Legislative Analyst's Office, October 2002


An Overview of California's Manufacturers' Investment Credit


The Assembly Committee on Revenue and Taxation has requested that the Legislative Analyst’s Office (LAO) review and assess the effectiveness and appropriateness of the Manufacturers’ Investment Credit (MIC). Specifically, the LAO was requested to provide a report on the MIC that would review and comment on existing information relating to the performance of this tax program, and identify additional information that would be required to more thoroughly evaluate its effectiveness.

This report contains the following sections:

Also provided are the following appendices: (1) comments from industry regarding the MIC; (2) detailed information regarding use of the MIC by industry; (3) research findings of current literature; and (4) investment credits by other states and the federal government.

Background on the MIC

What Is the MIC?

Tax Program Basics. The MIC is a tax program that allows certain businesses to reduce their personal income tax (PIT) or corporation tax (CT) liabilities by 6 percent of the costs of acquiring and installing manufacturing equipment. The MIC was put into place pursuant to Chapter 881, Statutes of 1993 (SB 671, Alquist). The legislation allowed credits to begin accruing effective January 1, 1994, and to be claimed by businesses during tax years beginning on or after January 1, 1995. The MIC is available only for certain types of equipment and may be used only for the purpose of offsetting current or future tax liabilities. Generally, the MIC is available only to manufacturing firms, although recent legal decisions have resulted in the broadening of its availability to other types of firms.

Additional MIC Features. In addition to the 6 percent tax credit for income tax liabilities discussed above, the tax program provides the following features in lieu of the tax credit:

The first of these SUT-related tax incentive features was intended to assist new businesses which had no income tax liability. The second provision was intended to provide flexibility to businesses in the assignment of tax benefits among their operating units.

Program Restrictions. Once a company receives the MIC, the property that was used for credit eligibility must remain in the state for one year. If the property is removed during the one-year period following the date that the credit was claimed, regulations provide a process for reclaiming a portion or all of the credit. The credit generally may be carried forward for up to eight years and up to ten years for certain small businesses. In addition, the MIC itself is not refundable, may not be used to offset the corporate minimum tax, and may not be used to reduce the alternative minimum tax (AMT). (It may, however, be used to reduce the corporation’s regular CT liability to the calculated AMT level.)

Sunset Provisions. Enabling legislation provided that the tax credit would expire on January 1, 2001, if the level of manufacturing employment on that date (excluding aerospace employment) did not exceed by 100,000 jobs the number that existed on January 1, 1994. The sunset provision was later changed such that the MIC would expire during any year that the number of these manufacturing jobs did not exceed the 1994 level by at least 100,000. Current data indicates that the state had 1.537 million manufacturing jobs on January 1, 1994 and 1.687 million of such jobs on January 1, 2002. (The 2002 estimate will be revised this February.) In the event that the MIC becomes inoperative under these employment level requirements, the enabling legislation would be automatically repealed. Thus, subsequent action by the Legislature would be required for the program to go into effect again.

Other Program Changes. Certain other alterations to the MIC after its initial adoption made it more generous for certain types of businesses. In 1995, for example, (1the MIC was expanded to include special buildings for the semiconductor industry, and (2the preferential treatment of small businesses under the MIC was extended to certain biotechnology and biopharmaceutical business. In 1998, the MIC was further expanded to cover equipment used in the production of computer programming and software.

Intent of the MIC Legislation

Adopted during a period of significant economic uncertainty in the state, the MIC was preceded by several years of negative economic growth. In fact, the California economy—which had outperformed the national economy throughout the late 1980s—suffered greater reductions in economic output, employment, and income than did the nation as a whole during this period. Furthermore, as a consequence of severe reductions in defense spending, corporate downsizing (especially in high-technology sectors), and a real estate slump, the state lagged the nation during the economic recovery period. The recession led to a particularly severe downturn in the manufacturing sector. The state lost approximately 300,000 manufacturing jobs during the period 1989 through 1993, with a 45 percent reduction in the aerospace sector alone.

