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

                       2006 TAX RETURN FILING SEASON AND
                      THE IRS BUDGET FOR FISCAL YEAR 2007

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

                                    HEARING

                                   before the

                           SUBCOMMITTEE ON OVERSIGHT

                                     of the

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

                           ONE HUNDRED NINTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 APRIL 6, 2006

                                   __________

                               Serial No. 109-72

                                   __________

             Printed for the use of the Committee on Ways and Means

                        U.S. GOVERNMENT PRINTING OFFICE
    30-443                      WASHINGTON : 2006
    _____________________________________________________________________________
    For Sale by the Superintendent of Documents, U.S. Government Printing Office
    Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512�091800
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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
    PHIL ENGLISH, Pennsylvania           WILLIAM J. JEFFERSON, Louisiana
    J.D. HAYWORTH, Arizona               JOHN S. TANNER, Tennessee
    JERRY WELLER, Illinois               XAVIER BECERRA, California
    KENNY C. HULSHOF, Missouri           LLOYD DOGGETT, Texas
    RON LEWIS, Kentucky                  EARL POMEROY, North Dakota
    MARK FOLEY, Florida                  STEPHANIE TUBBS JONES, Ohio
    KEVIN BRADY, Texas                   MIKE THOMPSON, California
    THOMAS M. REYNOLDS, New York         JOHN B. LARSON, Connecticut
    PAUL RYAN, Wisconsin                 RAHM EMANUEL, Illinois
    ERIC CANTOR, Virginia
    JOHN LINDER, Georgia
    BOB BEAUPREZ, Colorado
    MELISSA A. HART, Pennsylvania
    CHRIS CHOCOLA, Indiana
    DEVIN NUNES, California

                        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
    JOHN LINDER, Georgia                 MICHAEL R. MCNULTY, New York
    E. CLAY SHAW, JR., Florida           JOHN S. TANNER, Tennessee
    SAM JOHNSON, Texas                   CHARLES B. RANGEL, New York
    DEVIN NUNES, California
    J.D. HAYWORTH, Arizona

    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
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    unintentional errors or omissions. Such occurrences are inherent in the
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                                C O N T E N T S

                                   __________

                                                                       Page

    Advisory of March 30, 2006 announcing the hearing................     2

                                   WITNESSES

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

                                     ______

    U.S. Department of the Treasury, Hon. J. Russell George, Treasury
      Inspector General for Tax Administration.......................    37
    Internal Revenue Service Oversight Board, Hon. Raymond T. Wagner,
      Chairman.......................................................    46
    Free File Alliance, Hon. Timothy D. Hugo.........................    64
    U.S. Government Accountability Office, James R. White, Director,
      Tax Issues.....................................................    67

                                     ______

    American Bar Association, Dennis B. Drapkin......................    98
    American Institute for Certified Public Accountants, Thomas J.
      Purcell........................................................   102
    National Association of Enrolled Agents, Francis X. Degen........   110

                           SUBMISSIONS FOR THE RECORD

    National Society of Accountants, statement.......................   121
    Scorse, Gerald, New York, NY, statement..........................   124

                       2006 TAX RETURN FILING SEASON AND
                      THE IRS BUDGET FOR FISCAL YEAR 2007

                                  ----------

                            THURSDAY, APRIL 6, 2006

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

        The Subcommittee met, pursuant to notice, at 10:02 a.m., in
    room 1100, Longworth House Office Building, Hon. Jim Ramstad
    (Chairman of the Subcommittee) presiding.
        [The advisory announcing the hearing follows:]

    ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                           SUBCOMMITTEE ON OVERSIGHT

                                                    CONTACT: (202) 225-7601
    FOR IMMEDIATE RELEASE
    March 30, 2006
    OV-6

                          Ramstad Announces Hearing on

                     2006 Tax Return Filing Season and the

                        IRS Budget for Fiscal Year 2007

        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 2006 tax return filing season,
    the Internal Revenue Service (IRS) budget for fiscal year 2007, and
    other issues in tax administration. The hearing will take place on
    Thursday, April 6, 2006, in the main Committee hearing room, 1100
    Longworth House Office Building, beginning at 10:00 a.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 Mark Everson and
    representatives of the U.S. Government Accountability Office, the
    Treasury Inspector General for Tax Administration, the IRS Oversight
    Board, and several tax practitioner groups.

    BACKGROUND:

        This year's tax return filing season runs from January 1st to April
    17th, and during this time, the IRS expects to receive over 130 million
    tax returns, over half of which will be filed electronically. The IRS
    anticipates issuing more than $200 billion in refunds to approximately
    105 million taxpayers during this period. Seeking assistance from the
    IRS in preparing their returns, Americans will contact the Service via
    telephone more than 25 million times and will make almost 120 million
    visits to the IRS website, which is one of the busiest in the world
    during the filing season.

        To carry out these and other tax administration duties next year,
    the Administration has requested $10.6 billion to fund IRS operations
    for fiscal year 2007, a 0.2-percent increase over the amount enacted
    last year. This amount will be supplemented by $135 million in new user
    fees that the IRS expects to collect by providing individualized
    services to taxpayers. This level of funding will support nearly
    100,000 employees who will collect nearly $2 trillion in revenue.

        In addition to examining IRS performance during the filing season
    and the proposed budget for next year, the hearing will also provide
    the opportunity to review a number of significant tax administration
    issues that have recently arisen. For example, last year the IRS
    renegotiated the agreement with the Free File Alliance, a consortium of
    tax preparation software companies that provide free software to some
    taxpayers through the IRS website. The hearing will review the effects
    of the new agreement. Another issue that has recently arisen is
    proposed IRS regulations governing the use of taxpayer information by
    tax return preparers. The hearing will allow Members of the
    Subcommittee the opportunity to inquire about these proposed
    regulations and their potential effects on taxpayer privacy.

        In announcing the hearing, Chairman Ramstad stated, ``By collecting
    $2 trillion in revenue, the IRS fulfills a vital mission for the
    Federal Government, and the IRS must pursue its enforcement obligations
    aggressively. However, the IRS impacts the lives of all Americans, and
    it is important that the IRS respects taxpayers' rights and provides
    top-rate service in a time of budgetary constraints. I look forward to
    hearing from Commissioner Everson and the other witnesses as they
    discuss how the IRS is carrying out these responsibilities this year.''

    FOCUS OF THE HEARING:

        The hearing will focus on the 2006 tax return filing season, the
    IRS budget for fiscal year 2007, and current tax administration issues
    facing the IRS.

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        Note: All Committee advisories and news releases are available on
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    noted above.

        Chairman RAMSTAD. The hearing will come to order. Welcome
    to our three distinguished panels. Welcome to all our guests.
    Commissioner, good to see you again. In a little more than a
    week we will reach the culmination of the annual tax return
    filing season, as we all know. This is a time of the year when
    Americans are reminded of the tax burden they face, and the
    mind-numbing complexity of the Tax Code. This is also the time
    of the year that brings millions of Americans into contact with
    the Internal Revenue Service (IRS). I know everyone there
    around the country is working overtime these days. 105 million
    taxpayers will receive refunds from the IRS. Taxpayers will
    place 25 million calls to the IRS, and they will make 120
    million visits to the IRS website, truly mind-numbing numbers.
        With all of this interaction, it is important that the IRS
    provide high-quality service to taxpayers even in the face of
    budgetary constraints. It is just as important that the Service
    vigorously enforce the law to ensure that all taxpayers pay
    their fair share. We know this is a delicate balancing act, but
    it is essential to maintaining high levels of voluntary
    compliance with our tax laws.
        I have been following the filing season closely, and I have
    some concerns that I will explore in detail at this hearing,
    that indeed, all of us on this Subcommittee will explore at
    this hearing.
        First I want to ask about the Free File Alliance. Four
    years ago, the IRS entered into an agreement with a group of
    tax preparation software companies. The purpose of the
    agreement was to encourage more taxpayers to file their tax
    returns electronically. Under the agreement, the Government
    promised not to develop its own preparation software as the
    quid pro quo. In return, the companies, known as the Free File
    Alliance, would provide free preparation software to the
    American public for the taxpayers.
        For the first 3 years under the agreement, this program was
    successful, and it grew in popularity with taxpayers. Its use,
    in fact, increased by 26 percent 2 years ago, and 46 percent
    last year. The popularity of Free File was due in large part to
    the fact that last year many of the participating companies
    decided to offer free Federal preparation to all taxpayers,
    regardless of their income level.
        However, several months ago, the IRS renegotiated this
    agreement, and included for the first time a cap on the number
    of taxpayers who can be served by the Free File Alliance. This
    is the first filing season in which the new agreement has been
    in place, and as you can see from the graph, use of the Free
    File Alliance is down over 21 percent, like I said, in just one
    year.
        We will explore today more about this agreement that seems
    to prevent many taxpayers from receiving free return
    preparation services, and apparently discourages taxpayers from
    electronic filing. We will also, today, talk more about the
    agreement that keeps companies from offering free tax
    preparation services to taxpayers through the IRS website. We
    are going to explore this with the various panels here today,
    and they know the Commissioner has some concerns he wants to
    express as well, because this 21-percent decline in the use of
    the program in this year alone is certainly concerning to all
    of us on the Subcommittee.
        In fact, as I expressed on the record, I had some concerns
    about this agreement at the time it was signed, but I wanted to
    see if it would work, but now that the numbers are in and we
    see a dramatic drop-off in the public's use of Free File, I
    think we need to seriously look at whether this agreement
    should be renegotiated.
        We are going to also look at a number of issues facing the
    IRS, as we routinely do at these yearly oversight hearings, the
    one during the filing season. For example, a number of Members
    have expressed concerns about how tax preparers handle their
    clients' taxpayer information. Last December the IRS proposed a
    new rule that expanded some of the ways that return preparers
    can use taxpayer information. This rule has been criticized by
    a number of people, including me, but what really concerns me
    is current law. Current law allows return preparers to share
    taxpayers' private information with any third party as long as
    they have taxpayers' consent.
        I fear that many taxpayers may not give meaningful consent,
    and that many taxpayers will find their private information is
    being sold to third parties. This is a real privacy issue that
    I know concerns a number of Members.
        I am interested in hearing the views of the witnesses as to
    whether Congress should consider changes to current law to
    provide greater protection to taxpayer information.
        I certainly look forward to the Commissioner's testimony as
    well as the other two distinguished panels here today on these
    important matters.
        I am now pleased to recognize my good friend, the
    distinguished ranking Member, Mr. Lewis.
        Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
        Again, this year the Subcommittee is holding an oversight
    review to examine how the current tax return filing season is
    progressing and the adequacy of the administration's proposed
    IRS budget for the coming year. Mr. Chairman, I want to thank
    you for conducting this annual hearing on the IRS.
        More than 130 million tax returns will be filed during the
    2006 tax return filing season. This year, the filing season
    ends a little later than usual, on April 17th, since April 15th
    is a Saturday. Reports indicate that the tax return filing
    season is progressing smoothly.
        The administration has proposed, for fiscal year 2007, an
    IRS budget of about $10.6 billion. It is important that the IRS
    be adequately funded and have a balanced approach to
    administering our tax laws.
        I welcome today's hearing witnesses, and look forward to
    each of your testimonies. Importantly, I want to commend you,
    Mr. Commissioner, I want to commend you for all of your good
    work, and all of the IRS employees nationwide for their good
    work, and their hard work to see that our tax laws are
    enforced, and that we get the revenue that is due the
    government.
        Thank you, Mr. Chairman.
        Chairman RAMSTAD. I thank the ranking Member, and I
    certainly concur in his sentiments. Nobody has a tougher job in
    Washington, except maybe the President, than you do,
    Commissioner, and you are doing a tough job very well, and all
    of the people that work for you are to be commended as well.
        We look forward to your testimony, and, please, proceed.

       STATEMENT OF THE HONORABLE MARK W. EVERSON, COMMISSIONER,
                        INTERNAL REVENUE SERVICE

        Mr. EVERSON. Thank you for those kind words. Mr. Chairman,
    Mr. Lewis, Mr. Shaw, I am pleased to be here today to testify
    on the 2007 budget request for the IRS. I will also provide you
    with an update on the tax filing season currently under way.
        Let me comment first on the tax gap. As you know, the tax
    gap is the difference between the amount that taxpayers should
    pay for a given year and the amount that they actually pay on a
    timely basis. The tax gap represents in dollar terms the annual
    amount of noncompliance with our tax laws. We have refined our
    research, and now estimate that for the year 2001, the overall
    growth tax gap for all types of tax was approximately $345
    billion, or a noncompliance rate of 16.3 percent. Our estimate
    of the net tax gap, or what remains after enforcement and other
    late payments, is $290 billion. Our 2007 budget will help us
    reduce the tax gap.
        Before discussing this budget though, I want to thank you
    for your support for last year's budget. We are using the
    moneys that Congress provided to continue our progress in
    building a balanced program of service and enforcement. The
    2007 budget would sustain this progress. Our request is for
    $10.6 billion in direct appropriations, supplemented by $135
    million in incremental user fee revenue, to represent a total
    operational level of $10.7 billion, or 1.4 percent more than
    this year's 2006 budget.
        Let me touch briefly on IRS efforts in our three areas of
    strategic focus: service, enforcement and modernization, and
    then make brief comments on certain legislative proposals
    accompanying the 2007 budget which we believe will help close
    the tax gap.
        We seek to improve service to taxpayers. We also enforce
    the law against those who do not comply. As you know, our
    working equation at the IRS is ``service plus enforcement
    equals compliance.'' We strive to pursue a balanced and fair
    approach for all taxpayers.
        First, services. We are enjoying a successful filing
    season. Electronic filing is up by almost 3 percent from last
    year, reflecting a strong increase in the use of tax software
    on home computers, partially offset by the effect of the
    elimination of our telephone filing program, and as you have
    pointed out, Mr. Chairman, somewhat lower returns received via
    the Free File Alliance. Our phone level of service is better
    than last year, as is the accuracy of our answers to tax law
    questions.
        We are also seeing continued strong growth in our community
    based volunteer tax preparation program. The VITA sites are an
    increasingly important part of our efforts, and in fact, last
    year, the IRS was recognized by the Points of Light Foundation
    for its successful efforts. This was the first time any
    government agency has ever been so recognized. Previous
    recipients were March of Dimes, Mothers Against Drunk Driving,
    organizations like that, no other government agency.
        As to enforcement, the fiscal year 2005 results demonstrate
    that we have restored the credibility of our enforcement
    programs. Individual audits were up 20 percent from 2004 to 1.2
    million. That is 97 percent up since 2000. High-income audits
    were also up, and have now increased 120 percent since 2000.
    Corporate audits, which had bottomed out in 2003, have
    recovered now by over 50 percent. Collections are more robust.
    Last year we had 2.7 million levies against 200,000 in 2000.
    All told, enforcement revenues increased from $43.1 billion in
    2004 to $47.3 billion last year. Concerning 2006, we expect
    continued progress in enforcement, although I would say, not as
    dramatic as some of the double-digit increases I have just
    indicated. We are bringing on new personnel with the moneys you
    provided, but it will take some time before they get fully up
    to speed.
        As for the modernization of our computer systems, we have
    realized a number of achievements. In particular, I would note
    the progress of our taxpayer master file update, the CADE
    system. Last year CADE posted 1.4 million returns. Thus far
    this year we have already processed 5 million returns through
    CADE.
        Before taking your questions, let me make one additional
    point. As I indicated, we refined our estimates of the tax gap.
    We will be using this information to update our audit models
    and selection procedures and to calibrate our resource
    allocation within our business units. The research also clearly
    indicates that where there is third-party reporting, there is
    better compliance. In this regard I would draw to your
    attention a number of proposals that accompany the President's
    2007 budget request. These proposals aim to address
    administrative and reporting issues. The most important of
    these is a proposal to mandate reporting to the IRS of gross
    receipts by credit card issuers for their business customers.
        I believe the five legislative proposals that accompany the
    funding request can make a significant contribution to reducing
    the tax gap. I hope they will enjoy your support.
        Finally, I would indicate that I remain a strong advocate
    of tax reform and simplification.
        Thank you.
        [The prepared statement of Commissioner Everson follows:]

           Statement of The Honorable Mark W. Everson, Commissioner,
                            Internal Revenue Service

    Introduction
        Chairman Ramstad, Ranking Member Lewis and members of the
    Subcommittee, I thank you for the opportunity to testify today on the
    2006 Income Tax Filing Season. I would also like to update you on both
    the FY 2007 budget request for the Internal Revenue Service as well our
    latest numbers of the tax gap.
    2006 Filing Season
        We expect to process almost 135 million individual tax returns in
    2006, and we anticipate a continued growth in the number of those that
    are e-filed. In the 2005 filing season, over 50 percent of all income
    tax returns were e-filed.
        We fully expect to exceed that number this year. As of April 1st,
    we have received nearly 54 million tax returns filed through e-file, an
    increase of over 3 percent compared to the same period last year.
        This increase in e-filing is being driven by people using their
    home computers. The total number of self-prepared returns that are e-
    filed are up by 16.9 percent compared to this time a year ago. Almost
    15 million returns have been e-filed by people from the comfort of
    their own home, up from just over 12 million for the same period a year
    ago. Fully, 28 percent of all electronically filed returns have been
    done on home computers. This is up 3 percentage points over this time
    frame last year.
        Overall, 67 percent of the nearly 80 million returns filed thru
    April 1, have been e-filed, over a 3 percent increase compared to the
    same period in the 2005 filing season.
        Encouraging e-filing is good for both the taxpayer and for the IRS.
    Taxpayers who use e-file can generally have their tax refund deposited
    directly into their bank account in two weeks or less. That is about
    half the time it takes us to process a paper return. For the IRS, the
    error rate for returns e-filed is less than for paper returns.
        Most people are choosing to have their tax refunds directly
    deposited into their bank than ever before. So far this year, we have
    directly deposited more than 44 million refunds, or 69 percent of all
    refunds issued this tax filing season. This is up from 65 percent for
    the same period in 2005.
        People are also visiting our web site, IRS.gov in record numbers.
    The IRS has recorded almost 90 million visits to our web site, up from
    84 million for the same period a year ago. This is a 6.43 percent
    increase.
        The millions of taxpayers that have visited IRS.gov have benefited
    from many of the updates that we have made for this filing season. We
    have made it easier for taxpayers to get answers to many of their tax
    questions. The web site:

          Allows a taxpayer to determine whether he or she
    qualifies for the Earned Income Tax Credit (EITC);
          Assists the taxpayer in determining whether he or she is
    subject to the Alternative Minimum Tax (AMT);
          Allows more than 70 percent of taxpayers the option to
    actually file their tax returns at no cost through the FreeFile
    program;
          Assists hurricane victims with information on many of the
    changes in the tax laws that are designed to help them along with a
    toll free number for victims to get their questions answered; and
          Allows a taxpayers who are expecting refunds to track its
    progress via the ``Where's My Refund?'' feature on the site.

        As of April 1, we have received almost 80 million returns, a very
    slight decline over the same period as last year. We have issued 66.7
    million refunds this year for a total of $154.3 billion. The average
    refund this year is $2,314, $104 more than last year. In addition, more
    than 17 million taxpayers have tracked their refund on IRS.gov, up
    almost 18 percent over last year.
        At the present time we have been able to mitigate much of the
    impact of retaining 15 hours of service on our toll free lines. Our
    planning assumptions called for reducing toll-free operating hours from
    15 hours to 12 hours while still maintaining the same service level for
    our customers. When this change was not implemented, the expected
    savings were restored and used to increase overtime. In addition,
    resources from answering paper correspondence were diverted to
    telephones. To date, these strategies have produced positive results.
        In addition to these personnel actions, we have not yet experienced
    some of the workload increases that were anticipated as a result of the
    hurricane disasters. Overall, this filing season through March 25th, we
    have actually received about one million fewer telephone calls that
    last year (24.6 million in 2006 vs. 25.6 million in 2005). As a result,
    our Customer Service Representative (CSR) Level of Service (percent of
    calls answered) is slightly above last year (84.19% in 2006 vs. 82.60%
    in 2005). Additionally, we have received over 204,000 fewer pieces of
    correspondence than last year. However, because we deployed Adjustments
    staff to the telephones, paper inventories are 110.6.9% of last year
    (870,987 in 2006 vs. 787,491 in 2005). The number of cases that are
    overage has also increased significantly (44,915 in 2006 vs. 32,578 in
    2005).
        While it is still too early to tell if the expected hurricane
    disaster calls will materialize, if they do not we are guardedly
    optimistic that we will be able to maintain these service levels for
    the remainder of the filing season.
        As of March 18th, our Taxpayer Assistance Centers (TACs) are
    reporting a 12.6 percent decline in face to face contacts this filing
    season as compared to last year. We believe that the decline in visits
    to our TACs as well as the reduction in the number of calls is largely
    attributable to taxpayers increasing their use of IRS.gov and other
    electronic means to get their questions answered and obtain tax forms.
        The use of other alternatives, such as volunteer return assistance
    at Volunteer Income Tax Assistance (VITA) sites and Tax Counseling for
    the Elderly sites (TCEs), has steadily increased while the numbers of
    TAC contacts have decreased. In FY 2005 over 2.1 million returns were
    prepared by volunteers. As of March 25th, volunteer return preparation
    is up 6.5 percent above last year's level. Volunteer e-filing is also
    up, by 4.5 percent over the same period in the last tax filing season.
    This is reflective of continuing growth in existing community
    coalitions and partnerships.
    Free File
        I recognize there have been some questions raised as to the renewal
    of our Free File agreement. Allow me to update you on the both the
    background of Free File and the new agreement.
        Free File's roots can be found in the President's FY 2002
    Management Agenda. It contained five Government-wide initiatives, one
    of which was to expand electronic government. The overarching goal was
    to ``champion citizen-centered electronic government that will result
    in major improvements in the federal government's value to the
    citizen.''
        Subsequently, in November 2001, OMB's Quicksilver Task Force
    established 24 e-government initiatives as part of the President's
    Management Agenda. These initiatives were designed to improve
    government-to-government, government-to-business, and government-to-
    citizen electronic capabilities.
        One initiative instructed the IRS to provide free online tax return
    preparation and filing services to taxpayers. In accordance with this
    OMB directive, the IRS began working in partnership with the tax
    software industry to develop a solution. Two principles guided its
    development: no one should be forced to pay extra to file his or her
    return and the IRS should not get into the software business.
        The IRS believes that private industry, given its established
    expertise and experience in the field of electronic tax preparation,
    has a proven track record in providing the best technology and services
    available. Rather than entering the tax software business, IRS'
    partnership with private industry: (1) provides taxpayers with high
    quality services by using the existing private sector expertise; (2)
    maximizes consumer choice; (3) promotes competition within the
    marketplace; and (4) meets these objectives at the least cost to
    taxpayers.
        On October 30, 2002, the IRS and the Free File Alliance, LLC,
    signed an agreement that created a public-private partnership to
    provide free services to the majority of taxpayers.
        The Free File Alliance, LLC, is a private-sector consortium of tax
    preparation software companies. The original agreement was for three
    years with a series of two year renewal options. The primary candidates
    for Free File were those taxpayers who prepare their own taxes and
    still file paper returns.
        While membership in the Alliance may change from time to time, all
    members must meet certain IRS standards. Specifically, we must approve
    each member's proprietary tax preparation software. In addition, each
    member must obtain third party privacy and security certification.
    Finally, all Alliance members must adhere to all Federal laws regarding
    taxpayer privacy.
        Each Free File Alliance member was allowed to set taxpayer
    eligibility requirements for its program. Generally, eligibility was
    based on such factors as age, adjusted gross income, state residency,
    eligibility to file a Form 1040EZ or for the Earned Income Tax Credit.
    But, as a whole, under the original agreement, the Alliance was
    required to provide free services to at least 60 percent or 78 million
    of the nation's individual taxpayers. In addition, all active armed
    forces, federal reservist and National Guard personnel were eligible to
    free file through a separate program operated by the military.
        While the IRS did not support or endorse any Free File Alliance
    company or product offered, it did provide a listing of the Alliance
    members via the Free File web page, which is hosted on IRS.gov.
    Companies were allowed to offer ancillary services to taxpayers for a
    fee, but the taxpayer was under no obligation to purchase any of those
    services as a condition of getting their Federal tax return prepared
    free of charge.
        The intent of the Free File program was to reduce the burden on
    individual taxpayers, make tax preparation easier and expand the
    benefits of electronic filing to a majority of Americans. In the 2003
    filing season, 2.8 million taxpayers took advantage of Free File. This
    number rose to 3.4 million in 2004. In 2005, the number increased to
    over 5 million.
        The 2005 number may be a bit of an aberration in that many of the
    companies in the Alliance opted to lift qualification restrictions on
    taxpayers thus allowing any taxpayer, regardless of income, to utilize
    Free File. This started as some companies sought a competitive
    advantage by expanding their base and ended with many of the companies'
    offering free return preparation services to anyone.
        While this was good for taxpayers in general, it posed a serious
    threat to the survival of the Alliance and was a prime topic of
    discussion when the contract was up for renewal at the end of last
    year. Many of the companies could not continue in the Free File
    Alliance unless it returned to offering the free service to low and
    moderate income individuals. The loss of these companies would have
    jeopardized the continued existence of the Alliance.
        As we prepared for negotiations to extend the Free File agreement
    in 2005, the IRS took the position that Free File should be available
    to as many taxpayers as possible. The Alliance's position was that Free
    File should only be available to low and moderate income taxpayers.
        As is the case in most negotiations, we compromised and agreed that
    Free File would be offered to 70 percent of taxpayers, or anyone with
    an AGI of $50,000 or less in 2005. This covers approximately 93 million
    of the 133 million taxpayers expected to file. This is an improvement
    over our earlier agreement which only guaranteed coverage of 60 percent
    or availability to 78 million taxpayers. The active armed forces,
    federal reservist and National Guard personnel continue to be eligible
    to free file under their own program.
        In 2006, three Free File Alliance members are offering state filing
    for free. Seven members are offering to file F4868, Extension of Time
    to File Individual return. As of the end of February, 653 extension
    forms had been filed. In addition, there are two companies offering
    free packages in Spanish.
        While the number of taxpayers taking advantage of Free File in 2006
    will likely be less than in 2005, we are unable at this time to fully
    explain the decline. Certainly the fact that it is not available to
    everyone is one factor, but there likely are other factors as well.
        A year ago, the Free File program was benefited greatly by a major
    article on the front page of USA Today. Immediately following that
    article, there was a tremendous surge of positive publicity as well as
    a surge in Free File usage by taxpayers. We have not been the
    beneficiary of similar publicity this year and to the extent we have
    received coverage much of it has focused on the taxpayers that Free
    File does not cover.
        One of the major concerns that many critics of the Free File
    program have had has been the ability of the Alliance members to use
    Free File to market other services to taxpayers. These include the
    filing of state tax refunds and the offering of refund anticipation
    loans (RALs). We make it clear to taxpayers that the IRS does not
    endorse any of these products or services nor is the completion of
    their tax return at no cost conditioned on the purchase of any product
    or service.
        We generally do not know what, if any, fee services taxpayers
    actually use from the Free File vendors. The one service that we do
    have data on is refund anticipation loans (RALs). RALs are designed to
    provide the taxpayer an immediate refund in the form of a consumer
    loan. Often the costs incurred with the RAL are disproportionate to the
    amount of the refund, especially considering that a taxpayer that files
    electronically will get the refund from the IRS in about two weeks.
    Unfortunately, it is often low income taxpayers, the ones that can
    least afford it, which choose RALs.
        What we are seeing from our Free File data thus far in this regard
    is encouraging. Only 0.6 percent of the taxpayers utilizing Free File
    have utilized a RAL. In fact, half of the Free File vendors do not even
    offer refund anticipation loans.
        This 0.6 percent RAL participation for Free File is the lowest of
    any of our electronic filing groups. Other online filers have a 0.8
    percent participation rate. The rate for online returns done by paid
    tax preparers is the highest. Approximately 20 percent of the preparer
    returns submitted electronically include a RAL.
        Now, I would like to talk about the President's FY 2007 proposed
    budget for the IRS.
    President's FY 2007 Budget Maintains the Balance between Taxpayer
            Service and Enforcement
        Our total budget request for FY 2007 is $10.6 billion in direct
    appropriations supplemented by $135 million in new user fee revenue,
    for a total operating level of $10.7 billion. This request represents a
    total increase of 1.4 percent from the FY 2006 enacted level. The FY
    2007 Budget sustains the enforcement funding increase provided in FY
    2006 to improve tax compliance. More importantly, the budget maintains
    the balance between service and enforcement.
        The IRS' taxpayer service and enforcement activities are funded
    from the three appropriations: Processing, Assistance and Management
    (PAM); Tax Law Enforcement (TLE); and Information Systems (IS). The
    total FY 2007 Budget request for these three operating accounts is
    $10.4 billion supplemented by the $135 million in new user fee revenue,
    for a total operating level of $10.5 billion, or 1.8 percent increase
    over the FY 2006 enacted level.
        The $135 million in new user fees revenue will be generated from
    several increased and new user fees earned from special or non-routine
    services provided to taxpayers by the IRS. These would include such
    services as providing private letter rulings for interpretations of tax
    law and applications for exempt status. The largest portion of the
    anticipated increase in fees will come from new and restructured
    installment agreements ($66.7 million). Another $47.1 million is
    expected from letter rulings and determinations. The remainder will
    come from technical training and enrolled agent fee increases.
        These increased fees were designed to more fully reflect the cost
    of providing these services as required by OMB Circular A-25. Every two
    years the fees are re-examined to see whether they reflect the full
    cost.
        The budget includes an additional $137 million, a 2 percent
    increase for enforcement to fund the pay raise and other cost
    adjustments needed to maintain the FY 2006 enforcement initiative
    increase. Similar to last year, the President's Budget proposes to fund
    this enforcement increase through an adjustment to the discretionary
    cap, which in effect would increase the amount of funding dedicated to
    tax enforcement from $6.82 billion in FY 2006 to $6.96 billion in FY
    2007. The IRS will continue to focus its enforcement resources on
    efforts designed to increase compliance and reduce the tax gap. We will
    continue our examination of tax-exempt entities used to violate federal
    income tax law and tax strategies involving international elements for
    both corporations and high income individuals.
        I would remind the Subcommittee that in FY 2005 we brought in a
    record of $47.3 billion in enforcement revenue, an increase of $4.2
    billion from the previous year. In FY 2006, we expect that total to
    increase to $48.1 billion, a 42 percent increase from FY 2001.
        We have done a lot of work at the IRS regarding our return on
    investment (ROI) for the enforcement dollars we are spending. Based on
    that work, we estimate that when we receive the full productive
    benefits of the FY 2006 increase, the ROI for additional enforcement
    resources will be 4:1. Stated another way, we estimate that each dollar
    invested in enforcement will return four dollars in additional
    enforcement revenue, although this should not be interpreted as a fixed
    ratio.
        This estimated ``return'' is based on the amount of additional tax
    collected and attributes the revenue to the enforcement occupations
    that originated each case. For each type of IRS enforcement employee,
    the associated amount of additional tax collections is estimated based
    on an extensive data base, covering the most recent 11 years of
    collection experience.
        This analysis does not include the indirect effect of increased
    enforcement activities in deterring taxpayers considering engaging in
    non-compliant behavior. Econometric estimates of the indirect effects
    indicate that they may be 10 times the size of the direct effects, or
    larger.
        The $3.58 billion for taxpayer service, including the $135 million
    from new user fee revenue, will maintain our commitment to provide
    high-quality taxpayer services through improvements to information
    technology and other targeted efficiencies such as those resulting from
    increased electronic filing.
        The Business Systems Modernization appropriations account funds the
    IRS' costs to develop and deploy our critical, major information
    systems. The requested level for BSM is $167.3 million, a 15.1 percent
    reduction from the FY 2006 level. This is discussed later in the
    testimony.
        Lastly, the Health Insurance Tax Credit appropriation (HITCA)
    remains a separate account that funds the administration of a
    refundable tax credit. The FY 2007 request for HITCA is $14.9 million,
    a 25.8 percent reduction from the FY 2006 enacted level.
    FY 2007 Detailed Budget Summary
        Our FY 2007 Budget request of $10.7 billion, which is offset by the
    $135 million in new user fee revenue, primarily funds costs to maintain
    the IRS' current levels of service and enforcement ($272.2 million) and
    an initiative to consolidate the Philadelphia Campus ($20.9 million).
    This request also includes several program savings and efficiencies
    that reflect the IRS' aggressive efforts to identify and deploy
    technology improvements that will benefit both taxpayer service and
    enforcement programs. Collectively, these cost savings total $116.1
    million:

          E-File Savings -$6,760,000/-174 FTE: This savings results
    from increased electronic filing (e-file) and a reduction in Individual
    Master File paper returns. Estimated e-file savings are based on the
    projected reduction in the number of paper returns processed each year,
    offset by the cost of processing e-filed returns.
          Improvement Project Savings -$8,215,000/-135 FTE: This
    savings results from operational improvements generated by the Contact
    Recording, Queuing Management (Q-Matic), Correspondence Imaging
    Systems, and End-to-End Publishing improvement projects already in
    progress.
          Competitive Sourcing Savings -$17,000,000/-242 FTE (The
    -242-FTE is a revised figure which corrects an error included in the FY
    2007 President's budget request for the IRS). These savings reflect
    efficiencies and savings that will be achieved through the IRS'
    competitive sourcing efforts resulting from six different projects in
    various phases of implementation.
          Program Efficiencies -$84,121,000/-873 FTE: (-873 FTE is
    a revised figure, which corrects an error included in the FY 2007
    President's Budget request for the IRS) These savings reflect Service-
    wide efficiencies resulting from the elimination of duplicative
    overhead in internal support functions, increased productivity through
    improved workload selection, and distribution techniques, automation of
    certain taxpayer assistance functions, and deployment of the FY 2006
    enforcement hires to full time examiner positions. These efficiency
    savings can be realized with no adverse impact on taxpayer service and
    enforcement operations.

        Of the $84 million in efficiency savings, approximately $24 million
    of this reduction reflects savings from renegotiated information
    systems and telecommunication contracts. Another $38 million of these
    savings are based on enhanced productivity and efficiency of the IRS'
    enforcement programs achieved by consolidating, reducing, and
    redirecting some of the overhead resources, as well as reengineering of
    processes and improved workload selection techniques in examination and
    collection. Some examples of these improvements include:

          Increased efficiency of LMSB examination process to
    improve identification of risks and issues to enable earlier issue
    resolution, reduce audit cycle time, and increase inventory turnover;
          Conversion of enforcement trainees hired in 2006 to
    examiner positions, allowing veteran examiners (working as trainers) to
    resume exam work;
          Re-engineering of workload selection techniques to
    resolve simple cases quickly, and concentrate resources on the most
    egregious cases;
          Maintenance of audit coverage for large organizations
    through improved data collection techniques. Reduction of time required
    to complete compliance checks to place returns with agents more
    quickly; and
          Improved investigative efficiencies, enhanced managerial
    oversight, streamlined business processes, and improved technological
    capability to process electronic data and evidence.

        The remaining $22 million of these savings results from
    efficiencies to taxpayer services, including the judicious distribution
    of workload and the automation of certain taxpayer assistance
    functions, such as the centralized monitoring of case inventories. For
    example, approximately $12 million of these efficiencies in taxpayer
    service are based on improvements such as:

          Deployment of the use of the Individual Taxpayer
    Identification Number Real Time System (ITIN RTS). The ITIN RTS will
    save time and resources for both the Service and taxpayers, through
    automation of the process of providing an Individual Taxpayer
    Identification Number (ITIN) to taxpayers ineligible for a Social
    Security Number but required to provide identifying information on tax
    returns.
          Reductions in printing and postage costs due to
    efficiencies to the current processes for notices, and
          Expanding the use of automated reference tools, such as
    operator scripts, to improve telephone operations.

        In addition to the program savings and increases for taxpayer
    service and enforcement, the FY 2007 Budget includes a $5.5 million
    reduction to the Health Insurance Tax Credit Administration (HICTA)
    Program. This funding adjustment for HITCA reflects the program's
    effort to align fiscal year costs with contract year expenditures.
    IRS Modernization
        The requested level for BSM of $167.3 million, a decrease of $29.7
    million, will continue the support for Customer Account Data Engine
    (CADE), Filing and Payment Compliance (F&PC) and the Modernized e-File
    (MeF) project along with some of the needed investments to upgrade our
    modernized infrastructure.
        After several years of cost, schedule, and performance problems,
    the BSM program has demonstrated a markedly improved performance in the
    past two years in delivering projects and releases on time, on budget,
    and meeting or exceeding expectations. Taxpayers are now realizing the
    benefits of our enhanced BSM program management capabilities. In FY
    2006 and continuing in FY 2007, we are revising our modernization
    strategy to emphasize the release of projects to deliver business value
    sooner at a lower risk. We will concentrate on delivering releases of
    the major tax administration projects, along with infrastructure
    initiatives that support all modernization projects, and continuing our
    improvements to program management operations. These projects and
    initiatives address core IRS strategic priorities: taxpayer service,
    enforcement, and modernization.
        As part of our continuing effort to improve taxpayer service, we
    plan to expand services provided and the number of taxpayers served by
    Modernized E-File (MeF). MeF uses the latest secure Internet technology
    and speeds turnaround time for tax return submissions, equating to
    significant reductions in burden and time for corporate and tax-exempt
    taxpayers.
        As of March 25th, MeF had processed nearly 240,000 Form 1120 and
    1120S corporate returns. This compares to 95,000 at this point a year
    ago. In addition, there have been another 335,000 requests for
    extensions as opposed to 46,000 at this point in 2005. In recent
    regulations, the IRS has mandated the nation's largest corporations and
    tax exempt organizations file electronically in 2006 through the use of
    MeF.
        Finally, we will continue to expand the use of the Customer Account
    Data Engine (CADE). CADE will ultimately replace our antiquated Master
    File system, which is the repository of taxpayer information. CADE
    allows faster refunds, improved taxpayer service, faster issue
    detection, more timely account settlement, and a robust foundation for
    integrated and flexible modernized systems. CADE posted more than 1.4
    million returns and generated more than $427 million in refunds in
    2005. In 2006, CADE has already posted 5.2 million returns and
    generated over $2.5 billion in refunds from electronic filers alone. We
    anticipate to processing an additional 1.5 to 2 million returns during
    this filing season. In the 2007 filing season, we expect that number to
    rise 33 million. CADE serves as the single authoritative repository for
    account and return data for those returns.
    Private Collection Agencies (PCA)
        The American Jobs Creation Act of 2004 created section 6306 of the
    Internal Revenue Code, which allows the IRS to use private contractors
    to collect delinquent taxes in instances where the amount owed is not
    in dispute. It is important to understand that these PCAs will be
    assigned cases where the tax balance is not in dispute and will not be
    performing audits or assessing penalties, or taking enforced collection
    actions of any kind. They will only be used in instances where what is
    owed has been determined but the taxpayer has not paid.
        On March 9th, we announced the award of contracts to 3 PCAs. It is
    our expectation that these firms will begin work as soon as issues are
    resolved regarding the two protests to these awards. If cases are
    placed in FY 2006, as allowed by statute, the IRS will retain 25
    percent of any posted revenue receipts from this program which we will
    use to supplement our existing budget (for collection related
    activities). We anticipate an even greater return for FY 2007 since
    case placements are expected to increase.
    The Tax Group
        To understand the need for full funding of IRS's proposed FY 2007
    budget, one also needs to understand the nature of the tax gap. The tax
    gap is the difference between the amount of tax imposed on taxpayers
    for a given year and the amount that is paid voluntarily and timely.
    The tax gap represents, in dollar terms, the annual amount of
    noncompliance with our tax laws.
        It is the need to reduce that gap that drives much of what we do.
    This is true not only from a revenue standpoint, but also from a
    taxpayer fairness perspective. Our tax system is largely based on
    voluntary compliance and that compliance is enhanced if taxpayers
    believe that everyone is paying their fair share.
        A year ago, we released preliminary estimates of the tax gap based
    on data derived from a National Research Program (NRP) study done on
    individual income tax returns from Tax Year 2001. This was the first
    comprehensive update of our tax gap estimate since 1988. We have now
    revised those estimates and I would like to summarize them for you.
        Our latest numbers show that there is an overall gross tax gap of
    approximately $345 billion, leading to a noncompliance rate of 16.3
    percent. Both of these numbers are in the upper end of the range of
    estimates provided last spring. Our estimate of the corresponding net
    tax gap, or what is remaining after enforcement and other late
    payments, is $290 billion, also in the upper end of the earlier range.
        Noncompliance takes three forms: not filing required returns on
    time; not reporting one's full tax liability even when the return is
    filed on time; and not paying by the due date the full amount of tax
    reported on a timely return. We have separate tax gap estimates for
    each of these three types of noncompliance.
        Underreporting constitutes nearly 82 percent of the gross tax gap,
    up slightly from our earlier estimates. Nonfiling constitutes 8.6
    percent and underpayment 9.6 percent of the gross tax gap.
        Individual income tax accounts for 46 percent of all tax receipts.
    However, individual income tax underreporting is approximately $197
    billion. This constitutes about 56 percent of the overall tax gap.
        As in previous compliance studies, the NRP data suggest that well
    over half ($109 billion) of the individual underreporting gap came from
    understated net business income (unreported receipts and overstated
    expenses). Approximately 28 percent ($56 billion) came from
    underreported non-business income, such as wages, tips, interest,
    dividends, and capital gains. The remaining $32 billion came from
    overstated reductions of income (i.e. statutory adjustments,
    deductions, and exemptions), and from overstated tax credits.
        The corresponding estimate of the self-employment tax
    underreporting gap is $39 billion, which accounts for about 11 percent
    of the overall tax gap. Self employment tax is underreported primarily
    because self-employment income is underreported for income tax
    purposes. Taking individual income tax and self employment tax
    together, then, we see that individual underreporting constitutes about
    two-thirds of the overall tax gap.
    Increasing Compliance through Service and Enforcement
        It is important to understand that the complexity of our current
    tax system is a significant reason for the tax gap. It is easy for even
    sophisticated taxpayers to make honest mistakes. We must achieve
    fundamental reform and simplification of the tax law in order to
    achieve significant reductions in the tax gap.
        Until we have fundamental tax reform, there are some changes in the
    law that will improve compliance and provide us with additional tools
    that we can use to go after those taxpayers unwilling to pay their fair
    share. Later in my testimony, I will discuss five specific legislative
    proposals that are offered as part of the FY 2007 budget and designed
    to reduce the tax gap.
        IRS is committed to assisting taxpayers in both understanding the
    tax law and remitting the proper amount of tax. We are continuing to do
    this by maintaining the balance between service and enforcement that is
    so critical to tax administration.
    Service
        I have already talked about IRS.gov and how it can answer many
    taxpayer questions on issues ranging from the Earned Income Tax Credit
    (EITC) to the Alternative Minimum Tax (AMT) to refund tracking. On a
    recent day, our site ranked third in overall hits according to Yahoo's
    Buzz Index. The American Customer Satisfaction Index has ranked our
    site well ahead of the government benchmark in the areas of content,
    functionality, navigation, privacy, satisfaction and in many other
    areas. Thus far this year, visits to our site are up 6.43 percent over
    the same period a year ago.
        This success has been recognized by others. In 2004, IRS.gov won
    the Keynote Performance Award as the most reliable Federal web site for
    performance and availability. It won the 2005 Government Computer News
    agency award for innovation and is a finalist for the 2005
    Excellence.gov Award in recognition of being an outstanding Federal
    interactive web site.
        We believe the internet has become our primary vehicle for
    delivering service information to taxpayers. Please note that I said
    primary and not exclusive. We recognize that we will likely always have
    a percentage of taxpayers that we need to serve through either direct
    personal service or over the telephone, but we hope to continually
    drive that number down, while at the same time improving the levels of
    service and taxpayer satisfaction. This will not only save us time and
    resources, but also will provide a valuable service to taxpayers. They
    can get answers to their questions at their home, at their convenience,
    rather than visiting a walk-in site.
        We continue to get good marks on various customer service surveys.
    Our toll free telephone service customer satisfaction rating is 94
    percent. In FY 2005, the IRS' customer assistance call centers answered
    59.1 million calls. We achieved an 82.6 percent toll-free-telephone CSR
    level of service, exceeding our FY 2005 target of 82 percent. We also
    improved our toll free tax law accuracy rate to 89 percent, an increase
    from 80 percent in FY 2004. While this is the highest yearly rate ever,
    we continue to strive to improve. This filing season through February,
    the tax law accuracy rate is 90.2 percent.
        We provided and staffed toll-free FEMA phone assistance lines for
    hurricane victims and answered approximately 950,000 calls. The IRS
    also implemented numerous tax law changes to help the victims of
    hurricanes Katrina, Rita and Wilma, businesses located in the disaster
    areas, and individuals donating to charities to support the victims.
        We continue to leverage community partnerships to provide free tax
    return preparation assistance through successful programs such as
    Volunteer Income Tax Assistance (VITA) and Tax Counseling for the
    Elderly (TCE). In 2005, 62,000 trained volunteers at 14,000 locations
    across the country prepared more than 2.1 million tax returns, an 80
    percent increase since 2001. We expect the number of customers served
    this year to exceed 2.2 million.
        I personally have had the opportunity to visit several VITA sites
    and I remain impressed by the diligence, the competence, and the
    commitment of the thousands of volunteers that make this program work.
        For small businesses, we simplified the employment tax filing
    process for more than 950,000 small companies by allowing them to file
    their employment tax return annually, rather than quarterly. Our office
    of Taxpayer Burden Reduction led a collaborative effort to redesign the
    Form 1041 Schedule K-1, which among other things, is used to report
    income, deductions, and credits from trusts and estates to
    beneficiaries.
        We are also making progress on our Taxpayer Assistance Blueprint
    (TAB). This is an ambitious, agency-wide, five-year taxpayer services
    plan aimed at improving IRS services.
        Over the past five years we have taken significant steps to
    understand the needs and preferences of individual taxpayers, our
    primary customers, and their representatives. Many studies, such as the
    Multilingual Initiative, the EITC outreach, and partnerships with
    organizations such as AARP and the National Community Tax Coalition
    have focused on understanding key demographic and behavioral
    differences in our customers. Before now, those initiatives have not
    been integrated to form a complete picture of customer needs.
        The TAB project will pull the pieces of the puzzle together and
    develop a complete picture of our customer base. Through a systematic
    data collection and analysis process, a dynamic plan (or Blueprint)
    will be developed to meet our short and long term business needs as it
    relates to taxpayer assistance and address concerns expressed by
    Congress and other oversight bodies.
        In short, TAB will help us better understand our customers--their
    characteristics, how they access our services, what services they use
    and prefer, and if our services truly meet their needs.
        We are nearing completion of the first phase of the TAB project. In
    Phase 1, we are conducting research and surveying taxpayers,
    stakeholders, and IRS employees to form a preliminary assessment of
    taxpayer needs, preferences, and demands. We will complete that phase
    by mid-April. In Phase 2, we will perform extensive primary research
    with taxpayers to refine our assessment and conclude by creating an IRS
    blueprint for taxpayer service delivery. We will complete this phase in
    October 2006.
    Enforcement
        The IRS made significant progress towards achieving its enforcement
    related goals in FY 2005. We achieved increases in every major area of
    enforcement. We have:

          Audited nearly 220,000 high income taxpayers in 2005,
    more than double the number audited in 2000.
          Increased audits for individuals to 1.2 million, 20
    percent more than 2004 and almost double the level five years earlier.
          Audited nearly 5,000 businesses with assets over $250
    million, an increase of 11 percent. In addition, we audited one out of
    every five companies with assets of $10 million. Finally, audits of
    businesses with less than $10 million in assets rose 145 percent from
    2004.
          Increased enforcement revenue from audits of corporations
    and individuals to $17.7 billion in 2005, compared to $10.7 billion in
    2003.
          Increased overall collections from heightened enforcement
    efforts by 10 percent, from $43.1 billion in 2004 to $47.3 billion in
    2005.
          Generated more than $4.7 billion in revenue through two
    prominent settlement initiatives aimed at reducing examination and
    litigation expenses while deterring the use of abusive tax shelters.
          Increased collection closure cases by 12 percent and
    dollars collected by 14 percent over 2004.
          Increased convictions to 2,151 (from 1,926 in 2002)
    through increased productivity.

