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



 
  DEPARTMENTS OF TRANSPORTATION, TREASURY, THE JUDICIARY, HOUSING AND 
URBAN DEVELOPMENT, AND RELATED AGENCIES APPROPRIATIONS FOR FISCAL YEAR 
                                  2006

                              ----------                              


                        THURSDAY, APRIL 7, 2005

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 9:30 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Christopher S. Bond (chairman) 
presiding.
    Present: Senators Bond, Murray, and Dorgan.

                       DEPARTMENT OF THE TREASURY

                        Internal Revenue Service

STATEMENTS OF:
        MARK W. EVERSON, COMMISSIONER
        J. RUSSELL GEORGE, TREASURY INSPECTOR GENERAL FOR TAX 
            ADMINISTRATION

            OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND

    Senator Bond. Good morning. The Senate Appropriations 
Subcommittee on Transportation, Treasury, Judiciary, Housing, 
Urban Development, and Related Agencies will come to order. I'm 
going to have to get used to that, Senator Murray. The 
committee is often called the THUD committee but we will go 
with the full name for this event.
    We welcome Internal Revenue Service Commissioner Mark 
Everson and J. Russell George, the Treasury Inspector General 
for Tax Administration to this morning's hearing. I look 
forward to hearing each of your views on the IRS's fiscal year 
2006 budget as well as issues related to the administration and 
enforcement of our Nation's tax code. With the April 15 tax 
filing deadline rapidly approaching, you can see everybody 
smiling about what a wonderful day that will be. As a result, 
we're especially looking forward to Commissioner Everson's 
testimony on the current state of the IRS and how the service 
is responding not only to taxpayers' needs but what has become 
popularly described as the ``tax gap''; namely, what taxes 
should be paid and what taxes are actually paid.
    We also are looking forward to the IG's perspective on the 
strengths and weaknesses of the IRS's capacity to effectively 
collect taxes.
    As I understand the budget request for 2006, the IRS is 
making renewed efforts to reduce the tax gap through an 
increased investment in enforcement funding. I understand and 
support these efforts. Closing this gap is especially important 
as the Federal Government seeks to reduce the deficit and 
reform Social Security. I believe that those of us who pay 
taxes as we should bear a heavy burden when 15 percent of taxes 
that are owed are not collected. Consequently, I've appreciated 
discussions about how we can close that gap so that we can get 
the taxes that are actually owed and enable the government to 
lower the deficit that we face.
    In particular, the IRS is proposing to close this gap by 
increasing the Nation's investment in enforcement, proposing an 
8 percent increase in enforcement. Moreover, the budget 
proposes that no less than $6.446 billion must be used 
exclusively for tax enforcement, which would result in an 
additional $446.5 million in contingent funding for 
appropriations. The use of this budget mechanism is justified 
because the government collects $4 for every $1 spent for 
enforcement. I'm not convinced of the arithmetic. I am 
convinced, however, additional enforcement spending will result 
in additional collections. This is true despite the fact that 
the strength and weakness of our Nation's Federal income tax 
system is its reliance on the voluntary compliance of American 
taxpayers. Most Americans believe in the law and pay their 
taxes. Nevertheless, there will always be some that fail to 
comply or engage in outright fraud. This is the IRS's greatest 
managerial challenge and I believe the IRS should have the 
resources to meet that challenge.
    That's why effective enforcement of the tax laws are so 
critically important and why I support an increase in the 
funding for enforcement efforts. Enforcement cannot be lax, 
ineffective, or uneven; otherwise, more people will be 
encouraged to commit fraud. We also must ensure enforcement 
funds are used for enforcement and not other priorities. I'm 
disappointed that the subcommittee does not get adequate credit 
under the convoluted budget scoring principles for the savings 
achieved through enforcement, especially since OMB has proposed 
the underfunding of so many other parts of our bill. If we 
could get credit for the additional collections coming from 
enforcement, we would be able to meet many of our threshold 
needs. However, the overall budget has been cut by 2 percent 
with many functions in our budget requiring cost-of-living 
increases which are not addressed. Housing, for example, does 
not get 2 percent less expensive. As a result, this budget puts 
us in a very difficult position, a theme that we will be 
reiterating in our discussions with all of the other agencies 
that come before us.
    The primary mission of the IRS is to ensure the full and 
fair compliance of all taxpayers to meet their tax obligations. 
This is the underlying purpose of the IRS's budget. However, 
I'm concerned about the proposed 1 percent decrease in taxpayer 
service funding. The IRS needs to balance customer service with 
its compliance and enforcement efforts. As a result, the IRS 
must provide high quality and in-depth customer service to 
assist taxpayers, especially low-income taxpayers. I believe 
that most people who fail to comply with the code do so 
unintentionally because of its difficulty and complexity. 
Active and timely guidance from the service is imperative to 
ensure taxpayer compliance.
    Nevertheless, I remain concerned about the proposed 
reduction in customer service, especially since the IRS has 
improved its customer service and guidance over the past 2 
years. I'm especially impressed over the improvement through 
internet, telephone, and in-person assistance. E-file options 
have become especially important, helping to reduce the burden 
of filing tax returns both for the government and the taxpayer.
    Unfortunately, the biggest hurdle facing taxpayers and the 
IRS and all of us is the Federal Tax Code, its regulations and 
other guidance, which constitute more than 54,000 pages. It is 
too complex, too confusing, and too costly. On a daily basis, I 
hear complaints from small tax practitioners and businesses 
that the code has become unmanageable and confusing, resulting 
in excessive cost and administrative burdens that far exceed 
reasonable tax compliance. I believe it was Walt Kelly's 
``Pogo'' who said those famous words, ``We have met the enemy 
and he is us''. This is our responsibility and, unfortunately, 
even with all the wisdom in the Appropriations Committee, we 
don't write the tax code. Nevertheless, I firmly support a 
comprehensive reform of the tax code based on simplicity and 
reasonableness. This alone would result in substantially 
reduced tax fraud by making the process simpler and the system 
far fairer for all taxpayers.
    Finally, I direct concerns to an area of particular 
importance to me: the ongoing efforts of the IRS to modernize 
the IRS computer system known as Business System Modernization 
or BSM. The ultimate success of this system is critical to 
collections. Historically, the IRS has long been dependent upon 
antiquated computer systems to perform basic tax administration 
activities. As a result, Congress created a special business 
systems account to fund the replacement of these outdated 
systems. Nevertheless, the cost for BSM is fast approaching $2 
billion. The key feature of the modernization program and the 
customer account data engine, with acronym being CADE, is 
hampered by development problems and cost overruns while 
remaining inadequate and ineffective. For example, the report 
on Custodial Accounting Project, CAP, showed that it was 
significantly behind schedule and over budget. This system was 
designed to correct longstanding weaknesses in the IRS 
financial management systems, which account for approximately 
$2 trillion in tax collections annually. Additionally, TIGTA 
found the IRS and CAP contractor did not adequately manage 
system requirements. In another example, TIGTA reported that 
the security audit system used to record the online activity of 
IRS employees through audit trails was accepted by IRS even 
though the required functions the IRS paid for were not 
operating. The bottom line is that scheduling and cost 
estimation have been a big problem. Almost every system is 
behind schedule and over cost and is delivering less 
functionality than originally planned.
    Commissioner, your budget request is $199 million for BSM. 
I'm not convinced this system works adequately, but ultimately 
the IT system is the heart of the entire collection and 
compliance system. BSM must be fixed and must be made workable 
to establish clearer requirements and benchmarks for its 
progress. As I understand it, the system was supposed to be 
completed in 10 years. I don't believe anyone believes this 
schedule is now achievable as schedule delays and cost over-
runs continue to rule--this is not the exception in this 
ongoing effort: schedule slippages and cost over-runs have been 
epidemic and, in fact, I believe the IRS is running late and is 
over-budget on all seven core projects related to BSM. I'm 
concerned BSM is becoming the 21st century version of the TSM 
program which was the IRS's prior modernization effort that was 
abandoned after 6 years and $4 billion. TSM was a total loss. 
The current BSM effort began in 1998 and has already cost $2 
billion. This program, like TSM before it, raises more 
questions than answers.

                           PREPARED STATEMENT

    Commissioner, I support your efforts in enforcement and 
closing the tax gap. I applaud your efforts but an effective 
BSM is critical. I'm looking forward to working with you and 
the IRS on these efforts. I also applaud your commitment on 
addressing the funding, schedule, and requirement needs of the 
BSM. I thank you for coming to testify today and I look forward 
to your testimony and the testimony of Mr. George on the many 
challenges confronting the IRS in the 21st century. It's now my 
pleasure to turn to my ranking member, Senator Murray.
    [The statement follows:]

           Prepared Statement of Senator Christopher S. Bond

    The Senate Appropriations Subcommittee on Transportation, Treasury, 
the Judiciary, Housing and Urban Development and Related Agencies will 
come to order. We welcome Internal Revenue Service Commissioner Mark 
Everson and J. Russell George, the Treasury Inspector General for Tax 
Administration, to this morning's hearing. I look forward to hearing 
each of your views on the IRS's fiscal year 2006 budget as well as 
issues related to the administration and enforcement of our Nation's 
tax code.
    With the April 15 tax filing season deadline rapidly approaching, 
we are especially looking forward to Commissioner Everson's testimony 
on the current state of the IRS and how the Service is responding not 
only to taxpayers' needs but what has become popularly described as the 
``Tax Gap''; namely, what taxes should be paid and what taxes are 
actually paid. We also are looking forward to the IG's perspective on 
the strengths and weakness of the IRS's capacity to effectively collect 
taxes.
    As I understand the budget request for fiscal year 2006, the IRS is 
making renewed efforts to reduce the tax gap through an increased 
investment in enforcement funding. I understand and support these 
efforts. Closing this gap is especially important as the Federal 
Government seeks to reduce the deficit and reform social security.
    In particular, the IRS is proposing to close this gap by increasing 
the Nation's investment in enforcement by proposing an 8 percent 
increase in enforcement. Moreover, the budget proposes that no less 
than $6.446 billion be used exclusively for tax enforcement which would 
result in an additional $446.5 billion in contingent funding for 
appropriations. The use of this budget mechanism is justified because 
the government collects $4 for every $1 dollar spent for enforcement. 
While I am not convinced of the arithmetic, I am convinced that 
additional enforcement spending will result in additional collections 
to a point. This is true despite the fact that the strength and 
weakness of our Nation's Federal income tax system is its reliance on 
the voluntary compliance of American taxpayers. Most Americans believe 
in the law and pay their taxes. Nevertheless, there will always be some 
that fail to comply or engage in outright fraud. This is the IRS's 
greatest managerial challenge and the IRS should have the resources.
    That is why effective enforcement of our tax laws is so critically 
important, and why I support an increase in the funding of enforcement 
efforts. Enforcement cannot be lax, ineffective, or uneven; otherwise 
more people will be encouraged to commit fraud. We must ensure 
enforcement funds are used for enforcement and not other priorities. I 
am disappointed that the subcommittee does not get adequate credit and 
savings for its investment in enforcement, especially since the 
administration has proposed underfunding of so many other parts of our 
bill.
     The primary mission of the IRS is to ensure the full and fair 
compliance of all U.S. taxpayers with their tax obligations. These 
efforts cannot through enforcement and compliance solely. Consequently, 
I am very troubled by the proposed 1 percent decrease in Taxpayer 
Service funding. The IRS needs to balance customer service with its 
compliance and enforcement efforts.
    As a result, the IRS must provide high quality and in-depth 
customer service to assist taxpayers, especially low-income taxpayers. 
I believe that most people who fail to comply with the code do so 
unintentionally because of its difficulty and complexity. Accurate and 
timely guidance from the Service is imperative to ensuring taxpayer 
compliance.
    Nevertheless, while I remain concerned about the proposed 
reductions in customer service, the IRS has improved its customer 
service and guidance over the past few years. I especially am impressed 
over improvements through the internet, telephone and in-person 
assistance. E-file options have become especially important, helping to 
reduce the burden of filing tax returns for both the government and the 
taxpayer.
    Unfortunately, the biggest hurdle facing taxpayers and the IRS is 
the Federal tax code, its regulations and other guidance, which has 
morphed to more than 54,000 pages--this is too complex, confusing, and 
costly. On an almost daily basis, I hear complaints from small tax 
practitioners and businesses that the Code has become unmanageable and 
confusing, resulting in excessive cost and administrative burdens that 
far exceed reasonable tax compliance. I firmly support a comprehensive 
reform of the tax code that is founded in simplicity and 
reasonableness. This alone would result in substantially reduced tax 
fraud by making the process simpler and the system far fairer for all 
taxpayers.
    Finally, I'd like to direct my concerns to an area of particular 
importance to me: the ongoing efforts of the IRS to modernize the IRS 
computer systems, known as Business Systems Modernization (BSM). The 
ultimate success of this system is critical to collections.
    Historically, the IRS has been long dependent upon antiquated 
computer systems to perform basic tax administration activities. As a 
result, Congress created a special business systems modernization 
account to fund the replacement of these outdated systems. 
Nevertheless, the cost for the BSM program is fast approaching $2 
billion. The key feature of the modernization program, Customer Account 
Data Engine (CADE), is hampered by delays in development and cost 
overruns while remaining inadequate and ineffective.
    For example, TIGTA's report on the Custodial Accounting Project 
(CAP) showed that it was significantly behind schedule and over budget. 
This system was designed to correct longstanding weaknesses in the IRS 
financial management systems systems, which account for approximately 
$2 trillion in tax collections annually. Additionally, TIGTA found the 
IRS and the CAP contractor did not adequately manage system 
requirements. In another example, TIGTA reported that the system 
(Security Audit and Analysis System) used to record the online activity 
of IRS employees through audit trails which was accepted by IRS even 
though the required functions IRS paid for were not operating.
    The bottom line is that scheduling and cost estimation have been a 
very big problem for IRS. Almost every system is behind schedule, over 
cost, and is delivering less functionality than originally planned.
    Mr. Commissioner, your budget request seeks $199 million for BSM. I 
am not convinced this system works, but ultimately the IT system is the 
heart of the entire collection and compliance system. BSM must be 
fixed. IRS needs to establish clear requirements and benchmarks for 
progress. As I understand it, this system was supposed to be completed 
in 10 years. I do not believe that anyone believes this schedule is now 
achievable and schedule delays and cost overruns continue to be the 
rule--not the exception--to this ongoing effort. These schedule 
slippages and cost-overruns have been epidemic. In fact, I believe the 
IRS is running late and is over budget on all seven core projects 
related to BSM.
    I am very concerned that BSM is becoming the 21st century version 
of the Tax Systems Modernization (TSM) program, which was the IRS's 
prior modernization effort that was abandoned after consuming 6 years 
and $4 billion in Federal tax dollars. That effort was a complete loss.
    The current BSM effort began in 1998 and has already cost almost $2 
billion. This program, like TSM before it, raises more questions than 
answers.
    Commissioner Everson, I support your efforts in enforcement and 
closing the tax gap. I applaud your efforts. However, an effective BSM 
is critical to these efforts. I am looking forward to working with you 
on these efforts. However, I also am looking to your commitment on 
addressing the funding, schedule and requirement needs of the BSM.
    I thank you again coming to testify before the subcommittee this 
morning. I look forward to your testimony and the testimony of Mr. 
George on the many challenges confronting the IRS in the 21st century.
    I now turn to my Ranking Member, Senator Murray.

                   STATEMENT OF SENATOR PATTY MURRAY

    Senator Murray. Thank you very much. Mr. Chairman, I want 
to welcome back IRS Commissioner Everson and I want to welcome 
Russell George who is our new Treasury Inspector General for 
Tax Administration testifying before this subcommittee for the 
first time. In 8 days, millions of Americans who play by the 
rules will go to the post office to file their tax returns. 
These honest taxpayers should be appalled by the IRS's findings 
released last week that reveal that the agency will fail to 
collect between a quarter and a third of a trillion dollars 
it's owed this year because of tax cheats. That figure is the 
equivalent of the amount we spent on the entire Department of 
Defense a couple of years ago. It represents roughly $1 out of 
every $5 that is owed by American taxpayers.
    According to the IRS, the majority of these unpaid taxes 
take the form of unreported income by businesses, partnerships, 
estates, and so-called S corporations. Thankfully, the IRS now 
recognizes they need to get serious with tax cheats. The agency 
is asking for almost an 8 percent increase for tax law 
enforcement and a budget that is extremely frugal when it comes 
to other areas of domestic spending.
    While some Senators have expressed concern that boosting 
IRS's enforcement budget could cost the agency to return to its 
troubled past when IRS agents used excessive force to harass 
taxpayers, I want to believe the agency has learned from its 
past mistakes and would use this funding boost to go after the 
real criminals. But what troubles me about this proposed IRS 
budget is the lack of balance between the desire to boost 
enforcement and the need to fund critical services to 
taxpayers. A detailed review of the budget request for the IRS 
shows that buried within the overall funding increase for the 
agency is almost a quarter billion dollars in anticipated cuts 
in current activities. Most disappointing is that the majority 
of those cuts come in the form of cuts in direct taxpayer 
services. Proposals to achieve these cuts include closing as 
many as one out of every four taxpayer assistance centers in 
the United States. The IRS wants to eliminate phone filing, a 
tool currently used by more than 5 million individuals and 
business every year. Other proposed cuts in taxpayer services 
include shortening phone service hours, discontinuing tax law 
assistance through the internet, limiting distribution of some 
outreach publications and face-to-face contacts with 
practitioners, and eliminating phone-routing sites and 
staffing.
    In last year's hearing, the commissioner shared with us his 
motto that ``service plus enforcement equals compliance''. That 
motto is also prominently featured in his testimony this year. 
However, I fear a review of the budget request might indicate 
the motto should more appropriately be ``only enforcement 
yields compliance so let's cut services to pay for it''. I 
believe that service to taxpayers is still a critical mission 
of the IRS and I know I'm not alone in believing this. While a 
recent IRS Oversight Board Taxpayer Attitude Survey found that 
62 percent of taxpayers thought the IRS should get more money 
for enforcement, 64 percent of taxpayers said the IRS should 
get more money to assist taxpayers on the phone and in person. 
But it's precisely those types of services that the IRS wants 
to cut.

                           PREPARED STATEMENT

    Now, while she's not appearing before us today, I have 
reviewed the submitted testimony of the Taxpayer Advocate, Nina 
Olson. The Office of the Taxpayer Advocate was created by 
Congress so there would be staffed professionals with access to 
the commissioner to constantly look out for the interests of 
individual taxpayers as the IRS develops his processes and 
procedures. The Advocate is also charged with assisting 
taxpayers in resolving problems with the IRS and communicating 
the interests of taxpayers directly to Congress. According to 
Ms. Olson, closing taxpayer assistance centers at this time 
will irrevocably harm taxpayers. She points out that the IRS 
has not offered alternatives to the face-to-face interaction of 
these centers. It seems the only face-to-face alternative left 
is for affected taxpayers to drive much farther to another 
center. Especially because the IRS is moving so quickly on 
these new proposals, I would like to use a portion of today's 
hearing to discuss in detail precisely what the impact will be 
on individual taxpayers resulting from IRS-proposed cuts, as 
called for in the administration's budget. The tax code is 
complicated enough without our cutting back on the level of 
assistance our citizens have come to expect as they seek to 
file the taxes accurately and on time. Thank you very much, Mr. 
Chairman.
    [The statement follows:]

               Prepared Statement of Senator Patty Murray

    Thank you, Mr. Chairman.
    I want to welcome back IRS Commissioner Everson. I also want to 
welcome Russell George, our new Treasury Inspector General for Tax 
Administration, who is testifying before us for the first time.
    In 8 days, millions of Americans who play by the rules will go to 
the post office to file their tax returns. These honest taxpayers 
should be appalled by the IRS's findings, released last week, that 
reveal that the agency will fail to collect between a quarter and a 
third of a trillion dollars it is owed this year because of tax cheats.
    That figure is the equivalent of the amount we spent on the entire 
Department of Defense a couple of years ago. It represents roughly $1 
out of every $5 that is owed by American taxpayers.
    According to the IRS, the majority of these unpaid taxes take the 
form of unreported income by businesses, partnerships, estates, and so-
called ``S-corporations.''
    Thankfully, the IRS now recognizes that they need to get serious 
with tax cheats. The agency is asking for almost an 8 percent increase 
for tax law enforcement in a budget that is extremely frugal when it 
comes to other areas of domestic spending.
    While some Senators have expressed concern that boosting IRS's 
enforcement budget could cause the agency to return to its troubled 
past, when IRS agents used excessive efforts to harass taxpayers, I 
want to believe that the agency has learned from its past mistakes and 
would use this funding boost to go after the real criminals.
    What troubles me about this proposed IRS budget is the lack of 
balance between the desire to boost enforcement and the need to fund 
critical services to taxpayers. A detailed review of the budget request 
for the IRS reveals that buried within the overall funding increase for 
the agency is almost a quarter billion dollars in anticipated cuts in 
current activities.
    Most disappointing is that the majority of those cuts come in the 
form of cuts in direct taxpayer services. Proposals to achieve these 
cuts include closing as many as one out of every four Taxpayer 
Assistance Centers in the United States.
    The IRS wants to eliminate phone filing, a tool currently used by 
more than 5 million individuals and businesses every year. Other 
proposed cuts in taxpayer services include:
  --shortening phone service hours;
  --discontinuing tax law assistance through the Internet;
  --limiting distribution of some outreach publications and face-to-
        face contact with practitioners; and,
  --eliminating phone-routing sites and staffing.
    In last year's hearing, the Commissioner shared with us his motto 
that, ``Service Plus Enforcement Equals Compliance.'' That motto is 
also prominently featured in his testimony this year. However, I fear a 
review of the IRS's budget request might indicate that the motto should 
more appropriately be: ``Only Enforcement Yields Compliance--So Let's 
Cut Services to Pay For It.''
    I believe that service to taxpayers is still a critical mission of 
the IRS--and I know I am not alone in believing this. While a recent 
IRS Oversight Board Taxpayer Attitude Survey found that 62 percent of 
taxpayers thought that the IRS should get more money for enforcement, 
64 percent of taxpayers said that the IRS should get more money to 
assist taxpayers on the phone and in person.
    But it is precisely those types of services that the IRS wants to 
cut.
    Now, while she is not appearing before us today, I have reviewed 
the submitted testimony of the Taxpayer Advocate, Nina Olson. The 
Office of the Taxpayer Advocate was created by Congress so that there 
would be staffed professionals with access to the Commissioner to 
constantly look out for the interests of individual taxpayers as the 
IRS develops its processes and procedures.
    The Advocate is also charged with assisting taxpayers in resolving 
problems with the IRS and communicating the interest of taxpayers 
directly to Congress.
    According to Ms. Olson, ``closing Taxpayer Assistance Centers at 
this time will irrevocably harm taxpayers.'' She points out that the 
IRS has not offered alternatives to the face-to-face interaction of 
these centers. It seems the only face-to-face alternative left is for 
affected taxpayers to drive much farther to another center.
    Especially because the IRS is moving so quickly on these new 
proposals, I would like to use a portion of today's hearing to discuss 
in detail precisely what the impact will be on individual taxpayers 
resulting from IRS-proposed cuts, as called for in the administration's 
budget.
    The tax code is complicated enough without our cutting back on the 
level of assistance our citizens have come to expect as they seek to 
file their taxes accurately and on time.
    Thank you, Mr. Chairman.

    Senator Bond. Thank you very much, Senator Murray. Senator 
Dorgan, do you have a brief opening statement?

                  STATEMENT OF SENATOR BYRON L. DORGAN

    Senator Dorgan. Mr. Chairman, first of all, thank you for 
holding this hearing. I think recent announcements about the 
size of the tax gap should cause all of us great concern. It's 
something I want to visit with the IRS officials about. Also, 
the issues of taxpayer assistance, I assume my colleague was 
just discussing that as I walked in. Let me defer and hear from 
the commissioner and then I will ask some questions.
    Senator Bond. Thank you very much, Senator Dorgan, and 
Commissioner Everson, we're making your full statement part of 
the record and I believe you have provided a summary. We invite 
you to give that now. Thank you.

                      STATEMENT OF MARK W. EVERSON

    Mr. Everson. Chairman Bond, Ranking Member Murray, Senator 
Dorgan, I'm happy to be here. I appreciate the opportunity to 
testify on the President's request.
    The President's 2006 request for the IRS is crafted to 
continue the necessary rebuilding of our enforcement 
capabilities, and it maintains a stable commitment to our 
important IT modernization program. Enforcement and 
modernization were categorized earlier this year by the GAO as 
high risk areas of government-wide importance. The 2006 budget 
request calls for a modest amount of belt-tightening in 
taxpayer services. The cut to services of 1 percent is 
consistent with the requests for domestic discretionary 
programs other than those associated with homeland security. In 
a report issued last year, the GAO stated, ``Taxpayer services 
are much improved, raising a question about the appropriate 
balance to strike between investing in further service 
improvements and enforcement. At the same time, the use of 
IRS's walk-in assistance sites is declining. The improvements 
in telephone service, increased web site use, and the 
availability of volunteer sites raise a question about whether 
the IRS should continue to operate as many walk-in sites. 
Reconsidering the level and types of services is an option--but 
not a recommendation--to be considered by IRS management and 
the Congress.''
    [The information follows:]

                  GAO's Comments on Walk-In Assistance
    ``. . . the use of IRS's walk-in assistance sites is declining. The 
improvements in telephone service, increased Web site use, and the 
availability of volunteer sites raise a question about whether IRS 
should continue to operate as many walk-in sites. Reconsidering the 
level and types of service is an option--but not a recommendation--to 
be considered by IRS management and the Congress.''--Statement of James 
R. White, Director, Tax Issues.

                       PRESIDENT'S BUDGET REQUEST

    The President's request for the IRS adopts just this 
approach. I am comfortable with this request and support it 
wholeheartedly. I want to stress to you, Senator Murray, that I 
believe that we will provide good services. If enacted at the 
requested level without constraining language, we will continue 
to do our job on the service front.
    The budget will hold Business System Modernization funding 
steady at substantially the same level as 2005. In terms of 
modernizing our big computer systems at the IRS, after years of 
cost over-runs and missed delivery dates, we've finally turned 
the corner. In the past 9 months, two important systems have 
come on-line. We have a new financial system to help better 
manage the agency, and more importantly, this filing season the 
IRS has already processed over 1 million 1040EZ tax returns 
using the first new processing system in 40 years. The 2006 
budget continues investment in three critical areas: further 
work on return processing, collections, and electronic filing.

                          ENFORCEMENT FUNDING

    Let me turn to the need for more enforcement funding.
    As you mentioned, 2 weeks ago we announced that the gross 
tax gap--that's the difference between what taxpayers should 
pay and what they actually pay on a timely basis--exceeds $300 
billion per year. Average Americans pay their taxes honestly 
and accurately and have every right to be confident that when 
they do so, neighbors and competitors are doing the same. We've 
taken some important steps to bolster this confidence.



                              AUDIT RATES

    We have ramped up our audits of individuals. You can see 
they've gone from 618,000, 4 years ago to over 1 million last 
year, and they will go up again in 2005. We've done this 
particularly for high-income individuals. You can see they've 
doubled from $192,000, pardon me, $92,000 to $195,000 over the 
same period, and they're going to go up again in a double-digit 
increase for 2005.
    We are doing more with corporations and we're doing more 
with criminal investigations. This next chart shows the 
referrals we've made to the Justice Department, which have come 
up significantly in the last several years. We recently 
announced collections of over $3.2 billion in the settlement 
initiative for Son of Boss, a particularly abusive shelter.
    The 2006 budget calls for nearly 8 percent increase for 
enforcement. This will enable us to expand our efforts over 
strategic compliance by corporations, individual taxpayers, and 
other contributors to the tax gap; ensure that attorneys, 
accountants, and other tax practitioners adhere to professional 
standards and follow the law; detect and deter domestic and 
off-shore based tax and financial criminal activity; and, deter 
abuse within tax-exempt and governmental entities and misuse of 
such entities by third parties for tax evasion or other 
unintended purposes. It's a very important subject that was the 
subject of an inquiry by the Finance Committee just 2 days ago.
    These investments will pay for themselves several times 
over. The IRS yields more than $4 in direct revenue from its 
enforcement efforts for the money invested in its total budget, 
including our service and outreach activities. That's to say, 
the $43 billion in enforcement revenue compares to the $10.2 
billion we are appropriated. The $10.2 billion includes 
everything we do, not just the enforcement, but the processing 
and the outreach, all those activities.



                          ENFORCEMENT REVENUE

    Now, last year, the $43 billion, that represented a 15 
percent increase from the year before, so you can see that is 
coming up. That is a result of all the other things you saw. I 
want to emphasize that these figures 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. So this 
is just the direct return.
    Let me make one additional point that the chairman has 
touched upon about enforcement.
    The President's budget calls for the Congress to adjust its 
302(a) allocation to the Appropriations Committee up to $446 
million, once the base level of $6.4 billion for IRS 
enforcement is fully funded and restricted for use only on IRS 
enforcement. The $446 million consists of $265 million for new 
enforcement initiatives and $182 million for maintaining 
current enforcement levels.



                           BUDGET RESOLUTION

    The Senate Budget Resolution contains language which would 
allow this proposal to proceed. The House Resolution does not. 
I urge you to see the Senate position maintained during the 
conference. This proposal will allow the IRS to devote 
resources where needed: in enforcement. Thank you.
    [The statement follows:]

                 Prepared Statement of Mark W. Everson

                              INTRODUCTION

    Chairman Bond, Ranking Member Murray, and members of the 
subcommittee, thank you for the opportunity to testify today on the 
fiscal year 2006 budget request for the Internal Revenue Service.
    Our working equation at the IRS is service plus enforcement equals 
compliance. The better we serve the taxpayer, and the better we enforce 
the law, the more likely the taxpayer will pay the taxes he or she 
owes.
    This is not an issue of service OR enforcement, but service AND 
enforcement. As you know, IRS service lagged in the 1990's. In 
response, we took important and necessary steps to upgrade service--we 
significantly improved the answering of taxpayer telephone inquiries 
and electronic filing to name just a couple areas.
    Unfortunately, improvement in service coincided with a drop in 
enforcement of the tax law. After 1996, the number of IRS revenue 
agents, officers, and criminal investigators dropped by over 25 
percent.

