Ready. Set. Showdown.

Apr 28, 2007, By Shane Peterson

Source: Government Technology

It's the little things that cause big trouble.

A California agency created an unusual, new method of tax filing for state residents with extremely simple returns. Normally a state agency wins acclaim for taking a fresh approach to streamlining transactions with its constituents.

Not so in this situation.

Instead, the new method, called ReadyReturn, sparked an intense battle between the state's tax agency and the California Legislature. ReadyReturn ignited an equally heated lobbying campaign to kill the program - a campaign masterminded by manufacturers of tax preparation software, who argued that ReadyReturn unfairly competed with their products. And taxpayer groups questioned whether California's tax collector should also serve as a tax preparer.

The fight didn't end until December 2006, and state lawmakers nearly succeeded in killing ReadyReturn. But a last-minute, unanimous vote by the tax agency's governing board defied the Legislature and spared ReadyReturn from the executioner's ax - at least for one more year.

With the long-term outcome still uncertain, California's continuing ReadyReturn drama illustrates the upheaval created by innovations that challenge the status quo.

Trouble Brewing
The California Franchise Tax Board (FTB) administers two of the state's major tax programs: the personal income tax and the corporation tax. In February 2005, the FTB announced the launch of the ReadyReturn pilot for the 2004 tax year, stirring immediate controversy.

The ReadyReturn process itself is straightforward. For citizens with the simplest tax returns - those with wages earned from a single employer, no dependents and no deductions - the FTB uses income data from employer W2 forms to calculate income and the tax owed, then sends a completed tax form to taxpayers who elect to participate. The service is offered for free to qualified residents.

By offering ReadyReturn, the FTB put itself in a novel role - a tax-collection agency would prepare income-tax returns for certain taxpayers. This dual role sparked heated debate, via opinion pieces in newspapers throughout the state, over a tax agency taking this unprecedented step.

Critics contended that ReadyReturn had conflict of interest written all over it. Supporters countered that the program removed unnecessary mystery from the income-tax process.

The FTB's premise for offering the ReadyReturn service was simple, said Steve Westly, California's state controller from 2003 to 2007.

Because the FTB receives personal income information from employers via W2 forms, Westly said, the agency has all the necessary information to fill out an income-tax return for the taxpayer and perform income-tax calculations on that return.

The FTB mailed the completed returns to approximately 50,000 taxpayers selected to participate in the ReadyReturn pilot, and those taxpayers decided what to do. The taxpayer could either ignore the invitation and prepare his or her own tax return; verify the information on the completed return, sign it, and return it to the FTB; verify the information on the completed return, then visit the FTB's Web site to electronically file the return; or make modifications to the form.

Westly supported ReadyReturn because it fit his vision of how state government ought to operate, and it removed a layer of complexity from the state's income-tax system.

"I said when I ran for office that I was going to bring technology to state government in California," Westly recalled, "and I was going to bring technology that would be not only cost-effective, but would help improve people's lives."

Before being elected to office, Westly became one of the early executives of Internet-commerce pioneer eBay. He joined the company in 1997 and went on to hold a series of executive-level positions. Technology also played a central theme in his campaign for controller.

When the initial idea for ReadyReturn surfaced, Westly said he spoke with Joseph Bankman, a leading tax law scholar and the Ralph M. Parsons professor of law and business at Stanford Law School. He said Bankman compared the concept behind ReadyReturn to how property taxes are collected in California.

When property-tax time rolls around every year, assessors do not send homeowners a stack of tax tables and a complicated form and ask them to calculate their own property taxes.

"Assessors say, "you live at X address. The house is assessed at Y value. We know that value. We know where you live. We know what the multiplier is, and here's how much you owe,'" Westly said. "You don't fool with anything. You get it, and you pay the tax."

Of the 50,000 people who were invited to use ReadyReturn, 23 percent, or 11,620 taxpayers, opted to take part in the pilot, according to an FTB report.

