Analysis of the 2008-09 Budget Bill: General Government

Board of Equalization (0860)

The Board of Equalization (BOE) is one of California’s two major tax collection and administration agencies. In terms of its responsibilities, BOE: (1) collects state and local sales and use taxes (SUTs) and a variety of business and excise taxes and fees, including those levied on gasoline, diesel fuel, cigarettes, and hazardous waste; (2) is responsible for allocating certain tax proceeds to local jurisdictions; (3) oversees the administration of the property tax by county assessors; and (4) assesses certain utilities and railroad property. The board is also the final administrative appellate body for personal income and corporation taxes, which the Franchise Tax Board (FTB) administers. The BOE is governed by a constitutionally established board—consisting of four members elected by geographic district and the State Controller.

The Governor’s budget proposes $430 million in support of BOE operations, with $242 million from the General Fund and most of the remainder from local government reimbursements. The proposed level of support represents an overall increase in funding of $33 million ($20 million General Fund) from the 2007–08 level. The number of personnel–years (PYs) for BOE is budgeted to increase from 3,800 to 4,035, with the growth concentrated in SUT activities.

E–Services Deliver a Return on Investment

We recommend that the Board of Equalization’s budget be reduced to account for savings associated with increased use of electronic filing of sales and use tax returns and the associated reductions in paper processing. We also recommend mandatory electronic filing for larger taxpayers to further increase efficiencies. (Reduce Item 0860–001–0001 by $1.4 million.)

Background. The BOE has been converting to electronic technologies in the filing of tax returns and remittances, as well as the processing of these returns. The advantages of shifting to electronic remittances and returns are significant. From the taxpayers’ perspective, using electronic filing can minimize record keeping requirements, increase filing accuracy, and reduce costs. From a tax agency perspective, electronic technologies decrease processing time, reduce storage costs, minimize personnel requirements, improve data accuracy, and facilitate sharing of information among the different agencies for enforcement and compliance purposes.

Electronic Processing Results in Savings. From a budgetary perspective, the costs associated with processing electronically filed returns and remittances are a fraction of the costs associated with paper documentation. For example, FTB has reported that about 4,800 electronic remittances are processed per staff hour. By comparison, only 62 paper remittances are processed per staff hour. This cost differential can translate directly into budget savings. In addition to processing savings, additional savings typically occur because the electronic submissions of remittances and returns are more accurate than their paper counterparts, thus requiring less follow–up contact with the taxpayer to correct inaccuracies.

BOE’s Efforts. Since 2005–06, BOE has undertaken several initiatives and pilot programs to increase electronic filings. To date, BOE has instituted these programs on a voluntary basis without mandating that any taxpayer file electronically. As part of the 2007–08 budget process, the department committed to the Legislature that it could achieve $930,000 in General Fund savings in 2008–09, based upon the department’s projected 7.5 percent growth in electronic filing of returns (from 2.5 percent of all filings to 10 percent of all filings). Information provided by BOE indicates some growth in electronic filing of returns in the current year. The department expects additional growth to continue in the budget year in order to meet the original target of 10 percent. Yet, the Governor’s budget does not reflect any administrative savings from this trend.

Recommend Accounting for Savings. Based on current estimates, we recommend that the Legislature reduce BOE’s budget by $930,000 for 2008–09 to account for savings associated with increased use of electronic return processing and associated reductions in the amount of paper printing and mailings.

Recommend a Plan for Increased Electronic Filing. In addition, in order to increase electronic filing participation, we recommend that the department mandate electronic filing for larger taxpayers. The FTB already has such requirements. The BOE currently mandates electronic payment for all SUT accounts that average over $10,000 or more in tax due per month. We recommend that these same thresholds be used as a starting point to mandate electronic filing. This would result in approximately a 4.5 percent increase in electronic filing and additional General Fund savings of about $500,000 in the budget year.

Some Tax Gap Auditors Would Provide Minimal Benefit

We recommend that the Legislature delete $9.4 million ($5.9 million General Fund) of proposed spending on sales and use tax gap enforcement activities. Many of the proposed activities would provide minimal revenue benefit. The corresponding net reduction in budget–year revenues would be about $15 million ($10 million General Fund). Our recommendations for the Franchise Tax Board would more than make up for this revenue loss. (Reduce Item 0860–001–0001 by $5.9 million.)

Background. There is a significant difference between the amount of taxes that are statutorily owed to the state and the taxes that are actually remitted by taxpayers. This difference between owed and voluntarily remitted taxes is known as the “tax gap.” Using federal estimates and state sources of information, BOE has pegged California’s tax gap associated with the SUT at $2 billion annually. The BOE and federal officials indicate that the SUT tax gap is most associated with noncompliance in remitting the use tax. (The use tax is the tax paid on items purchased out of state—for example, by telephone, over the Internet, by mail, or in person—for use in California when the seller does not collect the SUT.) Approximately 60 percent of the SUT gap is related to the use tax, while the remainder of the SUT gap is related to nonfiling by those with a sales tax liability and underreporting of SUT liabilities by registered taxpayers. As in the case of all SUT administrative costs, a portion of the costs to close the tax gap are paid by local governments. Any increased SUT revenues are also shared between the state and local governments.

