BILL ANALYSIS Ó AB 43 Page A Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 43 Mark Stone - As Amended February 12, 2015 Majority vote. Fiscal committee. Tax levy. SUBJECT: Personal income taxes: credit: earned income. SUMMARY: Provides a credit, in modified conformity to the federal Earned Income Tax Credit (EITC), as specified, for taxable years beginning on or after January 1, 2016, and provides that, in those years in which an appropriation is made by the Legislature, the credit would be refundable. Specifically, this bill: 1)Provides, under the Personal Income Tax (PIT) Law, for taxable years beginning on or after January 1, 2016, a credit in an amount determined in accordance with the federal EITC, as AB 43 Page B follows: a) A credit equal to 35% of the federal earned income tax amount for an eligible individual who has at least one qualifying child less than five years of age; b) A credit equal to 60% of the federal earned income tax amount for an eligible individual who does not have a qualifying child; and, c) A credit equal to 15% of the federal earned income tax amount for an eligible individual that has a child more than five years of age. 2)Provides that if the amount allowable as a credit under this section exceeds the tax liability computed under this part for the taxable year, the excess shall be credited against other amounts due and the balance shall be refunded to the qualified taxpayer upon appropriation of the Legislature. 3)Provides that amounts refunded to a taxpayer shall not be included in income subject to tax. 4)Provides that, notwithstanding any other state law, and to the extent permitted by federal law, amounts refunded shall be treated the same as the federal credit for purposes of determining eligibility for benefits under the Welfare and Institutions Code Section 1000 et seq. 5)Provides that this credit is allowed notwithstanding Revenue and Taxation Code (R&TC) Section 41. AB 43 Page C 6)Makes findings and declarations. 7)Takes effect immediately as a tax levy. EXISTING LAW allows eligible individuals a refundable EITC. A refundable credit allows for the excess of the credit over the taxpayer's tax liability to be refunded to the taxpayer. As the name implies, the credit is based on a percentage of the taxpayer's earned income, and is phased out as income increases. The percentage varies depending on whether the taxpayer has qualifying children. Married individuals are eligible for only one credit on their combined earned income and must file a joint return to claim the credit. EXISTING STATE LAW: 1)Allows various tax credits designed to provide tax relief for taxpayers who incur certain expenses or to influence behavior, including business practices. 2)Provides that individuals with income below a certain threshold are not required to file a return because the standard deduction and personal exemption credit eliminate any tax liability. For 2011, these thresholds are $15,152 in gross income or $12,122 in adjusted gross income (AGI) for single taxpayers and $30,305 in gross income or $24,244 in AGI for married individuals filing jointly. These thresholds are increased based on the number of dependents claimed and are increased annually for inflation. 3)Does not allow an EITC. FISCAL EFFECT: Assuming no appropriation is made by the Legislature, the Franchise Tax Board (FTB) estimates General AB 43 Page D Fund revenue loss of $38 million in fiscal year (FY) 2015-16, $190 million in FY 2016-17, and $200 million in FY 2018-19. If an appropriation is made by the Legislature, the FTB estimates General Fund revenue loss of $380 million in FY 2015-16, 1.9 billion in FY 2016-17, and $2 billion in FY 2017-18. COMMENTS: 1)Author's Statement : The author has provided the following statement in support of this bill: AB 43 addresses the lack of income gains for working Californians in the Post-Great Recession economic recovery while simultaneously providing a much-needed economic stimulus in the most economically distressed communities. This bill establishes a refundable California Earned Income Tax Credit (EITC) for working low- and middle-class families. The federal EITC is a refundable tax credit targeted at low- to middle-income working households that reduces poverty and rewards work. Researchers cite the federal EITC as among the most effective tools for reducing poverty across the nation. Without it, child poverty is estimated to be 25% higher. As the California Budget Project points out, for children, the federal EITC results in improved health and education outcomes that translate into higher incomes in adulthood. From 2010 to 2012, the federal EITC pulled 1.3 million people (629,000 children) above the federal poverty line within California. Twenty five states have already established their own EITC to magnify the impact of the federal EITC, although California has not done so. AB 43 Page E Studies focused on state EITCs adopted in other states have estimated that each additional dollar received by a tax filer can generate a further $1.50-2.00 in local economic activity. The impact of the increased purchasing power in communities benefited by federal and state EITC dollars is undeniable. In its analysis of policy options for economic and employment growth during 2010, the Congressional Budget Office highlights that the best options to foment growth are those that assist households by spurring demand for goods and services. Therefore, the type of tax credit provided by AB 43, which targets lower income households with fewer assets, would have a larger impact on consumer spending, in comparison with tax cuts aimed at higher income households. 