Mixed Reviews on Tax Cut Plan

To meet its goal of guiding the state’s bureaucracy into the 21st century, the California Performance Review has come up with more than a thousand recommendations, nearly all of which are designed to save money by consolidating, improving or eliminating government functions.

One proposal is different.

It calls for a corporate tax cut that would drain the state’s depleted coffers by as much as $400 million a year.

Proponents of the measure, which would eliminate the sales tax on manufacturing and telecommunications equipment, say it would more than pay for itself by creating 25,000 jobs a year.

Opponents say that targeted tax cuts never pay for themselves and that the tax-relief proposal reveals much about the secret way the performance review was assembled over the last five months. Public debate gets underway in Riverside today with the first of five statewide hearings.

The 1,200 proposals in the performance review -- the cornerstone of Gov. Arnold Schwarzenegger’s plan to “blow up the boxes” of state government -- were assembled by 275 public employees and consultants. The governor said this week that he was mulling over whether he should bypass the Legislature and take the review directly to the voters as a ballot item.

When the plan first leaked to the media two weeks ago, there was immediate controversy over the access given to high-tech corporations, including Microsoft Corp. and Hewlett-Packard Co., during its drafting. Many of the proposals call for expanding the state government’s use of the Internet, a step that could be a windfall for high-tech service providers.

But of all the items in the 2,500-page review, few would be as beneficial to as many businesses as the tax cut. Schwarzenegger has not endorsed or rejected any of the proposals.

Walter Barnes, chief administrative officer for the state controller’s office, headed the team preparing the section of the performance review that includes the tax cut. He said he couldn’t remember exactly how the measure first surfaced. But it’s clear whose ideas are being endorsed.

“We were out doing a lot of shouting,” said Dorothy Rothrock, vice president of government relations for the California Manufacturers and Technology Assn., a Sacramento-based trade group.

The performance review bases its tax-cut recommendation on a study by the Milken Institute, a Santa Monica think tank. But the review never mentions that the study was commissioned by the manufacturers association.

Thirteen of the 15 footnotes in the two-page recommendation refer to the association, its members or the Milken report. No critics are cited.

California has a growing reputation as a difficult and expensive place to run a business, a notion that the proposed tax cut -- as well as the performance review itself -- is trying to address.

Giving a tax break to manufacturers is hardly a new concept in California. A manufacturers’ investment tax credit, or MIC, arose out of the recession of the early 1990s, another bad time for factories. More than a quarter-million manufacturing jobs were lost around the state during those years, many of them in aerospace and defense.

Passed in 1994 as part of a stimulus package, the MIC effectively cut the price of manufacturing equipment 6%.

Although aerospace continued to struggle, the following years were good ones for high-tech manufacturing in the state. Industry attributed some of that to the MIC.

Intel Corp., which had been one of the chief lobbyists for the MIC, said its passage encouraged the chip maker to immediately invest $700 million in a Santa Clara, Calif., plant. Subsequent Intel investments in Santa Clara and Folsom, Calif., totaled an additional $2 billion.

But the MIC wasn’t designed to be permanent. Rather, opponents of the tax break made sure it was enacted with a sunset clause, causing it to expire if all manufacturing employment (aside from aerospace, which seemed to be in terminal decline) fell below a certain point.

That would be proof, the MIC’s foes said, that the measure wasn’t working. In 2003, after three years of rapid employment decline, the trigger was reached.

Despite extensive lobbying -- the manufacturing association called for doubling the credit instead of killing it -- legislators decided that the state’s fiscal needs were paramount. They said they could no longer afford the MIC, and allowed it to lapse.

Now the performance review wants to bring the MIC back -- and in expanded form. Instead of a tax reduction that can be used only by profit-making businesses, even money-losing start-ups would get a refund on the 5% of the sales tax that goes to the state. (The portion of the sales tax that goes to local communities would still be charged.)

The resurrection puzzles longtime MIC foes such as Jean Ross of the California Budget Project, a Sacramento watchdog group for low- and middle-income people.

“I have no idea why this ended up in the California Performance Review,” she said. “There’s no evidence its inclusion was part of a systematic review of tax policy.”

Barnes, the state controller’s administrator, defends the sales tax exemption as “not just tax relief.”

“It’s tax relief with a purpose,” he said. “This seemed to be one proposal we could move down the road and come up with a justification for.”

The justification is the jobs the MIC supposedly would create. The Milken study calculated that a sales-tax exemption would result in 140,000 new manufacturing jobs over the next decade and create 360,000 jobs in other industries as a bonus. The performance review cut those projections in half.

“Very few tax reductions pay for themselves,” said Ross DeVol, Milken’s director of regional economics. “But this is one of them.”

Therese McGuire, a faculty fellow at Northwestern University’s Institute for Policy Research who has been studying for 20 years the effects of taxes on economic development, is unconvinced.

“This is the old supply-side argument: You reduce taxes, which spurs economic activity, which increases tax revenue,” she said. “There is no empirical evidence that this works.”

McGuire’s belief is that sales tax exemptions are not a useful economic development tool. “The differences between California, Oregon, Illinois and New York are so big that fairly small changes in the tax burden are likely to be outweighed by other factors,” she said.

After 10 years of the MIC, there’s no agreement over how many jobs it saved, if any.

“No one has really done a detailed, sophisticated study to show whether the MIC was a success,” Milken’s DeVol said. “It’s an important question but difficult to answer.”

Even a manufacturer that would directly benefit from the tax cut is a little ambivalent.

Last winter, days before the MIC expired, Ace Clearwater Enterprises in Torrance bought and installed a mill for cutting large blocks of metal. It cost $350,000, which is a big chunk of change for a company that has revenue of about $24 million a year.

One incentive to buying the mill was the MIC. Because of the credit, Ace Clearwater says it saved $29,000 on its state taxes. Under accelerated depreciation rules, the maker of welded assemblies for aerospace and power firms saved an additional $213,000 on its federal taxes.

“I can’t say we took it and gave everybody a raise,” said Gary Johnson, who runs the 178-employee family-owned firm with his wife, Kellie. “But it stayed in the company, instead of going to Uncle Sam or Uncle Arnold.”

To operate the mill, Ace Clearwater hired one employee and promoted another, whose $4-an-hour raise means he probably will pay a little more in taxes.

Although this was arguably a net gain for the state economy, Johnson also noted that he needed to buy the mill anyway. In fact, it has helped his business so much, he’s thinking about buying another -- even without a tax rebate.

“How I feel about this tax relief as a businessman is real easy,” he said. “But I realize the state needs money too.”

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On the factory floor

Manufacturing jobs in California, seasonally adjusted (in millions)

Jan. 1990: 1.975 Feb. 1994: 1.665 Jan. 2001: 1.875 June 2004: 1.530

Source: California Employment Development Department