[Senate Hearing 109-697]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-697
 
       UNCOLLECTED TAXES: CAN WE REDUCE THE $300 BILLION TAX GAP?

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

                                HEARING

                               before the

                FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT
                     INFORMATION, AND INTERNATIONAL
                         SECURITY SUBCOMMITTEE

                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 26, 2005

                               __________


       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs



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        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
TOM COBURN, Oklahoma                 THOMAS R. CARPER, Delaware
LINCOLN D. CHAFEE, Rhode Island      MARK DAYTON, Minnesota
ROBERT F. BENNETT, Utah              FRANK LAUTENBERG, New Jersey
PETE V. DOMENICI, New Mexico         MARK PRYOR, Arkansas
JOHN W. WARNER, Virginia

           Michael D. Bopp, Staff Director and Chief Counsel
   Joyce A. Rechtschaffen, Minority Staff Director and Chief Counsel
                  Trina Driessnack Tyrer, Chief Clerk


FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT INFORMATION, AND INTERNATIONAL 
                         SECURITY SUBCOMMITTEE

                     TOM COBURN, Oklahoma, Chairman
TED STEVENS, Alaska                  THOMAS CARPER, Delaware
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
LINCOLN D. CHAFEE, Rhode Island      DANIEL K. AKAKA, Hawaii
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
PETE V. DOMENICI, New Mexico         FRANK LAUTENBERG, New Jersey
JOHN W. WARNER, Virginia

                      Katy French, Staff Director
                 Sheila Murphy, Minority Staff Director
            John Kilvington, Minority Deputy Staff Director
                       Liz Scranton, Chief Clerk


                            C O N T E N T S

                                 ------                                
Opening statement:
                                                                   Page
    Senator Coburn...............................................     1
    Senator Carper...............................................     4
    Senator Collins (ex officio).................................     6
    Senator Akaka................................................     6
    Senator Levin................................................    19

                               WITNESSES
                      Wednesday, October 26, 2005

Hon. Mark Everson, Commissioner, Internal Revenue Service........     9
Bart L. Graham, Commissioner, Georgia State Department of Revenue    22
Colleen M. Kelley, National President, National Treasury 
  Employees Unoin................................................    27

                     Alphabetical List of Witnesses

Everson, Hon. Mark:
    Testimony....................................................     9
    Prepared statement...........................................    38
Graham, Bart L.:
    Testimony....................................................    22
    Prepared statement with an attachment........................    49
Kelley, Colleen M.:
    Testimony....................................................    27
    Prepared statement...........................................    69

                                APPENDIX

Chart entitled ``TAX GAP MAP for Tax Year 2001 (in $ Billions) 
  submitted by Senator Coburn....................................    37
Michael Brostek, Director Strategic Issue, Government Accounting 
  Office, prepared statement.....................................    77
J. Russell George, Treasury Inspector General for Tax 
  Administration, prepared statement.............................    94
Nina Olson, National Taxpayer Advocate, prepared statement.......   110


       UNCOLLECTED TAXES: CAN WE REDUCE THE $300 BILLION TAX GAP?

                              ----------                              


                      WEDNESDAY, OCTOBER 26, 2005

                                       U.S. Senate,
            Subcommittee on Federal Financial Management,  
        Government Information, and International Security,
                          of the Committee on Homeland Security    
                                        and Governmental Affairs,  
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:36 p.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Tom Coburn, 
Chairman of the Subcommittee, presiding.
    Present: Senators Coburn, Collins (ex officio), Carper, 
Levin, and Akaka.

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. The Committee will come to order.
    I want to thank our witnesses ahead of time for coming. I 
appreciate their attendance at our hearing. I want to give 
credit to Senator Carper. We are holding this hearing because 
of his pursuit of this issue, which is a very important issue 
for our country. This hearing is not about tax policy. That is 
a time for a different debate at a different time and a 
different subcommittee. What this hearing is about is the tax 
gap and whether or not the Federal Government is receiving its 
due, and how that impacts everybody else's paying their fair 
share when some of our citizens do not pay their fair share, 
whether they are corporate, personal, or payroll taxes.
    So it is important, and the tone of this hearing is about 
the tax gap, the uncollected taxes that are owed that are now 
being shouldered not only by those people who are paying taxes 
appropriately in this country, but also going to be shouldered 
by our children and grandchildren because people who did not 
pay their fair share today, they are going to transfer it to 
our children and our grandchildren in the form of higher 
national debt. The actual national debt increased $564 billion 
last year. In our hearing yesterday, I quoted $600 billion. My 
staff corrected me. It was not quite $600 billion; it was just 
$564 billion. That is enough for $2,000 for every man, woman, 
and child in this country. It is something that cannot happen.
    I pursue fiscal restraint, but the other thing is proper 
revenues under the law should be coming to the Federal 
Government, and it is important that they do so.
    So I do want to give credit to Senator Carper. We are 
working as a bipartisan Subcommittee. Partisanship has no play 
on this Subcommittee. We are not going to work that way. We 
have agreed not to work that way. We think that is what the 
American people expect of us. So we will do that.
    The gap between revenues that should have been collected 
and those that actually were is known as the ``tax gap.'' 
According to research by the IRS, on individual income tax 
returns, the tax gap falls somewhere between the range of $311 
and $353 billion for the year 2001. Four-year-old data is the 
most recent data we have. Even worse, some argue that the tax 
gap is actually much larger than the $350 billion.
    The tax gap is at least as big and probably much larger 
than our Enron accounting current deficit numbers. I find it 
troubling to think that if taxpayers were paying the amount 
they owe in taxes each year, the Nation could be running a 
positive balance at the end of the year rather than adding what 
we have added in terms of national debt.
    The tax gap is a combination--underreporting, underpaying, 
and non-filing of required tax returns altogether or on time 
are the three areas where noncompliance occurs. The tax gap is 
also measured by type of tax in terms of income, employment, 
estate, or excise.
    According to the IRS' most recent study completed in 2002, 
underreporting on individual income and self-employment taxes 
accounts for 80 percent of the tax gap. The IRS also reports 
that individual income and self-employment taxes on unreported 
income makes up between $134 to $155 billion, almost half of 
the gross tax gap.
    As you might expect, underreporting can be either 
intentional or nonintentional, but nobody, including the IRS, 
is measuring which it is in most cases. The National Taxpayer 
Advocate reports that given the size of the current tax gap, 
the average returns includes a $2,000-per-year surtax to 
subsidize, noncompliance. That is a tax that everybody else is 
paying, on average, to subsidize those who are not paying. If 
the average American knew that $2,000 of his or her annual tax 
payment went to pay for intentional or unintentional tax 
evasion of others, I believe there would be an aggressive call 
for the IRS to do a better job of solving the problem. The tax 
gap deals with fundamental fairness and how each tax-abiding 
citizen of this country is paying or not paying the money they 
owe to the country.
    This hearing is not to focus on what type of tax policy is 
fair to the most American people--as I said, that is for 
another hearing--or what type of tax system will boost the 
economy. That is for another hearing as well. I believe that 
increasing the tax burden on the American people while we are 
currently wasting their money through innumerable improper 
payments, fraud, and unaccountable programs is the wrong 
policy, but today's hearing is not about the size of the tax 
burden or what should be done to the Tax Code. Today, we are 
talking about the $350 billion problem and how it might be 
solved.
    This hearing will allow us to take a better look at the 
sources of the tax gap, the reasons the income is lost, and 
what weaknesses exist within the current system to cause these 
billion-dollar deficiencies. The IRS balances its approach to 
tax gap reduction by focusing on both prevention--that is, 
improving taxpayer services--and enforcement after the fact. 
However, I have found no official long-term compliance goals 
are driving the IRS endeavor. If we really want to see 
noncompliant rates decrease, the IRS must develop a results-
oriented approach, something that can measure progress made in 
reducing the tax gap. They must also have data that is more 
current than 2001 in order to get accurate results of how big 
the tax gap really is.
    It is inherently unfair for one taxpayer's delinquency to 
be another taxpayer's burden. I look forward to hearing from 
our witnesses on what the tax gap is, its impact on the Federal 
deficit, and what it means for the future of our country. I 
want to thank the witnesses for their time and preparation and 
thank Senator Carper most especially for his help in securing 
this hearing.
    [The prepared statement of Senator Coburn follows:]

                  PREPARED STATEMENT OF SENATOR COBURN

    The Federal budget deficit hit $318 billion for the year just 
ended. The gap between revenues that should have been collected and 
those that actually were is known as the ``tax gap.'' According to 
research by the Internal Revenue Service on individual income tax 
returns, the tax gap falls somewhere within the range of $311 and $353 
billion for the 2001 tax year. Four-year-old data is the most recent we 
have. Even worse, some argue that the tax gap is actually much larger 
than $350 billion.
    The tax gap is at least as big as--and probably much larger than--
our current annual Federal deficit numbers. I find it troubling to 
think that if taxpayers were paying the amount they owe in taxes each 
year, the Nation could be running a positive balance at the end of each 
year, rather than adding $3 or $4 billion each year in the looming $4.3 
trillion Federal deficit.
    The tax gap is the combination of underreporting, underpaying, and 
non-filing of required tax returns altogether or on time, are the three 
areas where non-compliance occurs. The tax gap is also measured by type 
of tax: Income, employment, State, or excise.
    According to the IRS' most recent study, underreporting on 
individual income and self-employment taxes accounts for 80 percent of 
the tax gap. The IRS also reports that individual income and self-
employment taxes on unreported income makes up $134 to $155 billion, 
almost half of the gross tax gap. As you might expect, underreporting 
can be either intentional or non-intentional, but nobody, including the 
IRS, is measuring which it is in most cases.
    The National Taxpayer's Advocate reports that given the size of the 
current tax gap, the average tax return includes a $2,000 per year 
``surtax'' to subsidize noncompliance. If the average American knew 
that $2,000 of his or her annual tax payment went to pay for the 
intentional or unintentional tax evasion of others, I believe there 
would be an aggressive call for IRS to do a better job at solving the 
problem.
    The tax gap deals with fundamental fairness in how each tax-abiding 
citizen of this country is paying--or not paying--the money they owe to 
the country.
    This hearing is not to focus on what type of tax policy is most 
fair to the American people; or what type of tax system will boost the 
economy. I believe that increasing the tax burden on the American 
people while we are currently wasting their money through innumerable 
improper payments, fraud, and unaccountable programs is the wrong 
policy. Today's hearing is not about the size of the tax burden but 
what should be done to the tax code.
    Today, we're talking about the $350 billion problem and how it 
might be solved. This hearing will allow us to take a better look at 
the sources of the tax gap, the reasons income is lost, and what 
weaknesses exist within the current system to cause these billion 
dollar inefficiencies.
    The IRS balances its approach to tax gap reduction by focusing on 
both prevention--that is, improving taxpayer services--and enforcement 
after the fact. However, no official long-term compliance goals are 
driving IRS' endeavor. If we really want to see non-compliance rates 
decrease, the IRS must develop a results-oriented approach--something 
that can measure progress made in reducing the tax gap.
    It is inherently unfair for one taxpayer's delinquency to be 
another taxpayer's burden. I look forward to hearing from our witnesses 
on what the tax gap and its impact on the Federal deficit means for the 
future of our country.
    I want to thank our witnesses for their time and preparation.