        Combating abusive tax shelters remains a high priority in FY 2006.
    Last October we announced a global settlement initiative that covered
    21 listed and non-listed transactions. They include a wide range of
    transactions involving funds used for employee benefits, charitable
    remainder trusts, offsetting foreign currency contracts, debt
    straddles, lease strips, and certain abusive conservation easements.
        Taxpayers had until January 23,2006 to file an election to take
    part in the global settlement program. Under the terms of the
    settlement, taxpayers will generally be required to pay 100 percent of
    taxes owed, interest and, depending on the transaction, either a
    quarter or half the accuracy-related penalty the IRS will otherwise
    seek.
        We have been pleased by the response to this initiative, and we
    believe the response was buoyed by provisions in the Gulf Opportunity
    Zone Act of 2005 that modified the rules for calculating interest on
    tax deficiencies of individual taxpayers who participated in certain
    abusive tax shelters, increasing the incentives for individuals to come
    forward as part of this program.
        In addition, our Large and Mid-Sized Business Division (LMSB) has
    issued more than 500 administrative summonses as part of our attack on
    shelter promoters, and we have approximately 200 active promoter
    examinations under way. Entities being looked at include banks,
    accounting firms, law firms and brokerage houses. We want to make it
    clear that taxpayers who take aggressive return positions relying on
    the ``audit lottery'' and the chance they will not be examined have
    made a really bad decision.
        In addition, we are continuing to focus on improper uses of certain
    tax exempt bonds and trusts, questionable transfer-pricing practices,
    offshore accounts, and charitable donations of intangible assets.
        Another 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. The vast majority of practitioners
    are conscientious and honest, but even the honest tax professionals
    suffered from the sad and steep erosion of ethics in recent years by
    being subjected to untoward competitive pressures.
        We have done quite a bit 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. New Treasury Department regulations
    took effect last June that revise Circular 230 governing tax
    practitioner behavior. The new regulations establish standards for
    written tax advice prepared by practitioners.
        Further, additional revisions to Circular 230 were recently
    proposed to make disciplinary proceedings more transparent so that
    practitioners may learn the types of behavior IRS is likely to
    challenge under the Circular.
        The IRS has made noncompliance by tax exempt and governmental
    entities and misuse of the tax exempt status of such entities by third
    parties for tax avoidance purposes another major enforcement priority.
    For example, earlier this year, we concluded that more than 30 credit
    counseling firms, accounting for more than 40 percent of the industry's
    revenues, are not entitled to tax exempt status. The proposed
    revocations of the tax exempt status of these entities are the
    culmination of more than two years of work covering more than 60 credit
    counseling organizations.
        These organizations were granted tax exempt status originally
    because they were supposed to be educating and assisting people who
    have credit or cash flow problems. Unfortunately, too many of these
    organizations instead operate for the benefit of insiders or are
    improperly in league with profit making companies. We want to make sure
    that money donated to charities goes for the purpose intended and not
    into the pockets of individuals associated with the charitable
    organization.
        In 2006, our Tax Exempt/Government Entities (TE/GE) division will
    continue to focus on key areas where organizations are abusing their
    exempt status or where others are using them for unintended purposes.
    Three of the areas in which we anticipate renewed enforcement include
    political intervention, compensation and abusive transactions.
        Regarding political intervention by entities claiming tax exempt
    status, in 2006 we will be finishing up contacts with 130 organizations
    suspected of political intervention in the 2004 election. Almost half
    of these are churches. Thus far we have completed 82 examinations and
    have concluded that nearly three-quarters of the non-profits examined,
    including churches, engaged in some level of prohibited activity. Most
    of these exams concerned one-time, isolated occurrences of prohibited
    campaign activity, which the IRS addressed through written advisories
    to the organizations. In three cases involving non-churches, the
    prohibited activity was egregious enough to warrant the IRS proposing
    the revocation of the organization's tax-exempt status.
        We have also issued a fact sheet designed to offer guidance to non-
    profits on what is and is not permissible activity for tax-exempt
    organizations. In addition, we have taken steps to ensure that all
    referrals regarding campaign activity that the IRS receives from the
    public, as well as activity the IRS itself uncovers, are reviewed
    expeditiously, and treated consistently and fairly.
        Excessive compensation of executives also will be a main focus of
    our enforcement efforts. There are indications that tax-exempt
    organizations have allowed key executives too great a voice in
    determining their own compensation or otherwise have not used due
    diligence in setting compensation levels. We have contacted almost 2000
    Section 501(c)(3) organizations, including about 400 private
    foundations regarding this issue. In addition, we are exploring
    compensation to tax-exempt hospital executives.
        In the FY 2006 budget, our enforcement resources increased by $442
    million (post-rescission). I know it is important to you, and it is
    equally important to us, to show a return on that investment.
        Of the total $442 million in increased funding, $180 million funds
    the pay and non-pay inflationary costs to maintain the $6.4 billion
    devoted to enforcement. The remaining $262 million funds direct costs
    for enhanced enforcement hiring, including staff for the Counsel and
    Appeals organizations, and associated indirect costs for these hires.
    We will focus these resources on:

          Increased coverage of high-risk compliance problems to
    address the largest portion of the tax gap--the underreporting of tax--
    across all major compliance programs;
          Complex high-risk issues in abusive tax avoidance
    transactions, promoter activities, corporate fraud and aggressive
    transactions, resulting in increased corporate and high income audit
    coverage;
          Efforts aimed at reversing the erosion of individual tax
    compliance and support of the strategy to implement a balanced
    compliance program;
          Return preparer fraud identified through enhanced
    operations of the Fraud Detection Centers located on IRS campuses;
          Improved ability to identify compliance risks and
    significantly expanded coverage of tax-exempt communities;
          Safeguarding compliant customers from unscrupulous
    promoters through earlier detection of abusive schemes and heightened
    efforts to prevent their proliferation; and
          Increased vigilance to ensure the assets of tax-exempt
    organizations are put to their intended tax-preferred purpose and not
    misdirected to fund terrorism or for private gain, including enhanced
    processing of questionable exemption applications and increased
    technical support to the examination process.
    Legislative Proposals
        IRS understands that the complexity of the current tax system is a
    significant reason for the tax gap. It is easy for even sophisticated
    taxpayers to make honest mistakes. We must achieve fundamental reform
    and simplification of the tax law in order to achieve significant
    reductions in the tax gap.
        Until we have fundamental tax reform, however, there are some
    changes in the law that will improve compliance, without imposing a
    significant burden on taxpayers, and provide us with additional tools
    that we can use to go after those taxpayers unwilling to pay their fair
    share.
        The President's FY 2007 proposed budget includes five legislative
    recommendations, the enactment of which is critical to closing the tax
    gap. Collectively, these five changes should generate $3.6 billion over
    the next ten years. Allow me to address each proposal individually.
        The first and perhaps most important proposal would increase
    reporting on payment card transactions. Our tax gap study shows clearly
    that increased information reporting and backup withholding are highly
    effective means of improving compliance with tax laws. More than 150
    million wage earners already have their information reported directly
    by their employer to the IRS and the non-compliance rate for this group
    is less than 1 percent. All of these wage earners are also subject to
    mandatory withholding of taxes.
        Payment cards (including credit cards and debit cards) are a
    growing form of payment in retail business transactions. The failure of
    some merchants to accurately report their gross income, including
    income derived from payment card transactions, accounts for a
    significant portion of the tax gap and creates a significant
    competitive advantage for those businesses that underreport.
        Specifically, the Administration proposes that the Treasury
    Secretary be given the authority to promulgate regulations requiring
    annual reporting of the aggregate reimbursement payments made to
    merchants in a calendar year, and to require backup withholding by
    payment card companies in the event that a merchant payee fails to
    provide a valid taxpayer identification number.
        Because reimbursement information is already provided to merchants,
    requiring this information to be reported to the IRS on an aggregate
    annual basis will impose minimal burden on payment card companies and
    no burden on the affected merchants. In addition, implementing a backup
    withholding system for payment card reimbursements to businesses would
    lead to material improvements in the compliance rates of these
    taxpayers without imposing a significant burden on the card companies.
    Finally, the IRS will be able to use payment card reporting information
    to better focus its resources and relieve the burden that existing
    audits place on businesses that accurately report their gross income.
        The second legislative proposal would clarify when employee leasing
    companies can be held liable for their clients' Federal employment
    taxes. Employee leasing is the practice of contracting with an outside
    business to handle certain administrative, personnel, and payroll
    matters for a taxpayer's employees. Typically, these firms prepare and
    file employment tax returns for their clients using the leasing
    company's name and employer identification number, often taking the
    position that the leasing company is the statutory or common law
    employer of the clients' workers.
        Non-compliance with the Federal employment tax reporting and
    withholding requirements is a significant part of the tax gap. Under
    present law, there is uncertainty as to whether the employee leasing
    company or its client is liable for unpaid Federal employment taxes
    arising with respect to wages paid to the client's workers. Thus, when
    an employee leasing company files employment tax returns using its own
    name and employer identification number, but fails to pay some or all
    of the taxes due, or when no returns are filed with respect to the
    wages paid by a company that uses an employee leasing company, there
    can be uncertainty as to how the Federal employment taxes are assessed
    and collected.
        The Administration's proposal would set forth standards for holding
    employee leasing companies jointly and severally liable with their
    clients for Federal employment taxes. The proposal would also allow
    employee leasing companies to qualify to be solely liable if they met
    certain specified standards.
        Our third proposal would amend collection due process procedures
    for employment tax liabilities. Currently, we are authorized to take
    various collection actions including issuing Federal tax levies to
    collect past-due taxes. Before a tax levy can be issued, however, the
    IRS generally must provide the taxpayer with notice and an opportunity
    for an administrative collection due process (CDP) hearing, and for
    judicial review.
        Frequently, an employer who fails to satisfy its Federal tax
    liabilities for one period will also fail to satisfy them for later
    periods, resulting in a ``pyramiding'' of unpaid taxes. Some employers
    who request a CDP hearing or judicial review for one tax period will
    continue to accrue, or pyramid, their employment tax liabilities during
    the CDP proceedings. Liabilities for the subsequent periods cannot be
    collected by levy until the employer has been given notice and
    opportunity for a hearing and judicial review for each period. The
    existing CDP framework compounds the pyramiding problem by depriving
    the government of enforced collection as a tool to encourage employers
    to satisfy their current Federal employment tax obligations.
        Our proposal would allow the levy to be imposed prior to a CDP
    hearing in a fashion similar to current law provisions for levies
    issued to collect a federal tax liability from a state tax refund.
    Taxpayers would have the right to a CDP hearing with respect to
    employment tax liabilities within a reasonable time after the levy.
    Taxpayers would also continue to have access to existing pre-collection
    administrative appeal rights other than CDP.
        The fourth proposal would require increased information reporting
    and backup withholding for certain government payments for property and
    services. It should be noted that present law requires information
    reporting for the provision of services and direct sales, but does not
    for provisions of goods. This proposal will extend information
    reporting, with some exceptions, to the purchase of goods by federal,
    state, and local governments.
        Our proposal would authorize the Treasury Secretary to promulgate
    regulations requiring information reporting and backup withholding on
    non-wage payments by Federal, state and local governments to procure
    property and services. Certain payments would, of course, be exempt.
    These include payments of interest, payments for real property,
    payments to tax exempt entities or foreign governments,
    intergovernmental payments, and payments made pursuant to a classified
    or confidential contract.
        The final legislative proposal would expand the signature
    requirement and penalty provisions applicable to paid tax return
    preparers. Under current law a paid tax return preparer is required to
    sign and include his/her taxpayer identification number (TIN) on an
    income tax return and related documents that he/she prepares for
    compensation. Paid return preparers, however, are not required to sign
    and include their TINs on non-income tax returns, such as employment
    tax returns, excise tax returns, and estate and gift tax returns, and
    tax return related documents filed with the IRS. The Administration's
    proposal would expand preparer identification and penalty provisions to
    non-income tax returns and tax return-related documents prepared for
    compensation. Further, it would impose penalties for preparing tax
    return related documents that contain false, incomplete, or misleading
    information or certain frivolous positions that delay collection.
        These five legislative changes strategically target areas where (1)
    research reveals the existence of significant compliance problems, (2)
    improvements will burden taxpayers as little as possible, and (3) the
    changes support the Administration's broader focus on identifying
    legislative and administrative changes to reduce the tax gap.
        In addition to these specific legislative proposals, we will study
    the distinction between independent contractors and employees under
    current law. The improper classification of employees as independent
    contractors is a significant problem and substantial contributor to the
    tax gap.
    Conclusions
        Mr. Chairman, Members of the Subcommittee, I would like to
    emphasize the following points:

          E-Filing continues to grow. Over 50 million people have
    already e-filed their return, 67 percent of all returns filed.
          Taxpayers who are e-filing from their home computers show
    the greatest increase in e-filing, up almost 17 percent from a year
    ago.
          Hits to IRS' web site, IRS.gov are almost 90 million, up
    6.43 percent over last year.
          Returns filed by VITA and TCE sites are up 6.5 percent
    over a year ago.

        In addition, the best way to reduce the tax gap and continue the
    progress made last year in both service and enforcement is the adoption
    of the President's proposed budget for FY 2007, particularly the $137
    million for enforcement that is part of a program integrity cap
    adjustment, and enactment of the five legislative proposals.
        Thank you, Mr. Chairman and I will be happy to respond to any
    questions.

        Chairman RAMSTAD. Thank you very much, Commissioner. I
    certainly appreciate your testimony. I have a couple questions,
    and I can applaud the significant progress that you have made
    in a number of important areas that you highlighted today.
        I want to, as I said in my opening statement, ask a couple
    questions about the Free File agreement. I know in your written
    testimony you stated that the new Free File agreement is an
    improvement over the original agreement because the original
    agreement guaranteed coverage of only 60 percent of taxpayers.
    That is a direct quote. However, I am somewhat puzzled because
    with this new agreement we have the cap on the number of
    taxpayers that can be covered under Free File, and it seems to
    me, based on the statistics we have seen, that the effect of
    the cap is that more than 40 million Americans who could use
    Free File last year cannot do so this year. Isn't that a major
    concern?
        Mr. EVERSON. If you will indulge me, let me try to talk
    about this through the passage of time here, because as you
    indicate, we think this is a very important and good program.
    We had the initial three-year term, and that lapsed after last
    filing season, so then we have renegotiated with this new deal,
    as you indicated.
        I think that the overall tradeoff that was always in the
    spirit of the first negotiation was that the government would
    not get into the preparation of tax returns or providing
    software that is actually being provided by industry. That was
    sort of the quid pro quo, if you will, of the agreement.
        What happened here was that, I think as the volumes grew--
    and as you indicated, Mr. Chairman, they grew rapidly, and last
    year they exceeded 5 million, and there were no caps. Some of
    the players--I guess it was about 17 or 18 firms--they let it
    go all the way up. We were interested in a couple of things,
    and we wanted to make sure, as we renegotiated this, that we
    got as high a cap as possible on the income, because they
    indicated to us they wanted to put in a cap to keep it to
    middle-income and lower-income people. We were also interested
    in getting protection on Refund Anticipation Loans (RALs). The
    RALs--as you know, we do not favor RALs. We think that they are
    predatory and that they are bad for taxpayers. They are not a
    real big deal in connection with the Free File Alliance, but
    what we did do was we were anxious to get more protections in
    terms of clear, up-front indication, ``do you want to be given
    information or not on these kinds of products?`` So, that was a
    goal that we had.
        We were working in what I would call a difficult
    negotiation because the parties on the other side, they wanted
    to limit this as much as they could. Then you should know that
    both sides of this issue are present in Congress, and in a
    voice vote in the Senate appropriations process last fall, in
    October, an amendment was agreed to that said--and this was
    right in the last hours of negotiation--``The Internal Revenue
    Service shall provide taxpayers with free individual tax
    electronic preparation and filing services only through the
    Free File program, and the Internal Revenue Service's Taxpayer
    Assistance Center's tax counseling for the elderly, and VITA
    sites.'' The effect of that was to say all of our leverage,
    which was that the government 1 day might provide these
    services for free to taxpayers, was effectively removed. Now,
    thankfully, the House didn't follow that. It dropped out in the
    Conference Report.
        So, I think that we did our best to negotiate the best deal
    we could, but corporate interests intruded at a delicate moment
    in a negotiation, and limited what we got. We had a proposal on
    the table which would have increased that. Our threshold is
    about $50,000. That is a 70 percent level. We would have gotten
    a higher level we think had this maybe not have happened, but
    we got the protection on the RAL, so overall, I am disappointed
    that the volumes have gone down. There has been a lot less
    publicity on it. Last year, USA Today really trumped it up. I
    am hopeful that it will recover over the life of the program.
        Going to your point, should we renegotiate it? I want to
    get out of this year's filing season, see where we stand, also
    understand where the Congress is, because Senators Grassley and
    Baucus, in a hearing earlier this week, were talking about more
    like the government ought to get into this. On the other hand,
    I got a question last week from Members that were saying the
    Government should never get into this, so I am not quite sure
    where the Congress is on this issue, sir.
        Chairman RAMSTAD. I appreciate that explanation. I think
    there are some flaws or problems that you obviously have agreed
    to look at, some results that are hard to understand, quite
    frankly. I just don't understand why the IRS should prohibit
    companies willing to offer free services to all taxpayers from
    doing so on the IRS website. I know that one member of the
    Alliance, to be more specific, offers free Federal preparation
    software to all taxpayers on its own website and through
    advertisements on the Internet. The same company can offer free
    preparation software on the IRS website, as you know, only to
    taxpayers making less than $50,000. It just seems to me that
    the IRS shouldn't prohibit companies willing to offer free
    services to all taxpayers from doing so on the IRS website. I
    just don't understand that distinction.
        Mr. EVERSON. I haven't thought of that particular point,
    but I guess that I would express some concern about trumpeting
    any commercial product on our website, even if an element of it
    is being offered for free, because obviously, the private
    entity is doing that for ultimately some commercial benefit. It
    is part of their program to----
        Chairman RAMSTAD. Only to taxpayers with income under
    $50,000.
        Mr. EVERSON. Right.
        Chairman RAMSTAD. It seems to people what is good for the
    goose is good for the gander.
        Mr. EVERSON. Yes, I understand what you are saying, but I
    haven't thought----
        Chairman RAMSTAD. There is inconsistency, and I trust you
    will certainly look at that in terms of renegotiating.
        Mr. EVERSON. Yes.
        Chairman RAMSTAD. Of course, the bottom line here, if you
    look at the aggregate, as we talked about, use of Free File
    again, as the graph depicted, is down over 21 percent this
    year.
        Mr. EVERSON. Yes.
        Chairman RAMSTAD. Obviously, having a negative impact on
    electronic filing overall. It seems to me that can only be
    construed as a negative result of the agreement. Is it your
    plan or your desire to renegotiate the agreement?
        Mr. EVERSON. I haven't reached a conclusion on that at this
    stage. There are two factors. One, I want to see how we do
    through the whole filing season, and one of the things we were
    able to do here also is get a little more data. I think we will
    have better data on who participated in the Free File exercise
    through some of the stuff that was renegotiated. That is a good
    thing. We will know more. We will have to assess it, and then
    again, I do want to work with the Congress and understand,
    because I think there are two different views on this.
        Many people say the government shouldn't get into this.
    Others seem to be saying the government ought to provide the
    software. That gets to this issue too, sir.
        Chairman RAMSTAD. At the very least you are----
        Mr. EVERSON. We will sit back and----
        Chairman RAMSTAD. You will consider renegotiating.
        Mr. EVERSON. Of course. At the end of this filing season we
    will take a good hard look at what happened and why and talk
    with all the involved parties, yes, sir.
        Chairman RAMSTAD. I want to now defer to the ranking
    Member, to recognize the ranking Member. I assume that either
    the ranking Member or other colleagues will broach the new
    regulations relating to the handling of taxpayer information by
    tax return preparers.
        Mr. EVERSON. I hope not.
        Chairman RAMSTAD. There are some serious privacy concerns I
    know my friend from my Arizona has, and so I am going to now
    yield to the distinguished ranking Member, Mr. Lewis.
        Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
        Again, Mr. Commissioner, I thank you for being here this
    morning. I just want to ask one question. Have the tax laws
    become more complex or simpler during the past 10 years?
        Mr. EVERSON. Is this a trick question?
        [Laughter.]
        Mr. LEWIS OF GEORGIA. No, Mr. Commissioner. I would never
    attempt to trick you, Mr. Commissioner.
        Mr. EVERSON. No, of course, they get more complex all the
    time. I got this question yesterday at Small Business, and it
    is nothing new under this Congress or this administration, it
    is a steady march toward complexity that exists in our system.
    You look at something like the American Jobs Creation Act (JOBS
    Act) (P.L. 108-357), numerous provisions that we had to respond
    to extremely rapidly. One that is--like just the manufacturing,
    the benefit for manufacturing activities entails a lot of
    complexity in terms of regulation writing and everything else.
    So, absolutely, we are not doing tax compliance any favor here,
    sir, as we write more and more laws. I would say there are two
    reasons for that, one, the inherent complexity, and two,
    stability. Obviously, to the degree to which there is stability
    in a system, people or businesses can better understand over
    time what their obligations are.
        Mr. LEWIS OF GEORGIA. Thank you, sir.
        Thank you, Mr. Chairman.
        Chairman RAMSTAD. Thank you, Mr. Lewis.
        The distinguished gentleman from Florida, Mr. Shaw.
        Mr. SHAW. Thank you, Mr. Chairman.
        I would like to follow up on Congressman Lewis's question
    because I think it was at the tail end of your remarks where
    you talked about simplification. Would simplification promote
    compliance?
        Mr. EVERSON. I don't think there is any question to that,
    sir. I believe that complexity obscures understanding, and the
    people who want to be compliant have a harder time. Look at
    something as important as the Earned Income Tax Credit (EITC),
    where there is a lot of complexity about whether a child
    qualifies. There are something like seven different educational
    credits. It is a morass for people to try and understand that
    system, let alone when you get into the corporate area. So, the
    compliant taxpayer has difficulty. I would say the unscrupulous
    taxpayer takes advantage of the complexity, trying to tier
    transactions or make it harder for us to detect what the
    reality is. So, the good guys suffer and the government suffers
    as well, from a compliance point of view.
        I am not suggesting, again, that there aren't valid public
    policy reasons for what you do up here.
        Mr. SHAW. I think maybe we need some help there too, as to
    your last point. Where are some areas that you would look to
    for simplification? I know now that most of your tax preparers
    couldn't possibly file many of the returns that they have today
    without computers.
        Mr. EVERSON. Yes.
        Mr. SHAW. It used to be I would sit down at probably the
    dining room table or somewhere in the house, and go through it,
    usually on the morning of April 15, and pencil out my tax
    return, and then run to the post office by midnight. That is
    impossible now with the Alternative Minimum Tax (AMT) and all
    of these things, because if you try to do it by hand, you are
    probably going to end up with some errors in the return itself.
    Where are some areas that you would look to for simplification?
    Where should this Committee go to search out areas of
    simplification? I would like for you to include in your answer
    your thoughts with regard to the AMT.
        Mr. EVERSON. That was where I was going to start, because
    this whole concept of going through a return, and then getting
    to the end, and then we sort of pull the rug out from
    underneath the taxpayer, ``Aha, that's not your real tax. It's
    over here on a separate schedule.'' That is hard to understand.
    It undoubtedly makes people mad, and in the end, they may throw
    up their hands and say, ``Geez, why bother with all this?``
        So, I think the AMT, whatever you think about it from a
    policy point of view, it hurts compliance because of that
    dynamic that I just talked about.
        Mr. SHAW. I wish we could score it that way.
        Mr. EVERSON. Yes, I don't know if you can. I would get rid
    of that, obviously, and then I would focus on these credits
    that I have mentioned, the multitude of credits is one area
    that is problematical. I think that the incredible complexity
    on the corporate side of the ledger is also an area that is
    damaging or corrosive to the system, if you will.
        Mr. SHAW. Mr. Chairman, I would say here there is a fertile
    ground for you to spend the next couple of years in going
    through the tax code and looking over where we might do better
    and where we might be able to solve some of these problems to
    report back to the full Committee.
        Thank you, sir, Commissioner, appreciate your being here.
        Thank you, Mr. Chairman. I yield back.
        Chairman RAMSTAD. Thank you, Mr. Shaw.
        The distinguished gentleman from North Dakota, Mr. Pomeroy.
        Mr. POMEROY. So, much to ask, so little time. Mr. Chairman,
    we may need another panel round, if that would be all right.
        Mr. Chairman, you were following a particularly interesting
    line of discussion relative to the $50,000 limit. I think we
    will start right there.
        Commissioner, I like you. I think that from a management
    perspective you have done a terrific job, and yet there are
    some things about the IRS that just make me shake my head. You
    are telling me that because one appropriations Members of
    Congress wrote a letter to you during negotiations with this
    Free File Alliance, you felt--of course, the appropriations
    Member writing basically the talking points of a couple of
    stakeholders that very much wanted to have the Free File limit,
    not for all taxpayers but limited to the $50,000 level, that
    based on that single letter from one Member of the
    Appropriations Committee----
        Mr. EVERSON. No, sir.
        Mr. POMEROY. You felt like----
        Mr. EVERSON. No, no. Perhaps I wasn't clear. What happened
    was, when we were in the final days of negotiation, in a voice
    vote on an appropriations bill, the Senate passed the language
    that I read. The Senate passed it, and it was part of the
    massive--it didn't go through the authorizing Committees. This
    is a fundamental change to our tax administration system that
    bypassed any discussion with either Finance or Ways and Means.
        Mr. POMEROY. It wasn't adopted by the House.
        Mr. EVERSON. In the end it was not adopted by the House. It
    came out in the conference. It was not a letter, a single
    letter, no, sir.
        Mr. POMEROY. A voice vote in the Senate Approps that in the
    end didn't----
        Mr. EVERSON. A voice vote when the Appropriations bill was
    on the floor, yes, sir.
        Mr. POMEROY. So, the Senate has their version, the House
    has their version. They are reconciled in Conference Committee.
    This was not one of those items that was specifically in the
    legislation coming out of----
        Mr. EVERSON. In the end, we were in the latter days of the
    negotiation last fall, and there was the Senate language that
    came out of the Appropriations Committee, and then when that
    came to the floor, that amendment that I read to you was added
    to that. So, it was in the pending legislation on the Senate
    side.
        Now, I learned, to my peril, last year, that things that I
    was told would come out of conference, in conference, and then
    didn't, particularly on the Senate side and some of the
    language that we are living with now, that I had better take
    pretty seriously anything that is in a bill on either side of
    the appropriations process.
        Mr. POMEROY. I will tell you something, I think that your
    principal responsibility is to the taxpayers of this Nation,
    and if you come into your job wondering what kind of mood is
    Congress in today, you are going to have a miserable, miserable
    job. I think you need to administer the tax laws of this
    country in a way that benefits the taxpayers, and if Congress
    legislates something, you follow it, but you don't have old
    Floyd watching legislative debate with Senator Hucklestuffel
    said this and such. Forget that. So to suggest to us that this
    kind of intramural discussion ought to force the Agency to
    knuckle under to this collusive, rotten limit advanced by the
    Alliance, is ridiculous.
        Mr. EVERSON. I am talking about at the margin, sir. We are
    talking about a couple percentage points in terms of
    eligibility. We got to 70 percent, so we protected the middle
    income and the lower income people, and we had----
        Mr. POMEROY. Wait a minute. The $50,000 cap protects middle
    income people? We have just now defined middle income as
    $50,000 as below?
        Mr. EVERSON. I think it covers 70 percent of the taxpayers,
    so----
        Mr. POMEROY. I represent a lot of folks, North Dakota is
    not a high income State.
        Mr. EVERSON. I understand.
        Mr. POMEROY. There are a lot of people who are making
    $55,000 in joint income today who would be really thrilled to
    know they have just been promoted to the upper class. That is,
    in my opinion, completely insufficient. It shows to me--and I
    am going to pursue this in future panels--that there is way too
    much influence by this--basically, the Alliance, they are
    supposed to be helping this effort. We are not supposed to be
    running this effort for the benefit of the Alliance, and I kind
    of think things got a little askew here, and I think the
    $50,000 cap--as long as you are so attentive to legislative
    intent, let me tell you, this legislator thinks a $50,000 cap
    is absurd.
        Mr. EVERSON. Okay. I understand your view. I wanted to see
    higher. There is only so much we can do to impose an agreement
    between two parties that is being freely negotiated, but I
    appreciate your interest and the espousal of that side, because
    that side was silent at that point in time in the Congressional
    debate.
        Mr. POMEROY. Sorry to hear that.
        Chairman RAMSTAD. Thank you, Mr. Pomeroy.
        The distinguished gentleman from Georgia, Mr. Linder.
        Mr. LINDER. Thank you, Mr. Chairman.
        Good morning.
        Mr. EVERSON. Morning.
        Mr. LINDER. Nice to have you here.
        How much do you charge e-filers for filing electronically?
        Mr. EVERSON. We don't make a charge.
        Mr. LINDER. Who does make the charge? Because people have
    been telling me that it cost them $30 to file electronically.
    Would that be the tax preparer?
        Mr. EVERSON. That would be the entity that is processing
    them.
        Mr. LINDER. Why do you want to have the gross receipts from
    credit cards information?
        Mr. EVERSON. If you will indulge me, I have a couple of
    charts that I will show you on this. If you look at the tax
    gap--let's go to the overall tax gap map. It is kind of hard to
    see here, but the total tax gap of $345 billion, over 80
    percent of that comes from under reporting. That is this center
    area. The biggest piece of the under reporting is off that blue
    column down on the left, which is individual under reporting,
    which is about $200 billion.
        If you go to the next chart, this chart shows you, sir,
    that the noncompliance rate on wages where there is third-party
    reporting and withholding is only 1 percent. 150 million
    Americans are used to getting 235 million W-2s each year. We
    get that information. People report accurately.
        If you go all the way to the right here, so there is only
    about $10 or $11 billion in that tax gap is in that area, where
    you get third-party reporting withholding.
        Mr. LINDER. I am sure you are going to come to the credit
    card issue pretty soon.
        Mr. EVERSON. Yes. When you come all the way to the right
    here where you get no reporting at all, the noncompliance rate
    is more like 50 percent. This is particularly relating to
    Schedule C income--and this is important because over the
    years, since 1978, the percentage of people filing Schedule C
    returns, saying they have a business, has increased by 175
    percent, instead of the normal--that is the red line there. The
    normal filer, that has just gone up by 50 percent. That is
    where we have no income verification.
        So, what we wanted to craft--and I got some tough questions
    from Chairman Manzullo yesterday on this because it affects the
    small businesses--we wanted to craft the least burdensome way
    to making sure we got the information on the revenues. We feel
    by having the credit card issuers report to us once a year the
    gross receipts, we will get that information, but without the
    small businesses themselves having to do more reporting.
        Mr. LINDER. Is your under reporting including what you
    think is in the underground economy that doesn't report at all?
        Mr. EVERSON. In this proposal it wouldn't get to that
    because we are talking only about the credit cards, and when
    you are talking about strictly the cash, obviously, that would
    fall outside of that. That is an even more difficult element.
        Mr. LINDER. That is 2 to 3 trillion dollars a year.
        Mr. EVERSON. 2 or 3 trillion, you are saying?
        Mr. LINDER. Yes.
        Mr. EVERSON. I don't have an exact number on that.
        Mr. LINDER. Your under reporting doesn't even consider an
    estimate of the underground economy?
        Mr. EVERSON. We don't have--we have not captured in this
    $345 billion all of the underground economy, no, sir.
        Mr. LINDER. How much do you think is in the offshore
    financial centers in dollar denominated deposits?
        Mr. EVERSON. I don't have an exact answer. You are saying
    how much cash is sitting offshore? I don't have an answer for
    that. We have been pretty clear that we are very concerned
    about, in the corporate domain in particular, about the
    increasing difficulty of understanding the international
    transactions and the complexity entailing from globalization.
        Mr. LINDER. Would you believe $10 trillion?
        Mr. EVERSON. That is entirely possible. We have, as you
    know, the big trade deficits that are generating hundreds of
    billions of dollars each year, so, yes.
        Mr. LINDER. What percentage of the revenues you receive
    from income comes from corporations?
        Mr. EVERSON. From corporations, it is down--I don't have
    the exact number with me--but I think it is about 15, 16
    percent or something like that.
        Mr. LINDER. About 11.
        Mr. EVERSON. 11 percent.
        Mr. LINDER. 11. What do you think it was in 1950?
        Mr. EVERSON. It was much higher. I know it was 20 or 30
    percent, something like that.
        Mr. LINDER. 23. Is that because they are getting better at
    it or because it is too complex?
        Mr. EVERSON. I think that those are a variety of policy
    choices that the Congress has taken in terms of what it has
    done, and it also changes the economic activity. If you go back
    to that map that I showed you a minute ago, we have estimated
    the corporate tax gap for the larger corporations at $25
    billion. I believe that is probably understated. We did not
    update the research on that. It may be understated by half, but
    it doesn't change the way I would propose allocating our
    resources.
        If you look at the coverage rates we do, sir, we are
    already auditing each year the biggest companies, 44 percent of
    those businesses each year. So, the hard thing here, I would
    say, if I could be clear, the hard thing here goes back to this
    question of simplification. It is the structure of
    international transactions, the complexity of the Code. It
    would be a lot easier for us to get after more of the corporate
    money if we had some help on simplification.
        Mr. LINDER. Do you actually believe corporations pay taxes?
        Mr. EVERSON. Well, they pay----
        Mr. LINDER. They collect them.
        Mr. EVERSON. If you are asking me to defend corporate
    practices, I have spoken to this, and I have said that there
    are two different incentives. There is an incentive to increase
    book earnings that is taking place for the public companies,
    and to decrease taxable earnings and maximize cash. I am very
    concerned about that, and that dynamic. They have extremely
    good help in the sense of very talented attorneys and
    accountants.
        Mr. LINDER. They all used to work here.
        Mr. EVERSON. Yes, and who operate on a global basis. We do
    not operate on a global basis. We have worked to sort of
    increase our relationships with Inland Revenue, and everybody
    else, and we have projects where we now have an entity--be
    happy to have you come down and visit it--the Joint
    International Tax Shelter Information Center, with the United
    Kingdom, Canada, Australia, where we are sharing case
    information with each of those countries so that we can do
    better, because one thing I am very concerned about is tax
    arbitrage, not strictly illegal, but you need to look at this
    because increasingly a business will structure a transaction so
    it comports with one set of laws on one side, and got no tax on
    our side, and then you got no tax on the United Kingdom side
    either, because it is debt here or equity there. It is an area
    we need to look at.
        Mr. LINDER. Thank you, Mr. Chairman.
        Chairman RAMSTAD. Thank you, Mr. Linder.
        The distinguished gentleman from Arizona, Mr. Hayworth.
        Mr. HAYWORTH. Let me thank the distinguished Chairman for
    the recognition, and we thank our very distinguished guest.
    Commissioner, thank you for coming back by, and we appreciate
    the time you spend in front of these Committees.
        As you might expect, given the nature of our constitutional
    office, we spend a lot of time talking to constituents. So it
    was when all of us were home recently, we read with great
    interest of proposed new regulations from the IRS relating to
    the handling of taxpayer information by tax return preparers.
    Commissioner, I must tell you, at the various townhalls that I
    conducted across the width and breadth of the Fifth
    Congressional District of Arizona, there was genuine concern
    about privacy protection.
        One of the proposed regulations would allow preparers to
    use taxpayer information to solicit taxpayers for financial
    services offered by unrelated third parties. I will tell you
    that I am hearing from my constituents, and they are not vague
    on this at all. They are very concerned at what seems to be an
    unnecessary and unwise expansion for current rules and
    regulations. Can you tell me why you think this change is
    important?
        Mr. EVERSON. Absolutely. It comes back to some of the
    remarks that the Chairman made in the opening statement. This
    area, the regulations in this area have been in effect since
    1974. Under the law, a taxpayer could always have that
    information shared with others if there was consent by the
    taxpayer. We felt that--what had happened was there had been a
    change over the years, these standards were too general. They
    didn't recognize what had evolved with the Internet,
    outsourcing the preparation of hundreds of thousands of returns
    in India and places like that. There was a lot of concern that
    came from this body, in part, the outsourcing of the returns.
        As we look at this, we said, ``Geez, we need to tighten up
    in this area.'' We think we have tightened up in this area.
    What our proposal seeks to do is to make some pretty clear
    standards and improve the consent process, if you will. It even
    goes so far as to have a type size that has to be there so that
    it is not in some little paragraph at the end of something you
    are signing when you are under pressure to get a return
    finished.
        As I look at this--and there have been a lot of comments on
    both sides of this--I think that we are tightening this up. I
    think this is a classic kind of Washington story, where the
    purest in the consumer protection group who would have no
    information shared, they have been vocal and they have caused
    the concerns--given light to the concerns that you are hearing
    about, but the folks who really oppose this regulation the
    most, which are the corporate interests, they have been silent,
    relatively silent. They are writing to us and commenting
    officially, but they have been silent in the public space
    because they would like the proposal to die.
        The comments I have gotten from corporations, I will read
    you one from a letter from a lawyer. ``It requires a nearly
    impenetrable morass of language to see anything.''
        If we stand down on this, this would basically be the H&R
    Block Relief Act, because right now, the big players, they can
    sit down with you when you are getting your return prepared and
    they say, ``Geez, you ought to be in an Individual Retirement
    Account (IRA). We can put you in an IRA.'' Yet your fellow back
    in Arizona, who has a little three-man operation, who
    understands your situation, he cannot say, ``Geez, First Bank
    and Trust down the street has got a product that would save you
    money here.'' What we are trying to do is level the
    playingfield so that you, as the taxpayer, knowingly consent if
    you want to use your information for anything other than just
    filing your return. That is what we are trying to do here.
        Let me make one final point if I could. I know I have gone
    on. There is talk, as the Chairman said, about changing the
    statute. What I would point out here is, the basic question is,
    whose information is this? I do think that the civil
    libertarians, some of whom are talking about this, I think they
    would jump down my throat if I said that you as a citizen
    couldn't make a decision to share something with Jim Ramstad as
    a citizen. All we are trying to do here is make sure that if
    that happens, that there are clear rules of the road and that
    it is done knowingly. That is what we are trying to do, sir.
        Mr. HAYWORTH. Mr. Chairman, I would ask your indulgence. I
    see the time has expired, but I just feel it is important to
    pursue this line of questioning.
        Chairman RAMSTAD. Proceed.
        Mr. HAYWORTH. You offered the hypothetical of the small
    operations and the financial services offered down the block.
    It has been my experience, and I think the experience of
    virtually every taxpaying American, that there is already a
    deluge of investment and financial opportunities marketed to
    consumers, and I just wonder how you really believe this helps
    consumers. Now, you have talked about some of the dynamics
    within the tax preparation field, but how does it benefit
    consumers to set up this pipeline, because even in your answer
    you acknowledge that for so many people who go to different
    preparers, let's say, on the morning of the 15th, trying to get
    things postmarked by midnight, ``Yes, sure, let me sign, let me
    sign, let me sign.'' Caveat emptor, of course, is a doctrine
    that has served us well. I suppose it is caveat taxpayer, but
    even with the type change, what is the benefit to consumers to
    see this information shared for yet more financial information
    showing up at their doorstep?
        Mr. EVERSON. I think there is a benefit in some instances.
    Obviously, you do have to weigh--and the Congress can weigh, as
    the Chairman indicated, a change in the statute to say that you
    want to draw a hard wall on this. You can weigh those two
    competing interests, because, obviously, privacy--we are very
    concerned about privacy of information. I have been doing some
    TV work on phishing. We are getting increasing phishing
    exercised. You know what that is, when somebody does a scam to
    try and get information. It is a big issue.
        What we were trying to do here is work with the current law
    in the context of all the changes that have taken place. We
    just had a hearing on this this week, where we get people to
    come in. We are going to digest all the comments, and we may
    make some refinements in this, but we welcome a dialog with the
    Congress, because you are right, there is a case to be made to
    say, ``No, you can't do this if you are a tax preparer.'' That
    case can be made, I agree with you. However, there are other
    benefits that can occur, because some people do, sir, turn to
    their tax advisor as their real trusted financial advisor. They
    may not have a broker or something like that.
        Mr. HAYWORTH. I will just finish up. I thank you for being
    indulgent with the time.
        Commissioner, it also seems that advice is one area, but
    solicitation is something all together different.
        Mr. EVERSON. I agree with that.
        Mr. HAYWORTH. Given our constitutional charge, Mr.
    Chairman, I have prepared information. Let me be fair about
    this. I think, for example, one of the proposed regulations
    that says that a taxpayer would be provided with information if
    his or her return was outsourced overseas, I welcome that.
    However, Mr. Chairman, it is incumbent upon us in the Congress
    to make sure that this wall of privacy exists, and I have
    prepared legislation to that effect for us to fulfill our
    constitutional obligations, mindful and thankful, as we always
    are, for our friends in the IRS handling things from the
    administrative angle. It is important for constitutional
    officers to weigh in on behalf of the people to make sure that
    the wall of privacy exists, as the Commissioner pointed out,
    for phishing, ``ph'' phishing, if you will, on the Internet
    with e-mail and a variety of other concerns. So I welcome the
    Commissioner's response and look forward to working with the
    Chairman on legislation.
        Mr. EVERSON. If I could, Mr. Chairman, I think that is a
    very fair characterization. This is worthy of a public debate,
    I would suggest, sir.
        Chairman RAMSTAD. The Chair thanks the gentleman from
    Arizona for his questioning.
        Commissioner, each of the five Members presently on the
    dais, has at least one more question that they would like to
    ask. Does your schedule so permit?
        Mr. EVERSON. I am okay until I think about 11:30 or so.
        Chairman RAMSTAD. We will try to be as concise as possible,
    and we will certainly have you out of here at 11:30, at which
    time we are also expecting a round of votes, so that will
    coincide with the vote schedule.
        Let me just ask you one question. I want to broach a
    subject that has not been talked about today, and that is the
    authorization that Congress gave Treasury to enter into private
    debt collection of delinquent taxes owed the Federal
    government, with the obvious purpose being to shrink an
    incredible inventory of potentially uncollectible Federal tax
    debt.
        A number of us were strong supporters of my predecessor's
    bill, former Chairman Amo Houghton, who authored the bill to
    provide for private debt collection, because we believe that
    this authority given the Treasury Department, the IRS, has a
    potential to raise literally hundreds of millions of dollars
    for the Federal government. These are for delinquent taxes that
    aren't being paid and aren't going to be paid for the most
    part.
        You recently said it would cost more to hire private debt
    collectors than to hire additional IRS employees to do the same
    work. I am not sure I understand that because we went through
    that, if you look at the legislative history, and given the
    various percentages charged by the debt collectors, it seems to
    me not entirely accurate to make that claim. Maybe you could
    explain. Maybe it is taken out of context.
        Mr. EVERSON. I think what I have said is I do believe that
    if we had infinite resources at the IRS, we could do this work
    as cheaply or more cheaply than the private sector. As you
    know, we do the President's Competitive Sourcing Initiative and
    we look at different things all the time, different projects,
    and more often than not, the government wins because it doesn't
    have to make a profit. So, I believe you could do this more
    cheaply internally.
        The reason I support this is because we have limited
    resources, as we have all indicated, in terms of appropriated
    funds. This extends our reach on a segment of the debt that we
    want to get after. We are working to provide all the
    appropriate privacy protections on this. We have just awarded
    contracts in the first tranche to three. There has been a
    protest that has been lodged. That runs for 100 days, so that
    will run till the end of June with GAO, and we are hopeful that
    will be resolved, and then we will get after this, and that it
    will prove successful.
        I didn't mean to imply that this is a bad deal for the
    Government. It is not a bad deal. Mr. Rothman, in
    Appropriations, was trying to get me to say I was wasteful. I
    don't believe this is wasteful. I think this is an intelligent
    thing that we have done, and we will do a good job of it.
        Chairman RAMSTAD. I certainly appreciate that
    clarification, and that is what I assumed you would say, and
    that has been your position certainly, because given the
    limited resources with which you are operating, it seems to me
    that without private debt collection, this debt is sure to go
    uncollected. So, I appreciate it.
        So, when then, given the 100-day period you mentioned
    pursuant to the protest, when can we expect that private debt
    collection firms will begin collecting taxes owed the Federal
    government?
        Mr. EVERSON. Later this fiscal year is our hope that we
    will finally get after it. We are ready to go. We are taking
    some steps that we can do now in terms of some background
    checks and some of the potential individuals who will be doing
    the work. We have worked very carefully to develop models for
    the training, and again, I want to reassure the Committee
    that--it goes back to this privacy issue--we are very sensitive
    to that and the private debt collectors, and they are already
    being used in the vast majority of States, and they are being
    used by the Federal Government for education loans and things
    like that. We are going to make sure that the standards are
    pretty rigorously enforced.
        Chairman RAMSTAD. As you alluded, a number of critics of
    this authority are still raising concerns about the private
    debt collection program, and maybe you could just outline very
    briefly the safeguards that the IRS has instituted, the
    safeguards which you alluded to to protect taxpayer privacy and
    taxpayer rights.
        Mr. EVERSON. I think it really comes down to two areas. It
    comes down to within a parameter that they have to have the
    same standards that we do in terms of they can't share
    information. It comes down to training, and we have been
    working on developing good training models on this, and then it
    will have very rigorous contract performance monitoring where
    our people are in and able to monitor what is happening.
        Obviously, particularly, as we ramp this up, I am acutely
    aware, sir, that as we ramp this up, we are only going to get
    one swing at bat on this and we have to do it right. I meet
    monthly with our team that includes training people, technical
    people on the use of the systems because one of the issues here
    is we have to make sure that the people who are making the
    calls have the same data. If we are talking to Mr. Pomeroy and
    he has sent a payment in 3 weeks ago, but the private
    contractor doesn't have that reflected, that is not going to be
    good. So, there is a system element here too.
        Chairman RAMSTAD. I don't think you will get any
    disagreement from this panel that it has to be done right, that
    there is only one, as you put it, crack at the bat. I think
    those parameters you spelled out will result in getting it
    right, in administering this in a fair manner, one that
    protects taxpayer rights, taxpayer privacy, and one, at the
    same time, an effort that at the same time will yield good
    results for the Federal Treasury.
        Mr. EVERSON. Yes. If I can make one final point on this. I
    know that Mr. George, who is the Inspector General--you will be
    hearing from him later--he has made this one of his personal
    areas of concern, so we are going to get--as has the Taxpayer
    Advocate--we are going to get a lot of help, sort of if anybody
    sees anything going awry here, very quickly we will see it and
    respond.
        Chairman RAMSTAD. Thank you again, Commissioner.
        The Chair now recognizes the distinguished gentleman from
    North Dakota, Mr. Pomeroy, for a second question.
        Mr. POMEROY. Thank you.
        I have three quick items. First one, you and I have talked
    about the tax treatment of conservation reserve payment for
    retired farmers.
        Mr. EVERSON. Yes.
        Mr. POMEROY. The self-employment applied, the question that
    exists on that.
        Mr. EVERSON. Yes.
        Mr. POMEROY. We had worked to get this as a work item to
    get resolution from the Service. Where is that?
        Mr. EVERSON. It has been in the guidance plan, I guess,
    this year. It was in last year. I think it got squeezed out
    because of that JOBS Act and all the things that happened
    there, but I checked on this, having been reliably informed you
    might ask about it. Our guidance here ends June 30th. I am
    confident we are going to get this resolved. Now, I am not sure
    you are going to get the answer that necessarily some of your
    folks would be interested in, but I think we will get this done
    by June 30th with the guidance plan.
        Mr. POMEROY. Well, you are going to have favorable
    resolution.
        Mr. EVERSON. I know, I know.
        Mr. POMEROY. The next issue. You never see the day where
    you have in the U.S. Post Office, a little private vendor in
    the corner, ``Get your payday loan here.'' You just never have
    that. The Federal Government is not going to sponsor what I
    believe is private enterprise engaged in such shoddy, predatory
    lending with usurious rates charged by those that might
    participate.
        Yet the Consumer Law Center and the Consumer Federation of
    America tell us that the effective annualized rate of an RAL,
    based on a 10-day loan period, and then annualized--or an
    average refund size of $2,150. An annualized rate for that loan
    is 178 percent, and that loan gets even worse if the refund--if
    someone's taking out an anticipation loan on a smaller refund.
        Mr. EVERSON. Right.
        Mr. POMEROY. I am anxious about minimum standards that
    these Free File partners of ours need to have. In my opinion,
    when we refer taxpayers to them from the IRS website for Free
    File, and then they are just free to market this stuff that
    does not involve sufficient minimum quality standards, I
    believe, I think it is very much like the payday loan guy
    sitting in the corner of a post office. So, I have encouraged
    you in the past to look at minimum quality, minimum standards
    for the products that our Free File Alliance partners might be
    selling, so that it is appropriate. Has that gone forward?
        Mr. EVERSON. Let me make a general comment. First of all, I
    don't like these RALs. I particularly don't like the fact that
    some of the preparers keep an interest in the paper. I think
    the banks want that because they feel that they get a more
    reliable indication that the loan will be repaid. Yet I am
    concerned about the inherent conflict there. It gets back to
    sort of this privacy issue, and what are we allowing preparers
    to do.
        Mr. POMEROY. Right.
        Mr. EVERSON. Your concern is one that we had that we
    addressed in this negotiation that the Chairman was talking
    about earlier and that you were mentioning. In actual fact, my
    understanding, sir, is that the percentage of Free File
    participants who actually get the RALs is de minimis. It is
    less than 1 percent, in contrast to a much higher number for
    folks who walk into a preparer and someone says, ``By the way,
    do you want your money this afternoon?``
        Mr. POMEROY. Yes, but we don't sponsor those.
        Mr. EVERSON. So, what we did though was we put in some
    additional standards, and I think to be very clear, up front,
    when you come on, do you want to be solicited or not for this
    kind of a product? That's the change we put in to be absolutely
    clear that you do, if you want to go down that road. Then if
    you say no, I believe you cannot then--there is no other pop-up
    that takes place.
        Mr. POMEROY. Right. I do encourage--I think the Service has
    a continuing obligation to make sure our private partners are
    only offering acceptable quality products to the taxpayers.
        The final issue really relates to something that
    Congressman Hayworth was asking about, privacy, and privacy in
    the context of this taxpayer information. Congress is embroiled
    in an immigration debate, and I am wondering if the Service is
    involved in discussions with any segment of Congress or the
    Treasury Department regarding use of taxpayer data for
    immigration enforcement? I would be terribly alarmed if there
    were discussions along that line proceeding.
        Mr. EVERSON. Mr. Pomeroy, I think this did come up, and
    there was a hearing in this room some 4 or 6 weeks ago that
    involved the U.S. Department Homeland Security (DHS) and Social
    Security, and myself. It was part of the Subcommittee on Social
    Security, and some of the Members here, Mr. Hayworth in
    particular, were present.
        What I have said on this issue is that I do not oppose the
    sharing of that information. I understand the great stakes that
    our Nation has in having a strong immigration, an effective
    immigration system.
        What I have said, however, is that against that public
    good--and there is no doubt if DHS had the information, they
    would be better able to enforce workplace rules. We must
    understand, though, that a price will be paid in our tax
    administration system if we go down that path, because right
    now my job is to make sure we get our share of the money
    whether you are working----
        Mr. POMEROY. Not to recount. I think your view is very
    interesting. I am cognizant of my time being up. I just want to
    know, so we know the state of play here, are discussions
    proceeding regarding the use of taxpayer data?
        Mr. EVERSON. That is in the administration proposal. That
    is in the administrative proposal that is being discussed on
    the Senate side, is my understanding. One of the principal
    areas is that, yes, you are strengthening the--stopping
    employers from hiring people, and if there is a no-match here,
    yes, they want that information, they do, sir.
        Mr. POMEROY. So, we are going to use taxpayer data for
    immigration enforcement, under discussion.
        Mr. EVERSON. That is under discussion, and I have given the
    caveat that from my point of view, this would hurt tax
    administration, but I am saying if we do effective immigration
    reform. I am a former Immigration and Naturalization Services
    (INS) deputy, as you may recall. That is a big problem. We have
    to fix that.
        Mr. POMEROY. Thank you.
        Chairman RAMSTAD. The Chair recognizes Mr. Shaw.
        Mr. SHAW. Thank you, Mr. Chairman. I would like to proceed
    with the sharing of data problem, but going off in a different
    direction. You could, in my opinion--and correct me if my
    opinion is all wrong--if we were to simply provide that the
    EITC is paid on Social Security wages, and then you were to get
    information from Social Security as to whose account has gotten
    credit for Social Security and how much that is, wouldn't that
    almost eliminate any need to audit the EITC? I noticed on the
    figures that you had up a while ago it is like 2.39 percent of
    your effort is toward that.
        Mr. EVERSON. Right.
        Mr. SHAW. I would think that when you start auditing that,
    you are really talking to a lot of people who have no records
    or anything else, which probably makes it very difficult and
    probably you are spinning your wheels a lot.
        Mr. EVERSON. I think part of this may be income issues, but
    it is also who qualifies or not, and there is a lot of
    complexity as indicated before on the qualifying child and
    other issues like that. Let me try and frame this issue for
    you, sir. The EITC, we dispense about $40 billion a year to 22
    million claimants. The cost that we have to run that program,
    which is a back end program--it is the largest means tested
    benefit program--is about $165 million. It has a very high
    error rate, which has been a concern. In contrast, if you look
    at food stamps, which has, instead of a 25 or 30 percent error
    rate, a 6 percent error rate, they dispense $30 billion a year,
    but they have a $3 billion administrative budget that is paid
    for or used by the States.
        So, what we have here is an honors system. You claim the
    credit, and at the back end the IRS looks at it, which is
    totally different than any other benefits program where there
    is an up-front verification process. That is why the audit rate
    is a little bit higher than for some other areas.
        Mr. SHAW. I think up to a certain level, the more income
    you produce or show, the better deal you get on the EITC. As I
    view the IRS, you are not really geared up to catching people
    for over reporting income, you are geared to catching them for
    under reporting income. So, it would appear to me that if we
    were to simply say that the EITC is to be based upon Social
    Security--we can talk about dependents and all of that stuff
    too--but Social Security wages, and then you had a direct link
    to what has been paid in, so that if somebody is trying to
    claim the EITC on wages that they didn't pay that Social
    Security was not paid on, but that wouldn't qualify. It would
    seem that that would simplify your system and make it very easy
    to back away from even having to do any audits in that regard.
        Mr. EVERSON. It is an interesting idea on the revenue side.
    As you indicate, you are absolutely right, there is a sweet
    spot at something like $14,000 or $15,000 dollars where the
    credit maxes out and then starts to come down until--I think it
    drops off entirely in the mid 30s.
        Mr. SHAW. This would also I think--and of course, another
    hot-button subject, which Mr. Pomeroy was talking about, is
    what about the wages paid of Social Security wages or wages
    that are paid where there is withholding on illegal immigrants.
    That is a whole different subject to get into, and I am not
    going to prolong the hearing to get involved in that, but that
    would also be an area that you could probably stop payment on a
    lot of those things and being able to save the American
    taxpayer some money.
        Thank you, and I yield back.
        Chairman RAMSTAD. The gentleman from Arizona, Mr. Hayworth.
        Mr. HAYWORTH. Mr. Chairman, mindful of the time and the
    indulgence of the Commissioner, I will yield to my friend from
    California if that is okay.
        Mr. NUNES. Thank you, Mr. Hayworth, appreciate that.
        Welcome Commissioner. I just want to talk briefly about the
    501(c)(3)s, and recently the IRS conducted a study where out of
    the 82 examinations that you did, 59 had engaged in prohibited
    political activity. I assume you are familiar with that report.
        Mr. EVERSON. Yes, sir.
        Mr. NUNES. Which I commend you for conducting that report.
    I think it is important. I have two letters here that are dated
    March 1st from the IRS to Greenpeace, to their 501(c)(4) and
    the Greenpeace Fund, which is a 501(c)(3), in which in the
    letter you say that they continue to qualify for exemption from
    Federal income tax despite the fact that it clearly outlines
    the political activity that was a violation of Federal law. It
    looks to me like from what they were doing, it is Enron-type
    accounting, where they were moving money from one account to
    another, and then never repaying the loan.
        With all the political activity that is going around this
    place now, I guess I wonder when are you actually going to
    enforce the law on some of these 501(c)(3)s, and stop them from
    engaging in this political activity?
        Mr. EVERSON. Let me make several points here. First of all,
    I will not comment on a particular matter. As this Committee is
    well aware, I can't do that.
        Mr. NUNES. I understand.
        Mr. EVERSON. As a general comment, we were very concerned
    in the 2004 cycle about increasing indications of political
    intervention in 501(c)(3)s. We very much ramped up our effort
    on that. We established a small group of experts, all career
    people, and they went through a very detailed process of
    deciding which matters to look at. That was reviewed
    independently by the Inspector General. There is no politics in
    any of this. As you indicate, our conclusions were that it did
    substantiate political intervention. At the extreme end, we
    have proposed the revocation of the tax exempt status for three
    of those organizations, and in fact, one of the revocations has
    been finalized.
        Most of the problems we have seen were one-time problems,
    where we issue an advisory, and the organization agrees to
    stand down on that practice. A lot of this involves education
    of the organization and making sure they understand the rules
    of the road.
        So, we are doing two things for this 2006 cycle. We have
    issued a lot of increased guidance, a lot of sort of scenarios,
    what is okay, what is not okay, and we are going to have that
    same group--we are going to augment it as we need to--to work
    very quickly to address problems that we see.
        More broadly speaking, if I could comment upon the
    regulatory scheme here. Congress does need to look--and I have
    indicated this in my testimony on tax exempts generally--at the
    sanctions, because all too often in this area, or in the area
    of noncompliance generally by exempt organizations, we are
    really faced with two choices, the imposition of a de minimis
    tax--in this case, 10 percent of the cost of the activity,
    which can be quite de minimis--or lifting the tax exemption,
    which may not, on the other hand, be in the public good because
    of the many good things the organization is doing. Something in
    the middle that has got a little more pain to it, I think would
    make our jobs easier, sir.
        Mr. NUNES. I think that is a very good point, because you
    can understand. My concern is that if you look at this
    activity, clearly these groups are sophisticated at what they
    are doing, especially in the case--I know you don't want to
    comment on it--but these are sophisticated groups that are very
    good at what they do, and perhaps you are right, that this
    Committee, Mr. Chairman, should look more into these
    501(c)(3)s, into not only the political activities they are
    doing, but the possible penalties that the IRS is able to
    enforce. I think that is a very good point. Thank you for being
    here once again, Commissioner.
        I yield back the balance of my time.
        Chairman RAMSTAD. Thank you, Mr. Nunes.
        Thank you very much, Commissioner, for your testimony
    today. I think some very important issues have been covered,
    and I appreciate the ongoing dialog, and look forward to
    working with you. Thank you again.
        Mr. EVERSON. Thank you, sir.
        Chairman RAMSTAD. The Chair now would ask the second panel
    to take seats so we can begin. The second panel, while they are
    coming forward, comprises the Hon. Russell George, Treasury
    Inspector General for Tax Administration (TIGTA); the Hon.
    Raymond T. Wagner, Chairman of the IRS Oversight Board; the
    Hon. Timothy Hugo, Executive Director of the Free File
    Alliance; and Director James R. White, Director of Tax Issues
    at the Government Accountability Office (GAO).
        We will begin as soon as we get the dais rearranged. We
    will begin with you, Inspector General George, please. Take
    your time. I don't mean to rush you at all, Inspector General.

