BILL ANALYSIS                                                                                                                                                                                                    



          SENATE COMMITTEE ON APPROPRIATIONS
                             Senator Ricardo Lara, Chair
                            2015 - 2016  Regular  Session

          AB 43 (Mark Stone) - Personal income taxes: credit: earned  
          income.
          
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          |Version: June 1, 2015           |Policy Vote: GOV. & F. 6 - 0    |
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          |Urgency: No                     |Mandate: No                     |
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          |Hearing Date: August 17, 2015   |Consultant: Robert Ingenito     |
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          This bill meets the criteria for referral to the Suspense File.







          Bill  
          Summary: AB 43 would create a second refundable Earned Income  
          Tax Credit (EITC), equal to an unspecified percentage of the  
          federal EITC.


          Fiscal  
          Impact: 
                 The Franchise Tax Board (FTB) indicates that, primarily  
               because the percentage of the bill is currently  
               unspecified, it is unable to determine the costs to  
               administer this bill. Because this bill would provide a  
               refundable credit on a year-to-year basis, and could impact  
               over three million California taxpayers who claimed the  







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               federal EITC, many of which have no current California  
               income tax return filing requirement, the costs would  
               likely be significant.

                 The unspecified percentage also precludes FTB from  
               estimating the revenue loss resulting from the current  
               version of the bill. As an order of magnitude, however, if  
               the Legislature makes an appropriation in accordance with  
               the 5/20/15 version of the bill FTB estimates an  
               approximate annual revenue loss of $2 billion (General  
               Fund).




          Background: Tax credits differ from other tax expenditures in that they  
          directly reduce income tax liability, as opposed to indirectly  
          by reducing taxable income. For instance, a one dollar credit  
          reduces tax liability by one dollar, whereas a tax deduction of  
          one dollar will reduce taxable income by one dollar, but reduces  
          tax liability by the marginal tax rate. For example, an  
          additional one dollar of deduction for a taxpayer in the 10  
          percent tax bracket reduces tax liability by 10 cents, while a  
          taxpayer in the 39.6 percent tax bracket reduces tax liability  
          by 39.6 cents.
          The federal EITC was enacted in 1975. It was originally intended  
          to be temporary in nature, to mitigate the impact of (1) the  
          Social Security payroll tax, and (2) rising food and energy  
          prices. Instead, the EITC was made permanent in 1978. The Tax  
          Reform Act of 1986 indexed both the maximum earned income and  
          phase-out income levels to inflation. The EITC differs from most  
          other tax credits in that it is partially or fully refundable. A  
          taxpayer with $100 in tax liability and $200 in a refundable tax  
          credit would receive a tax refund of $100.


          The EITC is considered both (1) an anti-poverty program and (2)  
          an alternative to cash-transfer programs because it incentivizes  
          work. The EITC is work-oriented in that the amount of the credit  
          is based on earnings. The amount of the credit (which varies  
          depending on the number of qualifying children in addition to  
          earned income) initially rises as earnings increase, then  
          reaches a plateau, and then falls as earnings increase further.  
          For example, for a couple with two children in 2014, the credit  








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          is equal to 40 percent (the credit rate) of the first $13,700 in  
          earnings. The maximum credit of $5,460 is received by taxpayers  
          with earnings between $13,700 and $23,300. The credit phases out  
          at a rate of 21.06 percent (that is, it is reduced by 21.06  
          cents for every additional dollar of earnings) for earnings over  
          $23,300 and is zero for taxpayers with earnings over $43,950.


          The value of the EITC has increased over time. For example, the  
          maximum credit for a worker with three children has increased  
          from $400 in 1978 (roughly $1,465 in 2014 dollars) to $6,143 in  
          2014.


          Current state law provides that individuals with income below  
          specified levels are not required to file a return, as the  
          standard deduction and personal exemption credit eliminate any  
          tax liability.  For 2013, these thresholds are $12,838 in  
          adjusted gross income for single filers, and $25,678 for married  
          individuals filing jointly.  These thresholds are increased  
          based on the number of dependents claimed and are increased  
          annually for inflation.


          Federal law specifies that if the federal EITC is denied, and  
          the Internal Revenue Service (IRS) determined that the  
          taxpayer's error was due to reckless or intentional disregard of  
          EITC rules, the EITC would be denied for the next two years.  If  
          the error was due to fraud, the denial period would be ten  
          years.


          As part of the 2015-16 budget, the Governor signed SB 80  
          (Committee on Budget and Fiscal Review), which established a  
          state EITC.  The California EITC is identical to the Governor's  
          EITC proposal included in the 2015 May Revison; it provides a  
          refundable tax credit for wage income for households with income  
          limits of $6,580 (zero dependents) up to $13,870 (three or more  
          dependents). The credit matches 85 percent of the federal  
          credits up to half of the federal phase-in range; and then  
          begins to taper off relative to these maximum wage amounts. The  
          tax credit is estimated to reduce revenues by $380 million  
          annually beginning in 2015-16, and benefit an estimated 825,000  
          families. The estimated average household benefit is $460 per  








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          year, with a maximum credit of $2,653.


          Proposed Law: This bill would allow a refundable EITC, upon  
          appropriation of the Legislature.  In a year when an  
          appropriation is not made by the Legislature, the credit becomes  
          nonrefundable. The credit is computed by multiplying the federal  
          credit amount due by the state credit percentage.  The state  
          credit percentage is 0 percent, unless the Legislature provides  
          a percentage in a bill related to the budget. 


          The bill identifies three categories of taxpayers: (1) an  
          individual who has at least one qualifying child under five  
          years of age, (2) an individual who does not have a qualifying  
          child, and (3) an individual who does not meet the above  
          requirements.


          The bill provides that amounts refunded to a taxpayer shall not  
          be included in income subject to tax, and, 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.  


          It would take effect immediately as a tax levy, and apply to  
          taxable years 2016 through 2020.




          Related  
          Legislation: SB 80 (Committee on Budget and Fiscal Review,  
          Chapter 21, Statutes of 2015), created a refundable CA EITC for  
          taxable years beginning on or after January 1, 2015.


          Staff  
          Comments: FTB estimates that the state's current EITC will  
          impact less than one million individuals. Administrative costs  
          are estimated to be $22 million in 2015-16, $11.6 million in  
          2016-17, and $10.1 million annually thereafter. 









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