Legislative Analyst's Office Analysis of the 2001-02 Budget Bill

Franchise Tax Board (1730)

The Franchise Tax Board (FTB) is one of the state's major tax collecting agencies. The board's primary responsibility is to administer California's Personal Income Tax and Bank and Corporation Tax laws. The board also administers the Homeowners' and Renters' Assistance program, the Political Reform Act audit program, and the Household and Dependent Care Expense Credit (HDCEC) program. In addition, the board administers several nontax programs, including collection of child support and court-ordered payments. A three-member boardthe Director of Finance, the Chair of the State Board of Equalization, and the State Controlleroversees the department. A board-appointed executive officer is charged with administering the day-to-day operations.

The 2001-02 Governor's Budget proposes $427 million ($385 million General Fund) and 5,755 positions in support of the FTB's operations. The total amount is $11 million and 118 positions less than the current year. The main changes are (1) position reductions from implementing e-filing and from the termination of the Student Loan Collection pilot program, (2) an increase in resources for processing and fraud investigation activities associated with the HDCEC program, and (3) the elimination of some vacant positions.

California Child Support Automation System Project

We withhold recommendation on funding for the Franchise Tax Board's California Child Support Automation System. We further recommend that the board, in conjunction with the Department of Child Support Services, submit an updated budget proposal to the Legislature that is consistent with its latest report to the federal Administration of Children and Families.

Chapter 479, Statutes of 1999 (AB 150, Aroner), required FTB to act as the Department of Child Support Services' (DCSS) agent for the procurement, development, implementation, and maintenance of the California Child Support Automation System (CCSAS). (For a comprehensive discussion of these developments, see our report entitled, Child Support Enforcement: Implementing the Legislative Reforms of 1999, issued January 27, 2000.)

The 2001-02 Governor's Budget proposes no increase in the current $19.5 million support level for the project ($4.8 million from the General Fund and $14.7 million in federal reimbursements).

Proposal Inconsistent With Report to the Federal Government. In November 2000, the board provided a Planning Advance Planning Document Update (PAPDU) regarding this project to the Administration of Children and Families (ACF). The ACF requires a state to submit this document when requesting additional funds or a schedule change to a federally funded automation project.

According to the PAPDU, the board currently estimates budget-year funding needs for the project of $29.7 million ($7 million from the General Fund and $22.7 million in federal reimbursements). In addition, the PAPDU reports a schedule extension of five months to account for the additional time needed to develop the project charter and define the requirements for the procurement proposal. Once that is done, the procurement for the new statewide system is expected to be completed by August 2002.

Board Should Explain Budget Inconsistencies. Based on our review of the PAPDU, the Governor's budget proposal for this project ($19.5 million), when compared to information in the PAPDU ($29.7 million), is underfunded by $10.2 million ($2.2 million General Fund and $8 million federal reimbursements). In addition, the PAPDU's project schedule is inconsistent with the last information provided to the Legislature. For these reasons, we recommend that the board, in cooperation with DCSS, provide to the Legislature prior to budget hearings a project and schedule update, an explanation of budget inconsistencies, and a revised budget proposal reflecting the funding required in the budget year.

Child Support Collection Program

Our review of the board's California Arrearage Management Project indicates that the project (1) has exceeded its original costs and time frame for implementation, (2) did not receive federal funding as originally anticipated, (3) may adversely affect implementation of the statewide California Child Support Automation System thereby continuing federal penalties related to administrative costs, (4) may ultimately require development of another statewide arrearage system, and (5) resulted in funding redirections and revised contracting strategies of which the Legislature was not notified. For this reason, we recommend that the board explain at budget hearings the reasons it did not advise the Legislature of the denial of federal funds and the resultant General Fund redirection and contracting revisions.

In addition, we recommend the Legislature consider amending existing law to delay a portion of the board's arrearage collection time frame. We further recommend that the board examine and report to the Legislature, prior to budget hearings, on the costs associated with deferring the arrearage collection time lines.

The Governor's budget proposes $11.2 million to continue project development efforts for its child support arrearage collection system, the California Arrearage Management Project (CAMP). This is the same amount as in the current year. The purpose of this system is to collect unpaid and overdue child support known as "arrearage."

Program History. In 1993, the board began a child support delinquency collection pilot project in six counties and expanded the collection program to all counties two years later. The board was responsible for collecting child support payments that were delinquent by 90 days or more. County district attorneys could also choose to have the board collect payments that were delinquent by 30 days or more as well as current support payments.

