Report 2015-119 Recommendation 2 Responses

Report 2015-119: State Board of Equalization: Its Tobacco Tax Enforcement Efforts Are Effective and Properly Funded, but Other Funding Options and Cost Savings Are Possible (Release Date: March 2016)

Recommendation #2 To: Equalization, Board of

Unless the Legislature directs the board to eliminate the compliance fund's excess fund balance within a time frame of more than a year, the board should eliminate the excess fund balance by June 30, 2017 by using it to offset the licensing program's annual funding shortfall. The board should also limit the fund's future balance to no more than two months' worth of licensing program expenditures.

Annual Follow-Up Agency Response From October 2022

In FY14 -15, the Cigarette Licensing Program's costs exceeded revenues by $8M. The Licensing Fund's appropriation was $1.9M, preventing CDTFA from using more of the fund balance. The difference was covered by Cigarette & Tobacco Tax revenues.

As part of the FY15-16 audit of the Cigarette Licensing Program, CSA recommended that the Legislature make the licensing program self-supporting and use the existing fund balance to cover any shortfall (by 6/30/17).

Since the audit, the Legislature enacted laws that increased licensing fee revenues, barred the use of Cigarette &Tobacco Tax revenues from funding the program, and required CDTFA to report annually on the program's financial position. These actions ensured that the program was self-funded. However, beginning in 2018-19, as a result of higher administrative costs and other expenses, expenditures exceed revenues creating an annual funding deficit, and as a result the fund reserve is being spent down. CDTFA forecasts the annual deficit to persist. In FY 21-22, the deficit was $361,000 and will continue to increase in future fiscal years.

Given the changes since the 2015 audit including changes in statute, annual funding deficit, and potential fund shortfall in the coming years CDTFA has complied with the audit findings and continues to spend down the fund reserve. While the Licensing Fund balance can currently cover the annual deficit, eventually a fee increase will likely be needed.

CDTFA is required to annually report to the Legislature on the adequacy of funding for the program. The report details annual revenues, expenditures, and the Licensing Fund's beginning and ending balance. The report ensures fund transparency, showing that the fund balance is no longer growing and is sufficient to support the program. The report for 21-22 will be completed by 12/31/22.

California State Auditor's Assessment of Annual Follow-Up Status: Partially Implemented

The annual report CDTFA provided shows the fund balance decreased, but it still remains high--approximately equal to one full year of program expenditures. As noted in the original audit report, guidance from the GFOA recommends that a fund with stable revenue and expenditures should have a balance to cover two months of expenditures. Therefore, to acknowledge that CDTFA has taken some steps to reduce the fund balance, we evaluate this recommendation as partially implemented, because more steps are needed for CDTFA to bring the balance to a more reasonable level.

Annual Follow-Up Agency Response From October 2021

In FY14 -15, the Cigarette Licensing Program's costs exceeded revenues by $8M. The Licensing Fund's appropriation was $1.9M, preventing CDTFA from using more of the fund balance. The difference was covered by Cigarette & Tobacco Tax revenues.

As part of the FY15-16 audit of the Cigarette Licensing Program, CSA recommended that the Legislature make the licensing program self-supporting and use the existing fund balance to cover any shortfall (by 6/30/17).

Since the audit, the Legislature enacted laws that increased licensing fee revenues, barred the use of Cigarette &Tobacco Tax revenues from funding the program, and required CDTFA to report annually on the program's financial position. These actions ensured that the program was self-funded. However, beginning in 2018-19, as a result of higher administrative costs and other expenses, expenditures exceed revenues creating an annual funding deficit, and as a result the fund reserve is being spent down. CDTFA forecasts the annual deficit to persist. In FY 20-21, the deficit was $388,000 and will continue to increase in future fiscal years.

Given the changes since the 2015 audit including changes in statute, annual funding deficit, and potential fund shortfall in the coming years CDTFA has complied with the audit findings and continues to spend down the fund reserve. While the Licensing Fund balance can currently cover the annual deficit, eventually a fee increase will likely be needed.

