Sales Tax Exemption on Manufacturing and R&E equipment purchases: Currently, California double-taxes productive assets used in both manufacturing and research. By offering a sales and use exemption for purchases of manufacturing equipment, California will end this practice of double taxation of such investments, a practice that inhibits job growth and retention that are critical to the future health of California. Most other states offer a sales tax exemption for manufacturers for equipment purchased in the manufacturing process, and some even provide tax credits for the purchase of manufacturing equipment. More details
The Proposal: Industry-specific tax exemptions and credits for manufacturing and research equipment purchases have proven to be very effective in creating or increasing demand. These incentives are driving factors for businesses to bring in revenue which is used to expand jobs and operations. A broad-based sales tax exemption can be leveraged on the recent success of the green manufacturing exemption, which is recognized as a vital incentive to encourage businesses to stay and grow in California and invest in jobs.
Job Creation impacts: A sales tax exemption on the purchase of manufacturing and research equipment would help level the competitive playing field for California as a primary destination to expand jobs.
Examples from other jurisdictions:
- Arizona: Arizona, along with 42 other states in the U.S., offers a full sales tax exemption on manufacturing equipment. A California company decided to expand in Arizona resulting in $1 billion initially in revenue alone providing subsequent job growth to local schools, construction, and supporting industries. This capital investment amounted to 1,000 new jobs alone at the manufacturing facility.
- Washington: The State of Washington is far ahead, for example. Nearly a decade ago, a bipartisan group of legislators in Washington restored the sales tax exemption on manufacturing machinery and equipment with spectacular results. An Association of Washington Businesses’ survey found that 150 small manufacturers invested more than $250 million in the first year alone. During the first decade, Washington added $81.5 billion to the state coffers, generated more than $16.5 billion in income and created nearly 285,000 jobs.
Protect the Single Sales Factor Apportionment: California is transitioning to a knowledge and service-based economy, which has ramifications for how the current tax structure influences investment decisions, as well as how much revenue is generated by certain taxes. With the highest business tax rates in the U.S., California must continue to seek innovative ways to improve competitiveness by updating the state’s business tax code in a way that is competitive with other states.
Strengthen the California Research and Development Tax Credit: Despite California having a permanent credit, growing numbers of R&D activities are heading to other countries and states to start new businesses or to expand R&D labs. In a survey of California-based high-tech firms, researchers from the University of California at Berkeley found that along with manufacturing, research and development is one of the first functions to be outsourced to other states or sent to foreign countries.
Although the R&D tax credit is one of the stronger incentives that California offers, the state’s R&D tax credit allows a 15% credit on the investment. The federal R&D tax credit rate allows a higher 20% credit rate of return on all purchases including a broader group of businesses who qualify for the credit under the “alternative simplified credit.” And, effective January 2010, the California R&D tax credit can be shared among a related group of affiliate or subsidiary companies sometimes referred to as unitary utilization. This change will help some employers who are not currently able to fully utilize their promised tax credits, despite having engaged in the desired R&D activities.
The Proposal: As the largest R&D producer in the nation, increasing the credit percentage to the 20% federal rate will help California compete for R&D investments, highly-skilled jobs and intellectual capital with other states and countries. California currently provides one-fifth of all R&D activity in the U.S. In Silicon Valley alone, employers annually invest more than $41 billion in research and development and would invest even more with a permanent and expanded R&D credit. Longevity and predictability of the credit are critical because future decisions on R&D investments are based on knowing that the credit will be in place at the time the R&D project is completed, which can easily take 5 to 10 years. More details
Job Creation impacts: By lowering the cost of hiring R&D workers, the tax credit helps to maintain and create new, highly-skilled, high-wage R&D jobs. It is a “jobs credit” because 80 percent of credit dollars are attributable to R&D wages. R&D tax credits are also widely known to create a multiplier effect for the state’s economy. Recent reports have determined that such credits produce a rate of return of at least a dollar increase in research spending, and up to as much as $2.96 for every dollar claimed as a credit (source: U.S. Bureau of Labor Statistics).
Together, the state and federal research tax credits have helped California retain its leadership in innovation, particularly when California is competing for investments with China, Japan, Hong Kong, Singapore, the European Union and others.
Examples from other jurisdictions:
- China: Provides a super-deduction of 150% of qualifying research and development expenses.
- France: According to the OECD, France offers the most generous R&D incentives out of all OECD countries. There is no restriction on the types of entities that may qualify. Also, if a company invests more, they receive a larger percentage of deduction.
Projected Cost: The Department of Finance Tax Expenditure report estimates a “static” cost of $945 million. However, it is also important to consider “dynamic” budget revenue scoring estimates – taking into account how the incentive investment would impact economic growth and macroeconomic variables (investment, income, employment, total revenue) – would result in long-term growth to the state, offsetting any initial costs.
When the Department of Finance, Board of Equalization or Franchise Tax Board analyze legislation, there does not appear to be any reconciliation between the projected estimates presented to the Legislature and the actual fiscal impact of legislation once the policy is implemented.
Due to state budget shortfalls, the Legislative Analyst Office (LAO) has previously recommended suspending the state R&D tax credit, or even worse – repealing it. However, the LAO has also noted that the intent behind the R&D tax credit in 1986 was to conform to federal legislation, and the credit subsequently was expanded to reﬂect “concerns regarding the state’s business climate, and a desire to attract economic activity perceived as being conducive to high growth.”