        STATEMENT OF THE HONORABLE J. RUSSELL GEORGE, TREASURY
     INSPECTOR GENERAL FOR TAX ADMINISTRATION, U.S. DEPARTMENT OF
                              THE TREASURY

        Mr. GEORGE. Thank you, Mr. Chairman. Chairman Ramstad,
    Members of the Subcommittee, thank you for the opportunity to
    testify.
        The IRS' planning for the 2006 season was unusually
    difficult due to the tax law changes enacted in response to
    Hurricanes Katrina and Rita. However, to date, my office has
    not identified any significant processing problems resulting
    from that. In fact, our review of the IRS' preparation for the
    2006 filing season has determined that the IRS accurately
    updated its tax products and computer programming to
    incorporate tax law and other changes.
        As of March 24, 2006, the IRS has received more than 73
    million returns. Of those, the IRS has seen an increase in
    electronically filed returns of 2.6 percent, and a decrease in
    paper returns of 6.5 percent compared to the same period in
    2005. Over the past several years the IRS has seen a steady
    growth in electronic filing of income tax returns. In 2005 the
    number of electronically filed returns increased to 51 percent
    of the total individual income tax returns received. While the
    IRS will not meet its Congressionally mandated goal of having
    80 percent of all tax returns electronically filed by 2007, it
    does expect to see continued growth in electronic filing,
    albeit at a diminished rate.
        Although electronic filing continues to increase overall,
    there are indications that taxpayers are shifting between the
    various types of electronically filed returns, and in some
    segments the numbers of electronically filed returns is
    actually decreasing. Returns filed electronically are generated
    from three basic sources: paid preparers who submit their
    clients' tax returns, taxpayers who purchase tax preparation
    software, and filed their own return via the Internet from
    their personal computers, and taxpayers who take advantage of
    free electronic filing programs, such as the Free File program,
    or in past years, the TeleFile program.
        The IRS Restructuring and Reform Act 1998 (P.L. 105-206)
    required the IRS to work with the private sector to increase
    electronic filing. In 2003, the Free File program was launched
    featuring private sector partners that allowed qualifying
    taxpayers to prepare and file their taxes online at no cost.
    This was made possible through a public-private partnership
    consisting of a consortium of tax software companies, known
    collectively as the Free File Alliance.
        According to statistics provided by the Alliance, almost
    2.8 million taxpayers used the program in its first year. In
    subsequent years, use of the program increased significantly to
    just over 5 million taxpayers in 2005. Following the 2005
    filing season, the IRS and the Alliance amended their agreement
    which resulted in a significant change in the focus of the
    program. While the new agreement comported with the original
    goal of increasing the number of taxpayers who electronically
    filed their returns, it effectively changed the intent of the
    program to focus on assisting lover income and underserved
    taxpayers.
        The agreement limits the program's availability to 70
    percent, approximately 93 million taxpayers for the 2005 tax
    year this limit equates to an adjusted gross incomes, as was
    discussed by the Commissioner, of $50,000 or less. The net
    impact of that during the 2006 filing season, approximately 40
    million taxpayers are not being offered free filing services
    through the program. This change, as was discussed, has support
    from Congress. With the 2005 budget, the House Committee on
    Appropriations restated the proposition that the Alliance is
    foremost intended to provide electronic tax return preparation
    and electronic filing services at no cost to the working poor
    and underserved taxpayers. This stems in part from the
    different objectives of the IRS and Alliance members.
        One of the IRS' principal purposes for establishing the
    program was to increase electronic filing. Alliance members,
    however, incur a cost to provide these services. According to
    the Alliance members my office interviewed, their primary goal
    is to keep the Federal Government from entering the tax
    preparation business. Furthermore, Alliance members we spoke to
    acknowledge that participants in the program are afforded the
    opportunity to market additional services to taxpayers.
        Overall, my office has found that the increase in
    electronic filing this season appears to be the result of a
    greater number of taxpayers paying for online filing services.
    As of March 18, 2006, paid online filing was up 25 percent.
    Free online filing, however, fell 21 percent. There are two
    possible explanations for this disparity. Taxpayers who filed
    electronically through a practitioner last year may have
    decided to purchase software and file online this year, or
    taxpayers who filed through the Free File program last year and
    who were disqualified from participating this year, purchased
    software to file online.
        Another factor that may have contributed to the decline of
    free online filing is the elimination of the IRS' TeleFile
    program. The IRS and the Alliance had hoped that many of the
    3.3 million taxpayers who TeleFiled in 2005, would migrate to
    the Free File program. However, we have found that many former
    TeleFilers have instead opted to file paper returns.
        In addition, I am concerned that the Free File program may
    not be accessible to all who were eligible for it. Many low-
    income families do not have Internet access. Although the IRS
    Free File Internet site allows taxpayers to determine whether
    they qualify, finding the best software package to meet their
    needs may be difficult for less savvy computer users.
        I must point out that in preparation for today's hearing, I
    called the IRS' 800 number yesterday, which is, as you know,
    designed to assist taxpayers in preparing their tax returns.
    The many automated options provided did not contain information
    on how to access Free File materials. When I reached an IRS
    assistor, she did not mention the program to me at all.
    Instead, I had to suggest to her that there was an opportunity
    to file my taxes online free of charge. Once I made that
    statement to her, I was directed to the IRS website for
    information regarding the program.
        Overall, I am concerned that changes in the Free File
    program agreement, along with the elimination of the Tele-File
    program, have contributed to a significant slowing of the
    growth in electronic filing, which will defer the efficiency
    gains the IRS hoped to achieve this year.
        Before proceeding with any reduction in customer services,
    whether related to tax preparation and filing options, or walk-
    in and toll free telephone assistance, the IRS needs to better
    understand the impact of such changes on taxpayers.
        Mr. Chairman, Members of the Committee, thank you for
    allowing me to share my views. I would be pleased to answer any
    questions you may have at the appropriate time.
        [The prepared statement of Mr. George follows:]
       Statement of The Honorable J. Russell George, Treasury Inspector
        General for Tax Administration, U.S. Department of the Treasury
        Chairman Ramstad, Ranking Member Lewis, and Members of the
    Subcommittee, I thank you for the opportunity to testify today on the
    Internal Revenue Service's (IRS) 2006 Filing Season and the 2007 budget
    proposal. I will discuss the challenges facing the IRS during the 2006
    Filing Season, its longer term goal of increasing the number of
    taxpayers who file electronically, and its ability to provide quality
    taxpayer service.
    The 2006 Filing Season
        During the 2006 Filing Season, the IRS expects to process an
    estimated 135 million individual returns. One of the major challenges
    for the IRS each filing season is the implementation of tax law
    changes. Changes to tax law have a major impact on how the IRS conducts
    its activities, the resources it requires, and how quickly it can meet
    its strategic goals. Congress generally makes changes to tax law each
    year, and before each filing season begins, the IRS must identify tax
    law changes, revise various tax forms, instructions, and publications,
    and reprogram its computer system to ensure returns are accurately
    processed.
        So far, TIGTA has not identified any significant problems with the
    IRS' processing of individual tax returns during the 2006 Filing
    Season. As of March 24, 2006, the IRS has received over 73.4 million
    returns. Of those, 50.3 million were filed electronically (an increase
    of 2.6 percent from this time last year), and 23.1 million were filed
    on paper (a decrease of 6.5 percent from 2005). Additionally, $144.5
    billion in refunds have been timely issued. Of this amount, $113.4
    billion were directly deposited to taxpayer bank accounts, an increase
    of 4 percent compared to last year.
        Planning for the 2006 Filing Season was unusually difficult for the
    IRS because of many tax law changes enacted late last year in response
    to unprecedented natural disasters. Disaster relief provisions were
    enacted into law for taxpayers affected by Hurricanes Katrina, Rita,
    and Wilma, and were intended to provide relief to over11 million
    taxpayers who lived in the affected areas of the Gulf Coast, as well as
    to others who may have been adversely impacted by these storms.
        This year, TIGTA is reviewing 28 new tax law provisions and also
    closely monitoring the implementation of changes intended to assist
    taxpayers adversely affected by the 2005 hurricanes. New tax law
    provisions were included in the Katrina Emergency Tax Relief Act of
    2005,\1\ the Gulf Opportunity Zone Act of 2005,\2\ and in provisions in
    the Working Families Tax Relief Act of 2004 \3\ and the American Jobs
    Creation Act of 2004,\4\ all of which became effective in 2005. The
    latest legislation, the Gulf Opportunity Zone Act of 2005, was signed
    into law on December 21, 2005.
    ---------------------------------------------------------------------------
        \1\ Pub. L. No. 109-73, 119 Stat. 2016 (to be codified in scattered
    sections of 26 U.S.C.).
        \2\ Pub. L. No. 109-135, 199 Stat. 2577 (2005).
        \3\ Pub. L. No. 108-311, 118 Stat. 1166 (2004).
        \4\ Pub. L. No. 108-357, 118 Stat. 1418 (2004).
    ---------------------------------------------------------------------------
        TIGTA reviewed the IRS' preparation for the 2006 Filing Season and
    determined that the IRS accurately updated its tax products and
    computer programming to incorporate the tax law changes effective in
    2005. TIGTA reviewed 42 tax forms, publications, and instructions that
    required updating, and determined that they were accurately updated.
    The IRS also accurately updated its computer programming and returns
    processing programs for the new tax law provisions and other
    adjustments or changes.\5\ TIGTA will continue to monitor the IRS'
    processing of income tax returns during the 2006 Filing Season and will
    report its results later this year.
    ---------------------------------------------------------------------------
        \5\ Discussion Draft Report Tax Products and Computer Programs for
    Individual Income Tax Returns Were Accurately Updated for the 2006
    Filing Season (Audit # 200640015)
    ---------------------------------------------------------------------------
    Electronic Filing
        The IRS has seen a steady growth in electronic filing (e-file) of
    income tax returns over the past several years. In Calendar Year 2002,
    35.9 percent of the 130.3 million individual income tax returns
    received by the IRS were e-filed. Last year, the percentage of e-filed
    returns increased to 51.7 percent of the total individual income tax
    returns received. The number of e-filed returns increased 46.2 percent
    over the three-year span. While the IRS will not meet its goal of
    having 80 percent of all tax returns e-filed by 2007, it does expect to
    see continued growth in electronic filing, although at a somewhat
    diminished growth rate from year to year. For example, the IRS expects
    the e-file percentage to reach 54.1 percent this year, 57.7 percent in
    2007, and 60.6 percent in 2008.
        Although e-filing continues to increase overall, TIGTA notes some
    indications that taxpayers are shifting between the various types of e-
    filed returns, and some segments of e-filed returns are starting to
    show a decrease in the numbers filed. E-filed returns are generated
    from three basic sources--paid preparers who transmit their clients'
    tax returns, taxpayers who purchase tax-preparation software and file
    their own returns via the Internet from their personal computers, and
    taxpayers who take advantage of free e-filing options, such as the Free
    File Program, or in years past, via the TeleFile Program.
        Overall, as of mid-March of this year, e-filing has increased 2.6
    percent compared to the same period in 2005, although this is
    significantly less than the 6 percent increase the IRS expected. While
    the number of taxpayers e-filing from their home computers is up 16.6
    percent this Filing Season, the number of taxpayers taking advantage of
    free online filing is down 21 percent below last year. I am concerned
    that more taxpayers are not using the free e-filing services offered by
    the IRS, and I will discuss some issues related to the Free File and
    TeleFile Programs in the following sections of this testimony.
    Free File Program
    Background
        In February 2002, President Bush established an agenda to improve
    management of the Federal Government. One of his agenda items is E-
    Government. E-Government is an integral part of the President's
    Management Agenda to make it easier for citizens and businesses to
    interact with the government, save taxpayer dollars and streamline
    citizen-to-government transactions. In response to the President's E-
    Government initiative, the Office of Management and Budget (OMB)
    developed the EZ Tax Filing Initiative. EZ Tax Filing was intended to
    make it easier for citizens to file taxes in a Web-enabled environment.
    Citizens would no longer have to pay for basic, automated tax
    preparation. The goal of this initiative was to increase the number of
    citizens who filed their tax returns electronically.
        The IRS Restructuring and Reform Act of 1998 (RRA 98) \6\
    established a goal for the IRS of having 80 percent of Federal tax and
    information returns filed electronically by 2007. It also required the
    IRS to work with private industry to increase electronic filing. In
    response to this requirement, in 2003 the Department of the Treasury
    (Treasury), OMB and the IRS launched the Free File Program featuring
    private-sector partners that allow qualifying taxpayers to prepare and
    file their taxes online for free. The Treasury, OMB and IRS made this
    possible through a public-private partnership with a consortium of tax
    software companies, the Free File Alliance, LLC (Alliance).
    ---------------------------------------------------------------------------
        \6\ Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in
    scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22
    U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
    ---------------------------------------------------------------------------
        The Free File Program provides taxpayers with access to free online
    tax preparation and e-filing services made possible through a
    partnership agreement between the IRS and the tax software industry.
    Eligible taxpayers may prepare and e-file their Federal income tax
    returns using commercial online software provided by Alliance members.
    After the IRS and Alliance entered into a Free File Agreement, the Free
    File Program debuted in January 2003. According to statistics provided
    by the Alliance, more than 2.79 million taxpayers used the program in
    its first year. In subsequent years, use of the Free File Program
    increased significantly, to about 3.51 million taxpayers in 2004, and
    5.12 million taxpayers in 2005.
    The Amended Free File Alliance Agreement and Its Potential Impact on
            Electronic Filing
        After the 2005 Filing Season, the IRS and the Alliance amended
    their agreement to continue the Free File Program through October 2009.
    With the amended agreement, the overall focus of the Free File Program
    changed significantly. While the amended agreement still contributes to
    the original goal of increasing the number of citizens who
    electronically file their tax returns, new limits effectively changed
    the intent of the Free File Program. The original intent of the program
    was to provide free tax preparation and electronic filing services to
    all taxpayers. The revised intent is to assist lower income and
    underserved taxpayers.
        The original 2002 agreement between the IRS and the Alliance
    established a minimum number of taxpayers who should be served by the
    Free File Program and was more in line with the intent of the EZ Tax
    Filing Initiative. There is, however, some support in Congress for the
    shift in the program's focus to lower income and underserved taxpayers.
    For example, according to the House Appropriations Committee Report
    accompanying the IRS' FY 2005 Budget Appropriations, the Committee
    reaffirmed its position that the Alliance is first and foremost
    intended to provide electronic Federal tax return preparation and e-
    filing services at no cost to the working poor and other disadvantaged
    and underserved taxpayers.
        As part of the amended agreement, new limits were set for
    participation in the Free File Program. The new limits stem, in part,
    from the differing objectives of the IRS and the Alliance members. One
    of the IRS' principal purposes for establishing the program was to add
    another avenue for electronic filing with the intent of increasing
    electronic filing overall. However, Alliance members are businesses
    that incur a cost to provide free services. According to
    representatives of Alliance member companies that TIGTA interviewed,\7\
    their primary goal is to keep the Federal Government from entering the
    tax preparation business. A secondary benefit of their participation in
    the program is the opportunity to market their other products for free.
    Taxpayers opting to use these services provide additional revenues to
    Alliance members.
    ---------------------------------------------------------------------------
        \7\ TIGTA interviewed a sample of 6 of the 20 Alliance member
    companies.
    ---------------------------------------------------------------------------
        Per the initial agreement, a minimum of 60 percent of all taxpayers
    (approximately 78 million) were eligible for the Free File Program.
    Last year, the Alliance opened the program up to almost 130 million
    taxpayers. However, only 5.12 million taxpayers took advantage of it.
    The amended agreement now limits the program's availability to 70
    percent of taxpayers (approximately 93 million). For Tax Year 2005,
    this limitation equates to an Adjusted Gross Income (AGI) of $50,000 or
    less. The maximum AGI to achieve the 70 percent limit, however, may
    vary from year to year. The net impact of this new limit is that during
    the 2006 Filing Season approximately 40 million taxpayers will no
    longer be offered free filing services through the program.
        As mentioned earlier, online filing on home computers is up 16.6
    percent this Filing Season. This increase, however, appears to be the
    result of additional taxpayers paying for online filing services. As of
    March 18, 2006, paid online filing is up 33.8 percent while free online
    filing is down 21 percent. Two possible explanations for the growth in
    online filing from home computers and the decline in free online filing
    are: 1) taxpayers who filed electronically through a practitioner last
    year may have decided to purchase software and file online this year;
    and 2) taxpayers who filed through the program last year do not qualify
    this year, and they purchased software to file online.
        Another factor that appears to have contributed to the decline in
    free online filing is elimination of the IRS' TeleFile Program. The IRS
    and the Alliance had hoped that many of the 3.3 million taxpayers who
    used TeleFile in 2005 would migrate to the Free File Program. However,
    current Filing Season statistics indicate that many former TeleFilers
    are no longer electronically filing and instead are filing their
    returns on paper.
    Positive Provisions of the New Free File Alliance Agreement
        Although the changes in the amended Free File Agreement limit the
    number of taxpayers offered free tax preparation and filing services,
    several other changes enhance the quality of the program. Under the
    amended agreement, Alliance members must adhere to more stringent
    disclosure on the nature, costs, and alternative methods of receiving
    refunds faster. In addition, not all taxpayers will be offered a Refund
    Anticipation Loan (RAL). There is some controversy over RALs because of
    the high fees and rates sometimes associated with those loans. Starting
    in 2006, the agreement guarantees that some taxpayers using the Free
    File Program will have the option to prepare and file their tax return
    without being offered a RAL. The decision of whether or not to accept
    an RAL lies with the taxpayer; however, these new provisions make the
    choice more clear. If taxpayers choose to apply for an RAL, all terms
    of the loans must be fully disclosed.
        The amended agreement also increased security requirements and
    added performance measures for the individual Alliance members.
    Alliance members must have third party security assessments to ensure
    that taxpayer information is adequately protected. Also, performance
    standards require a 60 percent acceptance rate \8\ for providers who e-
    file returns through the program. This acceptance rate will be
    gradually increased in future years.
    ---------------------------------------------------------------------------
        \8\ The percentage of returns an individual provider must transmit
    to the IRS error free.
    ---------------------------------------------------------------------------
        Under the amended agreement, Alliance members also agreed for the
    first time to provide the IRS with an indicator that identifies those
    taxpayers who use the Free File Program. Prior to the amendment, the
    IRS had no way to independently determine how many taxpayers
    participated in the program, or which taxpayers were using it.
    Previously, individual Alliance members reported data on participation
    in the program, and the IRS lacked a method to monitor participation.
    This significantly hampered the IRS' ability to evaluate the program's
    success or the effects of changes to the program.
    Difficulties Using the Free File Program
        Although the Free File Program offers some taxpayers the option to
    prepare and file their tax return for free, the program may not be
    accessible to all who are eligible for it and it is not necessarily
    easy to use. The Free File Internet site easily allows taxpayers to
    determine whether they qualify for the program, but finding the best
    software provider for their needs is time consuming and may be
    difficult for less savvy computer users.
        Taxpayers must access the Free File Program through the IRS'
    Internet site at IRS.gov. The Internet site clearly identifies the
    basic requirements for participation in the program and provides a tool
    that guides taxpayers to free filing providers. This tool presents
    taxpayers with a number of providers from which to choose based on some
    basic information that taxpayers provide. Although this tool guides
    taxpayers to the providers they qualify to use, the tool does not
    assist taxpayers with determining which of those providers best meets
    their needs.
        Taxpayers must access each provider's Internet site to determine
    the services offered and must then compare the services offered and
    select the provider that is the best for them. Additionally, each
    Alliance member company sets taxpayer eligibility requirements for its
    own program. These requirements may differ from company to company.
    Generally, eligibility is based on such factors such as age, adjusted
    gross income, State residency, military status or eligibility for the
    Earned Income Tax Credit.
        Although the Free File Program is currently focused on low-income
    taxpayers, many of these taxpayers do not have access to the tools to
    use it. For example, taxpayers who speak limited English have not been
    provided access to all the filing options offered. Only two providers
    offer services in Spanish and neither of them offer free electronic
    filing of Form 4868, Automatic Extension of Time to File.
        The Free File Program also requires taxpayers to have access to a
    computer and the Internet. Taxpayers who have access to the necessary
    technology must also be savvy enough to navigate the IRS' and the
    Alliance members' Internet sites. The focus of the program on lower
    income taxpayers may be at odds with their ability to participate in
    it. In her 2004 Report to the Congress, the National Taxpayer Advocate
    wrote that in 2001 approximately 50 percent of low income families \9\
    used a computer and only 38 percent had access to the Internet.
    Furthermore, access to a computer or the Internet does not necessarily
    indicate that a person has the ability to navigate the Internet or use
    tax preparation software.\10\
    ---------------------------------------------------------------------------
        \9\ Income of less than $25,000.
        \10\ National Taxpayer Advocate 2004 Annual Report to the Congress,
    Volume 1 December 2004.
    ---------------------------------------------------------------------------
        The IRS offers free assistance to taxpayers with tax preparation
    and filing through its Taxpayer Assistance Centers, Voluntary Income
    Tax Assistance, and Tax-Aide Programs as well as through the Free File
    Program. Similar to the Free File Program, taxpayers must meet certain
    requirements in order to receive assistance from those other programs.
    The Free File Program, however, is the only free filing option that
    taxpayers may use from their homes. Taxpayers must bring their tax
    documentation to an assistance site to take advantage of the other free
    tax preparation and filing services.
        The addition of the RAL provisions, increased security, and added
    performance measures to the agreement are important means to further
    promote public confidence in the Free File Program. Adding the
    electronic indicator to returns filed through the program will provide
    the IRS with information to measure the program's success. However,
    limiting the scope of the program to 70 percent of taxpayers has
    impacted the use of the program. Based on the statistics Alliance
    members provided in previous years, the new limits in the amendment to
    the agreement appear to be substantially reducing participation in the
    program. Furthermore, the AGI limit also keeps the program from
    achieving the full intent of the EZ Tax Filing Initiative, which never
    specified any such limits for access to free, basic, automated tax
    preparation and electronic filing. Not yet known, however, is whether
    the IRS' ability to better understand who is using and who is not using
    the program will help the IRS better market the program and expand its
    usage despite the new limits. The answer to that question may
    ultimately have a significant effect on the overall growth rate of
    electronic filing.
    Elimination of the TeleFile Program
        As mentioned earlier in my statement, one factor that appears to
    have negatively impacted the Free File Programgrowth of e-filing this
    year is the elimination of the TeleFile Program. The IRS discontinued
    this program for individual taxpayers in August 2005. The TeleFile
    Program allowed taxpayers with the simplest tax returns \11\ to file
    their returns by telephone. The pilot TeleFile Program was launched on
    a limited basis in 1992, and the program became available nationally in
    1997. The RRA 98 included the expectation that the IRS would continue
    to offer and improve TeleFile, and make a similar program available on
    the Internet.
    ---------------------------------------------------------------------------
        \11\ Forms 1040EZ.
    ---------------------------------------------------------------------------
        Despite its initial success, use of the TeleFile Program began to
    decrease in 1999. According to IRS electronic filing statistics as of
    April 17, 2005, approximately 3.3 million filers used TeleFile in 2005,
    a 12.7 percent decline from the previous year. Until the IRS eliminated
    the TeleFile Program last year, participation in the program had
    declined every year since 1999 when 5.2 million filers used it.
        Declining use was one factor the IRS considered when deciding
    whether or not to end the TeleFile Program. Other contributing factors
    included the increasing cost of maintaining an aging TeleFile system,
    declining and discontinued State TeleFile programs, and the growing use
    of other electronic filing alternatives, such as the Free File Program.
        According to the IRS, taxpayers who previously used TeleFile may
    continue to file electronically using one of the following five
    methods:

        1.  Tax preparers;
        2.  Personal computers with Internet access and tax preparation
    software;
        3.  IRS' Free File Program;
        4.  Free tax assistance sites, such as the Voluntary Income Tax
    Assistance and Tax-Aide Programs; and
        5.  IRS Taxpayer Assistance Centers.

        However, two of the five alternatives require the taxpayer to pay
    for tax preparation and filing services that were previously free, and
    two other options require taxpayers to have access to computers and the
    Internet. Consequently, in many cases, the most cost-effective avenue
    for the taxpayer is to file a paper tax return. According to initial
    IRS statistics, a significant number of former TeleFile users are
    reverting to filing paper returns this year. As of March 17, 2006, the
    number of paper Form 1040EZ returns filed has increased 22 percent
    compared to this time last year (4.5 million in 2006 compared to 3.7
    million in 2005), and there has been a corresponding decrease in
    electronically filed Forms 1040EZ (5.8 million in 2006 vs. 7.3 million
    in 2005).
        TIGTA will further evaluate the impact of the elimination of the
    TeleFile Program on taxpayers and the IRS' efforts to increase
    electronic filing, and will report the results later this year.
    Providing Quality Taxpayer Service Operations for the 2006 Filing
            Season
        Providing quality customer service to the taxpayer is not only a
    primary goal of the IRS, but it is also one of its major management
    challenges. The Commissioner has frequently stated that service
    combined with enforcement will result in compliance. Quality taxpayer
    service includes helping the taxpaying public understand their tax
    obligations while making it easier to participate in the tax system.
        Since the passage of the RRA 98, the IRS' focus on customer service
    has led to many improvements. One of the goals of the IRS is to improve
    taxpayer service by improving service options, facilitating
    participation in the tax system by all sectors of the public, and
    simplifying the tax process. Every year, the IRS helps millions of
    taxpayers understand their tax obligations by answering questions on
    its toll-free telephone lines or in person at local offices, making
    information available on its web site, and responding to
    correspondence.
        Over the past seven years, the IRS has made commendable strides in
    customer service. However, I am concerned that the IRS does not
    sufficiently ensure that it uses adequate and reliable data for making
    decisions that impact customer service operations. Recent decisions to
    close Taxpayer Assistance Centers (TAC) and reduce the hours of
    operation for toll-free telephone service were based primarily on input
    from IRS functional areas and considered other factors that included
    internal priorities, resource demands, and shifts in the IRS' customer
    service perspective. However, data were not obtained from taxpayers who
    use these services to determine the impact of removing or reducing
    them.
        After the IRS' closure announcement, Congress enacted legislation
    to delay the closure of any TACs.\12\ The IRS is prohibited from using
    funds provided in the Fiscal Year 2006 budget appropriation to reduce
    any taxpayer service function or program until TIGTA completes a study
    detailing the effect of the IRS' plans to reduce services relating to
    taxpayer compliance and taxpayer assistance.
    ---------------------------------------------------------------------------
        \12\ Transportation, Treasury, Housing and Urban Development, the
    Judiciary, the District of Columbia, and Independent Agencies
    Appropriations Act, 2006, Pub. L. No. 109-115, 119 Stat. 2396 (2005).
    ---------------------------------------------------------------------------
    IRS.gov
        IRS.gov continues to be one of the most visited Web sites in the
    world, especially during filing seasons. As of the week ending March
    18, 2006, the IRS is reporting a 5.7 percent increase in the number of
    visits to IRS.gov over the same period last filing season. The IRS now
    provides practitioners with online tools to provide better service to
    their customers, such as electronic account resolution, transcript
    delivery, and disclosure authorization. As of the week ending March 18,
    2006, the IRS is also reporting a 17.9 percent increase in taxpayers
    obtaining their refund information online via ``Where's My Refund.''
    Toll-Free Operations
        The 2006 Filing Season has presented unique challenges for the IRS
    toll-free operations. The IRS had also planned to reduce the hours of
    its toll-free telephone operation in Fiscal Year 2006. The IRS has
    about 400 fewer full-time equivalents for toll-free telephone
    operations than it had in Fiscal Year 2005 because of plans to reduce
    operating hours from 15 to 12 hours per day. Congress, the Taxpayer
    Advocate and the National Treasury Employees Union have expressed
    concerns about the IRS reducing operating hours for the toll-free
    telephone lines. A new law enacted in November 2005 requires the IRS to
    consult with stakeholder organizations, including TIGTA, regarding any
    proposed or planned efforts to terminate or significantly reduce any
    taxpayer service activity.\13\ Congress recently further defined a
    reduction of taxpayer service to include limiting available hours of
    telephone taxpayer assistance on a daily, weekly, and monthly basis
    below the levels in existence during the month of October 2005. TIGTA
    is currently assessing the IRS' plans to reduce operating hours and
    will report its results later this year.
    ---------------------------------------------------------------------------
        \13\ The Transportation, Treasury, Housing and Urban Development,
    the Judiciary, the District of Columbia, and Independent Agencies
    Appropriations Act, Pub. L. No. 109-115, 119 Stat. 2396 (2006).
    ---------------------------------------------------------------------------
        As of March 18, 2006, assistor level of service has not been
    negatively impacted, with an IRS reported level of service rate of 84.3
    percent. In addition, about 8 percent fewer assistor calls are being
    answered but the number of taxpayers who hang-up prior to reaching an
    IRS assistor is up 8.5 percent. The average speed of answer is about 60
    percent of the time planned so those taxpayers who are calling and
    talking with an assistor are not experiencing longer wait times.
        In planning for Fiscal Year 2006, IRS management expected fewer
    calls program-wide, even after taking into consideration taxpayers
    affected by Hurricanes Katrina and Rita. IRS management believed that
    most taxpayers needing disaster relief assistance obtained it during
    the latter part of 2005. Prior to the start of the filing season, TIGTA
    brought to IRS management's attention our concern that more taxpayers
    than expected could call the help line with questions due to the
    effects of Hurricanes Katrina and Rita.
        After we shared our concern, IRS management raised the estimated
    volume of services to these telephone lines by about 78,000 services,
    from approximately 27,000 to about 105,000 from January through June
    2006, a 365.1 percent increase over the total Fiscal Year 2005 services
    provided on those telephone lines. For the 2006 Filing Season it
    appears that the calls to these telephone lines are higher than
    anticipated. For example, the IRS had planned 59,081 services for one
    of its applications devoted to assisting disaster victims; however,
    through March 16, 2006, the IRS has already provided 106,141 services.
    Taxpayer Assistance Centers
        The TACs are walk-in sites where taxpayers can receive answers to
    both account and tax law questions, as well as receive assistance
    preparing their returns. The IRS has acknowledged that staffing would
    be a challenge during the 2006 Filing Season since not all TACs would
    be fully staffed and not all TACs will provide standard services or
    standard hours of operation (from 8:30 a.m. to 4:30 p.m., Monday
    through Friday). As of December 1, 2005, the IRS identified 47 TACs
    with critical staffing shortages (a critical vacancy is one that must
    be filled to ensure that a TAC remains open).
        The IRS took actions to minimize the impact of the staffing
    shortages. As of January 31, 2006, the IRS had hired additional
    frontline technical employees, recalled intermittent employees back to
    work, detailed former TAC employees from their current positions in
    other IRS functions back to the TACs, and made plans to have some
    employees travel between TACs to ensure that all TACs remain open
    daily. The IRS' decision to focus more resources on compliance
    activities, however, has further limited resources available for the
    TAC Program. As a result, the IRS has limited some assistance services
    and not all TACs are open during standard operating hours. As of the
    week ending March 11, 2006, the IRS is reporting a 12.8 percent
    reduction in TAC contacts with taxpayers.
        Although the IRS publicized when TAC operating hours are limited,
    it did not publicize when TACs limit their services. When notified by
    TIGTA, the IRS implemented changes and standardized the list of
    services offered at each TAC. Furthermore, the IRS modified its
    Internet site, IRS.gov, to indicate when TACs would provide limited
    services.
        While planning for the 2006 Filing Season, the IRS considered the
    impact of Hurricanes Katrina and Rita. Specifically, the IRS accounted
    for all employees affected by the hurricanes and located alternate
    office space in affected areas. All TACs in impacted areas are open and
    operational for the 2006 Filing Season. The IRS also added services to
    help lessen taxpayer burden, including tax return preparation for
    taxpayers affected by the hurricanes regardless of the income
    guidelines. Additionally, the scope of tax law topics in which
    assistors are trained was expanded to provide assistance to taxpayers
    with questions about casualty losses. Furthermore, the IRS will treat
    taxpayers affected by Hurricanes Katrina and Rita as meeting extreme
    hardship criteria. That designation allows affected taxpayers to
    request and immediately receive transcripts of prior year tax returns
    instead of having to order them and wait for delivery.
        TIGTA is currently in the process of making anonymous visits to
    TACs to determine if taxpayers are receiving quality service, including
    correct answers to their questions. TIGTA will also visit additional
    TACs to ask tax law questions specifically related to the Katrina
    Emergency Tax Relief Act of 2005. IRS assistors should have been
    trained to answer these questions. TIGTA's preliminary observations are
    that assistors sometimes inappropriately refer taxpayers to
    publications to conduct their own research, or respond to tax law
    questions without following required procedures such as using the
    publication method guide that requires them to ask probing questions.
    Volunteer Income Tax Assistance (VITA) Program
        The VITA Program plays an increasingly important role in IRS'
    efforts to improve taxpayer service and facilitate participation in the
    tax system. The VITA Program provides no-cost Federal tax return
    preparation and electronic filing to underserved taxpayer segments,
    including low income, elderly, disabled, and limited-English-proficient
    taxpayers. These taxpayers are frequently involved in complex family
    situations that make it difficult to correctly understand and apply tax
    law.
        TIGTA is currently in the process of visiting VITA sites to
    determine if taxpayers are receiving quality service, including the
    accurate preparation of their individual income tax returns. TIGTA
    developed scenarios that are designed to present volunteers with a wide
    range of tax law topics that taxpayers may need assistance with when
    preparing their tax returns. These scenarios include the
    characteristics (e.g., income level, credits claimed, etc.) of tax
    returns typically prepared by the VITA Program volunteers based on an
    analysis of the Tax Year 2004 VITA-prepared tax returns. TIGTA's
    preliminary observations are that volunteer sites do not always use the
    tools and information available when preparing returns.
    Conclusions
        To date, TIGTA has not identified any significant processing
    problems during the 2006 Filing Season. Furthermore, the IRS has taken
    a number of actions to ensure that taxpayers impacted by Hurricanes
    Katrina and Rita are able to obtain disaster relief assistance. TIGTA
    will continue monitoring the IRS' administration of the disaster relief
    provisions to ensure that impacted taxpayers are receiving the relief
    to which they are entitled.
        While the 2006 Filing Season appears to be progressing without
    major problems, I am concerned that changes in the Free File Agreement
    as well as the elimination of Telefile Program may have contributed to
    a significant slowing of the growth in electronic filing this year.
    This slowed growth comes at a time when the IRS is still far from
    reaching Congress' goal of 80 percent electronic filing by 2007. Slower
    growth in electronic filing will defer the efficiency gains for the IRS
    that result from electronic filing.
        Reducing customer services, such as TAC closures, the elimination
    of the TeleFile Program, and a reduction in toll-free hours of
    operation, to gain resource efficiencies must be carefully considered
    before any further decisions are made. TIGTA continues to be concerned
    that the IRS does not ensure that it has adequate and reliable data
    prior to making decisions that impact customer service operations.
    Before proceeding with these efforts, the IRS needs to better
    understand the impact of such changes on taxpayers as well as
    taxpayers' abilities to obtain these services through alternative
    means.
        I hope my discussion of some of these 2006 Filing Season issues
    will assist you with your oversight of the IRS' filing season
    operations. Mr. Chairman and Members of the Subcommittee, thank you for
    allowing me to share my views. I would be pleased to answer any
    questions you may have at this time.

        Chairman RAMSTAD. Thank you, Mr. George. The Chair would
    now recognize the Honorable Raymond T. Wagner. Chairman Wagner?

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

        Mr. WAGNER. Thank you, Mr. Chairman, Members of the
    Committee. Thank you for this opportunity to present the
    Oversight Board's recommendations for the IRS fiscal year 2007
    budget. I have submitted a written statement with more details,
    and I respectfully ask this Committee to make that statement a
    part of this hearing record.
        Chairman RAMSTAD. So ordered.
        Mr. WAGNER. The Oversight Board recommends an fiscal year
    2007 IRS budget of $11.31 billion, an increase of $732 million
    over the enacted fiscal year 2006 budget. This compares to the
    President's budget request of $10.59 billion in direct
    appropriations. The two budgets share some essential elements.
    Both reflect the same adjustments for inflation of $272
    million. Both show a savings in reinvestment of $122 million,
    and both are supplemented by $135 million in increased user
    fees to achieve a higher operating level.
        The Board recognizes the theme of the fiscal austerity in
    all components of the President's budget, and we highly respect
    what the administration is doing. That said, the Board's
    statutory responsibility is to speak to a budget which will
    ensure that the IRS can carry out its mission and its annual
    and long-term strategic plans.
        Mr. Chairman, we believe that effective tax administration
    and reducing the tax cap requires a comprehensive multi-faceted
    long-term plan with organizational commitment and action on
    many fronts, from a simpler tax code and more complete income
    reporting, to more effective enforcement and service that
    improve taxpayer compliance.
        We recommend program increases of $705 million in four
    program areas. The Board recommends $44 million for more
    taxpayers services, $368 million for more enforcement, $105
    million for management and infrastructure, $189 million for
    business systems modernization (BSM).
        Let me summarize the Board's recommendations. In the area
    of customer service, the Oversight Board seeks to restore
    levels to the fiscal year 2003--2004 levels of performance.
    During that period the telephone level of service on the main
    toll free line was 87 percent. Since then there has been a
    modest erosion in that measure with a 2007 level of service
    target of 82 percent. The Board also recommends an additional
    $368 million for enforcement. Of that, $308 million would
    provide for additional resources to combat egregious
    noncompliance, especially among small business and self-
    employed taxpayers. We would also add resources to curtail
    noncompliance and abusive schemes, nonfilers in corporate
    employment taxes and EITC payment fraud.
        The Board also calls for $60 million to provide up-to-date
    research on taxpayer compliance and the sources of
    noncompliance, which could then therefore be used to influence
    strategic planning in their resource allocation decisions.
        To this end, the Board recommends that the IRS make the
    National Research Program permanent, perform compliance
    research annually, and produce solid up-to-date tax gap
    estimates for all taxpayer segments. We also need solid
    research on customer service needs and how customer service
    affects compliance.
        I want to emphasize that taxpayers want more service and
    enforcement from the IRS. The Board surveys of taxpayer
    attitudes in 2004 and in 2005 indicate that approximately two-
    thirds of taxpayers support additional IRS funding for both
    service and enforcement. Time does not permit me to describe
    our recommendation for infrastructure and management fully, but
    I would like to highlight one specific recommendation, the need
    to restore leadership, development training to fiscal year 2003
    levels. The lack of leadership training capacity at the IRS is
    especially critical during a period in which approximately 50
    percent of the IRS managers are eligible for retirement.
        It is also critical to discuss BSM. Despite productivity
    improvements in recent years, the IRS is still forced to rely
    upon a 40-year-old information system. No modern financial
    institution in the private sector could survive under these
    conditions, and eliminating these limitations are key to making
    the IRS as efficient and as effective as a modern financial
    institution. The Board recommends that BSM move forward at an
    accelerated pace.
        Another very important topic to taxpayers is the ability to
    electronically file their tax returns, as we have heard much
    discussion about so far today. Electronic filing of individual
    tax returns so far this filing season is growing at a mere 2.6
    percent compared to the previous year. Although the filing
    season is far from over, this growth rate is below the historic
    growth rate. The Board has recommended in its 2005 electronic
    filing report to Congress to extend the Congressionally
    mandated goal of 80 percent of all returns file electronically
    from 2007 until 2011. The 2007 goal has become unrealistic, as
    we have heard, and will not be met. Extending the goal to 2011
    will not only clarify Congressional intent that the goal is
    important, but by setting a realistic date, it will restore the
    goal's ability to influence key policy decisions and affect
    electronic filing.
        Mr. Chairman, this concludes my oral statement, and I would
    be pleased to answer your questions. Thank you, sir.
        [The prepared statement of Mr. Wagner follows:]

            Statement of The Honorable Raymond T. Wagner, Chairman,
                    Internal Revenue Service Oversight Board

    INTRODUCTION AND OVERVIEW
        Mr. Chairman, thank you for this opportunity to present the
    Oversight Board's views on the Administration's FY2007 IRS budget
    request. I will explain in my testimony why the Board believes its
    proposed budget is needed to meet the needs of the country and of
    taxpayers. In developing these recommendations, the Board has applied
    its own judgment but has also drawn on the collective wisdom of others
    in the tax administration community, including the IRS, Government
    Accountability Office (GAO), the Treasury Inspector General for Tax
    Administration (TIGTA), National Taxpayer Advocate, and Congress.
        In fulfilling its responsibilities, the Board must ensure that the
    IRS' budget and the related performance expectations contained in the
    performance budget support the annual and long-ranges plans of the IRS,
    support the IRS mission, are consistent with the IRS goals, objectives
    and strategies and ensure the proper alignment of IRS strategies and
    plans. In addition to my statement today, the Board is developing a
    formal report in which it will explain why it has recommended this
    budget for the IRS.
        Now is a fiscally challenging time for our nation. Defense and
    homeland security needs coupled with rebuilding efforts along the
    hurricane-ravaged Gulf Coast have placed an enormous strain on the
    federal budget.
        In addition to our fiscal challenges, taxpayers are expected to
    comply with an increasingly complex tax code which places heavy burdens
    on honest taxpayers who wish to comply and offers untold opportunities
    for mischief by those who do not.
        Against this backdrop, it is imperative that government work better
    and smarter and get the most out of every taxpayer dollar. But there is
    also a drain on the Treasury that undermines our country's tax revenues
    and threatens the integrity of our tax administration system--the tax
    gap.
        The IRS recently disclosed that the nation's annual tax gap--the
    difference between what is owed and what is collected annually--stands
    at $345 billion, and some experts believe it could be even more. The
    Board considers the existence of such a large tax gap to be an affront
    to honest taxpayers, and is pleased with the attention that Congress
    has focused on the tax gap in the last year, especially with the
    release of the IRS' latest tax gap estimates. The Board, along with
    many other members of the tax administration community, believe that
    reducing the tax gap requires a comprehensive, multi-faceted plan with
    action on many fronts--from a simpler tax code and more complete income
    reporting to better enforcement and quality customer service.
        Such an approach needs to be more thoughtful and comprehensive that
    merely increasing IRS resources and expecting that the gap will shrink.
    However, increased IRS resources are certainly a part of the solution.
    A successful strategy will encompass several separate but interrelated
    approaches that will reinforce each other to produce the desired
    result. In the Board's opinion, a number of actions that can be taken
    will require additional IRS resources.
        The Oversight Board recommends an integrated set of strategies to
    close the tax gap: (1) tax code simplification; (2) improved
    information reporting and enforcement tools related to the cash
    economy; (3) improved customer service to make taxpayers aware of their
    obligations and modern technology to ease their burdens; (4) greater
    focus on research; (5) more productive partnerships between the IRS and
    tax professionals; and (6) and more emphasis on personal integrity.
        There can be no doubt that in the last five years the agency has
    achieved significant progress in all dimensions of its mission.
    Customer service has rebounded from the lows of the 1990s and through
    targeted investments and greater management focus, IRS enforcement has
    also turned the corner.
        This across-the-board improved performance has not gone unnoticed--
    especially among taxpayers. According to the 2005 American Customer
    Service Index, overall satisfaction among individual tax filers with
    the Internal Revenue Service remains stable at 64 percent; it is even
    higher among e-filers. The IRS Oversight Board 2005 Annual Survey also
    found that American taxpayer support for overall compliance reached an
    all-time high. However, the IRS's job is far from complete and it must
    close the tax gap while achieving balance in other parts of its
    critical mission.
        The Board recommends budget increases in four IRS program areas in
    FY2007: customer service, enforcement, Business Systems Modernization,
    and infrastructure and management tools.
        To achieve balance and ultimately compliance, the Board recommends
    two modest investments in customer service to ensure that there is no
    slippage in hard won gains. For example, the toll-fee telephone level
    of service is slightly down and wait times have increased compared to
    FY2004. The Board proposes restoring customer service to FY2003/4
    levels and investing in telephone infrastructure. It is far less
    expensive to prevent or solve a problem early on than let it grow.
        The Board proposes a modest increase in resources for virtually all
    IRS enforcement activities. This is money well-spent and there is a
    growing recognition of the positive return on money invested in the
    IRS. The Board strongly believes that the enforcement increase includes
    a significant investment in research to better understand enforcement
    and customer service needs and the impact of customer service on
    voluntary compliance. The Board's recommended budget puts the IRS on
    track to make the National Research Program (NRP) permanent and produce
    annual tax gap estimates. The Board further recommends that the IRS
    consider developing a long-term strategic plan for research.
        Business Systems Modernization is also a priority and the Board
    advocates a larger investment in information technology to improve IRS
    productivity and reduce taxpayer burden. Despite productivity
    improvements in recent years, the IRS is still hampered in its efforts
    to modernize because of its reliance on a forty-year-old information
    system for its central recording-keeping functions, which limit the IRS
    to weekly updates of its central taxpayer records. No modern financial
    institution in the private sector could survive under these conditions
    and eliminating these limitations is key to making the IRS an efficient
    and effective modern financial institution.
        Last, the Board recommends a number of management increases that
    will help the IRS cope with unfunded mandates, implement BSM projects,
    and restore leadership training to FY2003 levels, which has become
    especially critical during a period in which over 50 percent of IRS
    managers are eligible to retire.
        Overall, the Oversight Board proposes a budget that is good for the
    country, good for taxpayers, and allows the IRS to achieve its
    strategic goals and objectives in an efficient and effective manner. It
    calls for $11.3 billion funding for FY2007, a 6.9 percent increase over
    last year's appropriation.
        The Board has also voiced concern that two items in the
    Administration's proposed FY2007 budget for the IRS pose significant
    risks. First, the budget proposes $84 million in savings from program
    efficiencies. The Oversight Board believes there is a risk that these
    reductions will decrease performance. Second, last December the IRS
    announced that it would dramatically raise fees for certain services
    and the President's budget assumes that the IRS will receive an
    additional $135 million in fee revenue. Although the IRS has expressed
    confidence it would receive this amount in additional fees based on its
    estimates, there is still some risk whether the estimated fee revenue
    can be achieved. In addition, external stakeholders have expressed
    concern that the additional fees could have an unintended negative
    impact on taxpayer compliance.
        In conclusion, the Board believes that it has constructed a
    fiscally responsible and realistic budget for the IRS that meets
    national needs and priorities. It would help shrink the tax gap while
    providing taxpayers with a level of service they rightly deserve and
    need. It would speed the modernization of the IRS' antiquated
    technology and give it the research tools to better understand current
    and developing trends. Most importantly, it would maintain that
    delicate but critical balance between enforcement and customer service
    that America's taxpayers have said time and again they want, and which
    has been validated through the Board's Taxpayer Attitude Survey. The
    IRS is now solidly on the right track and is making progress, but we
    must give it the resources to do its job. It is the right investment
    for this and future generations of taxpayers.
    Recommended IRS Oversight Budget in Brief
        The IRS Oversight Board recommends an FY2007 IRS budget of $11.31
    billion, an increase of $732 million over the enacted FY2006 budget.\1\
    This recommendation compares to the President's budget request for the
    IRS of $10.59 billion in direct appropriations. The two budgets share
    the following characteristics:

          Both reflect the same adjustments for inflation, $272
    million
          Both show a savings and reinvestment of $121.6 million
          Both are supplemented by $135 million in increased user
    fees to achieve a higher operating level

        The Board's budget, however, proposes program increases of $705
    million compared to a proposed program decrease of nearly $9 million in
    the President's budget, as shown in the table below.