    I notice that our Chairman of the full Committee is here. I 
will recognize Senator Carper and then recognize Senator 
Collins thereafter.
    Senator Carper. Thank you very much, Mr. Chairman. I would 
be happy to yield to Senator Collins.
    Chairman Collins. Please go right ahead.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. Our Chairman has been very generous in 
giving me some credit, and my staff, some credit for calling 
attention to this issue and asking that we hold this hearing. I 
am grateful that we are. He and I have a passion for trying to 
reduce our budget deficit. I know it is a passion shared by 
Senator Collins and Senator Akaka as well. When you have a 
situation where we are running these huge budget deficits and 
we know there is money that is out there that is owed in taxes 
that are on the books and we have some idea who owes the money, 
we have an obligation, I think, to people who are paying their 
fair share of taxes to help you, Mr. Commissioner, and others 
whose responsibility it is to collect the revenues to collect 
them.
    We have had some opportunity earlier this year, as the 
Chairman knows, and I think as our other colleagues know, to 
focus on the issue of improper payments. And this hearing today 
sort of reminds me of that. In fact, I think we have had two 
hearings now and identified that there is about $45 billion or 
so that are made in improper payments each year. For the most 
part, it is money that is overpaid and paid to vendors or 
payees that ought not be getting that money. We also learned 
that the number is just the tip of the iceberg, and there are a 
bunch of agencies that are not reporting at all on their 
improper payment problems. And as we learn more about what 
improper payments they are making, I think we are likely to see 
that $45 billion number grow further.
    And the same can really be said about this so-called tax 
gap that the Chairman has alluded to. Officially I am told 
there are between $300 and $400 billion in taxes owed the 
Federal Government, and they go uncollected by the IRS or some 
agency of the Federal Government each year. This number does 
not include, I am told, cash payments made for legitimate 
business transactions that are made in the underground economy. 
I am also told that it does not include accurate, up-to-date 
data on taxes that are owed to underreported corporate tax 
income and other key factors.
    Like with improper payments, then, we are probably pretty 
far from truly knowing everything that we should know about the 
extent of the tax gap in our country. Every dollar wasted on 
erroneous or fraudulent payments means that there is one fewer 
dollar that we can spend on worthy programs, so one more dollar 
we have to borrow around the world from China, Japan, South 
Korea, or somebody else as well. And that is not a good thing 
whether you happen to live in Delaware, Oklahoma, Maine, or 
even Hawaii.
    Mr. Commissioner, I know that in your testimony today you 
are going to testify, I think, among other things, about 
efforts that are underway at the IRS to go after abusive tax 
shelters and to increase the audits of large corporations and 
high-income individuals. We welcome that and are anxious to 
hear what you have to report. We applaud you and those that you 
lead for those efforts.
    What I also want to learn more about today, though, is the 
extent to which we have the information necessary to focus on 
compliance, focus on enforcement and customer service efforts 
at the IRS on the right things. We might be making progress, 
but I don't know if we are there yet. I always say, Mr. 
Commissioner, that everything I do I can do better. My guess is 
that the same is true of you and the folks that you lead.
    In closing, Mr. Chairman, I would like to note for the 
record that we have some experience in our State, in Delaware, 
in dealing with these issues. At the beginning of my political 
career, I was State Treasurer of a State that had the worst 
credit rating of any State in America. We were the best in the 
Nation at overestimating revenues and underestimating spending. 
Nobody was as good as us. We ended up with a BAA credit rating, 
which tied us for dead last with Puerto Rico. We had all of our 
money in a bank owned by the State. We were closed out of 
credit markets. Nobody would lend us any money. We had no cash 
management system. And at the tender age of 29, I got to be 
State Treasurer.
    So these are issues that are sort of near and dear to my 
heart. Later, as Governor of Delaware, my team and I worked 
with the legislature and others to turn around the State 
Division of Revenue, which is our State counterpart to the IRS, 
which was not getting the job done in a variety of areas, 
including customer service. And after a lot of years on 
behalf--by a lot of people and some hard work, we were actually 
able to bring the collections of delinquent taxes up to record 
highs. We also made it easier to file taxes online and save our 
State and our families and businesses, I think, a fair amount 
of time and money.
    One of the things I am proudest of, we have an annual 
award, a Quality Award. And you probably have them in your 
States. We have one for the Nation. In my second term as 
governor, just before I came here to join some of my 
colleagues, our Division of Revenue was actually recognized for 
its customer service and the way they did their job by winning 
the Quality Award for Delaware, which a lot of times 
corporations win those, sometimes a nonprofit. But the idea of 
a State agency, essentially the tax-collecting State agency, 
would win the award for quality was something we were 
enormously proud of in our State.
    And I say all this not to blow our horn in Delaware, but to 
point out that there are road maps out there for the IRS to 
follow, and I am sure you are aware of that. Our budget in 
Delaware is only a fraction of the Federal budget, but I am 
sure that some of what we have done there and much of what has 
been done in other States to identify problems, to fix them, 
and improve collections and customer satisfaction at the same 
time just might be replicated, at least in part, at the Federal 
level.
    Again, Mr. Chairman, thanks for allowing us to have this 
hearing and for all our staff and the work that they have done 
to get us to this day. And we are delighted to welcome the 
Commissioner and our other witnesses, including from as far as 
Georgia and from GAO. Thank you so much--and the Treasury 
employees as well I think are represented here. We thank you 
very much for coming and look forward to all your testimony. 
Thank you.
    Senator Coburn. Thank you, Senator Carper.
    I recognize our Chairman, the Senator from Maine, Senator 
Collins. Thank you very much.

             OPENING STATEMENT OF CHAIRMAN COLLINS

    Chairman Collins. Thank you very much, Mr. Chairman.
    Senator Coburn and Senator Carper, I would like to begin my 
remarks by thanking you for your leadership in examining the 
financial management and sometimes financial mismanagement in 
the Federal Government. I know that our partner, the Senator 
from Hawaii, also has a deep-felt commitment to improving the 
financial management of the U.S. Government.
    We all have a responsibility to contribute to the running 
of our government, and a large measure of that responsibility 
involves paying our taxes fully and on time. In previous 
hearings before the full Committee and the Permanent 
Subcommittee on Investigations, I have taken a great interest 
in improper payments, but also focusing on the revenue side of 
the ledger. We have held hearings on Federal contractors who 
cheat on their taxes, and we have looked at improvements that 
can be made in the way that the IRS and other government 
agencies can cooperate to increase tax collection. And I am 
just delighted that this Subcommittee is building on that work 
because we have obviously not made much of a dent in what is a 
considerable problem.
    I also am pleased to see the Treasury Employees Union here, 
and Colleen Kelley, whom I have worked with so closely, because 
I think we can get a lot of good ideas from the employees of 
IRS on how we can do a better job.
    We ask a lot of our citizens--every year we ask that they 
write a check to the government or contribute through payroll 
taxes, contributing their hard-earned dollars to the public 
good. And most of our citizens do comply. But for every 
individual or every corporation that does not fully comply, 
honest Americans have to pay more than their fair share. This 
just isn't right and I hope that this hearing and the 
information we gather today will spur more progress on the part 
of the IRS and other agencies as we work to increase tax 
compliance.
    So thank you for holding this important hearing.
    Senator Coburn. Thank you, Madam Chairman.
    To one of the nicest men in the Senate, I would like to 
recognize the Senator from Hawaii, Senator Akaka.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you. Thank you very much, my good 
friend, Chairman Coburn, for calling this hearing today and 
focusing on the $300 billion in taxes owed to the Federal 
Government but not collected, as was pointed out by each of 
you.
    I wish to compliment you and the Ranking Member, Mr. 
Chairman, for assembling such a distinguished witness group 
today, including IRS Commissioner Everson. I remember that I 
last saw you in a hearing in May, and I look forward to your 
testimony today.
    Also, I want to compliment the Chairman of our full 
Committee for her leadership of the Committee and feel that we 
really moved well in serving the Senate under her leadership.
    I want you to know that I agree with the Chairman and 
Ranking Member that regularly measuring compliance with our 
Nation's tax laws and understanding why taxpayers fail to pay 
their taxes is needed now more than ever. Our witnesses today 
without question in my mind will give us many reasons for the 
noncompliance.
    I would like to start by clearing up a common 
misconception, and that is, filing errors among low-income 
taxpayers are simply acts of fraud and contribute to the tax 
gap. The low quality of tax preparation services for the earned 
income tax credit earner contributes significantly to the 
errors found in the EITC-related returns. The EITC helps 
working families meet their food, clothing, housing, 
transportation, and educational needs. Do you know that 57 
percent of EITC over-claims were made on returns prepared by 
paid tax preparers?
    Steps must be taken to improve the quality of tax 
preparation services, which is why I worked with our colleagues 
Senators Bingaman, Smith, Baucus, Grassley, Schumer, and Pryor 
to develop S. 832, the Taxpayer Protection and Assistance Act.
    Our bill will provide the Department of the Treasury with 
improved authority to regulate individuals preparing Federal 
income tax returns and other documents for submission to the 
Internal Revenue Service. The bill requires three things--
examinations, one; education, two; and oversight of paid 
preparers, three--and urges citizens to utilize the services of 
an accredited or licensed tax preparer.
    Enactment and implementation of this legislation would 
improve the quality of tax preparation services available to 
our citizens and reduce the error rate among returns filed by 
EITC recipients. Only through stronger regulation of the tax 
preparation industry and providing additional resources to help 
volunteer and community tax preparation programs will error 
rates among low-income filers be reduced, which will help close 
the tax gap.
    Mr. Chairman, I am also concerned about a problem that 
likely contributes to the tax gap: Business-owned life 
insurance, which is insurance owned on the life of an employee 
that benefits the corporation or the business, and that is 
BOLI. They benefit from the earnings on the policy's cash value 
building up tax-free and are not taxed unless the policy is 
surrendered prior to the death of the insured. Because you are 
a proponent of fiscal responsibility, Mr. Chairman, I believe 
you may be interested in this problem as well.
    In response to a request from Senator Bingaman and myself, 
the GAO released a study in May 2004 on BOLI that found limited 
data is available on the use and prevalence of BOLIs. We simply 
do not have good data on the number and use of BOLIs, many of 
which exist for no other purpose than to shelter income from 
taxes.
    More needs to be done to understand the justification and 
costs of retaining the Federal tax advantages of BOLI. We are 
in a difficult fiscal environment which requires difficult 
choices, especially when there are calls for cutting essential 
health care programs such as Medicaid or education programs. 
Imposing regulatory reporting requirements on BOLIs would 
provide needed information on the use and prevalence of these 
policies and would give Congress the data needed to evaluate 
whether or not these tax benefits are justified.
    I look forward to a thorough discussion of these issues as 
part of today's hearing on the tax gap. Again, I want to say 
thank you to our witnesses and thank you to the Chairman and 
Ranking Member for having this hearing. Thank you.
    [The prepared statement of Senator Akaka follows:]

                  PREPARED STATEMENT OF SENATOR AKAKA

    Thank you, Mr. Chairman, for calling today's hearing which focuses 
on the $300 billion in taxes owed to the Federal Government but not 
collected. I wish to compliment you and Ranking Member Carper for 
assembling such distinguished witnesses, including IRS Commissioner 
Everson who I last saw at the Joint Taxation Committee's hearing in 
May.
    I agree with the Chairman and Ranking Member that regularly 
measuring compliance with our Nation's tax laws and understanding why 
taxpayers fail to pay their taxes is needed now more than ever. Our 
witnesses today will touch on many reasons for noncompliance. I would 
like to start by clearing up a common misconception: That filing errors 
among low-income taxpayers are simply acts of fraud and contribute to 
the tax gap. The low quality of tax preparation services for the Earned 
Income Tax Credit (EITC) earner contributes significantly to the errors 
found in EITC-related returns.
    The EITC helps working families meet their food, clothing, housing, 
transportation, and educational needs. Fifty-seven percent of EITC 
over-claims were made on returns prepared by paid tax preparers. Steps 
must be taken to improve the quality of tax preparation services, which 
is why I worked with our colleagues, Senators Bingaman, Smith, Baucus, 
Grassley, Schumer, and Pryor to develop S. 832, the Taxpayer Protection 
and Assistance Act. Our bill will provide the Department of the 
Treasury with improved authority to regulate individuals preparing 
Federal income tax returns and other documents for submission to the 
Internal Revenue Service (IRS). The bill requires: Examinations, 
education, and oversight of paid preparers, and urges citizens to 
utilize the services of an accredited or licensed tax preparer.
    Enactment and implementation of this legislation would improve the 
quality of tax preparation services available to our citizens and 
reduce the error rate among returns filed by EITC recipients. Only 
through stronger regulation of the tax preparation industry and by 
providing additional resources to help volunteer and community tax 
preparation programs, will error rates among low-income filers be 
reduced, which will help close the tax gap.
    Mr. Chairman, I am also concerned about a problem that likely 
contributes to the tax gap--business owned-life insurance (BOLI), which 
is insurance owned on the life of an employee that benefits the 
corporation or business. They benefit from the earnings on the 
policies' cash value building up tax-free, and are not taxed unless the 
policy is surrendered prior to the death of the insured. Because you 
are a proponent of fiscal responsibility, I believe you may be 
interested in this problem as well.
    In response to a request from Senator Bingaman and myself, the GAO 
released a study in May 2004 on BOLI that found limited data is 
available on the use and prevalence of BOLIs. We simply do not have 
good data on the number and use of BOLIs, many of which exist for no 
other purpose than to shelter income from taxes. More needs to be done 
to understand the justification and costs of retaining the Federal tax 
advantages of BOLI.
    We are in a difficult fiscal environment which requires difficult 
choices, especially when there are calls for cutting essential health 
care programs, such as Medicaid or education programs. Imposing 
regulatory reporting requirements on BOLIs would provide needed 
information on the use and prevalence of these policies and would give 
Congress the data needed to evaluate whether or not these tax benefits 
are justified.
    I look forward to a thorough discussion of these issues as part of 
today's hearing on the tax gap. I thank the witnesses for appearing 
this afternoon. Thank you, Mr. Chairman.

