Enterprise Zone Reform — At Last

July 29, 2013

Earlier this month, Governor Brown signed into law several bills included in the 2013-14 budget agreement that, at long last, reform the state’s controversial Enterprise Zone (EZ) Program. The program was created nearly 30 years ago with admirable intentions — to provide tax breaks to promote job creation in economically distressed areas. However, independent studies, including our own, have questioned the effectiveness of EZ tax breaks in achieving their goals — even as program costs skyrocketed. Among the problems highlighted in our most recent report:

  • The annual cost of the EZ tax credits and deductions had grown to $700 million and — without program changes — were expected to reach $1 billion in 2016;
  • The EZ program’s tax breaks primarily benefited very large corporations, with two-thirds of the credits being claimed by corporations with assets of at least $1 billion; and,
  • The hiring tax credits, which comprised nearly 60 percent of the total cost of the EZ program, were poorly structured, allowing companies to claim the credits without actually creating new jobs.

Since its inception, the California Budget Project has critiqued the structure, usage, and rising costs of the EZ program. We’ve consistently called for significant reforms to the program, including narrowing the hiring tax credits and zone designations to better ensure that the credits result in new job creation in economically distressed areas. Reform was a long time in coming, despite a body of evidence showing that the program failed to produce its intended outcomes at an increasingly high cost to the state.

The 2013-14 budget agreement puts in place a series of reforms that effectively phase out the EZ program and replace it with a new and revised package of incentives (see our prior blog for more on the specifics of the budget agreement). In brief, the budget agreement:

  • Modifies the current EZ designations to include the use of the credits in census tracts throughout the state that rank in the top 25 percent in both unemployment and poverty;
  • Alters key elements of the hiring tax credit, including requiring businesses to create new jobs (as opposed to hiring new workers for existing positions) and narrowing the hiring tax credit to fewer categories of disadvantaged workers; and,
  • Creates a manufacturing equipment sales and use tax exemption for use within manufacturing and biotech industries. The exemption is available statewide, rather than just within certain geographic areas, helping reduce incentives for jurisdictions in California to compete against each other for businesses.

The budget agreement also includes a number of provisions designed to enhance our ability to evaluate the performance of the credits. The new policy requires businesses to return money to the state if certain terms are not met, sets benchmarks to ensure small businesses benefit from the new incentives, and includes sunset dates for the credits.

In short, the package of reforms more effectively targets job creation in the state’s most distressed areas and allows us to evaluate and revisit the programs over time based on performance. That’s a win, at long last, for Californians and California.

Beyond EZ Reform

Beyond EZ reform, we will be monitoring two issues in particular. First, while there is much to celebrate in the budget agreement, the package of reforms also includes the establishment of a business incentive fund, to be administered by the Governor’s “GO-Biz” office to retain and attract business in California. The Governor used the signing of the new package to comment on Texas Governor Rick Perry’s travels to California earlier in the year in an effort to attract businesses to Texas, saying, “Those fellas in Texas, watch out…California has some new tools.” The Governor’s remarks point to an underlying problem with the new business incentive fund, in that it could be used to engage in a zero-sum, state-to-state competition for business, rather than investing in new jobs overall. A critique of the prior EZ system was that it encouraged local jurisdictions in the state to compete for businesses and jobs, rather than creating new opportunities. The same critique can just as easily be applied to the new business incentive fund if it merely results in state-vs.-state gaming of the system. Further, it perpetuates myths that lower state taxes inevitably result in state economic growth and that business location decisions are influenced by tax credits — claims that are clearly not supported by research. Fortunately, the new fund is limited in size ($30 million in 2013-14) and is subject to the same evaluation and performance requirements noted above, but how the fund is used in the coming years is worth watching closely.

Second, in the deliberations about EZ reform, local leaders opposing the reforms often noted that the elimination of Redevelopment Agencies (RDAs) in 2011 and restructuring of the EZ program would leave local governments with few available tools to promote local economic development and redevelopment. From our vantage point, RDAs and EZs were poorly structured to achieve these goals. But their elimination (RDAs) and reform (EZs) expose a significant gap in state and local economic development and redevelopment, particularly in terms of affordable housing. With EZ reform at long last a reality, it is time for state and local leaders to identify effective strategies and tools that position the state for growth and broadly shared prosperity.

