The Personal Income Tax Law allows various credits against the taxes imposed by that law.

This bill, for taxable years beginning on or after January 1, 2016, and before January 1, 2021, 2019, would allow a credit equal to 25% of the amount paid or incurred by a qualified taxpayer for water-efficiency improvements, as defined, on qualified real property in this state, as specified. The bill would limit the cumulative amount of the credit to $2,500 for each qualified real property for all taxable years. The bill would also require the amount of the credit to be multiplied by the tax credit adjustment factor, as specified. The bill would require a qualified taxpayer to obtain and retain a certification of the water-efficiency improvements from the appropriate regional or local water agency after completion of the improvements and to provide a copy of this certification to the Franchise Tax Board upon request.

This bill would take effect immediately as a tax levy.

The Personal Income Tax Law allows various credits against the taxes imposed by that law.

This bill, for taxable years beginning on or after January 1, 2017, 2016, and before January 1, 2022, 2021, would allow a credit equal to 25% of the amount paid or incurred by a qualified taxpayer for water-efficiency improvements, as defined, on qualified real property in this state, as specified. The bill would limit the cumulative amount of the credit to $2,500 for each qualified real property for all taxable years. The bill would require a qualified taxpayer to obtain and retain a certification of the water-efficiency improvements from the appropriate regional or local water agency after completion of the improvements and to provide a copy of this certification to the Franchise Tax Board upon request.

This bill would take effect immediately as a tax levy.

The Personal Income Tax Law allows various credits against the taxes imposed by that law.

This bill, for taxable years beginning on or after January 1, 2017, and before January 1, 2022, would allow a credit equal to 25% of the amount paid or incurred by a qualified taxpayer for water-efficiency improvements, as defined, on qualified real property in this state, as specified. The bill would limit the cumulative amount of the credit to $2,500 for each qualified real property for all taxable years. The bill would require a qualified taxpayer to obtain and retain a certification of the water-efficiency improvements from the appropriate regional or local water agency after completion of the improvements and to provide a copy of this certification to the Franchise Tax Board upon request.

This bill would take effect immediately as a tax levy.

Date of Hearing: May 25, 2016

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez, Chair

ABPCA Bill Id:AB 2040

Author:(Melendez) – As Amended Ver:May 16, 2016

Urgency: No State Mandated Local Program: No Reimbursable: No

SUMMARY:

This bill allows a tax credit under the personal income tax law for voluntary water efficiency improvements to outdoor landscapes. Specifically, this bill:

1. Allows, for years beginning on or after January 1, 2016 and before January 1, 2019, a cumulative tax credit of the lesser of $2,500 or 25% of the amount paid or incurred by a taxpayer on voluntary water efficiency improvements to outdoor landscapes on real property owned by the taxpayer and used as the taxpayer's principal residence. Unused credits may be carried forward for an additional three years.
2. Limits the credit to property owners whose income is less than or equal to 120% of the county median income.
3. Limits eligible water efficiency improvements to those certified by a regional or local water agency as compatible with state or local water-efficient landscape statutes or ordinances, or certain water-efficient landscape programs developed by a regional or local water agency, and excludes amounts paid or incurred for water-efficiency improvements mandated by local ordinance or state law.
4. Specifies that the availability of this this credit is contingent upon an appropriation to the Franchise Board (FTB) to oversee and audit the credit.
5. Specifies that the size of the credit will depend on the “adjustment factor” established during the annual budget process, but the default is 0%.

FISCAL EFFECT:

1. Potentially significant GF costs to Franchise Tax Board (FTB) to administer changes to forms and systems.
2. Estimated annual GF cost pressures of $27 million, $22 million, and $27 million in FY 2016-17, FY 2017-18, and FY 2018-19, respectively.

COMMENTS:

1. Purpose. This bill is intended to boost water conservation efforts by providing a tax credit for individuals who go above and beyond mandated water conservation. The author believes many residents have voluntarily implemented water conservation strategies, including installation of drought-friendly landscaping. However, the author believes those water conscious efforts can be expensive, and sometimes cost prohibitive.
2. Local Water Rebate Programs. Several local governments and agencies offer rebate programs to encourage water conservation. For example, the Metropolitan Water District of Southern California and the City of Sacramento Department of Utilities both offer rebates for water-intensive turf removal based on the square footage of turf removed. The popularity of lawn replacement programs is expected to increase as residents continue to cope with the effects of the drought.
3. How would this credit work? The bill was amended in policy committee with two provisions that affect the availability and size of the credit. Specifically:
4. The availability of the credit is contingent upon a Budget Act appropriation to FTB to administer the credit. The credit is only operative when FTB is provided the resources needed to oversee and audit returns.
5. The Budget Act must set an adjustment factor for the credit, which determines its size. The adjustment factor is set at a default of 0%, meaning that unless otherwise specified, this credit is not available. An adjustment factor of 0.5 would mean that the credit would be half of large as it normally would be (up to a $1,250).