    Senator Coburn. I thank the Senator.
    Our first witness is Mark Everson. He is the Commissioner 
of the Internal Revenue Service. Prior to his time at IRS, he 
was Deputy Director for Management for the Office of Management 
and Budget, where he provided government-wide leadership to the 
Executive Branch agencies to strengthen Federal financial 
management and improve program performance, and this 
Subcommittee has seen some of the benefits of his work as we 
have seen how there are starting to be chief financial officers 
and some transparency starting to develop within the various 
agencies. And so I think you were incremental in helping get 
that done. We are very appreciative of that.
    Your entire statement will be made a part of the record. 
You are recognized for 5 minutes.

   TESTIMONY OF HON. MARK EVERSON,\1\ COMMISSIONER, INTERNAL 
                        REVENUE SERVICE

    Mr. Everson. I want to start off correctly here. Do I say 
``Mr. Chairman'' or ``Madam Chair''? What is the right protocol 
here?
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    \1\ The prepared statement of Mr. Everson appears in the Appendix 
on page 38.
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    Senator Coburn. ``Madam Chairman.''
    Mr. Everson. Madam Chairman, Mr. Chairman----
    Senator Carper. Actually, we use ``Excellency'' a lot. 
[Laughter.]
    Mr. Everson. Senators Carper and Akaka, I am pleased to be 
here to discuss the important subject of the tax gap. This is 
the first time that I have testified as Commissioner before 
this Subcommittee. I did actually testify earlier on erroneous 
payments several years ago when at OMB. But it is certainly not 
the first time I have testified before the Homeland Security 
and Governmental Affairs Committee.
    I want to thank the Members of the Subcommittee for your 
strong support for sound tax administration. In particular, I 
want to share with you my assessment that the work of the 
Permanent Subcommittee on Investigations has been instrumental 
to the government's efforts to combat abusive tax shelters, 
efforts which I believe have enjoyed considerable success.
    Turning to today's subject, simply put, the tax gap is the 
difference between the tax that taxpayers should pay and what 
they actually pay on a timely basis. Our research confirms that 
the vast majority of Americans pay their taxes honestly and 
accurately, but the findings also show that even after IRS 
enforcement efforts and late payments, the government is being 
shortchanged by over a quarter trillion dollars each year 
because some pay less than their fair share. People who are not 
paying their taxes shift their burden to the rest of us. In 
this time of budget deficits, a dollar not received by the 
government becomes debt, the burden of which will be felt by 
future generations.
    Moreover, as President Kennedy stated in 1961, ``Large 
continued avoidance of tax on the part of some has a steadily 
demoralizing effect on the compliance of others.'' Beyond the 
effect on the government's revenue stream, persistent 
noncompliance erodes respect for the rule of law.
    Our research shows that the gross tax gap for 2001 was 
between $312 billion and $353 billion. The old tax gap estimate 
for 2001 was $311 billion, a figure based on studies conducted 
in 1988 and earlier. So there has been what I would term a 
modest deterioration in tax compliance among individuals since 
the last study was conducted in 1988.
    IRS enforcement activities, coupled with late payments, 
recover about $55 billion of the total gross gap, leaving a new 
annual tax gap of between $257 billion and $298 billion. The 
new research for 2001 addresses the underreporting of income 
and self-employment taxes by individual taxpayers. It is based 
on the audits of 46,000 individual returns. The study did not 
address corporate compliance.
    Preliminary findings include: Underreporting noncompliance 
is the largest component of the tax gap. Preliminary estimates 
show underreporting accounts for more than 80 percent of the 
total tax gap with non-filing and underpayment at about 10 
percent each.
    Individual income tax is the single largest source of the 
annual tax gap, accounting for about two-thirds of the total.
    For individual underreporting, more than 80 percent comes 
from understated income, not overstated deductions. Let me 
repeat that: understated income, not overstated deductions.
    Most of the understated income comes from business 
activities, not wages or investment income. Compliance rates 
are highest where there is third-party reporting or 
withholding. Less than 1.5 percent of wages and salaries are 
misreported.
    The next stage of our research will be to finish the data 
analysis and refine the tax gap estimates, which we will do by 
the end of this year. The IRS will use the data to update its 
statistical tools for selecting individual audits--or 
individual returns for audit. The tax gap study confirms a key 
point involving enforcement. The IRS needs to enforce the law 
so that when Americans pay their taxes, they are confident 
their neighbors and business competitors are doing the same.
    Since 2001, we have taken a number of steps to bolster 
enforcement. We have increased total individual audits to more 
than 1 million. You can see that recovery after the sharp fall-
off in the late 1990s. We have more than doubled high-income 
audits. We have brought up recommended criminal prosecutions, 
the same timing of the deterioration that took place in the 
late 1990s where we actually--we reduced our manning in revenue 
agents, revenue officers, and criminal investigators by over a 
quarter following 1996, as resources were just taken away from 
that in the environment with which I think we are all familiar.
    Between fiscal year 2001 and 2004, the IRS increased its 
enforcement revenue from $33.8 billion to $43.1 billion, and 
when we release 2005, that is going to go up again. Enforcement 
revenues are the monies that result from IRS collection, audit, 
and document-matching activities. Enforcement revenues directly 
reduce the tax gap and the Nation's budget deficit. They 
exclude the positive impact on compliance that occurs when 
someone learns in a casual conversation that their neighbor has 
been audited and then thinks twice about fudging his or her own 
return.
    The President has called for a nearly 8-percent increase 
for enforcement activities in the Administration's 2006 budget 
request. These investments will pay for themselves several 
times over and help reduce the tax gap. This is a case where 
more spending will get more revenues.
    I want to thank the Senate for fully funding the 
President's request in our 2006 appropriation bill which you 
passed last week. Please protect that funding.
    I would like to point out that our system of tax 
administration is fundamentally one of self-assessment and 
enjoys a high compliance rate. The IRS is moving aggressively 
to reduce the tax gap. With proper funding over a number of 
years, we will be able to close a significant portion of the 
gap, but no one should think that we can totally eliminate the 
gap. That would take draconian measures and make the government 
too intrusive. We have to strike the right balance.
    Finally, the tax gap challenge underscores the President's 
call for tax reform. Complexity obscures understanding. 
Complexity in the Tax Code compromises both the service and 
enforcement missions of the IRS. Those who try to follow the 
law but cannot understand their tax obligations may make 
inadvertent errors or ultimately throw up their hands and say, 
``Why bother?'' Meanwhile, individuals who seek to pay less 
than what they owe often hide behind the Code's complexity in 
order to escape detection by the IRS and pay less. Thank you.
    Senator Coburn. Thank you, Mr. Commissioner.
    It looks like you are on the right track. There are some 
concerns we have as to how you measure it and the fact that you 
are working off of old data, and I am going to put up this 
chart over here.\1\ It is a little bit wordy. But the problem 
with the data is we know actual amounts, we have got reasonable 
estimates, and then we have weaker estimates. In Oklahoma, we 
call a weaker estimate ``just a guess.'' It is not a weaker 
estimate. It is that we do not really know, but this is our 
best shot at it.
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    \1\ Chart submitted by Senator Coburn appears on page 37.
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    Tell me what you have in plans to measure your performance 
within the IRS and how can you do that with such old data.
    Mr. Everson. I do not want to defend the long gap it took 
to reinvigorate and do these studies. We stood down from doing 
research basically at the insistence of the Congress during the 
1990s because it was considered too intrusive, some of the 
audits that were being done. And it was quite controversial 
before we moved forward to do this research in and of itself. 
But it has been done in a way that I think it generated very 
few complaints as we went through these 46,000 audits, and in 
some instances there was not even contact with the taxpayers, 
depending on the returns.
    I think that the 2001 data--I wouldn't consider that out of 
date. Those returns are filed in 2002, and the work on the 
audits was done in 2003 and 2004. It is unrealistic to think 
that the timing will get too much more compressed than that 
because once the research is done, you need to adjust the 
numbers. If Bill Gates is in the sample, you have to sort of 
figure out whether that is representative, because it makes a 
difference if Bill Gates is there or myself. You get a 
different weighting, and you need to have the statisticians go 
through all this very carefully.
    So that piece, I wouldn't consider that old. What we have 
not done here, though, as you indicate, is the corporate side 
particularly, we are moving forward now to do flow-through 
entities. The flow-through entities have exploded, 1120 S-
corps, they have increased by tenfold over the last period of 
years in terms of a vehicle of choice. We are concerned there 
may be problems there.
    What we are doing right now is, as we finish up assessing 
this data--and by year-end we will have more precise numbers 
within the ranges--we are also developing a plan for updating 
that. As you know, GAO has said we ought to do this more 
periodically. I agree with this entirely. It is really, again, 
a question in part of cost, because doing 46,000 audits to the 
degree we did it, very resource-intensive. They are randomly 
selected. They are not following the same model of going 
through a risk assessment and then going after the audits that 
are going to generate probably a real picture of noncompliance. 
The other thing we did was we oversampled on the high-income 
audits so that took time.
    What I have committed to doing to Finance, which is have 
this same discussion, and particularly Senator Baucus, is that 
as we finish this research, we will then come up with what we 
say are the long-term goals for compliance, because until you 
know really where you are, it is hard to set a goal for where 
you want to go. And, also, we will develop a plan for ongoing 
research. We have had conversations on that internally already.
    Senator Coburn. When should we see the commitment on that?
    Mr. Everson. I think that will happen early next year, and 
in my view, it also depends in part on the signal we get from 
the Congress on funding. If the monies are provided to enforce 
the law adequately and that sends a clear signal that--unlike 
in previous years, where the Congress has cut this President's 
request, and even before that, sometimes President Clinton's 
request, if the Congress is now supporting this and we can be 
assured that we will have the adequate resources, I think you 
can do a better job of projecting improvements.
    Senator Coburn. So you do not think that we need to have 
better research than what we have or more timely research? We 
just need to take care of what we have got now and then develop 
a plan based on that?
    Mr. Everson. No, I am not suggesting that. I think we do 
need to do that. We need to cover the other boxes in here that 
have not been covered, and we need to have a routine schedule 
for refreshing this. But we need to assess if we need to do a 
full-blown 46,000 or whatever the statistically valid piece is, 
or are there other ways to get after this? Because it is very 
expensive.
    Senator Coburn. Is there not somebody out there that can 
design you a model that will allow you to statistically do 
this, computer-enhanced, where you can have better information 
on a faster turnaround, where you can make decisions where you 
can assess your progress? I have no doubt in my mind that the 
IRS wants to do a good job. We have got great IRS employees. 
And I have no doubt in my mind their commitment to it. What I 
am worried about is a management system that says how do we 
measure our performance. And I do not see that, and that is the 
thing that concerns me. You have identified what the problem 
is. Others estimate it to be significantly higher than that. 
How do we develop the system where you have a management goal 
that rates the performance of IRS in terms of accomplishing 
this goal?
    Mr. Everson. I think, as I said, that with this data and as 
we update our models, we are able to make better commitments.
    Now, there are issues here that came up when we did the 
Finance testimony about setting goals, and I want to make sure 
you understand this. I am unable to measure employee 
performance based on enforcement results. My job is to deliver 
$2 trillion to the government every year. But I cannot measure 
an employee based on that.
    Senator Coburn. Sure.
    Mr. Everson. So it is a complicated question as to how you 
bring down performance, measure performance, when one of our 
jobs is clearly--it is not just to regulate charities and see 
that they are following the law or, as Senator Akaka was 
talking about, get out the earned income tax credit to over 20 
million participants. It is also to bring in that money.
    So there are a whole series of things that have to be done 
and have to be done carefully.
    Senator Coburn. All right. Senator Carper.
    Senator Carper. I mentioned earlier, Mr. Commissioner, that 
there are lessons from--probably lessons from the States that 
we can take to heart, and I always call them experiments in--
laboratories in democracy. And give us some ideas, some--do you 
have a mechanism that enables you to exchange ideas and 
information with the States--I am pretty sure you do--so that 
one hand can sort of wash the other? How does that work? So 
that is the first part of my question.
    The second part of my question is: Can you cite some 
examples of things that States are doing that you think might 
be worthwhile for us to do at the Federal level?
    Mr. Everson. I am glad you raise this question because 
there are several issues here that are of great importance. We 
do work with the States, and we have increased that 
coordination very significantly in just the last several years, 
particularly on the abusive shelters where now almost every 
State--I think it is 46 States. We have memorandums of 
understanding with them on sharing information about the 
abusive shelters. We are only going to get to so many cases. We 
may give them a list of participants in shelters that we have 
identified to the State of California, and then they will 
follow up on some, and then if they get the tax, they notify 
us, and then we go after it. So we are working--I am sure my 
colleague from Georgia will touch on this as well--particularly 
in this area of abusive transactions.
    It leads me to another point, though, where there is a 
weakness where we can get the help from the Congress. Again, 
going back to charities, we regulate charities. The law 
precludes us from sharing information about charities with the 
State regulators of charities. That is to say, credit 
counseling, it is a mess. We have 50 percent of that industry 
under audit right now because of the abuses that are out there. 
We cannot talk to the State regulators of charities if an 
operation is in Delaware and in Oklahoma and we know about 
something that is going on in Oklahoma, we cannot share it with 
a regulator from your State. So there are opportunities----
    Senator Carper. What is the rationale for that, Mr. 
Everson?
    Mr. Everson. It is 6103. One of the absolute bedrock 
principles of the Tax Code is privacy of the return 
information, and that is an absolute prohibition, but then 
there are carve-outs. There are specific carve-outs, 
exceptions, if you will, that are provided. But as Senator 
Levin knows, because we have had this conversation in previous 
hearings, I cannot even share with the PCAOB.
