California is changing the rules of the incentives game.
Several pain points bedevil the incentives process for economic development organizations: containing costs, determining the optimal distribution of program funds, and balancing confidentiality issues with the need for transparency, to name a few. California’s new tax credit program directly addresses several of these topics.
What Is the California Competes Tax Credit?
The California Competes Tax Credit is an income tax credit for “high-value” businesses growing in California. The purpose is to attract and retain employers in California in industries with high economic multipliers and that provide their employees good wages and benefits.
The credit is awarded through a two-phase competitive process, with three rounds of applications planned for FY 2014-15. The program is capped at $150 million for this fiscal year and $200 million for each the next two fiscal years. Any business can apply, and 25% of the available credits are reserved for small businesses.
Key points here are that any business can apply – none are excluded from the program thereby eliminating the tendency to define and lobby for narrow interests – and the program serves attraction and retention purposes – limiting controversy associated with bestowing credits on out-of-state firms over valued in-state firms. The set-aside for small businesses also addresses the common criticism that incentive programs unduly favor large businesses at the expense of small companies.
How It Came To Be
California Competes is one of three programs that replaced the state’s poorly performing Enterprise Zone program. The other two are a partial sales tax exemption for manufacturing equipment and the New Employment Credit that provides a tax credit for hiring qualified employees in designated census tracts or economic development areas. The Enterprise Zone program was the state’s marquee incentive, but it was considered ineffective for business attraction purposes and it excluded many high-value companies in the state due to the geographic designation. California Competes was designed to remedy those problems.
The Governor’s Office of Economic Development (GO-Biz) worked through both formal and informal mechanisms with private sector representatives, legislators, business groups, CALED and consultants to obtain input and build support for the different elements of the new incentive program. The Franchise Tax Board, which administers California’s personal income tax and corporation tax programs, was also at the table and plays a critical role in program administration.
What Makes It Interesting
- Caps on spending — The total value of the credits allocated through the program are capped each fiscal year. Further, no more than 20% of the total amount may be granted to a single taxpayer. Caps on tax credits can prevent costs from spiraling out of control and creating budget uncertainty.
- Specified value and time frame — The dollar value of the credit and the timeframe in which the credit may be taken are specified in the agreement with each company awarded the incentive, mitigating the forecasting challenge associated with accumulating tax credits without knowing when companies may choose to use their credits.
- Competitive application process that rewards minimizing the credit request relative to project size — Companies submit an online application for a two-phase review. The process starts with a quantitative analysis in which the credit amount requested is divided by the sum of aggregate investment and aggregate employee compensation (new full-time employees in California only). The applicants with the lowest ratios advance to Phase II. In the first round last year, the cutoff ratio for large businesses to advance to Phase II was 0.0184, and for small business, the ratio was .0925.
Phase II involves review of several additional factors, including:
- Number of jobs to be created or retained
- Compensation paid, including wages, benefits, and fringe benefits
- Investment in the state
- Unemployment or poverty where the business is located
- Incentives available to the business in the state (from all entities)
- Incentives available to the business in other states
- Duration of the proposed project
- Overall economic impact
- Strategic importance to the state, region or locality
- Opportunity for future growth
- Extent to which anticipated benefit exceeds the tax credit
- Supplemental financial or other documentation to verify information provided
The main point here is that the value of the tax credit is based on several factors reflecting multiple economic development criteria and goals – not just proposed jobs and investment.
- Strong language regarding competition with other locations — Companies may move directly to Phase II if “the owner, president, chief executive officer, chief financial officer or other equivalent person of the applicant certifies to GO-Biz that absent award of the credit the applicant’s project will occur in another state or the applicant will terminate or relocate all or a portion of its employees to another state.” Note the word “will” – not “is considering” or “might.”
- Balancing privacy and confidentiality — GO-Biz states clearly that it will post specific information about tax credit recipients on its website, including taxpayer name, estimated investment amount, estimated number of jobs, tax credit allocation, and amount recaptured (if applicable). Further, applications could be subject to the Public Records Act, but GO-Biz offers to work with the applicant to protect proprietary and trade secret information if records are requested.
- Compliance process based on data sharing between Go-Biz and the Franchise Tax Board — All documentation is to be shared with the Franchise Tax Board, which may review “books and records to ensure compliance with the terms of the agreement.” The Franchise Tax Board notifies GO-Biz in the case of breach of agreement, and GO-Biz determines the terms of the recapture in agreement with the Franchise Tax Board.
- Limits on consultant fees — As addressed here and here, fees for consultants and other third parties must be disclosed and contingent fees must be less than or equal to the product of the number of hours of service provided to the applicant.
Is It Working?
Twenty-nine companies were awarded just under $29 million in tax credits in the first round last year. As promised, the list is on the GO-Biz website. However, it is too soon to tell if the program will work as anticipated to support high-value business growth in the state. We understand that GO-Biz continues to work to develop its internal systems for monitoring and reporting on compliance and performance. We are eager to follow this program as it progresses.