— Chris Hoene and Kristin Schumacher


Phasing Out Enterprise Zones as We Know Them

July 9, 2013

The CBP has been following and informing the debate over California’s controversial Enterprise Zone (EZ) Program for several years, and has published a number of reports and blog posts that highlight the escalating costs and serious shortcomings of the EZ Program as well as opportunities for reform. This past Wednesday, AB 93 and SB 90 — budget trailer bills that phase out the EZ Program and replace it with a new package of economic development incentives — were transmitted to Governor Brown and await his signature. [Update: On Thursday, July 11, the Governor signed AB 93 and SB 90.] As a result, our analysis of the 2013-14 budget agreement has been updated with a detailed review of the changes to EZs and the state’s tax system.

Specifically, the budget agreement:

  • Retains current EZ designations but modifies them to more effectively target the most economically distressed areas of the state. Current EZ designations will remain intact for the 40 existing EZs, plus two recently expired zones — Antelope Valley and Watsonville — but incentives will also be available for use in census tracts throughout the state that rank in the top 25 percent in both unemployment and poverty rate. Further, census tracts with low unemployment and low poverty rates will be removed from the existing EZs, ensuring that the hiring tax credit truly is targeted to businesses located in the state’s most economically distressed areas. Lastly, the seven existing Local Area Military Base Recovery Areas (LAMBRAs) will be preserved and eligible for incentives as well.
  • Alters key elements of the EZ hiring credit to create and retain jobs for disadvantaged individuals. The budget agreement makes major changes to the hiring tax credit to improve performance. These changes include:
    • Requiring businesses to create new jobs — not just make new hires — as a condition of claiming hiring credits.
    • Discontinuing retroactive vouchering, whereby credits are awarded for hires made in past years.
    • Maintaining the credit for a particular employee at a constant level over a five-year period, instead of having the credit decrease over time. This change removes the incentive and reward for employers that “churn” their workforces.
    • Ensuring that companies that take the hiring credit pay employees a living wage. Specifically, the budget agreement increases the amount of qualified wages from up to 150 percent of minimum wage — currently $12 per hour — to between 150 percent and 350 percent of minimum wage. This currently is between $12 and $28 per hour. The credit is only available for qualified wages paid to employees who work an average of at least 35 hours per week. In five pilot areas that would be designated by the Governor’s Office of Business and Economic Development (GO-Biz), qualified wages will be set between $10 an hour and 350 percent of minimum wage to reflect working conditions in areas with average wages less than the statewide average.
    • Targeting the hiring tax credit to five categories of individuals, which is much narrower than the 10 groups included in current eligibility requirements. The targeted groups will include individuals who have been previously unemployed for six months, recipients of the Earned Income Tax Credit, recipients of CalWORKs or General Assistance, unemployed veterans, and ex-offenders.
  • Creates a manufacturing equipment sales and use tax (SUT) exemption. The SUT exemption will eliminate the California portion of sales and use tax for basic manufacturing and research and development (R&D) purchases for use within manufacturing and biotech industries. This exemption will be available statewide — rather than just within certain geographic areas. The maximum amount of purchases eligible for the SUT exemption statewide is not to exceed $200 million annually.
  • Establishes a business incentive fund to retain and attract businesses to California. The budget agreement establishes a new fund that will be administered by GO-Biz for the purpose of negotiating business tax credits in exchange for investments and employment expansion in California. The budget agreement also creates the California Competes Tax Credit Committee — consisting of representatives from the Treasurer’s Office, Department of Finance, and GO-Biz, and an appointee from both the Senate and Assembly — which will provide final approval for GO-Biz’s allocation of tax incentives. The fund will be limited to $30 million in 2013-14, increasing to $200 million annually in 2015-16 through 2018-19.

The budget agreement includes a number of provisions intended to ensure that the new economic development package is effective, transparent, and available to small businesses. First, the hiring tax credit, the SUT exemption, and the GO-Biz fund require annual evaluations to ensure that program administrators, policymakers, and the public are able to track program usage, and they each contain provisions that require businesses to return money to the state if certain terms are not met. Second, the budget agreement creates clear benchmarks to ensure that small businesses — defined as having less than $2 million in gross receipts in the previous year — benefit from the economic development package. Specifically, 25 percent of the hiring tax credit will be reserved for small businesses, and industry restrictions on the hiring tax credit will be lifted for small businesses as well. In addition, 25 percent of the funds allocated to GO-Biz will also be reserved for small businesses. Lastly, the budget agreement includes sunset dates for the programs, a provision that does not exist within the current EZ Program.

