.g., child adoption) or to influence behavior, including 
            business practices and decisions �e.g., research and 
            development (R&D) credit or economic development area hiring 
            credits].  These benefits, generally, are designed to provide 
            incentives for taxpayers to perform various actions or 
            activities that they may not otherwise undertake.

          2)Does not require tax expenditure provisions to include 
            specific goals, purposes, objectives, performance measures, or 
            a sunset date.

          3)Requires the DOF to provide an annual report to the 
            Legislature on tax expenditures by no later than September 15 
            of each year.  Provides that the report must include, among 
            other information, a comprehensive list of tax expenditures 
            exceeding $5 million in annual cost, a brief description of 
            each expenditure and its beneficiaries, and estimates for the 
            state and local revenue loss for the current FY and the two 
            subsequent FYs.  








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          4)Provides that the Governor must submit to the Legislature, 
            within the first 10 days of each calendar year, a budget for 
            the ensuing FY (Article IV, Section 12 of the California 
            Constitution). 

          5)Specifies that the Governor's Budget must include a complete 
            plan and itemized statement of all proposed expenditures and 
            all estimated revenues for the ensuing FY.  It must also 
            contain a comparison for those proposed "budget year" 
            expenditures and revenues with the actual revenue and 
            expenditure amounts for the previous completed FY and the 
            estimated revenue and expenditures for the current year. 

          6)Requires the DOF to submit to the Legislature, at the time of 
            the submission of the Governor's Budget, or as soon thereafter 
            as feasible, total recommended state General Fund (GF) 
            expenditures and estimated state GF revenues. 

           FISCAL EFFECT  :  The FTB and BOE staff estimates that this bill 
          will have no direct impact on state tax revenues. 

           COMMENTS  :   

           1)Author's Statement.   The author states that, "According to the 
            Department of Finance's (DOF) latest report on tax 
            expenditures, the State forgoes more than $43 billion annually 
            in personal income, corporation, and sales taxes - an amount 
            roughly equivalent to half of the State's General Fund budget. 
             Local agencies forgo an additional $9 billion a year from tax 
            expenditures.  Statutes enacted in 2006 required the DOF to 
            substantially augment its tax expenditure reporting and added 
            new obligations for the BOE and FTB.  Specifically, these 
            changes required DOF to begin including, for specified tax 
            expenditures, information on the original legislative intent, 
            beneficiaries, and future year costs.  While improvements to 
            the quality of tax expenditure reporting have been made in 
            recent years, these reports are not timed and have not 
            influenced budget deliberations.  Given the enormity of the 
            State's investment in tax expenditures, coupled with its 
            persistent, long-term budget challenges, it is imperative that 
            the cost of tax expenditures be more transparent and relevant 
            to the budget process.  AB 2638 would make the costs and 
            reporting of tax expenditures more transparent and relevant to 
            the budget process to determine the impact these tax 








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            expenditures have on state revenues and if they cost more or 
            less than originally expected when adopted."

           2)Arguments in Support  .  The proponents state that, in light of 
            California's perennial budget crisis and economic malaise, "it 
            is imperative that elected leaders have the most complete 
            information possible to make informed decisions."  They 
            observe that, remarkably, "the interrelationship between the 
            State's $90 billion General Fund budget and the "off budget" 
            TEs �tax expenditures] is largely absent from budget 
            deliberations."  The proponents argue that, while 
            "improvements to the quality of TE reporting have been made in 
            recent years, these reports are neither comprehensive nor 
            issued in time to influence budget deliberations." As an 
            example, an annual report prepared by the DOF "lacks key 
            information and receives little attention."  The proponents 
            assert that AB 2638 is needed to "shed increased light and 
            scrutiny to state tax expenditures which cost the state 
            billions of dollars every year" and many of which "are no 
            longer serving their intended purpose."

           3)Arguments in Opposition  .  The opponents state that this bill 
            should be amended to require the DOF, the FTB and the BOE to 
            use dynamic revenue modeling.  They argue that existing static 
            revenue estimates "do not reflect realistic revenue impacts 
            that result from changes in taxpayer behavior," do not "take 
            into account the added economic benefit of a tax expenditure," 
            and do not provide the Legislature with "comprehensive fiscal 
            data with which to make important decisions regarding the 
            state's finances." 