                                TAX GAP

    We currently have a serious tax gap--the difference between what 
taxpayers are supposed to pay and what is actually paid--in this 
country. The results of the National Research Program indicate the 
Nation's tax gap increased slightly to between $312 billion and $353 
billion in tax year 2001. This compares to the old tax gap estimate for 
2001 of $311 billion based on earlier studies. By our best estimates, 
we lose almost $300 billion each year due to non-filing, 
underreporting, and underpayment, although this number reflects the 
fact that we do eventually recover about $55 billion of the gross tax 
gap.
    We launched the National Research Program (NRP) in 2001. We 
designed the NRP to measure individual taxpayer reporting compliance 
for tax year 2001. Over the course of the next 3 years, we randomly 
selected about 46,000 returns for review and examination. We largely 
completed these audits by the fall of 2004. To gather statistically 
valid data, the return selection process for the NRP included an 
oversampling of high income returns. This enables IRS researchers to 
draw valid conclusions about important sub-categories of taxpayers.
    For instance, slightly more than 6 percent of individual taxpayers 
filed Schedule C as sole proprietors in 2001. These taxpayers reflect a 
wide range of economic activity. To draw valid conclusions on Schedule 
C filers, the NRP examined about 21,000 individuals who filed a 
Schedule C, slightly less than 46 percent of the total sample.
    The current data from the NRP are preliminary, so the results are 
shown as ranges. As refinements are made to the tax gap analysis, some 
of these estimates may change. It is unlikely, but possible, that the 
final estimates of the tax gap will fall outside of the established 
range.
    The tax gap figure does not include taxes that should have been 
paid on income from the illegal sector of the economy.
    For Tax Year 2001, all taxpayers paid $1.77 trillion on time, a 
figure that represents from 83.4 percent to 85 percent of the total 
amount due. The 2001 tax gap, the difference between taxes owed and 
taxes paid on time is from $312 billion to $353 billion for all types 
of taxes.
    Overall, the noncompliance rate is from 15 percent to 16.6 percent 
of the true tax liability. The old estimate, derived from compliance 
data for Tax Year 1988 and earlier, was 14.9 percent.
    Late payments and other IRS enforcement and compliance efforts, 
including taxpayer audits and collection activities (payment 
arrangements, liens, levies and other legal actions) recover some of 
the Tax Gap. For Tax Year 2001, we expect eventually to collect an 
additional $55 billion of the tax gap, reducing the net amount of the 
tax gap to between $257 billion and $298 billion.
    Among the areas where taxpayer compliance appears to have worsened 
are:
  --Reporting of net income from flow-through entities, such as 
        partnerships and S corporations;
  --Reporting of proprietor income and expenses, such as gross 
        receipts, bad debts and vehicle expenses; and,
  --Reporting of various types of deductions.
    Among the areas where compliance seems to have improved is the 
reporting of farm income.
    Overall, compliance is highest where there is information reporting 
and/or withholding. For example, most wages, salaries and tip 
compensation are reported by employers to the IRS through Form W-2. 
Preliminary findings from the NRP indicate that less than 1.5 percent 
of this type of income is misreported on individual returns.
    IRS researchers anticipate identifying other specific areas of 
deterioration and improvement in the coming months as they complete the 
detailed analysis of the study's data.
    Today I will give you an update on what we've accomplished over the 
past year, speaking in particular about enforcement, the area where our 
challenges remain the greatest. We must restore the balance between 
service and enforcement, but that will not come at the expense of 
taxpayer service. In recent years, we have begun to attack the decline 
in enforcement by revitalizing our investigations, audits and 
prosecutions against those who do not pay their taxes. The President's 
fiscal year 2006 budget--if approved by Congress--will help with our 
efforts to boost enforcement while maintaining our levels of service. 
This budget includes $265 million for initiatives aimed at enhancing 
the enforcement of tax laws.
    Before I talk specifically about our fiscal year 2006 budget 
request, let me first talk about our progress in service. By service, 
we mean helping people understand their tax obligations and making it 
easier for them to participate in the tax system.
    Electronic filing continues to grow. Last year Americans filed over 
61 million electronic returns. This year we expect that over half of 
all individual returns will be e-filed. Thus, it appears that 
individuals who file on paper will soon be in the minority. We take 
every opportunity we can to proclaim the benefits of electronic filing, 
including a reduction in processing errors and cost savings for 
taxpayers and the IRS. E-filing is fast, convenient and gets your 
refund to you in half the time of paper returns.
    Use of our website, IRS.gov, is also up sharply. During the filing 
season, it is one of the busiest websites in the world. We average more 
than 1 million visits a day. Just to give you a frame of reference: one 
major search engine reported that in a recent week we were surpassed 
only by Paris Hilton, Clay Aiken, Pamela Anderson, Britney Spears, and 
a poker game. During the past year, we have also rolled out important 
new on-line services to tax professionals to help them better serve 
their clients.
    In terms of modernizing our big computer systems at the IRS, we've 
finally turned the corner. Since March 2004, two important systems have 
started operating. First, we have a new financial system to help better 
manage the agency. And secondly, and more importantly, for the first 
time in 40 years, the IRS is processing tax returns on a new computer 
system. We started with 1040EZ returns and have processed over 1 
million as of April 4. This is a big step forward in our effort to 
modernize our antiquated computer systems.

             CONTINUING SERVICE AND INCREASING ENFORCEMENT

    We are quite aware of the need to operate efficiently, consolidate 
operations and drive down costs wherever we can. In today's fiscal 
environment, we recognize that resources are tight. Nevertheless, we 
are determined to do all we can to improve service and modernize the 
IRS. In the last several years, we have begun to arrest the decline in 
enforcement and stabilize IRS enforcement staffing; now 73 percent of 
taxpayers completely agree that it is every American's duty to pay 
their fair share of taxes, up from 68 percent in 2003. A 2004 IRS 
Oversight Board commissioned NOP World study revealed 79 percent of 
taxpayers believe it is very important for the IRS to enforce 
compliance from high-income individuals and 85 percent believe it is 
very important for the IRS to enforce compliance from corporations. But 
in order to continue to reverse the downward trend of compliance, we 
must continue to use our resources wisely.
    We are working aggressively to improve productivity and achieve 
cost savings, which we will apply to other priority areas, such as 
enforcement. The fiscal year 2006 budget reduction initiatives focus 
mainly on targeted reductions in assistance, outreach, and processing 
program areas. Reductions will also be achieved through improved 
efficiencies and re-engineering of business processes in key program 
areas in accounts management, submission processing, media and 
publications, field assistance, and outreach and education. 
Approximately 65 percent of these reductions will occur in assistance, 
20 percent in outreach and 15 percent in processing. We will minimize 
the impact on taxpayers by providing alternative means to obtain 
service, wherever possible. Our budget estimates all these taxpayer 
service reengineering initiatives will yield $134 million in savings we 
can reinvest in other program areas. The reductions represent a 
balanced approach in program delivery and service to taxpayers to 
enable them to meet their tax obligations.
    We estimate savings of $75 million to $95 million from additional 
efficiencies in our field assistance, accounts management and toll-free 
telephone operations. We will achieve these savings, in part, because 
of our recent consolidation our Customer Accounts Service organizations 
and revamping our business processes. For example, due to the steady 
decline in taxpayers corresponding with us about their accounts, we 
will need fewer resources to manage these accounts. We are also 
adjusting the hours of our toll-free telephone operations from 15 to 12 
hours daily, Monday through Friday in the local times zones, beginning 
in 2005. We expect minimal impact to our level of service for taxpayers 
who call us. Another portion of these savings will come from reducing 
the number of walk-in sites. In recent years, the number of taxpayers 
walking into a Taxpayer Assistance Center (TAC) site for assistance has 
decreased from a high of nearly 10 million contacts in fiscal year 2000 
to about 7.7 million contacts in fiscal year 2004. This trend reflects 
the increased availability and quality of services that do not require 
travel or waiting in line. Examples include improved access to IRS 
telephone service, the increasing availability of volunteer assistance, 
and the many services now available through IRS.gov, such as ``Free 
File'' and ``Where's My Refund.'' In addition, the ability to download 
forms online has also contributed to the decline in the number of 
customers walking into a TAC. We have also continued to improve our 
telephone service for taxpayers who call the IRS with questions. The 
use of other alternatives, such as volunteer return assistance at 
Volunteer Income Tax Assistance (VITA) sites and Tax Counseling for the 
Elderly (TCE) sites, has steadily increased while the number of TAC 
contacts decreased. In fiscal year 1999, for example, VITA sites filed 
almost 584,000 returns, and TCE sites filed 446,000 returns. In the 
next 5 years, the numbers of returns filed through these sites 
increased 88 percent, reaching 976,000 VITA returns and 958,000 TCE 
returns in fiscal year 2004.
    Because of these other options, fewer taxpayers need to travel to 
an IRS office to get the services they need. There are currently about 
400 TAC sites across the country which are serviced by approximately 
2,300 TAC employees. We believe that adjusting the TAC sites to more 
closely align to this decreased walk-in volume will yield staffing and 
building cost savings of $45 million to $55 million of the $75 million 
to $95 million in savings, and allow us the flexibility to improve 
efficiencies and concentrate more on front-line enforcement.
    We have developed a criteria model that measures the impact on 
taxpayers across the country. The criteria include: location, employee 
cost, facilities cost, workload, and demographic measurements. In 
anticipation of the closing of approximately 70 TACs and their 
employees, we have requested authority to offer early-outs and buy-outs 
to all eligible IRS TAC personnel. We expect to have further 
announcements in the near future.
    In addition to reducing the number of TAC sites, we will save $20 
million to $31 million in outreach programs though reductions in 
printing and postage and additional efficiencies in our outreach 
organizations. For example, we will save more money in printing and 
postage as taxpayers shift to e-filing, and as we eliminate redundant 
services and publications.
    We will save another $17 million to $23 million by retiring 
Telefile, implementing program enhancements in the processing of 
employment tax returns, and re-engineering processes in Submission 
Processing. We will redirect taxpayers who previously used Telefile to 
e-file alternatives, such as Free File, that are available through 
IRS.gov so we maintain an acceptable level of service.
    Though we are re-engineering how we provide service, we will 
continually strive to improve service to taxpayers. Having stated this, 
I must address the fundamental issue of enforcement.
    While the President's Budget Request to Congress would increase IRS 
enforcement activities by 7.8 percent, given the current budgetary 
constraints, we responsibly proposed to reduce spending in other areas 
throughout the Service. We are confronted with difficult choices.
    Average Americans pay their taxes honestly and accurately, and have 
every right to be confident that when they do so, their neighbors and 
competitors are doing the same. Let me provide an overview of the steps 
we have taken over the past year to bolster this confidence, turning 
briefly to each of our four service-wide enforcement priorities.
    Our first enforcement priority is to discourage and deter non-
compliance, with emphasis on corrosive activity by corporations, high-
income individuals, and other contributors to the tax gap.
  --In 2004, audits of high-income taxpayers jumped 40 percent from the 
        year before. We audited almost 200,000 high-income individuals 
        last year--double the number from 2000.
  --Overall, audits for individuals exceeded the 1 million mark last 
        year, up from 618,000 4 years earlier.
  --In 2004, the number of audits of the largest businesses--those with 
        assets of $10 million or more--finally increased after years of 
        decline.
    The centerpiece of our enforcement strategy is combating abusive 
tax shelters, both for corporations and high-income individuals. I will 
touch upon two important initiatives of the past 12 months.
    We have continued our program of settlement offers for those who 
entered into abusive transactions in the past but would like to get 
their problems behind them. Last May, we made a settlement offer 
regarding the Son of Boss tax shelter, a particularly abusive 
transaction used by wealthy individuals to eliminate taxes on large 
gains, often in the tens of millions of dollars. In this program, for 
the first time, the IRS required a total concession by the taxpayer of 
artificial losses claimed. I am pleased with the response to the offer. 
So far, $3.2 billion in taxes, interest and penalties have been 
collected from the 1,165 taxpayers who are participating in the 
settlement initiative. The typical taxpayer payment was almost $1 
million, with 18 taxpayers paying more than $20 million each and one 
paying over $100 million. Processing of individual settlements 
continues.
    Based on disclosures we have received from promoter investigations 
and from investor lists from Justice Department litigation, we have 
determined that just over 1,800 people participated in Son of Boss. 
When the project concludes in the coming months, we expect the 
collected figure should top $3.5 billion.
    In February 2005, we announced a second important settlement 
initiative--this one involving executive stock options. This abusive 
tax transaction involved the transfer of stock options or restricted 
stock to family-controlled entities. These deals were done for the 
personal benefit of executives, sometimes at the expense of public 
shareholders. This shelter was not just a matter of tax avoidance but, 
in some instances, raises basic questions about corporate governance. 
Again, the settlement offer is a tough one: full payment of the taxes 
plus a penalty.
    A noteworthy point about the stock option settlement offer is that 
our actions in this matter were closely coordinated with the Securities 
and Exchange Commission and the Public Company Accounting Oversight 
Board.
    Our settlement initiatives and increased audits have sent a signal 
to taxpayers: the playing field is no longer as lopsided as it once 
was. Non-compliant taxpayers might have to pay the entire tax, 
interest, and a stiff penalty. A taxpayer might have to wrestle with 
questions like ``how much am I going to have to pay the lawyers and 
expert witnesses to litigate this thing?'' Moreover, going to court is 
a public matter. Damage to one's reputation is a potential factor. Many 
wealthy individuals, otherwise seen as community leaders, may not want 
to be identified as paying less than their fair share in taxes.
    Another example of cooperation in the battle against abusive 
shelters is in the international arena. A year ago, I announced the 
formation of what has come to be known as the Joint International Tax 
Shelter Information Centre. Since last Labor Day, we have had an 
operational task force of personnel from Australia, Canada, the United 
Kingdom, and the United States working together on-site here in 
Washington. We are exchanging information about specific abusive 
transactions. Results to date are promising. Thus far, we have 
uncovered a number of transactions which, but for the Centre, we would 
have unraveled only over a number of years, if ever. It makes sense 
that we continue to work with other countries because, in this 
increasingly global world, we are up against what is, in essence, a 
reinforcing commercial network of largely stateless accounting firms, 
law firms, investment banks, and brokerage houses.
    The government stepped up its use of civil injunctions in 2001 to 
prohibit promoters from selling illegal tax schemes on the Internet, at 
seminars or through other means. Currently the courts have issued 
injunctions against 99 abusive scheme promoters--81 permanent 
injunctions and 18 preliminary injunctions. They have issued 
injunctions against 17 abusive return preparers--all permanent 
injunctions. And an additional 49 suits have been filed by Justice 
seeking injunction action--28 against scheme promoters and 21 against 
return preparers. Injunctions issued have involved schemes such as:
  --Using abusive trusts to shift assets out of a taxpayer's name while 
        retaining control;
  --Misusing ``corporation sole'' laws to establish phony religious 
        organizations;
  --Using frivolous ``Section 861'' arguments to evade employment 
        taxes;
  --Claiming personal housing and living expenses as business expenses;
  --Filing tax returns reporting ``zero income''; and,
  --Misusing the Disabled Access Credit.
    The IRS has another 1,000 investigations ongoing for possible 
referral to the Department of Justice; and individual examinations are 
being conducted on thousands of scheme participants. Most of the 
investigations and examinations are being conducted by the IRS Small 
Business/Self-Employed (SB/SE) Division.
    Our second enforcement priority is to assure that attorneys, 
accountants, and other tax practitioners adhere to professional 
standards and follow the law.
    Our system of tax administration depends upon the integrity of 
practitioners. Altogether, there are approximately 1.2 million tax 
practitioners. The vast majority of practitioners are conscientious and 
honest, but even honest tax professionals suffered from the sad and 
steep erosion of ethics in recent years by being subjected to untoward 
competitive pressures. The tax shelter industry had a corrupting 
influence on our legal and accounting professions.
    We have done quite a bit since March 2004 to restore faith in the 
work of tax professionals. We have strengthened regulations governing 
the standards of tax practice to discourage the manufacturing of bogus 
legal opinions on the validity of tax shelters. The IRS standards set 
forth rules governing what does and does not qualify as an independent 
opinion about a tax shelter.
    Last year, the government won a series of court opinions on 
privilege. The cases established that promoters who develop and market 
generic tax shelters can no longer protect the identity of their 
clients by hiding behind a false wall of privilege.
    Abusive tax shelters often flourished because penalties were too 
small. Some blue chip tax professionals actually weighed potential fees 
from promoting shelters, but not following the law, against the risk of 
IRS detection and the size of our penalties. Clearly, the penalties 
were too low. They were no more than a speed bump on a single-minded 
road to professional riches.
    But these speed bumps have become speed traps. Last fall, Congress 
enacted the American Jobs Creation Act. The legislation both created 
new penalties and increased existing penalties for those who make false 
statements or fail to properly disclose information on tax shelters. 
Under the new law, the IRS can now impose monetary penalties not just 
on tax professionals who violate standards, but also on their 
employers, firms, or other entities if those parties knew, or should 
have known, of the misconduct.
    Our third enforcement objective is to detect and deter domestic and 
off-shore based criminal tax activity and related financial criminal 
activity.
    Last year, the IRS referred more than 3,000 cases to the Justice 
Department for possible criminal prosecution, nearly a 20 percent jump 
over the previous year. We continue our active role in the President's 
Corporate Fraud Task Force. We are going after promoters of tax 
shelters--both civilly and, where warranted, criminally. This tactic is 
a departure from the past. Previously, during a criminal investigation, 
all civil activity came to a halt. The result was that our business 
units were reluctant to refer matters for criminal investigation lest 
they lose their traditional turf. But, we are now moving forward on 
parallel tracks with the Department of Justice. We have a number of 
important criminal investigations. The enforcement model is changing.
    Our fourth enforcement priority is to discourage and deter 
noncompliance within tax-exempt and government entities, and misuse of 
such entities by third parties for tax avoidance purposes.
    Consider, for example, certain credit counseling agencies. 
Increasingly, it appears that some credit counseling organizations have 
moved from their original purposes, that is, to counsel and educate 
troubled debtors, to inappropriately enrolling debtors in proprietary 
debt-management plans and credit-repair schemes for a fee. These 
activities may be disadvantageous to the debtors and are not consistent 
with the requirements for tax exemption. Further, a number of these 
organizations appear to be rewarding their insiders by negotiating 
service contracts with for-profit entities owned by related parties. 
Many newer organizations appear to have been created as a result of 
promoter activity.
    Some shelter promoters join with tax-exempt organizations to create 
abusive shelters. The organization receives a large fee from the 
taxpayer who is taking advantage of its tax-free status. That is an 
unintended abuse of the tax exemption that our Nation bestows upon 
charities.
    It is heartening to see leading members of the nonprofit community 
taking steps to address abuses. I particularly want to salute the 
Independent Sector--which recently delivered a constructive report to 
the Senate Finance Committee. The report states that ``government 
should ensure effective enforcement of the law'' and calls for tougher 
rules for charities and foundations. The report calls for stronger 
action by the IRS to hold accountable charities that do not supply 
accurate and timely public information. I encourage the accounting, 
legal, and business communities to be as enthusiastic about confronting 
abuses and the erosion of professional ethics as the nonprofit 
community. An interesting point to note is that the report supports 
mandatory electronic filing of all tax returns for nonprofits.
    The threat to the integrity of our Nation's charities is real and 
growing. At the IRS, we take it very seriously. We are augmenting our 
resources in the nonprofit area. By the end of September, we will have 
increased the number of our personnel who audit tax-exempt 
organizations by over 30 percent from 2 years earlier. If we do not act 
expeditiously, there is a risk that Americans will lose faith in our 
Nation's charitable organizations. If that happens, Americans will stop 
giving and those in need will suffer.
    As we move forward with these priorities, we will leverage our 
success to achieve greater results within our fiscal year 2006 budget 
request.

                           BUDGET RESTRUCTURE

    To facilitate full alignment and integration of the Service's goals 
and measures with its resources, we are proposing to restructure our 
budget beginning in fiscal year 2006. These changes will facilitate a 
more accurate assessment of the overall value of IRS programs, simplify 
the full costing of programs, and allow the IRS to demonstrate 
incremental increases in an initiative's effectiveness based on the 
level of funding received.
    In addition, this new budget structure will enable us to manage 
activities more effectively. The normal processing of tax returns 
generally proceeds from pre-filing activities to filing activities, and 
finally to compliance activities, should they prove necessary. Although 
these activities are interrelated, we currently distribute their 
resources among three appropriations, with unevenly distributed support 
costs. This system makes it difficult to manage, track, and report the 
full cost of a given Taxpayer Service or Enforcement program.
    This new budget structure will enable us to prepare a true 
performance-based budget by providing the capability to integrate 
operational and support costs into one appropriation, thereby allowing 
us to cost budget activities and programs fully for the first time. The 
new structure will also facilitate the full incorporation of 
performance measures into the budget, as the measures could be tied to 
funds in one appropriation rather than a series of program activities 
dispersed across multiple appropriations. The proposed new budget 
structure will allow stakeholders to assess more accurately the overall 
value of IRS programs, and make program reviews, such as the Office of 
Management and Budget's Program Assessment Rating Tool (PART), more 
effective, thus providing greater accountability and results-oriented 
management focus.
    The proposed budget structure combines the three major 
appropriations accounts--Processing, Assistance and Management (PAM); 
Tax Law Enforcement (TLE); and Information Systems (ISY)--into one 
appropriation called Tax Administration and Operations (TAO).
    The Taxpayer Service and Enforcement programs of the TAO 
appropriation are divided among eight critical program areas. These 
budget activities focus on Assistance, Outreach, Processing, 
Examination, Collection, Investigations, Regulatory Compliance, and 
Research. Full funding for each activity will be reflected in the 
budget, along with key performance measures. As we continue to move 
toward the development and implementation of this new structure, we 
will refine these program areas and the associated resource 
distributions to provide more accurate costing.
    Let me now provide more details on the budget request for the IRS.
   president's fiscal year 2006 budget seeks increase in enforcement
    The President's fiscal year 2006 budget requests $10.7 billion for 
the IRS, a 4.3 percent increase over the fiscal year 2005 enacted 
level. This request represents a 1 percent decrease in Taxpayer Service 
and a 2 percent decrease in Business Systems Modernization (BSM), but 
an 8 percent increase in enforcement.
    This budget includes $265 million for initiatives aimed at 
enhancing the enforcement of tax laws. This request is above the 
increases to fund the pay raise and other cost adjustments ($182 
million), for a total of $446 million for new enforcement investments 
and cost increases. It is important the Congress fully fund these cost 
increases and new enforcement investments. The President's budget 
proposal to fund them as contingent appropriations reflects the 
importance of this investment to the administration.
    To ensure full funding of the new enforcement investments, the 
budget proposes to employ a budget enforcement mechanism that allows 
for an adjustment by the Budget Committees to the section 302(a) 
allocation to the Appropriations Committees found in the concurrent 
resolution on the budget. In addition, the administration will also 
seek to establish statutory spending limits, as defined by section 251 
of the Balanced Budget and Emergency Deficit Control Act of 1985, and 
to adjust them for this purpose. To ensure full funding of the cost 
increases, either of these adjustments would only be permissible if the 
Congress funds the base level for IRS enforcement at $6.4 million and 
restricts the use of the funds to the specified purpose. The maximum 
allowable adjustment to the 302(a) allocation and/or the statutory 
spending limit would be $446 million for 2006, bringing the total 
enforcement level in the IRS to $6.9 million.
    We will use the additional funds for enforcement in several key 
ways to combat the tax gap. Combating tax non-compliance is a top 
priority for us. Americans deserve to feel confident that when they pay 
their taxes, their neighbors and competitors are doing the same. These 
investments will yield substantial results.
    The IRS yields more than $4 in direct revenue from its enforcement 
efforts for every $1 invested in its total budget. In fiscal year 2004, 
we brought in a record $43.1 billion in enforcement revenue--an 
increase of $5.5 billion from the year before, or 15 percent. Beyond 
the direct revenues generated by increasing audits, collection, and 
criminal investigations, our enforcement efforts have a deterrent 
effect on those who might be tempted to skirt their tax obligations.
    The nearly 8 percent increase for enforcement activities in the 
administration's 2006 IRS budget request will increase audits of 
corporations and high-income individuals as well as expand collection 
and criminal investigation efforts.

                        DETAILED BUDGET SUMMARY

    Our fiscal year 2006 request of $10.7 billion includes a transfer 
from the Justice Department of $53.913 million and 329 FTE for our 
portion of the Interagency Crime and Drug Enforcement (ICDE) 
appropriation, $277.6 million for a 2.3 percent pay raise and non-labor 
inflationary costs, and $264.6 million for initiatives aimed at 
enhancing our enforcement efforts. This request also includes a $22 
million rent reduction to result from consolidation of space, and the 
$134.1 million reduction to taxpayer service activities that we will 
responsibly leverage through productivity improvements and program 
reengineering, as previously discussed. We will take a balanced 
approach to these targeted reductions.
    In addition to the taxpayer service reengineering initiatives, we 
also expect to continue to realize savings, which we reinvest to other 
key areas, through the following other reengineering initiatives:
  --Savings from Increased Individual Master File (IMF) E-Filing 
        (Reduction: -$7,700,000 and -190 FTE; Reinvestment: +$7,600,000 
        and +12 FTE).--This savings is based on processing efficiencies 
        from the projected decrease in IMF paper returns and processing 
        costs for electronically filed IMF returns in Submission 
        Processing Centers. These savings will be reinvested to enable 
        us to continue our consolidation of IMF returns processing into 
        fewer Submissions Processing sites.
  --Consolidation of Case Processing Activities to Maximize Resources 
        Devoted to Front-Line Operations (Reduction: -$66,654,000 and 
        -649 FTE; Reinvestment: +$66,654,000 and +585 FTE).--Staffing 
        for conducting case processing activities that support our 
        examination, collection and lien-processing programs will be 
        consolidated from nearly 100 sites and centralized among four 
        campuses (Philadelphia, Cincinnati, Ogden and Memphis).
  --Consolidation of Insolvency Activities to Maximize Resources 
        Devoted to Front-Line Operations (Reduction: -$14,928,000 and 
        -134 FTE; Reinvestment: +$14,928,000 and +156 FTE).--Staff 
        conducting insolvency operations to protect the government's 
        interest in bankruptcy proceedings will be consolidated from 
        numerous sites and centralized at the Philadelphia campus.
  --Detection and Deterrence of Corrosive Corporate Non-Compliance 
        (Reduction: -$6,711,000 and -52 FTE; Reinvestment: +$6,711,000 
        and +52 FTE).--By using improved issue-management and risk-
        assessment strategies for examining corporations, the IRS 
        expects to realize productivity improvements. These savings 
        will be reinvested to fund front-line enforcement activities.
    Finally, the fiscal year 2006 request includes several program 
increases, totaling $264.6 million:
  --Attack Corrosive Non-Compliance Activity Driving the Tax Gap 
        (+$149,700,000 and +920 FTE).--This initiative increases 
        coverage of the growing number of high-risk compliance problems 
        and addresses the largest portion of the tax gap--
        underreporting of tax. It proposes a funding increase across 
        all major domestic and international compliance programs to 
        leverage new workload-selection systems and case-building 
        approaches from continuing reengineering efforts.
  --Detect and Deter Corrosive Corporate Non-Compliance (+$51,800,000 
        and +236 FTE).--This initiative addresses complex, high-risk 
        issues in abusive tax avoidance transactions, promoter 
        activities, corporate fraud, and aggressive domestic and off-
        shore transactions, resulting in increased corporate and high-
        income return closures and audit coverage. This initiative also 
        includes critical post-filing support provided by outside 
        experts to expedite the resolution of issues at the field 
        examination level, reducing taxpayer burden, and increasing the 
        credibility of the Service's positions on the most complex and 
        potentially highest compliance impact issues sent to court.
  --Increase Individual Taxpayer Compliance (+$37,900,000 and +417 
        FTE).--This initiative addresses the tax gap through: the 
        identification and implementation of actions needed to address 
        non-compliance with filing requirements; increased Automated 
        Underreporter resources to address the reporting compliance tax 
        gap; increased audit coverage; and expanded collection work in 
        Taxpayer Assistance Centers.
  --Combat Abusive Transactions by Entities with Special Tax Status 
        (+$14,460,000 and +77 FTE).--This initiative focuses on the 
        most egregious cases of non-compliance and identifies 
        compliance risks sooner, reducing burden on compliant customers 
        and enabling the development of new interventions to curtail 
        the growth of abusive transactions.
  --Curtailing Fraudulent Refund Crimes (+$10,772,000 and +22 FTE).--
        This initiative is aimed at attacking the increased 
        questionable refunds and return preparer fraud identified 
        through expanded operations of the Fraud Detection Centers 
        located on IRS campuses. Fraudulent refund schemes are one of 
        the most serious threats to voluntary compliance and an IRS 
        investigative priority.
    The fiscal year 2006 request of $10.7 billion funds the IRS's three 
appropriations: Tax Administration and Operations (TAO) for operations, 
service and enforcement; Business Systems Modernization (BSM) for 
modernization; and, the Health Insurance Tax Credit (HITCA) for 
administering a refundable tax credit for qualified individuals. I will 
describe each in turn.

