IV. REVENUE ANALYSIS

The staff of the Joint Committee on Taxation estimates that the proposal would reduce
fiscal year Federal budget receipts by just over $300 million in the ten-year budget period from
fiscal year 1998 to fiscal year 2007.

The staff estimates that these tax incentives will result in a loss of approximately $300
million in Federal fiscal year budget receipts in the first five years. Because most of the tax
incentives are available only during the first five years, the revenue loss in the second five years
is minimal; the proposal in its entirety would lose approximately $325 million over ten years.

The tax proposals attempt to provide incentives both for the start-up and retention of
business in the District of Columbia, and for the hiring of lower-income District residents.
Several provisions promote the use of tax-exempt financing to lower investment costs for private
businesses that are deemed to be desirable additions to the District of Columbia economy, and
more start-up capital will be made available by the tax credit for providing loans and equity
capital to projects selected by the EDC. To the extent that businesses are generating positive
cash flow, increased expensing under section 179 will provide an incentive for investment in
equipment, while the wage credits for people who work anywhere in the District but who live
only in certain parts of the District is likely to favor the hiring of certain District residents by
local firms. In general, these tax provisions are modest enough in scope that it is not anticipated
that they will result in a major increase in the growth of the economy of the District of Columbia
metropolitan area as a whole, although concentrated allocation of the capital incentives by the
EDC could result in significant revitalization of targeted areas within the District.

Currently, several restrictions in the laws governing the authority of the District of
Columbia government to issue debt have inhibited the issuance of private activity bonds to
provide financing within the District. The removal of these obstacles and the creation of a new
category of private activity bond should enable the District to make substantial use of its private
activity bond volume cap within four or five years after enactment of these changes. These.
private activity bonds will provide a cheaper source of funds for both “start-ups” and business
expansions within the District, as will the start-up capital generated by the proposed tax credits.
These incentives have the potential to serve as a significant economic development tool. The
Joint Committee staff's revenue estimate assumes that the EDC will allocate the full $95 million
of proposed investment tax credits by the end of the five-year allocation period, and that most of
the credits would be allocated in the third and fourth years after the EDC is created.

The location-specific nature of the additional section 179 expensing and tax-exempt
financing benefits should encourage more business development within the favored areas (i.e.,
census tracts with poverty rates of 15 percent or more) than outside such areas. The criterion
that an eligible census tract is one with at least 15 percent poverty allows for the inclusion of
some already thriving pockets within the favored areas. Thus, it is unclear whether the business-
location tests would directly benefit those areas of the District of Columbia that are most in need
of assistance, except to the extent that the overall District tax base is enhanced by tax-subsidized

18



year, the business had a “significant portion” of its activities in census tracts with high poverty
rates and at least 35 percent of the employees of the business are residents of any census tract
within the District (regardless of the poverty rate in the census tract). In order for these proposed
tax incentives to have real incentive effects, a taxpayer would, at the time that a hiring or
investment decision is made, have to speculate whether, by the end of the year, the Tequired
nexus to census tracts with high poverty rates will be satisfied.'*

With respect to the proposed employment credit, the proposal requires that a qualified
employee must be a District resident throughout the one-year period after the employee begins
work for the employer. For the proposed special District welfare-to-work credit, an employee
must be a District resident throughout the two-year period after the employee commences work.
In addition, if the employee is not a member of a WOTC-targeted group, he or she must have his
or her “principal place of abode” for the entire year within a population census tract in the
District that has a poverty rate of 15 percent of more and expect to be paid less than $28,500.
Determining whether an employee’s “principal place of abode” is within such a census tract for
the entire one-year period would be difficult. A similar issue arises with respect to employees
who are members of a WOTC-targeted group or with respect to whom a District welfare-to-work
credit is claimed, although, for these purposes, the employee’s “principal place of abode” can be
anywhere within the District. An individual may have more than one place of abode, or could
claim to reside with relatives or friends for some portion of the one-year (or two-year) period?"
The Administration’s proposal specifically requires that, for each employee with respect to”
whom the employment credit or District welfare-to-work credit is claimed, the employer must
obtain certification from a local designated agency that the employee’s principal place of abode
is within the District as a whole and, for employees who are not members of a WOTC-targeted
group, within a high poverty rate census tract in the District. However, this certification would
be obtained before (or shortly after) the time that an employee begins work for the employer and,
thus, would not guarantee that the employee satisfies the residency test for the entire one-year (or
two-year) period.

In addition, because the proposed employment credit would be available only during an
employee’s first year of employment with the employer, there would be an incentive for
employers to fire existing employees (i.e., those who have worked for that employer for more
than one year) and hire new employees (or even trade employees with other employers) and
thereby claim the maximum $4,000 credit with respect to the new employees. The
Administration’s proposal includes a rule to prevent rehiring of the same employee, but if the
proposal were to be modified to prevent the “churning” of different employees to fill the same

'® The nexus to a census tract with a high poverty rate would not be required when an
employment credit is claimed with respect to an employee who is a member of a WOTC-targeted
group. Nevertheless, even though that employee has been certified as being a WOTC-targeted
group member at the start of his or her first year of service, eligibility for the credit could be lost
if that employee moves out of the District at any time during the first year of service for that
employer.

12


new Federal tax incentives and the District’s expanded revenue bond authority.

District of Columbia Economic Development Corporation

The proposal would establish a new “District of Columbia Economic Development
Corporation.” The Economic Development Corporation (“EDC”) would be an instrumentality of
the District government for Federal income tax purposes, and thus would be eligible to receive
tax-deductible charitable contributions.