Based on significant concerns about the state’s economy (and in particular, the severe declines in manufacturing), the MIC was adopted by the Legislature and signed into law. The tax program was perceived as a means of compensating for high costs of production as well as other business costs in the state. By reducing the tax burden with respect to certain types of activities, policymakers attempted to make the state’s tax environment more favorable for business expansion and as a relocation site for out-of-state firms. Originally proposed as a SUT exemption for certain equipment purchases, the MIC was changed to an income tax credit largely in order to lessen the impact on state revenues.

Additional tax changes favorable to business were also approved during the early 1990s, including (1more generous treatment of business’ net operating losses, (2reduced taxes for Subchapter S corporations, and (3elimination of the sunset provision for the research and development (R&D) tax credit.

MIC Provisions in Detail

Eligibility for the MIC

In order to receive the MIC, the eligibility requirements regarding qualified taxpayer, qualified costs, and qualified property must be met. We describe the requirements below and identify issues raised before the Board of Equalization (BOE) for each category.

Issues With Eligibility Requirements

Qualified Taxpayer. A recent BOE ruling declared that a taxpayer need only be engaged in a specified activity to be eligible for the MIC. This decision reverses Franchise Tax Board (FTB) regulations that required a taxpayer’s primary business be classified under the proper SIC codes in order to qualify.


Issues With Eligibility Requirements

Qualified Costs. There are currently two cases before the BOE regarding what type of capitalized labor costs qualify for the MIC. This issue is particularly contentious when dealing with payments made to third-party contractors.


Issues With Eligibility Requirements

Qualified Property. A recent BOE decision found against the FTB, ruling that the MIC statute did not allow for the bifurcation of property. A second, unresolved, issue is whether FTB regulations have made the definition of inherently permanent structures too narrow, thereby limiting the types of property that are eligible for the MIC.


How Does the MIC Work?

For both PIT and CT filers, the MIC acts as a credit against computed tax liabilities. California PIT liabilities are based on California resident or nonresident income earned in California. California CT liabilities are based on income attributable to California, which, for multistate and multinational corporations, is the share apportioned to California, based on the state’s share of the firm’s total property, payroll, and sales.

Example of MIC Tax Effects

State Tax Liability Only. Figure 1 shows a hypothetical firm with gross revenue of $1,000,000, costs of $850,000 (including capital expenditures of $150,000), and net income apportioned to California of $150,000. Without the MIC, the company has a state corporate tax liability of $13,260. Assuming the company can claim the MIC on $50,000 of its qualified capital expenditures, this translates into a tax credit of $3,000, reducing the company’s final tax liability to $10,260.

The corporation’s tax liability cannot fall below the AMT, which is equal to 6.64 percent of California net income, disregarding exemptions and credits. If a firm’s tax liability is higher under the AMT than the CT, the firm would be required to pay the difference. In the example shown in Figure 1, the AMT results in a lower tax liability than the regular tax ($9,960 versus $10,260, respectively), and is therefore not applicable.

State and Federal Tax Interaction. Due to the interaction between state and federal corporate taxes, the actual value of the credit to a company will be less than the amount by which its California tax is reduced. Since state taxes are deducted from federal taxable income, the reduction in state taxes will result in an increase in federal tax liability. As shown in Figure 2, the company’s federal taxable income, and therefore its federal tax liability, is higher under the credit. The company’s total tax liability remains lower with the credit, but by $1,830, as opposed to $3,000. This means that the state loses more in forgone revenues than companies receive in reduced taxes through the MIC program.



Figure 1

Hypothetical California Firm
California Corporate Tax Liability











  Capital expenditures:






    Subtotal, Costs


Taxable Income


  Pre-Credit State Corporate Tax Liability (8.84 percent)


  Less MIC (6 percent of $50,000)


    Total State Corporate Tax Liability





Figure 2

Hypothetical California Firm
California and Federal Tax Liability

Tax Liability Without MIC

State taxable income


State tax liability without MIC


Federal taxable income


Federal tax liabilitya


  Total State and Federal
    Corporate Tax Liability


Tax Liability With MIC

State taxable income


State tax liability after MIC


Federal taxable income


Federal tax liabilitya


  Total State and Federal
    Corporate                Tax Liability


Value of Credit

Additional federal taxes


Decreased state revenues


Reduced taxes for firm


a Federal corporate tax liabilities are based on marginal tax rates varying from 15 percent to 39 percent.

