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Testimony:

Before Congressional Committees:

United States Government Accountability Office:

GAO:

For Release on Delivery Expected at 3:00 p.m. EDT, Thursday, May 19, 
2005:

IRS Modernization:

Continued Progress Requires Addressing Resource Management Challenges:

Statement of James R. White, Director, Strategic Issues: 
David A. Powner, Director, Information Technology Management Issues: 
Steven J. Sebastian, Director, Financial Management and Assurance:  
Gregory C. Wilshusen, Director, Information Security Issues:

GAO-05-707T:

GAO Highlights:

Highlights of GAO-05-707T, a testimony before congressional committees: 

Why GAO Did This Study:

Since the passage of the IRS Restructuring and Reform Act of 1998 (RRA 
98), the Internal Revenue Service (IRS) has faced the challenge of 
managing its resources to simultaneously improve service to taxpayers, 
assure taxpayersí compliance with the tax laws, and modernize its 
antiquated information systems. 

As requested, this statement provides our assessment of IRSís current 
performance in the areas of taxpayer service, tax law enforcement, and 
systems modernization. Looking ahead, this statement also describes the 
challenges that IRS faces in addressing resource constraints as well as 
realizing efficiency and information systems improvements.

What GAO Found:

IRSís most noticeable progress has been in IRSís taxpayer service, 
which has been of special concern to the Congress. Since the passage of 
RRA 98, improvements in access to IRS by telephone, the accuracy of 
answers given to taxpayer inquiries, and the growth of IRSís Web site, 
which now provides a variety of services, have been noteworthy 
accomplishments.

IRS experienced declines in enforcement staffing after 1998, but 
recently stopped the declines and begun to show increases. Despite 
this, enforcement remains a high risk area because of the continued 
need to improve enforcement and make progress towards reducing the tax 
gap.

IRS has made significant progress in establishing management controls 
and acquiring infrastructure as part of the BSM program, as well as 
significant progress in addressing financial management issues. 
However, BSM remains at risk because of the scope and complexity of 
modernization activities and the need for better management capacity to 
avoid repeating the programís history of schedule delays and cost 
overruns.

Looking ahead, continuing the progress described above depends on IRS 
addressing resource constraints and realizing efficiency and systems 
improvements. We highlight several such opportunities:

* Developing long-term goals would help IRS and Congress assess agency 
performance and make budget decisions.
* Considering additional funding enhancements such as user fees and 
private debt collection which may help mitigate budget constraints.
* Leveraging nonfederal partners such as states to assist with tax law 
enforcement and volunteers to help provide taxpayer service.
* Prioritizing taxpayer service activities could help IRS minimize the 
impact of budget cuts.
* Targeting enforcement resources could help IRS make more efficient 
use of available resources and help the agency make progress towards 
reducing the tax gap.
* Creating the necessary systems to enable IRS to develop accurate cost 
accounting information would help IRS make resource allocation 
decisions.
* Developing and using better productivity data would help IRS make 
productivity improvements and thereby make better use of available 
resources. 
* Making needed management improvements would help IRS bring planned 
new information systems on-line in a timely and cost-effective manner.
Making needed improvements to assure information systems security would 
reduce vulnerabilities.

What GAO Recommends:

GAO is not making any new recommendations, but has recommendations 
outstanding related to taxpayer service, tax law enforcement, Business 
Systems Modernization (BSM), and systems security.

IRS is in general agreement with our recommendations and is in the 
process of implementing many of them.

www.gao.gov/cgi-bin/getrpt?GAO-05-707T.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact James R. White at (202) 
512-9110 or whitej@gao.gov.

[End of section]

Mr. Chairman and Members of the Committees:

Mr. Chairman, we are pleased to participate in this joint review of the 
Internal Revenue Service (IRS). Since passage of the IRS Restructuring 
and Reform Act of 1998 (RRA 98), IRS has faced the challenge of 
managing its resources to simultaneously improve service to taxpayers, 
assure taxpayers' compliance with the tax laws, and modernize its 
antiquated information systems. As you are well aware, making these 
improvements is important. IRS is responsible for collecting the 
roughly $2 trillion in tax revenue used to fund the government and 
annually touches more Americans than any other federal agency. IRS's 
service and enforcement efforts influence Americans' confidence in the 
fairness of the tax system and their perception of the effectiveness of 
their government.

As requested, this statement provides our assessment of IRS's current 
performance in all three areas. We then look ahead, describing the 
challenges that IRS faces in addressing resource constraints as well as 
realizing efficiency and information systems improvements.

Our discussion of both recent progress and challenges facing IRS is 
based primarily on recently issued GAO products. We used our recent 
reports and testimony on IRS's budget, the tax gap, filing season 
reviews, financial audits, systems modernization activities, Business 
Systems Modernization (BSM) expenditure plans, and information 
security. Our work was performed in accordance with generally accepted 
government auditing standards.

In summary, IRS has made progress in improving service and modernizing 
operations, but the gains have not been uniform. The most noticeable 
progress has been in IRS's taxpayer service, an area that has been of 
special concern to the Congress. Access to IRS by telephone, the 
accuracy of answers given to taxpayer inquiries, and the growth of 
IRS's Web site, which now provides a variety of services, including 
forms and instructions, information on the status of refunds, and 
answers to frequently asked questions, have been noteworthy 
accomplishments in the years since passage of RRA 98. With respect to 
tax law enforcement, IRS experienced declines in enforcement staffing 
after 1998 but has recently stopped the declines and begun to show 
increases. However, tax law enforcement remains a high-risk area 
because of the need to improve enforcement and make progress towards 
reducing the tax gap--the difference between taxes owed and taxes paid 
on time.[Footnote 1] As for systems modernization, IRS has made 
significant progress in establishing long-overdue management controls 
and in acquiring foundational system infrastructure and applications as 
part of the BSM project, as well as significant progress in addressing 
financial management issues. However, BSM remains at risk because of 
the scope and complexity of modernization activities and the need for 
better management capacity to avoid repeating the program's history of 
schedule delays and cost overruns.

Looking ahead, continued progress depends on IRS addressing resource 
constraints and realizing efficiency and systems improvements. Long- 
term goals would help stakeholders, including the Congress, evaluate 
the adequacy of IRS's budget. Further, additional resources might be 
brought to bear by, perhaps, additional user fees or the leveraging of 
nonfederal partners beyond what is now done with states and volunteers. 
Efficiency gains may be possible by, for example, prioritizing taxpayer 
services in order to focus on those that provide greater benefit, 
targeting enforcement by using better data on noncompliance, collecting 
more accurate cost information to improve day-to-day and long-term 
decision making, and realizing productivity improvements. Finally, IRS 
needs to bring planned new systems on line in a timely and cost- 
effective manner while also assuring systems security. GAO has 
outstanding recommendations related to taxpayer service, tax law 
enforcement, BSM, and systems security. IRS is in general agreement 
with our recommendations and is in the process of implementing many of 
them.

IRS Has Improved Taxpayer Service but Enforcement and BSM Remain High 
Risk:

IRS has made noticeable progress in improving taxpayer service since 
passage of RRA 98. While progress has also been made in the tax law 
enforcement and BSM areas, however, serious ongoing issues have kept 
both on our high-risk list.[Footnote 2]

IRS Has Improved Taxpayer Service but Is Shifting Priorities:

IRS has made meaningful progress in four key taxpayer service areas; 
paper and electronic processing, telephone assistance, IRS's Web site, 
and walk-in assistance. Table 1 shows IRS performance in these areas 
since 2002. While the progress is widespread, table 1 also shows that 
there are some areas of performance that merit attention, especially in 
light of current and proposed cuts to IRS's taxpayer service budget. In 
fiscal year 2005 and in its proposed 2006 budget, IRS is shifting 
priorities by reducing taxpayer service and increasing resources for 
enforcement.

Table 1: IRS Performance in the First Weeks of the Filing Season, 2002- 
2005:

Volume in thousands.

Actual returns processed[A]: Paper; 
2002: 24,491; 
2003: 22,117; 
2004: 20,232; 
2005: 17,607.

Actual returns processed[A]: Electronic; 
2002: 35,067; 
2003: 38,627; 
2004: 42,988; 
2005: 45,848.

Telephone assistance: Total calls[B]; 
2002: 34,489; 
2003: 27,905; 
2004: 29,058; 
2005: 23,340.

Telephone assistance: Total calls[B]: Answered by assistors; 
2002: 9,208; 
2003: 9,434; 
2004: 10,116; 
2005: 9,421.

Telephone assistance: Total calls[B]: Answered by automation; 
2002: 25,281; 
2003: 18,471; 
2004: 18,942; 
2005: 13,919.

Telephone assistance: Total calls[B]: Customer service representative 
level of service; 
2002: 62%; 
2003: 82%; 
2004: 84%; 
2005: 83%.

Telephone assistance: Total calls[B]: Average speed of answer[C]; 
2002: 227 seconds; 
2003: 183 seconds; 
2004: 199 seconds; 
2005: 235 seconds.

Telephone assistance: Accounts accuracy rate estimates[D]; 
2002: 88%; +/-1%; 
2003: 88%; +/- 1%; 
2004: 89%; +/-1%; 
2005: 92%; +/-1%.