The powers of the EDC would be vested in a board of directors consisting of nine voting
members. Five directors would be appointed by the President of the United States, in
consultation with the Congress. The five directors would be required to maintain a primary
residence in the District or have a primary place of business in the District, and such directors
could not otherwise be employees of the District government or of the Federal government. Of
the five directors appointed by the President, four directors would be selected from the for-profit
business community and one director would be selected from “community-based organizations.”
One of the five directors selected by the President would be designated as chair of the board.
One director would be selected by the Mayor from the for-profit business community or from
community-based organizations.’ The remaining three members of the board of directors would
be ex officio members, and would include one member chosen by the President from certain
Federal agencies, the Mayor or a designee, and the Chairman of the District Council or a
designee. The members of the board of directors generally would serve six-year terms.

The EDC would be directed to review and evaluate existing economic development plans
for the District, and then to establish a comprehensive strategic plan for carrying out economic
development in the District of Columbia. In furtherance of this directive, the EDC would be
authorized to provide financial assistance for economic development projects. Such financial
assistance would include making loans, extensions of credit, equity investments, or grants;
leasing or conveying of land; allocating tax credits for qualified equity investmerits and loan;
issuing tax-exempt private activity bonds; and issuing project revenue bonds for any economic
development project approved by the EDC. The total amount of financial assistance provided
would be limited to the capital of the EDC (which would include a Federal appropriation of $50
million for fiscal year 1998) and the value of the land of the EDC. Generally, no one person or
project could receive financial assistance valued at more than 15 percent of the total capital and
land of the EDC. However, no such limits (aggregate or individual) would apply to tax credits,
loans funded from the proceeds of tax-exempt economic development bonds or project revenue
obligations, which are subject to separate limits described below. The EDC would be required to
provide the lesser of $20 million or 40 percent of the amount appropriated directly to non-profit
organizations (or to nonprofit intermediary organizations) to promote and finance job training,

3 This director also would be required to maintain a primary residence in the District of
have a principal place of business in the District, and could not otherwise be an officer or ~
employee of the District government or of the Federal government.

3

—



projects. However, there is no guarantee that projects favored by these incentives would not
have located elsewhere in the District of Columbia without the incentives. In fact, it is likely
that a significant portion of them would fall into this category.

The Joint Committee staff's revenue estimate also assumes that there is likely to be some
confusion about the exact boundaries of eligible areas, the residency of particular employees,
and the work-location requirements that will result in some ineligible businesses claiming the
expensing and/or wage credits. For example, two otherwise identical businesses on opposite
sides of a street bordering an eligible tract would face substantially different tax liabilities.
Because they both have the same street and zip code in their addresses, it will be difficult for the
Internal Revenue Service to monitor compliance with the business activity location and
employee residency tests. This problem is not unique to the District of Columbia tax incentives;
it exists with any sub-city location incentive.

The staff of the Joint Committee on Taxation is currently engaged in a study of the
feasibility of including these macroeconomic effects in its revenue estimates. However, it is
likely that any net economic growth and increased tax revenues resulting from the tax incentives
would be quite small relative to the relocation effects of this proposal. The location-based nature
of this proposal creates opportunities both for intensified economic development within the
favored location in lieu of some other location. Therefore, increases in taxable income in the’
District of Columbia resulting from these behavioral responses would not be expected to be *
replicated in a nationwide application of this proposal.

19



Uniformity Clause does not prohibit Congress from fashioning legislation to address
"geographically isolated problems."”’ If a tax provision is framed in geographic terms, the Court
"will examine the classification closely to see if there is actual geographic discrimination."

In Ptasynski, the Court considered whether the exemption from the crude oil windfall

profits tax for certain Alaskan oil violated the Uniformity Clause. The Court concluded that the __ =
special treatment for Alaskan oil was justified based on neutral factors, citing the
disproportionate costs and difficulties involved in oil extraction in the particular region.” The
Court noted that there was no evidence that Congress intended to grant an undue preference to
Alaska.” The exemption at issue applied not to all oil produced in Alaska, but only to a
relatively small percentage of such oil; moreover, the exemption was not limited to Alaska, but
applied also to oil produced in certain offshore territorial waters. In this regard, the Court stated
that

[t]he exemption thus is not drawn on state political lines.

Rather it reflects Congress’ considered judgment that unique

climatic and geographic conditions require that oil produced

from this exempt area be treated as a separate class of oil.”!

Like the windfall profits tax exemption at issue in Ptasynski, the preferential tax.
treatment that would be provided to certain business activities conducted in the District of
Columbia under the Administration’s proposal is couched in geographic terms. Accordingly, the
provisions would be subject to scrutiny under the Uniformity Clause. The Uniformity Clause
analysis with respect to the proposal would turn on whether the provision of special tax
treatment to certain business activities conducted in the District could be justified on the basis of
neutral factors. Because of the few judicial decisions in this area, the actual level of scrutiny a
court would apply is not clear. Indeed, it should be noted that no Federal tax statute has been

27 Ptasynski at 83-84.

°8 Ptasynski at 85. In this regard, a commentator has suggested that "[b]y ‘actual
geographic discrimination,’ the Court apparently had in mind a situation in which the geographic
distinctions were intended simply to benefit one state or region at the expense of others (or to
harm one state or region to the benefit of others), rather than to address 'geographically isolated
problems.'" Zelenak, "Are Rifle Shot Transition Rules and Other Ad Hoc Tax Legislation
Constitutional?", 44 Tax Law Review 563 (1989).

>> Ptasynski at 85.
3° Ptasynski at 85-86.
31 Ptasynski at 78.

* For a discussion of the level of scrutiny:to be applied in light of the decision in
Ptasynski, see Zelenak, supra, at 590-591.