Tax Policy Issues Regarding the MIC

A targeted tax program such as the MIC raises important tax policy issues for policymakers. For example, there are legitimate arguments both in favor of and opposed to the basic MIC program. In addition, the administration of the program and its governing regulations raise other issues for policymakers.

Arguments Against the MIC

Critics of the MIC argue that it is an inequitable, inefficient, and ineffective means by which to encourage investment. Their criticisms fall into the following broad categories:

Arguments Supporting the MIC

Supporters of the MIC generally view it as an effective means to assist particular businesses suffering from financial difficulties and a means to assist the state’s economy at the same time. Their arguments typically fall into the following categories:

Other Issues Regarding the MIC

A number of issues have been raised by industry regarding the administration and compliance costs of the MIC. For example, some firms have found the program to be more restrictive than necessary. Others cited difficult and expensive compliance issues. In addition, there has been some discussion of changing the nature of the tax credit by allowing the sale and purchase of credits between firms, or eliminating the MIC in favor of SUT exemption for purchased equipment. Appendix A presents additional material regarding some of these issues.

In addition to concerns raised by industry, some who favor the MIC raise objections regarding its implementation and design. One common suggestion is that the MIC be redesigned to restrict—as much as possible—its availability to investment that would not have been undertaken without the MIC. For example, a base level of annual capital equipment investment could be established, with only investment in excess of this level eligible for the MIC. A similar approach is used with respect to California’s R&D tax credit.

How Important is the MIC?

Revenue Impacts of the MIC

The MIC is one of the most significant tax programs in the state in terms of the amount of foregone revenues from the PIT and CT. Figure 3 indicates the amount of revenue foregone beginning in the year that credits were first available through 2002‑03. These estimates are based on direct revenue impacts due to reduced taxes from MIC claims. These may be partially offset by indirect revenue increases due to additional economic activity generated by the credit. The amount of credits claimed is expected to drop from the peak of approximately $460 million in 2000-01 to an estimated $420 million for 2002‑03. The Department of Finance (DOF) indicates that the MIC generally results in indirect additional revenues to the state of approximately 30 percent of the credits’ direct revenue loss. Thus, MIC revenue losses of $420 million would be offset by an increase in revenues of approximately $126 million, for a net revenue loss of $294 million. The amount of MIC claims for any year include those due to current-year investment, as well as credits that were not used in prior years and have been carried forward.

As a percentage of total foregone revenues, MIC claims under the CT are currently estimated to be about 7 percent, as shown in Figure 4. This represents a decline from the estimated 7.3 percent in 2000-01. MIC claims under the PIT are a relatively minor portion of total MIC claims, and represent a small percentage of PIT revenues.

MIC Claims by Sector and Industry

The use of the MIC by CT taxpayers is concentrated in particular sectors, as shown in Figure 5. The largest dollar amount of MIC claims is concentrated in electrical and electronics businesses (including computer and related industries), which is responsible for over 40 percent of the dollar value. However, the largest number of returns with MIC claims is in other (miscellaneous) manufacturing, which represents about 57 percent of these returns. Additional detail regarding industry distribution of the MIC is provided in Appendix B.


Figure 5

MIC Returns and MIC Claims are Distributed Differently
2000 Income Year


Tax Returns with MIC Claims


Amount of MIC Claimed



Percent of Total



Percent of Total

Food and kindred products






Chemicals and allied products












Oil and gas and related industries






Electrical and electronic equipment






Other manufacturing





















MIC Claims by Size of Firm

Most tax returns with MIC claims are filed by small- and medium-sized businesses, in terms of income. As shown in Figure 6, roughly 90 percent of the returns with MIC claims are filed by businesses with incomes of under $1 million. In terms of the actual amount of credit awarded, however, this is largely attributable to larger businesses with incomes in excess of $10 million. This suggests that most of the benefit goes to larger businesses although the data does not address the relative importance of the MIC to small and large businesses based on income or operating expenses.