              Comprison of Board and President's Program Increases
                           (all dollars in thousands)
    ------------------------------------------------------------------------
                                         Oversight Board       President's
                 Function                 Recommendation         Request
    ------------------------------------------------------------------------
    Taxpayer Service                   $ 43,637             $     0
    ------------------------------------------------------------------------
    Enforcement                        $367,768             $     0
    ------------------------------------------------------------------------
    Infrastructure and Mgt             $104,715             $20,900
     Modernization
    ------------------------------------------------------------------------
    Business Systems Modernization     $188,600             ($29,700)
    ------------------------------------------------------------------------
    Total Program Increases            $704,720             ($ 8,800)
     (Decreases)
    ------------------------------------------------------------------------

        Recommended initiatives for enforcement, customer service,
    infrastructure and management and Business Systems Modernization can be
    found in the individual sections of this statement and Appendices 2
    through 5.
    IRS Performance from FY2001 to FT2005
        The agency, which had become synonymous with poor customer service
    in the late 1990s, has demonstrated a remarkable performance
    improvement in the last five years. Toll-free telephone level of
    service has steadily increased from 56 percent in FY2001 to a high of
    87 percent in FY2004. (In FY2005, there was a slight three percent drop
    which the IRS attributes to reduced funding for taxpayer services.)
    Toll-free tax law accuracy also rose from 82 percent in FY2003 to an
    impressive 88 percent in FY2005.
        Perhaps the most important and notable gain recorded over the past
    five years is the percent of individuals filing electronically--31
    percent in FY2001 to 51 percent in FY2005.\2\ And although it will miss
    the 2007 deadline, the IRS is making steady progress in closing in on
    the 80 percent e-file goal established by the IRS Restructuring and
    Reform Act of 1998.
        Through targeted investments and greater management focus, IRS
    enforcement has also turned the corner. Enforcement revenue rebounded
    from $33.8 billion in FY2001 to $44.1 billion in FY2005. Audit rates
    also steadily increased. For high-income individuals they rose from
    0.79 percent in FY2001 to 1.61 percent in FY2005. Over the same time
    period, corporate and small business audits increased respectively from
    13.5 percent to 16.9 percent and 0.88 percent to 1.32 percent.
    Taxpayers Respond to Better Performance but Problems Remain
        This across-the-board improved performance has not gone unnoticed--
    especially among taxpayers. According to the 2005 American Customer
    Service Index, overall satisfaction among individual tax filers with
    the IRS remains stable at 64 percent. However, the number is much
    higher among e-filers who had an ACSI score of 77 percent.\3\ By way of
    comparison, the IRS received a 51 percent score in 1998. Taxpayer
    attitudes have also improved. Since 2002, the IRS Oversight Board has
    conducted an annual survey to gain a deeper understanding of taxpayers'
    attitudes. Of great concern was the growing number of individuals who
    thought it acceptable to cheat on their taxes.
        In 2003, twelve percent of respondents thought it acceptable to
    cheat a ``little here and there'' on their taxes, and five percent
    would cheat as much as possible. However, two years later those numbers
    have dropped to seven and three percent respectively and public support
    for tax compliance is at an all-time high. Moreover, the 2005 survey
    found that 82 percent of respondents say that their own personal
    integrity has the greatest influence on whether or not they report and
    pay their taxes honestly--double the number who cite any other factor.
    Significantly, the survey also found two out of three surveyed
    expressed continued support for additional funding for both IRS
    assistance and enforcement.\4\ America's taxpayers want a balanced tax
    administration system.
        However, as welcome as the news may be, it cannot disguise the hard
    fact that the tax gap has remained unacceptably high. In testimony
    before the Senate Budget Committee, Comptroller General David Walker
    stated that the $345 billion tax gap estimated by the IRS could indeed
    be greater: ``IRS has concerns with the certainty of the overall tax
    gap estimate in part because some areas of the estimate rely on old
    data and IRS has no estimates for other areas of the tax gap. For
    example, IRS used data from the 1970s and 1980s to estimate
    underreporting of corporate income taxes and employer-withheld
    employment taxes.'' \5\
        The tax gap is more that an abstract number. According to National
    Taxpayer Advocate Nina Olson, it hurts taxpayers in a very concrete
    way:
        The collective failure by certain taxpayers to pay their taxes
    imposes greater burdens on other taxpayers. The IRS receives
    approximately 130 million individual income tax returns each year.
    Given the size of the net tax gap, the average tax return includes a
    ``surtax'' of about $2,000 to make up for tax revenues lost to
    noncompliance. The tax gap may also impose significant costs on
    businesses in the form of unfair competition by noncompliant
    competitors who can pass along a portion of their tax ``savings'' to
    customers by charging lower prices.
        Most importantly, the tax gap can erode the level of confidence
    that taxpayers have in the government, thereby reducing federal revenue
    and increasing the need for more examination and collection actions.
    The tax gap, then, can produce a vicious cycle of increased
    noncompliance and increased enforcement.\6\
        The IRS Oversight Board believes that its FY2007 IRS budget
    recommendations are part of the solution to reversing this corrosive
    trend.
    Budget Environment Should Not Discourage Investment
        The IRS does not operate in a vacuum and the Oversight Board
    recognizes that the current budget environment stresses fiscal
    restraint and austerity. However, at the same time, we should not throw
    up our hands in defeat and say we can do no more to improve tax
    administration. We should look at the larger picture.
        Unlike other government agencies, there is a positive return on
    money invested in the IRS. Senate Budget Committee Chairman Judd Gregg
    agrees. He observed at a recent hearing on the tax gap, ``We've got to
    talk to the CBO about scoring on that [investing in IRS enforcement],
    clearly there's a return on that money.'' \7\
        The Board would welcome such a change but also recognizes that this
    is a problem that has plagued the IRS for decades. Former IRS
    Commissioner Charles O. Rossotti wrote:
        When I talked to business friends about my job at the IRS, they
    were always surprised when I said that the most intractable part of
    job, by far, was dealing with the IRS budget. The reaction was usually,
    ``Why should that be a problem? If you need a little money to bring in
    a lot of money, why wouldn't you be able to get it? \8\
        Indeed, this lack of recognition of a direct return on investment
    has left many puzzled. In his April 14, 2004 column, Washington Post
    financial writer Al Crenshaw wondered why the Administration and
    Congress ``aren't falling over themselves to give the IRS more money.
    Tax Enforcement pays for itself many times over, and it would be a good
    way to cut the deficit.'' \9\
        In its FY2007 budget recommendation, the Board calls for increases
    in enforcement that would result in a real return on investment,
    ranging from three to six dollars on every dollar spent, resulting in
    $730 million revenue by FY2009 on a $242 million investment.
        The Oversight Board urges Congress to adopt the Board's budget
    recommendations and invest in more effective tax administration.
    SIX STRATEGIES TO REDUCE THE TAX GAP
        The Board considers the existence of such a large tax gap to be an
    affront to honest taxpayers, and is pleased with the attention that
    Congress has focused on the tax gap in the last year, especially with
    the release of IRS latest tax gap estimates. The Board, along with many
    other members of the tax administration community, believe that
    reducing the tax gap requires a comprehensive, multi-faceted plan with
    action on many fronts--from a simpler tax code and more complete income
    reporting to better enforcement and quality customer service.
        Such an approach needs to be more thoughtful and comprehensive than
    merely increasing IRS resources and expecting that the gap will shrink.
    That being said, however, increased IRS resources are a part of the
    solution. A successful strategy will encompass several separate but
    interrelated approaches that will reinforce each other to produce the
    desired result. In the Board's opinion, a number of actions that can be
    taken will require additional IRS resources.
        The Board supports six strategies that it believes would constitute
    an over-arching plan to reduce the tax gap. This information is
    presented here only to provide some additional background to understand
    the Board's FY2007 budget recommendations, so that these
    recommendations can be understood in the context of an overall approach
    where the individual elements reinforce each other.
        The first is a simplified tax code. Our complex and ever changing
    tax code not only confounds honest taxpayers who want to comply with
    their obligations under the law, but provides ample opportunity for
    those who exploit its complexity to cheat. The President's Advisory
    Panel on Federal Tax Reform observed:
        Since the last major reform effort in 1986, there have been more
    than 14,000 changes to the tax code, many adding special provisions and
    targeted tax benefits, some of which expire after only a few years.
    These myriad changes decrease the stability, consistency, and
    transparency of our current tax system while making it drastically more
    complicated, unfair, and economically wasteful. Today, our tax system
    falls well short of the expectations of Americans that revenues needed
    for government should be raised in a manner that is simple, efficient,
    and fair.\10\
        Second, the Oversight Board recommends improved information
    reporting and enforcement tools to address large areas of the tax gap
    related to what has been called the cash economy. Although the Board is
    prohibited by statute from endorsing any specific proposal, we note
    that in its FY2007 budget submission for the IRS, the Administration
    makes five legislative recommendations to close the tax gap that
    include: (1) increasing information reporting on payment card
    transactions; and (2) expanding information reporting to certain
    payments made by federal, state and local governments to procure
    property and services. They certainly merit congressional discussion
    and consideration.
        The National Taxpayer Advocate also recommended in her 2005 Annual
    Report to Congress that the IRS create a cash economy program office,
    similar to the Earned Income Tax Credit program office. The Board is
    pleased that the IRS Small Business/Self-Employed Operating Division
    Commissioner has agreed to establish a task force on the cash economy
    that will seek to determine the feasibility of this and other
    recommendations.
        In testimony before the Senate Budget Committee, the National
    Taxpayer Advocate further recommended that to address the tax gap ``we
    should begin by identifying various categories of transactions that
    currently are not subject to information reporting and determine, on a
    case-by-case basis, whether the benefits of requiring reporting
    outweigh the burdens such a requirement would impose.'' \11\ The Board
    supports such analysis.
        Third, the Board believes that the IRS must improve customer
    service to make taxpayers aware of their legal obligations and ease
    taxpayer burden through modernization. Indeed, not all non-compliance
    is willful; a significant amount of is due to the complexity of the tax
    laws that results in errors. IRS Commissioner Mark Everson recently
    testified:
        [T]he tax gap does not arise solely from tax evasion or cheating.
    It includes a significant amount of noncompliance due to the complexity
    of the tax laws that results in errors of ignorance, confusion, and
    carelessness. This distinction is important, though, at this point, we
    do not have sufficiently good data to help us know how much arises from
    willfulness as opposed to innocent mistakes. This is an area where we
    expect future research to improve our understanding.\12\
        Fourth, there should be a much greater emphasis and focus on
    research so the IRS can more effectively target areas of major non-
    compliance. It bears mentioning that a lack of research in the 1990s
    contributed in part to the IRS' failure to detect the emergence and
    subsequent epidemic of illegal tax avoidance schemes. The Board
    recommends an additional $60 million in funding for research. The IRS
    needs to know much more about non-compliance than it currently does to
    mount a successful campaign against the tax gap.
        Fifth, the Board urges a more productive partnership between IRS
    and the tax administration community. At the Board's 2006 open meeting,
    the AICPA supported the IRS' efforts to partner with professional
    organizations in the area of pro bono tax assistance, noting that such
    a synergy provides the IRS with the opportunity to leverage precious
    resources and increase customer service at the same time. The Board
    would add that such a partnership also contributes directly to
    compliance.
        Sixth, there must be more emphasis on personal integrity in making
    tax decisions. The Board has found that the vast majority of taxpayers
    state that their personal integrity is a very import factor in
    influencing their tax compliance. In the Board's most recent Taxpayer
    Attitude Survey, 82 percent of taxpayers cite personal integrity as the
    principal factor for reporting and paying their taxes honestly.
    Commissioner Everson also testified at the Senate Budget Committee tax
    gap hearing:
        [A]nother 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. The vast majority of practitioners
    are conscientious and honest, but even the honest tax professionals
    suffered from the sad and steep erosion of ethics in recent years by
    being subjected to untoward competitive pressures.\13\
        Our tax administration system should challenge taxpayers to be
    conscious of the need for integrity when making tax decisions.
        The Oversight Board recognizes that no single initiative or program
    will solve the tax gap--a multi-faceted effort must be taken to shrink
    it. The plan must be more comprehensive than just applying additional
    resources to do more of what is being done today. Indeed as
    Commissioner Everson told the Senate Budget Committee, a combination of
    appropriate funding, legislative changes, new enforcement tools, tax
    simplification and auditing and taxpayer service improvements, will
    allow the IRS to collect an additional $50-100 billion.\14\ The $705
    million in additional funding recommended by Board to help in this
    effort is dwarfed in comparison to this estimate of new revenues
    collected.
    COMPARING THE PRESIDENT'S AND BOARD'S FY2007 BUDGET RECOMMENDATIONS
        The size of the tax gap should be a clarion call for our nation to
    examine the tax administration system and invest time, energy, and
    resources to making it better.
        This is not the time to stand still but to move forward in a
    comprehensive and unified way to build on what has already been
    accomplished and give America's taxpayers a better, more efficient and
    fair system in return--what the President's tax reform panel suggested.
    The Oversight Board's FY2007 budget recommendations focus on the IRS
    resources needed to move forward in FY2007, but much more needs to be
    done.
        To this end, the Board recommends additional investments in better
    service, enforcement, infrastructure and management, and BSM in the
    following amounts:

    Taxpayer Service                              $ 43,637
    Enforcement                                   $367,768
    Infrastructure and Management                 $104,715
    BSM                                           $188,600

        Additionally, the Oversight Board has identified two areas of
    significant risk in the IRS' FY2007 budget request. First, the IRS
    budget justification includes $84.1 million in savings coming from
    program efficiencies. The Board is concerned that the IRS may not be
    able to achieve these efficiencies without decreasing performance.
        Second, the proposed IRS budget for FY2007 in direct appropriations
    is supplemented by $135 million in increased user fees. The IRS
    announced last December that it would charge taxpayers for receiving
    advance assurance from the IRS about the tax consequences of certain
    transactions. For example, the fee for IRS Chief Counsel private letter
    rulings will increase from $7,000 to $10,000.\15\
        The Oversight Board believes that there is risk in assuming that
    this revenue stream will be available without a proven record of
    collecting fees at this level, especially since the IRS could not
    present the Board with FY2006 data to confirm the realism of the
    proposed FY2007 revenue stream. The Board recommends that Congress
    evaluate actual FY2006 fee collection data to evaluate the validity of
    the proposed FY2007 revenue expected from increased fees.
        The Board is also concerned about the negative impact these fees
    might have on taxpayer compliance. Testifying at the Board's annual
    public meeting, the AICPA was also apprehensive that these increases
    will result in a substantial reduction in general taxpayer use of
    critical IRS programs:
        These programs for the most part encourage taxpayers to seek
    advance assurance from the IRS that the tax consequences of their
    proposed actions will be treated consistently by both the taxpayer and
    the IRS. Actions by the IRS that discourage use of programs, such as
    private letter ruling requests, could result in greater compliance
    costs for taxpayers and enforcement costs for the IRS.\16\
    Customer Service: What Is ``Good Enough?''
        Good customer service leads to fully informed and satisfied
    taxpayers who understand their tax obligations and experience few
    problems in interacting with the IRS. Clearly, there is a linkage
    between customer service and compliance. Speaking at the Board's 2006
    open meeting, Diana Leyden, Associate Clinical Professor of Law,
    University of Connecticut School of Law Tax Clinic said:
        Customer service at the Internal Revenue Service has a direct
    impact on voluntary compliance and ultimately on the tax gap. For
    example: (1) making it easier for taxpayers to get their returns
    prepared free of charge and quickly encourages taxpayers to become
    compliant; (2) providing face-to-face interaction with IRS employees
    helps taxpayers get advice in `real time' and usually reduces the time
    for resolution of problems.\17\
        At the April 14, 2005 Senate Finance Committee hearing on closing
    the tax gap, Ranking Member Max Baucus similarly observed:
        The IRS cannot close the tax gap simply by increasing enforcement.
    Issuing more liens. Conducting more seizures. Levying more bank
    accounts. We do need targeted, appropriate enforcement. If, however,
    the IRS lets taxpayer service slide--if the IRS diminishes the access
    and accuracy of taxpayer service--including the essential need for
    face-to-face taxpayer service--then we fail to help taxpayers comply
    with the law on the front end. Ensuring up front quality is more
    efficient than back end enforcement.\18\
        However, efforts to provide quality customer service are hindered
    by the fact that there is no consensus among the tax administration
    community on desired customer service standards of performance, which
    makes informed decision-making about desired levels of service very
    difficult. Achieving such a consensus among the executive and
    legislative branches and external stakeholder organizations would allow
    customer service requirements to influence budget decisions rather than
    having budget decisions set service levels.
        The drive for improved customer service is further aggravated by
    the lack of data on the impact that service levels have on taxpayer
    compliance. Such data could be used to make a stronger case to policy
    makers about the importance of customer services. We should not retreat
    from the high customer service levels previously achieved during
    FY2003/2004. Two initiatives contained in the Board's budget are
    designed to prevent such a reduction.
        First, although significant progress has been made during the past
    five years, toll-free telephone level of service is slightly down from
    FY2004 and call wait-time on hold has increased. To restore the level
    of service, the Oversight Board proposes an initiative to restore the
    toll-free telephone service to FY2003/2004 levels. Although the cost is
    $35 million, the Board believes that this level of service should be
    provided to taxpayers. The potential impact of lower service is that
    taxpayers will not get the assistance they need, hurting compliance,
    and creating a need for additional enforcement. As Senator Baucus
    rightly observed, preventing problems is more cost-effective than the
    price of future corrections, such as collection.
        Second, the Board also recommends an $8.7 million investment in
    telephone infrastructure to expand services to callers and provide
    telephone representatives with a more state-of-the-art call center
    environment. The IRS predicts this investment would result in lower
    queue times across the enterprise for all applications and would
    counter a negative trend in telephone service. (Wait time on hold for
    taxpayers has been increasing in the last three years. It has gone from
    158 seconds in FY2004 to 258 seconds in FY2005, and the FY2006 target
    is 300 seconds.)
    Enforcement Must Continue to Improve; More Research Needed
        As noted earlier in this report, the IRS has boosted its
    enforcement activity, and enforcement revenue has increased during the
    last two years. The IRS is working smarter and it needs to continue to
    improve and build on this important trend.
        However, it should be noted that despite these positive results, it
    is difficult to evaluate the impact that increased enforcement activity
    has had on overall taxpayer compliance.
        Absent this information, the Oversight Board still believes that
    one important element of the campaign to reduce the tax gap should be
    increasing IRS enforcement resources, especially since the application
    of additional resources has a positive return on investment. The Board
    recommends a modest increase in enforcement resources in virtually all
    IRS enforcement activities, including:

        1.  Combat Egregious Non-Compliance and Prevent Tax Gap Growth
    (+$136 million) Add 748 FTEs to enhance coverage of high-risk
    compliance areas and address the tax gap associated with small business
    and self-employed taxpayers.
        2.  Intensify Tax Enforcement (+$28 million) Add 86 FTEs to curtail
    non-compliance in abusive schemes, corporate fraud, non-filers,
    employment tax and Bank Secrecy Act
        3.  Attack Fraudulent Payments (+$27 million) Add 62 FTEs to
    address fraudulent payments made through the EITC program.

        The IRS must also do a better job of identifying where non-
    compliance is occurring. For example, IRS data indicates impressive
    results on abusive, high-profile tax shelters, such as Son-of-BOSS.
    However, the most recent research indicates that a majority of the tax
    gap is the result of underreporting of income in areas where there is
    little third-party reporting.
        According to the IRS' National Research Program, half ($109
    billion) of the individual underreporting gap came from understated net
    business income (unreported receipts and overstated expenses).
    Approximately 28 percent ($56 billion) came from underreported non-
    business income, such as wages, tips, interest, dividends, and capital
    gains. The remaining $32 billion came from overstated subtractions from
    income (i.e. statutory adjustments, deductions, and exemptions), and
    from overstated tax credits.
        Given this situation, the Oversight Board believes that special
    attention should be placed on the National Research Program and
    additional research be conducted on customer service and its relation
    to compliance. Indeed, the National Taxpayer Advocate ``recommends that
    the IRS undertake a research-driven needs-assessment, from the
    taxpayers' perspective, to help identify what services taxpayers need
    and want and how best to deliver them.'' \19\ These efforts are
    necessary to improve tax administration to the point where the effects
    of IRS activities on taxpayer compliance can be better understood. To
    this end, the Board proposes two research initiatives: (1) Improve Tax
    Gap Estimates (+$46 million); and (2) Additional Customer Service
    Research (+$15 million).
        The first of these two initiatives, Improve Tax Gap Estimates, will
    establish permanent staffing for the NRP program and put the IRS on a
    path to conducting research annually. The Oversight Board recommends
    that the NRP be made a permanent program. The NRP is now reporting
    estimates of the tax gap based on 2001 tax returns. Prior estimates
    were based on extrapolations of 1988 data. It is time to progress from
    ``catching up'' to making current research the normal and preferred way
    of doing business.
        The Board also proposes that the IRS consider developing a long-
    range strategic plan for research that goes beyond the current 2009 end
    date for the IRS Strategic Plan, and covers approximately a decade. In
    such a plan, the IRS should describe how it will bring its research on
    all taxpayer segments up to date, and perform a limited sample every
    year so that its research on all segments will be as current as
    possible.
        The Board believes the availability of up-to-date research data
    will allow the IRS to more effectively focus its service and
    enforcement programs on areas that have the greatest impact on taxpayer
    compliance, and use the changes in taxpayer compliance rates as
    feedback to evaluate the effectiveness of IRS' service and enforcement
    program on actual taxpayer compliance. Achieving such a capability will
    be a vast improvement over the current situation in which the lack of
    data makes it virtually impossible to evaluate the effectiveness of IRS
    activity on taxpayer compliance and make informed decisions.
        The second research initiative recommended by the Board is to add
    $15 million to begin research on the impact of customer service on
    voluntary compliance and the service needs of taxpayers. The need for
    such research is also consistent with recommendations made by Treasury
    Inspector General for Tax Administration and the National Taxpayer
    Advocate in testimony last year to the Senate Appropriations Committee
    on the closing of a number of Taxpayer Assistance Centers. (The
    committee has also requested TIGTA to evaluate the connection between
    service and compliance in its study of TAC closings, but TIGTA was
    unable to find much existing research.)
        However, the IRS has told the Oversight Board that it could extend
    and update research efforts in two major areas: evaluating the service
    needs of taxpayers and estimating the effect of customer service on
    taxpayer compliance. Additional resources in FY2007 would be used to
    further evaluate the service needs of taxpayers and to scope and design
    the data gathering and analysis capability to estimate the effect of
    customer service on taxpayer compliance.
        A modest initial effort should include identifying promising areas
    of research and determining data needs. If the initial efforts are
    promising, this could be expanded in future years. Due to the long-term
    nature of these studies, resources should be provided on a multi-year
    basis.
    Modernizing Infrastructure and Management
        The Oversight Board is pleased that the IRS is developing an IRS
    Infrastructure Roadmap. It is a detailed plan for replacing the
    agency's aging IT equipment in an orderly and cost-effective manner.
    Rather than replacing outdated equipment on a one-for-one basis, the
    roadmap will identify and prioritize opportunities to consolidate
    equipment, retire redundant and low-demand infrastructure components,
    and replace old equipment with new technology that is cheaper to
    maintain and use. Because the IRS fully anticipates that the
    Infrastructure Roadmap will identify new strategies for IT
    infrastructure delivery that will mitigate the cost of replacing old IT
    equipment while assuring a sound IRS IT infrastructure, the Board is
    deferring any recommendations on modernizing IT infrastructure until
    FY2008.
        The Oversight Board does recommend funding infrastructure and
    management initiatives that will assist the IRS to cope with unfunded
    mandates, implement BSM projects, and restore its capacity for
    leadership development training to FY2003 levels:

        1.  Fund Business Unit IT Solutions (Non-Major Investments)
        2.  Implement e-Travel
        3.  Fund HR Connect
        4.  Consolidate Philadelphia Campus (included in the President's
    budget)
        5.  Restoration of Leadership Development Training to FY2003 levels
    (Board-initiated)

        The Board notes that a lack of leadership training capacity at the
    IRS is especially critical during a period in which approximately 50
    percent of IRS managers are eligible for retirement. The Board
    recommends a consistent budget base to allow planning for these
    anticipated leadership development training needs.
        The requested funds would enable the IRS to: (1) eliminate the
    backlog of untrained leaders at all levels by the end of FY2007; (2)
    ensure enough capacity to train new managers upon selection in all
    Business Units; (3) improve and expand readiness programs to provide a
    cadre of manager candidates to step up to management positions; (4)
    revise the management curriculum to incorporate more e-learning and
    promote continuous learning; and (5) evaluate the effectiveness and
    impact of the leadership development training program.
        Funding Leadership Development Training at FY2003 levels will also
    assist in meeting the objectives of the President's Management Agenda,
    which in turn will improve performance and the IRS' objectives of
    enhanced employee engagement, employee satisfaction and customer
    satisfaction.
    Business Systems Modernization
        The Board is pleased that the IRS' once-troubled BSM program
    experienced better performance in FY2005. In a recent report submitted
    to Congress on the BSM FY 2006 expenditure plan, the Government
    Accountability Office offered these positive comments:
        IRS has made further progress in implementing BSM--Future BSM
    project deliveries face significant risks and issues which IRS is
    addressing--.IRS has made additional progress in addressing high-
    priority BSM program improvement initiatives. [They] appear to be an
    effective means of assessing, prioritizing, and addressing BSM issues
    and challenges--In response to our prior recommendations, IRS reports
    having efforts under way to develop a new Modernization Vision and
    Strategy to address a new modernization roadmap.\20\
        GAO also had some criticism of the IRS and BSM, but improved
    management focus over the past few years has helped the BSM program
    deliver within cost and budget targets important technology projects
    that will generate greater efficiencies throughout the agency and real
    world benefits for taxpayers.
        The first taxpayers have already been moved to a modernized data
    base known as the Customer Account Data Engine (CADE) and corporate
    taxpayers are now able to file their income tax returns with the IRS
    electronically using the Modernized e-File system. Indeed, CADE will
    process more than 30 million returns in 2007 and will process 70
    million by 2009. Daily updates by CADE will allow taxpayers to receive
    their refund in just a few days.
        Future BSM deliverables are also critical to improved customer
    service and enforcement. The IRS does not yet offer products and
    services familiar to customers of many financial institutions, such as
    daily updating of accounts, electronic access by customers to account
    records, and a full range of electronic transactions. However, with the
    help of modern technology, the IRS can close this gap.
        If the IRS can continue to demonstrate improvement, it would seem
    desirable and logical to increase BSM's pace and program funding in
    FY2007, especially as BSM funding levels were severely reduced in the
    last several years: from $388 million in FY2004 to $203 million in
    FY2005, and a requested $199 million in FY2006. In addition to the
    base, the Board would fund:

        1.  Web-based Self-service (+$24 million)
        2.  Filing and Payment Compliance (+$30 million)
        3.  Modernized e-Filing (+$70 million)
        4.  Customer Account Date Engine (+$25 million)
        5.  Core Infrastructure (+$18 million)
        6.  Architecture, Integration, and Management (+$13 million)
        7.  Management Reserve (+$9 million)

        Therefore, the Board recommends that the BSM program move forward
    at an accelerated pace. Not only will this allow the IRS to operate
    more efficiently and effectively, it will strengthen the agency's
    efforts to enforce the tax law and improve customer service. Despite
    productivity improvements in recent years, the IRS is still hampered in
    its efforts to modernize because of its reliance on a forty-year-old
    information system for its central recording-keeping functions, which
    limit the IRS to weekly updates of its central taxpayer records. No
    modern financial institution in the private sector could survive under
    these conditions, and eliminating these limitations is key to making
    the IRS an efficient and effective modern financial institution.
        We would like to make one last point on modernization. Both GAO and
    TIGTA have reported on the cost overruns and delays the BSM program has
    experienced. However, one cost you will not hear about is the
    significant cost to the taxpayers of delaying the benefits of a
    modernized IRS.
        Professor Joel Slemrod of the University of Michigan testified to
    the President's Advisory Panel on Federal Tax Reform that individual
    taxpayers spend approximately $85 billion a year complying with the tax
    code.\21\ If a modernized IRS makes taxpayers only five percent more
    efficient, that would still save taxpayers over $4 billion a year.
    Electronic Filing
        Another topic that is important to millions of taxpayers is the
    ability to electronically file their tax returns. Electronic filing of
    individual tax returns so far this filing season is growing at a 2.6
    percent rate compared to the previous year. Although the filing season
    is far from over, this growth rate is below the historical growth rate
    and seems to be influenced by the following two factors:

          The loss of approximately 2.6 million TeleFile returns
          Fewer returns received through the Free File Alliance,
    which is not offering free tax preparation and electronic filing for
    taxpayers with income in excess of $50,000 this year. Last year this
    capability was offered to all taxpayers.

        The Board had reported in its 2005 Electronic Filing report to
    Congress that although the e-filing goal had had very positive impacts
    on the IRS and taxpayers, the IRS will not meet its congressionally-
    mandated goal of 80 percent of all returns filed electronically by
    2007, and that other groups, such as the Electronic Tax Administration
    Advisory Council (ETAAC) have made similar observations. In this
    report, the Board recommended that Congress extend the goal to 2011,
    and performed an analysis to demonstrate the revised goal was
    realistic.
        The Board is concerned that the 2007 goal is becoming so widely
    perceived as unrealistic that it is losing its potency. Extending the
    goal to 2011, as recommended by the Board, will not only clarify
    congressional intent that the goal is important, but by setting a
    realistic date it will restore the goal's ability to influence key
    policy decisions that affect electronic filing.

    CONCLUSION
        The IRS Oversight Board believes that it has constructed a fiscally
    responsible and realistic budget for the IRS that meets national needs
    and priorities. It would help shrink the tax gap while providing
    taxpayers with a level of service they rightly deserve and need. It
    would speed the modernization of the IRS' antiquated technology and
    give it the research tools to better understand current and developing
    trends. Most importantly, it would maintain that delicate but critical
    balance between enforcement and customer service that America's
    taxpayers have said time and again they want. The IRS is now solidly on
    the right track and is making progress but we must give it the
    resources to do its job. It is an investment we must make for this and
    future generations of taxpayers.
                                     ______

    Appendices:
        1.  Comparison of the Administration's IRS FY2007 Budget Request
    and IRS Oversight Board Recommendation
        2.  Recommended FY2007 Program Increases: Enforcement
        3.  Recommended FY2007 Program Increases: Taxpayer Service
        4.  Recommended FY2007 Program Increases: Infrastructure and
    Management Modernization
        5.  Recommended FY2007 Program Increases: Business Systems
    Modernization
        6.  Explanation for Difference in IRS Oversight Board Budget in the
    Administration's FY2007 Budget Request and this Recommendation

        Appendix 1:

      Comparison of the Administration's IRS FY2007 Budget Request and IRS
                         Oversight Board Recommendations
                           (all dollars in thousands)
    ------------------------------------------------------------------------
                                       Board's    President's
           Final Board Budget          budget        Budget      Difference
    ------------------------------------------------------------------------
    FY2006 Enacted budget (with 1%   $10,573,70  $10,573,706    $0
     rescission)                      6
    ------------------------------------------------------------------------
    FY2007 Maintaining Current       ..........  .............  ............
     Levels (MCLs) Adjustments
     (includes HITCA)
    ------------------------------------------------------------------------
      Labor Annualization            $61,994     $61,994        $0
    ------------------------------------------------------------------------
      Labor MCL (2.7 %)              $149,819    $149,819       $0
    ------------------------------------------------------------------------
      Non-Labor MCL (1.5 %)          $60,418     $60,418        $0
    ------------------------------------------------------------------------
          Total MCL Adjustments      $272,231    $272,231       $0
    ------------------------------------------------------------------------
    Base Reinvestment                ..........  .............  ............
    ------------------------------------------------------------------------
      Increase Returns processing    $12,237     $12,237        $0
     efficiencies
    ------------------------------------------------------------------------
    Program Cost Savings             ..........  .............  ............
    ------------------------------------------------------------------------
      E-file savings                 ($6,760)    ($6,760)       $0
    ------------------------------------------------------------------------
      Improvement project savings    ($8,215)    ($8,215)       $0
    ------------------------------------------------------------------------
      Competitive sourcing savings   ($17,000)   ($17,000)      $0
    ------------------------------------------------------------------------
      Program efficiencies           ($84,121)   ($84,121)      $0
    ------------------------------------------------------------------------
      HITCA program efficiency       ($5,500)    ($5,500)       $0
    ------------------------------------------------------------------------
          Total Savings and          ($121,596)  ($121,596)     $0
     Reinvestments
    ------------------------------------------------------------------------
    Transfer Out to TIGTA            ($941)      ($941)         $0
    ------------------------------------------------------------------------
          Total, FY2007 Current      $10,735,63  $10,735,637    $0
     Service Level                    7
    ------------------------------------------------------------------------
    Program Increases                ..........  .............  ............
    ------------------------------------------------------------------------
      Tax Administration Operations  ..........  .............  ............
    ------------------------------------------------------------------------
      Taxpayer Service               $43,637     $0             $43,637
    ------------------------------------------------------------------------
      Enforcement                    $367,768    $0             $367,768
    ------------------------------------------------------------------------
      Infrastructure and Mgt         $104,715    $20,900        $83,815
     Modernization
    ------------------------------------------------------------------------
      Business Systems               $188,600    ($29,700)      $218,300
     Modernization
    ------------------------------------------------------------------------
      Total, Program Increases       $704,720    ($8,800)       $713,520
     Above FY2006 Current Service
     Level
    ------------------------------------------------------------------------
          Total, FY2007 Operating    $11,440,35  $10,726,837    $713,520
     Level                            7
    ------------------------------------------------------------------------
    Fee Adjustment                   ($135,000)  ($135,000)     ............
    ------------------------------------------------------------------------
    FY2007 Budget Appropriation      $11,305,35  $10,591,837    $713,520
     Request                          7
    ------------------------------------------------------------------------
    Growth Over FY2006 Enacted       $731,651    $18,131        $713,520
     Budget
    ------------------------------------------------------------------------
    Percent Growth                   6.9%        0.2%           ............
    ------------------------------------------------------------------------

        Appendix 2:

                Recommended FY2007 Program Increases: Enforcement
                                (In $/thousands)
    ------------------------------------------------------------------------
                                                  Enforcement-     Service-
      Enforcement Program Increases     Total       Related        Related
    ------------------------------------------------------------------------
    Combat Egregious Non-Compliance
     and Prevent Tax Gap Growth

    This initiative provides an       $135,518  $132,696         $2,822
     increase of 748 FTE and $135.5
     million to enhance coverage of
     high-risk compliance areas as
     well as address the tax gap
     associated with small business
     and self-employed taxpayers.
    ------------------------------------------------------------------------
    Increase Individual Taxpayer
     Filing and Payment Compliance

    The initiative provides 84 FTE    $7,773    $6,968           $805
     (87 positions) and $8 million
     to support the IRS' enforcement
     presence through contracts with
     Private Collection Agencies
     (PCAs) for Qualified Tax
     Collection Contracts.
    ------------------------------------------------------------------------
    Detect and Deter Non-Compliant
     Enterprise Structures
    This initiative provides an       $37,008   $37,008          ...........
     increase of 200 FTE (400
     positions) and $37 million to
     increase the coverage of the
     flow-through population,
     including examination of
     controlling enterprise
     entities, that are posing
     significant compliance risks.
    ------------------------------------------------------------------------
    Increase Individual Taxpayer
     Reporting Compliance
    This initiative provides an       $10,821   $8,808           $2,013
     increase of 100 FTE (125
     positions) and $10.8 million to
     enable the Automated
     Underreporter (AUR) program to
     address reporting compliance in
     a program that is effective,
     efficient, less labor intensive
     and less costly.
    ------------------------------------------------------------------------
    Enhance Enforcement in the Tax-
     Exempt and Governmental Sectors
    This initiative requests an       $12,941   $12,941          ...........
     additional 69 FTE (138
     positions) and $12,940,668 to
     improve detection of compliance
     risks, accelerate enforcement
     actions, and balance the
     pursuit of critical enforcement
     initiatives while maintaining
     adequate coverage of the exempt
     community.
    ------------------------------------------------------------------------
    Intensify Tax Enforcement
    This initiative requests an       $27,570   $27,570          ...........
     increase of 86 FTE (172
     positions) and $27.6 million to
     curtail non-compliance in the
     following areas: abusive
     schemes, corporate fraud, non-
     filers, employment tax and Bank
     Secrecy Act (BSA).
    ------------------------------------------------------------------------

          Recommended FY2007 Program Increases: Enforcement--Continued
                                (In $/thousands)
    ------------------------------------------------------------------------
                                                  Enforcement-     Service-
      Enforcement Program Increases     Total       Related        Related
    ------------------------------------------------------------------------
    Attack Fraudulent Payments
    This initiative, which provides   $26,998   $26,837          $161
     an increase of 62 FTE (123
     positions) and $27 million,
     relates directly to the
     President's Management Agenda
     Program Initiative
     ``Eliminating Improper
     Payments,'' and also supports
     the IRS' strategies for
     addressing erroneous payments
     and non-compliance involving
     Earned Income Tax Credits
     (EITC).
    ------------------------------------------------------------------------
    Improve Compliance With the Bank
     Secrecy and PATRIOT Acts
    This initiative provides an       $25,858   $25,858          ...........
     increase of 124 FTE (248
     positions) and $25.9 million to
     improve the Bank Secrecy Act
     (BSA) compliance program.
    ------------------------------------------------------------------------
    Strengthen Regulatory Compliance
    This initiative provides an       $6,616    $6,376           $241
     increase of 38 FTE (76
     positions) and $6.6 million to
     strengthen regulatory
     compliance activities to deter
     fraud, abuse, and terrorist
     financing in the tax exempt and
     governmental entities
     community.
    ------------------------------------------------------------------------
    Improve Enforcement of Circular
     230
    This initiative provides an       $4,104    $4,104           ...........
     increase of 8 FTE (16
     positions) and $4.1 million to
     detect and address tax
     practitioner misconduct. The
     IRS, Treasury, and Congress are
     placing increased emphasis on
     practitioner misconduct by
     providing new statutory and
     regulatory tools to address
     abusive behavior.
    ------------------------------------------------------------------------
    Improve Tax Gap Estimates,
     Measurement and Detection of
     Non-Compliance
    Supports 268 FTE (536 positions)  $45,942   $45,942          ...........
     and $45.9 million to fund and
     support ongoing Reporting
     Compliance Studies through the
     National Research Program.
    ------------------------------------------------------------------------
    Study EITC Compliance
    This initiative provides an       $6,822    $6,822           ...........
     increase of 49 FTE (65
     positions) and $6.8 million to
     develop estimates of Earned
     Income Tax Credit compliance.
    ------------------------------------------------------------------------

          Recommended FY2007 Program Increases: Enforcement--Continued
                                (In $/thousands)
    ------------------------------------------------------------------------
                                                  Enforcement-     Service-
      Enforcement Program Increases     Total       Related        Related
    ------------------------------------------------------------------------
    Improve Compliance Through Data-
     Driven Workload Identification
    This initiative provides an       $4,796    ...............  $4,796
     increase of 67.5 FTE (90
     positions) and $4.8 million to
     develop and test decision
     analytical tools and models for
     improved identification of high-
     risk filers.
    ------------------------------------------------------------------------
    Customer Service Research Begin   $15,000   $15,000          ...........
     research on the impact of
     customer service on voluntary
     compliance and the service
     needs of taxpayers.
    ------------------------------------------------------------------------
          Subtotal Enforcement        $367,768  $356,931         $10,837
    ------------------------------------------------------------------------

        Appendix 3:

             Recommended FY2007 Program Increases: Taxpayer Service
                                (In $/thousands)
    ------------------------------------------------------------------------
        Taxpayer Service Program                  Enforcement-     Service-
                Increases               Total       Related        Related
    ------------------------------------------------------------------------
    Increase Accounts Management
     Efficiencies
    Provides funding to improve the   $8,657    ...............  $8,657
     telephone infrastructure, e.g.,
     Compliance Services and
     Accounts Management call
     centers, by expanding services
     to customers and providing
     telephone representatives with
     a more state-of-the-art center
     environment and providing
     taxpayers with improved service
     through multiple access
     channels. Enterprise queuing
     will eliminate the queuing of
     calls at the local level and be
     queued at the enterprise level,
     reducing taxpayer wait times.
    ------------------------------------------------------------------------
    Restore Customer Service to
     FY2004 levels
    Supports 450 FTE from W&I to      $34,980   ...............  $34,980
     restore telephone level of
     service back to 87.3 percent
     achieved in FY2004 rather than
     the current 82 percent target.
     Improves TE/GE service measures
     for EP and EO determination
     timeliness, CAS toll-free level
     of service, correspondence
     timeliness measures to FY2004
     levels.
    ------------------------------------------------------------------------
          Subtotal: Taxpayer Service  $43,647   ...............  $43,647
    ------------------------------------------------------------------------

        Appendix 4:

       Recommended FY2007 Program Increases: Infrastructure and Management
                                  Modernization
                                (In $/thousands)
    ------------------------------------------------------------------------
         Infrastructure and Mgt                   Enforcement-     Service-
     Modernization Program Increases    Total       Related        Related
    ------------------------------------------------------------------------
    Expand IT Security--Personal
     Identity Verification
    This initiative requests an       $20,000   $12,576          $7,424
     increase of $20 million to
     ensure IRS' compliance with
     Homeland Security Policy
     Directive--12 (HSPD-12) and
     Federal Information Processing
     Standards-201 (FIPS-201).
    ------------------------------------------------------------------------
    Close Financial Management
     Material Weaknesses--Custodial
     Detail Data Base
    This initiative provides $4.7     $4,743    $2,982           $1,761
     million to develop the CFO
     Custodial Detail Data Base
     (CDDB) which will establish the
     foundation for building an IRS-
     modernized custodial financial
     management system.
    ------------------------------------------------------------------------
    Fund Modernization Information
     Systems (Major Investments) O&M
    This initiative will result in    $15,000   $9,432           $5,568
     modernized information systems
     to improve enforcement
     activities.
    ------------------------------------------------------------------------
    Fund Business Unit IT Solutions
     (Non-Major Investments) O&M
    This initiative provides an       $9,972    $7,121           $2,851
     increase of $15 million for the
     successful transition of
     Business Systems Modernization
     (BSM) projects to the Current
     Production Environment (CPE),
     funding their operations and
     maintenance as they move to
     full production.
    ------------------------------------------------------------------------
    Implement e-Travel
    Treasury has mandated that IRS    $10,000   $6,288           $3,712
     must implement eTravel by
     October 1, 2006.
    ------------------------------------------------------------------------
    Fund HR Connect
    The initiative requests $11.9     $11,900   $7,482           $4,418
     million in FY 2007 to fully
     fund the additional Operations
     and Maintenance cost associated
     with the HR Connect system that
     the IRS has implemented and is
     billed through the Treasury's
     Working Capital Fund.
    ------------------------------------------------------------------------
    Consolidate Philadelphia Campus   $20,900   $14,215          $6,685
    ------------------------------------------------------------------------
    Restoration of Leadership
     Training to FY2003 levels
    The requested funds would enable  $12,200   $7,564           $4,636
     the IRS to: (1) eliminate the
     backlog of untrained leaders at
     all levels by the end of
     FY2007; (2) ensure enough
     capacity to train new managers
     upon selection in all Business
     Units; (3) improve and expand
     readiness programs to provide a
     cadre of manager candidates to
     step in to management
     positions; (4) revise the
     management curriculum to
     incorporate more e-learning and
     promote continuous learning;
     and (5) evaluate the
     effectiveness and impact of the
     leadership training program.
    ------------------------------------------------------------------------
          Subtotal Modernization      $104,715  $67,660          $37,055
    ------------------------------------------------------------------------

        Appendix 5:

      Recommended FY2007 Program Increases: Business Systems Modernization
                                (In $/thousands)
    ------------------------------------------------------------------------
         Business Systems Modernization Program
                       Increases                              Total
    ------------------------------------------------------------------------
    Web-based Self Service
    Identify and design initial set of internet      $24,200
     self-service applications.
    ------------------------------------------------------------------------
    Filing & Payment Compliance (F&PC)
    Completes delivery of full capability needed to  $30,000
     support Private Collection Agencies.
    ------------------------------------------------------------------------
    Modernized e-file (MeF)
    Funds development, testing and deployment of     $70,200
     modernized electronic filing for Form 1040.
    ------------------------------------------------------------------------
    Customer Account Data Engine (CADE)
    Process 33 million returns for the FY2007        $25,000
     filing season.
    ------------------------------------------------------------------------
    Core Infrastructure Projects
    Improve the facilities which allow pre-          $17,900
     deployment testing and integration of
     modernized systems, which help ensure
     modernized systems will operate as needed when
     they are deployed.
    ------------------------------------------------------------------------
    Architecture, Integration & Management
    Ongoing support and improvements to BSM's        $12,800
     program with planning, engineering, and
     management activities.
    ------------------------------------------------------------------------
    Management Reserve                               $8,500
    ------------------------------------------------------------------------
       Subtotal BSM                                  $188,600
    ------------------------------------------------------------------------

    Explanation for Difference in IRS Oversight Board Budget in the
            Administration's FY2007 Budget Request and this Recommendation
        After the Board-approved budget is submitted to the Department of
    Treasury, it is reviewed and modified by both the Treasury Department
    and the Office of Management and Budget (OMB) before being incorporated
    into the President's budget. During the first several years of IRS
    Oversight Board operation, the Treasury Department would inform the
    Oversight Board of changes as the IRS budget progressed through the
    formulation process. However, for the past two years, the Treasury
    Department has taken the position that although RRA98 provides the
    Oversight Board with the responsibility of reviewing and approving the
    budget request prepared by the Commissioner and submitted to the
    Department of the Treasury, this authority does not include
    participating in subsequent budget decision adjustments and formulation
    of the President's Budget.
        Consequently, changes in IRS requirements that occur after the
    Board approves the IRS budget are not provided to the Board, and can
    only be considered by the Board when the President's budget is made
    available to the public. The Board adjusted its previously approved
    budget to account for the following circumstances:

          The Board's initial FY2007 budget was based on the FY2006
    President's request, not the enacted appropriation, and is adjusted to
    use the FY2005 enacted level as the base.
          The inflation factors for labor and non-pay inflation
    were not known to the Board when it first approved the IRS budget, and
    are adjusted to reflect the lower base as well as changes in rates.
          The IRS budget submitted to the Board identified
    approximately $15 million in savings, which the Board approved. During
    subsequent reviews with the Treasury Department and OMB, the IRS
    identified an additional $106 million in savings, for a total savings
    of $121 million. The Board's budget is adjusted to reflect these
    additional savings, despite the Board's assessment that they may
    represent some risk.
          The IRS budget submitted to the Board did not identify
    any fee offsets, which were not yet authorized by Congress. The Board's
    budget is adjusted to reflect these offsets.
          The budget is adjusted to reflect the development of an
    IRS Infrastructure Blueprint to define a cost-effective approach to
    meeting IRS infrastructure needs and the elimination of the need to
    fund Kansas City growth in FY2007.
    Endnotes
        \1\ The President's budget includes on pages IRS-127 to IRS-129 of
    the Congressional Justification, as required by law, a copy of the
    FY2007 IRS budget the Oversight Board approved and submitted to the
    Department of the Treasury. The Board's recommended budget, as show on
    these pages, is higher than the request shown above; Appendix 6
    provides an explanation of the differences.
        \2\  Statistics provided to the Oversight Board by the IRS.
        \3\  Professor Claes Fornell, ``ACSI Commentary: Federal Government
    Scores'', December 15, 2005.
        \4\  IRS Oversight Board, 2005 Taxpayer Attitude Survey.
        \5\  Comptroller General David Walker, Testimony Before the Senate
    Budget Committee, ``Tax Gap: Making Significant Progress in Improving
    Tax Compliance Rests on Enhancing Current IRS Techniques and Adopting
    New Legislative Actions,'' February 15, 2006, GAO-06-453T.
        \6\  Nina E. Olson, National Taxpayer Advocate, Testimony Before
    the Senate Subcommittee on Federal Financial Management, Government
    Information, and International Security Committee on Homeland Security
    and Governmental Affairs, October 26, 2005
        \7\  Tax Notes, February 16, 2006
        \8\  Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to
    Turn Around the Most Unpopular Organization in America, Harvard
    University Press, 2005. p. 278.
        \9\  Al Crenshaw, ``Letting Cheaters Prosper,'' Washington Post,
    April 14, 2004.
        \10\  Statement by the Members of the President's Advisory Panel on
    Federal Tax Reform, ``America Needs a Better Tax System,'' April 13,
    2005.
        \11\  National Taxpayer Advocate, ``Testimony Before the Senate
    Budget Committee, Causes and Solutions to the Federal Tax Gap,''
    February 15, 2006.
        \12\  IRS Commissioner Mark Everson, Testimony Before the Senate
    Budget Committee, February 15, 2006
        \13\  Everson, op.cit.
        \14\  Tax Notes, Everson Says IRS Could Collect Up To $100 Billion
    More Per Year, February 16, 2006
        \15\  IRS Press Release, ``IRS to Raise Some User Fees in 2006,''
    IR-2005-144, December 19, 2005.
        \16\  AICPA, ``Statement Presented to the IRS Oversight Board,
    ``Meeting the Customer Service Needs of Taxpayers and the Importance of
    Measures'', February 8, 2006.
        \17\  Statement of Diana Leyden, Associate Clinical Professor of
    Law, University of Connecticut School of Law Tax Clinic Before the IRS
    Oversight Board, February 8, 2006.
        \18\  Senator Max Baucus, Opening Statement, Senate Finance
    Committee, Hearing, April 14, 2005.
        \19\  The National Taxpayer Advocate, 2005 Annual Report to
    Congress, Executive Summary, p. I-1.
        \20\  General Accountability Office, Report to Congress, ``Business
    Systems Modernization: Internal Revenue Service's Fiscal Year 2006
    Expenditure Plan,'' February 2006, GAO-06-360, pp. 2-3.
        \21\ Statement of Professor Joel Slemrod, University of Michigan
    Ross School of Business, before the President's Advisory Panel on
    Federal Tax Reform, March 3, 2005.

