[Senate Hearing 108-493]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-493

                   DOD CONTRACTORS WHO CHEAT ON THEIR
                 TAXES AND WHAT SHOULD BE DONE ABOUT IT

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 12, 2004

                               __________

      Printed for the use of the Committee on Governmental Affairs


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                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
      Joyce A. Rechtschaffen, Minority Staff Director and Counsel
                      Amy B. Newhouse, Chief Clerk

                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                   NORM COLEMAN, Minnesota, Chairman
TED STEVENS, Alaska                  CARL LEVIN, Michigan
GEORGE V. VOINOVICH, Ohio            DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

       Raymond V. Shepherd, III, Staff Director and Chief Counsel
        Elise J. Bean, Minority Staff Director and Chief Counsel
                     Mary D. Robertson, Chief Clerk


                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Coleman..............................................     1
    Senator Levin................................................     4
    Senator Collins..............................................     8
    Senator Lautenberg...........................................     9
    Senator Fitzgerald...........................................    26
    Senator Akaka................................................    29

                               WITNESSES
                      Thursday, February 12, 2004

Gregory D. Kutz, Director, Financial Management and Assurance, 
  U.S. General Accounting Office.................................    11
Steve Sebastian, Director, Financial Management and Assurance, 
  U.S. General Accounting Office.................................    12
John J. Ryan, Assistant Director, Office of Special 
  Investigations, U.S. General Accounting Office.................    12
Hon. Mark Everson, Commissioner, Internal Revenue Service, U.S. 
  Department of the Treasury.....................................    33
Richard L. Gregg, Commissioner, Financial Management Service, 
  U.S. Department of the Treasury................................    35
Lawrence J. Lanzillotta, Principal Deputy Under Secretary 
  (Comptroller), U.S. Department of Defense......................    38

                     Alphabetical List of Witnesses

Everson, Hon. Mark:
    Testimony....................................................    33
    Prepared statement...........................................    82
Gregg, Richard L.:
    Testimony....................................................    35
    Prepared statement with an attachment........................    92
Kutz, Gregory D.:
    Testimony....................................................    11
    Combined prepared statement..................................    53
Lanzillotta, Lawrence J.:
    Testimony....................................................    38
    Prepared statement...........................................    98
Ryan, John J.:
    Testimony....................................................    12
    Combined prepared statement..................................    53
Sebastian, Steve:
    Testimony....................................................    12
    Combined prepared statement..................................    53

                                EXHIBITS

1. GAO Report to Congressional Requesters [The Honorable Norm 
  Coleman, Chairman, The Honorable Carl Levin, Ranking Minority 
  Member, Permanent Subcommittee on Investigations, Committee on 
  Governmental Affairs; and The Honorable Janice Schakowsky, 
  House of Representatives], FINANCIAL MANAGEMENT: Some DOD 
  Contractors Abuse the Federal Tax System with Little 
  Consequence, February 2004, GAO-04-95..........................   102

2a. GAO Chart: Potential Diversions of Payroll Taxes for 
  Personal Gain..................................................   174
2b. GAO Chart: Composition of the $246 Billion of Unpaid 
  Assessments as of September 30, 2003...........................   175

3. IRS Chart: Increasing Tax Debts Available for Levy...........   176

4. Response for the record of Steven J. Sebastian, Director, 
  GAO's Financial Management and Assurance Team regarding IRS 
  proposed $300 million funding increase.........................   177

5. Responses to supplemental questions for the record submitted 
  to Mark Everson, Commissioner, Internal Revenue Service........   178

6. Responses to supplemental questions for the record submitted 
  to Richard L. Gregg, Commissioner, Financial Management 
  Service, Department of the Treasury............................   189

7. Responses to supplemental questions for the record submitted 
  to Lawrence J. Lanzillotta, Principal Deputy Under Secretary 
  and Deputy Under Secretary for Management Reform (Comptroller), 
  U.S. Department of Defense.....................................   192

8. SEALED EXHIBIT: List of Department of Defense contractors 
  owing back taxes provided to the Permanent Subcommittee on 
  Investigations by the Department of Defense....................     *

* May be found in the fields of the Subcommittee.

 
                   DOD CONTRACTORS WHO CHEAT ON THEIR
                 TAXES AND WHAT SHOULD BE DONE ABOUT IT

                              ----------                              


                      THURSDAY, FEBRUARY 12, 2004

                                     U.S. Senate,  
                Permanent Subcommittee on Investigations,  
                         Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:35 a.m. in 
room SD-342, Dirksen Senate Office Building, Hon. Norm Coleman, 
Chairman of the Subcommittee, presiding.
    Present: Senators Coleman, Levin, Collins, Lautenberg, 
Fitzgerald, and Akaka.
    Staff Present: Raymond V. Shepherd, III, Staff Director and 
Chief Counsel; Mary D. Robertson, Chief Clerk; Jay Jennings, 
Investigator; Elise J. Bean, Minority Staff Director and Chief 
Counsel; Brian C. Plesser, Counsel to the Minority; Andrew 
Plehal, Intern; Brian Kowalski, Intern; Alec Rogers (Senator 
Collins); and Marianne Upton (Senator Durbin).

              OPENING STATEMENT OF SENATOR COLEMAN

    Senator Coleman. This hearing is called to order. I would 
first like to note the presence of the Chairman of the 
Governmental Affairs Committee, Chairman Collins and I am 
pleased to have you here today.
    Also I'd like to recognize the Ranking Member, Senator 
Levin. I will note that during your tenure as Chairman of this 
Subcommittee, you certainly shined a light on instances where 
individuals were bringing in millions in one pocket but then 
were cheating the system. And this hearing today, I think, 
really is an offshoot of the focus that you have brought.
    Senator Levin. Thank you.
    Senator Coleman. And so, I thank you for the work you did 
and appreciate your cooperation in the work that we are doing 
together here.
    We are holding this hearing to address a continuing and 
growing problem at the Internal Revenue Service relating to the 
collection of delinquent taxes. In particular, our focus today 
is on the Department of Defense contractors who receive 
billions of dollars in contract payments each year and who 
currently owe $3 billion in unpaid taxes.
    Let me, if I can sum it up just very succinctly, we are 
talking about individuals, deadbeat taxpayers, who are being 
paid taxpayer dollars while they cheat the system, and the 
system is not doing enough to stop it. And hopefully, what we 
do today will move us in a direction to stop it.
    Under the Taxpayer Relief Act of 1997, the Internal Revenue 
Service has the authority to levy 15 percent of these 
contractors' payments, if the Department of Defense refers its 
contract payments to the Financial Management Service and the 
Internal Revenue Service has made these cases available for 
collection. However, the Department of Defense is not referring 
all of its payments and the Internal Revenue Service has not 
made all of these cases available for collection.
    These failures are costing the government over $100 million 
in lost tax revenue each year. No one likes to pay taxes. But 
taxes are a necessity because freedom is not free. Our taxes 
help to fulfill the American dream. They provide for the 
Nation's defense. They promote commerce and fair trade. They 
protect workers, promote health, and provide for education. 
They preserve our natural resources, advance research and 
preserve our culture. They feed the hungry and house the poor. 
They ensure justice and provide transportation. In short, taxes 
are the membership dues we pay to preserve our way of life. All 
Americans are beneficiaries of the Federal tax system.
    The focus of today's hearing is DOD's contractors who have 
abused the Federal tax system. Some of these abuses are 
appalling in their audacity and contemptible in their abject 
selfishness. They cannot and should not be tolerated. Those who 
are committed to the service of this Nation must bear their 
full responsibility in that service.
    I am especially concerned about DOD contractors who have 
withheld payroll taxes in trust for their employees and have 
failed to remit those taxes, cheating not only their own 
employees but the American people as well.
    The adverse impact on taxpayers' faith in the fairness of 
our tax system would be reason enough to remedy this problem. 
However, these employers' betrayal of their own employees 
demands our attention. An investigation recently completed by 
the General Accounting Office found that over 27,000 Federal 
contractors at the Department of Defense owed about $3 billion 
in unpaid taxes. If properly administered, the Debt Collection 
Act of 1996 would have provided DOD with the opportunity in 
fiscal year 2002 to collect at least $100 million from these 
contractors.
    However, because DOD has not fully implemented the 
provisions of the act, only $332,000 was collected. This 
problem has been further exacerbated by the IRS' failure to 
aggressively pursue collections against these contractors. 
Specifically, IRS' increasing collection workload and 
decreasing collection resources have led IRS to freeze 
collection activity in one of every three collection cases. 
Further, the IRS has allowed many cases to interminably 
languish in their antiquated collection process.
    In order to improve collections, DOD and the Internal 
Revenue Service must work with the Financial Management Service 
to identify delinquent contractors and levy their contract 
payments.
    I had a chance to meet with Commissioner Everson yesterday. 
I am pleased with his vision for an increased focus on 
investigative and collection efforts and by his commitment to 
expeditiously address the concerns raised by this Subcommittee 
and the GAO report.
    Let me outline some of the most egregious tax abuses that 
have occurred:

     A business that provides snow removal and 
landscaping service at a military base was awarded contracts of 
over $1 million and owes over $1 million in unpaid payroll and 
employment taxes. During 2002, the contractor received over 
$200,000 from DOD.
     An individual business that performs repair 
services on military vehicles owes over $500,000 in business 
and individual taxes. This contractor has contracts with the 
DOD that are worth over $60 million and recently received an 
annual payment of over $100,000.
     IRS suspended collection activity against a 
contractor in 1999 because the IRS believed the contractor 
lacked the funds to pay their debt. However, between 1999 and 
2002, DOD paid the contractor almost $700,000.
     IRS initiated collection against a DOD contractor 
who owed about $270,000 in unpaid taxes. Because of its 
workload, IRS suspended collection activity against the 
contractor for 10 months. IRS then reinitiated collection 
against the contractor and placed the contractor's case in a 
queue of collection cases awaiting assignment. The contractor 
remained in the queue for 19 months. During this 29-month 
period, DOD paid the contractor at least $110,000.

    With the passage of the Debt Collection Improvement Act of 
1996, Congress obligated DOD to levy their contractor payments 
to ensure that individuals and businesses who receive Federal 
payments and have failed to pay their just tax can have a 
portion of their payments forwarded to the IRS to satisfy their 
tax debt. The Federal Payment Levy Program, administered by the 
Financial Management Service, relies on computer matching of 
information provided by IRS and DOD. If the taxpayer 
identification information is incorrect or not provided, then, 
the Financial Management Service cannot match the DOD and IRS 
information. As a result, the IRS cannot effectively identify 
nonfilers, determine their full tax liability and levy 
contractors' payments to collect the taxes that are owed, and 
DOD will continue to fully pay tax scofflaws who are abusing 
the Federal tax system.
    When we find fraud and abuse, we must fix it and stop it 
from occurring again. As we begin this hearing, I want to 
reiterate my commitment to finding solutions to the problems in 
government.
    This morning, we will hear from representatives of the 
General Accounting Office on their recently completed 
investigation of DOD contractors who habitually abuse the 
Federal tax system. We will also hear from the Department of 
Defense, the IRS and the Financial Management Service 
concerning the actions that they have taken, or plan to take to 
ensure that DOD contractors pay the taxes that they owe.
    Senator Levin.

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Thank you.
    Thank you for your leadership in this effort. You have been 
the leader in this investigation, and we have been delighted to 
be supportive of it. But the credit belongs to you, and the 
leadership has been very strong, and I think every taxpayer in 
this country is in your debt because of it.
    The men and women in our military are putting their lives 
on the line every day for our Nation. At the same time, the GAO 
is telling us that over 27,000 of the Department of Defense's 
contractors--that is about 10 percent of the Department's 
contractors--are dodging their tax bills and have outstanding 
tax debts to Uncle Sam totalling at least $3 billion--27,000 
DOD contractors with $3 billions in unpaid taxes; I am not sure 
which figure is more shocking.
    Tax dodging by any Federal contractor is unfair, not only 
to the honest taxpayers left to make up the difference but also 
to the honest companies that have to compete against the tax 
dodgers for government contracts. Tax dodging by contractors 
taking taxpayers' dollars to support our military is not only 
unfair; it is unpatriotic.
    The General Accounting Office tells us that the vast 
majority of the 27,000 Department of Defense contractors with 
unpaid taxes, about 25,000 of them, have failed primarily to 
pay the payroll taxes which they have withheld and which they 
owe. That means these contractors have failed to send to the 
IRS sums that are withheld from employees' wages for Federal, 
State, Social Security, and Medicare taxes.
    When the GAO took a closer look at 47 of these Department 
of Defense contractors, it found that all 47 had evidence of 
tax avoidance, and in some cases, they unearthed unseemly tales 
of individuals and companies dodging taxes for years and using 
the money meant for payroll taxes on luxuries for themselves 
instead: Expensive homes, cars, boats, and vacations. One 
contractor with $10 million in unpaid taxes had been paid $3.5 
million in taxpayers' dollars in fiscal year 2002 alone to 
provide the custodial services at military bases. This 
contractor had already defaulted on an IRS installment 
agreement; yet, it is unclear whether one dime of the $3.5 
million was withheld to pay down the contractor's tax debt.
    Tax chiseling by Federal contractors is not a new story, 
and that is why Congress tackled this issue in 1996 and 1997 
when they enacted the Taxpayer Relief Act, which, in part, 
authorized Federal agencies to withhold 15 percent of any 
Federal payment going to a person with an outstanding tax debt. 
The goal was to stop taxpayer dollars from being paid to a tax 
deadbeat unless 15 percent was withheld to reduce that person's 
tax debt.
    The Taxpayer Relief Act sought to apply a commonsense 
principle to government operations to offset the taxpayer 
dollars sent to people who have not paid their tax bills by 
directing a percentage of the total to reduce their tax debt. 
But this commonsense principle is not easy to apply in a 
government that pays hundreds of thousands of contractors to 
work on even more contracts; in essence, it requires the 
Federal Government to set up financial payment systems that 
make sure that the left hand knows what the right hand is 
doing, to make sure, for example, that contract payments do not 
go to a contractor with an outstanding tax debt unless a 
portion is withheld to satisfy a part of that debt.
    The first agency to begin implementation of that law was 
the Financial Management Service or FMS in the Treasury 
Department. That agency took until July 2000 to establish an 
automated tax levy program under a larger Treasury offset 
program, which handles offsets for a variety of reasons. Since 
then, FMS has sent about $76 million in tax levy money to the 
IRS. It took another 2 years, until December 2002, for the 
Department of Defense to follow suit. It set up its first 
automated tax levy program for its largest contractor payment 
system, MOCAS, which handles payments on the Department of 
Defense's major long-term contracts.
    Fifteen other payment systems, however, have not yet been 
automated. And so, we have a joint effort involving the 
Department of Defense, FMS, and the IRS which have to work 
together to match the people who are delinquent with the people 
who are being made payments by the Department of Defense. It is 
a very straightforward piece of technology. It just depends on 
willpower to be implemented; a decision made to implement this. 
So many much more miraculous technological feats are being 
performed within seconds on our computers these days--take a 
look at Google--that there is no excuse conceivably for not 
making this match. It is just simply a default on the part of 
our agencies, as far as I am concerned, to do what technology 
now allows them to do and the technology which is now in place.
    Senator Coleman, let me ask you if I could then put the 
balance of my statement in the record at this point.
    Senator Coleman. Without objection.
    Senator Levin. Thank you
    [The prepared opening statement of Senator Levin follows:]