16


within the District; (5) at least 35 percent of the employees are residents of the District; and (6)
no more than five percent of the average of the aggregate unadjusted bases of the property
owned by the business is attributable to certain financial property or collectibles not held
primarily for sale to customers in the ordinary course of an active trade or business.”

A "qualified business" is defined under present-law section 1397B as any trade or
business other than a trade or business that consists predominantly of the development or holding
of intangibles for sale or license." In addition, the leasing of real property that is located within
the District to others would be treated as a qualified business only if (1) the leased property is
not residential property, and (2) at least 50 percent of the gross rental income from the real
property is from qualified District businesses. The rental of tangible personal property to others
would not be a qualified business unless substantially all of the rental of such property is by
qualified District businesses or by residents of the District.

“Qualified District property”

Qualified District property would be defined to mean any property that would constitute
qualified zone property under present law section 1397C, with certain modifications. Thus,
qualified District property would be depreciable property acquired by the taxpayer by purchase
after the date of enactment, substantially all of the use of which is in the active conduct of a

° The President’s fiscal year 1998 budget also contains a proposal to modify section
1397B so that rather than requiring that "substantially all" tangible and intangible property (and
employee services) of an enterprise zone business be used (and performed) within a designated
zone or community, a "substantial portion" of tangible and intangible property (and employee
services) of an enterprise zone business would be required to be used (and performed)) within a
designated zone or community. Moreover, the proposal would further amend the section 1397B
tule governing intangible assets so that a substantial portion of an entity's intangible property
must be used in the active conduct of a qualified business within a zone or community, but there
will be no need (as under present law) to determine whether the use of such assets is "exclusively
related to" such business. However, the present-law rule of section 1397B(d)(4) would continue
to apply, such that a "qualified business” would not include any trade or business consisting
predominantly of the development or holding or intangibles for sale or license. The proposal
also would clarify that an enterprise zone business that leases to others commercial property
within a zone or community may rely on a lessee's certification that the lessee is an enterprise
zone business. Finally, the proposal would provide that the rental to others of tangible personal
property shall be treated as a qualified business if and only if at least 50 percent of the rental of
such property is by enterprise zone businesses or by residents of a zone or community (rather
than the present-law requirement that "substantially all" tangible personal property rentals of an
enterprise zone business satisfy this test).

4 Also, a qualified business does not include certain facilities described in section
144(c)(6)(B) (e.g., massage parlor, hot tub facility, or liquor store) or certain large farms.

8



New Tax Incentives

The proposal would provide four new tax incentives for businesses located or conducting
business activities in the District of Columbia--an employment credit and extended District
welfare-to-work credit, additional expensing under Code section 179, expanded tax-exempt
development bonds, and tax credits for certain equity investments in and loans to District of

~ Columbia businesses.

District of Columbia employment credit; extension of welfare-to-work credit

The proposal would provide employers a 40-percent credit on the first $10,000 of eligible
wages paid to qualified District employees during the employee’s first year of employment with
the employer. Thus, the maximum credit would be $4,000 per employee.

An individual would be a “qualified District employee” only if he or she satisfies three
tests--a residence test, a work-location test, and an income test. To meet the residence test, an
individual must be certified by a designated agency as having a principal place of abode in the
District of Columbia.> The work-location test would be satisfied if either (1) substantially all of
the services provided by the employee for the employer during the year are in the District of
Columbia or (2) the employer’s principal place of business is located in the District of Columbia.
Finally, the income test would be satisfied if either (1) the employee is a member of one of the
work opportunity tax credit (‘WOTC”) targeted groups (including the new food stamp recipient
group proposed in the President’s fiscal year 1998 budget') or (2) the employee lives in a
population census tract that has a poverty rate of 15 percent or more’ and the employer

* This residence test must be satisfied throughout the one-year period during which the
wage credit is earned. Thus, if an individual establishes a new principal place of abode outside
of the District at any time during that one-year period, then the individual would not satisfy the
residence test.

° For purposes of the present-law WOTC, targeted groups include: (1) members of
families receiving assistance (AFDC or successor program); (2) qualified ex-felons; (3) high-risk
youth 18-24 years old who reside in an empowerment zone or enterprise community; (4)
vocational rehabilitation referrals; (5) qualified summer youth employees 16 or 17 years old who
reside in an empowerment zone or enterprise community; (6) qualified veterans; (7) qualified
food stamp recipients who are 18 to 24 years old. The President’s fiscal year 1998 budget would
extend the WOTC for an additional year through September 30, 1998, and would add a new
recipient group that includes adults who are 18-50 years old and are subject to the time limits for °
food stamp receipt under the Administration’s proposals (but who have not become ineligible by
refusing to work or failing to comply with the work requirements). This new group would be
eligible for a 12-month period beginning on the date the time limit is reached.

7 As with the-residence test, the individual must live in such a census tract throughout the
one-year period during which the employment credit is earned.

5



placement and related activities for certain targeted residents of the District of Columbia.4

In reviewing applications for financial assistance, the EDC would be directed to consider
certain factors, including (1) the likelihood the project can be expected to create or retain private
sector jobs in the District of Columbia; (2) the contribution of the project to the economy of the
District of Columbia; (3) whether the project will serve the interests of the community where it is
located; (4) whether the project is located in a distressed area (generally defined as a population
census tract with a poverty rate of at least 15 percent); (5) whether the project is consistent with
the comprehensive strategic plan developed by the EDC; and (6) whether the project will
improve links between the economy of the District of Columbia and the surrounding region. In
general, with respect to any project, the EDC would be intended to act as the funding source of
last resort, and would commit no more than the minimum capital necessary.