                TAX ADMINISTRATION AND OPERATIONS (TAO)

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

                  BUSINESS SYSTEMS MODERNIZATION (BSM)

    The IRS tax administration system, which collects $2 trillion in 
revenues annually, is critically dependent on a collection of 40-year-
old, obsolete computer systems. Recognizing the long-term commitment 
needed to solve the problem of modernizing these antiquated systems, 
Congress and the administration created a special business systems 
modernization account. They designed the BSM program to bring the IRS's 
business systems to a level equivalent with best practices in the 
private and public sectors while managing the risks inherent in a 
program that is unquestionably one of the largest, most visible, and 
most sensitive modernization programs ever undertaken.
    In 2004, the modernization budget was $387 million. Based on the 
challenges the modernization program was facing, we realized the 
program needed to be smaller in 2005 so we requested a lesser budget of 
$285 million. In the end, Congress appropriated $203 million. One of 
the ways we are accommodating these changes is by substantially 
lowering the costs of the core infrastructure as well as the 
architecture, integration, and management parts of the BSM program in 
2005. These two areas are the programmatic elements of the program, and 
cost $160 million in fiscal year 2004. We certainly cannot justify that 
level of continued investment for a program that is roughly $200 
million. Therefore, we are dramatically reducing those core services to 
$107 million in fiscal year 2005 and we anticipate making additional 
reduction in fiscal year 2006. For fiscal year 2006, we request funding 
of $199 million for all BSM activities, substantially the same funding 
as the fiscal year 2005 appropriated level.
    Our most successful year ever for the modernization program was 
2004; we measured our success by the number of projects we delivered, 
the schedule and cost targets we hit, and the substantial improvements 
we made in program management.
    We delivered the first release of the Customer Account Data Engine 
(CADE) project in July 2004, allowing the IRS to process an initial set 
of the simplest tax returns on a new computer system for the first time 
in 40 years. We launched IRS's new Integrated Financial System (IFS), 
and declared it the IRS's financial accounting system of record. IFS 
will provide the capability for improved timeliness and accuracy of the 
financial reports and information available to IRS management and key 
stakeholders, facilitating continued clean financial audit opinions of 
the IRS. We deployed a full suite of e-Services products, providing tax 
professionals and businesses with new Web-based tools that dramatically 
improve their interface with the IRS. Additionally, we released 
Modernized e-File, whereby corporations and tax-exempt organizations 
can file their annual income tax and information returns 
electronically.
    We have also made significant improvements in our cost estimating 
and scheduling. In the Fall and Winter of 2003, we re-baselined the 
cost estimates and delivery schedules for each of the BSM program 
projects. Since then, we have shown a marked improvement in 
significantly reducing our variances between cost estimates and actual 
delivery costs from 33 percent in 2002 to 4 percent in 2004.
    In terms of improving program management, we identified four key 
areas that we had to address to enhance the performance of the 
modernization program:
  --Resizing our modernization efforts to better align with our 
        management and skill capacity;
  --Engaging IRS business units to drive the modernization projects 
        with a business focus;
  --Improving contractor performance on cost, schedule, and 
        functionality; and
  --Hiring outside executives to achieve a better balance between large 
        project management and tax administration experience.
    We have made significant progress in addressing each of these major 
challenges.
    First, the IRS will concentrate on a few key projects and will 
develop a track record of improved management and successful delivery 
of modernization projects.
    Second, the IRS assigned a business unit leader to each project 
with responsibility for leading the related BSM Governance Committee, 
and sharing accountability for delivering the modernization project as 
stated in their annual performance commitments.
    Third, we are making real progress in improving the accountability 
of the PRIME contractor. I meet monthly with the Chief Operating 
Officer of the Computer Sciences Corporation (CSC) to reinforce the 
accountability of the contractor to the IRS. Additionally, we have made 
major progress in restructuring BSM project contracts with the PRIME 
that shift an appropriate amount of financial risk to the contractor 
and tie costs to performance. These steps have resulted in improved 
contractor performance, as demonstrated in the deliverables in 2004 and 
the general adherence to costs and schedules.
    Fourth, we have made great progress in hiring experienced 
executives and seasoned managers from outside the agency who have 
expertise in running large-scale information technology programs and 
projects. A little over a year ago the mix of leadership at the top of 
the BSM program consisted of one outside expert and six internal IRS 
executives. Today, that mix will soon be five outside experienced 
outside experts and three internal IRS executives. This mix is a much 
better balance of the project management and technology talent and tax 
administration experience needed to successfully run the BSM program.
    While we were very successful in 2004, we have a lot of work ahead 
of us. It is critical that we continue this level of performance in 
2005 and beyond.
    Our focus for fiscal year 2005 is on maintaining substantial 
modernization work for three key tax administration systems that will 
provide additional benefits to taxpayers and IRS employees, 
specifically:
  --The Customer Account Data Engine (CADE) project;
  --Modernized e-File; and
  --Filing and Payment Compliance (F&PC).
                                  cade
    CADE replaces the IRS's antiquated system called the Master File 
which is the Service's repository of taxpayer information. With CADE 
being the core fundamental component of the modernized systems, it is 
the IRS's highest priority technology project.
    We cannot over-emphasize the importance of CADE. The current Master 
Files have served the IRS for more than 40 years. However, they were 
developed in a different era and rely on an obsolete programming 
language and a flat-file system that still requires batch updates. 
These systems are very expensive to maintain; development of new 
applications costs the IRS two to three times what it would cost if 
they were already retired. Yet the IRS must update the Master Files 
every year to take into account tax law changes. As importantly, the 
vast majority of the workforce who are familiar with these old systems 
will be retiring over the next few years and we cannot hire individuals 
with these obsolete skills. Until the Master Files are replaced, the 
IRS can not offer service approaching what a typical financial services 
firm offers today (such as full account views for employees and real-
time account updates and settlement).
    The returns we are processing in CADE are the most basic of 1040EZ 
forms and have a narrow range of taxpayer information, but it marks the 
first time since the 1960's that the IRS has processed individual tax 
returns in a new way. The success of CADE proves that we can deliver 
technology that will process tax returns on a 24-hour cycle, breaking 
the 40-year-old standard of processing on a weekly cycle. As of March 
25, 2005, CADE had processed 965,000 returns and generated nearly $318 
million in refunds to taxpayers. This achievement is significant. CADE 
will have processed over 1 million 1040EZ tax returns by the time of 
this hearing and for the 2005 filing season that figure should reach 
over 1.3 million returns.
    The CADE system is scheduled to be phased in over several years, 
processing increasingly more complex tax returns. When fully 
operational, CADE will be a modern database that will house tax 
information for more than 200 million individual and business tax 
returns. It will provide a variety of benefits to taxpayers, such as 
faster refunds (by over 50 percent) along with daily postings of 
transactions and updating accounts, which (with other technology 
elements) will significantly improve customer service and enforcement. 
With CADE, we will have the flexibility necessary to respond quickly to 
our complex tax law and tax reform changes.
    One of the most significant changes that we introduced in 2004 was 
the segmentation of CADE releases into two annual deliveries--one in 
July and one in January. The July delivery will involve higher risk, 
more complex functionality, and the January delivery will include 
filing season changes combined with additional changes as capacity 
permits. For the July release, returns will be available from the 
previous 6 months which will enable us to test the higher risk, complex 
changes with high volumes, and then go live with reduced volumes, which 
will mitigate the operational risks.

                           MODERNIZED E-FILE

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

       FILING AND PAYMENT COMPLIANCE/PRIVATE COLLECTION AGENCIES

    In 2004, Congress passed the American Jobs Creation Act, allowing 
the IRS to use Private Collection Agencies (PCAs). The legislation 
authorized the IRS to augment our collection efforts by allowing us to 
use PCAs to pursue what has been deemed as uncollectible tax 
liabilities; these agencies will not have enforcement authority and 
will only contact delinquent taxpayers to arrange voluntary, full-
payment installment agreements. We will use the Filing and Payment 
Compliance (F&PC) system to analyze tax collection cases and divide the 
complex cases requiring direct IRS involvement from the simple 
``balance due'' cases that can be handled by PCAs. The use of PCAs is 
to supplement--not supplant--current IRS personnel. Quite frankly, this 
activity is geared for an inventory that the IRS currently can not 
chase with existing resources.
    PCAs will benefit the IRS in three major ways:
  --PCAs will help reduce the significant and growing amount of tax 
        liabilities deemed uncollectible.
  --PCAs will help maintain taxpayer confidence in our tax system.
  --PCAs will allow the IRS to focus on more difficult cases and 
        issues.
    We expect to issue a Request for Procurement (RFP) in the next 
several weeks. We plan to award contract in June 2005, to begin an 
initial limited release of the uncollected tax inventory in January 
2006. We provided all interested parties notification via the IRS.gov/
Business Opportunity webpage and electronic letters.
    Safeguarding taxpayer rights is paramount. The same IRS standards 
for customer service and protection of taxpayer rights will be strictly 
enforced. PCAs will be prohibited from threatening or intimidating 
taxpayers or implying that enforcement action will be taken against 
them. Specific safeguards to protect the taxpayer include:
  --Fair Debt Collection Practices Act protections;
  --Protections against unauthorized disclosures;
  --Assistance from the National Taxpayer Advocate; and,
  --Protections with respect to third party contacts, installment 
        agreements and communications.
    The IRS expects to place cases with PCAs using the following 
criteria:
  --The taxpayer does not dispute the liability;
  --The liability is reportable on the Form 1040 series of returns;
  --The balance due is greater than $100; and,
  --The case does not involve a restriction on collection or otherwise 
        indicate that discretion or enforcement action may be required 
        to resolve the liability.
    The delivery of the CADE project was a major milestone, but we 
still have a long way to go and a lot of work ahead of us as we 
introduce technology changes and expand into processing more complex 
tax returns at greater volumes. To that end, we recognize that a 
project of this complexity must continually look at new technologies 
that can support the level of development and implementation 
productivity needed for a project of this scale.
    We certainly hope, and expect, that we will build on the successes 
of 2004, and we will continue to mature the modernization program by 
gaining a solid reputation for on-time deliveries with high 
productivity.

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

                          PROGRAM PERFORMANCE

    The IRS expects to achieve the following levels of performance 
after attaining full performance of the requested fiscal year 2006 
initiatives:
  --Increase in field examinations for high-income individuals with 
        complex returns; significant increase in collection processed; 
        and closing of over 40 percent more delinquent balance-due 
        accounts in fiscal year 2008 than in fiscal year 2004.
  --Nearly double the audit coverage for individuals with income 
        between $250,000 and $1 million, from 1.5 percent in fiscal 
        year 2004 to 2.8 percent in fiscal year 2008.
  --Auditing 15 percent more individuals earning above $1 million, from 
        3.4 percent projected for fiscal year 2004 to 3.9 percent in 
        fiscal year 2008.
  --Significantly more collection cases processed, closing 50 percent 
        more delinquent accounts in fiscal year 2008 than fiscal year 
        2004.
  --Double the audit coverage for mid-size corporations, from 7.6 
        percent in fiscal year 2004 to 16 percent in fiscal year 2008.
  --Increased efforts to deter abusive tax shelters among corporations.

                         LEGISLATIVE PROPOSALS

    The President's fiscal year 2006 request includes several proposals 
that will assist me in managing the agency more efficiently and 
effectively. These proposals, if enacted, will allow us to focus more 
resources on high-income, high-risk areas, automate several routine 
transactions, use electronic data to reduce costly manual transactions, 
consolidate resources related to judicial and counsel review, and 
broaden administrative authorities and accesses to support further 
electronic administration and tax reform. We are seeking to:
  --Make Section 1203 of the IRS Restructuring and Reform Act of 1998 
        more effective and fair;
  --Curb the use of frivolous submissions and filings made to impede or 
        delay tax administration;
  --Allow for the termination of installment agreements for failure to 
        file returns and for failure to make tax deposits;
  --Consolidate judicial review of collection due process cases in the 
        United States Tax Court;
  --Eliminate the monetary threshold for counsel review of offers in 
        compromise;
  --Allow the Financial Management Service to retain transaction fees 
        otherwise paid from IRS appropriations from levied amounts to 
        recover delinquent taxes;
  --Extend the due date for electronically filed returns to provide 
        additional incentive for taxpayers to e-file and expand the 
        authority to require electronic filing by businesses and exempt 
        organizations; and,
  --Allow IRS to access information in the National Directory of New 
        Hires for tax administration purposes.

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

    Senator Bond. Thank you very much, Commissioner. Now we 
turn to Mr. George.
    Now, again, as I said, your full statement will be 
submitted as a part of the record and we invite you to give a 
summary.

                     STATEMENT OF J. RUSSELL GEORGE

    Mr. George. Thank you, Mr. Chairman. Chairman Bond, Ranking 
Member Murray, Senator Dorgan. Thank you for the opportunity to 
testify this morning. As you consider the fiscal year 2006 
appropriation for the Internal Revenue Service, while I've held 
the position of Treasury Inspector General for Tax 
Administration for a little over 3 months, many of the issues I 
will discuss today are issues that I worked on over a decade 
ago. I served as a staff director and chief counsel of the 
House subcommittee with oversight responsibilities of the 
management and financial accounting practices of Federal 
agencies including the Internal Revenue Service. Unfortunately, 
many of the very same challenges facing the IRS not only 
persist 10 years later but in some cases have actually 
worsened. The office of the Treasury Inspector General for Tax 
Administration or, TIGTA, has identified 10 significant 
challenges facing the Internal Revenue Service.
    They are: modernizing IRS systems, ensuring tax law 
compliance, reducing tax law complexity, preventing erroneous 
and improper payments, providing quality customer service, 
protecting taxpayers and taxpayer rights, securing IRS 
employees, facilities, and information systems, integrating 
performance and financial management, managing human capital, 
and finally processing returns and implementing tax law changes 
during the tax filing season.
    My written statement addresses each of these challenges. 
Given the time constraints I will limit my comments to three of 
these issues, those being modernizing IRS systems, providing 
quality customer service, and ensuring tax law compliance.
    The first issue, modernizing IRS computer systems, that's 
been a persistent challenge for many years. Unfortunately, it 
will likely remain a challenge for the foreseeable future. In 
1986 the IRS initiated the tax systems modernization program to 
replace its antiquated computer systems. After spending over 10 
years and approximately $3 billion on tax systems modernization 
the program was scrapped and a new effort was begun. The new 
effort is called Business Systems Modernization. It is 
estimated that this modernization effort will last up to 15 
years and cost over $8 billion. While the program is 
progressing the modernization effort is behind schedule, it is 
over budget and it's still delivering less functionality than 
originally planned. TIGTA, the government accountability 
office, and the IRS oversight board have all expressed concerns 
about the ability of the IRS to effectively manage its 
portfolio or modernization projects. To succeed the IRS must 
demonstrate that it can handle the overall management of the 
modernization effort.
    A second challenge facing the IRS is one that affects many 
taxpayers this time of year, receiving quality customer 
service. As the commissioner noted in his testimony the IRS has 
made progress in customer service, however, I am concerned that 
the IRS may take a step backwards on customer service if it 
follows through with the proposal to close many taxpayer 
assistance centers. The taxpayer assistance centers are walk-in 
sites where taxpayers can receive answers to both account 
questions and tax law questions as well as receive assistance 
preparing their tax returns. The IRS is considering closing 
nearly 20 percent of the approximately 400 taxpayer assistance 
centers nationwide. As part of an ongoing audit we at TIGTA are 
reviewing the methodology used by the IRS to determine which 
taxpayer assistance centers to close. At this point I am 
skeptical that the IRS has adequate data to assess the impact 
that closing these centers will have on customer service. I'm 
also concerned that the IRS has insufficient data to draw 
conclusions on the likelihood that taxpayers who used these 
centers in the past will be able to use other methods of 
seeking help, such as the Internet or telephone. I strongly 
recommend that the IRS further research these issues before 
closing selected taxpayer assisted centers.
    Finally, on the topic of improving tax law compliance the 
IRS continues to and will always face challenges in ensuring 
that taxes are paid of time. According to IRS estimates the tax 
gap, which again is defined as the difference between what 
taxpayers are supposed to pay and what is actually paid is as 
noted approximately between $312 and $353 billion each year. To 
improve tax compliance the IRS must begin to use private 
contractors to collect taxes in the next year. While the use of 
private collection agencies could result in significant 
recoveries of unpaid taxes the potential for abuse exists. My 
office has developed a three-phase strategy to monitor this 
initiative. We will be vigilant in ensuring the IRS effectively 
uses its new authority to use private debt collectors while 
also ensuring that taxpayers due rights and privacy rights are 
protected.

                           PREPARED STATEMENT

    Mr. Chairman, members of the subcommittee, I hope this 
brief discussion of three of the major challenges facing the 
IRS aids you as you consider its fiscal year 2006 
appropriation. Thank you for allowing me to share my views. I 
look forward to taking whatever questions you might have at the 
appropriate time.
    [The statement follows:]

                Prepared Statement of J. Russell George

                              INTRODUCTION

    Chairman Bond, Ranking Member Murray, and members of the 
subcommittee, I thank you for the opportunity to testify as you 
consider the fiscal year 2006 appropriations for the Internal Revenue 
Service. As the relatively new Treasury Inspector General for Tax 
Administration--having been on the job for 16 weeks--my observations 
are based on the body of work my organization has developed through 
audits and investigations of the IRS. I will focus on the major 
challenges facing the IRS to assist you in your consideration of the 
IRS's fiscal year 2006 budget.
    Though I have been the Treasury Inspector General for Tax 
Administration (TIGTA) for only a few short months, my first experience 
conducting oversight of the Internal Revenue Service (IRS) dates back a 
number of years. In 1995, one of the initial charges I received as 
staff director of the House Subcommittee on Government Management, 
Information and Technology was to examine inefficiency at the IRS. 
Under then Chairman Stephen Horn's leadership, we reviewed several 
issues such as the IRS's tax systems modernization program, as well as 
ways to improve Federal debt collection practices. A decade later, I am 
disappointed to report that some of the same concerns Chairman Horn 
reviewed 10 years ago continue at the IRS today.
    While the IRS faces longstanding challenges, it deserves credit for 
making marked progress in an area that will always be a challenge: 
providing quality customer service to the American taxpayer. 
Commissioner Everson's guiding principle for the IRS is 
Service+Enforcement=Compliance. Over the past few years, TIGTA audits 
have shown the accuracy of information provided by the IRS to taxpayers 
with tax law questions has generally improved, the average time spent 
by taxpayers waiting for IRS assistance on the phone or in person has 
declined, and the general professionalism with which taxpayers were 
treated by the IRS has increased. Since most interactions between the 
IRS and taxpayers involve these types of customer services, it is 
encouraging to see that the IRS's focus on customer service has made 
headway.

                       CHALLENGES FACING THE IRS

    Despite such progress in customer service, improvements need to be 
made in this and other areas where significant challenges face the IRS 
in accomplishing its mission. The Treasury Inspector General for Tax 
Administration (TIGTA) has identified the following management and 
performance challenges that confront the IRS:
  --Modernizing IRS Systems;
  --Ensuring Tax Law Compliance;
  --Reducing Tax Law Complexity;
  --Preventing Erroneous and Improper Payments;
  --Providing Quality Customer Service;
  --Protecting Taxpayers and Taxpayer Rights;
  --Securing IRS Employees, Facilities, and Information Systems;
  --Integrating Performance and Financial Management;
  --Managing Human Capital; and,
  --Processing Returns and Implementing Tax Law Changes during the Tax 
        Filing Season.\1\
---------------------------------------------------------------------------
    \1\ The filing season refers to the period from January through 
mid-April when most individual income tax returns are filed.
---------------------------------------------------------------------------
Each of these areas presents its own unique challenges, which will be 
addressed individually in the remaining portion of my testimony.

                        MODERNIZING IRS SYSTEMS

    Modernizing the IRS's computer systems has been a persistent 
challenge for many years, and will likely remain a challenge for the 
foreseeable future. As I noted above, back in 1995, under Chairman 
Stephen Horn's leadership, the House Subcommittee on Government 
Management, Information and Technology began reviewing what was then 
referred to as tax systems modernization.
    The IRS initiated the tax systems modernization program in 1986. 
The purpose of the tax systems modernization program was to replace the 
antiquated computer systems that the IRS still relies on today to 
conduct tax administration. The tax systems modernization program 
intended to create a tax processing environment that was virtually 
paper-free, an environment where taxpayer information would be readily 
available to IRS employees to update taxpayer accounts and respond to 
taxpayer questions.\2\ The program, however, was plagued by management 
and technical weaknesses.\3\ After spending over $3 billion on tax 
systems modernization,\4\ the program was scrapped and a new effort was 
begun under a fresh moniker, Business Systems Modernization (BSM) 
program.
---------------------------------------------------------------------------
    \2\ See General Accounting Office Report GAO/AIMD/GGD-98-54, Tax 
Systems Modernization: Blueprint Is a Good Start But Not Yet 
Sufficiently Complete to Build or Acquire Systems (Feb. 1998).
    \3\ See General Accounting Office Report GAO/T-GGD-97-79, IRS 
Management: Improvement Needed in High-Risk Areas (Apr. 14, 1997).
    \4\ See General Accounting Office Report T-GGD-97-52, Modernization 
of Processes and Systems Necessary to Resolve Problems (Mar. 4, 1997).
---------------------------------------------------------------------------
    This latest effort to modernize the IRS's systems, the BSM program, 
began in fiscal year 1999. The purpose of the BSM program is to 
modernize the IRS's technology and related business processes. 
According to the IRS, this effort will involve integrating thousands of 
hardware and software components. Through March 2005, the IRS has 
received appropriations of approximately $1.8 billion to support the 
BSM program, and the fiscal year 2006 budget requests an additional 
$199 million. It is estimated that the BSM program will last up to 15 
years and cost over $8 billion.\5\
---------------------------------------------------------------------------
    \5\ The Internal Revenue Service Has Appropriate Processes to 
Accept Modernization Software From Developers (Reference Number 2005-
20-028, February 2005).
---------------------------------------------------------------------------
    Succeeding in the modernization effort is critical--not only 
because of the amount of time and money at stake--but also to improve 
the level of service provided to taxpayers. To accomplish the 
modernization effort, the IRS hired the Computer Sciences Corporation 
(CSC) as the PRIME\6\ to design, develop, and integrate the modernized 
computer systems.
---------------------------------------------------------------------------
    \6\ The PRIME stands for Prime Systems Integration Services 
Contractor.
---------------------------------------------------------------------------
    The joint effort between the IRS and CSC has shown progress. In 
July 2004, the IRS released the first part of the Customer Account Data 
Engine (CADE) project. The CADE is the foundation for managing taxpayer 
accounts in the modernization plan. The CADE will replace the IRS's 
existing Master File.\7\ Once fully operational, the capabilities of 
the CADE will far surpass those of the Master File.\8\
---------------------------------------------------------------------------
    \7\ The Master File is the IRS database for storing taxpayer 
account information on individuals, businesses, employee retirement 
plans, and exempt organizations.
    \8\ The CADE will include applications for daily posting, 
settlement, maintenance, refund processing, and issue detection for 
taxpayer account and return data. In conjunction with other 
applications, the CADE will allow employees to post transactions and 
update taxpayer account and return data on-line from their desks. 
Updates will be immediately available to any IRS employee who accesses 
the data and will provide a complete, timely, and accurate account of 
the taxpayer's information. In contrast, the current Master File 
processing system can take up to 2 weeks to update taxpayer accounts, 
and IRS employees may need to access several computer systems to gather 
all relevant information related to a taxpayer's account.
---------------------------------------------------------------------------
    The first release of the CADE allowed the IRS to process some of 
the simplest tax returns, Form 1040EZ, using a new database of taxpayer 
accounts. The IRS has also deployed projects that provide value to 
taxpayers, such as ``Where's My Refund?,'' the web-based application 
that allows taxpayers to check the status of their refunds. In 
addition, the IRS and its contractors have built the infrastructure 
needed to support these projects and have developed an enterprise 
architecture to guide the Business Systems Modernization (BSM) program.
    Although progress is being made, the modernization program is 
behind schedule, over budget, and is delivering less functionality than 
originally planned. TIGTA, GAO and the IRS Oversight Board have 
expressed concerns over the IRS's ability to effectively manage its 
portfolio of BSM projects. Both TIGTA and GAO have recommended that the 
IRS slow the pace of the BSM program due to some of the risks that have 
surfaced. Specifically, the imbalance between the number and pace of 
the BSM projects and available management capabilities has added 
significant cost, schedule, and performance risks that have continued 
to escalate.
    In addition, TIGTA has identified four primary challenges that the 
IRS must overcome for modernization to be successful: (1) The IRS must 
implement planned improvements in key management processes and commit 
necessary resources to succeed; (2) The IRS must manage the increasing 
complexity and risks of the modernization program; (3) The IRS must 
maintain continuity of strategic direction with experienced leadership; 
and, (4) The IRS must ensure that CSC's performance and accountability 
are effectively managed.
    Without these four challenges being addressed, modernization will 
not succeed.\9\ In addition, IRS is reassessing its relationship with 
the PRIME contractor. For the past 6 years, the PRIME contractor has 
performed the role of system integrator and program manager for the BSM 
effort. In the new operating model, the IRS assumes responsibility for 
overall program management. The IRS must demonstrate that it can 
effectively manage the BSM program before its chances for success 
improve.
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    \9\ Annual Assessment of the Business Systems Modernization Program 
(Reference Number 2004-20-107, dated June 2004).
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                      ENSURING TAX LAW COMPLIANCE

    The IRS continues to face challenges in ensuring that taxes owed 
are paid on time. The importance of this issue cannot be overstated. 
The Nation's ability to provide for the general welfare and protect its 
citizens is based on the ability to raise revenue through taxes. Yet, 
the tax gap, which the IRS defines as the difference between what 
taxpayers are supposed to pay and what is actually paid, is at 
staggering levels.\10\ On March 29, 2005, the IRS released updated 
estimates of the tax gap. For tax year 2001, the IRS estimated the 
annual gross tax gap \11\ to be between $312 billion and $353 
billion.\12\
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    \10\ See written statement of Commissioner of Internal Revenue Mark 
Everson before the Committee on Finance United States Senate Hearing on 
``Bridging the Tax Gap,'' (July 21, 2004).
    \11\ The amount of tax that is imposed for a given tax year, but is 
not paid voluntarily and timely.
    \12\ It is worth noting that the recently released tax gap figures 
noted above did not update key segments of the tax gap that are at 
least 15 years old, such as nonfiled tax returns and underreported 
corporate income tax for large corporations.
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    For some time, the IRS, the Congress, and other stakeholders have 
been concerned about the slow erosion of voluntary tax compliance. IRS 
tax compliance programs must ensure that noncompliant taxpayers who do 
not meet their tax obligations are identified and penalized. The 
undermining of voluntary compliance begins when honest taxpayers 
believe that others are not paying their fair share.\13\
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    \13\ The IRS fiscal year 2006 budget requests a significant 
increase in enforcement funds. As the IRS attempts to increase 
enforcement, it is worth considering the results of a 2003 GAO report. 
GAO found that the IRS's frontline enforcement employees understood--
but feared--section 1203 of the Internal Revenue Service Restructuring 
and Reform Act of 1998. Section 1203 outlines conditions for firing IRS 
employees for committing any of 10 acts of misconduct. These 
enforcement employees also reported that, because of section 1203, 
their work takes longer and the likelihood of their taking an 
enforcement action, such as recommending a seizure has decreased. See 
General Accounting Office Report GAO-03-394, IRS and TIGTA Should 
Evaluate Their Processing of Employee Misconduct under Section 1203 
(February 2003).
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    To improve tax compliance, the IRS must fully exercise its 
authority under the law. The American Jobs Creation Act of 2004 enables 
the IRS to use private contractors to collect unpaid taxes. While the 
use of private collection agencies could result in significant 
recoveries of unpaid taxes, the potential for abuse exists. TIGTA has 
developed a three phase audit strategy to monitor this initiative. In 
the first phase, TIGTA will review the IRS's planning and initial 
implementation of the program. In the second phase, TIGTA will review 
the initiative after full implementation, which may not occur until 
fiscal year 2007. In the third phase, TIGTA will review the 
effectiveness of the program. The goal of this audit strategy is to 
ensure that the IRS effectively uses its new authority to use private 
debt collectors, while also ensuring that taxpayers' due process and 
privacy rights are protected.
    Congress has provided other statutory tools to the IRS to increase 
tax compliance. The IRS has the legal authority to charge a monetary 
penalty, called the Failure to Pay (FTP) tax penalty, against taxpayers 
who fail to pay their taxes on time.\14\ The law also requires the IRS 
to charge interest on FTP tax penalties.\15\ A recent TIGTA report 
found that the IRS computer system would assess the FTP tax penalty on 
taxpayers' accounts, but would not officially charge these assessments 
to accounts. By not assessing these penalties periodically, the IRS has 
foregone the interest associated with them. If the IRS had assessed all 
penalty accruals at least quarterly, TIGTA estimates that for calendar 
year 2002 alone, over $817 million in interest on accrued penalties 
would be due to the IRS.\16\ This is one example of how the IRS could 
better use the tools at its disposal.
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    \14\ 26 U.S.C.  6651 (2004).
    \15\ 26 U.S.C.  6601(e)(2)(A) (2004).
    \16\ This report also found that the IRS's current practice results 
in inconsistent treatment of taxpayers. Some taxpayers in hardship 
situations, such as victims of natural disasters or military personnel 
serving in combat zones, have accounts that are administered by the IRS 
manually rather than by computer. IRS personnel periodically calculate 
and manually assess penalties on these accounts. Because the manually 
computer FTP penalties are periodically assessed, interest is charged 
to these taxpayer accounts but not charged to taxpayer accounts 
administered by computer. Procedures Regarding the Failure to Pay Tax 
Penalty Result in Inconsistent Treatment of Taxpayers and Hundreds of 
Millions of Dollars in Lost Revenue (Reference Number 2005-30-052, 
dated March 2005).
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    In addition to more fully exercising authority provided by 
Congress, the IRS must obtain timely and reliable data on the tax gap 
to improve tax compliance. To collect such data, the IRS launched the 
National Research Program, a study of individual taxpayer reporting 
compliance for tax year 2001. The National Research Program is intended 
to produce timely and reliable data that will allow the IRS to better 
target its limited enforcement resources on taxpayers who are not 
complying with the tax law instead of law-abiding individuals.
    While timely and reliable data will help the IRS quantify 
noncompliant segments of the population, different approaches are also 
needed to determine how to most effectively address noncompliance. The 
Taxpayer Advocate's 2004 Annual Report to Congress depicts some of the 
complexities involved in structuring an enforcement program to address 
the tax gap. The Taxpayer Advocate also describes the efforts the IRS 
still needs to make to analyze the effectiveness of various compliance 
techniques.\17\ Similarly, in two recent audit reports, TIGTA 
identified examination programs that the IRS implemented nationwide 
before obtaining results on their possible effectiveness or before 
implementing an effective strategy to measure the results of the 
program.\18\
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    \17\ National Taxpayer Advocate 2004 Annual Report to Congress 
(Dec. 31, 2004).
    \18\ In TIGTA's judgment, the IRS implemented the High-Income 
Taxpayer Strategy, designed to target individuals with the financial 
resources to use sophisticated methods of tax avoidance, without a 
method and specific baselines to measure the strategy's success. In 
addition, the IRS introduced the Limited Issue Focused Examination 
(LIFE) process to reduce the length of examinations of large and mid-
sized businesses. While the LIFE process has merit, the IRS implemented 
it nationwide before obtaining results on its possible effectiveness. 
The High Income Taxpayer Strategy Was Effectively Implemented, Although 
Its Success Still Needs to Be Determined (Reference Number 2005-30-012, 
dated November 2004) and The Limited Issue Focused Examination Process 
Has Merit, but Its Use and Productivity Are Concerns (Reference Number 
2005-30-029, dated February 2005).
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    Accurate measures of the effectiveness of actions taken to reduce 
the tax gap are critical to the IRS for strategic direction, budgeting, 
and staff allocation. The Department of the Treasury also needs such 
measures for the purpose of creating tax policy. Additionally, the 
Congress could use this information to develop legislation that 
improves the efficacy of the tax system.
    In addition to gathering better compliance data, TIGTA, other 
oversight groups, and interested stakeholders have made a number of 
recommendations to close the tax gap. These recommendations include: 
reducing the complexity of the tax code; instituting withholding on 
non-employee compensation; improving compliance with estimated tax 
payments; using document matching to verify business income; addressing 
escalating levels of late filed returns; increasing resources in the 
IRS enforcement functions; and addressing delays in systems 
modernization. While reducing the complexity of the tax code lies 
outside the authority of the IRS, the remaining recommendations are 
within the IRS's discretion and should be acted upon to further tax 
compliance.

