Governor Brown, certain legislators and the press appear to be blindly using flawed data backed by union interests.  The following Op-Ed reconciles the difference between the various economic studies and supports the retention of the California EZ program.

For latest CA EZ Program legislative updates:

www.twitter.com/taxcredits_cpa

http://www.blakechristian.com/blog/

www.caez.org  (Please see second section and sign the EZ petition)

www.ezpolicyblog.com

Long Beach Business Journal Op-Ed

CA Enterprise Zone Program – Job Panacea or Budget Casualty

Blake Christian, CPA

February 2011

The California EZ program was initially adopted in 1986 and common to most of the other 42 state EZ programs can trace their roots back to Location-Based Incentive Credit programs (LBIC’s) first established in the aging villages throughout the U.K.    To encourage business owners to keep or move their businesses to these regions, various tax incentives were offered. 

The U.K. program was a smashing success and U.S legislators quickly adopted similar programs that encourage businesses to hire and train economically and physically/ mentally challenged individuals and move them from taxpayer funded entitlement programs to private payrolls. Today there are over 8,500 distinct tax zones throughout the U.S.                                                

The California EZ program began in 1986 and today applies to 43 zones throughout the state, and Long Beach’s current EZ current program benefits over 300 companies and over 7,000 employees annually.  Similar job creation and job retention results can be found throughout California and the U.S.

Despite being a big EZ proponent while Mayor of Oakland, Governor Brown in his second term has proposed to plug a portion of the $28 billion state deficit with savings from terminating the EZ program. Based on the most recent 2008 Franchise Tax Board (FTB) data, scrapping the EZ program would potentially save $291 Million ($274 Million in Hiring and Sales Tax Credits and $17 Million of benefits for Banks that make riskier loans to these inner city businesses).  This is only 29% of the $1 billion EZ program cost often quoted in the press.  The Business Deduction and Net Operating Loss (NOL) benefits are simply timing difference and do not reflect true revenue losses for the state.

The California EZ Program contains 5 different tax incentives:

1)        Employee Hiring Credit – To encourage job creation and retention, employers can earn a maximum credit for qualifying employees of $6 per hour. 

2)        Sales & Use Tax Credits – To encourage investment in new equipment, tax credits of 10% or more can be secured for certain assets used exclusively in the EZ.

3)        Asset Expensing and NOL Provisions – These provisions have limited application and simply accelerate deductions in certain years.

4)        Lender Net Interest Deduction – Lenders that make loans to certain distressed EZ’s are allowed to exclude from California taxable income the net interest income. 

5)        Employee-Level EZ Credit – Certain part-time workers who work in an EZ may claim a $525 tax credit.

The recent battle in Sacramento has revolved around competing EZ studies –  2008 Public Policy Institute of California (PPIC) study and the 2006 HCD (California Department of Housing and Community Development) study http://www.hcd.ca.gov/fa/cdbg/ez/HCD_Final_Report.pdf  and the 2010/2011 USC/Maryland studies https://msbfile03.usc.edu/digitalmeasures/cswenson/intellcont/EZ_JH%20oct_2010-1.doc. 

The PPIC study, as authored by Jed Kolko and David Neumark claims to have analyzed “every California business” from 2002 to 2007 , concluded that while “well run and well marketed EZ’s were effective in creating and retaining jobs”, most EZ’s did not.  The California Budget Report summarizes the the PPIC findings:  http://www.cbp.org/

The PPIC Study used jobs as the sole measure, and the major flaw in their analysis relates to their use of imprecise Dun & Bradstreet (D&B) job ranges, rather than securing specific year-to-year job figures.  D&B surveys ask employers to disclose employee numbers in general ranges such as 0 to 5, 6 to 10, 100 to 250, etc.; therefore, if  headcount rose from 3 to 5, or 100 to 120 (40% and 20% increases), no job growth would be reported using the D&B ranges. 

The competing 2006 HCD and 2010/2011 national and California studies were performed by USC and University of Maryland professors and used more detailed data, including 8,000 national  census tracts, as well as each of the census tracts in California containing an EZ.   The USC/Maryland studies measured and concluded the following for EZ communities:

-           Reduced unemployment rates by 3.1% (CA)/ 3.4% (Nat’l)

-           Reduced poverty rates by 8.6% (CA) /  26.1% (Nat’l)

-           Increased average wages and salary income by over $3,100 (CA)/ $2,700 (Nat’l)

-           Generally the programs did not “steal” businesses from one area of a state, but rather kept those businesses from fleeing the state.

To reconcile the main disputes between these studies, following are some key points: 

- The CBP states that over 90% of businesses utilizing the program are large businesses and they use $10 million of assets as the low end of “large”.   Using gross receipts as the proper measure shows that the number of companies claiming credits is relatively evenly dispersed across company sizes. More importantly, the vast majority of taxpayers are formed as closely-held “pass-through” entities such as LLC’s, S Corps and partnerships.  Not surprisingly, the number of personal returns (generally representing smaller businesses) claiming EZ benefits in 2007 was 14,317 while only 5,631 corporate returns  claimed EZ benefits.  This omission creates another critical distortion in the CBP’s analysis. The vast majority of EZ clients we review have less than 100 employees.

- One misunderstood aspect of the EZ program related to large companies concerns the tax “apportionment” rules which severely limit larger company’s ability to utilize the EZ credits.  As a simplified example, if Walmart operated 10% of their California stores in EZs, only 10% of the gross liability can generally be reduced from 8.84% by 10% to the extent EZ credits are available, resulting in a 7.56% tax rate – hardly a bargain compared to other states.

-The CBP Paper highlights that larger cities claim large annual tax breaks as compared to rural EZs.  Larger cities will virtually always produce larger credit amounts.

-  Assembly member V. Manual Perez has recently submitted AB 231 to fine-tune the TEA guidelines, including eliminating higher earning TEA residents from EZ qualification.  He has also submitted AB 232 which fine-tunes the overall EZ program approval and administration process.

With businesses and jobs fleeing to other lower cost, and business friendly, states at an accelerating rate, Governor Brown and the legislature will be wise to re-work and retain the EZ program, rather than scrap it.