LAO 2005-06 Budget Analysis: General Government

Analysis of the 2005-06 Budget Bill

Legislative Analyst's Office
February 2005

Franchise Tax Board (1730)

The Franchise Tax Board (FTB) is one of the state's two major tax collection agencies. The FTB's primary responsibility is to administer California's personal income tax (PIT) and corporation tax (CT) programs. The FTB also administers the Homeowners' and Renters' Assistance Programs, the Political Reform Act audit program, and the Household and Dependent Care Expense Credit. In addition, the FTB administers several nontax-related programs, including the collection of child support payments and other court-ordered payments. The FTB is governed by a three-member board, consisting of the Director of Finance, the Chair of the Board of Equalization, and the State Controller. An executive officer, appointed by the board, administers the daily operations and functions of the FTB.

The Governor's budget proposes $700 million ($512 million General Fund) and 5,285 positions in support of FTB's operations. Compared to the current-year budget, this represents an increase of $81 million (13 percent) and a General Fund increase of $26 million.

The increase in funding is due almost entirely to increased support for the California Child Support Automation System (CCSAS). This program is funded largely through reimbursements from other departments, but also receives General Fund support. The total increase in support for CCSAS is $79 million, comprising $53 million of other funds and $26 million General Fund. Elsewhere in this analysis, we discuss the past performance and current status of CCSAS and related child support collection activities (see "Health and Social Services" chapter).

In addition to the increase in support for CCSAS, there is an increase in General Fund support for two components of FTB's tax program activities. The ongoing activities associated with abusive tax shelters is slated to receive an additional $1.8 million and a new "tax gap" enforcement pro gram has been proposed at a cost of $8.6 million. These increases are partially offset by decreases due to one-time cost reductions, expiring programs, and unallocated reductions in state operations.

Electronic Technologies Cut Costs

We recommend that the Legislature reduce the Franchise Tax Board's budget by $800,000 to account for cost savings in 2004-05 and 2005-06 associated with the migration of tax return and remittance submissions from paper versions to electronic data. (Reduce Item 1730-001-0001 by $800,000.)

In our January 2005 report, Tax Agency Consolidation: Remittance and Return Processing, we noted that some of the state's tax agencies have made considerable strides in electronic remittance and return processing, including FTB. The costs associated with processing electronically filed returns and remittances is a fraction of the costs associated with paper documentation. For example, the FTB reports that about 4,800 electronic remittances are processed per each direct staff hour. By comparison, only 62 paper remittances are processed per direct staff hour. This cost differential translates directly into budget savings.

Information provided by FTB indicates substantial growth in electronic filing of returns and remittances. This growth has occurred as a combined result of statutory mandates for tax practitioners as well as a "natural" migration from paper to electronic filing by individual and business taxpayers. The FTB reports that between the 2000 tax year and the 2003 tax year, electronically filed returns expanded from 2.3 million to 3.7 million, or 63 percent. Similarly, electronically filed remittances grew from 0.8 million to 1.2 million, or 47 percent. The department expects 10 percent annual growth in electronic remittances through 2008, and 5 percent to 10 percent annual growth in electronic returns through the same period.

Reflecting the growth in electronic filings and remittances—and the large cost savings associated with the use of this technology—the department's budget was reduced in stepwise fashion beginning in 2001-02 and continuing through 2003-04. These reductions ranged from $400,000 to about $1 million. The largest reduction was proposed in the context of requiring mandatory e-filing by tax practioners filing in excess of a specified number of tax returns.

No such budget reductions were proposed as part of the 2004-05 budget or the 2005-06 budget. Given the continued growth in e-filing and the cost savings associated with not printing, mailing, or processing paper returns, FTB has experienced cost savings associated with this shift in filing methods. Based on the lower end of the savings achieved in prior years, we recommend that the Legislature reduce the FTB budget by $800,000, reflecting savings achieved in 2004-05 and 2005-06 through the development and deployment of electronic technologies.

Tax Gap Expenditures Could Be Reduced

We recommend that the Legislature reduce budget authority by $200,000 to account for cost savings associated with hiring auditors at the entry-level salary instead of the midrange given the straightforward nature of the audits such individuals will be conducting. (Reduce Item 1730-001-0001 by $200,000.)

The administration's proposal to fund a tax gap project for FTB includes a sizeable cost component for the hiring of auditors. The proposal calls for the hiring of 36 associate tax auditors at a monthly salary of $4,782, or at the midrange of the salary schedule.

To a large extent, FTB's most experienced auditors have been shifted over to the abusive tax shelter project, where very complex auditing and financial activities are conducted. The audits that are likely to be associated with tax gap activities, by contrast, are likely to be rather straightforward and not require a substantial amount of previous experience. While in past years hiring auditors at the entry-level salary may have been difficult, we think the current hiring situation allows for budgeting these positions at the entry level. As a result of the improved hiring climate, the agency should be able to attract sufficient applicants at the entry-level salary.

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