BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Michael J. Machado, Chair
SB 1291 - Alquist
Amended: As introduced
Hearing: April 26, 2006 Tax Levy Fiscal: YES
SUBJECT: Sales and Use Tax: Exemption for personal
property purchased by manufacturers and other
taxpayers
EXISTING LAW requires entities engaged in
manufacturing, research & development, telecommunications,
software production, printing, biotechnology or
pharmaceuticals that purchase, lease or rent equipment and
other supplies to pay sales or use tax on their purchases
of tangible personal property. But purchases of tangible
personal property that become ingredients of an item to be
resold are exempt from tax.
THIS BILL, starting in 2006, would grant a sales tax
exemption to "qualified persons" (manufacturers and
entities engaged in research and development) for purchase,
lease or rental of (1) property that will become an
ingredient or component part of property manufactured,
processed, fabricated or used in research activities; (2)
tangible property directly used or consumed in or during
actual manufacturing, processing, research, and causes a
chemical or physical change to the product being (a)
manufactured, processed, fabricated, or used for research,
or (b) an intermediate or preliminary product that will
become part of the product being manufactured, processed,
etc.; (3) various listed switches, semiconductors,
transformers, fuel, devices and equipment used for
pollution control, lubricants, chemicals, gasses; (4)
tangible personal property used for quality control; (5)
personal property use of which is essential in compliance
with public health requirements; (6) personal property
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installed to conserve or recycle water; (7) clean rooms and
related equipment (defined by the bill in detail).
The bill specifies that newspaper publishers are
manufacturers. It also provides that computer software
manufacturing begins with the design and writing of the
code for the software, and includes testing and
demonstration of the software.
In order to receive this exemption, the purchaser must
provide the retailer with an exemption certificate
(completed in accordance with Board rules), and the
retailer must furnish the Board a copy of each certificate.
The exemption would apply to the state sales and use
tax only, and NOT to local sales or transactions and use
taxes, or the taxes levied for the Local Revenue Fund or
the Local Public Safety Fund.
The exemption would not apply to any property that,
within one year of purchase, is removed from California, or
converted from an exempt use to another use not qualified
for the exemption. And if the purchaser certifies to the
seller that the property will be
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used for an exempt purpose, and within one year the
property is used in a manner not qualified for the
exemption, the purchaser must pay the sales tax. (Note -
this "claw-back" provision would not apply if the purchaser
did not certify to the retailer that the property would be
used for exempt purposes. The "exemption certificate"
would need to contain detailed certification that the
property would be used for the exempt purpose.)
The exemption would not apply to sales or transactions
and use taxes levied by local governments, nor to taxes
deposited in the Local Revenue Fund.
FISCAL EFFECT:
Based on Board of Equalization data, estimated state
revenue loss from the bill would be about $1.75billion
annually starting in 2006. (As the exemption begins with
purchases made in January 2006 and thereafter, it would
appear to have retroactive effect.)
The Department of Finance has developed a "dynamic"
revenue estimating model, which attempts to capture the
full effects of tax changes as they work their way through
the economy. Based on past estimates of tax changes using
that model, it is estimated that after three to five years
the net revenue effect, after taking dynamic effects into
account would reduce the "static" revenue loss by about
10%. So the net revenue, after dynamic effects, would be
about $1.6 billion. (Note that the relatively small
difference between static and dynamic estimates is largely
due to the fact that the Finance model takes account of
reduced economic activity attributable to reduced
governmental spending resulting from the revenue loss.)
COMMENTS:
A. Purpose of the bill
The author indicates that the bill would help
California compete with other states for jobs. California
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needs to be competitive to retain manufacturing jobs.
Forty-two other states offer some version of this economic
stimulus. Without the exemption, incumbent California job
providers have no reason to stay in the state. Furthermore,
the bill provides job providers with the certainty they'll
need to make major decisions regarding the creation of new
facilities - directly resulting in new jobs.
B. Jobs in California and Outsourcing.
Proponents of this measure note that California lost
18 percent of its manufacturing jobs since January, 2001.
In order to retain and grow manufacturing employment,
proponents state that the state must remove competitive
boundaries to hiring and making new investments in
California.
Opponents, however, note that there is little evidence
that this exemption would make a difference in terms of
location decisions.
C. Offshoring
It is unclear whether any incentive could make a
difference in job growth in the manufacturing sectors of
the economy due to the macroeconomic trend of outsourcing.