    Senator Carper. With the what?
    Mr. Everson. The PCAOB, that is the group that looks after 
the audit firms. I cannot even share with them the results of 
what we are doing in civil inquiries on accounting firms. So 
there are a lot of places where we can do more to share.
    Senator Carper. OK. Can you cite some examples that you are 
familiar with where you have actually done good work, helped 
one another?
    Mr. Everson. These abusive shelters, we formed that 
agreement 2 years ago, and we have shared lots of information 
back and forth, and they are actively working cases out in the 
States now, and they are using our information. On an ongoing 
basis, when we do audits, we share information with the States, 
as you know. Over 40 of the States, their tax returns start 
with a line in the Federal return. So that is shared routinely.
    Senator Carper. I am told that the IRS tried to have 
private collections release a portion of the monies that were 
owed several years ago. The project was not very successful, 
and I do not know if you are going to try a new variation of 
that or a demonstration project or not. But can you tell us 
what may have gone wrong 10 years ago? If it was not 
successful, why not? And how might you structure something 
differently to try this time?
    Mr. Everson. We do have authorization and are actively 
proceeding to have private collection agencies assist with a 
portion of our collections portfolio. So that was passed by the 
Congress sometime ago, and now we are moving to implement that.
    The experience that you reference in the 1990s we all agree 
was not handled correctly. It was not planned for adequately, 
and I think the lessons learned in terms of the selection of 
the inventory, some of it was very old inventory, and other 
things that needed to be followed up on, we have taken that 
into account in the planning, which has been very careful in 
this area. We have a contract procurement out there right now 
that is going to identify the initial tranche of suppliers 
here.
    I want to emphasize--I am sure you will hear from my friend 
Colleen, and occasionally she disagrees with some of the things 
I say--that this work should be done by government employees. 
You give me a blank check, we will have the government 
employees do that. But we never get the funding that we ask. 
And even if we get the full funding the President has asked 
for, it is not going to cover all of our employee needs because 
you passed a pay raise that is in excess of what is in the 
budget.
    So very tough for us to get enough people to do the work 
that Colleen would want us to do. We are supplementing her 
members' efforts, if you will, through this effort. We are 
going to do it responsibly.
    Senator Carper. Do you have a mechanism for getting ideas, 
deriving good ideas, encouraging your employees to provide good 
ideas to increase colleagues as a way to incentivize that?
    Mr. Everson. We get ideas all the time from lots of people. 
I get e-mails every day from my folks. Colleen gives me ideas 
once a month, I would say, when she comes to see me. So I don't 
think there is a shortage of good ideas that come in to us. But 
we are a conservative organization. One of the things I have 
been trying to do is get it to be more speedy and more agile 
because by its nature and through experiences like the 1990s, 
it is very slow to change. I think it needs to change more 
rapidly and accept more ideas.
    Senator Carper. Thanks very much.
    Senator Coburn. Let me clarify something. Your entire 
increase in budget this year will be consumed with payroll 
increases for present employees?
    Mr. Everson. No, I did not suggest that, sir. What I am 
saying is when we get an increase, we have asked for an 
increase that will--it is almost $500 million. But even if we 
get all that, we will not deliver as many employees into the 
system because over 70 percent of our costs, our payroll costs, 
are benefits.
    Senator Coburn. Thank you for clarifying that.
    I am happy to recognize the Senator from Hawaii. We will go 
in order of appearance, and we note that Senator Levin has 
joined us, and we welcome him. Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Commissioner, the earned income tax credit returns comprise 
48 percent of audits while EITC over-claims make up only an 
estimated 4 percent of the overall tax gap. Do you believe low-
income taxpayers are being targeted disproportionately in 
enforcement actions?
    Mr. Everson. I do not share that view, Senator. I think you 
know that there is a long history, including separation 
appropriations for the earned income tax credit, not in effect 
now but that were set up because of the high error rate within 
that particular population.
    As you probably know, under my tenure we have made the 
centerpiece of our work going after high-income and corporate 
problems, which this Subcommittee, and the Permanent 
Subcommittee, has been very aggressive in supporting. So I 
think that we are definitely working to increase the other 
areas.
    Now, in terms of EITC, we are absolutely committed to both 
increasing participation in the program, which has a higher 
percentage participation of those who are eligible than food 
stamps and other benefit programs, we are still not satisfied 
with the 70 or 80 percent that it is. We want to get it up 
further than that. But we also want to make sure that the 
relatively high error rate--it is much higher than other 
benefit programs--comes down. It is higher because unlike food 
stamps or rental subsidies, there is no front end to that 
process. You take that on the return. You do not come in and 
apply and go through some screening process earlier.
    So what we have done over the last couple of years, we have 
steered what I think is a sensible middle ground on this. We 
have worked with a lot of people to try and improve our 
notices. We have done a lot of testing and certification, and I 
think we are going to make some real progress in this area, but 
no, we do not target that group. I think that Senator Levin 
would agree that, if anything, in the last couple of years we 
have targeted people, and we have targeted the attorneys and 
the accountants who have been out there peddling abusive 
shelters.
    Senator Akaka. Well, I thank you for that. That was just 
for the record.
    Mr. Everson. OK.
    Senator Akaka. Does the IRS need additional statutory 
authority or resources to improve the quality of tax 
preparation services that are available to low-income 
taxpayers?
    Mr. Everson. The money is always an issue, as we have 
indicated. Now, what I have said, though, is I have not taken a 
position favoring this regulatory authority, expanding our 
reach, if you will, to include all tax preparers. Where there 
is fraud and where there is abuse of the taxpayers, I do not 
think by our registering them that that will get after that. 
People who want to help others prepare fraudulent returns, they 
are going to--they may not even register. They will not even 
show up. We have got so much to do. I am not in favor of 
expanding our duties at this time. I am not suggesting never, 
but I do not believe in that proposal right now.
    Senator Akaka. Well, I like your thoughts about eventually 
getting to a point where it is balanced, and it is something to 
seek, and I hope we can continue moving in that direction.
    As I indicated in my statement, I believe the true size of 
the tax gap may be larger than we are currently aware of due to 
the unknown use and prevalence of corporate or business-owned 
life insurance. And I did mention it and use business and 
corporate companies, too.
    What steps should be taken to increase the awareness of the 
number and use of these policies and to ensure that the tax 
advantages of life insurance are not being abused?
    Mr. Everson. Senator, I am going to take the Fifth here 
based on the Chairman's quite clear statement that this is not 
a tax policy hearing. Our inquiries into this area have not 
indicated compliance problems. The corporate-owned life 
insurance, COLI, that the IRS dealt with and that Congress 
dealt with, that was a compliance issue, and then also 
statutory steps were taken.
    As we have looked at what you have talked about and what 
GAO has spoken to, we have not, on the basis of our inquiries, 
concluded that what is happening is at variance with the Code. 
So it would not be in the tax gap. Sure enough, the Congress 
could take actions to generate that revenue if it wished. But 
from my point of view, I do not consider it a compliance issue.
    Senator Akaka. Finally, you mentioned privatization of 
collections. What safeguards will there be to ensure privacy? 
And how will the training of contractors differ from career 
employees?
    Mr. Everson. Sir, we are taking our responsibilities in 
this regard very seriously. The scrutiny, first, of the firms 
that can actually be eligible to secure the work, they have to 
have been on a GSA schedule for having done other appropriate 
government work, and we will be applying the same standards 
that our employees have to follow in regards to taxpayer 
privacy and the kinds of questions they can ask to the 
contractors. They will not be dealt with in a separate 
standard. It will be the same standard.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Senator Coburn. Thank you.
    I would want both our panelists and our Members to know we 
have five stacked votes at 4:15. That will necessitate us 
changing the order of our witnesses, and the reason we will do 
that is we have witnesses from out of town. We will schedule a 
follow-up hearing for what was our second panel of witnesses 
for an individual hearing on their testimony--I have the 
concurrence of my Ranking Member in that--so that we do not 
keep you sitting here until 7 o'clock, because that is how long 
it is going to take us to do those five stacked votes. And I do 
not think any of you want to be here that long.
    So I would recognize Madam Chairman of our full Committee, 
and I also would tell you that I have to be in the Chair in the 
Senate at 4 o'clock. So I will be leaving. Senator Carper will 
be taking over as Chairman of the hearing, and we will finish 
it up with our guest from Georgia and others, and then we will 
reschedule what was the second panel. And you have my 
apologies. We do not control the floor.
    Madam Chairman.
    Chairman Collins. Thank you, Mr. Chairman.
    Commissioner, you have stated in your testimony today that 
the tax gap arises in part from noncompliance due to the 
complexity of our tax laws, and that can result not in 
cheating, which obviously is a huge issue, but in a lack of 
understanding that leads to noncompliance.
    In recent years, the IRS has decreased by 50 percent the 
number of taxpayer assistance centers in my State from ten to 
five, and earlier this year, the IRS proposed the closure of a 
number of Senators across the Nation, including two more in 
Maine. And I want to commend you and thank you for responding 
to the concerns that a number of us expressed to you about what 
the impact would be.
    But that is an area where spending money may well save you 
money. It seems to me that encouraging taxpayers with questions 
to come to these centers to seek help may, in fact, increase 
compliance.
    Going forward, what are your plans as far as assisting 
taxpayers with compliance? I am talking about the honest but 
overwhelmed or confused taxpayers.
    Mr. Everson. We are constantly assessing our services. If 
you look at what we have done in recent years, including under 
my tenure--some have suggested that I have been so pro-
enforcement I have been out to decrease services. Not the case. 
As a whole, we have increased services, continued to do that. 
What we face, though, is difficult choices. When the President 
submitted the budget request for this year, he gave us, as we 
have discussed, a large augmentation on the enforcement side. 
But he looked at the services and said, We are going to ask you 
to take the same 1-percent cut that other non-Homeland, non-DOD 
discretionary programs were taking.
    I felt that was a reasonable thing to do, and that is the 
context in which we made the choices where we continued to 
invest on phone services, improving our tax law accuracy there, 
our services for electronic filing and other things. So it is 
not that we are against the walk-in centers. Hardly. But we are 
faced with choices as to within limitations, budgetary 
limitations what we think are the highest impact. The walk-in 
centers are the most costly. The footprint, if you will, was 
largely still associated with the Midwest and the East Coast, 
where you had the historic centers of the population. The 
country had moved. So if you went back and did a study of this 
right now and said if you wanted to stick with all these 
centers, where would you put them, you wouldn't put them in a 
lot of places where they are, some sort of relative ordering.
    That having been said, I got the message. Both the 
appropriations bills said stand down on a tax. As you know, we 
have done that. Now, that is going to cause other issues on 
services as we go forward because we are constantly having to 
squeeze our money. So I don't want anybody to think that this 
is an issue that won't arise again as we continually try--and 
GAO, they were the ones who said you ought to be assessing your 
services against your finite resources and constantly upgrading 
the mix, if you will, or addressing the mix. So that is all we 
are trying to do.
    Chairman Collins. I just think that, as you said earlier, 
sometimes when you spend money, you actually save money, and 
this may be one of them.
    I was struck by the chart that you put up earlier that 
shows the exhibit and flow of audits, if you will.
    Mr. Everson. Yes.
    Chairman Collins. The huge drop in the 1990s, the increase 
now, which have brought in more revenues. It would be helpful 
to put it up.
    I think that this probably reflects the pressures from 
Congress on the IRS. I suspect that this is our fault, not the 
IRS' fault. And the reason I believe this is when I look at the 
dates, it seems to me that they coincide with high-profile 
hearings that were held by the Congress looking at abuses--and 
there were undoubtedly some real ones, but also there were 
probably some that were exaggerated--in the audit process.
    I remember many years ago when I was a staffer for this 
Subcommittee, Senator Levin and my old boss, Senator Cohen, 
having hearings berating the IRS--I will say Senator Cohen 
berated the IRS--for being too hard on small businesses that 
had run into tax difficulty.
    How do we strike the right balance between ensuring that we 
have an aggressive, well-funded, but fair system of audits and 
how do we reach that and not have these peaks and valleys that 
are attributable to whether or not Members of Congress can find 
some horror stories, some legitimate abuses, but that 
undermines the overall effort to close this gap?
    Mr. Everson. I think that is an excellent question. People 
often ask me--I have been on the job about 2\1/2\ years now, 
and they say, ``What is the principal change or achievement?'' 
or whatever. I think that what we have done in the last couple 
years is there is a broad recognition up here now out in the 
taxpaying public that you have to do both, service--the 
formula, we say it is service plus enforcement equals 
compliance. And I think that what we have done is we have 
changed the dialogue here. It is a more intelligent dialogue. A 
lot of it, as the Chairman was saying, it has got to be data-
driven to do better on making some of our decisions. But I 
think the philosophy is now relatively better set.
    Let me just say to you one thing, if I can, about this 
balance. I think we are doing that job now. The oversight board 
just released its annual report, and let me just quote what the 
Chairman said: ``The results we have seen over the past year 
demonstrate that it is possible to achieve balance between 
customer service and enforcement and be successful in both 
areas.'' We are doing that.
    Now, we are having discussions, arguments about tax or some 
other areas, but I think, by and large, we have gotten on to 
this with the help of this Subcommittee. You mentioned the 
levies, the Federal levies that you and Senator Levin have been 
selective in. I talked about the shelters where what happened 
with KPMG would not have happened but for the congressional 
oversight, frankly, very instrumental.
    I think the enforcement is not being short-changed. If we 
can augment that now with the money the President has asked 
for, look at some things--there may be a need for more 
reporting. As I indicated in my opening statement, we are not 
going to give up on the service side. I do not want you to 
think we are.
    Chairman Collins. Thank you very much.
    Senator Coburn. Senator Levin, welcome.

