[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 
                                  2007

                              ----------                              


                        THURSDAY, APRIL 27, 2006

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 9:35 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Christopher S. Bond (chairman) 
presiding.
    Present: Senators Bond, Murray, Durbin, and Dorgan.

                       DEPARTMENT OF THE TREASURY

                        Internal Revenue Service

STATEMENTS OF:
        MARK W. EVERSON, COMMISSIONER
        RAYMOND T. WAGNER JR., CHAIRMAN, IRS OVERSIGHT BOARD
        J. RUSSELL GEORGE, TREASURY INSPECTOR GENERAL FOR TAX 
            ADMINISTRATION
ACCOMPANIED BY:
        DAVID A. POWNER, INFORMATION DIRECTOR, GOVERNMENT 
            ACCOUNTABILITY OFFICE
        JAMES WHITE, DIRECTOR, STRATEGIC ISSUES, GOVERNMENT 
            ACCOUNTABILITY OFFICE

            OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND

    Senator Bond. Good morning. The Subcommittee of the Senate 
Transportation, Treasury, the Judiciary, HUD, and Related 
Agencies, Appropriations will come to order.
    This is the budget hearing on the fiscal year 2007 budget 
for the Internal Revenue Service. We have a very distinguished 
panel of witnesses today. I welcome back IRS Commissioner Mark 
Everson. I also welcome Ray Wagner, Chairman of the IRS 
Oversight Board; Nina Olson, the National Taxpayer Advocate, 
and I believe that Russell George, Treasury Inspector General 
for Tax Administration will be joining us shortly.
    I also note that the Government Accountability Office has 
submitted a statement for the record at my request and has sent 
two senior officials to answer any questions during the 
hearing, and we appreciate that. GAO has served us extremely 
well, especially with their detailed reviews and oversight of 
the IRS Business Systems Modernization program.
    Before I begin my formal comments, personally I thank all 
of the witnesses today for their service and commitment to the 
IRS. The IRS is probably one of the least appreciated Federal 
Agencies, but it is definitely one of the most important to the 
functioning of our Government and the payment of our salaries. 
I would add as a personal note, as for those who would wish to 
take my questions and comments out of context and suggest that 
I am opposed to the IRS or question its leadership, let me be 
clear. We had our hearing 3 weeks ago on the Treasury, and I 
commended Secretary Snow for doing an excellent job, but in the 
course of our questions, as we do in all agencies, we asked 
them about problem areas, and we are here, my distinguished 
ranking member and I, not only to commend what is going on, but 
to find out how we can help in areas where additional resources 
are needed.
    So we will be asking tough questions because there are many 
challenges in this area, and we want to be as supportive of 
Commissioner Everson and the people who assist him in their 
roles today, and I want that known for the record.
    The tax filing deadline ended 10 days ago. So we will be 
able to review some of the preliminary results of the IRS 
performance for this tax filing system. We will also focus on 
the agency's efforts and plans in addressing the so-called tax 
gap. I look forward to all the witnesses' views on these issues 
and their suggestions on how we can improve taxpayer 
compliance.
    To the IRS credit, the Service continues to improve its tax 
administration performance. Based on preliminary results from 
the current filing season, returns processing has been smooth 
and taxpayers are receiving refunds without too many problems. 
Electronic filing is growing. More taxpayers are turning to the 
IRS website for information. Telephone service has improved. 
The accuracy of IRS responses to tax law and accounting 
questions has improved. Compared to the 1990's, the IRS has 
come a long way in its service delivered to taxpayers and to 
the people of the United States.
    On the enforcement front, IRS has made major strides. 
Enforcement revenue over the past 5 years has increased by 
$13.5 billion from $33.8 billion to $47.3 billion, or almost 40 
percent. The IRS has accomplished these results by stepping up 
audits, combating illegal and abusive tax shelters, and 
increasing criminal convictions. These actions are very 
positive not only deterring taxpayers from cheating, but in 
increasing honest taxpayers' confidence in the Government.
    There are, however, some troubling signs. Electronic filing 
is growing at a slower pace compared to previous years, and the 
IRS will not meet the congressionally mandated goal of 80 
percent of taxpayers E-filing by 2007. The IRS continues to be 
overly dependent upon an antiquated system which will limit 
both service and enforcement capabilities, and most troubling 
is the tax gap does not appear to be shrinking. Some believe 
that the tax gap may be actually higher than projected.
    The gap, which is the difference between what taxpayers 
timely and accurately pay in taxes and what they should pay 
under the law, not only creates an unfair burden on taxpayers 
who voluntarily and honestly pay their taxes, but also hurts 
our Nation's fiscal stability for our future generations. I 
would urge everyone to read the Comptroller General's February 
15 testimony before the Senate Budget Committee. I think the CG 
did a commendable job of putting the tax gap in context of our 
Nation's fiscal health. While most of the attention on our 
fiscal health is on discretionary spending or tax cuts in the 
economy, the CG adds that we cannot ignore the tax gap. He 
concludes that while our long-term fiscal imbalance cannot be 
eliminated with a single strategy, reducing the tax gap is one 
approach that could help address the looming fiscal challenge 
facing the Nation, closed quote, and I agree with that 
assessment.
    The views of the CG should be more than sobering. They 
should energize us to attack the tax gap because it is about 
good Government. The Government has a moral obligation in 
punishing those who unfairly burden honest citizens who 
voluntarily pay their taxes as their civic duty. It is also 
about our future. The consequence of a persistent tax gap hurts 
our long-term fiscal and economic health. It harms our 
children's future and the future of the children's children, 
and ultimately their future will be directly impacted by the 
actions we take today in addressing the tax gap.
    Closing the entire tax gap is not realistic, but there is 
not any reason, there is no excuse, not to dedicate ourselves 
to attacking this problem and lessening the tax gap. Even small 
or moderate reductions will yield significant results. Even a 1 
percent reduction in the tax gap could yield some $3 billion 
annually. The administration has set a very laudable goal in 
addressing the tax gap to increase voluntary compliance to 85 
percent by 2009. I support this goal, but 85 percent should be 
a floor. We need a detailed plan. So today, I will direct the 
IRS to work with the IRS Oversight Board, the National Taxpayer 
Advocate, and other important stakeholders to develop a plan to 
achieve this goal by 2009 and to quantify the amount by which 
this will reduce the gap.
    To achieve any reduction in the tax gap, multiple 
strategies will be required, such as simplifying the tax code, 
which I happen to believe is a compelling overwhelming need, 
conducting more sustained research, obtaining better data on 
noncompliance, improving taxpayer service, enhancing 
enforcement, and leveraging technology. I support all of these 
strategies, but I recognize that some of these strategies 
require additional resources. Therefore, it is through the lens 
of the tax gap that we scrutinize the budget request before us 
today. To say that I am disappointed in what came out of OMB 
would be an understatement.
    In terms of the 2007 budget request, the administration 
proposes some $10.6 billion for the IRS. This budget request is 
an increase of $18.1 million or 0.2 percent above the 2006 
enacted level. The request, however, contains a number of 
budget assumptions that pose significant risks to the IRS. Some 
might even call them a slight of hand. Specifically, it assumes 
$135 million in new user fees, some $121 million in savings 
through program efficiencies, and $137 million in budget cap 
adjustment. There is some merit to these ideas, but if these 
assumptions are not attained, the IRS would face a cut of some 
$240 million from the fiscal year 2006 enacted level, and to be 
blunt, I question whether these assumptions are realistic and 
that the bases can be achieved.
    Moreover, even if the IRS attains savings in new fees, the 
GAO calculates that the budget request is still a small 
decrease compared to the 2006 enacted level after adjusting for 
expected inflation. In fact, the GAO notes that the budget 
request would result in staffing cuts to both service and 
enforcement.
    The budget request cuts the IRS Business Systems 
Modernization program by $30 million or 15 percent. I will be 
the first to admit that the BSM has had challenges and risks; 
however, cutting this program by 15 percent when the IRS 
continues to be highly dependent upon systems from the dark 
ages makes no sense to me. From my young sports car 
enthusiasts, I have heard that it is equivalent to running a 
Formula One race with a Ford Pinto. I strongly believe that the 
BSM should be the IRS's top priority due to its impact on 
service and enforcement and ultimately in reducing the tax gap. 
GAO noted the reduction to the BSM ``could delay delivery of 
improved services for taxpayers.'' Further, the IRS team, led 
by a very competent Associate CIO, has begun to make real 
progress on BSM. For example, the new Customer Account Data 
Engine System processed over 6 million returns and dispersed 
5.3 refunds this year without disruptions and faster than under 
the old system. Cutting BSM greatly damages the momentum built 
up over 2 years. To me, cutting the BSM is equivalent to 
punishing good behavior.
    Frankly, I question cutting any part of the IRS budget. The 
IRS needs more resources. It needs more resources for taxpayer 
services. It need more resources for enforcement. It needs more 
resources for system modernization.
    In terms of taxpayer services, this budget request cuts 
these activities by some $85 million from the 2006 enacted 
level without assuming new user fees. While I do not object to 
the IRS retaining user fees for their activities, using them to 
offset direct appropriations is not appropriate in my view. The 
IRS has made significant improvements in taxpayer services over 
the past several years, but some services may be in peril. 
Since 2004, IRS taxpayer services have been cut by $180 
million, or 4.8 percent. While these cuts have not appeared to 
impact performance, IRS officials have cautioned that, ``the 
agency cannot continue to absorb reductions in taxpayer service 
without beginning to compromise some services''.
    Now, all the witnesses here today have acknowledged that 
improving taxpayer service is a key component of reducing the 
tax gap. GAO believes that, ``providing quality services to 
taxpayers is an important part of any overall strategy to 
improve compliance and thereby reduce the tax gap''.
    Over the past year, IRS has forwarded a number of cost-
cutting proposals to its taxpayer service programs; however, 
stakeholders and auditors have raised questions about these 
proposals. For example, TIGTA reviewed the IRS analysis behind 
its proposal to close 68 walk-in taxpayer assistance centers 
and found that the IRS lacked accurate and complete information 
on its centers, which hindered the IRS's ability to make 
appropriate decisions when determining locations and services 
it provides to taxpayers seeking assistance.
    In addition, the IRS has justified some of its proposed 
cuts where programs' reduced usage of service was caused by the 
IRS's own policies. For example, the IRS established guidelines 
to reduce tax return preparation in the taxpayer assistance 
centers by 20 percent.
    Another example is the Electronic Tax Law Assistance, or 
ETLA, feature on the service's website. GAO reported that usage 
of this program has declined apparently by design. 
Specifically, the GAO found that the IRS purposely moved the 
ETLA feature to a less prominent position on the website and 
found that, ``in its current location, IRS does not expect 
taxpayers to be aware of the ETLA feature unless they stumble 
on it accidentally''. Because of these actions, the reduction 
in demand and usage of these particular programs becomes a 
self-fulfilling prophecy.
    The IRS must provide an accurate analysis of any reductions 
to ensure that taxpayer compliance and its effort to reduce the 
tax gap are maximized, especially as the tax code gets more and 
more complicated. IRS believes the tax gap includes, ``a 
significant amount of noncompliance due to the complexity of 
the tax law that results in errors of ignorance, confusion, and 
carelessness''. For those of you old enough to remember the 
cartoon strip Pogo, I believe it was his famous words that ``we 
have met the enemy, and he is us'', and that is Congress.
    The IRS repeatedly and justifiably touts the success of its 
E-filing service on its website with such tools as ``Where is 
my refund?''. However, I fear that taxpayers will begin to ask 
``Where is my service?''.
    In addition to my concerns about the budget request, I 
raise concerns about the IRS privacy rule on section 7216 of 
the tax code and the recent problems identified with the ``Free 
File'' program.
    In terms of the IRS proposed regulations on disclosure and 
use of taxpayer information, there are concerns, legitimate 
concerns, about taxpayer privacy being compromised by the 
proposed regulations. Some of these concerns seem to be based 
on misunderstandings whereas others are legitimate issues 
regarding the disclosure of confidential taxpayer information. 
This is a complex issue with a number of land mines. As a 
result, many in Congress, including the Senate Finance 
Committee, thankfully, are examining the proposed rule and the 
underlying statute to address taxpayer privacy concerns. I look 
forward to the wise guidance of the Finance Committee and hope 
that the Treasury and IRS can balance the needs and problems to 
ensure that maximum confidentiality of all taxpayer information 
to the extent possible is under the current statute, but given 
the limitations under the current statute, additional 
legislative action may be needed to resolve these concerns.

                           PREPARED STATEMENT

    In terms of Free File, I am concerned that fewer taxpayers 
are using the program, which is impacting the overall number of 
E-filings. One possible solution that Senator Grassley and 
others have suggested is the creation of a direct electronic 
filing portal through the IRS website. I think that idea has 
merit and I ask the witnesses to look into that matter and we 
will be happy to discuss it with them.
    It is now my pleasure to turn to my colleague and ranking 
member, Senator Murray, for her statements and comments.
    [The statement follows:]
           Prepared Statement of Senator Christopher S. Bond
    The subcommittee will come to order. This morning, the Senate 
Transportation, Treasury, the Judiciary, HUD, and Related Agencies 
Appropriations Subcommittee will conduct its budget hearing on the 
fiscal year 2007 budget for the Internal Revenue Service. We have a 
distinguished panel of witnesses here today. I welcome back the IRS 
Commissioner Mark Everson to the hearing. I also welcome Ray Wagner, 
the Chairman of the IRS Oversight Board; J. Russell George, the 
Treasury Inspector General for Tax Administration; and Nina Olson, the 
National Taxpayer Advocate. I also note that the Government 
Accountability Office has submitted a statement for the record at my 
request and has sent two senior officials to answer any questions 
during the hearing. GAO has served us extremely well, especially with 
their detailed reviews and oversight of the IRS's Business Systems 
Modernization program.
    Before I begin my formal comments, I personally thank all of the 
witnesses today for their service and commitment to the IRS. The IRS is 
probably one of the least appreciated Federal agencies but is 
definitely one of the most important to the functioning of our 
government.
    The tax filing deadline ended 10 days ago, so today we will be able 
to review some of the preliminary results of the IRS's performance for 
this tax filing season. We also will focus on the agency's efforts and 
plans in addressing the so-called ``tax gap.'' I look forward to all 
the witnesses' views on these issues and their suggestions on how we 
can improve taxpayer compliance.
    To the IRS's credit, the IRS continues to improve its tax 
administration performance. Based on preliminary results from the 
current filing season, returns processing has been smooth and taxpayers 
are receiving refunds without too many problems. Electronic filing is 
growing. More taxpayers are turning to the IRS website for information. 
Telephone service has improved. The accuracy of IRS's responses to tax 
law and account questions has improved. Compared to the 1990's, the IRS 
has come a long way in service.
    On the enforcement front, the IRS has made major strides. 
Enforcement revenue over the past 5 years has increased by $13.5 
billion--from $33.8 billion to $47.3 billion--or by almost 40 percent. 
The IRS has accomplished these results by stepping up audits, combating 
illegal and abusive tax shelters, and increasing criminal convictions. 
These actions are very positive in not only deterring taxpayers from 
cheating, but in increasing honest taxpayers' confidence in government.
    There are, however, some troubling signs. Electronic filing is 
growing at a slower pace compared to previous years and the IRS will 
not meet the congressionally-mandated goal of 80 percent of taxpayers 
e-filing by 2007. IRS continues to be overly-dependent upon antiquated 
systems, which limits both service and enforcement capabilities. And 
most troubling is that the tax gap does not appear to be shrinking. 
Some believe that the tax gap may actually be higher than projected.
    The tax gap--the difference between what taxpayers timely and 
accurately pay in taxes and what they should pay under the law--not 
only creates an unfair burden on taxpayers who voluntarily and honestly 
pay their taxes but also hurts our Nation's fiscal stability for our 
future generations. I urge everyone to read the Comptroller General's 
February 15, 2006, testimony before the Senate Budget Committee. I 
believe the CG did a commendable job in putting the tax gap in context 
of our Nation's fiscal health. While most of the attention on our 
fiscal health is on discretionary spending or tax cuts or the economy, 
the CG adds that we cannot ignore the tax gap. He concludes that while 
``our long-term fiscal imbalance cannot be eliminated with a single 
strategy, reducing the tax gap is one approach that could help address 
the looming fiscal challenges facing the nation.'' I agree.
    The views of the CG should be more than sobering. They should 
energize us to attack the tax gap because it is about good government. 
The government has a moral obligation in punishing those who unfairly 
burden honest citizens who voluntarily pay their taxes as their civic 
duty. It is also about our future. The consequences of a persistent tax 
gap hurt our long-term fiscal and economic health. It harms our 
children's future and the future of our children's children. And 
ultimately, their future will be directly impacted by the actions we 
take today in addressing the tax gap.
    Closing the entire tax gap is not realistic but this is no excuse 
to not dedicate ourselves to attacking this problem. Even small or 
moderate reductions in the tax gap will yield significant results. For 
example, even a 1 percent reduction in the tax gap would yield some $3 
billion annually. The administration has set a very laudable goal of 
addressing the tax gap by setting a goal to increase voluntary 
compliance to 85 percent by 2009. I support this goal but 85 percent 
should be a floor. However, we need a detailed plan. So today, I direct 
the IRS to work with the IRS Oversight Board, the National Taxpayer 
Advocate, and other important stakeholders to develop a plan to achieve 
this goal by 2009 and to quantify the amount by which this will reduce 
the tax gap.
    To achieve any reduction in the tax gap, multiple strategies will 
be required such as simplifying the tax code, conducting more sustained 
research, obtaining better data on noncompliance, improving taxpayer 
service, enhancing enforcement, and leveraging technology. I support 
all of these strategies. But, I recognize that some of these strategies 
require additional resources. Therefore, it is through the lens of the 
tax gap that we scrutinize the budget request before us today.
    In terms of the fiscal year 2007 budget request, the administration 
proposes some $10.6 billion for the IRS. This budget request is an 
increase of $18.1 million or 0.2 percent above the fiscal year 2006 
enacted level. The request, however, contains a number of budget 
assumptions that pose significant risks to the IRS. Specifically, it 
assumes $135 million in new user fee revenues, some $121 million in 
savings through ``program efficiencies'', and $137 million in a budget 
``cap adjustment.'' There is some merit to these ideas. But, if these 
assumptions are not attained, the IRS will face a cut of some $240 
million from the fiscal year 2006 enacted level. And to be blunt, I 
question whether these assumptions will be achieved.
    Moreover, even if the IRS attains these savings and new fees, the 
GAO calculates that the budget request is still a small decrease 
compared to the fiscal year 2006 enacted level after adjusting for 
expected inflation. In fact, the GAO notes that the budget request 
would result in staffing cuts to both service and enforcement.
    The budget request cuts the IRS's Business Systems Modernization 
program by $30 million or 15 percent. I will be the first to say that 
BSM has many challenges and risks. However, cutting this program by 15 
percent when the IRS continues to be highly dependent upon systems from 
the dark ages makes no sense to me. It is equivalent to running a 
formula one race today with a Ford Pinto. I strongly believe that BSM 
should be the IRS's top priority due to its impact on service and 
enforcement and, ultimately, in reducing the tax gap. GAO noted that 
the reduction to BSM ``could delay delivery of improved services for 
taxpayers.'' Further, the IRS team, led by a very competent Associate 
CIO, has begun to make real progress on BSM. For example, the new 
Customer Account Data Engine system processed over 6 million returns 
and dispersed 5.3 million refunds this year without disruptions and 
faster than under the old system. Cutting BSM greatly damages the 
momentum built up over the past 2 years. In other words, cutting BSM is 
equivalent to punishing good behavior.
    Frankly, I question cutting any part of the IRS's budget. The IRS 
needs more resources. It needs more resources for taxpayer services. It 
needs more resources for enforcement. It needs more resources for 
systems modernization.
    In terms of taxpayer services, this budget request cuts these 
activities by some $85 million from the fiscal year 2006 enacted level 
without assuming the new user fees. While I do not object to the IRS 
retaining user fee revenues for their activities, using them to off-set 
direct appropriations is inappropriate. The IRS has made significant 
improvements in taxpayer services over the past several years. However, 
some of the services may be in peril. Since fiscal year 2004, IRS 
taxpayer service programs have been cut by some $180 million or 4.8 
percent. While these cuts have not appeared to have impacted 
performance, IRS officials have cautioned that ``the agency cannot 
continue to absorb reductions in taxpayer service without beginning to 
compromise some services.''
    All of the witnesses here today have acknowledged that improving 
taxpayer service is a key component of reducing the tax gap. GAO 
believes that ``providing quality services to taxpayers is an important 
part of any overall strategy to improve compliance and thereby reduce 
the tax gap.''
    Over the past year, the IRS has forwarded a number of cost-cutting 
proposals to its taxpayer service programs. However, stakeholders and 
auditors have raised questions about these proposals. For example, 
TIGTA reviewed the IRS's analysis behind its proposal to close 68 walk-
in taxpayer assistance centers and found that the IRS lacked accurate 
and complete information on its centers, which hindered IRS's ability 
to make appropriate decisions when determining the locations and 
services it provides to taxpayers seeking assistance.
    In addition, the IRS has justified some of its proposed cuts where 
a program's reduced usage of services was caused by the IRS's own 
policies. For example, the IRS established guidelines to reduce tax 
return preparation in the taxpayer assistance centers by 20 percent.
    Another example is the Electronic Tax Law Assistance feature on 
IRS's website. The GAO reported that usage of this program has declined 
apparently by design. Specifically, the GAO found that the IRS 
purposely moved the ETLA feature to a less prominent position on the 
website. GAO found that ``in its current location, IRS does not expect 
taxpayers to be aware of the ETLA feature unless they stumble upon it 
accidentally . . .''.
    Because of these actions, the reduction in demand and usage of 
these particular programs became a self-fulfilling prophecy.
    The IRS must provide an accurate analysis of any reductions to 
ensure that taxpayer compliance and its efforts to reduce the tax gap 
are maximized, especially as the tax code gets more and more 
complicated. IRS believes that the tax gap includes ``a significant 
amount of noncompliance due to the complexity of the tax laws that 
results in errors of ignorance, confusion, and carelessness.'' The IRS 
repeatedly and justifiably touts the success of its e-filing services 
and its web site with such useful tools as ``Where's my refund?'' 
However, I fear that taxpayers will begin to ask ``Where's my 
service?''
    In addition to my concerns about the budget request, I raise 
concerns about the IRS's privacy rule on section 7216 of the tax code 
and the recent problems identified with the ``Free File'' program.
    In terms of the IRS's proposed regulations on disclosure and use of 
taxpayer information, there are concerns about taxpayer privacy being 
compromised by the proposed regulations. Some of these concerns seem to 
be based on misunderstandings whereas others are legitimate issues 
regarding the disclosure of confidential taxpayer information. This is 
a complex issue with a number of landmines. As a result, many in 
Congress, including the Senate Finance Committee, are examining the 
proposed rule and the underlying statute to address taxpayer privacy 
concerns. I am hopeful that the Treasury and the IRS can balance out 
the needs and problems to ensure the maximum confidentiality of all 
taxpayer information to the maximum extent possible under the current 
statute. But given the limitations under the current statute, some 
additional legislative action may be needed to resolve these concerns.
    In terms of Free File, I am concerned that fewer taxpayers are 
using the program, which is impacting the overall number of e-filing. 
One possible solution that Senator Grassley and others have suggested 
is the creation of a direct electronic filing portal through the IRS 
web site. I think this idea has merit and request that all the 
witnesses look into at this matter.
    I now turn to my colleague and ranking member, Senator Murray for 
her statement and any comments.

                   STATEMENT OF SENATOR PATTY MURRAY

    Senator Murray. Thank you very much, Mr. Chairman.
    Exactly 10 days ago, millions of taxpayers hurried to the 
Post Office to file their 2005 tax return right at the 
deadline. American taxpayers have come to expect certain things 
when it comes to the way their taxes are prepared, processed, 
and collected in this country. First, they expect honesty. They 
expect that, like themselves, the vast majority of their 
neighbors are paying what they owe and that the IRS is there to 
ensure that everyone pays his or her fair share.
    Second, they expect integrity. They expect that their taxes 
will be processed correctly, especially if they have paid a tax 
preparation firm to do it for them.
    Third, they expect privacy. They expect that the personal 
financial information that they share with the IRS will be kept 
private and will stay private whether it is in the hands of tax 
preparers or the IRS.
    And, finally, they expect some help. They expect that if 
they need some help understanding the very complex tax code, 
the IRS will be there to assist them.
    Those are all reasonable expectations. Unfortunately, today 
the IRS is falling short of meeting those expectations. Rather 
than everyone paying his or her fair share, it has become clear 
that we have a huge tax gap in this country--estimated at $345 
billion. That is the difference between the amount that the 
Americans owe and the amount that the IRS actually collects. 
Now, I want to note that the IRS Commissioner deserves some 
credit for being outspoken on this problem.
    When it comes to taxes being prepared accurately, the IRS 
has at times had a spotty record in providing accurate tax 
advice to inquiring citizens. Now we see more recent reports 
indicating that even the tax preparation professionals are 
doing an inadequate job of preparing people's taxes, exposing 
our citizens to potentially significant fines and tax debts.
    When it comes to keeping taxpayer information private, we 
have seen several instances where IRS contractors have been 
granted inappropriate access to taxpayers' information--access 
they do not need to do their job. And now we have a new 
regulatory proposal from the IRS to modernize the rules that 
pertain to privacy. In some cases, that proposal actually makes 
it easier for taxpayer information to be sold to private 
vendors.
    Let me be clear. Taxpayers deserve more privacy, not less. 
If taxpayers really want salesman to have access to their tax 
returns, they can mail it to them themselves. The IRS should 
not be an accomplice in selling taxpayer information.
    Now, I recognize the IRS's new privacy proposal is 
complicated and some aspects of it can be seen to improve 
privacy while some aspects certainly can be seen to degrade it. 
But for me the question is not whether we should make it 
slightly harder or easier for an individual's taxpayer 
information to be sold. For me the question is whether any of 
this taxpayer information should be sold to anybody, ever. What 
consumer wants to have this information available to marketing 
firms? What consumer really wants to have their dinner 
interrupted by a telemarketer who is looking at a copy of their 
private tax return? If those taxpayers are out there, I don't 
know any of them.
    So I hope the IRS will take a fresh look at those 
regulations and provide an outright prohibition on this 
information being shared with anybody. When it comes to the 
taxpayers getting help from the IRS, the IRS is moving in the 
wrong direction by trying to cut back on taxpayer services.
    Worse still, when the IRS tried to minimize the impact of 
these service cuts, they couldn't get it right. Last year, 
Commissioner Everson testified to us his desire to close almost 
70 Taxpayer Assistance Centers across the Nation. He told us 
these reductions would only be made after his careful analysis 
of the location, costs, demographics, and workloads of those 
centers. Now, many of us in Congress, including the chairman 
and myself, had deep-seated doubts about the wisdom of that 
proposal. As a result, we added language to the fiscal year 
2006 Appropriations act that prohibited the Commissioner from 
closing those centers until the Inspector General completed a 
study on the impacts of reducing taxpayer services on 
compliance and assistance. That act further directed the IRS to 
consult with and get approval from the Appropriations 
committees prior to any such eliminations, consolidations, or 
reorganizations of the workforce.
    Well, the Inspector General has now reported that the data 
the IRS used to close those centers was faulty and outdated. 
The report makes it clear that the IRS was hastily putting 
together inaccurate data simply for the purpose of defending 
its plan to close those centers without any real regard for the 
needs of local citizens. The record with this proposal raises 
the question as to whether this subcommittee should believe any 
representation from the IRS when it comes to the availability 
of adequate taxpayer services.
    Officially, the President's budget for fiscal year 2007 
does not include formal cuts to taxpayer services though it is 
notable that the increase is less than the rate of inflation; 
however, included in this budget is more than $84 million in 
so-called efficiencies--areas where the IRS intends to make 
budget cuts next year with consequences that are either unknown 
or unexplained.
    Mr. Chairman, I hope we will pursue today exactly what 
efficiencies the Commissioner intends to launch next year so we 
don't find out after the fact that taxpayers have once again 
lost access to important forms of assistance when they are 
preparing their taxes. Taxpayers should not have their 
reasonable expectations dashed again.
    Thank you, Mr. Chairman.
    Senator Bond. Thank you, Senator Murray.
    Now we turn to Senator Dorgan for his comments and any 
questions he may wish to leave for the record.

                  STATEMENT OF SENATOR BYRON L. DORGAN

    Senator Dorgan. Mr. Chairman, thank you very much. I won't 
be able to stay for the entire hearing, but I wanted to be 
here. The hearing with respect to the appropriations request 
for the Internal Revenue Service is very important.
    I used to be a tax commissioner, I think probably about the 
time that the chairman of the committee was the Secretary of 
State in Missouri and I was State Tax Commissioner in North 
Dakota.
    Senator Bond. When was that?
    Senator Dorgan. Back in the 1970's.
    Senator Bond. I was Governor.
    Senator Dorgan. You were Governor then.
    Being a tax commissioner, I understood we had an income 
tax. I understood that there are fines and jail time for 
unauthorized disclosure of tax information. And I understood 
the need for safeguarding taxpayers' information is very 
important. I want to talk about that for just a moment.
    First, I notice the discussion about the tax gap. The tax 
gap has been around a long time. I want to put up a picture 
that I have used before. This is called the Ugland House. It is 
on Church Street in the Cayman Islands. I think perhaps I used 
this with the IRS previously, but David Evans from Bloomberg 
News has done some pretty good work of pointing out that this 
five-story building is home to 12,748 corporations. Let me say 
that again. This five-story building on a quiet street called 
Church Street in the Cayman Islands is home to 12,748 
corporations. Are they there? No, they are not there. They just 
use the address. An attorney fixed them up with an address 
here.
    What does that mean? They are avoiding a lot of taxes. I 
have used this picture on the floor of the Senate many times. I 
am wondering whether anybody has been sent down there to take a 
look at who all these companies are. I assume Treasury or IRS 
has done that, but if not, I am going to ask if you can give us 
some information about it.
    My point is this: Hundreds of billions of dollars are being 
shifted away from the tax authorities in this country, some 
legally, some illegally. Part of that responsibility has to be 
Congress'. We have to plug the holes here. And part of it has 
to be aggressive enforcement by the Internal Revenue Service. 
Frankly, I don't think either has done its job with respect to 
this, but I point this out as an example of what is going on. 
It is unbelievable, and we are losing a substantial amount of 
tax revenue as a result of it.
    The new construct, as you know, is to export good American 
jobs, import cheap labor, and sell your products in America and 
run the income through the Cayman Islands so you don't pay U.S. 
taxes. That is a strategy I think that weakens this country 
dramatically.
    But let me get to the point on the IRS's proposed 
regulation involving section 7216 of the Internal Revenue Code, 
that one of my colleagues just described. Mr. Commissioner, you 
have sent me a letter dated yesterday in response to my letter 
to you about section 7216. This issue about disclosure and the 
use of taxpayers' information is not about regular business. In 
your letter to me, Mr. Commissioner, you suggest somehow that 
there is an unfairness to certain tax preparers because some 
tax preparers are in businesses with affiliated groups and so 
they have a broader range of opportunities to use taxpayer 
information that they have acquired through their tax 
preparation business for other business enterprises, or 
business solicitations and because some of the smaller and 
other tax preparers aren't involved in affiliated groups, you 
need to give them an opportunity to have as much business 
opportunity as others do.
    This is not about business. With all due respect, this is 
about safeguarding the information that is filed by the 
American taxpayers and by preparers. Frankly, I don't believe 
when someone holds themselves out to do business as a tax 
preparer and gets paid for it that they ought to be using that 
tax return information that is given them by American taxpayers 
for unrelated purposes. You seem to suggest in your written 
testimony that this might be a radical proposal.
    You say if Congress would prohibit the use of tax return 
information by tax preparers to solicit additional business, 
that somehow that would be a disadvantage. I don't think so. 
You say the law has existed 30 years. It may have existed 30 
years, but eliminating the affiliated group requirement for 
solicitations and providing greater opportunity for others is 
not going to solve the problem. I would say as well, in 30 
years, there has been much greater concentration in business 
through mega-mergers and that has dramatically changed what 
this affiliated group definition really means.
    So I think you are headed in the wrong direction. You say 
that the rule is not complete and you also say that you are 
surprised by the furor over this. Don't be surprised. The furor 
is going to get worse if you go ahead and do this.
    This is not about business, about allowing someone to 
generate additional business by using confidential return 
information from their tax preparer business. If that is what 
we want to do, we are dead wrong, and I hope you will close the 
door rather than open the door.
    Having said all of that, I am going to submit a list of 
questions on the issues that I have raised, the tax gap, the 
Ugland House, and the section 7216 proposed regulations. I 
don't want to browbeat here, but I hope at the end of the day 
that you will not be surprised by the outcry from the American 
people and from Congress about this. They expect the 
information they file on their tax returns to be kept 
confidential. Those who would disclose tax return information 
in an unauthorized basis are subject to fines and jail terms 
because it is sensitive information. We should not expect this 
to be widely distributed for commercial or business purposes, 
and that is where I think this proposed regulation is heading. 
I think it is dead wrong and I think it disserves American 
taxpayers. I hope you will re-think that and make a change.
    At any rate, thank you for being here. You have a tough 
job, and you have a chairman and a ranking member who I have 
the privilege of working with that want you to do your job 
successfully. This is a tough, tough job, trying to figure out 
how you collect these taxes, diminish the tax gap, and get rid 
of tax avoidance and tax evasion. Because it is not easy, we 
want to work with you to do that.
    Mr. Chairman, thank you.

               PREPARED STATEMENT OF SENATOR TED STEVENS

    Senator Bond. Thank you very much, Senator Dorgan. We will 
be happy to include your questions for the record. We will also 
include Senator Stevens' statement for the record at this time.
    [The statement follows:]
               Prepared Statement of Senator Ted Stevens
    I support the IRS' technology modernization and agree that many 
benefits are derived from the modernization. However, I am concerned 
with the difficulties experienced by rural Alaskan taxpayers when they 
have attempted to use the national toll-free information line. In light 
of these difficulties, many Alaskans have sought the assistance of the 
Taxpayer Advocate Service Center when they need help to complete their 
tax submissions. The Center provides a necessary service to Alaskans. I 
support the Taxpayer Advocate Service Center in Alaska and believe the 
Center should be fully staffed in order to answer tax questions.

                      STATEMENT OF MARK W. EVERSON

    Senator Bond. Now, with that, we will turn to the 
Commissioner.
    Welcome, Mark. We will have your full statement, all of 
your full statements, included for the record, and if you would 
highlight what you think is most important for us to focus on.
    Mr. Everson. Certainly. Thank you, Mr. Chairman, Senator 
Murray, Senator Dorgan.
    Before I start, I would like to introduce two people. This 
is Take Your Kid to Work Day, I am informed, and Emma Everson, 
if she could stand up, is here. She knows the chairman pretty 
well. She has not met the ranking member, but I want to point 
out that she has never been to Missouri. After school ends this 
year, she is going to take a trip out to see her cousins in 
Seattle. So if that gets us some help in the questioning and 
you choose not to embarrass me a little because my daughter is 
here, I will take whatever I can get.
    Senator Bond. A cheap trick, but a very good defense.
    Mr. Everson. I try to be effective.
    The other person I would like to introduce is Evelyn 
Petchek. Evelyn, if you could stand. She is my chief of staff 
who has served for 2 years, and as the chairman knows, she has 
played an important role from time to time in terms of sorting 
some things out with the committee. She is retiring about a 
month from now and she is going back to her beloved New Mexico, 
but she has done a great job in a long career with the IRS. So 
I thank her as well.
    Senator Bond. We thank her for her service and wish you 
well and know that it is going to be tough to find somebody to 
support the Commissioner.
    Mr. Everson. And, Senator Dorgan, if you have to leave, I 
would certainly want to come see you directly and visit you 
soon to talk about some of these important issues, which we 
will cover.
    Senator Dorgan. I would be happy to do that, and we would 
invite your daughter if she is driving from here to Seattle to 
stop in North Dakota for an extended stay.
    Mr. Everson. Very good.
    Okay. It is good to be back before the subcommittee to 
discuss the 2007 budget as proposed by the President. We 
believe, if fully funded, we can maintain the important balance 
between strong taxpayer service and the enforcement that is 
necessary to reduce the tax gap.
    Before I discuss the proposed budget, let me first thank 
the members of the subcommittee for fully funding the IRS as 
part of the 2006 budget process. This has allowed us to move 
forward on several important initiatives, particularly in the 
area of enforcement.
    The 2007 budget would sustain this progress. Our request is 
for $10.6 billion in direct appropriation supplemented by $135 
million in an incremental user fee to represent a total 
operational level of about $10.7 billion or 1.4 percent above 
the previous budget.
    Before taking your questions, let me turn briefly to IRS 
efforts in our three areas of strategic focus, services, 
enforcement, and modernization, and then make brief comments on 
certain legislative proposals accompanying the 2007 budget 
which would help to close the tax gap.
    First, services. We are drawing to a close of a successful 
filing season. Electronic filing is up by over 6 percent from 
last year, reflecting in particular a strong increase in the 
use of tax software on home computers. Our phone level of 
service is consistent with last year. The accuracy of our 
answers to tax law questions has improved. I would note that 
the results on the phones have exceeded our expectations, 
explained by the fact that call volumes are down from last 
year.
    We have also seen strong growth in our community-based 
volunteer tax preparation program. The VITA sites are an 
increasingly important part of our efforts, and, in fact, last 
year the IRS was recognized by the Points of Light Foundation 
for its successful efforts. This is the first time a government 
agency has received this recognition. Usually it has been 
Mothers Against Drunk Drivers, March of Dimes, organizations 
like that. This program has grown by 8 percent compared to last 
year.
    As to enforcement, the fiscal year 2005 results demonstrate 
that we have restored the credibility of our enforcement 
programs. Individual audits were up 20 percent from 2004 to 1.2 
million. They are up 97 percent since 2000. High income audits 
were also up and have increased 120 percent since 2000. 
Corporate audits bottomed out in 2003, but by 2005 had 
recovered by over 50 percent. Collections are more robust. Last 
year, we had 2.7 million levies versus 200,000 in 2000. All 
told, enforcement revenues increased from 43.1 billion in 2004 
to 47.3 billion last year.
    Concerning 2006, we expect continued progress, although not 
as dramatic as some of these double-digit increases that I have 
just indicated. We are bringing on new personnel with the 
monies you provided, but it will take some time before they 
fully get up to speed.
    In terms of modernization, we have realized a number of 
achievements. In particular, I would note the progress of our 
taxpayer master file update, the CADE system. Last year CADE 
posted 1.4 million returns. This year, we have processed 6.6 
million returns through CADE and refunded more than $3 billion.
    The 2007 budget request has two important components. The 
funding request keeps the IRS basically at level funding up 
just slightly to largely absorb inflation. Part of this funding 
is from increased user fees. If the appropriation request is 
fully funded, these monies will allow us to maintain the 
progress we are making both in the service and enforcement 
missions of the agency as well as to continue our modernization 
efforts.
    Before taking your questions, let me make one additional 
point. We recently refined our estimates of the tax gap. We 
will be using this information to update our audit models and 
selection procedures and to calibrate our resource allocation 
within business units. The research also clearly indicated that 
where there is a third-party reporting, there is better 
compliance.
    What this chart says, over to the left, you have a 
noncompliance rate of about 1 percent on wages. One-hundred-
fifty million Americans get W-2s. They don't get it wrong when 
they report the information to us. All the way out at the 
right, you have categories where we don't get any information 
or very little information. Principally, this is about 
individuals who organize themselves as small businesses, but 
aren't incorporated and there is no reporting that comes to us. 
There, the noncompliance rate is over 50 percent.


                           PREPARED STATEMENT

    In the President's budget request, we have made several 
administrative and reporting proposals. The most important of 
these is the proposal to mandate reporting to the IRS of gross 
receipts by credit card issuers for their business customers. I 
believe the five legislative proposals that accompany the 
funding request can make a significant contribution to reducing 
the tax gap. So I hope they will enjoy your support.
    Finally, let me indicate that I remain a strong advocate of 
simplification of the code. Thank you.
    [The statement follows:]
                   Prepared Statement of Mark Everson
                              introduction
    Senator Bond, Ranking Member Murray and members of the 
subcommittee, it is good to be back before the subcommittee to discuss 
the fiscal year 2007 IRS budget as proposed by the President. We 
believe if funded fully, we can maintain the important balance between 
strong taxpayer service and the enforcement that is necessary to reduce 
the tax gap.
    Before I discuss the proposed budget, let me first thank the 
members of the subcommittee for fully funding the IRS as part of the 
fiscal year 2006 budget. This allowed us to move forward on several 
important initiatives, particularly in the area of enforcement.
    My goal this morning is to offer you insight on what we are 
accomplishing with that full funding in fiscal year 2006 and to offer 
some insight in what we hope to accomplish in fiscal year 2007. I also 
hope to touch on some current issues that I know are of concern to 
subcommittee members as well as other Senators.
    First, however, I want to provide you the latest information on 
2006 Filing Season.

                           2006 FILING SEASON

    We expect to process almost 135 million individual tax returns in 
2006, and we anticipate a continued growth in the number of those that 
are e-filed. In the 2005 filing season, over 50 percent of all income 
tax returns were e-filed.
    We fully expect to exceed that number this year. As of April 15, we 
have received over 63 million tax returns filed through e-file, an 
increase of 2.25 percent compared to the same period last year. This 
represents 63 percent of the more than 100.3 million returns that had 
been filed as of that date.
    This increase in e-filing is being driven by people preparing their 
tax returns using their home computers. The total number of self-
prepared returns that are e-filed is up by over 13 percent compared to 
this time a year ago. Over 17.3 million returns have been e-filed by 
people from the comfort of their own home, up from 15.3 million for the 
same period a year ago. Fully, 27 percent of all electronically filed 
returns have been done on home computers. This is 2.6 percentage points 
above last year.
    Encouraging e-filing is good for both the taxpayer and for the IRS. 
Taxpayers who use e-file can generally have their tax refund deposited 
directly into their bank account in 2 weeks or less. That is about half 
the time it takes us to process a paper return. Moreover, the error 
rate for e-filed returns is less than for paper returns, saving IRS 
resources and avoiding taxpayer inconvenience.
    Despite this overall growth in e-file, we are disappointed that we 
are experiencing a significant decline in the number of taxpayers that 
are using our Free File program. Currently, we have almost 24 percent 
fewer taxpayers choosing to use Free File as compared to 2005. I will 
discuss this in more detail later in my testimony.
    More people are choosing to have their tax refunds directly 
deposited into their bank than ever before. So far this year, we have 
directly deposited more than 49 million refunds, or 64 percent of all 
refunds issued this tax filing season. This is up from 60 percent for 
the same period in 2005.
    People are also visiting our web site, IRS.gov, in record numbers. 
The IRS has recorded over 114 million visits to our web site, up from 
110 million for the same period a year ago. This is a 3.4 percent 
increase.
    The millions of taxpayers that have visited IRS.gov have benefited 
from many of the updates that we have made for this filing season. We 
have made it easier for taxpayers to get answers to many of their tax 
questions. The web site:
  --Allows a taxpayer to determine whether he or she might qualify for 
        the Earned Income Tax Credit (EITC);
  --Assists the taxpayer in determining whether he or she is subject to 
        the Alternative Minimum Tax (AMT);
  --Allows more than 70 percent of taxpayers the option to actually 
        file their tax returns at no cost through the Free File 
        program;
  --Assists hurricane victims with information on many of the changes 
        in the tax laws that are designed to help them and provides a 
        toll free number for victims to get their questions answered; 
        and
  --Allows taxpayers who are expecting a refund to track its progress 
        via the ``Where's My Refund?'' feature on the site.
    The 100.3 million individual tax returns received as of April 15 
represents a decline of 3.7 percent over the same period as last year. 
We have issued 78.1 million refunds this year for a total of $177 
billion. The average refund this year is $2,265, $98 more than last 
year. In addition, more than 20 million taxpayers have tracked their 
refund on IRS.gov, up 14 percent over last year.
    Our planning assumptions called for reducing toll-free operating 
hours from 15 hours to 12 hours while still maintaining the same level 
of taxpayer service. When this change was not implemented, the expected 
savings were restored and used to increase overtime. In addition, 
resources from answering paper correspondence were diverted to 
telephones. To date, these strategies have produced positive results.
    In addition to these personnel actions, we have not yet experienced 
some of the workload increases that were anticipated as a result of the 
hurricane disasters. Overall, this filing season through April 15, we 
have actually received about 1.4 million fewer telephone calls than 
last year (32.4 million in 2006 vs. 31 million in 2005). As a result, 
our Customer Service Representative (CSR) Level of Service (percent of 
calls answered) is above last year (83.25 percent in 2006 vs. 81.65 
percent in 2005). However, because we deployed Adjustments staff to the 
telephones, paper inventories are 117.2 percent of last year (1,108,774 
in 2006 vs. 946,223 in 2005). The number of cases that are over-age has 
also increased significantly (123,425 in 2006 vs. 63,580 in 2005).
    As of April 8, our Taxpayer Assistance Centers (TACs) are reporting 
a 12.5 percent decline in face to face contacts this filing season as 
compared to last year. We believe that the decline in visits to our 
TACs as well as the reduction in the number of calls is largely 
attributable to taxpayers increasing their use of IRS.gov and other 
electronic means to get their questions answered and obtain tax forms.
    The use of other service alternatives, such as volunteer return 
assistance at Volunteer Income Tax Assistance (VITA) sites and Tax 
Counseling for the Elderly sites (TCEs), has steadily increased while 
the numbers of TAC contacts have decreased. In fiscal year 2005 over 
2.1 million returns were prepared by volunteers. As of April 15, 
volunteer return preparation is up 7.3 percent above last year's level. 
Volunteer e-filing is also up, by 4.7 percent over the same period in 
the last tax filing season. This is reflective of continuing growth in 
existing community coalitions and partnerships.

   PRESIDENT'S FISCAL YEAR 2007 BUDGET MAINTAINS THE BALANCE BETWEEN 
                    TAXPAYER SERVICE AND ENFORCEMENT

    Our total budget request for fiscal year 2007 is $10.6 billion in 
direct appropriations, supplemented by $135 million in new user fee 
revenue, for a total operating level of $10.7 billion. This request 
represents a total increase of 1.4 percent from the fiscal year 2006 
enacted level. The fiscal year 2007 budget sustains the enforcement 
funding increase provided in fiscal year 2006 to improve tax 
compliance. More importantly, the budget maintains the balance between 
service and enforcement.
    The IRS's taxpayer service and enforcement activities are funded 
from three appropriations: Processing, Assistance and Management (PAM); 
Tax Law Enforcement (TLE); and Information Systems (IS). The total 
fiscal year 2007 budget request for these three operating accounts is 
$10.4 billion supplemented by the $135 million in new user fee revenue, 
for a total operating level of $10.5 billion, or 1.8 percent increase 
over the fiscal year 2006 enacted level.
    The $135 million in new user fees revenue will be generated from 
several increased and new user fees earned from special or non-routine 
services provided to taxpayers by the IRS. These would include such 
services as providing private letter rulings for interpretations of tax 
law and applications for exempt status. The largest portion of the 
anticipated increase in fees will come from new and restructured 
installment agreements ($66.7 million). Another $47.1 million is 
expected from letter rulings and determinations. The remainder will 
come from technical training and enrolled agent fee increases. These 
increased fees were designed to more fully reflect the actual cost of 
providing these services, as required by OMB Circular A-25.
    The budget includes an additional $137 million for enforcement to 
fund the pay raise and other cost adjustments needed to maintain the 
fiscal year 2006 enforcement initiative increase, a 2 percent increase. 
Similar to last year, the President's budget proposes to fund this 
enforcement increase through an adjustment to the discretionary cap, 
which in effect would increase the amount of funding dedicated to tax 
enforcement from $6.82 billion in fiscal year 2006 to $6.96 billion in 
fiscal year 2007. The IRS will continue to focus its enforcement 
resources on efforts designed to increase compliance and reduce the tax 
gap. We will continue our examination of tax-exempt entities used to 
facilitate abusive transactions and our examination of tax strategies 
involving international elements for both corporations and high income 
individuals.
    I would remind the subcommittee that in fiscal year 2005 we brought 
in a record of $47.3 billion in enforcement revenue, an increase of 
$4.2 billion from the previous year. In fiscal year 2006, we expect 
that total to increase to $48.1 billion, a 42 percent increase from 
fiscal year 2001.
    We believe taxpayers have a right to expect a return on the 
additional investment in enforcement. We estimate that when we receive 
the full productive benefits of the fiscal year 2006 funding increase, 
the return on investment (ROI) for additional enforcement resources 
will be 4:1. Stated another way, we estimate that each $1 invested in 
enforcement will return $4 in additional enforcement revenue, although 
this should not be interpreted as a fixed ratio.
    This estimated ``return'' is based on the amount of additional tax 
collected and attributes the revenue to the enforcement occupations 
that originated each case. For each type of IRS enforcement employee, 
the associated amount of additional tax collections is estimated based 
on an extensive data base, covering the most recent 11 years of 
collection experience.
    This analysis does not include the indirect effect of increased 
enforcement activities in deterring taxpayers considering engaging in 
non-compliant behavior. Econometric estimates of the indirect effects 
indicate a significant impact from increased enforcement activities.
    The $3.58 billion for taxpayer service in the fiscal year 2007 
budget request, including the $135 million from new user fee revenue, 
will maintain our commitment to provide high-quality taxpayer services 
through improvements to information technology and other targeted 
efficiencies such as those resulting from increased electronic filing.
    The Business Systems Modernization appropriations account funds the 
IRS's costs to develop and deploy our critical, major information 
systems. The requested level for BSM is $167.3 million, a 15.1 percent 
reduction from the fiscal year 2006 level. This is discussed later in 
the testimony.
    Lastly, the Health Insurance Tax Credit appropriation (HITCA) 
remains a separate account that funds the administration of a 
refundable tax credit. The fiscal year 2007 request for HITCA is $14.9 
million, a 25.8 percent reduction from the fiscal year 2006 enacted 
level.

                FISCAL YEAR 2007 DETAILED BUDGET SUMMARY

    Our fiscal year 2007 budget request of $10.7 billion, which 
includes the $135 million in new user fee revenue, primarily funds 
costs to maintain the IRS's current levels of service and enforcement 
($272.2 million) and an initiative to consolidate the Philadelphia 
Campus ($20.9 million). This request also includes several program 
savings and efficiencies that reflect the IRS's aggressive efforts to 
identify and deploy technology improvements that will benefit both 
taxpayer service and enforcement programs. Collectively, these cost 
savings total $116.1 million:
  --E-File Savings: -$6,760,000/-174 FTE.--This savings results from 
        increased electronic filing (e-file) and a reduction in 
        Individual Master File paper returns. Estimated e-file savings 
        are based on the projected reduction in the number of paper 
        returns processed each year, offset by the cost of processing 
        e-filed returns.
  --Improvement Project Savings: -$8,215,000/-135 FTE.--This savings 
        results from operational improvements generated by the Contact 
        Recording, Queuing Management (Q-Matic), Correspondence Imaging 
        Systems, and End-to-End Publishing improvement projects already 
        in progress.
  --Competitive Sourcing Savings: -$17,000,000/-242 FTE (The -242 FTE 
        is a revised figure which corrects an error included in the 
        fiscal year 2007 President's budget request for the IRS).--
        These savings reflect efficiencies and savings that will be 
        achieved through the IRS's competitive sourcing efforts 
        resulting from six different projects in various phases of 
        implementation.
  --Program Efficiencies: -$84,100,000/-873 FTE (-873 FTE is a revised 
        figure, which corrects an error included in the fiscal year 
        2007 President's budget request for the IRS).--These savings 
        reflect Service-wide efficiencies resulting from the 
        elimination of duplicative overhead in internal support 
        functions, increased productivity through improved workload 
        selection, and distribution techniques, automation of certain 
        taxpayer assistance functions, and deployment of the fiscal 
        year 2006 enforcement hires to full time examiner positions. 
        These efficiency savings can be realized with no adverse impact 
        on taxpayer service and enforcement operations.
    The $84.1 million in efficiency savings is broken down into three 
major categories.
    Shared Services in Support of Taxpayer Service and Enforcement 
Operations ($31.4 million).--This includes approximately $24 million in 
expected savings from renegotiated information systems and 
telecommunication contracts that the Treasury Department plans to 
award. Another $7.2 million will come from implementing improved 
processes for issuing notices.
    Enhanced Productivity and Efficiencies in Enforcement Programs 
($35.0 million/433 FTE).--The Service will realize $14.5 million (256 
FTE) in savings due to the implementation of several productivity 
efficiencies. These savings will be achieved through an improved 
employee to management span of control, the elimination of non-critical 
vacancies, and the reduction of resources allocated to overhead and 
internal support functions. In addition, the Service will benefit from 
higher productivity levels resulting from the transition of the new 
hires to examiner work and the return of trainers to full time exam 
work. Other savings in this area include:
  --$500,000 (5 FTE) due to improved productivity stemming from more 
        effective workload selection techniques such as creating and 
        implementing new discriminate index function (DIF) formulas, 
        which also will decrease taxpayer burden by allowing us to 
        focus enforcement resources on the most egregious examples of 
        abuse.
  --$12.1 million (120 FTE) by implementing improvements in the 
        corporate examination process through improved techniques in 
        data collection and risk identification. These improvements 
        will result in earlier issue resolution, reduced audit cycle 
        time, and increased inventory turnover. In addition, scanned 
        returns will allow examiners to follow and evaluate data 
        electronically.
  --$800,000 (13 FTE) due to the deployment of various technology 
        improvements. The Generalized Integrated Data Retrieval System 
        (IDRS) Interface and the Intelligent Call Management system 
        will increase productivity and improve the quality and level of 
        service to taxpayers.
  --$7.1 million (39 FTE) from enhanced investigations of tax fraud 
        through the implementation of technology improvements to 
        systems that process electronic data and evidence. The 
        streamlined work processes and technological advancements will 
        reduce administrative burden of investigations involving 
        domestic and offshore abusive scheme promoters, corporate 
        fraud, and other complicated investigations involving multi-
        national financial transactions.
    Taxpayer Service Programs and Processes ($17.7 million/440 FTE).--
IRS operations will improve through a variety of efforts, including 
enhanced workload distribution and the automation of certain taxpayer 
assistance functions. The IRS will achieve $14.6 million (355 FTE) in 
efficiencies from improved employee to management span of control 
throughout the organization, judicious distribution of management work, 
identification and elimination of non-critical vacancies, and the 
replacement of journeymen losses with lower-graded/entry-level 
positions. The deployment of the Individual Taxpayer Identification 
Number Real Time System saves time and money for both the Service and 
taxpayers. The system automates the process of providing a Taxpayer 
Identification Number (TIN) to those taxpayers ineligible for a Social 
Security Number but required to provide identifying information on a 
tax return. The Service anticipates $3.1 million (85 FTE) in 
efficiencies due to this new automated system.
    In addition to the program savings and increases for taxpayer 
service and enforcement, the fiscal year 2007 budget includes a $5.5 
million reduction to the Health Insurance Tax Credit Administration 
(HICTA) Program. This funding adjustment for HITCA reflects the 
program's effort to align fiscal year costs with contract year 
expenditures.