The EDC would have the authority to issue project revenue bonds, including refunding
obligations, and to use the proceeds to provide financial assistance to economic development
projects in the District. Such bonds would not be obligations of the District of Columbia or of
the Federal government, but would be special obligations of the EDC, payable solely from the
revenues, assets and property of the economic development project for which the financial
assistance is provided. The EDC would not be authorized to issue general obligation bonds and
the amount of any project revenue bonds would be excluded from the amount of general :
obligation bonds the District of Columbia is permitted to issue. In addition, the EDC would havé
power to acquire and assemble land through condemnation in the name of the District of
Columbia (referred to as the “power of eminent domain”) to carry out its economic development
purposes. The EDC would not have the power to tax or to pledge, encumber or otherwise place
a lien on District tax revenues.

The EDC would not be permitted to enter into any commitment to provide new financial
assistance or to issue any new project revenue bonds after September 30, 2007. The EDC
generally would be required to terminate its affairs on or before September 30, 2010, at which
time its assets would be liquidated or transferred to another entity selected by the District
Council. If the EDC has not terminated its affairs by September 30, 2010, the Mayor of the
District of Columbia would have the responsibility to terminate the EDC and would succeed to
all of its power, assets, duties and liabilities in order to effect that termination.

* For these purposes, “targeted residents” would mean individuals whose principal place
of abode is in the District and who either (1) are members of a targeted group for purposes of the
work opportunity tax credit (see footnote 6 for list of targeted groups) or (2) live in a population
census tract with a poverty rate of at least 15 percent and have an annual income of less than
$28,500. Because nonprofit organizations that are tax-exempt cannot utilize the employment or
welfare-to-work credits described below, amounts appropriated under this provision could
provide an analogous subsidy to encourage the hiring of disadvantaged District residents.

4



invalidated under the Uniformity Clause.

To varying degrees, the different tax incentives provided for by the Administration
proposal would be tied to high-poverty rate census tracts or the employment of disadvantaged
residents of the District. (This is not necessarily the case, however, with the proposed
investment credits to be allocated by the EDC, although the EDC would be directed to consider,
as one factor, whether the project seeking a credit allocation will benefit a distressed area.) In
this regard, the Administration proposal resembles the special tax treatment provided for
business activities in areas designated as empowerment zones or enterprise communities under
legislation enacted in 1993. The designated empowerment zones and enterprise communities
generally are composed of census tracts that satisfy specified poverty and other criteria. To date,
the special tax treatment provided for empowerment zones and enterprise communities has not
been challenged under the Uniformity Clause.

Providing special tax relief for business activities located in (or with a nexus to) census
tracts with high poverty rates can be contrasted to other proposals that would provide an across-
the-board income tax reduction for residents of the District.** Nonetheless, because the
Administration proposal would provide special tax treatment for certain business activities
defined in geographic terms, a clear record would have to be made that Congress determined that
the preferential treatment to be accorded certain business activities in the District (and not tox:
business activities with ties to similar census tracts located elsewhere) is necessary to address ~“
specific unique circumstances existing with respect to the District. The more detailed the record
is on these issues, and the stronger the nexus between special tax incentives and economically
disadvantaged census tracts and residents, the more likely a court is to give deference to the
judgment of Congress in enacting legislation providing preferential treatment for qualifying
District business activities. Because the proposed tax incentives contained in the
Administration’s proposal use different residency and business location tests (with varying ties
to high poverty rate census tracts), it is possible that one or more of the tax incentives provided
by the Administration proposal could survive challenge under the Uniformity Clause, while one
or more other tax incentives could be found by a court to be insufficiently targeted at
geographically isolated problems.

* See H.R. 889, introduced by Ms. Norton on February 27, 1997.
17


The District of Columbia proposal would extend the proposed welfare-to-work credit for
an additional two years, from September 30, 2000, to September 30, 2002, with respect to certain
residents of the District. To qualify for the extended credit, a qualified long-term family
assistance (AFDC or its successor program) recipient’s principal place of abode must be in the
District during the two years of employment on which the credit is claimed"! and either
substantially all of the services performed by the employee must be performed in the District of
Columbia or the employer’s principal place of business must be located in the District.

Additional section 179 expensing

Qualified District businesses would be eligible to receive up to $20,000 of additional
expensing under Code section 179 for qualified District property placed in service during the
taxable year. Thus, for 1998, qualified District businesses would be allowed to expense up to
$38,500 of the cost of certain business equipment and machinery.

The allowable amount that could be expensed under the proposal would be reduced by
$.50 for each $1.00 of investment over $400,000. Thus, for 1998, the $38,500 maximum
expensing amount allowed under the proposal would be phased out for businesses with
investment between $400,000 and $477,000.

“Qualified District business”

A “qualified District business” generally would be required to satisfy a two-part test.
First, the business would be required to have a significant portion of its activities in census tracts
within the District that have a poverty rate of 15 percent or more. Second, the business would be
tequired to satisfy certain of the criteria of an “enterprise zone business” under Code section
1397B.” Thus, a qualified District business would be a corporation or partnership (or
proprietorship) that has a significant portion of its activities in census tracts in the District with
poverty rates of 15 percent or more if, for the taxable year: (1) at least 80 percent of the total
gross income is derived from the active conduct of a "qualified business" within the District; (2)
substantially all of the business's tangible property is used within the District; (3) substantially
all of the business's intangible property is used in, and exclusively related to, the active conduct
of such business; (4) substantially all of the services performed by employees are performed

"In contrast to the employment credit which requires residency throughout the year of
employment on which the credit is claimed, the extended welfare-to-work credit requires
residency during the two-year employment period. It is assumed that the requirements are
intended to be parallel, and require an individual to maintain a principal place of abode in the
District throughout the applicable period.

