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New Day for Economic Development in California

Loren Kaye
President of the California Foundation for Commerce and Education

Governor Brown executed a political double-play last week: wrapping top priorities for business and labor into a single bill and gaining bi-partisan support for the package.

At issue was the future of the once-popular, but recently embattled enterprise zone program. Eliminating that program’s hiring tax incentives had been a priority for the Governor since he regained the office – and for much longer for his union allies. While labor wanted to dismantle a program they believed was subsidizing nonunion workforces (and incidentally grab the money for general programs), the Governor had wanted to redeploy the economic resources for more effective incentives.

Fortunately for the California economy, the Governor’s path prevailed.

Out of the ashes of the enterprise zone program arose several new economic development incentives, including one long-sought by businesses and economic developers.

The most important new incentive is creation of a true exemption from the state general sales tax for equipment and personal property used in manufacturing and in research and development. The exemption is limited to equipment and property with a useful life of more than one year, and does not include equipment used in agriculture or natural resource extraction.

The exemption would be limited annually to the first $200 million of equipment purchased per taxpayer, but there is no overall cap on the total amount or number of exemptions that could be claimed statewide.

This means that beginning in one year, July 1, 2014, manufacturers and researchers will no longer be subject to the 4.19% state general sales tax, until June 30, 2022.

The sales tax exemption is long-overdue step in rationalizing California’s treatment of business property used for manufacturing, bringing California closer to the policies followed by nearly every other state with a sales tax. But with the average California state and local rate at around 8.4 percent, this exemption offsets only about half of the overall sales tax burden on manufacturing equipment. The challenge for business leaders and economic development officials during the next eight years will be to demonstrate the importance of this reform to justify making it permanent and expanding it to encompass the entire sales tax rate.

But wait, there’s more.

The Administration also devised an intriguing new economic development incentive that is unprecedented in California. For five years, the Governor’s Office of Business and Economic Development (with the approval of an oversight committee) will distribute up to $780 million in income or corporate tax incentives to companies seeking to locate, expand or remain in California.

Compared to a typical tax credit or exemption, which the taxpayer automatically receives if the targeted activity qualifies, the criteria to qualify for these credits are vague. GO-Biz will have wide latitude in determining how to select eligible companies.

At a minimum, GO-Biz must “give priority” to companies with projects in areas of high unemployment or high poverty. In addition, GO-Biz must differentiate the amount of the credit according to 11 enumerated factors, such as job creation, compensation levels, economic impact and the “strategic importance” of a project.

Every tax credit agreement must be ratified by an oversight committee, comprising the director of GO-Biz, the Treasurer, Director of Finance and two legislative appointees. The identities and tax credit terms of all applicants would be discussed in open meetings and become public records.

The tax credit program ramps up quickly, with $30 million provided to GO-Biz this year, $150 million next year, and $200 million each for the three following years.

At least one-quarter of all credits annually allocated must be reserved for small businesses, and no single business may receive more than 20 percent of any single year’s total allocation. The credit may be carried forward for up to five years, and is subject to recapture if the business does not meet the terms and conditions negotiated with GO-Biz.

This new program has the potential to launch GO-Biz into the upper tier of state economic development agencies – at least for five years – in terms of incentives available to attract and retain businesses. Competition will be fierce for these incentives among individual businesses and local economic development agencies seeking to land new economic development. After all, with the demise of redevelopment agencies and enterprise zones, the GO-Biz incentives will become one of the few competitive incentives available in California.

The challenge for GO-Biz will be to develop transparent, predictable, and de-politicized criteria that serve a region’s and the state’s economic and growth interests, and not the interests of narrow constituencies. Enterprise zones may have been inefficient and overbroad, but the new grants will help create more jobs if they are not constrained by, for example, prevailing wage requirements and other costly mandates.

California’s unemployment and poverty rankings are shameful. Used properly, the new sales tax exemption and GO-Biz incentives can materially improve them.

Follow Loren on Twitter: @KayeLoren

Crossposted on CalChamber.com

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