[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]




 
 2005 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2006

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

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 14, 2005

                               __________

                           Serial No. 109-32

                               __________

         Printed for the use of the Committee on Ways and Means


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                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

E. CLAY SHAW, JR., Florida           CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut        FORTNEY PETE STARK, California
WALLY HERGER, California             SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana               BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan                  JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. MCNULTY, New York
ROB PORTMAN, Ohio                    WILLIAM J. JEFFERSON, Louisiana
PHIL ENGLISH, Pennsylvania           JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona               XAVIER BECERRA, California
JERRY WELLER, Illinois               LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri           EARL POMEROY, North Dakota
RON LEWIS, Kentucky                  STEPHANIE TUBBS JONES, Ohio
MARK FOLEY, Florida                  MIKE THOMPSON, California
KEVIN BRADY, Texas                   JOHN B. LARSON, Connecticut
THOMAS M. REYNOLDS, New York         RAHM EMANUEL, Illinois
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana

                    Allison H. Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       SUBCOMMITTEE ON OVERSIGHT

                    JIM RAMSTAD, Minnesota, Chairman

ERIC CANTOR, Virginia                JOHN LEWIS, Georgia
BOB BEAUPREZ, Colorado               EARL POMEROY, North Dakota
THOMAS M. REYNOLDS, New York         MICHAEL R. MCNULTY, New York
JOHN LINDER, Georgia                 JOHN S. TANNER, Tennessee
E. CLAY SHAW, JR., Florida           CHARLES B. RANGEL, New York
SAM JOHNSON, Texas
ROB PORTMAN, Ohio

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            C O N T E N T S

                               __________

                                                                   Page

Advisories announcing the hearing................................     2

                               WITNESSES

Internal Revenue Service, Hon. Mark Everson, Commissioner........     6

                                 ______

Internal Revenue Service Oversight Board, Raymond Wagner, Chair..    58
U.S. Government Accountability Office, James R. White, Director, 
  Tax Issues.....................................................    30

                                 ______

American Bar Association, Kenneth Gideon.........................    67
American Institute of Certified Public Accountants, Thomas J. 
  Purcell, III...................................................    71
National Association of Enrolled Agents, Frank Degan.............    76
National Council for Taxpayer Advocacy, William Stevenson........    80
Intuit Corporation, Brad Smith...................................    84

                       SUBMISSIONS FOR THE RECORD

National Treasury Employees Union, Colleen M. Kelley, statement..   101
Northern Illinois University, Katrina L. Mantzke, and University 
  of Wisconsin-Milwaukee, Christin C. Bauman, joint statement....   103
Scorse, Gerald E., New York, NY, statement.......................   112


 2005 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2006

                              ----------                              


                        THURSDAY, APRIL 14, 2005

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.

    The Subcommittee met, pursuant to notice, at 3:40 p.m., in 
room B-318, Rayburn House Office Building, Hon. Jim Ramstad 
(Chairman of the Subcommittee) presiding.
    [The advisory and revised advisory announcing the hearing 
follow:]

ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
March 31, 2005
OV-1

                      Ramstad Announces Hearing on

                 2005 Tax Return Filing Season and the

                    IRS Budget for fiscal Year 2006

    Congressman Jim Ramstad (R-MN), Chairman, Subcommittee on Oversight 
of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on the 2005 tax return filing season, 
current issues in tax administration, and the Internal Revenue Service 
(IRS) budget for fiscal year 2006. The hearing will take place on 
Thursday, April 7, 2005, in the main Committee hearing room, 1100 
Longworth House Office Building, beginning at 2:00 p.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. 
Witnesses will include IRS Commissioner Everson and representatives of 
the U.S. Government Accountability Office (GAO), the IRS Oversight 
Board, the Tax Section of the American Bar Association, the American 
Institute of Certified Public Accountants, National Council for 
Taxpayer Advocacy, and the National Association of Enrolled Agents.
      

BACKGROUND:

      
    The 2005 tax return filing season refers to the period from January 
1st to April 15th when U.S. taxpayers will file more than 100 million 
tax returns, including more than 50 million e-filed returns. During 
this period the IRS is expected to issue more than 80 million tax 
refunds, answer more than 20 million telephone calls from taxpayers 
asking for assistance, and its homepage will receive more than 100 
million visits. The IRS website is among the busiest in the world 
during the filing season.
      
    The Administration's budget requests $10.68 billion to fund the IRS 
for fiscal year 2006, an increase of 4.3 percent over the FY 2005 
enacted amount. This level of funding will support approximately 97,010 
employees who will collect nearly $2 trillion in revenue from all 
sources and pay over $200 billion in refunds. The fiscal year 2006 
budget request addresses the Administration's key strategic goals for 
the IRS.
      
    In announcing the hearing, Chairman Ramstad stated, ``More than 130 
million Americans will report their income and file a tax return this 
year. These taxpayers deserve efficiency and fair and courteous 
treatment from the government they are helping to support.
      
    ``I look forward to hearing from IRS Commissioner Mark Everson and 
a number of tax experts about this year's tax filing season. The 
Oversight Subcommittee will seek to ensure that the IRS is using its 
resources efficiently, that it is doing everything possible to promote 
voluntary compliance, and that it is dealing fairly and honestly with 
taxpayers.''

FOCUS OF THE HEARING:

      
    The hearing will focus on the 2005 tax return filing season, 
current issues in tax administration, and the IRS budget for fiscal 
year 2006.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
for the hearing record must follow the appropriate link on the hearing 
page of the Committee website and complete the informational forms. 
From the Committee homepage, http://waysandmeans.house.gov, select 
``109th Congress'' from the menu entitled, ``Hearing Archives'' (http:/
/waysandmeans.house.gov/Hearings.asp?congress=17). Select the hearing 
for which you would like to submit, and click on the link entitled, 
``Click here to provide a submission for the record.'' Once you have 
followed the online instructions, completing all informational forms 
and clicking ``submit'' on the final page, an email will be sent to the 
address which you supply confirming your interest in providing a 
submission for the record. You MUST REPLY to the email and ATTACH your 
submission as a Word or WordPerfect document, in compliance with the 
formatting requirements listed below, by close of business Thursday, 
April 21, 2005. Finally, please note that due to the change in House 
mail policy, the U.S. Capitol Police will refuse sealed-package 
deliveries to all House Office Buildings. For questions, or if you 
encounter technical problems, please call (202) 225-1721.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item not in compliance with these 
guidelines will not be printed, but will be maintained in the Committee 
files for review and use by the Committee.
      
    1. All submissions and supplementary materials must be provided in 
Word or WordPerfect format and MUST NOT exceed a total of 10 pages, 
including attachments. Witnesses and submitters are advised that the 
Committee relies on electronic submissions for printing the official 
hearing record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. All submissions must include a list of all clients, persons, 
and/or organizations on whose behalf the witness appears. A 
supplemental sheet must accompany each submission listing the name, 
company, address, telephone and fax numbers of each witness.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://waysandmeans.house.gov.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.

                                 

            * * * NOTICE--CHANGE IN DATE AND LOCATION * * *

ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
April 14, 2005
OV-1 Revised

               Change in Date and Location for Hearing on

                 2005 Tax Return Filing Season and the

                    IRS Budget for fiscal Year 2006

    Congressman Jim Ramstad (R-MN), Chairman, Subcommittee on Oversight 
of the Committee on Ways and Means, today announced that the 
Subcommittee hearing on the 2005 tax return filing season, current 
issues in tax administration, and the Internal Revenue Service budget 
for fiscal year 2006, previously scheduled for Thursday, April 7, 2005, 
at 2:00 p.m., in the main Committee hearing room, 1100 Longworth House 
Office Building, will now be held on Thursday, April 14, 2005, in B-318 
Rayburn House Office Building, at 2:00 p.m., or at the conclusion of 
the full Committee hearing.
      
    The deadline to provide a submission for the record will now be 
close of business, Thursday, April 28, 2005. All other details for the 
hearing remain the same. (See Subcommittee Advisory No. OV-1, dated 
March 31, 2005).

                                 

    Chairman RAMSTAD. The hearing will come to order. Please 
bear with me, because the last time I chaired a hearing or 
chaired anything, was as student council president.
    [Laughter.]
    Chairman RAMSTAD. I want to welcome all of you, on the eve 
of tax day, to this hearing on the 2005 tax return filing 
season and the 2006 Internal Revenue Service (IRS) budget. Now, 
I am going to apologize to all the witnesses and all of you 
here for the delay. House rules are House rules, and as long as 
the full Committee on Ways and Means was meeting, we could not 
convene this hearing for the Subcommittee on Oversight. 
Nonetheless, I apologize for the delay. I also want to say it 
is a privilege to serve on this Subcommittee with such a 
distinguished Ranking Member, my friend from Georgia, one of 
the most-respected Members in the entire Congress, Mr. Lewis. 
John, look forward to working with you, just as my predecessor, 
Chairman Amo Houghton, worked so closely with Mr. Pomeroy on 
this Subcommittee.
    A hallmark of our tax system is the honesty of the American 
taxpayer. A recent study by IRS showed that over 80 percent of 
all income earned is faithfully reported by individuals and 
businessowners. Taxpayers will pay just over $2 trillion in 
taxes this year. These hard-working taxpayers want and deserve 
an IRS that is responsive to their needs. While there is still 
work to do, the IRS has made great strides in improving 
taxpayer service since 1998. One example of many is the IRS 
website which will receive well over 100 million visits during 
this tax filing season. More than 4 million taxpayers will file 
online for free, thanks to an innovative partnership with the 
private sector known as Free File. Retaining the goodwill of 
American taxpayers by providing professional service and 
detailed guidance on how to comply with the law is critical to 
sustaining voluntary compliance. I look forward to hearing 
Commissioner Everson's plans to maintain high levels of service 
in the face of expected budget constraints. Under Commissioner 
Everson's leadership, the IRS also has made outstanding 
progress in stemming the tide of corrosive tax shelters and 
overly aggressive tax planning. With President Bush's support, 
the Commissioner has increased the number of frontline 
enforcement personnel and has launched a series of enforcement 
initiatives aimed at stopping illegal tax fraud. Through these 
efforts, Commissioner Everson has helped restore peace of mind 
to compliant taxpayers who in recent years had begun to wonder 
if they were paying more than their fair share.
    We are fortunate to have a number of distinguished 
witnesses before us today. The first panel will consist of IRS 
Commissioner Mark Everson. The second panel will consist of 
Director James White of the U.S. government Accountability 
Office (GAO) and Chairman Ray Wagner of the IRS Oversight 
Board. The third panel will feature testimony from 
representatives of practitioner groups. They will discuss the 
filing season from the perspective of experts who help the 
average taxpayer interact with the IRS. I am now pleased to 
recognize the distinguished Ranking Member, my friend, Mr. 
Lewis.
    [The opening statement of Chairman Ramstad follows:]

Opening Statement of The Honorable Jim Ramstad, Chairman, Subcommittee 
   on Oversight, and a Representative in Congress from the State of 
                               Minnesota

    I want to welcome all of you to this hearing on the 2005 tax return 
filing season and the 2006 Internal Revenue Service (IRS) budget.
    A hallmark of our tax system is the honesty of the American 
taxpayer. A recent study by the IRS showed that over eighty percent of 
all income earned is faithfully reported by individuals and business 
owners. Taxpayers will pay just over $2 trillion in 2005. These 
taxpayers deserve an Internal Revenue Service that is responsive to 
their needs.
    While there is still work to do, the IRS has made great strides in 
improving taxpayer service since 1998. One example is the IRS website, 
which will receive well over 100 million visits during the tax filing 
season.
    More than four million taxpayers will file online for free, thanks 
to an innovative partnership with the private sector, known as Free 
File. Retaining the good will of American taxpayers by providing 
professional service and detailed guidance on how to comply with the 
law is critical to sustaining voluntary compliance. I look forward to 
hearing Commissioner Everson's plans to maintain high levels of service 
in the face of expected budget constraints.
    Under Commissioner Everson's leadership, the IRS also has made 
outstanding progress in stemming the tide of corrosive tax shelters and 
overly aggressive tax planning. With President Bush's support, the 
Commissioner has increased the number of frontline enforcement 
personnel, and has launched a series of enforcement initiatives aimed 
at stopping illegal tax dodges.
    Through these efforts Commissioner Everson has helped to restore 
peace of mind to compliant taxpayers, who in recent years had begun to 
wonder if they were paying more than their fair share.
    We are fortunate to have a number of distinguished witnesses before 
us today. The first panel will consist of IRS Commissioner Mark 
Everson.
    On the second panel, we will hear from Director James White of the 
Government Accountability Office and Chairman Ray Wagner of the IRS 
Oversight Board. These witnesses will provide their assessment of the 
IRS's recent work, and its budget for next year.
    The third panel will feature testimony from representatives of 
practitioner groups. They will discuss the filing season from the 
perspective of experts who help the average taxpayer interact with the 
IRS. We value their insights regarding a number of the challenges 
confronting the IRS, including the complexity of the tax code and 
electronic filing. I look forward to all of the witnesses' testimony.

                                 

    Mr. LEWIS. Thank you very much, Mr. Chairman. I am pleased 
to serve as the Ranking Member of the Committee on Ways and 
Means, Subcommittee on Oversight for the 109th Congress. I look 
forward to working closer with you, Mr. Chairman, my friend, my 
colleague, my brother. It is wonderful to be working with you. 
Since serving on the Committee on Ways and Means, since serving 
on the Congress, we have been friends, and on this Committee we 
will continue to be friends. It is my hope and my prayer that 
we will work so close together, people will not know whether I 
am a Democrat or whether you are a Republican.
    [Laughter.]
    Mr. LEWIS. Mr. Chairman, I want to thank you for postponing 
the hearing today, so that I and the Subcommittee Members could 
be here to participate. As in the past, the Subcommittee is 
holding their first hearing of the year to examine how to 
current tax return filing season is progressing, and the 
adequacy of the Administration proposed budget for the IRS for 
the next fiscal year. I want to thank you, Mr. Chairman, for 
conducting this annual oversight review of the IRS. More than 
130 million tax returns will be filed during the 2005 tax 
return filing season which ends tomorrow, April 15th. Reports 
indicate that the tax return filing season is progressing 
smoothly. IRS employees nationwide should be commended for 
their diligence and their very hard work. The Administration 
has proposed, for fiscal year 2006, an IRS budget of $10.68 
billion. I note with great interest that the IRS Oversight 
Board recommend a 13-percent increase over the amount that 
Congress provided the IRS last year. I look forward to our 
discussion of the Board's concern and the testimony of our 
other distinguished witnesses. It is important that the IRS 
operate in a fair manner with a balanced approach to administer 
our tax laws. Mr. Chairman, again, it is a pleasure, an honor, 
to serve with you and I especially want to recognize and thank 
the Commissioner for being here, for all of his good work. 
Thank you very much, Mr. Chairman.
    Chairman RAMSTAD. Thank you, Mr. Lewis.
    It is now a pleasure to introduce our first witness, the 
Commissioner of the IRS, Commissioner Mark Everson.

   STATEMENT OF MARK EVERSON, COMMISSIONER, INTERNAL REVENUE 
                            SERVICE

    Mr. EVERSON. Thank you, Mr. Chairman and Mr. Lewis. I 
appreciate the opportunity to be here with you today, and I 
congratulate you and thank you for your willingness to serve in 
your positions. We felt a little jilted by Mr. Pomeroy. I guess 
he decided that agriculture was more important to his State 
than maybe the taxes, but we understand, and, Mr. Lewis, we are 
very pleased that you are devoting your energies to this 
position.
    Mr. LEWIS. You won't miss him. He will be back. He will be 
right here, to my left.
    Chairman RAMSTAD. Still a Member of the Subcommittee.
    Mr. EVERSON. Very good. As of April 8, 2005 we have 
received more than 88 million total individual returns. Of 
these, 55.8 million were electronically filed and 32.3 million 
were paper. Electronic filing continues to grow. Last year 
individuals filed almost 62 million electronic returns. This 
year we expect that over half of all individual returns will be 
e-filed. Paper filers are now in the minority. Electronic 
filing is fast, convenient and gets you your refund back in 
half the time of a paper return. As of April 2, use of our 
website, which you mentioned, Mr. Chairman, has already 
exceeded 110 million hits, about double the amount of last 
year. Taxpayer use of our popular ``Where's my refund'' feature 
on the web page has risen to 45 percent over last year. Our 
telephone service, that is answering questions from taxpayers, 
continues to improve. Through the end of March our customer 
accuracy was 91.6 percent, up from 89.3 percent, and our tax 
law accuracy has improved from 77.7 percent last year to 88 
percent in 2005. While we improve services, we are boosting 
enforcement. The President's 2006 request for the IRS is 
crafted to continue to do the necessary rebuilding of our 
enforcement capabilities, and it maintains a stable commitment 
to our important IT modernization programs. Both enforcement 
and modernization were categorized earlier this year by the GAO 
as high-risk areas of government-wide importance.
    The 2006 budget request calls for a modest amount of belt 
tightening in taxpayer services. The percent cut to services is 
consistent with the request for domestic discretionary 
programs, other than those associated with homeland security. 
In a report issued last year--and there is a chart here--the 
GAO stated: ``Taxpayer services are much improved, raising a 
question about the appropriate balance to strike between 
investing in further service improvements and enforcement. At 
the same time the use of IRS' walk-in assistance sites is 
declining. The improvements in telephone service, increased 
website use and the availability of volunteer sites raise a 
question about whether IRS should continue to operate as many 
walk-in sites. Reconsidering the level and types of service is 
an option-but not a recommendation-to be considered by IRS 
management and the Congress.'' The President's request for the 
IRS adopts just this approach. I am comfortable with the 
request and support it wholeheartedly. I believe that if 
enacted at the requested level, without constraining language, 
the IRS will continue to provide good services to taxpayers. 
The budget will hold Business Systems Modernization (BSM) 
funding steady at substantially the same level as 2005. In 
terms of modernizing our big computer systems at the IRS after 
years of cost overruns and missed delivery dates, we are 
finally showing results. In the past 9 months, two important 
systems have come online. We have a new financial system to 
help better manage the Agency, and more importantly, this 
filing season we have already processed over a million 1040-EZ 
returns using the first new processing system in 40 years.
    The 2006 budget continues investment in three critical 
areas: further work on return processing, collections and 
electronic filing. Several weeks ago we announced that the 
gross tax gap, that is, the difference between what taxpayers 
should pay and what they actually pay on a timely basis, 
exceeds $300 billion per year. Average Americans pay their 
taxes honestly and accurately, and have every right to be 
confident that when they do so, neighbors and competitors are 
doing the same. We have taken some important steps to bolster 
this confidence. We have ramped up our audits of individuals. 
That is, in that chart over there, 600,000 audits 4 years ago 
to over a million audits in fiscal year 2004. Particularly for 
high-income individuals, as you can see, we have basically 
doubled that number over the same period. Corporations have 
come up as well, and we are focusing more attention on abusive 
shelters and more criminal investigations. We recently 
announced collections of over $3.2 billion in a settlement 
initiative for Son of Boss, a particularly abusive shelter. The 
proposed 2006 budget calls for a nearly 8-percent increase for 
enforcement. This will enable us to expand our activities 
across each of our four strategic enforcement priorities; 
first, to discourage and deter noncompliance with emphasis on 
corrosive activity by corporations, high income individuals, 
and other contributors to the tax cap; second, to ensure that 
attorneys, accountants and other tax practitioners adhere to 
professional standards; third, to detect and deter domestic and 
offshore based tax and financial criminal activity; and, 
finally, to deter abuse within tax exempt and governmental 
entities and misuse of such entities by third parties.
    [The exhibits follow:]

    [GRAPHIC] [TIFF OMITTED] T4767A.001
    

    [GRAPHIC] [TIFF OMITTED] T4767A.002
    

    [GRAPHIC] [TIFF OMITTED] T4767A.003
    

    [GRAPHIC] [TIFF OMITTED] T4767A.004
    

    What I am going to do now is just make one final point, 
since I see your red light. I would point out that, in the 
Senate budget resolution there is a protection of this 
enforcement initiative. That is not present on the House side. 
I urge you to support what is the Senate's position so that we 
can get that money and continue to rebuild our compliance 
efforts, the success of which is in the final chart I have of 
the direct enforcement revenues, which have increased from $34 
billion in fiscal year 2002 to $41 billion in fiscal year 2004.
    [The prepared statement of Mr. Everson follows:]

Statement of The Honorable Mark Everson Commissioner, Internal Revenue 
                                Service

    Chairman Ramstad, Ranking Member Lewis, and Members of the 
Subcommittee, thank you for the opportunity testify today on the 2005 
tax filing season and our FY 2006 budget request. I congratulate you, 
Mr. Chairman and Ranking Member Lewis, for your selections as the 
leaders on this panel. I look forward to working with you as you 
exercise your oversight responsibilities and we ensure the fair and 
efficient administration of taxes.
    I have been on the job for nearly two years. Last year, I testified 
about the IRS mission of service and enforcement, and about our need to 
modernize. I spoke about how the IRS was doing a good job improving 
service, had a mixed record on modernization, and had work to do to 
restore enforcement to proper levels.
    Today, I wish to update the Subcommittee on what we have 
accomplished over the past year, addressing enforcement, the area where 
our challenges remain the greatest. Let me first update the 
Subcommittee about service. By service, I mean helping people 
understand their tax obligations and making it easier for them to 
participate in the tax system.
    The IRS has greatly improved service to our nation's taxpayers over 
the last several years. We are delivering services to taxpayers and we 
have improved the efficiency and effectiveness for our tax 
administration system. The deficit in the quality of service that the 
IRS was providing prior to the 1990s is closing.
Customer Satisfaction
    The American Customer Satisfaction Index (ACSI), which began in 
1994, is a measure of customer satisfaction that covers seven economic 
sectors, 40 industries, more than 200 private sector companies, and 
many governmental agencies. Scores are reported on a 0 to 100 scale 
based on survey data from consumer households across the nation. The 
ACSI is produced by the NationalQualityResearchCenter at the University 
of Michigan Business School, the Claes Fornell International (CFI) 
Group, and the Federal Consulting Group (FCG). Claes Fornell, Chairman 
of the CFI Group, recently praised our progress. He said,

          The Internal Revenue Service (IRS) continues to improve its 
        services. The IRS is obviously in a special category when it 
        comes to the satisfaction of the people it deals with, and 
        cannot be compared with the private sector or even with most 
        public sector services. The collection of taxes is not an 
        activity that taxpayers look forward to or expect a great deal 
        of satisfaction from. But even in the face of this handicap, 
        the IRS continues to improve on taxpayer satisfaction. Since 
        1999, IRS' overall ACSI score has surged by 26%. While the rate 
        of the improvement has slowed recently, it is clear that a good 
        deal of this increase is attributable to electronic filing. 
        Filers find it convenient, accurate, and refunds are delivered 
        quickly. The satisfaction score for electronic filing stands at 
        a remarkable 78, compared with paper filing at 52. The more tax 
        filers the IRS manages to move from paper to electronic filing, 
        the more customer satisfaction can be expected to increase.

Return Receipts / Electronic Filing
    Electronic filing continues to grow. Last year, individuals filed 
over 61 million electronic returns. This year, we expect that over half 
of all individual returns will be e-filed. Thus it appears that 
individuals who file paper tax returns will soon be in the minority. We 
take every opportunity we can to broadcast the benefits of electronic 
filing, including a reduction in processing errors and cost savings for 
taxpayers and the IRS. E-filing is fast, convenient, and gets your 
refund to you in half the time of paper returns.
    As of April 8, 2005, we have received more than 88 million total 
individual returns. 55.8 million returns (63.4 percent) are 
electronically filed and 32.3 million (36.7 percent) are paper.

      The number of online returns is 13.6 million, a 14.6 
percent increase from last year.
      Through March 30, 2005, 3.9 million Free File returns 
have been accepted, an increase of 44 percent from last year.
      We have issued 72.3 million refunds. Total dollars paid 
are 3.44 percent higher than last year, with an average refund of 
$2,189 paid.
IRS.gov
    Use of our website, IRS.gov, has exceeded 105.4 million homepage 
visits, up 117 percent from 2004. Not surprisingly, during the filing 
season, it is one of the busiest websites in the world. We average more 
than one million visits a day. Many of those visits are to the ``Free 
File'' page, which allows taxpayers visiting the website to chose among 
several free, online filing options. As of April 9, over 16.1 million 
taxpayers used the ``Where's my Refund'' feature on the web page, an 
increase of 45 percent from the same time last filing season. These 
visits decrease the need to visit a Taxpayer Assistance Center (TAC), 
or to call our operators, which allows them to focus on more complex 
calls. During the past year, we have also rolled out important new 
online services to tax professionals to help them better serve their 
clients. Tax practitioners and other third parties, such as banks and 
brokerage firms that file 1099s, may now access the following 
functionalities online: electronic account resolution, transcript 
delivery, secure email, disclosure authorization, and bulk Taxpayer 
Identification Number (TIN) matching. In fact, as of April 12, 2005, 
tax practitioners submitted 2925 cases for Electronic Account 
Resolution, 52,824 requests for transcripts, 24.3 million Bulk TIN 
matching requests, and over 13,000 powers of attorney or disclosure 
authorizations.

Telephone Service
    Our efforts to improve call routing, as well as staffing and 
training of phone assistors have allowed us to reach world-class 
service. In filing season 2005, we are maintaining the level of service 
that our customers have come to expect from us.
    As recently as fiscal year 2002, the level of service for those 
taxpayers who want to speak to an assistor was 68 percent. Our 
improvement efforts raised the level to 80 percent in 2003 and to an 
all-time high of 87 percent in 2004.
    Calls are routed from taxpayers to the proper subject matter expert 
and the system balances workforce planning against the historic 
workload patterns to reduce waiting time from 263 seconds in fiscal 
year 2002 to 205 seconds in fiscal year 2005. That's about a minute 
less time on hold for every call.
    In FY 2004, the number of taxpayers receiving busy signals 
decreased to 220,000, a 66 percent reduction from the previous year. 
And, that is a reduction of 99.5 percent from the 2.6 million busy 
signals generated as recently as FY 2002.
    Our telephone service--that is, answering questions from 
taxpayers--continues to improve. We measure telephone quality two ways, 
1) customer account accuracy and 2) tax law accuracy. For the filing 
season, our customer account accuracy is 91.6 percent, up from 89.3 
percent; our tax law accuracy has improvedfrom 77.7 percent in 2004 to 
88 percent in 2005.

Continuing Service and Increasing Enforcement
    We are quite aware of the need to operate efficiently, consolidate 
operations and drive down costs wherever we can. In today's fiscal 
environment, we recognize that resources are tight. Nevertheless, we 
are determined to do all we can to improve service and modernize the 
IRS. In the last several years, we have begun to arrest the decline in 
enforcement and stabilize IRS enforcement staffing; now 73 percent of 
taxpayers completely agree that it is every American's duty to pay 
their fair share of taxes, up from 68 percent in 2003. A 2004 IRS 
Oversight Board commissioned NOP World study revealed 79 percent of 
taxpayers believe it is very important for the IRS to enforce 
compliance from high-income individuals and 85 percent believe it is 
very important for the IRS to enforce compliance from corporations. But 
in order to continue to reverse the downward trend of compliance, we 
must continue to use our resources wisely.
    We are working aggressively to improve productivity and achieve 
cost savings, which we will apply to other priority areas, such as 
enforcement. The FY 2006 budget reduction initiatives focus mainly on 
targeted reductions in assistance, outreach, and processing program 
areas. Reductions will also be achieved through improved efficiencies 
and re-engineering of business processes in key program areas in 
accounts management, submission processing, media and publications, 
field assistance, and outreach and education. Approximately 65 percent 
of these reductions will occur in assistance, 20 percent in outreach 
and 15 percent in processing. We will minimize the impact on taxpayers 
by providing alternative means to obtain service, wherever possible. 
Our budget estimates all these taxpayer service reengineering 
initiatives will yield $134 million in savings we can reinvest in other 
program areas. The reductions represent a balanced approach in program 
delivery and service to taxpayers to enable them to meet their tax 
obligations.
    We estimate savings of $75 to 95 million from additional 
efficiencies in our field assistance, accounts management and toll-free 
telephone operations. We will achieve these savings, in part, because 
of our recent consolidation our Customer Accounts Service organizations 
and revamping our business processes. For example, due to the steady 
decline in taxpayers corresponding with us about their accounts, we 
will need fewer resources to manage these accounts. We are also 
adjusting the hours of our toll-free telephone operations from 15 to 12 
hours daily, Monday through Friday in the local times zones, beginning 
in 2005. We expect minimal impact to our level of service for taxpayers 
who call us. Another portion of these savings will come from reducing 
the number of walk-in sites. In recent years, the number of taxpayers 
walking into a Taxpayer Assistance Center (TAC) site for assistance has 
decreased from a high of nearly 10 million contacts in FY 2000 to about 
7.7 million contacts in FY 2004. This trend reflects the increased 
availability and quality of services that do not require travel or 
waiting in line. Examples include improved access to IRS telephone 
service, the increasing availability of volunteer assistance, and the 
many services now available through IRS.gov, such as ``Free File'' and 
``Where's My Refund.'' In addition, the ability to download forms 
online has also contributed to the decline in the number of customers 
walking into a TAC. We have also continued to improve our telephone 
service for taxpayers who call the IRS with questions. The use of other 
alternatives, such as volunteer return assistance at Volunteer Income 
Tax Assistance (VITA) sites and Tax Counseling for the Elderly (TCE) 
sites, has steadily increased while the number of TAC contacts 
decreased. In FY 1999, for example, VITA sites filed almost 584,000 
returns, and TCE sites filed 446,000 returns. In the next five years, 
the numbers of returns filed through these sites increased 88 percent, 
reaching 976,000 VITA returns and 958,000 TCE returns in FY 2004.
    Because of these other options, fewer taxpayers need to travel to 
an IRS office to get the services they need. There are currently about 
400 TAC sites across the country which are serviced by approximately 
2,300 TAC employees. We believe that adjusting the TAC sites to more 
closely align to this decreased walk-in volume will yield staffing and 
building cost savings of $45 to 55 million of the $75 to 95 million in 
savings, and allow us the flexibility to improve efficiencies and 
concentrate more on front-line enforcement.
    We have developed a criteria model that measures the impact on 
taxpayers across the country. The criteria include: location, employee 
cost, facilities cost, workload, and demographic measurements. In 
anticipation of the closing of approximately 70 TACs and their 
employees, we have requested authority to offer early-outs and buy-outs 
to all eligible IRS TAC personnel. We expect to have further 
announcements in the near future.
    In addition to reducing the number of TAC sites, we will save $20 
to $31 million in outreach programs though reductions in printing and 
postage and additional efficiencies in our outreach organizations. For 
example, we will save more money in printing and postage as taxpayers 
shift to e-filing, and as we eliminate redundant services and 
publications.
    We will save another $17 to $23 million by retiring Telefile, 
implementing program enhancements in the processing of employment tax 
returns, and re-engineering processes in Submission Processing. We will 
redirect taxpayers who previously used Telefile to e-file alternatives, 
such as Free File, that are available through IRS.gov so we maintain an 
acceptable level of service.
    Though we are re-engineering how we provide service, we will 
continually strive to improve service to taxpayers. Having stated this, 
I must address the fundamental issue of enforcement.
    While the President's Budget Request to Congress would increase IRS 
enforcement activities by 7.8 percent, given the current budgetary 
constraints, we responsibly proposed to reduce spending in other areas 
throughout the Service. We are confronted with difficult choices.
    Average Americans pay their taxes honestly and accurately, and have 
every right to be confident that when they do so, their neighbors and 
competitors are doing the same. Let me provide an overview of the steps 
we have taken over the past year to bolster this confidence, turning 
briefly to each of our four service-wide enforcement priorities.
    Our first enforcement priority is to discourage and deter non-
compliance, with emphasis on corrosive activity by corporations, high-
income individuals, and other contributors to the tax gap.

      In 2004, audits of high-income taxpayers jumped 40 
percent from the year before. We audited almost 200,000 high-income 
individuals last year--double the number from 2000.
      Overall, audits for individuals exceeded the one million 
mark last year, up from 618,000 four years earlier.
      In 2004, the number of audits of the largest businesses--
those with assets of $10 million or more--finally increased after years 
of decline.

    The centerpiece of our enforcement strategy is combating abusive 
tax shelters, both for corporations and high-income individuals. I will 
touch upon two important initiatives of the past twelve months.
    We have continued our program of settlement offers for those who 
entered into abusive transactions in the past but would like to get 
their problems behind them. Last May, we made a settlement offer 
regarding the Son of Boss tax shelter, a particularly abusive 
transaction used by wealthy individuals to eliminate taxes on large 
gains, often in the tens of millions of dollars. In this program, for 
the first time, the IRS required a total concession by the taxpayer of 
artificial losses claimed. I am pleased with the response to the offer. 
So far, $3.2 billion in taxes, interest and penalties have been 
collected from the 1,165 taxpayers who are participating in the 
settlement initiative. The typical taxpayer payment was almost $1 
million, with 18 taxpayers paying more than $20 million each and one 
paying over $100 million. Processing of individual settlements 
continues.
    Based on disclosures we have received from promoter investigations 
and from investor lists from Justice Department litigation, we have 
determined that just over 1,800 people participated in Son of Boss. 
When the project concludes in the coming months, we expect the 
collected figure should top $3.5 billion.
    In February 2005, we announced a second important settlement 
initiative--this one involving executive stock options. This abusive 
tax transaction involved the transfer of stock options or restricted 
stock to family-controlled entities. These deals were done for the 
personal benefit of executives, sometimes at the expense of public 
shareholders. This shelter was not just a matter of tax avoidance but, 
in some instances, raises basic questions about corporate governance. 
Again, the settlement offer is a tough one: full payment of the taxes 
plus a penalty.
    A noteworthy point about the stock option settlement offer is that 
our actions in this matter were closely coordinated with the Securities 
and Exchange Commission and the Public Company Accounting Oversight 
Board.
    Our settlement initiatives and increased audits have sent a signal 
to taxpayers: the playing field is no longer as lopsided as it once 
was. Non-compliant taxpayers might have to pay the entire tax, 
interest, and a stiff penalty. A taxpayer might have to wrestle with 
questions like ``how much am I going to have to pay the lawyers and 
expert witnesses to litigate this thing?'' Moreover, going to court is 
a public matter. Damage to one's reputation is a potential factor. Many 
wealthy individuals, otherwise seen as community leaders, may not want 
to be identified as paying less than their fair share in taxes.
    Another example of cooperation in the battle against abusive 
shelters is in the international arena. A year ago, I announced the 
formation of what has come to be known as the Joint International Tax 
Shelter Information Centre. Since last Labor Day, we have had an 
operational task force of personnel from Australia, Canada, the United 
Kingdom, and the U.S. working together on-site here in Washington. We 
are exchanging information about specific abusive transactions. Results 
to date are promising. Thus far, we have uncovered a number of 
transactions which, but for the Centre, we would have unraveled only 
over a number of years, if ever. It makes sense that we continue to 
work with other countries because, in this increasingly global world, 
we are up against what is, in essence, a reinforcing commercial network 
of largely stateless accounting firms, law firms, investment banks, and 
brokerage houses.
    The government stepped up its use of civil injunctions in 2001 to 
prohibit promoters from selling illegal tax schemes on the Internet, at 
seminars or through other means. Currently the courts have issued 
injunctions against 99 abusive scheme promoters--81 permanent 
injunctions and 18 preliminary injunctions. They have issued 
injunctions against 17 abusive return preparers--all permanent 
injunctions. And an additional 49 suits have been filed by Justice 
seeking injunction action--28 against scheme promoters and 21 against 
return preparers. Injunctions issued have involved schemes such as:

      Using abusive trusts to shift assets out of a taxpayer's 
name while retaining control
      Misusing ``corporation sole'' laws to establish phony 
religious organizations
      Using frivolous ``Section 861'' arguments to evade 
employment taxes
      Claiming personal housing and living expenses as business 
expenses
      Filing tax returns reporting ``zero income''
      Misusing the Disabled Access Credit

    The IRS has another 1,000 investigations ongoing for possible 
referral to the Department of Justice; and individual examinations are 
being conducted on thousands of scheme participants. Most of the 
investigations and examinations are being conducted by the IRS Small 
Business/Self-Employed (SB/SE) Division.
    Our second enforcement priority is to assure that attorneys, 
accountants, and other tax practitioners adhere to professional 
standards and follow the law.
    Our system of tax administration depends upon the integrity of 
practitioners. Altogether, there are approximately 1.2 million tax 
practitioners. The vast majority of practitioners are conscientious and 
honest, but even honest tax professionals suffered from the sad and 
steep erosion of ethics in recent years by being subjected to untoward 
competitive pressures. The tax shelter industry had a corrupting 
influence on our legal and accounting professions.
    We have done quite a bit since March 2004 to restore faith in the 
work of tax professionals. We have strengthened regulations governing 
the standards of tax practice to discourage the manufacturing of bogus 
legal opinions on the validity of tax shelters. The IRS standards set 
forth rules governing what does and does not qualify as an independent 
opinion about a tax shelter.
    Last year, the government won a series of court opinions on 
privilege. The cases established that promoters who develop and market 
generic tax shelters can no longer protect the identity of their 
clients by hiding behind a false wall of privilege.
    Abusive tax shelters often flourished because penalties were too 
small. Some blue chip tax professionals actually weighed potential fees 
from promoting shelters, but not following the law, against the risk of 
IRS detection and the size of our penalties. Clearly, the penalties 
were too low. They were no more than a speed bump on a single-minded 
road to professional riches.
    But these speed bumps have become speed traps. Last fall, Congress 
enacted the American Jobs Creation Act. The legislation both created 
new penalties and increased existing penalties for those who make false 
statements or fail to properly disclose information on tax shelters. 
Under the new law, the IRS can now impose monetary penalties not just 
on tax professionals who violate standards, but also on their 
employers, firms, or other entities if those parties knew, or should 
have known, of the misconduct.
    Our third enforcement objective is to detect and deter domestic and 
off-shore based criminal tax activity and related financial criminal 
activity.
    Last year, the IRS referred more than 3,000 cases to the Justice 
Department for possible criminal prosecution, nearly a 20 percent jump 
over the previous year. We continue our active role in the President's 
Corporate Fraud Task Force. We are going after promoters of tax 
shelters--both civilly and, where warranted, criminally. This tactic is 
a departure from the past. Previously, during a criminal investigation, 
all civil activity came to a halt. The result was that our business 
units were reluctant to refer matters for criminal investigation lest 
they lose their traditional turf. But, we are now moving forward on 
parallel tracks with the Department of Justice. We have a number of 
important criminal investigations underway. The enforcement model is 
changing.
    Our fourth enforcement priority is to discourage and deter 
noncompliance within tax-exempt and government entities, and misuse of 
such entities by third parties for tax avoidance purposes.
    Consider, for example, certain credit counseling agencies. 
Increasingly, it appears that some credit counseling organizations have 
moved from their original purposes, that is, to counsel and educate 
troubled debtors, to inappropriately enrolling debtors in proprietary 
debt-management plans and credit-repair schemes for a fee. These 
activities may be disadvantageous to the debtors and are not consistent 
with the requirements for tax exemption. Further, a number of these 
organizations appear to be rewarding their insiders by negotiating 
service contracts with for-profit entities owned by related parties. 
Many newer organizations appear to have been created as a result of 
promoter activity.
    Some shelter promoters join with tax-exempt organizations to create 
abusive shelters. The organization receives a large fee from the 
taxpayer who is taking advantage of its tax-free status. That is an 
unintended abuse of the tax exemption that our nation bestows upon 
charities.
    It is heartening to see leading members of the nonprofit community 
taking steps to address abuses. I particularly want to salute the 
Independent Sector--which recently delivered a constructive report to 
the Senate Finance Committee. The report states that ``government 
should ensure effective enforcement of the law'' and calls for tougher 
rules for charities and foundations. The report calls for stronger 
action by the IRS to hold accountable charities that do not supply 
accurate and timely public information. I encourage the accounting, 
legal, and business communities to be as enthusiastic about confronting 
abuses and the erosion of professional ethics as the nonprofit 
community. An interesting point to note is that the report supports 
mandatory electronic filing of all tax returns for nonprofits.
    The threat to the integrity of our nation's charities is real and 
growing. At the IRS, we take it very seriously. We are augmenting our 
resources in the nonprofit area. By the end of September, we will have 
increased the number of our personnel who audit tax-exempt 
organizations by over 30 percent from two years earlier. If we do not 
act expeditiously, there is a risk that Americans will lose faith in 
our nation's charitable organizations. If that happens, Americans will 
stop giving and those in need will suffer.
    As we move forward with these priorities, we will leverage our 
success to achieve greater results within out FY 2006 budget request.

Budget Restructure
    To facilitate full alignment and integration of the Service's goals 
and measures with its resources, we are proposing to restructure our 
budget beginning in FY 2006. These changes will facilitate a more 
accurate assessment of the overall value of IRS programs, simplify the 
full costing of programs, and allow the IRS to demonstrate incremental 
increases in an initiative's effectiveness based on the level of 
funding received.
    In addition, this new budget structure will enable us to manage 
activities more effectively. The normal processing of tax returns 
generally proceeds from pre-filing activities to filing activities, and 
finally to compliance activities, should they prove necessary. Although 
these activities are interrelated, we currently distribute their 
resources among three appropriations, with unevenly distributed support 
costs. This system makes it difficult to manage, track, and report the 
full cost of a given Taxpayer Service or Enforcement program.
    This new budget structure will enable us to prepare a true 
performance-based budget by providing the capability to integrate 
operational and support costs into one appropriation, thereby allowing 
us to cost budget activities and programs fully for the first time. The 
new structure will also facilitate the full incorporation of 
performance measures into the budget, as the measures could be tied to 
funds in one appropriation rather than a series of program activities 
dispersed across multiple appropriations. The proposed new budget 
structure will allow stakeholders to assess more accurately the overall 
value of IRS programs, and make program reviews, such as the Office of 
Management and Budget's Program Assessment Rating Tool (PART), more 
effective, thus providing greater accountability and results-oriented 
management focus.
    The proposed budget structure combines the three major 
appropriations accounts--Processing, Assistance and Management (PAM); 
Tax Law Enforcement (TLE); and Information Systems (ISY)--into one 
appropriation called Tax Administration and Operations (TAO).
    The Taxpayer Service and Enforcement programs of the TAO 
appropriation are divided among eight critical program areas. These 
budget activities focus on Assistance, Outreach, Processing, 
Examination, Collection, Investigations, Regulatory Compliance, and 
Research. Full funding for each activity will be reflected in the 
budget, along with key performance measures. As we continue to move 
toward the development and implementation of this new structure, we 
will refine these program areas and the associated resource 
distributions to provide more accurate costing.
    Let me now provide more details on the budget request for the IRS.