° However, qualified District businesses that are corporations or partnerships would

note subject to the requirement that the sole trade or business of the corporation or partnership
be the active conduct of a qualified business within the District.

7


WRITTEN TESTIMONY
OF THE STAFF OF THE JOINT COMMITTEE ON TAXATION
REGARDING PRESIDENT CLINTON’S TAX PROPOSALS
FOR THE DISTRICT OF COLUMBIA

FOR A HEARING OF
THE SUBCOMMITTEE ON THE DISTRICT OF COLUMBIA
OF THE HOUSE COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT
105TH CONGRESS
ON
MAY 22, 1997

PRESENTED BY
KENNETH J. KIES
CHIEF OF STAFF
JOINT COMMITTEE ON TAXATION
U.S. CONGRESS

ICX-15-97

May 22, 1997



functionally related and subordinate land. Any credits allocated to a taxpayer making an equity
investment would be subject to recapture if the equity interest is disposed of by the taxpayer
within five years.

The credits could be allocated by the EDC for equity investments or loans made during
the period January 1, 1998, through December 31, 2002. However, taxpayers would not be
allowed to claim any unused credits in a taxable year that ends after December 31, 2002."

Clarification and expansion of District’s authority to issue revenue bonds

The proposal would modify Federal law (other than Federal tax laws contained in the
Internal Revenue Code) to expand the District’s authority to issue revenue bonds. Specifically,
the proposal would authorize the District government to approve the issuance of taxable and tax-
exempt revenue bonds to finance, refinance, or reimburse the costs of certain facilities not °
covered by existing revenue bond authority. These facilities would be: (1) sports, convention,
tourism, hospitality and entertainment facilities; (2) manufacturing facilities; (3) industrial and
commercial development facilities; (4) facilities to house and equip operation of the District
government or its instrumentalities; (5) public infrastructure development and redevelopment;
(6) elementary and secondary education facilities; (7) solid and hazardous waste disposal
facilities; (8) parking facilities; (9) any other project that will, as determined by the District:
Council, contribute to the health, safety, welfare, the creation or preservation of jobs, or the
economic development of the District of Columbia or its residents; and (10) any facilities or real
or personal property used in connection with or supplementing any of the foregoing.

In addition, the proposal would clarify the District of Columbia’s authority to provide
security and insurance for revenue bonds, and would expand the District’s authority to delegate
to any instrumentality of the District government the authority to issue taxable or tax-exempt
revenue bonds, to borrow money, and to provide insurance for any authorized purpose. Finally,
the proposal would exclude the amount of any revenue bonds issued by the District of Columbia
or instrumentality thereof from the limitations on the amount of general obligation bonds that the
District of Columbia is authorized to issue.

'S Asa general business credit, the credit could be carried back three years (but not
before the date of enactment) and forward for fifteen years, subject to the limitation that no
credit could be claimed in a taxable year ending after December 31, 2002.

10



qualified District business. Property that is substantially renovated could constitute qualified
District property if, during any 24-month period after the date of enactment, additions to basis
with respect to the property exceed the greater of (1) an amount equal to 15 percent of the
adjusted basis of the property in the hands of the taxpayer at the commencement of the 24-month
period, or (2) $5,000.

The additional expensing would be available for property placed in service after
December 31, 1997, and before January 1, 2003.

Tax-exempt economic development bonds

A qualified District business (defined above) would be permitted to borrow proceeds
from the issuance of a new category of tax-exempt, private activity bonds. The proceeds from
such bonds could be used to finance certain business property, including commercial ‘and retail
facilities as well as the land underlying such facilities. The aggregate amount of outstanding
bond proceeds that could be borrowed by any qualified District business could not exceed $15
million.

The bonds would be subject to the District’s present-law, annual $150 million private
activity bond volume cap. The EDC (described above) would have authority to allocate $75 «
million of the District’s annual private activity bond volume cap (i.e., 50 percent of the District’s
annual $150 million private activity bond volume cap).

The special tax-exempt bond provisions would apply to bonds issued after the date of
enactment and prior to January 1, 2003.

Tax credits for equity investments in and loans to businesses located in the District

of Columbia

The EDC (described above) would be authorized to allocate $95-million in tax credits to
taxpayers that make certain equity investments in, or loans to, businesses (either corporations or
partnerships) engaged in a trade or business in the District. Such credits would be nonrefundable
and could be used to offset a taxpayer’s alternative minimum tax (AMT) liability.

Under the proposal, the amount of credit could not exceed 25 percent of the amount
invested (or loaned) by the taxpayer. Thus, the EDC could allocate the full $95 million in tax
credits to no less than $380 million in equity investments in, or loans, to District businesses. The
EDC would allocate the credits pursuant to criteria established by the EDC itself. Such criteria
would include, among numerous factors, whether the project is located in a distressed area
(defined as a census tract with a poverty rate of at least 15 percent) or benefits the residents of a
distressed area.

Under the proposal, credits could be allocated to loans made to District businesses only if
the business uses the loan proceeds to purchase depreciable tangible property and any

9

ote



reasonably expects to pay the employee compensation of not more than $28,500 during the
employee’s first year of employment. The proposal also would provide that certain employees
would not be qualified District employees, including persons related to the employer, prior
employees who are fired and rehired, employees who are employed for fewer than 180 days or
have completed fewer than 400 hours of service for the employer, and individuals employed by
certain businesses (i.e., private and commercial golf courses, country clubs, massage parlors, hot
tub facilities, suntan facilities, racetrack or other facility used for gambling, or any liquor store).

