Outdated State Tax Program Costs California Billions

Friday, April 15, 2016
California Auditor Elaine Howle

By Nick Cahill, Courthouse News Service


SACRAMENTO, Calif. (CN) - As tax day approaches, the California state auditor said Tuesday that the state doesn't monitor and hasn't updated its corporate tax program — and the tax breaks are costing the state billions.


Lax oversight over the state's six largest corporate income tax expenditures cost it more than $2.6 billion in forgone revenue in 2012-13 alone and the state auditor says it's unclear if some of the corporate tax breaks are actually sparking economic activity.


The audit found that the state's popular research and development credit has essentially been ignored by regulators and that there isn't enough evidence to conclude if it's cost-effective.


"We were unable to determine the research-and-development credit's effectiveness because no state entity oversees or regularly evaluates it," the audit states. "Further, although the credit is the state's largest corporate income tax expenditure, its effectiveness is not regularly evaluated."


Large corporations are able to greatly reduce their tax liability by claiming the research-and-development credit and are allowed to carry over unused credits to future filings. The audit found that since 1987, corporations have racked up more than $14 billion in unused credits and the carryovers represent a huge future liability for the state.


The auditor said the research-and-development credit was last reviewed in 2003, and recommended a major study to determine whether the tax break should be improved or scrapped altogether.


A similar program expired last year in Washington state, after officials determined that the credit produced just 454 new jobs at a cost of nearly $50,000 per job over a four-year span.


The auditor also criticized the state for its regulation of the franchise-tax exception, which was enacted in 1999.


The credit exempts new corporations from paying the minimum franchise tax in their first taxable year and was created by lawmakers in hopes of increasing corporate formation in the Golden State. California corporations are taxed based on a percentage of their income or a minimum of $800, whichever is greater.


The report again found insufficient studies into or state oversight of the franchise tax exception, and the auditor can't tell if the program is still encouraging businesses to incorporate.


"It is not clear whether the franchise exemption, which cost the state $45 million in forgone revenue in tax year 2012, had a noticeable effect on the formation of new corporations in California," the 36-page audit states.


It's up to the Legislature to call for studies on the two tax programs to determine if they are still meeting their original objectives, according to the audit.


The audit focused on California's six largest tax expenditures and examined data from the three most recent years for which data was available. While the auditors met with the California Franchise Tax Board during the process, the tax board was not given direct recommendations because they are not liable for oversight of the programs.


Three tax expenditure programs received a passing grade from State Auditor Elaine Howle, including the "water's-edge election," low-income housing credit and the film and television credit. Howle said the credits "appear" to be effective and that the film and television credit is keeping some production studios from leaving the state.


While the water's-edge election expenditure — which allows multinational corporations to exclude income generated outside the United States from its state tax filings — appears to be working, Howle warned that it may have the unintended consequence of allowing corporations to stash profits overseas.


"The water's-edge election could be improved by no longer allowing corporations to select between two tax structures and by taxing corporate profits kept in offshore tax havens," the audit states.


Howle recommended that the state create sunset dates for all of its future tax expenditures and set a deadline for completing studies on each of the current programs.


To Learn More:

Millions Donated at Tax Time Don't Reach Their Target (by Ken Broder, AllGov California)

Not Enough Free Taxpayer Money for Corporations to Go Around (by Ken Broder, AllGov California)

State Analyst Warns of Film Tax Credit “Race to the Bottom” (by Ken Broder, AllGov California)

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