CSA
Summary
Read the report at California State Auditor ↗
Board of
Equalization:
Policies and Cost Assessment Methods
for Special Tax Jurisdictions Need
Reconsideration
January 1996
95022
Table of Contents
Summary S-1
Introduction 1
Chapter 1
A Policy Decision Underlying the Cost
Model Used by the Board of
Equalization Needs To Be Reassessed 9
Recommendation 17
Chapter 2
Some of the Costs the Board of Equalization
Assesses Special Tax Jurisdictions Are
Unreasonable or Inequitable While
Others Are Questionable 19
Recommendations 26
Appendix A
The Board of Equalization’s
Computation of Assessment Amounts
Fiscal Year 1995-96 29
Appendix B
Actions the Board of Equalization Is
Taking To Improve Efficiency 31
Appendix C
Alternatives to the
Board of Equalization’s
Administration of Taxes for
Special Tax Jurisdictions 33
Appendix D
Methods the Board of Equalization
Uses To Calculate Assessments
for Special Tax Jurisdictions 37
Response to the Audit
Board of Equalization 45
Summary
T
he Board of Equalization (board) is responsible for
administering 21 tax programs that generate a total of
Audit Highlights ... more than $30 billion in annual revenue. Among the
taxes that the board administers are sales-and-use taxes
The board: (sales taxes) which the board administers for the State and
for cities and counties, and transactions-and-use taxes
Uses a cost model (transactions taxes) which the board administers for special
that reflects a tax jurisdictions (STJ). Our review focused on whether the
significant policy board’s charges to STJs for the administration of their tax
decision to assess its program were reasonable and equitable. The board uses
basic, or
a cost model comprised of direct costs, shared costs, and
infrastructure, costs
central agency costs to calculate assessments for STJs.
to others.
We describe each of these cost elements in Chapter 1.
We noted the following key impacts associated with the
Passed on
board’s application of the cost model:
$157.5 million of
infrastructure costs to
The cost model reflects a significant policy decision to
STJs and local
governments during allocate the board’s basic, or infrastructure, costs of
the past three years. operating its tax administration system to STJs and
local governments (cities and counties). From fiscal
Inappropriately year 1993-94 through 1995-96, the board passed on
charged the STJs nearly 28 percent ($157.5 million) of its infrastructure
nearly $6.6 million costs to the STJs and local governments. Of this
during the past three amount, the board assessed STJs $55.4 million to help
years. pay for infrastructure costs. The board would continue
to incur these costs even if it did not administer the
Used questionable taxes for these entities.
estimates of workload
to calculate STJ direct
While the State and local governments appear to be
costs.
paying for the board’s tax administration system to the
degree that they benefit from it (i.e., the proportion of
Used an allocation
revenue they generate is roughly equal to the proportion
method that resulted
of costs they pay), the proportion of costs the STJs pay
in nearly $1.7 million
is nearly twice as much as the proportion of revenue
in over- and
they earn. This occurs because the STJs are
undercharges to
STJs. assessed a large amount of direct costs associated with
the unique nature of their transactions taxes as well as
a large amount of shared costs while the State and local
governments are assessed few direct costs in addition
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to their portion of shared costs.The application of the
cost model results in assessments to the STJs that are
regressive in nature. STJs with tax rates of less than
0.5 percent pay a higher proportion of their revenue to
the board for administrative costs than do STJs with tax
rates of 0.5 percent because it generally costs the same
amount to administer a transactions tax with a
0.1 percent rate as one with a 0.5 percent rate.
Notwithstanding the impacts identified above, we noted the
following concerns during our review of the costs the board
assessed STJs:
The board inappropriately charged the STJs for costs
associated with its administration of two unrelated
statewide sales taxes resulting in the STJs paying
nearly $6.6 million in additional charges from fiscal year
1993-94 through 1995-96.
To calculate part of the costs to assess the STJs, the
board used estimates of workload (workload factors)
that were either developed without benefit of workload
studies or were not updated since they were developed
using data from fiscal year 1987-88. Therefore, we are
unable to conclude whether these costs were
reasonable or equitable.
The board based its allocations to individual STJs, in
part, on proportion of revenue rather than entirely on
key indicators of workload such as the number of
permits and the number of returns. The board’s use of
proportion of revenue led to 18 STJs being overcharged
by nearly $1.7 million and 11 STJs being undercharged
by the same amount in fiscal year 1995-96.
The board made two minor errors when it calculated the
STJ assessments for fiscal year 1995-96.
Recommendations
Because the cost model used by the board reflects a
significant policy decision to allocate infrastructure costs to
the entities that benefit from the board’s tax administration
system and because of the impacts caused by the
S-2
application of the cost model, the State’s policy makers
should examine whether STJs should bear a percentage of
the infrastructure costs associated with the board’s
administration of sales taxes.To ensure reasonable and
equitable assessments to the STJs, the board should:
Stop charging the STJs for partial costs of administering
the two statewide half-cent sales taxes;
Use workload factors that are based on workload
studies;
Periodically update the workload factors it uses in the
model to calculate direct costs;
Allocate costs to individual STJs based on key
indicators of workload, such as the number of permits
and the number of returns, rather than proportion of
revenue; and
Correct the minor errors we identified.
Agency Comments
The board states that it has no conceptual disagreement
with our findings, the report’s recommendations are worthy
of further consideration, and it will follow the direction of the
Governor and Legislature with regard to any changes in
policy.
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[Blank page inserted for reproduction purposes only.]
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Introduction
T
he Board of Equalization (board) administers 21 tax
programs that generate a total of more than
$30 billion in annual revenue. The board’s sales and
use tax program, administered by its sales and use tax
division, is expected to generate $24.9 billion during fiscal
year 1995-96. Sales tax applies to all retail transactions
not subject to special exemptions provided by law. Use
tax applies to the storage, use, or other consumption of
tangible personal property purchased at retail without
payment of sales tax. As of November 30, 1995, the
statewide sales-and-use tax (sales tax) rate was
7.25 percent.
One of the taxes administered by the board’s sales and use
tax division is the transactions-and-use tax (transactions
tax) for special tax jurisdictions (STJ) where voters have
approved additional tax assessments. Voters within a
specific district can approve a measure authorizing an STJ.
Although most are created to finance transportation
agencies or authorities, others finance open space
protection, hospitals, and libraries. Generally, an STJ
district will have the same boundaries as a county;
however, some districts have city boundaries. Of the 32
current STJs, 26 have county boundaries, 3 have city
boundaries, and 3 are within the City and County of
San Francisco. Table 1 presents a listing of the STJs,
their tax rates, and their year of implementation.
Administration of the Sales
and Use Tax Program
The board also administers the State’s 5 percent sales tax,
the 1.25 percent local government sales tax, and the two
statewide half-cent sales taxes, one for public safety and
one for local revenue. Administration of transactions taxes
and sales taxes encompasses four elements:
Registration of taxpayers;
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Processing of tax returns and payments;
Auditing taxpayers; and
Collecting delinquent taxes.
Table 1
Special Tax Jurisdictions
Year of Tax Rate
Implementatio Jurisdiction (Percent)
n
1970 Bay Area Rapid Transit District .5
1976 Santa Clara County Transit District .5
1979 Santa Cruz Metropolitan Transit District .5
1982 San Mateo County Transit District .5
1982 Los Angeles County Transportation Commission .5
1987 Alameda County Transportation Authority .5
1987 Fresno County Transportation Authority .5
1988 San Diego County Regional Transportation .5
Commission
1988 Inyo County Rural Counties Transactions Tax .5
1989 San Benito County Council of Governments .5
1989 San Mateo County Transportation Authority .5
1989 Sacramento Transportation Authority .5
1989 Contra Costa Transportation Authority .5
1989 Riverside County Transportation Commission .5
1990 San Francisco County Transportation Authority .5
1990 Imperial County Local Transportation Authority .5
1990 Santa Barbara County Local Transportation Authority .5
1990 San Bernardino County Transportation Authority .5
1990 Madera County Transportation Authority .5
1991 Los Angeles County Transportation Commission .5
1991 Orange County Local Transportation Authority .5
1991 San Joaquin Transportation Authority .5
1991 Sonoma County Open Space Authority .25
1991 Santa Cruz County Earthquake Recovery Bond .5
1992 Calexico Heffernan Memorial Hospital District .5
1993 Del Norte County District .5
1993 Fresno Metropolitan Projects Authority .1
1993 San Francisco County Public Finance Authority .25
1994 San Benito County General Fund Augmentation .5
1995 City of Clearlake Public Safety Transactions and Use .5
Tax
1995 Stanislaus County Library Transactions and Use Tax .125
1995 Tulare County Transactions and Use Tax .5
Staff in the board’s field offices register taxpayers.
Registration enables the board to furnish proper tax forms
and instructions to taxpayers for reporting and allocating
taxes. Among the board’s sections responsible for
processing tax returns are the return analysis section and
the local tax section. The return analysis section is
responsible for reviewing returns for arithmetic accuracy
2
and questionable tax-exempt deductions, billing for
additional taxes due, and providing instructions to
taxpayers regarding preparation of tax returns. The local
tax section is responsible for the proper allocation and
distribution of local taxes to local governments and STJs.
