[Senate Hearing 108-]
[From the U.S. Government Publishing Office]



 
  DEPARTMENTS OF TRANSPORTATION, TREASURY AND GENERAL GOVERNMENT, AND 
          RELATED AGENCIES APPROPRIATIONS FOR FISCAL YEAR 2005

                              ----------                              


                        WEDNESDAY, APRIL 7, 2004

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:17 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Richard C. Shelby (chairman) 
presiding.
    Present: Senators Shelby and Reid.

                       DEPARTMENT OF THE TREASURY

                        Internal Revenue Service

STATEMENTS OF:
        MARK O. EVERSON, COMMISSIONER
        PAMELA J. GARDINER, ACTING TREASURY INSPECTOR GENERAL FOR TAX 
            ADMINISTRATION, DEPARTMENT OF THE TREASURY
    Senator Shelby. The subcommittee will come to order.
    Good morning. I would like to welcome Internal Revenue 
Service (IRS) Commissioner Mark Everson and Pamela Gardiner, 
the Acting Treasury Inspector General for Tax Administration 
(TIGTA) to this morning's hearing. I look forward to hearing 
each of your views on the IRS's administration and enforcement 
of our Nation's tax code.
    As we all know, the April 15th tax filing season deadline 
is rapidly approaching. Each year the subcommittee requests 
that the IRS Commissioner appear before it in order to provide 
an update on how the Service is responding to the influx of 
questions and assistance that taxpayers need to correctly file 
their tax returns. This year we have also asked TIGTA to 
participate in order to provide a different perspective on the 
IRS's performance.
    I have taken note of the IRS's stated mission to provide 
America's taxpayers with top quality service by helping them to 
understand and meet their tax responsibilities, and by applying 
the tax law with integrity and fairness to all. This mission 
statement is appropriate, but some might question whether we 
are making progress toward achieving that goal.
    The IRS continues to face numerous challenges in tax law 
enforcement, customer service, and the modernization of its 
computer systems. While some strides have been made in some 
areas, much work remains to be completed. Each one of these 
tasks would prove difficult to undertake individually and to 
tackle all three at once is daunting indeed.
    I look forward to discussing each of these areas with both 
of you. The strength and weakness of our Nation's Federal 
income tax system is its reliance on the voluntary compliance 
of American taxpayers. Most Americans make every effort to 
comply with the law and pay their taxes. But as with any law, 
some intentionally seek to avoid compliance or engage in 
outright fraud. That is why effective enforcement of our tax 
laws is so important. If enforcement is lax, ineffective, or 
uneven, it encourages more people to commit fraud.

                        IRS ENFORCEMENT FUNDING

    While it is uncertain whether tax fraud is on the rise, I 
am certain that funding for the IRS tax enforcement has been 
and will continue to be an important priority for the 
administration and for the Congress. Over the past several 
years Congress has consistently increased funding for tax law 
enforcement, including a $265 million increase this past year.
    In each fiscal year since 2000, Congress provided the IRS 
with additional funding to increase its enforcement staff. 
Inexplicably, these staffing needs were not filled and the 
funds were instead used for other budgeted expenses. The use of 
these additional dollars to cover other funding shortfalls 
rather than increase staffing belies the priority the Service 
claims to place on enforcement. This diversion of funds is in 
direct contravention to your own statements, Mr. Commissioner, 
and is simply unacceptable.
    The first and foremost mission of the IRS must be to ensure 
the full and fair compliance of all U.S. taxpayers with their 
tax obligations. Yet, how can we ensure that the IRS is taking 
its enforcement responsibilities seriously if we continue to 
allow the Service to spend its funding for purposes other than 
that for which they have been requested and for which Congress 
has provided them?
    If there are administrative shortfalls caused by absorbing 
pay increases or diverting funds to other priorities and other 
unbudgeted items, then the IRS should ask for funding for these 
expenses and not hide behind claims of underfunding of 
initiatives such as customer service and enforcement. With 
100,000 employees and an annual budget that exceeds $10 
billion, I find it hard to believe that the IRS lacks the 
resources it needs to get the job done.
    I look forward to hearing both your comments and any update 
on how the IRS is utilizing the additional $265 million in 
enforcement and compliance funding appropriated recently. In 
the long term, a strong enforcement capability supported by 
necessary funding will continue to be a key part of combating 
tax non-compliance. But enforcement alone will never be enough. 
The IRS must provide high-quality customer service to assist 
taxpayers. I believe that many people who fail to comply with 
the code do so unintentionally because of its difficulty and 
complexity. Accurate and timely guidance from the Service is 
imperative to ensuring taxpayer compliance.
    The IRS is to be commended for the improvements it has made 
in customer service over the past few years. Helpful guidance 
is now much more accessible by way of the Internet, telephone, 
and in-person assistance. The accessibility of e-file options 
has eased the burden of filing tax returns for both the 
Government and the taxpayer.
    While the IRS has improved its responsiveness to taxpayer 
questions, the troubling fact remains that nearly one in four 
callers to its toll-free helpline receive inaccurate guidance. 
The numbers are only slightly better for online questioners and 
considerably worse for those taxpayers who seek in-person 
assistance in an IRS-operated taxpayer assistance center.
    I was even more alarmed, Mr. Commissioner, after learning 
of TIGTA spot audit visits to 26 different assistance centers 
throughout the country that uncovered, ``IRS employees 
incorrectly prepared 19 of 23 tax returns that they prepared,'' 
during the audits. How can we expect taxpayers to understand 
and comply with the complexities of the tax code when IRS's 
employees themselves have so much trouble understanding and 
explaining it?
    Our Federal tax code is a large part of the problem. The 
code and accompanying regulations are more than 54,000 pages 
long, and are too complex, too confusing and costly to comply 
with. Comprehensive reform of the tax code itself would go a 
long way towards reducing tax fraud by making the process 
simpler and the system fairer for all taxpayers. Additionally, 
a less complex tax code would provide fewer opportunities for 
cheaters and reduce the paperwork burden for all taxpaying 
Americans.
    I continue to believe that a simple and transparent tax 
structure would promote taxpayer compliance and lead to 
increased collections for the Treasury, while also markedly 
reducing the huge cost of administration and enforcement of our 
current tax system.

                     BUSINESS SYSTEMS MODERNIZATION

    Now I would like to focus for just a few minutes on an area 
of particular concern to me, the ongoing effort to modernize 
the IRS computer systems, known as Business Systems 
Modernization (BSM). This effort has been ongoing for a number 
of years, and it has consistently run over schedule and over 
budget while also failing to achieve meaningful milestones for 
its development.
    Mr. Commissioner, your budget request wisely seeks a 
decrease of $102 million for BSM. I agree that now is an 
appropriate time to focus on reengineering efforts to achieve 
the goals set for the BSM initiative. This initiative was 
supposed to be completed in 10 years. However, I do not believe 
that anyone expects this schedule to be achievable as schedule 
delays continue to be the rule, not the exception, to this 
ongoing effort.
    By way of example, the Customer Account Data Engine (CADE), 
the centerpiece of the entire BSM effort, was originally 
scheduled to roll-out in January of 2002, 2 years ago. Former 
Acting Commissioner Wenzel last year testified that CADE would 
be ready in August of 2003. It is now April 2004, and there is 
still no sign of CADE. True to form, CADE is not only late but 
significantly over budget. These schedule slippages and cost 
overruns have been epidemic. In fact, the IRS is running late 
and is over budget on all seven core projects related to BSM.
    I am very concerned that BSM is becoming the 21st-century 
version of the Tax Systems Modernization (TSM) program which 
was abandoned after consuming $4 billion of Federal tax 
dollars. That prior modernization effort was a complete loss. 
The current BSM effort began in 1998 and has already cost $1.7 
billion. This program, like TSM before it, raises more 
questions than it answers. As you noted, Commissioner Everson, 
in February of 2002, ``good intentions and good beginnings are 
not the measure of success. What matters in the end is 
completion, performance, and results.'' Applying your own 
standard, Commissioner Everson, I think you will agree that the 
BSM effort has woefully under-performed.
    I look forward to hearing the thoughts of both witnesses as 
to the best approach to take to keep this all-important 
modernization program on track. Again, I welcome you to the 
committee. Your written testimony will be made part of the 
record in its entirety, and Mr. Commissioner, we will start 
with you.

                    STATEMENT OF SENATOR HARRY REID

    Senator Reid. Excuse me, can I make a statement?
    Senator Shelby. Senator Reid. Excuse me.
    Senator Reid. I also feel at somewhat of a disadvantage. 
You are 6 foot 4 and I am just a small guy, and you have got a 
pad under your chair and I am here in this hole. It does not 
seem fair to me, Mr. Chairman.
    Senator Shelby. I do not think you would be at a 
disadvantage to anybody, Senator Reid.
    Senator Reid. I briefly want to just say this. I have a 
statement that is prepared and I do not want to take the time 
of the committee, but I would ask your permission that it be 
made part of the record.
    Senator Shelby. It will be made part of the record in its 
entirety and you may proceed as you wish.
    Senator Reid. Mr. Chairman, let me just say this. I hope 
that we can give the Commissioner of the Internal Revenue 
Service (IRS) the money that has been requested. I hope we do 
not have to cut that. I say that because we in Nevada have been 
faced with someone who has been indicted, and I think that is 
good, but he has promulgated falsehoods around the country 
saying you do not have to pay your taxes, and thousands of 
people have followed his lead. As a result of that, it is just 
one indication of why we have to have an Internal Revenue 
Service that has the manpower to collect the money that is due 
the government, because it places an unfair burden on those of 
us who pay their taxes fairly, if others are not.

                           PREPARED STATEMENT

    Nobody likes to pay their taxes, but I would hope that we 
would give the Internal Revenue Service the tools they need to 
collect the taxes, and especially the tools to go after those 
people who are, like the person in Nevada, openly cheating. 
They do not have the manpower to do this adequately and I hope 
we can help them in that regard.
    [The statement follows:]
                Prepared Statement of Senator Harry Reid
    Mr. Chairman, I want to thank you for calling this important 
meeting to talk about one of the most serious challenges facing the 
Internal Revenue Service today--the mismatch between the resources 
devoted to the Service's enforcement activities and the results that we 
in Congress and the public at large expect of it.
    Back in his 1996 State of the Union address, President Clinton 
declared that the ``era of big government is over.'' Generally 
speaking, with the exception of homeland security and defense, that has 
continued to be the case. It's a positive step to demand a more 
efficient, effective, and accountable government. Bloated and wasteful 
government is dangerous.
    But there is also danger in not having enough government to perform 
critical services in a responsible fashion. Take the S&L Crisis as an 
example. Back in the 1980s and early 1990s, the pool of Federal bank 
regulators shrank dramatically in size, training, and experience. That 
was a material contributing factor in the savings and loan crisis that 
saw over a thousand S&Ls with over $500 billion in assets fail. The 
Federal bailout of S&Ls eventually cost us $124 billion. If we had 
employed a better-trained, more experienced, and larger team of 
examiners, we could have prevented that crisis at a miniscule fraction 
of what it eventually cost us.
    I view the IRS's enforcement budget in much the same way. It's not 
that we're attempting to avert a crisis here--it's just that we have to 
make sure that the IRS has the tools it needs to conduct its important 
work effectively.
    Nobody likes to pay their taxes, but taxes are necessary for our 
society to function. And the collection of those taxes should be 
efficient, accurate, and fair. Without an adequate staff and budget, 
the IRS can't collect taxes efficiently, it can't collect them 
accurately, and it can't collect them fairly.
    Since 1996, the number of IRS agents has fallen from just under 
23,000 to 16,750, which is a decline of nearly a third. The number of 
taxpayers audited fell from 1.9 million to 849,000. Criminal cases 
against alleged tax offenders have fallen by about half, and civil 
cases have fallen by more than 60 percent.
    Those numbers indicate that the IRS is experiencing difficulty 
carrying out its mission--collecting revenue. Last year, the IRS chose 
not to pursue $16.5 billion of taxes owed on 2 million tax returns, 
mainly because of short-staffing. That represents 1.8 percent of the 
total individual and corporate income taxes expected for 2003. 
According to officials of the Service, many of these taxpayers would 
pay their bills if an agent simply called them.
    The problem extends beyond the delinquent accounts. As was noted in 
yesterday's USA Today, the Service estimates that it loses $250 billion 
every year from taxpayers who cheat, fail to file, or abuse tax 
shelters. The lost revenue constitutes 10 percent of the Federal 
budget. That amounts to almost as much as we spend on Medicare!
    When the IRS has a limited organizational capacity to go after this 
money--which is fairly owed--it means that the tax burden just got a 
little bit heavier on everyone who pays their taxes honestly. That's 
not right.
    Furthermore, especially at a time when the Federal budget deficit 
is $500 billion, we should be ensuring that everyone pays in full.
    Sometimes in our haste to create a smaller government, we settle 
for a considerably less efficient and productive government. That is 
unacceptable when it comes to the enforcement activities of the IRS, 
and I look forward to working with Commissioner Everson and his 
talented associates to ensure that they are equipped with the resources 
necessary to do their vital enforcement work.

    Senator Shelby. Thank you.
    Senator Reid. I am sorry to be here late.

               PREPARED STATEMENT OF SENATOR PATTY MURRAY

    Senator Shelby. That is okay, Senator Reid.
    Senator Murray has submitted a prepared statement which 
will also be included in the record.
    [The statement follows:]
               Prepared Statement of Senator Patty Murray

    Thank you, Mr. Chairman. Over the past 3 years, our country has 
pursued a destructive and inequitable economic policy centered on 
providing tax cuts to the wealthiest Americans while restricting 
spending on programs that help all Americans. As a result, our Federal 
budget has gone from one of the greatest surpluses in its history to 
the highest deficit ever known in the history of our country--$478 
billion--close to half a trillion dollars in the current fiscal year.
    But if that sea of red ink is not bad enough, it is even more 
disturbing when you consider that a growing percentage of Americans 
believe that it is okay to avoid the taxes that they do owe the Federal 
Government.
    Our IRS Commissioner, Mark Everson, is before the subcommittee 
today to report that the estimated tax gap, the difference between what 
the Nation's taxpayers actually owe versus the amount of actual tax 
receipts paid has grown to the level of $255 billion.
    In about 1 week from today, millions of American families who work 
hard every day and play by the rules will struggle to write a check to 
the Internal Revenue Service to cover their Federal tax liability while 
the rich and the super-rich in this country will pay an increasingly 
smaller percent of their income in taxes. If that isn't galling enough, 
the situation is made worse when you recognize that the Internal 
Revenue Service is very ill-equipped to catch and penalize those 
crooked Americans that do cheat on their taxes, especially the most 
wealthy and sophisticated of tax cheats.
    Indeed, the IRS's own methods of prosecuting tax cheats and 
collecting old debts is so troubled that the Treasury Inspector General 
for Tax Administration recently reported that the IRS has failed to 
collect the taxes due even from dozens of individuals who have been 
convicted in court for tax evasion. This is an appalling situation 
where the government goes through the effort and expense of dragging 
these individuals into court and convicting them of cheating on their 
taxes. Even then, the IRS fails to collect the debts owed by these 
convicted criminals. This situation is unacceptable and it has got to 
change. The IRS must turn a corner and cease to be the laughing stock 
of the wealthy and super-wealthy tax cheaters in this country.
    I am pleased to say that, today, the IRS Commissioner Mark Everson 
is here to testify on behalf of a budget that seeks to do something 
about the problem. He is asking for a 9.4 percent boost in funding for 
tax law enforcement, including funding for 2,942 additional enforcement 
agents. However, there are several questions that surround the 
Commissioner's request in this area that must be addressed in today's 
hearing.
    The first question is: are the resources that the Commissioner is 
seeking enough to do the job? Recently, an oversight board appointed by 
the President said that the answer is ``no.'' That oversight board 
pointed out that, absent even more resources beyond the level requested 
by the administration, the IRS will actually have to curtail some of 
its most critical enforcement and collection efforts.
    A second question of equal importance is ``will this subcommittee 
be in a position to fund the increased resources sought by the IRS?'' 
Here, I believe that the Republican budget resolution adopted by the 
thinnest majority in the U.S. Senate indicates that the answer is 
``no.''
    At a time when the IRS is seeking a budget increase for tax law 
enforcement of 9.4 percent, the budget resolution adopted by the 
Senate, which I voted against, allows for an overall funding increase 
in discretionary spending of less than 1 percent. This is precisely one 
of the reasons that I voted against the budget resolution. That budget 
calls for continuing tax cuts to the wealthiest Americans while forcing 
difficult and illogical choices when it comes to Federal spending.
    We know that when we provide for increased spending for the 
education of our young, we avoid even greater expenses down the road in 
job training, welfare payments, even the construction of new prisons. 
Similarly, if we can't fund enhanced enforcement in the Internal 
Revenue Service, our Federal budget will not gain the tax revenue that 
it is due and our deficit will be far worse. It is estimated that an 
increase in IRS enforcement efforts of several hundred million of 
dollars could yield billions in additional revenue that is owed to the 
government.
    A third question that must be asked is whether the IRS can really 
do the job when it comes to hunting down and prosecuting tax cheats. 
The agency is working with very antiquated computer systems, and its 
efforts to modernize those computer systems have failed to produce 
promised results. Moreover, the President's Budget singles out these 
modernization efforts for a 26.5 percent funding cut for the coming 
fiscal year.
    We have to recognize that it takes upwards of half a dozen years or 
longer for the IRS to finally pursue and prosecute individuals cheating 
on their taxes. We regularly have underpaid and overworked government 
lawyers going to court against handsomely paid private lawyers. Often 
times, those private lawyers are the very same lawyers that concocted 
the very complicated tax avoidance schemes that landed their client in 
court.
    So, I hope our hearing will, at a minimum, pursue these three 
central questions that surround the Commissioner's request. I am glad 
that he is here to testify before us. I should say that I believe his 
commitment to reversing the growing trend in tax avoidance and tax 
cheating is a sincere one and I look forward to hearing his testimony 
this morning.
    Thank you, Mr. Chairman.

    Senator Shelby. Mr. Commissioner.

                      STATEMENT OF MARK W. EVERSON

    Mr. Everson. Thank you, Mr. Chairman, Senator Reid. Nice to 
see you again. Thank you very much for your opening remarks. I 
am pleased to be here before the subcommittee today to speak 
about the President's 2005 budget request for the IRS. I would 
also like to welcome the future taxpayers behind me to this 
hearing.
    Our working equation for the IRS is service plus 
enforcement equals compliance, not service or enforcement. The 
IRS must do both. We must run a balanced system of tax 
administration based on a foundation of taxpayer rights.
    Last month we released our enforcement statistics for 
fiscal year 2003. They demonstrate that we have arrested the 
enforcement decline which began in the 1990s and worsened with 
the implementation of RRA 1998. Audits, criminal investigations 
and monies collected were all up. In particular, when compared 
with the fiscal year which started October 1, 2000, audits of 
taxpayers with incomes over $100,000 were up by over 50 
percent. That is taxpayer's income over $100,000. You can see 
how badly over a period of years this declined, as did a lot of 
our audit rates. But you can see we have turned that around and 
we have given great prominence to this category in particular.


                       IRS ENFORCEMENT ACTIVITIES

    The President's 2005 budget request for the IRS will 
continue to rebuild our enforcement activities. I would note 
that two-thirds of the new monies requested will be devoted to 
enforcing our compliance efforts in the areas of high income 
individuals, corporations, and criminal activities. The extra 
$300 million in new monies that we seek will carry out our four 
objectives in enforcement. They are, discourage cheating and 
non-compliance, particularly by corporations, high income 
individuals and tax-exempt groups; help attorneys, accountants, 
and other professionals adhere to professional standards and 
obey the law; detect and deter domestic and offshore tax and 
financial criminal activity; and discourage and deter non-
compliance within tax-exempt and government entities, and 
misuse of such entities by third parties for tax avoidance and 
other purposes.

                       ADDRESSING NON-COMPLIANCE

    These incremental resources will help us address the tax 
gap, the difference between what is owed and what is paid due 
to non-filing, underreporting and underpayment, and secure 
billions of dollars for the Treasury. Furthermore, over a 4-
year period we have seen an increase in the percentage of 
Americans who think it is okay to cheat on their taxes; an 
increase from 11 percent to 17 percent. I find this alarming, 
as I am sure do you. I believe, however, that enhanced 
enforcement efforts will improve attitudes concerning 
compliance by reassuring the average American who pays his or 
her taxes that when he or she pays neighbors and competitors 
will do the same.
    Once we have hired and trained the new enforcement 
personnel as requested in the President's budget, this direct 
return on investment would be 6 to 1. That is the dollars we 
would get back directly. Beyond the incremental revenues 
associated with the increased audits, investigations, and 
collection activities there will also be a favorable spillover 
effect. Other taxpayers will be discouraged from cheating when 
they observe that those who play fast and loose with the tax 
code are being held accountable. Behaviors at the margin will 
change.
    I am convinced we can augment our enforcement activities 
without diminishing our commitment to service. Our filing 
season results thus far in 2004 show that we can. Through last 
Friday, total returns filed have increased more than 1 percent. 
Our electronically filed returns are up 12 percent from last 
year. Electronic filing is more reliable both for the taxpayer 
and Service, and it is faster, allowing the IRS to issue 
refunds in half the time. Also noteworthy is that the Free File 
initiative, which helps low and middle-income taxpayers, has 
grown in volume by 23 percent from last year.
    Our other service indicators for the most part also show 
improvement. We have handled increased call volumes with stable 
resources and bettered our level of service. There is increased 
usage of automated services both on the phone and the Internet. 
While we made some changes to improve tax law accuracy and had 
some startup problems earlier in the season, in recent weeks 
our results in this area have recovered.
    I want to assure you that should the Congress approve our 
budget request we will spend these resources wisely. I am aware 
of the problems in the past, particularly in the efforts to 
modernize information technology at the IRS. We are addressing 
our challenges in IT modernization and our plans in the 2005 
budget take into account the necessity to improve as you 
indicated.

                           PREPARED STATEMENT

    In conclusion, let me note with gratitude the strong 
bipartisan support the President's IRS budget request is 
getting here in the Senate. I was pleased by the letters of 
support from the leaders of the Governmental Affairs Committee 
to the Appropriations Committee as well as the letter from the 
Finance Committee to the Budget Committee. I think the tax 
administration can and should be a matter of broad bipartisan 
agreement.
    Thank you.
    [The statement follows:]

                 Prepared Statement of Mark W. Everson

                              INTRODUCTION

    Chairman Shelby, Ranking Member Murray, and Members of the 
subcommittee, thank you for the opportunity to testify today on the 
fiscal year 2005 budget request for the Internal Revenue Service.
    Our working equation at the IRS is service plus enforcement equals 
compliance. The better we serve the taxpayer, and the better we enforce 
the law, the more likely the taxpayer will pay the taxes he or she 
owes.
    This is not an issue of service OR enforcement, but service AND 
enforcement. As you know, IRS service lagged in the 1990's. In 
response, we took important and necessary steps to upgrade service--we 
significantly improved the answering of taxpayer telephone inquiries 
and electronic filing to name just a couple areas.
    Unfortunately, improvement in service coincided with a drop in 
enforcement of the tax law. After 1996, the number of IRS revenue 
agents, officers, and criminal investigators dropped by over 25 
percent.
    We currently have a serious tax gap--the difference between what 
taxpayers are supposed to pay and what is actually paid--in this 
country. By our best estimates, we lose a quarter trillion dollars each 
year due to non-filing, under-reporting, and underpayment. (This is a 
rough estimate based largely upon data from our old Taxpayer Compliance 
Measurement Program, most of which was collected in the 1980's. Our 
estimates have been updated to reflect changes in the economy during 
the intervening years, but a key assumption is that compliance behavior 
has remained largely unchanged. If taxpayer compliance has changed in 
the last 15 years, the tax gap could well be much different than our 
estimate suggests.)
    In addition, over the last 4 years, the number of Americans saying 
it is OK to cheat on taxes rose from 11 to 17 percent. Sixty percent of 
Americans believe that people are more likely to cheat on taxes and 
take a chance on being audited.
    We must restore the balance between service and enforcement, but 
that will not come at the expense of continued improvements to taxpayer 
service. In recent years, we have begun to attack these declines by 
revitalizing our investigations, audits and prosecutions against those 
who do not pay their taxes. The President's fiscal year 2005 budget--if 
approved by Congress--will help with our efforts to boost enforcement 
while maintaining our levels of service. The submission requests an 
additional $300 million for enforcement activities over the fiscal year 
2004 consolidated appropriations level.
   president's fiscal year 2005 budget seeks increase in enforcement
    The President has asked for an IRS fiscal year 2005 budget of 
$10.674 billion, a 4.8 percent increase over the fiscal year 2004 
consolidated appropriations level for the IRS.
    This budget includes the goals of customer service, infrastructure/
modernization and enforcement. After a period of declining enforcement 
resources, the IRS has stabilized and increased the amount of resources 
dedicated to enforcement.
    This budget has an increase of $300 million for a more vigorous 
enforcement of the tax laws. This strong commitment to tax 
administration will provide a significant augmentation of our 
enforcement resources.
    The additional $300 million will increase enforcement in several 
key ways:
  --Discourage and deter non-compliance, with emphasis on corrosive 
        activity by corporations, high-income individual taxpayers and 
        other contributors to the tax gap;
  --Assure that attorneys, accountants and other tax practitioners 
        adhere to professional standards and follow the law;
  --Detect and deter domestic and off-shored based tax and financial 
        criminal activity;
  --Discourage and deter non-compliance within tax-exempt and 
        government entities and misuse of such entities by third 
        parties for tax avoidance or other unintended purposes.
    Let me now provide more details on the broad categories of the 
budget request for the IRS.

                 PROCESSING, ASSISTANCE, AND MANAGEMENT

    We are seeking $4,148,403,000 for processing, assistance and 
management. This includes necessary expenses for pre-filing taxpayer 
assistance and education, filing and account services, shared services 
support, and general management and administration. Up to $4.1 million 
of the $4.1 billion total will be for the Tax Counseling for the 
Elderly Program and $7.5 million of the total will be available for 
low-income taxpayer clinic grants.
    The Processing, Assistance, and Management (PAM) appropriation 
handles all functions related to processing tax returns, including both 
manual and electronic submissions, and provides assistance and 
education to taxpayers to enable them to file accurate returns. The PAM 
appropriation issues refunds, maintains taxpayer accounts, and provides 
tax law assistance that includes tax law interpretation and rulings and 
agreements related to tax law issues. This appropriation is responsible 
for IRS personnel, facilities, and procurement services.
    The IRS will continue to focus on pre-filing services and is 
requesting funding for taxpayer communication and education to help all 
taxpayers comply with tax laws and assume their fair share of the tax 
burden. Funding is being requested for resources to warn taxpayers of 
abusive tax schemes and improve compliance by preventing fraud and 
abuse. The IRS is redirecting funding to enhance customer service by 
reengineering processes to complement new technology and to develop an 
outreach strategy for the Child Tax Credit.
    The IRS is reinvesting resources for filing and account services by 
providing funding for field assistance to reduce filing season details 
of compliance staff, funding the Business Master File workload 
increase, improving the level of telephone service to taxpayers, and 
updating processes to complement technology.
    As part of the shared services program, the IRS will reinvest 
resources in new training and training delivery methods to develop and 
to improve expert consultative skills. This effort will significantly 
improve administrative and resource management decisions that will 
enhance delivery of compliance initiatives. Additional resource 
reinvestments will be used to defer rent annualization costs (based on 
partial year costs extrapolated annually for approved fiscal year 2003 
space expansion projects) to fulfill the IRS's operational mission 
objectives. Shared services will implement HR Connect, the integrated 
Human Resources Management System over the next 2 years. This system 
will seamlessly link multiple Human Resource applications that should 
result in significant program efficiencies.
    The OMB Program Assessment Rating Tool (PART) review of Submissions 
Processing recommends that IRS successfully implement the Modernized E-
File IT projects. IRS is enabling e-file growth by increasing the 
numbers of returns eligible to be electronically filed. In fiscal year 
2005, the IRS plans to complete the architecture and engineering 
analysis required to develop and deploy functionality, allowing 
taxpayers to electronically file Forms 1065, 990T, and 1041.

                          TAX LAW ENFORCEMENT

    For enforcement, we are requesting $4,564,350,000. This 
appropriation ensures IRS's ability to: provide equitable and 
appropriate enforcement of the tax laws, identify possible non-filers 
for examination, investigate violations of criminal statutes, support 
the Statistics of Income program, conduct research to identify 
compliance issues and support the national effort to combat domestic 
and international terrorism.
    The resources in the Tax Law Enforcement (TLE) Appropriation 
provide service to taxpayers after a return is filed and support 
activities such as research to identify compliance and tax 
administration problems, as well as tabulation and publication of 
statistics related to tax filing. In fiscal year 2001, Tax Law 
Enforcement was realigned and redefined as mandated by the Internal 
Revenue Restructuring and Reform Act of 1998 (RRA 98) to better serve 
the needs of taxpayers. The modernized IRS structure is similar to 
those widely used in the private sector: organized around customers' 
needs, in this case taxpayers. The IRS has set up four operating 
divisions to service the four major categories of taxpayers; Wage and 
Investment Income (W&I), Small Business and Self-Employed (SBSE), Tax 
Exempt and Government Entities (TEGE) and Large and Mid-Sized Business 
(LMSB). Each of these business units has substantial operations within 
the Tax Law Enforcement appropriation. The Criminal Investigation (CI) 
business unit investigates criminal violations of the Internal Revenue 
Code and also supports the national effort to combat terrorist 
financing by integrating CI special agents into the Joint Terrorism 
Task Forces and other anti-terrorism task forces. CI has the largest 
part of its operation within the Tax Law Enforcement appropriation.
    The TLE appropriation is the primary source of funding for the 
compliance functions of the IRS, including: (1) automated, in-person 
and correspondence collection of delinquent taxpayer liabilities, (2) 
the matching of reporting documents with taxpayer returns, to insure 
reporting compliance, (3) face-to-face examination to determine 
taxpayers' correct income levels and corresponding tax liabilities, (4) 
service center support of the field examination function and 
correspondence with taxpayers regarding tax issues, (5) investigation 
of criminal violations of the tax laws, (6) processing of currency 
transaction reports over $10,000, (7) tax litigation, (8) acting as an 
advocate to provide prompt resolution of taxpayer problems and (9) a 
general counsel function to offer legal advice and guidance to all 
components of the IRS.
    I would specifically like to emphasize our continuing commitment to 
the administration's efforts to combat terrorism. The funding provided 
in the President's budget request will allow us to continue to make a 
significant contribution to this effort.
    The functions in TLE are essential to accomplishing the primary 
goals of the Fiscal Year 2005 Budget Request. To accomplish this goal, 
the IRS must restore the strength of the compliance function. Staffing 
devoted to compliance and enforcement operations has declined in recent 
years. Annual growth in return filings and additional work related to 
RRA 98 have contributed to a steady decline in enforcement presence, 
audit coverage and case closures in front-line compliance programs.
    The Fiscal Year 2004 Appropriations Act merged the Earned Income 
Tax Credit (EITC) Appropriation with the TLE Appropriation. The merge 
of EITC into the TLE appropriation will provide for customer service 
and public outreach programs, strengthened enforcement activities and 
enhanced research efforts to reduce over claims and erroneous filings 
associated with the Earned Income Tax Credit (EITC) compliance 
initiative.
    Customer service for the EITC initiative includes dedicated toll-
free telephone assistance, community-based tax preparation sites and a 
coordinated marketing and educational effort (including paid 
advertising and direct mailings) to assist low-income taxpayers in 
determining their eligibility for EITC. Improved compliance activities 
include increased staff and systemic improvements in submission 
processing, examination, and criminal investigation programs. Increased 
examination coverage, prior to issuance of refunds, reduces 
overpayments and encourages compliance in subsequent filing periods; in 
addition, post-refund correspondence audits by service center staff aid 
in the recovery of erroneous refunds. Criminal investigation activities 
target individuals and practitioners involved in fraudulent refund 
schemes and generate referrals of suspicious returns for follow-up 
examination. Examination staff assigned to district offices audit 
return preparers and may apply penalties for non-compliance with ``due 
diligence requirements.''
    OMB Program Assessment Rating Tool (PART) observations concluded 
that the IRS does not work enough collection cases with its current 
resources, work processes and technology to ensure fair tax 
enforcement. Each year IRS fails to work billions of dollars worth of 
collection cases. Consequently, the Budget includes a legislative 
proposal to allow IRS to hire private collection contractors to assist 
the IRS in addressing a significant number of cases. In addition to the 
increased resources requested, the IRS is making internal process 
improvements, including: developing models to better identify high 
priority work, better use of the predictive dialer, realigning the 
workforce to core hours and creating a performance support tool to 
provide employees with technical guidance while handling calls. The 
PART review also determined that IRS financial management systems 
remain weak. In response, the IRS plans to modernize its collection 
technology to improve effectiveness. New technology tools will be 
developed for collection employees (e.g., electronic Automated 
Collection System, contact recording, and desktop integration), which 
will improve program efficiency.

               HEALTH INSURANCE TAX CREDIT ADMINISTRATION
 
   We are requesting $34,841,000 for expenses necessary to implement 
the health insurance tax credit included in the Trade Act of 2002. This 
appropriation provides operating funding to administer the advance 
payment feature of the Trade Adjustment Assistance health insurance tax 
credit program to assist dislocated workers with their health insurance 
premiums. The Trade Act of 2002 created the tax credit program and it 
became effective in August of 2003.

                          INFORMATION SYSTEMS

    We are requesting $1,641,768,000 for information systems. This 
appropriation is for necessary expenses of the Internal Revenue Service 
for information systems and telecommunications support, including 
developmental information systems and operational information systems.
    It provides for IRS information systems operations and maintenance, 
investments to enhance or develop business applications for the IRS 
Business Units and staff support for the Service's Modernization 
program.
    The appropriation includes staffing, telecommunications, hardware 
and software (including commercial-off-the-shelf), and contractual 
services. It also provides for Servicewide Information Systems (IS) 
operations, IRS staff costs for support and management of the Business 
Systems Modernization effort, and investments to support the 
information systems requirements of the IRS business units. It includes 
staffing, telecommunications, hardware and software (including 
commercial-off-the-shelf software), and contractual services.
    Staffing in this activity develops and maintains the millions of 
lines of programming code supporting all aspects of the tax-processing 
pipeline as well as operating and administering the Service's hardware 
infrastructure mainframes, minicomputers, personal computers, networks, 
and a variety of management information systems.
    In addition, the Information Systems ``Tier B'' modernization 
initiatives fund projects that modify or enhance existing IRS systems 
or processes, provide changes in systemic functionality, and establish 
bridges between current production systems and the new modernization 
architecture being developed as part of the Servicewide Business 
Systems Modernization efforts. Investment activities also include 
improvements or enhancements to business applications that support 
requirements unique to one of the IRS business units. These Tier B 
projects yield increased efficiency and allow the Service to 
progressively improve the quality of its interactions with the 
taxpaying public and its many other internal and external customers.

                     BUSINESS SYSTEMS MODERNIZATION

    We are seeking $285,000,000, for our Business Systems Modernization 
(BSM) efforts. This request is based upon the resizing efforts we began 
following the various internal and external reviews of BSM.
    This appropriation provides for the planning and capital asset 
acquisition of information technology systems, including related 
contractual costs of such acquisition and contractual costs associated 
with operations authorized by 5 U.S.C. 3109, to modernize IRS's 
antiquated business systems.
    The IRS collects $1.7 trillion in revenues annually through an 
assortment of computer systems developed over a 40-year period. The IRS 
developed the most important systems that maintain all taxpayer records 
in the 1960's and 1970's. These outdated systems do not allow the IRS 
to meet today's taxpayer and business needs. Failure to modernize IRS's 
tax administration business systems will result in a significant 
increase in resources required to maintain legacy systems--systems that 
no longer efficiently or effectively serve America's taxpayers.
    The BSM Appropriation provides for revamping business practices and 
acquiring new technology. The IRS is using a formal methodology to 
prioritize, approve, fund and evaluate its portfolio of BSM investments 
across the IRS Business Units and Modernization and Information 
Technology Services (MITS). This methodology enforces a documented, 
repeatable and measurable process for managing investments throughout 
their life cycle. The MITS Enterprise Governance (MEG) Committee, which 
includes the Chief Information Officer and other senior MITS 
executives, the Chief Financial Officer, and the heads of the Business 
Operating Divisions, approves investment decisions. This executive-
level oversight ensures that products and projects delivered under the 
Business Systems Modernization program are fully integrated into IRS 
Business Units. The Department of the Treasury Investment Review Board 
also reviews the BSM expenditure Plan once the IRS executive-level 
oversight board approves the investment decisions. The plan is then 
cleared through OMB and submitted through the Appropriations 
Committees.
    The IRS has undergone an intensive servicewide portfolio 
prioritization effort, leading to a long-term modernization plan 
identifying selected modernization projects, a release sequence for 
each project, and estimated costs for each project. The effort is based 
on vision and strategy initiatives that created an enterprise-wide 
view, which unified the needs of the IRS Business Units. Fiscal year 
2005 resources will fund the infrastructure, program management, and 
releases of business applications to support the successful delivery of 
a modernized tax administration system. More complete details are 
provided in the BSM Expenditure Plan.
    A partial Fiscal Year 2004 BSM Expenditure Plan was submitted by 
the Department of Treasury for Congressional approval in January 2004, 
and the full-year revision incorporating current project information 
should be completed by this spring.

                          PROGRAM PERFORMANCE

    The IRS expects to achieve the following levels of performance 
after attaining full performance of the requested fiscal year 2005 
initiatives:
  --Examine an additional 30,000 investor returns in the Small Business 
        and Self-Employed (SB/SE) business unit and increase coverage 
        of high-income taxpayers, generating an additional $170 million 
        in fiscal year 2006. SB/SE also anticipates closing an 
        additional 50,000 taxpayer delinquent accounts, resulting in an 
        estimated $215 million in additional revenue.
  --Hire and train over 2,000 new staff in the Examination, Collection 
        and Document Matching programs. These increases will generate 
        some $2.8 billion in direct enforcement revenue through fiscal 
        year 2007. Additional audits of investor returns and high-
        income taxpayers, together with 55,000 correspondence 
        examinations, will yield more than $1.0 billion during that 
        same period. Collection closures will increase by 240,000 and 
        taxpayer contacts through the Automated Underreporter Program 
        by some 300,000 through fiscal year 2007--generating an 
        additional $1.8 billion.
  --Increase the overall audit coverage rate in the Large and Mid-Sized 
        (LMSB) business unit from 5.1 percent in fiscal year 2004 to 
        9.6 percent in fiscal year 2007 and increase projected return 
        closures by 63 percent from 16,067 returns in fiscal year 2004 
        to 26,193 returns in fiscal year 2007. Enforcement revenue 
        recommended for the 3 years fiscal year 2005 through fiscal 
        year 2007 should increase by over $3 billion.
  --Complete 229 significant Corporate Fraud investigations through 
        fiscal year 2007. Tax-related completed investigations will 
        increase by approximately 20 percent over the fiscal year 2003 
        level by fiscal year 2007. In addition, CI is striving to 
        reduce elapsed time on completed investigations by 30 percent 
        from fiscal year 2002 levels.

                           IMPROVING SERVICE

    We are improving service to the taxpayer. Let me give a broader 
picture of service and compliance, and how the President's budget will 
lead to more effective and fair collection of taxes.
    It was not long ago that IRS service was not all that it should 
be--some would even say it was poor. In many areas the service level we 
provided, or more accurately stated, failed to provide, frustrated 
taxpayers in their effort to understand and comply with the tax law.
    Regardless of the merits of some of the allegations directed 
against the IRS in the mid-1990's, there was a significant gap between 
the quality of service that the IRS was providing taxpayers and the 
quality of service that the public had a right to expect. This 
shortfall in services clearly warranted the fundamental improvements 
and reorganization established under RRA 98.
    The reorganization of the IRS along customer lines of business and 
the other changes brought about by RRA 98 were, taken as a whole, sound 
reforms. The twin themes of the legislation were improvement of service 
and protection of taxpayer rights.
    Through an almost single-minded focus on RRA 98 implementation, the 
IRS has demonstrated unmistakable progress in improving customer 
service and increasing its recognition of, and respect for, taxpayer 
rights. While we still aim to reach a higher level of customer service, 
our improvement and commitment with respect to these core goals is 
measurable.
    Last year 53 million individuals filed their returns 
electronically. Thus far this year, nearly 1 week away from ``tax 
day'', electronic filing is up again, by about 12 percent. Electronic 
filing is more reliable, both for the taxpayer and the IRS. And it is 
faster. Over three-quarters of Americans get refunds, and we issue the 
refund in about half the time when a taxpayer files electronically.
    Another challenge in the 1990's was getting through to the IRS at 
all. We now have a world-class telephone call routing system. A call is 
directed to the right person, someone who knows something about 
charitable contributions or IRA's--whatever the subject may be--and the 
system balances workforce planning against predictable workload 
patterns to reduce waiting time. By 2003, overflows to the telephone 
system, such as busy signals--the crudest indication of service 
failure--decreased 99 percent from its worst performance of 400 
million. We also reduced taxpayer call-waiting time by half since 2001, 
reduced the number of abandoned calls by half since 2002, and doubled 
the number of refund inquiries from our Spanish-speaking taxpayers.
    Meanwhile, we have delivered other applications that provide 
tangible benefits to taxpayers and improve the efficiency and 
effectiveness of our tax administration system. They include:
  --Where's My Refund?/Where's My Advance Child Tax Credit?, which 
        gives taxpayers instant updates on the status of their tax 
        refunds and advance child tax credits. Where's My Refund? has 
        provided almost 11 millions services and Where's My Advance 
        Child Tax Credit? has provided another 20 million services. By 
        shifting a significant volume of customer demand to the 
        Internet and automated telephone services, we have seen a 
        measurable improvement in service for taxpayers who still need 
        to talk with an IRS assistor.
  --e-Services, which includes preparer tax identification number (TIN) 
        applications with instant delivery, individual TIN matching for 
        third party payers, on-line registration for electronic e-
        Services, and on-line initiation of the electronic originator 
        application (currently released to a controlled segment of 
        external users). I am pleased to announce that we recently made 
        the first part of e-Services available on our public website. 
        The remaining parts will come out over the next several months.
  --Internet EIN, which permits small businesses to apply for, and 
        receive, an Employer Identification Number on-line.
  --HR Connect, which allows IRS users to perform many personnel 
        actions on-line. This technological advance will enable the 
        Service to redirect hundreds of positions to enforcement 
        activities by the time it is fully deployed, which we have 
        planned for October 2005.
    Are we where we need to be on service? Not yet. As you know, I have 
been emphasizing enforcement, but I do not want this subcommittee or 
anyone to think the IRS will walk away from service. We still continue 
to maintain and improve service.
    Our objectives for improved taxpayer service are three-fold:
  --First, to improve and increase service options for the tax-paying 
        public;
  --Second, to facilitate participation in the tax system by all 
        sectors of the public; and
  --Third, to simplify the tax process.
    These are service objectives that recognize the dynamics of a 
rapidly changing world, one in which the Internet will be the dominant 
communications tool. Yet we realize there will remain a wide range of 
computer and technological literacy among individual taxpayers, and we 
must not fail to provide the same level of service to all taxpayers 
regardless of their technological sophistication. Our objectives also 
recognize an America with an increasingly diverse population, and that 
diversity will create challenges for us as tax administrators. 
Nevertheless, we are confident that we can and will serve all American 
effectively.
    Continued changes in traditional media will make it harder to cover 
the waterfront as we seek to educate taxpayers. Moreover, the 
complexity of our tax laws, along with the frequency of changes to 
these laws, is not only a challenge to taxpayers trying to comply with 
the tax laws, but a basis of cynicism about complying with the tax 
laws. The administration is committed to addressing this complexity. 
While it remains, we have an obligation to help taxpayers navigate 
these laws and make it as easy as possible for them to comply.
    In a world increasingly impatient for prompt and reliable 
information and transaction processing, all of these factors pose 
significant challenges to the IRS as it strives to improve the level of 
service provided to the American taxpayer.
    A good example of the challenges we will face is reconciling our 
desire to standardize our processes through electronic filing with the 
reality that some groups, such as immigrants and the elderly, will need 
different, targeted services. Electronic filing is important to the IRS 
and to taxpayers, but we cannot overemphasize it to the detriment of 
services to taxpayer groups who will not utilize it. Addressing 
competing priorities on the service side of the IRS will not be easy, 
but we will work diligently to provide a balanced, effective program.

                         EFFECTIVE ENFORCEMENT

    Our focus on the strong mandate of RRA 98 to improve IRS services 
to the taxpaying public made it difficult for us to balance both the 
service and enforcement elements that are so necessary to the success 
of our tax system. Improved taxpayer service enhances compliance and 
respect for our laws among the vast majority of Americans who do their 
best to pay their fair share. Improved taxpayer service also may help 
discourage those who might not otherwise do what is necessary to comply 
with our tax laws. Taxpayer service, however, does not address those 
who actively seek to avoid paying their fair share. I believe most 
people would agree that we achieved improvement of IRS taxpayer 
services in large part at the expense of needed enforcement activities.
    Over a 5-year period beginning in 1997, the IRS refocused its 
enforcement resources significantly. The number of revenue agents 
(those who conduct audits), the number of revenue officers (those who 
collect monies due), and the number of criminal investigators (those 
who prepare cases for possible prosecution by the Justice Department) 
each declined by over a quarter.
    In essence, we did not observe the wise admonition of President 
John F. Kennedy that ``Large continued avoidance of tax on the part of 
some has a steadily demoralizing effect on the compliance of others.''
    We are correcting our course and re-centering the agency. We are 
strengthening the IRS enforcement of the tax laws in a balanced, 
responsible fashion. And we will do so without compromising taxpayer 
rights. As the IRS enhances enforcement, we have four priorities:
    First, we are working to discourage and deter non-compliance, with 
emphasis on corrosive activity by corporations and high-income 
individuals. Attacking abusive tax shelters is the centerpiece of this 
effort. What is at stake is greater than many billions of dollars of 
lost tax revenues. Our surveys indicate that 80 percent of Americans 
believe it is very important for the IRS to enforce the law as applied 
to corporations and high-income individuals. Enforcing compliance in 
these sectors is critical to maintaining Americans' faith that our 
system is fair. The abuses of recent years have to a very real degree 
strained the credibility of our tax administration system.
    The IRS is moving aggressively to attack these transactions. 
Working with our partners in the Treasury Department, we have 
accelerated the issuance of guidance identifying abusive and 
potentially abusive transactions and improved disclosure requirements 
to provide greater transparency--sorely needed in today's complex 
world. And we have over 100 promoter audits underway, not to mention 
thousands of audits of high-income individuals and corporations who 
have entered into potentially abusive transactions. Where necessary, 
the Treasury Department, on behalf of the administration, has proposed 
legislation that would stop abusive transactions that we may not be 
able to fully or quickly address under existing law.
    However, we need to do better. We need to do more, and we 
particularly need to do it faster. The length of time it takes us to 
complete the audit of a large, complex corporation is 5 years from the 
date the return is filed, which in most cases is already 8\1/2\ months 
after year end. And these figures don't include the appeals process, 
which runs another 2 years before the matter is settled or goes to 
court. That means that half of our current inventory of large cases is 
from the mid 1990's or the early 1990's. In today's rapidly changing 
world, we might as well be looking at transactions from the Civil War.
    Simply stated, the IRS did not detect and deter the abusive 
transactions that spread during the 1990's on an adequate or timely 
basis because we did not have an informed view of current taxpayer 
behavior, only an historical understanding of events long past. And the 
challenge is becoming greater every day, as promoters of abusive tax 
transactions operate globally, without regard to national boundaries.
    The lessons we have learned make it imperative to get current in 
our audits, to identify transactions and shorten the feedback loop so 
that abusive transactions can be shut down promptly. I am convinced we 
can do it. Technology will help. Right now it takes 2 years on average 
before complicated corporate returns find their way into the hands of 
the assigned examiner. We are addressing this issue. Electronic filing 
by corporations will facilitate our analysis of data and help us 
calibrate risk. Through speedier audits we will provide better service 
to the compliant taxpayer by resolving ambiguity earlier, and hold 
accountable those who seek to game the system. And we are creating a 
web of disclosure, registration and maintenance of investor lists that 
will provide information about abusive transactions.
    Second, we are working to ensure that attorneys, accountants and 
other tax practitioners adhere to professional standards and follow the 
law. In recent decades, with an accelerated slide in the 1990's, the 
model for accountants and attorneys changed. The focus shifted from 
independent audit and tax functions, premised on keeping the client out 
of trouble, to value creation and risk management. The tax shelter 
industry had a corrupting influence. It got so bad that in some 
instances blue-chip professionals actually treated compliance with the 
law--in this case IRS registration and list maintenance requirements--
as a business decision. They weighed potential fees for promoting 
shelters but not following the law against the risk of IRS detection 
and the size of our penalties.
    Our system of tax administration depends upon the integrity of 
practitioners. The vast majority of practitioners are honest and 
scrupulous, but even they suffered from the erosion of ethics by being 
subjected to untoward competitive pressures. The IRS is acting. We have 
augmented our Office of Professional Responsibility by doubling its 
size and appointing as its director a tough, no-nonsense, former 
prosecutor; we are tightening the regulatory scheme; and we are 
receiving excellent support from the Justice Department in our promoter 
and associated investigations. But we need the Congress to enact the 
tougher penalties proposed by the administration for those promoters 
who have not yet gotten the message.
    Third, we must detect and deter domestic and offshore-based 
criminal tax activity, our traditional area of emphasis, and financial 
criminal activity. Our Criminal Investigation Division is a storied and 
proud law enforcement agency. Their expertise comprises not just 
criminal tax matters but other financial crimes. Our investigators are 
the best in law enforcement at tracking and documenting the flow of 
funds. In addition to our tax investigations, the IRS has over 100 
agents assigned on an ongoing basis to support the President's 
Corporate Fraud Task Force. We will continue and intensify these 
important efforts.
    Two factors account in significant part for America's great 
economic vigor and success. They are our pervasive culture of 
entrepreneurship, on the one hand, and the stability and transparency 
of our markets on the other. The reputation and attractiveness of our 
markets have been compromised by the scandals of recent years. The 
President's Corporate Fraud Task Force and the President and Congress 
with Sarbanes-Oxley have taken important steps to restore confidence. 
Through these three enforcement initiatives, the IRS will do its part 
so that sound tax administration contributes to public confidence in 
our economic system.
    We have one more enforcement priority. The stakes for America in 
this area are also important. We will discourage and deter non-
compliance within tax exempt and government entities, and the misuse of 
such entities by third parties for tax avoidance or other unintended 
purposes. Non-compliance involving tax-exempt entities is especially 
disturbing because it involves organizations that are supposed to be 
carrying out some special or beneficial public purpose. Enforcement in 
this area has suffered as IRS staffing in the exempt organizations area 
fell from 1996 through 2003. Enactment of the President's budget would 
allow us to gradually build up staffing in this important area and step 
up enforcement.
    If we do not act to guarantee the integrity of our charities, there 
is a risk that Americans will lose faith in and reduce their support 
more broadly for charitable organizations, damaging a unique and vital 
part of our Nation's social fabric.
    A case in point is credit-counseling agencies. These organizations 
have been granted tax-exempt status because they are supposed to be 
educating and assisting people who are experiencing credit or cash flow 
problems. Based on the information we have reviewed, we believe that a 
troubling number of these organizations, however, instead are operating 
for the benefit of insiders or in league with profit-making companies, 
such as loan companies, to generate income from lending to these 
distressed individuals and families. We are taking a close look at 
these organizations to ensure that they are operating within the bounds 
of the law.
    It is, of course, imperative as we reinvigorate the enforcement 
program that IRS employees maintain their respect for and diligence to 
all taxpayer due process rights and protections.
    We are making progress in our effort to reduce the annual tax gap. 
Our enforcement statistics for Fiscal 2003, released in early March, 
demonstrate that we have arrested the enforcement decline that began in 
the 1990's and worsened with the implementation of RRA 98. Audits, 
criminal investigations and monies collected were all up. In 
particular, the number of high-income taxpayer audits again increased 
by 24 percent. Moreover, audits of taxpayers with income over $100,000 
were up over 50 percent from 2 years ago. Overall audits of all 
taxpayers increased to 849,296, an increase of 14 percent from 2002.