CDTFA is required to annually report to the Legislature on the adequacy of funding for the program. The report details annual revenues, expenditures, and the Licensing Fund's beginning and ending balance. The report ensures fund transparency, showing that the fund balance is no longer growing and is sufficient to support the program. The report for 20-21 will be completed by 12/31/21.

California State Auditor's Assessment of Annual Follow-Up Status: Partially Implemented

Similar to last year, the spreadsheet CDTFA provided shows the fund balance still remains high and will remain high throughout the period projected (to FY 2027-28). As noted in the original audit report, guidance from the GFOA recommends that a fund with stable revenue and expenditures should have a balance to cover two months of expenditures. In this case, with the changes that have occurred, that recommended fund balance would be approximately $1.7 million ($9,909 x 2/12). The estimated fund balance for FY 2020-21 is greater than the estimated expenditures for that year. Moreover, the balance now is higher than it was during the audit. Therefore, to acknowledge that CDTFA has taken some steps to reduce the fund balance, we evaluate this recommendation as partially implemented as more steps are needed for CDTFA to bring the balance to a more reasonable level.

Annual Follow-Up Agency Response From October 2020

In FY14 -15, the Cigarette Licensing Program's costs exceeded revenues by $8M. The Licensing Fund's appropriation was $1.9M, preventing CDTFA from using more of the fund balance. The difference was covered by Cigarette & Tobacco Tax revenues.

As part of the FY15-16 audit of the Cigarette Licensing Program, CSA recommended that the Legislature make the licensing program self-supporting and use the existing fund balance to cover any shortfall (by 6/30/17).

Since the audit, the Legislature enacted laws that increased licensing fee revenues, barred the use of Cigarette &Tobacco Tax revenues from funding the program, and required CDTFA to report annually on the program's financial position. These actions were to ensure that the program was sufficiently funded and resourced. At the time, the changes made the program self-funded. However, as a result of higher administrative and other expenses, there has been an annual funding deficit, and CDTFA forecasts the annual deficit to persist. In FY 19-20, the deficit was$1.1M.

While the licensing fund balance currently can cover the annual deficit, eventually a fee increase will likely be needed. Given the changes since the 2015 audit - including the statute, annual funding deficit, and potential fund shortfall in the coming years - CDTFA contacted CSA in September 2019 to clarify its recommendations.

CDTFA is required to annually report to the Legislature on the adequacy of funding for the program. The report details annual revenues, expenditures, and the Licensing Fund's beginning and ending balance. The report ensures fund transparency, shows that the fund balance is no longer growing, and is sufficient to support the program. The report for 19-20 will be completed by 12/31/21.

California State Auditor's Assessment of Annual Follow-Up Status: Partially Implemented

Annual Follow-Up Agency Response From November 2019

In FY 14-15, the costs of the Cigarette Licensing Program exceeded revenues by $8M. The shortfall was covered by Cigarette & Tobacco Tax revenues ($7.9M) and excess licensing fund balance ($0.lM). The appropriation from the licensing fund was only $1.9M, preventing CDTFA from using more of the fund balance.

Included in the 15/16 audit of the Licensing program, CSA made 2 recommendations. !)Legislature to make the program self-supporting. 2)Use the fund balance to address the shortfall (by 6/30/17).

Since the audit, the Legislature enacted laws that raised the fee, changed the fee to an annual fee, barred the use of Cigarette & Tobacco Tax revenues from funding the program, and required CDTFA to annually report on the adequacy of funding for the program. These actions were to ensure the program is self-funded and resourced to maintain enforcement.

The changes helped the program's funding to make it self-funded. However, based on forecasted expenses and revenues, CDTFA projects a funding shortfall. The estimated shortfall for 2019-20 and on­going is $1M per year. The balance in the fund can cover this shortfall until it is depleted to allow the program to continue without requiring a fee increase. CDTFA contacted CSA in September to clarify its recommendation, in light of the legislation and the fund's condition, i.e., the shortfall is expected to persist.

One of the law changes requires a report on the adequacy of funding for the program to the Legislature annually. This report states the revenues and expenditures, i.e., whether the program is self-supporting, and the licensing fund's beginning balance, change, and ending balance. This ensures transparency that the fund balance is no longer growing and is sufficient to run the program. Estimated completion is 12/31/20. The 19/20 results will provide more clarity on whether the shortfall persists and to what degree.