President's FY 2006 Budget Seeks Increase in Enforcement to Address 
        Growing Tax Gap
    The President's fiscal year 2006 budget requests $10.7 billion for 
the IRS, a 4.3 percent increase over the fiscal year 2005 enacted 
level. This request represents a 1 percent decrease in Taxpayer Service 
and a 2 percent decrease in Business Systems Modernization (BSM), but 
an 8 percent increase in enforcement.
    This budget includes $265 million for initiatives aimed at 
enhancing the enforcement of tax laws. This request is above the 
increases to fund the pay raise and other cost adjustments ($182 
million), for a total of $446 million for new enforcement investments 
and cost increases. It is important the Congress fully fund these cost 
increases and new enforcement investments. The President's budget 
proposal to fund them as contingent appropriations reflects the 
importance of this investment to the Administration.
    To ensure full funding of the new enforcement investments, the 
budget proposes to employ a budget enforcement mechanism that allows 
for an adjustment by the Budget Committees to the section 302(a) 
allocation to the Appropriations Committees found in the concurrent 
resolution on the budget. In addition, the Administration will also 
seek to establish statutory spending limits, as defined by section 251 
of the Balanced Budget and Emergency Deficit Control Act of 1985, and 
to adjust them for this purpose. To ensure full funding of the cost 
increases, either of these adjustments would only be permissible if the 
Congress funds the base level for IRS enforcement at $6.4 million and 
restricts the use of the funds to the specified purpose. The maximum 
allowable adjustment to the 302(a) allocation and/or the statutory 
spending limit would be $446 million for 2006, bringing the total 
enforcement level in the IRS to $6.9 million.
    We will use the additional funds for enforcement in several key 
ways to combat the tax gap, the difference between what taxpayers are 
supposed to pay and what they actually do pay, due to non-filing, 
underreporting, and nonpayment. Combating tax non-compliance is a top 
priority for us. Americans deserve to feel confident that when they pay 
their taxes, their neighbors and competitors are doing the same. These 
investments will yield substantial results. Even though we have 
increased the focus on specific areas of noncompliance, the tax gap 
increased slightly to between $311 billion and $353 billion in tax year 
2001. IRS enforcement activities, coupled with late payments, recover 
about $55 billion of the tax gap, leaving a net tax gap of between $257 
billion and $298 billion.
    Since 2001, the year covered by the National Research Program (NRP) 
three-year study in which we audited 46,000 individual income tax 
returns, we have taken a number of steps to bolster enforcement. We 
increased our enforcement revenues by nearly 28 percent from $33.8 
billion in 2001 to $43.1 billion in 2004. Audits of high-income 
taxpayers--those earning $100,000 or more--topped 195,000 in fiscal 
year 2004, which is more than double those conducted in 2001.Total 
audits of all taxpayers topped 1 million last year--a 37 percent jump 
from 2001.
    We are ramping up our audits on high-income taxpayers and 
corporations, focusing more attention on abusive shelters and launching 
more criminal investigations. We recently announced we collected $3.2 
billion in the settlement initiative for Son of Boss, a particularly 
abusive tax shelter.
    Our enforcement efforts are designed to increase compliance and 
reduce the tax gap.
    The preliminary results of the NRP determined a range for the tax 
gap, which will be refined into final, more detailed estimates by year-
end 2005. It is unlikely but possible that the final estimates of the 
total tax gap will fall outside the established range. We need to 
continue our efforts in these areas and increase the investment in 
these areas.
    We need to enforce the law so that when Americans pay their taxes, 
they are confident that neighbors and business competitors are doing 
the same. At the same time, this research underscores the President's 
call for tax reform. Complexity obscures understanding. Complexity in 
the tax code compromises both the service and enforcement missions of 
the IRS. Those who try to follow the law but cannot understand their 
tax obligations may make inadvertent errors or ultimately throw up 
their hands and say ``why bother.'' Meanwhile, individuals who seek to 
pay less than what they owe often hide behind the tax code's complexity 
in order to escape detection by the IRS and pay less than their fair 
share.
    The IRS yields more than four dollars in direct revenue from its 
enforcement efforts for every dollar invested in its total budget. In 
FY 2004, we brought in a record $43.1 billion in enforcement revenue--
an increase of $5.5 billion from the year before, or 15 percent. Beyond 
the direct revenues generated by increasing audits, collection, and 
criminal investigations, our enforcement efforts have a deterrent 
effect on those who might be tempted to skirt their tax obligations.
    The nearly 8 percent increase for enforcement activities in the 
Administration's 2006 IRS budget request will increase audits of 
corporations and high-income individuals as well as expand collection 
and criminal investigation efforts.

Detailed Budget Summary
    Our FY 2006 request of $10.7 billion includes a transfer from the 
Justice Department of $53.9 million and 329 FTEfor our portion of the 
Interagency Crime and Drug Enforcement (ICDE) appropriation, $277.6 
million for a 2.3 percent pay raise and non-labor inflationary costs, 
and $264.6 million for initiatives aimed at enhancing our enforcement 
efforts. This request also includes a $22 million rent reduction to 
result from consolidation of space, and the $134.1 million reduction to 
taxpayer service activities that we will responsibly leverage through 
productivity improvements and program reengineering, as previously 
discussed. We will take a balanced approach to these targeted 
reductions.
    In addition to the taxpayer service reengineering initiatives, we 
also expect to continue to realize savings, which we reinvest to other 
key areas, through the following other reengineering initiatives:

      Savings from Increased Individual Master File (IMF) E-
Filing (Reduction: -$7,700,000 and -190 FTE; Reinvestment: +$7,600,000 
and +12 FTE): This savings is based on processing efficiencies from the 
projected decrease in IMF paper returns and processing costs for 
electronically filed IMF returns in Submission Processing Centers. 
These savings will be reinvested to enable us to continue our 
consolidation of IMF returns processing into fewer Submissions 
Processing sites.
      Consolidation of Case Processing Activities to Maximize 
Resources Devoted to Front-Line Operations (Reduction: -$66,654,000 and 
-649 FTE; Reinvestment: +$66,654,000 and +585 FTE): Staffing for 
conducting case processing activities that support our examination, 
collection and lien-processing programs will be consolidated from 
nearly 100 sites and centralized among four campuses (Philadelphia, 
Cincinnati, Ogden and Memphis).
      Consolidation of Insolvency Activities to Maximize 
Resources Devoted to Front-Line Operations (Reduction: -$14,928,000 and 
-134 FTE; Reinvestment: +$14,928,000 and +156 FTE): Staff conducting 
insolvency operations to protect the government's interest in 
bankruptcy proceedings will be consolidated from numerous sites and 
centralized at the Philadelphia campus.
      Detection and Deterrence of Corrosive Corporate Non-
Compliance (Reduction: -$6,711,000 and -52 FTE; Reinvestment: 
+$6,711,000 and +52 FTE): By using improved issue-management and risk-
assessment strategies for examining corporations, the IRS expects to 
realize productivity improvements. These savings will be reinvested to 
fund front-line enforcement activities.

    Finally, the FY 2006 request includes several program increases, 
totaling $264.6 million:

      Attack Corrosive Non-Compliance Activity Driving the Tax 
Gap (+$149,700,000 and +920 FTE): This initiative increases coverage of 
the growing number of high-risk compliance problems and addresses the 
largest portion of the tax gap--underreporting of tax. It proposes a 
funding increase across all major domestic and international compliance 
programs to leverage new workload-selection systems and case-building 
approaches from continuing reengineering efforts.
      Detect and Deter Corrosive Corporate Non-Compliance 
(+$51,800,000 and +236 FTE): This initiative addresses complex, high-
risk issues in abusive tax avoidance transactions, promoter activities, 
corporate fraud, and aggressive domestic and off-shore transactions, 
resulting in increased corporate and high-income return closures and 
audit coverage. This initiative also includes critical post-filing 
support provided by outside experts to expedite the resolution of 
issues at the field examination level, reducing taxpayer burden, and 
increasing the credibility of the Service's positions on the most 
complex and potentially highest compliance impact issues sent to court.
      Increase Individual Taxpayer Compliance (+$37,900,000 and 
+417 FTE): This initiative addresses the tax gap through: the 
identification and implementation of actions needed to address non-
compliance with filing requirements; increased Automated Underreporter 
resources to address the reporting compliance tax gap; increased audit 
coverage; and expanded collection work in Taxpayer Assistance Centers.
      Combat Abusive Transactions by Entities with Special Tax 
Status (+$14,460,000 and +77 FTE): This initiative focuses on the most 
egregious cases of non-compliance and identifies compliance risks 
sooner, reducing burden on compliant customers and enabling the 
development of new interventions to curtail the growth of abusive 
transactions.
      Curtailing Fraudulent Refund Crimes (+$10,772,000 and +22 
FTE): This initiative is aimed at attacking the increased questionable 
refunds and return preparer fraud identified through expanded 
operations of the Fraud Detection Centers located on IRS campuses. 
Fraudulent refund schemes are one of the most serious threats to 
voluntary compliance and an IRS investigative priority.

    The FY 2006 request of $10.7 billion funds the IRS' three 
appropriations: Tax Administration and Operations (TAO) for operations, 
service and enforcement; Business Systems Modernization (BSM) for 
modernization; and, the Health Insurance Tax Credit (HITCA) for 
administering a refundable tax credit for qualified individuals. I will 
describe each in turn.

Tax Administration and Operations (TAO)
    For FY 2006, we request funding of $10,460,051,000, an increase of 
4.6 percent over the FY 2005 appropriation of $9,998,164,640 for 
programs previously funded from the PAM, TLE, and ISY appropriations.
    The TAO appropriation provides resources for the IRS' service and 
enforcement programs. The IRS is responsible for ensuring that each 
taxpayer receives prompt and professional service. To that end, the 
IRS' assistance, outreach, and processing activities funded in the TAO 
appropriation are dedicated to providing assistance to taxpayers in all 
forms--electronic interaction, published guidance, paper 
correspondence, telephone contact, and face-to-face communication--so 
that taxpayers may fulfill their tax obligations timely and accurately. 
It also includes the resources the IRS requires to handle the 
processing and disposition of tax returns, refunds, and other filing 
materials.
    We are also responsible for the fair enforcement of the nation's 
tax laws. Each year, a small percentage of taxpayers file erroneous 
returns or, for reasons both innocent and less benign, fail to file a 
return at all. The IRS conducts enforcement activities using a variety 
of methods, including correspondence audits, matching reporting 
documents (such as Forms W-2) to information on taxpayer returns, in-
person audits, criminal investigations of those suspected of violating 
tax laws, and participation in joint governmental task forces. The IRS' 
examination, collection, investigations, regulatory compliance, and 
research activities funded in the TAO appropriation provide the 
resources required for equitable enforcement of the tax code and the 
investigation and prosecution of individuals and organizations that 
circumvent tax laws.

Business Systems Modernization (BSM)
    The IRS tax administration system, which collects $2 trillion in 
revenues annually, is critically dependent on a collection of 40-year-
old, obsolete computer systems. Recognizing the long-term commitment 
needed to solve the problem of modernizing these antiquated systems, 
Congress and the Administration created a special business systems 
modernization account. They designed the BSM program to bring the IRS' 
business systems to a level equivalent with best practices in the 
private and public sectors while managing the risks inherent in a 
program that is unquestionably one of the largest, most visible, and 
most sensitive modernization programs ever undertaken.
    In 2004, the modernization budget was $387 million. Based on the 
challenges the modernization program was facing, we realized the 
program needed to be smaller in 2005 so we requested a lesser budget of 
$285 million. In the end, Congress appropriated $203 million. One of 
the ways we are accommodating these changes is by substantially 
lowering the costs of the core infrastructure as well as the 
architecture, integration, and management parts of the BSM program in 
2005. These two areas are the programmatic elements of the program, and 
cost $160 million in FY 2004. We certainly cannot justify that level of 
continued investment for a program that is roughly $200 million. 
Therefore, we are dramatically reducing those core services to $107 
million in FY 2005 and we anticipate making additional reduction in FY 
2006. For FY 2006, we request funding of $199 million for all BSM 
activities, substantially the same funding as the FY 2005 appropriated 
level.
    Our most successful year ever for the modernization program was 
2004; we measured our success by the number of projects we delivered, 
the schedule and cost targets we hit, and the substantial improvements 
we made in program management.
    We delivered the first release of the Customer Account Data Engine 
(CADE) project in July 2004, allowing the IRS to process an initial set 
of the simplest tax returns on a new computer system for the first time 
in 40 years. We launched IRS' new Integrated Financial System (IFS), 
and declared it the IRS' financial accounting system of record. IFS 
will provide the capability for improved timeliness and accuracy of the 
financial reports and information available to IRS management and key 
stakeholders, facilitating continued clean financial audit opinions of 
the IRS. We deployed a full suite of e-Services products, providing tax 
professionals and businesses with new Web-based tools that dramatically 
improve their interface with the IRS. Additionally, we released 
Modernized e-File, whereby corporations and tax-exempt organizations 
can file their annual income tax and information returns 
electronically.
    We have also made significant improvements in our cost estimating 
and scheduling. In the Fall and Winter of 2003, we re-baselined the 
cost estimates and delivery schedules for each of the BSM program 
projects. Since then, we have shown a marked improvement in 
significantly reducing our variances between cost estimates and actual 
delivery costs from 33 percent in 2002 to 4 percent in 2004.
    In terms of improving program management, we identified four key 
areas that we had to address to enhance the performance of the 
modernization program:

      Resizing our modernization efforts to better align with 
our management and skill capacity;
      Engaging IRS business units to drive the modernization 
projects with a business focus;
      Improving contractor performance on cost, schedule, and 
functionality; and
      Hiring outside executives to achieve a better balance 
between large project management and tax administration experience.

    We have made significant progress in addressing each of these major 
challenges.
    First, the IRS will concentrate on a few key projects and will 
develop a track record of improved management and successful delivery 
of modernization projects.
    Second, the IRS assigned a business unit leader to each project 
with responsibility for leading the related BSM Governance Committee, 
and sharing accountability for delivering the modernization project as 
stated in their annual performance commitments.
    Third, we are making real progress in improving the accountability 
of the PRIME contractor. I meet monthly with the Chief Operating 
Officer of the Computer Sciences Corporation (CSC) to reinforce the 
accountability of the contractor to the IRS. Additionally, we have made 
major progress in restructuring BSM project contracts with the PRIME 
that shift an appropriate amount of financial risk to the contractor 
and tie costs to performance. These steps have resulted in improved 
contractor performance, as demonstrated in the deliverables in 2004 and 
the general adherence to costs and schedules.
    Fourth, we have made great progress in hiring experienced 
executives and seasoned managers from outside the agency who have 
expertise in running large-scale information technology programs and 
projects. A little over a year ago the mix of leadership at the top of 
the BSM program consisted of one outside expert and six internal IRS 
executives. Today, that mix will soon be five outside experienced 
outside experts and three internal IRS executives. This mix is a much 
better balance of the project management and technology talent and tax 
administration experience needed to successfully run the BSM program.
    While we were very successful in 2004, we have a lot of work ahead 
of us. It is critical that we continue this level of performance in 
2005 and beyond.
    Our focus for FY 2005 is on maintaining substantial modernization 
work for three key tax administration systems that will provide 
additional benefits to taxpayers and IRS employees, specifically:

      The Customer Account Data Engine (CADE) project;
      Modernized e-File; and Filing and
      Payment Compliance (F&PC).

CADE
    CADE replaces the IRS' antiquated system called the Master File 
which is the Service's repository of taxpayer information. With CADE 
being the core fundamental component of the modernized systems, it is 
the IRS' highest priority technology project.
    We cannot over-emphasize the importance of CADE. The current Master 
Files have served the IRS for more than 40 years. However, they were 
developed in a different era and rely on an obsolete programming 
language and a flat-file system that still requires batch updates. 
These systems are very expensive to maintain; development of new 
applications costs the IRS two to three times what it would cost if 
they were already retired. Yet the IRS must update the Master Files 
every year to take into account tax law changes. As importantly, the 
vast majority of the workforce who are familiar with these old systems 
will be retiring over the next few years and we cannot hire individuals 
with these obsolete skills. Until the Master Files are replaced, the 
IRS can not offer service approaching what a typical financial services 
firm offers today (such as full account views for employees and real-
time account updates and settlement).
    The returns we are processing in CADE are the most basic of 1040EZ 
forms and have a narrow range of taxpayer information, but it marks the 
first time since the 1960s that the IRS has processed individual tax 
returns in a new way. The success of CADE proves that we can deliver 
technology that will process tax returns on a 24-hour cycle, breaking 
the 40-year old standard of processing on a weekly cycle. As of April 
11, 2005, CADE had processed 1.1 million returns and generated nearly 
$354 million in refunds to taxpayers. This achievement is significant. 
CADE will process over 1.3 million 1040EZ tax returns by the end of the 
2005 filing season.
    The CADE system is scheduled to be phased in over several years, 
processing increasingly more complex tax returns. When fully 
operational, CADE will be a modern database that will house tax 
information for more than 200 million individual and business tax 
returns. It will provide a variety of benefits to taxpayers, such as 
faster refunds (by over 50 percent) along with daily postings of 
transactions and updating accounts, which (with other technology 
elements) will significantly improve customer service and enforcement. 
With CADE, we will have the flexibility necessary to respond quickly to 
our complex tax law and tax reform changes.
    One of the most significant changes that we introduced in 2004 was 
the segmentation of CADE releases into two annual deliveries--one in 
July and one in January. The July delivery will involve higher risk, 
more complex functionality, and the January delivery will include 
filing season changes combined with additional changes as capacity 
permits. For the July release, returns will be available from the 
previous six months which will enable us to test the higher risk, 
complex changes with high volumes, and then go live with reduced 
volumes, which will mitigate the operational risks.

Modernized e-File
    Modernized e-File will provide a single point Federal/State filing 
option for Forms 1120, 1120S (corporations) and 990 (tax-exempt 
organizations) returns in many states via a Web Services interface. Our 
work on Modernized e-File will be comprised of Release 3.1, which 
includes additional Forms 1120, 7004 (Application for Automatic 
Extension of Time to file Corporation Income Tax Return) and 990, and 
tax law changes for filing season 2004. Release 3.1 deployed initial 
operating capabilities on schedule on January 10, 2005. Release 3.2 
will provide an interface with state tax information retrieval systems 
and a redesign of the signature matching process for Form 8453 (U.S. 
Individual Tax Declaration for Electronic Filing).

Filing and Payment Compliance/Private Collection Agencies
    In 2004, Congress passed the American Jobs Creation Act, allowing 
the IRS to use Private Collection Agencies (PCAs). The legislation 
authorized the IRS to augment our collection efforts by allowing us to 
use PCAs to pursue what has been deemed as uncollectible tax 
liabilities; these agencies will not have enforcement authority and 
will only contact delinquent taxpayers to arrange voluntary, full-
payment installment agreements. We will use the Filing and Payment 
Compliance (F&PC) system to analyze tax collection cases and divide the 
complex cases requiring direct IRS involvement from the simple 
``balance due'' cases that can be handled by PCAs. The use of PCAs is 
to supplement--not supplant--current IRS personnel. Quite frankly, this 
activity is geared for an inventory that the IRS currently can not 
chase with existing resources.
    PCAs will benefit the IRS in three major ways:

    1.  PCAs will help reduce the significant and growing amount of tax 
liabilities deemed uncollectible.
    2.  PCAs will help maintain taxpayer confidence in our tax system.
    3.  PCAs will allow the IRS to focus on more difficult cases and 
issues.

    We expect to issue a Request for Procurement (RFP) in the next 
several weeks. We plan to award contract in June 2005, to begin an 
initial limited release of the uncollected tax inventory in January 
2006. We provided all interested parties notification via the IRS.gov/
Business Opportunity webpage and electronic letters.
    Safeguarding taxpayer rights is paramount. The same IRS standards 
for customer service and protection of taxpayer rights will be strictly 
enforced. PCAs will be prohibited from threatening or intimidating 
taxpayers or implying that enforcement action will be taken against 
them. Specific safeguards to protect the taxpayer include:

      Fair Debt Collection Practices Act protections;
      Protections against unauthorized disclosures;
      Assistance from the National Taxpayer Advocate; and,
      Protections with respect to third party contacts, 
installment agreements and communications.

    The IRS expects to place cases with PCAs using the following 
criteria:

      The taxpayer does not dispute the liability;
      The liability is reportable on the Form1040 series of 
returns;
      The balance due is greater than $100; and,
      The case does not involve a restriction on collection or 
otherwise indicate that discretion or enforcement action may be 
required to resolve the liability.

    The delivery of the CADE project was a major milestone, but we 
still have a long way to go and a lot of work ahead of us as we 
introduce technology changes and expand into processing more complex 
tax returns at greater volumes. To that end, we recognize that a 
project of this complexity must continually look at new technologies 
that can support the level of development and implementation 
productivity needed for a project of this scale.
    We certainly hope, and expect, that we will build on the successes 
of 2004, and we will continue to mature the modernization program by 
gaining a solid reputation for on-time deliveries with high 
productivity.

Health Insurance Tax Credit Administration (HITCA)
    In August 2002, the President signed Public Law 107-210, the Trade 
Act of 2002, which, among other things, provides a refundable tax 
credit for the cost of health insurance for certain individuals who 
receive a trade readjustment allowance or a benefit from the Pension 
Benefit Guaranty Corporation (PBGC). The Health Insurance Tax Credit 
Administration (HITCA) Appropriation funds the costs to administer a 
refundable tax credit for health insurance to qualified individuals. 
The tax credit is equal to 65 percent of the health insurance premium 
paid by eligible persons for themselves and qualifying family members. 
For FY 2006 we request funding of $20,210,000, a decrease of 41.5 
percent below the FY 2005 appropriation of $34,562,272. Costs for the 
HITCA program have declined since implementation due to our active 
program oversight and management, as well as several cost-cutting 
initiatives we began to implement in March 2004. We developed a 
comprehensive action plan outlining cost-reduction initiatives and are 
following it to achieve these significant savings.

Program Performance
    The IRS expects to achieve the following levels of performance 
after attaining full performance of the requested FY 2006 initiatives:

      Increase in field examinations for high-income 
individuals with complex returns; significant increase in collection 
processed; and closing of over 40 percent more delinquent balance-due 
accounts in FY 2008 than in FY 2004.
      Nearly double the audit coverage for individuals with 
income between $250,000 and $1 million, from 1.5 percent in FY 2004 to 
2.8 percent in FY 2008.
      Auditing 15 percent more individuals earning above $1 
million, from 3.4 percent projected for FY 2004 to 3.9 percent in FY 
2008.
      Significantly more collection cases processed, closing 50 
percent more delinquent accounts in FY 2008 than FY 2004.
      Double the audit coverage for mid-size corporations, from 
7.6 percent in FY 2004 to 16 percent in FY 2008.
      Increased efforts to deter abusive tax shelters among 
corporations.

Legislative Proposals
    The President's FY 2006 request includes several proposals that 
will assist me in managing the agency more efficiently and effectively. 
These proposals, if enacted, will allow us to focus more resources on 
high-income, high-risk areas, automate several routine transactions, 
use electronic data to reduce costly manual transactions, consolidate 
resources related to judicial and counsel review, and broaden 
administrative authorities and accesses to support further electronic 
administration and tax reform. We are seeking to:

      Make Section 1203 of the IRS Restructuring and Reform Act 
of 1998 more effective and fair;
      Curb the use of frivolous submissions and filings made to 
impede or delay tax administration;
      Allow for the termination of installment agreements for 
failure to file returns and for failure to make tax deposits;
      Consolidate judicial review of collection due process 
cases in the United States Tax Court;
      Eliminate the monetary threshold for counsel review of 
offers in compromise;
      Allow the Financial Management Service to retain 
transaction fees otherwise paid from IRS appropriations from levied 
amounts to recover delinquent taxes;
      Extend the due date for electronically filed returns to 
provide additional incentive for taxpayers to e-file and expand the 
authority to require electronic filing by businesses and exempt 
organizations; and,
      Allow IRS to access information in the National Directory 
of New Hires for tax administration purposes.

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

                                 

    Chairman RAMSTAD. Thank you, Commissioner. Like the other 
witnesses, your complete statement will be entered into the 
record. I know you have another commitment at four o'clock, so 
I am going to be very brief, and then yield to my Ranking 
Member. I understand, given the budget constraints, you are 
going to be forced to close approximately 70 of the 400 
Taxpayer Assistance Centers (TACs) around the country, 
including three in my own home State of Minnesota. Without 
these centers taxpayers in certain areas will be deprived of 
face-to-face interaction with the IRS, as you know. At the same 
time the Taxpayer Advocate has raised concern about the ability 
of taxpayers to interact with people in authority at the IRS by 
phone. In your judgment, Commissioner, what impact will the 
closure of these TACs have on taxpayers, and how does the IRS 
plan to improve service in other areas to compensate for the 
closing of the TACs?
    Mr. EVERSON. As I indicated, Mr. Chairman, we have been 
asked to do a little bit of belt tightening in this area. We 
are working to continue to drive the demand into the phones 
where you get the best answer. If someone has a question on the 
Tax Code, which is so complicated, the best place to get an 
answer is from the phone lines where your question gets routed 
to someone who understands that area of the law very 
specifically. We are also directing people to the website. That 
change is comparable in many ways to what you see happening in 
other States such as, where I live, Virginia. You can't go to 
the library any more and get a Virginia tax return form. That 
just isn't provided any more. It has all migrated to telephones 
or print on demand off on the web.
    We are trying to be as responsible as we can. Congressman 
Lewis, I have seen your letter. We are going to respond to you 
very quickly. We have gone through a modeling process here, 
which takes into account five different factors. Cost is 
certainly one of them, but so are geography, demographics and 
workload. The whole thing is depicted here. We have come up 
with two different proposals. One would close 67 sites. The 
other would close 105. The difference between the two is really 
the difference between weighting cost and weighting things like 
workload. If you weight workload, you tend to shutter more of 
the smaller centers out in the rural States. We need to work 
hard to continue to work on the phones. We also need to work on 
the volunteer sites. We have got 14,000 Volunteer Income Tax 
Assistance (VITA) sites, volunteer sites, around the country, 
where good community activists get out there and help people 
with their taxes as well.
    [The exhibits follow:]

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    [GRAPHIC] [TIFF OMITTED] T4767A.006
    

                        ------------------------

    Chairman RAMSTAD. The other question I have, Commissioner, 
I know the IRS has an inventory of roughly $280 billion in 
unpaid tax assessments, not your Agency's fault, but a large 
percentage of this $280 billion is in a deferred status because 
I know you lack the resources at the IRS to pursue collection. 
Last year, as you know, we enacted legislation to allow you to 
use Private Collection Agencies (PCAs). My question is how soon 
will the IRS be in a position to get these PCAs, these 
contractors up and running, or as they say, up and collecting?
    Mr. EVERSON. This is a very important question for us. This 
is an important new authority. It is one that is enjoyed by 
over 40 States that use PCAs. Of paramount importance to us is 
that we use it responsively, and accordingly, we are proceeding 
very deliberately. Probably later this year, about June, we 
will let the initial contracts to some of the providers, but we 
need to do some systems work before the collections begin. If a 
contractor contacts you because you owe us money, but you have 
already sent us a check in the last few days, we want to make 
sure that is recorded correctly. We need to do some systems 
work to achieve this level of timeliness. So, I would suggest 
sir, that the collections themselves will probably start very 
early January or so of next year.
    Chairman RAMSTAD. Thank you, Commissioner. The Chair 
recognizes Mr. Lewis.
    Mr. LEWIS. Thank you very much, Mr. Chairman. Thank you, 
Mr. Commissioner, for being here and for your testimony. I want 
to be very brief also, like the Chairman, and follow up on this 
whole idea of the shut down of some centers.
    Mr. EVERSON. Sure.
    Mr. LEWIS. Will they start very soon? I think I heard maybe 
as early as September.
    Mr. EVERSON. They would start in the fall, sir, in order to 
realize the savings that we have embedded in the request. That 
is correct. Closures would start in this coming fall.
    Mr. LEWIS. Are you planning--maybe this was in my letter--
are you planning to shut down any operation in my State of 
Georgia, or in the city of Atlanta? Atlanta and the State of 
Georgia are growing so fast; there are a lot of people in 
Metropolitan Atlanta. The population is now moving toward 4 
million in the metropolitan area.
    Mr. EVERSON. I believe, sir, that Georgia is included on 
that list. I will make a very general comment, that if you look 
at nearly any model for closing these centers--and there are 
over 400 of these centers at present--the models tend to 
shutter more centers on the East Coast and in the Midwest. That 
is comparable to what has changed in the demographics of the 
country with people moving more toward California or into 
places like Texas. You do get a disproportionate impact on the 
eastern areas.
    Mr. LEWIS. Is it true that a computer picked the sites to 
be shut down?
    Mr. EVERSON. It is absolutely true. These sites were picked 
based on the model that was developed that had some three dozen 
factors. As I said, we used all those factors because we want 
to be scrupulously fair so that there is not some inference 
that we don't like you or we want to protect the appropriators 
which would actually, probably be a sensible thing to do.
    [Laughter.]
    Mr. EVERSON. So, what we have done is use the model and we 
are happy to take you through that model, sir. I will come up 
and do that myself if you wish, to make sure you think it is 
fair. Let me make one additional point on this subject. I 
talked about constraining language. I want you to know that if 
there is constraining language written in the Appropriations 
bill that says, ``Don't shutter these centers,'' it just gets 
harder for us. We will have to cut back in other areas, which, 
we think, would be even more damaging.
    Mr. LEWIS. This will be my final question, Mr. Chairman. 
How many times has the IRS revoked the tax exempt status of 
organizations in the past 10 years, or since you have been the 
Commissioner?
    Mr. EVERSON. It is my understanding that we have not had a 
lot of revocations. It is a relatively small number, yes, sir.
    Mr. LEWIS. Thank you very much, Mr. Chairman.
    Chairman RAMSTAD. The Chairman recognizes the distinguished 
gentleman from North Dakota, Mr. Pomeroy.
    Mr. POMEROY. Thank you, Mr. Chairman, Ranking Member. I 
would note for the Subcommittee, this being our initial 
hearing, in particular that each of you have enormous shoes to 
fill, and of course, Amo Houghton we miss as our Chairman; I am 
told the last Ranking Member was something else too.
    [Laughter.]
    Mr. EVERSON. You missed my remarks. I said we feel jilted.
    [Laughter.]
    Mr. POMEROY. I am very pleased to be back on this 
Subcommittee, and we are very proud of Rob Portman, all of us 
are, that he has been chosen to ascend to the Ambassador rank 
as U.S. Trade Representative, and I would observe for the 
record that of Members of the--the Subcommittee on Oversight is 
the one that really has to pay attention to the nitty-gritty 
details of revenue collection in this country, and we will work 
closely with the IRS as that moves forward. I don't think any 
Member of the Congress has been more diligent in this regard 
than Rob Portman.
    Mr. EVERSON. Yes.
    Mr. POMEROY. As he moves to the executive branch we will 
have to pick up the slack. We are going to miss him. I have 
like five areas of inquiry, all rather quick. First, I was very 
pleased to see that the issue of conservation reserve program 
income, for retired farmers, as part of a broader issue of the 
tax treatment of this kind of program payment to retired 
farmers not actively working their land, was part of your 
priority work list, and I am wondering how that is coming 
along.
    Mr. EVERSON. It is on that list, the guidance list. As you 
know, there was a collision with the American Jobs Creation Act 
(P.L. 108-357) that caused the revision of that list to make 
sure we get out some very pressing guidance. It is still an 
active part of that list and receiving our attention.
    Mr. POMEROY. Good. This will be the second tax year we have 
gone into this circumstance. I know that you are a man of your 
word and I simply hope that that doesn't in the end----
    Mr. EVERSON. I will ask how it is going.
    Mr. POMEROY. Thank you.
    Mr. EVERSON. That always helps.
    [Laughter.]
    Mr. POMEROY. That is great. That is why I love being on 
this Subcommittee. An issue that I have been very interested in 
is the Savers Credit which is a savings incentive for modest 
income households, and the tax data from the last couple of 
years show that it has been very effective in '02 and '03 in 
terms of generating those applying for this credit. Now in 
order to qualify they had to make a contribution, a qualifying 
contribution to a savings account, and we show over the last 
couple of years about 5 million a year have done that. Now if 
that truly represents 5 million new retirement savings accounts 
the first couple years of this program, I think we are off to a 
good start. Unfortunately, it expires and if the administration 
allows it to expire, we will have to wrestle with this one in 
Congress. Do you have any observations in terms of whether the 
Savers Credit is functioning well?
    Mr. EVERSON. Frankly, I have not had any conversations 
indicating one way or the other, from a tax administration 
impact, how this is functioning. It has not bubbled up as an 
issue, like the earned income tax credit (EITC), which is so 
controversial. That has not been the case, nor like the health 
coverage tax credit, which has had a very slow start, as you 
know.
    Mr. POMEROY. One of the things that we are intrigued with 
is we couldn't reauthorize it and improve it by having the 
refund eligible for direct deposit into the savings account, as 
opposed to distribute it to the taxpayer. I understand that 
technically this is now possible. Do you have an evaluation?
    Mr. EVERSON. We have looked. There is a comparable issue 
about split refunds that is coming up on the returns. Some of 
this work does take further investment in technology. As you 
know, despite your active efforts, we haven't always received 
as much money from the Congress as the Administration has 
requested. This does have an impact, particularly in a systems 
area, so that is a constraint. On this particular matter I 
would have to check and see about it.
    Mr. POMEROY. I would appreciate it if you would check and 
let us know what we need to do to make it work. I think that 
would be important. My final question involves--there was a 
news report that was quite interesting, and it was those using 
refund loans, which is a subprime lending activity that I think 
is generally scurrilous and overcharged, and varies 
significantly in different parts of the country. I know that in 
the past we have talked about this issue in the context of e-
filing partners. The IRS, they would e-file without charge, but 
they would then be a vendor for their services, and I felt 
under that circumstance that the Service has a private partner, 
it ought to do some due diligence in terms of the quality of 
product sold. The fact that we are seeing substantially 
different take-up rates depending on which part of the country 
you are from tells me this is at least as much about marketing 
and information to the taxpayer as it is broad generic need for 
this kind of service. I am wondering if this is something the 
IRS is concerned about.
    Mr. EVERSON. It could be about marketing. I don't have a 
defined position on that, but if you look across the country, 
e-filing varies dramatically by State. You get some States with 
relatively low rates of e-filing. Connecticut is relatively 
low, Iowa very high. So, there are geographic differences 
across all of these issues, and I don't know if there is a 
correlation along the lines that you are suggesting. We can 
certainly look at it. The Free File Alliance--I think you are 
hearing from them later--has been tremendously successful and 
is increasing the use of e-file. We are reaching the end of the 
initial period, and we will be reviewing the program with the 
20-some companies that have worked on it as this filing season 
comes to an end.
    Mr. POMEROY. Do you have a way of capturing, besides from 
the e-file part--I know my time--just a quick follow-up, Mr. 
Chairman. Thank you for indulgence. Do you have a way of 
capturing the refund loan information beyond your e-file 
partners?
    Mr. EVERSON. We don't regulate those loans. That is not the 
job of the IRS. If it is in regulations, it is States or other 
Federal regulations with which I am not familiar. I don't like 
them. I am not suggesting that Refund Anticipation Loans (RALs) 
are a good thing. Our answer to that is electronic filing, and 
if somebody electronically files they get their refund back in 
half the time. It is even quicker if they use the direct 
deposit option, which takes a week off of it. So, I don't want 
you to misinterpret the fact that I am sticking up for refund 
loans. I am not. I would like to see that taken off the table 
at some point.
    Mr. POMEROY. Would the Service send to the Committee or at 
least to my office the participants in your e-file partnership 
and----
    Mr. EVERSON. Absolutely----
    Mr. POMEROY. The services that they are then selling to 
Members? In addition to that, any inquiry, if any, by the IRS 
about the general suitability of those services, recognizing 
that some of this lending activity is duly regulated in other 
sectors?
    Mr. EVERSON. Sure. We can certainly do that.
    [The information follows:]

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                        ------------------------

    Mr. POMEROY. Thank you. Thank you, Mr. Chairman. Great to 
work with you again.
    Mr. EVERSON. Nice to see you. I promised a visit to North 
Dakota, I know, but do I have to go to Georgia first now? I am 
not sure how that works.
    [Laughter.]
    Mr. POMEROY. The Commissioner did agree to come to North 
Dakota, but it was qualified. He said not in the winter.
    Chairman RAMSTAD. We all know he is a very smart man. The 
Chairman now recognizes the distinguished gentleman from New 
York, Mr. Reynolds.
    Mr. REYNOLDS. Commissioner Everson, thank you for being 
here today, and I look forward to working with you on a variety 
of issues in the 109th Congress. I am particularly interested 
in your testimony regarding the IRS plans to partner with PCAs. 
As you know, many of us in Congress worked hard last year to 
ensure that the Jobs Bill, which President Bush signed into law 
last October, include a limited and carefully crafted provision 
authorizing PCAs to assist the IRS in collecting delinquent tax 
debt. Although some critics of the partnership argued that 
taxpayer rights would be greatly threatened by permitting PCAs 
to play limited supplementary role to IRS collection efforts, 
isn't it true that the new law would include the important 
safeguards to ensure that taxpayer rights are protected, and 
could you elaborate on some of those key safeguards?
    Mr. EVERSON. Yes, sir, you are absolutely right. We started 
to talk about this a moment ago. We are proceeding very 
deliberately on this. We recognize that we will get one shot at 
this. We can't blow this. We are going to respect taxpayer 
rights; the same standards of the Fair Debt Collections Act 
(P.L. 104-208) apply here. Also, the same standards that affect 
our own employees will apply. The Treasury Inspector General 
for Tax Administration (TIGTA) which is the independent 
inspector general, is going to be auditing this program as we 
build it up. I can only assure you that we will use this 
authority responsibly. It really gives us a terribly important 
benefit though. We are underfunded in this area, and as anybody 
who gets involved in debt can tell you, the longer you wait, 
the harder it is to get the money. This authority will help us 
speed up the process, and that is a good thing in terms of 
bringing in the revenues we need to bring in.
    Mr. REYNOLDS. Just building further on the PCA issue, your 
testimony notes that the so-called tax gap, the difference 
between what U.S. taxpayers are supposed to pay and what they 
actually pay, grew between $311 billion and $353 billion in 
2001, and the IRS enforcement efforts that year, coupled with 
late payments, did manage to bring the net tax gap back down to 
between $257 billion and $298 billion. I am sure that you will 
agree those figures are still totally unacceptable for what we 
are looking at. So, I guess the question is, do you believe, as 
I do, that the PCAs can play that useful role in closing the 
tax gap with the provisions of where we are set forth, and now 
you implementing the procedures that you just outlined?
    Mr. EVERSON. Yes, sir. I believe that they will be an 
important component in increasing further the direct 
enforcement revenues that we already are building up through a 
variety of processes, increased examinations, the audits we are 
doing, increased collection efforts. This just shows you that 
these are the moneys that we get from audits, from collection 
efforts and from document matching. We brought that up from 
$33.8 billion three years ago to $43.1 billion. The collection 
agencies will help significantly.
    [The chart follows:]

    [GRAPHIC] [TIFF OMITTED] T4767A.008
    

    Mr. REYNOLDS. I thank the Commissioner. Mr. Chairman, thank 
you.
    Chairman RAMSTAD. Thank you, Commissioner, and again, we 
are sorry for the delay. Thank you for your testimony.
    Mr. EVERSON. For me it is just a question of point and 
shoot this time of the year. They tell me where to go, and, you 
know.
    [Laughter.]
    Chairman RAMSTAD. I will look forward to seeing you again.
    Mr. LEWIS. Mr. Chairman, just before the Commissioner 
leaves, I would like to ask unanimous consent that additional 
questions be submitted for the hearing record. At this point I 
would like to submit questions from Representative Neal and 
Emanuel about the IRS plan to close the TACs.
    Chairman RAMSTAD. Without objection, so ordered.
    [The information was not received at the time of printing.]
    Thank you, Commissioner. The second panel consists of IRS 
Oversight Board Chairman Ray Wagner and GAO Director of Tax 
Issues, James White. Gentlemen, welcome, and the same apologies 
are apropos in your cases. Thank you for your patience. Thank 
you for your service. You may proceed, and as I said, your 
complete statements will be entered into the record.