Telephone assistance: Tax law accuracy rate estimates[D]; 
2002: 84%; +/-1%; 
2003: 81%; +/-1%; 
2004: 76%; +/-1%; 
2005: 87%; +/-1%.

Internet assistance: Forms and publications downloaded[E]; 
2002: N/A; 
2003: N/A; 
2004: N/A; 
2005: 70,321.

Internet assistance: Refund status inquiries[F]; 
2002: N/A; 
2003: 9,300; 
2004: 14,300; 
2005: 16,400.

Walk-in assistance: Total walk-in contacts[G]; 
2002: N/A; 
2003: 2,740; 
2004: 2,433; 
2005: 2,163.

Walk-in assistance: Returns prepared at IRS walk-in sites[H]; 
2002: 436; 
2003: 291; 
2004: 186; 
2005: 145.

Walk-in assistance: Returns prepared at volunteer sites[I]; 
2002: 466; 
2003: 594; 
2004: 741; 
2005: 915.

Source: IRS.

[A] From January 1 to March 22, 2002; March 21, 2003; March 19, 2004; 
and March 18, 2005.

[B] Total calls (i.e., calls answered by assistors and automation) and 
CSR level of service are based on actual counts from January 1 to March 
16, 2002; March 15, 2003; March 13, 2004; and March 12, 2005. The 2002 
totals include increased call demand as a result of the Economic Growth 
and Tax Relief Reconciliation Act of 2001 (Pub. L. No. 107-16 (2001)).

[C] From January 1 to March 16, 2002; March 15, 2003; March 13, 2004; 
and March 12, 2005.

[D] Based on a representative sample estimated at the 90 percent 
confidence level from January to February 2002, 2003, 2004, and 2005.

[E] As of February 28, 2005.

[F] From January 1 to March 20, 2003; 2004; and 2005.

[G] From January 1 to March 15, 2003; March 13, 2004; and March 12, 
2005.

[H] From January 1 to March 16, 2002; March 15, 2003; March 13, 2004; 
and March 12, 2005.

[I] From January 1 to March 9, 2002; March 8, 2003; March 13, 2004; and 
March 12, 2005.

[End of table]

Returns Processing:

As shown in table 1, electronic filing has increased while paper filing 
has dropped. The increase in electronic filing has allowed IRS to 
reduce the resources devoted to processing. As shown in figure 1, IRS 
reduced the staff devoted to processing paper returns between 1999 and 
2004 by just over 1,100 staff years. The figure also shows that as the 
number of e-filed returns has increased, the number of staff years used 
to process those returns has not increased. The decline in paper 
processing staff allowed IRS to close its Brookhaven processing center 
in 2003.[Footnote 3] In addition, IRS is in the process of closing its 
paper processing operation in Memphis.

Figure 1: Change in Methods of Tax Return Filing Since 1999:

[See PDF for image]

[A] Fiscal years 2005 and 2006 are IRS projections and, given the 
current lower e-file growth rates, the estimates may be optimistic.

[End of figure]

In addition to saving IRS resources, electronic filing offers benefits 
to taxpayers in that it allows taxpayers to receive refunds faster and 
is less error prone. IRS employees manually transcribe paper tax return 
information into IRS's computer systems, which can introduce errors.

Telephone Assistance:

As shown in table 1, by several measures IRS's telephone service has 
improved since 2002. One measure of access, the customer service 
representative (CSR) level of service (the percentage of taxpayers who 
attempted to reach CSRs and actually got through and received service) 
increased from 62 percent to 83 percent. Accuracy also showed some 
improvement; accounts accuracy (accuracy of answers to taxpayer 
questions about their accounts) exceeded 90 percent in 2005. However, 
taxpayers are waiting somewhat longer in 2005 to get answers than in 
2002, 2003, and 2004.

Web Site:

IRS's Web site is performing well. A relatively recent addition to 
IRS's menu of services, the Web site first became available during the 
1996 filing season. We found it to be user friendly because it was 
readily accessible and easy to navigate. An independent weekly study 
ranked it in the top 4 out of 40 federal government web sites in terms 
of accessibility.

The site is used extensively. In the early weeks of the 2005 filing 
season the IRS Web site was visited about 83 million times by users who 
viewed about 628 million pages and downloaded about 70.3 million forms 
and publications. IRS's Web site continues to provide two very 
important tax service features: (1) "Where's My Refund," which enables 
taxpayers to check on the status of their refund and (2) Free File, 
which provides taxpayers the ability to file their tax return 
electronically for free. This filing season IRS provided new 
functionality for "Where's My Refund" whereby taxpayers whose refunds 
could not be delivered by the Postal Service (i.e., returned as 
undeliverable mail), could change their addresses on the Web site.

IRS and Volunteer Walk-in Sites:

Taxpayer use of IRS's walk-in sites has decreased while use of 
volunteer sites has increased. As shown in figure 2, IRS projects it 
will see about 3.4 million visits to its 400 walk-in sites this year, 
down from over 3.5 million in 2004 and about 4.3 million in 2001. Over 
the same period, IRS expects taxpayer visits to volunteer sites to 
increase to just over 2 million visits in 2005; a substantial increase 
over about 1.6 million visits in 2004 and fewer than 1 million in 2001. 
IRS continues to encourage taxpayers to use volunteer sites for return 
preparation.

Figure 2: Assistance Provided by IRS Walk-in and Volunteer Sites, 2001-
2006 Filing Seasons:

[See PDF for image]

Note: "Other walk-in contacts" includes assistance for account notices, 
tax law inquiries, forms, and compliance work, but not return 
preparation. For the walk-in sites, the time periods covered are 
December 31, 2000, through April 28, 2001; December 30, 2001, through 
April 27, 2002; December 29, 2002, through April 26, 2003; and December 
28, 2003, through April 24, 2004. For volunteer sites, the time period 
covered for 2001 is January 1, 2001, through April 21, 2001; all other 
periods are the same as those for IRS walk-in sites.

[A] Fiscal years 2005 and 2006 are IRS projections.

[End of figure]

This shift is important because it transfers time-consuming services, 
particularly return preparation, to volunteers and allows IRS to 
concentrate on services that only it can provide, such as account 
assistance or compliance work. While it reduces the demand on IRS 
resources, the shift from IRS to volunteer sites has raised concerns 
about the quality of service provided. We and the Treasury Inspector 
General for Tax Administration (TIGTA) have called attention to the 
quality of service at both IRS walk-in and volunteer sites. IRS has 
separate quality initiatives under way at both IRS walk-in and 
volunteer sites, although data remain limited and cannot be compared to 
prior years.

Post-Filing Taxpayer Service:

Another concern is post-filing service to taxpayers when IRS has 
undertaken compliance or collection actions. An example of this is the 
release of federal tax liens against taxpayers' property. IRS is 
required to release a federal tax lien within 30 days after the date 
the tax liability is satisfied or has become legally unenforceable or 
the Secretary of the Treasury has accepted a bond for the assessed tax 
but, as have we reported for several years as part of our financial 
audits, most recently in November 2004, IRS has not always met this 
standard.[Footnote 4]

IRS Has Stopped Declines In Enforcement Staffing, but Enforcement 
Remains High Risk:

We have long been concerned about tax noncompliance and IRS efforts to 
address it. Collection of unpaid taxes was included in our first high- 
risk series report in 1990, with a focus on the backlog of uncollected 
debts owed by taxpayers. In 1995, we added Filing Fraud as a separate 
high-risk area, narrowing the focus of that high-risk area in 2001 to 
Earned Income Credit Noncompliance because of the particularly high 
incidence of fraud and other forms of noncompliance in that program. We 
expanded our concern about the Collection of Unpaid Taxes in our 2001 
high-risk report to include not only unpaid taxes (including tax 
evasion and unintentional noncompliance) known to IRS, but also the 
broader enforcement issue of unpaid taxes that IRS has not detected. In 
our high-risk update that we issued in January,[Footnote 5] we 
consolidated these areas into a single high-risk area--Enforcement of 
Tax Laws--because we believe the focus of concern on the enforcement of 
tax laws is not confined to any one segment of the taxpaying population 
or any single tax provision.

Tax law enforcement is a high-risk area in part because of the size of 
the tax gap. IRS's recent estimate of the difference between what 
taxpayers timely and accurately paid in taxes and what they owed ranged 
from $312 billion to $353 billion for tax year 2001. IRS estimates it 
will eventually recover some of this tax gap, resulting in a net tax 
gap from $257 billion to $298 billion. The tax gap arises when 
taxpayers fail to comply with the tax laws by underreporting tax 
liabilities on tax returns; underpaying taxes due from filed returns; 
or "nonfiling," which refers to the failure to file a required tax 
return altogether or in a timely manner.

