Legislative Analyst's Office
Analysis of the 2003-04 Budget Bill
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 and Corporation Tax laws. The FTB also administers the Homeowners' and Renters' Assistance Program (HRA), the Political Reform Act audit program, and the Household and Dependent Care Expense Credit (HDCEC) program. In addition, FTB administers several nontax programs, including collection of child-support 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 FTB.
The Governor's budget proposes $445 million ($403 million General Fund) and 5,914 positions in support of FTB's operations. The total amount of support represents a decline of $17 million, or 3.7 percent, from the current year. General Fund support for FTB would decline by $15 million. The largest areas of reductions in the budget are (1) $11.8 million in reductions from the completion of the Integrated Nonfiler Compliance Project; (2) savings of $1.4 million from mandatory E-filing for certain tax practitioners; and (3) $1.5 million in reductions due to decreased outreach activities, program savings, and out-of-state travel restrictions. On the other hand, the budget proposes increases for workload associated with withholding on real estate sales of nonresidential property.
We recommend that the budget proposal requiring E-filing for all tax practitioners filing 100 or more returns be expanded to require E-filing for all those filing 50 or more returns. (Reduce Item 1730-001-0001 by $140,000.) We also recommend that the Franchise Tax Board (FTB) charge tax practitioners for the use of the hotline maintained and staffed by FTB at the expense of taxpayers in general. (Reduce Item 1730-001-0001 by $1 million.)
E-Filing Proposal Should Be Expanded. Under the administration's E-filing proposal, tax practitioners who file 100 of more tax returns will be required to E-file or face a fine of $50 per return. The FTB estimates that the annual savings from this requirement would be approximately $1.4 million (51 PYs). Reducing the E-filing threshold to 50 or more returns would result in an additional annual savings of $140,000 (5.5 personnel-years).
Currently, the level of E-filing has leveled out, after a number of years of rapid growth. Mandatory E-filing by tax practitioners is one major means by which to expand the level of tax E-filing, thereby achieving considerable administrative savings. The FTB indicates that the reduction in the threshold from 100 to 50 tax filings would result in increased gross savings in excess of $400,000, but net savings of only $140,000, due the expected increase in taxpayers assistance costs associated with additional E-filers. Nevertheless, we recommend that the Legislature approve the lower threshold for two primary reasons:
Tax Practitioners Should Be Charged for Special Services. The FTB operates a number of taxpayer assistance programs. For example, individual taxpayers may call the department's call center for individual assistance. The call center receives between 2.5 million and 3 million calls per year. Tax practitioners receive a higher level of service than do individual taxpayers through the tax practitioner's hotline as part of FTB's Tax Practitioner Support Team (TPST). This service offers free technical advice to attorneys, enrolled tax agents, and certified public accounts.
The FTB spends approximately $1 million (12.5 PYs) on the tax practitioner's hotline, which handles about 200,000 calls annually. We think that the activities carried-out by the TPST constitute specialize business advice that is not available to taxpayers in general. Consequently, these activities should be considered a "cost of doing business'" and as a result, should appropriately be borne by the businesses receiving them. We therefore recommend that businesses availing themselves of these services be charged for them.
The FTB has indicated that a charge per call would not be an option without investing in a more complex and expensive telephone infrastructure. On the other hand, an annual fee charged to each tax practitioner for a certain amount of use would be an alternative, according to the department. We therefore recommend that the department explore further the feasibility of this option and report its findings at budget hearings, including an estimate of the appropriate per-practitioner fee and the means by which to assess it.
We recommend that the Legislature augment the budget in order to expand the integrated nonfiler compliance (INC) program, which would lead to increased revenues of $4.4 million. (Augment Item 1730-001-0001 by $800,000 for 14 positions and recognize an additional $4.4 million in revenues.)
The INC Program Helps Ensure Tax Compliance. The overall objective of FTB's non-filer compliance program is to ensure that businesses and individuals required to file tax returns in California carry out this obligation. The FTB's program uses a variety of automated and manual processes to achieve tax compliance from nonfilers. The INC program is part of this larger nonfiler compliance program operated by FTB. As part of this program, FTB receives federal tax returns from the Internal Revenue Service (IRS) for the last three years, wage information from the Employment Development Department, as well as various other data. By analyzing these data in an automated fashion, FTB can determine whether the records from these sources indicate that a federal return was filed or income was earned, and yet no state income tax return was filed.
Program Has Recently Been Improved. The FTB has recently completed improvements to its nonfiler compliance program, resulting in cost savings and greater efficiencies. The new system will allow for the integration of more data into the system and lead to the identification of an additional 100,000 non-filers. The program is also expected to reduce unnecessary taxpayer intrusion by reducing the number of erroneous notices, assessments, and collection actions which have occurred in the past as a result of incomplete or inaccurate data.
Current Program Should Be Expanded. Currently, once a nonfiler has been identified and the data indicate that a tax liability of at least $200 is owed, the nonfiler is sent correspondence from FTB about the need to file. We recommend lowering the threshold from $200 to $100, which would result in FTB contacting an estimated 120,000 additional nonfilers. The nonfilers would be sent a series of communications until payment is made or alternative arrangements are made with the FTB. The FTB estimates that these additional contacts would generate an additional $4.4 million in 2003-04. The overall cost of the expanded program is $800,000, resulting in a benefit-cost ratio in excess of 5:1. At this point, FTB has indicated that a lower threshold than $100 would only be marginally effective.
LAO Recommendation. Given the state's fiscal position currently, we recommend that the Legislature provide additional funding to FTB in the amount of $800,000, in order to expand the INC program and recognize an additional $4.4 million General Fund revenue in the budget year.
We recommend that the Franchise Tax Board report at budget hearings regarding the feasibility and cost-effectiveness of participating in the existing Treasury Offset Program in order to reduce tax collection costs and increase revenues to the General Fund.
Background. Federal law provides for the collection of various past due liabilities owed the state—including state tax obligations—by the federal government through the reduction in the amount of refunds payable to federal taxpayers. In return, the federal government requires states to offset against state tax refunds certain federal obligations. Currently, 25 states participate in the Treasury Offset Program (TOP) and have reciprocal arrangements with the IRS with respect to tax delinquencies.
California Does Not Currently Participate. The FTB performed a study in 1998 to determine whether California's participation in TOP would be effective for California's tax collection programs. The FTB determined that participation was not effective for the following principal reasons:
In sum, FTB concluded the program at that time was not cost-effective for California and that it was receiving better results from its existing collection activities than would be available through the TOP.
Given the current level of participation by other states and the program experience that accompanies this level of participation, it may be that the existing program would now be suitable for California's participation. This could allow the state to reduce the amount of resources devoted to tax collections and maintain (or even enhance) its existing revenue stream. In view of this, we recommend that the FTB report at budget hearings on the existing requirements imposed on states to participate in the TOP, the effectiveness that the program has been able to achieve since it was established, and whether the program would benefit California at this time.