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BNA’s Laura Mahoney on the Revised Enterprise Zone Proposal

Laura Mahoney, who writes for BNA‘s Daily Tax Report, often has the most comprehensive and well researched reporting on California’s Enterprise Zone. Here is her latest about the Governor’s revised budget proposal:

Reproduced with permission from Daily Tax
Report, 101 DTR H-1 (May 25, 2011). Copyright 2011
by The Bureau of National Affairs, Inc.
(800-372-1033) http://www.bna.com

Gov. Brown to Cut Employer Hiring Credit, But Save Enterprise Zones in Latest Proposal

SACRAMENTO, Calif.–Although Gov. Jerry Brown (D) backed off his proposal to eliminate tax credits for business located in enterprise zones in his latest budget plan released May 16, he proposed new changes to the EZ program that would drastically reduce and gradually squeeze the ability of employers to claim the most lucrative credit in the program.

Brown conceded when he unveiled his revised budget that he is reversing his call to eliminate the EZ program only because he does not have enough support in the Legislature. Since he first proposed elimination of EZs in January (7 DTR H-2, 1/11/11), both Democrats and Republicans have rallied to support the program as a key economic development tool for local governments during a severe economic downturn. He said his overall opinion that the program does not work, and is not worth saving, has not changed.

“Don’t see the votes there,” he said to explain his shift on EZs at a May 16 news conference.

His enterprise zone proposal is part of his overall revised budget for the 2011-12 fiscal year that begins July 1.

The governor’s latest swing at the EZ program prompted immediate criticism, with the program’s supporters saying as they did in January that the changes would be an unprecedented and unconstitutional taking of tax benefits, and its detractors saying it would do little to fix a program that does not work in the first place (32 DTR GG-1, 2/16/11).

Save EZs, Slash Hiring Credit.

Brown’s proposal would save the 42 EZs around the state but drastically change the hiring credit available to employers located within them, which can reach $30,000 for hiring workers who have barriers to employment. It also takes direct aim at the practice the Brown administration labels “retro-vouchering,” through which employers secure vouchers from local EZ programs for the hiring credit and use the vouchers to file amended tax returns claiming the credit months or years after hiring qualified workers. The amended returns are often filed with the help of tax consultants who earn a percentage of the total EZ tax credits given to the employers.

Brown is also attempting to ensure the credit goes to employers who create new jobs. Under the program’s current rules, employers can receive the hiring credit without increasing the overall number of jobs. For example, an employer can receive a credit for hiring a qualified worker to fill a job that already existed, or for replacing an employee for which it already received a credit with another qualified worker.

The proposed reforms would focus the program more appropriately on creating jobs, and get rid of abuses that now exist, Jay Chamberlain, chief of financial research for the governor’s DOF, told BNA May 20.

“This makes it more difficult to get the credit,” he said. “You actually have to increase employment.”

Five-Year Carryforward From 2006.

Although he would keep the overall EZ program, Brown proposed to eliminate his earlier provisions that would have wiped out EZ credits companies have earned in previous years but not yet claimed on their tax returns. This provision accounted for more than half of the two-year, $924 million revenue gain that he originally estimated, but prompted outcries from EZ supporters who vowed to challenge the proposal in court if it became law.

Instead, Brown said he wants to impose a new, five-year limit on carryforwards for EZ credits earned but not claimed. No limit on carryforwards for EZ hiring credits now exists.

Under the proposal, credits earned but not claimed for years before 2006 would indeed be wiped out. Credits from 2006 and later would be limited to a five-year carryforward, meaning employers would lose remaining balances on earned credits unless they claim them within five years.

Employers could still file amended returns for open years and claim the credits in some situations, despite the carryforward limitation, according to the governor’s Department of Finance. For example, if a federal or state audit resulted in an increased tax liability for 2005, and an employer had unclaimed EZ credits for that year, the employer could file an amended return and claim the credits against the new tax liability.

Voucher System Would Go Away.

The most sweeping changes in the governor’s plan relate to the current EZ credit voucher system. Under current law, employers who can show they have hired workers who fall into one of several categories, such as long-term unemployed, veterans, or people coming off public assistance, obtain vouchers from local EZ administrators. The companies then use those vouchers to claim the credits on their tax returns.

The hiring credit amount varies, depending on the salary of a qualified worker, and can reach $30,000.