Participants were surveyed and gave the service glowing reviews - 98 percent of those who used ReadyReturn to file a 2004 tax return online and 97 percent of taxpayers who used the service to file paper returns said they would use the service again, according to the FTB's report.

Participants also expressed strong opinions on whether it's government's role to provide such a service - 95 percent of taxpayers who used ReadyReturn to file a 2004 tax return online and 83 percent of taxpayers who used it to file a paper return said ReadyReturn was a service government should provide, the FTB's report said.

In mid-2005, the FTB's governing board voted unanimously to expand the program in 2006 for the 2005 tax year - announcing plans to place an invitation to participate in ReadyReturn in 540 2EZ tax booklets, which reach approximately 800,000 taxpayers. The FTB reckoned that ReadyReturn's second year would attract 30,000 participants - just under three times the number of users in the pilot.

But as ReadyReturn gained momentum, opponents of the plan shifted into high gear.

 Intruding Government
The concept of a government tax-collection agency calculating and preparing income-tax returns, even the most basic of returns, stoked plenty of fires, and the FTB's decision to expand ReadyReturn prompted intense opposition.

Groups such as the California Chamber of Commerce, the California Taxpayers' Association and the Computer and Communications Industry Association (CCIA), joined with private-sector tax-preparation firms such as Intuit and H&R Block to fight ReadyReturn.

Their argument: ReadyReturn represents an unwarranted and unnecessary intrusion into the private sector.

"It's taxpayer-funded competition into a sector where private industry is providing outstanding services and solutions for consumers," argued Rob Stutzman, a principal at Navigators, a firm that bills itself as specializing in issues management, with offices in Washington, D.C., Sacramento, Calif., and Tallahassee, Fla.

When contacted for comment on this story, Intuit, a high-profile critic of ReadyReturn, referred Government Technology to Stutzman.

One private-sector service that's very similar to government programs such as ReadyReturn, he said, is the Free File program, which offers free federal tax return preparation and e-filing for those earning $52,000 or less. Approximately 21 states participate in the Free File Program.

The program, which debuted in 2003, is a partnership between the IRS and the Free File Alliance, a group of private-sector tax software companies.

Intuit plays a big role in Free File, along with other software providers, he said, and to ask these companies - which have created significant software innovations to simplify tax-preparation for consumers - to compete with ReadyReturn is an unnecessary step.

"It's the government coming in and competing, for really no good reason," he said. "It's not as if there's an absence of adequate level of service in this sector. There's certainly not a need for it. It's certainly unfair for these companies to have to confront that type of competition."

Given the lack of a practical need for ReadyReturn, he said, opponents question the motivation for governments to launch such programs.

"We think there are some reasons that are not officially spoken to in the motives of the proponents of programs like ReadyReturn, or even the Franchise Tax Board itself," Stutzman explained. "They may be doing it to optimize, or increase revenue.

"If that's the case," he continued, "that's certainly a very regressive tax-conformity program on behalf of the government in that it's targeting filers at the lower level at a time when, in the FTB's instance, they have a shortage of auditors to go after scofflaws at the higher end of the income level."

This argument proved extremely successful in the California Legislature, especially with Democratic lawmakers, Stutzman said, and is why the Legislature didn't act to make ReadyReturn a permanent program.

Westly freely acknowledged that perhaps the biggest reason for starting ReadyReturn was to draw people into the tax system. Of the nearly 12.5 million tax filers in California, approximately 800,000 people aren't filing returns.

However, Westly offered a different rationale for drawing taxpayers into the tax-collection system.

"A few of these are high-end scofflaws, but a lot of them are immigrants or non-English speakers or poor folks who just didn't know they owed," Westly said. "The point is to make it easier for those people to do their taxes, to let them know they owe, and to bring them into the system.

"Over time, that is a smart thing for any democracy to do - to make sure you get everybody started on their responsibility in a democracy, which is to pay their fair share."