2)Arguments in Support : According to the California Tax Reform Association, "[p]revious research has shown that the EITC encourages employment among single parents who have accessed CalWORKS and also among the broader low- and moderate-income population. According to an improved way of measuring poverty that incorporates taxes paid and tax credits received, the EITC meant the difference between living in poverty and not living in poverty for 600,000 adults and 560,000 children in California in 2011." 3)Arguments in Opposition : The California Taxpayers Association states that "[a] September 2014 report by the U.S. Treasury's Inspector General for Tax Administration says that the IRS estimates that 24 percent of all EITC payments made in the 2013-14 fiscal year were paid in error - equating to $14.5 billion that was paid in error. The problems associated with refundable credits are exacerbated when the [FTB] determines AB 43 Page F that a refund is fraudulent after the refund has been made, making it difficult for the state to recover these refunds. And, if identity theft is involved, taxpayers must suffer through the pain and expense of recovering their identities, which sometimes can take years." 4)What is a "tax expenditure" ? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, United States Treasury officials began arguing that these features of the tax law should be referred to as "expenditures," since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues). This bill enact a new tax expenditure in the form of a state EITC. 5)How is a tax expenditure different from a direct expenditure ? As the Department of Finance notes in its annual Tax Expenditure Report, there are several key differences between tax expenditures and direct expenditures. First, tax expenditures are reviewed less frequently than direct expenditures once they are put in place. This can offer taxpayers greater certainty, but it can also result in tax expenditures remaining a part of the tax code without demonstrating any public benefit. Second, there is generally no control over the amount of revenue losses associated with any given tax expenditure. Finally, it should also be noted that, once enacted, it generally takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date. This effectively results in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their efficacy, without a supermajority vote. This bill provides a credit, in modified conformity to the federal EITC but does not contain a sunset date. Because it takes a supermajority vote to rescind a tax expenditure, the Committee may wish to add a five year sunset. AB 43 Page G 6)What is an EITC ? The EITC is a federal tax credit for low- to moderate-income individuals and families. Congress originally approved the tax credit legislation in 1975, in part to offset the burden of Social Security taxes and to provide an incentive to work. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. In order for a taxpayer to qualify for the credit, an individual's AGI in the 2015 taxable year, must be less than $47,747 ($53,267 filing jointly) with three or more qualifying children; $44,454 ($49,974 filing jointly) with two qualifying children; $39,131 ($44,651 filing jointly) with one qualifying child; or $14,820 ($20,330 filing jointly) without a qualifying child. The current maximum credit for taxpayers with three or more qualifying children is $6,242; and for taxpayers with two qualifying children, the maximum is $5,548. For taxpayers with one qualifying child, the maximum credit amount is $3,359, and for taxpayers with no qualifying children, the maximum amount is currently $503. 7)Encouraging Workforce Participation : Increasing the number of individuals who enter the job market reduces the unemployment rate and generally improves economic conditions. According to the California Budget Project, the EITC encourages and rewards additional work by providing a larger credit as workers' earnings increase. As an example, a single mother with two children earning $7,500 in 2014 is eligible for a $3,000 credit; but if she earns twice as much, she will qualify for the maximum credit of $5,460. As such, she receives a larger credit by working more.<1> Several studies have shown that the federal EITC has raised labor force participation rate of single mothers by at least seven --------------------------- <1> California Budget Project, a state EITC: making california's tax system work better for Working families, December 2014. AB 43 Page H percentage points<2>. Other studies show that the federal EITC causes one out of every ten individuals who would normally be out of the labor force to start working<3>. Most studies have shown a significant increase in labor force participation of unmarried mothers. In fact, one study showed that more than 60% of employment gains made by single mothers, when compared to mothers without children, was due to the EITC<4>. Additionally, a separate study focused on employment among California women who received cash assistance at some point between 1987 and 2000. The study found that more than three-quarters of the employment gains between 1991 and 2000 for women with multiple children relative to those with only one child was attributable to the expansion of the EITC<5>. 