It also verifies amounts listed on tax returns and
determines whether taxpayers reported the proper amount
of taxes for the STJs.
The field audit section’s purpose is to ensure uniform
compliance with tax laws and to protect the state and local
tax base. The board selects taxpayers for audit based on
the principle of marginal analysis. Specifically, the
selection process is statistically designed to cover the tax
base in a manner that will result in audits of those
taxpayers most likely to make substantial errors in reporting
that will result in tax deficiencies. A tax deficiency is the
difference between the self-assessed tax amount and the
final determination of the tax amount due after auditing.
The board uses factors such as past audit experience,
leads, and staff’s knowledge of the industry to identify
those taxpayers most likely to submit returns that will result
in tax deficiencies.
Field offices are primarily responsible for the collection of
delinquent taxes. The board uses a computer program to
pursue delinquencies of less than $5,000. If the balance
due is not remitted within predetermined time frames, the
computer program automatically generates and sends a
series of increasingly serious notices demanding payment
from the taxpayer. Delinquencies of $5,000 or more are
assigned to a collector in one of the board’s 16 district field
offices. The board uses another computer program to
increase collections by prioritizing workloads based on a
set of criteria developed to determine the probability of
collection.
Distinctions Between Sales Taxes
and Transactions Taxes
There are two significant distinctions between sales taxes
and transactions taxes. First, sales taxes are assessed
based on the “point-of-sale” whereas transactions taxes are
assessed based on the “point-of-delivery” or “point-of-use.”
Point-of-sale taxes are based on the tax rate in effect at the
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location a sale takes place. For example, when a retailer
sells an item to a consumer, the retailer is responsible for
reporting the tax amount associated with the 7.25 percent
sales tax rate in effect in the county. On the other hand,
point-of-delivery taxes are based on the tax rate in effect at
the location to which the retailer delivers an item, and
point-of-use taxes are based on the tax rate in effect at the
location an item is first used. For example, if a retailer in a
county without an STJ delivers an item to a purchaser who
lives in another county that charges a 0.5 percent
transactions tax rate, the retailer generally is responsible
for reporting not only the tax amount associated with the
7.25 percent sales tax rate in effect at the retailer’s location
but also the tax amount associated with the 0.5 percent
transactions tax rate in effect in the county to which the
item is delivered.
The second distinction is that, while the sales tax rate is
uniformly applied statewide, transactions tax rates are not.
As of November 1995, the sales tax rate in all 58 counties
in California was 7.25 percent. However, the rates for STJ
transactions taxes ranged from 0.1 percent for the Fresno
Metropolitan Projects Authority to 0.5 percent charged by
28 other STJs. Areas that do not have STJs charge only
the 7.25 percent sales tax.
The distinctions between the two types of taxes result in
costs to the board that it would not incur if it administered
only state and local government sales taxes. For example,
when auditing, the board not only determines whether a
retailer properly reported the sales tax in the county of
purchase, but also whether the retailer properly reported
the transactions tax, if any, in the county of delivery or first
use. Therefore, the board assesses the STJs the entire
costs related to auditing the point-of-delivery or first-use
nature of the transactions tax in addition to part of the costs
related to auditing the sales tax.
The Cost Model
Annually, the board assesses each STJ a portion of its total
cost for administering the transactions taxes and the four
sales taxes. The board currently determines the
assessment amount by applying a cost model. The board
uses the same cost model to determine the assessments
4
for the other entities for which it administers sales taxes,
namely, the State and local governments (cities and
counties). The cost model includes three primary
elements: central agency costs, direct costs, and shared
costs. We describe each of these cost elements in
Chapter 1. Appendix A shows the results of the board’s
application of the cost model for fiscal year 1995-96.
The Auditor General previously reviewed the cost model
the board used to develop a reimbursement rate for STJs
starting with fiscal year 1991-92. In a report entitled “The
Board of Equalization Needs To Adjust Its Model for Setting
Reimbursement Rates for Special Tax Jurisdictions” issued
in March 1992, the Auditor General concluded that,
although the use of the cost model for calculating a
reimbursement rate was defendable, the board needed to
refine the model. Specifically, the report recommended
that the board:
Exclude the cost of registering taxpayers, processing
returns, auditing retailers, and collecting taxes
receivable that are related to counties that do not have
STJs from costs that are shared between the State,
cities and counties, and STJs;
Use a workload standard basis for allocating costs
between STJs located in counties with one STJ and
STJs located in counties with two STJs;
Incorporate an adjustment mechanism into the model
that considers the over- or under-collection of
reimbursement amounts during the previous period; and
Develop a method to better quantify existing workload
standards.
The board implemented the first three recommendations
but did not implement the fourth.
Overall Increases in
Tax Administration Costs
The board’s costs for tax administration increased from
$163.3 million in fiscal year 1990-91 to $241.0 million in
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fiscal year 1995-96, an increase of $77.7 million
(47.6 percent). Although there are numerous reasons why
this increase occurred, three stand out. First, the board
included in its budgets $29.7 million in salary increases,
including merit salary adjustments. Second, the board
included in its budgets $11.7 million to establish new or
improve existing computer systems. We describe two of
the improvement projects in Appendix B of this report.
Finally, during this period, the board included in its budgets
$10.3 million for additional auditors and related support
staff.
Increases In STJ Assessments
As we show in Table 2, STJ assessments increased from
$22.4 million in fiscal year 1990-91 to $39.2 million in fiscal
year 1995-96, an increase of $16.8 million (75 percent).
Several reasons explain this increase. From fiscal year
1990-91 through 1992-93, STJ assessments increased by
a net of $1.9 million, from $22.4 million to $24.3 million.
This increase is attributable to increases in the amount of
revenue the board estimated the STJs would earn and a
reduction in the reimbursement rates established by law.
During this three-year period, state law directed the board
to calculate assessments by multiplying
statutorily-established reimbursement rates by the amounts
of estimated revenue. Estimated STJ revenue increased
from $1.5 billion in fiscal year 1990-91 to $1.8 billion in
fiscal year 1992-93, a $312.2 million increase. Although
the effective reimbursement rate for STJs dropped from
fiscal year 1990-91 to fiscal years 1991-92 and 1992-93,
the substantial increase in STJ revenue caused an overall
increase in their assessments.
Table 2
Assessment Amounts (in Millions)
Fiscal Years 1990-91 Through 1995-96
1990-91 1991-92 1992-93 1993-94 1994-95 1995-96
STJs $ 22.4 $ 25.1 $ 24.3 $ 35.0 $ 37.8 $ 39.2
Local Governments 29.0 27.2 27.4 36.0 39.5 42.0
State 111.9 127.6 143.1 141.4 150.3 159.8
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Total $163.3 $179.9 $194.8 $212.4 $227.6 $241.0
Source: Data supplied by the Board of Equalization.
STJ assessments increased 44 percent (from $24.3 million
to $35.0 million) from fiscal year 1992-93 to 1993-94
because the board changed its method of calculating them.
Chapter 75, Statutes of 1993, required the board to use the
cost model to calculate assessment amounts for fiscal year
1993-94 and annually thereafter rather than using the
model to establish rates in legislation. Therefore, instead
of basing the assessments on the amount of revenues the
board estimated the STJs would earn, as it formerly had,
the board now based the assessments on estimates of
costs it would incur.
From fiscal year 1993-94 through 1995-96, STJ
assessments increased by $4.2 million (12 percent), from
$35.0 million to $39.2 million. Increases in the board’s
costs for processing tax returns and for auditing generally
accounted for this assessment growth. During this same
period, the costs of the board’s
tax administration system increased by $28.6 million
(13.5 percent), from $212.4 million to $241.0 million.
Scope And Methodology
The Budget Act of 1995 (Chapter 303, Statutes of 1995)
mandated our audit of the board’s cost assessments to the
STJs to identify means of reducing the assessments.
Specifically, we were directed to:
Determine whether the costs the board assessed to the
STJs were reasonable and equitable;
Evaluate the board’s efficiencies and economies,
including our consideration of eliminating low-priority or
noneconomic activities associated with its
administration of STJ taxes;
Identify alternatives to the board’s administration of the
STJ tax revenues;
7
Identify alternatives to the board’s allocation of shared
costs; and
Certify whether the charges were equitable, and
whether the board has implemented all reasonable
economies and efficiencies or if it could achieve
additional savings through other means.
To determine whether the costs the board assessed to the
STJs were reasonable and equitable, we researched
policies concerning the recovery of costs associated with
services provided by state departments and California laws
concerning recovery of costs from STJs and local
governments, analyzed the board’s assessments to STJs
for fiscal years 1990-91 through 1995-96 and the budget
increases for the sales and use tax division, analyzed the
cost model the board used to calculate direct costs and
shared costs to assess the STJs, and identified and
evaluated the impacts of the board’s application of the cost
model.