 Into the Lion's Den
The FTB needed to introduce a bill in the Legislature to change California statutes to make ReadyReturn a permanent FTB service, and to secure funding for the program.

Assuming the bill passed, it would then need Gov. Arnold Schwarzenegger's signature to become law. Though governors can be capricious, it's fair to say the bill at least had a fighting chance with Schwarzenegger.

The director of the California Department of Finance, who's appointed by the governor and sits on the FTB's governing board, voted with the other two members to expand ReadyReturn. If the governor was inclined to put the kibosh on ReadyReturn, a "no" vote from the director of finance would have signaled the governor's disapproval.

In February 2006, the first Legislative action regarding ReadyReturn came in the form of AB 2905, introduced by former Assemblyman Dario Frommer, a Democrat who represented parts of Los Angeles.

Frommer said ReadyReturn is important to state government because the program helps tax returns get filed more quickly and because it reflects the importance of government adapting how it interacts with its customers.

"Taxes are never fun, and we're not going to make it fun," he said. "But we can make it easy for people, encourage them to get their stuff in on time and, if they have a refund, get it to them much faster."

The bill, which was sponsored by Westly, would have made ReadyReturn a permanent FTB service offering. The bill made it out of committee hearings, but Frommer pulled the bill when it became apparent he wouldn't get enough votes from the Assembly for it to pass.

AB 2905 attracted plenty of opponents, including the American Electronics Association, the California Chamber of Commerce, the California Taxpayers' Association, the CCIA, the Small Business and Entrepreneurship Council and TechNet.

After AB 2905 was pulled in May 2006, another Frommer bill, AB 1046, underwent a "gut and amend" in a Senate committee in July. That action transformed the bill, previously called the "Earthquake Safety and Hospital Preservation Bond Act," into another attempt to make ReadyReturn permanent.

"I must say I was surprised at the opposition," Frommer recalled, "particularly when you consider that the people who were eligible for ReadyReturn are not the type of people who are going to use the prepackaged tax programs that are commonly sold."

Frommer said AB 1046 ran out of time, and he wasn't sure if he could get sufficient votes to pass the bill in both legislative houses before the 2006 session ended. He let the bill become inactive.

Intuit, maker of TurboTax software, spent significant money lobbying against AB 1046 and ReadyReturn - as much as $500,000 over two years, according to extensive newspaper coverage of the conflict.

The fight did get interesting.

In May 2006, while AB 2905 was still alive, the CCIA released results of a statewide poll showing widespread opposition to ReadyReturn. According to that poll, 81 percent of California taxpayers would trust an independent tax preparer over the state agency to prepare their taxes, and 86 percent of taxpayers would choose to do their taxes themselves instead of participating in ReadyReturn.

Intuit representatives also testified regularly against ReadyReturn at legislative committee hearings, questioning the ability of the FTB to calculate taxes for taxpayers, whether the program was an invasion of privacy and raising the issue of government competition in an area that's already served by the private sector.

"The opposition on this was," Frommer said, pausing, "you know, I'm out of office so I'm just going to say it now: They were unscrupulous. The type of claims that were made about the program and the misinformation that was put out about who it affected and who could qualify for it and what it would do, were just beyond the pale.

"I've got to tell you, and I've been in government for about 20 years, I've never seen anything like this - the kind of misinformation campaign that was directed by Intuit and by its lobbyist in Sacramento. It really made a mountain out of a molehill, but obviously it was successful. There were enough legislators who peeled off on the issue and got nervous about it that we couldn't move that legislation in either house."

Of course, the view from the other side is a bit different.

"There was no misinformation," Stutzman said. "Shifting the government to the dual role of tax collector and tax preparer is an issue that should concern all citizens, and the evident negative reaction to that concept is why the legislation died."

Boardroom Coup
The legislation was needed because ReadyReturn was facing a time bomb. Intuit had persuaded the Legislature to drop a poison pill into the 2005 budget bill in the form of an amendment to terminate ReadyReturn after the 2005-2006 fiscal year.

