Report 2014-110 Summary - November 2014

California Department of Resources Recycling and Recovery:

The Beverage Container Recycling Program Continues to Face Deficits and Requires Changes to Become Financially Sustainable

HIGHLIGHTS

Our audit of the California Department of Resources Recycling and Recovery's (CalRecycle) administration of the Beverage Container Recycling Program (beverage program) revealed the following:

  • In the last four fiscal years, the beverage program has been operating under an annual deficit in which the revenue generated was insufficient to cover expenditures.
  • The beverage program's collective gap between revenues and expenditures across all five funds has exceeded $100 million over three of the last four fiscal years.
  • There are viable options available that CalRecycle and the Legislature may want to consider for enhancing revenue and reducing expenditures to the beverage program.
  • CalRecycle needs to better respond to the fraud risk presented by the importation of out-of-state beverage containers for recycling refund payments.
  • CalRecycle is unable to demonstrate that it is focusing its limited resources in the areas of highest risk to ensure the greatest financial return to the beverage program.

RESULTS IN BRIEF

The Beverage Container Recycling Program (beverage program) was created in 1986 by the California Beverage Container Recycling and Litter Reduction Act (act). The intent of the act is to encourage and increase consumer recycling: it has a goal of recycling 80 percent of the qualified beverage containers sold in California. Beverage distributors are required to make a redemption payment to the Beverage Container Recycling Fund (beverage fund) for every qualified beverage container sold or offered for sale in the State. To encourage recycling, consumers can return qualified beverage containers to recycling centers and receive payment representing the California refund value (recycling refund payment). The California Department of Resources Recycling and Recovery (CalRecycle) is responsible for enforcing and administering the act. Because not all beverage containers are recycled—CalRecycle reported that 85 percent of the containers sold in the State were recycled in 2013—funds not used to ultimately pay consumers are used instead to support the beverage program's operational costs as well as other expenses mandated in state law.

In each of the last four years from fiscal years 2010-11 through 2013-14, the beverage program has been operating under an annual deficit in which the revenue generated has been insufficient to cover expenditures. The collective gap between expenditures and revenues across all five funds that support the beverage program exceeded $100 million in three of those four fiscal years. The principal source of revenue comes into the beverage program through redemption payments beverage distributors make based on the number of beverages sold or offered for sale in the State. The beverage program can become financially unstable once recycling rates become too high and required recycling refund payments—those paid to consumers when they recycle their empty beverage containers—and other statutorily mandated payments cannot both be satisfied. In 2013 CalRecycle reported recycling rates were at 85 percent and had increased beyond what it calls its "break-even" point—currently a 75 percent recycling rate; based on that recycling rate, the revenue collected from beverage distributors is no longer adequate to cover the recycling refund payments and other mandated spending. Although expenditures have exceeded revenues over those past four fiscal years, the program has been receiving significant loan repayments, primarily from the State's General Fund. In fact, these loan repayments have been so substantial that the combined ending balances in the five funds supporting the beverage program actually increased by almost $64 million in those four fiscal years. At the end of fiscal year 2009-10, the beverage program had reached the height of its lending with outstanding loans of $496.8 million receivable from the General Fund and the Air Pollution Control Fund. However, these loans are now nearly repaid with only $82.3 million outstanding. Based on the recent financial condition of the beverage program—where combined expenditures exceeded combined revenues by $100 million in three of the last four fiscal years—immediate action is needed to ensure the continued viability of the beverage program.

A variety of revenue enhancements and expenditure reductions are available that we believe the Legislature may want to consider. For example, the most financially significant proposal is reducing or eliminating the State's subsidies to beverage manufacturers and requiring them to pay the full cost of processing fees. State law requires beverage manufacturers to pay a processing fee, which the State then uses to make processing payments to recycling centers (and other entities) to encourage them to recycle certain beverage containers, such as glass and plastic; however, the beverage program currently subsidizes more than half of these processing fees. By requiring beverage manufactures to pay the full cost of the processing fee, the beverage program could collect additional revenue ranging between $60 million and $80 million annually. Another option to increase revenue includes eliminating administrative fees for beverage distributors. Under state law, beverage distributors are only required to pay 98.5 percent of the redemption payment owed to the State, keeping the remaining 1.5 percent for administrative costs. In fiscal year 2013-14, redemption revenue into the beverage fund amounted to roughly $1.2 billion. Since the $1.2 billion equals 98.5 percent of what could otherwise be collected, the beverage program is missing an opportunity to collect roughly $18 million from distributors. In addition, beginning in 2013, state law requires beverage distributors to electronically report program-related data and, according to CalRecycle, electronic reporting reduces the distributors' financial and administrative burden associated with participating in the beverage program. Collectively, the options we present in this audit report provide an opportunity to achieve as much as $233 million in annual savings and revenue enhancements. Regardless of the options the Legislature might choose, we believe change is necessary to ensure that the beverage program can remain financially stable.

