The 2017-18 Budget

The Board of Equalization

State Board of Equalization (BOE) Has Key Responsibilities for Many Taxes and Fees. BOE is headed by a five-member board, with four members directly elected by district, and the fifth—the State Controller—elected on a statewide basis. BOE administers the sales and use tax (SUT) and many smaller tax and fee programs, promulgates related regulations, and adjudicates tax disputes and appeals.

BOE’s Use of Resources

Background

State Laws Address Board Members’ Use of Resources. Some provisions of the Government Code govern the allocation of staff to BOE’s board members. These statutes authorize each of the four district-elected board members to hire six staff who are exempt from state civil service. Historical documents suggest that the state’s annual budget also has authorized each district-elected board member to employ six civil service staff—for a total of 12 staff per board member—dating back to the late 1990s.

Resources for Audits and Collections. The administration’s proposed budget includes provisional language directing BOE not to divert resources away from certain tax administration functions, including collections and audits. Prior budget acts have included similar language. BOE submits an annual report to the Legislature briefly summarizing its use of resources for collections and audits. This provisional language and reporting requirement reflect longstanding legislative concerns about BOE’s use of resources.

Recent Concerns About BOE’s Use of Resources. Over the last year, some board members, the Legislature, and other observers have expressed concerns about other aspects of BOE’s use of resources, including outreach and communications activities, vacancies, executive pay, furniture acquisition, and the use of office space. As a result, the Legislature included some new reporting requirements for BOE in the 2016-17 budget package, such as a report on BOE’s office space.

Audits Likely to Conclude This Spring. The 2016-17 Budget Act authorized the Department of Finance to conduct an audit of various BOE activities. Other state departments—including the Department of General Services and the State Personnel Board—are also auditing BOE. Some of these audits likely will conclude this spring.

LAO Comments

Board Members Have Used Staff Budgeted for Other Purposes. According to BOE’s office space report, BOE has a practice of reassigning, or “loaning,” staff to board members. These staff functionally report to board members, but their funding comes from other areas within the organization. Based on data provided by BOE, we estimate that the loaned resources totaled 7 personnel-years (PYs) in 2015-16.

Loan Durations and Functions Vary. In our view, the practice of loaning staff is most reasonable when the loans last for a very short period—a few weeks or perhaps a few months. Short-term loans can be useful when workloads are high or when the loaned staff possess highly technical or specialized expertise. In practice, some loans last less than a month, while others continue for years. The loaned staff represent a variety of classifications and departments within BOE, but they are more likely to come from some areas than from others. For instance, about one-third of the loaned staff perform communications or outreach functions.

Loans Problematic. While some degree of organizational flexibility is reasonable, two aspects of the loan process are troubling. First, many loans last for significant periods—often for six months or more. Second, the loans are a one-way flow of resources to board members from other parts of BOE. Taken together, these facts suggest that many loans are de facto additions to board members’ staff in excess of budgetary authority.

LAO Recommendation

Use Provisional Language to Restrict Board Members’ Use of Resources. We recommend that the Legislature adopt provisional language explicitly restricting board members’ redirections of resources away from other parts of BOE. These limits could allow some flexibility for minor, temporary redirections similar to the “loans” currently used. For example, the language could allow loans but set limits on the total amount of loaned resources per board member or on the duration of individual staff loans. If the administration believes that each board member should have more than 12 positions on an ongoing basis, it could submit a formal budget proposal to the Legislature in the future.

CROS

BOE is Undertaking a Major IT Project. The Centralized Revenue Opportunity System (CROS) is a large-scale ($280 million) effort to replace BOE’s major IT systems and to change some related business practices. On August 30, 2016, BOE’s Board Members approved a contract with FAST Enterprises Inc. to provide the CROS solution. The implementation phase of the project began shortly thereafter.

Administration’s Proposal for CROS. The administration requests $30 million ($17.2 million General Fund, $3.2 million special funds, and $9.7 million reimbursements) in 2017-18—and varying amounts in 2018-19 and beyond—to implement the CROS project. The 2017-18 amount includes $3 million for vendor payments and $27 million for other resources. These resources include BOE staff (a mix of permanent positions, temporary help, and overtime) and consulting services. The proposal includes provisional language allowing the $3 million for vendor payments to be spent in 2017-18 or 2018-19. It also includes provisional language allowing the Department of Finance—after notifying the Legislature—to augment the appropriation by no more than $1.4 million to incorporate new tax laws into CROS.

