[Senate Hearing 110-]
[From the U.S. Government Publishing Office]



 
  FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL 
                               YEAR 2009

                              ----------                              


                       WEDNESDAY, APRIL 16, 2008

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 3 p.m., in room SD-192, Dirksen 
Senate Office Building, Hon. Richard J. Durbin (chairman) 
presiding.
    Present: Senator Durbin, Brownback, and Allard.

                       DEPARTMENT OF THE TREASURY

                        Internal Revenue Service

STATEMENT OF DOUGLAS SHULMAN, COMMISSIONER
ACCOMPANIED BY:
        RICHARD SPIRES, DEPUTY COMMISSIONER
        LINDA STIFF, DEPUTY COMMISSIONER

             OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

    Senator Durbin. Good afternoon. This hearing will come to 
order.
    I am pleased to welcome you to this session before the 
Financial Services and General Government Appropriations 
Subcommittee. My colleagues will be joining me a little later 
on, and I will certainly welcome them.
    Our focus today is on the President's fiscal year 2009 
budget request for the Internal Revenue Service (IRS). It is a 
perfect day, is it not, the day after tax day?
    Funding for the IRS alone constitutes just over one-half of 
the total amount requested by the administration for the nearly 
30 agencies under this subcommittee's jurisdiction. Each year 
IRS employees make hundreds of millions of contacts with 
American taxpayers and businesses, and the IRS represents the 
face of Government to more U.S. citizens than any other agency.
    Appearing before the subcommittee is a distinguished group 
of witnesses. They bring valuable expertise and public service 
experiences in their lives to this hearing today, and I 
appreciate it.
    First, I am going to welcome Douglas Shulman, now in his 
fourth week--4 weeks now, Mr. Commissioner--as the 47th 
Commissioner of the Internal Revenue Service of the United 
States. Thank you for embarking on this challenge.
    Joining us on the second panel will be three of IRS's key 
partners and watchdogs: J. Russell George, Treasury Inspector 
General for Tax Administration; Paul Cherecwich, Chairman of 
the IRS Oversight Board; and Nina Olson, National Taxpayer 
Advocate. I appreciate their work and look forward to their 
testimony.

       PREPARED STATEMENT OF THE GOVERNMENT ACCOUNTABILITY OFFICE

    I also want to acknowledge the helpful contributions of the 
Government Accountability Office (GAO) in response to our 
request for analysis. I welcome senior GAO officials: James R. 
White, Director of Strategic Issues, and David Powner, Director 
of Information Technology, Management Issues; and other members 
of their team. Their prepared statement will be a part of the 
record, and they stand ready to respond to questions.
    [The statement follows:]
   Prepared Statement of James R. White, Director, Strategic Issues, 
                    Government Accountability Office

  Internal Revenue Service: Assessment of the Fiscal Year 2009 Budget 
                                Request

                               HIGHLIGHTS

Why GAO Did This Study
    The fiscal year 2009 budget request for the Internal revenue 
Service (IRS) is a road map for how IRS plans to allocate resources and 
achieve ambitious goals for improving taxpayer service, increasing 
research, and continuing to invest in modernized information systems. 
One complicating factor in implementing IRS's plans in the immediate 
future is the recent passage of the Economic Stimulus Act of 2008, 
which creates additional, unanticipated workload for IRS.
    GAO was asked to (1) assess how the President's budget request for 
IRS allocates resources and justifies proposed initiatives; (2) 
determine the status of IRS's efforts to develop and implement its 
Business Systems Modernization (BSM) program; and (3) determine the 
total costs of administering the economic stimulus legislation. To meet 
these objectives, GAO drew upon and updated recently issued reports.

What GAO Recommends
    GAO is not making new recommendations, but the statement highlights 
outstanding recommendations to extend the use of return on investment 
(ROI) analysis to cover major enforcement programs and improve BSM 
management controls and capabilities.

What GAO Found
    The President's fiscal year 2009 budget request for IRS is $11.4 
billion, 4.3 percent more than last year's enacted amount. The request 
proposes to maintain taxpayer service at recent levels, in part by 
realizing efficiency gains from electronic filing, despite a decrease 
in staffing. It also proposes a 7 percent increase in enforcement 
spending, including spending for 21 legislative and nonlegislative 
initiatives. The legislative proposals are projected to cost $23 
million in fiscal year 2009, funding that IRS would not need if the 
proposals are not enacted. Similarly, if IRS were to fall behind in its 
proposed enforcement hiring efforts, it would not need all $226 million 
of the associated funding. IRS justified its nonlegislative enforcement 
initiatives with ROI analyses, which are useful, despite limitations, 
for making resource allocation decisions. The budget request does not 
provide ROI information for activities that constitute a large part of 
the budget request--activities other than the proposed initiatives.
    The request for BSM is over $44 million lower than the fiscal year 
2008 enacted amount. IRS said this funding level will allow it to 
continue its primary modernization projects, but it did not describe 
how specific projects or benefits to taxpayers would be affected. IRS 
has continued to make progress in implementing BSM projects and 
improving modernization management controls and capabilities. However, 
further improvements are needed. For example, the agency has yet to 
develop long-term plans for completing BSM and consolidating and 
retiring legacy systems.
    IRS estimated that the costs of implementing the economic stimulus 
legislation may be up to a total of $767 million--including a $202 
million supplemental appropriation. In addition to the supplemental 
appropriation, IRS is reallocating hundreds of collections staff to 
answering taxpayer telephone calls, resulting in up to $565 million in 
foregone enforcement revenue. In addition, IRS expects some 
deterioration in telephone service because of the increased call 
volume. For example, IRS is expecting its assistor level of service to 
drop to as low as 74 percent compared to its goal of 82 percent.

   THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS FULL-TIME EQUIVALENTS (FTES) COMPARED TO FISCAL YEAR 2008
                                               ENACTED BUDGET FTES
----------------------------------------------------------------------------------------------------------------
                                                                    Fiscal year     Fiscal year     Percentage
                          Appropriation                            2008 enacted   2009 requested      change
----------------------------------------------------------------------------------------------------------------
Enforcement.....................................................          47,349          49,792            +5.2
Taxpayer Service................................................          31,218          30,792            -1.4
Operations Support..............................................          12,181          11,989            -1.6
BSM.............................................................             358             333            -7.0
Health Insurance Tax Credit.....................................              17              16            -5.9
                                                                 -----------------------------------------------
      Total.....................................................          91,123          92,922            +2.0
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.

    Mr. Chairman and Members of the Subcommittee: We appreciate this 
opportunity to comment on the President's fiscal year 2009 budget 
request for the Internal Revenue Service (IRS).
    Financing of the Federal Government depends largely on IRS's 
ability to effectively administer the tax laws. The President has 
requested $11.4 billion in program dollars to fund IRS's fiscal year 
2009 operations, including $11.1 billion for service to taxpayers and 
tax law enforcement, plus $223 million for the BSM program, IRS's 
ongoing effort to improve the agency's business and tax processing 
systems.
    The fiscal year 2009 budget request is a road map for how IRS 
intends to allocate resources in order to carry out ambitious plans of 
improving enforcement, improving taxpayer service, increasing research, 
and continuing to invest in modernized information systems. Together 
with the budget request, IRS's recently published strategies spell out 
its intentions for improving taxpayer service and reducing the net tax 
gap--the difference between the taxes owed and eventually paid, most 
recently estimated at $290 billion for tax year 2001.\1\ The budget 
request and strategies aim to build on recent IRS accomplishments such 
as annually bringing in more revenue through enforcement and making 
progress on modernizing IRS's business and tax processing systems. One 
complicating factor for carrying out IRS's ambitious plans in the 
immediate future is the recent passage of the Economic Stimulus Act of 
2008, which creates additional, unanticipated workload for IRS this 
year.\2\ Passage of this act required IRS to act quickly to deal with 
taxpayers' questions and begin issuing payments.
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    \1\ Internal Revenue Service, Reducing the Federal Tax Gap 
(Washington, D.C.: Aug. 2, 2007); and Internal Revenue Service, The 
2007 Taxpayer Assistance Blueprint (Washington, D.C.: 2007).
    \2\ Pub. L. No. 110-185 (2008).
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    Based on your request, our objectives were to (1) assess how the 
President's budget request for IRS for fiscal year 2009 allocates 
resources for enforcement, service, research, and systems modernization 
primarily compared to fiscal year 2008 enacted levels; (2) assess the 
rationales for differences between the 2 years, including the 
rationales for initiatives and the extent to which those rationales 
have been justified; (3) determine the status of IRS's efforts to 
develop and implement its BSM program; and (4) determine the total cost 
of administering the economic stimulus program.
    To meet these objectives, we drew upon and updated a recently 
issued report on the budget request and IRS's 2008 tax filing season, 
and for our BSM work, we relied primarily on our review of the fiscal 
year 2008 BSM expenditure plan.\3\ For the first report, we compared 
enacted and requested budgets for IRS; reviewed documents, including 
estimates of revenues and costs from initiatives; and interviewed IRS 
officials. For our BSM report, we analyzed the expenditure plan, 
reviewed other documents, and interviewed IRS officials. In assessing 
the cost of the economic stimulus package, we obtained performance and 
production data, looking for factors that significantly affected 
performance, and we interviewed IRS officials. We conducted the current 
performance audit from March 2008 through April 2008 in accordance with 
generally accepted government auditing standards. Those standards 
require that we plan and perform the audit to obtain sufficient, 
appropriate evidence to provide a reasonable basis for our findings and 
conclusions based on our audit objectives. We believe that the evidence 
obtained provides a reasonable basis for our findings and conclusions 
based on our audit objectives. For a more detailed discussion of our 
scope and methodology, see the appropriate sections in the budget and 
filing season and the BSM reports.
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    \3\ GAO, Internal Revenue Service: Fiscal Year 2009 Budget Request 
and Interim Performance Results of IRS's 2008 Tax Filing Season, GAO-
08-567 (Washington, D.C.: Mar. 13, 2008) and GAO, Business Systems 
Modernization: Internal Revenue Service's FISCAL Year 2008 Expenditure 
Plan, GAO-08-420 (Washington, D.C.: Mar. 7, 2008).
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    In summary, we make the following major points:
  --The President's budget request for IRS proposes to maintain 
        taxpayer service at recent levels and increase enforcement. 
        Overall, it increases spending on IRS by 4.3 percent. Spending 
        on taxpayer service would increase by less than 1 percent, 
        which would result in reduced staffing, but the level of 
        taxpayer service would be maintained by realizing efficiency 
        gains, in part, through increases in electronic filing. The 
        budget proposes a 7 percent increase in enforcement spending, 
        including funds and staffing for various legislative and 
        nonlegislative initiatives. According to the proposal, the 
        legislative initiatives would raise about $36 billion in 
        revenue over 10 years. They are projected to cost $23 million 
        in fiscal year 2009, funding IRS would not need if none of the 
        legislative initiatives were enacted. Similarly, if IRS were to 
        fall behind in meeting its challenging hiring goals for the 
        nonlegislative initiatives, it would not need all $226 million 
        of the associated funding for fiscal year 2009.
  --IRS included more information than past years on the initiatives in 
        the fiscal year 2009 proposed budget. Of particular note, IRS 
        included return on investment (ROI) information for all 
        nonlegislative initiatives. However, beyond those initiatives, 
        the budget request does not provide an analytic basis for key 
        resource allocation decisions. Such decisions include 
        allocating resources among a variety of enforcement programs 
        and taxpayer services. Analytic data such as ROI can be helpful 
        to IRS's management and the Congress for making these decisions 
        as well as decisions about the overall balance between taxpayer 
        service and enforcement. Although the budget request provides 
        performance measure data, it does not provide ROI for programs 
        or activities that constitute a large part of the budget 
        request--activities other than the proposed initiatives.
  --The requested budget for BSM is over $44 million lower than the 
        fiscal year 2008 enacted amount of about $267 million and 
        roughly $185 million less than the amount the IRS Oversight 
        Board is proposing. Modernized e-File (MeF) is the project with 
        the largest difference between the requested budget and the 
        fiscal year 2008 enacted amount. IRS stated that the requested 
        BSM funding level will allow it to continue developing and 
        delivering its primary modernization projects but did not 
        provide details on how plans to deliver specific projects or 
        benefits to taxpayers would be affected. IRS continues to make 
        progress in implementing BSM projects and meeting cost and 
        schedule commitments for most deliverables, but three project 
        milestones recently experienced significant cost or schedule 
        delays.\4\ IRS has also taken steps to address our prior 
        recommendations; however, work remains to fully implement them, 
        including developing long-term plans for completing the BSM 
        program. Future releases of the Customer Account Data Engine 
        (CADE) and Account Management Services (AMS) continue to face 
        risks and challenges, which IRS is working to mitigate. 
        Finally, we recently recommended that IRS complete a plan with 
        specific time frames for implementing initiatives supporting 
        its information technology (IT) human capital strategy, and IRS 
        agreed.
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    \4\ Milestones represent different phases in IRS's project life 
cycle.
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  --IRS estimates that the cost of implementing the economic stimulus 
        legislation may be up to a total of $767 million, including a 
        $202 million supplemental appropriation. In addition to the 
        supplemental appropriation, IRS is reallocating resources from 
        enforcement to taxpayer service by shifting hundreds of 
        collections staff to answering telephone calls and, as a 
        result, may forego up to $565 million in enforcement revenue. 
        IRS has experienced a deterioration of telephone access and 
        expects a further decline. For example, IRS's assistor level of 
        service--which measures a taxpayer's ability to get through and 
        speak to an assistor--has already declined, and IRS expects 
        access to continue to drop to as low as 74 percent, down from 
        the fiscal year 2008 goal of 82 percent.

   THE FISCAL YEAR 2009 BUDGET REQUEST PROPOSES TO MAINTAIN TAXPAYER 
           SERVICE AT RECENT LEVELS AND INCREASE ENFORCEMENT

    The President's budget request is proposing to maintain taxpayer 
service levels with fewer staff by realizing efficiency gains; it also 
proposes to increase enforcement by adding staff. The President's 
fiscal year 2009 budget request of $11.4 billion for IRS is 4.3 percent 
more than the fiscal year 2008 enacted budget and represents an 
increase of less than 1 percent for taxpayer service and 7 percent for 
enforcement, as shown in table 1.

   TABLE 1.--THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS COMPARED TO THE FISCAL YEAR 2008 ENACTED BUDGET
                                             [Dollars in thousands]
----------------------------------------------------------------------------------------------------------------
                                                                    Fiscal year     Fiscal year     Percentage
                             Program                               2008 enacted   2009 requested      change
----------------------------------------------------------------------------------------------------------------
Enforcement.....................................................      $6,997,226      $7,487,209            +7.0
Taxpayer Service................................................       3,612,833       3,636,230            +0.6
BSM.............................................................         267,090         222,664           -16.6
Health Insurance Tax Credit.....................................          15,235          15,406            +1.1
                                                                 -----------------------------------------------
      Total.....................................................      10,892,384      11,361,509            +4.3
----------------------------------------------------------------------------------------------------------------
Note: Dollar amounts include amounts for operations support.

Source: GAO analysis of IRS data.

    The budget request increases IRS-wide staff levels, measured in 
full-time equivalents (FTEs), by 2 percent, with a 1.4 percent decrease 
in taxpayer service FTEs and a 5.2 percent increase in enforcement 
FTEs, as shown in table 2.

TABLE 2.--THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS FTES COMPARED TO FISCAL YEAR 2008 ENACTED BUDGET FTES
----------------------------------------------------------------------------------------------------------------
                                                                    Fiscal year     Fiscal year     Percentage
                          Appropriation                            2008 enacted   2009 requested      change
----------------------------------------------------------------------------------------------------------------
Enforcement.....................................................          47,349          49,792            +5.2
Taxpayer Service................................................          31,218          30,792            -1.4
Operations Support..............................................          12,181          11,989            -1.6
BSM.............................................................             358             333            -7.0
Health Insurance Tax Credit.....................................              17              16            -5.9
                                                                 -----------------------------------------------
      Total.....................................................          91,123          92,922            +2.0
----------------------------------------------------------------------------------------------------------------
Note: The decline in taxpayer services, including operations support, reflects 91 FTEs in efficiency savings and
  207 FTEs in electronic filing savings. The increase in enforcement, including operations support, includes an
  additional 1,431 revenue agents and 582 revenue officers who will work on initiatives.

Source: GAO analysis of IRS data.

    The President's budget proposal is consistent with longer-term 
trends for IRS. Compared to actual spending in fiscal year 2006, the 
proposed fiscal year 2009 budget increases taxpayer service funding by 
3.7 percent, a real decrease after inflation, while increasing IRS's 
enforcement funding by 10 percent.
    The budget request proposes to maintain taxpayer service at recent 
levels. As an example, the key taxpayer service measures shown in table 
3 are projected to remain relatively stable through fiscal year 2009.

                                      TABLE 3.--TELEPHONE SERVICE MEASURES
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                    Fiscal year     Fiscal year     Fiscal year     Fiscal year
                     Measure                        2006 actual     2007 actual    2008 planned    2009 planned
----------------------------------------------------------------------------------------------------------------
Telephone performance--access: Assistor level of            82.0            82.1            82.0            82.0
 service (percentage of taxpayers who wanted to
 talk with an assistor and actually got through
 and received service)..........................
Telephone performance--accuracy:
    Tax law customer accuracy (percentage of                90.9            91.2            91.0            91.0
     calls in which telephone assistors provided
     accurate answers on tax law and took
     appropriate action)........................
    Accounts customer accuracy (percentage of               93.2            93.4            93.5           93.7
     calls in which telephone assistors provided
     accurate answers on customer accounts and
     took appropriate action)...................
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.