To evaluate the board’s efficiencies and economies and
identify possible low-priority or noneconomic activities
associated with the board’s administration of STJ taxes, we
identified the processes the board used to register
taxpayers, process tax returns, audit taxpayers, and collect
delinquent taxes; observed these processes to identify
activities that the board could change to improve efficiency;
and reviewed actions the board is taking to improve
efficiency through two computer automation projects
currently being implemented and an internal review of its
return processing activity. During our observations, we
identified no board activities associated with administration
of STJ taxes that we would consider low priority or
noneconomic. Further, no activities that the board could
change to significantly improve efficiency other than those
already identified by the board came to our attention. We
present the results of our review of the actions the board is
taking to improve efficiency in Appendix B.
To identify alternatives to the board’s administration of the
STJ tax revenues, we reviewed available literature (e.g.,
journal articles) concerning efforts to privatize government
operations. We also reviewed the efforts other states
undertook to delegate tax administration responsibilities to
local governments or special districts and the degree to
8
which other states or local governments privatized their tax
administration operations. We present the results of our
review in Appendix C.
In Appendix D, we provide a detailed description of the
board’s cost model, including how the board calculates
direct and shared costs, and allocates costs to individual
STJs.
To identify alternatives to the board’s allocation of shared
costs, we surveyed 13 states to determine how they
calculated fees for administering their local taxes. We
identified several other methods of calculating fees for
administration of taxes. Some states do not charge a fee
to local governments or special districts for administering
their taxes, while others charge a flat rate per retailer or
a percentage of the revenues collected, ranging from
1 percent to 3 percent. None of the states we surveyed
assessed a type of cost similar to the board’s shared costs.
9
Chapter 1
A Policy Decision Underlying the Cost
Model Used by the Board of
Equalization Needs to be Reassessed
Chapter Summary
A
lthough the Revenue and Taxation Code directs the
Board of Equalization (board) to assess central
agency costs, direct costs, and shared costs to
special tax jurisdictions (STJ) to help pay for the board’s
tax administration system, several factors led us to
conclude that the State’s policy makers should examine the
reasonability and equitability of the cost model used to
calculate STJ assessments. First, the cost model reflects
a significant policy decision to allocate the board’s basic, or
infrastructure, costs of operating its tax administration
system to STJs and local governments. The board would
continue to incur these costs, which are defined as shared
costs, even if it did not administer the taxes for these
entities.
Second, the application of the cost model creates an
apparent imbalance between the proportion of revenue
STJs earn and the proportion of costs they pay. While the
State and local governments (cities and counties) appear to
be paying for the board’s tax administration system to the
degree that they benefit from it (i.e., the proportion of
revenue they generate is roughly equal to the proportion of
costs they pay), the proportion of costs the STJs pay is
nearly twice as much as the proportion of revenue they
earn. This occurs because the STJs are assessed a large
amount of direct costs associated with the unique nature of
their transactions taxes as well as a large amount of shared
costs. On the other hand, the State and the local
governments are assessed few direct costs in addition to
their portion of shared costs.
Finally, the application of the cost model results in
assessments to the STJs that are regressive in nature.
Specifically, STJs with tax rates of less than 0.5 percent
10
pay a higher proportion of their revenue to the board for
administrative costs than do STJs with tax rates of
0.5 percent. This occurs because it generally costs the
board the same amount to administer a tax with a
0.1 percent rate as one with a 0.5 percent rate.
Background
Section 7273 of the California Revenue and Taxation Code
directs the board to assess STJs central agency costs,
direct costs, and shared costs to help pay for the board’s
administration of STJ taxes. It does not, however, define
these costs. In the absence of statutory definitions, the
chief of the board’s financial management division stated
that the board applies definitions it developed in
conjunction with the Department of Finance.
Central Agency Costs
Central agency costs are those costs incurred by the
State’s central service departments for activities that
benefit all state departments, including the board.
Examples of these activities include the state controller
issuing warrants and the state treasurer cashing warrants.
During fiscal year 1995-96, central agency costs accounted
for $1.7 million, or 4 percent, of the $39.2 million the board
assessed the STJs.
Direct Costs
Direct costs are defined as those directly associated with
each tax program. The board estimates them based on
workload standards and other forms of cost measurement.
The State and local governments incur few direct costs
because the application of the cost model identifies few
Direct costs are those activities from which only they derive benefits. STJs,
additional costs the
however, bear a large amount of direct costs. The direct
board incurs
costs assessed to the STJs represent any additional or
administering the STJ tax
incremental costs that the board can identify as being
program.
incurred because it administers the STJs’ transactions
taxes. Concerning direct costs assessed to the
STJs, an underlying theme is that the STJs are the only
type of entity that receives benefits from the board’s
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workload associated with these costs. A second
underlying theme is that the board would not incur these
costs if it did not administer the STJs’ taxes. Specifically, if
STJs did not exist or if some other entity besides the board
administered their taxes, the board would not have incurred
the direct costs that it assessed the STJs. During fiscal
year 1995-96, direct costs accounted for $17.6 million, or
45 percent, of the $39.2 million the board assessed the
STJs.
Shared Costs
Shared costs are defined as the costs of the board’s tax
administration system that benefit the State, local
governments, and STJs individually and jointly but cannot
be separately identified as being directly incurred to
support any entity. The board calculates the amount of
shared costs by subtracting costs unrelated to
administration of the STJs’ transactions taxes and local
Shared costs are the
governments’ sales taxes, as well as direct costs for the
board’s basic, or
STJs, local governments, and the State from the total costs
infrastructure, costs.
of its tax administration system. In other words, shared
costs are the board’s basic, or infrastructure, costs of
operating its tax administration system. Therefore,
through the use of the cost model, the board allocates a
portion of its overall costs associated with registration,
return processing, auditing, and collection of delinquent
taxes to STJs even though those costs are not directly
related to STJ workload. According to the chief of the
board’s financial management division, the board would still
incur these costs if it did not administer taxes for the STJs
and the local governments. During fiscal year 1995-96,
shared costs accounted for $19.9 million (51 percent) of the
$39.2 million the board assessed the STJs.
The Board’s Assessment of
Shared Costs Raises Questions
The definitions of central agency costs and direct costs
used by the board are reasonable.1 However, we believe
that the definition of shared costs used by the board, as
1 See Chapter 2 of this report for our discussion of problems we found
concerning the board’s calculation of direct costs.
12
well as its assessment of this type of cost, is worthy of
consideration as to its reasonability and equitability.
The board assesses shared costs to the STJs and local
governments because it believes the entities that receive
benefits (i.e., tax revenues) from its basic tax administration
system should help pay for that system. Because the
board distributes tax revenues to the State, local
governments, and STJs, it believes that all three types of
entities should help pay for the costs the board incurs to
administer these taxes over and above any direct costs.
The board believes that the cost model distributes shared
costs to each entity to the extent that each benefits from its
tax administration system.
The Board’s Approach Is One
of Several Alternatives
Although numerous methods can be used to charge costs
to the STJs, there are two basic approaches. The board
uses the basic approach of including existing costs when
calculating the costs of administering the STJs’ taxes. In
March 1992, the Office of the Auditor General concluded
that, although the board needed to refine and correct its
cost model reflecting this approach, its use was defendable
because, among other reasons, sharing the costs of the
board’s tax administration system did not conflict with the
applicable state statutes and because the State, local
governments, and the STJs all benefited from the system.
The report also concluded that the other basic approach, to
charge the STJs for only the incremental or direct costs of
administering their transactions taxes, was also
defendable. This conclusion was based on the concept
that local governments and STJs should have to reimburse
the board only for costs that it would otherwise not incur to
administer their tax programs. Clearly, the incremental
approach is a much less costly alternative to the STJs. If
the board had used this approach in fiscal year 1995-96, it
would have charged the STJs only $17.6 million rather than
$39.2 million.
Shared Costs Are Not Indirect Costs
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The definition of shared costs used by the board is not
limited to only the indirect costs other state agencies are
required to charge when they provide goods or services.
Section 8752 et seq. of the State Administrative Manual
(SAM) requires departments to recover central service
costs, direct costs, and indirect costs whenever they
provide goods or services for others, except when statutes
Shared costs include
prohibit full cost recovery. Although the definitions of
more than the usual
overhead and support central agency costs and direct costs used by the board
costs. are similar to the SAM’s definitions of central service costs
and direct costs, the definition of shared costs used by the
board is not the same as the SAM’s definition of indirect
costs. The SAM defines indirect costs as those support
costs that usually benefit more than one cost objective or
organizational unit [emphasis added]. The SAM also
refers to indirect costs as overhead costs. Examples
provided include personnel costs of administrative,
supervisory, and executive staff; personnel costs of support
units, such as clerical and housekeeping; and operating
and equipment costs not included as part of direct costs.