California State Auditor's Assessment of Annual Follow-Up Status: Pending

Annual Follow-Up Agency Response From October 2018

The Budget Act of 2018-19 (SB 840, Chapter 29) reflects all funding of the Cigarette and Tobacco Products Licensing Program (Licensing Program) from the Cigarette and Tobacco Products Compliance

Fund (Compliance Fund). (http://www.ebudget.ca.gov/2018-

19/pdf/Enacted/GovernorsBudget/7500/7600.pdf , Page 9).

This satisfies the requirement of AB 2770, which prohibits the use of cigarette tax revenue to fund the administration of the Licensing Program by July 1, 2019, one year earlier than required.

Limiting the Balance of the Compliance Fund:

The Department of Finance and the Legislature control how much is appropriated from the Compliance Fund. The amount appropriated to CDTFA, other state departments, and for Statewide General Administrative Expenditures (pro rata) versus the revenue collected from license fees influence the fund balance every year. The completion date of the recommendation is dependent on these factors.

Pursuant to AB 2770, the CDTFA is required to report "on or before January 1, 2019, and on and before January 1 annually thereafter," on the adequacy of funding for the Licensing Program. The annual report, as required by Business and Professional Code 22990.5, will provide a monitoring mechanism. It will report data, maintain an effective enforcement program, and can make recommendations to limit

the fund balance to an appropriate level.

The CDTFA will fully implement "a practice of limiting its balance to no more than two months' worth of expenditures," as stated in the recommendation, when it assesses a full year's worth of data on the

impact of the legislation and tax change. A recommendation will be made when the CDTFA reports this information to the Legislature, which is due by January 1, 2019.

California State Auditor's Assessment of Annual Follow-Up Status: Pending

Annual Follow-Up Agency Response From February 2018

The California Department of Tax and Fee Administration (CDTFA), with the assistance of the Department of Finance (DOF), has shifted all funding of the Cigarette and Tobacco Products Licensing Program (Licensing Program) to the Cigarette and Tobacco Products Compliance Fund (Compliance Fund) in the proposed 2018-19 Governor's Budget (http://www.ebudget.ca.gov/2018-19/pdf/GovernorsBudget/7500/7600.pdf , Page 10).

This action will satisfy the requirement of AB 2770, which prohibits the use of cigarette tax revenue to fund the administration of the Licensing Program by July 1, 2019, one year earlier than required.

Limiting the Balance of the Compliance Fund:

The Department of Finance and the Legislature control how much is appropriated from the Compliance Fund. The amount appropriated to CDTFA, other state departments, and for Statewide General Administrative Expenditures (pro rata) versus the revenue collected from license fees influence the fund balance every year. The completion date of the recommendation is dependent on these factors.

Pursuant to AB 2770, the CDTFA is required to report "on or before January 1, 2019, and on and before January 1 annually thereafter," on the adequacy of funding for the Licensing Program. The annual report, as required by Business and Professional Code 22990.5, will provide a monitoring mechanism. It will report data, maintain an effective enforcement program, and can make recommendations to limit the fund balance to an appropriate level.

The CDTFA will fully implement "a practice of limiting its balance to no more than two months' worth of expenditures," as stated in the recommendation, when it assesses a full year's worth of data on the impact of the legislation and tax change. A recommendation will be made when the CDTFA reports this information to the Legislature, which is due by January 1, 2019.

California State Auditor's Assessment of Annual Follow-Up Status: Pending

Annual Follow-Up Agency Response From November 2017

The California Department of Tax and Fee Administration (CDTFA) and the Department of Finance are in the process of eliminating all funding for the Cigarette Licensing Program that comes from the cigarette tax revenues through the annual budget process. This will result in the program being funded solely from the fees generated by the program in the 2018-19 fiscal year. It will also bring the CDTFA into compliance of AB 2770, which prohibits the use of cigarette tax revenue to fund the administration of the Licensing Program by July 1, 2019, one year earlier than required.