                      REDUCING TAX LAW COMPLEXITY

    The scope and complexity of the United States Tax Code make it 
virtually certain that taxpayers will face procedural, technical, and 
bureaucratic obstacles before meeting their tax obligations. The IRS 
has consistently sought to ease the process for all taxpayers, but each 
tax season brings new challenges, and old problems sometimes resist 
solution.
    According to the Taxpayer Advocate's 2004 Annual Report to 
Congress, the most serious problem facing taxpayers and the IRS is the 
complexity of the Internal Revenue Code.\19\ The Joint Committee on 
Taxation conducted a study in 2001 that demonstrates the vastness of 
the tax code. The study found that, in 2001, the tax code consisted of 
nearly 1.4 million words. There were 693 sections of the code 
applicable to individuals, 1,501 sections applicable to businesses, and 
445 sections applicable to tax exempt organizations, employee plans, 
and governments.\20\
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    \19\ National Taxpayer Advocate 2004 Annual Report to Congress 
(Dec. 31, 2004).
    \20\ Study of the Overall State of the Federal Tax System and 
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of 
the Internal Revenue Code of 1986, Staff of the Joint Committee on 
Taxation, JCS-3-01 (Apr. 2001).
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    The complexity of the code hampers the ability of the IRS to 
administer the Nation's tax system and confuses most taxpayers. The IRS 
has attempted to provide assistance to taxpayers with questions about 
the tax code through toll-free telephone lines, Taxpayer Assistance 
Centers (TACs), kiosks, and the IRS internet web site. TIGTA has 
performed numerous audits of the accuracy of IRS responses to taxpayer 
questions submitted via these methods and found that even some IRS 
employees cannot apply the tax code correctly.
    Our most recent audit of the accuracy of responses provided to tax 
law questions received via the toll-free telephone lines during the 
2004 Filing Season found that 62 percent of the answers given were 
correct.\21\ The IRS conducted its own tests and found an accuracy rate 
of 79 percent. Both of these figures were well below the IRS's accuracy 
goal of 85 percent for this service. Tax law complexity contributes to 
the IRS's challenges in reaching these accuracy goals, as well as to 
taxpayer frustration with attempting to decipher the tax code.
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    \21\ Additional Effort Answering Tax Law Questions Would Improve 
Customer Service (Reference Number 2004-40-150, dated August 2004).
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    Besides adding to the burden on the taxpayer and the IRS, tax law 
complexity also may inadvertently contribute to the tax gap. Complexity 
has given rise to the latest generation of abusive tax avoidance 
transactions, with taxpayers attempting to take advantage of the tax 
code's length and complexity by devising intricate schemes to illegally 
shelter income from taxation. Administering such a complex tax code 
makes the job of pursuing these abusive tax avoidance schemes 
challenging and costly to the IRS. For example, in 2004, the hours 
revenue agents spent per return on examinations increased by 23 percent 
for individual tax returns and 19 percent for corporate tax returns 
compared to 2003 figures.\22\
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    \22\ TIGTA analysis of IRS Data Book information.
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    As part of its goal to improve service to taxpayers, the IRS 
includes simplifying the tax process as an objective in its new 
Strategic Plan. Simplification could incorporate a range of actions 
from developing legislative recommendations to clarifying tax 
instructions or forms. Changing tax laws, however, can be a lengthy 
process since the IRS only administers the tax code that is passed by 
the Congress. Thus, the IRS must work extensively with these 
stakeholders, as well as the Department of the Treasury, to identify 
and develop legislative recommendations that would reduce tax law 
complexity and taxpayer burden.

               PREVENTING ERRONEOUS AND IMPROPER PAYMENTS

    One of the goals of The President's Management Agenda is to reduce 
erroneous payments.\23\ Further, the Improper Payments Information Act 
of 2002 \24\ greatly expanded the administration's efforts to identify 
and reduce erroneous and improper payments in government programs and 
activities. While the administration has pushed to prevent erroneous 
and improper payments, stewardship over public funds remains a major 
challenge for IRS management.
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    \23\ The President's Management Agenda, announced in the summer of 
2001, is the President's aggressive strategy for improving the 
management of the Federal Government. It focuses on five areas of 
management weakness across the Government where improvements should be 
made.
    \24\ Public Law No. 107-300, 116 Stat. 2350.
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    Improper and erroneous payments include inadvertent errors, 
payments for unsupported or inadequately supported claims, payments for 
services not rendered, payments to ineligible beneficiaries, and 
payments resulting from outright fraud and abuse by program 
participants or Federal employees. For the IRS, improper and erroneous 
payments generally involve improperly paid refunds, tax return filing 
fraud, or overpayments to vendors or contractors.
    Some tax credits, such as the Earned Income Tax Credit (EITC), 
provide opportunities for taxpayer abuse. The EITC is a refundable 
credit available to taxpayers who do not exceed a certain amount of 
income per year. The EITC was intended to provide significant benefits 
to the working poor, but some taxpayers have abused the credit, which 
has resulted in a significant loss of revenue to the Federal 
Government. An IRS compliance study of tax year 1999 returns estimated 
between $8.5 billion and $9.9 billion (27 to 32 percent) of the $31 
billion in EITC claimed for tax year 1999 should not have been 
paid.\25\ A TIGTA review of EITC claimed for tax year 2002 estimated 
that the IRS allowed over $16 million in potentially erroneous credits 
because the claimed qualifying ``child'' was significantly older than 
the primary taxpayer.
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    \25\ IRS report, Compliance Estimates for Earned Income Tax Credit 
on 1999 Returns (dated February 2002).
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    In addition to erroneous payments of credits, contract expenditures 
represent a significant outlay of IRS funds and are also susceptible to 
mistakes or abuse. The IRS approved payment of nearly a billion dollars 
for the Business Systems Modernization contract. Initially, neither the 
IRS nor the contractor could provide proper supporting documentation 
for approximately $9.5 million (approximately 54 percent of the $17.6 
million sampled) in direct charges.\26\ The contractor subsequently 
provided additional documentation, and TIGTA was able to verify all but 
approximately $52,200. Nevertheless, to assure that its billings are 
adequately justified and to facilitate timely independent reviews, the 
IRS should strengthen its invoice review process by routinely 
requesting and reviewing a sample of supporting documents.
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    \26\ Improvements Are Needed in the Invoice Review Process for the 
Business Systems Modernization Contract (Reference Number 2004-10-117, 
dated June 2004).
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                   PROVIDING QUALITY CUSTOMER SERVICE

    Providing quality customer service to the taxpayer is not only a 
primary goal of the IRS, but it is also one of its major management 
challenges. The Commissioner has frequently stated that service 
combined with enforcement will result in compliance. Quality taxpayer 
service includes helping the taxpaying public understand their tax 
obligations while making it easier to participate in the tax system.
    Since the passage of the IRS Restructuring and Reform Act of 1998 
(RRA 98),\27\ the IRS's focus on customer service has led to many 
improvements. Taxpayer satisfaction rates with the IRS have increased 
since the Act's passage, growing almost 2 percent in 2004 alone.\28\ 
Every year, the IRS helps millions of taxpayers understand their tax 
obligations by answering questions on its toll-free telephone lines or 
in person at local offices, making information available on its Web 
site, and responding to correspondence.
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    \27\ Public Law No. 105-206, 112 Stat. 683 (codified as amended in 
scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 
U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
    \28\ Special Report on IRS Fiscal 2006 Budget, IRS Oversight Board, 
March 15, 2005.
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    The IRS internet site, www.IRS.gov, is an excellent source for 
forms, publications, and other guidance. Taxpayers visited the site 
over 139 million times last year.\29\ The site also received an award 
for being the Nation's most reliable government internet site.\30\ 
Electronic filing of tax returns continues to grow, and the ability to 
check the status of tax refunds online has been a successful IRS 
project that is helpful to taxpayers.\31\
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    \29\ IRS.gov Cited As Most Reliable Government Web Site, IR-2004-
131, October 25, 2004.
    \30\ Id.
    \31\ Free File Tops Last Year's Total, IR-2005-36, March 23, 2005.
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    As for the toll-free telephone system, access by taxpayers to the 
IRS via telephone has improved. Callers were able to connect with the 
IRS more easily and received better, quicker service. Surveys of 
callers during the 2004 filing season showed that the vast majority of 
taxpayers were satisfied with the services they received.\32\ While the 
IRS exceeded its goals in professionalism and timeliness, the accuracy 
of answers provided to taxpayers on tax law questions slipped in 1 year 
from 73 percent to 62 percent. TIGTA attributed this decrease to IRS 
employees not always using the required Probe and Response Guide to 
obtain sufficient information from taxpayers or the employees were not 
correctly interpreting the tax law.
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    \32\ Taxpayers Experienced Improved Access to Toll-Free Telephone 
Services During the 2004 Filing Season (Reference Number 2004-30-144, 
dated August 2004).
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    The IRS has obviously made strides in customer service over the 
past 7 years. TIGTA is concerned, however, that the IRS may disrupt the 
balance between customer service and enforcement by closing many of its 
Taxpayer Assistance Centers. The TACs are walk-in sites where taxpayers 
can receive answers to both account and tax law questions, as well as 
receive assistance preparing their returns. Over the past few years, 
customer service at Taxpayer Assistance Centers has shown 
improvement.\33\ Yet, the IRS is considering closing nearly a quarter 
of its approximately 400 TACs nationwide. TIGTA is skeptical that the 
IRS has adequate data to assess the impact that closing TACs will have 
on customer service.
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    \33\ Customer Service at the Taxpayer Assistance Centers Is 
Improving but Is Still Not Meeting Expectations (Reference Number 2005-
40-021, dated December 2004).
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    From the information provided by the IRS to TIGTA, the IRS is using 
the following criteria to select TACs to close: location, labor cost, 
facility cost, workload, and demographics. The last criterion, 
demographics, falls short of capturing the information needed to make a 
well-informed decision. To compile information on the demographics of a 
particular TAC location, the IRS is collecting data, by zip code, on 
population size, income level, age, unemployment, and percent of 
population who e-file. TIGTA believes this information is insufficient 
to draw conclusions on the capability and likelihood that taxpayers who 
have used these centers in the past will be willing to use alternative 
methods of seeking help, such as the internet or telephone. I strongly 
recommend that the IRS further research these issues before closing 
TACs.

                PROTECTING TAXPAYERS AND TAXPAYER RIGHTS

    Congress realized the importance of protecting taxpayers and 
taxpayer rights when it passed RRA 98. This legislation required the 
IRS to devote significant attention and resources to protecting 
taxpayer rights. The RRA 98 and other legislation require TIGTA to 
review IRS compliance with taxpayer rights provisions. Our most recent 
audit results on some of these taxpayer rights provisions are:
  --Notice of Levy.--TIGTA reports have recognized that the IRS has 
        implemented tighter controls over the issuance of systemically 
        generated levies, and TIGTA testing of these controls indicated 
        that they continue to function effectively. However, revenue 
        officers who issue levies manually still are not always 
        properly notifying taxpayers of their appeal rights.\34\
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    \34\ Additional Efforts Are Needed to Ensure Taxpayer Rights Are 
Protected When Manual Levies Are Issued (Reference Number 2004-30-094, 
dated April 2004).
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  --Restrictions on the Use of Enforcement Statistics to Evaluate 
        Employees.--The IRS is complying with the law. A sample review 
        of employee performance and related supervisory documentation 
        revealed no instances of tax enforcement results, production 
        quotas, or goals being used to evaluate employee 
        performance.\35\
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    \35\ Fiscal year 2004 Statutory Audit of Compliance With Legal 
Guidelines Restricting the Use of Records of Tax Enforcement Results 
(Reference Number 2004-40-066, dated March 2004).
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  --Notice of Lien.--The IRS did not completely comply with the law. 
        For example, the IRS did not always timely mail lien notices. 
        In other cases, the IRS could not provide proof of mailing. In 
        addition, the IRS did not always follow its guidelines for 
        notifying taxpayer representatives and for maintaining 
        certified mail listings.\36\
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    \36\ Fiscal year 2004 Statutory Review of Compliance With Lien Due 
Process Procedures (Reference Number 2004-30-086, dated April 2004).
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  --Seizures.--The IRS did not always comply with legal provisions and 
        internal procedures when conducting seizures. The TIGTA review 
        did not identify any instances where taxpayers were adversely 
        affected, but not following legal and internal guidelines could 
        result in abuses of taxpayer rights.\37\
---------------------------------------------------------------------------
    \37\ Legal and Internal Guidelines Were Not Always Followed When 
Conducting Seizures of Taxpayers' Property (Reference Number 2004-30-
149, dated August 2004).
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  --Illegal Tax Protestor Designations.--The IRS is prohibited by law 
        from designating taxpayers as ``illegal tax protestors'' but 
        may refer to taxpayers as ``nonfilers.'' TIGTA has reviewed the 
        Master File for illegal tax protestor designations. We found 
        that the IRS has not reintroduced such designations on the 
        Master File, taxpayer accounts that were formerly coded as 
        illegal tax protestor accounts have not been assigned similar 
        designations, and current IRS publications do not refer to 
        illegal tax protestors. However, a few illegal tax protestor 
        references still exist in manuals, job aids, computer systems, 
        and isolated case files.\38\
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    \38\ Fiscal year 2004 Statutory Audit of Compliance With Legal 
Guidelines Prohibiting the Use of Illegal Tax Protester and Similar 
Designations (Reference Number 2004-40-109, dated June 2004).
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  --Denials of Requests for Information.--The IRS improperly withheld 
        information from requesters in 4.4 percent of the Freedom of 
        Information Act \39\ and Privacy Act of 1974 \40\ requests, and 
        14.6 percent of the 26 U.S.C.  6103 requests reviewed.\41\
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    \39\ 5 U.S.C.  552.
    \40\ 5 U.S.C.  552a.
    \41\ Improvements Are Needed to Ensure Compliance With the Freedom 
of Information Act (Reference Number 2004-40-064, dated March 2004).
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  --Collection Due Process.--IRS Appeals Officers and Settlement 
        Officers substantially complied with the requirements of the 
        law when conducting collection due process hearings. However, 
        the Settlement Officers did not always address all the issues 
        raised by the taxpayers.\42\
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    \42\ Appeals Complied With the Provisions of the Law for the 
Collection Due Process (Reference Number 2004-40-067, dated March 
2004).
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    Neither TIGTA nor the IRS could evaluate the IRS's compliance with 
three RRA 98 provisions since IRS information systems do not track 
specific cases. These three provisions relate to: restrictions on 
directly contacting taxpayers instead of authorized representatives, 
taxpayer complaints, and separated or divorced joint filer requests.

      SECURING IRS EMPLOYEES, FACILITIES, AND INFORMATION SYSTEMS

    As the Nation's primary revenue collector and an integral part of 
the Nation's critical infrastructure, the IRS is a prime target for 
anti-government protestors, international terrorists, and other 
extremists. Millions of taxpayers entrust the IRS with sensitive 
financial and personal data, which are stored and processed by IRS 
computer systems. The risks that sensitive data or computer systems 
could be compromised and that computer operations could be disrupted 
have increased over the last few years due to the external threats 
noted above and the increased connectivity of computer systems. In 
addition, IRS systems and data are vulnerable to unhappy taxpayers and 
disgruntled employees, as well as natural disasters. Although many 
steps have been taken to limit risks, IRS systems and taxpayer 
information remain susceptible to threats that could impact the 
confidentiality, integrity, and availability of data and information 
systems.
    For the past 4 years, TIGTA assessments have concluded that the 
security infrastructure and the applications that guard sensitive data 
are weak because of inadequate accountability and security awareness, 
as well as insufficient training for key security employees. The IRS 
has focused on technical solutions to this issue, but the primary 
causes are managerial and operational factors. For example, in 2004, 
TIGTA found that while security roles and responsibilities have been 
defined, we continue to identify significant security weaknesses 
throughout the IRS that can be attributed to employees not fulfilling 
their responsibilities.\43\ This results in the IRS failing to 
establish an organizational culture that strongly emphasizes the 
security and privacy of taxpayer data. In addition, some disaster 
recovery plans require additional development, testing, or personnel 
training to ensure that the IRS can quickly recover in the event of a 
disaster.
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    \43\ Computer Security Roles and Responsibilities and Training 
Should Remain Part of the Computer Security Material Weakness 
(Reference Number 2004-20-155, dated September 2004).
---------------------------------------------------------------------------
    TIGTA has also identified security weaknesses in a number of IRS 
systems. For example, the IRS envisions the Security Audit and Analysis 
System (SAAS) as the audit trail collection and reporting system for 
the IRS's modernized applications. To date, no modernization 
applications are employing the SAAS for this purpose. This failure to 
employ the SAAS for audit trail collection and reporting results in at 
least two weaknesses. First, the IRS could deploy modernization 
applications without proper audit trail controls in place. Second, the 
IRS may spend additional resources to employ an application-specific 
audit trail that is not consistent with the IRS's architecture and 
would, in essence, represent a double investment in audit trail 
controls. Furthermore, the SAAS was accepted by the IRS despite the 
fact that it did not meet performance requirements.\44\
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    \44\ For example, the SAAS users cannot query the audit trail 
information to generate reports. In addition, the functionality and 
software performance problems of the SAAS prevent the IRS business 
units from using it to identify questionable activities on modernized 
applications. See The Audit Trail System for Detecting Improper 
Activities on Modernized Systems Is Not Functioning, (Reference Number 
2004-20-135, dated August 2004).
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    The IRS has taken several positive steps toward improving security 
in the IRS. In October 2003, the IRS combined key security activities 
into a single organization to promote better performance and consistent 
customer focus. Adequate security policies and procedures have been 
established and, in most cases, the IRS has the necessary hardware and 
software to provide adequate system security. While the IRS has become 
a leader in government under this management structure, it must 
emphasize the importance of security to its employees.
    For the IRS to make the largest strides in improving computer 
security at a relatively low cost, managers and employees must be aware 
of the security risks inherent in their positions and consider security 
implications in their day-to-day activities. Thus, IRS business unit 
managers should be held accountable for the security of their systems 
and key security employees should be adequately trained to carry out 
their responsibilities. It is also vital that the IRS continues to 
refine its plans and capabilities to manage emergency situations in a 
manner that protects employees and allows restoration of business 
operations in a timely manner. In addition, aggressive network control, 
monitoring, and incident response capabilities are necessary to prevent 
incursions into IRS systems from external and internal sources.

            INTEGRATING PERFORMANCE AND FINANCIAL MANAGEMENT

    The President's Management Agenda aims to place a greater focus on 
performance by formally integrating it with budget decisions. In 
addition, without accurate and timely financial information, it is not 
possible to accomplish the President's agenda to secure the best 
performance and highest measure of accountability for the American 
people. The IRS has made some progress; however, integrating 
performance and financial management remains a major challenge.
    The IRS has achieved mixed success in establishing long-term goals 
to integrate performance and financial management. During the fiscal 
year 2005 budget formulation process, the IRS took the important step 
of aligning performance and resources requested. The IRS also modified 
its budget and performance plans to include more customer-focused and 
``end result'' measures. However, TIGTA believes the IRS must continue 
to integrate performance into its decision-making and resource 
allocation processes to completely achieve an integrated performance 
budget.
    The IRS also continues to analyze the critical data needed to 
develop long-term enforcement outcome measures. For example, the IRS 
released the first results from its National Research Program and they 
provide fresh data on taxpayer voluntary compliance levels--the first 
in more than a decade. Such data is essential to establishing 
enforcement measures and effectively allocating resources to related 
activities. The IRS, however, needs to develop a more strategic 
approach to the entire tax administration system. Such an effort would 
better identify the characteristics of an effective and efficient tax 
administration system, help pinpoint desired outcomes, and create a 
road map for the next decade that would complement the IRS's strategic, 
budget, and annual performance plans.
    The IRS's financial statements and related activities also continue 
to be of concern to IRS stakeholders. The GAO audits the IRS's 
financial statements annually. The audit determines whether the IRS: 
(1) prepared reliable financial statements; (2) maintained effective 
internal controls; and, (3) complied with selected provisions of 
significant laws and regulations, including compliance of its financial 
systems with the Federal Financial Management Improvement Act of 1996 
(FFMIA).\45\
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    \45\ Public Law No. 104-208, 110 Stat. 3009.
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    In audits of the IRS's financial statements, the GAO has concluded 
that the records were fairly presented in all material respects.\46\ 
The GAO, however, identified some continuing serious deficiencies in 
the IRS's financial systems, including control weaknesses and system 
deficiencies affecting financial reporting, unpaid tax assessments, tax 
revenue and refunds, and computer security. However, the IRS again had 
to rely extensively on resource-intensive compensating processes to 
prepare its financial statements. Without a financial management system 
that can produce timely, accurate, and useful information needed for 
day-to-day decisions, the IRS's financial stewardship responsibilities 
continue to be one of the largest challenges facing IRS management.
---------------------------------------------------------------------------
    \46\ Financial Audit: IRS's fiscal years 2003 and 2002 Financial 
Statement (GAO-04-126, dated November 2003).
---------------------------------------------------------------------------
                         MANAGING HUMAN CAPITAL

    Like much of the Federal Government, managing the extensive human 
capital resources at the IRS remains a serious concern. Workforce 
issues, ranging from recruiting to training and retaining employees, 
have challenged Federal agencies for years. The GAO, the Office of 
Management and Budget, and the Office of Personnel Management have all 
made the strategic management of human capital a top priority. 
Specifically for the IRS, recent reorganization and modernization 
efforts, such as the focus on e-filing, have made many jobs dealing 
with processing paper tax returns redundant.
    The Large and Mid-Size Business Division reported in its fiscal 
year 2006 strategic assessment that it will continue to lose 
substantial experience in the Revenue Agent position through attrition. 
Similarly, in the Small Business/Self-Employed Division, the human 
capital crisis continues to intensify as employees in key occupations 
increasingly become eligible for retirement, are lost through 
attrition, or migrate to other areas. Stagnant funding allocations have 
impacted the ability to attract new hires and retain existing 
employees. Thus, potential losses in critical occupational groups 
(e.g., Revenue Agents, Revenue Officers, Tax Compliance Officers), 
coupled with concerns regarding grade and competency gaps, further 
emphasize the need to strategically manage human capital.
    The Tax-Exempt/Government Entities Division is already understaffed 
to handle the current volume of customer calls. The Division's toll-
free service is still maturing and acquiring new customers; however, 
without additional staffing or system enhancements, the level of 
service will deteriorate. This issue requires immediate attention 
because the Division relies on quality toll-free customer service to 
help ensure voluntary compliance among its customers, since it has very 
limited resources for more traditional compliance activities like 
examinations.
    In contrast, the Wage and Investment Division has reported that it 
has made significant progress in the human capital area. Examples 
include increased employee use of electronic learning and training by 
demand, and improved technical assessments for identifying skill levels 
and training needs of employees. In addition, the Division effectively 
planned and realigned its workforce as the result of reduced workload 
demands and technological improvements. Even so, more work needs to be 
completed to attract and retain high-quality employees, to increase 
productivity and quality, and to provide equal employment opportunities 
for all.
    The Criminal Investigation function has also moved forward in this 
area. The function is implementing a computer-based knowledge 
management program, which can immediately identify current subject 
matter experts. Skill transfer programs will be implemented to provide 
continuity of technical subject matter expertise, and continuing 
education programs will provide updated training on emerging issues, 
strategies, and operational priority subjects.
    The President's fiscal year 2006 budget may offer some relief in 
staffing shortages; however, the overall training and acclimation 
process will take some time. The IRS must devote significant attention 
to managing human capital to overcome the challenges noted above.

  PROCESSING RETURNS AND IMPLEMENTING TAX LAW CHANGES DURING THE TAX 
                             FILING SEASON

    Each filing season tests the ability of the IRS to implement tax 
law changes made by the Congress during the year. It is during the 
filing season that most individuals file their income tax returns and 
call the IRS if they have questions about specific tax laws or filing 
procedures. Correctly implementing tax law changes is a continuing 
challenge because the IRS must identify the tax law changes; revise the 
various tax forms, instructions, and publications; and reprogram the 
computer system used in processing returns.
    This year's filing season includes significant tax law changes 
created by the American Jobs Creation Act of 2004.\47\ One significant 
tax law change for the 2005 filing season that many taxpayers are 
familiar with is the ability to deduct sales tax instead of State and 
local income tax. Changes to the tax law can have a major effect on how 
the IRS conducts its activities, how many resources are required, and 
how much progress can be made on strategic goals. Generally, the 
Congress makes changes to the tax law each year, so some level of 
change is a normal part of the IRS environment. However, certain kinds 
of changes can significantly impact the IRS in terms of the quality and 
effectiveness of service and in how taxpayers perceive the IRS.
---------------------------------------------------------------------------
    \47\ Public Law No. 108-357, 118 Stat. 1418 (2004).
---------------------------------------------------------------------------
    To date, we have seen no significant problems during the 2005 
filing season. During the 2004 filing season, most of the 123.1 million 
individual income tax returns received through May 28, 2004 (including 
over 60 million received electronically, an increase of nearly 16 
percent from 2003) were timely and accurately processed. TIGTA 
determined that the IRS correctly implemented the key tax law changes 
that affected 2003 returns. However, TIGTA has previously identified 
tax law changes that have not yet been effectively implemented and 
could result in loss of taxpayer entitlements and erroneous tax 
reductions. For example, TIGTA identified taxpayers that are continuing 
to receive erroneous deductions for student loan interest, taxpayers 
with potentially unclaimed Additional Child Tax Credits, and taxpayers 
that were allowed questionable ``dual benefits'' for the tuition and 
fees deduction and the education credit.\48\ These tax law changes must 
be effectively implemented to fairly apply the law to all taxpayers.
---------------------------------------------------------------------------
    \48\ The 2004 Filing Season Was Completed Timely and Accurately, 
but Some Tax Law Changes Have Not Been Effectively Implemented 
(Reference Number 2005-40-016, dated Dec. 2004).
---------------------------------------------------------------------------
    I hope this discussion of the major challenges facing the IRS aids 
you in your consideration of the IRS's appropriation for fiscal year 
2006. Mr. Chairman and members of the committee, thank you for allowing 
me to share my views. I would be pleased to answer any questions you 
might have at this time.

    Senator Bond. Thank you very much, Mr. George. We will try 
to go 5 minutes each for questioning so all of us have an 
opportunity to go. Now, we will go as long as we can stand up 
to it. So let me begin.
    Mr. Everson. As long as you can stand up to it.
    Senator Bond. I haven't lost too many witnesses at the 
witness table but there have been one or two occasions. I doubt 
if this will be the case today, but looking at BSM and the 
customer account data engine, CADE, which is essential for the 
BSM, we are concerned that IRS has re-baselined the program and 
has a moving set of requirements which obscures oversight and 
allows success to be measured in terms of garbage in rather 
than revenue coming out.
    But let me ask two questions to begin. BSM, the biggest 
challenge you have, is fast approaching $2 billion, with CADE 
as a key feature. I would like to know, No. 1, how much will it 
cost to include all 120 million individual taxpayers? Moreover, 
since CADE currently only allows for the processing of the 
easiest returns of taxpayers using the EZ form, how many filers 
will be processed during the 2004 tax season by CADE?

                     BUSINESS SYSTEMS MODERNIZATION

    Mr. Everson. Let me back up and talk about the whole 
program for a moment, if I may? I agree with your 
characterization. As I stated, the whole program has been too 
costly and delayed, and didn't get us the functionality we 
needed. When I came in 2 years ago I immediately commissioned a 
set of reviews. The set of reviews were consistent, the four 
different reviews, and the conclusions that were reached were 
that No. 1, we were too ambitious. We had been encouraged by 
the oversight board and others to move very quickly. And we 
spent hundreds or millions of dollars; the funding stream on 
this was $400 or $500 million a year at one point. We felt we 
needed to resize the portfolio. We had inadequate business unit 
involvement, meaning customers, people that were going to use 
these things in the process. We changed that as well. We had 
uneven performance by the contractor. Now, it would be easy to 
blame everything on the contractor, but I don't think that was 
appropriate. The final thing is we had very little in the way 
of outside experts coming in and helping us, in terms of our 
staff. We've addressed each of those issues and I think that we 
have, as I said, turned a corner. We've reset dates and we met 
those dates last year in both CADE and in the financial system 
that we put on line.
    So we brought down the funding level from about $400 
million to this $200 million and we straight-lined it in fiscal 
year 2006, even though I think we could have made a case to 
increase it further this year. We want to proceed carefully and 
what we're doing now, Mr. Chairman, is limiting our ongoing 
work to just three areas so that we can stay on it. We're going 
to continue to work on this master file, the processing that 
includes the EZ's, and right now I think we're going to get 1.3 
million or 1.5 million out of the total filing season for 2004. 
I can't tell you because we're not looking at how quickly this 
will ramp up over the years, what the remainder of the CADE 
program will be. We will get that number to you as soon we've 
done some additional work on it. The second piece we're working 
on right now, as I indicated, is the collections. There's 
several hundred billion dollars of monies that haven't come in 
to the government. We need to update our systems so that we can 
work better, including the pieces done by the private 
collection agencies. That is the thrust of our modernization 
effort.
    And the last is electronic filing. We have mandated 
electronic filing for corporations. This change will speed up 
our audits. It cuts 1\1/2\ years out of the audit process, 
which now goes 5 years. It's way too long for us to detect 
what's going on in these corporations. We're working on those 
three areas, very limited, and I think we will meet our 
deadlines and our cost targets as we go forward because our 
record in the last year has been good.
    Senator Bond. Thank you, Commissioner. I would like to turn 
to Mr. George. How can the BSM be successful, within what time 
frame and at what cost? What is the TIGTA assessment?
    Mr. George. That's a very difficult question to answer, Mr. 
Chairman. When you look at CADE and then look at the fact that 
it's over $130 billion, $130 million over budget, and 30 months 
behind schedule already, and then of course when you look at 
the TSM, the Tax Systems Modernization effort that occurred 10 
years ago, it really doesn't give one a lot of encouragement 
that something as massive as BSM will be any much more 
successful unless a complete understanding as to what went 
wrong with TSM is had. I don't question that the current 
commissioner is examining the problems and has examined the 
problems of tax system modernization, but it involves not only 
the major prime contractor, Computer Science Corp, but many 
subcontractors. And we are in the process, Senator, of 
conducting audits on some of those sub-contractors and we'll 
share that information with this committee once those ordered 
audits are complete.
    Senator Bond. We appreciate your continuing to share this 
information with us. This hearing is just the beginning of our 
inquiries and we look forward to having that information.
    Let me ask one quick question to the Commissioner. Since 
the IRS is only getting 11 of the 15 items promised with the 
next CADE delivery in July, can you tell me how much the 
government will be refunded for the four dropped items?

                      CUSTOMER ACCOUNT DATA ENGINE

    Mr. Everson. I'm not sure to which items you are 
specifically referring. I will certainly take a look at that 
and provide the information for the record. We've had ongoing 
discussions and negotiations with the contractors and reached 
some pretty tough deals over the last year, where we've changed 
the way we're dealing with them and the relationship is subject 
to renegotiation. I want you to know my commitment here. I meet 
monthly with the President and chief operating officer of CSC 
and I've done that for a year and a half now, and their 
performance has improved significantly. We are continuing to 
hold their feet to the fire to make sure we get everything, 
every nickel's worth that the government pays.
    Senator Bond. Thank you very much, Mr. Commissioner. 
Senator Murray.
    Senator Murray. Thank you, Mr. Everson. I appreciate your 
testimony and as I talked about in my opening statement the IRS 
is talking about significant cuts to taxpayer services in order 
to pay for enforcement. You're proposing closing taxpayer 
assistance centers, reducing telephone service, eliminating 
phone-routing sites, discontinuing TeleFile, and reducing 
communications with practitioners. Last year, you published a 
comprehensive reorganization plan but those reductions are 
nowhere to be found in that plan. Why are you now suddenly 
proposing cuts when they were never a part of your recent 
reorganization plan?