                           IRS MODERNIZATION

    The requested level for BSM of $167.3 million, a decrease of $29.7 
million, will continue the support for Customer Account Data Engine 
(CADE), Filing and Payment Compliance (F&PC) and the Modernized e-File 
(MeF) project along with some of the needed investments to upgrade our 
infrastructure.
    After several years of cost, schedule, and performance problems, 
the BSM program has improved its performance in the past 2 years by 
delivering projects and releases on time, on budget, and meeting or 
exceeding expectations. Taxpayers are now realizing the benefits of our 
enhanced BSM program management capabilities. In fiscal year 2006 and 
continuing in fiscal year 2007, we are revising our modernization 
strategy to emphasize the release of projects to deliver business value 
sooner at a lower risk. We will concentrate on delivering releases of 
major tax administration projects, along with infrastructure 
initiatives that support all modernization projects, and continuing our 
improvements to program management operations. These projects and 
initiatives address core IRS strategic priorities: taxpayer service, 
enforcement, and modernization.
    As part of our continuing effort to improve taxpayer service, we 
plan to expand services provided and the number of taxpayers served by 
Modernized E-File (MeF). MeF uses the latest secure Internet technology 
and speeds turnaround time for tax return submissions, equating to 
significant reductions in burden and time for corporate and tax-exempt 
taxpayers.
    As of April 16, MeF had processed nearly 684,000 returns. This 
compares to approximately 176,000 in 2005, a 289 percent increase. In 
recent regulations, the IRS has mandated the Nation's largest 
corporations and tax exempt organizations file electronically in 2006 
through the use of MeF.
    Finally, we will continue to expand the use of the Customer Account 
Data Engine (CADE). CADE will ultimately replace our antiquated Master 
File system, which is the repository of taxpayer information. CADE 
allows faster refunds, improved taxpayer service, faster issue 
detection, more timely account settlement, and a robust foundation for 
integrated and flexible modernized systems. CADE posted more than 1.4 
million returns and generated more than $427 million in refunds in 
2005. In 2006, CADE has posted over 6.4 million returns and generated 
over $3 billion in refunds. In the 2007 filing season, we expect CADE 
to process 33 million returns. CADE serves as the single authoritative 
repository for account and return data for those returns.

                   PRIVATE COLLECTION AGENCIES (PCA)

    The American Jobs Creation Act of 2004 created section 6306 of the 
Internal Revenue Code, which allows the IRS to use private contractors 
to collect delinquent taxes in instances where the amount owed is not 
in dispute. It is important to understand that these PCAs will only be 
assigned cases where the tax balance is not in dispute and will not be 
performing audits or assessing penalties, or taking enforced collection 
actions of any kind. They will only be used in instances where what is 
owed has been determined but the taxpayer has not paid.
    On March 9, we announced the award of contracts to 3 PCAs. It is 
our expectation that these firms will begin work as soon as issues are 
resolved regarding protests to these awards. If cases are placed in 
fiscal year 2006, as allowed by statute, the IRS will retain 25 percent 
of any posted revenue receipts from this program which we will use to 
supplement our existing budget (for collection related activities). We 
anticipate an even greater return for fiscal year 2007 since case 
placements are expected to increase.

                              THE TAX GAP

    To understand the need for full funding of IRS's proposed fiscal 
year 2007 budget, one also must understand the nature of the tax gap. 
The tax gap is the difference between the amount of tax imposed on 
taxpayers for a given year and the amount that is paid voluntarily and 
timely. The tax gap represents, in dollar terms, the annual amount of 
noncompliance with our tax laws.
    It is the need to reduce that gap that drives much of what we do. 
This is true not only from a revenue standpoint, but also from a 
taxpayer fairness perspective. Our tax system is largely based on 
voluntary compliance and that compliance is enhanced if taxpayers 
believe that everyone is paying their fair share.
    A year ago, we released preliminary estimates of the tax gap based 
on data derived from a National Research Program (NRP) study conducted 
on individual income tax returns from Tax Year 2001. This was the first 
comprehensive update of our tax gap estimate since 1988. We have now 
revised those estimates and I would like to summarize them for you.
    Our latest numbers show that the overall gross tax gap for Tax Year 
2001 was approximately $345 billion, resulting in a noncompliance rate 
of 16.3 percent. Both of these numbers are in the upper end of the 
range of estimates provided last spring. Our estimate of the 
corresponding net tax gap, or what remains unpaid after enforcement and 
other late payments, is $290 billion, also in the upper end of the 
earlier range.
    Noncompliance takes three forms: not filing required returns on 
time; not reporting one's full tax liability even when the return is 
filed on time; and not paying by the due date the full amount of tax 
reported on a timely return. We have separate tax gap estimates for 
each of these three types of noncompliance.
    Underreporting constitutes 82.6 percent of the gross tax gap, up 
slightly from our earlier estimates. Nonfiling constitutes 7.8 percent 
and underpayment 9.6 percent of the gross tax gap.
    Individual income tax accounts for 46 percent of all tax receipts. 
However, individual income tax underreporting amounts to approximately 
$197 billion, or 57 percent of the overall tax gap.
    As in previous compliance studies, the NRP data suggest that well 
over half ($109 billion) of the individual underreporting gap came from 
understated net business income (unreported receipts and overstated 
expenses). Approximately 28 percent ($56 billion) came from 
underreported non-business income, such as wages, tips, interest, 
dividends, and capital gains. The remaining $32 billion came from 
overstated reductions of income (i.e. statutory adjustments, 
deductions, and exemptions), and from overstated tax credits. The 
corresponding estimate of the self-employment tax underreporting gap is 
$39 billion, which accounts for about 11 percent of the overall tax 
gap. Self employment tax is underreported primarily because self-
employment income, which is not subject to third party reporting, is 
underreported for income tax purposes. Taking individual income tax and 
self employment tax together, then, we see that individual 
underreporting constitutes over two-thirds of the overall tax gap.

         INCREASING COMPLIANCE THROUGH SERVICE AND ENFORCEMENT

    It is important to understand that the complexity of our current 
tax system is a significant reason for the tax gap. It is easy for even 
sophisticated taxpayers to make honest mistakes. Accordingly, helping 
taxpayers understand their obligations under the tax law is a critical 
part of addressing the tax gap.
    IRS is committed to assisting taxpayers in both understanding the 
tax law and remitting the proper amount of tax. We are continuing to do 
this by maintaining the balance between service and enforcement that is 
so critical to tax administration.
Service
    I have already talked about IRS.gov and how it can answer many 
taxpayer questions on issues ranging from the Earned Income Tax Credit 
(EITC) to the Alternative Minimum Tax (AMT) to refund tracking. On a 
recent day, our site ranked third in overall hits according to Yahoo's 
Buzz Index. The American Customer Satisfaction Index has ranked our 
site well ahead of the government benchmark in the areas of content, 
functionality, navigation, privacy, satisfaction and in many other 
areas. Thus far this year, visits to our site are up 3.4 percent over 
the same period a year ago.
    This success has been recognized by others. In 2004, IRS.gov won 
the Keynote Performance Award as the most reliable Federal web site for 
performance and availability. It won the 2005 Government Computer News 
agency award for innovation and is a finalist for the 2005 
Excellence.gov Award in recognition of being an outstanding Federal 
interactive web site.
    We believe the internet has become our primary vehicle for 
delivering service information to taxpayers. Please note that I said 
primary and not exclusive. We recognize that we will always have a 
percentage of taxpayers that we need to serve through either direct 
personal service or over the telephone, but we hope to continually 
drive that number down, while at the same time improving the levels of 
service and taxpayer satisfaction. This will not only save us time and 
resources, but also will provide a valuable service to taxpayers. They 
can get answers to their questions at their home, at their convenience, 
rather than visiting a walk-in site.
    We continue to get good marks on various customer service surveys. 
Our toll free telephone service customer satisfaction rating is 94 
percent. In fiscal year 2005, the IRS's customer assistance call 
centers answered 59.1 million calls. We achieved an 82.6 percent toll-
free-telephone CSR level of service, exceeding our fiscal year 2005 
target of 82 percent. We also improved our toll free tax law accuracy 
rate to 89 percent, an increase from 80 percent in fiscal year 2004. 
While this is the highest yearly rate ever, we continue to strive to 
improve. This filing season through March, the tax law accuracy rate is 
90 percent.
    We provided and staffed toll-free FEMA phone assistance lines for 
hurricane victims and answered approximately 950,000 calls. The IRS 
also implemented numerous tax law changes to help the victims of 
Hurricanes Katrina, Rita and Wilma, businesses located in the disaster 
areas, and individuals donating to charities to support the victims.
    We continue to leverage community partnerships to provide free tax 
return preparation assistance through successful programs such as 
Volunteer Income Tax Assistance (VITA) and Tax Counseling for the 
Elderly (TCE). In 2005, 62,000 trained volunteers at 14,000 locations 
across the country prepared more than 2.1 million tax returns, an 80 
percent increase since 2001. We expect the number of customers served 
this year to exceed 2.2 million.
    I personally have had the opportunity to visit several VITA sites 
and I remain impressed by the diligence, the competence, and the 
commitment of the thousands of volunteers that make this program work.
    For small businesses, we simplified the employment tax filing 
process for more than 950,000 small companies by allowing them to file 
their employment tax returns and pay their employment tax liabilities 
annually, rather than quarterly. Our office of Taxpayer Burden 
Reduction led a collaborative effort to redesign the Form 1041 Schedule 
K-1, which among other things, is used to report income, deductions, 
and credits from trusts and estates to beneficiaries.
    We are also making progress on our Taxpayer Assistance Blueprint 
(TAB). This is an ambitious, agency-wide, 5-year taxpayer services plan 
aimed at improving IRS services.
    Over the past 5 years we have taken significant steps to understand 
the needs and preferences of individual taxpayers, our primary 
customers, and their representatives. Many studies, such as the 
Multilingual Initiative, the EITC outreach, and partnerships with 
organizations such as AARP and the National Community Tax Coalition 
have focused on understanding key demographic and behavioral 
differences in our customers. Before now, those initiatives have not 
been integrated to form a complete picture of customer needs.
    The TAB project will pull the pieces of the puzzle together and 
develop a complete picture of our customer base. Through a systematic 
data collection and analysis process, a dynamic plan (or Blueprint) 
will be developed to meet our short and long term business needs as it 
relates to taxpayer assistance and address concerns expressed by 
Congress and other oversight bodies.
    In short, TAB will help us better understand our customers--their 
characteristics, how they access our services, what services they use 
and prefer, and if our services truly meet their needs.
    We have completed the first phase of the TAB project. In Phase 1, 
we conducted research and surveyed taxpayers, stakeholders, and IRS 
employees to form a preliminary assessment of taxpayer needs, 
preferences, and demands. We have just recently delivered our Phase 1 
report to the subcommittee. In Phase 2, we will perform extensive 
primary research with taxpayers to refine our assessment and conclude 
by creating an IRS blueprint for taxpayer service delivery. We will 
complete this phase in October 2006.
Enforcement
    The IRS made significant progress towards achieving its enforcement 
related goals in fiscal year 2005. We achieved increases in every major 
area of enforcement. We have:
  --Audited nearly 220,000 high income taxpayers in 2005, more than 
        double the number audited in 2000.
  --Increased audits for individuals to 1.2 million, 20 percent more 
        than 2004 and almost double the level 5 years earlier.
  --Audited nearly 5,000 businesses with assets over $250 million, an 
        increase of 11 percent. In addition, we audited one out of 
        every five companies with assets of $10 million. Finally, 
        audits of businesses with less than $10 million in assets rose 
        145 percent from 2004.
  --Generated more than $4.7 billion in revenue through two prominent 
        settlement initiatives aimed at reducing examination and 
        litigation expenses while deterring the use of abusive tax 
        shelters.
  --Increased collection closure cases by 12 percent and dollars 
        collected by 14 percent over 2004.
  --Increased criminal convictions to 2,151 (from 1,926 in 2002).
  --Increased overall collections by 10 percent through heightened 
        enforcement efforts, from $43.1 billion in 2004 to $47.3 
        billion in 2005.
    Combating abusive tax shelters remains a high priority in fiscal 
year 2006. Last October we announced a global settlement initiative 
that covered 21 listed and non-listed transactions. They include a wide 
range of transactions involving funds used for employee benefits, 
charitable remainder trusts, offsetting foreign currency contracts, 
debt straddles, lease strips, and certain abusive conservation 
easements.
    Taxpayers had until January 23, 2006 to file an election to take 
part in the global settlement program. Under the terms of the 
settlement, taxpayers will generally be required to pay 100 percent of 
taxes owed, interest and, depending on the transaction, either a 
quarter or half the accuracy-related penalty the IRS will otherwise 
seek.
    We have been pleased by the response to this initiative, and we 
believe the response was buoyed by provisions in the Gulf Opportunity 
Zone Act of 2005 that modified the rules for calculating interest on 
tax deficiencies of individual taxpayers who participated in certain 
abusive tax shelters, increasing the incentives for individuals to come 
forward as part of this program.
    In addition, our Large- and Mid-Sized Business Division (LMSB) has 
issued more than 500 administrative summonses as part of our attack on 
shelter promoters, and we have approximately 200 active promoter 
examinations under way. Entities being looked at include banks, 
accounting firms, law firms and brokerage houses. We want to make it 
clear that taxpayers who take aggressive return positions relying on 
the ``audit lottery'' and the chance they will not be examined have 
made a really bad decision.
    In addition, we are continuing to focus on improper uses of certain 
tax exempt bonds and trusts, questionable transfer-pricing practices, 
offshore accounts, and charitable donations of intangible assets.
    Another enforcement priority is to assure that attorneys, 
accountants, and other tax practitioners adhere to professional 
standards and follow the law. Our system of tax administration depends 
upon the integrity of practitioners. The vast majority of practitioners 
are conscientious and honest, but even the honest tax professionals 
suffered from the sad and steep erosion of ethics in recent years by 
being subjected to untoward competitive pressures.
    We have done quite a bit to restore faith in the work of tax 
professionals. We have strengthened regulations governing the standards 
of tax practice to discourage the manufacturing of bogus legal opinions 
on the validity of tax shelters. New Treasury Department regulations 
took effect last June that revise Circular 230 governing tax 
practitioner behavior. The new regulations establish standards for 
written tax advice prepared by practitioners.
    Further, additional revisions to Circular 230 were recently 
proposed to make disciplinary proceedings more transparent so that 
practitioners may learn the types of behavior IRS is likely to 
challenge under the Circular.
    The IRS has made noncompliance by tax exempt and governmental 
entities and misuse of the tax exempt status of such entities by third 
parties for tax avoidance purposes another major enforcement priority. 
For example, earlier this year, we concluded that more than 30 credit 
counseling firms, accounting for more than 40 percent of the industry's 
revenues, are not entitled to tax exempt status. The proposed 
revocations of the tax exempt status of these entities are the 
culmination of more than 2 years of work covering more than 60 credit 
counseling organizations.
    These organizations were originally granted tax exempt status 
because they were supposed to be educating and assisting people who 
have credit or cash flow problems. Unfortunately, too many of these 
organizations instead operate for the benefit of insiders or are 
improperly in league with profit making companies. We want to make sure 
that money donated to charities goes for the purpose intended and not 
into the pockets of individuals associated with the charitable 
organization.
    In 2006, our Tax Exempt/Government Entities (TE/GE) division will 
continue to focus on key areas where organizations are abusing their 
exempt status or where others are using them for unintended purposes. 
Three of the areas in which we anticipate renewed enforcement include 
political intervention, executive compensation and abusive 
transactions.
    Regarding political intervention by entities claiming tax exempt 
status, in 2006 we will be finishing up contacts with 130 organizations 
suspected of political intervention in the 2004 election. Almost half 
of these are churches. Thus far we have completed 82 examinations and 
have concluded that nearly three-quarters of the non-profits examined, 
including churches, engaged in some level of prohibited activity. Most 
of these exams concerned one-time, isolated occurrences of prohibited 
campaign activity, which the IRS addressed through written advisories 
to the organizations. In three cases involving non-churches, the 
prohibited activity was egregious enough to warrant the IRS proposing 
the revocation of the organization's tax-exempt status.
    We have also issued a fact sheet designed to offer guidance to non-
profits on what is and is not permissible activity for tax-exempt 
organizations. In addition, we have taken steps to ensure that all 
referrals regarding campaign activity that the IRS receives from the 
public, as well as activity the IRS itself uncovers, are reviewed 
expeditiously, and treated consistently and fairly.
    Excessive compensation of executives also will be a main focus of 
our enforcement efforts. There are indications that tax-exempt 
organizations have allowed key executives too great a voice in 
determining their own compensation or otherwise have not used due 
diligence in setting compensation levels. We have contacted almost 
2,000 Section 501(c)(3) organizations, including about 400 private 
foundations regarding this issue. In addition, we are exploring 
compensation to tax-exempt hospital executives.
    In the fiscal year 2006 budget, our enforcement resources increased 
by $442 million (post-rescission). I know it is important to you, and 
it is equally important to us, to show a return on that investment.
    Of the total $442 million in increased funding, $180 million funds 
the pay and non-pay inflationary costs to maintain the $6.4 billion 
devoted to enforcement. The remaining $262 million funds direct costs 
for enhanced enforcement hiring, including staff for the Counsel and 
Appeals organizations, and associated indirect costs for these hires. 
We will focus these resources on:
  --Increased coverage of high-risk compliance problems to address the 
        largest portion of the tax gap--the underreporting of tax--
        across all major compliance programs;
  --Complex high-risk issues in abusive tax avoidance transactions, 
        promoter activities, corporate fraud and aggressive 
        transactions, resulting in increased corporate and high income 
        audit coverage;
  --Efforts aimed at reversing the erosion of individual tax compliance 
        and support of the strategy to implement a balanced compliance 
        program;
  --Improved ability to identify compliance risks and significantly 
        expanded coverage of tax-exempt communities;
  --Safeguarding compliant customers from unscrupulous promoters 
        through earlier detection of abusive schemes and heightened 
        efforts to prevent their proliferation; and
  --Increased vigilance to ensure the assets of tax-exempt 
        organizations are put to their intended tax-preferred purpose 
        and not misdirected to fund terrorism or for private gain, 
        including enhanced processing of questionable exemption 
        applications and increased technical support to the examination 
        process.

                         LEGISLATIVE PROPOSALS

    While fundamental tax reform is the only comprehensive solution to 
reducing the tax gap, until that is achieved, we must work within the 
current system to reduce the tax gap as much as possible. Allow me to 
discuss five specific legislative proposals that are offered as part of 
the fiscal year 2007 budget and designed to reduce the tax gap. 
Collectively, these five changes should generate $3.6 billion over the 
next 10 years.
    The first and perhaps most important proposal would increase 
reporting on payment card transactions. Our tax gap study shows clearly 
that increased information reporting and backup withholding are highly 
effective means of improving compliance with tax laws. More than 150 
million wage earners already have their information reported directly 
by their employer to the IRS and the non-compliance rate for this group 
is less than 1 percent. All of these wage earners are also subject to 
mandatory withholding of taxes.
    Payment cards (including credit cards and debit cards) are a 
growing form of payment in retail business transactions. The failure of 
some merchants to accurately report their gross income, including 
income derived from payment card transactions, accounts for a 
significant portion of the tax gap and creates a significant 
competitive advantage for those businesses that underreport.
    The administration proposes that the Treasury Secretary be given 
the authority to promulgate regulations requiring annual reporting of 
the aggregate reimbursement payments made to merchants in a calendar 
year, and to require backup withholding in the event that a merchant 
payee fails to provide a valid taxpayer identification number.
    Because reimbursement information is already provided to merchants, 
requiring this information to be reported to the IRS on an aggregate 
annual basis will impose minimal burden on payment card companies and 
no burden on the affected merchants. In addition, implementing a backup 
withholding system for payment card reimbursements to businesses would 
lead to material improvements in the compliance rates of these 
taxpayers without imposing a significant burden on the card companies. 
Finally, the IRS will be able to use payment card reporting information 
to better focus its resources and relieve the burden that existing 
audits place on businesses that accurately report their gross income.
    The second legislative proposal would clarify when employee leasing 
companies can be held liable for their clients' Federal employment 
taxes. Employee leasing is the practice of contracting with an outside 
business to handle certain administrative, personnel, and payroll 
matters for a taxpayer's employees. Typically, these firms prepare and 
file employment tax returns for their clients using the leasing 
company's name and employer identification number, often taking the 
position that the leasing company is the statutory or common law 
employer of the clients' workers.
    Non-compliance with the Federal employment tax reporting and 
withholding requirements is a significant part of the tax gap. Under 
present law, there is uncertainty as to whether the employee leasing 
company or its client is liable for unpaid Federal employment taxes 
arising with respect to wages paid to the client's workers. Thus, when 
an employee leasing company files employment tax returns using its own 
name and employer identification number, but fails to pay some or all 
of the taxes due, or when no returns are filed with respect to the 
wages paid by a company that uses an employee leasing company, there 
can be uncertainty as to how the Federal employment taxes are assessed 
and collected.
    The administration's proposal would set forth standards for holding 
employee leasing companies jointly and severally liable with their 
clients for Federal employment taxes. The proposal would also allow 
employee leasing companies to qualify to be solely liable if they met 
certain specified standards.
    Our third proposal would amend collection due process procedures 
for employment tax liabilities. Currently, we are authorized to take 
various collection actions including issuing Federal tax levies to 
collect past-due taxes. Before a tax levy can be issued, however, the 
IRS generally must provide the taxpayer with notice and an opportunity 
for an administrative collection due process (CDP) hearing, and for 
judicial review.
    Frequently, an employer who fails to satisfy its Federal tax 
liabilities for one period will also fail to satisfy them for later 
periods, resulting in a ``pyramiding'' of unpaid taxes. Some employers 
who request a CDP hearing or judicial review for one tax period will 
continue to accrue, or pyramid, their employment tax liabilities during 
the CDP proceedings. Liabilities for the subsequent periods cannot be 
collected by levy until the employer has been given notice and 
opportunity for a hearing and judicial review for each period. The 
existing CDP framework compounds the pyramiding problem by depriving 
the government of enforced collection as a tool to encourage employers 
to satisfy their current Federal employment tax obligations.
    Our proposal would allow the levy to be imposed prior to a CDP 
hearing in a fashion similar to current law provisions for levies 
issued to collect a Federal tax liability from a State tax refund. 
Taxpayers would have the right to a CDP hearing with respect to 
employment tax liabilities within a reasonable time after the levy. 
Taxpayers would also continue to have access to existing pre-collection 
administrative appeal rights other than CDP.
    The fourth proposal would require increased information reporting 
and backup withholding for certain government payments for property and 
services. It should be noted that present law generally requires 
information reporting for the provision of services and direct sales, 
but does not for provisions of goods and other property. This proposal 
will extend information reporting, with some exceptions, to the 
purchase of property by Federal, State, and local governments.
    Our proposal would authorize the Treasury Secretary to promulgate 
regulations requiring information reporting and backup withholding on 
non-wage payments by Federal, State and local governments to procure 
property and services. Certain payments would, of course, be exempt. 
These include payments of interest, payments for real property, 
payments to tax exempt entities or foreign governments, 
intergovernmental payments, and payments made pursuant to a classified 
or confidential contract.
    The final legislative proposal would expand the signature 
requirement and penalty provisions applicable to paid tax return 
preparers. Under current law a paid tax return preparer is required to 
sign and include his/her taxpayer identification number (TIN) on an 
income tax return and related documents that he/she prepares for 
compensation. Paid return preparers, however, are not required to sign 
and include their TINs on non-income tax returns, such as employment 
tax returns, excise tax returns, and estate and gift tax returns, and 
tax return related documents filed with the IRS. The administration's 
proposal would expand preparer identification and penalty provisions to 
non-income tax returns and tax return-related documents prepared for 
compensation. Further, it would impose penalties for preparing tax 
return related documents that contain false, incomplete, or misleading 
information or certain frivolous positions that delay collection.
    These five legislative changes strategically target areas where: 
(1) research reveals the existence of significant compliance problems; 
(2) improvements will burden taxpayers as little as possible; and (3) 
the changes support the administration's broader focus on identifying 
legislative and administrative changes to reduce the tax gap.
    In addition to these specific legislative proposals, we will study 
the distinction between independent contractors and employees under 
current law. The improper classification of employees as independent 
contractors is a significant problem and substantial contributor to the 
tax gap.

                               FREE FILE

    The IRS wants to make free filing of tax returns available to as 
many taxpayers as possible. We have looked to the private sector for 
assistance to make this happen as quickly as possible. I referenced 
earlier the fact that we are experiencing a significant decline in the 
use of the Free File program in the 2006 Filing season. I also 
recognize there have been some questions raised as to the renewal of 
our Free File agreement. Allow me to update you on both the background 
of Free File and the new agreement.
    Free File's roots can be found in the President's fiscal year 2002 
Management Agenda. It contained five Government-wide initiatives, one 
of which was to expand electronic government. The overarching goal was 
to ``champion citizen-centered electronic government that will result 
in major improvements in the federal government's value to the 
citizen.''
    Subsequently, in November 2001, OMB's Quicksilver Task Force 
established 24 e-government initiatives as part of the President's 
Management Agenda. These initiatives were designed to improve 
government-to-government, government-to-business, and government-to-
citizen electronic capabilities.
    One initiative instructed the IRS to provide free online tax return 
preparation and filing services to taxpayers. In accordance with this 
OMB directive, the IRS began working in partnership with the tax 
software industry to develop a solution.
    The IRS believes that private industry, given its established 
expertise and experience in the field of electronic tax preparation, 
has a proven track record in providing the best technology and services 
available. IRS's partnership with private industry: (1) provides 
taxpayers with high quality services by using the existing private 
sector expertise; (2) maximizes consumer choice; (3) promotes 
competition within the marketplace; and (4) meets these objectives at 
the least cost to taxpayers.
    On October 30, 2002, the IRS and the Free File Alliance, LLC, 
signed an agreement that created a public-private partnership to 
provide free services to the majority of taxpayers. The Free File 
Alliance, LLC, is a private-sector consortium of tax preparation 
software companies. The original agreement was for 3 years with a 
series of 2-year renewal options. The primary candidates for Free File 
services were those taxpayers who prepare their own taxes and still 
file paper returns.
    While membership in the Alliance may change from time to time, all 
members must meet certain IRS standards. Specifically, we must approve 
each member's proprietary tax preparation software. In addition, each 
member must obtain third party privacy and security certification. 
Finally, all Alliance members must adhere to all Federal laws regarding 
taxpayer privacy.
    Each Free File Alliance member was allowed to set taxpayer 
eligibility requirements for its program. Generally, eligibility was 
based on such factors as age, adjusted gross income, State residency, 
eligibility to file a Form 1040EZ or for the Earned Income Tax Credit. 
But, as a whole, under the original agreement, the Alliance was 
required to provide free filing services to at least 60 percent or 78 
million of the Nation's individual taxpayers. In addition, all active 
armed forces, Federal reservist and National Guard personnel were 
eligible to free file through a separate program operated by the 
military.
    While the IRS did not support or endorse any Free File Alliance 
company or product offering, it did provide a listing of the Alliance 
members via the Free File web page, which is hosted on IRS.gov. 
Companies were allowed to offer ancillary services to taxpayers for a 
fee, but the taxpayer was under no obligation to purchase any of those 
services as a condition of getting their Federal tax return prepared 
free of charge.
    The intent of the Free File program was to reduce the burden on 
individual taxpayers, make tax preparation easier and expand the 
benefits of electronic filing to a majority of Americans. In the 2003 
filing season, 2.8 million taxpayers took advantage of Free File. This 
number rose to 3.4 million in 2004. In 2005, the number increased to 
over 5 million. Nearly 3.9 million taxpayers have utilized Free File in 
this filing season.
    The 2005 number may be a bit of an aberration in that many of the 
companies in the Alliance opted to lift qualification restrictions on 
taxpayers thus allowing any taxpayer, regardless of income, to utilize 
Free File. This started as some companies sought a competitive 
advantage by expanding their base and ended with many of the companies 
in the Alliance offering free return preparation services to anyone.
    While this was good for taxpayers in general, it posed a serious 
threat to the survival of the Alliance and was a prime topic of 
discussion when the contract was up for renewal at the end of last 
year. Many of the companies could not continue in the Free File 
Alliance unless it returned to offering the free service to low and 
moderate income individuals. The loss of these companies would have 
jeopardized the continued existence of the Alliance.
    As we prepared for negotiations to extend the Free File agreement 
in 2005, the IRS took the position that Free File should be available 
to as many taxpayers as possible. The Alliance's position was that Free 
File should only be available to low and moderate income taxpayers.
    As is the case in most negotiations, we compromised and agreed that 
Free File would be offered to 70 percent of taxpayers, or anyone with 
an AGI of $50,000 or less in 2005. This covers approximately 93 million 
of the 133 million individual taxpayers expected to file returns this 
year. This is an improvement over our prior agreement which only 
guaranteed coverage of 60 percent or availability to 78 million 
taxpayers. The active armed forces, Federal reservist and National 
Guard personnel continue to be eligible to free file under their own 
program.
    In 2006, three Free File Alliance members are offering State filing 
for free. Seven members are offering to file Form 4868, Extension of 
Time to File Individual return. Approximately 46,000 extension forms 
had been filed as of April 15. In addition, there are two companies 
offering free packages in Spanish.
    While the number of taxpayers taking advantage of Free File in 2006 
will likely be less than in 2005, we are unable at this time to fully 
explain the decline. Certainly the fact that it is not available to 
everyone is one factor, but there likely are other factors as well.
    A year ago, the Free File program benefited greatly from a major 
article on the front page of USA Today. Immediately following that 
article, there was a tremendous surge of positive publicity as well as 
a surge in Free File usage by taxpayers. We have not been the 
beneficiary of similar publicity this year and to the extent we have 
received coverage much of it has focused on the taxpayers that Free 
File does not cover.
    One of the major concerns that many critics of the Free File 
program have had has been the ability of the Alliance members to use 
Free File to market other services to taxpayers. These include the 
filing of State tax returns and the offering of refund anticipation 
loans (RALs). We make it clear to taxpayers that the IRS does not 
endorse any of these products or services nor is the completion of 
their tax return at no cost conditioned on the purchase of any product 
or service.
    Because the IRS does not directly monitor Free File return 
preparation, we generally do not know what, if any, fee services 
taxpayers actually use from the Free File vendors. The one service that 
we do have data on is refund anticipation loans (RALs). RALs are 
designed to provide the taxpayer an immediate refund in the form of a 
consumer loan. Often the costs incurred with the RAL are 
disproportionate to the amount of the refund, especially considering 
that a taxpayer that files electronically will get the refund from the 
IRS in about 2 weeks. Unfortunately, it is often low income taxpayers, 
the ones who can least afford it, who choose RALs.
    What we are seeing from our Free File data thus far in this regard 
is encouraging. Only 0.6 percent of the taxpayers utilizing Free File 
have utilized a RAL. In fact, half of the Free File vendors do not even 
offer refund anticipation loans. In part this may be due to the strong 
consumer protection language included in the new agreement. The 
agreement specifies that any alliance member offering a RAL must 
include clear language indicating that RALs are a loan and not a faster 
way of receiving an IRS refund. It also requires them to specify that 
because the RAL is a short term loan, interest rates may be higher than 
some other forms of credit available to consumers. The agreement also 
limits an Alliance member to asking a taxpayer about a RAL only once. 
If the taxpayer says no, then there can be no other pressure applied to 
convince him or her to change his or her mind.
    This 0.6 percent RAL participation for Free File is the lowest of 
any of our electronic filing groups. Other online filers have a 0.8 
percent participation rate. The rate for online returns done by paid 
tax return preparers is the highest. Approximately 20 percent of the 
paid preparer returns submitted electronically include a RAL.

                       7216 PROPOSED REGULATIONS

    Another issue about which there has been considerable controversy 
is the proposed modification of regulations under section 7216 of the 
Internal Revenue Code, which addresses use and disclosure of tax return 
information by tax preparers. I must admit that I was somewhat 
surprised by the reaction to the proposed regulations particularly 
since the current regulations have allowed for taxpayer consent to 
disclosure for more than 30 years. Protecting the confidentiality of 
tax return information is of paramount importance to the IRS and our 
intent in proposing the regulations was to tighten existing rules and 
articulate how the tightened rules should be applied in an electronic 
return preparation environment.
    The furor that has arisen in recent weeks over the proposed changes 
tells me that few taxpayers were previously aware of this provision and 
of the consequences of consenting to disclosure or use of their tax 
return information. To that extent, the debate has been good in that 
taxpayers are hopefully now better educated about disclosure and 
sharing of information and will be more careful about what they consent 
to.
    Beyond that, it is important to remember several things. First, 
this is only a proposed regulation. We have had numerous comments both 
in writing and at the public hearing we held on April 4. We will 
evaluate all those comments before going forward with any final 
regulation.
    Second, the proposal contains some important taxpayer protections 
relative to what a tax return preparer would have to do in order to get 
consent to share or use any of the taxpayer information the taxpayer 
gave the return preparer to prepare his or her tax return. In addition, 
there are important new restrictions on the ability of tax return 
preparers to shift tax return information overseas for tax return 
preparation or data processing purposes.
    Third, the proposed regulations would treat all tax return 
preparers the same way. Under the current regulations, tax return 
preparers that are part of an ``affiliated group'' of corporations can 
obtain taxpayer consent to use information to solicit business for 
their corporate affiliates. This rule was written over 30 years ago and 
has no application to the vast majority of return preparers that are 
not organized as affiliated groups of corporations. This leads to 
illogical results, particularly when contrasted with the provision in 
the current rules that allows taxpayers to consent to ``disclose'' 
their tax return information to third parties that have no connection 
whatsoever with the tax return preparer. The IRS has received a number 
of comments on this issue and will carefully consider them in 
finalizing the proposed regulation to ensure that the goal of 
protecting taxpayer privacy is achieved.
    Finally, an outright ban on sharing of tax return information 
raises some interesting questions and may lead to illogical results if 
taxpayers were prohibited by law from ever consenting to a tax return 
preparer disclosing or using their tax return information for any 
purpose.

                              CONCLUSIONS

    Mr. Chairman, members of the subcommittee, I would like to 
emphasize the following points:
  --E-Filing continues to grow. Over 63 million people have already e-
        filed their return, 63 percent of all returns filed.
  --Taxpayers who are e-filing from their home computers show the 
        greatest increase in e-filing, up almost 13 percent from a year 
        ago.
  --Hits to IRS's web site, IRS.gov are almost 114 million, up 3.39 
        percent over last year.
  --Returns filed by VITA and TCE sites are up 7.3 percent over a year 
        ago.
    In addition, the best way to maintain our success in our compliance 
and enforcement efforts, reduce the tax gap, and continue the 
achievements made in 2006 is the adoption of the President's proposed 
budget for fiscal year 2007, particularly the $137 million for 
enforcement that is part of a program integrity cap adjustment, and 
enactment of the five legislative proposals.
    Thank you, Mr. Chairman and I will be happy to respond to any 
questions.

                  STATEMENT OF RAYMOND T. WAGNER, JR.

    Senator Bond. Thank you very much, Commissioner, and now 
let me turn to Chairman Wagner.
    Mr. Wagner. Thank you, Mr. Chairman.
    Before I begin, I almost feel compelled to dial up my 11-
year-old daughter, Mary Ruth, and put her on my speakerphone 
right here or at least take her photo and put it on the front 
side of my name tag.
    Mr. Chairman, members of the committee, Senator Murray, 
thank you for the opportunity to present the IRS Oversight 
Board's recommendations for the fiscal year 2007 budget. Before 
I begin my testimony on the budget, I would like to take a 
moment to commend the Commissioner and the Internal Revenue 
Service on what appears from all accounts to be a very 
successful filing season.
    I have submitted a detailed written statement and ask that 
it be made a part of the hearing record.
    The Oversight Board recommends a fiscal year 2007 IRS 
budget of $11.3 billion, an increase of $732 million or 6.9 
percent over the enacted fiscal year 2006 budget as compared to 
the administration's request of $10.6 billion. The two budgets 
share some essential elements. Both reflect the same 
adjustments for inflation of $272 million. Both show a savings 
and reinvestment of $122 million, and both are supplemented by 
$135 million in increased user fees.
    The board recognizes the theme of fiscal austerity in the 
President's budget and respects the administration's request; 
however, our statutory charge is to recommend a budget that 
will ensure that the IRS can carry out its mission and annual 
and long plans.
    Mr. Chairman, you are very aware of the large tax gap. You 
spoke of it in your opening statement. We believe that reducing 
the tax gap requires a comprehensive long-term plan with 
organizational commitment and actions described in my written 
statement. The board believes that a flat IRS budget does not 
do enough to shrink the tax gap and recommends an increase of 
$705 million in four program areas: $44 million for more 
taxpayer services, $368 million for more enforcement, $105 
million for management and infrastructure, $189 million for the 
Business Systems Modernization program.
    In the area of customer service, the board seeks to restore 
the telephone level of service on IRS's main toll-free line to 
the fiscal year 2004 level of performance or 87 percent. The 
board also recommends an additional $368 million for 
enforcement. Of that, $308 million would provide for the modest 
increase in IRS enforcement resources across all taxpayer 
segments. The IRS has demonstrated there is a positive return 
on these types of investments.
    The remaining $60 million for our enforcement increase is 
for additional research. The IRS needs to know much more about 
the noncompliance to mount a successful campaign against the 
tax gap. It is time that the IRS make up-to-date research the 
normal way of doing business. To this end, the board recommends 
that the IRS make the National Research Program permanent and 
perform compliance research annually. This effort should be 
guided by a long-term plan for research. We also need solid 
research on customer service needs and how customer service 
affects compliance.
    I want to emphasize that taxpayers want more service and 
more enforcement from the IRS. The board surveys of taxpayer 
attitudes in 2004 and 2005 indicates that approximately two-
thirds of taxpayer support additional IRS funding for both 
service and enforcement.
    Time does not permit me to describe our recommendation for 
infrastructure and management fully, but I would like to 
highlight one specific recommendation, the need to restore 
leadership development training to fiscal year 2003 levels, 
which is especially critical during a period in which 
approximately 50 percent of IRS managers are eligible for 
retirement.
    It is also critical to discuss Business Systems 
Modernization. Despite productivity improvements, the IRS is 
still forced to rely on a 40-year-old information system for 
its central recordkeeping, which limits the IRS to weekly 
updates of its primary taxpayer records. No modern financial 
institution in the private sector could survive under these 
conditions. Eliminating these limitations are key to making the 
IRS as efficient and effective as a modern financial 
institution.

                           PREPARED STATEMENT

    Improved management focus has helped BSM deliver important 
technology projects that are generating greater efficiencies 
and real world benefits for taxpayers, such as CADE and 
modernized E-file. Cutting back on modernization will force the 
program to take longer and cost more than necessary in the long 
run. The board recommends that BSM move forward at an 
accelerated pace.
    Mr. Chairman, this concludes my oral statement and I will 
be pleased to accept your questions.
    [The statement follows:]

              Prepared Statement of Raymond T. Wagner, Jr.

                       INTRODUCTION AND OVERVIEW

    Mr. Chairman, thank you for this opportunity to present the 
Oversight Board's views on the administration's fiscal year 2007 IRS 
budget request. I will explain in my testimony why the Board believes 
its proposed budget is needed to meet the needs of the country and of 
taxpayers. In developing these recommendations, the Board has applied 
its own judgment but has also drawn on the collective wisdom of others 
in the tax administration community, including the IRS, Government 
Accountability Office (GAO), the Treasury Inspector General for Tax 
Administration (TIGTA), National Taxpayer Advocate, and Congress.
    In fulfilling its responsibilities, the Board must ensure that the 
IRS's budget and the related performance expectations contained in the 
performance budget support the annual and long-range plans of the IRS, 
support the IRS mission, are consistent with the IRS goals, objectives 
and strategies and ensure the proper alignment of IRS strategies and 
plans. In addition to my statement today, the Board is developing a 
formal report in which it will explain why it has recommended this 
budget for the IRS.
    Now is a fiscally challenging time for our Nation. Defense and 
homeland security needs coupled with rebuilding efforts along the 
hurricane-ravaged Gulf Coast have placed an enormous strain on the 
Federal budget.
    In addition to our fiscal challenges, taxpayers are expected to 
comply with an increasingly complex tax code which places heavy burdens 
on honest taxpayers who wish to comply and offers untold opportunities 
for mischief by those who do not.
    Against this backdrop, it is imperative that government work better 
and smarter and get the most out of every taxpayer dollar. But there is 
also a drain on the Treasury that undermines our country's tax revenues 
and threatens the integrity of our tax administration system--the tax 
gap.
    The IRS recently disclosed that the Nation's annual tax gap--the 
difference between what is owed and what is collected annually--stands 
at $345 billion, and some experts believe it could be even more. The 
Board considers the existence of such a large tax gap to be an affront 
to honest taxpayers, and is pleased with the attention that Congress 
has focused on the tax gap in the last year, especially with the 
release of the IRS's latest tax gap estimates. The Board, along with 
many other members of the tax administration community, believe that 
reducing the tax gap requires a comprehensive, multi-faceted plan with 
action on many fronts--from a simpler tax code and more complete income 
reporting to better enforcement and quality customer service.
    Such an approach needs to be more thoughtful and comprehensive that 
merely increasing IRS resources and expecting that the gap will shrink. 
However, increased IRS resources are certainly a part of the solution. 
A successful strategy will encompass several separate but interrelated 
approaches that will reinforce each other to produce the desired 
result. In the Board's opinion, a number of actions that can be taken 
will require additional IRS resources.
    The Oversight Board recommends an integrated set of strategies to 
close the tax gap: (1) tax code simplification; (2) improved 
information reporting and enforcement tools related to the cash 
economy; (3) improved customer service to make taxpayers aware of their 
obligations and modern technology to ease their burdens; (4) greater 
focus on research; (5) more productive partnerships between the IRS and 
tax professionals; and (6) and more emphasis on personal integrity.
    There can be no doubt that in the last 5 years the agency has 
achieved significant progress in all dimensions of its mission. 
Customer service has rebounded from the lows of the 1990's and through 
targeted investments and greater management focus, IRS enforcement has 
also turned the corner.
    This across-the-board improved performance has not gone unnoticed--
especially among taxpayers. According to the 2005 American Customer 
Service Index, overall satisfaction among individual tax filers with 
the Internal Revenue Service remains stable at 64 percent; it is even 
higher among e-filers. The IRS Oversight Board 2005 Annual Survey also 
found that American taxpayer support for overall compliance reached an 
all-time high. However, the IRS's job is far from complete and it must 
close the tax gap while achieving balance in other parts of its 
critical mission.
    The Board recommends budget increases in four IRS program areas in 
fiscal year 2007: customer service, enforcement, Business Systems 
Modernization, and infrastructure and management tools.
    To achieve balance and ultimately compliance, the Board recommends 
two modest investments in customer service to ensure that there is no 
slippage in hard won gains. For example, the toll-fee telephone level 
of service is slightly down and wait times have increased compared to 
fiscal year 2004. The Board proposes restoring customer service to 
fiscal year 2003-2004 levels and investing in telephone infrastructure. 
It is far less expensive to prevent or solve a problem early on than 
let it grow.
    The Board proposes a modest increase in resources for virtually all 
IRS enforcement activities. This is money well-spent and there is a 
growing recognition of the positive return on money invested in the 
IRS. The Board strongly believes that the enforcement increase includes 
a significant investment in research to better understand enforcement 
and customer service needs and the impact of customer service on 
voluntary compliance. The Board's recommended budget puts the IRS on 
track to make the National Research Program (NRP) permanent and produce 
annual tax gap estimates. The Board further recommends that the IRS 
consider developing a long-term strategic plan for research.
    Business Systems Modernization is also a priority and the Board 
advocates a larger investment in information technology to improve IRS 
productivity and reduce taxpayer burden. Despite productivity 
improvements in recent years, the IRS is still hampered in its efforts 
to modernize because of its reliance on a 40-year-old information 
system for its central recording-keeping functions, which limit the IRS 
to weekly updates of its central taxpayer records. No modern financial 
institution in the private sector could survive under these conditions 
and eliminating these limitations is key to making the IRS an efficient 
and effective modern financial institution.
    Lastly, the Board recommends a number of management increases that 
will help the IRS cope with unfunded mandates, implement BSM projects, 
and restore leadership training to fiscal year 2003 levels, which has 
become especially critical during a period in which over 50 percent of 
IRS managers are eligible to retire.
    Overall, the Oversight Board proposes a budget that is good for the 
country, good for taxpayers, and allows the IRS to achieve its 
strategic goals and objectives in an efficient and effective manner. It 
calls for $11.3 billion funding for fiscal year 2007, a 6.9 percent 
increase over last year's appropriation.
    The Board has also voiced concern that two items in the 
administration's proposed fiscal year 2007 budget for the IRS pose 
significant risks. First, the budget proposes $84 million in savings 
from program efficiencies. The Oversight Board believes there is a risk 
that these reductions will decrease performance. Second, last December 
the IRS announced that it would dramatically raise fees for certain 
services and the President's budget assumes that the IRS will receive 
an additional $135 million in fee revenue. Although the IRS has 
expressed confidence it would receive this amount in additional fees 
based on its estimates, there is still some risk whether the estimated 
fee revenue can be achieved. In addition, external stakeholders have 
expressed concern that the additional fees could have an unintended 
negative impact on taxpayer compliance.
    In conclusion, the Board believes that it has constructed a 
fiscally responsible and realistic budget for the IRS that meets 
national needs and priorities. It would help shrink the tax gap while 
providing taxpayers with a level of service they rightly deserve and 
need. It would speed the modernization of the IRS's antiquated 
technology and give it the research tools to better understand current 
and developing trends. Most importantly, it would maintain that 
delicate but critical balance between enforcement and customer service 
that America's taxpayers have said time and again they want, and which 
has been validated through the Board's Taxpayer Attitude Survey. The 
IRS is now solidly on the right track and is making progress, but we 
must give it the resources to do its job. It is the right investment 
for this and future generations of taxpayers.
Recommended IRS Oversight Budget in Brief
    The IRS Oversight Board recommends an fiscal year 2007 IRS budget 
of $11.31 billion, an increase of $732 million over the enacted fiscal 
year 2006 budget.\1\ This recommendation compares to the President's 
budget request for the IRS of $10.59 billion in direct appropriations. 
The two budgets share the following characteristics:
---------------------------------------------------------------------------
    \1\ The President's budget includes on pages IRS-127 to IRS-129 of 
the Congressional Justification, as required by law, a copy of the 
fiscal year 2007 IRS budget the Oversight Board approved and submitted 
to the Department of the Treasury. The Board's recommended budget, as 
show on these pages, is higher than the request shown above; Appendix 6 
provides an explanation of the differences.
---------------------------------------------------------------------------
  --Both reflect the same adjustments for inflation, $272 million.
  --Both show a savings and reinvestment of $121.6 million.
  --Both are supplemented by $135 million in increased user fees to 
        achieve a higher operating level.
    The Board's budget, however, proposes program increases of $705 
million compared to a proposed program decrease of nearly $9 million in 
the President's budget, as shown in the table below.

          COMPARISON OF BOARD AND PRESIDENT'S PROGRAM INCREASES
                        [In thousands of dollars]
------------------------------------------------------------------------
                                            Oversight
                Function                      Board        President's
                                         Recommendation      Request
------------------------------------------------------------------------
Taxpayer Service.......................          43,637  ...............
Enforcement............................         367,768  ...............
Infrastructure and Mgt Modernization...         104,715          20,900
Business Systems Modernization.........         188,600         (29,700)
Total Program Increases (Decreases)....         704,720          (8,800)
------------------------------------------------------------------------

    Recommended initiatives for enforcement, customer service, 
infrastructure and management and Business Systems Modernization can be 
found in the individual sections of this statement and Appendices 2 
through 5.
IRS Performance From Fiscal Year 2001 to Fiscal Year 2005
    The agency, which had become synonymous with poor customer service 
in the late 1990's, has demonstrated a remarkable performance 
improvement in the last 5 years. Toll-free telephone level of service 
has steadily increased from 56 percent in fiscal year 2001 to a high of 
87 percent in fiscal year 2004. (In fiscal year 2005, there was a 
slight 3 percent drop which the IRS attributes to reduced funding for 
taxpayer services.) Toll-free tax law accuracy also rose from 82 
percent in fiscal year 2003 to an impressive 88 percent in fiscal year 
2005.
    Perhaps the most important and notable gain recorded over the past 
5 years is the percent of individuals filing electronically--31 percent 
in fiscal year 2001 to 51 percent in fiscal year 2005.\2\ And although 
it will miss the 2007 deadline, the IRS is making steady progress in 
closing in on the 80 percent e-file goal established by the IRS 
Restructuring and Reform Act of 1998.
---------------------------------------------------------------------------
    \2\ Statistics provided to the Oversight Board by the IRS.
---------------------------------------------------------------------------
    Through targeted investments and greater management focus, IRS 
enforcement has also turned the corner. Enforcement revenue rebounded 
from $33.8 billion in fiscal year 2001 to $44.1 billion in fiscal year 
2005. Audit rates also steadily increased. For high-income individuals 
they rose from 0.79 percent in fiscal year 2001 to 1.61 percent in 
fiscal year 2005. Over the same time period, corporate and small 
business audits increased respectively from 13.5 percent to 16.9 
percent and 0.88 percent to 1.32 percent.
Taxpayers Respond to Better Performance but Problems Remain
    This across-the-board improved performance has not gone unnoticed--
especially among taxpayers. According to the 2005 American Customer 
Service Index, overall satisfaction among individual tax filers with 
the IRS remains stable at 64 percent. However, the number is much 
higher among e-filers who had an ACSI score of 77 percent.\3\ By way of 
comparison, the IRS received a 51 percent score in 1998. Taxpayer 
attitudes have also improved. Since 2002, the IRS Oversight Board has 
conducted an annual survey to gain a deeper understanding of taxpayers' 
attitudes. Of great concern was the growing number of individuals who 
thought it acceptable to cheat on their taxes.
---------------------------------------------------------------------------
    \3\ Professor Claes Fornell, ``ACSI Commentary: Federal Government 
Scores'', December 15, 2005.
---------------------------------------------------------------------------
    In 2003, 12 percent of respondents thought it acceptable to cheat a 
``little here and there'' on their taxes, and 5 percent would cheat as 
much as possible. However, 2 years later those numbers have dropped to 
7 and 3 percent respectively and public support for tax compliance is 
at an all-time high. Moreover, the 2005 survey found that 82 percent of 
respondents say that their own personal integrity has the greatest 
influence on whether or not they report and pay their taxes honestly--
double the number who cite any other factor. Significantly, the survey 
also found two out of three surveyed expressed continued support for 
additional funding for both IRS assistance and enforcement.\4\ 
America's taxpayers want a balanced tax administration system.
---------------------------------------------------------------------------
    \4\ IRS Oversight Board, 2005 Taxpayer Attitude Survey.
---------------------------------------------------------------------------
    However, as welcome as the news may be, it cannot disguise the hard 
fact that the tax gap has remained unacceptably high. In testimony 
before the Senate Budget Committee, Comptroller General David Walker 
stated that the $345 billion tax gap estimated by the IRS could indeed 
be greater: ``IRS has concerns with the certainty of the overall tax 
gap estimate in part because some areas of the estimate rely on old 
data and IRS has no estimates for other areas of the tax gap. For 
example, IRS used data from the 1970's and 1980's to estimate 
underreporting of corporate income taxes and employer-withheld 
employment taxes.'' \5\
---------------------------------------------------------------------------
    \5\ Comptroller General David Walker, Testimony Before the Senate 
Budget Committee, ``Tax Gap: Making Significant Progress in Improving 
Tax Compliance Rests on Enhancing Current IRS Techniques and Adopting 
New Legislative Actions,'' February 15, 2006, GAO-06-453T.
---------------------------------------------------------------------------
    The tax gap is more that an abstract number. According to National 
Taxpayer Advocate Nina Olson, it hurts taxpayers in a very concrete 
way:

    ``The collective failure by certain taxpayers to pay their taxes 
imposes greater burdens on other taxpayers. The IRS receives 
approximately 130 million individual income tax returns each year. 
Given the size of the net tax gap, the average tax return includes a 
`surtax' of about $2,000 to make up for tax revenues lost to 
noncompliance. The tax gap may also impose significant costs on 
businesses in the form of unfair competition by noncompliant 
competitors who can pass along a portion of their tax `savings' to 
customers by charging lower prices.
    ``Most importantly, the tax gap can erode the level of confidence 
that taxpayers have in the government, thereby reducing Federal revenue 
and increasing the need for more examination and collection actions. 
The tax gap, then, can produce a vicious cycle of increased 
noncompliance and increased enforcement.'' \6\
---------------------------------------------------------------------------
    \6\ Nina E. Olson, National Taxpayer Advocate, Testimony Before the 
Senate Subcommittee on Federal Financial Management, Government 
Information, and International Security Committee on Homeland Security 
and Governmental Affairs, October 26, 2005.

    The IRS Oversight Board believes that its fiscal year 2007 IRS 
budget recommendations are part of the solution to reversing this 
corrosive trend.
Budget Environment Should Not Discourage Investment
    The IRS does not operate in a vacuum and the Oversight Board 
recognizes that the current budget environment stresses fiscal 
restraint and austerity. However, at the same time, we should not throw 
up our hands in defeat and say we can do no more to improve tax 
administration. We should look at the larger picture.
    Unlike other government agencies, there is a positive return on 
money invested in the IRS. Senate Budget Committee Chairman Judd Gregg 
agrees. He observed at a recent hearing on the tax gap, ``We've got to 
talk to the CBO about scoring on that [investing in IRS enforcement], 
clearly there's a return on that money.'' \7\
---------------------------------------------------------------------------
    \7\ Tax Notes, February 16, 2006.
---------------------------------------------------------------------------
    The Board would welcome such a change but also recognizes that this 
is a problem that has plagued the IRS for decades. Former IRS 
Commissioner Charles O. Rossotti wrote:

    ``When I talked to business friends about my job at the IRS, they 
were always surprised when I said that the most intractable part of 
job, by far, was dealing with the IRS budget. The reaction was usually, 
`Why should that be a problem? If you need a little money to bring in a 
lot of money, why wouldn't you be able to get it?' '' \8\
---------------------------------------------------------------------------
    \8\ Charles O. Rossotti, ``Many Unhappy Returns: One Man's Quest to 
Turn Around the Most Unpopular Organization in America'', Harvard 
University Press, 2005. p. 278.

    Indeed, this lack of recognition of a direct return on investment 
has left many puzzled. In his April 14, 2004 column, Washington Post 
financial writer Al Crenshaw wondered why the administration and 
Congress ``aren't falling over themselves to give the IRS more money. 
Tax Enforcement pays for itself many times over, and it would be a good 
way to cut the deficit.'' \9\
---------------------------------------------------------------------------
    \9\ Al Crenshaw, ``Letting Cheaters Prosper,'' Washington Post, 
April 14, 2004.
---------------------------------------------------------------------------
    In its fiscal year 2007 budget recommendation, the Board calls for 
increases in enforcement that would result in a real return on 
investment, ranging from $3 to $6 on every $1 spent, resulting in $730 
million revenue by fiscal year 2009 on a $242 million investment.
    The Oversight Board urges Congress to adopt the Board's budget 
recommendations and invest in more effective tax administration.