 STATEMENT OF JAMES R. WHITE, DIRECTOR, STRATEGIC ISSUES, U.S. 
   GOVERNMENT ACCOUNTABILITY OFFICE; ACCOMPANIED BY DAVID A. 
  POWNER, DIRECTOR, INFORMATION TECHNOLOGY MANAGEMENT ISSUES, 
             U.S. GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. WHITE. Mr. Chairman and Members of the Subcommittee, I 
am pleased to participate in today's hearing. Since passage of 
the IRS Restructuring and Reform Act of 1998 (P.L. 105-206), 
IRS has improved taxpayer service, achieved efficiency gains 
and implemented some modernized information systems. However, 
the progress has not been uniform. The IRS' enforcement 
programs declined after 1998. Despite a recent up-tick in 
enforcement staffing, it is not back to what it was. A number 
of systems modernization projects are over-budget and behind 
schedule. The IRS is shifting its priorities, and tending to 
better address these problems. First, IRS is asking for an 8-
percent increase for enforcement for 2006, about $500 million. 
Second, IRS is proposing a 1 percent cut in spending on 
taxpayer service, although when cost increases are factored in, 
the real cut will be larger. To absorb the cut, IRS is 
proposing to reduce its teleph1 hours, has already reduced its 
telephone accessibility goal, and is proposing to reduce walk-
in sites. These reductions might have been larger except for 
noticeable efficiency gains, especially in processing tax 
returns. Third, IRS is proposing a small cut in its BSM budget, 
intending to focus on its highest priority projects and 
shifting significant program management responsibilities from 
contractor staff to IRS staff. Although there are sound reasons 
for the shifts in priorities, they also involve risks. One 
risk, as IRS shifts its priorities toward enforcement, is that 
some of the recent gains in taxpayer service could be 
surrendered. Another risk with BSM is more cost overruns, 
scheduled delays and postponed improvements for taxpayers. Mr. 
Chairman, if IRS starts surrendering some of its improvements 
to taxpayers service, we could revert to a swinging pendulum, 
where enforcement gains are achieved at the expense of 
taxpayers service and vice versa.
    Several steps could help avoid the swinging pendulum. One 
is to agree on long-term goals for IRS. The IRS is developing, 
but has not yet released such goals. Without long-term goals it 
is difficult to assess IRS' budget request or hold IRS 
management accountable. Long-term goals would make priorities 
clearer. For example, the budge request proposes some rollback 
in both telephone and walk-in service but does not provide 
details. What are IRS' taxpayer service goals? Are telephone 
and walk-in service equal priorities, or is one more important? 
Through mid March, IRS answered over 23 million telephone 
calls. About 9 percent as many taxpayers walked in. Another 
step to avoid a swinging pendulum is to review the menu of 
services that IRS provides to see if it is possible to maintain 
overall service to taxpayers, but at lower cost. The IRS has 
added one item to its service menu, Internet service, that now 
is used by tens of millions of taxpayers to get forms and 
information, access the Free File system, and learn the status 
of their refunds. Another menu item, telephone service, is 
noticeably improved. Despite reduced funding, telephone 
accuracy is improved and access is about the same. These new 
and improved services open up the possibility of maintaining 
overall service to taxpayers while cutting some items on the 
menu. The new or improved services might offset cuts in other 
areas. Targeting cuts requires criteria. Criteria might include 
duplication of services, cost per taxpayer served, and whether 
usage is declining. Options that fit some of these criteria 
include reducing walk-in sites and limiting certain types of 
calls. I call these options because these are not 
recommendations. There are tradeoffs.
    A third step to help avoid a swinging pendulum is to 
succeed at BSM. Business Systems Modernization is critical to 
good taxpayer service and enforcement. It allows, for example, 
taxpayers to file and retrieve information electronically, and 
provides technology solutions to the backlog of collection 
cases. For several years we have stated concerns about IRS's 
schedule and cost estimating, citing weaknesses in management 
controls and capabilities. We have made recommendations to 
improve BSM management and IRS has implemented or has begun to 
implement them. Today, the BSM program is undergoing 
significant changes as it adjusts to budget reductions, 
reductions due to congressional concerns about cost overruns 
and schedule delays, and a desire to have IRS focus on its 
highest priority projects, particularly the Customer Account 
Data Engine (CADE). It is too early to tell what effect the 
reductions will have on BSM. According to the new associate 
Chief Financial Officer (CFO) for BSM, IRS is redefining and 
refocusing the BSM program. In summary, IRS will be challenged 
to maintain the quality of service while shifting resources to 
enforcement. Success will require smart management and success 
at BSM. Mr. Chairman, this concludes my statement. I would be 
happy to answer questions.
    [The prepared statement of Mr. White follows:]

  Statement of James R. White Director of Tax Issues, U.S. Government 
                         Accountability Office

    Mr. Chairman and Members of the Subcommittee:
    We are pleased to participate in the Subcommittee's hearing on the 
Internal Revenue Service's (IRS) fiscal year 2006 budget request and 
performance during the 2005 tax filing season.
    IRS is in the midst of making significant adjustments to its 
modernization strategy to better serve taxpayers and ensure their 
compliance with the nation's tax laws. It is now seven years since the 
passage of the Internal Revenue Service Restructuring and Reform Act of 
1998 (RRA 98) \1\ and IRS is shifting its priorities from improving 
taxpayer service to strengthening tax law enforcement efforts. IRS is 
also adjusting its strategy for managing its Business Systems 
Modernization (BSM) effort by shifting significant program management 
responsibilities from contractor to IRS staff. Although there are sound 
reasons for these adjustments, they also involve risk.
---------------------------------------------------------------------------
    \1\ Pub. L. No. 105-206 (1998).
---------------------------------------------------------------------------
    We have reported that IRS has made progress improving taxpayer 
service since the passage of RRA 98.\2\ For example, IRS's telephone 
assistance is now more accessible and accurate. Further, IRS is more 
efficient at processing tax returns, in part, because of the growth of 
electronic filing, and has cut processing staff. IRS has also 
implemented some modernized information systems and increased its 
capacity to manage large systems acquisition and development programs.
---------------------------------------------------------------------------
    \2\ See for example, GAO-05-67, Tax Administration: IRS Improved 
Performance in the 2004 Filing Season, But Better Data on the Quality 
of Some Services Are Needed (Washington, D.C.: Nov. 15, 2004).
---------------------------------------------------------------------------
    However, progress has not been uniform. We have reported on large 
and pervasive declines in IRS's tax law enforcement programs after 
1998. We have also reported that a number of systems modernization 
projects were over budget and behind schedule.\3\
---------------------------------------------------------------------------
    \3\ GAO, Internal Revenue Service: Assessment of Fiscal Year 2005 
Budget Request and 2004 Filing Season Performance, GAO-04-560T 
(Washington, D.C.: Mar. 30, 2004).
---------------------------------------------------------------------------
    As noted, IRS is shifting its priorities to better address these 
problems. The risk, as IRS shifts its priorities towards enforcement, 
is that some of the gains in the quality of taxpayer service could be 
surrendered. There are analogous risks associated with moving more of 
the management of BSM in-house.
    With these risks in mind, our statement discusses both IRS's fiscal 
year 2006 budget request and 2005 filing season performance to date. To 
address your request, we assessed (1) how IRS proposes to balance its 
resources between taxpayer service and enforcement programs and the 
potential impact on taxpayers, (2) the status of IRS's efforts to 
develop and implement the BSM program, and (3) the progress IRS has 
made in implementing best practices for developing its information 
technology (IT) operations and maintenance budget. With respect to the 
interim results of key 2005 filing season activities, we compared IRS's 
performance to past years' and goals it set for this year.
    Our assessment of the budget request and BSM is based on a 
comparative analysis of IRS's fiscal year 2002 through 2006 budget 
requests, funding, expenditures, other documentation, and interviews 
with IRS officials. Our assessment of the interim results of the filing 
season is based on comparing IRS's performance this year to previous 
filing seasons, viewing operations at a processing center, call sites, 
and walk-in sites, monitoring various production meetings, interviewing 
IRS and Treasury Inspector General for Tax Administration (TIGTA) 
officials and paid tax practitioners and other external stakeholders, 
reviewing TIGTA and other external reports, and reviewing IRS's Web 
site. For both assessments, we used historical budget and performance 
data from reports and budget requests used by IRS, Department of 
Treasury, and Office of Management and Budget (OMB). In past work, we 
assessed IRS's budget and performance data.\4\ Since the data sources 
and procedures for producing this year's budget and performance data 
have not significantly changed from prior years, we determined that the 
budget data and filing season performance data were sufficiently 
reliable for the purposes of this report. The budget and performance 
data for fiscal years 2005 and 2006 are subject to change. Regarding 
our analysis of IRS's BSM program, we primarily used the agency's BSM 
expenditure plans to determine the status of the program. To assess the 
reliability of the cost and schedule information contained in these 
plans, we interviewed applicable IRS officials to gain an understanding 
of the data and discuss our use of that data. In addition, we checked 
that information in the plans was consistent with information contained 
in IRS internal briefings. Accordingly, we determined that the data in 
the plans were sufficiently reliable for purposes of this statement. We 
performed our work in Washington, D.C. and Atlanta, Georgia from 
December 2004 through March 2005, in accordance with generally accepted 
government auditing standards.
---------------------------------------------------------------------------
    \4\ GAO, Tax Administration: IRS Needs to Further Refine Its Tax 
Filing Season Performance Measures, GAO-03-143 (Washington, D.C.: Nov. 
22, 2002) and GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 
Financial Statements, GAO-05-103 (Washington, D.C.: Nov. 10, 2004).
---------------------------------------------------------------------------
    In summary, our assessment shows that:

      IRS's 2006 fiscal year budget request reflects a 
continuing shift in priorities from improving taxpayer service to 
strengthening enforcement efforts, but the potential impact of these 
changes on taxpayers in both the short- and long-term is unclear. IRS 
is requesting $10.9 billion, an increase of 3.7 percent over fiscal 
year 2005 enacted levels. This includes an 8 percent increase for 
enforcement, and a 1 percent and 2 percent decrease for taxpayer 
service and BSM, respectively. IRS has not finalized the details on 
where reductions in taxpayer service would occur. In addition, IRS is 
developing, but currently lacks, long-term goals that can help IRS 
inform stakeholders, including the Congress, and aid them in assessing 
performance and making budget decisions. In light of the current budget 
environment and IRS's improvements in taxpayer service over the last 
several years, this is an opportune time to reconsider the menu of 
services it provides. It may be possible to maintain the overall level 
of assistance to taxpayers by changing the menu of services offered, 
offsetting reductions in some areas with new and improved service in 
other areas.
      IRS has taken important steps forward towards 
implementing the BSM program by delivering the initial phases of 
several modernized systems in 2004 and early 2005. Nevertheless, BSM 
continues to be high risk because, in part, its projects have incurred 
significant cost increases and schedule delays, and the program 
continues to face major challenges. As a result of funding reductions 
and other factors, IRS has made major adjustments to the BSM program, 
including reducing the management reserve and changing the mix and 
roles of contractor versus federal staff used to manage the program. It 
is too early to tell what effect these adjustments will ultimately have 
on the BSM program, but they are not without risk, could potentially 
impact future budget requests, and will delay the implementation of 
certain functionality that was intended to provide benefit to IRS 
operations and taxpayers. Finally, the BSM program is based on visions 
and strategies developed years ago, which, coupled with the already 
significant delays the program has experienced and the changes brought 
on by the budget reductions, indicates that it is time for IRS to 
revisit its long-term goals, strategy, and plans for BSM, including an 
assessment of when significant future BSM functionality would be 
delivered. According to the Associate Chief Information Officer (CIO) 
for BSM, IRS is redefining and refocusing this program.
      IRS has made progress toward implementing investment 
management best practices that would improve its budget development and 
support for its IT operations and maintenance funding requests. For 
example, the recent release of a new accounting system included an 
activity-based cost module, which IRS considered to be a necessary 
action to implement these best practices. However, Office of the Chief 
Financial Officer officials stated that IRS needs 3 years of actual 
costs to have the historical data necessary to provide a basis for 
future budget estimates. Accordingly, they expect that IRS will begin 
using the activity-based cost module in formulating the fiscal year 
2008 budget and will have the requisite 3 years of historical data in 
time to develop the fiscal year 2010 budget.

    Our assessment of the 2005 filing season to date shows that:

      IRS has generally maintained or improved its 2005 filing 
season performance compared to last year. Electronic filing continues 
to increase, allowing IRS to continue reducing resources devoted to 
processing. However, IRS may not meet this year's electronic filing 
goal and is likely to not to meet its goal of 80 percent of all 
individual tax returns filed electronically by 2007. Access to 
telephone assistors remains relatively comparable to last year, 
although there are other indications of slippage in telephone access 
such as more abandoned calls and longer wait times. The tax law 
accuracy rate for answers provided via telephone or IRS's Web site has 
improved. IRS's performance so far in 2005 is good news, considering 
IRS received $104 million less in fiscal year 2005 than 2004 for 
taxpayer services. IRS plans to absorb this reduction, in part, by 
consolidating paper--processing operations, shifting resources from 
service to enforcement, and reducing some services--for example, 
reducing access to telephone assistors--in 2005. However, the filing 
season is not over, and whether or not IRS will achieve efficiency 
increases and the impact on IRS operations and taxpayers is not yet 
known.

IRS's Budget Request Continues to Shift Priority from Taxpayer Service 
        to Enforcement, but the Short--and Long-term Impacts on 
        Taxpayers Are Unclear
    IRS's fiscal year 2006 budget request reflects a continuing shift 
in priorities by proposing reductions in taxpayer service and increases 
in enforcement activities. The request does not provide details about 
how the reductions will impact taxpayers in the short-term. Nor does 
IRS have long-term goals; thus the contribution of the fiscal year 2006 
budget request to achieving IRS's mission in the long-term is unclear. 
Because of budget constraints and the progress IRS has made improving 
the quality of taxpayer services, this is an opportune time to 
reconsider the menu of services IRS offers.

IRS Is Proposing Reductions in Taxpayer Service and BSM and Increases 
        in Enforcement
    IRS is requesting $10.9 billion, which includes just over a 1 
percent decrease for taxpayer service, a 2 percent decrease for BSM, 
and nearly an 8 percent increase for enforcement, as shown in table 
1.\5\ As table 1 further shows, the changes proposed in the 2006 budget 
request continue a trend from 2004. In comparison to the fiscal year 
2004 enacted budget, the 2006 budget request proposes almost 4 percent 
less for service, almost 49 percent less for BSM, and nearly 14 percent 
more for enforcement.\6\
---------------------------------------------------------------------------
    \5\ IRS is proposing a new budget structure beginning in fiscal 
year 2006. The proposal would integrate support costs and the IT 
appropriation into taxpayer assistance and operations appropriation 
with eight program areas involving both taxpayer service and 
enforcement. See appendix I for information on the new budget 
structure.
    \6\ The Administration proposes to fully fund enforcement efforts 
and costs as contingent appropriations. This would be achieved by using 
one of two budgetary mechanisms that would allow for an adjustment to 
total discretionary spending for fiscal year 2006 of not more than $446 
million for IRS tax enforcement.

          Table 1: IRS Budget Summary for Key Activities, Fiscal Years 2004-2006 (dollars in millions)
----------------------------------------------------------------------------------------------------------------
                                          Fiscal     Fiscal
                                        year 2004  year 2005  Fiscal year    Percent      Percent      Percent
                                                                  2006        change       change       change
                                        (enacted)  (enacted)  (requested)  (2004-2005)  (2005-2006)  (2004-2006)
----------------------------------------------------------------------------------------------------------------
Taxpayer Service                         $3,710     $3,606      $3,567         -2.8%        -1.1%        -3.8%
----------------------------------------------------------------------------------------------------------------
Enforcement                               6,052      6,392       6,893           5.6          7.8         13.9
----------------------------------------------------------------------------------------------------------------
BSM                                         388        203         199         -47.6         -2.0        -48.7
----------------------------------------------------------------------------------------------------------------
Table 1:
Source: GAO analysis of IRS data.
Note: Numbers may not add due to rounding.

    As table 1 also shows, taxpayer service sustained a reduction of 
$104 million or 2.8 percent between fiscal years 2004 and 2005. 
According to IRS officials, the majority of this reduction was the 
result of consolidating paper-processing operations, shifting resources 
from service to enforcement, and reducing some services. IRS officials 
said that this reduction is not expected to adversely impact the 
services they provide to taxpayers but added that the agency cannot 
continue to absorb reductions in taxpayer service without beginning to 
compromise some services.
    For fiscal years 2005 and 2006, table 2 shows some details of 
changes in both dollars and full-time equivalents (FTE).\7\ Both are 
shown because funding changes do not translate into proportional 
changes in FTEs due to cost increases for salaries, rent, and other 
items. For example, the $39 million or 1.1 percent reduction in 
taxpayer service translates into a reduction of 1,385 FTEs or 3.6 
percent. Similarly, the over $500 million or 7.8 percent increase in 
enforcement spending translates into an increase of 1,961 FTEs or 3.4 
percent.
---------------------------------------------------------------------------
    \7\ According to IRS, an FTE is the equivalent of one person 
working full time for 1 year without overtime.

   Table 2: IRS Requested Changes in Funding for Taxpayer Service and Enforcement, Fiscal Years 2005 and 2006
                                                   (requested)
----------------------------------------------------------------------------------------------------------------
                                             Fiscal year 2005        Fiscal year 2006       Change fiscal year
                                                (estimated)             (requested)        2005-fiscal year 2006
                                         -----------------------------------------------------------------------
           Program activities              Dollars                 Dollars                 Dollars
                                             (in      Full-time      (in      Full-time      (in      Full-time
                                          millions)  equivalents  millions)  equivalents  millions)  equivalents
----------------------------------------------------------------------------------------------------------------
Assistance                                  $1,829      20,798      $1,806      20,160       - $23       - 638
----------------------------------------------------------------------------------------------------------------
Outreach                                       500       2,473         466       1,905        - 34       - 568
----------------------------------------------------------------------------------------------------------------
Processing                                   1,276      15,695       1,295      15,516          19       - 179
----------------------------------------------------------------------------------------------------------------
Taxpayer service                             3,606      38,966       3,567      37,581        - 39     - 1,385
  subtotal
----------------------------------------------------------------------------------------------------------------
Research                                       154       1,119         158       1,119           4           0
----------------------------------------------------------------------------------------------------------------
Examination                                  3,478      31,498       3,712      32,284         234         786
----------------------------------------------------------------------------------------------------------------
Collection                                   1,826      18,023       1,991      18,815         165         792
----------------------------------------------------------------------------------------------------------------
Investigation                                  682       4,899         767       5,250          85         351
----------------------------------------------------------------------------------------------------------------
Regulatory                                     253       1,912         265       1,944          12          32
----------------------------------------------------------------------------------------------------------------
Enforcement subtotal                         6,392      57,451       6,893      59,412         500       1,961
----------------------------------------------------------------------------------------------------------------
Taxpayer service and enforcement total       9,998      96,417      10,460      96,993         462         576
----------------------------------------------------------------------------------------------------------------
Table 2:
Source: GAO analysis of IRS data.
Note: Numbers may not add due to rounding.

    The difference between changes in dollars and FTEs could be even 
larger because of unbudgeted expenses. Unbudgeted expenses have 
consumed some of IRS's budget increases and internal savings increases 
over the last few years. Unbudgeted expenses include unfunded portions 
of annual salary increases, which can be substantial given IRS's large 
workforce, and other costs such as higher-than-budgeted rent increases. 
According to IRS officials, these unbudgeted expenses accounted for 
over $150 million in each of the last 4 years.
    An IRS official also told us they anticipate having to cover 
unbudgeted expenses in 2006. As of March 2005, IRS officials were 
projecting unbudgeted salary increases of at least $40 million. This 
projection could change since potential federal salary increases for 
2006 have not been determined.
    IRS Is Proposing $39 Million Less for Taxpayer Service, but the 
Impact on Taxpayers Is Unclear
    The budget request provides some detail on how IRS plans to absorb 
cost increases in the taxpayer service budget. IRS is proposing a gross 
reduction of over $134 million in taxpayer service from reexamining the 
budget's base and plans to use more than $95 million of it to cover 
annual increases such as salaries. This leaves a net reduction of 
nearly $39 million or 1.1 percent in the taxpayer service budget. The 
extent to which IRS is able to achieve the gross reductions will impact 
its ability to use the funds as anticipated.
    Decisions on how the $134 million gross reduction would be absorbed 
were not finalized prior to releasing the budget. According to IRS 
officials, some of the reductions would result from efficiency gains 
such as reducing printing and postage costs; however, others would 
result from reductions in the services provided to taxpayers such as 
shortening the hours of toll-free telephone service operations. The 
officials also said most decisions have now been made about general 
areas for reduction and most changes will not be readily apparent to 
taxpayers.
    Although IRS has made general decisions about the reductions, many 
of the details have yet to be determined. Therefore, the extent of the 
impact on taxpayers in the short term is unclear. For example, IRS 
plans to reduce dependence on field assistance, including walk-in 
sites, but has not reached a final decision on how to reduce services. 
Table 3 provides further detail on how IRS is proposing to reduce 
funding and resources for taxpayer service.

 Table 3: IRS Requested Changes in Funding and Full-time Equivalents for Taxpayer Service, Fiscal Years 2005 and
                                                      2006
----------------------------------------------------------------------------------------------------------------
                                             Fiscal year 2005        Fiscal year 2006       Change fiscal year
                                                 (actual)               (requested)              2005-2006
                                         -----------------------------------------------------------------------
           Program discipline              Dollars                 Dollars                 Dollars
                                             (in      Full-time      (in      Full-time      (in      Full-time
                                          millions)  equivalents  millions)  equivalents  millions)  equivalents
----------------------------------------------------------------------------------------------------------------
Assistance
----------------------------------------------------------------------------------------------------------------
  Electronic                                $1,536      17,745      $1,557      17,721         $21         -24
----------------------------------------------------------------------------------------------------------------
  Field                                        274       2,796         230       2,181         -44        -615
----------------------------------------------------------------------------------------------------------------
  EITC assistance                               19         258          19         258          <1           0
----------------------------------------------------------------------------------------------------------------
  Assistance total                           1,829      20,798       1,806      20,160         -23        -638
----------------------------------------------------------------------------------------------------------------
Outreach
----------------------------------------------------------------------------------------------------------------
  Publication & Media                          291         821         276         520         -15        -301
----------------------------------------------------------------------------------------------------------------
  Taxpayer Education & Communication           203       1,592         184       1,326         -19        -266
----------------------------------------------------------------------------------------------------------------
  EITC Outreach                                  7          60           7          60          <1           0
----------------------------------------------------------------------------------------------------------------
  Outreach total                               500       2,473         466       1,905         -34        -568
----------------------------------------------------------------------------------------------------------------
Processing                                   1,276      15,695       1,295      15,516          19        -179
----------------------------------------------------------------------------------------------------------------
Taxpayer service total                       3,606      38,966       3,568      37,581         -39      -1,385
----------------------------------------------------------------------------------------------------------------

Table 3:
Source: GAO analysis of IRS data.
Note: Numbers may not add due to rounding.
IRS Continues to Request Significant Increases for Enforcement to Build on Recent Hiring Gains

    IRS Continues to Request Significant Increases for Enforcement to 
Build on Recent Hiring Gains
    IRS's fiscal year 2006 budget request is the sixth consecutive year 
the agency has requested additional staffing for enforcement. However, 
up until last year, IRS was unable to increase enforcement staffing; 
unbudgeted costs and other priorities consumed the budget increase.
    IRS's proposal for fiscal year 2006, if implemented as planned, 
would return enforcement staffing in these occupations to their highest 
levels since 1999. Of the more than $500 million increase requested for 
2006, about $265 million would fund enforcement initiatives, over $182 
million would be used in part for salary increases, and over $55 
million is a proposal to transfer funding authority from the Department 
of Justice's Interagency Crime and Drug Enforcement. The $500 million 
increase would be supplemented by internal enforcement savings of $88 
million. As is the case with taxpayer service savings, the extent to 
which IRS achieves enforcement savings will affect its ability to fund 
the new enforcement initiatives.
    The $265 million for new enforcement initiatives consist of:

      $149.7 million and 920 FTEs to attack corrosive non-
compliance activity driving the tax gap such as abusive trusts and 
shelters, including offshore credit cards and organized tax resistance;
       $51.8 million and 236 FTEs to detect and deter corrosive 
corporate non-compliance to attack complex abusive tax avoidance 
transactions on a global basis and challenge those who promote their 
use;
      $37.9 million and 417 FTEs to increase individual 
taxpayer compliance by identifying and implementing actions to address 
non-compliance with filing requirements; increasing Automated 
Underreporter resources to address the reporting compliance tax gap; 
increasing audit coverage; and expanding collection work in walk-in 
sites;
      $14.5 million and 77 FTEs to combat abusive transactions 
by entities with special tax status by initiating examinations more 
promptly, safeguarding compliant customers from unscrupulous promoters, 
and increasing vigilance to ensure that the assets of tax-exempt 
organizations are put to their intended tax-preferred purpose and not 
misdirected to fund terrorism or for private gain; and
      $10.8 million and 22 FTEs to curtail fraudulent refund 
crimes.

    The $88 million in internal savings would be reinvested to perform 
the following activities:

      $66.7 million and 585 FTEs to devote resources to front-
line enforcement activities;
      $14.9 million and 156 FTEs to, in part, address 
bankruptcy-related taxpayer questions; and
      $6.7 million and 52 FTEs to address complex, high-risk 
issues such as compliance among tax professionals.

    In the past, IRS has had trouble achieving enforcement staffing 
increases because other priorities, including unbudgeted expenses, have 
absorbed additional funds. IRS achieved some gains in 2004 and expects 
modest gains in 2005. Figure 1 shows that the number of revenue agents 
(those who audit complex returns), revenue officers (those who do field 
collection work), and special agents (those who perform criminal 
investigations) decreased over 21 percent between 1998 and 2003, but 
increased almost 6 percent from 2003 to 2004.
Figure 1:  Revenue Agents, Revenue Officers, and Special Agents, Fiscal 
                            Years 1998-2006
[GRAPHIC] [TIFF OMITTED] T4767A.009


    Source: GAO Analysis of IRS Data
    \a\ Fiscal years 2005 and 2006 are IRS projections.

    IRS's recent gains in enforcement staffing are encouraging, as tax 
law enforcement continues to remain an area of high risk for the 
federal government because the resources IRS has dedicated to enforcing 
the tax laws have declined, while IRS's enforcement workload--measured 
by the number of taxpayer returns filed--has continually increased.\8\ 
Figure 2 shows the trend in field, correspondence, and total audit 
rates since 1995. Field audits involve face-to-face audits and 
correspondence audits are typically less complex involving 
communication through notices. IRS experienced steep declines in audit 
rates from 1995 to 1999, but the audit rate--the proportion of tax 
returns that IRS audits each year--has slowly increased since 2000. The 
figure shows that the increase in total audit rates of individual 
filers has been driven mostly by correspondence audits, while more 
complex field audits, continue to decline.
---------------------------------------------------------------------------
    \8\ GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.: 
January 2005).
---------------------------------------------------------------------------
        Figure 2:  Audit Rate of Individual Income Tax Returns,
                         Fiscal Years 1995-2004
[GRAPHIC] [TIFF OMITTED] T4767A.010


    Source: GAO Analysis of IRS Data

    The link between the decline in enforcement staff and the decline 
in enforcement actions, such as audits, is complicated, and the real 
impact on taxpayers' rate of voluntary compliance is not known. This 
leaves open the question of whether the declines in IRS's enforcement 
programs are eroding taxpayers' incentives to voluntarily comply. IRS's 
National Research Program (NRP) recently completed a study on 
compliance by individual tax filers based on tax data provided on 2001 
tax returns. The study estimated that the tax gap--the difference 
between what taxpayers owe and what they pay--is at least $312 billion 
per year as of 2001 and could be as large as $353 billion. This study 
is important for several reasons beyond measuring compliance. It is 
intended to help IRS better target its enforcement actions, such as 
audits, on non-compliant taxpayers, and minimize audits of compliant 
taxpayers. It should also help IRS better understand the impact of 
taxpayer service on compliance.

IRS Is Developing Long-term Goals That Can Be Used to Assess 
        Performance and Make Budget Decisions
    IRS is developing but currently lacks long-term goals that can be 
used to assess performance and make budget decisions.\9\ Long-term 
goals and results measurement are a component of the statutory 
strategic planning and management framework that the Congress adopted 
in the Government Performance and Results Act of 1993.\10\ As a part of 
this comprehensive framework, long-term goals that are linked to annual 
performance measures can help guide agencies when considering 
organizational changes and making resource decisions.
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    \9\ IRS has one long-term goal set by the Congress in RRA 98 for 
IRS to have 80 percent of all individual income tax returns filed 
electronically.
    \10\ Pub. L. No. 103-62 (1993). The Government Performance and 
Results Act of 1993 seeks to improve the management of federal 
programs, as well as their effectiveness and efficiency, by requiring 
executive agencies to prepare multiyear strategic plans, annual 
performance plans, and annual performance reports. Under the Act, 
strategic plans are the starting point for setting goals and measuring 
progress towards them. The Act requires executive agencies to develop 
strategic plans that include an agency's mission statement, long-term 
general goals, and the strategies that the agency will use to achieve 
these goals. The plans should also explain the key external factors 
that could significantly affect achievement of these goals, and 
describe how long-term goals will be related to annual performance 
goals.
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    A recent Program Assessment Rating Tool (PART) review conducted by 
OMB reported that IRS lacks long-term goals.\11\ As a result, IRS has 
been working to identify and establish long-term goals for all aspects 
of its operations for over a year. IRS officials said these goals will 
be finalized and provided publicly as an update to the agency's 
strategic plan before May 2005.
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    \11\ The PART was applied during the fiscal year 2004 budget cycle 
to ``programs'' selected by OMB. The PART includes general questions in 
each of four broad topics to which all programs are subjected: (1) 
program purpose and design, (2) strategic planning, (3) program 
management, and (4) program results (i.e., whether a program is meeting 
its long-term and annual goals). OMB also makes an overall assessment 
on program effectiveness.
---------------------------------------------------------------------------
    For IRS and its stakeholders, such as the Congress, long-term goals 
can be used to assess performance and progress towards these goals, and 
determine whether budget decisions contribute to achieving those goals. 
Without long-term goals, the Congress and other stakeholders are 
hampered in evaluating whether IRS is making satisfactory long-term 
progress. Further, without such goals, the extent to which IRS's 2006 
budget request would help IRS achieve its mission over the long-term is 
unclear.

This Is an Opportune Time to Review IRS's Menu of Taxpayer Services
    For at least two reasons, this is an opportune time to review the 
menu of taxpayer services that IRS provides. First, IRS's budget for 
taxpayer services was reduced in 2005 and an additional reduction is 
proposed for 2006. As already discussed, these reductions have forced 
IRS to propose scaling back some services. Second, as we have reported, 
IRS has made significant progress in improving the quality of its 
taxpayer services. For example, IRS now provides many Internet services 
that did not exist a few years ago and has noticeably improved the 
quality of telephone services. This opens up the possibility of 
maintaining the overall level of taxpayer service but with a different 
menu of service choices. Cuts in selected services could be offset by 
the new and improved services.
    Generally, as indicated in the budget, the menu of taxpayer 
services that IRS provides covers assistance, outreach, and processing. 
Assistance includes answering taxpayer questions via telephone, 
correspondence, and face-to-face at its walk-in sites. Outreach 
includes educational programs and the development of partnerships. 
Processing includes issuing millions of tax refunds.
    When considering program reductions, we support a targeted approach 
rather than across-the-board cuts.\12\ A targeted approach helps reduce 
the risk that effective programs are reduced or eliminated while 
ineffective or lower priority programs are maintained.
---------------------------------------------------------------------------
    \12\ GAO, 21st Century Challenges: Reexamining the Base of the 
Federal Government, GAO-05-325SP (Washington, D.C.: February 2005).
---------------------------------------------------------------------------
    With the above reasons in mind for reconsidering IRS's menu of 
services, we have compiled a list of options for targeted reductions in 
taxpayer service. The options on this list are not recommendations but 
are intended to contribute to a dialogue about the tradeoffs faced when 
setting IRS's budget. The options presented meet at least one of the 
following criteria hat we generally use to evaluate programs or budget 
requests.\13\ These criteria include that the activity
---------------------------------------------------------------------------
    \13\ We selected these criteria from a variety of sources based on 
generally accepted government auditing standards.

      duplicates other efforts that may be more effective and/
or efficient;
      historically does not meet performance goals or provide 
intended results as reported by GAO, TIGTA, IRS, or others;
      experiences a continued decrease in demand;
      lacks adequate oversight, implementation and management 
plans, or structures and systems to be implemented effectively;
      has been the subject of actual or requested funding 
increases that cannot be adequately justified; or
      has the potential to make an agency more self-sustaining 
by charging user fees for services provided.

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

      closing walk-in sites. As the filing season section of 
this testimony discusses, taxpayer demand for walk-in services has 
continued to decrease and staff answer a more limited number of tax law 
questions in person than staff answer via telephone.
      limiting the type of telephone questions answered by IRS 
assistors. IRS assistors still answer some refund status questions even 
though IRS provides automated answers via telephone and its Web site.
      mandating electronic filing for some filers such as paid 
preparers or businesses. As noted, efficiency gains from electronic 
filing have enabled IRS to consolidate paper processing operations.
      charging for services. For example, IRS provides paid 
preparers with information on federal debts owed by taxpayers seeking 
refund anticipation loans.

Progress in BSM Implementation, but the Program Remains High Risk and 
        Budget Reductions Have Resulted in Significant Adjustments
    Although IRS has implemented important elements of the BSM program, 
much work remains. In particular, the BSM program remains at high risk 
and has a long history of significant cost overruns and schedule 
delays. Furthermore, budget reductions have resulted in significant 
adjustments to the BSM program, although it is too early to determine 
their ultimate effect.

IRS Has Made Progress in Implementing BSM, but Much Work Remains
    IRS has long relied on obsolete automated systems for key 
operational and financial management functions, and its attempts to 
modernize these aging computer systems span several decades. IRS's 
current modernization program, BSM, is a highly complex, multibillion-
dollar program that is the agency's latest attempt to modernize its 
systems. BSM is critical to supporting IRS's taxpayer service and 
enforcement goals. For example, BSM includes projects to allow 
taxpayers to file and retrieve information electronically and to 
provide technology solutions to help reduce the backlog of collections 
cases. BSM is important for another reason. It allows IRS to provide 
the reliable and timely financial management information needed to 
account for the nation's largest revenue stream and better enable the 
agency to justify its resource allocation decisions and congressional 
budgetary requests.
    Since our testimony before this subcommittee on last year's budget 
request, IRS has deployed initial phases of several modernized systems 
under its BSM program. The following provides examples of the systems 
and functionality that IRS implemented in 2004 and the beginning of 
2005.

      Modernized e-File (MeF). This project is intended to 
provide electronic filing for large corporations, small businesses, and 
tax-exempt organizations. The initial releases of this project were 
implemented in June and December 2004, and allowed for the electronic 
filing of forms and schedules for the form 1120 (corporate tax return) 
and form 990 (tax-exempt organizations' tax return). IRS reported that, 
during the 2004 filing season, it accepted over 53,000 of these forms 
and schedules using MeF.
      e-Services. This project created a Web portal and 
provided other electronic services to promote the goal of conducting 
most IRS transactions with taxpayers and tax practitioners 
electronically. IRS implemented e-Services in May 2004. According to 
IRS, as of late March 2005, over 84,000 users have registered with this 
Web portal.
      Customer Account Data Engine (CADE). CADE is intended to 
replace IRS's antiquated system that contains the agency's repository 
of taxpayer information and, therefore, is the BSM program's linchpin 
and highest priority project. In July 2004 and January 2005, IRS 
implemented the initial releases of CADE, which have been used to 
process filing year 2004 and 2005 1040EZ returns, respectively, for 
single taxpayers with refund or even-balance returns. According to IRS, 
as of March 16, 2005, CADE had processed over 842,000 tax returns so 
far this filing season.
      Integrated Financial System (IFS). This system replaces 
aspects of IRS's core financial systems and is ultimately intended to 
operate as its new accounting system of record. The first release of 
this system became fully operational in January 2005.

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

BSM Program Has History of Cost Increases and Schedule Delays and Is 
        High Risk
    The BSM program has a long history of significant cost increases 
and schedule delays, which, in part, has led us to report this program 
as high--risk since 1995.\14\ Appendix II provides the history of the 
BSM life-cycle cost and schedule variances. In January 2005 letters to 
congressional appropriation committees, IRS stated that it had showed a 
marked improvement in significantly reducing its cost variances. In 
particular, IRS claimed that it reduced the variance between estimated 
and actual costs from 33 percent in fiscal year 2002 to 4 percent in 
fiscal year 2004. However, we do not agree with the methodology used in 
the analysis supporting this claim. Specifically, (1) the analysis did 
not reflect actual costs, instead it reflected changes in cost 
estimates (i.e., budget allocations) for various BSM projects; (2) IRS 
aggregated all of the changes in the estimates associated with the 
major activities for some projects, such as CADE, which masked that 
monies were shifted from future activities to cover increased costs of 
current activities; and (3) the calculations were based on a percentage 
of specific fiscal year appropriations, which does not reflect that 
these are multiyear projects.
---------------------------------------------------------------------------
    \14\ For our latest high-risk report, please see GAO, High-Risk 
Series: An Update, GAO-05-207 (Washington, D.C., January 2005).
---------------------------------------------------------------------------
    In February 2002 we expressed concern over IRS's cost and schedule 
estimating and made a recommendation for improvement.\15\ IRS and its 
prime systems integration support (PRIME) contractor have taken action 
to improve their estimating practices, such as developing a cost and 
schedule estimation guidebook and developing a risk-adjustment model to 
include an analysis of uncertainty. These actions may ultimately result 
in more realistic cost and schedule estimates, but our analysis of 
IRS's expenditure plans \16\ over the last few years shows continued 
increases in estimated project life-cycle costs (see fig. 3).
---------------------------------------------------------------------------
    \15\ GAO, Business Systems Modernization: IRS Needs to Better 
Balance Management Capacity with Systems Acquisition Workload, GAO-02-
356 (Washington, D.C.: Feb. 28, 2002).
    \16\ BSM funds are unavailable until the IRS submits to 
congressional appropriations committees for approval a modernization 
expenditure plan that (1) meets the OMB capital planning and investment 
control review requirements; (2) complies with IRS's enterprise 
architecture; (3) conforms with IRS's enterprise life-cycle 
methodology; (4) is approved by IRS, the Department of the Treasury, 
and OMB; (5) is reviewed by GAO; and (6) complies with acquisition 
rules, requirements, guidelines, and systems acquisition management 
practices.
---------------------------------------------------------------------------
       Figure 3:  Life-cycle Cost Estimates for Key BSM Projects
[GRAPHIC] [TIFF OMITTED] T4767A.011


    Source: GAO analysis of IRS data.

    The Associate CIO for BSM stated that he believes that IRS's cost 
and schedule estimating has improved in the past year. In particular, 
he pointed out that IRS met its cost and schedule goals for the 
implementation of the latest release of CADE, which allowed the agency 
to use this system to process certain 1040EZ forms in the 2005 filing 
season. It is too early to tell whether this signals a fundamental 
improvement in IRS's ability to accurately forecast project costs and 
schedules.
    The reasons for IRS's cost increases and schedule delays vary. 
However, we have previously reported that they are due, in part, to 
weaknesses in management controls and capabilities. We have previously 
made recommendations to improve BSM management controls, and IRS has 
implemented or begun to implement these recommendations. For example, 
in February 2002, we reported that IRS had not yet defined or 
implemented an IT human capital strategy, and recommended that IRS 
develop plans for obtaining, developing, and retaining requisite human 
capital resources.\17\ In September 2003, TIGTA reported that IRS had made 
significant progress in developing a human capital strategy but that it 
needed further development. In August 2004, the current Associate CIO 
for BSM identified the completion of a human capital strategy as a high 
priority. Among the activities that IRS is implementing are 
prioritizing its BSM staffing needs and developing a recruiting plan. 
IRS has also identified, and is addressing, other major management 
challenges in areas such as requirements, contract, and program 
management. For example, poorly defined requirements have been among 
the significant weaknesses that have been identified as contributing to 
project cost overruns and schedule delays. As part of addressing this 
problem, in March 2005, the IRS BSM office established a requirements 
management office, although a leader has not yet been hired.
---------------------------------------------------------------------------
    \17\ GAO-02-356.
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IRS Is Adjusting the BSM Program in Response to Budget Reductions
    The BSM program is undergoing significant changes as it adjusts to 
reductions in its budget. Figure 4 illustrates the BSM program's 
requested and enacted budgets for fiscal years 2004 through 2006.\18\ 
For fiscal year 2005, IRS received about 29 percent less funding than 
it requested (from $285 million to $203.4 million). According to the 
Senate report for the fiscal year 2005 Transportation, Treasury, and 
General Government appropriations bill, in making its recommendation to 
reduce BSM funding, the Senate Appropriations Committee was concerned 
about the program's cost overruns and schedule delays. In addition, the 
committee emphasized that in providing fewer funds, it wanted IRS to 
focus on its highest priority projects, particularly CADE.\19\ In 
addition, IRS's fiscal year 2006 budget request reflects an additional 
reduction of about 2 percent, or about $4.4 million, from the fiscal 
year 2005 appropriation.
---------------------------------------------------------------------------
    \18\ IRS uses the appropriated funds to cover contractor costs 
related to the BSM program. IRS funds internal costs for managing BSM 
with another appropriation. These costs are not tracked separately for 
BSM-related activities.
    \19\ U.S. Senate, Senate Report 108-342.
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     Figure 4:  Changes in the BSM budget (dollars in millions) \a\

[GRAPHIC] [TIFF OMITTED] T4767A.012


    Source: IRS.
    \a\ The BSM account authorizes funds to be obligated for 3 years.

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

      Reductions in Management reserve/project risk 
adjustments. In response to the fiscal year 2005 budget reduction, IRS 
reduced the amount that it had allotted to program management reserve 
and project risk adjustments by about 62 percent (from about $49.1 
million to about $18.6 million).\20\ If BSM projects have future cost 
overruns that cannot be covered by the depleted reserve, this reduction 
could result in (1) increased budget requests in future years or (2) 
delays in planned future activities (e.g., delays in delivering 
promised functionality) to use those allocated funds to cover the 
overruns.
---------------------------------------------------------------------------
    \20\ We did not include in our calculations, reductions to specific 
project risk adjustment amounts that were made for reasons other than 
the fiscal year 2005 budget reduction.
---------------------------------------------------------------------------
      Shifts of BSM management responsibility from the PRIME 
contractor to IRS. Due to budget reductions and IRS's assessment of the 
PRIME contractor's performance, IRS decided to shift significant BSM 
responsibilities for program management, systems engineering, and 
business integration from the PRIME contractor to IRS staff. For 
example, IRS staff are assuming responsibility for cost and schedule 
estimation and measurement, risk management, integration test and 
deployment, and transition management. There are risks associated with 
this decision. To successfully accomplish this transfer, IRS must have 
the management capability to perform this role. Although the BSM 
program office has been attempting to improve this capability through, 
for example, implementation of a new governance structure and hiring 
staff with specific technical and management expertise, IRS has had 
significant problems in the past managing this and other large 
development projects, and acknowledges that it has major challenges to 
overcome in this area.
      Suspension of the Custodial Accounting Project (CAP). 
Although the initial release of CAP went into production in September 
2004, IRS has decided not to use this system and to stop work on 
planned improvements due to budget constraints. According to IRS, it 
made this decision after it evaluated the business benefits and costs 
to develop and maintain CAP versus the benefits expected to be provided 
by other projects, such as CADE. Among the functionality that the 
initial releases of CAP were expected to provide were (1) critical 
control and reporting capabilities mandated by federal financial 
management laws; (2) a traceable audit trail to support financial 
reporting; and (3) a subsidiary ledger to accurately and promptly 
identify, classify, track, and report custodial revenue transactions 
and unpaid assessments. With the suspension of CAP, it is now unclear 
how IRS plans to replace the functionality this system was expected to 
provide, which was intended to allow the agency to make meaningful 
progress toward addressing long-standing financial management 
weaknesses. IRS is currently evaluating alternative approaches to 
addressing these weaknesses.
      Reductions in planned functionality. According to IRS, 
the fiscal year 2006 funding reduction will result in delays in planned 
functionality for some of its BSM projects. For example, IRS no longer 
plans to include Form 1041 (the income tax return for estates and 
trusts) in the fourth release of Modernized e-File, which is expected 
to be implemented in fiscal year 2007.

    The BSM program is based on visions and strategies developed in 
2000 and 2001. The age of these plans, in conjunction with the 
significant delays already experienced by the program and the 
substantive changes brought on by budget reductions, indicate that it 
is time for IRS to revisit its long-term goals, strategy, and plans for 
BSM. Such an assessment would include an evaluation of when significant 
future BSM functionality would be delivered. IRS's Associate CIO for 
BSM has recognized that it is time to recast the agency's BSM strategy 
because of changes that have occurred subsequent to the development of 
the program's initial plans. According to this official, IRS is 
redefining and refocusing the BSM program, and he expects this effort 
to be completed by the end of this fiscal year.

Additional Actions Needed to Improve Budgeting for IT Operations and 
        Maintenance
    IRS has requested about $1.62 billion for IT operations and 
maintenance in fiscal year 2006, within its proposed new Tax 
Administration and Operations account. Under the prior years' budget 
structure, these funds were included in a separate account, for which 
IRS received an appropriation of about $1.59 billion in fiscal year 
2005. The $1.62 billion requested in fiscal year 2006 is intended to 
fund the personnel costs for IT staff (including staff supporting the 
BSM program) and activities such as IT security, enterprise networks, 
and the operations and maintenance costs of its current systems. We 
have previously expressed concern that IRS does not employ best 
practices in the development of its IT operations and maintenance 
budget request.\21\ Although IRS has made progress in addressing our 
concern, more work remains.
---------------------------------------------------------------------------
    \21\ GAO, Internal Revenue Service: Improving Adequacy of 
Information Systems Budget Justification, GAO-02-704 (Washington, D.C., 
June 28, 2002).
---------------------------------------------------------------------------
    The Paperwork Reduction Act (PRA) requires federal agencies to be 
accountable for their IT investments and responsible for maximizing the 
value and managing the risks of their major information systems 
initiatives. The Clinger-Cohen Act of 1996 establishes a more 
definitive framework for implementing the PRA's requirements for IT 
investment management. It requires federal agencies to focus more on 
the results they have achieved and introduces more rigor and structure 
into how agencies are to select and manage IT projects. In addition, 
leading private--and public-sector organizations have taken a project--
or system-centric approach to managing not only new investments but 
also operations and maintenance of existing systems. As such, these 
organizations

      identify operations and maintenance projects and systems 
for inclusion in budget requests;
      assess these projects or systems on the basis of expected 
costs, benefits, and risks to the organization;
      analyze these projects as a portfolio of competing 
funding options; and
      use this information to develop and support budget 
requests.

    This focus on projects, their outcomes, and risks as the basic 
elements of analysis and decision making is incorporated in the IT 
investment management approach that is recommended by OMB and GAO. By 
using these proven investment management approaches for budget 
formulation, agencies have a systematic method, on the basis of risk 
and return on investment, to justify what are typically substantial 
information systems operations and maintenance budget requests.
    In our assessment of IRS's fiscal year 2003 budget request, we 
reported that the agency did not develop its information systems 
operations and maintenance request in accordance with the investment 
management approach used by leading organizations. We recommended that 
IRS prepare its future budget requests in accordance with these best 
practices.\22\ To address our recommendation, IRS agreed to take a 
variety of actions, which it has made progress in implementing. For 
example, IRS stated that it planned to develop an activity-based cost 
model to plan, project, and report costs for business tasks/activities 
funded by the information systems budget. The recent release of IFS 
included an activity-based cost module, but IRS does not currently have 
historical cost data to populate this module. According to officials in 
the Office of the Chief Financial Officer, IRS is in the process of 
accumulating these data. These officials stated that IRS needs 3 years 
of actual costs to have the historical data that would provide a basis 
for future budget estimates. Accordingly, these officials expected that 
IRS would begin using the IFS activity-based cost module in formulating 
the fiscal year 2008 budget request and would have the requisite 3 
years' of historical data in time to develop the fiscal year 2010 
budget request. In addition, IRS planned to develop a capital planning 
guide to implement processes for capital planning and investment 
control, budget formulation and execution, business case development, 
and project prioritization. IRS has developed a draft guide, which is 
currently under review by IRS executives, and IRS expects it to become 
policy on October 1, 2005. Although progress has been made in 
implementing best practices in the development of the IT operations and 
maintenance budget, until these actions are completely implemented IRS 
will not be able to ensure that its request is adequately supported.
---------------------------------------------------------------------------
    \22\ GAO-02-704.
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So Far This Filing Season IRS Has Generally Maintained or Improved 
        Performance, Including Telephone Accuracy, with Less Funding
    Results to date show IRS has generally maintained or improved its 
2005 filing season performance in key areas compared to last year 
despite a decrease in the 2005 budget for taxpayer service. These key 
areas are paper and electronic processing, telephone assistance, IRS's 
Web site, and walk-in assistance. Table 4 shows performance to date in 
these four areas.