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Thank you, and thank you, Mr. Chairman and 
Senator Carper, for these hearings. Thank you, Commissioner, 
for the good work of the IRS. You have been doing tremendous 
work in terms of enforcement. I applaud you on it. And you very 
properly give credit to an oversight Subcommittee which really, 
I think, led to a real important change in the environment and 
atmosphere when it comes to peddling tax shelters and going 
after those who have evaded and avoided the law with abusive 
shelters, such as KPMG. I want to thank you for that. These 
people who avoid paying taxes are insulting the men and women 
who serve our country in uniform. They are insulting taxpayers 
who pay their fair share. We all pay a price for that big 
figure you have got up there of the gap that exists between 
money that is owed to the IRS or the Treasury and that which is 
paid.
    And now we have to continue to put the pressure on people 
who avoid taxes, who cheat on their taxes, who dodge paying 
their taxes. I do remember, as our Chairman does, the days when 
we went after the IRS for IRS abuses. There were some. We 
passed the Taxpayer Bill of Rights. We were proud to have 
participated in that. We think it made some important changes. 
But now we are focusing on this gap, and it is a huge gap. And 
one of the areas that we focused on on the oversight 
Subcommittee, which is called PSI, Permanent Subcommittee on 
Investigations, one of the areas of the tax gap are these 
abusive tax shelters, which we have gone after. And the IRS is 
now really going after the people who peddle those tax 
shelters, and there are a lot outstanding. Eighteen hundred 
individuals bought the one tax shelter that we identified as 
BLIPs, which was one of the Sons of Boss. Apparently now a 
majority have agreed to pay the IRS what they owe. The IRS has 
collected over $3.5 billion so far this year, tracking down 
hundreds of taxpayers who have refused to settle. It shows just 
how big this tax shelter problem is, and I want to talk about a 
bill which has been introduced by Senator Coleman and myself.
    It is a bill which would put some greater teeth into the 
collection effort relative to tax shelters and tax havens. One 
of the things it would do is require an economic substance for 
transactions in order to be eligible for tax benefits. This is 
something that Senator Baucus and Senator Grassley very 
strongly support. They have taken a lead on it in the Finance 
Committee to make sure there is economic substance in 
transactions before people can claim tax deductions for losses.
    This chart we have up there is one of the Sons of Boss 
which showed the kind of convoluted efforts which were made, 
and that is a simplified chart.
    Mr. Everson. I know.
    Senator Levin. You have seen worse and I have seen worse, 
and we spent months and years going after KPMG and the others 
who perpetrated these kinds of convoluted, phony transactions 
in order to create tax losses.
    But one of the things we have got to do is increase 
penalties on people who promote abusive tax shelters or who 
knowingly aid and abet taxpayers to use them. And right now, 
while we have taken some action to increase penalties relative 
to promoters of tax shelters, when it comes to people who aid 
and abet--and this can be the lawyers who write the tax 
shelters or it can be the banks who finance them--we still have 
a minute penalty so that people calculate what their exposure 
is. And if their exposure is a maximum of a $10,000 fine and 
you are making millions of dollars writing phony tax shelters--
we have the e-mails where it says, ``We can take this risk. We 
could be out a maximum of $10,000, but we are making millions 
writing these letters.''
    And so one of the things our bill does, in the Levin-
Coleman bill, is we increase penalties for people who aid and 
abet taxpayers to understate their tax liability. Promoters now 
have to disgorge only half of their ill-gotten gains. So even a 
promoter who makes $10 million by promoting an abusive tax 
shelter, which the IRS goes after and collects on, the promoter 
only has to disgorge half the fees. The aider and abettor is 
maximally exposed to $10,000. And we have got to do better on 
both. There is no reason why someone who promotes an abusive 
tax shelter where the taxpayer has to come and pay the taxes 
plus a penalty, plus interest, while the promoter of that tax 
shelter should be able to keep half of his ill-gotten wealth or 
fee. And there is no reason in my book why the aider and 
abettor should be able to get by with a $10,000 fine.
    So one of the things our bill does is we up those fines 
again. We succeeded in increasing the penalty for the promoter 
to 50 percent in the bill which was referred to by the 
Commissioner in his testimony. But we can do better than that, 
and we should do better than that. He should disgorge all of 
the ill-gotten gain, not just half of it, and not just be 
exposed to a $10,000 fine in the case of aiders and abettors, 
which typically are lawyers and bankers.
    I have 30 seconds left, and I will ask you to comment about 
one other point, and that is the tax havens. We have a huge 
problem with tax havens in this country, and our bill, the 
Levin-Coleman bill, goes after the uncooperative tax havens by 
authorizing the Treasury to publish the annual list of 
uncooperative tax havens and ending the tax benefits of using 
an uncooperative tax haven. We would end the tax benefits--if 
you use the tax haven, put your funds in a tax haven, we would 
not under our bill allow you to have any tax benefit from that 
if it is on the Treasury annual list of a country which does 
not cooperate with us in the transparency which--is this the 
Chairman's chart? Forgive me. I missed this. But it is No. 1 on 
the Chairman's chart of accountability. It may be the Ranking 
Member's chart, too. I do not mean to exclude either one of 
you.
    So we have to crack down on the misuse of tax havens, and 
our bill does it, and we do it clean, too. Treasury, come up 
with your list, and you cannot take a tax benefit for putting 
your money on that tax haven if it is on the uncooperative tax 
haven list.
    I am out of time, but I would hope if you could take 
perhaps a minute to indicate that, while you may not be able to 
support every provision of the bill, in general you are 
supportive of both the effort to go after and to help you go 
after even more so--and you have done a great job of going 
after tax shelter abuses, but even more so to give you the 
tools to go after both the tax shelter abuses and the tax 
havens which are abused.
    Mr. Everson. Thank you, and thank you very much for your 
personal leadership on this issue, Senator. In the numerous 
conversations we have had, I think that we have enjoyed a very 
close relationship with the Subcommittee, and it has made a 
difference.
    Let me say this: I think the JOBS Act has made very real 
improvements to the regulatory scheme here. We agree entirely 
with you that the penalties were too low. They needed 
adjustment. I am not sure yet where they need to head to or 
whether what has been put in place will fully dampen what has 
happened. I do know that the changes, like making the material 
adviser subject to much higher liabilities, I know--I was up in 
New York speaking to international bankers in June. This has 
their attention. Non-funding of a loan and just sending it 
around a paper mill for a couple of hours, you do that now, you 
are subject to some fines and some reputational risk and a 
bunch of other things. I think that, the strengthening of our 
Office of Professional Responsibility, which was provided all 
these things, combined with the criminal actions that the 
Southern District has taken, are having a very big impact.
    I do support strong penalties. I cannot tell you with 
certainty how far they ought to go. I do know that there is a 
new world out there right now through the combination of our 
augmented activities, the fact that for the first time criminal 
prosecutions are being brought in areas of complex abuse, which 
we had not seen those happening before, and the changes that 
the Congress has made, largely through your efforts.
    So we, of course, support those new tools.
    Senator Coburn. We want to thank you again for being here.
    Senator Carper. We do not have time to ask this question 
and get your answer, but one of the questions that I should 
have asked before, I want to ask you for the record. It is sort 
of a laundry list of things that we can do to further 
strengthen your ability and that of the employees you lead to 
collect the monies that are owed.
    Mr. Everson. Make sure that money that is in the Senate 
bill is protected, even from those spending cut hawks that 
might be on the Committee.
    Senator Coburn. We have them, Commissioner. [Laughter.]
    Mr. Everson. Thank you.
    Senator Coburn. Our next panel, as we said--we will be 
going out of order--is Bart Graham, the Commissioner of the 
Georgia State Department of Revenue, where he has contributed 
greatly to Georgia's successful collection of nearly $173 
million owed in tax dollars from 2003 to 2005, and Colleen 
Kelley, who is the President of the National Treasury Employees 
Union, the Nation's largest independent Federal sector union.
    I would also want to apologize to our guests. I will be 
leaving in the next 5 minutes. I have read your testimony. We 
will be submitting questions to you, and Ranking Member Carper 
will take over the gavel, as I leave.
    Thank you. And you are recognized, Mr. Graham.