                  SIX STRATEGIES TO REDUCE THE TAX GAP

    The Board considers the existence of such a large tax gap to be an 
affront to honest taxpayers, and is pleased with the attention that 
Congress has focused on the tax gap in the last year, especially with 
the release of IRS latest tax gap estimates. The Board, along with many 
other members of the tax administration community, believe that 
reducing the tax gap requires a comprehensive, multi-faceted plan with 
action on many fronts--from a simpler tax code and more complete income 
reporting to better enforcement and quality customer service.
    Such an approach needs to be more thoughtful and comprehensive than 
merely increasing IRS resources and expecting that the gap will shrink. 
That being said, however, increased IRS resources are a part of the 
solution. A successful strategy will encompass several separate but 
interrelated approaches that will reinforce each other to produce the 
desired result. In the Board's opinion, a number of actions that can be 
taken will require additional IRS resources.
    The Board supports six strategies that it believes would constitute 
an over-arching plan to reduce the tax gap. This information is 
presented here only to provide some additional background to understand 
the Board's fiscal year 2007 budget recommendations, so that these 
recommendations can be understood in the context of an overall approach 
where the individual elements reinforce each other.
    The first is a simplified tax code. Our complex and ever changing 
tax code not only confounds honest taxpayers who want to comply with 
their obligations under the law, but provides ample opportunity for 
those who exploit its complexity to cheat. The President's Advisory 
Panel on Federal Tax Reform observed:

    ``Since the last major reform effort in 1986, there have been more 
than 14,000 changes to the tax code, many adding special provisions and 
targeted tax benefits, some of which expire after only a few years. 
These myriad changes decrease the stability, consistency, and 
transparency of our current tax system while making it drastically more 
complicated, unfair, and economically wasteful. Today, our tax system 
falls well short of the expectations of Americans that revenues needed 
for government should be raised in a manner that is simple, efficient, 
and fair.'' \10\
---------------------------------------------------------------------------
    \10\ Statement by the Members of the President's Advisory Panel on 
Federal Tax Reform, ``America Needs a Better Tax System,'' April 13, 
2005.

    Second, the Oversight Board recommends improved information 
reporting and enforcement tools to address large areas of the tax gap 
related to what has been called the cash economy. Although the Board is 
prohibited by statute from endorsing any specific proposal, we note 
that in its fiscal year 2007 budget submission for the IRS, the 
administration makes five legislative recommendations to close the tax 
gap that include: (1) increasing information reporting on payment card 
transactions; and (2) expanding information reporting to certain 
payments made by Federal, State and local governments to procure 
property and services. They certainly merit congressional discussion 
and consideration.
    The National Taxpayer Advocate also recommended in her 2005 Annual 
Report to Congress that the IRS create a cash economy program office, 
similar to the Earned Income Tax Credit program office. The Board is 
pleased that the IRS Small Business/Self-Employed Operating Division 
Commissioner has agreed to establish a task force on the cash economy 
that will seek to determine the feasibility of this and other 
recommendations.
    In testimony before the Senate Budget Committee, the National 
Taxpayer Advocate further recommended that to address the tax gap ``we 
should begin by identifying various categories of transactions that 
currently are not subject to information reporting and determine, on a 
case-by-case basis, whether the benefits of requiring reporting 
outweigh the burdens such a requirement would impose.'' \11\ The Board 
supports such analysis.
---------------------------------------------------------------------------
    \11\ National Taxpayer Advocate, ``Testimony Before the Senate 
Budget Committee, Causes and Solutions to the Federal Tax Gap,'' 
February 15, 2006.
---------------------------------------------------------------------------
    Third, the Board believes that the IRS must improve customer 
service to make taxpayers aware of their legal obligations and ease 
taxpayer burden through modernization. Indeed, not all non-compliance 
is willful; a significant amount of is due to the complexity of the tax 
laws that results in errors. IRS Commissioner Mark Everson recently 
testified:

    ``[T]he tax gap does not arise solely from tax evasion or cheating. 
It includes a significant amount of noncompliance due to the complexity 
of the tax laws that results in errors of ignorance, confusion, and 
carelessness. This distinction is important, though, at this point, we 
do not have sufficiently good data to help us know how much arises from 
willfulness as opposed to innocent mistakes. This is an area where we 
expect future research to improve our understanding.'' \12\
---------------------------------------------------------------------------
    \12\ IRS Commissioner Mark Everson, Testimony Before the Senate 
Budget Committee, February 15, 2006.

    Fourth, there should be a much greater emphasis and focus on 
research so the IRS can more effectively target areas of major non-
compliance. It bears mentioning that a lack of research in the 1990's 
contributed in part to the IRS's failure to detect the emergence and 
subsequent epidemic of illegal tax avoidance schemes. The Board 
recommends an additional $60 million in funding for research. The IRS 
needs to know much more about non-compliance than it currently does to 
mount a successful campaign against the tax gap.
    Fifth, the Board urges a more productive partnership between IRS 
and the tax administration community. At the Board's 2006 open meeting, 
the AICPA supported the IRS's efforts to partner with professional 
organizations in the area of pro bono tax assistance, noting that such 
a synergy provides the IRS with the opportunity to leverage precious 
resources and increase customer service at the same time. The Board 
would add that such a partnership also contributes directly to 
compliance.
    Sixth, there must be more emphasis on personal integrity in making 
tax decisions. The Board has found that the vast majority of taxpayers 
state that their personal integrity is a very import factor in 
influencing their tax compliance. In the Board's most recent Taxpayer 
Attitude Survey, 82 percent of taxpayers cite personal integrity as the 
principal factor for reporting and paying their taxes honestly. 
Commissioner Everson also testified at the Senate Budget Committee tax 
gap hearing:

    ``[A]nother enforcement priority is to assure that attorneys, 
accountants, and other tax practitioners adhere to professional 
standards and follow the law. Our system of tax administration depends 
upon the integrity of practitioners. The vast majority of practitioners 
are conscientious and honest, but even the honest tax professionals 
suffered from the sad and steep erosion of ethics in recent years by 
being subjected to untoward competitive pressures.'' \13\
---------------------------------------------------------------------------
    \13\ Everson, op. cit.

    Our tax administration system should challenge taxpayers to be 
conscious of the need for integrity when making tax decisions.
    The Oversight Board recognizes that no single initiative or program 
will solve the tax gap--a multi-faceted effort must be taken to shrink 
it. The plan must be more comprehensive than just applying additional 
resources to do more of what is being done today. Indeed as 
Commissioner Everson told the Senate Budget Committee, a combination of 
appropriate funding, legislative changes, new enforcement tools, tax 
simplification and auditing and taxpayer service improvements, will 
allow the IRS to collect an additional $50 billion to $100 billion.\14\ 
The $705 million in additional funding recommended by Board to help in 
this effort is dwarfed in comparison to this estimate of new revenues 
collected.
---------------------------------------------------------------------------
    \14\ Tax Notes, ``Everson Says IRS Could Collect Up To $100 Billion 
More Per Year'', February 16, 2006.
---------------------------------------------------------------------------
     COMPARING THE PRESIDENT'S AND BOARD'S FISCAL YEAR 2007 BUDGET 
                            RECOMMENDATIONS

    The size of the tax gap should be a clarion call for our Nation to 
examine the tax administration system and invest time, energy, and 
resources to making it better.
    This is not the time to stand still but to move forward in a 
comprehensive and unified way to build on what has already been 
accomplished and give America's taxpayers a better, more efficient and 
fair system in return--what the President's tax reform panel suggested. 
The Oversight Board's fiscal year 2007 budget recommendations focus on 
the IRS resources needed to move forward in fiscal year 2007, but much 
more needs to be done.
    To this end, the Board recommends additional investments in better 
service, enforcement, infrastructure and management, and BSM in the 
following amounts:
  --Taxpayer Service--$43,637.
  --Enforcement--$367,768.
  --Infrastructure and Management--$104,715.
  --BSM--$188,600.
    Additionally, the Oversight Board has identified two areas of 
significant risk in the IRS's fiscal year 2007 budget request. First, 
the IRS budget justification includes $84.1 million in savings coming 
from program efficiencies. The Board is concerned that the IRS may not 
be able to achieve these efficiencies without decreasing performance.
    Second, the proposed IRS budget for fiscal year 2007 in direct 
appropriations is supplemented by $135 million in increased user fees. 
The IRS announced last December that it would charge taxpayers for 
receiving advance assurance from the IRS about the tax consequences of 
certain transactions. For example, the fee for IRS Chief Counsel 
private letter rulings will increase from $7,000 to $10,000.\15\
---------------------------------------------------------------------------
    \15\ IRS Press Release, ``IRS to Raise Some User Fees in 2006,'' 
IR-2005-144, December 19, 2005.
---------------------------------------------------------------------------
    The Oversight Board believes that there is risk in assuming that 
this revenue stream will be available without a proven record of 
collecting fees at this level, especially since the IRS could not 
present the Board with fiscal year 2006 data to confirm the realism of 
the proposed fiscal year 2007 revenue stream. The Board recommends that 
Congress evaluate actual fiscal year 2006 fee collection data to 
evaluate the validity of the proposed fiscal year 2007 revenue expected 
from increased fees.
    The Board is also concerned about the negative impact these fees 
might have on taxpayer compliance. Testifying at the Board's annual 
public meeting, the AICPA was also apprehensive that these increases 
will result in a substantial reduction in general taxpayer use of 
critical IRS programs:

    ``These programs for the most part encourage taxpayers to seek 
advance assurance from the IRS that the tax consequences of their 
proposed actions will be treated consistently by both the taxpayer and 
the IRS. Actions by the IRS that discourage use of programs, such as 
private letter ruling requests, could result in greater compliance 
costs for taxpayers and enforcement costs for the IRS.'' \16\
---------------------------------------------------------------------------
    \16\ AICPA, Statement Presented to the IRS Oversight Board, 
``Meeting the Customer Service Needs of Taxpayers and the Importance of 
Measures'', February 8, 2006.

Customer Service: What Is ``Good Enough?''
    Good customer service leads to fully informed and satisfied 
taxpayers who understand their tax obligations and experience few 
problems in interacting with the IRS. Clearly, there is a linkage 
between customer service and compliance. Speaking at the Board's 2006 
open meeting, Diana Leyden, Associate Clinical Professor of Law, 
University of Connecticut School of Law Tax Clinic said:

    ``Customer service at the Internal Revenue Service has a direct 
impact on voluntary compliance and ultimately on the tax gap. For 
example: (1) making it easier for taxpayers to get their returns 
prepared free of charge and quickly encourages taxpayers to become 
compliant; (2) providing face-to-face interaction with IRS employees 
helps taxpayers get advice in `real time' and usually reduces the time 
for resolution of problems.'' \17\
---------------------------------------------------------------------------
    \17\ Statement of Diana Leyden, Associate Clinical Professor of 
Law, University of Connecticut School of Law Tax Clinic Before the IRS 
Oversight Board, February 8, 2006.

    At the April 14, 2005 Senate Finance Committee hearing on closing 
---------------------------------------------------------------------------
the tax gap, Ranking Member Max Baucus similarly observed:

    ``The IRS cannot close the tax gap simply by increasing 
enforcement. Issuing more liens. Conducting more seizures. Levying more 
bank accounts. We do need targeted, appropriate enforcement. If, 
however, the IRS lets taxpayer service slide--if the IRS diminishes the 
access and accuracy of taxpayer service--including the essential need 
for face-to-face taxpayer service--then we fail to help taxpayers 
comply with the law on the front end. Ensuring up front quality is more 
efficient than back end enforcement.'' \18\
---------------------------------------------------------------------------
    \18\ Senator Max Baucus, Opening Statement, Senate Finance 
Committee, Hearing, April 14, 2005.

    However, efforts to provide quality customer service are hindered 
by the fact that there is no consensus among the tax administration 
community on desired customer service standards of performance, which 
makes informed decision-making about desired levels of service very 
difficult. Achieving such a consensus among the executive and 
legislative branches and external stakeholder organizations would allow 
customer service requirements to influence budget decisions rather than 
having budget decisions set service levels.
    The drive for improved customer service is further aggravated by 
the lack of data on the impact that service levels have on taxpayer 
compliance. Such data could be used to make a stronger case to policy 
makers about the importance of customer services. We should not retreat 
from the high customer service levels previously achieved during fiscal 
year 2003/2004. Two initiatives contained in the Board's budget are 
designed to prevent such a reduction.
    First, although significant progress has been made during the past 
5 years, toll-free telephone level of service is slightly down from 
fiscal year 2004 and call wait-time on hold has increased. To restore 
the level of service, the Oversight Board proposes an initiative to 
restore the toll-free telephone service to fiscal year 2003/2004 
levels. Although the cost is $35 million, the Board believes that this 
level of service should be provided to taxpayers. The potential impact 
of lower service is that taxpayers will not get the assistance they 
need, hurting compliance, and creating a need for additional 
enforcement. As Senator Baucus rightly observed, preventing problems is 
more cost-effective than the price of future corrections, such as 
collection.
    Second, the Board also recommends an $8.7 million investment in 
telephone infrastructure to expand services to callers and provide 
telephone representatives with a more state-of-the-art call center 
environment. The IRS predicts this investment would result in lower 
queue times across the enterprise for all applications and would 
counter a negative trend in telephone service. (Wait time on hold for 
taxpayers has been increasing in the last 3 years. It has gone from 158 
seconds in fiscal year 2004 to 258 seconds in fiscal year 2005, and the 
fiscal year 2006 target is 300 seconds.)
Enforcement Must Continue to Improve; More Research Needed
    As noted earlier in this report, the IRS has boosted its 
enforcement activity, and enforcement revenue has increased during the 
last 2 years. The IRS is working smarter and it needs to continue to 
improve and build on this important trend.
    However, it should be noted that despite these positive results, it 
is difficult to evaluate the impact that increased enforcement activity 
has had on overall taxpayer compliance.
    Absent this information, the Oversight Board still believes that 
one important element of the campaign to reduce the tax gap should be 
increasing IRS enforcement resources, especially since the application 
of additional resources has a positive return on investment. The Board 
recommends a modest increase in enforcement resources in virtually all 
IRS enforcement activities, including:
  --1. Combat Egregious Non-Compliance and Prevent Tax Gap Growth 
        (+$136 million).--Add 748 FTEs to enhance coverage of high-risk 
        compliance areas and address the tax gap associated with small 
        business and self-employed taxpayers.
  --2. Intensify Tax Enforcement (+$28 million).--Add 86 FTEs to 
        curtail non-compliance in abusive schemes, corporate fraud, 
        non-filers, employment tax and Bank Secrecy Act.
  --3. Attack Fraudulent Payments (+$27 million).--Add 62 FTEs to 
        address fraudulent payments made through the EITC program.
    The IRS must also do a better job of identifying where non-
compliance is occurring. For example, IRS data indicates impressive 
results on abusive, high-profile tax shelters, such as Son-of-BOSS. 
However, the most recent research indicates that a majority of the tax 
gap is the result of underreporting of income in areas where there is 
little third-party reporting.
    According to the IRS's National Research Program, half ($109 
billion) of the individual underreporting gap came from understated net 
business income (unreported receipts and overstated expenses). 
Approximately 28 percent ($56 billion) came from underreported non-
business income, such as wages, tips, interest, dividends, and capital 
gains. The remaining $32 billion came from overstated subtractions from 
income (i.e. statutory adjustments, deductions, and exemptions), and 
from overstated tax credits.
    Given this situation, the Oversight Board believes that special 
attention should be placed on the National Research Program and 
additional research be conducted on customer service and its relation 
to compliance. Indeed, the National Taxpayer Advocate ``recommends that 
the IRS undertake a research-driven needs-assessment, from the 
taxpayers' perspective, to help identify what services taxpayers need 
and want and how best to deliver them.'' \19\ These efforts are 
necessary to improve tax administration to the point where the effects 
of IRS activities on taxpayer compliance can be better understood. To 
this end, the Board proposes two research initiatives: (1) Improve Tax 
Gap Estimates (+$46 million); and (2) Additional Customer Service 
Research (+$15 million).
---------------------------------------------------------------------------
    \19\ The National Taxpayer Advocate, 2005 Annual Report to 
Congress, Executive Summary, p. I-1.
---------------------------------------------------------------------------
    The first of these two initiatives, Improve Tax Gap Estimates, will 
establish permanent staffing for the NRP program and put the IRS on a 
path to conducting research annually. The Oversight Board recommends 
that the NRP be made a permanent program. The NRP is now reporting 
estimates of the tax gap based on 2001 tax returns. Prior estimates 
were based on extrapolations of 1988 data. It is time to progress from 
``catching up'' to making current research the normal and preferred way 
of doing business.
    The Board also proposes that the IRS consider developing a long-
range strategic plan for research that goes beyond the current 2009 end 
date for the IRS Strategic Plan, and covers approximately a decade. In 
such a plan, the IRS should describe how it will bring its research on 
all taxpayer segments up to date, and perform a limited sample every 
year so that its research on all segments will be as current as 
possible.
    The Board believes the availability of up-to-date research data 
will allow the IRS to more effectively focus its service and 
enforcement programs on areas that have the greatest impact on taxpayer 
compliance, and use the changes in taxpayer compliance rates as 
feedback to evaluate the effectiveness of IRS's service and enforcement 
program on actual taxpayer compliance. Achieving such a capability will 
be a vast improvement over the current situation in which the lack of 
data makes it virtually impossible to evaluate the effectiveness of IRS 
activity on taxpayer compliance and make informed decisions.
    The second research initiative recommended by the Board is to add 
$15 million to begin research on the impact of customer service on 
voluntary compliance and the service needs of taxpayers. The need for 
such research is also consistent with recommendations made by Treasury 
Inspector General for Tax Administration and the National Taxpayer 
Advocate in testimony last year to the Senate Appropriations Committee 
on the closing of a number of Taxpayer Assistance Centers. (The 
committee has also requested TIGTA to evaluate the connection between 
service and compliance in its study of TAC closings, but TIGTA was 
unable to find much existing research.)
    However, the IRS has told the Oversight Board that it could extend 
and update research efforts in two major areas: evaluating the service 
needs of taxpayers and estimating the effect of customer service on 
taxpayer compliance. Additional resources in fiscal year 2007 would be 
used to further evaluate the service needs of taxpayers and to scope 
and design the data gathering and analysis capability to estimate the 
effect of customer service on taxpayer compliance.
    A modest initial effort should include identifying promising areas 
of research and determining data needs. If the initial efforts are 
promising, this could be expanded in future years. Due to the long-term 
nature of these studies, resources should be provided on a multi-year 
basis.
Modernizing Infrastructure and Management
    The Oversight Board is pleased that the IRS is developing an IRS 
Infrastructure Roadmap. It is a detailed plan for replacing the 
agency's aging IT equipment in an orderly and cost-effective manner. 
Rather than replacing outdated equipment on a one-for-one basis, the 
roadmap will identify and prioritize opportunities to consolidate 
equipment, retire redundant and low-demand infrastructure components, 
and replace old equipment with new technology that is cheaper to 
maintain and use. Because the IRS fully anticipates that the 
Infrastructure Roadmap will identify new strategies for IT 
infrastructure delivery that will mitigate the cost of replacing old IT 
equipment while assuring a sound IRS IT infrastructure, the Board is 
deferring any recommendations on modernizing IT infrastructure until 
fiscal year 2008.
    The Oversight Board does recommend funding infrastructure and 
management initiatives that will assist the IRS to cope with unfunded 
mandates, implement BSM projects, and restore its capacity for 
leadership development training to fiscal year 2003 levels:
  --1. Fund Business Unit IT Solutions (Non-Major Investments);
  --2. Implement e-Travel;
  --3. Fund HR Connect;
  --4. Consolidate Philadelphia Campus (included in the President's 
        budget); and,
  --5. Restoration of Leadership Development Training to fiscal year 
        2003 levels (Board-initiated).
    The Board notes that a lack of leadership training capacity at the 
IRS is especially critical during a period in which approximately 50 
percent of IRS managers are eligible for retirement. The Board 
recommends a consistent budget base to allow planning for these 
anticipated leadership development training needs.
    The requested funds would enable the IRS to: (1) eliminate the 
backlog of untrained leaders at all levels by the end of fiscal year 
2007; (2) ensure enough capacity to train new managers upon selection 
in all Business Units; (3) improve and expand readiness programs to 
provide a cadre of manager candidates to step up to management 
positions; (4) revise the management curriculum to incorporate more e-
learning and promote continuous learning; and (5) evaluate the 
effectiveness and impact of the leadership development training 
program.
    Funding Leadership Development Training at fiscal year 2003 levels 
will also assist in meeting the objectives of the President's 
Management Agenda, which in turn will improve performance and the IRS's 
objectives of enhanced employee engagement, employee satisfaction and 
customer satisfaction.
Business Systems Modernization
    The Board is pleased that the IRS's once-troubled BSM program 
experienced better performance in fiscal year 2005. In a recent report 
submitted to Congress on the BSM fiscal year 2006 expenditure plan, the 
Government Accountability Office offered these positive comments:

    ``IRS has made further progress in implementing BSM . . . Future 
BSM project deliveries face significant risks and issues which IRS is 
addressing . . . IRS has made additional progress in addressing high-
priority BSM program improvement initiatives. [They] appear to be an 
effective means of assessing, prioritizing, and addressing BSM issues 
and challenges . . . In response to our prior recommendations, IRS 
reports having efforts under way to develop a new Modernization Vision 
and Strategy to address a new modernization roadmap.\20\
---------------------------------------------------------------------------
    \20\ General Accountability Office, Report to Congress, ``Business 
Systems Modernization: Internal Revenue Service's fiscal year 2006 
Expenditure Plan,'' February 2006, GAO-06-360, pp. 2-3.

    GAO also had some criticism of the IRS and BSM, but improved 
management focus over the past few years has helped the BSM program 
deliver within cost and budget targets important technology projects 
that will generate greater efficiencies throughout the agency and real 
world benefits for taxpayers.
    The first taxpayers have already been moved to a modernized data 
base known as the Customer Account Data Engine (CADE) and corporate 
taxpayers are now able to file their income tax returns with the IRS 
electronically using the Modernized e-File system. Indeed, CADE will 
process more than 30 million returns in 2007 and will process 70 
million by 2009. Daily updates by CADE will allow taxpayers to receive 
their refund in just a few days.
    Future BSM deliverables are also critical to improved customer 
service and enforcement. The IRS does not yet offer products and 
services familiar to customers of many financial institutions, such as 
daily updating of accounts, electronic access by customers to account 
records, and a full range of electronic transactions. However, with the 
help of modern technology, the IRS can close this gap.
    If the IRS can continue to demonstrate improvement, it would seem 
desirable and logical to increase BSM's pace and program funding in 
fiscal year 2007, especially as BSM funding levels were severely 
reduced in the last several years: from $388 million in fiscal year 
2004 to $203 million in fiscal year 2005, and a requested $199 million 
in fiscal year 2006. In addition to the base, the Board would fund:
  --1. Web-based Self-service (+$24 million);
  --2. Filing and Payment Compliance (+$30 million);
  --3. Modernized e-Filing (+$70 million);
  --4. Customer Account Date Engine (+$25 million);
  --5. Core Infrastructure (+$18 million);
  --6. Architecture, Integration, and Management (+$13 million); and,
  --7. Management Reserve (+$9 million).
    Therefore, the Board recommends that the BSM program move forward 
at an accelerated pace. Not only will this allow the IRS to operate 
more efficiently and effectively, it will strengthen the agency's 
efforts to enforce the tax law and improve customer service. Despite 
productivity improvements in recent years, the IRS is still hampered in 
its efforts to modernize because of its reliance on a 40-year-old 
information system for its central recording-keeping functions, which 
limit the IRS to weekly updates of its central taxpayer records. No 
modern financial institution in the private sector could survive under 
these conditions, and eliminating these limitations is key to making 
the IRS an efficient and effective modern financial institution.
    We would like to make one last point on modernization. Both GAO and 
TIGTA have reported on the cost overruns and delays the BSM program has 
experienced. However, one cost you will not hear about is the 
significant cost to the taxpayers of delaying the benefits of a 
modernized IRS.
    Professor Joel Slemrod of the University of Michigan testified to 
the President's Advisory Panel on Federal Tax Reform that individual 
taxpayers spend approximately $85 billion a year complying with the tax 
code.\21\ If a modernized IRS makes taxpayers only 5 percent more 
efficient, that would still save taxpayers over $4 billion a year.
---------------------------------------------------------------------------
    \21\ Statement of Professor Joel Slemrod, University of Michigan 
Ross School of Business, before the President's Advisory Panel on 
Federal Tax Reform, March 3, 2005.
---------------------------------------------------------------------------
                               CONCLUSION

    The IRS Oversight Board believes that it has constructed a fiscally 
responsible and realistic budget for the IRS that meets national needs 
and priorities. It would help shrink the tax gap while providing 
taxpayers with a level of service they rightly deserve and need. It 
would speed the modernization of the IRS's antiquated technology and 
give it the research tools to better understand current and developing 
trends. Most importantly, it would maintain that delicate but critical 
balance between enforcement and customer service that America's 
taxpayers have said time and again they want. The IRS is now solidly on 
the right track and is making progress but we must give it the 
resources to do its job. It is an investment we must make for this and 
future generations of taxpayers.
    Appendices.--(1) Comparison of the Administration's IRS Fiscal Year 
2007 Budget Request and IRS Oversight Board Recommendation; (2) 
Recommended Fiscal Year 2007 Program Increases: Enforcement; (3) 
Recommended Fiscal Year 2007 Program Increases: Taxpayer Service; (4) 
Recommended Fiscal Year 2007 Program Increases: Infrastructure and 
Management Modernization; (5) Recommended Fiscal Year 2007 Program 
Increases: Business Systems Modernization; (6) Explanation for 
Difference in IRS Oversight Board Budget in the Administration's Fiscal 
Year 2007 Budget Request and This Recommendation.

                               APPENDIX 1

  COMPARISON OF THE ADMINISTRATION'S IRS FISCAL YEAR 2007 BUDGET REQUEST AND IRS OVERSIGHT BOARD RECOMMENDATION
                                             [Dollars in thousands]
----------------------------------------------------------------------------------------------------------------
                                                                                   President's
                      Final Board Budget                         Board's Budget       Budget        Difference
----------------------------------------------------------------------------------------------------------------
Fiscal Year 2006 Enacted Budget (with 1 percent rescission)...     $10,573,706      $10,573,706   ..............
Fiscal Year 2007 Maintaining Current Levels (MCLs) Adjustments
 (includes HITCA):
    Labor Annualization.......................................         $61,994          $61,994   ..............
    Labor MCL (2.7 percent)...................................        $149,819         $149,819   ..............
    Non-Labor MCL (1.5 percent)...............................         $60,418          $60,418   ..............
                                                               -------------------------------------------------
      Total MCL Adjustments...................................        $272,231         $272,231   ..............
                                                               =================================================
Base Reinvestment:
    Increase Returns processing efficiencies..................         $12,237          $12,237   ..............
Program Cost Savings:
    E-file savings............................................         ($6,760)         ($6,760)  ..............
    Improvement project savings...............................         ($8,215)         ($8,215)  ..............
    Competitive sourcing savings..............................        ($17,000)        ($17,000)  ..............
    Program efficiencies......................................        ($84,121)        ($84,121)  ..............
    HITCA program efficiency..................................         ($5,500)         ($5,500)  ..............
                                                               -------------------------------------------------
      Total Savings and Reinvestments.........................       ($121,596)       ($121,596)  ..............
                                                               =================================================
Transfer Out to TIGTA.........................................           ($941)           ($941)  ..............
                                                               -------------------------------------------------
      Total, Fiscal Year 2007 Current Service Level...........     $10,735,637      $10,735,637   ..............
                                                               =================================================
Program Increases:
    Tax Administration Operations:
        Taxpayer Service......................................         $43,637   ...............         $43,637
        Enforcement...........................................        $367,768   ...............        $367,768
        Infrastructure and Mgt Modernization..................        $104,715          $20,900          $83,815
    Business Systems Modernization............................        $188,600         ($29,700)        $218,300
                                                               -------------------------------------------------
      Total, Program Increases Above Fiscal Year 2006 Current         $704,720          ($8,800)        $713,520
       Service Level..........................................
                                                               =================================================
      Total, Fiscal Year 2007 Operating Level.................     $11,440,357      $10,726,837         $713,520
                                                               =================================================
Fee Adjustment................................................       ($135,000)       ($135,000)  ..............
Fiscal Year 2007 Budget Appropriation Request.................     $11,305,357      $10,591,837         $713,520
Growth Over Fiscal Year 2006 Enacted Budget...................        $731,651          $18,131         $713,520
Percent Growth................................................             6.9              0.2   ..............
----------------------------------------------------------------------------------------------------------------

                               APPENDIX 2

                           RECOMMENDED FISCAL YEAR 2007 PROGRAM INCREASES: ENFORCEMENT
                                            [In thousands of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                   Enforcement-      Service-
                  Enforcement Program Increases                        Total          Related         Related
----------------------------------------------------------------------------------------------------------------
Combat Egregious Non-Compliance and Prevent Tax Gap Growth.--            135,518         132,696           2,822
 This initiative provides an increase of 748 FTE and $135.5
 million to enhance coverage of high-risk compliance areas as
 well as address the tax gap associated with small business and
 self-employed taxpayers........................................
Increase Individual Taxpayer Filing and Payment Compliance.--The           7,773           6,968             805
 initiative provides 84 FTE (87 positions) and $8 million to
 support the IRS's enforcement presence through contracts with
 Private Collection Agencies (PCAs) for Qualified Tax Collection
 Contracts......................................................
Detect and Deter Non-Compliant Enterprise Structures.--This               37,008          37,008  ..............
 initiative provides an increase of 200 FTE (400 positions) and
 $37 million to increase the coverage of the flow-through
 population, including examination of controlling enterprise
 entities, that are posing significant compliance risks.........
Increase Individual Taxpayer Reporting Compliance.--This                  10,821           8,808           2,013
 initiative provides an increase of 100 FTE (125 positions) and
 $10.8 million to enable the Automated Underreporter (AUR)
 program to address reporting compliance in a program that is
 effective, efficient, less labor intensive and less costly.....
Enhance Enforcement in the Tax-Exempt and Governmental Sectors.--         12,941          12,941  ..............
 This initiative requests an additional 69 FTE (138 positions)
 and $12,940,668 to improve detection of compliance risks,
 accelerate enforcement actions, and balance the pursuit of
 critical enforcement initiatives while maintaining adequate
 coverage of the exempt  community..............................
Intensify Tax Enforcement.--This initiative requests an increase          27,570          27,570  ..............
 of 86 FTE (172 positions) and $27.6 million to curtail non-
 compliance in the following areas: abusive schemes, corporate
 fraud, non-filers, employment tax and Bank Secrecy Act (BSA)...
Attack Fraudulent Payments.--This initiative, which provides an           26,998          26,837             161
 increase of 62 FTE (123 positions) and $27 million, relates
 directly to the President's Management Agenda Program
 Initiative ``Eliminating Improper Payments,'' and also supports
 the IRS's strategies for addressing erroneous payments and non-
 compliance involving Earned Income Tax Credits (EITC)..........
Improve Compliance With the Bank Secrecy and PATRIOT Acts.--This          25,858          25,858  ..............
 initiative provides an increase of 124 FTE (248 positions) and
 $25.9 million to improve the Bank Secrecy Act (BSA) compliance
 program........................................................
Strengthen Regulatory Compliance.--This initiative provides an             6,616           6,376             241
 increase of 38 FTE (76 positions) and $6.6 million to
 strengthen regulatory compliance activities to deter fraud,
 abuse, and terrorist financing in the tax exempt and
 governmental entities community................................
Improve Enforcement of Circular 230.--This initiative provides             4,104           4,104  ..............
 an increase of 8 FTE (16 positions) and $4.1 million to detect
 and address tax practitioner misconduct. The IRS, Treasury, and
 Congress are placing increased emphasis on practitioner
 misconduct by providing new statutory and regulatory tools to
 address abusive behavior.......................................
Improve Tax Gap Estimates, Measurement and Detection of Non-              45,942          45,942  ..............
 Compliance.--Supports 268 FTE (536 positions) and $45.9 million
 to fund and support ongoing Reporting Compliance Studies
 through the National Research Program..........................
Study EITC Compliance.--This initiative provides an increase of            6,822           6,822  ..............
 49 FTE (65 positions) and $6.8 million to develop estimates of
 Earned Income Tax Credit compliance............................
Improve Compliance Through Data-Driven Workload Identification.--          4,796  ..............           4,796
 This initiative provides an increase of 67.5 FTE (90 positions)
 and $4.8 million to develop and test decision analytical tools
 and models for improved identification of high-risk filers.....
Customer Service Research.--Begin research on the impact of               15,000          15,000  ..............
 customer service on voluntary compliance and the service needs
 of taxpayers...................................................
                                                                 -----------------------------------------------
      Subtotal Enforcement......................................         367,768         356,931          10,837
----------------------------------------------------------------------------------------------------------------

                               APPENDIX 3

                        RECOMMENDED FISCAL YEAR 2007 PROGRAM INCREASES: TAXPAYER SERVICE
                                            [In thousands of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                   Enforcement-      Service-
               Taxpayer Service Program Increases                      Total          Related         Related
----------------------------------------------------------------------------------------------------------------
Increase Accounts Management Efficiencies.--Provides funding to            8,657  ..............           8,657
 improve the telephone infrastructure, e.g., Compliance Services
 and Accounts Management call centers, by expanding services to
 customers and providing telephone representatives with a more
 state-of-the-art center environment and providing taxpayers
 with improved service through multiple access channels.
 Enterprise queuing will eliminate the queuing of calls at the
 local level and be queued at the enterprise level, reducing
 taxpayer wait times............................................
Restore Customer Service to Fiscal Year 2004 Levels.--Supports            34,980  ..............          34,980
 450 FTE from W&I to restore telephone level of service back to
 87.3 percent achieved in fiscal year 2004 rather than the
 current 82 percent target. Improves TE/GE service measures for
 EP and EO determination timeliness, CAS toll-free level of
 service, correspondence timeliness measures to fiscal year 2004
 levels.........................................................
                                                                 -----------------------------------------------
      Subtotal: Taxpayer Service................................          43,647  ..............          43,647
----------------------------------------------------------------------------------------------------------------

                               APPENDIX 4

           RECOMMENDED FISCAL YEAR 2007 PROGRAM INCREASES: INFRASTRUCTURE AND MANAGEMENT MODERNIZATION
                                            [In thousands of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                   Enforcement-      Service-
     Infrastructure and Mgt Modernization Program Increases            Total          Related         Related
----------------------------------------------------------------------------------------------------------------
Expand IT Security--Personal Identity Verification.--This                 20,000          12,576           7,424
 initiative requests an increase of $20 million to ensure IRS's
 compliance with Homeland Security Policy Directive-12 (HSPD-12)
 and Federal Information Processing Standards-201 (FIPS-201)....
Close Financial Management Material Weaknesses--Custodial Detail           4,743           2,982           1,761
 Data Base.--This initiative provides $4.7 million to develop
 the CFO Custodial Detail Data Base (CDDB) which will establish
 the foundation for building an IRS-modernized custodial
 financial management system....................................
Fund Modernization Information Systems (Major Investments) O&M.--         15,000           9,432           5,568
 This initiative will result in modernized information systems
 to improve enforcement activities..............................
Fund Business Unit IT Solutions (Non-Major Investments) O&M.--             9,972           7,121           2,851
 This initiative provides an increase of $15 million for the
 successful transition of Business Systems Modernization (BSM)
 projects to the Current Production Environment (CPE), funding
 their operations and maintenance as they move to full
 production.....................................................
Implement e-Travel.--Treasury has mandated that IRS must                  10,000           6,288           3,712
 implement e-Travel by October 1, 2006..........................
Fund HR Connect.--The initiative requests $11.9 million in                11,900           7,482           4,418
 fiscal year 2007 to fully fund the additional Operations and
 Maintenance cost associated with the HR Connect system that the
 IRS has implemented and is billed through the Treasury's
 Working Capital Fund...........................................
Consolidate Philadelphia Campus.................................          20,900          14,215           6,685
Restoration of Leadership Training to Fiscal Year 2003 Levels.--          12,200           7,564           4,636
 The requested funds would enable the IRS to: (1) eliminate the
 backlog of untrained leaders at all levels by the end of fiscal
 year 2007; (2) ensure enough capacity to train new managers
 upon selection in all Business Units; (3) improve and expand
 readiness programs to provide a cadre of manager candidates to
 step in to management positions; (4) revise the management
 curriculum to incorporate more e-learning and promote
 continuous learning; and (5) evaluate the effectiveness and
 impact of the leadership training program......................
                                                                 -----------------------------------------------
      Subtotal Modernization....................................         104,715          67,660          37,055
----------------------------------------------------------------------------------------------------------------

                               appendix 5

    RECOMMENDED FISCAL YEAR 2007 PROGRAM INCREASES: BUSINESS SYSTEMS
                              MODERNIZATION
                        [In thousands of dollars]
------------------------------------------------------------------------
    Business Systems Modernization Program Increases           Total
------------------------------------------------------------------------
Web-based Self Service.--Identify and design initial set          24,200
 of internet self-service applications..................
Filing & Payment Compliance (F&PC).--Completes delivery           30,000
 of full capability needed to support Private Collection
 Agencies...............................................
Modernized e-file (MeF).--Funds development, testing and          70,200
 deployment of modernized electronic filing for Form
 1040...................................................
Customer Account Data Engine (CADE).--Process 33 million          25,000
 returns for the fiscal year 2007 filing season.........
Core Infrastructure Projects.--Improve the facilities             17,900
 which allow pre-deployment testing and integration of
 modernized systems, which help ensure modernized
 systems will operate as needed when they are deployed..
Architecture, Integration & Management.--Ongoing support          12,800
 and improvements to BSM's program with planning,
 engineering, and management activities.................
Management Reserve......................................           8,500
                                                         ---------------
      Subtotal BSM......................................         188,600
------------------------------------------------------------------------

                               APPENDIX 6

    EXPLANATION FOR DIFFERENCE IN IRS OVERSIGHT BOARD BUDGET IN THE 
       ADMINISTRATION'S FISCAL YEAR 2007 BUDGET REQUEST AND THIS 
                             RECOMMENDATION

    After the Board-approved budget is submitted to the Department of 
Treasury, it is reviewed and modified by both the Treasury Department 
and the Office of Management and Budget (OMB) before being incorporated 
into the President's budget. During the first several years of IRS 
Oversight Board operation, the Treasury Department would inform the 
Oversight Board of changes as the IRS budget progressed through the 
formulation process. However, for the past 2 years, the Treasury 
Department has taken the position that although RRA98 provides the 
Oversight Board with the responsibility of reviewing and approving the 
budget request prepared by the Commissioner and submitted to the 
Department of the Treasury, this authority does not include 
participating in subsequent budget decision adjustments and formulation 
of the President's Budget.
    Consequently, changes in IRS requirements that occur after the 
Board approves the IRS budget are not provided to the Board, and can 
only be considered by the Board when the President's budget is made 
available to the public. The Board adjusted its previously approved 
budget to account for the following circumstances:
  --The Board's initial fiscal year 2007 budget was based on the fiscal 
        year 2006 President's request, not the enacted appropriation, 
        and is adjusted to use the fiscal year 2005 enacted level as 
        the base.
  --The inflation factors for labor and non-pay inflation were not 
        known to the Board when it first approved the IRS budget, and 
        are adjusted to reflect the lower base as well as changes in 
        rates.
  --The IRS budget submitted to the Board identified approximately $15 
        million in savings, which the Board approved. During subsequent 
        reviews with the Treasury Department and OMB, the IRS 
        identified an additional $106 million in savings, for a total 
        savings of $121 million. The Board's budget is adjusted to 
        reflect these additional savings, despite the Board's 
        assessment that they may represent some risk.
  --The IRS budget submitted to the Board did not identify any fee 
        offsets, which were not yet authorized by Congress. The Board's 
        budget is adjusted to reflect these offsets.
  --The budget is adjusted to reflect the development of an IRS 
        Infrastructure Blueprint to define a cost-effective approach to 
        meeting IRS infrastructure needs and the elimination of the 
        need to fund Kansas City growth in fiscal year 2007.

                     STATEMENT OF J. RUSSELL GEORGE

    Senator Bond. Thank you very much, Chairman Wagner.
    Now we turn to Treasury Inspector General for Tax 
Administration, or TIGTA, Mr. Russell George.
    Mr. George. Thank you, Mr. Chairman.
    Mr. Chairman, Ranking Member Murray, thank you for the 
opportunity to testify today regarding the 2007 appropriations 
for the Internal Revenue Service. Just over a year ago, I 
testified before you on the IRS's 2006 appropriations. 
Unfortunately, many of the challenges I discussed last year 
remain today.
    At the outset, I am pleased to report that our reviews thus 
far have shown that the IRS has done a very good job responding 
to taxpayers affected by Hurricanes Katrina and Rita. Still, I 
remain concerned about the potential for fraudulent claims 
resulting from the response to those disasters. TIGTA will 
continue to monitor this effort.
    I agree with the Commissioner's motto for customer service 
plus enforcement resulting in greater taxpayer compliance. 
Given its limited resources, the IRS is attempting to find the 
proper balance between these two important goals. The IRS 
proposed curtailing some levels of service, including closing 
68 of its 400 taxpayer assistance service centers and reducing 
the hours of its toll-free telephone service from 15 hours a 
day to 12.
    TIGTA is required to review these plans before they are 
implemented. We have examined the proposed TAC closures and 
concluded that the IRS did not have sufficient or reliable data 
to determine the effects of the proposed closures on taxpayers. 
One of our concerns about closures is that more taxpayers need 
to rely on the IRS's volunteer income tax assistance programs, 
which has significant problems in providing taxpayers with 
accurate answers. During the 2006 filing season, TIGTA made 
anonymous visits to both TACs and VITA sites to determine if 
taxpayers are receiving accurate assistance preparing their tax 
returns. We found that VITA volunteers accurately prepared tax 
returns at only 39 percent of the scenarios TIGTA presented to 
them, which was a slight improvement over last year's accuracy 
rate of 34 percent.
    TIGTA also visited 50 Taxpayer Assistance Centers and posed 
200 questions to determine if taxpayers received correct 
answers to their questions. TAC assisters correctly answered 73 
percent of the questions we presented compared to 66 percent 
during the 2005 filing season. We visited another 20 TACs and 
posed 80 tax law questions specifically related to the Katrina 
Emergency Tax Relief Act. Assisters answered 75 percent of 
those questions correctly.
    We are currently assessing the IRS's plans to reduce the 
operating hours of its toll-free telephone service. Thus far, 
we have found that the average speed of answering calls to this 
line is about 60 percent of the time that had been planned by 
the IRS.
    Commendably, the IRS has seen a steady growth in the 
electronic filing of income tax run returns over the last 3 
years. While the IRS may not meet its mandated goal of having 
80 percent of all tax returns E-filed by 2007, it has done a 
laudable job of providing helpful information on the internet 
and is anticipating that 54 percent of filed returns will be 
filed electronically this year; however, I am concerned that 
more taxpayers are not using the E-file services offered by the 
IRS. This year, the number of taxpayers E-filing from their 
home computers rose by just over 16 percent at the same time 
the number of taxpayers taking advantage of free online filing 
has fallen by 22 percent.
    This drop may be the result of a change in the ``Free 
File'' agreement between the IRS and the Free File Alliance, a 
consortium of private sector companies that provide preparation 
software and transmit tax returns pursuant to the agreement. 
Although the intent of the program was to provide a free method 
of E-filing to taxpayers, the IRS and the Alliance amended the 
agreement. This year, the agreement allowed only taxpayers with 
adjusted gross incomes of $55,000 or less to use the service.
    In addition, the IRS eliminated its telefile program for 
individual taxpayers in August 2005. This program allowed 
taxpayers the simplest tax returns, such as Form 1040EZ, to 
file by telephone. The alternative filing methods for these 
taxpayers included using Taxpayer Assistance Centers and VITA 
sites. They could also use a free-file program if they 
qualified, among other options. It appears, however, that many 
taxpayers who previously used the telefile system reverted to 
using paper tax returns.
    We have also found that the IRS is attempting to address 
its major challenges; however, much more is required on its 
part. For example, while the IRS is making progress with the 
Business Systems Modernization program, BSM remains behind 
schedule, overbudget, and is not delivering all of the 
functionalities that were promised. In TIGTA's initial review 
of the IRS's plan to use private debt collectors, we found that 
the IRS has taken positive steps to implement certain aspects 
of the program. TIGTA is working closely with the IRS to 
address security concerns, the protection of taxpayers' rights 
and privacy, and the development of integrity and fraud 
awareness training for contract employees.
    The last issue I will address is the tax gap, which the IRS 
has estimated at approximately $345 million. TIGTA has 
evaluated the reliability of the IRS-developed tax gap figure, 
and in a report released just on Tuesday, we think concluded 
that the IRS still does not have sufficient information to 
accurately assess the overall tax gap and voluntary compliance 
rate. The IRS has significant challenges in attaining complete 
and timely data and in developing the methods for interpreting 
that data. We urge the Commissioner to continue this effort and 
have provided recommendations toward obtaining a more accurate 
assessment of this important measurement.

                           PREPARED STATEMENT

    Mr. Chairman, Ranking Member Murray, Senator Durbin, I hope 
my discussion of the 2006 filing season and some of the 
significant challenges facing the IRS will assist you with your 
consideration of the budget, appropriations rather. Mr. 
Chairman and the subcommittee, thank you for allowing me to 
share my views. I will accept your questions 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 2007 appropriations for the Internal Revenue 
Service (IRS). It was just over 1 year ago that I appeared before you 
to testify on the IRS's fiscal year 2006 appropriations. Since my prior 
testimony, significant events have affected tax administration 
including Hurricanes Katrina and Rita, which impacted thousands of 
taxpayers and required rapid responses from many departments and 
agencies, including the IRS.
    When I testified before the subcommittee last year, I had only 
served as the Treasury Inspector General for Tax Administration (TIGTA) 
for a few short months. As I testify before the subcommittee today, I 
have been the TIGTA for 17 months. My four priorities as the TIGTA are 
to maintain our focus on IRS efforts to modernize its technology, 
enhance our ability to protect tax administration from corruption, 
assist the IRS with improving tax compliance initiatives, and monitor 
the IRS's use of private debt collection agencies. As the TIGTA, my 
observations are primarily based on the body of work my organization 
has developed through audits and investigations of the IRS. To assist 
you in your consideration of the IRS's fiscal year 2007 budget, I will 
focus on the 2006 Filing Season, electronic filing, the tax gap, 
customer service, the IRS's Private Debt Collection initiative and 
other major challenges facing the IRS.

                         THE 2006 FILING SEASON

Preparing for the Filing Season
    Planning for the 2006 Filing Season was difficult for the IRS 
because of many tax law changes enacted late last year in response to 
unprecedented natural disasters. Disaster relief provisions were 
enacted into law for taxpayers affected by Hurricanes Katrina, Rita, 
and Wilma, and were intended to provide relief to over 11 million 
taxpayers who lived in the affected areas of the Gulf Coast, as well as 
to others who may have been adversely impacted by these storms.
    This year, TIGTA reviewed 28 new tax law provisions and is also 
closely monitoring the implemented changes that are intended to assist 
taxpayers adversely affected by the 2005 hurricanes. New tax law 
provisions were included in the Katrina Emergency Tax Relief Act of 
2005,\1\ the Gulf Opportunity Zone Act of 2005,\2\ and also in the 
Working Families Tax Relief Act of 2004 \3\ and the American Jobs 
Creation Act of 2004,\4\ all of which became effective in 2005. The 
latest legislation, the Gulf Opportunity Zone Act of 2005, was signed 
into law on December 21, 2005.
---------------------------------------------------------------------------
    \1\ Public Law No. 109-73, 119 Stat. 2016 (to be codified in 
scattered sections of 26 U.S.C.).
    \2\ Public Law No. 109-135, 199 Stat. 2577 (2005).
    \3\ Public Law No. 108-311, 118 Stat. 1166 (2004).
    \4\ Public Law No. 108-357, 118 Stat. 1418 (2004).
---------------------------------------------------------------------------
    TIGTA reviewed the IRS's preparation for the 2006 Filing Season and 
determined that the IRS accurately updated its tax products and 
computer programming to incorporate the tax law changes that became 
effective in 2005. TIGTA reviewed 42 tax forms, publications, and 
instructions that required updating, and determined that they were 
accurately updated. The IRS also accurately updated its computer 
programming and returns processing programs for the new tax law 
provisions and other adjustments or changes.\5\ TIGTA is continuing to 
monitor the IRS's processing of income tax returns during the 2006 
Filing Season and will report its results later this year.
---------------------------------------------------------------------------
    \5\ Draft Report ``Tax Products and Computer Programs for 
Individual Income Tax Returns Were Accurately Updated for the 2006 
Filing Season'' (Audit No. 200640015, date April 24, 2006).
---------------------------------------------------------------------------
    While planning for the 2006 Filing Season, the IRS considered the 
impact of Hurricanes Katrina and Rita. Specifically, the IRS accounted 
for all employees affected by the hurricanes and located alternate 
office space in affected areas. All Taxpayer Assistance Centers (TAC) 
in impacted areas were open and operational for the 2006 Filing Season. 
The IRS also added services to help lessen taxpayer burden, including 
tax return preparation for taxpayers affected by the hurricanes 
regardless of the income guidelines. Additionally, the scope of tax law 
topics in which assistors are trained was expanded to provide 
assistance to taxpayers with questions about casualty losses. 
Furthermore, the IRS will treat taxpayers affected by Hurricanes 
Katrina and Rita as meeting extreme hardship criteria. That designation 
allows affected taxpayers to request and immediately receive 
transcripts of prior year tax returns instead of having to order them 
and wait for delivery.

