EZ Policy Blog

Thanks to a reader for bringing this Op-Ed by Stuart Butler, vice president for domestic policy issues for the Heritage Foundation in the Washington Times to my attention:

Time after time, Congress has used a recession to revive bad ideas, based on bad history. Meanwhile, good ideas of proven utility go overlooked.

The latest bad idea circulating in Washington is that Congress can “create” jobs that otherwise wouldn’t exist.

How? By “borrowing” people’s savings, or just taking their cash in taxes, and using it to hire other people.

This simple notion now fuels a raft of new proposals for “jobs” bills. Politicos blithely assume that, just by spending money on new roads and bridges, Washington will add to the total number of jobs in America.

I lived where that theory was put to the test for decades: in Britain during the 1950s, ’60s and ’70s. The prevailing view then was that the secret to economic growth was for Parliament to take money from one group of people and use it to hire people to do things (like building roads, bridges and ships). The actual result? One of the slowest-growing economies in the West.

The problem was that, when government took money away from the people, they no longer had it to buy things or to invest in factories and equipment. Turns out, government merely transferred jobs from one place to another - losing many along the way. Government is simply not a very efficient middleman.

Unfortunately, we occasionally fall into the same zero-sum game here. In virtually every recession, Congress has enacted British-style infrastructure “job-creation” programs that have subsequently proved to produce few, if any, net new jobs.

But there is one way government actually can create additional jobs (beyond those that would have been created in any case). That’s by establishing an environment that encourages those with savings to use their money to finance new businesses that employ people. How do you create such an environment? By reducing the red tape and tax costs of investing in job-creating firms.

In the 1980s, that simple fact led Margaret Thatcher’s government to come up with the idea of “enterprise zones” for high-unemployment areas. In these zones, the government made it simpler to start a business, and it cut taxes on those who invested. The zones boomed. It was like Hong Kong on the Thames.

Modest versions of enterprise zones were established in depressed areas of some American cities. But now is the time to enact an idea championed by former Housing and Urban Development Secretary Jack Kemp, an enterprise-zone booster since his days in Congress. Mr. Kemp’s vision was to establish just one enterprise zone - but one that would stretch from the Atlantic to the Pacific and between the Canadian and Mexican borders.

As Mr. Kemp argued, there are two keys to encouraging net new businesses that add to total jobs. The first is to cut or eliminate the capital-gains tax on investments in small businesses. The second is for state and local governments to streamline red tape: the zoning requirements, permitting requirements and other rules that add time and costs to the process of starting a business.

Why the focus on small businesses, such as subchapter S corporations or sole proprietors? Because they are the primary job creators in the economy. Larger firms tend to grow more slowly, even in good times.

Capital-gains relief is critical for these small firms because their startup money typically comes from investors, not from banks. These investors are willing to take more risks and look for capital growth, rather than dividends or interest.

So eliminating capital-gains taxes encourages them to take a chance on higher-risk small firms - the best job creators - rather than concentrate mainly on slower-growth but relatively safer large firms.

Speeding up the permit process and otherwise simplifying costly startup regulations is especially important to small firms. Delays that merely irritate a large established firm can be fatal to a “Joe the Plumber” entrepreneur with little financial leeway.

“Jobs” programs have a terrible track record when it comes to creating jobs or jump-starting economic growth. Lawmakers looking to spark job creation should reject that tired, failed approach and go with what really works. Make America a national enterprise zone.

The Fall 2008 LAEDC “Business Leader” Newsletter includes a defense of the Enterprise Zones by LAEDC Predident & CEO Bill Allen.

In these hard economic times, the California Enterprise Zone Program plays a key role in revitalizing economically-challenged areas of the state, encourages development in blighted neighborhoods and creates economically-stable communities by embracing entrepreneurship and private sector market forces to stimulate local economies. California’s Enterprise Zones remain one of the only dependable statewide tax incentives that local areas can use to encourage businesses to stay or locate in-state.

The Governor will hold a press conference at about 11:00 this morning to announce the creation of a Commission:

The Governor will hold a press conference to announce creation of the bipartisan Commission on the 21st Century Economy that will address California’s chronic budget problems and modernize our state’s tax laws.

Update: Here is the video:

Governor Announces Creation of Bipartisan Commission on the 21st Century Economy from Max Shenker on Vimeo.

As in past years, the CAEZ Conference had the benefit of receiving updates from Frank Luera of HCD and Jeannie Harriman of FTB.

HCD expects the final application for the next round of zone designations to be released as early as the week of Oct. 27.  Those applications would then be due sometime next March or April.

