BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 1252 HEARING: 4/25/12
AUTHOR: Rubio FISCAL: Yes
VERSION: 4/9/12 TAX LEVY: No
CONSULTANT: Grinnell
STATE INFRASTRUCTURE AND FACEBOOK
Diverts Revenue Increases from the Facebook IPO to
infrastructure projects.
Background and Existing Law
In general, property held for personal use or investment
purposes is a capital asset, such as held-for-investment
stocks and securities. When a capital asset is sold or
exchanged, the difference between the selling price and the
asset's adjusted basis, which is usually the amount the
taxpayer paid for the asset, is a capital gain or loss.
Federal law taxes capital gains at different rates than
earned income by applying a maximum tax rate of 35% on
short-term capital gains, and a maximum 15% rate on
long-term capital gains. State law taxes all income
identically, with a maximum rate of 9.3%, or 10.3% for
taxpayers with income above $1 million (Proposition 63,
2000).
Incorporated in 2004, Facebook, Inc. is a social networking
business that is currently privately held and operated.
Facebook estimates that 845 million people actively use its
website. On February 1, 2012, Facebook indicated its
intent to begin to publicly sell its shares on NASDAQ, also
known as an Initial Public Offering (IPO). Facebook
intends to sell $5 billion in stock, and values itself at
$100 billion. The firm also estimated $1 billion in profit
in 2011, with $3.7 billion. The IPO is estimated to take
place on May 17th or May 24th of this year, with private
markets indicating a price around $38 to $40 per share.
Proposed Law
Senate Bill 1252 requires the Department of Finance (DOF),
SB 1252 -- 4/9/12 -- Page 2
in consultation with the Franchise Tax Board (FTB) and
Employment Development Department (EDD), to estimate and
report to the Controller the amount of taxes raised by the
state of California from the Facebook IPO on or before
February 1, 2013. The Controller shall transfer that
amount from the General Fund to the State Infrastructure
Projects Fund, created by the bill, by March 1, 2013. DOF,
in consultation with FTB and EDD, must then reconcile and
report the final increase in gains to the Controller on or
before December 31, 2013, and the Controller must transfer
the difference between the final increase and the estimated
one to the State Infrastructure Projects Fund on or before
January 31, 2014.
The bill allows the Legislature to appropriate funds from
the State Infrastructure Projects Fund to:
State transportation projects.
Levee, dam, or water treatment system erection,
construction, alteration, repair, or improvement.
Erection, construction, alteration, repair, or
improvement of buildings or structures of rail lines,
rail beds, stations, platforms, switches, yards,
terminals, parking lots, and any and all other
facilities and equipment necessary or convenient for
the conduct of rail transit service or for the
movement of passengers or goods via public transit
within the state.
The measure also makes legislative findings and
declarations.
State Revenue Impact
No estimate.
Comments
1. Purpose of the bill . SB 1252 simply ensures that
billions of dollars in one-time revenues from the 'Facebook
Effect' provide one-time services-namely critical
infrastructure needs throughout California. Spending
one-time funds to balance the state budget has already
contributed significantly to California's budgeting
problems. SB 1252 will ensure that the only 'Facebook
SB 1252 -- 4/9/12 -- Page 3
Effect' that California sees is an increased investment on
infrastructure projects.
2. Looking for friends . The Legislature and the Governor
set the state's spending priorities each year when they
enact the State Budget. SB 1252 sets three significant
precedents by setting aside revenue from one transaction
for specific purposes outside the budget process:
First, revenue from the state's general's taxes
aren;t dedicated to a specific purpose except for the
California Constitution's requirement that proceeds
from the gasoline excise tax and the sales tax on
gasoline being dedicated to transportation purposes.
The State Budget programs all general purpose
revenue, which includes capital gains revenue from the
Facebook IPO.
Second, the Legislature has never specifically
designated and segregated revenue from one firm's IPO;
while Facebook is certainly one of the most
anticipated IPOs in recent years, will SB 1252
encourage future Legislatures into programming funds
from other popular firms for specified purposes?
Lastly, never before have revenue estimates for any
single transaction or series of transactions, such as
an IPO, been directed to a specific purpose. While
all state budgets rely on revenue estimates to
identify the amount of funds available to spend, those
estimates look at the economy as a whole to predict
revenues based on well-established indicators. If
California-based Chevron announces record earnings
next year, should the Legislature isolate those
revenues and spend them for clean air programs outside
the Budget?
While California's tax system is inherently volatile due to
its reliance on the amount of unearned income received by
affluent taxpayers, there are options for balancing this
volatility. The Legislature could divert all estimated
capital gains tax revenues from all taxpayers into a rainy
day or infrastructure fund, or allow taxpayers to pay taxes
on capital gains up to two taxable years following the year
the gain is realized, thereby smoothing the tax payment
amounts. The Committee may wish to consider the precedent
established by SB 1252, whether it is an appropriate remedy
for inherent volatility, and whether the Budget process is
the better forum to consider the measure's infrastructure
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spending.