The board includes most of the costs associated with its tax
administration system not specifically related to either the
STJs or local governments in the shared cost portion of the
model. The cost model apportions these shared costs to
the State, the STJs, and the local governments. Thus, the
STJs and local governments are paying for administration
costs that extend beyond the SAM’s definition of indirect
costs. The reasonability and equitability of this merits
consideration by the State’s policy makers.
Because the statutes do not define shared costs and
because both approaches are defendable, the questions of
Who should pay for
who should pay for the board’s infrastructure and to what
infrastructure costs, and
extent they should pay are policy issues. If it is the State’s
to what extent, are policy
policy makers’ intent that the STJs share in the costs of the
issues.
board’s infrastructure, then the cost model used by the
board is generally reasonable and equitable. If, on the
other hand, it is not their intent, then the cost model is not
reasonable or equitable.
The Cost Model Causes
Apparent Disparities
14
The board’s application of the cost model results in several
apparent disparities that the State’s policy makers should
be aware of when considering the model’s reasonability
and equitability. For example, as Table 3 shows, in each
fiscal year from 1993-94 through 1995-96, the board
passed on nearly 28 percent of its infrastructure costs to
the STJs and local governments. As the chief of the
board’s financial management division pointed out, the
State would incur these costs even if the board did not
administer the taxes of the local governments and the
STJs.
Table 3
Assessments of Shared Costs
Fiscal Years 1993-94 Through 1995-96
(in Millions)
1993-94 1994-95 1995-96
STJ portion of shared costs $ 16.9 $ 18.6 $ 19.9
Local government portion of shared costs 31.2 34.3 36.6
Subtotal 48.1 (27.9%) 52.9 (27.8%) 56.5 (27.9%)
State portion of shared costs 124.6 (72.1%) 137.3 (72.2%) 146.2 (72.1%)
Total Shared Costs $172.7 (100%) $190.2 (100%) $202.7 (100%)
The cost model also creates an apparent imbalance
between the proportion of revenue the STJs earn and the
proportion of costs they bear. Following the board’s
approach of allocating costs to each entity based on the
Cost model creates an
extent to which it benefits (i.e., receives tax revenues), one
apparent imbalance
would expect that the proportion of revenue that an entity
between the fees paid
receives would roughly equal the proportion of costs the
and benefits derived by
board assesses. As Table 4 shows, the two proportions
STJs.
for the State and the local governments were within
3 percentage points of each other from fiscal year
1993-94 through 1995-96. This indicates that generally
the State and local governments are paying for the board’s
tax administration system to the extent that they benefit.
However, for STJs, the proportion of costs was nearly twice
as high as the proportion of revenue.
Table 4
Comparison of Proportion of Revenue to Costs
15
Fiscal Years 1993-94 Through 1995-96
1993-94 1994-95 1995-96
STJs
Proportion of total tax revenue 8.5% 8.3% 8.3%
Proportion of total costs 16.5 16.6 16.3
Difference (8.0) (8.3) (8.0)
Local Governments (1.25 percent)
Proportion of total tax revenue 16.2 15.8 15.8
Proportion of total costs 16.9 17.4 17.4
Difference (0.7) (1.6) (1.6)
State
Proportion of total tax revenue 65.0 63.3 63.2
Proportion of total costs 64.3 65.9 66.2
Difference 0.7 (2.6) (3.0)
Statewide Half-Cent Taxes
Proportion of total tax revenue 10.3 12.6 12.7
Proportion of total costs 2.3a 0.1a 0.1a
Difference 8.0% 12.5% 12.6%
a
These amounts are direct costs paid from the State’s General Fund.
Shared and related central agency costs associated with these two half-cent
sales taxes are paid from the revenues generated by the State’s 5 percent
sales tax, the local governments’ 1.25 percent sales tax, and the STJs’
transactions taxes. We discuss this issue in Chapter 2.
This apparent disparity resulted from the STJs bearing
direct costs ranging from $16.6 million to $17.7 million from
fiscal year 1993-94 through 1995-96 in addition to shared
costs ranging from $16.9 million to $19.9 million. On the
other hand, the State and the local governments incurred
few direct costs in addition to their portion of shared costs.
According to the chief of the board’s financial management
The State and the local division, the STJs incur a large amount of direct costs
governments pay few
because the differences between the STJs’ transactions
direct costs. taxes and the State’s and local governments’ sales taxes
force the board to conduct several activities that benefit
only the STJs.2 The State and the local governments incur
2 We describe the differences between the two types of taxes in the
Introduction.
16
few direct costs because the application of the model
identifies few activities from which only they benefit. For
example, during fiscal year 1995-96, in addition to direct
costs associated with the interagency agreements with the
Department of Motor Vehicles and the Department of
Housing and Community Development, the State incurred
direct costs of $602,000 (which the board did not include in
the cost model) associated with the implementation of a tax
exemption and the local governments incurred direct costs
of $2.0 million associated with the board’s local tax section.
Finally, the model results in assessments to the STJs that
are regressive in nature. Specifically, STJs that have tax
rates of less than 0.5 percent pay a higher proportion of
their revenue to the board in the form of administrative
costs. As Table 5 shows, STJs with tax rates of
0.25 percent, 0.125 percent, and 0.10 percent paid
effective assessment rates that ranged from 3.3 percent to
7.3 percent during fiscal years 1993-94 through 1995-96.3
STJs with a tax rate of 0.5 percent paid effective rates of
less than 2 percent. This occurs because it generally
costs the board the same amount to administer a tax with a
0.1 percent rate as one with a 0.5 percent rate. Therefore,
those STJs with lower tax rates will pay a higher proportion
of their revenues in the form of administrative costs.
Table 5
Effective Assessment Rates
for Special Tax Jurisdictions
Fiscal Years 1993-94 Through 1995-96
Effective Assessment Rates
Tax Rate 1993-94 1994-95 1995-96
0.5 percent 1.85% 1.93% 1.85%
0.25 percent 3.40 3.34 3.50
0.125 percent N/A N/A 7.31
0.10 percent 4.89 6.63 6.44
3 Effective assessment rates are calculated by dividing an STJ’s
assessment costs by the revenue it generates.
17
Conclusion
The Revenue and Taxation Code directs the board to
assess central agency costs, direct costs, and shared costs
to special tax jurisdictions to help pay for its tax
administration system. However, we concluded that the
State’s policy makers should examine the reasonability and
equitability of the cost model used to calculate STJ
assessments. First, the cost model reflects a significant
policy decision to allocate the board’s infrastructure costs
of operating its tax administration system to STJs and local
governments. Second, the application of the cost model
creates an apparent imbalance between the proportion of
revenue STJs earn and the proportion of costs they pay.
The proportion of costs the STJs pay is nearly twice as
much as the proportion of revenue they earn. This occurs
because the STJs are assessed a large amount of direct
costs, while the State and the local governments are
assessed few direct costs. Finally, the application of the
model results in regressive assessments. STJs with tax
rates of less than 0.5 percent pay a higher proportion of
their revenue to the board for administrative costs than do
STJs with tax rates of 0.5 percent. This occurred because
it generally costs the board the same amount to administer
a tax with a 0.1 percent rate as one with a 0.5 percent rate.
Recommendation
Because the cost model used by the board reflects a
significant policy decision to allocate infrastructure costs to
the entities that benefit from the board’s tax administration
system, the State’s policy makers should examine the
policy decision. Specifically, they should consider whether
it is reasonable and equitable for special tax jurisdictions
and local governments to bear a percentage of the
infrastructure costs associated with the board’s tax
administration system.
18
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19
Chapter 2
Some of the Costs the Board of Equalization
Assesses Special Tax Jurisdictions Are
Unreasonable or Inequitable While
Others Are Questionable
Chapter Summary
O
ur review of the costs the Board of Equalization
(board) assessed special tax jurisdictions (STJ)
disclosed several problems. First, the board
charged the STJs additional costs associated with its
administration of two unrelated statewide sales taxes. As
a result, from fiscal year 1993-94 through 1995-96, the
STJs paid nearly $6.6 million in charges that they should
not have. Second, the board used questionable workload
factors when it calculated the amount of direct costs to
assess STJs; some were developed without benefit of
workload studies while others have not been updated since
they were developed using data from fiscal year 1987-88.
For these reasons, we were unable to conclude whether
the direct costs the board assessed the STJs were
reasonable or equitable. Third, the board based its
allocations to individual STJs, in part, on proportion of
revenue rather than entirely on workload indicators. The
board’s use of proportion of revenue led to 18 STJs being
overcharged by nearly $1.7 million and 11 STJs being
undercharged by the same amount. Finally, the board
made minor errors when it calculated the STJ assessments
for fiscal year 1995-96.
STJs Were Inequitably Charged Nearly
$6.6 Million for the Board’s Administration
of Two Other Taxes
According to the reasoning of the cost model used by the
board, entities receiving benefits (i.e., tax revenues) from
the board’s tax administration system should help pay for
the system to the extent that they benefit from it.