              PREPARED OPENING STATEMENT OF SENATOR LEVIN

7    Men and women in our military are putting their lives on the line 
every day for our Nation. At the same time, GAO tells us that over 
27,000 of DOD's contractors--more than 1 in 10--are dodging their tax 
bills and have outstanding tax debts to Uncle Sam totaling at least $3 
billion. 27,000 DOD contractors with $3 billion in unpaid taxes. I'm 
not sure which figure is more shocking.
    Tax dodging by any federal contractor is unfair--not only to the 
honest taxpayers left to make up the difference, but also to the honest 
companies that have to compete against the tax dodgers for government 
contracts. Tax dodging by contractors taking taxpayer dollars to 
support our military is not only unfair, it is unpatriotic and 
unacceptable.
    GAO tells us the vast majority of the 27,000 DOD contractors with 
unpaid taxes, more than 25,600 of them, have failed primarily to pay 
payroll taxes. That means these contractors have failed to send to the 
IRS sums withheld from employees' wages for federal, state, Social 
Security, and Medicare taxes. When GAO took a closer look at 47 of 
these DOD contractors, GAO found that all 47 had evidence of tax 
avoidance and, in some cases, unearthed unseemly tales of individuals 
and companies dodging taxes for years and using the money meant for 
payroll taxes on luxuries for themselves instead--expensive homes, 
cars, boats, and vacations. One contractor with $10 million in unpaid 
taxes had been paid $3.5 million in taxpayer dollars in FY2002 alone to 
provide custodial services at military bases. This contractor had 
already defaulted on an IRS installment agreement, yet it is unclear 
whether a dime of the $3.5 million was withheld to pay down the 
contractor's tax debt.
    Tax chiseling by federal contractors isn't a new story. It's an old 
one. And it's one that Congress has tackled in the past to recoup 
unpaid taxes and prevent new tax abuses. In 1997, Congress enacted the 
Taxpayer Relief Act which, in part, authorized federal agencies to 
withhold 15 percent of any federal payment going to a person with an 
outstanding tax debt. The goal was to stop taxpayer dollars from being 
paid to a tax deadbeat, unless 15 percent was withheld off the top to 
reduce that person's tax debt.
    The Taxpayer Relief Act sought to apply a common sense principle to 
government operations: To offset the taxpayer dollars sent to people 
who haven't paid their tax bills by directing a small percentage of the 
total to reduce their tax debt. But this common sense principle isn't 
easy to apply in a government that pays hundreds of thousands of 
contractors to work on even more contracts. In essence, it requires the 
federal government to set up financial payment systems that make sure 
the left hand knows what the right hand is doing--to make sure, for 
example, that contract payments don't go to a contractor with an 
outstanding tax debt unless a portion is first withheld to satisfy a 
part of that debt.
    The first agency to tackle the problem was the Financial Management 
Service or FMS in the Treasury Department. That agency took until July 
2000 to establish an automated tax levy program under a larger Treasury 
Offset Program, which handles offsets for a variety of reasons. Since 
then, FMS has sent about $76 million in tax levy money to the IRS, with 
about $60 million in FY2002 alone.
    It took another two years--until December 2002--for DOD to follow 
suit. Working with FMS, DOD set up its first automated tax levy program 
for its largest contractor payment system, called MOCAS, which handles 
payments on DOD's major, long-term contracts. In FY2002, MOCAS payments 
totaled about $95 billion, all of which is now reviewed for tax levies 
before the money goes out the door. DOD is planning to but has not yet 
extended its automated tax levy program to 15 other payment systems 
which, together, make contract payments totaling another $85 billion 
each year.
    As currently operated, the DOD tax levy program is a joint effort 
involving DOD, FMS and the IRS. It is a joint effort because, while FMS 
is authorized by law to review IRS data on unpaid taxes, DOD is not. So 
here's what happens. Each Monday morning, the Defense Financial and 
Accounting Service at DOD sends FMS an electronic file listing payments 
expected to be made to DOD contractors over the next few days. FMS 
immediately uses a computer match program to compare the names and 
taxpayer information numbers in the DOD payment data with data in IRS 
files listing persons with unpaid taxes. FMS compiles a list of the 
names that match and sends it to the IRS. The IRS then makes sure it 
has mailed a 30-day notice of intent to levy to each of the listed tax 
delinquent contractors. If the contractor does not respond within 30 
days by paying up, protesting the tax debt, or offering to settle it, 
the IRS notifies FMS which, in turn, tells DOD to begin withholding the 
15 percent from payments to the identified contractors. DOD does so and 
forwards any levied funds to FMS which, in turn forwards the fund to 
the IRS.
    GAO estimates that, in light of the huge DOD contract dollars and 
tax dollars at stake, DOD's tax levy program ought to be collecting at 
least $100 million each year. But last year, the first year of the DOD 
tax levy program, DOD collected less than $1 million, or less than 1 
percent of the projected total.
    The GAO report spells out a number of reasons why. The good news is 
that many, if not all, of these problems can be fixed.
    First, there is DOD. Right now, DOD is sending FMS payment data on 
only one day per week for only one of its payment systems. It needs to 
send more frequent payment data from all 16 payment systems. Another 
problem is that the payment data DOD sends to FMS is currently tainted 
with thousands of incorrect or missing taxpayer identification numbers, 
which makes it nearly impossible to match many DOD contractors to IRS 
lists of tax delinquents. DOD needs to set up new procedures to get 
valid taxpayer identification numbers (TINs) from its contractors and 
stop sending payments to contractors with invalid or missing TINs. 
Finally, when faced with having to make a payment to a contractor 
without a valid TIN, DOD has never set up the system required by law to 
withhold 28% of each payment to that contractor until a valid TIN is 
supplied. DOD needs to set up that backup withholding system.
    Next is the IRS. One key problem here is that the IRS has caused 
DOD to miss imposing tax levies on numerous contract payments, because 
the IRS hadn't yet mailed the 30-day notice to the relevant contractors 
warning of an upcoming levy. The IRS needs to revamp its levy notice 
procedures to eliminate delays and missed levies. The IRS also needs to 
change tax collection policies that currently prevent DOD from using 
its tax levy program on many of its contractors. For example, the IRS 
needs to end its practice of waiting a year before approving use of the 
levy program for contractors waiting in an IRS queue for assignment to 
a revenue officer. I understand that the IRS is willing and may have 
already made this change. Another problem is the IRS' automatic bar on 
using tax levies on contractors who are negotiating to settle, reduce, 
or stretch out repayment of their tax debt or are in bankruptcy or 
experiencing financial hardship, especially in the case of contractors 
with defaults on prior repayment agreements or a history of nonpayment 
of tax.
    In essence, when it comes to contractors paid with federal taxpayer 
dollars, the IRS must become much less cautious in using the 15 percent 
tax levy authorized by law, and it must stop allowing tax delinquent 
DOD contractors to receive full payment in taxpayer dollars without 
having a dime directed toward the taxes they've dodged. The IRS also 
needs, for the first time, to assign full-time revenue officers to the 
tax levy programs aimed at federal contractors, so that these officers 
can develop expertise, improve the DOD and FMS programs, and cut down 
on the tax abuses committed by federal contractors.
    Senator Coleman and I have been working on developing 
recommendations to strengthen the DOD tax levy program based upon the 
GAO report and discussions our staffs have held with the three 
agencies. DOD and the IRS have already indicated their willingness to 
make reforms, have made some concrete changes, and are considering 
additional improvements as well. Here are some of my thoughts about key 
improvements to strengthen use of tax levies for federal contractors.

Recommendations for DOD

          (1) 16 Payment Systems. DOD should meet its March 2005 
        deadline for automating tax levies in all 16 of its payment 
        systems, thereby bringing $85 billion more payments under 
        review each year in DOD's tax levy program.
          (2) More Frequent Payment Data. DOD should send its 
        contractor payment data to the Financial Management Service 
        more than once week and as often as practical to increase IRS 
        matches and identify more tax delinquent contractors.
          (3) TIN Consent. DOD should require all registrants in the 
        federal Central Contractor Registration (CCR) database to 
        provide consent during the registration process for DOD to 
        obtain IRS information to validate their taxpayer 
        identification numbers (TINs), and DOD should work with the IRS 
        to validate all TINs in the CCR.
          (4) TIN Requirement. DOD should prevent contract payments to 
        any contractor with an invalid or non-existent taxpayer 
        identification number.
          (5) Backup Withholding. In FY 2004, DOD should establish 
        systems to require automatic backup withholding from payments 
        to any contractor with an invalid TIN, as required by law, and 
        notify CCR registrants that contract payments are subject to 
        such withholding.

Recommendations for IRS

          (1) Using Tax Levies Sooner, Not Later. The IRS should change 
        its tax levy policies to use levies as a first resort, rather 
        than a last resort, for tax delinquent federal contractors.
          (2) Dedicated Revenue Officers. The IRS should assign full-
        time revenue officers to specialize in collecting unpaid taxes 
        from levies on federal contractors, and work with DOD and FMS 
        to improve the efficiency and effectiveness of their tax levy 
        programs.
          (3) Levy Notices. The IRS should revamp its procedures for 
        issuing levy notices to federal contractors to eliminate 
        delays, and consider such options as combining levy notices 
        with delinquency notices and sending levy notices to tax 
        delinquent CCR registrants with active contracts.
          (4) Queue Reform. The IRS should eliminate the policy 
        automatically barring initiation of a tax levy for one year on 
        any federal contractor waiting in the IRS queue for assignment 
        to a revenue officer, and instead initiate tax levies on 
        federal contract payments as a routine matter.
          (5) Recidivist Tax Abusers. The IRS should work with Congress 
        to eliminate administrative and statutory barriers to 
        initiating a tax levy on a federal contractor in negotiation to 
        repay a tax debt, in bankruptcy, or undergoing financial 
        hardship, if the contractor has defaulted on a prior IRS 
        repayment agreement or has a history of repeated misconduct 
        involving nonpayment of tax.

Recommendation for OMB

          Study. OMB, working with DOD, FMS, IRS and others, should 
        conduct a study on whether federal contractors with unpaid 
        taxes should be barred under some or all circumstances from 
        bidding on federal contracts, and whether federal contracting 
        officers should be informed of contractors who have engaged in 
        longstanding or egregious tax avoidance so they can assist in 
        tax collection efforts.

    DOD contracts represent nearly two-thirds of all federal contracts 
and, in FY2002, DOD contract payments totaled about $180 billion. The 
recipients of DOD contracts, whether individuals or businesses, are 
given an unique opportunity to support the men and women in our 
military. Most DOD contractors provide valuable goods or services to 
DOD, and do so while paying their taxes. Other DOD contractors, 
however, take payment in taxpayer dollars, while dodging paying their 
taxes to Uncle Sam. This tax dodging hurts honest taxpayers, honest 
businesses, and our country as a whole. Effective use of the DOD tax 
levy program is necessary to help keep the tax dodger's hand out of the 
taxpayer's wallet.
    I commend Senator Coleman and Congresswoman Janice Schakowsky for 
their leadership on this important issue. I look forward to the 
testimony today.

    Senator Coleman. Chairman Collins.

             OPENING STATEMENT OF CHAIRMAN COLLINS

    Chairman Collins. Thank you very much, Mr. Chairman.
    First of all, let me commend you for calling this hearing 
to shed light on what the General Accounting Office has 
uncovered regarding the failure of some of our Nation's defense 
contractors to pay their taxes. The crux of the GAO's findings 
that more than 27,000 defense contractors owe the Federal 
Government some $3 billion in taxes and that the Pentagon is 
not doing all that it can to collect this money is very 
disturbing and raises many questions about the Federal 
procurement system.
    Federal procurement laws require contractors to demonstrate 
integrity in order to do business with the Federal Government. 
That obviously includes paying their taxes. That some of those 
who provide goods and services to our Nation's fighting men and 
women fall woefully short of these standards is of great 
concern to me.
    At a time of high deficits, it is also very troubling that 
the Pentagon appears to have been negligent in reporting tax 
information and payment information that could have helped the 
IRS collect taxes owed but not paid. Under Federal law, the 
government may withhold part of a contractor's payment to 
offset for taxes the contractor owes the government. In order 
to accomplish this, however, agencies must report contract 
payment information to the Financial Management Service.
    As we will hear today, the Pentagon has failed to use this 
tool in far too many cases. Adding to the problem, the Internal 
Revenue Service has sometimes failed to pursue those cases it 
did know about, according to the GAO. I am determined to learn 
why it has failed to do so, and I am interested to learn what 
steps the Defense Department and the IRS intend to take in 
order to ensure better performance in the future.
    For businesses that are inexcusably delinquent in meeting 
their tax obligations, another important question arises. That 
is, why is the Department of Defense continuing to do business 
with these companies? The names of the contractors today are 
being withheld because their tax data were an integral part of 
GAO's research. Because we value taxpayer privacy so highly--
and rightly so--we cannot know for certain the specific 
circumstances surrounding each contractor's failure to pay.
    Nevertheless, the GAO has singled out 47 companies as 
especially egregious offenders, and the Pentagon should 
evaluate whether or not these companies should continue to do 
business with the Federal Government. The Pentagon should look 
at whether they meet the standards under Federal law to qualify 
as responsible bidders.
    Mr. Chairman, simply put, the 27,000 defense contractors 
who owe approximately $3 billion in uncollected taxes need to 
be held accountable. The Pentagon needs to be held accountable. 
And the IRS needs to be held accountable.
    I very much appreciate your holding this hearing this 
morning so that we can get to the bottom of this very 
disturbing problem. Thank you.
    [The opening prepared statement of Senator Collins 
follows:]

             PREPARED OPENING STATEMENT OF SENATOR COLLINS

    Mr. Chairman, thank you for calling this hearing to shed light on 
what the General Accounting Office has uncovered regarding the failure 
of some of our Nation's defense contractors to pay their taxes and the 
Department of Defense's response.
    The crux of GAO's findings--that over 27,000 DOD contractors owe 
the Federal Government some $3 billion in taxes, and that the 
Department may not be doing all that it can to collect this money--is 
very disturbing to me.
    As Chairman of the Governmental Affairs Committee, which has 
jurisdiction over government procurement, I have made clear my belief 
that there should be high ethical standards for Federal contractors. 
That some of those who provide goods and services to our Nation's 
fighting men and women fall short of those standards is of great 
concern to me.
    At a time of high deficits, it is also disturbing that the Pentagon 
appears to have been negligent in reporting payment data to the 
Treasury that could have helped the IRS collect taxes owed but not 
paid.
    Under Federal law, the government may withhold part of a 
contractor's payment to offset for taxes the contractor owes the 
government. In order to accomplish this, however, agencies must report 
contract payment information to the Financial Management System. As we 
will hear today, the Pentagon has failed to use this tool in far too 
many cases. Adding to the problem, the Internal Revenue Service has 
sometimes failed to pursue those cases it did know about according to 
GAO. I am determined to learn why it failed to do so, and am very 
interested to learn what steps the Defense Department and the IRS 
intends to take to ensure better performance in the future.
    For businesses that are inexcusably delinquent in paying their 
taxes, another question arises. Why is the Department of Defense, which 
is among the most sophisticated purchasers of goods and services of all 
Federal departments, continuing to do business with these companies?
    The names of the contractors today are being withheld because their 
tax data were an integral part of GAO's research. Because we value 
taxpayer privacy so highly, and rightly so, we cannot know the exact 
circumstances surrounding each one's failure to pay. Still, GAO has 
singled out 47 companies as especially egregious offenders, and the 
Pentagon should evaluate whether or not these companies meet the 
standards under Federal law to continue as government contractors.
    Mr. Chairman, simply put, the 27,000 defense contractors who owe 
approximately $3 billion in uncollected taxes need to be held 
accountable. I appreciate your holding this hearing and shining a light 
on this problem. Thank you.

    Senator Coleman. Thank you very much, Senator Collins. 
Senator Lautenberg.

            OPENING STATEMENT OF SENATOR LAUTENBERG

    Senator Lautenberg. Thanks very much, Mr. Chairman. I, too, 
want to commend you for holding this hearing.
    This delinquency, in my view, is what I would describe as 
almost traitorous conduct. Much of these expenses, much of 
these charges are as a result of having our people exposed to 
danger fighting a war, and its relationship to that singles 
them out as particularly scandalous in their behavior. I am 
dumbfounded by GAO findings that the Department of Defense 
contractors owe the Treasury over $3 billion.
    I am equally concerned that IRS officials have not fully 
worked out payment systems so their debtors can be quickly 
identified and their payments of unpaid taxes collected. One of 
the things that I had to note as I heard about IRS' inability 
to pursue these deadbeats; it reminds me of the fact that IRS 
was the subject of a review that said there are just too many 
employees there. So, while they have successfully reduced the 
number of people working at IRS, we have lots of evidence about 
IRS' inability to pursue delinquent tax accounts.
    Although I believe that today's topic is both worthy and 
pressing, I register my disappointment that another similarly 
urgent issue involving DOD contracting transparency and 
oversight has yet to be discussed by either our Subcommittee 
here or the full Governmental Affairs Committee. Three times 
since May, I have written to the Committee requesting that we 
hold a hearing to investigate the controversial contracts 
awarded by the Pentagon for the reconstruction of the Iraqi oil 
industry. No luck so far.
    The specific accounting problems and contracting ethics 
involved in these particular contracts are numerous and varied, 
too numerous to recite here. But they have been documented 
extensively by the press and by Members of the Congress, 
including this Senator. And just as an example, I want to call 
attention to three particular examples of potentially 
fraudulent accounting with respect to one company that is 
receiving billions of dollars in Pentagon contract assignments 
to rebuild Iraq. The company is Halliburton, including its 
subsidiary, KBR.
    First, Halliburton was awarded a no-bid contract last March 
to extinguish oil fires, in the worst-case scenario that were 
ignited by Saddam and his crew during the battle. The initial 
contract was slated to be $50 million. Subsequently, although 
the worst-case scenario never materialized, this no-bid 
contract mutated into a $2.2 billion monstrosity over the 
course of 8 months, despite the protests of many Members of 
Congress.
    Second, we began learning this fall that Halliburton was 
dramatically overcharging taxpayers for the services it was 
providing. In December, DOD auditors found that Halliburton 
charged the government more than $61 million, too much, to 
bring gasoline into Iraq. And third, we learned that 
Halliburton's employees were engaged in illegal business 
transactions by accepting kickbacks from Kuwaiti firms, 
amounting to $6 million.
    I believe that we are not fulfilling our oversight 
responsibilities as legislators if we dismiss or neglect that 
kind of a business practice. So I am, therefore, pleased that 
we are going ahead with this but keeping in mind all the time 
that the system looks like it is out of control, and we ought 
to find a way to collect taxes due this country from earnings 
that were specifically directed by DOD.
    Today's hearing is an important one, and I look forward to 
hearing from both GAO and the administration witnesses about 
how to hold accountable those DOD contractors who are 
undermining national security by avoiding paying their fair 
share of the taxes. But I believe it is equally imperative that 
we also investigate how DOD contracts are awarded and filled, 
especially in Iraq and especially when they are being given to 
a company like Halliburton that has such a poor business track 
record but such close ties to the administration.
    And I thank you, Mr. Chairman.
    Senator Coleman. Thank you, Senator Lautenberg.
    I would now like to welcome today's first panel to our 
hearing: Gregory Kutz, a Director with the Financial Management 
and Assurance Team at the General Accounting Office; Steve 
Sebastian, a Director with the Financial Management and 
Assurance Team at GAO; and finally, John Ryan, an Assistant 
Director with the Office of Special Investigations at GAO.
    As I mentioned in my opening statement this morning, GAO is 
here to release the results of its investigation of the 
Department of Defense, whose contractors were abusing the 
Federal tax system by either failing to file tax returns or not 
paying their taxes. The purpose of the hearing is to identify 
the corrective actions that can be taken to ensure that the 
Department of Defense contractors pay the taxes they owe the 
Federal Government.
    I appreciate your attendance at today's important hearing. 
Before we begin, pursuant to Rule 6, all witnesses who testify 
before this Subcommittee are required to be sworn. At this 
time, I would ask you all to please stand and raise your right 
hand.
    [Witnesses sworn.]
    Senator Coleman. Before we begin, Senator Levin has 
reminded me that much of the focus of this investigation was 
initiated at the behest of Congresswoman Schakowsky, who we 
intended to have testify before the Subcommittee. I believe 
there was a personal emergency that made that impossible. But I 
do want to make note of her diligence and her efforts in this 
regard and we are sorry that she cannot be with us today.
    We will be using a timing system, and I think you gentlemen 
understand this system. About a minute before you should wrap 
up your remarks, a yellow light will come on. Please limit your 
remarks to no more than 10 minutes. I will ensure that your 
complete statement will be entered into the record.
    Mr. Kutz, I believe you and Mr. Sebastian will be 
presenting the GAO statement this morning. Please proceed.