               BUSINESS SYSTEMS MODERNIZATION AT THE IRS

    While not as publicly visible as service or enforcement, 
modernization of IRS information technology is also a high priority. 
This effort is often referred to as Business Systems Modernization or 
BSM. Most of our tax administration systems are very old and difficult 
to keep current with today's fast paced environment--they must be 
modernized.
    We are committed to resizing our modernization efforts to allow 
greater management capacity and to focus on the most critical projects 
and initiatives. Last summer, we used comprehensive studies to help us 
identify opportunities to improve management, re-engineer business 
processes and implement some new systems and technology.
    As I have noted, the IRS has made progress on applications such as 
improved telephone service, electronic filing, and a suite of e-
services to tax practitioners. But we have failed thus far to deliver 
several important projects with which taxpayers are not directly 
involved.
    The projects include replacing our master file system, implementing 
the on-line security features, and building the modernized 
technological infrastructure on which all of our future modernization 
applications will depend.
    Four studies completed last year consistently identified the 
following problems in delivering the large information technology 
efforts:
  --Insufficient participation in the technology program by IRS 
        business units;
  --An overly ambitious portfolio;
  --Inadequate performance by the contractor.
    The IRS is responding by to this challenge by:
  --Increasing business unit ownership of projects;
  --Resizing the project portfolio and reducing the modernization 
        program from $388 million this year to $285 million in the 
        President's fiscal year 2005 request;
  --And revising our relationships with the contractor and ensuring 
        joint accountability.
    While we have much work to do on modernization, I can assure you 
that it is one of my top priorities as Commissioner. We need to put in 
place the foundation upon which the tax system will build and rely for 
decades to come.
    Before I conclude my testimony, let me give you an update on the 
2004 filing season and what we are doing to make the tax season easier 
and more convenient for the American taxpayer.

                           2004 FILING SEASON

    Mr. Chairman, I have been on the job for not quite a year so I am 
still going through my first filing season. Each year at the IRS, we 
process billions of tax-related documents. We process well over 100 
million taxpayer returns. We send out about 100 million refunds. And we 
do a lot of other things as well.
    It all peaks, of course, on April 15, a little more than 1 week 
away.
    Here are some highlights as of March 26th (unless otherwise 
indicated):

Return Receipts
    The IRS has received 74 million total individual returns. Twenty-
nine million returns (39 percent) are paper and 45 million (61 percent) 
are e-file.
  --The number of online returns is at 10.5 million, a 22.9 percent 
        increase from last year.
  --Through March 24th, 2.6 million Free File returns have been 
        accepted, an increase of 24 percent from last year (2.1 
        million).

Refunds
    Refund measures continue to show an increase over 2003. Total 
refunds are up from 2003 by 3.9 percent. Total dollars paid are 9.26 
percent higher than last year, with an average refund of $2,113 paid.
Telephone Measures
    As of March 28, assistor level of service, at 84.9 percent, is up 
1.9 percent compared to last year. Assistors have answered 
approximately 729,000 more calls than they did during the same period 
in 2003.
    Automated calls completed are 183,000 more than the same period in 
2003. A major contributor to this increase is Advanced Child Tax Credit 
(ACTC) related calls.
    We created automated ACTC applications for use in providing 
taxpayers the correct amount of ACTC to report on their 2003 tax 
return. These applications are available through telephone automation 
and interactive web applications.

Telephone Quality Rates
    We measure telephone quality two ways: (1) customer account 
accuracy and (2) tax law accuracy. While our customer account accuracy 
estimates, as of February 29th are 89.76 percent, up 1.32 percent over 
the past year, our tax law accuracy has declined to 75.79 percent thus 
far in 2004 (down 6.69 percent from last year.)
    Fiscal Year 2004 Quality Review results indicate that two of our 
most frequent tax law defects are: incomplete research and applying tax 
law incorrectly.
    We are undertaking the following efforts to improve performance:
  --Identifying root cause of performance deficiencies and implementing 
        corrective initiatives through analysis;
  --Establishing Quality Review Improvement Teams to determine the 
        drivers of Customer Accuracy rates and to establish resolution 
        priorities as needed; and
  --Strengthening accountability to the frontline managerial level to 
        facilitate improvement in services provided.

Taxpayer Assistance Centers (TAC's)
    The number of taxpayers walking into a TAC for assistance has 
decreased as a result of streamlined services in the TAC's and 
initiatives to educate taxpayers on alternate methods of obtaining 
services generally requiring a face-to-face contact. The advent of 
technological advances in irs.gov services such as ``Free File'' and 
``Where's My Refund'', and the accessibility of forms online have all 
contributed to the decline in the number of customers walking into a 
TAC.

                               CONCLUSION

    The IRS has lagged behind, for reasons that are understandable, in 
tax enforcement. But that is changing. We will continue to improve 
service and respect taxpayer rights. But we will also enforce the law. 
We won't relax until taxpayers who are unwilling to pay their fair 
share see that that is not a worthwhile course to follow.
    Mr. Chairman, the great majority of Americans honestly and 
accurately pay their taxes. Average Americans deserve to feel confident 
that, when they pay their taxes, their neighbors and competitors are 
doing the same.
    The President's budget request will help us enforce the tax law 
more fairly and efficiently. I am most grateful for your support of 
increased enforcement, and I look forward to working with you on this 
important budget request.
    Thank you very much. I'd be happy to take your questions.

    Senator Shelby. Ms. Gardiner.

                    STATEMENT OF PAMELA J. GARDINER

    Ms. Gardiner. Chairman Shelby, I appreciate the opportunity 
to appear before you today to discuss the Internal Revenue 
Service's budget and the related tax administration challenges.
    The IRS is critical to the functioning of our government. 
Each year the IRS collects over $2 trillion, processes over 200 
million tax returns, and issues nearly 100 million tax refunds. 
It provides service to millions of taxpayers by telephone, 
Internet and in person. Since the enactment of the IRS 
Restructuring and Reform Act of 1998, the IRS has made 
significant progress in identifying opportunities to improve 
its operations.
    For example, this filing season the IRS indicated it had 
received 43 million e-filed returns as of March 19, 2004, an 
increase of over 11 percent. The IRS has also made progress in 
providing information to taxpayers via its website, IRS.gov. 
Taxpayers have visited this website billions of times to obtain 
information. Just this tax season, the IRS stated taxpayers had 
made nearly 10 million visits by the end of February to obtain 
refund information from the ``Where's My Refund?'' section on 
this site.
    Even with this progress, the IRS faces significant 
challenges to meeting its mission. I will focus my remarks on 
two of these key challenges: systems modernization and customer 
service.
    The IRS's systems modernization program is in the sixth 
year of its effort to upgrade and modernize IRS information 
technology and business systems. This is an extremely complex 
effort and is expected to take up to 15 years at a cost of at 
least $7 billion. This program must be successful for IRS to 
reach its goals in customer service and tax compliance.
    Since 1999 about $1.5 billion has been appropriated and 
released for modernization. The Treasury Inspector General for 
Tax Administration (TIGTA) agrees with the IRS's recent moves 
to scale back its systems modernization efforts to focus on 
ensuring that the most critical systems are implemented. In 
fact TIGTA has recommended such reductions in the modernization 
projects in the past. Our concerns are based on the cost and 
schedule overruns in the modernization program, including 
significant delays in the most critical project, the Customer 
Account Data Engine (CADE). CADE will eventually replace the 
existing Master File of taxpayer accounts and will enable the 
implementation of other modernized systems.
    We believe the IRS and the PRIME contractor must address 
the following modernization challenges to be successful: 
implement planned improvements in key management processes; 
manage the increasing complexity and risks of the modernization 
program; maintain continuity with experienced leadership; and 
ensure PRIME contractor performance and accountability.
    Improving customer service has been a key focus at the IRS 
for the last few years. Taxpayers have several options from 
which to choose when they need assistance from the IRS. These 
options include toll-free telephone assistance, walk-in service 
at the taxpayer assistance centers, or TACs, and the IRS 
Internet website. Each of these systems potentially effects the 
taxpayer's ability and desire to voluntarily comply with the 
tax laws.
    The IRS's toll-free telephone system is the contact method 
most taxpayers choose when seeking answers to tax law questions 
or trying to resolve tax account issues. Taxpayers called the 
IRS toll-free telephone system over 50 million times during the 
2003 filing season. Access to the IRS's toll-free telephone 
system has significantly improved. In comparison to the prior 
filing season, for example, the level of service increased, 
more calls were answered, and fewer taxpayers abandoned their 
calls. We evaluated the toll-free system and found that 78 
percent of taxpayers received accurate answers to their account 
questions, and 73 percent of taxpayers received accurate 
answers to their tax law questions.
    The next most popular contact method is the taxpayer 
assistance centers which provide face-to-face assistance to 
taxpayers in meeting their filing and payment responsibilities. 
Significant improvements have occurred in the percentage of 
accurate answers to tax law questions that TAC employees 
provided to TIGTA auditors anonymously conducting visits during 
the past 2 years. IRS employees correctly answered 69 percent 
of the questions asked from July through December 2003, 
compared to only 57 percent during the same period in 2002.
    Although the IRS website has received billions of visits 
from taxpayers, most do not submit questions. Early statistics 
indicated approximately 75,000 questions had been received this 
year. Our past audit work indicated that over 80 percent of 
Internet questions were answered correctly.

                           PREPARED STATEMENT

    In conclusion, I believe the improvements in the levels of 
service the IRS has provided to taxpayers are impressive. 
However, challenges continue in the modernization effort. It 
must succeed if IRS is going to operate at a level that 
taxpayers expect and are entitled to receive from their 
government.
    I would be happy to answer any questions.
    [The statement follows:]

                Prepared Statement of Pamela J. Gardiner

    Chairman Shelby, Ranking Member Murray, and distinguished Members 
of the subcommittee, I appreciate the opportunity to appear before you 
today to discuss the Internal Revenue Service's (IRS) budget, and the 
challenges the IRS continues to face in using its funds to improve the 
economy, efficiency, and effectiveness of tax administration.
    The mission of the IRS is critical to the functioning of our 
government. Each year, the IRS processes over 200 million tax returns 
and collects over $2 trillion. The IRS also issues nearly 100 million 
tax refunds, provides service to millions of taxpayers in person and 
via telephone calls and the internet, and applies complex tax laws to 
help ensure taxpayers meet their tax obligations.
    E-filing provides significant benefits to both taxpayers and the 
IRS including quick acknowledgement to taxpayers that the IRS received 
their tax returns, more accurately processed tax returns, and faster 
refunds. In addition, the IRS estimates that the processing of an e-
filed tax return compared to that of a paper tax return results in cost 
savings of approximately $2.30 \1\ per tax return. Since the enactment 
of the IRS Restructuring and Reform Act of 1998 (RRA 98), the IRS has 
made significant progress in attracting taxpayers to e-file and 
continues to identify opportunities and create incentives for taxpayers 
to e-file. These efforts have resulted in individual taxpayers being 
able to electronically sign their tax returns, e-file their State tax 
returns with their Federal tax returns, pay their taxes using a credit 
card, e-file 99 percent of all tax forms, and e-file at no cost.\2\ 
Furthermore, in an attempt to encourage paid preparers to submit tax 
returns electronically, the IRS offers specific support services and is 
in the process of providing incentives exclusive to e-file 
providers.\3\ These incentives include the ability to apply to become 
an e-file provider online, interact with the IRS by email, and obtain 
client transcripts online. This filing season, the IRS indicated it had 
received 43 million e-filed returns as of March 19--an increase of over 
11 percent.
---------------------------------------------------------------------------
    \1\ Cost savings relate to the costs saved to process a tax return 
and do not include Information Technology and Customer Service costs as 
the IRS is still in the process of computing these costs.
    \2\ This no cost e-filing option is the result of the IRS entering 
into an agreement with tax preparation software companies and is 
available for taxpayers that meet certain requirements.
    \3\ E-file providers may be electronic return originators, 
transmitters, software developers, tax practitioners, and States.
---------------------------------------------------------------------------
    The IRS has also made progress in providing information to 
taxpayers via its internet website IRS.gov. Taxpayers have visited this 
website billions of times to obtain information. Just this tax season, 
the IRS stated taxpayers had made nearly 10 million visits by the end 
of February to obtain refund information from the ``Where's My 
Refund?'' application which is featured on this site. This is almost 
double the number received last year at this time.
    Even with much progress, the IRS still faces significant challenges 
to meeting its mission. TIGTA has identified major management 
challenges in the following areas that could affect the IRS's ability 
to help taxpayers address their tax responsibilities:
  --Systems Modernization.
  --Tax Compliance Initiatives.
  --Security of Employees, Facilities, and Information Systems.
  --Integrating Performance and Financial Management.
  --Complexity of the Tax Law.
  --Providing Quality Customer Service Operations.
  --Erroneous and Improper Payments.
  --Processing Returns and Implementing Tax Law Changes During the Tax 
        Filing Season.
  --Taxpayer Protection and Rights.
  --Human Capital.
    Although each of these areas presents its own unique challenges, I 
have chosen to focus the remainder of my remarks on two of these key 
areas, Systems Modernization and Providing Quality Customer Service 
Operations.

                         SYSTEMS MODERNIZATION

    The IRS's systems modernization program is in the sixth year of its 
effort to upgrade and modernize IRS information technology and business 
systems. It is expected that this program will take up to 15 years and 
cost at least $7 billion to complete. The modernization program is an 
extremely complex effort, since many of the IRS's current business 
systems are a mixture of technologies that date back to the 1960's. 
While difficult, the program must nevertheless be successful if the IRS 
is to meet its goals and commitments of improving its customer service 
and tax compliance activities. To facilitate the success of its 
modernization efforts, the IRS hired the Computer Sciences Corporation 
as the PRIME contractor and integrator for the modernization program, 
and created the Business Systems Modernization Office to guide and 
oversee the work of the PRIME contractor. Through March 2004, the IRS 
has received approximately $1.59 billion to support the systems 
modernization program, and the IRS plans to request an additional $142 
million for fiscal year 2004. Approximately $285 million has been 
included in the fiscal year 2005 budget to further fund systems 
modernization efforts.
    The Treasury Inspector General for Tax Administration (TIGTA) 
agrees with the IRS's recent moves to resize and scale back its systems 
modernization efforts to place additional focus on ensuring the most 
critical systems are implemented. In fact, TIGTA has been recommending 
such a reduction in the modernization projects based on the concerns we 
have raised with cost and schedule overruns in the modernization 
program. The IRS Commissioner recently launched a comprehensive review 
of the modernization program resulting in 21 recommendations for 
improvement. Many of those recommendations were similar to those made 
in TIGTA reports issued during the past 4 years.
    Over the last 2 fiscal years,\4\ TIGTA cited four challenges that 
the IRS and the PRIME contractor must overcome to be successful:
---------------------------------------------------------------------------
    \4\ Annual Assessment of the Business Systems Modernization Program 
(Reference Number 2003-20-208, dated September 2003). Annual Assessment 
of the Internal Revenue Service's Business Systems Modernization 
Program (Reference Number 2002-20-189, dated September 2002).
---------------------------------------------------------------------------
  --Implement planned improvements in key management processes and 
        commit necessary resources to enable success.
  --Manage the increasing complexity and risks of the modernization 
        program.
  --Maintain the continuity of strategic direction with experienced 
        leadership.
  --Ensure PRIME contractor performance and accountability are 
        effectively managed.
    The fourth challenge has recently become critical as oversight 
groups are starting to lose confidence in the PRIME contractor's 
ability to meet its commitments in modernizing the IRS's business 
systems and have raised concerns about future funding. In light of this 
concern, effective contract management, always difficult on a project 
of this magnitude, is becoming an increasingly important challenge that 
needs to be overcome.
    The IRS has made progress in defining the management processes and 
capabilities needed to effectively acquire and implement information 
technology systems. For example, it has deployed the infrastructure 
system on which future modernized applications will run. Establishing 
this infrastructure is a necessary prerequisite to introducing the 
business applications that are intended to provide benefits to 
taxpayers and the IRS. The IRS also deployed several applications that 
have immediately produced taxpayer benefits. The ``Where's My Refund'' 
application, as described earlier, has assisted taxpayers with millions 
of online inquiries to obtain refund information. Other applications 
that have been implemented allow businesses and taxpayers to obtain 
employer identification numbers online, tax preparers to apply to 
become an electronic filer and obtain an identification number for use 
in filing clients' returns, and businesses to electronically file 
certain tax returns.
    In response to concerns of TIGTA and others, the revised fiscal 
year 2003 modernization spending plan submitted in March 2003 focused 
the program on a smaller portfolio of existing key projects. Although 
the IRS expressed high confidence in the practicality of the revised 
plan and assured the Congress that it could timely deliver the revised 
fiscal year 2003 project portfolio, all of the projects experienced 
schedule delays and most incurred significant cost increases from 
fiscal year 2002 estimates. Also, management decisions were made to 
delay some of the functionality that was originally planned for these 
systems until sometime in the future.
    These schedule delays, cost increases, and delayed functionality 
occurred, in part, because modernization project teams did not always 
follow defined management and project development processes. The IRS 
and the PRIME contractor have particularly struggled to develop 
adequate cost and schedule estimation techniques. As a result, delivery 
schedules and cost estimates were very aggressive and overly 
optimistic.
    Additionally, the IRS and the PRIME contractor had not fully 
implemented disciplined project testing processes and procedures. 
Testing processes have been substantially revised and refined based on 
lessons learned during the early testing efforts for modernization 
projects. However, TIGTA analyzed several key projects and found the 
project teams were not consistently following the established testing 
processes. We believe the inadequate implementation of the testing 
processes was the result of the modernization project teams attempting 
to meet overly optimistic project schedules.
    While progress has been made in the IRS's modernization efforts, it 
did not achieve its goals for fiscal year 2003. This underachievement 
is disappointing considering that the expectations for the year were 
scaled back in hopes of being able to successfully deliver several key 
modernization projects.
    The delays in implementing projects can clearly be seen in the most 
critical modernization project, the Customer Account Data Engine 
(CADE). CADE will eventually replace the existing Master File \5\ of 
taxpayer accounts, and will enable the implementation of other 
modernized systems that will improve customer service and compliance 
and allow the on-line posting and updating of taxpayer account and 
return data. Therefore, CADE will be the foundation for managing 
taxpayer accounts in the modernized IRS. The portion of CADE related to 
individual tax accounts will be incrementally deployed in five 
releases, each related to a specific taxpayer segment, over several 
years, as shown in the revised CADE release schedule below.
---------------------------------------------------------------------------
    \5\ The Master File is the IRS's database that stores various types 
of taxpayer account information and includes individual, business, and 
employee plans and exempt organizations data.

                                                                  CADE RELEASE SCHEDULE
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Release One             Release Two           Release Three           Release Four           Release Five
--------------------------------------------------------------------------------------------------------------------------------------------------------
Tax Return Types...................  1040EZ, Refund or Even  1040EZ, 1040 Sch A, B,  All 1040 Family and    All 1040 Family and    All remaining
                                       balance.               D, 1040A Sch 1, 3,      supporting forms,      supporting forms,      individual tax
                                                              with Refund or Even     Refund or Full Paid.   Refund, Full Paid,     returns.
                                                              Balance.               1040A Sch 2, Refund     and Balance Due.
                                                             1040, 1040A 1040EZ,      or Balance Due.       941, 940, 720 Forms--
                                                              Full  Paid.            1040ES Pmts..........   Payroll,
                                                                                                             unemployment, and
                                                                                                             Excise returns for
                                                                                                             1040 taxpayers.
Filing Status......................  Single................  (Single, Married--      All (including Head    All..................  All.
                                                              Married once and no     of Household).
                                                              dependents).
Account Characteristics............  No account issues       No open account issues  No open account        No open account        All accounts not
                                      (Open or Closed).                               issues EITC.           issues.                included in previous
                                                                                                                                    releases.
Est. Returns :\1\
    Original estimate..............  6 Million.............  29 Million............  41 Million...........  34 Million...........  12 Million.
    Revised June 2003..............  5 Million.............  33 Million............  57 Million...........  20 Million...........  15 Million.
Est. Delivery:
    As of April 2000...............  January 2002..........  August 2002...........  July 2003............  July 2004............  July 2005.
    As of March 2001...............  January 2002..........  January 2003..........  January 2004.........  January 2005.........  January 2006.
    As of April 2003...............  August 2003...........  January 2005..........  TBD..................  TBD..................  TBD.
    As of Jan. 2004................  Rel 1.1 \2\.--August    TBD...................  TBD..................  TBD..................  TBD.
                                      2004.
                                     Rel 1.2/1.3.--January
                                      2005/January 2006.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Estimated tax returns (electronic and paper) are based on 1999 statistics.
\2\ Release 1 has been divided up into three separate releases--1.1, 1.2, and 1.3.

                            CUSTOMER SERVICE

    One of the Congress' principal objectives in enacting the RRA 98 
was to mandate that the IRS do a better job of meeting the needs of its 
customers. In the RRA 98, the Congress directed the IRS to achieve a 
better balance between its post-filing enforcement efforts and pre-
filing taxpayer assistance through education and service. To comply 
with this Congressional mandate, the IRS revised its mission statement 
to refocus its emphasis on helping taxpayers understand and meet their 
tax responsibilities. Additionally, the IRS has enhanced its focus on 
increasing the levels of electronic filing.
    Taxpayers have several options from which to choose when they need 
assistance from the IRS. These options include toll-free telephone 
assistance, walk-in service at the Taxpayer Assistance Centers (TAC), 
and the IRS internet website IRS.gov. The effectiveness of each of 
these services potentially affects a taxpayer's ability and desire to 
voluntarily comply with the tax laws.

Toll-Free Telephone Assistance
    The IRS's toll-free telephone system is the contact method most 
taxpayers choose when seeking answers to tax law questions or trying to 
resolve tax account-related issues. Taxpayers called the IRS toll-free 
telephone system over 50 million times during the 2003 Filing Season. 
The IRS's strategy for handling this significant customer demand is to 
direct those taxpayers with less complicated issues to its automated 
services (i.e., recorded information and interactive applications) and 
allow its Customer Service Representatives (CSR) to assist taxpayers 
with more difficult issues. However, during fiscal year 2003, over 26 
million of the calls were from taxpayers who had questions about their 
accounts and who chose to speak with a CSR.
    The TIGTA and others have raised continuing concerns about the 
IRS's ability to effectively meet the significant annual taxpayer 
demand for access to its toll-free telephone system. Over the past 
several years, the IRS has made many technological changes, as well as 
organizational and process changes, to its toll-free telephone system 
in an effort to provide taxpayers with better access and improve the 
quality of its service.
    Many aspects of the taxpayer experience in accessing the IRS toll-
free telephone system were significantly improved during the 2003 
Filing Season. This improvement was reflected in the measures the IRS 
uses to gauge the performance of its toll-free telephone system. In 
comparison to the prior filing season, for example, the level of 
service increased, more calls were answered, and fewer taxpayers 
abandoned (i.e., hung up) their calls before receiving assistance. 
Further, taxpayers that called with account- or refund-related 
questions had shorter wait times to receive service, and taxpayers that 
called with account-related questions were more likely to receive 
assistance when they reached a CSR assigned to an account application.
    Although taxpayer access to its toll-free telephone services 
improved, the IRS has opportunities to further enhance the taxpayer 
experience and reduce the costs of providing toll-free telephone 
services. A major improvement opportunity involves implementing 
enhancements to automated call routing solutions so that much of the 
need for call screeners can be reduced or eliminated. For the 2003 
Filing Season, using screeners to manually route calls cost the IRS 
almost $3.6 million in salaries and benefits that would not have been 
needed if the previously developed call routing solution had worked as 
planned. Another improvement opportunity involves reducing the high 
Assistor Availability levels \6\ that have existed for at least the 
past two filing seasons. The IRS had planned for a level of 5.5 percent 
in fiscal year 2003, but during the 2003 Filing Season, the rate was 
11.2 percent, and had further increased to 12.15 percent through the 
end of June. We estimate that this cost the IRS nearly $6.4 million in 
CSR salaries and benefits. Finally, the IRS needs a financial system 
that will accurately track its cost-per-call for various toll-free 
telephone services to provide management and key stakeholders 
sufficient information to make critical decisions.
---------------------------------------------------------------------------
    \6\ Assistor Availability is the measure the IRS uses to calculate 
how long its CSR's are available to take calls when none are coming in 
for their specific applications. Achieving the optimum Assistor 
Availability level is critical for effective and efficient call site 
operations.
---------------------------------------------------------------------------
    The IRS receives calls from taxpayers with account issues and 
questions about various aspects of the tax law. During the 2003 Filing 
Season, we reviewed both account assistance and tax law assistance 
calls for professionalism, accuracy, and timeliness.
    Account Assistance.--TIGTA evaluated the professionalism, accuracy, 
and timeliness of account assistance obtained through the Toll-Free 
program. From a judgmental sample of 191 calls monitored between April 
21 and May 16, 2003, we determined that CSR's treated taxpayers 
professionally for 99 percent of the calls and provided timely service 
for 83 percent of the calls. In addition, 78 percent of taxpayers 
received accurate answers to their account questions. Using a 
statistical sample during the same period we reviewed, the IRS reported 
rates of 100 and 97 percent, respectively, for professionalism and 
timeliness, and 88 percent for customer accuracy.
    Tax Law Assistance.--TIGTA monitored a judgmental sample of 294 
toll-free tax law calls between January 27 and March 13, 2003, and 
compared the results to records from an IRS statistically valid sample 
of 6,011 calls monitored during the same period. The 2 samples showed 
that CSR performance was professional and timely in 98 percent or more 
of the total number of calls monitored. Although our sample showed a 
customer accuracy rate of 73 percent as compared to the IRS' measured 
rate of 81 percent, the need for CSR's to fully probe the taxpayer for 
information was clearly evident as an ongoing issue requiring 
improvement in both of the samples taken. The primary reason incorrect 
responses were given was because CSR's were not effectively using the 
appropriate guidance. Without effective use of this guidance, CSR's are 
unable to fully understand the taxpayer's situation and may provide 
information that is incorrect or incomplete.

Taxpayer Assistance Centers
    The primary emphasis of the TAC's is to provide face-to-face 
assistance to taxpayers in meeting their filing and payment 
responsibilities, including educating taxpayers, providing self-help, 
interpreting tax laws and regulations, securing forms, resolving 
notices, and providing needs-based complimentary tax return 
preparation. The IRS has over 400 TAC's that served over 8.5 million 
taxpayers in fiscal year 2003.
    Significant improvements have occurred in the percentage of 
accurate answers to tax law questions TIGTA auditors asked when 
anonymously conducting site visits to TAC's during the past 2 years. 
IRS employees correctly answered 69 percent of the questions asked and 
incorrectly referred only 2 percent to publications from July through 
December 2003, compared to correctly answering only 57 percent of the 
questions asked and incorrectly referring 12 percent to publications 
from July through December 2002. TIGTA commends the IRS for the 
improvements it has made in this level of accuracy.
    Auditors also had positive experiences when they visited the TAC's. 
IRS employees were professional and courteous in 97 percent of the 194 
TIGTA site visits to 105 TAC's. Wait time for service was 1 hour or 
less for 99 percent of the visits. In addition, 85 (81 percent) of the 
TAC's visited by our auditors had office hours listed on the IRS 
internet website IRS.gov, which matched the hours posted at the TAC's.
    Although improvements have occurred in accuracy of responses to 
taxpayer questions, the accuracy of tax return preparation at the TAC's 
needs improvement. Complimentary tax return preparation and electronic 
filing is provided to those taxpayers whose returns meet certain 
requirements and limitations. For Tax Year 2002, IRS employees at the 
TAC's prepared 293,242 tax returns that involved refunds and tax 
liabilities totaling approximately $330 million and $6 million, 
respectively.
    Returns prepared at the TAC sites, however, are often inaccurate. 
From February through April 2003, TIGTA auditors made 34 anonymous 
visits to 26 TAC's nationwide in an attempt to have a tax return 
prepared. IRS employees incorrectly prepared 19 of the 23 tax returns 
prepared during our visits. If these returns had been filed, the IRS 
would have inappropriately refunded $32,000 and inappropriately 
withheld $2,400 in tax refunds. IRS management has taken action to 
improve the accuracy of the tax returns prepared, and TIGTA has 
recommended additional actions to ensure taxpayers receive proper and 
accurate customer service when requesting assistance with tax return 
preparation.

Service to Taxpayers via the Internet
    The use of the internet has increased dramatically. The latest 
statistics indicate that nearly 70 percent of the United States 
population are internet users. Since 1995, the IRS has administered a 
program to answer taxpayer questions submitted through its internet 
website IRS.gov. This program offers individual and business taxpayers 
an accessible and convenient alternative to using the telephone or 
visiting an IRS office to obtain answers to tax law questions. 
Taxpayers have the ability to submit tax law questions 24 hours a day, 
7 days a week. The IRS provides responses to taxpayer questions via an 
e-mail message.
    Past TIGTA testing indicated that the accuracy rate for the answers 
to the submitted questions was over 80 percent, which is higher than 
that received in TAC's or via the toll-free assistance telephone 
program. However, the IRS did not respond to several of the questions 
TIGTA submitted anonymously to the program. Additionally, the number of 
questions submitted dropped from over 200,000 questions in the 2000 
Filing Season to about 120,000 in the 2002 Filing Season. TIGTA 
encouraged management to provide clear instructions to taxpayers to 
help them locate the area to input tax questions on the internet 
website.
    Statistics obtained from the IRS indicated that for the 2003 Filing 
Season, 146,369 questions were received from taxpayers (a 23 percent 
increase over the prior year). However, the average response time for 
each question increased from 2.4 days to 4.2 days. Thus far, for the 
2004 Filing Season (through March 15, 2004), statistics indicate a 
reduction in the number of questions received--76,156 questions have 
been received (76 percent of the number received in the prior year 
during the same period) with an average response time of 3.6 days.
    In closing, I would like to reiterate that the improvements in the 
levels of service the IRS has provided to taxpayers are impressive. The 
IRS has made great strides in enhancing the level of electronic filing, 
providing information via its internet website, and improving the 
accuracy and availability of toll-free telephone service. The early IRS 
filing season statistics indicate a rise in electronic filing and an 
increase in the use of some of the services available via the internet. 
However, significant challenges remain to be addressed as the IRS 
strives to modernize its systems and provide world-class customer 
service to America's taxpayers.

                   ACCURACY OF TAX RETURN PREPARATION

    Senator Shelby. I have a number of questions. The Treasury 
Inspector General for Tax Administration (TIGTA) reported that 
the IRS employees incorrectly prepared 19 of 23 tax returns 
during a spot check of 26 taxpayer assistance centers around 
the country. Ms. Gardiner, what recommendations do you have to 
ensure taxpayers receive proper and accurate customer service 
when requesting assistance in the preparation of a tax return?
    Ms. Gardiner. The biggest problem that we see when mistakes 
are made, whether it is preparing tax returns or answering 
questions on the toll-free line or walk-in assistance, is that 
the IRS employees do not ask appropriate probing questions. For 
example, the earned income tax credit is a complicated law and 
there are so many different little pieces that make a 
difference in whether you qualify or not.
    Senator Shelby. I certainly would not be qualified----
    Ms. Gardiner. A common problem is just simply the number of 
months that a child resides with the taxpayer that would 
determine whether they do or do not get the credit, and that is 
a common mistake.
    Senator Shelby. There is a problem of verification, too, is 
it not?
    Ms. Gardiner. It is verification as well, but what we find 
is simply that they are not asking enough questions to get to 
the right answer.

              IMPROVING THE ACCURACY OF RETURN PREPARATION

    Senator Shelby. Mr. Commissioner, what actions have you 
taken to improve the accuracy of tax returns prepared by the 
IRS personnel?
    Mr. Everson. I think that as Ms. Gardiner has suggested, 
this is an area that needs our concern, and that is a 
relatively recent set of findings. We have had recent 
discussions--in fact, I think the issues here, Senator, extend 
beyond returns we prepare. As you may be aware, there are up to 
about 2 million returns that are prepared through volunteer 
organizations that work closely with the Service, to which 
people are referred and they may go visit one of these 
volunteer sites.
    Senator Shelby. How accurate are those returns?
    Mr. Everson. I think we are seeing that there are some of 
the same issues. This comes back to what you spoke about, it 
comes back to the complexity of the code. That is a root cause 
here. I would just expand upon Ms. Gardiner's remarks, which I 
think hit it correctly. There are a couple things that are 
difficult here. One is the true desire of our employers or 
others to help. If they are sitting there with you and they 
think they understand the situation, they may fail to ask that 
next probing question. It is on a script that they are supposed 
to be using, but they have made an assumption, and they 
probably should not have made that assumption.
    The way the scoring that TIGTA uses works and that we use 
works, sometimes it holds against them the fact they just have 
not asked that next question. Now, they may actually have been 
right but they did not fully follow the procedure, so there is 
a real risk that they have got the wrong answer. We need to 
keep working on our training. We are doing that. I think that 
this area----
    Senator Shelby. Does a lot of it go to training?
    Mr. Everson. Training is it, and getting good scripts. The 
same thing applies to the tax law accuracy question where we 
made some changes earlier this filing season. Overall, our 
filing season results are excellent, but we did have a dip in 
tax law accuracy, and that was because we were making changes 
to actually get better. We were changing some of these scripts. 
They proved a little more difficult to use. And we were also 
having some people who worked in the account area, which Ms. 
Gardiner talked about, that is the area where you call in and 
you say, ``I cannot remember what my payment ought to be,'' if 
you are on an installment plan, or ``I got a notice from you,'' 
or a question like that. We were taking some of those folks and 
having them work in the tax law area. Getting them properly 
trained and up to speed took a little more time than we 
thought.
    So this is an ongoing challenge. Whatever you can do to 
simplify the code, though, would really help us.
    Ms. Gardiner. Yes.
    Senator Shelby. I have tried.
    Mr. Everson. I know you have.

                         CORPORATE TAX SHELTERS

    Senator Shelby. Mr. Commissioner, I think we all know there 
have been a lot of abuse of tax shelters. We often hear of 
large corporations or high income taxpayers creating shelters 
that are obviously designed to avoid paying taxes. They do not 
have a real purpose, a business purpose, other than that. On 
top of that, these shelters are designed by a handful of 
attorneys, accountants, and tax practitioners whose standards 
and ethics are very, very questionable. You know this yourself. 
We have talked about it a little.
    Does the budget request reflect your plan for attacking 
these corporate shelters and the few unprofessional individuals 
who created them? I think you have got to go to the heart of 
this.
    Mr. Everson. Absolutely. If we could show the four 
enforcement priorities. We have very carefully constructed, 
through our planning process, four mutually reinforcing 
enforcement priorities. This issue is really at the heart of 
all four of these priorities.



                         ENFORCEMENT PRIORITIES

    Senator Shelby. Go over them.
    Mr. Everson. The first is to discourage and deter non-
compliance, with emphasis on the corrosive activities of 
corporations and high income individuals. That is the meat of 
the shelter question.
    The second is to assure that----
    Senator Shelby. A lot of these people just exist to think 
of creative ways to beat the tax code, do they not?
    Mr. Everson. That is the second point here: assure that 
attorneys and accountants and other tax practitioners adhere to 
professional standards and follow the law. If you could indulge 
me for just a minute. I started out my career at Arthur 
Andersen in the mid-1970s. The firm had one of the best 
reputations, and the standard of any Big Eight accounting firm 
was clear, any good law firm: you make sure that your clients 
follow the law. This all changed over a period of decades to 
become about value creation and risk management, and now you 
have interlocking networks of investment banks, accounting 
firms, law firms, commercial brokerages.
    Senator Shelby. Trying to beat the tax code?
    Mr. Everson. They are working to do this. So this element 
of it is terribly important.
    The third priority, augmenting our criminal investigations, 
gets to it too. Some of this gets to a criminal level. We have 
active criminal investigations, including against 
professionals, that will hold people to account.
    Senator Shelby. You have to do this, do you not?
    Mr. Everson. We have to. We are getting excellent support 
from the Department of Justice. They have litigated for the 
first time, as you may have seen, against law firms who have 
acted as promoters. They are not providing traditional advice 
to clients. They are acting as promoters of generic tax 
products that have had a corrupting influence on the practice 
of law and accounting.

                       IRS ENFORCEMENT PRIORITIES

    Senator Shelby. A lot of this advice has no real business 
purpose, does it?
    Mr. Everson. That is exactly right. And it gets even to the 
fourth point here, which is about the abuse of tax-exempt 
entities. This is a very serious one, where we have seen some 
of these charities are being used. We just prohibited a 
transaction last week where people would take advantage of 
charitable organizations in order to actually promote a tax 
avoidance scheme. If I could just show you one chart as to the 
problem we have got ourselves into over a period of years, and 
then I want to address one thing you said in your statement.
    Senator Shelby. You go ahead.

    
    
                              IRS STAFFING

    Mr. Everson. This green line, this is the growth over 6 
years starting in 1995 in total assets of 501(c)(3) entities. 
This is the number of returns filed, together with some 
projections. This is what happened to the staffing at the IRS. 
What happened, basically, was we maintained--as you said, we 
kept working on service, and that was good. We needed to do 
that. But the fallout in this was a dramatic decline across-
the-board--but this is just the people working on tax-exempt 
groups. And if you adjust for this volume increase in terms of 
number of charitable entities, this shows you how far we are 
down.
    This is bringing it back up. We brought it back up in 2004. 
What I wanted to say here, the only correction I would have, 
and I agree with your statement, is that in 2004 after I got 
here, the first thing I did was direct my two deputies to make 
sure that as we dealt with funding shortfalls we did not just 
take it out of enforcement. We stopped that last year, so that 
the fiscal year we are in now, we do have the enforcement 
increment the President and you want us to follow.
    But this just shows, we are bringing this back. This is a 
terribly important area because of what you just said. It is 
also terribly important because of abuses, the credit 
counseling industry----
    Senator Shelby. How much money are we talking about in 
abuses, in your judgment?
    Mr. Everson. In this area, in tax-exempt entities I would 
not have a precise figure but what I would tell you, let me 
give you----
    Senator Shelby. Could you furnish something for the record?
    [The information follows:]

    We do not have data with which to provide a precise answer. Lost 
revenues would generally result from tax-exempt organizations that are 
not operating in accordance with their exempt status, and therefore 
should be subject to tax. The market segment studies we are currently 
undertaking will enable us to better estimate revenue losses in 
particular segments or industries, but will not provide data that can 
be extended to exempt organizations generally.

    Mr. Everson. Let me tell you one statistic on this. There 
is a $1 billion credit counseling industry that is operating as 
not-for-profit, calling around to people, taking advantage of 
the fact that they are exempted from the do-not-call list 
because they are a charity, taking advantage of the fact that 
they are not regulated by your State or others for consumer 
protection laws. They are preying, many of these entities are 
preying on good average Americans who have found themselves in 
trouble with debts, and they are no longer providing counseling 
and educational services, which is their mission under tax-
exempt status.
    So we are going after them. We may very well lift some of 
the tax exemptions, and I believe there may very well be 
criminal referrals on some of these entities.
    Senator Shelby. That is what you ought to do.
    Mr. Everson. This is all what needs to be done. To get back 
to your statement, I want to give you my personal commitment 
that as we go forward--I am obviously asking for the 
President's full request. I am not asking for a penny more, but 
I am asking for the full request. I want to be crystal clear 
with you and your colleagues that we will protect that 
enforcement build and be very responsible at addressing 
shortfalls, should there be across-the-board rescissions and 
things like there have been in the past, or other gaps.
    Senator Shelby. You have got to have the money to do your 
job. What percentage, and you might want to furnish this for 
the record, of 501(c)(3) tax-exempt groups are abusing their 
status?
    Mr. Everson. That is a very difficult question, and I would 
tell you, we have fallen so far behind----
    Senator Shelby. A lot of them are very clean, very 
straight-up.
    Mr. Everson. Yes. Most of them are. What is really at stake 
here, Senator, is that Americans could lose faith in the 
integrity of charities and stop supporting our charitable 
institutions, which are so important to our way of life.
    [The information follows:]

    Currently, we do not have data that would yield a meaningful 
statistic. The 501(c) exempt organization community is made up of many 
different kinds of charities and other exempt organizations, with 
diverse activities and needs and correspondingly diverse compliance 
challenges. To address this diversity, we have divided the exempt 
organization community into several dozen market segments, and in 
fiscal year 2002 we began to conduct market segment studies. To date, 
we have begun studies looking at labor unions, business leagues, social 
clubs, community trusts, hospitals, colleges and universities, social 
services organizations, religious organizations (other than churches), 
private foundations, 509(a)(3) supporting organizations, fraternal 
organizations, elder housing organizations, arts & humanities 
organizations, as well as others. Although the results of these studies 
will allow us to make generalizations about compliance levels in 
particular segments or industries, we do not expect that they will 
allow us to make generalizations about the percentage of organizations 
that are not operating in accordance with their tax-exempt status.
    Recently, we have devoted more of our limited resources to 
enforcement areas with known or suspected compliance problems, such as 
donor advised funds, credit counseling organizations, excessive 
compensation issues, and others. Although we will continue with market 
segment studies, we anticipate that fewer resources will be devoted to 
new studies as we increasingly concentrate on existing areas of 
noncompliance.

                        EARNED INCOME TAX CREDIT

    Senator Shelby. Absolutely.
    Let us now focus on the earned income tax credit. As we all 
know, there is an estimated $8 billion to $10 billion of annual 
fraud. This is a lot of money. We were talking about $1 billion 
a minute ago, or $260 million, which is still a lot of money. 
But there is an estimated $8 billion to $10 billion dollars of 
annual fraud that occurs in the earned income tax credit 
program. What is the IRS doing currently to crack down on this? 
What is the status of your five-point initiative to improve the 
administration of the earned income tax credit (EITC)? And how 
and when does the IRS plan to determine whether the earned 
income tax credit pilot initiative, including the qualifying 
child certification filing status and income report, will be a 
success? Because we know a lot of people who receive the 
benefit do not abuse it. But we also know that there is a high 
rate of erroneous payments to people who should not receive it. 
It looks like it is a question of correlating information 
before you pay out, if you are double paying in areas. Do you 
want to respond?
    Mr. Everson. Certainly, Senator.
    Senator Shelby. This is important.
    Mr. Everson. It is very important. We want to make sure 
that everybody who qualifies for this program takes advantage 
of this program. That is our first objective. But the second 
one is, we want to, obviously, make sure that we are not paying 
out monies to people who legitimately do not qualify. As was 
indicated before, Ms. Gardiner indicated, there is some 
complexity in the program, so I would not want anybody to draw 
the impression that it is all fraud in there.
    Senator Shelby. No, it is not all fraud, but there is a lot 
of fraud.
    Mr. Everson. There is a legitimate error rate that accounts 
for a good chunk of what you talked about. Our studies have 
indicated an error rate somewhere between 25 and 30 percent, 
which is the highest in government.
    Let me draw the distinction, because your statement made 
reference to some things I said in my prior life over at OMB 
and this is something I looked at when we were there. The 
difference between this program and food stamps, or housing 
subsidies, is there is no front-end application process. In a 
lot of benefits programs, the government, either the Federal 
Government or a State entity, or somebody is going through an 
application process to determine whether you or I qualify for a 
benefit. That does not exist in the EITC. It is treated like it 
is embedded in the tax code. It is the largest means-tested 
program we have, so it is an odd animal.
    Senator Shelby. How much money, overall, is involved in the 
Earned Income Tax Credit?
    Mr. Everson. Last year I believe it was about $36 billion 
with about 21 million filers who took advantage of the program.
    Senator Shelby. A $36 billion program and, say, 25 percent 
of it's more or less questionable?
    Mr. Everson. Yes, 25 percent of it. So let me come back 
directly to your question. We do have the five-point program 
which is geared to hit those objectives, to help people 
participate, simplify forms. We are working on all that. We are 
bringing in a backlog of the old audits. The core of this 
though is this certification pilot. Right now we have got a 
certification--

              EARNED INCOME TAX CREDIT CERTIFICATION PILOT

    Senator Shelby. How does that work?
    Mr. Everson. We are asking people to demonstrate their 
eligibility this year at the time that they are filing for the 
credit, rather than getting--if they were in a high-risk 
category, rather than automatically getting their----
    Senator Shelby. Preapproval, in a sense?
    Mr. Everson. It is not quite preapproval, but in lieu of 
getting their refund held. What would happen in the past is, 
they might go down a corridor where if their return looked 
suspect--I will give you an example where you typically might 
see a problem. You see the same address for a husband and wife, 
but they are filing as head of household and splitting their 
kids. That is not the right thing to do, obviously, because the 
presumption would be that since they are living together that 
it is one family. That would be something--and there are other 
indicators where you might end up holding the refund.
    What we are doing here with this pilot group is we are 
looking, in a real-time basis, and asking them to complete the 
paperwork so that then their refund does not get held. I do not 
have the results for that yet. That is underway right now. My 
impression, and it is just an impression, is that so far, so 
good. But we are going to have an independent evaluation of 
this pilot done. We will not know until, I would tell you later 
in the summer, later in the year, how it has gone.
    Senator Shelby. Will you let us know how it is going?
    Mr. Everson. Of course we will. We want to ramp this up, 
but only if we prove that it works and that it gets us a good 
answer, that it does not dampen the participation of those who 
qualify, and that it does the job that it is supposed to do, 
which is reduce the error rate.

                 ADDRESSING FRAUD AT ALL INCOME LEVELS

    Senator Shelby. But you can have fraud at the highest 
level, the richest people, and you can have big fraud, as you 
pointed out, in the Earned Income Tax Credit. It is our job to 
root it out in both places, is it not?
    Mr. Everson. Absolutely correct. It is our job to run a 
balanced program. That is what I am seeking to do with this 
budget increase. But I do emphasize that where we start is at 
the high income and the corporate in the criminal area, because 
the basic sense of fairness of Americans is that the big guy 
should not get away with something here.
    Senator Shelby. Absolutely. And the little guy should not 
get away with it either.
    Mr. Everson. We want everybody to be compliant.
    Senator Shelby. Both of them. Because you cannot have fraud 
by anybody, can you?
    Mr. Everson. You cannot.
    Senator Shelby. Ms. Gardiner, what are your thoughts about 
the pilot and other initiatives in this area?
    Ms. Gardiner. We have been looking at the pilot concept, 
the design of the original test, and it looked pretty good. We 
made some suggestions that in the early stages of planning for 
it, because they did not seem to have good measures on how they 
would determine whether the pilot was a success or not. They 
have improved that.
    Senator Shelby. Does the pilot relate to a software program 
that can correlate all this information?
    Ms. Gardiner. No, it really is examining a sample of 
returns and related documentation, that would support the 
eligibility. So it is manual. The results could go into a 
database, of course.
    Senator Shelby. But this is a lot of money involved, as the 
Commissioner has pointed out, over time. There is a lot of 
money involved here in cheating. There is a lot of money 
involved in these fraudulent tax shelters, too.
    Mr. Everson. Yes, sir.
    Senator Shelby. If you could cut down on both tremendously 
it would mean a lot of savings to the IRS. It would mean a lot 
more revenue, legitimate revenue coming in, would it not, sir?

                                TAX GAP

    Mr. Everson. Senator, what you are getting to here is of 
great concern. It is what we call this tax gap. Our estimates 
are that this combination of non-filing, underreporting and 
underpayment is north of $250 billion a year. Now that number 
is not very precise and that is because it is based on a model 
that was last updated in the late 1980s, and adjusted for 
changes in demographics and economics. We are just now doing 
the research, through a new series of more in-depth audits, 
that will give us a basis for updating that number.
    My fear is that it might well be greater than the $250 
billion a year because of these shelters, the changes in 
behavior, and this change in compliance attitudes. So this is a 
serious problem, but anything that we do--and this is why I am 
so anxious to get the money--we help out on the deficit, we 
help out States, because when we get a dollar for the Federal 
Government, on average the blended rates across the country is 
that the States get 20 cents. So it is important everywhere.
    Senator Shelby. What are the current spending plans and 
changes the IRS has made to the Earned Income Tax Credit 
initiative as a result of the merger of appropriations with Tax 
Law Enforcement?
    Mr. Everson. Last year we had an increase from the previous 
year in the EITC, and if you look at 2004 versus 2005, the 
spending actually goes down. It is not going to affect this 
program that we are talking about or our ability to do more 
audits, because we were making some one-time investments as we 
got ready to do these pilots and some of the other educational 
data requirements. So that number has gone down from about $201 
million in 2004, to, I believe, it is $176 million. But it will 
not hurt our ability to move forward and do just what we were 
talking about.

                            FUEL TAX EVASION

    Senator Shelby. Mr. Commissioner, part of my duties as an 
appropriator of this subcommittee is transportation, as you 
know. Fuel tax fraud creates a drain on the Highway Trust Fund 
revenues which the Federal Highway Administration estimates 
could cost at least $1 billion a year. In testimony before this 
subcommittee, the Secretary of the Department of 
Transportation, Secretary Mineta, stated that he was not 
satisfied with the IRS's effort to combat evasion of Federal 
motor fuel taxes.
    Mr. Commissioner, does the IRS agree with the Federal 
Highway Administration's estimate of the loss; in other words, 
a loss of $1 billion or more, from the fuel tax?
    Mr. Everson. I have not looked at that specific number.
    Senator Shelby. Can you furnish that information?
    Mr. Everson. I have no reason to challenge it. I understand 
that there is a legislative fix pending that would actually 
provide the Service more resources to go after this important 
area. When I was recently traveling, I went to a fuel depot, a 
tank farm, and saw the testing procedures we have. This is a 
big issue, and it comes down to fairness again. If the fellow 
who is running a gas station sees the guy across the corner 
mixing his fuels, he has got a competitive advantage that is 
not fair. So we need to do more. I am hopeful that the fix that 
I have talked about will get the extra agents to keep on this 
issue.
    Senator Shelby. Will that be a collaborative effort with 
the States?
    Mr. Everson. I think that is more our own area. I could be 
wrong about that, but I believe--these are our folks that do 
the work themselves, and the fellows I met were just Service 
employees.
    Senator Shelby. It is still a lot of money involved.
    Mr. Everson. It is a lot of money and it goes into, again, 
business fraud. We need to be attentive, not just to 
individuals, but to the businesses here.

