Air Quality Improvement. Tax Credits. Initiative Statute.
	Analysis by the Legislative Analyst

Background

Air Quality Standards. Both the federal and state governments set standards for acceptable levels of various air pollutants in order to protect public health. Currently, most areas of the state are failing to meet one or more of these air quality standards. For example, almost all of the state fails to meet the state standard for ozone (a smog-forming pollutant). Mobile sources (such as cars, buses, trucks, and motorized equipment) contribute from 60 to 70 percent to smog-forming pollution, with stationary sources (such as industrial combustion, solvents, and pesticides) contributing the balance.

Methods for Achieving Air Quality Standards. In California, the state Air Resources Board (ARB) and local air districts enforce regulations in order to meet air quality standards. For example, the ARB requires the use of cleaner burning gasoline and diesel fuel in vehicles. Additionally, local air districts require industries to install pollution control technology.

Incentive programs are also used to meet air quality standards. These are voluntary programs that use monetary or other incentives to encourage behavior that results in a reduction in air pollution emissions. Currently, the state offers some tax incentives (including tax credits, tax deductions, and reduced tax rates) designed to improve air quality. For example, the state provides a tax credit for purchases of rice straw as an alternative to outdoor burning of such straw. The state also provides a reduced excise tax for the purchase of certain alternative fuels.

Prescribed Burning of Forests and Wildlands. The California Department of Forestry and Fire Protection conducts prescribed (controlled) burns of forests and wildlands. These burns are designed to improve forest health and can reduce the generation of air pollution resulting from wildfires.

Local Transportation Funds. Current law authorizes each county to establish a Local Transportation Fund (LTF) for public transportation purposes. Revenues to each county's LTF are derived from one-quarter cent of the sales tax collected in that county.

Proposal

Tax Credit for Air Pollution Control

This measure--the California Air Quality Improvement Act of 1998--provides tax credits to individuals and corporations for certain expenditures they make that reduce emissions of pollutants into the air. For example, a trucking company that modifies the engines on its older, heavy-duty diesel trucks so that the fuel burns more cleanly could be eligible for a tax credit under the measure. A tax credit reduces the amount of taxes paid to the state by an individual or corporation.

Under the measure, a maximum total of $218 million in tax credits would be available for award each fiscal year until January 1, 2011. This maximum amount may be reduced under specified circumstances when there is a drop in the state's General Fund revenues. Credits not awarded in one year may be carried over and awarded in a later year.

Projects Eligible for the Tax Credit. In general, projects eligible for a tax credit include:

• The purchase of new vehicles, engines, and motorized equipment that emit less pollution into the air than available alternatives.
• The retrofit of existing vehicles, engines, and equipment that results in a reduction in pollution emissions.
• The conversion or use of agriculture waste or rice straw as an alternative to outdoor burning of such waste.
• The research, development, or business development of technologies that have the potential to reduce air pollution from sources specified in the measure.

Figure 1 shows the maximum amount of tax credits that may be awarded annually among various categories of projects eligible for the tax credit.

Figure 1
California Air Quality Improvement Act of 1998 Project Categories Eligible for Tax Credit

(In Millions)

Annual Amount of Tax Credits Available

Cleaner heavy-duty vehicles and equipment used in farming, construction, and other uses	$ 59
Cleaner heavy-duty public fleet vehicles (such as buses)	55
Alternatives to agriculture waste and rice straw burning	23
Research and development of technologies to reduce air pollution	20
Cleaner air conditioning equipment	15
Cleaner engines and equipment at ports	15
Cleaner locomotive engines and equipment	10
Cleaner hearth products	10
Cleaner landscaping and other equipment	8
Cleaner off-road, nonrecreational vehicles	3
Total	$218

Who May Be Awarded a Tax Credit. Tax credits would be awarded on a competitive basis by the ARB (or, when delegated, by local air districts). In order to be awarded a tax credit, a taxpayer must apply to the ARB. Individuals as well as businesses may apply for the credit. A taxpayer may carry forward unused amounts of the tax credits awarded in one year to offset tax liabilities in future years, until the total credit amount is exhausted.

The measure requires the ARB to rank projects according to their cost-effectiveness at reducing air pollution, and award tax credits accordingly. A project is not eligible for a tax credit if it would otherwise be required by an air quality law or regulation in effect at the time of the award of the tax credit.

For most categories of projects, eligible applicants for the tax credit include manufacturers, suppliers, installers, purchasers, and end users. However, a tax credit for a single project can be awarded to only one applicant and not multiple applicants.