Generally speaking, the board calculates the total amount
20
of shared costs for each type of entity based on the
proportion of tax revenue that each receives.4 From fiscal
year 1993-94 through 1995-96, the board administered five
taxes: the State’s 5 percent sales tax; the STJs’
transactions taxes (ranging from 0.1 percent to 0.5 percent
of sales depending on the STJ); local governments’
statewide 1.25 percent sales tax; and two local
governments’ statewide half-cent sales taxes, one for
public safety and one for local revenue. The board’s
reasoning dictates that, because it administers these five
taxes for the State, STJs, and local governments, these
entities should help pay for the costs of administering the
taxes.
The Board Does Not Consistently Apply
the Reasoning of the Cost Model
To recover its costs associated with administering the five
taxes, the board withholds the amount of costs it is owed
from the revenue generated by only three taxes.
According to the chief of the board’s financial management
division, the State’s General Fund bears the direct cost of
administering the two
half-cent sales taxes. However, the board does not
withhold any revenue generated by the two half-cent sales
taxes to cover shared or related central agency costs.
Instead, it collects these costs from the revenues
generated by the State’s 5 percent sales tax, the STJs’
transactions taxes, and the local governments’
1.25 percent sales tax. Therefore, STJs are paying the
board an additional amount of the revenue generated by
their transactions taxes to help support two unrelated sales
taxes. From fiscal year 1993-94 through 1995-96, the
board assessed the STJs nearly $6.6 million (5.9 percent of
the total assessed to STJs) in costs associated with its
administration of the two unrelated half-cent sales taxes.
4 See Chapter 1 for a description of shared costs and other types of
costs the board assesses STJs.
21
The board does not withhold portions of the revenues of
the two half-cent taxes to cover their shared or central
agency costs because, although the board is directed by
statutes to recover the costs of its administration of the
The decision to recover
STJs’ transactions taxes and the local governments’
from STJs the costs of
1.25 percent sales taxes, according to the chief of the
two unrelated sales taxes
board’s financial management division, it has no statutory
is
or legal authorization to recover costs for administering the
unreasonable.
two half-cent taxes from their revenue. The chief further
stated that, in the absence of such authorization, staff of
the board and the Department of Finance decided that
shared costs could not be assessed against these two
taxes. The effect of this decision was to recover the
shared and central agency costs associated with
administering the two half-cent sales taxes from the
revenues of the other three taxes.
We believe the decision to recover costs associated with
the administration of the two half-cent sales taxes from the
STJs results in costs to the STJs that are neither
reasonable nor equitable. First, according to the logic of
the cost model, costs should be assessed based on the
degree to which the entities benefit from the board’s
administration. Since the STJs received no additional
benefits (i.e., revenues) from the board’s administration of
the two half-cent taxes, they should not have been
assessed additional costs. Second, although the board
stated that it had no statutory or legal authority to recover
administrative costs from the revenues of the two half-cent
sales taxes, it could not provide a statutory or legal
authority that enabled it to charge the STJs or local
governments for the administration of these two taxes.
The Board Used Questionable Workload
Factors To Calculate Direct Costs
The board determined the amount of direct costs to assess
the STJs based on inadequately supported or outdated
information. The chief of the board’s financial
management division indicated that the board estimates
the amount of direct costs to be charged to STJs because
the board’s time-reporting system does not enable it to
calculate the actual amount of direct costs. This estimate
is based on “workload factors” it has developed. However,
when it calculated the amount of direct costs to assess the
22
STJs, the board used some workload factors that were not
based on workload studies and others that have not been
updated recently. For fiscal year 1995-96, the board
assessed the STJs $17.6 million in direct costs. We
present an example of how the board uses workload
factors in its calculation of direct costs in Appendix D.
Previously, the Office of the Auditor General noted that the
board did not have workload studies for all direct costs. As
the Office of the Auditor General pointed out in its report
entitled “The Board Of Equalization Needs To Adjust Its
Model For Setting Reimbursement Rates For Special Tax
Jurisdictions” issued in March 1992, the board’s field audit
section estimated, without performing any studies, that
Estimates for most direct
when a county has one STJ, the field audit hours increase
costs were not based on
by 5 percent and when a county has two STJs, the field
workload studies or
audit hours increase by 6 percent. The board also
current information.
estimated that audit time in counties adjacent to STJ
counties caused an additional 50 percent increase in audit
hours calculated for STJ counties. These three estimates
were developed by the board’s principal tax auditor and
reviewed by board staff in several district offices. The
report concluded that an estimate of the incremental time
needed to audit in districts that had STJs could be
cost-effectively developed based on actual hours in a
sample of audits. However, for its calculation of direct
costs associated with audits for fiscal years 1993-94
through 1995-96, the board continued to use the three
estimates; it did not develop workload factors for audits
based on a sample of audit hours. Direct costs associated
with field audits comprised $7.3 million (18.6 percent) of the
STJs’ $39.2 million assessment for fiscal year 1995-96.
We also found that the board has not updated 12 of the 16
workload factors it uses to calculate direct costs associated
with the return processing function since it developed them
using information from fiscal year 1987-88. One of the 4
remaining workload factors has not been updated since
fiscal year 1991-92. Although the absence of recent
workload studies prevented us from determining whether
the board’s use of most workload factors in its calculations
resulted in under- or overassessments to the STJs, in one
instance, an updated workload factor would have resulted
in an additional $302,000 assessment to the STJs during
fiscal year 1995-96. Among those not updated are
workload factors the board uses to estimate the amount of
23
annual workload STJs generate for several of the board’s
organizational units and another used to estimate how
much work an individual can complete in one year.
To ensure it assesses the proper amount of direct costs to
STJs, the board should base its workload factors on
studies of workload and should periodically update the
factors it uses. Periodic updating is necessary because
changes in the board’s operations may change the
workload factors. Since fiscal year 1987-88, the year from
which it used data to develop most of its workload factors,
the board has changed some of its operations. For
example, according to the supervisor of the return analysis
section, in fiscal year 1989-90, the board automated its
process for recalculating amounts listed on tax returns and
for correcting errors that were previously performed
manually. He also stated that in fiscal year 1990-91 the
board further automated its billing system, resulting in
changes to the processes used by the billing unit within the
return processing element.
If the board’s use of inaccurate workload factors leads it to
assess too many costs to the STJs, the STJs will
We cannot conclude that
inappropriately subsidize the board’s operations.
the direct costs charged
Likewise, if their use leads the board to assess too few
the STJs were
costs, the STJs will inappropriately pay too little. Because
reasonable or equitable.
the board developed some of its factors without benefit of
workload studies and has not periodically updated other
workload factors, we cannot conclude that the amount of
direct costs the board charged the STJs was reasonable or
equitable.
The board contends that it has not conducted workload
studies and has not updated all of its workload factors
because, according to the chief of its financial management
division, it has been in a continual state of change since the
Office of the Auditor General issued its report. The chief
cited the board’s ongoing efforts to improve efficiency as
one example of change.5 The chief also stated that it
would not be cost effective for the board to update its
workload factors at this time because of its implementation
of a computer automation project and its review of the
return processing function. The chief stated that, because
5 We describe the board’s ongoing efforts to improve efficiency in
Appendix B.
24
the results of these projects will change the way it
operates, the workload factors the board uses to calculate
direct costs will change. However, to ensure that it is
charging an accurate and equitable amount of direct costs
to STJs, the board must periodically update the workload
factors it uses.
The Board Does Not Fully Use
Workload Indicators To
Assess Costs to STJs
The board’s method of allocating costs to the individual
STJs resulted in some STJs being over- and
undercharged. Once the board determines the amount of
total costs to assess the STJs, it must then determine how
much of these costs to assess each individual STJ. For
fiscal year 1995-96, the board determined that it would
assess the 32 STJs a total of $39.2 million in administrative
costs.
Currently, the board uses key indicators of workload such
as the number of permits and the number of returns
processed during portions of its calculation of the amount
of shared costs to be assessed. For instance, the board
uses key indicators to calculate costs associated with
workload in counties without STJs. These costs are then
subtracted from the total amount of shared costs so that
STJs are not charged for activities from which they
received little to no benefits. For example, if 15 percent of
the permits held by retailers in the state are held by
retailers located in counties without STJs, the board would
assess 15 percent of its costs for registration to non-STJ
counties. The board also uses key indicators to determine
the amount of shared costs each of the five groups of STJs
will bear.6 We believe that the board’s use of key
indicators to calculate these amounts is reasonable and
equitable.
However, when the board allocates costs to individual STJs
within each group, it bases the allocation on proportion of
revenue rather than extending the use of key indicators.
For example, if the board estimates that an STJ in one
6 See Appendix D for a description of how and why the board groups
STJs to assess costs.
25
group will earn 30 percent of the revenue earned by all
STJs in that group, the board will assess this STJ
30 percent of the costs assessed to that group.