                         WORKFORCE REALIGNMENT

    Senator Shelby. Mr. Commissioner, following the IRS's 
reform legislation of 1998, the IRS realigned significant 
levels of resources out of tax enforcement and compliance 
activities to customer service, telephone assistance, and 
submission processing activities. How do your fiscal 2005 
realignment proposals and new funding initiatives compare to 
the pre-reform legislation levels for the tax enforcement and 
compliance programs?
    Mr. Everson. Maybe I could show a chart on that.

    
    
    This just shows you what happens. I am not quibbling with 
RRA 1998. I want to be clear about that. The reforms that were 
contemplated were necessary to improve services. We were not 
doing everything we needed to do on service. I want to be clear 
about that. But as the IRS worked in a single-minded fashion to 
improve services--these are our service and infrastructure 
personnel--it kept those resources stable and invested in phone 
services, restructured the agency, did a lot of things to get 
things better.
    But what fell out was a decline in enforcement. This red 
dotted line represents FTEs as dollars turned into bodies for 
revenue agents, people who do audits, revenue officers, people 
who collect monies due, and criminal investigators. Over a 
period of time they fell by over a quarter.
    Now we have turned that back in 2004, as I indicated to 
you, by absorbing some of the shortfalls in congressional 
spending. Last year, you know we ended up $250 million short at 
the end of the day, plus the pay raise, plus the child credit; 
a series of factors. But for the first time what we did was, 
for this year, forced an allocation of these cuts in a way that 
protected enforcement, the enforcement initiative.
    We will bring this back further. There will be another 
several thousand FTEs that we will get through the 2005 
increment and about 4,000 positions. So this will make a 
difference in 2005. It does not bring us all the way back.
    Senator Shelby. It is progress, though.
    Mr. Everson. My commitment to the Secretary and to Josh 
Bolten at OMB is we will look at this on an ongoing basis to 
see that we run a balanced system. We are also improving our 
processes so that we get more leverage. You do not always have 
to have more money, but in this case we felt that we needed the 
money to improve our processes.

                    IRS SERVICE AND STAFFING LEVELS

    Senator Shelby. Mr. Commissioner, does your fiscal year 
2005 request reflect a belief on your part that sufficient 
service and staffing levels have been achieved for the customer 
service and processing program areas?
    Mr. Everson. As a general rule, I would suggest that I 
would like to continue to maintain and improve services with a 
relatively stable resource commitment on the service. We are 
near inflation, if you look at what we have got in the 2005 
request. I think that is appropriate.
    We need to challenge our people to get the same kind of 
productivity gains that you get in the private sector. That 
sometimes results in some painful adjustments in the workforce. 
You probably read of some of the actions we are taking. But I 
believe that it is difficult for me to come and ask you for 
money in this resource-starved environment, and time of 
deficits, if I have not done everything I can to run the agency 
efficiently. So we are asking our people to look at that 
productivity, and I think that we can continue to run our 
services and improve them at a relatively stable investment 
level.

                      TAX LAW ENFORCEMENT FUNDING

    Senator Shelby. Has the IRS invested all the resources 
appropriated by the Congress in recent years for tax law 
enforcement or have some of the new resources been reallocated 
to other areas?
    Mr. Everson. No, this is what we were just saying. The 
standing rule until I got here was that when there was a 
shortfall you took it out of enforcement to protect services. I 
have reversed that.
    Senator Shelby. That would be a mistake.
    Mr. Everson. I am not in the business of challenging the 
past. I am not sure there was a great deal of choice, given the 
overall environment and the absolute imperative to improve 
services. But, clearly, now we need to rebuild the enforcement 
side and that is what I have started to do in the last year and 
I am asking your support for going down the road.
    Senator Shelby. Mr. Commissioner, why has the IRS been 
unable, if this is true, to hire the revenue agents and revenue 
officers requested and funded in prior fiscal years? Is this 
about not competing in the market? Is there not enough money to 
hire people? Are the salaries too low or what?
    Mr. Everson. It has been, I would tell you, primarily a 
funding question. It is dependent, obviously, on the overall 
economy and the desirability of Federal employment. Right now 
we are doing very well, as we look at this enforcement build. 
We are very pleased with the caliber and the interest we are 
getting. We are doing some creative things.
    Senator Shelby. But you cannot do it overnight, can you?
    Mr. Everson. You cannot. This is why it is so important to 
get strong, continued support from you and your colleagues 
because what the IRS did, it stopped and started on its hiring. 
You do not develop a relationship with a good university to 
draw in accountants if you are there once and then you do not 
come back for 7 years. You have got to be there every year, 
develop a reputation as a good employer and then you get good 
people.
    Senator Shelby. Continuity is important.
    Mr. Everson. Continuity is important, and I think that we 
will be able to address demographics. The only other thing I 
would say on this is: in the group that works with our large 
and mid-size businesses, corporations over $10 million in 
assets, for the first time we are hiring outside the IRS from 
mid-career people; folks who have been 10, 15 years at 
companies or accounting firms. This is a good, helpful thing 
too, because as you know, people in America, they do not tend 
to stay with the same employer for their whole career any more. 
Why shouldn't we in the government be able to take advantage of 
that a little bit too?
    Senator Shelby. I think you can and you are.

                    RETURN ON ENFORCEMENT INVESTMENT

    What benefits does the IRS expect to derive from the 
additional $300 million that you have requested for 2005 in tax 
law enforcement?
    Mr. Everson. As we have looked at this, we think will get 
about a 6 to 1 return. That is a blended return in terms of the 
dollars that we are asking for. It will increase audit rates. 
Let me just give you one example.
    We will increase the penetration on corporations, largely 
mid-size corporations where we are not very active, from 7 
percent up to 13 percent. That is one area where we do not have 
adequate coverage, in my opinion, right now. This will get us 
more dollars, and it will also then have a derivative effect on 
behaviors.
    Same thing, we are going to be adding 350 special agents, 
plus support staff, to go after the crooks. Across the board 
there will--the chart that I showed before, for the first time 
in many years we will be adding to our agents in the tax-exempt 
area so they can look at these charities that have problems.
    Senator Shelby. Ms. Gardiner, is the IRS headed in the 
right direction, and can the Service execute the plan to 
improve the tax law enforcement without jeopardizing advances 
in taxpayer service? In other words, how do you balance that?
    Ms. Gardiner. I believe they are, because the areas in 
customer service where we find deficiencies rarely have 
anything to do with resources anymore. I would say several 
years ago that that was a problem. But now the phones are being 
answered, there are people available, the wait times are less 
than an hour. So there are people available to provide the 
customer service, so I would agree with the Commissioner's 
conclusion that keeping a steady resource level there is 
appropriate.
    On the flip side, with enforcement, clearly, the volume and 
complexity of returns is growing. Those resources have 
declined. I share the Commissioner's concern that the average 
American's perception has grown that you can cheat on your tax 
returns. That needs to be addressed, so I think it is the 
appropriate thing to increase enforcement.

                    RESOURCES FOR TAX ADMINISTRATION

    Senator Shelby. Mr. Commissioner, in recent testimony on 
Capitol Hill, you indicated that Congress has not provided you 
with the resources you need to meet your tax administration 
responsibilities. A review of your request by the subcommittee 
and independently confirmed by the General Accounting Office 
(GAO) shows that at least 98 percent, not all, but 98 percent, 
of the request has been funded. The GAO has estimated that even 
if this Subcommittee on Appropriations gives you every dime of 
your enforcement request, the IRS would have already spent at 
least one-third of any increase on unbudgeted expenses. Is this 
correct, or is the GAO wrong?
    Mr. Everson. The figure that we have overall is that--you 
know this. We are not the kind of agency that gets topped up in 
the appropriations process. If you look back over a 10-year 
period, the average shortfall to the President's request, that 
could be President Bush or President Clinton, is about 3 
percent. Now last year's shortfall was $250 million. Now that 
has got a bunch of things in it. It has got things that you do 
here in the subcommittee or the full committee, and then it has 
got the overall, end-of-the-day rescissions that go across-the-
board.
    That gets compounded further by a gap. Seventy percent of 
our costs are in the pay area. So that if the administration 
proposes a civilian pay raise at one level and the Congress 
funds it more generously, then of course we do have an 
additional handicap.
    What I would suggest to you, Senator, is I very much want 
100 percent of the President's request. If we end up in a 
situation where there are issues like that I think it is 
reasonable for me to challenge my organization to find those 
levels.
    What happens is, if you work to absorb 1 percent or 2 
percent and then you get further whacked by another 2 percent 
or 3 percent, then it gets a lot harder to redress some of the 
problems you have got.
    Senator Shelby. To do your job.
    Mr. Everson. To do the job, yes, sir.

                   COMMITMENT TO ENFORCEMENT FUNDING

    Senator Shelby. Mr. Commissioner, would you commit to this 
Subcommittee on Appropriations that any enforcement resources 
that we allocate to you will be used for the purpose it was 
appropriated for? In other words, for the enforcement 
initiatives which you have been pushing?
    Mr. Everson. Yes, sir, I will. The only exception I would 
give you is that if this problem you just talked about was so 
severe that if I had to take cuts, I will take them. I commit 
to you that I will take them across-the-board. I would take 
them at the service side, infrastructure, and I might have to 
touch some of the enforcement base. But we will make this 
build, the new programs on enforcement, we will do.

                        DELINQUENT TAX INVENTORY

    Senator Shelby. Every year the IRS fails to collect 
billions in delinquent tax obligations. What headway will the 
IRS make in curbing the growing delinquent tax inventory that 
exists? Do you anticipate another large write-off of delinquent 
taxes as was the case last year?
    Mr. Everson. Collections are an important element of this 
enforcement build. The revenue officers that I mentioned, those 
are the folks that actually go out and work to collect the 
dollars owed. We will add many collection officers through 
this.
    The other thing you may be familiar with that is important 
to us, is pending legislation to get private collection 
agencies to do some of the work here. This is somewhat more 
controversial, but frankly, over 40 States have this, in terms 
of their own tax programs. We will run this with full 
protection of taxpayer rights.
    Senator Shelby. But collection agencies would help you 
collect money that is owed to the government.
    Mr. Everson. Absolutely, and what it will enable us to do, 
sir, is focus on the more complicated matters, the ones--there 
was a hearing up here not too long ago on monies owed by 
defense contractors that we are not fully getting after. This 
initiative will enable us to work on things like that, if we 
have relatively more simple matters being attended to by some 
of the private collection agencies.
    Senator Shelby. Ms. Gardiner, has your office, the Treasury 
Inspector General for Tax Administration, reviewed the efforts 
of the IRS to collect outstanding tax debts? Would you comment 
on the proposal to improve the collection case management?
    Ms. Gardiner. We actually did an audit some time ago of the 
original pilot for using outside contractors, and then we 
looked at what IRS was proposing in this newer effort and 
believe it is an appropriate effort. I would guess that if IRS 
is not going to get the money to collect it themselves then we 
do believe that using outside debt collection agencies is a 
good move.
    Our only concern there would be that IRS still would need a 
sufficient level of staffing themselves to provide proper 
oversight, because it would be a little tricky in terms of just 
monitoring the accounts that are turned over to the private 
collection agencies, ensuring that they do the work 
appropriately, protect taxpayers' rights, and those issues.

                         WORKFORCE REALIGNMENT

    Senator Shelby. Mr. Commissioner, you announced a 
realignment of your workforce in January. You also expect 
savings from a related initiative to close some facilities, 
such as the Brookhaven service center. How much do you expect 
to save from these cost-reduction efforts?
    Mr. Everson. Through a variety of programs, Senator, we 
would expect to save over $100 million on an annual basis. What 
these actions do is enable us to free up a couple thousand 
folks that would work on the enforcement side of the house. A 
lot of this is due to the tremendous success we have in 
electronic filing. As electronic filing increases--it was 53 
million last year, up again 12 percent so far this year--you 
obviously do not need as many people opening the mail and doing 
the data entry.
    At the same time what we are doing is consolidating some of 
our processing operations where after we realigned the Service 
around four lines of business, we did not fully realign all of 
the support efforts, which a business would have done. Some of 
this is consolidation of activities, administrative activities 
that businesses did 10 and 20 years ago. We are doing this 
because--I think, again, it goes back to our earlier dialogue--
it is responsible that we be as efficient as possible.
    Senator Shelby. Ms. Gardiner, how likely are the 
anticipated savings the IRS is talking about to materialize?
    Ms. Gardiner. Some things are tied to you just working 
smarter, not harder. The National Research Program is an 
example of that. As IRS can devote its resources, the limited 
resources in a smarter way, then they really should have 
savings. Modernization should bring about savings too.
    For these particular efforts, we would have to look into 
them to see if the savings actually materialized.

                            TAX LAW ACCURACY

    Senator Shelby. The TIGTA testimony indicates that the 
telephone access rate for the IRS is steadily increasing. At 
the same time, the accuracy rate on tax law questions declined 
to 73 percent. Do you have a plan to bring that rate up? Does 
the telephone staff receive enough training? Are there specific 
questions that should not be answered by the telephone staff? 
How do you work all that?
    Mr. Everson. This comes back, Senator, to the conversation 
we had a little while ago about how we are continually trying 
to improve tax law accuracy both at the phones and also for the 
walk-in centers. It comes down to training. We did some things, 
as I mentioned, earlier this year that we believe in the long 
term will actually increase the accuracy rate, but because of 
training some people who had been working on the accounts side 
of it, and rewriting the scripts, there was a short-term 
degradation and the accuracy went down about 6 percent.
    Our figures are just a little bit different from TIGTA's, 
but they are basically consistent. They do show that decline. I 
think over time they will get better. We assess this on a 
weekly basis. We have real-time monitoring of conversations 
where supervisors are sitting in and listening randomly to the 
workers' calls. So we are continually trying to improve this.
    But again, work on the simplification; it will help us too.

                     BUSINESS SYSTEMS MODERNIZATION

    Senator Shelby. On the subject of modernization, the 
Congress has appropriated approximately $1.7 billion for the 
Business Systems Modernization (BSM) program. The IRS has 
requested an additional $285 million in this year's fiscal year 
2005 submission. This substantial investment is on top of 
almost $4 billion we provided and was lost by BSM's 
predecessor, TSM. The investment in TSM was a total loss. That 
was before your time, I have to say that to both of you. After 
serving a year as Commissioner of the IRS, what is your 
assessment on the progress of BSM at this time?
    Mr. Everson. This is a very important question. I 
established three themes, as I testified before the Finance 
Committee before my confirmation, and I continue to believe 
that they are the correct themes. They are to continue to 
improve service and implement the reorganization that former 
Commissioner Rossotti and his team did a splendid job on before 
I got here. They are to augment the enforcement efforts, as we 
have been discussing. But it is also to successfully execute 
the modernization of the IRS. That is fundamental to achieving 
the first two. We will not be able to continue to improve 
service and help taxpayers, we will not be able to enforce the 
law adequately, if we do not modernize the IRS. So it is 
terribly important.
    After I arrived, we commissioned a series of studies last 
summer to look at this basket of projects. I would say to you 
that, first of all, it is not all bad news. I give the Service 
a mixed grade here. There are many successes. It is true, some 
of them have cost more than they should have. As a taxpayer, 
you can check the status of your refund on the Internet, and 
you can file electronically. Practitioners now can get employer 
identification numbers. There is a whole suite of products 
where I would suggest to you the IRS has improved its services 
to the taxpayer--I would be hard-pressed to find another 
government agency that has made the dramatic leaps that we have 
made largely through technology. So that is a lot of good news.
    Where we have failed, though, is on these big ticket 
projects, like CADE that you discussed, that are at the core of 
our master files. Or also another one that you did not 
mention--
    Senator Shelby. We cannot afford to fail this time.
    Mr. Everson. We cannot afford to fail. The other one was 
the financial system we have been struggling to put in.
    These studies indicated three problems. The first was that 
the IRS business units did not have adequate ownership of the 
projects. They were running as independent technical solutions, 
so that the businesses were not involved in setting 
specifications or the testing and development schedules.
    The second observation was we were trying to do too much. 
GAO had said this, and as we studied this I concurred with all 
those observations.
    The third was that we were getting uneven performance from 
the vendor. We are working on each of these. We have got the 
business units much more involved. They are participating every 
step of the way. We have resized the portfolio, as you 
indicated. I am comfortable with this. It will provide more 
focus. I believe in the long run we will actually get more done 
because as we change our work processes and hold people 
accountable to get things done, I think we will actually move 
faster.
    We are working with the contractor. I meet with the 
president and chief operating officer of CSC--a big company, 
Computer Sciences Corporation runs the consortium--every month 
and we go over the deliverables. We will see. Later this summer 
we will have that long-delayed first step of CADE, which works 
on a section of the 1040EZ filers. The feedback I am getting is 
pretty optimistic at this stage. It is not done till it is 
done. And the same thing is true on the financial system. I 
will report back to you. We will know for sure what is 
happening here.
    Just to close I would say, we have held the contractor 
accountable in a way that I would say is fairly unusual in 
government. I sent a letter after they missed their last 
deadline and I said, look, for the next big piece of work we 
are going to do, which is a filing and payment compliance 
system, we are going to not automatically award that to this 
PRIME alliance. We are going to open it up to competition. That 
is a strong statement, very strong statement because it hurts 
them financially, and I think it got their attention.
    Senator Shelby. When do you expect BSM to be completed?
    Mr. Everson. I will have to get back to you on that. That 
is a big, complicated project.
    Senator Shelby. It is an important question.
    Mr. Everson. It is important. I think we will have a much 
better idea as we adjust our programs here. If we are 
successful with CADE, this first section of CADE, I will tell 
you that in about a year we will have a better capability of 
giving you a longer term projection.
    [The information follows:]

    The hallmark application of the Business Systems Modernization 
Program (BSM) is the Customer Account Data Engine (CADE), which is the 
application we are building to eventually replace the existing 
Individual Master File (IMF) and the Business Master File (BMF). CADE 
is now in service and handling its first filing season. Currently CADE 
is only handling a subset of Form 1040EZ filers, with the expectation 
that it will process approximately 1.9 million returns this calendar 
year. Our plans for CADE are now set for the next 2 years, with the 
expectation that CADE will handle 33 million returns in calendar year 
2007. It is not possible, however, for us to predict when CADE will be 
fully implemented, since timing is based on a variety of unknown 
factors, including BSM funding levels, insertion of new technology to 
improve development productivity on CADE, and policy decisions 
regarding the extent to which CADE will need to handle returns from 
prior years. As a point of comparison, former Commissioner Charles 
Rossotti stated that he expected BSM implementation to last 10 years. 
Progress anticipated in the first 4 years of the project, however, fell 
far short of our goals for reasons that we have publicly stated. In 
addition, we based that plan on extremely robust funding levels for 
fiscal year 2005 and fiscal year 2006. Because of steps we have taken 
to streamline and focus the work we are doing on BSM, we requested and 
received lower funding levels than Commissioner Rossotti anticipated 
when he provided his estimate.
    Additionally, given the size and complexity of the IRS's IT assets, 
modernization must be an ongoing endeavor. Modernization programs at 
the IRS have been difficult, mainly due to the fact that we did not 
have a program of continual modernization of its IT assets. This 
deficiency has led to a situation of increasingly antiquated software 
applications that are not well documented, are difficult to maintain 
and upgrade, and are difficult with which to interface. Given that the 
heart of our IT efforts is to increase the effectiveness and efficiency 
of tax administration, modernization will always be an ongoing activity 
at the IRS.

             RESOURCES NECESSARY TO COMPLETE MODERNIZATION

    Senator Shelby. Ms. Gardiner, I want to ask you a few of 
these questions since you are the Inspector General. How much 
more is needed to complete this effort to modernize the IRS's 
outdated systems and processes? And how is the IRS's 2005 
budget request consistent with that vision?
    Ms. Gardiner. As far as what is needed, the estimates are 
that it would be $7 billion to complete the whole----
    Senator Shelby. Say it again.
    Ms. Gardiner. Seven billion dollars to complete the whole 
effort, and those are the estimates.
    Senator Shelby. How many years?
    Ms. Gardiner. A total of 15, and I believe that includes 
the 6 that have already passed.
    Senator Shelby. That is a continuous modernization.
    Ms. Gardiner. Correct. Even with that, I am not sure that 
you will ever get to a point where you will say, okay, we are 
all done and we do not have to spend--you know, there will be 
upgrades and changes as time goes on.
    Senator Shelby. You will have to continue to do that to 
keep up.
    Ms. Gardiner. But I agree with the Commissioner that 
getting CADE, the first release accomplished, that has to occur 
before you can make any projections on anything else.
    Senator Shelby. When do you think that will be?
    Ms. Gardiner. I think everybody is giving it about 60 to 70 
percent odds that the first part will be rolled out this year 
in August.
    Senator Shelby. What do you think? You said everybody.
    Mr. Everson. I am interested in this answer.
    Ms. Gardiner. Actually I could answer it for IFS. I am not 
as sure for CADE.
    Senator Shelby. Give me your best judgment.
    Ms. Gardiner. It does appear that the testing and 
everything is going well. Certainly, the contractor is on 
notice that they need to do this. I would say it is probably a 
very good bet that in August they will be----
    Senator Shelby. Who is the main contractor here?
    Ms. Gardiner. CSC is the one that is overseeing the whole 
effort.
    Senator Shelby. What about the total cost overruns so far 
on this project? Does that bother you, Ms. Gardiner? You are 
the Inspector General.
    Ms. Gardiner. It does. We have been making recommendations 
for the past 2 years that we think have all been incorporated 
in these recent studies too, which is good, that it has 
validated what we have said and I think that that is getting 
the attention of Treasury and IRS and others. Some of the cost 
overruns were changing requirements. These projects are hard 
projects. They are totally new, and they are huge and complex. 
It would be one thing if you were just starting today to say, 
okay, let us create a master file. But the problem is they have 
to interface and talk to the old system. That is the biggest 
piece----
    Senator Shelby. Plus, you are doing business every day as 
you are doing this.
    Ms. Gardiner. That is right.
    Mr. Everson. Let me just expand, if I could, for a second 
on that last remark. This tie back to the legacy systems is 
very difficult because the IRS did a lousy job over a period of 
decades of keeping documentation of all the multitude of 
changes it made to the systems each year when the tax code 
would change. So when people have done the work, they developed 
a road map, but then all of a sudden when they get into doing 
the work they find it is much, much more complicated than they 
had contemplated. That, together with governance issues, too 
many changes in overall requirements, they all contributed to a 
very bad cocktail, I would suggest.

                           BSM COST OVERRUNS

    Senator Shelby. How much money are we talking about in 
overruns, hundreds of millions of dollars?
    Ms. Gardiner. I would have to get back to you on that. We 
do know that information and we keep track of it.
    [The information follows:]

    Through BSM spend plans, the IRS requests funding for program level 
activities (e.g. MITRE Corporation assistance, PRIME Program Management 
Office, etc.) and modernization projects (e.g. Infrastructure Shared 
Services (ISS), Customer Account Data Engine (CADE), etc.). As of 
February 2002, we determined that 20 BSM projects had experienced costs 
increases of approximately $75 million.\1\
---------------------------------------------------------------------------
    \1\ Analysis of Business Systems Modernization Cost, Schedule, and 
Functionality Performance (Reference Number 2003-20-007, dated October 
2003).
---------------------------------------------------------------------------
    At the time of our analysis, the majority of the projects were in 
the planning phases. IRS officials responded that the reliability of 
costs estimates for the development and deployment phases would be much 
greater than that for the planning phases. This belief has not proven 
to be true. Most projects have now moved into the development and 
deployment phases and cost increases have risen, partially due to the 
fact that projects require more funds during the development and 
deployments phases.
    The GAO testified in February 2004 that the IRS had experienced 
cost variances of approximately $290 million for 10 completed or 
ongoing projects.\2\ The chart below is reprinted from the most recent 
data available (GAO testimony).
---------------------------------------------------------------------------
    \2\ Business Systems Modernization: Internal Revenue Service Needs 
to Further Strengthen Program Management (GAO-04-438T, dated February 
2004).

------------------------------------------------------------------------
                                                             Reported/
                                           Cost Variance      Revised
              Project Name                (In Thousands)  Estimated Cost
                                                          (In Thousands)
------------------------------------------------------------------------
Completed Projects:
    Security and Technology                      +$7,553         $41,287
     Infrastructure Release 1...........
    Customer Communications 2001........          +5,310          46,420
    Customer Relationship Management              -1,938           7,375
     Exam...............................
    Human Resources Connect Release 1...            +200          10,200
    Internet Refund/Fact Of Filing......         +12,923          26,432
Ongoing Projects (as of 09/30/2003):
    Modernized e-File...................         +17,057          46,303
    e-Services..........................         +86,236         130,281
    CADE Release 1......................         +36,760          97,905
    Integrated Financial System Release          +53,916         153,786
     1..................................
    Custodial Accounting Project Release         +72,058         119,219
     1..................................
                                         -------------------------------
      TOTAL.............................        +290,075  ..............
------------------------------------------------------------------------

    Senator Shelby. Mr. Commissioner, we hold the American 
taxpayers to a high standard: file your return by April 15 or 
face stiff penalties and interest payments. Why should we not 
hold the IRS acquisition process and the Service's contractor 
to a similar standard and enforce penalties when deadlines are 
missed and costs are increased? Ms. Gardiner, what steps have 
been taken or would you recommend that the IRS take to improve 
acquisition and management and discipline?
    Ms. Gardiner. We actually have suggested that 
disincentives, or penalties so to speak, are built into 
contracts and that has not been looked on that favorably by the 
Service.
    Senator Shelby. Who has not looked on it favorably? I know 
the contractors never look on it favorably.
    Ms. Gardiner. IRS as well. The folks that do the 
contracting have not really accepted those types of 
recommendations. They have accepted another, and that is that 
we have recommended early on that IRS use firm fixed-price 
contracts as often as possible. When we looked at it in the 
first year they were used very infrequently, and now they are 
using them more. So that puts the burden on the contractor and 
we think that certainly is a step in the right direction.
    Mr. Everson. If I could, the other thing I would note on 
this is--after the contractor missed this deadline on the 
financial system, I did take that action of saying, we will 
open this up to competition for the next enforcement module. 
That is a very strong action because they contemplated, they 
had built their----
    Senator Shelby. That is a strong message.
    Mr. Everson. They built their business on a projection of 
how much work they were going to get over a period of years, 
and I just said, wait a minute, you have just potentially lost 
this piece of work. They can compete for it, but it is very 
different. I have run businesses, and when you have a 100 
percent account, that is different than running an account 
where there are other players in there. So that is a strong 
statement.
    I have also communicated that these upcoming deliverables 
for CADE and IFS are critical to the maintenance of our 
continued relationship. So I think the stakes are very clear at 
this point.

                             BSM MANAGEMENT

    Senator Shelby. Good. Mr. Commissioner, what is the IRS's 
plan and schedule for fully implementing and institutionalizing 
all management processes and controls needed to effectively 
manage the BSM program? I know that is a big job.
    Mr. Everson. This goes back to the point a few minutes ago 
of first and foremost getting an overall business sensitivity 
to this project. After I arrived at the Service I created a 
second deputy. It follows a model that we put in over at 
Homeland where we consolidated all of the support functions, 
CFO, CIO, human resources, in our case, mission assurance, 
which is security. We have cyber-security and physical 
security, people security, all of that, plus facilities 
management under one individual. He was our senior career 
official--came out of the business units--so that we would get 
proper attention to the long-term needs of the Service in our 
functions including the CIO function. I appointed our CFO, 
moved him over to be the CIO, to shake this up and to make sure 
that we are addressing this on a long-term basis.
    I would suggest to you that--you mentioned earlier the $4 
billion that had been squandered in the early 1990s. One of the 
reactions to that was the way this BSM project was done, 
perhaps too much was actually given to the PRIME alliance. We 
are taking a careful look at where we need to augment our own 
skills. It comes back to what Ms. Gardiner was saying before, 
it does not do us any good to just have contractors if you do 
not have enough people inside who are monitoring and working 
and understanding. So we are looking at that as well.
    Senator Shelby. Ms. Gardiner, do you view BSM's current 
problems as resource related, management related, or both?
    Ms. Gardiner. One of the big, broad issues was just 
matching the capability in-house with the portfolio of 
projects. That would be somewhat resource related because they 
tried to take on more than they really could. But I would say 
probably the bigger part is management. Things like, if your 
process says that you are going to clearly define requirements 
and you are going to follow certain steps before you go to the 
next stage of the project, that you have to stick with that, 
and that has been a problem. Or for testing, in order to move 
the project on to the next stage the same thing applies, that 
you have to test and make sure that defects are identified and 
fixed, and they really have had some problems with that. But 
they do recognize those problems and are addressing them.
    Senator Shelby. As far as modernization is concerned, we 
both noted that $4 billion was lost, squandered or misused. 
Could you assure this subcommittee that your current refocus 
can put the program back on track so it will not go the way of 
TSM? That is important. In other words, we do not want it to go 
the way of TSM. TSM money was squandered or wasted, and it was 
$4 billion.
    Mr. Everson. Senator, I can tell you that this is getting a 
lot of my attention. I am doing my level best to make sure it 
is being done responsibly, and we will reach a very real 
decision point. If this first piece of CADE and the financial 
system do not roll out correctly now, I will have to very 
seriously reassess it because we would run the risk of going 
down that corridor. I do not expect that will be the case, but 
we are not home free until we make sure we get that far. I give 
you my commitment that this will not leave my attention.

                      CUSTOMER ACCOUNT DATA ENGINE

    Senator Shelby. The Customer Account Data Engine (CADE), is 
the first major component of BSM and will replace the IRS's 
Master Files with a modern database management system. That is 
the goal. It will serve as the foundation for the rest of the 
BSM initiative. Thus far, the delivery of the first of CADE's 
five phases--I believe there are five phases--has already been 
delayed by at least 3 years. I think it has gotten off to a 
poor start. When will CADE be delivered, if you can say within 
some time frame? The first phase?
    Mr. Everson. It is our expectation that this first phase 
will be delivered this summer. So far the testing is proceeding 
according to plan.
    Senator Shelby. How much will CADE cost over the original 
estimate?
    Mr. Everson. I would want to respond for the record. It is 
many tens of millions of dollars. There are functions of 
complexity, also delay that have contributed to that problem.
    Senator Shelby. Do you have a figure on that, Ms. Gardiner?
    Ms. Gardiner. No.
    Senator Shelby. Can you give us a figure for the record?
    Mr. Everson. We will certainly do that. Let me say this 
though, we have just recently negotiated a cap on what this 
first module will cost, and that is responsive to what Ms. 
Gardiner was saying a few minutes ago about a change in 
philosophy in the last months that we have brought in, and we 
have worked very well with the vendor to do that. So that 
protects the Government's interest a lot more.
    [The information follows:]

    While we do not have current cost figures from the Automated 
Financial System (AFS) for the CADE, the following chart represents the 
funding that has been requested and received for the CADE project (all 
releases).

------------------------------------------------------------------------
                                              Amount          Amount
             BSM Spend Plan                  Requested       Received
------------------------------------------------------------------------
Spend Plan #1...........................      $3,500,322      $3,500,322
Emergency Funding Release #1............       1,616,000       1,616,000
Spend Plan #2...........................      15,312,000      15,312,000
Emergency Funding Release #2............       1,400,000       1,400,000
Spend Plan #3...........................  ..............  ..............
Spend Plan #4...........................      40,038,000      40,038,000
Spend Plan #5...........................      53,974,000      53,974,000
Spend Plan #6...........................      27,683,000      27,683,000
Spend Plan #7...........................      62,800,000      62,800,000
                                         -------------------------------
      TOTAL.............................  \1\ 206,323,32  \1\ 206,323,32
                                                       2               2
------------------------------------------------------------------------
\1\ This amount includes $15,574,000 that was requested in spend plan 5,
  but never spent on the CADE.

    As shown in the response to Question 1, the CADE Release 1 has 
experienced a $36,760,000 cost variance.
    Future releases of the CADE have also experienced cost variances of 
$25,723,000. Please see the table below.

----------------------------------------------------------------------------------------------------------------
                                                                                      Current
                                                                      Amount       Estimate (As
                       Release or Activity                          Originally     of September      Variance
                                                                     Requested         2003)
----------------------------------------------------------------------------------------------------------------
Release 2.......................................................     $38,400,000     $44,755,000      $6,355,000
Business Rules Management (Phase 1).............................  ..............       8,300,000       8,300,000
Business Rules Management (Phase 2).............................      17,000,000      17,000,000  ..............
Release 3.......................................................       9,779,000      20,837,000      11,058,000
                                                                 -----------------------------------------------
      TOTAL.....................................................  ..............  ..............      25,713,000
----------------------------------------------------------------------------------------------------------------

    According to the CADE Baseline Business Case from March 2001, the 
overall estimated cost of CADE is $982 million over its life cycle.
             CADE Cost Overrun (From the Original Estimate)
    The description below explains the costs that GAO reported in their 
Audit of the fiscal year 2004 Expenditure Plan:
    (1) Design work from September 2000 to July 2001:
  --$15.3 million.--Initial estimate in March 2000 Expenditure Plan;
  --$19.3 million.--Actual cost;
  --$4.0 million.--Variance due to design period being extended by 3 
        months to add detail in some areas and to bridge to 
        Development.
    (2) Development work from July 2001 to March 2004:
  --$40.0 million.--Initial estimate in March 2001 Expenditure Plan;
  --$53.6 million.--Actual cost;
  --$13.6 million.--A 2-month extension for a pilot using real tax 
        returns (cost of $5.3 million) and the addition of capacity at 
        the Martinsburg Computing Center to support Development and 
        Testing (cost of $4.0 million) created $9.3 million of this 
        variance. We incurred the cost of the delays outlined below, 
        creating the remaining variance of $4.3 million.
    (3) Cost impact of 2-year delay in delivering CADE:
  --$2.4 million.--Hiring of non-PRIME contractors to support our IRS 
        testing;
  --$1.9 million.--Establishing a CADE Program Office (work to build an 
        organizational framework to support multiple CADE releases 
        simultaneously);
  --$18.0 million.--Cost to apply tax law and other changes for 2003 
        and 2004 filing season.
    These costs do not reflect any changes since the GAO audit of the 
fiscal year 2004 Expenditure Plan.

                   IRS ACTIONS IN REGARD TO THE PRIME

    Senator Shelby. Let me ask you a tough question. What steps 
will the IRS take, Mr. Commissioner, if the PRIME contractor 
fails to deliver?
    Mr. Everson. I have made it very clear through the action 
to date----
    Senator Shelby. You are on top of them.
    Mr. Everson [continuing]. That we will hold them 
accountable. And I have also said that we will have to reassess 
the very continuance of the relationship if we cannot do what 
we have said we will do.
    Senator Shelby. You would change that if the effort 
continues to flounder?
    Mr. Everson. We will have to consider that, absolutely.
    Senator Shelby. Would you change if you thought you needed 
to?
    Mr. Everson. I retain that latitude, yes.
    Senator Shelby. What is your view, Ms. Gardiner, for the 
slowness of this program?
    Ms. Gardiner. I think some of it, as I mentioned, it 
certainly is complex. It is unique.
    Senator Shelby. It is complex.
    Ms. Gardiner. But I do think a big part of it too is just 
the whole cost and scheduling process was flawed. It gave much 
more optimistic deadlines than it should have in the first 
place, so it caused people's expectations to be higher than 
they should have been.
    For example, even just in simple segments of it for 
testing, they were so optimistic and they did not build in time 
for recovery in terms of if certain defects occurred, or there 
were failures, to fix those and then to start over again. So to 
some degree it is that, and then the rest is that it is very 
complex, and then also changing requirements. So I think 
everybody is disappointed, and we are too, as far as how long 
it is taking.
    Senator Shelby. But your modernization program is 
essential.
    Mr. Everson. We cannot back away from this effort. We have 
to do it. We have got aging technology right now and we have 
got an aging workforce. I liken this, as I have said before, to 
the movie ``Space Cowboys'', if you ever saw that, where they 
send Clint Eastwood out into outer space because they have got 
these old guys who are the only ones who understand the 
technology. We have a bunch of people who want to retire, but 
they are still helping us because we have got 1960s and 1970s 
technology that we are running. We cannot keep doing that 
forever.

                     PERFORMANCE OF THE CONTRACTOR

    Senator Shelby. Do you believe that the contractor is up to 
the challenge here? This is a very complex undertaking, but it 
has to be done. You are spending a lot of money here to 
modernize the IRS, which we think is important.
    Mr. Everson. I feel that I have seen an improvement in the 
attitude and the work that is being done in the year that I 
have been involved with the Service, and I very much appreciate 
the leadership of Mike Laphen, is the president of the company. 
He has been in my office once a month. That is quite a devotion 
of resources for someone who is running, I think it is a $13 
billion business. We have got a relationship that I believe is 
starting to improve. We had to let it all out, if you will. 
There had to be this accountability of what most recently 
happened. So I am cautiously optimistic that they can do this.
    Senator Shelby. But you are also guarded because you know 
what happened to $4 billion with TSM.
    Mr. Everson. This is the old Ronald Reagan, ``trust but 
verify'', attitude.
    Senator Shelby. We hope you will, and we wish you every 
success, and we will continue to help you.
    Mr. Everson. Thank you, sir.

                     ADDITIONAL PREPARED STATEMENT

    Senator Shelby. The subcommittee has received a statement 
from the Internal Revenue Service Oversight Board which will be 
included in the record.
    [The statement follows:]

   Prepared Statement of the Internal Revenue Service Oversight Board

                              INTRODUCTION

    The IRS Oversight Board thanks the Chairman for the opportunity to 
submit this statement to the Subcommittee on Transportation/Treasury 
and General Government of the Committee on Appropriations. The Internal 
Revenue Service (IRS) Oversight Board is required by 26 U.S.C. Section 
7802(d) to review and approve the budget request prepared by the IRS, 
submit a request to Treasury, and ensure that the approved budget 
supports the annual and long-range strategic plans of the IRS.
    This year, the IRS drafted a special report presenting its 
recommended fiscal year 2005 IRS budget, comparing it to the 
administration's request, and explaining why the Board believes its 
recommended budget is needed to support the annual and long-term needs 
of the IRS. This statement discusses that report. The complete version 
is available on the Board's website at www.irsoversightboard.treas.gov 
and the Board asks that this report be entered into the record as well.

             THE IRS OVERSIGHT BOARD BUDGET RECOMMENDATION

    The IRS budget is more than dollars and cents. It represents the 
choices that we as a Nation make about the future of our tax 
administration system and how we help over 100 million American 
taxpayers deal with an increasingly complex tax code while ensuring 
that everyone pays his or her fair share of taxes.
    The IRS Oversight Board acknowledges that the IRS's budget has 
increased in each year of President Bush's Administration, and that the 
administration's request for fiscal year 2005 is significant against 
other non-defense, non-homeland security discretionary funding. That 
commitment is commendable, and the Board recognizes and thanks 
Secretary Snow for his efforts, especially at a time when the Nation 
must balance many important and competing priorities.
    However, the Board believes that now is a critical time for our tax 
system to be strengthened, not merely maintained at current levels. 
Enforcement activities are still at unacceptable levels. Our Nation's 
tax gap is estimated at $311 billion,\1\ leaving billions of dollars on 
the table simply because the IRS does not have the resources to do its 
job.\2\
---------------------------------------------------------------------------
    \1\ Nina Olson, National Taxpayer Advocate's 2003 Annual Report to 
Congress, (Washington, DC: December 31, 2003) p. 20-21. This is based 
on a July 2001 IRS Office of Research report.
    \2\ Charles O. Rossotti, Report to the IRS Oversight Board: 
Assessment of the IRS and the Tax System (Washington, DC: September 
2002), p. 16.
---------------------------------------------------------------------------
    The Board's own research shows that each year, more Americans 
believe it is acceptable to cheat on their taxes. At the same time, our 
already complex tax code continues to be a changing, tangled mystery to 
most honest taxpayers--and an asset to those intent on skirting the 
law. Every effort must be made to provide quality service to honest 
taxpayers who want to comply with the law.
    In crafting its fiscal year 2005 budget for the IRS, the Board 
addressed these concerns head on by reinvesting in the IRS to produce 
tangible benefits and results for America's taxpayers and our Nation. 
It is a sensible and pragmatic budget that reflects the real world in 
which the IRS must operate and be funded.
    The Board recommends a 10 percent increase in funding from fiscal 
year 2004 to $11.204 billion, with a significant increase of 3,315 
full-time equivalents (FTEs) to boost enforcement efforts. If enacted, 
the Board's budget would increase our Nation's revenue by approximately 
$5 billion each year once the IRS has hired and trained additional 
enforcement personnel.\3\
---------------------------------------------------------------------------
    \3\ These estimates are based upon the projected revenue 
anticipated by hiring and training full-time employees who would audit 
or collect owed taxes in known cases of taxpayers who did not file or 
pay, or who substantially underreported their taxes, as described in 
former IRS Commissioner Charles O. Rossotti's Report to the IRS 
Oversight Board: Assessment of the IRS and the Tax System, p. 16.
---------------------------------------------------------------------------
    Under the Board's budget, the IRS would have the additional 
resources to:
  --Close over an additional 1,000 cases involving high risk/high-
        income taxpayers and promoters who avoid paying income taxes by 
        using offshore credit cards and abusive trusts and shelters.
  --Boost audit rates by 42 percent from fiscal year 2004 to examine 
        companies that use aggressive tax avoidance tactics, such as 
        offshore transactions and flow-through entities.
  --Contact an additional 200,000 taxpayers who fail to file or pay 
        taxes due; a 40 percent boost from fiscal year 2004 and a 27 
        percent increase from the administration's request. This alone 
        will allow the IRS to collect $84 million more in revenue owed 
        than the administration's request would allow.
  --Sustain the one-on-one assistance that millions of Americans rely 
        on at tax time. The Board's budget will ensure that the IRS 
        will be able to maintain its improved service to taxpayers by 
        answering eight out of ten phone calls.

              IRS MUST STAY THE COURSE ON CUSTOMER SERVICE

    Mr. Chairman, the vast majority of Americans want to file their 
returns and pay their fair share, yet our Nation's tax code continues 
to become more complex. Resources must be available so the IRS can 
answer taxpayers' questions and promptly and accurately, whether it is 
over the phone, through the IRS website, by mail, or at walk-in center.
    Under the board's proposed budget, customer service funding will 
remain at about the same level as fiscal year 2004; however, service 
should improve due to the deployment of self-service technology.
    For taxpayers, that means eight out of ten phone calls will be 
answered. For tax practitioners calling the IRS toll-free hotline to 
resolve problems regarding clients' accounts, hold-time will remain at 
current levels.
    The IRS call-routing systems as well as website applications that 
allow taxpayers to check the status of their tax refunds have already 
shown dramatic benefits in speeding service to taxpayers. New systems, 
such as e-Services, will soon be available, providing additional 
automated services to tax practitioners.
    Clearly, service to taxpayers has improved in the past 5 years. 
Such improvements make it all the more imperative that we sustain them 
and not allow this positive trend to languish, or worse, decline. The 
agency must stay the course.

            DAYS OF ``OUTMANNED AND OUTGUNNED'' IRS MUST END

    The IRS is doing a better job of identifying egregious 
noncompliance--now it needs the resources to fight back. In the past 2 
years, the IRS sharpened its compliance focus to identify and pursue 
promoters and participants of abusive tax shelters and tax evasion 
schemes. For example, the agency is now targeting its resources on 
promoters of illegal tax schemes that are often marketed to high-income 
individuals, but are also finding their way to middle-market 
businesses.
    Despite this focus, enforcement activities are still at an 
unacceptable level simply because the IRS does not have the resources 
needed to accomplish its mission. It continues to be outmanned and 
outgunned. In fiscal year 2003, the agency was able to pursue only 18 
percent of known cases of abusive devices designed to hide income, 
leaving an estimated $447 million uncollected.\4\
---------------------------------------------------------------------------
    \4\ Rossotti, p. 16.
---------------------------------------------------------------------------
                     TAX CHEATING: ALARMING TRENDS

    Public attitudes towards tax cheating show some alarming trends, 
particularly among young Americans. The Board's 2003 Survey on Taxpayer 
Attitudes found that support for total tax compliance diminished by 
four points over the previous year to 81 percent. In other words, 
nearly one out of five Americans now believe that it is acceptable to 
cheat at least a little on their taxes. Almost one-third (30 percent) 
of young adults age 18-24 age are among those most likely to feel that 
any amount of cheating is acceptable, an increase of six points since 
last year. Yet ironically, ``fear of being audited'' has the greatest 
impact on these non-compliers at a time when actually being audited is 
near historic lows.\5\
---------------------------------------------------------------------------
    \5\ Roper ASW, 2003 IRS Oversight Board Annual Survey on Taxpayer 
Attitudes, September 2003, p.17.



    The IRS must prove to the public that it can and will identify and 
pursue those who show contempt for the tax code. The Board's proposed 
budget allows the IRS to begin to reverse this disturbing trend.
    The Board's recommendation would increase our Nation's revenue by 
almost $5 billion each year once the IRS has hired and trained 
additional enforcement personnel. The Board believes the additional 
revenue achieved makes a strong business case for the recommended 
additional enforcement resources. While this is a modest boost in 
closing our compliance gap, it will also send a message to those 
contemplating tax avoidance: the IRS's hands are no longer tied.

              MODERNIZATION CRITICAL TO TAX ADMINISTRATION

    In December 2003, the Oversight Board released an independent 
analysis of the IRS Business Systems Modernization (BSM) program. The 
Board called for nine specific recommendations for turning around the 
critical but troubled program that has experienced significant and 
unacceptable delays and cost overruns.
    However, the Board still believes that the overall Modernization 
plan is sound and well-designed. Moreover, it is critical to the future 
of tax administration. As a Nation, we must remain committed to the 
IRS's computer modernization program. The Board testified before the 
House Ways & Means Subcommittee on Oversight on Feb 12, 2004:

    ``The IRS Oversight Board firmly believes that the IRS 
Modernization program cannot be allowed to fail. The IRS cannot 
continue to operate with the outmoded and inefficient systems and 
processes it uses today. Over time, the existing systems will become 
impossible to maintain and at that point, the ability to administer our 
country's tax system will be in grave danger. Such a risk to our nation 
is unacceptable. We remain convinced that the overall Modernization 
plan is sound and well-designed. The challenge is executing that plan. 
The IRS and the Prime must get it right this time.''\6\
---------------------------------------------------------------------------
    \6\ Larry R. Levitan, IRS Oversight Board Testimony before House 
Ways and Means Oversight Subcommittee Hearing on IRS BSM Program, 
February 10, 2004.

    The Board's proposed budget provides the stable resources needed to 
focus and stabilize the steady stream of funding for the IRS's computer 
modernization initiative. Special controls are in place to ensure that 
no funding in this account is spent until the IRS has the capability to 
spend it effectively. If the IRS does not correct the weaknesses in the 
BSM program by fiscal year 2005, the Board advocates that the funds 
earmarked for modernization should not be spent. However, the Board 
does not believe the IRS should plan for failure. The agency must be 
poised to move forward with BSM once it has demonstrated that it has 
corrected the program's weaknesses. The funding level recommended by 
the Board sets the foundation for genuine progress for the program in 
fiscal year 2005.
    The Board expects that the Customer Account Data Engine (CADE) 
Release 1 will occur in 2004. Over the next year, the IRS will test and 
build upon that system. The IRS should continue to strengthen its 
ability to manage the program and the Prime to deliver projects on 
budget and on time. By the end of fiscal year 2005 and early fiscal 
year 2006, the IRS should be able to proceed with the remaining 
releases of CADE as quickly as possible. This will minimize future risk 
and the long-term cost of modernization while providing a basis to 
deliver tangible results for taxpayers.
    If the IRS's fiscal year 2005 BSM funding is reduced to $285 
million, as it is in the administration's budget, future funding likely 
will be adversely affected. If that happens, the projects will drag on, 
risk will increase, and ultimately, the program will cost taxpayers 
much more.
    For that reason, the Board believes fiscal year 2005 BSM funding 
should be set at $400 million, with only $285 million put into the 
fiscal year 2005 spend plan. This will allow the IRS's Business Systems 
Modernization fund to operate like a multi-year fund, as originally 
envisioned by Congress and as the Board has recommended each year since 
its inception.
    Further, as its archaic, tape-based computers begin to give way to 
modern business systems, the IRS must plan for a smooth transition. The 
Board's budget recognizes that need. As new systems are incorporated, 
the IRS must plan to operate both the old and new systems in parallel 
for some time. The IRS must also retain employees with critical skills 
while training existing and new employees to use new systems. This will 
allow the IRS to reduce the risk of a catastrophic disruption to the 
system.
    In addition, the Board believes that the transition to 
modernization is a real cost that must be incurred. There are no short 
cuts to successful modernization--the IRS's budget must reflect the 
real cost of maintaining legacy systems while simultaneously supporting 
modernized systems. Accordingly, the Board recommends an additional $25 
million to cover these costs. The administration's budget fails to 
acknowledge them.

          THE ADMINISTRATION'S FISCAL YEAR 2005 BUDGET REQUEST

    By comparison, the Board believes the administration's fiscal year 
2005 budget cannot achieve its stated goal to add almost 2,000 
personnel to bolster the IRS's enforcement efforts, and will threaten 
hard-earned improvements in customer service. This year's request will 
lead to a $230 million shortfall in the IRS budget because it fails to 
budget adequately for the anticipated $130 million of congressionally-
mandated civilian pay raises, rent increases, and at least $100 million 
of unfunded expenses.
    In its fiscal year 2005 budget recommendation, the Board 
anticipates a 3.5 percent pay raise for civilian employees, which 
achieves parity with the administration's call for a 3.5 percent 
military pay raise. The administration, but contrast, calls for a 1.5 
percent civilian pay raise. While discussions are now underway in 
Congress regarding parity, the Board believes that the 1.5 percent 
civilian pay increase fails to recognize recent history.
    In fact, fiscal year 2005 is the fourth year in a row in which the 
administration has called for IRS staff increases, while not covering 
pay raises or required expenses.
    As a result, the administration's proposed increase in the IRS's 
fiscal year 2005 budget will erode before new employees can be hired, 
more taxpayer phone calls can be answered, or new audits of possible 
tax cheats can be conducted.

