A Taxing Situation

Imaging technology -- which can read, store and retrieve tax documents as electronic images -- is increasing tax-processing efficiency and helping generate much-needed revenue.

by / December 31, 1995
PROBLEM/SITUATION: State tax and revenue agencies collect less than what is owed.
SOLUTION: Imaging captures more data from tax forms to improve audits. Imaging also reduces the manpower needed to process tax forms.
JURISDICTION: Delaware Division of Revenue; Massachusetts Department of Revenue, Wyoming.
VENDORS: Northrup Grumman, Unisys, Kodak, Fujitsu, Sony, Plexus, Sun Microsystems, Microsoft, Informix, Datacap, Task Master, Intel.
CONTACT: Alan Golobski, deputy commissioner, Massachusetts Department of Revenue, Processing Division, 617/887-5010


By Tod Newcombe
Contributing Editor

Massachusetts taxpayers will discover some changes when they receive their tax forms this month. Instead of writing their figures on lines, they will need to put every numerical digit for income, deductions, credits and taxes into a box. While the boxes might be a pain for some, for the Department of Revenue (DOR), they add up to big benefits.

Completed tax forms -- pouring into DOR's mailroom between now and April 15 -- will bypass the army of keypunch operators and go straight to scanners for conversion into electronic images.

At the same time, intelligent character recognition (ICR) software will read all those handwritten numbers and convert them into data that the computers can use to verify the accuracy of the forms. "We're going to be able to capture twice as much data as before," remarked DOR Commissioner Mitchell Adams. "It was just too expensive doing it manually."

DOR is building a two-phase integrated imaging system with Unisys that can process all personal income tax forms.

The scanning and data capture benefits DOR in two ways. On the front end, it reduces the need for manual keypunching, filing and other labor-intensive tax processing tasks. According to Adams, the efficiency of imaging reduces the cost of processing a form from $1.28 to less than $1.00. At the back end, the extra data gives DOR the ability to carry out more accurate audits, which helps to increase voluntary tax compliance. More compliance equals more revenue for the state.

Auditing affects only a small percentage of tax returns, but results can be significant. The nation's federal and state tax system is based on voluntary compliance. What tax agencies are owed, but don't collect, is known as the tax gap. For states, closing that gap as much as possible is a major priority. The IRS, for example, calculates that a 1 percent boost in voluntary compliance brings in approximately $5 billion in additional revenue. To realize that benefit and to increase overall efficiency, the IRS has undertaken a multi-billion dollar investment in imaging and information management modernization.

"State legislatures aren't going to raise taxes," said Ken Rainey, director of program development and marketing for tax processing at Unisys Corp., "so states have to realize more net revenue from existing tax rates." Besides figuring out how to increase compliance, tax agencies are also under pressure to become more efficient. In the past five years, manpower at Massachusetts' DOR has shrunk 28 percent. With fewer resources available to collect taxes, agencies are hard-pressed to improve the way they process tax forms.

Imaging technology is one way to achieve these goals. Little more than a high-tech filing cabinet several years ago, imaging has matured into a productive processing and management tool that has become more affordable as hardware and software prices drop. More importantly, ICR as well as optical character recognition software, has greatly improved, making it possible for an imaging system to capture an image of a tax return and convert it into valuable data.

Despite the introduction of electronic tax filing methods, which bypass paper tax forms entirely, Commissioner Adams and other tax experts believe tax agencies are going to be dealing with paper for some time to come. Given that situation, and the maturity of imaging technology, more than a dozen states are operating or installing imaging systems to better manage both paper and data.

The Delaware Division of Revenue was one of the first tax agencies in the nation to use imaging for processing tax forms. The system helped reduce the amount of time spent on researching an audit case from 13 hours to two hours. Consequently, the agency has been able to increase the number of audits it conducts and raise revenue collection by 20 percent. Tax agencies also have had major problems with retrieving tax documents, whether for audits or for answering a taxpayer question.

In Massachusetts, paper forms are stored at three separate sites. If someone needs to look at a form that's more than four years old, it can take a week or more to find it. In Delaware, the problem was so bad only 10 percent of all taxpayer questions could be answered on the first call. Now with imaging, data is available to caseworkers immediately, and 85 percent of all questions are answered on the first call.

Imaging first got its foot in the door of tax agencies as a way to process tax remittances. These systems capture an electronic image of checks and accompanying "coupons," or check-sized forms for sales and business taxes. Because they process just a small amount of information -- usually the dollar amount on the check and coupon -- remittance transactions are good for simple, but high-volume imaging.

In Wyoming, remittance-based imaging has allowed the state to deposit checks the same day they are processed, boosting interest -- and state revenue -- by as much as $300,000 annually. Processing tax forms, however, requires a more sophisticated and complex imaging system. According to Jerry Michael, manager of imaging products for Northrup Grumman, the key components of tax form imaging include:

* Document preparation. This includes opening, sorting and validating tax returns.

* Scanning. Here, the paper documents are converted into electronic images using high-speed scanners.

* Image processing. This includes cleaning and enhancing the scanned image of the document so it can be "read" by software.

* Data capture. This step identifies the form and then uses one of several recognition engines -- software that can read either hand-printed or typed characters.

* Data verification. Human operators need to edit what the recognition software couldn't or didn't read properly.

* Indexing and storage. Tax forms must be properly indexed for later retrieval and then stored on either magnetic, optical or tape storage systems.

* Retrieval. Whether handling taxpayer queries or researching an audit case, an imaging system needs document management and workflow software to manage the information and to ensure that the right images and data go to the right worker at the right time.

Tax agencies must also execute two other non-technical, but critical steps if they want to gain the maximum performance from their imaging system. First, tax forms need to be redesigned so that the recognition software has an easier time reading the characters. In the case of Massachusetts, this meant requiring taxpayers to enter data into boxes that constrain their handwritten entries. By making it easier for the software to "read" the return, agencies can improve the performance of their systems, reducing the need to correct costly errors later on.

Second, agency workers have to be trained. "They have to become image-enabled," explained Michael. "Workers must make the transition from working with paper to working with images on a computer screen. It takes time to get accustomed to imaging," he said.

Not surprisingly, imaging in the tax arena doesn't come cheap. New Jersey awarded Northrup Grumman a contract to build a $1.5 million imaging system; Mississippi recently awarded the firm a contract worth $5 million.

Training and forms redesign, if necessary, can add to the cost. But every penny is worth it, according to Adams. "We have analyzed every element of the [tax] process, from records retention and retrieval, processing costs and amount of data captured," he said, "and on every count imaging is superior."