                   Table 4: IRS Performance in the First Weeks of the Filing Season, 2002-2005
----------------------------------------------------------------------------------------------------------------
                     Volume in thousands                          2002         2003         2004         2005
----------------------------------------------------------------------------------------------------------------
Actual returns processed\a\
----------------------------------------------------------------------------------------------------------------
Paper                                                              24,491       22,117       20,232       17,607
----------------------------------------------------------------------------------------------------------------
Electronic                                                         35,067       38,627       42,988       45,848
----------------------------------------------------------------------------------------------------------------
Telephone assistance
----------------------------------------------------------------------------------------------------------------
Total calls\b\                                                     34,489       27,905       29,058       23,340
----------------------------------------------------------------------------------------------------------------
  Answered by assistors                                             9,208        9,434       10,116        9,421
----------------------------------------------------------------------------------------------------------------
  Answered by automation                                           25,281       18,471       18,942       13,919
----------------------------------------------------------------------------------------------------------------
  Customer service representative level of service                    62%          82%          84%          83%
----------------------------------------------------------------------------------------------------------------
  Average speed of answer\c\                                  227 seconds  183 seconds  199 seconds  235 seconds
----------------------------------------------------------------------------------------------------------------
Accounts accuracy rate estimates\d\                              88%+/-1%     88%+/-1%     89%+/-1%     92%+/-1%
----------------------------------------------------------------------------------------------------------------
Tax law accuracy rate estimates\d\                               84%+/-1%     81%+/-1%     76%+/-1%     87%+/-1%
----------------------------------------------------------------------------------------------------------------
Internet assistance
----------------------------------------------------------------------------------------------------------------
Forms and publications downloaded\e\                                  N/A          N/A          N/A       70,321
----------------------------------------------------------------------------------------------------------------
Refund status inquiries\f\                                            N/A        9,300       14,300       16,400
----------------------------------------------------------------------------------------------------------------
Walk-in assistance
----------------------------------------------------------------------------------------------------------------
Total walk-in contacts\g\                                             N/A        2,740        2,433        2,163
----------------------------------------------------------------------------------------------------------------
Returns prepared at IRS walk-in sites\h\                              436          291          186          145
----------------------------------------------------------------------------------------------------------------
Returns prepared at volunteer sites\i\                                466          594          741          915
----------------------------------------------------------------------------------------------------------------
Source: IRS.
\a\ From January 1 to March 22, 2002; March 21, 2003; March 19, 2004; and March 18, 2005.
\b\ Total calls (i.e., calls answered by assistors and automation) and CSR level of service are based on actual
  counts from January 1 to March 16, 2002; March 15, 2003; March 13, 2004; and March 12, 2005. The 2002 totals
  include increased call demand as a result of the Economic Growth and Tax Relief Reconciliation Act of 2001
  (Pub. L. No. 107-16 (2001).
\c\ From January 1 to March 16, 2002; March 15, 2003; March 13, 2004; and March 12, 2005.
\d\ Based on a representative sample estimated at the 90 percent confidence level from January to February 2002,
  2003, 2004, and 2005.
\e\ As of February 28, 2005.
\f\ From January 1 to March 20, 2003; 2004; and 2005.
\g\ From January 1 to March 15, 2003; March 13, 2004; and March 12, 2005.
\h\ From January 1 to March 16, 2002; March 15, 2003; March 13, 2004; and March 12, 2005.
\i\ From January 1 to March 9, 2002; March 8, 2003; March 13, 2004; and March 12, 2005.

    Overall IRS's filing season performance to date is good news 
because, as table 1 shows (page 6), IRS's budget for taxpayer service 
is $104 million less than the year before. According to IRS officials, 
it absorb this reduction by generating additional internal savings and 
program reductions. However, because the filing season is not over, the 
extent to which IRS will achieve efficiency gains and the full impact 
of reductions on taxpayers in this or future filing seasons is not yet 
known.

Processing Has Been Smooth, Staff Continues to Decline, and Electronic 
        Filing Continues to Grow but not at a Rate to Meet Long-term 
        Goal
    As of March 18, IRS processed about 63 million individual income 
tax returns and 57 million refunds. According to IRS data and 
information from external stakeholders such as paid practitioners, 
processing has been uneventful and without significant disruptions. IRS 
officials attribute this year's smooth processing to adequate planning 
and few tax law changes. This year's processing activities are 
important, in part, because for the first time during the filing 
season, IRS is using CADE to process the simplest taxpayer accounts 
(1040EZ without problems or balance due). As we note in the BSM 
section, CADE is the foundation of IRS's modernization effort and will 
ultimately replace the Individual Master File that currently houses 
taxpayer data for individual filers. As of March 16, 2005, CADE has 
processed over 842,000 tax returns without significant problems.
    Growth in electronic filing (e-filing) helps fund IRS's 
modernization. Electronic filing allows IRS to control costs by 
reducing labor-intensive processing of paper tax returns. E-filing also 
improves taxpayer service by eliminating transcription errors 
associated with processing paper returns. E-filing also has benefits 
for taxpayers, primarily by allowing them to get their refunds in half 
the time of paper filers.
    As shown in figure 5, the number of e-filed returns has increased 
since 1999 and the number of paper returns has decreased. The figure 
also shows that these changes have allowed IRS to reduce the staff 
devoted to processing paper returns between 1999 and 2004 by just over 
1,100 staff years. As the number of e-filed returns has increased, the 
number of staff years used to process those returns has not. The 
decline in paper processing staff allowed IRS to close its Brookhaven 
processing center in 2003. In addition, IRS is in the process of 
closing its paper processing operation in Memphis.
    Figure 5:  Number of Individual Returns and IRS Staff Years for 
   Individual Paper and Electronic Processing, Fiscal Years 1999-2006

[GRAPHIC] [TIFF OMITTED] T4767A.013


    Source: GAO analysis of IRS data.
    * Fiscal years 2005 and 2006 are IRS projections and, given the 
current lower e-file growth rates, the estimates may be optimistic.

    Note: Staff years and FTEs are units of measurement that are often 
used interchangeably. According to IRS, an FTE is the equivalent of one 
person working full time for 1 year with no overtime. A staff year 
includes overtime. Therefore, the cost of 1 staff year is equal to the 
cost of one FTE plus overtime. As noted in the figure, staff years for 
paper filing are for selected major activities only.
    Although the growth in e-filing is about 6.7 percent over the same 
period last year, it is growing at a slower rate than previous years. 
Based on the current trend and the fact that the percentage of returns 
e-filed traditionally declines as April 15 approaches, it appears that 
IRS will not achieve its goal of having 68.2 million individual tax 
returns e-filed this year (an 11 percent increase over last year).
    Over recent years, IRS has undertaken numerous initiatives to 
increase e-filing. However, neither this year's current growth rate nor 
the projected annual growth rate will enable IRS to achieve its goal of 
80 percent of all individual tax returns being e-filed in 2007. This 
goal has focused attention on increasing e-filing. As we reported last 
year, IRS officials believe that achieving the goal would require 
additional measures to convert the tens of millions of taxpayers and 
tax practitioners who prepare individual income tax returns on a 
computer, but filed on paper to e-filing. IRS officials also stated 
that the additional measures might need to include legislation that 
mandates e-filing for certain classes of returns, such as those 
prepared by practitioners. Last year we reported five states, including 
California, that mandated the e-filing of state tax returns, also 
showed increases in the e-filing of federal returns.\23\ This year, 
three additional states have introduced mandatory e-filing of state 
returns by tax practitioners.
---------------------------------------------------------------------------
    \23\ GAO-05-67.
---------------------------------------------------------------------------
Telephone Access Has Remained Relatively Stable and Accuracy Has 
        Improved
    Between January 1 and March 12, IRS received approximately 23 
million calls. As shown in table 4, IRS's automated service handled 
nearly 14 million calls and customer service representatives (CSRs) 
handled just over 9 million. The percentage of taxpayers who attempted 
to reach CSRs and actually got through and received service--referred 
to as the CSR level of service--remained relatively stable at 83 
percent compared to 84 percent at the same time last year.
    IRS reduced its 2005 goal for CSR level of service from 85 percent 
in 2004 to 82 percent because of the budget reduction for taxpayer 
service. However, IRS has been able to achieve a relatively stable CSR 
level of service of 83 percent since last year. According to IRS 
officials, this level of performance is due to

      staff plans being made before the level of service goal 
was reduced;
      the agency receiving fewer calls due to fewer tax law 
changes than in 2004;
      the agency improving methods for handling calls; and
      an increased use of IRS's Web site.

    Although CSR level of service is about the same as last year, down 
one percentage point, there are other indications of slippage in 
telephone access. Specifically, taxpayers are waiting longer to speak 
to a CSR. Wait times have increased by about 35 seconds or 15 percent 
compared to the same period last year. Additionally, the rate at which 
taxpayers abandon their calls to IRS increased from 10 percent to 11.5 
percent, which translates into about 99,000 calls. The responsible IRS 
official considers the increase in wait time and increase in abandon 
rate to be acceptable, in part because IRS data are showing that the 
agency is using 9 percent fewer FTEs than last year and answering 195 
more calls per FTE.
    IRS officials said they lowered the CSR level of service goal in 
response to the reduction in the taxpayer service budget, and will 
adjust staffing plans after the filing season to address the taxpayer 
service budget reduction. IRS officials believe the adjustments will 
likely result in a lower level of service than is currently being 
achieved.
    IRS estimates that the accuracy of CSRs' answers to taxpayers' tax 
law questions improved compared to last year. Specifically, tax law 
accuracy increased to an estimated 87 percent as compared to 76 percent 
at the same time last year. This represents a significant change from 
last year, when we drew attention to the declining tax law accuracy 
rate.\24\ According to IRS officials and staff, the improvement is 
primarily due to formatting changes made in 2004 to the guide that CSRs 
use to help them answer taxpayers' tax law questions that have enhanced 
the usability of the guide. IRS officials stated that the revised guide 
is better and more user-friendly, partly because many of the suggested 
improvements were from CSRs who use the guide daily. In addition, IRS 
officials stated that the improved tax law accuracy rate reveals that 
the previous version of the guide was indeed the reason for last year's 
decline in tax law accuracy, and attributed fluctuations in the tax law 
accuracy rate to changes in the guide in past years.
---------------------------------------------------------------------------
    \24\ GAO-04-560T.
---------------------------------------------------------------------------
    IRS estimates that accounts accuracy (the accuracy of answers to 
questions from taxpayers about the status of their accounts) has 
improved compared to last year and since 2002. Taxpayers who called 
about their accounts received correct information an estimated 92 
percent of the time, which is an improvement compared to last year's 89 
percent rate and the 88 percent rate seen in 2002 and 2003. The 
responsible IRS official told us that accounts accuracy rates have 
improved because IRS has improved its ability to monitor and manage 
staff, expanded training, and improved its ability to search for 
account information.

Web Site Performing Well and Used Extensively
    Various data indicate that IRS's Web site is performing well. We 
found it to be user-friendly because it was readily accessible and easy 
to navigate. Problem areas that we reported in the past, such as the 
search function, were much improved this filing season, thus 
eliminating our previous concerns about the search function. 
Furthermore, an independent weekly study done during the filing season 
has reported that IRS's Web site has ranked in the top 4 out of 40 
government Web sites and that users were able to access the IRS Web 
site in.65 seconds or less. The same independent weekly assessment 
reported that IRS ranked first or second in response time of 
downloading data. Finally, the electronic tax law assistance program on 
IRS's Web site has shown marked improvement this year over last. For 
example, the average response time is down from 3.8 days to 1.6 days 
and the accuracy rate has improved from 56.9 percent to 87.5 
percent.\25\ According to IRS officials, this significant improvement 
is due to a decrease in the number of tax law questions being 
submitted--down from about 56,000 to 8,700 for the same time period.
---------------------------------------------------------------------------
    \25\ These estimates are based on IRS's random samples of 
electronic tax law assistance questions submitted via IRS's Web site. 
These estimates have a +/-4.6 percentage points range and +/-2.8 
percentage points range in 2004 and 2005 respectively, with a 90 
percent confidence level.
---------------------------------------------------------------------------
    IRS's Web site is experiencing extensive usage this filing season 
based on the number of visits, pages viewed, and forms and publications 
downloaded. As of February 28, 2005, the Web site was visited about 83 
million times by users who viewed about 628 million pages. This is the 
first time that IRS has publicly reported the number of visits to and 
number of pages viewed on its Web site. Further, about 70.3 million 
forms and publications had been downloaded this fiscal year through 
February, with about 45 million of those downloads occurring in January 
and February.
    IRS's Web site continues to provide two very important tax service 
features: (1) ``Where's My Refund,'' which enables taxpayers to check 
on the status of their refund and (2) Free File, which provides 
taxpayers the ability to file their tax return electronically for free 
via IRS's Web site. As of March 20, 2005, about 16 million taxpayers 
accessed the ``Where's My Refund'' feature to check the status of their 
tax refund--about a 15 percent increase over the same time period last 
year. Also, IRS provided new functionality for ``Where's My Refund'' 
whereby a taxpayer whose refund could not be delivered by the Postal 
Service (i.e., returned as undeliverable mail), can change their 
address on the Web site. In addition, as of March 16, 2005, 3.6 million 
tax returns had been filed via Free File, which represents a 44 percent 
increase over the same time period last year. In the 2005 filing 
season, all individual taxpayers are eligible to file free via IRS's 
Web site.

Use of IRS's Walk-in Assistance Continues to Decline, While Use of 
        Volunteer Assistance Increases
    As of March 12, assistance provided at IRS's approximately 400 
walk-in sites declined by 11 percent compared to the same time last 
year, with the number receiving tax preparation assistance declining by 
about 22 percent. Staff at those sites provides taxpayers with 
information about their tax accounts and answer a limited scope of tax 
law questions.\26\ If staff cannot answer taxpayers' questions, they 
are required to refer taxpayers to IRS's telephone operations or have 
taxpayers correspond via IRS's Web site. In combination with decreased 
demand, IRS reduced the staff used at walk-in sites for return 
preparation assistance and continues to encourage taxpayers to use 
volunteer sites for return preparation. These declines are consistent 
with IRS's goal to further limit return preparation and tax law 
assistance at walk-in sites by 2007 and with its 2006 budget request.
---------------------------------------------------------------------------
    \26\ Walk-in site employees are trained and authorized to only 
answer tax law questions on specific tax topics such as those related 
to income, filing status, exemptions, deductions, and related credits.
---------------------------------------------------------------------------
   Figure 6:  Assistance Provided by IRS Walk-in and Volunteer Sites,
                 2001-2006 Filing Seasons (in millions)

[GRAPHIC] [TIFF OMITTED] T4767A.014


    Source: GAO analysis of IRS data.
    \a\ Fiscal years 2005 and 2006 are IRS projections.
    Note: ``Other walk-in contacts'' includes assistance for account 
notices, tax law inquiries, forms, and compliance work, but not return 
preparation. For the walk-in sites, the time periods covered are 
December 31, 2000, through April 28, 2001; December 30, 2001, through 
April 27, 2002; December 29, 2002, through April 26, 2003; and December 
28, 2003, through April 24, 2004. For volunteer sites, the time period 
covered for 2001 is January 1, 2001, through April 21, 2001; all other 
periods are the same as those for IRS walk-in sites.

    As reflected in table 4 and figure 6, in contrast to IRS walk-in 
sites, the number of taxpayers seeking return preparation assistance at 
volunteer sites has increased this year and every year since 2001. 
These sites, staffed by volunteers certified by IRS, do not offer the 
range of services IRS provides, but instead focus on preparing tax 
returns primarily for low-income and elderly taxpayers and operate 
chiefly during the filing season. IRS officials estimated that the 
number of taxpayers receiving assistance at approximately 14,000 
volunteer sites has increased over 23 percent compared to the same time 
last year.
    The shift of taxpayers from walk-in to volunteer sites is 
important, because it has transferred time-consuming services, 
particularly return preparation, from IRS to volunteer sites and 
allowed IRS to concentrate on services that only it can provide such as 
account assistance or compliance work. As a result, IRS has devoted 
fewer resources to return preparation. While this shift is important to 
IRS, others have been more cautious. For example, in her January 2005 
report,\27\ the Taxpayer Advocate has expressed concern about the 
reduction of face-to-face services, such as those offered at walk-in 
sites. She stated that IRS's plan does not adequately provide for the 
segment of the population that continues to rely on the interaction 
provided by walk-in sites. At the same time, last year, we \28\ and 
TIGTA \29\ called attention to issues related to the quality of service 
at both IRS walk-in and volunteer sites. IRS has separate quality 
initiatives under way at both IRS walk-in sites and volunteer sites, 
although data remain limited and cannot be compared to prior years.
---------------------------------------------------------------------------
    \27\ National Taxpayer Advocate, 2004 Annual Report to Congress 
(Washington, D.C.: Dec. 31, 2004).
    \28\ GAO, Tax Administration: IRS Improved Performance in the 2004 
Filing Season, but Better Data on the Quality of Some Services Are 
Needed, GAO-05-67 (Washington, D.C.: Nov. 4, 2004).
    \29\ Treasury Inspector General for Tax Administration, 
Improvements Are Needed to Ensure Tax Returns Are Correctly Prepared at 
Taxpayer Assistance Centers, Reference No. 2004-40-025 (Washington, 
D.C.: 2003) and Treasury Inspector General for Tax Administration, 
Improvements Are Needed to Ensure Tax Returns Are Prepared Correctly at 
Internal Revenue Service Volunteer Income Tax Assistance Sites, 
Reference No. 2004-40-154 (Washington, D.C.: 2004).
---------------------------------------------------------------------------
Conclusions
    As IRS shifts its priorities to enforcement and faces tight budgets 
for service, the agency will be challenged to maintain the gains it has 
made in taxpayer service. In order to avoid a ``swinging pendulum,'' 
where enforcement gains are achieved at the cost of taxpayer service 
and vice versa, IRS and the Congress would benefit from a set of 
agreed-upon long-term goals. Long-term goals would provide a framework 
for assessing budgetary tradeoffs between taxpayer service and 
enforcement and whether IRS is making satisfactory progress towards 
achieving those goals. Similarly, long-term goals could help identify 
priorities within the taxpayer service and enforcement functions. For 
example, if the budget for taxpayer service were to be cut and 
efficiency gains did not offset the cut, long-term goals could help 
guide decisions about whether to make service cuts across the board or 
target selected services. To its credit, IRS has been developing a set 
of long-term goals, so we are not making a recommendation on goals. 
However, we want to underscore the importance of making the goals 
public in a timely fashion, as IRS has planned. The Congress would then 
have an opportunity to review the goals and start using them as a tool 
for holding IRS accountable for performance.
    In addition, the Congress would benefit from more information about 
the short-term impacts of the 2006 budget request on taxpayers. The 
2006 budget request cites a need for reducing the hours of telephone 
service and scaling back walk-in assistance but provides little 
additional detail. Without more detail about how taxpayers will be 
affected, it is difficult to assess whether the 2006 proposed budget 
would allow IRS to achieve its stated intent of both maintaining a high 
level of taxpayer service and increasing enforcement.
    BSM and related initiatives such as electronic filing hold the 
promise of delivering further efficiency gains that could offset the 
need for larger budget increases to fund taxpayer service and 
enforcement. Today, taxpayers have seen payoffs from BSM; however, the 
program is still high risk and budget reductions have caused 
substantive program changes. IRS has recognized it is time to revisit 
its long-term BSM strategy and is currently refocusing the program. As 
we did with long-term goals above, we want to underscore the importance 
of timely completion of the revision of the BSM strategy.
Recommendation
    We recommend that the Commissioner of Internal Revenue supplement 
the 2006 budget request with more detailed information on how proposed 
service reductions would impact taxpayers.
                                 ______
                                 
Appendix I
    Description of IRS's Proposed Budget Structure
    IRS's proposed new budget structure as depicted in figure 7 
combines the three major appropriations that the agency has had in the 
past--Processing, Assistance, and Management; Tax Law Enforcement; and 
Information Systems into one appropriation called Tax Administration 
and Operations. The Business Systems Modernization and Health Insurance 
Tax Credit Administration appropriations accounts remain unchanged. The 
Tax Administration and Operations appropriation is divided among eight 
critical program areas. These budget activities focus on Assistance, 
Outreach, Processing, Examination, Collection, Investigations, 
Regulatory Compliance, and Research. According to IRS, as it continues 
to move forward with developing and implementing this new structure, 
these program areas and the associated resource distributions will be 
refined to provide more accurate costing.
    IRS reported that the new budget structure has a more direct 
relationship to its major program areas and strategic plan. We did not 
evaluate IRS's proposed budget structure as part of this engagement 
because it was not within the scope of our review. However, we have 
recently completed a study on the administration's broader budget 
restructuring effort. In that study we say that, going forward, 
infusing a performance perspective into budget decisions may only be 
achieved when the underlying information becomes more credible and used 
by all major decision makers. Thus, the Congress must be considered a 
partner. In due course, once the goals and underlying data become more 
compelling and used by the Congress, budget restructuring may become a 
better tool to advance budget and performance integration.\30\
---------------------------------------------------------------------------
    \30\ For a more detailed discussion, see GAO, Performance 
Budgeting: Efforts to Restructure Budgets to Better Align Resources 
with Performance,GAO-05-117SP (Washington, D.C.: February 2005).
---------------------------------------------------------------------------
               Figure 7:  IRS's Proposed Budget Structure

[GRAPHIC] [TIFF OMITTED] T4767A.015


    Source: GAO representation of IRS information.

Appendix II
    BSM Project Life Cycle Cost/Schedule Variance and Benefits Summary
    The table below shows the life-cycle variance in cost and schedule 
estimates for completed and ongoing Business Systems Modernization 
(BSM) projects, based on data contained in IRS's expenditure plans. 
These variances are based on a comparison of IRS's initial and revised 
(as of July 2004) cost and schedule estimates to complete initial 
operation \31\ or full deployment \32\ of the projects.
---------------------------------------------------------------------------
    \31\ Initial operation refers to the point at which a project is 
authorized to begin enterprisewide deployment.
    \32\ Full deployment refers to the point at which enterprisewide 
deployment has been completed and a project is transitioned to 
operations and support.

                                       Table 5: BSM Project Life Cycle Cost/Schedule Variance and Benefits Summary
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Reported/
                                              Cost       revised    Schedule
                 Project                    variance    estimated   variance       Reported/ revised estimated         Reported IRS/ taxpayer benefits
                                               (in      cost (in      (in                completion date
                                           thousands)  thousands)   months)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Completed projects.......................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Security and Technology Infrastructure        +$8,450     $45,401         +5  1/31/02 (initial operation) \a\       Provides infrastructure for secure
 Release 1                                                                                                           telephony and electronic
                                                                                                                     interaction among IRS employees,
                                                                                                                     tax practitioners, and taxpayers
--------------------------------------------------------------------------------------------------------------------------------------------------------
Customer Communications 2001                  +14,562      60,762         +9  2/26/02 (full deployment)             Improves telecommunications
                                                                                                                     infrastructure, including telephone
                                                                                                                     call management, call routing, and
                                                                                                                     customer self-service applications
--------------------------------------------------------------------------------------------------------------------------------------------------------
Customer Relationship Management Exam            -721       9,245         +3  9/30/02 (full deployment)             Provides commercial, off-the-shelf
                                                                                                                     software to IRS revenue agents to
                                                                                                                     allow them to accurately compute
                                                                                                                     complex corporate transactions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Human Resources Connect Release 1                +200      10,200          0  12/31/02 (initial operation) \a\      Allows IRS employees to access and
                                                                                                                     manage their human resources
                                                                                                                     information online
--------------------------------------------------------------------------------------------------------------------------------------------------------
Internet Refund/Fact of Filing                +12,923      26,432        +14  9/26/03 (full deployment)             Provides instant refund status
                                                                                                                     information and instructions for
                                                                                                                     resolving refund problems to
                                                                                                                     taxpayers with Internet access
--------------------------------------------------------------------------------------------------------------------------------------------------------
Modernized e-File Release 1                   +21,057      50,303       +6.5  5/31/04 (initial operation) \a\       Provides initial electronic filing
                                                                                                                     capability for large corporations,
                                                                                                                     small business, and tax-exempt
                                                                                                                     organizations
--------------------------------------------------------------------------------------------------------------------------------------------------------
Ongoing projects
--------------------------------------------------------------------------------------------------------------------------------------------------------
Modernized e-File Release 2                         0      16,325          0  9/30/04 (initial operation)           Provides additional functionality to
                                                                                                                     support corporate electronic filing
                                                                                                                     and other capabilities, including
                                                                                                                     required public access to filed
                                                                                                                     returns for tax-exempt
                                                                                                                     organizations
--------------------------------------------------------------------------------------------------------------------------------------------------------
Modernized e-File Release 3                    +5,300      27,175          0  3/31/05 (initial operation)           Provides additional functionality to
                                                                                                                     support electronic filing for tax-
                                                                                                                     exempt organizations and other
                                                                                                                     capabilities, including the
                                                                                                                     interface with state retrieval
                                                                                                                     systems
--------------------------------------------------------------------------------------------------------------------------------------------------------
e-Services                                   +102,271     148,820        +18  4/30/05 (full deployment)             Provides a Web portal and other e-
                                                                                                                     Services to promote the goal of
                                                                                                                     conducting most IRS transactions
                                                                                                                     with taxpayers and tax
                                                                                                                     practitioners electronically
--------------------------------------------------------------------------------------------------------------------------------------------------------
Customer Account Data Engine--Individual     +118,129     182,774        +30  6/30/05 (full deployment)             Provides the modernized database
 Master File Release 1                                                                                               foundation to replace the existing
                                                                                                                     individual master file processing
                                                                                                                     systems. Facilitates faster refund
                                                                                                                     processing and more timely response
                                                                                                                     to taxpayer inquiries for Form
                                                                                                                     1040EZ filers
--------------------------------------------------------------------------------------------------------------------------------------------------------
Integrated Financial System Release 1         +73,710     173,580        +15  6/30/05 (full deployment)             Provides a single general ledger for
                                                                                                                     custodial and financial data and a
                                                                                                                     platform to integrate core
                                                                                                                     financial data with budget,
                                                                                                                     performance, and cost-accounting
                                                                                                                     data
--------------------------------------------------------------------------------------------------------------------------------------------------------
Custodial Accounting Project Release 1        +91,789     138,950        +33  11/01/05 (full deployment)            Provides integrated tax operations
                                                                                                                     and internal management information
                                                                                                                     to support evolving decision
                                                                                                                     analytics, performance measurement,
                                                                                                                     and management information needs
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
a Information on the costs and schedule for the full-deployment stage of these projects was not available in the BSM expenditure plans.

    How IRS Allocated Expenditures and Full-Time Equivalents in Fiscal 
Year 2004
    Figures 8 and 9 illustrate how the Internal Revenue Service (IRS) 
allocated expenditures and full-time equivalents (FTE) in fiscal year 
2004. Figure 8 shows total expenditures. The percentage of expenditures 
devoted to contracts decreased from 9 percent in 2002 to 5 percent in 
2004, because of fewer private contracts. The percentage of 
expenditures devoted to other nonlabor costs increased from 8 percent 
in 2002 to 12 percent in 2004, due to increases in miscellaneous costs.

            Figure 8:  IRS Expenditures in Fiscal Year 2004

[GRAPHIC] [TIFF OMITTED] T4767A.016


    Source: GAO analysis of IRS data.
    Note: Numbers do not add to the total and percentages do not add to 
100 percent due to rounding.

    Figure 9 shows IRS's total FTEs. FTEs have decreased slightly from 
99,180 in 2002 to 99,055 in 2004. We previously reported that 
processing FTEs declined 1 percentage point between 2002 and 2003. 
Between 2003 and 2004, IRS's allocation of FTEs remained similar with a 
1 percentage point increase in conducting examinations, and in 
management and other services.
        Figure 9:  How IRS Spent 99,055 FTEs in Fiscal Year 2004

[GRAPHIC] [TIFF OMITTED] T4767A.017


    Source: GAO analysis of IRS data.

                                 

    Chairman RAMSTAD. Thank you, Mr. White. Mr. Wagner.

STATEMENT OF RAYMOND T. WAGNER, JR., CHAIRMAN, INTERNAL REVENUE 
                    SERVICE OVERSIGHT BOARD

    Mr. WAGNER. Thank you, Mr. Chairman, for this opportunity 
to testify before the Subcommittee and to present the IRS 
Oversight Board's views on the President's proposed fiscal year 
2006 budget for the IRS. Also, I would extend my 
congratulations to you, sir, and to you, Mr. Lewis, on your new 
positions of leadership on the Subcommittee. I believe I also 
speak for the entire Board when I say how much we too will miss 
Representative Portman and his leadership in the area of tax 
administration. Mr. Chairman, the IRS Oversight Board recently 
released its fiscal year 2006 budget report. I would like to 
ask that the report be entered into the record at this time.
    [The information is being retained in the Committee files.]
    The Oversight Board's report describes improved performance 
which the IRS has achieved in fiscal year 2004 in three 
important areas: customer service, BSM and enforcement. Yet, 
while progress has been made we still face an enormous 
challenge, the amount of known taxes that are not paid. We all 
heard recently that as of 2001, the tax gaps stood at between 
$312 billion and $353 billion. To put this into perspective, if 
all taxpayers paid what they owe each year, our government 
would have enough money to cover more than 80 percent of the 
cost of running all non-Defense and non-Homeland Security 
agencies. With that in mind, I think we can all agree that the 
job is far from done.
    Before describing the Board's budget recommendations for 
the 2006 budget, I want to summarize the factors that 
influenced the Board's recommendations. First, we recognize the 
need for all discretionary funding to be thoroughly justified, 
and we must give priority to the tax administration as a whole. 
Second, the Board believes that with an effective tax 
administration system, taxpayers would find compliance easy to 
achieve and difficult to avoid. This simple paradigm 
illustrates the balance between service and enforcement that 
must be achieved. Third, taxpayers should feel that the service 
they receive is valuable to them in fulfilling their tax paying 
duties. Mr. Chairman, there is much to like in President Bush's 
2006 budget request for the IRS. When most budgets are being 
tightened, the President is asking for greater budget increases 
for the IRS than any other non-Defense or non-Homeland Security 
agency.
    With that in mind, the Board's recommendation builds upon 
the President's budget request. It calls for $11.6 billion in 
funding for fiscal year 2006, a 9-percent increase over the 
Administration's recommendation. The Board believes that the 
IRS must begin to close the tax gap through greater 
enforcement. For that reason we recommend an additional $435 
million for IRS enforcement efforts that could easily generate 
more than a billion and a half dollars in additional revenues. 
That is a solid business case we believe. The Board also 
recommends additional funding toward maintaining and improving 
customer service and supporting the BSM program. We are 
concerned and fear that the proposed reductions in customer 
service and modernization resources in the budget will have a 
negative impact on the IRS' ability to deliver quality service 
to taxpayers which ultimately will have a negative effect on 
taxpayer compliance. The Board is pleased to see the 
Administration's recommendation to adjust the 302(a) 
allocations to increase enforcement funding for the IRS. To 
deal with various problems, the Board's budget report 
recommends a full range of alternatives that recognize the 
value of investing in IRS enforcement. We urge the Committee to 
give our recommendations active consideration, especially the 
ones falling under this Committee's jurisdiction.
    The BSM program is critical to the future of the IRS, as 
you have heard. It must be successfully completed to provide a 
reliable and efficient means to serve the American taxpayers. 
Unfortunately, this program has a checkered history. Poor 
management by the IRS, and lack of delivery by the prime 
contractor have resulted in missed schedules and cost overruns. 
In response to this performance, the level of activity of the 
program was appropriately and significantly reduced in the 
past. Under Commissioner Everson's efforts, significant 
improvements have been made. The Board is now recommending an 
increased funding level for fiscal year 2006 for BSM. The 
Board, in short, believes that the BSM program should move 
forward at an accelerated pace. We have heard the Commissioner 
say many times that service plus enforcement equals compliance. 
A tax gap of $312 billion annually amounts to an unacceptable 
$2,000 per taxpayer every year. We must improve compliance, 
which means more enforcement and more service, and improved 
technology if we want to close this unacceptable gap.
    Mr. Chairman, in conclusion, the Board strongly believes 
that our Nation can ill afford to return to the days when the 
IRS fluctuated between customer service and enforcement, and in 
an effective tax administration system, the taxpayers would 
find compliance easy to achieve and difficult to avoid. The IRS 
is now on the right track and is making progress toward this 
goal, but we must give it the resources to do its job. Thank 
you and I would be happy to answer any questions.
    [The prepared statement of Mr. Wagner follows:]

      Statement of Raymond Wagner, Chair, Internal Revenue Service
                            Oversight Board

    Thank you, Mr. Chairman for this opportunity to testify before the 
subcommittee and to present the IRS Oversight Board's views on the 
President's proposed FY2006 budget for the Internal Revenue Service.
    I also want to thank and commend you and the members of the 
subcommittee for your continued oversight of tax administration issues. 
It is greatly appreciated. And I believe that I speak not only for the 
Board, but the entire tax administration community when I say how much 
we will miss Representative Portman. He has been an outstanding 
advocate for America's taxpayers.
    Mr. Chairman, the IRS Oversight Board recently released its FY2006 
IRS Budget Report. I would like to ask that this report be entered into 
the record.

Three Influencing Factors
    Before describing the Board's budget recommendations for the FY2006 
IRS budget, I want to present three factors that influenced the Board's 
recommendations
    First, the Oversight Board must weigh competing factors when 
considering the budget it recommends. The Board is cognizant that the 
world situation and projected deficits for the next several years 
increase the need to ensure that all federal spending be thoroughly 
justified, deliver value to the taxpayers, and meet priority needs. 
However, in our roles as members of the Oversight Board, we must always 
be mindful of how well the tax administration system is serving 
taxpayers.
    Second, the Board believes that with an effective tax 
administration system, taxpayers would find compliance easy to achieve 
and difficult to avoid. This simple paradigm illustrates the balance 
between service and enforcement that must be achieved. Those who need 
service to be compliant should receive it; those who flout the law 
should be identified and pursued.
    Third, taxpayers should feel that the service they receive is 
valuable to them and to society. While the tax collector will never win 
a popularity contest, the Oversight Board's most recent taxpayer 
attitude survey found wide support for additional funding for the IRS--
62 percent of respondents favor more funding for enforcement and 64 
percent favor more taxpayer assistance. The Board believes that this 
finding underscores a fundamental belief that our tax administration 
should operate in a way that is balanced between both service and 
enforcement.
    In fact, the willingness of a majority of taxpayers to support 
additional funding for the IRS reflects the increasing levels of 
satisfaction that taxpayers show in the IRS. Taxpayer satisfaction 
surveys such as the American Customer Satisfaction Index (ASCI) have 
shown a steady increase since 1999, as shown in the figure below.

[GRAPHIC] [TIFF OMITTED] T4767A.018


FY2004: Across-the-Board Progress
    The Oversight Board has advocated balance since its inception and 
it applauds the IRS for staying focused and raising both service and 
enforcement performance levels in FY2004 while also seeking greater 
efficiencies through its modernization program. The Board's recent 
budget report describes improved performance the IRS has achieved in 
FY2004 in three important areas: (1) customer service, (2) business 
systems modernization and (3) enforcement.
    Telephone service has greatly improved, helping taxpayers navigate 
an extremely complex tax code. In 2005, the IRS estimates that more 
than half of individual taxpayers will file their returns 
electronically and millions are using the IRS web site to download 
forms, get information on their tax law questions and track the status 
of their refunds. The IRS' computer modernization program met its cost 
and schedule milestones in 2004 and the first taxpayers have been moved 
off the old tape-based system to a modern reliable database. And 
although the agency's enforcement effort has been suffering from a 
declining resource base, in FY2004 the IRS was able to increase its 
enforcement resources and showed an impressive gain in enforcement 
revenue.
    While progress has been made, we still face an enormous challenge: 
our nation's tax gap--the amount of known taxes that are not paid. We 
all heard last week that as of 2001, the gap stood at between $312 and 
$353 billion; a slight increase from 1988, which was the last time the 
IRS measured the amount of known unpaid taxes.
    To put this into perspective, if all taxpayers paid what they owe 
each year, our government would have enough money to cover more than 85 
percent of the cost of operating\1\ all non-defense and non-homeland 
security agencies.
---------------------------------------------------------------------------
    \1\ According the Office of Management and Budget, in FY2004, 
discretionary budget authority for non-defense and non-homeland 
security totaled $386 billion. The mid-point of the tax gap range, $333 
billion, is 86 percent of this amount.
---------------------------------------------------------------------------
    With that in mind, I think we can all agree that the job is far 
from done. A lot more hard work is still required if the IRS is to 
become the tax administration agency envisioned by the authors of the 
IRS Restructuring and Reform Act of 1998.

FY2006 Budget Recommendation
    Mr. Chairman, let me now turn to President Bush's FY2006 budget 
request for the IRS. There is much to like in this request. First, the 
Oversight Board recognizes and appreciates that at a time when most 
budgets are being tightened, the President is asking for a greater 
budget increase for the IRS than other non-defense and non-homeland 
security agencies.
    The Board is heartened by the request for additional enforcement 
funding and is pleased that the Administration acknowledges that 
investments in IRS enforcement result in increased tax revenue.
    In addition, the President's focus on tax reform is most welcome by 
not only the Board, but all honest taxpayers. In the long term, 
simplification of the code will reduce the burden on America's 
taxpayers and in turn, on IRS customer service and even enforcement. In 
the short term, however, changes to the tax code will almost certainly 
increase the demand for IRS customer service.
    With that in mind, the Board's recommendation builds on the 
President's budget request. It proposes a budget that it believes will 
allow the IRS to fully achieve its strategic goals and objectives. It 
calls for $11.6 billion in funding for FY2006, a nine percent increase 
over the Administration's recommendation.

    Comparison of Administration's Request, IRS Oversight Board's Recommendation, and Enacted Appropriations
                                                 (in $ millions)
----------------------------------------------------------------------------------------------------------------
                                  FY2005                                                   FY2006
----------------------------------------------------------------------------------------------------------------
               Admin.                  Oversight Board        Enacted             Admin.        Oversight Board
----------------------------------------------------------------------------------------------------------------
10,674                                       11,206             10,233             10,679             11,629
----------------------------------------------------------------------------------------------------------------

    The Board believes that the IRS must begin to close the tax gap 
through greater enforcement. For that reason, we recommend an 
additional $435 million for IRS enforcement efforts that could easily 
generate more than a billion and a half dollars in additional tax 
revenue using the Administrations return on investment of four-to-one. 
From its private sector perspective, the Board believes it makes 
perfect sense to make the additional investments in enforcement that 
will pay for themselves many times over.
    The Board also recommends additional funding towards maintaining 
and improving customer service and supporting the BSM program. We are 
concerned that proposed reductions in customer service and 
modernization resources in the proposed FY2006 budget will have a 
negative impact on the IRS' ability to delivery quality service to 
taxpayers, which ultimately will also have a negative effect on 
taxpayer compliance.
    The IRS has already announced that it will end its TeleFile 
service, used by almost four million taxpayers. Another example of 
reduction in service is the requirement that tax return and tax account 
transcripts provided by Taxpayer Assistance Centers (TACs) must now be 
requested by phone or mail, which requires a two-week waiting period. 
These transcripts are often needed urgently by those applying for 
mortgages or other loans. This change in procedure burdens taxpayers 
and is counter to the IRS commitment to provide excellent customer 
service.
    Other possible customer service cuts may include:

      Closing some Taxpayer Assistance Centers, which in total 
serve 7.5 million taxpayers each year, many of them elderly and lower-
income taxpayers and those with limited or no English proficiency;
      Reducing hours on the IRS' toll-free lines; and
      Providing fewer paper versions of forms and publications, 
further burdening lower-income taxpayers who do not have ready access 
to the Internet.

    Business systems modernization is also key to improving customer 
service and enforcement. The program should be accelerated, not only to 
reduce costs and speed up delivery time, but to avoid a catastrophic 
collapse of the IRS' archaic legacy computer systems.
    However, for the past few years, the IRS has slowed down 
modernization even though it has demonstrated that past problems can be 
overcome and tangible benefits can be delivered to taxpayers.
    Mr. Chairman, the IRS needs a realistic budget that recognizes and 
provides for the anticipated expenses it will likely incur, such as 
congressionally-mandated pay raises, inflation and rent increases. By 
not fully funding these costs--as has been the case in the past--the 
IRS may yet again be forced to make program cuts to pay for them.
    Unfortunately, while we may completely agree that the Board's 
budget recommendations deliver value to taxpayers, the existing budget 
evaluation methodology makes it difficult to act on these 
recommendations because it considers enforcement initiatives simply as 
an expense, and does not recognize the amount of revenue that will be 
raised.
Changing the Way Congress Assesses the IRS Budget
    For that reason, the Board is pleased to see the Administration's 
recommendation to adjust 302(a) allocations to increase enforcement 
funding for the IRS.
    However, it is unclear how this recommendation could play out 
should Congress accept it. The Board is concerned that there could be 
unintended consequences. The recommendation could result in additional 
reductions in taxpayer services or modernization should budgets be cut 
or unanticipated costs arise.
    To deal with these potential problems, the Board recommends that 
Congress reviews a full range of alternatives that recognize the value 
of investing in IRS enforcement. These options could include revisiting 
the Office of Management and Budget's own budget methodology regarding 
enforcement revenue, authorizing enforcement increases under non-
discretionary funding, or allowing the IRS to retain a small percentage 
of enforcement revenue. The Board recognizes that several of these 
options fall under the jurisdiction of this Committee, and the Board 
urges the Committee to give this recommendation active consideration.

Conclusion
    Mr. Chairman, in conclusion, the Board strongly believes that our 
nation can ill afford to return to the days when the IRS fluctuated 
between customer service and enforcement. We cannot shift resources to 
pursue those who knowingly avoid taxes while neglecting the needs of 
honest taxpayers attempting to comply with a complex tax code. As I 
mentioned in the beginning of my testimony, in an effective tax 
administration system taxpayers would find compliance easy to achieve, 
but difficult to avoid.
    The IRS is now solidly on the right track and is making progress 
toward that goal but we must give it the resources to do its job. Thank 
you and I would be happy to answer your questions.

