Wednesday, April 16, 2008

Privatized tax debt collection not the bonanza that Congress thought

To the Republican-led Congress in 2004, limited privatization sure seemed like a win-win solution to the tax debt collection problem. At the time, the Internal Revenue Service (IRS) effectively "wrote off" many potentially collectable but small tax debts because of staff limitations. Staff prioritized the cases that they worked on, and time was spent on big cases that could recover large revenues.

Congress's idea was to turn smaller, "easy" cases that weren't going to be collected anyway over to private collection agencies (PCAs). The agencies would receive a commission of 25 cents for each overdue tax dollar collected, returning the other 75 cents to the treasury. This looked like a textbook case in how to increase government efficiency through privatization with the private companies profiting from the commissions, and the Federal government recovering more tax revenues.

So why is the Washington Post reporting that the program is losing money? Well, technically, the Post is wrong. It appears that the program probably brings in a small amount of money each year (I write "probably" because the IRS does not collect enough data to calculate the full costs and benefits).

According to testimony given to the House Ways and Means Committee on March 18 by the National Tax Advocate, the PCAs generated $23 million in gross revenues. The PCAs received 25 percent of that ($4.6 million) back in commissions, and the IRS spent $7.65 million administering the program. So the net return to the government was $11 million, which hardly put a dent in the more than $300 billion in tax arrears.

Even these meager returns may be overstated because they don't account for tax cases that complain or appeal and thus use additional government resources. Also, they overstate the effectiveness of the PCAs, because roughly a quarter of the cases respond to an initial letter sent out by the IRS and before ever being contacted by a PCA.

The benefits also neglect the opportunity cost of the $7.65 million that the IRS spends on administration. Suppose that the PCA program were shut down and the $7.65 million were redirected toward other under-staffed debt collection efforts. The IRS estimates that it could collect at least $13 for each dollar spent, or about $100 billion--far more than the $23 million collected by the PCAs and without paying commissions. Thus, on an opportunity cost basis, the government is foregoing about $73 million by administering the PCA program instead of directly collecting the debts.

The National Taxpayer Advocate has described numerous other problems with the PCA program.

The program originally began with three companies, but one company was let go because it mishandled taxpayer data. The PCAs have generated numerous complaints because of their heavy-handed tactics. Also, the incentives of the PCAs are misaligned from those of the government, leading to cases where the PCAs push immediate debt collection but jeopardize subsequent tax compliance. Finally, the PCAs are tightly constrained in terms of what they can do--for instance, they can't negotiate debts down and can't investigate tax mistakes.

Why then does the private collection program continue to operate? Direct campaign contributions from the companies involved to Congressional supporters might explain some of it. Good old fashioned corporate cronyism and corporate welfare are other explanations. Lastly, there is an unabiding faith by some in the wonders of private efficiency, even in situations where there is ample evidence to the contrary.

Before the next tax day rolls around, Congress should eliminate this boondogle.