                      IMPACT OF $230 MILLION BUDGET SHORTFALL ON THREE MAJOR IRS FUNCTIONS
----------------------------------------------------------------------------------------------------------------
                                                                                    Fiscal Year
                                                                                       2005        Revised Goal
                   Function                            Performance Measure          Performance     After $230
                                                                                       Goal         Million Cut
----------------------------------------------------------------------------------------------------------------
Field Collection..............................  Number of tax deliquent account          981,000         463,000
                                                 cases resolved.
Toll-free Telephone Level of  Service.........  Calls answered..................      32,000,000      17,000,000
Field Exam....................................  Exams of individual taxpayers            118,840          73,000
                                                 <$100,000 AGI.
----------------------------------------------------------------------------------------------------------------

               BOARD CITES COMPLEXITY AS FUNDAMENTAL FLAW

    The IRS Oversight Board is precluded by law from addressing tax 
policy issues, but it would be remiss not to address the cost of our 
Nation's complex tax system; a cost ultimately borne by taxpayers and 
the IRS. The administration's legislative proposals contained in its 
budget request only begin to address the problems caused by complexity. 
The approach so far to tax simplification fails to address a 
fundamental flaw in our tax system: its costly, confusing, and 
debilitating complexity. The administration has, however, requested 
that Congress provide some relief in fiscal year 2005 on the 
Alternative Minimum Tax, but has not yet identified a long-term 
solution.\7\ In her annual report, IRS National Taxpayer Advocate Nina 
Olson recommended repeal of the AMT, saying:
---------------------------------------------------------------------------
    \7\ Recent public remarks by Treasury Secretary Bodman noted that 
the President's budget extends through 2005 the temporary increase in 
the AMT exemption and the provision that allows certain personal 
credits to offset the AMT. These temporary provisions will keep the 
number of taxpayers affected by the AMT from rising significantly in 
the near-term. More importantly, they will allow the Treasury 
Department the time necessary to develop a comprehensive set of 
proposals to deal with the AMT in the long-term. Treasury Press Release 
JS-1250 contains the full statement of his remarks.

    ``The AMT is extremely and unnecessarily complex and results in 
inconsistent and unintended impact on taxpayers . . . [T]he AMT is bad 
policy, and its repeal would simplify the Internal Revenue Code, 
provide more uniform treatment for all taxpayers, and eliminate the 
oddity of dual tax systems. AMT repeal would also allow the IRS to 
realign compliance resources to facilitate more efficient overall 
administration of the tax code.'' \8\
---------------------------------------------------------------------------
    \8\ Olson, p. 16.

    The Board fully concurs with her assessment, and urges the 
administration and Congress to consider accepting this recommendation 
in future legislation.

                               CONCLUSION

    The Board was established to bring to bear its collective expertise 
and familiarity with private sector best practices on the IRS's 
problems. To the private-life Board members, investments in enforcement 
pay for themselves many times over, not only in revenue dollars but by 
the deterrence value of reinforcing the belief that all taxpayers are 
paying their fair share. A strong business case can be made for 
providing the IRS with several hundred million dollars so it can 
collect billions in revenue. At a time when Federal revenue as a 
percentage of the economy has shrunk to 1950s levels and we face a $500 
billion deficit, the Board believes it imperative that we strengthen 
our tax collection system.
    For that reason, the Board recommends that both Congress and the 
administration reevaluate their methodology by including the revenue 
value to the country when estimating budget requests for the IRS. 
Indeed, considering the positive impact of additional resources 
provides a better framework for making informed decisions and will lead 
to a more effective IRS.
    In conclusion, the Board calls for Congress to stay the course it 
set more than 5 years ago with the passage of the IRS Restructuring and 
Reform Act. The IRS has made progress in carrying out the spirit and 
letter of the Act; we must now give it the resources to finish the job.
                                 ______
                                 
    Attachment 1.--IRS Oversight Board Fiscal Year 2005 IRS Budget 
 Recommendation and Administration Request: Program Summary Comparison

                         ADMINISTRATION FISCAL YEAR 2005 BUDGET REQUEST PROGRAM SUMMARY
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                                             Increase
                                                    Fiscal Year     Fiscal Year  -------------------------------
               Appropriation Title                 2004 Enacted       2005 OB       Enacted vs.
                                                                      Request         Request         Percent
----------------------------------------------------------------------------------------------------------------
Processing, Administration and Management.......          $4,009          $4,148            $139             3.5
Tax Law Enforcement.............................           4,171           4,564             393             9.4
Information Systems.............................           1,582           1,642              60             3.8
Business Systems Modernization..................             388             285            -103           -26.5
Health Insurance Tax Credit Administration......              35              35  ..............  ..............
                                                 ---------------------------------------------------------------
      Appropriation.............................          10,185          10,674             490             4.8
----------------------------------------------------------------------------------------------------------------


                       IRS OVERSIGHT BOARD FISCAL YEAR 2005 BUDGET REQUEST PROGRAM SUMMARY
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                                             Increase
                                                    Fiscal Year     Fiscal Year  -------------------------------
               Appropriation Title                 2004 Enacted       2005 OB       Enacted vs.
                                                                      Request         Request         Percent
----------------------------------------------------------------------------------------------------------------
Processing, Administration and Management.......          $4,009          $4,291            $282             7.0
Tax Law Enforcement.............................           4,171           4,770             598            14.3
Information Systems.............................           1,582           1,708             126             8.0
Business Systems Modernization..................             388             400              12             3.1
Health Insurance Tax Credit Administration......              35              35  ..............             0.3
                                                 ---------------------------------------------------------------
      Appropriation.............................          10,185          11,204           1,019            10.0
----------------------------------------------------------------------------------------------------------------

        Attachment 2.--Unfunded IRS Costs, Fiscal Year 2002-2003

                UNFUNDED IRS COSTS, FISCAL YEAR 2002-2004
                     [Dollars in millions, rounded]
------------------------------------------------------------------------
                                         Fiscal      Fiscal      Fiscal
                Detail                  Year 2002   Year 2003  Year 2004
------------------------------------------------------------------------
Labor Inflation:
    Unfunded Pay Raise Increase             $42.3      $128
     (President's Request to
     Congressional Action)...........
                                      ==================================
                                             42.3       128
Non-Labor Inflation:
    Rent Shortfall...................        32          54
    Postage..........................        16          53
    Corporate & Electronic Contracts.  ..........        23
    Health Service Contract..........         3           2
    Interpreter's Contract...........         0.5         0.3
    Child Care Subsidy...............         1    ..........
    Increased Department of Labor             2    ..........
     EFAST Contract Processing Costs.
                                      ----------------------------------
      TOTAL..........................        55         132
                                      ==================================
Added Requirements:
    Background Investigations........  ..........         4
    Increase Cash Awards from 1.24            8          16
     percent to 1.42 percent.........
    Competitive Sourcing.............  ..........         8
    Campus Security Response.........        15    ..........
    Congressional Mandates...........         5    ..........
    Guard Services...................        20          16
    Public Transportation Subsidy....         9    ..........
                                      ----------------------------------
      TOTAL..........................        56          44
                                      ==================================
      Total..........................       153         304
                                      ----------------------------------
      Total Less Pay Raise and Rent..        79         122
------------------------------------------------------------------------

                              Attachment 3

                             WHERE THE ADDITIONAL ENFORCEMENT RESOURCES ARE APPLIED
                                         [Dollars in thousands, rounded]
----------------------------------------------------------------------------------------------------------------
                                                   Oversight Board       Administration          Difference
                                                   Recommendation        Recommendation    ---------------------
            Enforcement Initiatives            --------------------------------------------
                                                  Budget      FTE       Budget      FTE       Budget      FTE
----------------------------------------------------------------------------------------------------------------
SBSE-2 Curb Egregious Non-Compliance..........   $159,264      1,408    $90,161        874    $69,103        534
SBSE-3 Select High-Risk Cases for Examination.      5,500  .........  .........  .........      5,500  .........
SBSE-7 Savings through Consolidation--Case         16,085        200     14,469        144      1,616         56
 Processing...................................
SBSE-8 Savings through Consolidation--              7,656         69      5,531         65      2,125          4
 Insolvency Processing........................
WAGE-2 Increase Individual Taxpayer Compliance     46,406        521     15,469        175     30,937        346
WAGE-9 Improve ITIN Application Process.......     15,484         50  .........  .........     15,484         50
WAGE-10 Eliminate Erroneous EITC  Payments....     18,000  .........  .........  .........     18,000  .........
LMSB-1 Combat Corporate Abusive Tax Schemes...     60,017        394     36,100        207     23,917        187
TEGE-1 Combat Diversion of Charitable  Assets.      3,914         44      3,914         44  .........  .........
TEGE-5 Stop Abusive Transactions in the TEGE       11,140        100     11,140        100  .........  .........
 Community....................................
CI-1 Combat Financial Fraud in the Corporate       25,600         98     25,600         98  .........  .........
 Sector.......................................
CI-2 Dismantle International and Domestic          12,208         80  .........  .........     12,208         80
 Terrorist Financing..........................
CI-3 Reinforce Core Mission Tax Enforcement        34,086        130     34,086        130  .........  .........
 Resources....................................
CI-7 Forensic Electronic Evidence Acquisition       3,104          4      3,104          4  .........  .........
 and Analysis.................................
CI-10 Leverage/Enhance Special Agent                2,500         28      2,500         28  .........  .........
 Productivity.................................
APPEALS-1 Resolve Appeals.....................     13,945        112      7,000         56      6,945         56
COUNSEL-1 Combat Abusive Tax Avoidance........     10,852         75      5,426         38      5,426         37
NHQ-2 Deliver Strategic Compliance Data.......      2,712          2  .........  .........      2,712          2
                                               -----------------------------------------------------------------
      Fiscal Year 2005 Enforcement  Increases.    448,472      3,315    254,500      1,963    193,972      1,352
----------------------------------------------------------------------------------------------------------------

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Shelby. There are some additional questions that 
will be submitted in writing for your response.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

          Questions Submitted to the Internal Revenue Service

            Questions Submitted by Senator Richard C. Shelby

    Question. Following the IRS Reform legislation of 1997, the IRS 
realigned significant levels of resources from Tax Enforcement and 
Compliance activities to customer service, telephone assistance, and 
submission processing activities.
    How do the fiscal year 2005 realignment proposals and the new 
funding initiatives proposed for 2005 compare to the pre-reform 
legislation levels for those programs?
    Answer. The proposed fiscal year 2005 realignment proposals and new 
funding initiatives strive to better balance service and enforcement.
    The IRS's service lagged in the 1990's. In response to the IRS 
Restructuring and Reform Act of 1998 (RRA 98), the IRS took important 
and necessary steps to upgrade service--significantly improving the 
answering of taxpayer telephone inquiries and electronic filing. 
Unfortunately, improvement in service coincided with a drop in 
enforcement activity. Since 1996, the number of IRS revenue agents, 
officers, and criminal investigators has dropped.
    The President's fiscal year 2005 budget--if approved by Congress--
will help with IRS efforts to continue strengthening enforcement 
activities while maintaining and enhancing levels of service. The 
submission requests an enforcement increase of $300 million over the 
fiscal year 2004 consolidated appropriations level. This increase will 
allow a partial recovery in the numbers of enforcement personnel, but 
will not fully restore the workforce.

----------------------------------------------------------------------------------------------------------------
                                                            FTE        FTE      FTE Fiscal     FTE        FTE
                 Enforcement Workforce                     Fiscal     Fiscal    Year 2005     Fiscal    Percent
                                                         Year 1997  Year 2004  Initiatives  Year 2005    Change
----------------------------------------------------------------------------------------------------------------
Revenue Agents.........................................     14,592     12,172         841      13,387         -9
Revenue Officers.......................................      7,333      5,238         332       5,734        -28
Criminal Investigators.................................      3,244      2,553         160       2,739        -22
----------------------------------------------------------------------------------------------------------------

    Question. Will IRS essentially restore those realignments from 
1997, or does the request make real advances in tax compliance efforts?
    Answer. As in the past 2 years, the IRS has identified efficiency 
improvements that could generate resources to be applied to high 
priority areas. These resources will be applied to enforcement in 
fiscal year 2005. However, they are not sufficient to completely 
reverse the decline in enforcement performance. The IRS needs the 
increase in enforcement resources requested in the fiscal year 2005 
budget to carry out an appropriate level of activity in the enforcement 
arena.
    The primary goal in the fiscal year 2005 budget request is to 
continue restoring the strength of the enforcement function. Staffing 
devoted to compliance and enforcement operations declined in the 1990's 
as the IRS focused on customer service; it is just beginning to 
recover. The number of revenue agents, revenue officers, and criminal 
investigators each declined by over a quarter from fiscal year 1997 to 
fiscal year 2003. Annual growth in return filings and additional work 
related to RRA 98 have contributed to a steady decline in enforcement 
presence, audit coverage, and case closures in front-line compliance 
programs.
    This budget has an increase of $300 million for a more vigorous 
enforcement of the tax laws. This strong commitment to tax 
administration will provide a significant augmentation of enforcement 
resources, but will not completely restore enforcement personnel to 
1997 levels. Improvements will also come from productivity increases 
(e.g. reeningeering, better audit targeting).
    Question. Are the realignment proposals recognition that sufficient 
service and staffing levels have been achieved for IRS customer service 
and processing program areas?
    Answer. While the ultimate desired level of taxpayer service 
remains to be reached, the IRS has improved and increased recognition 
of, and respect for, taxpayer rights. The IRS has made steady gains in 
better serving American taxpayers. Each filing season and year is 
appreciably better than the previous one and the IRS continues to build 
on those successes.

 FISCAL YEAR 2004 FILING SEASON SUCCESSES--DATA AS OF APRIL 23 COMPARED
                   TO SAME PERIOD IN FISCAL YEAR 2003
------------------------------------------------------------------------
                                     Fiscal Year  Fiscal Year   Percent
             Service\1\                  2003         2004       Change
------------------------------------------------------------------------
Free Filed Returns.................          2.7          3.4         26
Where's My Refund..................          9.5         12.4         31
Telephone Level of Service                  83           85            2
 (Percent).........................
E-Filing From Home.................         11.7         14.2         21
------------------------------------------------------------------------
\1\ Service usage in millions, except percentages.

    The IRS is doing a better job; however, much more remains to be 
done. The objectives for improved taxpayer service are three-fold:
  --improve and increase service options for the taxpaying public;
  --facilitate participation in the tax system by all sectors of the 
        public;
  --simplify the tax administration process.
    Although the IRS is not requesting increases in fiscal year 2005 
for taxpayer service initiatives, the IRS will be able to build upon 
its experience over the past 6 years and will continue to improve 
taxpayer service. In recognition of the need to rebalance service and 
enforcement activities, consistent with the formula of service plus 
enforcement equals compliance, the only increases the IRS requested in 
fiscal year 2005 are for enforcement.
    Question. What headway will IRS's request make in the growing 
delinquent tax inventory that exists, or do you still anticipate large 
write-offs of delinquent taxes similar to this past year, even with the 
resource requests in the fiscal year 2005 budget?
    Answer. Delinquent tax write-offs declined by 35 percent from 
818,000 in fiscal year 2001 to 533,000 in fiscal year 2003. The dollar 
value of this inventory declined from $10.5 billion in March 2001 to 
$7.4 billion in March 2004. The fiscal year 2005 budget staffing 
increase will enable the IRS to continue this progress in reducing the 
delinquent tax inventory. Passage of the administration's proposed 
Private Collection Agent legislation would further reduce delinquent 
inventory.
    Question. A continuing priority of the IRS has been to maintain and 
improve the Tax Fraud and Criminal Investigations program area. This 
committee has supported IRS requests in this area.
    Has IRS invested all the resources granted by the Congress in 
recent years for the Criminal Investigations area or have some of the 
new resources been reallocated to other areas in the IRS?
    Answer. The IRS has directed all the resources provided by the 
Congress for the Criminal Investigation area to the Criminal 
Investigation division (CI). None of the resources have been 
reallocated to other areas in the IRS; however, the IRS has applied any 
across-the-board rescissions or unfunded pay raises to CI 
proportionally. The IRS has protected all new CI initiatives.
    Question. The IRS, in recent testimony, indicated that Congress has 
not provided the resources it needs to meet tax administration 
responsibilities. A review of IRS requests by GAO has shown that more 
than 98 percent of IRS's requests have been funded since fiscal year 
2002, with most reductions relating to across-the-board reductions and 
absorptions beyond the control of this committee.
    What is the basis of IRS's assessment on Congress' review of your 
requests?
    Answer. The IRS has based its budget strategy on increasing 
productivity in current operations from reengineering, modernization, 
and increases in electronic filing to free up resources for 
reinvestment in taxpayer service and enforcement. The administration 
also has sought modest FTE increases in the last few years. If 
successful, this strategy would have enhanced taxpayer service and met 
the demands of increased return workload. However, this strategy has 
not been as effective as anticipated due to unexpected cost increases. 
For example, the IRS absorbed $97 million to fund a portion of the 
fiscal year 2004 pay raise, in addition to an appropriation reduction 
of $252 million from the President's Budget.
    The IRS absorbed these costs across the agency, protecting only the 
new fiscal year 2004 enforcement initiatives from reduction. 
Nevertheless, although the IRS protected these enforcement initiatives, 
the enforcement base absorbed a prorated share of these unexpected cost 
increases discussed above, and this resulted in FTE reductions in 
enforcement activities.
    Question. Does IRS's assessment imply that the administration did 
not request sufficient resources for the IRS in past years' budgets?
    Answer. The IRS has received the administration's full support, and 
funding requests have been sufficient. However, unfunded expenses 
absorbed throughout the agency have negatively affected budget goals. 
These unfunded expenses have been driven primarily by pay raises higher 
than those proposed by the administration.
    Question. What is IRS's assessment of the request for fiscal year 
2005? Is it adequate to support IRS tax administration 
responsibilities?
    Answer. The proposed fiscal year 2005 budget takes a balanced, 
measured approach to the challenges facing the American tax system, 
with a needed emphasis on strengthening enforcement. The goal is to 
ensure that the tax system is fair for all while protecting taxpayer 
rights.
    The request, if funded, is adequate to support IRS tax 
administration responsibilities. However, the fiscal year 2005 budget 
request includes a 1.5 percent increase for the pay raise, as proposed 
by the administration. If Congress approves the 3.5 percent increase 
proposed by some members, it would result in a shortfall of $109 
million.
    Question. What is IRS's assessment of long term requirements?
    Answer. The vision of the IRS is to re-center the agency with the 
proper balance of service and enforcement poised to quickly meet 
technological and demographic changes, new challenges of taxpayer 
compliance, and customer expectations.
    The IRS's goals remain the same--to improve taxpayer service, 
enhance enforcement through uniform application of the law, and improve 
the IRS infrastructure and modernize technology. The IRS's working 
equation is that service plus enforcement equals compliance. The IRS is 
maintaining high levels of taxpayer service, while focusing on 
corrosive areas of non-compliance. Ensuring fairness will help maintain 
the taxpaying public's faith in the Nation's tax system.
    Question. How is the IRS's fiscal year 2005 request consistent with 
that vision?
    Answer. The IRS will enforce the law and it will continue to 
improve service and respect taxpayer rights. The administration's 
fiscal year 2005 budget request will help the IRS restore the balance 
between service and enforcement envisioned in the IRS's Strategic Plan.
    The fiscal year 2005 request allocates $300 million toward 
enforcement initiatives designed to curb abusive tax practices, end the 
proliferation of abusive tax shelters, improve methods of identifying 
tax fraud, identify and stop promoters of illegal tax schemes and 
scams, and increase the number and effectiveness of audits to ensure 
compliance with the tax laws. This budget will allow the IRS to apply 
resources to areas where non-compliance is greatest: promotion of tax 
schemes, misuse of offshore accounts and trusts to hide income, abusive 
tax shelters, underreporting and non-reporting of income, and failure 
to file and pay large amounts of employment taxes. The administration 
also has proposed a number of legislative changes to significantly 
enhance current enforcement programs and prevent the promotion of 
abusive tax avoidance transactions. The goal of these initiatives is to 
ensure that the tax system is fair for all, while protecting taxpayer 
rights.
    Question. Besides the across the board reductions, what other 
expenses did the IRS pay that were not budgeted?
    Answer. Examples of the expenses incurred that were not budgeted 
include $97 million for a portion of the unfunded pay raise, and 
unanticipated rent increases causing a shortage of $40 million. The IRS 
is working to manage our space inventory to minimize future rent 
increases to the extent possible.
    Question. The GAO states that IRS has requested more enforcement 
staff to be funded partly by budget increases and partly through 
internal savings.
    Please provide, for fiscal year 2002 and fiscal year 2003, a 
detailed breakout of the anticipated internal savings and the actual 
amount saved.
    Answer. In fiscal year 2002, the IRS intended to offset projected 
non-labor inflation of $57 million by reducing travel and contractual 
services and improving purchasing power through interdepartmental 
consolidation of procurements. Actual results of those actions in 
fiscal year 2002 were:

------------------------------------------------------------------------
                                                            Obligations
                                                           Variance From
                      Object Class                          Fiscal Year
                                                             2001-2002
------------------------------------------------------------------------
Temporary Space Leases..................................   ($19,765,165)
Management and Professional Support Services............    (10,462,898)
Contractual Labor--Private Sector.......................    (10,052,952)
Training/Travel.........................................     (4,114,005)
Misc Expenses, Foreign Posts--Government................     (3,151,254)
Printing, Reproduction, & Related Services--Commercial..     (1,900,000)
Support Services--Private Sector........................     (1,711,693)
Local Telephone Service.................................     (1,280,417)
Services and Maintenance to Buildings and Space.........     (1,088,284)
Administrative Mail Costs...............................     (1,042,750)
Telecommunications Equipment, Capitalized...............       (912,880)
Communication, Telephone Service--EE....................       (811,571)
Travel of Experts & Witnesses...........................       (577,566)
                                                         ---------------
      Total.............................................    (56,871,435)
------------------------------------------------------------------------

    The IRS highlighted specific initiatives for savings in fiscal year 
2003. Actual results of those reductions were:

                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                    Budgeted            Realized, EOY           Difference
          Savings--Fiscal Year 2003          -------------------------------------------------------------------
                                               Dollars      FTE      Dollars      FTE       Dollars       FTE
----------------------------------------------------------------------------------------------------------------
CI--Narcotics Program.......................      $14.6         85       $4.0         33     ($10.6)        (52)
CI--Realigned Attrition.....................      $11.6         80       $9.7         80      ($1.9)  ..........
COUNSEL--Reduced Tax Court Cases............       $0.6          5       $0.6          5  ..........  ..........
WAGE--E-File................................      $18.5        490      $12.0        475      ($6.5)        (15)
WAGE--Reengineering/Quality  Improvements...      $67.4      1,044  .........  .........     ($67.4)     (1,044)
WAGE, SBSE--e-services release..............       $4.0         69       $0.3          6      ($3.7)        (63)
LMSB--Customer Relationship Management (CRM)      $11.9        119       $1.2         12     ($10.7)       (107)
 Exam.......................................
MITS--Selected Tier B Projects..............       $3.3         57  .........  .........      ($3.3)        (57)
SBSE--Reduced Field Innocent Spouse.........      $13.8        184       $7.7        103      ($6.1)        (81)
SBSE--Reduced Filing Season Support.........      $12.1        154      $17.9        230       $5.8          76
                                             -------------------------------------------------------------------
      GRAND TOTAL...........................     $157.8      2,287      $53.4        944    ($104.4)     (1,343)
----------------------------------------------------------------------------------------------------------------

    Question. The GAO states that the IRS realized only 32 percent of 
its claimed internal savings in fiscal year 2003. Is this correct? If 
so, does this point to a weakness in budget formulation at the IRS?
    Answer. The actual figure is 34 percent. The fiscal year 2003 
budget submission is the first such submission to identify specific 
reduction initiatives that could be used to fund high priority 
initiatives. Since then, the IRS has been improving. For example, in 
fiscal year 2004, the IRS expects to achieve 68 percent of the 
projected savings. The savings result either from modernization 
projects or reengineered systems that generate productivity increases. 
Because the IRS starts development of budget estimates over 15 months 
prior to execution year, the assumptions made can change, and any 
changes in assumption will affect the actual savings realized. In many 
cases these savings have been delayed, but will eventually be realized.
    Question. Does it point to a lack of conviction to realize the 
savings promised to promote change at the IRS? If the IRS does not 
realize the savings assumed in its budget requests, how does it make up 
for the shortfall?
    Answer. The IRS's prior experience in realizing specific reduction 
initiatives, particularly with respect to fiscal year 2003, in no way 
reflects a lack of commitment by the IRS to achieve cost savings and 
efficiencies.
    In most cases, the savings generated are used to fund other high 
priority areas in the same business unit. Therefore, there is an 
incentive to ensure that the reengineering actions are taken so that 
the new work can be done. However, if for some reason the savings are 
not generated at the time expected, then the business unit must either 
scale back its hiring plans, and, therefore, projected performance, or 
reduce non-labor costs in other areas to maintain its performance 
level. Part of the problem experienced in fiscal year 2003 and 2004 was 
that the IRS did not use generated savings to fund higher priority 
work, as planned in the budget, but used the savings mainly to fund 
unfunded mandates and unexpected costs.
    Question. Congress has appropriated approximately $1.7 billion for 
the Business Systems Modernization program. IRS has requested an 
additional $285 million in this year's fiscal year 2005 budget. The 
current program is showing mounting delays in project milestones, with 
few results to show for the taxpayer.
    What is the current status of this program?
    Answer. The BSM program is--without a doubt--one of the largest, 
most visible, and most sensitive modernization programs ever undertaken 
in the world.
    The results have been mixed; but first, the good news. The IRS 
built a strong technical infrastructure and designed and implemented 
stringent security and control mechanisms into the infrastructure. The 
IRS also developed a rigorous enterprise life cycle methodology. Over 
the past 2 years, the IRS has been working toward instituting and 
integrating established streamlined governance and management 
processes. The IRS has made progress, but a major thrust now focuses on 
sustaining a solid balance of business commitment, accountability, and 
scope management. Finally, the IRS has achieved a great deal of success 
with the projects delivered to date.
    The IRS has fully deployed all e-Services Release 1.0 products and 
made them available over the Internet, including: registration and 
online address change access for third parties and IRS employees 
through secure user portals; Preparer Tax Identification Number (PTIN) 
online application; interactive Taxpayer Identification Number (TIN) 
matching; secure Electronic Return Originator (ERO) application 
processing; and access to e-Services registration and application 
processes by Modernized e-File (MeF) participants.
    E-Services Release 2.0 products are also now in production and 
available for use by IRS staff and taxpayers, including: Application 
for e-Filing (external); Electronic Account Resolution (EAR); 
Electronic TIN Bulk Matching (Bulk Requests); Disclosure Authorization 
(DA); and infrastructure support for outbound facsimile service.
    In March 2004, James D. Leimbach appeared before the Ways & Means 
Oversight Subcommittee on behalf of the National Association of 
Enrolled Agents (NAEA) and said, ``This new capability is truly going 
to revolutionize the way we conduct future business with the IRS. The 
ultimate beneficiary is the American taxpayer. We are truly amazed and 
thrilled beyond description at this way of doing business with the IRS, 
and we would like for you to understand why we feel as we do.''
    The IRS delivered several additional applications that are 
providing tangible benefits to taxpayers and improving the efficiency 
and effectiveness of the tax administration systems such as Where's My 
Refund?, Where's My Advance Child Tax Credit?, Internet EIN, Modernized 
e-File, HR Connect, etc. The following chart highlights the 
applications the IRS has delivered, as well as the measurable business 
benefits being realized.

                            BSM DELIVERS REAL BUSINESS VALUE (RESULTS AS OF 6/15/04)
----------------------------------------------------------------------------------------------------------------
              Project                             Description                         Recent Statistics
----------------------------------------------------------------------------------------------------------------
Internet Refund Fact of Filing       Improves customer self-service by      --17.9 million inquiries in 2003; 22
 (2002).                              providing instant refund status        million inquiries to date in 2004
                                      information and instructions for       (1/1/04-6/6/04).
                                      resolving refund problems to          --32 percent of all real time IRS
                                      taxpayers with internet access.        assistance calls come from IRFoF.
                                                                            --Modest reduction of
                                                                             telecommunications costs (about
                                                                             $250,000).
                                                                            --Every 1,000 IRFoF contacts
                                                                             eliminate 1,500-2,000 refund
                                                                             assistance calls.
Advanced Child Tax Credit (2003)...  Modifies the Internet Refund           --15.5 million inquiries in 2003;
                                      application to provide taxpayers       11.9 million inquiries to date in
                                      with Advance Child Tax Credit refund   2004 (10/1/03-6/13/04).
                                      status on the internet.               --Peak date 1.1 million interaction.
Customer Communications (2001).....  Improves communications                --68,000 calls in one 3-minute
                                      infrastructure, including telephone    period during initial week
                                      call management, call routing and      (coincided with start of Advanced
                                      customer self-service applications.    Tax Refund of 2001).
                                                                            --50 percent reduction in waiting
                                                                             time for assistor to answer call.
                                                                            --50 percent reduction in abandoned
                                                                             calls.
                                                                            --Number of Spanish calls doubled.
                                                                            --More accurate pre-routing of
                                                                             calls.
Internet Employee Identification     Allows businesses and taxpayers to     --1.37 million internet EIN
 Number (2003).                       apply for and receive employer         applications received to date (as
                                      identification numbers over the        of 6/5/04).
                                      internet.
HR Connect (2002)..................  Delivers an enterprise solution to     --75,000 internal users.
                                      allow IRS employees to access and     --Cited by Commissioner Everson as
                                      manage their human resources           an enabling factor in the
                                      information online.                    redirection of approximately 750
                                                                             staff years to enforcement.
                                                                            --Treasury was selected as 2004
                                                                             ComputerWorld Honors Laureate for
                                                                             HR Connect development and
                                                                             implementation.
e-Services R1 (2003-2004)..........  Creates a web portal and value adding  --Over 69,624 PTIN applications
                                      e-Services services to promote the     (W7P) entered to date, data entry
                                      goal of conducting most of the IRS's   productivity doubled (from 8/15/03-
                                      transactions with tax practitioners    6/10/04).
                                      electronically.                       --Over 58,201 e-File applications to
                                                                             the Third-Party-Data-Store (TPDS)
                                                                             entered to date (from 8/15/03-6/10/
                                                                             04).
                                                                            --Approximately 24,939 Registered
                                                                             (and confirmed) User Portal (RUP)
                                                                             to date (from 10/1/03-6/10/04).
Customer Relationship Management     Provides standard tax computation      --Deployed to almost 4,000 Revenue
 Exam (2001).                         software to Large & Mid-Sized          Agents.
                                      Business Revenue Agents.
Modernized e-File (2004)...........  Provides e-filing to large businesses  --Went live on 2/23/04.
                                      (1120 family) and tax exempt          --Over 35,090 returns (1120 family)
                                      organizations (990 family).            accepted as of 6/13/04.
                                                                            --Over 3,287 participating
                                                                             Electronic Return Originators as of
                                                                             6/13/04.
                                                                            --Winner of Government Solutions
                                                                             ``Best-of-the Best'' Pioneer
                                                                             Solutions.
----------------------------------------------------------------------------------------------------------------

    The bad news, however, is major. Significant cost overruns and 
repeated schedule delays have plagued critical projects, such as the 
Customer Account Data Engine (CADE), the Integrated Financial System 
(IFS), and the Custodial Accounting Project (CAP). CADE replaces the 
current master files that are the IRS's repository of taxpayer 
information. IFS will be the IRS's new core accounting system. CAP 
provides an integrated link between tax administration (revenue) and 
internal management (administrative) financial information.
    The IRS has delayed the CADE program four times. It originally 
planned to deliver the first release of CADE in December 2001. The IRS 
then rescheduled it for August 2003, and later rescheduled it for April 
2004. The IRS recently finalized the re-planning effort for CADE and 
set the latest delivery date for September 2004. While CADE is farther 
along than the IRS has ever been in replacing a component of the master 
file, there are still major hurdles to overcome. The CADE delays 
stemmed from infrastructure upgrades, initial poor software quality 
during the startup of systems integration testing combined with the 
failure to understand the complexity of balance and control, and the 
resolution of operational and performance issues that occurred during 
Phase 3 of the Release 1.0 pilot.
    Like CADE, IFS has been plagued with schedule delays. The IRS 
originally planned to deliver the first release of IFS in October 2003. 
The IRS then rescheduled it for January 2004. The IRS later rescheduled 
it for April 2004. The IRS has subsequently scheduled Release 1.0 for 
October 2004. The IRS delayed the first release of IFS because of the 
need to make technical changes to comply with the enterprise 
architecture, the inability to resolve key design and integration 
issues in a timely manner, the identification of the health coverage 
tax credit interface requirement late in the development process, and 
delays experienced in integration testing due to poor application 
quality and interface testing issues.
    IFS Release 1.0 will cover core accounting functions such as budget 
preparation, general ledger, accounts payable, accounts receivable, 
financial reporting, and purchasing. Problems continue to seriously 
jeopardize the scheduled delivery of this first release of IFS. The IRS 
is 2 weeks behind schedule on testing, which puts the data conversion 
schedule at risk. The IRS is negotiating a fixed price contract for the 
October delivery.
    The IRS is also encountering delays on the first release of the 
Custodial Accounting Project (CAP), which provides an integrated link 
between tax administration (revenue) and internal management 
(administrative) financial information. The first release of CAP will 
address revenue from individual taxpayers on initial tax payments. 
Later releases of CAP will address businesses and collections. CAP 
delays resulted from unstable CADE and IFS interface definitions, 
needing additional testing time due to a much larger than anticipated 
volume of data anomalies discovered during the conversion of data from 
the current Individual Master File (IMF), and the time required 
resolving system performance issues.
    In addition, though not directly responsible for CAP delays to 
date, the IRS has made some adjustments to the functionality that it 
needs to have in CAP Release 1 to support the GAO financial audit as 
well as internal accounting and management. These adjustments will 
increase the cost of later sub-releases of CAP Release 1. The IRS has 
now completed all testing for CAP Release 1, and is adding changes to 
reflect IMF changes from the start of the 2004 filing season (Release 
1.1). The IRS plans to start production, which includes the initial 
load of IMF data, in mid-August. The IRS negotiated a fixed price 
contract for Release 1 and Release 1.1 in May 2004.
    Question. Are the current problems resource-related or management-
related?
    Answer. The current problems experienced by the IRS are a 
combination of both. The IRS needs a more versatile team of seasoned 
executives to provide long-term stability to the program. The IRS is 
complementing the skills of experienced IRS tax executives with outside 
seasoned technology executives who have experience managing large-
scale, complex IT projects. As such, the IRS is hiring two Associate 
Chief Information Officers to join the MITS organization, and an 
executive search firm is conducting searches for five senior executives 
with a wide range of diverse experience in developing and implementing 
large modernization systems. As a result of missing CADE and IFS key 
deliverables last summer, the Commissioner and Computer Sciences 
Corporation (CSC) commissioned external assessment studies from outside 
experts. The studies produced no major surprises; but, the IRS now 
understands more about the issues. All of the assessments confirmed 
that the IRS modernization effort is a massive, highly complex, high-
risk program that is confronting a number of critical management and 
technological challenges. These studies also made it clear that the IRS 
should not turn back, but rather make a series of changes to strengthen 
the BSM program.
    While all of these studies assessed different components of the 
modernization program, three major recommendations emerged, including:
  --Scaling back the modernization portfolio to better align with IRS 
        and CSC's capacities;
  --Engaging IRS business units to drive the projects with a business 
        focus; and,
  --Improving contractor performance on cost, scheduling, and 
        functionality.
    The assessments also raised a number of other key improvement 
opportunities, including:
  --Adding outside expertise to help manage the program and to 
        complement IRS skills;
  --Strengthening human resources capacity management;
  --Adhering to methodologies in areas such as configuration 
        management, cost and schedule estimating, and contract 
        management;
  --Reducing the burden from oversight organizations;
  --Simplifying the budget process; and,
  --Initiating the testing of the business rules engine on CADE.
    Question. How much more is needed to complete this effort and 
modernize IRS's outdated systems and processes and is the fiscal year 
2005 budget request consistent with that projection?
    Answer. It is virtually impossible to estimate how much more is 
needed to complete the modernization effort and modernize IRS's 
outdated systems and processes. There are just too many unknown 
variables at this time. The IRS has a BSM Expenditure Plan in the 
approval process that includes a proposal on how it plans to allocate 
the $285 million in the administration's fiscal year 2005 budget 
request for the BSM program. This is the first time that the Business 
Systems Modernization Office (BSMO) has forecast so far ahead in an 
Expenditure Plan. The purpose of providing a 2-year plan is twofold. 
First, the goal is to provide key stakeholders with a comprehensive 
understanding of the sequencing of activities and to show the impact of 
changes to the plan across multiple years. Second, the objective is to 
provide enough information in advance so that funding for future fiscal 
years can be made available earlier in the fiscal year. The IRS will 
provide an updated BSM fiscal year 2005 Expenditure Plan in the summer 
of 2004, reflecting any adjustments made during the upcoming months.
    A key component to delivering on the challenge of modernizing 
America's tax system is for the IRS to establish credibility with key 
stakeholders that it is identifying and addressing barriers to 
achieving business modernization success, and to show its constituents 
that it can and will get modernization done ``right.'' The IRS must 
gain the trust of its stakeholders by consistently delivering systems 
on time and within budget, and significantly improving its 
productivity, quality, and effectiveness in building modernized 
systems.
    Getting modernization ``right'' means building systems that meet 
the business needs of tax administration, while delivering tangible 
benefits to taxpayers. The right balance of IRS business leaders are 
now engaging with the modernization technology team to help determine 
how to best apply technology in order to improve service to taxpayers, 
support enforcement activities, and improve compliance.
    Sharing leadership roles requires clarifying responsibilities, 
empowering managers with decision making authority, and holding 
individuals (both contractors and employees) accountable for delivering 
measurable results on time and within budget. The IRS has implemented 
processes and procedures to enable and enforce accountability, such as 
establishing a governance structure, clearly defining roles and 
responsibilities, and defining project milestone requirements.
    Scope growth and unresolved issues can easily derail the best laid 
plans for developing and implementing large, complex, high-risk 
systems. The IRS resized the business systems modernization project 
portfolio, adopted policies to support the prompt escalation of issues, 
and reached an agreement to significantly control discretionary change 
requests. Maturing management processes, strategically driven business 
requirements, and improved project life cycle methodologies will define 
and drive the modernization initiative going forward.
    The IRS has placed an emphasis on increasing the timeliness and 
accuracy of BSM communications to ensure that key stakeholders are well 
informed of program goals and the status of projects against schedule 
and cost targets.
    There is much more work to do, but the Commissioner is committed to 
modernizing the IRS's archaic computer systems. While progress to-date 
has been decidedly mixed, the IRS owes it to taxpayers to stay the 
course and put a solid foundation in place upon which the IRS can build 
for decades to come.
    Question. Please provide an update of all core systems being 
developed. In the update, please provide the original estimated cost of 
each program, the current cost estimate, the original estimated date of 
completion and the new completion date.
    Answer. Response is combined with the response to the subsequent 
question.
    Question. Please provide a list of any core system of the BSM 
program that the IRS has delivered on time and within the original 
budget estimate?
    Answer. The IRS and PRIME have not delivered any BSM projects on 
time and within the original budget estimate. The following describes 
the major projects and includes a table detailing cost and schedule 
variances to date.
Modernized e-File (MeF)
    Modernized e-File Release 1.0, which provides electronic filing for 
the first time ever to large corporations and tax exempt organizations, 
went live in February 2004. MeF provides 53 forms and schedules for 
1120/1120S (corporations) and 990 (tax exempt organization) e-filing. 
It also provides the functionality to support those forms including:
  --applicable interfaces;
  --validation;
  --retrieval and display options;
  --the capability for large taxpayers to file using the internet; and,
  --the capability to use Adobe files.
    Release 1.0 has exceeded project volume for the year after only 2 
months of operation. The project won the Government Solutions Pioneer 
Award from Federal Computer Week Magazine (1 of 15).
    Modernized e-file release 2.0 will include 36 additional forms and 
schedules that are filed with Forms 1120/1120S (corporations) and 990 
(tax exempt organizations). The IRS exited Release 2.0 Milestone 3 
System design in March 2004. The IRS plans deployment for the summer of 
2004. The IRS provides a chart listing the cost and schedule variances 
at the end of this response.
E-Services
    The e-Services project focuses on providing electronic account 
resolution and fostering easy-to-use electronic products and services 
targeted at specific practitioner segments that will inform, educate, 
and provide service to the taxpaying public. In addition, e-Services 
will provide electronic customer account management or Indirect Channel 
Management capabilities to all businesses, individuals, and other 
customers in a safe and secure manner. This project will help the IRS 
move toward the Congressional goal of receiving 80 percent of tax 
returns and information filings by electronic transaction, while 
achieving a 90 percent customer and employee satisfaction rate by 2007. 
Taxpayers who e-file will have the benefit of quicker refunds, more 
accurate transaction processing, and access to an array of new 
electronic services. The IRS has made noticeable improvements in the 
2003 and 2004 filing seasons, with considerable improvement resulting 
from a series of strategic enhancements resulting from a series of 
planned releases late in 2003.
    The IRS has delivered electronic services to tax practitioners, and 
other third parties such as banks and brokerage firms that report 
1099's. The IRS deployed all Release 1.0 and Release 2.0 initial 
operations functionality by the end of April 2004, except for 
Transcript Delivery System (TDS), which will be available in June 2004. 
The IRS conducted additional pilot and performance testing of both 
releases prior to deployment to the broad practitioner community.
    The IRS fully deployed, and made available over the Internet, all 
e-Services Release 1.0 products, including: registration and online 
address change access for third parties and IRS employees through 
secure user portals; Preparer Tax Identification Number (PTIN) online 
application; interactive Taxpayer Identification Number (TIN) matching; 
secure Electronic Return Originator (ERO) application process; and, 
access to e-Services registration and application processes by 
Modernized e-file (MeF) participants.
    E-Services Release 2.0 products are now in production and available 
for use by IRS staff and taxpayers, including: Application for e-Filing 
(external); Electronic Account Resolution (EAR), Electronic TIN Bulk 
Matching (Bulk Requests); Disclosure Authorization (DA); and 
infrastructure support for outbound facsimile service. A chart listing 
cost and schedule variances for the e-Services program is provided at 
the end of this response.
Customer Account Data Engine (CADE)
    The IRS has delayed the CADE program four times. The IRS originally 
scheduled the first release of CADE for delivery in December 2001. The 
IRS then rescheduled it for August 2003 and again for April 2004. The 
IRS recently finalized the re-planning effort for CADE--under a fixed 
price contract--and set the latest delivery date for September 2004.
    While CADE is farther along than the IRS has ever been in replacing 
a component of the master file, there are still major hurdles to 
overcome. The CADE delays stemmed from:
  --Infrastructure upgrades;
  --Failure to understand the complexity and control function combined 
        with poor software quality during the startup of systems 
        integration testing; and,
  --Resolution of operational and performance issues that occurred 
        during an initial release of the pilot.
    The delivery of the CADE project is particularly important because, 
for the first time, it moves taxpayer data from the outdated tape-to-
tape reels into an updated tax administration data and processing 
system that can be accessed and updated in real time. Like the new 
online technical infrastructure that the IRS deployed, CADE is a core 
fundamental component of the modernized systems. As such, CADE is the 
IRS's highest priority technology project. As of May 14, 2 weeks 
remained on 2004 filing season release pilot (Reprocesses cycles 4-8 
from earlier this year). The pilot has gone well. The IRS recently 
signed a fixed-price contract through initial operating capability 
(IOC) and has started work on the 2005 filing season release.
Integrated Financial System (IFS) Release 1
    Like CADE, IFS has been plagued with schedule delays. The IRS 
originally planned to deliver the majority of the first release of IFS 
in October 2003, and the balance in January 2004. The IRS later 
rescheduled it for April 2004. The IRS has subsequently scheduled 
Release 1.0 for October 2004. Delay of the first release of IFS 
occurred because of:
  --The need to make technical changes to comply with the enterprise 
        architecture;
  --The inability to resolve key design and integration issues in a 
        timely manner;
  --Identification of the health coverage tax credit interface 
        requirement late in the development process; and
  --Delays experienced in integration testing due to poor application 
        quality and interface testing issues.
    IFS Release 1.0 will cover core accounting functions such as budget 
preparation, general ledger, accounts payable, accounts receivable, 
financial reporting, and purchasing. Problems continue to seriously 
jeopardize the scheduled delivery of the first release of IFS.
    The IRS is currently negotiating a fixed-price contract for October 
delivery. Testing is behind schedule by 2 weeks and data conversion is 
at risk within the scheduled 6-week window. The IRS lists IFS cost and 
schedule variances in the chart at the end of this response.
Custodial Accounting Project (CAP) Release 1
    The IRS has encountered delays on the first release of the 
Custodial Accounting Project (CAP). This project provides an integrated 
link between the tax administration (revenue) and internal management 
(administrative) financial information. The first release of CAP will 
address revenue from individual taxpayers on initial tax payments. 
Later releases of CAP will address businesses and collections. CAP 
delays resulted from unstable CADE and IFS interface definitions. 
Additional testing time is necessary due to a much larger than 
anticipated volume of data anomalies discovered during the conversion 
of the data from the current individual Master File (IMF), and the time 
required resolving system performance issues.
    In addition, though not directly responsible for CAP delays to 
date, the IRS has made some adjustments to the functionality that it 
needs to have in CAP Release 1 to support the GAO financial audit, as 
well as its internal accounting and management. These adjustments will 
increase the cost of later sub-releases of CAP Release 1. The IRS has 
now completed all testing for CAP Release 1, and is adding changes to 
reflect IMF changes from the start of the 2004 filing season (Release 
1.1). The IRS plans to start production, which includes the initial 
load of IMF data, in mid-August.
    The IRS has scheduled the completion of negotiations of a fixed 
price contract for Release 1.0/1/1 for no later than the end of June. 
Once those negotiations are complete, the IRS will begin negotiating a 
fixed price contract for Release 1.2 (mid-year 2004 changes). The IRS 
lists cost and schedule variance information in the chart at the end of 
this response.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                 Initial Est.   Actual/Revised                     Initial Est. Completion        Actual/Revised Est.         Schedule
            Project                  Cost          Est. Cost     Cost Variance               Date                   Completion Date           Variance
--------------------------------------------------------------------------------------------------------------------------------------------------------
Customer Communications (CC)       $41,110,000     $46,420,000     +$5,310,000   5/31/01....................  2/26/02 (Full Deployment)..  +9 mo.
 2001.
    Improves communications
     infrastructure, including
     telephone call
     management, call routing,
     and customer self-service
     applications.
    Recent Statistics:
        --68,000 calls in one
         3-minute period
         during initial week
        --50 percent reduction
         in waiting time for
         assistor to answer
         call
        --50 percent reduction
         in abandoned calls
        --Number of Spanish
         calls doubled
        --More accurate pre-
         routing of calls
Customer Relationship               $9,313,000      $7,375,000     $(1,938,000)  6/30/02....................  9/30/02 (Full Deployment)..  +3 mo.
 Management Exam (CRM Exam).
    Provides standard tax
     computation software to
     Large & Mid-Sized
     Business Revenue Agents.
    Recent Statistics:
        --Deployed to almost
         4,000 Revenue Agents
        --Software meets 91
         percent of LMSB
         requirements
        --Average case time
         reduced due to new
         automated tax
         computation
        --Improved accuracy in
         computing corporate
         taxes
Security and Technology            $33,734,000     $41,287,000     +$7,553,000   8/31/01....................  1/31/02 (Initial Operation)  +5 mo.
 Infrastructure Release (STIR)
 Release 1.
Internet Refund/Fact of Filing     $13,509,000     $26,432,000    +$12,923,000   7/31/02....................  9/26/03 (Full Deployment)..  +14 mo.
 (IR/FoF).
    Improves customer self-
     service by providing
     instant refund status
     information and
     instructions for
     resolving refund problems
     to taxpayers with
     Internet Access.
    Recent Statistics:
        --17.9 million
         inquiries in 2003,
         19.2 million to date
         in 1994 (1/1/04-4/25/
         04)
        --32 percent of all
         real time IRS
         assistance calls come
         from IR/FoF
        --Modest reduction of
         telecommunications
         costs (about
         $250,000)
        --Every 1,000 IR/FoF
         contacts eliminate
         1,500-2,000 refund
         assistance calls
Human Resources (HR) Connect       $10,000,000     $10,200,000       +$200,000   12/31/02...................  12/31/02 (Initial            N/A.
 Release 1.                                                                                                    Operation).
    Delivers an enterprise
     solution to allow IRS
     employees to access and
     manage their human
     resources information
     online.
    Recent Statistics:
        --75,000 internal
         users
        --Cited by
         Commissioner Everson
         as an enabling factor
         in the redirection of
         approximately 750
         staff years to
         enforcement
        --Treasury was
         selected as 2004
         Computerworld Honors
         Laureate for HR
         Connect development
         and implementation
E-Services....................     $44,045,000    $130,281,000    +$86,236,000   10/31/03...................  4/30/05 (Full Deployment)..  +18 mo.
    Creates a web portal and
     value adding e-Services
     services to promote the
     goal of conducting most
     of the IRS's transactions
     with tax practitioners.
    Recent Statistics:
        --Over 57,000 PTIN
         applications (W7P)
         entered to date; data
         entry productivity
         doubled (from 8/15/03-
         4/21/04)
        --Over 56,000 e-file
         applications to the
         Third-Party-Data-
         Store (TPDS) entered
         to date (from 8/15/03-
         4/15/04)
        --Approximately 23,000
         Registered (and
         confirmed) User
         Portal (RUP) to date
         from (10/14/03-4/21/
         03)
        --4.7 million Bulk TIN
         requests
Modernized e-File (MeF)            $29,246,000     $46,303,000    +$17,057,000   ...........................  ...........................  +4.5 mo.
 Release 1.
    Provides e-filing to large  ..............  ..............  ...............  11/3/03: Assurance Testing.  11/04/03: Assurance Testing  +1 day.
     businesses (1120 family)                                                    12/22/03: Web-Filing.......  2/9/04: Web-Filing.........  +7 weeks.
     and tax exempt                                                              1/9/04: Production.........  2/23/04: Production........  +6 weeks.
     organizations (990
     family).
    Recent Statistics:
       --Went live 2/23/04
       --Over 30,600 returns
        (1120) family accepted
        as of 4/25/04
       --Over 3,109
        participating
        Electronic Return
        Originators as of 4/25/
        04
Customer Account Data Engine       $61,145,000     $97,905,000    +$36,760,000   12/31/02...................  September 2004.............  +21 mo. \1\
 (CADE)--Individual Master
 File (IMF) Release 1.
    Creates authoritative
     computations and stores
     data for individual
     taxpayer accounts and tax
     return information; it
     provides timely complete,
     accurate taxpayer
     information to IRS
     employees.
Custodial Accounting Project       $47,161,000    $119,219,000    +$72,058,000   1/31/03....................  August 2004................  20 mo.
 (CAP) Release 1.
    Provides integrated,
     reliable tax operations
     and internal management
     information to support
     evolving decision
     analytics, performance
     measurement, and
     management information
     needs.
Integrated Financial System        $99,870,000    $153,786,000    +$53,916,000   3/31/04....................  October/November 2004......  7-8 mo.
 (IFS) Release 1.
    Modernizes IRS financial
     management systems by
     providing a single
     general edger for
     custodial and financial
     data and a platform to
     integrate core financial
     data with budget,
     performance, and cost
     accounting data.
Customer Account Management        $57,578,000         TBD \2\         TBD \2\   10/31/04...................  TBD \2\ (Initial Operation)  TBD. \2\
 (CAM) Release 1.
    Delivers an enterprise
     solution to support
     access to tax account
     data, contact management,
     case management, outbound
     correspondence
     management, and workflow
     management.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ CADE, CAP and IFS project schedules are currently under review.
\2\ CAM project work suspended following completion of preliminary design activities ($15,452,000 expended). No further work planned until at least
  fiscal year 2005.

