Briefing Report: Enterprise Zones - Fix Them and Keep Them?

Wednesday, February 27, 2013

The health, safety, and welfare of the people of California depend upon the development, stability, and expansion of private business, industry, and commerce, and there are certain areas within the state that are economically depressed due to a lack of investment in the private sector. Therefore, it is declared to be the purpose of this chapter to stimulate business and industrial growth in the depressed areas of the state by relaxing regulatory controls that impede private investment.

It is in the economic interest of the state to have one strong, combined, and business-friendly incentive program to help attract business and industry to the state, to help retain and expand existing state business and industry, and to create increased job opportunities for all Californians.

- The Enterprise Zone Act, Legislative Findings, Government Code §7071

Introduction

California’s economy will continue to grow at a sluggish pace for the fourth year in a row with no near-term economic boon in sight, according to a recently released economic forecast by the University of the Pacific.[1] While California’s economy continues to add jobs, its unemployment rate continues to be the third worst in the nation at 9.8 percent behind only Nevada and Rhode Island.

While sluggish growth may be better than no growth at all, California’s seasonally adjusted employment is not projected to reach its pre–recession peak until 2015, or 7.5 years after its pre–recession peak in July 2007.[2]

At a time when many Californians are struggling to find meaningful employment, every job retained or created in this state is important.  This is especially true during a recession and particularly true to the businesses and employees living in so-called economically depressed areas of the state.

For many, the Enterprise Zone (EZ) program has been an invaluable resource for attracting business investments and creating and retaining jobs.  This applies to people and businesses in places like Fresno, Kings County, Oakland, the Coachella Valley, and Compton.  Until 2012, Watsonville and the Antelope Valley benefited from the program.

EZs, however, are not without their critics. Critics contend that the $700 million annual program is not cost effective and rewards businesses for hiring decisions that they may have made anyway.

In 2011, Governor Brown proposed eliminating EZs completely, but was rebuffed by the Legislature. This year, in the 2013-14 State Budget, the Governor proposes scaling back the EZ program through regulations and unspecified legislative actions.

Ironically, in the Governor’s 2013 State of the State speech, he touted working with Samsung to expand its research and development facility creating 2,500 jobs and the creation of over 1,000 new jobs at Amazon distribution centers in Patterson, San Bernardino and Tracy, but he failed to mention those jobs are located within the same EZ program he sought to eliminate in 2011.[3]

There is little disagreement that the program should be improved in order for taxpayers to receive a better job creation and retention to taxpayer expense ratio, especially at a time when every job and every tax dollar counts. But, caution should be taken when making any changes to a program that could have significant negative consequences on areas of the state that have been hard hit and are struggling to recover from the 21st century’s first great recession.

Enterprise Zones

Since 1984, California’s EZ program has used state tax benefits and other local incentives to entice businesses to invest in economically depressed rural and urban areas.  The amount of tax incentives used by the EZ program has grown from a $675,000 per year program in 1986 to a $700 million in 2012.[4]

The program is administered by the California Department of Housing and Community Development (HCD). Existing law permits the designation of up to 42 enterprise zones, 8 local agency military base recovery areas (LAMBRAs), 2 Manufacturing Enhancement Areas (MEAs) and 1 Targeted Tax Areas (TTAs).  Communities receive these designations from HCD through a competitive, but, bureaucratic process.

Currently, there are only 40 enterprise zones. Last year, two enterprise zones – Watsonville and Antelope Valley – were allowed to expire. According to HCD, the agency would not renew enterprise zone participants until changes to the program were made.

