Footing the bill: How local governments could tap federal funds for delinquent taxes

“Taxes are the price of civilization.”

Oliver Wendell Holmes Former U.S. Supreme Court Justice

One of the biggest problems concerning tax collection is that the federal government pays people who owe money to state or local government. There are several ways this can happen. People who owe state, county or city taxes get federal and state tax refunds, if they work for the government they get paychecks, if they are vendors or contractors they make money from government-funded projects and even social security checks fall into this category.

For those responsible for the management of state and local funds – the business of government – this presents a huge problem. But for Arlington County Treasurer Frank O’Leary, it also presents a huge opportunity.

In 1996, the Financial Management Service (FMS) formalized a collection program, called debt offset. FMS is a division of the U.S. Department of Treasury and initially they began collecting debt owed to federal agencies, but then expanded the program so states could submit unpaid child support debt to offset the Federal tax refunds of those who owed back child support. The move was part of legislation in the so-called “Deadbeat Dads” program. Then in 1998, Senators Orrin Hatch (R-Utah) and Charles Grassley (R-Iowa) introduced legislation that allowed state governments to collect income taxes owed to them from similar Federal payments (i.e. Federal tax refunds). The bill became law in 2001.

In the eight years since, though, little has been done to see that local government gets its share of debt offset money.

Mr. O’Leary is working to expand debt offset from states to localities, using the existing network, so county and city municipalities can also recoup money owed to them in back taxes.

“Debt offset is one of the best ways to get back taxes owed to the state or local government,” Mr. O’Leary said in an interview last week.

But to date, only nineteen states participate to the degree necessary to realize the full potential of the debt offset program. And the states of Alaska, Florida, Michigan, Nevada, New Hampshire, Tennessee, Texas, Washington and Wyoming do not currently participate in state of Federal debt offset programs, according to a document (.pdf) provided by the National Association of Counties.

The following diagram illustrates how the process works:


For those states that have intra-state, or in-state, offset programs, “All the pipelines have already been laid,” Mr. O’Leary said. “The pipeline from Richmond to D.C. has yielded $17 million in just the last year.”

So far, thirty-nine states and the District of Columbia participate in the Federal offset program, but since most of them do not have intra-state networks set up, county and city governments are left out of the picture.

The Arlington County Treasurer is hoping that will soon change. In June of this year, Mr. O’Leary was able to lobby the House Ways and Means Committee to introduce H.R. 3060 – a bill that would allow certain local tax debts to be collected through the reduction of Federal tax refunds.

Under the name of the “Local Taxpayers Fairness Act,” Representative James Moran (D-Va.) said the the bill would bring fairness to the current system which has honest taxpayers pay more in local taxes to cover those who are delinquent.

“It’s not fair for law-abiding taxpayers to have to cover the cost of those who skirt the law,” Rep. Moran said in a statement. The new system would allow, “local governments to recoup unpaid taxes in the same way state governments do, by directly receiving the amount owed from federal tax refunds,” he continued. Original cosponsors included Gerry Connolly (D-Va.), Bob Goodlatte (R-Va.), Rob Wittman (R-Va.), and Frank Wolf (R-Va.).

One of the most important reasons states have to develop an intra-state network, then join the federal program, is the issue of interstate migration.

Mr. O’Leary says “Arlington County has a 20 percent turnover rate in population, annually. Once they’re out of state, though, it’s extremely hard to collect from them. We can go after their credit rating, but that doesn’t do much to address the real problem,” of collecting money for the government.

If all states enacted in-state debt offset programs, it wouldn’t matter if someone who lived in Colorado, owing the state money in taxes, moved to Washington and received a check from the government. Currently, this scenario plays out without that individual having to pay Colorado unless she moves back.

“New York City estimates that they could receive $100 million annually, as a result of debt offset,” Mr. O’Leary said, “That’s their number, not mine. And New York is one of the states that don’t have an in-state offset program.”

According to Mr. O’Leary’s estimates, the benefits of implementing a system of intra- and inter-state debt offset networks would be huge for local governments.

“$2 to $3 billion could be generated for localities, nationwide,” Mr. O’Leary urged. “Debt offset could be the most powerful collection tool that local government has ever had.”

For more information on H.R. 3060 or for more on the debt offset program, click here to download a PowerPoint presentation.

For related articles, read the following:

States’ back taxes get back-filled with federal dollars

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