Processing Tax Returns

    During the 2006 Filing Season, the IRS expected to process an 
estimated 135 million individual returns. So far, TIGTA has not 
identified any significant problems with the IRS's processing of 
individual tax returns. As of April 8, 2006, the IRS has received over 
87.7 million returns. Of those, 57.7 million were filed electronically 
(an increase of 3.5 percent from this time last year), and 29.9 million 
were filed on paper (a decrease of 7.1 percent from 2005). 
Additionally, $164.5 billion in refunds have been timely issued. Of 
this amount, $124.3 billion were directly deposited to taxpayer bank 
accounts, an increase of 9.3 percent compared to last year.
Providing Quality Customer Service
    While the IRS continues to face longstanding challenges, it 
deserves recognition for making progress in an area that will always be 
a challenge: providing quality customer service to the American 
taxpayer. Providing quality customer service is the first component of 
Commissioner Everson's principle for the IRS, 
Service+Enforcement=Compliance. Over the past few years, TIGTA audits 
have shown that the IRS has improved customer assistance in its face-
to-face, toll-free telephone, tax return processing, and electronic 
services, including the IRS public Internet site (www.IRS.gov).
    Furthermore, it is encouraging to note that the IRS took numerous 
actions to provide broad relief to taxpayers affected by Hurricanes 
Katrina and Rita. These broad relief efforts included postponing 
deadlines for filing and payment, providing relief from interest and 
penalties, and waiving some low-income housing tax credit rules. The 
IRS also waived the usual fees and expedited requests for copies of 
previously filed tax returns for affected taxpayers that need them to 
apply for benefits or file amended tax returns to claim casualty 
losses.\6\
---------------------------------------------------------------------------
    \6\ ``Planning for the 2006 Filing Season Is on Course, but 
Challenges Exist for the Toll-Free Telephone Operations'' (Reference 
No. 2006-40-053, dated February 2006).
---------------------------------------------------------------------------
    IRS employees also provided tax assistance at Federal Emergency 
Management Agency (FEMA) Disaster Assistance Sites in a number of 
locations. Additionally, the IRS assigned 5,000 employees to augment 
Federal Government telephone call sites and provided additional 
employees to assist in approximately 34 FEMA disaster recovery centers 
in 13 States.
            IRS.gov
    IRS.gov continues to be one of the most visited Internet sites in 
the world, especially during filing seasons. As of the week ending 
April 8, 2006, the IRS reported a 6.46 percent increase in the number 
of visits to IRS.gov over the same period during the last filing 
season. The IRS now provides practitioners with online tools to provide 
better service to their customers, such as electronic account 
resolution, transcript delivery, and disclosure authorization. As of 
the week ending April 8, 2006, the IRS also reported a 17.02 percent 
increase in taxpayers obtaining their refund information online via the 
``Where's My Refund'' option found on the Internet site.
            Toll-Free Telephone Operations
    The 2006 Filing Season presented unique challenges for the IRS 
toll-free operations. The IRS had also planned to reduce the hours of 
its toll-free telephone operation in fiscal year 2006. The IRS had 
about 400 fewer Full-Time Equivalents \7\ for toll-free telephone 
operations than it had in fiscal year 2005 because of plans to reduce 
operating hours from 15 to 12 per day. Congress, the Taxpayer Advocate 
and the National Treasury Employees Union expressed concerns about the 
IRS reducing operating hours for the toll-free telephone lines. A new 
law enacted in November 2005 requires the IRS to consult with 
stakeholder organizations, including TIGTA, regarding any proposed or 
planned efforts to terminate or significantly reduce any taxpayer 
service activity.\8\ Congress recently further defined a reduction of 
taxpayer service to include limiting available hours of telephone 
taxpayer assistance on a daily, weekly, and monthly basis below the 
levels in existence during the month of October 2005. TIGTA is 
currently assessing the IRS's plans to reduce operating hours and will 
report its results later this year.
---------------------------------------------------------------------------
    \7\ A measure of labor hours in which 1 Full-Time Equivalent is 
equal to 8 hours multiplied by the number of compensable days in a 
particular fiscal year. For fiscal year 2005, 1 Full-Time Equivalent 
was equal to 2,088 hours.
    \8\ The Transportation, Treasury, Housing and Urban Development, 
the Judiciary, the District of Columbia, and Independent Agencies 
Appropriations Act, Public Law No. 109-115, 119 Stat. 2396 (2006).
---------------------------------------------------------------------------
    As of April 8, 2006, assistor level of service had not been 
negatively impacted, with an IRS-reported level of service rate of 83.8 
percent.\9\ In addition, about 6.49 percent fewer assistor calls were 
answered, but the number of taxpayers who hung up prior to reaching an 
IRS assistor was up 10.9 percent. The average speed of answer was about 
66 percent of the time planned, so those taxpayers who called and spoke 
with an assistor did not experience longer wait times.
---------------------------------------------------------------------------
    \9\ Level of Service is the primary measure of providing service to 
taxpayers. It is the relative success rate of taxpayers that call for 
services on the IRS's toll-free telephone lines.
---------------------------------------------------------------------------
    In planning for fiscal year 2006, IRS management expected fewer 
calls program-wide, even after taking into consideration taxpayers 
affected by Hurricanes Katrina and Rita. IRS management believed that 
most taxpayers needing disaster relief assistance obtained it during 
the latter part of 2005. Prior to the start of the filing season, TIGTA 
brought to IRS management's attention our concern that more taxpayers 
than expected could call the help line with questions due to the 
effects of Hurricanes Katrina and Rita.
    After we shared this concern, IRS management raised the estimated 
volume of services to these telephone lines by about 78,000 services, 
from approximately 27,000 to about 105,000. The estimate is for 
services from January through June 2006, a 365.1 percent increase over 
the total fiscal year 2005 services provided on those telephone 
lines.\10\ For the 2006 Filing Season it appears that the calls to 
these telephone lines were higher than anticipated. For example, the 
IRS had planned 77,235 services for one of its applications devoted to 
assisting disaster victims; however, through April 8, 2006, the IRS has 
already provided 136,552 services.
---------------------------------------------------------------------------
    \10\ A service is defined when a call is answered by an assistor. 
When the assistor answers the caller's question, a service is provided. 
If the same caller has an additional question or issue and is 
transferred to another area or assistor, an additional service is 
provided.
---------------------------------------------------------------------------
            Taxpayer Assistance Centers
                2006 Filing Season Services
    The TACs are walk-in sites where taxpayers can receive answers to 
both account and tax law questions, as well as receive assistance 
preparing their returns. The IRS acknowledged that staffing would be a 
challenge during the 2006 Filing Season since not all TACs would be 
fully staffed and not all TACs would provide standard services or 
standard hours of operation (from 8:30 a.m. to 4:30 p.m., Monday 
through Friday). As of December 1, 2005, the IRS identified 47 TACs 
with critical staffing shortages (a critical vacancy is one that must 
be filled to ensure that a TAC remains open).
    The IRS took actions to minimize the impact of the staffing 
shortages. As of January 31, 2006, the IRS had hired additional 
frontline technical employees, recalled intermittent employees back to 
work, detailed former TAC employees from their current positions in 
other IRS functions back to the TACs, and made plans to have some 
employees travel between TACs to ensure that all TACs remained open 
daily. The IRS's decision to focus more resources on compliance 
activities, however, further limited resources available for the TAC 
Program. As a result, the IRS limited some assistance services and not 
all TACs were open during standard operating hours. As of the week 
ending April 8, 2006, the IRS reported a 12.5 percent reduction in TAC 
contacts with taxpayers.
    Although the IRS publicized when TAC operating hours were limited, 
it did not publicize when TACs would only provide limited services. 
When notified by TIGTA, the IRS implemented changes and standardized 
the list of services offered at each TAC. Furthermore, the IRS modified 
its Internet site, IRS.gov, to indicate when TACs would provide limited 
services.
    TIGTA made anonymous visits to 50 TACs and asked 200 questions to 
determine if taxpayers received quality service, including correct 
answers to their questions. Assistors correctly answered 73 percent of 
the questions compared to 66 percent during the 2005 Filing Season. 
TIGTA visited an additional 20 TACs and asked 80 tax law questions 
specifically related to the Katrina Emergency Tax Relief Act of 2005. 
Assistors answered 75 percent of those questions correctly. IRS 
assistors should have been trained to answer these questions. TIGTA's 
observations were that assistors sometimes inappropriately referred 
taxpayers to publications to conduct their own research, or responded 
to tax law questions without following required procedures, such as 
using the publication method guide that requires them to ask probing 
questions.
                Closure
    Over the past few years, customer service at TACs has shown 
improvement. In May 2005, the IRS announced plans to close 68 of its 
TACs nationwide. Closing the 68 TACs was expected to yield staffing and 
facilities cost savings of $45 million to $55 million. After the IRS's 
closure announcement, Congress enacted legislation to delay the closure 
of any TACs.\11\ The IRS is prohibited from using funds provided in the 
fiscal year 2006 budget appropriation to reduce any taxpayer service 
function or program until TIGTA completes a study detailing the effect 
of the IRS's plans to reduce services relating to taxpayer compliance 
and taxpayer assistance. TIGTA completed its study in March.
---------------------------------------------------------------------------
    \11\ Transportation, Treasury, Housing and Urban Development, the 
Judiciary, the District of Columbia, and Independent Agencies 
Appropriations Act, 2006, Public Law No. 109-115, 119 Stat. 2396 
(2005).
---------------------------------------------------------------------------
    TIGTA reviewed \12\ the IRS's TAC Closure Model and data used to 
select the 68 centers scheduled for closure and identified that 
although the structure of the Model was sound, not all data used were 
accurate or the most current available, and some of the data were based 
on estimates and projections instead of actual available data. Data 
discrepancies affected the scores the Model calculated for each TAC 
and, ultimately, the ranking and overall selection of centers for 
closure. In addition, data discrepancies affected the IRS's ability to 
accurately determine cost savings. The IRS should ensure that data used 
in any decision-making tool are accurate and reliable before using 
them. For the TAC Program, the IRS should include data to identify 
customer characteristics and capture customer input to effectively 
measure the impact any changes might have on taxpayer service or 
compliance.
---------------------------------------------------------------------------
    \12\ ``The Taxpayer Assistance Center Closure Plan Was Based on 
Inaccurate Data'' (Reference Number 2006-40-061, dated March 2006).
---------------------------------------------------------------------------
    I am concerned that the IRS does not sufficiently ensure that it 
uses adequate and reliable data for making decisions that impact 
customer service operations. The decision to close TACs was based 
primarily on input from IRS functional areas and considered other 
factors that included internal priorities, resource demands, and shifts 
in the IRS's customer service perspective. However, data were not 
obtained from taxpayers who use these services to determine the impact 
of removing or reducing them.
            Volunteer Income Tax Assistance (VITA) Program
    The VITA Program plays an increasingly important role in IRS's 
efforts to improve taxpayer service and facilitate participation in the 
tax system. The VITA Program provides no-cost Federal tax return 
preparation and electronic filing to underserved taxpayer segments, 
including low income, elderly, disabled, and limited-English-proficient 
taxpayers. These taxpayers are frequently involved in complex family 
situations that make it difficult to correctly understand and apply tax 
law.
    TIGTA visited VITA sites to determine if taxpayers received quality 
service, including the accurate preparation of their individual income 
tax returns. TIGTA developed scenarios designed to present volunteers 
with a wide range of tax law topics that taxpayers may have needed 
assistance with when preparing their tax returns. These scenarios 
included the characteristics (e.g., income level, credits claimed, 
etc.) of tax returns typically prepared by the VITA Program volunteers 
based on an analysis of the Tax Year 2004 VITA-prepared tax returns. 
TIGTA had 36 tax returns prepared with a 39 percent accuracy rate, 
comparable to the 34 percent accuracy rate reported for the 2005 Filing 
Season. TIGTA's observations were that volunteers did not always use 
the tools and information available when preparing returns. TIGTA will 
report its final results later this year.
            The Tax Gap
    In an April 2004 U.S. Senate Committee on Finance news release, 
Senator Max Baucus called for 90 percent voluntary tax compliance by 
2010. Senator Baucus stated, in part, that ``Today, I'm calling on the 
IRS to achieve a 90 percent voluntary compliance rate by the end of the 
decade, which would raise at least an additional $100 billion each year 
without raising taxes.'' Perhaps the greatest challenge facing the IRS 
is finding ways to improve the voluntary compliance rate.
    Using different terms, Senator Baucus challenged the IRS to reduce 
what is commonly known as the tax gap. The IRS defines the gross tax 
gap as the difference between the estimated amount taxpayers owe and 
the amount they voluntarily and timely pay for a tax year. In February 
2006, the IRS estimated the gross tax gap at $345 billion for Tax Year 
2001.
    TIGTA evaluated the reliability of the IRS-developed tax gap 
figures and concluded that the IRS still does not have sufficient 
information to completely and accurately assess the overall tax gap and 
voluntary compliance.\13\ The IRS has significant challenges in both 
obtaining complete and timely data and developing the methods for 
interpreting the data.
---------------------------------------------------------------------------
    \13\ ``Some Concerns Remain About the Overall Confidence That Can 
Be Placed in Internal Revenue Service Tax Gap Projections'' (Reference 
Number 2006-50-077, dated April 2006).
---------------------------------------------------------------------------
    A reliable estimate of the overall tax gap and its components is 
important to tax administration and tax policy decision-makers. Without 
a reliable estimate, inappropriate decisions may be made on how to 
address the tax gap. If we assume that the total tax liability in Tax 
Year 2010 is the same as it was in Tax Year 2001, noncompliant 
taxpayers would have to pay timely and voluntarily an additional $134 
billion to achieve Senator Baucus' challenge to reach a 90 percent 
voluntary compliance rate by 2010.
    Despite the significant efforts undertaken in conducting the 
individual taxpayer National Research Program (NRP) \14\ for 
underreporting, the IRS still does not have sufficient information to 
completely and accurately assess the overall tax gap and the voluntary 
compliance rate. TIGTA's primary concerns are described in the 
following areas of nonfiling, reporting compliance, and payments 
collected.
---------------------------------------------------------------------------
    \14\ The NRP was a study designed to accurately measure reporting 
compliance of individual taxpayers while minimizing the burden on 
taxpayers during the process.
---------------------------------------------------------------------------
            Nonfiling
    Prior to the NRP, the IRS's estimate of the nonfiling gap was $30.1 
billion, consisting of $28.1 billion for individual income taxes and $2 
billion for estate taxes. In February 2006, the IRS updated this 
estimate to $25 billion for individuals. Supplementary data, however, 
suggest that substantial amounts are not included in the estimates 
provided in the tax gap projections. The IRS describes the nonfiling 
estimate as reasonable despite the missing segments of corporate 
income, employment, and excise taxes. These facts suggest the nonfiler 
estimate is incomplete and likely inaccurate.\15\
---------------------------------------------------------------------------
    \15\ There are no plans to update the estate tax segment or to 
estimate the corporate, employment, and excise tax nonfiler segment.
---------------------------------------------------------------------------
            Reporting Compliance
    At an estimated $285 billion, underreporting is by far the largest 
identified portion of the tax gap. Yet, this estimate may not be 
complete since there are at least four areas that suggest substantial 
amounts are not included in the tax gap estimates.
  --The effect that the current NRP on Subchapter S corporations will 
        have on individual taxpayer compliance estimates could be 
        substantial, as well as the effect on employment tax 
        estimates.\16\
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    \16\ This study is expected to take 2 years to 3 years to complete 
from its inception in October 2005.
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  --The $5 billion underreporting estimate for small corporations and 
        the $25 billion estimate for large corporations date back to 
        the 1980's and, according to the IRS, are considered weak.
  --The estimate for estate taxes was not updated during the current 
        NRP, and no estimate has been made for excise taxes.
  --The dated estimate for the Federal Insurance Contributions Act 
        taxes and unemployment taxes are considered weak by the IRS.
            Payments Collected
    The IRS estimates that it recovers about $55 billion of the annual 
tax gap through enforced collections and other late payments.\17\ This 
figure does not represent an actual amount but is an estimate based on 
formulas devised from historical analyses. The actual basis of these 
formulas seems to be very limited, as well as dated. Furthermore, these 
collections have two basic parts--voluntary payments received by the 
IRS and payments that result from some type of IRS intervention.\18\ 
The IRS does not currently correlate either type of payment to the 
applicable tax year and thus does not determine actual collections.
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    \17\ According to one IRS representative, these collections can 
take up to 10 years because of appeals and court decisions.
    \18\ Voluntary late payments are generally those remittances 
received after their due dates but before collection notices were sent 
or other collection actions were taken.
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            Measuring Noncompliance
    TIGTA attempted to determine whether the IRS's tax gap estimates 
coincide with estimates developed by independent sources. Although some 
independent studies exist, none provided sufficient information to 
allow close comparisons. One possible source of comparison was the 
annual Bureau of Economic Analysis estimate of the difference between 
its personal income figures and the IRS's measure of Adjusted Gross 
Income to derive what is called an Adjusted Gross Income Gap. IRS 
Office of Research officials suggested that this is a narrow definition 
of tax noncompliance based, in part, on IRS estimates. For Tax Year 
2001, the Bureau of Economic Analysis reported an Adjusted Gross Income 
Gap of $834.4 billion.\19\
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    \19\ This number is an income gap rather than a tax gap. Thus, it 
would have to be multiplied by a tax rate to determine the associated 
tax gap. Similarly, the $35 billion stated in the following paragraph 
could be significantly smaller, depending on whether some of these 
workers have actual filing obligations. Neither the BEA nor the IRS 
assumes a tax rate to calculate a tax gap estimate based on this income 
gap.
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    The private sector has also developed some estimates of the tax 
gap. For example, in January 2005, financial analysts calculated the 
number of illegal immigrants in the United States at more than double 
the United States Census Bureau's estimated 9 million. These 
undocumented workers may hold as many as 15 million jobs, with perhaps 
5 million collecting untaxed cash wages, costing the Federal Government 
an estimated $35 billion yearly.\20\
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    \20\ Bear Stearns, ``The Underground Labor Force Is Rising To The 
Surface''.
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    Performing a compliance measurement program is expensive and time 
consuming. The estimated cost for performing the Tax Year 2001 
individual taxpayer NRP was approximately $150 million. The IRS Office 
of Research staff explained that resource constraints are a major 
driver in NRP studies and will affect how often the NRP is updated. 
From fiscal years 1995 through 2004, the revenue agent workforce 
declined by nearly 30 percent while the number of returns filed grew by 
over 9 percent. Additionally, operational priorities must be balanced 
against research needs. This shortfall in examiner resources makes 
conducting large-scale research studies problematic.
    The IRS's budget submission to the Department of the Treasury 
(Treasury) for fiscal year 2007 requests funding to support ongoing NRP 
reporting compliance studies. It requests funding for 268 Full-Time 
Equivalents and $45.9 million that will include 26 analytical and 
technical positions to estimate reporting compliance for new segments 
of taxpayers (such as S corporations, partnerships, and other business 
entities) and to update estimates of reporting compliance for other 
segments. It also requests 510 additional revenue agents to conduct 
reporting compliance research examinations. The initiative seeks to 
provide a foundation for conducting compliance studies and to limit the 
diversion of resources to research audits from operational priorities. 
The IRS Oversight Board supports ongoing dedicated funding for 
compliance research. Unfortunately, funding for those resources in 
previous fiscal years did not materialize. Without a resource 
commitment to continually update the studies, the information will 
continue to be stale and less useful in improving voluntary compliance.
    TIGTA's review of the tax gap concluded that a determination cannot 
be made about the IRS's ability to meet Senator Baucus' challenge of 90 
percent voluntary compliance by 2010 with the information currently 
available. Regardless of whether a 90 percent voluntary compliance rate 
can be achieved, the IRS faces formidable challenges in completely and 
accurately estimating the tax gap and finding effective ways to 
increase voluntary compliance.

                           ELECTRONIC FILING

    The IRS has seen a steady growth in electronic filing (e-file) of 
income tax returns over the past several years. In Calendar Year 2002, 
35.9 percent of the 130.3 million individual income tax returns 
received by the IRS were e-filed. Last year, the percentage of e-filed 
returns increased to 51.7 percent of the total individual income tax 
returns received. The number of e-filed returns increased 46.2 percent 
over the 3-year span. While the IRS will not meet its goal of having 80 
percent of all tax returns e-filed by 2007, it does expect to see 
continued growth in electronic filing, although at a somewhat 
diminished growth rate from year to year. For example, the IRS expects 
the e-file percentage to reach 54.1 percent this year, 57.7 percent in 
2007, and 60.6 percent in 2008.
    Although e-filing continues to increase overall, TIGTA found some 
indications that taxpayers are shifting between the various types of e-
filed returns, and some segments of e-filed returns are starting to 
show a decrease in the numbers filed. E-filed returns are generated 
from three basic sources--paid preparers who transmit their clients' 
tax returns, taxpayers who purchase tax-preparation software and file 
their own returns via the Internet from their personal computers, and 
taxpayers who take advantage of free e-filing options, such as the Free 
File Program, or in previous years via the TeleFile Program.
    Overall, as of April 8, 2006, e-filing has increased 3.5 percent 
compared to the same period in 2005, which is significantly less than 
the 6 percent increase the IRS expected. While the number of taxpayers 
e-filing from their home computers is up 16.6 percent this Filing 
Season, the number of taxpayers taking advantage of free online filing 
is down 22 percent below last year. I am concerned that more taxpayers 
are not using the free e-filing services offered by the IRS.
Free File Program
            Background
    The IRS Restructuring and Reform Act of 1998 (RRA 98)\21\ 
established a goal for the IRS to have 80 percent of Federal tax and 
information returns filed electronically by 2007. It also required the 
IRS to work with private industry to increase electronic filing.
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    \21\ Public Law No. 105-206, 112 Stat. 685 (codified as amended in 
scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 
U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
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    In February 2002, President Bush established the President's 
Management Agenda to improve the overall management of the Federal 
Government. One of the five initiatives in the President's Agenda is E-
Government. The goal of this initiative is to make it easier for 
citizens and businesses to interact with the government, save taxpayer 
dollars and streamline citizen-to-government transactions. In response 
to the President's E-Government initiative, the Office of Management 
and Budget (OMB) developed the EZ Tax Filing Initiative. EZ Tax Filing 
was intended to make it easier for citizens to file taxes in an 
Internet-enabled environment. Citizens would no longer have to pay for 
basic, automated tax preparation. The goal of this initiative was to 
increase the number of citizens who filed their tax returns 
electronically.
    In response to this requirement and the statutory requirement of 
RRA 98, in 2003 the Treasury, the OMB and the IRS launched the Free 
File Program featuring private-sector partners that allow qualifying 
taxpayers to prepare and file their taxes online for free. The 
Treasury, OMB and IRS made this possible through a public-private 
partnership with a consortium of tax software companies, the Free File 
Alliance, LLC (Alliance).
    The Free File Program provides taxpayers with access to free online 
tax preparation and e-filing services made possible through a 
partnership agreement between the IRS and the tax software industry. 
Eligible taxpayers may prepare and e-file their Federal income tax 
returns using commercial online software provided by Alliance members. 
After the IRS and Alliance entered into a Free File Agreement, the Free 
File Program debuted in January 2003. According to statistics provided 
by the Alliance, more than 2.79 million taxpayers used the program in 
its first year. In subsequent years, use of the Free File Program 
increased significantly to about 3.51 million taxpayers in 2004 and 
5.12 million taxpayers in 2005.
            The Amended Free File Alliance Agreement and Its Potential 
                    Impact on Electronic Filing
    After the 2005 Filing Season, the IRS and the Alliance amended 
their agreement to continue the Free File Program through October 2009. 
With the amended agreement, the overall focus of the Free File Program 
changed significantly. While the amended agreement still contributes to 
the original goal of increasing the number of citizens who 
electronically file their tax returns, new limits effectively changed 
the intent of the Free File Program. The original intent of the program 
was to provide free tax preparation and electronic filing services to 
all taxpayers. The revised intent is to assist lower income and 
underserved taxpayers.
    The original 2002 agreement between the IRS and the Alliance 
established a minimum number of taxpayers who should be served by the 
Free File Program and was more in line with the intent of the EZ Tax 
Filing Initiative. There is, however, some support in Congress for the 
shift in the program's focus to lower income and underserved taxpayers. 
For example, according to the House Appropriations Committee Report 
accompanying the IRS's fiscal year 2005 Budget Appropriations, the 
committee reaffirmed its position that the Alliance is first and 
foremost intended to provide electronic Federal tax return preparation 
and e-filing services at no cost to the working poor and other 
disadvantaged and underserved taxpayers.
    As part of the amended agreement, new limits were set for 
participation in the Free File Program. The new limits stem, in part, 
from the differing objectives of the IRS and the Alliance members. One 
of the IRS's principal purposes for establishing the program was to add 
another avenue for electronic filing with the intent of increasing 
electronic filing overall. However, Alliance members are businesses 
that incur a cost to provide free services. According to 
representatives of Alliance member companies who TIGTA interviewed, 
their primary goal is to keep the Federal Government from entering the 
tax preparation business.\22\ A secondary benefit of their 
participation in the program is the opportunity to market their other 
products for free. Taxpayers opting to use these services provide 
additional revenues to Alliance members.
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    \22\ TIGTA interviewed a sample of 6 of the 20 Alliance member 
companies.
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    Per the initial agreement, a minimum of 60 percent of all taxpayers 
(approximately 78 million) were eligible for the Free File Program. 
Last year, the Alliance opened the program up to almost 130 million 
taxpayers. However, only 5.12 million taxpayers took advantage of it. 
The amended agreement now limits the program's availability to 70 
percent of taxpayers (approximately 93 million). For Tax Year 2005, 
this limitation equates to an Adjusted Gross Income (AGI) of $50,000 or 
less. The maximum AGI to achieve the 70 percent limit, however, may 
vary from year to year. The net impact of this new limit is that during 
the 2006 Filing Season approximately 40 million taxpayers were no 
longer offered free filing services through the program.
    As mentioned earlier, online filing on home computers is up 16.6 
percent this Filing Season. This increase, however, appears to be the 
result of an increase in the number of taxpayers who paid for online 
filing services. As of April 8, 2006, paid online filing is up 33.7 
percent while free online filing is down 22 percent. Two possible 
explanations for the growth in online filing from home computers and 
the decline in free online filing are: (1) taxpayers who filed 
electronically through a practitioner last year may have decided to 
purchase software and file online this year; and (2) taxpayers who 
filed through the program last year do not qualify this year and 
therefore purchased software to file online.
    Another factor that appears to have contributed to the decline in 
free online filing is elimination of the IRS's TeleFile Program. The 
IRS and the Alliance had hoped that many of the 3.3 million taxpayers 
who used TeleFile in 2005 would migrate to the Free File Program. 
However, current Filing Season statistics indicate that many former 
TeleFilers are no longer filing electronically and instead are filing 
their returns on paper.
Positive Provisions of the New Free File Alliance Agreement
    Although the changes in the amended Free File Agreement limit the 
number of taxpayers offered free tax return preparation and filing 
services, several other changes enhance the quality of the program. 
Under the amended agreement, Alliance members must adhere to more 
stringent disclosure of the nature, costs, and alternative methods of 
receiving refunds faster. In addition, not all taxpayers will be 
offered a Refund Anticipation Loan (RAL). There is some controversy 
over RALs because of the high fees and rates sometimes associated with 
those loans. Starting in 2006, the agreement guarantees that some 
taxpayers using the Free File Program will have the option to prepare 
and file their tax return without being offered a RAL. The decision of 
whether or not to accept an RAL lies with the taxpayer; however, these 
new provisions make the choice more clear. If taxpayers choose to apply 
for an RAL, all terms of the loans must be fully disclosed.
    The amended agreement also increased security requirements and 
added performance measures for the individual Alliance members. 
Alliance members must have third-party security assessments to ensure 
that taxpayer information is adequately protected. Also, performance 
standards require a 60 percent acceptance rate \23\ for providers who 
e-file returns through the program. This acceptance rate will be 
gradually increased in future years.
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    \23\ The percentage of returns an individual provider must transmit 
to the IRS error free.
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    Under the amended agreement, Alliance members also agreed for the 
first time to provide the IRS with an indicator that identifies those 
taxpayers who use the Free File Program. Prior to the amendment, the 
IRS had no way to independently determine how many taxpayers 
participated in the program, or which taxpayers were using it. 
Previously, individual Alliance members reported data on participation 
in the program, and the IRS lacked a method to monitor participation. 
This significantly hampered the IRS's ability to evaluate the program's 
success or the effects of changes to the program.
Difficulties Using the Free File Program
    Although the Free File Program offers some taxpayers the option to 
prepare and file their tax return for free, the program may not be 
accessible to all who are eligible for it, and it is not necessarily 
easy to use. The Free File Internet site readily allows taxpayers to 
determine whether they qualify for the program, but finding the best 
software provider for their needs is time consuming and may be 
difficult for less savvy computer users.
    Taxpayers must access the Free File Program through the IRS's 
Internet site at IRS.gov. The Internet site clearly identifies the 
basic requirements for participation in the program and provides a tool 
that guides taxpayers to free filing providers. This tool presents 
taxpayers with a number of providers from which to choose based on some 
basic information that taxpayers provide. Although this tool guides 
taxpayers to the providers they qualify to use, the tool does not 
assist taxpayers in determining which of those providers best meets 
their needs.
    Taxpayers must access each provider's Internet site to determine 
the services offered and must then compare the services offered and 
select the provider that is the best for them. Additionally, each 
Alliance member company sets taxpayer eligibility requirements for its 
own program. These requirements may differ from company to company. 
Generally, eligibility is based on such factors such as age, adjusted 
gross income, State residency, military status or eligibility for the 
Earned Income Tax Credit.
    Although the Free File Program is currently focused on low-income 
taxpayers, many of these taxpayers do not have access to the tools to 
use it. For example, taxpayers who speak limited English have not been 
provided access to all of the filing options offered. Only two 
providers offer services in Spanish and neither of them offer free 
electronic filing of Form 4868, Automatic Extension of Time to File.
    The Free File Program also requires taxpayers to have access to a 
computer and the Internet. Taxpayers who have access to the necessary 
technology must also be savvy enough to navigate the IRS's and the 
Alliance members' Internet sites. The focus of the program on lower-
income taxpayers may be at odds with their ability to participate in 
it. In her 2004 Report to the Congress, the National Taxpayer Advocate 
wrote that in 2001 approximately 50 percent of low-income families \24\ 
used a computer and only 38 percent had access to the Internet. 
Furthermore, access to a computer or the Internet does not necessarily 
indicate that a person has the ability to navigate the Internet or use 
tax preparation software.\25\
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    \24\ Income of less than $25,000.
    \25\ ``National Taxpayer Advocate 2004 Annual Report to the 
Congress, Volume 1'', December 2004.
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    The IRS offers free assistance to taxpayers with tax preparation 
and filing through its Taxpayer Assistance Centers, Voluntary Income 
Tax Assistance, and Tax-Aide Programs as well as through the Free File 
Program. Similar to the Free File Program, taxpayers must meet certain 
requirements in order to receive assistance from those other programs. 
The Free File Program, however, is the only free filing option that 
taxpayers may use from their homes. Taxpayers must bring their tax 
documentation to an assistance site to take advantage of the other free 
tax return preparation and filing services.
    The addition of the RAL provisions, increased security, and added 
performance measures to the agreement are important provisions to 
further promote public confidence in the Free File Program. Adding the 
electronic indicator to returns filed through the program will provide 
the IRS with information to measure the program's success. However, 
limiting the scope of the program to 70 percent of taxpayers has 
impacted the use of the program. Based on the statistics Alliance 
members provided in previous years, the new limits in the amended 
agreement appear to be substantially reducing participation in the 
program. Furthermore, the AGI limit also keeps the program from 
achieving the full intent of the EZ Tax Filing Initiative, which never 
specified any such limits for access to free, basic, automated tax 
return preparation and electronic filing. Not yet known, however, is 
whether the IRS's ability to better understand who is using and who is 
not using the program could help the IRS better market the program and 
expand its usage despite the new limits. The answer to that question 
may ultimately have a significant effect on the overall growth rate of 
electronic filing.

Elimination of the TeleFile Program
    As mentioned earlier in my statement, one factor that appears to 
have negatively impacted the Free File Program is the elimination of 
the TeleFile Program. The IRS discontinued this program for individual 
taxpayers in August 2005. The TeleFile Program allowed taxpayers with 
the simplest tax returns \26\ to file their returns by telephone. The 
pilot TeleFile Program was launched on a limited basis in 1992, and the 
program became available nationally in 1997. The RRA 98 included the 
expectation that the IRS would continue to offer and improve TeleFile 
and make a similar program available on the Internet.
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    \26\ Forms 1040EZ.
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    Despite its initial success, use of the TeleFile Program began to 
decrease in 1999. According to IRS electronic filing statistics as of 
April 17, 2005, approximately 3.3 million filers used TeleFile in 2005, 
a 12.7 percent decline from the previous year. Until the IRS eliminated 
the TeleFile Program last year, participation in the program had 
declined every year since 1999 when 5.2 million filers used it.
    Declining use was one factor the IRS considered when deciding 
whether or not to end the TeleFile Program. Other contributing factors 
included the increasing cost of maintaining an aging TeleFile system, 
declining and discontinued State TeleFile programs, and the growing use 
of other electronic filing alternatives, such as the Free File Program.
    According to the IRS, taxpayers who previously used TeleFile may 
continue to file electronically using one of the following five 
methods:
  --1. Tax preparers;
  --2. Personal computers with Internet access and tax preparation 
        software;
  --3. IRS's Free File Program;
  --4. Free tax assistance sites, such as the Voluntary Income Tax 
        Assistance and Tax-Aide Programs; and
  --5. IRS Taxpayer Assistance Centers.
    However, two of the five alternatives require the taxpayer to pay 
for tax preparation and filing services that were previously free, and 
two other options require taxpayers to have access to computers and the 
Internet. Consequently, in many cases, the most cost-effective avenue 
for the taxpayer is to file a paper tax return. According to initial 
IRS statistics, a significant number of former TeleFile users are 
reverting to filing paper returns this year. As of April 8, 2006, the 
number of paper Form 1040EZ returns filed has increased 19.2 percent 
compared to this time last year (5.9 million in 2006 compared to 4.9 
million in 2005), and there has been a corresponding decrease in 
electronically filed Forms 1040EZ (6.7 million in 2006 vs. 8.4 million 
in 2005).
    TIGTA will further evaluate the impact of the elimination of the 
TeleFile Program on taxpayers and the IRS's efforts to increase 
electronic filing, and will report the results later this year.

                        PRIVATE DEBT COLLECTION

    As of September 2005, the gross accounts receivable to the IRS was 
$258 billion. On October 22, 2004, the President signed the American 
Jobs Creation Act of 2004 \27\ that included a provision allowing the 
IRS to use Private Collection Agencies (PCA) to help collect Federal 
Government tax debts. The law allows PCAs to locate, contact, and 
request full payment from taxpayers specified by the IRS. The law also 
allows the IRS to retain and use an amount not in excess of 25 percent 
of the amount collected by the PCAs to pay for the cost of PCA 
services, and an amount not in excess of 25 percent collected for 
collection enforcement activities of the IRS. According to the IRS, the 
initiative to use PCAs will help reduce the significant and growing 
amount of tax liability deemed uncollectible because of IRS resource 
priorities, will help maintain confidence in the tax system, and will 
enable the IRS to focus its existing collection and enforcement 
resources on more difficult cases.
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    \27\ Public Law No. 108-357, 118 Stat. 1418 (2004).
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    The provisions of the Fair Debt Collection Practices Act \28\ apply 
to PCAs. PCAs are prohibited from committing any act or omission that 
employees of the IRS are prohibited from committing in the performance 
of similar services. The IRS requires that PCAs adhere to all taxpayer 
protections. PCAs are also prohibited from threatening or intimidating 
taxpayers or otherwise suggesting that enforcement action will or may 
be taken if a taxpayer does not pay the liability. The PCAs must also 
adhere to all security and privacy regulations for systems, data, 
personnel, physical security, and taxpayer rights protections. To 
ensure compliance with these requirements, the IRS is responsible for 
providing oversight of PCA actions.
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    \28\ 15 U.S.C.  1601 note, 1692-1920 (2000).
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    The IRS issued a detailed Request For Quotation \29\ (RFQ) for 
solicitation of debt collection services in support of the Private Debt 
Collection program on April 25, 2005. However, this RFQ was canceled 
after the United States Court of Federal Claims filed an order on July 
25, 2005, informing the IRS it intended to enjoin the solicitation. The 
order ruled that the IRS's restriction of the solicitation only to 
vendors with current Federal Government debt collection task orders was 
arbitrary and capricious. The IRS subsequently revised the RFQ and 
reissued it on October 14, 2005.
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    \29\ An RFQ is issued by the IRS's Office of Procurement and 
describes the requirements that prospective contractors should provide 
in support of needed products or services. TIGTA reviewed the RFQ dated 
April 25, 2005. The Private Debt Collection Request for Quotation 
Outlines Adequate Procedures and Controls (Reference Number 2005-10-
156, dated September 2005). TIGTA will soon report on its review of the 
revised RFQ dated October 14, 2005.
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    TIGTA reviewed the revised RFQ and determined that it adequately 
addressed the deficiencies cited by the United States Court of Federal 
Claims. The IRS deleted the requirement that PCAs must have a current 
Federal Government debt collection task order to be eligible for the 
solicitation. TIGTA did not identify any other restrictions in the RFQ 
which would have unnecessarily limited the procurement process. 
Further, the revised RFQ was reviewed by the IRS's Office of 
Procurement Policy Quality Assurance Branch and General Legal Services 
as required by IRS procurement procedures.
    On March 9, 2006, the IRS announced that it awarded contracts to 
three firms to participate in the first phase of its private debt-
collection initiative. The IRS has developed its own guidelines for the 
private firms, including background checks on all private-firm 
personnel associated with the projects as well as a mandatory, IRS-
directed training program for company personnel. The IRS planned to 
begin delivering delinquent tax account cases to the selected PCAs by 
July 2006. However, on March 23, 2006, the IRS announced that it had 
issued stop-work orders to the three PCAs after two unsuccessful 
bidders filed bid protests with the Government Accountability Office 
(GAO).
    In the second phase of the private debt-collection initiative, 
scheduled for 2008, the IRS intends to contract with up to 10 firms. 
Over the course of 10 years, the IRS expects that the private firms 
will help it collect an additional $1.4 billion in outstanding taxes.
    While the use of private collection agencies could result in 
significant recoveries of unpaid taxes, the potential for abuse exists. 
Experience at the State level demonstrates that the use of PCAs should 
be closely monitored. In December 2005, the State of New Jersey 
Commission of Investigation reported that what began as an effort to 
privatize the collection of tax debt 12 years ago evolved into a 
corrupt association between high- and mid-level managers in the 
Divisions of Taxation and Revenue and the PCAs.\30\ The State of New 
Jersey may have been over-billed by more than $1 million for a 5-year 
period.
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    \30\ State of New Jersey Commission of Investigation, ``The Gifting 
of New Jersey Tax Officials'' (December 2005).
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    The Commission reported that a lack of oversight and a lack of 
audits and quality controls directly contributed to the undetected 
over-billing. Additionally, the PCAs repeatedly ignored contract 
requirements and Taxation and Revenue officials failed to enforce them. 
While the Commission's report did not address this particular issue, 
TIGTA is also concerned about the quality of taxpayer service from PCAs 
during their attempts to collect outstanding taxes. Poor taxpayer 
service by PCAs could potentially have a negative impact on voluntary 
compliance.
    Since the IRS is just now embarking on this initiative, TIGTA has 
not yet seen indications of problems with the IRS's private debt-
collection initiative similar to those in New Jersey. However, a recent 
news story reported that a former official of one of the IRS's three 
selected PCAs for the first phase of this initiative was indicted for 
bribery of public officials to win a contract to collect unpaid fines 
and fees. According to the story, the official pleaded guilty to one 
count of conspiracy to commit bribery and one count of bank fraud in 
2005, and was sentenced to 30 months in prison and a $1 million fine. 
This particular case and the State of New Jersey experience clearly 
illustrate the need for proper oversight of this important initiative. 
According to the IRS, it has established an oversight unit responsible 
for ensuring that PCAs adhere to established procedures and that a 
tremendous amount of rigorous oversight will be applied to the PCAs.
    Overseeing the IRS's private debt-collection initiative is a top 
priority for TIGTA. TIGTA has coordinated with the IRS during the 
initial phases of implementation of this initiative by addressing 
security concerns with the contracts and protection of taxpayer rights 
and privacy, and by developing integrity and fraud awareness training 
for the contract employees. TIGTA plans to provide a presentation to 
IRS trainers for PCAs about TIGTA's role in the private debt-collection 
initiative.
    TIGTA has also developed a three-phase audit strategy to monitor 
this initiative and provide independent oversight. In the first phase, 
TIGTA is reviewing the IRS's planning and initial implementation of the 
program. As mentioned previously, our limited scope reviews of the 
original and revised RFQs did not identify any material omissions that 
would adversely affect the IRS's ability to manage this initiative 
effectively. Additionally, TIGTA recently reported that overall, the 
IRS has taken positive steps to effectively plan and implement certain 
aspects of the Private Debt Collection program. For example, the IRS 
has developed a draft letter and a related publication with pertinent 
information to notify taxpayers when their accounts are transferred to 
PCAs.
    While the IRS has taken positive steps to implement the Private 
Debt Collection program, TIGTA noted that approximately 72 percent of 
the IRS's original inventory of cases available for placement in the 
program had balances due \31\ that were over 2 years old. The IRS is 
now considering a revision to its case selection criteria that will 
increase the balance-due age even further. IRS management indicated 
that there is a long-term strategy in place to include more current 
cases in the program. However, the new Filing and Payment Compliance 
project \32\ currently limits their ability to accomplish this 
strategy.
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    \31\ A balance due represents an unpaid assessment for which a 
taxpayer owes the IRS.
    \32\ The Filing and Payment Compliance project was initiated to 
address the inventory of delinquent tax debt that is not actively being 
collected by the IRS due to limited resources.
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    For the initial phase of the program, the IRS plans to place 
simpler cases with PCAs, such as those in which the taxpayer has filed 
all tax returns due. TIGTA determined, however, that contrary to IRS 
intentions, the case selection criteria the IRS had established would 
have allowed certain nonfiler cases to be assigned to the PCAs. The IRS 
subsequently agreed to review nonfiler conditions and determine whether 
the nonfiler cases should be excluded from inventory.
    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 
exercises its new authority to use private debt collectors, while also 
ensuring that taxpayers' due process and privacy rights are protected.

                 OTHER MAJOR CHALLENGES FACING THE IRS

    Despite the overall progress in customer service and the broad 
relief provided to Hurricane victims, improvements need to be made in 
customer service and other areas in which the IRS faces significant 
challenges in accomplishing its mission. TIGTA has identified the 
following additional management and performance challenges that 
confront the IRS:
  --Modernization of the IRS;
  --Security of the IRS;
  --Complexity of the Tax Law;
  --Using Performance and Financial Information for Program and Budget 
        Decisions;
  --Erroneous and Improper Payments;
  --Taxpayer Protection and Rights;
  --Managing Human Capital.
    Each of the above presents its own unique challenges, which I will 
address individually in the remaining portion of my testimony.
Modernization of the IRS
    Modernizing the IRS's computer systems has been a challenge for 
many years and will likely remain a challenge for the foreseeable 
future. The latest effort to modernize the IRS's systems, the Business 
Systems Modernization (BSM) program, began in fiscal year 1999, and is 
a complex effort to modernize the IRS's technology and related business 
processes. According to the IRS, this effort involves integrating 
thousands of hardware and software components. Through February 2006, 
the IRS has received appropriations of approximately $2 billion to 
support the BSM program, and the President has requested an additional 
$167 million for fiscal year 2007.
    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 \33\ to design, develop, and integrate the 
modernized computer systems. However, in January 2005, the IRS began 
taking over the role of systems integrator from the PRIME due to 
reductions in funding for the BSM program and concerns about the 
PRIME's performance.
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    \33\ The PRIME is an acronym for Prime Systems Integration Services 
Contractor.
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    The BSM program has shown progress. The IRS and its contractors 
have been focusing on defining and delivering smaller, incremental 
releases of projects.\34\ For example, the IRS recently issued the 
fourth incremental release of the Modernized e-File project. The 
Modernized e-File project has provided the capability for corporations, 
exempt organizations, governmental entities, private foundations, and 
trusts to file 106 tax forms electronically. In January 2006, the IRS 
released the fourth incremental release of the Customer Account Data 
Engine (CADE) project which will eventually replace the IRS's existing 
Master File.\35\
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    \34\ A release is a specific edition of software.
    \35\ The Master File is the IRS database for storing taxpayer 
account information on individuals, businesses, employee retirement 
plans, and exempt organizations. 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 online 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.
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    Although progress is being made, the modernization program is 
behind schedule, over budget, and is delivering less functionality than 
originally planned. 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 contractors' performance and accountability 
        are effectively managed.
    In response to modernization challenges and reduced funding, the 
IRS began making dramatic changes to significant areas within the BSM 
program over the last year. For example, the GAO recommended and the 
House and Senate Appropriations Committees directed the IRS to develop 
a new version of the Modernization Vision and Strategy. In addition, 
the IRS's prior modernization approach involved a huge development 
effort aimed at replacing all current systems. The IRS is now focusing 
on using current systems to accomplish modernization. I believe these 
extensive changes signal the beginning of a different design and 
structure for the entire modernization effort.
    As risks and issues are identified within the BSM program, frequent 
changes are often required. However, the IRS's recent and planned 
changes do not eliminate the four challenges we have identified. Due to 
the criticality of the BSM program, the IRS must confront identified 
challenges and proactively address them in order to come closer to 
realizing expectations in this new phase of the BSM program.
Security of the IRS
    Millions of taxpayers entrust the IRS with sensitive financial and 
personal data, which are stored and processed by IRS computer systems. 
The risk of sensitive data being compromised has increased over the 
last few years because of the increased threat of identity theft. 
According to the Social Security Administration, identity theft is one 
of the fastest growing crimes in the United States. The Department of 
Commerce estimates that more than 50 million identities were 
compromised in 2005. The sensitivity of taxpayers' information stored 
by the IRS and the IRS's use of the Social Security Number as a 
taxpayer identifier on its computer systems add to the risks the IRS 
must address.
    As the Nation's primary revenue collector, the IRS may also be a 
prime target for attacks on its computer systems by anti-government 
protestors, international terrorists, and disgruntled employees. In 
addition to identity theft concerns, computer attacks can cause the 
loss of revenue and productivity by disrupting computer operations. 
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.
    The IRS has focused on technical solutions to protect its computer 
systems and data, and has established reasonable technical controls to 
prevent intruders from entering the IRS network. However, managerial 
and operational controls have not been adequately emphasized, leading 
TIGTA to conclude that systems and data remain vulnerable. In the past, 
the IRS relied mainly upon the Chief Information Officer and Chief, 
Mission Assurance and Security Services, to provide security controls. 
The IRS has recently increased business unit involvement to ensure 
adequate security and has added security responsibilities to 
executives' position descriptions. These changes are critical but will 
take time to improve the security posture of the IRS.
    The IRS has improved its processes and devoted additional resources 
for certifying and accrediting its systems; however, only 35 percent of 
its systems had been certified and accredited as of September 2005. 
Annual testing had not been conducted on a majority of its systems. In 
addition, only 300 of its 2,737 employees with key security 
responsibilities had received any specialized training in the last 
fiscal year. We have attributed several security weaknesses in the past 
to the lack of training for these employees and expect these weaknesses 
will persist until specialized training is given more emphasis. In 
addition, contractors and States who use taxpayer information to 
administer their States' tax laws have not been given sufficient 
oversight.
    Hurricanes Katrina and Rita affected 25 IRS offices. By adequately 
planning and taking aggressive actions after the hurricanes hit, the 
IRS was able to locate its employees and restore its computer 
operations to continue tax administration activities in the Gulf Coast 
area. However, disaster recovery plans for the IRS's large computing 
centers and campuses require additional development, testing, or 
personnel training to ensure that the IRS can quickly recover in the 
event of a disaster.
    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. 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.
Complexity of the Tax Law
    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 November 2005 Report of the President's Advisory 
Panel on Tax Reform, last year Americans spent more than 3.5 billion 
hours doing their taxes, the equivalent of hiring almost 2 million new 
IRS employees--more than 20 times the IRS's current workforce. About 
$140 billion is spent annually on tax preparation and compliance--about 
$1,000 per family.
    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.\36\
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    \36\ ``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, TACs, kiosks, and the 
IRS Internet 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.
    Tax law complexity contributes to the IRS's challenges in reaching 
accuracy goals to tax law questions, as well as to taxpayer frustration 
with attempting to decipher the tax code. For example, assistors are 
trained and expected to be knowledgeable in 318 tax law topics with 395 
subtopics. Additionally, they are expected to be able to respond to 
taxpayer issues for the current and prior tax years.
    In part because of the tax law complexity, taxpayers are continuing 
to receive inaccurate answers to their tax law questions. TIGTA's 
results for the 2006 Filing Season show that assistors provided 
accurate answers to 73 percent of the tax law questions asked at the 
TACs. Although this is an improvement from the accuracy rate of 66 
percent TIGTA reported for the 2005 Filing Season,\37\ taxpayers are 
still receiving incorrect answers to 27 percent of their questions 
asked at the TACs. Using its own methodology to calculate the accuracy 
rate, however, the IRS did meet its accuracy rate goal of 80 percent 
for the 2006 Filing Season.
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    \37\ ``Customer Accuracy at Taxpayer Assistance Centers Showed 
Little Improvement During the 2005 Filing Season'' (Reference Number 
2005-40-146, date September 2005).
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    As well as 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. The Son of Boss (Bond and 
Option Sales Strategies) is one such abusive tax shelter.\38\ Other 
than generating tax benefits, the IRS determined it lacked a business 
purpose.
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    \38\ IRS Notice 99-59 issued in December 1999 described Boss 
transactions as certain losses involving partnerships and foreign 
corporations that would not be allowed for tax purposes.
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    Overall, the IRS estimated the Son of Boss abusive tax shelter 
understated tax liabilities in excess of $6 billion. The IRS describes 
the Son of Boss abusive tax shelter as a highly sophisticated, 
technically complex, no-risk scheme designed to generate tax losses 
without corresponding economic risks, which was promoted by some 
prominent firms in the financial services industry to investors seeking 
to shelter large gains from the sale of a business or capital asset.
    The scheme used flow-through entities, such as partnerships, and 
various financial products \39\ to add steps and complexity to 
transactions that had little or no relationship to the investor's 
business or the asset sale creating the sheltered gain. Additionally, 
the losses generated from the transactions were often reported among 
other ``legitimate'' items in several parts of the income tax return. 
Some losses from the Son of Boss abusive tax shelter, for example, were 
reported as a reduction to gross sales, cost of goods sold, or capital 
gains.
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    \39\ The IRS defines financial products as instruments used in the 
global marketplace and include, among others, stocks, bonds, foreign 
currencies, mortgages, commodities, and derivatives.
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    Taken together, these characteristics, especially the use of flow-
through entities, made it very difficult for the IRS to detect the Son 
of Boss abusive tax shelter through its traditional process of 
screening returns individually for questionable items.\40\ 
Administering such a complex tax code makes the job of pursuing abusive 
tax avoidance schemes, such as the Son of Boss, challenging and costly 
to the IRS.
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    \40\ ``The Settlement Initiative for Investors in a Variety of Bond 
and Option Sales Strategies Was Successful and Surfaced Possible Next 
Steps for Curtailing Abusive Tax Shelters'' (Reference Number 2006-30-
065, dated March 2006).
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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 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 Congress. Thus, 
the IRS must work extensively with its stakeholders, as well as the 
Department of the Treasury, to identify and develop legislative 
recommendations that would reduce tax law complexity and taxpayer 
burden.

Using Performance and Financial Information for Program and Budget 
        Decisions
    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 that 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 NRP, which provided fresh data on 
taxpayer voluntary compliance levels--the first in more than a decade. 
Such data are 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, would help pinpoint desired outcomes, and would create a road 
map for the next decade that would complement the IRS's strategic, 
budget, and annual performance plans.
    This past year TIGTA reported on two circumstances that highlight 
the need for more integration of performance and budget data. The 
Federal Workforce Flexibility Act of 2004 \41\ requires agencies to 
regularly assess their training efforts to determine whether their 
training is contributing to the successful completion of the agencies' 
missions. However, the IRS was not able to assess how effectively the 
approximately $100 million spent on training enhanced its ability to 
fulfill its mission.\42\ Additionally, the IRS could better manage its 
facilities and office space. TIGTA determined that the lack of 
appropriate performance data prevents the IRS from cataloging office 
space freed up by employees who regularly participate in the IRS's 
telecommuting program. This lack of performance data prevented the IRS 
from freeing up underutilized space with an estimated annual cost of 
$18 million.\43\
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    \41\ Public Law 108-411 [S. 129] (2004).
    \42\ ``The Internal Revenue Service Does Not Adequately Assess the 
Effectiveness of Its Training'' (Reference Number 2005-10-149, dated 
September 2005).
    \43\ ``The Internal Revenue Service Faces Significant Challenges to 
Reduce Underused Office Space Costing $84 Million Annually'' (Reference 
Number 2004-10-182, dated September 2004).
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    The IRS has reported a yield of more than $4 in direct revenue from 
IRS enforcement efforts for every $1 invested in the IRS's total 
budget. However, we do not believe there is an adequate basis to use 
the total IRS budget to determine a return on investment for 
enforcement activities. Enforcement is only one component of the IRS 
that collects revenue. Enforcement revenue ($43.1 billion in fiscal 
year 2004) compared to the enforcement costs ($6.1 billion in fiscal 
year 2004) actually equates to an overall return on investment for 
enforcement activities of 7 to 1. The IRS also provided estimates that 
it would eventually achieve approximately $1.17 billion in additional 
revenues for its proposed fiscal year 2006 enforcement initiatives. 
This would equate to a 4.4 to 1 return on investment. However, our 
analysis indicates the revenue estimate may be too high. Furthermore, 
the IRS currently does not have a methodology to measure the revenue 
resulting from any initiatives that it implements.\44\
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    \44\ ``A Better Model is Needed to Project the Return on Additional 
Investments in Tax Enforcement'' (Reference Number 2005-10-159, dated 
September 2005).
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    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.\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 statements 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. Also, 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.
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    \46\ ``Financial Audit: IRS's fiscal years 2005 and 2004 Financial 
Statement'' (GAO-06-137, dated November 2005).
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    During fiscal year 2004, the IRS collected over $2 trillion in 
Federal tax revenue, which constituted approximately 95 percent of all 
Federal revenue. However, as reported by the GAO for the last several 
years, the systems used to account for these revenues do not meet 
current Federal financial management guidelines. For example, the IRS's 
Federal tax revenue financial management systems lack adequate audit 
trails, cannot readily produce reliable information regarding unpaid 
assessments at interim periods, and cannot readily generate custodial 
financial information needed for year-end reporting.
    To address these weaknesses, the IRS is developing the Custodial 
Detail Database (the Database). The purpose of the Database is to 
provide sub-ledgers for the custodial financial activities of the IRS. 
The IRS also plans to use the Database to track unpaid assessments 
throughout the year and to help support the lengthy extraction, 
reconciliation, and summarization process needed to produce the IRS's 
annual financial custodial statements. TIGTA's preliminary assessment 
indicates that the IRS faces a number of significant challenges in 
meeting these objectives, especially the development of a system that 
would support the production of current and reliable information 
regarding tax receivables throughout the year.
    To provide useful information on tax receivables at interim 
periods, the Database will also need to address collectibility issues, 
and accurately account for and eliminate duplicate assessments. 
Furthermore, the IRS continues to be unable to determine the specific 
amount of revenue it actually collects for three of the Federal 
Government's four largest revenue sources, primarily because the 
accounting information needed to validate and record payments to the 
proper trust fund is provided on the tax return, which is received 
months after the payment is submitted. The IRS has to use statistical 
methods to estimate the amounts of these taxes.\47\
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    \47\ The three revenue sources cited are Social Security, hospital 
insurance, and individual income taxes. ``The Custodial Detail Database 
Should Help Improve Accountability; However, Significant Financial 
Management Issues Still Need to Be Addressed'' (Reference Number 2006-
10-029, dated December 2005).
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Preventing Erroneous and Improper Payments
    One of the goals of The President's Management Agenda is to reduce 
erroneous payments.\48\ Further, the Improper Payments Information Act 
of 2002 \49\ 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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    \48\ ``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.
    \49\ 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. The IRS has estimated 
that approximately 30 percent of all EITC claims should not have been 
paid, which was approximately $9 billion of the $31 billion in EITC 
claimed for Tax Year 1999.\50\ The IRS has been developing an EITC 
initiative to combat the problems of fraudulent EITC claims. The 
initiative is focused on three concepts: certification of qualifying 
child residency requirements, verification of filing status, and 
verification of reported income. In October 2005, the IRS reported that 
as a result of these efforts, it had identified and prevented the 
payment of over $275 million in erroneous EITC claims. TIGTA has 
conducted an ongoing assessment of this initiative as the three 
concepts have been tested.\51\
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    \50\ IRS report, ``Compliance Estimates for Earned Income Tax 
Credit on 1999 Returns'' (dated February 2002).
    \51\ Audit reports previously issued: ``The Earned Income Tax 
Credit Income Verification Test Was Properly Conducted'' (Reference 
Number 2005-40-093, dated May 2005); ``The Earned Income Credit 
Recertification Program Continues to Experience Problems'' (Reference 
Number 2005-40-039, dated March 2005); ``Initial Results of the Fiscal 
Year 2004 Earned Income Tax Credit Concept Tests Provide Insight on 
Ways Taxpayer Burden Can Be Reduced in Future Tests'' (Reference Number 
2005-40-006, dated October 2004); and ``Management Controls Over the 
Proof of Concept Test of Earned Income Tax Credit Certification Need to 
Be Improved'' (Reference Number: 2004-40-032, dated December 2003).
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    The Criminal Investigation function of the IRS is responsible for 
detecting and combating tax refund fraud, through its Questionable 
Refund Program (QRP). TIGTA has repeatedly reported over the last 6 
years that additional controls and procedures were necessary to not 
only identify additional instances of potential fraud, but also to 
properly and timely release refunds that are later determined not to be 
fraudulent. This latter issue recently has been the subject of much 
debate, coming on the heels of the National Taxpayer Advocate's 2005 
Annual Report to the Congress in which the Taxpayer Advocate criticized 
the IRS for unnecessarily stopping refunds owed to legitimate 
taxpayers.
    TIGTA previously reported in March 2003 that there were unnecessary 
delays issuing legitimate, non-fraudulent refunds.\52\ That same audit, 
however, identified expired statutory periods for making civil 
assessments of tax, thereby preventing recovery of erroneously refunded 
monies through an examination of income or expense items on the tax 
returns.
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    \52\ ``Improvements Are Needed in the Monitoring of Criminal 
Investigation Controls Placed on Taxpayers' Accounts When Refund Fraud 
Is Suspected'' (Reference Number 2003-10-094, dated March 2003).
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    TIGTA is extremely concerned about this issue, believing that a 
necessary balance must be struck between protecting the revenue by not 
allowing refund fraud to go unchecked, and ensuring that legitimate 
taxpayers receive their refunds timely or, if challenged by the IRS, 
are afforded due process and notification. TIGTA is continuing its 
review of the IRS QRP and will report on its audit work later in the 
year.\53\
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    \53\ Audit reports previously issued: ``The Internal Revenue 
Service Can Improve the Effectiveness of Questionable Refund Detection 
Team Activities'' (Reference Number 2000-40-018, dated December 1999); 
``Revised Questionable Refund Program Procedures Were Not Consistently 
Implemented'' (Reference Number 2001-40-025, dated January 2001); 
``Improvements Are Needed in the Monitoring of Criminal Investigation 
Controls Placed on Taxpayers' Accounts When Refund Fraud Is Suspected'' 
(Reference Number 2003-10-094, dated March 2003); and ``The Internal 
Revenue Service Needs to Do More to Stop the Millions of Dollars in 
Fraudulent Refunds Paid to Prisoners'' (Reference Number 2005-10-164, 
dated September 2005).
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    Additionally, at the request of the House Committee on Ways and 
Means, TIGTA initiated an audit of the Electronic Fraud Detection 
System (EFDS). EFDS was designed to identify potentially fraudulent tax 
returns. We plan to report our results later in the year.
    In addition to erroneous payments of credits, contract expenditures 
represent a significant outlay of IRS funds and are also susceptible to 
mistakes or abuse. As of October 2005, the IRS was responsible for 
administering 553 contracts with a total systems life value of $28.2 
billion. TIGTA continues to perform audits of select contracts to 
ensure payments on selected vouchers are appropriate and in accordance 
with contract terms and conditions. TIGTA also provided the IRS with a 
summary report highlighting several system deficiencies identified by 
the Defense Contract Audit Agency (DCAA) in the past 5 years for a 
major IRS contractor. These deficiencies could lead to overstated and 
unsupported labor and other costs. Although the contractor is making 
progress in addressing previously reported system inadequacies, TIGTA 
believes significant risk still remains for the IRS on this contract.
Taxpayer Protection and Rights
    Congress realized the importance of protecting taxpayers and 
taxpayer rights when it passed the 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. In addition, 
        revenue officers who manually issued levies properly notified 
        taxpayers of their appeal rights.\54\
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    \54\ ``Taxpayer Rights Are Being Protected When Levies Are Issued'' 
(Reference Number 2004-30-072, dated June 2005).
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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.\55\
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    \55\ ``Fiscal year 2005 Statutory Audit of Compliance With Legal 
Guidelines Restricting the Use of Records of Tax Enforcement Results'' 
(Reference Number 2005-40-157, dated September 2005).
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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 resending notices when 
        they are returned as undeliverable.\56\
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    \56\ ``Fiscal Year 2004 Statutory Review of Compliance With Lien 
Due Process Procedures'' (Reference Number 2005-30-095, dated June 
2005).
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  --Seizures.--The IRS did not comply with all legal and internal 
        guidelines when conducting seizures. TIGTA's review did not 
        identify any instances in which taxpayers were adversely 
        affected, but not following legal and internal guidelines could 
        result in abuses of taxpayer rights.\57\
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    \57\ ``Fiscal Year 2005 Review of Compliance With Legal Guidelines 
When Conducting Seizures of Taxpayers' Property'' (Reference Number 
2005-30-091, dated June 2005).
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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 \58\ for illegal tax protestor designations. We 
        found that the IRS has not reintroduced such designations on 
        the Master File and formally coded illegal tax protestor 
        accounts have not been assigned similar Master File 
        designations. In addition, the IRS does not have any current 
        publications with illegal tax protestor references and has 
        initiated actions to remove references from various forms of 
        the Internal Revenue Manual. However, a few illegal tax 
        protestor references still exist in isolated case files.\59\
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    \58\ The IRS database that stores various types of taxpayer account 
information. This database includes individual, business, and employee 
plans and exempt organizations data.
    \59\ ``Fiscal year 2005 Statutory Audit of Compliance With Legal 
Guidelines Prohibiting the Use of Illegal Tax Protester and Similar 
Designations'' (Reference Number 2005-40-104, dated July 2005).
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  --Denials of Requests for Information.--The IRS improperly withheld 
        information from requesters in 7.1 percent of the Freedom of 
        Information Act and Privacy Act of 1974 requests, and 3.1 
        percent of the 26 U.S.C.  6103 requests reviewed.\60\
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    \60\ ``Some Improvements Have Been Made to Better Comply With the 
Freedom of Information Act Requirements'' (Reference Number 2005-10-
089, dated May 2005).
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  --Collection Due Process.--A significant portion of the Appeals 
        Collection Due Process and Equivalent Hearings closed case 
        files requested could not be located or did not contain 
        sufficient documentation. As a result, TIGTA could not 
        determine if the IRS complied with legal guidelines and 
        required procedures to protect taxpayer rights. Moreover, some 
        Appeals determination letters did not contain clear and 
        detailed explanations of the basis for the hearing officers' 
        decisions and did not adequately communicate the results of the 
        hearings to taxpayers. Some determination letters did not 
        address the specific issues raised or tax periods discussed by 
        the taxpayers in their hearing requests.\61\
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    \61\ ``The Office of Appeals Should Strengthen and Reinforce 
Procedures for Collection Due Process Cases'' (Reference Number 2005-
10-138, dated September 2005).
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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.
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 OMB, 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 IRS also faces personnel shortages in certain functions. The 
Wage and Investment Division is experiencing critical staffing 
shortages in its TAC program. The IRS's decision to focus more 
resources on compliance activities has limited available resources and 
the IRS's Field Assistance Office does not have the resources to offer 
unlimited services. Additionally, the uncertainty around the TAC 
closures created critical vacancies as TAC employees left for other 
jobs in the IRS. As of December 1, 2005, the Field Assistance Office 
Headquarters had identified 47 TACs with critical staffing shortages. 
Five vacancies are in TACs located in areas impacted by Hurricanes 
Katrina and Rita--three in Louisiana and two in Texas. These shortages 
come at a time when taxpayer visits in these areas may increase and the 
Field Assistance Office is adding services to help reduce the burden on 
taxpayers affected by the hurricanes. As noted earlier, the IRS has 
reported fewer taxpayers are seeking assistance at the TACs.\62\
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    \62\ ``The Field Assistance Office Has Taken Appropriate Actions to 
Plan for the 2006 Filing Season, but Challenges Remain for the Taxpayer 
Assistance Center Program'' (Reference Number 2005-40-037, dated March 
31, 2006).
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    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 IRS's ability to attract new hires and retain existing 
employees. Thus, potential losses in critical occupational groups, 
coupled with concerns regarding grade and competency gaps, further 
emphasize the need to strategically manage human capital. The IRS must 
devote significant attention to managing human capital to overcome the 
10 challenges discussed in this testimony.