Eligible wages would include cash wages, as well as amounts paid by the employer for
the following: (1) educational assistance excludable from income under Code section 127 (or
that would be excludable but for the expiration of section 127); (2) health plan coverage for the
employee, but not more than the applicable premium defined under Code section 4980B(f(4);
and (3) dependent care assistance excludable from income under Code section 129.8

An employer’s District of Columbia employment credit would be reduced to the extent
that the employer claims the WOTC and the proposed welfare-to-work credit for any of the same
wages paid to qualified District employees.

The proposal would be effective for wages paid to qualified employees hired after the
date of enactment and before October 1, 2002. ab Assi tics yok + goes pf Bets ahnathaabeate sang

Extension of welfare-to-work credit for certain D.C. residents

The President’s fiscal year 1998 budget includes a new welfare-to-work credit. The
proposal would provide employers a 50-percent credit on the first $10,000 of eligible wages?
paid to qualified long-term family assistance (AFDC or its successor program) recipients" for
both the first and second years of employment. Thus, the maximum credit each year would be
$5,000 per qualified employee. The proposed welfare-to-work credit would be effective for
individuals hired from the date of enactment through September 30, 2000.

* Under the proposal, it is not clear if this definition of “wages” also applies for purposes
of determining whether an employee’s “compensation” exceeds $28,500.

° The definition of eligible wages would be the same as for the employment credit,
described above.

© Qualified long-term family assistance recipients would mean any individual who is
certified by the designated local agency as being a member of a family that: (1) has received
family assistance for at least 18 consecutive months ending on the hiring date; (2) has received
family assistance for a total of at least 18 months (whether or not consecutive) after the date of
enactment of this credit if the individual is hired within 2 years after the date that the 18-month
total is reached; and (3) is no longer eligible for family assistance because of either Federal or
State time limits, if the individual is hired within 2 years after the Federal or State time limits
made the family ineligible for family assistance.

6



ESTIMATED REVENUE EFFECTS OF THE PRESIDENT'S TAX PROPOSALS FOR
THE DISTRICT OF COLUMBIA

Fiscal Years 1998 - 2007

[Billions of Dollars]

Provision Effective 1998 = 1999 2000) 2001 2002 = 1998-02 1998-07

The President's Tax Proposals For
The District of Columbia.

DOE (1] 0.1 0.1 0.1 0.1 -0.3 0.3

Joint Committee on Taxation
NOTE: Details may not add to totals due to rounding.

Legend for "Effective" column: DOE = date of enactment

[1] Loss of less than $50 million.


II. DESCRIPTION OF PROPOSAL
A. Summary of Key Features

The proposal would establish a new District of Columbia Economic Development
Corporation to develop and oversee a comprehensive economic development strategy for
the District of Columbia.

The proposal would provide four new tax incentives for businesses conducting business
activities in the District of Columbia--a new employment credit and extension of the
proposed welfare-to-work credit, additional section 179 expensing, expanded tax-exempt
development bonds, and tax credits for certain equity investments in and loans to District
of Columbia businesses.

The employment credit would provide employers a 40-percent credit on $10,000 of first-
year wages paid to employees who are District residents and who meet certain other
requirements. Thus, the maximum credit would be $4,000 per employee.

The proposal would extend the welfare-to-work credit proposed in the Administration’s.
fiscal year 1998 budget for an additional two years with respect to certain District
residents.

Qualified District businesses would be eligible to receive up to $20,000 of additional
expensing under Code section 179 for certain depreciable business property placed in
service during the taxable year.

Qualified District businesses would be permitted to borrow proceeds from the issuance of
a new category of tax-exempt, private activity bonds.

The District of Columbia Economic Development Corporation would be authorized to
allocate $95 million in tax credits to taxpayers that make certain equity investments in, or
loans to, businesses conducting business activities in the District of Columbia.

The proposal would clarify and expand the District of Columbia’s authority to issue
general revenue bonds.

B. Description of the Proposal

In general, the proposal establishes a new District of Columbia Economic Development

Corporation charged with developing a comprehensive economic development strategy for the
District of Columbia. The proposal also provides four new Federal tax incentives to encourage
economic development in the District of Columbia. In addition, the proposal clarifies and
expands the District of Columbia’s authority to issue revenue bonds. The following briefly
describes the powers and duties of the Economic Development Corporation, and outlines the

2


position, potentially complex anti-avoidance rules could be required.’

Business activity tests.--For purposes of the proposed employment credit and District
welfare-to-work credit, the business activity itself carried out by the employee need not be
conducted in a census tract with a high poverty rate. The business activity engaged in by the
particular employee need not even be conducted anywhere within the District if the employer’s
principal place of business is located in the District. Still, the proposed employment credit and
District welfare-to-work credit could raise compliance and administrative issues for businesses
that do not have a principal place of business in the District because the proposal requires that,
with respect to such a business, “substantially all” services performed by the employee must be
performed within the District. For example, it is not clear how such a “substantially all” services
test would be applied in the case of a property management company where some clients served
by the particular employee are located outside the District but within the same metropolitan area.

