Daniel Weintraub: Investment tax credit hasn't proven its worth

Sacramento Bee

by Daniel Weintraub

January 14, 2003

There's been a lot of talk in the Capitol lately about overhauling California's tax structure, which has become seriously dependent on the personal income tax to generate revenue. The personal income tax, in turn, has grown dependent on the fortunes of a wealthy few, the result of progressive tax rates and a distribution of income skewed toward the top end.

But Gov. Gray Davis, who says he wants to lead the rebuilding job, passed on a golden opportunity to do so last week when he announced that he favors preserving a big and clumsily aimed corporate tax break.

One reason the personal income tax has grown in stature over the past 10 years is that the state's other tax sources have been stagnant or growing only slowly. The tax on corporate profits, which generated $5.1 billion in 1989, produced $5.3 billion in 2000, barely growing even as the overall size of California's economy nearly doubled.

And a major reason for that lack of growth was the manufacturers investment credit, a tax credit companies can take to offset the cost of buying new equipment. For every $100,000 a company spends on new gadgets used to make stuff, the firm can erase $6,000 from its tax bill.

That might not sound like much, but it adds up. This year, companies that qualify for the credit will keep more than $400 million that they otherwise would owe to the state. Since its inception in the mid-1990s, the credit has diverted nearly $3 billion in corporate taxes from the treasury.

Fans of lower taxes might be tempted to cheer that news -- less money for the big spenders in Sacramento.

But not all tax cuts are created equal. The ideal tax structure would be broadly based, with the burden spread as evenly and lightly as possible. When the Legislature plays favorites by exempting a narrow few whose behavior meets some goal set in the Capitol, the remaining burden weighs more heavily on everyone else.

It's even worse when, as in this case, the companies taking this credit aren't necessarily meeting the goal set by the politicians. The manufacturers investment credit was supposed to create jobs. But there is no evidence that it has done so.

The credit was born in the early 1990s recession, when California's economy was undergoing dramatic structural changes. High-wage manufacturing jobs were disappearing as military contracts waned and companies shuttered factories. The state lost about 300,000 factory jobs between 1989 and 1993, with nearly half coming from the aerospace industry alone.

Business lobbyists argued that a tax credit on the purchase of new equipment would keep companies in California, spur investment and create jobs. The Legislature bought the argument.

But skeptical lawmakers managed to insert one condition: that the tax credit expire in 2001 if the number of manufacturing jobs had not grown by at least 100,000. Later, that provision was changed to allow the credit to expire at any time in which the number of manufacturing jobs fell below that standard.

That time is now. The state had 1.54 million manufacturing jobs in 1994 and 1.69 million a year ago, on Jan. 1, 2002. Figure in the number of jobs lost in the past year, and the state's net manufacturing job base has been virtually unchanged since the tax credit was enacted. If that's the case, it will expire on Jan. 1, 2004, unless the Legislature and Gov. Gray Davis take action to extend it.

Supporters of the tax credit, including Davis, argue that the situation would be even worse without it. They say that jobs created with the help of the tax break have offset jobs eliminated elsewhere. But even if you believe the credit is directly responsible for 100,000 new jobs, a generous assumption, that still equates to a cost to taxpayers of about $30,000 per job. That hardly seems to be an efficient way to create employment.

But according to the state's legislative analyst, studies show that tax credits such as this one have little or no effect on investment decisions. Chances are that most of the companies that have benefited from the credit would have bought their new equipment even without the tax break. What the investment credit does is give an advantage to equipment-intensive industries not enjoyed by firms whose costs lean more toward labor or materials.

And while manufacturing jobs can be higher-paying than other employment, their allure is not entirely well founded. Many such jobs are low-wage assembly work, and in total they represent barely 10 percent of the state's jobs base, now hovering at about 14.5 million. A job is a job, but this particular category of employment does not deserve an exalted place in our tax laws.

It's time for the governor and the Legislature to re-examine the state's entire tax code with an eye to making it stable and fair. One way to do that is to eliminate special breaks that powerful lobbies have persuaded lawmakers to insert on their behalf over the years. Allowing the manufacturers investment credit to expire on schedule would be a good place to start.