These amendments will help policymakers manage costs and require a newly created tax expenditure to be considered along with other spending items. Generally, tax expenditures are considered outside the budget process, even though they have a direct impact on the availability of funds for other programs.

These amendments also create practical complications for ensuring the credit is well targeted and effective. If the credit is provided in an inconsistent manner, its effectiveness as a tool to incentivize homeowners to install water efficiency improvements is undermined. New tax credits can take some time to get started in part because taxpayers need to be educated about the program and FTB needs time to develop systems, and a process by which the credit is provided in fits and starts only complicates the administration of the credit.

1. Related legislation. This bill is similar to AB 585 (Melendez), of 2015, which was held in this committee.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: May 9, 2016

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 2040 (

Author:Melendez) – As Amended Ver:April 6, 2016

Majority vote. Tax levy. Fiscal committee.

SUBJECT: Outdoor Water Efficiency Act of 2016: personal income tax credits: outdoor water efficiency

SUMMARY: Allows a tax credit, under the Personal Income Tax (PIT) Law, equal to 25% of the amount paid or incurred during the taxable year by a "qualified taxpayer" for "water- efficiency improvements" for outdoor landscapes on "qualified real property" in California, as specified. Specifically, this bill:

1. Contains the following legislative findings:
   1. The 2014 water year, ending on September 30, was the third driest based on the 119-year long statewide precipitation record;
   2. Temperatures in the first nine months of 2014 were a record-breaking 4.1 degrees above the 20^th century average across the state;
   3. Responding to these unprecedented dry and hot conditions, the United States (U.S.) Drought Monitor classified more than 80% of California in an "extreme" drought condition, with 58% of California in an "exceptional" drought, the highest condition;
   4. On January 17, 2014, the Governor called upon retail water providers throughout California to reduce residential per capita water use by 20% as compared to 2013 levels;
   5. Outdoor water use accounts for the highest percentage of regional water use;
   6. Landscape design, installation, maintenance, and management can and should be water efficient. The use of water-efficient landscapes contributes to the state's efforts to increase the reliability of its water supplies;
   7. Californians can achieve water efficient landscapes by installing a combination of drought-tolerant live plants; warm season turf varieties, which require 25% less water compared to cool season turf; soaker or drip-irrigation hoses; a moisture control for a sprinkler or irrigation system; mulch and soil; a rain barrel or an alternative rain and moisture collection system; a permeable ground cover surface that allows water to reach underground basins, aquifers, or water collection points; plant and grass seeds coated with a water-saving surfactant; and a water saving surfactant;
   8. Municipalities and local water agencies are tasked with enforcing water conservation ordinances to eliminate water waste and restrict outdoor water use; and,
   9. It is the Legislature's intent to provide an income tax credit for the purchase of outdoor water use efficiency improvements during the exceptional drought that California is facing.
2. Allows the PIT credit for taxable years beginning on or after January 1, 2016, and before January 1, 2021.
3. Provides that, for each "qualified real property", the credit shall not cumulatively exceed $2,500 for all taxable years.
4. Defines a "qualified taxpayer" as the owner of any "qualified real property".
5. Defines "qualified real property" as a principal residence of the qualified taxpayer, within the meaning of Internal Revenue Code Section 121, in this state.
6. Defines "water-efficiency improvements" as expenditures voluntarily paid or incurred by the qualified taxpayer that are certified by the appropriate regional or local water agency as water-efficient improvements compatible with any of the following:
   1. A local water-efficient landscape ordinance of a regional or local water agency adopted or in effect at the time the improvements are made;
   2. The state water-efficient landscape statutes adopted or in effect at the time the improvements are made; or,
   3. A water-efficient landscape program that is developed and implemented by a regional or local water agency for the specific purpose of reducing water use.
7. Provides that "water-efficiency improvements" do not include improvements performed to bring landscaping into mandatory compliance with a local water-efficient landscape ordinance or state law.
8. Requires a qualified taxpayer to:
   1. Obtain certification of the water-efficiency improvements from the appropriate regional or local water agency after completion of those improvements; and,
   2. Retain a copy of the certification and, upon request, provide a copy of the certification to the Franchise Tax Board (FTB).
9. Provides that this credit shall be in lieu of any other credit or deduction that the qualified taxpayer may otherwise claim with respect to the amounts paid or incurred for water-efficiency improvements for outdoor landscapes on qualified real property in this state.
10. Provides that, in cases where the credit amount exceeds the taxpayer's tax liability, the excess credit amount may be carried over in the following year, and succeeding three taxable years, if necessary, until the credit has been exhausted.
11. Provides that Revenue and Taxation Code (R&TC) Section 41 shall not apply to the credit allowed by this bill.
12. Provides that this bill's provisions shall remain in effect until December 1, 2021.
13. Takes immediate effect as a tax levy.