With respect to the proposed additional expensing under Code section 179 and new
category of tax-exempt, private activity bonds, only “qualified District businesses” would be
eligible for such special tax incentives. A “qualified District business” would be required to
have a “significant portion” of its activities in census tracts that have poverty rates of 15 percent
or more. It is not clear how this “significant portion” test (which applies to particular census
tracts) would be compared to the “substantially all” test (described above for the proposed)
employment credit and District welfare-to-work credit and which applies on a District-wide
basis). Applying this “significant portion” test could be difficult, particularly in cases of
businesses that do not have one fixed business location where most business activities are
conducted. For example, would a taxpayer who stores repair equipment in a high poverty rate
census tract satisfy the “significant portion” test if most or all of the repair work is performed at
the location of clients who live outside the census tract? Even when this “significant portion”
test is satisfied, a qualified District business must satisfy the additional requirement that at least
35 percent of its workforce be residents of the District (as well as certain criteria from Code
section 1397B). In this regard, the residency test~in contrast to the proposed employment credit
for employees who are not members of a WOTC-targeted group--is not tied to census tracts with
high poverty rates, but rather is determined by looking at the District in its entirety. Nonetheless,
similar problems of determining (and verifying) where each employee resides will arise, as
discussed above. As a result, a taxpayer may not know until the end of a taxable year whether
the “significant portion” test or 35-percent resident workforce test will be satisfied, even though
the decision to invest in section 179 property or to utilize tax-exempt financing may have to be
made at a much earlier time.

With respect to the proposed tax credits for equity investments in, and loans to,

? In contrast, the present-law employment credit available in empowerment zones under
Code section 1396 is not limited to the first year of an employee’s work for the employer and,
thus, does not create an incentive to fire employees simply because they have completed more
than one year of employment for an employer in the empowerment zone.

13



power to tax and the limiting requirement of uniformity, the Supreme Court noted that "the
[D]istrict of Columbia . . . is not less within the United States, than Maryland or
Pennsylvania....""? The Supreme Court revisited this issue in Downes v. Bidwell, 182 U.S. 244
(1901), a case involving the question of the application of the revenue clauses of the Constitution
to the territories of the United States. In Downes, the Court cited with approval the earlier
determination in Loughborough that the power to tax and the related requirement of uniformity
are applicable to the District of Columbia, noting that such résult is consistent with the fact that
the District of Columbia had been part of the States of Virginia and Maryland: "[i]ndeed, it
would have been a fanciful construction to hold that territory which had been once part of the
United States ceased to be such by being ceded directly to the Federal government."

In contrast to its application to the District of Columbia, the Uniformity Clause is not
necessarily applicable to the U.S. territories. In the case of the territories, its application depends
upon the status of the particular territory. The Supreme Court in Downes concluded that the ©
Uniformity Clause is not applicable to those territories that are not explicitly incorporated into
the United States.% On this basis, the Court held that the Uniformity Clause did not bar the
imposition of duties on imports from Puerto Rico.* Because the Uniformity Clause is not
applicable to the Commonwealth of Puerto Rico, the special tax provisions of present law for
residents of, and corporations doing business in, Puerto Rico do not give rise to issues under the
Uniformity Clause. so ,

The Uniformity Clause does not require that a tax must have an equal or proportionate
effect in every State and the District of Columbia. Rather, the Supreme Court has stated that "a
tax is uniform when it operates with the same force and effect in every place where the subject of
itis found." Thus, the imposition of a tax on tobacco, for example, is not forbidden under the
Uniformity Clause, notwithstanding the fact that tobacco is grown in some States but not in
others. On the other hand, a tax that applies only to tobacco grown in a particular State would
raise a potential issue under the Uniformity Clause.

Explicit geographic distinctions in Federal tax statutes are not necessarily invalid under
the Uniformity Clause. In United States v. Ptasynski, the Supreme Court first considered the
issue of whether the Uniformity Clause represents a per se prohibition on Congress defining the
subject of a tax in geographic terms. In a unanimous opinion, the Court concluded that the

” Loughborough v. Blake, 18 U.S. 317, 319 (1820).

3 Downes at 261.

> Downes at 286-7.

25 Downes at 287.

26 United States v. Ptasynski, 462 U.S. 74, 82 (1983) (quoting Head Money Cases, 112
U.S. 580, 594 (1884)).

15


I, INTRODUCTION

This document’ represents the written testimony of the staff of the Joint Committee on
Taxation at a hearing held on May 22, 1997, by the Subcommittee on the District of Columbia of
the House Committee on Government Reform and Oversight concerning the tax proposals
relating to the District of Columbia initially referenced in President Clinton’s fiscal year 1998

~- budget.

The General Explanation of the Administration’s Revenue Proposals prepared by the
Department of Treasury states that tax incentives are proposed “to encourage employment of
disadvantaged residents and to revitalize those areas of the District of Columbia where
development has been inadequate.” However, the details of such tax proposals were not
available at the time the Administration originally submitted its fiscal year 1998 budget to the

. Congress. The Administration subsequently has provided details of its proposed tax incentives
for the District of Columbia as part of its National Capital Revitalization and Self-Government
Improvement Plan.

This testimony describes the Administration tax-related proposals and discusses certain
issues raised by the proposals. These include compliance and administrative issues, residency
issues, and federalism and other issues. Finally, it discusses the revenue analysis of the’ #«.<.
proposals prepared by the staff of the Joint Committee on Taxation, and reviews certain
behavioral and other assumptions underlying the revenue estimate.

! This document may be cited as follows: Joint Committee on Taxation, Written
Testimony of the Staff of the Joint Committee on Taxation Regarding President Clinton's Tax
Proposals for the District of Columbia" (JCX-15-97), May 22, 1997.

>. General Explanation of the Administration’s Revenue Proposals, Department of
Treasury, February, 1997, page 31.