Because the board allocated shared costs to the STJs
within each group based on their proportion of revenue
rather than key indicators, some STJs are paying more
The board’s allocation of costs than they should while others are paying less. When
costs resulted in we recalculated assessment amounts using the board’s
$1.7 million in over- and information for key workload indicators rather than
undercharges to proportion of revenue, we found that, for fiscal year
STJs. 1995-96, the board has overcharged 18 STJs nearly
$1.7 million and has undercharged 11 others the same
amount. For example, the board has undercharged the
Orange County Local Transportation Authority by $619,000
and overcharged the Sacramento Transportation Authority
by $187,000. Table 6 shows the amounts
and percentages the board will overcharge or undercharge
the STJs during fiscal year 1995-96.
The board has the necessary information available to
allocate costs to each STJ based on key indicators rather
than proportion of revenue and could readily perform the
calculations. The chief of the board’s financial
management division indicated that the Auditor General
reviewed the allocation method and did not recommend
changing it. However, we believe the use of key indicators
to allocate costs to individual STJs is consistent with the
recommendations the Auditor General made and, as our
analysis shows, some STJs are paying more costs than
they should while others are paying less. Specifically, in
fiscal year 1995-96, the board will over- or undercharge 15
STJs by at
least $100,000 each and will over- or undercharge 18 STJs
by at least 10 percent. For example, the board will
overcharge the Fresno County Transportation Authority by
$123,000, or nearly 21 percent.
The Board Made Two Minor
Errors in Calculation
Notwithstanding the concerns we have with the board’s
current calculation and allocation processes, the board
made two minor errors when it calculated STJ assessments
for fiscal year 1995-96 using its current processes. In one
26
instance, the board did not include revisions that its audit
division had made to the number of audit hours when it
calculated the amount of shared costs for the audit element
to be allocated between non-STJ counties and STJs. As a
result, STJ counties were overcharged $172,400 for
auditing while non-STJ counties were undercharged the
same amount.
Table 6
Comparison of Assessments Calculated
Using Proportion of Revenue
Versus Using Workload Indicators
Fiscal Year 1995-96
Assessments Assessments Amount Percentag
Calculated Using Calculated Over or e
Proportion of Using (Under) Over or
Special Tax Jurisdiction Revenue Workload Assessed (Under)
Indicators Assessed
Alameda County Transportation Authority $ 1,234,000 $ 1,046,000 $ 188,000 18.0%
Bay Area Rapid Transit District 2,726,000 2,548,000 178,000 7.0
Calexico Heffernan Memorial Hospital District 28,000 36,000 (8,000) (22.2)
City of Clearlake Public Safety Transactions and Use 9,000 9,000 0 0.0
Tax
Contra Costa Transportation Authority 765,000 585,000 180,000 30.8
Del Norte County District 17,000 28,000 (11,000) (39.3)
Fresno County Transportation Authority 712,000 589,000 123,000 20.9
Fresno Metropolitan Projects Authority 264,000 264,000 0 0.0
Imperial County Local Transportation Authority 133,000 114,000 19,000 16.7
Inyo County Rural Counties Transactions Tax 26,000 35,000 (9,000) (25.7)
Los Angeles County Transportation Commissiona 7,377,000 7,807,000 (430,000) (5.5)
Los Angeles County Transportation Commission 7,280,000 7,436,000 (156,000) (2.1)
Madera County Transportation Authority 79,000 115,000 (36,000) (31.3)
Orange County Local Transportation Authority 3,136,000 3,755,000 (619,000) (16.5)
Riverside County Transportation Commission 1,218,000 1,113,000 105,000 9.4
Sacramento Transportation Authority 1,280,000 1,093,000 187,000 17.1
San Benito County General Fund Augmentation 23,000 18,000 5,000 27.8
San Benito County Council of Governments 24,000 20,000 4,000 20.0
San Bernardino County Transportation Authority 1,349,000 1,248,000 101,000 8.1
San Diego County Regional Transportation 2,754,000 2,611,000 143,000 5.5
Commission
San Francisco County Public Finance Authority 819,000 721,000 98,000 13.6
San Francisco County Transportation Authority 867,000 843,000 24,000 2.8
San Joaquin Transportation Authority 461,000 433,000 28,000 6.5
San Mateo County Transit District 739,000 626,000 113,000 18.1
San Mateo County Transportation Authority 733,000 630,000 103,000 16.3
Santa Barbara County Local Transportation Authority 403,000 426,000 (23,000) (5.4)
Santa Clara County Transit District 1,830,000 1,973,000 (143,000) (7.2)
Santa Clara County Transportation Authorityb 1,828,000 1,963,000 (135,000) (6.9)
Santa Cruz County Earthquake Recovery Bond 188,000 151,000 37,000 24.5
Santa Cruz Metropolitan Transit District 189,000 157,000 32,000 20.4
Sonoma County Open Space Authority 381,000 479,000 (98,000) (20.5)
Stanislaus County Library Transactions and Use Tax 366,000 366,000 0 0.0
27
Total 1995-96 STJ Assessments $39,238,000c $39,238,000 $
0d
a
Los Angeles County assesses two separate transactions taxes, both of which are associated with the Los Angeles
County Transportation Commission. This tax was implemented in 1982 while the other was implemented in 1991.
b
Although the board calculated this charge for the Santa Clara County Transportation Authority, it did not assess the
amount because the STJ did not come into existence.
c
The $39.2 million assessment, as calculated by the cost model, does not include a $207,000 net decrease to
compensate for the board’s overcollection of costs during fiscal year 1993-94. This adjustment affected some STJs
more than others.
d
The net effect of this allocation method for all 32 STJs is zero. However, the effect on individual STJs is an
overassessment of $1,668,000 for some STJs and an underassessment of the same amount for others.
Also, when the board was calculating the amount of shared
costs for collections to be allocated between non-STJ
counties and STJ counties, it counted certain collections for
one county twice as an STJ county. As a result, STJ
counties were overcharged $6,700 for collections while
non-STJ counties were undercharged the same amount.
Conclusions
Our review of the costs the board assessed STJs disclosed
several problems. For example, the board charged the
STJs for some costs associated with its administration of
two statewide half-cent sales taxes. As a result, the STJs
paid nearly $6.6 million in charges that they should not
have from fiscal year 1993-94 through 1995-96. Also, the
board used questionable workload factors when it
calculated the amount of direct costs to assess STJs.
These factors were questionable because the board
developed some without benefit of workload studies and
has not updated others since they were developed using
data from fiscal year 1987-88. Because the board used
these questionable workload factors, we cannot conclude
whether the direct costs the board assessed the STJs were
reasonable or equitable. Moreover, the board based its
allocations, in part, on proportion of revenue rather than on
key indicators of workload. The board’s use of proportion
of revenue led to 18 STJs being overcharged nearly
$1.7 million and 11 STJs being undercharged the same
amount. Finally, the board made two minor errors when it
calculated the STJ assessments for fiscal year 1995-96.
Recommendations
28
To ensure reasonable and equitable assessments to the
STJs, the Board of Equalization should:
Stop charging the STJs for partial costs of administering
the two statewide half-cent sales taxes;
Use workload factors that are based on workload
studies;
Periodically update the workload factors it uses in the
model to calculate direct costs;
Allocate costs to individual STJs based on key
indicators of workload rather than proportion of revenue;
and
Correct the minor errors we identified.
29
We conducted this review under the authority vested in the
state auditor by Section 8543 et seq. of the California
Government Code and according to generally accepted
governmental auditing standards. We limited our review to
those areas specified in the audit scope of this report.
Respectfully submitted,
KURT R. SJOBERG
State Auditor
Date: January 3, 1996
Staff: Karen L. McKenna, CPA, Audit Principal
Dale A. Carlson, CGFM
Carey G. Gilmour
Brian Lewis, CPA
Phyllis Miller, CPA
30
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31
Appendix A
The Board of Equalization’s
Computation of Assessment Amounts
Fiscal Year 1995-96
Cities and
Counties Special Tax
Cost Category State (1-1/4%) Jurisdictions Total
Shared Cost $146,217,559 $36,578,041 $19,903,238 $202,698,838
Direct Cost:
Various cost centers 6,011,336 6,011,336
Local tax section 2,008,217 2,140,992 4,149,209
Field audits 7,263,642 7,263,642
Audit section 679,375 679,375
Subtotal Direct Costs 0 2,008,217 16,095,345 18,103,562
Central Agency 6,828,000 1,802,000 1,681,000 10,311,000
Other Direct Cost:
Department of Motor 6,535,952 1,635,045 1,493,903 9,664,900
Vehicles
Department of Housing 18,868 4,720 64,112 87,700
and
Community
Development
Subtotal Other Direct 6,554,820 1,639,765 1,558,015 9,752,600
Total Costsa $159,600,379 $42,028,023 $39,237,598 $240,866,000
a The STJ total does not include a decrease of $207,000 to adjust the assessed costs for
fiscal year 1993-94. The board makes this adjustment annually to compensate for the
over- or underallocation of costs. Further, the total for all three entities does not
include $212,000 from the State’s General Fund for the two statewide half-cent sales
taxes.
