April 7, 1999 Web posted at: 12:01 p.m. EDT (1601 GMT) by Heather Hayes

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(IDG) -- Taxpayers never have clamored for higher tax rates, and despite a piping-hot economy, today's electorate shows even less enthusiasm for higher taxes. What has changed, however, is an increasingly vocal demand among citizens that tax agencies collect every dime to which they're legally entitled.

Tax administrators like to refer to this as the Fairness Doctrine. "The public is willing to pay their fair share as long as everyone else also pays their fair share," said P.K. Agarwal, chief information officer for the California Franchise Tax Board, the state's taxing authority. "So everything tax agencies do now is geared toward increasing tax receipts without increasing taxes."

And there's plenty of money out there to collect. Just a few years ago, California identified a $2.7 billion "tax gap," defined as the difference between what is believed to be owed and what actually is collected. And Kansas has reported a sizable $300 million shortfall.

Aggressively pursuing those dollars presents a dilemma. Like the Internal Revenue Service, state revenue departments feel a public backlash against what many see as intrusive and overbearing practices. To improve collection rates without resorting to such practices, states are turning to advanced technologies and processes typically used by major financial institutions, such as centralized and online account management, predictive dialing, automated tracking and monitoring, decision analytics and data mining.

States using such approaches-which include integrated tax systems, improved case management tools, informational Web sites and 24-hour interactive telephone hot lines-have seen a substantial increase in voluntary filing compliance and collected revenue, decreased expenditures, improved productivity and morale among employees, and a much better relationship with taxpayers.

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"Collections is an area where we can definitely apply private-sector practices to public-sector processes," said Steve Shubella, vice president for state and local practice at American Management Systems Inc. "Much of it involves providing agencies with the ability to manage cases and route workflow and make sure that people spend their time in the high-priority areas. But it also involves risk assessment of a taxpayer based on their filing and payment history and determining the right collection treatment."

Take, for example, a taxpayer who historically has filed and paid her tax debt but has recently encountered a financial hardship. Previously, revenue departments would have treated this debtor exactly the same as one with a deplorable compliance record. Now, with analytical decision support tools such as AMS' Strata product, collectors can differentiate between debtors.

"With a hard-luck case, there's a 95 percent chance that that person is going to eventually self-comply, so why hit her with hard-core tactics right off the bat?" said John Vranna, chief of the Accounts Receivable Management Division for the California Franchise Tax Board. "Instead, we'll send her a friendly notice and give her plenty of time to straighten her life out. Meanwhile, we'll put our resources to better use by going after someone who has a horrible history of filing and paying and might very well be on his way to bankruptcy."

Some new intelligent applications allow agencies to discern whether a debt is even worth collecting. "If it costs you $200 to collect an account, it really doesn't make much sense to go after a $5 account," Agarwal said. "So when you bring in database technology and a few of these sophisticated stratification tools, you start to make more intelligent decisions."

The benefits of these automation initiatives have been eye-opening. California reaped $42 million in revenue during the first year it operated its new Collection Account Processing System (CAPS), a solution that collects back taxes owed by banks and corporations. Moreover, the system, which was put together under a performance-based arrangement by AMS, paid for itself in 45 days. Meanwhile, Delaware's automated collections systems brought in $27 million during its first year of operation-a 12 percent increase over the previous year.

Kansas used to take a year or two to invoke liens and asset seizures on incorrigible debtors, but it now does so within 180 days. "If they're high-risk, we give them their 60-day appeal period, but before six months have passed, we're taking legal action," said Karla Pierce, Kansas' commissioner of revenue, who noted that the state has taken in an additional $46 million in taxes since implementing its automated collections system in 1996. "It's really a matter of improving productivity and getting to the right accounts in a timely manner."

The benefits don't stop there. State revenue departments have begun collecting nontax debts for other agencies, including child support, court fines, motor vehicle registrations and student loans. Some states, including Minnesota, California, Delaware and Michigan, have been incredibly successful.

If adopted widely, the ramifications could be significant for overall state operations. Among the possibilities is the consolidation of other processes, such as taxes and unemployment benefits or state and federal tax filing. Montana, for one, is looking into using its revenue department as a one-stop intake and licensing center for new businesses.

"The only way this can be accomplished is through automation and technology," said Harley Duncan, executive director for the Federation of Tax Administrators (FTA). "It's most vividly displayed right now within the tax agency because they've made the investment in technology. So why duplicate that infrastructure in other agencies if you don't need to? You can get so many economies of scale, and you can leverage your very limited resources."

Getting started

Applying automation to a revenue collections process is not as simple as bringing in new technology, proponents said. Like any other major overhaul, the project has to begin with hard questions about businesses processes and long-term strategic direction. "You really need to think about this in terms of general goals and long-term process specifics," Kansas' Pierce said. "Once those questions are answered, then you bring in a vendor to design your system and apply the technology."

A good funding strategy also is required. While most major projects rely on persuading a legislature to supply a massive dollar investment, collections systems by their nature offer a more viable option known as benefits-funded contracting (also called alternate procurement and performance-based contracting).