EZs are located across the state from San Diego and Imperial County to Siskiyou County and Shasta Metro. One is even located in the Silicon Valley with others located in areas that have not seen blight in years, such as San Francisco’s trendy SOMA district, located on expensive San Francisco waterfront properties.[5]

Businesses participating in the EZ Program receive both state tax incentives and local assistance specific and unique to the zone. State incentives include:

  • Hiring Tax Credit: State tax credit of $ $37,440 or more over five years for each qualified employee hired. (The largest EZ credit.)
  • Sales and Use Tax Credit: State tax credit for sales and use taxes paid, up to $20 million per year, on qualified machinery and machinery parts purchases.
  • Increased Expense Deduction: Accelerated expense deductions for certain depreciable property.
  • Net Operating Loss Carryforward:  Up to 100 percent net operating loss deduction and a 15-year carryforward.
  • Net Interest Deduction for Lenders: Net Interest Deductions for lenders on loans made to firms within an Enterprise Zone.
  • State Preference Points: Enterprise Zone companies can earn preference points on state contracts.

Supporters of the EZ program – business groups, state legislators and local officials – contend that it has been successful at attracting and retaining businesses and encouraging businesses to hire disadvantaged workers while improving poverty rates in economically depressed areas, or, at the very least, slowing economic hemorrhaging in areas where jobs are difficult to maintain during extended periods of economic turmoil.

In contrast, critics of the program argue that although some zones are more effective than others, on the whole the enterprise zones are inefficient, costly to the state to maintain, and fail to increase employment. The money spent on business tax incentives would be better spent on other state programs. These critics would like to see the EZ program either completely eliminated or significantly scaled back. In fact, the California Labor Federation, one of the largest and loudest critics of the program – says that one of its top legislative priorities for 2013 is targeting the enterprise zone program for repeal.[6]

Proposed Enterprise Zone Modifications

The Governor’s 2013-14 budget calls for making regulatory changes to the EZ program. The proposed regulatory changes include: 1) requiring all voucher applications be submitted within one year of an employee’s hire date to prevent retroactive hiring credits; 2) requiring third party verification of employee residence within a Targeted Employment Area; 3) streamlining the vouchering process for hiring veterans and recipients of public assistance; and 4) creating stricter zone audit procedures and audit failure procedures.

These changes could generate $10 million in the current year and $50 million in 2013-14 through decreased tax credits to businesses, according to the Governor.

The largest proposed change to the program is limiting the use of the voucher to within one year of hire. Generally, the California Revenue and Tax Code provides a state hiring tax credit for a "qualified taxpayer" who employs a "qualified employee" at a "qualified wage" within a designated Enterprise Zone. The taxpayer must apply to the local enterprise zone for a voucher certificate as evidence for utilization of the hiring credit on a state tax return. The hiring tax credit calculation is based on a formula provided by the Franchise Tax Board (FTB) to reduce the taxpayer’s state income tax.

Under current law, businesses are permitted to use the voucher in years other than those in which an employee is hired. However, HCD and EZ critics argue that that this retroactive vouchering is a “loophole” that needs to be closed. And since 30 percent of all vouchers are retroactive, the program as currently instituted rewards employers for past hiring decisions not incentivized by Enterprise Zones while having a significant impact on the state’s General Fund.

Those operating within EZs are concerned with HCD’s proposals, particularly the limitations on retroactive vouchering. A recent Business Journal article reports that Fresno County and Kings County EZs believe that the proposed rule changes would make it more difficult for existing businesses to expand existing or to attract new businesses in those areas.

In any event, HCD’s regulatory proposal will have a significant impact on the state’s EZ program. If the Governor’s goal is to make the EZ program more cost effective and to operate more efficiently, there are numerous ways in which the program can be modified to attain these goals while limiting the potential disruptions to the program. However, any changes to the program that involve reducing the utilization of tax incentives should be addressed by the Legislature and not through agency regulations.

Long-term Alternatives for Consideration

California’s business and tax climate has ranked at or near the bottom of most national rankings. For example, CEO Magazine’s annual survey of chief executive officers ranked California as the worst state to do business for eight consecutive years; Forbes Magazine rated the 41st worst state for business; and in the Tax Foundation’s 2013 State Business Tax Climate Index California had the third worst business climate in the nation.

One of the most supportable ways of addressing California’s hostility – both real and perceived – towards business and to boost its competitiveness is to adopt broad-based tax and regulatory reforms which would help to establish a stable and predictable business climate.