CONTENTS

Page

1 INTRODUCTION |... 00s esses cece e eter ee eee: weet e eee eeceees 1
1 DESCRIPTION OF PROPOSAL ..... 2.00... 0 0c cece cece cece ceceeteceneceuneeees 2
A. Summary of Key Features 2.2.0... 0.00. cece ccc e cece cuccueceuceusenceuces 2

B. Description of the Proposal 1... 20.00... ccc e cece cee cececeeveucucucene 2

II. DISCUSSION OF ISSUES ...... 0.0 oe cee cee c cee cence nee eee eectan eee 11
A. Compliance and Administrative Issues 2.2.2.0... 00. e seer ec ee eee v eeu neeees 11

B. Application of the Uniformity Clause ....... 00.000. c eee cece ce eee cence eee 14

IV. REVENUE ANALYSIS ....00 00.0 eee cece cee eee eee ee eeeee weavete ek cere BEEN 4 18
V. REVENUE TABLE ............... bevueeeeeeeeveeseteettteeeeeee. ceeeeees 20


II. DISCUSSION OF ISSUES
A. Compliance and Administrative Issues

The Administration’s proposed tax incentives for the District of Columbia would raise a

number of compliance and administrative issues. Individuals and corporate taxpayers claiming
* the proposed employment credit or the special District welfare-to-work credit, additional

expensing under Code section 179, or tax credit for certain equity investments or loans (or some
combination of such tax incentives) would be subject to special tax rules in computing their
Federal income tax liability.’ In addition to the increased complexity in calculating tax due, or
any refund, on the taxpayer’s annual return, determining the appropriate withholding or
estimated tax payments could also be more complicated for taxpayers who may claim one or
more of the proposed special tax incentives, assuming that the taxpayer attempts to adjust
withholding or estimated tax payments in order to receive the maximum economic value of the
tax incentives. However, such increased complexity could be viewed as a justifiable tradeoff for
the benefits flowing from the tax incentives.

Complexity also arises under the proposal because different tests for qualifying
businesses and eligible employees apply for purposes of the different District of Columbia tax
incentives proposed by the Administration. While these differing tests may be designed tosi-s:s«
further different policy objectives, such as targeting benefits to particular groups; realization of
those objectives could be undermined by deliberate as well as unintentional noncompliance with
the differing tests for qualifying businesses and eligible employees.’”

Employee residency tests.--The proposed employment credit and special District welfare-
to-work credit, additional section 179 expensing, and tax-exempt financing benefits would not be
available with respect to all employees who live or work, or businesses located, in the District.
For example, the employment credit could be claimed only with respect to a subset of employees
(.e., employees who not only reside in the District for the entire year the credit is earned, but
also are members of a WOTC targeted group, or residents of a census tract with a high poverty
rate with expected income of less than $28,500). In contrast, the additional section 179
expensing and tax-exempt financing benefits would be available only if, with respect to a taxable

© The proposal to create a new category of tax-exempt, private activity bonds would,
from the perspective of taxpayers who hold tax-exempt bonds, not add complexity to the present-
law rules that allow taxpayers to exclude interest income on tax-exempt bonds from gross
income.

'7 The proposal includes a requirement that the EDC engage an independent consulting
firm to evaluate the efficacy of the new tax incentives as aids to the EDC in carrying out its
purposes. Such evaluation would be performed in the fiscal years ending September 30, 2001,
and 2005, and the EDC would report the results to the Mayor, the District Council, the District
Control Board, the President, and the Congress.

11


businesses engaged in trade or business activities in the District, taxpayers that wish to make an
investment (or loan) and claim the credit would first have to obtain a credit allocation from the
EDC. In contrast to the proposed additional expensing under Code section 179 and special tax-
exempt bond financing, there is no requirement that the business that is allocated this special tax
benefit be a “qualified District business.” Thus, in theory, any business located anywhere in the
District (and any investor located inside or outside the District) could seek an allocation from the
EDC of tax credits to subsidize investment in such business. Applying for such a credit
allocation (regardless of whether the application formally is submitted by the investor/lender or
the business that will receive the funds) will result in transaction costs that will invariably lessen
the value of the maximum 25 percent subsidy that could be allocated in the form of a tax credit
to a particular investment. On its face, the Administration’s proposal would allow the EDC to
allocate tax credits (up to an aggregate amount of $95 million) to any business located anywhere
within the District. However, the proposal specifically provides that the EDC will allocate
credits pursuant to criteria it establishes, including, among numerous other factors, “whether the
project is in a distressed area or benefits the residents of a distressed areas.” Thus, projects that
are not targeted to particular distressed areas within the District, but rather are located in
relatively affluent areas of the District, may be reluctant to incur the transaction costs of applying
for a credit allocation if it is likely that other applicants will be judged more favorably by the
EDC.

B. Application of the Uniformity Clause

The provision of special tax treatment to certain business activities conducted in the
District of Columbia as contemplated in the Administration proposals raises a potential
constitutional issue. Because the proposals provide preferential tax treatment based on a
geographic classification, it would be subject to potential challenge as a violation of the
requirements of the Uniformity Clause of the United States Constitution.

Pursuant to the Constitution, Congress has broad powers to impose taxes. However, the
power to tax is not without limits. In particular, the Uniformity Clause requires that taxes "be
uniform throughout the United States." The Uniformity Clause operates to prevent the
Congress from exercising the power to tax with the purpose of providing undue preferences for
one region of the country over other regions.”!

The requirement of uniformity in taxes extends not only to the States, but also to the
District of Columbia. In considering the application to the District of Columbia of Congress’

0 Article I, section 8, clause 1.

71 Although there historically has been some debate over the application of the
Uniformity Clause in the case of income taxes, there is now a consensus that income taxes are
within the scope of the Uniformity Clause. See Brushaber v. Union Pacific Railroad Co., 240
US. 1 (1916).

14