TESTIMONY OF GREGORY D. KUTZ,\1\ DIRECTOR, FINANCIAL MANAGEMENT 
         AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE

    Mr. Kutz. Mr. Chairman, Members of the Subcommittee and 
Chairman Collins, thank you for the opportunity to be here to 
discuss abuse and potential criminal activity by DOD 
contractors. The bottom line of our testimony is that DOD 
contractors are abusing the Federal tax system with little or 
no consequences. The end result, as you have mentioned, is that 
compliant American taxpayers must pay more.
---------------------------------------------------------------------------
    \1\ The combined prepared statement of Mr. Kutz, Mr. Sebastian, and 
Mr. Ryan appears in the Appendix on page 53.
---------------------------------------------------------------------------
    Our testimony has two parts. First, I will discuss DOD 
contractors with unpaid Federal taxes, and second, my 
colleague, Mr. Sebastian, will discuss why little has been done 
to deal with abusive contractors.
    First, as mentioned, we found that over 27,000 contractors 
had nearly $3 billion in unpaid Federal taxes. Over 25,000 of 
these contractors were businesses that owed primarily payroll 
taxes. These taxes include amounts withheld from an employee's 
wages for Federal income taxes, Social Security, and Medicare.
    For all 47 contractors that we investigated, we found 
abusive or potentially criminal activity related to the Federal 
tax system. The 34 businesses had severely delinquent payroll 
taxes, owing up to 62 quarters or 15 years of taxes. However, 
rather than fulfill their role as trustees of this money and 
pay it to the IRS, these contractors diverted the money for 
their businesses or for personal gain.
    The poster board shows several examples of potential 
diversion of payroll taxes for personal gain, including the 
owner of a contract with $10 million of unpaid taxes using 
corporate funds to buy a home in the Caribbean and a luxury 
boat; another owner taking $1 million from his company to buy a 
large home and a Mercedes. Other potential diversions were for 
homes, airplanes, and other luxury cars.
    The typical diversion scheme funneled money to the owners 
and officers of the company through substantial salaries or 
loans that were never repaid. In addition to these more 
flagrant offenders, other contractors were in financial trouble 
and used the money to pay the utility bill or the rent rather 
than forward the money to the IRS. Regardless of the cause, 
willful failure to remit payroll taxes is a felony.
    Other interesting cases include DOD awarding over $60 
million in contracts to an individual with delinquent payroll 
taxes dating back to 1994; DOD paying a contractor to provide 
motivational speeches that has over $130,000 of unpaid taxes 
dating back to 1993; and a $400,000 contract award to a dentist 
who has substantial unpaid payroll and income taxes also dating 
back to 1993.
    Many of these contractors were also involved in other 
crimes of integrity. What was the reward for these 47 abusive 
contractors? Over $200 million of DOD contracts. These 
contractors are small and mid-sized businesses that provide 
basic services such as building maintenance, construction and 
catering; thus, DOD could get these services from legitimate, 
taxpaying contractors.
    Mr. Sebastian will now discuss why tax abusers can also be 
contractors and why there have been few consequences to date.

   TESTIMONY OF STEVEN J. SEBASTIAN,\1\ DIRECTOR, FINANCIAL 
 MANAGEMENT AND ASSURANCE, U.S. GENERAL ACCOUNTING OFFICE, AND 
    JOHN J. RYAN,\1\ ASSISTANT DIRECTOR, OFFICE OF SPECIAL 
         INVESTIGATIONS, U.S. GENERL ACCOUNTING OFFICE