    In order to maintain taxpayer service at recent levels despite a 
decrease in real spending and staffing, IRS expects to realize 
efficiency gains. For instance, IRS expects to devote 207 fewer FTEs to 
the labor-intensive processing of paper returns because of expected 
increases in electronic filing. These expected efficiency gains are 
consistent with past trends--between 1999 and 2007, IRS reduced staff 
devoted to processing paper returns by about 1,800 FTEs.
    IRS's ability to maintain or improve taxpayer service beyond 2009 
will likely depend on its ability to continue to improve efficiency. To 
this end, in recent reports, we made recommendations to further 
increase electronic filing. We recommended that IRS determine the 
actions needed to require software vendors to include bar codes on 
printed returns, and we suggested that the Congress mandate electronic 
filing by certain paid tax preparers.\5\ IRS agreed with our bar code 
recommendation and outlined the actions it would take.
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    \5\ GAO, Tax Administration: 2007 Filing Season Continues Trend of 
Improvement, but Opportunities to Reduce Costs and Increase Tax 
Compliance Should Be Evaluated, GAO-08-38 (Washington, D.C.: Nov. 15, 
2007) and GAO, Tax Administration: Most Filing Season Services Continue 
to Improve, but Opportunities Exist for Additional Savings, GAO-07-27 
(Washington, D.C.: Nov. 15, 2006).
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    Some of the real spending decrease proposed for fiscal year 2009 is 
because of one-time investments made in fiscal year 2008 or carryovers 
in funds from fiscal year 2008. For instance, the budget request 
proposes a $31 million reduction in funding for taxpayer assistance 
centers and outreach. However, IRS officials told us that this 
reduction includes funding used for long-term investments in fiscal 
year 2008 that would not need to be duplicated in fiscal year 2009. IRS 
officials also told us that a $7.7 million decrease in funding for the 
Taxpayer Advocate offsets a funding increase in fiscal year 2008 that 
is being used to lower the Advocate's outstanding caseload. Finally, an 
$8 million reduction in the Volunteer Income Tax Assistance (VITA) 
program reflects fiscal year 2008 funding that was not spent and 
carried over into fiscal year 2009.\6\
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    \6\ The funding provided in fiscal year 2008 was 2-year funding. 
Since IRS was ramping up the program being funded--providing matching 
grants to volunteer preparer organizations--in 2008, additional funding 
was not needed for 2009. Despite not asking for additional funding, IRS 
is expecting to see large, but unquantified, growth in tax returns 
prepared at VITA sites. According to IRS officials, IRS does not have a 
separate line item showing how much it spent on VITA overall.
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    The budget request for IRS's enforcement programs includes 
nonlegislative and legislative initiatives. According to the proposal, 
the five nonlegislative enforcement initiatives would cost about $338 
million in fiscal year 2009 and are expected to raise about $2 billion 
of direct revenue annually starting in fiscal year 2011.\7\ In 
addition, the budget request estimates that the enforcement initiatives 
would generate at least another $6 billion annually in indirect 
revenue. The indirect revenue results from improved voluntary 
compliance induced by taxpayers' awareness of expanded IRS enforcement. 
The budget request also proposes increases in examination coverage for 
corporations with assets of $10 million or more from a planned 6.6 
percent for fiscal year 2008 to 6.8 percent for fiscal year 2009. The 
coverage rate would increase to 7.6 percent in fiscal year 2010 as new 
enforcement staff hired in fiscal year 2009 complete training and can 
audit more returns.
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    \7\ These nonlegislative initiatives involve (1) reducing the tax 
gap for small businesses and the self-employed; (2) reducing it for 
large businesses; (3) increasing reporting compliance related to 
offshore activity; (4) through research, improving tax gap estimates, 
measurement, and detection of noncompliance; and (5) expanding document 
matching.
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    The budget request includes 16 legislative initiatives budgeted at 
$23 million for fiscal year 2009 that it says would raise about $36 
billion in revenue over 10 years; if none were enacted, IRS would not 
need the $23 million. We have reported on three of the proposals. In 
2006, we suggested that the Congress consider an idea for reducing 
securities capital gains noncompliance.\8\ In 1991, we supported the 
notion that payments to corporations be reported on information 
returns.\9\ Finally, in 2007, we described ways to mitigate the 
compliance costs related to these information returns and to other 
information returns associated with credit and debit card payments.\10\
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    \8\ GAO, Capital Gains Tax Gap: Requiring Brokers to Report 
Securities Cost Basis Would Improve Compliance if Related Challenges 
Are Addressed, GAO-06-603 (Washington, D.C.: June 13, 2006).
    \9\ GAO, Tax Administration: Benefits of a Corporate Document 
Matching Program Exceed the Costs, GAO/GGD-91-118 (Washington, D.C.: 
Sept. 27, 1991).
    \10\ GAO, Tax Administration: Costs and Uses of Third-Party 
Information Returns, GAO-08-266 (Washington, D.C.: Nov. 20, 2007).
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    The revenue expected from IRS's enforcement initiatives is modest 
compared to the net tax gap, which was last estimated at $290 billion 
for tax year 2001. As we noted in our statement to this Committee last 
year, no single approach, such as IRS enforcement, is likely to fully 
and effectively address noncompliance.\11\ Multiple approaches are 
needed because noncompliance has multiple causes and spans different 
types of taxes and taxpayers.
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    \11\ GAO, Internal Revenue Service: Assessment of the 2008 Budget 
Request and an Update of 2007 Performance, GAO-07-719T (Washington, 
D.C.: May 9, 2007).
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    Hiring needed staff for the nonlegislative initiatives will be 
challenging for IRS's Large and Mid-Size Business (LMSB) and Small 
Business/Self-Employed (SB/SE) divisions. For instance, the initiatives 
call for adding 1,431 revenue agents in addition to those who must be 
replaced from attrition, a high number relative to past years. IRS 
divisions have previously hired large numbers of staff in a short time 
because of specific budget initiatives, but officials reported that 
hiring gradually over time would reduce challenges. If IRS were to fall 
behind in its hiring efforts, it would not need all $226 million of the 
funding for staff for fiscal year 2009 initiatives.
 irs has enhanced its justifications for initiatives and could benefit 
   from using roi analyses more broadly, even with their limitations
    Responding to our recommendations from last year, IRS included more 
information on initiatives in the fiscal year 2009 proposed budget, 
including ROI information for all nonlegislative initiatives. Last 
year, we recommended that IRS have available basic descriptive, cost, 
and expected performance information on all new initiatives and include 
such information in future budget submissions.\12\ This year, the 
budget request has sections explicitly entitled, for instance, 
``Initiative Summary,'' ``Implementation Plan,'' ``Expected Benefits,'' 
and ``ROI.'' Four of the five nonlegislative enforcement initiatives 
for fiscal year 2009 were revisions of fiscal year 2008 initiatives, 
but with more total funds requested and generally more informative 
justifications than for fiscal year 2008.
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    \12\ GAO-07-719T.
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    However, IRS's ROI calculations have limitations that reflect the 
challenges of estimating ROIs. For example, the calculations do not 
account for benefits that are harder to measure, such as improved 
voluntary compliance. Another example showing ROI limitations is the 
$51 million National Research Project (NRP) initiative for which IRS 
estimates the ROI to be $0.40 per $1.00 invested. NRP funds research 
audits in order to develop more effective enforcement programs. The ROI 
calculation only includes direct revenue resulting from the research 
audits, not the potential for increased revenue from improved 
enforcement programs; nor does the calculation include the benefits of 
the Department of the Treasury's use of NRP data to provide the basis 
for legislative recommendations.
    Although the budget request for IRS provides performance measure 
data, it does not provide ROI analyses for programs or activities other 
than the new initiatives. As we noted in our recent report, analytic 
data such as ROI can be helpful to managers and the Congress when 
making resource allocation decisions.\13\ ROI analyses, even with their 
limitations, can help answer questions such as the following:
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    \13\ GAO-08-567.
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  --What are the implications for IRS's resource allocation of the 
        lower costs per taxpayer contact for some services compared to 
        others as shown in table 4?
  --Are there extra benefits that offset the higher costs of some 
        services, or could costs be reduced by promoting increased 
        reliance on the lower-cost options?

    TABLE 4.--COST OF PROVIDING TAXPAYER SERVICE IN FISCAL YEAR 2005
------------------------------------------------------------------------
                                                          Estimated cost
                         Service                            per contact
------------------------------------------------------------------------
Answering tax law questions via e-mail..................          $52.51
Providing assistance at taxpayer assistance centers.....           28.73
Answering correspondence................................           24.97
Providing assistance by assistors via toll-free                    19.46
 telephones.............................................
Providing assistance through VITA sites.................           12.01
Providing assistance by automation via toll-free                    0.71
 telephones.............................................
Providing assistance such as downloads and searches on              0.13
 IRS's Web site.........................................
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Note: IRS reported that these estimates do not fully allocate all
  indirect overhead and support costs. We have reported that because of
  long-standing limitations in IRS's cost accounting capability, cost
  data at this detailed level have not been audited (see, for example,
  GAO-07-310 and 07-247). From our perspective, it would be important to
  know more about the indirect and support costs to see if they might
  significantly change the cost estimates.

Source: GAO analysis of IRS data.

    Similar questions can be asked about enforcement based on table 5:
  --Is IRS appropriately allocating resources between field audits, 
        often conducted at a taxpayer's business, and correspondence 
        audits, which are simpler and conducted by mail? \14\
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    \14\ In fiscal year 2007 correspondence audits took, on average, 
1.4 hours to conduct compared to the 30.8-hour average for field audits 
done at taxpayers' locations and the 7.8-hour average for field audits 
done at IRS offices.
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  --For the rows in table 5 with average recommended additional tax per 
        return greater for correspondence audits than for field audits, 
        could resources be reallocated from field audits to 
        correspondence audits in order to help close the tax gap?
  --Are there other benefits to field audits, such as a greater impact 
        on voluntary compliance, that are not captured in IRS's data?

 TABLE 5.--FIELD AND CORRESPONDENCE AUDITS OF SOME BUSINESS CATEGORIES OF TAXABLE INDIVIDUAL INCOME TAX RETURNS,
                                           FISCAL YEARS 2006 AND 2007
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                                                    Number of returns examined    Average recommended additional
                                                 --------------------------------         tax per return
             Type and size of return                                             -------------------------------
                                                       Field      Correspondence       Field      Correspondence
----------------------------------------------------------------------------------------------------------------
Fiscal year 2006:
    Business nonfarm returns by size of total
     gross receipts (TGR):
        Under $25,000...........................          19,801         107,802          $3,918          $2,614
        $25,000 under $100,000..................          38,722          42,070           5,464           7,600
        $100,000 or more........................          54,716          34,515          25,787          27,863
Fiscal year 2007:
    Business nonfarm returns without earned
     income tax credit, by size of TGR:
        Under $25,000...........................          53,092          81,237           4,836          11,048
        $25,000 under $100,000..................          31,363          31,513           6,320          11,793
        $100,000 under $200,000.................          28,286          28,041          24,582          32,640
        $200,000 or more........................          11,319           1,730          15,959           7,017
Business returns with total positive income at            17,499          15,280          20,880          33,406
 least $200,000 and under $1 million............
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Note: This table does not include all categories of audits. For a number of those categories, field audits
  produce a higher average recommended additional tax per return than do correspondence audits.

Source: GAO analysis of IRS data.

    We recognize that developing ROI estimates for IRS's ongoing 
programs such as examinations and taxpayer service will be a challenge. 
However, because of the potential benefits of ROI analyses, we 
recommended in our previous report on the fiscal year 2009 budget 
request that the Commissioner of Internal Revenue extend the use of ROI 
in future budget proposals to cover major enforcement programs. At that 
time, IRS officials said that because of the short time frame for our 
report, they did not have time to fully analyze its recommendations, 
and, therefore, were unable to respond.\15\ We have agreed to meet with 
IRS to further discuss the ROI recommendation.
---------------------------------------------------------------------------
    \15\ GAO-08-567.
---------------------------------------------------------------------------
  FURTHER PROGRESS MADE IN IMPLEMENTING BSM, BUT CHALLENGES AND RISKS 
                                 REMAIN

    IRS's BSM program, initiated in 1999, involves the development and 
delivery of a number of modernized tax administration, internal 
management, and core infrastructure projects that are intended to 
provide improved and expanded service to taxpayers as well as IRS 
internal business efficiencies. Key tax administration projects include 
CADE, which is intended to provide the modernized database foundation 
to replace the existing Individual Master File processing system that 
contains the repository of individual taxpayer information; AMS, which 
is intended to enhance CADE by providing applications for IRS employees 
and taxpayers to access, validate, and update accounts on demand; and 
MeF, which is to provide a single standard for filing electronic tax 
returns. We recently reported that while IRS has continued to make 
progress in implementing BSM projects and improving modernization 
management controls and capabilities, challenges and risks remain, and 
further improvements are needed.\16\
---------------------------------------------------------------------------
    \16\ GAO-08-420.
---------------------------------------------------------------------------
    As shown in table 6, the fiscal year 2009 budget request for the 
BSM program is less than the enacted fiscal year 2008 budget by over 
$44 million and about $185 million less than the amount the IRS 
Oversight Board is proposing. When we asked about the impact of this 
reduction on its operations, IRS told us that the proposed funding 
level will allow it to continue developing and delivering its primary 
modernization projects but did not provide details on how plans to 
deliver specific projects or benefits to taxpayers would be affected. 
MeF is the project with the largest difference between the requested 
budget and the fiscal year 2008 enacted amount.

      TABLE 6.--BSM FUNDING DIFFERENCES, FISCAL YEAR 2008 AND 2009
                        [In thousands of dollars]
------------------------------------------------------------------------
                                                            Fiscal year
                 Project                    Fiscal year     2009 budget
                                           2008 enacted       request
------------------------------------------------------------------------
Customer Account Data Engine............          58,500          58,800
Accounts Management Services............          28,983          26,158
Modernized e-File.......................          55,802          25,000
Filing & Payment Compliance.............  ..............  ..............
Core Infrastructure.....................          39,150          32,000
Architecture, Integration, and                    35,100          35,000
 Management.............................
Management Reserve......................           4,310           2,300
                                         -------------------------------
      Subtotal Capital Investments......         221,845         179,258
BSM Labor...............................          44,000          42,052
                                         -------------------------------
      Subtotal Program Request..........         265,845         221,310
Maintaining Current Levels..............           1,245           1,354
                                         -------------------------------
      Total BSM Budget Request..........         267,090         222,664
------------------------------------------------------------------------
Source: IRS data.

    IRS has made progress in implementing BSM projects and meeting cost 
and schedule commitments for most deliverables, but three project 
milestones experienced significant cost or schedule delays.\17\ During 
2007, IRS completed milestones of the Filing and Payment Compliance 
(F&PC), a tax collection case analysis support system; MeF; CADE; and 
AMS. Our analysis of reported project costs and completion dates showed 
that 13 of the 14 associated project milestones that were scheduled for 
completion during this time were completed within 10 percent of cost 
estimates, and 11 of the 14 milestones were completed within 10 percent 
of schedule estimates. However, a milestone for CADE exceeded its 
planned schedule by 66 percent and experienced a 15 percent cost 
increase; another milestone for the same project incurred a 153 percent 
schedule delay, and a milestone for MeF experienced a 41 percent 
schedule delay (see fig. 1).
---------------------------------------------------------------------------
    \17\ Milestones represent different phases in IRS's project life 
cycle.



    IRS has taken steps to address our prior recommendations to improve 
its modernization management controls and capabilities. However, work 
remains to fully implement them. For example, in July 2005, we 
recommended that IRS fully revisit the vision and strategy for the BSM 
program and develop a new set of long-term goals, strategies, and plans 
consistent with the budgetary outlook and IRS's management 
capabilities.\18\ We also noted that the vision and strategy should 
include time frames for consolidating and retiring legacy systems. In 
response, IRS has developed a Modernization Vision and Strategy 
framework and supporting 5-year Enterprise Transition Plan. However, 
the agency has yet to develop long-term plans for completing BSM and 
consolidating and retiring legacy systems. We also recommended in 
February 2007 that IRS ensure that future BSM expenditure plans include 
a quantitative measure of progress in meeting scope expectations.\19\ 
We further recommended that, in developing this measure, IRS consider 
using earned value management since this is a proven technique required 
by the Office of Management and Budget for measuring cost, schedule, 
and functional performance against plans.\20\ While IRS has developed 
an approach to address our recommendation, it has not yet fully 
implemented it.
---------------------------------------------------------------------------
    \18\ GAO, Business Systems Modernization: Internal Revenue 
Service's Fiscal Year 2005 Expenditure Plan, GAO-05-774 (Washington, 
D.C.: July 22, 2005).
    \19\ GAO, Business Systems Modernization: Internal Revenue 
Service's Fiscal Year 2007 Expenditure Plan, GAO-07-247 (Washington, 
D.C.: Feb. 15, 2007).
    \20\ Earned value management is a project management tool that 
integrates the investment scope of work with schedule and cost elements 
for investment planning and control. This method compares the value of 
work accomplished during a given period with that of the work expected 
in the period. Differences between accomplishments and expectations are 
measured in both cost and schedule variances.
---------------------------------------------------------------------------
    Future BSM project releases continue to face significant risks and 
issues, which IRS is addressing. Specifically, the agency recently 
identified significant risks and issues with planned system deliveries 
of CADE and AMS and reported that maintaining alignment between the two 
systems will be a significant challenge and source of risk for the BSM 
program. IRS recognizes the potential impact of identified risks and 
issues on its ability to deliver projects within cost and schedule 
estimates and has developed mitigation strategies to address them. 
While mitigation strategies have been developed, the risks and 
challenges confronting future releases of CADE and AMS are nevertheless 
significant, and we will continue to monitor them and actions to 
address them.
    IRS also made further progress in addressing high-priority BSM 
program improvement initiatives during the past year. In September 
2007, IRS completed another cycle of initiatives and initiated a new 
cycle, which was scheduled to be completed at the end of March 2008. 
Initiatives that were addressed in the 6-month cycle ending in 
September 2007 included IT human capital, information security, and 
process improvements (e.g., developing and implementing standardized 
earned value management practices for major projects). IRS's program 
improvement process continues to be an effective means of regularly 
assessing, prioritizing, and incrementally addressing BSM issues and 
challenges. However, more work remains for the agency to fully address 
these issues and challenges.
    Finally, we recently reported that efforts to address human capital 
challenges continue, but more work remains. IRS developed an IT human 
capital strategy that addresses hiring critical personnel, employee 
training, leadership development, and workforce retention, and agency 
officials stated that they plan to undertake a number of human capital 
initiatives to support their human capital strategy, including 
conducting analyses of turnover rates and continuing efforts to replace 
key leaders lost to retirement. However, a specific plan with time 
frames for implementing these initiatives has not been developed. We 
recommended that IRS complete such a plan to help guide the agency's 
efforts in addressing its IT human capital gaps and measure progress in 
implementing them. IRS agreed with our recommendation and stated that 
it intends to develop a plan to implement its IT human capital 
strategy.


     IRS ESTIMATES THE COST OF IMPLEMENTING THE ECONOMIC STIMULUS 
 LEGISLATION MAY BE UP TO A TOTAL OF $767 MILLION AND EXPECTS DECLINES 
                       IN SOME TAXPAYER SERVICES

    The Economic Stimulus Act of 2008 is resulting in a significant 
workload increase not anticipated in the fiscal year 2008 budget. As 
part of the legislation, IRS received $202 million in a supplemental 
appropriation. However, because IRS could not find an alternative 
according to responsible officials, it has reallocated resources from 
enforcement to taxpayer service and is allowing some deterioration in 
telephone service.
    IRS will begin sending economic stimulus payments to more than 130 
million households in early May, after the current tax filing season, 
and is scheduled to be done by mid-July. These include an estimated 20 
million retirees and disabled veterans, and low-wage workers who 
usually are exempt from filing a tax return but will be eligible for 
stimulus payments. Taxpayers required to file a tax return must do so 
by April 15 in order to receive a stimulus payment by mid-July.\21\ 
People who are not required to file a tax return, but are doing so to 
receive a stimulus payment, are required to file an IRS Form 1040A by 
October 15, 2008.
---------------------------------------------------------------------------
    \21\ Taxpayers who are unable to meet the April 15 filing deadline 
can file a Form 4868, the automatic extension of time to file, which 
gives them until October 15 to submit a 2007 tax return.
---------------------------------------------------------------------------
    As part of the legislation, IRS received a supplemental 
appropriation of $202 million to help fund its costs for implementing 
the stimulus package. This funding will remain available until 
September 30, 2009. As shown in table 7, IRS plans to spend the bulk of 
the funding--$151.4 million--for Operations Support, most of it on 
postage for two mass mailings and on IT support. IRS also expects to 
spend $50.7 million for Taxpayer Services, including $26.2 million for 
staffing and overtime for telephone assistors. IRS is expecting 2.4 
million additional telephone calls in March and April with questions 
for IRS assistors about the economic stimulus legislation. These calls 
are in addition to the more than 14 million calls typically answered by 
IRS assistors between January and mid-April.

                TABLE 7.--IRS'S ESTIMATED COSTS OF IMPLEMENTING THE ECONOMIC STIMULUS LEGISLATION
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                                      Revised
                                                                     2008 goal       estimate         Amount
----------------------------------------------------------------------------------------------------------------
Supplemental appropriation:
    Operations Support:
        Postage.................................................  ..............  ..............         $90.613
        IT support..............................................  ..............  ..............         $43.965
        Telecommunications......................................  ..............  ..............          $8.370
        Printing................................................  ..............  ..............          $6.767
        Communications plan.....................................  ..............  ..............          $1.700
                                                                 -----------------------------------------------
          Total for Operations Support..........................  ..............  ..............        $151.415
Taxpayer Services: Additional staffing/overtime.................  ..............  ..............         $50.720
                                                                 -----------------------------------------------
      Total supplemental funding................................  ..............  ..............        $202.135
                                                                 ===============================================
IRS estimates of foregone revenue from shifting Automated
 Collection System (ACS) staff: \1\
    Wage and Investment (W&I)...................................  ..............  ..............        $191.728
    Small Business/Self-Employed (SB/SE)........................  ..............  ..............        $373.065
                                                                 -----------------------------------------------
      Total foregone revenue (up to)............................  ..............  ..............        $564.793
                                                                 -----------------------------------------------
      Total (up to).............................................  ..............  ..............        $766.928
                                                                 ===============================================
Taxpayer service: Assistor level of service (percent)...........              82         ( \2\ )         ( \3\ )
----------------------------------------------------------------------------------------------------------------
\1\ Revised as of early April 2008.
\2\ As low as 74.
\3\ Reduction--Down 8 percentage points.

Source: GAO analysis of IRS and Treasury data.