Source: GAO analysis of IRS data contained in Business Systems Modernization (BSM) Expenditure Plans.

    Question. The budget contains an initiative related to Private 
Collection Agencies. Please provide some detail justifying this 
initiative.
    How will taxpayer privacy rights be protected?
    Answer. Private Collection Agencies (PCAs) will be required to 
comply with all taxpayer protections with which IRS employees are 
required to comply, including the provisions of RRA98, and would be 
prohibited from threatening or intimidating taxpayers, or otherwise 
suggesting that enforcement action will, or may be taken, if a taxpayer 
does not pay the liability.
  --In no case would a PCA be permitted to take enforcement action 
        against a taxpayer.
  --PCAs will be required to comply with the Fair Debt Collection 
        Practices Act.
  --Under the proposal, taxpayers would be permitted to seek damages 
        from PCAs and their employees who violate the protections 
        provided.
  --The IRS will approve PCA operational plans that will detail the 
        actions a PCA will take to resolve IRS accounts.
  --The IRS will establish an oversight group with responsibility for 
        managing case referrals, monitoring and evaluating PCA 
        performance against the approved operations plan, and reviewing 
        and approving PCA actions.
  --The IRS oversight function will use live phone monitoring, recorded 
        phone monitoring, review of PCA systems for adherence to 
        operation plans, and on-site reviews to ensure taxpayer rights 
        are fully respected.
    Question. The IRS implemented a similar pilot program in 1996. What 
lessons were learned from that pilot?
    Answer. Implementation Period.--The IRS was required to implement, 
almost from scratch, the pilot program within the year of the 
appropriation legislation.
  --Funding.--The pilot program was funded from the IRS's Tax Law 
        Enforcement appropriation.
  --Processing and Communications.--At the time of the pilot program, 
        IRS computer and communication systems were not adequate for 
        the processing, delivery, and updating of liabilities being 
        handled by the PCAs.
  --Selection of Accounts.--The pilot program required the IRS to place 
        accounts where the IRS had previously made attempts to collect. 
        Consequently, the pilot program involved the referral of many 
        outstanding liabilities to PCAs that did not have realistic 
        collection potential. This resulted in wasted effort by both 
        the PCA and the IRS.
  --Taxpayer Information.--The pilot program overly restricted the 
        amount of information that could be provided to PCAs for 
        purposes of collecting outstanding liabilities. As a result, 
        many debts had to be returned by the PCAs to the IRS due to the 
        PCAs' inability to respond to often-straightforward questions 
        about a taxpayer liability.
  --Contract Structure.--The pilot program involved a fixed-price 
        contract with incentive payments.
    Question. Have those lessons been implemented in the new 
initiative?
    Answer. The administration's proposal reflects the lessons learned 
from the pilot program. The primary issues affecting the success of the 
pilot program, and the manner in which this proposal addresses those 
issues, are set out below.
  --Implementation Period.--In contrast, this proposal has been 
        developed over the past 2 years and has involved discussions 
        between the IRS, Treasury Department, Office of the National 
        Taxpayer Advocate, Department of Justice, and prospective 
        contractors. Moreover, even if authorizing legislation were 
        enacted in the next 6 months, this proposal contemplates that 
        an additional ramp-up period of over a year would be required 
        before the PCA program could begin. This additional time would 
        be required to ensure that the business processes, security and 
        oversight measures, and taxpayer protections are brought on-
        line and fully tested before the program begins.
  --Funding.--The pilot program conducted in 1996/1997 was funded from 
        IRS's Tax Law Enforcement appropriation. Funding in this manner 
        resulted in a net reduction to the IRS compliance resources. In 
        contrast, the administration's proposal to fund PCA activities 
        from proceeds would allow PCAs to supplement, not displace, 
        existing IRS resources.
  --Processing and Communications.--The IRS will invest in modernized 
        Collection Decision and Inventory Management Systems to ensure 
        the successful integration of PCA activities into the IRS 
        collection process.
  --Selection of Accounts.--The IRS, under the administration's 
        proposal, would focus on ensuring that the outstanding 
        liabilities referred to PCAs are those that not only are within 
        the authority of the PCA to resolve but also represent cases 
        with the greatest likelihood of payment if a PCA were to handle 
        the liability.
  --Taxpayer Information.--Under the administration's proposal, PCAs 
        would have access to specific information regarding an 
        outstanding tax liability (e.g., type of tax, tax years 
        affected, dates of assessment, whether the assessment is based 
        on a taxpayer's own balance due return or an IRS notice, prior 
        payments, and application of prior payments) in order to answer 
        basic, but important, questions that a taxpayer may have 
        regarding the liability. The taxpayer information that would be 
        provided to PCAs would be strictly limited to the information 
        required for the collection of the specific tax liability at 
        issue. PCAs would not receive, for instance, information 
        regarding a taxpayer's total or adjusted income, sources of 
        income, delinquency history for liabilities not being handled 
        by the PCA, or employer information.
      All existing restrictions imposed by section 6103 of the Code 
        would apply to the PCAs, and taxpayers would have the right to 
        assert a claim against PCA employees who violate those 
        protections.
  --Contract Structure.--The administration's proposal would involve a 
        competitive, fee-for-service, performance-based, incentive 
        contract structure. The performance evaluation would be based 
        on a balanced scorecard that would look to quality of service, 
        taxpayer satisfaction, and case resolution, in addition to 
        collection results.
      The allocation of accounts among the PCAs participating in the 
        program would be based on this performance evaluation, thereby 
        providing a further incentive for PCAs to respect all taxpayer 
        rights and protections. This compensation structure is modeled 
        on the successful FMS and Department of Education contracts.
  --Oversight.--The administration's proposal would involve extensive 
        IRS oversight of the PCAs participating in the program. This 
        IRS oversight would ensure that procedures are followed, and 
        that any issues are identified and resolved early.
    Question. How much outstanding tax debt owed to the Federal 
Government is likely to be collected if this initiative moves forward?
    Answer. The Treasury Department has estimated net revenue will 
total $1.5 billion over 10 years. The gross revenue collected in the 
Treasury calculations is $1.9 billion over 10 years.
    Question. The Customer Account Data Engine (CADE) is the 
centerpiece of the modernization effort. It holds the promise of moving 
the IRS from the tape driven system of the 1960's to a modern reliable 
database.
    What needs to occur to make this plan a reality for the IRS?
    Answer. As you have so appropriately noted, the delivery of the 
CADE project is particularly important because--like the new online 
technical infrastructure that the IRS deployed--CADE is a core 
fundamental component of the modernized systems. As such, CADE is the 
IRS's highest priority technology project.
    The first release of CADE is scheduled for delivery in September 
2004. The IRS has 2 weeks remaining on the fiscal year 2004 filing 
season release pilot. The pilot has gone well. The IRS is scheduled to 
go into initial production operation sometime in July or August under a 
fixed price contract through initial operating capacity.
    Question. What has caused the 30-plus month delay in the delivery 
of Phase 1 of this system?
    Answer. The CADE delays stemmed from infrastructure upgrades, 
initial poor software quality during the startup of systems integration 
testing combined with the failure to understand the complexity of 
balance and control, and the resolution of operational and performance 
issues that occurred during Phase 3 of the Release 1.0 pilot.
    Question. Why has the estimated cost gone from $61,145,000 to 
$97,905,000? When can the committee expect a delivery of Phase 1? What 
is the IRS doing to control the massive cost increases to this system?
    Answer. CADE Cost Overrun (from the original estimate of 
$61,145,000 to $97,905,000).--The description below explains the costs 
that GAO reported in their Audit of the fiscal year 2004 Expenditure 
Plan:
Design Work from September 2000 to July 2001
    $15.3 million--initial estimate in March 2000 Expenditure Plan.
    $19.3 million--actual cost.
    $4.0 million--variance due to design period being extended by 3 
months to add detail in some areas and to bridge to Development.
Development Work from July 2001 to March 2004
    $40.0 million--initial estimate in March 2001 Expenditure Plan.
    $53.6 million--actual cost.
    $13.6 million--$9.3 million of the variance was due to a 2-month 
extension for a Pilot using real tax returns (cost of $5.3 million) and 
the addition of capacity at the Martinsburg Computing Center to support 
Development and Testing (cost of $4.0 million). The remaining variance 
of $4.3 million was due to incurring the cost impact of delays (see 
first two items outlined below).
Cost Impact of 2-Year Delay in Delivering CADE
    $2.4 million--hiring of non-PRIME contractors to support IRS 
testing.
    $1.9 million--establishing a CADE Program Office (work to build an 
organizational framework to support multiple CADE releases 
simultaneously).
    $18.0 million--cost to apply tax law and other changes for 2003 and 
2004 filing season.
    These costs do not reflect any changes since the GAO audit of the 
fiscal year 2004 Expenditure Plan.
    Question. Please provide the committee with an update of the 
review.
    Answer. The IRS used the results from independent studies 
commissioned during the summer of 2003 to create a BSM Challenges Plan 
comprised of 40 some action items. Given the strategic importance of 
the plan, the Commissioner appointed an IRS business unit deputy 
commissioner to oversee the implementation of the plan.
    As a first step, the BSM project team developed a crosswalk to 
ensure that the BSM Challenges Plan's definition of the issues 
addressed and/or satisfied all of the recommendations from the four 
commissioned studies as well as the recommendations submitted by the 
IRS Oversight Board, and the Software Engineering Institute (SEI) study 
of CADE.
    While the deputy commissioner made significant progress in 
implementing the plan, the full closure of all actions items was 
unrealistic within the elapsed timeframe of the 6-month appointment. 
Concurrently, the CIO created a new direct report position for 
modernization management and assigned responsibility for implementing 
the plan to the individual recently hired into this newly created 
position.
    Under the leadership of the deputy commissioner, the IRS and CSC 
team brought closure to several key actions items, including: 
clarifying the roles of committees as advisory, identifying 
``blockers'' on contracting issues, appointing business leaders to each 
project, establishing a risk-adjusted schedule and new baseline for 
CADE Releases 1.0 and 1.1, and increasing the frequency of CADE reviews 
with the business owner to twice monthly. The majority of the action 
items are still works-in-progress, some of which will take time to 
fully complete. Others will span the life of the BSM program.
    For example, strengthening systems engineering capabilities by 
hiring external candidates will take time since it involves conducting 
the searches, interviewing the candidates, and negotiating the new 
hires to come on board. The IRS and CSC developed ground rules for 
escalating issues, but they will need to be continually enforced 
throughout the life of the program. The IRS rewrote the charters of the 
governing committees to reflect their advisory role and clearly 
articulated their responsibilities, however, it will probably take a 
year to truly evaluate and measure their effectiveness.
    As stated, the IRS has made progress toward closing all the action 
items, but it has much more work to do in critical areas. For example, 
the IRS needs to religiously follow the proper methodologies and hold 
people accountable if they do not. The IRS must start ``doing things 
right'' as opposed to ``doing things fast'' such as exiting milestones 
prematurely. An ongoing challenge will be balancing the scope and pace 
of projects consistent with capacity, ensuring that the right people 
are in place before launching a project, and setting realistic delivery 
schedules and cost estimates. The IRS is committed to staying-the-
course and delivering on its promise to modernize America's tax 
systems, but it is important for everyone to acknowledge this is a 
monumental effort.
    The magnitude and evolution of the BSM program dictates that the 
IRS will always be going through an evolution of assessment and 
improvements. In that regard, the BSM Challenges Plan is still evolving 
and the IRS is using certain action items to continuously improve the 
program.
    Question. What changes need to be implemented to get this mission 
critical system back on track?
    Answer. As a result of missing CADE and IFS key deliverables last 
summer, the Commissioner and CSC commissioned external assessments 
studies from outside experts. The studies produced no major surprises; 
but the IRS now understands more about the issues. All of the 
assessments confirmed that the IRS modernization effort is a massive, 
highly complex, high-risk program that is confronting a number of 
critical management and technological challenges. These studies also 
made it clear that the IRS should not turn back, but rather make a 
series of changes to strengthen the BSM program.
    While all of these studies assessed different components of the 
modernization program, three major recommendations emerged including:
  --Scaling back the modernization portfolio to better align with IRS 
        and CSC's capacities;
  --Engaging IRS business units to drive the projects with a business 
        focus; and
  --Improving contractor performance on cost, scheduling, and 
        functionality.
    The assessments also raised a number of other key improvement 
opportunities, including:
  --Adding outside expertise to help manage the program and to 
        complement IRS skills;
  --Strengthening our human resources capacity management;
  --Adhering to methodologies in areas such as configuration 
        management, cost and schedule estimating, and contract 
        management;
  --Reducing the burden from oversight organizations;
  --Simplifying the budget process; and
  --Initiating the testing of the business rules engine on CADE.
    The Software Engineering Institute (SEI) will periodically review 
the CADE program, and a third party (MITRE) will regularly assess the 
overall health of the modernization program reporting directly to the 
CIO.
    The IRS committed to scaling back the modernization efforts to 
better match its management capacity as well as the PRIME's, and to 
focus on the most critical projects and initiatives. The IRS reduced 
the size and scope of the modernization program considerably, and has 
initially developed a human resource capacity planning model to help 
ensure the right people, with the right skills, are dedicated for the 
right amount of time to each IT project it undertakes.
    The Commissioner is holding IRS senior business unit managers 
accountable for the success of modernization efforts as it relates to 
defining, developing, and controlling business requirements. For 
example, the involvement and leadership of the Deputy Commissioner for 
Wage and Investment played a key role in the successful delivery of 
Modernized e-File.
    It was evident that CSC, as the PRIME contractor, needed to 
significantly improve their performance. While CSC has improved their 
performance somewhat, delays and cost increases persist, as evidenced 
by the continual delays in delivering CADE, IFS, and CAP. As a result, 
the IRS will expand the competition for the new enforcement projects 
that it plans to start later this year and next year. The IRS is also 
moving to capped or fixed price contracts for development work to 
balance the financial risk between the Government and the contractor in 
modernization projects.
    The IRS needs a more versatile team of seasoned executives to 
provide long-term stability to the program. It is complementing the 
skills of experienced IRS tax executives with outside seasoned 
technology executives who have experience managing large-scale, complex 
IT projects. As such, the IRS is hiring two Associate Chief Information 
Officers to join the MITS organization, and an executive search firm is 
conducting searches for five senior executives with a wide range of 
diverse experience in developing and implementing large modernization 
systems.
    The IRS has placed an emphasis on increasing the timeliness and 
accuracy of BSM communications to ensure that key stakeholders are well 
informed of program goals and the status of projects against schedule 
and cost targets.
    There is much more work to do, but the IRS is committed to 
modernizing its archaic computer systems. While progress to-date has 
been decidedly mixed--the IRS owes it to the taxpayers to stay-the-
course and put a solid foundation in place upon which the IRS can build 
for decades to come.
    Question. The committee understands that the E-Services program is 
expected to be fully operational by fiscal year 2005. Is this program 
still on schedule? What has occurred to make this project cost go from 
$44,045,000 to $130,281,000? Why is it 18 months behind schedule?
    Answer. The IRS has achieved a great deal of success with the e-
Services project. The IRS has delivered electronic services to tax 
practitioners, and other third parties such as banks and brokerage 
firms that report 1099s. The IRS deployed all Release 1.0 and Release 
2.0 initial operations functionality by the end of April 2004. The IRS 
conducted additional pilot and performance testing of both releases 
prior to deployment to the broad practitioner community. The response 
has been extremely positive.
    In March 2004, James D. Leimbach appeared before the Ways & Means 
Oversight Subcommittee on behalf of the National Association of 
Enrolled Agents (NAEA) and said, ``This new capability is truly going 
to revolutionize the way we conduct future business with the IRS. The 
ultimate beneficiary is the American taxpayer. We are truly amazed and 
thrilled beyond description at this way of doing business with the IRS, 
and we would like for you to understand why we feel as we do.''
    All e-Services Release 1.0 products are fully deployed and 
available over the Internet, including:
  --Registration and online address change access for third parties and 
        IRS employees through secure user portals;
  --Preparer Tax Identification Number (PTIN) online application;
  --Interactive Taxpayer Identification Number (TIN) matching for 
        payers and/or authorized agents who submit any of six 
        information returns subject to backup withholding (Forms 1099-
        B, INT, DIV, OID, PATR, and MISC);
  --Secure Electronic Return Originator (ERO) application process; and
  --Access to e-Services registration and application processes by 
        Modernized e-file (MeF) participants.
    E-Services Release 2.0 products are now in production and available 
for use by IRS staff and taxpayers, including:
  --Electronic Account Resolution (EAR);
  --Electronic TIN Bulk Matching (Bulk Requests);
  --Disclosure Authorization (DA); and
  --Infrastructure support for outbound facsimile service.
    Statistics gathered as of May 13, demonstrate that the e-services 
program is providing important benefits for taxpayers and tax 
practitioners:
  --No. of Individuals registered=24,000;
  --No. of Individuals changing address during registration=3,000;
  --No. of Interactive TIN Match requests=221,000;
  --Bulk TIN Requests=4.7 million.
    There were five main causes for the schedule delays and cost 
increases from $44,045,000 to $130,281,000.
    Budget Omission for Infrastructure Functionality/Acquisition ($8-9 
million).--The original project budget failed to consider the 
integration of the e-services application with the modernized 
infrastructure or budget for the acquisition of specific hardware or 
software to support e-Services development and production environments.
    Extended Testing and Infrastructure Integration ($15-17 million).--
The quality of the software that CSC and Unisys delivered to the IRS 
for e-Services was lower than anticipated and the time it took to 
resolve each of the errors took longer than anticipated. In addition, 
there was a series of actual integration issues between the application 
and the infrastructure that were greater in number and took longer than 
anticipated to resolve.
    Modernized e-file 1040 e-file support ($4-6 million).--In reviewing 
the proposed design for the Modernized e-file project, it was 
discovered that the project plan called for a system that would not be 
multifunctional. The IRS developed an alternative plan to expand e-
Services functionality to provide these services for Modernized e-file 
in a manner that was consistent with the Enterprise Architecture, which 
describes the business and information systems and technical 
infrastructure that are both in place (Current) and planned (Target). 
In addition, the Enterprise Architecture defines the architectural 
strategies to be followed and prescribes standards and technologies to 
be used.
    IRS Initiated changes including filing season changes ($8-10 
million).--Due to the fact that it took longer than anticipated to 
build the e-Services system, the IRS made a number of significant 
changes to ensure that the e-Services system was consistent with filing 
season requirements and current production changes.
    Extension of MS5 and a misestimate of MS5 costs ($45-48 million--
increased estimates for costs through 9/30/05).--Because the e-Services 
project ran over cost and schedule estimates, the IRS deployed the 
project using version 8.1 Peoplesoft, CRM. Peoplesoft will stop 
maintenance of this version of the software in 2005. The IRS must 
upgrade the production system to conform to latest Peoplesoft CRM 8.8 
release. Due to the complexity of the upgrade, the BSM program had to 
make the changes before turning it over to ITS for operations and 
maintenance. The BSM program was originally scheduled to turn the e-
Services project over in May 2004. The program will now be maintaining 
and upgrading the system a year longer, until May 2005.
    Question. Of the ten computer modernization projects ongoing as of 
September 2003, nine are currently over their original cost estimate by 
a total of $292,013,000.
    What needs to occur for the IRS to better monitor the escalating 
costs of these systems?
    What types of oversight does the IRS provide over the contracts for 
development and acquisition of these projects?
    Answer. The IRS is currently putting in place several control 
mechanisms for Contractual, Enterprise Life Cycle, Earned Value 
Management, Performance and Cost and Schedule Estimating that directly 
address the estimate overruns. In particular, the IRS is enacting 
methodologies that will eliminate future ``escalating costs.''
    The IRS has been working jointly with MITRE and CSC (the PRIME 
Contractor) to improve cost and schedule estimating capability. The IRS 
is using the well-recognized Carnegie Mellon Software Engineering 
Institute's (SEIs) Requisites for Reliable Estimating Processes as a 
guide. The requisites provide for development and execution of the 
following key cost and schedule estimating objectives:
  --Maintaining historical data;
  --Structured estimating processes;
  --Mechanisms for extrapolating estimates from successful past 
        projects;
  --Audit trails; and
  --Ensuring integrity in dealing with dictated costs and schedules.
    Both CSC and the IRS have made significant progress towards 
achieving these key objectives. The IRS has implemented procedures for 
validating contractors' estimating systems and for reviewing cost and 
schedule estimates. The procedures provide guidance for evaluating 
reliability of documentation supporting individual estimates and for 
tracking compliance with sound estimating practices. Furthermore, the 
procedures also address professional development of personnel with the 
right skill set for developing and evaluating cost and schedule 
estimates. CSC has established a historical database, calibrated 
estimating models and developed detailed requirements for documenting 
and supporting bases of estimates along with related guidance and 
directives. Work is also in progress for continuing refinement and 
improvement in each of these elements.
    In addition, joint training is being conducted for IRS, CSC and 
MITRE personnel as an integral part of the overall plan to ensure 
competent deployment of improved processes and procedures. The IRS, 
with MITRE's assistance, recently completed a review of CSC's 
estimating system. The IRS is finalizing the results and will issue 
them in a report in the latter part of June. In general, there have 
been improvements. The report will include a time phased corrective 
action plan for addressing deficiencies. To ensure the tools, guidance, 
processes and procedures are part of a mature repeatable process, a 
concerted effort is underway to fully validate all aspects of the 
processes and procedures prior to official roll-out within the IRS. 
This pilot program is intended to verify the soundness of the processes 
and procedures and provide lessons learned, before full implementation 
is effected.
    Every effort is being made to hire qualified staff and fully 
implement improved tools, guidance, processes and procedures as soon as 
possible. However, this is taking more time than the IRS would like. 
This is a pervasive problem on programs of the size and complexity of 
the modernization initiative. Nonetheless, the IRS believes that there 
will be evidence of increased accuracy by the end of fiscal year 2004 
and continued improvements over time.
    Finally, all of these efforts are part of a highly visible set of 
plans geared to identifying, tracking, reporting, and reviewing the 
critical cost and schedule estimating commitments with IRS Executive 
Management and GAO/TIGTA.
    The following initiatives have been implemented (or are pending) to 
improve performance in the other areas:
  --Application of Performance-Based Contracting (PBC) Techniques.--
        Applying performance-based contracting techniques and 
        leveraging lessons learned enhances the IRS's ability to 
        proactively establish expectations for and manage the PRIME 
        contractor's performance.
  --Determination of Task Order for Acquiring Modernization Systems.--
        To further improve modernization controls and capabilities, the 
        IRS has established and is implementing a process for 
        determining the type of task order to be awarded when acquiring 
        modernization systems. The IRS issued a policy stating that 
        contracts and task orders for the BSM projects in Milestones 4 
        and 5 (development and deployment) will be fixed price, as 
        appropriate. This type of task order will shift most or all 
        risks from the IRS to the PRIME.
  --Implementation of Fixed Price Contracting Policy.--The IRS's 
        Contracting organization and the Enterprise Life Cycle program 
        are developing a joint approach to implement the fixed price 
        contracting policy.
  --Identification of Issues and Tracking Progress.--The IRS is making 
        use of Earned Value Management, Program Performance 
        Measurements, and a sophisticated electronic analysis and 
        reporting mechanism (the Dashboard) to track progress, identify 
        variances early, and facilitate escalation of issues early in 
        the life cycle.
  --Development of Metrics.--Finally, the Program Performance 
        Management Office (PPMO) is developing efficiency and outcome 
        metrics to:
    --decrease contracted program variances,
    --decrease requirements volatility, and,
    --increase contracted requirements delivery.
    These metrics support program management effectiveness, and provide 
the ability to assess achievement of program performance goals relative 
to cost, schedule, requirements scope, and requirements delivery.

                            FUEL TAX EVASION

    Question. The Federal Highway Administration (FHWA) Motor Fuel Tax 
Evasion Project supports Federal and State efforts to enhance motor 
fuel tax enforcement. The program was established by the Intermodal 
Surface Transportation Efficiency Act of 1991 (Public Law 102-240) and 
continued under the Transportation Equity Act for the 21st Century 
(TEA-21) (Public Law 105-178).
    Since 1998, the Department of Transportation has provided the 
Internal Revenue Service (IRS) $31 million from Highway Trust Fund 
revenues to enhance motor fuel tax enforcement, primarily by developing 
and operating an automated excise fuel tax reporting system, the Excise 
Fuel Information Reporting System (ExFIRS). The administration's 
proposed Safe, Accountable, Flexible and Efficient Transportation 
Equity Act (SAFETEA) of 2003 includes $163 million for the IRS through 
fiscal year 2009, and the Surface Transportation Authorization bill as 
passed by the Senate proposes about $300 million.
    The IRS has been struggling to modernize its automated systems. For 
example, the committee has been told that Commissioner Everson excluded 
one contractor from a project to update the IRS's tax enforcement 
systems after learning the contractor would miss an April deadline for 
putting in a new general ledger accounting system.
    How is ExFIRS currently being used to enhance motor fuel tax 
enforcement and what are its capabilities? Is the system fully 
operational and functioning as envisioned? If not, what is needed to 
complete the systems development effort?
    Answer. ExFIRS is an umbrella system made up of several subsystems/
modules that support the collection of motor fuel industry information, 
support automated analysis of this information, and help identify areas 
with the highest risk for non-payment of excise tax liabilities 
(therefore offering higher potential for return on investigative and 
enforcement activities). The most important of the subsystems is the 
Excise Summary Terminal Activity Reporting System (ExSTARS), which 
tracks all petroleum movements, in and out, through approved terminals, 
and captures information that the IRS shares with State taxing 
agencies.
    ExSTARS is the information reporting system that was designed 
similar to the IRS 1099 matching system that matches information 
received from employers, financial institutions and other businesses 
with information reported by taxpayers. It enables the IRS to track all 
reported fuel transactions that occur within the fuel industry's bulk 
shipping and storage system. It provides tracking capabilities of fuel 
from the pipeline/barge delivery system to the point of taxation for 
the Federal Excise Tax at the terminal. This information is then 
matched by the IRS to fuel sales transactions reported by taxpayers and 
to verify their tax liabilities reported on the quarterly Forms 720.
    ExSTARS was operational on April 1, 2001. However, the large volume 
of paper returns filed each month has hampered the maximum use and 
benefit of the system. ExSTARS requires information reporting from over 
1,400 terminals registered to transact fuel sales in this country, as 
well as the pipelines and barge carriers that transport the fuel from 
the refineries to the terminals. The IRS receives information reports 
on 10 to 14 million fuel transactions monthly. Approximately 70 percent 
of these are filed electronically. Working with the remaining 30 
percent filed on paper documents is both impractical and cost 
prohibitive. Senate Bill S. 1072, the Safe, Accountable, Flexible, and 
Efficient Transportation Equity Act of 2004 (SAFETEA), would require 
electronic filing of any return containing more then 25 transactions, 
as proposed in the administration's SAFETEA bill. This legislation, if 
passed, will greatly enhance the tracking capabilities of ExSTARS.
    ExFIRS includes a Data Warehouse module that interfaces with 
ExSTARS. This module uses the information reported in ExSTARS, on the 
distribution of fuel, to match against the reported amounts on 
taxpayer's 720 Excise Tax Returns. ExFIRS also includes legacy systems 
that the IRS used to track and monitor compliance in the motor fuel 
area. The Excise Tax Registration Authentication System (ExTRAS) 
contains the monitoring system for the registration program of 
taxpayers allowed to carry on tax free transactions within the fuel 
distribution system. The Excise Fuel On-line Network (ExFON) is the 
management information system used to monitor the Dyed Fuel Program. 
The IRS included these systems in the ExFIRS Program because they are 
an integral part of the motor fuel tax program and must be included in 
the IRS's tracking of activities that impact compliance in this area. 
The funding for the update and enhancement of these systems came from 
IRS operating funds. These systems have been operational for several 
years and the updated versions are in place and operating within the 
ExFIRS Program. The Excise Tax Agent Work Center (ExTAC) is an 
automated work center that will enable IRS Excise Tax Agents to receive 
tax returns in electronic format and to conduct examinations in an 
automated environment. ExTAC is a part of ExFIRS and will receive 
information from the system to assist in the examination of returns. 
ExTAC was funded by the IRS and is currently a working prototype 
version. The system will be in full production and used by agents by 
the end of the first quarter of fiscal year 2005.
    Question. Given the problems IRS has experienced fixing its other 
automated systems, what reasonable assurance can you provide this 
committee that taxpayers are getting a good return on their investment 
in ExFIRS and that the project is being properly managed?
    Answer. In 1998, Congress passed the Transportation Equity Act for 
the 21st Century, requiring the IRS to develop a fuel tracking system. 
This act required the IRS to use an outside contractor for the 
development and maintenance of the system. The IRS has met this 
requirement, and is using Software Engineering Institute (SEI) CMMI 
Level 2 development processes to manage the development efforts of the 
contractor and subcontractor personnel in order to ensure a continuous, 
uninterrupted, integrated approach to the development, installation and 
implementation of the ExFIRS subsystems.
    As stated above, the ExSTARS module of ExFIRS was operational April 
1, 2001. The design and development of this system was a joint effort 
between the IRS, industry and the States. The IRS is using the system, 
but the ability to date to maximize the effectiveness has been limited 
by two factors.
    Due to the high volume of paper returns that contain thousands of 
individual transactions, the IRS only captures summary information from 
paper returns. This limits the IRS's ability to meet the goal of 
matching ExSTARS information to filed Excise Tax returns.
    The filing requirements for ExSTARS required a significant 
investment for the fuel industry and at the time of ExSTARS becoming 
operational, some companies were not fully prepared to meet all of the 
filing requirements. Since April 1, 2001, the IRS has worked closely 
with industry filers to ensure accurate and timely filing of the 
information returns required for the operation of ExSTARS. The IRS 
formed a Data Perfection Team composed of IRS personnel along with 
outside contractors to work with and assist individual companies meet 
their filing requirements. Although the IRS has made great progress 
this area, some companies are still experiencing problems. The IRS has 
made a decision to continue to work in a cooperative manner with all 
companies that demonstrate a desire to address their problems and come 
into compliance with the ExSTARS filing requirements.
    The IRS is using the system today. It has the ability to track the 
movement of fuel in all States--but within the limitations of the 
problems outlined above. If the issue of paper returns is addressed, 
the IRS will be able to match individual filers to the ExSTARS 
database. This will enable the IRS to better determine where to 
allocate its enforcement resources to combat fuel tax non-compliance. 
This same information will allow States that have the same tax point as 
the Federal Excise Tax to ``piggyback'' on this data to enhance their 
own compliance efforts.
    On the question of the return on investment to the American 
taxpayers, one needs to look at the effectiveness of information 
reporting for compliance with income taxes. Matching information 
received from employers, financial institutions, and other businesses 
with information reported by taxpayers has long been recognized as one 
of the most powerful tools that the Internal Revenue Service has used 
to ensure income tax compliance. In fact, third parties report 
approximately 80 percent of the personal income received by taxpayers. 
Through its document matching programs, the Internal Revenue Service is 
able to use this data as an effective compliance tool. The ExFIRS 
Program will deliver the same effectiveness to the Excise Fuel Tax 
arena. The information gathered by the ExFIRS Program will be shared 
with all State motor fuel taxing agencies and will lead to increased 
compliance for the States. The States will directly benefit from the 
increased revenues that will be generated by a higher level of 
compliance in both the Federal and State areas.
    Question. How were systems requirements determined and were other 
Federal and State law enforcement agencies involved in defining the 
requirements?
    Answer. The design, development, and implementation of ExSTARS is a 
result of a working collaboration between the Internal Revenue Service, 
Contractors, Federal Highway Administration, State tax administrators, 
and industry stakeholders over more than a 5-year time period. A key 
goal in the development process was to create a system that would 
benefit State revenue agencies as well as the IRS. The system uses the 
Uniform Reporting Standards developed by the States to ensure all data 
is compatible with State systems. The Excise Tax On-line Exchange 
(ExTOLE) module was developed specifically for use by the States. 
ExTOLE allows States to exchange data that relates to motor fuel tax 
issues.
    Question. What is the total cost of ExFIRS to date? What is the 
cost, funding, and schedule status of any development effort still 
needed for the system? What is the annual cost to operate and maintain 
the system?
    Answer. The IRS and FhWA have provided funding for ExFIRS. The IRS 
funding is used to cover the incorporation of legacy system into 
ExFIRS. The two charts below show the cost to date:

                                                                FHWA ExFIRS EXPENDITURES
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Fiscal Year      Fiscal Year     Fiscal Year      Fiscal Year     Fiscal Year
                   Cost Categories                          1999            2000             2001            2002             2003            Totals
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial Distribution from FHWA......................      $9,430,000       $7,923,000      $4,479,000       $4,609,000      $4,739,000      $31,180,000
Budget Reduction from FHWA..........................        (180,000)  ..............         (11,000)  ..............         (32,500)        (223,500)
Total Available for Project.........................       9,250,000        7,923,000       4,468,000        4,609,000       4,706,500       30,956,500
Contractors.........................................       6,151,747        4,237,216       3,913,663        3,938,222       2,922,850       21,163,698
Labor...............................................         517,849          943,910  ...............         114,489  ...............       1,593,948
Training............................................          20,615           33,270          85,320          112,165          96,653          348,023
Travel..............................................         521,052          968,000  ...............         165,000         287,610        1,941,662
Background Investigations...........................  ...............          32,175          20,000            4,000           5,425           61,600
Hardware............................................       1,871,037          772,693          89,015          108,315         271,358        3,112,418
Software............................................  ...............         769,676         146,079           13,819         918,060        1,847,634
Maintenance.........................................  ...............           2,000          28,140            2,990          54,544           87,674
Criminal Investigation Division.....................         150,000          150,000         150,000          150,000         150,000          750,000
Telecom.............................................  ...............          14,060          35,783   ..............  ...............          49,843
                                                     ---------------------------------------------------------------------------------------------------
      Total Spent on Project........................       9,232,300        7,923,000       4,468,000        4,609,000       4,706,500       30,956,500
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                 IRS ExFIRS EXPENDITURES
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                       Fiscal Year      Fiscal Year     Fiscal Year      Fiscal Year      Fiscal Year
                  Cost Categories                          1999            2000             2001             2002             2003            Totals
--------------------------------------------------------------------------------------------------------------------------------------------------------
Initial Request from IRS...........................      $2,510,000       $2,101,000      $3,758,000       $5,204,000       $9,106,000      $22,679,000
Budget Reduction from IRS..........................         (92,338)  ..............      (1,037,469)      (3,406,000)      (7,220,000)     (11,755,807)
Total Available for Project........................       2,417,662        2,101,000       2,720,531        1,798,000        1,886,000       10,923,193
Contractors........................................       1,173,062        2,077,039       2,720,531        1,319,000        1,886,000        9,175,632
Labor..............................................  ...............  ..............  ...............  ...............  ...............  ...............
Training...........................................  ...............  ..............  ...............  ...............  ...............  ...............
Travel.............................................  ...............  ..............  ...............  ...............  ...............  ...............
Background Investigations..........................  ...............  ..............  ...............  ...............  ...............  ...............
Hardware...........................................         967,462            8,000  ...............          62,000   ...............       1,037,462
Software...........................................         149,998           15,961  ...............  ...............  ...............         165,959
Maintenance........................................         127,140   ..............  ...............         417,000   ...............         544,140
Criminal Investigation Division....................  ...............  ..............  ...............  ...............  ...............  ...............
Telecom............................................  ...............  ..............  ...............  ...............  ...............  ...............
                                                    ----------------------------------------------------------------------------------------------------
      Total Spent on Project.......................       2,417,662        2,101,000       2,720,531        1,798,000        1,886,000       10,923,193
--------------------------------------------------------------------------------------------------------------------------------------------------------

    In addition, here are spreadsheets detailing future development, 
maintenance and operating cost through fiscal year 2006. Funding is 
provided each year to assist the IRS CI in their efforts on motor fuel 
issues.

         ExFIRS SUPPORT CONTRACTOR COST ESTIMATES BY FISCAL YEAR
                        [In thousands of dollars]
------------------------------------------------------------------------
                                 Fiscal Year   Fiscal Year   Fiscal Year
  ExFIRS SW Develop/Enhance/      2004 Oct      2005 Oct      2006 Oct
 Maint Via TIPSS Type Contract    2003-Sep      2004-Sep      2005-Sep
                                    2004          2005          2006
------------------------------------------------------------------------
ExFON Dev/Maint/Enhancement            700.8         790.4         160.0
 (includes Legacy Maint, New
 ExFON Dev In Web Envir and
 Data Migration)..............
ExSTARS Dev/Maint/Enhancement        2,945.0       1,594.2         400.8
 (includes Maint of ExSTARS 1
 and Dev/Maint of ExSTARS 2)..
ExTRAS Dev/Maint/Enhancement            80.0         372.8         160.0
 (includes legacy maint and
 development in Web
 environment).................
BTRIS Dev/Maint/Enhancement            424.0       1,118.2         225.0
 (includes maint of current
 BTRIS and development of the
 Analyst Module)..............
ExCIDS Dev/Maint/Enhancement           190.6       1,182.7         120.0
 (includes devel of case mgt
 and workflow modules)........
ExTAC Dev/Maint/Enhancement            770.8         691.2         320.0
 (includes maint of current
 system, development of GM
 module, and migration to Web
 environment).................
ExTOLE Maint/Enhancement                80.0         160.0         120.0
 (includes maint of current
 system and development of
 enhancements called out in
 SOW).........................
ExMIS Dev/Maint/Enhancement            546.0         597.1         120.0
 (includes DW and ExCIS maint
 and analysis/reporting
 enhancements)................
Common Costs Associated with         2,466.2       2,476.1       1,866.4
 all Subsystems (includes Prog
 Mgt, Sys Engr, CM, QA,
 Testing, SEI/CMM, Security,
 Subcontract Mgt, travel
 expenses, etc.)..............
Infrastructure Costs--See            3,779.0       3,789.0       3,568.0
 Infrastructure sheet
 (includes SW/HW Upgrades/
 Migrations, Tier 2 and
 Modernization Requirements,
 COTS and SW Licenses/
 Maintenance, Technology
 Advancements, Service Center
 Support, etc.)...............
                               -----------------------------------------
      Subtotal................      11,982.4      12,771.7       7,060.2
                               -----------------------------------------
FhWA Funding at Current Rate..       4,200.0       4,200.0       4,200.0
Projected Need................       7,782.4       8,571.7       2,860.2
IRS Funding Allotted..........       4,959.0       4,250.0       3,453.0
Funding Shortfall.............       2,823.4       4,321.7        -592.8
------------------------------------------------------------------------


           ExFIRS INFRASTRUCTURE COST ESTIMATES BY FISCAL YEAR
                        [In thousands of dollars]
------------------------------------------------------------------------
                                 Fiscal Year   Fiscal Year   Fiscal Year
     ExFIRS Infrastructure        2004 Oct      2005 Oct      2006 Oct
           Estimates              2003-Sep      2004-Sep      2005-Sep
                                    2004          2005          2006
------------------------------------------------------------------------
Annual COTS Licenses, Yearly           656.0         637.0         668.0
 Maintenance and New User
 Licenses (Oracle,
 Informatica, Paper Free,
 Mecator, Business Objects,
 MapInfo, FileNet, Ventica)...
ExFIRS SW Migrations for New           924.0         236.0         970.0
 RDBMS/OS/COTS (Oracle/Sun/
 NT). Major migration every
 other year (even years)......
Tier 2 Requirements (New CM            231.0         243.0         100.0
 tool, additional security,
 move to Tier 2 infrastructure
 and web page compliance--
 508J)........................
ExFIRS Harware Migrations              236.0         892.0         248.0
 (production, development, and
 test servers/user desktops,
 laptops and handheld devices/
 gateway firewalls and routers/
 technology upgrades). Major
 upgrade every other year (odd
 years).......................
ExFIRS Service Center Expenses         982.0       1,031.0       1,082.0
 (SA/DBA personnel and
 training covered by SLA--9.9
 staff years).................
Other ExFIRS Expenses (SW              750.0         750.0         500.0
 upgrades for technolgy
 advancements, new user
 functionality and IRS
 modernization initiatives)...
                               -----------------------------------------
      Subtotal................       3,779.0       3,789.0       3,568.0
------------------------------------------------------------------------

    Question. What benefits does FHWA derive from the system? Does IRS 
believe FHWA receives satisfactory return on investment from the 
system?
    Answer. Tax receipts deposited in the Highway Trust Fund Account 
totaled $35.2 billion in fiscal year 2003, of which $30.2 billion went 
to the Highway Account and $5 billion to the Mass Transit Account. As 
described above, the ExFIRS Program will enhance fuel tax compliance 
directly impacting the FHWA's mission. In addition, the FHWA will be 
able to use data from the system in its own planning process. Just 
recently the IRS met and provided summary data to FHWA to assist in its 
efforts to develop their model of State revenue sharing.
    Question. Has an independent audit or review ever been performed of 
the ExFIRS development effort?
    Answer. ExFIRS has a requirement to operate at a minimum of 
Maturity Level 2 of the SEI CMM. Yearly Process Appraisal Review 
Methodology (PARM) review of the process was completed in February 23, 
2004. At Technology Solutions Center a CMMI SEI Level 2 rating was 
verified by independent evaluations (external SCAMPI Class A) on 
February 27, 2004.
    Question. Fuel tax fraud creates a drain on Highway Trust Fund 
(HTF) revenues, which FHWA estimates costs at least $1 billion 
annually. Department of Transportation Secretary Mineta has called 
evasion of Federal motor fuel taxes ``a serious and growing problem 
that requires a serious Federal response.'' The loss of motor fuel 
taxes is also detrimental to State programs. The impact of these losses 
is even greater coming at a time when we have experienced a reduction 
in the growth of HTF revenues, while demands on highway capacity have 
reached unprecedented levels, and replacement and rehabilitation costs 
for aging infrastructure are rapidly increasing.
    Although fuel excise taxes represent less than 2 percent of total 
Federal tax revenues, they are a critical funding source for DOT 
programs. Taxes on gasoline, diesel, and other fuels provide about $33 
billion each year, or 89 percent of the HTF revenues used to finance 
highway and transit projects nationwide. Increased tax collections mean 
increased Federal revenues for funding the Nation's highways and 
transit programs.
    In July 2002, FHWA Administrator Peters testified before Congress 
that the administration proposed to halt fuel tax evasion through ``a 
vigorous and more collaborative enforcement effort by State and Federal 
agencies'' and a significant increase in funding over TEA21. The 
administration proposed providing $202 million for the Highway Use Tax 
Evasion Project, of which $163 million would be transferred to the IRS.
    What does IRS currently estimate the losses from fuel tax evasion 
to be and how was this estimate derived?
    Answer. KPMG, not the Federal Highway Administration, estimates 
drain on the Highway Trust Fund revenues to be the $1 billion. Although 
it is difficult to estimate evasion because the IRS does not know what 
is not being reported, the IRS identified and is addressing critical 
areas of excise tax non-compliance. These include the:
  --Continuing misuse of dyed diesel fuel;
  --Smuggling to evade payment of taxes;
  --Cocktailing (increasing the fuel volume by mixing in other 
        products) to illegally reduce the effective tax rate; and
  --Diverting aviation jet fuel to highway use to illegally evade motor 
        fuel taxes.
    The IRS continues to discover misuse of dyed diesel fuel for tax 
evasion purposes despite the numerous legislative and regulatory steps 
Federal and State governments have taken. The 140 fuel compliance 
officers (FCO) monitor 1,400 terminals, all fuel wholesalers, thousands 
of retail motor fuel outlets, and U.S. border crossings. Additionally, 
FCOs periodically inspect on-road vehicles on highways throughout the 
country. From January 1, 2003 through December 15, 2003, FCOs have 
assessed over 1,400 penalties totaling over $1,400,000 for misuse of 
dyed diesel fuels. A further analysis of these results indicates that 
70 percent of the penalties involved the misuse of fuel by taxpayers in 
the construction and agriculture industries. Both of these industries 
are subject to broad-based tax exemptions for non-highway use of motor 
fuels, thereby, presenting opportunities for abuse.
    Another critical compliance problem is smuggling of motor fuel. 
This involves the illegal introduction of fuel into the United States 
to evade payment of excise taxes. This problem may occur at border 
crossing points and points of entry for ocean-going vessels. More than 
9 million trucks pass through the 55 border crossings between Canada 
and Mexico into the United States each year.
    The IRS also has found instances of fuel smuggled into the country 
by people using barges that off load from ocean-going vessels. The IRS 
is involved in two investigations of barges being used to smuggle fuel; 
however, it does not know the full extent of activities in this area. 
These activities are extremely hard to identify due to the multitude of 
locations and means smugglers may use. The Corps of Engineers has 
identified over 600 locations that are not terminals but are known to 
have the ability to off load fuel from barges. In addition, barges may 
have portable devices that become mobile racks, providing the ability 
to off load fuel at any location.
    Another compliance problem is the use of adulterated fuel through 
cocktailing. This technique increases profits by increasing the volume 
of diesel fuel with used motor oil and other distillates including 
pollutants, cleaning agents, and unfinished refinery products. This 
form of tax evasion is attractive for two reasons. First, the 
substances used to extend the fuel are often not regulated, so they are 
not recorded in any fuel reporting system. Second, in some cases, the 
substances are regulated as waste materials, providing an unscrupulous 
individual an opportunity to get paid to dispose of the product(s) and 
then blend them into gasoline and get paid again. This tax evasion 
technique results in an ongoing revenue loss. It may also be dangerous 
to the public when the taxable fuels are blended with hazardous waste.
    Aviation fuel is the last interchangeable product available within 
the legal fuel distribution system that is not taxed when the fuel 
leaves a terminal. In any given month, hundreds of millions of gallons 
of aviation fuel flow into and out of registered terminals. This exempt 
removal at the rack creates incentives and opportunities to divert 
aviation fuel to highway use. From fuel inspections, the IRS knows 
aviation fuel is being diverted. However, the IRS does not know for 
certain the amount diverted. The IRS is finding aviation fuel in small 
amounts blended into normal diesel in the propulsion tanks of trucks/
tractors. Also, the IRS has found aviation fuel in larger quantities in 
retail outlets through its Below The Rack compliance efforts. The IRS 
has found a blend of 5 to 10 percent in most cases.
    In 2002, KPMG released a report alleging that the possible loss 
each year to aviation fuel diversion may exceed $1 billion. The results 
from IRS internal efforts do not support or disprove an estimate of 
that size. The IRS initiated an audit program to determine if it could 
identify significant diversion through aviation fuel distributors 
operating as 637 H Registrants. In most situations, the distributor had 
the paperwork to support a tax free/reduced tax sale of the fuel. To 
date, the IRS has not identified registrants with massive amounts of 
fuel for which they cannot account. Due to the lapse of time between 
the sale of the fuel and the audit, the IRS could not successfully 
track down the ultimate users of the fuel to verify that the fuel was, 
in fact, used in a proper fashion. The only way to ensure the fuel is 
used properly is to track the fuel to each end user. The diversion of 1 
percent of the aviation fuel that leaves the terminals in the United 
States represents the loss of over $65,000,000 per year. Based on IRS's 
findings in the fingerprinting test, it believes that a 3 percent 
diversion is a conservative estimate. This amount of diversion would 
cost $195,000,000 per year.
    Dyed Fuel Misuse.--Dyed Fuel used on highways.--The IRS does not 
have an exact figure that it can state as the extent of total non-
compliance for the misuse of dyed fuel. Based on penalties asserted 
over the past 3 years, the IRS assesses a penalty on an average of 1 
percent of the trucks it inspects on the highway and 6 percent of the 
end user sites that it inspects. The IRS does not have data on the 
total volume of fuel involved in each of these cases; however, these 
results indicate a continuing non-compliance issue with the proper use 
of dyed fuel. Based on this experience, the IRS believes that at least 
1 percent of dyed fuel sold each year is diverted, resulting in loss of 
tax of at least $50,000,000.
    Cocktailing/Illegal Blending.--The Internal Revenue Service has 
developed a ``fuel fingerprinting'' technology to combat fuel tax 
evasion occurring ``below the rack''--particularly bootlegging, 
smuggling, and adulterated fuel through ``cocktailing'' or blending the 
product. Fuel fingerprinting is a technique that examines the 
``chemical fingerprint'' of samples taken from retail stations for 
adulteration or for a mismatch with samples taken from the terminal 
racks that normally supply those stations. This technology allows for 
the detection of untaxed kerosene intended to be used as aviation fuel, 
``transmix'' taken out of pipelines, waste vegetable oils, used dry-
cleaning fluids, and other chemicals that may be mixed with diesel fuel 
and find their way into the tanks of trucks on the road. Fuel 
fingerprinting provides a more efficient and comprehensive method to 
monitor compliance compared to traditional audit techniques. The IRS 
has conducted sampling on diesel fuel in several parts of the country. 
Results indicate approximately 8 percent of the diesel fuel tested has 
some form of adulterant. The amount of adulterant found in retail 
outlets has been in the range of 2 percent-25 percent with an average 
of 8.2 percent. Using these results, the IRS estimates that there is a 
minimum of $50,000,000 each year in tax loss due to illegal blending of 
diesel fuel.
    Due to safety issues with handling gasoline, the IRS has not 
conducted fuel fingerprinting tests for gasoline. The IRS has anecdotal 
information from informants that illegal blending is much more common 
for gasoline then diesel. The reason given is the huge demand for 
gasoline and the ease to hide the adulterants among the large volume of 
fuel moving through a location. Using estimates for diesel fuel and 
comparing the sale of gasoline to diesel (3 to 1), the IRS has a 
minimum estimate of $150,000,000 per year for illegal gasoline 
blending.
    Although the IRS has evidence of fuel being smuggled into the 
country, it does not have a reasonable basis for an estimate at this 
time. As mentioned in the discussion of the various schemes used for 
motor fuel tax non-compliance, the IRS does not have exact estimates of 
the potential revenue losses. All of these schemes are outside the law 
and the information is based on information the IRS has gathered 
through examinations and fuel testing. The IRS believes this is a 
conservative estimate and, in fact, does not include any estimation for 
smuggling in these numbers. In summary, estimates for the overall loss 
of revenue are as follows:

------------------------------------------------------------------------
                                                              Amount
------------------------------------------------------------------------
Misuse of Aviation Fuel.................................    $195,000,000
Misuse of Dyed Fuel.....................................      50,000,000
Cocktailing of Diesel...................................      50,000,000
Cocktailing of Gasoline.................................     150,000,000
                                                         ---------------
      Overall Estimate..................................     445,000,000
------------------------------------------------------------------------

    Question. How is IRS working with other Federal agencies and States 
to leverage enforcement resources? Since 2000, how many cases are being 
jointly investigated with other Federal and State law enforcement 
agencies?
    Answer. The IRS has a long history of working fuel cases with its 
State counterparts and, when appropriate, with other Federal agencies. 
With current disclosure provisions it is difficult to jointly 
investigate motor fuel cases with other Federal agencies. In the past, 
the IRS has successfully worked with other Federal agencies under the 
umbrella of the grand jury. Working with State counterparts is most 
effective when the State has a similar point of taxation, that being at 
the terminal rack.
    The IRS does not have a measurement process for determining how 
many cases have been worked with State or other Federal agencies. These 
situations have been on a case-by-case basis with the documentation in 
the case file.
    Question. Who is responsible for coordinating the overall Federal 
and State efforts for pursuing all fuel tax evasion-related offenses?
    Answer. The Internal Revenue Service is responsible for Federal 
efforts to pursue fuel tax evasion. It works in a collaborative fashion 
with State agencies and other Federal agencies. In these efforts, the 
IRS does not direct the resources of the other agencies; however, it 
does share information that it can properly share under the existing 
disclosure provisions. As stated earlier, the ability to share 
information with these partners must conform with the provisions of IRC 
6103 for disclosure of taxpayer information.
    Question. What is the total Federal ``level of effort'' in terms of 
staff and resources, being directed at these crimes?
    Answer. The IRS has several programs/activities that support motor 
fuel tax compliance and other taxes that support the Highway Trust 
Fund. The Small Business/Self Employed (SB/SE) Division has 
approximately 260 revenue agents who are excise tax specialists and 
approximately 140 fuel compliance officers (FCOS). Historically, IRS's 
revenue agents spend 40-50 percent of their direct examination time on 
the taxes that support the Highway Trust Fund. The FCOs spend 100 
percent of their time enforcing the dyed fuel laws and detecting 
illegally blended fuel through its below the rack (BTR) efforts. In 
addition to these employees, the IRS has approximately 50 tax examiners 
that audit claims for excise tax refunds, the majority being for motor 
fuel taxes. Motor fuel excise tax compliance is a priority for Criminal 
Investigation (CI) and included in its fraud program along with 
bankruptcy, insurance, healthcare, and other financial frauds. CI 
resources are applied to this program area based on the degree of 
criminal activity identified.
    Question. What is the IRS's budget request for fuel tax enforcement 
activities for fiscal year 2005? Please compare to funding allocated to 
this area of enforcement for the past 5 fiscal years. Does IRS have any 
plans to increase the number of resources devoted to this area? Should 
funding for this project increase?
    Answer.

