California and Incentives for Job Creation and Innovation

On 12/5/11, the California Assembly Revenue & Taxation Committee held a hearing on job creation and innovation (see prior post). I had the opportunity to testify. A few points I offered:

• California has one of the most generous research tax credits among the states and an underutilized jobs credit. Identify why these provisions are not promoting job creation and innovation to the desired level. For example, in 2009, $400 million was set aside for a $3,000 per new job tax credit for employers with employees with less than 20 employees. In November 2011, only $75 million has been used.
• Conform California law to more favorable depreciation rules of federal MACRS and Section 179 expensing. Encourage Congress to allow the IRS to update depreciable lives, such as for computers and semiconductor manufacturing equipment which generally is too long (5 years). In addition, encourage Congress to modernize Section 179 to apply to both tangible and intangible assets. While there should be discussion of whether any special rules, such as tax credits, should be in the law (they tend to add complexity and inequities and inefficiencies), there are considerations in designing the base that affect the economy. For example, to calculate taxable income of a business, depreciation needs to be calculated. If equipment can be depreciated using double-declining balance over 3 years, that has a different economic impact and affect on interstate and international business competitiveness than straight-line over 10 years.
• Encourage Congress and the IRS to improve the federal research tax credit including making it permanent.
• Develop a plan to phase out the sales tax on business purchases of manufacturing and R&D equipment. This might be funded by broadening the sales tax base for consumers to include consumption of personal services and digital goods, and to repeal the elective approach to apportionment (adopting the single sales factor approach due to its economic development foundation).
• Be ready with incentives for corporations to utilize cash in California should the federal government enact a repatriation tax break.

I had 18 recommendations which you can find here.

Four items in particular I found interesting about the hearing:

1. Three people testified via Skype - we could see and hear them well and they could hear us and participate. It did go down once for a few minutes, but technicians restored the connections.
   
2. The business rep panel for the most part suggested that California needs to get rid of the elective apportionment and go to just single sales factor apportionment. I agree and had the opportunity to note that, today, the corporate income tax has become an economic development tool. Thus, if we want to use it to encourage companies to locate employees and property in the state without having their tax bills go up, we offer single sales factor apportionment. But, at the same time to tell companies that do not locate payroll and property here, we want your CA taxes to be lower too, we are just fools (I didn't say fools, but that is what we are).
3. Professor Robert S. Chirinko, University of Illinois at Chicago, shared some of his research findings on the benefits of jobs credits. In a nutshell, that research found that there were no benefits. He also noted that such provisions can have some negative impact because when enacted, the incentives are not usually immediately effective so employers delay hiring until the effective date.
4. The Legislative Analyst's Office seems to have modified its view on the California research. James Nachbaur, an economist with the LAO presented a background paper on the credit. In a 2003 report, the LAO stressed that a key purpose of a research credit is to address spillover effects, but that the federal credit already handles that so why would a state also offer a credit? The 12/5/11 report notes that 2003 comment, but does not emphasize it. I think this may be because since 2003, corporate income taxes have become more of an economic development tool meaning that we should view a state research credit primarily in terms of whether it causes companies to engage in R&D in the state rather than elsewhere.

The hearing information should be posted to the committee's website soon.

What do you think?