    To help meet the increased telephone demand, IRS is shifting about 
half of its over 2,000 Automated Collection System (ACS) telephone 
staff from collecting delinquent taxes to answering economic stimulus 
telephone calls from March through May.\22\ To accommodate this shift, 
IRS stopped sending out some ACS-generated notices, such as notices of 
levy, several weeks ago.\23\ According to IRS officials, it takes about 
3 to 4 weeks before this adjustment in ACS-generated notices affects 
the ACS workload. IRS originally estimated that the revenue foregone by 
shifting ACS staff to be up to $681 million. However, according to IRS 
officials, in early April, IRS revised its foregone revenue estimate 
down to $565 million, shown in table 7, largely because of lower-than-
expected demand for telephone assistance in March.\24\
---------------------------------------------------------------------------
    \22\ When IRS has completed sending its initial series of notices 
to tax debtors, it assigns the debts to its collections programs, such 
as ACS. ACS is an automated telephone-based system designed to call tax 
debtors. ACS staffers then attempt to talk with tax debtors to try to 
collect outstanding tax debt. IRS estimated there are about 1,200 ACS 
staff in its W&I division and about 1,100 in its SB/SE division.
    \23\ IRS suspended notices sent by ACS examiners, such as final 
notices before enforcement, collection due process notices, and notices 
of levy.
    \24\ IRS arrived at the estimates by taking a 3-year average of 
dollars collected by closing ACS cases for both its W&I and SB/SE 
divisions. IRS determined the projected foregone revenue by multiplying 
the average dollars collected per ACS staff by the projected lost case 
closures. IRS plans to minimize the use of SB/SE staff because the 
revenue collected by SB/SE is greater than for W&I.
---------------------------------------------------------------------------
    According to IRS officials, IRS's priority is to respond to 
taxpayers' questions about the stimulus program; therefore, the 
officials are monitoring call volume and adjusting the number of ACS 
staff answering telephones accordingly. When call volume is low, ACS 
staff work on outstanding ACS collection cases. However, IRS officials 
stated that this work does not produce the same revenue as the ACS-
generated notices, particularly revenue generated from notices of levy. 
When IRS adjusts the volume of ACS-generated notices, it takes several 
weeks before that adjustment affects ACS workload. IRS officials do not 
want to resume sending ACS-generated notices until they are sure ACS 
staffers are available to handle the resulting workload.
    Should the lower-than-expected call volume continue, IRS may have 
an opportunity to shift the ACS staff back to their most productive 
collection work. This could further reduce the revenue foregone from 
using ACS staff to answer stimulus-related telephone calls. To date, 
IRS has not reduced its projections for future stimulus-related call 
volume. If the projections are reduced, IRS may be able to resume 
sending out at least some ACS-generated notices.
    According to IRS officials, IRS considered alternatives to shifting 
ACS staff, including contracting out, using other IRS staff, or using 
Social Security Administration or other Federal staff, but decided the 
alternatives were not feasible. For example, contracting out was not 
deemed feasible because of insufficient time to negotiate the contract 
and conduct background checks and training.
    Another cost--although not measured in dollars--is the decline in 
telephone service shown in table 7. Because of the increased call 
volume, IRS expects its assistor level of service to drop from 82 
percent (the 2008 goal) to as low as 74 percent--the lowest level since 
2002. IRS is already experiencing some declines in telephone service. 
As of March 29, the level of service had dropped to 80 percent, 
taxpayers were waiting a minute and a half longer than last year, and 
they were hanging up 43 percent more often while waiting to speak to an 
assistor. Between March 3 and March 29, IRS assistors answered over 
572,000 stimulus-related calls.\25\ IRS expects call volume to increase 
rapidly in upcoming weeks as taxpayers receive their stimulus notices 
in the mail.
---------------------------------------------------------------------------
    \25\ According to IRS officials, before March 3, taxpayers with 
stimulus-related calls were transferred to an automated message, which 
told taxpayers that additional information would be forthcoming. IRS 
estimated that the number of these calls frequently ranged from 20,000 
to 60,000 per day. IRS assistors started answering stimulus-related 
questions on March 3, and IRS established its dedicated telephone line 
for stimulus-related calls on March 14.
---------------------------------------------------------------------------
    Because IRS is in the early stages of implementing the stimulus 
legislation, IRS officials do not have much information about the 
actual costs. Through March, IRS estimates that it has spent almost 
$103 million, mostly for postage.

                            AGENCY COMMENTS

    In commenting on a draft of our earlier report on the fiscal year 
2009 budget request and 2008 tax filing season, IRS officials said 
that, because of the short time frame for our report, they did not have 
time to fully analyze our recommendation and, therefore, were unable to 
respond at the time. They provided technical comments at that time and 
again for this statement, and we made those changes where appropriate. 
We have agreed to meet with IRS to further discuss the ROI 
recommendation.
    Mr. Chairman, this concludes my prepared statement. Mr. Powner and 
I would be happy to respond to questions that you or other members of 
the subcommittee may have at this time.

          PREPARED STATEMENTS OF OMB WATCH AND COLLEEN KELLEY

    Senator Durbin. In addition, written statements have been 
received from OMB Watch and Colleen Kelley, President of the 
National Treasury Employees Union, on behalf of the employees 
of the Internal Revenue Service. Without objection, these 
materials will be made a part of the permanent record.
    [The statements follow:]

 Prepared Statement of Colleen M. Kelley, National President, National 
                        Treasury Employees Union

    Chairman Durbin, Ranking Member Brownback, and distinguished 
members of the subcommittee, I would like to thank you for allowing me 
to provide comments on the administration's fiscal year 2009 budget 
request for the Internal Revenue Service (IRS). As president of the 
National Treasury Employees Union (NTEU), I have the honor of 
representing over 150,000 Federal workers in 31 agencies, including the 
men and women at the IRS.

                  IRS FISCAL YEAR 2009 BUDGET REQUEST

    Mr. Chairman, as you know, the IRS budget forms the foundation for 
what the IRS can provide to taxpayers in terms of customer service and 
how the agency can best fulfill its tax enforcement mission. Without an 
adequate budget, the IRS cannot expect to continue providing taxpayers 
with top quality service and will be hampered in its effort to enhance 
taxpayer compliance and close the tax gap.
    While acknowledging that IRS employees continue to provide world 
class customer service and are more efficient than ever in collecting 
taxes and enforcing tax law, the administration continues to put forth 
insufficient and unrealistic budget requests that fail to allow the 
service to meet its customer service and enforcement challenges.
    Staffing levels are dramatically below 1995 levels.
    The decline in IRS personnel, particularly enforcement staff, can 
be attributed to unrealistic budget requests, which since 2003, have 
contemplated internally generated savings or ``efficiency savings'' to 
help fund proposed increased staffing for enforcement. For fiscal year 
2009, the budget request identifies ``efficiency savings'' of more than 
$94 million at the cost of almost 976 FTEs. If, as sometimes has been 
the case in previous years, IRS fails to realize all expected savings 
then the funds available for new enforcement personnel would be further 
reduced.
    And although it's widely recognized that additional funding for 
enforcement provides a great return on the investment, the IRS has 
repeatedly told Congress that the IRS does not need any additional 
funding above the President' budget request.
    Employee productivity is not the issue. Despite the significant 
decline in enforcement staff over the past 10 years, enforcement 
revenue has increased significantly, reaching $59.2 billion in 2007, up 
from $48.7 billion in 2006 and an increase of $46 billion since 2000. 
The $59.2 billion in collections in 2007 represents a 5.6 to 1 return 
on investment for all IRS activities. In addition, earlier this year 
the IRS Data Book for 2007 was released which demonstrated that the IRS 
is one of the most efficient tax collection systems in the world, 
spending only 40 cents to collect $100.
    Yet, between 1995 and 2007, the total number of employees has 
shrunk from 114,064 to 86,638. Even more alarming is that during that 
period, revenue officers and revenue agents--two groups critical to 
reducing the tax gap--have shrunk by 33 and 20 percent respectively. 
Revenue officers went from 8,139 to 5,468 and revenue agents fell from 
16,078 to 13,026. These drastic cuts have come at a time when the IRS 
workload has increased dramatically. According to IRS's own annual 
reports and data, taxpayers filed 114.6 million returns in 1995. After 
a steady annual climb, 11 years later, the Service saw 134.4 million 
returns filed. In addition, between 1997 and 2007, the number of 
individual tax returns with $100,000 in reported income, which are 
generally more complex returns, increased by 103 percent.
    Unfortunately, instead of recognizing that the dramatic cuts to the 
IRS workforce are straining the ability of IRS employees to handle the 
increasing workload, the IRS has continued to reduce its workforce. 
Further exacerbating the dire staffing situation at the Service is the 
aging of the IRS workforce. Approximately 4,000 of its employees are 
retiring annually presenting the Service with the difficult challenge 
of replacing a large portion of its workforce each year and the 
institutional knowledge they take with them. These retirements of some 
of the Services' most experienced personnel will only further stress 
the current IRS workforce already straining under a rising workload.
    Amazingly, IRS efforts to reduce the overall workforce have 
targeted some of the Service's most productive employees. These include 
the recent re-organization of the Estate and Gift Tax Program which 
sought the elimination of 157 of the agency's 345 estate and gift tax 
attorneys--almost half of the agency's estate tax lawyers--who audit 
some of the wealthiest Americans. The Service pursued this drastic 
course of action despite internal data showing that estate and gift 
attorneys are among the most productive enforcement personnel at the 
IRS, collecting $2,200 in taxes for each hour of work. It is difficult 
to understand why the IRS sought the elimination of key workforce 
positions in an area that could produce significant revenue to the 
general treasury.
    In addition, the Service continues to move forward with its plan to 
close 5 of its 10 paper tax return submission facilities by 2011. The 
IRS originally sought the closings of the five paper return submission 
centers due to the rise in the use of electronic filing (e-filing) and 
in order to comply with the IRS Restructuring and Reform Act of 1998 
(RRA 98) which established a goal for the IRS to have 80 percent of 
Federal tax and information returns filed electronically by 2007. But 
the IRS recently reported that in 2007 just 57 percent of Federal tax 
returns were filed electronically and has previously acknowledged that 
it is getting harder to convert additional taxpayers to e-filing as 
those that might convert most readily have already done so.
    The continued slow migration of taxpayers to e-filing recently 
caused the IRS Oversight Board to call on Congress to extend the 80 
percent deadline to 2012 in its recent report to Congress on e-filing.
    In addition, while the IRS has stated that it will achieve millions 
of dollars in cost savings as a result of the paper submission 
consolidation effort, an August 2007 report by the Treasury Inspector 
General for Tax Administration (TIGTA) found that the agency's business 
decision to consolidate sites did not even include a cost-benefit 
analysis (TIGTA Report Number: 2007-40-165). Furthermore, the report 
found that the IRS had not adequately updated or monitored financial 
information on the personnel costs of consolidations and had included 
savings not attributable to site consolidation in some of its analyses. 
What is most disturbing is that while the IRS acknowledged some of the 
assumptions used to determine the consolidation plan may have changed, 
they refused to complete a cost-benefit analysis to determine if the 
existing plan is optimal or if alternatives need to be considered.
    Mr. Chairman, while overall use of e-filing may be on the rise, it 
is clear that the number of taxpayers opting to use this type of return 
is not increasing as rapidly as the IRS had originally projected. 
Combined with the fact that the IRS consolidation strategy rests on an 
incomplete business plan which did not include any type of cost-benefit 
analysis, NTEU believes that the IRS should immediately postpone 
further site consolidations until a comprehensive cost-benefit analysis 
can be completed to ensure that the existing plan is optimal in terms 
of cost savings and benefits.
    It is clear that drastic reductions in some of the agency's most 
productive tax law enforcement employees directly contradict the 
Service's stated enforcement priority to discourage and deter non-
compliance. In addition, we believe these staffing cuts have greatly 
undermined agency efforts to close the tax gap which the IRS recently 
estimated at $345 billion. As Nina Olson, the National Taxpayer 
Advocate noted, this amounts to a per-taxpayer ``surtax'' of some 
$2,000 per year to subsidize noncompliance. And while the agency has 
made small inroads and the overall compliance rate through the 
voluntary compliance system remains high, much more can and should be 
done. NTEU believes that in order to close the tax gap and handle a 
rising workload, the IRS needs additional employees on the frontlines 
of tax compliance and customer service. In addition, we believe 
Congress should establish a dedicated funding stream to provide 
adequate resources for those employees.

                         NTEU STAFFING PROPOSAL

    In order to address the staffing shortage at the IRS, NTEU believes 
the workforce should be gradually increased to its pre-1996 levels. 
Specifically, we support a 3 percent annual net increase in staffing 
(roughly 2,600 positions per year) over a 5-year period to gradually 
rebuild the depleted IRS workforce to its pre-1996 levels from its 
current level of 86,638. Because it takes time and careful management 
to hire, train, and deploy qualified professional staff, consistent but 
modest annual increases are necessary. A similar idea was proposed by 
former IRS Commissioner Charles Rossotti in a 2002 report to the IRS 
Oversight Board. In the report, Rossotti quantified the workload gap in 
non-compliance, that is, the number of cases that should have been, but 
could not be acted upon because of resource limitations. Rossotti 
pointed out that in the area of known tax debts, assigning additional 
employees to collection work could bring in roughly $30 for every $1 
spent. The Rossotti report recognized the importance of increased IRS 
staffing noting that due to the continued growth in IRS' workload 
(averaging about 1.5 to 2 percent per year) and the large accumulated 
increase in work that should be done but could not be, even aggressive 
productivity growth could not possibly close the compliance gap. 
Rossotti also recognized that for this approach to work, the budget 
must provide for a net increase in staffing on a sustained yearly basis 
and not take a ``one time approach.''
    Adding staff to handle an increasing workload at the IRS is not a 
new concept. In its 2001 budget request, IRS asked for funding for the 
Staffing Tax Administration for Balance and Equity program (STABLE), an 
initiative aimed at restoring IRS staffing to mid-1990s levels and 
strengthening the Service's tax compliance and customer service 
functions. The STABLE initiative envisioned hiring nearly 4,000 new 
employees to help increase compliance and improve customer service. The 
proposal sought to boost staff in Field Offices, where IRS employees 
provide direct, in-person service to taxpayers, and Service Center/Call 
Sites, where service is typically provided via telephone and 
correspondence. Hiring requirements for the Field Offices was to be 
determined based on projected workload in the office's geographic area, 
and existing staff capabilities. Conversely, Service Center/Call Site 
workload would be planned on a nationwide basis due to the nature of 
the work, and staffing allocations based upon physical space and local 
labor market conditions around the center in question.
    Although such a staffing initiative would require a substantial 
financial commitment, the potential for increasing revenues, enhancing 
compliance and shrinking the tax gap makes it very sound budget policy. 
One option for funding a new staffing initiative would be to allow the 
IRS to hire personnel off-budget, or outside of the ordinary budget 
process. This is not unprecedented. In fact, Congress took exactly the 
same approach to funding in 1994 when Congress provided funding for the 
administration's IRS Tax Compliance Initiative which sought the 
addition of 5,000 compliance positions for the IRS. The initiative was 
expected to generate in excess of $9 billion in new revenue over 5 
years while spending only about $2 billion during the same period. 
Because of the initiative's potential to dramatically increase Federal 
revenue, spending for the positions was not considered in calculating 
appropriations that must come within annual caps.
    A second option for providing funding to hire additional IRS 
personnel outside the ordinary budget process could be to allow IRS to 
retain a small portion of the revenue it collects. The statute that 
gives the IRS the authority to use private collection companies to 
collect taxes allows 25 percent of collected revenue to be returned to 
the companies as payment, thereby circumventing the appropriations 
process altogether. Clearly, there is nothing magical about revenues 
collected by private collection companies. If those revenues can be 
dedicated directly to contract payments, there is no reason some small 
portion of other revenues collected by the IRS could not be dedicated 
to funding additional staff positions to strengthen enforcement.
    While NTEU agrees with IRS' stated goal of enhancing tax compliance 
and enforcement, we don't agree with the approach of sacrificing 
taxpayer service in order to pay for additional compliance efforts. 
That is why we were disappointed to see that the President's proposed 
budget calls for a $31 million cut in funding for Taxpayer Assistance 
Center (TACs) at a cost of 262 FTEs. NTEU believes providing quality 
services to taxpayers is an important part of any overall strategy to 
improve compliance and that reducing the number of employees dedicated 
to assisting taxpayers meet their obligations will only hurt those 
efforts. It is clear that IRS employees are continuing to provide 
quality customer service to American taxpayers. 2007 year end data from 
the IRS shows that IRS' customer assistance centers met the 82 percent 
level of service goal, with an accuracy rate of 91 percent for tax law 
questions. And while these numbers show that employees providing 
taxpayer services are helping taxpayers understand and meet their tax 
responsibilities, more can and should be done.
    Mr. Chairman, in order to continue to make improvements in taxpayer 
services while handling a growing workload and increasing collections, 
it is imperative to reverse the severe cuts in IRS staffing levels and 
begin providing adequate resources to meet these challenges. With the 
future workload only expected to continue to rise, the IRS will be 
under a great deal of pressure to improve customer service standards 
while simultaneously enforcing the Nation's tax laws. NTEU strongly 
believes that providing additional staffing resources would permit IRS 
to meet the rising workload level, stabilize and strengthen tax 
compliance and customer service programs and allow the Service to 
address the tax gap in a serious and meaningful way.

