Rev­enue from Ariz. tax au­dits de­clines

De­creases come in ar­eas where agency cut staff

The Arizona Republic - - Front Page - RON­ALD J. HANSEN

As Ari­zona lead­ers have built bud­gets that leave little room for teacher raises and other pop­u­lar spend­ing pri­or­i­ties, the state has cut back on ef­forts to en­sure tax­pay­ers — es­pe­cially busi­nesses — pay what they owe.

The Ari­zona Depart­ment of Rev­enue, the state’s tax col­lec­tor, has in­stead em­pha­sized cus­tomer ser­vice and col­lect­ing sales taxes on be­half of cities statewide.

The ef­fect? Rev­enue from au­dits fell from $155 mil­lion in 2016 to $80 mil­lion in 2017.

To put the de­cline in per­spec­tive, it is more than triple the $24 mil­lion bud­get short­fall state bud­get of­fi­cials ex­pect at the end of the cur­rent fis­cal year. And it oc­curred in ar­eas where the agency has cut staffing: cor­po­rate au­dit­ing, and check­ing busi­ness li­cens­ing for sales taxes.

It comes a year af­ter ex­perts warned state law­mak­ers that lay­offs in the agency’s au­dit­ing depart­ment at that time would even­tu­ally cut its col­lec­tions.

Since Gov. Doug Ducey tapped David Bri­ant to head the Depart­ment of Rev­enue in 2015, the agency has scaled back the num­ber of au­di­tors, re­ly­ing more on tech­no­log­i­cal anal­y­sis and pri­or­i­tiz­ing vol­un­tary tax com­pli­ance.

This has par­tially off­set the de­cline in au­dit­ing rev­enue, but not enough to com­pen­sate for the smaller au­dit­ing work­force. The num­ber of cor­po­rate au­di­tors has fallen from 30 in 2001 to 10 in 2016. The agency now has six au­di­tors, said Ed Green­berg, a spokesman for the agency.

“If there are times when depart­ment au­di­tors need to be in the field, then that will take place.” ED GREEN­BERG ARI­ZONA DEPART­MENT OF REV­ENUE SPOKESMAN

More use of an­a­lyt­ics

Those re­duc­tions come as the state re­lies more on an­a­lyt­ics to help iden­tify tax­pay­ers who should get more scru­tiny and less on hu­man au­di­tors who ex­am­ine tax re­turns and make judg­ment calls.

Green­berg said the depart­ment pro­motes a “more proac­tive, ef­fi­cient, trans­par­ent and tax­payer-friendly ap­proach.” And, he said, au­di­tors to­day are more ef­fi­cient, bring­ing in more rev­enue per per­son than in years past.

The depart­ment to­day uses a “21st-cen­tury ap­proach” to en­cour­age hon­est com­pli­ance, Green­berg said.

He pointed to a slight rise in other en­force­ment rev­enues, such as delin­quent taxes, though the losses in au­dit­ing erased most of the gains else­where.

Tax ex­perts say the loss of au­di­tors could cost the state even more in the years ahead, as busi­nesses adapt and be­come more ad­ven­tur­ous on their tax re­turns know­ing there’s little risk of se­ri­ous scru­tiny.

“As the risk of de­tec­tion goes up, the prob­a­bil­ity that an in­di­vid­ual or a cor­po­ra­tion is go­ing to evade taxes, or be re­ally ag­gres­sive on their taxes, goes down,” said Daniel Lynch, an as­sis­tant ac­count­ing pro­fes­sor at the Univer­sity of Wis­con­sin who has re­searched statelevel au­dit­ing.

Cut­backs in en­force­ment, mean­while, even­tu­ally lead to lower com­pli­ance. “The ques­tion is how much, but the di­rec­tion is pretty well-ac­cepted,” he said.

In a study of nine years of state tax data, Lynch found that for ev­ery dol­lar spent on au­dit­ing, agen­cies got back be­tween $8 and $11 in col­lec­tions.

Oth­ers share that view of au­dit­ing.

“The rea­son many tax­pay­ers com­ply with the tax laws is be­cause they don’t want to get au­dited and found that they owe not only back taxes, but penal­ties and in­ter­est,” said El­liott Hibbs, who headed the Ari­zona Depart­ment of Rev­enue un­der for­mer Gov. Janet Napoli­tano.

“It is penny wise and pound fool­ish to cut the Depart­ment of Rev­enue when ev­ery dol­lar spent on en­force­ment can bring in more than $10.”

Rev­enue de­clines

Ex­tra cash is in short sup­ply for the state.

In May, Ari­zona law­mak­ers pre­sumed they would end the year with about $38 mil­lion left over af­ter $9.8 bil­lion in spend­ing.