EXISTING LAW:

1. Allows various tax credits under the PIT Law. These credits are generally designed to encourage socially beneficial behavior or to provide relief to taxpayers who incur specified expenses.
2. Requires any bill authorizing a new credit to contain all of the following:
   1. Specific goals, purposes, and objectives that the tax credit will achieve;
   2. Detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives stated in the bill; and,
   3. Data collection requirements to enable the Legislature to determine whether the tax credit is meeting, failing to meet, or exceeding those specific goals, purposes, and objectives. The requirements shall include the specific data and baseline measurements to be collected and remitted in each year the credit is in effect, for the Legislature to measure the change in performance indicators, and the specific taxpayers, state agencies, or other entities required to collect and remit data. (R&TC Section 41.)
3. Provides, for taxable years beginning on or after January 1, 2014, and before January 1, 2019, a gross income exclusion for amounts received as a rebate, voucher, or other financial incentive issued by a local water agency or supplier for participation in a turf removal water conservation program.
4. Provides that, on or before January 1, 2010, every city, county, or city and county shall adopt one of the following:
   1. A water efficient landscape ordinance that is, based on evidence in the record, at least as effective in conserving water as the updated model ordinance adopted by the Department of Water Resources pursuant to law; or,
   2. The updated model ordinance, as specified. (Government Code Section 65595(c).)
5. Authorizes the governing body of a public water supply distributor, whether publicly or privately owned, to declare a water shortage emergency condition to prevail within the distributor's service area whenever it determines that the ordinary requirements of water consumers cannot be satisfied without depleting the distributor's water supply, as specified. (Water Code Section 350.) Further provides that, when a governing body has declared the existence of an emergency water shortage, it shall adopt such regulations and restrictions on the delivery of water as will in its sound discretion conserve the water supply for the greatest public benefit, as specified. (Water Code Section 353.)

FISCAL EFFECT: The FTB estimates General Fund revenue losses of $75 million in fiscal year (FY) 2016-17, $65 million in FY 2017-18, and $75 million in FY 2018-19.

COMMENTS:

1. The author has provided the following statement in support of this bill:

Due to the severity of this unprecedented drought, it is imperative that all Californians conserve water. This has been echoed by our local, state and federal officials. In response, [Californians] up and down the state have taken it upon themselves to implement water conservation strategies, including the installation of drought friendly landscaping. However, many of these water conscious efforts are expensive and cost-prohibitive to those who wish to partake.

In order to further encourage these efforts and extend water saving methods to everyone, AB [2040] provides a tax credit for individuals who go above and beyond the mandated water conservation.

1. This bill is supported by the League of California Cities, which notes the following:

Californians have experienced four years of historic drought conditions, and, with the statewide snowpack at only 87%, a fifth year looms. Last year, the State Water Resources Control Board (SWRCB) imposed, for the first time, a mandatory statewide water conservation standard of 25%. In early 2016, the SWRCB extended the conservation rule, with some modest changes, until October.

Even though the state as a whole was able to meet the ambitious goal of saving 1.2 million acre feet of water, many cities struggled to reduce water consumption to the required level. Those cities having the most difficultly conserving water, under threat of significant fines, often were those that are home to large commercial or industrial facilities that require large amounts of water to operate. Residents of those communities were expected to conserve water at higher levels to compensate for the water demand of key commercial and industrial facilities important to their local economies.

AB 2040 would provide property owners with a significant incentive to improve outdoor water efficiency, while also helping cities and other water suppliers meet the State's mandatory water conservation standard. Outdoor water use is often the single highest use of potable water, and it is also the easiest to reduce. Providing a tax credit of up to $2,500 would induce property owners to replace high water demand plants with more drought-tolerant landscaping that will yield long-term water savings.

1. This bill is opposed by the California Tax Reform Association, which notes the following:

This bill could arguably help continue the watering of landscapes that would otherwise be abandoned, for example, by giving a break for a system of watering large lawns somewhat more efficiently. There is not even a requirement that overall water use be lowered to receive the credit.

We believe that the tens of million[s] of dollars in this bill could better be directly invested by water districts in promoting conservation. The one tax change that is needed with regard to water is in Proposition 218, so that higher usage can be reflected in higher water rates, rather than the state giving an open-ended tax credit with questionable net results.

1. Committee Staff Comments
   1. What is a "tax expenditure"? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, U.S. Treasury officials began arguing that these features of the tax law should be referred to as "expenditures" since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues).
      