In terms of California’s highly progressive tax system, many free-market economists think that a predictable, general and stable tax environment enables a wider variety of businesses to enter the market and establish deeper roots.[7] Lowering taxes, broadening the tax base and reducing and removing exemptions, will lead to a more efficient and stable tax system while increasing state tax revenues.  A more simplified system should attract business investment and stimulate business growth and hiring.[8]

As for regulatory reforms, Winston Churchill once said, “If you have ten thousand regulations you destroy all respect for the law.”  A heavy regulatory environment is a primary barrier to greater entrepreneurial opportunities.  As such, policies that aim to stimulate economic activity in distressed areas should assess what barriers exist to entrepreneurship on the local level, such as excessive land use and business regulations and high local taxes or fees.[9]

At the top of the regulatory reform list is the California Environmental Quality Act ("CEQA"). When enacted in the 1970s, CEQA was intended to protect the environment and ensure smarter development. While some positive gains have been made since its enactment, the law has increasingly been abused to delay projects for reasons wholly unrelated to environmental protection. The CEQA process has also become so expensive, cumbersome and time-consuming it has become a barrier to growth and development.[10]

Finally, the potential negative economic and financial impact on the state’s businesses should be thoughtfully and thoroughly considered prior to enacting legislation or implementing new regulations.

Conclusion:

Meaningful broad-based tax and regulatory reforms would go a long way towards remaking California’s anti-business image while attracting new capital investments and businesses.  However, even if such difficult reforms were achieved, there will still remain the need for financial incentives for businesses to locate in areas that are not graced with the inducements of the Silicon Valley or Los Angeles or San Francisco.

Until then, substantive reforms should demonstrate that the tax incentives provided to those operating in enterprise zones are both cost effective for the taxpayer and meaningful for businesses investing in economically challenged locations. Any changes to the program that effectuate meaningful change should be conducted through the legislative process.

For more information on this report or other Governance & Finance issues, contact Scott Chavez, Senate Republican Office of Policy at 916/651-1501.


1 California & Metro Forecast February 2013, University of the Pacific. http://www.pacific.edu/Academics/Schools-and-Colleges/Eberhardt-School-of-Business/Centers-and-Institutes/Center-for-Business-and-Policy-Research.html; Fourth Year of Sluggish Growth Forecast for California, Dale Kasler, Sacramento Bee. February 13, 2013.http://www.sacbee.com/2013/02/13/5185988/fourth-year-of-sluggish-growth.html
2 U.S. Bureau of Labor Statistics, Local Area Unemployment Statistics, Unemployment Rates for States. http://www.bls.gov/web/laus/laumstrk.htm
3 Edmund G. Brown Jr., State of the State Address, Remarks as Prepared, January 24, 2013. https://www.gov.ca.gov/news.php?id=17906.
4 2010 Annual Report—Statistical Appendix Tables, Franchise Tax Board 2013. https://www.ftb.ca.gov/aboutFTB/Tax_Statistics/Reports/2010_Combined_Statistics.pdf
5 Jerry Brown Targets Enterprise Zone Program, Patrick McGreevy, Los Angeles Times. February 1, 2013. http://articles.latimes.com/2013/feb/01/local/la-me-enterprise-zones-20130202.
6 Californians to Watch in 2013: Angie Wei will carry labor's agenda to lawmakers, December 27, 2012. http://www.sacbee.com/2012/12/27/5077412/californians-to-watch-in-2013.html
7 California Enterprise Zones, Written Testimony Submitted to the Committee on Revenue and Taxation of the California Senate, Eileen Norcross, Mar 10, 2010. http://mercatus.org/publication/california-enterprise-zones
8 Tax Credits In California: Economic Engine or Wasteful Corporate Welfare, Adam Summers with Ankur Chawla. Reason Foundation & The Howard Jarvis Taxpayers Association, January 2013. http://reason.org/files/tax_credits_california_corporate_welfare.pdf
9 See Norcross.
10 Even California Democrats See Need for Regulatory Reform, Golden State lawmakers reluctantly face the economic facts. http://reason.com/archives/2013/02/08/even-california-democrats-see-need-for-r