                              CONCLUSIONS

    While the 2006 Filing Season appears to have been successful based 
on TIGTA's preliminary results, I am concerned about some of the 
challenges the IRS faces. In particular, it appears that changes in the 
Free File Agreement as well as the elimination of the TeleFile Program 
may have contributed to a significant slowing of the growth in 
electronic filing this year. This slowed growth comes at a time when 
the IRS is still far from reaching Congress's goal of 80 percent 
electronic filing by 2007. This slower growth will defer the efficiency 
gains for the IRS that result from electronic filing.
    Also, without reliable estimates of the tax gap, IRS's compliance 
and customer service efforts may not be as effective as necessary to 
improve the voluntary compliance rate and reduce the tax gap. 
Additionally, reductions in customer services, such as TAC closures, 
the elimination of the TeleFile Program, and a reduction in toll-free 
telephone hours of operation, to gain resource efficiencies must be 
carefully considered before any further decisions are made. TIGTA 
continues to be concerned that the IRS does not ensure that it has 
adequate and reliable data prior to making decisions that impact 
customer service operations. Before proceeding with these efforts, the 
IRS needs to better understand the impact of such changes on taxpayers 
as well as taxpayers' abilities to obtain these services through 
alternative means.
    I hope my discussion of the 2006 Filing Season and some of the 
significant challenges facing the IRS will assist you with your 
consideration of the IRS's fiscal year 2007 appropriations. Mr. 
Chairman and members of the subcommittee, thank you for allowing me to 
share my views. I would be pleased to answer any questions you may 
have.

    Senator Bond. Thank you very much, Mr. George, and we trust 
you will continue to monitor the Katrina emergency filing to 
make sure that people who deserve refunds are getting them and 
only those who deserve them. I think this is a concern that all 
of us share.

STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER ADVOCATE, 
            TAXPAYER ADVOCATE SERVICE
    Senator Bond. Now we turn to Ms. Nina Olson, the National 
Taxpayer Advocate. Ms. Olson, welcome.
    Ms. Olson. Thank you, Mr. Chairman, Senator Murray, and 
Senator Durbin.
    The overriding objective of the IRS should be to maximize 
voluntary compliance with the tax laws. The IRS recently 
estimated that the voluntary compliance rate was 83.7 percent 
in 2001, and it has established a goal of raising the voluntary 
compliance rate to 85 percent by 2009. That is an appropriate 
goal. Compared with 10 years ago, there is little doubt that 
the IRS has become a more responsive and effective 
organization.
    On the customer service side, the IRS Restructuring and 
Reform Act of 1998 and the IRS response has brought about 
fairly dramatic improvements. On the enforcement side, the IRS 
has been stepping up its enforcement of the tax laws over the 
past 5 years, particularly with regard to corporate tax 
shelters and high income individuals, but we can't just rest on 
our recent improvements and say that we are doing good enough. 
The IRS's central responsibility is to ensure that taxpayers 
comply with the tax laws. In fulfilling that responsibility, I 
believe job No. 1 is to provide high-quality outreach, 
education, and taxpayer assistance to enable taxpayers to meet 
their tax obligations voluntarily.
    In most cases, that will be sufficient, but where taxpayers 
are unwilling to comply with the laws, job No. 2 for the IRS 
must be to detect noncompliance where it exists and address it 
through appropriate enforcement action for the IRS getting the 
biggest bang for the buck places a premium on superior research 
and strategic planning. Direct revenue gains resulting from an 
IRS action are easy to measure, but it is the combination of 
direct and indirect revenue gains resulting from IRS actions 
that determine how much progress we are making in reducing the 
tax gap. Not all service and enforcement actions generate the 
same return on investment.
    Will the IRS ultimately bring in more revenue if it spends 
its next dollar on services or enforcement and more 
specifically on which services and on which enforcement 
activities? The truth is we don't know, and we, therefore, have 
limited information on which to base strategic decisions. 
Research is not cheap, but the IRS needs to devote more 
resources to understanding the causes of noncompliance and the 
relative returns of alternative compliance strategies in order 
to do its job more efficiently.
    On the service side, the recently released report on phase 
one of the Taxpayer Assistance Blueprint, or the TAB, is the 
first step toward establishing a long-term strategy for 
delivering needed taxpayer services within existing resource 
limitations. In the next phase of the TAB, we must focus on a 
number of areas that could have significant impact on 
congressional or IRS decisions about service delivery to 
taxpayers. In phase two, we must develop a baseline of 
services. We cannot assume that the current level of services 
reflects taxpayer preferences. The status quo is not 
necessarily what taxpayers want. It is merely what the IRS is 
currently willing or able to deliver.
    We must identify what we are doing now, what we still don't 
know about taxpayer needs, and what services we need to provide 
to meet those needs. We also must identify the best method to 
deliver those needed services, and we must keep in mind that 
there are taxpayers who cannot or will not use self-service 
options.
    To identify which services it should provide, the IRS must 
measure the impact of taxpayer service on compliance. The TAB 
notes that it is difficult to measure this impact. I believe 
the IRS does have the capability to develop useful estimates, 
and in my written testimony, I suggest a general framework for 
conducting this research. For example, we could identify a 
group of taxpayers who receive a particular service and an 
otherwise comparable group who do not receive that service. We 
could then measure the subsequent compliance of both groups by 
applying the three measures the IRS now uses to estimate the 
tax gap: payment compliance, filing compliance, and reporting 
compliance.
    The IRS can also do a better job of estimating the full 
costs of its programs, including what I call the downstream 
consequences of its actions. For example, what are the 
downstream consequences of a lien or a levy, including the 
resources that TAS, the Taxpayer Advocate Service, Appeals 
Council and the courts may ultimately devote to resolving a 
taxpayer challenge? Failure to incorporate these downstream 
costs can provide an extremely inaccurate portrait of a 
program's return on investment. Downstream consequences 
analysis not only tells us the true cost of IRS actions, but it 
also gives us clues as to how to improve our processes from an 
IRS and a taxpayer perspective.

                           PREPARED STATEMENT

    In conclusion, I believe that the IRS has taken major 
strides forward, but it can still do more to deliver its core 
mission more efficiently and effectively. To increase voluntary 
compliance, the IRS should incorporate an ongoing taxpayer-
centric assessment of taxpayer service needs into its strategic 
plans. It should conduct research into the causes of 
noncompliance and apply the resulting knowledge to service and 
enforcement strategies, including those pertaining to the cash 
economy; and, finally, it must have sufficient resources to 
move forward with its technological improvements on both a 
short-term and a long-term basis.
    Thank you.
    [The statement follows:]

                  Prepared Statement of Nina E. Olson

    Mr. Chairman, Ranking Member Murray, and distinguished members of 
the subcommittee, thank you for inviting me to testify today regarding 
the proposed budget of the Internal Revenue Service for fiscal year 
2007.\1\
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    \1\ The views expressed herein are solely those of the National 
Taxpayer Advocate. The National Taxpayer Advocate is appointed by the 
Secretary of the Treasury and reports to the Commissioner of Internal 
Revenue. The statute establishing the position directs the National 
Taxpayer Advocate to present an independent taxpayer perspective that 
does not necessarily reflect the position of the IRS, the Treasury 
Department, or the Office of Management and Budget. Accordingly, 
Congressional testimony requested from the National Taxpayer Advocate 
is not submitted to the IRS, the Treasury Department, or the Office of 
Management and Budget for prior approval. However, we have provided 
courtesy copies of this statement to both the IRS and the Treasury 
Department in advance of this hearing.
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    The overriding objective of the Internal Revenue Service should be 
to maximize voluntary compliance with the tax laws. In general, the IRS 
seeks to achieve compliance through two main types of activity. First, 
it seeks to enable taxpayers to comply with their tax obligations 
voluntarily. In most cases, outreach, education, and taxpayer 
assistance are sufficient to produce complete or substantial 
compliance. Second, it targets its enforcement resources at taxpayers 
who are unwilling to comply with the tax laws.
    While a variety of measures can be applied to measure the IRS's 
performance, one of the best measures is the percentage of taxes that 
taxpayers pay voluntarily. The IRS's most recent estimate of the gross 
tax gap (i.e., the amount of tax unpaid before accounting for late 
payments and collection activity) was $345 billion in tax year 2001, 
which implies a compliance rate of 83.7 percent.\2\ The IRS recently 
established a long-term performance goal of increasing the compliance 
rate to 85 percent by 2009.\3\ In my view, this is a laudable goal.
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    \2\ See IRS News Release IR-2006-28, ``IRS Updates Tax Gap 
Estimates'' (Feb. 14, 2006).
    \3\ Office of Management and Budget, Proposed Budget of the United 
States Government for Fiscal Year 2007, at 232.
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    What steps is the IRS currently taking to maximize voluntary 
compliance? What additional steps should it take? Can the IRS do more 
to reduce the tax gap without intruding unduly on fundamental taxpayer 
rights? These are the key questions I would ask in determining whether 
the IRS is making optimal use of its resources.
    In many respects, the IRS is doing a better job of performing its 
core mission than it did in years past. By the IRS's current objective 
measures, it is providing customer service at a much higher level than 
it did a decade ago. On the enforcement side, it is performing more 
audits and aggressively pursuing corporate tax shelters and 
noncompliance by high-income individuals. However, the IRS's existing 
measures do not adequately capture costs associated with the 
``downstream consequences'' of its programs and planning.\4\
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    \4\ By ``downstream consequences,'' I mean the cost of additional 
work that IRS or taxpayers must perform to correct problems or mistakes 
that result from an IRS action or failure to take an action. For 
example, inadequate taxpayer service may lead to inadvertent taxpayer 
noncompliance, limitations of IRS computer systems may lead to IRS 
rework and direct harm to taxpayers, and inadequate communication with 
taxpayers during the audit process may result in rework via audit 
reconsideration or work performed in Appeals or the Taxpayer Advocate 
Service.
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    To improve, the IRS must conduct an analysis of downstream 
consequences, including their impact on taxpayer service, and 
incorporate the results of that analysis into its strategic plans. 
Without adequate analysis of the downstream consequences of its 
options, the IRS cannot make informed strategic decisions about how to 
allocate resources between taxpayer service and enforcement activities 
and cannot tell its appropriators that it is using its limited 
resources wisely. Moreover, problems with IRS technology create 
additional downstream consequences. The IRS must be funded sufficiently 
to correct problems now with its existing technology--while it 
simultaneously strives to modernize its computer systems.
    In the balance of my testimony, I will identify key issues I 
believe the IRS should address to get the biggest compliance bang for 
its buck.

 THE IRS COULD DO A BETTER JOB OF ALLOCATING ITS RESOURCES PROPERLY IN 
                  ORDER TO INCREASE OVERALL COMPLIANCE

    Over the last 3 years, in hearings before the Senate Finance, 
Budget, and Homeland Security and Governmental Affairs committees, I 
have testified about ways to close the tax gap, both by reducing 
opportunities for noncompliance and by enhancing traditional 
enforcement actions.\5\ In the National Taxpayer Advocate's 2005 Annual 
Report to Congress, I discussed in detail what the IRS can do 
administratively and what Congress can do legislatively to address the 
``cash economy,'' which is the largest component of the tax gap.\6\
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    \5\ See Written Statement of Nina E. Olson, National Taxpayer 
Advocate, Before United States Senate Committee on the Budget on The 
Causes of and Solutions to the Federal Tax Gap (Feb. 15, 2006); Written 
Statement of Nina E. Olson, National Taxpayer Advocate, Before the 
United States Senate Committee on Homeland Security and Governmental 
Affairs Subcommittee on Federal Financial Management, Government 
Information, and International Security (Oct. 26, 2005); Statement of 
Nina E. Olson, National Taxpayer Advocate, Before the United States 
Senate Committee on Finance on the Tax Gap (April 14, 2005); Testimony 
of Nina E. Olson, National Taxpayer Advocate, Before the Senate 
Committee on Finance on The Tax Gap and Tax Shelters (July 21, 2004).
    \6\ National Taxpayer Advocate 2005 Annual Report to Congress 55-
75, 381-396. See also National Taxpayer Advocate 2004 Annual Report to 
Congress 478-489; National Taxpayer Advocate 2003 Annual Report to 
Congress 20-25, 256-269.
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    The question remains, however, whether the IRS is focusing its 
resources in the right direction to close the tax gap. The answer to 
that question depends, in part, on how we measure success. Is the IRS's 
goal merely to increase enforcement revenues? Or is the goal to 
increase compliance? Or is it to increase voluntary compliance?
    As I noted above, approximately 83.7 percent of the tax dollars 
known to be due and owing are voluntarily paid to the IRS. That figure 
is an IRS success, in and of itself. Now, what more can we do to 
achieve compliance with respect to the remaining 16.3 percent of the 
tax dollars for which taxpayers need some ``nudging'' to pay up? What 
types of ``nudging'' should the IRS apply? What resources does the IRS 
need to help these taxpayers comply or, in some instances, make them 
comply? The answers to these questions should inform the IRS's resource 
allocation decisions.
    The IRS is properly focused on increasing its traditional 
enforcement resources, since some taxpayers won't comply unless they 
are ``helped'' in that way. The IRS also needs an enforcement presence 
so that taxpayers are a bit nervous about fudging--or worse--on their 
taxes. Yet, although we may want slightly ``nervous'' taxpayers, we 
don't want them intimidated. That is, when taxpayers have a problem or 
a question, we want taxpayers to call the IRS so they will not make 
mistakes and join the ranks of noncompliant taxpayers. Every time a 
taxpayer calls the IRS or visits a taxpayer assistance center (TAC), 
the resulting interaction gives the IRS an opportunity to help that 
taxpayer comply with the tax laws. Why would we try to minimize these 
opportunities and not make positive use of them when they occur?
    In my view, then, the real challenge facing the IRS is determining 
how to allocate its resources to increase overall compliance, including 
voluntary compliance, and determining what actions it must take--
whether service or enforcement--to increase the number of taxpayers who 
voluntarily comply. In order to answer these questions, we must start 
with an understanding of taxpayer service needs--not what the IRS is 
willing or able to provide taxpayers, but what the taxpayer needs to 
have provided or available. The IRS mantra should be ``know your 
taxpayer.''

THE IRS SHOULD UNDERSTAND MORE ABOUT THE IMPACT OF TAXPAYER SERVICE ON 
    COMPLIANCE AND THE WAYS IN WHICH TAXPAYERS NEED SERVICES TO BE 
                               DELIVERED

    It is true that the IRS has improved its delivery of many aspects 
of taxpayer service over the last decade. However, we cannot just rest 
on this improvement and say that we are doing ``good enough.'' The 
IRS's central responsibility is to ensure that taxpayers comply with 
the tax laws. In fulfilling that responsibility, the IRS must provide 
taxpayers with the service, assistance, and education they need to 
comply. What we must consider now is just what level of service, 
assistance, and education is necessary for compliance.
    I define taxpayer service very broadly--it includes notice clarity, 
tax law assistance, account resolution, free tax preparation, free e-
filing, short response time, clear forms, and excellent education 
initiatives. This broad definition of taxpayer service makes clear its 
impact on compliance. Where noncompliance is attributable to complexity 
or confusion, for example, better forms, notices, and education 
initiatives can reduce the need for enforcement action.
    Acknowledging the impact taxpayer service has on compliance, 
Congress directed the IRS, its Oversight Board, and the National 
Taxpayer Advocate to develop a 5-year plan for taxpayer service that 
includes long-term goals that are strategic and quantitative and that 
balance enforcement and service.\7\ I have previously voiced my 
concerns about the IRS's need to study the trends in taxpayer service 
in order to understand the impact of taxpayer service on compliance and 
how taxpayers need services to be delivered.\8\
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    \7\ S. Rep. No. 109-109, at 133-134 (2005).
    \8\ Statement of Nina E. Olson, National Taxpayer Advocate, Before 
the United States House Appropriations Subcommittee on Transportation, 
Treasury, and Housing and Urban Development, the Judiciary, District of 
Columbia, and Related Agencies (March 29, 2006); National Taxpayer 
Advocate 2005 Annual Report to Congress 2-24; Statement of Nina E. 
Olson, National Taxpayer Advocate, Before the United States Senate 
Appropriations Subcommittee on Transportation, Treasury, the Judiciary, 
Housing and Urban Development, and Related Agencies (Apr. 7, 2005).
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    The IRS is facing a challenge. It has a responsibility to serve all 
taxpayers with limited resources. Thus, it must decide by taxpayer 
segment how to deliver needed services in the most effective and 
efficient manner possible, and in a way that does not negatively impact 
taxpayers' ability to comply with the tax laws. Toward this end, the 
IRS must gather data and develop criteria to make those decisions. The 
recently released report on Phase I of the Taxpayer Assistance 
Blueprint (TAB) is the first step toward developing a comprehensive 5-
year plan for taxpayer service that will establish a long-term strategy 
for delivering needed taxpayer services within existing resource 
limitations.
    In Phase I, we gathered both primary and secondary data about 
taxpayer needs and preferences. We also collected some information 
about our current level of services offered to taxpayers. From this and 
other information, we developed five hypotheses or ``themes'' that we 
think will improve service to taxpayers. However, Phase I is only the 
beginning. Phase II of the TAB will be even more critical because the 
goal of Phase II should be to test those hypotheses. To determine 
whether any of the hypotheses is correct, we must collect more primary 
source data about taxpayer service needs. We must then identify the 
gaps between taxpayer service needs and our present service offerings 
by analyzing how well our current level and type of service is actually 
serving different taxpayer segments. We will then see whether our 
hypotheses would improve service to different taxpayer segments.
    I applaud the dedicated work of the IRS team that has labored over 
this strategic plan and gathered important information over the last 5 
months. While we embark on the next phase of the TAB, we must focus on 
a number of areas that could have significant impact on Congressional 
or IRS decisions about service delivery to taxpayers.
    We must develop a baseline of services.--This baseline should 
consist of specific numbers addressing how well the IRS is currently 
meeting customer service preferences and needs by service, taxpayer 
segment, and delivery method. Although the TAB Phase I report states 
that the current baseline of taxpayer services is one item on which the 
strategic improvement themes of the report are predicated, I do not 
believe this statement is completely accurate. Throughout the TAB Phase 
I report, we examine the current usage and volume of current IRS 
services. However, these current usage statistics do not serve as a 
proxy for taxpayer preference. We cannot assume that the current level 
of service reflects taxpayer preferences. The status quo is not 
necessarily what taxpayers want--it is merely what the IRS has been 
willing (or able) to deliver. Instead, during Phase II, we must conduct 
research to develop this baseline of services. Only after this research 
is completed will we be able to measure how effective we are in 
improving our ability to meet taxpayer needs.
    We must identify what we don't know.--Before we can move forward 
with our research in Phase II, we need to understand what we still need 
to know and what questions we need to ask in order to find the right 
answers. It is important that the TAB not rely on pre-conceived 
decisions, but instead identify what we are doing now, what we still do 
not know about taxpayer needs, and what we need to do to address those 
needs or educate taxpayers and move them to other channels.
    We must identify the best channels through which to deliver 
services to taxpayers.--While electronic and self-assistance channels 
may be growing in popularity, mere use or access to these services does 
not necessarily mean that taxpayers are able to frame questions, 
conduct complex searches, and process or use the information correctly. 
Additionally, we must always remain cognizant that there is a segment 
of the population that cannot and will not avail itself of self-service 
options. However, by providing more self-service opportunities for 
taxpayers, the IRS should be able to reserve its in-person (face-to-
face or telephone) interaction for those issues and taxpayers that need 
such engagement.
    Thus, as part of the TAB, the IRS must commit to conduct--or at 
least to attempt to conduct--the additional research necessary to 
enable it to establish a broad baseline identifying how well taxpayer 
needs and preferences are currently being met for each of the major 
types of services by customer segment and channel--and to quantify the 
impacts associated with not meeting those needs (i.e., the downstream 
costs and taxpayer-compliance impact). Moreover, we need to understand 
why certain taxpayer segments have difficulties with our various types 
of services and why they are reluctant to use lower cost channels (if 
indeed they are). Only then can we develop effective ``migration'' 
strategies to encourage and educate taxpayers about appropriate lower 
cost channels--ones that will not ultimately increase noncompliance and 
lead to greater downstream costs.
    For example, it is true that computer ownership and Internet access 
have increased over the last decade.\9\ But those numbers do not 
necessarily mean that the computer owner is computer literate and can 
conduct site searches for complex tax information, much less understand 
how to apply that information once he finds it. In fact, in the 
financial services sector, banks have reversed the trend of closing 
branches in the hope of moving taxpayers to Internet banking.\10\ 
Instead, they are developing migration strategies for customers to 
complete certain types of transactions on-line or by phone, and are 
retaining their in-person services for more complicated transactions or 
for those customers who really cannot navigate the phones or Internet. 
Banks are certainly not turning those customers away, and now recognize 
that those customer segments are a relatively untapped market in need 
of services. There are lessons here for the IRS.
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    \9\ Internal Revenue Service, Wage and Investment Office of 
Research, ``Taxpayer of the Future'' (June 2003), 11.
    \10\ Bruce C. Smith, ``In Age of Online Banking, Lenders Branch 
Out'', Indianapolis Star (Oct. 2, 2005), available at http://
www.indystar.com/apps/pbcs.dll/article?AID=/20051002/BUSINESS/
510020335.
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 the irs should work with ``partners'' but not rely on them excessively
    The IRS is increasingly relying on partners to deliver core IRS 
services. Clearly, partners are very important to effective tax 
administration, and I applaud the efforts of dedicated professionals 
and volunteers in assisting taxpayers. However, this reliance raises 
several concerns. First, when the IRS relies on partners to deliver a 
message, we need to study what happens to the message in the course of 
delivery. Does the message change over distance and time? Is it less 
accurate? The worst result is a broad dispersion, through partners, of 
an incorrect or distorted message. Second, we need to measure the 
downstream consequences of this trend. What are the true costs of 
effective oversight over these partners? Who conducts such oversight 
and bears the cost? If taxpayers bear the cost, will they continue to 
comply if the cost is too great or the quality too poor? Will the IRS 
actually realize any savings or will it incur more expense through 
additional enforcement activity that could be avoided if the IRS itself 
delivered the assistance?
    On the other hand, if we begin to rely more heavily on our partners 
for the delivery of services, we must also ensure that we are providing 
our partners with adequate support and assistance. Without a sufficient 
support system in place, we cannot expect our partners to act as a 
delivery channel for services we are unable or unwilling to provide.
    Finally, we don't know what the impact on compliance or what the 
downstream cost will be if most of the IRS's direct contact with 
taxpayers is in the form of enforcement actions and most taxpayer 
assistance and service is delivered by third parties. As the IRS 
becomes more remote, except with respect to enforcement actions, will 
noncompliance increase because taxpayers feel less connection with 
their government? \11\
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    \11\ See Leslie Book, ``The Poor and Tax Compliance: Once Size Does 
Not Fit All'', 51 Kan L. Rev. 1145, 1151, 1175-1176 (2003). Professor 
Book discusses various studies that note that enforcement may be more 
effective in addressing intentional noncompliance where the taxpayer 
segment is disaffected from government and society at large. On the 
other hand, ``taxpayers who felt a shared identity with authorities 
seem to be more concerned with the overall justice of the tax system 
and the fairness of their treatment, regardless of individual 
outcome.'' Id. at 1151 n. 21.
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THE IRS SHOULD NOT IMPOSE UNREASONABLE BURDENS ON VOLUNTEER INCOME TAX 
                       ASSISTANCE (VITA) PROGRAMS

    As the IRS struggles with the challenge of serving all taxpayers 
with limited resources, we have already begun to reduce free tax 
preparation assistance previously provided to taxpayers. Over the past 
3 years, the IRS has reduced the number of tax returns prepared in 
Taxpayer Assistance Centers (TACs) from 665,868 tax returns in fiscal 
year 2003 to a proposed 305,000 tax returns in fiscal year 2006.\12\ 
Instead, the IRS has increased its reliance on the Volunteer Income Tax 
Assistance (VITA) Program to fill the gap and provide free tax 
preparation assistance to taxpayers.\13\ As IRS service has decreased, 
the VITA Program continues to expand. However, this expansion may have 
come too fast.
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    \12\ Wage and Investment, ``Business Performance Review, Wage and 
Investment Operating Division, Fiscal Year 2006''; Wage and Investment, 
``Business Performance Review, Wage and Investment Operating Division, 
Fiscal Year 2005''; Wage and Investment, ``Business Performance Review, 
Wage and Investment Operating Division, Fiscal Year 2004''; Wage and 
Investment, ``Business Performance Review, Wage and Investment 
Operating Division, Fiscal Year 2003''.
    \13\ The VITA Program was designed to provide free tax preparation 
to individuals who are unable to afford professional assistance. 
Stakeholder Partnerships, Education and Communication, ``VITA 
Celebrates Its Thirtieth Year of Service''. VITA is a diverse program 
comprising several segments, including community-based VITA, academic 
VITA, military VITA, Tax Counseling for the Elderly (TCE), and co-
located VITA, each serving a different taxpayer population.
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    The VITA Program provides a vital service to an underserved segment 
of taxpayers, but there are limits to what volunteers and volunteer-
staffed organizations can do. Although there are a number of successful 
volunteer organizations around the world, hallmarks of these success 
stories are that they are year-round organizations supported by a 
large, paid infrastructure dedicated to the support of the volunteers. 
The VITA Program primarily operates for 4 months during the tax season 
and receives limited resources and support from the IRS. This makes it 
hard to ensure quality and consistency in the returns prepared at VITA 
sites.
    While the service VITA provides is critical, the IRS cannot rely 
entirely on these volunteers to provide a service the IRS has deemed 
too costly or time consuming to provide itself. Instead of 
concentrating on expanding the VITA Program, the IRS should concentrate 
on developing a fundamental support structure for the program, 
including site management, training, and quality review.\14\ Once the 
IRS has developed a strong infrastructure for the VITA Program and has 
established consistent quality in the returns prepared by volunteers, 
then the IRS can work to expand the program. However, the IRS must 
remain cognizant that VITA, or any volunteer program, cannot and should 
not be expected to serve as a substitute for IRS-provided service.
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    \14\ The IRS has taken a step in the right direction with the 
development of the Link & Learn training site which allows volunteers 
to receive training and become certified online. According to IRS data, 
the new training program has proven successful and the number of 
certifications issued for 2006 was 11,885, compared with 10,402 
certifications issued as of the same time last year.
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THE IRS SHOULD MAKE IT POSSIBLE FOR TAXPAYERS TO PREPARE AND FILE THEIR 
            TAX RETURNS ELECTRONICALLY WITHOUT PAYING A FEE

    Electronic filing of tax returns brings benefits to both taxpayers 
and the IRS.\15\ From a taxpayer perspective, e-filing eliminates the 
risk of IRS transcription errors, pre-screens returns to ensure that 
certain common errors are fixed before the return is accepted, and 
speeds the delivery of refunds. From an IRS perspective, e-filing 
eliminates the need for data transcribers to input return data manually 
(which could allow the IRS to shift resources to other high priority 
areas), allows the IRS to easily capture return data electronically, 
and enables the IRS to process and review returns more quickly.\16\
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    \15\ See S. Rep. No. 105-174, at 39-40 (1998).
    \16\ The IRS Restructuring and Reform Act of 1998 directed the IRS 
to set a goal of having 80 percent of all returns filed electronically 
by 2007. See Internal Revenue Service Restructuring and Reform Act, 
Pub. L. No. 105-206,  2001(a)(2), 112 Stat. 685 (1998). The 80 percent 
e-filing goal is probably not achievable by 2007. However, we believe 
Congress should reiterate its commitment to seeing the IRS increase the 
e-filing rate as quickly as possible.
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    In my view, the IRS should place a basic, fill-in template on its 
website and allow any taxpayer who wants to self-prepare his or her 
return to do so and file it directly with the IRS for free.\17\
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    \17\ See National Taxpayer Advocate 2004 Annual Report to Congress 
471-477 (Key Legislative Recommendation: Free Electronic Filing for All 
Taxpayers).
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    Some representatives of the software industry have taken the 
position that such a template would place the IRS in the position of 
improperly competing with private industry or, worse, create a conflict 
of interest between the IRS's role of tax preparer and tax auditor.
    This is nonsense. Since the inception of the tax system, there have 
always been two categories of taxpayers--those who are comfortable 
enough with the rules to self-prepare their returns and those who turn 
to paid professionals for assistance. In the paper-filing world, the 
IRS has always made its forms and instructions universally available 
without charge to all taxpayers, and those taxpayers who require help 
have always been free to seek the assistance of paid preparers.
    Imagine that, shortly after the income tax was enacted, a large 
group of bricks-and-mortar tax preparers had launched a lobbying 
campaign to try to persuade Congress to prohibit the IRS from making 
forms and instructions available to the public on the ground that the 
availability of these materials improperly placed the government in the 
position of competing with private industry. Or on the ground that it 
created a conflict between the government's role as preparer and 
auditor. Congress almost certainly would have rejected such arguments 
as ludicrous. Yet those are exactly the same conceptual arguments being 
raised today by those who contend that the government's provision of a 
basic web-based, fill-in form to all taxpayers would undercut the 
private sector.
    The answer to these arguments in today's electronic environment 
should be the same answer that Congress would have provided 80 years 
ago in a paper environment. For those taxpayers who are comfortable 
preparing their returns without assistance, the government will provide 
the means to do so without charge. For those taxpayers who do not find 
a basic template sufficient and would prefer to avail themselves of the 
additional benefits of a sophisticated software program, they are free 
to purchase one.
    A brief personal anecdote. Although I prepared tax returns 
professionally for 27 years before I became the National Taxpayer 
Advocate and don't need assistance from others to prepare my return, my 
government salary places me above the income cap to qualify to use Free 
File products. To prepare my return electronically last month, I 
therefore spent $19.99 to purchase tax preparation software. When I 
completed preparing my return, the software program informed me that, 
to file electronically, I would have to pay a fee of $14.95. If I 
wanted this fee deducted from my refund rather than charged to a credit 
card, an even higher fee would apply. Although I deeply believe that e-
filing is best for both taxpayers and the IRS for a host of reasons, I 
resented the notion that I would have to pay separate fees to prepare 
my return and to file it, so I printed out my return and mailed it in.
    I am hardly alone. IRS data shows that about 40 million returns are 
prepared using software yet are mailed in rather than submitted 
electronically.\18\ This is a shame, because the practice delays the 
length of time for processing refunds, it requires the IRS to devote 
additional resources to entering the data manually when it receives the 
return, and it creates a risk of transcription error.
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    \18\ IRS Tax Year 2004 Taxpayer Usage Study (Aug. 26, 2005).
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    There is no reason why taxpayers should be required to pay 
transaction fees in order to file their returns electronically. A free 
template and direct filing portal would go a long way toward addressing 
this problem and would result in a greater number of taxpayers filing 
their returns electronically. Both taxpayers and the government would 
stand to benefit.\19\
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    \19\ In addition to benefiting taxpayers and the IRS, I believe 
this proposal would be good for the software industry. Under the 
existing Free File arrangement, the industry is making its Federal tax 
products available for free to tens of millions of taxpayers. By 
itself, that is hardly a recipe for business success. If industry is 
able to make a profit under this arrangement, it is only because it is 
aggressively marketing ancillary products to taxpayers and making money 
on the sale of those ancillary products. The provision of a basic 
preparation and filing option would enable taxpayers who don't want to 
pay a fee and know how to prepare their tax returns to do so, but all 
taxpayers who want the benefits of a question-and-answer format and 
checks to ensure they do not overlook any tax benefits to which they 
are entitled would have to pay to purchase the tax product. Moreover, 
the IRS would be unlikely to develop a template itself. The IRS almost 
certainly would contract with the private sector to develop it. In that 
respect, the IRS would be utilizing the innovation of the private 
sector--not competing with it.
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   THE IRS CAN AND SHOULD DO A BETTER JOB OF MEASURING THE IMPACT OF 
                     TAXPAYER SERVICE ON COMPLIANCE

    The Taxpayer Assistance Blueprint notes that it is difficult to 
measure the impact of taxpayer service on compliance. Of the private 
sector and government entities that the TAB team surveyed, all had 
concluded that customer service at least indirectly impacts their 
organizations, but only one had attempted to empirically measure that 
impact.
    Although little has been done in this area, I believe the IRS does 
have the capability to develop useful estimates, and am suggesting a 
general framework for conducting this research. Measuring the 
compliance impact of customer service would entail identifying a group 
of taxpayers who received a particular service (the ``treatment 
group'') and an otherwise comparable group that did not receive that 
service (the control group). Compliance of both groups could then be 
measured on returns filed subsequent to the receipt of service by the 
treatment group. The three measures used to estimate the tax gap could 
be applied: payment compliance, filing compliance, and reporting 
compliance.
    We can determine the payment compliance of survey respondents by 
simply observing whether the full tax liability was paid at the time of 
filing. We can estimate their filing compliance by determining whether 
non-filers appeared to have a filing requirement. To determine 
reporting compliance, by far the biggest component of the tax gap, we 
could use IRS developed algorithms for estimating reporting compliance. 
These algorithms have been updated based on results from the recently 
completed National Research Program (NRP) and should provide good 
preliminary estimates. The estimates could subsequently be validated 
during the next NRP by comparing actual reporting compliance against 
predicted reporting compliance based on the IRS algorithms.

                      MEASURING THE DIRECT EFFECT

    If we accept the above proposed framework as a valid means of 
estimating compliance, surveys could then be designed and administered 
to identify groups of taxpayers who did or did not receive certain 
services, such as telephone or Internet assistance with tax law 
questions, Internet or TAC assistance obtaining forms, etc. Subsequent 
compliance of those who receive the service could then be compared to 
compliance for a comparable group who do not. Taxpayer satisfaction 
with services received might also be an interesting variable to 
examine.

                       MEASURING INDIRECT EFFECTS

    It is possible that taxpayer compliance behavior may be influenced 
by knowledge and attitudes about IRS customer service offerings, even 
if the affected taxpayers have not used those services. The same basic 
proposed framework could be used to measure these indirect effects. We 
would have to determine a set of relevant attributes to identify 
taxpayer groups indirectly affected by IRS customer service offerings. 
It seems to me that such attributes would probably include use, 
awareness, access and general satisfaction level:
  --Use.--To be indirectly affected, a taxpayer could not have used the 
        service in question (at least during the year being studied).
  --Awareness.--A taxpayer would have to be aware of the existence of a 
        service to be influenced by it.
  --Access.--It seems likely that taxpayers who could access the 
        service if they chose to are more likely to be influenced 
        (e.g., those living close to a TAC).
  --Satisfaction Level.--It seems likely that taxpayers having a 
        generally favorable level of satisfaction with our services are 
        more likely to be positively influenced (and vice versa).
    Surveys could be administered to determine whether compliance was 
impacted based on the values for the above attributes (or others 
suspected of indirectly affecting compliance).

                           RETURN PREPARATION

    The IRS has data that enable us to estimate compliance for the 
entire population of returns by type of preparation: IRS prepared, 
VITA/TCE, commercial, taxpayer prepared. I think it would be 
interesting to compare estimated reporting compliance for IRS prepared 
returns against comparable returns (i.e., low income, especially EITC) 
prepared by the other methods. We might find that IRS-prepared returns 
are substantially more compliant--especially when EITC is claimed. If 
so, this would provide strong support for continuing and perhaps 
expanding return preparation in the TACs.

 THE IRS SHOULD INCLUDE THE COST OF THE DOWNSTREAM CONSEQUENCES OF ITS 
         ACTIONS IN ITS RETURN ON INVESTMENT (ROI) CALCULATIONS

    The IRS needs to conduct more thorough and accurate analyses when 
measuring return on investment (ROI) in order to allocate future 
dollars appropriately. For example, although in the short run it may 
cost more to process and review an Offer in Compromise and it may 
appear that the government is writing off revenue, the taxpayer in the 
long run may pay more tax dollars into the system as a result of his 
promise to be fully compliant for the 5 succeeding years.\20\ Five 
years is a long enough period to enable the taxpayer to ``learn'' a new 
norm of behavior, namely, compliance. And when you compare the 16 cents 
on the dollar that IRS receives from offers \21\ to the virtually no 
cents it collects after year 3 of the 10-year collection period,\22\ 
the Offer in Compromise suddenly looks like a very efficient and 
productive program.
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    \20\ If a taxpayer fails to comply with all his tax obligations 
over the 5-year period following IRS acceptance of an offer, the IRS 
may rescind the offer and reinstate the tax debt. See IRS Form 656, 
Offer in Compromise.
    \21\ IRS Small Business/Self Employed Division, Offer In Compromise 
Program, ``Executive Summary Report'' (Jan. 2006).
    \22\ IRS Automated Collection System Operating Model Team, 
``Collectibility Curve'' (August 5, 2002).
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    When computing ROI, the IRS should include the costs of the 
downstream consequences of its enforcement actions. Downstream 
consequences analysis tells us not only true ROI (i.e., the true cost 
to the IRS) but also gives us clues as to how to improve our processes 
from an IRS and a taxpayer perspective. That is, downstream 
consequences analysis is a form of taxpayer service.
    The Criminal Investigation Division's Questionable Refund Program 
(QRP) is a recent example of the failure to capture an accurate return 
on investment. The QRP serves an important tax administration purpose 
by helping the IRS detect and prevent the payment of fraudulent refund 
claims.\23\ Criminal Investigation (CI) dedicates approximately 600 
Full Time Equivalents (FTEs) to this program. As we described in the 
National Taxpayer Advocate's 2005 Annual Report to Congress, the QRP 
was freezing hundreds of thousands of refunds each year without 
notifying the affected taxpayers. This failure to notify taxpayers that 
their refunds were being held generated more taxpayer calls to the IRS 
toll-free lines and to the Taxpayer Advocate Service (TAS) than CI 
could respond to in a timely fashion.
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    \23\ For a detailed discussion of the Questionable Refund Program, 
see National Taxpayer Advocate 2005 Annual Report to Congress 25-54.
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    In fiscal year 2005, the Taxpayer Advocate Service (TAS) received 
over 28,000 QRP cases. In TAS's office in the Atlanta campus, 
approximately 65 percent of case inventory per case advocate involves 
QRP. Moreover, during fiscal year 2005, the IRS Examination function 
reviewed 25,621 QRP cases, and some of those cases went on to the IRS 
Appeals function. This level of activity protected approximately $2.2 
billion in fiscal year 2004, of which $1.8 billion was attributable to 
just two returns that should have been discovered anyway, particularly 
since the Joint Committee on Taxation must review any refund over $2 
million. So, the maximum direct revenue protection generated by all 
that IRS activity was $400 million. In addition, my office found in a 
study of the 28,000 QRP cases that came to TAS that fully 80 percent of 
taxpayers whose refunds were frozen as potentially fraudulent 
ultimately were found to be entitled to a full or partial refund. Had 
the IRS actually tracked the downstream consequences of the QRP and 
included these costs in the program's ROI, the IRS probably would have 
figured out a way to protect the same level of revenue with fewer FTE 
or developed a better method of identifying cases with the same CI FTE 
that did not generate the need for phone, exam, Appeals, and TAS FTE--
not to mention interest the IRS is having to pay to tens of thousands 
of taxpayers whose refunds were frozen unnecessarily.
    The QRP is a prime example of an IRS program that grew up over time 
without the benefits of true strategic planning or proper oversight. 
Despite the volume of taxpayer calls coming in on our toll-free lines 
about these refunds, the Fraud Detection Centers have limited capacity 
to make or receive phone calls. Thus, their processes are designed to 
avoid any direct or interactive contact with taxpayers or others. As 
TIGTA noted in several reports,\24\ the QRP has inadequate management 
oversight processes, including inadequate reports of inventory levels 
and case status. Further, the little taxpayer correspondence generated 
by QRP was uninformative and intimidating. Today, the IRS is scrambling 
to meet the terms of its agreement with my office as to how it will 
correct these program deficiencies. Each day we face challenges, 
primarily arising from system limitations in reprogramming.\25\
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    \24\ Treasury Inspector General for Tax Administration, ``The 
Internal Revenue Service Needs to Do More to Stop the Millions of 
Dollars in Fraudulent Refunds Paid to Prisoners'' (Ref. No. 2005-10-
164) (September 2005); Treasury Inspector General for Tax 
Administration, ``Improvements Are Needed in the Monitoring of Criminal 
Investigation Controls Placed on Taxpayers' Accounts When Refund Fraud 
Is Suspected'' (Ref. No. 2003-10-094) (March 31, 2003); Treasury 
Inspector General for Tax Administration, ``Revised Questionable Refund 
Program Procedures Were Not Consistently Implemented'' (Ref. No. 2001-
40-025) (Jan. 2, 2001); Treasury Inspector General for Tax 
Administration, ``The Internal Revenue Service Can Improve the 
Effectiveness of Questionable Refund Detection Team Activities'' (Ref. 
No. 2000-40-018) (Dec. 22, 1999).
    \25\ The National Taxpayer Advocate believes that the QRP will only 
function properly, productively, within the norms of taxpayer rights, 
and without creating excessive downstream consequences if it is moved 
out of the sole jurisdiction of CI and into a collaborative arrangement 
between CI and either the Wage & Investment or Small Business/Self-
Employed Operating Division. This approach reflects the current model 
for the Frivolous Filer program.
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  IRS STRATEGIC PLANNING AND RESOURCE ALLOCATION DECISIONS SHOULD BE 
                   BASED ON MORE AND BETTER RESEARCH

    The need for better research underlies all of these challenges. The 
IRS must conduct research, organized by taxpayer segment, to better 
understand taxpayer behavior and taxpayer response to IRS's various 
service and enforcement ``touches.'' The absence of research about 
taxpayer needs often leads the IRS to place its immediate resource 
needs over taxpayers' immediate and long-term needs.\26\ This approach 
may cause more taxpayers to become noncompliant, thereby requiring more 
expensive enforcement actions. Concern over the lack of research and 
taxpayer-centric strategic planning led Congress to enact Section 205 
of the fiscal year 2006 Appropriations Act funding the IRS and to 
direct the IRS to develop a 5-year strategic plan for taxpayer 
service.\27\
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    \26\ The declining number of Taxpayer Assistance Center (TAC) 
visits is an example of IRS placing its resource needs over taxpayer 
needs. For fiscal year 2006, IRS established a goal of preparing 20 
percent fewer tax returns in TACs than in fiscal year 2005. Not 
surprisingly, TAC visits for year-to-date fiscal year 2006 have 
declined 14 percent compared with this time last year. Even though the 
decline in TAC usage appears to result from IRS-imposed limitations on 
service, the IRS is nonetheless citing this decline as a justification 
for making further reductions in service at the TACs. Wage & 
Investment, ``2006 Filing Season Data: Cumulative Statistics Report'' 
(Feb. 25, 2006).
    \27\ Public Law No. 109-115,  205, 119 Stat. 2396 (2005). 
Specifically, the statute provides:
    ``None of the funds appropriated or otherwise made available in 
this or any other Act or source to the Internal Revenue Service may be 
used to reduce taxpayer services as proposed in fiscal year 2006 until 
the Treasury Inspector General for Tax Administration completes a study 
detailing the impact of such proposed reductions on taxpayer compliance 
and taxpayer services, and the Internal Revenue Service's plans for 
providing adequate alternative services, and submits such study and 
plans to the Committees on Appropriations of the House of 
Representatives and the Senate for approval: . . . Provided further, 
That the Internal Revenue Service shall consult with stakeholder 
organizations, including but not limited to, the National Taxpayer 
Advocate, the Internal Revenue Service Oversight Board, the Treasury 
Inspector General for Tax Administration, and Internal Revenue Service 
employees with respect to any proposed or planned efforts by the 
Internal Revenue Service to terminate or reduce significantly any 
taxpayer service activity.''
    The accompanying Joint Explanatory Statement of the Committee of 
Conference stated: ``The conferees direct the IRS, the IRS Oversight 
Board and the National Taxpayer Advocate to develop a 5-year plan for 
taxpayer service activities . . . The plan should include long-term 
goals that are strategic and quantitative and that balance enforcement 
and service.'' H. Rep. No. 109-307, 209 (2005).
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    I have written at length elsewhere on the need to understand the 
causes of noncompliance so that the IRS doesn't adopt a one-size-fits-
all enforcement approach.\28\ Each year, academics and other scholars 
propose many ideas that a 21st century tax administrator should be 
examining and testing. In fact, the IRS has such a vehicle for 
partnering with academics in the Intergovernmental Personnel Act (IPA) 
program. Unfortunately, this program is underutilized. The IRS must 
conduct and underwrite such applied research, just as other world-class 
tax administration systems do.
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    \28\ See National Taxpayer Advocate 2004 Annual Report to Congress 
211 (Most Serious Problem: IRS Examination Strategy) and 226 (Most 
Serious Problem: IRS Collection Strategy); National Taxpayer Advocate 
2005 Annual Report to Congress 55 (Most Serious Problem: The Cash 
Economy); Written Statement of Nina E. Olson, National Taxpayer 
Advocate, Before the Subcommittee on Federal Financial Management, 
Government Information, and International Security, Committee on 
Homeland Security and Governmental Affairs, United States Senate, on 
``The Tax Gap'' (Oct. 26, 2005); Written Statement of Nina E. Olson, 
National Taxpayer Advocate, Before the Committee on the Budget, United 
States Senate, on ``The Causes of and Solutions to the Federal Tax 
Gap'' (Feb. 15, 2006).
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    Because taxpayer service and enforcement are the drivers of overall 
compliance, we need to measure taxpayer service needs concurrently with 
our efforts to measure the tax gap. Thus, the National Research Program 
should update its analysis of taxpayer service needs at the same time 
it is measuring taxpayer noncompliance for the particular taxpayer 
population it is studying. The IRS can make informed resource 
allocation decisions only if it is armed with both types of 
information.

THE IRS SHOULD ADDRESS THE IMPACT OF IRS BUSINESS SYSTEMS MODERNIZATION 
    LIMITATIONS ON BOTH TAXPAYER SERVICE AND ENFORCEMENT INITIATIVES

    When I was in private practice as an attorney representing clients 
before the IRS, I did not have a full appreciation of how significant a 
role Business Systems Modernization (BSM) plays in both creating and 
solving problems for taxpayers and the IRS. As the National Taxpayer 
Advocate, I know that on a regular basis my office identifies systemic 
problems for which the complete solution requires some sort of BSM fix.
    When Commissioner Everson began his tenure, he ordered three 
separate reviews--two external, one internal--of the state of IRS BSM 
projects. Based on these reviews, the Commissioner quickly--and, I 
believe, correctly--concluded that the IRS was spreading its internal 
BSM resources too thin. Project managers and experts charged with 
overseeing our key initiatives--such as the Integrated Financial System 
(IFS) and the Customer Account Data Engine (CADE)--were also managing 
scores of smaller projects, all more or less important but all 
detracting from our central progress on IFS and CADE.
    For the past 2 years, the IRS has focused on its primary projects 
and strictly controlled the number of other BSM projects. This approach 
makes sense because it is critical to both effective service and 
enforcement that the IRS move forward with its primary initiatives. On 
the other hand, many projects cannot be deferred too much longer 
without significantly impacting taxpayer rights, accuracy of taxpayer 
data, and effective examination and collection initiatives. Indeed, 
improvements to TAS's own Systemic Advocacy Management System, our 
database for receiving, tracking, and managing taxpayer and IRS 
employee submissions of systemic problems in tax administration, were 
requested in November 2004. Although worked on intermittently, these 
changes are not yet completed or delivered. Until recently, this 
project was ranked number 33 on a list of 33 projects in terms of 
priority.
    I will provide one illustration of the impact of the IRS's outdated 
computer systems. In the National Taxpayer Advocate's 2004 Annual 
Report to Congress, I reported that the IRS is miscalculating 
collection statute expiration dates on certain taxpayer accounts. The 
collection statute expiration date (CSED) represents the date beyond 
which the taxpayer is no longer obligated on a tax debt and the IRS 
must cease its collection efforts.\29\ Miscalculations of CSEDs can 
negatively affect a taxpayer when the CSED on a particular tax 
erroneously appears on the IRS computer systems as being within the 
statute of limitations period, resulting in continued IRS collection 
activity, when in fact the statutory period for collections has 
expired. An incorrectly calculated CSED can also negatively impact the 
IRS when the CSED is miscalculated to reflect that the statute of 
limitations period has expired when in fact the debt is still 
collectible.\30\ This problem continues today and harms tens of 
thousands of unsuspecting taxpayers. Where the IRS or the taxpayer 
identifies a case of unlawful collection, the taxpayer experiences 
delays in receiving a return of the unlawfully levied proceeds. In some 
instances, the IRS takes the position that the taxpayer will never 
receive the unlawfully levied funds because the refund is barred by the 
applicable statutory period of limitations.
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    \29\ IRC  6502(a)(1).
    \30\ National Taxpayer Advocate 2004 Annual Report to Congress 180-
192.
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    In response to TAS's concerns, the IRS and TAS established a joint 
team that identified impacted taxpayers, developed additional guidance 
and training alerts, and submitted requests for systems improvements to 
eliminate the problem of incorrectly calculated CSEDs. Given the 
current demand on IRS programming personnel, the final system 
modifications are not now scheduled to occur until some time in 2007.
    Internal Revenue Code Section 7433 permits a taxpayer to file a 
civil action for damages against the United States in Federal district 
court where an IRS officer or employee disregards any provision of the 
Code or its regulations with respect to collection of tax. In general, 
damages under this provision are limited to $1 million where the breach 
is attributable to reckless or intentional disregard and $100,000 where 
it is attributable to negligence. Thus, the IRS's knowing failure to 
correct the CSED problem in a timely fashion exposes the government to 
potentially large damages.