As noted before, HCD is still working with the LAMBRAs to reexamine what ought to be the correct designation dates of those zones.

In addition, we should expect HCD to begin a process of modifying the vouchering regulations.  While the main impetus for doing so is to codify the allowance of the W4 form, there will likely be an opportunity to revisit many of the issues dealt with in the regulations.  That should be fun.

How does the current economic climate effect the program?  HCD feels that the Governor is actually embracing the program to an even greater degree than in the past and views it as an important part of an economic stimulus.

Most of the discussion with FTB centered around trying to understand the technical implications of the new budget and AB 1452 with SBX1 28.  Both the NOL suspension and the 50% usage limitation will not apply to taxpayers with “net business income” less than $500,000.  FTB is still not entirely certain how to define “net business income,” and will hopefully have some guidence out for us in the near future.

The requirement to file IRS forms 8886 and 8918 were reiterated (see also FTB Notice 2008-1).

When asked if the current budget troubles are resulting in an increase in FTB audits of credits, Jeannie answered that in fact the FTB is “winding down” their heightened interest in hiring credits.  FTB is operating with increased confidence in vouchers issued since the implementation of vouchering regulations in January 2007.  As more and more returns are filed based on vouchers issued subsequent to the regulations, FTB is reducing its audit activity with regard to the credits.

KSBW, channel 8 in Monterey aired a news story about the new Enterprise Zone:

KSBW Report - Salinas Valley Enterprise Zone from Max Shenker on Vimeo.

City leaders from up and down the Salinas Valley laid out a plan on Tuesday to create thousands of new jobs on the Central Coast by creating an “enterprise zone” stretching from King City to Salinas.

All five Salinas Valley cities are working to make the zone, which would offer businesses tax breaks and incentives to open shop, a reality as soon as next month.

The Salinas Valley enterprise zone would be the biggest of its kind between Los Angeles and San Jose.

There have been a number of news items along these lines in recent days, today’s Sacramento Bee seems to have more details: “Governor will call special legislative session on budget.”

With the economy reeling, Gov. Arnold Schwarzenegger announced Monday that he will call lawmakers back into session next month to grapple with a shortfall that is “much bigger” than the $3 billion projected just three weeks ago.

“I think everything is happening very quickly,” Schwarzenegger said, pointing to a nose-diving stock market that has had “tremendous impact on our capital gains and the revenues coming in.”

Schwarzenegger declined to pinpoint the size of the state’s budget gap, saying more should be known within days. Senate President Pro Tem Don Perata put the figure at $10 billion.

“We have to deal with it quickly,” Schwarzenegger said.

The GOP governor, accompanied by legislative leaders, said he will call Nov. 5 – the day after statewide balloting – for a special legislative session on bridging the budget gap, stimulating the economy and increasing employment.

“As long as we delay it, we’re just creating a worse problem later,” Perata said.

Next month’s special legislative session is expected to discuss easing the state’s mortgage foreclosure crisis, bolstering the state’s unemployment insurance fund, and fast-tracking previously approved public works projects to create jobs.

Schwarzenegger said a new tax commission will be created to discuss what changes, if any, are needed to the state’s tax structure.

The tax panel is expected to tackle numerous issues, but one idea floated by Democrats is to extend sales taxes beyond retail products to assess services, such as lawn mowing or auto repair.

Schwarzenegger said he prefers to tackle the economic crisis with incumbents rather than “drag it out” by waiting for winners of Tuesday’s election to be sworn into office Dec. 1.

“They’ve dealt with the problems throughout the year, with the economic decline and with the housing crisis and the shortfall in revenues, and all those kinds of things,” Schwarzenegger said of incumbents. “They’re very experienced.”

Next year’s multibillion-dollar gap comes on the heels of this year’s massive shortfall, which exceeded $15 billion and sparked a record 85-day delay in passing a state budget.

Democrats and Republicans have been deeply split all year on whether to increase taxes to ease the state’s money crisis.

Monday provided no indication that the partisan split has subsided.

Republican legislative leaders, in a letter to Schwarzenegger, called Monday for tax cuts to stimulate the economy.

State unemployment has grown to 7.7 percent from 4.6 percent about two years ago.

Assembly Republican leader Mike Villines, of Clovis, and Senate Republican leader Dave Cogdill, of Modesto, said lower taxes would spur job creation.

“We just want to get the economy moving – and jobs is the best way,” Villines said.

Specifically, the GOP leaders recommended a tax credit for businesses that hire the unemployed; a manufacturing investment credit for equipment purchases; a cut in the capital gains tax to spur business investment; and modification of the tax code and suspension of regulatory burdens to spark job creation.