8)Additional Benefits : In addition to increasing labor participation, the EITC provides a long list of additional benefits to low-income families. Specifically, studies have shown that low-income students perform better in school when families' incomes are boosted by the federal EITC. The EITC may result in increasing completion rates for high school and college. Other studies have also shown an increase in --------------------------- <2> See Jeffrey Grogger, The Effects of Time Limits, the EITC, and Other Policy Changes on Welfare Use, Work, and Income Among Female-Headed Families, Review of Economics and Statistics, 2003; and Jeffrey Liebman and Nadda Eissa, Labor Supply Response to the Earned Income Tax Credit, Quarterly Journal of Economics, 1996. <3> The President's Proposal To Expand the Earned Income Tax Credit, Executive Office of the President and U.S. Treasury Department, March 2014. <4> Bruce D. Meyer and Dan T. Rosenbaum, Welfare, the Earned Income Tax Credit, and the Labor Supply of Single Mothers, The Quarterly Journal of Economics (2001). <5> V. Joseph Hotz, Charles H. Mullin, and John Karl Scholz, Examining the Effect of the Earned Income Tax Credit on the Labor Market Participation of Families on Welfare, National Bureau of Economic Research Working Paper (December 2005). AB 43 Page I academic achievement and an increase in college attendance<6>. Additionally, the EITC may help offset the disproportionate cost that low-income families pay on state and local taxes. As provided for by the Institute on Taxation and Economic Policy, the bottom fifth of families (those making less than $13,000 per year), pay, on average, an estimated 10.6% of their income in state and local taxes. In contrast, the top 15% of families pay 7.4% and the top 1% of families pay 8.8%<7>. Furthermore, according to the California Budget Project, implementing a state EITC could further reduce economic hardship by boosting workers' wages and strengthen California's social safety net. Specifically, the EITC can make it easier for families to transition out of the California Work Opportunity and Responsibility to Kids (CalWORKS) program, which provides cash assistance for struggling families. The threshold at which families lose eligibility for CalWORKS is low. As such, a parent could conceivably lose CalWORKS eligibility and still be below the poverty line. Providing a state EITC could provide the additional income necessary to lift that family out of poverty. 9)Individuals with Children Receive larger Benefit : In 2014, a single individual with an AGI of less than $14,500 and no children would qualify for a maximum of $496. In contrast, a single parent with an AGI of less than $46,997 and three children would qualify for a maximum of $6,143. The federal EITC clearly favors working families over individuals without --------------------------- <6> Gordon B. Dahl and Lance Lochner, The Impact of Family Income on Child Achievement: Evidence From the Earned Income Tax Credit, American Economic Review (2012); and Raj Chetty, John N. Friedman, and Jonah Rockoff, New Evidence on the Long-Term Impacts of Tax Credits, Statistics of Income Paper Series (November 2011) <7> California Budget Project, A STATE EITC, citing the analysis conducted by Institute on Taxation and Economic Policy. AB 43 Page J children. This bill, however, disproportionately provides a much larger credit percentage to individuals without children. Specifically, this bill provides a credit equal to 60% of the federal earned income tax amount for an eligible individual who does not have a qualifying child, and only a credit equal to 15% of the federal amount for an eligible individual with a child five years or older. On its face, the credit percentage for individuals without children is larger but the amount received is much lower. As stated above, the maximum amount an individual without children can qualify for is $496. Receiving a state credit equal to 60% of the maximum federal amount is $298, giving the California tax filer a total of $794. A parent with three children can qualify for a maximum of $6,143 under the federal EITC. Assuming all of the children are over the age of five, the qualifying parent can receive $921, giving the tax payer a total of $7,064. If just one of the children is less than five years of age, the parent can qualifying for a state EITC of $2,150, or a total of $8,293. 