[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
_____________________________________________________________________________
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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 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            C O N T E N T S

                               __________

                                                                   Page

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.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
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FORMATTING REQUIREMENTS:

      
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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\
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    \9\ Income of less than $25,000.
    \10\ National Taxpayer Advocate 2004 Annual Report to the Congress, 
Volume 1 December 2004.
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    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.
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    \21\ IRS has funding in other appropriation accounts that support 
its taxpayer service programs.
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    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.
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    \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\
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    \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.
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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.
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    \25\ GAO, Internal Revenue Service: Improving Adequacy of 
Information Systems Budget Justification, GAO-02-704 (Washington, D.C.: 
June 28, 2002).
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    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.
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    \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.
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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.
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    \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).
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    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.
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    \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.
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    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.
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    \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.
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    \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.
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    \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.
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    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.
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    \34\  IRS had planned to develop a workload management system, but 
has postponed this project indefinitely, due to budget constraints.
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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
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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.
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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.
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    \35\ GAO-06-453T.
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    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.
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    \36\ GAO-06-453T.
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    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\
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    \1\ Department of Treasury--Budget in Brief Fiscal Year 2007, 
February 6, 2006, pages 59-60.
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    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\
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    \2\ Id., page 62.
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    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\
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    \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.
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    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\
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    \4\ AICPA letter to Commissioner Everson (dated December 23, 2005) 
regarding the reporting of capital gains and loss transactions on Form 
1040, Schedule D.
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    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\
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    \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.
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    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.

                                  
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