           4)What is a "Tax Expenditure  "?  Existing law provides various 
            credits, deductions, exclusions, and exemptions for particular 
            taxpayer groups.  According to legislative analyses prepared 
            for prior related measures, United States (U.S.) Treasury 
            officials and some Congressional tax staff began arguing in 
            the late 1960s that these features of the tax law should be 
            referred to as "expenditures," since they are generally 
            enacted to accomplish some governmental purpose and there is a 
            determinable cost associated with each (in the form of 
            foregone revenues).  A recent report by the Legislative 
            Analyst's Office (LAO) shows that tax expenditure programs 
            cost the state nearly $50 billion in FY 2008-09.  The LAO 
            report noted that resources are allocated to a new tax 
            expenditure program automatically each year, with limited, if 








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            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.  

           3)How is a Tax Expenditure Different from a Direct Expenditure?   
            As the 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.  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.

           4)Current Review of Tax Expenditures  .  Although there is no 
            requirement for the Legislature itself to review existing tax 
            expenditures, several state agencies are required to issue 
            annual tax expenditures reports.  In 1985, the Legislature 
            passed ACR 17 (Bates), which called upon the LAO to prepare a 
            biennial "tax expenditure" report. Additionally, the DOF 
            currently publishes an annual report on tax expenditures, 
            pursuant to Government Code 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.  The BOE prepares a publication 
            listing various exemptions and exclusions from the SUT, 
            including a brief description and an estimate of the revenue 
            loss for the exemption or exclusion, if available.  Finally, 
            since 2007, the FTB has been publishing an annual report, 
            "California Income Tax Expenditures," describing tax 
            expenditures found in the PIT and the CT Tax Laws.  

            According to the DOF report for the FY 2011-12, the vast 
            majority of tax expenditures are included in the PIT Law.  To 








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            this end, the DOF estimates that tax expenditures reduced PIT 
            revenues by roughly $31 billion in FY 2011-12.  The SUT Law, 
            in turn, contains identifiable state tax expenditures worth 
            about $11 billion annually, and CT expenditures amounted to 
            roughly $5 billion.  

           1)How Would This Bill Improve a Legislative Review of Tax 
            Expenditures?   As discussed, the DOF is required to compile 
            and submit to the Legislature its annual tax expenditure 
            report by September 15 of each year.  This bill would expand 
            the scope of information required to be included in the DOF 
            annual report, such as, for example, a revenue loss amount 
            that was estimated to result from a tax expenditure by the 
            final fiscal committee analysis of the act that established 
            the expenditure, adjusted for inflation.  According to the 
            2011 report issued by the Senate Office of Oversight and 
            Outcomes, some "tax breaks enacted by the state of California 
            over the past two decades have turned into blank checks, with 
            actual costs to state government surpassing initial estimates 
            of foregone revenue by billions of dollars."  AB 2638 is 
            intended to inform decisions makers by highlighting the 
            difference, if any, between the estimated and actual revenue 
            loss attributable to a particular tax expenditure. 

            Currently, the DOF is also required to submit to the 
            Legislature, by January 10, the Governor's Budget, and with 
            it, total recommended state GF expenditures and estimated, 
            including any proposed, state GF revenues.  AB 2638 would 
            request the DOF to include in the Governor's Budget an 
            estimated revenue loss in the upcoming FY for each tax 
            expenditure exceeding $5 million in annual costs.  It would 
            also require state tax agencies - the FTB and BOE - to submit 
            their tax expenditure reports to the DOF and the Legislature 
            by January 10 of each year.  These new requirements will 
            mirror the requirements for the President's Budget at the 
            federal level, where tax expenditures are separately listed, 
            explained, and estimated, and, most likely, will generate 
            discussion, as part of the budget process, about effectiveness 
            of certain tax expenditures. 