    Mr. Sebastian. Thank you, Mr. Kutz.
---------------------------------------------------------------------------
    \1\ The combined prepared statement of Mr. Kutz, Mr. Sebastian, and 
Mr. Ryan appears in the Appendix on page 53.
---------------------------------------------------------------------------
    Mr. Chairman, Members of the Subcommittee and Chairman 
Collins, Federal law presently does not prohibit contractors 
with unpaid taxes from receiving government contracts. However, 
tools exist to facilitate the collection of taxes for 
contractors. In 1996, the Congress passed legislation to 
improve the government's debt collection, and in 1997, granted 
IRS the authority to continuously levy up to 15 percent of 
Federal payments to collect outstanding taxes.
    Critical to the levy program is the matching of DOD 
disbursing records with Treasury's centralized database of 
Federal debt, including tax debt. Thus, with no legal 
prohibition, the government is dependent on DOD and IRS to 
ensure contractors pay their fair share. However, as our work 
shows, both agencies have been deficient in this regard.
    In the 6 years since Congress granted continuous levy 
authority, DOD has collected less than $700,000, and prior to 
December 2002, nothing had been collected for DOD contractors. 
Collections to date relate to DOD only recently providing 
information to Treasury for one payment system which had $86 
billion in fiscal year 2002 disbursements. Contractors paid 
through this system owed $750 million in taxes. At present, DOD 
is not providing data to Treasury for other payment systems 
that disbursed $97 billion in fiscal year 2002.
    The potential benefits of an effective levy cannot be 
overstated. In reviewing disbursements for five DOD payment 
systems, we estimate that DOD could have levied contractors' 
payments and collected at least $100 million in fiscal year 
2003 alone.
    As the Nation's tax collector, IRS plays a key role. As 
reflected on the poster board,\1\ with $246 billion in unpaid 
taxes, only 8 percent of which is deemed collectible, efficient 
and effective means of collecting taxes is critical to IRS' 
mission. However, restrictive policies and procedures as well 
as control deficiencies at IRS hinder the levy program's 
collection potential.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 2b. which appears in the Appendix on page 175.
---------------------------------------------------------------------------
    Current IRS policies restrict which and at what stage in 
the collection process cases enter the levy program. For 
example, IRS excludes cases in the queue or holding tank from 
potential levy for at least 1 year. In one of our case studies 
involving a contractor that owed $270,000 in taxes, the account 
was placed in the queue, where it sat for 19 months with no 
attempts to collect the taxes. DOD paid this contractor over 
$110,000 in fiscal year 2002.
    Processing delays also prevent cases from entering the levy 
program. When a taxpayer offers to settle its tax debt for 
pennies on the dollar, called an offer in compromise, IRS is 
required to suspend any efforts to levy payments. Our work 
shows that IRS continues to experience significant delays in 
processing such offers. These delays, in turn, reduce potential 
collections.
    For example, in one case, a contractor with $400,000 in 
unpaid taxes proposed an offer in compromise. IRS took over a 
year before it finally rejected the offer and over 2 years to 
reject a second proposal. During this time, DOD paid the 
contractor over $200,000, $30,000 of which could have been 
collected.
    Additionally, inaccurate records impede IRS' collection 
efforts. In one case, a contractor proposed to pay by 
installment. At that time, IRS entered a code in its system to 
block the account from levy. IRS formally rejected the proposal 
1 year later but never reversed the code. The account was thus 
erroneously excluded from levy action for 2 years.
    Finally, IRS attempts to work with contractors to achieve 
voluntary compliance, delaying more aggressive enforcement 
actions like levies until later. This results, however, in some 
contractors continuing to receive payments while making no 
effort to pay their taxes. In one case, a business with DOD 
contracts that generated $4 million had unpaid taxes of over 
$10 million. As the contractor's tax debt mounted, IRS 
continued working with the business, taking no enforcement 
action.
    During this time, as Mr. Kutz mentioned, the owner diverted 
funds for personal gain, shut the company down, and moved to 
the Caribbean, leaving the IRS with uncollectible taxes of over 
$10 million.
    In conclusion, allowing contractors to do business with the 
government while not paying their taxes creates an unfair 
competitive advantage for them at the expense of the vast 
majority of DOD contractors that fulfill their tax obligations. 
DOD's failure to fully comply with debt collection mandates and 
IRS' continuing challenges in collecting unpaid taxes have 
contributed to this unacceptable situation. As a result, the 
government has missed opportunities to collect hundreds of 
millions of dollars in unpaid taxes.
    We believe prompt implementation of the recommendations in 
our report, released today, will result in millions of dollars 
of immediate tax collections.
    Mr. Chairman, this concludes our statement. We would be 
pleased to answer any questions you or the other Senators may 
have.
    Senator Coleman. Thank you very much, Mr. Sebastian.
    Mr. Kutz, you have indicated--you started your testimony by 
talking about abusive and criminal activities, failure to pay 
these taxes is a crime; is that correct?
    Mr. Kutz. Yes, that is correct.
    Senator Coleman. And I believe it is a felony-level crime?
    Mr. Kutz. There is a felony-level for not remitting the 
taxes, and there is a misdemeanor for not properly segregating 
the taxes.
    Senator Coleman. We have heard that in one of the 47 cases 
that you reviewed, the individual involved is now living in the 
Caribbean. But do you have a sense of whether these cases are 
still prosecutable?
    Mr. Kutz. Well, Mr. Ryan could probably answer that from a 
legal standpoint.
    Senator Coleman. Or certainly the other cases also.
    Mr. Ryan. I believe that the 47 cases that we looked at, we 
took 12, and we dug down and looked at those cases. We believe 
that those cases have some additional elements for prosecution, 
and we have referred those to the IRS for whatever action they 
deem necessary.
    Senator Coleman. Very good, Mr. Ryan, and I will ask 
Commissioner Everson about those cases.
    Now, you identified 47 cases among the 27,100 contractors 
you identified as owing taxes. Are there more examples of 
potential criminal abuse among the 27,100 beyond the 47? I take 
it these 47 are just a small sampling.
    Mr. Kutz. That would be a small selection. They were not a 
sample. We did use some data mining techniques to get to them, 
but there are hundreds or potentially thousands of similar 
stories out there.
    Senator Coleman. Would the data mining techniques be such 
that you were looking at perhaps the worst abusers among the 
47?
    Mr. Kutz. Yes, and we were also looking for cases where the 
taxpayer had agreed to the assessment. In some cases, there is 
an unagreed-to assessment, but for all of the cases we looked 
at, the taxpayer had agreed that they owe the money.
    Senator Coleman. I find the figure stunning in the report 
saying that DOD could have collected over $100 million in back 
taxes this past year if payments had been levied. Are you 
confident you have not overstated the collection potential of 
these cases?
    Mr. Kutz. Yes, in fact, I would say we probably understated 
it to be conservative. When we did a mechanical match of just 
what we had, we actually came up with a little over $300 
million. But what we did was we assumed that certain cases 
would be collected in the normal course of business; some of 
these were not as delinquent as others. But we believe it is at 
least--that is why we said at least $100 million, to give an 
order of magnitude here.
    Also, keep in mind, we only looked at 72 percent of the DOD 
database. And so, you are talking about another $50 billion or 
$60 billion of business that we did not look at. And then, with 
respect to the data quality, the taxpayer information, the only 
time we would get a match here would be is if the taxpayer 
identification numbers in IRS' database matched those in the 
DOD database. So in some cases, we probably have other 
situations where there was erroneous information where we did 
not get a match.
    Senator Coleman. And the key here to get the match is the 
taxpayer identification number.
    Mr. Kutz. Correct.
    Senator Coleman. If you have the match, you can follow up, 
and the IRS can follow up. If there is not a match, then, it is 
problematic. There is a provision in law that provides that if 
there is something wrong with the taxpayer information number 
that one can withhold up to 28 percent of the contract?
    Mr. Kutz. Backup withholding; that is correct.
    Senator Coleman. So those provisions are in law. We do not 
need to change that.
    Mr. Kutz. Correct.
    Senator Coleman. What can be done to increase the number of 
matches? Because that seems to be a critical element here.
    Mr. Kutz. Well, I think that there are several things. 
There is the contract registry, which is now a database that 
DOD manages that includes contractors from all over the 
government. The data in that database needs to be validated. 
That would be step one. And step two would be to make sure that 
data is interfaced with all of the government's payment 
systems, because the payment systems are the ones that are 
turned over to Treasury for the actual match.
    And I would say just one other thing: There needs to be 
human capital involved in this, too. This is not simply a 
mechanical exercise. There are going to have to be people 
involved to make sure that once someone starts getting levied, 
they are going to figure out a way to get a new taxpayer 
identification number or change it so that they do not get 
levied anymore.
    Senator Coleman. The key, again, though, is to get the data 
flowing into the system. Am I correct in understanding that as 
we sit here today, less than half of DOD contractor data 
regarding taxpayer identification numbers is flowing into the 
system? I mean, one of their management systems, which is close 
to 50 percent, is flowing into the Financial Management 
Service.
    Mr. Kutz. That is correct; it is called the MOCAS system, 
which is for the large contract payments for multiyear weapons 
systems.
    Senator Coleman. But over half as we sit here today is not 
flowing into this system.
    Mr. Kutz. Nearly $100 billion is not being--yes.
    Senator Coleman. What I find so stunning here, reflecting 
on your testimony, Mr. Sebastian, is we have the greatest 
fighting force in the world. We have the most powerful, the 
most advanced, the most technologically savvy fighting force in 
the world, and thank God we do. We respect and we support and 
we hold up as a great example our great military capability.
    And yet, as I am listening to your testimony that says we 
have record systems that do not work. We have got information 
not being compiled. And I am very perplexed by all of that. And 
again, when you provided your testimony about processing delays 
and inaccurate records, we are just talking about the 47 cases 
here; is that correct, that you looked at?
    Mr. Sebastian. The examples that I spoke of in my oral 
statement came out of the 47 cases.
    Senator Coleman. So we have still got 27,053, at least, 
contractors who we have not even looked at the problems there.
    Mr. Sebastian. Yes, I would also point out that some of 
these issues are not new to us. In the course of conducting the 
annual audit of IRS' financial statements, we have identified 
issues such as inaccuracies in taxpayer records, delays in 
processing activities such as offers and installment 
agreements. So these are not new issues. We are not too 
surprised to see some of this in the 47 cases we looked at.
    Senator Coleman. One of the keys here is to get the Federal 
Payment Levy Program moving right away; in other words, if you 
identify a problem, you levy; you start to levy up to 15 
percent. And then, you can work it out. The IRS can work things 
out. But you have got to initiate that as a first step. My 
understanding, as I review the report, that in these instances, 
it appeared that the levy was not the first step, that perhaps 
it was a last resort. Is that a correct reading of the report?
    Mr. Sebastian. Yes, that is correct. When we speak of the 
first step, we need to be cognizant of the fact that the first 
step could only take place after such time as IRS has followed 
its own statutory requirements to provide appropriate notice to 
the taxpayer, and gives the taxpayer the opportunity to appeal 
the assessment or come into the office to try to make a workout 
arrangement, such as an offer or an installment agreement.
    But short of that, the cases that we saw sitting in the 
holding tank or queue could have been subject to levy. Cases 
with the revenue officers could also have been subject to levy.
    Senator Coleman. Are there specific legislative changes 
that you believe have to be enacted to make sure that this 
system is working and is more accountable?
    Mr. Sebastian. Well, I think the only issue that creates 
some problem would be that IRS is also legally required to 
suspend any levy actions if a contractor were to come to the 
IRS to offer some type of payment arrangement, such as an offer 
to compromise on the tax debt or to enter into an installment 
agreement. At that time, IRS would have to discontinue any levy 
action they began.
    The intent there, ultimately, is that the taxpayer is 
trying to comply. The concern we have is that in the work we 
have done, not only on this job but in prior years, we have 
seen companies use this as a stall tactic: Enter into and then 
default on installment agreements on a number of occasions.
    So one possible alternative legislative area that might be 
pursued would be to take a look at that provision and see if 
there is some leeway such that the IRS could continue to levy 
during such time as these workout arrangements are underway and 
perhaps use the levy as the collecting mechanism for an offer 
in compromise or an installment agreement.
    Senator Coleman. But other than that, the system is there. 
Since 1996-97, we have got a system in place that provides for 
matching of taxpayer identification numbers, levy authority and 
an ability to be getting some payment back while you are 
involved in this process. The authority is there.
    Mr. Sebastian. Yes, short of the legal restrictions I 
noted, the delays or the lack of levy action on some of these 
accounts had been policy decisions up to this point.
    Senator Coleman. And, of course, no one is forced to take a 
government contract. You enter into a voluntary arrangement. So 
I presume, as part of that process, you could require--for 
instance, is there any question about getting taxpayer 
identification numbers? I believe that they are required for 
service contracts but not for supply contracts; is that 
correct?
    Mr. Ryan. That is correct, sir.
    Senator Coleman. But we could certainly, as a condition of 
signing the contract, require people to provide taxpayer 
identification numbers in any kind of contract.
    Mr. Sebastian. That would be true, especially if we could 
get the contractor, when they fill out in the central registry, 
to provide the correct and accurate information that could be 
checked with the IRS records.
    We have now gone to a system where all of the government 
contractors need to be registered in a central register. We 
need to expand possibly in that area so that all contractors 
can be checked, not just the DOD contractors but all 
contractors can be checked. It is important that we validate 
that information, because as Mr. Kutz says, we need to 
integrate that information into the pay systems. Because if the 
pay systems are going to provide the money to the contractors, 
it is a good means of identifying delinquent taxes.
    Senator Coleman. Again, the systems are in place since 
1997. I believe, Mr. Kutz, was it your testimony that prior to 
September 2002, nothing had been collected?
    Mr. Kutz. Mr. Sebastian said it, but that is correct. Prior 
to 2002, nothing had been done with DOD's contract systems.
    Senator Coleman. Thank you. Senator Levin.
    Senator Levin. Thank you, Mr. Chairman. Let me go to the 
notices, those levy notices. The IRS is required by law to send 
out a notice of levy, as I understand it, before it levies.
    Mr. Sebastian. That is correct.
    Senator Levin. Could it, in its delinquency notice, notify 
the delinquent taxpayer that it will be subject to a levy on 
any contract payments, so that there does not have to be a 
second notice sent out?
    Mr. Sebastian. In fact, there are multiple notices that go 
to the taxpayers; depending on whether you are a business or an 
individual, up to four separate notices would be issued.
    Senator Levin. Does the delinquency notice contain that 
statement, that your payment is going to be subject to a levy?
    Mr. Sebastian. I do not know if the first notice does. I 
know when we get to the second and third notices, there is a 
reference to a levy. And then, the notice of intent to levy is 
clearly----
    Senator Levin. Is there any reason why there has to be a 
notice of intent to levy if the taxpayer has already been 
notified that a future payment is subject to a levy? Is there 
any reason why there has to be an additional, separate notice?
    Mr. Sebastian. Other than legal requirements----
    Senator Levin. No, is there a legal requirement, is there 
something in the law that says that?
    Mr. Sebastian. Yes, the IRS is required to issue a notice 
of intent to levy and give the taxpayer an additional 30 days 
before the levy action occurs.
    Senator Levin. Could we legally, do you believe, if you can 
give us advice on this, give the notice of an intent to levy in 
the delinquency notice, so we do not have to send out another 
notice?
    Mr. Sebastian. That would certainly be a policy option that 
the Congress could consider.
    Senator Levin. Well, I think we ought to take a look, 
surely, at that one. I mean, it seems to me that is fair 
notice, if somebody is told you are delinquent, and if you 
dispute this, you can come in and talk to us. That seems to me 
to be sufficient notice of an intent to levy if, in a 
delinquency notice, the taxpayer is told, hey, if you do not 
come in and work this thing out, you are subject to a levy on 
your payments. It seems to me--and I do not want to start 
giving legal advice, because I never made much money as a 
lawyer--but in any event, I do think that we ought to at least 
check with our legal counsel on that in terms of any 
legislation. Because if we are the ones in our law that says 
there has to be a separate notice of intent, then, it seems to 
me we probably could avoid that additional third notice by 
putting it right in the delinquency notice.
    If there is a proposal by the taxpayer to compromise, no 
matter how absurd the offer is, does that automatically stop a 
levy from occurring?
    Mr. Sebastian. No, if the IRS----
    Senator Levin. So it has to be a reasonable offer in the 
law?
    Mr. Sebastian. If, on the surface, it appears to be fairly 
reasonable, and the IRS accepts it for processing, it is only 
at that point in time that you would suspend the levy action.
    Senator Levin. All right. So, if the IRS determines it is 
an unreasonable offer, they can reject it?
    Mr. Sebastian. Yes, and they have the opportunity to reject 
at a later stage, once they have gone through the process of 
checking the financial records, the background of the 
individual.
    Senator Levin. All right. So, it is basically up to the IRS 
as to whether or not it stops the levy from occurring, because 
they are the ones who decide there is a good faith offer.
    Mr. Sebastian. Yes.
    Senator Levin. Well, that seems to me to be reasonable. I 
mean, providing an unreasonable offer or an offer that is 
rejected does not stop the levy from occurring.
    Mr. Sebastian. I believe the term they use is frivolous 
offer.
    Senator Levin. That sounds reasonable at that point.
    The IRS is going to tell us this morning, apparently, that 
the 2005 budget of the administration includes a proposal that 
will allow the IRS to deal quickly with frivolous settlement 
offers and requests for hearings. If that already exists, as 
you have just testified, what more needs to be done in that 
area?
    Mr. Sebastian. Well, it may go beyond just the point of an 
offer that appears frivolous on the surface. As you get in and 
actually begin to work with the taxpayer, requesting additional 