Tax law enforcement is also high risk because past declines in IRS's 
enforcement activities threatened to erode taxpayer compliance. In 
recent years, the resources IRS has been able to dedicate to enforcing 
the tax laws have declined. For example, the number of revenue agents 
(those who examine complex returns), revenue officers (those who 
perform field collection work), and special agents (those who perform 
criminal investigations) decreased over 21 percent from 1998 through 
2003. However, IRS achieved some staffing gains in 2004 and expects 
modest gains in 2005. IRS's proposal for fiscal year 2006, if funded 
and implemented as planned, would return enforcement staffing in these 
occupations to their highest levels since 1999.[Footnote 6]

Concurrently, IRS's enforcement workload--measured by the number of 
taxpayer returns filed--has continually increased. For example, from 
1997 through 2003, the number of individual income tax returns filed 
increased by about 8 percent. Over the same period, returns for high- 
income individuals grew by about 81 percent.[Footnote 7] Due to their 
income levels, IRS believes that these individuals present a particular 
compliance risk. In light of declines in enforcement staffing and the 
increasing number of returns filed, nearly every indicator of IRS's 
coverage of its enforcement workload has declined in recent years. 
Although in some cases workload coverage has begun to increase, overall 
IRS's coverage of known workload is considerably lower than it was just 
a few years ago. Figure 3 shows the trend in examination rates--the 
proportion of tax returns that IRS examines each year--for field, 
correspondence, and total examinations since 1995. Field examinations 
involve face-to-face examinations and correspondence examinations are 
typically less comprehensive and complex, involving communication 
through written notices. IRS experienced steep declines in examination 
rates from 1995 to 1999, but the examination rate has slowly increased 
since 2000. However, as the figure shows, the increase in total 
examination rates of individual filers has been driven mostly by 
correspondence examinations, while more complex field examinations 
continue to decline.

Figure 3: Audit Rate of Individual Income Tax Returns, Fiscal Years 
1995-2004:

[See PDF for image]

[End of figure]

Further, IRS's workload has grown ever more complex as the tax code has 
grown more complex. IRS is challenged to administer and explain each 
new provision, thus absorbing resources that otherwise might be used to 
enforce the tax laws. Concurrently, other areas of particularly serious 
noncompliance have gained the attention of IRS and the Congress, such 
as abusive tax shelters and schemes employed by businesses and wealthy 
individuals that often involve complex transactions that may span 
national boundaries. Given the broad declines in IRS's enforcement 
workforce, IRS's decreased ability to follow up on suspected 
noncompliance, and the emergence of sophisticated evasion concerns, IRS 
is challenged in attempting to ensure that taxpayers fulfill their 
obligations.

On the collection front, IRS's use of enforcement sanctions, such as 
liens, levies, and seizures, dropped precipitously during the mid and 
late 1990s. In fiscal year 2000, IRS's use of these three sanctions was 
at 38 percent, 7 percent, and 1 percent, respectively, of fiscal year 
1996 levels. However, beginning in fiscal year 2001, IRS's use of liens 
and levies began to increase. By fiscal year 2004, IRS's use of liens, 
levies, and seizures reached 71 percent, 65 percent, and 4 percent of 
1996 levels, respectively.

IRS is working to further improve its enforcement efforts. In addition 
to recent favorable trends in enforcement staffing, correspondence 
examinations, and the use of some enforcement sanctions, IRS has 
recently made progress with respect to abusive tax shelters through a 
number of initiatives and recent settlement offers that have resulted 
in billions of dollars in collected taxes, interest, and penalties. In 
addition, IRS is developing a centralized cost accounting system, in 
part to obtain better cost and benefit information on compliance 
activities, and is modernizing the technology that underpins many core 
business processes. It has also redesigned some compliance and 
collections processes and plans additional redesigns as technology 
improves. Finally, the recently completed National Research Program 
(NRP) study of individual taxpayers not only gives us a benchmark of 
the status of taxpayers' compliance but also gives IRS a better basis 
to target its enforcement efforts.

IRS Has Made Progress in Implementing BSM, but Program Has History of 
Cost Overruns and Schedule Delays and Is High Risk:

IRS has long relied on obsolete automated systems for key operational 
and financial management functions, and its attempts to modernize these 
aging computer systems span several decades. Modernization has 
encountered a long history of continuing delays and design difficulties 
and the impact of these problems on IRS's operations led GAO to 
designate IRS's systems modernization as a high-risk area in 1995 and 
it remains so today.

IRS's current modernization program, BSM, is a highly complex, 
multibillion-dollar program that is the agency's latest attempt to 
modernize its systems. BSM is critical to supporting IRS's taxpayer 
service and enforcement goals. For example, BSM includes projects to 
allow taxpayers to file and retrieve information electronically and to 
provide technology solutions to help reduce the backlog of collections 
cases. BSM is also important to allow IRS to provide the reliable and 
timely financial management information needed to account for the 
nation's largest revenue stream and better enable the agency both to 
determine and to justify its resource allocation decisions and 
congressional budgetary requests.

Over the past year, IRS has deployed initial phases of several 
modernized systems under its BSM program. The following provides 
examples of the systems and functionality that IRS implemented in 2004 
and the beginning of 2005.

* Modernized e-File (MeF). This project is intended to provide 
electronic filing for large corporations, small businesses, and tax- 
exempt organizations. The initial releases of this project were 
implemented in June and December 2004, and allowed for the electronic 
filing of forms and schedules for the form 1120 (corporate tax return) 
and form 990 (tax-exempt organizations' tax return). IRS reported that, 
during the 2004 filing season, it accepted over 53,000 of these forms 
and schedules using MeF.

* e-Services. This project created a Web portal and provided other 
electronic services to promote the goal of conducting most IRS 
transactions with taxpayers and tax practitioners electronically. IRS 
implemented e-Services in May 2004. According to IRS, as of late March 
2005, over 84,000 users have registered with this Web portal.

* Customer Account Data Engine (CADE). CADE is intended to replace 
IRS's antiquated system that contains the agency's repository of 
taxpayer information and, therefore, is the BSM program's linchpin and 
highest priority project. In July 2004 and January 2005, IRS 
implemented the initial releases of CADE, which have been used to 
process filing year 2004 and 2005 1040EZ returns, respectively, for 
single taxpayers with refund or even-balance returns. According to IRS, 
as of March 16, 2005, CADE had processed over 842,000 tax returns so 
far this filing season.

* Integrated Financial System (IFS). This system replaced aspects of 
IRS's core financial systems and is ultimately intended to operate as 
its new accounting system of record. The first release of this system 
became fully operational in January 2005.

In prior years, IRS deployed several systems, including (1) Customer 
Communications 2001, to improve telephone call management, call 
routing, and customer self-service applications; (2) Customer 
Relationship Management Examination, to provide off-the-shelf software 
to IRS revenue agents to allow them to accurately compute complex 
corporate transactions; and (3) Internet Refund/Fact of Filing, to 
improve taxpayer self-service by providing to taxpayers via the 
Internet instant refund status information and instructions for 
resolving refund problems.

Although IRS is to be applauded for delivering important BSM 
functionality, the BSM program is far from complete. Future deliveries 
of additional functionality of deployed systems and the implementation 
of other BSM projects are expected to have a significant impact on 
IRS's taxpayer services and enforcement capability as well as its 
efforts to continue to improve its financial management. For example, 
IRS has projected that CADE will process about 2 million returns in the 
2005 filing season. However, the returns being processed in CADE are 
the most basic and constitute less than 1 percent of the total tax 
returns expected to be processed during the current filing season. IRS 
expects the full implementation of CADE to take several more years. 
Another BSM project--the Filing and Payment Compliance (F&PC) project-
-is expected to increase (1) IRS's capacity to treat and resolve the 
backlog of delinquent taxpayer cases, (2) the closure of collection 
cases by 10 million annually by 2014, and (3) voluntary taxpayer 
compliance. As part of this project, IRS plans to deliver an initial 
limited private debt collection capability in January 2006, with full 
implementation of this aspect of the F&PC project to be delivered by 
January 2008 and additional functionality to follow in later years. 
Finally, full implementation of CADE, as well as the successful 
implementation of future releases of IFS and efforts to address the 
impact of IRS's decision to discontinue the Custodial Accounting 
Project (CAP) will be critical to addressing many of IRS's remaining 
and long-standing financial management issues.

Continued Progress Depends on IRS Addressing Resource Constraints and 
Realizing Efficiency and Systems Improvements:

For IRS to build on the gains made since passage of RRA 98, the agency 
must address numerous challenges related to resource management. IRS 
faces budgetary constraints that may be addressed in part through the 
development of goals for assessing performance and to help in making 
budget decisions, looking for opportunities to enhance its funding, and 
leveraging the resources of nonfederal partners. IRS also faces the 
challenges of improving efficiency in taxpayer service and tax law 
enforcement, developing useful cost accounting tools, and improving 
productivity. Finally, IRS faces information systems challenges in both 
BSM and systems security shortfalls.

Long-term Goals Would Help IRS Assess Performance and Make Budget 
Decisions:

For IRS, the Congress, and IRS's other stakeholders, long-term goals 
can be used to assess performance and progress towards these goals, and 
determine whether budget decisions contribute to achieving those goals. 
Without long-term goals, the Congress and other stakeholders are 
hampered in evaluating whether IRS is making satisfactory long-term 
progress. Further, without such goals, the extent to which IRS's 2006 
budget request would help IRS achieve its mission over the long term is 
less clear.

