GG17 - Tax Relief on Manufacturing Equipment

California is losing manufacturing jobs to lower tax states. [1] The Governor should work with the Legislature to provide a 5 percent sales tax credit for sales tax paid in the previous year on manufacturing and telecommunications equipment.

The cost of doing business in California is third highest in the country; its composite tax and business costs are 32 percent higher than the national average. [2] This high-cost business climate hurts its companies, particularly manufacturers who are competing in national and global markets. California lost a total of 190,000 manufacturing jobs in 2001 and 2002. [3] Manufacturers have a choice of where to locate facilities. [4] Decisions on where to build manufacturing production facilities are especially sensitive to differences in taxes and business costs. [5]

California's manufacturing workers are paid an average of $25,000 more per year than service-sector employees. The economic multiplier effect of each manufacturing job is two and one-half, the highest of any type of job. Thus, when California loses one manufacturing job, 2.5 jobs in other sectors of the economy also disappear. [6]

Between 1989 and 1993, California lost 300,000 manufacturing jobs. [7] In 1994, California enacted a Manufacturer's Investment Tax Credit in an attempt to stem the flow of manufacturing jobs out of California, offset the higher costs of doing business and help restore California's business climate. The credit was allowed to expire in 2003 amid concerns about its effectiveness at creating jobs. Dorothy Rothrock of the California Manufacturer's and Technology Association has said that the Manufacturer's Investment Tax Credit, along with other positive California features, were not sufficient incentive to overcome a decline in defense spending and high California costs. Ms. Rothrock advises that Manufacturer's Investment Credit is a smaller program than a sales tax exemption, with smaller foregone tax revenues but also less stimulus effect. [8]

Two-thirds of respondents to a survey by the California Manufacturing and Technology Association stated that they had invested more in California at least partly because of the Manufacturers Investment Credit. In the same survey, 86 percent said they hired more employees in California as well. [9] Others indicated that since the legislature had made the continuation of California's tax credit past 2003 contingent upon specific sustained job growth, many businesses found it to be no incentive at all. [10] Ray Rossi of Intel Corporation states that the expiration of the Manufacturing Investment Credit amounted to a 6 percent tax increase for manufacturers on the heels of high energy costs. Board of Equalization Member Bill Leonard says companies have told him they have refrained from purchasing manufacturing equipment in California since the Manufacturer's Investment Credit was allowed to expire. [11]

California manufacturers have called for a sales tax exemption on manufacturing equipment. Thirty-eight states exempt the purchase of manufacturing equipment from sales tax. Of those, 15 also offer an investment tax credit to further encourage investment in new equipment. [12]

According to a Milken Institute study, a sales tax reduction would create long-term benefits for the economy by producing increased personal income and corporate tax revenues that would exceed the loss of sales tax revenue. In the short term, however, it would result in reduced overall revenues in the year equipment was purchased (see Exhibit 1 below). [13]

If the waiver were provided on a delayed basis, the revenues in the short term could be made positive as well. Manufacturers have indicated that a one-year delay would not prevent most from making an investment. [15]

It should be noted that while the sales tax is at least 7.25 percent throughout California, only 5 percent is deposited into the State General Fund (.5 percent is for the Local Revenue Fund, .5 percent is for the Local Public Safety Fund and 1.25 percent is for city/county transportation funds and other operations). Any amounts collected above the 7.25 percent also are not deposited into the state's General Fund.

While the legislature can approve a permanent or temporary waiver of this tax with a simple majority, a two-thirds approval of the legislature is currently required to undo any permanent waiver (as it would be perceived as a tax increase in the year implemented). In the past, the legislature has placed a sunset date on some waiver programs to maintain flexibility in extending or sunsetting the program without the two-thirds threshold.

The credit would be allowed on sales tax returns once twelve months had elapsed from the date of the equipment purchase. This legislation would be effective from 2005 through 2014, to allow credits to be taken from 2006 thru 2015.

A sales tax reduction of 5 percent on manufacturing and telecommunications equipment would result in more than 25,000 new jobs per year over the next ten years, of which over 7,000 would be in the manufacturing sector. These estimates assume that the equipment investment projections in the Milken Study are reduced by 20 percent because businesses would not be allowed to claim the reduction until a year after the date of the equipment purchase. State tax revenues from added personal and corporate income tax receipts would offset the sales tax credits in all of the ten years of this program. As this decrease is only the state's share of the sales tax, there would be no adverse effects to counties, cities or other jurisdictions.