BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 998 HEARING: 5/14/14
AUTHOR: Knight FISCAL: Yes
VERSION: 5/6/14 TAX LEVY: Yes
CONSULTANT: Grinnell
TAX CREDITS FOR NEW AEROSPACE PROJECTS
Enacts two tax benefits for aerospace companies
manufacturing new aerospace projects.
Background and Existing Law
The aerospace industry in California began with a few
aircraft builders around World War I, and then vastly
expanded in the mobilization for World War II. The
industry steadily grew during the cold war encompassing a
wide range of activities, including military and civilian
aircraft, reconnaissance and communications satellites,
strategic missiles, and space exploration. By the 1980s,
about 40 percent of the aerospace business resided in
southern California, and the industry employed close to a
half-million people. One of the region's strongest selling
points for aerospace was its environment: the clear blue
skies and ample open spaces were ideal for testing new
aircraft. California also was home to a variety of related
industries, particularly petroleum, as well as to top-notch
research universities and a large labor pool.
Defense spending peaked at $557 billion in 1985 (in
constant fiscal 2009 dollars) and then began a downward
trend. The Soviet Union collapsed in December 1991, ending
the Cold War: in the next decade, more than 50 major
defense companies consolidated into only six. According to
the Employment Development Department's Labor Market
Information Division, employment in the Aerospace
Production and Manufacturing sector declined almost by half
from 139,300 in 1993 to 70,800 in 2013, although almost all
of the decline occurred before 2004. Additionally, defense
spending is expected due to fall due to the implementation
of federal budget cuts.
California law allows various income tax credits,
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deductions, and sales and use tax exemptions to provide
incentives to compensate taxpayers that incur certain
expenses, such as child adoption, or to influence behavior,
including business practices and decisions, such as
research and development credits. The Legislature
typically enacts such tax incentives to encourage taxpayers
to do something that but for the tax credit, they would not
do. The Department of Finance is required to annually
publish a list of tax expenditures, currently totaling
around $50 billion per year.
Last year, the Legislature enacted AB 93 (Committee on
Budget) and SB 90 (Committee on Budget and Fiscal Review),
measures which reformed California's economic development
policies by eliminating enterprise zones and other
geographically-targeted economic development areas, instead
allowing three new tax benefits:
Tax credits for wages paid by taxpayers to
qualified employees within former enterprise zones,
and other areas that suffer from high levels of
poverty and unemployment. The credit lasts from the
2014 taxable year until the 2019 taxable year,
A sales and use tax exemption on purchases of
manufacturing equipment made by taxpayers within
specific North American Industrial Classification
System codes, capped at $200 million annually per
taxpayer, effective July 1, 2014, and ending July 1,
2022.
The California Competes Tax Credit, where the
California Competes Tax Credit Committee can award
various tax credits up to an annually capped amount to
taxpayers who apply.
Proposed Law
Senate Bill 998 enacts two tax benefits for aerospace
manufacturers:
A credit against the Personal Income Tax and
Corporation Tax equal to the taxpayer's amount of
capital investment in the taxable year for a new
aerospace project, beginning in the 2015 taxable year,
and
An exemption from the $200 million annual cap on
tangible personal property eligible for the sales and
use tax exemption for new aerospace projects.
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SB 998 allows the taxpayer to carry over the credit for
nine years, but disallows any credit in taxable years after
the conclusion or completion of the contract that is the
subject of the new aerospace project. The credit is
limited solely to a person engaged more than 50% in
aerospace production and manufacture.
The measure defines the terms "capital investment," "new
aerospace project," and "manufacturing." SB 998 allows the
Franchise Tax Board (FTB) to issue rules, guidelines, or
procedures for the qualified taxpayer to use to determine
the amount of the tax credit.
State Revenue Impact
Pending.
Comments
1. Purpose of the bill . According to the author, "SB 998
provides tax preferences to aerospace manufacturing
companies that are determining which state to locate a
yet-to-be awarded contract for large-scale government
defense programs. In this struggling economy, aerospace
businesses are being lured by other states via tax
incentives and credits that are proving to be better than
California's. It is imperative that California provides an
environment where innovation that happens here allows our
state to compete and thrive in this industry. Recently the
U.S. Air Force has called for a five-year plan for
production of a new long-range bomber, the Pentagon's top
weapons projects, according to military budget figures
(Bloomberg News, March 6). Given a declining Department of
Defense (DOD) budget, it has become imperative for any new
military spending to be tightly monitored and the per-copy
cost must be as low as possible. Businesses in California
seeking to apply for contracts such as this must decide the
best location to manufacture these bombers in a very short
amount of time. The estimated award of this specific
contract, as projected by the Air Force, is approximately
$12 billion dollars. The per-copy break down is near $550
million. Currently, the exemption for purchases of
manufacturing and research and development equipment is
capped at $200 million. With large-scale government
contracts totaling a near $12 billion in total cost, this
$200 million cap provides little tax relief to businesses
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looking to expand, build, spend their dollars, and create
much-needed jobs in California. California competes with
other states that are competitive and incentivizing
businesses in this industry. This legislature should
ensure we communicate to the business community that we are
serious and are doing everything in our power to attract
new large-scale government defense programs to be built in
California. SB 998 helps to position California as an
attractive state to expand upon new aerospace manufacturing
and create thousands of jobs in this era of high
unemployment. Beyond helping the businesses that may be
awarded new DOD contracts, the multiplier effect to
hundreds of small suppliers in this state is a win-win for
all Senate and Assembly districts across California.