A recent Program Assessment Rating Tool (PART) review conducted by the 
Office of Management and Budget (OMB) reported that IRS lacks long-term 
goals.[Footnote 8] As a result, IRS has been working to identify and 
establish long-term goals for all aspects of its operations for over a 
year. [Footnote 9] IRS officials said these goals will be finalized and 
provided publicly as an update to the agency's strategic plan in the 
near future.

Long-term goals and results measurement are a component of the 
statutory strategic planning and management framework that the Congress 
adopted in the Government Performance and Results Act of 1993.[Footnote 
10] As a part of this comprehensive framework, long-term goals that are 
linked to annual performance measures can help guide agencies when 
considering organizational changes and making resource decisions. For 
example, long-term goals would provide IRS with a framework for 
assessing budgetary tradeoffs between taxpayer service and enforcement 
and whether IRS is making satisfactory progress towards achieving those 
goals. Similarly, long-term goals could help identify priorities within 
the taxpayer service functions (e.g., if the budget for taxpayer 
service were to be cut and efficiency gains did not offset the cut, 
long-term goals could help guide decisions about whether to make 
service cuts across a broad or target selected services).

Perhaps most important, long-term compliance goals coupled with 
periodic measurement of compliance levels would provide IRS with a 
better basis for determining to what extent its various day-to-day 
service and enforcement efforts contribute to compliance in the long 
run. Furthermore, long-term, quantitative goals may help IRS consider 
new strategies to improve compliance, especially since these strategies 
could take several years to implement. For example, IRS's progress 
toward the goal of having 80 percent of all individual tax returns 
electronically filed by 2007 has required enhancement of its 
technology, development of software to support electronic filing, 
education of taxpayers and practitioners, and other steps that could 
not be completed in a short time frame. Focusing on intended results 
can also promote strategic and disciplined management decisions that 
are more likely to be effective because managers who use fact-based 
performance analysis are better able to target areas most in need of 
improvement and select appropriate interventions.

Considering Funding Enhancements Could Help Mitigate Budget Constraints:

Identifying potential new sources of funds could be an opportunity for 
helping to mitigate IRS's budget constraints. Current examples of 
resource enhancers--user fees and private debt collection--may provide 
useful models for IRS and Congress to consider. User fees are collected 
from identifiable recipients of special benefits beyond those accruing 
to the general public. In 2004, IRS collected over $137 million in user 
fees for a wide range of services, including installment agreements, 
offers in compromise, and Freedom of Information Act (FOIA) 
requests.[Footnote 11] In fiscal year 2004, about 82 percent of all 
user fees collected by IRS were for installment agreements or Employee 
Plans and Exempt Organizations letter rulings and determination 
letters.[Footnote 12] The 1995 Treasury Appropriation Act specifies 
that IRS can keep a maximum of $119 million per year of the user fees 
it collects, with the rest of the user fees going into the Treasury 
general fund. In 2004, IRS retained about $90 million from the user 
fees collected (see table 2). In comparison, IRS's total spending in 
2004 was $10.7 billion.

Table 2: User Fees and Reimbursable User Fees Collected by IRS, Fiscal 
Year 2004:

Dollars in millions.

Installment agreements; 
Fiscal year 2004 user fees collected: $69.4; 
User fees to General Fund: $0.0; 
User fees retained by IRS: $69.4.

Offers in compromise; 
Fiscal year 2004 user fees collected: $6.6; 
User fees to General Fund: $0.0; 
User fees retained by IRS: $6.6.

Employee plans and exempt organizations letter rulings and 
determination letters; 
Fiscal year 2004 user fees collected: $43.1; 
User fees to General Fund: $41.2; 
User fees retained by IRS: $1.9.

Chief Counsel letter rulings and determination letters; 
Fiscal year 2004 user fees collected: $9.3; 
User fees to General Fund: $5.5; 
User fees retained by IRS: $3.8.

Photocopy reimbursable user fees; 
Fiscal year 2004 user fees collected: $6.4; 
User fees to General Fund: $0.0; 
User fees retained by IRS: $6.4.

Other; 
Fiscal year 2004 user fees collected: $2.8; 
User fees to General Fund: $1.2; 
User fees retained by IRS: $1.6.

Total; 
Fiscal year 2004 user fees collected: $137.6; 
User fees to General Fund: $47.9; 
User fees retained by IRS: $89.7.

Source: IRS officials.

[End of table]

In setting certain user fees, IRS must follow Internal Revenue Code 
(IRC) Section 7528, which authorizes user fees for letter rulings, 
opinion letters, determination letters, and similar requests.[Footnote 
13] IRC Section 7528 requires that user fees (1) vary according to 
categories or subcategories, (2) take into account the average time and 
difficulty of requests by categories or subcategories, (3) be payable 
in advance, and (4) be subject to appropriate exemptions and reduced 
fees within limits specified by Section 7528. IRS is precluded from 
expending any fees collected pursuant to IRC Section 7528 unless 
provided by an appropriations act. As mentioned earlier, the 1995 
Treasury Appropriation Act specifies that IRS can keep a maximum of 
$119 million per year in user fee collections.

OMB Circular A-25, User Charges, establishes general federal policy for 
user fees assessed for government services by executive branch 
agencies.[Footnote 14] A-25 requirements include (1) identifying 
services and activities that convey special benefits; (2) determining 
their full cost or market price, as appropriate; (3) biennial reviews 
of user fees for unanticipated cost or market price changes; and (4) 
biennial reviews of agency programs not subject to user fees to 
determine if such fees should be assessed.

Private debt collection provides another example of a revenue 
enhancement model that may be useful for IRS. The 2004 American Jobs 
Creation Act permitted IRS to contract with private collection agencies 
(PCA) to collect some federal tax debts and allows IRS to keep a 
portion of the funds collected by PCAs.[Footnote 15] PCAs will not 
replace IRS's own collection resources, but will handle cases that do 
not require enforcement action or discretion in resolving tax 
liabilities. According to IRS, the private debt collection program will 
help reduce the significant and growing amount of uncollectable cases 
that are not currently collected, and enable IRS to focus existing 
resources to address more difficult cases. IRS will begin a limited 
implementation phase of the private debt collection in 2005, and full 
implementation is planned for 2007. The law allows IRS to retain and 
use up to 25 percent of any amounts collected to pay for collection 
services and IRS collection enforcement activities. IRS expects to 
retain $10 million of PCA collections in fiscal year 2007 and more in 
later years.

Leveraging Nonfederal Partners Is Another Way to Accomplish More:

IRS has leveraged nonfederal resources to make improvements to taxpayer 
service and tax law enforcement. The examples below highlight the 
variety of such leveraging and could provide a basis for exploring 
whether additional such opportunities exist.

One example involving taxpayer service is the Free File Alliance. In 
2003 IRS entered into a 3-year agreement with the Free File Alliance, a 
consortium of tax preparation companies that provides free electronic 
filing to taxpayers who access any of the companies via a link on IRS's 
Web site. IRS has benefited from this partnership because it encourages 
electronic filing of tax returns. For example, as of March 16, 2005, 
3.6 million tax returns had been filed via Free File, which represents 
a 44 percent increase over the same time period last year.

IRS has also established partnerships with states and several cities to 
assist in combating abusive tax schemes.[Footnote 16] In September 
2003, IRS announced the establishment of a nationwide partnership to 
combat abusive tax avoidance. Under agreements with individual states, 
IRS shares information on abusive tax avoidance transactions and those 
taxpayers who participate in them. The agreements creating this 
partnership were designed to enable States and IRS to move more 
aggressively in addressing this tax compliance problem. The partnership 
also includes joint public outreach activities to more effectively 
counter the claims of those marketing tax schemes.

Another example of IRS's effort to leverage nonfederal resources is the 
over 13,500 volunteer sites run by community-based coalitions. IRS 
awards grants, trains and certifies volunteers, and provides reference 
materials, computer software and, in some cases, computers to these 
volunteer organizations to assist primarily low-income and elderly 
taxpayers prepare their returns. Since 2001, the number of taxpayers 
seeking return preparation assistance at volunteer sites has increased 
an average of 19 percent per year. During the 2004 filing season, 
taxpayers had over five times more returns prepared at volunteer sites 
than at IRS walk-in sites. This trend reflects IRS's strategy to shift 
return preparation to sites staffed by volunteer and community-based 
coalitions that are overseen by IRS. IRS has encouraged the shift by 
advertising the locations of these sites.

As we noted earlier, the shift of taxpayers from walk-in to volunteer 
sites is important because it has transferred time-consuming services, 
particularly return preparation, from IRS to volunteer sites and 
allowed IRS to concentrate on services that only it can provide, such 
as account assistance or compliance work. However, as we also noted 
earlier, there have been concerns raised about the quality of service 
at both walk-in and volunteer sites. In addition, in her January 2005 
report,[Footnote 17] the Taxpayer Advocate expressed concern about the 
reduction of face-to-face services, such as those offered at walk-in 
sites. She stated that IRS's plan does not adequately provide for the 
segment of the population that continues to rely on the interaction 
provided by walk-in sites. Better data about the quality of service at 
volunteer sites would provide a baseline for making decisions about how 
to better manage quality.