                         PRIVATE TAX COLLECTION

    Mr. Chairman, as stated previously, if provided the necessary 
resources, IRS employees have the expertise and knowledge to ensure 
taxpayers are complying with their tax obligations. That is why NTEU 
continues to strongly oppose the administration's private tax 
collection program. NTEU believes this misguided proposal is a waste of 
taxpayer's dollars, invites overly aggressive collection techniques, 
jeopardizes the financial privacy of American taxpayers and may 
ultimately serve to undermine efforts to close the tax gap.
    NTEU strongly believes the collection of taxes is an inherently 
governmental function that should be restricted to properly trained and 
proficient IRS personnel. When supported with the tools and resources 
they need to do their jobs, there is no one who is more reliable and 
who can do the work of the IRS better than IRS employees.
    As you know, in September 2006, the IRS began turning over 
delinquent taxpayer accounts to private collection agencies (PCAs) who 
are permitted to keep up to 24 percent of the money they collect. NTEU 
strongly believes the collection of taxes is an inherently governmental 
function that should be restricted to properly trained and proficient 
IRS personnel.
    NTEU believes this misguided proposal is a waste of taxpayer's 
dollars, invites overly aggressive collection techniques, jeopardizes 
the financial privacy of American taxpayers and may ultimately serve to 
undermine efforts to close the tax gap.
    According to the IRS, in fiscal year 2007, the PCAs brought in just 
$32 million in gross revenue, far below original projections of up to 
$65 million. After deducting commission payments to the PCAs, the true 
net revenue from PCA (non-IRS) collection activity was just $20 
million. Therefore, after spending $71 million in start up and ongoing 
maintenance costs through the end of fiscal year 2007, the IRS private 
tax collection program lost more than $50 million.
    According to Nina Olson, the National Taxpayer Advocate, the dismal 
performance of the private collectors is forcing the IRS to downwardly 
revise its original 10-year projections for the program. For fiscal 
year 2008, the IRS is now projecting gross revenues of just $23 
million, despite projections as recently as last May indicating the 
program would bring in up to $127 million. In addition, despite 
assurances that the program would recover all start-up and maintenance 
costs by April of this year, the IRS is now projecting the program will 
not break even until late fiscal year 2010.
    NTEU also believes that sky high commission payments to the private 
contractors for work on the easiest to collect cases is unjustified and 
unnecessary. Under current contracts, private collection firms are 
eligible to retain 21 percent to 24 percent of what they collect. The 
legislation authorizing the program actually allows PCAs to retain up 
to 25 percent of amounts collected. These commission rates were never 
put up for competition. Before the initial bid solicitations went out, 
the IRS set commission rates at 21 to 24 percent of the revenue 
collected by contractors, denying bidders an opportunity to make offers 
on terms that would have resulted in the IRS getting a greater share of 
the collected revenue. Consequently, one of the companies that lost its 
bid for a contract filed a protest with GAO and noted in its bid 
protest that ``offerors were given no credit for proposing lower fees 
than the ``target' percentages recommended by the IRS.''
    The problem of excessive commission rates was recently addressed by 
Congress in legislation overhauling the Department of Education's 
student loan program, which the IRS has consistently held up as a model 
for the IRS private collection program. Amid charges that student aid 
lenders have engaged in abusive and potentially illegal collection 
tactics including charging excessively high collection fees, coercing 
consumers into payment plans they could not afford and misrepresenting 
themselves as Department of Education employees, the House and Senate 
approved H.R. 2669, the ``Higher Education Access Act of 2007,'' which 
lowers from 23 percent to 16 percent the amount of recovered money that 
private guaranty agencies contracted by the Government can retain on 
defaulted loans.
    Mr. Chairman, in addition to being fiscally unsound, the idea of 
allowing PCAs to collect tax debt on a commission basis also flies in 
the face of the tenets of the IRS Restructuring and Reform Act of 1998 
(RRA 98) which specifically prevents employees or supervisors at the 
IRS from being evaluated on the amount of collections they bring in. 
But now, the IRS has agreed to pay PCAs out of their tax collection 
proceeds, which will clearly encourage overly aggressive tax collection 
techniques, the exact dynamic the 1998 law sought to avoid.
    The fear that allowing PCAs to collect tax debt on a commission 
basis would lead to contractor abuse was realized when the IRS recently 
confirmed that the agency had received more than five dozen taxpayer 
complaints against the PCAs, including violations of the taxpayer 
privacy laws under Code section 6103. At least one of those complaints 
was confirmed by an IRS Complaint Panel to be a serious violation of 
law. In addition, penalties totaling $10,000 have been imposed by the 
IRS on the PCAs for taxpayer violations. In one instance, private 
collectors made 150 calls to the elderly parents of a taxpayer after 
the collection agency was notified he was no longer at that address. 
And one of the three private contractors was dropped by the IRS for 
dubious practices despite the Service's previous assurance that its 
oversight would prevent abuse.
    Mr. Chairman, NTEU is not alone in our opposition to the private 
tax collection program. Opposition to the IRS tax debt collection 
program has also been voiced by a growing number of major public 
interest groups, tax experts, two former IRS Commissioners as well as 
the National Taxpayer Advocacy Panel, whose members are appointed by 
the IRS and the Treasury Department. In addition, the National Taxpayer 
Advocate, an independent official within the IRS previously identified 
the IRS private tax collection initiative as one of the most serious 
problems facing taxpayers and recently renewed her prior call for 
Congress to immediately repeal the IRS' authority to outsource tax 
collection work to private debt collectors.
    Opposition to the program has also been growing within Congress. 
Since granting IRS the authority to use PCAs in the American Jobs 
Creation Act of 2004, the House of Representatives, with bi-partisan 
support, has twice passed language prohibiting the IRS from moving 
forward with its private collection initiative. In addition, last 
session, the House overwhelmingly approved two separate tax bills (H.R. 
3056, the ``Tax Collection Responsibility Act of 2007'' & H.R. 3996, 
the ``Temporary Tax Relief Act of 2007'') that contain language that 
would repeal IRS' authority to use private debt collectors to pursue 
tax debts.
    In the Senate, stand alone legislation (S. 335) introduced by 
Senator Byron Dorgan (D-ND) that would force the IRS to immediately and 
permanently suspend its plan to outsource part of its tax debt 
collection responsibilities to PCAs and prohibit the use of any IRS 
funds for that purpose has 24 co-sponsors.
    Mr. Chairman, instead of rushing to privatize tax collection 
functions which jeopardizes taxpayer information, reduces potential 
revenue for the Federal Government and undermines efforts to close the 
tax gap, NTEU believes the IRS should increase compliance staffing 
levels at the agency to ensure that the collection of taxes is 
restricted to properly trained and proficient IRS personnel.
    The IRS already has a significant collection infrastructure with 
thousands of trained employees, including 14 Automated Collection 
System (ACS) sites which allow the IRS to contact taxpayers by 
telephone and collect delinquent taxes. The ACS function is a critical 
Collection operation, collecting nearly $1.49 million per employee per 
year. The IRS itself has analogized the use of private collectors to 
the ACS, where IRS collection representatives interact with taxpayers 
on the telephone. But unlike the private collectors, ACS personnel are 
able to analyze financial statement information, research assets, enter 
into installment agreements, make currently not collectible 
determinations, and can take lien and/or levy enforcement actions. ACS 
employees also receive training that is far more comprehensive and 
rigorous than that of the private collectors. In addition, these 
employees undergo mandatory annual training on topics such as 
confidentiality and privacy of taxpayer information, ethics awareness, 
taxpayer rights and computer security.
    Unfortunately, inadequate staffing at ACS sites has prevented the 
IRS from using its current systems to proactively contact taxpayers by 
telephone to resolve delinquent accounts. The need for the IRS to 
expand ACS' use of outbound calls has been recognized by IRS management 
and at least two recent internal IRS study groups have recommended 
making more outbound calls as a way to make the ACS operation more 
effective and efficient.
    Mr. Chairman, according to the IRS they will spend $7.65 million to 
run the private collection program in fiscal year 2008. NTEU believes 
that instead of continuing to expend valuable IRS resources on this 
failed program, this $7.65 million should instead be used to fund 
roughly 102 additional ACS employees that could return more than $151 
million to the Treasury annually. By comparison, the IRS is now 
projecting the PCAs to bring in just $23 million in gross revenue in 
fiscal year 2008, far less than its original estimate of up to $127 
million.
    NTEU believes that increasing the number of ACS personnel would 
allow the IRS to maximize its ability to proactively resolve delinquent 
accounts by contacting taxpayers directly. This would also help ensure 
that the high level of customer service to those taxpayers who call the 
ACS seeking account resolution is preserved. The IRS has acknowledged 
that ACS employees are already performing admirably noting that in 
2006, ACS customer service and quality ranged between 89.5 to 99.5 
percent (pg. 54--IRS response to Olson 2006 Report to Congress). These 
exceptional ratings are all the more impressive when you consider ACS 
employees generally work on much more complex and often contentious 
cases than those being worked by the private collectors and that the 
total number of cases worked by ACS employees dwarfs those worked by 
the private collectors.
    Mr. Chairman, NTEU understands and commends efforts to ensure that 
all taxpayers pay their fair share of taxes. Without a doubt, rank and 
file IRS employees are committed to achieving this goal in the most 
cost-effective manner while providing a high level of customer service 
to American taxpayers. But the facts make clear that the use of private 
tax collection companies is not in the best interest of American 
taxpayers, could potentially undermine future efforts to close the tax 
gap, and should be terminated immediately.
    A number of other issues important to NTEU members are often 
addressed in the FSGG Appropriations bill and I would like to address 
some of them here.

                               PAY RAISE

    The Federal Employees Pay Comparability Act (FEPCA), enacted in 
1990 to close the gap between Federal and private sector pay, has never 
been fully implemented. As a result, there is now a 23 percent 
disparity between Federal employees and their private sector 
counterparts. Under the President's plan, Federal employees will fall 
even further behind the private sector.
    The administration's budget proposed a 2.9 percent pay raise for 
Federal workers next year. This not only fails to recognize the 
important role of our Nation's workforce, it is below the 3.4 percent 
pay raise the President recommended for the military. The 
administration's recommendation ignores the essential role of Federal 
employees in protecting our Nation at the borders, in the domestic and 
international movement of money, in public health, in nuclear security, 
and in the collection of revenue among others. Further, it ignores the 
longstanding principle of pay parity, the recognition that Federal 
civil servants and their brothers and sisters in the military, work 
side by side and should receive an equal level of pay increase. 
Importantly, pay parity was just reaffirmed on March 13, 2008, in House 
of Representatives when it passed H. Con Res. 312, the fiscal year 2009 
budget resolution. I urge the subcommittee to report its bill in 
keeping with this pay parity principle.
    For most of the last 20 years, Government employees in civil 
service and military personnel have received the same level of pay 
increase. Last year, both the military and Federal civil servants 
received a 3.5 percent pay raise in the final fiscal year 2008 bills. 
That amounted to the annual raise in the Employment Cost Index (ECI) 
plus one-half percent, the standard pay figure received in every year 
of the current administration with the exception of 2007. For 2009, the 
current raise in the ECI as calculated by the Department of Labor is 
3.4 percent, and an extra one-half percent equals 3.9 percent. NTEU 
urges the subcommittee to follow the precedent of ECI plus one-half 
percent and report legislation for fiscal year 2009 providing a 3.9 
percent raise to Federal employees. We will be working with the 
appropriate committees to enact a military raise of the same level.
SEC Pay
    NTEU represents the employees of the Securities and Exchange 
Commission (SEC). We believe that the SEC must be provided with 
adequate resources to ensure that its performance based pay system can 
be a viable tool for employee retention and recruitment. While there 
have been numerous problems with this pay system, adequate funding is 
essential. From fiscal year 2002 to fiscal year 2005, the SEC budget 
included a 3 percent increase over current compensation levels to fund 
the performance pay system. However, for the past 2 years, the SEC's 
budget has included only a 2 percent increase. This year, the President 
has only requested a 1.5 percent increase. The continuing performance 
pay funding crisis has hamstrung SEC managers' ability to provide 
meaningful and appropriate performance based salary increases to their 
employees. As budget shortfalls have shifted the system from being 
fundamentally performance based, some senior managers at the SEC have 
sent notices to their employees stating that they are being given lower 
ratings not for performance reasons but because of budgetary 
limitations. This state of affairs is having severe and negative 
impacts on employee morale and retention at SEC, contrary to the stated 
purpose of the performance pay system. NTEU would ask for an additional 
$5 million in funding for the SEC for this purpose.

                     OPM PRESCRIPTION DRUG SUBSIDY

    Mr. Chairman and members of the subcommittee, it is NTEU's position 
that OPM should apply for the drug subsidy to which it is entitled 
under the Medicare Prescription Drug, Improvement, and Modernization 
Act of 2003 (Public Law 108-173). Under this law, which created the 
Medicare Part D prescription drug program, the Government, as an 
employer, is eligible to receive a subsidy payment made available to 
all employers that provide prescription drug benefits as generous as 
the Medicare program. The ``Medicare employer payment'' was designed to 
encourage employers to retain such benefits.
    According to GAO, if OPM had applied for the subsidy, it would have 
lowered the average 2006 FEHBP premium by 2.6 percent. Some of the 
individual health plans that serve a high number of retirees could have 
realized a slowdown in premium growth by as much as 3.5 to 4 percent. 
These savings could have been passed on to keep the enrollee portion of 
the premium down. Unfortunately, estimates are that OPM has have left 
more than $1 billion on the table by forgoing the subsidy. NTEU would 
support legislative language require OPM to apply for the subsidy, 
which would help keep FEHBP costs down for millions of Federal 
employees and their families who are enrolled.

                            CONTRACTING OUT

    Another issue pertinent to the subcommittee's jurisdiction is the 
contracting out of Government positions and responsibilities. I want to 
commend and thank the subcommittee for incorporating important 
privatization language in its portion of the fiscal year 2008 Omnibus 
Appropriations bill to help level the playing field for Federal 
employees.
    Unfortunately, the administration's fiscal year 2009 budget request 
has called for the repeal of these important provisions. We strongly 
urge Congress to oppose any efforts to repeal these important 
provisions that allow Federal employees the ability to fairly compete 
with the private sector.
    In addition, NTEU strongly supports making Government-wide a number 
of additional contracting out reforms included in the fiscal year 2008 
Defense Authorization Bill which currently only apply to the Department 
of Defense. These include provisions that would encourage 
``insourcing'' by providing employees Government-wide the opportunity 
to compete for new work or work currently performed by contractors, 
allow Government employees to acquire new work by allowing agencies to 
bring work in-house without going through the A-76 process, eliminate 
the automatic recompetition requirement which previously only applied 
to Federal employees and not contractor employees, and establishment of 
a contractor inventory in every Government agency to track the cost and 
performance of every service contract to help identify contract work 
that could be converted to performance by Federal employees.
    By making these important contracting out reforms applicable to the 
entire Federal workforce, Congress can help bring fairness and 
accountability to the entire competitive sourcing process. NTEU firmly 
believes that Federal employees are the best value for taxpayers' 
dollars and they deserve a fair and level playing field on which to 
demonstrate their effectiveness and efficiency to the White House, 
Congress, and the American public.

                               CONCLUSION

    Mr. Chairman, while Federal workers, and in particular IRS 
employees, continue to get mixed signals regarding their value to this 
administration, they remain committed to serving the American public to 
the best of their abilities. With the expected surge in Federal 
retirements in the coming years, it is imperative that the Federal 
Government do all it can to retain the hundreds of thousands of 
talented public servants who have the knowledge and expertise to 
continue contributing to the Federal workforce while at the same time 
preparing to compete for the best and brightest of the young new 
workers.
    Therefore, NTEU believes it is imperative that the administration 
reverse many of its policies that have devalued the role of Federal 
employees and the work that they do including the failure to pay 
competitive salaries and the constant focus on downsizing and 
outsourcing. These misguided policies have reduced morale of Federal 
employees Government-wide and have put the Federal Government at a 
disadvantage when it comes to attracting, developing and retaining 
qualified employees.
                                 ______
                                 
                    Prepared Statement of OMB Watch

    OMB Watch would like to submit the report, ``Bridging the Tax Gap: 
The Case for Increasing the IRS Budget,'' into the record for the 
Committee on Appropriations Subcommittee on Financial Services and 
General Government hearing on the IRS fiscal year 2009 budget on April 
16, 2008.
    OMB Watch supports efforts by the IRS to close the so-called ``tax 
gap,'' and believes increased funding of the IRS budget is a necessary 
condition to achieving this goal. The $4.6 billion appropriated to the 
IRS's enforcement budget in fiscal year 2008 is less than the 1995 IRS 
enforcement budget (in inflation-adjusted terms). As the enforcement 
budget was cut, the IRS saw the number of tax returns filed increase 11 
percent from 205 million in 1995 to 228 million in 2006 (the last year 
for which such data are available).
    In addition to the amount of resources available to the IRS, also 
of concern are the means by which the IRS enforces tax laws. The use of 
private tax collectors not only exposes taxpayer data to private firms, 
but when compared to Federal tax collectors, private collectors are 
extremely inefficient. Use of Federal employees for tax collection 
results in a 13:1 return-on-investment (ROI) ratio ($13 collected for 
each dollar spent), while private tax collectors achieve an ROI of 
4.5:1. That the IRS would continue this program represents an egregious 
mismanagement of tax collection resources.
    OMB Watch also believes better targeting of audits and the types of 
audits performed would enhance the IRS's ability to close the tax gap. 
Although the overall audit rate has seen a slight increase in recent 
years (a positive development, to be sure), that increase has been 
largely constituted of increases in correspondence audits. Compared to 
face-to-face audits, correspondence audits result in lower revenue 
yields. Whereas correspondence audits of individuals earning over 
$100,000 per year result in about a $32,000 increase in identified tax 
liability, face-to-face audits yield, on average, about $55,000.
    Additionally, the IRS has been spending too much time auditing low-
income Americans. Forty percent of all audits performed in 2006 were of 
taxpayers claiming the EITC, resulting in a 2.25 percent audit rate for 
EITC claimants--more than double the 1 percent rate for all taxpayers. 
With an average yield of $2,895, EITC-return audits have the lowest 
rate of return of any audit conducted by the IRS. That so many IRS 
resources are devoted to these low-yield audits underscore the depth of 
inefficient enforcement practices.
    Instead of employing this punitive approach to closing the tax gap 
through EITC compliance, the IRS should increase resources devoted 
Taxpayer Assistance Centers (TAC) to increase EITC return accuracy. 
TAC-prepared EITC returns reduce overpayments by $640-$1,300. However, 
the number of TAC-prepared returns have been declining as TACs 
experience staffing shortages. By increasing resources devoted to TACs, 
the IRS would not only reduce the tax gap, but would expand much-needed 
services to low-income taxpayers.
    These important tax enforcement issues, and others, are explored in 
greater detail the report we are submitting. We hope this will help 
raise awareness of the importance of addressing enforcement issues at 
the IRS and that the committee will use the findings of this report in 
formulating IRS legislation.

                                                      January 2008.

      Bridging the Tax Gap--The Case for Increasing the IRS Budget

                            ACKNOWLEDGEMENTS

    Matt Lewis, a Federal Fiscal Policy Analyst, conducted the primary 
research and writing of this report, with assistance from Adam Hughes, 
Director of Federal Fiscal Policy. Other OMB Watch staff provided 
advice and research support. Brian Gumm, Communications Coordinator, 
provided editorial support and designed the report.
    OMB Watch is a nonprofit research and advocacy organization whose 
core mission is increasing Government accountability and improving 
citizen participation. Responsible, fair, and equitable budget and tax 
policy has been an important part of our work for more than 20 years, 
and we have practical experience in promoting and informing the public 
on budget and tax legislation and regulations.
    This report is available electronically at: http://
www.ombwatch.org/budget/irstaxgap2008.pdf.

                              INTRODUCTION

    A significant and pernicious problem facing the Nation is the tax 
gap, the difference between what is owed in taxes and what is paid. 
Estimated to be over $300 billion annually, the tax gap represents an 
enormous revenue loss for the Government. This lack of revenue often 
causes unnecessary increases in annual deficits and the national debt, 
increasing national interest payments and adding pressure to cut vital 
Government services. Unfortunately, much of the gap must be made up 
eventually by honest taxpayers through higher taxes and by 
beneficiaries of Federal investments through service cuts.
    The Internal Revenue Service (IRS) is responsible for enforcing tax 
laws and collecting taxes, and therefore, it has the greatest capacity 
and responsibility to reduce the tax gap. The extent to which the IRS 
can influence the tax gap is mostly a product of the resources and 
powers lawmakers in Congress provide the agency and how well IRS 
administers those resources and powers.\1\
---------------------------------------------------------------------------
    \1\ Significant changes to tax laws have reduced the IRS's 
influence over tax enforcement, and many proposals have been made to 
increase tax compliance with authorizing legislation. For one in-depth 
overview, see Max Sawicky's Bridging the Tax Gap: Addressing the Crisis 
in Federal Tax Administration (Washington, DC: Economic Policy 
Institute, 2005).
---------------------------------------------------------------------------
    Congress has given considerable lip service to doing something 
about the tax gap for years but has done little to actually give the 
IRS the tools to make significant progress in closing it. Despite this 
fact, Congress has demanded the IRS close the tax gap without making 
more resources available for the agency to do so. Thus, the IRS has 
been forced to make difficult choices as to how to use the limited 
resources it has been allocated. As a result, at the very least, the 
tax gap remains a large problem, and most experts believe it has 
probably increased in size as the IRS has largely scaled back tax law 
enforcement over the last 10 years.
    The IRS can reduce the size of the tax gap--progress that would 
yield billions in additional revenue each year. In order to accomplish 
this, Congress and the IRS will need to invest more in three areas of 
the IRS budget: audits, collections, and tax preparation services for 
low-income taxpayers eligible for the Earned Income Tax Credit. With 
sufficient resources, the IRS should be able to implement effective and 
efficient tax enforcement policies and programs that will have a real 
impact on reducing the tax gap.

                 THE $300 BILLION PROBLEM: THE TAX GAP

    IRS defines the tax gap in two ways. The gross tax gap is the total 
amount of taxes that were not paid when tax returns were first filed, 
while the net tax gap consists of taxes that are not paid after the IRS 
takes steps to enforce tax laws. The most recent data on the gross tax 
gap comes from the IRS National Research Project, which evaluated tax 
returns from fiscal year 2000. It put the gross tax gap at between $312 
billion and $353 billion annually, or about 16 percent of all taxes 
owed. Although the percentage of the economy the tax gap represents has 
not changed significantly, the absolute size of the gross tax gap has 
in all likelihood grown in step with the economy.\2\ Most of the tax 
gap results from taxpayers underreporting their income.
---------------------------------------------------------------------------
    \2\ Internal Revenue Service, ``New IRS Study Provides Preliminary 
Tax Gap Estimate,'' http://www.irs.gov/newsroom/article/
0,,id=137247,00.html (accessed October 10, 2007).
---------------------------------------------------------------------------
    It is unclear, however, how much the tax gap has increased as a 
percentage of the total amount of taxes owed. In the last two decades, 
IRS has only measured the tax gap three times. Each time, it found the 
tax gap represented between 16 and 20 percent of total revenues 
owed.\3\ On the other hand, anecdotal evidence, particularly the work 
of Pulitzer Prize-winning journalist David Cay Johnston, suggests the 
tax gap has grown as wealthier taxpayers have responded to and 
requested reductions in the IRS enforcement presence.
---------------------------------------------------------------------------
    \3\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free 
Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf 
(accessed October 10, 2007).
---------------------------------------------------------------------------
    In any case, the IRS can influence both the net and the gross tax 
gap by encouraging and requiring tax compliance. The IRS recovered 
$48.7 billion of the tax gap in fiscal year 2006, which, coupled with 
late payments, brought the net tax gap to between $257 billion and $298 
billion.\4\ Enforcement efforts also have a strong impact on the gross 
tax gap, because voluntary compliance tends to increase when 
enforcement programs are more active. More enforcement increases the 
fear of being audited and perhaps heightens the public sense of civic 
responsibility, both of which are thought to promote voluntary 
compliance. But the exact extent of the impact is subject to debate. 
Some studies have found the increase in voluntary compliance is many 
times greater than the money the IRS directly recovers through 
enforcement programs.\5\
---------------------------------------------------------------------------
    \4\ Internal Revenue Service, ``IRS Enforcement Activities Continue 
To Recover,'' http://www.irs.gov/pub/newsroom/11-06_stat_charts.pdf 
(accessed October 10, 2007).
    \5\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free 
Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf 
(accessed October 10, 2007).