32
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33
Appendix B
Actions the Board of Equalization Is
Taking to Improve Efficiency
A
s part of our audit of the Board of Equalization
(board), we considered and evaluated economies
and efficiencies in its administration of taxes for
special tax jurisdictions (STJ). The board has recognized
that certain inefficiencies currently exist in the way it does
business, and as a result, has pursued various projects to
improve its processes. We examined documentation for
two ongoing automation projects and one project the board
is undertaking to improve the cost efficiency of its tax
administration system. However, we did not assess the
viability or progress of any of these projects.
Transfer of the Board’s
Central Computing Systems
One of the projects involves the transfer of the board’s
central computing systems, including data storage, to the
State’s Teale Data Center, while retaining certain
computing activities at the board. The project evolved as a
result of several problems with the current system. These
problems included an outdated
and inflexible computer architecture created by repeated
modifications of files and processes within the present
structure. Additionally, the current system was operating
at above rated capacity, with an estimated cost of $35 to
$45 million to replace the mainframe. Also, the board’s
ability to process and deliver timely information was at risk.
The board acknowledged that these difficulties resulted in
data redundancies, limited the usefulness of the current
system, and posed potential risks to its ability to collect
revenue. The transfer to the Teale Data Center is
designed to result in faster processing time and an
updated, integrated, and centralized computer system with
the ability to handle necessary tasks. The project is
scheduled for completion in May 1997.
34
The Automated Compliance
Management System
The board believes that the Automated Compliance
Management System (ACMS) will improve efficiency by
assisting collectors in prioritizing and managing collection
workloads. According to the board, the ACMS should help
the limited number of field staff keep pace with the growing
number of accounts, which increased 81 percent from
fiscal years 1988-89 to 1992-93, while collection staff
increased only 19 percent for the same time period. The
board expects the automation to increase productivity,
which has been limited due to decentralized,
paper-dependent processes. The board believes that
problems, such as an overloaded mainframe, limited
supervisory resources, and limited access to debtor
information, will also improve as a result of the ACMS
implementation. The board expects the ACMS to increase
revenue collection by $205 million over its six-year project
life and improve collection efficiency by reducing the
amount of paperwork, increasing taxpayer compliance,
reducing delinquent account additions, and improving
employee performance measurement. The ACMS project
is currently in the system development phase, and the
board plans to have it fully implemented in fiscal year
1996-97.
The Return Processing
Reengineering Project
The Return Processing Reengineering Project (project)
involves identifying processing delays, finding ways to
streamline return processing, identifying methods to correct
unreliability of electronically stored tax data, and
redesigning tax forms. The goal of the project is to
determine how the return processing function operates,
identify any problems and inefficiencies, and then make
both short- and long-term suggestions for improvement.
As of November 1995, the project did not have a set
completion date.
These projects will result in increased short-term costs to
the STJs during development and implementation.
However, the documentation we reviewed indicates that
35
efficiencies achieved through the transfer of computing
services to the Teale Data Center, implementation of the
ACMS, and identification of how to improve the return
processing function will benefit the State by ultimately
resulting in increased revenue or avoided costs.
Presumably, then, the projects would also benefit the STJs,
since they are a part of the State’s tax administration
program. However, although all of the projects have
designated benefits, the board provided quantifiable
information for only the ACMS project.
36
Appendix C
Alternatives to the
Board of Equalization’s
Administration of Taxes for
Special Tax Jurisdictions
O
ne of the purposes of our audit was to consider and
evaluate alternatives to the Board of Equalization’s
(board) administration of sales taxes associated with
special tax jurisdictions (STJ). Although the California
Revenue and Taxation Code currently requires STJs to
contract with the board for administration of their taxes, we
considered two options: delegation of administration
responsibilities to the STJs and contracting with private
firms for some or all of the administrative functions. We
surveyed 13 states to determine who administers their local
sales taxes, the degree to which they delegate or privatize
their tax administration functions, and benefits or problems
associated with delegation or privatization. These 13
states were Alabama, Arizona, Arkansas, Illinois,
Louisiana, Minnesota, Missouri, Nevada, New York, Ohio,
Texas, Utah, and Washington.
Delegation
Although none of the thirteen states in our survey
delegated tax administration functions to special districts or
other similar jurisdictions that had taxing authority, local
governments in Alabama, Arizona, Louisiana, and
Minnesota have some responsibilities for administering
local taxes. In Alabama, the state delegates responsibility
for administration of local sales taxes to approximately 160
of its cities or counties. Discussions with representatives
in Alabama disclosed no major problems associated with
delegation. According to a representative of one county in
Alabama, the county supports delegation because it enjoys
increased control over the taxing functions. She also
stated that she could not name any specific problems
associated with delegation. The president of a private firm
that handles all tax administration functions other than
37
auditing for 65 cities and 2 counties in Alabama identified
only one problem: the lack of a single, multi-purpose form
that the company could provide to retailers in various cities
and counties for reporting tax information. He added that
his company is currently developing one.
Louisiana delegates almost all tax administration
responsibility to its parishes (counties).7 The deputy
director of an association of local governments in this state
explained that parishes experienced possible problems
with retailer compliance with tax laws, with political
connections between retailers and local politicians, both of
which caused lost revenue, and with delays in distributing
revenues from the entities that collected it. She
concluded, however, that parishes generally enjoy
autonomy over their tax administration.
Privatization
Three of the 13 states we surveyed contract with private
firms for certain portions of their administration of local
sales taxes. For example, Missouri contracts with firms
and assigns them certain tax accounts from which it is
difficult to collect revenues. A representative explained
that it is more cost effective to use contractors because of
the low possibility of collection from the accounts and
because of savings realized by not using the services of
regular state employees. Also, Texas hires telephone
collectors to pursue non-filers and low-dollar accounts. It
experiences savings due to not bearing the expense of
benefit packages for the contracted telephone collectors.
We also found examples of cities or counties that
contracted for portions of their tax administration. The
functions most often contracted out by the local
governments we contacted were auditing and collection of
delinquent taxes. For example, in Alabama, most local
governments contract for audits of retailers.
A representative we spoke with identified a problem
associated with local governments privatizing aspects of
tax administration. Specifically, a representative of a local
government association in Louisiana mentioned difficulties
7 The only exception is the motor vehicle sales and use tax, which the
state administers.
38
with auditors occasionally overcharging local entities.
Although the representative was unable to quantify the
problem, she stated that it did not appear to occur on a
large scale.
Potential Problems
Aside from the survey results, potential problems came to
light that may arise with delegation or privatization. For
example, local governments may experience difficulties,
such as duplication of administration or increases in
non-filing due to taxpayers assuming it is easier to evade
local taxing authorities than it is the states’ authority.
Difficulties with registration of retailers, such as
inadvertently omitting retailers, may also occur.
Furthermore, contractors may have more problems
enforcing tax laws because of their perceived lack of
authority. Government entities may also experience
difficulties in finding suitable contractors to perform the tax
administration functions they wish to privatize.
Finally, we should point out that the sales taxes
administered by local governments in the states we
contacted generally are “point-of-sale” taxes.8 Because
taxes that are assessed based on point-of-use or
point-of-delivery provide revenue that may be generated
from outside the jurisdiction, potentially serious concerns,
such as the inability to efficiently and effectively audit
retailers outside the jurisdiction, could arise if
administration of these types of taxes is delegated to an
entity other than the State.
Presumably, there are cost savings when transactions are
performed on a statewide scale, but there are also benefits,
as evidenced by our survey, to local governments
administering their own tax programs or contracting out for
it. Further study regarding the specific costs and related
benefits of delegation and privatization would be needed
before these options are pursued.
8 Taxes administered by local governments in Louisiana are
“point-of-delivery” taxes. See the Introduction for our discussion of
the differences between “point-of-sale” taxes, “point-of-delivery”
taxes, and “point-of-use” taxes.
39
[Blank page inserted for reproduction purposes only.]
40
Appendix D
Methods the Board of Equalization
Uses To Calculate Assessments
for Special Tax Jurisdictions
T
he Board of Equalization (board) uses a complex cost
model to calculate direct costs and shared costs for
special tax jurisdictions (STJ). Generally speaking,
the board calculates direct costs based on workload factors
and other forms of cost measurement while it calculates
shared costs using both proportion of revenue and key
indicators of workload such as the number of permits and
the number of returns processed.
Calculating Direct Costs
The board assesses direct costs to the STJs for the return
processing and audit elements of its tax administration
system. To determine the amount of direct costs for the
various sections and units within these elements, the board
uses a series of calculations. For example, to calculate
the direct costs for STJs associated with the
correspondence unit within its return analysis section, the
board first calculates the amount of annual workload
generated by the STJs (total annual STJ workload).
According to the chief of the board’s financial management
division, “total annual STJ workload” represents the
number of lines on tax returns that pertain only to STJs.
As we show in Table 7, for fiscal year 1995-96, the board
estimated “total annual STJ workload” to be a little more
than 5 million lines. Next, the board multiplies this amount
by the percentage of “total annual STJ workload” that
generates workload for the correspondence unit (workload
factor #1). This calculation results in an estimated amount
of annual STJ workload for the unit. In fiscal year
1995-96, the board estimated that, since 1.5 percent of the
“total annual STJ workload” would generate workload for
the correspondence unit, the total annual workload
attributable to STJs was 75,100 correspondence items
(e.g., letters and memoranda).