Manufacturing firms have long used foreign labor, either by
importing inputs made by unrelated companies, or by setting
up their own companies overseas to produce these inputs<1>.
Many economists agree that offshoring, as a form of
international trade, is generally good for the economy and
will increase overall productivity.
Therefore, since these jobs are generally offshored to
other countries (not within the United States), it is
important to consider whether any incentive would be able
to affect this trend, as it is true for the nation as well
as the state.
D. Is this a jobs bill?
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<1> PPIC report: "Services Offshoring," by Jon Haveman and
Howard Shatz
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This bill's predecessor, the Manufacturers Investment
Credit, offered a 6% income tax credit for purchases of
manufacturing equipment for use in California. There is
little evidence that this credit actually created many new
jobs, especially since most manufacturing equipment is in
effect "labor-saving." However, it may have had a marginal
impact of holding jobs in California or bringing other jobs
to California. And the MIC's sunset provision, based on
growth in jobs, eventually allowed the MIC to sunset due to
too few new jobs.
E. Or is it just good tax policy?
Almost all respectable economists who study government
finance and taxation agree that inputs to business (e.g.,
business equipment, research costs, raw materials, etc.)
should be exempt from sales tax, because generally the
outputs from business are subject to sales tax, and to tax
both business inputs and business outputs results in double
taxation. In fact, the Value Added Tax (VAT), used to
finance most European governments, is economically
equivalent to a sales tax with a broad exemption for
business inputs. Most economists would agree that this bill
would move California's sales tax in the direction of a
VAT, and that would be considered a good thing from an
economist's perspective. Indeed, this bill probably should
not be looked upon as a "tax expenditure" with the intent
of stimulating the economy, so much as a fundamental reform
of the tax structure to one more closely akin to a VAT.
However, this bill would be added to a system of
credits, expenditures and exemptions and would not be
allowed to operate as a true VAT. Before passing a measure
like this one which is arguably good tax policy, the
committee may wish to consider it in the context of the
existing tax structure.
Furthermore, in most countries that use a VAT system,
the system includes some taxation of services (although not
as inputs to businesses). Therefore, before California
could move in this direction, it would also need to
consider which services-in addition to goods-should be
taxed.
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F. No sunset date specified
The exemption offered by this bill begins on January
1, 2006. And the bill does not contain a sunset date - it
would be a permanent change in our sales tax structure.
G. Much broader coverage than prior MIC
This bill's predecessor, the Manufacturing Investment
Credit, generally applied only to those manufacturing
activities described in specific codes of the Standard
Industrial Classification manual. And the credit only
applied to equipment used by manufacturers. This bill
applies to manufacturers and entities engaged in research
and development. And the definitions in the bill are much
broader and less detailed that those in the old MIC. The
bill is focused on tangible property involved or included
in the manufacturing or research and development process,
rather than just manufacturing equipment used by
manufacturers.
H. Revenue sharing with federal government
The sales tax exemption granted by this bill is
approximately 5.25% of the cost of equipment and other
items qualified for the exemption. However, purchasers of
these items are eligible to deduct the cost of these
purchases for both federal and state income tax. The
exemption provided by the bill will thus reduce by 5.25%
the federal and state income tax deductions that eligible
companies may claim for purchases subject to the exemption.
This so-called "income tax interaction" will thus reduce
the after-tax benefit to the taxpayer by roughly one-third
(from $1.75 billion to about $1.16 billion), with the
federal government becoming richer by the about $500
million federal income tax increase (due to reduced income
tax deductions by California taxpayers).
I. Broad definitions leave much room for interpretation
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The definitions contained in the prior Manufacturing
Investment Credit were fairly precisely drafted and limited
to businesses described by the federal SIC manual. The
definitions used in this bill are much more broad and far
less precise. Even with the reasonably clear definitions
used by the MIC, the definition of "manufacturer" was
stretched to include a grocery store bakery, for example.
The definitions in this bill would likely lend themselves
to very broad interpretation by the administering agency,
thus increasing the potential revenue loss well beyond that
envisioned by the Legislature.
Support and Opposition
Support: Silicon Valley Leadership Group (sponsor)
AeA (American Electronics
Association)
California Chamber of Commerce
California Grocers Association
Auto Supply Company
L. A. Envelope Inc.
Milpitas Chamber of Commerce
Lockheed Martin Space Systems
California Manufacturers & Technology
Association
Oppose: California Tax Reform Association
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Consultant: Martin Helmke & Gayle Miller