        Chairman RAMSTAD. Thank you, Mr. Wagner. Mr. Hugo, please.

             STATEMENT OF TIMOTHY HUGO, EXECUTIVE DIRECTOR,

                           FREE FILE ALLIANCE

        Mr. HUGO. Mr. Chairman, thank you for the opportunity to
    appear before you today. I am Tim Hugo, and I am the Executive
    Director of the Free File Alliance, and I have served in this
    position since July of 2005.
        The Free File Alliance is a voluntary association of tax
    software companies that provides free tax preparation e-file
    service under a growing set of rules that govern the IRS Free
    File program. Currently, we have 20 members. Member companies
    come and go, and we are open to new members each year.
        I am very proud of the public-private partnership that the
    Alliance and the IRS have created over the life of the program,
    now in its fourth year. The Alliance companies have donated
    over $14 million free tax returns to U.S. taxpayers. Estimates
    are that each return has saved the U.S. taxpayer approximately
    $30, and a case can be made that it is even more, but this
    would also indicate that the U.S. taxpayers have saved over $42
    million, but the savings to the IRS are far greater and are
    summarized below.
        First, the IRS has been able to avoid the cost the industry
    must accept to development software product which changes every
    year as Congress makes changes to the Code. Second, the IRS has
    avoided the necessity of building computer and telecom
    infrastructure to take individual returns from the Alliance.
    Alliance companies paid this cost. Third, the IRS saves $7 or
    more each time a paper return filer converts to submitting a
    return electronically. Fourth, and perhaps most importantly, it
    keeps the IRS from accepting the conflicting role of tax
    preparer and tax cop. Fifth, the IRS has avoided significant
    technological and political risk of a security breach or a
    failure of an IRS product. Sixth, the Free File Alliance makes
    the IRS and the Alliance member partners, not opponents. If the
    IRS were to become a competitor, it would create a very
    different and dynamic relationship with industry.
        This 2005 renewal of the agreement between the IRS and the
    Alliance, after three pioneering years, was the work of the
    program's maturity and success, but it required a balance.
        Again, this year, we refocused, as has been commented
    earlier, we have refocused on the low-income and low and middle
    income that serves $93 million--makes eligible $93 million, 70
    percent of the taxpayers.
        We have a full statement that I would ask be submitted for
    the record, and I thank you, sir, and look forward to answering
    questions.
        [The prepared statement of Mr. Hugo follows:]
        Statement of The Honorable Timothy D. Hugo, Executive Director,
                               Free File Alliance
        Good morning, Mr. Chairman, and other distinguished Members of the
    Subcommittee.
        I am the Executive Director of the Free File Alliance, LLC
    (``Alliance''). I have served in that capacity since July of 2005. I am
    only part-time on this role. I also serve as an elected Member of the
    Virginia General Assembly where I am in my third term.
        The Free File Alliance is a voluntary association of tax software
    companies that provide free tax preparation and efiling services under
    the growing set of rules that govern the IRS Free File Program.
    Currently, we have twenty member companies. Member companies can and do
    come and go. We are open to new members each year.
        I am very proud of the public-private partnership the Alliance and
    IRS have created. Over the life of the program, now in its fourth year,
    the Alliance companies have donated over 14,000,000 free tax returns to
    the U.S. taxpayers. I estimate that each return has saved U.S.
    taxpayers approximately $30 and a case can be made for an even greater
    number. That would indicate U.S. taxpayers have directly saved over
    $42,000,000. But the savings to the IRS are far greater, and can be
    summarized as follows.
        First, the IRS has been able to avoid the costs industry must
    accept to develop a software product--which must be changed each year
    as Congress makes its changes in the Code.
        Second, the IRS has avoided the necessity of building the computer
    and telecommunications infrastructure to take individual returns from
    taxpayers--Alliance companies pay these costs.
        Third, the IRS saves $7 or more each time a paper return filer
    converts to submitting a return electronically.
        Fourth, and perhaps most importantly, it keeps the IRS from
    accepting the conflicting role of tax preparer and tax cop.
        Fifth, the IRS has also avoided significant technological and
    political risks of a security breach or failure of an IRS product.
        Sixth, the Free File Program makes the IRS and Alliance members
    partners, not opponents. If the IRS becomes a competitor, it will
    create a very different and dynamic relationship with industry.
        The 2005 renewal of the Agreement between the IRS and the Alliance
    after three pioneering years was a mark of the program's maturity and
    success, but required a balance between conflicting policy goals. The
    2005 Agreement continues the same core agreement as was originally
    negotiated, but with some interesting changes. The IRS is still not
    permitted to take on the role of a tax preparation company.
        The Alliance member companies do not always agree on what is good
    policy, or what is good for their companies. Within the government
    there is also disagreement as to what should be the requirements of
    this program, which revealed itself when the IRS and Treasury took
    slightly different negotiating positions with the Alliance in 2005,
    notwithstanding that they both work for the same President. Important
    Members of Congress have urged different policies for the Free File
    Program. The 2005 Agreement is a product of all these forces. Let me
    tick off what I think are the key elements of the 2005 Agreement.
        First, the Alliance member companies have over time voluntarily
    agreed to impose standards of conduct on themselves which exceed all
    government regulation and requirements. These standards were often
    suggested or sought by the IRS. While accepting this challenge, the
    Alliance has an appropriate corresponding fear that over time the IRS
    or Congress will use the existence of the Free File Program to create a
    new regulatory regime that will burden the companies in the Free File
    Program, but not companies who do not participate. After years of
    experience, it became clear that both the IRS and the Alliance need to
    have authority to restrict any Alliance member company that does not
    meet the voluntary high standards. Correspondingly, a dispute
    resolution mechanism was created in the 2005 Agreement to utilize the
    General Services Board of Contract Appeals (``GSBCA'') to arbitrate
    with companies who contest IRS determinations that their practices do
    not meet the high standards.
        Second, and related to the first issue, Alliance members agreed to
    restrictions on sale of certain ancillary products, particularly Refund
    Anticipations Loans (``RALs''), that exceed those required by law and
    regulation.
        Third, the IRS and the Alliance agreed to certain measures designed
    to refocus the Free File Program on its original intent to service
    lower income, disadvantaged and underserved taxpayer populations. How
    and why did we do so?
        The Alliance companies are currently required to provide free
    services to 93 million taxpayers, which is 70% of the U.S. taxpayers.
    This is an increase from the 60% of taxpayers the Alliance agreed to
    cover in the original Agreement. This binding 70% coverage requirement
    will increase in numbers as the taxpayer population increases.
        This focus on the poor, lower income, disadvantaged and underserved
    was an underpinning of the original Alliance-IRS agreement. It has been
    recognized throughout the Program's history. It is contained in many of
    the documents that collectively constitute our forming our agreement.
        For example, this language is written in the first and only
    Supplemental Memorandum of Understanding Between the IRS and Free File
    Alliance. A copy of this one page document is appended to my statement.
        It also appears as a portion of the Purpose in the Alliance
    Operating Agreement (a current version of paragraph 2.6 of that
    document is appended to my statement).
        It is contained in the Preamble of the Memorandum of Understanding
    on Service Standards and Disputes Between the IRS and Free File
    Alliance executed in 2005 (``offer online preparation and filing
    services to taxpayers least able to afford e-filing tax returns. . .
    .'').
        It also appears in a letter from Chairman Ernest Istook, then
    Chairman of the Transportation, Treasury and Independent Agencies
    Appropriations Subcommittee, to the current Treasury Secretary and IRS
    Commissioner, and states in part that the program should be focused
    upon the ``under served and lower income citizens. . . . There should
    be no uncertainty that the Free File Alliance program is not intended
    to provide universal free service to all regardless of need. Such an
    objective could break the market-based model that enables the donation
    of the services at no cost to those who truly need them.''
        Some may assert the program should provide Bill Gates and Warren
    Buffett, or other wealthy folks, with free returns. But I do not think
    a compelling policy case can be made that such high wealth individuals
    need such free services. Last year $4 billion in eligible EITC payments
    were not paid to U.S. taxpayers who qualify. Those are the people to
    whom I want to provide free services to, and potentially transform
    their lives.
        Fifty-five million people in this country have no bank account.
    Let's bring them into some aspect of the modern financial system, even
    if they have to do their Free File return at a VITA site or public
    library. A very few miles from this hearing room, in Anacostia, on the
    aptly named Good Hope Road, Operation HOPE, an African-American focused
    financial literacy group, provides 16 internet work stations where
    people in the community can and do take advantage of Free File
    services. Those are the people I believe we should focus upon.
        Both the IRS and the Alliance made their own evaluations of how to
    ensure the long term success of the program. Both concluded the 2005
    agreement meets a variety of needs. The 2005 Agreement has created a
    stable program with well understood rules. Free for everyone may sound
    great, but it has consequences, such as creating pressure for sales of
    ancillary products. We have tried to appropriately balance policy
    concerns, and now we need to see how that balance works out in
    practice. If any company wants to give away their product free to
    everyone, there is no restriction in their choosing to do so at the
    their own web page, or in Union Station, or anywhere else but the Free
    File site.
        We do not yet know the final volumes of Free File returns in this
    tax season. The IRS and Alliance annually cooperate in evaluating each
    season, decide what went well, what needs to be fixed, and what
    research is needed to better evaluate this season. We need to do so
    again, and evaluate how the IRS can help the 93 million eligible
    taxpayers generate savings for themselves and the IRS.
        The Alliance program remains dynamic. But it cannot be used to
    satisfy every policy. Let me give an example. All fifty states have
    little IRS-type organizations to collect taxes, and these agencies have
    a professional association called the Federation of Tax Administrators
    (FTA). Approximately 20 states, led by New York, Michigan and many
    others, are working to replicate the success of the Free File model. We
    appreciate those states' efforts. The Alliance does not administer
    these state Free File programs. But the FTA has in the past focused
    their efforts on the other 20 states that have chosen to compete and
    create tax software products. FTA took the position that the IRS should
    require that the Alliance provide free state tax returns to states that
    compete. We do not feel comfortable dealing in an indirect manner with
    groups like the FTA. If the FTA wants to talk to us about this program,
    we welcome them--but note that the FTA walked out of such talks when
    the Free File Program was starting and hence are not fully reaping the
    benefits of the program.
    CONCLUSION
        We appreciate the Subcommittee's interest in the Free File Program,
    and look forward to answering your questions.

        Chairman RAMSTAD. Thank you, Mr. Hugo. The Chair now
    recognizes Mr. White, please.

     STATEMENT OF JAMES R. WHITE, DIRECTOR, STRATEGIC ISSUES, U.S.
                    GOVERNMENT ACCOUNTABILITY OFFICE

        Mr. WHITE. Thank you, Mr. Chairman. Mr. Chairman and
    Members of the Committee, we are pleased to participate in
    today's hearing. I want to cover three topics: the filing
    season, IRS' 2007 budget requests, and IRS's new long-term
    goals.
        First, IRS' filing season performance so far has improved
    compared to last year, and this continues a trend of
    improvement going back several years. Return processing has
    gone smoothly with over 70 percent of refunds now directly
    deposited to taxpayers' bank accounts, which is faster, less
    costly and more convenient than issuing paper checks. Telephone
    assistance continues to improve with the accuracy rate for both
    tax law and taxpayer account questions now over 90 percent.
    Wait time to get through to the telephone assistor is down from
    almost 4 minutes to 3 minutes. IRS' website is heavily used and
    highly rated by external reviewers.
        Taxpayers continued the recent pattern of using IRS' walk-
    in sites less, and volunteer sites run by community based
    organizations more.
        Perhaps the biggest concern about the filing season is the
    slower growth rate of electronic filing that has been
    discussed. Electronic filing is up this year, but only by 2
    percent compared to last year. E-filing is important because it
    reduces the staff needed for labor-intensive processing of
    paper returns. Since 1999 IRS reduced staff devoted to paper
    processing by about 1,600. According to IRS, the slower growth
    of e-filing is due to new income limits in the Free File
    program, which reduced the number of taxpayers eligible to file
    electronically for free via IRS website and the termination of
    the Tele-File program.
        Turning to IRS' budget, the 2007 budget request is for $11
    billion, a slight decrease after adjusting for inflation. The
    decrease is reflected in staffing. IRS is proposing to cut
    staffing for service by about 4 percent, and for enforcement by
    about 2 percent.
        However, IRS is proposing to improve performance for both
    service and enforcement. The 2007 budget request sets
    performance goals that are higher than or equal to those for
    2006. The proposed budget also reduces funding by 15 percent
    for BSM, the ongoing effort to replace IRS' aging information
    systems. This reduction could impede progress delivering
    improvements to taxpayers.
        In a tight budget environment, savings and efficiencies can
    help agencies fund their programs. For 2007 IRS has identified
    $121 million in savings, expected to free up about 1,400 FTEs
    for other uses. While commendable, there are opportunities for
    additional savings. For example, we were told that IRS' 25 call
    sites have underutilized space. Because calls to IRS are routed
    through a central call processing center in Atlanta, the 25
    call sites could be consolidated without affecting service to
    taxpayers.
        Another option for gaining efficiencies is to increase
    electronic filing by additional mandates. The IRS currently
    mandates electronic filing for large corporations, and 12
    States mandate electronic filing of individual tax returns by
    certain tax preparers.
        Now I want to discuss IRS' new long-term goals. The IRS'
    budget request sets two long-term goals, increasing the
    voluntary compliance rate from 83 percent to 85 percent, and
    reducing the percentage of taxpayers who think it is acceptable
    to cheat on their taxes to under 9 percent by 2009. However,
    the effect of taxpayer service and enforcement on compliance
    has never been quantified. Consequently, IRS does not have a
    database plan demonstrating how it will achieve the goals, nor
    does IRS have a plan to measure compliance by 2009. The
    compliance rate has been measured once since 1988. Reducing the
    net tax gap of $290 billion and increasing compliance will be a
    challenge.
        For years, we have listed tax law enforcement as a high-
    risk area. Despite IRS' efforts, the tax gap has persisted at a
    relatively stable level for decades. Although IRS' enforcement
    efforts are vital, reducing the tax gap will require innovative
    solutions beyond funding for IRS. These solutions include
    increasing the types of income subject to withholding, more
    information reporting about income, and simplifying the Tax
    Code.
        Mr. Chairman, this conclude my statement. I would be happy
    to answer any questions.
        [The prepared statement of Mr. White follows:]

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

        Mr. Chairman and Members of the Subcommittee:
        Since the passage of the Internal Revenue Service (IRS)
    Restructuring and Reform Act of 1998 (RRA 98),\1\ IRS has made
    noticeable improvements to taxpayer services such as telephone
    assistance, and delivered some modernized information systems that,
    among other benefits, speed up refunds to taxpayers. Increased funding
    financed some of the improvements, but a significant portion has been
    financed internally through efficiencies from increased electronic
    filing of tax returns and other operational improvements.
    ---------------------------------------------------------------------------
        \1\ Pub. L. No. 105-206 (1998).
    ---------------------------------------------------------------------------
        IRS has also increased revenue collected through its enforcement
    programs; however, tax law enforcement continues to be included on our
    list of high-risk federal programs.\2\ This is due, in part, to the
    persistence of a large tax gap.\3\ IRS estimated the gross tax gap to
    be $345 billion for tax year 2001. After late payments by taxpayers and
    revenue brought in by IRS's enforcement efforts, the resulting net tax
    gap is estimated to be $290 billion.\4\ Even modest progress in
    reducing the tax gap would yield significant revenue; each 1 percent
    reduction would likely yield nearly $3 billion annually.
    ---------------------------------------------------------------------------
        \2\ GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.:
    January 2005).
        \3\ The tax gap is an estimate of the difference between the taxes
    that should have been timely and accurately paid and what was actually
    paid. Throughout this statement, references to the tax gap refer to the
    gross tax gap unless otherwise noted.
        \4\ GAO, Tax Gap: Making Significant Progress in Improving Tax
    Compliance Rests on Enhancing Current IRS Techniques and Adopting New
    Legislative Actions, GAO-06-453T (Washington, D.C.: Feb. 15, 2006).
    ---------------------------------------------------------------------------
        If its 2007 budget request is a harbinger of longer term funding,
    IRS faces an era of tight budgets. Consequently, continued performance
    improvements will depend on the extent to which IRS can make more
    efficient use of limited resources to provide internal funding for the
    improvements. By indicating how resources are allocated to specific
    programs and activities within the agency, the budget request is a key
    planning tool showing where the agency intends to achieve additional
    efficiencies.
        The 2007 budget request is also an indication of how IRS intends to
    achieve longer term goals. For the first time, IRS lists two agencywide
    long-term goals: to increase the compliance rate and reduce the
    proportion of taxpayers who think it is acceptable to cheat on their
    taxes.\5\ This budget can be viewed as a first step in a series of
    annual steps that will determine whether IRS achieves these long-term
    goals.
    ---------------------------------------------------------------------------
        \5\  The Congress set one long-term goal for the IRS in RRA 98 for
    IRS to have 80 percent of all individual income tax returns filed
    electronically by 2007. We and IRS have previously reported that IRS
    likely will not meet this goal. Also, IRS's budget describes plans to
    establish other agencywide goals, targets for which have not yet been
    established and therefore are not listed in the budget request.
    ---------------------------------------------------------------------------
        Our statement discusses IRS's 2006 filing season performance to
    date and fiscal year 2007 budget request. To address your request, we
    assessed (1) the interim results of IRS's 2006 filing season
    performance compared to prior years; (2) IRS's budget request compared
    to prior years; and (3) how the budget helps IRS achieve its long-term
    goals aimed at reducing the tax gap.
        Our assessment of the interim results of IRS's filing season is
    based on comparing IRS's performance this year to prior filing seasons,
    monitoring various production meetings and production statistics,
    reviewing other IRS documents and reports, 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. Our
    assessment of the budget request is based on a comparative analysis of
    IRS's fiscal year 2002 (in most cases) through 2007 budget requests,
    funding, expenditures, and other documentation and interviews with IRS
    officials. We used historical budget and performance data from reports
    and budget requests used by the IRS, Department of the Treasury, and
    Office of Management and Budget. In past work, we assessed IRS's budget
    and performance data. 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 data
    were sufficiently reliable for the purposes of this statement. The
    budget and performance data for fiscal years 2006 and 2007 are subject
    to change as IRS revises its estimates. We did not verify IRS's
    estimates for enforcement revenue and the tax gap. IRS presents tax gap
    information as supplemental information in its financial statements;
    that information is not required to be audited. However, we have been
    involved in tax gap methodology briefings, and the TIGTA has an ongoing
    review of the accuracy of IRS's tax gap estimates. Additionally, our
    analysis of IRS's Business Systems Modernization (BSM) program was
    based primarily upon the results of our detailed review of IRS's fiscal
    year 2006 BSM expenditure plan in a recent report.\6\ We performed our
    work in Washington, D.C., and Atlanta, Georgia, from January 2006
    through April 2006, in accordance with generally accepted government
    auditing standards.
    ---------------------------------------------------------------------------
        \6\ GAO, Business Systems Modernization: Internal Revenue Service's
    Fiscal Year 2006 Expenditure Plan, GAO-06-360 (Washington, D.C.: Feb.
    21, 2006).
    ---------------------------------------------------------------------------
        Our statement makes these key points: IRS has improved its 2006
    filing season performance to date in important areas compared to last
    year, continuing a recent trend. IRS's returns processing has gone
    smoothly and over 70 percent of refunds are now directly deposited to
    taxpayers' bank accounts, which is faster, more convenient and less
    costly than issuing paper checks. Electronic filing continues to grow,
    but at a slower rate. So far this filing season, electronic filing has
    grown 2.4 percent compared to 4.3 percent annually for the previous two
    years. According to IRS officials, the slower rate of growth is due, in
    part, to new income limits in the Free File program, which reduced the
    number of taxpayers eligible to file electronically for free via IRS's
    Web site, and the termination of the TeleFile program, which eliminated
    electronic filing by phone. Telephone assistance has improved this
    year, in part, due to lower call volume. The percentage of taxpayers
    attempting to reach an IRS telephone assistor and who actually received
    service increased 1 percentage point to 84 percent this filing season
    and the length of time taxpayers waited to get their calls answered
    decreased from 235 seconds to 182 seconds. The accuracy of IRS's
    responses to tax law and account questions improved--both are now at 90
    percent or more. IRS's Web site is being used more, is performing well
    based on third-party evaluations, and has been reconfigured with the
    goal of improving taxpayer service. Taxpayers continued the recent
    pattern of using IRS's walk-in sites less, and using sites run by
    community-based organizations and staffed by volunteers more.

          IRS's fiscal year 2007 proposed budget is $11 billion,
    which is a small decrease compared to the 2006 enacted level after
    adjusting for expected inflation.\7\ For service, the budget proposes
    to cut staffing by 4 percent. For enforcing tax laws, the budget
    proposes to cut staffing by 2 percent. However, for service and
    enforcement, the budget sets performance goals for 2007 that are higher
    than or equal to those for 2006. For maintaining and operating IRS's
    existing information systems (IS), the 2007 budget request shows an
    increase in resources when compared to the 2006 enacted budget.
    However, when compared to the level currently assumed for 2006, the
    2007 budget request leaves Full-time Equivalents (FTE) \8\ for IS
    virtually constant. For the BSM program, which is the ongoing effort to
    replace the agency's aging information systems, the budget proposes to
    reduce spending by about 15 percent. This reduction could delay
    delivery of improved services for taxpayers. As it has in prior years,
    IRS's budget request identifies savings--the 2007 budget proposes to
    save over $121 million and 1,424 FTEs. However, additional
    opportunities exist for savings. One is to increase electronic filing
    by additional use of mandates. IRS currently mandates electronic filing
    by large corporations and 12 states currently mandate electronic filing
    of individual income tax returns by certain tax preparers. Another
    opportunity is to consolidate IRS's 25 telephone call sites. IRS
    officials told us that the call sites have space that is not used for
    850 staff. Call sites could be consolidated without affecting service
    to taxpayers. Finally, IRS has long been hampered by a lack of current
    and accurate cost information for making resource allocation decisions.
    IRS recently implemented components of a cost accounting system, but
    needs to continue gathering the cost data needed to make it an
    effective planning tool.
    ---------------------------------------------------------------------------
        \7\ The Congressional Budget Office is estimating inflation to be
    1.8 percent in 2007. Congressional Budget Office, The Budget and
    Economic Outlook: Fiscal Years 2007 to 2016. (Washington, D.C.: January
    2006).
        \8\  According to IRS, a FTE is the equivalent of one person
    working full-time for one year with no overtime. A staff year includes
    overtime. Therefore, the cost of 1 staff year is equal to the cost of 1
    FTE plus overtime.
    ---------------------------------------------------------------------------
          IRS's budget request sets two long-term goals: increasing
    the rate of voluntary compliance from 83 percent to 85 percent by 2009
    and reducing the percentage of taxpayers who think it is acceptable to
    cheat on their taxes from 10 percent to 9 percent in 2008. These goals
    will be challenging to meet because the tax gap has persisted at a
    relatively stable level of 81 to 84 percent for many years. However,
    because the effect of taxpayer service and enforcement on compliance
    has never been quantified, IRS does not have a data-based plan
    demonstrating how it will use its programs to achieve its goals and
    reduce the tax gap. Nor does IRS have a plan for measuring compliance
    by 2009. Reducing the tax gap will likely require new and innovative
    solutions such as simplifying the tax code, increasing income subject
    to withholding, and increasing information reporting about income.
    IRS's budget request includes several proposals for increasing
    compliance that would not require additional resources for IRS. For
    example, the Department of the Treasury plans to study, and we have
    long supported, clarifying the definition of independent contractors
    and requiring additional information reporting on their income, steps
    that could increase tax revenue by billions of dollars.
    IRS's Filing Season Performance to Date Has Improved in Important
            Areas, Continuing a Recent Trend
        IRS improved its 2006 filing season performance in important areas
    that affect large numbers of taxpayers. This continues a trend of
    improvement since at least 2002. Returns processing has gone smoothly
    and electronic filing continues to grow, although at a slower rate than
    in previous years. Taxpayer assistance has improved in the two most
    commonly used services--toll-free telephones and the Internet Web site.
    Fewer taxpayers visited IRS's walk-in sites, and more sought assistance
    at volunteer-staffed sites.
    Return Processing Has Been Smooth and Electronic Filing Continues to
            Grow, Although At a Slower Rate Than Previous Years
        From January 1 through March 17, 2006, IRS processed about 63
    million individual income tax returns, about the same number as the
    same period last year. Of those returns, 47 million returns were filed
    electronically (up 2.2 percent) and 16 million returns were filed on
    paper (down 9.8 percent).
        According to IRS data and officials, returns processing has gone
    smoothly so far this filing season. IRS issued 56 million refunds, 40
    million, or 71 percent, of which were directly deposited, up 3
    percentage points over the same period as last year. Direct deposit is
    faster, more convenient for taxpayers, and less expensive for IRS than
    mailing paper checks.
        Because of the volume of tax returns, it is normal for IRS to
    experience some processing disruptions, although this year, disruptions
    have not been significant. For example, 13 different tax forms were
    unavailable for electronic filing until February 1 due to the late
    hurricane relief legislation, which caused a minor processing delay for
    some returns.
        Furthermore, IRS officials said that the new Customer Account Data
    Engine (CADE), which is intended eventually to replace IRS's antiquated
    Master File system containing taxpayer records, processed 4.3 million
    returns and dispersed 3.8 million refunds, so far during the 2006
    filing season without disruptions. IRS is reporting that direct deposit
    refunds and paper check refunds are being issued within 4 and 6
    business days, respectively, after tax returns are posted to CADE,
    which is faster than for returns processed by the Master File system.
    CADE's growth in future years will directly benefit taxpayers. Not only
    can it speed up refunds, but it also updates taxpayer account
    information quicker than the Master File system.
        Representatives of the taxpayer industry corroborated IRS's view
    that the filing season is going smoothly. Groups and organizations that
    we talked to included the National Association of Enrolled Agents, the
    American Institute of Certified Public Accountants, and others. In
    addition, the TIGTA recently testified that thus far it has seen no
    significant problems during the filing season.\9\
    ---------------------------------------------------------------------------
        \9\ Written statement of Treasury Inspector General for Tax
    Administration, J. Russell George, before the Committee on
    Appropriations, Subcommittee on Transportation, Treasury and Housing
    and Urban Development, the Judiciary, District of Columbia, and
    Independent Agencies, U.S. House of Representatives, Hearing on the
    Internal Revenue Service's Fiscal Year 2007 Budget, Washington, D.C.,
    Mar. 29, 2006.
    ---------------------------------------------------------------------------
        The growth of electronic filing is important, because it generates
    savings by reducing staff years needed for labor intensive paper
    processing. Between fiscal years 1999 and 2006, IRS reduced the number
    of staff years devoted to paper and electronic processing by 1,586, or
    34 percent as shown in figure 1.
    Figure 1: Number of Individual Returns and IRS Staff Years for
            Individual Paper and Electronic Processing, Fiscal Years 1999-
            2007
            [GRAPHIC] [TIFF OMITTED] T0443A.001

        \a\ Fiscal years 2006 and 2007 are IRS projections.
        Note: Staff years and FTE are units of measurement that are often
    used interchangeably. As noted in the figure, staff years for paper
    filing are for selected major activities only.

        Electronic filing continues to grow but at a slower rate than
    previous years. This year's 2.4 percent rate of growth is less than the
    average annual rate of growth of 4.3 percent for each of the preceding
    2 years. According to IRS officials, the slower growth in electronic
    filing this year is due, in part, to changes in the Free File program,
    which reduced the number of taxpayers eligible to file electronically
    for free this year and to reduced advertising by companies involved in
    that program, and the termination of the TeleFile program, which
    eliminated the way for taxpayers to file their returns electronically
    via telephone.
        The Free File program enables taxpayers to file their returns
    electronically via IRS's Web site. Through IRS's Web site, taxpayers
    can access the Web sites of 20 companies comprising the Free File
    Alliance. The alliance is a consortium of tax preparation companies
    that agreed to offer free return preparation and electronic filing for
    taxpayers that meet certain criteria (see app. 1 for further detail).
    In an amended agreement with IRS that took effect this year, the Free
    File Alliance set a $50,000 income limitation on taxpayer
    participation. This limit was absent last year and reduced the number
    of taxpayers eligible to participate in the program. As of March 19,
    2006, IRS processed about 2.9 million free file returns, which is a
    decrease of 23 percent from the same period last year. This decline is
    inconsistent with IRS's projection that it would receive 6 million tax
    returns filed through the Free File program, almost a million more
    compared to last year.
        For 2006, IRS terminated the TeleFile program. IRS expected that
    eliminating TeleFile would reduce electronic filing, but justified the
    decision because of declining usage and relatively high costs. The
    number of taxpayers using the program had been decreasing--from
    approximately 5.7 million in 1999 to 3.8 million in 2004. IRS estimated
    the cost per tax return submitted through TeleFile, typically Form
    1040EZ, to have been $2.63 versus $1.51 for a return filed on paper,
    largely due to contractor, telecommunications, and other costs. Given
    the limitations of IRS's cost accounting system, the validity of these
    figures is unknown. IRS officials stated that the reason for this
    year's increase in the number of 1040EZ returns filed on paper is due,
    in part, to the elimination of TeleFile. Through March 17, 2006, the
    number of 1040EZ returns has increased 18 percent from last year.
        Options for increasing electronic filing, in particular mandated
    electronic filing, will be discussed in the budget section of this
    statement.
    Telephone Access and Accuracy Improved, in Part Due to Lower Call
            Volume
        Taxpayers' ability to access IRS's telephone assistors and the
    accuracy of answers provided improved compared to previous years. From
    January 1 through March 11, 2006, IRS answered approximately 22 million
    phone calls, which is about a 7 percent decline from the same period as
    last year.\10\ The call volume has been less than projected by IRS and
    less than was assumed when IRS set staffing levels for telephone
    assistors for the filing season. IRS officials offered several
    explanations for the unexpected decline in call volume. One explanation
    is that more taxpayers are using improved tax preparation software,
    which reduces their need to call IRS. Another explanation is that more
    taxpayers are getting through to a telephone assistor the first time
    they call, thus reducing the need for taxpayers to call again.
    ---------------------------------------------------------------------------
        \10\ Despite less demand overall, call volume increased from
    affected taxpayers in federally-declared disaster areas. IRS maintains
    a special services hotline (1-866-562-5227) to provide assistance on
    questions related to hurricane relief and combat zone participation.
    Between January 1 and March 11, 2006, the hotline received 36,552
    calls, an increase of 158 percent over the same period in 2005.
    According to IRS officials, the hotline received primarily combat zone
    calls in 2005 because there were so few federally-declared disaster
    areas. Therefore, IRS officials attribute the 2006 increase to the
    three major hurricanes in 2005.
    ---------------------------------------------------------------------------
        As shown in table 1, the percentage of taxpayers who attempted to
    reach an assistor and actually got through and received service--
    referred to as the level of service--was 84 percent so far this filing
    season compared to 83 percent over the same period last year--and
    greater than its 2006 fiscal year goal of 82 percent. According to IRS
    officials, one possible explanation for the improvement in access is
    the decline in overall call volume. When call volume decreases,
    taxpayers are likely to wait less time to speak with an IRS telephone
    assistor. As a result, fewer taxpayers would likely hang up, increasing
    the percentage of taxpayers who get through to an assistor.
        IRS also reported that, so far this filing season, the average
    speed of answer (length of time taxpayers wait to get their calls
    answered) is down 53 seconds from the same time last year to 182
    seconds, a decrease of about 23 percent, and significantly better than
    IRS's 2006 fiscal year goal of 300 seconds. IRS also reported that the
    rate at which taxpayers abandoned their calls \11\ to IRS decreased
    from 11.5 percent to 8.9 percent compared to the same period last year.
    ---------------------------------------------------------------------------
        \11\ IRS divides abandoned calls into two subsets, primary abandons
    and secondary abandons. Primary abandons occur when callers hang up
    before being put into queue to wait for an available assistor.
    Secondary abandons are the number of callers who hang up after being
    put into the queue to wait for an assistor. In November 2004, IRS
    established a program to help determine where primary abandons occur
    within the IRS scripts. According to IRS officials, looking at the
    number and percentage of where callers hang up highlights opportunities
    where IRS can improve its menu prompt phrasings in a way that would be
    more beneficial for callers.

     Table 1: IRS Telephone Assistance Performance in the First Weeks of the
                        Filing Seasons, 2002 through 2006
    ------------------------------------------------------------------------
          Telephone assistance         2002    2003    2004    2005    2006
    ------------------------------------------------------------------------
    Total calls \a\                  34,489   27,905  29,058  23,340  21,616
    ------------------------------------------------------------------------
    Answered by assistors            9,208    9,434   10,116  9,421   8,653
    ------------------------------------------------------------------------
    Answered by automation           25,281   18,471  18,942  13,919  12,963
    ------------------------------------------------------------------------
    Assistor level of service        62%      82%     84%     83%     84%
    ------------------------------------------------------------------------
    Average speed of answer \b\      227      183     199     235     182
                                     seconds  second  second  second  second
                                               s       s       s       s
    ------------------------------------------------------------------------
    Accounts customer accuracy rate  88.3%    87.9%   89.1%   91.7%   92.7%
     estimates \c\                   +/-.9%   +/-.7%  +/-.8%  +/-.7%  +/-.7%
    ------------------------------------------------------------------------
    Tax law customer accuracy rate   83.5%    81.2%   75.8%   87.5%   90.2%
     estimates \c\                   +/-.7%   +/-     +/-     +/-     +/-
                                               1.0%    1.3%    1.0%    1.0%
    ------------------------------------------------------------------------
    Source: IRS.
    \a\ 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; March12, 2005; and
      March 11, 2006.
    \b\ From January 1 to March 16, 2002; March 15, 2003; March 13, 2004;
      March 12, 2005; and March 11, 2006.
    \c\ Based on a representative sample estimated at the 90 percent
      confidence interval from January through February 2002, 2003, 2004,
      2005, and 2006.

        Using a statistical sampling process, IRS estimates that the
    accuracy of telephone assistors' responses to taxpayers' tax law and
    account questions improved compared to last year. IRS estimates its tax
    law accuracy rate to be 90.2 percent, an increase of 2.7 percentage
    points over the same time period last year, continuing an improvement
    since 2004. Additionally, IRS estimates that the accuracy rate to
    taxpayers' inquiries about their accounts, to be 92.7 percent this year
    compared to 91.7 percent over same period last year, continuing an
    improvement since 2003. IRS officials attribute these improvements in
    performance to several factors, including better and more timely
    performance feedback for telephone assistors, increased assistor
    experience, better training, and increased use of the Probe and
    Response Guide, a script used by telephone assistors to understand and
    respond to tax law questions.
    IRS's Web Site Is Being Used More, Is Performing Well, and Has Been
            Reconfigured withthe Goal of Improving Taxpayer Service
        Use of IRS's Web site has increased so far this filing season
    compared to prior years based on the number of visits and downloads.
    From January 1 through February 28, IRS's Web site was visited 67
    million times by visitors who downloaded 56 million forms and
    publications. The number of visits reflects a 7 percent increase over
    the same period last year while the number of forms and publications
    downloaded has increased by 25 percent.
        Further, IRS's Web site is performing well. For example,

          we found IRS's Web site to be readily accessible, easy to
    navigate, and easy to search,
          an independent weekly study by Keynote, a company that
    evaluates Web sites, reported that IRS's Web site has repeatedly ranked
    second out of 40 government agencies evaluated in terms of average
    download time. The same study also reported that IRS has repeatedly
    ranked first out of the most commonly accessed government related Web
    sites for response time and success rate, and
          the American Consumer Satisfaction Index overall customer
    satisfaction with IRS's Web site increased from 68 to 72 percent after
    IRS reconfigured the site.

        IRS reconfigured its Web site for the 2006 filing season. According
    to IRS officials, the goal for reconfiguring the Web site was to
    improve overall customer service through easier navigation and a more
    effective search function. As a result, the number of Web site searches
    has decreased by 53 percent, from 76 million during the same period
    last year to 36 million this year. Typically, search functions are used
    when users fail to find information through links. According to IRS
    officials, the decrease in the number of searches indicates that users
    are finding the information that they need faster.
        IRS also added the following new features to its Web site this
    year:

          Electronic IRS: The Electronic IRS brand reconfigured the
    IRS's Web site and made it easier to locate items, as evidenced by the
    decline in searches;
          Alternative Minimum Tax (AMT) Assistant: Helps taxpayers
    determine if they do not owe AMT; and
          Help for Hurricane Victims: A special link that provides
    victims of the recent hurricanes information on special tax relief,
    assistance and how to get help with tax matters;
          IRS's Web site continues to include several important
    features in addition to the Free File program;
          Where's My Refund, which allows taxpayers to check on the
    status of their refunds. As of March 20, 2006, 19.8 million taxpayers
    accessed the Where's My Refund feature to check on the status of their
    tax refunds. This was a 21 percent increase from the same period last
    year; and
          Electronic Tax Law Assistance, where taxpayers can ask
    IRS general tax law questions via its Web site. From January 1 through
    March 20, 2006, IRS received 7,353 emails requesting tax law assistance
    (down over 32 percent compared to last year). As of February 28, 2006,
    IRS estimated the accuracy rate of IRS's responses to tax law questions
    submitted via the Web site, to be 85 percent down from 88 percent in
    2005. However, the average number of days that it took IRS to respond
    to tax law questions submitted via the Web site improved to 2.4 days,
    compared to 4 days in 2005.
    Taxpayers Continue Their Recent Pattern of Using IRS's Walk-In Sites
            Less and Using Volunteer Sites More, and Information About the
            Quality of Service Remains Limited
        Fewer taxpayers have used IRS's 400 walk-in sites so far in the
    2006 filing season compared to the same period in prior years. Staff at
    walk-in sites provide taxpayers with information about their tax
    accounts and answer taxpayers' questions within a limited scope of
    designated tax law topics, such as those related to income, filing
    status, exemptions, deductions, and related credits.\12\ Walk-in site
    staffs also provide need-based tax return preparation assistance,
    limited to taxpayers meeting certain requirements.\13\ As of March 11,
    2006, the total number of contacts at IRS's walk-in sites declined by
    approximately 12 percent compared to last year. The decline thus far
    this year is consistent with the annual trends in walk-in use shown in
    figure 2, including IRS's projection for 2006. The declines in the
    number of taxpayers using IRS's walk-in sites, including for tax return
    preparation, are also consistent with IRS's strategy to reduce its
    costly face-to-face assistance by providing taxpayers with additional
    options, such as IRS's toll-free telephone service, Web site, and
    numerous volunteer sites. It is unclear, however, whether the declining
    volume is an indicator of how well IRS is meeting taxpayers' demand for
    face-to-face assistance. For example, IRS does keep track of the number
    of taxpayers entering a walk-in site, taking a number to queue for
    service, but then leaving the site without receiving service. If a
    taxpayer did not take a number, IRS would have no way of counting those
    taxpayers.
    ---------------------------------------------------------------------------
        \12\ IRS considers some tax law questions to be out of scope
    related to businesses and corporations, for example. If staff cannot
    answer taxpayer's questions, they are required to refer taxpayers to
    IRS's telephone service or Web site.
        \13\ Return preparation assistance is limited to taxpayers with
    income of $38,000 or less. According to IRS, this limitation
    approximates the amount set in the tax code for claiming the Earned
    Income Tax Credit. IRS has required appointments for most taxpayers
    seeking this assistance since 2003.
    ---------------------------------------------------------------------------
        IRS officials said the types of services offered at walk-in sites
    remained constant for most sites from 2005 to 2006. For sites in areas
    with a high number of natural disaster victims, IRS expanded the types
    of assistance provided. For example, IRS eliminated income limits for
    taxpayers seeking return preparation assistance.
    [GRAPHIC] [TIFF OMITTED] T0443A.002

        Figure 2: Assistance Provided at IRS Walk-in Sites and Volunteer
    Sites, 2001--2006 Filing Seasons (contacts in millions)
        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; December 28,
    2003, through April 24, 2004; and December 26, 2004, through April 23,
    2005. For volunteer sites, the time period covered for 2001 is January
    1, 2001, through April 21, 2001; December 30, 2001, through April 27,
    2002; December 29, 2002, through April 26, 2003; December 28, 2003,
    through April 24, 2004; and December 26, 2004, through April 23, 2005.
        \a\ Fiscal years 2006 and 2007 are IRS projections. For walk-in
    sites, projections cover the time periods of December 25, 2005 through
    April 22, 2006, and December 31, 2006 through April 28, 2007. For
    volunteer sites, projections cover the time periods from January 1
    through April 30, 2006 and 2007.

        In contrast to IRS walk-in sites, the number of taxpayers seeking
    return preparation assistance at approximately 14,000 volunteer sites
    has increased this year by 5.6 percent, continuing the trend since 2001
    (see fig. 2). These sites, often run by community-based organizations
    and staffed by volunteers who are trained and certified by IRS, do not
    offer the range of services IRS provides at walk-in sites, but instead
    focus on preparing tax returns primarily for low-income and elderly
    taxpayers and operate chiefly during the filing season. As we have
    previously reported,\14\ the shift of taxpayers from walk-in to
    volunteer sites is important because it has allowed IRS to transfer
    time-consuming services, such as return preparation, from IRS to other
    less costly alternatives that can be more convenient for taxpayers.
    ---------------------------------------------------------------------------
        \14\ 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. 15, 2004).
    ---------------------------------------------------------------------------
        IRS has used both walk-in and volunteer sites to provide relief
    efforts for federally-designated disaster zones such as in hurricane-
    affected areas. IRS developed a Disaster Referral Services Guide and
    new training materials for employees to better equip them to address
    disaster-related issues. Also, IRS adjusted the type of tax law
    questions that it would answer at walk-in sites to include casualty
    loss and removed income limitations for disaster victims seeking return
    preparation assistance at walk-in sites. Volunteer sites performed
    outreach within their network of partners by creating training material
    for tax practitioners, and agreeing with two organizations to accept
    referrals from IRS of disaster victims needing tax return preparation
    assistance.
        Concerning the quality of services provided at walk-in and
    volunteer sites, IRS continues to lack reliable and comprehensive data
    on the quality of the services provided. As in previous years, TIGTA is
    conducting an audit on the accuracy of some services provided at walk-
    in sites, although the results will not be available until after the
    filing season. However, TIGTA has noted problems with the quality of
    services provided at IRS walk-in sites in prior reports.\15\ We have
    made recommendations for IRS to improve its quality measurement at
    walk-in sites.\16\ At volunteer sites, IRS is conducting different
    types of reviews to monitor tax return preparation assistance.\17\
    According to IRS officials, the results to date show that the quality
    of service has improved at volunteer sites compared to previous years,
    but they acknowledge that challenges remain in terms of volunteers'
    adherence to IRS's procedures and use of IRS materials. As in previous
    years, TIGTA will conduct limited quality reviews at volunteer sites.
    While the results of those reviews are based on a judgmental sample,
    TIGTA has concluded in the past that, while significant improvements
    have been made in the oversight of volunteer sites, continued effort is
    needed to ensure the accuracy of tax return assistance provided.\18\
    ---------------------------------------------------------------------------
        \15\ Treasury Inspector General for Tax Administration,
    Coordination and Monitoring Are Needed for Continued Improvement in the
    Tax Return Preparation Process at the Taxpayer Assistance Centers,
    Reference No. 2004-40-147, (Washington, D.C.: 2005), and Treasury
    Inspector General for Tax Administration, Customer Accuracy at Taxpayer
    Assistance Centers Showed Little Improvements During the 2005 Filing
    Season, Reference No. 2005-40-146, (Washington, D.C.: 2003).
        \16\ See GAO-05-67 and GAO-06-51.
        \17\ The different types of reviews include site reviews to measure
    the administrative aspects of a volunteer site such as readiness. IRS
    plans on conducting 825 of these site reviews. IRS also plans on
    conducting 2,475 return reviews, approximately 3 during each site
    review, which will involve on-site review of the return for accuracy
    and discretionary reviews for problem sites not operating in accordance
    with the IRS's guidelines.
        \18\ Treasury Inspector General for Tax Administration, Significant
    Improvements Have Been Made in the Oversight of the Volunteer Income
    Tax Assistance Program, but Continued Effort Is Needed to Ensure the
    Accuracy of Services Provided, Reference No. 2006-40-004, (Washington,
    D.C.: 2005).
    ---------------------------------------------------------------------------
    IRS's Budget Proposes Decreases in Staffing and Identifies Savings, but
            Opportunities for Additional Savings Exist
        IRS's fiscal year 2007 budget request is a small decrease compared
    to 2006 enacted levels after adjusting for expected inflation. It
    proposes to reduce overall staffing levels, as well as staffing levels
    for taxpayer service and enforcement activities, while maintaining or
    improving taxpayer service and enforcement. As it has in prior years,
    IRS has identified some savings, but additional opportunities exist for
    enhancing savings.
    IRS's Budget Proposes Decreases in Funding After Adjusting for Expected
            Inflation and in Staffing
        IRS's proposed fiscal year 2007 budget is $11 billion (a 1.6
    percent increase), but after adjusting for expected inflation, it
    reflects a slight decrease over last year's enacted budget. The $11
    billion includes $417 million from new and existing user fees and
    reimbursable agreements with other federal agencies.\19\ The 2007
    budget request for IRS's appropriation accounts is shown in table 2
    (see app. II for more details).\20\
    ---------------------------------------------------------------------------
        \19\ According to IRS, the $417 million estimate is based on
    receiving $135 million from increasing existing user fees and
    establishing new ones. IRS has committed to distributing the $135
    million over its PAM, TLE, and IS accounts, exclusively for taxpayer
    service. The remaining user fees will be used as needed by IRS.
        \20\ The PAM appropriation account primarily funds functions
    related to taxpayer service which includes funding for enforcement; TLE
    primarily funds enforcement activities but includes funding for
    taxpayer services; IS funds information technology support and
    improvements for legacy systems which support both taxpayer services
    and enforcement; BSM funds the new modernized business system; and
    HITCA administers a refundable tax credit for health insurance for
    qualified individuals. We did not review the HITCA account as part of
    our work.

                      Table 2: IRS's Changes in Funding and FTEs for Fiscal Years 2006 through 2007
    ----------------------------------------------------------------------------------------------------------------
                                                   Fiscal year 2007         Fiscal year 2006      Percentage change
                                               requested including new          enacted           fiscal year 2006-
               Dollars in thousands                user fee revenue    -------------------------         2007
                                              -------------------------                         --------------------
                                                   Dollars       FTEs       Dollars       FTEs     Dollars     FTEs
    ----------------------------------------------------------------------------------------------------------------
    Processing, Assistance, and Management         $4,159,893   37,126      $4,095,212   38,796         1.58   -4.30
     (PAM)
    ----------------------------------------------------------------------------------------------------------------
    Tax Law Enforcement (TLE)                       4,764,954   49,479       4,678,498   50,559         1.85   -2.14
    ----------------------------------------------------------------------------------------------------------------
    IS                                              1,619,834    7,351       1,582,977    7,032         2.33    4.54
    ----------------------------------------------------------------------------------------------------------------
    BSM                                               167,310        0         197,010        0       -15.08    0.00
    ----------------------------------------------------------------------------------------------------------------
    Health Insurance Tax Credit                        14,846       17          20,008       17       -25.80    0.00
     Administration (HITCA)
    ----------------------------------------------------------------------------------------------------------------
    Total                                         $10,726,837   93,973     $10,573,706   96,404         1.45   -2.52
    ----------------------------------------------------------------------------------------------------------------
    Existing user fees and reimbursablesa            $282,543    1,503        $258,820    1,350         9.17   11.33
    ----------------------------------------------------------------------------------------------------------------
    Total program operating level                 $11,009,380   95,476     $10,832,526   97,754         1.63   -2.33
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Notes: For fiscal year 2007, the figures shown for requested FTEs reflect an IRS adjustment and differ slightly
      from what IRS reported in its budget request. The Congressional Budget Office projects the inflation rate to
      be 1.8 percent in 2007; therefore, IRS's proposed increases are less than the rate of inflation.
    \a\ Reimbursables are payments IRS receives for providing services to other federal agencies and states.