Though Schwarzenegger will call for the special session Nov. 5, legislative leaders will negotiate on key economic issues before convening lawmakers at the Capitol on an unspecified date, Assembly Speaker Karen Bass said.

H.D. Palmer, Schwarzenegger’s spokesman for finance, said an updated shortfall projection may be released later this week, following an annual exercise today in which outside economists analyze the state’s revenue figures.

“The situation is far more severe than it was when we were negotiating (this year’s) budget,” Bass said. “We really can’t wait until a new class comes in.”

Incoming Senate President Pro Tem Darrell Steinberg, a Sacramento Democrat who assumes the post next month, declined to comment Monday on whether a tax increase is needed to bridge the massive budget gap without cutting key services.

“I think nothing’s off the table,” he said.

“Crisis is opportunity,” Steinberg said, lamenting the state’s annual boom-or-bust revenue outlook. “Finally, let’s take the bull by the horns and fix this ailing system.”

Steinberg, asked to comment on the GOP tax-cutting proposal, said he’s willing to consider all ideas but that he’s wary of doing anything that might exacerbate future budget gaps.

The Service Employees International Union urged state officials Monday to solve its red ink with “lasting revenues” rather than to cut school, health care or other vital services.

“In a fiscal downturn, families need more support, not less,” the union said.

I have just returned from another great CAEZ Conference, this year in beautiful Long Beach. First of all, congratulations to Craig Johnson for hosting a very successful conference as well as being elected the new President of CAEZ.  Congratulations also to Kelly Trevino of Fresno on her election to the CAEZ Board.  Fresno, incidentally, will be the site of the 2009 CAEZ Conference.  I am honored to have the opportunity to serve along with them as a new Board Advisor.

Over the next week or so (because I’m busy) I will try to fill in the various updates we got from HCD, FTB and the zones.

I am sure we will hear more from HCD later this week at the CAEZ Conference about when they intend to start the application process for the four zones set to expire next year (their website still states that they expect the application to be released Sept. 30).

In the mean time, sometimes there are clues about new areas that might get in on the competition. In an article in the Colusa County Sun-Herald about local elections, “Colusa candidates jostle for votes,” is the following nugget:

Speaking not necessarily to a voting audience, but as an encouragement for people to get out and vote, Williams city councilman Don Baker, up for reelection, put his best foot forward, as did Princeton school board candidate Jesus Campos.

Baker took office four years ago, and helped to develop a workable three-year budget, funding a swimming pool upgrade, new police K-9 unit, a new police station and street repairs.

Barker said he is also working with other local agencies to get an Enterprise Zone approved and complete specific plans for downtown and commercial development.

Previous clues:

“Big Zone”
“Needles, NV?”
“Cathedral City EZ in 2009”
“Kern Update”
“Calaveras County EZ in 2009?“

Don’t forget to register for the CAEZ Conference in Long Beach October 22-24.

Back in June I asked, “What ever happened to Arvin?“  While there had been some expressions of concern about ever seeing an Arvin Enterprise Zone, representatives from the City assured me that they were working diligently toward completion.

Today I spoke with Mike Kunz who heads up the Enterprise Zone effort for Arvin’s Economic Development Department.  He told me that since June the City has had their EIR (Environmental Impact Report) certified and submitted to HCD, completed their draft MOU for the zone, and gotten their TEA application done.  He is now working on the MOU Suppliment which will define more specific metrics for the success of the zone.  Kunz thinks that should be the last hurdle and he estimated completion and zone designation within 6-8 weeks.

How exactly are these credit transfers going to work for EZ credits?  In “What We Know So Far Part 2,” I reported that an FTB representative told me that they were leaning in the direction of the most strict interpretation of SX1 28.  The FTB has now issued the following statement in an email:

New Revenue and Taxation Code section 23663(a)(3) provides that “following an assignment of any eligible credit under this section, the eligible assignee shall be treated as if it originally earned the assigned credit.” Section 8(a) of SBX1 28 further provides that “[f]or purposes of applying Section 23663 of the Revenue and Taxation Code, . . .any limitations on allowance of any credit against the ‘tax’ that would apply to the assigning taxpayer in the absence of an assignment shall also apply to the same extent to the allowance of that assigned credit against the ‘tax’ of the eligible assignee.”

Reading these two provisions together, it is clear that the Legislature intended the eligible assignee of any assigned credit under new Revenue and Taxation Code section 23663 to “step into the shoes” of the affiliated assignor that originally was allowed the credit, with the result that the zone limitation provisions restricting application of zone credits against income earned from that same zone would apply equally to the eligible assignee as they would have applied to the assignor in the absence of an assignment under this new section.