With the two bills withering on the legislative vine, ReadyReturn looked close to death. But then-Controller Westly engineered a stunner.

After securing opinions from the state Office of the Legislative Counsel (which includes the lawyers who draft bill language) and the FTB's general counsel during his last meeting as the chairman of the FTB, Westly and the two other board members - John Chiang and Mike Genest, director of the state Department of Finance - voted unanimously to circumvent the Legislature and revive ReadyReturn. The program would now be funded solely by the FTB.

"We had this climactic meeting in December [2006], where the governor's representative, wanting, I think, to be noncontroversial, said, '"Well, let's just postpone this vote one more time,'" Westly recalled. "I said, 'No, this is my last meeting. We've already postponed it twice. Let's get this going.'"

Chiang - who later was elected California state controller, replacing Westly - suggested returning to the Legislature to drum up more support, but Westly said he argued against the idea because of Intuit's success in lobbying the Legislature and blocking the bills to make ReadyReturn permanent.

"After a moment of real drama, we were able to get not one but both of these guys to go forward," Westly said, acknowledging that he felt confident in getting Chiang's support but wasn't certain he would get the support of Genest, who was the governor's representative on the FTB's governing board.

Westly said there was precedent for the support of the Department of Finance: Tom Campbell, who was director of the Department of Finance before Genest, strongly supported ReadyReturn. Campbell was a member of the FTB's governing board in 2005, and voted to approve the initial ReadyReturn pilot.

Regime Change
Chiang, who became state controller in 2007, is no stranger to the ReadyReturn battle.

Since 1997, Chiang has served as a member of the California State Board of Equalization, an entity that administers tax programs for California in four general areas: sales and use taxes, property taxes, special taxes and the tax appellate program.

Chiang also served as chairman of the Board of Equalization, and in that capacity, served on the governing board of the FTB. He, along with Westly and Campbell, voted to authorize the original ReadyReturn pilot.

Normally candidates vying for the state controller job aren't exactly front-page news during election season, but Chiang was targeted by Intuit and other tax-preparation-software companies because of his stance on ReadyReturn.

The companies contributed nearly $1 million to Chiang's opponent's campaign in an effort to deny Chiang's bid to become state controller, according to the Los Angeles Times, and the political contest made headlines up and down the state.

"I never thought I would get this much attention," Chiang said. "I didn't think [ReadyReturn] would cause electoral drama. I know it's been a significant public policy issue. Intuit and some others have been very, very concerned about any added benefit provided the Franchise Tax Board, in terms of taxpayer assistance."

Chiang recalled that the company put up a stiff fight when the FTB decided, several years ago, to add a calculator function to its Web site to assist taxpayers.

"I knew on that front that the [ReadyReturn] discussion would be challenging, but I didn't think it would cross over," he said, adding that ReadyReturn is on hiatus for the 2006 year because the FTB is upgrading the software to handle more users. "We do have the funding to operate ReadyReturn. We're taking [the money] out of the current budget of the Franchise Tax Board, and we hope to continue to do so in the future."

The FTB is focusing on making sure the software can scale up to handle the approximately 1 million taxpayers who qualify for the ReadyReturn program.

Chiang said the FTB will operate ReadyReturn for "the foreseeable future" because it's a program that benefits the public, though he acknowledged that the Legislature could, during any session, try to block the FTB from doing so.

"We know there are some legislators who are strongly supportive of the program," he said, "but with the constant turnover in the Legislature, it's going to take frequent updating and education of the purpose of the program."

For the most part, Chiang said, ReadyReturn's most appealing feature to legislators is that it provides free tax assistance to individuals of modest and low income, and that the program helps foster "financial literacy" for the low-income demographic.

"When you think of the federal and state tax codes - there are 10 million words in the federal tax code, and there are 1.5 million words in the California tax code," Chiang said. "People are begging for assistance, and ReadyReturn is a great step forward for people to get assistance."