California’s economic development programs have lately been a work in progress – just as these efforts need to shift into overdrive. No time like a recovering economy to put our best foot forward.
State government has focused the last couple years on structure: creating a new economic development agency, opening our first new foreign trade office since 2002, and creating new rules for analysis of major administrative regulations. The Legislature and Governor have also shuttered some key economic development tools: redevelopment agencies and enterprise zones, to name two venerable ex-incentives.
But state leaders have also reoriented tax policy to add some new tools to our bag of incentives, including two new policies that rose from the ashes of the enterprise zone program.
- A new exemption from the 4.17% state sales tax rate for equipment used in manufacturing and research and development. This exemption will take effect beginning next July.
- A new income tax credit for individuals and corporations who locate or expand in California, based on criteria developed by the Governor’s Office of Business and Economic Development (GO-Biz).
This new economic development tax credit will be worth more than three-quarter of a billion dollars, which will put California on par with some of the richest customized tax incentive programs in the country. Because California’s budget is itself still recovering from mismanagement and the recession, the value of the incentive will ramp up over the next four years.
GO-Biz is in the early stages of fleshing out its criteria for businesses to qualify for the incentive, so is not yet aggressively marketing this new tool. It also has not announced how much in new tax credits it anticipates will be available for distribution this year. Just this week it is beginning the first public outreach on developing the criteria for this new credit.
This slow rollout is a mistake. Economic development leaders should maintain the little bit of momentum they achieved with the dual successes of a balanced state budget and new tax incentives. Explaining and marketing the new tax incentive should be a key element of this rollout, even if the money isn’t yet available for distribution.
As GO-Biz leaders finally reach out to business and economic development leaders, they should keep the following in mind as they develop new criteria:
Establish and maintain a few key economic development goals
The point of eliminating the enterprise zone program and replacing it with new tax incentives is to improve the state’s economic development leverage. Therefore, just as EZs were criticized for inefficiency and insufficient measurable outcomes, this new incentive should aim for progress on what should be the top economic priorities for the state: sustained job creation, especially in areas with high unemployment and poverty. As an overlay, the program should prioritize high leverage economic sectors, that is, industries from mobile and tradable sectors that generate high job multipliers and which are especially vulnerable to interstate competition. These sectors include manufacturing, professional services, information and some finance.
Weigh the statutory criteria consistent with these goals
The legislation lays out 11 separate criteria for GO-Biz to use in determining the amount of the credit. These criteria should be weighed to maximize economic benefit to California:
- The strongest weight should be given to objective measures that are highly relevant to state economic development goals: overall job creation and retention, the duration of the project, and unemployment or poverty in the location of the business or project.
- Medium weight should be given to measures that are more difficult to measure, but that can be tied to economic or growth benefits, including the overall economic impact of the project and the amount of investment in the state by the taxpayer.
- Weak weight should be given to measures in the legislation that are subjective or speculative, and therefore subject to manipulation, abuse, or ex post facto penalty. These include the “strategic importance of the taxpayer’s project or business to the state, region or locality,” the “opportunity for future growth and expansion in this state,” and the “extent to which the anticipated benefit to the state exceeds the projected benefit to the taxpayer.” Each of these criteria is aspirational, and should not be given much weight unless the measurements can be refined and the expectations on the part of both the taxpayer and GO-Biz can be adequately expressed and aligned.
Resist pressure to use this incentive to advance non-economic development goals
If the Administration is not careful, three-quarters of a billion dollars in competitive, negotiated tax incentives will become the “go-to” source for policy leverage and political grease. To protect the integrity of this incentive program, the regulations should be explicit not only about what it takes to win a tax incentive, but also what will not be considered in evaluating an application. The economic development mission should be walled off from:
- Policy attributes not plainly enumerated in the authorizing legislation, such as project labor agreements, green building requirements or environmental mitigation requirements that go beyond existing regulations or CEQA.
- Creation of “co-benefits” criteria that give credit for attributes that are neither in the statute or service economic development.
- Limitations to certain preferred industries, based on attributes that are disconnected from economic development. As I stated earlier, it may make sense to give a priority to industries that are by their nature mobile or tradable, but this is a general characteristic that defines competitiveness and job multipliers, which are intrinsic to economic development and growth. You should resist focusing on particular industries based solely on their political salience.
- Conditions that place requirements on a business (or increase its cost) that a business would not normally incur absent the incentive.
Explicitly describe the criteria and attributes that would result in a tax incentive
The GO-Biz process should not be a “black box.” Competing businesses, as well as taxpayers, elected officials and local economic developers, should have a strong sense of what it will take to obtain a tax incentive. The credibility and integrity of this program will be directly related to its transparency. Certainly, the identity of new business prospects can be confidential, but the amount of a tax incentive – especially since it the details eventually will be public – should not come as a surprise.
Ensure a fair and prudent process
Even though the tax incentives will be freely negotiated contracts, they should still provide reasonable protections for the taxpayer from arbitrary state action. In particular, the conditions under which an incentive can be recaptured should be made explicit in the regulations, and the taxpayer should be given an opportunity to contest the recapture and challenge any findings made by the Franchise Tax Board before the California Competes Tax Credit Committee.
Also, since the law designates FTB to “ensure compliance with the terms and conditions” of the agreement, the regulations should provide that GO-Biz can only require conditions that are verifiable by FTB staff using documentation that would ordinarily be available in company or public resources. The recapture rules should also include a proportionality standard, where small, harmless or unintentional violations of the terms and conditions do not result in forfeiture of the entire tax incentive.
GO-Biz should also maintain a balance between the resources available for tax incentives and the commitments it makes to encumber those resources. Once the program is up-and-running, the pressure will build to make commitments. Especially in the early years when the total available for incentives is lower, the temptation to obligate funds from future years will be strong. But obligating out-years’ resources for current projects would inevitably reduce your ability to provide incentives for excellent prospects in the future. GO-Biz should resist front-loading the spending just because the pressure for projects is high.
Just the prospect of being in the mix to assemble the new generation Boeing 777X jetliner should spur state economic development officials to a fever pitch on this project. Capturing new business during an economic recovery should not be treated as business as usual.