March 10, 2023
California Competes Provides Incentives to Attract Business Investment. California Competes is an economic development tax incentive program that allows the Governor’s Office of Business and Economic Development (GO‑Biz) to negotiate tax credit agreements with individual companies that agree to meet multiyear hiring and investment targets. Companies that meet their hiring and investment targets can claim credits against their corporation or income taxes. On the other hand, the state “recaptures” tax credits from companies that fail to meet their targets. GO-Biz is permitted to make agreements committing $180 million plus amounts recaptured from prior agreements in tax credits each year.
Recent Expansion. In 2021-22, the state did a one year expansion of California Competes that (1) increased the amount of credits that could be awarded to $290 million and (2) permitted California Competes to award $120 million in grants as an alternative to tax credits. The 2022-23 budget included an additional $120 million for a second year of grants. The Governor’s budget proposes to provide $120 million for a third year of grants in 2023-24.
Awards Increased in 2021-22. GO-Biz made agreements with 48 businesses in 2021-22, committing a total of $390 million in tax credits. This was an increase of $161 million from the year before. GO-Biz also awarded all $120 million in grant funds to 8 businesses in 2021-22.
Significant Portion of Credits Are Recaptured. 55 percent of the tax credits awarded across 2014-15 to 2016-17 have since been recaptured. 36 percent of credits awarded in 2017-18 have thus far been recaptured. Agreements for more recent awards are still ongoing so few have been recaptured to date.
Promised Investments. The figure below shows two measures of investments promised by California Competes tax credit recipients (1) capital investments per $1 of tax credit and (2) new jobs per $100,000 of tax credit (adjusted for inflation). The new jobs measure has been trending down for several years. The capital investment measure has fluctuated over time, but notably reached an all-time low in 2021-22. Both measures of investment were higher in 2021-22 for grant recipients than tax credit recipients. Promised capital investment per grant dollar was three times higher than investment per tax credit dollar.
Two Recent Studies on California Competes. Two recent studies have examined whether California Competes spurs new business investment that would not have occurred in the absence of the program. The first study (Freedman et al. ) compares employment outcomes in neighborhoods with businesses that received California Competes tax credits to similar neighborhoods that did not. The study finds larger employment increases in neighborhoods with credit recipients but does not offer compelling evidence that this outcome was not simply a continuation of recent growth in those neighborhoods. The second study (Hyman et al. ) compares employment outcomes across two similar groups of California Competes applicants. Despite similarity of the applicants, program rules resulted a higher share of applicants in one group receiving tax credits than the other group. The study finds that employment was much higher two years later among the group that received more tax credits.
Fairly Good Evidence That California Competes Increases Business Investment. Overall, these recent studies provide fairly good evidence that California Competes encourages recipients to make new investments in California. Given the time period examined by these studies, this conclusion applies to California Competes prior to its large expansion in 2021-22. While it is reasonable to assume these results apply to small expansions of the program, caution is warranted for larger expansions. The research methods used do not readily allow the results to be extrapolated to large, rapid expansions of California Competes. This means these findings do not allow the state to be confident the program will remain effective when expanded significantly.
Squaring Study Findings with High Recapture Rate. These conclusions seem somewhat at odds with the significant share of credits recaptured from businesses due to their failure to meet investment targets. One potential interpretation is that the state is making high risk-high reward bets on businesses. While many of these bets do not pan out, the ones that do can be successful enough to yield overall benefits for the state. This dynamic is not necessarily problematic given that the state recaptures credits from unsuccessful agreements.
Finding the Right Scale. The state enacted a large expansion of California Competes in 2021-22 and continued it in part in 2022-23. Taking a chance that the program could maintain its effectiveness under such rapid expansion may have been somewhat reasonable two years ago, when the state was flush with resources. However, the state is now facing an anticipated budget shortfall. As such, each dollar of spending should be subjected to heightened scrutiny. In this environment, proposals to significantly enlarge California Competes—such as the Governor’s grants proposal for 2023-24—are less prudent. The state may be better off reverting the program back to its 2020-21 size. However, recognizing that inflation has been elevated recently, a smaller increase could be reasonable to maintain the size of the program in inflation-adjusted terms. For example, reducing the Governor’s grants proposal to between $60 million and $80 million would (1) adjust California Competes resources to reflect inflation that has occurred since the time period looked at by the studies discussed above and (2) provide a modest increase to total program funding.
Grants Versus Credits. As we discussed two years ago, there were some good reasons to add a grants component to California Competes. The recent research, however, warrants revisiting the way the grant program has been structured over the last two years. In particular, given evidence supporting the effectiveness of the credits, it likely makes sense to align the structure of the grant program as closely as possible with the credit program. The grant program has most clearly deviated from the credit program on one dimension: the number and size of the awards. Because of the grant program’s focus on businesses making big investment promises, significantly larger awards have been made to a much smaller number of businesses. Should the state maintain a grant program moving forward, relaxing or eliminating this focus on big investment promises could make sense.
Note: This report was prepared in fulfilment of the reporting requirements of Chapter 256, Statutes of 2021 (AB 176, Committee on Budget).