                                 

    Chairman RAMSTAD. I want to thank both Members of this 
panel for your excellent testimony and for adhering to the 5-
minute rule as well. I have two questions. The first is for 
Chairman Wagner concerning the Free File Alliance and the Free 
File program. I know that when the Free File program was 
formed, the intent was to cover at least 60 percent of 
individual filers. However, it wasn't agreed that service would 
be limited to 60 percent, or that it would be stuck at 60 
percent. This year all individual filers, I believe, have 
access to Free File. There is some dispute about whether this 
program should be made available to all taxpayers or restricted 
to low income taxpayers. What is your opinion? Do you think it 
should be available to as many taxpayers as possible or are 
limits needed?
    Mr. WAGNER. Mr. Chairman, thank you for that question. I 
would say preliminarily that the Board does wholeheartedly 
support the Free Filing Alliance. We were supportive of the 
original purpose, to provide free filing opportunities for 
oftentimes low income individuals. It is only in the past year, 
as I understand it, that the program has been expanded to 
include 100 percent of all individual taxpayers. The Board has 
not taken a position on this issue, but we are aware of some of 
the concerns that surround it. We are aware of the concerns 
between Members of that alliance and I believe you will be 
hearing more about that this afternoon. The National Taxpayer 
Advocate has expressed concerns about the ancillary products 
which are being marketed at the same time. That all said, my 
own personal opinion is that, to the extent that we can 
facilitate for all individual taxpayers, whether they be low, 
middle or high income individuals, the use of electronic 
systems, then I would support as many people as possible being 
encouraged to file electronically and for free.
    Chairman RAMSTAD. Should the priority be to low income 
individuals?
    Mr. WAGNER. The priority to the low income individuals, 
yes, sir. The second question concerns an issue you both 
broached in your testimony and that is BSM. I know that the IRS 
is taking on more of the management, as you mentioned--I 
believe Mr. White--in your testimony, of the BSM programs. 
Prior to the start of BSM, Congress ended a lengthy effort by 
the IRS to modernize computers. Both you gentlemen, I am sure, 
remember that. It came with great expense to taxpayers, and I 
believe the program failed because the IRS lacked the capacity 
to manage the modernization of the scale and scope that was 
proposed. It was a huge undertaking and I just don't think they 
had the resources nor the capability. My question to either or 
both of you, does the IRS have the capacity to manage BSM 
today? Mr. White?
    Mr. WHITE. Mr. Chairman, my statement was jointly authored 
by Dave Powner, who is Director of Information Technology at 
GAO. He is here and he would be an excellent person to answer 
that question.
    Chairman RAMSTAD. Thank you. Welcome to the Subcommittee.
    Mr. POWNER. Thank you, Mr. Chairman. Clearly the IRS is in 
a transition mode as we transition responsibility from the 
contractor to the IRS. There have been steps in the right 
direction to have the appropriate resources on board, but they 
acknowledge that they still have many challenges in this human 
capital area to fill important positions in order to manage 
this effectively. In addition to that, managing the contractor 
will still be a challenge for the IRS as they move 
responsibilities in-house. That is something that is 
acknowledged by the current CIO. Then third, bolstering their 
program management remains a challenge for them. So, I think 
there is movement in the right direction. They acknowledge 
those risks, but clearly there is a lot of work ahead, and this 
next year will be a true test of whether they can successfully 
pull this off.
    Chairman RAMSTAD. So, it is a fair summation that the jury 
is still out?
    Mr. POWNER. Correct.
    Chairman RAMSTAD. I appreciate your responses, from all 
three of you, and your testimony. The Chairman will now yield 
to the distinguished Ranking Member.
    Mr. LEWIS. Thank you very much, Mr. Chairman. Thank you, 
Director White and Chairman Wagner for your testimony. Director 
White, what is the appropriate level of spending for the IRS, 
the level proposed by the President or the higher level 
proposed by the IRS Oversight Board?
    Mr. WHITE. That is an excellent question, and I think the 
answer depends on IRS' long-term goals. As I indicated, IRS 
right now does not have long-term goals for either service or 
enforcement, which makes it very difficult to evaluate the 
budget proposal for 2006. With long-term goals, Congress and 
others would be much better positioned to be able to tell how 
much the budget proposal--how close the budget proposal would 
move the IRS to those long-term goals; being able to achieve 
its long-term goals. So, we think it is very important that IRS 
finish developing these goals and make them public so that 
there can be some assessment of the goals in terms of whether 
they are appropriate or not.
    Mr. LEWIS. Thank you. Let me just ask you, what concern 
does GAO have about cuts to IRS taxpayer service as proposed by 
the Administration? Are you concerned about it?
    Mr. WHITE. We are. As I indicated, our major concern is the 
swinging pendulum sort of situation. We don't want to end up 
with a swinging pendulum where taxpayer service suffers in 
order to shift resources to enforcement, and then in turn 
enforcement gets cut back when the focus returns to providing 
service. IRS has made noticeable improvements to service since 
1998. We hope that those service gains would not be 
surrendered. In order to do that, we think that one thing that 
IRS needs to do in thinking about services is to think about 
what their priorities are right now. They have added some new 
services that didn't exist 10 years ago such as the Internet. 
Telephone service is greatly improved compared to 10 years ago. 
I look back at one of our statements from 10 years ago, and 92 
percent of phone calls to IRS got busy signals then. That 
situation has been dramatically turned around. So, with the new 
service and the improved service, we think there may be options 
to change the menu of services that IRS offers; to provide good 
overall service to taxpayers but at lower cost. So, in our 
statement we laid out some material about areas to cut if cuts 
are needed without sacrificing the overall level of service. 
That would be focusing on things like duplication, for example.
    Mr. LEWIS. Thank you very much, Director White. Chairman 
Wagner, do you know which Taxpayer Service sites are on the 
Administration's chopping block? Do you have any idea?
    Mr. WAGNER. Mr. Lewis, we have just recently begun to 
explore that. We intend to meet with the Commissioner and learn 
of the 60 to 105 sites that he discussed. We are very concerned 
about the issue of closing the sites. We have raised the issue 
before for the same reasons that Mr. White articulated, that 
these are important services. Our surveys have indicated that 
many taxpayers prefer walk-in sites over the Internet, over the 
telephone. That said, I appreciate what Commissioner Everson 
said about trying to drive taxpayers to perhaps more cost 
effective vehicles for services, but this is something that we 
at the Board have expressed our concerns about, and we have 
agreed to monitor it.
    Mr. LEWIS. Let me ask you, what could IRS do with an 
addition of $1 billion for resources? Could they use another $1 
billion? Would it be helpful for them to get an additional 
billion dollars? Most of the agencies would like to have more 
moneys to do a lot of things.
    Mr. WAGNER. Yes, sir, Mr. Lewis. I believe if you take a 
look at our report, we have outlined and listed a number of 
initiatives that would effectively total up to $1 billion of 
additional resources. We are mindful that a recent study has 
indicated that for every dollar that goes into the IRS, $4 of 
revenue are produced with that. So, there comes a point at 
which perhaps a billion dollars or some amount of money 
wouldn't be efficiently absorbed into the organization. With 
proposed improvements in services, which we have outlined, 
enforcement, pursuing to a greater extent at this time BSM, the 
Board has taken the position that the IRS could use additional 
resources.
    Mr. LEWIS. Thank you very much, Chairman Wagner. Thank you, 
Mr. Chairman.
    Chairman RAMSTAD. The Chairman recognizes the gentleman 
from North Dakota.
    Mr. POMEROY. Thank you, Mr. Chairman. I want to commend 
you, Mr. Wagner, for the Board's work, because I think it is 
extremely helpful to have a highly-qualified group of 
individuals provide basically a fresh look at whether the 
country is getting from the Service what it needs and whether 
the Service is getting fair treatment by Congress.
    Mr. WAGNER. Thank you, sir.
    Mr. POMEROY. I note with great interest your recommendation 
that additional resources, especially additional resources to 
the Service, means better service to taxpayers, to keep centers 
open that you are otherwise going to have to close, and 
accelerated collection. Indeed your testimony talks about a 4 
to 1 return on additional investment in collection. Could you 
elaborate on that just briefly?
    Mr. WAGNER. Let me make a couple of points with respect to 
that question. Additional resources will buy additional 
services and additional enforcement activities, but I need to 
be careful to say, the IRS can also improve performance out of 
the current resources. I don't want to suggest that only 
additional monies are going to make the lone difference in 
improving collections and reducing that tax gap. I think the 
Commissioner's points are very well taken with respect to the 
improvements within the IRS that they are making both with 
technology, and the Internet, and with the particular 
initiatives they have under way with respect to enforcement. 
Again, that said, our statutory charge provided to us in the 
IRS Restructuring and Reform Act 1998, with which you are 
familiar, is to focus on the IRS and to come up with a budget, 
and to submit a budget that would ensure that the IRS obtains 
its strategic long-term goals, and its annual plans.
    Mr. POMEROY. I am sorry to interrupt. You have been very 
patient in waiting to testify, but my time is going to run too 
short, sir.
    Mr. WAGNER. Sure.
    Mr. POMEROY. I am just looking at page 3 of your testimony, 
``For that reason we recommend an additional $435 million for 
IRS enforcement efforts that could easily generate more than a 
billion and a half additional tax revenue using the 
Administration's return on investment, 4 to 1.''
    Mr. WAGNER. Yes, sir.
    Mr. POMEROY. You also have a table that shows, although you 
asked for more than the Administration sought, Congress didn't 
even fund the Administration's request; is that correct?
    Mr. WAGNER. That is correct, sir, and----
    Mr. POMEROY. That has resulted in lost revenue to the 
treasury as a consequence and a deeper deficit to this country; 
is that correct?
    Mr. WAGNER. One could argue that, and I would urge this 
Congress to fund the President's budget at a minimum.
    Mr. POMEROY. You would like even more than that?
    Mr. WAGNER. We believe that the IRS could utilize the 
additional resources above that recommendation.
    Mr. POMEROY. We have an expression at home, ``You don't eat 
your seed corn,'' and if you cut revenue to the IRS, and you 
can't collect the revenue that you are owed, you are 
essentially eating your seed corn.
    Mr. WAGNER. Right.
    Mr. POMEROY. There is another thing that I would like to 
direct you to, and I would like to direct the GAO to as well. I 
think it is important, and that is this private participation 
we have with Free File. If we are putting the auspices of 
partnership with the IRS before the public, we, I believe, 
infer approval of the private partner, and the private 
partner's ongoing relationships with the public. So, someone 
entering, basically a relationship with one of our private 
partners because they are a partner of the IRS, this just 
creates something that we need to be attentive to. Are you 
aware of whether the IRS has been able to collect information 
on what has been sold by these private partners?
    Mr. WAGNER. I am not aware if they have been able to 
collect the information, or if they have that available. I know 
that it is an issue that has been raised.
    Mr. POMEROY. I don't think they do. I have got my hand on a 
letter that just makes me mad. I don't know why I didn't see it 
before, but I had written and asked for, ``What are you 
selling?`` I get a letter back saying, ``Our Member companies 
cannot lawfully examine and combine a report of the taxpayer 
information you are seeking without the lawful consent of 
subject taxpayers.'' I think that is a crock because we are 
talking about aggregated data of sales information. This isn't 
individual tax--I am not asking whether Harry Hanson bought a 
certain policy. I am asking, ``What did Intel sell as a private 
partner?'' Do you think that we ought to be able to have this 
information?
    Mr. WAGNER. I think the information probably could be 
obtained by simply going to the sites and seeing what products 
are offered with respect to other financial services and other 
investment opportunities, the RALs and so on. The short answer 
is, I think that information in the aggregate most definitely 
should be available.
    Mr. POMEROY. I think it should be available. I also think 
it is something that the Board might want to exercise some 
Service oversight, because if among vendors we have vastly 
different take-up rates on, for example, refund lending, it 
certainly might raise an inquiry in terms of, say, what is our 
private partner doing here to generate such a differential 
return. To the GAO, I would also think that this would be a 
matter of interest. Is it something that you think might be an 
appropriate inquiry of the GAO?
    Mr. WHITE. It very well could be. One general management 
proposition that we support is programs and initiatives ought 
to periodically be reviewed, ought to be assessed, their 
performance ought to be judged based on empirical data. We now 
have several years worth of experience with the Free File 
program, so this might be a good time for such a review.
    Mr. POMEROY. Right. The Free File program; we were 
interested of course in the numbers that used it, but I always 
had an interest in what are they selling.
    Mr. WHITE. Right.
    Mr. POMEROY. It doesn't seem to me that that inquiry has 
even begun. I am going to work with you on getting it done, but 
I hope that within the----
    Mr. WAGNER. Your point is well taken, Congressman, and we 
will communicate with each other and begin to look into that.
    Mr. POMEROY. I appreciate it and look forward to the 
ongoing input the Board will give this Subcommittee on 
Oversight as we try to work these things through. Thank you 
very much. Thank you. I yield back.
    Chairman RAMSTAD. I want to thank the Members of this 
second panel for your important testimony and your important 
service. You are now excused. Thank you very much. It is now a 
pleasure to call the third panel. As I said earlier, this panel 
will feature testimony from representatives of practitioner 
groups. Mr. Kenneth Gideon, Chair of the Tax section of the 
American Bar Association; Mr. Thomas J. Purcell, Chair of the 
Tax Executive Committee of the American Institute of Certified 
Public Accountants; Mr. Frank Degen, President-elect of the 
National Association of Enrolled Agents; Mr. William Stevenson, 
Enrolled Agent, Spokesperson for the National Council of 
Taxpayer Advocacy; and finally, Mr. Brad Smith, Senior Vice 
President, Consumer Tax Group of Intuit Corporation. Welcome, 
gentlemen to the Subcommittee and thank you for your patience 
this afternoon. Please deliver your testimony. I don't know if 
you have any order.
    Mr. GIDEON. I am on the list first and I am happy to begin, 
Mr. Chairman. My name is Kenneth Gideon.
    Chairman RAMSTAD. Let us go right down the list, Mr. 
Gideon, Mr. Purcell, Mr. Degen, Mr. Stevenson, Mr. Smith. 
Please, Mr. Gideon.

  STATEMENT OF KENNETH W. GIDEON, CHAIR, SECTION OF TAXATION, 
                    AMERICAN BAR ASSOCIATION

    Mr. GIDEON. I am the Chair, as you said, of the ABA Tax 
Section. The ABA appreciates this opportunity to appear before 
the Subcommittee on Oversight to talk about the critical need 
for simplification of our Federal tax laws and to support full 
funding of the IRS budget request. Making the tax system 
fairer, simpler and easier to administer has been a legislative 
priority of the ABA for nearly 30 years. We have been on the 
record urging simplification, a broad tax base and lower rates. 
In recent years we worked with our colleagues at the American 
Institute of Certified Public Accountants and the Tax 
Executives Institute to identify simplification priorities and 
realistic simplification initiatives on which Congress can act. 
It is important that Congress act in every tax bill and that it 
also join in the effort and actually simplify the tax law.
    A substantial effort at identifying complex provisions that 
can be simplified has already been undertaken by the staff of 
the Joint Committee on Taxation (JCT) in their comprehensive 
2001 study on simplification. The effects of complexity, we 
believe, contributes substantially to taxpayer perceptions that 
our tax laws are not fair. While JCT's 2001 study provides a 
substantial number of simplification alternatives, we believe 
that some like the Alternative Minimum Tax (AMT) require urgent 
attention. The dual system created by the AMT is one of the 
most serious complexity problems of the current Code. Each year 
more and more middle class Americans have to compute their 
taxes under two systems to determine which they must pay. The 
individual AMT is complex. It leads to frequent errors, and 
whatever policy justification it may have had long ago has long 
since disappeared. We believe that the individual and corporate 
AMT should be repealed. We recognize that replacement sources 
of revenue will likely have to be identified to accomplish 
this, but the time has come to eliminate the complexity and 
burden imposed by the AMT. Even if big ticket simplification 
such as AMT repeal cannot be accomplished immediately, there 
are a range of important but smaller simplification proposals, 
such as simplifying phase-out provisions that can be 
accomplished with appropriate legislative focus. Other useful 
simplification proposals, such as the elimination of provisions 
that have little current utility or current revenue impact, 
called ``deadwood,'' should be considered.
    If, in every session, Congress would set itself the task of 
enacting legislation to address some of these problems, Members 
could create momentum that, over time, could make a real 
difference in improving the Code, easing taxpayer burdens and 
making tax laws far more administrable. In addition, we have 
consistently urged that the IRS be provided with adequate 
resources to carry out its missions of taxpayer service and 
fair administration and enforcement of the Federal tax 
statutes. We continue to believe that adequate funding is vital 
and, therefore, urge you and your colleagues to work with the 
appropriators to fully fund the President's budget request for 
the IRS and to consider the further requests made by the IRS 
Oversight Board.
    In closing, we understand that simplification is not easy. 
It frequently requires that either revenue be foregone or 
choices be made that some taxpayers benefit and some taxpayers 
suffer as a result of enacting simplification proposals, but 
simplification is worth the cost. It pays dividends in terms of 
easing the burden of compliance for all taxpayers, simplifying 
the task of taxpayer education and law enforcement for the IRS, 
and improving taxpayer morale by making it easier to appreciate 
that the law operates fairly for all taxpayers. The tax section 
Members stand ready to work with you and your staff Members to 
achieve simplification. We commend you for what you have done, 
and it is vital that you continue and that you succeed. Thank 
you.
    [The prepared statement of Mr. Gideon follows:]

     Statement of Kenneth Gideon Chair, Tax Section, American Bar 
                              Association

    Thank you, Mr. Chairman. My name is Kenneth Gideon. I am Chair of 
the American Bar Association Section of Taxation. This testimony is 
presented on behalf of the American Bar Association.
    The American Bar Association appreciates the opportunity to appear 
before the Subcommittee on Oversight (the ``Subcommittee'') today to 
discuss the critical need for simplification of the federal tax laws. 
We know this is an issue the Subcommittee takes seriously, and we 
appreciate the efforts the Chairman and other Members of the 
Subcommittee have taken over the past few years to focus attention on 
the need for simplification--and to motivate Congress to enact 
important simplification legislation.

ABA Section of Taxation
    The ABA is comprised of more than 400,000 members and its Section 
of Taxation has more than 18,000 tax lawyers who work in law firms, 
corporations and other business entities, government, nonprofit 
organizations, academia, accounting firms and other multidisciplinary 
organizations.
    Our members provide advice on every substantive and procedural area 
of the tax laws, and interact regularly with the Internal Revenue 
Service (the ``Service''), the Treasury Department, and other 
government agencies and offices responsible for administering and 
enforcing the tax laws. Many of our members have served in staff and 
executive-level positions at the Service, the Treasury Department, the 
Tax Division of the Department of Justice, and Congressional tax-
writing committees.

The Need for Simplification
    Making the tax system fairer, simpler and easier to administer is a 
legislative priority of the ABA. For nearly thirty years, the ABA and 
the Section of Taxation have been on record urging tax law 
simplification, a broad tax base and lower tax rates.
    In recent years, the Section of Taxation has worked with our 
colleagues at the AICPA Tax Division and the Tax Executives Institute 
to identify simplification priorities and realistic simplification 
initiatives on which Congress can act. The Tax Section and our 
colleagues in our cooperating organizations will continue this 
important work. But it is important that Congress--in every tax bill--
also join in the effort and actually enact viable simplification 
proposals. In this regard, we want to acknowledge that the Congress did 
just that last year in enacting important simplification in the 
definition of a ``child'' in the Internal Revenue Code. This definition 
affects many provisions of the Code. Your efforts last year made life a 
little easier for millions of taxpayers, and we thank you for it. But 
much more needs to be done.
    We believe that complexity is at the root of many significant 
obstacles to efficient and effective administration of the tax laws. 
Indeed, the National Taxpayer Advocate and others have repeatedly 
demonstrated that complex tax law provisions make life harder for 
everyone. They cost taxpayers time in simply trying to understand what 
is required of them, and they make errors by taxpayers and the IRS a 
virtual certainty. Eliminating complexity where we can identify it and 
fix it must be a continuing priority of the Congress.
    We understand that simplification is not easy. It frequently 
requires that either revenue be foregone or choices made such that some 
taxpayers benefit and some taxpayers suffer as a result of enacting 
simplification proposals. But simplification is worth the cost. It pays 
dividends in terms of easing the burden of compliance for all 
taxpayers, simplifying the task of taxpayer education and law 
enforcement for the IRS, and improving taxpayer morale by making it 
easier to appreciate that the law operates fairly for all taxpayers.
    A substantial effort at identifying complex provisions that can be 
simplified has already been undertaken by the staff of the Joint 
Committee on Taxation in their comprehensive 2001 study on tax 
simplification. As the Joint Committee noted, complexity reduces 
taxpayers' perceptions of fairness of the federal tax system by 
creating disparate treatment of similarly situated taxpayers. Although 
perceptions--and their impact--are difficult to measure, the effects of 
complexity, we believe, contribute substantially to taxpayer 
perceptions that our tax laws are not fair.
    While the Joint Committee's 2001 study provides a substantial 
number of simplification alternatives, we would like to emphasize a few 
requiring urgent attention. The dual tax system created by the 
Alternative Minimum Tax is one of the most serious complexity problems 
in the current Code. Each year, more and more middle-class Americans 
have to compute their taxes under two systems to determine which they 
must pay. The individual AMT is complex, leading to frequent errors. It 
results in indefensible policy outcomes such as a taxpayer prevailing 
in a lawsuit only to find that she owes the IRS more than she 
collected. In short, whatever policy justification may have existed for 
the individual AMT when it was enacted has long since disappeared.
    The American Bar Association believes that the individual AMT 
should be repealed. We recognize that replacement sources of revenue 
will likely have to be identified to accomplish this--but the time has 
come to eliminate the complexity and burden of having a growing number 
of middle-class Americans each year compute individual taxes under two 
different systems.
    The Tax Section also notes that the corporate alternative minimum 
tax creates complexity for corporate taxpayers that is in many ways 
akin to the problem for individuals. The Tax Section has written to 
Congressional leaders urging that the corporate AMT also be repealed. 
Again, we recognize that this may well require replacement revenues to 
be identified and substituted--but, as a matter of tax policy, making 
corporate taxpayers compute their taxes under two different systems 
creates major and wholly unnecessary complexity in our tax system. Our 
position on the corporate AMT represents the views of the Section of 
Taxation. This position has not been approved by the ABA House of 
Delegates or its Board of Governors and should, therefore, not be 
construed as representing the position of the American Bar Association.
    Even if big ticket simplification such as AMT repeal cannot be 
accomplished immediately, there are a range of important, but smaller 
scale, simplification proposals that can be adopted if appropriate 
legislative focus is applied. We called your attention last year to the 
need to address the complexity arising from the numerous provisions 
such as educational benefits, the earned income tax credit, and 
retirement savings provisions that are phased out as a taxpayer's 
income increases. Because these provisions have typically not been 
coordinated, the phase out thresholds and ranges in such provisions 
vary widely--and often overlap.
    The result is not merely mind-numbing complexity but often 
disappointed taxpayer expectations as the complicated calculations make 
it difficult for taxpayers to plan whether they will be able to utilize 
tax benefits subject to phase-outs. For example, a teacher contributes 
to an individual retirement account only to discover that she earned 
$1500 too much last year to claim the deduction. Perhaps even more 
important are the disincentives created by combining phase-outs that 
occur when a taxpayer attempts to avail himself of benefits under 
several provisions. Such combination phase-outs can create marginal tax 
rates well in excess of what the section 1 tax table says that 
taxpayer's marginal rate should be. Again, we applaud the Congress for 
the limited but important action it has taken to address the phase-out 
problem in the context of personal exemptions and the overall 
limitation on itemized deductions. But much more can and should be 
done--and the time has come to do it.
    Other useful simplification proposals such as elimination of 
provisions that have little current utility or current revenue impact, 
i.e., ``deadwood,'' should be considered. There has been progress: 
corporate taxpayers will be spared having to consider what might make a 
corporation ``collapsible'' because Congress repealed the provision. 
Congress could also review whether the accumulated earnings tax 
provisions are needed and whether one set of anti-deferral rules could 
replace the multiple sets of rules we have now.
    We strongly recommend, as we have in the past, that Congress 
seriously consider the many excellent simplification recommendations 
made by the Joint Committee in 2001. If, in every session, Congress 
would set itself the task of enacting legislation to address some of 
these problems, members could create momentum that, over time, could 
make a real difference, by improving the Code, easing taxpayer burdens, 
and making the tax laws far more administrable. We urge you to call on 
us and our colleagues in the AICPA and TEI. There is a consensus for 
simplification, and we are ready to roll up our sleeves and to help you 
make tax simplification a reality.
    We and others recently testified before the IRS Oversight Board in 
support of Treasury and IRS efforts to achieve simplification through 
the regulatory process. Fundamental to this effort is the publication 
of prompt and clear administrative guidance dealing with new 
legislation as well as new developments in the way business is 
transacted. The Treasury and IRS deserve commendation for their efforts 
to publish guidance on the 2004 Act that was timely and answered 
important questions. But the guidance process is continuous, and its 
work is never done. Timely, clear guidance advances the goal of 
simplification by reducing ambiguity and uncertainty. We believe that a 
strong published guidance program constitutes one of the most important 
contributions the Treasury and IRS can make to simplification.
    We also want to record our continuing support for IRS efforts to 
improve the examination process by improving its targeting and 
currency. Important practical simplification can also be achieved 
administratively by the creation of clear, accessible procedures for 
the resolution of recurring taxpayer errors. There are several such 
programs now, but more could be implemented. It is worth noting, 
however, that consistently recurring errors over a period of years are 
probably a strong signal to the Congress that the Code provision giving 
rise to such errors could probably be improved.
    As always, Tax Section members stand ready to work with you and 
your staff members to achieve simplification. We commend you for what 
you have done, but it is vital that your efforts continue and that they 
succeed.

                                 

    Chairman RAMSTAD. Thank you, Mr. Gideon. Mr. Purcell, 
please.

   STATEMENT OF THOMAS J. PURCELL, III, CHAIR, TAX EXECUTIVE 
 COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

    Mr. PURCELL. Mr. Chairman and Members of the Subcommittee, 
it is my pleasure today to represent the American Institute of 
Certified Public Accountants before you, and thank you for the 
opportunity to testify. You have my written comments. I have 
four brief points that I want to make in my oral testimony: 
first, I want to address the filing season; second, I want to 
address the budget request; third, the simplification issues; 
and fourth, tax practitioner responsibility.
    With respect to the filing season, it has been our 
experience so far this year not to have any significant issues, 
and in terms of practitioners, we have not heard of issues 
coming up through the ranks to us. So, partly we think that is 
because of the fact that there have not been any significant 
new changes in the law, and so they have had a chance to 
implement over the past year. We do recognize, though, that 
there have been some isolated events with regard to the 1099 
dividend form that we noted last year. We are still monitoring 
that, and we will be pleased to provide you with information as 
we get more information. Again, with the filing, we think it is 
very important to continue the effort toward e-filing. We 
support the IRS' moves in that regard. However, we did express 
some concern. They just recently proposed mandatory e-filing 
for certain corporations and nonprofit organizations to take 
place for next filing season, and we have been on record as 
asking for a suspension of that for 1 year. It does not appear 
that they are going to offer that suspension, and our concern 
with that is, not so much that taxpayers will have problems 
being able to implement, although that will be a major 
imposition on taxpayers, but also that the IRS will be able to 
absorb that number of e-filed returns when it comes to the time 
of the filing crunch that will take place in September, when 
things get extended to the September filing deadline. So, that 
is a major concern that we have.
    Second, on the budget, we do support the budget 
appropriation for the IRS. We think it is important to give the 
IRS the money it needs to do its job. Currently, for every 
dollar that you appropriate, they generate revenue of $180. 
That is a pretty good return on the investment. If, at the 
margin, the 4:1 number that has been suggested today is 
accurate, even that is a very good return on investment. My 
colleague and friend from Omaha, Warren Buffett, would probably 
jump at the chance to get that kind of return. So, I would 
encourage that if that is, in fact, the rate of return that is 
there. However, we do share the concern about the TACs that the 
IRS proposes to close, because they touch a major segment of 
the population that does not otherwise have a chance to 
interact with the IRS, or provide information that people need 
to do their tax return. Coupled with a decrease and suspension 
of the TeleFile Program, some people do not have Internet 
access, do not have access to volunteer taxpayer sites, and so 
they will be left without very many resources to provide 
information they need to do their tax return. So, we are 
concerned with that, as well as the Oversight Board's concern 
mentioned earlier today.
    Third, with regard to simplification, it has been our 
pleasure to partner with the ABA and the TEI in the past, and 
we continue to support the sentiments that Mr. Gideon has 
mentioned today. Again, my experience of over 35 years of being 
involved in tax practice is that there is no quick fix to this. 
It did not get complex overnight. You are not going to fix the 
complexity overnight, so I really support Mr. Gideon's proposal 
that you incrementally fix this. If you take it upon yourselves 
as a regular basis to try and implement simplification in the 
process and we are there to help you do that, to identify areas 
where we can make it a more simpler Code, then this will pay 
off in the long run in terms of helping taxpayers become more 
compliant. There has been some recent empirical evidence which 
indicates that once you get an equilibrium point of compliance 
and you start to cut back on the enforcement efforts, you stay 
at an equilibrium level of compliance for a while, but when 
those efforts become lower, the equilibrium shifts downward, 
and to shift it back up takes even more effort and a longer 
period of sustained enforcement activities. So, we would 
encourage the funding for enforcement, that it continue, and 
the simplification, which would help compliance.
    Finally, the last point--and I am almost out of time, but 
would be happy to answer questions in the later period--would 
be that we support taxpayer responsibility. As a profession, we 
are constantly challenging ourselves to have high ethical 
standards, and we are constantly looking to our Members and 
requiring that they comply with our high ethical standards. So, 
we support the efforts of the IRS in trying to implement that. 
However, we work in partnership with them rather than in 
opposition. So, we are trying to help make that work for all 
practitioners. Thank you for your time today, and I will answer 
questions at the end.
    [The prepared statement of Mr. Purcell follows:]

 Statement of Thomas J. Purcell, III, Chair, Tax Executive Committee, 
           American Institute of Certified Public Accountants

    Mr. Chairman and members of the House Ways and Means Subcommittee 
on Oversight, the American Institute of Certified Public Accountants 
thanks you for the opportunity to appear before you today. I am Tom 
Purcell, Chair of the AICPA Tax Executive Committee; and Associate 
Professor of Accounting and Professor of Law at Creighton University, 
Omaha, Nebraska. The AICPA is the national, professional organization 
of certified public accountants comprised of more than 340,000 members. 
Our members advise clients on federal, state, and international 
matters, and prepare income and other tax returns for millions of 
Americans. They provide services to individuals, not-for-profit 
organizations, small and medium-sized businesses, as well as America's 
largest businesses. It is from this broad base of experience that we 
offer our comments today on the IRS budget and the 2005 tax filing 
season.
    The AICPA is happy to report that the 2005 filing season is 
progressing largely without any significant problems and American 
taxpayers and practitioners are generally pleased with the Service's 
performance. However, we would like to bring an issue to your 
attention. Last year, brokerage firms and mutual funds had major 
difficulties determining which dividends constituted ``qualified 
dividends'' for purposes of the new 15 percent rate, a situation that 
resulted in large numbers of erroneous Forms 1099-DIV being sent to 
taxpayers.
    While the complaints from practitioners and taxpayers are 
substantially less than what occurred in 2004, we have received a 
number of reports from CPAs that some taxpayers still have not received 
their Forms 1099-DIV or that they are receiving a number of corrected 
Forms 1099-DIV. We will keep the Subcommittee on Oversight apprised 
should any significant developments occur with respect to Form 1099-
DIV.
    Our comments focus on a number of programs of critical importance 
to the Service, specifically: (1) the IRS budget for fiscal year 2006; 
(2) Business Systems Modernization; (3) achieving e-filing goals; (4) 
tax practitioners and professional responsibility; and (5) tax 
simplification.

1. THE IRS BUDGET
    The AICPA urges Congress to support full funding of the Internal 
Revenue Service's fiscal year 2006 budget. The AICPA has long advocated 
funding levels which would allow the IRS to efficiently and effectively 
administer the tax laws and collect taxes. Giving the Service the 
resources necessary to properly process tax returns and enforce the tax 
laws is vital to maintaining our voluntary compliance tax system. We 
expect the Service to identify responsible ways to allocate any 
additional resources it receives over prior year funding; and Congress 
will, through its oversight responsibilities, ensure that those 
resources are properly utilized.
    The Administration's 2006 budget requests a $500 million increase 
in IRS funding, bringing the allocation to $10.7 billion. The AICPA 
supports the budget proposal's objectives of principally focusing on 
increasing staffing and resources in the enforcement area. In light of 
Commissioner Mark Everson's February 7, 2005 statement that increased 
enforcement funding would be coupled with ``a modest amount of belt 
tightening in the area of taxpayer services,'' we encourage Congress 
and the Administration to maintain an appropriate balance between 
enforcement and taxpayer service. The AICPA stands ready to work with 
the Service to ensure that the needs of American taxpayers are 
adequately addressed.
    Many AICPA members are tax practitioners. As such, we have seen 
first-hand the problems caused by an IRS that is not responsive to the 
taxpayers as customers. We have also witnessed the improvements 
initiated by Commissioner Everson, particularly with respect to 
enforcement. Any lack of attention to the Service's funding needs will 
likely only serve to undercut the tax administration improvements 
Congress expects and the nation's taxpayers deserve.

2. BUSINESS SYSTEMS MODERNIZATION
    The fiscal year 2006 budget submission generally recommends funding 
the Service's Business Systems Modernization (BSM) program at 
approximately the same level Congress approved for 2005. In 
acknowledging this relatively flat funding level in his February 7, 
2005 statement, Commissioner Everson highlighted the successes that the 
IRS's modernization program had over last year, including ``the first 
update to the main IRS database in 40 years, the roll-out of new 
Internet services for taxpayers and practitioners and improved 
administration systems.''
    Although we appreciate and commend the IRS's successes, the Service 
continues to experience difficulties with BSM. We strongly encourage 
Congress to stay the course in terms of supporting appropriate funding 
for the modernization effort. This is an issue that must remain a 
central feature of the Service's strategic plan.
    The BSM goals are critical to future IRS success. BSM is designed 
to change the entire way the Service conducts business with taxpayers 
and stakeholders, by (1) implementing systems to improve IRS 
effectiveness in receiving, routing, and responding to millions of 
taxpayer telephone calls; (2) supplying Revenue Agents with software 
capable of accurately assessing a taxpayer's liability when faced with 
a complex tax matter or calculation; (3) establishing a modern, 
reliable data base; and (4) implementing a nationwide e-mail and voice-
mail messaging system for Service employees.

3. ACHIEVING E-FILING GOALS
    The AICPA supports the IRS's long-range goals for electronic tax 
administration in general, and electronic filing in particular, and we 
applaud the success of e-filing for the 2004 and 2005 filing seasons. 
As of March 25, 2005, taxpayers have submitted 49 million e-filed 
returns, or a 7 percent increase over the same period last year. 
Approximately 60 million Americans utilized e-file options in 2004.
    We concur with Commissioner Everson'sJanuary 11, 2005, comments 
that ``electronic filing can improve both [the IRS's] service and 
enforcement missions.'' Moreover, we appreciate the administrative 
benefits e-filing offers, including faster tax processing, reduced 
cycle time, quicker identification of emerging audit trends, and the 
potential for more current resolution of taxpayer uncertainties.
    The IRS has done a commendable job of introducing programs--such as 
the Free File and the Volunteer Income Tax Assistance (VITA) programs--
to help low income taxpayers who often don't own computers to file 
their own income tax returns. We are pleased to report that many CPAs 
routinely volunteer at VITA sites to help these taxpayers with their 
returns. Another critical component of helping low income taxpayers is 
to consider funding for low-income tax return preparation clinics, in a 
similar fashion to the funding low income (controversy) clinics receive 
under Internal Revenue Code section 7526. We believe this latter 
recommendation would encourage e-filing and improve compliance by low 
income taxpayers generally.
    The IRS has developed an excellent website for use by taxpayers 
through IRS.gov. We have received a number of suggestions for further 
improvements for the website, including a suggestion for the Service to 
upgrade the website's search capacity. We have received a few reports 
that persons searching for a particular tax form have found it 
difficult to find the form because the current search engine at the 
IRS.gov home page searches the full IRS website--unless the person 
alternatively scrolls down and clicks on the Forms and Publications 
category. The Service should consider having two separate search 
engines at the agency's home page--one for the website at large and one 
specifically for forms and publications.
    We support the IRS's suite of web-based products for tax 
professionals and taxpayers called ``e-services.'' Through e-services, 
practitioners and taxpayers have access to a suite of online products, 
including the Preparer Tax Identification Number (PTIN) Application; 
the Online e-file Application; Electronic Account Resolution (EAR); 
submission of Form 2848, Power of Attorney and Declaration of 
Representative; and the Service's Transcript Delivery System (TDS).
    When the program was launched in 2004, e-services was made 
available to tax professionals who e-filed 100 or more individual 
returns. The IRS announced last month that the e-Services suite will 
now be available to tax professionals who e-file 5 or more individual 
and business income tax returns. We believe this expansion of e-
services to more practitioners should have the added benefit of making 
the IRS's interaction with tax professionals more efficient, thereby 
generating significant cost savings to the Service as well.
E-File for Large Corporations and Exempt Organizations
    On January 11, 2005, the IRS issued temporary and proposed 
regulations (REG-130671-04) regarding mandatory requirements for 
electronically filing (1) income tax returns for large corporations; 
and (2) annual information returns for certain exempt organizations. 
Based on the Service's difficult experience several years ago with the 
mandatory large partnership e-file program, the IRS should expect to 
encounter significant issues when implementing this new mandatory e-
filing program for large corporations and exempt organizations.
    During the last several years, the IRS has generally done an 
outstanding job in terms of seeking input from key stakeholders on the 
details and development of tax administration programs, prior to formal 
announcement of the program's start-up. Unfortunately, the IRS did not 
actively reach out and seek prior input from all key stakeholders in 
advance of the launch of the corporate component of the e-file project. 
When the Service announces a new initiative without vetting the 
proposed program with stakeholders in advance, the new program has 
often encountered significant problems, forcing the IRS to suspend the 
program in mid-course.
    Our members have concerns about the steps, if any, the IRS has 
taken to mitigate chances of a significant security breach. Corporate 
and exempt organization officers are likely to be very concerned about 
the risks associated with the implementation of a weak security system 
otherwise subject to attack by computer viruses or hackers attempting 
to steal sensitive financial data or tax return information. Before 
engaging in electronic filing, practitioners and taxpayers should be 
made comfortable with the security features of the e-file program.
    We appreciate that the IRS intends to issue guidance as to how a 
taxpayer may request a hardship waiver. Nevertheless, because the 
corporate and exempt organization e-file program is so new, the IRS 
should maintain a posture of flexibility on the issue of filing waivers 
and not attempt to establish a stated policy of only granting waivers 
in exceptional cases.
    The regulations' preamble states that: ``A return filed 
electronically is deemed to be filed on the date of the electronic 
postmark.'' While we strongly support the concept and use of an 
electronic postmark with the new e-file program, we are concerned that 
the electronic postmark feature could become unworkable or meaningless 
should the IRS experience ``capacity'' problems with the mandatory e-
file system or should the system ``crash.''
    At the IRS's March 16, 2005 hearing on REG-130671-04, we stressed 
the need for further planning and collaboration between the Service and 
stakeholders; and accordingly, we recommended during the hearing that 
the IRS delay implementation of the regulations by at least one year to 
allow these issues to be resolved satisfactorily. During this 
transition period from a voluntary to mandatory e-file program, we look 
forward to working with the Service to develop, test, and ultimately 
implement an effective program for taxpayers.

4. TAX PRACTITIONERS AND PROFESSIONAL RESPONSIBILITY
Professional Ethics
    The AICPA applauds Commissioner Everson's commitment to high 
standards for tax professionals, as exemplified by the final 
regulations revising Circular 230 (as released on December 8, 2004), 
and his efforts to upgrade the Office of Professional Responsibility. 
We view this commitment as one of the best opportunities for the 
Service to take advantage of working with external stakeholders.
    We have a longstanding track record of establishing high 
professional standards for our CPA members, including the AICPA Code of 
Professional Conduct and enforceable Statements on Standards for Tax 
Services. These standards provide meaningful guidance to CPA members in 
performing their professional responsibilities.
    The AICPA is actively communicating with our membership and state 
CPA societies regarding the new Circular 230 provisions governing 
``best practices'' for tax advisors and tax shelter (``covered'') 
opinion standards. In this context, we are interested in the IRS 
providing further guidance to help clarify some of the inevitable 
questions that are arising as a result of these new provisions. We 
agree with the preamble of the final regulations, that:
    Tax advisors play a critical role in the Federal tax system, which 
is founded on the principles of compliance and voluntary self-
assessment. The tax system is best served when the public has 
confidence in the honesty and integrity of the professionals providing 
tax advice.
    The AICPA has a clear position on abusive tax transactions--we 
unequivocally support their eradication. We have consistently supported 
protecting the public interest by prohibitions against the misuse of 
our tax system. We continue to be actively engaged in proposing and 
evaluating various legislative and regulatory measures designed to 
identify and prevent taxpayers from undertaking, and tax advisers from 
rendering advice on, transactions having no purpose other than the 
reduction of federal income taxes in an abusive manner.
    We also support initiatives focused on ethics training for Service 
employees. We believe that IRS examination and collections employees 
must be able to ``step into the shoes'' of tax professionals and vice 
versa. Government workers and professional tax practitioners must be 
able to understand each other in order to ensure greater strides in tax 
compliance.

Registration of Federal Income Tax Return Preparers and Refund 
        Anticipation Loans
    The AICPA strongly supports the implementation of high professional 
standards for tax practitioners, as discussed above. For this reason, 
we support the concept of the Senate Finance Committee's proposal 
requiring the registration of all income tax preparers. This measure 
was included in the Tax Administration and Good Government Act (H.R. 
1528); legislation that passed the full Senate in 2004 but which was 
not enacted into law.
    It is apparent that the legislation was introduced as a partial 
response to (1) the high error rate associated with Earned Income Tax 
Credit (EITC) claims and (2) consumer protection concerns with refund 
anticipation loans. The AICPA believes that direct approaches might 
better resolve these enforcement and consumer protection issues and 
result in more tangible increases in compliance levels than a preparer 
registration process alone might yield.
    We recommend enacting legislation that directly attacks the fraud, 
negligence, and abuses committed by some preparers with respect to EITC 
claims. We also strongly urge Congress to enact legislation that 
further restricts or outright prohibits the use and availability of 
refund anticipation loans.

Tax Return Outsourcing
    On the issue of tax return outsourcing,the AICPA has adopted two 
new and one revised ethics rulings that address a member's 
responsibilities when outsourcing services to third-party service 
providers. In general, we define a third-party service provider as any 
entity that an AICPA member individually or collectively with his firm, 
does not control and any individual who is not employed by the CPA 
member or his firm. Accordingly, the new standards would apply to all 
independent contractors used by the firm.
    The new ethics ruling under Rule 102, Integrity and Objectivity of 
the AICPA Code of Professional Conduct requires that, prior to sharing 
confidential client information (such as a tax return) with a service 
provider, the AICPA member must inform the client, preferably in 
writing, that he or she may be using a third-party service provider 
when providing professional services to the client. The rule also 
emphasizes that members are not required to inform clients of third-
party service providers used only to provide administrative support 
services such as record storage, software application hosting and 
authorized e-file tax transmittal services. In addition, the new ethics 
ruling under Rule 201, General Standards and Rule 202, Compliance With 
Standards, states the AICPA's longstanding belief that members--who use 
third-party service providers in providing professional services to 
clients--remain responsible for the work performed by the service 
provider.
    Finally, Rule 301, Confidential Client Information, of the AICPA 
Code of Professional Conduct was updated to require an AICPA member to 
(1) enter into a contractual agreement with the third-party service 
provider to maintain the confidentiality of the client's information 
and (2) be reasonably assured that the third-party service provider has 
appropriate procedures in place to prevent the unauthorized release of 
such information.

5. TAX SIMPLIFICATION
    Enacting tax simplification measures is integral to the success of 
future filing seasons. As Commissioner Everson stated in his March 3, 
2005 testimony before the Tax Reform Commission:
    Complexity in the tax code compromises both the [IRS's] service and 
enforcement missions. That is because complexity obscures 
understanding. Those who seek to comply but cannot understand their tax 
obligations may make inadvertent errors or ultimately throw up their 
hands and say why bother. In the enforcement context, complexity in the 
code facilitates behaviors at variance with those intended by Congress.
    Simplification of the tax laws is a high priority of the AICPA. We 
have worked closely with the American Bar Association and the Tax 
Executives Institute to jointly identify specific proposals for 
simplification. Similarly, we have recently released a study entitled, 
``Understanding Social Security Reform: The Issues and Alternatives,'' 
and we anticipate releasing a study on fundamental tax reform in the 
next few months.
    The IRS released a study in the last few weeks stating the tax gap 
is in excess of $312 billion. We believe tax simplification can play a 
significant role in helping to reduce the overall tax gap, as 
simplification would (1) result in fewer errors on tax returns and (2) 
reduce taxpayer susceptibility to the marketing of abusive tax 
shelters.
    Thank you for the opportunity to share these views with you.

                                 

    Chairman RAMSTAD. Thank you, Mr. Purcell. Mr. Degen, 
please.