CalRecycle also needs to better respond to the fraud risk presented by the importation of out-of-state beverage containers for recycling refund payments. CalRecycle's Recycling Program Enforcement Branch (enforcement branch) is responsible for inspecting and investigating beverage program participants and for protecting the beverage fund from fraudulent or improper payments. A significant fraud risk to the beverage program occurs when recycling centers redeem containers that were sold out of state—where beverage distributors did not initially pay into the fund; the fund suffers a 100 percent loss on those payments. Beverage containers sold outside of the State may contain the California refund value logo, and thus consumers are able to bring these containers back to California and ultimately receive recycling refund payments. According to the Can Manufacturers Institute, in 2012 nearly 22.4 billion aluminum cans were sold outside of California with the California refund value logo. Assuming that as little as 3 percent of the 22.4 billion in out-of-state aluminum cans with the California refund logo were brought back to California for recycling (or roughly 672 million cans), the beverage fund would pay roughly 5 cents for each can, for a total of $33.6 million. In this hypothetical example, the entire $33.6 million would represent a loss to the beverage fund since the beverage distributors did not initially pay into the beverage fund for these out-of-state containers.

To increase monitoring on the State's borders, CalRecycle partnered with the California Department of Food and Agriculture (Food and Agriculture) to have Food and Agriculture's agents inspect and collect data on the amount of the empty beverage containers that individuals transport into California, which CalRecycle will then analyze for use in criminal investigations and in the prosecution of fraud suspects. However, CalRecycle has yet to analyze all of the data it receives from Food and Agriculture and indicated it will not have a formal process for analyzing these data until the end of 2014. While CalRecycle has not fully analyzed those data, it appears to have taken the initial steps necessary to establish a systematic process for monitoring and responding to the risk of out-of-state beverage containers. CalRecycle needs to continue with these efforts in order to fully evaluate the effect that out-of-state importation has on the beverage program.

While out-of-state beverage containers may represent the largest fraud risk facing the beverage program, CalRecycle has identified other areas of the program that are also at risk for fraud. CalRecycle's enforcement branch has developed a fraud management plan and many of its fraud prevention practices appear reasonable, but our review found that it lacks estimates of what types of fraudulent activities pose the greatest financial risk to the beverage program. Lacking this insight, neither the Legislature, the public, nor CalRecycle will be able to evaluate the effectiveness of CalRecycle's fraud prevention efforts.

Finally, significant disagreements exist between CalRecycle and program stakeholders regarding how much revenue should be collected. We believe the Legislature should consider a different revenue collection model that may help resolve this debate. Currently, state law requires beverage distributors to make payments into the beverage fund based on the number of beverage containers sold, or offered for sale in California. CalRecycle performs risk-based audits each year to verify that the amounts paid to the beverage program are correct for roughly 30 to 40 beverage distributors out of more than 1,400 distributors located throughout the State, according to CalRecycle. Although CalRecycle's audits appear to add value and identify funds due to the beverage program, the amounts identified are not significant in the overall context of the beverage program. For example, according to CalRecycle it completed 39 audits during fiscal year 2013-14 and it identified just over $8 million in funds due to the beverage program. This equates to less than 1 percent of the $1.2 billion in revenue the beverage program recorded during that year. Moreover, because beverage containers display refund logos from multiple states and some out-of-state companies import beverages for sale in California, CalRecycle's task of identifying who owes money to the beverage program (and how much) becomes a difficult one whose accuracy is subject to debate. A potentially simpler model of revenue collection, should it be found feasible, would be for the Legislature to amend state law to require the California State Board of Equalization (Equalization) to collect redemption and processing fees at the point of sale when consumers actually purchase their beverages in California's grocery stores, convenience stores, and other consumer-facing businesses. Equalization already collects point-of-sale payments on behalf of CalRecycle for another state program—the California Tire Fee program—and CalRecycle should work with Equalization to further evaluate the feasibility and cost-effectiveness of this new revenue collection model and then report back to the Legislature. Having a revenue collection process that is customer-centric recognizes the important role consumers play in the recycling process and sends a strong signal to further encourage them to recycle.

RECOMMENDATIONS

THE LEGISLATURE

To better ensure that the beverage program is financially sustainable, the Legislature should consider enacting statutory changes that increase revenue, reduce costs, or a combination of both. Our report lists some specific proposals for the Legislature's consideration in Table 3, beginning on page 19.

CALRECYCLE

To ensure that it can demonstrate that its fraud prevention efforts are maximizing financial recoveries for the beverage program, CalRecycle should both modify and annually update its fraud management plan to include the following:

  • Finalize a process to analyze the data Food and Agriculture provided on out-of-state containers and act on the results to identify and prosecute those committing fraud.
  • Develop fraud estimates—by type of fraudulent activity—that quantify the potential financial losses to the beverage program and the methodology CalRecycle used to develop these estimates.
  • Identify the amount of actual fraud in the prior year by type of fraudulent activity, such as the financial losses resulting from the redemption of out-of-state beverage containers or the falsification of reports used to substantiate program payments.
  • Identify the amount actually recovered for the beverage program in the form of cash for restitution and penalties resulting from fraud.

To ensure that all appropriate redemption payments are identified and made to the beverage fund, CalRecycle should do the following:

  • Contract with Equalization to determine the feasibility and cost of transferring its revenue collection duties and audit reviews to Equalization.
  • Should CalRecycle find that it is feasible and cost-effective, it should pursue legislative changes that enable Equalization to collect revenues for the beverage program at the point of sale and remit the money to the beverage fund.

AGENCY COMMENTS

In its response to the audit, CalRecycle generally agreed with our report's conclusions and recommendations, but it offered additional comments regarding our recommendations; however, we needed to clarify some of its statements beginning on page 59. Further, our report did not make any specific recommendations to the California Department of Justice (Justice). Nevertheless, Justice offered comments regarding some of our conclusions and we provide clarification on page 65.


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