The 2018-19 Budget: California’s New Tax Departments

The 2018-19 Budget: California’s New Tax Departments MAC TAYLOR LEGISLATIVE ANALYST APRIL, 2018 Summary New Laws Reorganized State Tax Agencies. In 2017, the Legislature passed two laws that made major changes to tax administration and appeals in California. Prior to these laws, the Board of Equalization (BOE) had administrative and appeals responsibilities for many taxes and fees. The laws created two new departments—the California Department of Tax and Fee Administration (CDTFA) and the Office of Tax Appeals (OTA)—and transferred most of BOE’s duties to these departments. Governor Proposes $714 Million for These Tax Agencies in 2018-19. The administration’s 2018-19 budget proposal includes $30 million for BOE, $664 million for CDTFA, and $20 million for OTA. The Department of Finance has been reviewing some key components of these budgets and will report its findings to the Legislature this spring. Administration Has Begun Establishing OTA. The new laws created OTA, transferring most of BOE’s tax appeal duties to the new office. This year, the executive branch has begun executing these new laws and establishing the new department. So far, OTA has determined its organizational structure; proposed an initial budget and size; established its physical locations in Sacramento, Fresno, and Los Angeles; and begun hearing tax appeal cases. INTRODUCTION In 2017, the Legislature passed two laws— (CDTFA) and the Office of Tax Appeals (OTA)—and AB 102 and AB 131—that made major changes to transferred most of the Board of Equalization’s tax administration and appeals in California. The (BOE) duties to these departments. In this report, laws created two new departments—the California we summarize these changes and provide an Department of Tax and Fee Administration update on OTA. analysis full gutter 2018-19 BUDGET TAX ADMINISTRATION AND APPEALS PRIOR TO THE NEW LAWS State Tax System. The state collects revenue elected directly by district, and the fifth—the State from a variety of taxes and fees. Most state Controller—elected on a statewide basis. revenue comes from three major sources—the Franchise Tax Board (FTB) Administers personal income tax, the sales and use tax, and the Personal Income Tax and Corporation Tax. FTB corporation tax. The state also collects revenues administers personal income and corporate taxes from a variety of other taxes, including taxes on and is headed by a three-member board: the State alcohol and on insurance. County governments in Controller, the Director of Finance, and the chair California administer the property tax, collecting of the BOE. In 2016-17, FTB had a budget of the funds and distributing them to other local $758 million and 6,167 full-time equivalent (FTE) governments. employees. Tax Administration Tax Appeals BOE Administered Many Taxes and Fees. Taxpayers Can Appeal Decisions. When Prior to the new laws, BOE’s primary responsibility taxpayers disagree with the state about the taxes was to administer the sales and use tax (see they owe, they can appeal. In the initial steps of the Figure 1 below). It also administered dozens of appeal process, taxpayers interact with the same smaller tax and fee programs, including some agency that administered the disputed tax. If these programs related to property taxes. BOE is headed initial steps do not resolve the disagreements, by a five-member board, with four members taxpayers can have their appeals heard by a quasi-judicial body. Figure 1 Tax Administration and Appeals Prior to the New Laws Taxes Administration Appeals Income Taxes Personal and Franchise Tax Board Corporate Income Taxes Board of Equalization Sales and Use Tax Sales and Use Tax Board of Equalization Other Alcohol, Insurance, Property Other Other Taxes and Fees Alcohol, Insurance, Property 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET BOE Heard Tax Appeals. Prior to the new the 1949-50 Budget Bill noted inconsistencies in laws, BOE was the quasi-judicial body that heard tax administration among board members’ districts. appeals for state tax programs. The five-member Recent Concerns. In recent years, various board presided over appeals hearings and ruled on audits, evaluations, hearings, and other inquiries appeals by a majority vote of the board. Taxpayers have indicated a variety of problems with BOE’s who disagreed with the board’s decisions could operations, including actions that were not have their appeals heard in the trial courts. Tax consistent with legislative directives. For example, administration agencies, however, could not appeal an evaluation by the Department of Finance found the board’s decisions. that board members routinely supplemented their personal staff by redirecting BOE employees who Concerns About BOE were supposed to be performing other tasks, such Longstanding Concerns. BOE’s structure as audits. combines specific features of the legislative, BOE Established in State Constitution . . . The executive, and judicial branches of government. State Constitution sets up BOE’s basic structure, BOE is like the legislative branch in the sense that including its elected officers. The Constitution geographically distinct districts elect the board also establishes BOE’s authority over assessment members. However, BOE must carry out activities and collection of the alcoholic beverage tax, prescribed by the Legislature—a feature typically assessment of