  THE IRS'S FILING AND PAYMENT COMPLIANCE (F&PC) INITIATIVE SHOULD BE 
                            MADE A PRIORITY

    Filing and Payment Compliance (F&PC) is one of the IRS's most 
important business modernization initiatives.\31\ The F&PC initiative 
was designed to offer the IRS a modernized collection system with a 
focus on applying the right collection ``touch'' to suit the 
characteristics of the case. Instead of the automatic three-stage IRS 
collection process that does not differentiate among the causes of non-
compliance,\32\ the implementation of F&PC was going to establish four 
treatment streams for collection cases:
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    \31\ Testimony of Internal Revenue Service Commissioner Mark W. 
Everson, Before the Senate Committee on Appropriations Subcommittee on 
Transportation, Treasury, the Judiciary, Housing and Urban Development 
and Related Agencies (April 7, 2005).
    \32\ In the 2004 Annual Report to Congress, we set forth a critique 
of the IRS's traditional approach to collection and identified the 
elements of a modern collection strategy, including the ability to 
identify the appropriate collection touch for the particular cause of 
noncompliance. National Taxpayer Advocate 2004 Annual Report to 
Congress 226.
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  --Self-Assist/Self-Correct.--Using enhanced systems, the IRS would 
        allow for electronic payment, Internet-based payment, and 
        payment via telephone application. Thus, taxpayers would have 
        more payment options to resolve delinquency issues.
  --Assisted Correction.--Using commercially available decision 
        analytic software, the IRS would select the appropriate 
        treatment for taxpayers depending on factors such as payment 
        history and other actions taken by the taxpayer. Modernized 
        systems would provide up-to-date taxpayer information so that 
        decisions would be made on the most recent data.
  --Private Collection Agencies.--The IRS proposed using private 
        collectors to locate and contact taxpayers, request that full 
        payment be sent to the IRS, and in appropriate cases, request 
        taxpayer financial information. While we are extremely 
        concerned about the use of private collectors and about the 
        structure being put in place to support the initiative,\33\ its 
        use in conjunction with other appropriate treatment streams 
        provided some assurance that the IRS would narrowly tailor the 
        use of private collectors.\34\
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    \33\ We have addressed numerous concerns about the initiative, 
including the limited training of frontline private collection 
employees on issues such as taxpayer rights. See National Taxpayer 
Advocate 2005 Annual Report to Congress 76. We are also skeptical that 
the PDC initiative will produce a positive return on investment. See 
discussion, infra.
    \34\ In testimony last month before a House Appropriations 
subcommittee, IRS Commissioner Mark Everson acknowledged that tax debts 
to be assigned to private collection agencies could be collected more 
efficiently by additional IRS collection personnel. See Dustin Stamper, 
``Everson Admits Private Debt Collection Costs More, Defends Return 
Disclosure Regs,'' 2006 Tax Notes Today 61-1 (March 30, 2006); Rob 
Wells, ``US Rep. Rothman Calls IRS Pvt Tax Collection Pact Wasteful'', 
Dow Jones Newswires (March 29, 2006).
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  --Enforcement.--For those cases that cannot be resolved through 
        communication efforts with the taxpayer, traditional 
        enforcement efforts would be used.\35\
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    \35\ Filing and Payment Compliance Concept of Operations, Filing 
and Payment Compliance Project Office, April 18, 2005, 75-80.
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    Release 1 of the F&PC initiative involves the use of private 
collectors.\36\ Release 2 will employ commercial off-the-shelf software 
to assist in case selection for the private collection effort as well 
as the development of the Self-Assist treatment. In Release 3, the case 
selection software will be augmented with additional decision analytics 
software for the development of Assisted Correction treatments.\37\
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    \36\ Treasury Inspector General For Tax Administration, Ref. No. 
2006-20-026, ``The Alternatives for Designing and Developing the Filing 
and Payment Compliance Project Should be Revalidated'' (Dec. 2005); see 
also Capital Asset Plan and Business Case, Business Systems 
Modernization, Exhibit 300 (2005).
    \37\ Id.
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    The F&PC initiative has not been adequately funded to ensure that 
the most useful, taxpayer-friendly, and forward-thinking treatments, 
i.e. Self-Assist and Assisted Correction, will be funded. While it 
appears that the IRS is fully committed to privatizing collection, 
having already reached Release 1,\38\ cuts to F&PC funding will 
endanger the prospects of achieving F&PC's other objectives--objectives 
that do not raise the significant taxpayer rights concerns of the 
Private Debt Collection initiative.\39\ Thus, the failure to fund F&PC 
Releases 2 and 3 ensures that the only legacy of F&PC will be private 
debt collection.
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    \38\ Challenges to the procurement process have delayed 
implementation of the initiative. Dustin Stamper, ``IRS Orders Private 
Debt Collectors to Stop Work'', Tax Notes Today (March 24, 2006).
    \39\ Testimony of James R. White, Director of Tax Issues, General 
Accountability Office, Fiscal Year 2007 Budget Request, Committee on 
House Ways and Means Subcommittee on Oversight (April 6, 2006).
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    We are also concerned that the lack of funding for F&PC systems not 
only deprives taxpayers of a sophisticated collection approach but also 
encourages the IRS to take actions to reduce collection cycle time 
without adequate consideration for taxpayer rights or taxpayer 
compliance.\40\
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    \40\ By way of example, the IRS has undertaken several initiatives 
to hasten the issuance of taxpayers' Collection Due Process (CDP) 
notices in order to reduce collection cycle time. Pursuant to Code 
sections 6320 and 6330, taxpayers are entitled to a collection due 
process hearing after the filing of the first Notice of Federal Tax 
Lien and before the imposition of the first levy on a tax account. One 
such initiative, termed the ``Initial Contact Initiative,'' required 
revenue officers to issue CDP rights to taxpayers on initial contact 
with the taxpayers instead of when a levy was the next planned action. 
Because we believed this initiative makes CDP hearings less meaningful, 
we opposed the initiative. After discussions with the IRS, it was 
agreed that the Initial Contact Initiative would only apply to business 
taxpayers and to certain individual taxpayers who also have business 
tax delinquencies. Recently, the IRS planned to move the CDP notice up 
even further in the collection process to the second notice issued to 
business taxpayers. After discussion with my office, the IRS agreed 
that this latest initiative would not be undertaken at this time. We 
believe that the IRS has been attempting to implement broad collection 
initiatives because its current business systems do not adequately 
differentiate among taxpayers based on their compliance history.
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THE RETURN-ON-INVESTMENT OF THE PRIVATE DEBT COLLECTION INITIATIVE WILL 
                    PROBABLY BE LOWER THAN EXPECTED

    The Private Debt Collection (PDC) initiative as envisioned under 
Phase I of F&PC is another example of a program that might not be 
undertaken, or would be approached differently, if its downstream 
consequences were considered. The premise of the PDC initiative is 
essentially this: ``There is a significant amount of tax debt that the 
IRS can't go after because it doesn't have the resources. If we simply 
turn those cases over to private collection agencies, they'll collect 
the debt for us and the government will get to keep 75 to 80 cent of 
every dollar the PDCs are able to collect.''
    The problem with that simple approach is that it fails to take into 
account the enormous amount of IRS resources that need to be devoted to 
creating and supporting the program. Once the program rolls out, the 
IRS estimates that only a small percentage of taxpayers--perhaps on the 
order of 15 percent--will be resolved by the PDC unit itself. The rest 
of the cases will be sent back to the IRS ``Referral Unit'' for 
additional actions that only the IRS can constitutionally take on the 
account. Keep in mind that these are cases that the IRS currently 
considers too unproductive to devote resources to. Yet ironically, 
under the PDC initiative, the IRS will end up pulling employees off 
high-priority, high-return cases to work on these low-priority, low-
return cases.
    This approach makes little business sense, and on top of that, the 
program raises significant concerns about the adequacy of taxpayer 
rights protections and confidentiality of tax return information. In 
fact, to make the program profitable, the IRS will be under pressure to 
expand the authorized actions private collection agencies can take on a 
case so they can work higher dollar, more complex cases. This expansion 
would clearly raise constitutional concerns.\41\
---------------------------------------------------------------------------
    \41\ For a detailed discussion of the IRS Private Debt Collection 
initiative and its constitutional and taxpayer rights implications, see 
``Use of Private Agencies to Improve IRS Debt Collection'', 
Subcommittee on Oversight, House Committee on Ways and Means, 108th 
Cong., 1st Sess. (statement of Nina E. Olson, National Taxpayer 
Advocate, May 13, 2003); see also National Taxpayer Advocate 2005 
Annual Report to Congress 76-93.
---------------------------------------------------------------------------
    Thus, the PDC initiative is a paradigm example of how looking at 
the narrow justification for a program can make it look brilliant, 
while viewing the program in its totality paints a very different 
picture.

        TRENDS IN TAXPAYER ADVOCATE SERVICE (TAS) CASE INVENTORY

    I close with a reflection on the Taxpayer Advocate Service and its 
role in identifying and mitigating the downstream consequences of IRS 
actions and programs, and improving taxpayers' attitudes toward the tax 
system. This recent March 1 marked my 5-year anniversary as the 
National Taxpayer Advocate. They have been quite remarkable years--I 
have watched my talented and dedicated employees achieve a quality 
rating of 91.6 percent through fiscal year 2005, up from 71.6 percent 
in 2001. They achieved this quality despite a 15 percent decline in 
case advocates in our statutorily mandated offices around the country, 
from 1,325 case advocates in March 2003 to 1,127 case advocates in 
February 2006. And these successes were achieved despite a slight 
increase in TAS case receipts from fiscal year 2003 to fiscal year 
2005.\42\
---------------------------------------------------------------------------
    \42\ In fiscal year 2005, TAS received a total of 197,679 cases. In 
fiscal year 2003, TAS received a total of 196,040 cases.
---------------------------------------------------------------------------
    In fact, TAS case receipts themselves provide an interesting study 
in downstream consequences. As IRS increases its enforcement activity, 
TAS compliance inventory increased to nearly 70 percent of our case 
receipts for the first quarter fiscal year 2006, up from 67 percent in 
first quarter fiscal year 2005. In fiscal year 2005, TAS cases 
involving liens and levies increased by 50 percent and 43 percent, 
respectively, over fiscal year 2004. During first quarter fiscal year 
2006, TAS continued to see an increase in lien and levy cases. Lien and 
levy cases tend to involve economic urgency to the taxpayer. TAS 
procedures require case advocates to respond immediately to the 
taxpayer's request for assistance in these cases. With the increasing 
number, complexity, and urgency of our case load, TAS risks getting 
behind on cases that involve IRS system failure as we give priority to 
cases that involve economic harm. If the balance between our staffing 
and the number of cases we handle continues to deteriorate, TAS is in 
jeopardy of becoming part of the IRS problem rather than the advocate 
for the solution, as Congress intended.
    Significantly, TAS Customer Satisfaction surveys provide some 
evidence that the quality and nature of taxpayer service has an impact 
on taxpayer attitudes toward the tax system. When a taxpayer brings an 
eligible case to TAS, he is assigned a case advocate who works with him 
throughout the pendency of the case. Taxpayers have a toll-free number 
direct to that case advocate, and each TAS office has a toll-free fax 
number. TAS employees are required to spot and address all related 
issues and to educate the taxpayer about how to avoid the problem from 
occurring again, if possible. This level and quality of service drives 
TAS's high taxpayer satisfaction scores,\43\ which have averaged about 
4.35 on a scale of 5.0 for the last two fiscal years. Most importantly, 
57 percent of taxpayers stated that they feel better about the IRS as a 
whole after coming to TAS. Even among taxpayers who did not obtain the 
result they sought, an astonishing 41 percent reported that they had a 
more positive opinion of the IRS because of their experience with TAS.
---------------------------------------------------------------------------
    \43\ Taxpayer Advocate Service customer satisfaction survey data 
for the period from October 2003 through September 2005, as collected 
by The Gallup Organization.
---------------------------------------------------------------------------
                               CONCLUSION

    Compared with 10 years ago, the IRS today is a more responsive and 
effective organization. On the customer service side, the IRS 
Restructuring and Reform Act of 1998 and the IRS response has brought 
about fairly dramatic improvements. On the enforcement side, the IRS 
has been stepping up its enforcement of the tax laws over the past 5 
years, particularly with regard to corporate tax shelters and high-
income individuals.
    But the IRS can, and should, do better. To increase voluntary 
compliance, it should incorporate an ongoing taxpayer-centric 
assessment of taxpayer service needs into its strategic plans. It 
should conduct research into the causes of noncompliance and apply the 
resulting knowledge to IRS enforcement strategies, including those 
pertaining to the cash economy. Finally, it must have sufficient 
resources to move forward with its technological improvements, on both 
a short-term and a long-term basis.

    Senator Bond. Thank you very much, Ms. Olson. You certainly 
shared my concerns about the funding, and I think that your 
points about research are well worth considering, because I 
think there are some opportunities here to improve it.
    Before we turn to the questions, we have been joined by 
Senator Durbin. Senator, would you like to offer an opening 
statement, either orally or in writing?
    Senator Durbin. No. Proceed, Mr. Chairman.
    Senator Bond. Okay. We will turn now to the questions.

                                TAX GAP

    Mr. Commissioner, as I stated in my opening remarks, I 
believe the IRS needs more resources to effectively attack the 
tax gap. The budget request flat funds it. How does your budget 
request reduce the tax gap?
    Mr. Everson. Well, Mr. Chairman, as I have indicated--we 
can maybe look at the tax gap map--we have several components. 
The budget request will continue the enforcement build that 
this committee and the Senate and the House provided for last 
year. We have been hiring or are in the process of hiring those 
people now. So there will be a time of training, and then you 
will see, as they become more effective, we will continue to 
bring up the number of audits, the number of collections, the 
document-matching activities. That will have an impact.
    Beyond that, in the budget request, as I indicated, we have 
several legislative proposals that I think are terribly 
important. I would point out that they have been characterized 
by some as modest. I agree with that, but if you compare them 
to anything that has been done in 20 years, there have been no 
requests on additional third-party reporting. If we can agree 
that is required, as shown in the chart I showed a few minutes 
ago where you have the No. 1 and No. 2 noncompliance rates 
where you don't get any reporting, I think that will be an 
equally important step, sir.

                   ALLOCATION OF ADDITIONAL RESOURCES

    Senator Bond. The IRS Oversight Board recommended 
additional funding of $363 million. The Senate took the 
Oversight Board's recommendation. I know it is above the OMB 
budget request, but if you were to receive that additional 
funding, how would you propose to spend it?
    Mr. Everson. Yes. I am aware of the Budget Committee 
action, and as you say, it is about $330 million or $340 
million. We are looking at that now in the event that it should 
carry through. We would do two things. We would add bodies, of 
course, across a range of activities, but we would, and I think 
it would be permitted under the resolution, specifically add to 
the infrastructure and the systems money. At this stage, it is 
important for us to invest in technology on both the service, 
but particularly on the enforcement side of the house.
    So I don't have a specific answer yet, but we are working 
on that.
    Senator Bond. I would like to ask the others. I would like 
to ask Chairman Wagner what he would suggest and any comments 
from the others.
    Mr. Wagner. Thank you, Mr. Chairman, with the additional 
funding, of course I would agree with the Commissioner that 
adding additional FTE toward targeted areas would be warranted 
and would be contemplated by our recommendation. Certainly some 
of the additional resources would go toward the research that 
we have all talked about in order to best determine which area 
to allocate those additional resources, whether they are toward 
attacking the fraudulent payments dealing with the cash economy 
that was suggested in the Commissioner's chart, dealing with 
non-compliant enterprises and so on and so forth.
    The other thing that we would hope would come from 
additional resources would be the development of more 
productive partnerships between IRS and tax professionals, more 
emphasis on the website communicating customer service 
opportunities toward the taxpayers and, of course, improving 
customer service through issues such as telephone service and 
so on.
    Senator Bond. That is a heavy burden to put the little 
$300-plus million.
    Mr. George, any further comments?
    Mr. George. Mr. Chairman, simply to state regarding the tax 
gap, there is no question that if the complexity of the tax 
code were simplified or erased, compliance would increase 
tremendously. I realize that is not within the jurisdiction of 
this committee. Nonetheless, that would certainly help close 
the tax gap.
    As the chairman's chart showed, you have a major 
underreporting within the small business community, and I think 
if you had third-party reporting, as he noted, of those tax 
receipts or the income receipts, that would also assist in 
closing the gap.
    Senator Bond. I think everybody knows my commitment to 
small business. I want to see small business succeed, but we 
expect them to pay the taxes they owe.
    Ms. Olson, any comment on additional dollars?
    Ms. Olson. Well, I think it would be wise to invest in the 
next phases of filing and payment compliance, particularly the 
risk-based assessment system of identifying how collection 
cases should be handled, who should get the touches, and my 
other point would be that additional personnel would enable the 
IRS to focus on some current projects that are being shelved 
because of our rightful focus on our big projects, but there is 
not a day that goes by that I say to the IRS, ``Can't we solve 
this problem for this group of taxpayers?'' and I am told, ``We 
can't do that right now; we have to focus on this big 
project.''
    Senator Bond. Thank you very much, Ms. Olson.
    Now we turn to the ranking member.
    Senator Murray. Thank you very much, Mr. Chairman.

                        PRIVACY OF TAXPAYER DATA

    Mr. Everson, I wrote to you on March 22 to express my 
opposition to the proposed regulations regarding the privacy of 
taxpayer information. In some respects, the proposed 
regulations I know tighten some of the restrictions, but in 
other ways, they really loosen them--I know there is taxpayer's 
sign-off--to allow them to sell that to unidentified 
unaffiliated third parties.
    My view personally is this: taxpayers are not likely to 
want their information going to marketers at all. I would like 
you to share with this committee why you are providing any 
opportunity for tax preparers and their affiliates to use 
personal financial data to sell mortgages or mutual funds or 
IRA accounts or life insurance--don't taxpayers already have 
enumerable opportunities to shop for services like that without 
subjecting their personal tax returns to perusal by marketers?
    Mr. Everson. I appreciate the question, Senator. This is an 
important subject, and I have testified on it several times 
already. The first thing I would like to say is we are taking a 
lot of comments on this. I have gotten a lot of letters. We 
have actually had hearings on this, which we do with important 
regulatory proposals. We are going to assess all of those.
    What we are trying to do here is have a balanced approach. 
This piece of the law has been in effect for over 30 years, but 
the world has changed since that time. The regulation is 
prompted, as much as anything, by Congress in terms of 
inquiries on the outsourcing, the preparation of tax returns 
overseas in India where nobody was aware of that happening.
    So we are trying to move to make better protections here. I 
guess the basic question is: ``Whose information is it?'' Is it 
the taxpayers' information or is it the Government's 
information? We at the IRS, as you know, don't share their 
information with anybody. So it is a question of preparers, and 
I guess we don't think that under current law the IRS can say 
you as an individual don't have the right to share financial 
information with Kit Bond if you want to. That is--if I could 
just finish, I was trying to get to the dynamic here.
    So what we are trying to do is provide a really clear 
protection that in the event that that arrangement starts to 
take place, that you have a clear detailed consent, a warning 
as to what could happen, but we don't think under statute now 
we could say you aren't free to share your information with 
that preparer.
    Senator Murray. Do you think there is a critical mass of 
people in the country who want their information sold?
    Mr. Everson. I don't. What I do think, though, is that this 
gets to Senator Dorgan's remarks. Certain firms, the big firms, 
they now have integrated services and they are providing a 
range of services, like IRAs or advice, to taxpayers. Other 
smaller firms who are the trusted real financial advisor of 
somebody, once a year they sit down and they get their health 
check-up financially, if you will, and they say how are you 
doing, and they could be able to maybe advise someone to get 
the IRA on behalf of a bank or whatever else is there.
    The other thing I would point out to your staff, we are 
very concerned about the possible implication of this to the 
VITA sites. Those are programs that, as you are aware, operate 
around the country. Over 2 million returns were prepared this 
year. They are very exciting to communities because people come 
in. They file largely for the EITC. That money goes out into 
the community, but the coalitions that are out there also do 
other things. They share. They help get the people banked or 
into other benefit programs.
    You may know, in your own State, 2.8 percent of the returns 
last year in Washington came through the VITA program as 
opposed to 1.6 percent nationally. Our people are very 
concerned if we move to outright prohibition of any sharing 
that you would kill that program and that all the good things 
that are happening for those people where there is a bundling 
of services wouldn't be allowed.
    So it is a complicated issue, Senator.
    Senator Murray. Look, I am very worried about this being 
abused. You know, we know how this works. It is 4 p.m. on April 
15. You are signing the last piece of paper the tax preparer 
has put in front of you. You are signing everything as fast as 
you can, and I have heard that tax preparers actually want you 
to loosen this requirement that pertains to the way they get 
consent from taxpayers to sell their information.
    Do you think there is any chance in the world that the 
final rule is going to loosen consent procedures under your 
proposed rule?
    Mr. Everson. Loosen consent procedures? By that, you mean 
change the consent form that we propose?
    Senator Murray. Yes.
    Mr. Everson. I think that clearly the consent procedures 
are much tighter, but I don't want to say anything precise, 
because I think that would be wrong under the APA, for me to 
comment as to what the final rule will look like. I am not 
involved in that at this stage, but we are really honestly 
looking at this, and is it is a tough issue.
    Senator Murray. Well, under your proposed regulation, you 
require written consent from the taxpayer if the tax preparer 
wants to process that overseas.
    Mr. Everson. Yes.
    Senator Murray. You justified that requirement because as 
the Commissioner, you don't have any enforcement authority to 
prosecute abuses overseas. If you don't have authority to 
protect taxpayers' privacy overseas, why are you allowing this 
information to go overseas at all?
    Mr. Everson. I don't think that we have the authority to 
stop that. I think that that is something that is done by 
private parties. There is no law that says people can't 
contract out, or it is a far broader question. It is not any 
different than a company hiring a subcontractor to develop 
parts for an auto or something else.
    Senator Murray. But the law says you have to enforce 
privacy.
    Mr. Everson. Yes.
    Senator Murray. So you are telling us you can't enforce the 
law? So why are we allowing this to go overseas?
    Mr. Everson. Well, I think we are attempting to strengthen 
the control over the privacy through this proposal. The other 
thing I would indicate is we have increased our investigations 
of promoters of return preparers dramatically in the last 2 
years. A year ago, we had 125 reviews taking place. This year, 
we have over 500 reviews taking place.
    My understanding is, and perhaps this is a question for Mr. 
George, that the provisions of 7216 are actually largely 
enforced by TIGTA. So there is a shared responsibility here on 
this.
    Senator Murray. My time is up, but, Mr. Chairman, I am 
deeply concerned about this privacy issue. I think most people 
assume their taxpayer information is private that goes to the 
IRS, and I think we have to be very, very careful that it 
doesn't become some kind of marketing program.
    Senator Bond. I would agree with that, and I think I 
understand the point that the Commissioner is making. If you 
read ``The World is Flat'', you will find that there is a 
tremendous amount of, heaven forbid, legal research being done 
overseas too which threatens some of our professions as well as 
some taxpayers services being done overseas.
    I turn now to Senator Durbin.
    Mr. Everson. Mr. Chairman, could you indulge for me 1 
minute? I want to say one thing. Of course, if the Congress 
looks at this to change the law, which I guess I believe would 
be necessary to really have an outcome, we, of course, will 
work with the Congress at looking at all these issues. So it is 
not beyond the regulation.
    Senator Bond. Senator Durbin.
    Senator Durbin. Thanks, Mr. Chairman. Thank you all for 
being here today.
    I have this notion that if every member of Congress was 
required to prepare their own income tax returns personally, we 
would see simplification of the tax code overnight. We turn, 
instead, to bookkeepers, accountants, lawyers to try to guide 
us through this thicket, and we can't blame anyone other than 
others. We write the law.
    So I hope that as a result of this hearing and others, we 
will be inspired to make this a little more easily understood. 
Nobody likes to pay taxes, but if they think that they are 
being taxed fairly, they are a lot more accepting of this 
responsibility.

                        INDEPENDENT CONTRACTORS

    Speaking of paying taxes fairly and tax evasion, I recently 
had a group of bricklayers from Chicago meet with me in the 
basement of the Capitol, and they came in to complain. They 
said we understand that every contractor isn't a union 
contractor; we have to compete with non-union contractors, but 
we are concerned about another problem.
    Too many of these so-called non-union contractors don't 
have employees. They have independent contractors working for 
them. The net result is taxes are not withheld from the wages 
or income that is paid to these workers, and so ultimately 
taxes are not paid, neither State, Federal, local taxes, 
unemployment compensation, and workers' compensation.
    Mr. Wagner, you were former head of the Illinois Department 
of Revenue.
    Mr. Wagner. Yes, sir.
    Senator Durbin. In 2004 alone, misclassifying these workers 
as independent contractors when, in fact, they were employees 
was at a rate of 21 percent in the State of Illinois, 67,745 
employers statewide, 7,478 in the construction industry. The 
State of Illinois alone lost $158 million in income taxes not 
withheld from actual employees because they called themselves 
independent contractors.
    So the bricklayers said to me, Senator, what are you going 
to do about this; we don't mind competing with people who are 
paying taxes as we are, but why should we have to try to 
compete with people for evading their taxes; where is the 
Internal Revenue Service?
    So I would like to ask you where is the Internal Revenue 
Service?
    Mr. Everson. Senator, you are covering a very important 
subject. Let me make a couple of points about it. As I 
indicated, we have five legislative proposals on strengthening 
tax administration. It is the most ambitious since the Reform 
Act of 1986, which had effect of where citizens, taxpayers, had 
to list the Social Security number of their dependents, and the 
next year, 5 million dependents vanished. So we know when you 
do more reporting, you get more compliance.
    Why is this important? Take a look at this: Starting in 
1978, all individual returns, the number of returns we have 
gotten, have increased by 50 percent. The number of Schedule C 
filers--these are the folks that are organized as independent 
contractors--they have increased by 175 percent, and as I 
indicated, I think before you came in--let us go back to this 
other chart--the noncompliance rate is 50 percent in this 
category of individuals where they organize as small 
businesses, but they are unincorporated, because basically they 
are not reporting all of their income.
    There are issues on the employer side which you are talking 
about. I can assure you that the number of 1099 miscellaneous 
forms, the reporting they are supposed to do to us, that has 
not increased as rapidly as the number of Schedule C returns 
has increased.
    So this is an important area. We have said beyond the five 
proposals that we want to look at the definition of independent 
contractor. This is the manual that our people have to go 
through to assess whether somebody is an independent 
contractor. We have been precluded by statute since 1978, I 
believe was the year, from addressing what is the definition of 
an independent contractor. We are going to study that and 
hopefully make some proposals, but it is terribly important 
because the world has changed, as those charts indicated and as 
your constituents indicate.
    We do need to address this jointly.
    Senator Durbin. Let me ask you are you saying that it is a 
problem in definition or a problem in law or it is a lack of 
resources to investigate and enforce?
    Mr. Everson. It is both, sir. We have been precluded from 
changing the standards by which we look at independent 
contractors for approaching 30 years now. That is because of 
the importance, which is legitimate, of small business in this 
country and a reluctance to look at that issue, but we have 
said as an administration that we want to study it and then 
work to get a better definition and more consistency so that 
people fall on the right side of the line just as you are 
indicating, because what happens is what you are saying. 
Somebody is paid as an independent contractor, as a business 
that isn't absorbing those employment taxes that they ought to 
be, and then the individual, as we have indicated here, is not 
reporting the gross income.
    Senator Durbin. How long is this going to take?
    Mr. Everson. Well, we will be making the study over the 
course of coming months, and what is important now, I would 
suggest to you in a leadership position, it is very important 
to take a look at these five proposals that we have made right 
now on gross receipts, say for credit card issuers. That is a 
big start in this area.
    Senator Durbin. This is all well and good, and I support 
what you are doing, but let me suggest in the meantime a few 
cops on the beat wouldn't hurt. Sending some investigators out 
and starting to ask questions of contractors who are using so 
many independent contractors may put a chill on this practice 
while we are trying to come up with the modernization of the 
law and more resources for you to enforce it.
    Mr. Everson. We are increasing our audits, sir.
    Ms. Olson. If I may.
    Senator Bond. Go ahead.
    Ms. Olson. In this year's annual report to Congress, my 
annual report to Congress, I reported on this very issue. I 
reported on a program that the United Kingdom has to address 
this very issue that they have had for the last 30 years. They 
have focused on the construction industry because there is so 
much cash economy in underreporting, and they require workers 
who are independent contractors in the construction industry 
that when they are hired, they have to present to the person 
who is hiring them a compliance certificate from England 
Revenue that states that they are fully in compliance with the 
tax laws and with their payment, and if they are not in 
compliance, then the person who is hiring them has to do a 
withholding on the gross payments that they are making. They 
find that that approach has really helped with that cash 
economy and leveled the playing field between people who are 
treated as employees and independent contractors.
    Senator Durbin. Thank you.

                        PRIVACY OF TAXPAYER DATA

    Senator Bond. Ms. Olson, you may want to comment on the 
proposed rules. I know you have been involved in the 
development on the rule on privacy, and for the record, I would 
like to get your comments on that.
    Ms. Olson. Thank you, sir. The 7216 rules have two 
categories of approaches, use and disclosure, and I think there 
are concerns with each one of those applications. I find the 
proposed rules, which I worked on very closely with the IRS, to 
be a vast improvement over the current rules, which I find very 
anti-taxpayer and provide very little consumer protection.
    I want to make the distinction that ``use'' is the term 
that we use where the taxpayer is having a conversation with 
the preparer. The information doesn't go outside the room, and 
the preparer is asking for permission to use the taxpayer's 
information to peddle a product, but you are not talking with a 
third person at that point.
    ``Disclosure'' is where the information is leaving the room 
with a preparer and going out to the taxpayer. Under the 
current rules, the taxpayer isn't told the impact of that 
disclosure, isn't told what might happen if the information 
goes overseas, isn't told that that third party when you get 
that information can be disseminated and sold and reused by 
anyone for any amount of time. So the current rules really 
focus on a lot of restrictions and up-front notification.
    Now, I am the first to admit that we could do more, but I 
think that we need legislation in this area. The current rules 
only apply to preparers. So we have no rules about what happens 
to people who receive this information if we don't do an out-
and-out ban. We have no criminal penalties against them. We 
have no civil fines against them.
    So there are a number of things that we can do to improve 
it.
    Senator Bond. Thank you, Ms. Olson.

                     BUSINESS SYSTEMS MODERNIZATION

    I would like to ask the GAO witnesses to join us at the 
table because I want to talk about the BSM. We are hearing that 
BSM is making some progress, but the budget request, the OMB 
request for BSM, looks like they are, as I said, punishing good 
performance.
    How do you see, Mr. Commissioner, the performance of BSM 
and how does it compare to the success 2 years ago?
    Mr. Everson. Mr. Chairman, as you know from following this, 
we have made modernization of the IRS one of our three 
strategic priorities, and that relates to work processes and in 
particular the systems. I think we have made a great deal of 
progress on this. We downsized the portfolio a couple of years 
ago, provided greater focus to it, and inserted more business 
people into the process that had been done largely with just 
the tech folks. That has made a lot of difference. The CADE 
project is on sounder footing now. One huge success is the 
modernized E-filing.
    It hasn't been mentioned yet, but in December 2004, we 
mandated the electronic filing of returns by corporations and 
nonprofit institutions over a certain size. We have received 
over 300,000 returns this year thus far. There was no 
technology to do that at the time that we did this. There was a 
lot of uproar from industry saying you can't do this, industry 
told us or the software people said, until you mandate it, we 
won't have the product. So it was a chicken and the egg thing.
    We mandated it. The software was developed, and now we are 
moving forward. So there are successes.
    Your point, drawing it down, I think that this is a minimal 
level for us to proceed. It is a complicated question, as you 
know, as to the overall funding levels. In those negotiations 
as we work with the administration, I spread the money to what 
I thought was the most responsible way, sir.
    Senator Bond. Mr. Powner, if you would give us your full 
name and comments on the BSM performance, better or worse.
    Mr. Powner. I am David Powner with the Government 
Accountability Office. Performance has improved consistently 
over the years. Our work for you, Mr. Chairman, in looking at 
the expenditure plans on an annual basis has shown that is 
performance perfect? No, but when you compare this to past 
performance of other programs across the Federal Government, 
this is one of the better-run programs when you look at their 
performance over the past couple of years, if you look at the 
leadership of this program. Decreasing funding on the BSM at 
this point in time clearly, as our statement indicates, will 
decrease the pace and momentum and could affect the long-term 
delivery of systems such as CADE.
    Senator Bond. I appreciate your good work, your very 
technical analysis of all of this. I have a former GAO worker, 
who can translate for me, who seems to indicate that you are 
saying we should provide more money to the BSM program. Is that 
an accurate assessment of your very good technical analysis?
    Mr. Powner. Yes. Mr. Chairman, at this point in time, if 
you inched up their budget, we are clearly in that camp given 
their past performance. I think they deserve that. I think it 
is an opportunity to keep the pace going. We are not in the 
camp with Chairman Wagner, looking at a doubling of the budget. 
There still are many risks associated with the program and 
contractor performance, we should report to you, last week, in 
looking at IRS's internal capacity to manage requirements.
    So yes. I think it would be prudent to increase the budget 
slightly, but a doubling of the budget, we are clearly not in 
that camp today.
    Senator Bond. Mr. George, do you have a comment on it?
    Mr. George. I would just note, Mr. Chairman, that there is 
no question BSM has improved over the progress in the last few 
years. At the same time, as I noted in my oral statement, it is 
still behind schedule and it is also over budget. For example, 
the CADE system, if fully implemented, would certainly have 
expedited the return of refunds to taxpayers tremendously, and 
it is not yet fully implemented. So that is a problem, and then 
the modernized E-file system that the Commissioner averted to, 
they have had three releases thus far. That too is 18 months 
behind schedule and is over $37 million over budget.
    So there is a recurring problem in that report, sir, and it 
is not limited solely to BSM. I think it is throughout the 
service. Again, progress has been made, but more needs to be 
done.
    Senator Bond. Thank you very much, Mr. George.
    Senator Murray.

                      TAXPAYER ASSISTANCE CENTERS

    Senator Murray. Mr. George, I wanted to ask you when you 
analyzed the data that the IRS used to justify their proposal 
to close the Taxpayer Assistance Centers, you found that IRS's 
data for as many as one-quarter of the TACs was found to be 
fraught with errors. You found that not all the data used was 
accurate or the most current available and some of the data was 
based on estimates and projections instead of actual data 
currently available. Those errors affected the ranking and 
overall selection of the TACs the IRS wanted to close.
    Mr. Everson, I wanted to give you an opportunity to 
respond.
    Mr. Everson. Sure. I was a little hurt by your strong 
statement earlier that this called into question anything the 
IRS ever said. I know I am exaggerating a little.
    Senator Murray. I will let you rebut.
    Mr. Everson. I don't think that is the case, and I think 
that we do our very best to be credible in any representation 
we make either to the public or, of course, to the Congress. 
Sometimes we make mistakes or information is incomplete.
    On the TACs, the IG looked at it. We had something like 35 
or 36 categories that went in to the model. The conclusion that 
was reached was that the model was a good one. It weighted 
appropriately a whole series of demographic and other cost 
factors. You are correct. There were individual data errors, 
but the model was not particularly sensitive to those 
conclusions. In something like--I can't recall the exact 
number--maybe 10 of the numbers would have changed the relative 
rankings, but it didn't take something that was No. 40 on the 
list and make it No. 380, if you will.
    This was a tool that we wanted to use to identify the best 
candidates for reduction. It was never going to be so 
incredibly precise that we had overridden the criteria, the 
strict criteria for a couple of factors. You may recall we 
didn't want to eliminate more than half the TACs, in any State. 
We said the TACs had to be in the 35 major metropolitan areas 
no matter how they came out.
    So I think perhaps that statement that the model produced 
nothing of value, I wouldn't agree with that. Can we do better? 
We always can do better on data integrity. So yes.
    The last thing I will say is this did cause a lot of 
concern last year. We stood down in our proposal well before 
this report was ever done, as you know. We stood down on that 
proposal, oh, last July, I guess it was when I suspended it. 
Closing down those 68 centers is not a part of the current 
request. Both you and the chairman have talked about our 
savings proposals. We believe that we will be able to achieve 
those savings proposals without reducing services or closing 
any of these walk-in centers.
    So I want to reassure that is not an active proposal at 
all. My concern would be the chairman is talking about adding 
money, potentially, to BSM. I want to make sure that we do 
fully fund the services piece, as is well within this budget. 
My worry would be if it was cut a little bit or, as you know, a 
lot of this is salary dollars. If the pay increase comes in 
above what is proposed, there could be pressure here.
    Senator Murray. Well, in a briefing that we had last year 
by TIGTA on these Taxpayer Assistance Centers, I learned that 
some of the TACs have as little as one or two staff and what 
TIGTA called a critical staffing storage. Now, the House and 
Senate majority and minority said no to the proposal to cut 
back TACs until the TIGTA completed a study on the impact of 
the reductions, but are you, in fact, allowing these TACs to 
eventually close by just letting the staffs dwindle?
    Mr. Everson. No, we are not. There were some employees who 
chose to move to other parts of the agency while this was 
currently before the Congress. So we had some storage shortages 
as the filing season approached, and what we did was we 
reassigned employees out of other pieces of the agency to make 
sure that we would keep the centers open.
    A year ago, I had several inquiries from members of 
Congress about----
    Senator Murray. Are you currently filling those vacancies?
    Mr. Everson. Yes. We are moving to re-hire those people, 
and we don't have any plans for closing TACs at this time and 
would not draw them down. If what you are saying is just 
somebody leaves and we don't re-fill the position, no, we are 
not doing that.
    Senator Murray. Mr. George or Ms. Olson, do either one of 
you want to comment?
    Mr. George. Just briefly, Senator Murray. There is no 
question that the model that the IRS has developed, we 
determined it was sound. Some of the data was inaccurate. Other 
parts of it were not current, but all of the ranking of the 
TACs were not accurate as a result of having inaccurate or 
outdated information.
    Ms. Olson. I believe that regardless of what the actual 
architecture of the model looked like that it was based on 
flawed assumptions. It was based on the current status quo of 
what services the IRS was offering, and as we know, over the 
last year, it has been declining as a goal, the number of tax 
returns that they have prepared within the TACs. So when you 
say, well, usage is dropping, it is because we are turning 
people away at the door.
    We never measured the number of people who were lined up 
outside the walk-in sites, and my employees in Federal 
buildings throughout the United States informed me that people 
were lined up during filing season outside the doors, blocking 
access to the Taxpayer Advocate Service doors for my employees.
    Yesterday and the day before yesterday, I was in North 
Dakota. Senator Dorgan is not here, but I was in North Dakota, 
and I held a town hall meeting with taxpayers, and one person 
informed me that they drove quite a distance to the walk-in 
site to ask a question as an agriculture taxpayer, and that is 
determined out of scope. They said, I'm sorry; we don't answer 
those questions in the TAC. And I think for States like North 
Dakota and Wyoming, that is silly.
    So these are the sorts of things that we are using as base 
measurement for the services that we are offering in the TAC, 
and then saying taxpayers aren't coming there, no surprise 
there.
    Mr. Everson. Could I make one comment?
    Senator Bond. If you will forgive me, I am going to have to 
ask one complicated question for brief answers and then turn 
the rest of the hearing over to Senator Murray, because I was 
expected for an important Intelligence Committee meeting at 
11:00, and I apologize, but I know that you can continue these 
discussions.

                                 E-FILE

    I would like to ask you, Mr. Commissioner and then Chairman 
Wagner and Ms. Olson, about the E-filing problem. Getting the 
80 percent appears out of reach. One possible reason, there was 
a media report that due to the cost of the E-filing, more than 
a quarter of a million individual filers, some 36 million, 
prepared their tax returns on computer, printed them out and 
mailed them to the IRS.
    Would you outline your current plans and what you see as 
the problem with E-filing? And also, Senator Grassley and other 
experts have suggested that the IRS develop a direct filing 
portal through the IRS website to increase E-filing, and I 
would like to hear you include that in your comments.
    Mr. Everson. Yes. You have covered a lot of ground there. 
Electronic filing continues to increase. We think it will 
continue to do so. It is true that in terms of some of the 
software providers, you buy the package and then there is a 
built-on cost at the end to file, to actually make the 
electronic filing. I don't think that the Government regulates 
the price of products from private parties. So that is a 
question of the private participants.
    The Free File Alliance, which has generated a lot of 
discussion, that was in existence for 3 years. The term of that 
agreement lapsed last year after the filing season. We then 
worked to conclude a new agreement. We had two objectives. One 
was to get more protections on these RALs, these predatory 
loans that take place, not a huge issue for the free file 
participants, but it is still is something, and also we wanted 
to have as high a participation rate.
    The consortium members were concerned because the program 
had moved toward where anybody could file. They didn't want 
that, and in the late stages of the negotiation, the number was 
around 70 percent. We wanted to get it higher as to 
eligibility. They wanted to get it lower.
    Then I do have to say the Senate had a voice vote to an 
amendment to the appropriations bill that was moving, whenever 
it was, in November of last year or October, that the IRS 
couldn't develop software, that no free file software could be 
developed without the Alliance. That had the effect of gutting 
our negotiation position with the Alliance because we can't 
force private parties to provide free file services. The reason 
they do it is because of their concern that one day there would 
be a portal or that one day there will be--the government will 
provide the software and they will be out of business. That is 
why they do this.
    So that dynamic is complicated one.
    The final point I would make, Mr. Chairman, the question of 
developing a portal, that would be a very costly and 
complicated endeavor, I am informed, for the IRS to do that. 
Right now, it is only the top 20 filers. All these returns are 
bucketed, if you will, or grouped. They do 82 percent of the 
electronic filing. If we were to do this, you would have to 
compare companies like Intuit who are spending $200 million a 
year in research. This would be a big effort. It sounds simple, 
but it would be a big effort is what I would say.
    Senator Bond. Well, we tried to make it clear that the IRS 
and Free File should come together to make an agreement. We 
only took the floor amendment because there did not appear to 
be agreement and our amendment was not intended to restrict the 
IRS. So we need to continue to work on that.
    Chairman Wagner.
    Mr. Wagner. Mr. Chairman, just a couple of points. I know 
you are in a rush. We too believe the E-filing objectives are 
very sound and very good. We are pleased that more people are 
choosing to file electronically these days and the rate is 
going up. We are troubled by the fact that it is increasing at 
a lower pace than it has in the prior years. We have concerns 
over the Free Filing Alliance and have expressed those 
concerns, in particular the caps.
    The notion of a portal is something that ought to be 
considered on behalf of the taxpayers. Certainly I can access 
Government in so many other areas by going directly on line and 
submitting my information. There are two components of paying 
your taxes: preparing the return and filing the return. 
Certainly the IRS ought to do everything it can to facilitate 
the filing of the return.
    The goal, the 80 percent goal by 2007, is not going to be 
met. We have recommended that that goal be extended to 2011, 
applying a statistical analysis to it because we do believe the 
goal is a motivator and that it does keep the IRS focused on 
the goal as well as preparers. There are additional mandates 
that might be considered by this committee, including mandated 
filing by preparers, extending the filing date for electronic-
filed returns to perhaps April 30 to provide an additional 
incentive for consumers to file electronically and so on.
    Senator Bond. Ms. Olson.
    Ms. Olson. Well, I believe that the lack of free electronic 
filing is a major barrier to reaching our 80 percent goal. I 
think contrary to what some may suggest, taxpayers want to 
provide their financial data directly to the Government without 
any intermediaries and certainly with no add-on charges, and in 
this way a portal is like telefile, which was a very successful 
program, was simple, was easy to use, and the information went 
directly to the IRS.
    I note, as Chairman Wagner does, that on the education 
website, you can file your FASA, your Financial Aid Student 
Application, directly with the Government in a fill-in simple 
form and you push the button and it is there. I think it galls 
taxpayers who are giving over their hard earned dollars to have 
to pay to E-file, and that is why we have 40 million taxpayers 
who buy a software package and then they print out the returns. 
I am one of those 40 million taxpayers this year.
    And the last thing I would note, because I have a visually 
impaired employee, and he attempted to go on to Free File, and 
because these are private products, they are not required to be 
accessible for people who visually impaired. Federal websites 
under section 508, we have this 508 rule that says that all of 
our websites have to be accessible for visually impaired 
persons, and I think that is another really significant thing 
that we have to think about. There is a whole population out 
there.
    Senator Bond. Thank you, Ms. Olson and other witnesses, and 
now my apologies and my thanks to Senator Murray. I will turn 
the hearing over to the her.
    Senator Murray [presiding]. Thank you, Mr. Chairman.
    I just have few questions and then I will close it out.

                              BUDGET CUTS

    Mr. Everson, the fiscal year 2007 budget doesn't make any 
reference to specific reductions in taxpayer services, as you 
shared, but your budget does refer to $84.1 million in savings 
and the elimination of more than 2,000 FTEs due to contemplated 
``program efficiencies''. Can you share with us how much of 
these savings in FTE reductions is associated with taxpayer 
service cuts and how much is associated with enforcement cuts?
    Mr. Everson. The $84 million comes across three major 
categories. There are cuts. If you go to page 6 of my written 
statement, Senator, it sort of lays this all out. There are 
shared services, and one of the examples here is for a new 
telecommunications contract, we are going to save $24 million. 
That doesn't have an impact. Obviously, it is just a cost 
reduction. That is a shared area between enforcement and 
services.
    We have what we think will be $35 million against 
enforcement programs in terms of efficiencies, and that is a 
wide variety of categories where we are working more 
efficiently--we are a big organization. We are spending $7 
billion on enforcement. As you would expect, each year we 
reassess our processes and we go through and we make changes to 
become more efficient. So we have laid out there a whole series 
of reductions ranging from 5 FTE to, you know, over a 100.
    The services piece, if you will, is down to about $18 
million of reductions which we believe, again, we will get 
through improved performance, better use of technology, 
redesigning our processes in ways that won't have an impact on 
you as a taxpayer or anybody trying to do business with the 
IRS. These have been developed over months. We can share more 
details if the committee wants them, certainly, and we will 
continue to develop new opportunities as we go on.
    We are always looking look at--my charge to my team is 
particularly to look at the reduction of overhead. I have 
conversations with Colleen Kelly, the head of the union, who 
says: ``Look, you have got too many middle and other 
managers.'' We are working on the span of control to try and 
increase the span of control so that there are more employees 
per supervisor. That gives you the ability to hold down the 
cost and yet keep the number of employees on line who are 
either in walk-in centers or who are out there doing audits.
    Senator Murray. Bottom line, can you ensure us on the 
subcommittee that none of those so-called efficiencies will 
negatively impact taxpayer services?
    Mr. Everson. Yes, I can, again, as long as we get that 
funding level, you know, within a reasonable proximity. The 
problem you get to, Senator, as you are well aware, we come in 
with a request and it does get nicked from time to time, even 
through the rescission process, where 1 percent gets whacked. 
There is always space. If we are quite close to it, I think 
have no problems we will be able to cover this, but if 
something dramatic happens, then we have to revisit it.
    Senator Murray. Okay. Well, Chairman Wagner, your fiscal 
year 2007 special report from the IRS Oversight Board states 
your belief that the $84 million in program efficiencies may 
decrease performance. Can you tell me what specific IRS 
functions you are concerned would be eroded under this 
proposal?
    Mr. Wagner. Senator Murray, we did express in our 2007 
report, the 2006 report, as well as my testimony that I have 
submitted today that this is one of the areas of risk. 
Accumulating savings of $84 million just does seem to the board 
inherently to present a risk, and we are going the continue to 
watch it to ensure that customer services are not compromised 
and that the enforcement continues to stay on track. We are 
also concerned that it could impact the rate at which the 
systems modernization is proceeding and so on.
    But to spread $84 million across the entire organization 
could be done and hopefully will be done, as the Commissioner 
suggests, without any cut in services, any detectable 
noticeable cut in services, but on the other hand, it might 
very well cause some damage, and we will continue to monitor 
that as well.
    Senator Murray. Thank you. Mr. Everson, you have cut some 
taxpayer services conducted through telephone or face-to-face 
contact and you propose to eliminate Telefile by arguing that 
it would be cheaper for the IRS if those citizens filed 
electronically. Now that Telefile is eliminated, taxpayers who 
used Telefile are not filing electronically. Instead, a 
significant number of those taxpayers are reverting back to 
paper filing, which is, as we know, a more expensive form to 
process. How do you explain that result?
    Mr. Everson. Well, Senator, as you may be aware, the 
Congress in RRA 98 directed the IRS to have an advisory 
committee in this area. That was established, and they advised 
over a course of a couple of years that we eliminate telefile 
as a part of this overall program. So we did take that advice 
and we did it, as you indicate, largely through as a measure of 
cost savings. There may very well be, as you have indicated--I 
haven't seen the final data on this--migration into paper, but 
the Telefile piece was the most expensive way to process the 
returns. I don't have the precise figure. I certainly can get 
it to you, but we saved, I believe, something between $15 
million and $20 million through the curtailment of that 
program, which we ramped down, as you know, over the course of 
fiscal year 2005 and took effect this filing season.
    Senator Murray. I think we have to be very careful, when we 
cut back taxpayer services, of the unintended consequences.
    Mr. Everson. Yes.
    Senator Murray. Which I think we are seeing with that.
    Ms. Olson, do you have any concerns in this area?
    Ms. Olson. Well, I think that this is an example where the 
IRS said that they were going to make some savings in the short 
run and incur longer-term costs and they also missed an 
opportunity to take those taxpayers and help migrate them to 
another electronic approach, and we just walked away from that. 
I just think if that is the wave of the future, we are going to 
have a real reduction in taxpayer services.
    Senator Murray. So we need to help taxpayers find----
    Ms. Olson. Exactly. We have to help them, assist them. A 
good example is, again, from my visiting the United Kingdom, 
what they used were screeners that would greet taxpayers at the 
door, and they would say what are you needing. They would say: 
``Well, I would like to find an answer to a question'', and 
they would say: ``Do you know that you can look this up on the 
computer?'' and they would walk them over to a computer bank 
and they would stand there just like people in the airline 
industry, stand by you as you are trying to do those confusing 
screens as you get your ticket. But they walk you through. So 
you do that two or three times, you have learned, you have 
migrated.
    Senator Murray. So we need an education process.

                       REFUND ANTICIPATION LOANS

    Let me go back to Commissioner Everson. The Taxpayer 
Advocate recently highlighted refund anticipation loans, RALs, 
as a serious problem facing taxpayers, in her 2005 report to 
Congress. More than half of those RAL customers are EITC 
recipients despite the fact that the EITC recipients constitute 
only 15 percent of all of our taxpayers. The money that is 
received by EITC recipients is also often very minimal, but the 
paperwork isn't. So many of our EITC recipients often seek out 
paid tax preparers to help them and frequently they pay for tax 
preparer services by signing up for a RAL, never realizing that 
it is a loan and not the refund itself.
    Can you share with us what you are doing to help reduce the 
number of taxpayers who fall victim to these predatory refund 
anticipation loans?
    Mr. Everson. Well, the first thing is we try to cajole and 
work with the industry. I think these are distasteful vehicles, 
and I have said that publicly. It is not a direct regulatory 
role for us in the sense of a loan. It is not something that we 
are charged with monitoring.
    At the same time, I do have real questions as to conflicts 
of interest where big preparers, they are in the tax 
preparation business, but then they are marketing other 
products. In part, it comes back to this question we started 
out with some time ago about what is the suite of services that 
are proper for a tax preparer to provide. What I find 
particularly concerning here is that some of the firms, they 
end up keeping an interest in the loan, if you will, over the 
life of the loan, and I think the banks want that because they 
want the preparer to make sure they are doing adequate fraud 
reviews and not providing the loans, if you will, to someone 
who is not going to get the money back.
    I do think it is area of continuing inquiry, maybe mostly 
for the Congress. There is a lot more concern about paid 
preparers now, including the big chains. There was reference to 
the recent GAO report. What you see is if you look at, frankly, 
the tax gap figures we showed, you see the same problems within 
the returns prepared by a preparer than you do in the overall 
population. That is hardly surprising given the fact that over 
half of returns are prepared by preparers. They obviously have 
to be a part of those problems.
    Senator Murray. I have spoken on this committee before 
about that. I am very concerned about that. I think it is a 
huge problem.
    I just want to end, Ms. Olson, if you could, just what else 
can we do?
    Ms. Olson. Well, right now, the IRS in cooperation with my 
offices is working on a report about refund anticipation loans 
and the debt indicator and identifying alternatives to RALs. 
The Treasury Department has a banking initiative and is looking 
at alternatives to RALs, ways of getting people into the 
system, and I think that some of the things that we will be 
reporting on will be very helpful to Congress.
    Senator Murray. When do you expect that?
    Ms. Olson. I think that the legislation says the conference 
report is June 30, and I think we are planning to deliver that 
on that date, and we are going out and talking to stakeholders, 
you know, the consumer groups to hear their concerns as well as 
members of the industry.
    I do have to respectfully disagree with the Commissioner 
about the IRS's role in this. We do set the rules for the 
electronic return originators who are the people who are 
offering these RALs, and our rules allow up to a 49 percent 
ownership interest in these loans. So we could change those 
rules. We also could do much more oversight. I did cover that 
in my annual report to Congress. We don't do sufficient 
oversight on these electronic return originators, in my 
opinion, and I think that we could also impose some due 
diligence requirements on the banks, that they make sure that 
the retail outlets are doing what they are required to do now 
in terms of disclosure. We don't know that.
    So I think there are some areas for improvement even in the 
current environment.
    Senator Murray. Yes.
    Mr. White. Senator, if I could just add, my name is James 
White at GAO. I think this highlights the importance of systems 
modernization at IRS. Taxpayers use RALs because they are a 
vehicle for getting their refund money faster. To the extent 
that IRS can process refunds faster, that would reduce the 
demand for RALs.
    Ms. Olson. Absolutely.
    Senator Murray. Okay.
    Mr. Wagner. Senator, that is exactly a point that I was 
about to make, that modernizing the system will allow the 
turnaround of refunds more promptly, within 2 to 3 days, and 
alleviate the need for the RALs. I might also add that I think 
the IRS has additional leverage in connection with these RALs 
in the process of the Free File Alliance and negotiating that.
    Senator Murray. Okay. Mr. Everson, why don't we just lower 
the time?
    Mr. Everson. Well, I think as the advocate indicated, we 
are actively continuing to look at all of these areas. I don't 
mean to say that we are precluded from doing anything. My 
remark was the principal regulation on the loans. So we are 
actively looking at this on a concerted basis, and we did do 
something in the Free File Alliance. We got additional 
protections in as to how people would be notified and what they 
would be told before a product like that would be offered. We 
focused on that very clearly in that negotiation. The RAL 
percentage there is not very high. I am hoping it is actually 
less than 1 percent. I am hoping that it goes away entirely 
maybe after this filing season.
    So we continue to work on it, most recently on that area.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Murray. Well, thank you very much to all of our 
witnesses today.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

                 Questions Submitted to Mark W. Everson
           Questions Submitted by Senator Christopher S. Bond

                     TAXPAYER ASSISTANCE BLUEPRINT

    Question. As mandated by our appropriations act, the IRS recently 
issued the first phase of the Taxpayer Assistance Blueprint. I asked 
for this business plan so that the IRS and the Congress could plan 
strategically on developing future taxpayer services based on taxpayer 
needs. I also expected the plan to address demographic and geographic 
differences. Ultimately, this plan should help to improve voluntary 
compliance with the tax code. I expected the plan to focus beyond 
current IRS services and develop innovative approaches.
    Please explain how the blueprint is meeting my needs, when we will 
receive the final plan, and how it will be integrated in the 
administration's future budget requests.
    Answer. The Taxpayer Assistance Blueprint (TAB) team is conducting 
and reviewing extensive research regarding taxpayer expectations. The 
TAB Phase 1 report, delivered to Congress in April 2006, discussed 
initial findings, including an inventory of current services and 
service channels. Several new studies, including a 40,000 taxpayer 
survey, are underway to add to the knowledge base. When released, the 
TAB Phase 2 report will address differences in taxpayer demographics 
and geography based on empirical data and recommend changes in service 
delivery options. It will also include development of an implementation 
plan for its recommendations; integration of recommendations; 
integration of recommendations into the budgeting process; and 
integration of the blueprint into the IRS Strategic Plan. We anticipate 
delivery of the report to Congress in October 2006, at which time we 
will have completed integrating its findings into our strategic 
planning and ultimately assisting in improving voluntary compliance.