Measuring the Effect of the MIC

Perhaps the most crucial issues for the Legislature to address are whether or not the MIC is effective and efficient based on particular measurement criteria. Two of the most common measures of effectiveness that have been used are (1the amount of new investment caused by the MIC and (2the number of jobs that have been generated by the MIC. Criteria regarding efficiency might include (1) the revenue loss to the state in generating a given level of investment, and (2) the revenue loss incurred per job created.

While there are numerous criteria upon which to judge the value of the MIC, carrying out such evaluations is costly and resource intensive. In addition, all such studies require numerous behavioral assumptions that can add a great deal of uncertainty to any conclusions that might be drawn from such analyses. Nevertheless, some relevant studies have been conducted for other states, regions, and at the federal level that can provide some useful background. Most have been conducted by academic or other independent researchers. Although tax credits are viewed favorably by many policymakers, there is general consensus among economists that such policies are neither particularly effective nor efficient. In general, the empirical evidence suggests that while taxes do influence economic activity, state-level investment tax credits have little impact on business decisions relative to other factors.

Studies relating to the effectiveness of investment tax credits have centered on three major areas:

Impact of Taxes on Economic Activity

Recent literature has primarily focused on estimating how responsive employment, investment, gross state product, and plant start-ups are to overall taxes. These studies have typically shown that if overall taxes were lowered by 10 percent, economic activity would increase between 1 percent and 6 percent. (Additional information regarding the findings of these studies is presented in Appendix C.) The studies also indicate that:

Impact of Investment Tax Credits on Investment

Although fewer studies exist on the direct impact of investment tax credits on investment, there have been a variety of econometric and statistical techniques used in these investigations. Generally, these studies concluded that investment tax credits have only small or undetectable effects on investment. One reason why tax credits are found to have little impact may result from the benefits of such credits being passed “up” to producers of inputs and “down” to employees, as opposed to showing up as increasing investment. In fact, evidence has shown that investment tax credits can lead to higher input prices and wages, at least in a short or intermediate term. The following study approaches and results bear mentioning:

Estimating the Cost of Job Creation

A substantial amount of economic development research has attempted to measure the public cost per job created. Most studies have shown these costs to be significant, with evidence generally consistent with the belief that economic development subsidies are likely to be associated with substantial net costs per job.

One recent study estimated the average public cost per manufacturing job generated by a tax incentive in 17 states, including California. The states were chosen based on high levels of manufacturing production and a decline in effective corporate tax rates from 1990 through 1998. The loss in state and local revenue per job, over a 20-year period, was estimated to equal $46,000 on a net present value basis. The study also looked at the impact of the increased economic activity on state revenues, and concluded that over the same 20-year period, additional revenues of $18,000 in net present-value terms would be collected. In each year, revenue reductions were greater than revenue increases.

Other studies have reached similar conclusions regarding job costs. It should be noted that even with such costs associated with job creation, policymakers may decide that a job-creation policy is appropriate. This may be due to the perceived advantages of making overall employment larger even at the expense of state revenues.

Alternatives for Further Study

Should the Legislature wish to pursue further specific investigation into the effects of the MIC, there are several different options, each with its own set of advantages and disadvantages. With each of the approaches, attempts would have to be made to separate the effect of the MIC from other factors that have an effect on economic activity. Such independent measurement of the MIC impact is essential in estimating its effectiveness. In many cases, a particular approach would require the collection and analysis of substantial amounts of data. Possible data collection options would include voluntary filings by individual firms or collection of investment and other data by FTB in conjunction with businesses’ tax filings.

The principal approaches to studying the impact of tax incentives are:

Appendix A
Perspectives of Industry


We held several meetings with various business representatives regarding the use of  California’s Manufacturers’ Investment Credit (MIC). The major points that were raised during these discussions are outlined below.

Tax Credits in General

Role of the Credits in Investment Decisions. Industry representatives stated that the credits do have an impact on investment decisions. Several companies incorporate the credits into their cost models. One firm noted that although they look at the tax ramifications of the credits, they do not quantify the marginal benefit of the credits themselves. Another firm indicated that they help the “bottom line,” suggesting that rather than act as an “incentive” they instead serve as a “reward.”