   2. How is a tax expenditure different from a direct expenditure? As the Department of Finance notes in its annual Tax Expenditure Report, there are several key differences between tax expenditures and direct expenditures. First, tax expenditures are reviewed less frequently than direct expenditures once they are put in place. While this affords taxpayers greater financial predictability, it can also result in tax expenditures remaining a part of the tax code without demonstrating any public benefit. Second, there is generally no control over the amount of revenue losses associated with any given tax expenditure. Finally, it should also be noted that, once enacted, it takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date, effectively resulting in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their cost or efficacy, without a supermajority vote.
      
   3. California's drought: California is currently facing a historically severe drought. Seven of the nine years since 2007 have been dry. California has also experienced record warmth during this period, increasing negative impacts to the mountain snowpack and cold-water fisheries. 2014 and 2015 were, respectively, the warmest and second-warmest years in 121 years of statewide average temperature records.

While this has been the wettest year since the drought began in 2012, one marginally improved season does not compensate for four prior years of water scarcity. Parts of northern California remain at below-average precipitation and all of southern California is well below average. Although water storage is recovering in some of the large Sacramento Valley reservoirs, this is not the case for the San Joaquin Valley. Groundwater levels throughout the state dropped to historic levels during the past four years and as much as 100 feet below previous historic lows in parts of the San Joaquin Valley. Finally, as of today, the statewide snowpack stands at 89% of the April 1 average, the time of maximum historical snow accumulation.

• 1. Where does our limited water go? According to the Public Policy Institute of California, California agriculture is largely dependent on irrigation, which accounts for roughly 80% of the state's human water use. Households and non-farm businesses, in turn, account for about 20% of human water use in California. Major metropolitan regions in Southern California and the Bay Area are still relatively well supplied, owing to significant investments in conservation, infrastructure, and supply diversification. In the northern and central parts of California, however, communities without diverse water supplies have faced dramatic cutbacks in water use, with some communities receiving emergency supplies from the state. One important key to conservation is reducing the amount of water used for landscaping, which currently accounts for roughly 50% of all urban water use.
  2. R&TC Section 41 shall not apply: On September 29, 2014, Governor Brown signed SB 1335 (Leno), Chapter 845, Statutes of 2014, which added R&TC Section 41. SB 1335 recognized that the Legislature should apply the same level of review used for government spending programs to tax preference programs, including tax credits. Thus, Section 41 requires any bill introduced on or after January 1, 2015 that allows a new income tax credit to contain specific goals, purposes, and objectives that the tax credit will achieve. In addition, Section 41 requires detailed performance indicators for the Legislature to use when measuring whether the tax credit meets the goals, purposes, and objectives so-identified.

This bill provides that R&TC Section 41 shall not apply to this credit. The Committee may wish to consider the appropriateness of this Section 41 exemption. Advocates of the exemption may argue that obtaining useful performance data (e.g., year-over-year increases in water conservation expenditures) would be cumbersome in light of the relatively modest per-taxpayer financial subsidy proposed. Critics of a Section 41 exemption, however, might argue that the carve-out exacerbates one of the primary problems inherent in crafting tax expenditure measures – namely, it is often unclear what objectives the Legislature is aiming to achieve and how it plans to measure the attainment of such objectives.

• 1. What exactly are we incentivizing? Generally, tax credits are provided as a matter of

legislative grace to encourage socially beneficial behavior that likely would not occur

absent a financial incentive. Because this bill applies to taxable years beginning on or after January 1, 2016, this bill would be providing a credit for behavior that had already taken place before this bill's enactment. The Committee may wish to consider the policy implications of providing such an incentive.

• 1. Related legislation:
     1. AB 585 (Melendez) would have allowed a PIT credit to a taxpayer for water-efficient improvements to outdoor landscapes. AB 585 was held on the Assembly Committee on Appropriations' Suspense File.
     2. AB 603 (Salas) would have allowed a tax credit, under the PIT Law and the Corporation Tax Law, equal to 25% of the costs paid or incurred by a taxpayer to replace conventional lawn on the taxpayer's property, as specified. AB 603 was held on the Assembly Committee on Appropriations' Suspense File.

REGISTERED SUPPORT / OPPOSITION:

Support

A-G Sod Farms, Inc.

California Apartment Association

California Association of Nurseries and Garden Centers

California Municipal Utilities Association

California Retailers Association

City of Lakewood

Consumer Specialty Products Association

League of California Cities

Nursery Growers Association

Scotts Miracle-Gro Company

West Coast Turf

Opposition

California Tax Reform Association

Analysis Prepared by: M. David Ruff / REV. & TAX. / (916) 319-2098