In this analysis, we discuss our findings and recommendations regarding the Governor's proposals regarding the California Competes tax credit program. This affects two departments: (1) the Governor's Office of Business and Economic Development (GO-Biz) and (2) Franchise Tax Board.
The 2018-19 Budget: California Hiring Tax CreditsReport Feb 21, 2018
The 2018-19 Budget: California Competes ProposalReport Oct 31, 2017
[PDF] Review of the California Competes Tax Credit
California Competes Tax Credit Program Created in 2013. Chapter 69 of 2013 (AB 93, Committee on Budget) eliminated state economic development programs known as Enterprise Zones and replaced them with several new economic development programs. One such program—the California Competes tax credit—provides tax credits to select businesses on a case-by-case basis. California Competes allows companies to request a credit against the corporation tax (CT) or the personal income tax (PIT) in exchange for meeting specific hiring and investment goals over a five-year period.
GO-Biz May Allocate Tax Credits Through 2017-18. The Governor’s Office of Business and Economic Development (GO-Biz) administers the California Competes tax credit program. GO-Biz negotiates written tax credit agreements with businesses on a case-by-case basis. (Businesses that receive tax credit agreements are identified through a competitive application process. The agreements are approved by a five-member committee.) These agreements specify an amount of tax credits available to each business once they achieve specific and pre-determined employment and investment targets over a five-year period. The amount of tax credits available varies from year to year according to a formula established in law. $243.4 million in tax credits were available for GO-Biz to allocate during 2016-17. Under current law, GO-Biz may only allocate tax credits through the 2017-18 fiscal year.
FTB Verifies Taxpayer Compliance. The Franchise Tax Board (FTB) is one of California's tax agencies, administering the PIT and the CT. FTB is generally required to review the records of businesses allocated a California Competes tax credit. (FTB is not required to audit small business recipients, defined as having annual revenues under $2 million, though they may do so at their discretion.) At the end of each year, businesses are first required to report to GO-Biz whether they achieved their hiring and investment targets for the year, meaning they will be able to claim the tax credit. GO-Biz collates this information and provides it to FTB monthly. FTB verifies that the businesses have complied with the terms and conditions of their agreements after they have claimed the tax credit. To date, businesses have only been able to claim credits against their taxes for the 2014 and 2015 taxable years. FTB has not identified any cases in which a business was in a “material breach” of their agreement, meaning they claimed a tax credit without first meeting their hiring and investment targets. In the future, should FTB determine a business is potentially in material breach of their tax credit agreement, they will notify GO-Biz. GO-Biz then determines whether to recapture the tax credit.
Limited-Term Positions Expiring This Year. The Legislature initially provided funding and positions to GO-Biz and FTB to administer the California Competes tax credit program on a limited-term basis because it was a new program with unclear and temporary funding requirements. The three-year limited term position authority—10 at GO-Biz and 4 at FTB—will expire at the end of the current fiscal year.
GO-Biz Seeks Continued Funding At Current Levels For Three Years. The Governor’s budget proposes $1.2 million General Fund to GO-Biz in each of 2017-18 through 2019-20. This would allow GO-Biz to continue administering the California Competes tax credit program at current staffing levels—10 positions—for three more years.
FTB Seeks Increased Funding For Taxpayer Compliance. The Governor’s budget proposes $1.7 million General Fund in 2017-18 and $1.6 million General Fund in 2018-19 and 2019-20 for FTB compliance activities related to the California Competes tax credit. While the proposal provides funding equivalent to a total of 14 positions—an increase of 10 from current levels—the request does not increase FTB’s total position authority, meaning they will be required to leave positions in other areas of the department vacant.
Under Current Law, No New Tax Credits Negotiated After 2017-18. GO-Biz negotiated 212 California Competes tax credit agreements in 2014-15 and 259 agreements in 2015-16. We estimate that GO-Biz may negotiate a somewhat higher number in 2016-17 and 2017-18 because of unallocated tax credits from prior years. As we mention previously, under current law, GO-Biz may only allocate tax credits through the 2017-18 fiscal year. At that point, most of the California Competes workload at GO-Biz goes away. GO-Biz’s remaining duties include monitoring the status of their existing agreements, responding to inquiries from FTB’s compliance staff, and acting to recapture tax credits if necessary.
FTB Taxpayer Compliance Workload Will Increase Over Coming Years. The first businesses that negotiated California Competes tax credit agreements with GO-Biz in 2014 were allowed to claim tax credits against their 2014 tax year income tax liability (provided they achieved their hiring and investment targets). These returns were not filed until 2015. According to information provided by FTB, in 2015-16 taxpayer compliance staff reviewed the records of 15 businesses to verify they complied with the terms of their tax credit agreement. In 2016-17, given their current resources, FTB estimates they will be able to review the books of 40 taxpayers (about 10 reviews per staff equivalent per year). Meanwhile, the number of businesses that have claimed California Competes tax credits has been increasing significantly. FTB estimates that they will end the current year with an inventory of 449 cases pending a review. This amount includes businesses that have met their first year milestone, but not all of these have yet filed a return claiming the tax credit. Also note that FTB does not review the records of every business in every year (and only reviews the records of a subset of small business). However, the number of businesses claiming California Competes tax credits will steadily rise over the coming years—to as many as 1,000—before tapering off as existing tax credit agreements end and no additional agreements, under current law, are signed.
Approve GO-Biz Funding For One Year. The administration’s proposal for $1.2 million General Fund per year for three years is not justified given that the bulk of the program’s workload will end next year under current law. We recommend the Legislature approve funding for one year and revisit next year what amount of on-going funding to GO-Biz is necessary to continue administering this program. Establishing the 10 positions permanently, as requested by the administration, would not preclude the ability of the Legislature to make changes to the California Competes tax credit program, or end the program, should it chose to do so.
Consider Approving Portion of FTB Request As On-Going. The administration’s proposal for three years of funding is reasonable in light of some amount of continuing uncertainty about FTB’s workload from year to year. As the California Competes tax credit program is temporary, the Legislature may consider approving this item as requested. We note, however, that the workload will be very clearly increasing over the next three to four years and then tapering off over a period of several more years. Increasing FTB’s position authority by the 14 for which the administration proposes funding—or some portion thereof—would allow FTB to continue their other revenue collection responsibilities unhindered. When the California Competes tax credit compliance workload ends after several years, the department could then redirect those positions to other revenue collection activities or the Legislature can reduce the total number of positions at FTB if there is not a need for them at that time.