This approach, which has been used successfully by California, Kansas, Minnesota and Virginia, among others, allows an agency to focus on outcomes rather than solely on system functionality. Typically, the agency and a vendor will agree that no money will be paid until results are realized. In other words, Agarwal said, "if we don't make any new revenues from the system, the partner doesn't get paid. It's as simple as that. Luckily, though, there are plenty of vendors out there that specialize in tax systems that are willing to put their money where their mouth is."

To offset the vendor's long-term investment and keep the project manageable, it's important to design the system in such a way that it can be implemented in small chunks. "If we know that our vendor/partner is going to sink $10 million into the project in the first year, then we look for ways that we can generate a quick $10 million by looking for low-hanging fruit," Agarwal said, noting that going after small debts incurred by people who forget to include their Form 1098 bank and investment interest on their tax returns is one way to produce quick cash. "That way, there's no net cost in any one fiscal year."

A third consideration is whether to outsource the collections operations once the system is in place. Michigan, though it still maintains a hands-on approach, has been outsourcing its long-term delinquent collections process to a private firm, GC Services, since the late 1980s.

Outsourcing collections can be more cost-effective, especially when dealing with debtors is a private firm's core competency. Relying on an outsourcer also provides a central location for the collection of all debts. "A taxpayer that might owe taxes, court fines and child support is now going to get just one contact into their home instead of three or four," said Mike Reynolds, administrator for Michigan's Revenue Division. "It cuts down on any confusion."

Kansas and Delaware have opted for a part-time outsourcing arrangement. Kansas pays employees of GC Services to make outgoing phone calls to debtors. This frees up state employees to handle incoming calls that require problem resolution, and it increases the chances of reaching debtors at home because third-party workers are available to work the evening shift.

Delaware uses six third-party vendors to make outgoing telephone calls. "Collections is a job that has a high burnout rate," said Bill Remington, director of Delaware's Department of Revenue. "It's not a pleasant job, and people get tired of it pretty easily, so we really don't want our state employees doing it." Instead, state employees are used to administer the process, conduct problem resolution and perform audits.

Remington noted that without a solid integrated collections system in place, outsourcing is not even an option. "They've got to have good information," he said. "It's bad enough to have state employees calling and demanding payment from a debtor who has already paid the bill or set up an installment plan, but to have a third-party source doing that would be disastrous. You'd be doing a terrible service to your public perception."

In contrast, the Minnesota Collection Enterprise, an arm of the state's Revenue Department, which collects tax and nontax debts, decided to hang on to its collections operations after running a mock competition against eight private collection firms. The study was conducted because of political divisions between Republican and Democratic legislators, but the MCE easily outperformed various vendors, collecting 27 cents on the dollar compared with an average of 19 cents collected by its competitors.

"Basically, we had better information sources, and we have a better, more stable work force," said Jerry McClure, director of the MCE. "So in my opinion, the state can do a better job, a higher-quality job, and at lesser price than if you privatized it."

Enterprise collections

Whether or not a state decides to outsource its collections operations, it will have to decide whether to centralize the collections function for all revenue-producing agencies. State tax experts say there are plenty of incentives to do this, including the ability to leverage existing technology, lower overall governing costs and allow agencies to concentrate on their core missions. But making the jump to collecting nontax debts presents its own share of problems.

"It's a logical transition but not always an easy one," FTA's Duncan said. For one thing, the state legislature has to pass a law that is signed by the governor-and other state agencies may have to create their own internal statutes-in order to give the revenue department the authority it needs to take over the collections process.

Many agencies are hesitant to turn over their debt collection because of worries about losing personnel and command of their own data and accounts. "Other agencies are sometimes concerned that the revenue department will focus on tax debts first and other debts second," AMS' Shubella said. "It's a legitimate concern that revenue administrators need to address."

Outside opposition is another concern. Many privacy groups and other advocacy groups worry about the impact this trend could have on citizens. "Revenue departments have many, many more sweeping powers than any other agency or private collections firm would have under fair debt collection laws," said Pete Sepp, spokesman for the National Taxpayers Union. "So now what you'll have is revenue agents who are used to using those broad powers going after people who owe court fines or student loans. Some people might think this is great, but if you start unleashing the power of the government on those people, they might actually begin to chafe at such practices. I don't think it's a good idea."

California's Vranna believes that states can head off such criticism by creating strongly defined regulations and practices. "We go into this business cautiously," he said. "We don't see ourselves as the owner of those debts but as an organization that has services to provide in the collection arena. As long as certain criteria have been met, then there are things that we can do to leverage the various information sources that we have."

Moving forward

The most obvious result of this technological activity within collections departments is, of course, increased revenue. But the greater benefit, observers noted, may be a more professional and cooperative relationship with taxpayers.

"As more people pay their fair share, people see more equity in the tax system and end up being happier with the way things are," Shubella said. "And for those that do fall behind paying their debts, they'll find themselves being treated with more understanding and have better access to their own filing and payment information. So the whole effort is really as much a customer service initiative as a collections project."

Minnesota's McClure agreed but added that a successful collection enterprise reaps rewards for all of state government. "What we're doing now is really an entrepreneurial, business type of approach that is very effective," he said. "I think that over the long term it will help change the perception that government can't do things right or can't do things well. In fact, we can do certain things quite well-and in this case in particular-even better than the private sector."

Heather Hayes is a free-lance writer based in Stuarts Draft, Va.