Administration’s Proposal. The administration proposes five major SUT gap initiatives for the budget year. These proposals would add 137 PYs in 2008–09, at a cost of $14 million ($9 million General Fund), increasing to 254 PYs in 2009–10, at a cost of $23 million ($15 million General Fund). As Figure 1 shows, the initiatives are projected to generate $32 million ($20 million General Fund) in additional revenue in 2008–09, almost doubling to $61 million ($38 million General Fund) in 2009–10. The initiatives are:

• Expanded Bankruptcy and Out–of–State Collections. This proposal provides resources for BOE to contract with FTB for increased information sharing. The BOE would use FTB’s bankruptcy court records to match noncompliant taxpayers that have bankruptcy plans under court review. The BOE would then obtain a lien priority in those plans, in order to recoup unpaid SUT. The proposal also allocates additional resources for out–of–state collectors to collect SUT debts from these bankrupt out–of–state businesses. The proposal would fund five new PYs, at a cost of $545,000 ($354,000 General Fund) in 2008–09, increasing to nine PYs and $735,000 ($478,000 General Fund) in 2009–10. The BOE estimates it would raise $4.2 million ($2.6 million General Fund) annually, beginning in 2008–09.

• In–State Service Businesses. This proposal targets service industry businesses that are likely to have failed to remit use taxes owed. The proposal would fund 52 PYs in 2008–09 at a cost of $4.7 million ($3.1 million General Fund), increasing to 109 PYs and $8.4 million ($5.5 million General Fund) in 2009–10. The funds would be used for audits, education, outreach, and collection activities associated with noncompliant taxpayers within the state. Of the total, about $884,000 is for field audit and collection activities, with the remainder for headquarters activities. The BOE estimates the program would raise $14 million ($8.8 million General Fund) in 2008–09, increasing to $26 million ($16 million General Fund) in 2009–10.
• Collection Program Improvements. This initiative allocates additional resources for collectors in BOE’s field offices. The new positions would focus on existing collection workloads that are currently not being addressed. The proposal would fund 14 new PYs, at a cost of $1.3 million ($861,000 General Fund) in 2008–09, increasing to 24 PYs and $2.1 million ($1.4 million General Fund) in 2009–10. The BOE estimates it would raise $2.9 million ($1.8 million General Fund) in 2008–09, increasing to $5.8 million ($3.7 million General Fund) in 2009–10.
• Audit Program Improvements. This proposal allocates additional resources for audits and collection activities associated with both in–state and out–of–state noncompliant taxpayers. The proposal would fund 63 new PYs, at a cost of $7 million ($4.6 million General Fund) in 2008–09, increasing to 110 PYs and $11 million ($7.4 million General Fund) in 2009–10. The BOE estimates it would raise $12 million ($7.6 million General Fund) in 2008–09, increasing to $25 million ($16 million General Fund) in 2009–10.
• Non–Filers and Tax Evaders. This proposal focuses on SUT noncompliance of nonstationary vendors, cash–based businesses, and Internet sellers and purchasers. The funds would allow BOE to create three, three–year pilot programs that would identify and issue permits to each of these three groups of noncompliant taxpayers. The proposal would fund three PYs at a cost of $351,000 ($227,000 General Fund). There are no revenues associated with this proposal. Rather, BOE would use the results of these pilots to better inform its procedures and general approach to these segments of the tax gap in the future.

Some Revenues Are Understated. Our analysis indicates that the administration’s proposals for expanded bankruptcy and out–of–state collections would generate more revenue than indicated. Due to inconsistent assumptions about the amount of revenue generated by new collectors, the administration’s revenue estimates for this initiative are understated. Based on our review, we recommend the Legislature score an additional $84,000 in revenue in 2008–09 ($53,000 General Fund) and an additional $1.3 million in revenue in 2009–10 ($0.8 million General Fund) and annually thereafter.

Some Initiatives Have Little Benefit. As shown in Figure 1, most of the administration’s initiatives have low benefit–cost ratios. For instance, BOE’s proposed audit improvement and collection improvement initiatives would bring in less than $3 for each $1 spent by 2009–10. In contrast, FTB’s tax gap proposals would bring in an average of $10 for each $1 spent. We therefore recommend rejecting the audit improvement and collection improvement initiatives. The field audit and collection piece of the in–state service businesses proposal faces similar shortcomings. The 9.5 PYs associated with these activities would cost about $884,000 in 2008–09 and produce $1 million in revenue. A year later, the new staff would grow to 37 PYs and cost about $3.4 million in return for less than twice that amount in revenue. The BOE’s revenue estimates are subject to some uncertainty, particularly for new tax gap activities. In order to ensure that the new activities are a good return of taxpayer funding, therefore, we recommend the Legislature delete these audit and collection activities. After adjusting for the field component, we recommend approval of $3.8 million of the in–state service businesses initiative at headquarters due to a higher benefit–cost ratio.

Focus Pilot Programs. As described above, BOE proposes to conduct three pilot programs which are not expected to generate near–term revenues. Given the state’s limited resources, we recommend limiting the pilot programs to those areas which offer the greatest potential for a substantial revenue return in the future. In our view, the Internet sellers activities pilot program meets this criterion.

Summary of Recommendations. Due to the poor expected revenue benefit associated with audit, collection, and pilot program activities, we recommend that the Legislature delete $9.4 million from BOE’s request. Specifically, we recommend deleting $7 million from audit improvements, $1.3 million from collection improvements, $884,000 from in–state service business activities, and $232,000 from nonfiler and tax evader pilot programs. Figure 2 summarizes our recommended approach, which also adjusts for the understated revenue returns described above. As we discuss in the “Franchise Tax Board” write–up (Item 1730), some of the reduced resources can be better used for tax gap activities at FTB, resulting in a net increase in General Fund revenues at a lower cost compared to the Governor’s budget.