Single Statewide Automation System. The ACF required the state to develop a single statewide system by 1997 for all of its child support enforcement activities that met specific information technology and program requirements. One of these requirements was that the statewide system be able to perform arrearage collections as part of its overall collection functions. For reasons unrelated to arrearage collection activities, the state was unsuccessful in implementing the single system known as the Statewide Automated Child Support System. As a result, the federal government began imposing annual penalties by reducing federal funds for administration of the state's child support enforcement program. This year's reduction is expected to be $114 million and is expected to increase until such time as the state is able to implement the new CCSAS system.

Restructured Arrearage Collection Program. Chapter 478, Statutes of 1999 (AB 196, Kuehl) and Chapter 480, Statutes of 1999 (SB 542, Burton), assigned a number of additional child support collection responsibilities to the board, as summarized in Figure 1, and required the board to phase these in by December 31, 2002. At the time the legislation was enacted, the board had not determined the nature of the relationship between arrearage collection and the CCSAS system. The board, therefore, decided to develop CAMP as a separate system to meet the requirements and time frames of the new state legislation. Ultimately, however, the state's collection function will need to be included in the CCSAS in order to meet federal certification requirements for a statewide automation system.

Board Seeks Federal Funding for CAMP Development. In July 2000, the board submitted a request to ACF for an additional $3.7 million in federal funds for CAMP. This request also indicated a need for an additional $1.8 million of state funds in the budget year. The board reported to ACF that the total cost for CAMP was estimated to be $59 million.

In October 2000, ACF denied all federal funds requested by the board for CAMP. The ACF's letter stated "we continue to urge California to concentrate its system development efforts on implementation of a statewide CSE [child support enforcement system] and we find that CAMP, as proposed is not an interim enhancement to an existing system, but in fact a new system development . . . We urge the State to focus its full efforts on accelerated planning, development, and implementation of a statewide system. Federal Funding Participation will only be provided for new system development in the context of a statewide system."

In response to the federal funding denial, we understand that the board has redirected General Fund monies during the current year to continue the CAMP development effort. At the time this analysis was prepared, the board had not informed the Legislature of the federal funding denial or of this redirection.

According to the Governor's budget, the board is now pursuing a "performance-based contract" to meet the arrearage collection requirement. This contracting approach, which the board has used in its tax collection operations, allows the board to defer vendor payments until the automation system is operational and is achieving an agreed upon level of benefitsgenerally increased revenues. When the state achieves that benefit level, it begins to pay the vendor.

Concerns With State's Pursuit of CAMP. Our review of the implementation history of CAMP raises a number of concerns.

• The CAMP Is More Costly Than Originally Expected. Prior to the final passage of Chapter 478 and Chapter 480, the board estimated the cost for a collection arrearage system to be $12 million. Since then, that estimate has been revised upward. According to Department of Finance's (DOF) approval letter for CAMP, the total project costs were estimated to be $35 million in February 2000. Now, according to the information reported to ACF, the board believes the total project costs to be $59.7 million. While some cost increases are understandable, this is almost double the cost reported to the Legislature during last year's budget hearings.
• The CAMP Is Taking Longer to Implement Than Originally Expected. In addition to increased costs, the amount of time required to implement the system also is increasing. According to DOF's approval letter for CAMP, the system was to be operational by August 2002. The information reported to ACF, however, states the board will begin county transitions in April 2002 with full county operation occurring in December 2003. This means the state will be unable to meet the legislative mandate of full county transition by December 2002.
• Federal Government Appears Unwilling to Fund CAMP. The response the board got from ACF when it denied funds for CAMP indicates the federal government views CAMP as a separate system that is not a part of the state's efforts to achieve a statewide child support collection system.
• The CCSAS Must Include Arrearage Collection Functions to Satisfy Federal Requirements. It is important for the state ultimately to meet the federal certification requirements for CCSAS in order to eliminate federal administrative penalties. To meet these requirements, the automated arrearage collection capability will need to reside within CCSAS. Implementation of CAMP, which is designed to be a stand-alone system, will prevent the state from receiving federal certification and, thus, have no impact on reducing federal penalties. This in turn would make it necessary for the state to discontinue CAMP and develop a second arrearage collection system to be incorporated in CCSAS.
• Board Has Made Significant Funding Redirections and Developed a New Contracting Strategy Without Notifying the Legislature. As noted earlier, the board has failed to notify the Legislature of its failure to receive federal funds as anticipated, and its subsequent redirection of state General Fund monies to replace the federal funds. The board also has not provided information to the Legislature regarding its new contract strategy, nor has it received approval from Department of Information Technology, DOF, and the Department of General Services to pursue this strategy.
• The CAMP Could Limit Technology Direction of Single Statewide System. Since CAMP is expected to be operational (in 2003) two years before full implementation of CCSAS (in 2005), it could set the technology direction for the new statewide automation system. This is due to the fact that CAMP would need to be incorporated into the CCSAS to meet federal certification requirements. To do this, however, the board would need to include technical specifications in its procurement for the single statewide system to ensure compatibility with CAMP. This strategy would be inconsistent with those provisions of Chapter 479 which require that the statewide system:
• Be capable of implementation by multiple vendors.
• Offer the greatest chance of achieving program and project success.
• Meet program specifications as opposed to technology-specific specifications.