— Kristin Schumacher


Enterprise Zone Reform at a Critical Juncture

June 25, 2013

Deliberations over the future of the Enterprise Zone (EZ) Program — California’s controversial economic development program — are entering a pivotal stage. Assembly Bill 93, which would substantially reform the program, passed out of the Senate Committee on Budget and Fiscal Review yesterday and is scheduled to be heard on the Senate floor this afternoon.

Earlier this month, we released a report detailing the escalating costs and serious shortcomings of the EZ Program. This report included a set of policy recommendations for improving the EZ Program and making it more cost-effective, with a focus on how EZ hiring tax credits are awarded. AB 93 would move California in the right direction on enterprise zones and economic development by improving the tax credit in ways that could eliminate the most severe program inefficiencies.

Specifically, AB 93 would restructure the hiring tax credit in five crucial ways:

  • Discontinuing retroactive hiring credits, whereby credits are awarded for hires made in past years.
  • Requiring businesses to create new jobs — not just make new hires — as a condition of claiming hiring credits.
  • Eliminating residency in a Targeted Employment Area as a qualifying criterion for the tax credit and specifically targeting the tax credit for three categories of individuals: those that have been previously unemployed for six months, recipients of the Earned Income Tax Credit, and veterans.
  • Changing the credit formula to remain the same over a five-year period, instead of decreasing over time — thereby removing the incentive and reward for employers that “churn” their workforces.
  • Ensuring that companies that take the credit pay employees a living wage by increasing the amount of qualified wages from up to $12 per hour to between $12 and $28 per hour for employees.

AB 93 also would address the EZ Program’s current inability to target areas of the state that are most in need of job growth, new businesses, and assistance with economic development. While the current EZ designations would remain intact, the new hiring tax credit would also be available in census tracts throughout the state that rank in the top 25 percent in both unemployment and poverty rate. Further, census tracts with low unemployment would be removed from the eligible areas, ensuring that the hiring tax credit truly is targeted to businesses located in the state’s most economically distressed areas.

In addition to making major improvements in how the EZ hiring credits are targeted and awarded, AB 93 would create a manufacturing equipment sales tax exemption. This sales and use tax exemption would eliminate the California portion of sales tax for basic manufacturing and biotech equipment purchases, and will be offered statewide — rather than within certain geographic areas. Currently, California is among only a very few states that do not offer this type of exemption. AB 93 also would establish the California Competes Tax Credit Committee, administered by the Governor’s Office, with the purpose of negotiating business tax credits in exchange for investments and employment expansion in California. While we have voiced skepticism in the past concerning the efficacy of state tax credits in creating jobs and growing the economy, AB 93’s strong provisions in two key areas of the program — transparency and performance evaluation — would enable program administrators, policymakers, and the public to track these credits’ impact and their return on investment.

The reforms contained in AB 93 represent major improvements to California’s EZ Program and are designed to address the worst abuses and inefficiencies within the program. These reforms are a significant step forward for the state in fostering positive economic development and long-term fiscal health. Stay tuned as AB 93 is taken up today in the Senate.

—  Kristin Schumacher


Dollar for Dollar: California’s Enterprise Zone Program Falls Short

June 7, 2013

As deliberations over the 2013-14 state budget continue, one key issue under discussion is the future of California’s Enterprise Zone (EZ) Program. This program was created nearly 30 years ago to promote business development and job creation in economically distressed areas, but independent studies have questioned the effectiveness of EZ tax breaks in achieving their goals — even as program costs have skyrocketed.

A new CBP report on the EZ Program examines the growing cost to the state of the EZ tax breaks, looks at who receives these breaks, and discusses current proposals to reform the EZ Program, including those contained in Governor Brown’s May Revision of his proposed 2013-14 budget. Dollar for Dollar: California’s Enterprise Zone Program Falls Short shows that:

  • The annual cost of EZ tax credits and deductions has grown to more than $700 million and — without program changes — is expected to reach $1 billion by 2016. Between 1986 and 2010, the average cost per zone grew from approximately $48,000 to $17.2 million.
  • The EZ Program’s tax breaks primarily benefit very large corporations. Corporations with assets of at least $1 billion claimed more than two-thirds of the total dollar value of EZ tax credits in 2010, the most recent year for which data are available.
  • The high cost of the EZ Program is primarily due to its hiring tax credit, which cost the state $414 million in 2010 — nearly 60 percent of the total cost of the EZ tax breaks. Yet because companies can claim these credits without actually creating new jobs, the hiring tax credit has generally been ineffective in promoting job growth.