   STATEMENT OF FRANCIS X. DEGEN, PRESIDENT-ELECT, NATIONAL 
                 ASSOCIATION OF ENROLLED AGENTS

    Mr. DEGEN. Thank you, Mr. Chairman, Mr. Lewis, Mr. Pomeroy. 
I will speak today as NAEA, which represents 40,000 enrolled 
agents throughout the United States. We appreciate our time 
here today. Enrolled agents are the only practitioners for whom 
the IRS directly attests competency and ethical behavior. As it 
has been noted, it has been a relatively smooth season, though 
I would like to concentrate my remarks on three areas to ensure 
equally successful seasons in the future.
    The first area is that Congress must provide adequate 
budgetary resources to the IRS, which includes both enforcement 
and service to the taxpayer, as well as to the practitioner 
community. Please do not let the pendulum swing wildly back and 
forth between funding customer service on one side and funding 
compliance programs on the other. The truth of the matter is 
that both of these strategic objectives, service and 
enforcement, must be adequately funded for the system to work 
correctly. The IRS interacts with more citizens than any other 
government agency. The Service's budget allocation should 
reflect the agency's essential position within the government.
    The second area, the recent push for tax reform provides a 
wonderful opportunity to create a simpler system. While the 
Presidential Commission's search for the best theoretical tax 
system is interesting, I suggest that efforts to insert plain 
language into instructions, regulations, and the Code would go 
a long way toward creating a better, more understandable, and 
simpler system. The esteemed jurist, Learned Hand, once wrote, 
``The Tax Code is a fantastic labyrinth whose words merely 
dance before my eyes in a meaningless procession: cross-
reference to cross-reference, exception upon exception.'' 
Gentlemen, the Tax Code is undecipherable to the average 
taxpayer, and I submit if we can send a man to the moon, we 
should be able to write a Tax Code in plain language that a 
high school graduate can read and understand.
    The third area, we urge the Subcommittee to move 
expeditiously to regulate all people doing tax returns in order 
to ensure the integrity of the tax administration system. If I 
get my hair cut, I go to a licensed barber. If my wife goes to 
get her nails done, she goes to a licensed manicurist. If a 
taxpayer goes to someone for tax preparation, shouldn't that 
individual also be licensed? NAEA believes the answer should be 
yes, and we encourage Congress to enact legislation.
    The good news is that there is an existing structure 
already in place. The IRS has established an Office of 
Professional Responsibility. This office regulates what I will 
call Circular 230 practitioners: enrolled agents, CPAs, and 
attorneys. Legislative changes should focus on expanding and 
promoting this current regulatory regime rather than creating 
an overlapping and possibly confusing new system. The 
legislation should direct the U.S. Department of Treasury to 
enroll individuals under a modified Circular 230.
    Additionally, the legislation must ensure adequate funding 
for the Office of Professional Responsibility by dedicating all 
fees and penalties for practitioners for its operations. Simply 
mandating the regulation of potentially hundreds of thousands 
of new enrollees without beefed-up enforcement would merely 
push the problem preparers underground. The professionalism of 
the practitioner completing the return is among the most 
important and the lowest cost of the factors in increasing 
compliance. An ounce of prevention is worth a pound of cure. An 
incorrect return dramatically shifts its cost over to the IRS.
    Finally, the IRS needs to be given the resources to promote 
all Circular 230 practitioners with the public in this new 
system. Most taxpayers would be astounded to find out, while 
their barber or their manicurist is licensed, that their tax 
preparer may not be and usually is not. Comparing the downside 
of a bad haircut to an incorrect tax return, I would hazard to 
say that the public would support legislation requiring all 
preparers to demonstrate ethical behavior and basic competency. 
As Members of Congress, you have dedicated your professional 
lives to public service. We ask you to carry this mission out 
and ensure that the taxpayers of this country are protected. In 
summary, Mr. Chairman, I thank you once again for allowing NAEA 
to speak today. We ask Congress to provide the correct funding 
for the IRS, to simplify the tax system and starting working on 
the plain language, and to expand and enhance the current 
system of regulating preparers. Thank you, sir.
    [The prepared statement of Mr. Degen follows:]

   Statement of Frank Degen President-Elect, National Association of 
                            Enrolled Agents

    Thank you, Mr. Chairman, Ranking Member Pomeroy, and members of the 
Oversight Subcommittee for asking the National Association of Enrolled 
Agents (NAEA) to testify before you today. As you know, NAEA is the 
premier organization representing the interests of the 40,000 enrolled 
agents (EAs) across the country. EAs are the only practitioners for 
whom the IRS directly attests competency and ethical behavior. Over the 
years, NAEA has worked tirelessly to increase the professionalism of 
its members and the integrity of the tax administration system as a 
whole.
    The 2005 filing season has progressed relatively smoothly this 
year. EAs have reported precious few problems. Those reported are 
fairly insignificant and range from the inability to e-file some 
complex returns (i.e., cases in which more than 50% of pension or wages 
are withheld for taxes) to a printing problem with thousands of Forms 
1120H (Income Tax Return for Homeowners Associations), which, as 
printed, would have credited tax to another homeowners association. On 
the flip side, EAs are by and large pleased with the quick e-file cycle 
time and the new Schedules K-1 (notwithstanding any difficulties with 
businesses that prepare them incorrectly).
    Using the success of the 2005 filing season as a springboard, we 
would like to take this opportunity to emphasize three areas for the 
subcommittee to focus its attention on in the coming months and years 
to ensure future filing seasons are equally successful.
    First, we urge the subcommittee to dedicate its substantial 
prestige to advocating your fellow Members of Congress for adequate 
resources at the IRS, which includes both enforcement and service--and 
service includes service to the taxpayer as well as to the practitioner 
community. Second, please continue to act as the conscience of the tax-
writing committee when it comes to the creation of tax laws that are 
both administrable by the agency and understandable to the public. 
Finally, we urge the subcommittee to move expeditiously to pass 
legislation to require all people doing tax returns to demonstrate 
competency and ethical standards under the existing regulatory 
framework.
    We cannot urge too strongly that the subcommittee--in its capacity 
as the overseer of the IRS and its budget--continues to advocate that 
the IRS budget is adequate for the agency to meet its strategic goals. 
An adequate budget includes funding to meet reasonable goals for both 
compliance and service, as well as funding for the technology 
investments the agency needs to support its strategic objectives in 
those two areas. NAEA urges you to act as a bulwark against the 
tendency of policymakers to pendulum wildly back and forth between 
funding taxpayer/practitioner service on one side and funding 
compliance programs on the other. As to service, we need to stress that 
IRS is uniquely positioned to provide assistance and education to 
taxpayers as well as to practitioners. The truth of the matter is that 
both of these strategic objectives--service and enforcement--must be 
adequately funded for the system to work correctly. Particularly in 
light of IRS' recent tax gap estimate, which pegs the gap between $312 
and $353 billion annually, we hope that members of the committee can 
work with the appropriators to ensure sufficient funding. Let's not 
forget that the IRS collects nearly all the government's revenues and 
interacts with more citizens than any other government agency. As a 
result, we believe the Service's budget allocation should reflect the 
agency's essential position within the government.
    At a micro level, Congress should continue to support (and urge the 
agency to support) a number of programs that at first blush appear to 
be strictly taxpayer service oriented, but upon closer inspection have 
real returns for compliance. The public liaison program is one such 
function. Immediately after the passage of the IRS Restructuring and 
Reform Act, the IRS instituted a significant field-base public liaison 
effort with practitioners around the country. These forums made a real 
contribution to improving efficiency in helping taxpayers comply with 
the tax laws. Recently, our members have seen these meetings curtailed 
drastically or eliminated completely. We have every reason to believe 
this shortsighted movement will serve only to increase downstream costs 
for the agency as it attempts to respond--after the fact--to problems 
that could have been resolved with better communications upfront at a 
lower cost.
    The e-services program is another example of front-loaded 
investment that will produce untold millions of dollars of return. By 
allowing practitioners to go online to resolve a large number of 
taxpayer problems, it has freed up thousands of staff hours at the 
agency and saved taxpayers millions of dollars worth of practitioner 
costs. We applaud the recent IRS announcement expanding the program to 
preparers e-filing five or more returns. At the same time, we sincerely 
hope Congress and the IRS will continue to expand this program with new 
technology investments and by making it accessible to all Circular 230 
practitioners, without respect to the number of returns e-filed. We 
note that some Circular 230 practitioners provide representation 
services exclusively and comprise, in our opinion, one of the 
populations that could benefit most from Electronic Account Resolution. 
While expanding electronic filing continues to be an important 
priority, it should not happen in spite of good tax administration. Our 
members have noticed a marked increase in advertising that seems to 
suggest that being an ERO indicates some level of competency in the 
preparation of returns. This is a serious problem for the system.
    Tying e-services back to the budget, we are seriously concerned to 
hear that due to cuts for business systems modernization, the IRS has 
cancelled all scheduled improvements and additional rollouts of the e-
services program. While we acknowledge the current budget constraints, 
we believe canceling the technology expansions of the program is a 
quintessential example of being penny wise and pound foolish.
    In the area of simplification, the President's Advisory Panel on 
Tax Reform, the Department of Treasury, IRS, and Congress are well 
advised to heed Commissioner Everson's trenchant comments when he 
unveiled the new tax gap estimates. He said, ``Complexity obscures 
understanding.'' Everson went on to say, ``Those who try to follow the 
law but cannot understand their tax obligations may make inadvertent 
errors or in the end simply throw up their hands. . . .''
    The recent push for tax reform provides a wonderful opportunity to 
create a simpler system. We hope policymakers remember that for low and 
middle income people--who comprise the vast majority of all taxpayers--
the measure of simplification is straightforward: How long does it take 
or how expensive is it to do my return every year? We hope that in the 
search for a new system, practical simplification proposals are not 
lost in the search for more academic or theoretical solutions. 
Additionally, and I cannot stress this enough, do not add to the IRS' 
woes by creating a whole new tax system for it to administer without 
repealing an old tax regime. For instance, if policymakers are going to 
institute a VAT or new consumption tax, they need to eliminate one of 
the existing systems such as the corporate tax or payroll tax. At the 
risk of sounding like Chicken Little, such a move could be the last 
straw for the tax administrator.
    During the last Congress, key members of the tax-writing committees 
considered whether to regulate all return preparers. NAEA has worked 
closely with Senators Grassley and Baucus as well as Congressman 
Portman and former Congressman Houghton to ensure they do not reinvent 
the wheel. We believe strongly that if Congress is going to expand 
oversight of all preparers, its legislative changes should focus on 
expanding and promoting the current regulatory regime rather than 
creating an overlapping and possibly confusing new system. We feel 
strongly that to avoid confusion and possible opposition from state 
accountancy boards, the legislation should direct the Department of 
Treasury to enroll individuals under a modified Circular 230. 
Additionally, the legislation must ensure adequate funding to IRS' 
Office of Professional Responsibility by dedicating all fees and 
penalties for practitioners to its operation. Simply passing the 
regulation of potentially hundreds of thousands of new enrollees 
without beefed up enforcement will merely push the problem preparers 
underground.
    Additionally, the IRS needs encouragement from policymakers at 
Treasury and Congress to do everything within its means to promote 
Circular 230 practitioners to taxpayers and to support and enhance this 
credential. The IRS is making a major shift toward bolstering 
compliance. What we can learn from the current system is that the 
professionalism of the practitioner doing the return in the end is one 
of the most important factors in increasing compliance. The old adage, 
``An ounce of prevention is worth a pound of cure,'' is certainly apt 
here. If the information on the return is purposely incorrect, then the 
cost of compliance shifts dramatically over to the agency. Let's face 
it, the IRS has gone through the time and money to create a regime of 
certifying competency and integrity; it needs strenuously to support 
those practitioners that equally have gone through the effort and cost 
to enroll and stay current under this program.
    In closing, Mr. Chairman and members of the subcommittee, the 
National Association of Enrolled Agents and its members stand prepared 
to work with you and the IRS in ensuring a strong tax administration 
system and improving voluntary compliance. It is up to Congress, 
however, to do its part to provide the agency with the proper level of 
funding; simplify the tax system; and to encourage the use of Circular 
230 practitioners, expanding and enhancing the current system of 
regulating practitioners to include all people paid to complete a tax 
return.
    Thank you and I stand ready to answer any questions you may have.
                                 ______
                                 
    The National Association of Enrolled Agents (NAEA) is the 
professional society representing enrolled agents (EAs), which number 
some 40,000 nationwide. Its 11,000 members are licensed by the U.S. 
Department of the Treasury to represent taxpayers before all 
administrative levels of the IRS, including examination, collection, 
and appeals functions.
    While the enrolled agent license was created in 1884 and has a long 
and storied past, today's EAs are the only tax professionals tested by 
IRS on their knowledge of tax law and regulations. EAs provide tax 
preparation, representation, tax planning, and other financial services 
to millions of individual and business taxpayers. EAs adhere to a code 
of ethics and professional conduct and are required by IRS to take 
Continuing Professional Education. Like attorneys and certified public 
accountants, enrolled agents are governed by Treasury Circular 230 in 
their practice before the IRS.
    Since its founding in 1972, NAEA has been the enrolled agents' 
primary advocate before Congress and the IRS. NAEA has affiliates and 
chapters in 42 states. For additional information about NAEA, please go 
to our website at www.naea.org.

                                 

    Chairman RAMSTAD. Thank you, Mr. Degen. Mr. Stevenson, 
please.

      STATEMENT OF WILLIAM STEVENSON, ENROLLED AGENT, AND 
      SPOKESPERSON, NATIONAL COUNCIL FOR TAXPAYER ADVOCACY

    Mr. STEVENSON. My name is Bill Stevenson. I, too, am an 
enrolled agent. An interesting thing about enrolled agents is 
that we are creatures of Congress. We were created by Congress 
as a group authorized to represent taxpayers before the IRS. 
Today marks my 10th anniversary of providing testimony for this 
Committee, and I kind of miss Congressman Portman down at the 
other end, who was there at the time. Ten years ago, 2 1/2 
years prior to the famous Senate hearings, I pleaded with this 
organization that I am looking at now to provide more oversight 
to the IRS, and here I am 10 years later asking the same thing, 
and this is why. When we were working with the Commission to 
Restructure the IRS, the major issue that we faced in the 
beginning is: What is the mission of the IRS? Is it an 
enforcement mission? We are talking primary mission, because an 
organization can only have one primary mission. Is it 
enforcement? Is it service?
    The Commissioners and the staff of the restructuring 
commission came to the conclusion that what this Nation needed 
was an agency with a service mission. That was one of the most 
important decisions that was made because if you make that 
decision, then everything that follows, every decision you make 
after that, you ask your question: Is this following our 
primary mission? If the Commission had said we should have an 
enforcement agency, the restructuring would have been entirely 
different. The most important moment of my life, because I am 
the one who recommended this, is when Congress adopted that 
mission and made it statutory. I thought my work was done in 
trying to help provide feedback and insight into how to improve 
the IRS, because a primary mission of service layered on top of 
people of good will would give us what we wanted as far as 
raising the quality of life of Americans everywhere and not 
having an abusive type of agency in our lives.
    Let me give you examples, though, that really trouble me, 
and these examples show that the adoption of the primary 
mission may not be service. An organization that emphasized 
service would emphasize liaison with the people in the 
community. Practitioners don't--we don't just do 1040 tax 
returns. We are the ones who stand in between most of the 
taxpayers and the IRS. We are on the frontlines. The money that 
comes into the IRS is not collected. It is received. It is a 
process that is in place where, through W-2 withholding, most 
of the money goes in automatically. Who prepares these taxes? 
It is the practitioner community; and when there is a problem, 
who has to resolve these problems? It is the Members of the 
practitioner community.
    Tax processing has really become great. The IRS has done a 
fabulous job. It is the problems that have to get resolved 
afterward where things start falling apart, because the agency 
is not seeing itself as a service agency. Another example is, 
you gave us a Taxpayer Advocate service to help us--not only 
the taxpayers but the practitioner community--resolve problems 
because these people were more sensitive and knew the 
shortcuts. The IRS has taken them away from us. They are 
cutting their budget. Another example is the IRS Oversight 
Board. Now, I am talking from an outside practitioner. I am not 
on the inside. I don't owe anything to anybody. I know a little 
bit about administration. I have a doctorate in that field, and 
I am here to tell you, from my perspective and those of many of 
my colleagues, the IRS is making it very difficult for the 
Oversight Board to provide oversight. Another example, 
education and training was viewed as a major component of 
restructuring the IRS. You even had it in your Committee report 
and insisted that the IRS deploy assets to fund education and 
training of its employees. It is not an acceptable program. 
They don't deploy enough assets to it. Its employees are not 
trained. When we try to deal with them to resolve problems, 
they cannot resolve them because they do not know how, and they 
are not even empowered to do it, even if some of them did know 
how. Another example is the offer in compromise program. You 
told the IRS to liberalize it, and yet most of us have taken it 
off the table. We cannot use it because the IRS has made it 
more restrictive. We have well-meaning people in the IRS trying 
to do a job. We respect them, but they have not followed 
congressional intent and the law in administering the service 
through the eyes of a service mission.
    [The prepared statement of Mr. Stevenson follows:]

    Statement of William Stevenson Enrolled Agent and Spokesperson, 
       National Council for Taxpayer Advocacy, New York, New York

    Considering any balance between the concepts of service and 
enforcement presumes that both concepts have equal weight. It is 
axiomatic to professionals of administrative theory that an 
organization can have only one primary mission. The United States 
Supreme Court realized in the 1950's that the concept of `separate but 
equal' was flawed. The United States Congress in the IRS Restructuring 
and Reform Act of 1998 (RRA '98) also agreed with the notion that there 
could only be one primary mission and ordered the IRS to revise its 
mission statement to place the emphasis on serving the public and 
meeting taxpayers' needs.
    Congress' recognition of the need to have a service-oriented IRS 
was significant. All of the recommendations made by the Commission to 
Restructure the IRS that became the blueprint for RRA' 98 describes an 
IRS that is to be built on a foundation of service. Legislating 
adoption of a primary mission of enforcement would have yielded 
entirely different results in both the Commission's report and the 
legislation that followed.
    Service should be the foundation of our voluntary tax system. In a 
democracy we will not achieve broad based tax compliance without having 
service as the primary mission of the tax administration agency. The 
belief that the Internal Revenue Service is a tax collection agency is 
a myth. The Internal Revenue Service is a tax receiving agency. The 
major portion of the tax revenues of our nation is collected by 
employers who are required by law to withhold taxes from the wages of 
their employees. Tax practitioners of all kinds: Enrolled Agents, 
Certified Public Accountants, Attorneys, commercial tax preparers, 
payroll tax services and others facilitate the process. Practitioners 
prepare over 60% of all individual tax returns, most employment tax 
returns and a wide variety of business related returns. In doing so, 
these professionals determine the additional taxes that are paid by 
taxpayers through their calculations of estimated tax payments and 
balance due tax returns.
    The practitioner community and taxpayers need and deserve a service 
oriented Internal Revenue Service to nourish and foster our voluntary 
tax system. Most taxpayers, with the help of practitioners early or 
timely file tax returns indicating overpaid taxes. These citizens 
deserve the service of rapid processing and prompt refund of their 
money. Also deserving service are the several million employers who, 
with the help of practitioners, have actually collected the tax from 
their employees. These non paid `tax collectors' deserve service in the 
form of easy deposit systems; accurate accounting for receipts; 
trouble-free information return procedures and straight forward, post-
filing resolution of problems. Practitioners, who are the real 
compliance experts, play a major role in the process of administering 
our tax laws. They deserve the opportunity for liaison with IRS 
management so that they may understand the difficulties IRS employees 
face when they attempt to service the needs of practitioners' clients. 
Liaison activities are more beneficial to the IRS than they are to the 
practitioner community. Yet, opportunities for liaison between the IRS 
and practitioners are declining. Longstanding and regular forums, 
panels and mutual education opportunities have been reduced by IRS 
management officials at national and local levels. For example, in 2004 
the IRS Nationwide Tax Forums attracted an audience of over 17,000 
practitioners who serve almost ten million taxpayers. The Forums 
provided a conduit of information helpful to practitioners who prepare 
tax returns and helpful to those who are eligible to represent their 
clients before the IRS. In addition, the IRS Forums provided feedback 
to the IRS useful in improving the effectiveness of its programs and 
procedures. Additionally, the IRS Forums provided `case resolution' 
services where with help from the Taxpayer Advocate Service, 
practitioners were given the opportunity to bring difficult, yet to be 
resolved taxpayer problem cases for resolution assistance. The Taxpayer 
Advocate Service employees were able to resolve 90% of these cases on 
site. The Forums are scheduled for this year. However, due to budget 
cuts in service, practitioners understand that the Forums are not being 
supported by IRS management to the same degree. It is even rumored that 
the Service has determined that case resolution is too expensive to 
devote the resources of the IRS Taxpayer Advocate Service even though 
its employees remain dedicated to the program. Practitioners have been 
advised that many of the supporting divisions such as Criminal 
Investigation and Appeals may not be sending staff to interact with 
practitioners. Accordingly, compliance and enforcement initiatives will 
not be shared by IRS management with practitioners and the opportunity 
to receive feedback information which might reveal potential problems 
in IRS strategy will be lost. An organization with a primary mission of 
Service would be making different decisions about how it interacts with 
the professional community.
    Another example of a different decision that should have been made 
is the IRS decision to deny access to the electronic account resolution 
(EAR) services to the only practitioners that it tests and licenses--
the Enrolled Agent. The Services refuses access to these account 
resolution services unless applicants file five electronic returns a 
year. Many Enrolled Agents do not process tax returns, but specialize 
on representing taxpayers before various divisions of the IRS. These 
are the professionals who need the EAR system more than any other. The 
IRS has lost an opportunity to provide rapid access for account 
resolution to the most capable account resolvers.
    Everyone understands that noncompliant taxpayers must face 
enforcement. The IRS, however, doesn't seem to distinguish among those 
who are temporarily unable to comply from those who intentionally fail 
to comply. Those who are trying to comply should be treated 
sympathetically and realistically in light of their current 
inabilities. Those who won't comply should get the service of prompt 
enforcement measures.
    In RRA '98 Congress called for a new mission statement that 
emphasized service as the primary mission for the Internal Revenue 
Service. Yet, the IRS' 2005-2009 Strategic Plan identifies service and 
enforcement as equal priorities. Their strategic plan is in conflict 
with the principles of administration and possibly violates the law and 
intent of Congress. In fact, it is our understanding that the Service 
is making significant cuts in the budgetary areas that they don't 
consider enforcement.
    Congress saw the need to provide taxpayers with a powerful tool to 
cut through the red tape inertia that is endemic to bureaucracies. They 
gave taxpayers a service-minded IRS including a Taxpayer Advocate 
Service sympathetic to hardships and taxpayer rights. From a 
practitioner's perspective, it appears that IRS has management 
eliminated service as first priority and marginalized the vital 
functions of the Taxpayer Advocate Service by slashing their budget and 
leaving their personnel un-empowered and demoralized. Most taxpayers 
will never know what a friend they may have had in the Taxpayer 
Advocate Service, a would be friend that is being returned from whence 
it came. At this crucial time, the National Taxpayer Advocate's voice 
inside the IRS must be heeded. Practitioners have high hopes that 
Congress will respond positively and constructively to the 
recommendations within her annual report and restore the Taxpayer 
Advocate Service to the original intent of Congress.
    As part of its attempt to rebuild public confidence in the tax 
system, Congress created the IRS Oversight Board. The practitioner 
community considers the Board to be acting as its voice in the process 
of improvement of tax administration. The Board is generally 
responsible for overseeing the IRS in its administration and management 
of the internal revenue laws. Our country needs an effective Oversight 
Board. It appears, however, that the IRS has made oversight difficult 
for the Oversight Board. The Service, contrary to Congressional intent, 
does not seem to want the Board to make a real difference any more than 
it wants the Taxpayer Advocate Service to be effective.
    Congress in RRA '98 directed the IRS to implement an employee 
training program to ensure adequate service training because the need 
was apparent to change the internal structure of the IRS from one that 
is enforcement driven to one that is more responsive to taxpayer 
service needs. While the IRS believes it has followed the letter of the 
law by providing Congress with such a plan, everyday observations 
reveal that the culture of the agency remains enforcement minded. The 
IRS' in-service educational programs in most areas are relatively 
ineffective, inconsequential and unacceptable by even the minimum of 
standards. Evidence of this is manifest by IRS employees involved in 
telephone and face to face conferences who are unaware of the law and 
regulations they are paid to administer.
    An organization dedicated to a mission of service would have a 
robust training and education program at every level. Problem solving 
by under trained staff is preventing both compliant and out-of-
compliance taxpayers from efficiently resolving their issues 
efficiently. A service mission requires that IRS staff at all levels be 
involved in a continuous training program to bolster their abilities to 
perform their functions with a perspective of the real world built on a 
foundation of technical knowledge. The Committee Report from RRA '98 
stated: ``The bill requires the IRS to place a high priority on 
employee training and to adequately fund employee training programs. . 
. .'' Also, TIGTA reported on September 29, 2003, that ``. . . the 
training data provided to the IRS Oversight Board by the IRS were not 
adequate for the Board to perform an assessment or to develop a 
baseline of training in the IRS.'' The apparent lack of commitment to 
education and training is revealed by the lack of resources deployed to 
fund and support a major effort. Even when the IRS adopts service as 
its primary mission, it will fall short in the delivery due to the lack 
of appropriate funding for its education and training programs.
    Congress legislated an Offer in Compromise (OIC) program years ago 
and recently directed the IRS to make it available to more taxpayers by 
liberalizing it. In response, the IRS created an obtuse and unrealistic 
program. It is so flawed that many practitioners have removed OIC's 
from the box of tools they use to try obtain relief for taxpayer's 
problems. The OIC program is more restrictive now than it was prior to 
RRA '98. With a new bankruptcy law on the horizon, practitioners will 
have lost their last outpost of financial mercy on the route to 
repairing taxpayers' financial lives.
    In conclusion, There can be no balance between service and 
enforcement. Service is the foundation of enforcement in a voluntary 
tax system and it must have the greatest weight. If service is not the 
IRS' primary mission, perhaps the name Internal Revenue Service should 
be replaced with Internal Revenue Enforcement Agency.
                                 ______
                                 
    William Stevenson is president of National Tax Consultants, Inc. (a 
tax preparation and taxpayer representation firm for individuals and 
businesses). Bill is an Enrolled Agent, a Certified Financial Planner, 
and earned a Doctorate in Education from Temple University in 
administration. In addition, he is admitted to practice before the 
United States Tax Court as a non-attorney. He serves on both IRS 
``Area'' and New York State Taxation and Finance liaison committees. He 
is the only Enrolled Agent to serve on the New York State Tax 
Tribunal's Advisory Committee on Practices and Procedures. Bill is a 
member of the National Council for Taxpayer Advocacy, the National 
Society of Accountants, the National Association of Enrolled Agents, 
and is a Fellow of the National Tax Practice Institute. He has served a 
two-year term on the Commissioner's Advisory Group, worked closely with 
the Commission to Restructure the IRS, and meets periodically with IRS 
and Congressional officials in Washington to recommend changes in 
procedure as well as to provide the staff with feed-back from the 
practitioner community. Dr. Stevenson has testified on numerous 
occasions before both Houses of Congress, the IRS Oversight Board, the 
Government Accountability Office and the Treasury Inspector General for 
Tax Administration. In 2002, Bill was named ``Accountant of the Year'' 
by the National Society of Accountants. He is also the spokesperson for 
the National Council for Taxpayer Advocacy.

                                 

    Chairman RAMSTAD. Well, thank you, Mr. Stevenson. Finally, 
Mr. Smith, please.

 STATEMENT OF BRAD SMITH, SENIOR VICE PRESIDENT, CONSUMER TAX 
                   GROUP, INTUIT CORPORATION

    Mr. SMITH. Thank you, Mr. Chairman, Mr. Lewis, Mr. Pomeroy. 
I am appreciative of the opportunity to present Intuit's views 
on this year's tax filing season, as well as other issues that 
we feel face our tax system as a whole. Our mission at Intuit 
is to simplify complex financial functions and activities for 
consumers, for small businesses, and for their most trusted 
advisor, the tax practitioner. Our ultimate goal is to actually 
allow them to take control of their financial lives. We are a 
21-year-old company. We have industry-leading products that you 
may recognize: Quicken, personal finance software; QuickBooks 
for small businesses; ProSeries and Lacerte for the tax 
practitioner; and also the Nation's industry-leading consumer 
tax product, TurboTax.
    First, I would like to begin with a few comments on e-
filing. As was mentioned earlier, this year the United States 
will cross that important threshold of having over half of all 
of our individual Federal income tax returns filed 
electronically. That is a major milestone. We want to 
congratulate the Commissioner; the new IRS Director of the 
Electronic Tax Administration, Bert DuMars; as well as 
recognize the former Director of Electronic Tax Administration, 
Terry Lutes, for having laid the foundation for this tremendous 
success. It is important to note that other countries' tax 
systems have not achieved nearly as much in such a short period 
of time. For example, Great Britain chose to build and deploy a 
government-provided tax software system rather than unleashing 
the private sector in the competitive consumer marketplace. As 
a result, today only 3 percent of British taxpayers are willing 
to use that government system. Now, this is a sharp contrast 
between our American citizen-centric solution and the Great 
Britain government-centric solution.
    Now, despite our success to date, our focus must be on 
affirmative efforts to continue to identify and remove the 
remaining barriers to electronic filing. These barriers range 
from having to remember your adjusted gross income--for many 
consumers, that term in and of itself is Greek. In addition to 
that, the fact that you have to remember last year's adjusted 
gross income to file this year's return is definitely a 
challenge. In addition to that, you have to do other things, 
like pick a one-time personal identification code, or wait 48 
hours to actually know whether or not it was electronically 
received by the IRS. These are just some of the examples that 
represent that we still have opportunities in front of us. The 
good news is, the software in the e-filing industry has all the 
capabilities needed to make e-filing work and go beyond the 50-
percent threshold we have reached today and continue to push 
forward. Once again, the key enabler must be a renewed 
government commitment to both modernization as well as the 
speedy removal of these barriers.
    I would like to briefly comment on the Free File Alliance 
that has come up several times in the afternoon. The former IRS 
Commissioner Charles Rossotti testified before Congress in 2000 
and said, and I quote, ``I don't think there is any gray area 
about what the IRS role is in terms of providing services, 
because I don't believe we should provide tax preparation 
services nor tax software.'' We clearly agree. Intuit is proud 
to have originated a national program of voluntary deductions 
of online tax preparation and e-filing services. We called this 
program the Intuit Tax Freedom Project, and we launched this 
program in 1998, becoming the model for what is now today the 
Nation's Free File Alliance Initiative. This initiative was 
created in 1998 and, once again, formed with private and public 
partnership in 2002 to provide electronic tax preparation and 
e-filing to lower-income, working poor, disadvantaged, and 
underserved populations. I am proud to say in the 3 years since 
its inception, the program has supplied these services to 
literally millions of people across the Nation at no cost to 
the user nor the public treasury.
    Unfortunately, something has happened along the way. The 
Free File program has drifted far from its original purpose. 
Rather than focusing on assisting the underserved with no 
obligation to purchase any additional products or service, it 
has now become a universal free service program operating off a 
national marketing and sales platform hosted by the IRS and 
heavily dependent on ancillary sales of additional products. 
Now, after a couple of years of this trend developing 
unfettered, others, including Intuit, have joined the fray, but 
we want to be clear. We have concerns--concerns about consumer 
protection in this environment, concerns about the government 
serving as either a market maker for commercial business in 
this country or permitting public assets and endorsement to be 
used for commercial marketing and sales. The good news is the 
Free File Alliance is up for renewal and renegotiation, and 
this is an opportunity for us to get the program refocused on 
servicing the lower-income and the underserved taxpayers.
    So, let me conclude by saying it has always been said that 
voting and paying your fair share of taxes are two of the most 
basic obligations of citizenship. Whatever tax policies are 
eventually developed over the years in this country, it will be 
important to retain the citizen-centric character of voluntary 
compliance that is uniquely American, preserving the personal 
participation of our people in these most basic processes and 
obligations of individual citizenship. It helps keep government 
on its toes, and it helps keep our citizens in charge. Thank 
you.
    [The prepared statement of Mr. Smith follows:]

  Statement of Brad Smith Senior Vice President, Consumer Tax Group, 
                           Intuit Corporation

    Chairman Ramstad and Members of the Subcommittee, I am Brad Smith, 
Senior Vice President of Intuit, responsible for our Consumer Tax 
Group. Thank you for the opportunity to present Intuit's views on this 
year's tax filing season, the IRS budget, and other issues facing our 
tax system.
    Our mission at Intuit is to make complex financial functions and 
activities easy for consumers, small businesses, and accountants 
helping them to simplify and take control of their financial lives and 
better manage the financial lives of their clients. A 21-year-old 
company, Intuit's market-leading products include Quicken, QuickBooks, 
the ProSeries and Lacerte suites of tax and accounting software for 
accountants, and, of course, the leading consumer tax software, 
TurboTax.
    The private sector invention of tax software has reduced much of 
the pain and complexity of tax compliance for average Americans, while 
bringing accurate preparation and speedy filing of returns within the 
economic reach of all. In addition, Intuit is proud to have originated 
a national program of voluntary donation of free online tax preparation 
and e-filing services for lower income, disadvantaged and underserved 
taxpayers across the country, as well as for our active duty military. 
The Intuit Tax Freedom Project, begun in 1998, became the model for 
today's industry-wide Free File Alliance initiative, a national public-
private partnership between the private sector and the IRS that was 
created in 2002 and has donated millions of tax returns to the needy. 
And likewise, a Free File Alliance has now been created in almost 20 
States, once again providing free services for those who need them 
most, at no cost to either the government or the individual.
    Let me begin my testimony today by addressing the current income 
tax filing season.

Filing Season 2005 Success
    The 2005 filing season has gone very smoothly with few exceptions. 
The working relationship between the IRS and the tax software industry 
continues to improve each year. As the IRS now describes it, there is 
an eco-system of support for the American taxpayer that involves the 
cooperative and complementary roles of the IRS and the private sector, 
working together to serve our citizens.
    The IRS has reported that electronic filing is up over 7% year-to-
date, with a total of over 50 million returns accepted so far. At this 
rate, it is likely that over 50% of individual American taxpayers will 
fulfill their obligation this year via electronic filing. This 
represents a tremendous milestone for the IRS and industry along the 
road to achieving the 80% goal set by Congress in 1998.
    Just this year, e-file growth at Intuit has been dramatic. Intuit 
has produced over one quarter of the e-filed returns received by the 
IRS, having electronically filed over 28 million returns through the 
end of March--a growth rate in excess of 21% over last year.
    We congratulate the new Director of the Electronic Tax 
Administration, Bert DuMars, for his leadership in ensuring the success 
of the electronic filing season. We would also like to recognize the 
former Director of ETA, Terry Lutes, for his many years of exceptional 
leadership, which continue in his new role as Associate Chief 
Information Officer at the IRS.
    As we cross the 50% e-filing threshold in theUnited States, the 
significance of this progress cannot be understated, and it can be 
directly attributed to the productivity of the partnership between 
government and industry to drive toward this national objective for our 
American citizen-centric tax system.
    In comparison, tax systems elsewhere around the world have not 
fared as well nor achieved as much in this same period of time. One 
often-cited example is the United Kingdom, where the government set a 
50% e-filing objective at the same time we set ours at 80%. However, 
the UK chose to build and deploy a government-provided tax software 
system rather than unleashing the private sector in the competitive 
consumer marketplace. As a result, today only about 3% of British 
taxpayers are willing to use that government's online tax system, and 
as a result, just last summer the British tax agency, Inland Revenue, 
quietly lowered their national long-term e-filing objective down to 
only 25%. The sharp contrast between the failure of that government-
centric solution, and the success of the American citizen-centric 
solution, is dramatic, and we're very proud to be part of the 
remarkable success story here in the United States.

Ways to Improve and Accomplish More
    Although much has been accomplished in the drive toward electronic 
filing as the preferred method of tax compliance in the United States, 
we still have further to go.
    Today, it is still easier to mail a tax return than to 
electronically file one. But this is not a matter of cost. The filing 
of paper returns still requires the cost of either postage, special 
delivery, registered mail or express services. In contrast, there are 
free electronic tax preparation and e-filing alternatives widely and 
readily available. And so our focus must be on continued affirmative 
efforts to identify and remove the remaining barriers to electronic 
filing, and we should do so as expeditiously as possible.
    If cost is not the issue, then what are the real impediments to 
electronic filing? One of the obstacles is time and effort. As modern 
software tools have reduced the time it takes to self-prepare a simple 
return down to a half hour, the process of electronic filing commonly 
takes another 50% of that time, or an additional fifteen minutes, just 
to transmit the return. Here are some of the reasons why electronic 
filing is still unnecessarily difficult:

      Taxpayers need to enter up to 20 additional figures from 
their W-2, just to electronically file;
      Taxpayers need to electronically sign their return using 
their previous year's Adjusted Gross Income number, when a great many 
taxpayers can neither understand the concept of what AGI is, nor 
remember what last year's AGI number was; many taxpayers approximate 
what they think their income was in the previous year, effectively 
making up a number;
      The number one reason e-filed returns are rejected by the 
IRS is a mismatch of what the taxpayer enters as their previous year's 
AGI vs. the number the IRS has in their database;
      Taxpayers must make up and use a Personal Identification 
Number (PIN), a number that they'll never use again;
      Once the taxpayer transmits their return, they then need 
to wait 24-48 hours before they know whether their return has been 
accepted or rejected; this is in sharp contrast to commercial 
transactions in electronic commerce which are generally instantaneous;
      If the taxpayer's electronic return is rejected (which 
happens to between 14 and 19% of e-filed returns for various reasons), 
they need to repeat the entire process over again; many simply give up 
and print and mail their returns;
      Many taxpayers are not able to e-file due to late law 
changes that result in a late release of IRS forms; for example, filers 
who donated over $500 dollars in non-cash contributions to a charity 
were not able to electronically file until late in February due to the 
late release of form 8283 by the government, driven by the late 
enactment of the changes to the law;
      Approximately 20% of tax filers owe a balance due, and 
many of these taxpayers believe that they will have to pay instantly if 
they electronically file, and therefore choose to file by paper to slow 
down payment and improve family cash flow.

    In addition to these obstacles that can be removed to facilitate 
greater taxpayer reliance on e-filing, there are important barriers 
which must also be removed to encourage greater e-filing by the 
professional tax preparer and accountant community. Major expansion of 
e-filing by professional tax practitioners must take place in order to 
substantially improve today's e-filing numbers; in order to do this, 
the government must:

      Eliminate the awkward and archaic requirements that stand 
in the way of expanding registration of tax professionals as authorized 
e-filers; most professional tax practitioners (73%) are one-person 
operations for whom the current process of e-file registration is 
burdensome and unattractive;
      The current reporting agent enrollment process for e-
filing takes up to 30 days and is paper based and subject to error and 
rework; the process does not use electronic signatures, and requires 
manual entry of information both at the IRS and at the small 
businesses; this must be modernized;
      E-filing processes must be improved to take into 
consideration the workflow needs of practitioners, eliminate the need 
for rework, and recognize that they are in a business that must work 
efficiently if they are to earn a living. E-filing must be at least as 
easy for a practitioner as paper filing.

    All of these obstacles must be addressed and removed, effectively 
and expeditiously, if we are to accelerate the national transition to 
electronic filing as the predominant method of Voluntary Compliance in 
the American tax system.
    Beyond barrier removal, there are also affirmative steps that can 
be taken which could contribute in significant ways to the growth and 
acceptance of e-filing. Primary examples would include:

      Expand educational and public information efforts to 
promote the benefits of e-filing and help taxpayers overcome 
misconceptions; for example, the top reasons that our customers e-file 
are to get a faster refund and an acknowledgement from the IRS 
confirming receipt of their return, while the top reason that people 
don't e-file relates to worries about security and also fear of being 
targeted for audit
          Public awareness efforts must be redoubled in 
        reassuring public confidence in the security of electronic 
        filing, and that e-filing in no way increases the chances of 
        audit, and indeed may reduce such chances due to a reduction in 
        errors in returns.
      Add meaningful benefits for the 20% of tax filers who do 
not have the attraction of getting a refund; such ideas include:
          Extended time to pay--consider offering all e-filers 
        additional time to pay their taxes due;
          It has been proposed by several Administrations that 
        a small tax credit be offered for those who electronically 
        file; it is time to take that step;
          Work with the banking industry to encourage balance 
        due payment by major credit card with no convenience fee;
              Current solutions such as Opay and Link2Gov 
            charge users a 2.49% convenience fee;
              In contrast, our learnings from this filing 
            season indicate that there is pent up demand for a no-
            convenience-fee option; this year in partnership with the 
            Discover Card we waived the convenience fee for the balance 
            due payment option and saw 5-fold growth in consumer 
            adoption.

    In addition, expanded public-private partnership between government 
and industry will be an essential element of taking e-filing to the 
next level. Congress and the IRS should look to existing vehicles such 
as a well-focused ``free file'' program and the Electronic Tax 
Administration Advisory Committee (ETAAC) to drive a collaboration 
strategy:

      Work jointly with industry to simplify the e-file use 
experience;
      Work jointly with industry to eliminate and reduce e-file 
rejects (for example, having the ability to ping the IRS' database to 
proactively detect issues that might result in a rejected return could 
save time, resources and wasted effort, which could benefit everyone);
      Remove barriers to facilitate small business e-filing, e-
payment and other transactions;
      Enhance coordination between the IRS, states and 
industry:
          The Joint Tactical Advisory Group between the IRS and 
        the state Federation of Tax Administration is a good concept to 
        focus energy at a working level on Fed/State issues, but 
        Industry has no seat at the table; that void needs to be 
        rectified, as all three parties together can accomplish much 
        more than any two alone;
          The current national Free File Alliance program today 
        is a federal-only Agreement; as a result, some 20 states have 
        had to create their own look-alike free file program for free 
        state returns to assist lower income, disadvantaged and 
        underserved citizens in their jurisdictions; many states have 
        found that building, deploying, and operating their own tax 
        software systems wasn't the optimal use of scarce budget 
        dollars and drew little public acceptance or participation; as 
        a result, many states have turned to the Free File Alliance 
        solution instead; however, the absence of the states from the 
        federal program has created a complex and awkward substitute 
        strategy, and reduced company participation in the state 
        programs; to correct this deficiency, the renegotiation of the 
        federal Free File Agreement this year should include dialogue 
        with states aimed at finding ways to facilitate state 
        participation in coordinated free file programs, and likewise 
        encourage industry participation in the state programs.

    If an updated national e-filing strategy is approached with a new 
sense of commitment and innovation, substantial additional growth in e-
filing is still possible and could be achieved in a foreseeable 
timeframe, just as the first 50% milestone was reached in a relatively 
short period of time. The only question is how serious we are about 
driving e-filing even further as the preferred method of Voluntary 
Compliance in this country. Substantially greater growth is achievable 
if there is a genuine commitment to making it happen.

Tax Services to Assist those in Need
    The Free File Alliance program began as an innovative solution to 
the public interest objective of providing ready access to electronic 
tax preparation and e-filing for lower income individuals and families, 
the working poor, disadvantaged, underprivileged, and underserved 
taxpayer populations at no cost to either the taxpayer or the public 
treasury. A voluntary public-private partnership between the IRS and 
the software industry, the current Free File Alliance program had the 
objective of making free electronic tax preparation and filing 
available to 60% of American taxpayers. The ability to assist the needy 
and underserved would be made possible by commercial sales of online 
tax preparation and e-filing to the rest of the taxpaying public. And 
at typical costs of $20 per tax return, web-based tax software and e-
filing had already driven the costs of tax compliance down to very low 
levels, within the reach of almost everyone.
    The commitment of the private sector to donate electronic returns 
and filing to those in need enabled government to completely avoid the 
potential cost of trying to build and provide its own tax software 
products, which countries like the United Kingdom have discovered to be 
a failed and expensive strategy. After spending hundreds of millions of 
Pounds Sterling building, deploying, operating and advertising the 
Inland Revenue's Self-Assessment OnLine tax software service, UK 
taxpayer adoption has not exceeded 3%, and the Chancellor of the 
Exchequer has reported to the House of Commons that the cost of the 
system still exceeded $ 50 per return after several years of operation. 
This government-centric solution stands in sharp contrast to the U.S. 
estimated cost of.75 cents a return for our government receiving and 
processing a privately prepared and electronically filed return in this 
country, employing our citizen-centric system to get the job done 
efficiently and inexpensively.
    The adoption of the private-sector-provided Free File solution in 
the United States allowed the IRS to instead focus its investment on 
critical infrastructure modernization, enabling those unique and 
specialized operations and services that only government can provide. 
As then-IRS Commissioner Charles Rossotti said in Congressional 
testimony:

         ``I don't think there is any gray area about what the IRS  
        role is in terms of providing services, because I don't believe 
        we should provide tax preparation services or tax software.''

