An Ohio lawmaker wants to allow the state to distribute income tax refunds on prepaid debit cards, which could save taxpayers money and benefit low-wage residents who do not participate in the traditional financial sector.

Many Ohioans do not have checking and savings accounts, and these residents often incur significant fees when they cash their refund checks at checking-cashing businesses, payday lenders and other providers of alternative financial services, consumer advocates said.

Senate Bill 365 would give taxpayers the option of receiving their state income tax refunds on prepaid debit cards. The program could help residents avoid fees while also receiving a convenient method to pay bills and access funds, experts said. The state could also save money on printing and mailing costs related to the distribution of paper checks.

But some officials said they worry the program’s costs could outweigh its benefits. The U.S. Treasury suspended a $1.4 million pilot program that distributed federal income tax refunds on prepaid cards after only a small fraction of taxpayers chose to participate.

“We have not taken a final position,” said Gary Gudmundson, spokesman with the Ohio Department of Taxation. “However, we do have some concerns about this proposed debit card program, largely based on the experience of the (federal government).”

Currently, taxpayers can have their refunds mailed as checks or directly deposited into their accounts, and increasingly residents are choosing the second option.

In 2011, the Ohio Department of Taxation issued 465,092 tax refunds to residents in Butler, Champaign, Clark, Greene, Miami, Montgomery and Warren counties, according to data obtained by the Dayton Daily News. Only about 40 percent of recipients received paper checks, while the rest received direct deposit. In those counties, the average tax refund was about $312.

Change would save money

Direct deposit is convenient for taxpayers because they receive their refunds quicker than people who opt for paper checks. There is also less chance the refunds will be stolen or go missing. Direct deposit saves also taxpayers money, because it costs the state 54 cents to issue a check, and virtually nothing to directly deposit money, according to officials.

But state Sen. Eric Kearney, D-Cincinnati, said he would like to further reduce distribution costs by offering taxpayers the choice of receiving their tax refunds on prepaid debit cards. Earlier this year, he introduced S.B. 365, which would allow the state to form an agreement with a financial service provider to issue refunds on prepaid cards.

“It saves money for the state,” he said.

Other states have enacted similar bills in the hopes of cutting costs related to mailing and printing checks. The Oklahoma Tax Commission is eliminating paper checks, and some state lawmakers said issuing refunds on prepaid debit cards would save the state millions of dollars.

In South Carolina, prepaid debit cards are intended to eventually replace the printing and mailing of paper checks, saving the state significant costs in tax dollars and processing time, according to the state’s Department of Revenue.

But Kearney said one of the main motivations for crafting the bill was to help residents who lack bank accounts. Last year, about 414,000 of Ohio’s 4.72 million households did not have a checking or savings account, according to a survey released in September by the Federal Deposit Insurance Corp.

Kearney said prepaid cards can give residents a safe and easy way to access their funds, and the cards could help residents avoid fees stemming from check-cashing services. The state already distributes some types of government assistance, such as unemployment benefits, via debit cards. The federal government is phasing out distributing Social Security benefits on paper checks.

“Constituents said they would appreciate such an option,” Kearney said. “Checks are going out of fashion.”

Prepaid cards can help low- and moderate-income Ohioans keep their refund money in a safe and secure location, and they could spare residents from paying check-cashing fees, said David Rothstein, project director for asset building with Policy Matters Ohio.

Policy Matters Ohio, however, released a dozen recommendations about how properly to administer the program, partly to protect participants from bank fees.

“I think the bill lays out a good structure, but obviously the devil is in the details in any kind of financial product,” Rothstein said.

Rothstein said the debit cards should not contain credit or lending features, and the cards should clearly disclose how consumers can access their funds without incurring fees and penalties. He said also Ohio should have an open and transparent bidding process for financial companies that want to provide the cards, so they can obtain the most advantageous agreement possible.

Kearney said he will consider input on how to create an efficient program.

Ohio is the latest state to consider using prepaid debit cards to deliver tax refunds. Connecticut, Georgia, Louisiana, New York, Oklahoma and South Carolina have introduced similar programs.

Tax departments across the country are facing budget constraints, and prepaid cards can save agencies time and money, said Verenda Smith, deputy director of the Federation of Tax Administrators. Some agencies hope to eliminate paper checks entirely in coming years.

“It is expensive to print paper checks, so why are we doing it when you can meet the needs of people without banking accounts and those with accounts?” she said. “Agencies are also trying to be more responsive to taxpayers who are unbanked and don’t have banking accounts.”

But Gudmundson said tax officials are concerned the program will not have a high participation rate and it could create the potential for fraud. He said a similar federal pilot program was suspended after it had a low participation rate.

The Treasury sent out letters to 808,000 U.S. taxpayers with low to moderate incomes inviting them to receive their federal income tax refunds on reloadable, prepaid debit cards. Only about 1,933 taxpayers were issued the cards, and only about one-third of recipients used the cards.

But the Urban Institute — which the government hired to evaluate the pilot program — concluded the program has promise, and the participation rate was consistent with the sign-up rate of direct credit card offers in the mail.

Kearney’s bill has not been assigned to a committee, but he said it should pass because it is a bipartisan issue. Republican-controlled legislatures in other states have passed similar measures.