                IRS STRATEGIC PLAN AND TAXPAYER SERVICE

    Mr. Everson. Do you mean you're citing a strategic plan? 
I'm not sure what you mean by the reorganization plan.
    Senator Murray. The strategic plan that was published last 
year.
    Mr. Everson. We have set out a strategic plan and it has 
three objectives, which are to continue to maintain and improve 
taxpayer services, to significantly enhance enforcement, and to 
modernize the IRS. And I think that plan has guided all of our 
internal work and our budget discussions. Now, the IRS is not 
protected from overall fiscal realities so we have been asked 
to do our share and we are going to do our share to tighten our 
belt where we can. What we've done is gone through a very 
detailed process, and my two deputies are leading a lot of 
discussions to tighten up where we can. We're making a lot of 
increases in productivity and efficiency. You mentioned 
reducing phone services as an example. We've taken a look at 
the phones. Right now we provide 15 hours of access. We're 
going to bring that down to 12 hours. That is comparable to 
what Social Security and Blue Cross/Blue Shield do. Ninety-
three percent of the calls that come in fall within those 12 
hours. We believe that we can save money through less overtime 
pay, but not reduce services there.

                        TAXPAYER SERVICE CENTERS

    Closing the tax centers, I understand that that will cause 
some disruption of services. It is relatively higher cost 
services and our decisions here are based upon just as GAO 
said, an increase in things like the VITA volunteer centers. 
There are 14,000 VITA sites around the country. There will 
necessarily be a shifting of work to these sites. We see other 
changes. For instance, the calls coming into our telephone 
system now are down 6 or 7 percent this year. That reflects 
movement activity over to the Internet, where contacts have 
doubled.
    Senator Murray. But there are always people who don't have 
access to the Internet.
    Mr. Everson. Absolutely, Senator. You look at tele-file as 
an example where in terms of individuals, that usage has been 
going down 10 or 15 percent a year. I've asked our people to 
come up with what were the tough choices, instead of bleeding 
away and cutting everything over a period of years by 5 percent 
or something. To take a look at what we do and then make the 
hard choices to not do 110 different things, to strip off some 
of those so that we can do well what we ought to do. There are 
some tough choices here. I agree with you.
    Senator Murray. But your budget says you want to improve 
taxpayer service by, ``make it easier for people to participate 
in the tax system'', and when you close centers that puts undue 
hardship on a number of people who are already living in more 
remote locations to travel further. So that is at odds with 
your statement, but let me ask you, how do you plan to measure 
the adverse impacts of these proposals on taxpayers?

                        TAXPAYER SERVICE CHANGES

    Mr. Everson. What we have done is gone through a process 
that looks at five different considerations. We ended up 
developing two models and we've taken input from a variety of 
people, including an advisory committee, an IRS advisory 
committee, and I----
    Senator Murray. It's a little hard to read.
    Mr. Everson. I think you have copies of this. It's my 
understanding, anyway. If you don't, I'll give you mine.



    We've looked across our system. We have 408 of these 
taxpayer assistance centers and have compared them using some 
three dozen factors that we have loaded into the models we've 
run. There are over 13,000 different data points, is my 
understanding. We're looking at geography. As you say, how far 
is it to the next TAC? How far is it to the next volunteer 
center? We'd look at the cost. Obviously, a part of this is 
trying to drive down cost and hold the funding to a reasonable 
cost. It includes employee cost, it includes a facilities cost. 
We've looked at workload, obviously. Some TACs that are in more 
rural states have one or two people as opposed to in larger 
cities. And we've looked at demographics, changes in the 
country. We had a team of 12 people that's been doing this work 
for the last several months and we've ended up developing two 
models. This was after an initial conversation we had with the 
taxpayer advocate who has said, make sure you're looking at 
things that affect taxpayer access and that gets more to this 
question of workload. And initially a model that we had had 
something like 37 TACs being closed. They were all in big 
locations, big cities, and high cost operations, but what we've 
now done is refine this to two different models. One of them 
ends up with 67 TACs closed in 27 States across the country. 
And that gives a slightly greater weight to employee facilities 
costs. The other ends up with 105 closed and that gives more 
weight to issues like workload and demographics. And the 
difference is, in some States you obviously end up with a 
deeper impact like in Washington or North Dakota or any place 
in going to the second model. Our inclinations are to go to 
option No. 1. We've been reviewing these options with others 
and we haven't reached any final decisions. We're still 
refining this.
    Senator Murray. Well, let me ask Mr. George, because in 
your formal testimony you expressed concern to us that the IRS 
may disrupt a balance between customer service and enforcement 
by closing some of these centers. Then you question whether the 
IRS has sufficient data to conclude the taxpayers that use 
these centers would be willing and able to use alternative 
methods to gain tax preparation assistance from the IRS. So 
given all of these uncertainties you've just seen do you 
believe the cost savings closing these centers will yield is 
worth the sacrifice that will be endured by taxpayers?
    Mr. George. Senator, we have no evidence that it will or 
won't just because the data is not there. But the one thing 
that I would note that is striking in terms of what is missing 
from the components of the criteria that the commissioner noted 
is the behavior of those who use the taxpayer assistance 
centers. As was noted we truly do not know what options they 
will or will not pursue of this and I do not believe that the 
Internal Revenue Service has considered that as a factor when 
it's considered.
    Senator Murray. Are you concerned that it's not a fair way 
to evaluate the system?
    Mr. George. I think it is not a complete way in which to do 
it.
    Senator Murray. Can you tell me exactly what you think 
needs to be added to it?
    Mr. George. I think a very comprehensive survey of the 
users of the taxpayer assistance centers using a methodology 
which is reasonable given the large numbers that are affected 
by this, something of that sort, Senator.

                          LEGISLATIVE LANGUAGE

    Mr. Everson. If I could prolong this for just a second. I 
want the committee to understand what the stakes really are 
here. I mentioned in the opening statement the impact if we're 
constrained from taking this action. We've gone through a very 
deliberate, careful process to try to squeeze down into the 
President's service mark. If you tell us not to do this and you 
use the President's mark for service as the ceiling, you will 
be doing things like forcing us into further cuts on services 
for telephones, stopping basic transcription of information 
like K1 data which we use for high income audits. We will be 
reducing support to our VITA programs because we have already 
gone through a whole series of belt tightening exercises over 
recent years. So I do caution you. Obviously, we will do 
whatever is said here but unless you----

                      EFFECT OF SERVICE REDUCTIONS

    Senator Murray. Are you telling us costs savings for option 
No. 1 or option No. 2?
    Mr. Everson. They both cost about $52 or $54 million, I 
can't remember which is which, but they're comparable for the 
two options.
    Senator Murray. For what time period?
    Mr. Everson. That is what comes out next year.
    Senator Murray. But we don't know whether that will mean 
reduced number of taxes paid because people don't get the 
correct assistance.
    Mr. Everson. I think that if we were to attempt to quantify 
that, it would be an excruciatingly long and detailed process 
because I've not seen any research that ties that kind of 
service changes directly to taxes paid give that answer. You 
would have to wait years to get that answer.
    Senator Murray. That may well be but if people do their 
taxes accurately the first time around it does save us money in 
not having to go back and forth with them.
    Mr. Everson. I agree with that. I agree with what the 
chairman said that if we simplify all this we would get a lot 
better answers. Now we're working in other areas, like the VITA 
sites, where TIGTA and others have said the quality of their 
return preparation isn't what it ought to be. We're trying to 
increase that service so those are the kinds of considerations 
we have getting at just what you're talking about.
    Senator Murray. I'm out of time.
    Senator Bond. Thank you very much, Senator Murray. Senator 
Dorgan.
    Senator Dorgan. Mr. Chairman, thank you very much. I thank 
you and the ranking member. At one point, I was a chairman and 
then ranking member of the subcommittee that funded the IRS. 
I've always been very supportive of the IRS. I'm a former Tax 
Administrator but I'll tell you over the years you almost run 
out of patience on this. This year we're told modernization, a 
program for which we have literally shoveled money out of this 
Congress, is behind schedule, over budget, and probably will 
produce a product less valuable than anticipated. You know at 
some point this is not the type of science that requires 
sending a person to the moon. Modernizing the computer system 
of the Internal Revenue Service ought to be able to be done. It 
is really disappointing to hear these reports and we do it 
every year. It's not just on your watch. Behind schedule, over 
budget, less valuable than we expect.
    With respect to the tax gap I just wanted to make a couple 
of comments and ask you, Mr. Commissioner, to respond. The tax 
gap continues to grow. I think we need to increase enforcement 
in order to respond to that but we can't increase enforcement 
at the cost of closing taxpayer assistance centers in my 
judgment. For 2 years I put money in your budget for the 
Inspector General to go have people anonymously visit taxpayer 
assistance centers every 2 months and tell us about the quality 
of the taxpayer assistance. One of the reasons I did that is 
because a large percent of the time the IRS employees 
themselves were giving inaccurate information and couldn't 
complete the tax returns properly. The results were still 
pretty miserable, frankly. The Inspector General now has 
reported about 44 anonymous visits to IRS Volunteer Income Tax 
Assistance centers and here's what they found. These are the 
centers that you would increase I think if you close some 
taxpayer assisted centers. From February to April last year 
Inspector General employees conducted 44 anonymous visits to 
VITA sites. Thirty-five tax returns were prepared. None of them 
were prepared correctly. Of the 35, if 28 of those returns had 
been filed the IRS would have incorrectly refunded $26,000. If 
the remaining 7 returns had been filed, the taxpayers would 
have failed to receive $4,500 in refunds. For 9 of the 44 
visits, tax returns were not prepared at all because the VITA 
sites weren't open, had been relocated or too many people were 
in line. But the fact is that of the 35 people who actually got 
help, none of them got correct help. All of them, 100 percent, 
incorrect. And so I mean to close taxpayer assisted centers 
themselves--that themselves have a pretty miserable record. 
Relying on VITA sites, I think is the wrong thing.
    Let me just say one other thing. I think big multinational 
corporations are having a field day with the Internal Revenue 
Service on the issue of transfer pricing. They're now doing 
business all across the world so you have related companies in 
this country and abroad. They are buying and selling to each 
other in order to move profits out of this country so that they 
can't be taxed. They inflate prices, or deflated prices as it 
were, and let me give you some examples. Tweezers, $4,800 each 
purchased from your own subsidiary. That is an inflated price. 
Safety pins, $29 each. Deflated prices, tractor tires for $7. 
Pianos for $50. Missile launchers for $52. There are two 
professors, Doctors Simon Pak and John Zdanowicz at Penn State 
and Florida International University, respectively, who are 
doing some research, that I helped fund through an earmark to 
determine about how much tax revenue we may be losing due to 
abnormal pricing. The IRS is using the arms-length method to 
deal with their pricing abuses. It's like trying to take two 
plates of spaghetti and fuse the ends together. It is 
impossible and the corporations are having a field day. In my 
judgment, there's massive tax avoidance and nobody seems to do 
much about it. And there are some obvious answers to it. I 
don't have time to deal with it here but I wanted to make this 
final point.
    We need more enforcement, better enforcement, smarter 
enforcement, and we need more taxpayer assistance and taxpayer 
assistance that is accurate. And if that requires additional 
funding we need to do that. You can't have a tax system you 
impose on the shoulders of the American people and say to them 
you comply even though paid IRS employees can't figure it out 
when a citizen walks up to get help. So you've got a tough job 
Mr. Everson. I want to be supportive of you but I'm telling you 
I'm really discouraged year after year to see modernization 
apparently failing and to see all of these other things pile up 
and the tax cap grow much larger. Now, is that a mouthful, and 
you deserve an opportunity to respond.

                               COMPLIANCE

    Mr. Everson. You covered a lot of ground there. Maybe I'll 
be somewhat selective in what I respond to. Let's go to this 
chart.


    No one has spoken more aggressively or acted more 
aggressively to go after corporations and high income 
individuals than I have since coming onto this job 2 years ago. 
We asked for more money last year. We didn't get it all, and 
the President's request again gives a great deal of focus, as 
you can see, to corporations. We're asking for $63 million in 
new funding, and for high-income individuals compliance we're 
asking for $46 million. I agree with your assessment. The 
corporations, it's a relatively small portion of the tax gap. 
We did not update the corporate tax gap in our work, but I 
suspect that the gap is understated. We are working 
aggressively on this. We're doing something like establishing a 
joint international tax shelter information center here in town 
with counterparts from Britain, Australia, and Canada. We're 
sharing information and we're seeing many of the things you're 
talking about. Corporations, in too many instances, are not 
just interested in going through a low tax jurisdiction, they 
want to set up transactions that have two different treatments 
in two different taxing jurisdictions, and then no taxes paid. 
So we're working on this very aggressively. We do need that 
funding to keep giving that problem prominence, and we do that 
even though, in terms of a tax gap, the larger portion of the 
tax gap is in individuals and an understatement of income, 
largely associated with schedule C, their own sort of business 
activities. We give that prominence because of the sense of 
fairness that is so important to average Americans. They can't 
feel that just because you're rich or you're a company you get 
away with it. So I'm with you a 100 percent on that and so is 
the President in terms of the allocation of resources.

                     BUSINESS SYSTEMS MODERNIZATION

    BSM. I think there's a risk here that the committee is 
drawing the wrong impression. I do not disagree at all that 
this has been a troubled program, and it's tempting to say 
let's cut that program down to a $100 million or put further 
controls on it. That would, in my view, be exactly the wrong 
thing to do. We are just now getting a handle on this. We're 
just now delivering the systems. I think that the problems that 
Inspector General stated are absolutely correct, but that was a 
view from 2 years ago. We've acted and we are turning a corner 
here and if we act as if nothing has happened then you will 
choke it off and then we really will be at risk of this system 
cratering because we won't move forward. These fiscal pressures 
as you know, Senator, are not going to get any easier. If we 
don't invest in this technology, you won't get the services. 
Right now we're at over 50 percent of the returns being filed 
electronically. That is good news. It helps everybody. If we 
don't keep going on this--hold me accountable to do it right 
for sure--but if we don't continue to have a baseline of 
funding--and this $200 million is a very modest amount compared 
to where we were at $400 million or $500 million just 2 or 3 
years ago--I fear we will really not make it.
    Senator Dorgan. Mr. Chairman, could I just observe that if 
you are always turning a corner you may be going in a circle. 
The reason I say that and Mr. Everson I want you to succeed and 
I want to work with you and be helpful to you but for 8 years 
working on this subcommittee or some derivation of it, I've 
been told by Commissioners we're turning the corner. At some 
point it is apparently a track that we're on. So I guess in the 
final analysis, Mr. George, your work is very important. You 
tell us exactly what's happening down there. Mr. Everson, we 
want you to succeed. This is not criticism. It is frustration. 
So, Mr. Chairman, thank you for allowing me that therapy.
    Senator Bond. Senator Dorgan, I hope you feel better.
    Senator Dorgan. Much better. Thank you.
    Senator Bond. We look forward to hearing your suggestions 
how we can make sure we're turning the corner in the right 
direction based on your experience. Senator Murray.
    Senator Murray. Thank you very much. Mr. Chairman, I have a 
Veteran's Committee hearing that I want to get to so let me 
just ask you a quick question on the tax gap. Are there any 
findings in your report that are going to cause you to change 
your area of emphasis on enforcement?

                           COMPLIANCE BUDGET

    Mr. Everson. I would say that we've looked at this and the 
results are preliminary, Senator. We're going to be refining 
them over the course of the year. That is why we've established 
this range. The statisticians are continuing to go through all 
of these areas. I have been struck by the fact that our 
allocation of resources is generally consistent with what we're 
seeing in the gap. You can see that we're asking for more 
money. Last year we didn't really touch individuals and small 
businesses very much compared to the high income and the 
corporation. This year in the request we're starting to move 
past those two areas to cover that area more--that is where the 
big preponderance of the gap is. And so I think what we're 
doing here is generally consistent. The final point I would 
make for you to consider is that we've got two buckets of 
money: criminal activity and the tax-exempt area. They're not 
as directly tied to the gap. It's very tempting for the 
committee to just fund the things that get you the very best 
return, but we have other responsibilities, like maintaining 
the integrity of tax exemption, that are very important too. So 
while I think our resource allocation is consistent with the 
findings, we have to make sure we go beyond just the tax cap.
    Senator Murray. Okay. Thank you very much. Thank you, Mr. 
Chairman. I appreciate it.
    Senator Bond. Thank you very much, Senator Murray. I 
believe that we do need to support via some funding but we need 
clear benchmarks and requirements. We need a plan to lay out a 
straight path forward, so we know we're getting there. Mr. 
George, I'm sure, will be all over it to help us to determine 
that we're on that right path. TIGTA reported that the Security 
Audit and Analysis System that was developed to audit online 
activity of IRS employees was accepted by IRS even though its 
required functions IRS paid for were not operating. How much 
did it cost? What weaknesses still exist? And what are you 
doing to make the system work as advertised?

                              IT SECURITY

    Mr. Everson. IT security is an issue of paramount concern 
for us. It is something that we've recognized. After I arrived 
at the agency, we stripped out our security functions from a 
variety of pockets in the agency and put together one mission 
assurance organization. One of my two deputies gives it the 
appropriate providence. I think that is bearing results. We've 
never had any penetrations from the outside of the IRS into our 
systems. TIGTA has correctly pointed out, as have others, that 
when you're inside the system there's maybe too much latitude, 
and we do have some problems where things can get compromised 
from time to time. We're working on that. We need to address it 
further. I think we're making progress. All I can tell you is 
that it is the subject of regular conversations at the most 
senior levels. So we're not going to move off this. We're going 
to continue to give it the prominence it needs because we don't 
want the security compromised. We recognize the terrible 
ramifications of that.
    Senator Bond. So you're telling me that we saw this theft 
of personal information from ChoicePoint by criminals accessing 
data, posing as legitimate users, but you're telling me that 
nobody has been able, from the outside, to access the IRS 
system? It is not vulnerable to similar attack?
    Mr. Everson. That is correct. Now I don't want to sound 
overconfident about that. But we have really good people who 
continue to work on that. People try to penetrate the system, 
Senator, from around the world everyday, but we've got good 
firewalls there. And we're going to continue to be vigilant to 
make sure we're doing absolutely everything we can to prevent 
that. I think TIGTA would certainly say within the firewalls 
we've got some more work to do as well.
    Senator Bond. I was kind of concerned when TIGTA called 100 
IRS managers and employees pretending to be help desk 
employees, and they were able to convince 35 managers and 
employees to reveal their account name and change their 
passwords to one suggested by TIGTA. Doesn't that show the 
likelihood of defeating security measures? What can be done to 
make sure that that problem does not recur?
    Mr. Everson. That's exactly the kind of thing I'm saying 
internally, within the firewalls, and we're obviously moving 
forward on a lot of what's in that report, and other measures. 
I think it is an area of continuing discussion and there's a 
lot of focus from TIGTA as we move forward on their stuff.
    Senator Bond. Mr. George, what's your comments on that?
    Mr. George. Well, Senator first of all to quote former 
Commissioner Sheldon Cohen, he thinks he is an honest man who 
has never been given the opportunity to cheat. And in effect 
that there are opportunities, that additional firewalls were 
maintained. Yes that would enhance the strength, in terms of 
outside attempts. But there's no question that internal access 
by disgruntled employees, it's a great risk to the IRS. And now 
that the Commissioner has restated his commitment to address 
that, I am more optimistic that something will and can be done. 
But it is something that TIGTA certainly will be monitoring, 
and we'll report back to you on.
    Senator Bond. Thank you, Mr. George. Well, the Taxpayer 
Service Budget, Commissioner, assumes a reduction of $134 
million through taxpayer service reengineering. Until this 
week, however, we had not received details on how the IRS plans 
to achieve these savings. The Taxpayers Advocate's testimony, 
as you know, said increasing enforcement and reducing service 
is based on more of an instinct than solid research. Can you 
lay out for us, and give us further detail, for the record, if 
that's appropriate, on how you arrive at these proposed cuts. 
We've had some discussions----

                     TAXPAYER SERVICE REENGINEERING

    Mr. Everson. I'm absolutely happy to do that. We've had a 
long process of 2 or 3 months of detailed planning and weighing 
of options. And I think it is a sound proposal and we will 
provide you those details.
    [The information follows:]
     Taxpayer Service Fiscal Year 2006 Budget Reduction Initiatives
                               assistance
    Closing selected Taxpayer Assistance Centers realigns service with 
changing trends.--TACs are one of the most expensive methods of 
customer service. The number of people accessing TACs continues to 
decline as more taxpayers use the IRS toll-free telephone system to get 
answers to their questions. Web-site use and e-filing continues to 
rise. Volunteer tax preparation and other outreach assistance is also 
increasing. The IRS created a business model based on five neutral 
criteria to identify the most appropriate TACs to close. Based on 
internal and external input on the model, taxpayer-centric needs, such 
as workload, geography, and demographics were given greater weight than 
labor and facilities costs. The estimated savings are $45 million-$55 
million.
    Changing the Toll-Free Telephone Hours of Operation.--The hours of 
toll-free telephone operations will change beginning October 2005 from 
15 to 12 hours 8:00 a.m. to 8:00 p.m., Monday though Friday, in local 
time zones. Current call volume is low during the late evening and 
early morning. Ninety-three percent of the calls come in from 8 a.m. to 
8 p.m. The change in level of service is minimal. The estimated savings 
are $10 million-$16 million.
    IRS will reduce Electronic Tax Law Assistance (ETLA) service.--The 
will reduce the level of service in fiscal year 2006. Less than 150,000 
tax law inquiries were received in fiscal year 2004. This compares with 
over 8.6 million tax law inquiries handled via our toll-free lines. The 
IRS will discontinue providing ETLA in early fiscal year 2006 for 
customers living in the United States. ETLA will continue for customers 
located overseas (Taxpayers living abroad and Military Personnel) 
because this is their only toll-free communication tool. The estimated 
is still being evaluated but is less than $1 million.
    The IRS is closing non-continuing call-sites.--The IRS will 
consolidate work in its Boston, Chicago, Des Moines, Houston, Omaha, 
and Wichita telephone call-sites into its larger phone centers for 
greater efficiency and lower costs. The change will be invisible to 
customers. Taxpayers won't notice a change; their calls are currently 
routed and answered nationwide. The IRS has 26 call-sites nationwide--
these six non-continuing sites are satellites of the 26 sites. 
Nationwide the IRS has approximately 15,000 employees providing 
customer service. Savings from staff realignment have not yet been 
finalized. Rent savings of up to $1.2 million will be achieved 
primarily in fiscal year 2007.
    Updates in processing of applications for Employer ID numbers 
submitted through the Internet.--The IRS will complete upgrades to its 
system for accepting applications through the Internet for employer 
identification numbers (EINs). The current system for accepting the EIN 
applications at the front-end of the process is automated. This will 
improve back-end processing of the applications. By September 2006, 100 
percent of the forms submitted through the Internet should be fully 
automated. The estimated savings are $2 million-$5 million.
    Efficiencies in managing customer accounts will result in 
savings.--The process improvements and productivity gains achieved over 
the past few years, along with the decline in correspondence from 
taxpayers who have account or tax law inquiries, have changed the need 
for the same staff levels. The estimated savings are $15 million-$17 
million.

                                OUTREACH

    Greater efficiencies in distributing tax products, increases in e-
filing and use of Internet to download tax products will decrease 
printing and postage costs.--For example: The IRS's forms distribution 
site will be more efficient and save staff, printing and postage 
resources as a result of consolidating operations from three sites to 
one site. Other savings include mailing out fewer tax packages because 
more taxpayers are filing electronically. The IRS will reduce excess 
quantities of tax products based on increases in e-filing and internet 
downloads of tax forms and publications, and by streamlining some tax 
products. The estimated savings are $5 million-$10 million.
    Discontinuing lower value products in outreach programs and 
reducing some program travel will have little affect on customers.--IRS 
will discontinue developing some lower value publications and outreach 
material used to support volunteer tax assistors and outreach partners. 
For example, the IRS will discontinue some small quantities of end-of-
season flyers, brochures and pamphlets used by its field staff, and 
reduce some operational travel. The estimated savings are up to $1 
million.
    Realigning and refocusing communications, outreach, and liaison 
efforts within the Small Business/Self-Employed (SB/SE) Division.--The 
merger will improve service to small business taxpayers and tax 
professionals, clarify the individual missions, coordinate programs, 
and minimize any overlapping responsibilities. Efficiencies gained 
through the realignment will allow the IRS to redirect staff resources 
to front line enforcement efforts. The estimated savings are $15 
million-$20 million.

                               PROCESSING

    IRS will discontinue TeleFile.--The IRS will end its TeleFile 
program after August 16, 2005. TeleFile allows taxpayers to file 
certain forms by telephone: Form 1040EZ, Income Tax Return for Single 
Filers and Joint Filers with No Dependents; Certain State individual 
tax returns, Form 4868, Application for Automatic Extension of Time to 
File U.S. Individual Income Tax Return, and Form 941, Employer's 
Quarterly Federal Tax Return. Decline in use for most forms (e.g., less 
than 4 million of the 16 million eligible EZ filers used TeleFile), 
coupled with increasing costs to maintain the system, and the growth of 
other electronic filing options led to the decision to end the program. 
The expected printing and postage savings is $4 million-$5 million.
    Improved efficiencies in processing tax returns.--The IRS will have 
additional savings due to improved efficiencies in its Service Center 
campus processing operations, through re-engineering of its processes, 
and because more taxpayers are e-filing or using computer software to 
prepare their tax returns. For example: The IRS is evaluating its 
current processing procedures so that it can reduce unnecessary labor 
costs, especially when the returns are prepared by taxpayers and 
practitioners using computer software. The IRS will improve its 
productivity rates in data transcription of data from the forms. The 
expected savings are $9 million-$12 million.
    Enhancements to processing of paper Forms 941 will improve 
productivity.--The IRS will modify its existing Service Center 
Recognition/Image Processing System (SCRIPS) to add a new application 
for processing paper Employer's Quarterly Federal Tax Return, Forms 
941. This will result in improved productivity rates and increased 
accuracy in data capture. Fewer additional seasonal employees will be 
needed. The estimated savings are $4 million-$6 million.

    Senator Bond.--We would also like to have Mr. George's 
review of it so we can take a look at it.
    You've already discussed the criteria that you're 
considering to close Taxpayer Assistance Centers. And you have 
not, as I understand it, made a determination which of the, on 
the blue chart, which methodology you're going to use.
    Mr. Everson. That's correct. I think we're leaning towards 
the option No. 1, which has the impact of the smaller number of 
sites being closed. But we're still assessing that over the 
next coming weeks.
    Senator Bond. All right. The tax gap you mentioned--how did 
you calculate the $4 received for every dollar of enforcement 
spending?

                          RETURN ON INVESTMENT

    Mr. Everson. The chart that you saw there of enforcement 
revenues, that's a pretty simple thing. We track the 
collections, which is the bulk of this money. We've got a small 
strip, a couple of billion dollars of monies that come in from 
document matching activities. And then the rest is from our 
audits. And we follow how much money comes in from each of 
those actions. And now that is turning back up, that is a 
comparison. That $43 billion, that's cash in hand. And that 
compares, as I said, to the total budget that you've given us 
of $10.2 billion. It's a gross simplification. The $10.2 
includes the $6 plus billion for enforcement, but also all the 
other money for processing returns or answering phones, or the 
outreach that we do. And I'm simply pointing out to everybody 
that you get $4:$1 on average. Now you get better than that, 
obviously, if you look only at enforcement programs.
    Senator Bond. If you took the audit function and the 
enforcement function alone, you might get a higher number?
    Mr. Everson. You would get a higher number, and what we try 
to do, Senator is run a balanced program here. We could invest 
in certain strips of activity that would get you $10:$1 or 
$20:$1, but then you would be ignoring other areas. And you'd 
be, maybe, going after more middle class people just on under 
reporting as opposed to trying to run a balanced system, where 
you go across that whole tax gap map. If you look at the tax 
gap map there are a lot of activities in there that you have to 
get after. And you have to show some enforcement presence 
across everything.
    Senator Bond. Mr. George, do you have any input on those 
figures?
    Mr. George. We're in the process now, Senator, of 
evaluating the methodology and the conclusions that you heard 
the Commissioner state. And so we will issue that report as 
soon as we can. And we'll give that to you.
    Mr. Everson. That $43 billion in the methodology has been 
audited by GAO years ago when that system was set up. So I 
think the integrity of that number is pretty well established.
    Senator Bond. Mr. George, as related by Senator Dorgan, 
your oversight of the VITA program had some pretty stunning 
results. Out of 35 VITA returns, they were zero for 35 in 
accuracy, which doesn't get you into a higher league certainly 
if you're batting zero. Did you present particularly difficult 
returns? How did you structure this?
    Mr. George. Senator, there's no question that the 
complexity of tax law is a factor. And so that then leads to 
the degree to which VITA volunteers are trained. So we do have 
some question as to whether or not that is being effectively 
done. Lastly, volunteers did not in effect follow normal 
procedures in many instances. Some of the mistakes that were 
made could have been avoided had they, for example used intake 
sheets properly and were supervised properly. The problems we 
found are something that we don't believe are insurmountable. 
Again, through proper training and through appropriate 
oversight. We think many of the problems could be avoided in 
the future.
    Senator Bond. Commissioner, what do you propose to do to 
fix that problem?

                              VITA PROGRAM

    Mr. Everson. Let me make a couple comments on this. I think 
that in response to your question, were these overly complex 
returns, the answer is yes. And in fact TIGTA is looking at 
this year, I believe both parties agree--and the Inspector 
General wouldn't notice because he wasn't here last year--a 
more representative sampling of the returns. It does not yield, 
based upon the work that is being done now, a good return or a 
good rate, but it doesn't yield a zero either. So I think that 
the change in the methodology of how the returns have been 
selected shows an improvement. Now we have taken their 
recommendations and are working on them with one exception. 
We've done more training; we're working on the software, and 
the whole series of things. We're making sure people are using 
the guide. There was some contention around one suggestion, and 
we backed away from the proposal, that we have IRS observers 
doing more onsite monitoring. We probably will end up doing 
this in the next filing season when we satisfy ourselves that 
it can be handled with the appropriate disclosure discussion 
with taxpayers before we do it. They had recommended that step. 
The Taxpayer Advocate felt that it was not an appropriate step. 
The volunteer organizations themselves, who do the bulk of this 
work, have told me that they think it is good idea. AARP, which 
does about half of this work, they told me they were fine with 
having IRS people there to watch what was going on. So I think 
we want to do that down the road, having organized it 
correctly. So we have a lot more to do here. To strengthen this 
area, I think what they're doing is helpful to us. And they're 
refining what they do and we're refining what we do. And we've 
got to do better.
    Senator Bond. IRS estimates that 740,000 people have set up 
offshore financial accounts, concealing taxable income at a 
loss of $20 to $40 billion a year. When you had a voluntary 
compliance initiative, only 1,300 of them came forward. How can 
you shut down this abusive practice? And what realistically can 
you do about it to go after the other 738,000-some-odd 
taxpayers who are non-taxpayers?