the insurance tax, and several associated with the executive branch. At the same aspects of property taxes. time, the board must resolve disputes over the . . . But Most Duties Were Statutory. Prior to application of laws—a judicial function. Due to the the new laws, state statute assigned most of BOE’s conflicts inherent in this structure, our office and roles, including the largest one—administering the others long expressed concerns about BOE’s ability sales and use tax. State statute also gave BOE the to operate effectively. For example, our analysis of authority to hear appeals of state taxes and fees. TAX ADMINISTRATION AND APPEALS UNDER THE NEW LAWS Laws Transferred BOE’s Statutory Duties to transferred most of BOE’s budget, staff, facilities, New Departments. In June 2017, the Legislature and other resources to CDTFA. CDTFA is a passed and the Governor signed AB 102. This department within the Government Operations law created two new departments—CDTFA and (GovOps) Agency. The head of the department is a OTA—and transferred all of BOE’s statutorily director appointed by the Governor and confirmed assigned duties to these new departments. The by the Senate. law did not amend the State Constitution, so BOE Tax Appeals maintained its constitutional authority over taxes on alcoholic beverages, insurance, and property OTA. The new laws also created OTA, (see Figure 2 on the next page). The law did not transferring most of BOE’s tax appeal duties to the make any changes to FTB. In September 2017, the new office. OTA is now responsible for hearing tax Governor signed AB 131, which further clarified appeal cases formerly assigned by statute to BOE, some of the changes made by AB 102. including personal income, franchise, and sales tax appeals. Unlike CDTFA, OTA is not part of a state Tax Administration agency. Like CDTFA, however, the head of the CDTFA. Under the new laws, CDTFA administers department is a director appointed by the Governor most of the tax and fee programs formerly and confirmed by the Senate. OTA’s director reports administered by BOE. Accordingly, the new laws directly to the Governor. www.lao.ca.gov 3 analysis full gutter 2018-19 BUDGET Figure 2 Tax Administration and Appeals Under the New Laws Taxes Administration Appeals Income Taxes Personal and Franchise Tax Board Corporate Income Taxes Office of Tax Appeals California Department of Sales and Use Tax Sales and Use Tax Tax and Fee Administration Other Other Other Taxes and Fees Alcohol, Insurance, Property Board of Equalization Board of Equalization Alcohol, Insurance, Property New Laws Funded OTA in 2017-18. The new New Laws Directed OTA to Hear Appeals laws appropriated $5 million in 2017-18 to establish in Three Offices. The new laws directed OTA to OTA. The new laws also gave the administration hear cases in tax appeals panels, each consisting the authority to augment this appropriation using of three administrative law judges (ALJs). These a transfer of funds from BOE’s budget to OTA’s panels are to hear cases in three locations: budget with notification to the Legislature. The Sacramento, Fresno, and Los Angeles. The laws administration notified the Legislature it was making also directed OTA to issue a written opinion for such a transfer of $2.2 million in February, bringing each case decided by the panels within 100 days. OTA’s total budget for 2017-18 to more than Similar to the process that existed with BOE, the $7 million. laws allowed taxpayers to appeal decisions made by OTA to the trial courts. 2018-19 BUDGET PROPOSALS The administration proposes $714 million in the 2017-18 budget. As a single entity, in 2016-17, total funds in 2018-19 to support 4,554 FTE BOE had a budget of $617 million and 4,716 FTE employees at the three tax agencies reorganized in employees. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET BOE Administration Conducting Mission-Based Review. The Department of Finance is currently Administration Proposes $30 Million and conducting a mission-based review of CDTFA’s 204 FTE Employees for BOE in 2018-19. The administration of the sales and use tax. Such administration proposes $30 million in General reviews examine state programs in greater depth Fund spending and 204 FTE for BOE in 2018-19. than the standard budget process. The goal of This proposal amounts to five percent of BOE’s these reviews is to align programs’ activities and 2016-17 budget. use of resources as closely as possible with their Report on Board Members’ Staff. The 2017-18 core missions. At this time, it is unclear whether Budget Act directed the Department of Finance to the sales and use tax review will lead to any report to the Joint Legislative Budget Committee by proposals—such as new statutes or changes April 1, 2018 regarding the ongoing staffing needs in CDTFA’s budget—that would require formal of the board members. Our office will comment on legislative action. Even if such action is not this report in upcoming budget hearings. required, the review presents an opportunity for Some Programs Administered by CDTFA. legislative oversight of the new department. Under a memorandum of understanding, CDTFA OTA administers the alcoholic beverage tax and the insurance tax on behalf of BOE. These programs— Administration Proposes $20 Million and listed under CDTFA’s budget—account for nearly 80 FTE Employees for OTA in 2018-19. The $4 million and 21 FTE employees. administration proposes $20 million