10)The President's Proposal : Under federal law, an "eligible individual" is defined as an individual who either: (a) has a qualifying child for the taxable year; or, (b)) is between 25 and 65 years of age, is not claimed as a dependent by other taxpayers and whose principal residence for more than six months in the taxable year was located in the United States. (IRC Section 32). As noted above, the federal EITC has been shown to increase the number of individuals who participate in the job market. However, because the EITC is not available to individuals under the age of 25, it provides little assistance to childless individuals at or near the poverty line and a smaller incentive to enter the workforce. President Obama recently proposed expanding the federal EITC by doubling the maximum credit amount available to childless individuals to $1,000, increasing the phase-out income limit to $18,000 and AB 43 Page K reducing the age from 25 to 21<8>. Because EITC has been shown to increase workforce participation rates among single mothers, it stands to reason that expanding the EITC program for younger, childless individuals would have similar impact. The California Budget Project has also suggested increasing the amount of credit available to childless workers. Men working in low-wage jobs would likely account for the largest share of childless workers. This group of individuals has seen substantial erosion in earnings over the last few decades but the group is also less likely to qualify for government assistance than those with children. Providing a larger credit to childless workers, as this bill does, can provide an economic boost to those who are often excluded from many of the social services programs. 11)The Governor's Proposal : The Governor's May revise of the State budget included the first ever state EITC. Under the Governor's proposal, the EITC would be refundable and would focus on the state's lowest income individuals. Specifically, the state EITC would be available to households with income less than $6,580 if there are no dependents or less than $13,870 if there are three or more dependents. The credit is estimated to benefit 825,000 families and 2,000,000 individuals, with an average household credit of $460 and a maximum credit of $2,653. The EITC would be available for tax returns filed for wages earned in 2015. 12)Performance Measurement Standards : Existing law requires any bill introduced on or after January 1, 2015 that authorizes a new credit under either the PIT Law or the CT Law to provide performance measurement standards. According to legislative findings and declarations, tax preferences represent a major --------------------------- <8> The President's Proposal to Expand the Earned Income Tax Credit, Executive Office of the President and U.S. Treasury Department, March 2014. AB 43 Page L exercise of government power, but face less oversight than the spending side of the budget. As a way of ensuring transparency and accountability when investing public dollars through tax credit programs, the Legislature decided to apply performance measurement standards as a way of reviewing tax credits with the same level of scrutiny as spending programs. This bill was introduced on December 1, 2014 and is, therefore, not required to abide by the standards under RTC Section 41. Irrespective of Section 41's application, this bill provides that the provisions of R&TC Section 41 shall not apply to this credit. Providing clear metrics and data collection may provide valuable information on the effectiveness of a state EITC. The Committee may wish to consider the appropriateness of this Section 41 exemption. REGISTERED SUPPORT / OPPOSITION: Support United Way of California (Sponsor) Alameda County Board of Supervisors (Co-Sponsor) Allen Temple Baptist Church Alliance for African Assistance American Federation of State, County and Municipal Employees AB 43 Page M Amigos de Guadalupe Center for Justice & Empowerment Arrowhead United Way Asian Americans Advancing Justice Brighter Beginnings California Alternative Payment Program Association California Association of Food Banks California Association of Nonprofits California Catholic Conference of Bishops California Communities United Institute California Food Policy Advocates California Partnership California Reinvestment Coalition California Tax Reform Association AB 43 Page N Catholic Charities of Santa Clara County Children's Defense Fund Children's Partnership Community Child Care Council of Alameda County Consumer Action Contra Costa AFL-CIO Labor Council Contra Costa County Board of Supervisors Contra Costa's Family Economic Security Partnership Cooperative Center Federal Credit Union Council of California Goodwill Industries Council of Philippine American Organizations of San Diego County of Santa Cruz Board of Supervisors EARN AB 43 Page O FIRST 5 of Monterey County FIRST 5 of Santa Clara County Housing California Jewish Family Services of Silicon Valley Jewish Federation of Silicon Valley Law Foundation of Silicon Valley Legal Aid Association of California Monterey County Board of Supervisors National Association of Social Workers Northeast Community Federal Credit Union Older Women's League Sacramento Capitol Policy Link Puente AB 43 Page P Samaritan House San Francisco Community Empowerment Center San Jose Silicon Valley Chamber of Commerce San Mateo County Central Labor Council San Cruz County Children's Network Santa Clara County Board of Supervisors Solano Children's Alliance Somos Mayfair St. Joseph's Family Center Step Up Silicon Valley United Way of Fresno County United Way of Monterey County United Way of Orange County AB 43 Page Q United Way of San Diego County United Way of Santa Barbara County United Way of Bay Area United Way of Santa Cruz County United Way of Silicon Valley United Way of Stanislaus County United Way of Wine Country Western Center on Law & Poverty Women's Building 1 individual Opposition California Taxpayers Association AB 43 Page R Analysis Prepared by:Carlos Anguiano / REV. & TAX. / (916) 319-2098