41
Table 7
Calculation of Direct Costs for the
Board of Equalization’s Correspondence Unit
Fiscal Year 1995-96
Line
Number Calculation Element Amount
1. Total annual STJ workload 5,006,666 lines
2. Percentage generating workload for the
correspondence unit (workload factor #1) 1.5%
3. Amount of annual STJ workload for the 75,100
correspondence unit (line 1 times line 2) correspondence
items
4. Annual number of items processed per
personnel year (workload factor #2) 2,558
5. Personnel years necessary to handle
STJ-related 29.4
information (line 3 divided by line 4)
6. Annual cost per personnel year $69,591
7. Total costs to STJs for the correspondence
unit (line 5 times line 6) $2,045,975
The next step the board takes is to divide the total annual
workload attributable to STJs by the number of items a staff
person can process during the year (workload factor #2) to
determine the number of personnel years (PYs) necessary
to process STJ-related information.9 For 1995-96, the
board used 2,558 items as the workload factor for the
correspondence unit, resulting in 29.4 PYs necessary to
process STJ-related information. Finally, the board
multiplies the number of PYs necessary to process
STJ-related information by the cost per PY. For 1995-96,
the board multiplied the 29.4 PYs by $69,591 to arrive at a
9 A personnel year is the actual or estimated portion of a position
expended for the performance of work. For example, a full-time
position which was filled by an employee for half of a year would
result in an expenditure of 0.5 personnel years.
42
total direct cost to the STJs for the correspondence unit of
more than $2 million.
The board uses similarly complex calculations to determine
the amount of direct costs for the seven other sections
within the return processing element and for two areas
within the audit element. In total, the board uses 21
separate workload factors when calculating the amount of
direct costs to assess the STJs. In Table 8, we show a
breakdown of the direct costs the board assessed the STJs
during fiscal year 1995-96.
Table 8
Direct Costs Assessed to
Special Tax Jurisdictions
Fiscal Year 1995-96
Percentage
Element of of Total
Direct Costs Amount of Direct Costs Direct Costs
Return Processing
Local Tax Section $2,140,992 12.1%
Return Analysis:
Verification 1,550,305 8.8
Billing 731,027 4.1
Correspondence 2,045,975 11.6
Central Files 880,680 5.0
Word Processing 420,910 2.4
Accounting 331,727 1.9
Account Reference 50,712 0.3
Subtotal 8,152,328 46.2
Audits
Field Audits 7,263,642 41.1
Audit Section 679,375 3.9
Subtotal 7,943,017 45.0
Other Direct Costs
Department of Motor
Vehicles 1,493,903 8.5
Department of Housing
and Community
Development 64,112 0.3
Subtotal 1,558,015 8.8
43
Total Direct Costs $17,653,360 100.0%
Calculating Shared Costs
To calculate shared costs, the board determines the
amount of its costs for each of the four elements of the tax
administration system that will be shared by the State, local
governments, and the STJs, and the proportion of total
shared costs it will assess the STJs.10
To determine the amount of costs to be shared, the board
starts with the amounts the Governor’s Budget allocates for
each of the four tax administration elements. The board
subsequently revises these amounts based on adjustments
reflected in the annual Budget Act. As we show in Table
9, the total for the four elements for fiscal year 1995-96 was
$233.9 million. From this amount, the board subtracts two
types of costs. First, the board subtracts amounts that are
unrelated to its administration of the STJs’ and local
governments’ taxes so that it does not charge costs from
which the STJs and local governments do not benefit.
Second, the board subtracts the amounts of direct costs it
will assess the STJs and local governments so that it does
not double charge them. For the STJs only, the board
subtracts a third type of costs; specifically, those
associated with its work in counties that do not have STJs.
The board deducts these costs so that it does not charge
costs from which the STJs will receive little to no benefit.
The board later distributes these “non-STJ-county” costs to
the State and local governments. In fiscal year 1995-96,
the total amount of costs to be shared among the State, the
local governments, and the STJs was $181.6 million.
To calculate the proportion of total shared costs it will
assess the STJs, the board first estimates the amount of
revenue to be generated from each of the five taxes it
administers.11 As we show in Table 10, for fiscal year
1995-96, the board estimated that the five taxes would
generate $24.9 billion. Next, the board subtracts the
revenue it estimates will be earned from the two statewide
10 We describe the four elements of the board’s tax administration
system in the Introduction.
11 We describe the five taxes the board administers in the Introduction.
44
half-cent sales taxes. The board does this because it does
not withhold portions of the revenues from these two taxes
to help pay for its tax administration system. We discuss
this problem in Chapter 2. After subtracting the estimated
amount of STJ revenue, the board multiplies the remaining
amount by the percentage of dollar value of sales occurring
in counties with STJs. Since the board does not charge
the STJs for its work in counties that do not have STJs, the
board believes that it is more equitable to calculate the
Table 9
Calculation of Costs To Be Shared
Between the State, Local Governments,
and Special Tax Jurisdictions
Fiscal Year 1995-96
(in Millions)
Return
Calculation Element Registratio Processin Audits Collectio Total
n g n
Total tax administration
budget $36,523 $55,094 $110,096 $32,225 $233,938
Less unrelated costs (37) (2,645) (498) 0 (3,180)
Less direct costs for
STJs 0 (19,983) (8,076) 0 (28,059)
and local governments
Less costs incurred in
counties without STJs (6,144) (5,166) (6,195) (3,583) (21,088)
Total $30,342 $27,300 $ 95,327 $28,642 $181,611
proportion of STJ revenue by using only the total revenue
earned in counties with STJs rather than the total revenue
earned throughout the State. The board then adds the
estimated STJ revenue into the subtotal to arrive at the
adjusted amount of total revenue generated from the taxes.
To calculate the proportion of STJ revenue, the board
divides the estimated amount of STJ revenue by the
adjusted amount of total revenue. The board then
multiplies the resulting proportion of STJ revenue by the
total amount of costs to be shared to determine the amount
of shared costs to assess the STJs. In fiscal year
45
1995-96, the board multiplied 10.96 percent (from Table
10) by $181.6 million (from Table 9) to arrive at an STJ
assessment of $19.9 million for shared costs.
The Board’s Method for Allocating
Costs to Individual STJs
After the board calculates the amounts of direct and shared
costs to assess the STJs in total, it calculates how much of
these costs each STJ will be assessed. To begin this
process, the board places each STJ into one of five groups
depending on two factors: whether the STJ is located in a
county with another STJ (2-STJ county) or is alone in the
county (1-STJ county) and on the tax rate the STJ charges.
In fiscal year 1995-96, 14 STJs
Table 10
Calculation of the Percentage of Shared Cost
To Be Assessed to Special Tax Jurisdictions
Fiscal Year 1995-96
Amount
Line (Dollars in
Number Calculation Element Millions)
1. Total revenue estimated to be earned
from the five sales taxes $24,931
2. Less revenue estimated to be earned
from the two half-cent taxes 3,153
3. Subtotal #1 21,778
4. Less revenue estimated to be earned
from the STJs 2,069
5. Subtotal #2 19,709
6. Times percentage of dollar value of sales
in counties with STJs 85.31%
7. Subtotal #3 16,813
8. Plus revenue estimated to be earned
from the STJs 2,069
9. Subtotal #4 18,882
46
10. Proportion of STJ revenue to total
revenue 10.96%
(line 8 divided by line 9)
were in the 2-STJ county group that charged a tax rate of
0.5 percent, 14 STJs were in the 1-STJ county group that
charged a tax rate of 0.5 percent, 2 STJs were in the 1-STJ
county group that charged a tax rate of 0.25 percent, one
STJ was in the 1-STJ county group that charged
0.125 percent, and one STJ was in the 1-STJ county group
that charged a tax rate of 0.1 percent.
The board takes the number of STJs within a county into
consideration when it performs the calculations because an
STJ in a 2-STJ county shares the costs of the board’s
workload in that county with the other STJ whereas those
STJs in 1-STJ counties incur the entire costs. The board
takes the tax rates STJs charge into consideration
because, if it did not, the method of cost allocation used to
allocate costs to individual STJs would result in those STJs
that charge higher tax rates subsidizing STJs with lower tax
rates.
Once the STJs are placed in the applicable groups, the
board calculates the proportion of costs each group should
pay. The board calculates the proportion of both direct
and shared costs each group incurs based on key
indicators of workload. For example, if 54 percent of the
tax returns in the State are filed by retailers in STJs that fall
into the 2-STJ county group, the board will allocate
54 percent of the direct and shared costs for return
processing to this group.
The board then allocates to each STJ an amount
proportionate to the revenue that STJ will earn. For
instance, if an STJ in the 2-STJ county group earns
37 percent of the revenue generated by the STJs in the
group, the board allocates 37 percent of that group’s costs
to the STJ.
47
48