California plays a unique and a pivotal role in the
aerospace industry. It has been a reliable source of
employment, innovation, and export income. Engineers in
our state have led the United States in aerospace and
defense services. California continues to set the
precedent for aerospace industries in other states and
countries, and we should stay a step ahead of our
competition. SB 998 is one step to tell aerospace
manufacturers in California, 'Please, choose to do your
business here.' Until we show this industry that we want
their business, they will continue to look to other state's
incentives and move out of California, one by one."
2. Sure, but will it work ? Tax benefits directed at
specific industries do two things: First, they reward
behavior that would have occurred without the subsidy,
so-called "deadweight loss." Some aerospace product
manufacturers won't employ more persons, pay higher wages,
or reimburse more tuition because of the tax benefit,
instead increasing returns to capital in amount equal to
the amount of the tax credit. In these instances, the
state receives no marginal benefit, and transfers wealth
from purposes it would otherwise spend money on for
government purposes to the manufacturer. Second, the bill
may generate additional employment, wage payments, and
economic activity resulting from a new aerospace project;
the incentive will lower production costs at the margin in
amounts necessary for aerospace firms to choose to make
products in California instead of somewhere else. A
successful tax credit would lead to more economic activity
at the margin than its deadweight loss, but no tax credit
has yet conclusively demonstrated that its benefits
outweigh its costs. The Committee may wish to consider how
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much additional economic activity SB 998 will spur versus
its deadweight loss.
Additionally, enacting a new tax exemption requires cuts in
spending or higher taxes to match the amount of foregone
revenue resulting from SB 998. Tax credits do not pay for
themselves: the state's last effort of "dynamic revenue
analysis" indicates that while dynamic effects are
definitely present and visible, their effects are generally
relatively modest.<1> The Committee may wish to consider
whether the benefits resulting from this manufacturing
incentive are worth the tradeoff of cuts in spending or
taxes on other activities.
3. Too soon ? Last year, the Legislature and Governor
Brown enacted wholesale reform to California's tax
incentives for economic development. While the wage credit
is currently in place, the sales and use tax exemption and
the California Competes credit haven't yet commenced. SB
998 would amend the sales and use tax exemption's
per-taxpayer cap for a specific industry before the
incentive has even started. The Committee may wish to
consider waiting to see if its reforms are successful
before it expands them.
4. Single-industry . Generally, tax incentives apply to
any taxpayer who engages in a specified activity, like
conducting research and development, or deducting mortgage
interest. The Motion Picture Production Credit is among
the exceptions to this rule, as the Legislature enacted the
credit to respond to other states enacting and enriching
tax breaks for making movies, shifting film production away
from California. SB 998 removes the sales and use tax
exemption cap only for the aerospace industry, as well as
enacts a 100% tax credit for the industry's capital
expenditures from a new aerospace project, both of which
are without precedent. The Committee may wish to consider
the justification for allowing unprecedented tax benefits
for a single industry.
5. To boldly go . SB 998 allows for a 100% credit for a
taxpayer's capital investment related to a new aerospace
project; usually, tax credits are based on some percentage
-------------------------
<1>
"Whatever Happened to Dynamic Revenue Analysis in
California?" John David Vasche, prepared for the
Federation of Tax Administrators, September, 2006.
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of a taxpayer's costs, like 50% of the gain of qualified
small business stock, or 15% of qualified incremental
research expenditures. Additionally, the measure allows
expenses that are either deductible as normal business
expenses or capitalized into basis to qualify for the
credit. The same expenses may also qualify for Research
and Development Credits under the Board of Equalization's
recent decision in the Pacific Coast Building Products
case, which allowed a taxpayer to claim research and
development credits for normal manufacturing equipment. If
enacted, SB 998 could allow a taxpayer to claim a credit
equal to 100% of its costs, while deducting those same
costs as expenses, or claim both an SB 998 credit and a
research and development credit for the same expenses. The
Committee may wish to consider amending SB 998 to preclude
taxpayers from choosing to claim two tax benefits for the
same costs.
6. Sunset and performance measures ? SB 998's removal of
the per-taxpayer cap on sales and use tax exemptions expire
when the general exemption does on January 1, 2023, but its
income tax credit doesn't have a sunset. Additionally,
neither provision contains goals or objectives, or data
collection requirements for a future Legislatures to use to
determine whether the bill's new tax expenditures were
effective. The bill could choose to measure aerospace
employment, amount of capital investment in aerospace
production in the state, or some other indicator. The
Committee may wish to consider placing a sunset on the
bill's income and corporation tax credit, and adding
performance measures.
7. Technicals . FTB and Committee Staff recommend deleting
the measure's two grants of authority to the Board of
Equalization to issue regulations relating to the previous
version of the bill's tax credit based on the taxpayer's
increase in assessed valuation resulting from a new
aerospace project, as well as the measure's two definitions
for new construction, because they relate to property tax
components of a previous version of the bill.
Support and Opposition (5/8/14)
Support : California Manufacturers and Technology
Association; Lockheed
Martin Corporation.
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Opposition :
Unknown.