Another reader pointed out that the intent of the legislature was made explicitly clear in the Senate floor analysis of the bill:

Second, AB 1452 additionally allowed taxpayers to assign tax credits to an affiliated corporation within the commonly controlled group. The bill provided that the affiliated corporation receiving the credit shall be treated as if it originally earned the credit, and existing law requires that the value of enterprise zone hiring credits cannot exceed the amount of a taxpayer’s business income apportioned to the enterprise zone. This bill provides that for purposes of the enterprise zone hiring credit, any limitations on the assigning party also apply to the affiliated corporation receiving the credit.

When did CAEZ get expanded powers?

In early 2008, the Salinas Valley received a conditional Enterprise Zone designation. Final designation from the California Association of Enterprise Zones is expected soon.

Charles Rangel Introduces Young Adult Jobs Bill

Embattled Rep. Charles Rangel (D-NY), chairman of the House Committee on Ways & Means, has introduced legislation to provide tax incentives for employers to hire “disconnected youth,” young adults, age 16 to 24, who are out of school and out of work.

…

H.R. 7066 includes youth aged 16 through 24 who are designated by a State employment security agency to have not been regularly employed or in school for the past six months and who lack basic skills for employment.

Here is the October 2008 edition of the FTB’s “Tax News” newsletter.

Here is a press release issued today by the California Association of Enterprise Zones:

SACRAMENTO, Calif., Sept 29, 2008 /PRNewswire via COMTEX/ — Commenting on the state budget just passed, “The California Association of Enterprise Zones (CAEZ) appreciates that the Governor and the Legislature could have considered larger and additional cuts to various economic programs throughout the state and did manage to keep many programs intact, including the Enterprise Zone (EZ) Program,” said Lydia Moreno, San Diego Enterprise Zone Coordinator. “However, we are concerned about the impact of the various tax credit and Net Operating Loss provisions of the budget and how they will impact small businesses in our state, especially those located in EZs, which are comprised of distressed communities.” As managers of the EZs in California, the CAEZ is keenly aware of the difficult decisions that had to be made during this tough budget year.
With the highest unemployment rate in the history of California of 7.7 percent, putting the state in a tie with Mississippi for the third-highest jobless rate in the U.S., now is the worst time to add to the costs of doing business in our state. Lydia continued, “We are concerned these small businesses will face higher costs and will have trouble making ends meet, which could impact their ability to keep and retain employees. Even the businesses within EZs, where there have been added benefits for employers to stimulate job growth in the highest unemployment areas, will not be able to take advantage of those cost-cutting measures. Additionally, attracting companies to California will be difficult.”
“In rural areas, it’s worse,” said Tonya Dowse, Siskiyou County Economic Development Director and EZ Coordinator. “The jobless rates already are high in our area. At least being in an EZ had helped to attract businesses that might not have come here. Now the benefits of being in an EZ truly are hindered.”
“We look forward to working with the Legislature next year to find solutions that will help stimulate our economy and grow jobs. Additional jobs will help keep California strong by infusing more revenue into the state to help keep important programs that serve the people,” said Lydia Moreno.

The Oakland Enterprise Zone expires tomorrow, Sept. 27, 2008 after 15 years of operation.  Sunday the 28th marks the first day of the new conditionally designated Oakland EZ’s existence.

Oakland is the last of the eight zones to expire in 2008.  Four zones will expire in 2009:

1. Los Angeles - Harbor Area
2. Madera
3. Sacramento - Army Depot
4. Sacramento - Florin/Perkins

As I have mentioned recently, HCD is about to announce the launch of the open competition for these four slots.

Regarding the adjustment made by SBX1 28 to AB 1452 with this language:

SEC. 8. (a) For purposes of applying Section 23663 of the Revenue and Taxation Code, as added by Assembly Bill 1452 of the 2007-08 Regular Session, any limitations on allowance of any credit against the “tax” that would apply to the assigning taxpayer in the absence of an assignment shall also apply to the same extent to the allowance of that assigned credit against the “tax” of the eligible assignee.

In my previous post I asked:

One question that arises regarding this new language in SBX1 28 is, does “shall apply to the same extent” mean that credits generated in a particular zone must be used only against tax generated in that same zone even if the credits are assigned to an affiliate with tax generated in a different zone?

I have since received a tentative response from a representative with FTB, “yes.” In other words, the assignee entity would have to have income from the identical Enterprise Zone as the assigning entity in order to make use of tax credits.  I was also told to expect written guidance from FTB on this issue in the near future.

Let me know if you can think of a case where this would help someone.