     TESTIMONY OF BART L. GRAHAM,\1\ COMMISSIONER, GEORGIA 
                     DEPARTMENT OF REVENUE

    Mr. Graham. Thank you very much, Mr. Chairman and Members 
of the Subcommittee. Thank you for allowing me the opportunity 
to discuss the initiatives we have begun in Georgia to collect 
in excess of $1.6 billion in past-due taxes that have 
accumulated over the last 15 years in Georgia. Even at the 
State level, tax evasion, fraud, and aggressive practices of 
tax professionals have a substantial impact on State services 
and the request from the Federal Government for continued help. 
We see the same thing at the local county level as well.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Graham appears in the Appendix on 
page 49.
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    In order to better understand how I came to this role, I 
want you to understand that I am not a career public servant. I 
did not work on Governor Perdue's campaign. I am an appointed 
official, and I did not give his campaign any money. And I 
think that has contributed to our perception of being 
nonpartisan in our approach to addressing this $1.6 billion 
pass-through initiative.
    My background is in capital markets and corporate banking, 
and I also spent 7 years as a chief financial officer of 
various companies, which, again, aided my ability to see and 
address the problem in the department because we had 
substantial tax practice, but we did not have a great 
understanding in the department with how the banking system 
works and how people are laundering money into the Greek 
Islands and to the Caribbean, as you mentioned, and some of the 
other tax shelters and schemes that go on.
    The way we came out identifying the problem, $1.6 billion, 
I asked early on, as a CFO would ask, What are our assets like? 
What are our past due's? And when it took them 3 weeks to 
accumulate that, I knew it was going to be a problem. And it 
took me a while to convince the Administration that it really 
was $1.6 billion, not just $1 million. It was a million 
accounts that had accumulated that.
    In order to address the problem, we also felt like we had 
to have accountability within the department, dual 
accountability, dual authorizations. We instituted some of the 
provisions you find in the Sarbanes-Oxley Act where we have 
dual accountability, rotation of auditors within the 
department. Even things that I would sign have to be vetted 
through other people in the department so they understand what 
we are doing.
    This also required a cultural shift within the department. 
The goal was to collect the correct amount of money from the 
correct obligated taxpayers, not how much money we could 
collect. We were not trying to solve a budget problem. Even 
though Georgia was faced with over a $700 million deficit, that 
was not the objective, because I determined over the process 
that there is plenty of money there to collect, and if we do so 
fairly and equitably, most of the budget problems that Georgia 
faced would be taken care of in the process. And we have been 
able to bear most of that out.
    Part of the cultural shift that we had to identify and 
change was there was a strategy of help us get $5 million more 
in appropriated money and we will collect $50 million.
    Well, to me I saw it as too easy given my background and 
knowing how to put pressure on people to do the right thing who 
have passed on their opportunities for customer service. I said 
we are going to go out and we are going to collect $100 million 
with what we have and then ask for help to enhance the system 
going forward from there. And, again, the accountability had to 
be there within the department so we did not get a reputation 
for being overzealous in our approach.
    The other thing I heard from management on a repeated basis 
was we do not have enough time, money, or people to do our job. 
What happened was we were giving our best customer service to 
the worst delinquents in the State because we would meet with 
them four and five times or six times. Meanwhile, the people 
who were trying to be honest, trying to get help, were not 
getting any help from anybody. And the phone would ring 
constantly, and nobody would answer. So we made measures to 
change that.
    We found ways to execute strategies that would make 
taxpayers accountable for themselves, and in some cases, we 
established strategies that actually pit industry groups 
against each other, that they have skin in the game in what we 
are doing so that if they deliver a product--say in the alcohol 
industry a distributor delivers product to an unlicensed 
retailer, then I am going to go after the distributor who is 
doing business illegally in Georgia. And that makes people 
highly cooperative when you start interfering with their cash 
flow stream.
    As I believe you--and I know you have heard now from 
Commissioner Everson that penalties, fines, and prosecutions 
simply are not strong enough in Georgia and we are moving to 
improve that.
    We are trying to change the curve of enforcement from the 
overzealousness of the past of doing something like this on the 
very front end of enforcement or just going negative, like you 
have seen in the audit records you had here, is to start out 
with customer service, make sure we treated people fairly, make 
sure they have the opportunity to do the right thing. And then 
if they pass that opportunity, then we escalate the 
enforcement.
    Part of that dual accountability is looking at revenue 
employees of yours, make sure they are filing. When I got to 
the department, employees were checked, but if they left the 
department and came back, they were not re-checked. We found an 
indicted felon on our staff who had embezzled $100,000 from two 
different banks, and one of our friends in the private sector 
called me and said, ``Congratulations.'' Well, we took care of 
that, and we started re-screening everybody. Well, once we did 
that, other State agencies said we want to know if our 
employees are complying.
    In that process, we found State legislators, judges, and 
others who were not complying, and, again, if you make it 
public, once it becomes a public record and you show people 
what you are doing about it, you get support for it. And people 
want that fairness and equity in the system as long as you hold 
yourselves accountable for it.
    I know we are pressed for time, so I am going to move on to 
how we actually addressed dealing with the $1.6 billion.
    We decided to implement a four-phase plan that would, first 
and foremost, address the individual taxpayer. We participate 
greatly in the Treasury Offset Program with the IRS, and it is 
a very successful venue for us, and we want to continue to see 
that grow. We are currently in the process of increasing the 
use of withholding tax offsets. And one of the things we do 
with our work in private collection agencies is we have 
shortened the length of time that it takes us to get paper to 
the agencies. They now get paper within 185 days. Before, it 
was nearly 500 days. Part of what they get in Georgia is only a 
tax lien, which is a public record. So we are protecting the 
confidentiality of the tax return. Collection agencies are not 
seeing a return. They are just seeing the delinquency that is a 
public filing.
    We also have a 20-percent premium penalty that is added to 
that paper which is turned over to the agencies, and they are 
paid out of that 20 percent. We do not take a discount to what 
the tax obligation, penalty, or interest is in that process.
    We meet with the collection agencies twice a year to re-
emphasize the need and requirement to keep people from being 
overzealous. Any investigations are investigated, and any 
rampant abuse and the agency would be terminated. Since we 
ramped up this procedure approximately 20 months ago, I have 
gotten exactly four complaints. Two were people who never lived 
in Georgia, and the other two we resolved without having to 
terminate the agency that was involved. And we have 4.5 million 
taxpayers in Georgia, and, again, I personally meet with the 
collection agencies as a group in those two meetings to re-
emphasize the way we are going to do business and protect that 
confidentiality and that we are not going to have abusive 
treatment of taxpayers.
    Our second focus was on trust taxes, the sales and use and 
withholding taxes. That is one of the biggest abuses in 
Georgia. I firmly believe that 10 to 12 percent of trust taxes 
are misappropriated illegally in Georgia, and we have numerous 
cases that I can document. My own father, who is not a tax 
professional, identified two Fortune 500 companies doing 
business in Georgia that had established nexus and were doing a 
mail order business and not paying sales tax appropriately. One 
of them recently settled for $600,000, plus an agreement to 
comply going forward, as did the other one. So, again, the 
issue of nonperformance is staggering.
    Phase III of the plan was to accelerate delinquent income 
tax investigations, creation of an internal call center to give 
the customer service level there so people have the opportunity 
to bail out of a collection process and take care of their 
obligations. We also recently hired 15, first time ever, out-
of-state auditors to go after aggressive tax planning 
strategies that arise out of State.
    The results to date include over $173 million of collected 
money from the $1.6 billion that had accrued on the system. We 
have roughly worked 75 percent of that list, and due to death 
and bankruptcies and some overestimations of what we thought 
the delinquency was, we have now removed the rest of that 
obligation. So part of this was a management exercise that we 
also wanted to update our books and records so that we did not 
have that overhanging account receivable there if it was not 
legitimate for the long-term future.
    Again, of that $173 million, one of the most successful 
ventures was private collection agencies, and the first most 
beneficial is the Treasury Offset Program that is phenomenal in 
our working relationships. One piece of legislation that I 
think would be helpful to all sides of the parties involved is 
the ability to exchange records on non-residents. People who 
formerly lived in Georgia, who have an obligation to Georgia, 
now relocated, we are not allowed to exchange that information 
with the IRS. And we are constantly looking for ways to enhance 
our relationships with not only other States but also with the 
IRS, because if people see that you will treat them fairly and 
give them an opportunity to solve their problem, and then if 
they pass on that, then they are going to put pressure on other 
people to comply because people do not want to get on our list.
    We also in the past year started posting delinquencies on 
the Internet, and people have to work hard to get on that list. 
We do not put them all up there because it would be--the amount 
of data it would take would be staggering. But there are 
400,000 individuals and roughly 15,000 businesses and corporate 
officers that are up there, and that, too, as you will see from 
our record, that has collected almost $19 million in the 18 
months that it has been in process.
    I will close with some of the essentials of success, and 
that is, the transparency that you have on your priority 
screen, that people see that people are being held accountable, 
but we are very careful to protect confidentiality. Our 
confidentiality laws in Georgia are some of the most stringent 
in the country, so that collection agencies only see records 
that are publicly filed liens. So the accountability is back on 
the department. If we give a bad lien to a collection agency 
that then is pursued and is in a courthouse, it is not the 
collection agency's fault. It is our fault. And I am happy to 
take that burden.
    Again, we also have to treat everybody fairly and 
equitably, and we are quick to release any information where 
our employees have done something wrong or we have had to 
terminate employees or prosecute employees for tax evasion or 
tax problems. Our goal at the end of the day is to deal with 
taxpayers fewer numbers of times for less amount of times and 
have them going away feeling with the minimum belief that they 
have received a fair opportunity, received what they wanted.
    One last thing on the collection effort that we have seen 
is one of the biggest abuses we see in Georgia is refund fraud, 
and those are folks claiming head of household and claiming 
ineligible dependents. That, unfortunately, often centers on 
low-income people claiming dependents that are not theirs. If 
they can find a single parent with children and the parent is 
not working--and we got on to this last year when someone 
called because somebody did not honor it, and it was an 
employee that was taking the head-of-household deduction and 
claiming that someone else had kids and they did not pay off as 
the deal was struck. So we looked throughout the department, 
and we terminated 15 people in our own department doing that. 
We stopped over $2 million in refund fraud just on head-of-
household claims being filed with ineligible dependents. And it 
is not just the education of the taxpayer not knowing how to 
file a return. They are going to tax preparers who are saying, 
Here is your tax return, they do not review it or have the 
capacity to review it, and the preparer is making fake W-2s and 
claiming fake dependents. They are finding a real lot of 
people. In one case, we stopped in Columbus, Georgia, and the 
taxpayer's office, they had the entire school list in the 
public schools in Muscogee County with every parent's Social 
Security number and every student's Social Security number. And 
the guy was just sitting there hitting the ``Send'' button on a 
daily basis.
    I want to thank you again for letting me appear today. For 
me personally this is a very special opportunity to share with 
you what we are doing in Georgia. Obviously, I can have all the 
vision and strategy and determination I want in doing this, but 
if it was not for the employees of the department pursuing what 
we are trying to accomplish, it would not happen. And I am 
pleased to take any questions and appear in the future if you 
can find any help from us.
    Senator Carper [presiding]. Great. What you have provided 
already has been a lot of help and, frankly, a source of 
inspiration. We commend the team that you lead, and we are 
delighted that you are here to present this testimony to us 
today.
    And the same is true of Colleen Kelley. Welcome. We are 
delighted to see you, and thank you for joining us and being 
willing to move up to serve on the second panel here and 
present your testimony, and a little bit later, I want to 
foster a dialogue between the three of us, and whoever else 
might rejoin us, and talk about some of the things that we have 
been raising.
    Ms. Kelley, you are welcome to submit your entire statement 
for the record or just proceed orally, however you prefer.
    Ms. Kelley. I would like to make some oral statement, 
Senator, if I could.
    Senator Carper. Welcome.