        The real decrease in the proposed budget can be seen in staffing.
    IRS proposes to fund 95,476 FTEs in fiscal year 2007, down over 2
    percent from 97,754 FTEs in enacted fiscal year 2006 (see table 5 in
    app. II for comparisons in enacted FTE levels for fiscal years 2002
    through 2007). Actual FTEs tend to be lower than enacted FTEs, in part,
    because of how IRS absorbs unbudgeted costs (see table 6 in app. II for
    actual FTEs).
        The decrease in FTEs may be greater than shown in IRS's fiscal year
    2007 budget request. Every year agencies, including IRS, are expected
    to absorb some costs that are not included in their budget requests.
    For fiscal year 2007, IRS officials currently anticipate having to
    absorb over $117 million in costs, including about $41 million for
    homeland security-related controls over physical access to government
    facilities. Absorbing such costs reduces the actual number of FTEs that
    IRS can support. For example, for fiscal year 2005, the enacted level
    of FTEs was 96,435 but the actual level was 94,282.
    IRS's Budget Request Proposed to Maintain or Improve Taxpayer Services
            with Fewer Resources
        IRS is requesting $4.2 billion for PAM, including some user fees,
    which is funding primarily spent on providing service to taxpayers.\21\
    The amount requested is about a 1.6 percent increase over fiscal year
    2006 enacted levels, but is a slight decrease after adjusting for
    expected inflation. This funding level translates into reduced
    staffing, down over 4 percent from an enacted level of 38,796 FTEs in
    fiscal year 2006 to 37,126 proposed FTEs in fiscal year 2007. Since
    fiscal year 2002, FTEs devoted to PAM have declined over 15 percent
    from an enacted level of 43,866 FTEs.
    ---------------------------------------------------------------------------
        \21\ IRS has funding in other appropriation accounts that support
    its taxpayer service programs.
    ---------------------------------------------------------------------------
        Despite the proposed inflation-adjusted decrease in funding in
    2007, IRS is planning to maintain or improve taxpayer services. For
    every one of the major taxpayer services listed in the budget, 2007
    planned performance goals are higher or equal to 2006 performance
    goals. These services include telephone assistance and refund issuance.
    IRS's Budget Request Reduces Enforcement Staffing Slightly, While
            Increasing Major Enforcement Activities
        IRS is requesting $4.8 billion for TLE.\22\] The 2007 budget
    request proposes an overall decrease in enforcement FTEs, down over 2
    percent to a proposed 49,479 FTEs from last year's enacted level of
    50,559 FTEs. For its three main categories of skilled enforcement
    staff, IRS is proposing a marginal increase in staffing of 0.2 percent
    (see fig. 3). For special agents (those who perform criminal
    investigations), the increase is 1.7 percent. For the other two
    categories--revenue agents (those who examine complex returns), revenue
    officers (those who perform field collection work)--IRS is proposing to
    keep the number of staff the same as in 2006.
    ---------------------------------------------------------------------------
        \22\ In his recent testimony, the IRS Commissioner said that if the
    Congress failed to provide funding outside the program integrity cap
    adjustment it could potentially jeopardize past gains. This year, IRS
    is seeking $137 million outside the cap.
    [GRAPHIC] [TIFF OMITTED] T0443A.003

        Figure 3: Revenue Agents, Revenue Officers, and Special Agents,
    Fiscal Years 1998--2007
        Notes: Numbers for 2006 and 2007 are IRS estimates. IRS
    recalculated the figures since GAO reported them last year. GAO is
    using the new figures because IRS has validated those figures using its
    new cost accounting system.

        Despite keeping skilled enforcement staff virtually unchanged, IRS
    is proposing to maintain or increase its major enforcement activities.
    For all the major enforcement activities listed in the budget, IRS is
    establishing goals in 2007 that are higher or equal to 2006 planned
    performance goals. Major enforcement activities include individual
    taxpayer examinations, collection coverage,\23\ and criminal
    investigations completed. IRS officials anticipate increased revenue
    collected and other performance improvements as a result of using data
    from IRS's most current compliance research effort, known as the
    National Research Program (NRP).\24\
    ---------------------------------------------------------------------------
        \23\ The number of collection cases closed or otherwise eliminated
    compared to the total number of collection cases in inventory.
        \24\  NRP replaced the Taxpayer Compliance Measurement Program,
    which last measured compliance for individuals for 1988 but was
    canceled because of concerns about costs and burdens on taxpayers. GAO,
    Tax Administration: New Compliance Research Effort Is on Track, but
    Important Work Remains, GAO-02-769 (Washington, D.C.: June 27, 2002)
    and Tax Administration: Status of IRS' Efforts to Develop Measures of
    Voluntary Compliance, GAO-01-535 (Washington, D.C.: June 18, 2001)
    discuss the development of the NRP study.
    ---------------------------------------------------------------------------
    Budget for IS Request for Funding Is Up Slightly, and IRS Has Taken
            Additional Steps to Improve Budgeting for IS Operations and
            Maintenance
        IRS is requesting about $1.6 billion for IS in fiscal year 2007,
    which is intended to fund information technology (IT) staff and related
    costs for activities such as information security and maintenance and
    operations of its current tax administration systems. Although the
    number of FTEs proposed in 2007 is up when enacted FTEs are considered,
    it is virtually the same as the operating level currently assumed in
    2006 (see app. II for more details).
        In 2002, we reported that the agency did not develop its fiscal
    year 2003 IS operations and maintenance budget 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.\25\ To address our
    recommendation, IRS agreed to take a variety of actions, which it has
    made progress in implementing. For example, 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. In August 2005, IRS issued the
    initial version of its IT Capital Planning and Investment Control
    (CPIC) Process Guide, which (1) provides executives with the framework
    within which to select, control, evaluate, and maintain the portfolio
    of IT investments to best meet IRS business goals and (2) defines the
    governance process that integrates the agency's IT investments with the
    strategic planning, budgeting, and procurement processes. According to
    IRS officials and documentation, the agency formulated its prioritized
    fiscal year 2007 IT portfolio and associated budget request, including
    operations and maintenance requirements, in accordance with this CPIC
    Process Guide. We will continue to monitor the implementation of IRS's
    CPIC process as its IT investment management process matures.
    ---------------------------------------------------------------------------
        \25\ GAO, Internal Revenue Service: Improving Adequacy of
    Information Systems Budget Justification, GAO-02-704 (Washington, D.C.:
    June 28, 2002).
    ---------------------------------------------------------------------------
        In addition, 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 IS budget. During fiscal year 2005, as part of
    the first release of the Integrated Financial System (IFS),\26\ IRS
    implemented a cost module that is potentially capable of allocating
    costs by activity. However, agency officials stated that they needed to
    accumulate 3 years of actual costs to have the historical cost data
    necessary to provide a basis for meaningful future budget estimates.
    Since then, according to the Office of the Chief Financial Officer, IRS
    has (1) populated the cost module with all actual fiscal year 2005
    expenses; (2) identified the data needed from IFS to support its budget
    requests; and (3) developed a system to capture, test, and analyze the
    cost data to devise a standard methodology to provide the necessary
    data from the cost module. Once the pilot results and recommendations
    have been reviewed, an implementation plan will be developed. IRS still
    expects to have the requisite 3 years of historical cost data available
    in time to support development of the fiscal year 2010 budget request.
    Although IRS has made progress in implementing best practices in
    developing its IS operations and maintenance budget, until IRS
    completes the actions necessary to fully implement the activity--based
    cost module, the agency will not be able to ensure that its request is
    adequately supported.
    ---------------------------------------------------------------------------
        \26\ IFS 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.
    ---------------------------------------------------------------------------
    IRS's Proposed BSM Budget Reduction Could Impede Future Progress
        BSM is a high-risk, highly complex effort that involves developing
    and delivering a new set of information systems that are intended to
    replace the agency's aging tax processing and business systems. The
    program 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. It also helps IRS considerably in providing the reliable and
    timely financial management information needed to account for the
    nation's largest revenue stream and better enable the agency to both
    determine and justify its resource allocation decisions and budget
    requests.
        IRS's fiscal year 2007 budget request of $167.3 million for the BSM
    program reflects a reduction of about 15 percent (and even greater when
    adjusted for expected inflation), or about $30 million, from the
    enacted fiscal year 2006 budget of $197 million.
        Since our testimony before this subcommittee on last year's budget
    request, IRS has made further progress in implementing BSM, although
    some key projects did not meet short-term cost and schedule
    commitments. During 2005 and the beginning of 2006, IRS deployed
    additional releases of several modernized systems that have delivered
    benefits to taxpayers and the agency, including CADE, e-Services (a new
    Web portal and electronic services for tax practitioners), and
    Modernized e-File (a new electronic filing system). While three BSM
    project releases were delivered within the cost and/or schedule
    commitments presented in the fiscal year 2005 expenditure plan, others
    experienced cost increases or schedule delays. For example, two IFS and
    Modernized e-File project releases experienced cost increases of 93
    percent \27\ and 29 percent, respectively. As we have previously
    reported,\28\ the BSM program has had a history of cost increases and
    schedule delays that have been due, at least in part, to deficiencies
    in various management controls and capabilities that have not yet been
    fully corrected. IRS is in the process of implementing our prior
    recommendations to correct these deficiencies.
    ---------------------------------------------------------------------------
        \27\ IRS recently reported that it plans to redirect about $5
    million of unobligated funding from the IFS project to program
    management reserve, which would reduce this cost overrun.
        \28\ For example, see GAO, Business Systems Modernization: Internal
    Revenue Service's Fiscal Year 2005 Expenditure Plan, GAO-05-774
    (Washington, D.C.: July 22, 2005).
    ---------------------------------------------------------------------------
        IRS has identified significant risks and issues that confront
    future planned system deliveries. For example, according to IRS,
    schedule delays and contention for key resources between multiple
    releases of CADE necessitated the deferral of some functionality. The
    deferral of these requirements may negatively impact the cost and
    schedule for two important releases, which are planned to be deployed
    later this year. The agency, however, recognizes the potential impact
    of these project risks on its ability to deliver planned functionality
    within cost and schedule estimates, and to its credit, has developed
    mitigation strategies to address them. IRS has also made additional
    progress in addressing high-priority BSM program improvement
    initiatives during the past year, including initiatives related to
    shifting the role of systems integrator from the prime contractor to
    IRS. IRS's program improvement process appears to be an effective means
    of assessing, prioritizing, and addressing BSM issues and challenges.
    However, much more work remains for the agency to fully address these
    issues and challenges.
        In addition, in response to our prior recommendation, IRS is
    developing a new Modernization Vision and Strategy to address BSM
    program changes and provide a modernization roadmap. According to the
    Associate Chief Information Officer for BSM, the agency's new strategy
    focuses on promoting investments that provide value in smaller,
    incremental releases that are delivered more frequently, with the goal
    of increasing business value. IRS is currently finalizing a high-level
    vision and strategy as well as a more detailed 5-year plan for the BSM
    program. We believe these actions represent sound steps toward
    addressing our prior recommendation to fully revisit the vision and
    strategy and develop a new set of long-term goals, strategies, and
    plans consistent with the budgetary outlook and with IRS's management
    capabilities.
        While the requested fiscal year 2007 BSM budget will allow IRS to
    continue the development and deployment of the CADE, Modernized e-File,
    and Filing and Payment Compliance (F&PC) \29\ projects, the proposed
    reduced funding level would likely affect the agency's ability to
    deliver the functionality planned for the fiscal year and could result
    in project delays and/or scope reductions. This could, in turn, impact
    the long-term pace and cost of modernizing tax systems and of
    ultimately improving taxpayer service and strengthening enforcement.
    For example, according to IRS documents, the agency had planned to
    spend $85 million in fiscal year 2007 to develop and deploy additional
    CADE releases that would enable the system to process up to 50 million
    individual tax returns by the 2008 filing season and issue associated
    refunds faster. However, with a proposed budget of $58.5 million--over
    30 percent less than anticipated--IRS would likely have to scale back
    its planned near-term work on this project. In addition, the reductions
    to the planned budgets for the Modernized e-File and F&PC projects may
    also result in IRS having to redefine the scope and/or reassess
    schedule commitments for future project releases.
    ---------------------------------------------------------------------------
        \29\ F&PC is a series of projects expected to provide support for
    detecting, scoring, and working nonfiler (filing compliance) and
    delinquency (payment compliance) cases. The first phase of F&PC is
    Private Debt Collection, which will use advanced software to analyze
    tax collection cases and divide them into the complex cases requiring
    IRS involvement and the less complex (balance due) cases that can be
    handled by private collection agencies.
    ---------------------------------------------------------------------------
        The proposed BSM budget reduction would also significantly reduce
    the amount allotted to program management reserve by about 82 percent
    (from $13 million in fiscal year 2006 to $2.3 million in fiscal year
    2007). If BSM projects have future cost overruns that cannot be covered
    by the depleted reserve, this reduction could result in increased
    budget requests in future years or delays in planned future activities.
        While the BSM program still faces challenges, IRS has recently made
    progress in delivering benefits and addressing project and program-
    level risks and issues. Reducing BSM funds at a time when benefits to
    taxpayers and the agency are being delivered could adversely impact the
    momentum gained from recent progress and result in delays in the
    delivery of future benefits. However, until IRS addresses our prior
    recommendation by clearly defining its future goals for the BSM program
    as well as the impact of various funding scenarios on meeting these
    goals in its new Modernization Vision and Strategy, the long-term
    impact of the proposed budget reduction is unclear.
    IRS's Budget Request Identified Some Savings, but Opprotunities Exist
            for Enhancing Savings
        In its 2007 budget request, IRS identified savings as it has done
    in prior years and plans to redirect some of those savings to front-
    line taxpayer service and enforcement activities. IRS is proposing to
    save over $121 million and 1,424 FTEs by, for example, automating the
    process of providing an individual taxpayer identification number to
    those taxpayers ineligible for a Social Security number and improving
    data collection techniques and work processes for enforcement
    activities through increased financial reporting requirements and
    scanning and imaging techniques.
        IRS's history of realizing savings proposed in past budget requests
    provides some confidence that the agency will be able to achieve
    savings in fiscal year 2007. For example, IRS reported it realized 88
    percent of the anticipated dollar savings and 86 percent of the
    anticipated staff savings identified in the fiscal year 2004 budget
    request. IRS also reported exceeding the savings targets in the fiscal
    year 2005 budget request (see app. III).
        In addition to the areas identified by IRS in its budget request,
    there may be additional opportunities for efficiency gains.

          Increasing electronic filing: In an era of tight budgets,
    continued growth in electronic filing may be necessary to help fund
    future performance improvements. One proposal for continuing to
    increase electronic filing is additional use of electronic filing
    mandates. Currently, IRS mandates electronic filing for large
    corporations. The 2007 budget request proposes a legislative change
    that would expand its authority to require electronic filing for
    businesses. Moreover, 12 states now mandate electronic filing for
    certain classes of tax practitioners (see app. IV for more information
    on state mandates). As we have reported,\30\ although there are costs
    and burdens likely to be associated with electronic filing mandates for
    paid tax preparers and taxpayers, state mandates have generated
    significant increases in electronic filing. IRS has an electronic
    filing strategy, which the agency is updating.
    ---------------------------------------------------------------------------
        \30\ GAO-06-51.

          Changing the menu of taxpayer services: IRS currently
    lacks a comprehensive strategy explaining how its various taxpayer
    services (including its telephone, walk-in, volunteer, and Web site
    assistance) will collectively meet taxpayer needs. In response to a
    Congressional directive,\31\ IRS is developing such a strategy. The
    strategy is important because some taxpayers may not be well served by
    the current service offerings. IRS's attempts to reduce some taxpayer
    services, namely reducing the hours of telephone operations and closing
    some walk-in sites, have met with resistance from the Congress.
    Although congressional directives to study the impact of IRS's actions
    exist,\32\ we still believe there may be opportunities to adjust IRS's
    menu of services to reduce costs, without affecting IRS's ability to
    meet taxpayers' needs.
    ---------------------------------------------------------------------------
        \31\ In the H.R. Conf. Rep. No. 109-307 (2005), the Congress
    directed the IRS, in conjunction with the IRS Oversight Board and the
    National Taxpayer Advocate, to develop a 5-year plan for taxpayer
    service activities and report to the House and Senate Committees on
    Appropriations by April 14, 2006.
        \32\ In Pub. L. No. 109-115,  205, (Nov. 30, 2005), the Congress
    directed the IRS not to reduce taxpayer services as the IRS proposed in
    fiscal year 2006 until TIGTA completed a study on the impact of such
    reductions on taxpayer compliance and services. Further, IRS was
    directed, to consult with stakeholder organizations, including, but not
    limited to, the IRS Oversight Board, National Taxpayer Advocate, TIGTA
    and Internal Revenue employees with respect to any efforts by the IRS
    to terminate or reduce significantly any taxpayer service activity.
    Pub. L. No. 109-148,  5021 (Dec. 30, 2005) extends above provisions to
    include any reduction in available hours of telephone taxpayer
    assistance below the levels in existence during the month of October
    2005.

          Consolidating telephone call sites: IRS operates 25 call
    sites throughout the country. Consistent with earlier plans, IRS closed
    two of its smallest call sites--Chicago and Houston--in March 2006, to
    realize savings in its toll-free telephone operations. Also, IRS has
    gained efficiencies from using a centralized call router located in
    Atlanta. As a result, there are currently more than 850 workstations
    that are not being used; consequently, IRS may have the potential to
    close several additional call sites. Consolidations would not affect
    telephone service and would be invisible from the taxpayer's
    perspective.
    Accurate Cost Information Would Help IRS Make Resource Allocation
            Decisions, and Help Provide Some Information About the Return
            on Investment for its Programs
        Managing a federal agency as large and complex as IRS requires
    managers to constantly weigh the relative costs and benefits of
    different approaches to achieving the goals mandated by the Congress.
    Management is constantly called upon to make important long-term
    strategic as well as daily operational decisions about how to make the
    most effective use of the limited resources at its disposal. As
    constraints on available resources increase, these decisions become
    correspondingly more challenging and important. In order to rise to
    this challenge, management needs to have current and accurate
    information upon which to base its decisions, and to enable it to
    monitor the effectiveness of actions taken over time so that
    appropriate adjustments can be made as conditions change.
        In its ongoing effort to make such increasingly difficult resource
    allocation decisions and defend those decisions before the Congress,
    IRS has long been hampered by a lack of current and accurate
    information concerning the costs of the various options being
    considered. Instead, management often has relied on a combination of
    the limited existing cost information; the results of special analysis
    initiated to establish the full cost of a specific, narrowly defined
    task or item; and estimates based on the best judgment of experienced
    staff. This has impaired IRS's ability to properly decide which, if
    any, of the options at hand are worth the cost relative to the expected
    benefits. For example, accurate and timely cost information may help
    IRS consider changes in the menu of taxpayer services that it provides
    by identifying and assessing the relative costs, benefits, and risks of
    specific projects. Without reliable cost information, IRS's ability to
    make such difficult choices in an informed manner is seriously
    impaired. The lack of reliable cost information also means that IRS
    cannot prepare cost-based performance measures to assist in measuring
    the effectiveness of its programs over time.
        Further, IRS does not have the capability to develop reliable
    information on the return on investment for each category of taxpayer
    service and enforcement. IRS lacks reliable information on both the
    return from services (the additional revenue collected by helping
    taxpayers understand their tax obligations) and the investment or cost
    of the services. While developing return on investment information is
    difficult, the cost component of that equation may be the least complex
    to develop. Having such cost information is a building block for
    developing return on investment estimates. For its enforcement
    programs, IRS has developed a rough measure of return on investment in
    terms of tax revenue that is directly assessed from uncovering
    noncompliance. Continuing to develop return on investment measures
    could help officials make more informed decisions about allocating
    resources.\33\ The new NRP data, for example, are to be used to better
    identify which tax returns to examine so that fewer compliant taxpayers
    are burdened by unnecessary audits and IRS can increase the amount of
    noncompliance that is addressed through its enforcement activities.
    Even without return on investment information, cost information can
    help IRS determine if, for example, IRS should change the menu of
    services provided.
    ---------------------------------------------------------------------------
        \33\ Developing such measures is difficult because of incomplete
    information on all the costs and all the tax revenue ultimately
    collected from specific enforcement efforts, as well as incomplete
    information on the indirect tax revenues generated when current
    enforcement actions prompt voluntary compliance improvements in the
    future.
    ---------------------------------------------------------------------------
        As discussed in the BSM section, in fiscal year 2005, IRS
    implemented a cost accounting module as part of IFS. However, while
    this module has much potential and has begun accumulating cost
    information, IRS has not yet determined what the full range of its cost
    information needs are or how best to tailor the capabilities of this
    module to serve those needs. Also, IRS does not have an integrated
    workload management system which would provide the cost module with
    detailed allocation of personnel cost information.\34\ In addition, as
    noted in developing its IS budget, because it generally takes several
    years of historical cost information to support meaningful estimates
    and projections, IRS cannot yet rely on IFS as a significant planning
    tool. It will likely require several years, implementation of
    additional components of IFS, and integration of IFS with IRS's tax
    administration activities before the full potential of IFS's cost
    accounting module will be realized. Furthermore, IRS's fiscal year 2007
    BSM budget request does not include funding for additional releases of
    IFS. In the interim, IRS decision making will continue to be hampered
    by inadequate underlying cost information.
    ---------------------------------------------------------------------------
        \34\  IRS had planned to develop a workload management system, but
    has postponed this project indefinitely, due to budget constraints.
    ---------------------------------------------------------------------------
    IRS Sets Long-Term Goals, but Lacks a Data-Based Plan for Achieving the
            Goals, and Addressing the Tax Gap Requires Solutions Beyond
            Funding and Staffing for IRS
        For the first time, IRS's budget request sets long-term goals aimed
    at reducing the tax gap, although IRS does not have a data-based plan
    for achieving the goals. However, because of its persistence, reducing
    the tax gap requires solutions which go beyond funding and staffing for
    IRS.
    IRS's Budget Proposes Long-Term Goals, but Lacks a Data-Based Plan for
            Achieving Them
        IRS established two agencywide, long-term performance goals, as
    shown in table 3. IRS plans to improve voluntary compliance from 83
    percent in 2005 to 85 percent by 2009, and reduce the number of
    taxpayers who think it is acceptable to cheat on their taxes from 10
    percent in 2005 to less than 9 percent in 2010. According to IRS, these
    are the first in a series of quantitative goals that will link to its
    three strategic goals--improve taxpayer service, enhance tax law
    enforcement, and modernize IRS through technology and processes.

                                                Table 3: IRS Agencywide Goals for Fiscal years 2004 through 2010
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                       Fiscalyear 2004  Fiscalyear 2005  Fiscalyear 2006  Fiscalyear 2007  Fiscalyear 2008  Fiscalyear 2009  Fiscalyear 2010
            Performance level               actual           actual           planned          planned          planned          planned          planned
                                         performance      performance      performance      performance      performance      performance      performance
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Improve voluntary compliance.....  N/A              83.0%            N/A              N/A              N/A              85.0%            N/A
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Reduce the percentage of           12.0%            10.0%            10.0%            10.0%            9.0%             <9.0%            <9.0%
     taxpayers who think it is
     acceptable to cheat on their
     taxes.
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Source: IRS.

        These goals will be challenging to meet, because for three decades,
    IRS has consistently reported a persistent, relatively stable tax gap.
    Although IRS has made a number of changes in its methodologies for
    measuring the tax gap, which makes comparisons difficult, regardless of
    methodology used, the voluntary compliance rate that underpins the gap
    has tended to range from around 81 percent to around 84 percent.
        Because of a lack of quantitative estimates of how changes to its
    service and enforcement programs affect compliance, IRS is unable to
    show in a data-based plan how it will use those programs to reach the
    two long-term goals shown in table 3. If IRS could quantify the impact
    of its service and enforcement programs on the compliance rate or
    attitudes towards cheating, it could use the information to show the
    kinds of changes to the programs needed to achieve the long-term goals
    and how best to direct resources towards achieving those goals.
    Unfortunately, quantifying the impact of IRS's service and enforcement
    programs on compliance or cheating is very challenging. The type of
    data needed to make such a link does not currently exist, and may not
    be easy to collect.
        Lacking such quantitative estimates, IRS must take a more
    qualitative approach in its plans for increasing compliance, which
    would likely also involve changing attitudes towards cheating. IRS's
    overall approach to reducing the tax gap consists of improving service
    to taxpayers and enhancing enforcement of the tax laws. We recently
    reported that IRS has taken a number of steps that may improve its
    ability to reduce the tax gap.\35\ Favorable trends in staffing of IRS
    enforcement personnel; examinations performed through correspondence,
    as opposed to more complex face-to-face examinations; and the use of
    some enforcement sanctions such as liens and levies are encouraging.
    Also, IRS has made progress with respect to abusive tax shelters
    through a number of initiatives and recent settlement offers that have
    resulted in billions of dollars in collected taxes, interest, and
    penalties. Finally, IRS has continually improved taxpayer service by
    increasing, for example, the accuracy of responses to tax law
    questions.
    ---------------------------------------------------------------------------
        \35\ GAO-06-453T.
    ---------------------------------------------------------------------------
        The effect of this overall approach and the 2007 budget proposal
    will have on voluntary compliance has not been quantified by IRS.
    Therefore, the Congress will have to rely on the IRS Commissioner for
    qualitative explanations, of why, in his judgment, IRS's mix of
    taxpayer service and enforcement and overall approach for reducing the
    tax gap, including the 2007 budget proposal, will be sufficient to
    start IRS on a path towards achieving its long-term goals. More
    specifically, such explanations could include a clear statement of
    which service and enforcement programs have priorities for expansion
    because they are expected to contribute the most to increasing the
    compliance rate and the evidence that supports that judgment.
        In addition, IRS lacks a plan for measuring progress towards one
    goal--improving voluntary compliance. IRS plans to measure progress
    towards the second goal--reducing the percentage of taxpayers who think
    it is acceptable to cheat--via the IRS Oversight Board's annual
    Taxpayer Attitude Survey.
        Nevertheless, IRS recently estimated voluntary compliance as part
    of the NRP study, which reviewed the compliance of a random sample of
    individual taxpayers and used those results to estimate compliance for
    the population of all taxpayers. The study took several years to plan
    and execute. In addition to providing an estimate of the compliance
    rate, the study's results will be used to better target IRS's audits of
    potentially non-compliant taxpayers. Better targeting reduces the
    burden on taxpayers because IRS is better able to avoid auditing
    compliant taxpayers.
        At this time, however, IRS has not made plans to repeat the study
    in time to measure compliance by 2009. Furthermore, doing compliance
    studies once every few years does not give IRS or others information
    about what is happening in the intervening years. Annual estimating of
    the compliance rate could provide information that would enable IRS
    management to adjust plans as necessary to help achieve the goal in
    2009. One option that would not increase the cost of estimating
    compliance would be to use a rolling sample. IRS Oversight Board
    officials and we agree that instead of sampling, for example, once
    every 5 years, one-fifth of the sample could be collected every year.
    The total sample could include 5 years worth of data--with each passing
    year the oldest year would be dropped from the sample and the latest
    year added. The availability of current research data would allow IRS
    to more effectively focus its service and compliance efforts.
    Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing
            for IRS
        For years, we have reported that tax law enforcement is a high-risk
    area, in part because of the size of the gross estimated tax gap, which
    IRS most recently estimated to be $345 billion for tax year 2001. IRS
    estimated it would recover around $55 billion through late payments and
    enforcement revenue, resulting in a net tax gap of around $290
    billion.\36\ Reducing the tax gap would yield significant revenue and
    even modest progress, such as a 1 percent reduction, would likely yield
    nearly $3 billion annually. In recent years, IRS reported increases in
    enforcement revenue--revenue brought in as a result of IRS taking
    enforcement action. Between fiscal years 2003 and 2005, IRS reported
    that enforcement revenue grew from $37.6 billion to $47.3 billion, with
    a level of $48.1 billion estimated for 2006. However, the voluntary
    compliance rate has persisted at a relatively stable level.
    ---------------------------------------------------------------------------
        \36\ GAO-06-453T.
    ---------------------------------------------------------------------------
        We have reported that significant reductions in the tax gap will
    likely require exploring new and innovative solutions.\37\ Such
    solutions that may not require significant additional IRS resources,
    but are nonetheless difficult to achieve, include
    ---------------------------------------------------------------------------
        \37\ GAO-06-453T.

          simplifying the tax code to make it easier for
    individuals and businesses to understand and comply with their tax
    obligations;
          increasing tax withholding for income currently not
    subject to withholding;
          improving information reporting; and
          leveraging technology to improve IRS's capacity to
    receive and process tax returns.

        IRS's 2007 budget request includes five new legislative proposals
    to address some of these solutions to reduce the tax gap, along with a
    proposal to study independent contractor compliance that would not
    require additional resources. In recent testimony, the IRS Commissioner
    stated that the amount of enforcement revenue IRS expects from the
    legislative proposals will be $3.6 billion over the next 10 years
    (about 0.1 percent of the tax gap). However, the proposals should also
    increase revenue voluntarily paid without any IRS enforcement actions.
    The amount of that revenue is uncertain. The IRS Commissioner
    recognizes the implications of the tax gap and states in the budget
    that addressing it is a top priority. Although IRS's 2007 budget
    request does not propose allocating IRS resources to new initiatives to
    reduce the tax gap, according to IRS officials, they plan to continue
    initiatives identified in prior budgets. For example, IRS has two
    ongoing BSM projects--F&PC and Modernized e-File--which, according to
    IRS's Associate Chief Information Officer for BSM, could help reduce
    the tax gap. F&PC is expected to increase IRS's capacity to resolve the
    growing backlog of delinquent taxpayer cases and increase collections,
    while Modernized e-File is expected to help make it easier for IRS to
    process tax returns, look for irregularities, and track down unpaid
    taxes.
        The budget request states that the administration will study the
    standards used to distinguish between employees and independent
    contractors for purposes of paying and withholding income taxes. We
    have long supported efforts aimed at improving independent contractor
    compliance.\38\ Past IRS data have shown that independent contractors
    report 97 percent of the income that is reported on information returns
    to IRS, while contractors that do not receive these information returns
    report only 83 percent of income. We have also identified other options
    for improving information reporting by independent contractors,
    including increasing penalties for failing to file required information
    returns, lowering the $600 threshold for requiring such returns, and
    requiring businesses to separately report on their tax returns the
    total amount of payments to independent contractors.\39\ We previously
    reported that clarifying the definition of independent contractors and
    extending reporting requirements for those contractors could possibly
    increase tax revenue by billions of dollars.\40\
    ---------------------------------------------------------------------------
        \38\ GAO, Tax Administration: Approaches for Improving Independent
    Contractor Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23,
    1992).
        \39\ GAO-06-453T.
        \40\ GAO, Opportunities for Congressional Oversight and Improved
    Use of Taxpayer Funds, GAO-04-659 (Washington, D.C.: May 7, 2004).
    ---------------------------------------------------------------------------
        Two of the legislative proposals call for more information
    reporting on payment card transactions from certain businesses and on
    payments by federal, state, and local governments to businesses.
    Information reporting has been shown to significantly reduce
    noncompliance. Although information reporting is highly effective in
    encouraging compliance, such reporting imposes costs and burdens on the
    businesses that implement it. However, information reporting is a way
    to significantly increase voluntary compliance without increasing IRS's
    budget.
        Mr. Chairman, this completes my prepared statement. I would be
    happy to respond to any questions you or other members of the
    subcommittee my have at this time.
    Contacts and Acknowledgments
        For further information regarding this testimony, please contact
    James R. White, Director, Strategic Issues.or David A. Powner,
    Director, Information Technology Management Issues. Contact points for
    our Offices of Congressional Relations and Public Affairs may be found
    on the last page of this statement. Individuals making key
    contributions to this testimony include Joanna Stamatiades, Assistant
    Director; Amanda Arhontas; Paula Braun; Terry Draver; Paul Foderaro;
    Chuck Fox; Tim Hopkins; Kathryn Horan; Hillary Loeffler; Sabine Paul;
    Cheryl Peterson; Neil Pinney; Steve Sebastian; Tina Younger.
                                     ______

    Appendix I: Differences Between the 2002 and 2005 Free File Agreements
        In 2002, Internal Revenue Service (IRS) entered into a 3-year
    agreement with the Free File Alliance, a consortium of 20 tax
    preparation companies to provide free electronic filing to taxpayers
    who access any of the companies via a link on IRS's Web site. The 2002
    Free File Agreement stated that as part of the agreement, IRS would not
    compete with the Consortium in providing free, online tax return
    preparation and filing services to taxpayers. IRS and the Consortium
    amended the agreement in 2005. Key differences between the two
    agreements are: the new income limitation of $50,000 and new language
    in the amendment that states the Alliance members must disclose early
    on if state tax return services are available, and if so, whether a fee
    will be charged for such services; and provide the necessary support to
    accomplish a customer satisfaction survey. It also added language
    pertaining to the marketing and offering of Refund Anticipation Loans
    (RALs) \41\ whereby:
    ---------------------------------------------------------------------------
        \41\  Refund Anticipation Loans are very short-term loans issued
    while taxpayers wait for their refunds.

          No offer of free return preparation and filing of an
    electronic return in the free file program shall be conditioned on the
    purchase of a RAL; and
          RALs will be offered with clear language indicating, for
    example, that RALs are loans, not a faster way of receiving an IRS
    refund; must be repaid even if the IRS does not issue a full refund;
    are short-term loans interest rates may be higher and customers may
    wish to consider using other forms of credit; and may be offered but
    not promoted.

        IRS tests each Consortium member's software to ensure it is in
    accordance with the Free File provisions, including those cited
    previously, before allowing a link to IRS's Web site. In addition, IRS
    officials monitor complaints about the Free File program received via
    IRS.gov, including allegations regarding false, deceptive, or
    misleading information or advertising. While IRS does not track the
    number of complaints it receives, according to IRS officials, most of
    the complaints received thus far were a result of the taxpayer either
    not carefully reading or following instructions, or incorrectly
    entering information. GAO conducted limited testing of the Free File
    program and found that the Consortium members were complying with the
    terms outlined in the amended Free File agreement pertaining to RALs.
        The amended Free File agreement contains provisions that enable IRS
    to monitor taxpayer participation beginning in the 2006 filing season,
    unlike prior years where Free File Alliance members self-reported
    filing figures. IRS also tracks the number of free file users who are
    accepting any financial products, such as RALs. As of March 16, IRS
    reported that 163,000 Free File returns accepted financial products.
    This represents 5.6 percent of all returns filed through the Free File
    program.
        The number of taxpayers using free file to electronically file
    their individual income tax returns has increased steadily from 2.8
    million in 2003, to 3.5 million in 2004, to 5.1 million in 2005. The
    substantial growth between 2004 and 2005 was due to, in part, several
    Consortium members offering free filing to all taxpayers through the
    free file program regardless of their income in 2005. However,
    according to IRS officials, the lack of income limitation created
    conflict among Consortium members as it put pressure on all Alliance
    members to offer free service, which may not have been economically
    feasible for some, threatening competition if members were to drop out
    of the Alliance.
        IRS projected that 6.1 million taxpayers would use free file in
    2006. However, this projection may be optimistic, because between
    January 1 and March 19, IRS has reported receiving only 2.9 million
    free file returns compared to 3.8 million during the same period last
    year, a decline of 23 percent. According to IRS officials, contributing
    factors to this decline are, in part, due to decreased press attention
    and advertising by the participating companies and the income
    limitation. The income limitation provides coverage to 70 percent of
    the nation's taxpayers, or more than 92 million people. This coverage
    includes taxpayers with an adjusted gross income of $50,000 or less.
                                     ______

    Appendix II: Comparison of IRS's Actual and Enacted Funding and Full-
            Time Equivalents, Fiscal Years 2002 through 2007
        For fiscal year 2007, the Internal Revenue Service (IRS) has
    requested $10.7 billion in its appropriation accounts. This request
    consists of $10.6 billion in direct appropriations and $135 million in
    revenue from new user fees, which IRS will commit to taxpayer service
    activities in its Processing, Assistance, and Management (PAM), Tax Law
    Enforcement (TLE), and Information System (IS) accounts. In addition,
    IRS is projecting to collect and use $282 million from existing user
    fees and reimbursable agreements with states and other federal
    agencies. This brings IRS's proposed fiscal year 2007 budget to
    approximately $11 billion (a 1.6 percent increase over fiscal year
    2006). After adjusting for expected inflation, IRS's $11 billion budget
    request reflects a slight decrease from last year's enacted budget.
        IRS's enacted budgets for its appropriation accounts from fiscal
    years 2002 through 2007 are shown in table 4. IRS's enacted budget has
    increased almost 8 percent since fiscal year 2002. By far, the biggest
    percentage increase has been TLE--almost 21 percent--and is reflective
    the shift in resources devoted to TLE from PAM during this period. The
    biggest percentage decrease was in the Business Systems Modernization
    (BSM) program, down almost 58 percent.

                                Table 4: IRS's Funding for Fiscal Years 2002 through 2007
    ----------------------------------------------------------------------------------------------------------------
                                    Fiscal year    Fiscal     Fiscal     Fiscal     Fiscal     Fiscal    Fiscal year
                                        2007     year 2006  year 2005  year 2004  year 2003  year 2002   2002--2007
                                   ---------------------------------------------------------------------------------
         Dollars in thousands        Requested
                                     including                                                           Percentage
                                      new user    Enacted    Enacted    Enacted    Enacted    Enacted      change
                                        fees
    ----------------------------------------------------------------------------------------------------------------
    PAM                             $4,159,893   $4,095,21  $4,056,85  $4,009,20  $3,930,06  $3,982,97  4.44
                                                  2          7          5          4          1
    ----------------------------------------------------------------------------------------------------------------
    TLE                              4,764,954    4,678,49   4,363,53   4,171,24   3,849,88   3,940,74   20.92
                                                  9          9          4          4          1
    ----------------------------------------------------------------------------------------------------------------
    IS                               1,619,834    1,582,97   1,577,76   1,581,57   1,621,83   1,620,90   -0.07
                                                  7          8          5          4          5
    ----------------------------------------------------------------------------------------------------------------
    BSM                              167,310      197,010    203,360    387,699    363,621    391,593    -57.27
    ----------------------------------------------------------------------------------------------------------------
    HITCA                            14,846       20,008     34,562     34,794     69,545     NA         NA
    ----------------------------------------------------------------------------------------------------------------
    Total appropriations requested  $10,726,837  $10,573,7  $10,236,0  $10,184,5  $9,834,94  $9,936,21  7.96
                                                  06         87         17         8          0
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Notes: Numbers may not add due to rounding. Fiscal year 2007 includes $135 million in new user fee revenue
      distributed in PAM, TLE, and IS accounts. Without user fees, IRS is requesting $4,045,122 for PAM, $4,762,327
      for TLE, and $1,602,232 for IS.

        Tables 5 and 6 show IRS's enacted and actual Full-time Equivalents
    (FTEs) for fiscal years 2002 through 2007. Overall, actual FTEs tend to
    be lower than enacted FTEs due in part to the way IRS funds its
    unbudgeted requirements. When both enacted and actual FTEs are
    considered, FTEs for PAM have steadily decreased and, for the most
    part, FTEs for TLE have increased since fiscal year 2002. However,
    steady trends are not apparent when comparing enacted and actual FTEs
    in IRS's IS account. For example, when enacted FTEs are considered, IS
    staffing appears to fluctuate up and down between fiscal years 2002
    through 2007; yet, when actual FTEs are considered, IS staffing
    decreased from fiscal year 2002 through 2005 and increased from fiscal
    years 2005 to 2006. IRS officials attribute these fluctuations in FTEs
    to reorganizations and other factors.
        Tables 5 and 6 also show significant differences in percentage
    changes between enacted and actual FTEs in some of IRS's appropriations
    accounts from fiscal years 2006 to 2007. The enacted level of FTEs is
    the number IRS projected it could support given the level of funding
    the Congress enacted. According to IRS officials, enacted levels tend
    to be overstated compared to actual FTEs for several reasons. First,
    IRS, like most federal agencies, does not receive its budgets when
    expected and cannot fill all positions. Also, as the costs of
    maintaining current FTE levels increase annually, IRS is not able to
    realize all of the FTEs it projects to fund with the appropriations the
    Congress enacts.

                             Table 5: IRS's Enacted FTEs for Fiscal Years 2002 through 2007
    ----------------------------------------------------------------------------------------------------------------
                                     Fiscal     Fiscal    Fiscal    Fiscal   Fiscal   Fiscal    Fiscal      Fiscal
                                   year  2007    year      year      year     year     year   year 2006-- year 2002--
                                  ------------   2006      2005      2004     2003     2002      2007        2007
                                              ----------------------------------------------------------------------
                                    Requested                                                 Percentage  Percentage
                                                Enacted   Enacted  Enacted  Enacted  Enacted    change      change
    ----------------------------------------------------------------------------------------------------------------
    PAM                            37,126      38,796    39,901    42,332   43,452   43,774   -4.30       -15.19
    ----------------------------------------------------------------------------------------------------------------
    TLE                            49,479      50,559    49,132    49,147   47,478   48,628   -2.14       1.75
    ----------------------------------------------------------------------------------------------------------------
    IS                             7,351       7,032     7,385     7,559    7,445    7,499    4.54        -1.97
    ----------------------------------------------------------------------------------------------------------------
    BSM                            0           0         0         0        0        NA       0.00        NA
    ----------------------------------------------------------------------------------------------------------------
    HITCA                          17          17        17        17       6        NA       0.00        NA
    ----------------------------------------------------------------------------------------------------------------
    Total                          93,973      96,404    96,435    99,055   98,381   99,901   -2.52       -5.93
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the budget was printed. Also, we are not
      reporting FTEs for user fees and reimbursable as shown in an earlier section of this statement, because we
      were unable to obtain this information for all years in time for this statement.

                                                                     Table 6: IRS's Actual FTEs from Fiscal Years 2002 through 2007
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                      Fiscal          Fiscal            Fiscal                  Fiscal
                                         Fiscal     Requested      Fiscal     Operating     Fiscal     Actual     Fiscal     Actual    year   Actual   year   Actual  year 2006-- Percentage  year 2002--
                                       year 2007                 year 2006      Level     year 2005             year 2004              2003            2002              2007       change       2007
    -------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------
    PAM                               37,126      38,308         38,710     41,436        43,452     44,191     -3.09      -15.99
    ----------------------------------------------------------------------------------------------------------------------------------
    TLE                               49,479      49,721         48,544     47,704        47,478     48,238     -0.49      2.57
    ----------------------------------------------------------------------------------------------------------------------------------
    IS                                7,351       7,340          7,015      7,279         7,445      7,773      0.15       -5.43
    ----------------------------------------------------------------------------------------------------------------------------------
    BSM                               0           0              0          0             0          NA         0.00       NA
    ----------------------------------------------------------------------------------------------------------------------------------
    HITCA                             17          17             13         12            6          NA         0.00       NA
    ----------------------------------------------------------------------------------------------------------------------------------
    Total                             93,973      95,386         94,282     96,431        98,381     100,202    -1.48      -6.22
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the budget was printed. Also, we are not reporting FTEs for user fees and reimbursable as shown in an earlier section of this
      statement, because we were unable to obtain this information for all years in time for this statement.

        In its fiscal year 2006 budget request, IRS showed its budget
    distributed by taxpayer services and enforcement, including IS funding
    for those areas, because the agency's current appropriation accounts
    are not divided clearly between taxpayer service and enforcement. As
    table 7 shows, funding for enforcement increased 15 percent between
    fiscal years 2004 and 2007 to $6.96 billion, while funding for taxpayer
    service declined over 3 percent to almost $3.6 billion.

             Table 7: IRS's Funding for Taxpayer Service and Enforcement for Fiscal Years 2004 through 2007
    ----------------------------------------------------------------------------------------------------------------
                                                                                                        Percentage
            Dollars in Millions           Fiscal year     Fiscal year    Fiscal year    Fiscal year   change  2004-
                                        2007  requested   2006 enacted   2005 enacted  2004 enacted        2007
    ----------------------------------------------------------------------------------------------------------------
    Taxpayer Service                    $3,583           $3,533         $3,606         $3,710        -3.4
    Enforcement                         $6,961           $6,824         $6,392         $6,052        15.0
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Note: IRS's taxpayer service and enforcement programs are funded through its PAM, TLE, and IS accounts.

                                     ______

    Appendix III: IRS's Estimated and Actual Savings and Reinvestments
        In its 2007 budget request, the Internal Revenue Service (IRS) is
    proposing to save over $121 million and 1,424 Full-time Equivalents
    (FTEs) and reinvest over $12 million and 11 FTEs. Based on IRS's
    ability to achieve prior year savings and reinvestments as shown in
    table 8, we have a basis to believe that IRS will achieve most, if not
    all, of these savings. For example, IRS reported it realized 88 percent
    of its anticipated budget savings and 86 percent of its anticipated
    staff savings for savings identified in its fiscal year 2004 budget
    request, and IRS reported exceeding savings targets in fiscal year
    2005.

            Table 8: IRS's Estimated and Actual Savings and Reinvestments for Fiscal years 2004 through 2007
    ----------------------------------------------------------------------------------------------------------------
                                      Fiscal year 2004     Fiscal year 2005     Fiscal year 2006    Fiscal year 2007
                                           actual               actual              estimate            estimate
         Dollars in  Thousands     ---------------------------------------------------------------------------------
                                      Dollars     FTEs     Dollars     FTEs     Dollars     FTEs    Dollars    FTEs
    ----------------------------------------------------------------------------------------------------------------
    Savings\a\                      ..........  .......  ..........  .......  ..........  .......  .........  ......
    ----------------------------------------------------------------------------------------------------------------
    Budgeted                        $160,872    1,993    $110,841    1,442    $230,096    2,230    $121,596   1,424
    ----------------------------------------------------------------------------------------------------------------
    Actual                          $141,142    1,711    $127,239    1,628    $226,908    2,230    NA         NA
    ----------------------------------------------------------------------------------------------------------------
    Percentage realized             88          86       115         113      99          100      NA         NA
      between Budgeted and
     Actual\b\.
    ----------------------------------------------------------------------------------------------------------------
    Reinvestments\a\                ..........  .......  ..........  .......  ..........  .......  .........  ......
    ----------------------------------------------------------------------------------------------------------------
    Budgeted                        $141,419    602      $66,343     359      $95,893     805      $12,237    11
    ----------------------------------------------------------------------------------------------------------------
    Actual                          $118,330    313      $96,481     958      $92,030     805      NA         NA
    ----------------------------------------------------------------------------------------------------------------
    Percentage realized             84          52       145         267      96          100      NA         NA
      between Budgeted and
     Actual\b\.
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.
    Note: Fiscal year 2007 FTE savings reflect an adjustment after the budget was printed.
    \a\ IRS considers savings to be gained through process or systems improvements and reinvestments to be those
      savings that were realized and available for other purposes.
    \b\ IRS reported actuals for 2004 and 2005, and year-end projections for 2006.