Unitary Returns. California generally requires a member of a group of two or more related corporations to file a combined return. A combined or unitary return means that a corporation’s taxable income is determined by adding all units’ revenues and costs together. However, the MIC can only be applied to that unit which purchased the equipment. Industry noted that this limits the amount of the MIC that can be used. For instance, the credits could not be used to offset a firm’s tax liability if the unit that purchased the equipment were unprofitable, even though the corporation as a whole had taxable income.

Available Only to Profitable Firms. Due to the nature of tax credits, they can only be used when a firm has tax liability. In any year a firm is not profitable, the credits go unused. In addition, since a firm’s tax liability cannot fall below the alternative minimum tax, firms with many deductions and credits may not be able to utilize the credits in their entirety.

MIC Particulars

MIC Versus Sales Tax Exemption. Industry representatives noted that a sales tax exemption is preferable to a tax credit, since it would be less complicated to calculate, result in less administrative work and auditing, and not be limited only to firms with taxable income. One firm noted that a sales tax exemption of less than 6 percent may be preferable in some respects to the current MIC.

The Audit Process. The MIC audit is generally considered by industry to be one of the longest and most arduous, both for the Franchise Tax Board (FTB) and businesses. Industry is under the impression that the FTB targets businesses using the MIC, and is “aggressively” attempting to disallow many expenses that appear to qualify.

Documentation of Direct/Indirect Labor. The MIC can be applied to certain labor costs, but only those that are direct or “capitalized” into the equipment. In order to properly document costs, companies must often keep separate and very detailed records of employment time spent on particular projects. Industry also noted that this documentation is particularly difficult when outside contractors have been retained. Firms reported that costs that would qualify had the firm done the work in-house do not always qualify when an outside contractor is hired.

Appendix B
Detail on Manufacturers’ Investment Credit (MIC)
 Claims By Industry


Additional details regarding the use of the MIC is provided in Figure B-1. The figure indicates the concentration of the credit amounts in computer-related industries, which is responsible for over one-third of total MIC claimed.


Figure B-1

MIC Activity by Industry

2000 Income Year
(Dollars in Thousands)


of MIC

Percent of
Total MIC







  Petroleum refining



  Other manufacturing



  Electronic equipment









  Transportation equipment



  Beverage and tobacco



  Fabricated metal















  Computer services









Non bank holding companies









Agriculture, forestry, and fishing



Transportation and utilities















Finance, insurance, and real estate










Appendix C
Results of Recent Research on Tax Impacts


Estimates of the impact of taxes on economic activity show broad variations, as shown in Figure C-1. For example, estimates for increased manufacturing investment given a 10 percent decline in general taxes (such as personal income taxes and sales use taxes) range from 5.4 percent to 10.2 percent, with a median response of 3 percent. Similarly, estimates for increased manufacturing investment given a 10 percent decline in business taxes (such as corporate income taxes and business license taxes) range from 1 percent to 3.6 percent, with a median response of 2 percent. In theory, since the effect of various taxes should be reflected to a greater or lesser extent in a firm’s costs, the impact of reductions in general and business taxes should be somewhat similar.

The following figure summarizes the various results from these studies, grouping them by economic indicator:


Figure C-1

Evidence From Recent Studies

Change in Economic Activity Due to 10 Percent Decline in Taxes

Economic Indicator

Number of Studies



Total employment



0 to 8.5%




-0.5 to 15.4

Investment in manufacturing



-5.4 to 10.2

Gross state product



-2.7 to 8.8

Manufacturing plant start-ups



0 to 4.0

Change in Economic Activity Due to 10 Percent Decline in Business Taxes

Economic Indicator

Number of Studies



Total employment



0 to 1.6%




0 to 2.6

Investment in manufacturing



1.0 to 3.6

Gross state product




Manufacturing plant start-ups



-0.6 to 157.0


NA=Not available



Appendix D
Investment Tax Credits (ITC) at the
Federal Level and in Other States

Federal ITC

California’s Manufacturers’ Investment Credit (MIC) is modeled, in part, on a similar federal program that existed from 1962 through 1986. The federal ITC was originally introduced for the purpose of increasing economic stability by protecting the economy from short-run fluctuations in business investment spending, but was later viewed as a tool to stimulate the economy. Applicable to capital equipment purchases made by any industry, the amount of the ITC was dependent on the depreciable life of the equipment—ranging from 2.33 percent for equipment with a tax life of four to six years to 7 percent for equipment with a tax life greater than eight years.