TESTIMONY OF COLLEEN M. KELLEY,\1\ NATIONAL PRESIDENT, NATIONAL 
                    TREASURY EMPLOYEES UNION

    Ms. Kelley. Thank you. I very much appreciate the 
opportunity to be here on behalf of the 150,000 Federal 
employees and 30 agencies represented by NTEU, and that 
includes the men and women of the IRS who do the work of the 
IRS every day.
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    \1\ The prepared statement of Ms. Kelley appears in the Appendix on 
page 69.
---------------------------------------------------------------------------
    The IRS needs more Federal employees on the front lines of 
tax compliance and enforcement in order to help close the tax 
gap. As Congress considers ways to cut the growing Federal 
deficit, I urge you to avoid any across-the-board cuts for the 
IRS.
    While the IRS workload has increased by 16 percent based on 
increases in tax returns filed, the number of employees has 
decreased by 16 percent, and that is just between 1999 and 
2002. The combined collection and exam employees, which do all 
the enforcement work of the IRS, has declined by 36 percent 
since 1996.
    NTEU agrees with the IRS' goal of enhancing tax compliance 
and enforcement, but we do not agree with the approach of 
eliminating front-line customer service employees in order to 
pay for the additional complaint efforts. There needs to be 
funding for both.
    Congress has agreed with NTEU that the IRS should not close 
the Taxpayer Assistance Centers, the TACs, as we heard in the 
prior conversation. And the IRS should not be allowed to slash 
customer service this year or next year, or in years after 
that, for the sake of bolstering enforcement. Again, the 
funding is needed for all of these efforts.
    NTEU also supports GAO's recent tax gap report that a more 
regular compliance assessment is needed if the IRS wishes to 
obtain a clearer picture of the extent of the tax gap. But I 
would emphasize that the IRS must determine those factors which 
encourage and enable taxpayers to voluntarily comply, as well 
as determine reasons for noncompliance.
    NTEU strongly opposes the Administration's plan to 
privatize the IRS tax debt collection, which was authorized by 
the American Jobs Creation Act of 2004, and we are going to 
continue to work towards its repeal. Under that statute, the 
IRS is permitted to hire, as we have heard, private sector debt 
collectors and to pay them a bounty of up to 25 percent of what 
they collect. The IRS' proposal would risk the loss of 
confidentiality of millions of taxpayers' private information, 
which provide incentives for the use of abusive tactics by 
private debt collectors, and it would cost U.S. citizens much 
more money than if IRS employees did this work. The 2-year 
pilot that was referred to earlier was so unsuccessful that it 
was canceled after 1 year. And while there were lessons learned 
from that, I think too often there is not enough of a focus on 
why that failed and why it does not make any sense to move 
forward with this.
    The IRS does point to State tax revenue agencies that have 
contracted out collection work to demonstrate successful 
privatization of tax collection work, and surely we have just 
heard of some of that work from Mr. Graham in Georgia. However, 
States have also faced many problems with private collection 
agencies--or PCAs, as they are called. Just last year, the Ohio 
Attorney General's office canceled the debt collection contract 
with a PCA due to its mishandling of Social Security numbers 
and private taxpayer information. A similar contract was 
canceled with a PCA in Montana this past summer due to numerous 
complaints of rudeness by the PCA employees that were filed by 
Montana residents.
    According to GAO's May 2003 testimony before the House 
Transportation, Treasury Appropriations Subcommittee, one major 
concern the IRS must address prior to implementing any tax 
collection outsourcing is its ability to identify what they 
call delinquent debts with the highest probability of 
resolution through PCA contracts. However, as NTEU understands 
it, systems being developed are supposed to predict which cases 
are most appropriate to turn over to the PCAs, and those 
systems will not be available until 2011, long after when the 
cases are supposed to be put in the hands of these PCAs.
    Furthermore, the IRS does not have the technology in place 
to ensure that taxpayer information is kept secure and 
confidential when it is handed over to the PCAs. In March 2004, 
TIGTA noted that the IRS is still unable to oversee its 
contractors and ensure that sensitive taxpayer data is secure, 
and I quote that TIGTA report. It says, ``Contractor personnel 
assigned to an IRS modernization project committed numerous 
security violations that placed IRS equipment and taxpayer data 
at risk. In some cases, contractors blatantly circumvented IRS 
policies and procedures, even when security personnel 
identified inappropriate practices.''
    If those revenues that are collected by the PCAs could be 
dedicated directly to contract payments and IRS enforcement 
efforts, there is absolutely no reason that some small portion 
of other revenues collected by the IRS could not be dedicated 
to IRS enforcement efforts. This would allow for increased 
enforcement by IRS employees, which most in Congress indicate 
is the preferable route and would eliminate the large bounty 
payments to PCAs and significantly increase the net revenue to 
the general treasury. Front-line IRS employees are the best 
defense against an increasing U.S. tax gap, but front-line 
staffing has dropped dramatically, even while the number of 
managers within the IRS has grown, and this trend must be 
addressed.
    I thank you very much for holding this important hearing 
today, and NTEU supports and offers assistance in your mission 
to shrink the U.S. tax gap. Thank you.
    Senator Carper. Ms. Kelley, thank you so much.
    Go back, if you will, to the 1990s, the late 1990s, a 
period of time when there were fairly extensive hearings 
underway. I remember talking with employees of the IRS in my 
own State, in Delaware, who felt dispirited, almost demonized, 
because of the allegations and assertions that were sort of 
thrown at the IRS in general, and they felt, personally, at 
them. And I am going to ask you just to revisit with us what 
was going on then and how it affected the morale and maybe the 
productivity of Treasury employees and the IRS, and how in the 
roughly half-dozen or so years since then, are we seeing any 
recovery from that and return of spirit.
    Ms. Kelley. The impact on those hearings was really 
devastating to front-line IRS employees because they did feel 
as if they were being personally attacked, and they also knew 
that the allegations that were being made were not true. In the 
end, of course, they were proven to be untrue. When the 
headlines hit and the allegations were made, it was on page 1 
of newspapers across the country. When it was proven that the 
allegations were false in every case that was brought before 
the Congress----
    Senator Carper. It was every case, wasn't it?
    Ms. Kelley. It was every case.
    Senator Carper. Pretty amazing.
    Ms. Kelley. And when those allegations were proven to be 
untrue, that was not on page 1 of the newspapers. It was buried 
in page 37 somewhere, and no one saw it. But what everyone 
remembered----
    Senator Carper. I saw it.
    Ms. Kelley [continuing]. Were the accusations. I know you 
did, Senator Carper, but most did not see it.
    But what they saw were the accusations, and what IRS 
employees then saw was a severe restriction on their ability to 
do their job. In some ways, it was a legitimate reaction by the 
IRS to the actions of Congress, and in other ways, it was 
really an overreaction. And employees then saw a lot of the 
tools that they needed to do their job, the authorities they 
had taken away from them, which then resulted in a decrease in 
taxes collected, a decrease in examinations conducted. And 
there is a very direct correlation between those hearings and 
many of the results that you saw on the charts that 
Commissioner Everson used.
    Now, in addition to that, what happened after that was a 
reluctance on the part of Congress to fund the IRS because of 
those hearings, and there was a great decline in the funding 
that was provided to them, and that also resulted in----
    Senator Carper. Let me just ask you another question. Was 
it a reluctance on the part of Congress to appropriate funding, 
or was there also a reluctance on the part of the 
Administration to ask for it? Or was it both or was it one or 
the other?
    Ms. Kelley. I think it was a combination of both. It was a 
combination of both, definitely. But the numbers speak for 
themselves. The reality of what happened is that now there are, 
as I said in my testimony, 36 percent fewer employees doing 
enforcement work of the IRS when the number of tax returns have 
increased, depending on which time frame you look at, at least 
10 percent, if not 16 percent. And yet the employees, the 
number of employees have decreased.
    So employees feel that even today they still are not being 
given not only the authority but the support and the advice and 
the direction from the agency in order to be able to do their 
jobs. And they also know that they need more staffing because 
what they are experiencing today is--and I just met with 
leaders from across the country this morning, and we were 
talking about this. There is so much work that needs to be done 
in both collection and examination in the IRS, audits that need 
to be done and taxes that need to be collected. And because 
there are not enough employees, these employees have very large 
inventories that they are responsible for, and they are not 
making timely contacts to taxpayers, either for the examination 
or the collection end of it, because they have too much work 
assigned to them and there are too few employees.
    So I would say it continues to have a devastating effect, 
and the environment in which they find themselves is not one 
that helps them to do the best work they can or that they feel 
like they are getting support they need from a funding 
standpoint as well as from an agency standpoint.
    Senator Carper. All right. Thank you.
    Mr. Graham, you mentioned, I think, at one point in your 
testimony--I think I heard you say that you hired 15 out-of-
state auditors. Is that correct?
    Mr. Graham. That is correct.
    Senator Carper. Are those State of Georgia employees, or 
are they folks who you hired from the private sector? How does 
that work?
    Mr. Graham. Well, they become State of Georgia employees. 
The State of Florida has 75 auditors in Atlanta alone to help 
do their work, and they have a different tax platform because 
they do not have an income tax there.
    That is designed purely to target companies that are 
underreporting that are doing business in Georgia that are 
headquartered outside of the State. That is an area that has 
just been woefully absent. And what we were able to get the 
support from the General Assembly and the governor on is 
everybody sees the need for this greater enforcement, but we do 
not always just need to squeeze the last dollar out of somebody 
in Georgia, when these other out-of-state companies are doing 
business here.
    Like I said before, we are not trying to get every dollar 
of penalty we can get out of everybody. It sounds like to me 
some of the union's concern with the IRS proposal is really a 
structure of the program. The structure of the Georgia program 
would deal with some of their concerns, I think.
    Our approach in Georgia on the $1.6 billion is if we manage 
it correctly, it should be a one-time event, at least for a 
generation, before you have another anomaly that creates it. 
And we do not want to be in a position to have to terminate a 
lot of people. We do need people in examination and audit and 
other functions to make sure these programs run correctly and 
the call centers, in essence, so that taxpayers who do not want 
to go down the road of a collection agency have a chance to 
bail out and come back and do the right thing. So we are after 
behavioral change of people, having determined that the State 
of Georgia is their cheapest source of capital.
    Senator Carper. All right. Ms. Kelley mentioned several 
States. I think Montana was one.
    Ms. Kelley. Ohio.
    Senator Carper. Ohio was another, where the experience 
apparently with using private sector folks to do some of the 
debt collection has not been satisfactory. Let me just ask you 
to share with us your own experience in Georgia with private 
collections--I think you mentioned you have done some of that--
and some safeguards that--if the IRS is going to do this, some 
safeguard that we ought to have in place so that we do not 
replicate at the Federal level what may have been done in Ohio 
and Montana, and maybe some other places as well.
    Mr. Graham. I am not specifically familiar with how their 
programs work, but part of how we get to the check and balance 
is nothing goes to a collection agency without there already 
having been a lien filed in a courthouse somewhere in the 
State. That is what they get to pursue. They do not get the tax 
return. They do not get it just being delinquent. And we add--
once it goes, it gets an additional 20-percent cost of 
collection fee added to it, and the agencies are paid out of 
that fee. The State is not taking a reduction in the tax 
penalty and interest that was used to create the lien 
originally. So there is not a bounty. In the world of tax, if I 
were paid a commission for how much more I got, there is 
clearly a problem there, and there would be in this model as 
well. It is a fixed percentage of that 20 percent that each 
collection agency gets.
    Also, again, since it is a public record that goes to the 
collection agencies, if we make a mistake and they pursue 
someone who does not owe the money, it is our fault, not 
theirs. What we have to manage them for is abusive behavior. 
Again, we meet with them twice a year, and it has to be with 
the senior management of each of the agencies that are under 
contract, and I meet with them personally in that joint session 
to talk about what is working, what is not working, and we also 
follow up on every complaint that we get.
    I can document that in the 20 months since we ramped up 
this process, only four complaints have come to my office. All 