                         IMPACT OF THE TAX GAP

    The tax gap affects the public in two ways. Mainly, it reduces what 
compliant taxpayers already have. Because this revenue is intended to 
be collected and used by the Government, not collecting it makes 
implementing Government services and investments more difficult. The 
existence of the tax gap is kind of like a recurring and permanent tax 
cut, in the sense it generally must be paid for by either shifting the 
tax burden to others (in this case, compliant taxpayers), curtailing 
Government services, or increasing debt. The IRS National Taxpayer 
Advocate (NTA), for example, has testified before Congress that unpaid 
taxes shift the tax burden onto compliant taxpayers. If all compliant 
taxpayers were to assume an equal portion of the tax gap, it would add 
$2,200 to their annual tax bills.\6\ Looked at another way, if the IRS 
eliminated the tax gap, Americans could receive the same level of 
services and programs while paying significantly less in taxes. The 
actual impact of the tax gap on the taxes paid by each individual most 
likely depends on personal circumstances and future policy decisions.
---------------------------------------------------------------------------
    \6\ National Taxpayer Advocate, ``National Taxpayer Advocate's 2006 
Annual Report To Congress,'' Internal Revenue Service, http://
www.irs.gov/advocate/article/0,,id=165806,00.html (accessed October 10, 
2007).
---------------------------------------------------------------------------
    But unlike a tax cut, the tax gap creates a patently perverse set 
of winners and losers--taxpayers who do not follow the law benefit and 
taxpayers who do lose out. Larger burdens also tend to fall on lower-
and middle-income taxpayers, whose compliance rates are higher than 
other income levels. Higher-income taxpayers, small business owners, 
and corporations are the main beneficiaries, as their compliance rates 
are lower. Because of this, on the whole, the tax gap makes the tax 
code less progressive than the statutory structure indicates, though by 
exactly how much has not been quantified.\7\
---------------------------------------------------------------------------
    \7\ Jason Furman, Lawrence H. Summers, and Jason Bordoff, 
``Achieving Progressive Tax Reform in an Increasingly Global Economy,'' 
Brookings Institution, http://www3.brookings.edu/views/papers/furman/
200706bordoff_summers.pdf (accessed October 10, 2007).
---------------------------------------------------------------------------
    Secondly, and perhaps more importantly, the tax gap reduces what 
the public could have. The tax gap deprives the Government of more 
revenue to finance the expansion of Government services and 
investments, a reduction in the annual deficit, or payments to reduce 
the national debt. If the tax gap were reduced or eliminated, the 
additional revenue brought into the Government would, in most 
circumstances, make the tax code much more progressive. There are 
surely many different proposals about how to invest the revenue owed, 
but regardless of how the $300 billion would be used, the Federal 
Government is never afforded the opportunity to decide.
    On a less practical, but equally important level, the tax gap also 
represents the eroding integrity of the tax system and could reduce 
public support for the Federal Government. Such a large amount of 
unpaid taxes makes the tax system appear ineffective and unfair, since 
the tax gap regressively favors wealthier people and businesses who 
have the means to avoid and evade tax law. These perceptions of 
unfairness in the tax system may have large-scale effects on public 
policy, undermining public confidence in Government as a fiscal 
manager.\8\ Compliant taxpayers may also object to tax increases on the 
grounds they would be paid arbitrarily and regressively, and, as a 
corollary, new Government services or investments financed by tax 
increases may receive less support. Taxpayers may also view ineffective 
tax enforcement as indicative of Government incompetence generally and, 
therefore, oppose expansion of the Government's role. Too many citizens 
may see no option but to favor tax cuts as a way to restore the 
integrity of revenue collection and protect themselves from bearing 
unjust burdens as compliant taxpayers.
---------------------------------------------------------------------------
    \8\ Alison Kladec and Will Friedman, ``Understanding Public 
Attitudes about the Federal Budget: A Report on Focus Groups,'' Public 
Agenda, http://www.publicagenda.org/research/pdfs/
understanding_public_attitudes_about_the_federal_budget.pdf (accessed 
October 10, 2007).
---------------------------------------------------------------------------
             A PRIMARY CAUSE: LACK OF RESOURCES AT THE IRS

    While it is widely established that increased resources at the IRS 
could help to reduce the tax gap, IRS funding levels have not kept up 
with growing demands on its budget. The total IRS budget has remained 
static after adjusting for inflation since the mid-1990s. The funding 
decline has been most pronounced in the enforcement account of the IRS 
budget, which includes funding for tax return examinations, tax 
collections, and document matching services that compare financial 
records with tax returns. In fiscal year 1995, IRS had $4.43 billion in 
its enforcement account. By fiscal year 2006, this budget had only 
risen to $4.65 billion--less than a 5 percent increase. During the same 
period:
  --Inflation had eroded the value of this funding by 36 percent; \9\
---------------------------------------------------------------------------
    \9\ Bureau of Labor Statistics. ``Inflation Calculator,'' U.S. 
Department of Labor, http://www.bls.gov/cpi/ (accessed October 10, 
2007).
---------------------------------------------------------------------------
  --The size of the economy grew 42 percent; \10\
---------------------------------------------------------------------------
    \10\ Bureau of Economic Analysis, ``National Economic Accounts'' 
U.S. Department of Commerce, http://www.bea.gov/national/index.htm#gdp 
(accessed October 10, 2007).
---------------------------------------------------------------------------
  --The number of tax returns the IRS processed increased 11 percent, 
        from 205 million to 228 million; \11\ and
---------------------------------------------------------------------------
    \11\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books,'' 
http://www.irs.gov/taxstats/article/0,,id=102174,00.html (accessed 
October 10, 2007).
---------------------------------------------------------------------------
  --Hundreds of changes to the IRS's authority and tax laws gave the 
        agency more work.\12\
---------------------------------------------------------------------------
    \12\ Charles O. Rossotti, ``Report to the IRS Oversight Board: 
Assessment of the IRS and Tax System,'' http://nteuirswatch.org/
documents/numbers/Rossotti%2002%20report%20to%20oversight%20board.pdf 
(accessed October 10, 2007).
---------------------------------------------------------------------------
    Experts inside and outside Government have recognized the resource 
problem at IRS. IRS National Taxpayer Advocate Nina Olson, who operates 
independent of the IRS, believes funding shortages have become so 
problematic, she has called for the creation of special rules for IRS 
budget bills. Charles Rossotti, former commissioner of the IRS, told 
the IRS Oversight Board in 2002 that much of the tax gap is a result of 
the failure of Congress to provide enough resources for tax law 
administration:




    The source of this problem are two conflicting, long-term trends: 
one, ever increasing demands on the tax administration system due to 
rapid growth in the size and complexity of the economy; and two, a 
steady decline in IRS resources due to budget constraints. The 
cumulative effect of these conflicting trends over a 10-year period has 
been to create a huge gap between the number of taxpayers who are not 
filing, not reporting or not paying what they owe, and the IRS' 
capacity to require them to comply.
    The resources crunch can be seen more apparently in staffing 
levels: the number of IRS employees is down sharply from 10 years ago. 
Between 1995 and 2006, the total number of IRS employees shrunk 18 
percent--falling from 114,000 to less than 92,000. The number of 
revenue agents and officers--IRS employees who perform audits--has 
decreased even faster, by 40 and 30 percent, respectively.\13\ Those 
categories of employees have decreased from 8,139 to 5,665 for revenue 
agents and 16,078 and 12,859 for revenue officers.\14\ Fewer staff at 
the IRS has a direct impact on the auditing function at the agency.
---------------------------------------------------------------------------
    \13\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \14\ Ibid.
---------------------------------------------------------------------------
    There have been many experts who have called for increased funding 
for the IRS, including the Treasury Inspector General for Tax 
Administration,\15\ the Government Accountability Office,\16\ the IRS 
Oversight Board, Max Sawicky, then of the Economic Policy 
Institute,\17\ Robert McIntyre of Citizens for Tax Justice,\18\ Eric 
Toder of the Urban-Brookings Tax Policy Center,\19\ and former IRS 
Commissioner Donald C. Alexander.\20\
---------------------------------------------------------------------------
    \15\ Treasury Inspector General for Tax Administration. ``Trends In 
Compliance Activities Through Fiscal Year 2006,'' U.S. Department of 
the Treasury, http://www.treas.gov/tigta/auditreports/2007reports/
200730056fr.html (accessed October 10, 2007).
    \16\ Michael Brostek, ``Tax Compliance: Multiple Approaches Are 
Needed To Reduce The Tax Gap,'' Government Accountability Office, 
http://www.gao.gov/new.items/d07488t.pdf (accessed October 10, 2007).
    \17\ Max Sawicky, ``Do-it-yourself tax cuts: The crisis in U.S. tax 
enforcement'' in Bridging the Tax Gap: Addressing the Crisis in Federal 
Tax Administration (Washington, DC: Economic Policy Institute, 2005).
    \18\ Robert McIntyre, ``Statement of Robert S. McIntyre Before the 
Senate Budget Committee, January 23, 2007,'' Senate Budget Committee, 
http://budget.senate.gov/democratic/testimony/2007/
McIntyre_TaxGap012307.pdf (accessed October 10, 2007).
    \19\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free 
Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf 
(accessed October 10, 2007).
    \20\ Max Sawicky, ``Interview: Former IRS Commissioner Donald C. 
Alexander'' in Bridging the Tax Gap: Addressing the Crisis in Federal 
Tax Administration (Washington, DC: Economic Policy Institute, 2005) 
52.
---------------------------------------------------------------------------
    IRS needs additional funding to fulfill its mission as the 
guarantor of tax compliance. Where funding is needed most is in the IRS 
enforcement budget, particularly for audits of high-income taxpayers 
and corporations, the collection function, and services for low-income 
taxpayers who receive the Earned Income Tax Credit (EITC).


                     INCREASES RESOURCES FOR AUDITS

    One of the most disturbing trends in enforcement policy over the 
last 10 years has been a sharp decline in audits, which are an 
essential tool in the fight against unpaid taxes. Most of the gross tax 
gap--between $250 and $260 billion--results from individuals and 
businesses underreporting their income. The IRS determines who 
inaccurately reported their income and how much they owe in taxes 
through a variety of means. Examinations, or audits, are one way the 
IRS makes this determination. In fiscal year 2006, IRS audits showed 
that an additional $43.95 billion was owed on all tax returns that were 
audited.\21\ The IRS performed 1.4 million audits, resulting in an 
audit coverage rate of 0.8 audits per 100 tax returns, or less than 1 
percent.\22\
---------------------------------------------------------------------------
    \21\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \22\ Ibid.
---------------------------------------------------------------------------
    In the last decade, there has been a general decline in most types 
of audits. In fiscal year 1996, the audit rate for all individual 
income tax returns was 1.67 percent.\23\ In fiscal year 2006, the rate 
had dropped to 1 percent of all individuals, after reaching a low of 
0.5 percent in 2000.\24\ The recent upswing in audits is encouraging, 
but the rate is still far below earlier levels and even farther below 
historic and adequate levels, according to tax administration 
experts.\25\
---------------------------------------------------------------------------
    \23\ Government Accountability Office, ``Tax Administration: Audit 
Trends and Results for Individual Taxpayers,'' http://www.gao.gov/
archive/1996/gg96091.pdf (accessed October 16, 2007).
    \24\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \25\  Sawicky, ``Interview: Former IRS Commissioner Sheldon S. 
Cohen,'' 25.
---------------------------------------------------------------------------
    Making things worse, the general decrease in audits has been 
unequally distributed by taxpayer income with audits of higher-income 
earners falling faster than the overall decrease. The decline in audits 
has been the steepest among taxpayers reporting an income over 
$100,000. Audits of these filers have dropped from 2.85 percent in 
fiscal year 1996 to 1.3 percent in fiscal year 2006. Decreases in these 
audits before 1996 were even more drastic: in fiscal year 1992, higher-
income filers were audited 5.28 percent of the time.
    Furthermore, business income has been insufficiently audited. 
Business income, which is reported on individual income tax returns, 
has been audited at a relatively steady rate since fiscal year 1995. 
Nevertheless, more audits are needed, as the IRS National Research 
Project identified the underreporting of income by small businesses as 
the category that contributed the most to the tax gap, accounting for 
more than $109 billion in unpaid taxes annually. $68 billion of these 
unpaid taxes are owed by self-proprietorships, known more commonly as 
the self-employed, and another $22 billion came from partnerships, S 
corporations, estates, and trusts. In order to close the tax gap, the 
IRS will need the necessary resources to expand its investigation and 
enforcement of tax laws related to these returns, not hold them steady.
Decline in Quality and Quantity of Corporate Audits
    Individual taxpayers are not alone in experiencing a decrease in 
the likelihood of being audited. Audits related to the corporate income 
tax for all sizes of corporations have declined significantly. The 
overall corporate audit rate has been cut in half, dropping from 2.4 
percent in 1996 to 1.2 percent in 2006.\26\ What's more, new data from 
the last 5 years obtained by the Transactional Records Access 
Clearinghouse (TRAC) show that the quality of those audits has also 
suffered.
---------------------------------------------------------------------------
    \26\ Transactional Records Access Clearinghouse, ``IRS Spending 
More Time on Face-to-Face Corporate Audits that Produce No Revenue,'' 
Syracuse University, http://trac.syr.edu/tracirs/newfindings/current/ 
(accessed October 16, 2007).
---------------------------------------------------------------------------
    Disturbingly, the decline has been most pronounced among the 
largest corporations. Audits of corporations with assets between $5 and 
$10 million dropped from 14 percent in fiscal year 1995 to 3.4 percent 
in fiscal year 2006--a 70 percent drop.\27\ Slightly larger 
corporations--with assets of $50 million to $100 million--were audited 
at a rate of 13.8 percent in fiscal year 2006, down from 21.3 percent 
in fiscal year 1996--a 35 percent decline. Audits of the largest 
corporations, those with assets of $250 million or more, have declined 
by almost a third, from 50 percent in fiscal year 1995 to 35.2 percent 
in fiscal year 2006.\28\ While companies with over $250 million in 
assets are small in number--they filed only 0.2 percent of corporate 
tax returns in 2002--they accounted for a staggering 90 percent of all 
corporate assets and 87 percent of all corporate income during that 
year.\29\ The decrease in audits among these corporate tax filers must 
be reversed.
---------------------------------------------------------------------------
    \27\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \28\ Transactional Records Access Clearinghouse, ``IRS Spending 
More Time on Face-to-Face Corporate Audits that Produce No Revenue.''
    \29\ Transactional Records Access Clearinghouse, ``Relatively Few 
Corporations Have Most Income and Assets,'' Syracuse University, http:/
/trac.syr.edu/tracirs/trends/v10/corpassets.html (accessed October 17, 
2007).



    Audits of the largest corporations inexplicably vary by sector, 
which seems to be an inefficient method of tax enforcement. In fiscal 
year 2006, only 15 percent of financial services corporations were 
audited, compared to 100 percent of all large manufacturing and 
transportation 1corporations.\30\ Yet companies in the financial sector 
make up a large part of the economy. The largest corporations in the 
financial sector account for 25 percent of total receipts of large 
corporations and over 62 percent of total net income--more than 2.5 
times the next highest sector.\31\
---------------------------------------------------------------------------
    \30\ Transactional Records Access Clearinghouse, ``Corporate Audit 
Rates--Wide Disparities Found for Different Industries,'' Syracuse 
University, http://trac.syr.edu/tracirs/latest/127/. (accessed October 
16, 2007).
    \31\ Transactional Records Access Clearinghouse, ``Net Income of 
Largest Corporations,'' Syracuse University, http://trac.syr.edu/
tracirs/trends/v10/netincsecG.html (accessed October 16, 2007).
---------------------------------------------------------------------------
    What's more unfortunate, however, is that the audits that have been 
done for corporate filers have been increasingly unproductive, 
particularly among face-to-face corporate audits--the most thorough and 
intense audits the IRS conducts. The number of nonproductive auditing 
hours, which is defined by the IRS as face-to-face examination hours 
that produce a ``no change'' result in the amount of tax owed, has 
increased for every corporate asset class over the last 5 years.\32\ 
The average increase in unproductive hours across all corporate asset 
classes between fiscal year 2001 and fiscal year 2006 was 40 percent. 
If the IRS audited a high percentage of corporations, a rise in 
unproductive hours could be interpreted as a good thing, with companies 
increasingly paying the taxes they owe. However, because the IRS audits 
too few corporations and because the tax gap points to large amounts of 
taxes not being collected, a rise in unproductive hours shows the IRS 
is being inefficient in selecting which corporations it chooses to 
audit--a waste of valuable enforcement resources and a missed 
opportunity to collect more tax revenues.
---------------------------------------------------------------------------
    \32\ Transactional Records Access Clearinghouse, ``Net Income of 
Largest Corporations.''
---------------------------------------------------------------------------
    The rise in unproductive auditing hours increased at faster rates 
as the size of the corporation increased, especially for large 
corporations (those with assets over $10 million). While all four asset 
classes over $10 million saw increases in unproductive hours well above 
the average of 40 percent, as the asset class grows larger, the 
increases are even more pronounced. At the low end, audits of 
corporations between $10 million and $50 million saw a 61 percent 
increase in unproductive hours, while audits of corporations above $250 
million in assets saw the largest increases, at 109 percent--more than 
double the rate from 5 years earlier.\33\
---------------------------------------------------------------------------
    \33\ Transactional Records Access Clearinghouse, ``IRS Corporate 
Audit Hours Spent on Nonproductive Examinations Increasing,'' Syracuse 
University, http://trac.syr.edu/tracirs/trends/v12/audittimechange.html 
(accessed October 16, 2007).
---------------------------------------------------------------------------
    Another alarming trend is the decrease in the number of hours spent 
per corporate audit. In the last 5 years, every corporate asset class 
except one ($10-$50 million) has seen double-digit decreases in the 
average length of audits, with the average corporate audit lasting 21 
fewer hours.\34\ This represents almost a 10 percent drop in the length 
of corporate audits.
---------------------------------------------------------------------------
    \34\ Transactional Records Access Clearinghouse, ``Change in 
Average Audit Length Fiscal Year 2001 vs Fiscal Year 2006,'' Syracuse 
University, http://trac.syr.edu/tracirs/trends/v12/
auditlengthchange.html (accessed October 16, 2007).
---------------------------------------------------------------------------
    IRS data on corporate audits, combined with the new data obtained 
by TRAC on audit length, depict disturbing trends in both the quality 
and quantity of corporate audits--particularly those of the largest 
corporations. Not only is the IRS performing fewer corporate audits 
overall than it did 10 years ago, the ones they do perform are done too 
quickly and are poorly targeted. Due to the size and complexity of the 
business transactions of large corporations, those returns are likely 
to produce more reporting errors, and therefore, the IRS should be 
auditing more of those companies (not less) and spending more time (not 
less) on each audit.
    There have been a few reports that some of the changes within the 
corporate auditing section (the Large and Mid-Sized Business Division) 
have been forced on IRS auditors by senior level managers at the IRS. 
These changes put a strong focus on completing more audits by pre-set 
deadlines in order to drive up total audit numbers regardless of the 
quality of the audit or of auditors' opinions about possible serious 
tax violations they had not had time to investigate during audits. 
David Cay Johnston reported in The New York Times on March 20, 2007, 
that almost two dozen revenue agents had been pressured by their 
managers to close open audits too soon--actions the auditors said could 
cost the Government billions of dollars in unpaid taxes.\35\
---------------------------------------------------------------------------
    \35\ David Cay Johnston, ``IRS Agents Feel Pressed To End Cases.'' 
New York Times, March 20, 2007. http://www.nytimes.com/2007/03/20/
business/20tax.html.
---------------------------------------------------------------------------
    This phenomenon was recognized by Colleen Kelley, President of the 
National Treasury Employees Union, in testimony before the House 
Appropriations Committee on Financial Services and General Government. 
Kelley testified the pressure put on IRS auditors was not a recent 
occurrence but had been happening since 2002. Kelley believes it was 
the result of a new IRS policy called Limited Focused Examination 
(LIFE) and said the union had heard directly from its members that the 
policy was undermining both efforts to make sure companies were paying 
all the taxes they owed and employee morale at the IRS.\36\
---------------------------------------------------------------------------
    \36\ Colleen Kelley, ``Statement of Colleen Kelley, National 
President, National Treasury Employees Union on `Internal Revenue 
Service Budget fiscal year 2008,' '' National Treasury Employees Union, 
http://nteuirswatch.org/documents/numbers/CMK%20Testimony%20to%20House 
%20FServices%20sub%203-29-07.pdf (accessed October 18, 2007).
---------------------------------------------------------------------------
    The combination of a decrease in overall corporate audit rates, and 
reports that those audits being done are closed too soon, will 
encourage tax evasion behavior among corporations, which may have more 
cause to believe they will not be audited, and that audits themselves 
are not to be feared.
Wrong Strategy: Relying on Correspondence Audits
    As far as reducing the tax gap is concerned, the type of audit 
being administered is equally, if not more important than who is being 
audited. There are two types of audits: a traditional face-to-face 
audit, which can happen inside an IRS office or at a taxpayer's home or 
business, and a correspondence audit. Traditional face-to-face audits 
involve comprehensive reviews of assets and records, requiring more 
time and effort for both the taxpayer and the IRS. Correspondence 
audits consist of the IRS sending a letter to a non-compliant taxpayer 
in which he or she is asked a few questions about his or her tax 
return. Striking the right balance between these two types of audits is 
essential to effective tax enforcement.
    Face-to-face audits typically generate far more revenue than 
correspondence audits, and ones on high-income earners in particular 
produce the highest yields. In fiscal year 2006, face-to-face audits of 
high-income earners generated an average of $54,934.\37\ Face-to-face 
audits on individuals earning between $50,000 and $100,000, in 
contrast, only averaged a $3,877 yield, yet these taxpayers were 
audited almost as much (0.23 percent) as their higher-income 
counterparts (0.44 percent).\38\ Even face-to-face audits on returns 
with business income over $100,000 yielded less than half as much 
($25,787) as audits of high-income filers.\39\ The high yields on face-
to-face audits of high-income filers show both that they are a good 
investment and also that there are significantly more taxes due among 
those filers.
---------------------------------------------------------------------------
    \37\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \38\ Ibid.
    \39\ Ibid.
---------------------------------------------------------------------------
    Despite the high yields of these audits, the IRS is performing them 
too rarely. IRS administered face-to-face audits for 0.44 percent of 
all high-income filers in fiscal year 2006, compared to 2.9 percent in 
fiscal year 1992 and 1.7 percent in fiscal year 1996.\40\ Yet the IRS 
claims, and rightly so, that overall audit rates have been gradually 
increasing in the last few years. These additional audits have 
increased the yield on tax enforcement, from a 10-year low of $32.9 
billion in fiscal year 1999 to $48.7 billion in fiscal year 2006.
---------------------------------------------------------------------------
    \40\ Transactional Records Access Clearinghouse, ``IRS `Face-to-
Face' Audits of Federal Income Tax Returns Filed by Individuals,'' 
Syracuse University, http://trac.syr.edu/tracirs/highlights/current/
audpctcompare_ind.html (accessed October 16, 2007).