Now the fore­cast is a $24 mil­lion short­fall.

Last year’s au­dit­ing de­cline ex­ceeded the $60 mil­lion that state schools Su­per­in­ten­dent Diane Dou­glas sought — and didn’t get — for up­grad­ing buses and re­cruit­ing new teach­ers for ru­ral Ari­zona schools.

The de­cline in au­dit­ing rev­enues is also on top of the steep de­cline in cor­po­rate in­come-tax col­lec­tions due in part to lower cor­po­rate prof­itabil­ity and to tax cuts passed in 2011.

Dur­ing the past fis­cal year, the sec­tions of the au­dit­ing depart­ment that had pro­duced large fi­nan­cial re­turns for the state in the past in­stead showed steep de­clines.

Rev­enue from cor­po­rate au­dits fell from $33 mil­lion in 2016 to about $6 mil­lion.

Rev­enue from check­ing busi­ness salestax li­censes dropped from $41 mil­lion to $7 mil­lion.

Taxes owed for hav­ing an in-state busi­ness pres­ence dropped from $57 mil­lion to $38 mil­lion.

Those losses more than off­set rel­a­tively small in­creases in other au­dit­ing ar­eas, such as in­di­vid­ual in­come-tax au­dits, which saw rev­enue climb from $8 mil­lion to $10 mil­lion.

The changes come as Ari­zona’s tax col­lec­tors have taken on sig­nif­i­cantly more re­spon­si­bil­i­ties in re­cent years, fur­ther di­vid­ing the agency’s re­sources.

The Depart­ment of Rev­enue now col­lects sales taxes for the state’s 14 largest cities, as well as res­i­den­tial rental-prop­erty taxes.

Be­fore the 2017 bud­get, au­dit col­lec­tions had re­mained rel­a­tively sta­ble for years even as the rev­enue agency whit­tled away its work­ers. Be­tween 2008 and 2016, au­dit rev­enues av­er­aged $146 mil­lion an­nu­ally.

That fi­nally gave way as staff re­duc­tions that be­gan a decade ago deep­ened, agency records show.

In 1996, there was one au­di­tor for ev­ery 24,000 in­di­vid­ual tax­pay­ers in Ari­zona. By 2006, it was one for ev­ery 67,000 tax­pay­ers. In 2016, the num­ber had risen to one for ev­ery 192,000 tax­pay­ers.

It’s a sim­i­lar story for cor­po­rate and sales-tax au­di­tors.

In 1996, there was a cor­po­rate au­di­tor for ev­ery 1,100 fil­ers. By 2016, it was 4,800.

There was one salestax au­di­tor for ev­ery 1,600 fil­ers in 1996. In 2016, there were 5,700 fil­ers for each au­di­tor.

Tax ex­perts say au­di­tors have their great­est ef­fect on cor­po­rate and sales-tax col­lec­tions be­cause the fi­nan­cial stakes are much higher.

Not on the road again

Be­yond the num­ber of work­ers, the Rev­enue Depart­ment has trimmed other au­dit­ing ex­penses, too. Ari­zona spent $100,000 trav­el­ing for au­dits in fis­cal 2016. In fis­cal 2017, the state spent $4,500.

Green­berg said the state’s cur­rent au­dit tech­niques don’t re­quire much travel be­cause of tech­no­log­i­cal im­prove­ments and more elec­tronic trans­ac­tions.

“With tech­nol­ogy and process im­prove­ments in place, in­clud­ing the in­creased use of elec­tronic data, au­di­tors can con­duct au­dits elec­tron­i­cally,” he said.

“If there are times when depart­ment au­di­tors need to be in the field, then that will take place.”

If Ari­zona has mas­tered long-dis­tance tax com­pli­ance, other states still find it worth­while to send tax col­lec­tors out­side their bor­ders.

Texas, for ex­am­ple, has per­ma­nent of­fices in New York, Los An­ge­les, Chicago and Tulsa, Ok­la­homa. Cal­i­for­nia has of­fices in New York, Chicago and Hous­ton. Florida has seven out-of-state of­fices. Utah sends its “au­di­tors to cor­po­rate head­quar­ters all over the United States.”

Hibbs, for one, thinks Ari­zona’s travel cut­backs re­flect a mis­guided ap­proach to tax col­lec­tion.

“To me, that’s shock­ing,” Hibbs said. “There’s nothing you can do up front to be able to en­sure the tax re­turn com­ing in is in fact go­ing to be cor­rect. I’ve heard the depart­ment is try­ing to do some things elec­tron­i­cally with other sources to maybe do a bet­ter job.

“But I just can’t see how that re­places what a per­son would look at in terms of ex­am­in­ing books and records of a busi­ness or an in­di­vid­ual.”

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