records to determine the validity, you may, at that point in 
time, find you are talking about a frivolous offer.
    The same with respect to installment agreements----
    Senator Levin. OK; stop there.
    Mr. Sebastian. Sure.
    Senator Levin. Under current practice or law, can they not 
at that point then say we are stopping these discussions; it is 
now frivolous; the levy is going to continue? Can they not do 
that now?
    Mr. Sebastian. At the point in time that they have 
determined that the offer is frivolous, yes, they could.
    Senator Levin. I am trying to figure out--I have not read 
the budget request, so I am not familiar with the exact 
language--but are you familiar with this request or proposal in 
the 2005 budget that will allow the IRS to deal more quickly 
with frivolous settlement offers? What more is needed that is 
not already in their power?
    Mr. Sebastian. Yes, I am familiar with the fact that it is 
in the proposal. I do not know to what extent it will 
effectively deal with the issue that we are talking about here.
    Senator Levin. Or that it is necessary.
    Mr. Sebastian. Or that it is necessary with respect to 
reviewing frivolous offers.
    Senator Levin. If you could give us a reaction to that 
proposal for the record,\1\ that would be helpful.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 4 that appears in the Appendix on page 177.
---------------------------------------------------------------------------
    Now, on this queue rule, apparently, a tax levy cannot be 
initiated for a year if one is waiting to be assigned to a 
revenue officer. Do I have that correctly?
    Mr. Sebastian. By IRS policy, that is correct. There is no 
legal requirement.
    Senator Levin. Right; by IRS policy. I understand that 
policy has now been eliminated, by the way. Is that your 
understanding?
    Mr. Sebastian. Our understanding is that has occurred very 
recently.
    Senator Levin. OK. Perhaps as a result of the initiative of 
this Subcommittee, or of your GAO report, apparently, fairly 
recently, there has been this step taken by the IRS. And 
whether there is a cause-effect or not is not the point. It is 
a good step forward, I gather, in your view.
    Mr. Sebastian. Yes.
    Senator Levin. There is no longer that automatic 
withholding of a levy because you are waiting in line to see a 
revenue officer.
    Mr. Sebastian. Yes. Bear in mind, too, that the cases that 
are sitting in the queue are not being touched by anyone. But 
what is occurring is that the statutory period for the IRS to 
collect those taxes continues to run. IRS has, in general, 10 
years from the time of the assessment to collect the taxes. 
After that point in time, the uncollected taxes come off the 
books.
    Senator Levin. On the queue, if there is a taxpayer who 
says look, I want to settle this, I want to do partial 
payments, or there is a dispute, and I want to resolve the 
dispute, if that person cannot see a revenue officer to discuss 
the settlement, why, then, should there be a levy? I want to 
now go at it from the opposite side, I want to go at it from 
the taxpayer's perspective. If there is an honest effort to 
make the payments or an honest effort to resolve a dispute, if 
that person is unable to talk to the IRS, why should he or she 
be levied on?
    Mr. Sebastian. Well, I believe if the taxpayer is coming 
forward with an attempt to try and make a workout arrangement, 
they will be able to contact the IRS. They have phone lines, 
customer service representatives that would assist them.
    Senator Levin. Well, then, what was the queue rule before 
it was eliminated?
    Mr. Sebastian. The case was not being worked by anyone, nor 
was the taxpayer coming forth and making any attempt to repay 
their tax debt.
    Senator Levin. You are assuring us, however, that if there 
is an effort being made under new policy with no queue rule, 
and a good faith effort is being made by the taxpayer to work 
out a problem that the levy will not occur.
    Mr. Sebastian. I am fairly certain of that.
    Senator Levin. OK. One last question, if I am not out of 
time, and that is were you surprised, Mr. Kutz, by the extent 
of the problem that you uncovered, by the 27,000 figure? Did 
that surprise you?
    Mr. Kutz. Not necessarily. Mr. Sebastian and I testified on 
this several years ago, looking at all of unpaid payroll taxes, 
and we saw significant evidence there that there were 
government contractors that were involved in this. So it is not 
that surprising to us that this has happened.
    Senator Levin. Thank you. Thank you, Mr. Chairman.
    Senator Coleman. Thank you. Chairman Collins.
    Chairman Collins. Thank you, Mr. Chairman.
    Mr. Ryan, back in 2001, you and I worked together on an 
important investigation where we examined the security of the 
transportation of missiles and ammunition--Mr. Kutz was 
involved also--to storage sites by the Department of Defense. 
As part of that investigation, we concluded that there were 
serious security lapses and vulnerabilities of missiles that 
were held at contractor facilities.
    Today, you have identified contractors that not only abuse 
the Federal tax system but are also involved in other ``crimes 
of integrity''. I am concerned that in addition to the problem 
of tax-dodging that some of these companies may represent a 
security threat. If they are not paying their taxes, and you 
have found kinds of diversions and evidence of possible crimes, 
this raises serious questions in my mind.
    I have two questions for you: First of all, did the 47 
contractors whom you did in depth investigations of perform 
work on weapons systems or on military bases? And second, based 
on what you saw about the possible criminal activity and the 
lack of integrity of these contractors, do you think we are 
dealing also with a potential security risk in addition to tax 
evasion?
    Mr. Ryan. Thank you, Senator. It was good working with you 
back then.
    In this particular case, we did find that there were, in 
the 12 particular contractors that we jumped into, we tried to 
pull back all the layers. Some of the things or questionable 
actions, from the background work that we did, we found that 
there were, with these 12 contractors, product substitution 
problems, false statements to Federal agents, money laundering, 
submitting false statements to insurance companies, paying 
employees in cash to avoid payroll taxes, establishing shell 
companies to avoid the IRS getting hold of any government 
payments, the issuing of payroll checks to their employees 
where the accounts were closed.
    All of these issues add up to, as you say, crimes, I call, 
of integrity, based on my experience. When we talk about the 
security of our military installations, we spend an awful lot 
of time talking about ensuring who it is that is coming into 
the facilities. Just short of the biometric system, we have to 
try to establish something. There has to be some kind of a risk 
analysis done.
    We obviously do not want embarrassing situations at our 
military installations. We do not want government contractors 
coming in and conducting criminal activities on military 
installations and buildings. So I think it is absolutely 
necessary that we do something to ensure that the contractors 
that we are bringing into our installations and to our 
buildings, that security has to be put in place. There has to 
be backgrounds. There has to be determined what the minimum 
standard is, and then, based on the exposure of those type of 
contractors to the facility, that needs to rise. There needs to 
be a gradual increase.
    Mr. Kutz. Some of these contracts were also dealing with 
weapons programs, major weapons programs.
    Chairman Collins. That is what concerns me. Is there any 
evidence that these bad actors, and they certainly appear to be 
bad actors, were referred by Federal contracting officials for 
possible debarment or suspension? In other words, did you come 
across any indications that Federal procurement officials were 
taking a look at the question of whether these companies should 
even be doing business with the Federal Government in the first 
place?
    Mr. Kutz. There was no evidence of that. In fact, there is 
a concern that they do not really know who they are dealing 
with here. In one of the cases that the individual basically 
stole the money and went to the Caribbean, the business was 
turned over to a relative of that individual, and the 
Department, I think, still thought it was doing business with 
the person who was gone to the Caribbean. That is where the 
payments were being made to.
    Chairman Collins. It is extraordinary to me that Federal 
contracting officials are not looking at tax delinquencies when 
they are making responsibility determinations, when they are 
determining whether or not a company is a responsible bidder. 
We are supposed to have safeguards in our procurement laws to 
ensure that the Federal Government is only doing business with 
companies that demonstrate ethics and a certain level of 
business integrity. And I am at a loss to see how that is the 
case with the contracts that you investigated.
    But you have found no evidence that Federal procurement 
officials were even looking at this evidence?
    Mr. Kutz. No.
    Mr. Ryan. No.
    Chairman Collins. In the year 2000, the GAO testified in 
support of legislation that would have amended the Debt 
Collection Improvement Act to prohibit delinquent Federal 
debtors, including Federal taxpayers, from being eligible to 
contract with Federal agencies. Mr. Kutz, could you tell me if 
that is still GAO's position? Would you like to see legislation 
that would prohibit a company that has a serious tax 
delinquency from being eligible to do business with the Federal 
Government?
    Mr. Kutz. As we noted back in 2000, it is a valid policy 
consideration for the Congress to look at, and it is something 
that--there are some implementation issues, such as data 
reliability; how quickly you can actually get a response from 
the IRS as to whether someone has tax debt. For example, if it 
would take 2 or 3 weeks, you would slow down the procurement 
process. If you could get one-day turnaround, it might be 
something feasible.
    So at that point in time, there were serious implementation 
issues related to automated systems that still exist today, to 
some extent. But from a policy perspective, that is something 
that could be very well considered, like it was back then.
    Chairman Collins. It occurs to me that companies that are 
failing to remit their payroll taxes can enjoy lower labor 
costs. And ironically, that gives these scofflaws a competitive 
advantage in bidding on Federal contracts. If you are a company 
that remits your fair share of Social Security and Medicare 
taxes to the Federal Government as well as the employee's 
share, your costs are about 15 percent higher.
    If you are a company that is not remitting these payroll 
taxes, you are able to show lower labor costs. Do you think 
that is an issue as well, Mr. Kutz?
    Mr. Kutz. Absolutely, and Mr. Ryan has a case that he can 
mention to you. But it gives you a 15.3 percent advantage on 
your wage base, and almost all the 47 that we looked at are 
wage-based-type companies providing services. So that is a 
substantial difference. Plus, many of these contractors were 
not paying their income taxes. So, on top of the payroll taxes, 
the income taxes give you a substantial advantage. And I think 
Mr. Ryan's case is quite interesting.
    Chairman Collins. Mr. Ryan.
    Mr. Ryan. Yes, Senator, I met a retired contractor who is 
not part of this job; I just met a retired contractor; we were 
talking. And he was explaining to me that several years ago, he 
bid on government contracts. He paid his employees; paid his 
payroll taxes; and was taking care of his State 
responsibilities. And what he was finding was that other 
contractors were coming in, fly-by-nights, getting government 
contracts, staying in existence for a short period of time, 
doing away with that company, changing the name.
    In one case, he said that they had magnetic signs that they 
put on the truck. And when the contract was done, they would 
take it off and put another one on. And they were able to get 
away, because no one ever followed up. They got a new EIN, and 
they just kept bidding on government contracts.
    Mr. Kutz. In 1999, we found that individuals were doing 
this with dozens of companies. We had some individuals that 
were involved in 40 or more companies that would run another 
into the ground; start them up; run them into the ground. And 
so, this is something that is an issue out there.
    Chairman Collins. Thank you very much. Thank you, Mr. 
Chairman.
    Senator Coleman. Thank you. Senator Lautenberg.
    Senator Lautenberg. Thanks, Mr. Chairman. I must say our 
friends at the witness table offered some pretty interesting 
testimony. Enough to kind of wonder what is happening with the 
review of a contractor's ability and who they are before these 
contracts are issued. It sounds like it is kind of a 
conspiratorial thing to find these systems that permit you to 
go ahead, get a contract and get out of town.
    And I think one of the worst violations of all is to not 
remit the employee withholding. It is employee money that they 
are stealing. They are stealing from the government, but they 
are also stealing from those employees, who should have those 
amounts credited to their Social Security and so forth.
    I noticed your report said what GAO recommends--and thank 
you for this excellent report. Now, it says embargoed. I assume 
that embargo is off now that it is in the record.
    Mr. Kutz. Right.
    Senator Lautenberg. Now, it says GAO makes recommendations 
to DOD for complying with statutory guidance supporting IRS 
efforts in collecting unpaid taxes. It was recommended to the 
office of OMB to develop options for prohibiting Federal 
contract awards to businesses and individuals that abuse the 
Federal tax system. DOD and IRS partially agreed. OMB did not 
agree that we ought to be able to punish these contractors who 
have showed this kind of an attitude about their obligations to 
the country and to their fellow citizens.
    What happened, by the way, to the guy who built the 
Caribbean home? Is he living there peacefully, or did we find a 
better place for him to live? [Laughter.]
    Mr. Ryan. Well, actually, he is still there, and, as a 
matter of fact, one of the agents who worked on this, Kenny 
Hill, actually sent him an email, and he got a reply back. We 
told him what we wanted, and after that, he decided not to 
email us back anymore.
    Senator Lautenberg. Is he out of reach?
    Mr. Ryan. In the Caribbean, he is, yes.
    Senator Lautenberg. We need an extradition treaty with that 
country.
    Mr. Kutz. Senator, can I make one point on one of the 
things that you said? You talked about the employees and 
whether they are made whole. I just wanted to make the point: 
The way the system works is that the employees are made whole--
--
    Senator Lautenberg. I figured that.
    Mr. Kutz [continuing]. For Social Security and withholding 
taxes. And the money comes from the general fund. So the 
taxpayers are paying for it.
    Senator Lautenberg. But the fund is deprived of the receipt 
of those taxes.
    Mr. Kutz. Right, and when we reported on this years ago, it 
is tens of billions of dollars over time that the Social 
Security fund has had to be subsidized by the general fund. So 
it is a substantial amount of money over time.
    Senator Lautenberg. Was there any evidence of a 
conspiratorial nature among some of these questionable 
contractors? Was there, perhaps, a connection how to deal with 
the government on these things, easy pickings, as they say?
    Mr. Ryan. I think of the contractors that we looked at, 
Senator, we did not uncover anything that would show a 
conspiracy, necessarily, between the contractor, the 
contracting officer, or the government representative. In one 
of the cases that my colleagues mentioned, about the gentleman 
who went to the Caribbean, he did have substantial contracts. 
He was taking the money out the back door and improving his 
lifestyle.
    At the same time, he was subcontracting his contract to 
family members, friends, or people who actually left the first 
company and went to the second one. And in response, he wanted 
a kickback. He wanted to get a substantial amount of money from 
these subcontractors to ensure that they would have the work. 
He wanted the money paid under the table and sent to offshore 
accounts.
    Mr. Kutz. In another case, what was happening is the 
company was paying the owner and the owner's wife's bills for 
them: The mortgage, credit card bills, and car payments. And 
so, this money was coming out of the company. The company was 
using it as a deduction, probably, and these people were not 
reporting it as income. And they were calling it a loan, but 
the money was never paid back. So there were other schemes.
    And, as Mr. Ryan said earlier, a lot of the companies, 
there was evidence they were paying their employees wages in 
cash, which means that you have unreported payroll taxes under 
the table, basically.
    Senator Lautenberg. It sounds like these problems are 
initiated at the time of contract issue, and the notion that we 
cannot even withhold payments to them for work that they 
purportedly did allows that--this sounds a little bit like a 
sad comedy about our inability, giving out these billions of 
dollars worth of contracts, that we cannot withhold money you 
owe us.
    Mr. Ryan, I want to ask you a question: I wonder if you 
could update us on the progress of a report that was requested 
by Members of Congress last April on the Defense Department 
contracts that were awarded to Halliburton over the past couple 
of years. What has happened with it, and can we expect it to be 
released for Congressional review?
    Mr. Ryan. I have no knowledge of that work. It is not 
within my investigative responsibilities.
    Mr. Kutz. GAO does have work underway in that area, but 
none of us are involved in that work at this point.
    Senator Lautenberg. I see.
    I was curious about whether or not some of the auditors 
found that--first of all, you were able to uncover this 
information. Why was this information not covered routinely by 
IRS or even DOD? There was a question asked before about DOD 
collecting taxes. Does DOD have that responsibility, tax 
collection?
    Mr. Kutz. Under the Debt Collection Improvement Act, their 
responsibility is to refer their payment systems to the 
Treasury Department for offset purposes before they make the 
payment, and any items that are tagged, they are supposed to 
withhold and remit the money back to the Treasury Department. 
So they do have that responsibility.
    Senator Lautenberg. So what is it? Have you found any 
obstructionism from the other members of government agencies 
that prevented the review of these cases?
    Mr. Kutz. I am not sure I understand the question.
    Senator Lautenberg. Well, I mean, has there been any 
evidence that these investigations were stopped, blocked in any 
way, as a result of friends in government or anything?
    Mr. Kutz. No, there is no evidence of that. But there is 
evidence that these companies are doing significant business 
with other Federal agencies, like NASA, the Department of 
Energy, HHS, etc. So they are doing significant business with 
others.
    Senator Lautenberg. Well, the reason I asked that question, 
forgive me, is the Army Corps of Engineers waived an auditor's 
demand for information data from Halliburton and shut off an 
audit review because DOD's own auditing agency found that 
Halliburton has both failed to conduct adequate subcontracting 
price evaluations and had also overcharged U.S. taxpayers $61 
million. This was public information, for the importation of 
fuel to Iraq.
    Subsequently, the Army Corps waived the auditors' demands 
for more information and data from Halliburton, effectively 
shut off the audit. Is that a familiar----
    Mr. Kutz. No.
    Senator Lautenberg [continuing]. Case to any of you?
    Mr. Kutz. We are not familiar with that.
    Mr. Ryan. No.
    Senator Lautenberg. That is why I asked the question about 
whether or not there was any attempt by one part of a 
government agency to say look, this is not really that 
important, and let us forget about it.
    Mr. Kutz. But let me say something else, though: With the 
47 case studies we had, these are potential felonies, as I 
mentioned in the opening statement, as we talked about earlier. 
There was no evidence that any of these 47 were being pursued 
for prosecution under those laws that applied on failure to 
withhold and pay payroll taxes.
    Senator Lautenberg. That is pretty astounding information, 
that they rest in comfort at the expense of the taxpayers and 
the country.
    Senator Coleman. Senator Lautenberg, I would note that your 
time has expired.
    Senator Lautenberg. I am sorry. Thank you.
    Senator Coleman. Senator Fitzgerald.

