BILL ANALYSIS Ó SENATE COMMITTEE ON APPROPRIATIONS Senator Ricardo Lara, Chair 2015 - 2016 Regular Session AB 43 (Mark Stone) - Personal income taxes: credit: earned income. ----------------------------------------------------------------- | | | | | | ----------------------------------------------------------------- |--------------------------------+--------------------------------| | | | |Version: June 1, 2015 |Policy Vote: GOV. & F. 6 - 0 | | | | |--------------------------------+--------------------------------| | | | |Urgency: No |Mandate: No | | | | |--------------------------------+--------------------------------| | | | |Hearing Date: August 17, 2015 |Consultant: Robert Ingenito | | | | ----------------------------------------------------------------- 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 AB 43 (Mark Stone) Page 1 of ? 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 AB 43 (Mark Stone) Page 2 of ? 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 AB 43 (Mark Stone) Page 3 of ? 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. AB 43 (Mark Stone) Page 4 of ? -- END --