Prioritizing Taxpayer Service Could Minimize Impacts of Budget Cuts:

For at least two reasons, this is an opportune time to review the menu 
of taxpayer services that IRS provides. First, IRS's budget for 
taxpayer services was reduced in 2005 and an additional reduction is 
proposed for 2006. These reductions have forced IRS to propose scaling 
back some services, including the hours of telephone contact 
availability. Second, as we have reported, IRS has made significant 
progress in improving the quality of its taxpayer services. For 
example, IRS now provides many Internet services that did not exist a 
few years ago, and has noticeably improved the quality of telephone 
services. This opens up the possibility of maintaining the overall 
level of taxpayer service but with a different menu of service choices. 
Cuts in selected services could be offset by the new and improved 
services.

Generally, as indicated in the budget, the menu of taxpayer services 
that IRS provides covers assistance, outreach, and processing. 
Assistance includes answering taxpayer questions via telephone, 
correspondence, and face to face at its walk-in sites. Outreach 
includes educational programs and the development of partnerships. 
Processing includes issuing millions of tax refunds.

When considering program reductions, we support a targeted approach 
rather than across-the-board cuts.[Footnote 18] A targeted approach 
helps reduce the risk that effective programs are reduced or eliminated 
while ineffective or lower priority programs are maintained.

With the above reasons in mind for reconsidering IRS's menu of 
services, we have compiled a list of options for targeted reductions in 
taxpayer service. The options on this list are not recommendations, but 
are intended to contribute to a dialogue about the tradeoffs faced when 
setting IRS's budget. The options presented meet at least one of the 
following criteria that we generally use to evaluate programs or budget 
requests.[Footnote 19] These criteria include that the activity:

* duplicates other efforts that may be more effective and/or efficient;

* historically does not meet performance goals or provide intended 
results as reported by GAO, TIGTA, IRS, or others;

* experiences a continued decrease in demand;

* lacks adequate oversight, implementation and management plans, or 
structures and systems to be implemented effectively;

* has been the subject of actual or requested funding increases that 
cannot be adequately justified; or:

* has the potential to make an agency more self-sustaining by charging 
user fees for services provided.

We recognize that the options listed below involve tradeoffs. In each 
case, some taxpayers would lose a service they use. However, the 
savings could be used to help maintain the quality of other services. 
We also want to give IRS credit for identifying savings, including some 
on this list. The options include the following:

* Closing walk-in sites. As discussed previously, taxpayer demand for 
walk-in services has continued to decrease and staff answer a more 
limited number of tax law questions in person than staff answer via 
telephone.

* Limiting the type of telephone questions answered by IRS assistors. 
IRS assistors still answer some refund status questions even though IRS 
provides automated answers via telephone and its Web site.

* Mandating electronic filing for some filers such as paid preparers or 
businesses. As noted, efficiency gains from electronic filing have 
enabled IRS to consolidate paper processing operations.

* Charging for services. For example, IRS provides paid preparers with 
information on federal debts owed by taxpayers seeking refund 
anticipation loans.

Targeting Enforcement Could Make More Efficient Use of Resources:

Multiple enforcement strategies could help IRS reduce the tax gap. 
Given its size, even small or moderate reductions in the net tax gap 
could yield substantial returns. For example, based on IRS's most 
recent estimate, a 1 percent reduction in the net tax gap would likely 
yield more than $2.5 billion annually.

Although reducing the tax gap may be an attractive means to improve the 
nation's fiscal position, achieving this end will be a challenging task 
given persistent levels of noncompliance. IRS has made efforts to 
reduce the tax gap since the early 1980s; yet the tax gap is still 
large--although without these efforts it could be even larger. Also, 
IRS is challenged in reducing the tax gap because the tax gap is spread 
across the five different types of taxes that IRS administers, and a 
substantial portion of the tax gap is attributed to taxpayers who are 
not subject to withholding or information reporting requirements. 
Moreover, as we have reported in the past,[Footnote 20] closing the 
entire tax gap may not be feasible or desirable, as it could entail 
more intrusive recordkeeping or reporting than the public is willing to 
accept or more resources than IRS is able to commit.

Although much of the tax gap that IRS currently recovers is through 
enforcement actions, a sole focus on enforcement will not likely be 
sufficient to further reduce the net tax gap. Rather, the tax gap must 
be attacked on multiple fronts and with multiple strategies on a 
sustained basis. For example, efforts to simplify the tax code and 
otherwise alter current tax policies may help reduce the tax gap by 
making it easier for individuals and business to understand and 
voluntarily comply with their tax obligations. For instance, reducing 
the multiple tax preferences for retirement savings or education 
assistance might ease taxpayers' burden in understanding and complying 
with the rules associated with these options. Also, simplification may 
reduce opportunities for tax evasion through vehicles such as abusive 
tax shelters. For any given set of tax policies, IRS's efforts to 
reduce the tax gap and ensure appropriate levels of compliance will 
need to be based on a balanced approach of providing service to 
taxpayers and enforcing the tax laws.

Furthermore, providing quality services to taxpayers is an important 
part of any overall strategy to improve compliance and thereby reduce 
the tax gap. As we have reported in the past,[Footnote 21] one method 
of improving compliance through service is to educate taxpayers about 
confusing or commonly misunderstood tax requirements. For example, if 
the forms and instructions taxpayers use to prepare their taxes are not 
clear, taxpayers may be confused and make unintentional errors. One 
method to ensure that forms and instructions are sufficiently clear is 
to test them before use. However, we reported in 2003 that IRS had 
tested revisions to only five individual forms and instructions from 
July 1997 through June 2002, although hundreds of forms and 
instructions had been revised in 2001 alone.[Footnote 22]

Finally, in terms of enforcement, IRS will need to use multiple 
strategies and techniques to find noncompliant taxpayers and bring them 
into compliance. One pair of tools has been shown to lead to high 
levels of compliance: withholding tax from payments to taxpayers and 
having third parties report information to IRS and the taxpayers on 
income paid to taxpayers. For example, banks and other financial 
institutions provide information returns (Forms 1099) to account 
holders and IRS showing the taxpayers' annual income from some types of 
investments. Similarly, most wages, salaries, and tip compensation are 
reported by employers to employees and IRS through Form W-2. 
Preliminary findings from NRP indicate that more than 98.5 percent of 
these types of income are accurately reported on individual returns.

Regularly measuring compliance can offer many benefits, including 
helping IRS identify new or major types of noncompliance, identify 
changes in tax laws and regulations that may improve compliance, more 
effectively target examinations of tax returns or other enforcement 
programs, understand the effectiveness of its programs to promote and 
enforce compliance, and determine its resource needs and allocations. 
For example, by analyzing 1979 and 1982 compliance research data, IRS 
identified significant noncompliance with the number of dependents 
claimed on tax returns and justified a legislative change to address 
the noncompliance. As a result, for tax year 1987, taxpayers claimed 
about 5 million fewer dependents on their returns than would have been 
expected without the change in law. In addition, tax compliance data 
are useful outside of IRS for tax policy analysis, revenue estimating, 
and research.

IRS research officials have proposed a compliance measurement study 
that will allow IRS to update underreporting estimates involving flow-
through entities. This study, which IRS intends to begin in fiscal year 
2006, would take 2 to 3 years to complete. Because either individual 
taxpayers or corporations may be recipients of income (or losses) from 
flow-through entities, this study could affect IRS's estimates for the 
underreporting gap for individual and corporate income taxes.

While these data and methodology updates could improve the tax gap 
estimates, IRS has no documented plans to periodically collect more or 
better compliance data over the long term. Other than the proposed 
study of flow-through entities, IRS does not have plans to collect 
compliance data for other segments of the tax gap. Also, IRS has 
indicated that given its current research priorities, it would not 
begin another NRP study of individual income tax returns before 2008, 
if at all, and would not complete such a study until at least 2010. 
When IRS initially proposed the NRP study, it had planned to study 
individual income tax underreporting on a 3-year cycle.

According to IRS officials, IRS has not committed to regularly 
collecting compliance data because of the associated costs and burdens. 
Taxpayers whose returns are examined through compliance studies such as 
NRP bear costs in terms of time and money. Also, IRS incurs costs, 
including direct costs and opportunity costs--revenue that IRS 
potentially forgoes by using its resources to examine randomly selected 
returns, which may include returns from compliant taxpayers, as opposed 
to traditional examinations that focus on taxpayer returns that likely 
contain noncompliance and may more consistently produce additional tax 
assessments.

Although the costs and burdens of compliance measurement are legitimate 
concerns, as we have reported in the past, we believe compliance 
studies to be good investments. Without current compliance data, IRS is 
less able to determine key areas of noncompliance to address and 
actions to take to maximize the use of its limited resources. The lack 
of firm plans to continually obtain fresh compliance data is troubling 
because the frequency of data collection can have a large impact on the 
quality and utility of compliance data. As we have reported in the 
past, the longer the time between compliance measurement surveys, the 
less useful they become given changes in the economy and tax 
law.[Footnote 23]

In designing its recently completed NRP study, IRS balanced the costs, 
burdens, and compliance risk of studying that area of the tax gap. Any 
plans for obtaining and maintaining reasonably current information on 
compliance levels for all portions of the tax gap would similarly need 
to take into account costs, burdens, and compliance risks in 
determining which areas of compliance to measure and the scope and 
frequency of such measurement.