    Agreement was reached between industry and government in July 2002, 
through the auspices of the Electronic Tax Federal Advisory Committee 
(ETAAC): the industry would provide free access to consumer electronic 
tax services to segments of the population underserved and under-
represented among electronic tax filers, and those with the greatest 
financial need. As a part of the agreement, the government would not 
seek to duplicate private sector investments or services. The agreement 
was published in the Federal Register in August 2002, and received more 
than 700 public comments, which ran 6-to-1 in favor of the innovative 
proposal.
    In the three years since the Free File Alliance project was 
launched, millions of taxpayers have received free electronic tax 
returns and free electronic filing. The IRS has reported that the Free 
File Alliance program has significantly contributed to the growth in e-
filing over that time period. Unfortunately, something else has 
happened. The current Free File Alliance program has drifted very far 
from its original public service purpose and objective.
    Rather than being dedicated to assisting the working poor, 
disadvantaged, and underserved, the Free File Alliance has now become a 
``universal-free'' program, operating off a national marketing and 
sales platform hosted by the IRS, where participating companies depend 
on the sales of other products and services to the free return 
recipients in order to make it possible to provide the federal returns 
for free, such as sales of a basic staple like state tax returns. This 
kind of economic interdependency was never supposed to be the business 
model for free file. The original idea, of great merit, was for 
industry to have the ability to donate services to those in need as a 
result of their ongoing competitive commercial sales to the vast bulk 
of customers in the regular marketplace, where companies would normally 
be selling their services in substantial quantities to the general 
public. That original free file business model, enabling public service 
donation to the truly needy through a philanthropic model, was in the 
public interest and must be restored.
    After several years of this new universal-free trend developing 
unfettered within Free File Alliance program, others, including Intuit, 
have individually found it necessary to join the fray in competitive 
response. However, we and others have expressed a range of concerns 
about the interests of low income consumers in this kind of free-for-
all environment, and concerns as well about the government serving as 
either the market-maker for commercial business in this country, or 
permitting public assets and endorsement to be used for commercial 
marketing and sales purposes.  Finally, the absence of the states from 
a place at the table for discussion with the Federal Government and 
industry in the Free File Alliance program limits the potential public 
benefits from the program since state tax filers, including low income 
participants, are being charged for tax preparation under the current 
model.
    The original public service concept of a free file initiative had 
great merit. It was an unprecedented public service initiative to help 
those least able to enjoy the benefits of modern electronic commerce in 
this country. We believe a private-sector-provided free file program 
can still have great merit, but any public-private partnership must 
focus on helping the underserved and underprivileged, with appropriate 
and sensible rules, governance and accountability, in which the IRS 
must play a key, active, and engaged program management role in 
cooperation with the private sector.
    Indeed, recent budgetary decisions by government underscore the 
need for an improved and refocused free file program to be successful 
and stable for years to come. The inordinate costs of government 
providing TeleFile have long been a practical concern, and more recent 
decisions to cut back significantly on traditional bricks-and-mortar 
IRS Walk-In assistance centers, underscores the crucial role a well-
focused free file program can play in providing assistance to the 
working poor, to those in need, to the disadvantaged, to the elderly on 
fixed incomes, and to various other underserved taxpayer populations. 
This dedicated purpose of voluntary public service to assist those in 
need must be restored as the purpose and mission of free file, and 
should be accomplished well before the beginning of the next tax 
season.
    The current Free File program agreement between IRS and industry is 
up for renegotiation this year, and that milestone represents the 
opportunity to establish an improved program for the purpose of 
providing a philanthropic tax preparation and e-filing service program 
for those in our society who need it most, harnessing the investments, 
innovations and capabilities of the private sector to achieve important 
public service objectives. A midcourse correction in this program is 
urgently needed, indeed overdue, to restore this founding and defining 
purpose. We pledge ourselves to actively support that important 
objective, and strongly urge Congress and the IRS to do the same, 
restoring this valuable initiative to its original purpose and promise, 
so it can serve the public interest for years to come.

Looking Ahead
    The Congressional policy decision to move the United States toward 
an electronic-filing tax culture was not only the right direction, but 
as we look ahead should be thought of in much broader terms about the 
whole process of taxation in the American economy:

      As states increasingly adopt Simplified Sales Tax 
legislation, the path forward is clearly to enable electronic filing of 
sales tax reports by small businesses across the country to the 
respective jurisdictions, eventually enabling all forms of sales to be 
compliant, whether businesses are of the traditional ``bricks and 
mortar'' variety or are conducted over the Internet. Software will even 
further simplify the complexity of different sales tax rates across 
jurisdictions, making compliance practical and easy. Such basic 
technologies can likewise make it possible for thousands of web-based 
small businesses to track and report income from their internet 
transactions.
           If part of future federal taxation were to eventually 
        include either some form of a Value-Added or Sales Tax, the 
        process of compliance could be greatly simplified through 
        software and electronic filing that would be available through 
        the competitive commercial marketplace. Indeed, all of these 
        tools are well-within industry's capability to provide to 
        American taxpayers. Whatever the future tax compliance needs of 
        consumers and small businesses may be, the software industry 
        can make them simple, fast, and inexpensive.
           At the same time, the ability of industry to invent and 
        bring to market easy software tools for tax compliance should 
        never be an excuse for building excessive complexity into the 
        U.S. tax code. Tax simplification benefits everyone and is the 
        right policy direction.
      There is also a huge opportunity to expand small business 
e-filing beyond income tax and into the employment and sales tax areas. 
Our data show that while some small businesses are e-paying federal 
taxes (about 40%) significantly fewer are e-filing federal forms, only 
15%. More importantly, these small businesses would also strongly 
prefer to integrate their e-filing with their accounting software. This 
e-filing integration with accounting software has benefits both to 
small business and the government. The small business will benefit from 
accuracy, ease of use, and time-savings. The government will benefit 
from increased e-filing participation, lower costs, and increased 
accuracy.
        There are a couple of key barriers to small businesses adopting 
e-filing.

          First, there is no integrated methodology to e-file 
        from within accounting software.
          Second, the government agency enrollment mechanisms 
        are complex, lengthy, and paper-based. For companies such as 
        Intuit, that are working to offer payroll e-filing, the 
        barriers are similar--no automated enrollment mechanisms, no 
        industry standards, complexity of dealing with 50 different 
        states and the federal government, and the lack of a joint 
        Federal/State gateway for employment taxes. Manual processes 
        are too costly and lead to higher prices for small business 
        and, therefore, less usage.

        We recommend several steps to increase small business 
employment tax e-filing and payment, including the development of the 
following:

        1.  A joint Federal/State gateway for employment taxes and 
        forms.
        2.  Completely automated enrollment for federal and state 
        employment taxes e-filing.
        3.  Completely automated filings. (For example, the SSA 
        requires W-2s to be manually uploaded to a web site by payroll 
        operators, and there is no automated server-to-server 
        (computer-to-computer) connection.)

      E-Filing can be a win-win for small business and government, 
helping everybody save time and money. Industry can enable efficient 
and accurate e-filing for almost a million small businesses. Taking 
steps such as the joint Federal/State gateway, and completely 
automating enrollment and filings, will help us all realize this vision 
faster.
Summary Thoughts
    The fact is that the technology industry that invented income tax 
software can also greatly simplify and facilitate whatever tax system 
needs we may have in the future, for both consumers and small business, 
where the vast bulk of compliance burdens would otherwise lie. Having 
said this, it is also clear from our experience with millions of 
taxpayer customers that there is extensive complexity in the tax system 
that would plainly benefit from simplification and clarification in the 
best interest of the nation, our citizens, and the government itself.
    Some of the most common difficulty today comes from the use of what 
may seem to be basic concepts in the current tax code, but which 
actually represent great confusion for taxpayers, such as ``Adjusted 
Gross Income,'' a term which many find inexplicable. Similarly, the 
multiplicity of current retirement and other specialized savings 
vehicles are likely underutilized today due to practical confusion and 
uncertainty as to the tax status, treatment, rules and differences of 
the various alternatives. Likewise, the multiplicity of current tax 
credits leaves many taxpayers mystified, uncertain which may really 
apply to them or what the rules may be, which may result in under-
claiming of credits for which the taxpayer may be eligible. We in the 
tax software and electronic financial services industry significantly 
help taxpayers sift through the complexity of the current tax code, and 
minimize their tax liability to only that which they truly owe, but 
confusion and uncertainty remains.
    Other examples include the Earned Income Tax Credit, and non-cash 
charitable deductions, which are each becoming more difficult for 
eligible citizens to claim as these shift to more paper intensive 
processes. These are areas of the code that would benefit a great deal 
from fresh thinking that would bring them into fuller conformity with 
the nation's statutory policy preference for electronic tax 
administration--that is, to fully apply electronic filing to the 
process of claiming these credits and deductions, rather continuing a 
growing presumption that they must be claimed via paper, which can 
substantially raise costs and difficulty for citizens. The bottom line 
is that real movement toward statutory and regulatory reduction of 
complexity is in everyone's interest, but broader eligibility for all 
elements of the code to be available for electronic filing can be an 
important part of that practical simplification for everyone.
    Notwithstanding these opportunities for improvement, easy-to-use 
software and e-filing has already enabled millions of individuals, 
families, and small businesses to deal with taxes with a much greater 
degree of simplicity, at much lower cost, as a central part of taking 
personal control of their finances. And looking ahead, the next 
generation of highly computer-literate young men and women entering the 
workforce will be the first generation in history to never file a paper 
tax return. In fact, the tech-savvy generation is already using the 
fast and inexpensive electronic tools of web-based tax preparation and 
e-filing to meet their obligation, viewing this as an integrated part 
of how they manage and control their personal finances. They are the 
future of tax compliance in this country, and the leading edge of a 
generational change that will help the nation not only meet but exceed 
the original 80% e-filing objective.
    It has always been said that voting and paying your fair share of 
taxes are two of the most basic obligations of citizenship. These 
really are two of the essential ways we directly participate in our 
democracy, the ways by which we touch our government and hold it 
accountable--even to understand the costs of our government.
    Just this week, in remarks delivered before a tax policy conference 
at Urban Institute, the IRS Taxpayer Advocate Nina Olson said how 
important it is to retain the role of an active, engaged citizenry in 
the process of annual tax compliance in the culture of the United 
States. Some others have tried to suggest that the ultimate answer for 
the United States tax structure is to put the government in charge, 
from cradle to grave, not only collecting taxes, enforcing compliance, 
auditing returns, and writing and administering tax regulations, but 
also acting as the citizen's tax preparer at the outset of the process, 
effectively removing the taxpayer from the equation altogether through 
a Return-Free Tax System.
    Some have estimated a revenue boon, as is being experimented by the 
California Franchise Tax Board in that state right now, pursuing a 
strategy that assumes putting government in charge of both ends of the 
tax process--automatic return preparation at the front end, and revenue 
collection and enforcement at the back end--will produce significantly 
higher revenue receipts from taxpayers overall. Some have suggested 
that the tax collector might have little motivation to point out all 
the deductions, exemptions and credits a citizen might be entitled to, 
resulting in an unfair individual tax burden. But the removal of the 
citizen from the process would have other downsides beyond the obvious 
risk of paying higher taxes. As Nina Olson observed:

         ``I don't think the IRS and the government really give 
        credence to that ritual act. For many, many individuals it's 
        the only time they sit down and look at what happened to them 
        financially over the last year, and I wouldn't want to lose 
        that in a Return-Free System, because for the broader financial 
        health of the country, that's an important ritual.''

    At this same tax policy conference this week, Eric Toder of the 
Urban Institute echoed the Taxpayer Advocate's advice and conclusions:

         ``There's something healthy about that. I don't think it 
        should be complicated, but I think there's something positive 
        about the citizenship ( seeing what they pay annually).''

    We agree. Managing your taxes is an integral element of managing 
your personal finances, part of both financial literacy and achieving 
financial self-reliance. Indeed, in whatever tax policies are adopted 
over the years in this country, it will be vitally important to retain 
the citizen-centric character of American Voluntary Compliance that is 
so unique to our national history and culture, preserving the personal 
participation of our people in these most basic processes and 
obligations of individual citizenship. It helps keep our government 
accountable and on its toes, and our citizens in charge.

                                 

    Chairman RAMSTAD. Thank you, Mr. Smith. I am going to 
adhere to the 5-minute rule myself, so I would like to ask each 
of you experts--truly we have five of the best and brightest 
tax experts in this town--in a minute or less, because I only 
have 5 minutes, if you could identify the single most important 
reform Congress should enact to simplify the Tax Code. I will 
start with you, Mr. Gideon.
    Mr. GIDEON. I think it is easy and short. Get rid of the 
AMT.
    Chairman RAMSTAD. Mr. Purcell?
    Mr. PURCELL. Well, I would certainly echo that, but also 
there is a significant series of overlapping definitional 
terms. Last year, Congress addressed the one definition of a 
child, which makes life easier, will make life easier. We have 
identified those types of things over the years. So, that would 
certainly help implement simplification across the board.
    Chairman RAMSTAD. Thank you, Mr. Purcell. Mr. Degen?
    Mr. DEGEN. I will go back to what I said about the plain 
language. If I was writing the Tax Code--I will give you an 
example because researchers recently, based on a post on a tax 
web board--these are catch-up provisions, so people that are 50 
or older, if they want to contribute an extra $3,000. If I was 
writing the Code, I would have said, ``If you are 50 or older 
and you participate in a 401(k) or 403(b), a SARSEP or a simple 
IRA, or a 457 plan, you can put an extra $3,000 in your plan.'' 
Does the Code say that? No. You start in section 414(d) where 
catch-ups are defined. That sends you to 414(u). section 414(u) 
now sends you to 402(d)(3). section 402(d)(3) sends you--you 
have to look at 402(h), and then that sends you back somewhere 
in 408. I may have some of those numbers wrong, but you gather 
the drift of my conversation. So, I think we could really serve 
the public and get rid of some of that deadwood which was 
mentioned before.
    Chairman RAMSTAD. Your point, Mr. Degen, is very well taken 
and very well illustrated by you. Mr. Stevenson?
    Mr. STEVENSON. You expect me to follow that?
    [Laughter.]
    Chairman RAMSTAD. I think he has lectured on that before.
    Mr. STEVENSON. Standard deductions for Schedule C, 1120 
S's, partnership returns, keep standard deductions at a level 
that is acceptable, and if the taxpayer wants to go above it, 
then they have got to take the chance of being audited. By the 
way, I have ten revenue-raiser concepts that I have copyrighted 
that I have provided to your staff in case you are interested, 
but we have to do a deal to release the copyright.
    Chairman RAMSTAD. Thank you.
    Mr. STEVENSON. Only kidding.
    Chairman RAMSTAD. Thank you. Mr. Smith, please.
    Mr. SMITH. Mr. Chairman, we would focus the energy and the 
efforts on simplifying tax credits and retirement and education 
savings vehicles.
    Chairman RAMSTAD. I want to take the remaining time. Mr. 
Degen, I believe, talked about the need--I don't think that is 
an overstatement--for the registration, limited registration of 
paid preparers. In my home State of Minnesota, I have heard 
some real horror stories of unscrupulous preparers preying on 
recent immigrants, particularly from Somalia. We have the 
second-largest Somalian population now in the country, and some 
of these people have been treated just outright fraudulently. 
Do you believe, like your barber and like your wife's 
manicurist, that simple registration with a number of 
continuing education courses--what do you foresee there?
    Mr. DEGEN. I think, Mr. Chairman, the thing we want to do 
is keep it as simple as possible without creating a new system. 
As I mentioned in my testimony, there is a system in place now. 
It may have to be modified to some degree, but absolutely we 
would anticipate and hope that when this program began--we call 
it enrollment of tax preparers--that we would definitely want 
to have continuing education requirements. It is absolutely 
essential. Also, what is very, very important is there has to 
be an enforcement action. Currently right now in Circular 230, 
the Office of Professional Responsibility can censure, 
sanction, suspend, or disbar--that is the wrong word. I should 
not use that word, but get rid of either an attorney, a CPA, or 
an enrolled agent if they perform unethical practices. You 
could go home right now and start doing tax returns, and if you 
screw them up, the IRS could not do anything about--unless you 
were fraudulent, but that is what we want to stop.
    Chairman RAMSTAD. I think it is alarming. According to our 
figures, there are approximately 1.2 million tax preparers that 
have no formal training and are not required to adhere to any 
professional standards. Thank you again, gentlemen. I 
appreciate your testimony. I now recognize the distinguished 
Ranking Member.
    Mr. LEWIS. Thank you very much, Mr. Chairman. Thank you, 
gentlemen, for being here today. Mr. Gideon, do you think the 
IRS is funded and staffed so they can appropriately deal with 
tax shelter abuse, tax evasion by large corporations, and 
welfare taxpayers? Do you think there is more lost revenue in 
this area or by those claiming EITC?
    Mr. GIDEON. I wouldn't be capable of speculating on where 
more lost revenue would occur between those two. I would simply 
say that from prior experience at the IRS, it is important that 
there be a balanced program. In other words, the IRS, in order 
to do its job, has to have the resources to perform adequate 
enforcement tasks across all areas. If it is missing--in other 
words, if it is not enforcing the law in any sector of the 
economy, we are going to have a problem because people will 
figure that out pretty quickly. So, I think the important 
problem for appropriators is achieving balance, and it is 
important to stay balanced across all areas.
    Mr. LEWIS. Thank you. Mr. Purcell, I think in your 
testimony you answered this question, but I would like for you 
to just state it again maybe for the record. Does your 
organization think the IRS should cut taxpayer service in the 
coming year as proposed by the President's budget?
    Mr. PURCELL. When we prepared our comments, we had not seen 
the suggestion that the TACs be abolished or be cut back, and 
so we did not address that specifically. We are concerned that 
the taxpayer service must also be provided as well as 
enforcement efforts. So, I think we would be in favor of 
maintaining service as much as possible, given the payback that 
you have from service, and recognizing that low-income people 
generally are the ones who would benefit most from that 
personal touch of service. They need that type of service, so, 
yes, I think we would be in favor of that.
    Mr. LEWIS. Thank you, Mr. Purcell. Mr. Smith, why does your 
company refuse to offer an RAL to low-income customers?
    Mr. SMITH. Mr. Lewis, we are very familiar with RALs, but 
we don't offer them because our customers aren't interested in 
them. In fact, several years ago, we moved away from RALs. We 
do feel, however, that there is a challenge in the United 
States, particularly for low-income families, and it is 
unbanked, and we think there are creative alternatives to help 
individuals who don't have banking relationships today get 
access to tools. In fact, in the last week there has been a lot 
of press around a program that we are actually working with 
several people in the industry to try to provide a reverse 
Automated Teller Machine (ATM) card that basically allowed a 
lower-income family to be able to take their refund, put it 
directly on this ATM card, and pay their bills, do their 
grocery shopping, or other things. We think there are many 
other avenues beyond RALs today that we are interested in 
pursuing.
    Mr. LEWIS. Thank you very much. Thank you, Mr. Chairman.
    Chairman RAMSTAD. The gentleman from North Dakota.
    Mr. POMEROY. I thank the Chairman. Very interesting panel, 
and each of you did a superb job, and I appreciate it. Mr. 
Gideon, you are a tax lawyer?
    Mr. GIDEON. Yes, sir.
    Mr. POMEROY. Are you familiar with this Free File 
relationship?
    Mr. GIDEON. Actually, I have not been as familiar with it 
as others clearly are here, but I learned about it when I 
testified before the Oversight Board, and I filed my daughter's 
tax return with it about 2 days ago.
    [Laughter.]
    Mr. POMEROY. That is sufficient background. What I want to 
ask is if in your view the Committee's inquiry into aggregate 
data on products sold by a Free File participant would be 
violative of taxpayer confidentiality information.
    Mr. GIDEON. Well, I think that the Committee ought to be 
able to get aggregate data. I think there is always a concern 
about data that would be identifying that would invade anyone's 
privacy needs.
    Mr. POMEROY. Absolutely.
    Mr. GIDEON. On the other hand, the Committee gets aggregate 
data from the IRS. It gets aggregate data from many other 
sources. While care would have to be exercised, it seems to me, 
it certainly would be reasonable for you to get aggregate data 
from those who participate in this program.
    Mr. POMEROY. Is Michael Cavanaugh in the room? I have a 
letter that I want to introduce for the record of the 
Committee's inquiry to Mr. Cavanaugh, the manager for the Free 
File Alliance, and his response, wherein they totally stiff the 
Committee in getting information, hiding behind taxpayer 
confidentiality.
    [The information follows:]

                                        Committee on Ways and Means
                                        Subcommittee on Oversight  
                                               Washington, DC 20515
                                                      March 4, 2003
Mr. Michael F. Cavanagh
Free File Alliance
600 Cameron Street,
Suite 309
Alexandria, VA 22314

Dear Mr. Cavanagh:

    Thank you for testifying at the recent Ways and Means Oversight 
Subcommittee hearing on the Free File Program. I commend you and your 
Alliance Members for providing taxpayers, nationwide, with a great 
public service. As I stated at the hearing, it is exciting to see this 
kind of public-private partnership in action for the 2003 tax return 
filing season.
    I am writing to follow-up on our discussion at the hearing. Thank 
you for agreeing to survey your association Members on use of the Free 
File Program and add-on products/services purchased by taxpayers 
seeking free tax return filing through www.irs.gov. Based on testimony 
at the hearing, I believe that the following information would be 
useful:

      the number of filers (out of 78 million eligible);
      the number of filers by various income levels
       the number of filers claiming the EITC;
      the total number and amount of product sales/services 
sold (including specific information on (1) the number/amount of tax 
refund anticipation loans sold, amounts charged for such loans and 
related services, and the number of ``direct deposit indicators'' 
provided by the IRS, (2) the number and amount of state returns sold, 
and (3) the number and amount of other product sales/services sold by 
type; and,
      the number of taxpayers entering the website for free 
filing services that did not qualify for free services (and the 
percentage that purchased Federal return services).

    I would like this information to cover the current tax return 
filing season (January-April 15th) and I request an informal report 
from you by the end of May 2003. (I have made a similar request of IRS 
Acting Commissioner Wenzel and suggested that the IRS' work incorporate 
some of your survey results.)
    I appreciate your commitment to the success of the Free File 
Program. Your survey will be most helpful to me in understanding 
taxpayers' experiences in using the new Free File Program this year and 
how it might be expanded and/or improved for the future.
    Thank you again for your assistance. If you have any questions, 
please contact Beth Vance of the Committee staff at (202) 225-4021 or 
A.J. Wojciak of my Washington Office staff at (202) 225-2611.
            Sincerely,
                                                       Earl Pomeroy
                                                     Ranking Member
                                 ______
                                 
                                                 Free File Alliance
                                         Alexandria, Virginia 22314
                                                       June 5, 2003
Hon. Earl Pomeroy
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515

Dear Congressman Pomeroy:

    On March 4, 2003, you requested certain information regarding the 
Free File Program. This letter is a preliminary response, based on the 
conclusion of the first season of the Free File Program.
    In response to your final question, approximately 2.7 million 
taxpayers utilized the free tax preparation and e-filing services from 
the 17 Member companies. We are very proud that the number of returns 
provided substantially exceeded the IRS' well considered pre-season 
estimates. It is a base for continued success. We believe the value of 
the service to taxpayers saved them tens of millions of dollars, and 
that the IRS avoided costs of hundreds of millions of dollars.
    As to your remaining questions, we have spent a significant amount 
of time considering how to meet your request, and have met several 
times with the IRS to review the issue, because IRS privacy 
restrictions are such a significant barrier to reporting the 
information you seek. Modem data base technology can normally enable 
the collection of certain types of customer data, provided it is done 
in a manner consistent with law, regulation, a company's own published 
privacy policies, and the data collection capabilities of individual 
company systems. However, that is not true of companies that provide 
tax preparation or e-file services. The legal and policy restrictions 
protecting the privacy of taxpayers impose strict limitations on 
service providers which substantially exceed those imposed even for 
similar types of financial services data under appropriately 
restrictive laws such as Title V of Gramm-Leach-Bliley. Much of the 
taxpayer information you have sought \1\ in your request is protected 
from collection or disclosure by longstanding law and associated IRS 
regulations. Therefore, our Member companies cannot lawfully examine, 
compile or report the taxpayer information you are seeking without the 
lawful consent of the subject taxpayers. Under IRS Regulation 7216, 
taxpayer ``consent'' must be obtained before returns or collecting 
taxpayer private data.
---------------------------------------------------------------------------
    \1\ The number of filers by various income levels; the number of 
file's claiming the EITC; the total number and amount of product sales/
services sold (including specific information on (1) the number/amount 
of tax refund anticipation loans sold, amounts charged for such loans 
and related services. and the number of ``direct deposit indicators'' 
provided by the IRS, (2) the number and amount of state returns sold, 
and (3) the number and amount of other product sales/services sold by 
type; and the number of taxpayers entering the website for free filing 
services whose personally identifiable taxpayer profile did not qualify 
for free services (and the percentage that purchased Federal return 
services).
---------------------------------------------------------------------------
    In addition, the 7216-compliant privacy policies published by 
Alliance Member companies constitute a condition of the terms of 
service under which the individual customer transactions were 
conducted. Our FFA companies did not, and as a practical matter could 
not, seek each of the 2.7 million separate consents that would be 
necessary to permit the companies to review, collect and report the 
taxpayer information you seek. Even if the establishment of such 
individual consents to disclosure of taxpayer information were 
feasible, it is unclear how many of the 2.7 million individuals would 
respond to the disclosure request, or grant permission. Given the 
practical limitations to such an undertaking, our Members have no 
previous experience which would be predictive of the likely taxpayer 
response. It would, of course, be additionally unlawful for the 
Alliance management staff to have collected such taxpayer information 
from each of the companies, since the Alliance staff is not in privity 
with the customer taxpayers to seek their lawful consent.
    IRS may be able to provide you some aspects of the taxpayer 
information you wish to review, from its unique legal position as the 
revenue agency of the United States and the holder of much individual 
taxpayer information, but even here we are not sure that legal privacy 
requirements may not also restrict the disclosure of taxpayer 
information by the IRS itself.. The legal interpretation of applicable 
Federal rules, policies and procedures as they pertain to disclosure of 
private taxpayer information is a subject best pursued directly with 
the IRS General Counsel.
    We look forward to working with your office and Committee to make 
the Free File Alliance a continued success. Your support of the Free 
File option is important to us. We remain available to be of ongoing 
assistance as you conduct your Oversight of this important public 
service initiative.
            Sincerely,
                                               Michael F. Cavanaugh

                                 

    Mr. POMEROY. I will send another letter to Mr. Cavanaugh, 
or the Free File Alliance, in the event Mr. Cavanaugh is no 
longer with this association, asking once again for aggregate 
data so that we might observe the marketing practices of these 
Free File partners.
    Mr. Smith, I commend Intuit for your testimony, which I 
think is very candid and direct. It is not often to have a 
self-critique moved forward by a private sector participant in 
a program, and I frankly take some of your testimony to be a 
self-critique, not of Intuit, but of the industry, in terms of 
the drift of the original incentive of providing these services 
to taxpayers, to now much more of a profit motive, ``sell them 
stuff '' type of circumstance. Would you describe basically 
what you mean in this portion of your testimony that is found--
you do not have page numbers, but that portion of your 
testimony that alludes to that?
    Mr. SMITH. Yes, Mr. Pomeroy, I would be happy to. When this 
program was originally launched--actually, prior to the 
program, when we launched the Intuit Tax Freedom Project, we 
had very specific qualifications to have the program focused on 
underprivileged, underserved, lower-income, active military, 
and other select citizens in the country. Unfortunately, what 
has happened, as a result of the last 3 years in this public-
private partnership, is that you have new companies coming into 
the Free File Alliance and actually seeing it as an IRS-hosted 
platform to enter into the business and then be able to get 
product into the hands of a consumer with a free lead offer and 
then sell additional products. This is completely contrary to 
the spirit of the program. It is contrary to the program we 
have had in existence since 1998. We resisted this and have 
worked with the alliance and the IRS in the off seasons for the 
last 3 years. Unfortunately, this year we found ourselves in a 
situation, competitively, where we had no alternative but to 
enter into the game.
    Mr. POMEROY. Do you believe the IRS has actively exercised 
oversight for the entrepreneurial practices of its partners 
relative to U.S. taxpayers?
    Mr. SMITH. Mr. Pomeroy, I believe that the IRS has an 
opportunity to take it further. There is only so much private 
industry can do before it begins to step toward the lines of 
the Sherman Act and any areas in antitrust. The good news is 
the IRS, by not only the laws of the country but also by the 
alliance voting unanimously, has given the IRS the ability to 
govern this program more tightly. Unfortunately, up to this 
point, they haven't been willing to do that, and we are 
confident as we go into this year's renegotiation that that 
will be addressed.
    Mr. POMEROY. Tell me about the renegotiation. Who is that 
between?
    Mr. SMITH. At this point in time, the IRS is meeting with 
each of the individual alliance Members to better understand 
their needs. It has historically been between the executive 
director of the Free File Alliance, who was Mike Cavanaugh, who 
has resigned at this point, and the IRS. So, at this point each 
individual company is meeting with the IRS, and we are looking 
forward to a defined process to get it back on the table.
    Mr. POMEROY. Mr. Chairman, I would ask that you consider 
having a hearing, an oversight hearing, to bring in the IRS and 
bringing in Free File partners at this critical time of 
renegotiation. I think we need to get a handle on what is 
taking place relative to industry practices, and what is in the 
Service's mind as they sit down with private sector partners. I 
want them to be looking--I want them to be seeking information 
in terms of what are the private sector activities that these 
companies are doing with taxpayers. Basically they are entering 
into the relationship on an IRS platform, and I believe there 
is at least the impression conveyed that there is almost an 
endorsement of these services. I very much want to hear from 
the IRS in terms of the safeguards that they exercise relative 
to consumer protections. We heard the Commissioner say, well, 
they don't regulate these products. They may not, but they have 
got--they don't regulate the products as a bank lender. On the 
other hand, these products come into contact with the taxpayer 
by virtue of the IRS, so they surely have some oversight 
responsibilities. I trust that they are doing something, but I 
want to hear more about what they are doing.
    In addition, I want to acquire a better understanding about 
what is being sold, about whether or not product mix is roughly 
consistent across the private sector participants. For example, 
if we have a private sector participant that has got a ton of 
refund loans relative to its overall business, I would be 
highly suspicious of the marketing practices of that private 
sector partner. It alarms me deeply that it does not seem like 
the IRS has not even inquired as to this aggregate data, 
because I think some--it would seem to me that that would be 
basic information the IRS would want, and to be rebuffed by the 
alliance, as we were in 2003, is, quite frankly, very 
irritating. I appreciate the forthright testimony Intuit has 
brought us today, and I really do think, Mr. Chairman and 
Ranking Member, that this should be a matter of further 
inquiry.
    Mr. LEWIS. On this point that Mr. Pomeroy is raising, maybe 
Mr. Smith could give us some of the worst, outlandish examples.
    Mr. SMITH. I am sorry, Mr. Lewis. Examples of the up-
selling that may be occurring?
    Mr. LEWIS. Yes.
    Mr. SMITH. This year, for example, the growth in the 
alliance participation has gone from roughly a dozen Members 
last year to literally over 20. If you go back in time and you 
look at how long these businesses have been in existence, I 
think you are going to find them ranging from companies like 
ourselves, who have been in business for decades, to companies 
that literally have started in the last year. Unfortunately, 
when you start----
    Mr. LEWIS. Are these sort of fly-by-night?
    Mr. SMITH. Well, Mr. Lewis, I would say that----
    Mr. LEWIS. You do not want say anything about----
    [Laughter.]
    Mr. SMITH. Thank you for----
    Mr. LEWIS. I understand. I understand.
    Mr. SMITH. Right. So, the ultimate concern that we have is 
that you have companies out there who do not make a living at 
doing this or have not done this for years and have not learned 
the proper ways to actually do tax preparation software and e-
filing. The other concern we have is that they make their money 
today--you very seldom find them in the paid market. You only 
find them in the Free File Alliance where they have a pseudo-
endorsement from the IRS, where they are using the IRS' basic 
platform as a sales and marketing platform, and they are 
bringing consumers in for free, and then they are selling 
additional products. That was not the intent. So, outlandish 
examples go from RALs----
    Mr. POMEROY. Like what? What products?
    Mr. SMITH. Like RALs, access to IRAs, access to buying 
additional products and services that they may sell, refund 
transfers.
    Mr. LEWIS. Are you saying this is a rip-off of taxpayers? 
You are not saying that?
    Mr. SMITH. No, sir, not at all. In fact, I will tell you 
that the Free File Alliance, its philosophy is right on target. 
There have been millions and millions of consumers who have 
been able to leverage this Free File Alliance to get access to 
consumer tax software. Unfortunately, because of the way the 
program is today and it is not being governed, it is getting 
out of control, and it is putting a lot of people at risk, 
particularly the consumer.
    Mr. POMEROY. Mr. Chairman, you have been most indulgent, 
but I would just make a final observation. If it is incorrect, 
you can correct me. So, the IRS--is there a due diligence 
requirement in terms of participating on this platform?
    Mr. SMITH. There is. Yes, Mr. Pomeroy, there is.
    Mr. POMEROY. There is no due diligence relative to side 
products offered?
    Mr. SMITH. There are operating philosophies in the 
operating agreement that the adherence of--actually governing 
those philosophies has been less than diligent.
    Mr. POMEROY. Is there an inspection by the IRS of the 
products prior to their marketing?
    Mr. SMITH. There is an inspection of each of the offerings 
that come into the Free File Alliance. Yes, there is.
    Mr. POMEROY. Is that by the alliance or the IRS?
    Mr. SMITH. Excuse me 1 second. Thank you, sir. It is with 
the IRS. There are third parties that will look at some of the 
products as well, but it is basically just around the offer 
itself. It is not necessarily around the product and the 
functionality of the product.
    Chairman RAMSTAD. Well, thank you again----
    Mr. POMEROY. Finally, there is not a review of the product, 
and then there is not a review of the aggregate sales numbers?
    Mr. SMITH. That is correct, sir.
    Mr. POMEROY. Mr. Chairman, what do you think about further 
inquiry on that?
    Chairman RAMSTAD. Hearing what I have just heard, the 
Chairman will certainly take your suggestion under advisement. 
I want to thank the five distinguished Members of this panel 
for your counsel, your testimony, and your patience as well. Is 
there any other business to come before the Subcommittee?
    [No response.]
    Chairman RAMSTAD. No further business. The hearing is 
adjourned.
    [Whereupon, at 5:25 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]

   Statement of Colleen M. Kelley, National Treasury Employees Union
``2005 Tax Return Filing Season and the IRS Budget for Fiscal Year 
        2006''

    NTEU represents l50,000 federal employees in 30 federal agencies 
and departments, including the men and women who work at the Internal 
Revenue Service. I appreciate the opportunity to provide the 
Subcommittee with comments on the IRS budget for fiscal year 2006.
    There are several items in the Administration's IRS budget that 
NTEU believes would be detrimental to the IRS' mission. The two most 
egregious items include the Administration's plans to contract out tax 
collection to private collection agencies starting this summer, and an 
inadequate budget request that will prevent the IRS from continuing to 
improve its customer service record while bolstering enforcement 
efforts.
Budget
    The President's FY 2006 IRS budget proposal is woefully inadequate 
to provide the resources necessary to meet its enforcement goals to 
reduce the outstanding U.S. tax gap. I commend the Administration for 
acknowledging in its Budget in Brief that the ``IRS yields more than 
four dollars in direct revenue from its enforcement efforts for every 
dollar invested in its total budget.'' But I must criticize the 
Administration for failing to request a budget that would enable the 
IRS to meet the enforcement challenges it faces with its $350 billion 
annual tax gap.
    The IRS brought in $5.5 billion more in FY '04 than it did in FY 
'03 through enforcement efforts. This represents a 15% increase. It 
makes good business sense to fund the Agency at an amount where it can 
continue to see a similar return on investment. Unfortunately, the 
President's budget does not make good business sense.
    The IRS needs an appropriation that anticipates required expenses 
such as congressionally imposed pay raises and rent increases. Part of 
the President's IRS budget request for enforcement will be used to 
cover inflationary costs. Of the $446 million proposed for new 
enforcement investments, $182 million will be needed just to keep 
enforcement at its current levels.
    Furthermore, the way in which the Administration proposes to 
enhance the enforcement budget will mean cuts to other parts of the IRS 
budget--such as taxpayer assistance. The President's budget calls for a 
cut of 1,385 service personnel--87 percent of whom directly assist 
taxpayers and tax professionals. The IRS has taken great strides to 
improve taxpayer service over the past few years and has been quite 
successful in making significant progress. The Service must not let the 
pendulum swing in the other direction and neglect service so that it 
can focus on enforcement. Service and enforcement must go hand in hand 
toward increasing taxpayer compliance and shrinking the tax gap.
    NTEU strongly supports the IRS Oversight Board's proposed budget 
recommendation of $11.6 billion for FY '06--a nine percent increase 
over the President's budget recommendation and a thirteen percent 
increase over the FY '05 appropriation. I urge the Subcommittee to also 
support the Board's recommendation.

Private Tax Collection
    NTEU strongly opposes the Administration's plan to privatize IRS 
debt collection, as authorized by Congress last year in H.R. 4520, 
American Jobs Creation Act of 2004. Under the statute, the IRS would be 
permitted to hire private sector debt collectors and pay them a bounty 
of up to 25 percent of the money they collect. Let me be clear: NTEU 
opposes this short-sighted proposal, anticipates its complete failure 
as witnessed in a similar 1996 pilot program and will work towards its 
repeal.
    This proposal would risk the loss of confidentiality of millions of 
taxpayers' private information, would subject taxpayers to the abusive 
tactics of private debt collectors, and would cost U.S. citizens much 
more money than if IRS employees did the job.
    One of the most often heard arguments in favor of the use of 
private collection agencies is that if they are paid out of the 
proceeds of what they collect, it increases the IRS' enforcement 
capabilities without having to increase appropriations. Numerous 
Congressional supporters said they would prefer to have tax collection 
done by federal employees, but would go along with the use of private 
collection agencies solely because it avoids the difficult issue of 
getting Congress to approve additional appropriations for the IRS.
    The statute that gives the IRS the authority to use private 
collection agencies (PCAs) allows 25 percent of collected revenue to be 
returned to the collection companies as payment and 25 percent to be 
retained by the IRS for enforcement efforts, thereby circumventing the 
appropriations process altogether.
    There is nothing magical about revenues collected by private 
collection companies. If those revenues could be dedicated directly to 
contract payments and IRS enforcement efforts, there is no reason some 
small portion of other revenues collected couldn't be dedicated to IRS 
enforcement efforts. This would allow for increased enforcement by IRS 
employees, which most people indicate is the preferable route and 
eliminate large payments (up to 25% of collections) to private 
collection companies, significantly increasing net revenue to the 
General Treasury. While legislation would be required to allow for this 
kind of dedication of revenue, I believe the precedent has now been set 
with the private collection agency funding provisions. Congress should 
consider supporting this approach as a common sense way to make real 
progress in closing the tax gap, lowering our deficits and making more 
funding available for our Nation's critical needs.
    According to GAO's May 2003 testimony before the House Treasury 
Appropriations Subcommittee (GAO-03-732T), one major concern the IRS 
must address prior to implementing tax collection outsourcing is the 
ability to identify ``delinquent debts with the highest probability of 
resolution through PCA contacts. Earlier pilot efforts to study the use 
of PCAs in 1996 and 1997 were hindered, in part, because the IRS was 
unable to do this--While IRS proposes using the ``case selection 
analytics'' to identify appropriate cases, the analytical model has not 
been developed.''
    It appears as though the IRS has not yet addressed case selection. 
According to the IRS' February 15, 2005 ``Filing and Payment Compliance 
Modernization Briefing: The Use of Private Collection Agencies,'' there 
are five major issue areas that still need to be addressed before 
handing work over to the PCAs. One of the issue areas is selecting the 
workload for PCAs (called Filing and Payment Compliance), which will be 
part of the Business Systems Modernization Program. Since case 
selection was a major obstacle for the IRS in its 1996 pilot program, 
the IRS should ensure that the technology is in place prior to handing 
over any work to the PCAs.
    Furthermore, the IRS does not have the technology in place to 
ensure that taxpayer information is kept secure and confidential when 
it is handed over to the PCAs. The IRS expects to hand over taxpayer 
information, including Social Security number, to the private 
collection companies.
    Recent security breaches at three data brokerage firms here in the 
U.S. should alarm every Member of Congress and put into question the 
IRS' plans for moving forward with this privatization plan. ChoicePoint 
compromised the personal information of 145,000 Americans. At 
LexisNexis, thieves were able to access 32,000 records including Social 
Security numbers and drivers licenses. And Bank of America recently 
reported it has lost personal data--including Social Security numbers 
and account information--on 1.2 million federal employees, including 
some members of the Senate. These are companies that are in the 
business of trading--and securing--personal information. If they aren't 
able to secure confidential consumer information, I have little faith 
that a private debt collection company will be able to guarantee U.S. 
taxpayers that their information will remain secure.
    I would urge the Subcommittee to work with your colleagues to 
repeal this ill-fated proposal. Additionally, I would urge the 
Subcommittee to require the IRS to perform cost comparisons and closely 
track the contractors' costs. This is the only way that taxpayers can 
be certain their tax dollars are being spent wisely.

Customer Service Cuts
    The President's budget proposes to cut $134,103,000 and 1,205 
positions from customer service, with Taxpayer Assistance Centers 
(TACs) targeted for drastic reductions. IRS Taxpayer Assistance Centers 
are taxpayers' source for personal, face-to-face tax help. Taxpayers 
who have complex issues, need to resolve a tax problem, or are more 
comfortable talking with someone in person can visit a local Taxpayer 
Assistance Center. IRS representatives in these offices can help with 
inquiries or adjustments to tax accounts, payment plans for those who 
owe tax and cannot pay the full amount, questions about IRS letters and 
notices, and levies on wages or bank accounts.
    These cuts will mean that minorities and low-income taxpayers, who 
rely on the Centers to help with language barriers, the earned-income 
tax credit and general tax preparation, will see the tax services they 
rely on cut. As Janet Spragens, law professor and director of American 
University College of Law's Federal Tax Clinic, notes in her testimony 
before the IRS Oversight Board (February 1, 2005):

    ``. . . these taxpayers, many of whom have limited or no 
proficiency in English, are generally not part of the information age. 
They are not Internet connected. . . . They tend to be helped better 
through local walk-in offices and opportunities for face-to-face 
meetings than with an organizational structure based on specialization 
of function, remote offices, mailed documents, telephone trees with 
automated selections and electronic transfers.''

    Even the IRS Oversight Board raises concerns of the IRS' plan to 
eliminate additional customer service personnel. In its FY2006 IRS 
Budget Special Report (March 2005), the Board states its concerns:

    ``Increasing enforcement resources at the expense of service 
resources is a trend that can lead to a system that fails to meet the 
needs of all honest taxpayers.''

    The IRS claims that taxpayers will continue to have access to tax 
forms and information through on-line access, telephone assistance and 
volunteer tax preparation. Unfortunately, many taxpayers who use the 
walk-in centers have little or no proficiency in English and are not 
part of the electronic information age. Tax forms on the Internet and 
phone trees do them little to no good. They rely on face-to-face 
contact with their local Taxpayer Assistance Centers to help them 
comply with various complexities of the tax code.
    While the agency has not yet provided specific information either 
to NTEU or to affected employees, it is my understanding that the 
agency is reviewing options that include closing either 105 TACs, 
affecting 528 employees, or 67 TACs, affecting 516 employees. Either 
way, the plan is a significant step backward in the ability of the IRS 
to do its job effectively.
    The IRS has suggested that private tax assistance programs using 
volunteers can fill the void that will be created by the cutbacks. 
While volunteer taxpayer assistance organizations play an extremely 
helpful role in assisting taxpayers to meet their tax obligations, it 
is foolhardy for the agency to rely on volunteers to do work that 
should be performed by trained and accountable federal employees. 
Volunteers claim there's already a shortage of computers and other 
resources to help every taxpayer who seeks assistance, and that 
situation will only worsen if the IRS follows through with its proposed 
cuts to customer service.
    Furthermore, as the IRS is cutting back walk-in customer service 
operations, it is also planning to close six of its call sites in 
Boston, Houston, Chicago Des Moines, Wichita, and Omaha. Especially 
hard hit will be the Boston, Houston and Chicago facilities where 
nearly 200 employees could be affected. These are facilities where the 
employees receive taxpayers' inquiries and respond to their tax 
questions.
    Congress must commit to funding the IRS at adequate levels so the 
IRS is not made to choose between bolstering enforcement and providing 
the superior service our taxpayers expect and deserve. I urge the 
Subcommittee to again take the budget recommendation of the IRS 
Oversight Board, prohibit the IRS' proposed cuts in customer service 
and require the Service to maintain all current Taxpayer Assistance 
Centers.
Conclusion
    On behalf of the dedicated federal employees NTEU represents, I am 
proud to submit these views for the hearing record. I encourage the 
Oversight Subcommittee to make a strong investment in the federal 
workforce by supporting a strong budget for the IRS; repealing the IRS' 
authority to privatize tax collection; and prohibiting the IRS from 
closing up to one-quarter of its Taxpayer Assistance Centers.
    Without a doubt, the frontline employees are committed to working 
with management and Congress to increase efficiency and customer 
satisfaction. NTEU is committed to striking a balance between taxpayer 
satisfaction, business results and employee satisfaction. I encourage 
Congress to join us in this commitment.