    Unfortunately, the details behind the IRS data on increased audits 
tell a different story. Much of the increase cited by the IRS has been 
due to an emphasis on correspondence audits, not the more effective 
face-to-face audits. Overall, in fiscal year 2006, 77 percent of all 
audits--more than three out of four--were by correspondence.\41\ What's 
more, correspondence audits--not face-to-face audits--have accounted 
for 74 percent of the recent increase in audits among high-income 
individuals.\42\ Face-to-face audit levels have increased only modestly 
over that time.
---------------------------------------------------------------------------
    \41\ Transactional Records Access Clearinghouse, ``Targeting of 
Correspondence Audit Improves,'' Syracuse University, http://
trac.syr.edu/tracirs/newfindings/current (accessed October 16, 2007).
    \42\ Treasury Inspector General For Tax Administration, ``Trends in 
Compliance Activities Through Fiscal Year 2006,'' U.S. Treasury 
Department, http://www.treas.gov/tigta/auditreports/2007reports/
200730056fr.html (accessed October 16th, 2007).
---------------------------------------------------------------------------
    This trend is problematic because correspondence audits are less 
effective than face-to-face audits, partly because this type of audit 
can only spot problems that are evident from information submitted by 
the taxpayer or from information reported by third parties (employers, 
banks, and other sources). For comparison, in fiscal year 2006, face-
to-face audits on individual income tax returns for earners over 
$100,000 yielded an average of $54,934, while correspondence audits 
brought in $31,912.\43\ For other types of tax returns, such as large 
corporations, the difference was even more dramatic. The average yield 
of a face-to-face audit for large corporations in fiscal year 2006 was 
$2.6 million, but correspondence audits of similarly sized companies 
averaged a meager return of $285,000.\44\
---------------------------------------------------------------------------
    \43\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \44\ Ibid.
---------------------------------------------------------------------------
    The IRS seems to have chosen to use correspondence audits so much 
mainly because administering them requires less staff time and 
resources. In fiscal year 2006, correspondence audits took an average 
of only 1.4 auditor hours each, drastically lower than the hundreds of 
hours face-to-face audits can take.\45\ Indeed, IRS data shows even as 
overall audit rates have increased in the last few years, few 
additional staff have been added.
---------------------------------------------------------------------------
    \45\ Transactional Records Access Clearinghouse, ``Targeting of 
Correspondence Audit Improves,'' Syracuse University, http://
trac.syr.edu/tracirs/newfindings/current (accessed October 17, 2007).
---------------------------------------------------------------------------
    The IRS has decided, perhaps because of limited resources, to shift 
to less efficient and effective processes for auditing. If Congress and 
others in Government are serious about creating a robust tax 
enforcement system and closing the tax gap, additional resources are 
crucial. Increased funds could be used to raise staffing levels enough 
that IRS may gradually perform more high-yield face-to-face audits, 
which would have a greater impact on reducing the tax gap.

                     EXPAND INTERNAL TAX COLLECTION

    Tax law enforcement does not end once an audit has been completed. 
The IRS will have to actively pursue unpaid taxes it identifies if they 
are not paid voluntarily. IRS collection officers may make an agreement 
with the taxpayer to pay the taxes, or issue levies, liens, or property 
seizures. Agents are also charged with identifying taxpayers who do not 
file a tax return and collecting the taxes owed. To do these things, 
significant staffing and resources are required.
    Billions are lost annually because Congress does not sufficiently 
finance the IRS collection department. In 2002, former IRS Commissioner 
Charles Rossotti reported to the IRS Oversight Board that an annual 
investment of under $400 million in IRS collections could generate over 
$11 billion each year.\46\ This additional funding could be used to 
hire more full-time employees to pursue cases the IRS has not taken 
action on due to insufficient personnel. Even without additional 
resources, NTA Nina Olson has recently stated the IRS can tackle many 
of those additional cases by implementing improvements to its current 
collection regimes.
---------------------------------------------------------------------------
    \46\  Charles O. Rossotti, ``Report to the IRS Oversight Board: 
Assessment of the IRS and Tax System.''
---------------------------------------------------------------------------
    Since Rossotti issued the 2002 report, activity in the collection 
function has increased modestly. Some key measurements have been on a 
steady upward trajectory, including the quantity of liens and levies 
issued by IRS collection staff.\47\ However, the level of liens and 
levies is still down sharply from fiscal year 1996 levels, even 
excluding growth in the economy and tax returns. Some measures--such as 
the quantity of seizures--have not increased at all. Indeed, a 2007 
Treasury Inspector General for Tax Administration (TIGTA) report found 
a robust collection function continues to be hampered by inadequate 
resources, as staffing for collection activities remains 30 percent 
below fiscal year 1997 levels.\48\
---------------------------------------------------------------------------
    \47\  Transactional Records Access Clearinghouse, ``IRS Collection 
Enforcement Trends,'' Syracuse University, http://trac.syr.edu/tracirs/
highlights/current/collenfG.html (accessed October 16, 2007).
    \48\ Treasury Inspector General for Tax Administration, ``Trends In 
Compliance Activities Through Fiscal Year 2006.''
---------------------------------------------------------------------------
Wrong Strategy: Private Debt Collection
    In 2004, Congress enacted--and in September 2006, the IRS 
implemented--a program to outsource the responsibility of collecting 
small tax debts to private debt collection firms. The principle 
rationale for creating the program was that its funding would not show 
up in the IRS budget. Although the Government still spends resources, 
using private collectors does not require additional annual 
appropriations. Under the program, private collectors get to keep a 
portion of the taxes they collect as payment. Therefore, given limited 
budgets, the IRS would be afforded an opportunity to collect taxes it 
otherwise could not.
    However, the private tax collection program is wasteful and 
dangerous. Private collection agencies (PCAs) yield a return-on-
investment (ROI) of 4:1, whereas--as former IRS Commissioner Mark 
Everson has acknowledged--Federal employees at the IRS produce a 13:1 
ROI. Even more efficient, the IRS' Automated Collection System 
currently collects about $20 for every $1 spent on staffing, according 
to the NTA.\49\
---------------------------------------------------------------------------
    \49\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2007 Annual Report to Congress,'' Internal Revenue Service, 
http://wwwrs.gov/advocate/article/0,,id=177301,00.html (accessed 
January 9, 2008).
---------------------------------------------------------------------------
    Furthermore, despite claims the program has no costs, as of May 23, 
2007, the IRS had spent $71 million in appropriated funding to set it 
up. If that money had instead been spent on those high-yield automated 
functions, an additional $1.4 billion in revenues could have been 
collected in just 1 year. Yet for all those missed opportunities, the 
private collection program is expected to yield only around $1.1 
billion altogether over the next 10 years.
    Initial data on the program are now available for the first year of 
operation, and the Washington Post has reported the PCAs averaged a 
4.5:1 ROI, collecting $29 million, from which they were paid $6.34 
million--far below both the IRS' ROI levels and initial revenue 
projections for the program.\50\
---------------------------------------------------------------------------
    \50\ Business Section ``Collectors Get $29 Million for IRS,'' 
Washington Post, January 9, 2008, http://www.washingtonpost.com/wp-dyn/
content/article/2008/01/08/AR2008010804439.html.
---------------------------------------------------------------------------
    Regardless of the program's cost, many experts continue to worry 
PCAs might violate taxpayer rights. Olson has expressed a great deal of 
concern that profit-motivated companies could abuse taxpayers. 
According to Olson, PCAs have the opportunity to use ``trickery, 
device, and belated Fair Debt Collection Practices Act warnings to take 
advantage of taxpayers,'' and yet they are not obligated to disclose 
their ``operational plans'' regarding practices, letters, or scripts 
they will use.\51\
---------------------------------------------------------------------------
    \51\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2006 Annual Report to Congress,'' Internal Revenue Service, 
http://www.irs.gov/advocate/article/0,,id=165806,00.html (accessed 
October 16, 2007).
---------------------------------------------------------------------------
    Indeed, anecdotal reports on the program's operations have borne 
out many of the concerns Olson voiced regarding abusive practices. At a 
May 23, 2007, hearing of the House Ways and Means Committee, Rep. John 
Lewis (D-GA) presented tapes of conversations between PCA employees and 
taxpayers.\52\ Due to IRS privacy protections, PCA employees did not 
identify themselves, the nature of their business, or the purpose of 
their calls, and haggled with taxpayers to obtain their Social Security 
numbers. The taxpayers in the conversations refused to reveal their 
Social Security numbers and responded angrily when PCA employees asked 
repeatedly for the numbers but did not disclose the purpose of the 
conversations.
---------------------------------------------------------------------------
    \52\ For a transcript of the tapes, see http://
waysandmeans.house.gov/media/pdf/110/07 
%2005%2023%20Debt%20Collector%20call%20transcript.pdf.
---------------------------------------------------------------------------
    Olson reiterated her concerns about the ability of the program to 
operate efficiently and effectively in the recently released 2007 NTA 
report, stating tax collection is an inherently governmental function 
that should be handled only by Government employees trained to protect 
taxpayer rights. Olson argues the IRS could currently collect the 
outstanding debts given to the PCAs by improving its collection 
strategy and use of currently available resources, enabling the IRS to 
reach ``most, if not all, of these cases [given to PCAs] at less cost 
to taxpayers and less risk to taxpayer rights.'' \53\
---------------------------------------------------------------------------
    \53\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2007 Annual Report to Congress,'' Internal Revenue Service, 
http://www.irs.gov/advocate/article/0,,id=177301,00.html (accessed 
January 9, 2008).
---------------------------------------------------------------------------
    The sum of the evidence supports the need to shut down this program 
immediately. In 2007, Ways and Means Chairman Charles Rangel (D-NY) 
requested the IRS not issue any new contracts for the program, and the 
House passed a bill in October 2007 to end it entirely. This would be a 
wise change in IRS policy. Unfortunately, the IRS is moving forward 
with soliciting bids from additional PCAs for the second part of the 
program--full implementation. While Olson has pushed the IRS to include 
more transparency and taxpayer safeguards in the solicitation of new 
contracts, she continues to voice strong concerns and recommends 
Congress end the program.
    Congress needs to act immediately to end this program and instead 
should make more resources available to the IRS to expand existing 
internal collection efforts.

                  INCREASE SERVICES FOR EITC TAXPAYERS

    Re-establishing a robust auditing regime at the IRS is crucial to 
closing the tax gap. But focusing on enforcement at every turn, 
particularly having that focus land disproportionally on low-income 
taxpayers, is not the best solution. The IRS has taken an approach to 
overseeing and enforcing the Earned Income Tax Credit (EITC) that 
relies far too much on audits and not enough on services. This is 
unfair to those taxpayers who claim the EITC, who are held to a higher 
standard by the IRS than any other taxpayer group, and it fails to 
address EITC over-claims caused by errors, not malfeasance.
    The EITC is a refundable tax credit for low-income workers. In tax 
year 2005, the EITC provided more than $41 billion to over 21 million 
families and individuals.\54\ It lifts more working families out of 
poverty than any other work support; in 2003, the EITC helped raise 4.4 
million people, including 2.4 million children, above the poverty 
line.\55\
---------------------------------------------------------------------------
    \54\ Center on Budget and Policy Priorities, ``EIC Participation 
for Tax Year 2005, by State,'' http://www.cbpp.org/eic2008/docs/
EIC%20participation%20prelim%20ty%202005.pdf (accessed October 17, 
2007).
    \55\ Robert Greenstein, ``The Earned Income Tax Credit: Boosting 
Employment, Aiding the Working Poor,'' Center on Budget and Policy 
Priorities, http://www.cbpp.org/7-19-05eic.htm (accessed October 17, 
2007).
---------------------------------------------------------------------------
    Since it is a tax credit, the IRS administers the EITC and is 
responsible for maintaining its integrity. In 1999, the IRS estimated 
the EITC noncompliance rate at between 27 and 32 percent, resulting in 
between $8.5 to $9.9 billion annually in overpayments, or about 3 
percent of the tax gap (though the NTA believes that rate is 
overstated).\56\
---------------------------------------------------------------------------
    \56\ Ibid.
---------------------------------------------------------------------------
Wrong Strategy: Punishing EITC Taxpayers
    Mostly by congressional mandate, the IRS has taken a punitive 
approach to EITC error reduction. Congress designates a portion of the 
annual IRS budget specifically for EITC compliance. In fiscal year 
2006, Congress allocated $167 million for EITC compliance, which the 
IRS used on several initiatives that focus disproportionate enforcement 
efforts on EITC taxpayers.
    With this funding, Congress has instructed the IRS to heavily audit 
EITC taxpayers. Under the EITC compliance initiative in fiscal year 
2006, almost 517,617 audits were performed on tax returns where the 
EITC was claimed. These audits constituted about 40 percent of all 
audits performed on individual tax returns in fiscal year 2006.\57\ The 
examination rate for EITC recipients was 2.25 percent, compared to 1 
percent for all individual income tax returns, and 1.3 percent of all 
individuals making over $100,000.\58\ Yet EITC audits yield only a 
fraction of the total revenues recovered by IRS examinations. EITC 
audits identified nearly $1.5 billion in excess payments, resulting in 
a yield of only $2,895 per audit--the lowest rate of return for any 
type of audit performed by the IRS.\59\
---------------------------------------------------------------------------
    \57\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
    \58\ Ibid.
    \59\ Ibid.
---------------------------------------------------------------------------
    Aside from a disproportionately large number of audits, EITC 
taxpayers are subject to a set of additional enforcement programs. 
First, the IRS applies a unique type of examination--called 
``recertification''--only to EITC taxpayers. The recertification 
program requires taxpayers to ``recertify'' if they had the EITC denied 
during an examination. This denial places recertification indicators on 
a taxpayer's account until the taxpayer proves he or she is eligible to 
receive the credit again. Once the taxpayer has provided sufficient 
evidence, he or she is deemed ``recertified,'' and the taxpayer is once 
again eligible for the EITC. The number of taxpayers subject to this 
recertification tripled from 326,000 in September 1999 to almost 1 
million by December 2003.\60\ No other tax credit, deduction, or 
exemption requires such a high burden of proof.
---------------------------------------------------------------------------
    \60\ Treasury Inspector General for Tax Administration, ``The 
Earned Income Credit Recertification Program Continues to Experience 
Problems,'' U.S. Department of Treasury, http://www.treas.gov/tigta/
auditreports/2005reports/200540039fr.html (accessed October 17, 2007).
---------------------------------------------------------------------------
    The IRS has also put holds on millions of refunds to crack down on 
EITC errors. Beginning in 2005, the Criminal Investigations Division of 
the IRS began a program that postponed sending EITC refunds to people 
suspected of fraud. The NTA's 2005 Report to Congress revealed that of 
the 1.6 million taxpayers who had their refunds frozen, 75 percent were 
EITC recipients.\61\ In 80 percent of the frozen refund cases brought 
to the NTA last year, the IRS ended up paying full or partial refunds, 
indicating a very large percentage of innocent filers had to face 
hardships resulting from delayed refunds.
---------------------------------------------------------------------------
    \61\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service, 
http://www.irs.gov/advocate/article/0,,id=152735,00.html (accessed 
October 17, 2007).
---------------------------------------------------------------------------
    Moreover, anecdotal evidence indicates the fear of punitive action 
by the IRS discourages workers from claiming the EITC. Currently, one 
in five workers who is eligible for the EITC does not claim it. Much of 
the energy and funding the IRS devotes to EITC compliance programs 
could be better spent by offering the helping hand of taxpayer services 
rather than punitive enforcement.