The ITC was modified numerous times after its initial adoption:

It was temporarily repealed during the economic expansions of 1966‑67 and 1969‑71.

The top credit rate was temporarily increased to 10 percent in 1975 in response to several years of negative economic growth. This temporary increase was extended and then made permanent in 1979.

The credit was expanded in 1981 to include a greater variety of investments and the credit rate was made uniform for all types of equipment.

The program was eliminated in 1986 as part of attempts to simplify the tax system and in conjunction with other tax changes reduce the overall tax burden.

In 1993, the Clinton Administration proposed a permanent ITC for small businesses and a temporary targeted credit for large corporations. Neither of these proposals was enacted. In 2001, legislation to reinstate an investment tax credit was introduced into the House of Representatives, but stalled in committee.

ITCs in Other States

Although investment tax credits are not currently in place at the federal level, they are numerous at the state level. Currently, 39 of the 46 states that levy taxes on corporations have some type of investment tax credit. Among these states, tax credits are available for a variety of activities, including: expenditures by new businesses; investments in enterprise development zones; expenditures on research and development; and investment in equipment used in either manufacturing or high-technology industries.

At the present time, 19 states (including California) offer statewide manufacturers’ ITCs. In addition, 30 states exempt manufacturing equipment from the sales tax, while eight states offer a limited sales tax exemption program (including California). Five of the top ten manufacturing states offer a MIC (including California). Figure D-1 provides basic information on the various tax programs offered by California and selected manufacturing and high-technology states.


Figure D-1

Investment Incentives of Large Industrial States


Percent of
U.S. Production

Tax Rate

Sales Tax

Tax Credit?













5.1 to 8.5


















North Carolina










New York






















As indicated in Figure D-1, five states (shown in bold in addition to California) offer an ITC on equipment purchases. Each of these states also exempts from the sales tax the purchase price of most equipment purchases. Only Virginia, among those states surveyed, offers neither a sales tax exemption nor an ITC.

Each of the ITC programs in the five states identified above differs somewhat from California’s MIC, as shown in Figure D-2.



Figure D-2

Investment Tax Credits for Selected States


MIC Rate

Notable Characteristics


·   1 percent to 5 percent for expenditures over $50,000, depending on location of investment; 6 percent to 10 percent for expenditures over $5 million, depending on location and size of investment.

·   Eligibility depends on the taxpayer operating a manufacturing facility within the state for the previous three years.


·   3 percent of all expenditures.

·   Credit may be claimed for any depreciable property.

New Yorkc

·   5 percent for expenditures up to $350 million; 4 percent for expenditures above $350 million.

·   Credit may be claimed for any depreciable property.

North Carolinad

·   7 percent of the lower of: (1) the actual cost of new equipment and machinery or (2) the amount by which the value of the companies’ equipment and machinery has increased in the previous three years. Credit is only available for expenditures that exceed a given threshold ranging from $0 to $1 million, depending upon the location of the investment.

·   Credit is available for all expenditures that exceed the threshold, and must be taken in equal installments over seven years.


·   7.5 percent (or 13.5 percent for enterprise zones) of expenditures that exceeds the companies’ average annual investment costs over the previous three years.

·   Credit is available for all expenditures that are in excess of the three-year average, and must be taken in equal installments over seven years.


a  State of Georgia, State Revenue Department.

b  Commonwealth of Massachusetts, Department of Revenue.

c  State of New York, Department of Taxation and Finance.

d  State of North Carolina, Department of Revenue.

e  State of Ohio, Department of Revenue.


Although Georgia and North Carolina did not estimate the credit’s impact on their state revenues, direct revenue impact estimates were available for New York, Ohio, and Massachusetts, as shown in Figure D-3. While the California MIC resulted in the largest amount of foregone revenues, New York’s revenue loss is the highest in relation to both manufacturing output and total tax revenues. 


Figure D-3

Revenue Impacts of Investment Tax Credits

(Dollars in Millions)



Percent of


Production Value





New York













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