$526M in state tax foulups spur questions about oversight

Of course, to the layman, the fact that such a thing exists is probably a surprise, let alone that it would have caught $526 million worth of tax errors that resulted in layoffs, pay cuts and other strains associated with the massive budget cuts made over the last four years.

While the $526 million figure is a simple, if massive number, on the surface, underneath that massive amount of money are hundreds of thousands of individual financial transactions and decades of statutes and politics.

The $320 million error found in December was discovered through one of 28 tax "streams" that carry the sales, income, corporate and other taxes into the state. The $206 million mistake that the state discovered earlier this month was money supposed to be sent out to the counties. In both problems, computer programming is being blamed, specifically errors in the state's tax return processing system.

State Board of Accounts chief Bruce Hartman, who conducted an initial review for lawmakers, says his agency is only required to conduct a sweeping financial audit and reviews triggered by allegations of waste and fraud. It isn't required to conduct IT audits, which would have caught this $526 million in errors.

The complex issue has launched an intense political battle over who should get to pry, and where.

Gov. Mitch Daniels originally said his administration would handle the financial review alone. The Legislature's Republican leaders later insisted on having their say in how the audit is done. Democrats have called for an expansive independent audit that would look beyond computer programming errors.

"Is there anything we are looking at today that would go beyond programming to operational checks and controls?" asked Sen. Karen Tallian, D-Portage, during a State Budget Committee hearing Friday at which lawmakers discussed the problems.

Hartman responded by ticking off a Bubba-Gump Shrimp-style list of reviews designed to catch errors before they grow into hundreds of millions of dollars and start costing people their jobs:

"There are a number of types of audits," he said. "There are financial audits, there are compliance audit, there are internal audits done by staff of the agency, there's IT audits and there are efficiency or operational audits."

And then there's the trigger, the point at which inside an audit things get examined more closely. The industry term is "materiality." Broadly, for Indiana, the "materiality" trigger is $70 million. Things below that level don't get a separate vetting because there just isn't enough time or resources to check every single blip, Hartman said.

Error is built into the equation.

Indeed, the state's local income tax process itself has error built into its equation. The state hands out money to counties based on last year's collections, and the two are constantly adjusting who owes who what.

John Mikesell, a professor of public budgeting at Indiana University, noted that the transfers between other states and their localities are routine and almost never perfect.

"Correct allocations between state and local components and between localities has been a problem in other states in the past, but the Indiana error sets a record for size of the mistake," Mikesell wrote in an email to The Associated Press.

A deputy director for the Federation of Tax Administrators has called Indiana's $320 million error "eye-catching," noting that states routinely have errors in their collections, but nothing quite of that magnitude.

The problem in this case, says State Budget Director Adam Horst, is that the traditional tools for catching mistakes would not necessarily have worked. For instance, changing the "materiality" trigger would not have worked because the numbers being generated for the reports themselves were wrong, he said.

"That materiality threshold would not have changed their finding," he said. "If you don't find it in the first place, whatever that number is—whether it's 70 million, or 20 million or 10 million—is somewhat irrelevant."

Horst, however, has noted routinely throughout each budget debacle that the state's internal safeguards did eventually kick in.

The person who started unraveling this whole thing upon discovering one small, but tangible error last November? An unnamed internal auditor.

Still, it took three years before investigators found the first thread of this massive problem, and it took another few weeks after the initial discovery to determine there was a $320 million problem. That $320 million problem, in turn, led state workers to discover the first traces of the $206 million error announced earlier this month.

The problems aren't likely to stop here. Horst says there are "indications" of more errors. But he doesn't want to jump the gun with any announcements before his internal "reconciliation" review is completed.