The NRP survey had an added benefit of including the use of 
casebuilding to aid examiners in determining whether IRS needs to have 
any contact with taxpayers to verify the accuracy of information 
reported on their tax returns. The casebuilding tools consisted of data 
from both IRS and third-party sources. IRS's NRP casebuilding included 
return information from the prior 3 years, audit history, payment and 
filing history, information return data reported by third parties 
(banks, lending institutions, and others), and bank reports on large 
cash transactions. NRP casebuilding tools also included data from third-
party sources, such as external public database containing real estate 
and other asset ownership information (e.g., motor vehicle 
registrations and ownership of luxury items like watercraft and 
aircraft). Another third-party data source was the Dependent Data Base, 
which is a combination of Department of Health and Human Services and 
Social Security Administration data. These data were used to provide 
custody information that can be used to help determine the validity of 
dependent and Earned Income Tax Credit (EITC) claims. Use of these data 
helped IRS enforcement staff to rule out compliance issues that could 
be verified without contacting taxpayers.

As IRS moves to further strengthen enforcement and introduce 
enforcement initiatives, one management challenge will be coordinating 
across IRS programs and offices. An initiative that identifies 
noncompliance has resource implications for downstream activities such 
as collections, criminal investigations, and appeals. Without 
appropriate, coordinated follow-up, compliance initiatives run the risk 
of becoming toothless. IRS has experienced this sort of imbalance in 
the past. For example, in 2002 we reported on the growing backlog of 
collections cases generated by the upstream exam and assessment 
functions that the downstream collections function lacked the capacity 
to pursue.[Footnote 24]

Accurate Cost Information Would Help IRS Make Resource Allocation 
Decisions:

Managing a federal agency as large and complex as IRS requires managers 
to constantly weigh the relative costs and benefits of different 
approaches to achieving the goals mandated by the Congress. Management 
is constantly called upon to make important long-term strategic as well 
as daily operational decisions about how to make the most effective use 
of the limited resources at its disposal. As constraints on available 
resources increase, these decisions become correspondingly more 
challenging and important. In order to rise to this challenge, 
management needs to have at its disposal current and accurate 
information upon which to base its decisions, and to enable it to 
monitor the effectiveness of actions taken over time so that 
appropriate adjustments can be made as conditions change.

However, in its ongoing effort to make such increasingly difficult 
resource allocation decisions and defend those decisions before the 
Congress, IRS management has long been hampered by a lack of current 
and accurate information concerning the costs of the various options 
being considered. This has impaired management's ability to properly 
decide which, if any, of the options at hand are worth the cost 
relative to the expected benefits. For example, accurate and timely 
cost information may help IRS consider changes in the menu of taxpayer 
services that it provides by identifying and assessing the relative 
costs, benefits, and risks of specific projects. Without reliable cost 
information, IRS's ability to make such difficult choices in an 
informed, reasoned manner is seriously impaired. Similarly, IRS should 
periodically reassess the prices it charges taxpayers in user fees for 
various services, such as entering into installment agreements and 
making determinations about the tax exemption status of certain 
organizations. The cost of providing such services is supposed to be a 
major factor in setting the related fees. However, without timely and 
reliable cost information, the basis for the fees becomes problematic. 
The lack of reliable cost information also means that IRS cannot 
prepare cost-based performance measures to assist in measuring the 
effectiveness of its programs over time.

IRS lacks reliable and timely cost information because prior to fiscal 
year 2005, it did not have a cost accounting system to accumulate and 
report the reliable cost information that managers needed to support 
informed decision making. Instead, management often relied on a 
combination of the limited existing cost information; the results of 
special analysis initiated to establish the full cost of a specific, 
narrowly defined task or item; and estimates based on the best judgment 
of experienced staff. In fiscal year 2005, IRS implemented a cost 
accounting module as part of the first release of its IFS. However, 
while this module has much potential and has begun accumulating cost 
information, management has not yet determined what the full range of 
its cost information needs are or how best to tailor the capabilities 
of this module to serve those needs. IRS has also not yet implemented a 
related workload management system intended to provide the cost module 
with detailed personnel cost information. In addition, because it 
generally takes several years of historical cost information to support 
meaningful estimates and projections, IRS cannot yet rely on this 
system as a significant planning tool. It will likely require several 
years and implementation of additional components of IFS before the 
full potential of IRS's cost accounting module will be realized. In the 
interim, IRS decision making will continue to be hampered by inadequate 
underlying cost information.

Productivity Improvements Could Help Offset Budget Cuts:

IRS needs to make the most use of its available resources and a key to 
this is improved productivity. Productivity is defined as the 
efficiency with which inputs are used to produce outputs. It is 
measured as the ratio of outputs to inputs. Productivity and cost are 
inversely related--as productivity increases, average costs decrease. 
Consequently, information about productivity can inform budget debates 
as a factor that explains the level or changes in the cost of carrying 
out different types of activities. Improvements in productivity either 
allow more of an activity to be carried out at the same cost or the 
same level of activity to be carried out at a lower cost.

Sound productivity data are an important element of meaningful 
productivity improvement efforts. As part of our review of IRS process 
improvement initiatives,[Footnote 25] private sector executives we met 
with stressed the benefits of productivity analysis. They said that an 
inadequate understanding of productivity makes it harder to distinguish 
processes with a potential for improvement from those without such 
potential. GAO's Business Process Reengineering Assessment Guide also 
highlighted the importance of being able to identify processes that are 
in greatest need of improvement.[Footnote 26]

Opportunities exist to improve enforcement productivity data and give 
IRS managers a more informed basis for decisions on how to make 
improvements. Statistical methods that are widely used in both the 
public and private sectors can be used to adjust productivity measures 
for quality and complexity. In particular, by using these methods, 
managers can distinguish productivity changes that represent real 
efficiency gains or losses from those that are due to changes in 
quality standards. These methods could be implemented using data 
currently available at IRS. The cost of implementation would be chiefly 
the staff time required to adapt the statistical models. Although the 
computations are complex, the methods can be implemented using existing 
software. We currently have under way a separate study that illustrates 
how these methods can be used to create better productivity measures at 
IRS.

Additional Management Improvements Needed for BSM Success:

The BSM program has a long history of significant cost increases and 
schedule delays, which, in part, has led us to report this program as 
high risk since 1995.[Footnote 27] In January 2005 letters to 
congressional appropriation committees, IRS stated that it had showed a 
marked improvement in significantly reducing its cost variances. In 
particular, IRS claimed that it reduced the variance between estimated 
and actual costs from 33 percent in fiscal year 2002 to 4 percent in 
fiscal year 2004. However, we do not agree with the methodology used in 
the analysis supporting this claim. Specifically, (1) the analysis did 
not reflect actual costs, but instead reflected changes in cost 
estimates (i.e., budget allocations) for various BSM projects; (2) IRS 
aggregated all of the changes in the estimates associated with the 
major activities for some projects, such as CADE, which masked that 
monies were shifted from future activities to cover increased costs of 
current activities; and (3) the calculations were based on a percentage 
of specific fiscal year appropriations, which does not reflect that 
these are multiyear projects.

In February 2002 we expressed concern over IRS's cost and schedule 
estimating and made a recommendation for improvement.[Footnote 28] IRS 
and its prime systems integration support (PRIME) contractor have taken 
action to improve their estimating practices, such as developing a cost 
and schedule estimation guidebook and developing a risk-adjustment 
model to include an analysis of uncertainty. These actions may 
ultimately result in more realistic cost and schedule estimates, but 
our analysis of IRS's expenditure plans[Footnote 29] over the last few 
years shows continued increases in estimated project life-cycle costs 
(see fig. 4).

Figure 4: Life-cycle Cost Estimates for Key BSM Projects:

[See PDF for image]

[End of figure]

The Assistant Chief Information Officer (CIO) for BSM stated that IRS's 
cost and schedule estimating has improved in the past year. Our 
comparison of IRS's reported project costs and milestone completion 
dates presented in the July 2004 and April 2005 expenditure plans shows 
that two BSM projects, CADE Releases 1.1 and 1.2, were delivered at the 
estimated cost and on or before the scheduled completion dates 
projected in the July 2004 expenditure plan. It is important to note 
that this recent success is based on project cost and schedule 
estimates that were re-baselined in the second quarter of fiscal year 
2004 with delivery dates in late fiscal year 2004 and early fiscal year 
2005. It is too early to tell whether this signals a fundamental 
improvement in IRS's ability to accurately forecast project costs and 
schedules.