3. The great unknown . Economic and stock market
projections are inherently difficult; estimating the state
tax revenue effects of a single IPO doubly so. Each year,
both the DOF and the Legislative Analyst's Office issue
revenue estimates for the state budget, and this year they
disagreed by more than $3 billion, mostly due to differing
estimates of capital gains revenues. While California
revenue estimators include some of the world's most
intelligent economists, their estimates are always
uncertain because they seek to predict the future. As
such, by directing DOF, FTB, and EDD to estimate gains from
the Facebook IPO, SB 1252 asks a great deal of estimators.
The Committee may wish to consider relying on calculating
tax gains from a single IPO given the estimate's inherent
uncertainties.
4. Friend request forthcoming ? According to LAO's
overview of the Governor's 2012-13 Budget, "Facebook Inc.,
a privately held company headquartered in Palo Alto, may
proceed with an initial public offering (IPO) of its stock
in 2012. Facebook reportedly is considering issuing $10
billion of stock in an IPO that would value the company at
over $100 billion. Other companies also are considering
IPOs in the coming years. In the coming months, the
state's revenue forecasts will need to be adjusted somewhat
to account for the possibility of hundreds of millions of
dollars of additional revenues related to the Facebook IPO.
These revenues could affect the budgetary outlook beginning
in 2012-13. We caution that it will be impossible to
forecast IPO-related state revenues with any precision, and
it is likely that little information about the state
revenue gain from the Facebook IPO will be available before
investors file tax returns in April 2013. (Even then, due
to the confidentiality of individual taxpayer information,
we are unlikely to know precisely how much state revenues
increased due to Facebook's IPO.) In considering the size
of the Facebook IPO effect in the coming months, revenue
forecasters will have a difficult task. Our office's income
models are based on historical trends and, therefore,
already assume that some level of IPO activity occurs for
California companies each year. Moreover, in our recent
forecasts, our office has deliberately built in "extra"
capital gains (above those generated by our model) in 2010,
2011, and 2012 to try to account for a variety of factors,
SB 1252 -- 4/9/12 -- Page 5
including the surprisingly strong PIT receipts in some
recent months. Finally, Facebook-related capital gains
likely will prove to be a relatively small percentage of
California's overall capital gains in 2012. If the stock
market as a whole has an unusually strong or weak year,
that fact could change forecasted capital gains up or down
by much more than the positive Facebook effect." The
Committee may wish to consider adding LAO to the bill's
revenue estimation procedure.
5. Status updates . In an IPO, taxpayers that currently
hold equity shares (stock) in Facebook may seek gains by
selling their shares at higher prices after the IPO. These
taxpayers could have been founding members of the firm,
bought stock from founders or on private markets prior to
the IPO, or acquired stock by exchanging cash for stock, as
Microsoft did when it swapped $240 million for a 1.6% share
in Facebook in 2007. Employees can also be paid directly
in stock or in options, which allows employees to purchase
stock at a predetermined price in the future. For each of
these taxpayers, their gain will be the sales price after
the IPO minus the amount they paid for it. However, the
amount of tax each employee will pay is impossible to know.
Additionally, employees or individuals holding majority
shares cannot sell until 90 or 180 days after the IPO,
known as a "lock-out" period, intended to ensure that the
firm can be publicly traded for enough time to show
viability before owners can profit.
6. The social network . As mentioned above, Facebook
employees can exercise their options at any time. When an
employee exercises an option, he or she realizes a taxable
gain equal to the difference of the price of the option and
the public or private market price. They again realize a
capital gain if and when they sell the stock, which can
happen at the same time they exercise the option.
According to Facebook, CEO Mark Zuckerberg will exercise
options to purchase 120 million shares at six cents per
share. If the stock reaches a price of $40 when he sells,
he will make $4.8 billion in profit taxable as personal
income. The personal income tax revenue will only happen
once, as Facebook plans to pay Zuckerberg a salary of $1
per year in the future. Additionally, Facebook may deduct
the entire value of all the options for Zuckerberg and all
other employees as business expenses, which could well
reduce or eliminate Facebook's corporate taxes, and
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generate net operating losses which could offset future
taxes.
7. Another look . As the measure directly affects the
2012-13 State Budget by dedicating yet-to-be realized
revenue from the budget year, the Committee may wish to
consider sending the measure to the Rules Committee for
possible referral to the Committee on Budget and Fiscal
Review.
8. Likes and dislikes . Committee staff recommends the
following amendments:
Taxpayers don't realize gains in calendar years,
they do in taxable years. (Page 3, line 23).
Any revenue gains from the Facebook IPO will not be
realized exclusively in the 2012 taxable year. The
calculation, transfer, reconciliation functions should
take place annually. (Pages 3 and 4).
If final gains are greater than estimated ones, the
bill requires the Controller to transfer the
difference to the infrastructure fund. However, if
final gains are less than estimated ones, the bill
doesn't require the Controller to transfer the excess
back to the general fund (Pages 3 and 4).
Support and Opposition (4/19/12)
Support : American Council of Engineering Companies of
California
Opposition : Unknown.