Report 98118.2 Summary - March 1999

Franchise Tax Board:

Its Revenue From Audits Has Increased, but the Increase Did Not Result From Additional Time Spent Performing Audits

RESULTS IN BRIEF

The Franchise Tax Board (board) is one of the primary tax-collecting agencies in the State. For fiscal years 1990-91 through 1997-98, it collected an average of $20 billion in Personal Income Tax (PIT) revenues and $5 billion in Bank and Corporations (B&C) tax revenues, annually. To increase the board's audit revenues, the Legislature authorized 362 new audit positions for the board's audit branch between fiscal years 1992-93 and 1995-96. The board projected a $993 million return on the State's $73 million investment in these additional positions.

Since one interpretation of a revenue increase is an increase in revenues from prior years, we computed the growth in audit revenues before and after the staffing increases. Our analysis isolates the impact of the additional audit positions by eliminating revenues from audits, such as follow-ups on Internal Revenue Service (IRS) leads and audits with potential for large-dollar assessments, that the board would complete even if it did not have the additional staff.

We determined that the board's revenue increases of $558 million would have occurred regardless of the added positions since the increases came from audit types that traditionally receive high staffing priority because of their potential for very high returns. In fact, when we isolated the impact of the new audit positions from the continuing efforts of the entire audit branch, we found that revenues actually decreased by $128.6 million from prior years in the audits where we would expect the board to assign new staff. Several factors have contributed to a decrease in revenues in these types of audits. However, one significant reason is that the board is not spending additional time on these revenue-generating audits. Instead, although the total hours for the entire audit branch increased to reflect 100 to 130 additional audit staff, the number of hours spent performing audits dropped.

The board disagrees with our assessment of its performance and asserts that it has not only met its projection of $993 million in increased revenue but has exceeded it by an additional $490 million. To determine these amounts, the board used a differing interpretation of a revenue increase from audits, a method which the board asserts was understood by readers of its budget documents. The board's analysis compares budgeted revenues to actual assessments; however, it does not isolate the benefits of the additional staff.

We believe the board's budgeting concept that forecasts future audit revenues by estimating the effects of changes in tax laws, changes in the economy, and other relevant factors is defensible. However, the board's analysis does not fully describe its actual revenue resulting from the State's investment in the new positions because it did not exclude the effects of IRS leads and audits with potential for large-dollar assessments that it would have completed even without the additional staff.

To fully describe the actual revenue it received as a result of the State's investment in new positions, the board's analysis should indicate, by category of revenue, the hours to be charged to specific types of audits and the audit revenues projected to result from each type if the staffing increase is approved or denied. The board then needs to compare these projected hours and revenues to subsequent actual hours and revenues by type of audit.

The board anticipates that changes in IRS operations will result in a decrease in the leads from this source and reduce audit revenues by at least 30 percent. Based on fiscal year 1997-98 data, each 10 percent drop in IRS leads could result in a $41 million decrease in audit revenues annually. Not only do many of the board's audit assessments stem from IRS leads, but the costs associated with audits from these leads are lower, thus providing a greater return for each dollar it spends. For example, during fiscal years 1992-93 through 1997-98, audit assessments from IRS leads averaged $374 million annually, but the board spent only $12 million each year to generate these revenues.

The Legislature asked the board to report on the benefits and costs of its audit program; however, it did not request information specific enough to fully assess the revenues resulting from the board's 362 additional audit positions. Furthermore, the board's report did not include essential assessment information such as all costs of its audit program.

RECOMMENDATIONS

The Franchise Tax Board (board) should do the following:

  • The board's budget documents should clearly indicate whether the board will use additional personnel hours for mandatory activities, such as filing enforcement and tax return processing, or for audit activities that are discretionary. If the additional hours will be used for audits, the budget documents should explicitly show, by category of revenue, the hours that will be charged to discretionary audits as well as the audit revenues that are projected to result from each type of audit with or without the staffing increase.

  • In subsequent years' budget documents, the board should compare these projections to actual hours and revenues by type of audit.

  • If the board intends to request funding for auditors to generate additional revenue, it should use these resources to supplement, rather than supplant, the auditors it has in the field. However, if the board later determines the resources can produce a greater benefit in support functions, it should report this to the Legislature.

  • The board should continue to monitor changes in audit revenues resulting from fewer IRS leads and either shift existing staff or request additional staff accordingly to maintain tax revenues.

AGENCY COMMENTS

The Franchise Tax Board (board) disagrees with the methodology we used to analyze the revenues generated by its additional audit staff. The board asserts that actual audit assessments should be compared to budgeted assessments to determine the benefit of increased staffing.


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