                                           COSTS FOR EXCISE AGENTS \1\
----------------------------------------------------------------------------------------------------------------
                                                                FTE       Salaries     Benefits        Total
----------------------------------------------------------------------------------------------------------------
Fiscal year 2000...........................................        271      $59,636      $18,832     $21,264,828
Fiscal year 2001...........................................        267       61,249       19,342      21,517,797
Fiscal year 2002...........................................        285       63,451       20,037      23,794,080
Fiscal year 2003...........................................        282       65,421       20,659      24,274,560
Fiscal year 2004...........................................        252       68,103       21,506      22,581,468
Fiscal year 2005 \2\.......................................        240       69,465       21,936      21,936,240
----------------------------------------------------------------------------------------------------------------
\1\ Based on GS-13 Step 5 RUS.
\2\ Projected.

    The above chart reflects the total number of Excise Agents that 
worked all Excise returns. The IRS is currently evaluating the staffing 
levels for fiscal year 2005 but no decisions have been made to date. In 
its SAFETEA legislation, the administration proposed $54.5 million for 
highway use tax evasion projects in fiscal year 2005. This funding 
would enable the IRS to increase resources applied to motor fuel tax 
compliance. As ExFIRS becomes a more viable system, the IRS anticipates 
having improved data to determine the appropriate level of future 
staffing.
    Question. What is IRS's current fuel tax evasion investigative 
caseload? How many staff does IRS devote to this area? Does the IRS 
need to devote additional revenue agents or criminal investigators to 
fuel tax evasion fraud? Why or why not?
    Answer. Criminal Investigation currently has fourteen motor fuel 
cases under investigation. In fiscal year 2003 the IRS devoted nine 
special agent FTE and three non-special agent FTE to excise tax cases. 
Criminal Investigation does not anticipate a significant increase in 
resources devoted to motor fuel excise tax evasion cases because the 
legislative changes enacted over the past decade have significantly 
curtailed opportunities for abuse that previously existed, but CI will 
commit additional resources if local or regional compliance problems 
arise.
    Question. How does IRS measure the success or failure of its fuel 
tax evasion efforts? What indictments, recoveries, and convictions has 
IRS attained as a result of their fuel tax evasion efforts? What 
successes or failures have the States and other Federal agencies had in 
this area?
    Answer. Criminal Investigation has no formal measures to gauge the 
success of its excise tax program. Ultimately, it is the impact of 
successful prosecutions that ultimately determine success or failure. 
During the period fiscal year 1993 through fiscal year 2003, the IRS 
prosecuted 364 people for participating in schemes to evade excise 
taxes. In aggregate, these prosecutions involved over $500,000,000 in 
tax revenue and involved many prominent members of organized crime. CI 
reported the magnitude of this effort in the excise tax case summaries 
contained in their annual reports from fiscal year 1993 through fiscal 
year 2001. These summaries chronicle many prominent cases and the 
history of motor fuel enforcement efforts over the last decade. After 
fiscal year 1997, motor fuel tax evasion case initiations began to 
decline. Subsequent schemes lacked the complexity and scope previously 
seen. This decline is attributable to the following factors:
  --The cooperative efforts of Federal and State revenue and regulatory 
        agencies;
  --Support from the motor fuel distribution industry and professional 
        associations;
  --Effective criminal prosecutions;
  --Development of improved auditing and compliance tools (particularly 
        fuel tracking systems, fuel dyeing and the on road inspection 
        programs; and,
  --Passage of fundamental legislative changes that reduced the 
        opportunities for evasion.
    Question. Does the IRS have a plan for achieving a more vigorous 
and collaborative Federal and State effort for pursuing fuel tax 
evasion? If so, please describe the plan. Does IRS see any barriers to 
expanding current efforts to collaborate with other agencies on fuel 
tax fraud-related investigations?
    Answer. The IRS is continuing to work closely with other Federal 
and State agencies that enforce motor fuel laws. It also works with 
State environmental agencies when notified of misuse of hazardous 
materials in illegal cocktailing and blending. The IRS is participating 
with nine regional task force groups as part of the joint project with 
FHWA. IRS staff meets periodically with State counterparts to share 
information and conduct joint investigations. The IRS is involved in 
several ongoing cases with multiple States and agency.
    With the expansion of the ExSTARS reporting, several of the holes 
will be plugged in tracking motor fuel products. With the enhanced 
reporting, the States and the IRS will be able to easier identify fuel 
diversions. The principal roadblock to collaborating with other Non-
revenue State and Federal agencies is the disclosure restrictions.
    Question. How do fuel tax evasion-related crimes relate to homeland 
security? How is IRS working with the U.S. Customs and Border 
Protection agency to combat this problem?
    Answer. Motor fuel product is a very volatile liquid and in the 
hands of the wrong individuals could have disastrous results. Criminal 
Investigation is a member of the FBI's Joint Terrorism Task Forces. 
These task forces are aware fuel tanker trucks could be utilized by 
terrorists to perpetrate a terrorist attack. Since September 11, 2001, 
all allegations involving fuel tanker trucks have been vigorously 
investigated, as have allegations that persons potentially affiliated 
with terrorist groups may be acquiring licenses to operate fuel tankers 
or transport hazardous materials.
    The IRS believes the ExFIRS/ExSTARS programs have the capability to 
handle enhanced tracking of fuel systems and it supports the 
legislation that would track vessels both for security and tax 
purposes. The IRS has also developed an acoustical device for 
identifying product that is being transported to ensure that the actual 
product being shipped matches the shipping paperwork.

                      BANK SECRECY ACT ENFORCEMENT

    Question. Given the limited resources in the IRS budget for 
enforcement and compliance, what standards does the IRS use to select 
cases to review for Bank Secrecy Act (BSA) compliance?
    Answer. The Internal Revenue Manual (IRM) 4.26.3.2.4, Selection for 
Assignment provides specific guidelines to the Anti-Money Laundering 
(AML) coordinators about case selection. It provides:
  --The AML coordinator should select entities from the nonbank 
        financial institution (NBFI) database or the Form 8300 
        inventory, using risk-based analysis to select those entities 
        with the highest potential for noncompliance for compliance 
        examinations or reviews, such as:
    --Entities with a high volume of cash transactions or abnormal cash 
            activity;
    --Entities in local geographic areas with high potential in money 
            laundering;
    --Entities which have a previous history of noncompliance; and
    --Entities which have been cited for poor or inadequate 
            recordkeeping.
  --The AML coordinator should consider available resources as well as 
        balanced coverage (geographic area and industry) when selecting 
        NBFIs or Non-financial trade or Businesses (NFTB) for 
        compliance examinations or reviews.
  --Input from other operating divisions (e.g. TE/GE) can assist the 
        coordinator in assessing risk.
  --Prior to opening the exam or review the names of selected entities 
        are to be furnished to Criminal Investigation (CI) for 
        clearance.
    The IRS and the Financial Crimes Enforcement Network (FinCEN) 
jointly establish the priorities for types of NBFIs to be examined, and 
the IRS provides these priorities to its AML coordinators in an annual 
program letter. In addition, as part of the efforts to improve the 
effectiveness of the AML program, the IRS provided training for its AML 
coordinators in March 2003 on methods to apply against the Currency 
Banking and Retrieval System (CBRS) to identify cases. Since that time, 
CBRS analysis has been provided to the coordinators on a regular basis 
to assist them in the identification of cases. To further ensure 
consistency in case selection, the IRS plans to centralize the case 
identification process by October 2004. The IRS is also working with 
its SBSE Research to enhance the case selection criteria.
    Question. Are the standards for determining BSA cases for review 
uniform in every office? Please provide a copy of those uniform 
standards.
    Answer. The standards for selecting cases for review are detailed 
in the response to the question above. During the AML program reviews 
conducted by the headquarters office, conformity with these guidelines 
is reviewed specifically.
    The IRS is currently centralizing case selection. BSA typed 
inventory varies demographically and changes or moves constantly. The 
IRS is seeing the shift of currency cells away from banks and larger 
cities. Efforts to centralize inventory selection will better help the 
IRS recognize these trends and quickly shift field resources as needed.
    Question. How many cases were reviewed for BSA compliance? How many 
possible cases are there? What percentage of total cases are forwarded 
for prosecution or further review?
    Answer. In fiscal year 2003, the IRS closed 3,655 NBFI cases. The 
IRS also contacted an additional 8,800 businesses to determine if those 
that had a requirement to register had done so. The number of possible 
Money Service Businesses (MSB) is constantly changing, but there are 
currently more than 88,000 potential NBFIs on the database. One of the 
objectives of the program is to identify new businesses while removing 
from the database those that no longer are in business.
    In fiscal year 2003, seven cases were forwarded to the IRS's 
Criminal Investigation Division and two cases were referred to FinCEN 
for penalty consideration. The number of cases is less than 1 percent 
of those examined.
    Question. Does the IRS train its compliance personnel in the IRS's 
responsibilities under the USA PATRIOT Act?
    Answer. IRS Compliance personnel involved in the AML program 
receive specific training regarding BSA AML Compliance Programs and 
related proposed regulations. IRS revised its Basic AML Course to 
reflect the changes resulting from the USA PATRIOT Act. As part of this 
training, personnel are:
  --Instructed on how to access the Office of Foreign Asset Control's 
        (OFAC) website to identify individuals and countries which have 
        been placed on OFAC's Specially Designated Nationals (SDN) 
        list. In addition, information regarding the SDN list is placed 
        on the AML Website to insure that examiners are aware of any 
        changes to the list.
  --Trained to look for transactions going to OFAC sanctioned 
        countries. If such transactions are found, personnel are 
        trained to contact the OFAC's Compliance Hotline and proceed 
        directly to OFAC.
  --Trained to look for unlicensed money transmitters. Two Continuing 
        Professional Education (CPE) modules have been developed 
        specifically addressing Informal Value Transfer Systems and 
        Section 352 of the USA PATRIOT Act.
  --Trained in audit procedures to detect structuring, using data from 
        actual examples of structured transactions. They are taught to 
        follow the transaction through the final clearing in order to 
        identify structured transactions through OFAC sanctioned 
        countries.
    Question. What training does each compliance officer receive each 
year related to BSA and the USA PATRIOT Act?
    Answer. This year, the IRS provided CPE modules to IRS's AML 
examiners: Suspicious Activity Reports, Structuring, Informal Value 
Transfer Systems, and Section 352 of the USA PATRIOT Act. The IRS 
provides examiners with workshops regarding the BSA during group 
meetings held at least once a year. The IRS makes AML Technical 
Advisors available to attend these group meetings.
    In addition, information regarding new regulations is forwarded 
from Headquarters to Territory Managers for immediate dissemination to 
examiners, and examiners review FinCEN's SAR Activity Reviews Digests 
as well as other issued guidance. In addition, examiners are required 
to refer to the AML website on a regular basis for any changes to 
procedures and/or regulations.
    Question. When the IRS audits a casino, is the auditor versed in 
the intricacies of the Patriot Act?
    Answer. AML examiners, all of whom have received training that 
deals specifically with the USA PATRIOT Act (for example, the four 
recent CPE modules: Suspicious Activity Reports, Structuring, Informal 
Value Transfer Systems, and Section 352 of the USA PATRIOT ACT), 
conduct the IRS's examinations of casinos. In addition, the Casino 
Course these examiners attend includes changes in the law under the 
Patriot Act, and the IRS makes these changes available to all casino 
examiners on the AML web page.
    Question. Does IRS have any performance measures to determine 
auditor knowledge of the laws they enforce?
    Answer. The official IRS position descriptions for the AML 
examiners outline the job knowledge required as well as Critical Job 
Elements. The Critical Job Elements on which AML examiners are 
evaluated include Knowledge and Application of Anti-Money Laundering 
Law. The IRS is currently developing case review procedures that will 
centralize closed case reviews using full time reviewers as well as 
provide managers with a review document. The attributes in the case 
review document include the interview conducted, managerial 
involvement, interpretation and application of the law, fact gathering, 
penalty determination, and documentation.
    Question. Is there any follow-up with the casinos or money service 
businesses to get feed-back on its audit?
    Answer. The IRS has an effort under way to develop a customer 
satisfaction survey for the AML Program by the end of fiscal year 2004.
    Question. How many cases were referred by the IRS in fiscal year 
2003 for enforcement action? What were the outcomes of the referrals?
    Answer. In fiscal year 2003, seven cases were referred to IRS's 
Criminal Investigation (CI) Division; three are currently under active 
investigation. In addition, during the first 6 months of fiscal year 
2004, SB/SE referred an additional seven cases to CI, five of which are 
under investigation. As a result of referrals from its AML program, the 
IRS also examined and closed 538 cases for income tax violations in 
fiscal year 2003.
    Question. How many cases were referred by the IRS in fiscal year 
2003 to FinCEN for further review? What were the outcomes of the 
referrals?
    Answer. In fiscal year 2003, the IRS referred two cases to FinCEN 
for penalty consideration. Both were issued warning letters. The IRS 
referred two additional cases in the first half of fiscal year 2004, 
and is currently developing another two for referral.
    Question. What level of oversight regarding the compliance of 
casinos and money service businesses (MSB's) does the IRS exercise? 
Please describe those efforts in detail.
    Answer. The IRS has been delegated responsibility for civil 
examinations for BSA compliance. In addition to examinations, the IRS 
also conducts outreach (in coordination with FinCEN) to ensure 
businesses are aware of their filing, recordkeeping and registration 
responsibilities. The IRS currently has approximately 350 examiners 
(including managers) assigned to the Anti-Money Laundering (AML) 
program. They are supported by 16 Area AML coordinators and 
approximately 8 computer audit specialists from LMSB. IRS AML examiners 
currently are conducting 5,576 examinations, which reflects 6 percent 
of the IRS-known potential population.
    In addition to the examination of NBFIs, the AML examiners also 
conduct reviews for compliance with the currency reporting requirements 
of Sec. 6050I of the Internal Revenue Code. Since Sept. 30, 2000, the 
IRS has added 48,688 potential NBFI entities to the database. As of 
March 31, 2004 the NBFI database reflected over 88,000 potential NBFIs. 
The IRS is also conducting investigations on 690 businesses for 
potential registration requirements.
    From September 30, 2000 through the present, the IRS has closed 
13,288 cases and conducted 5,940 (fiscal year 2003 and fiscal year 
2004) registration examinations.
    Since 2002, the AML Compliance program has transitioned from 
conducting individual education visits to focusing on examinations. The 
education and outreach now is performed by the Small Business and Self-
Employed operating Division's (SB/SE) Taxpayer Education and 
Communication (TEC) Division. TEC delivers education/outreach to 
external stakeholders, using leveraged resources to reach a larger 
number of covered businesses. The National TEC AML strategy was 
designed in conjunction with SB/SE Compliance, IRS's Criminal 
Investigation Division and FinCEN to increase compliance of MSBs, NBFIs 
and casinos with the BSA.
    Question. What performance measures are in place to measure IRS 
compliance efforts as they relate to MSB's and casinos?
    Answer. The current measures for the AML examination program 
include the number of NBFIs identified, the number of examinations 
conducted and closed, and the results of completed examinations. The 
IRS also now has a database in place that provides information on the 
hours per closed case as well as the cycle time of cases. In the course 
of the BSA examinations conducted, the IRS also identifies potential 
cases for unreported income under Title 26. On the education/outreach 
side, the TEC organization monitors the number of outreach events they 
deliver and the number of participants at the events.
    Question. The Tax Inspector General for Tax Administration (TIGTA) 
reports that the IRS small business/self employed (SB/SE) division 
responsible for compliance of the BSA for non-bank financial 
institutions lacks meaningful performance measures, has no useful data 
to provide oversight of program performance, and does not base case 
selection in risk factors. Similar findings also occurred in a previous 
audit in December of 2000. The IRS has known since at least 2000 that 
these problems were pervasive in the compliance program. In September 
of 2003, the IRS continues to fail in delivering compliance results 
commensurate with the resources spent. In the response on this issue to 
the committee the IRS has stated that the agency ``does not 
characterize this as a problem''. There are two TIGTA audit reports 
which demonstrate the IRS has failed repeatedly to make meaningful 
progress in its compliance efforts for BSA. If the IRS and FinCEN do 
not believe this as a problem, what would elevate it to warrant 
recognition? How can the IRS allow these types of lapses to recur?
    Answer. In 2002, the IRS made a commitment to ensure the effective 
operation of the Anti-Money Laundering Program. In particular, the IRS 
has taken the following steps:
  --Named a national AML program manager in February 2002;
  --Created 32 groups nationwide dedicated to the AML program (added 
        one additional group in 2004);
  --Replaced part-time revenue agents, for whom AML was a collateral 
        duty, with full-time, fully trained revenue agents dedicated to 
        AML;
  --Minimized the use of lower-graded tax compliance officers, who 
        previously handled many of the AML examinations;
  --Designated a territory manager in each IRS Area for AML program 
        responsibility;
  --Designed a Management Information System to capture the results of 
        BSA examinations; and
  --Secured funding from FinCEN, beginning in fiscal year 2003, to add 
        70 additional FTEs to the AML compliance program.
    As a result of these improvements, all program indicators (numbers 
of MSBs identified, outreach contacts, and examinations) are trending 
up. In the first half of fiscal year 2004, the IRS's SB/SE Division 
made more referrals to FinCEN and had more referrals accepted by CI 
than in all of fiscal year 2003. In fiscal year 2003, SB/SE also 
focused on ensuring that MSBs that had a requirement to register did, 
in fact, register. Those efforts resulted in an additional 2500 
registrations, which represented a 20 percent increase in the number of 
registered MSBs.
    In a recent review of the AML program, TIGTA acknowledged the IRS's 
efforts to enhance the program but identified the need for further 
improvements. Ongoing efforts include the following:
  --Centralization of case identification, incorporating leads from the 
        field and CI, as well as CBRS analysis for October 2004;
  --Piloting of MSB examinations at the entity's corporate headquarters 
        level to facilitate the identification of MSB agents with the 
        highest risk of noncompliance;
  --Incorporation of quality performance measures into the embedded 
        quality process in October 2004;
  --Transition of outreach activities from Compliance to TEC within SB/
        SE to provide broad educational opportunities to external 
        stakeholders;
  --Completion of a template for a Fed/State MOU to provide reciprocal 
        opportunities to leverage resources for examinations, outreach, 
        and training;
  --Partnership with FinCEN to identify locations of potential 
        noncompliance, as well as the first joint examination of a 
        major MSB with FinCEN; and
  --MOU with FinCEN to allow IRS full access to SARs (for purposes of 
        BSA examinations only).
    Question. What is the IRS doing to ensure case selection criteria 
are uniform? Please provide a copy to explain how case selection 
criteria have changed since the Tax Inspector General for Tax 
Administration (TIGTA) audit in 2003.
    Answer. As mentioned previously in questions 1 and 2, the Internal 
Revenue Manual provides guidelines about case selection to the AML 
coordinator in IRM 4.26.3.2.4, Selection for Assignment. During AML 
program reviews conducted by the SB/SE headquarters office, conformity 
with the guidelines is an item specifically reviewed.
    TIGTA identified a concern that there was no consistency in how the 
IRS selected AML cases for examination. To remedy this situation, the 
IRS increased program oversight to ensure the compliance risk case 
selection tools provided to the field are being used to identify cases. 
The centralization of case identification, incorporating leads from the 
field and Criminal Investigation, as well as CBRS analysis, is 
scheduled to be in place by October 2004. The centralization of 
workload identification will ensure consistency in risk based case 
selection. The IRS is including FinCEN in this process. Case selection 
methods are addressed in Area program reviews. In addition, SB/SE's 
Research organization has undertaken a project to possibly identify 
other methods for selection.
    Question. The IRS has a poor record regarding regulatory compliance 
operation and management of BSA data according to numerous IG, GAO, and 
TIGTA reports. What is the IRS doing to correct these long-standing 
problems? What guarantees can the IRS provide that will show they will 
do the job right this time?
    Answer. In recent years, the IRS has shown significant commitment 
to the effective operation of the Anti-Money Laundering Program, and 
considers the identification of opportunities for improvement to be an 
ongoing process. Improvement efforts in progress include the 
centralized review process, the embedded quality initiative, improved 
management information systems and centralized compliance examinations.
    In particular, the IRS has taken the following steps to enhance the 
effectiveness and professionalism of the AML program:
  --Named a national AML program manager in February 2002;
  --Created 32 groups nationwide dedicated to the AML program (added 
        one additional group in 2004);
  --Replaced part-time revenue agents, for whom AML was a collateral 
        duty, with full-time, fully trained revenue agents dedicated to 
        AML;
  --Minimized the use of lower-graded tax compliance officers, who 
        previously handled many of the AML examinations;
  --Designated a territory manager in each IRS Area for AML program 
        responsibility;
  --Designed a Management Information System to capture the results of 
        BSA examinations; and
  --Secured funding from FinCEN, beginning in fiscal year 2003, to add 
        70 additional FTEs to the AML compliance program.
    As a result of these improvements, all program indicators (numbers 
of MSBs identified, outreach contacts, and examinations) are trending 
up. In the first half of fiscal year 2004, the IRS's SB/SE Division 
made more referrals to FinCEN and had more referrals accepted by CI 
than in all of fiscal year 2003. In fiscal year 2003, SB/SE also 
focused on ensuring that MSBs that had a requirement to register did, 
in fact, register. Those efforts resulted in an additional 2500 
registrations, which represented a 20 percent increase in the number of 
registered MSBs.
    In a recent review of the AML program, TIGTA acknowledged the IRS's 
efforts to enhance the program but identified the need for further 
improvements. Ongoing efforts include the following:
  --Centralization of case identification, and incorporating leads from 
        the field and CI, as well as CBRS analysis for October 2004;
  --Piloting of MSB examinations at the entity's corporate headquarters 
        level to facilitate the identification of MSB agents with the 
        highest risk of noncompliance;
  --Incorporation of quality performance measures into the embedded 
        quality process in October 2004;
  --Transition of outreach activities from Compliance to TEC within SB/
        SE to provide broad educational opportunities to external 
        stakeholders;
  --Completion of a template for a Fed/State MOU to provide reciprocal 
        opportunities to leverage resources for examinations, outreach 
        and training;
  --Partnership with FinCEN to identify locations of potential 
        noncompliance, as well as the first joint examination of a 
        major MSB with FinCEN; and
  --MOU with FinCEN to allow IRS full access to SARs (for purposes of 
        BSA examinations only).
    Question. The IRS, in its response to the committee, states that 
there are standards in place to select cases in all compliance 
programs. TIGTA states in its 2000 and 2003 audit that the program 
still lacks performance standards. The only performance goal that 
exists for this program is ``delivery of Direct Examination Staff Years 
(DESYs).'' To accomplish this goal the IRS need only assign sufficient 
personnel to the program to meet the allocated DESYs. There are no 
other measures for evaluating the program's performance. Does the IRS 
consider this performance measure sufficient to measure the outputs and 
outcomes of this program? Are other compliance programs held to such a 
low threshold?
    Answer. In addition to the delivery of DESYs, the AML Program 
currently measures the number of NBFIs identified, the number of 
examinations conducted and closed, the results of completed 
examinations, the number of Title 26 information items prepared and 
related income tax examinations completed. The TEC organization 
monitors the number of outreach visits, seminars, participants, and 
mailings accomplished. Recent improvements to the MIS now provide 
information on the hours per closed case, as well as the cycle time of 
cases.
    Question. The committee understands that IRS has begun to review 
its performance measures and is in the process of establishing 
measurable performance-based indicators for BSA programs. What is the 
status of this effort? Please include in your response the new 
performance measures being used to measure fiscal year 2004 
performance?
    Answer. The current measures for the AML examination program 
include the number of NBFIs identified, the number of examinations 
conducted and closed, and the results of completed examinations. The 
IRS also now has a database in place that provides information on the 
hours per closed case, as well as the cycle time of cases. In the 
course of the BSA examinations conducted, examiners also identify 
potential cases for unreported income under Title 26. On the education/
outreach side, the TEC organization monitors the number of outreach 
events they deliver and the number of participants at the events.
    Question. In Treasury's April 30 responses to the committee, the 
Department and the IRS contend that IRS compliance programs include 
reviews of examiners work. Performance plans for all managers include 
the requirement to review cases and to be involved in case development. 
Yet the IRS in its response to the TIGTA report state ``there continues 
to be significant risk of undetected noncompliance and inconsistent 
program delivery. Based on our review of a judgmentally selected sample 
of 76 cases from 3 Area Offices, standard case selection criteria are 
not used, cases are not properly documented and potential noncompliance 
information is not available''. How does the IRS explain the 
discrepancy between stated requirements and failed results?
    Answer. The quote attributed above to the IRS was actually a 
statement made by TIGTA in their Report (Audit No. 200330004). The 
relevant TIGTA recommendations from that report, and the actions the 
IRS is taking to implement them, are as follows:
  --Develop standard risk-based case selection criteria that would 
        provide minimum requirements and parameters for case selection.
      The SB/SE Division Research function is developing a scoring 
        system, or set of rules, to prioritize workload by using 
        Currency Banking Retrieval System data. Until the scoring 
        system is implemented, the IRS has taken other steps to ensure 
        appropriate case selection. The IRS has increased program 
        oversight to ensure the compliance risk case selection tools 
        already provided to the field are being used to identify cases. 
        In addition, case selection methods are addressed as part of 
        the Area program reviews. The centralization of case 
        identification, incorporating leads from the field and Criminal 
        Investigation, as well as CBRS analysis, is scheduled to be in 
        place by October 2004. This centralization will ensure 
        consistency in using risk based case selection for the AML 
        cases.
  --Reinforce the importance of case documentation with specific 
        instructions or case models and implement a centralized quality 
        review process.
      The IRS has taken a number steps to increase the quality of the 
        cases. In July 2003, two technical advisors were added to 
        headquarters staff to provide technical assistance to the 
        field. Since their arrival, they have visited several areas, to 
        review cases and meet with the examiners and managers to 
        discuss their observations. This has been well received by the 
        field personnel, and requests for their participation continue 
        to increase. The first AML Technical Digest, which addresses 
        examination issues, will be published on the AML web page in 
        late May 2004.
      The IRS is on target to incorporate quality performance measures 
        for AML into the new embedded quality process that will be in 
        place in October 2004. Including AML in the embedded quality 
        process will provide a systemic method for consistent 
        managerial feedback. In addition, the centralized closed case 
        review process, which will be a part of embedded quality, will 
        provide headquarters with the ability to identify trends and 
        training needs.
  --Coordinate with the FinCEN to secure BSA examiner and RA access to 
        SARs.
      The Commissioner, SB/SE Division, initiated a Memorandum of 
        Understanding with the Director of the FinCEN to permit BSA 
        examiners access to SARs for the purpose of MSB compliance 
        checks. That MOU has been signed by both the IRS and FinCEN. 
        IRS senior executives are continuing to pursue access to SARs 
        for RAs in the regular examination program.
    Question. TIGTA found that ``no standard criteria exist for 
selecting BSA compliance cases.''
    Should the committee be concerned that there are no standards that 
exist for case selection?
    IRS states that AML coordinators use their own criteria. Please 
provide a complete list of those criteria.
    Given Mr. Everson's strong statements about the need for more 
resources, does this program not point out that IRS has enormous 
savings to be realized by using its current resources in a smarter and 
more efficient manner?
    Answer. Through its Internal Revenue Manual (IRM) 4.26.3.2.4, 
Selection for Assignment, the IRS provides specific guidelines to its 
AML coordinators about case selection. It reads as follows:
  --The AML coordinator should select entities from the nonbank 
        financial institution (NBFI) database or the Form 8300 
        inventory, using risk-based analysis to select those entities 
        with the highest potential for noncompliance for compliance 
        examinations or reviews, such as:
    --Entities with a high volume of cash transactions or abnormal cash 
            activity;
    --Entities in local geographic areas with high potential in money 
            laundering;
    --Entities which have a previous history of noncompliance;
    --Entities which have been cited for poor or inadequate 
            recordkeeping;
  --The AML coordinator should consider available resources as well as 
        balanced coverage (geographic area and industry) when selecting 
        NBFIs or NFTBs for compliance examinations or reviews;
  --Input from other operating divisions (e.g. TE/GE) can assist the 
        coordinator in assessing risk;
  --Prior to opening the exam or review the names of selected entities 
        are to be furnished to Criminal Investigation (CI) for 
        clearance.
    The IRS has increased program oversight to ensure these compliance 
risk case selection tools provided to the field are being used to 
identify cases. In addition, the IRS and FinCEN jointly establish the 
priorities for types of NBFIs to be examined, and the IRS provides 
these priorities to its AML coordinators in an annual program letter. 
Further, as part of the efforts to improve the effectiveness of the AML 
program, the IRS provided training for its AML coordinators in March 
2003 on methods to apply against the Currency Banking and Retrieval 
System (CBRS) to identify cases. Since that time, CBRS analysis has 
been provided to the coordinators on a regular basis to assist them in 
the identification of cases. Case selection methods also are addressed 
during Area program reviews.
    To further ensure consistency in case selection, the IRS plans to 
centralize the case identification process by October 2004. This 
centralization, which will incorporate leads from the field and 
Criminal Investigation, as well as CBRS analysis, will ensure 
consistency in risk based case selection and allow for improved trend 
analysis. In addition, SB/SE's Research organization has undertaken an 
effort to enhance the case selection criteria.
    To improve its utilization of resources, the IRS is piloting the 
examination of Money Service Businesses (MSB) at the entity's corporate 
headquarters level. Three such examinations are currently underway. 
Working with the business, IRS will be able to identify the MSB's 
agents with the highest risk of noncompliance. This is a new approach 
for the program, one that was developed in cooperation with FinCEN, and 
one that will provide better customer service.
    Question. IRS indicates that it is creating a scoring system to 
prioritize its BSA workload. Please provide an update to the committee 
on the development of this system?
    Answer. SB/SE Research is designing a process that uses the 
Currency and Banking Retrieval System (CBRS) data to prioritize or 
select entities for Title 31 and Form 8300 examinations based on risk 
factors. The project is organized into five phases, including 
assessment of current processes used to select workload (Phase 1), 
development of rules that express predictive and evaluative factors of 
non-compliance with BSA requirements (Phase 2), engineering of formulas 
to evaluate and rank entities for risk of non-compliance based on CBRS 
data and completion of the decision factor set that will be used (Phase 
3), suitability testing to ensure the proposed system follows the best 
practices identified by AML technical advisors (Phase 4), and 
assessment of automation and programming needs required to pilot the 
proposed system (Phase 5).
    To date, much of the data and knowledge acquisition activity has 
been completed. As a by-product of this work, the research team 
developed a work flow diagram depicting ``best practices'' of 
processes, tools, techniques, and decisions in the AML program. 
Following review by the technical advisors, the IRS plans to make this 
interim work product will be available to Compliance Policy/AML 
examiners in July 2004 for use in the current program. The work that 
SB/SE Research is doing to develop a risk-based selection process using 
CBRS data will assist the IRS in applying case selection standards 
uniformly across the country. The proposed system will use the same 
identified scoring factors (with priorities and weights) to rank all 
entities for examination potential. Subsequently, local program 
managers will be able to filter the ranked list for geographic 
location, providing a local list that reflects the same selection 
criteria as any other case. A potential side benefit of the proposed 
system will be IRS's ability to assess whether their resources are 
appropriately deployed geographically and make adjustments based on 
where the prioritized workload actually exists.
    Question. TIGTA has identified that IRS examiners have a perception 
that FinCEN does not assess penalties. TIGTA has also identified that 
FinCEN has a negative perception of the IRS case quality and that the 
cases referred for enforcement actions do not contain sufficient 
information to assess penalties. What are these two organizations doing 
to overcome these barriers?
    Answer. FinCEN and the IRS are jointly committed to identifying 
opportunities to improve case development and the ability to assess 
civil penalties when appropriate. As a part of the IRS's revamped 
training efforts, FinCEN is participating in AML basic training classes 
to provide guidance on developing cases for penalty referral to FinCEN. 
For fiscal year 2004 the IRS has committed to taking a more proactive 
approach to getting FinCEN's input when serious violations have been 
identified, by providing them opportunity for involvement early in the 
development of the penalty case. To support this commitment, the IRS 
also has developed new referral guidelines based on previous well-
developed cases, and has included these guidelines in the AML Technical 
Digest.
    Question. The SB/SE division is responsible for compliance with the 
BSA. This unit spends $43 million for BSA compliance including 
examinations outreach and compliance. Please provide a detailed break 
out of how the $43 million is spent on by activity. Given the numerous 
reports about the failures of the SB/SE division, what is the IRS doing 
to correct the deficiencies identified?
    Answer. The original estimate of $43 million for BSA compliance 
included some one-time training costs related to BSA, but did not 
include costs associated with Currency Transaction Report (CTR) 
processing (which is essential to the AML program). Based on a revised 
estimate, which reflects only annualized costs, SB/SE expects to spend 
$53.7 million in fiscal year 2004 in support of BSA compliance, 
including examinations, education and outreach activities, and 
processing of CTRs. The breakdown of these costs for both fiscal year 
2003 and fiscal year 2004 is shown in the following table:

                     EXPENDITURES FOR BSA COMPLIANCE
                        [In millions of dollars]
------------------------------------------------------------------------
                                                            Fiscal Year
           Functional Activity              Fiscal Year        2004
                                           2003 (Actual)    (Projected)
------------------------------------------------------------------------
Compliance..............................           33.66           34.97
Taxpayer Education and Communications...            0.86            1.14
CTR Processing \1\......................            7.81           17.57
                                         -------------------------------
      Total for SB/SE...................           42.33           53.68
------------------------------------------------------------------------
\1\ In fiscal year 2003, IRS's Modernizing Information Technology
  Systems spent $8.84 million in support of CTR Processing. In fiscal
  year 2004, SB/SE is responsible for the full program.

    As described in the responses to the earlier questions, the IRS has 
taken, and is continuing to take, a series of proactive steps to 
improve its AML program. To summarize, the IRS has:
  --Revamped the structure and staffing of its AML program by:
    --Naming a national AML program manager in February 2002;
    --Creating 32 groups nationwide dedicated to the AML program (added 
            one additional group in 2004);
    --Replacing part-time revenue agents, for whom AML was a collateral 
            duty, with full-time, fully trained revenue agents 
            dedicated to AML;
    --Minimizing the use of lower-graded tax compliance officers, who 
            previously handled many of the AML examinations;
    --Designating a territory manager in each IRS Area for AML program 
            responsibility; and
    --Securing funding from FinCEN, beginning in fiscal year 2003, to 
            add 70 additional FTEs to the AML compliance program;
  --Focused increased attention on case selection using current 
        guidelines, while developing a centralized case identification 
        process;
  --Ensured all AML examiners receive appropriate training, including 
        the changes resulting form the USA PATRIOT Act;
  --Undertaken a research-driven effort to design and develop a method 
        for prioritizing case selection based on CBRS data;
  --Taken steps to improve AML case quality via technical case reviews 
        and included the AML program in the embedded quality measures 
        process to be implemented in October 2004;
  --Transferred AML outreach activities from Compliance to TEC within 
        SB/SE to provide broad educational opportunities to external 
        stakeholders; and
  --Increased its coordination with FinCEN, especially in the areas of 
        training, workload identification and penalty referrals.

                   WORKFORCE AND FACILITY REALIGNMENT

    Question. The IRS expects to receive some savings from the closure 
of the Brookhaven Service Center. Are you going to increase the 
frontline enforcement personnel with these savings?
    Answer. The IRS anticipates savings in fiscal year 2005 of $6 
million and 147 FTE because of e-file efforts, including the closure of 
the Brookhaven facility. These savings, along with $105 million 
additional savings, will be reapplied as described in the IRS's fiscal 
year 2005 Congressional Justification. These reinvestments are:

                          [Dollars in millions]
------------------------------------------------------------------------
                                               Millions of
                Reinvestment                     Dollars         FTE
------------------------------------------------------------------------
Curb Egregious Noncompliance................          $31.4          293
Select High Risk Cases for Examination......           $6.0  ...........
Embedded Quality \1\........................           $1.6           26
Consolidation--Case Processing..............          $13.7           80
Consolidation--Insolvency...................           $2.1           15
Combat Corporate Abusive Tax Schemes........           $5.0           34
Leverage/Enhance Special Agent Productivity.           $2.5           28
Standardize CLMC Training Rooms.............           $0.5  ...........
IRS Reorganization Transition...............           $5.0  ...........
Servicewide Competitive Sourcing............           $9.1  ...........
MITS Reorganization Transition..............          $34.0          236
                                             ---------------------------
      Total.................................         $110.9          712
------------------------------------------------------------------------
\1\ This initiative, through an Embedded Quality system in Submission
  Processing (EQSP), will create a new measurement system that will
  identify the cause and impact of errors, apply common measures to
  every level of the new organization, and enable frontline employees to
  understand how their contributions impact IRS's performance. An
  embedded quality system links individual and business performance with
  multiple quality review sources. EQSP will instill complete
  accountability for quality performance across operations.

     TAX LAW ENFORCEMENT BUDGET PRIORITIES AND RESOURCE ALLOCATION

    Question. Given IRS's inability to increase enforcement in recent 
years, what will be different in fiscal year 2005?
    Answer. The IRS's enforcement statistics for fiscal year 2003 
demonstrate that IRS has arrested the enforcement decline that began in 
the 1990's and continued through the implementation of RRA 98. Audits, 
criminal investigations, and monies collected have all increased. In 
particular, when compared with fiscal year 2001, audits of taxpayers 
with incomes over $100,000 increased by over 50 percent by fiscal year 
2003.
    The administration's 2005 budget request for the IRS will continue 
to rebuild its enforcement activities. Two-thirds of the new monies 
requested will be devoted to addressing abuses by high-income taxpayers 
and corporations, and increasing criminal investigations.
    In fiscal year 2005, the IRS is seeking an additional $300 million 
for enforcement activities to focus on the following four objectives in 
enforcement:
  --Discourage and deter non-compliance, with emphasis on corrosive 
        activity by corporations, high-income individuals and other 
        contributors to the tax gap;
  --Ensure that attorneys, accountants and other tax professionals 
        adhere to professional standards and follow the law;
  --Detect and deter domestic and off-shore tax and financial criminal 
        activity; and
  --Discourage and the misuse of tax-exempt and government entities for 
        tax avoidance and other purposes.
    These incremental resources will help IRS to address the tax gap, 
the difference between what is owed and what is paid due to non-filing, 
underreporting, and underpayment, and secure billions of extra dollars 
for the Treasury. Once the IRS hires and trains enforcement personnel, 
it estimates the direct return on investment will be about 6 to 1 for 
direct revenue-producing initiatives. Beyond the incremental revenues 
directly associated with the increased audits, investigations and 
collection activity, the increased publicity of these actions will 
discourage other taxpayers from cheating.

                      FUTURE STAFFING REQUIREMENTS

    Question. What is IRS's assessment of the IRS's long term 
requirements?
    Answer. The vision of the IRS remains to re-center the agency with 
the proper balance of service and enforcement poised to quickly meet 
technological and demographic changes, and customer expectations.
    The IRS's goals remain the same--to improve taxpayer service, 
enhance enforcement through uniform application of the law, and improve 
the IRS infrastructure and modernize technology. The IRS working 
equation is that service plus enforcement equals compliance. The IRS is 
maintaining high levels of taxpayer service while focusing on corrosive 
areas of non-compliance. Ensuring fairness will help restore faith in 
the Nation's tax administration system.
    Question. Can the IRS assure this committee that the current 
refocus can put this program back on schedule so that it will not go 
the way of TSM?
    Answer. The IRS needs a more versatile team of seasoned executives 
to provide long-term stability to the program. The IRS is complementing 
the skills of experienced IRS tax executives with outside seasoned 
technology executives who have experience managing large-scale, complex 
IT projects. As such, the IRS is hiring two Associate Chief Information 
Officers to join the MITS organization, and an executive search firm is 
conducting searches for five senior executives with a wide range of 
diverse experience in developing and implementing large modernization 
systems.
    In addition, the IRS used the results from independent studies 
commissioned during the summer of 2003 to create a BSM Challenges Plan 
comprised of 40 some action items. Given the strategic importance of 
the plan, the Commissioner appointed an IRS business unit deputy 
commissioner to oversee the implementation of the plan.
    As a first step, the BSM project team developed a crosswalk to 
ensure that the BSM Challenges Plan's definition of the issues 
addressed and/or satisfied all of the recommendations from the four 
commissioned studies as well as the recommendations submitted by the 
IRS Oversight Board, and the Software Engineering Institute (SEI) study 
of CADE.
    While the deputy commissioner made significant progress in 
implementing the plan, the full closure of all actions items was 
unrealistic within the elapsed timeframe of the 6-month appointment. 
Concurrently, the CIO created a new direct report position for 
modernization management and assigned responsibility for implementing 
the plan to the individual recently hired into this newly created 
position.
    Under the leadership of the deputy commissioner, the IRS and CSC 
team brought closure to several key actions items, including: 
clarifying the roles of committees as advisory, identifying 
``blockers'' on contracting issues, appointing business leaders to each 
project, establishing a risk-adjusted schedule and new baseline for 
CADE Releases 1.0 and 1.1, and increasing the frequency of CADE reviews 
with the business owner to twice monthly. The majority of the action 
items are still works-in-progress, some of which will take time to 
fully complete. Others will span the life of the BSM program.
    For example, strengthening systems engineering capabilities by 
hiring external candidates will take time since it involves conducting 
the searches, interviewing the candidates, and negotiating the new 
hires to come on board. The IRS and CSC developed ground rules for 
escalating issues, but they will need to be continually enforced 
throughout the life of the program. The IRS rewrote the charters of the 
governing committees to reflect their advisory role and clearly 
articulated their responsibilities, however, it will probably take a 
year to truly evaluate and measure their effectiveness.
    As stated, the IRS has made progress toward closing all the action 
items, but it has much more work to do in critical areas. For example, 
the IRS needs to religiously follow the proper methodologies and hold 
people accountable if they do not. The IRS must start ``doing things 
right'' as opposed to ``doing things fast'' such as exiting milestones 
prematurely. An ongoing challenge will be balancing the scope and pace 
of projects consistent with capacity, ensuring that the right people 
are in place before launching a project, and setting realistic delivery 
schedules and cost estimates. The IRS is committed to staying-the-
course and delivering on its promise to modernize America's tax 
systems, but it is important for everyone to acknowledge this is a 
monumental effort.
    The magnitude and evolution of the BSM program dictates that the 
IRS will always be going through an evolution of assessment and 
improvements. In that regard, the BSM Challenges Plan is still evolving 
and the IRS is using certain action items to continuously improve the 
program.

                             BSM MANAGEMENT

    Question. Is IRS's schedule for completing the remaining corrective 
actions identified in the associated BSM Action Plan?
    Answer. Please see response to previous question.

                       ACTUARIAL SOFTWARE PROGRAM

    Question. What number of life insurance companies or what 
percentage of the industry does the IRS consider an appropriate amount 
to examine in order to provide the IRS with ``sufficient data to 
conduct a cost benefit analysis?''
    Answer. The IRS has determined that a sample of four Coordinated 
Industry life insurance audits (based on the criteria as described in 
the question below) will give sufficient data for preliminary results 
from a cost benefit analysis. The fact that the IRS anticipates closing 
four cases led it to determine that a 5 percent completion rate would 
give it preliminary figures so that it could project over the total 
population.
    Question. What selection criteria is the IRS using to make sure 
that the initial examination results analyzed are an accurate 
estimation or cross-section of the industry?
    Answer. The IRS based the selection criteria it used on a mix of 
variables, such as the stage of the audit cycle, product mix, and size 
of taxpayers. These criteria allowed the IRS to have a cross-section of 
the industry. Due to the length of time it takes to examine life 
insurance reserves, the stage of the audit means that the IRS needs to 
examine reserves very early in the audit and not when the audit's 
estimated completion date is approaching. Product mix means that the 
IRS attempted to select taxpayers for audit who sold different kinds of 
policies such as traditional life insurance, universal life insurance, 
variable life insurance, single premium annuities, and etc. Size of the 
taxpayer means that the IRS is looking to select not only the extremely 
large taxpayers in the Coordinated Industry arena but also the ones who 
have lesser gross receipts and assets in size.
    Question. When does the IRS expect to have sufficient data?
    Answer. The IRS is projecting to have four audits complete by the 
end of the fiscal year that would give sufficient data. The fact that 
the IRS anticipates closing four cases led it to determine that a 5 
percent completion rate would give it preliminary figures so that it 
can project over the total population.
    Question. Congress has funded the program for 3 years, yet due to 
the very late start date of the program, although the program has been 
provided fiscal year 2004 funding, the program is still using fiscal 
year 2003 funding. Has the IRS set aside the fiscal year 2004 funding 
provided for the third year of the program?
    Answer. The appropriation language for fiscal year 2003 reads that 
the IRS will provide up to $4 million from available funds to support 
the program. As services are rendered and invoices received, the IRS is 
currently paying amounts to the vendor out of fiscal year 2003 funding 
for the actuarial software license, maintenance, actuary salaries, and 
related travel costs to conduct training sessions. In addition, the IRS 
has available $2 million from fiscal year 2004 funding for IRS employee 
travel and training expenses, testing and the related implementation 
costs, the purchase of additional memory to upgrade revenue agent 
computers to 512MB capacity, the purchase of additional software which 
is required for the vendor's Total Life software to work, and the 
possibility of hiring additional life insurance actuaries to assist on 
examinations.
    Question. What plans does the IRS have for this funding?
    Answer. Please see response to previous question.
    Question. In March 2004, the IRS stated that after software 
training for 2004 is complete, ``this will result in 41 coordinated 
life insurance examinations having the use of the software.'' How many 
coordinated life insurance examinations currently exist?
    Answer. There currently are approximately 75 Coordinated Industry 
life insurance examinations, of which 30 are either using the software 
or are planning to use it in the near future. Another class is 
scheduled for the second week in June where more teams will receive 
training in using the software. The fact that the IRS anticipates 
closing four cases led it to determine that a 5 percent completion rate 
would give it preliminary figures so that it can project over the total 
population.
    Question. Should not the software be used on all life insurance 
examinations?
    Answer. If the results of the cost benefit analysis prove 
productive and promote compliance, the goal would be to use the 
software on any life insurance examination, as appropriate. The stage 
of the audit cycle, as mentioned in the second question above, will 
dictate when it is appropriate to use the software on the balance of 
the Coordinated Industry life insurance cases.
    Question. Given the technical nature of the program, does the IRS 
have personnel with sufficient expertise and knowledge to effectively 
implement the program? What additional personnel, if any, does the IRS 
believe it needs to make the program fully effective?
    Answer. Experience has shown over the last year of training revenue 
agents and computer audit specialists that they would have the 
expertise to utilize the software on audits immediately following 
training with the assistance of a life insurance actuary. The Large and 
Mid-Size Business Operating Division has two in-house life insurance 
actuaries with the level of expertise and knowledge to implement the 
program. Since audit cycles are normally 2 to 3 years in length, on an 
average, a revenue agent may only use this software once during this 
time frame, which may result in a high learning curve or the need for 
additional refresher training for subsequent and additional audit 
cycles. The IRS believes that it is essential for life insurance 
actuaries to be involved as the focal point to utilize this software 
effectively.
    Depending on the benefit analysis results, the IRS will evaluate 
the opportunity to hire additional life insurance actuaries as funding 
permits.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

                  FAILURE TO COLLECT DELINQUENT TAXES

    Question. Based on your collections to date, it appears that IRS is 
not pursuing billions of dollars in uncollected taxes. In recent 
testimony before the Finance Committee, Treasury Deputy Secretary 
nominee Samuel Bodman stated that:
  --As of the end of fiscal year 2003, $16.5 billion was in deferred 
        status, meaning that these taxpayers have filed a return and 
        owe tax, but have not paid it or have only partially paid.
  --The largest delinquent amount in deferred status is more than $50 
        million.
  --In recent years, accounts in deferred status have decreased 
        slightly but the dollar amounts have increased.
    Mr. Everson, how do you respond to this pathetic record of 
collecting unpaid taxes?
    Answer. The collection results for accounts that are in a deferred 
status are not indicative of the IRS's overall Collection effort. 
During fiscal year 2003, the IRS issued first notices to about 11.8 
million new balance due accounts, as required by IRC section 6303. 
During the same period, the IRS resolved about 7.6 million accounts by 
full payment, installment agreement, or other means as a result of the 
taxpayer's response to the first or subsequent notices. The IRS 
subsequently resolves a significant portion (on average, about 67 
percent) of the balance due accounts, which are not resolved in notice 
status and become Taxpayer Delinquent Accounts (TDAs), through full 
payment or the initiation of an installment agreement.
    Deferred accounts are placed in a suspended category because of 
other collection priorities and resource limitations and they are first 
subject to risk and collection probability analysis. Cases that have a 
modest compliance risk, i.e., lesser impact on tax administration and 
subsequent noncompliance, and low probability of collection are 
deferred, freeing Collection resources to work more in-business trust 
fund cases and cases where there is a likelihood of full payment. 
However, the IRS is refining its Collection models for these cases and 
evaluating the benefit of filing notices of Federal tax liens on 
deferred accounts.
    Question. Mr. Everson, your budget documents say that a growing 
number of Americans think it is okay to cheat on their taxes and that 
``this trend threatens the government's future revenue stream and basic 
respect for the law.'' Why should these taxpayers take their IRS debt 
seriously if the agency never presses for collection?
    Answer. All delinquent accounts receive Collection action. The 
treatment for a particular delinquent account depends on the amount 
owed and the predicted compliance risk. Taxpayers generally receive at 
least two notices and if they fail to respond, enforcement action is 
likely. Each year, the IRS resolves a large percentage of its 
delinquent accounts through full payment or installment agreement. Many 
others are ultimately resolved through refund offsets, abatements, and 
Offers in Compromise. As shown in the following chart, overall 
enforcement actions on taxpayer delinquent accounts have increased 
significantly since fiscal year 2000. In fiscal year 2003, the IRS 
filed 548,683 Notices of Federal Tax Lien and served 1,680,844 Notices 
of Levy. Passage of the administration's proposed Private Collection 
Agent (PCA) legislation will further improve these results.