            The idea of spurring discussion on this important issue is a 
            good one.  California is experiencing one of the worst 
            recessions in recent history.  In an effort to balance the 
            state's budget, the Legislature has been forced to make cuts 
            to vital programs, including education, health and human 








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            services, and transportation.  AB 2638 seeks to improve 
            transparency in California's budget process by informing 
            decision makers and the public regarding California's $43 
            billion in tax expenditures.  Accurate information about all 
            of the state's expenditures, including the costs of state 
            departments, state programs and state tax expenditures, is 
            necessary to facilitate an honest debate on the budget.  In 
            the past, some budget observers argued that including limited 
            tax expenditure data as part of the Governor's Budget would 
            not be helpful because it lacks the fiscal and policy 
            information contained in the Tax Expenditure Report.  AB 2638 
            addresses this concern by requiring both the BOE and FTB to 
            report to the Legislature, at the time of the Budget 
            submission.  Their reports will contain not only fiscal but 
            policy information, including data regarding the economic, 
            tax, and demographic profile of claimants and usage data for 
            similar tax expenditures adopted by other states.   

            In contrast to spending items, tax expenditures, for the most 
            part, do not require appropriation of funds and are not part 
            of the state budget.  Having the information relating to the 
            costs of tax expenditures available while the budget 
            negotiations are taking place will ensure that the Legislature 
            has the information necessary to address California's fiscal 
            condition.  In addition, it will allow the public and 
            interested parties to contrast spending programs with tax 
            expenditure programs with similar goals, i.e. programs that 
            require budgetary appropriations versus those that are 
            financed through foregone revenues.  

           1)Related Legislation.  

             a)   AB 2564 (Swanson), introduced in the 2009-2010 
               Legislative Session, would have required the DOF to submit 
               its annual tax expenditure report to the Legislature by 
               February 1 instead of September 15.  AB 2564 was vetoed by 
               Governor Schwarzenegger.   

             b)   AB 831 (Parra), introduced in the 2007-08 Legislative 
               Session, would have required any legislation creating a new 
               tax expenditure, or extending the operation of an existing 
               tax expenditure, to include a sunset provision.  AB 831 
               failed to pass out of the Senate Committee on Revenue and 
               Taxation. 









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             c)   AB 1933 (Coto), introduced in the 2005-06 Legislative 
               Session, would have required any legislative measure 
               creating a new tax expenditure, or extending the operation 
               of an existing tax expenditure, to include legislative 
               findings regarding the purpose of the tax expenditure, an 
               estimate of the attributable revenue losses, a specific 
               methodology for measuring the anticipated benefits, and a 
               sunset date no later than five years in the future.  AB 
               1933 failed to pass out of the Senate Committee on Revenue 
               and Taxation.  

             d)   AB 2199 (Brown), introduced in the 1995-96 Legislative 
               Session, would have required all tax expenditures to be 
               authorized via an appropriation in the annual Budget Act.  
               AB 2199 failed to pass out of this Committee.  

             e)   AB 2884 (Villaraigosa), introduced in the 1995-96 
               Legislative Session, would have required the Legislative 
               Analyst, together with DOF, FTB, and the BOE, to conduct an 
               evaluation of all tax expenditures, as defined.  AB 2884 
               failed to pass out of this Committee.

             f)   SB 1233 (Hayden), introduced in the 1993-94 Legislative 
               Session, would have required the LAO to review each tax 
               expenditure program, as directed by this Committee and its 
               Senate counterpart, to determine if its objectives are 
               being realized, whether its benefits exceed its revenue 
               costs, and weather there is a less costly way of providing 
               the same benefits.  Governor Wilson vetoed the bill.  
           
          REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          John Chiang, California State Controller (Sponsor)
          California Federation of Teachers
          California Labor Federation
          American Federation of State, County and Municipal Employees 
          (AFSCME), AFL-CIO
          California Tax Reform Association
          The Service Employees International Union
          The California School Employees Association 
          California Professional Firefighters

           Opposition 








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          California Taxpayers Association 
          The California Manufacturers and Technology Association
           
          Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916) 
          319-2098