Legislature Typically Approves Major IT Budget Proposals on a Year-to-Year Basis. This practice enables the Legislature to remain involved in major decisions and to conduct oversight over the life of the project.

2017-18 Vendor Payments Unlikely. The administration’s proposal for CROS notes that vendor payments are unlikely in 2017-18, but it still requests an appropriation of $3 million for this purpose. Under the administration’s proposed provisional language, any portion of the $3 million not spent in 2017-18 would be set aside for vendor payments in 2018-19.

Some Requested Resources Likely Not Needed. The CROS proposal includes some resources for communications and outreach specialists. These resources include one position for an Associate Governmental Program Analyst for CROS-related video communications. They also include overtime and temporary help in Information Officer II and Business Taxes Specialist II classifications in the External Affairs Department to provide input on CROS’s functions related to their areas of expertise. While allocating these resources to CROS is reasonable, the administration has not made a convincing case that existing BOE communications and outreach resources are insufficient to address these needs.

LAO Recommendations

Approve CROS Resources for 2017-18 Only. Year-by-year budgeting is a standard practice to help the Legislature conduct meaningful oversight over major IT projects. To implement this recommendation, the Legislature would need to reject the provisional language allowing the administration to spread vendor payments across multiple fiscal years (Provisions 5 and 6 under BOE’s General Fund appropriation in the budget bill). The Legislature can appropriate funds for 2018-19 vendor payments one year from now, when more information will be available.

Appropriate Slightly Reduced Amount. We recommend that the Legislature appropriate $400,000 less than the administration has requested for 2017-18. In particular, we recommend that the Legislature reject the requested funding for the communications and outreach resources described above. While the department will have some new CROS-related workload in this area, we believe the department could accommodate this workload within BOE’s existing budget—in particular, by reducing resources spent on the lowest-priority outreach and video production activities.

Tobacco Programs

Background

BOE Administers Tobacco Tax and Licensing Programs. California imposes excise taxes on cigarettes and on other tobacco products, such as cigars and chewing tobacco. The state also licenses sellers, distributors, and manufacturers of these products. As we described in a 2015 report, BOE administers these tax and licensing programs.

2016 Legislation Made Changes to Licensing Program. In 2016, the Legislature made significant changes to the tobacco licensing program. SBx2-5 expanded the licensing program to include electronic cigarettes (also known as e-cigarettes). ABx2-11 raised license fees and replaced the one-time fee for retailers with an annual fee.

Proposition 56 Raises Tobacco Taxes and Taxes E-Cigarettes. On November 8, 2016, California voters passed Proposition 56. Effective April 1, 2017, this measure will increase the state excise tax rate on cigarettes by $2 per pack—from 87 cents to $2.87—and increase the state excise tax on other tobacco products by a similar amount. The measure established a new special fund for the resulting tax revenue, and it laid out a variety of spending requirements—including a couple of provisions setting aside resources for BOE. Proposition 56 also expands the tax base for the excise tax on other tobacco products to include e-cigarettes.

Proposition 56 Limits Discretion on Tobacco Spending. Proposition 56 contains two provisions that allocate funding to BOE. The first is a broad allowance for administrative costs. The second is much more specific: $6 million per year to enforce certain types of tobacco laws. (In practice, the requirement for 2017-18 is $7.5 million, due to an additional quarter of revenue from the end of 2016-17.)

Proposition 56 Enforcement Funding

Proposition 56 Enforcement Spending. BOE’s Proposition 56 proposal includes $5.8 million in 2017-18, $5.0 million in 2018-19, $4.8 million in 2019-20, and $0.7 million in 2020-21 and ongoing for enforcement of tobacco laws. These resources would be used for investigations, appeals, collections, and audits related to tobacco taxes. The funding would come from the new tobacco taxes established by Proposition 56.