----------------------------------------------------------------------------------------------------------------
                    Activity                           2000            2001            2001            2003
----------------------------------------------------------------------------------------------------------------
Enforcement activity (actual numbers):
    Number of notices of Federal tax liens filed         287,517         426,166         482,509         548,683
    Number of notices of levy served upon third          219,778         674,080       1,283,742       1,680,844
     parties....................................
    Number of seizures..........................              74             234             296             399
----------------------------------------------------------------------------------------------------------------

    In addition, the IRS has taken a number of steps recently to 
further address taxpayers' noncompliance with their filing and payment 
obligations, including:
  --Case Selection.--The IRS refined its inventory delivery system so 
        that the higher priority cases (in terms of impact on tax 
        administration and subsequent noncompliance as well as 
        potential for collection) are selected for assignment to the 
        Collection field function and the Automated Collection System. 
        The IRS continually examines how case selection can be 
        improved.
  --Employment Taxes.--The failure of employers to make their Federal 
        tax deposits and pay over the withheld trust fund taxes is a 
        serious compliance issue. The IRS has developed and is 
        implementing a strategy to improve collection of employment 
        taxes.
  --Causes for Underpayment and Non-Filing.--The IRS is working to 
        identify the components of its potentially collectible 
        inventory, the main causes of non-compliance, and the 
        contributing market segments. The information obtained is being 
        used to address taxpayers through outreach and education, and 
        to determine potential systems and policy changes. One 
        significant component involves estimated tax compliance.
  --Taxpayer Education.--The IRS is aggressively reaching out to 
        taxpayers before they either intentionally or inadvertently, 
        fail to file or fail to pay the full amount of tax due. 
        Stopping noncompliance before it occurs is far preferable than 
        having to find it afterwards. The IRS website has been a 
        tremendous success and has been an important resource for 
        taxpayers. It also is an important way for the IRS to 
        communicate to taxpayers, including reaching out to those 
        taxpayers who may be missing out on important tax benefits when 
        they fail to file a return. The IRS is continuing to examine 
        how taxpayer outreach can be improved and made more effective.
    Question. A recent report by the Treasury Inspector General for Tax 
Administration (TIGTA) found that IRS's existing procedures are 
ineffective in ensuring even that criminals who are convicted in court 
for tax evasion are paying their civil tax liabilities. Why can't IRS 
collect from tax cheats?
    Answer. In response to problems identified in the TIGTA audit, the 
IRS completed a review of the process for referring criminal cases for 
civil disposition that have conditions of probation. CI conducted this 
review in partnership with SB/SE. Furthermore, CI and SB/SE have taken 
the following steps:
  --The Chief CI and SB/SE Commissioner issued a joint memorandum on 
        April 13, 2004, to field office personnel stressing the 
        importance of cooperation in handling civil closings for 
        sentenced taxpayers and provided operating procedures for 
        processing the civil closings of all sentenced taxpayers. CI 
        and SB/SE are revising the Internal Revenue Manual to implement 
        these procedural changes.
  --The Technical Service, Advisory Unit within SB/SE is reviewing 
        assessed tax liabilities in these cases to identify cases 
        wherein the conditions of probation were not met and will 
        report this information to CI.
  --CI's Research Unit has identified all cases within their management 
        information system that have outstanding conditions of 
        probation or appear anomalous. The Research Unit forwarded the 
        information to the appropriate CI field office for review and 
        corrective action, if necessary. Twice a year, the Research 
        Unit will submit similar information to the responsible field 
        office(s) for verification and correction.
  --The CI Research Unit added additional tracking codes to the 
        management information system to ensure that management only 
        tracks and reviews viable open cases.
  --CI revised its Criminal Investigation Closing Report. This report 
        will serve as CI's notice to the SB/SE Territory Manager of 
        Technical Services that the court has sentenced a taxpayer and 
        document the tax-related conditions of the sentence.
  --CI is developing a ``Fraud Life Cycle'' communications model as an 
        educational tool to improve its understanding of the 
        interaction among the various CI and SB/SE functional 
        processes. This model will help CI and SB/SE develop ways to 
        improve the processing of conditions of probation cases.
  --CI front line managers received refresher training on using current 
        systems to effectively identify, report, and monitor terms and 
        conditions of probation on tax investigations.
  --CI's Review and Program Evaluation (RPE) Section has incorporated, 
        as part of its field office review process, an analysis of the 
        CIMIS information on terms and conditions of probation. Senior 
        executives in CI will use RPE reports to ensure that all 
        conditions of probation procedures are effectively implemented 
        in each field office.
  --The Program Manager, Technical & Insolvency of SB/SE will include 
        the monitoring of conditions of probation in fiscal year 2005 
        reviews of Technical Services operations and keep the Director, 
        Payment Compliance informed of adherence to IRM procedures. 
        These procedures require Technical Services to immediately 
        report to CI evasive or uncooperative taxpayers, as well as 
        taxpayers who have fully complied with conditions of probation. 
        For other non-compliant taxpayers subject to conditions of 
        probation, Technical Services must provide the required reports 
        to CI no later than 6 months before the probation expires. CI 
        will advise the Courts of these conditions.
    These steps will improve coordination between CI and SB/SE, clarify 
areas of responsibility, enhance employees' understanding of newly 
implemented procedures, and improve the processing of conditions of 
probation cases.
    Question. Ms. Gardiner, given the fact that the head of IRS-
Criminal Investigations disagreed with a number of your 
recommendations, are you confident that this grotesque abuse will be 
stopped? Mr. Everson, would you care to comment as well? Ms. Gardiner, 
why do you believe that IRS has not cleared up even the simplest of 
cases of uncollected taxes? Do you consider it a possibility that IRS 
has not done so in order to build a case for the use of private 
collection agencies?
    Answer. The IRS unequivocally states that no collection action has 
been taken or not been taken for the purpose of building a case for the 
use of private collection agencies (PCAs). Under the administration's 
proposals, PCAs would supplement, and not supplant, IRS collection 
efforts. PCAs would expand the IRS's overall capability to address 
outstanding tax liabilities while also allowing the IRS resources to be 
directed at more complex cases and issues.
    TIGTA will respond separately.
    Question. Ms. Gardiner, why do you believe that IRS has not cleared 
up even the simplest of cases of uncollected taxes?
    Answer. TIGTA will respond separately.
    Question. Do you consider it a possibility that IRS has not done so 
in order to build a case for the use of private collection agencies?
    Answer. TIGTA will respond separately.
    Question. In response to questions posed at the Treasury Deputy 
Secretary's nomination hearing, Mr. Bodman said that IRS has 
implemented several actions to ensure that all deferred accounts 
receive adequate collection. But as I read it, only one of these four 
actions actually tries to collect from the taxpayer: the annual notices 
that remind taxpayers to pay their obligations. The other three seem to 
only further penalize the already delinquent party. How do these other 
activities really help in the collection of tax debts? Don't they 
simply compound the problem? Are these really the best ways to go after 
tax cheats?
    Answer. The actions described by Dr. Bodman (refund offsets, the 
Federal Payment Levy Program (FPLP), and reactivation) are the 
principal methods of collection for deferred accounts; the IRS also 
uses these techniques as supplemental collection techniques for other 
types of cases. Since these methods generally employ automated 
processes, they allow the IRS to pursue these accounts at relatively 
low cost. Reactivation of a deferred account may be triggered when the 
taxpayer incurs a new liability, a tax filing delinquency occurs, or 
the IRS learns of a source of income. Based on the triggering event, 
the IRS reevaluates the priority of the case in terms of compliance 
risk and potential to collect the delinquency. Typically, if the case 
is deemed collectible, the IRS can expect to collect 64 percent of the 
debt through full payment or an installment agreement.
    As noted in Dr. Bodman's response, many of the accounts in deferred 
status represent taxpayers who have filed a tax return showing an 
amount of tax due, but who have failed to pay the tax. Other accounts 
represent taxpayers who have been assessed additional tax by the IRS 
and have made three or more voluntary payments to satisfy that 
additional tax, but who have stopped making payments. These taxpayers 
are aware of their outstanding liabilities. The IRS, however, is unable 
to continuously pursue each taxpayer with an outstanding tax liability 
because of other resource and collection priorities. Many taxpayers 
with outstanding tax liabilities, however, would make payment if 
contacted by telephone and, if necessary, offered the ability to make 
payment of the full amount in installments. The administration's fiscal 
year 2005 budget proposes to permit the IRS to use private collection 
agencies (PCAs) to address accounts in deferred status.
    Question. Mr. Everson, a recent IRS Oversight Board report claims 
that each year, ``the IRS must absorb millions of unfunded costs, such 
as rent increases and postage, left uncovered by the administration's 
budget request.'' The Board estimates that in both fiscal year 2004 and 
fiscal year 2005, there will be at least $100 million in unfunded 
expenses. Further, the ``resulting shortfalls mean that the IRS is 
consistently unable to hire the personnel assumed in the 
administration's request.'' In what areas has the IRS cut, in order to 
pay these unfunded costs?
    Answer. The IRS took reductions across-the-board from all programs 
to fund pay parity, but protected enforcement initiatives. When 
absorbing the appropriation reduction, the IRS protected enforcement 
initiatives and related support costs, and took the majority of the cut 
from Information Systems and other support.
    The fiscal year 2005 budget includes a 1.5 percent increase for 
pay. If Congress approves and the President signs the anticipated 3.5 
percent increase, the impact of this increase would result in a 
shortfall of $109 million. Most of the IRS budget is composed of labor 
(71 percent) and most of the remainder is composed of items that 
support staff directly (travel, rent, supplies and equipment). The 
total percentage of the IRS budget that does not support staff directly 
is less than 18 percent. Any reduction to IRS funding or any absorption 
of an unfunded mandate like a pay raise would, of necessity, have a 
direct impact on FTE. Because most IRS staffing is devoted to taxpayer 
casework--answering telephones, collecting overdue money, or auditing 
returns--reductions inevitably affect these taxpayer assistance areas, 
affecting both taxpayer service and enforcement.
    [Clerk's Note.--The report follows:]

                                 Report

                               BACKGROUND

    The National Commission on Restructuring the IRS issued a report in 
1997 defining ``A Vision for a New IRS.'' In 1998, the IRS 
Restructuring and Reform Act (RRA 98) codified much of that vision into 
law. Since the passage of RRA 98, the IRS has undergone enormous 
changes, including the most extensive reorganization of the agency in 
the past 50 years. Prior to the IRS reorganization, all ten IRS 
Submission Processing Centers performed similar functions and processed 
returns for both the Individual Taxpayers (IMF) and Business Taxpayers 
(BMF). Each center also handled Taxpayer Accounts (correspondence/
telephones) and Compliance programs for both IMF and BMF.
    Although the ten-center configuration was successful and worked for 
many years, we felt we could improve our business results and better 
respond to customer needs by organizing around our customer segments. 
We based the initial IMF Consolidation Strategy of our centers around 
Wage and Investment (W&I), Small Business/Self Employed (SB/SE), Large 
and Mid-Size Business (LMSB), and Tax Exempt and Government Entities 
(TE/GE) customer segments. As a result of this reorganization, we 
realigned the ten Processing Campuses into eight W&I (IMF) and two SB/
SE (BMF) Submission (paper returns) Processing Centers. We completed 
this realignment of the customer base in 2002. Now, all BMF taxpayers 
file their paper returns at our processing centers located at either 
Ogden, Utah or Cincinnati, Ohio. All IMF taxpayers file their paper 
returns at one of the W&I centers.
    The RRA 98 also mandated that the IRS improve the Electronic Tax 
Administration program to reach the goal of 80 percent of individual 
returns filed electronically by 2007. With increased emphasis and 
success of electronic filing, the volume of paper returns has 
decreased. To effectively administer and manage this change in taxpayer 
behavior, the IRS analyzed ``E-file versus Paper Trends'' and developed 
a detailed business plan to gradually reduce the number of IMF paper 
Processing Centers. We approved this ``Business Plan,'' which will take 
several years to fully implement, in 2002. The plan calls for the 
consolidation of an IMF paper processing center every few years, 
contingent on the public's continued migration from paper to 
electronically filed returns.
    At the completion of each filing season, we assess both the e-file 
progress and the paper return filing pattern to see if we need to 
adjust the consolidation timelines for the next filing season. 
Flexibility is a key component in this plan, allowing the IRS to plan 
and react appropriately as paper return volumes fluctuate. Many 
restructuring changes have already taken place at the Ogden, Utah; 
Cincinnati, Ohio; and Brookhaven, New York campuses. At Memphis, 
Tennessee; Philadelphia, Pennsylvania; and Andover, Massachusetts, the 
IRS will consolidate the paper return processing function over the next 
several years.
    However, compliance and tax account work will remain at all the 
campuses, making them key employment centers. Our timetable for 
consolidating IMF paper processing at the campuses is as follows:
  --Consolidate the processing of BMF paper returns into two sites 
        (Ogden, Utah and Cincinnati, Ohio). We completed this migration 
        in 2002.
  --Discontinue the processing of IMF paper returns at Brookhaven, New 
        York. We completed this change in October 2003.
  --Discontinue the processing of IMF paper returns at Memphis, 
        Tennessee by June 2005.
  --Discontinue the processing of IMF paper returns at Philadelphia, 
        Pennsylvania by June 2007.
    We will determine the specific dates for consolidating of the 
remaining centers based on e-file and paper volume projections for 
subsequent years.

                           ELECTRONIC FILING

    In 1999 the IRS processed 29 million electronically filed returns, 
and in 2003, 53 million taxpayers chose to file electronically. We 
estimate that nearly half of all taxpayers will e-file in 2004. We are 
encouraged by both the growth of e-file to date and the projected 
growth through 2010. We will continue to strive to reach the RRA 98 
goal, but believe that individual returns filed electronically will not 
reach 80 percent by 2007; however the IRS's electronic tax filing 
program has experienced tremendous gains in customer acceptance. The 
chart below reflects the progress we made in e-file from 1997 through 
2003, and our projections for the future look equally promising.

                                                     ACTUAL
                                              [Volume in millions]
----------------------------------------------------------------------------------------------------------------
                                              1997      1998      1999      2000      2001      2002      2003
----------------------------------------------------------------------------------------------------------------
Total Returns.............................     120.7     125.2     126.0     128.4     131.0     131.7     130.1
Total Paper...............................     101.5     100.6      96.7      93.0      90.9      85.0      77.2
Total Electronic..........................      19.2      24.6      29.3      35.4      40.1      46.7      52.9
Percent e-filed...........................      15.9      19.6      23.3      27.6      30.6      35.5      40.7
Percent growth Electronic.................  ........      28.1      19.1      20.8      13.3      16.5      13.3
Percent decrease Paper....................  ........       0.9       3.9       3.8       2.3       6.5       9.2
----------------------------------------------------------------------------------------------------------------


                                           PROJECTED--2004 AND BEYOND
                                              [Volume in millions]
----------------------------------------------------------------------------------------------------------------
                                              2004      2005      2006      2007      2008      2009      2010
----------------------------------------------------------------------------------------------------------------
Total Returns.............................     130.9     133.3     135.5     137.3     139.0     140.5     141.9
Total Paper...............................      71.1      66.6      62.2      58.1      54.8      51.9      49.5
Total Electronic..........................      59.8      66.7      73.3      79.2      84.2      88.6      92.4
Percent e-filed...........................      45.7      50.0      54.1      57.7      60.6      63.1      65.1
Percent growth Electronic.................      13.5      11.5       9.9       8.0       6.3       5.2       4.3
Percent decrease Paper....................       8.1       6.3       6.6       6.6       5.7       5.3       4.6
----------------------------------------------------------------------------------------------------------------

                        PROCESSING PAPER RETURNS

    As a result of the increase in e-file volume, the paper return 
volume has decreased each year since 1998. For example, in 1999 we 
processed over 97 million paper returns, or 77 percent of the total 
returns processed by the IRS. From 1999 through 2003, paper return 
volume has decreased by almost 26 million returns, a 26 percent 
reduction. In 2004, we project we will process 71 million paper 
returns, which is 54 percent of the total returns processed. This is an 
average of over 4 million fewer paper returns each year; a trend that 
we expect will continue. Based on these trends, we analyzed the impact 
on operations and developed a comprehensive business plan by looking at 
the impact e-file would have on our processing centers (Phase I), and 
then developing a strategy to address the decline in paper return 
volumes (Phase II).

                   PHASE I OF CONSOLIDATION STRATEGY

    Due to the actual and projected increases in electronic filing 
(ELF), we decided to assess the current and future impact of e-file on 
our paper processing sites. In 2000, we developed a long-term strategy 
by answering three key questions about the future of IMF return 
processing:
  --How does an increased ELF volume affect the workforce?
  --What is the ideal configuration (end state) of centers when we 
        achieve 80 percent ELF?
  --How will the IRS manage the path toward the end-state 
        configuration?
    We assessed projected volumes of ELF and paper processing capacity 
at each site, multiple transition scenarios, and business objectives to 
arrive at a consolidation strategy. The results of this analysis showed 
that continuing to operate ten paper processing sites was inefficient. 
Although we analyzed multiple strategies, consolidating one IMF center 
at a time (as the volume of e-file returns continues to increase) was 
the most efficient strategy. We shared this strategy with all our 
internal and external stakeholders, then proceeded to implement this 
``Modernization/Consolidation of Submission Processing Centers,'' 
starting with the consolidation of the Brookhaven IMF Submission 
Processing operation. As a result, Brookhaven stopped processing 
individual paper returns as of October 2003.
    Our strategy will allow us to improve customer service, increase 
business performance, and adjust the plan as paper and e-file volumes 
and patterns dictate. It will also permit us to reduce overhead and 
real estate costs campus by campus.

                   PHASE II OF CONSOLIDATION STRATEGY

    For the second phase of our analysis, we reviewed each site against 
factors including business operational alignment, economies of scale, 
labor market issues, and real estate costs. This analysis identified 
the order of the consolidation of IMF processing centers, starting with 
the Brookhaven Submission Processing center in October 2003, the 
Memphis Submission Processing center in October 2005, and the 
Philadelphia Submission Processing Center in October 2007.
    We expect these consolidations to be followed by the Andover 
Submission Processing center, and so forth, until the IRS reaches its 
``end state'' configuration. Again, this plan is contingent on the 
continued growth in the number of e-filed returns.

                            TAXPAYER IMPACT

    At the very beginning of our modernization efforts, we recognized 
the challenge we would face in ensuring our customers understood the 
reason for consolidating our operations and the changes they could 
expect to see. We have tried to minimize the impact of these changes by 
consulting with various groups including the National Treasury 
Employees Union (NTEU) and Tax Practitioner groups. Working with our 
own Multi-Media operation, we made sure that various tax packages 
included updated instructions on the location to send returns. We also 
made presentations at various tax forums around the country. Although 
this effort has been challenging, we have successfully consolidated IMF 
and BMF customer processing sites and the Brookhaven Submission 
Processing operation. Even though we substantially reduced the number 
of returns processed at Brookhaven in 2003, we completed one of our 
most successful filing seasons. We review each consolidation process 
and build on that foundation as we continue our consolidation efforts.

                            WORKFORCE IMPACT

    We recognize that one of our greatest assets is the people who help 
in the daily processing of taxpayers' returns. We also recognize that 
consolidating paper processing operations will affect our workforce. In 
anticipation of the consolidation, we stopped hiring ``career 
conditional'' employees and started hiring ``temporary'' employees in 
Memphis, Philadelphia, and Andover. The new hires understand their 
appointment is temporary. When job reductions occur, we will make every 
effort to minimize the adverse effects on our employees. For example, 
when we realigned the processing of IMF/BMF paper returns into eight 
IMF centers and two BMF centers, we did so without a loss of jobs. In 
addition, in the Brookhaven and Memphis centers we prepared for staff 
downsizing by consolidating our Centralized Offer in Compromise (COIC) 
program in the centers, creating hundreds of job opportunities at each 
location. We also recently announced the proposed consolidation of Case 
Processing and the Insolvency Program, which will also create hundreds 
of jobs in Memphis and Philadelphia.
    We are working with NTEU to develop workforce transition plans and 
to take advantage of every tool we have to help employees through this 
transition. We have held ``Town Hall'' meetings with the employees at 
all our campuses and will continue to do so as we schedule specific 
campuses for consolidation. We will also continue to provide our 
employees with job placement assistance. Of course, if we must 
involuntarily separate employees from the IRS, we will give them all 
the benefits to which they are entitled under the law.

                               CONCLUSION

    We began modernizing our paper processing centers in 1998. We 
conducted an extensive business plan analysis before making 
consolidation decisions, and we continue to rely on this business plan 
as we move forward with consolidation. We also adjust our plan based on 
our initial experiences with the streamlining of the service centers. 
This report captures at a high level the analysis, efforts and progress 
we have made in improving our processing operations. We would welcome 
the opportunity to present this extensive business case to you and your 
staff at your earliest convenience.

    Question. In addition to the new enforcement funding IRS is seeking 
from Congress, the IRS's budget justification states the following 
about its intention to fund enforcement from other areas: ``In fiscal 
year 2005, $111 million will come from current operations to improve 
enforcement and infrastructure.'' ``The majority of resources ($61 
million) generated from base mining will be diverted to enforcement 
activities. . . .'' Why is only a little more than half of the money 
going toward enforcement? For what specific purposes is the other money 
going and what is meant by infrastructure?
    Answer. The IRS is emphasizing enforcement, but it cannot ignore 
service or the infrastructure supporting it. Thus, in order to balance 
its efforts, the IRS redirected some funds to modernizing IRS 
infrastructure. The IRS budget strategy is designed to redirect 
productivity enhancements from increases in electronic processing and 
modernization of business systems to continue to improve taxpayer 
service and enforcement.
    Of the $111 million in redirected resources, $61 million will be 
diverted to enforcement activities. The remaining $50 million will be 
redirected as follows:

                         INFRASTRUCTURE EXPENSES
                        [In millions of dollars]
------------------------------------------------------------------------
                                                              Amount
------------------------------------------------------------------------
Cost of Transitioning Employees\1\......................            39.0
Continue Competitive Sourcing Studies...................             9.0
Embedded Quality \2\....................................             1.6
Create ADA-Compliant Training Facility..................             0.5
                                                         ---------------
      TOTAL.............................................            50.1
------------------------------------------------------------------------
\1\ Includes lump-sum leave, severance and relocation.
\2\ This initiative, through an Embedded Quality system in Submission
  Processing (EQSP), will create a new measurement system that will
  identify the cause and impact of errors, apply common measures to
  every level of the new organization, and enable frontline employees to
  understand how their contributions impact IRS's performance. An
  embedded quality system links individual and business performance with
  multiple quality review sources. EQSP will instill complete
  accountability for quality performance across operations.

    Infrastructure refers to programs and activities that support 
enforcement and taxpayer service. These activities align with the IRS's 
third strategic goal, ``modernize the IRS through its people, 
processes, and technology.''
    Question. As part of its budget request, IRS proposes spending 
$121.6 million and 1,167 FTE to ``curb egregious noncompliance''. 
Please provide a table citing each instance of egregious noncompliance, 
along with the associated dollar amount and FTE.
    Answer. The ``Curb Egregious Noncompliance'' (CEN) enforcement 
initiative addresses the continuing concern over the proliferation of 
abusive domestic and international tax avoidance transactions and 
schemes. In addition, requested staffing will allow the IRS to address 
issues associated with certain individual taxpayers and those who use 
structured transactions and flow-through entities to conceal or 
improperly reduce taxable income and avoid payment of taxes owed. This 
noncompliance represents a real threat to the American system of 
voluntary compliance. Traditional approaches aimed at maintaining audit 
coverage and managing growing case inventories with a declining 
resource base have failed to adequately address these complex 
enforcement issues.
    To address these issues, the CEN initiative will allow the IRS to 
hire and train new staff in the Examination, Collection and Document 
Matching programs during fiscal year 2005.
    The following table shows the projected expenditures of FTE and 
dollars by program.

                          [Dollars in millions]
------------------------------------------------------------------------
                 Program                        FTE           Amount
------------------------------------------------------------------------
Field Examinations......................             492           $66.0
Field Collection........................             332           $29.2
Automated Underreporter.................              53            $4.2
Automated Collection (ACS)..............             125           $10.9
Correspondence Exams....................             165           $11.3
                                         -------------------------------
      Total.............................           1,167          $121.6
------------------------------------------------------------------------

    Question. Please provide a breakdown by percentage of how proposed 
enforcement resources would be allocated toward the various segments of 
the taxpayer population within $25,000 increments.
    Answer. In fiscal year 2005, proposed increases for the Tax Law 
Enforcement account, including annualization and enforcement 
initiatives, total $393 million. The IRS aligns increases in 
enforcement as follows:
  --Corporations.--$59 million (22 percent) and 562 FTE;
  --High-income taxpayers (>$100,000).--$57 million (21 percent) and 
        674 FTE;
  --Criminal activity.--$64 million (23 percent) and 299 FTE;
  --Tax-exempt organizations.--$16 million (6 percent) and 180 FTE; and
  --Other contributors to the tax gap.--$76 million (28 percent) and 
        1,226 FTE.
    The increase also includes $121 million for inflation to maintain 
current levels.

                           IRS REORGANIZATION

    Question. Please summarize in detail what has happened to IRS 
employees who were determined to be ``transitional'', stating from 
which program area they were taken and when, how many reassigned, how 
many were lost due to attrition, as well as how the requested $5 
million will remove the remaining employees ``from the rolls.''
    Answer. Upon stand-up in September 2000, approximately 5,000 
employees did not align with the new organizational structure. Over the 
next 3 years, the IRS placed approximately 4,450 employees into 
permanent positions or they voluntarily left the IRS. Approximately 
1,000 of these employees left under Voluntary Early Retirement 
Authority (VERA) or Voluntary Separation Incentive Payment (VSIP). On 
August 9, 2003, the IRS terminated the ``transition'' designation and 
declared permanent all employees previously designated as 
``transition.'' At that time, there were approximately 550 formerly 
transition employees. Of this group, the IRS placed approximately 290 
employees in permanent positions and 260 remained in non-continuing 
positions. The IRS expects to offer VERA/VSIP to the employees in the 
non-continuing positions to facilitate voluntary separations.
    Question. In early January, IRS officials announced a major 
organizational restructuring resulting in 2,400 layoffs as well as 
office consolidations. As part of the same announcement, IRS indicated 
its intention to then fill 2,200 new positions. What is the cost of the 
2,200 new enforcement positions the IRS intends to add? What is the 
cost savings associated with the layoffs and consolidations?
    Answer. As noted in the January announcement, as a result of our 
planned consolidation, the IRS expects to perform its Case Processing 
and Insolvency operations while using fewer full-time employees--saving 
approximately 350 staff years. Similarly, the IRS expects that Support 
Optimization initiative will allow it to deliver its operations support 
services while saving approximately 750 staff years. The Memphis 
Submissions Processing ramp-down will eliminate approximately 2,200 
positions. The January announcement stated the intention to redeploy 
the personnel reductions towards enforcement priorities.
    In determining the approximate numbers of full-time positions that 
could be redirected to enforcement activities, the IRS assumed a 1-for-
1 redeployment of the full time positions (i.e., approximately 350 from 
Case Processing and Insolvency and 750 from Support Optimization) and a 
2-for-1 redeployment for the submissions processing positions (i.e., 
for every two submission processing positions eliminated the IRS could 
expect approximately one full-time position available for redeployment, 
or approximately 1,100 positions). Thus, the IRS estimated that 
approximately 2,200 positions would be available for redeployment to 
enforcement activities that would not be otherwise available without 
such efficiencies.
    In determining the numbers of employees potentially subject to 
involuntary separation, the IRS estimated the numbers of employees in 
positions to be eliminated, and reduced that figure to account for the 
numbers of employees who are expected to voluntarily leave through 
normal attrition, the use of Voluntary Early Retirement Authority 
(VERA) and Voluntary Separation Incentive Payments (VSIP), and those 
employees expected to be placed in other positions with the IRS. For 
this determination, the IRS did not include employees hired for 
limited-term appointments, because employees accepted these positions 
with the understanding that the positions would ``sunset'' in 2005 and 
because the elimination of these positions does not require the same 
involuntary separation procedures.
    For the income tax returns processing initiative, the IRS estimates 
that approximately 2,200 positions will be eliminated. Of this number, 
approximately 400 are term appointments. Therefore, the IRS determined 
that approximately 1,800 permanent (full-time or seasonal) positions 
would be eliminated. Based on this figure, the IRS anticipates 
approximately 1,000 employees will be involuntarily separated. For the 
case processing and insolvency initiatives, the IRS estimates that 
approximately 1,400 positions will be eliminated. Of this number, it 
anticipates that approximately 1,000 employees will be involuntarily 
separated (because the case processing and insolvency initiative 
involves consolidating work, i.e., eliminating positions in field 
offices while creating positions in the four consolidated campus 
locations, the net number of positions available for redeployment 
(approximately 350) is less than the gross numbers of positions being 
eliminated (approximately 1,400)). The Support Optimization initiative 
involves eliminating approximately 750 positions, and based on that 
figure, the IRS anticipates approximately 400 employees will be 
involuntarily separated. Thus, the total number of employees estimated 
to be subject to involuntary separation is estimated to be 2,400.
    Question. The nationwide case processing and insolvency support 
workforce would be reduced from 1,600 positions to 1,200, a 25 percent 
reduction. What analysis has been done to show that 25 percent fewer 
employees can perform this work? What cost savings does the IRS project 
from this? All background on how the savings are projected should be 
provided.
    Answer. The IRS has been studying the reengineering of the case 
processing and insolvency operations since 2000. Even after taking into 
account costs such as severance, hiring, training, salary cost 
differentials, and infrastructure, the IRS expects these initiatives to 
yield more than $300 million in savings over the next 10 years. These 
savings will allow us to redirect the equivalent of 350-425 full-time 
employees to front line tax law enforcement.
    The IRS considered alternative approaches, including switching 
staffing allocations from the area offices to the campuses at a pace 
driven by natural attrition. The IRS rejected this approach because of 
low return on investment and implementation difficulties. Competitive 
outsourcing was also considered and rejected because case processing 
and insolvency work is mainly inherently governmental.
    The IRS's analysis involved baselining the existing case processing 
and insolvency processes currently performed in the areas, identifying 
best practices, and standardizing the processes to be implemented in 
the campus from these baselines and best practices. The new operational 
structure builds on existing processes currently being performed at IRS 
campuses, provides economies of scale and standardization, allows the 
creation of a quality review unit, offers staffing flexibility, and 
creates space savings due to shift work.
    The IRS's analysis of sources such as OMB and best practices used 
in private industry predicted that a 35 percent reduction in case 
processing and insolvency costs would be possible through consolidation 
and process standardization. The results predicted from external 
indicators were compared with area and campus case closure 
efficiencies. Centralized staffing calculations were updated based on 
area and campus efficiency and projected work plans resulting in a more 
conservative of 25 percent cost savings projection.
    Question. IRS has stated that no employee would be involuntarily 
separated before January 2005. When would new employees be hired and 
what kind of training will be provided? How would IRS deal with an 
inexperienced workforce--reduced by 25 percent from current levels--
that will have no institutional memory?
    Answer. The IRS is currently in negotiations with NTEU regarding 
the potential reduction in force. Until negotiations are finalized, no 
employee will be involuntarily separated. However, the IRS has recently 
entered into a separate memorandum of understanding with NTEU that 
authorizes a staged hiring at the campus consolidated sites to address 
excess workload in the area offices created by the natural attrition of 
staff. This step will allow the organization to begin ramp up by 
providing training and significant experience with the work before any 
off rolls occur.
    Once this IRS reaches its final agreement with NTEU, full 
implementation will occur with a staged deployment of hiring at the 
campuses, redirecting work from the field, and workforce transition in 
the non-continuing sites. This approach allows campus personnel 
additional experience with total centralization before off rolls will 
occur in 2005.
    The IRS established a training team made up of subject matter 
experts from case processing, insolvency, and campus employees to 
revise existing training material, write additional training lessons 
and develop training guidelines and timeframes. All campus hires will 
be given a combination of classroom and on the job training as soon as 
they are hired, which is a significant improvement over current field 
practices in case processing and insolvency.
    Learning curves were projected for centralized case processing and 
insolvency new hires aligned by grade level and skill set. These 
learning curves provided the underpinnings for decisions regarding the 
timing for early ramp up and staging the implementation. Projections 
for the time needed for training are conservative as many of the hires 
will already have experience from positions and activities currently 
performed on the campus that are similar to those in centralized case 
processing and insolvency.
    Question. How is it more efficient to move these case processing 
staff away from the collection staff they are supporting to centralized 
locations?
    Answer. In a centralized situation, a smaller team of employees can 
focus on one function for longer periods of time, and can work more 
efficiently than the larger number of staff in the separate locations. 
The workload can also be more easily managed and scheduled because of 
the consolidation. Training expenses and other costs have been 
considered, and the resulting savings shows centralization is cost 
effective.
    Many revenue officers and revenue agents currently mail their work 
to the area offices and under the new design the only change for them 
would be the address they mail to. To address lingering concerns of the 
collection staff there will be a FORT (Field Office Resource Team) 
consisting of revenue officers who will be responsible for assisting 
tax examiners and field collection personnel in making any necessary 
corrections to reports or closing documents.
    Question. How is it more efficient to centralize insolvency/
bankruptcy staff when this work is ruled in large part by 50 different 
State laws?
    Answer. Over 900 Insolvency Specialists and Advisors will remain in 
the area offices to address the more technical issues. They will no 
longer be pulled away from the technical work to help with clerical and 
para-professional duties. Therefore, centralization will actually 
enhance the relationships with the bankruptcy courts, trustees and 
external stakeholders that have been established over the years and 
increase customer service.
    The new structure provides economies of scale and standardization, 
allows the creation of a quality review unit, offers staffing 
flexibility, and creates space savings due to shift work. 
Centralization will also help create an environment suitable for 
electronic processing and transmission of Proofs of Claim. The planned 
use of an electronic knowledge system will provide a national resource 
for State law information.
    Question. Have you discussed this reorganization with the affected 
parties? What do the revenue officers and agents think the impact of 
this will be on their efficiency? What do tax practitioner groups think 
of this?
    Answer. There is a natural concern and uneasiness that accompanies 
any change. Focus interviews and customer surveys were conducted with 
area directors, revenue officers, revenue agents, and other bargaining 
unit employees in which the case processing redesign team received 
valuable information on issues and ideas to be considered for possible 
centralization. As a result of this feedback, the IRS developed the 
concept of the Field Office Resource Team (FORT). The FORT, consisting 
of revenue officers, will be available to address the needs of field 
collection personnel in making any necessary corrections to reports or 
closing documents.
    Insolvency has little contact with revenue officers, revenue 
agents, or practitioners. A centralized phone number and phone unit 
will be established to answer calls and concerns of trustees, taxpayers 
as well as any internal customers.
    The Case Processing Team had conversations with some of the large 
institutional practitioner groups and received support for the 
redesign.
    Question. At the Memphis Service Center, 2,200 current employees 
would be laid off and not replaced. IRS claims that this is aimed at 
reducing paper processing staff in response to increases in electronic 
filing. IRS has already downsized returns processing employees at the 
Brookhaven, NY Service Center. The House report accompanying the fiscal 
year 2004 Transportation, Treasury Appropriations bill recommended that 
IRS refrain from initiating any premature and ill-considered reductions 
in force until reporting to Congress. What progress has been made on 
the report to Congress and when will it be submitted? What are the cost 
savings associated with the reduction in force?
    Answer. The IRS delivered the report to Congress on April 22, 2004. 
A copy is attached. The IRS estimates the cost savings for Memphis to 
be $12.5 million for the period 2004 through 2006 and then an annual 
cost avoidance of $9.5 million dollars a year starting in 2007.
    Question. GAO has indicated that electronic filing is far short of 
IRS projections. What is the level of electronic filing compared to IRS 
projections? What level of increase in electronic filing is IRS 
projecting that will make it plausible to lay off 2,200 return 
processing employees within the next year?
    Answer. While the IRS is below projections needed to achieve the 
goal of 80 percent of individual returns filed electronically by 2007, 
it is continuing to make strong gains. The Consolidation Strategy is 
based on projections that are keyed to the workload shifts necessary to 
process the reduced paper volumes. In 2004, the IRS projected 59.8 
million electronic returns would be filed. As of May 14, taxpayers 
exceeded the number e-filed returns from the prior year by over 8 
million returns to reach the 60 million mark. This figure equates to 
approximately 50 percent of all individual returns filed and represents 
a milestone in e-file progress. The IRS's Consolidation Strategy is on 
track.

         PROBLEMS WITH IRS BUSINESS SYSTEMS MODERNIZATION (BSM)

    Question. In a March 2004 review, GAO found that although IRS has 
made some progress in implementing their recommendations and improving 
its modernization management, certain recommendations have not yet been 
fully implemented or institutionalized. These weaknesses have 
contributed, at least in part, to BSM project cost and schedule 
shortfalls. GAO states that, ``Projects continue to incur cost 
increases and schedule delays for several reasons, including inadequate 
definition of systems requirements, increases in project scope, and 
cost and schedule estimating deficiencies.'' Mr. Everson, this 
modernization effort has been plagued with these problems from the 
start. What have you done to ensure that IRS staff is adequately 
prepared to define its systems requirements instead of relying 
completely on the contractors to do so? What steps are you taking to 
ensure that cost and schedule estimates, which have been grossly off-
track, will now be more accurate?
    Answer. Recent improvements to the IRS Enterprise Life Cycle (ELC) 
will ensure that the IRS adequately defines system requirements in the 
future. The recent updates to the ELC include a new milestone 
(Milestone 4A), that requires a detailed definition of a systems' 
physical design baseline under strict configuration management (CM) 
control. This baseline can be used for awarding fixed priced contracts 
for the development, integration, and testing of the system. As a 
prerequisite to the implementation of MS 4A, the ELC now requires 
redefinition of requirements management, and strict CM control for 
projects in prior milestones. For example, at Milestone (MS) 2, 
business requirements constitute the functional baseline. The 
functional baseline is then decomposed into logical systems 
requirements that are baselined under CM control at MS 3. Requirements 
that evolve from milestone 1 through 4A are verifiable and traceable in 
both directions and must be compliant with the Enterprise Architecture 
in order for a project to gain approval to move to the next stage of 
development. There will be a major systems engineering review at the 
end of each development phase, conducted by IRS business and technical 
personnel.
    As the IRS moves forward, constant involvement of the IRS 
stakeholder organizations is critical. Stakeholder involvement in the 
definition, approval, and coordination of system requirements will 
ensure that what the IRS develops is closely traced to IRS's business 
needs and that ownership is clearly identified and understood. As this 
revised ELC strategy is unveiled, training will be provided to ensure 
that IRS personnel are adequately prepared to achieve success.
    The IRS has been working jointly with MITRE and CSC (the PRIME 
Contractor) to improve cost and schedule estimating capability. The IRS 
is using the well-recognized Carnegie Mellon Software Engineering 
Institute's (SEIs) Requisites for Reliable Estimating Processes as a 
guide. The requisites provide for development and execution of the 
following key cost and schedule estimating objectives:
  --Maintaining historical data;
  --Structured estimating processes;
  --Mechanisms for extrapolating estimates from successful past 
        projects;
  --Audit trails; and
  --Ensuring integrity in dealing with dictated costs and schedules.
    Both CSC and the IRS have made significant progress towards 
achieving these key objectives. The IRS has implemented procedures for 
validating contractors' estimating systems and for reviewing cost and 
schedule estimates. The procedures provide guidance for evaluating 
reliability of documentation supporting individual estimates and for 
tracking compliance with sound estimating practices. Furthermore, the 
procedures also address professional development of personnel with the 
right skill set for developing and evaluating cost and schedule 
estimates. CSC has established a historical database, calibrated 
estimating models and developed detailed requirements for documenting 
and supporting bases of estimates along with related guidance and 
directives. Work is also in progress for continuing refinement and 
improvement in each of these elements.
    In addition, joint training is being conducted for IRS, CSC and 
MITRE personnel as an integral part of the overall plan to ensure 
competent deployment of improved processes and procedures. The IRS, 
with MITRE's assistance, recently completed a review of CSC's 
estimating system. The IRS is finalizing the results and will issue 
them in a report in the latter part of June. In general, there have 
been improvements. The report will include a time phased corrective 
action plan for addressing deficiencies. To ensure the tools, guidance, 
processes and procedures are part of a mature repeatable process, a 
concerted effort is underway to fully validate all aspects of the 
processes and procedures prior to official roll-out within the IRS. 
This pilot program is intended to verify the soundness of the processes 
and procedures and provide lessons learned, before full implementation 
is effected.
    The IRS is making every effort to hire qualified staff and fully 
implement its improved tools, guidance, processes, and procedures as 
soon as possible. However, this is taking more time than the IRS would 
like. This is a pervasive problem on programs of the size and 
complexity of the modernization initiative. Nonetheless, the IRS 
believes that there will be evidence of increased accuracy by the end 
of fiscal year 2004 and continued improvements over time.
    Finally, all of these efforts are part of a highly visible set of 
plans geared to identifying, tracking, reporting, and reviewing the 
critical cost and schedule estimating commitments with IRS Executive 
Management and GAO/TIGTA.
    Question. The modernization of IRS business systems has suffered 
numerous problems and delays and now some IRS staff integral to the 
process are leaving, including the director of BSM. How will this 
affect the program, what steps are being taken to ensure that 
institutional knowledge of the modernization program remains?
    Answer. In addition to putting a succession management plan in 
place, the IRS needs a more versatile team of seasoned executives to 
provide long-term stability to the program. The IRS is complementing 
the skills of its experienced tax executives with outside seasoned 
technology executives who have experience managing large-scale, complex 
IT projects. As such, the IRS is hiring two Associate Chief Information 
Officers to join the MITS organization, and an executive search firm is 
conducting searches for five senior executives with a wide range of 
diverse experience in developing and implementing large modernization 
systems. The new Associate CIOs will assume modernization management 
responsibilities so that the Associate CIO of business systems 
modernization can focus primarily on delivering projects.
    Question. Until recently, IRS has used its information technology 
services staff with minimal input from its business units. The business 
units will be the ultimate users of this program. What steps has IRS 
taken to incorporate the business managers into BSM?
    Answer. The Commissioner is holding IRS senior business unit 
managers accountable for the success of modernization efforts as it 
relates to defining, developing, and controlling business requirements. 
For example, a senior business unit manager is responsible for working 
closely with the BSM and Modernization and Information Technology 
Services (MITS) executives to ensure that the delivery of the CADE 
project meets all business requirements.
    Question. GAO has concluded that the IRS must institutionalize the 
management processes and controls necessary to resolve the deficiencies 
identified by the reviews and assessments in order to strengthen 
management of the Business Systems Modernization program. What steps is 
IRS undertaking to accomplish this?
    Answer. Over the past 2 years, the BSM organization has been 
working diligently toward integrating and institutionalizing the 
management processes of the BSM program. While the IRS has achieved 
real progress, as recognized by TIGTA and GAO, the BSM Challenges Plan 
has complemented ongoing efforts by providing a special focus on 
significant issues that needed more attention.
    GAO recognized the need for continual growth in the maturity of the 
BSM management processes and raised concerns in key areas such as 
configuration management, human capital management, contract 
management, and cost and schedule estimating. Accordingly, BSMO 
committed to maturing its management processes and established 
corrective action plans for each area, assigned responsibilities and 
set milestones, and initiated a formal monitoring process for measuring 
progress in each area.
    For example, the IRS has developed configuration management 
processes and is institutionalizing configuration procedures. It 
established a process for determining the type of task order to be 
awarded and MITS is implementing plans for attracting, developing, and 
retaining requisite human capital resources. Key stakeholders are 
reviewing documented procedures for how to effectively validate the 
cost and scheduling estimates submitted by the PRIME.
    Question. The IRS Oversight Board stated in a December 2003 report 
that, as the foundation of the modernization project, the Customer 
Account Data Engine (CADE), requires special attention. CADE will 
replace the existing IRS Master File of taxpayer accounts. It is the 
most costly, complex, largest, and longest-running project within the 
BSM portfolio. IRS has engaged Carnegie Mellon's Software Engineering 
Institute (SEI) to review CADE. One of SEI's findings is that a key 
component of CADE, its ``business rules engine'' which translates tax 
processing rules into computer code, must be defined and modeled in 
order for CADE to succeed. Is IRS following this recommendation and if 
so, what is the status? If not, why not?
    Answer. The IRS is following the recommendation from Carnegie 
Mellon's Software Engineering Institute. The IRS tasked PRIME to do a 
business rules engine performance engineering study that measured and 
modeled the performance of the business rules engine. The IRS also 
tasked PRIME to evaluate design alternatives that lowered risk of 
implementing business rules. The PRIME has completed performance tests.
    Senior engineers from IRS, PRIME, MITRE, and Sapiens (the business 
rules vendor) met the week of May 10, to review the test results and 
assess alternatives that will improve the performance of CADE and lower 
the risk of implementing business rules. Design changes will be modeled 
using the performance data obtained in the tests. The final report is 
due to be completed June 20, 2004.
    Question. In Ms. Gardiner's formal testimony, she states that 
oversight groups are starting to lose confidence in the ability of your 
PRIME contractor to meet its commitment in modernizing the IRS's 
business systems. This observation is clearly based on the deadlines 
that have already been missed and the cost overruns already incurred. 
Mr. Everson, what is your current assessment of your PRIME contractor's 
ability to get the job done without further delays and further cost 
overruns? Are you giving any consideration to changing your PRIME 
contractor on this critically important endeavor? If so, what would be 
the cost to the taxpayer of changing your PRIME contractor at this 
time?
    Answer. There are no current plans to replace CSC as the PRIME 
contractor, however, Commissioner Everson has made it vividly clear to 
Mike Laphen, the President and Chief Operating Officer of CSC, that CSC 
needs to significantly improve their performance. In February 2004, he 
announced his decision to direct the upcoming enforcement modernization 
projects for collection contract support and filing and payment 
compliance to other contracts. It is the Commissioner's hope that this 
action, while no doubt unwelcome to CSC, will lead to a sharpened focus 
and discipline, and will in fact enhance the prospects for successful 
and timely delivery of other modernization projects by CSC.
    While CSC has improved their performance somewhat, the IRS 
carefully assessing CSC's performance on current projects and the 
results of CSC's overall program management and integration efforts 
before awarding any follow-on work for existing projects. The IRS needs 
consistent, high-level performance and service from CSC. The IRS has 
also moved to capped or fixed price contracts for almost all 
development work to balance the financial risk on modernization 
projects.

                          COMPETITIVE SOURCING

    Question. Mr. Everson, you are very familiar with the President's 
competitive sourcing initiative since you served as Deputy Director for 
Management at OMB. I understand that you plan to spend $9.1 million in 
unbudgeted funds in fiscal year 2005. What areas are you planning to 
contract out?
    Answer. The $9.1 million you cite is the amount the IRS has 
requested in the fiscal year 2005 budget submission to support the 
Competitive Sourcing program. The IRS plans to use public-private 
competition to improve operations, but only if it makes economic sense. 
Traditionally, the employee government bid teams have won over 50 
percent of the public-private competitions. Historically, organizations 
that have successfully used competition to improve operations have 
achieved an overall 30 percent reduction in operating costs. These 
reductions are typically in the support functions and are achieved 
through such actions as consolidation of existing facilities (releasing 
commercially leased space), staff reductions, and increased use of 
technology. Similarly, the IRS focus is on support functions.
    Question. What is the status of all the competitive sourcing 
studies that have been undertaken at IRS? Please include year, area, 
and result. How much money has been spent on these competitions? Since 
the competitions are not budgeted for, where has the money come from?
    Answer. It has been difficult to finance the Competitive Sourcing 
Program since the IRS does not know the outcomes in advance, the exact 
level of savings are yet to be determined, and it takes time to realize 
these savings. The IRS had to internally realign. However, the 
investments made today in public-private competitions show a return on 
investment usually within 2-3 years (including payment of transition 
costs--voluntary early retirement, voluntary separation incentive, 
etc.). At that time, the IRS plans to reinvest the savings to fund 
future competitions and cover transition costs. It will take several 
years to get there. The IRS does request funding in the fiscal year 
2005 budget for the Competitive Sourcing program.
Status of IRS Competitive Sourcing Studies
    Architects and Engineers (10 FTE).--Streamline competition resulted 
in in-house award. The in-house team was most efficient.
    No savings achieved.
    Area Distribution Centers (500 FTE in Bloomington, IL; Rancho 
Cordova, CA; Richmond, VA).--The three Area Distribution Centers 
distribute tax forms, instructions and publications to taxpayers and 
internal use documents to IRS employees.
    Standard Competition with award decision scheduled for June 28, 
2004.
    Expected Saving and Benefits: Consolidation of activities and 
geographic locations resulting in the release of commercial space, 
revised operational processes and procedures to gain efficiencies, new 
information system, reduced staff and increased managerial span of 
control.
    Anticipated return on investment (fiscal year 2005-fiscal year 
2009): $22 million.
    Building Delegations or Operation and Maintenance (O&M) of 
Delegated Buildings (100 FTE in Covington, Fresno, Austin, Ogden, 
Philadelphia, Headquarters).--O&M are those functions identified in the 
Building Delegation Agreements between the General Services 
Administration (GSA) and the IRS. These services include 
responsibilities to operate and maintain building systems (electrical, 
HVAC, control systems, etc.).
    Standard Competition with solicitation release scheduled for June 
2004.
    Expected Saving and Benefits: Revised operational processes and 
procedures to gain efficiencies; reduced staff; and increased 
managerial span of control.
    Anticipated return on investment (fiscal year 2006-fiscal year 
2010): $3.9 million.
    Mail Rooms (70 FTE).--Mailroom services functions include all 
aspects of the delivery of mail from full service delivery to mail stop 
or desktop to self-service mailrooms where customers pick up their own 
mail. The IRS made a decision to divide the study among headquarters, 
nationwide ``stand alone sites'' and campuses.
    The IRS plans to use public-private competition to improve 
operations.
    Direct Conversion--in progress.
    Fully Implemented--Denver, CO; Detroit, MI; Plantation, FL; Detroit 
Computing Center, MI; Houston (Leland), TX; Laguna Niguel, CA; Oklahoma 
City, OK; and San Francisco, CA.
    Partially Implemented--Washington, DC; New Carrollton, MD.
    Scheduled for Implementation--Cincinnati, OH; Jacksonville, FL (5/
17); and Nashville, TN.
    Implementation Not Scheduled--Atlanta, GA; Baltimore, MD; Boston, 
MA; Buffalo, NY; Dallas, TX;; Greensboro, NC; Hartford, CT; Houston 
(Alliance), TX; Indianapolis, IN; Los Angeles, CA; Milwaukee, WI; New 
Orleans, LA; Oakland, CA; Philadelphia, PA; Phoenix, AZ; Richmond, VA; 
Chicago, IL; Springfield, NJ; St. Louis, MO; St. Paul, MN.
    Anticipated return on investment (fiscal year 2005-2009): $399,000.
    Campus Operations (Information Technology) (350 FTE in Ogden, UT; 
Atlanta, GA; Brookhaven, NY; Andover, MA; Cincinnati, OH; Fresno, CA; 
Austin, TX; Memphis TN; Kansas City, MO; Philadelphia, PA).--This 
functional area provides the Information Systems (IS) computer 
operations at the ten IRS Campus facilities. The positions include 
computer operators, production controllers, tape librarians, computer 
specialists, and clerks.
    Standard Competition with award decision scheduled for July 2004.
    Expected Saving and Benefits: Revised operational processes and 
procedures to gain efficiencies; reduced staff; and increased 
managerial span of control.
    Anticipated return on investment (fiscal year 2005-2009): $12.7 
million.
    Logistics Support (formerly Warehouse and Transportation) (160 FTE 
in Andover, MA; Philadelphia, PA; Brookhaven, NY; Atlanta, GA; 
Covington, KY; Austin, TX; Kansas City, MO; Ogden, UT; Fresno, CA; 
Memphis, TN).--This functional area provides warehousing and 
transportation, mainly at the 10 campus sites. This activity includes 
positions such as material handlers, warehouseman, motor vehicle 
operators, laborers, and clerks.
    Standard Competition with Performance Work Statement development 
underway.
    Expected Saving and Benefits: Revised operational processes and 
procedures to gain efficiencies, release of leased space, reduced staff 
and increase of managerial span of control.
    Anticipated return on investment (fiscal year 2006-2010): $4.8 
million.
    Campus Files Activity (1458 FTE in Austin, TX; Andover, MA; 
Philadelphia, PA; Brookhaven, NY; Cincinnati, OH; Memphis, TN; Atlanta, 
GA; Kansas City, MO; Ogden, UT; Fresno, CA).--This functional area 
receives, controls, shelves and maintains all returns/documents for 
retention and retirement. They retrieve documents as requested by 
customer organizations. Liaison work is critical with the Federal 
Records Centers for final retention of documents. The work is routine 
and does not involve making complex determinations or present unique 
fact patterns.
    Standard Competition with solicitation release scheduled for the 
fourth quarter of 2004.
    Expected Saving and Benefits: Revised operational processes and 
procedures to gain efficiencies; reduced staff; and increased 
managerial span of control.
    Anticipated return on investment (fiscal year 2006-2010): $22 
million.
    Learning and Education (617 FTE Service-wide).--This functional 
area is responsible for determining service-wide and division-level 
professional training requirements, developing training plans and 
curriculum, evaluating the effectiveness of training, and performing a 
broad spectrum of program administration.
    Standard Competition with Performance Work Statement development 
underway.
    Expected Saving and Benefits: Consolidation of activities, revised 
operational processes and procedures to gain efficiencies, 
implementation of learning content management and learning management 
systems, reduced staff and increased managerial span of control.
    Anticipated return on investment (fiscal year 2006-2010): $25 
million.