How the Tax Credit is Calculated. In general, the amount of a tax credit would be less than the full cost of a project. It would generally be the difference between the project's costs, including purchase and maintenance costs, and the costs of a less clean air alternative. The ARB may award tax credits above this amount if it considers the higher amount necessary to encourage the purchase of cleaner vehicles and equipment or the retrofit of existing vehicles and equipment in order to reduce air pollution. A taxpayer may not claim a tax credit under this measure for a project that receives government grants, loans, or other tax credits for the same costs.

Other Provisions

In addition to setting up a tax credit program, the measure includes the following provisions:

Prescribed Burning of Forests and Wildlands. The measure requires that funds recovered by the state from the private sector for fire suppression costs be deposited in a special account in the General Fund, to be used only for prescribed burning projects that reduce air pollution caused by wildfires. The measure requires the ARB to study the feasibility of an incentive program for prescribed burning projects by January 1, 2001.

Local Transportation Funds. The measure designates LTFs as trust funds and prohibits the funds from being abolished. The measure further prohibits LTF money from being diverted from specified transportation purposes to other purposes.

Fiscal Effect

Impact on State General Fund Revenue. The tax credit program under the measure would result in the following two effects on General Fund revenues:

• Decrease in Income Tax Revenues. The amount of tax credits claimed would reduce personal income and bank and corporation tax revenues by an unknown amount, but potentially averaging in the tens of millions of dollars to over a hundred million dollars annually from 1999 to beyond 2010. The actual revenue loss would vary from year to year, depending on the total amount of tax credits that are used to offset tax liabilities in any one year. Because unused tax credits could be carried forward to offset future tax liabilities, the revenue loss could exceed the maximum $218 million annual tax credit allocation in some years, depending on the amount of tax credits outstanding and the size of the taxpayers' annual liabilities. The amount of annual reduction in tax revenues would be lessened somewhat (possibly in the millions of dollars) to the extent that there would be savings resulting from taxpayers not claiming other tax credits for which they are currently eligible.
• Increase in Sales and Use Tax Revenues. In general, tangible goods purchased in California, or outside the state for use inside California, are subject to the state and local sales and use tax. To the extent that the measure results in additional purchases of vehicles, equipment, or retrofit devices that would not have occurred otherwise, the state would receive additional sales and use tax revenues. The amount of the additional revenues is unknown, but potentially could be several millions to tens of millions of dollars annually.

The net revenue impact of these two effects is unknown, and would depend on the amount of tax credits claimed annually. It is likely that, on average, there would be a net state revenue reduction in the tens of millions to over a hundred million dollars annually.

Impact on Proposition 98 Funding for K-14 Education. Under Proposition 98, the California Constitution guarantees minimum funding for school districts and community college districts, based in part on the total amount of General Fund revenues. This measure provides that any General Fund revenue loss resulting from the tax credit would not affect the Proposition 98 minimum funding guarantee. As a consequence, any General Fund revenue loss resulting from the tax credit program would be borne entirely by those state-funded programs that are outside of the minimum school funding guarantee.

State Costs to Implement Measure. The measure appropriates $4,350,000 annually, from 1998-99 through 2010-11, from the General Fund to the ARB to administer the tax credit program. Additionally, the state would incur General Fund costs of between $150,000 and $350,000 annually to audit and to provide various reports on the tax credit program.

Prescribed Burning Projects. Funds recovered by the state from the private sector for fire suppression costs fluctuate but average in the hundreds of thousands of dollars annually. The measure would redirect these funds from the General Fund to a new special account to be used for prescribed burning projects that reduce air pollution caused by wildfires.

Impact on Local Sales Tax Revenues. To the extent that the measure results in additional purchases of equipment (subject to the state and local sales and use tax) that would not have otherwise occurred under current law, local sales tax revenues would increase. The amount of the increase is unknown, but would potentially average in the millions of dollars annually through 2010-11.

Potential Savings in Health Care Expenditures. Air pollution has been linked to various health problems by the U.S. Environmental Protection Agency and numerous scientific studies. The state and local governments incur costs for providing (1) health care for low-income persons and (2) health insurance coverage for state and local government employees. Consequently, changes in state law that affect the health of the general populace--and low-income persons and public employees in particular--would affect publicly funded health care costs. To the extent that the measure results in improved air quality--due to the purchase of cleaner vehicles and equipment or retrofit of existing vehicles and equipment to make them cleaner--it would probably reduce state and local health care costs in the long term. The magnitude of these savings is unknown.