Proposed Enforcement Spending Lower Than Required by Proposition 56. The administration has requested $5.8 million for enforcement in 2017-18—less than the $7.5 million required by Proposition 56. This amount is one piece of a larger sum that, according to the measure, “annually shall be used for the purpose of funding law enforcement efforts.” Within the law enforcement category, the measure states that a specific amount “shall be apportioned” to BOE. While the administration has presented a sound fiscal rationale for appropriating a smaller amount in 2017-18, the law does not allow the state to do so.

Structure of New Fund Not Consistent With Alternative Interpretation. The administration interprets “annually shall be used” and “shall be apportioned” to include not only current spending, but also money set aside for future spending. However, the administration has not established a sub-account specifically for BOE, so Proposition 56 revenue set aside for future BOE spending is not apparent in any public budget document. As a result, the administration’s proposal would not enable the public to monitor the administration’s compliance with the measure on an ongoing basis.

Little Reason to Make Enforcement Resources Limited-Term. The administration requests $5.8 million for enforcement in 2017-18, but the vast majority of this money—$5.1 million—is limited-term. In light of the limited budgetary discretion allowed by Proposition 56, there is little reason to commit to revisiting this funding at a fixed point in time.

Other Tobacco Proposals

Other Administrative Costs for Proposition 56. The administration requests $1.1 million in 2017-18, $0.6 million in 2018-19, $0.5 million in 2019-20, and $0.2 million in 2020-21 and ongoing for BOE to administer aspects of Proposition 56 unrelated to enforcement, such as registering taxpayers and processing returns. The funding would come from the new tobacco taxes established by Proposition 56.

2016 Licensing Legislation. The administration requests $0.3 million in 2017-18 and $0.2 million in 2018-19 and ongoing for BOE to implement two of the laws described above: ABx2-11 and SBx2-5.

Ongoing Workload Uncertain Due to Data Limitations... For the most part, BOE has taken a reasonable approach to estimating the tobacco licensing and tax administration workloads for these proposals. However, the proposals do not fully account for the uncertainty in these estimates. The first major source of uncertainty is the lack of reliable data on the current number of e-cigarette retailers and distributors that will register with BOE. To determine the increase in workload for e-cigarettes, the administration obtained estimates from the e-cigarette industry; to determine the increase in revenue from e-cigarettes, the administration examined a comparable policy change in Minnesota. Both approaches are reasonable, but they lead to substantially different estimates—illustrating the uncertainty in both.

…and Policy Changes. BOE’s workload estimates assume no reduction in the taxpayer or licensee population due to the new taxes imposed by Proposition 56. While the magnitude of this effect is highly uncertain, we can reasonably expect the number of taxpayers and licensees to decline to some extent. Federal actions—such as enforcement of the Food and Drug Administration’s new regulations on e-cigarettes—are another source of uncertainty.

LAO Recommendations

Approve $7.5 Million for Enforcement in 2017-18… As noted above, Proposition 56 requires that a certain sum of money “annually shall be used for the purpose of funding law enforcement efforts” and that $7.5 million “shall be apportioned” to BOE in 2017-18 ($6 million per year thereafter). We interpret this requirement to mean that $7.5 million—a larger amount than the administration has requested—must be appropriated for this purpose in 2017-18. We recommend that the Legislature follow the law by appropriating this amount. If, instead, the Legislature concurs with the administration’s interpretation of the law, then we recommend that the Legislature require the administration to apply its interpretation more transparently. To do so, the administration would need to create four sub-accounts within the Tobacco Law Enforcement Account.

…Including $6 Million Ongoing. As described above, Proposition 56 sets firm requirements for enforcement spending. These requirements do not expire, so the Legislature’s options will be just as limited three years from now as they are today. Under these circumstances, limited-term funding makes little sense. If, in future years, BOE adjusts the amount of enforcement funding as directed by Proposition 56, the administration can submit a new proposal at that time.

Approve Other Resources On a Limited-Term Basis. The ongoing tobacco tax and licensing workload could be substantially higher or lower than the administration’s current estimate. Two or three years from now, the Legislature will be in a much better position to assess the ongoing workload for these programs. Consequently, we recommend that the Legislature approve the non-enforcement tobacco requests on a limited-term basis.