                                 

 Statement of Christine C. Bauman, University of Wisconsin-Milwaukee, 
          and Katrina L. Mantzke, Northern Illinois University

AN EDUCATION AND ENFORCEMENT APPROACH TO DEALING WITH UNSCRUPULOUS TAX 
        PREPARERS

ABSTRACT
    In both her 2002 and 2003 Annual Reports to Congress, the National 
Taxpayer Advocate (NTA) proposed national registration, examination, 
certification, and enforcement requirements for all Federal Tax Return 
Preparers (FTRP). An FTRP is defined as someone, other than an 
attorney, CPA, or enrolled agent, who prepares more than five federal 
tax returns in a calendar year. This proposal was primarily motivated 
by the NTA's experience in dealing with taxpayers who were exploited by 
unscrupulous tax preparers, especially with respect to the earned 
income credit (EIC). Although the IRS believes that all taxpayers 
should have access to quality tax return preparation, it contends that 
it is premature to consider a legislative remedy to tax preparer 
problems since the full extent of the problem is unknown and the 
related financial impact on limited IRS resources has not been 
quantified.
    The purpose of this paper is to examine the proposed regulation of 
FTRPs by reviewing the development of similar regulatory proposals over 
the past several decades, outlining current and proposed federal 
regulation of tax preparers, discussing state regulation of tax 
preparers, describing concerns with increased regulation, and offering 
alternative recommendations to regulation, specifically education and 
enforcement.

AN EDUCATION AND ENFORCEMENT APPROACH TO DEALING WITH UNSCRUPULOUS TAX 
        PREPARERS
    In its 90 years of existence, the U.S. income tax has evolved into 
a complex taxation scheme. As a result, taxpayers bear not only the 
burden of their taxes but also the burden of complying with a complex 
and often confusing taxation system. Not surprisingly, IRS Statistics 
of Income Data \1\ show over 60% of all individual 2001 income tax 
returns were prepared by federal tax return preparers (FTRP). A tax 
preparer is defined under Internal Revenue Code (IRC) Section 
7701(a)(36) as any person who prepares any U.S. income tax return or 
any claim for refund of U.S. income tax for compensation. This 
definition also includes any person who employs one or more persons to 
prepare such tax returns.
---------------------------------------------------------------------------
    \1\ Internal Revenue Service. Statistics of Income Data, 2002.
---------------------------------------------------------------------------
    A recent U.S. Government Accounting Office (GAO) survey found that 
77% of taxpayers that used paid preparers were generally confident that 
they did not pay more than their share of taxes. However, anecdotal 
evidence indicates that some taxpayers are poorly served by their 
FTRPs.\2\ Unfortunately, little data exists on the overall quality of 
the services provided by FTRPs to the population of taxpayers using 
their services. Nevertheless, the quality of these services can be 
inferred. The GAO estimates that over 2 million taxpayers overpaid 
their 1998 taxes by $945 million because they used the standard 
deduction instead of itemizing. Since half of all tax returns are 
prepared by FTRPs, the GAO concluded that these data raise questions 
regarding the quality of service provided by FTRPs.\3\ Similar 
arguments can be made with respect to tax credits available to 
taxpayers. The Treasury Inspector General for Tax Administration 
(TIGTA) estimated that 230,000 taxpayers who used FTRPs for their 2001 
tax returns appeared to be eligible to claim the additional child tax 
credit but did not.\4\ Similarly, the IRS estimated that a subset of 
1999 tax returns claimed $11 billion more in EIC than was permissible, 
while another subset of 1999 tax returns claimed $710 million less EIC 
than was permissible.\5\ Since more than 65 percent of tax returns 
claiming EIC for 1999 were filed by FTRPs, it is likely that some of 
these EIC errors relate to services provided by FTRPs.
---------------------------------------------------------------------------
    \2\ U.S. Government Accounting Office. Paid tax preparers: most 
taxpayers believe they benefit, but some are poorly served. GAO-03-
610T, April 1, 2003. The GAO is quick to note that its survey only 
measures taxpayer perceptions. Since many taxpayers use paid preparers 
because they do not understand the tax laws, they are ill-equipped to 
truly evaluate their paid preparers' work. As such, the results of the 
GAO survey may overstate the actual quality of the services being 
provided.
    \3\ U.S. Government Accounting Office. Tax deductions: further 
estimates of taxpayers who may have overpaid federal taxes by not 
itemizing, GAO-02-509, March 29, 2002.
    \4\ Treasury Inspector General for Tax Administration. Analysis of 
statistical information for returns with potentially unclaimed 
additional child tax credit. Washington, D.C., January 2003, Ref. 
Number: 2003-40-046.
    \5\ Internal Revenue Service, Department of the Treasury. 2002. 
Compliance estimates for earned income tax credit claimed on 1999 
returns. Washington, D.C.: February 28, 2002.
---------------------------------------------------------------------------
    While most tax preparers are reputable, there is a concern that 
some FTRPs prey on taxpayers. According to a May 2002 Brookings 
Institute and Progressive Policy Institute Report \6\, the vast 
majority of paid tax preparation services for individuals are provided 
by a disparate array of unaffiliated professionals including certified 
public accountants, attorneys, and enrolled agents, as well as fly-by-
night amateurs. Since there are no national educational or professional 
standards for tax preparers, the tax preparation industry is 
fragmented, unregulated, and primarily seasonal. This observation is 
corroborated by Treasury Regulation Section 301.7701-15(a)(3) which 
states that ``a person may be an income tax return preparer without 
regard to educational qualifications and professional status 
requirements.'' Similarly, many preparers are ill-equipped to deal with 
the ever-increasing complexity of tax laws. As a result, the issue of 
improved regulation of tax preparers has been hotly debated over the 
past three decades.
---------------------------------------------------------------------------
    \6\ Berube, A., A. Kim, B. Forman, and M. Burns. May 2002. The 
price of paying taxes: How tax preparation and refund loan fees erode 
the benefits of the EITC. Center for Urban & Metropolitan Policy, The 
Brookings Institute and the Progressive Policy Institute.
---------------------------------------------------------------------------
    In both her 2002 and 2003 Annual Reports to Congress, the NTA 
recommends that Congress enact a registration, examination, 
certification, and enforcement program for FTRPs. An FTRP is defined in 
the proposal as someone, other than an attorney, CPA, or enrolled 
agent, who prepares more than five federal tax returns in a calendar 
year and satisfies registration, examination, and certification 
requirements. The NTA has convened a cross-functional team to explore 
the feasibility of requiring annual certification and professional 
education for all commercial preparers  not currently covered by 
Treasury Department Circular 230 (31 C.F.R. Part 10).\7\
---------------------------------------------------------------------------
    \7\ Circular 230 provisions apply to attorneys, certified public 
accountants, and enrolled agents.
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    The proposed regulation of FTRPs is not a novel suggestion. Such 
regulation has been considered numerous times during the last 30 years 
without subsequent changes to the status quo. The purpose of this paper 
is to examine the currently proposed FTRP regulation by reviewing the 
history of former proposals, outlining current and proposed federal 
regulation of tax preparers, discussing state regulation of tax 
preparers, describing concerns with increased regulation, and offering 
alternative recommendations.

HISTORY OF PROPOSED TAX PREPARER REGULATION
    As early as 1972, the National Society of Accountants (NSA) \8\ 
called for increased regulation of tax preparers.\9\ The NSA presented 
the IRS with an eight-point plan focused primarily on the mandatory 
registration of every individual providing tax preparation services for 
a fee. The NSA argued that incompetent and irresponsible tax preparers 
would be easier to identify once they were registered. Once identified, 
the NSA argued that these preparers would then be held accountable for 
their work, thereby protecting American taxpayers. The NSA plan did not 
require any competence qualifications for initial registration. 
However, registration renewal would require preparers to participate in 
IRS prescribed continuing education, reported in three-year intervals. 
The plan called for penalties for those preparers who did not comply. 
Preparing tax returns without a registration or with an invalid 
registration would be a misdemeanor subject to fine and/or imprisonment 
upon conviction. Similarly, the IRS would have the power to revoke or 
suspend registrations for appropriate cause.
---------------------------------------------------------------------------
    \8\ Prior to 1995, the National Society of Accountants was called 
the National Society of Public Accountants.
    \9\ Anonymous. 1972. NSPA's eight-point program for regulating tax 
return preparers. The National Public Accountant, Vol.17, No.5, May, 
pp. 16-18.
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    There is no evidence that the IRS did anything with the NSA plan 
proposed in the 1970s. Yet, the issue of regulating tax preparers did 
not die. In 1989, the Commissioner's Advisory Group (CAG) within the 
IRS studied the issue.\10\ The CAG's report outlined the concerns many 
had about tax preparers and summarized the penalties to which these 
individuals were subject. The report weighed the pros and cons of a 
regulatory/registration program and concluded that such a program 
should be established. Shortly after this recommendation was made, 
Congress busied itself with changes to the IRC's tax preparer and 
accuracy related penalties, and the Treasury Department made changes to 
the regulations governing practice before the IRS. Accordingly, the 
CAG's recommendations were shelved.
---------------------------------------------------------------------------
    \10\ Shapiro, L. 1995. Commercial tax return preparers. The 
National Public Accountant, Vol. 40, Sept., p. 7.
---------------------------------------------------------------------------
    In 1994-1995, the issue resurfaced. Following up on its concept-
oriented report from the 1980s, the CAG now made specific 
recommendations for a formal regulation/registration program.\11\ The 
program called for the registration of all tax preparers as defined by 
IRC Section 7701(a)(36) that were not already covered by the 
regulations outlined in Circular 230. While initial registration would 
not require proof of continuing professional education (CPE), 
subsequent registration renewal would require proof of CPE. The report 
was presented to the IRS Commissioner for consideration but did not 
result in any changes to the tax preparation industry.
---------------------------------------------------------------------------
    \11\ See supra note 10.
---------------------------------------------------------------------------
    Most recently, Senator Bingaman (Democrat, New Mexico) sponsored 
the ``Low Income Taxpayer Protection Act of 2003.'' Among other things, 
this bill would have required the registration of tax preparers and 
refund anticipation loan (RAL) providers, and the prohibition of the 
payment of refunds to tax preparers and RAL providers that fail to 
provide their registration numbers. On March 31, 2003, this bill was 
referred to the Senate Finance Committee. To date, there is no evidence 
that this bill progressed any further in the legislative process.

EXISTING FEDERAL REGULATION OF TAX PREPARERS
    The IRS is empowered to deal with incompetent and irresponsible tax 
preparers via existing laws. Various code sections assess penalties 
based on the content of tax returns compiled by paid preparers. IRC 
Section 6694 imposes penalties on tax preparers for understatements of 
tax due to unrealistic positions. IRC Section 6701 imposes penalties on 
tax preparers for aiding and abetting taxpayers in the understatement 
of tax. Finally, IRC Section 6702 imposes penalties on tax preparers 
who file frivolous income tax returns on behalf of their clients.
    Other code sections assess penalties on tax preparers for their 
actions in compiling tax returns. IRC Section 6695 assesses a litany of 
penalties on tax preparers, including penalties for failure to provide 
the taxpayer with a copy of his/her tax return, failure to sign the tax 
return, failure to furnish the preparer's identification number, and 
failure to be diligent in determining eligibility for EIC. IRC Section 
6713 imposes penalties on tax preparers for disclosing taxpayer 
information or using such information for purposes other than tax 
return preparation. Gutierrez \12\ presents a thorough discussion of 
each of the foregoing provisions and their legislative history.
---------------------------------------------------------------------------
    \12\ Gutierrez, T. 2001. Return preparer penalties: A comprehensive 
review. The CPA Journal, Vol. 71, Issue 6, June, pp. 34-43.
---------------------------------------------------------------------------
    The Internal Revenue Code also provides for civil and criminal 
sanctions with respect to the preparation of tax returns. From a civil 
perspective, IRC Section 7407 permits the Secretary of the Treasury to 
bring a civil action against a preparer to enjoin him/her from 
preparing tax returns if he/she has engaged in any conduct subject to 
the penalties discussed above or the following criminal penalties. IRC 
Section 7201 assesses criminal penalties on taxpayers and their return 
preparers who willfully attempt to evade taxes. IRC Sections 7206 and 
7207 assess criminal penalties on the making of fraudulent or false 
statements, the willful aiding, assisting, counseling or advising in 
the preparation or presentation of fraudulent or false statement, and 
the delivery or disclosure of a fraudulent or false statement. Finally, 
IRC Section 7216 assesses criminal penalties on tax preparers who 
disclose or use taxpayer information for purposes other than the 
preparation of the tax return.
    It is interesting to note that the only substantive change made to 
the IRC penalties for tax preparers since the CAG's last report in 1995 
was the addition of Section 6695(g), due diligence requirements with 
respect to EIC. This change suggests that problems exist with the 
administration of the EIC. In addition, there is significant evidence 
that the extensive penalty provisions for tax preparers are not being 
enforced.

Failure to Enforce Tax Preparer Penalties
    On October 18, 2002, the IRS Advisory Council (IRSAC) presented a 
``General Report'' at a public forum expressing concern with the 
underutilization of tax preparer penalties given tax preparation error 
rates.\13\ IRSAC members of the IRS Wage and Investment Subgroup were 
concerned about the relative scarcity of preparer penalties in recent 
years. For example, in 2001, only 248 paid preparers were assessed the 
$100 penalty for violating due diligence requirements regarding EIC. 
Further, a mere 3,000 preparers were assessed a $50 penalty under IRC 
Section 6695(a)-(f). About 4,000 preparers were assessed the $250 
penalty for negligent return preparation. A $1,000 penalty for 
deliberate or willful return errors was imposed on about 3,000 
preparers. The Subgroup expressed similar concern with the low number 
of criminal sanctions compared to reported error rates on EIC returns.
---------------------------------------------------------------------------
    \13\ Neuder, L. 2002. IRSAC praises Commissioner Rossotti's recent 
programs. CCH, 2002TaxDay, October 23.
---------------------------------------------------------------------------
    IRSAC concluded that the low rate of tax preparer sanctions imposed 
for preparer malfeasance creates the perception in the non-enrolled 
(not subject to Circular 230) tax community that negligent or willful 
errors on returns carry a limited risk of penalty sanctions. The IRSAC 
panel urged the IRS Wage and Investment group to review its current 
allocation of resources and its strategies for imposing sanctions 
against non-enrolled, paid preparers.\14\
---------------------------------------------------------------------------
    \14\ See supra note 13.
---------------------------------------------------------------------------
    The IRS's disciplinary authority is the de facto source of tax 
practice standards that all tax practitioners have in common, whether 
they be CPAs, attorneys, enrolled agents, or unenrolled preparers.\15\ 
Thus, the failure to enforce current regulation of tax preparers raises 
the concern about how additional regulation will succeed.
---------------------------------------------------------------------------
    \15\ Raby, B. and W. L. Raby. 2002. Tax practitioner standards and 
professional self-discipline. Tax Notes Today, October 25.
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PROPOSED FEDERAL REGULATION OF TAX PREPARERS
    The NTA's 2002 Annual Report recommended that Congress enact a 
registration, examination, certification, and enforcement program for 
FTRPs. The FTRP program would include the following components:
    (1) A requirement that all persons who prepare more than five 
federal tax returns for a fee must register with the IRS. The IRS would 
be authorized to impose a per return penalty for failure to register, 
absent reasonable cause for the failure.
    (2) A requirement that the IRS develop a series of examinations 
designed to test the technical knowledge and competency of unenrolled 
return preparers to prepare federal tax returns.
    (3) A requirement that all persons who prepare more than five 
federal tax returns for a fee must pass, in their first year of 
preparing such returns, an initial examination testing their technical 
knowledge and competency to prepare individual and/or business tax 
returns.
    (4) A requirement that the IRS annually certify as FTRP those 
unenrolled paid preparers who have successfully passed the required 
examinations and are authorized to prepare federal tax returns for a 
fee.
    (5) Authorization for the IRS to conduct a public information and 
consumer education campaign, utilizing paid advertising, to inform the 
public of the requirements that paid preparers must (1) sign the return 
prepared for a fee; and (2) display their FTRP registration card, which 
demonstrates current skill and competency in federal tax return 
preparation.
    (6) Authorization for the IRS to maintain a public list of FTRP who 
are registered and certified, registered but not certified, and whose 
registration has been revoked.
    (7) Authorization for the IRS to notify any taxpayer about the fact 
that his or her return was prepared by an unenrolled return preparer 
who is not registered or by a FTRP who is registered but not certified.
    In her 2003 Annual Report to Congress, the NTA makes 15 
recommendations with respect to FTRPs. Topping this list is the call 
for a registration, examination, certification, and enforcement program 
for FTRPs. This recommendation echoes the primary recommendation made 
in the NTA's 2002 report. The next 10 recommendations call for new or 
increased penalties for preparer wrong-doing. Recommendation #12 calls 
for a study of the accuracy of tax returns prepared in conjunction with 
the cross-marketing of other consumer products and services. 
Recommendation #13 requires the appointment of consumer protection 
advocates to the IRS' Electronic Tax Administration Advisory Committee. 
Recommendation #14 calls for the FTRP to identify his/her return 
preparer category (e.g., attorney, CPA, enrolled agent, or unenrolled 
preparer), and recommendation #15 encompasses taxpayer education 
regarding their rights and responsibilities in dealing with FTRPs.

STATE REGULATION OF TAX PREPARERS
    While the issue of improved regulation of tax preparers has been 
kicked around at the federal level for years with no real resolution, 
the states have been similarly reluctant to address the issue. In 
recent years, licensing laws were proposed but were not enacted in 
Florida, Illinois and Texas.\16\ However, the exceptions to this 
general rule are California and Oregon.
---------------------------------------------------------------------------
    \16\ Sager, W. 1995. Why regulation and registration of commercial 
tax return preparers is a bad idea. The National Public Accountant, 
Vol. 40, December, pp. 34-35.
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California
    Since July 1997, the California Tax Education Council (CTEC) has 
regulated tax preparers in the state. Compliance with the California 
Tax Preparers Act (California Business and Professions Code, Chapter 
14, Sections 22250-22259) requires completing a qualifying education 
tax course, obtaining a surety bond, and obtaining a certificate of 
completion from the CTEC. Failure to comply with these rules is a 
misdemeanor, punishable by fine and/or imprisonment.
    While California law governs tax preparers practicing in 
California, a private institution handles the enforcement of this law. 
The CTEC is an industry association that establishes the standards 
against which professional tax education is measured and approves 
educators that meet these standards. The CTEC's other responsibilities 
include verifying and registering paid preparers who meet California's 
education and/or experience requirements. To date, the CTEC has not 
published statistics regarding its enforcement efforts.

Oregon
    While California has established education and registration 
requirements for its tax preparers, Oregon has gone much further with 
its regulation of tax preparers. For the past thirty years, the Oregon 
State Board of Tax Practitioners (the Board) has required instate tax 
preparers to be licensed (http://www.open.org/ortaxbrd/). This 
licensing program requires preparers to demonstrate their competence 
via examination. Once licensed, tax preparers must comply with 
continuing education requirements on an annual basis.
    Oregon's licensing program was established with the primary goal of 
protecting taxpayers from incompetent and unethical tax return 
preparers. While this is still one of the Board's primary goals, issues 
surrounding identity theft have accounted for many of the Board's 
investigations in recent years. The Board is continually working to 
improve the efficiency and effectiveness of the program, including the 
education of Oregon taxpayers. The Board utilizes a variety of outlets 
to spread the word about this program, including public service 
announcements, press releases, and print and television ads. The Board 
also benefits from industry associations communicating information 
about the program to their members.
    Oregon's Board differs from the California Tax Education Council in 
that it is a governmental agency, with all board members being 
appointed by the Governor and approved by the Senate. The Board's other 
responsibilities include investigating taxpayer complaints and when 
appropriate, assessing civil penalties, suspending or revoking 
licenses, and requiring the payment of restitution to harmed consumers. 
The Board also works with other governmental authorities to bring 
criminal charges when warranted. To date, the Board has not published 
statistics regarding its enforcement efforts.

CONCERNS WITH A REGULATORY APPROACH
    By all indications, it appears that U.S. tax system is at least 
somewhat impaired by problems caused by FTRPs. However, evaluating 
proposals for increased regulation is hampered by the lack of 
systematic evidence of the extent of the problem and the effectiveness 
of existing regulation.\17\ As such, it is not clear that increased 
regulation is the answer.
---------------------------------------------------------------------------
    \17\ U.S. Government Accounting Office. Tax administration: most 
taxpayers believe they benefit from paid tax preparers, but oversight 
for IRS is a challenge. GAO-04-70, October, 2003.
---------------------------------------------------------------------------
Identification and Quantification of the Problem
    It is very difficult, if not impossible, to solve a problem before 
determining what the problem truly is. In recommending increased 
regulation for tax preparers, the NTA does not specifically identify 
the problem with tax preparers nor does she quantify the cost of this 
problem.\18\ The only statistics that are presented relate to returns 
claiming the EIC. In identifying EIC return preparation as a problem 
area, the NTA quotes various statistics regarding errors encountered on 
EIC returns \19\, but acknowledges that there is no consistent data 
regarding the number and types of errors on returns, tracked by type of 
tax preparer. Consequently, it appears that the broad-reaching 
proposals to regulate tax preparers are based on anecdotal evidence of 
emotionally charged taxpayers and tax advisors rather than statistical 
evidence of error rates and noncompliance. Without knowing the source 
of the problem and its size, it does not follow that increased 
regulation is necessarily the correct fix.
---------------------------------------------------------------------------
    \18\ National Taxpayer Advocate Report to Congress. 2002. pp. 216-
217.
    \19\ See supra note 18. pp. 69-72.
---------------------------------------------------------------------------
    Unfortunately, it appears that quantifying the problems associated 
with unscrupulous tax preparers might be an insurmountable task. The 
GAO notes repeatedly in its recent studies that ``examples of 
problematic preparer behavior are easy to find but reliable estimates 
of the number of taxpayers affected by the problems do not exist and 
would be difficult, perhaps impossible, to develop''.\20\ 
Interestingly, the GAO noted that nothing suggested that the percentage 
of taxpayers affected by unscrupulous tax preparers is large. The GAO 
also noted that the IRS has several offices responsible for taking 
action against problem paid preparers including the newly formed Office 
of Professional Responsibility.\21\ Therefore, it would be illogical to 
create a new regulatory system when a newly formed IRS office has 
already been charged with this responsibility.
---------------------------------------------------------------------------
    \20\ See supra note 17. p. 25.
    \21\ In January 2003, the new Office of Professional Responsibility 
for Tax Practitioners (OPR) replaced the old Director of Practice. OPR 
has a core staff of approximately 35.
---------------------------------------------------------------------------
    In concluding its report, the GAO did not make any recommendations 
but stated that expanded regulation of tax preparers is a judgment call 
that Congress and IRS management must make together, after considering 
1) the benefits and costs to taxpayers, 2) that the IRS is not in the 
consumer protection business, and 3) the related implications for IRS 
resources.\22\
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    \22\ See supra note 17. p. 22.
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The Cost of Increased Regulation
    Although the cost of increased regulation has not been estimated, 
there is little doubt that it will be a costly venture. Not 
surprisingly, the IRS indicated it had insufficient resources to 
administer a FTRP program as outlined in the proposed legislation and 
could not support a legislative remedy to the problem. The NTA 
estimates that there may be up to 600,000 FTRPs that would be covered 
by the legislative proposal. While specific costs have not yet been 
projected, the IRS looked at existing procedures that govern practice 
before the IRS as well as other areas that require high volume 
processing of information. If the proposed regulation of FTRPs has at 
least the same if not more processing and monitoring requirements, the 
IRS hypothesized that increased regulation would require the creation 
of a new mini submission processing operation with operating systems to 
process applications, certification, test results, etc.
    According to the IRS, significant additional resources would be 
required.

IRS Concerns with Proposed Regulation
    The IRS in its formal response \23\ to the NTA on the FTRP proposal 
outlines concerns similar to those listed previously. The IRS 
specifically cites five concerns namely that licensing of professionals 
has been a states' rights issue; public perception, opportunity cost, 
enforcement, and added taxpayer cost.
---------------------------------------------------------------------------
    \23\ Internal Revenue Service Position Paper. 2003. Regulation of 
federal tax return preparers.
---------------------------------------------------------------------------
ALTERNATIVE RECOMMENDATIONS
    Instead of regulation, we posit that increased enforcement of 
existing preparer sanctions and increased taxpayer education will help 
to mitigate the problems caused by FTRPs. Then, in the event that 
increased regulation is seriously considered, steps must be taken to 
identify and quantify the problem. The state regulatory programs should 
then be evaluated to determine if those programs are effective and if 
so, how a similar system could be effectively implemented at the 
federal level.

Increased Enforcement
    Paid returns preparers are currently subject to criminal and civil 
penalties for a wide range of inappropriate behavior. However, there is 
a dearth in the enforcement of existing regulations. The lack of tax 
preparer penalty enforcement cannot be ignored as a contributing factor 
to problems with tax preparers.
    If additional resources were to become available, IRS prefers to 
increase enforcement of the current return preparer penalty provisions, 
thus encouraging higher professional standards of practitioners and 
unenrolled return preparers.\24\
---------------------------------------------------------------------------
    \24\ See supra note 23.
---------------------------------------------------------------------------
    The IRS's Small Business/Self-Employment (SB/SE) division is 
responsible for assessing and collecting monetary penalties against any 
paid tax preparer who does not comply with tax laws in return filing. 
For calendar years 2001 and 2002, SB/SE assessed about $2.4 million in 
penalties and collected 12 percent of them, including all or some 
portion of penalties from 44 percent of penalized preparers.\25\ While 
a reprioritization on enforcement and collection may help to curb 
abuse, SB/SE stated that its priorities are focused on abusive tax 
schemes and it cannot afford to make relatively low dollar paid 
preparer cases a priority.
---------------------------------------------------------------------------
    \25\ See supra note 17. p. 16.
---------------------------------------------------------------------------
    The GAO also noted that the monetary amounts of preparer penalties, 
although small in comparison to IRS's other compliance efforts, may not 
reflect the overall importance that penalties play as a deterrent to 
unscrupulous tax preparers. According to the Internal Revenue Manual, 
penalty assertion is the key enforcement vehicle for noncompliant 
preparers. However, the GAO duly noted that the IRS may actually be 
sending preparers a mixed message about whether poor performance by 
preparers will be tolerated when penalties are assessed but not 
collected.
    Alternative enforcement methods should also be employed. According 
to Richard Speier Jr., former acting deputy chief of IRS Criminal 
Investigation Unit, low-income individuals are swindled by tax 
preparers who guarantee them greater returns. Speier states that ``the 
best way to address [abusive preparers] is with undercovers.'' CI has 
instituted a ``return-preparer shopping'' task force whereby undercover 
agents are assigned to get word-of-mouth referrals to these tax 
preparers during tax filing season.\26\
---------------------------------------------------------------------------
    \26\ Gary, K. A. 2003. CI division increases productivity, IRS 
official says. Tax Notes Today, October 30.
---------------------------------------------------------------------------
    Over the past two decades, numerous studies have researched the 
effectiveness of preparer penalties from different perspectives. 
Jackson and Jones \27\ provide evidence that the magnitude of the 
penalty may be more important than the risk of detection in developing 
an effective penalty system. A decade later, Carnes and Englebrecht 
\28\ modeled the penalty sanctions included in the Internal Revenue 
Code. They found that even low levels of penalty sanctions influence 
compliance behavior, suggesting that penalties can successfully deter 
noncompliance. Research has also considered the effect that penalties 
have on the aggressiveness of tax advice. Cuccia \29\ found that 
increasing sanctions on preparers caused CPAs to invest more effort in 
finding tax savings for their clients and had little effect on the 
aggressiveness of their interpretations of ambiguous tax issues. In 
contrast, Anderson and Cuccia \30\ studied experimental markets that 
incorporated competition and moral hazard and found that increased 
penalties resulted in a reduction of aggressive advice. While the 
extant literature has studied different aspects of preparer penalties, 
a synthesis of the literature suggests that penalty sanctions do have a 
positive influence on tax preparer behavior. Thus, academic research 
supports our contention that increased enforcement of existing 
penalties would better address the problems associated with paid 
preparers than would increased regulation of that group.
---------------------------------------------------------------------------
    \27\ Jackson, B. and S. Jones. 1985. Salience of tax evasion 
penalties versus detection risk. Journal of the American Taxation 
Association 6 (Spring): 7-17.
    \28\ Carnes, G. and T. Englebrecht. 1995. An investigation of the 
effect of detection risk perceptions, penalty sanctions, and income 
visibility on tax compliance. Journal of the American Taxation 
Association 17 (Spring): 26-41.
    \29\ Cuccia, A. 1994. Tax preparers: Integrating economic and 
psychological factors. Journal of the American Taxation Association 16 
(Spring): 41-66.
    \30\ Anderson, S. and A. Cuccia. 2000. A closer examination of the 
economic incentives created by tax return preparer penalties. Journal 
of the American Taxation Association 22 (Spring): 56-77.
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Taxpayer Education is Paramount
    While the foregoing discussion focuses on the supply side of the 
equation (i.e., regulation of FTRPs supplying these services), the 
demand side (i.e., taxpayers demand for these services) should also be 
addressed. Educating taxpayers about their rights may prove to be 
equally effective in deterring unscrupulous FTRPs. Similarly, taxpayer 
education may prove to be the most fruitful use of resources since 
taxpayers cannot be ruled out as contributing to the problems seen with 
tax compliance (e.g., by providing incorrect/incomplete information; by 
active complicity in avoiding taxes, etc.). Finally, the taxpayer is 
ultimately responsible for his/her tax return and what it reports, 
regardless of any tax preparer involvement. Therefore, it would seem 
logical that any efforts to deal with the problems surrounding tax 
preparation start with the taxpayers themselves.
    Currently, taxpayers must be proactive in determining their rights 
and responsibilities with respect to the tax returns they file.\31\ In 
April 2001, the NTA recommended that the IRS do more to build public 
awareness regarding taxpayer rights and responsibilities. She suggested 
that the IRS include a consumer alert in appropriate brochures and 
publications. This alert should state in plain language that taxpayers 
that pay for return preparation should receive a copy of their return 
signed by the preparer. The message should also clearly state, ``If 
they don't sign, don't pay.'' Public service announcements could then 
be used to reinforce that message and toll-free phone numbers could be 
established for reporting tax preparers who refused to sign returns.
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    \31\ Taxpayers must access the IRS website or other IRS resources 
such as Tax Topic 254, ``How to Choose a Paid Tax Preparer,'' to learn 
about their rights and responsibilities.
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    The NTA has suggested that regulation is necessary because return 
preparer penalties are not sufficient to combat the problem. In light 
of the enormous profits to be made, the NTA's goal is to get the 
``bottom feeders'' out of the industry. Those who lack proficiency and 
knowledge in return preparation harm taxpayers in a number of ways, in 
the form of significant adjustments to taxpayers' accounts, errors made 
in filing status, exemptions and credits, and preparation based on 
outdated tax provisions. However, the IRS used education and 
enforcement, not preparer regulation, in a successful education 
campaign to address inappropriate slavery reparation claims and to 
reduce unscrupulous tax preparers operating in this area. The IRS 
indicated that more than 80,000 tax returns were filed in 2001 seeking 
fictitious slavery tax credits totaling $2.7 billion.\32\ IRS estimated 
that $30 million was mistakenly paid out in slave reparations in 2000 
and part of 2001. However, the Service reports a significant drop in 
reparation claims attributable to stepped up scrutiny of tax returns 
and an aggressive media campaign targeting scam artists promising to 
secure these phony tax credits for taxpayers.
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    \32\ Bergman, J. 2003. Dad, daughter get prison for slavery claim. 
Milwaukee Journal Sentinel, October 25.
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    The IRS recognizes that it faces a particularly difficult challenge 
in getting information to and identifying the needs of unenrolled tax 
return preparers. A current IRS effort to test the effect of education 
materials on those preparers who prepare EIC returns may provide a 
model of how to meet this challenge. This effort centers on a pilot 
program that sends a brochure to three groups of EIC preparers and then 
compares their subsequent rates of errors over three years to groups 
with similar characteristics who did not get the brochure. The 
brochure, with a desired outcome of reducing errors and improving EIC 
compliance, includes material on tax law changes, due diligence and 
information on where to get further EIC information.\33\
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    \33\ See supra note 23.
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    In addition to these efforts, the IRS has several education and 
outreach projects that educate taxpayers about unscrupulous tax 
preparers. IRS Fact Sheet 2004-10 \34\ urges taxpayers to be very 
careful when choosing a tax preparer by stating that taxpayers should 
``be as careful as you would in choosing a doctor or a lawyer. It is 
important to know that even if someone else prepares your return, you 
are ultimately responsible for all the information on the tax return.'' 
The fact sheet offers ``Helpful hints when choosing a return 
preparer,'' including ``Use a reputable tax professional that signs 
your return and provides you with a copy for your records.'' Taxpayers 
hearing claims from preparers offering larger refunds than other 
preparers are encouraged to check it out with a trusted tax 
professional or the IRS before getting involved. The fact sheet also 
lists examples of four tax return preparers sentenced to prison.
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    \34\ Internal Revenue Service. Fact Sheet, FS-2004-10. 2004. Return 
preparer fraud.
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    IRS Fact Sheet 2004-08 \35\ is directed at taxpayers claiming the 
EIC. It reminds these taxpayers that ``the vast majority of EIC 
claimants allow a third-party to prepare their taxes. If you allow 
someone to prepare your taxes, make sure you seek out reputable tax 
professionals. Regardless of who completes your tax form, you are 
responsible for its accuracy.''
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    \35\ Internal Revenue Service. Fact Sheet, FS-2004-08. 2004. IRS 
outlines EITC eligibility for 2003 tax year.
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    IRS New Release 2004-12 \36\ is also directed at taxpayers that are 
eligible for EIC. This release states that ``EIC is an important 
program, and you should check to see if you qualify. EIC rules can be 
complicated so you should carefully review the qualifications. Know, 
don't guess, if you are qualified. If in doubt, contact the IRS or its 
volunteer partners for help. If someone prepares your taxes, seek out a 
reputable professional who understands EIC rules and who will avoid 
common mistakes.''
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    \36\ Internal Revenue Service. News Release, IR-2004-12. 2004. IRS 
urges taxpayers to review EITC eligibility.
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Identity and Quantify the Problem
    If Congress and the IRS do embrace increased tax preparer 
regulation, the existing problems must first be identified and 
quantified. The IRS National Research Program (NRP) provides a timely 
opportunity to take the necessary first step.
    The NRP is a comprehensive effort by the IRS to measure payment, 
filing and reporting compliance for different types of taxes and 
different sets of taxpayers.\37\ The NRP began collecting data on 
individual taxpayers in September 2002. In addition to the information 
that will be collected to serve the NRP, this program could also 
collect information regarding tax preparers for subsequent analysis 
regarding preparer performance. By focusing on tax preparers rather 
than individual taxpayers, the IRS may make more effective use of its 
limited resources. In addition to the NRP data, it seems the IRS could 
perform more statistical sampling of signed and unsigned tax returns 
identifying high error rates. For the ``invisible tax preparer,'' the 
IRS may consider using geographic error rates to highlight unscrupulous 
preparers.
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    \37\ Internal Revenue Service. 2002. IRS Release No. FS-2002-07. 
National research program--fact sheet.
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    In the event that increased regulation is imposed, such regulation 
will need to include penalties for failure to register. The IRS notes 
that without such penalties, it is likely that many of these preparers 
will simply ignore regulatory provisions and continue their business as 
usual. Alternatively, many unscrupulous tax preparers could go 
underground (making their detection extremely difficult) offering their 
services at a lower cost, not signing tax forms, and evading any 
subsequent enforcement activities. This would make IRS enforcement that 
much more difficult and resource intensive.

Learn from State Regulation
    In addition to studying this issue at the Federal level, a rigorous 
investigation of Oregon's and California's programs could provide 
useful insights for the proposed Federal regulation. The GAO noted in 
its study that neither state has systematically evaluated the 
effectiveness of its regulation efforts, so little is known for certain 
about the successes and challenges of these programs.\38\
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    \38\ See supra note 17.
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    Based on the foregoing, it is surprising that the NTA believes 
Oregon's program has significantly improved the accuracy of tax 
returns. For the 1999 tax year, the NTA looked at the number of tax 
returns containing errors to the total number of returns filed. The NTA 
found that the error rate of tax preparers in Oregon was 30 to 60% 
lower than those of the other states when Oregon is compared to states 
similar in size. In her 2002 report to Congress,\39\ the NTA concluded 
that this statistic is ``compelling support for registering tax 
preparers.'' However, neither the IRS nor the GAO concurs with this 
position. A simple comparison of error rates between states lacks the 
rigor necessary to draw inferences regarding the overall effectiveness 
of the Oregon program.
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    \39\ See supra note 18. p. 226.
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    The IRS Position Paper \40\ duly notes that neither California nor 
Oregon has data on the effectiveness of their programs and California 
specifically noted the difficulty in identifying unregistered 
preparers. It remains an empirical question whether or not California 
and Oregon's efforts at tax preparer regulation are effective. The IRS 
indicated intent to continue dialogue with these states as their 
experience could provide important information to guide future Federal 
action in this area.
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    \40\ See supra note 23.
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SUMMARY REMARKS
    For several years, the NTA has proposed national registration, 
examination, certification, and enforcement requirements for all FTRPs, 
including unenrolled tax preparers. However, given the lack of 
quantification of the problem, cost/benefit justification, and the 
documented failure to enforce paid tax preparer penalty provisions 
already in place, the proposed legislation does not appear justified at 
this time.
    As a supplement to regulation, the NTA has also advocated an 
extensive campaign to educate taxpayers about using certified return 
preparers. She cites some low-cost solutions to help reduce low-income 
taxpayers' reliance on unenrolled preparers. One is to get Congress to 
including funding for return preparation services in grants to low-
income taxpayer clinics. Another is to underwrite programs on computer 
and financial literacy for low-income taxpayers. ``There are 20,000 
answers that government could come up with--. If it cared to, to 
address this problem,'' Olson said.\41\
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    \41\ Miller, K. 2003. ABA Tax Section Meeting: Taxpayer Advocate 
plugs enrolled agent registration. Tax Notes Today, September 16.
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    An initial approach to addressing the unscrupulous tax preparer 
problem is focusing on education and enforcement. The IRS has been 
extremely successful through education and outreach in drastically 
reducing slavery reparation claims over a short period of time. In 
addition, both the IRS and the GAO note that the Service needs to 
establish an effective enforcement program to show taxpayers and tax 
return preparers that they must comply with the law. The education 
campaign used in Oregon could serve as a starting point for a national 
campaign. In his response dated October 28, 2003 to the GAO report \42\ 
on paid tax preparers, IRS Commissioner Everson indicates that the IRS 
has formed a multi-functional work group to improve communications 
between functions and develop a national return preparer strategy. 
These education and enforcement strategies should be given a reasonable 
time to be implemented and evaluated before revisiting national 
regulation of unenrolled tax preparers.
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    \42\ See supra note 17.

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           Statement of Gerald E. Scorse, New York, New York
    This is my third submission for the record urging the closing of a 
particular loophole in the personal income tax law. No loophole is 
desirable, but some are small and relatively innocuous; by contrast, 
this one is large and especially offensive.
    Wages are reported by a third party to the IRS. The same goes for 
interest and dividends, and various types of miscellaneous income. But 
capital gains income is exempt from this standard reporting 
requirement, and instead is self-reported.
    This is inequitable and costly. Why should wages be reported to the 
IRS, and not capital gains? At a time of soaring budget deficits, why 
should double-digit billions be lost every year because of this 
loophole?
    There is no good reason; what's more, the loophole could be easily 
closed.
    I invite the Subcommittee, the full Committee and the House at 
large to read ``Searching for Tax Fairness,'' below, which explores the 
issue and suggests an obvious and simple solution.
    Thank you (for the third time) for the opportunity to make a 
submission.

                       Searching for Tax Fairness

    If you haven't read James Surowiecki's The Wisdom of Crowds, get 
ready for a surprise.
    In a book that's part math, part psychology and part common sense, 
Surowiecki upends the popular belief that individuals are smarter than 
groups. Not so, he says. When it comes to solving problems, look to the 
group for dead-on answers.
    Paying taxes, Surowiecki states, ``is a classic example of a 
cooperation problem''. Everyone benefits from the services that taxes 
provide, but this is true whether or not they pay any taxes. Therefore, 
why pay?
    In Surowiecki's view, taxpayers ante up in large part because they 
believe that others are doing likewise. Americans, according to 
historian Margaret Levi, are ``contingent consenters''. Few of us are 
thrilled to pay taxes, but we don't mind paying our share as long as 
we're sure that the folks next door are paying theirs.
    But hold on. What makes us believe that our fellow citizens are 
giving the taxman his due? Are we being chumps, or does something in 
the system give us the assurance we need?
    The answer arrives like clockwork every tax season. It's the 
blizzard of W-2s and 1099s sent out by employers, banks, brokerage 
houses and mutual funds, telling us how much we made the year before in 
wages, interest, dividends and other forms of income. Each bears the 
reminder, ``This information is being furnished to the Internal Revenue 
Service.''
    It's this third-party reporting that forms the linchpin of our 
``voluntary'' tax system. It is the lodestar that keeps us on the 
straight and narrow, and tells us that we're all in the same boat.
    But hold on one more time. There's a gold mine of unearned income 
that has its own set of rules, that isn't ``furnished to the Internal 
Revenue Service.'' This rich vein is capital gains income from the sale 
of stocks, bonds and mutual funds. None of this income is reported by a 
third party to the IRS, though you could easily think it is.
    To explain: The IRS does get reports of proceeds from stock, bond 
and mutual fund sales. But the agency isn't told what these holdings 
cost to begin with, or when they were bought. In tax-speak, income from 
these transactions is ``self-reported''; the figures don't come from a 
third party, they come from the taxpayer.
    This is unfair on its face, and porous tax policy besides.
    A major IRS study found that misreporting rises sharply with self-
reporting, climbing to more than 12 times the rate for income reported 
by third parties. Other government and scholarly studies have produced 
similar results. Kim Bloomquist, a senior economist with the IRS, makes 
the point the other way around: ``One of the few generally accepted 
facts in the literature on tax compliance economics is the existence of 
a positive relationship between transaction visibility and reporting 
compliance.''
    There's no question that the self-reporting of capital gains costs 
the U.S. Treasury; the only question is how much. Unless we're a nation 
of angels, the figure likely hits the double-digit billions every year. 
On top of that there's the multiplier effect: states and cities which 
simply plug federal totals into their tax returns get short-changed as 
well.
    The solution is only half a step away, staring us in the face and 
daring us to put it in place.
    Brokerage houses and mutual funds routinely track their customers' 
basis prices, purchase dates and realized capital gains, and report the 
information to them. With little more than the click of a mouse, the 
same data could be reported to the IRS at tax time.
    Circle back to Surowiecki: ``Getting people to pay taxes is a 
collective problem. We know what the goal is: everyone should pay their 
fair share--.'' Just last month, IRS Commissioner Mark W. Everson 
sounded a similar note when he told the National Press Club, ``Average 
Americans pay their taxes honestly and accurately, and have every right 
to be confident that when they do, their neighbors--are doing the 
same.''
    It's time to put more reality into Everson's rhetoric; it's time to 
treat capital gains income the same as wage income, and have it 
reported by third parties.
    Just ask any crowd.
SOURCES
    Bloomquist, Kim M. ``Trends as Changes in Variance: The Case of Tax 
Noncompliance,'' presented at the IRS Research Conference, June 2003. 
Bloomquist is Senior Economist, Office of Research, IRS. His paper 
cites the agency's major study, and several others, on the relationship 
between tax compliance, third-party reporting (``matchable income'') 
and self-reporting (``nonmatchable income''). The article is accessible 
online: go to Google, search for ``Kim M. Bloomquist,'' and click on 
the third link, which is the title of the paper. See pp. 2-3.
    Everson, Mark W. Speech at the National Press Club, Washington, 
D.C., March 15, 2005.
    Surowiecki, James M. The Wisdom of Crowds: Why the Many Are Smarter 
Than the Few and How Collective Wisdom Shapes Business, Economies, 
Societies and Nations. Doubleday, 2004. The quote in paragraph 3 is 
from p. 137; in paragraph 4, from p. 138; in the next-to-last 
paragraph, from p. 141.
    Note: Capital gains distributions by mutual funds are a technical 
exception to the rule; they are the only capital gains reported by a 
third party.

                           Supplemental Sheet

    I make this submission on my own behalf as a taxpayer and a citizen 
of the United States of America. I represent no-one other than myself.

                                  
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