Revenue from Ariz. tax audits declines

Decreases come in areas where agency cut staff

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.”