Brown is proposing to eliminate the voucher system and variable value of the credit as of July 1, 2011, and replace them with a flat $5,000 credit for employers that can show an overall increase in full-time jobs from one year to the next. New hires would no longer have to fall into one of the categories of workers with barriers to employment to qualify for the credit.

Employers also would no longer be able to claim the EZ hiring credit on amended returns, but would be required to claim it on original returns only.

Brown’s proposal includes a grace period for companies that have hired qualified workers in the past few months, to accommodate those who typically gather all vouchers for the year at one time, usually toward the end of a fiscal year, Chamberlain said.

Grace Period Helps Fiscal Year Filers.

Beginning July 1, employers would have 90 days to secure vouchers from local EZ administrators for recent hires. Companies with fiscal years that end between September and December 2011 and hire a qualified employee after September 2011 would have an additional 30 days to secure their vouchers. After the grace period, vouchers would no longer be part of the EZ hiring credit program.

Other credits available in enterprise zones, including a sales and use tax credit for employer machinery purchases, and an interest deduction for lenders who issue loans to employers in the zones, would remain in place with no changes.

Brown’s changes to the hiring credit would increase state revenue by far less than the $924 million in two years than his January proposal to eliminate the EZ program would have. But the changes would gradually increase revenue as the five-year carryforwards for existing credits expire, according to the administration.

Brown’s EZ proposal would result in revenue gains of $23 million in fiscal year 2010-11, $70 million in 2011-12, $120 million in 2012-13, $160 million in 2013-14, and $270 million in 2014-15, the latest year for which the administration has projected revenues.

Supporters, Opponents Do Not Like Brown’s Ideas.

Brown’s proposed reforms failed to win over critics of the program, including the Legislative Analyst’s Office, which provides nonpartisan fiscal and policy analysis to the Legislature. LAO has repeatedly told lawmakers that the EZ program should be on the top of the list of expenditures to be eliminated because it does not increase overall employment.

Legislative Analyst Mac Taylor said May 19 the governor’s latest proposal could reduce the attractiveness of the hiring credit even further. LAO continues to support elimination of the entire EZ program, he said.

Jean Ross, executive director of the California Budget project and a frequent critic of the EZ program, told BNA the governor’s proposed changes are mixed, but overall would not make the program better.

Although the intent of the program has never been fulfilled, elimination of the categories of disadvantaged workers that qualify an employer for the hiring credit would move even further from the program’s intent, Ross said.

At the same time, elimination of retro-vouchering and the requirement that employers show a net increase in employment to earn the credit are positive improvements, she said.

“We would have a somewhat less costly program that still doesn’t work,” Ross said.

Supporters of the EZ program told BNA the governor’s proposed changes would still be illegal, as was Brown’s original proposal to eliminate the program altogether.

Brown’s proposal would change the terms of the EZ program retroactively through the five-year carryforward limitation, eliminating fully vested credits in violation of the Due Process Clause of the U.S. Constitution, said Marty Dakessian, an attorney for Reed Smith in Los Angeles and representing a coalition called Communities to Save Enterprise Zones.

Scope Is Smaller, but Plan Still Illegal.

The difference between the governor’s January and May proposals is the scope of the revocation of credits and magnitude of the taking, Dakessian said.

“Reducing the dollar amount of this constitutional violation doesn’t change the fact that it is a violation in the first place,” he said.

Dakessian also echoed Ross, saying elimination of the categories of disadvantaged workers who would make an employer qualify for the credit would frustrate the original intent of the EZ program and take away an important safety net for those workers. It would reduce the bureaucracy of the program, but at the expense of disadvantaged workers, he said.

“In the world of federal, state, and local taxation, the governor’s proposed action is an unprecedented, retroactive taking of bargained for, earned, and paid for tax benefits,” Dakessian said.

The Senate and Assembly will examine the governor’s EZ proposal, and other tax proposals, at hearings scheduled for May 26 at 10 a.m. before the Senate Budget Subcommittee on State Administration and General Government, and at 1:30 p.m. before the Assembly Budget Subcommittee on State Administration.

Lawmakers are required to adopt a budget for the new fiscal year by June 15 to give the governor time to sign it by July 1. They often miss the deadline, and this year they are struggling to fill a $10 billion deficit.

By Laura Mahoney

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