            OPENING STATEMENT OF SENATOR FITZGERALD

    Senator Fitzgerald. Thank you, Mr. Chairman.
    Mr. Chairman, if I could have unanimous consent to submit 
my opening statement for the record, I would appreciate that.
    Senator Coleman. Without objection.
    [The prepared opening statement of Senator Fitzgerald 
follows:]
            PREPARED OPENING STATEMENT OF SENATOR FITZGERALD
    Good morning. I want to join my colleagues in welcoming the 
distinguished witnesses who are present today.
    I would like to thank Chairman Coleman for holding this important 
hearing on Department of Defense contractors who are not paying taxes 
owed to the Federal Government.
    The spending at the Department of Defense accounts for nearly a 
fifth of the Federal Government's annual budget. According to the U.S. 
General Accounting Office, over $183 billion was disbursed to 
contractors of the Department of Defense through 16 different payment 
systems in fiscal year 2002. At the same time, 27,1000 Department of 
Defense contractors owed nearly $3 billion in unpaid taxes. And it's 
not just the large contractors who are evading taxes, it's also the 
small contractors like the dentist and the caterer. The lack of 
controls that allowed such payments to be made without first deducting 
delinquent axes is astounding.
    The efforts of the Department of Defense to refer contractors to 
the Financial Management Service (FMS) at the Department of the 
Treasury as required by the Debt Collection Improvement Act of 1996 are 
obviously inadequate. Only one payment system out of 16 separate DOD 
payment systems is set up to refer payment information to FMS to offset 
contractor payments. And in numerous cases--4,900 cases--DOD 
contractors provided invalid taxpayer identification numbers, which 
were not validated before payment was made. For one of the Federal 
Government's largest agencies to make billions of dollars in payments 
and not verify taxpayer identification numbers when the resources are 
right there is beyond me. What is more appalling is the fat that some 
of these unpaid taxes are payroll taxes deducted from employees' 
paychecks, but never remitted to the government.
    It is the obligation of all persons, businesses and organizations 
in the U.S. that earn non-exempt income to pay their Federal taxes, 
particularly if those taxes have been withheld from an employee's 
wages. When hardworking Americans comply with this requirement while 
others blatantly fail to do so, there is an injustice and a breakdown 
of the system. And when there is a failure to pay taxes, it is theft--
from the Federal Government and from the hardworking taxpayers in 
America.
    The Federal tax system is based on voluntary compliance and the 
IRS, though fearsome in its reputation, is essentially a very large, 
and not very efficient, collection agency. although the Treasury's 
Financial Management Service runs the Treasury Offset Program, which 
matches IRS tax debtors with Federal payees to identify payments that 
can be levied, much more needs to be done--by both the Department of 
Defense and Treasury.
    I look forward to hearing from our witnesses from GAO today 
regarding their review of Department of Defense contractors' compliance 
with tax laws, including the scope of their investigation, their 
findings, and their recommendations on tightening the system. 
Additionally, I look forward to hearing from our witnesses from the 
Internal Revenue Service, Financial Management Service and the 
Department of Defense about their operations, the Treasury Offset 
Program and the referral of the DOD payment systems to Treasury.
    As Members of Congress, we fail to act as stewards of taxpayer 
money if we allow these contractors to dodge taxes with impunity.
    Again, I thank the witnesses for appearing today, and I look 
forward to hearing their testimony. Thank you, Mr. Chairman.

    Senator Fitzgerald. And thank you, gentlemen, for being 
with us today.
    I imagine this is far more pervasive than just the problem 
with the Defense Department. And I think you did a report back 
in April 2000 talking about how the same sort of thing is 
happening with government contracts from all agencies of the 
Federal Government.
    Are we talking, in general, about contracts that are so 
small they are not subject to our competitive bidding or our 
procurement law?
    Mr. Kutz. No, they are not that small generally.
    Senator Fitzgerald. They are ones that may have been 
competitively bid?
    Mr. Kutz. Right; most of those smaller ones would be used--
the purchase card would actually be used to procure those. 
These were not purchase card disbursements. These were 
competitively-bid contracts generally.
    Senator Fitzgerald. OK, competitively-bid contracts. We 
have a huge procurement code that walks through what you have 
to do for a competitive bid process, but it seems to me we are 
really not checking to see that those who are bidding are even 
true companies. You talk about fly-by-night companies that 
somebody maybe just opened up a week before they go in to get 
this government contract, and all of a sudden, they are in 
business. Then, when they get their payment, they take the 
magnetic sign off their van, and they are in some other 
business.
    This is really pretty astonishing, the lack of controls 
over who is qualifying for these government contracts. Is that 
not an area, a fundamental threshold area, that we need to 
address?
    Mr. Kutz. We did not look at that systematically, but there 
was very little evidence that the Department's contracting 
officers and contract community really knew who they were 
dealing with, as you mentioned. Again, we would have to look at 
that more systematically, but there are supposed to be 
processes and controls in place to make sure these contractors 
are reputable before we do business with them, but for these 47 
cases, they were not there, and they were not working.
    Senator Fitzgerald. They were not there, and you saw ones 
who really were not legitimate businesses, is basically what 
you are saying.
    Mr. Kutz. Well, they were not paying their taxes in all 47 
cases, and, as Mr. Ryan said, many of them were involved in 
these other crimes: Embezzlement, money laundering, forgery, 
grand theft, etc. So there were some serious background issues 
with many of these contractors.
    Senator Fitzgerald. So it looks like there had been no 
investigation, no background check at all on the part of the 
DOD before they did business with these entities.
    Mr. Kutz. If there was, it would have not picked--it did 
not pick these things up, or no one did anything about it. So 
again, we did not look at that process, but we saw no evidence 
that anyone had raised any questions.
    Senator Fitzgerald. Well, it would seem to me that if we 
required them to do a criminal background check, required them 
to check to make sure their taxes were paid, required them to 
have been in business for a certain period of time and have a 
corporation in good standing--although I suppose some of 
these--are unincorporated sole proprietorships----
    Mr. Kutz. Correct, some of them were.
    Senator Fitzgerald. But we could put some requirements in 
the law before they could even enter into a contract with the 
company, could we not?
    Mr. Kutz. Yes, we could. And I think there are some 
policies in place from a governmentwide perspective, but again, 
we did not see that they were necessarily working. I mean, 
these contractors could have been debarred if someone had been 
aware of what they were doing. So for some reason, they were 
not aware what they were doing, or they were aware, and they 
did nothing about it.
    Senator Fitzgerald. There is no requirement that DOD do a 
criminal background check on a prospective contractor. Is that 
correct?
    Mr. Ryan. I do not know, Senator.
    Senator Fitzgerald. Is there a requirement that they check 
to make sure they do not have delinquent taxes?
    Mr. Kutz. No, not that I am aware of.
    Mr. Ryan. No.
    Senator Fitzgerald. No. Well, we could put those into the 
law before they could enter into a contract with companies. And 
it seems to me that some of these companies may be winning the 
competitive bidding, as a couple of the other Senators said, 
because they are not paying their employees' payroll taxes. 
They are paying their employees, perhaps, under the table and 
so forth. They have less overhead expense than a legitimate 
company that plays by the rules and funds its payroll taxes.
    Were any of these 47 cases referred to prosecutors?
    Mr. Ryan. We referred them back to the agency, for the 
agency to decide what they want to do with them. I think we 
developed enough evidence to indicate that the case should be 
reopened. I think you will have to ask the next panel as to 
what they decide to do with that information. We have made our 
full investigative files available to the agents of the IRS, 
and we will be glad to share the information with them and also 
continue to work with them.
    Mr. Kutz. We referred all 47, basically, for collection 
follow-up and several that Agent Ryan is talking about for 
criminal review.
    Senator Fitzgerald. I would think some high-profile 
prosecutions by U.S. Attorneys around the country of these bad 
actors would send a message out that might chill further 
criminal activity.
    Well, I appreciate your being here. You do agree that this 
is not just a DOD problem. This is no doubt going on with 
perhaps all our other agencies of government.
    Mr. Kutz. It would appear so. Just these contractors alone, 
the 47, had a lot of business with other government agencies.
    Senator Fitzgerald. So this is probably a governmentwide 
problem, and we are probably losing billions and billions of 
dollars in waste, and we are missing an easy opportunity to 
collect back taxes for the IRS.
    Mr. Kutz. I will note that for non-DOD agencies, the actual 
contractor offset of taxes has only yielded about $6 million in 
2003. For DOD, it was under $1 million. So even though DOD is 
two-thirds of the government's contracting, and the others are 
a third, the other program has not been much more successful 
than the DOD. So something is wrong with the entire levy 
program for payments to contractors--$7 million a year in 
collections. There is something very wrong with that.
    Senator Fitzgerald. Something is wrong.
    Well, Mr. Chairman, thank you very much, and gentlemen, 
thank you for your time.
    Senator Coleman. Thank you, Senator Fitzgerald. Senator 
Akaka.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman. I really 
appreciate your conducting today's hearing and for your 
leadership, Mr. Chairman, in shedding light on tax evasion by 
DOD contractors.
    Mr. Chairman, I have a statement that I would like to have 
placed in the record at this point.
    Senator Coleman. Without objection.
    [The prepared statement of Senator Akaka follows:]

              PREPARED OPENING STATEMENT OF SENATOR AKAKA

    Thank you Mr. Chairman. I appreciate your conducting today's 
hearing and for your leadership in shedding light on tax evasion by DoD 
contractors.
    At a time when this country faces an unprecedented projected budget 
deficit of $480 billion, this year, it is wrong that 27,000 contractors 
owe the government $3 billion in unpaid taxes.
    Americans incur a high cost as a result of the failure of 
government contractors to pay their taxes. The General Accounting 
Office report, which is the focus of today's hearing, found that well 
over half of the cases of abuse involved a failure to submit payroll 
taxes. This has resulted in a $1.2 billion funding shortfall to the 
U.S. Treasury, Medicare, Social Security, and federally funded State 
programs.
    As the Ranking Member of the Governmental Affairs Financial 
Management Subcommittee and the Armed Services Readiness Subcommittee, 
I believe GAO's findings raise serious concerns at a time when my 
constituents are calling for investigations into overcharges for Iraqi 
contracts and the debarment of those contractors who are guilty of 
misconduct.
    By law, government contractors must comply with ethical standards 
of conduct. Yet when contractors do break the law, they often continue 
to receive government contracts. A 2002 Project on Government Oversight 
report found that 16 of the top 43 federal contractors had been 
convicted of criminal violations. Only one had been suspended from 
receiving federal contracts.
    Surprisingly, federal law does not prevent contractors with unpaid 
taxes from receiving contracts. The rate of tax payment delinquency 
among federal contractors is almost double the rate among the general 
public. I am disappointed that the Administration chose to weaken 
ethical standards in the Federal Acquisition Regulation for contractors 
eligible to receive federal contracts.
    GAO's findings also go to the heart of existing management 
challenges at DoD, which for the past 12 years have been on GAO's High 
Risk list. Without addressing systemic problems in DoD's financial 
systems, we will continue to see such abuses.
    Shortcomings in DoD financial management systems are a decades-old 
problem. While these challenges are not exciting or easily understood, 
correcting them is vitally important. As we can see from the GAO 
report, billions of dollars are at stake. DoD's inability and 
unwillingness to track accurately tax levies has an impact on a variety 
of DoD functions and operations.
    I want to know why aren't DoD and IRS working together to share 
relevant information and aggressively pursuing tax evading contractors?
    Prior to today's hearing, DoD claimed that enabling all 20 of its 
pay systems to report payment information to the Treasury Offset 
Program (TOP) database, where it can be screened for discrepancies, 
presented too much of a hardship. This is unacceptable. Federal 
agencies are required to share this information under the Debt 
Collection Improvement Act of 1996.
    Mr. Chairman thank you again for holding this hearing. I look 
forward to learning from all of our witnesses on how we can prevent 
these abuses in the future.