                                     ______

    Appendix IV: State Mandates
        Of the 50 states, 12 have electronic filing mandates for tax
    practitioners in effect for the 2006 filing season (see fig. 4). The
    mandates differ in their implementation dates and schedules, thresholds
    for filing, and penalties. The differences between mandates may affect
    the magnitude of electronic filing increases in each state.
        Figure 4: States with Electronic Filing Mandates for Tax Preparers
        [GRAPHIC] [TIFF OMITTED] T0443A.004

        We recently reported that state mandates encourage electronic
    filing of federal tax returns and recommended that IRS develop better
    information about the costs to tax practitioners and taxpayers of
    mandatory electronic filing of tax returns for certain categories of
    tax practitioners.\42\ These mandates require tax practitioners who
    meet certain criteria, such as filing 100 individual state tax returns
    or more, to file individual state returns electronically.
    ---------------------------------------------------------------------------
        \42\ GAO-06-51.
    ---------------------------------------------------------------------------
        Between tax years 2001 and 2004, electronic filing had grown in the
    9 states with mandates from an average of 36.7 percent to 56.8 percent,
    or an increase of over 20 percentage points, compared to an increase of
    14 percentage points for the 41 non mandated states over the same time
    period. We expect this trend to continue as 3 additional states--New
    York, Utah and Connecticut--implemented mandates in time for the 2006
    filing season. Of these 3 states, New York may have the most to gain
    because it currently has the lowest rate of electronic filing rate,
    with fewer than 38 percent of its nearly 9 million federal individual
    income tax returns electronically filed last year.
                                     ______

        Appendix V: Bibliography of GAO Resources
    Filing Season Performance:
        Tax Administration: IRS Improved Some Filing Season Services, but
    Long-Term Goals Would Help Manage Strategic Trade-offs, GAO-06-51
    Washington, D.C.: November 14, 2005.
        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.: November 10, 2004.
        Tax Administration: IRS's 2003 Filing Season Performance Showed
    Improvements, GAO-04-84 Washington, D.C.: October 31, 2003.
        IRS's 2002 Tax Filing Season: Returns and Refunds Processed
    Smoothly; Quality of Assistance Improved, GAO-03-314 Washington, D.C.:
    December 20, 2002
    IRS's Budget Requests:
        Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
    Request, GAO-05-566 Washington, D.C.: April 27, 2005.
        Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
    Request and Interim Results of the 2005 Filing Season, GAO-05-416T
    Washington, D.C.: April 14, 2005.
        Internal Revenue Service: Assessment of Fiscal Year 2005 Budget
    Request and 2004 Filing Season Performance, GAO-04-560T Washington,
    D.C.: March 30, 2004.
    Tax Gap and Compliance:
        Tax Gap: Making Significant Progress in Improving Tax Compliance
    Rests on Enhancing Current IRS Techniques and Adopting New Legislative
    Actions, GAO-06-453T Washington, D.C.: February 15, 2006.
        Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term
    Goals Are Needed to Improve Taxpayer Compliance, GAO-06-208T
    Washington, D.C.: October 26, 2005.
        Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
    Sustainability but Will Require a Variety of Strategies, GAO-05-527T
    Washington, D.C.: April 14, 2005.
        Taxpayer Information: Data Sharing and Analysis May Enhance Tax
    Compliance and Improve Immigration Eligibility Decisions, GAO-04-972T
    Washington, D.C.: July 21, 2004.
        Compliance and Collection: Challenges for IRS in Reversing Trends
    and Implementing New Initiatives, GAO-03-732T Washington, D.C.: May 7,
    2003.
    Financial Statement Audits:
        Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial
    Statements, GAO-06-137 Washington, D.C.: November 10, 2005.
        Internal Revenue Service: Status of Recommendations from Financial
    Audits and Related Financial Management Reports, GAO-05-393 Washington,
    D.C.: April 29, 2005.
        Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial
    Statements, GAO-05-103 Washington, D.C.: November 10, 2004.
        Internal Revenue Service: Status of Recommendations from Financial
    Audits and Related Financial Management Reports, GAO-04-523 Washington,
    D.C.: April 28, 2004.
        Financial Audit: IRS's Fiscal Years 2003 and 2002 Financial
    Statements, GAO-04-126 Washington, D.C.: November 13, 2003.
    Business Systems Modernization:
        Business Systems Modernization: Internal Revenue Service's Fiscal
    Year 2006 Expenditure Plan, GAO-06-360 Washington, D.C.: February 21,
    2006.
        Business Systems Modernization: Internal Revenue Service's Fiscal
    Year 2005 Expenditure Plan, GAO-05-774 Washington, D.C.: July 22, 2005.
        IRS Modernization: Continued Progress Requires Addressing Resource
    Management Challenges, GAO-05-707T Washington, D.C.: May 19, 2005.
        Business Systems Modernization: IRS's Fiscal Year 2004 Expenditure
    Plan, GAO-05-46 Washington, D.C.: November 17, 2004.
        Business Systems Modernization: Internal Revenue Service Needs to
    Further Strengthen Program Management, GAO-04-438T Washington, D.C.:
    February 12, 2004.
        IRS Modernization: Continued Progress Necessary for Improving
    Service to Taxpayers and Ensuring Compliance, GAO-03-796T Washington,
    D.C.: May 20, 2003.
    Other:
        Tax Administration: IRS Can Improve Its Productivity Measures by
    Using Alternative Methods, GAO-05-671 Washington, D.C.: July 7, 2005.
        21st Century Challenges: Reexamining the Base of the Federal
    Government, GAO-05-325SP Washington, D.C.: February 2005.
        High Risk Series: An Update, GAO-05-207 Washington, D.C.: January
    21, 2005.
        Internal Revenue Service: Challenges Remain in Combating Abusive
    Tax Schemes, GAO-04-50 Washington, D.C.: November 19, 2003.
        Tax Administration: IRS Is Implementing the National Research
    Program as Planned, GAO-03-614 Washington, D.C.: June 16, 2003.
        Tax Administration: IRS Needs to Further Refine Its Tax Filing
    Season Performance Measures, GAO-03-143 Washington, D.C.: November 22,
    2002.
        The Results Act: An Evaluator's Guide to Assessing Agency Annual
    Performance Plans, GAO/GGD-10.1.20 Washington, D.C.: April 23, 1998.
        For more information on Department of the Treasury major management
    challenges, see http://www.gao.gov/pas/2005/treasury.htm

        Chairman RAMSTAD. Thank you to all four of you
    distinguished gentlemen for your testimony. The Chairman and
    each Member of the Committee appreciates the expertise that you
    literally bring to the table, and appreciate your testimony
    again here today.
        Mr. George, I would like to ask you the first question, and
    I think it is important that we delve into a little more deeply
    the Free File agreement situation. I think it is important that
    we focus on what the agreement was all about. Now, in your
    written testimony, Mr. Hugo, you claim that the original intent
    of the agreement was to serve low-income and disadvantaged
    persons, taxpayers. Looking at the original agreement, I see no
    support for this contention.
        In your view, Mr. George, what was the original purpose of
    the Free File agreement?
        Mr. GEORGE. Thank you, Mr. Chairman. Let me quote, if I
    may, from the original agreement. It states that, ``This
    agreement provides for free online tax return preparation and
    filing to individual taxpayers,'' and it delineates five
    points, which I will briefly summarize.
        It wanted to ensure free and secure electronic preparation
    and filing options for additional taxpayers. It wanted to make
    sure that tax return preparation was easier and would reduce
    the burden on the individual taxpayer. Third, it wanted to
    support the IRS' goal to increase e-filing pursuant to the
    Restructuring Act 1998, and the goal of the IRS to achieve 80
    percent of electronically filed returns by 2007. Four, it
    wanted to provide greater service and access to taxpayers, and
    last, it wanted to support the President's proposal in his
    fiscal year 2003 budget, which again, specifically encouraged
    further growth in electronic filing.
        Nowhere in the original agreement was there any mention on
    restrictions placed on who could participate in the program.
        Chairman RAMSTAD. That was my reading as well.
        Mr. White, do you agree?
        Mr. WHITE. Yes, Mr. Chairman.
        Chairman RAMSTAD. Chairman Wagner?
        Mr. WAGNER. Yes, sir, Mr. Chairman. I am not aware of any
    restrictions in the original agreement, and I would think the
    spirit of the original agreement should be carried forward
    today as well.
        Chairman RAMSTAD. Mr. Hugo, do you want to respond?
        Mr. HUGO. Yes, sir.
        Chairman RAMSTAD. By the way, if I may--excuse my
    interruption--we have two votes. The first vote will last 17
    minutes. I would like to finish with this panel prior to going
    to vote, so we will adhere to the five-minute limit so we won't
    have to detain you unnecessarily, and then we will recess for
    15 minutes, 20 minutes max, until the next panel.
        Please proceed, Mr. Hugo.
        Mr. HUGO. Mr. Chairman, thank you for the opportunity.
        I think one of the things, that question arose when we came
    before your staff earlier a couple weeks ago, and also with
    TIGTA. One of the things that I wanted to clarify--again, I
    have been there since July of 2005. So, what we did is went
    back to some of the original negotiators. In fact, we conferred
    with Mr. Rossotti, the original Commissioner at the time this
    was negotiated, and got an e-mail from him, some communication
    from him just the other day, saying that the original intent
    was to make sure that low and moderate income tax payers were
    not deterred by the fee, that the fee was not a deterrent.
        In the information that we also supplied to the Committee
    here, within months of that first agreement, there was an
    amendment, and again, I think we furnished that to your staff,
    that again talked about serving low and underserved
    communities. That was the purpose, and I think you have that
    information. So, that amendment that we talked about that is
    part of the agreement that has been part of the ongoing dialog
    is something that has been in place for 4 years, and then we
    have also received direction from Congress, not just from a
    bill that has passed one house, but in the Treasury
    Appropriations bill there has been language that talks about
    serving the low and underserved communities, and that was in
    some of the Treasury appropriation bills that have passed.
        Chairman RAMSTAD. Well, I think everyone here probably
    agrees, or most, that the Free File Alliance should not have to
    provide free preparation software to people like Bill Gates and
    Warren Buffett, but what about a husband and wife living in the
    third district of Minnesota. Each, let's say, has an adjusted
    gross income of $26,000. The filed jointly. Why shouldn't they
    be allowed to use Free File this year? Mr. Hugo.
        Mr. HUGO. Yes, sir. One of the things that perplexes me,
    what the Alliance agreement that we negotiated with the IRS, it
    covers $93 million Americans, 70 percent. I am perplexed, quite
    candidly, that we are focusing on the--you say the Warren
    Buffetts, the Bill Gates, that top 30 percent. I am curious why
    we are not focusing on maximizing that $93 million.
        Mr. Chairman, I am an elected official. I am a Member of
    the Virginia legislature. I am even on the Finance Committee. I
    had a real job at one time. I was Chief of Staff to a
    Congressman, a job that was halfway important. For preparation
    for this hearing, one of the things I was thinking about--and I
    conferred with the IRS before. I said, ``Did you tell every
    Member of Congress that they could let their constituents know
    in newsletters or communications that they can have free tax
    preparation for under 50 adjusted gross income?`` No, didn't
    happen.
        One of the things I think we are going to do is write every
    Member of Congress and every U.S. Senator next year, and say,
    please understand this is available to your constituents. That
    way we are maximizing, focusing on the $93 million, the low to
    moderate income, the direction we have gotten from Congress,
    which is direction we have gotten in legislative language that
    has passed, and I would be happy----
        Chairman RAMSTAD. It seems to me, Mr. Hugo, that you are
    missing a point relative to the original agreement. Your
    written testimony claims that the new Free File agreement
    covers more taxpayers than the original agreement, but the
    point you are missing is that the original agreement
    established a floor, that 60 percent of taxpayers had to be
    covered, while the new agreement establishes a cap, only 70
    percent of taxpayers are allowed to be covered. It seems to me
    that is an important distinction, and it seems to me that that
    point has been missed.
        Let me ask Mr. White. Under the new agreement, as we have
    seen previously, more than 40 millon taxpayers who were
    eligible for Free File last year are not eligible this year,
    and again, that is depicted graphically over there on the
    screen. Has this cap that we have discussed led to the 21
    percent decrease we see in Free File usage this year in your
    judgment, Mr. White?
        Mr. WHITE. It is certainly something that it has very
    likely contributed to that. We don't know all the reasons that
    have contributed, but it seems very logical that that has to be
    part of the explanation.
        Chairman RAMSTAD. As a follow up, has the decreased use
    then of Free File contributed to the lower than expected rate
    of growth in electronic filing, in e-filing this year?
        Mr. WHITE. There are a number of factors that have
    contributed to that, but again, it seems very logical that this
    has to be one factor that is contributing to that.
        Chairman RAMSTAD. The only conclusion the Chairman can
    reach, based on the testimony, is that, simply put, under the
    new agreement, fewer taxpayers are eligible for Free File,
    fewer taxpayers are using it, and electronic filing is not
    growing as projected. So, how can we call this agreement good
    for taxpayers, Mr. White?
        Mr. WHITE. Well, the----
        Chairman RAMSTAD. Let me rephrase that.
        Mr. WHITE. Sir, the questions that you are asking are
    valid.
        Chairman RAMSTAD. That is more than leading, even by
    Congressional standards.
        [Laughter.]
        Chairman RAMSTAD. Let me ask you, do you, in your view,
    believe this agreement is good for taxpayers?
        Mr. WHITE. Mr. Chairman, the agreement involves some
    tradeoffs. Taxpayers, some taxpayers get free filing. The
    private sector agreed to provide free return filing for those
    taxpayers. IRS got some other things in the agreement. There is
    more disclosure on the terms and conditions attached to RALs,
    for example. It is a judgment call about whether on balance,
    overall, it is a good agreement or not.
        Chairman RAMSTAD. Any of the other witnesses, would you
    like to comment? Mr. George?
        Mr. GEORGE. I would just note, Mr. Chairman, that even when
    the program was available to any taxpayer, you had only about 5
    million of an approximately 130 million eligible taxpayers
    taking advantage of it. So, while giving people access to it is
    good, it wasn't promoted to the point where it was taken
    advantage of.
        Chairman RAMSTAD. Chairman Wagner?
        Mr. WAGNER. Mr. Chairman, I think the agreement and the
    Alliance is very good for 93 million taxpayers, but I also
    think that it ought to extend to all the other taxpayers. I
    think in my own personal State, my parents, I assisted them in
    preparing their returns through the Free File Alliance a few
    years or so ago, and this year they will just barely not
    qualify. So, we will be confronted with either buying the
    product or pushing the paper.
        Chairman RAMSTAD. Prior to recessing for our vote, the
    Chairman recognizes the gentleman from North Dakota.
        Mr. POMEROY. I thank the Chair. So, I get this all
    straight, basically this public-private partnership has its
    origination in trying to advance the goal of expanding
    electronic filing of taxpayers. Is that correct, Mr. White?
        Mr. WHITE. Yes, sir.
        Mr. POMEROY. That is the goal of it. Mr. Hugo, are you in
    the State Senate or State House?
        Mr. WHITE. House.
        Mr. POMEROY. Representative Hugo--I like the House, by the
    way.
        Mr. HUGO. Yes, sir, the people's body.
        Mr. POMEROY. The people's body. Would you say,
    Representative Hugo, that if there was a mission statement from
    the Alliance, expanding e-filing of taxpayers is the goal of
    the Alliance?
        Mr. HUGO. The goal of the Alliance, and this was stated in
    the operating agreement and the recent MOU, it was stated, like
    you said, within months the comment that we put in writing----
        Mr. POMEROY. The goal of the Alliance----
        Mr. HUGO. Is to provide free tax preparation to low and
    moderate income underserved communities.
        Mr. POMEROY. Okay. The goal of the Alliance is not to
    expand electronic filing of taxpayers?
        Mr. HUGO. I think that is part of it. I think that will
    accomplish the fact that----
        Mr. POMEROY. What is the goal? This is very important. I
    believe the only reason that we ought to be in a public-private
    partnership is if the public goal of expanding electronic
    filing is advanced. Is that the primary goal?
        Mr. HUGO. I think it is the goal and I think it is that we
    are----
        Mr. POMEROY. How many of the 5 million last year were over
    50,000?
        Mr. HUGO. I am sorry.
        Mr. POMEROY. I am sorry. Representative Hugo, how many of
    the 5 million taxpayers were over $50,000 last year?
        Mr. HUGO. That I don't know the answer. I can provide that
    information to you, sir.
        Mr. POMEROY. It seems to me just basic, if you put a cap on
    who gets to use this, you are inconsistent with the goal of
    expanding e-filing, and I think it is related, maybe not in a
    huge way, but certainly related in a direct way to the comment
    made by Mr. George that we are falling off pace in terms of
    electronic filing.
        Mr. HUGO. Mr. Chairman and Mr. Pomeroy, let me answer, and
    I would like to take from the direct testimony that the head of
    the Electronic Tax Administration Mr. Dumars made in front of
    the Senate. One of the reasons he believes the numbers are down
    this year is because we did not get the press. A year ago, it
    was on the front page of USA Today. The IRS budget to advertise
    this program has been slashed and----
        Mr. POMEROY. My time is short, and we have got a vote. I
    appreciate----
        Mr. HUGO. I would say----
        Mr. POMEROY. --that line of argument, but let me tell you--
    --
        Mr. HUGO. No, no, I--okay.
        Mr. POMEROY. --as one that is going to continue to evaluate
    whether we ought to have a public-private partnership in any
    event, I am going to look at whether or not this thing is
    operating with focus and as a clear priority, advance the
    public goal of electronic take-up rates with taxpayers. If this
    thing starts to be diverted where it seems like the goal is
    advancing the ancillary business interests of the Alliance
    members or the biggest alliance members, then I have got some
    concerns.
        Mr. George, as you have evaluated this, do you see the
    Alliance in any of its operations having kind of a cartel
    effect, an anticompetitive effect on what might be the emerging
    enterprises in this electronic filing business?
        Mr. GEORGE. Mr. Pomeroy, we are in the process of reviewing
    this, and we have not yet looked at that issue.
        Mr. POMEROY. It is very important. I will be really eager
    for your report. Has the GAO had a chance to look at that, Mr.
    White?
        Mr. WHITE. No, we have not, Mr. Pomeroy.
        Mr. POMEROY. I think the message we have delivered loud and
    clear. We hate this 50,000 cap. I hope that it is not in the
    next agreement. I think the IRS did not operate consistent with
    Congressional intent in doing it. I think it is bad public
    policy, and I am disappointed with this report this year.
        Moving on, though, to other issues, Chairman Wagner, we
    really appreciate what the Advisory Committee does.
        Mr. WAGNER. Thank you, sir.
        Mr. POMEROY. We think that you play a very important role
    in terms of oversight and sometimes advocacy beyond what the
    IRS can itself self-advocate.
        Mr. WAGNER. Thank you.
        Mr. POMEROY. Is there a----
        Chairman RAMSTAD. Excuse me, Mr. Pomeroy. The Chairman will
    recess the Subcommittee for 20 minutes or subject to the call
    of the Chair. We are running out of time.
        Mr. POMEROY. I think we can clarify--when you don't come up
    with the appropriation you need, does that diminish the ability
    of the Service to efficiently and effectively collect taxes?
        Mr. POMEROY. When you do not get the appropriation you
    need, does that impact the Service's ability to efficiently and
    effectively----
        Mr. WAGNER. It requires more creativity at that point, but
    I think the Service can efficiently fulfill its mission with
    the resources that it has been provided.
        Mr. POMEROY. I am done.
        Chairman RAMSTAD. The Subcommittee is in recess subject to
    the call of the Chair. It should not be more than 20 minutes.
        [Recess.]
        Chairman RAMSTAD. The Committee will come to order. While
    our witnesses are taking their seats, let me welcome to the
    Subcommittee on Oversight, Chairman Dennis Drapkin, the
    American Bar Association (ABA) section of Taxation; Chair
    Thomas Purcell, of the Tax Executive Committee of the American
    Institute for Certified Public Accountants (AICPA); and Francis
    X. Degen, President, National Association of Enrolled Agents
    (NAEA).
        We will begin with your testimony, please, Mr. Drapkin.

    STATEMENT OF DENNIS B. DRAPKIN, CHAIRMAN, SECTION OF TAXATION,
                        AMERICAN BAR ASSOCIATION

        Mr. DRAPKIN. Thank you, Mr. Chairman, for the opportunity
    to appear before the Subcommittee this morning. My name is
    Dennis Drapkin. I am the Chair of the Tax section of the ABA,
    and my testimony is presented on behalf of the ABA.
        I will focus on three keys issues essential to the
    administration of the tax laws and also briefly address pending
    legislation relating to offers in compromise.
        First, the importance of adequate funding for the IRS. The
    ABA has consistently supported full funding of the IRS. We note
    that the administration's proposed 2007 budget includes an
    increase in IRS funding as compared with the prior year enacted
    level, and we urge that Congress fund the IRS at least at the
    level the administration has proposed.
        Adequately funding is essential for the IRS to provide
    taxpayers with quality service. The IRS needs these resources
    to collect taxes fairly and efficiently without imposing undue
    burdens on taxpayers.
        Second, let me speak to the need for balance between
    enforcement and taxpayer service. Achieving acceptable levels
    of compliance requires a balance of effective taxpayer service
    and vigorous enforcement. Up-front taxpayer service enhances
    voluntary compliance, which reduces the demands on enforcement.
    Credible enforcement of the tax laws, in turn, encourages
    greater voluntary compliance.
        Complex tax laws make taxpayer service a necessity.
    Taxpayers must be able to obtain accurate information on the
    tax laws that affect them. The IRS responds in ways that are
    vital to providing taxpayers with the information they require.
    Adequate funding is also essential for effective enforcement.
    Taxpayers must believe that the laws will be enforced and that
    those who cheat will be caught. Enforcement must be apparent
    throughout all parts of the economy. Funding must be sufficient
    for those in the Service whose primary mission is compliance.
        In addition, funding must be adequate to support ongoing
    administration of the tax laws. The Service must be able to
    publish clear and understandable guidance, train its personnel,
    continuously improve compliance programs, and obtain accurate
    information about how the tax system is functioning.
        The third key issue is the need to simplify the tax laws.
    Complexity is a major obstacle to efficient and effective
    administration of the tax laws. For 30 years, the ABA and the
    section of Taxation have been on record urging tax law
    simplification. Making the tax system simpler is also a
    legislative priority of the ABA. We appreciate the efforts that
    the Chairman and other Members of the Subcommittee have made
    over the past few years to focus attention on the need for
    simplification and to motivate Congress to enact important
    simplification legislation. Achieving simplification is not
    easy. Often it must be weighed against concerns relating to
    equity and fairness. Yet simplification is worth the effort. It
    can ease the burden of compliance for all taxpayers and reduce
    the demands placed on the IRS.
        As always, the Tax section stands ready to work with you
    and your staff to achieve simplification. We commend you for
    what you have done, but it is vital that your efforts continue
    and that they succeed.
        Finally, speaking on behalf of the ABA Tax section, I would
    like to address pending legislation regarding offers in
    compromise. Offers in compromise are an important tax
    collection tool. The Tax Relief Act of 2005, S. 2020, would add
    a 20-percent downpayment requirement to lump-sum offers in
    compromise. The downpayment would be nonrefundable and retained
    by the IRS even if the offer is rejected. This change is
    intended to reduce offers that are not made in good faith.
        We, and others, have serious concerns about the proposal.
    Relatives and employers are often the source of funds for
    offers. They will be far less willing to do so if this proposal
    is enacted. As a result, the new downpayment requirement could
    dramatically reduce outside funding for potential offers. This
    would decrease the number of legitimate offers submitted, the
    number of offers accepted, and the number of individuals re-
    entering the tax system. This is not a desirable outcome.
        Mr. Chairman, thank you again for the opportunity to appear
    before the Subcommittee today, and I will be pleased to respond
    to any questions.
        [The prepared statement of Mr. Drapkin follows:]

         Statement of Dennis B. Drapkin, Chairman, Section of Taxation,
                            American Bar Association

        Thank you, Mr. Chairman. My name is Dennis Drapkin. I am the Chair
    of the American Bar Association Section of Taxation. This testimony is
    presented on behalf of the American Bar Association (the ``ABA'').
        The ABA is comprised of more than 400,000 members. The Section of
    Taxation includes 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'' or ``IRS''), 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.
        I greatly appreciate the opportunity to appear before the
    Subcommittee on Oversight (the ``Subcommittee'') today. My testimony
    will focus on three key issues bearing on the administration of the tax
    laws: (i) the importance of adequate funding for the Internal Revenue
    Service, (ii) the need for a balance between enforcement and providing
    services to taxpayers, and (iii) the need to simplify the tax laws. I
    will also briefly address pending legislation relating to offers in
    compromise.
    IRS Funding
        The ABA has consistently supported full funding of the IRS to carry
    out its missions of taxpayer service and fair administration and
    enforcement of the tax laws. We note that the Administration's proposed
    2007 Budget includes an increase in IRS funding as compared with the FY
    2006 enacted level. We urge that Congress fund the Service at least at
    the level the Administration has proposed.
        Adequate funding is central to the ability of the Service to
    provide America's taxpayers with top quality service by helping them to
    understand and meet their tax responsibilities and by applying the tax
    law with integrity and fairness to all. Fulfilling this mission is
    possible only if the Service has the resources necessary to collect
    taxes owed efficiently and effectively without imposing undue burdens
    on taxpayers.
    The Need for Balance Between Enforcement and Service
        Achieving acceptable levels of compliance requires a balance of
    effective taxpayer service and vigorous enforcement. Effective front-
    end taxpayer service enhances voluntary compliance, thereby reducing
    the demands on enforcement down the road. Consistent fair and credible
    enforcement of the tax laws, in turn, encourages greater voluntary
    compliance.
        Given the level of complexity of our tax laws, taxpayer service is
    a necessity. Taxpayers must be able to obtain accurate information on
    complicated tax law provisions affecting them. The Service fulfills
    this task in a number of ways, e.g., telephonic call-in lines, walk-in
    information sites, print publications, and, increasingly, electronic
    communications. All these activities are vital to providing taxpayers
    with the information they need to fulfill their responsibilities and to
    obtain the benefits to which the law entitles them. In her 2005 Annual
    Report to Congress, the National Taxpayer Advocate underscored the need
    for adequate taxpayer services, and suggested a number of areas that
    could be improved. At the February 8, 2006 meeting of the IRS Oversight
    Board, the need for greater and more effective taxpayer service was
    stressed by many of the speakers.
        The Service must also have adequate funding to perform its
    fundamental enforcement mission. In order for our voluntary tax system
    to work, taxpayers must believe that the laws will be enforced and
    those who cheat will be caught. To be effective, the Service's
    enforcement efforts must be broad-based in two senses. First, an
    enforcement presence must be apparent throughout the economy. A
    perception that the Service's enforcement efforts are too narrowly
    targeted leads to noncompliance in areas perceived to be out of the
    spotlight. Second, funding must be sufficient for all those in the
    Service whose primary mission is compliance, i.e., auditing revenue
    agents, appeals officers, tax litigators, and revenue officers, to do
    their jobs. Neglect of any of these inevitably compromises the ability
    of the others to fulfill their compliance responsibilities.
        In addition to supporting adequate service and enforcement,
    constant attention must be given to ongoing administration of the tax
    laws. The economic environment in which the tax law operates is
    constantly changing. The Treasury Department and the Service must
    address these changes through publication of clear and understandable
    guidance to taxpayers, through training of Service personnel, and
    through improvements to processing, audit, and controversy resolution
    techniques. Techniques and procedures for prompt and efficient
    resolution of recurring errors must be formulated and implemented, and
    longer term solutions to eliminate such errors through simplifying
    legislation or otherwise must be identified. Such solutions, in turn,
    are possible only when decision makers have accurate information
    concerning how the system is actually functioning. Thus, adequate
    funding for those who compile statistics of income and perform research
    on administration and compliance is also vital. There have been
    important initiatives at the Service aimed at improving audit currency
    and achieving better resource targeting in audits. These are worthwhile
    programs that should be encouraged and continued.
    The Need for Simplification
        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 demonstrated
    repeatedly 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. Reducing complexity must be a continuing priority of
    the Congress.
        Making the tax system simpler is a legislative priority of the ABA.
    For 30 years, the ABA and the Section of Taxation have been on record
    urging tax law simplification, so that laws can be (1) easily
    understood and complied with by taxpayers, and (2) fairly and
    consistently administered and enforced by the IRS. We know that
    simplification is an issue the Subcommittee takes seriously, and we
    appreciate the efforts the Chairman and other Members of the
    Subcommittee have made over the past few years to focus attention on
    the need for simplification and to motivate Congress to enact important
    simplification legislation.
        In this regard, we wish to acknowledge that in 2004 Congress
    enacted important simplification of the definition of a ``child'' under
    the Internal Revenue Code. After the new definition was adopted, issues
    were raised with respect to the allocation of dependency exemptions
    between custodial and noncustodial parents. On September 1, 2005, we
    wrote to the Chairman and Ranking Members of the House Committee on
    Ways and Means and the Senate Committee on Finance to suggest changes
    to the technical corrections originally introduced to address these
    issues. In the Gulf Opportunity Zone Act of 2005, Congress enacted
    technical corrections to resolve these issues adopting the approach
    suggested in our letter. We applaud the quick action of Congress in
    addressing these issues.
        Questions have since been raised about other unintended
    consequences of the new definition of a child. We are studying these
    questions and the solutions that have been proposed, including the
    recent proposals by the Treasury, and we stand ready to work with you
    and your staff to address these questions. It is important, however,
    that the issues that have arisen with respect to simplifying the
    definition of a child not deter the Congress from pursuing additional
    simplification of other complex provisions of the Code.
        As this recent experience indicates, simplification is not easy.
    The new issues regarding the definition of child, for example,
    illustrate the difficulties inherent in balancing simplification, on
    the one hand, against addressing a multitude of perceived inequities,
    on the other. In addition to requiring careful examination of possible
    unintended consequences, simplification frequently requires either
    foregoing revenue or making choices that benefit some taxpayers and
    adversely affect other taxpayers. But simplification is worth the cost.
    Simplification 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 understand how the law operates.
        In recent years, the Section of Taxation has worked with the
    American Institute of Certified Public Accountants (``AICPA'') and the
    Tax Executives Institute (``TEI'') to identify simplification
    priorities and realistic simplification initiatives. Together with
    these other organizations, the Tax Section 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. There
    is a consensus for tax simplification, and we urge you to call on us
    and our colleagues in the AICPA and TEI to help you make it a reality.
        We would like to take this opportunity emphasize a few
    simplification matters 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. The ABA recommends that the
    individual AMT be repealed. We recognize that replacement sources of
    revenue likely will 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.
        Even if big-ticket simplification such as AMT repeal cannot be
    accomplished immediately, there are other important, but smaller scale,
    simplification proposals that can be adopted in the near term if
    appropriate legislative focus is applied. For example, we have called
    your attention in prior testimony 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. Perhaps even more important are the
    disincentives that occur when a taxpayer attempts to avail himself of
    benefits under several provisions and the combined phase-outs create
    marginal tax rates well in excess of what the section 1 tax table says
    the taxpayer's marginal rate should be. We recognize the action taken
    by the Congress 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.
        We also note that the President's Advisory Panel on Tax Reform
    offered a number of separate recommendations in its November 2005
    report that could promote significant simplification of the federal
    income tax, including repeal of the individual and corporate AMT. The
    Panel also recommended a limited number of tax credits relating to
    family status; simplifying tax benefits for charitable donations, home
    ownership and health coverage; and restructuring numerous individual
    savings and retirement provisions. We commend the Panel for its focus
    on simplification. Its report has made numerous useful suggestions that
    merit further study and consideration.
        We and others previously 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, and we have publicly applauded the
    prompt guidance they issued in response to Hurricane Katrina. The
    guidance process is, however, continuous, and the work of the IRS and
    Treasury 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.
        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.
    Offers in Compromise
        Offers in compromise are an important collection tool that can
    provide taxpayers with a ``fresh start'' and foster long term
    compliance. The Tax Relief Act of 2005, S. 2020, proposes adding a 20-
    percent down payment requirement to lump-sum offers-in-compromise. It
    is apparently intended that the lump-sum down payment would be
    nonrefundable and retained by the Service if the offer is rejected.
    While the apparent objective of the proposed changes--to reduce the
    number of offers that are not made to the IRS in good faith--is
    laudable, we nevertheless have serious concerns about this proposal.
        A successful offer-in-compromise program raises revenue both from
    the offer and by bringing taxpayers back into the system. Relatives and
    employers of the taxpayer are often the source of funds for offers in
    the current system. These parties will understandably be far less
    willing to commit non-refundable monies under the regime that would be
    created by the Senate bill. Because the 20-percent nonrefundable down
    payment requirement could dramatically reduce available outside funding
    for potential offers, there is a significant risk that the proposal
    could decrease the number of legitimate offers submitted, the number of
    offers accepted and the number of individuals reentering the tax
    system. The provision also marks a change in direction from the 1998
    Taxpayer Bill of Rights. Accordingly, we recommend that the proposal
    not be adopted.
        Mr. Chairman, thank you for the opportunity to appear before the
    Subcommittee today. I will be pleased to respond to any questions.

        Chairman RAMSTAD. Thank you, Mr. Drapkin. Dr. Purcell,
    please?

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

        Mr. PURCELL. Mr. Chairman, thank you for this honor of
    being able to present our testimony today before the
    Subcommittee. I have two main points that I would like to make,
    and the bulk of my comments are taken from the written
    testimony that we have already provided to you, and I would be
    happy to answer questions as we have time at the end of my
    comments.
        First, with regard to the progress so far in the filing
    season, we have no evidence from our members that there have
    been any issues, insurmountable issues that have arisen with
    regard to filing individual tax returns. It seems to be a
    relatively typical filing season from that perspective.
    Obviously, there is going to be the last-minute crunch that
    happens in the next 2 weeks, and then also the extension
    period, which now is a 6-month period that will take us into
    the fall. Other than those types of things, we have not heard
    anything from members that would give us any pause.
        We do have concerns, though, that continue with regard to
    the mandatory e-filing for larger taxpayers, the corporations
    with over $50 million and the nonprofit organizations of over
    $100 million. Our sense is that people are going slow on this,
    that the numbers that you are seeing that people are filing on
    time, these go slow at this point because there is still
    pushback from software providers that have not stepped up to
    fully implement the software necessary to make this happen.
    Companies are still having difficulties conforming their
    software and their information with the platform that will need
    to be used. So we anticipate that there could be a significant
    crunch when we get toward the 6-month filing timeframe for
    corporations, which would be September 15. So, we anticipate
    that sometime in late August, early September, there is going
    to be a flurry of activity. We do not know how that will be
    resolved because the IRS has been very adamant that they are
    going to be very careful on providing waivers for this, but we
    do not know how that will be resolved. Frankly, we are
    concerned about that.
        The second level of concern on that would then extend to
    next year because the filing threshold drops to $10 million,
    which is a significantly larger net of taxpayers. So our
    concern there is that more people be pulled in that do not
    anticipate this, and we have only had one season to try and get
    it ready. So, hopefully we can continue to work with the IRS on
    making this be a more painless process.
        As you know, there were some issues early on with regard to
    Schedule D reporting. We continue to work with the IRS on this,
    and we are grateful that they have taken the approach to try
    and work with us on trying to clarify the type of information
    and what will be acceptable to them for reporting transactions
    with regard to stocks and bonds and other things that might
    come from brokers.
        We do not have a position on the free file. I have listened
    to the discussion today, but we have not had a position on free
    file because it is not an issue that many of our clients would
    be involved in.
        On the budget side, I would echo Dennis's comments that we
    continue to remain very much in favor of funding for the IRS at
    appropriate levels so it can do the job it is expected to do.
    We watch with anticipation the business modernization approach
    because those business systems are where we interact very much
    with the IRS, and our concern is that as we go to a 21st
    century agency, a 21st century tax practice, that the
    technology is sufficient to support what is needed by both the
    taxpayer and by the IRS.
        We also look at the user fees as a level of concern. The
    approach that was taken was that we would increase--the IRS has
    increased the user fees, in some cases quadrupling the size of
    them. Our concern is that there will be twofold impacts from
    this: one, if they are anticipating an increase in revenues
    because of that, taxpayers could well push back and not pay the
    fees because they are so much higher; and, two, if you do not
    get that type of service as a taxpayer, it could create a
    situation where there is greater compliance issues on the back
    end and enforcement issues because you do not have the surety
    that the transaction that you are looking at will be given
    favorable treatment by the IRS.
        Finally, we watch with concern the outsourcing of
    collections, the reduction in taxpayer services. We understand
    the service plus compliance attitude that the IRS has, but we
    do remain concerned that all taxpayers are able to get the
    services they need in order to fulfill their obligation, and
    that if the Service cuts too many services that are not
    available to taxpayers that otherwise we serve, there could be
    a deleterious effect on enforcement.
        Thank you for the opportunity to testify.
        [The prepared statement of Mr. Purcell follows:]

        Statement of Thomas J. Purcell, Chair, Executive Tax Committee,
              American Institute for 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 approximately 330,000 members. Our
    members advise clients on federal, state, and international tax 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 2006 tax filing season.
        The AICPA is happy to report that the 2006 filing season is
    progressing largely without any significant problems and American
    taxpayers and practitioners are generally pleased with the Service's
    performance. However, while generally not developing into problems
    during the filing season, tax professionals expressed strong opposition
    in late 2005 to sections of the 2005 Form 1040 instructions involving
    (1) tax preparation cost estimates and (2) the requirement to list all
    capital gains or loss transactions on Form 1040, Schedule D.
        Our comments today focus on a number of programs of critical
    importance to the Service, specifically: (1) the IRS budget for fiscal
    year 2007, (2) Business Systems Modernization, (3) Form 1040
    instructions and stakeholder outreach, (4) achieving e-filing goals,
    (5) the increase in user fees, (6) tax practitioners and professional
    responsibility, (7) private debt collection efforts, (8) offers in
    compromise, and (9) tax simplification.
    1. THE IRS BUDGET
        The AICPA urges Congress to support full funding of the Internal
    Revenue Service's fiscal year 2007 budget. We have 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.
        Under President Bush's fiscal year 2007 budget proposal, the IRS
    would have an operating budget of approximately $10.7 billion,
    supplemented by certain additional user fees and reimbursable
    resources. According to the Department of Treasury's fiscal year 2007
    budget summary document, ``The IRS budget request--supports the IRS's
    five year strategic plan. This plan underscores the IRS' commitment to
    provide quality service to taxpayers while enforcing America's tax laws
    in a balanced manner.'' \1\
    ---------------------------------------------------------------------------
        \1\ Department of Treasury--Budget in Brief Fiscal Year 2007,
    February 6, 2006, pages 59-60.
    ---------------------------------------------------------------------------
        Giving the Service with the proper resources to fund its mission
    will empower the Service to fulfill both its customer service and
    enforcement responsibilities. We appreciate Commissioner Everson's
    recognition that any increase in enforcement funding must be balanced
    with positive responses to the taxpaying public as customers. We
    encourage this type of balanced approach and stand ready to work with
    the Service to ensure that the needs of America's taxpayers are
    fulfilled. As we have stated in the past, all taxpayers must have
    access to resources that enable them to fulfill their responsibilities,
    and budgetary funding must be provided to insure this access.
        Many AICPA members are tax practitioners. As such, we have seen
    first-hand the problems caused by an IRS that is not responsive to
    taxpayers as customers. We have also witnessed the improvements
    initiated by Commissioner Everson, particularly with respect to
    enforcement. Reductions in IRS funding requests that focus on customer
    service will only undercut efforts to improve compliance, and the
    nation's taxpayers will suffer as a direct result.
    2. BUSINESS SYSTEMS MODERNIZATION
        The fiscal year 2007 budget submission generally recommends
    reducing the budget for the Service's Business Systems Modernization
    (BSM) program by 15.1 percent from the level approved by Congress for
    2006. In recommending this sizable cut in the BSM budget, the Treasury
    (on behalf of the Administration) maintains that the ``BSM program has
    begun to improve its performance on delivering projects and releases on
    time, on budget, and meeting or exceeding scope expectations.'' \2\
    ---------------------------------------------------------------------------
        \2\ Id., page 62.
    ---------------------------------------------------------------------------
        We appreciate the Treasury's view that the Service is now achieving
    its project costs, scheduling, and performance goals, especially after
    the long period of implementation difficulties. While the AICPA cannot
    easily discern whether a 15.1 percent cut in the BSM's fiscal year 2007
    budget is prudent under the circumstances, we encourage Congress to
    closely scrutinize the Administration's proposed budget for BSM. In the
    end, it is critical for Congress to provide the Service with the
    appropriate funding levels for the modernization effort.
        BSM must remain a central feature of the Service's strategic plan.
    It is designed to provide benefits to both taxpayers and IRS employees,
    through implementation of (1) the Customer Account Data Engine (CADE),
    which is designed to replace the Service's ancient Master File System,
    (2) Modernized e-File, and (3) the Filing and Payment Compliance
    system. We strongly support these objectives.
    3. FORM 1040 INSTRUCTIONS AND STAKEHOLDER OUTREACH
        The IRS has generally done a very good job in recent years, of
    seeking the input of the AICPA and other stakeholders prior to the
    agency's announcement of a new program, initiative, or policy change.
    Examples of previous initiatives in which the Service did seek the
    input of the practitioner community with positive results include the
    National Research Program, and the development of the new Schedules K-1
    and M-3.
        However, when the Service has inadvertently failed to consult with
    the practitioner community about a new initiative, the IRS has found
    itself at times in a difficult position. The most recent examples of
    what we believe were poor communications and collaboration efforts on
    the Service's part involve the inclusion of (1) tax return preparation
    cost estimates as part of the 2005 Form 1040 instructions and (2) the
    specific requirement in the 2005 Form 1040, Schedule D instructions for
    taxpayers to physically list all capital gains or loss transactions on
    Schedule D.
        The tax return preparation cost estimates, appearing on page 79 of
    the 2005 Form 1040 Instructions, provide estimates of the average
    preparation times and expenses associated with certain Form 1040
    schedules that have been (1) self-prepared without tax software, (2)
    self-prepared with tax software, and (3) prepared by a paid
    professional. We informed the Service that these cost estimates did not
    fully reflect marketplace reality and lacked any contextual explanation
    that might mitigate confusion.\3\
    ---------------------------------------------------------------------------
        \3\ AICPA letter to Commissioner Everson (dated November 30, 2005)
    regarding the IRS's inclusion of tax preparation cost estimates in the
    2005 Form 1040 instructions.
    ---------------------------------------------------------------------------
        With respect to the requirement for taxpayers to list all capital
    gains and loss transactions on Form 1040, Schedule D, we suggested that
    the time needed to manually list each capital gains or loss transaction
    could create significant taxpayer burden and in the case of taxpayers
    using paid preparers, unnecessarily raise the overall cost of preparing
    the return.\4\
    ---------------------------------------------------------------------------
        \4\ AICPA letter to Commissioner Everson (dated December 23, 2005)
    regarding the reporting of capital gains and loss transactions on Form
    1040, Schedule D.
    ---------------------------------------------------------------------------
        While expressing our strong opposition to the preparer cost
    estimates and the Schedule D instructions matters, it is critical to
    mention that IRS executives have assured us that they value the input
    of the practitioner community on important policy initiatives; and as
    evidence, the Service did quickly respond to practitioner concerns
    regarding the preparer cost estimates and Schedule D. However, our
    members continue to express concern that even the recent clarifications
    by the IRS do not fully address the Schedule D issue and so we do not
    consider this issue resolved. We will continue to work with the IRS on
    satisfactory resolution of these issues. Unfortunately, we believe the
    Service has lost credibility and generated unnecessary frustration with
    tax professionals over the initial communication of their positions on
    these policy issues.
    4. ACHIEVING E-FILING GOALS
    Modernized E-File
        The AICPA recognizes the administrative efficiencies and budgetary
    savings the IRS's electronic tax administration program achieves for
    the agency, as well as the customer service benefits that accrue to
    taxpayers from an effective electronic filing (e-file) program. The
    administrative benefits of e-filing include faster tax processing,
    reduced cycle time, quicker identification of emerging audit trends,
    and the potential for more current resolution of taxpayer
    uncertainties.
        We applaud the success the IRS is having with the e-filing program
    during the 2006 filing season. According to IRS statistics, 68 percent
    of the 73.4 million individual returns filed through March 24 were
    electronically filed; with returns filed from home computers up about
    16.8 percent over last year. We will continue to work closely with the
    Service to meet its expectations of approximately 135 million
    individual e-filed returns during 2006 filing season.
        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. 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 tax
    (controversy) clinics receive under Internal Revenue Code section 7526.
    We believe funding for tax return preparation clinics would encourage
    e-filing and improve compliance by low income taxpayers generally.
        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. Last year, the IRS lowered this threshold by making the e-
    Services suite available to tax professionals who e-file 5 or more
    individual and business income tax returns. The AICPA believes this
    expansion of e-services to more practitioners has the added benefit of
    making the IRS's interaction with tax professionals more efficient,
    thereby generating significant cost savings to the Service. Since e-
    services benefits the IRS and tax professionals in so many ways, such
    as fostering the Service's enforcement and collection activities, we
    recommend that the IRS strongly consider dropping the 5 return
    threshold altogether.
    E-File for Large Corporations and Exempt Organizations
        The AICPA is closely consulting with the IRS on implementation of
    the mandatory e-file program during the current 2006 filing season, a
    program that generally requires large corporations (total assets of $50
    million or more) and tax exempt organizations (total assets of $100
    million or more) to file returns electronically.
        As the 2006 filing season progresses, the IRS must remain mindful
    of the difficult experience that taxpayers and the agency had with the
    mandatory large partnership e-file program rolled-out several years
    ago. The AICPA has previously recommended that the IRS delay the start
    of the new mandatory e-file program for one year, and we continue to
    observe that it is not unreasonable for the Service to anticipate
    significant issues with respect to implementation of this new program
    for large corporations and exempt organizations. This situation is
    especially critical as we move closer to September 15, the due date for
    calendar year-end corporate returns on extension.
        Our members remain concerned about a number of implementation
    issues, such as the potential for security breaches and the ability of
    the IRS's computer systems to handle peak load demands by taxpayers.
    Moreover, we continue to recommend that the IRS maintain a posture of
    flexibility in terms of granting hardship waivers to corporations and
    exempt organizations, as opposed to a policy that grants waivers only
    in exceptional cases.
        Even though this is the first filing season for implementation of
    the mandatory corporate and exempt organization e-file program, we
    cannot over-emphasize the need for the Service to also adopt a posture
    of flexibility on critical implementation decisions for next year's
    filing season. For purposes of the 2007 filing season, the e-file
    thresholds will drop even further, subjecting middle-sized market
    corporations and exempt organizations to the mandatory e-file program,
    taxpayers who routinely (1) don't employ tax professionals on the
    entity's payroll and (2) utilize the services of tax professionals
    working for large and smaller-sized accounting firms. We will continue
    to work with the IRS in resolving the various implementation issues as
    e-filing is expanded.
    5. INCREASE IN USER FEES
        The IRS announced a series of increases in user fees in December
    2005, effective for 2006. These user fees are levied to charge
    taxpayers for the privilege of receiving advance assurance from the IRS
    about the tax consequences of certain transactions. For example, under
    the new fee schedule, the IRS Chief Counsel has increased the fees for
    private letter rulings by $2,500 to $10,000 (with lower fees for
    taxpayers earning under $1 million); requests for changes in accounting
    method by $1,000 to $2,500; corporate pre-filing agreements to a flat
    fee of $50,000, and Advance Pricing Agreements to as much as $50,000.
        We understand that these increases generally reflect an attempt to
    respond to an Office of Management and Budget directive for agencies to
    charge user fees reflecting the full cost of goods or services.
    Moreover, it is our understanding these user fee increases are
    considered as a supplement (in addition) to any final fiscal year 2007
    IRS budget approved by Congress.
        The AICPA is concerned these increases in user fees (many of which
    are dramatic increases over previous levels) will result in a
    substantial reduction in general taxpayer use of critical IRS programs
    that encourage taxpayers to seek advance assurance about the tax
    consequences of their proposed actions. Any actions that discourage use
    of these programs could result in greater compliance costs for
    taxpayers and enforcement costs for the IRS. The AICPA does not support
    the Service's possible use of fee increases as a management tool to
    control its workload burden.
    6. TAX PRACTITIONERS AND PROFESSIONAL RESPONSIBILITY
        The AICPA applauds Commissioner Everson's commitment to high
    standards for tax professionals and his efforts to upgrade the Office
    of Professional Responsibility. In this context, 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.
        We have recently sent submissions to Treasury and IRS on two very
    important topics involving professional responsibility, as well as
    presented oral testimony before the IRS on April 4, 2006. These topics
    involve the Circular 230 written tax advice standards and the proposed
    amendments to the regulations under Internal Revenue Code (IRC) section
    7216. We recommend that the Subcommittee closely monitor the
    deliberations between the tax professional community and the federal
    government as these issues evolve.
    Circular 230
        The AICPA has been actively communicating with our membership and
    state CPA societies regarding the Circular 230 provisions on ``best
    practices'' and written tax advice. In this context, we are encouraged
    by recent comments by Treasury and the IRS officials that the
    government is considering whether it may be appropriate to make
    substantial changes to the Circular 230's standards involving written
    tax advice. The AICPA shares many of the concerns expressed within the
    practitioner community that, as currently written, these regulations
    are having an adverse impact on the delivery of tax advice to clients
    and on the role of tax advice in facilitating the administration of the
    tax system.
        We strongly support the drafters' goals of increased public
    confidence in the tax system and greater transparency in the
    practitioner-client relationship. Like other commentators, however, we
    also are concerned that the breadth and specificity of the current
    rules are inhibiting the provision of written tax advice to taxpayers,
    and increasing the expense to taxpayers of written tax advice,
    including for routine transactions, without a corresponding benefit to
    the tax system.
        Both Treasury and the IRS have expressed willingness to consider a
    principle-based approach within the standards to better support
    Circular 230's essential role. We support this reconsideration to
    alleviate the unintended consequences that have occurred.
        In a March 6, 2006 letter to Treasury and IRS, we suggested several
    ways that the government could adopt a principle-based approach. We
    also offered an alternative approach for revising the covered opinion
    rules (under Circular 230, section 10.35) by substituting broader
    principles, with examples or illustrations, for the detailed rules
    currently in section 10.35. A model for discussion might include AICPA
    Interpretation No. 1-2, Tax Planning, of AICPA Statement on Standards
    for Tax Services No. 1, Tax Return Positions.
    Proposed Section 7216 Regulations
        In December 2005, the IRS released proposed amendments to the
    regulations under Internal Revenue Code (IRC) section 7216, which in
    large part respond to (1) suggestions that the section 7216 regulations
    needed to be updated to reflect current common industry practices,
    particularly in the area of electronic preparation or filing of tax
    returns, and (2) concerns about the outsourcing of tax return
    preparation to foreign countries.
        In comments we submitted to the IRS on March 8, 2006, the AICPA
    suggested that the Service generally not attempt to regulate the
    disclosure or use of tax return information by preparers in the context
    of section 7216--which is a criminal statute. Rather, we believe a
    civil penalty is a more practical mechanism for regulating a
    practitioner's everyday disclosure and use of taxpayer information.
    Civil penalties have long been recognized as effective tools for
    encouraging compliance, modifying behavior and deterring unwanted
    behavior. Criminal provisions by their very nature inject a level of
    complexity and concern which may well prove counterproductive in this
    area. One possible approach would be to prescribe primary regulations
    under IRC section 6713 while utilizing regulations under section 7216
    to address the circumstances under which a preparer's behavior would
    satisfy the ``knowing or reckless'' standard to justify criminal
    sanctions.
        We are also concerned about the extent to which the proposed
    regulations fashion an entirely new consent regime for any return
    preparation activities that involve parties located outside the borders
    of the United States. The proposed regulations are drafted in a manner
    that adds unnecessary and extremely burdensome steps to the current tax
    return processes used by many professional service providers. It
    appears that at the very time the IRS is eliminating barriers to the
    achievement of its goal for increasing electronic filings and payments,
    the agency is incongruously making it more complex for its partners--
    the professional providers of tax assistance and return preparation--to
    sustain their current professional business processes.
        To properly complete the tax return of a U.S. or non-U.S.
    multinational company with offices in the United States and overseas,
    tax professionals located in the United States typically consult with
    tax professionals located overseas. The same circumstances exist when
    preparing returns for thousands of U.S. citizens (expatriates)
    stationed around the world in the employment of U.S. and non-U.S.
    multinational companies. In the normal course of these engagements the
    client generally anticipates that the tax return preparer would
    disclose tax return information to an overseas office, consistent with
    the applicable legal and ethical responsibilities of the tax preparer
    unless the taxpayer directs otherwise. The examples of how tax return
    information may be used in providing services to multinational
    companies go far beyond a tax return preparation context. Examples
    include audits of financial statements and cross border tax planning.
    These uses serve the needs of taxpayers and aren't efforts to market
    unwanted services or use information for inappropriate ways.
        We do not believe that these situations should require the tax
    preparer to obtain consent from the taxpayer in the specific format
    described in proposed regulation section 301.7216-3 and the proposed
    revenue procedure (set out in Notice 2005-93) because these taxpayers
    anticipate their tax information will be disclosed outside of the
    United States. We believe the AICPA ethics rules (regarding outsourcing
    services to third-party service providers) are more in line with modern
    business practicesthan what is provided for under the proposed
    regulations.\5\
    ---------------------------------------------------------------------------
        \5\ 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. In addition, 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.
    ---------------------------------------------------------------------------
        The AICPA strongly encourages the IRS to adopt the approaches
    suggested in our March 8 comments. If that is not acceptable, we urge
    the IRS to engage the professional service provider industry in a
    substantive discussion prior to issuing final regulations about how to
    best ensure the requisite security of tax return information in the
    context of today's modern (global) business practices.
    7. PRIVATE DEBT COLLECTION EFFORTS
        The IRS is in the process of launching a private debt collection
    program, as authorized by the American Jobs Creation Act of 2004. We
    appreciate that using private collection agencies could help the IRS
    resolve a portion of its collection inventory, and could potentially
    enable the Service to focus the energies of its employees on the more
    difficult or complex collections cases. The Service has announced that
    private debt collection agencies will be held to the ``same standards
    of service and protection of taxpayer rights'' required of IRS
    employees. We believe that this program is a critical test program for
    the Service, especially in terms of enabling the IRS to leverage
    private sector involvement with a reallocation of vital resources
    towards programs of critical needs. Nevertheless, because collections
    is a program area which has historically been an area of chronic
    taxpayer complaint and alleged taxpayer rights abuse, we strongly urge
    the Subcommittee on Oversight to closely monitor implementation of the
    private debt collection program; and work with the IRS on establishing
    positive and realistic performance measures for the private debt
    collection firms.
    8. OFFERS IN COMPROMISE
        Section 523 of S. 2020, the Tax Relief Act of 2005, generally
    requires a taxpayer who submits a ``lump-sum'' offer-in--compromise
    (OIC) to include 20 percent of the amount of such offer at the time the
    offer is submitted. The provision defines the term ``lump-sum'' offer
    to mean the payment of 5 or fewer installments. The AICPA is very
    concerned about the negative impact that this measure will have on the
    future viability of the overall OIC program.
        The AICPA has received numerous reports from practitioners that the
    IRS's OIC program is not working, due in large part to the Service's
    continual classification of large numbers of offers as ``non-
    processable'' and based on the agency's high rejection rate of offers
    being submitted. These reports are consistent with the public comments
    of National Taxpayer Advocate Nina Olson on May 18, 2005. In that
    communication, she revealed that taxpayers submitted approximately
    39,000 offers during the first six months of fiscal 2005, which amounts
    to a 45 percent drop in the number of offers submitted from the same
    period in 2004.
        Based on the significant drop in the number of offer submissions,
    coupled with the IRS's high rejection and return rate for offers, we
    believe this provision--while intended to be a revenue raiser--will in
    actuality raise little or no revenue.
        In general, a taxpayer submits an offer to the IRS because he or
    she is in financial distress and thus, looking for a ``fresh start''
    financially. Under these circumstances, a taxpayer who has a
    significant outstanding tax liability with the government is not likely
    to be able to afford a 20 percent up-front ``down-payment'' on an
    offer. In all likelihood, enactment of the up-front 20 percent payment
    on offers is likely to shut down the OIC program and instead, because
    of the increased financial burden on the taxpayer, increase the
    attractiveness of federal bankruptcy filings.
        To the extent Congress includes the 20 percent offer payment
    provision as part of a final bill, we recommend that there be an
    exemption for low-income taxpayers. If you accept this recommendation,
    we encourage you to use an existing statutory definition for ``low-
    income'' to avoid adding another level of complexity to the Code. For
    example, section 7526 of the Internal Revenue Code generally defines a
    low-income taxpayer as someone who has income that does not exceed 250
    percent of the poverty level.
        S. 2020 also requires any taxpayer who submits a ``periodic
    payment'' offer to comply with the taxpayer's proposed installment
    schedule during the period that the IRS is evaluating the offer for
    acceptance. Thus, the taxpayer is required under this proposal to
    effectively make installment payments to the IRS during the time period
    that the Service has the offer under review. The legislative language
    is not clear as to what would happen to these payments should the IRS
    subsequently reject the taxpayer's offer. One possible interpretation
    is that the taxpayer would be permitted to stop making the installment
    payments, but the Service would(1) keep all payments made by the
    taxpayer to date and (2) retain the right to begin enforcement action.
    Moreover, if the taxpayer does not maintain his or her proposed payment
    schedule, while the Service is reviewing the offer, the legislation
    does state that the offer would be considered withdrawn by the taxpayer
    at the time the payments cease.
        We believe that the periodic payment offer proposal--like the 20
    percent offer payment provision described above--will have a negative
    impact on the future viability of the overall OIC program. The periodic
    payment proposal does not do anything to encourage efficiency on the
    part of the IRS, i.e., for the Service to be more efficient in the
    processing and review of offers on a timely basis. In fact, the
    proposal would appear to create a situation in which the IRS would be
    better off by not rejecting too quickly an offer that the agency might
    otherwise find unacceptable.
        There may also be circumstances in which, for legitimate reasons,
    the taxpayer may be required to discontinue (i.e., may no longer be
    able to afford financially) the periodic payments while the IRS is
    reviewing the taxpayer's offer submission. We do not believe that IRS
    consideration of the taxpayer's offer should cease under such
    circumstances. A fairer result would be for the IRS to provide
    guidance--under a reasonable cause standard--as to the circumstances
    that a taxpayer's offer would continue to be reviewed and considered by
    the Service.
    9. 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 Tax Reform: A Guide to 21st Century Alternatives,
    September 2005. Our study discusses how many of the goals of tax reform
    can be achieved by modifying the current income tax system through
    significant simplification. Some of the more important proposals to
    reduce administration and compliance costs are discussed. The text of
    the full study is available at: http://www.aicpa.org/taxreform/.
        The IRS released updated statistics in February 2006 that the tax
    gap is about $345 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 very much, Dr. Purcell. Mr.
    Degen, please?

