Centrelink hit at least 21,000 families with bogus Family Tax Benefit debts last year, the federal government has conceded.
The welfare agency sent 65,000 demands in November 2016 to repay money received through the family assistance payment but about 21,400 of the families hit with the debt notices were able to prove they owed Centrelink nothing.
Centrelink's parent department, Human Services, blames the error rate of at least 33 per cent on its clients' failure to "engage" and says it has already improved its efforts to get in touch with recipients.
But Labor is scathing of the latest debt recovery revelation, saying something is "terribly wrong" at Centrelink and "hardworking, honest Australians" have been "intimidated" into handing over their money.
The true rate of bogus debts could be higher than the official 33 per cent because the Human Services does not record or disclose how many families simply paid the money to get Centrelink off their backs or lacked the documentation to fight the debt notices.
The Family Tax Benefit recovery effort is a separate process to the controversial 'robo-debt' data-matching scheme which has mired Centrelink in controversy for several months.
In its submission to the Parliamentary inquiry into the controversy, Human Services says it writes in March each year to FTB recipients who have not filed a tax return, asking them to update their tax affairs "or advise the department that they do not need to lodge a tax return."
In 2016, 260,000 such letters were sent out, according to the DHS submission.
"Not all people responded to the departmental letters, as 65,000 debt notices had to be raised in November 2016," Human Services said.
"Of these debt notices, 33 per cent were then changed to zero dollars as the individual responded with further information once they had received the debt notice and a reassessment was able to be undertaken."
The department also noted the rate of bogus FTB debts dwarfed that of robo-debt.
"By contrast to the FTB scenario above, only 3.5 per cent of 130,000 online compliance debts raised from July 2016 to January 2017 were later reduced to zero dollars," the submission reads.
DHS says it has listened to the torrent of political, public and media criticism it has endured since the robo-debt controversy emerged in December.
In its submission, the department re-iterated its central argument that much of the trouble would be avoided if its clients simply engaged in the process at an early stage.
"The department has listened to feedback and made refinements to not only the content of the letters, but also how they are delivered to recipients to ensure recipients receive the letters," the submission reads.
"Improvements have also been made to how recipients access the online portal as well as its readability and functionality."
Labor's Human Services spokesperson Linda Burney said the submission showed both Centrelink and its political bosses were well aware of the flaws in its systems.
"Something is going terribly wrong at Centrelink," she said.
"It is clear from the Department's own submission that those issues aren't just real, they are well known to the Minister and to Centrelink."
"It is deeply concerning that many more people may have simply paid these alleged debts because they were intimidated by the process.
"This system is broken and it is everyday Australian's paying the price."
