BILL ANALYSIS AB 2218 Page 1 Date of Hearing: May 24, 2006 ASSEMBLY COMMITTEE ON APPROPRIATIONS Judy Chu, Chair AB 2218 (Torrico) - As Amended: May 17, 2006 Policy Committee: Revenue and Taxation Vote: 6-0 Urgency: No State Mandated Local Program: No Reimbursable: SUMMARY This bill exempts from the state sales and use tax purchases of manufacturing equipment for a 10-year period beginning January 1, 2007. In order to maintain eligibility for the exemption, an employer would need to demonstrate to the Board of Equalization (BOE) that it continues to employ at least as many employees as in the prior year, beginning in 2008. FISCAL EFFECT 1)The BOE estimates annual General Fund revenue losses of $698 million ($33 million of which would be attributable to the Fiscal Recovery Fund rate of .25%). 2)The BOE would incur administrative costs in the range of $250,000 annually to verify employment levels of manufacturers. COMMENTS 1)Background . California's Sales and Use Tax Law imposes tax on the sale or use of tangible personal property. Entities engaged in activities such as manufacturing, research and development, and software production pay sales and use tax on their purchases of tangible personal property, unless that property is an input to production that becomes physically incorporated into a product for sale, in which case it is exempt from tax. (The sales and use tax then is imposed on the final product for sale.) The combined state and local sales and use tax rate totals AB 2218 Page 2 7.25%, as follows: ----------------------------------------------------------------- |Rate |Jurisdiction |Purpose | |---------------------+---------------------+---------------------| |5.0% |State General Fund |General | |---------------------+---------------------+---------------------| |0.25% |State Fiscal |Repayment of | | |Recovery Fund |Economic Recovery | | | |Bonds | |---------------------+---------------------+---------------------| |0.50% |State Local Revenue |Health and welfare | | |Fund |programs shifted to | | | |local governments | | | |under 1991-92 | | | |realignment | |---------------------+---------------------+---------------------| |0.50% |State Local Public |Local public safety | | |Safety Fund |programs under | | | |Proposition 172 | |---------------------+---------------------+---------------------| |1.0% |Cities and counties |General and County | | |(Bradley-Burns) |transportation | |(0.75% city rate | | | |credited against | | | |1.0% county rate) | | | |---------------------+---------------------+---------------------| |7.25% |Total State and | | | |Local Sales and Use | | | |Tax | | ----------------------------------------------------------------- Proposition 57, approved by the voters in 2004, temporarily suspends the authority of a county or a city to impose the local 1.25 percent Bradley-Burns sales and use tax rate and instead provides for a local sales and use tax rate of 1 percent, in the case of a county, and 0.75 percent, in the case of a city, for the duration of the "revenue exchange period." During this period, the state sales tax rate is increased by 0.25 percent, which is dedicated to the Fiscal Recovery Fund for the retirement of Economic Recovery Bonds authorized by Proposition 57. Cities and counties are reimbursed for the 0.25 sales and use tax reduction through property tax revenues shifted from the schools for the duration of the revenue exchange period. The state, in turn, AB 2218 Page 3 backfills the schools' revenue loss through the General Fund (hence, the "Triple Flip"). Additionally, local agencies may establish a special taxing jurisdiction to levy a "transactions and use tax" ranging from 0.25% to 2.0%, on the same tax base, and collected in the same manner, as the sales and use tax, 2)Manufacturer's Investment Credit (MIC) . Prior California tax law contained various tax incentives referred to as the MIC to encourage investment in manufacturing equipment to be used in California. The MIC provided for an exemption from the state share of sales and use tax for purchases of manufacturing equipment, or a credit against the personal income tax or corporate tax liability (equal to 6%) of the amount paid or incurred for qualified property placed in service in California. The MIC expired on January 1, 2004, pursuant to a finding by the Employment Development Department (EDD) that total manufacturing jobs on the preceding January 1, did not exceed the total manufacturing jobs in California on January 1, 1994 by 100,000 jobs. 3)Purpose . This bill is sponsored by the author. According to the author's office, it is intended to stimulate California's economy by reducing the costs of capital investments in the research and development, manufacturing, and software publishing industries. Although the exemption would provide an incentive for investment in new machinery and equipment, it would undermine the fundamental objective of the state's tax structure - to generate sufficient revenue to pay for state services. A more pragmatic approach might be to offset the state General Fund revenue loss of nearly $700 million annually by broadening the sales and use tax base to include certain services. Analysis Prepared by : Stephen Shea / APPR. / (916) 319-2081