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

        Mr. DEGEN. Thank you, Mr. Chairman, for asking the NAEA to
    testify before you today. I will limit my comments pretty much
    to tax filing season issues.
        I am happy to report that, for the most part, the 2006
    filing season is progressing smoothly. Nonetheless, we need to
    bring a handful of issues to your attention. As we heard only
    too starkly at the Finance Committee hearing on Tuesday,
    unenrolled tax return prepares continue to be a problem for
    taxpayers and the tax administration system. Mr. Chairman, I
    have previously brought this issue before your Subcommittee,
    and I urge you to move expeditiously to pass legislation to
    require all paid tax return preparers to demonstrate competency
    and ethical standards through licensure and continuing
    education. The NAEA believes that such legislation will greatly
    aid all taxpayers, especially low-income taxpayers, to comply
    with our Nation's tax laws by helping to ensure access to
    competent and ethical tax preparation services.
        As usual, complexity rears its ugly head in the 2006 filing
    season. While the AMT continues to stand out as the poster
    child for today's taxpayers, two new issues have been
    particularly troublesome for practitioners this filing season.
    The first is the new definition of ``dependent'' as defined in
    section 152 of the Internal Revenue Code. While we applaud
    Congress for trying to simplify the definition of ``child,''
    the law of unintended consequences has reared its head with
    respect to the new definitions of ``qualifying child'' and
    ``qualifying relative.'' Quite frankly, the definitions have
    probably resulted in more rather than less confusion. The
    examples we cite in our letter to Commissioner Everson--and I
    believe you have a copy of that, sir--need to be addressed.
        I would also like to comment on the IRS expectation that
    the details of every capital transaction be reported on a
    Schedule D. The goal in submitting a tax return is to report
    the correct tax liability of the taxpayer. The NAEA fails to
    understand why the listing of every transaction on a Schedule D
    is necessary to achieve that goal. The IRS espouses that it
    strives to lessen the burden on taxpayers. This requirement of
    reporting every detail is counterproductive to that claim and
    greatly increases the burden on taxpayers.
        Taxpayers who use professional assistance in preparing
    their tax returns are facing extra costs due to this
    requirement. Given the fact that many taxpayers now trade in
    the stock and bond markets, the goal should be to prepare an
    accurate tax return and not a meaningless exercise in reporting
    details.
        Along a similar vein, our members cite a growing problem
    with information reporting on 1099 forms and cite example after
    example of brokerage firms sending two, three, and sometime as
    many as four corrections of the Form 1099. We would like to
    caution Congress as it considers possible legislation to expand
    reporting requirements in this area, to give the IRS and the
    industries involved plenty of lead time to develop and
    implement such an expansion. Otherwise, the taxpayer will
    suffer and be required to file amended tax returns.
        While not a specific filing season problem, NAEA is
    concerned, as the ABA noted, that the Senate offer in
    compromise (OIC) proposal in the reconciliation bill now in
    conference is unduly burdensome to taxpayers. While the steep
    entry cost would certainly deter frivolous offers, it will also
    certainly prevent most, if not all, earnest taxpayers from
    making their offers as well.
        We urge Congress to drop this provision or, alternatively,
    to work with us to put forward an alternative such as the one
    outlined in our written testimony, which I know you have.
        Finally, NAEA has been a strong proponent of beefing up
    enforcement at the IRS while maintaining good customer service
    level for taxpayers. There are full details in my written
    testimony, but in the interest of time, I will only note that
    the IRS needs to consider building in some level of flexibility
    for its employees to be able to work with practitioners during
    the filing season. The clear result will be higher-quality
    audits and better responses to IRS inquiries.
        In closing, Mr. Chairman and Members of the Subcommittee,
    NAEA and its members stand prepared to work with you and the
    IRS in ensuring a strong tax administration system and
    improving voluntary compliance, and we welcome any questions
    you may have.
        [The prepared statement of Mr. Degen follows:]

         Statement of Francis X. Degen, President, National Association
                               of Enrolled Agents

        Thank you, Mr. Chairman, Ranking Member Lewis, and members of the
    Oversight Subcommittee for asking the National Association of Enrolled
    Agents (NAEA) to testify before you today. NAEA is the premier
    organization representing the interests of the 46,000 enrolled agents
    (EAs) across the country. EAs are the only practitioners for whom the
    IRS directly attests competency and ethical behavior. NAEA is dedicated
    to increasing the professionalism of its members and the integrity of
    the tax administration system as a whole.
        In regard to the 2006 filing season, I am happy to report that for
    the most part, the season is progressing smoothly. Nonetheless, a
    number of major issues are affecting taxpayers and tax practitioners,
    and we would like to take to take this opportunity to bring a handful
    of issues to your attention.

        1.  A few ``bad eggs'' in the paid preparer community are adversely
    affecting the public's faith in the tax system.
        2.  Complexity for individual taxpayers continues unabated,
    centering this year on AMT, definition of dependent, and Schedule D
    information.
        3.  The Offers-in-Compromise program is in jeopardy because of a
    provision of the Reconciliation bill currently in conference.
        4.  Increased enforcement actions during filing season are creating
    some significant headaches for enrolled agents and their clients.
    HOW TO DEAL WITH A FEW BAD EGGS
        Lately, it seems as if every day we pick up the papers only to read
    about another scheme with the potential for defrauding taxpayers. Last
    year, this subcommittee reviewed the trend of linking tax preparation
    with some unrelated services or goods, such as car or furniture sales.
    This season, the great new idea is to load tax refunds on gift cards.
    Further, we have been hearing a lot about the sale of questionable
    financial services linked to tax preparation. Last week, we awoke to
    headlines, however dubious, screaming of practitioners being allowed to
    sell tax data to the highest bidder.
        Very quietly hidden behind these juicy headlines is in actuality a
    much more sinister yet mundane story: the growing problem of taxpayers'
    forum shopping to maximize their refunds at the expense of the
    Treasury. In other words, enrolled agents are seeing taxpayers pick up
    their records and move down the street looking for unscrupulous
    preparers who will ``pump-up'' their refunds. Unlicensed tax return
    preparers are making outrageous guarantees on refunds, saying, ``Come
    to us and we promise you a $1,000 back from Uncle Sam.'' Suddenly the
    taxpayer is taking phony home office or business deductions or finding
    long lost children.
        The message to taxpayers with respect to cheating is that everyone
    is doing it and you are a dupe if you aren't doing it too. As
    practitioners licensed to practice before the IRS, we too often end up
    representing these taxpayers once the IRS catches up with them.
    Unfortunately, unlicensed paid return preparers are often outside the
    current regulatory rules governing competency and ethical behavior. It
    is our contention that this issue is the key to maintaining, and even
    to restoring, taxpayer faith in a fair and equitable tax collection
    system.
        To address this situation, Mr. Chairman, we urge the subcommittee
    to move expeditiously to pass legislation to require all paid tax
    return preparers to demonstrate competency and ethical standards
    through licensure and continuing education.
        NAEA believes that such legislation will greatly aid all
    taxpayers--but especially low income taxpayers--to comply with our
    nation's tax laws by helping to ensure access to competent and ethical
    tax preparation services. In her 2003 and 2004 annual reports, the
    National Taxpayer Advocate expressed that oversight of unenrolled
    return preparers was one of the most serious problems facing taxpayers.
    In 2003, she noted that over 55 percent of the 130 million individual
    taxpayers paid a return preparer to prepare their returns. Close to
    half these preparers did not possess a legitimate license demonstrating
    basic competency or ethical standards. Shockingly, at least 57 percent
    of EITC earned income overclaims were attributable to returns prepared
    by unlicensed paid preparers, resulting in billions of dollars in lost
    revenue to the government.
        NAEA supports S. 832 (the Taxpayer Protection and Assistance Act of
    2005) because we believe the bill will help ensure the integrity of the
    tax system by promoting licensed tax professionals to the general
    public and ensuring strong enforcement against the unlicensed and
    unethical. We believe the proposed legislation:
    A. Contributes significantly to taxpayer access to competent and
            ethical tax preparation services.
        The legislation would require all paid preparers to pass an exam
    testing their understanding of basic tax laws and ethical standards.
    Further, paid preparers would be required to undergo annual continuing
    education and be subject to the ethical requirements of Circular 230.
        This will help ensure that only qualified and ethical individuals
    will be preparing returns.
    B. Builds on the existing regulatory framework and consolidates
            enforcement under one entity
        Rather than constructing a parallel regulatory framework and
    enforcement entity for different groups of paid preparers, the
    legislation would consolidate all persons preparing returns (lawyers,
    CPAs, EAs, and paid preparers) under the current regulations (Circular
    230) and the existing Office of Professional Responsibility (OPR). In
    other words, there would be one ethical code, coordinated exams that
    would allow for advancement within the profession, and standardized
    continuing education requirements all administrated under the already
    existing system.
        In addition to being cost effective, this consolidation would
    ensure uniformity of standards and enforcement across all preparers.
    C. Ensures adequate resources for administration, promotion, and, most
            importantly, enforcement.
        The legislation would allow OPR to retain all registration fees for
    administration of the program, including policing all practitioners and
    preparers under their jurisdiction. Most importantly, the authorization
    to retain these fees would ensure that the office would have adequate
    resources to investigate and penalize unlicensed individuals. This will
    discourage taxpayers from shopping for the ``best deal'' among
    preparers and will help shut down many EITC mills across the country.
        Additionally, the bill would authorize OPR to retain penalties
    administered under the program for promotion of all Circular 230
    preparers to the general public. This will assist the public in
    understanding the importance of paying only licensed individuals for
    tax preparation and will assist the public in understanding the
    difference between the various groups allowed to do paid preparation.
    D. Strikes the correct balance for creating a new tax practice
            credential.
        Congress needs to be cognizant of the ramifications of creating a
    new credential in the world of tax administration. Currently, the
    general public is presented with three options for individuals who are
    licensed to practice before the IRS: lawyers, CPAs, and enrolled
    agents. Circular 230 is very specific as to how these individuals may
    advertise and generally present themselves to the public. A credential
    that implies a higher level of authority and competency than merely
    preparing basic individual tax returns will cause confusion and
    undermine the general intent of the legislation.
        Since the passage of the IRS Restructuring and Reform Act, there
    has been a great deal of confusion as to the credentials and bona fides
    of Electronic Return Originators or EROs. The IRS has issued signage
    denoting official endorsement of individuals qualifying as EROs, as
    well as financed a public awareness campaign in support of the program.
    Anecdotal evidence (the appearance of billboards and bus stop signage)
    in poorer neighborhoods demonstrates the danger of putting out to the
    public confusing titles or credentials that overstate competency.
        Additionally, state regulators would be very leery if not outright
    hostile toward the creation of a new credential in the accounting/tax
    preparation marketplace. States regulate the use of credentials and
    many list a litany of titles (e.g., certified tax consultant, chartered
    accountant, registered accountant) and abbreviations likely or intended
    to be confused with CPA that may not be used. After years of conflict,
    the majority of state boards of accountancy have accepted that a person
    recognized by IRS as being enrolled may use the enrolled agent name and
    EA abbreviation. Creating nomenclature that might overstate its
    intended mission is likely to re-ignite this battle, and at the very
    least potentially counter the underlying intent of the legislation.

    PRACTITIONER CONCERNS
        While the alternative minimum tax--which holds the distinction of
    being both unfair and extremely complex--continues to stand out as the
    poster child for dazed taxpayers, two new issues have been particularly
    troublesome for practitioners this filing season.
        The first is the new definition of dependent as defined in  152 of
    the Internal Revenue Code. While we applaud Congress for trying to
    simplify the definition of child, the law of unintended consequences
    has reared its head with respect to the new definition of qualifying
    child and qualifying relative. (Please see our attached letter to
    Commissioner Everson). Quite frankly, the definitions have probably
    resulted in more rather than less confusion. The examples we cite in
    our letter need addressing. We note that the Treasury Department's Blue
    Book for the 2007 budget attempts to offer solutions to some of these
    problems, but we need to act before the 2007 tax year.
        NAEA supports efforts to simplify the filing of federal taxes and
    its 11,000 members stand ready to assist Congress and the President in
    accomplishing real, practical reform for the American taxpayer. While
    the concept of simplifying the tax code often plays well on the
    campaign trail, the nitty-gritty of what is reform and how it is
    accomplished makes comprehensive reform a daunting political
    undertaking for policymakers. May I be so bold as to suggest that the
    practitioner community have some role in future changes? Those of us
    ``in the trenches'' may, based on practical experience, be able to see
    problems staff writers may not envision.
        I would also like to comment on the IRS expectation that the
    details of every capital transaction be reported on a Schedule D. The
    goal in submitting a tax return is to report the correct tax liability
    of the taxpayer. NAEA fails to understand why the listing of every
    transaction on a Schedule D is necessary to achieve that goal. The IRS
    should strive to lessen the burden on taxpayers. This requirement of
    reporting every detail is counterproductive to that concept and greatly
    increases the burden on taxpayers. Taxpayers who use professional
    assistance in preparing their tax returns are facing extra costs due to
    this requirement. Given the fact that many taxpayers now trade in the
    stockand bond markets, the goal should be to prepare an accurate tax
    return and not a meaningless exercise in reporting details.
        Along a similar vein, our members cite a growing problem with
    information reporting from third parties (e.g., Forms 1099 and
    Schedules K-1). While Congress and the IRS have become more reliant on
    third-party reporting to ensure compliance, the process has become
    incredibly complex. Our members cite example after example of brokerage
    firms sending two, three, and sometimes as many as four corrections of
    the Form 1099. The brokerage firms point out that in this complex,
    multinational world we live in it is becoming more and more difficult
    to provide the required information within the required deadlines. We
    would like to caution Congress as it considers possible legislation to
    expand reporting requirements in this area to give the IRS and the
    industries involved plenty of lead time to develop and implement such
    an expansion.

    OFFERS-IN-COMPROMISE
        While increasing offer quality is an admirable goal, NAEA is
    concerned that the approach taken by the Senate in the Reconciliation
    bill now in conference is unduly burdensome to taxpayers. While the
    steep entry cost would certainly deter frivolous offers, it will also
    certainly prevent most, if not all, earnest taxpayers from making their
    offers as well.
        As you are aware, the provision requires that a taxpayer make a
    good faith down payment of 20 percent of any lump sum offer-in-
    compromise with any application for an offer. For periodic payment
    offers, the taxpayer is required to comply with his or her own payment
    schedule. The proposal also repeals the $150 user fee. Additionally, it
    provides that an offer will be deemed accepted if the IRS does not
    reject it within twenty-four months (twelve months beginning in 2010).
    The proposal is estimated to raise $683 million over five years.
        With IRS permitted to wait twenty-four months to accept an offer,
    at least until 2010, one of the common concerns is the possibility that
    IRS may use this new rule to further slow its processing of offers
    (particularly in the case of taxpayers making monthly ``good faith''
    payments).
        A further concern is that many taxpayers borrow to meet their tax
    obligations (often from family or friends) and such taxpayers would see
    this plan as a great disincentive to make an offer. We do not believe
    it makes sense for a taxpayer to borrow in an effort to square up with
    the IRS only to risk that a rejected offer would put the taxpayer even
    more in debt, both to IRS and to the source of the borrowed ``good
    faith'' payment.
        It is not clear how the provision, which NAEA believes will reduce
    significantly the number of offers submitted to IRS, would generate the
    10-year dollars that the Senate bill claims it will.
        NAEA would like to offer a counter proposal that we believe would
    provide true reform. In short, our proposal would:

          Require that if a taxpayer uses a paid third party to
    prepare the offer that such preparer be a current Circular 230
    practitioner;
          Create a $5,000 frivolous filing penalty for the taxpayer
    and for any paid preparer assisting in the preparation of the frivolous
    offer;
          Maintain the current user fee; and
          Deem an offer accepted if not rejected by the IRS within
    twelve months.

        This alternative approach should eliminate most of the frivolous
    offers, while at the same time giving taxpayers a time-certainfor
    response from the IRS.

    ENFORCEMENT DURING TAX FILING SEASON
        NAEA has been a strong proponent of beefing up enforcement at the
    IRS, while maintaining good customer service levels for taxpayers. We
    are encouraged by the improved numbers we are seeing from the agency on
    both audit and collection. Many of our members, however, have reported
    a problem arising from this renewed emphasis. Namely, there has been a
    major increase in the number of audits, collections, and notices coming
    from the agency during the height of the tax filing season. This
    situation is coupled with an absolute unwillingness to work with
    practitioners to accommodate the sheer crush of work brought about at
    this time of the year. The IRS needs to consider building in some level
    of flexibility for its employees to be able to work with practitioners
    during filing season. The clear result will be higher quality audits
    and better responses to IRS inquiries.
        In closing, Mr. Chairman and members of the subcommittee, NAEA and
    its members stand prepared to work with you and the IRS in ensuring a
    strong tax administration system and improving voluntary compliance.
    Thank you and I stand ready to answer any questions you may have.
                                     ______

        [i] The National Association of Enrolled Agents (NAEA) is the
    professional society representing enrolled agents (EAs), which number
    some 46,000 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 CPAs, EAs 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 forty-two states. For additional information about NAEA,
    please go to our website at www.naea.org.

        Chairman RAMSTAD. Thank you very much, Mr. Degen, and the
    Chairman thanks all three distinguished members of this panel.
        I would like to address the first question to any or all of
    you, for that matter, about the proposed regulations to expand
    the permissible use of taxpayer information by tax return
    preparers. I, as other Members have expressed today, have some
    serious privacy concerns about the proposed regulations to
    expand the use of such information.
        In your judgment--again, any or all of you may respond--are
    there any compelling reasons for the IRS to broaden tax return
    preparers' ability to use taxpayer information? Mr. Drapkin?
        Mr. DRAPKIN. Well, the ABA and the Tax section do not have
    a position, so I will be speaking on my own behalf. In
    reviewing the materials for this hearing, it struck us that,
    for one thing, the sharing of information has been authorized
    by regulation since 1974, both by a tax return prepared with
    its own affiliates and at direction of the taxpayer to disclose
    return information to anyone. So, these authorizations have
    existed in the law effectively since Congress enacted the
    statute in 1971. The privacy----
        Chairman RAMSTAD. Pursuant, of course, to taxpayer consent.
        Mr. DRAPKIN. Pursuant to the taxpayer's consent in both
    cases.
        Now, the IRS commendably spends a good deal of effort in
    the proposed regulation and the proposed revenue procedure on
    the consent side, beefing up consent, making it meaningful and
    apparent. This may well be a subject that this Committee might
    want to look into because it overlaps both the proposed
    regulations and the existing regulations as to whether or not
    this information should be shared, what are the compelling
    interests either way, the commercial advantages to the tax
    return preparer versus the concerns on privacy.
        Chairman RAMSTAD. Well, let me ask the obvious question
    then that flows from your statements. Do you believe current
    regulations on disclosure of taxpayer information by preparers
    should be reconsidered?
        Mr. DRAPKIN. Well, in light of what has happened since
    December, when the proposed regulations came out, and we
    understand in part outsourcing was one of the issues that
    concerned the government in coming back to this area really for
    the first time in 30 years, that the nature of privacy concerns
    and the nature of consumer interests has changed so much since
    1971 to 1974, when the legislation was enacted and the rules
    developed, that a Committee like this one, Mr. Chairman, might
    well want to look into, again, what are the legitimate
    concerns, how well does the statute and the legislation reflect
    those concerns, and not just the ones raised by the proposed
    changes, but also by those raised by the existing rules.
        Chairman RAMSTAD. Dr. Purcell, please.
        Mr. PURCELL. Mr. Chairman, our concern--and we had provided
    testimony on Tuesday, as well as in our comments for today. The
    7216 is a criminal statute, and its penalties are criminal in
    nature. So much of the disclosure question should be carefully
    considered in the fact that you are imposing criminal sanctions
    on people as opposed to many concerns that you might have in
    the relationship with your tax preparer, which might be
    inadvertence or oversight, but not intentional criminal
    conduct. So, we urge going slowly on trying to overkill with
    the process of legislating here or regulating something that
    could well be better handled through an ethical concern.
        The second concern that we have is that the discussion
    about the disclosure really is the means to the end, and the
    end is whether taxpayers are being unfairly taken advantage of
    through the existing regimen, being asked to do something or
    being the victim of identity or some other type of exposure of
    their information because someone is trying to sell an
    additional service or trying to use that information for
    financial gain. It might be better to focus on some of the
    things you have already heard this morning, such as the RAL, as
    an entity in itself rather than the means that it's being used
    to get there, which is the perhaps aggressive use of taxpayer
    information.
        So, I think it is important as a policy matter, what is the
    information being used for and should it even be used for this
    in any circumstance. Should anybody be able to do this, yes or
    no? Then if this is a legitimate use of information, what
    safeguards should we put in to make sure the information is not
    unfairly shared?
        Chairman RAMSTAD. I certainly agree with that. I think you
    couched the threshold question very well, and secondary ones as
    well, and we need to address those questions. I also think your
    caveat as to proceeding with due caution is a good one. Thank
    you, Dr. Purcell.
        Mr. Degen, please.
        Mr. DEGEN. Yes, Mr. Chairman, I think it is fair to say
    that we would agree primarily with the position of the Taxpayer
    Advocate. I think she basically said that, as a policy
    decision, it is up to the Congress to decide whether there
    should be any disclosure or not. However, given the fact that
    their existing regulations do allow a certain amount, the
    proposed regulations actually enhance protection for the
    taxpayer. So, if the Congress is not going to make a complete
    change, then we would support those regulations in terms of
    enhancing.
        I think there was also one other point--I believe this was
    mentioned at the hearing on Tuesday when the IRS had the
    hearing on the proposed regulations--that it would be seemingly
    in the interests of the taxpayer and the IRS to perhaps involve
    the practitioner community before some of these things are
    proposed. Quite often, we feel that the IRS would be better
    served, the public would be better served if they operated in a
    mode called ``consult, then decide,'' as opposed to in a mode
    of ``decide, then explain.'' So, I think that is something that
    we would hope that the practitioner community--while clearly we
    do not make decisions and we do not make policy, but I think
    there is a lot of insight and input from the trenches, so to
    speak, that may be in the best interest of the Service to look
    at beforehand.
        Chairman RAMSTAD. I think that point is very well made, and
    you certainly bring an expertise that is important, and I think
    we need to work more in that collaborative way.
        Let me ask you, Mr. Drapkin, in your testimony you touched
    on the need for simplification of tax laws. I do not think you
    will get much disagreement anywhere in any venue that we need
    to simplify the Tax Code, and we have been going in the wrong
    direction if you look at it en masse, in todo. I know the ABA
    has been advocating simplification of the Tax Code for a number
    of years.
        I think also everyone concedes around here at least that
    wholesale simplification is off the table for this year. Yet
    are there some viable incremental steps that Congress can take
    now to simplify the Tax Code short of dealing with it in a
    comprehensive way? Or should we not deal with it an incremental
    way pending comprehensive reform?
        Mr. DRAPKIN. Well, I think there are a number of avenues,
    as has been mentioned. The AMT, both in its individual and
    corporate form, is a source of immense complexity, and it has
    also become clear that in recent years, particularly the
    individual AMT is hitting sectors of the taxpayer community
    that, I think it is fair, Congress probably did not contemplate
    when it first enacted the provisions. So, I do not know if you
    could call removal of a provision of that magnitude
    ``incremental,'' but short of wholesale tax reform, that is
    certainly one area.
        We mentioned in our testimony this time and before that re-
    examination of the phase-out provisions and trying to
    coordinate and correlate them would be greatly simplifying. I
    would also point out, as I think the Chairman well knows, the
    report of the President's panel on tax reform made a number of
    proposals that actually could be isolated from the broader
    proposals, areas that could merit attention from this Committee
    and others, such as bringing together various provisions on
    education credits and other types of credits and trying to
    unify them into one single provision.
        So, I think there are a large number of possibilities out
    there that the Subcommittee and other entities in Congress
    could examine if they wanted to find fruitful areas for
    simplification short of wholesale tax reform.
        Chairman RAMSTAD. I certainly agree the AMT is a ticking
    time bomb and needs to be addressed, and I would also go
    further than you and say the AMT is hitting taxpayers that
    Congress definitely--not probably, but definitely did not
    intent to impact. So I appreciate that.
        Do either of you gentlemen have any additional input on
    that point?
        Mr. PURCELL. I think I would--on behalf of the AICPA, I
    think we would echo Dennis's comments, and certainly we have
    worked together, ABA and the AICPA, extensively on
    simplification issues.
        When we look at the issues that come up, though, I think
    two things that would be kind of broader, I guess, cautions or
    concepts, we seem to have had--I have been in tax practice in
    one form or another since the late 1960s, early 1970s, and I
    keep on my shelf a copy of every tax law that has been passed.
    Well, there is no room on my shelf anymore because so many have
    been passed. We seem to have accelerated the rate of change so
    that we are writing not just simplification laws, but we are
    writing technical correction laws before the first law has even
    been fully enacted.
        So, one caution would be just we need to slow down. We need
    to make sure that if we are going to pass something that it is
    needed. So, rather than rush to get something done, I think
    calling us, calling in different constituent groups to look at
    an issue such as education credits and education incentives or
    issues such as the AMT and making sure that before we try to
    fix it we have got a good fix that will stand up for 5 or 10
    years.
        The other thing is anytime Congress puts in a threshold
    amount, it needs to be very careful to make sure that it is
    inflation adjusted. We would not have the problem we have today
    with the AMT if the exemption had been inflation adjusted when
    it was first enacted. We would not have the problem we have
    today with the estate tax if the exemption amount had been
    inflation adjusted back in 1916, because most taxpayers would
    then not be subject to either one of those taxes.
        When we look back to try to fix it after years and years
    and you look at the revenue cost, it becomes very problematic,
    if not impossible. So, as a matter of activity that if you just
    inflation-adjust something when you first enact it, that could
    certainly help.
        So, those would be the two other thoughts besides the ones
    Dennis raised.
        Chairman RAMSTAD. Thank you.
        Mr. Degen, did you want to comment further?
        Mr. DEGEN. Yes, I would like to, I think, echo what Dr.
    Purcell said in terms of new legislation going slow. I would
    ask that the Congress do take a look at that section 152. That
    has been a huge problem in the practitioner community. In a
    typical Ozzie and Harriet family, it is not a problem. Yet in
    America today, we do not have as many Ozzie and Harriet
    families as we used to. We have a lot of families where people
    are not married, they live together, they have children, they
    have nieces, nephews, people die. What that section has done--
    the intent was good. It is always easy, Mr. Chairman, to be a
    Monday morning quarterback. Hindsight is the best sight, isn't
    it? In all seriousness, the Treasury Department has recognized
    this. In their Blue Book, they call the 2007 budget proposal an
    attempt to fix some of these things. Yet their fixes seem to
    create just as many problems. The 152 needs to be looked at.
        One of the problems that we have had is the interpretation
    of the IRS. In the law it says ``another taxpayer.'' Well, the
    Internal Revenue Code defines a taxpayer basically as anyone
    that breathes. When they made the ``qualifying child,'' I
    thought the intent of Congress was to prohibit two people from
    claiming the same child as a dependent. I do not know how the
    law was written. I am not an expert in that, but the IRS has
    interpreted ``taxpayer'' in the sense of anyone who breathes is
    qualifying. They use the phrase ``another person'' or ``someone
    else.'' I am not terribly sure that was the intent of Congress
    to use that in the same--so I really believe that, in fairness
    to the taxpayer, because, quite frankly, practitioners--and I
    am not talking about Circular 230 necessarily, but just
    practitioners in general--are interpreting it in different ways
    and not everyone is being treated the same.
        So, I really think that is an issue that needs to be looked
    at seriously.
        Chairman RAMSTAD. Thank you, Mr. Degen.
        I want to ask you another question, Mr. Degen. The last
    numbers I saw claimed that 60 percent of taxpayers use a
    professional tax preparer to complete their return--60 percent
    of taxpayers. Obviously, then, it is important that tax
    practitioners receive adequate assistance from the IRS when the
    paid preparers have questions about the Code.
        Are members of your constituent group, your association,
    tax practitioners you represent, are they receiving the
    assistance they need from the IRS? Have things improved in that
    regard?
        Mr. DEGEN. Quite frankly, Mr. Chairman, I do not believe
    too many of our members would actually solicit responses from
    the IRS in terms of typical tax situations. I think most of our
    members take a lot of continuing education and do not rely on
    the IRS for guidance on mundane issues. Clearly on the issue I
    brought up before about the section 152 is a different ball
    game. I do think that would be a fairer question to ask if
    taxpayers who do not use professional assistance are getting
    what they need from IRS. That I cannot answer, but I do think
    that it is not an issue for most of us in terms of the IRS
    providing assistance.
        Chairman RAMSTAD. Maybe I should have asked the question:
    Which, if any, of the taxpayers services that the IRS offers
    are utilized by practitioners in preparing returns?
        Mr. DEGEN. Well, one issue--this is not necessarily in
    preparing returns, but I think it may be apropos to your
    question--will be the notion of the e-services. E-services are
    something that the IRS has provided for tax practitioners to
    avail themselves of being able, with appropriate power of
    attorney, to electronically download transcripts of taxpayer
    information reporting and that type of thing.
        Unfortunately, the Service has made a decision that access
    to that is predicated upon the fact whether you file five
    returns electronically or not. It makes no difference whether
    or not you have any expertise. That is the criteria.
        The Service, through the Office of Professional
    Responsibility, monitors Circular 230 practitioners, and yet
    they refuse to allow the practitioners who they monitor access
    unless they file five tax returns. I am sure ABA has many
    members who do not file tax returns but do represent taxpayers.
    These folks, as well as enrolled agents--and I am sure
    certified public accountants are in the same position. These
    folks have the most need for these e-services, and they are not
    available to them. So it does not make sense that you predicate
    a very important service based on filing five tax returns
    electronically.
        Chairman RAMSTAD. Dr. Purcell, did you want to address
    that?
        Mr. PURCELL. I think I would echo Frank's comment that we
    are on record as supporting a drop in the threshold level for
    qualification for the Electronic Return Originator (ERO)
    because it does not make sense, and for the reasons that Frank
    has already outlined.
        Chairman RAMSTAD. Any further comment, Mr. Drapkin?
        Mr. DRAPKIN. No, Mr. Chairman.
        Chairman RAMSTAD. Well, the Chairman again wants to thank
    all three of you for your continuing input to the Subcommittee
    on Oversight as well as the full Committee on Ways and Means.
    We appreciate your expertise and counsel, and thank you for
    your indulgence today. Hopefully you will be able to grab lunch
    despite the hour, and the Subcommittee will stand adjourned.
        [Whereupon, at 12:43 a.m., the Subcommittee was adjourned.]
        [Submissions for the Record follow:]
                Statement of the National Society of Accountants
        The National Society of Accountants (NSA) welcomes the opportunity
    to submit our views regarding any difficulties encountered during the
    current tax return filing season, the ``Estimates of Taxpayer Burden''
    tables that appeared in the instructions for the 2005 Form 1040 and the
    regulation of federal income tax preparers. NSA is a voluntary
    association of certified public accountants, enrolled agents, licensed
    public accountants, licensees of State Boards of Accountancy, tax
    practitioners who are licensed by state agencies and accountants and
    tax practitioners who hold credentials from ACAT, a nationally
    recognized credentialing body.
        NSA and its affiliated state organizations represent approximately
    30,000 practitioners who provide accounting, advisory and tax related
    services to more than 19 million individuals and small businesses. NSA
    represents accountants who serve Main Street rather than Wall Street.
    2006 Filing Season
        NSA members have encountered a greatly increased work load during
    the current tax return filing period and believe that this has proven
    costly to taxpayers due to the increased number of hours required to
    prepare their returns. Some of the increase in the work load has
    resulted from changes to forms and instructions. For example, one NSA
    member was asked to prepare a return that required more than 600 stock
    transaction entries on Schedules D and D-1 in order to e-file the
    return. Another example involved one of our members whose client
    received a Form 1099 from a stock brokerage firm and just recently
    received an amended Form 1099B due to the division between ordinary and
    qualified dividends. This resulted in a delayed filing that will be
    followed by the filing of an amended return. I am sure that entities
    that must send and re-send Forms 1099 are frustrated by the complexity
    of the requirements, but a taxpayer is virtually unable to prepare a
    return during the early part of the filing season if there is any
    possibility of receiving an amended Form 1099. All of this also
    dramatically increases the cost of preparing a return accurately the
    first time.
        In preparation for the current filing season the Internal Revenue
    Service has also encouraged taxpayers to prepare their own tax returns
    using computer tax software programs. A number of NSA members have
    heard from taxpayers who are finding it often takes an entire day to
    prepare their tax return, even though it may not be a complex return.
    In many instances, our members have been called upon to correct costly
    mistakes that have been made.
        Preparers from all over the country are being bombarded with
    taxpayer complaints due to the Alternative Minimum Tax adding to the
    taxpayer's tax burden and tax liability. Taxpayers feel they are unable
    to present their views to the IRS, so preparers are forced to take the
    brunt of these protests. This adds more hours to the preparers' already
    overloaded schedule and can add significantly to the cost of preparing
    a return as preparers explain the AMT and why it adds to the tax that
    must be paid.
    IRS Estimates of Taxpayer Burden
        The Internal Revenue Service recently published an ``Estimates of
    Taxpayer Burden'' tables as part of its Form 1040 instructions. The
    National Society of Accountants (NSA) believes these estimates to be
    patently wrong, make no distinction with respect to the sophistication
    of the self-filing preparer or the complexity of a return even assuming
    the criteria the tables set forth. Further, the tables encourage the
    conclusion that business self-filers use improper and invalid
    assumptions to prepare their tax returns. Finally, the tables purport
    to set forth the fees charged by tax preparation professionals without
    any apparent thought to regional cost of living differences or in the
    types of schedules required for various types of income.
        NSA questions the estimates and how they were obtained. Clearly,
    judging from the number of comments we and other representatives of the
    professional tax preparation community have received, very few if any
    of our members were asked to provide any estimates of the time spent to
    prepare a particular return and the fee charged. Any such request would
    have quickly revealed that our members believe that every taxpayer is
    different. For example, one table makes a particular estimate about a
    nonbusiness filer who files a Schedule D but not a Schedule A. How many
    transactions are assumed to be reflected on the Schedule D? Even if
    there is only one transaction, what is assumed about the availability
    of information related to basis, capital improvements and other
    necessary and relevant information? There is no way a tax professional
    can ``blanket charge'' his clients in light of those differences.
        Further, the fee charged for tax preparation services is likely to
    vary substantially based on where the services are performed. Tax
    preparation professionals practicing within a large metropolitan area
    such as New York or Chicago must charge more than their counterparts
    living in small town or farming communities because their overhead is
    far greater. Every area of the United States is different. For the IRS
    to issue a table suggesting to taxpayers how much a tax professional
    should charge to prepare a return is absolutely misleading and
    counterproductive.
        Another concern is the assertion in the table that a business filer
    who prepares a return himself without tax software will spend less time
    (45.1 hours) preparing the return than if that same individual used tax
    software (67.1 hours) or used the services of a paid professional 47.9
    hours). It seems obvious that someone who sees a particular form once
    per year will spend more time than a professional who is not only
    familiar with the form but has likely prepared the same form thousands
    of times. The only way this can possibly be true is if the self-
    preparer ignores the time needed to actually obtain the numbers
    required to prepare a return properly and instead relies on estimates
    (or the numbers on last year's return). Reputable tax professionals
    know that the majority of time spent on a return is the process of
    compiling all of the figures necessary. That being the case, the
    numbers are either wrong or the tables assume that taxpayers who self-
    file are using estimates rather than going through the tedium of
    looking through their records for the actual numbers. If the latter is
    true, where does that put the IRS's push for compliance?
        We sincerely hope the IRS will reconsider the publication of these
    estimates of taxpayer burden contained in the tables.
    S. 832
        NSA members have noticed an increase in the number of fraudulent
    tax preparers. In fact, a recent GAO report found that, of the 19 chain
    tax preparer offices tested, all returns were prepared incorrectly.
    Further, USA Today conducted a recent study and concluded that the
    number of fraudulent preparers has increased substantially in the last
    5 years. Competence and reliability can be very hard for taxpayers to
    determine, especially in light of limited government oversight. The IRS
    has pushed electronic filing to the forefront, and unfortunately this
    has led to an abundant increase of unenrolled preparers who operate
    from their cars, their homes, storefronts, on a table in their
    businesses, etc.
        Senate Bill S. 832 proposes new regulation for the federal tax
    preparation industry. This proposed legislation would have a
    significant impact on the profession and the Internal Revenue Service.
    Estimates of the number of tax practitioners required to register in
    the first year of the program range from 200,000 to as high as 600,000.
        The Senate bill instructs Treasury to develop (or approve) and
    administer an eligibility examination designed to test the knowledge
    and technical competency of individuals who prepare federal income tax
    returns. NSA has supported the concept of registration for federal
    income tax preparers since we first introduced the concept several
    years ago. NSA further supports the use of an eligibility examination.
    However, NSA can fully support the Senate bill, and any similar
    legislation, only if it provides recognition of tax practitioners who
    have already demonstrated their professional competence and their
    commitment to life-long learning either by earning credentials offered
    by a nationally recognized credentialing body or by being licensed to
    practice accounting by a state Board of Accountancy or by being
    licensed to prepare income tax returns by an agency established under
    state law. Allowing individuals who possess such credentials or
    licenses to receive a waiver from the initial examination requirement
    will achieve that recognition. These individuals would still be
    required to register, pay the appropriate fees and meet the other
    requirements specified in the bill.
        The Accreditation Council for Accountancy and Taxation (ACAT), a
    nationally recognized credentialing organization, offers three
    credentials that fully satisfy the competency and ethical standards
    that the Senate bill seeks to achieve. Those credentials are:
    Accredited Business Accountant (ABA), Accredited Tax Advisor (ATA) and
    Accredited Tax Preparer (ATP). Individuals who hold these credentials
    have demonstrated their knowledge and competency through a regimen that
    includes education, experience and examination on topics that include
    substantial taxation and ethical components. To maintain their
    credentials, they comply with rigorous annual continuing professional
    education requirements. ACAT credentials are recognized for licensing
    or regulatory purposes in a number of states, including Iowa and
    Minnesota, and NSA believes that S.832 should be modified to recognize
    that any individual who has taken and passed an ACAT examination and
    maintains his accreditation is exempt from any testing required by the
    bill.
        Any individual holding a license from a state Board of Accountancy
    has likewise demonstrated a level of competence that is based on a
    long-established regulatory standard that has education, experience and
    examination as required components. Every state accountancy regulatory
    scheme requires continuing professional education as a condition for
    license renewal.
        The states of California and Oregon license tax preparers in their
    respective jurisdictions. The licensing qualifications differ slightly
    in each state, but both require a substantial educational element,
    including state and federal taxation and ethical conduct, as a
    prerequisite to granting a license. In both states, continuing
    professional education is a requirement for license renewals.
    California currently licenses approximately 36,000 tax preparers and
    Oregon licenses approximately 8,000 preparers under their respective
    programs. These states already impose adequate and efficient licensing
    requirements on their tax and accounting professionals. We do not
    believe additional federal requirements should be imposed on these
    individuals or similarly situated individuals in other states.
        In addition, the Internal Revenue Service has extended Circular 230
    privileges to public accountants in the States of Pennsylvania, New
    Jersey and Rhode Island. Under the provisions of Circular 230, a
    ``certified public accountant'' is a person duly qualified to practice
    as a certified public accountant in any state, territory, or possession
    of the United States. Certified public accountants that are not
    currently under suspension or disbarment from practice before the
    Internal Revenue Service may practice before the Internal Revenue
    Service. A number of other states have a public accountant license
    class that has practice rights substantially equivalent, if not
    identical, to those granted to CPAs. These licensed public accountants,
    like their CPA counterparts, are subject to regulation and supervision
    by state Boards of Accountancy and must meet continuing education,
    professional standards and other requirements in order to maintain
    their practice rights. We firmly believe that if the Internal Revenue
    Service has already recognized the competence and integrity of these
    tax and accounting professionals in these states, Congress should as
    well.
        The Senate bill has a section that ``clarifies'' the Enrolled Agent
    credential. NSA supports this concept because it will establish a
    uniformity of regulation and eliminate ambiguities and conflicting
    restrictions that have evolved in many state regulatory schemes over
    time. The truthful use of earned credentials is an individual right
    that all responsible regulatory legislation should serve. National
    attention to this issue is both appropriate and overdue.
        The descriptor used to identify this new class of regulated tax
    preparers deserves the attention of your Committee. The staff notes,
    accompanying the Senate bill, include the term ``enrolled preparer''
    when referencing those individuals subject to the proposed regulation.
    NSA believes that this term diminishes the Enrolled Agent credential
    and has the potential to confuse the public. Further, it does not
    adequately describe the services performed by this group of tax
    preparers. We recommend that terminology used to describe this group be
    neutral. We suggest ``Registered Federal Tax Return Preparer.''
        Another section of the Senate bill provides for levying fines and
    then keeping the money to fund a public awareness campaign. We question
    the propriety of this provision and ask that Congress reconsider the
    potential for abuse. Principled legislation should allow Treasury to
    abate a punitive fine for an inadvertent human error. Perhaps there
    should be a ``pattern of neglect or misconduct'' before heavy fines are
    levied.
        The ``one-year from enactment'' provision is another area that must
    concern everyone. Such a short time period to develop both a testing
    and a registration system certainly has the potential to disrupt the
    subsequent tax-filing season. The staff description of the Senate bill
    states, ``Efficiencies will be gained by coordinating the exam
    requirement with the enrolled agent exam.'' Until such time as the
    enrolled agent exam is successfully outsourced and its structure
    entirely revised, we believe this conclusion is questionable at best
    and could lead to a disruption of the filing season in the first year
    of implementation. Processing the exams and the attending record
    keeping for 200,000 to 600,000 individuals certainly has the potential
    to overwhelm the system. A safer approach would be to instruct Treasury
    to devise a testing system independent of the Special Enrollment
    Examination that applicants could use throughout the year. Such a
    process would follow the proven model that the securities and insurance
    industries use. We think that development of a workable regulatory
    structure, as anticipated by S. 832, simply requires more time to both
    develop and implement. Extending the time frame to two years or perhaps
    three would be more realistic.
    In summary, with respect to S. 832 NSA supports:
        1.  The concept of registration of tax preparers.
        2.  The use of an initial examination by those who have not taken
    and passed an existing national examination, including those offered by
    the Accreditation Council for Accounting and Taxation.
        3.  A requirement for ongoing continuing professional education.
        4.  The requirement for registration renewal every three years.
        5.  A waiver of initial examination for individuals who:
           a.  Hold credentials offered by nationally recognized
    credentialing bodies; or
           b.  Hold a license to practice accountancy from a state Board of
    Accountancy; or
           c.  Hold a license to prepare tax returns established under
    state law.
        6.  The clarification of the Enrolled Agent credential.
        7.  Finding a better descriptor than ?enrolled preparer.
        8.  Reconsideration of using preparer penalty money to fund public
    awareness efforts.
        9.  Extending the time period for development and implementation of
    the structure.

                  Statement of Gerald E. Scorse, New York, NY

        My testimony today will make the same point, and urge the same
    action, as my testimony before this honorable Subcommittee in 2003,
    2004 and 2005.
        With one key difference: I now count as an ally National Taxpayer
    Advocate Nina E. Olson. Let me quote from the legislative
    recommendations of the Advocate's 2005 Annual Report to Congress:
    Requiring Brokers to Track and Report Cost Basis for Stocks and Mutual
            Funds.
        Many financial institutions through which investors own stocks and
    mutual funds (?brokers') do not currently keep track of an investor's
    basis in the stocks or mutual funds, and no brokers report basis
    information to both taxpayers and the IRS on a Form 1099-B, Proceeds
    from Broker and Barter Exchange Transactions. The absence of
    information reporting creates serious problems for many taxpayers and
    the government alike. For taxpayers, tracking basis can be
    extraordinarily complex and many taxpayers seeking to comply with the
    law find they simply cannot do so with accuracy, leaving them exposed
    if audited. From the government's perspective, the absence of
    information reporting enables underreporting by taxpayers who
    deliberately overstate their basis (thereby reducing their gain or even
    generating a loss), because they know the IRS generally cannot detect
    errors in basis reporting in the absence of an audit. One recent
    estimate puts the revenue loss to the government from such
    underreporting at $250 billion over the next 10 years. We recommend
    that brokers be required to keep track of an investor's basis, transfer
    basis information to a successor broker if the investor transfers the
    stock or mutual fund holding, and report basis information to the
    taxpayer and the IRS (along with the proceeds generated from the sale)
    on Form 1099-B. To offset the cost of implementing such a tracking
    system, we note that Congress could provide a one-time tax credit for
    brokers.''
        And so the National Taxpayer Advocate comes down on the side of
    third-party reporting of capital gains for stock transactions. (Aside:
    I suggested to Ms. Olson and would suggest to the Subcommittee that the
    same rule should apply to home sales and other real estate
    transactions. Even more than with stocks, there is no defensible reason
    for self-reporting of this income.)
        Ms. Olson bases her recommendation on the twin pillars of tax
    simplification for taxpayers and ending billions of dollars in annual
    revenue losses by the Treasury. Both are hugely worthwhile, and reason
    enough to translate her proposal into law.
        I would add other reasons as well.
        I was drawn to the issue in the beginning as a simple matter of tax
    fairness.
        It is inequitable to have a stricter tax reporting standard for
    wages than for capital gains; it is inequitable to require third-party
    reporting of wage income and not have the same requirement for capital
    gains income.
        I owe it to IRS Commissioner Mark Everson for pointing to another,
    allied reason. In remarks prepared for this Subcommittee's 2005
    hearing, the Commissioner noted that ``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.''
        So the integrity of the tax system, and the belief of average
    Americans in the integrity of the system, are also at issue here.
        I respectfully ask the Subcommittee, and all the members of the
    House, to address the Taxpayer Advocate's recommendation and bring it
    to fruition. A House bill directly along these lines is being prepared,
    and I urge your support when it is introduced.
        In these divisive political times, allow me to offer a final
    thought:
        Third-party reporting of capital gains is a nonpartisan issue. Tax
    simplification is not a Democratic or a Republican issue; billions of
    dollars lost to the Treasury, year after year, is not a Democratic or a
    Republican issue; tax fairness and the integrity of the tax system are
    not Republican or Democratic issues.
        They are issues on which both sides of the aisle should be able to
    unite, and do the right thing.
        Thank you.