    Senator Akaka. From what I have learned, I am completely 
shocked at what is happening in our country, especially when we 
think about how much tax revenue is not being collected. At a 
time our country faces an unprecedented projected budget 
deficit of $480 billion this year, 27,000 contractors owe the 
government $3 billion in unpaid taxes.
    As the Ranking Member of Governmental Affairs' Financial 
Management, the Budget, and the International Security 
Subcommittee and the Armed Service's Readiness and Management 
Support Subcommittee, and from working with Senator Fitzgerald, 
I believe GAO's findings raise serious concerns, especially 
when my constituents in Hawaii are calling for investigations 
into overcharges for Iraqi contracts and debarment of those 
contractors who are guilty of misconduct.
    And hearing from the Federal side here, I also wonder about 
what is happening to State taxes from these contractors.
    Mr. Kutz. We can assure you that just about all 47 of them 
were deadbeat State taxpayers, too. We saw that in just about 
every case, pretty much. When you saw Federal, it was State. So 
all the States are affected by this, also.
    Senator Akaka. So it is a huge problem that we are facing, 
and I am astonished that Federal law does not prevent 
contractors with unpaid taxes from receiving contracts. The 
rate of tax payment delinquency among Federal contractors is 
almost double the rate among the general public. I am 
disappointed that the administration chose to weaken ethical 
standards in the Federal Acquisition Regulations for 
contractors eligible to receive Federal contracts.
    And I have two questions, one difference that I cannot 
understand is that in his written statement, Deputy Under 
Secretary Lanzillotta states that DOD has collected $2.1 
million through the levy program, your report states that DOD 
has only collected $332,000 through the levy program. Can you 
clarify the discrepancy in these numbers?
    Mr. Sebastian. I have a possible explanation for you. The 
less than $700,000 that we are referring to has to do with the 
15 percent continuous levy authority. In the case of the other 
roughly $1.3 million that may be referred to in the Under 
Secretary's statement, that may be a direct one-time levy 
against that particular contractor's payments, meaning it is 
not systematic. The IRS and DOD working in tandem would have 
made the levy against that particular payment, and it may not 
have been capped at 15 percent. But it was a one-time levy. And 
there may have been a few situations like that that created the 
additional $1.3 or $1.4 million.
    Mr. Kutz. Right. The continuous levy would mean if 20 
payments were made to a contractor in a year, you would take 15 
percent of each and every payment versus a one-time hit outside 
of this program.
    Senator Akaka. In your written statement, you stated that 
improving DOD's ability to aid the IRS in its levy program may 
require legislative changes from Congress, and after hearing 
the comments that are made and responses and the questions 
here, this question becomes very important to us. Could you 
elaborate on what kind of legislation you think is necessary to 
deal with the kinds of problems we are facing?
    Mr. Kutz. There are several that have come up here. The 
first one is the bar, the legislative bar, as you mentioned in 
your statement a couple of minutes ago of not letting 
contractors do business with the government that have 
significant or severe unpaid tax problems. And that was a bill 
that was produced in the House, I guess, in 1999 and 2000. And 
it got through the Government Reform Committee, and then, it 
stalled at that point in time. So, certainly, the most severe 
type of legislative action would be the bar. And again, there 
are some implementation issues with that, but conceptually, 
that is a policy alternative.
    One other thing is sharing of information between DOD and 
IRS to validate the contractor information. There is some 
restriction. Now, this contractor database includes not only 
DOD contractors but other agency contractors. Right now, due to 
the disclosure rules, they are not able to share all of that 
information for validation purposes with the Internal Revenue 
Service to make sure we validate everyone in the contract 
system.
    And then, Mr. Sebastian spoke earlier about possibly some 
legislation in the levy area.
    Mr. Sebastian. Right. Such as taking a look at some of the 
restrictions in place with regard to a contractor that comes to 
the IRS in an attempt to make a payment arrangement through an 
offer or installment agreement; currently, the levy process 
would suspend over the period of time in which IRS is 
evaluating that proposal. And if the proposal is accepted, the 
contractor would be paying under those arrangements.
    One legislative change you could have, would be to ensure 
that the levy continues and may actually become a collecting 
mechanism for an agreed-to installment agreement or an offer in 
compromise. So you are guaranteed a stream of payments in the 
event you are dealing with a contractor who went into the 
arrangement knowing full-well they intended to default on the 
agreement.
    Senator Akaka. Mr. Chairman, it is obvious that this is a 
much larger problem than just in DOD, and we need to expand 
what we are doing to all Federal contractors and try to correct 
this for the benefit of our taxpayers.
    Thank you very much, Mr. Chairman.
    Senator Coleman. Thank you, Senator Akaka, and I assure you 
that we will continue down this path. Clearly, we have a rat's 
nest here, and my sense is that at least we have got folks in 
the system that a lot of good could happen, as it impacts not 
just DOD but other agencies; as it impacts local governments 
that depend on tax receipts; it may cut off other criminal 
activity. But the system has got to grab somebody, and 
obviously, that is not being done.
    Gentlemen, I want to thank you for your testimony. Your 
report was exemplary; your testimony compelling. The record 
will be held open for another 2 weeks if my colleagues have 
other questions for you, but I want to thank you for your 
testimony today.
    Mr. Sebastian. Thank you.
    Senator Coleman. I would now like to welcome our final 
panel of witnesses for this morning's hearing.
    We have a vote posted. I believe we have 12 minutes. I will 
begin the hearing, and hopefully, one of my colleagues will 
return and continue. If that does not happen, we will simply 
recess for a very short period.
    Our final panel, the Hon. Mark Everson, Commissioner of the 
Internal Revenue Service; Richard Gregg, the Commissioner of 
the Treasury Department's Financial Management Service; and 
finally, from the Department of Defense, Lawrence J. 
Lanzillotta, the Principal Deputy Under Secretary of Defense 
for the Comptroller.
    Mr. Everson, it is good to see you again. As you remember, 
in November, you testified before this Subcommittee regarding 
the IRS' response to abusive tax shelters that robbed the U.S. 
taxpayers of an estimated $85 billion over 6 years, according 
to GAO's study of abusive tax shelters. In that regard, I want 
to acknowledge and applaud the IRS' recent legislative 
proposals to curb abusive tax shelters, which would raise 
penalties to promoters and taxpayers alike. And I would also 
note before your testimony, and I know you have to testify 
other places, but I did note this morning, I appreciated the 
opportunity we had to visit yesterday and your commitment to 
followup and root out some of the abuses and particularly the 
cases that have come before us. I wanted to thank you for that.
    Mr. Everson. Thank you.
    Senator Coleman. Mr. Lanzillotta, I also want to welcome 
you back and look forward to hearing how you propose to levy 
your contractor payments where it is warranted. I thank all of 
you for your attendance this afternoon, and I look forward to 
hearing your reaction to the recent GAO examination of DOD 
contractors who are abusing the Federal tax system. And I am 
particularly interested in learning what corrective actions you 
would propose to ensure that DOD contractors pay the taxes that 
they owe the Federal Government.
    Before we begin, pursuant to Rule 6, all witnesses before 
this Subcommittee are required to be sworn. I would ask you to 
please stand and raise your right hand.
    [Witnesses sworn.]
    Senator Coleman. Thank you, gentlemen.
    We will be using a timing system. You are aware of this 
system: One minute before the red light comes on, you will see 
the lights go from green to yellow. If you can, then, limit 
your testimony to that period of time. Your written statement 
will be entered in its completeness in the record.
    Commissioner Everson, we will have you go first, followed 
by Commissioner Gregg and finally Mr. Lanzillotta. After we 
have heard all of the testimony, we will turn to questions.
    Commissioner Everson, you may proceed.

   TESTIMONY OF HON. MARK EVERSON,\1\ COMMISSIONER, INTERNAL 
        REVENUE SERVICE, U.S. DEPARTMENT OF THE TREASURY

    Mr. Everson. Mr. Chairman, Senator Fitzgerald, thank you 
for inviting me here today. I am particularly pleased to be 
here on February 12, President Lincoln's birthday. After all, 
he signed into law the first income tax and appointed the first 
Commissioner of Internal Revenue, and despite that fact, he 
remains one of our most popular and revered Presidents. 
[Laughter.]
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Everson appears in the Appendix 
on page 82.
---------------------------------------------------------------------------
    I welcome the opportunity to testify on the General 
Accounting Office's study of the need for strengthened 
government procedures and assuring that the Department of 
Defense contractors meet their Federal tax obligations. I want 
to say at the outset that we at the IRS agree with the major 
conclusions of the GAO study and believe that many improvements 
can be made to our own efforts in this area. A number of 
positive steps are already underway.
    Before turning to this subject, I want to say a few things 
about our goals at the IRS and tax collection in general. I 
have set three priorities for the IRS during my 5-year term as 
Commissioner. First, we must continue to improve service, 
making it easier for the taxpayer to understand and comply with 
the tax laws. Through focused implementation of the IRS 
Restructuring and Reform Act of 1998, the IRS has measurably 
improved service to taxpayers and practitioners. We are not 
backing away from this commitment to improve service.
    The second area of emphasis is information technology 
modernization. We have made a great deal of progress in 
increasing e-filing and providing information to taxpayers and 
practitioners online and other important gains in technology. 
But we have struggled to update our master files and improve 
our financial and other infrastructure systems. We are 
addressing these challenges on an ongoing basis and must 
modernize.
    The third area of focus, a core element of which is the 
subject of your hearing today--collections--is to strengthen 
the integrity of the Nation's tax system through enhanced 
enforcement activities. I know you are familiar with our 
enforcement efforts, and I remain appreciative of the 
Subcommittee's leadership in this area, including holding a 
hearing last fall on abusive tax shelters and their promotion 
by professional services firms.
    I strongly support your call for more stringent penalties 
for promoters who violate the law and very much appreciate the 
fact that you have called for augmenting resources at the IRS. 
As you know, the President recently transmitted the 2005 budget 
request to Congress. It calls for a 5 percent overall increase 
for the IRS, including a 10 percent boost to our enforcement 
activities. The President's budget addresses a number of areas 
about which the Subcommittee has concerns, including enhanced 
collections, combatting abusive tax shelters and confronting 
tax abuses within the tax-exempt sector. I hope I can count on 
your active support for this request.
    Turning to today's subject, let me reiterate what I said a 
moment ago: We largely agree with the GAO report. The GAO has 
made thoughtful observations about why the IRS has not levied 
taxes from many defense contractors. The GAO observed that the 
IRS had, ``a collection philosophy of continuing to work with 
businesses and individuals to achieve voluntary compliance 
rather than taking reliable enforcement actions such as levies 
of Federal contractor payments.''
    I agree with this assessment, which I believe reflects an 
overhang from the 1998 Reform Act. The GAO has also said that, 
``due to resource constraints, the IRS has established policies 
that either exclude or delay referral of a significant number 
of cases to the levy program.'' I largely, but do not entirely, 
agree with this view. I believe we are making progress on both 
of these concerns. We are giving greater emphasis to 
enforcement, which will address some of the reticence our 
employees have had to use the levy tool. And, as I just noted, 
we are seeking more resources to boost our activities for 
enforcement.
    This having been said, a central conflict remains between 
two competing public policy goals: Taxpayer rights, on the one 
hand, and the expectation that those who do business with the 
government have a clean bill of financial health, on the other. 
The Taxpayer Relief Act of 1997 expanded the collection 
authority of the government by allowing the IRS to continuously 
levy up to 15 percent of payments to contractors. But the IRS 
Restructuring and Reform Act of 1998 established new procedures 
which limited the prompt collection of monies due in order to 
protect taxpayer rights.
    In addition, I would note that certain privacy protections 
significantly limit the IRS' ability to share taxpayer 
information with other agencies for collection purposes. The 
chart over here shows the effects of these competing 
priorities. As GAO has noted, in 2002, there were about a 
quarter of a trillion dollars of monies owed to the government. 
This is all money owed to the government. And as GAO also said, 
it stays on the books of the government for 10 years.
    The pie wedges show that statutory and operational 
exclusions limit the amount that is available for the levy 
program. As examples, the statutory exclusions include the 
right of a taxpayer to appeal an IRS decision, which can delay 
the collection process for months or even years and prevents a 
matter from being considered for levy. This is also the case, 
for example, if there is already an installment agreement in 
place between the IRS and the taxpayer.
    As for operational, or as the GAO called it, policy 
exclusions, the IRS has excluded from the levy portfolio 
certain other categories of debt: Cases involving financial 
hardship to the taxpayer, where the taxpayer has died, and 
where the taxpayer is living in a designated disaster area, to 
mention a few.
    Responding to the GAO report and to the interests of the 
Subcommittee, we have already taken steps to reduce operational 
exclusions. Again, this is based on the 2002 audited data. As 
you can see on the chart, we are making available an additional 
$26 billion for potential levy through adjustment of certain 
exclusion criteria.
    These steps will take effect over the next few months, as 
we update the programming of our systems. We are also creating 
a joint task force with Treasury, Defense, and OMB to examine 
the contractor collection issue. By June of this year, the task 
force will make recommendations on short-term operational 
improvements, mid- and long-term operational changes and 
potential statutory proposals that could improve the collection 
of taxes from Federal contractors. The statutory limits on tax 
debt collection merit a public discussion about the conflict 
between the need for taxpayer rights versus the need to make 
sure that government vendors have a clean bill of financial 
health.
    Defense contractors do not have to do business with the 
government. It can be argued that contractors should be held to 
a higher standard.
    Again, I want to thank the GAO and the Subcommittee for 
focusing on the issue of collections from delinquent defense 
contractors. I am happy to take any questions.
    Senator Coleman. Thank you, Mr. Everson. If there is 
anything else in your full statement, we will make sure that it 
is entered into the record.
    Commissioner Gregg, I think what we might do here, as I am 
told the time is winding down on the time to vote, is I am 
going to recess this hearing very briefly. Senator Levin should 
be on his way back. But let me recess, hopefully, for not more 
than 10 minutes, and then, we will return with your testimony.
    [Recess.]
    Senator Levin [presiding]. The Subcommittee will be back in 
order, and we will call upon you, Mr. Gregg. The Chairman would 
like us to proceed, so please do so.

   TESTIMONY OF RICHARD L. GREGG,\1\ COMMISSIONER, FINANCIAL 
      MANAGEMENT SERVICE, U.S. DEPARTMENT OF THE TREASURY

    Mr. Gregg. Thank you, Senator.
---------------------------------------------------------------------------
    \1\ The prepared statementof Mr. Gregg with an attachment appears 
in the Appendix on page 92.
---------------------------------------------------------------------------
    Thank you for inviting me today to discuss the role of the 
Financial Management Service in collecting unpaid Federal taxes 
that are owed by DOD contractors. Treasury appreciates your 
focusing attention on government financial management issues.
    FMS is a Treasury bureau charged with broad financial 
management responsibilities, including disbursing payments, 
collecting revenue and maintaining the government's accounts. 
And I welcome the opportunity today to acquaint the 
Subcommittee with FMS' fourth business line, which is the 
collection of delinquent debts owed to the government, both 
non-tax and tax.
    The Debt Collection Improvement Act of 1996 is the 
principal law under which FMS collects non-tax debts owed to 
Federal agencies. Our collections are accomplished through two 
programs: The Treasury Offset Program, TOP, and cross-
servicing. I will just focus on TOP today.
    TOP is our largest collection program and is directly 
linked to payment disbursements. Through TOP, FMS reduces the 
amount of individuals' or businesses' Federal payments 
disbursed by Treasury and other agencies to satisfy delinquent 
debts. Types of payments include benefit payments paid on 
behalf of the Social Security Administration, Office of 
Personnel Management retirement payments, Federal income tax 
refund payments and payments to businesses, vendor payments, 
for goods and services provided to the Federal Government.
    A reduction or offset occurs if the name and taxpayer 
identifying number of a debtor included in the TOP database is 
matched against the name and the taxpayer identifying number of 
a Federal payment recipient. The TOP debtor information is 
supplied by the agencies to which the debts are owed.
    The recent GAO report notes that FMS also has a key role in 
the collection of Federal tax debts. In partnership with FMS, 
the IRS collects unpaid Federal income taxes through the 
continuous levy of certain Federal payments disbursed by FMS. 
Vendor, Federal employee salary, OPM retirement, and Social 
Security benefit payments are among those that are levied 
continuously at a rate of up to 15 percent until a debt is 
satisfied. This is accomplished through an automated process 
using the TOP system. If there is a match between the IRS tax 
debts and FMS payment records, IRS initiates a process by which 
the debtor is given a minimum of 30 days to make payment 
arrangements, appeal the proposed levy action, or apply for a 
hardship determination. The levy of a payment occurs only after 
IRS completes its due process notification and directs FMS to 
levy future payments. The Continuous Levy Program was 
authorized under the Taxpayer Relief Act of 1997.
    I spoke earlier of the link between TOP and payment 
disbursements. While Treasury is the primary disburser, with 85 
percent of the government's disbursements, nearly 1 billion 
payments a year, other agencies, including DOD and the U.S. 
Postal Service, have payment disbursement authority as well. 
These agencies, which disburse payments such as salary and 
vendor, began matching their payments against FMS' TOP debtor 
database in 2002.
    Individuals or businesses receiving these non-Treasury 
disbursed payments may also have their payments levied if they 
owe tax debts and would be afforded the same due process as 
those receiving a Treasury disbursed payment. Routinely, we 
work with our partner agencies on debt collection issues by 
providing information and making recommendations for enhanced 
collections. As an example, we have been working with DOD and 
IRS for some time on ways that are tailored to their specific 
needs to improve collections. In the case of DOD, the existing 
program is designed in such a way that their contractors may 
either have their payments offset, if they owe non-tax debts, 
or levied if they owe tax debts.
    At present, payments disbursed through two of DOD's 
contract pay systems are being matched against the TOP data for 
both offset and levy purposes. I have been advised that in the 
coming months, DOD expects to begin matching vendor payments it 
disburses through its remaining systems. For our part, FMS is 
working closely with DOD, and we are well-prepared to assume 
the additional work load.
    Mr. Chairman, Treasury views debt collection as an 
important financial management tool. Moreover, collecting money 
owed to the government is in close alignment with one of the 
governmentwide initiatives under the President's management 
agenda: Improved financial performance. Along these lines, you 
may be interested to know that the President's 2005 budget 
includes proposals to further improve the Federal Government's 
collection of delinquent debts. And one of these proposals 
would increase the continuous levy on Federal vendor payments 
from the current 15 percent to 100 percent.
    Unlike many Federal payments such as salary and retirement 
and benefit payments, vendor payments are not recurring, and, 
thus, fewer opportunities exist for collection. This levy 
increase would not affect the administrative processes already 
in place that give the debtor 30 days to make payment 
arrangements, appeal the levy action or apply for a hardship 
determination.
    We believe that devoting resources to debt collection is 
both wise and of enormous benefit to agencies in managing their 
budget accounts and producing accurate financial statements. As 
you can see from the chart attached to my statement, FMS' debt 
programs have resulted in the collection of more than $18 
billion since 1997. Our success can be attributed, in large 
part, to having the expertise and the infrastructure and 
cooperative working relationships with agencies to collect 
millions of dollars of outstanding debts.
    At the same time, we recognize that there are always ways 
to improve. For example, to help maximize the potential of the 
levy program, we are actively engaged with IRS in examining the 
feasibility of making two important improvements. First, we are 
discussing ways to increase the number of tax debts in TOP that 
can be actively collected following the completion of IRS due 
process notification, and, in fact, as the Commissioner pointed 
out, some of that has already occurred.
    Under this approach, IRS may consider ways to provide due 
process to delinquent taxpayers before, not after, the tax 
debts are transmitted to TOP. Presently, payments to DOD 
contractors, many of which are one-time, have already been 
disbursed by the time the due process is completed. Modifying 
the due process timing would ensure that the payments being 
disbursed to DOD contractors who are identified as delinquent 
tax debtors can be levied immediately. We welcome the 
opportunity to work with DOD and IRS to devise procedures that 
address this issue.
    Second, we are exploring with IRS ways to improve the 
accuracy of information pertaining to taxpayer identification 
numbers, names and addresses contained in DOD's central 
contractor registration database. IRS advises, however, that 
there may be legal impediments under current law concerning the 
circumstances under which TIN matching may be used by IRS, the 
information the IRS may disclose as a result of that matching, 
and to whom the information is disclosed.
    If--I repeat if--these important issues can be addressed, 
we would anticipate increased matches of the delinquent tax 
debts with vendor payments to those same debtors. Increased 
matches would very likely result in greater collections.
    Once more, I appreciate the opportunity to testify today 
and would be happy to answer questions.
    Senator Levin. Thank you, Mr. Gregg. Mr. Lanzillotta.