                OFFSHORE VOLUNTARY COMPLIANCE INITIATIVE

    Mr. Everson. I think that this offshore area is 
particularly troublesome and difficult. Basically augmenting 
those resources going back in to the offshore compliance and 
audit rate, that helps sweep in more of these taxpayers. We do 
look at returns. We have access to other information; we see 
how people are spending their money. If we see things that are 
out of line maybe we can get after this in other ways. But the 
other thing is we're getting better cooperation from other 
countries. We've had some issues with getting all of the 
information we need from credit card providers and others. But 
we're working through those. It is a big, big continuing 
challenge, internationalization and sending money offshore. It 
goes beyond what Senator Dorgan was saying on corporations. It 
really does go into individuals too. And what we have is a very 
aggressive program with the Justice Department to get 
injunctions against promoters if we see schemes that are being 
sold to people. We attack them and try to leverage our findings 
from the promoters as well.
    Senator Bond. Many of the questions we raised really deal 
with the complexity of the IRS code. With 54,000 pages of tax 
law regulation and related advisory material, I think we all 
agree it is too complex, confusing, and costly. What can be 
done administratively to simplify it? And does the 
administration have specific legislative changes to reduce the 
complexity, to assist taxpayers and assist in enforcement?

                             TAX COMPLEXITY

    Mr. Everson. I've testified before the Tax Panel that has 
been formed, as you know, with your former colleagues Senators 
Mack and Breaux. And I've said that the simplification is 
terribly important. Our view is that complexity obscures 
understanding. People either make inadvertent errors or they 
throw up their hands and say ``Why bother?'' at a certain 
point. On the other hand the complexity provides an opportunity 
for those who would skirt the tax laws to hide and to avoid 
detection by the IRS. So I agree with your sentiment 100 
percent. I've said to the tax panel that compliance is 
something that they need to watch for when they come forward 
with proposals that you will ultimately see. We need to look at 
compliance. A couple of quick points: no system is immune to 
compliance issues. So you've got to consider its 
administerability. Look at a VAT as an example. We were in 
Britain a few months ago and they've got an 11 or 12 percent 
compliance problem with the VAT system, so you have to be 
cognizant of these problems, no matter what system you chose. 
And the administration is, I think, well aware of that, as is 
the tax panel as they go through these discussions.
    Senator Bond. A final question. Some small business tax 
preparers are concerned and I wonder whether the IRS has any 
plans to charge fees for those who can afford them for some of 
IRS's services, especially where there are competing services 
provided by the private sector. Is it feasible to consider 
charging fees where it is obvious that the taxpayers, if not 
for getting IRS service, would be using private sector tax 
preparers?

                            FEES FOR SERVICE

    Mr. Everson. We have something like 1.2 million tax 
practitioners out there that we're highly relying on. The IRS 
doesn't do all the work and it doesn't do all the contacts with 
the individuals. We rely on professionals, good professionals 
in lots of small firms to help us guide people through the 
process. I'm unaware at this time of any new fee proposals 
along the lines of what you've suggested. And I'll check to see 
what the status is and let you know. But we think the vitality 
of small practitioners is very central to what we're doing.
    Senator Bond. Mr. George, any closing comments?
    Mr. George. Senator, again thank you for the opportunity. 
This being my first hearing in my new capacity as IG. There is 
no question of the vital role that the Internal Revenue Service 
plays to our Nation's security. And I have known of Mark 
Everson and have worked with him in his capacity as managing 
official at OMB.
    Mr. Everson. That's why he's skeptical.
    Mr. George. Not at all, not at all. So I believe that he is 
committed to helping ensure that this important organization 
fulfills its mandate. And I can assure you that I'm committed 
to assisting in terms of tax administration and ensuring that 
that organization does what it's supposed to do. And if it 
engages in activity that's inappropriate, that we bring that to 
both your attention and to the attention of the Secretary of 
the Treasury.
    Senator Bond. Thank you, Mr. George. Commissioner, any 
closing comments?
    Mr. Everson. No. I appreciate your interest. We're in tough 
territory here; you've got some other needy clients. I ask you 
to bear in mind that we feel we've constructed a balanced 
proposal. But that getting this enforcement funding does help 
the government's top line. And that's obviously of some very 
real importance in this time of deficits.

                    ADDITIONAL SUBMITTED STATEMENTS

    Senator Bond. Additional prepared statements have been 
submitted, and they will also be included in the record.
    [The statements follow:]

 Prepared Statement of James R. White, Director, Strategic Issues, and 
 David A. Powner, Director, Information Technology Management Issues, 
                    Government Accountability Office

  INTERNAL REVENUE SERVICE--ASSESSMENT OF THE FISCAL YEAR 2006 BUDGET 
                                REQUEST

                             GAO HIGHLIGHTS

    Highlights of GAO-05-566, a statement for the record for the 
Subcommittee on Transportation, Treasury, the Judiciary, Housing and 
Urban Development, and Related Agencies, Committee on Appropriations.

                         WHY GAO DID THIS STUDY

    The Internal Revenue Service (IRS) has been shifting its priorities 
from taxpayer service to enforcement and its management of Business 
Systems Modernization (BSM) from contractors to IRS staff. Although 
there are sound reasons for these adjustments, they also involve risks.
    With respect to the fiscal year 2006 budget request, GAO assessed 
(1) how IRS proposes to balance its resources between taxpayer service 
and enforcement programs and the potential impact on taxpayers, (2) 
status of IRS's efforts to develop and implement the BSM program, and 
(3) the progress IRS has made in implementing best practices in 
developing its Information Technology (IT) operations and maintenance 
budget.

                          WHAT GAO RECOMMENDS

    In a related statement (GAO-05-416T), GAO recommended that the 
Commissioner of Internal Revenue supplement the 2006 budget request 
with more detailed information on how proposed service reductions would 
impact taxpayers. GAO has recommendations still outstanding related to 
BSM management controls and IT budget justification.

                             WHAT GAO FOUND

    IRS's fiscal year 2006 budget request of $10.9 billion is an 
increase of 3.7 percent over last year's enacted levels. This includes 
an 8 percent increase for enforcement, and a 1 percent and 2 percent 
decrease for taxpayer service and BSM. However, the potential impact of 
these changes on taxpayers in either the short- or long-term is 
unclear, because IRS has not provided details of proposed taxpayer 
service reductions, and although it is developing long-term goals, they 
are not yet finalized. Because of the proposed reductions and new and 
improved taxpayer services in recent years, this is an opportune time 
to examine the menu of services IRS provides. It may be possible to 
maintain the overall level of service to taxpayers by offsetting 
reductions in some areas with new and improved service in other areas 
such as on IRS's Web site.
    Taxpayers and IRS are seeing some payoff from the BSM program, with 
the deployment of initial phases of several modernized systems in 2004. 
Nevertheless, the BSM program continues to be high-risk, in part, 
because projects have incurred significant cost increases and schedule 
delays and the program faces major challenges in areas such as human 
capital and requirements management. As a result of budget reductions 
and other factors, IRS has made major adjustments. It is too early to 
tell what effect these adjustments will have on the program, but they 
are not without risk and could potentially impact future budgets. 
Further, the BSM program is based on strategies developed years ago, 
which, coupled with the delays and changes brought on by budget 
reductions, indicates that it is time for IRS to revisit its long-term 
goals, strategy, and plans for BSM. Because of these challenges, IRS is 
redefining and refocusing the BSM program.
    Likewise, IRS has made progress in implementing best practices that 
would improve its budget development and support for its IT operations 
and maintenance request. In particular, the recent release of a 
modernized financial management system included a cost module. However, 
at this time, historical data is not yet available for IRS to use this 
module in formulating its IT operations and maintenance request.

                          IRS BUDGET SUMMARY FOR KEY ACTIVITIES, FISCAL YEARS 2004-2006
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                            Fiscal     Fiscal     Fiscal
                                          Year 2004  Year 2005  Year 2006    Percent      Percent      Percent
                                                                              Change       Change       Change
                                          (Enacted)  (Enacted)  (Request)  (2004-2005)  (2005-2006)  (2004-2006)
----------------------------------------------------------------------------------------------------------------
Taxpayer service........................     $3,710     $3,606     $3,567        -2.8         -1.1         -3.8
Enforcement.............................      6,052      6,392      6,893         5.6          7.8         13.9
BSM.....................................        388        203        199       -47.6         -2.0        -48.7
----------------------------------------------------------------------------------------------------------------
Source.--GAO analysis of IRS data.
Note.--Numbers may not add due to rounding.

    Mr. Chairman and members of the subcommittee, we are pleased to 
present this statement for the record regarding the Internal Revenue 
Service's (IRS) fiscal year 2006 budget request and in support of your 
April 7, 2005 hearing on IRS's appropriations.
    IRS is in the midst of making significant adjustments to its 
modernization strategy to better serve taxpayers and ensure their 
compliance with the Nation's tax laws. It is now 7 years since the 
passage of the Internal Revenue Service Restructuring and Reform Act of 
1998 (RRA 98) \1\ and IRS is shifting its priorities from improving 
taxpayer service to strengthening tax law enforcement efforts. IRS is 
also adjusting its strategy for managing its Business Systems 
Modernization (BSM) effort by shifting significant program management 
responsibilities from contractor to IRS staff. Although there are sound 
reasons for these adjustments, they also involve risk.
---------------------------------------------------------------------------
    \1\ Public Law No. 105-206 (1998).
---------------------------------------------------------------------------
    We have reported that IRS has made progress improving taxpayer 
service since the passage of RRA 98.\2\ For example, IRS's telephone 
assistance is now more accessible and accurate. Further, IRS is more 
efficient at processing tax returns, in part, because of the growth of 
electronic filing, and has cut processing staff. IRS has also 
implemented some modernized information systems and increased its 
capacity to manage large systems acquisition and development programs. 
However, progress has not been uniform. We have reported on large and 
pervasive declines in IRS's tax law enforcement programs after 1998. We 
have also reported that a number of systems modernization projects were 
over budget and behind schedule.\3\
---------------------------------------------------------------------------
    \2\ See for example, GAO-05-67, Tax Administration: IRS Improved 
Performance in the 2004 Filing Season, But Better Data on the Quality 
of Some Services Are Needed (Washington, DC: Nov. 15, 2004).
    \3\ GAO, Internal Revenue Service: Assessment of Fiscal Year 2005 
Budget Request and 2004 Filing Season Performance, GAO-04-560T 
(Washington, DC: Mar. 30, 2004).
---------------------------------------------------------------------------
    As noted, IRS is shifting its priorities to better address these 
problems. The risk, as IRS shifts its priorities towards enforcement, 
is that some of the gains in the quality of taxpayer service could be 
surrendered. There are analogous risks associated with moving more of 
the management of BSM in-house.
    With these risks in mind, our statement for the record discusses 
IRS's fiscal year 2006 budget request. To address your request to 
provide this statement, we assessed (1) how IRS proposes to balance its 
resources between taxpayer service and enforcement programs and the 
potential impact on taxpayers, (2) the status of IRS's efforts to 
develop and implement the BSM program, and (3) the progress IRS has 
made in implementing best practices for developing its information 
technology (IT) operations and maintenance budget.
    Our assessment of the budget request and BSM is based on a 
comparative analysis of IRS's fiscal year 2002 through 2006 budget 
requests, funding, expenditures, other documentation, and interviews 
with IRS officials. For this assessment, we used historical budget and 
performance data from reports and budget requests used by IRS, 
Department of Treasury, and Office of Management and Budget (OMB). In 
past work, we assessed IRS's budget and performance data.\4\ Since the 
data sources and procedures for producing this year's budget data have 
not significantly changed from prior years, we determined that the data 
were sufficiently reliable for the purposes of this report although for 
fiscal years 2005 and 2006 subject to change. Regarding our analysis of 
IRS's BSM program, we primarily used the agency's BSM expenditure plans 
to determine the status of the program. To assess the reliability of 
the cost and schedule information contained in these plans, we 
interviewed applicable IRS officials to gain an understanding of the 
data and discuss our use of that data. In addition, we checked that 
information in the plans was consistent with information contained in 
IRS internal briefings. Accordingly, we determined that the data in the 
plans were sufficiently reliable for purposes of this statement. We 
performed our work in Washington, DC and Atlanta, Georgia from December 
2004 through March 2005, in accordance with generally accepted 
government auditing standards.
---------------------------------------------------------------------------
    \4\ GAO, Tax Administration: IRS Needs to Further Refine Its Tax 
Filing Season Performance Measures, GAO-03-143 (Washington, DC: Nov. 
22, 2002) and GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 
Financial Statements, GAO-05-103 (Washington, DC: Nov. 10, 2004).
---------------------------------------------------------------------------
    In summary, our assessment shows that:
  --IRS's 2006 fiscal year budget request reflects a continuing shift 
        in priorities from improving taxpayer service to strengthening 
        enforcement efforts, but the potential impact of these changes 
        on taxpayers in both the short- and long-term is unclear. IRS 
        is requesting $10.9 billion, an increase of 3.7 percent over 
        fiscal year 2005 enacted levels. This includes an 8 percent 
        increase for enforcement, and a 1 percent and 2 percent 
        decrease for taxpayer service and BSM, respectively. IRS has 
        not finalized the details on where reductions in taxpayer 
        service would occur. In addition, IRS is developing, but 
        currently lacks, long-term goals that can help IRS inform 
        stakeholders, including the Congress, and aid them in assessing 
        performance and making budget decisions. In light of the 
        current budget environment and IRS's improvements in taxpayer 
        service over the last several years, this is an opportune time 
        to reconsider the menu of services it provides. It may be 
        possible to maintain the overall level of assistance to 
        taxpayers by changing the menu of services offered, offsetting 
        reductions in some areas with new and improved service in other 
        areas such as on IRS's Web site.
  --IRS has taken important steps forward towards implementing the BSM 
        program by delivering the initial phases of several modernized 
        systems in 2004 and early 2005. Nevertheless, BSM continues to 
        be high risk because, in part, its projects have incurred 
        significant cost increases and schedule delays, and the program 
        continues to face major challenges. As a result of funding 
        reductions and other factors, IRS has made major adjustments to 
        the BSM program, including reducing the management reserve and 
        changing the mix and roles of contractor versus Federal staff 
        used to manage the program. It is too early to tell what effect 
        these adjustments will ultimately have on the BSM program, but 
        they are not without risk, could potentially impact future 
        budget requests, and will delay the implementation of certain 
        functionality that was intended to provide benefit to IRS 
        operations and taxpayers. Finally, the BSM program is based on 
        visions and strategies developed years ago, which, coupled with 
        the already significant delays the program has experienced and 
        the changes brought on by the budget reductions, indicates that 
        it is time for IRS to revisit its long-term goals, strategy, 
        and plans for BSM, including an assessment of when significant 
        future BSM functionality would be delivered. According to the 
        Associate Chief Information Officer (CIO) for BSM, IRS is 
        redefining and refocusing this program.
  --IRS has made progress toward implementing investment management 
        best practices that would improve its budget development and 
        support for its IT operations and maintenance funding requests. 
        For example, the recent release of a new accounting system 
        included an activity-based cost module, which IRS considered to 
        be a necessary action to implement these best practices. 
        However, Office of the Chief Financial Officer officials stated 
        that IRS needs 3 years of actual costs to have the historical 
        data necessary to provide a basis for future budget estimates. 
        Accordingly, they expect that IRS will begin using the 
        activity-based cost module in formulating the fiscal year 2008 
        budget and will have the requisite 3 years of historical data 
        in time to develop the fiscal year 2010 budget.

IRS'S BUDGET REQUEST CONTINUES TO SHIFT PRIORITY FROM TAXPAYER SERVICE 
 TO ENFORCEMENT, BUT THE SHORT- AND LONG-TERM IMPACTS ON TAXPAYERS ARE 
                                UNCLEAR

    IRS's fiscal year 2006 budget request reflects a continuing shift 
in priorities by proposing reductions in taxpayer service and increases 
in enforcement activities. The request does not provide details about 
how the reductions will impact taxpayers in the short-term. Nor does 
IRS have long-term goals; thus the contribution of the fiscal year 2006 
budget request to achieving IRS's mission in the long-term is unclear. 
Because of budget constraints and the progress IRS has made improving 
the quality of taxpayer services, this is an opportune time to 
reconsider the menu of services IRS offers.

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

                     TABLE 1.--IRS BUDGET SUMMARY FOR KEY ACTIVITIES, FISCAL YEARS 2004-2006
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                            Fiscal     Fiscal     Fiscal
                                          Year 2004  Year 2005  Year 2006    Percent      Percent      Percent
                                                                              Change       Change       Change
                                          (Enacted)  (Enacted)  (Request)  (2004-2005)  (2005-2006)  (2004-2006)
----------------------------------------------------------------------------------------------------------------
Taxpayer service........................     $3,710     $3,606     $3,567        -2.8         -1.1         -3.8
Enforcement.............................      6,052      6,392      6,893         5.6          7.8         13.9
BSM.....................................        388        203        199       -47.6         -2.0        -48.7
----------------------------------------------------------------------------------------------------------------
Source.--GAO analysis of IRS data.
Note.--Numbers may not add due to rounding.

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

   TABLE 2.--IRS REQUESTED CHANGES IN FUNDING FOR TAXPAYER SERVICE AND ENFORCEMENT, FISCAL YEARS 2005 AND 2006
                                                   (REQUESTED)
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                             Fiscal Year 2005        Fiscal Year 2006       Change Fiscal Year
                                                (Estimated)             (Requested)        2005-Fiscal Year 2006
           Program Activities            -----------------------------------------------------------------------
                                                      Full-time               Full-time               Full-time
                                           Dollars   Equivalents   Dollars   Equivalents   Dollars   Equivalents
----------------------------------------------------------------------------------------------------------------
Assistance..............................     $1,829      20,798      $1,806      20,160        -$23        -638
Outreach................................       $500       2,473        $466       1,905        -$34        -568
Processing..............................     $1,276      15,695      $1,295      15,516         $19        -179
                                         -----------------------------------------------------------------------
      Taxpayer service subtotal.........     $3,606      38,966      $3,567      37,581        -$39      -1,385
                                         =======================================================================
Research................................       $154       1,119        $158       1,119          $4           0
Examination.............................     $3,478      31,498      $3,712      32,284        $234         786
Collection..............................     $1,826      18,023      $1,991      18,815        $165         792
Investigation...........................       $682       4,899        $767       5,250         $85         351
Regulatory..............................       $253       1,912        $265       1,944         $12          32
                                         -----------------------------------------------------------------------
      Enforcement subtotal..............     $6,392      57,451      $6,893      59,412        $500       1,961
                                         =======================================================================
      Taxpayer service and enforcement       $9,998      96,417     $10,460      96,993        $462         576
       total............................
----------------------------------------------------------------------------------------------------------------
Source.--GAO analysis of IRS data.
Note.--Numbers may not add due to rounding.

    The difference between changes in dollars and FTEs could be even 
larger because of unbudgeted expenses. Unbudgeted expenses have 
consumed some of IRS's budget increases and internal savings increases 
over the last few years. Unbudgeted expenses include unfunded portions 
of annual salary increases, which can be substantial given IRS's large 
workforce, and other costs such as higher-than-budgeted rent increases. 
According to IRS officials, these unbudgeted expenses accounted for 
over $150 million in each of the last 4 years.
    An IRS official also told us they anticipate having to cover 
unbudgeted expenses in 2006. As of March 2005, IRS officials were 
projecting unbudgeted salary increases of at least $40 million. This 
projection could change since potential Federal salary increases for 
2006 have not been determined.

IRS Is Proposing $39 Million Less for Taxpayer Service, but the Impact 
        on Taxpayers Is Unclear
    The budget request provides some detail on how IRS plans to absorb 
cost increases in the taxpayer service budget. IRS is proposing a gross 
reduction of over $134 million in taxpayer service from reexamining the 
budget's base and plans to use more than $95 million of it to cover 
annual increases such as salaries. This leaves a net reduction of 
nearly $39 million or 1.1 percent in the taxpayer service budget. The 
extent to which IRS is able to achieve the gross reductions will impact 
its ability to use the funds as anticipated.
    Decisions on how the $134 million gross reduction would be absorbed 
were not finalized prior to releasing the budget. According to IRS 
officials, some of the reductions would result from efficiency gains 
such as reducing printing and postage costs; however, others would 
result from reductions in the services provided to taxpayers such as 
shortening the hours of toll-free telephone service operations. The 
officials also said most decisions have now been made about general 
areas for reduction and most changes will not be readily apparent to 
taxpayers.
    Although IRS has made general decisions about the reductions, many 
of the details have yet to be determined. Therefore, the extent of the 
impact on taxpayers in the short term is unclear. For example, IRS 
plans to reduce dependence on field assistance, including walk-in 
sites, but has not reached a final decision on how to reduce services. 
Table 3 provides further detail on how IRS is proposing to reduce 
funding and resources for taxpayer service.

TABLE 3.--IRS REQUESTED CHANGES IN FUNDING AND FULL-TIME EQUIVALENTS FOR TAXPAYER SERVICE, FISCAL YEARS 2005 AND
                                                      2006
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                             Fiscal Year 2005        Fiscal Year 2006       Change Fiscal Year
                                                 (Actual)               (Requested)              2005-2006
           Program Activities            -----------------------------------------------------------------------
                                                      Full-time               Full-time               Full-time
                                           Dollars   Equivalents   Dollars   Equivalents   Dollars   Equivalents
----------------------------------------------------------------------------------------------------------------
Assistance:
    Electronic..........................     $1,536      17,745      $1,557      17,721         $21         -24
    Field...............................       $274       2,796        $230       2,181        -$44        -615
    EITC assistance.....................        $19         258         $19         258         <$1  ...........
                                         -----------------------------------------------------------------------
      Assistance total..................     $1,829      20,798      $1,806      20,160        -$23        -638
                                         =======================================================================
Outreach:
    Publication & Media.................       $291         821        $276         520        -$15        -301
    Taxpayer Education & Communication..       $203       1,592        $184       1,326        -$19        -266
    EITC Outreach.......................         $7          60          $7          60         <$1  ...........
                                         -----------------------------------------------------------------------
      Outreach total....................       $500       2,473        $466       1,905        -$34        -568
                                         =======================================================================
Processing..............................     $1,276      15,695      $1,295      15,516         $19        -179
                                         =======================================================================
      Taxpayer service total............     $3,606      38,966      $3,568      37,581        -$39      -1,385
----------------------------------------------------------------------------------------------------------------
Source.--GAO analysis of IRS data.
Note.--Numbers may not add due to rounding.

IRS Continues to Request Significant Increases for Enforcement to Build 
        on Recent Hiring Gains
    IRS's fiscal year 2006 budget request is the sixth consecutive year 
the agency has requested additional staffing for enforcement. However, 
up until last year, IRS was unable to increase enforcement staffing; 
unbudgeted costs and other priorities consumed the budget increase.
    IRS's proposal for fiscal year 2006, if implemented as planned, 
would return enforcement staffing in these occupations to their highest 
levels since 1999. Of the more than $500 million increase requested for 
2006, about $265 million would fund enforcement initiatives, over $182 
million would be used in part for salary increases, and over $55 
million is a proposal to transfer funding authority from the Department 
of Justice's Interagency Crime and Drug Enforcement. The $500 million 
increase would be supplemented by internal enforcement savings of $88 
million. As is the case with taxpayer service savings, the extent to 
which IRS achieves enforcement savings will affect its ability to fund 
the new enforcement initiatives.
    The $265 million for new enforcement initiatives consist of:
  --$149.7 million and 920 FTEs to attack corrosive non-compliance 
        activity driving the tax gap such as abusive trusts and 
        shelters, including offshore credit cards and organized tax 
        resistance;
  --$51.8 million and 236 FTEs to detect and deter corrosive corporate 
        non-compliance to attack complex abusive tax avoidance 
        transactions on a global basis and challenge those who promote 
        their use;
  --$37.9 million and 417 FTEs to increase individual taxpayer 
        compliance by identifying and implementing actions to address 
        non-compliance with filing requirements; increasing Automated 
        Underreporter resources to address the reporting compliance tax 
        gap; increasing audit coverage; and expanding collection work 
        in walk-in sites;
  --$14.5 million and 77 FTEs to combat abusive transactions by 
        entities with special tax status by initiating examinations 
        more promptly, safeguarding compliant customers from 
        unscrupulous promoters, and increasing vigilance to ensure that 
        the assets of tax-exempt organizations are put to their 
        intended tax-preferred purpose and not misdirected to fund 
        terrorism or for private gain; and
  --$10.8 million and 22 FTEs to curtail fraudulent refund crimes.
    The $88 million in internal savings would be reinvested to perform 
the following activities:
  --$66.7 million and 585 FTEs to devote resources to front-line 
        enforcement activities;
  --$14.9 million and 156 FTEs to, in part, address bankruptcy-related 
        taxpayer questions; and
  --$6.7 million and 52 FTEs to address complex, high-risk issues such 
        as compliance among tax professionals.
    In the past, IRS has had trouble achieving enforcement staffing 
increases because other priorities, including unbudgeted expenses, have 
absorbed additional funds. IRS achieved some gains in 2004 and expects 
modest gains in 2005. Figure 1 shows that the number of revenue agents 
(those who audit complex returns), revenue officers (those who do field 
collection work), and special agents (those who perform criminal 
investigations) decreased over 21 percent between 1998 and 2003, but 
increased almost 6 percent from 2003 to 2004.



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



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

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

This Is an Opportune Time to Review IRS's Menu of Taxpayer Services
    For at least two reasons, this is an opportune time to review the 
menu of taxpayer services that IRS provides. First, IRS's budget for 
taxpayer services was reduced in 2005 and an additional reduction is 
proposed for 2006. As already discussed, these reductions have forced 
IRS to propose scaling back some services. Second, as we have reported, 
IRS has made significant progress in improving the quality of its 
taxpayer services. For example, IRS now provides many Internet services 
that did not exist a few years ago and has noticeably improved the 
quality of telephone services. This opens up the possibility of 
maintaining the overall level of taxpayer service but with a different 
menu of service choices. Cuts in selected services could be offset by 
the new and improved services.
    Generally, as indicated in the budget, the menu of taxpayer 
services that IRS provides covers assistance, outreach, and processing. 
Assistance includes answering taxpayer questions via telephone, 
correspondence, and face-to-face at its walk-in sites. Outreach 
includes educational programs and the development of partnerships. 
Processing includes issuing millions of tax refunds.
    When considering program reductions, we support a targeted approach 
rather than across-the-board cuts.\12\ A targeted approach helps reduce 
the risk that effective programs are reduced or eliminated while 
ineffective or lower priority programs are maintained.
---------------------------------------------------------------------------
    \12\ GAO, 21st Century Challenges: Reexamining the Base of the 
Federal Government, GAO-05-325SP (Washington, DC: February 2005).
---------------------------------------------------------------------------
    With the above reasons in mind for reconsidering IRS's menu of 
services, we have compiled a list of options for targeted reductions in 
taxpayer service. The options on this list are not recommendations but 
are intended to contribute to a dialogue about the tradeoffs faced when 
setting IRS's budget. The options presented meet at least one of the 
following criteria that we generally use to evaluate programs or budget 
requests.\13\ These criteria include that the activity:
---------------------------------------------------------------------------
    \13\ We selected these criteria from a variety of sources based on 
generally accepted government auditing standards.
---------------------------------------------------------------------------
  --duplicates other efforts that may be more effective and/or 
        efficient;
  --historically does not meet performance goals or provide intended 
        results as reported by GAO, the Treasury Inspector General for 
        Tax Administration (TIGTA), IRS, or others;
  --experiences a continued decrease in demand;
  --lacks adequate oversight, implementation and management plans, or 
        structures and systems to be implemented effectively;
  --has been the subject of actual or requested funding increases that 
        cannot be adequately justified; or
  --has the potential to make an agency more self-sustaining by 
        charging user fees for services provided.
    We recognize that the options listed below involve tradeoffs. In 
each case, some taxpayers would lose a service they use. However, the 
savings could be used to help maintain the quality of other services. 
We also want to give IRS credit for identifying savings, including some 
on this list. The options include:
  --closing walk-in sites. Taxpayer demand for walk-in services has 
        continued to decrease and staff answer a more limited number of 
        tax law questions in person than staff answer via telephone.
  --limiting the type of telephone questions answered by IRS assistors. 
        IRS assistors still answer some refund status questions even 
        though IRS provides automated answers via telephone and its Web 
        site.
  --mandating electronic filing for some filers such as paid preparers 
        or businesses. As noted, efficiency gains from electronic 
        filing have enabled IRS to consolidate paper processing 
        operations.
  --charging for services. For example, IRS provides paid preparers 
        with information on Federal debts owed by taxpayers seeking 
        refund anticipation loans.
 progress in bsm implementation, but the program remains high risk and 
       budget reductions have resulted in significant adjustments
    Although IRS has implemented important elements of the BSM program, 
much work remains. In particular, the BSM program remains at high risk 
and has a long history of significant cost overruns and schedule 
delays. Furthermore, budget reductions have resulted in significant 
adjustments to the BSM program, although it is too early to determine 
their ultimate effect.