four have been investigated, and it did not necessitate 
removing an agency from the program.
    It does require a lot of time. It takes a lot of time on 
our folks' staff to make sure we have it right when we give the 
paper to them. That is where I want to put resources, because 
that is part of giving the taxpayer better service, is making 
sure we can answer their questions. We have a product line that 
nobody wants to buy, but we have to engage people with it.
    There was a study done in our department before I ever got 
there about closing all our field offices. Well, if you have a 
product line nobody wants to do business with you and you close 
the field offices, you are not going to find them again 
forever, and that is the end of it. You have to support that, 
at least some accessibility and openness in the process.
    Senator Carper. Thanks.
    Ms. Kelley, can you give us some insights as to what went 
wrong in Ohio and what went wrong in Montana and how that might 
guide the IRS if they are going to do this demonstration 
project on this private collection? How might those experiences 
guide us?
    Ms. Kelley. Well, in both of those situations, I, of 
course, have the same information as anyone who read the 
newspaper accounts. I do not have any of the inside 
information. But it was about confidentiality and disclosure of 
private taxpayer information and misuse of that information. 
And this is a huge risk when you put the kinds of information 
in the hands of anyone that the IRS is talking about putting in 
the hands of these PCAs.
    IRS employees are held accountable for enforcing the 
language in the legislation that Congress has passed on 
taxpayer rights, and they are held accountable and are at risk 
of losing their job if they do--and, of course, in addition to 
any kind of criminal proceedings. But if they lose their job, 
you are talking about IRS employees who--many of them are 
career employees. In the private collection agencies, the 
workforce in most of these agencies has an average tenure of 10 
months on the job. This is not a huge risk to tell someone that 
if they do something wrong, they are going to lose their job. 
It is a very different environment.
    IRS employees take this responsibility seriously. They know 
that it is their responsibility as a Federal employee and as a 
protector of taxpayer rights to do this. And in the pilot that 
was done in the late 1990s, one of the things that we learned, 
we know from experience, is that there were very inappropriate 
actions taken by the PCAs. There were phone calls made at 4 
o'clock in the morning to taxpayers, harassing them about the 
information that was given and the collectability of the taxes 
that they have. And I do not see anything in place that should 
put taxpayers at ease that these things will not occur again.
    Senator Carper. Mr. Graham, any comments or reflections you 
would have on what Ms. Kelley has just presented?
    Mr. Graham. This may already be obvious to you. if it is 
not, I just want to make sure it was. When we ramped ours up, 
it was not a mechanism to send employees home. Everybody is 
still doing everything they were. There is just that much 
evasion going on and noncompliance going on that we had that 
much more paper. If you look at Georgia's economic growth and 
population growth and new businesses registered, it went on 
that kind of curve for the last 20 years, and it is still 
going, whether we like it or not. But our department, too, 
shrank, as was described at the Federal level. At some point 
you have got to find a different way, what I call go to market 
or do business, in order to close that gap, and this is the 
same kind of gap you are talking about here. Everything we are 
doing with the agencies is designed to augment what our 
employees are already doing. We were not at all interested 
necessarily, as long as we had jobs and work to do, to send 
anybody home. That is just one nuance, I think, that is 
certainly relevant to the dialogue.
    Ms. Kelley. In the IRS, what they are currently doing is 
not eliminating current positions. They are not sending anyone 
home in the IRS. It is to supplement--the way they frame it is 
to supplement the current workforce.
    One distinction I would make is when Mr. Graham talks about 
a one-time hit and you do not expect this work to reoccur, 
there are so many uncollectible accounts in what the IRS calls 
its queue that they just do not have employees to assign the 
work to. There are so many accounts in this queue that this is 
not about that work ever going away.
    And so when Commissioner Everson said to you earlier, in 
response to a question that was asked, to write him a check and 
he will hire these employees so that the IRS employees can do 
the work, I mean, that is what this is about, is that the IRS 
needs appropriate funding; and if IRS employees were doing this 
work, it would put more money back in the general treasury than 
is going to come to the general treasury to attack these tax 
gap issues than is going to come to the general treasury 
through PCAs. It is not a close call that more money will go to 
the treasury and that IRS employees can do this work less 
expensively than the PCAs can.
    Senator Carper. Mr. Graham.
    Mr. Graham. I, too, do not believe it is going to go away 
forever. You are always going to have some of it. But--I am 
trying to think of the best way to say this. In the spirit of 
time, I will come back to it maybe afterward.
    Senator Carper. OK. That happens to me all the time.
    I asked the Commissioner a question earlier about how the 
IRS incentivizes employees to come forward with good ideas that 
are helpful. I remember when I was Governor in Delaware, we 
were trying to figure out how to structure a welfare system to 
try to reduce the likelihood that people stay on welfare for a 
long, extended period of time. What we did is just invite a lot 
of welfare families, welfare mothers in to talk to us about 
their experience. We were trying to figure out how to reduce 
teen pregnancy, and we decided to bring a lot of young people, 
a lot of teenagers in to talk about boys and girls from all 
kinds of walks of life.
    We were trying to figure out how to reduce the runoff from 
our poultry industry from the--the environmental runoff from 
all the chicken houses and stuff, and we decided to bring in 
the poultry farmers themselves to help us figure it out.
    Are you able to--are the employees called on or are there 
ways to incentivize employees to help--they probably know as 
well as anybody else, except maybe some of the perpetrators--
what is going on here and how best to control it and to reduce 
it. How do we incentivized that?
    Ms. Kelley. Well, I actually made a note when you asked 
that question of Commissioner Everson's response because I am 
going to follow up with him on what should be done versus what 
is being done.
    I do not doubt for a minute he gets e-mails from employees 
every day with their opinions or ideas. But there really is not 
any formal process that invites those kinds of suggestions from 
employees and gives them a procedure that lets them know that 
it will be acted on or responded to, at least, so that it is 
fully considered. And there is a sense of many in the IRS, just 
because of the size of the agency and the layers of management, 
that very often when ideas do get moved forward, they do not 
get very far. And I believe many of them never get to 
Commissioner Everson or to the executives who are responsible 
for those programs.
    So I have made myself a note to initiate a new conversation 
with Commissioner Everson about how we can make this more 
formal, more responsive, and to assure that the ideas these 
employees have--and I absolutely agree with you. They have 
ideas that will help, that could help to solve the problem, at 
least to take us steps forward in solving it. And we need to 
have a better process to allow for that input and action on it.
    Senator Carper. Good. Let me change focus again a little 
bit and talk about technology and how we use technology, how 
the folks you represent are using technology, and, Mr. Graham, 
the people who work on your team, how you use technology to 
enable them to be more effective in their job and to close that 
tax gap.
    Ms. Kelley, I do not know if you want to take the first 
stab at it, but I welcome your comments.
    Ms. Kelley. Technology and the money for the technology, 
again, is always an issue for the IRS. Their technology budget 
the last couple of years, probably the last 6 years, has been 
cut every year. And it is a huge problem because it is blocking 
tools that employees need to do their jobs most effectively 
from putting those tools in the hands of the employees.
    And, again, you mentioned the hearings and the impact that 
had on employees. Well, there were also some past problems with 
the IRS many years ago, and when Congress reviewed how past 
technology money was spent, you were not very happy with it. So 
you put some pretty strict rules in place for them, and it has 
been a very tight budget since. Even though I think in many 
ways they have delivered and done a much better job with the 
technology money that they are given, it is not enough money to 
really give them the cutting-edge technology that they need to 
really be able to do the best jobs possible.
    Senator Carper. Mr. Graham, how have you all been using 
technology to help you close your own tax gap?
    Mr. Graham. When I got to the department, the mantra was we 
are trying to get $150 or $200 million to build a whole new 
technology platform, and faced with a $700 million previously 
undisclosed deficit, that just was not going to happen at all. 
And so what we sought to do was to give the taxpayer relief on 
the very front end, to improve the customer service and shorten 
that transaction time, the transaction time from the second 
they log on to the computer from the second they start to drive 
in the parking lot, not just when they get up to the counter to 
get help. Is the information there that they need?
    Also, in our sales tax platform, we determined early on 
that out of 130,000 sales tax returns we sent out a month, 60 
percent come back with errors, and we were doing the error 
resolution. So our process right now is to continue to enhance 
our online filing, and the error resolution has to be corrected 
before it is submitted to the department for acceptance so that 
we can take the resources in doing error resolution for years 
and dedicate it to compliance, enforcement, and customer 
service of helping educate taxpayers to do things the right way 
if they ask for help in that process. Again, it is one of the 
ways to find a different way to go to market and do our 
business.
    We are in the early--not early stages but the middle stages 
of doing that, of fixing that front-end customer service. And 
that can be done--the part that we are doing there is going to 
impact every online filer. There are over 2 million online 
filers today, and that is being done at an expense of only $4 
to $5 million.
    Senator Carper. OK. I wanted to ask a question of Mr. 
Everson, and the question that I wanted to ask him at the end 
but we just did not have time was for him just to kind of go 
through a list of things we ought to be doing to enable the IRS 
to do their job more effectively. And I will ask him that for 
the record.
    I am going to ask you that question for the record, too, 
Ms. Kelley, but before I do that, let me just ask if you could 
just mention some of the most important things that we can be 
doing to enable your members, the IRS employees to do their 
jobs more effectively to reduce this tax gap.
    Ms. Kelley. Well, the short answer is to start with 
funding, but then also to support----
    Senator Carper. And Mr. Everson made that point.
    Ms. Kelley. Yes. One of the things he and I agree on is 
that the IRS needs more funding. And also to support the idea 
that both customer service and enforcement are needed in order 
to really increase the compliance, which is what everyone 
wants, is to increase the compliance rate.
    The support for IRS employees does not often come publicly, 
and it is something that would be welcomed by them in support 
for the difficult work that they are trying to do. But I would 
welcome the opportunity to also give you a substantive list of 
things that would help them do their jobs better. I will submit 
that for the record.
    Senator Carper. Good. We would appreciate that.
    We started our vote, the first of five votes, and we are 
trying to enforce a more timely arrival of Senators to cast 
their votes. And so I am going to have to close things down 
here today and to head over to the floor.
    I really want to thank each of you for taking time. Mr. 
Graham, you have come a long way from Georgia, and we 
appreciate the work that you all are doing, and I always like 
to say States are laboratories for democracy and we can learn a 
lot from what is going on in the States.
    I appreciate what I think is a fairly good, cooperative 
relationship between the States and the IRS to share 
information. We can always do better on that front, as we know.
    We have had a whole panel of folks who have been good 
enough to prepare for today and to come here to join us, and 
they are not going to have the opportunity to testify today. 
And I apologize for all of us that that is the case and to the 
extent that we have inconvenienced those panel members, we 
apologize. We hope to have the opportunity within the next 
several weeks to reschedule that panel and to invite you to 
come back. I think that includes representatives from GAO, from 
Treasury Department Inspector General for Tax Administration, 
and I think the National Taxpayer Advocate.
    I was taught the Golden Rule to treat other people the way 
we want to be treated, and I do not like it when we treat folks 
like this. It is only because neither Senator Coburn nor I are 
the Majority Leader of the Senate, so we do not get to schedule 
these votes. But when we are, we will not schedule them to 
occur right in the middle of our panels for the Subcommittees 
that we chair. [Laughter.]
    It has been a good hearing thus far, and we hope that the 
rest will be even more so.
    Thank you very much for joining us today, and with that, 
this hearing stands adjourned.
    [Whereupon, at 4:27 p.m., the Subcommittee was adjourned.]


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