Competitive Sourcing Competition Costs

                        [In millions of dollars]
------------------------------------------------------------------------
                                                             Amount\1\
------------------------------------------------------------------------
Fiscal year 2003........................................             5.0
Fiscal year 2004........................................             6.3
------------------------------------------------------------------------
\1\ Travel, training, staffing, expert contractor support (PWS, Most
  Efficient Organization, Independent Review)--does not reflect
  transition/separation costs.
Note.--Return on investment includes cost of conducting competition and
  transition/separation costs. The IRS calculated savings calculated
  through fiscal year 2007.

Business Case Analysis/Feasibility Studies
    Tax Law Telephone.--This is a preliminary feasibility assessment of 
having a vendor provide tax law telephone assistance. After the 
completion of the preliminary feasibility assessment, the IRS will make 
a decision as to whether to go forward with the competition.
    Fuel Compliance Activity (140 FTE Service-wide).--This function 
area monitors 1,400 terminals, all fuel wholesalers, thousands of 
retail motor fuel outlets, and U.S. border crossings. Additionally, 
these personnel are charged with conducting periodic inspections of on-
road vehicles on highways throughout the country.
    IT Support (Service-wide).--This is identification and development 
of sourcing strategy to identify candidate public-private competition 
activities.
    Question. One of the provisions included in last year's 
appropriations bill was a prohibition against using fiscal year 2004 
funds to contract out any Federal job overseas. To my shock, the 
President's budget specifically requests that this provision be deleted 
for fiscal year 2005. Mr. Everson, could you cite for me some instances 
at IRS where you might take work that is currently be conducted by 
Federal employees and send that work overseas?
    Answer. The IRS has no specific plans to move work overseas. There 
are added complexities and security challenges that make moving work 
that would involve access to the IRS's information technology systems 
and/or sensitive data cost prohibitive.
    However, while the IRS has no specific plans to contract work 
overseas, it is conceivable that qualified bidders with overseas 
operations may be responsive to future IRS public-private competitions 
that do not involve access to the IRS's information technology systems 
and/or taxpayer return information. The IRS will continually identify a 
series of functions that are commercial in nature in accordance with 
the FAIR Act. At that time, a business case is developed that indicates 
whether or not a more efficient method of operation may be available. 
If so, a competitive sourcing initiative is begun under the guidelines 
of the OMB A-76 Circular. A contractor may then bid for that work. It 
is highly unlikely that a contractor would bid work to be performed 
overseas given the nature of the work the IRS has identified to date or 
anticipates identifying. Under the IRS Competitive Sourcing Program, no 
initiative has resulted in Federal jobs being outsourced overseas. The 
IRS adheres primarily to the Federal Acquisition Regulations (FAR) and 
the A-76 Circular when conducting public-private competitions for work 
performed by Federal employees. The FAR currently contains some 
limitation on issuance of contracts to some overseas locations.

                            CUSTOMER SERVICE

    Question. IRS consistently finds its own accuracy rates higher than 
TIGTA does when measuring taxpayer assistance functions, whether we are 
talking about toll-free telephone assistance, walk-in service at 
Taxpayer Assistance Centers, or the IRS website. Mr. Everson, how do 
you explain the discrepancy? Ms. Gardiner, would you care to comment?
    Answer. Typically, TIGTA's reports on accuracy are based on limited 
judgmental sampling conducted during the brief period of their 
fieldwork on a particular audit. The results that they report are not 
statistically valid. The IRS results for telephone accuracy and for 
irs.gov e-mail assistance are based upon an on-going process that is 
statistically reliable. TIGTA typically acknowledges the limitations of 
their data in their reports with statements such as, ``We selected a 
judgmental sample of calls to monitor between April 21 and May 16, 
2003. Our results cannot be compared to the statistical results 
reported by the IRS.''
    The discrepancy between the TIGTA accuracy rates and the Taxpayer 
Assistance Center (TAC) walk-in service accuracy rates is due to the 
calculation methodology. TIGTA and the IRS treat responses to tax law 
questions differently. In contrast to the IRS, TIGTA includes referrals 
to publications, service denied, and referrals to other employees in 
its accuracy calculation. The IRS disagrees with the assertion that a 
non-response is synonymous with providing an incorrect answer. While it 
is clear that there is some disparity in methodology, it is important 
to note that neither of these methods of measuring walk-in service 
accuracy is statistically reliable.
    TIGTA will respond separately.
    Question. As stated in testimony, TIGTA found that IRS employees 
incorrectly prepared 19 of the 23 tax returns prepared during TIGTA 
audit visits to Taxpayer Assistance Centers. What steps has IRS taken 
to remedy this egregious example of inaccuracy and Mr. Everson, do you 
plan to implement the additional actions that TIGTA recommended?
    Answer. The IRS implemented the recommendations made by TIGTA and 
has taken several steps to remedy inaccurate return preparation. The 
IRS directed all TAC employees to adhere to existing screening 
procedures to ensure taxpayers meet the return preparation criteria. In 
addition, the IRS required all employees to use the appropriate 
worksheets in the return preparation software and the publication 
method guide to assist in determining a taxpayer's eligibility for 
deductions and credits claimed on the tax return.
    The IRS also implemented a quality review plan to ensure TAC 
employees adhere to these and other return preparation procedures in 
the Internal Revenue Manual. The IRS requires group managers to 
complete three employee return preparation reviews and the quality 
review staff is required to visit each Area and conduct at least two 
return preparation reviews.
    Question. As stated in testimony, TIGTA found that IRS didn't 
respond to several of the questions TIGTA submitted anonymously to the 
website. Do you have statistics about the number of questions that go 
unanswered? How is this allowed to happen? What is being done to 
prevent this in the future?
    Answer. During the period from February 22 to March 6, 2002, TIGTA 
anonymously submitted 90 questions through the website. TIGTA reported 
that they did not receive a response to 14 of these questions. During 
that period of time, the IRS was making system changes that affected 
its responsiveness. As it transitioned to a new server and a new 
contractor, some messages did not transfer between servers. The IRS was 
able to recover most messages, but unfortunately lost several, 
including some initiated by TIGTA.
    In an October 2002 report, Reference No. 2003-40-014, TIGTA 
recommended that the IRS improve its control system by sending an e-
mail receipt acknowledgement to the requestor and develop a system to 
track each question submitted to ensure the IRS provides a response. 
The IRS concurred with these recommendations and modified the program 
to add both new features in 2003. Both of these enhancements are 
performing as designed. However, taxpayer e-mail limitations, such as 
address problems, discontinued service, mailbox full, and stringent 
spam filters may continue to block delivery of an IRS response.
    Question. Ms. Gardiner points out that the IRS revised its 
modernization plan for fiscal year 2003 to focus on executable segments 
that could be accomplished in a timely manner. Despite all of the IRS's 
assurances to the contrary, all of the projects on the newly downsized 
list still experienced delays and most incurred significant cost 
increases. What are her observations regarding the IRS's abilities to 
deliver modernization projects on time and on budget for the current 
fiscal year and next year? Why should we believe that the IRS and its 
contractors will improve its performance on these projects going 
forward? Mr. Everson, do you care to comment on this matter?
    Answer. The BSM program is--without a doubt--one of the largest, 
most visible, and most sensitive modernization programs ever undertaken 
in the world.
    When nominated in February 2003, the Commissioner set three 
priorities for his term as Commissioner. First, the IRS must continue 
to improve service to make it easier for taxpayers to understand and 
comply with tax laws. Second, modernization of IRS information 
technology is also a high priority. The third priority is to strengthen 
the integrity of the American tax system with enhanced enforcement 
activities. The Commissioner's first action to address the 
modernization priority was to appoint two new leaders to the 
modernization effort.
    Commissioner Everson appointed John Dalrymple, a 30-year IRS 
veteran who has spent his career focusing on front-line taxpayer 
issues, as the Deputy Commissioner for Operations Support to own the 
modernization initiative and drive productivity across the IRS. 
Simultaneously, he appointed the former IRS Chief Financial Officer, W. 
Todd Grams, to the position of Chief Information Officer to bring 
stronger leadership and discipline to the technology modernization 
program.
    These executive appointments to the IRS modernization program 
represent a major change in the way the IRS has managed previous 
modernization projects. They were necessary steps to bring more 
management discipline and increased business unit knowledge and 
involvement to the modernization program. The following is a brief 
recap of IRS's progress and struggles over the past year.
    The results have been mixed. The IRS built a strong technical 
infrastructure, and designed and implemented stringent security and 
control mechanisms into the infrastructure. It also developed a 
rigorous enterprise life cycle methodology. Over the past 2 years, the 
IRS has been working toward maturing its management processes. The IRS 
has made progress, but a major thrust now focuses on sustaining a solid 
balance of business commitment, accountability, and scope management. 
Finally, the IRS has achieved a great deal of success with the projects 
delivered to date.
    For the first time ever, corporations and tax exempt organizations 
have the option of filing their annual income tax and information 
returns electronically using Modernized e-File (MeF). This new 
electronic filing system significantly reduces the time and cost for 
corporations and tax exempt entities to file their Forms 1120 and 990. 
Simply by using a secure Internet connection to file 1120 and 990 
forms, corporations and tax exempt organizations eliminate the need to 
submit hundreds of pages of paper returns. The e-Gov Institute recently 
chose MeF as a winner of the Government Solutions Center Pioneer 
Awards.
    The IRS has achieved a great deal of success with the e-Services 
projects. All e-Services Release 1.0 products are fully deployed and 
available over the Internet, including: registration and online address 
change access for third parties and IRS employees through secure user 
portals; Preparer Tax Identification Number (PTIN) online application; 
interactive Taxpayer Identification Number (TIN) matching; secure 
Electronic Return Originator (ERO) application processing; and access 
to e-Services registration and application processes by Modernized e-
File (MeF) participants.
    E-Services Release 2.0 products are also now in production and 
available for use by IRS staff and taxpayers, including: Application 
for e-Filing (external); Electronic Account Resolution (EAR); 
Electronic TIN Bulk Matching (Bulk Requests); Disclosure Authorization 
(DA); and infrastructure support for outbound facsimile service.
    In March 2004, James D. Leimbach appeared before the Ways & Means 
Oversight Subcommittee on behalf of the National Association of 
Enrolled Agents (NAEA), the professional society of enrolled agents, to 
present NAEA's views regarding e-Services delivering electronic 
services to tax practitioners. NAEA's overall assessment was that the 
2003 filing season has run very smoothly--and the NAEA gave the IRS a 
great deal of praise.
    Mr. Leimbach said, ``The difficulty in integrating a 1960's era 
mainframe with the Internet and doing so in an environment using highly 
complex encryption is enormous, costly, and worth every effort and 
every dime spent.'' He added, ``This new capability is truly going to 
revolutionize the way we conduct future business with the IRS. The 
ultimate beneficiary is the American taxpayer. We are truly amazed and 
thrilled beyond description at this way of doing business with the IRS 
and we would like for you to understand why we feel as we do.''
    Mr. Leimbach cited numerous examples of eliminating time delays of 
over a week and reducing response times from weeks and months to 3 days 
simply by having the ability--24 hours a day, 7 days a week--to submit 
information directly to the IRS using the Internet.
    The IRS delivered several additional applications that are 
providing tangible benefits to taxpayers and improving the efficiency 
and effectiveness of tax administration systems such as Where's My 
Refund?, Where's My Advance Child Tax Credit?, Internet EIN, Modernized 
e-File, HR Connect, etc. The following chart highlights the 
applications the IRS delivered, as well as the measurable business 
benefits being realized.

                            BSM DELIVERS REAL BUSINESS VALUE (RESULTS AS OF 6/15/04)
----------------------------------------------------------------------------------------------------------------
              Project                             Description                         Recent Statistics
----------------------------------------------------------------------------------------------------------------
Internet Refund Fact of Filing       Improves customer self-service by      --17.9 million inquiries in 2003; 22
 (2002).                              providing instant refund status        million inquiries to date in 2004
                                      information and instructions for       (1/1/04-6/6/04).
                                      resolving refund problems to          --32 percent of all real time IRS
                                      taxpayers with internet access.        assistance calls come from IRFoF.
                                                                            --Modest reduction of
                                                                             telecommunications costs (about
                                                                             $250,000).
                                                                            --Every 1,000 IRFoF contacts
                                                                             eliminate 1,500-2,000 refund
                                                                             assistance calls.
Advanced Child Tax Credit (2003)...  Modifies the Internet Refund           --15.5 million inquiries in 2003;
                                      application to provide taxpayers       11.9 million inquiries to date in
                                      with Advance Child Tax Credit refund   2004 (10/1/03-6/13/04).
                                      status on the internet.               --Peak date 1.1 million interaction.
Customer Communications (2001).....  Improves communications                --68,000 calls in one 3-minute
                                      infrastructure, including telephone    period during initial week
                                      call management, call routing and      (coincided with start of Advanced
                                      customer self-service applications.    Tax Refund of 2001).
                                                                            --50 percent reduction in waiting
                                                                             time for assistor to answer call.
                                                                            --50 percent reduction in abandoned
                                                                             calls.
                                                                            --Number of Spanish calls doubled.
                                                                            --More accurate pre-routing of
                                                                             calls.
Internet Employee Identification     Allows businesses and taxpayers to     --1.37 million internet EIN
 Number (2003).                       apply for and receive employer         applications received to date (as
                                      identification numbers over the        of 6/5/04).
                                      internet.
HR Connect (2002)..................  Delivers an enterprise solution to     --75,000 internal users.
                                      allow IRS employees to access and     --Cited by Commissioner Everson as
                                      manage their human resources           an enabling factor in the
                                      information online.                    redirection of approximately 750
                                                                             staff years to enforcement.
                                                                            --Treasury was selected as 2004
                                                                             ComputerWorld Honors Laureate for
                                                                             HR Connect development and
                                                                             implementation.
e-Services R1 (2003-2004)..........  Creates a web portal and value adding  --Over 69,624 PTIN applications
                                      e-Services services to promote the     (W7P) entered to date, data entry
                                      goal of conducting most of the IRS's   productivity doubled (from 8/15/03-
                                      transactions with tax practitioners    6/10/04).
                                      electronically.                       --Over 58,201 e-File applications to
                                                                             the Third-Party-Data-Store (TPDS)
                                                                             entered to date (from 8/15/03-6/10/
                                                                             04).
                                                                            --Approximately 24,939 Registered
                                                                             (and confirmed) User Portal (RUP)
                                                                             to date (from 10/1/03-6/10/04).
Customer Relationship Management     Provides standard tax computation      --Deployed to almost 4,000 Revenue
 Exam (2001).                         software to Large & Mid-Sized          Agents.
                                      Business Revenue Agents.
Modernized e-File (2004)...........  Provides e-filing to large businesses  --Went live on 2/23/04.
                                      (1120 family) and tax exempt          --Over 35,090 returns (1120 family)
                                      organizations (990 family).            accepted as of 6/13/04.
                                                                            --Over 3,287 participating
                                                                             Electronic Return Originators as of
                                                                             6/13/04.
                                                                            --Winner of Government Solutions
                                                                             ``Best-of-the Best'' Pioneer
                                                                             Solutions.
----------------------------------------------------------------------------------------------------------------

    The bad news, however, is major. Significant cost overruns and 
repeated schedule delays have plagued critical projects, such as the 
Customer Account Data Engine (CADE), the Integrated Financial System 
(IFS), and the Custodial Accounting Project (CAP). CADE replaces the 
current master files that are the IRS's repository of taxpayer 
information. IFS will be the IRS's new core accounting system. CAP 
provides an integrated link between tax administration (revenue) and 
internal management (administrative) financial information.
    The IRS has delayed the CADE program four times. It originally 
planned to deliver the first release of CADE in December 2001. The IRS 
then rescheduled it for August 2003, and later rescheduled it for April 
2004. The IRS recently finalized the re-planning effort for CADE and 
set the latest delivery date for September 2004. While CADE is farther 
along than the IRS has ever been in replacing a component of the master 
file, there are still major hurdles to overcome. The CADE delays 
stemmed from infrastructure upgrades, initial poor software quality 
during the startup of systems integration testing combined with the 
failure to understand the complexity of balance and control, and the 
resolution of operational and performance issues that occurred during 
Phase 3 of the Release 1.0 pilot.
    Like CADE, IFS has been plagued with schedule delays. The IRS 
originally planned to deliver the first release of IFS in October 2003. 
The IRS then rescheduled it for January 2004. The IRS later rescheduled 
it for April 2004. The IRS has subsequently scheduled Release 1.0 for 
October 2004. The IRS delayed the first release of IFS because of the 
need to make technical changes to comply with the enterprise 
architecture, the inability to resolve key design and integration 
issues in a timely manner, the identification of the health coverage 
tax credit interface requirement late in the development process, and 
delays experienced in integration testing due to poor application 
quality and interface testing issues.
    IFS Release 1.0 will cover core accounting functions such as budget 
preparation, general ledger, accounts payable, accounts receivable, 
financial reporting, and purchasing. Problems continue to seriously 
jeopardize the scheduled delivery of this first release of IFS. The IRS 
is 2 weeks behind schedule on testing, which puts the data conversion 
schedule at risk. The IRS is negotiating a fixed price contract for the 
October delivery.
    The IRS is also encountering delays on the first release of the 
Custodial Accounting Project (CAP), which provides an integrated link 
between tax administration (revenue) and internal management 
(administrative) financial information. The first release of CAP will 
address revenue from individual taxpayers on initial tax payments. 
Later releases of CAP will address businesses and collections. CAP 
delays resulted from unstable CADE and IFS interface definitions, 
needing additional testing time due to a much larger than anticipated 
volume of data anomalies discovered during the conversion of data from 
the current Individual Master File (IMF), and the time required 
resolving system performance issues.
    In addition, though not directly responsible for CAP delays to 
date, the IRS has made some adjustments to the functionality that it 
needs to have in CAP Release 1 to support the GAO financial audit as 
well as internal accounting and management. These adjustments will 
increase the cost of later sub-releases of CAP Release 1. The IRS has 
now completed all testing for CAP Release 1, and is adding changes to 
reflect IMF changes from the start of the 2004 filing season (Release 
1.1). The IRS plans to start production, which includes the initial 
load of IMF data, in mid-August. The IRS negotiated a fixed price 
contract for Release 1 and Release 1.1 in May 2004.
    Question. Ms. Gardiner, in her testimony, points out that she found 
several instances where the Business System Modernization project teams 
at the IRS were cutting corners and not following established testing 
procedures due to their desire to meet overly optimistic project 
schedules. It seems that the IRS responds to missing its deadlines by 
cutting corners and thus undermining the likelihood that the agency 
will get what it paid for. What has Ms. Gardiner concluded about the 
IRS's ability to manage these projects effectively and ethically? Is 
there any reason to hope that the IRS is turning a corner and actually 
getting value for the taxpayer from these modernization projects? Mr. 
Everson, would you care to comment?
    Answer. The IRS used the results from independent studies 
commissioned during the summer of 2003 to create a BSM Challenges Plan 
comprised of 40 some action items. Given the strategic importance of 
the plan, The Commissioner appointed an IRS business unit deputy 
commissioner to oversee the implementation of the plan.
    As a first step, the BSM project team developed a crosswalk to 
ensure that the BSM Challenges Plan's definition of the issues 
addressed and/or satisfied all of the recommendations from the four 
commissioned studies as well as the recommendations submitted by the 
IRS Oversight Board, and the Software Engineering Institute (SEI) study 
of CADE.
    While the deputy commissioner made significant progress in 
implementing the plan, the full closure of all actions items was 
unrealistic within the elapsed timeframe of the 6-month appointment. 
Concurrently, the CIO created a new direct report position for 
modernization management and assigned responsibility for implementing 
the plan to the individual recently hired into this newly created 
position.
    Under the leadership of the deputy commissioner, the IRS and CSC 
team brought closure to several key actions items, including: 
clarifying the roles of committees as advisory, identifying 
``blockers'' on contracting issues, appointing business leaders to each 
project, establishing a risk-adjusted schedule and new baseline for 
CADE Releases 1.0 and 1.1, and increasing the frequency of CADE reviews 
with the business owner to twice monthly. The majority of the action 
items are still works-in-progress, some of which will take time to 
fully complete. Others will span the life of the BSM program.
    For example, strengthening systems engineering capabilities by 
hiring external candidates will take time since it involves conducting 
the searches, interviewing the candidates, and negotiating the new 
hires to come on board. The IRS and CSC developed ground rules for 
escalating issues, but they will need to be continually enforced 
throughout the life of the program. The IRS rewrote the charters of the 
governing committees to reflect their advisory role and clearly 
articulated their responsibilities, however, it will probably take a 
year to truly evaluate and measure their effectiveness.
    As stated, the IRS has made progress toward closing all the action 
items, but it has much more work to do in critical areas. For example, 
the IRS needs to religiously follow the proper methodologies and hold 
people accountable if they do not. The IRS must start ``doing things 
right'' as opposed to ``doing things fast'' such as exiting milestones 
prematurely. An ongoing challenge will be balancing the scope and pace 
of projects consistent with capacity, ensuring that the right people 
are in place before launching a project, and setting realistic delivery 
schedules and cost estimates. The IRS is committed to staying-the-
course and delivering on its promise to modernize America's tax 
systems, but it is important for everyone to acknowledge this is a 
monumental effort.
    The magnitude and evolution of the BSM program dictates that the 
IRS will always be going through an evolution of assessment and 
improvements. In that regard, the BSM Challenges Plan is still evolving 
and the IRS is using certain action items to continuously improve the 
program.
                                 ______
                                 
            Questions Submitted by Senator Richard J. Durbin

                       TAX EVASION/IRS COLLECTION

    Question. In the days leading up to April 15, newspapers around the 
country ran features on personal and corporate tax evasion and the 
IRS's failure to collect many of the taxes it is owed. The President 
proposes a 4.6 percent increase in IRS funding for fiscal year 2005, 
claiming that this will allow the hiring of 5,000 new auditors and 
collectors. While increasing the number of IRS agents and officers is 
central to more effective tax collection, the IRS Oversight Board 
argues that much of the 4.6 percent increase will be swallowed by 
rising salaries and administrative costs. In fact, the Oversight Board 
claims that fiscal year 2005 is the fourth year in a row in which the 
administration has called for IRS staff increases while failing to 
cover pay raises or required expenses.
    In your estimation, how many new auditors and collectors would be 
hired as a result of a 4.6 percent increase in IRS funding in fiscal 
year 2005, and what would be the impact of such an increase on the 
IRS's ability to collect some of the estimated $250 billion in owed 
taxes that go unpaid each year due to tax evasion?
    Answer. The IRS will hire approximately 5,000 new enforcement 
personnel. These new hires will improve voluntary compliance by 
increasing the number of individual and corporate returns examined and 
directly increasing collections of delinquent revenue owed to the 
government by approximately $3 billion in the first 3 years of the 
initiative, fiscal year 2005 through fiscal year 2007, and additional 
collections of $1.5 billion annually thereafter. This increase in IRS 
enforcement personnel also improves voluntary compliance by deterring 
would-be tax cheats from engaging in illegal behavior.

                    TAX ASSISTANCE PROGRAM--ILLINOIS

    Question. In the fiscal year 2004 Senate Transportation-Treasury 
Appropriations report, language was included regarding the Tax 
Assistance Program in Chicago, Illinois. ``The Committee is aware of an 
innovative financial literacy and tax assistance project in Chicago, 
Illinois--Tax Assistance Program--designed to assist low income workers 
and their families with tax education and filing, in cooperation with 
the State of Illinois and the City of Chicago's Earned Income Tax 
Credit (EITC) outreach efforts. The Committee encourages the IRS to 
continue to provide appropriate technical and financial assistance for 
this worthwhile initiative.''
    Is the IRS working with the Tax Assistance Program in Chicago, 
Illinois, and what Federal resources are being provided? Will the IRS 
continue to work with programs like TAP in Chicago in fiscal year 2005?
    Answer. The IRS has partnered with the Tax Assistance Program (TAP) 
for several years and each year has been increasingly impressed with 
the achievements and the dedication of the staff and volunteers. The 
IRS is very fortunate to have this fine organization as a partner in 
providing free tax preparation to low income taxpayers in the Chicago 
metro area. The IRS hopes to sustain this relationship in fiscal year 
2005 and for many years to come. However, outside the Low Income Tax 
Clinic (LITC) Grant Program, the IRS has no legal authority to offer 
funding to the TAP organizations. The TAP currently receives Federal 
funds available through the LITC Grant Program, and the IRS anticipates 
that the TAP will continue to apply for funding through this program in 
the future.
                                 ______
                                 
     Questions Submitted to the Treasury Inspector General for Tax 
                             Administration

            Questions Submitted by Senator Richard C. Shelby

                             MODERNIZATION

    Question. How much more is needed to complete and modernize the 
IRS's outdated systems and processes?
    Answer. We do not know the true total cost needed to complete the 
Business Systems Modernization (BSM) effort. To date, the Internal 
Revenue Service (IRS) has received $1.6 billion for this effort. The 
IRS anticipates that the value of the PRIME \1\ contract will be $8 
billion. However, the PRIME contract is not the only cost associated 
with the BSM effort as other contractors, such as Northrop Grumman, 
International Business Machines, and MITRE Corporation, are involved in 
the BSM effort. In addition, the IRS is incurring substantial internal 
costs in managing the BSM effort. The sum of all PRIME contractor, 
other modernization contractors, and IRS costs for the life of the BSM 
program is not known.
---------------------------------------------------------------------------
    \1\ The PRIME contractor is the Computer Sciences Corporation, 
which heads an alliance of leading technology companies brought 
together to assist with the IRS's efforts to modernize its computer 
systems and related information technology.
---------------------------------------------------------------------------
    Question. Is the fiscal year 2005 budget request consistent with 
that TIGTA assessment?
    Answer. Yes. We have recommended since September 2002 that the IRS 
slow the pace of the BSM program due to some of the risks that have 
surfaced. The fiscal year 2005 budget request is consistent with our 
past recommendations.
    Question. When will BSM be completed?
    Answer. The BSM program is currently in its sixth year of a 15-year 
contract. However, the IRS and the PRIME contractor have been 
experiencing significant delays. For example, the Customer Account Data 
Engine (CADE) \2\ project is approximately 30 months behind schedule, 
and the detailed planning for the business taxpayer account portion 
(Federal tax deposits, corporate entities, partnerships, etc.) of the 
project has not been completed. Unless the IRS and the PRIME contractor 
take actions to make up the lost time and thoroughly plan all projects, 
it is difficult to know how long the BSM effort will last.
---------------------------------------------------------------------------
    \2\ The CADE is the foundation for managing taxpayer accounts in 
the IRS's modernization plan. It will consist of databases and related 
applications that will replace the IRS's existing Master File 
processing systems and will include applications for daily posting, 
settlement, maintenance, refund processing, and issue detection for 
taxpayer tax account and return data.
---------------------------------------------------------------------------
    Question. What is the status of IRS's efforts to resolve the 
findings and deficiencies identified by the various internal and 
independent assessments of BSM?
    Answer. To address the results of the recent assessments, the IRS 
and the PRIME contractor have developed a 48-point action plan, known 
as the ``BSM Challenge Plan''. While the 48 planned corrective actions 
should help improve the BSM program, it will take time to 
institutionalize new processes and ensure they are being followed. Only 
at that time will it be possible to determine if the actions have been 
effective.
    The IRS recently reported that 44 of the 48 action plan items were 
closed. However, our preliminary analysis shows that additional actions 
are scheduled for many of these closed items. The IRS Chief Information 
Officer acknowledged that follow-on actions are required to completely 
address the various internal and independent BSM assessments.
    It should be noted that the various assessments resulted in 21 
recommendations for improvement in the BSM program, 15 of which are 
similar to those made in Treasury Inspector General for Tax 
Administration (TIGTA) reports issued during the past 3 years. In 
several instances, the principal recommendations were reported multiple 
times during this period. Since many of the prior TIGTA recommendations 
have resurfaced as part of the recent assessments, we conclude that 
previous weaknesses have proven difficult to correct. Only time will 
tell whether actions taken as part of the 48-point plan will completely 
address the root causes identified in the various assessments.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

                             MODERNIZATION

    Question. Ms. Gardiner, your testimony says that IRS plans to 
request $142 million--the remainder of the $388 million appropriated 
last year--for Business Systems Modernization in fiscal year 2004. In 
your opinion, based on performance to date, should the Congress 
withhold or make conditional the approval of that $142 million?
    Answer. While we have not been provided with a copy of the revised 
spending plan, our opinion is that the Congress should approve the 
release of the remaining $142 million. In February 2004, the 
Commissioner testified, ``It's no secret that our projects have 
consistently run late, delivered less functionality than planned, and 
cost significantly more than targeted.'' The IRS's track record is of 
concern; however, the withholding of funds could cause projects to 
stop, which would result in the loss of contractor expertise and would 
lead to additional costs needed to restart the projects. In addition, 
there has been little time to determine if the actions being taken as 
part of the 48-point plan are leading to improvements.
    We believe the $142 million in additional funding should be 
provided, but we would recommend to the Appropriations Subcommittee 
that the BSM program be monitored closely to determine if future 
funding is warranted. The IRS and the PRIME contractor have developed a 
48-point plan to respond to various internal and independent 
assessments. Once the 48-point plan is implemented, it will take time 
to institutionalize new processes and ensure they are being followed. 
Only at that time will it be possible to determine if the corrective 
actions have been effective.
    Question. Ms. Gardiner, you point out that the IRS revised its 
modernization plan for fiscal year 2003 to focus on executable segments 
that could be accomplished in a timely manner. Despite all of the IRS's 
assurances to the contrary, all of the projects on the newly downsized 
list still experienced delays and most incurred significant cost 
increases. What are your observations regarding the IRS's abilities to 
deliver modernization projects on time and on budget for the current 
fiscal year and next year? Why should we believe that the IRS and its 
contractors will improve its performance on these projects going 
forward? Mr. Everson, do you care to comment on this matter?
    Answer. We believe that there are two critical areas that the IRS 
needs to address to be able to deliver modernization projects on time 
and on budget: requirements management and contract management. We have 
provided recommendations for improvement to the IRS in these areas, and 
the 48-point plan also addresses these areas. In addition, we have 
additional concerns in the areas of portfolio management, integration 
management, and staffing.

Requirements Management
    The PRIME contractor testified that the heart of the problem has 
been the lack of fully defined requirements. While it is inevitable 
that some requirements changes will be needed, e.g., legislative 
changes, the PRIME contractor testified that it often began work 
without fully understanding requirements, and requirements were still 
being identified during the testing phase. In our opinion, this is the 
fault of both the IRS and the PRIME contractor. The IRS should create 
detailed requirements before moving forward, and a contractor at the 
maturity level of the PRIME contractor should know not to start work 
without a full understanding of requirements. Requirements instability 
will continue to lead to increased costs and schedule delays if not 
corrected. This area has been a continuing concern and has been 
reported in several TIGTA reports, beginning in November 2001.

Contract Management
    Beginning in February 2001, we have made recommendations to assist 
the IRS in shifting financial risk to the PRIME contractor. Our 
recommendations have ranged from including positive and negative 
contractor incentives in task orders to using firm-fixed price task 
orders whenever possible. The recent BSM assessments also recommended 
moving toward a firm-fixed price model. When requirements are fairly 
stable, a firm-fixed price task order shifts some of the risk away from 
the government and to the contractor. If requirements become stable and 
firm-fixed price task orders begin to be issued, this will begin to 
curb some of the cost overruns that have been experienced to date. 
However, this may not have an effect on the timeliness of delivery.

Portfolio Management
    Beginning in 2002, both the TIGTA and the General Accounting Office 
recommended that the IRS slow the pace of the BSM program due to some 
of the risks that have surfaced. The recent internal and independent 
assessments also make this point. While the IRS responded to this 
concern by scaling back the scope and number of projects in fiscal year 
2003, we noted the fiscal year 2004 BSM plan includes an additional 
modernization project (Collection Contract Support--part of the Filing 
and Payment Compliance project).\3\ Since the IRS and its contractors 
have been unable to deliver the scaled-back portfolio of projects on 
time and within cost, we continue to be concerned that the IRS and its 
contractors may not have the ability to successfully manage the BSM 
portfolio.
---------------------------------------------------------------------------
    \3\ The Filing and Payment Compliance project will provide support 
for detecting, scoring, and working nonfiler cases (filing compliance) 
and delinquency cases (payment compliance).
---------------------------------------------------------------------------
Integration Management
    When the BSM effort began, the PRIME contractor was responsible for 
all modernization projects, with the exception of the Custodial 
Accounting Project.\4\ As such, one significant role of the PRIME 
contractor was to ensure integration between all modernization 
projects. This role has become blurred recently with the PRIME 
contractor not being responsible for the Modernized e-File project. In 
addition, the Commissioner testified that he had decided to direct 
upcoming enforcement modernization projects to other contracts. With 
more modernization work being performed outside of the PRIME contract, 
the risk increases that modernization projects will not work in a fully 
integrated fashion.
---------------------------------------------------------------------------
    \4\ The CAP will be a single, integrated data repository of 
taxpayer account information, integrated with the general ledger and 
accessible for management analysis and reporting.
---------------------------------------------------------------------------
Staffing
    Recently, the IRS reported to the IRS Oversight Board that it has 
or will make changes in six of eight executive positions within the BSM 
program in an effort to bring more outside experience into the program. 
While the addition of new executives from outside the organization may 
bring new ideas and energy to the program, we are concerned about the 
potential disruption that it may cause. As part of our annual BSM 
assessment, we have included the following challenge for the last 3 
fiscal years: ``Maintain the continuity of strategic direction with 
experienced leadership.''
    Question. Ms. Gardiner, in your testimony, you point out that you 
found several instances where the Business System Modernization project 
teams at the IRS were cutting corners and not following established 
testing procedures due to their desire to meet overly optimistic 
project schedules. It seems that the IRS responds to missing its 
deadlines by cutting corners and thus undermining the likelihood that 
the agency will get what it paid for. Ms. Gardiner, what have you 
concluded about the IRS's ability to manage these projects effectively 
and ethically? Is there any reason to hope that the IRS is turning a 
corner and actually getting value for the taxpayer from these 
modernization projects? Mr. Everson, would you care to comment?
    Answer. Our audits are not designed to examine the ethics of 
project management and, therefore, we cannot answer this portion of the 
question. The IRS and its contractors have deployed projects that 
provide value to taxpayers and have built the infrastructure needed to 
support these projects. Some of the BSM projects that have delivered 
value to taxpayers are the Customer Communications, Internet Refund/
Fact of Filing (IRFOF), Internet Employer Identification Number (I-
EIN), e-Services, and Modernized e-File (MeF) projects.
    Customer Communications.--This project has improved customer 
service by increasing the capacity of the toll-free telephone system 
and providing the ability to route taxpayers' calls to the appropriate 
IRS employees. This project became operational in August 2001.
    IRFOF.--This application (also known as ``Where's My Refund?'') 
offers improved customer self-service by providing refund status 
information via the Internet. The pilot version of the ``Where's My 
Refund?'' application was deployed in May 2002. The application was 
upgraded in 2003 and was accessed 17.9 million times that year 
according to the IRS. In 2003, the application was modified to provide 
taxpayers with Advance Child Tax Credit refund status via the Internet. 
The IRS stated that 15.5 million Advance Child Tax Credit inquiries 
were received in 2003.
    I-EIN.--This application allows small businesses and self-employed 
taxpayers to obtain EINs online, eliminating the need to send paperwork 
to the IRS. This application was deployed in May 2003. The Commissioner 
recently testified that the application had processed over 450,000 
applications as of February 2004.
    e-Services.--Deployed in August 2003, this project allows tax 
professionals the ability to register online, create an electronic 
account, and apply for a Preparer Tax Identification Number to use in 
place of their Social Security Number for submitting returns. The IRS 
reported in January 2004 that over 16,000 tax professionals had applied 
to use the e-Services application.
    MeF.--This project is developing the modernized, web-based platform 
for electronically filing approximately 330 IRS forms. The first 
release of the MeF project was deployed in late February 2004 and 
provided electronic filing for 59 forms, including United States (U.S.) 
Corporation Income Tax Return (Form 1120), U.S. Income Tax Return for 
an S Corporation (Form 1120S), Return of Organization Exempt From 
Income Tax (Form 990), Short Form Return of Organization Exempt From 
Income Tax (Form 990-EZ), U.S. Income Tax Return for Certain Political 
Organizations (Form 1120-POL), and Application for Extension of Time To 
File an Exempt Organization Return (Form 8868). The IRS has stated that 
over 18,520 tax returns had been accepted by March 21, 2004.
    Progress is being made. Nonetheless, BSM projects are taking longer 
and costing more to deliver less than originally anticipated. Over the 
past 2 fiscal years, we have cited 4 primary challenges the IRS and its 
contractors must overcome to be successful: (1) implement planned 
improvements in key management processes and commit necessary resources 
to enable success, (2) manage the increasing complexity and risks of 
the BSM program, (3) maintain the continuity of strategic direction 
with experienced leadership, and (4) ensure PRIME contractor 
performance and accountability are effectively managed. Based on the 
results of recent TIGTA audits, as well as the assessment findings, we 
believe these four challenges still need to be met to achieve program 
success.
    While the actions in the 48-point plan mentioned previously should 
help improve the BSM program, it will take time to institutionalize new 
processes and ensure they are being followed. Only at that time will it 
be possible to determine if the corrective actions have effectively 
addressed the four major challenges.

                  FAILURE TO COLLECT DELINQUENT TAXES

    Question. A recent report by the Treasury Inspector General for Tax 
Administration (TIGTA) found that IRS's existing procedures are 
ineffective in ensuring even that criminals who are convicted in court 
for tax evasion are paying their civil tax liabilities. Why can't IRS 
collect from tax cheats?
    Answer. In response to our recommendations in the subject report, 
the IRS issued an April memorandum to both the Small Business/Self-
Employed Division and the Criminal Investigation organization 
containing interim procedures to process cases with terms of probation 
and to monitor compliance with these cases.
    Question. Ms. Gardiner, given the fact that the head of IRS-
Criminal Investigations disagreed with a number of your 
recommendations, are you confident that this grotesque abuse will be 
stopped?
    Answer. The IRS did, in fact, disagree with several of our 
recommendations. First, the IRS disagreed with our recommendation 
concerning a technical legal matter on disclosure of tax information, 
stating that it believed it already had sufficient instructions on the 
matter. Our main concern in reporting the issue was to ensure that the 
disclosure rules were interpreted consistently and with the broadest 
possible application. The disclosure issue itself is tangential to the 
main problem of inadequate monitoring of, and follow-up on, probation 
cases.
    The IRS also disagreed with our characterization of the impact of 
the errors in the Criminal Investigation Management Information System. 
Again, this issue is tangential to the main problem and does not affect 
the IRS's need for or commitment to improving its processes on 
monitoring terms of probation.
    Finally, although the IRS disagreed with a recommendation to 
establish certain procedures and part of another recommendation to 
establish periodic systemic reports, it committed to reemphasizing its 
existing instructions and procedures, which it did in the April 
memorandum referenced above. As we stated in our report, we believe 
that this commitment satisfied the intent of our recommendations.
    As to whether we are confident that this abuse will be stopped, the 
key will be the proper implementation and monitoring of the corrective 
actions recently taken or planned. If done properly, the IRS should be 
in a much better position to report to the courts whenever terms of 
probation are not met. Of course, collecting delinquent taxes or 
securing delinquent returns will also be a function of the taxpayer's 
ability to pay or requirement to file.
    Question. Ms. Gardiner, why do you believe that IRS has not cleared 
up even the simplest of cases of uncollected taxes?
    Answer. The IRS collection process for most cases begins with a 
series of notices mailed to taxpayers, asking them to pay the balance 
due. If the taxpayers do not respond, the cases are assigned either to 
the Queue (which is a holding area for cases waiting further assignment 
to the Collection Field function (CFf)) or the Automated Collection 
System (ACS) to be worked by telephone collectors. Generally, higher-
priority cases are placed in the Queue while lower-priority cases are 
assigned to the ACS. If the ACS cannot resolve the cases, some of them 
are also assigned to the Queue. Cases in the Queue are assigned to 
Revenue Officers in the CFf according to priorities established by IRS 
management. In addition, the IRS has recently implemented a risk-based 
approach that attempts to select those cases with the highest 
probability of being collected. As a result, many lower dollar amount 
cases for individual taxpayer liabilities may not be collected if the 
taxpayer did not respond to the notice or a phone call.
    Overall, the IRS is making some progress in collecting unpaid 
taxes. As we reported in April 2004, the level of compliance activities 
and the results obtained in many Collection function areas in fiscal 
year 2003 showed a continuing increase. Enforcement actions were higher 
in fiscal year 2003 than in fiscal year 2002, but they have not 
returned to pre-1998 levels. Enforcement revenue collected increased 
substantially in fiscal year 2003, while the total amount of 
uncollected liabilities and the gap between new delinquent accounts and 
account closures decreased slightly. Finally, the amount owed on 
accounts in the Queue decreased in fiscal year 2003, but the number of 
accounts in inventory increased.
    Question. Do you consider it a possibility that IRS has not done so 
in order to build a case for the use of private collection agencies?
    Answer. The IRS does not have the resources to work every 
delinquent account case. It has established risk-based priority systems 
in an attempt to use ACS and CFf resources as efficiently as possible. 
We have no evidence that the IRS is intentionally not working these 
cases to build a case for the use of private collection agencies.

                            CUSTOMER SERVICE

    Question. IRS consistently finds its own accuracy rates higher than 
TIGTA does when measuring taxpayer assistance functions, whether we are 
talking about toll-free telephone assistance, walk-in service at 
Taxpayer Assistance Centers, or the IRS website. Mr. Everson, how do 
you explain the discrepancy? Ms. Gardiner, would you care to comment?
    Answer. The large number of taxpayers who use Toll-Free Telephone, 
Taxpayer Assistance Centers (TAC), or the IRS's website, IRS.gov, to 
get answers to their tax law and account questions prohibits us from 
using statistical sampling techniques in our audits to determine the 
accuracy of IRS answers.

----------------------------------------------------------------------------------------------------------------
                                                                   IRS-Reported    IRS-Reported   TIGTA-Reported
                         Type of Service                             Customers       Accuracy        Accuracy
                                                                      Served         (Percent)       (Percent)
----------------------------------------------------------------------------------------------------------------
Taxpayer Assistance Centers.....................................       8,588,850          \1\ 75              69
Referral-Mail...................................................         279,558              72              74
Toll-Free Accounts..............................................      27,645,540              89              78
Toll-Free Tax Law...............................................       5,381,687              83              73
Internet-based IRS website, IRS.gov.............................         119,036             N/A         Over 80
----------------------------------------------------------------------------------------------------------------
\1\ IRS accuracy rate reported in the Wage and Investment Operating Division Business Performance Report, page
  10, dated May 11, 2003.

    Figures for TACs, Referral-Mail, Toll-Free Accounts, and Toll-Free 
Tax Law reported by the IRS are for fiscal year 2003. Figures for 
IRS.gov reported by the IRS are for the 2002 Filing Season.
Toll-Free Telephone Assistance
    The differences in the TIGTA's and IRS's accuracy rates are based 
largely on the differences in the sampling methodologies, including the 
sample sizes. For example, during the 2004 Filing Season, we monitored 
over 350 toll-free tax law calls while during the same time period for 
the same types of tax law questions (referred to as applications) the 
IRS selected for monitoring a statistically valid sample of 1,527 tax 
law calls. For fiscal years 2002, 2003, and 2004, we monitored a 
judgmental sample of live taxpayer toll-free tax law calls received by 
the IRS during the filing season, generally considered the months of 
January through April. Although our judgmental sample is not 
statistically valid, we attempt to ensure it is representative of the 
population by creating a sampling plan in which the percentage of calls 
monitored by type of tax law question is reflective of the IRS's 
planned filing season volumes of calls per application. However, we do 
not always monitor calls on late evenings and on the weekends.
    See ``Improvement Is Needed in E-Mail Responses to Complex Tax 
Questions Submitted Through Toll-Free Telephone Help Lines'' (Reference 
Number 2004-40-029, dated December 2003); ``Toll-Free Account 
Assistance to Taxpayers Is Professional and Timely, but Improvement Is 
Needed in the Information Provided'' (Reference Number 2004-40-057, 
dated February 2004); ``Toll-Free Tax Law Assistance to Taxpayers Is 
Professional and Timely, but Improvement Is Needed in the Information 
Provided'' (Reference Number 2003-40-216, dated September 2003).
Taxpayer Assistance Centers
    The IRS did not measure the accuracy of its answers to tax law 
questions asked in the TACs until fiscal year 2003. For 2003, the IRS 
used judgmental sampling to determine accuracy. In fiscal year 2004, 
the IRS is attempting to establish a baseline using statistical 
sampling.
    Though we used judgmental sampling for Calendar Years 2002 and 2003 
to determine whether taxpayers were provided correct and prompt answers 
to their questions, we did ensure all TACs were visited during these 2 
years. For Filing Season 2004, we again used a judgmental sample of 
TACs, ensuring that we visited at least one TAC in each of the IRS's 
territory offices. We visited 199 TACs in 2002, 209 in 2003, and 64 in 
2004 (note that these numbers are only TACs visited to ask questions 
within the scope of TAC employees' training).
    However, we average 80 questions per month while the IRS's Field 
Assistance quality reviewers average 420 a month (Wage and Investment 
Operating Division Business Performance Report, page 6, dated May 11, 
2003). In addition, the IRS does not compute its accuracy rates the 
same way we compute it. TIGTA results present the overall results of 
auditor visits. Accuracy rates are calculated by dividing the total 
response for each category (i.e., correct, incorrect, refer to 
publication, etc.) by the total number of questions asked. In contrast, 
the IRS disagrees with our methodology for including referrals to 
publications and service denied when computing accuracy rates.
    See ``Taxpayer Assistance Center Employees Correctly Answered More 
Tax Law Questions During September and October 2003 Than Compared to 
One Year Ago'' (Reference Number 2004-40-037, dated January 2004), 
``Accuracy Rates Have Increased at Taxpayer Assistance Centers, but 
Improvement Is Needed to Provide Taxpayers Top-Quality Customer 
Service'' (Reference Number 2004-40-065, dated February 2004), and 
``Taxpayer Assistance Center Employees Correctly Answered More Tax Law 
Questions During November and December 2003 Than Compared to One Year 
Ago'' (Reference Number 2004-40-090, dated April 2004).
IRS.gov
    The differences in the TIGTA's and IRS's accuracy rates are based 
on the different methodologies, including the sample sizes. For the 
TIGTA fiscal year 2002 audit, TIGTA auditors anonymously submitted 90 
tax law questions typical of those that may be submitted by an 
individual taxpayer. We rated the answers to those questions we 
submitted. In contrast, during the 2001 Filing Season, the IRS quality 
review system selected 995 questions for quality review.
    The IRS has a centralized quality review site that samples email 
responses for accuracy and measures accuracy with a statistically valid 
sampling plan designed by its Statistics of Income function. The 
sampling plan requires the selection of email responses without regard 
to the type of taxpayer or tax law category, i.e., whether the tax law 
question pertains to individual or business taxpayers.
    See ``Response Accuracy Is Higher for the Internet Program Than 
Other Options Available to Taxpayers Needing Assistance With Tax Law 
Questions'' (Reference Number 2003-40-014, dated October 2002) and 
``Management Advisory Report: The Internal Revenue Service Needs a 
Reliable Measure of the Quality of Electronic Tax Law Assistance 
Provided to Small Businesses and Self-Employed Taxpayers'' (Reference 
Number 2002-30-120, dated July 2002).

                          SUBCOMMITTEE RECESS

    Senator Shelby. I appreciate both of you appearing here, 
and we will be meeting and talking from time to time.
    Ms. Gardiner. Thank you very much.
    Senator Shelby. The hearing is recessed.
    [Whereupon, at 11:27 a.m., Wednesday, April 7, the subcom-
mittee was recessed, to reconvene subject to the call of the 
Chair.]
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