The reasons for IRS's cost increases and schedule delays vary. However, 
we have previously reported that they are due, in part, to weaknesses 
in management controls and capabilities. We have previously made 
recommendations to improve BSM management controls, and IRS has 
implemented or begun to implement these recommendations. For example, 
in February 2002, we reported that IRS had not yet defined or 
implemented an information technology human capital strategy, and 
recommended that IRS develop plans for obtaining, developing, and 
retaining requisite human capital resources.[Footnote 30] In August 
2004, the current Associate CIO for BSM identified the completion of a 
human capital strategy as a high priority. Among the activities that 
IRS is in the process of implementing are prioritizing its BSM staffing 
needs and developing a recruiting plan. IRS has also identified, and is 
in the process of addressing, other major management challenges. For 
example, poorly defined requirements have been among the significant 
weaknesses that have been identified as contributing to project cost 
overruns and schedule delays. As part of addressing this problem, in 
March 2005, the IRS BSM office established a requirements management 
office, although a leader has not yet been hired.

IRS Is Adjusting the BSM Program in Response to Budget Reductions:

The BSM program is undergoing significant changes as it adjusts to 
reductions in its budget. Figure 5 illustrates the BSM program's 
requested and enacted budgets for fiscal years 2004 through 
2006.[Footnote 31] For fiscal year 2005, IRS received about 29 percent 
less funding than it requested (from $285 million to $203.4 million). 
According to the Senate report for the fiscal year 2005 Transportation, 
Treasury, and General Government appropriations bill, in making its 
recommendation to reduce BSM funding, the Senate appropriations 
committee was concerned about the program's cost overruns and schedule 
delays. In addition, the committee emphasized that in providing fewer 
funds, it wanted IRS to focus on its highest priority projects, 
particularly CADE.[Footnote 32] In addition, IRS's fiscal year 2006 
budget request reflects an additional reduction of about 2 percent, or 
about $4.4 million, from the fiscal year 2005 appropriation.

Figure 5: Changes in the BSM budget (dollars in millions):

[See PDF for image]

Note: The BSM account authorizes funds to be obligated for 3 years.

[End of figure]

It is too early to tell what effect the budget reductions will 
ultimately have on the BSM program. However, the significant 
adjustments that IRS is making to the program to address these 
reductions are not without risk, could potentially impact future budget 
requests, and will delay the implementation of certain functionality 
that was intended to provide benefit to IRS operations and the 
taxpayer. For example,

* Reductions in management reserve/project risk adjustments. In 
response to the fiscal year 2005 budget reduction, IRS reduced the 
amount that it had allotted to program management reserve and project 
risk adjustments by about 62 percent (from about $49.1 million to about 
$18.6 million).[Footnote 33] If BSM projects have future cost overruns 
that cannot be covered by the depleted reserve, this reduction could 
result in (1) increased budget requests in future years or (2) delays 
in planned future activities (e.g., delays in delivering promised 
functionality) to use those allocated funds to cover the overruns.

* Shifts of BSM management responsibility from the PRIME contractor to 
IRS. Due to budget reductions and IRS's assessment of the PRIME 
contractor's performance, IRS decided to shift significant BSM 
responsibilities for program management, systems engineering, and 
business integration from the PRIME contractor to IRS staff. For 
example, IRS staff are assuming responsibility for cost and schedule 
estimation and measurement, risk management, integration test and 
deployment, and transition management. There are risks associated with 
this decision. To successfully accomplish this transfer, IRS must have 
the management capability to perform this role. Although the BSM 
program office has been attempting to improve this capability through, 
for example, implementation of a new governance structure and hiring 
staff with specific technical and management expertise, IRS has had 
significant problems in the past managing this and other large 
development projects, and acknowledges that it has major challenges to 
overcome in this area.

* Suspension of the Custodial Accounting Project (CAP). Although the 
initial release of CAP went into production in September 2004, IRS has 
decided not to use this system and to stop work on planned improvements 
due to budget constraints. According to IRS, it made this decision 
after it evaluated the business benefits and costs to develop and 
maintain CAP versus the benefits expected to be provided by other 
projects, such as CADE. Among the functionalities that the initial 
releases of CAP were expected to provide were (1) critical control and 
reporting capabilities mandated by federal financial management laws; 
(2) a traceable audit trail to support financial reporting; and (3) a 
subsidiary ledger to accurately and promptly identify, classify, track, 
and report custodial revenue transactions and unpaid assessments. With 
the suspension of CAP, it is now unclear how IRS plans to replace the 
functionality this system was expected to provide, which was intended 
to allow the agency to make meaningful progress toward addressing long- 
standing financial management weaknesses. IRS is currently evaluating 
alternative approaches to addressing these weaknesses.

* Reductions in planned functionality. According to IRS, the fiscal 
year 2006 funding reduction will result in delays in planned 
functionality for some of its BSM projects. For example, IRS no longer 
plans to include form 1041 (the income tax return for estates and 
trusts) in the fourth release of Modernized e-File, which is expected 
to be implemented in fiscal year 2007.

The BSM program is based on visions and strategies developed in 2000 
and 2001. The age of these plans, in conjunction with the significant 
delays already experienced by the program and the substantive changes 
brought on by budget reductions, indicates that it is time for IRS to 
revisit its long-term goals, strategy, and plans for BSM. As we have 
previously reported, such an assessment would include an evaluation of 
when significant future BSM functionality would be delivered.[Footnote 
34] IRS's Associate CIO for BSM has recognized that it is time to 
recast the agency's BSM strategy because of changes that have occurred 
subsequent to the development of the program's initial plans. According 
to this official, IRS is in the process of redefining and refocusing 
the BSM program, and he expects this effort to be completed by the end 
of this fiscal year. However, clear milestones for completing these 
activities have not been defined and we plan to address this in our 
ongoing 2005 BSM expenditure plan review for the appropriations 
committees.

IRS Needs to Remedy Serious Information Security Weaknesses over 
Taxpayer and Bank Secrecy Act Information:

Information security is a critical consideration for any organization 
that depends on information systems and computer networks to carry out 
its mission or business. It is especially important for government 
agencies where maintaining the public's trust is essential. In December 
2002, the Congress enacted the Federal Information Security Management 
Act of 2002 (FISMA) to strengthen security of information and systems 
within federal agencies.[Footnote 35] FISMA requires each agency to 
develop, document, and implement an agencywide information security 
program to provide information security for the information and systems 
that support the operations and assets of the agency. IRS relies 
extensively on interconnected information systems to perform vital 
functions, such as collecting and storing taxpayer data, calculating 
interest and penalties, and generating refunds. In addition to 
processing its own financial and tax information, IRS provides 
information processing support to the Financial Crimes Enforcement 
Network (FinCEN), a Treasury bureau responsible for administering and 
enforcing the Bank Secrecy Act (BSA) and its implementing provisions.

While IRS has made progress in correcting or mitigating previously 
reported information security control weaknesses, serious control 
weaknesses continue to exist over key financial and tax processing 
information systems. For example, during our review of information 
security at IRS facilities in 2004,[Footnote 36] we determined that IRS 
corrected or mitigated 32 of the 53 weaknesses that we reported as 
unresolved at the time of our last review in 2002. In addition to the 
21 previously reported weaknesses that remained uncorrected, we 
identified 39 new information security control weaknesses during this 
review that placed sensitive taxpayer and BSA data--including 
information related to financial crimes, terrorist financing, money 
laundering, and other illicit activities--at significant risk of 
unauthorized disclosure, modification, and destruction. These include 
the following:

* Access controls over the mainframe computing environment provided no 
logical separation between IRS's taxpayer data and FinCEN's BSA data, 
allowing all 7460 mainframe users--IRS employees, non-IRS employees, 
and contractors--regardless of their official duties, the ability to 
read and modify taxpayer and BSA data, including information about 
citizens, law enforcement personnel, and individuals subject to 
investigation. Thus, IRS users could read or copy BSA information, and 
law enforcement users could read or copy taxpayer information.

* User accounts and passwords were not adequately controlled to ensure 
that only authorized individuals had access to IRS's servers and 
networks, thereby increasing the risk that unauthorized users could 
gain authorized user ID and password combinations to claim a user 
identity and then use that identity to gain access to sensitive 
taxpayer or BSA data.

* Audit and monitoring of security-related events on IRS's servers 
suffered from insufficient retention of security logs, heightening the 
risk of unauthorized system activity going undetected.

* Security over access to sensitive areas was jeopardized due to the 
lack of accountability over the issuance of master keys at an IRS 
facility, thereby increasing the likelihood that an unauthorized person 
could gain possession of a master key and use it to unlock sensitive 
computing areas within the facility.

These information security control weaknesses exist primarily because 
IRS has not fully implemented an agencywide information security 
program to effectively protect the information and information systems 
that support the operations and assets of the agency. Consequently, 
these identified weaknesses in information security controls impair 
IRS's ability to ensure the confidentiality, integrity, and 
availability of sensitive financial, taxpayer and FinCEN's BSA data 
hosted at its facility.

We made recommendations to the Secretary of the Treasury to direct the 
IRS Commissioner to take several actions to fully implement a 
comprehensive agencywide information security program and to determine 
whether taxpayer data have been disclosed to unauthorized 
individuals.[Footnote 37] In addition, we recommended that the 
Secretary of the Treasury direct the FinCEN Director to perform an 
assessment to determine whether BSA data have been disclosed to 
unauthorized individuals. The Acting Deputy Secretary of the Treasury 
generally agreed with the recommendations and identified specific 
completed and planned corrective actions, which we did not verify.