IRS Has Made Progress in Implementing BSM, but Much Work Remains
    IRS has long relied on obsolete automated systems for key 
operational and financial management functions, and its attempts to 
modernize these aging computer systems span several decades. IRS's 
current modernization program, BSM, is a highly complex, multibillion-
dollar program that is the agency's latest attempt to modernize its 
systems. BSM is critical to supporting IRS's taxpayer service and 
enforcement goals. For example, BSM includes projects to allow 
taxpayers to file and retrieve information electronically and to 
provide technology solutions to help reduce the backlog of collections 
cases. BSM is important for another reason. It allows IRS to provide 
the reliable and timely financial management information needed to 
account for the Nation's largest revenue stream and better enable the 
agency to justify its resource allocation decisions and congressional 
budgetary requests.
    Since our testimony before this subcommittee on last year's budget 
request, IRS has deployed initial phases of several modernized systems 
under its BSM program. The following provides examples of the systems 
and functionality that IRS implemented in 2004 and the beginning of 
2005.
  --Modernized e-File (MeF).--This project is intended to provide 
        electronic filing for large corporations, small businesses, and 
        tax-exempt organizations. The initial releases of this project 
        were implemented in June and December 2004, and allowed for the 
        electronic filing of forms and schedules for the form 1120 
        (corporate tax return) and form 990 (tax-exempt organizations' 
        tax return). IRS reported that, during the 2004 filing season, 
        it accepted over 53,000 of these forms and schedules using MeF.
  --e-Services.--This project created a Web portal and provided other 
        electronic services to promote the goal of conducting most IRS 
        transactions with taxpayers and tax practitioners 
        electronically. IRS implemented e-Services in May 2004. 
        According to IRS, as of late March 2005, over 84,000 users have 
        registered with this Web portal.
  --Customer Account Data Engine (CADE).--CADE is intended to replace 
        IRS's antiquated system that contains the agency's repository 
        of taxpayer information and, therefore, is the BSM program's 
        linchpin and highest priority project. In July 2004 and January 
        2005, IRS implemented the initial releases of CADE, which have 
        been used to process filing year 2004 and 2005 1040EZ returns, 
        respectively, for single taxpayers with refund or even-balance 
        returns. According to IRS, as of March 16, 2005, CADE had 
        processed over 842,000 tax returns so far this filing season.
  --Integrated Financial System (IFS).--This system replaces aspects of 
        IRS's core financial systems and is ultimately intended to 
        operate as its new accounting system of record. The first 
        release of this system became fully operational in January 
        2005.
    Although IRS is to be applauded for delivering such important 
functionality, the BSM program is far from complete. Future deliveries 
of additional functionality of deployed systems and the implementation 
of other BSM projects are expected to have a significant impact on 
IRS's taxpayer services and enforcement capability. For example, IRS 
has projected that CADE will process about 2 million returns in the 
2005 filing season. However, the returns being processed in CADE are 
the most basic and constitute less than 1 percent of the total tax 
returns expected to be processed during the current filing season. IRS 
expects the full implementation of CADE to take several more years. 
Another BSM project--the Filing and Payment Compliance (F&PC) project--
is expected to increase (1) IRS's capacity to treat and resolve the 
backlog of delinquent taxpayer cases, (2) the closure of collection 
cases by 10 million annually by 2014, and (3) voluntary taxpayer 
compliance. As part of this project, IRS plans to implement an initial 
limited private debt collection capability in January 2006, with full 
implementation of this aspect of the F&PC project to be delivered by 
January 2008 and additional functionality to follow in later years.

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



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

    
    

    It is too early to tell what effect the budget reductions will 
ultimately have on the BSM program. However, the significant 
adjustments that IRS is making to the program to address these 
reductions are not without risk, could potentially impact future budget 
requests, and will delay the implementation of certain functionality 
that was intended to provide benefit to IRS operations and the 
taxpayer. For example:
  --Reductions in Management reserve/project risk adjustments.--In 
        response to the fiscal year 2005 budget reduction, IRS reduced 
        the amount that it had allotted to program management reserve 
        and project risk adjustments by about 62 percent (from about 
        $49.1 million to about $18.6 million).\20\ If BSM projects have 
        future cost overruns that cannot be covered by the depleted 
        reserve, this reduction could result in (1) increased budget 
        requests in future years or (2) delays in planned future 
        activities (e.g., delays in delivering promised functionality) 
        to use those allocated funds to cover the overruns.
---------------------------------------------------------------------------
    \20\ We did not include in our calculations, reductions to specific 
project risk adjustment amounts that were made for reasons other than 
the fiscal year 2005 budget reduction.
---------------------------------------------------------------------------
  --Shifts of BSM management responsibility from the PRIME contractor 
        to IRS.--Due to budget reductions and IRS's assessment of the 
        PRIME contractor's performance, IRS decided to shift 
        significant BSM responsibilities for program management, 
        systems engineering, and business integration from the PRIME 
        contractor to IRS staff. For example, IRS staff are assuming 
        responsibility for cost and schedule estimation and 
        measurement, risk management, integration test and deployment, 
        and transition management. There are risks associated with this 
        decision. To successfully accomplish this transfer, IRS must 
        have the management capability to perform this role. Although 
        the BSM program office has been attempting to improve this 
        capability through, for example, implementation of a new 
        governance structure and hiring staff with specific technical 
        and management expertise, IRS has had significant problems in 
        the past managing this and other large development projects, 
        and acknowledges that it has major challenges to overcome in 
        this area.
  --Suspension of the Custodial Accounting Project (CAP).--Although the 
        initial release of CAP went into production in September 2004, 
        IRS has decided not to use this system and to stop work on 
        planned improvements due to budget constraints. According to 
        IRS, it made this decision after it evaluated the business 
        benefits and costs to develop and maintain CAP versus the 
        benefits expected to be provided by other projects, such as 
        CADE. Among the functionality that the initial releases of CAP 
        were expected to provide were (1) critical control and 
        reporting capabilities mandated by federal financial management 
        laws; (2) a traceable audit trail to support financial 
        reporting; and (3) a subsidiary ledger to accurately and 
        promptly identify, classify, track, and report custodial 
        revenue transactions and unpaid assessments. With the 
        suspension of CAP, it is now unclear how IRS plans to replace 
        the functionality this system was expected to provide, which 
        was intended to allow the agency to make meaningful progress 
        toward addressing long-standing financial management 
        weaknesses. IRS is currently evaluating alternative approaches 
        to addressing these weaknesses.
  --Reductions in planned functionality.--According to IRS, the fiscal 
        year 2006 funding reduction will result in delays in planned 
        functionality for some of its BSM projects. For example, IRS no 
        longer plans to include Form 1041 (the income tax return for 
        estates and trusts) in the fourth release of Modernized e-File, 
        which is expected to be implemented in fiscal year 2007.
    The BSM program is based on visions and strategies developed in 
2000 and 2001. The age of these plans, in conjunction with the 
significant delays already experienced by the program and the 
substantive changes brought on by budget reductions, indicate that it 
is time for IRS to revisit its long-term goals, strategy, and plans for 
BSM. Such an assessment would include an evaluation of when significant 
future BSM functionality would be delivered. IRS's Associate CIO for 
BSM has recognized that it is time to recast the agency's BSM strategy 
because of changes that have occurred subsequent to the development of 
the program's initial plans. According to this official, IRS is 
redefining and refocusing the BSM program, and he expects this effort 
to be completed by the end of this fiscal year.

 ADDITIONAL ACTIONS NEEDED TO IMPROVE BUDGETING FOR IT OPERATIONS AND 
                              MAINTENANCE

    IRS has requested about $1.62 billion for IT operations and 
maintenance in fiscal year 2006, within its proposed new Tax 
Administration and Operations account. Under the prior years' budget 
structure, these funds were included in a separate account, for which 
IRS received an appropriation of about $1.59 billion in fiscal year 
2005. The $1.62 billion requested in fiscal year 2006 is intended to 
fund the personnel costs for IT staff (including staff supporting the 
BSM program) and activities such as IT security, enterprise networks, 
and the operations and maintenance costs of its current systems. We 
have previously expressed concern that IRS does not employ best 
practices in the development of its IT operations and maintenance 
budget request.\21\ Although IRS has made progress in addressing our 
concern, more work remains.
---------------------------------------------------------------------------
    \21\ GAO, Internal Revenue Service: Improving Adequacy of 
Information Systems Budget Justification, GAO-02-704 (Washington, DC, 
June 28, 2002).
---------------------------------------------------------------------------
    The Paperwork Reduction Act (PRA) of 1995 \22\ requires Federal 
agencies to be accountable for their IT investments and responsible for 
maximizing the value and managing the risks of their major information 
systems initiatives. The Clinger-Cohen Act of 1996 \23\ establishes a 
more definitive framework for implementing the PRA's requirements for 
IT investment management. It requires Federal agencies to focus more on 
the results they have achieved and introduces more rigor and structure 
into how agencies are to select and manage IT projects. In addition, 
leading private- and public-sector organizations have taken a project- 
or system-centric approach to managing not only new investments but 
also operations and maintenance of existing systems. As such, these 
organizations:
---------------------------------------------------------------------------
    \22\ Public Law No. 104-13 (1995).
    \23\ Public Law No. 104-106 section 5001 et. seq. (1996).
---------------------------------------------------------------------------
  --identify operations and maintenance projects and systems for 
        inclusion in budget requests;
  --assess these projects or systems on the basis of expected costs, 
        benefits, and risks to the organization;
  --analyze these projects as a portfolio of competing funding options; 
        and
  --use this information to develop and support budget requests.
    This focus on projects, their outcomes, and risks as the basic 
elements of analysis and decision making is incorporated in the IT 
investment management approach that is recommended by OMB and GAO. By 
using these proven investment management approaches for budget 
formulation, agencies have a systematic method, on the basis of risk 
and return on investment, to justify what are typically substantial 
information systems operations and maintenance budget requests.
    In our assessment of IRS's fiscal year 2003 budget request, we 
reported that the agency did not develop its information systems 
operations and maintenance request in accordance with the investment 
management approach used by leading organizations. We recommended that 
IRS prepare its future budget requests in accordance with these best 
practices.\24\ To address our recommendation, IRS agreed to take a 
variety of actions, which it has made progress in implementing. For 
example, IRS stated that it planned to develop an activity-based cost 
model to plan, project, and report costs for business tasks/activities 
funded by the information systems budget. The recent release of IFS 
included an activity-based cost module, but IRS does not currently have 
historical cost data to populate this module. According to officials in 
the Office of the Chief Financial Officer, IRS is in the process of 
accumulating these data. These officials stated that IRS needs 3 years 
of actual costs to have the historical data that would provide a basis 
for future budget estimates. Accordingly, these officials expected that 
IRS would begin using the IFS activity-based cost module in formulating 
the fiscal year 2008 budget request and would have the requisite 3 
years' of historical data in time to develop the fiscal year 2010 
budget request. In addition, IRS planned to develop a capital planning 
guide to implement processes for capital planning and investment 
control, budget formulation and execution, business case development, 
and project prioritization. IRS has developed a draft guide, which is 
currently under review by IRS executives, and IRS expects it to become 
policy on October 1, 2005. Although progress has been made in 
implementing best practices in the development of the IT operations and 
maintenance budget, until these actions are completely implemented IRS 
will not be able to ensure that its request is adequately supported.
---------------------------------------------------------------------------
    \24\ GAO-02-704.
---------------------------------------------------------------------------
                              CONCLUSIONS

    As IRS shifts its priorities to enforcement and faces tight budgets 
for service, the agency will be challenged to maintain the gains it has 
made in taxpayer service. In order to avoid a ``swinging pendulum,'' 
where enforcement gains are achieved at the cost of taxpayer service 
and vice versa, IRS and the Congress would benefit from a set of 
agreed-upon long-term goals. Long-term goals would provide a framework 
for assessing budgetary tradeoffs between taxpayer service and 
enforcement and whether IRS is making satisfactory progress towards 
achieving those goals. Similarly, long-term goals could help identify 
priorities within the taxpayer service and enforcement functions. For 
example, if the budget for taxpayer service were to be cut and 
efficiency gains did not offset the cut, long-term goals could help 
guide decisions about whether to make service cuts across the board or 
target selected services. To its credit, IRS has been developing a set 
of long-term goals, so we are not making a recommendation on goals. 
However, we want to underscore the importance of making the goals 
public in a timely fashion, as IRS has planned. The Congress would then 
have an opportunity to review the goals and start using them as a tool 
for holding IRS accountable for performance.
    In addition, the Congress would benefit from more information about 
the short-term impacts of the 2006 budget request on taxpayers. The 
2006 budget request cites a need for reducing the hours of telephone 
service and scaling back walk-in assistance but provides little 
additional detail. Without more detail about how taxpayers will be 
affected, it is difficult to assess whether the 2006 proposed budget 
would allow IRS to achieve its stated intent of both maintaining a high 
level of taxpayer service and increasing enforcement.
    BSM and related initiatives such as electronic filing hold the 
promise of delivering further efficiency gains that could offset the 
need for larger budget increases to fund taxpayer service and 
enforcement. Today, taxpayers have seen payoffs from BSM; however, the 
program is still high risk and budget reductions have caused 
substantive program changes. IRS has recognized it is time to revisit 
its long-term BSM strategy and is currently refocusing the program. As 
we did with long-term goals above, we want to underscore the importance 
of timely completion of the revision of the BSM strategy.

                             RECOMMENDATION

    In a related statement (GAO-05-416T), GAO recommended that the 
Commissioner of Internal Revenue supplement the 2006 budget request 
with more detailed information on how proposed service reductions would 
impact taxpayers.
      Appendix I.--Description of IRS's Proposed Budget Structure
    IRS's proposed new budget structure as depicted in figure 5 
combines the three major appropriations that the agency has had in the 
past--Processing, Assistance, and Management; Tax Law Enforcement; and 
Information Systems into one appropriation called Tax Administration 
and Operations. The Business Systems Modernization and Health Insurance 
Tax Credit Administration appropriations accounts remain unchanged. The 
Tax Administration and Operations appropriation is divided among eight 
critical program areas. These budget activities focus on Assistance, 
Outreach, Processing, Examination, Collection, Investigations, 
Regulatory Compliance, and Research. According to IRS, as it continues 
to move forward with developing and implementing this new structure, 
these program areas and the associated resource distributions will be 
refined to provide more accurate costing.
    IRS reported that the new budget structure has a more direct 
relationship to its major program areas and strategic plan. We did not 
evaluate IRS's proposed budget structure as part of this engagement 
because it was not within the scope of our review. However, we have 
recently completed a study on the administration's broader budget 
restructuring effort. In that study we say that, going forward, 
infusing a performance perspective into budget decisions may only be 
achieved when the underlying information becomes more credible and used 
by all major decision makers. Thus, the Congress must be considered a 
partner. In due course, once the goals and underlying data become more 
compelling and used by the Congress, budget restructuring may become a 
better tool to advance budget and performance integration.\25\
---------------------------------------------------------------------------
    \25\ For a more detailed discussion, see GAO, Performance 
Budgeting: Efforts to Restructure Budgets to Better Align Resources 
with Performance, GAO-05-117SP (Washington, DC: February 2005).


    Appendix II.--BSM Project Life Cycle Cost/Schedule Variance and 
                            Benefits Summary

    The table below shows the life-cycle variance in cost and schedule 
estimates for completed and ongoing Business Systems Modernization 
(BSM) projects, based on data contained in IRS's expenditure plans. 
These variances are based on a comparison of IRS's initial and revised 
(as of July 2004) cost and schedule estimates to complete initial 
operation \26\ or full deployment \27\ of the projects.
---------------------------------------------------------------------------
    \26\ Initial operation refers to the point at which a project is 
authorized to begin enterprise-wide deployment.
    \27\ Full deployment refers to the point at which enterprise-wide 
deployment has been completed and a project is transitioned to 
operations and support.

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

 Appendix III.--How IRS Allocated Expenditures FTEs in Fiscal Year 2004
    Figures 6 and 7 illustrate how the Internal Revenue Service (IRS) 
allocated expenditures and full-time equivalents (FTEs) in fiscal year 
2004. Figure 8 shows total expenditures. The percentage of expenditures 
devoted to contracts decreased from 9 percent in 2002 to 5 percent in 
2004, because of fewer private contracts. The percentage of 
expenditures devoted to other non-labor costs increased from 8 percent 
in 2002 to 12 percent in 2004, according to IRS officials, due to of 
increases in miscellaneous costs.



    Figure 7 shows IRS's total FTEs. Since 2002, FTEs have decreased 
slightly from 99,180 in 2002 to 99,055 in 2004. We previously reported 
that processing FTEs declined 1 percentage point between 2002 and 2003. 
Between 2003 and 2004, IRS's allocation of FTEs remained similar but 
with a 1 percent increase in enforcement activities in conducting 
examinations, and in management and other services.



                                 ______
                                 
    Prepared Statement of Nina E. Olson, National Taxpayer Advocate

    Mr. Chairman and distinguished members of the subcommittee, thank 
you for inviting me to submit a statement in connection with your 
hearing on the proposed budget of the Internal Revenue Service for 
fiscal year 2006.
    The IRS is at a critical juncture in its history. In the 6+ years 
since the enactment of the Internal Revenue Service Restructuring and 
Reform Act of 1998, the IRS has successfully incorporated valuable 
customer service practices into its daily activities at all levels of 
the organization. It is now trying to increase its enforcement activity 
without eroding these taxpayer service gains. I strongly support a 
robust and research-driven IRS that undertakes well-designed 
examination and collection activities and criminal investigations. I 
believe that the IRS is capable of conducting these activities in an 
environment of superior taxpayer service. Given the size of the tax 
gap, I believe that the IRS needs additional resources to apply to both 
of these areas.
    I also support increased funding for IRS Business Systems 
Modernization, providing the funds are spent wisely. Systems 
modernization is a critical component not only for the examination and 
collection aspects of IRS work but also for the taxpayer service 
component. Without sufficient funding, we are left continually 
apologizing to taxpayers because our systems aren't functioning; we 
create work for ourselves, fixing errors manually because systems 
create taxpayer problems rather than avoid them.
    The role of taxpayer service in an environment of increasing 
enforcement activity is of great import to taxpayers, tax 
administrators, and Congress alike. I identified several areas of 
concern for taxpayer service in my 2004 Annual Report to Congress. 
Before I discuss some of these issues, I will comment generally about 
the balance between taxpayer service and enforcement.

                        THE COMPLIANCE EQUATION

    In the IRS Strategic Plan for 2005-2009 and elsewhere, the IRS has 
emphasized that its guiding principle is 
``Service+Enforcement=Compliance.'' The proposed IRS budget for fiscal 
year 2006 would revamp existing budget categories to fit this guiding 
principle, placing 33 percent of the IRS budget into a ``taxpayer 
service'' account and 65 percent of the IRS budget into an 
``enforcement'' account. (The remaining 2 percent of the proposed 
budget is allocated to Business Systems Modernization and Health 
Insurance Tax Credit Administration.)
    At a conceptual level, the ``Service+Enforcement=Compliance'' 
principle is indisputably correct. Compliance represents the sum total 
of IRS's success in helping taxpayers file tax returns and pay tax, and 
IRS's success at enforcing the law when taxpayers fail to do what is 
required. What is less clear is the appropriate balance between service 
and enforcement, particularly in a resource-constrained budget 
environment. ``Service+Enforcement=Compliance'' does not in and of 
itself define a specific level of compliance. That is, each of the 
equation's elements is a variable. Thus, if we reduce service, there is 
no guarantee--no matter how much we increase our enforcement efforts--
that compliance will increase overall. It is entirely possible that an 
increase in enforcement initiatives, offset by a decrease in taxpayer 
service, would result in less compliance.
    How can that be? The answer is that our estimated 84 percent 
voluntary compliance rate is driven primarily by the fact that most 
income is subject to income and payroll tax withholding or to third-
party income reporting. If we do not provide adequate taxpayer service 
to these taxpayers and their employers or payors--who are either 
compliant or trying to be compliant--then compliance by these taxpayers 
will decline. The IRS would then be forced to divert its enforcement 
resources, in part, to address this new source of noncompliance.
    Last week, the IRS released a preliminary estimate of the tax gap 
based on the recent National Research Program study. This study 
estimates the net tax gap (i.e., the gross gap reduced by late payments 
and enforced payments) in the range of $257-$298 billion annually and a 
voluntary compliance rate of approximately 84 percent. That rate is 
generally consistent with the results of prior studies.
    Today, there are approximately 130 million individual taxpayers. 
Each individual taxpayer is paying, on average, a ``surtax'' of at 
least $2,000 a year to subsidize noncompliance. That's the bad news. 
The ``good'' news, if you can call it that, is that notwithstanding 
claims that the decline in IRS enforcement activity in the aftermath of 
the IRS Restructuring and Reform Act of 1998 led to rampant cheating, 
the estimate of the compliance rate in the recent tax gap study is 
approximately the same as the compliance rate when the prior study was 
conducted in the late 1980's.
    Even so, a principal function of the IRS is to collect all tax due, 
so the big question is what do we do now to increase the compliance 
rate? The proposed IRS budget reflects the view that enforcement 
activity should be increased while taxpayer service is reduced. Is that 
the right answer?
    If I were developing a budget from scratch, I would argue that both 
enforcement and taxpayer service funding should be increased. The IRS 
is the accounts receivable department of the Federal Government, and it 
is clear to me that additional funding for both enforcement and 
taxpayer service--if spent wisely--would bring in significantly more 
dollars.
    Given the budget realities, however, I am concerned that the IRS 
does not have better research to show where its dollars could be most 
effectively spent. Indeed, the one function I am certain requires more 
resources is the IRS research function. The IRS is able to track 
revenue collected as a direct result of its enforcement activities. 
While that is useful information, it is the indirect effects of IRS 
activities--on both the taxpayer service side and the enforcement 
side--that generate a far greater amount of revenue. Even if the IRS 
only audits about 1 percent of tax returns, for example, much larger 
numbers of taxpayers will choose to comply because of the possibility 
that they could be audited. Thus, a single audit has a ``ripple'' 
effect or, in economic terms, a ``multiplier'' effect.
    Not all audits are created equal, however: $1 spent on auditing 
industries with historically high rates of noncompliance, such as the 
construction industry, may have a very different multiplier than an 
audit of a corporate tax shelter. Similarly, $1 spent on making it 
easier for taxpayers to comply with their tax obligations--e.g., 
publishing forms, advertising e-file, answering tax law questions--
almost certainly has a multiplier effect as well. We simply don't have 
adequate research to show where the next dollar is best spent.
    Moreover, in terms of improving overall tax compliance, we don't 
have data that show whether the ``multiplier effect'' is generally 
greater at this time for enforcement or for taxpayer service. Thus, a 
decision to increase enforcement and reduce taxpayer service is, to a 
large degree, based more on instinct than solid research. To be sure, 
this is not easy research to do, and in any event, it is a long-term 
project that will not assist in fiscal year 2006 budget decisions. But 
in the absence of better research, it is important to emphasize that 
the decision about how much to increase or decrease certain activities 
represents merely a policy call based on educated guessing.
    If the proposed budget categories are enacted, we still face the 
challenge of allocating IRS costs among them. Many, if not most, IRS 
expenses cannot be unambiguously placed under either the 
``enforcement'' or the ``taxpayer service'' umbrella. For example, the 
proposed budget lists the $1.3 billion cost of submission processing as 
a ``taxpayer service.'' In reality, I view this cost more as a core 
business function. Processing tax returns provides service to the 
extent that it is necessary to enable the IRS to issue tax refunds. On 
the other hand, return processing is central to the IRS's ability to 
classify returns for audits and determine balances due on returns.
    The proposed division of the budget into two categories has also 
triggered internal budget competition. Since the overall budget 
proposes to increase the enforcement category by 8 percent and reduce 
the taxpayer service category by 1 percent, operating divisions and 
functions clearly benefit from placing as much of their programming as 
possible into the enforcement category. Although final decisions have 
not been made, this budget approach seems to be leading to some 
questionable results.
    For example, we have been told that more than 90 percent of the 
funding for the Office of Appeals and the Office of Chief Counsel will 
be allocated to enforcement. By contrast, we have been told that none 
of the funding for the Taxpayer Advocate Service (TAS) will be 
allocated to enforcement--indeed, that TAS will be the only function in 
the IRS allocated entirely to taxpayer service. Considering that 85 
percent of TAS's funding is currently allocated to the Tax Law 
Enforcement (TLE) account and that fully two-thirds of TAS's cases are 
enforcement-related (i.e., cases where taxpayers seek help from TAS due 
to actual or perceived mistakes made by IRS examination or collection 
personnel), there is little principled basis for this difference in 
treatment. The practical effect of allocating TAS entirely to taxpayer 
service is that it increases the likelihood that the TAS budget will 
sustain significant cuts.
    Among the many measures the IRS is considering to reduce taxpayer 
service costs, I discuss my concerns about two below.

                  ELECTRONIC TAX LAW ASSISTANCE (ETLA)

    Electronic Tax Law Assistance (ETLA) is a service provided through 
a link on the official IRS website that allows taxpayers or 
practitioners to send tax law questions electronically to the IRS. The 
system is designed to allow employees to pull responses from the 
database of pre-written answers and thus save time researching and 
responding to frequently asked questions. As originally conceived, ETLA 
was the first stage in a multi-level approach to tax law assistance, 
using artificial intelligence technology to recognize and answer the 
easiest questions and reserving valuable IRS employees for the more 
complex questions. In a recent customer survey, over 90 percent of 
taxpayers using ETLA stated that they would use the service again.
    We understand that the IRS is considering a proposal to discontinue 
providing tax law assistance over the Internet. I think this would be a 
mistake. The benefits of providing answers to taxpayer questions by 
Internet are significant. Most taxpayers now have Internet access, and 
many taxpayers prefer to write up their questions precisely and submit 
them electronically to avoid waiting on hold to speak with telephone 
assisters. In fact, in other areas of tax administration, the IRS is 
justifying the reduction of face-to-face service due to the 
availability of Internet applications. Although Internet-based 
assistance should not be the sole or even primary means of providing 
tax law assistance, ETLA is still very useful, and I understand the 
savings from eliminating it would be only about $1.5 million.

                   TAXPAYER ASSISTANCE CENTERS (TACS)

    The IRS is planning to close a significant number of its 
approximately 400 walk-in sites (also called ``Taxpayer Assistance 
Centers'' or ``TACs''). Here, the estimated savings are larger--
approximately $50 million. To date, the IRS has not identified 
alternative means to assist taxpayers who require face-to-face 
assistance. This is unfortunate since taxpayers will continue to seek 
the assistance they require. The Taxpayer Advocate Service and other 
IRS offices co-located with TACs subject to closure are particularly 
likely to see an upsurge in taxpayer requests for assistance.
    In a tax system with 130 million individual taxpayers, there is no 
one-size-fits-all solution to any problem. Some taxpayers strongly 
prefer--or, depending on personal limitations, may even require--face-
to-face contacts, some need telephone contacts, and some prefer to 
interact with the IRS electronically. A significant study released last 
year by the Pew Internet and American Life Project examined how 
Americans communicate with the government. Generally, the study found 
that most Americans prefer to communicate with the government orally 
(either by phone or in person), rather than by letter or over the 
Internet. Notably, fully 20 percent of Americans reported that their 
most recent contact with the government was in person. In a few States, 
the IRS has experimented with using mobile vans to cover a greater 
number of areas. For example, the van might move weekly among five 
locations in a State. It could show up at a local library in a town 
every Monday, for example, and visit other cities on other days of the 
week. A mobile van would not be as convenient as having a fully staffed 
office that is open daily, but if the IRS is planning to close a 
significant number of offices, it should at a minimum consider whether 
an approach like this might allow the IRS to remain accessible at a 
much lower cost.
    The IRS has developed a model incorporating many factors to help it 
determine which TACs to close. I applaud the serious effort that went 
into creating this model over a very short period of time--a matter of 
months. Built using demographic and other taxpayer data, the model 
provides an excellent first stage for an analysis of TAC closures. In 
my view, however, the IRS should supplement this model with a 
comprehensive survey of taxpayers' need for face-to-face service. The 
model's reliance on TAC usage over the last few years, as a proxy for 
taxpayer need, is inadequate since the IRS has reduced the services 
provided in TACs over that period due to resource concerns.
    The speed with which the IRS is making decisions of such momentous 
import to taxpayer service, and the lack of stakeholder engagement, is 
of great concern to me. I was briefed on this model on March 22 of this 
year, too late to have any but the most trivial influence on its 
development. It is my understanding that the IRS consulted the Internal 
Revenue Service Advisory Committee (IRSAC) with respect to the 
weighting of factors used to determine closings. However, the IRS did 
not consult the Taxpayer Advocacy Panel (TAP), a Treasury panel of 
volunteer taxpayers specifically chartered under the Federal Advisory 
Committee Act to advise the IRS on matters pertaining to customer 
service. Nor did the IRS seek comments or suggestions from the Low 
Income Taxpayer Clinics funded by the IRS under IRC  7526, which 
presumably represent the interests of a portion of the taxpayer 
population affected by these closings.
    In light of the lack of any taxpayer-centric assessment of the need 
for face-to-face service, or any accurate measure of the impact of TAC 
closings on compliance, or any significant engagement with 
stakeholders, or any identification of alternative methods for 
providing face-to-face service, I believe that closing Taxpayer 
Assistance Centers at this time will irrevocably harm taxpayers.

                               CONCLUSION

    The IRS faces significant challenges in the next few years as it 
attempts to increase taxpayer compliance. To achieve this goal, the IRS 
needs to do a better job of identifying and balancing both taxpayer 
needs and enforcement efforts. Rather than making resource-driven 
decisions that are based on inadequate research and that fail to 
identify equivalent alternatives, the IRS must develop a world-class 
research function that is the foundation for all of its customer 
service and enforcement activities. Research--and truly strategic 
planning--should inform the IRS's allocation of resources so that we 
achieve the maximum compliance possible by obtaining the optimal 
balance between service and enforcement.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Bond. As I've indicated earlier in my statement, it 
would help us a lot if we could get some funding credit in the 
badly out-of-date scoring systems for the money that comes in 
for the IRS activities that we fund. This would help Congress 
and the IRS to assist more taxpayers and, more importantly, 
bring in more revenue.
    We will leave the record open until next week for my 
colleagues to submit questions. And we would appreciate your 
prompt attention to and response to these. And I thank our 
witnesses and those who've come to hear us.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

            Questions Submitted by Senator Pete V. Domenici

   CAPITAL GAINS TAX RATE FOR ART AND COLLECTIBLES AND FUEL TAX FRAUD

    Question. Commissioner Everson, I am a long-time advocate of 
equitable treatment for all capital gains, and I plan to introduce a 
bill to correct the tax code's disparate treatment of various capital 
gains to ensure fairness for all types of investors.
    My legislation would reduce the capital gains tax rate for sales of 
art and collectibles to 15 percent--the same rate of taxation for most 
capital gains relating to stock and bond sales. In addition to being 
fair to individuals who choose to invest in art or other collectibles, 
I believe that this legislation would raise revenue for the U.S. 
Treasury because lowering the capital gains rate would encourage people 
to buy and sell art and collectibles, which would increase the number 
of people paying tax on art and collectibles.
    Would you anticipate an increase in art and collectibles sales if 
the capital gains tax rate were lowered for such sales?
    Answer. Generally, a reduction in tax may result in an increase in 
affected sales. However, the Department of the Treasury has not 
prepared a revenue estimate that would chart the effects of this 
particular proposal.
    Question. Will you provide me with the amount of revenue generated 
last year by the capital gains tax on the sale of stocks and bonds and 
the amount of revenue generated last year by the capital gains tax on 
the sale of art and collectibles?
    Answer. For 2002, the most recent year for which tax data are 
available, total tax revenue on capital gains from stocks, bonds, and 
other assets subject to preferential capital gains rates was $49 
billion. Separate data are not available for capital gains on sales of 
artworks and collectibles. This category is likely well below 1 percent 
of capital gains realizations and revenues, and too small to be 
measured meaningfully with existing sales of capital assets tax data 
samples.
    Question. What was the administration's reasoning for lowering the 
capital gains tax rate for some investments, but keeping a higher tax 
rate for art and collectibles?
    Answer. The Taxpayer Relief Act of 1997 generally reduced the 
maximum rate on adjusted net capital gain of an individual from 28 to 
20 percent. Although both the House and Senate versions of the Act 
generally reduced the maximum capital gains tax rate for individuals, 
both versions maintained the then-current law maximum 28 percent rate 
for collectibles such as artwork, rugs, antiques, metals, gems, stamps 
or coins, and the conference report retained this rule for 
collectibles. The legislative history of the Act does not give a 
specific reason for this treatment. The Jobs and Growth Tax Relief 
Reconciliation Act of 2003 generally reduced the maximum rates on 
adjusted net capital gain of an individual from 10 and 20 percent to 5 
and 15 percent. It did not modify the category of 28 percent rate gain 
including collectibles.
    Question. Has the administration considered expanding the new, 
lower capital gains tax rate to apply to art and collectibles?
    Answer. The administration's Budget does not include any proposed 
modifications to the taxation of sales or exchanges of collectibles. 
The President has appointed an Advisory Panel on Federal Tax Reform to 
consider fundamental changes throughout the tax Code. The Panel's 
report is due by July 31, 2005.