This new report includes a set of policy recommendations for improving the EZ Program and making it more cost-effective, with a focus on two areas that are especially important targets for reform: the hiring tax credit and the designation of enterprise zones. Look for updates and commentary here on California Budget Bites as the debate over EZs and other key budget issues moves forward in the coming weeks.

— Chris Hoene


Governor’s New Restructuring Proposal Stirs Up Debate Over Future of Enterprise Zone Program

May 22, 2013

One of the issues we’ve been tracking closely in this year’s budget debate is potential reform of the state’s Enterprise Zone (EZ) Program. Established in 1984, the EZ Program provides a variety of tax credits intended to encourage businesses to locate in economically distressed areas as well as to promote job creation. However, research shows that, as currently structured, the program fails to achieve its goals. At the same time, the EZ Program places an increasing strain on the state budget: The program cost the state $720 million in 2010 and is projected to cost $1 billion by 2015-16.

Governor Brown’s revised 2013-14 budget, released a week ago, includes a new, revenue-neutral set of proposals that would significantly restructure the EZ Program. These proposals include narrowing the EZ hiring tax credit, expanding statewide the sales and use tax credit for the purchase of manufacturing and biotech equipment, and creating a California Competes Recruitment and Retention Fund, which would provide tax credits for business investment and job creation throughout California.

The May Revision’s proposed changes to the EZ Program are controversial and have generated media attention across the state, with, for example, articles in the Los Angeles Times and the Sacramento Business Journal pointing to the mixed reactions to the Governor’s new proposal.

As we noted in our discussion of the Governor’s January budget proposal and our analysis of the May Revision, policymakers have real choices in crafting a budget, even when facing revenue constraints. As policymakers choose the future direction for EZs in California, the upcoming debate will likely focus on three issues.

First, the Governor’s proposals to narrow the hiring tax credit and expand the sales and use tax credits statewide essentially end EZs as they are currently structured. But, as noted earlier, the program doesn’t produce significant outcomes given the costs to the state in foregone revenue. In light of its serious shortcomings, elimination or restructuring of the EZ Program would not be expected to have an adverse effect on employment or job growth.

Second, local leaders argue that the loss of EZs is an egregious hit coming on top of the elimination of redevelopment agencies (RDA) just last year. They have a point. Much like in prior years’ battle over RDAs, the issue isn’t the intent of the program — most of us support efforts to redevelop and create jobs in economically distressed areas. Rather, the issue is that these programs are poorly structured to produce the desired outcomes, and they come at a high cost to state and local governments and constrain their ability to invest in other priorities. However, the debate over EZs shouldn’t be a fight to the death, as with RDAs. The Governor and local leaders should come together to craft legitimate strategies for economic development. If not RDAs, or EZs, then alternatives need to be developed that put state and local investments on the same page.

This brings us to the third issue: the Governor’s proposed California Competes Recruitment and Retention Fund, which would operate out of the Governor’s Office of Business and Economic Development (GO-Biz). The details are lacking at this point, but on early review, the proposal raises concerns that it apparently gives discretion to the Governor’s Office to provide tax credits throughout the state. Not only does research show that EZs fail to produce the intended outcomes, but considerable research also suggests that state tax credits are equally if not more ineffective than area-based credits. While the narrowing of the credits as noted above has the potential for considerable state savings, we suspect the new Fund is what results in the Governor’s proposals being revenue-neutral, rather than providing an increase in revenue. Bottom line, we think the state’s money could be better spent elsewhere.

A more critical look at state and local economic development incentives along with a more ambitious restructuring of the EZ Program could reduce the strain on the state budget and provide funds for needed investments elsewhere, such as increasing the number of subsidized child care and preschool slots, repealing the 10 percent cut to Medi-Cal provider payments, and strengthening the CalWORKs Program.

The CBP will soon release a report analyzing California’s EZ Program. Stay tuned.

— Kristin Schumacher and Chris Hoene