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Two California Bio Groups Seek Tax Breaks, Other Incentives Despite Budget Shortfall

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The San Francisco Bay Area’s life science industry group plans to lean on state lawmakers to enact a series of new tax breaks for California’s universities and other initiatives, and to kick-start cluster-building programs despite a showdown between Gov. Arnold Schwarzenegger and lawmakers over his proposed fix for the state’s $3.3 billion budget gap and a projected $14.5 billion shortfall next fiscal year.
 
BayBio last week issued a 12-point wish list for legislation it wants state legislators to enact in fiscal 2009, including new centers to nurture early-stage businesses and train workers, several new economic-development subsidies, and incentives designed to draw and retain life-science companies in the Golden State.
 
“We certainly don’t see California companies leaving lock, stock, and barrel,” Matthew Gardner, president and CEO of BayBio, told BioRegion News last week. “We see California companies committed to headquarters operations here.”
 
But without these proposals being enacted, “the flip side to that is we may be missing a window of opportunity to capture growth here that other regions will benefit from,” he added.
 
BayBio has begun promoting its Twelve Point Action Plan to Support Califorinia’s Life Science Industry through a series of launch events statewide, starting with one in San Francisco on Jan. 10.
 
That day, Schwarzenegger unveiled a $141 billion budget for fiscal 2009, which begins July 1, that will slice $11 billion in spending. The state plans to wipe out the rest of the $14.5 billion shortfall by issuing $3 billion in bonds.
 
For California’s two biggest university systems, the result is a double-edged sword. While the University of California and California State University appear to be spared, the governor’s 2008-09 proposed budget applies a 10-percent across-the-board cut to all state programs, which would more than offset the spending gain budgeted for both university systems for the coming fiscal year.
 
The cuts would mean that in fiscal 2009, UC would lose 3.4 percent, or $109 million, from the $3.3 billion in state general fund funding it received in fiscal 2008. UC’s total fiscal 2008 budget was $18 billion.
 
That cut nearly quadruples to $400 million when compared to the budget proposed by the university’s Board of Regents. Absent the 10-percent cut, UC would have seen its overall budget grow by about 5.3 percent, or $1 billion, to $19 billion in fiscal 2008.
 
This budget proposal will have serious impacts on our ability to deliver on our mission for our students and for the people of California,” UC President Robert Dynes said in a statement.
 
For CalState, the cuts would also turn what was a projected increase into an overall 9 percent loss, or $312.9 million, from the state funding portion of its $7.6 billion budget for fiscal 2009, leaving it with slightly more than $3.6 billion from Sacramento. Absent the cut, CalState’s overall budget would have grown 4.4 percent to nearly $7.3 billion in fiscal 2009.
 
As for research spending, UC’s outlay would have grown 2.8 percent, or $16.6 million, in 2008-09 to $618.6 million. CalState’s research spending in fiscal 2009 was set to climb 3.8 percent to $4.8 million over this year.
 
On Jan. 10, hoping to obtain a quick response from lawmakers, Schwarzenegger declared a “fiscal emergency” forcing legislators to act on his spending plan within 45 days, and ahead of other business. If no accord is reached in that period, the lawmakers will have to continue crafting a budget until they come to terms on a plan that Schwarzennegger would sign before moving on to other issues.
 
The showdown threatens to be a long one. Schwarzennegger, a Republican, faces opposition over the spending cuts from leaders of the Assembly and state Senate, both controlled by Democrats; and even his own lieutenant governor John Garamendi, also a Democrat.
 
The legislature’s near-exclusive focus on passing a budget has Calfornia’s other life science industry group mapping out a different strategy from BayBio. BIOCOM, which serves the San Diego and Orange County regions, has not announced a wish list and will instead pursue a smaller number of proposals — such as those that streamline regulations but won’t cost the state money — while resisting proposed cutbacks affecting the industry, said Jimmy Jackson, BIOCOM’s vice president of public policy.
 
“With this kind of a budget, any striving for economic incentives for the industry — any additional credits, that type of thing — are pretty much off the table, other than maybe changes in tax policy that are fairly revenue neutral,” Jackson told BioRegion News a day after Schwarzennegger unveiled his budget proposal. “When you’re talking about severely cutting health and welfare programs and cutting education programs, it’s not realistic to think in that kind of environment you’re going to get economic incentives for business.”
 
