California Plan Proves Taxing to Private Industry

By Steve LeSueur, Staff Writer

The state of California plans to install a controversial Internet tax filing system by January 2001 despite a recent state court ruling that prevented it from getting the system set up for the 1999 tax season.

The project faces fierce opposition from H&R Block Inc. of Kansas City, Mo., and Intuit Inc. of Mountain View, Calif.

Intuit, the No. 1 maker of personal finance software, had revenue of about $850 million this year. H&R Block, North America's leading tax preparer, had revenue of $1.5 billion in 1999, according to Hoover's Inc., Austin, Texas.

These tax-preparation giants persuaded a judge last month to block immediate installation of the service because California's Franchise Tax Board had violated procurement rules when it selected a vendor to develop software for the online system.

The heart of the dispute, however, does not center on procurement procedures but on questions regarding the role of government and whether the California agency is setting itself up as a competitor in the lucrative, commercial tax-preparation marketplace.

"We don't believe government agencies have a proper role competing with the private sector where the private sector is already providing state-of-the art services and for free," said Gene Goldenberg, vice president of software and e-commerce for H&R Block Financial Corp.

But California officials said the Internet filing service is the electronic equivalent of paper tax forms that are mailed by citizens directly to the government without the intervention of tax-preparation companies.

"Many people don't want to send their taxes through a third party. They want to keep their information confidential," said P.K. Agarwal, the Franchise Tax Board's chief information officer.

California's tax board, which receives and processes more than 14 million personal income tax returns and collects $33 billion in tax revenue from individuals, banks and corporations annually, plans to begin another pilot project in time for the 2000 tax season.


The board, which is managed by a three-member board of directors chaired by the state controller, Kathleen Connell, will make a decision within six weeks whether to hire a vendor or develop the software in-house, Agarwal said.

Andersen Consulting of Chicago played a major role in the initial pilot project under a subcontract to MCI WorldCom Inc., Clinton, Miss., and Bell South of SBC Communications Inc., San Antonio. The companies hired Andersen in September to put the tax forms online by January under a joint contract they held to provide telecommunications services to the state of California.

The project would have enabled taxpayers using the 540EZ form to file and pay their taxes over the Internet. The tax forms also would automatically calculate the columns of numbers provided by taxpayers as they filled out the forms.

But H&R Block and Intuit filed suit Oct. 12 against the proposed project, contending that the California Integrated Information Network telecommunications contract was an improper vehicle for developing Internet filing software.

Judge James Ford of the Sacramento County Superior Court ruled against the Franchise Tax Board at an Oct. 21 hearing, and Nov. 19 the California agency formally agreed not to pursue the Internet filing system using the telecommunications contract.

The delay caused by the lawsuit made it impossible to get the service online for the 1999 tax season anyway, said state officials.

At a Nov. 11 meeting, Connell and fellow board members adopted a resolution directing the tax board "to implement an Internet filing option by January 2001 or earlier, if practicable, which will allow taxpayers a choice of filing tax returns directly with the department in a secure and confidential manner."

The board also emphasized that the service be "free" or "at no charge" to taxpayers, and that the staff examine approaches being considered by other states.

"Board members were clearly expressing their view that this is a service that should be provided directly to California taxpayers and not through a third party," said Jim Shepherd, a spokesman for the tax board.

Agarwal called the planned Internet filing project a "plain vanilla option" for taxpayers who may not need or want the more sophisticated tax preparation software developed by the private sector. His agency's Web site will continue to provide links to tax-preparation vendors for those who want to use them.

"Their software involves tax strategies, not just filling out forms," he said. "We couldn't imagine doing what they're doing."

But industry officials contend that because the planned California software calculates taxes, it crosses the line of simple filing into tax preparation.

"Tax preparation is manipulating the data before it's filed," said Bernie McKay, vice president of corporate affairs for Intuit. "The characterization of this as e-filing is wrong."

Moreover, a tax collection agency should not be trusted to help people figure out how much they owe, especially because tax preparation requires many subjective judgments, industry officials said.

Despite assurances from tax board officials that their main goal is to provide e-filing capability, some industry officials fear the California agency will expand to more complicated tax forms and tax preparation.

"The vision goes way beyond the pilot," said McKay.

California's telephone filing service, called TeleFile, can calculate taxes, and it is not competing for tax-preparation business, said the tax board's Shepherd.

"It's mathematics, not tax counseling," he said.

Meanwhile, the state of Washington offers online filing for businesses, but that system has not generated complaints from tax-preparation companies.

And several states, including Michigan, New York and West Virginia, are considering offering free online services with hot links to the vendors rather than building their own systems, said McKay.

This type of approach, in which the companies provide the free online filing service, is preferred by companies like H&R Block and Intuit.

These companies would offer such services in hopes that EZ-form taxpayers purchase their services when they require more sophisticated tax assistance. By Steve LeSueur

The dispute over Internet tax filing in California is a harbinger of coming debates over public-private boundaries in electronic government.

The Internet has lowered the barriers to entry for delivering products and services for both government and industry. Governments no longer shy away from services such as online licensing, vehicle registration or tax filing because of a lack of infrastructure or other cost barriers.

At the same time, the Internet enables industry to reach into areas traditionally considered the domain of government. Companies such as the National Information Consortium Inc., ezgov.com inc. and govWorks Inc. are offering new models in which they act as intermediaries that deliver government services to citizens over the Internet. Many of these transactions previously were conducted directly with the government.

As a result, there has been a blurring of traditional boundaries. "The real issue is the role of government in the Internet age," said Thomas Davies, senior vice president for Current Analysis Inc., a Sterling, Va. company that provides rapid analysis of market events and trends.

Any lines that may have existed will be called into question, and in many instances the historical rational for those lines may no longer be defensible, he said. "New arguments for where the lines should be drawn will need to be made and debated," he said.

Take the e-filing system brouhaha in California.

"In the case of H&R Block, the threat is not direct competition by government, but rather eliminating or reducing the need for its services," said Mike Benzen, chief information officer for Missouri. "Just because we've created the need for these companies, do we have an obligation to keep them in business?"

Gene Goldenberg of H&R Block acknowledged that his company is fighting for its commercial interests, but argued that a key issue is how best to provide e-filing for citizens. Tax-preparation companies have invested millions of dollars over the past decade to develop online software, he said, and are willing to offer citizen's EZ e-filing services for free.

"Should the government start building cars just because it doesn't like the cars General Motors?" he said.

Moreover, just because the government can do something does not mean it should, said Grover Norquist, president of the Washington-based Americans for Tax Reform, which favors lower taxes.

Privacy is an important element underlying this and other concerns related to e-government. Much of the efficiency gained from e-government initiatives comes from the rapid sharing of information facilitated by Web transactions.

But this also leaves open the possibility of abuse by those with access to government information. Many citizens worry about what happens to confidential information collected by local, state and federal governments in the information age. Congress, for example, enacted legislation that would prevent the states from selling driver's license photographs and information to third parties.

Such issues will increase as government and industry leaders wrestle with the ramifications of e-government.

"The old structures are being broken down. The creation of the new is not an orderly process," said P.K. Agarwal, the California tax board's CIO.

? Steve LeSueur