            CAPITAL GAINS TAX RATE FOR ART AND COLLECTIBLES

    Question. The legislation I mentioned would also correct the 
inequity afforded to artists who donate their work to charity. Under 
current law, if a collector donates a painting to a museum, he or she 
is entitled to a tax deduction equal to the fair market value of the 
artwork. However, if the artist who created the work were to donate the 
same painting, he or she is only entitled to a deduction for the paint, 
the canvas, and any other art supplies involved in creating the work.
    This provision of the Tax Code creates a tremendous disincentive 
for artists to donate their work and negatively impacts museums, 
libraries, and schools, which depend on such donations to grow their 
collections. My legislation would remedy this unfairness by allowing 
artists to deduct the full market value of artwork they donate.
    Would you expect more artists to donate their works to charity if 
they were subject to the same charitable contribution rules as art 
collectors?
    Answer. Yes. We would anticipate a significant increase. The IRS 
anticipates a significant increase because the proposal would allow 
artists to claim a deduction for amounts that are not included in 
income. Current law does not allow a deduction for the value of donated 
services. This current-law rule generally produces the same tax results 
for individuals who assist charities by providing volunteer services as 
for individuals who make charitable contributions of cash.
    Question. Can you tell me how many artists sought deductions for 
charitable contributions of their art work in 2004?
    Answer. This information is not available.

                             FUEL TAX FRAUD

    Question. Commissioner Everson, over the last several months we 
have been working very hard to identify ways of shoring up the highway 
trust fund without raising taxes. Recently a lot of attention has 
focused on the revenue lost to fuel tax fraud, and in this case, the 
ability of criminals to remove red dye from untaxed diesel fuel using 
straightforward techniques. I have heard from your office that the IRS 
is looking at various technologies to address this issue, but it is 
being held up because there is no field test. It certainly seems we 
could be simultaneously implementing more effective technology while 
exploring options for a more effective field test.
    Why is a field test critical to the success of this program?
    Answer. Each year U.S. consumers buy more then 61 billion gallons 
of diesel fuel and over 26 billion gallons of aviation grade kerosene. 
Both of these products can be and are used in highway vehicles. 
Currently, the IRS uses the red dye field test to monitor compliance 
with the payment of fuel excise taxes. When the IRS takes a sample of 
fuel from a motor vehicle, the results are immediate. If the sample 
does not show any traces of red dye, the IRS releases the vehicle and 
discards the sample. If the field sample shows traces of red dye, the 
IRS forwards the sample to its laboratory for a complete analysis, and 
the Fuel Compliance Officers (FCOs) gather information from the owner 
of the truck, which the IRS uses to assess a penalty for improper use 
of dyed fuel. Without such a field detection device, the IRS would have 
to randomly select fuel from millions of highway vehicles and tens of 
thousands of retail stations, and gather identifying information from 
them as well, in order to monitor compliance with the payment of fuel 
excise taxes. The IRS would have to analyze each sample at a laboratory 
and then would have to follow up with those individuals or businesses 
that failed the test.
    The principal drawback to the current testing is the inability to 
determine immediately if the red dye has been removed from red dye 
diesel fuel. If this removal has been done effectively, there is no 
visible trace left to detect, and the fuel looks just the same as taxed 
fuel that has never been dyed. While the IRS agrees some type of 
invisible marker (such as the recently promoted molecular marker) would 
enable the IRS to detect dye removal, it would have to send all fuel 
samples to a lab for analysis to determine the presence of the marker 
in the fuel. Such an approach is not operationally or economically 
feasible. Hence, the IRS needs some type of field device by which IRS 
FCOs can readily detect the existence of a marker. To date, the IRS has 
not been shown a practical field device.
    Question. It certainly appears that the Red Dye has failed as a 
field test, so why are we allowing perfect to be the enemy of the good 
and losing hundreds of millions of dollars by not implementing another 
method to detect fraudulent fuel?
    Answer. The IRS does not believe that the red dye field test regime 
has been a failure. In the vast majority of cases, the red dye 
provisions have been successful in keeping non-taxable fuel off the 
highways. Upon its initial implementation, the red dye regime yielded 
significant tax increases and continues to be an effective deterrent 
today. It is only recently that the IRS has begun to see products that 
appear to have had the red dye removed. The extent of the removals is 
unknown, but the IRS does not believe that it is widespread. The IRS is 
not aware, nor has it stated, that it is losing hundreds of millions of 
dollars due to the removal of the red dye. As requested in the 
Appropriations bill, the IRS is continuing to look at the possibility 
of using the molecular marking regime and has discussed the potential 
usage with the American Petroleum Institute (API). They have raised 
significant issues regarding the blending, product quality, company 
indemnification and reliability of the sampling. The IRS is continuing 
to work with the promoter of the field screening device to reach an 
acceptable field performance level.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

                      PRIVATE COLLECTION AGENCIES

    Question. In January of 2005, the IRS briefed my staff on the 
schedule for implementing private debt collection over the next few 
years, including the number of agencies involved, and how much the IRS 
plans to spend in fiscal year 2005 and successive years. Please provide 
a detailed update of this information.
    Answer. The IRS has made significant progress toward the initial 
implementation of the private debt collection initiative. Since the 
briefing in January 2005, the IRS has developed a release schedule that 
will provide for limited implementation in January 2006. The IRS will 
develop additional systemic functionality for January 2007. Full 
implementation of the private debt collection program is scheduled for 
January 2008 with enhanced reporting, monitoring and control 
capabilities. This schedule will allow for a controlled ramp-up of 
additional volumes of delinquent account placements with private 
collection agencies.
    In March 2005, the IRS selected a software vendor to provide 
inventory management support of the private debt collection accounts. 
The vendor is a proven leader in collection inventory management 
applications with over 19 State deployments of their software. The 
inventory management vendor is on board and has been working with IRS 
staff to ensure successful deployment of the supporting software 
applications in time for placement of delinquent accounts with private 
collection agencies.
    The IRS has prepared the statement of work to secure the services 
of private collection agencies, and the contracting officer provided it 
to potential vendors on April 27, 2005. The IRS expects to award 
contracts in July 2005 with initial account placements in late January 
2006. The IRS has identified the initial workload for placement with 
private collection agencies and anticipates placing approximately 
40,000 accounts within the first 9 months of operation.
    The IRS has developed support structures and roles and 
responsibilities. The IRS has identified operational sites and is 
making progress on securing facilities. The IRS has identified a number 
of key policy concerns and successfully worked them to resolution. The 
IRS is drafting internal and external policies and procedures, with 
anticipated completion scheduled for late summer.
    The IRS has developed and approved a project schedule for the 
limited implementation. The IRS has also developed a project budget and 
secured funding for the current fiscal year. Additional funding is 
included in the BSM spend plan requests for fiscal year 2006. The IRS 
has established a project governance structure and its members meet 
regularly with the project leadership to review progress against 
scheduled activities and to provide guidance to the team. With the 
current strong leadership in place, the IRS anticipates a successful 
implementation of the private debt collection efforts.
    The current information technology projected costs and budget for 
fiscal year 2005 totals $15.5 million. This funding amount reflects the 
full costs of the ``limited implementation'' for January 2006 of $9.5 
million and an additional $6 million to begin the activities that 
support the January 2007 implementation.

                     BUSINESS SYSTEMS MODERNIZATION

    Question. Once finalized, the Custodial Accounting Project is 
supposed to be a single, integrated data repository of taxpayer account 
information and accessible for management analysis and reporting. 
However, costs for the Custodial Accounting Project have continued to 
increase, with the cost for the first phase in the neighborhood of $98 
million. But this project is now on hold and may never go forward. What 
is the latest on this project's cost and do you expect it to ever come 
to fruition?
    Answer. The BSM office designed CAP to provide integrated, reliable 
tax operations and internal management information to support decision 
analytics, performance measurement, and management information needs. 
CAP also provided a data warehouse loaded with detailed taxpayer 
account and collections information to be used for analysis and 
financial reporting to oversight organizations. The IRS conceived CAP 
as a multi-release solution, and BSM delivered the first two releases 
into production in September 2004 and November 2004. However, for CAP 
to have sustainable value to the IRS, it required two additional 
releases--for business master file taxpayers and for collections data. 
Collectively, these releases would take at least 3 years to complete 
and cost more than $100 million. In addition, maintenance and support 
for fielded CAP releases will cost more than $10 million annually. 
Within the current budget context, the IRS evaluated benefits and costs 
of continued CAP investment against the value to taxpayers and IRS 
employees, competing priorities such as CADE, MeF, F&PC, and 
maintaining core infrastructure. The IRS determined in January 2005 
continued CAP investment is no longer a viable or sound business 
decision; however, the IRS will leverage CAP work products and 
knowledge gained in other BSM initiatives (e.g., BSM will use CAP data 
models on CADE; the IRS now performs data segmentation and analysis in 
a more modernized way, etc.). The CFO's office is pursuing a current 
production environment (CPE) upgrade alternative that meets their 
needs. There are no plans to revive CAP at this time.
    Question. The contractor for Business Systems Modernization 
developed a system for the IRS known as the Security Audit and Analysis 
System to gather information for use in audits. Specifically, the 
system would enable users to detect unauthorized activities and 
facilitate the reconstruction of events if unauthorized activities 
occurred. However, problems have prevented users from accessing the 
data once it has been collected. When the contractor delivered the 
system to the IRS in 2002, the IRS was aware that the system did not 
meet IRS requirements but accepted the system with the understanding 
that it would be fixed. Have these problems with the system been 
resolved?
    Answer. Since the initial delivery of the system in 2002, the IRS 
has successfully resolved several requirements issues and is pleased 
the Security Audit and Analysis System (SAAS) is effectively managing 
audit trail data for modernization systems. Security Managers and 
Modernization System Managers can generate Modernization Managers 
Security Reports (MMSR) of employee access to taxpayer data from the 
SAAS system. The Treasury Inspector General for Tax Administration 
(TIGTA) should be able to begin their pilot use of SAAS in the summer 
2005. The use of the SAAS reports by TIGTA is delayed until they 
complete the testing of the current system audit trails. Final data 
updates for this capability are underway and the TIGTA should complete 
testing in the summer 2005. Activities continue to plan the transition 
of current production systems audit trail analysis capabilities to the 
SAAS system for TIGTA use. Mission Assurance and Security Services, 
TIGTA, Modernization, Information Technology Services (ITS) and the 
PRIME Contractor are working together to define and prioritize the 
implementation of additional requirements and enhancements to the SAAS 
system, which will be implemented in 2005 and 2006.
    When IRS fully deploys SAAS, it will process two sources of ``audit 
trail'' data. One source is audit trails for modernized systems (e.g. 
IFS, Modernized E-file, E-services, IRFOF, etc.) and another is audit 
trail historic data from the legacy Integrated Data Retrieval System 
(IDRS) and Corporate Files on Line (CFOL) production systems. A current 
production system called ATLAS, which continues to function while the 
IRS transitions its capabilities to SAAS, currently captures this 
legacy system audit trail data and processes it. The TIGTA will 
continue to utilize ATLAS to review potential Unauthorized Access 
(UNAX) violations until the IRS fully tests the SAAS system in a 
production environment using production data. The IRS moved the ATLAS 
data to SAAS to provide more modern technology support to the TIGTA 
users, provide a single system for TIGTA to access their data instead 
of their accessing both ATLAS and SAAS, and to allow the retirement of 
the ATLAS system. The IRS previously processed and loaded the ATLAS 
data into a data mart containing 60 months of historic data, but the 
IRS is currently updating it to contain data from the last 4 months of 
2004 audit trail information into SAAS, and then it will load the IDRS/
CFOL data from 2005.
    Once the IRS loads the remaining 2004 historic IDRS data into SAAS, 
the IRS needs to complete testing of multi-year report functionality. 
At that point, TIGTA will begin to conduct a formal customer acceptance 
test in the SAAS Production system. After the TIGTA completes the 
customer acceptance test results, the IRS will make any necessary 
systems changes and TIGTA will begin a 3-month parallel test of both 
ATLAS and SAAS in Production prior to making any decisions about 
retiring the current CPE system. TIGTA may determine that a second 3-
month parallel test of both ATLAS and SAAS is required based on the 
results of the CAT testing and the initial parallel test. The current 
completion dates are in the SAAS Production schedule (05/31/2005 
schedule) as follows:
  --Final Data Checkout on the loading of the 60 months of historic 
        data into the SAAS DataMart.--7/19/05;
  --Complete initial TIGTA CAT in Production.--8/22/05.
    The IRS is still working with TIGTA to reach agreement on a plan 
and schedule for conducting the parallel test between SAAS and ATLAS in 
Production. The IRS based the current schedule, which calls for this 
test to begin in November 2006, upon the current estimates for loading 
all historical audit trail data for 2005 into the SAAS data mart. 
Delays in loading the most current 60 months of historic audit trail 
data into the SAAS Production system have caused schedule delays, and 
the IRS is looking at options (e.g., performance enhancements, capacity 
upgrades) that may accelerate the current schedule estimates. The 
current projected completion dates in the SAAS Production schedule as 
of 05/31/2005 are:
  --Final Datamart load of the 2005 data.--9/12/06;
  --Execute 3 month parallel ATLAS/SAAS Production testing.--12/08/06;
  --Execute 2nd 3 month parallel testing.--3/31/07--dependent on 
        TIGTA's satisfaction following the first 3 months parallel 
        testing;
  --Retire ATLAS.--3/31/07 following 6-month ATLAS/SAAS parallel 
        testing.

               TELEFILE--FILING TAX RETURNS BY TELEPHONE

    Question. The IRS is reducing submissions processing activities 
because taxpayers are filing fewer paper returns. In 2004, almost 4 
million taxpayers filed by telephone--57 percent of whom had income of 
$20,000 or less and 97 percent had income of $50,000 or less. 
Additionally, nearly 1 million businesses used the TeleFile technology 
to file their employment tax forms. The IRS's own survey reveals that 
nearly 40 percent of the individual TeleFilers will go back to paper 
filing. Further, there is currently no electronic alternative for the 
businesses that use TeleFile. Nonetheless, the IRS is proposing to 
eliminate TeleFile because the IRS says use has declined somewhat and 
it is a bit more expensive to maintain than paper or electronic filing. 
Why was the decision made to eliminate TeleFile without first providing 
a viable, easy-to-access means of filing for these individuals and 
businesses that ensured an electronic filing rather than forcing them 
back to paper filing? Did the IRS look at ways to achieve efficiencies 
in the operation of the current TeleFile system? If so, what were they? 
Were these pursued?
    Answer. The TeleFile program has certain requirements, such as 
telecom, printing and postage cost that cannot be restructured or 
reduced; therefore, the IRS could not develop efficiencies within the 
current TeleFile program.
    In making the decision to sunset TeleFile, the IRS considered the 
declining use of TeleFile, the discontinuation of several State 
TeleFile programs, including California's decision to cease TeleFile in 
2005, and the growth of other electronic filing alternatives, such as 
Free File. In fact, Free File volumes grew from 3.5 million returns in 
2004 to 5.0 million returns in 2005, a 46.6 percent increase. At least 
60 percent of individual filers qualify for Free File services and all 
TeleFile-eligible filers with access to the Internet can use Free File. 
Additionally, in their decision, the IRS considered the June 2004 
Electronic Tax Administration Advisory Commission (ETAAC) report 
recommendation to discontinue TeleFile. By sunsetting TeleFile, the IRS 
will eliminate growing information systems operational costs of $3 
million-$5 million annually and printing and postage costs of $4 
million-$5 million annually.
    The IRS has not developed a similar alternative for employment tax 
returns. The same cost and infrastructure issues that the IRS faced 
with Forms 1040 still persist. However, there are low cost alternatives 
currently available to electronically file the Form 941.
    TeleFilers may initially revert to paper filing (37 percent 
according to a customer satisfaction survey), but research shows they 
rebound to electronic filing at a higher rate than the general 
population. Sixty-two percent of TeleFilers said they would try another 
e-file option if TeleFile was no longer available.

                           TAXPAYER SERVICES

    Question. The IRS is reducing its face-to-face service providing 
taxpayers with information and filing assistance. Instead, the IRS 
wants to direct taxpayers to the IRS website and to volunteer tax 
return preparers. In particular, the IRS plans to decrease the level of 
pre-filing services offered by Taxpayer Assistance Centers. The problem 
with this is that some taxpayers rely on the face-to-face service. The 
IRS notes, in its Strategic Plan, that it must ``continue to use a 
comprehensive range of products and services to reach [their] 
customers, including those who do not use electronic services.'' Mr. 
Everson, how does the IRS's plan to reduce face-to-face services 
adequately provide for these taxpayers who won't use electronic 
services?
    Answer. In recent years, the IRS has seen a significant shift in 
the ways Americans interact with the Service. Compared to the past, 
fewer taxpayers are choosing to write or call the IRS; even fewer 
taxpayers are using walk-in TACs. Instead, more and more Americans are 
turning to volunteers for return preparation and they are obtaining 
forms and tax information from the IRS's Internet site. In addition, 
most TAC services are available through the IRS's Toll-Free telephone 
system at a greatly reduced cost and with higher quality. In a report 
issued last year, the Government Accountability Office (GAO) stated, 
``improvement in phone service, increased web site use and the 
availability of volunteer sites raises a question about whether the IRS 
should continue to operate as many walk-in sites.''
    In making the business decision regarding the TACs, the IRS 
considered the long-standing concept of operations for Field Assistance 
that emphasizes accounts and collection work, with customers who need 
assistance increasingly served through self-service mechanisms, and 
reliance on community-based volunteer partners for return preparation 
assistance. The IRS anticipated that as these partnerships grew and 
increasingly met the needs of community members, the customer traffic 
in IRS TACs would be reduced. In making this decision, the IRS also 
considered changing taxpayer behavior, the availability of new and 
improved alternative services, and the cost benefits of these 
alternatives compared to walk-in service.
    When taxpayers have tax law questions or questions about their 
accounts, the IRS's Toll-Free service will route them to the assistor 
who has the expertise to answer their particular question. If a 
taxpayer needs a form, the IRS website has every form available for 
download, and paper forms are available at 32,000 local libraries, 
banks, post offices and other outlets. When taxpayers need help 
preparing their returns, they can visit one of the 14,000 VITA and TCE 
sites available throughout the country. If a taxpayer still needs face-
to-face service with an IRS representative, more than 300 TACs will 
still be available across the country to provide that service as well.

                      ACCURACY OF TAX INFORMATION

    Question. Mr. Everson, if you succeed in reducing the number of 
Taxpayer Assistance Centers, it will become even more important that 
the remaining avenues available to taxpayers seeking information be 
accurate. Recently, the Treasury Inspector General for Tax 
Administration (TIGTA) found that taxpayers have alerted the IRS of 
possible errors on the IRS.gov website but these concerns were not 
always addressed. TIGTA also found that the IRS could not verify 
whether correct changes had been made to the website. Mr. Everson, if 
compliance is an utmost priority to the IRS, how can you expect 
taxpayers to comply if the information they receive from the IRS isn't 
accurate or reliable?
    Answer. After the Treasury Inspector General for Tax Administration 
(TIGTA) review on the accuracy of IRS.gov, the IRS implemented several 
controls to ensure taxpayer concerns regarding the web site are 
directed to the appropriate IRS.gov Point of Contact (POC). The IRS 
also issued more specific procedures to the IRS.gov Helpdesk vendor 
regarding the handling of IRS.gov inquiries (comments, questions and 
problems) from web users, to ensure the vendor is forwarding those 
inquiries for resolution. Inquiries from web users regarding the 
accuracy of the web site or inquiries that indicate that information on 
the web site is different from other web documents are immediately 
forwarded to the IRS.gov POCs for resolution.
    The IRS has also added a staff member dedicated to monitoring the 
resolution of inquiries forwarded to the IRS.gov POCs to ensure that 
these inquiries are addressed. The IRS has also implemented the use of 
Unresolved Escalation Reports to follow-up on unresolved inquires with 
the Content Area Administrators and, when necessary, management. If 
IRS.gov POCs do not respond to inquiries within designated timeframes, 
a follow-up is scheduled to ensure issues are resolved.
    In addition, the IRS has updated its procedural document 
``Guidelines for Responding to IRS.gov Escalations'' to provide 
specific responsibilities for IRS.gov POCs. On January 11, 2005, the 
IRS held a meeting with the IRS Content Area Administrators and 
explained the changes in procedures. Since January 2005, the new 
procedures have been effectively implemented.

                   PROPOSED CUTS TO TAXPAYER OUTREACH

    Question. Funding for taxpayer outreach has steadily decreased in 
the past few years. Outreach activities include proactive programs for 
taxpayers, businesses, tax practitioners, and others to understand 
their tax obligations and have the information and materials necessary 
to do so. For fiscal year 2006, a 7 percent cut is proposed, which is 
almost the same as the increase proposed for enforcement. Doesn't 
cutting outreach directly conflict with your Strategic Plan to improve 
taxpayer service by making it easier for people to participate in the 
tax system? Have you been able to identify a decline in the need for 
outreach? Do you have data--has a study been completed to demonstrate 
this? If yes, please provide a copy. If there has been no decline in 
the need for outreach, how are you going to meet this need, if you are 
cutting outreach?
    Answer. The change in the level of resources requested for the 
Outreach activity in fiscal year 2006 reflects the IRS's commitment to 
providing high-quality services to taxpayers in the most efficient and 
effective manner possible. However, the reduction in Outreach is not 
comparable to the increase in Enforcement resources. Outreach is a 
single budget activity with a relatively small budget, while the term 
``Enforcement'' encompasses five budget activities with a substantially 
larger budget. A more appropriate comparison would be between the 
reduction in ``Taxpayer Service'' resources--encompassing several 
budget activities--and the increase in ``Enforcement'' resources. As 
proposed for fiscal year 2006, ``Taxpayer Service'' resources decline 
by 1 percent, while ``Enforcement'' resources reflect a 7.8 percent 
increase.
    The IRS must provide strong customer service to taxpayers, but the 
way taxpayers pay their taxes and access IRS information is changing. 
In recent years, the use of IRS.gov and e-filing has increased rapidly 
while paper filing and visits to walk-in Taxpayer Assistance Centers 
(TACs) have declined. In fact, this filing season individuals filed 
more returns electronically than on paper, marking the first time in 
history that e-filing has outpaced paper returns. The closure of TAC 
sites and corresponding reduction in Outreach resources has been 
carefully evaluated to minimize the impact on taxpayers while 
simultaneously making additional resources available for other 
essential functions.
    The number of taxpayers walking into a Taxpayer Assistance Center 
(TAC) for assistance has decreased from a high of nearly 10 million 
contacts in fiscal year 2000 to about 7.7 million contacts in fiscal 
year 2004. To date this filing season, traffic is down again by over 9 
percent. This trend reflects the increased availability and quality of 
services that do not require travel or waiting in line. Examples 
include improved access to IRS telephone service, the increasing 
availability of volunteer assistance, and the many services now 
available through IRS.gov, such as access to all forms and 
publications, ``Free File,'' and ``Where's My Refund?''
    These shifts present an opportunity to adjust the way the IRS 
serves taxpayers and to focus on the most efficient services. Changing 
the way the IRS provides customer service to meet the new ways people 
are dealing with their taxes in the 21st century allows the IRS to meet 
the needs of taxpayers while spending their tax dollars more 
efficiently and responsibly.
    With respect to quality, Toll-Free telephone service is the best 
option for most customers to get a correct and complete answer to their 
tax law or account questions. Unlike the walk-in environment, the 
sophisticated capabilities of our Joint Operations Center allow Toll-
Free customers to be routed to an IRS employee specifically trained to 
address their particular issues. This filing season, Toll-Free tax law 
and account accuracy are at 88 percent and 91.5 percent respectively. 
Treasury Inspector General for Tax Administration (TIGTA) audits 
assessed the walk-in level of tax law accuracy at 75 percent for the 
same time period; however, the IRS notes the TIGTA does not base its 
results on a statistically valid sample. The IRS is developing a new 
Field Assistance Embedded Quality Review System (EQRS) to determine the 
true accuracy rate, but it is still too early in development to yield 
measures of which the IRS is confident.
    The Wage and Investment Division Stakeholder Partnerships, 
Education and Communication (SPEC) business model focuses upon the 
delivery of education and tax preparation services solely through 
community-based partners such as non-profit, social services, 
educational, financial, governmental, faith-based, and corporate 
organizations. Since inception in 2001, this collaborative partnership 
has increased the volume of volunteer tax return preparation from 1.1 
million returns to over 2 million returns in 2005.
    The IRS also believes it can streamline certain other outreach 
programs while meeting or exceeding the service expectations. In 
particular, the ongoing effort to realign and refocus communications, 
outreach, and liaison efforts within the Small Business/Self-Employed 
(SB/SE) Division will enable the IRS to enhance the level of service 
and the quality of its interactions with small business taxpayers in 
support of its strategic plan. The core mission of this merged 
organization will focus efforts in three areas--practitioner liaison; 
stakeholder engagement; and, support of strategic compliance 
initiatives--and will result in the following benefits for small 
businesses and practitioners:
  --Centralized organization and delivery of key messages to ensure 
        national stakeholders and partners in tax administration at the 
        local level receive consistent, accurate and up-to-date 
        information.
  --Targeted communications with practitioner groups to provide 
        consistent information on changes to the IRS's policies and 
        procedures and keep our stakeholders apprised of the many 
        services we offer--such as E-services for those who file 
        electronically on behalf of their clients.
  --An enhanced Issue Resolution program to encourage and address the 
        feedback received from small business and practitioner 
        stakeholders and enable the IRS to continually make 
        improvements in examination, collection, and campus operations 
        that benefit small businesses and practitioners.
  --Continued educational outreach to meet the needs of small 
        businesses through comprehensive curriculum, which the IRS 
        updates for all tax code changes. The website, which is 
        dedicated to small businesses, contains about 10,000 pages of 
        content arranged by major industry groups and by major tax 
        areas, such as employment taxes and depreciation. Response to 
        this site has been overwhelming. For example, in January 2005, 
        the site had 1.7 million visitors--more than double the number 
        from January 2004.
    Finally, the IRS believes it can achieve greater efficiencies in 
distributing tax products by leveraging on the continuing growth in e-
filing and taxpayers' increased use of Internet. For example, 
consolidating the IRS's forms distribution operations from three sites 
to one site not only will be more efficient, but also will save staff, 
printing and postage resources. Other savings will accrue as increased 
e-filing results in the need to mail fewer tax packages, and Internet 
downloads allow the IRS to reduce excess quantities of tax forms, 
publications and other tax products.
    Question. Congress created the Taxpayer Advocate so that taxpayers 
could receive assistance in solving their problems with the IRS. 
However, taxpayers aren't able to take advantage of this service if 
they don't know about it. Research indicates that only a small 
percentage of taxpayers eligible for Taxpayer Advocate Services have 
ever even heard of the Taxpayer Advocate. To what degree will the cuts 
you are proposing affect the Taxpayer Advocate? Won't these cuts 
further erode the public's awareness of the Taxpayer Advocate?
    Answer. The IRS will continue to make taxpayers aware the Taxpayer 
Advocate Service is available to help them solve their problems with 
the IRS. The proposed changes to taxpayer service--reduced outreach 
spending and fewer Taxpayer Assistance Centers--may minimally reduce 
taxpayer awareness of the availability of the Taxpayer Advocate Service 
(TAS). However, outreach activities that publicize TAS should continue. 
The reduced outreach spending will be possible due to savings in 
printing and postage caused by shifts to electronic filing and by 
providing publications on-line, rather than through the mail. Reduced 
IRS face-to-face assistance may increase the TAS workload as taxpayers 
seek such service from TAS, especially in cases where TAS is collocated 
with a TAC that's been closed. However, the IRS expects these impacts 
to be minimal because of the overall trend toward alternate forms of 
assistance via the Internet and the telephone. Further, VITA assistance 
and SPEC and TEC outreach programs will supplement IRS reductions to 
face-to-face service and will maintain significant support for the 
awareness of TAS's services.

                                 ______
                                 
                Question Submitted by Senator Harry Reid

    Question. The National Research Program (NRP) estimates that 
underreporting of tax attributable to individual income tax filers is 
the largest component of the tax gap. The shortfall of taxes paid to 
taxes owed has been estimated by the IRS at being in the range of $200 
billion-$235 billion annually. Of this amount, the Service estimates 
that as much as $9 billion of this underpayment relates to errors in 
calculating taxable gains on the sale of equity assets. I understand 
that the NRP program used, on a limited basis, a computer program to 
help derive this underpayment estimate. Would an expansion of the use 
of this program assist the Service in reducing the underpayment of tax 
in this area?
    Answer. The National Research Program (NRP) analyzed about 46,000 
individual income tax returns for Tax Year 2001 and the Office of 
Research used the data collected in its update of the Tax Gap figures 
released in late March. NRP examiners and classifiers tested computer-
based tools to determine if the calculated amount of capital gains 
reported by the taxpayer could easily be checked. The test was 
inconclusive, with some examiners and classifiers saying the tool was 
somewhat useful and others saying it was not helpful. In large part 
these results reflect the fact that taxpayers do not always list the 
exact purchase date for assets (such as shares of stock) they sell in a 
particular tax year. Often, the acquisition date is given as 
``various,'' reflecting purchases of more than one block of shares or 
the ongoing acquisition of shares through dividend reinvestment. 
Moreover, even where there is a specific acquisition date, the share 
price may fluctuate on that day by 10 percent or more, and it is 
unclear whether the taxpayer purchased the shares at the top of the 
range, at the bottom, or somewhere in between. Given the current level 
of information reporting for capital gains transactions (e.g., only 
gross sales proceeds are reported by brokerage firms, not the basis of 
the publicly-traded assets that were sold), it is not clear that the 
benefits generated by using a computer-based tool to help calculate 
basis of capital assets would exceed the costs.

    Senator Bond. The hearing is recessed.
    [Whereupon, at 10:50 a.m., Thursday, April 7, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
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