The budget crunch “does change how we look at the upcoming legislative year,” he said.
 
Gardner, for his part, defended BayBio’s wish-list approach, contending that the group’s proposals will benefit California overall by eventually helping to generate more jobs and tax revenue that can help the state pay for the programs and services it will struggle to pay for now.
 
He also said the 12-point plan would ensure that California’s life-sciences cluster remains the nation’s largest and stays competitive with emerging clusters overseas.
 
“In essence, we’re taking the long-term view here, because we’re confident the budget debate will dominate discussion in California this year,” Gardner said. “It’s going to be a tremendously challenging year for the state government here. I think this gives us a couple of concerns in this industry.”
 
Among them is how to respond if the state maintains it cannot support the life sciences with the types of programs being sought by BayBio and other advocates.
 
“We’ve been hearing for some years that the state could not afford to support a rapid growth industry like this,” said Gardner. “Part of our response back to the state is, ‘We’ve been making investments in California for decades, in a loss-making industry.’
 
“One of the things that this means is that regions trying to build biotech around the world will have opportunities to work with California companies that need to grow and have a difficult time growing in California,” Gardner added.
 
BayBio’s other wishes include legislative proposals that found support last year, though not enough of it to pass both houses and be signed into law by Schwarzenegger.
 
One of those proposals would double from 10 to 20 years the amount of time that biotech companies can carry forward tax deductions on their net operating losses.
 
The measure, AB 1370, won support from the second-most powerful Assembly leader, Speaker Pro Tempore Sally Lieber (D-Mountain View), whose backing helped the bill pass the Assembly in June 2007.
 
Since then, however, the measure has remained stuck in the state Senate’s revenue and taxation committee, the first stop of all legislation that would change the state’s balance sheet. Gardner said he expects the senate to take up the measure in the spring.
 
The fact it cleared the Assembly at all last year reflects the partial success of a strategy carried out by BayBio and other life science industry advocates: Uncoupling from the bill another measure sought by BayBio and other life science advocates, namely provisions that would also have allowed biotech companies to sell unused net operating losses.
 
The latter is now being carried out through Assembly Bill 1147, introduced by Assembly member Gene Mullin (D-South San Francisco), who chairs the Assembly’s Select Committee on Biotechnology. AB 1147 is another plank in BayBio. The combined legislation of 2006 would have cost the state $30 million — one key reason why it foundered.
 
The current carry-forward bill would apply to companies “engaged in biopharmaceutical business activities or other biotechnology business activities that are described in Codes 325411 to 325414, inclusive, and 541710 of the North American Industry Classification System,” and that have not received FDA product approval.
 
Code 325411 covers medicinal and botanical manufacturing. Other NAICS codes eligible for the carry-forward are 325412 (pharmaceutical preparation manufacturing), 325413 (in vitro diagnostic substance manufacturing), 325414 (biological product manufacturing, except diagnostic manufacturing), and 541710 (research and development in the physical, engineering and life sciences).
 
The carry-forward would apply only to net operating losses incurred by biotech and biopharma companies on or after Jan. 1, 2008, through Dec. 31, 2027.
 

“With this kind of a budget, any striving for economic incentives for the industry — any additional credits, that type of thing — are pretty much off the table. … ”

As a result, the state would not lose money until the 2019-2020 fiscal year, when California would lose a projected $300,000, based on a state Franchise Tax Board estimate that $6 million in net operating losses set to expire that fiscal year would instead be carried forward.
 
Yet the prospect of losses in 2019 and beyond isn’t likely to daunt today’s legislators, who are term-limited to six years in the Assembly and eight years in the state Senate.
 
“The budget realities here are what they are, but we’re still optimistic” about extending carry-forward, Gardner said. “It’s a relatively inexpensive initiative compared to other tax reform programs.”
 
BIOCOM’s Jackson said his group would join in lobbying for the carry-forward extension. He predicts it has a chance of being approved even in this tough budget year since it would not cost the state anything over the next decade.
 
The carry-forward and net-operating-loss changes were among topics discussed by BayBio in its Impact 2008 report, a study of the Bay Area’s life science industry released with the 12-point plan [See SIDEBAR for a set of industry statistics from Impact 2008].
 