Limiting the Balance of the Compliance Fund

The Department of Finance and the Legislature control how much is appropriated from the Compliance Fund. The amount appropriated to CDTFA, other state departments, and for Statewide General Administrative Expenditures (pro rata) versus the revenue collected from license fees influence the fund balance every year. The completion date of the recommendation is dependent on these factors.

Pursuant to AB 2770, the CDTFA is required to report "on or before January 1, 2019, and on and before January 1 annually thereafter," on the adequacy of funding for the Licensing Program. The annual report, as required by Business and Professional Code 22990.5, will provide a monitoring mechanism. It will report data, maintain an effective enforcement program, and can make recommendations to limit the fund balance to an appropriate level limit the fund balance.

The CDTFA will fully implement "a practice of limiting its balance to no more than two months' worth of expenditures," as is stated in the recommendation, when it assesses a full year's worth of data on the impact of the legislation and the tax change. A recommendation will be made when the CDTFA reports this information to the Legislature, which is due by January 1, 2019.

California State Auditor's Assessment of Annual Follow-Up Status: Pending

1-Year Agency Response

In the 2016-17 Budget Act, the Legislature shifted funding of the Cigarette and Tobacco Products Licensing Program (Licensing Program) from the four funds that receive Cigarette and Tobacco Products Surtax revenue to the Cigarette and Tobacco Products Compliance (Compliance) Fund. This funding shift will decrease the Compliance Fund by $5.2 million annually. In 2016, the Legislature also enacted ABx2-11, which changed the retailer licensing fee from a $100 one-time fee to an annual $265 fee and increased the annual fee for wholesalers and distributors from $1,000 to $1,200. Combined, these legislative changes will both reduce the Compliance Fund's balance and make the Licensing Program self-funded. In addition the Legislature enacted AB 2770, which prohibits the BOE from using revenues derived from the Cigarette and Tobacco Products Surtax to fund the Licensing Program by July 1, 2019. This Legislation also requires the BOE to report to the Legislature no later than January 1, 2019, and annually thereafter, regarding whether the Licensing Program is adequately funded.

California State Auditor's Assessment of 1-Year Status: Pending

Although there have been several law changes, the status of this recommendation is pending the outcome of fiscal year 2016-17 to determine if the excess balance in the compliance fund has been eliminated. Additionally, in its follow-up communications with us, the board indicates that it will implement a practice of limiting the compliance fund's balance to no more than two months worth of expenditures, after it assesses a full fiscal year of data on the impact of these law changes.

6-Month Agency Response

The Legislature approved an action that reallocated $5.2 million of BOE's appropriation for the Cigarette and Tobacco Licensing Program in the spring of 2016. This reallocation will shift expenditures to the Cigarette and Tobacco Tax Compliance (Compliance) fund from the four funds that receive revenue from the Cigarette and Tobacco Products Surtax. This action will reduce the Compliance fund in the 2016-17 fiscal year by increasing BOE's appropriation to $7.5 million.

Additionally, two pieces of legislation were signed into law in May 2016 that changed the requirements of the Cigarette and Tobacco Licensing program. ABx2 11 increased the cost of the license and changed it from a one-time fee to an annual fee. SBx2 5 added to the definition of "tobacco products" any electronic nicotine delivery device, including, but not limited to, an electronic cigarette, cigar, pipe, or hookah; any component, part, or accessory of a tobacco product, whether or not sold separately. These law changes will change the revenue of the Compliance fund. BOE will continue to work with the Department of Finance and the Legislature to ensure the fund balance is at appropriate levels.

California State Auditor's Assessment of 6-Month Status: Pending

Ultimately, the excess of the fund balance depends on the affect of the recent legislation.

60-Day Agency Response

The Board of Equalization is in active discussions with the Department of Finance as to the best way to reduce the fund balance in the recommended time frame. Any adjustment to the appropriation of the Cigarette Licensing Program would require the approval of the Department of Finance and notification to the Legislature.

California State Auditor's Assessment of 60-Day Status: Pending

All Recommendations in 2015-119

Agency responses received are posted verbatim.