Expanded Assistance Would Reduce Error Rates
    The EITC error rate could be significantly reduced by increasing 
the capacity of nonprofit or Government tax preparation services to 
assist EITC-eligible taxpayers.\62\ EITC error rates do not distinguish 
taxpayers who intentionally cheated on their returns from those who 
simply made mistakes. EITC filings are complicated, requiring a 50-page 
instruction manual, \63\ and therefore, many EITC over-claims are the 
result of mistakes that could be prevented. In fact, as much as 50 
percent of all tax returns with errors are thought to be unintentional 
and have been linked to the complexity of EITC eligibility 
requirements.\64\ These errors could be addressed principally by 
simplifying tax laws and, when necessary, giving taxpayers help in 
preparing what may unavoidably be a complicated application process.
---------------------------------------------------------------------------
    \62\ Another effective approach is to simplify the credit. See Max 
Sawicky, ``Where the Money Isn't,'' Economic Policy Institute, http://
www.epinet.org/content.cfm/issuebriefs_ib183.
    \63\ See the IRS web site for the manual: http://www.irs.gov/pub/
irs-pdf/p596.pdf.
    \64\ Max Sawicky, ``Where the Money Isn't,'' Economic Policy 
Institute, http://www.epinet.org/content.cfm/issuebriefs_ib183 
(accessed October 17, 2007).
---------------------------------------------------------------------------
    Through its nationwide network of Taxpayer Assistance Centers 
(TACs), the IRS makes tax return preparation services available for 
low-income tax filers on a walk-in basis. Studies have found IRS-
prepared returns from these centers are substantially more accurate 
than both self-prepared and commercially prepared returns.\65\ Audits 
show that TAC-prepared EITC returns resulted in between $640-$1,300 
less in erroneous payments than unprepared returns.\66\
---------------------------------------------------------------------------
    \65\ Nina Olson, ``The IRS and the Tax Gap,'' Testimony before the 
Committee on the Budget, U.S. House of Representatives, http://
www.house.gov/budget_democrats/hearings/2007/08Olsontestimony.pdf 
(accessed October 16, 2007).
    \66\ Ibid.
---------------------------------------------------------------------------
    Yet the IRS has decided to reduce the quantity and quality of 
services available at TACs. The number of tax returns TACs prepared 
declined from 665,868 in fiscal year 2003 to a projected 406,612 in 
fiscal year 2006.\67\ A 2006 report by TIGTA also found more than 10 
percent of TACs (47 of 400) were critically understaffed.\68\ As the 
sheer volume of returns processed by TACs has decreased, the range of 
services they provide has also been narrowed.\69\ For example, in North 
Dakota, where farming is a major industry, the TACs have been 
instructed not to answer questions related to reporting farm income on 
tax returns.\70\ As more evidence of the detrimental combination of 
limited resources and unwise decisions at the IRS, employees at TACs 
have also been reassigned to jobs unrelated to taxpayer assistance, 
including being instructed to perform collection activities. This 
change diverts additional resources away from services offered at 
TACs.\71\
---------------------------------------------------------------------------
    \67\ Nina Olson, ``Hearing on Internal Revenue Service Fiscal Year 
2008 Budget Request'' Written Statement before the Subcommittee on 
Financial Services and General Government Committee on Appropriations, 
U.S. Senate, April 9, 2007.
    \68\ Treasury Inspector General for Tax Administration, ``The Field 
Assistance Office Has Taken Appropriate Actions to Plan for the 2006 
Filing Season But Challenges Remain for the Taxpayer Assistance 
Program.'' U.S. Department of Treasury, http://www.treas.gov/tigta/
auditreports/2006reports/200640067fr.pdf (accessed October 16, 2007).
    \69\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service. 
http://www.irs.gov/advocate/article/0,,id=152735,00.html
    \70\ Nina Olson, ``Hearing on Internal Revenue Service Fiscal Year 
2008 Budget Request.''
    \71\ National Taxpayer Advocate Service, ``National Taxpayer 
Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service. 
http://www.irs.gov/advocate/article/0,,id=152735,00.html
---------------------------------------------------------------------------
    Even more worrisome, the IRS has also been attempting to close 
TACs. In 2005, the IRS announced plans to shut down 68 of the 400 TACs 
nationwide. Before the IRS could carry out these plans, Congress passed 
a bill prohibiting the IRS from closing the TACs until TIGTA could 
evaluate the potential impact the closures would have on taxpayers. In 
March 2006, TIGTA completed the report, which concluded the data 
concerning TAC usage, on which the IRS based its plans for TAC 
closures, was unreliable. IRS has so far delayed the closures.\72\
---------------------------------------------------------------------------
    \72\ Treasury Inspector General for Tax Administration, ``The 
Taxpayer Assistance Center Closure Plan Was Based on Inaccurate Data.'' 
U.S. Department of Treasury, http://www.treas.gov/tigta/auditreports/
2006reports/200640061fr.pdf (accessed October 16, 2006).
---------------------------------------------------------------------------
    Dedicating additional resources to low-income services would have 
the benefit of reducing EITC error rates, closing the tax gap, and 
expanding needed services to more low-income taxpayers. At a minimum, 
the IRS and Congress should dedicate sufficient resources to maintain 
existing TACs. Even more funding would make the TAC network more 
responsive to taxpayer needs, both by opening more centers around the 
country and expanding the scope of services offered to taxpayers.

                  TAX ENFORCEMENT HAS TO BE A PRIORITY

    The tax gap is an eminently solvable problem. If Congress were to 
prioritize funding for IRS examination, collection, and tax preparation 
services, it would drastically reduce the tax gap. The practical effect 
of expanding these activities at the IRS would be to make the tax code 
more equitable, and it would bring in additional revenue that could 
responsibly finance new programs and services. If implemented in the 
right way, closing the tax gap could also help to increase public 
confidence in the tax system and the Federal Government.
    Congress needs to enact sustained increases in the IRS budget 
immediately and should make a commitment to continue to provide the IRS 
with the extra resources that are so crucial to effective tax 
enforcement.
    This report has only highlighted a few sections of the IRS budget 
that merit additional funding and reforms. However, it refrains from 
specifying the dollar amounts needed to address these concerns and 
recommends a thorough congressional review of the entire IRS budget. We 
believe Congress, IRS administrators, and outside experts, upon whose 
research and expertise this report mainly relies, should come together 
to find common ground on what an appropriate funding increase would 
look like, how quickly it should be implemented, and how it could be 
sustained in coming years. Most experts, both inside the IRS and out, 
prefer gradual increases in funding, as opposed to a sudden increase. A 
sudden increase would likely overwhelm the IRS and be implemented 
inefficiently and with too little oversight. Despite this 
recommendation, we believe the IRS funding shortage is an urgent matter 
and should be addressed as quickly as possible.
    Ultimately, as with most fiscal issues, the root of the problem is 
political. The case must be made that fears of an IRS run amok are, in 
a way, a self-fulfilling prophecy. Attempting to curtail the powers of 
the IRS through inadequate funding levels has had unintended 
consequences--it has forced the IRS to institute policies and 
enforcement practices detrimental to tax collection, taxpayers' rights, 
and the progressivity of the tax code. So long as the IRS is 
underfunded, it will be forced to enforce the tax code unfairly and 
punitively. However, if the IRS is properly funded and administered 
correctly, the Federal Government will have the opportunity to make 
substantial progress in reducing the tax gap and to ensure the tax 
system is as progressive in practice as it is in law.

                 STATEMENT OF SENATOR RICHARD J. DURBIN

    Senator Durbin. The IRS administers the tax laws and 
collects $2.4 trillion in revenue that fund over 96 percent of 
Federal Government operations. With approximately 90,000 
employees, the IRS is effectively the accounts receivable 
department of the United States. Simply stated, the more 
revenue the IRS collects, the more revenue Congress may spend 
to either cut taxes, reduce the deficit, or advance important 
programs. And conversely, the less that is collected, the less 
revenue Congress has for these same purposes.
    The IRS relies on three sources of funds it needs to 
operate: appropriated funds, user fees, and reimbursables, 
which are payments to the IRS which they receive from other 
Federal agencies and State government for services. Nearly the 
entire IRS budget, 97 percent of it, is derived from 
appropriated funds.
    For fiscal year 2009, the Bush administration is asking a 
direct appropriation of $11.36 billion. It is an overall 
increase of $469 million, or 4.3 percent, above fiscal year 
2008.
    In addition to the request for appropriated funds in fiscal 
year 2009, the IRS also expects to realize nearly $108 million 
from reimbursable programs and $177 million in user fees, 
bringing total spending to $11.647 billion.
    By breakdown of the nearly $11.4 billion appropriation 
requested, $2.15 billion is for taxpayer services; $5.12 
billion for enforcement; $3.86 billion for operations support; 
$222.7 million for business system modernization; and $15.4 
million for health insurance tax credit administration.
    As the subcommittee evaluates the President's request, we 
will take stock of the recommendations of the Oversight Board 
and a lot of experts. I know the Oversight Board is tasked by 
law to review and assess the annual budget request for the IRS 
to make sure it supports the agency's annual and long-term 
strategic plans.
    Before we hear our panelists, I would like to mention just 
a few of the issues we will be considering.
    First, how does the proposed budget address the tax gap? 
The great majority of Americans pay their fair share of taxes, 
but there is still a significant tax gap. That is the 
difference between what taxpayers are supposed to pay and what 
they actually pay. I note that as part of its budget 
submission, the IRS proposes 16 legislative reforms to recoup 
$36 billion of the $290 billion net tax gap over the next 10 
years.
    Questions have been raised that such an approach is not 
aggressive enough and amounts to a return of just slightly over 
a penny on the dollar. I am anxious to hear perspectives from 
our panel members.
    Second, does this proposed budget achieve the proper 
balance between enforcement and service? It is fundamental that 
as enforcement initiatives to boost compliance are advanced, 
resources for taxpayer services not be sacrificed. Taxpayer 
service plays an integral role in facilitating voluntary 
compliance.
    Third, does the proposed budget promote critical 
investments and ensure meaningful progress in information 
technology enhancements? Let me just say that we know that the 
IRS is facing, in addition to the regular tax return filing 
season, the issuance of $100 billion in stimulus payments in 
the form of rebate checks over the next few months. I 
understand that as of March 28, the IRS received an estimated 
1.4 million tax returns from individuals who filed them solely 
to receive the rebates. I also understand the IRS has been 
receiving an average of more than 63,000 calls per day above 
the normal volume asking questions about the rebates.
    Let me just say there are many topics of concern that we 
will go into in the hearing, but in the interest of moving it 
along, I am going to ask my colleague, Senator Allard from 
Colorado, if he has an opening statement or a comment that he 
would like to make.
    Senator Allard. I do, Mr. Chairman, just brief comment, if 
I might.
    Senator Durbin. And when he is finished, we will proceed 
with questions.

                   STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman, for holding 
today's hearing. I would like to thank our panelists for 
joining us this afternoon.
    For some time now, I have been following closely and 
showing some concern on the IRS's ongoing audit process 
involving the conservation easement donations in Colorado. I 
understand Colorado is one of the top States in the number of 
conservation efforts that it has undertaken, and it is an issue 
of great importance to our State and many people in it and our 
quality of life as far as our goals for open space. And I 
support the IRS investigation and enforcement of legitimate 
fraud in an effort to route out abuse of the conservation 
easements tax credit program.
    However, at times I wonder if the IRS has wrongly targeted 
honest and hardworking Coloradans throughout their 
investigation. I hope that they would refocus its investigation 
and approach the issue in a fair and reasonable manner. There 
are at least 96 audits involving donations to mainstream 
conservation organizations that follow the letter and the 
spirit of the law, I believe. Some of the 96 donations were 
verified by legitimate conservation easements by the U.S. 
Department of Agriculture and other Government agencies, I am 
led to believe.
    I would urge you to follow the model set by Colorado and 
refocus on cases involving an appraiser or land trust who has 
been disciplined or is currently under investigation by the 
State. Hopefully, this approach will rightly target the actual 
abuse, while releasing lawful easement donations from 
multiyear, stressful, and unjustified audits.
    So we will be following this particular area closely, Mr. 
Chairman. My office has been contacted by a number of 
organizations that work with these easements. And I would 
encourage the Internal Revenue Service on their investigations 
to use common sense in their approach, and I understand that 
there are violations and there have been reasons why you have 
had to look at some of these deals in Colorado. But on the 
other hand, we hope that we do not get too broad and snare and 
tie up innocent parties that perhaps did not violate the law.
    So thank you very much, Mr. Chairman.
    Senator Durbin. Thank you, Senator Allard.
    [The statement follows:]

               Prepared Statement of Senator Wayne Allard

    Thank you, Mr. Chairman, for holding today's hearing. I would also 
like to thank our panelists for joining us this afternoon.
    For some time now I have been involved and concerned by the IRS' 
ongoing audit process involving conservation easement donations in 
Colorado. Colorado is a national leader in conservation, and it is an 
issue of great importance to our state's economy and quality of life.
    I support the IRS' investigation and enforcement of legitimate 
fraud in an effort to root out abuse of the conservation easement tax 
credit program. However, I feel the IRS has wrongly targeted honest and 
hard working Coloradoans throughout their investigation.
    I hope the IRS would refocus its investigation and approach the 
issue in a fair and reasonable manner. There are at least 96 audits 
involving donations to mainstream conservation organizations that 
follow the letter and spirit of the law. Some of these 96 donations 
were verified to be legitimate conservation easements by the U.S. 
Department of Agriculture and other Government agencies.
    The IRS should follow the model set by Colorado and refocus on 
cases involving an appraiser or land trust who has been disciplined or 
is currently under investigation by the State. This approach will 
rightly target the actual abuse while releasing lawful easement donors 
from multi-year, stressful, and unjustified audits.
    If the IRS decides not to alter the ongoing audit process they and 
the hardworking taxpayers can expect a long drawn-out battle. If they 
stay on their current course, the IRS may be faced with over 200 
appeals. This many appeals will take a lot of time and resources to 
build a case for every easement in question. At what cost? The American 
taxpayers are on the hook for this process that has been going on for 
several years already and there is no end in sight.
    There is a significant need for conservation easements in Colorado 
and a few abuses should not end the charitable tax credit for everyone.
    Thank you, Mr. Chairman.

    Senator Durbin. Senator Brownback.

                   STATEMENT OF SENATOR SAM BROWNBACK

    Senator Brownback. Thank you very much, Mr. Chairman. I 
appreciate this.
    Welcome, Commissioner. Glad to have you here, 4 weeks onto 
the job. Yesterday, I guess, was your big day. The rest of us 
were not celebrating yesterday. But delighted to have you here 
and in that job and position.
    I do want to make a point about yesterday, and I appreciate 
the hearing, appreciate you being here on our budget. But I was 
noting in my opening remarks that on the complexity of the Tax 
Code, you have 800 different IRS tax forms--800. And I do not 
know if any one person fills out all 800 of them. If they fill 
out 100 of them or if they fill out 50, this is an unbelievably 
complex Tax Code. That is your problem to enforce, but that is 
our problem in the creation of it. And as I just pointed out I 
think we are well overdue for tax simplification.
    You are only 4 weeks into a job, but it is a 5-year 
appointment, and I would hope that over the period of time that 
you are Commissioner, that you really help us work on tax 
simplification and that you become an advocate for it. I 
mention that you note there is a part of your enforcement 
problem that is involved the so-called tax gap. In your 
congressional budget justification, you state that a major 
contributing factor to the tax gap is that our tax system is so 
complex that taxpayers cannot figure out what they owe. So a 
big part of your enforcement problem is taxpayers not being 
able to figure out which of the 800 forms they are supposed to 
fill out. That is why I really think we have got to look at tax 
simplification.
    I have put forward a proposal, an optional flat tax, leave 
the Code in place, but let people choose a simpler system. And 
I do not expect you to put a proposal forward in the short term 
while you are in, but I do hope during the time that you are 
Commissioner you really help us wrestle with that problem. It 
will make your job a lot simpler. I think it will be well 
received across the country, that they want to see a simpler, 
fairer, flatter system, and I would hope that we could learn in 
your position to get a Code that is a lot easier for people to 
understand and a lot easier to enforce too.
    Thank you, Mr. Chairman.
    [The statement follows:]

              Prepared Statement of Senator Sam Brownback

    Good afternoon. I want to thank you, Chairman Durbin, for your 
leadership on this subcommittee. As always, I look forward to working 
with you during this coming year as we make funding decisions and 
provide oversight to the various agencies within this subcommittee's 
jurisdiction.
    Commissioner Shulman, thank you for appearing before our 
subcommittee today. I understand you have only been with the IRS a few 
weeks, so this is certainly a busy time for you to be taking the reins. 
I'm pleased we have such a highly qualified person in the job and I 
look forward to hearing the details of your fiscal year 2009 budget 
request. Your budget justification says that the IRS ``represents the 
face of the U.S. government to more American citizens than any other 
agency.'' As surprising as it may seem in Washington, many Americans 
only come into direct contact with the Federal Government on Tax Day. I 
appreciate the work that you and your staff do to ensure taxpayer 
compliance and to provide taxpayer assistance.
    I must take this opportunity, though, to express my deep concerns 
about the current tax system. Yesterday was a dark day for most 
Americans as they rushed to file their tax returns. Every year, 
taxpayers suffer under the burden of our complex and complicated tax 
code, confused by over 800 different IRS tax forms, perplexed by 
hundreds of pages of IRS instruction books, and nervous that they will 
make a mistake trying to calculate how much of their money they owe the 
Federal Government.
    This current maze of tax regulations is so convoluted and complex 
that many Americans believe it is not only incomprehensible, but 
unfair. This confusion is one reason why almost two-thirds of all 
taxpayers have given up on trying to figure out how to complete their 
own tax returns and now spend even more of their hard-earned wages to 
pay someone else to sort it all out.
    I'm not blaming you for this state of affairs, Commissioner 
Shulman. Lawmakers have created this labyrinthine maze and you and your 
people are just working to administer it.
    Looking at the President's budget request, I am pleased that it 
includes a 7 percent increase for taxpayer enforcement to work toward 
closing the so-called ``tax gap.'' Certainly, we must ensure that taxes 
which are owed are collected. But your own congressional budget 
justification states that a major contributing factor to the ``tax 
gap'' is that our tax system is so complex that taxpayers cannot figure 
out what they owe. I have been informed that the annual tax gap is 
about $290 billion. I'm glad to see that the IRS is devoting resources 
to closing this gap, but I believe that as long as we have this 
convoluted and burdensome system, the gap between taxes owed and taxes 
paid will remain substantial.
    Again, Commissioner Shulman, this system is one that you have 
inherited. I am in no way blaming you for this state of affairs. But I 
have to take this opportunity to continue to push for an optional flat 
Federal income tax. A flat tax would be a clear and fair way for 
American families to figure out what they owe and put it on a one-page 
form to the Federal Government. As long as a flat tax rate is 
reasonable, it is a fairer tax than the current system because it taxes 
all earned income at the same rate. Workers would not be punished for 
working harder and earning more money, because each dollar that they 
earn would be taxed at the same exact rate. This would be fairer, 
simpler, easier to understand, and would produce more economic activity 
and jobs.
    Finally, I am pleased that Americans will soon be receiving 
economic stimulus checks in the mail. I certainly support these tax 
rebates to hard-working families. But the complexity of the tax system 
was again evident when the IRS recently had to hold a ``Super 
Saturday,'' opening hundreds of IRS offices to help folks file their 
returns so that they could receive their economic stimulus payments. In 
fact, your agency must spend over $2 billion every year just to help 
people figure out how to complete their tax returns. Quite frankly, 
that says it all.
    So Commissioner Shulman, I thank you for your service and I look 
forward to hearing your testimony this afternoon.
    Thank you, Mr. Chairman.