                        BETTER TAX GAP ESTIMATES

    Question. While the IRS has done a commendable job in updating the 
tax gap estimates, there remain significant gaps in the gap. The IRS 
and others have expressed concerns with the certainty of the overall 
tax gap estimate in part because some areas of the estimate rely on old 
data (from the 1970's and 1980's) and it has no estimates for other 
areas of the tax gap. GAO, TIGTA, the Taxpayer Advocate, and the IRS 
Oversight Board also have all recommended greater and more frequent 
data collection and studies of the tax gap. I wholeheartedly agree.
    What will it take in terms of resources to address these concerns? 
Should the IRS conduct research on how services affect compliance?
    Answer. The difference between the amount of tax for a given tax 
year paid voluntarily and timely and the corresponding estimate of the 
true tax liability for that tax year is the Tax Gap. The three 
components of the Tax Gap include underpayment, nonfiling, and 
underreporting.
    The IRS regularly tabulates the underpayment tax gap from Master 
File data for each major tax and for major groups of taxpayers. This 
component of the Tax Gap is the only one that is actually observed; the 
rest must be estimated.
    The IRS currently estimates the nonfiling gap only for the 
individual income tax and for the estate tax. We must overcome some 
conceptual and data issues before we can develop nonfiling gap 
estimates for the remaining taxes, which requires the successful 
completion of various research projects.
    The underreporting gap has been estimated for various types of 
taxes (except excise taxes) and usually has been based on operational 
audits or audits of randomly selected returns. In general, the latter 
situation is believed to generate better estimates of the extent of 
underreporting in the population. The resources required to undertake a 
sufficient number of audits of randomly selected returns can be 
substantial. Therefore, much of the data underlying the underreporting 
gap estimates, for areas other than the individual income tax, date 
from the Taxpayer Compliance Measurement Program (TCMP) which conducted 
its last audits for Tax Year 1988.
    When the IRS conducted compliance studies under the auspices of the 
TCMP in the 1970's and 1980's, it generally sought to conduct studies 
of several components of the tax gap simultaneously, and to repeat the 
reporting compliance studies as often as every 3 years. IRS examination 
resources are nowhere near the levels they were 2 or 3 decades ago, so 
a schedule along these lines is not feasible. In fact, for some groups 
of taxpayers, the IRS used to conduct a greater number of random audits 
under TCMP than the total number of operational audits conducted today 
on those taxpayer groups. This change in resource allocations has led 
the IRS currently to conduct these research audits at a measured pace, 
and to consider conducting studies over more than 1 tax year--for 
example, the IRS is currently conducting a reporting compliance study 
of S-Corporations over a 2-tax-year period, to spread out the workload.
    Fully funding the President's budget request would be a start in 
establishing a resource base for undertaking reporting compliance 
audits on a recurring basis, with different types of reporting 
compliance being studied over time. As Congress increases the resource 
level the IRS can devote to operational audits, it becomes increasingly 
possible to use some of these resources for reporting compliance 
studies. Moreover, to the extent research resources permit, we will 
investigate alternative methodologies for estimating portions of the 
Tax Gap.
    In the past, the IRS has attempted to determine the impact that our 
service activities have on compliance. However, this area is extremely 
difficult to evaluate, in part because there is no direct link between 
the level of service provided/received and the consequent level of 
taxpayer compliance. The relevant research in tax administration has 
focused much more attention on the link between enforcement activity 
and overall compliance levels (the so-called indirect effect of 
enforcement actions). The results have generally shown a positive 
effect on compliance of increased enforcement activity (such as more 
audits), but the magnitude of the effect is subject to some dispute.
    The link between service and compliance has been even harder to 
define. Taxpayers who take advantage of service opportunities (asking 
tax law questions, searching the IRS website) generally cannot be 
linked to specific compliance outcomes. The IRS has had to look for 
indirect ways to detect this relationship. In some cases, the IRS has 
designed narrow studies to see if a particular intervention had a 
detectable effect. In other cases, it has meant devising complicated 
analytical approaches to establish the relationship (if any). However, 
these studies have not been comprehensive and have barely scratched the 
surface on understanding how provision of enhanced services affects 
overall compliance (both in the short and long term).
    The Taxpayer Assistance Blueprint study (now underway) is an 
attempt to understand better the relationship between service levels 
and compliance (among other things). We expect this to be an integral 
part of laying out a future research strategy to enhance our 
understanding in this area.

                BALANCE BETWEEN SERVICE AND ENFORCEMENT

    Question. There continues to be questions and debate on the proper 
balance between taxpayer service and enforcement. But given the data 
limitations of the tax gap and the IRS's inability to measure 
quantitatively the return on investment on service or enforcement, it 
is a difficult question to answer.
    What is known quantitatively about the impact of taxpayer service 
and enforcement on compliance? How much do IRS's service programs 
affect compliance? How much do IRS's enforcement programs affect 
compliance? What is your analytical basis for deciding on the balance 
between service and enforcement? What evidence do you have that IRS is 
striking the correct balance between its taxpayer service and 
enforcement efforts? Do you believe that one approach is more cost-
effective than the other?
    Answer. We do not know the quantitative impact of taxpayer service 
and enforcement upon compliance. During TAB Phase 1, the IRS conducted 
interviews with private sector organizations and other governmental 
agencies to identify customer service leading practices and the impact 
of service upon business results. Most of the organizations acknowledge 
the inherent challenge in quantitatively linking customer services to 
business results. They indicate that current metrics used to measure 
business impact from customer services are predominantly how those 
organizations measure qualitative or quantitative proxies. However, we 
have eight distinct initiatives in the TAB research plan to evaluate 
whether establishing a quantitative link is possible.
    It is not clear at this time whether the limited effects on 
compliance detected so far result from the difficulty in detecting this 
relationship between service and compliance (for example, the 
difficulty of disentangling all other potential effects), the design of 
the research studies or experiments, or the existence of a fairly weak 
relationship. We must do careful research in this area in order to 
support definitive conclusions about the strength and direction of the 
effect. Two papers presented at the IRS Research conference in June 
examined the link between service levels and compliance. One study 
found some service and education interventions led to modest 
improvements in compliance for some groups of taxpayers, and no 
improvements for other groups. Another paper noted that educational 
programs can have offsetting effects on compliance--on the one hand, 
they can inform taxpayers about potential ways to inappropriately 
report their tax liability, while on the other hand they can discourage 
this inappropriate behavior. At this point, the literature exploring 
the relationship between taxpayer service levels and compliance is in 
its infancy and there are few, if any, definitive results.
    We know slightly more about how enforcement programs affect 
compliance levels. A few IRS and academic studies have addressed this 
issue (for example, Dubin, Graetz, and Wilde (1990), Plumley (1996), 
and Dubin (2004)). All these studies find that increased enforcement 
(measured, for example, by increased audit coverage) is associated with 
increased voluntary compliance levels (this is the so-called indirect 
effect). However, the magnitude of the effect estimated by these 
studies varies widely. Further research is needed to pin down the size 
of this relationship and to estimate how it varies for different types 
of taxpayers.
    Ideally, the IRS would like to be able to estimate the cost-
effectiveness of each enforcement program and service offering, and how 
the effectiveness varies with level of effort. Cost-effectiveness in 
this context would take into account both the direct revenue effect 
(e.g., payments of back taxes from taxpayers subject to audit) and the 
indirect effect (the increased voluntary compliance levels in the 
general population resulting from the enforcement action taken or 
service provided). The costs of the activity would include all the 
costs to the IRS, including any overhead costs. If all these benefits 
and costs could be quantified, then in principle, it would be possible 
to determine the appropriate mix of services and enforcement.
    At this point, the IRS believes that a balanced program, 
maintaining service levels at those achieved in recent years while 
devoting any additional resources to enforcement activities is the best 
approach to improving voluntary compliance. However, ongoing research 
in several areas (such as the Taxpayer Assistance Blueprint project) 
will provide us with the data needed to determine if this is the 
correct balance or if we need to devote a greater or lesser proportion 
of resources to taxpayer service offerings.

                          INCREASING E-FILING

    Question. The current growth rate of e-filing will not allow the 
IRS to reach the congressionally-mandated goal of having 80 percent of 
all tax returns e-filed by 2007. One possible reason is the lack of 
financial incentive for taxpayers. There are reports that due to the 
cost of e-filing, more than a quarter of individual filers (40 million) 
prepared tax returns on a computer, printed them out, and mailed them 
to the IRS.
    What is your current plan on how and when you will achieve the 80 
percent goal? When does IRS project that electronic filing will meet or 
exceed the IRS Restructuring and Reform Act of 1998 goal of 80 percent? 
What actions and strategies are most likely to facilitate increased 
electronic filing? What can IRS do to eliminate or at least reduce the 
cost to taxpayers of electronic filing? How does your plan address the 
40 million people that prepared tax returns on a computer, printed them 
out, and mailed them to the IRS so that they will be incentivized to e-
file instead of mailing in paper returns? As suggested by the GAO, 
should the IRS consider expanding the use of electronic filing 
mandates?
    Answer. The vision of IRS electronic tax administration is one in 
which we accomplish electronically any exchange or transaction that 
currently occurs in person, over the phone, or in writing. All 
taxpayers would have the option of conducting their transactions 
electronically. Taxpayers would have multiple choices in terms of how 
they interact with us and what value-added services (for example, 
Where's My Refund, and paying electronically via debit or credit card) 
they choose to use. Taxpayers would become e-customers.
    Our e-strategy for growth outlines our plans to reduce taxpayer 
burden and increase electronic filing. Key strategies include:
  --Making electronic filing, payment and communication so simple, 
        inexpensive, and trusted that taxpayers will prefer them to 
        calling and mailing.
  --Substantially increasing taxpayer access to electronic filing, 
        payment, and communication products and services.
  --Aggressively protecting transaction integrity and internal 
        processing accuracy.
  --Delivering the highest quality products and services as promised.
  --Partnering with States and other governmental entities to maximize 
        opportunities to reduce burden for our common customer base.
  --Encouraging private sector innovation and competition.
    To achieve these strategic goals, we will continue to develop and 
implement e-file marketing strategies, expand the use of electronic 
signatures, and enhance our website services for both practitioners and 
taxpayers. Ultimately, our goal is to offer all taxpayers and their 
representatives the ability to conduct nearly all of their interactions 
with the IRS electronically.
    We have collaborated with the private sector in developing a Free 
On-Line Electronic Tax Filing Agreement. The agreement makes available 
to 70 percent of taxpayers, at no cost, the tax preparation and filing 
services of 20 participating companies. In processing year 2005, more 
than 5.1 million taxpayers took advantage of the opportunity to file 
electronically at no cost.
    Section 6011(e)(1) indicates that the Secretary may not require 
returns of any tax imposed by subtitle A on individuals, estates and 
trusts to be other than on paper forms supplied by the Secretary. The 
IRS does not support a general e-file mandate for individual taxpayers. 
There are too many individual circumstances that might make such a 
mandate a burden to some taxpayers and make it impossible to enforce. 
The IRS believes that there are approaches other than individual 
mandates that lessen the chance for burden on specific taxpayers. 
However, we strongly urge Congress to act on the administration's 
proposal to provide the IRS with additional authority to require 
electronic filing, short of blanket individual mandates. This proposal, 
on page 262 of the Analytical Perspectives, will allow the IRS to 
process more returns and payments efficiently.
    Regarding the people who prepare their returns on a computer and 
then mail them to the IRS, a group of taxpayers whom we call ``V-
Coders,'' we have a plan, developed by our Stakeholder Partnerships, 
Education and Communications (SPEC) organization, to specifically 
target these filers and reduce these types of returns by using 
leveraged outreach through partner channels to market our full 
portfolio of electronic products and services.

                      PRIVATE COLLECTION AGENCIES

    Question. One new tool that you have mentioned that will help in 
collections and enforcement is the use of private collection agencies 
(PCAs).
    What is the status of the PCAs? What controls are you providing to 
protect taxpayer rights and privacy?
    Answer. On June 14, 2006, the Government Accountability Office 
(GAO) denied protests of the IRS contract award of March 9, 2006 to 
three Private Collection Agencies (PCAs). GAO's resolution of the 
protests lifts the 100-day Suspension of Work Order and clears the way 
for IRS plans to begin placing cases with the PCAs by early September 
2006.
    The IRS has a variety of safeguards in place to protect taxpayer 
rights and privacy as the private debt collection initiative moves 
forward. Before they can receive delinquent taxpayer account 
information, PCA employees are required to undergo background 
investigations and complete all IRS-mandated training. Individual 
privacy will be protected by the confidentiality provisions of the 
Internal Revenue Code (IRC) Section 6103 and the Privacy Act of 1974, 
as amended. Private collection agency (PCA) employees will be held to 
the same ethical standards regarding disclosure and privacy as IRS 
employees and are subject to the same penalties as IRS employees. 
Failure to adhere to these laws and regulations may subject employees 
to criminal penalties or to civil causes for action.
    Additionally, PCA firms will be monitored for compliance with all 
applicable Federal and State laws, including the Fair Debt Collection 
Practices Act. The IRS established a Private Debt Collection Oversight 
Unit (OU) and a Referral Unit (RU) to: manage PCA inventory; monitor 
security and privacy requirements; monitor quality, and; evaluate PCA 
performance and compliance with contractual requirements. Through the 
OU and the RU, the IRS will ensure that the PCAs maintain taxpayer 
confidentiality at all times through a combination of training and 
strict oversight. The IRS will conduct on-site security reviews to 
ensure PCAs implement appropriate access controls to segregated areas 
where IRS work will be performed.
    Failure to comply with the confidentiality safeguards will be 
considered a breach of contract. Contractors are not authorized to 
communicate with third parties (other than the taxpayer's designated 
representative) and are prohibited from soliciting direct receipt of 
funds from taxpayers. Unauthorized disclosure of confidential tax 
information by officers or employees of the firms will subject those 
individuals to felony charges punishable by up to $5,000 and 5 years in 
prison.

                       E-FILING FOR CORPORATIONS

    Question. Electronic filing is now required for corporations having 
assets of $50 million or more. Next year, for 2006 returns, the 
threshold drops to $10 million in assets.
    Do you believe the corporate world will be ready for this filing 
requirement? What is your basis for your response? What steps are you 
taking to assist corporations to meet the new e-filing mandate? Along 
this same requirement, will the IRS have the capacity to handle what is 
likely to be a significant increase in corporate electronic filings?
    Answer. We believe the corporate world will be ready for next 
year's e-filing requirement for several reasons. By June 18 of this 
year (which is relatively early in the corporate filing season) over 15 
percent of the corporations required to e-file (those corporations with 
assets greater than $50 million) had e-filed their 2005 tax returns. As 
has been publicly announced, General Electric (GE) successfully e-filed 
the Nation's largest tax return on May 18, 2006. On paper, GE's e-filed 
return would have been approximately 24,000 pages long. After filing, 
GE received IRS's acknowledgement of its filing in about an hour. The 
file was 237 megabytes.
    The ability of these firms to meet the electronic filing 
requirements also clearly indicates the IRS Modernized e-File system is 
fully operational and is accepting and processing large and complex 
corporate tax returns. We also believe the necessary support for the 
corporations being added to the e-file requirement next year will be 
available. A few of the corporations that have e-filed so far this year 
used their own software and/or transmitted their own returns to the 
IRS. However, the clear majority of the corporations are using 
commercial tax preparation software and/or third-party transmitters to 
e-file their returns. Corporations with assets between $10 to $50 
million will use the same software packages and return transmitters as 
are currently being used by those with assets over $50 million.
    Additionally, the vast majority of the corporations being added to 
the e-filing requirement next year generally rely on CPA's as their tax 
advisers. We are actively working with the AICPA on efforts to get 
their members knowledgeable about corporate e-filing and the related 
requirements. So far these efforts have included contacting the five 
largest CPA State Societies to work towards getting e-filing 
information and presentations as part of their 2006 CPE programs and, 
jointly developing an e-filing course to be available to all CPA CPE 
programs.
    Lastly, with regard to the system being able to handle increased 
capacity demands because of the filing requirement dropping to $10 
million, since bringing the system online we have followed a continual 
program of monitoring filing patterns, adjusting our projections 
accordingly, and then developing and executing stress tests of the 
system to ensure its ability to respond to our return projections. 
Based on this program of stress testing and projections, we make the 
necessary adjustments to ensure that we have the infrastructure in 
place to support the anticipated volume. Thus, we believe we will be 
well positioned to handle next year's increase in corporate e-filed 
returns.

               STRATEGIC PLAN FOR ADDRESSING THE TAX GAP

    Question. As I stated at the hearing, the IRS is directed to work 
with the IRS Oversight Board, the National Taxpayer Advocate, and other 
stakeholders to develop a strategic plan for meeting the 
administration's stated goal of increasing voluntary compliance to 85 
percent by 2009. The strategic plan should identify a wide range of 
goals, objectives, and strategies, at least some of which would be 
beyond the scope of the IRS, such as implementing tax code 
simplification, and providing new tax administration tools such as 
additional reporting requirements.
    How will the IRS develop such a plan? How long will it take the IRS 
to complete such as plan?
    Answer. We recognize that the best way to address the tax gap is to 
maintain a balance between service and enforcement. The IRS will 
consult with the Oversight Board, the National Taxpayer Advocate, and 
other stakeholders to ensure that our plan for improving voluntary 
compliance maintains the proper balance. While the IRS has restored 
credibility to its compliance programs over the last 2 years, 
additional enforcement alone is not the answer. Studies show that 
voluntary compliance is higher where there is third-party reporting 
and/or tax withholding. Therefore, our plan will likely involve both 
recommendations for improving voluntary compliance and tax 
administration efficiency, such as the legislative proposals for 
improving IRS operations submitted with the fiscal year 2007 IRS 
budget. The IRS will use also the results from its recent compliance 
studies to improve audit selection models, and we will continue to 
combat abusive tax shelters by corporations and high-income individuals 
and vigorously pursue those who promote these illegal schemes.
    The IRS has already begun laying the groundwork for a strategic 
compliance plan that will improve voluntary compliance and reduce the 
tax gap. We intend to present a proposal for consideration this fall. 
Because this proposal may include administrative and legislative 
changes, we will need to coordinate the proposal with the IRS's budget 
submission.

                           LONG-TERM BSM PLAN

    Question. The GAO has informed the subcommittee that the 5-year IT 
Modernization Vision and Strategy document should be supplemented with 
an additional plan that covers the remainder of the BSM program. GAO 
further recommended that the plan be tied to a known spending level, so 
that Congress can understand the funding requirements to implement the 
plan and the impact of funding delays.
    Has the IRS begun to develop a plan for the remainder of the BSM 
program? How would you develop the plan? What information will it 
contain to give Congress the information it needs to monitor program 
execution?
    Answer. In August 2005, the IRS embarked on a lengthy, 
comprehensive, and collaborative IT modernization planning effort 
involving more than 80 IRS employees from across the Agency. The 
resulting strategy, known as the Modernization Vision and Strategy 
(MV&S), will speak to the modernization of IRS's core tax 
administration functions and include BSM projects as well as smaller-
scale system efforts.
    Presented as a 5-year plan, MV&S will outline the projects that the 
IRS plans to carry out to meet the highest business priorities 
identified by individual business units. The plan will include all IT 
modernization investments (not just BSM) and ensure that the complete 
set of modernization initiatives is optimized and coordinated. The MV&S 
approach emphasizes enhancing existing systems in lieu of full 
replacement; full replacements are to be undertaken in those few cases 
where upgrade is impractical.
    To keep the MV&S current, the IRS is instituting a planning process 
to annually update the 5-year plan. Further, the annual BSM Expenditure 
Plan will address major project enhancements emanating from MV&S 
planning. Congress will be able to assess and monitor program 
performance against the Expenditure Plan.

                               BSA DIRECT

    Question. During our last hearing with the Treasury, we discussed 
the problems surrounding the BSA Direct system. I understand the IRS is 
helping FinCEN in ensuring continuity of service to users and is 
looking at how to meet other BSA Direct needs.
    Please provide a status report on the IRS's work on BSA Direct in 
terms of the specific actions the IRS has taken to address the needs of 
FinCEN and how much money the IRS plans to spend on carrying out these 
actions.
    Answer. To ensure continuity of service to FinCEN users, IRS and 
FinCEN IT representatives have met weekly since April 2006 to address 
FinCEN's unique Gateway (case information) requirements and develop 
connectivity, training, and conversion plans for their users to 
WebCBRS. The IRS implemented their unique Gateway processing 
requirements in the WebCBRS on June 1, 2006. FinCEN reimbursed the IRS 
for associated programming costs of $300,000. FinCEN's internal users 
are connected and are testing WebCBRS, with plans to continue training 
and incrementally converting their Regulatory and Law Enforcement users 
to WebCBRS by September 2006.
    On June 7, 2006, the IRS and FinCEN met to discuss other BSA Direct 
needs that FinCEN is defining, including new and changed BSA forms, 
with estimated costs of $750,000. The IRS's first priority is to ensure 
FinCEN users are connected, trained and converted by September 2006. 
Once this step is accomplished, the IRS will continue to partner with 
FinCEN to address specific BSA Direct requirements, along with 
estimated costs and proposed delivery dates.

                          ESTATE AND GIFT TAX

    Question. I understand that the IRS is implementing a survey of the 
Estate and Gift (E&G) tax returns filed from 2000 to 2007.
    What is the purpose of that survey?
    Does the IRS have any plans to reduce the number of Estate and Gift 
Tax Attorneys? If so, what timeline are you considering?
    Answer. The IRS is studying the projected volume of filings of 
estate and gift returns in light of the increasing filing threshold 
amounts. Furthermore, we are reviewing the staffing levels and audit 
coverage within the estate and gift program to effectively balance 
enforcement resources.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

  CUTTING THE IRS OFFICE RESPONSIBLE FOR SERVICE WHILE EXPECTING MORE 
                        FROM VOLUNTEER PROGRAMS

    Question. Mr. Everson, the IRS's Stakeholder, Partnership, 
Education and Communication (SPEC) office has overall responsibility 
for community partnerships such as the Volunteer Income Tax Assistance 
(VITA) and Tax Counseling for the Elderly (TCE) programs. In recent 
years, this IRS office has suffered cutbacks while the number of 
taxpayers seeking help from by VITA and TCE for tax preparation 
continues to increase dramatically. Moreover, you stated recently that 
you expect to rely heavily on VITA programs to improve taxpayer 
services.
    How do you justify continuing to cut the SPEC office while giving 
it an increasing workload?
    Answer. The IRS is devoting the necessary staff to support the 
Stakeholder Partnerships, Education and Communication (SPEC) business 
model that partners with external organizations to deliver volunteer 
return preparation (VITA/TCE), outreach/education, and asset building 
services. Since the reorganization of the IRS in 2000, the SPEC 
organization has evolved from 531 SPEC on-rolls (staffing) in fiscal 
year 2001 to 565 on-rolls (staffing) in fiscal year 2006.
    We believe the community-based programs play an important role in 
improving taxpayer service and are critical in providing no-cost tax 
return filing assistance to underserved taxpayers, including low-
income, elderly, disabled, and taxpayers with limited English 
proficiency. As such, the IRS has established partnerships with more 
than 60 national organizations representing financial institutions, 
educational institutions, tribal governments, community and volunteer 
organizations and many others. At the local level, the IRS has formed 
over 295 coalitions (up from six coalitions in fiscal year 2001), 
representing thousands of partners. As our experience, program 
knowledge, and relationships with external partners have grown and 
matured over time, our capacity to deliver more service through the 
leveraged business model has significantly increased. For example, as 
of June 17, 2006, community-based partners had prepared 2.24 million 
returns compared to 1.17 million returns for the entire fiscal year of 
2001.
    Question. Ms. Olson, what is your opinion on this matter?
    The VITA program operates for only about 4 months of the year 
during tax season and receives limited support from the IRS. Ms. Olson, 
in your statement, you say that the IRS should concentrate on 
developing a fundamental support structure for the program and expand 
the program. You also say that the IRS should not let VITA or any other 
volunteer program serve as a substitute for IRS-provided service.
    Ms. Olson, why do you take that position, and Mr. Everson, what is 
your response to this?
    Answer. As previously stated, the assistance the SPEC organization 
provides through the support of its partners play an important role in 
improving taxpayer service and is critical in providing no-cost tax 
return filing assistance to underserved taxpayers, including low-
income, elderly, disabled, and taxpayers with limited English 
proficiency. However, it is important to note that the success we have 
achieved each filing season, as outlined in the preceding paragraph, is 
largely predicated on the rigorous planning effort that takes place 
throughout the fiscal year with national and local partners. A national 
program of this magnitude requires year-round support to incorporate 
planning, training, filing season assessment, partner recruitment 
activities and partner satisfaction improvement.
    This support is essential to maintaining existing partner 
relationships and attracting new partners and the investment is 
substantial. It provides partners with tax law and software training, 
marketing materials, educational products, research data for optimal 
site placement and effectiveness, supplies, technology support 
(software, computers and printers) and the necessary products, 
procedures, and technical expertise for effective site operations. 
SPEC, with its partners, supports over 12,000 volunteer return 
preparation sites nationwide that are strategically placed to 
facilitate access for low-income taxpayers. Our annual research report 
on SPEC site coverage indicates 99 percent of low-income taxpayers have 
access to a free tax return preparation site within 45 minutes of their 
home. This coverage is a complement to, rather than a replacement of, 
IRS-provided services.

         SETTING TAXPAYER ASSISTANCE CENTERS (TACS) UP TO FAIL

    Question. In a briefing last year by TIGTA on Taxpayer Assistance 
Centers, I learned that some TACs have as little as one or two staff, 
what TIGTA calls a ``critical staffing shortage''. The House and 
Senate, Majority and Minority, said no to your proposal to cut back 
TACs until TIGTA completes a study on the impact of such reductions on 
taxpayer compliance and taxpayer services.
    Mr. Everson, are you, in fact, allowing these TACs to eventually 
close by letting the staffing levels dwindle? Do you believe that is 
consistent with the direction from this committee?
    Answer. In response to the congressional directive received with 
our fiscal year 2006 budget appropriation, a concentrated effort was 
made to keep all of our 400 Taxpayer Assistance Centers (TAC) open 
during filing season. I am pleased to report that we not only kept all 
of these TACs open, but we addressed all potential critical staffing 
shortages in our one and two person TACs. Specifically, during the 
fiscal year 2006 filing season, we hired almost 60 critical permanent 
front line employees, returned seasonal employees and detailed back 
former TAC employees who were assigned to other IRS organizations. We 
also temporarily deployed technical employees as necessary from other 
TACs in an effort to keep every TAC open daily. We initiated a second 
wave of hiring after the filing season and expect to employ over 300 
front line employees to fill behind attrition. These actions will bring 
our staffing levels at the end of fiscal year 2006 to the same on-rolls 
we had at the beginning of fiscal year 2006 (2,080), as well as 
position us to deliver services in fiscal year 2007 with a minimal 
amount of contingencies required.
    While we expect the Taxpayer Assistance Blueprint (TAB) initiative 
to guide future decisions about the proper staffing levels for the TACs 
and the kinds of services we will offer, we are committed to achieving 
and maintaining an appropriate level of staffing and service in the 
TACs as demonstrated this fiscal year.
    Question. Mr. George or Ms. Olson, do either of you care to 
comment?
    Mr. Everson, your statement mentions the identification and 
elimination of non-critical vacancies as one of the means through which 
you intend to achieve efficiencies within taxpayer service programs and 
processes.
    When it comes to staffing at the taxpayer assistance centers, are 
you trying to achieve through attrition what you couldn't achieve due 
to legislative restrictions?
    Answer. As indicated in our above response, we are committed to 
achieving and maintaining an appropriate level of staffing and service 
in the TACs. The IRS demonstrated this commitment by the staffing 
actions taken to prepare for the 2006 filing season and the post-filing 
season actions to fill behind attrition. We expect to employ over 300 
front line employees to address staffing vacancies caused by attrition. 
These actions will bring our staffing levels at the end of fiscal year 
2006 to the same on-rolls we had at the beginning of fiscal year 2006 
(2,080, including the 300 attrition hires), as well as position us to 
deliver the same level of services in fiscal year 2007 with little to 
no alternative staffing contingencies.

                        SERVICES OFFERED AT TACS

    Question. Mr. Everson and Ms. Olson, why hasn't the IRS involved 
taxpayers who need or desire face-to-face assistance in determining 
what services are offered at the TACs?
    Answer. Since September 2005, the Taxpayer Assistance Blueprint 
(TAB) team has been conducting extensive research directly with 
taxpayers to identify taxpayer needs and preferences for receiving 
services including those offered at our TACs. As you know, we delivered 
the TAB Phase 1 Report to Congress in April 2006. The TAB Phase 2 
report, which we expect to deliver to Congress in October 2006, will 
validate the service recommendations through extensive primary research 
with taxpayers. Current ongoing customer preference and needs research 
includes surveys, focus groups, and experimental research aimed at 
providing customer-centric information to decision-makers.
    Question. Mr. George, your recent audit report says that prior to 
making decisions on closing any TACs, the IRS should ensure that it is 
known which taxpayers visit the TACs for assistance and why, so the IRS 
can determine the impact on these taxpayers and ensure alternative 
service deliver channels are effective in meeting the needs of these 
taxpayers.
    Ms. Olson, I would imagine you agree?
    Mr. Everson, TIGTA recently found that 8 of 11 stakeholder groups 
believe that closing the TACs may make it harder for their constituents 
to stay compliant with tax laws and file tax returns. TIGTA also found 
that 11 of 11 stakeholder groups believe their constituents are not 
currently likely to use alternative methods, such as the internet or 
email to obtain the services they need.
    In light of your efforts to reduce face-to-face interaction between 
the IRS and the taxpayer and your efforts to increase compliance, have 
you re-thought some of your earlier decisions on reducing taxpayer 
services?
    Answer. Balancing customer service with enforcement to achieve 
compliance has been and will continue to be a fundamental goal of the 
IRS. Currently there are no efforts underway to reduce face-to-face 
interaction between the IRS and taxpayers. However, we are optimistic 
that the TAB study, which includes comprehensive research around the 
needs and preferences of taxpayers, will not only identify more 
efficient and cost-effective service delivery channels, but also 
provide a business model that balances taxpayer preference with 
business values. Our goal is to make service investment decisions in 
order to reach the most taxpayers through their preferred service 
channel within available resources.

                     REDUCTION OF TAXPAYER SERVICES

    Question. Mr. Everson, last year, you:
  --eliminated ``TeleFile'', the ability to file taxes by telephone;
  --proposed the elimination of as many as one quarter of all walk-in 
        Taxpayer Assistance Centers;
  --proposed shortening phone assistance hours; and
  --began the process to eliminate several telephone call-routing 
        sites.
    In a profile of online population, Census data indicates that in 
any given age group (ages 18-29; 30-39, etc.), not even one-third of 
adults are on-line. We know that the Nation's large senior citizen, 
limited proficient English, and underserved populations are not as 
likely to use or have access to the internet as other forms of 
communication.
    Given this and the digital divide at every generation, how do you 
rationalize the elimination of face-to-face and telephone interaction 
in favor of electronic communication?
    Answer. The Taxpayer Assistance Blueprint (TAB) team is analyzing 
taxpayer needs, preferences and behaviors to determine the optimal 
delivery of service across all channels. As stated previously, the TAB 
Phase 2 report, which we expect to deliver to Congress in October 2006, 
will use extensive primary research with taxpayers to validate its 
service recommendations. Current ongoing customer preference and needs 
research includes surveys, focus groups, and experimental research 
aimed at providing customer-centric information to decision-makers. In 
this context, careful consideration is being given to those taxpayers 
facing a barrier to online self-service options. Again, our goal is to 
maintain a balanced service portfolio that meets the needs of the 
greatest number of taxpayers within limited resources.
    We made our initial proposal to shorten phone assistance hours in 
an effort to more closely match our hours of operation to the hours of 
our customer's greatest demand to ensure the most efficient usage of 
our scarce resources while providing the best service possible to our 
customers. We decided not to implement this change as planned due to 
language in the 2006 appropriation bill directing the IRS not to reduce 
services.
    We made the decision to close three call sites (Boston, Chicago and 
Houston) because the IRS identified them as non-continuing sites in the 
early 1990's. This decision was made after a nationwide study showed 
the benefits of reducing the number of call sites and the best 
locations for consolidating our telephone operations based on rent, 
cost of living, competitive salaries and similar factors. Throughout 
the intervening years, we did not fill vacancies in Boston, Chicago, 
and Houston because of our long-standing plans to close those sites. As 
the number of employees in Boston, Chicago, and Houston continued to 
shrink it was no longer fiscally responsible to rent large, underused 
offices. By closing these sites and consolidating call operations, the 
IRS saved a significant amount of rent and support costs and gain 
productivity efficiencies with no impact whatsoever on our telephone 
customers.
    To further put this action in context, in the early 1970's we were 
operating 135 call sites. The IRS derived efficiencies from 
consolidating smaller sites into larger operations so that by 1975, the 
IRS had reduced the total number of sites to 85. By the early 1990's, 
the IRS had undertaken further consolidations toward achieving a 25-
site footprint. We designated Boston, Chicago, and Houston as non-
continuing, no-growth sites, along with others that have since closed 
including Anchorage, Brooklyn, Honolulu, Los Angeles, Milwaukee, 
Newark, Omaha, Phoenix and St. Paul.
    We serve our telephone customers using an enterprise approach and a 
toll-free telephone network that now consists of 25 call sites 
nationwide. Since we manage toll-free traffic nationally, the calls 
previously answered in Boston, Chicago and Houston are automatically 
routed to other call sites without affecting overall telephone service. 
Regardless of our customers' geographic locations, when they call us, 
our system routes their call to an available assistor who can best 
answer their type of question at any of our 25 sites. This routing 
occurs within seconds and is transparent to callers.

HOW HAVE YOU SPENT THE ADDITIONAL ENFORCEMENT FUNDING YOU GOT IN FISCAL 
                               YEAR 2006?

    Question. Mr. Everson, the fiscal year 2005 budget resolution 
included language that enabled our bill last year to provide an 
additional $446 million to be used for enforcement. Your March 7, 2006 
report on enforcement indicates that 40 percent of that funding will 
maintain your base costs and 60 percent of that funding will allow 
hiring of 1,146 new enforcement FTEs, which you have already begun.
    At this point in time, how many of those positions have you hired?
    Answer. As of June, we have hired 1,224 positions for our fiscal 
year 2006 enforcement initiatives. These positions include over 500 
Revenue Agents, as well as additional front-line enforcement staff. The 
number of positions hired corresponds to 959 FTE.
    Question. What is your time frame for the rest of these hires?
    Answer. Several IRS business units are planning additional hires 
during the remainder of the fiscal year. Through the fourth quarter we 
will be hiring approximately 120 additional Revenue Agents and 60 
additional enforcement staff, though some of these will be allocated to 
attrition hiring.
    Question. How much money has not yet been obligated?
    Answer. Approximately $13.3 million in initiative enforcement funds 
remain to be obligated, primarily in salary and benefit resources that 
will be used to pay current and future staff costs through the balance 
of the fiscal year.

                           FREE FILE ALLIANCE

    Question. Mr. Everson, recently, the Finance Committee found that 
taxpayers using the Free File on-line tax return preparation services 
are presented with surprise fees, expensive add-ons, loan solicitations 
and other marketing pitches. While there is no obligation to buy these 
services, the fees occur so late in the process that taxpayers may feel 
forced to pay them or completely redo their taxes with another vendor 
who may also charge fees. It is my understanding that the IRS has not 
conducted much research on how many taxpayers fall prey to these sales 
pitches.
    What is the IRS doing to protect taxpayers from predatory sales 
pitches and do you plan to do more comprehensive research on these 
activities?
    Answer. The new Free File Alliance agreement contains a number of 
program improvements meant to increase the overall quality of the 
program and customer satisfaction. For example, the new agreement 
contains enhanced standards for consumer protection if a refund 
anticipation loan (RAL) is offered by a Free File Alliance (Alliance) 
member. Also, Alliance members must disclose on the members' individual 
landing pages if State tax return preparation and filing services are 
available and, if so, whether a fee will be charged for such services. 
If a fee is charged for such services, the cost to the taxpayer must be 
clearly stated on the members' landing pages.
    For the 2007 filing season, we will continue to be vigilant with 
the Alliance members to ensure that the companies are adhering to the 
terms of the agreement, including those provisions designed to ensure 
the protection of taxpayer rights and confidentiality of taxpayer 
information. We also acknowledge that the companies may offer products 
and services which are closely related to the tax preparation process 
and are of beneficial value to taxpayers.
    In order to conduct more research, we are conducting a Free File 
survey this year with the following objectives:
  --To determine, among taxpayers using Free File in 2006, how they 
        were introduced to Free File, their reasons for choosing this 
        electronic product, how they used it, and how they perceived 
        the product in terms of its ease of use, use of specific 
        product features, and satisfaction with the usage experience.
  --To provide results that can be used to assist the IRS with making 
        policy decisions related to expanding the use of e-file.
       addressing shoddy work by tax preparers and practitioners
    Question. Just this month, GAO reported that there may be serious 
problems with the accuracy of the tax returns prepared by many of the 
private tax preparation companies. The GAO found that these companies 
often prepared returns that were incorrect, with tax consequences that 
were sometimes significant. Some of these mistaken returns could have 
exposed taxpayers to penalties for such things as negligence and 
willful or reckless disregard of tax rules. Furthermore, TIGTA found, 
this month, that the IRS is not taking the necessary disciplinary 
action against tax practitioners who have been convicted or had their 
licenses revoked by State authorities.
    Mr. Everson, why aren't you taking a more aggressive approach to 
regulating these individuals?
    Answer. I agree that all taxpayers should be able to receive 
accurate return preparation assistance. While most paid preparers do 
their best to provide their clients with tax returns that are fully 
compliant with our Nation's tax laws, preparers who violate this public 
trust should be identified and subjected to the full range of sanctions 
available. Although more can always be done, the IRS is aggressively 
pursuing those paid preparers who are negligent or encourage out-right 
fraud.
    In 2006, the IRS developed a new multi-functional Preparer 
Strategy, improving our coordination of preparer-related workload and 
ensuring that we work preparer non-compliance issues consistently, 
timely, and effectively. More than 500 Program Action Cases (PACs) were 
in process at the end of the first quarter of fiscal year 2006, a 500 
percent increase over the number in process for the same period in 
fiscal year 2005. PACs are one of the processes used to investigate 
appropriate return preparer penalties. The main preparer penalty 
provisions are  6694, Understatement of Taxpayer's Liability by Income 
Tax Return Preparer, and  6695, Other Assessable Penalties With 
Respect to the Preparation of Income Tax Returns for Other Persons. 
These two sections are exclusively applied to return preparers and 
range from $50 to $1,000 per offense.
    In fiscal year 2005, the Department of Justice secured injunctions, 
based on IRS referrals, against more than 40 promoters/preparers, 
preventing these individuals from preparing returns and promoting 
abusive schemes. The IRS continues to make referrals and work with the 
Department of Justice on securing injunctions against additional 
promoters/preparers to prevent these individuals from further 
participating in unscrupulous conduct.
    The Criminal Investigation Division (CI) initiated 248 return 
preparer investigations in fiscal year 2005, a 20 percent increase from 
the previous year. CI utilizes many techniques, including the use of 
the undercover program, search warrants, witness interviews; and 
contacts with informants, banks, and local law enforcement, to 
vigorously pursue investigations of unscrupulous return preparers.

          INAPPROPRIATE COMPETITIVE SOURCING OF MAILROOM WORK

    Question. Mr. Everson, the fiscal year 2004 Transportation-Treasury 
Appropriations Act included a prohibition on funding for the conversion 
of work performed by 10 or more Federal employees to a contractor 
without holding a public-private competition. At the time the bill was 
enacted (January 23, 2004), approximately 65 Federal employees, 
including those with disabilities, were performing mailroom work. Yet, 
in 2004, the IRS permitted a private contractor to replace the RIF'ed 
mailroom employees.
    How is it that the IRS did not conduct a public-private competition 
for its mailroom operations?
    Answer. In fiscal year 2003, the IRS made the decision to directly 
convert the mailroom positions and selected a contractor under the 
Javits-Wagner-O'Day Act Program, which provides greater employment 
opportunities for people with disabilities. The IRS chose to conduct an 
A-76 Direct Conversion to a NISH (formerly the National Institute for 
the Severely Handicapped) provider because fewer than 25 employees 
would be affected and because of the proven past performance with IRS 
mailrooms (the IRS already contracted 10 mailrooms through NISH). In 
October 2003, the IRS signed the contract with 4 option years with 
ServiceSource for mail delivery in 33 locations. ServiceSource is a 
Community Rehabilitation Partner which creates opportunities for 
individuals with disabilities, is certified by NISH and has over 30 
years of experience providing mailroom services to Federal and State 
agencies in both on-site and off-site facilities. The contract provided 
the capability for IRS and the contractor to incrementally on a site-
by-site basis issue task orders to phase-in contractor performance. 
This phase-in approach afforded the IRS greater opportunity to work 
with employees on mitigation strategies to reduce the number of 
potential employees facing a reduction-in-force.
    The IRS had previously begun reduction-in-force negotiations with 
the National Treasury Employees Union (NTEU) and offered assistance to 
impacted employees--voluntary early retirement and voluntary separation 
incentive, some placement opportunities within IRS for other positions, 
and potential employment with the contractor. The IRS issued the 
reduction-in-force notices to 12 employees in October 2004. The IRS 
placed two of the employees in other agency positions and most of the 
remaining 10 employees went to work for the contractor.
    Question. Furthermore, I'm told that the Federal employees 
performed administrative and support activities, in addition to their 
mailroom responsibilities, such as opening mail and delivering mail to 
employee desks. I understand that the contract employees would not have 
done these additional duties, yet the IRS used the same assumptions 
when comparing these costs.
    How do you explain that?
    Answer. The IRS addressed the duties of opening and subsequent 
desktop delivery of mail during the data gathering phase of the 
Business Case Analysis for this Competitive Sourcing Initiative. That 
data indicated that desktop delivery of mail was not being performed in 
94 percent of the sites impacted by the study before the conversion to 
contract delivery. We retained that desktop delivery feature at those 
locations (2 of 32) when the Contractor took over this operation. As 
for opening of all mail, these duties were not identified as being 
performed in any sites.
    The process of researching mail where the delivery point was 
unidentifiable by the address provided was reflected in the data 
gathering phase as being performed at all locations. This research task 
did require the opening of this small percentage of correspondence by 
IRS mail clerks, and this practice has continued within the statement 
of work for the contractor.
    Question. A lawsuit was filed against the IRS, challenging the 
legality of the conversion of the mailroom employees. Subsequently, an 
IRS spokesperson said in mid-March that the IRS is currently reviewing 
the judge's decision.
    What is the result of that review?
    Answer. The interim court ruling concluded that even though the IRS 
had signed a contract prior to the enactment of the fiscal year 2004 
appropriations, the IRS could have exercised discretion on whether or 
not to issue the individual task orders, and therefore, violated the 
provisions of the 2004 appropriations. Both parties (NTEU and IRS) are 
currently exchanging proposals of remedy for the former employees who 
were involuntarily separated.

                                TAX GAP

    Question. Mr. Everson, at a recent Senate hearing on the tax gap, 
you testified that the IRS could collect an additional $50-$100 billion 
each year without changing the way the Government interacts with the 
taxpayer. However, the five legislative proposals in your budget, aimed 
at reducing the tax gap, are estimated to raise only $3.5 billion over 
10 years, or $350 million per year.
    Mr. Everson, with a requested budget increase of 0.2 percent next 
year--basically a flat budget--how will the IRS be able to collect this 
$50-$100 billion?
    Answer. The collection of an additional $50 to $100 billion each 
year is a possibility without significant change in IRS interactions 
with taxpayers, however, the IRS cannot accomplish this alone. The IRS 
cannot audit its way out of the tax gap. Tax simplification must 
accompany any meaningful effort to reduce the tax gap, and would allow 
the IRS to further streamline its operations and increase the 
effectiveness of its compliance strategies. Additionally, legislative 
proposals such as those requiring increased information reporting in 
certain sectors, as well as the increase in information-sharing from 
other agencies, will further contribute to reducing the largest element 
of the tax gap--underreporting. Admittedly, the five proposals included 
in the fiscal year 2007 budget request are only first step toward 
addressing the quarter-trillion dollar tax gap. But they are a step in 
the right direction, and represent one critical element of a successful 
strategy.
    Question. Individuals have long been evading the payment of taxes 
by hiding income in other countries. The IRS recently won court 
approval to ask PayPal, a popular on-line payment service, to turn over 
customer records as part of an investigation into tax cheats who hide 
money overseas. This would involve those who sent money to a bank or 
credit card account in more than 30 foreign countries and would cover 
the past 8 years.
    What is the latest about whether PayPal will comply?
    Answer. We expect compliance, but the disclosure restrictions of 
IRC  6103 prohibit us from further discussion about the status of our 
efforts at this time. However, the Offshore Credit Card Project (OCCP), 
in furtherance of which the court issued the PayPal summons, is a 
continuing effort. The IRS has requested and the courts have issued 
prior John Doe summonses to major credit card companies, third-party 
credit card processors, and over 100 merchants in an effort to identify 
individuals who have evaded tax by moving money offshore. The IRS has 
completed several thousand examinations and over 1,200 are currently in 
process. In addition, the OCCP has provided leads and other information 
which has led to numerous successful criminal prosecutions.
    Question. What else are you doing to prevent offshoring of 
taxpayers' money?
    Answer. The IRS has several other initiatives to address this 
concern:
    Broker Initiative.--The IRS is identifying withholding agents for 
Form 1042 (Annual Withholding Tax Return for U.S. Source Income of 
Foreign Persons) examinations. The dual purpose of these examinations 
is to assess the withholding and information reporting compliance of 
the withholding agent, as well as that of the U.S. beneficial owners of 
accounts established in the names of entities domiciled in secrecy 
jurisdictions. The IRS is currently examining several withholding 
agents, with more planned.
    Seven Country Initiative.--Although this initiative was originally 
formed under the auspices of the Pacific Association Tax 
Administrations (PATA), the group's members currently consist of 
Australia, Canada, France, Germany, Japan, United Kingdom and the 
United States. The purpose of this group is to enhance each country's 
capacity to deal with compliance risks associated with offshore secrecy 
jurisdictions, share best practices and approaches addressing abusive 
offshore arrangements and their promoters. These discussions will 
provide opportunities for bilateral action and exchange of information. 
To further expand its compliance initiatives, the group formed 
subgroups to address non-compliance facilitated through the brokerage 
and banking industries and International Business Corporations (IBC). 
The Seven Country Initiative is focused on high wealth individuals and 
closely-held entities involved in abusive offshore arrangements using 
tax secrecy jurisdictions.
    Promoter Program.--The IRS has made significant strides in 
combating the offshoring of taxpayers' money through its efforts on 
promoters of offshore schemes and transactions. Based on referrals, the 
IRS has authorized investigations pursuant to I.R.C.  6700 (Promoting 
Abusive Tax Shelters) for various promoters of offshore schemes. When 
appropriate, the IRS has referred these promoters to the Department of 
Justice for potential pursuit of penalties and injunctions. This 
process prohibits the promoter from continued marketing of abusive 
schemes and assists the IRS in identifying participants in offshore 
transactions for compliance purposes.
 is the irs complying with sections 205 and sec. 204 of the tthud bill?
    Question. The Fiscal Year 2006 Transportation-Treasury 
Appropriations Act included a provision (Sec. 205) stipulating that no 
funds may be used to reduce taxpayer services as proposed in fiscal 
year 2006 until TIGTA completes a study detailing the impact of such 
proposed reductions on taxpayer compliance and taxpayer services, and 
the IRS's plans for providing adequate alternatives services, and 
submits such study and plan to us for approval. Despite this language 
and the provision Sec. 204 stating that funds shall be available to 
improve and increase 1-800 help line service, you decided to decrease 
those telephone hours last year after enactment of our bill. We had to 
add clarifying language in the Supplemental Appropriations Act last 
year so that you would not reduce telephone service hours.
    So, Mr. Everson, I'd like to ask you: Is the IRS complying with 
Sec. 205 and Sec. 204?
    Answer. Yes. We continue to provide the same number of daily hours 
of service as in fiscal year 2005 with our toll-free telephone lines 
open from 7:00 a.m. to 10:00 p.m. Monday through Friday (local time) 
and limited service on Saturdays during the filing season. In January 
2006, we actually extended the operational hours of service from 7:30 
a.m. to 6:00 p.m. Monday through Friday (local time) to 8:00 a.m. to 
8:00 p.m. Monday through Friday (local time), for the Practitioner 
Priority Service telephone line.
    Our proposal to change the operational hours in fiscal year 2006 
was another step towards providing our customers with the highest level 
of service as we continue to identify ways to improve our toll-free 
operation. To put our proposal to reduce hours of service into context, 
in 1999, we increased our operational hours to 24 hours a day, 7 days a 
week in an effort to expand service to our taxpayers. However, after 
identifying periods of low call demand (assistors were available and 
waiting for incoming calls) and alternate periods of excess demand (we 
did not have enough assistors on the phones to handle incoming call 
traffic during specific hours), we re-evaluated our decision to provide 
service around the clock. In October 2001, we reduced our operating 
hours to 7:00 a.m. to 10:00 p.m. Monday through Friday (local time) 
with limited service on Saturdays during filing seasons. This reduction 
afforded us the most efficient usage of our scarce resources while 
providing the best service possible to our customers.
    However, despite our attempt at providing coverage during the right 
periods of time, we continued to experience periods of low call demand, 
primarily before 8:00 a.m. and after 8:00 p.m., resulting in assistors 
sitting idle during these times. After further evaluation of incoming 
call demand and available assistor resources, we proposed a reduction 
to our fiscal year 2006 hours of service. However, we did not implement 
this change, in accordance with Sec. 205.

                  BUSINESS SYSTEMS MODERNIZATION (BSM)

    Question. Over the long-term, Business Systems Modernization (BSM) 
has suffered numerous project delays and cost overruns, which has 
warranted oversight and recommendations from GAO. On an encouraging 
note, in the past 2 years, progress has been made. GAO's No. 1 concern 
is that since the BSM vision and strategy is no longer current given 
project delays, the IRS must develop brand-new long-term program goals 
and strategies. Although the IRS is developing a 5-year plan, GAO still 
believes further longer-term goals are necessary.
    Mr. Everson, how do you respond?
    Answer. We appreciate the Senate Appropriations Committee's 
acknowledgement of BSM's improved performance.
    The MV&S team specifically chose a 5-year planning horizon for two 
reasons. First, given the rapid pace of technological change, it is 
increasingly difficult to predict what technology will become 
commonplace over longer planning horizons. Second, IRS's business 
emphasis can likewise change over longer planning periods. Recognizing 
these issues, the IRS believes that the key element is not the planning 
horizon, but rather the commitment to institutionalize an annual 
planning process that reassesses and updates the MV&S 5-year plan based 
on IRS's current technology environment, foreseen future technology 
enablers, and the current IRS strategic focus.
    Given this context, longer-term goals have provided a meaningful 
backdrop to MV&S planning. The first goal is to make investments in 
technology that will have a demonstrable impact on lowering the $300 
billion-a-year tax gap. IT initiatives that both support increased 
voluntary compliance (through better IRS service) and enforcement 
(through improved compliance productivity) are vital to lowering the 
tax gap over time. Second, given the explosion of the Internet, the IRS 
needs to leverage its power to offer better service to our constituents 
while lowering our own costs (chiefly by offering self-assist/self-
correct capabilities). Finally, we recognize that true IT modernization 
will only come about when the IRS can finally retire our aging master 
files and the Integrated Data Retrieval System (IDRS)--systems built 
originally in the 1960's and 1970's. These systems are the core of the 
U.S. tax administration system today, but hamper the IRS's ability to 
provide real-time, accurate, and complete data to our constituents. The 
IRS must place continued focus on replacing these systems with 
modernized systems, including the Customer Account Data Engine (CADE) 
to replace the master files and projects to replace IDRS.
                                 ______
                                 
             Questions Submitted by Senator Byron L. Dorgan

                    PROPOSED DISCLOSURE REGULATIONS

    Question. Mr. Commissioner, I am deeply concerned about the 
disclosure regulations proposed by the Internal Revenue Service (IRS) 
last December. I believe these regulations put at risk rampant 
distribution of private taxpayer information by tax return preparers 
for all kinds of unrelated marketing purposes.
    You point out that tax return preparers can currently seek consent 
from customers to use tax return information to solicit their customers 
to purchase products by the tax preparer or its affiliated group. The 
approach taken in the regulations now expands this by allowing tax 
preparers to solicit their customers to purchase products from third 
parties including marketers and data brokers--risking even further 
dissemination of taxpayer information.
    Do you believe that this proposed change provides additional 
disclosure protections for taxpayers?
    Answer. I want to assure you that protecting taxpayer privacy by 
preventing return preparers from improperly disclosing or using tax 
return information is of utmost importance. The proposed rules 
represent a significant improvement over existing regulations in 
protecting taxpayer privacy interests and would strengthen taxpayers' 
control over their tax information in the hands of tax preparers and 
tax preparation software companies. Specifically, the proposed rules 
provide that tax return preparers must give all taxpayers clear 
warnings and consent notices that allow taxpayers to make a knowing, 
informed, and voluntary decision over the disclosure or use of their 
tax information by their preparer.
    In addition, Congressional concerns and inquiries led to proposed 
changes to the rules requiring written taxpayer consent before a return 
preparer may outsource preparation services or send tax return 
information outside the United States. This protection does not exist 
under the current regulations. The proposed rules also retain the 
requirement that tax return preparers obtain written consent from 
taxpayers to ``use'' tax return information. The current rules, 
however, do not define ``use,'' creating uncertainty in a number of 
areas, including whether the term includes targeted advertising. The 
proposed rules eliminate this uncertainty by expressly defining ``use'' 
to include return preparers' reliance upon tax return information to 
target advertising to their customers.
    Under the proposed regulations, return preparers must still obtain 
customer consent before using any information gleaned from tax returns 
as a basis for marketing any product or service. The consent must 
identify each specific type of product or service that may be 
solicited. If the taxpayer declines to execute the consent, the 
information cannot be used and the return preparer cannot ask for the 
taxpayer's consent again.
    Question. You appear to justify this particular change because you 
believe that such solicitations may be for products that positively 
affect taxpayers' financial lives.
    Answer. Our primary focus in proposing the regulations was to 
update existing rules, promulgated in the early 1970's, that do not 
provide adequate guidance to protect taxpayers' return information in 
an era of electronic return preparation and filing. While the IRS is 
sensitive to the impact that these rules may have on taxpayers' 
finances, our primary concern is protecting taxpayer privacy. Other 
reasons for publishing the proposed regulations include concern about 
whether return preparers were engaged in practices not contemplated 
when the regulations were originally promulgated, including outsourcing 
preparation services or sending tax information outside the United 
States. Congressional inquiries about the appropriateness of 
outsourcing preparation services and sending tax return information 
overseas without the knowledge of the taxpayer contributed to 
prioritizing the project.
    Additionally, there has been a misunderstanding regarding the 
proposed rules with respect to the difference between ``disclosure'' 
and ``use'' of tax return information that has led to confusion over 
how the proposed rules relating to the disclosure of tax return 
information have been strengthened. The misunderstanding of the 
proposed rules stems from a proposed change relating not to preparer 
disclosure of information to third parties, but rather to a return 
preparer's own use of tax return information to solicit additional 
products and services for itself or other parties. Currently, return 
preparers may seek consent from customers to use tax return information 
to solicit their customers to purchase current products or services 
offered by the preparers or their ``affiliated group.'' Since few 
return preparers are organized in a corporate structure, much less an 
``affiliated group,'' this provision has little current relevance or 
application. Moreover, notwithstanding the ``affiliated group'' 
limitation on ``use'' of return information, the existing regulations 
do not limit the permissible ``disclosure of return information to 
third parties with the taxpayers' consent.'' Such disclosures may be 
for products that positively affect taxpayers' financial lives or 
participation in government benefit programs.
    As before, the regulations afford taxpayers the ability to control 
and direct the disclosure or use of their own tax return information. 
Under the proposed regulations, return preparers must still obtain 
customer consent before using information gleaned from tax returns as a 
basis for marketing any product or service. The consent would need to 
identify each specific type of product or service that may be solicited 
and if the taxpayer says no, the information cannot be used and the 
return preparer cannot ask again.
    Question. Do you think that when Section 7216 was enacted and 
imposed a stiff fine and possible jail time for tax preparers who make 
unauthorized disclosures of taxpayer return information that Congress 
intended to allow sweeping exceptions for widespread marketing?
    Answer. Neither the current regulations, which have been in place 
since 1974, nor the proposed regulations, contain sweeping exceptions 
for widespread marketing. To the contrary, the existing regulations 
require taxpayer consent for most disclosures and the proposed 
regulations tighten the applicable consent provisions to help ensure 
that the consents are informed. That is, the taxpayer, and only the 
taxpayer, can control and direct the disclosure or use of tax return 
information by a tax return preparer. Section 7216 as enacted in 1971, 
provides the Secretary with the authority to prescribe regulations 
governing the disclosure or use of tax return information. It was clear 
at that time that Congress understood that there would be circumstances 
when the disclosure or use of tax return information by tax return 
preparers for purposes other than tax return preparation would be 
permissible. Consistent with this understanding and the long-standing 
regulations, it has been common industry practice to solicit taxpayer 
disclosure consents for a variety of purposes other than tax return 
preparation.
    Question. You indicate that in both the current regulations and the 
proposed regulations tax return preparers have been permitted to 
disclose their customers' tax return information to affiliates and 
third parties if the customers consent.
    Do you have the authority to prohibit such disclosures to 
affiliates or third parties if such disclosure is not for purposes 
relating to the preparation of a taxpayer's return? Would legislation 
be required to prohibit such disclosures?
    Answer. Congress provided broad authority to the Secretary under 
Section 7216(c) to prescribe regulations permitting the disclosure or 
use of tax return information. By giving the Secretary this broad 
authority, it is clear Congress understood there would be circumstances 
when the disclosure or use of tax return information by tax return 
preparers for purposes other than tax return preparation would be 
permissible. The regulations implementing Section 7216(c) have been in 
place for more than 30 years. Given the long-standing existence of the 
current regulations under Section 7216, the absence of virtually any 
controversy with respect to consensual disclosures under the current 
regulations, and the fact that the current controversy is the result of 
a mischaracterization of the nature and scope of both the current 
regulations and the proposed regulations, I believe that legislation 
would be the way to completely prohibit the types of disclosures to 
affiliates or third parties that you reference.