Here is what we know so far about the implications of the budget on the Enterprise Zones.

There are two budget trailer bills that impact the usage of the tax credits: AB 1452 and SBX1 28, neither of which have been signed by the Governor yet.

AB 1452 has three provisions that could effect Enterprise Zone businesses:

• Suspends the NOL for two years 2008-2009
• Limits the ability to reduce tax below 50% of liability with tax credits (such as Enterprise Zone credits) for tax years 2008-2009
• Beginning in 2010, allows corporations to assign all or a portion of any unused tax credits to an affiliated corporation that is a member of the same combined reporting group.

Taxpayers with less than $500,000 in “net business income” are exempt from both the NOL suspension and the credit usage limitation.  Any credits that go unused because of the limitation in 2008-2009 will carry forward.

The most interesting, and confusing, area is, of course, this new ability to reassign credits between entities.  My understanding is that this compromise was primarily, if not exclusively, targeted to placate large taxpayers with large Research & Development credits who have been lobbying for this kind of reform for years.  How this provision could be used by taxpayers with excess Enterprise Zone credits is unclear, at least to me.

In a posting on the left-wing website California Progress Report,  California’s Treasurer Bill Lockyer warned:

These tax provisions also affect enterprise zone tax credits. The Legislature created this program to encourage businesses to locate and create jobs in economically-disadvantaged communities. The budget undermines the entire purpose of the program by allowing enterprise-zone businesses to transfer tax credits they don’t use to affiliates outside the zone.

Currently, there are $768 million worth of unused enterprise zone tax credits in California. It’s likely a good portion of those credits will be shifted to businesses outside these areas if this budget becomes law. This is another tax shelter that will drain more revenues and further weaken the state’s fiscal health.

Leaving aside the discussion regarding the wisdom of a business incentive program that leaves $768 million of unusable credits on the books, I was not sure that Mr. Lockyer’s assessment of the bill was correct. I thought that once assigned, the assignee would then be subject to the same tax code rules governing the use of whatever tax credits had been assigned.  Apparently, there were some in the legislature who agreed that Mr. Lockyer’s concern needed to be addressed and that’s where we come to SBX1 28 where we find:

SEC. 8. (a) For purposes of applying Section 23663 of the Revenue and Taxation Code, as added by Assembly Bill 1452 of the 2007-08 Regular Session, any limitations on allowance of any credit against the “tax” that would apply to the assigning taxpayer in the absence of an assignment shall also apply to the same extent to the allowance of that assigned credit against the “tax” of the eligible assignee.

The Enterprise Zone tax credit includes a significant inherent limitation on credit usage known as the apportionment limitation.  Taxpayers with EZ tax credits can only reduce the tax which results from income in an Enterprise Zone.   Not only that, but for taxpayers who operate in more than one zone, tax credits generated in one zone can only be used to reduce tax resulting from income in that very same zone.  One question that arises regarding this new language in SBX1 28 is, does “shall apply to the same extent” mean that credits generated in a particular zone must be used only against tax generated in that same zone even if the credits are assigned to an affiliate with tax generated in a different zone? In any case, it is difficult to think of scenarios in which the ability to reassign tax credits to affiliates will help Enterprise Zone businesses.

Furthermore, the fact that EZ credits are already so limited in their usage means that the largest taxpayers will be unaffected by the 50% limit imposed by AB 1452.  Large taxpayers operating throughout the state (such as Wal-Mart) can never hope to reduce their tax anywhere near 50% with EZ tax credits as it is.  Very small businesses are exempted.  So who will AB 1452 hurt the most?  Just those profitable, small businesses who are wholly locally owned and operated, and contribute a significant number of jobs to the local distressed communities.

HCD has posted an update to their website announcing the impending launch of the next round of Enterprise Zone expirations and applications:

Update on the 2008/2009 Designation Round — The Department is currently drafting the Application Guidebook for the next designation round. For this round, there will be four slots available. At this time, the Department expects to release the guidebook by September 30 with a due date of late January or early February. If you need more information on a release date, please call Lesley James at (916) 322-1112.

I’m not sure what they are smiling about:

Gov. Arnold Schwarzenegger signed a $103.4 billion general-fund spending plan Tuesday in his office with little fanfare, officially ending the state’s longest-ever budget delay at 85 days.

Update: Apparently, the budget has already increased by $41.6 billion in the 80 minutes between when the Sacramento Bee posted its story, and when the L.A. Times posted its story:

Another Update: A helpful reader has pointed out that the $103 billion referenced in the Bee refers to the General Fund only, while the Times also includes additional funds such as federal, special, bonds, etc.