Concluding Observation:

IRS is operating in a difficult budget environment. On the one hand, 
its workload--represented by the number of returns and the complexity 
of those returns--is growing. On the other hand, IRS faces pressure to 
hold down spending.

Addressing the resource challenges summarized in this statement can 
help policy makers assessing IRS's budget. Long-term goals can help 
determine overall budgetary requirements. Revenue enhancements and the 
leveraging of nonfederal resources can help, to some extent, meet those 
requirements. Productivity gains and successful new investments in 
systems can help ensure that existing resources are used as efficiently 
as possible, helping minimize the need for additional funding. 
Addressing these resource challenges does not promise a painless way 
out of difficult budget decisions. However, it could provide a clearer 
picture of the tradeoffs involved.

Mr. Chairman, this concludes my testimony. I would be happy to answer 
any questions you may have at this time.

Contact and Acknowledgments:

For further information on this testimony, please contact James White 
on (202) 512-9110 or whitej@gao.gov. Individuals making key 
contributions to this testimony include Perry Datwyler, George Guttman, 
Tonia Johnson, David Lewis, Neil Pinney, Jeffrey Schmerling, Henry 
Sutanto, and Jenniffer Wilson.

FOOTNOTES

[1] In April 2005, we discussed the tax gap in testimony before the 
Senate Committee on Finance (GAO-05-527T). In our statement, we 
reported that IRS recently released its tax gap estimate for tax year 
2001. IRS estimated that the difference between taxes owed and taxes 
paid on time was between $312 billion and $353 billion. After tax law 
enforcement recovers a portion of the unpaid taxes, IRS estimates it 
will eventually recover some of this tax gap, resulting in a net tax 
gap of between $257 billion and $298 billion in tax year 2001.

[2] GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.: 
January 2005).

[3] In March 2005 we reported that IRS successfully completed the 
rampdown at Brookhaven without any significant disruptions in service. 
(GAO-05-319R)

[4] GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial 
Statements, GAO-05-103 (Washington, D.C.: Nov. 10, 2004).

[5] GAO-05-207.

[6] GAO, Internal Revenue Service: Assessment of Fiscal Year 2006 
Budget Request and Interim Results of the 2005 Filing Season, GAO-05- 
416T (Washington, D.C.: Apr. 14, 2005).

[7] High-income individuals are those reporting $100,000 or more of 
"total positive income," which is, in general, the sum of all positive 
amounts shown for the various sources of income reported on individual 
tax returns and thus excludes net losses.

[8] The PART was applied during the fiscal year 2004 budget cycle to 
"programs" selected by OMB. The PART includes general questions in each 
of four broad topics to which all programs are subjected: (1) program 
purpose and design, (2) strategic planning, (3) program management, and 
(4) program results (i.e., whether a program is meeting its long-term 
and annual goals). OMB also makes an overall assessment on program 
effectiveness.

[9] IRS has one long-term goal set by the Congress in RRA 98 for IRS to 
have 80 percent of all individual income tax returns filed 
electronically. 

[10] Pub. L. No. 103-62 (1993). The Government Performance and Results 
Act of 1993 seeks to improve the management of federal programs, as 
well as their effectiveness and efficiency, by requiring executive 
agencies to prepare multiyear strategic plans, annual performance 
plans, and annual performance reports. Under the act, strategic plans 
are the starting point for setting goals and measuring progress towards 
them. The act requires executive agencies to develop strategic plans 
that include an agency's mission statement, long-term general goals, 
and the strategies that the agency will use to achieve these goals. The 
plans should also explain the key external factors that could 
significantly affect achievement of these goals, and describe how long- 
term goals will be related to annual performance goals.

[11] Installment agreements are for taxpayers who cannot pay the full 
amount owed on their tax returns when due. IRS charges a one-time fee 
to these taxpayers, and allows them to make monthly installment 
payments. An offer in compromise (OIC) is an agreement between a 
taxpayer and IRS that resolves the taxpayer's tax liability for less 
than the full amount owed for taxes, interest, and penalties. IRS 
charges a one-time fee. FOIA requestors are charged a one-time fee and 
are provided with agency records as requested, with some exceptions.

[12] A letter ruling is a written determination issued in response to a 
written inquiry from an individual or an organization about its status 
for tax purposes or the tax effects of its acts or transactions, prior 
to the filing of returns or reports that are required by the revenue 
laws. A determination letter is a written determination that applies 
the principles and precedents previously announced by IRS to a specific 
set of facts. It is issued only when a determination can be made based 
on clearly established rules in a statute, a tax treaty, the 
regulations, a conclusion in a revenue ruling, or an opinion or court 
decision that represents the position of IRS.

[13] Section 7528 was added to the Code by section 202 of the Temporary 
Assistance for Needy Families Block Grant Program, Pub. L. 108-89, and 
was extended to September 30, 2014, by section 690 of the American Jobs 
Creation Act of 2004, Pub. L. 108-357.

[14] Circular A-25 applies to executive branch agencies assessing 
charges under the general user fee statute enacted in the Independent 
Offices Appropriations Act of 1952 and codified at 31 U.S.C. 9701. The 
circular also provides guidance to agencies imposing user fees under 
other statutes to the extent that the circular is not inconsistent with 
the statute in question.

[15] The American Jobs Creation Act of 2004, P.L. 108-357.

[16] Abusive tax schemes encompass distortions of the tax system such 
as falsely describing the law (saying, for example, that the income tax 
is unconstitutional), misrepresenting facts (for instance, promoting 
the deduction of personal expenses as business expenses), or using 
trusts or offshore bank accounts to hide income.

[17] National Taxpayer Advocate, 2004 Annual Report to Congress 
(Washington, D.C.: Dec. 31, 2004)

[18] GAO, 21st Century Challenges: Reexamining the Base of the Federal 
Government, GAO-05-325SP (Washington, D.C.: February 2005).

[19] The derivation of these criteria is detailed in our earlier 
testimony, Internal Revenue Service: Assessment of Fiscal Year 2006 
Budget Request and Interim Results of the 2005 Filing Season, GAO-05- 
416T (Washington, D.C.: Apr 14, 2005).

[20] GAO, Taxpayer Compliance: Analyzing the Nature of the Income Tax 
Gap, GAO/T-GGD-97-35 (Washington, D.C.; Jan. 9, 1997).

[21] GAO/T-GGD-97-35.

[22] GAO, Tax Administration: IRS Should Reassess the Level of 
Resources for Testing Forms and Instructions, GAO-03-486 (Washington, 
D.C.: Apr. 11, 2003).

[23] GAO, IRS Plans to Measure Tax Compliance Can Be Improved, GAO/GGD- 
93-52 (Washington, D.C.: Apr. 5, 1993).

[24] Tax Administration: Impact of Compliance and Collection Declines 
on Taxpayers, GAO-02-674 (Washington, D.C.: May 22, 2002).

[25] GAO, Tax Administration: Planning for IRS's Enforcement Process 
Changes Include Many Key Steps But Can Be Improved, GAO-04-287 
(Washington, D.C.: Jan. 20, 2004).

[26] GAO, Business Process Reengineering Assessment Guide, GAO/AIMD- 
10.1.15 (Washington, D.C.: April 1997).

[27] GAO-05-207.

[28] GAO, Business Systems Modernization: IRS Needs to Better Balance 
Management Capacity with Systems Acquisition Workload, GAO-02-356 
(Washington, D.C.: Feb. 28, 2002). 

[29] BSM funds are unavailable until the IRS submits to congressional 
appropriations committees for approval a modernization expenditure plan 
that (1) meets the OMB's capital planning and investment control review 
requirements; (2) complies with IRS's enterprise architecture; (3) 
conforms with IRS's enterprise life-cycle methodology; (4) is approved 
by IRS, the Department of the Treasury, and OMB; (5) is reviewed by 
GAO; and (6) complies with acquisition rules, requirements, guidelines, 
and systems acquisition management practices.

[30] GAO, Business Systems Modernization: IRS Needs to Better Balance 
Capacity With Systems Acquisition Workload, GAO-02-356 (Washington, 
D.C.: Feb. 28, 2002). 

[31] IRS uses the appropriated funds to cover contractor costs related 
to the BSM program. IRS funds internal costs for managing BSM with 
another appropriation. These costs are not tracked separately for BSM- 
related activities. 

[32] U.S. Senate, Senate Report 108-342. 

[33] We did not include in our calculations reductions to specific 
project risk adjustment amounts that were made for reasons other than 
the fiscal year 2005 budget reduction.

[34] GAO-05-416T.

[35] FISMA was enacted as title III, E-Government Act of 2002, Pub. L. 
No. 107-347, 116 Stat. 2946 (Dec. 17, 2002).

[36] GAO, Information Security: Internal Revenue Service Needs to 
Remedy Serious Weaknesses over Taxpayer and Bank Secrecy Act Data, GAO- 
05-482 (Washington, D.C.: Apr. 15, 2005).

[37] GAO-05-482.