LAO Recommendations. Given the issues noted above, we recommend that the Legislature take two sets of action. First, we recommend that the Legislature require the board to report at budget hearing on the reasons why it did not advise the Legislature of the denial of federal funds, its redirection of General Fund monies, and its revised contracting strategy. Second, we recommend that the Legislature consider:

• Deferring Legislative Time Frame for Implementing Arrearage Collections Activities. Specifically, we believe it would be better to defer the deadline for transitioning counties to the board's arrearage collection program and instead have the counties begin using the board's program once they transition to the single statewide system. We believe this offers the best solution to the automation and funding issues noted above. In addition, it allows the state to focus solely on developing the single statewide system which is the only child support automation effort that will eliminate the federal penalties.

According to the board, counties are to begin transitions to the new CCSAS system in 2003 with full implementation occurring in 2005. The CCSAS time frame corresponds relatively closely to the latest CAMP schedule. Implementing the board's arrearage collection program to correspond with CCSAS implementation would mean an overall delay of at most two years.

• Requesting Information on Costs Associated With Deferring Child Support Collection Activities. Before the Legislature acts on deferring the arrearage collection time frames contained in existing law, we recommend that the board report to the Legislature prior to budget hearings on the costs associated with that deferral. This report should include what arrearage collection activities could be implemented now without the CCSAS system, the impact of redirecting existing resources to other child support activities, and other costs associated with deferring existing arrearage collection requirements.

The Household and Dependent Care Expense Credit

We withhold recommendation on the board's request for $3.8 million (General Fund) and 64.4 personnel-years for processing and fraud detection associated with implementation of the Household and Dependent Care Expense Credit program pending receipt of additional information on actual filing for tax year 2000.

The Governor's budget proposes $3.8 million and 64.4 personnel-years (PYs) for the FTB to cover increased processing and fraud prevention activities associated with the implementation of Chapter 114, Statutes of 2000 (AB 480, Ducheny).

Program. Chapter 114 established the HDCEC. This tax credit, which became effective beginning tax year 2000, allows for a refundable credit to be taken as a percent (depending on income level) of household and dependent care expenses incurred as necessary costs to sustain employment. The credit is tied to the federal nonrefundable credit known as the Child and Dependent Expense credit. The credit is primarily limited by the taxpayer's California adjusted gross income, ranging from 63 percent of the allowable federal credit for adjusted incomes of $40,000 or less to 42 percent for incomes up to $100,000. The credit is not available for incomes over $100,000 and the maximum allowable credit is $907.

The FTB's Concerns Over Fraud. Based on the board's experience with the Renter's Credit and federal experience with the Earned Income Credit, the board is concerned that there could be substantial fraud related to income tax filings under the HDCEC program. Based on these programs, the board estimates the possible losses from fraudulent filings could range from $7.2 million to $104.6 million. Since the HDCEC is tied to the federal Dependent and Child Expense credit, and the federal forms must accompany the state tax filing, it would seem reasonable for the board also to assess the fraud experience in this federal program when estimating the potential fraud under HDCEC. In any case, tax filings for 2000 will be the first year of claims under HDCEC. Consequently, the board should be in a better position to assess the impact of this program as the 2000 tax filings are received and reviewed.

The board should undertake this review, as well as assess fraud activity in the federal nonrefundable program, and report its findings to the Legislature during the budget process. These data should provide a reasonable measure of the workload requirements for the HDCEC. Thus, we withhold recommendation on the $3.8 million and 64.4 PY request pending receipt and review of this information.