in General Fund spending for OTA in 2018-19. The budget CDTFA includes nearly $12 million to support the salaries Administration Proposes $664 Million and and benefits of 80 FTE employees and around 4,270 FTE Employees for CDTFA in 2018-19. The $8 million for operating expenses and equipment. administration proposes $664 million ($354 million About $2 million of these funds are dedicated for General Fund) in funding and 4,270 FTE employees one-time purposes, such as purchasing furniture for CDTFA. This proposal includes $70 million for and making office modifications. an ongoing large-scale information technology (IT) project. OFFICE OF TAX APPEALS IN 2018-19 In this section, we provide updates for the out the department’s core mission of hearing Legislature on how the administration is interpreting tax appeals. the law as it establishes and begins operations in • Foundation. This division consists primarily of OTA. tax counsels, who will primarily provide case research for the hearings. Organization and Staffing • Case Management. This division provides OTA Organized Into Five Divisions. OTA plans other support functions for the hearings, to organize its 80 staff members into five divisions. including setting the hearing calendar for tax They are: appeals. • Administrative. This division provides • Executive. This division, which includes the fiscal oversight and performs personnel director and chief counsel, leads and directs management, IT, and business service OTA. functions. • Hearing. This division includes the ALJs—the personnel most directly involved in carrying www.lao.ca.gov 5 analysis full gutter 2018-19 BUDGET OTA Has Hired 20 ALJs, Including Two Executive Team Will Not Be Directly Involved Presiding ALJs. OTA has hired 20 ALJs, including in Hearings. Under law, the director of OTA is two presiding ALJs. These ALJs will form a number prohibited from directing, overseeing, supervising, of “fluid” panels so that the same three individuals or otherwise being involved in the decision-making do not always hear cases together. The presiding process of the tax appeals panels. OTA has ALJs will perform both management and review indicated that the hearing division will maintain this functions for other ALJs (and occasionally will independence. However, the management structure hear cases by sitting on the panels). The review of OTA will nonetheless intertwine the executive and functions will include reading cases for consistency hearing divisions. For example, the presiding ALJs across decisions and clarity. Through this review will report to the chief counsel and the director. process, OTA aims to ensure consistency in OTA also states that the chief counsel will read the decisions across panels. written opinions of the panels and review them for Panels Will Issue Written Opinions. The panels consistency and clarity, but will not be involved in of ALJs will issue a written opinion on each case the decision-making process. The director will only within 100 days of hearing that case. In order to read cases after they are published. issue an opinion, at least two of the three panel Workload members must concur in the holding of the opinion. Both taxpayers and the state are permitted to OTA Began Hearing Cases in January 2018. submit a petition for a rehearing in the event of an The new laws directed OTA to begin hearing irregularity, accident, new evidence, or if the party cases on January 1, 2018 and prohibited BOE can demonstrate there was insufficient evidence to from conducting appeals or taking an action with justify the decision. Under law, taxpayers, but not respect to appeals after that date. OTA held its first the state, may also appeal decisions made by OTA hearings in Sacramento on January 22 and 23 and to the trial courts. in Los Angeles on March 28. OTA plans to begin OTA Plans to Hear Cases in Three Offices, hearing cases at its Fresno office in the early fall of But Have Permanent Staff in Two. As required by 2018. law, OTA will hear cases in three locations in the OTA Faces an Active Backlog of Cases. state: Sacramento, Fresno, and Los Angeles. The OTA believes it will receive a total backlog of Sacramento office will serve as OTA’s headquarters, approximately 2,200 cases from BOE, although where the executive division staff, 12 ALJs, and about 1,200 of the cases received so far are active 1 presiding ALJ (among other staff) will work. (meaning OTA is able to take action on the case). The remaining staff, including six ALJs and one This active backlog represents about a year of presiding ALJ will be located in Los Angeles. typical case workload. OTA has indicated it intends The Fresno office will have a venue for panels to to prioritize working down the backlog of active hear cases, but right now, OTA does not plan to cases. have any staff permanently located in this office. OTA Currently Has 28 Vacancies. OTA For cases to take place in Fresno, ALJs (and has 28 vacancies and is actively recruiting or occasionally other staff) from the other offices will interviewing for 22 of those vacant positions. These travel to Fresno. vacancies are concentrated in the Los Angeles office. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2018-19 BUDGET www.lao.ca.gov 7 analysis full gutter 2018-19 BUDGET LAO PUBLICATIONS This report was prepared by Ann Hollingshead and Seth Kerstein. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 8 LEGISLATIVE ANALYST’S OFFICE