                            TAX HAVEN ABUSES

    Question. We have known for many years that some very profitable 
U.S. multinational businesses are using offshore tax havens to avoid 
paying their fair share of U.S. taxes. In fact, recent evidence 
suggests that the tax-haven problem is getting much worse and may be 
draining the U.S. Treasury of tens of billions of dollars every year.
    According to an investigative report written by David Evans with 
Bloomberg News, there is a building called the Ugland House in Grand 
Cayman that is used as the address of 12,748 companies. In my judgment, 
it is the hood ornament of the growing tax haven abuse problem.
    I have authored legislation with Senator Levin that we believe 
would put an end the tax benefits for U.S. companies that shift income 
to offshore tax-haven subsidiaries. The Joint Tax Committee says our 
legislation to close this tax avoidance scam would save U.S. taxpayers 
some $15 billion over the next decade.
    Do you agree that the use of offshore tax havens by large 
multinational firms to park profits that would otherwise be taxed in 
this country is a problem? If so, what is the IRS doing to tackle it?
    Answer. As I stated in my testimony of June 13, 2006, we recognize 
that certain taxpayers seek to shift significant profits offshore. 
These taxpayers manipulate the price of related transactions so they 
can claim that the income is earned outside the United States, 
preferably in a low- or no-tax jurisdiction. Further, the transfer of 
intangibles outside the United States has been a high risk compliance 
concern for the Service and we have seen a significant increase in such 
transactions in recent years. Cost-sharing arrangements are often the 
method for this activity. The buy-in amount in cost-sharing 
arrangements is frequently troublesome. It is often understated, 
resulting in the improper shifting of income offshore.
    In response to the compliance risks of pricing issues, the LMSB 
Commissioner issued guidance to all field examination personnel 
regarding potential transfer pricing issues and we require all field 
examination personnel to request and review taxpayer transfer pricing 
studies. As a subset of the transfer pricing issue category, a section 
936 Termination Strategy issue has been identified for additional 
compliance coordination. Associated with the sunsetting of section 936, 
taxpayers have created structured transactions to transfer U.S. 
intangibles that were used in Puerto Rico to other low tax 
jurisdictions. An Issue Management Team (IMT) has been established to 
identify, coordinate, and propose resolution alternatives for this 
issue.
    As part of our response to the cost-sharing arrangements issues, we 
proposed a comprehensive set of cost-sharing regulations in August 2005 
to ensure that such arrangements do not facilitate a disguised transfer 
of intangible assets outside the United States in a manner inconsistent 
with the arm's-length standard. We intend to finalize these regulations 
this year.
    We have also established a cost-sharing IMT to improve Service-wide 
coordination in the identification, development, and resolution of 
cost-sharing issues. The IMT issued a cost-sharing audit checklist in 
2005 that provides guidance to field examiners for developing potential 
cost-sharing audit issues and ensuring consistency. The team has 
completed its efforts to identify and review cases with a cost-sharing 
issue to determine the impact and compliance risk. The team is 
developing a coordinated issue paper that will provide the basis and 
support for examining issues and to assist with potential Appeals 
Settlement Guidelines.
    Question. What action did the IRS take when the Ugland House matter 
was reported in the press?
    Answer. The IRS has recognized that companies are using entities 
such as international business corporations (IBCs) in offshore 
financial secrecy jurisdictions. Depending on the offshore 
jurisdiction, shareholders of the IBC may remain confidential. When the 
article you cited came out in 2004, we canvassed a number of offshore 
jurisdictions (including the Cayman Islands) and requested they provide 
a list of their registered IBCs. At that time the jurisdictions we 
contacted could not provide the information due to their financial 
secrecy laws. If we have a name or IBC number we are able to contact 
public registries directly and get information on companies 
incorporated or registered in the jurisdiction, but that information is 
limited to IBC name and number, name and address of registered agent, 
authorized capital, and status of the IBC (whether it is active or 
inactive.) The public registries do not contain ownership information 
or shareholders. That information is held by registered agents (RA) and 
is often subject to the secrecy and privacy laws.
    Over the past few years, the IRS and Treasury Department have been 
negotiating Tax Information Exchange Agreement (TIEAs) with these 
jurisdictions. We can now make requests under these TIEAs for the 
ownership information. The Cayman Islands TIEA became effective March 
10, 2006 for civil tax issues. If we have a valid tax administration 
purpose, the TIEAs enable us to request information such as books and 
records, minutes of meetings, and analysis of functions a company 
performs to determine whether they have complied with U.S. tax 
provisions. This is predicated upon the fact that such documentation 
exists in the jurisdiction.
                                 ______
                                 
           Question Submitted by Senator Barbara A. Mikulski

    Question. I remain very concerned about any proposals to reduce 
taxpayer services or close any of the 68 Taxpayer Assistance Centers 
(TACs) across the country, including 4 of 8 in my home State of 
Maryland. According to a recent Treasury Inspector General for Tax 
Administration (TIGTA) report (Reference Number: 2006-40-061), 
management does not have reliable data on the Taxpayer Assistance 
Centers (TACs) to make decisions about TAC operations. TIGTA also 
points out that 47 of the 400 TACs nationwide--nearly 12 percent--are 
``critically'' understaffed, meaning that they would be in danger of 
closing were it not for the dedicated IRS employees who are filling in 
from nearby TACs and through the use of seasonal employees. In its 
first report, TIGTA sharply criticizes the business model the IRS used 
to justify the TAC closings last year (see TIGTA Reference Number: 
2006-40-067). These two reports strongly indicate that the IRS lacks 
the management information necessary to provide adequate oversight of 
its TAC operations, much less make a decision to close any of them.
    How does IRS plan to report to Congress with reliable and 
verifiable data on the status of taxpayer services and explain how cuts 
to customer services would affect underserved populations such as the 
elderly, low-income taxpayers, minorities, those with language barriers 
and those without access to the Internet? How will you measure the 
affect of such closures on taxpayers when TIGTA points out that the IRS 
does not track this data?
    Answer. We have taken a number of steps to improve both the data 
capture methodology and the reliability of management information 
discussed in the TIGTA reports you mention. Efforts include automating 
a previously manual process of capturing the number of taxpayers served 
in the Taxpayer Assistance Centers and development and piloting of a 
web-based Management Information System that provides critical program 
planning and control data at the local and national levels. Input data 
from all of these sources will be incorporated in future iterations of 
the TAC Business Model.
    In addition, the research and initiatives currently underway in the 
Taxpayer Assistance Blueprint (TAB) will significantly enhance 
collection of customer information and customer characteristics. As you 
know, we delivered the TAB Phase I report in April 2006. The TAB Phase 
II report, which we expect to deliver to Congress in October 2006, will 
use extensive primary research with taxpayers to validate its service 
recommendations. Current ongoing customer preference and needs research 
includes surveys, focus groups, and experimental research aimed at 
providing customer-centric information to decision-makers. The service-
related research includes the underserved taxpayers identified in your 
question. We intend to continue extensive research initiatives in 
future years to enrich and refine our understanding of these taxpayers' 
needs.
    Finally, we do not envision that taxpayer services will be reduced. 
Careful consideration is being given to those taxpayers facing a 
barrier to online self-service options and how to best meet those 
needs. The goal is to maintain a balanced service portfolio that meets 
the needs of the greatest number of taxpayers within available 
resources.
                                 ______
                                 
             Questions Submitted to Raymond T. Wagner, Jr.
           Questions Submitted by Senator Christopher S. Bond

                              BSM FUNDING

    Question. As noted at our hearing and as recommended by the Board, 
the IRS's Business Systems Modernization (BSM) program should receive 
more funding for fiscal year 2007 above the budget request.
    If additional funding were to be provided to the BSM account, which 
projects could most benefit from additional funding? How would 
additional funding benefit the BSM program?
    Answer. Two BSM projects would particularly benefit from additional 
funding during fiscal year 2007: the Customer Account Data Engine 
(CADE) and Modernized e-Filing (MeF). The CADE project is so central to 
IRS modernization that any additional money spent on speeding up the 
replacement of the 40-year-old Individual Master File (IMF) by CADE 
would offer many benefits to taxpayers. The legacy IMF system limits 
the IRS to weekly updates, but CADE will give the IRS the ability to 
update taxpayer records daily, and provide the IRS with the capability 
to serve taxpayers much like modern financial institutions serve their 
customers. On the other hand, using additional BSM funding in fiscal 
year 2007 on the Modernized e-Filing project would allow the IRS to 
begin the modernization of the e-filing platform for Form 1040 tax 
returns a year earlier than currently planned. Such modernization is a 
prerequisite for the IRS to offer a direct filing portal to individual 
taxpayers. The Electronic Tax Administration Advisory Committee 
(ETAAC), in both its 2005 and 2006 annual reports has stressed the 
importance of modernizing the system for receiving individual tax 
returns.
    Based on consultations with IRS BSM personnel, the Board believes 
that the MeF project would be a better choice for additional funding in 
fiscal year 2007. The CADE project is already funded in fiscal year 
2007 but the MeF project is not. Funding MeF in fiscal year 2007 would 
allow this project to start a year earlier, and bring the benefits of 
improved electronic filing systems to taxpayers a year earlier. The 
Board believes this would be of more benefit to taxpayers than spending 
additional money on the CADE project, which is already underway.

                        BETTER TAX GAP ESTIMATES

    Question. While the IRS has done a commendable job in updating the 
tax gap estimates, there remain significant gaps in the gap. The IRS 
and others have expressed concerns with the certainty of the overall 
tax gap estimate in part because some areas of the estimate rely on old 
data (from the 1970's and 1980's) and it has no estimates for other 
areas of the tax gap. GAO, TIGTA, the Taxpayer Advocate, and the IRS 
Oversight Board also have all recommended greater and more frequent 
data collection and studies of the tax gap. I wholeheartedly agree.
    What will it take in terms of resources to address these concerns? 
Should the IRS conduct research on how services affect compliance?
    Can your office conduct research on the impact of taxpayer service 
on compliance?
    Answer. The IRS Oversight Board believes additional research will 
provide the IRS with better data on taxpayer compliance, which will 
help the IRS better identify areas of non-compliance and ultimately 
provide some feedback on how IRS service and enforcement programs are 
affecting taxpayer compliance. This belief is consistent with 
recommendations from the National Taxpayer Advocate, who recommended 
that the IRS undertake a research-driven taxpayer needs-assessment that 
will identify services taxpayers need and how best they should be 
delivered.
    For these reasons, the Board recommended that the following 
research initiatives be included in the fiscal year 2007 budget: (1) 
Improve Tax Gap Estimates (+$46 million); and (2) Additional Customer 
Service Research (+$15 million).
    The first initiative, Improve Tax Gap Estimates, will establish 
permanent staffing for the National Research Program (NRP) and put the 
IRS on a path to conducting research annually, without affecting the 
existing examination staff in place within the operating divisions. 
Currently it takes too long to conduct research that can be used on a 
timely basis; the tax gap estimates released by the IRS in 2006 are 
based on an analysis of 2001 tax returns. Prior estimates were based on 
extrapolations of 1988 data.
    As part of an overall strategy to conduct more research and use it 
to guide IRS service and enforcement efforts, the Board believes the 
IRS would be well-served to develop a long-range strategic plan for 
research that is separate from its overall IRS Strategic Plan and goes 
beyond the current 2009 end date for that plan, covering approximately 
a decade. In such a plan, the IRS should describe how it will bring its 
research on all taxpayer segments up to date, and perform a limited 
sample every year so that its research on all segments will be as 
current as possible.
    The GAO was particularly supportive of this approach during its 
testimony to the committee. It testified that ``doing compliance 
studies once every few years does not give IRS or others information 
about what is happening in the intervening years. Annual estimating of 
the compliance rate could provide information that would enable IRS 
management to adjust plans as necessary to help achieve the goal in 
2009. One option that would not increase the cost of estimating 
compliance would be to use a rolling sample. IRS Oversight Board 
officials and we agree that instead of sampling, for example, once 
every 5 years, one-fifth of the sample could be collected every year.''
    The Board believes the availability of up-to-date research data 
will allow the IRS to focus more effectively its service and 
enforcement programs on areas that have the greatest impact on taxpayer 
compliance, and use the changes in taxpayer compliance rates as 
feedback to evaluate the effectiveness of IRS's service and enforcement 
program on actual taxpayer compliance. Achieving such a capability will 
be a vast improvement over the current situation in which the lack of 
data makes it virtually impossible to evaluate the effectiveness of IRS 
activity on taxpayer compliance and make informed decisions.
    The second research initiative recommended by the Board is to add 
$15 million to begin research on the impact of customer service on 
voluntary compliance and the service needs of taxpayers. The need for 
such research is also consistent with recommendations made by Treasury 
Inspector General for Tax Administration and the National Taxpayer 
Advocate in testimony last year to the Senate Appropriations Committee.
    In response to the Board's request, the IRS has said that it could 
extend and update research efforts in two major areas: evaluating the 
service needs of taxpayers and estimating the effect of customer 
service on taxpayer compliance. Additional resources in fiscal year 
2007 would be used to further evaluate the service needs of taxpayers 
and to scope and design the data gathering and analysis capability to 
estimate the effect of customer service on taxpayer compliance.
    With respect to your question on whether the Board could conduct 
research on the impact of customer service on compliance, please see 
the answer to question 4. The Board has a limited budget for survey 
work, but did conduct a survey of customer service needs and channel 
preferences, which has been provided to the IRS.

                          DIRECT FILING PORTAL

    Question. Some experts have suggested that the IRS develop a direct 
filing portal through the IRS website to increase e-filing. To be 
clear, this is not about the Government preparing tax returns but to 
simply provide an easier, cheaper way for taxpayers to file their 
returns.
    What are your thoughts on the direct filing portal? Do you believe 
it would significantly increase e-filing? Would this approach be more 
cost-effective for the IRS than continuing to use an extremely labor-
intensive approach to processing paper returns?
    Answer. As your question noted, the concept of a direct filing 
portal has received considerable attention lately, although much of the 
expert commentary has not been based on a common definition of a direct 
filing portal. The best way to explore these differences is to start by 
differentiating the act of tax preparation from the act of tax filing.
    Commercial tax software products, including products available 
through the Free File Alliance, typically perform both functions. They 
guide the taxpayer though the process of tax preparation by using a 
series of questions, checklists, interview techniques, and reference 
material to ensure that all tax obligations have been identified, 
critical choices explained, relevant decisions made, and all 
calculations completed accurately. At the end of this process, most 
programs provide a summary review of the process to let the taxpayer 
know that preparation is complete.
    At the completion of the tax preparation phase, the program then 
presents the taxpayer with filing and payment options. The taxpayer may 
choose to print the completed return and mail it to the IRS, or file it 
electronically. Payment or refund options, both paper and electronic, 
are also presented to the taxpayer.
    If a taxpayer elects to file electronically, an output file is 
sent, not to the IRS, but to the tax software company, which combines 
individual returns into large batches, and sends these batched returns 
to the IRS. The IRS receives the batched returns and notifies the 
transmitter, usually the software company in the case of self-prepared 
returns, if the return has been accepted. Returns prepared by 
professional tax preparers go through a similar process, except that 
professional preparers may use a third-party transmitter instead of the 
software company to transmit batched returns to the IRS. A direct 
filing portal would allow taxpayers to file their already completed 
returns directly to the IRS without going through a third-party 
intermediary.
    There has been some confusion because there are different 
interpretations of the term ``direct filing portal.'' Many experts, 
when speaking of a direct filing portal, only refer to the capability 
of the IRS to receive a completed output file in what is known as 
Extensible Markup Language (XML). The creation of the output file must 
still be accomplished by a separate software package that assists the 
taxpayer to perform tax preparation. The developers of the tax 
preparation software must ensure that the output file created is 
compatible with IRS's direct filing portal. However, the software gives 
the taxpayer the opportunity to send the output file directly to the 
IRS instead of the software company. This feature relieves the software 
company of the responsibility to receive the output files created by 
its software product, batch them, send them to the IRS, and maintain 
and protect them. The elimination of this responsibility reduces cost 
to the software developer and consequently is expected to remove a 
barrier to entry of new tax preparation software companies from the 
marketplace.
    However, other experts have used the term direct filing portal to 
refer to the capability for a taxpayer to access an IRS site where the 
taxpayer may do both elementary tax preparation as well as electronic 
tax filing, all in a single operation. Under this definition, tax 
preparation is combined with electronic filing, both of which are 
performed under the auspices of the IRS. Some States (e.g., Maryland) 
offer direct filing portals that offer taxpayers the opportunity to 
fill in a simple tax form and file it directly with the State 
department of revenue.
    The Oversight Board believes that the IRS should explore the 
possibility of developing a direct filing portal that is capable of 
receiving output files produced by commercial tax preparation packages. 
The Modernized e-File program for 1120 tax returns offers the taxpayer 
the option of filing the return directly with the IRS. The Board 
believes that individual filers would benefit if offered such a choice, 
and that the availability of such a choice would promote electronic 
filing. A recent survey completed by the Board indicated that many 
taxpayers have concerns about security on the Internet, and the 
availability of a direct filing portal may alleviate some of these 
concerns. However, a complete cost benefit analysis should be conducted 
to determine if the benefits of developing this capability justified 
the development costs. The Board encourages further evaluation of this 
important issue.
    On the other hand, the Board has reservations about the development 
of a direct filing portal to perform both tax preparation and filing 
functions, except for possibly the simplest of tax returns, as was the 
case with the TeleFile program. The IRS Restructuring and Reform Act of 
1998 states that it is Congress's intent for the IRS to offer a 
comparable program to Telefile on the Internet. However, such a 
development involves complex public policy issues, such as the 
appropriate role for government in tax preparation. The Act encourages 
the IRS to cooperate with the private sector and encourage competition 
in the private sector. The Board believes that creation of a direct 
filing portal strictly to receive output files from commercial tax 
software products would be one effective method to promote private 
sector competition. Again, the Board encourages further evaluation of 
this issue.

                     TAXPAYER ASSISTANCE BLUEPRINT

    Question. As mandated by our appropriations act, the IRS recently 
issued the first phase of the Taxpayer Assistance Blueprint (TAB). I 
asked for this business plan so that the IRS and the Congress could 
plan strategically on developing future taxpayer services based on 
taxpayer needs. I also expected the plan to address demographic and 
geographic differences. Ultimately, this plan should help to improve 
voluntary compliance with the tax code. I expected the plan to focus 
beyond current IRS services and develop innovative approaches.
    Since the IRS is mandated by the act to work with the Board on the 
TAB, please explain how the Board has been involved with this project 
and if the Board believes the TAB is addressing my needs and 
expectations.
    Answer. The IRS has provided the Oversight Board with several 
opportunities to participate in the process of developing the Taxpayer 
Assistant Blueprint (TAB). The Board Chairman has been asked to become 
a member of the TAB Executive Steering Committee (ESC), and has 
participated both directly and through representation in a number of 
ESC teleconference meetings.
    The IRS has also provided to the Board access to its working 
documents and plans, and has invited Board members and staff to 
participate in TAB in-process planning and review meetings. Board staff 
have attended several meetings in Atlanta during the development of the 
Phase I report as well as a Phase II planning meeting.
    The Board has recently completed its own survey of taxpayer service 
needs and channel preferences. The survey results were recently 
presented to the full Board at its last meeting, and the full results 
provided to the IRS. The Board Staff Director and survey company 
Project Director traveled to Atlanta to present and discuss the results 
of the Board's survey with IRS's complete TAB project team, which lead 
to a comprehensive discussion of the results and how the IRS might 
incorporate the results into the Phase II report.
    The Board is currently preparing a public report on the results of 
its survey, but would be pleased to present the results to you and your 
staff at any time.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

                        SERVICES OFFERED AT TACS

    Question. Mr. Everson and Ms. Olson, why hasn't the IRS involved 
taxpayers who need or desire face-to-face assistance in determining 
what services are offered at the TACs?
    Mr. George, your recent audit report says that prior to making 
decisions on closing any TACs, the IRS should ensure that it is known 
which taxpayers visit the TACs for assistance and why, so the IRS can 
determine the impact on these taxpayers and ensure alternative service 
deliver channels are effective in meeting the needs of these taxpayers.
    Ms. Olson, I would imagine you agree?
    Mr. Everson, TIGTA recently found that 8 of 11 stakeholder groups 
believe that closing the TACs may make it harder for their constituents 
to stay compliant with tax laws and file tax returns. TIGTA also found 
that 11 of 11 stakeholder groups believe their constituents are not 
currently likely to use alternative methods, such as the Internet or 
email to obtain the services they need.
    In light of your efforts to reduce face-to-face interaction between 
the IRS and the taxpayer and your efforts to increase compliance, have 
you re-thought some of your earlier decisions on reducing taxpayer 
services?
    Mr. Wagner, the IRS Oversight Board has recommended budget 
increases in customer service and toll-free telephone service in 
particular.
    Would you care to comment?
    Answer. Based on the belief that good customer service leads to 
fully-informed and satisfied taxpayers who understand their tax 
obligations and experience few problems in complying with the tax code, 
the Board recommends funding an increase in customer service to restore 
customer service to fiscal year 2003/4 levels and investing in 
telephone infrastructure. The rationale behind these recommendations is 
that it is less expensive to prevent problems before a taxpayer files 
than to correct it later. While some IRS services have continued to 
improve, others have not and should be restored to their prior levels.
    To restore the level of service in fiscal year 2007 to those 
achieved during fiscal year 2003 and fiscal year 2004, the Board 
recommends adding $32 million to the IRS's service budget. The Board 
also recommends an $8.7 million investment in telephone infrastructure 
to expand services to callers and provide telephone representatives 
with a more state-of-the-art call center environment. The IRS predicts 
this investment would result in lower queue times across the enterprise 
for all applications and would counter a negative trend in telephone 
service. (Wait time on hold for taxpayers has been increasing in the 
last 3 years. It has gone from 158 seconds in fiscal year 2004 to 258 
seconds in fiscal year 2005, and the fiscal year 2006 target is 300 
seconds.)
    With respect to taxpayers' needs for in-person services, I would 
note that the Board has recently completed its own survey of taxpayer 
service needs and channel preferences. The survey results were recently 
presented to the full Board at its last meeting, and have been 
presented and discussed with the IRS's complete Taxpayer Assistance 
Blueprint project team. The Board's survey resulted in an innovative 
approach to segmenting taxpayers by attitude, behavior, and need, which 
led to a comprehensive discussion of the results and how the IRS might 
incorporate them into the Phase II report.
    The Board is currently preparing a public report on the results of 
its survey, but would be pleased to present the results to you and your 
staff at any time.
                                 ______
                                 
                Questions Submitted to J. Russell George
              Questions Submitted by Senator Patty Murray

       ADDRESSING SHODDY WORK BY TAX PREPARERS AND PRACTITIONERS

    Question. Just this month, GAO reported that there may be serious 
problems with the accuracy of the tax returns prepared by many of the 
private tax preparation companies. The GAO found that these companies 
often prepared returns that were incorrect, with tax consequences that 
were sometimes significant. Some of these mistaken returns could have 
exposed taxpayers to penalties for such things as negligence and 
willful or reckless disregard of tax rules. Furthermore, TIGTA found, 
this month, that the IRS is not taking the necessary disciplinary 
action against tax practitioners who have been convicted or had their 
licenses revoked by State authorities.
    Mr. George, do you think the IRS is doing an adequate job here?
    Answer. Recently, the IRS has placed a greater emphasis on the 
oversight of tax practitioners. To help ensure adequate resources are 
devoted to provide this oversight, the IRS substantially increased the 
budget and staffing of the Office of Professional Responsibility (OPR). 
In fiscal year 2002, the OPR had a budget of $1.8 million and a staff 
of 15. By fiscal year 2005, it had a budget of $5 million and a staff 
of 56.
    During this time, the number of disciplinary actions by the OPR 
also increased, primarily because of expedited suspensions, which are 
generally used by the OPR in response to action already taken by 
Federal or State Government agencies to convict or disbar a tax 
practitioner or to revoke a practitioner's license.
    Notwithstanding the increases in enforcement activity, there are 
still a significant number of tax practitioners whose conduct appears 
to warrant disciplinary action by the IRS but who have not been 
identified by the OPR. TIGTA believes the OPR needs to improve its 
ability to identify such practitioners so it can take appropriate 
disciplinary actions. Some tax practitioners who have been convicted of 
tax-related crimes or whose licenses have been suspended or revoked by 
State authorities have not been suspended from practice before the IRS.
    In March of this year, TIGTA reported that the IRS does not have an 
adequate method to notify the OPR of tax practitioners who are not 
compliant with their own tax obligations. In a statistical sample of 
750 of the approximately 407,000 licensed tax practitioners, there were 
34 (4.5 percent) who were not compliant with their individual tax 
obligations. These 34 practitioners had a total of 81 tax periods with 
balances due of $826,709 and 34 tax periods for which required tax 
returns had not been filed. Based on this sample, TIGTA estimates that 
there are approximately 22,500 licensed tax practitioners who are not 
compliant with their tax obligations but who have not been identified 
for referral to the OPR.
    TIGTA previously reviewed the OPR in 2001 (the OPR was then known 
as the Office of the Director of Practice) and reported problems with 
the lack of information needed to assess or manage the resources used 
for the disciplinary proceedings program. During the March 2006 review, 
TIGTA found that the OPR had not implemented some of the 
recommendations from 2001. Consequently, the problems reported in 2001 
still existed. The OPR still does not have the information needed to 
effectively monitor program activities and resources, and the case 
management system still contains unreliable information.
    In March 2006, TIGTA recommended that the Director, OPR: (1) work 
with other law enforcement agencies, including the Department of 
Justice, to improve the referral process and develop a process to 
obtain relevant information on State disciplinary actions by 
coordinating with State licensing authorities such as State bar 
associations and boards of accountancy; (2) coordinate with other IRS 
functions to identify practitioners who are not compliant with their 
individual tax obligations; and (3) implement the recommendations from 
the 2001 report. The IRS agreed to take corrective actions on our 
recommendations.
    Question. In a briefing last year by TIGTA on Taxpayer Assistance 
Centers, I learned that some TACs have as little as one or two staff, 
what TIGTA calls a ``critical staffing shortage.'' The House and 
Senate, Majority and Minority, said no to your proposal to cut back 
TACs until TIGTA completes a study on the impact of such reductions on 
taxpayer compliance and taxpayer services.
    Mr. Everson, are you, in fact, allowing these TACs to eventually 
close by letting the staffing levels dwindle? Do you believe that is 
consistent with the direction from this committee?
    Mr. George or Ms. Olson, do either of you care to comment?
    Answer. During the 2006 Filing Season, TIGTA auditors visited 70 
TACs from January through April 2006. The 70 TACs consisted of 10 TACs 
in each of the IRS's five geographical areas, plus 20 TACs in areas 
heavily affected by Hurricanes Katrina and Rita. TIGTA did not identify 
or report any significant concerns relating to staffing or wait times. 
All TACs that TIGTA visited were open and their addresses and hours of 
operations matched the addresses posted on the IRS's Internet site 
(irs.gov) and provided through the IRS's toll-free telephone numbers.
    TIGTA plans to audit the Taxpayer Assistance Blueprint in fiscal 
year 2007 and also plans to monitor the 2007 Filing Season.
                                 ______
                                 
                  Questions Submitted to Nina E. Olson
           Questions Submitted by Senator Christopher S. Bond

                BALANCE BETWEEN SERVICE AND ENFORCEMENT

    Question. There continue to be questions and debate on the proper 
balance between taxpayer service and enforcement. But given the data 
limitations of the tax gap and the IRS's inability to measure 
quantitatively the return on investment on service or enforcement, it 
is a difficult question to answer.
    Based on your expertise, what are your views on the balance between 
service and enforcement? Do you believe that one approach is more cost-
effective than the other? Since most revenue is collected voluntarily, 
should the IRS invest more in service than enforcement?
    Answer. Without a doubt, voluntary compliance is more cost-
effective than enforced compliance. When a taxpayer complies 
voluntarily, the Government incurs no costs beyond the cost of 
processing the taxpayer's return. When a taxpayer fails to comply, the 
Government must spend funds identifying errors on a return if 
submitted, locating the taxpayer, and seeking to collect the balance 
due. The IRS is spending billions of dollars to audit and collect 
balances from substantially less than 1 percent of taxpayers. Even if 
we were somehow able to double the examination rate, more than 98 
percent of taxpayers would not be examined each year. So we need to 
focus on maximizing voluntary compliance by simplifying the tax laws, 
increasing third-party information reporting, and improving IRS 
outreach and education efforts, while reserving targeted enforcement 
actions to combat clear disputes or abuses and send a message to all 
taxpayers that noncompliance has consequences.
    As it is, Congress seems likely to appropriate nearly $5 billion 
for enforcement and only about $2 billion for taxpayer services for 
fiscal year 2007, and the IRS seems inclined to continue to seek a 
higher proportion of resources for enforcement in the future. I am 
concerned that the IRS is emphasizing stepped-up enforcement over 
stepped-up taxpayer service without data to support this approach.
    To arrive at an optimal allocation of resources to close the tax 
gap, the IRS needs to do a better job of understanding the reasons why 
the tax gap exists.
    At the risk of oversimplifying matters, let me suggest that we 
consider three types of taxpayers: (1) taxpayers who will go to great 
lengths to comply with whatever requirements exist; (2) taxpayers who 
view taxes as one of many burdens they face in everyday life and who 
will comply if doing so is straightforward and not time-consuming; and 
(3) taxpayers who willfully seek to evade their tax obligations.\1\
---------------------------------------------------------------------------
    \1\ Analysis has been conducted on types of noncompliance that is 
more detailed and subdivides taxpayers into narrower categories. See 
Leslie Book, ``The Poor and Tax Compliance: One Size Does Not Fit 
All'', 51 U. Kan. L. Rev. 1145 (2003).
---------------------------------------------------------------------------
    For each type of taxpayer, what is the reason for noncompliance and 
what is the optimal government response?
  --For taxpayers who generally will go to great lengths to comply, the 
        likely source of noncompliance is the complexity of the tax 
        code. Thus, our approach should be to emphasize simpler laws 
        and better explanations.
  --For taxpayers who will comply if doing so is easy enough, our main 
        emphasis should also be simpler laws and procedures, and better 
        outreach and education. Here, though, we might also want to 
        incorporate gentle enforcement action in our approach to try to 
        persuade taxpayers that paying taxes must be a higher priority. 
        In doing so, the IRS should incorporate taxpayer service within 
        its enforcement actions. That is, at the same time that the IRS 
        conducts audits or seeks to collect unpaid tax liabilities, the 
        IRS should be courteous and should focus on trying to teach 
        taxpayers how to avoid getting into trouble in the future. The 
        IRS also must be careful to avoid creating noncompliance by 
        imposing unrealistic procedural burdens on taxpayers who are 
        trying to comply.
  --For taxpayers who willfully seek to avoid paying taxes, enforcement 
        is required--although even for these taxpayers, I think IRS 
        employees generally should focus on trying to induce the 
        taxpayers to comply prospectively.
    What percentage of taxpayers falls into each of these three 
categories? I suspect that the middle category is largest, although it 
is impossible to know with precision. But we need to know more. 
Determining the reasons for noncompliance and measuring the impact of 
taxpayer service on compliance and the indirect impact of enforcement 
actions on compliance (i.e., the increase in compliance that results 
from taxpayers not subject to audits when word of the IRS's increasing 
audit coverage spreads) is admittedly difficult research to do, but 
that is not an adequate reason not to do it. At present, the IRS has 
very little hard data to compare the return on investment of a dollar 
spent wisely on enforcement against the return on investment of a 
dollar spent wisely on taxpayer service. Indeed, there is very little 
hard data that has been developed to show what a ``wise'' expenditure 
would be on either the service or the enforcement side.
    I believe this committee and the IRS itself would benefit 
considerably if more research were conducted in this area to help guide 
us in making intelligent resource allocation decisions.

                          DIRECT FILING PORTAL

    Question. Some experts have suggested that the IRS develop a direct 
filing portal through the IRS website to increase e-filing. To be 
clear, this is not about the government preparing tax returns but 
simply provide an easier, cheaper way for taxpayers to file their 
returns.
    What are your thoughts on the direct filing portal? Do you believe 
it would significantly increase e-filing? Would this approach be more 
cost-effective for the IRS than continuing to use an extremely labor-
intensive approach to processing paper returns?
    Answer. I believe the IRS should provide a direct filing portal to 
enable taxpayers to e-file their returns directly with the IRS for 
free. In fact, I made exactly this recommendation in my 2004 annual 
report to Congress.\2\
---------------------------------------------------------------------------
    \2\ See National Taxpayer Advocate 2004 Annual Report to Congress 
471-477 (Key Legislative Recommendation: Free Electronic Filing for All 
Taxpayers).
---------------------------------------------------------------------------
    E-filing brings benefits to both taxpayers and the IRS. From a 
taxpayer perspective, e-filing eliminates the risk of IRS transcription 
errors, pre-screens returns to ensure that certain common errors are 
fixed before the return is accepted, and speeds the delivery of 
refunds. From an IRS perspective, e-filing eliminates the need for data 
transcribers to input return data manually (which could allow the IRS 
to shift resources to other high priority areas), allows the IRS to 
easily capture return data electronically, and enables the IRS to 
process and review returns more quickly. For these reasons, Congress in 
1998 directed the IRS to set a goal of having 80 percent of all returns 
filed electronically by 2007.\3\
---------------------------------------------------------------------------
    \3\ Internal Revenue Service Restructuring and Reform Act, Public 
Law No. 105-206,  2001(a)(2), 112 Stat. 685 (1998).
---------------------------------------------------------------------------
    To its considerable credit, the IRS has succeeded in raising the e-
file rate above 50 percent. That is a significant achievement, but the 
rate remains substantially below 80 percent. In addition, the IRS 
reports that nearly 40 million returns are currently prepared using 
software--which means they are generally in a form that could be easily 
transmitted electronically--yet are printed out and mailed into the IRS 
on paper.
    If the IRS could persuade these nearly 40 million taxpayers to file 
these returns electronically, it would achieve its 80 percent e-filing 
goal. Under the current system, there are two significant reasons why 
taxpayers shy away from e-filing. First, some taxpayers are unwilling 
to pay a separate fee to third-party software providers to file their 
tax returns. This is an understandable sentiment. As it is, taxpayers 
are filing tax returns to comply with the requirement that they pay a 
high percentage of their income--often 33 percent or more--to the 
Government. The notion that they should have to pay a fee in order to 
pay over all this money is unpalatable to many. Second, some taxpayers 
have concerns from a security standpoint about routing personal 
financial and tax information through third parties. In focus groups, 
taxpayers have said they would be comfortable transmitting this 
information directly to the IRS, but they are concerned that the risk 
the data could be improperly accessed increases when routed through 
third parties.
    A direct filing portal would address concerns about fees and 
security. For that reason, I believe it could help the IRS considerably 
in its efforts to boost the e-filing rate.

                        BETTER TAX GAP ESTIMATES

    Question. While the IRS has done a commendable job in updating the 
tax gap estimates, there remain significant gaps in the [data]. The IRS 
and others have expressed concerns with the certainty of the overall 
tax gap estimate in part because some areas of the estimate rely on old 
data (from the 1970's and 1980's) and it has no estimates for other 
areas of the tax gap. GAO, TIGTA, the Taxpayer Advocate, and the IRS 
Oversight Board also have all recommended greater and more frequent 
data collection and studies of the tax gap. I wholeheartedly agree.
    What will it take in terms of resources to address these concerns? 
Should the IRS conduct research on how services affect compliance?
    Can your office conduct research on the impact of taxpayer service 
on compliance?
    Answer. Determining the resource commitment required to update all 
components of the tax gap is a complex problem. Given the information, 
planning assumptions and analyses required, TAS cannot provide an 
accurate estimate in response to this question. The actual cost would 
vary greatly depending on the methods chosen to address the various tax 
gap components, the time frames in which the research would be done, 
and the commitment made to periodically refresh information to assure 
continued accuracy. For example, where the IRS relies on examinations 
to identify underreporting for a particular class of returns (e.g., 
individual income as reported on the Form 1040 series of returns), 
costs would vary depending on a variety of factors, including:
  --The total number of examinations (increasing the number of 
        examinations allows the IRS to study more subsets of the 
        taxpaying population in isolation--e.g., EITC taxpayers, self-
        employed taxpayers, etc.);
  --The number of examinations conducted face-to-face (as opposed to 
        via correspondence);
  --The number of issues that would not have to be addressed during the 
        examination because they could be resolved using data available 
        through electronic means;
  --The number and kinds of analyses conducted once examination results 
        became available (which would depend on the purposes for which 
        the information is to be used).
    This question could probably best be addressed by the IRS, based on 
experience to date with the National Research Program (NRP), and 
current planning assumptions. I do believe, however, that conducting 
such research is vital to increasing IRS productivity and taxpayer 
compliance. Each year, the IRS should identify a particular category of 
taxpayers--individual, pass-through, corporate, or tax-exempt--and 
dedicate a unit of its auditors to examining a random sample of 
returns. The revenue resulting from the improved selection of returns 
for audit should more than offset the minor reduction in audit 
resources used to conduct these studies. The IRS must learn to view 
this type of research as part of its regular tax administration 
activity instead of as a special activity that ``distracts'' its 
auditors from their ``real'' work.
    Concerning the need to conduct research on how services affect 
compliance, as I stated above in my response to question No. 1, the IRS 
has very little hard data to compare the return on investment of a 
dollar spent wisely on enforcement against the return on investment of 
a dollar spent wisely on taxpayer service. In addition, the data that 
is available suggests that a substantial percentage of noncompliance is 
inadvertent. Additional research is needed to develop better 
information on the underlying causes of noncompliance and the degree to 
which different approaches, including enhancements to customer service, 
can improve compliance.
    TAS is working with the Taxpayer Assistance Blueprint (TAB) team to 
develop and conduct research projects that will help identify the 
impact customer service has on taxpayer compliance. Several studies are 
currently underway that are exploring various facets of this issue, 
including:
  --The impact of IRS return preparation on compliance;
  --The impact of other customer service options on compliance; and
  --The impact of high-end account resolution services on compliance.
    We will be in a better position to assess the need for additional 
research once we have reviewed the results of these studies.
                                 ______
                                 
              Questions Submitted by Senator Patty Murray

  CUTTING THE IRS OFFICE RESPONSIBLE FOR SERVICE WHILE EXPECTING MORE 
                        FROM VOLUNTEER PROGRAMS

    Question. Mr. Everson, the IRS's Stakeholder, Partnership, 
Education and Communication (SPEC) office has overall responsibility 
for community partnerships such as the Volunteer Income Tax Assistance 
(VITA) and Tax Counseling for the Elderly (TCE) programs. In recent 
years, this IRS office has suffered cutbacks while the number of 
taxpayers seeking help from by VITA and TCE for tax preparation 
continues to increase dramatically. Moreover, you stated recently that 
you expect to rely heavily on VITA programs to improve taxpayer 
services.
  --How do you justify continuing to cut the SPEC office while giving 
        it an increasing workload?
  --Ms. Olson, what is your opinion on this matter?
    Answer. I strongly support the VITA Program, and commend the 
tireless efforts of its volunteers in assisting an underserved segment 
of taxpayers. If the IRS wants to retain responsibility for VITA and 
set the standards that sites must meet, however, it must be willing to 
give the sites more assistance than it currently provides. The IRS must 
be willing to change its relationship with VITA from one that is merely 
supplementary, where VITA sites are providing a service the IRS is 
unwilling to provide, to a relationship that is complementary, where 
the IRS and VITA sites work together to provide a service and achieve 
specific goals. As the IRS considers the future of VITA, it must take a 
hard look at the needs and concerns of local and national partners, 
without whose continued support the program will cease to exist.
    The IRS must also provide adequate funding for the VITA Program. 
From 1999 to 2004, the number of VITA sites grew dramatically from 
6,000 to nearly 14,000, an increase of 8,000 sites.\4\ From 2001 to 
2004, the amount of technology support provided to the VITA Program 
increased only modestly, from $2.9 to $3.3 million, an increase of 
$400,000.\5\ In combination, technology support decreased from $483.00 
per site to $236.00 per site on average, a decrease of more than 50 
percent. Thus, aggregate funding and support provided by the IRS have 
not been increasing at a rate sufficient to keep up with the growth of 
the program. The IRS needs to determine the growth limit of the VITA 
Program and how to respond when that limit is reached. It must also 
undertake more comprehensive strategic planning regarding the future of 
the VITA program and the support it is providing before it continues to 
increase the amount of assistance it expects these sites to provide.
---------------------------------------------------------------------------
    \4\ Stakeholder Partnerships, Education and Communication, ``VITA 
Celebrates Its Thirtieth Year of Service''; additional information 
provided by the IRS.
    \5\ Information provided by the IRS. It is important to note that 
budget information is not available for years prior to 2001 when the 
VITA Program operated under the Taxpayer Education function.
---------------------------------------------------------------------------
    Question. The VITA program operates for only about 4 months of the 
year during tax season and receives limited support from the IRS. Ms. 
Olson, in your statement, you say that the IRS should concentrate on 
developing a fundamental support structure for the program and expand 
the program. You also say that the IRS should not let VITA or any other 
volunteer program serve as a substitute for IRS-provided service.
    Ms. Olson, why do you take that position?
    Answer. As the IRS struggles with limited resources to meet the 
service needs of all taxpayers, we have already begun to reduce free 
tax preparation assistance previously provided to taxpayers. Over the 
past 3 years, the IRS has reduced the number of tax returns prepared in 
Taxpayer Assistance Centers (TACs) from 665,868 tax returns in fiscal 
year 2003 to a proposed 305,000 tax returns in fiscal year 2006.\6\ To 
fill the gap, the IRS has increased its reliance on the VITA Program to 
provide free tax preparation assistance to taxpayers.
---------------------------------------------------------------------------
    \6\ Wage and Investment, ``Business Performance Review, Wage and 
Investment Operating Division, Fiscal Year 2006''; Wage and Investment, 
``Business Performance Review, Wage and Investment Operating Division, 
Fiscal Year 2005''; Wage and Investment, ``Business Performance Review, 
Wage and Investment Operating Division, Fiscal Year 2004''; Wage and 
Investment, ``Business Performance Review, Wage and Investment 
Operating Division, Fiscal Year 2003.''
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    Clearly, partners are very important to effective tax 
administration, and I applaud the efforts of dedicated professionals 
and volunteers in assisting taxpayers. However, this reliance raises 
several concerns. First, when the IRS relies on partners to deliver a 
message, we need to study what happens to the message in the course of 
delivery. Does the message change over distance and time? Is it less 
accurate? Second, we need to measure the downstream consequences of 
this trend. What are the true costs of effective oversight over these 
partners? Who conducts such oversight and bears the cost? Will the IRS 
actually realize any savings or will it incur more expense through 
additional enforcement activity that could be avoided if the IRS itself 
delivered the assistance?
    On the other hand, if we begin to rely more heavily on our partners 
for the delivery of services, we must also ensure that we are providing 
our partners with adequate support and assistance. Without a sufficient 
support system in place, we cannot expect our partners to act as a 
delivery channel for services we are unable or unwilling to provide.
    While the service VITA provides is critical, the IRS cannot rely 
entirely on these volunteers to provide a service the IRS has deemed 
too costly or time-consuming to provide itself. Instead of 
concentrating on expanding the VITA Program, the IRS should concentrate 
on developing a fundamental support structure for the program, 
including site management, training, and quality review. Once the IRS 
has developed a strong infrastructure for the VITA Program and has 
established consistent quality in the returns prepared by volunteers, 
then the IRS can work to expand the program. However, the IRS must 
remain cognizant that VITA, or any volunteer program, cannot and should 
not be expected to serve as a substitute for IRS-provided service. 
Taxpayers have the right to expect some level of assistance from the 
tax agency they fund with their tax dollars.

         SETTING TAXPAYER ASSISTANCE CENTERS (TACS) UP TO FAIL

    Question. In a briefing last year by TIGTA on Taxpayer Assistance 
Centers, I learned that some TACs have as little as one or two staff, 
what TIGTA calls a ``critical staffing shortage.'' The House and 
Senate, Majority and Minority, said no to your proposal to cut back 
TACs until TIGTA completes a study on the impact of such reductions on 
taxpayer compliance and taxpayer services.
    Mr. Everson, are you, in fact, allowing these TACs to eventually 
close by letting the staffing levels dwindle? Do you believe that is 
consistent with the direction from this committee?
    Mr. George or Ms. Olson, do either of you care to comment?
    Answer. The IRS is facing a challenge. It has limited resources yet 
also has the responsibility to serve all taxpayers. Thus, it must 
decide by taxpayer segment how to deliver needed services in the most 
effective and efficient manner possible, and in a way that does not 
negatively impact taxpayers' ability to comply with the tax laws. 
Toward this end, the IRS must gather data and develop criteria to make 
those decisions. The Phase I report of the Taxpayer Assistance 
Blueprint (TAB) is the first step toward developing a comprehensive 5-
year plan for taxpayer service that will establish a long-term strategy 
for delivering needed taxpayer services within existing resource 
limitations.
    The IRS must take a close look at what services taxpayers need and 
want. The status quo is not necessarily what taxpayers want--it is 
merely what the IRS has been willing (or able) to deliver. Instead the 
IRS must conduct research to develop a baseline of services. Only after 
this research is completed will we be able to measure how effective we 
are in improving our ability to meet taxpayer needs and begin to study 
how any changes to our current service offerings will affect taxpayer 
compliance.

                        SERVICES OFFERED AT TACS

    Question. Mr. Everson and Ms. Olson, why hasn't the IRS involved 
taxpayers who need or desire face-to-face assistance in determining 
what services are offered at the TACs?
    Answer. The Taxpayer Assistance Blueprint Team (TAB), as part of 
its work developing a 5-year plan for taxpayer service, conducted a 
number of research projects designed to identify the needs and 
preferences of taxpayers. As part of these studies, the IRS is looking 
specifically at taxpayers who use the TACs to determine what services 
these taxpayers need. This data will hopefully allow the IRS to 
structure the TACs in order to best meet the needs of the taxpayers who 
require face-to-face assistance.
    Question. Mr. George, your recent audit report says that prior to 
making decisions on closing any TACs, the IRS should ensure that it is 
known which taxpayers visit the TACs for assistance and why, so the IRS 
can determine the impact on these taxpayers and ensure alternative 
service deliver channels are effective in meeting the needs of these 
taxpayers.
    Ms. Olson, I would imagine you agree?
    Answer. Before the IRS makes any decision about altering the 
current services offered to taxpayers, it should study the trends in 
taxpayer service in order to understand the impact of taxpayer service 
on compliance and how taxpayers need services to be delivered. The 
Taxpayer Assistance Blueprint Team (TAB) conducted a number of research 
projects designed to identify the needs and preferences of taxpayers. 
One research study involves interviews with taxpayers who sought TAC 
services, including those who were not actually served or did not 
receive the service they requested. This information will be invaluable 
in determining taxpayer needs and preferences. However, additional 
research must be conducted to determine the impact of taxpayer service 
on compliance. This research would allow the IRS to determine how 
changes to taxpayer service will potentially impact compliance.

                     REDUCTION OF TAXPAYER SERVICES

    Question. Mr. Everson, last year, you:
  --eliminated ``TeleFile'', the ability to file taxes by telephone;
  --proposed the elimination of as many as one-quarter of all walk-in 
        Taxpayer Assistance Centers;
  --proposed shortening phone assistance hours; and
  --began the process to eliminate several telephone call-routing 
        sites.
    In a profile of online population, Census data indicates that in 
any given age group (ages 18-29; 30-39, etc.), not even one-third of 
adults are on-line. We know that the Nation's large senior citizen, 
limited-proficient English, and underserved populations are not as 
likely to use or have access to the internet as other forms of 
communication.
    Given this and the digital divide at every generation, how do you 
rationalize the elimination of face-to-face and telephone interaction 
in favor of electronic communication?
    Ms. Olson, does this concern you?
    Answer. I believe the IRS should work harder to identify the best 
channels through which to deliver services to taxpayers. While 
electronic and self-assistance channels may be growing in popularity, 
mere use or access to these services does not necessarily mean that 
taxpayers are computer literate and can conduct website searches for 
complex tax information--much less understand how to apply that 
information once they find it.
    Moreover, we need to understand why certain taxpayer segments have 
difficulties with our existing services and why they are reluctant to 
use lower cost channels (if indeed they are). Only then can we develop 
effective ``migration'' strategies to encourage and educate taxpayers 
about appropriate lower cost channels--ones that will not ultimately 
increase noncompliance and lead to greater downstream costs. 
Additionally, we must always remain cognizant that there is a segment 
of the population that cannot and will not avail itself of self-service 
options. However, by providing more self-service opportunities for 
taxpayers, the IRS should be able to reserve its in-person (face-to-
face or telephone) interaction for those issues and taxpayers that need 
such engagement.

                           FREE FILE ALLIANCE

    Question. Mr. Everson, recently, the Finance Committee found that 
taxpayers using the Free File on-line tax return preparation services 
are presented with surprise fees, expensive add-ons, loan solicitations 
and other marketing pitches. While there is no obligation to buy these 
services, the fees occur so late in the process that taxpayers may feel 
forced to pay them or completely redo their taxes with another vendor 
who may also charge fees. It is my understanding that the IRS has not 
conducted much research on how many taxpayers fall prey to these sales 
pitches.
    What is the IRS doing to protect taxpayers from predatory sales 
pitches and do you plan to do more comprehensive research on these 
activities?
    Ms. Olson, do you have a view on this?
    Ms. Olson, you've advocated for free tax preparation on the IRS 
website.
    Do you believe that is the only way the IRS will achieve its goal 
of having 80 percent of taxpayers filing electronically?
    Answer. I have significant concerns about the Free File Program. It 
is very confusing for taxpayers to navigate, some of the participating 
companies subject taxpayers to an array of confusing sales pitches, and 
it has done very little to achieve the IRS's objective of increasing 
the e-filing rate. On this latter point, I note that only about 4 
million taxpayers used Free File during the 2006 filing season out of 
approximately 135 million individual income tax returns filed--and IRS 
data from the prior year shows that the significant majority of Free 
File users filed their returns electronically in prior years,\7\ which 
means that Free File's success at creating new e-filers is limited at 
best. As I have recommended previously, I believe the IRS and taxpayers 
would both be much better off if the IRS were to create a direct filing 
portal and to make available a basic electronic filing template on its 
website for those taxpayers who are unwilling to pay fees to purchase 
fully functional software products.\8\
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    \7\ IRS Wage & Investment Research Group 6, ``Final Report: Free 
File Survey Analysis, Research Project 6-05-08-2-038N'' 12 (Aug. 31, 
2005).
    \8\ See National Taxpayer Advocate 2004 Annual Report to Congress 
471-477 (Key Legislative Recommendation: Free Electronic Filing for All 
Taxpayers).
---------------------------------------------------------------------------
    As for navigating Free File, several experienced attorneys in my 
office tested each of the Free File sites in March 2006 seeking to 
prepare returns reflecting four fact patterns on each site. We 
conducted the tests partly to follow up on testing my office performed 
in 2004 and partly in response to a request from the staff of the 
Finance Committee. The goal of the testing was to determine the 
experience of taxpayers as they attempt to navigate the sites and 
prepare and file their returns through Free File products accessible 
through the official IRS website. The results of our tests, in my view, 
were disappointing.\9\ We found that Free File is not generally an easy 
service for taxpayers to navigate, and it can even result in inaccurate 
returns. As structured during the 2006 filing season, Free File 
amounted to a Wild, Wild West of differing eligibility requirements, 
differing capabilities, differing availability of and fees for add-on 
products, and many sites were difficult to use.\10\
---------------------------------------------------------------------------
    \9\ The objective of our study was to determine the existence and 
extent of limitations and problems that a user of the Free File sites 
would encounter. In some instances, the tax attorneys testing the sites 
found them very difficult to navigate and were unable to locate forms 
or answers that later testing was able to locate. Therefore, the 
results we describe reflect simply what our attorneys experienced and 
not necessarily what a site was capable of accomplishing.
    \10\ For a detailed discussion of the tests, see ``Preparing Your 
Taxes: How Costly Is It? Hearing Before Senate Comm. On Finance'', 
109th Cong., 2nd Sess. (Apr. 4, 2006) (statement of Nina E. Olson, 
National Taxpayer Advocate, IRS).
---------------------------------------------------------------------------
    From an IRS perspective, the rationale for creating the Free File 
program was to make e-filing more accessible to taxpayers and thereby 
help it to achieve the congressionally-mandated goal of having 80 
percent of all taxpayers filing their returns electronically. However, 
the relatively low usage of Free File, the remarkably low usage by new 
e-filers, and the decline in usage in 2006 as compared with 2005 
indicate that the program is not meeting its objectives. Taking into 
account the additional concerns about cross-marketing of other 
products, the appearance that the IRS is endorsing the Free File 
products (notwithstanding disclaimers, taxpayers start out from the 
official IRS website), and taxpayer concerns about the confidentiality 
of their tax data, I see little justification to continue with Free 
File and every justification for the IRS to develop a tax preparation 
template and to provide free e-filing for all taxpayers--just as it 
does for paper filers. If the IRS template and direct filing portal are 
simple, accurate, and confidential, I think both the IRS and taxpayers 
will benefit enormously and the e-file rate will increase.

                          SUBCOMMITTEE RECESS

    Senator Murray. This subcommittee is recessed until 
Thursday, May 4 when we take testimony from the Federal 
Aviation Administrator.
    Thank you very much.
    [Whereupon, 11:25 a.m., Thursday, April 27, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