   TESTIMONY OF LAWRENCE J. LANZILLOTTA,\1\ PRINCIPAL UNDER 
      SECRETARY (COMPTROLLER), U.S. DEPARTMENT OF DEFENSE

    Mr. Lanzillotta. Thank you, Senator.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Lanzillotta appears in the 
Appendix on page 98.
---------------------------------------------------------------------------
    Mr. Chairman, Members of the Subcommittee, I am pleased to 
be here today to discuss the Department of Defense program for 
offsetting payments to commercial entities that either have tax 
or non-tax debts owed to the Federal Government. Even though 
the collection of Federal debts is not a primary mission of the 
Department of Defense, it is an important and inherent 
management responsibility.
    It is part of our DOD leadership's resolve to exercise 
strong stewardship over the taxpayers' dollars. We want to 
thank this Subcommittee and the General Accounting Office for 
focusing on how we can improve this component of our 
stewardship. The Department of Defense agrees with the four GAO 
report recommendations and has taken action to address the 
report findings.
    Since 1991, DOD has partnered with IRS to levy offset 
commercial payments to collect Federal debts through a manual 
process involving what we call paper levies. In July 2000, IRS, 
in conjunction with the Financial Management Service, FMS, 
started the Federal Payment Levy Program. This program provides 
for the collection of Federal debts through continuous levy on 
commercial payments.
    In 2001, DOD began working with FMS to participate in the 
program. In October 2002, DOD began providing its databases on 
pending commercial payments to FMS for matching against the 
Treasury Offset Program, TOP, database, which includes both 
Federal tax debt and non-tax debt. In December 2002, we began 
taking offsets.
    The Department currently provides a commercial payments 
database only for its largest commercial payment system, the 
Mechanized Contract Administrative Service, MOCAS, system, and 
does this once a week. As of January 31, 2004, DOD had 
collected about $2.1 million through offsets. This $2.1 million 
collection is far below what should be achieved. Increasing 
this performance requires changes not only within the 
Department but also changes in partnerships with other 
agencies, to include possible legislative changes.
    The primary challenge is to better identify, through 
automation, those DOD contractors whose payments should be 
offset because of their Federal debts. When DOD receives a 
notification that the contractor is indebted to the U.S. 
Government, and its payments are subject to levy, we have 
little trouble in executing prescribed offsets.
    DOD is advancing several actions and changes to improve the 
Federal levy performance. We are refining our procedures for 
Federal levies to ensure they are streamlined and efficient as 
possible. We have clarified with the IRS and Treasury that the 
Department's central point of contact for executing levies is 
the Defense Finance and Accounting Service, particularly the 
Commercial Payment Center in Columbus, Ohio. This will enable a 
single office to handle levies for all DOD commercial pay 
systems. Instead of once-a-week, the Department will twice 
weekly provide its database on MOCAS to FMS and evaluate 
whether we can even increase the frequency.
    Consistent with the GAO recommendation, the Department will 
continue to devote sufficient resources to implement all 
aspects of its formal plan to improve its levy performance. The 
Department is pursuing long-term changes. Some involve other 
agencies. We are expanding the DOD automated levy process 
beyond MOCAS to the rest of the Department's commercial pay 
systems. We have already included another pay system and will 
have the additional 18 pay systems that could be matched to the 
TOP database using the new automated system. We are currently 
working with Treasury to include these systems in the 
continuous offset program. This expanded automation should be 
completed no later than March 2005.
    We will have 90 percent of our payments completed by August 
2004, which includes all of the DFAS-owned systems, to match 
against the TOP database.
    This action meets the GAO recommendation that DOD develop a 
formal plan for providing payment information to TOP for all of 
its commercial pay systems. This full automation is the 
Department's main focus for improving its levy performance.
    When our input is automated, DOD has fewer problems 
offsetting payments for matched vendors once we receive an 
automated file from Treasury. However, the total dollars offset 
is only about 1 percent of the debts we receive from IRS. We 
recognize the automated process can be more effective and are 
working with Treasury and IRS to get the needed changes. With 
manual procedures, we are seldom successful because by the time 
we become informed of a match for a pending payment, we have 
disbursed the payments. Still, we are considering possible 
interim procedures to use until full automation is completed.
    The Department of Defense relies on the information in the 
Central Contract Registration Database for the commercial 
payments provided to FMS for matching with its TOP database. 
This information comes from the contractors themselves. If 
either the name or the taxpayer identification number, the TIN, 
provided by the contractor differs from the name or the TIN 
listed on the debt record, the TOP database will not identify 
that contractor for an offset or levy.
    We believe that increasing the accuracy of the CCR will 
increase the effectiveness of the TOP system's ability to 
identify many contractors with Federal debt. We are working 
with IRS and FMS on how best to validate or correct the TIN and 
the name of the commercial activity in the CCR database. The 
goal is to eliminate the CCR inaccuracies as an obstacle to 
better levy collections.
    There are legal limitations. In seeking to achieve more 
levies, the Department of Defense must stay within the 
framework and the limitations of the Federal law and will honor 
taxpayers' rights. For example, certain tax-related information 
cannot be released even between Federal agencies except in 
strict compliance with Federal law.
    The Department looks forward to working with the IRS, FMS 
and others in considering what legislative and legal changes 
might help achieve more successes for this program. In closing, 
I assure you that the Department of Defense will support the 
Federal Payment Levy Program. We have a good partnership with 
IRS and FMS, and I am sure that we will produce substantial 
results. I also want to assure this Subcommittee that the 
Department of Defense is continuing its broader challenge of 
transforming all of its business and financial management 
processes. We have made a strong start in our historical 
overhaul of DOD management processes and the information 
systems that support them.
    Once fully implemented, several years from now, our 
Business Management Modernization Program will consolidate and 
integrate our management information systems. It will enable 
the maximum permissible exchange of information that is key to 
ensuring all of our business management responsibilities.
    Thank you for this opportunity to explain how the 
Department of Defense is working to sustain sound management 
and strong stewardship of its public resources. Thank you, Mr. 
Chairman.
    Senator Coleman [presiding]. Thank you, Mr. Lanzillotta.
    A kind of micro-focus question: Here, in terms of the 
number of DOD payment systems, my notes indicate that Thomas 
Bloom, former Director of the Defense Finance and Accounting 
Service, told GAO auditors there were 16 DOD payment systems, 
and I think the report was based on that. The Director of 
Commercial Pay Systems told the investigative staff of the 
Permanent Subcommittee that there were 18 DOD payment systems, 
and I believe your testimony today talks about 20 DOD payment 
systems.
    Could you please tell me the correct number of DOD payment 
systems?
    Mr. Lanzillotta. Mr. Chairman, in this area, there are 20 
systems. Six are owned internally by DFAS; 14 are owned by 
other organizations such as the military services.
    Senator Coleman. OK. In listening to your testimony, it is 
clear that the solution to a lot of the problems lies in 
expanded automation. You have got to automate your systems; get 
them up to capacity. Apparently, we are talking about 90 
percent of the work will be done by 2004, but March 2005 is 
when you expect to have things in place?
    Mr. Lanzillotta. In August 2004, we expect to have 90 
percent of the dollar volume automated. It will take us until 
March 2005 to get that last 10 percent. But those last 10 
percent represent numerous systems that are small and are more 
challenging.
    Senator Coleman. Can you help me understand or the 
Subcommittee understand what happened? From 1996 to 1997, when 
the Financial Management Service system was put in place; 
Taxpayer Offset Program, all of that, up until today, you have 
got a long period of time. I understand that collections under 
the system did not really, in any kind of significant way, take 
place until 2002-2003. What happened in the interim?
    Mr. Lanzillotta. As I mentioned in my statement earlier, we 
have always done manual processes. But when we process 12 
million vouchers a year, these manual processes, because of the 
deliberative process, were not terribly effective. It was not 
until July 2000 that FMS and IRS gave us the ability to use 
automation. We were working as part of the development of those 
systems to ensure that we would be able to transmit data with 
FMS.
    In 2001, we started our own contractor debt system, which 
allowed us to pull from the MOCAS system the information that 
FMS would need. In 2002, it took us from 2001 to 2002 to 
perfect our system, run test data and test files, to where we 
could certify to the system that it was accurate and that we 
would not be making offsets or doing things that later we would 
regret.
    Senator Coleman. One of the keys to accuracy is having 
correct taxpayer identification numbers. Can you tell me what 
your plan is to ensure that you get correct taxpayer 
identification numbers prior to being paid?
    Mr. Lanzillotta. Right now, we are working with both FMS 
and IRS and hope to resolve this in the task force that was 
announced.
    In the Department of Defense currently, the TIN number is 
provided by the vendor on a voluntary basis. He just writes in 
the number that he has. We have no way to validate it until we 
get a readback from FMS as to what that is. There are 270,000 
contractors currently in the database. It only works 
effectively if we can do a bump and know where our mistakes 
are. Individual queries are somewhat time consuming.
    Senator Coleman. You say it is voluntary. Is there anything 
that would preclude you from requiring----
    Mr. Lanzillotta. I stand corrected, Mr. Chairman. It is not 
voluntary. In the case of service contracts, it is required by 
law.
    Senator Coleman. Services, but not goods, it is not 
required by law?
    Mr. Lanzillotta. There are some cases where the TIN numbers 
are not required by the vendor to put in.
    Senator Coleman. Is there anything that would preclude you 
from requiring, as a condition of getting a contract, in all 
contract cases, the submission of a TIN number?
    Mr. Lanzillotta. You know, this is kind of a question 
outside my expertise. It requires a procurement official. But a 
lot of these payments are what we call miscellaneous payments. 
They are payments to the credit cards, airlines, utilities, 
some agreements that we have, tariff agreements, where we just 
do things--they provide a service, and we just pay them, and a 
contract does not exist.
    Our goal would be to get TIN numbers for as much as we 
possibly could, because that is the key for us to be able to 
identify where the offset should be taken.
    Senator Coleman. One of the penalties for not providing 
taxpayer identification numbers is backup withholding, I 
believe about 28 percent. Do you know if you have implemented 
that?
    Mr. Lanzillotta. No, Mr. Chairman, we have not, but we 
will.
    Our problem that we are running into is when a vendor 
provides us a TIN, we do not know that it is a bad TIN until we 
bump it up against a payment, against the FMS. We do not know 
ahead of time. So we are having trouble ensuring that he has 
provided a valid TIN, because we have to make absolutely sure 
that when we hold up 28 percent of the payment that it is 
legally correct.
    Senator Coleman. I would strongly urge that you focus on 
what you need to do to make sure that you can evaluate whether 
somebody has a valid TIN, taxpayer identification number; and 
then, at that point in time, you can use the backup 
withholding. And when you said you will, when will you begin to 
use backup withholding?
    Mr. Lanzillotta. We have immediately told DFAS to make a 
plan for people who have not provided a TIN in areas where the 
law requires a TIN to implement the 28 percent. It will take 
us--I do not know exactly how much time--to work out with FMS 
and IRS the validation of the TINs, so we will know ahead of 
time that the TIN is wrong, and we can withhold the 28 percent.
    Senator Coleman. I turn to the commissioners, perhaps to 
supplement the response there. Can you give us a better sense 
of what kinds of things have to be done so that we can ensure 
that you have that kind of very basic information of a taxpayer 
identification number?
    Mr. Everson. I guess the one point I would emphasize is 
what I said before more generally that there are two 
conflicting sets of interests here. Generally, in this area, 
the protection of the taxpayer rights in terms of the 
procedures for due process that came in through RRA 1998 and 
some that we follow that we are reviewing, as we have already 
said, in terms of cleaning up some of these operational 
constraints. That is one set of conflicts with prompt 
collection.
    The other does relate to the absolute protection of 
taxpayer information, and there is a part of the Internal 
Revenue Code, that really protects information. Now, there is a 
carve-out here where we can share information on services, as 
Larry was just indicating. The carve-out relates to active 
contracts. This database is broader than that. It includes the 
registration of those who would wish to do business with the 
government, and that is not a carve-out that qualifies--the 
broader population does not qualify for the data sharing, nor 
does, as was indicated, goods that are purchased.
    So there is a whole series of issues here regarding 
taxpayer information that we need to get to, and I know some 
have suggested maybe people could waive their protections 
there, and then, we could address it that way. I think we need 
to focus on these issues over the next few months and figure 
out what the best way to jump on this problem so that we can 
automate the solution.
    As Larry said, and I agree, unless we automate it, we are 
not going to get anywhere. It is too cumbersome if it is all 
done by manpower.
    Senator Coleman. Commissioner Gregg, anything to add?
    Mr. Gregg. Yes, I think that the basic issue is if we could 
take a slice of the CCR and look at those that are active, but 
then, it gets down to--it is one thing for us to be able to 
identify that a TIN does not match, but what is necessary--and 
maybe legislation is necessary to give IRS the authority to 
provide the correct information to DOD, because it does not 
help very much if we just tell them that sorry, no match, and 
we cannot give them the information that is a valid TIN for 
that particular vendor. So that is something that I think IRS 
is looking at, but perhaps legislation is required. I am not 
sure.
    Senator Coleman. Please let us know if you think you need 
that authority, because certainly, we would be inclined to move 
in that direction.
    We are going to have a second round, but before my round is 
over, just to Commissioner Everson, in the 47 cases that were 
identified in the GAO report, can you tell us what your plans 
are with the folks involved in those cases?
    Mr. Everson. Certainly, I think you know, and Senator Levin 
knows, we worked very closely with this Subcommittee, on the 
followup of the hearings that you had in November, and I very 
much appreciate the materials that you have provided to us in 
connections with those matters that you were looking at.
    It is going to be the same thing here. We are going to take 
these 47 cases that happen to come from GAO. Our normal 
procedure would be that our business unit that handles these 
matters would look at them as a screen and then send potential 
cases into the Criminal Investigations Division, where they 
might take the case, investigate them.
    I am going to shortcut that process and ask our CI people 
to look at each and every one of these 47 cases to see what 
they think, in case they would conclude that they ought to look 
at some of them that maybe the business unit would not have 
looked at.
    Senator Coleman. Your CI people means criminal 
investigators?
    Mr. Everson. Criminal investigators, 1,811 law enforcement 
officials.
    Senator Coleman. Thank you very much, Commissioner. Senator 
Levin.
    Senator Levin. Thank you, Mr. Chairman, and thank you all 
for your testimony.
    The first question has to do with whether we should require 
that the Department of Defense contractors be paid up on their 
taxes or, at a minimum, be paid up on an installment agreement 
so that they not be on default on either their taxes or on an 
installment agreement. What is the Department of Defense's 
position on that? In other words, in order to get a new 
contract, you are not going to get a contract if you are in 
default on your taxes.
    Mr. Lanzillotta. In concept, Senator, I do not believe the 
Department would oppose that at all and would welcome the 
opportunity to have some legislative authority, because as it 
was mentioned before, it is not against the law to owe back 
taxes and still have a contract with the Federal Government.
    Senator Levin. It is not a matter of being against the law. 
The question is whether we ought to be giving a contract to 
people, paying them money when they owe us money. It is not a 
matter of whether it is a crime or illegal. It is a matter of 
just pure business common sense. No business would operate that 
way, and we are always told we should try to be more 
businesslike in our operations.
    So why would the Department of Defense, if we are owed 
money from a contractor on taxes, they are delinquent on taxes, 
or they are delinquent on an installment agreement, why would 
we be giving that contractor another contract?
    Mr. Lanzillotta. I completely agree with the concept, 
Senator, that we should require full payment or give us the 
ability to get full payment. But we will need some legislative 
authority to do that.
    Senator Levin. Will you recommend it?
    Mr. Lanzillotta. In concept, I certainly support it.
    Senator Levin. Would you let the Subcommittee know whether 
you would recommend it, that the Department ask the Secretary 
as to whether or not he and the Department would support it? I 
understand OMB opposes it. Do you know if that is true?
    Mr. Lanzillotta. Well, it happened in 2000, and so, 
everybody who was involved with that is not here to ask as to 
what were their reasons. I would have to get the provision and 
take it back and look at it. But in concept, we are looking at 
ourselves, and we looked at our database whether we could have 
a certification on the database as to whether somebody had paid 
their back taxes and make them certify, during registration, 
that they were not in arrears.
    We were told that legally, that is challenging to put that 
certification in there, that we did not have that authority, 
and then, if we did, in some cases, it would still be 
meaningless, because we would not have a way to back it up to 
see if they were lying to us or not. I think we need to look at 
it.
    Senator Levin. But false representation to get a contract 
is a pretty serious business under law. If you make a 
misrepresentation about a fact in order to get a Federal 
contract, you have got problems. And so, it is a real 
deterrent. It is a real weapon here to try to collect taxes.
    But rather than pursue it further, if you would get the 
Department's position on that issue, it would be helpful to us, 
because I think some of us, at least, want to seriously 
consider that kind of a requirement.
    Obviously, people can owe back taxes. A lot of times, that 
is going to be true. But if there is not an agreement to pay 
back taxes which is being complied with, if a contractor does 
not even have that, it seems to me that we should be mighty 
reluctant to give that contractor any additional contracts, 
unless there is some national security reason to do it. If that 
is the only contractor who is providing us with a substance 
that we cannot get anywhere else, I guess we have got to take 
our licks on that one. But other than that, I think we should 
be a lot more commonsensical about handing out taxpayer dollars 
to contractors who owe the IRS money.
    Mr. Lanzillotta. I will turn this over to Commissioner 
Everson. The Department does not know or does not have a list 
of vendors who owe back taxes. We only know when we submit a 
vendor payment against the database at that time.
    Senator Levin. You can require that the person represent 
that they do not owe back taxes before they get a contract.
    Mr. Lanzillotta. A certification-type process.
    Senator Levin. A certification process, yes.
    And just give us your position on a certification process. 
Commissioner Everson.
    Mr. Everson. Yes, thank you, Senator. I think this comes 
back to what I said is a conflict of two legitimate public 
policy interests. One is taxpayer rights, on the one hand, and 
the other is the desire of the government to have its vendors 
have a clean bill of financial health. We do have to be careful 
here, because there are instances where there are legitimate 
disputes between companies or individuals and the government. 
And they do take time to get resolved.
    So I do not think that I would be in a position to advocate 
that one side of this trumps the other, if you will. We need to 
improve, clearly, the sharing of information. We need to look 
at that so that judgment can be brought to bear into this 
discussion. But I would be reluctant to encourage a one-sided 
solution. It has got to be a balanced solution.
    As I indicated in the statement, we have agreed, this group 
plus OMB, has agreed to look at this, and I had a meeting with 
OMB on this subject earlier this week, and as they indicated, 
in the information that potential vendors bring to the 
government to be considered for a contract, information beyond 
that which is normally required between two contracting parties 
in the private sector is requested and then considered.
    I do believe that the administration can look at whether, 
in its procurement policies, additional changes can be made in 
that regard. But again, this involves more than just the 
procedural rights of taxpayers. You also get into privacy 
considerations, and there will need to be discussion as to 
whether statutory modifications are appropriate to have 
information sharing.
    Senator Levin. I do not see that there is any privacy issue 
in requiring that a potential contractor certify that he or she 
does not owe any withholding taxes. That is a certification 
issue.
    Mr. Everson. That is a procurement issue, that is exactly 
right.
    Senator Levin. That is not a privacy issue.
    Mr. Everson. But if you want to ping the IRS database to 
see whether that is correct or not, that is a different issue.
    Senator Levin. That may be a different issue.
    Mr. Everson. Right.
    Senator Levin. But just requiring the certification, now 
25,000 of the 27,000----
    Mr. Everson. Right.
    Senator Levin [continuing]. Cases are withholding issues. 
Those are usually not disputed issues. That is money which 
was----
    Mr. Everson. Just trying to be clear here.
    Senator Levin. No, I can understand that there can be 
legitimate disputes. I can understand that. And we have got 
major defense contractors who have very legitimate disputes 
over contract issues, including whether taxes are owed.
    Mr. Everson. Yes.
    Senator Levin. We can protect that legitimate right. But 
when 90 percent of your cases deal with withholding taxes, over 
which there is no dispute at all, it seems to me just requiring 
a certification which would subject somebody who falsely 
certifies it to a criminal action could provide a real 
deterrent, a real collection device for back taxes.
    When the 30-day levy notice is finally sent, when is the 
money actually withheld? Is it at the same time that notice is 
sent, or is it the end of the 30 days?
    Mr. Everson. I would defer to my colleague.
    Mr. Gregg. Yes, it depends on the type of payment. If it is 
a recurring payment for a non-levy----
    Senator Levin. The first one on a levy, when notice of a 
levy goes out.
    Mr. Gregg. And that depends on--what I said in my statement 
is that sometimes, because of the sending out the notice, the 
due process notice, we miss that first payment, because we get 
the information from DOD, and at that time, the payment may 
have to go out the door in 10 or 15 days, and by the time the 
due process notice goes out, the payment is out the door. So 
what we do is have our files ready for the subsequent payment.
    Senator Levin. But you do not wait for the 30 days.
    Mr. Gregg. No, we do not hold, or DOD does not hold 
payments up because of----
    Senator Levin. Until after the 30-day period is up.
    Mr. Gregg. No.
    Senator Levin. Mr. Lanzillotta.
    Mr. Lanzillotta. The due process has to take place before I 
can make a payment offset.
    Senator Levin. Are payments made during that 30-day 
process?
    Mr. Lanzillotta. If FMS or the IRS has not completed their 
process, and a payment is due, a payment is made, yes.
    Senator Levin. Well, my question is you are sent a notice, 
a 30-day notice, a so-called due process notice, that a levy is 
going to attach. My question is will payments be made during 
that 30-day period?
    Mr. Lanzillotta. Yes.
    Senator Levin. OK. So you have a situation here where this 
is the fourth step in a process, right? Frequently, there has 
been a year's wait while somebody is in a queue.
    Mr. Everson. But as you indicated, Senator, this chart 
here--I want to respond to a point you made earlier. You asked 
if some of this is in response to the Subcommittee's interest 
or the GAO's interest; very much so. We have already taken some 
actions here to improve just what you are talking about. If you 
look over on the left, this pink box, it has got what we call--
I have characterized it as operational exclusions. GAO said 
policy. Below that squiggly line are areas where we have 
already looked, and we are making changes. This queue issue is 
one of them.
    And we are going to do more to clean this up.
    Senator Levin. That is good news in terms of this queue, 
because that one seems fairly--I mean, I am glad you have 
cleaned that one up. It is pretty obvious that it needed to be 
cleaned up, and I commend you for it.
    My last question in this round, then, would be do you have 
officers, in the IRS, that are there full-time revenue officers 
that work in the Tax Levy Program?
    Mr. Everson. That is a good question. We have revenue 
officers, of course, but you are asking about the levy program 
for Federal contractors, per se, I think is the substance of 
what you are asking.
    Senator Levin. Right. That is correct.
    Mr. Everson. Yes, it is entirely automated is the answer, 
Senator. So I have seen your proposal on this, and all five of 
the points that you have made, I think that this task force 
that we have suggested we are going to put together ought to 
look at that, because expertise attaches to all kinds of 
elements of our responsibility, and collections, as you know, 
as we have discussed, we have drawn down our revenue officers 
by over 25 percent due to resource constraints in the last 6 or 
7 years. We are bringing that back up. The kind of thing we do 
need to consider is the expertise of revenue officers as we go 
forward, and we will in this task force.
    Senator Levin. I want to commend you for not just 
considering that but for fighting for resources for tax 
collection. We have got to turn this around. We cannot have 
these many uncollected taxes out there that just go by default 
because we do not have the resources to go after folks. There 
are a lot of areas where we need to go after them, and I 
appreciate your leadership and seeking the resources to do 
that.
    Mr. Everson. Thank you.
    Senator Coleman. Thank you, Senator Levin.
    Just to follow up on that comment, I share the concerns of 
Senator Levin, and I appreciate in our conversations, 
Commissioner, your intent to focus those resources, focus them 
on folks who are making a lot of money and should be paying 
their fair share, and they are not. And I think that the focus 
piece is also an important piece that the average taxpayer 
needs to understand and appreciate.
    Commissioner, Senator Levin in his questioning had raised 
the issue of a certification process, a taxpayer contractor 
certifying that they are not in violation of any taxpaying 
obligation. Do you know if any other agencies have a 
certification process?
    Mr. Everson. It is really a procurement question, Senator, 
and I am not sure that I know the answer to that. And again, 
from our point of view, it is not a consideration unless you 
cure this issue of the data sharing because of privacy. Then, 
it could play for us.
    Senator Coleman. And certainly, the Department of Defense 
is the 800-pound gorilla when it comes to contracting. Such a 
substantial percentage of Federal contracts are within that 
Department. But the testimony from earlier witnesses gave us 
the very clear understanding that these problems exist in other 
agencies.
    For Mr. Gregg, I would turn to you and raise the resource 
issue. For instance, just in these cases, we are talking about 
27,100 tax-delinquent contractors identified by the GAO, with 
the potential of there being many more throughout the Federal 
Government. Does the FMS have the resources to levy all 
contractor payments?
    Mr. Gregg. Yes, we do, Senator. We have a very highly 
automated system, and we are basically prepared to handle about 
anything--we have huge amounts of debt already in our database 
and resources, not that I say they are unlimited, but they are 
enough to handle this.
    Senator Coleman. That is very encouraging, Commissioner.
    At the present time, I believe, the Defense Finance and 
Accounting Service is sending one computer tape a week, and I 
think, Mr. Lanzillotta, you said that you were trying to 
increase that, to mechanize your MOCAS system payments, sending 
a tape once a week. Was the intent to increase, sending that 
tape twice a week?
    Mr. Lanzillotta. Yes, Mr. Chairman, what we are looking at 
now is what is the cycle time that we have right now on a tape, 
and we are going to go to two tapes a week with the hope of 
doing a continuous offset, where all the new contracts or new 
vouchers would just constantly be sent to FMS.
    Senator Coleman. And I guess, then, the same question to 
you, Commissioner: Is that a resource question? Are you 
prepared to begin accepting and processing more MOCAS tapes?
    Mr. Gregg. Yes, we are.
    Senator Coleman. OK; that is very helpful.
    I take it if taxpayer identification numbers in the Central 
Contractor Registry are validated, that will increase your 
ability to make matches for levy purposes?
    Mr. Gregg. If there is a way for IRS to validate and 
provide accurate information back to DOD, if there is a problem 
with one of the TINs, then, yes. And I think that is something 
that this task force can look at, to see how much flexibility 
they have there.
    Senator Coleman. OK; the last question I am going to have 
is the Department of Defense has its one major disbursement 
system now going through the FMS process, but apparently a 
large number of other systems are not. Is there anything that 
the IRS can do, working with the Defense Department to 
accelerate the process of getting these systems referred to the 
FMS?
    Mr. Lanzillotta. Mr. Chairman, we are accelerating the 
process. And this is a DOD thing that we have to do. By August, 
we hope to have 90 percent of our volume, no later than August, 
90 percent of our volume through the FMS system. The last 
systems, the remaining 10 percent, they represent a lot of 
smaller systems that we are just going to have to work on to 
ensure that no later than March 2005, we will have 100 percent 
of our vouchers being able to go through the FMS.
    Senator Coleman. Commissioner, perhaps on another occasion, 
we can have a broader discussion of the conflicting values 
issue that you raised, two important values: Taxpayer rights, 
and you have the value of trying to make sure that collections 
are done properly.
    Mr. Everson. Yes.
    Senator Coleman. Because taxpayers are impacted when 
collections are not collected properly, and I can see that 
here. But when payments are not made to Social Security, and to 
Medicare, taxpayers are paying for that.
    Mr. Everson. Yes, absolutely. I could not agree with you 
more. It is a very important subject. We need to run a balanced 
system that gives adequate consideration to both of those 
considerations.
    Senator Coleman. And as all of you gentlemen, I am sure, 
can tell by the reaction of my colleagues to this GAO report, 
there are a lot of concerns about the present state of affairs, 
a lot of concerns; certainly with DOD but beyond DOD, within 
the Federal Government. And I think it is quite obvious that we 
expect that those concerns will be addressed, that they be 
addressed expeditiously and that we do what we can to raise the 
level of confidence in the average taxpayer that they are 
paying their fair share, and they are not alone.
    So, with that, Senator Levin?
    Senator Levin. Thank you, Mr. Chairman.
    On this balance issue, I totally agree with you. One of the 
first things that I got involved in when I came to Washington, 
was a taxpayers' bill of rights.
    Mr. Everson. Yes.
    Senator Levin. As a matter of fact, that taxpayers' bill of 
rights came out of this Governmental Affairs Committee. Senator 
Pryor was involved; a number of other people were involved. It 
was a bipartisan effort, and it was very important, because 
there are abuses not just by taxpayers but by the IRS.
    Mr. Everson. Yes.
    Senator Levin. We do not want abuses on either side. But 
this issue, it seems to me and I think all of us, is an issue 
where we are handing out money. I mean, the Chairman is really 
focused on this aspect of it, and he is so right. I do not 
think this is the same thing as having a normal tax dispute 
about how much money does a taxpayer owe the government.
    We are handing out money to taxpayers. Ninety percent of 
the delinquent taxpayers here are people who have not paid 
their withholding, which I think is a crime.
    Mr. Everson. I agree with that entirely. The only 
cautionary note I am suggesting is that if you make things 
automatic, there are always exceptions, and I believe, however, 
the sharing of information that allows people to exercise 
judgment, that is where you get to a good answer.
    Senator Levin. I agree. You can get into areas where there 
are going to be disputes, but where you have got 25,000 of the 
27,000 are withholding issues----
    Mr. Everson. Yes, that is pretty clear cut.
    Senator Levin. Now, on the due process issue, if you send 
out a delinquency notice to somebody, that you are delinquent, 
can the IRS not give notice in that delinquency notice that you 
can be levied, in fact, any payment from the government to you 
can be levied for this delinquency unless you come in and work 
out something? Can't the levy due process notice be right in 
the delinquency notice?
    Mr. Everson. There are a series of steps that are in the 
laws from RRA 1998, and then, there are some other procedural 
things that the IRS does. And if you look at the whole time 
line--I considered doing a blow-up of this chart but declined 
to do it.
    Senator Levin. You took pity on us.
    Mr. Everson. Because you still could not see it. 
[Laughter.]
    The whole process and the dozen or more steps runs up to 
2\1/2\ years. Someone who has a potential problem of $5,000 at 
the end goes all the way through the process, and has sustained 
penalties and interest, might owe $30,000 but not until 2\1/2\ 
years later.
    Someone can keep this moving if they want to. Some of this 
is at our discretion. I am not suggesting it is all in RRA 
1998. And we have got to look at that. But some of the notices 
that we will send are actually very effective, because they do 
not require a great deal of investment of manpower, and they 
draw a certain response. So with the shortage of the revenue 
agents that we have had that we have all discussed, there has 
been more reliance on a bare-bones, automated system here.
    We need to attack that. As I have indicated, we have over 
1,000 collection personnel who will come in if the Congress 
provides the monies we have asked for. This can help us, and 
perhaps as we look at these procedures, we can, as we are doing 
here, improve our times. And then, we will also look at 
legislative remedies. I do believe the Congress is open to 
considering whether there need to be some modifications. I am 
not suggesting throwing out RRA 1998. I do not want to be 
misinterpreted at all on that. But perhaps there are some 
modifications in order. One was mentioned earlier about 
frivolous offers to settle something, where you say I will 
settle a $1 million debt with $1. That can keep the process 
alive and provide rights. That is not a good thing, obviously.
    So we have got to look at both internal procedures and, I 
suggest, perhaps, statutory changes.
    Senator Levin. So you will be giving us recommendations for 
statutory changes?
    Mr. Everson. What we have agreed is that the three 
organizations represented here and OMB are going to take a look 
at this whole set of issues, both what is out there 
operationally; which largely might be in my shop; might be at 
DOD; could be in FMS, although I doubt--I mean, they are really 
sort of--largely a conduit here, a processor; we are going to 
look at that, and we will look and see what statutory 
considerations or processes might be warranted.
    Senator Levin. What kind of time line is there for that 
review?
    Mr. Everson. We will do something by June. I think that 
gives us 3 or 4 months to look at it.
    Senator Levin. That is great.
    Mr. Lanzillotta, why are you delivering data to FMS only 
twice a week? Why not every day?
    Mr. Lanzillotta. Senator, that is the goal, but what we 
have to make sure we do is when we pay a voucher, we send it 
over to FMS. They have to process it and come back and tell us 
where the offset should take place.
    Senator Levin. But is this not all automated?
    Mr. Lanzillotta. It still takes about a day for us to send 
a file over to FMS; for them to bump the file and send it back 
to us.
    Senator Levin. I know that, but can the list not be sent 
over automatically every day instead of twice a week?
    Mr. Lanzillotta. We are trying to get to that point where 
we----
    Senator Levin. What is the problem, if it is automated, in 
getting to that point?
    Mr. Lanzillotta. Our systems. We have to redo the system a 
little bit, modify the system. Because what we do not want to 
do is get caught up where we have a transaction in transit 
somewhere, and we make a payment or fail to make a payment or 
collect twice or not collect at all.
    Senator Levin. Final question, then, would be whether or 
not you can share with us the DOD contractor list that you have 
imposed tax levies on?
    Mr. Lanzillotta. Senator, I can give you the same reference 
my fiscal lawyers gave me that says no.
    Senator Levin. And that is because of a privacy concern?
    Mr. Lanzillotta. That is because their interpretation of 
the statute says that we cannot release that information. I 
understand that there is some differing of opinion.
    Senator Levin. The question is this: Under Section 6103 of 
the Tax Code, you are not allowed access to confidential 
taxpayer information?
    Mr. Lanzillotta. Senator----
    Senator Levin. You have it. You have a list of contractors 
that are in default and that have been levied upon. So if you 
got that list, why can we not have that list?
    Mr. Lanzillotta. Senator, I am just going to have to----
    Senator Levin. Can you get us the legal opinion from your 
shop that says that you cannot share it with us? That is, would 
you get your lawyers to send a letter to the Subcommittee here 
explaining why it is that you can have it, despite Section 
6103, but we cannot? That is the question. I am not asking you 
for the answer today.
    Mr. Lanzillotta. Certainly, Senator.
    Senator Levin. Would you get that from your lawyer to the 
Subcommittee? \1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7 (question No. 1) which appears in the 
Appendix on page 192.
---------------------------------------------------------------------------
    Thank you, Mr. Chairman.
    Senator Coleman. Thank you very much, Senator Levin.
    Gentlemen, thank you for your testimony; again, to the GAO, 
thank you for your work.
    This hearing will be closed. The record, however, will be 
left open for 14 days.
    [Whereupon, at 12:15 p.m., the Subcommittee adjourned.]


                            A P P E N D I X

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