In addition to the carry-forward and net-operating-loss changes, BayBio’s 12-point plan calls for a new California Science & Technology Trust that would fund early-stage prototyping for small companies — and serve, in effect, as a California equivalent of the US Small Business Technology Transfer Program.
 
The trust would use state revenue from intellectual property owned or shared by the state, as well as from state-owned commercial and industrial land set aside for future development. It would be headed by a cabinet-level science advisor to the state, who would also oversee several other new programs proposed by BayBio, including:
  • A fellows program that would train students to advise all branches of state government on science issues. BayBio said it envisions a program modeled after that of the American Association for the Advancement of Science;
  • A network of “training centers of excellence” focused on training undergraduates for life science careers, and linked to CalState’s system of 23 campuses. Gardner’s group favors CalState campuses competing for the centers, with the winners displaying success in linking with private partners; and
  • New “greenhouses” or incubators linked to UC that would nurture early-stage life-sciences. The greenhouses would be funded with $150 million in state money over 10 years.
‘Market Failing’
 
Gardner said California should partially emulate Pennsylvania, which earlier this decade established three “life sciences greenhouses” using a portion of the state’s proceeds from a 1999 tobacco settlement.
 
But where Pennsylvania located one greenhouse in each of the state’s three most populated regions — Philadelphia, Pittsburgh, and the state capital of Harrisburg — Gardner said BayBio prefers seeing UC’s 10 campuses compete for three centers, with the winners being those that have forged successful public-private partnerships.
 
He added that BayBio could accept greenhouses that were spread out geographically through California’s northern, Bay, and southern regions.
 
“The only reason we suggest this is to remedy a market failing,” Garnder said. “The market failing here is basically the cost of real estate. Startups that can afford lab and R&D space face another obstacle: the traditional reluctance of commercial property owners to enter into leases with tenants seeking less than 5,000 square feet, an underpinning for the rise of startup incubators elsewhere.”
 
According to Gardner, the space squeeze is most acute in the Berkeley area given the creation of new companies by several institutions — including UC Berkeley and Lawrence Berkeley National Laboratory, the country’s oldest national lab.
 
“By one count, UC Berkeley has generated 60 biotech startups in the last decade,” Gardner said. Today, ”they’ve had to fend for themselves” to expand.
 
To benefit the medical device industry, BayBio began by suggesting that state lawmakers fully exempt from capital gains taxes investment in startup companies focused on information technology systems for healthcare and life sciences purposes.
 
Gardner said he envisions the credit benefiting companies worth less than $50 million at the time of their inception “to encourage more early-stage [investment] activity and company formation where capital is at its tightest.”
 
Other proposals within BayBio’s wish list:
  • Allowing companies making major investments in California to select an adjusted corporate income tax apportionment formula;
  • Converting California’s R&D tax credit into a tax rebate. According to Gardner, 90 percent of life science companies in the state “can’t capture a tax credit. They have nothing to write off against;”
  • Creating unspecified new state incentives for local communities to establish new zones for life sciences research parks. The zones should be “in close proximity to growing housing areas;”
  • Setting benchmarks toward aligning state environmental law with federal environmental law, starting with a “Harmonization Conference” that would join life science businesses with state and federal environmental protection officials;
  • Expanding the activity of the California Infrastructure and Economic Development Bank to include loans for pre-environmental report work and infrastructure preparation on “sites of high potential for life sciences expansion;” and
  • Crafting a package to subsidize the bioprocessing and biomanufacturing operationsof life science businesses. The program would offset the costs for production plant investments, capital equipment purchases, facility construction, long-term employee training, and infrastructure.
Gardner said the incentives made sense despite thinking by some industry observers that the Bay Area and other US biotech clusters cannot depend on manufacturing for long-term job and business growth.
 
At a BayBio conference last September, Scott Morrison, US life sciences leader with Ernst and Young, said US life science companies may ramp up production short-term during their clinical testing phases, drawing on proximity to researchers, but will ultimately face the same pressure to cut costs that other industries have addressed by shifting their manufacturing to China or India [BioRegion News, Oct. 1].
 
California should see increased biomanufacturing over the next decade and beyond as biofuels programs take off, creating a demand for manufacturing, Gardner said.
 
“We’ll be facing competing pressures of close to market and lowest-cost location,” he said. “There’s a window here where leadership has yet to be established.”

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