             STATEMENT OF IRS COMMISSIONER DOUGLAS SHULMAN

    Senator Durbin. Thanks a lot.
    Commissioner Shulman, the table is yours for a 5-minute 
statement. All the rest will be put in the record. And welcome.
    Mr. Shulman. Thank you, Chairman Durbin, Ranking Member 
Brownback, Senator Allard. I appreciate the opportunity to 
appear here before the subcommittee. As you have noted and 
noticed, I am in my fourth week on the job. Let me reiterate to 
this subcommittee that I look forward to working with you 
during my entire tenure here to address the critical issues 
related to the IRS.
    I would also like to introduce the IRS's two Deputy 
Commissioners, Richard Spires and Linda Stiff, who are here 
with me today. They have really done an excellent job guiding 
the agency through what, by any measure, are some tough times: 
this filing season, the late enactment of the alternative 
minimum tax (AMT) legislation, and then the stimulus package. I 
am lucky to have them on the team. I also wanted to make sure 
we are responsive to any questions and given that I am 4 weeks 
into this, I wanted to make sure they were here with me today.
    This morning I will touch quickly on the filing season and 
our proposed budget, but I will also try to give you a little 
sense of my approach to the job.
    Yesterday we completed what looks like a successful filing 
season. Electronic filers were up 10 percent as of yesterday. 
The number of returns prepared by our volunteer income tax 
assistance and tax counseling for the elderly centers 
throughout the country were up 26 percent. The usage of our 
Free File program, which allows 70 percent of all Americans to 
prepare and file their returns electronically, was up 20 
percent this year. And visits to IRS.gov were up 21 percent.
    We also, as I mentioned, are having a successful filing 
season despite some pressures, including late enactment of the 
AMT and, as you mentioned, Mr. Chairman, the stimulus program 
which was put on top of filing season.
    Regarding the stimulus program, we have done an extensive 
outreach program to make sure Americans know that all they need 
to do is file a tax return in order to get a stimulus payment. 
We put particular emphasis on informing Americans who normally 
would not file a return, but are eligible for stimulus 
payments, that they need to file a return this year. These are 
people who receive Social Security, receive veterans benefits, 
low income workers.
    I also want to urge this subcommittee to support full 
funding of the IRS's 2009 budget request. This budget will 
allow us to continue a strong emphasis on taxpayer service, but 
also to continue to build on our good record of enforcement 
programs to target noncompliance.
    During my confirmation process, I was asked by the Senate 
Finance Committee whether I thought it was most important to 
focus on service or to focus on enforcement. And my answer 
there--and I fervently believe this--is that for the IRS to 
achieve its compliance objectives, we have to continue to focus 
on both service and enforcement. Said another way, I think we 
need to do everything we can to make it as seamless and easy as 
possible for taxpayers who want to pay the right amount of 
taxes to navigate our organization, get their questions 
answered, pay their taxes, and get on their way. But for anyone 
who understands his or her tax obligation and is trying to 
evade that obligation, we need to have aggressive enforcement 
programs.
    Another area of focus for me will be technology 
modernization. The evolution of technology has changed the way 
that every major organization, private and public, goes about 
doing its work. As we adapt to this changing world, my goal is 
relatively simple. It is to get the right information into the 
hands of the right people at the right time, whether that is 
getting information into the hands of taxpayers or our people 
trying to do service or enforcement.
    The other area I would mention quickly is our need to 
continue to focus on leadership and workforce. The IRS, like 
other Government agencies, is going to have a lot of people 
retiring in the next couple of years. There is competition for 
talent, and we are going to need to keep focusing on building 
our next generation of leaders and developing our workforce.

                           PREPARED STATEMENT

    So let me thank you again, Mr. Chairman, for the 
opportunity to appear this morning. In my short tenure, I have 
found the people at the IRS to be extremely professional, 
hardworking, and dedicated to the American people every day. I 
am committed to work every day to provide the level of service 
that taxpayers deserve, as well as to rigorously enforce the 
tax laws. We obviously need resources to execute this mission, 
and I encourage this subcommittee to fully fund the 
administration's 2009 proposed budget. Thank you, and I am 
happy to answer questions.
    Senator Durbin. Thanks, Mr. Commissioner.
    [The statement follows:]

                 Prepared Statement of Douglas Shulman

                              INTRODUCTION

    Chairman Durbin, Ranking Member Brownback, and members of the 
subcommittee, thank you for the opportunity to appear today. This is my 
third hearing as the IRS Commissioner and I look forward to working 
with the Members of this subcommittee in the future as we address 
issues related to the IRS.
    As I settle in to my new role, it becomes clearer to me each day 
what a privilege it is to be the Commissioner of the IRS. The IRS and 
its employees represent the face of United States Government to more 
American citizens than any other Government agency. We administer 
America's tax laws and collect over 96 percent of the revenues that 
fund the Federal Government each year.
    My most recent experience has been as the Vice Chairman of the 
Financial Industry Regulatory Authority (FINRA), formerly the NASD. In 
2007, NASD consolidated with the member regulation, enforcement, and 
arbitration functions of the New York Stock Exchange to form FINRA. 
Based on my previous experience, I believe that leaders of large 
organizations--public and private--always must be focused on ensuring 
that resources are aligned with strategic priorities. It is incredibly 
important that there be a balance of resources between day-to-day 
execution and investments for the longer term. In my first 4 weeks, I 
have been working with the senior executive team of the IRS to 
understand how resource allocation decisions have been made. The 
subcommittee can expect ongoing dialog and personal engagement from me 
on these issues.

                           2008 FILING SEASON

    The biggest challenge the IRS faced at the end of 2007, as it 
approached the 2008 filing season, was the uncertain status of 
legislation to address the situation of an additional 21 million 
taxpayers who otherwise would have become subject to the alternative 
minimum tax (AMT).
    On October 30, 2007, Chairman Baucus, Ranking Member Grassley of 
the Senate Finance Committee House and their counterparts on the House 
Ways and Means Committee, sent a letter assuring the IRS that Congress 
intended to enact AMT relief (the AMT patch) in a manner acceptable to 
the Senate, the House of Representatives, and the President. I am told 
that this letter was very helpful because it allowed the IRS to move 
forward on certain planning and design aspects of implementing the AMT 
relief legislation, shortening the implementation process by a number 
of weeks.
    However, the IRS indicated at the time that its key systems could 
accommodate only one programming option without introducing excessive 
risk to the filing season. As a result, the IRS was able to proceed 
only so far without actual legislation being enacted. When the 
President signed the AMT relief law on December 26, 2007, the IRS 
immediately began the detailed reprogramming of systems to accommodate 
the new law. IRS employees worked diligently to modify systems to 
implement the changes in a very short time period. My thanks go out to 
all of those dedicated employees who worked almost around the clock to 
enable us to implement this AMT relief legislation in record time.
    Given their efforts, we were able to begin the filing season on 
schedule for most taxpayers. However, the processing of returns filed 
by approximately 13.5 million taxpayers that included one of five forms 
associated with the AMT legislation was delayed. These taxpayers had to 
wait until February 11, 2008, before their returns could be processed.
    The other challenge facing us this filing season is the 
implementation of the economic stimulus package enacted in early 
February, specifically the planning for the distribution of the 
stimulus payments to eligible recipients throughout the country this 
spring. To deliver the 2008 stimulus payments, we have been programming 
our systems to calculate the appropriate amount for each eligible 
taxpayer based on their 2007 returns so that the payments can be 
distributed, through Treasury's Financial Management Service, by direct 
deposit or by paper check, based on the preferences expressed on the 
taxpayer's return.
    We will begin immediately after the close of the filing season to 
distribute those payments with the expectation that the first payments 
will be sent electronically starting in the first week of May and with 
the first paper checks being mailed shortly thereafter. We have 
established a distribution schedule that is published on the IRS 
website on a page dedicated to informing citizens about the economic 
stimulus payments.
    However, there are millions of individuals who may be eligible for 
economic stimulus payments, but who typically do not have an income tax 
filing requirement. This group includes retirees or those who have 
minimal income and are thus not required to file. But in order to 
receive the 2008 stimulus payment, the recipient must file a tax return 
for 2007. To reach these recipients and educate them requires an 
extensive outreach program that includes the mailing of information 
packets and IRS coordinating with the Social Security Administration 
and Department of Veterans Affairs, along with private groups such as 
the AARP.
    Despite the challenges presented by the late enactment of the AMT 
patch and the implementation of the economic stimulus payments, I am 
proud to report that thus far the filing season has gone very well. 
Allow me first to give an update on some of the numbers we are looking 
at as we close out the filing season.

Numbers Thus Far
    We expect to process nearly 140 million individual tax returns in 
2008, and we anticipate continued growth in the number of those that 
are e-filed. In the 2007 filing season, almost 60 percent of all income 
tax returns were e-filed. We fully expect to exceed that number this 
year. As of April 5, we have received over 67 million tax returns 
electronically, an increase of 10 percent compared to the number of 
returns that were e-filed during the same period last year.
    This increase in e-filing is being driven by people preparing their 
own returns using their personal computers. The total number of self-
prepared returns that are e-filed is up by 18.2 percent compared to the 
number of self-prepared returns filed during the same period a year 
ago. Over 19 million returns have been e-filed by people from their 
personal computers, up from just over 17 million for the same period a 
year ago.
    Overall, nearly 70 percent of the returns filed through April 5 
have been e-filed. 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. For 
the IRS, the error-reject rate for e-filed returns is significantly 
lower than that for paper returns.
    More people are choosing to have their tax refunds deposited 
directly into their bank account than ever before. As of April 5, we 
have directly deposited over 53.6 million refunds, or over 71 percent 
of all refunds issued this tax filing season.
    People are also visiting our web site--IRS.gov--in record numbers. 
We have recorded over 132 million visits to our site this year, up over 
21 percent from 109 million for the same period a year ago. The 
millions of taxpayers that have visited IRS.gov have benefited from 
many of the services that are available through the IRS.gov web site. 
The web site:
  --Allows taxpayers to obtain information on the economic stimulus 
        package including determining the payment amount they can 
        expect to receive and learning when they can expect their 
        payment based on their Social Security Number (SSN);
  --Assists taxpayers in determining whether they qualify for the 
        Earned Income Tax Credit (EITC);
  --Assists taxpayers in determining whether they are subject to the 
        Alternative Minimum Tax (AMT);
  --Allows more than 70 percent of taxpayers the option to prepare and 
        file their tax returns at no cost through the Free File 
        program. This includes giving a free option for those taxpayers 
        who normally do not file a tax return, but are required to this 
        year in order to receive their stimulus payment;
  --Allows taxpayers who are expecting refunds to track the status via 
        the ``Where's My Refund?'' feature; and
  --Allows taxpayers to calculate the amount of their deduction for 
        State and local sales taxes.
    We have issued 75.1 million refunds as of April 5, for a total of 
$183 billion. The average refund thus far is $2,436. In addition, 
nearly 28 million taxpayers have tracked their refund on IRS.gov, up 
nearly 20 percent over last year.
    As of March 29, our Taxpayer Assistance Centers (TACs) are 
reporting over 2.1 million taxpayers assisted. Our telephone assistors 
have answered over 13 million calls, and over 17 million callers 
received automated services.

Free File
    Over 3.6 million people have utilized Free File as of April 5, 
2008, an increase of 19.7 percent compared to the number of taxpayers 
that used Free File during the same period a year ago. This year anyone 
with adjusted gross income of $54,000 or less is eligible for Free 
File, which includes 97 million taxpayers. The number of Free File 
returns compared to the prior year has been steadily increasing, and we 
expect to meet or exceed 2007 totals by the end of the filing season. 
One reason for this increase is that we have committed additional 
resources to promote the Free File program.

VITA/TCE Sites and Other Community Partnerships
    The use of tax return preparation alternatives, such as volunteer 
assistance at Volunteer Income Tax Assistance (VITA) sites and Tax 
Counseling for the Elderly sites (TCEs), has steadily increased over 
the years. In 2007, over 2.6 million returns were prepared by 
volunteers. As of April 5, 2008, volunteer return preparation is up 
over 26 percent compared to the number of volunteer-prepared returns 
filed during the same period a year ago. This is reflective of 
continuing growth in existing community coalitions and partnerships.
    We also have made a concerted effort to expand outreach to 
taxpayers, particularly those taxpayers who may be eligible for the 
EITC. For example, we sponsored again this year EITC Awareness Day on 
January 31, 2008, in an effort to partner with our community coalitions 
and partnerships to reach as many EITC-eligible taxpayers as possible 
and urge them to claim the credit. Over 125 coalitions and partners 
hosted local news conferences and issued more than 100 press releases 
highlighting EITC Awareness Day this year.

         A COMMITMENT TO SERVICE, ENFORCEMENT AND MODERNIZATION

    I understand that in fiscal year 2007, the IRS continued making 
improvements in our service and enforcement programs as well as having 
significant successes in our IT modernization program. A few highlights 
of the IRS' fiscal year 2007 accomplishments include:
  --The IRS customer assistance call centers answered 33.2 million 
        assistor telephone calls and 21.1 million automated calls. We 
        maintained an 82.1-percent level of service on the telephone 
        with an accuracy rate of 91.2 percent on tax law questions.
  --Outreach and educational services were enhanced through 
        partnerships between the IRS and public organizations. Through 
        its 11,922 VITA and TCE sites, the IRS provided free tax 
        assistance to the elderly, disabled, and limited English 
        proficient individuals and families. Over 76,000 volunteers 
        filed 2.63 million returns for these individuals. Additionally, 
        the IRS established 6 new tax clinics in rural areas to help 
        low-income taxpayers meet their tax obligations.
  --Enforcement revenue has risen from $33.8 billion in fiscal year 
        2001 to $59.2 billion, an increase of 75 percent. These numbers 
        do not include the deterrent effect that an increased 
        enforcement presence has on voluntary compliance.
  --Both the levels of individual returns examined and coverage rates 
        have risen substantially. The IRS conducted nearly 1.4 million 
        examinations of individual tax returns in fiscal year 2007, an 
        8-percent increase over fiscal year 2006. This level of 
        examinations is over three-quarters more than were conducted in 
        fiscal year 2001, and reflects a steady and sustained increase 
        since that time. Similarly, the audit-coverage rate has risen 
        from 0.6 percent in fiscal year 2001 to 1 percent in fiscal 
        year 2007. This increase was achieved without a significant 
        increase in resources as compared to the previous fiscal year.
  --The Customer Accounts Data Engine (CADE) Release 3.2 was delivered 
        on time (January 14, 2008) for this filing season and is doing 
        well in production. As, of April 11, CADE had processed 24.98 
        million returns, which is more than 25 percent of all 
        individual returns filed to date for this year. CADE also has 
        issued almost $38 billion in tax refunds.
  --Modernized e-File (MeF) is the IRS designated e-File platform 
        (electronic filing system) for the future and provides e-Filing 
        capability for large corporations, small businesses, 
        partnerships, and non-profit organizations. As of April 5, MeF 
        has accepted 1.82 million corporate, partnership, and tax 
        exempt tax returns, a 45-percent increase from this same period 
        a year ago. MeF Release 5 went into production as planned in 
        January 2008 and provides the ability to file electronically 
        Form 1120F (tax returns for foreign corporations) and Form 990N 
        (so-called electronic postcard for small tax-exempt 
        organizations to meet their filing requirement).

THE ADMINISTRATION'S FISCAL YEAR 2009 BUDGET FUNDS TAXPAYER SERVICE AND 
                              ENFORCEMENT

    The fiscal year 2009 budget request funds activities that promote 
better tax administration and compliance with the tax laws. The fiscal 
year 2009 budget request for the enforcement program is $7,487,209,000, 
an increase of $489,983,000, or 7 percent, over the fiscal year 2008 
enacted level. The Administration proposes to include these enforcement 
increases as a Budget Enforcement Act program integrity cap adjustment. 
The enforcement program is funded from the Enforcement appropriation 
and part of the IRS Operations Support appropriation.

Budget Request
    For fiscal year 2009, the President is requesting a total of 
$11,361,509,000 for IRS activities. This amount is a $469,125,000 
increase, or 4.3 percent, over the fiscal year 2008 enacted level.
    The overall IRS budget is broken down into the following five 
appropriations:
  --Taxpayer Services.--The fiscal year 2009 requested level for this 
        area is $2,150,000,000. This is the same as the fiscal year 
        2008 enacted level. The Operations Support account provides an 
        additional $1.5 billion to support taxpayer service activities.
  --Enforcement.--The fiscal year 2009 request is $5,117,267,000. This 
        level is an increase of 7.1 percent from the fiscal year 2008 
        enacted level. As mentioned earlier, the Operations Support 
        budget provides an additional $2.4 billion to support 
        enforcement activities.
  --Operations Support.--The fiscal year 2009 request is 
        $3,856,172,000. This level is an increase of 4.8 percent from 
        the fiscal year 2008 enacted level.
  --Business Systems Modernization.--The fiscal year 2009 request is 
        $222,664,000. This level is a reduction of 16.6 percent from 
        the fiscal year 2008 enacted level. This appropriation funds 
        the planning and capital asset acquisition of information 
        technology to modernize the IRS business systems, including 
        labor and related contractual costs.
  --Health Insurance Tax Credit Tax Administration.--The fiscal year 
        2009 request for this program is $15,406,000. This is an 
        increase of 1.1 percent from the fiscal year 2008 enacted 
        level. This appropriation funds costs to administer a 
        refundable tax credit for health insurance to qualified 
        individuals, which was enacted as part of the Trade Adjustment 
        Assistance Reform Act of 2002.
    The justification for the requests in each of these areas is 
discussed in detail below.

Adjustments from Fiscal Year 2008 Levels To Help Improve Compliance
    The IRS total requested funding increase for fiscal year 2009 is 
$469,125,000. This increase will go to improving compliance. These 
investments fund increased front-line enforcement efforts, enhanced 
research, and implementation of legislative proposals to help narrow 
the tax gap. By fiscal year 2011, these investments are projected to 
increase annual enforcement revenue by $2 billion. In addition, the 
legislative proposals included in the fiscal year 2009 budget to 
improve tax compliance are estimated to generate $36 billion over the 
next ten years, if enacted.
    Specific increases to improve compliance include:
  --Reduce the Tax Gap for Small Business and the Self Employed 
        (+$168,498,000/+1,608 FTE).--This enforcement initiative will 
        increase enforcement efforts to improve compliance among small 
        business and self-employed taxpayers by: increasing audits of 
        high-income returns, increasing audits involving flow-through 
        entities, implementing voluntary tip agreements, increasing 
        document-matching audits, and collecting unpaid taxes from 
        filed and non-filed tax returns. This request will generate 
        $981 million in additional annual enforcement revenue once new 
        hires reach full potential in fiscal year 2011.
  --Reduce the Tax Gap for Large Businesses (+$69,488,000/+519 FTE).--
        This enforcement initiative will increase examination coverage 
        of large and mid-size corporations, including multi-national 
        businesses, foreign residents, and smaller corporations with 
        significant international activity. It also will enable the IRS 
        to use existing systems further to capture other electronic 
        data through scanning and imaging. The initiative will allow 
        the IRS to address risks arising from the rapid increase in 
        globalization, and the related increase in foreign business 
        activity and multi-national transactions where the potential 
        for non-compliance is significant. Funding of this request will 
        generate $544 million in additional annual enforcement revenue 
        once the new hires reach full potential in fiscal year 2011.
  --Improve Tax Gap Estimates, Measurement, and Detection of Non-
        Compliance (+$51,058,000/+393 FTE).--This enforcement 
        initiative will support and expand ongoing research studies, 
        including the National Research Program, of filing, payment, 
        and reporting compliance to provide a comprehensive picture of 
        the overall taxpayer compliance level. Research allows the IRS 
        to target better specific areas of noncompliance, improve 
        voluntary compliance, and allocate resources more effectively. 
        Improved research data will be used to refine workload 
        selection models, reducing audits of compliant taxpayers.
  --Increase Reporting Compliance of U.S. Taxpayers with Offshore 
        Activity (+$13,697,000/+124 FTE).--This enforcement initiative 
        will address domestic taxpayer offshore activities. Abusive tax 
        schemes, under-reporting of flow-through income, and certain 
        high-income individuals are prime channels or candidates for 
        tax evasion. This initiative will focus on uncovering offshore 
        credit cards, disguised corporate ownership, and brokering 
        activities in order to identify individual taxpayers who are 
        involved in offshore arrangements that facilitate 
        noncompliance. Funding of this request will generate $102 
        million in additional annual enforcement revenue once the new 
        hires reach full potential in fiscal year 2011.
  --Expand Document Matching (+$35,060,000/+413 FTE).--This enforcement 
        initiative will increase coverage within the Automated 
        Underreporter (AUR) program. This program matches third-party 
        information returns (e.g., Form W-2 and Form 1099 income 
        reports) against income claimed on tax returns. When potential 
        underreporting is discovered taxpayers are contacted to resolve 
        the issue. This request will produce $359 million in additional 
        annual enforcement revenue once the new hires reach full 
        potential in fiscal year 2011.
  --Implement Legislative Proposals To Improve Compliance 
        (+$23,045,000/0 FTE).--While the IRS continues to address 
        compliance by improving customer service and using traditional 
        methods of enforcement, the fiscal year 2009 budget also 
        includes legislative proposals that would provide additional 
        enforcement tools to improve compliance. It is estimated that 
        these proposals, if enacted, will generate $36 billion in 
        revenue over 10 years (see the Treasury Blue Book, available on 
        the Treasury Department web site, for more information). The 
        proposals would expand information reporting, improve 
        compliance by businesses, strengthen tax administration, and 
        expand penalties. This enforcement initiative includes funding 
        for purchasing software and making modifications to the IRS IT 
        systems necessary to implement the proposals. The specific 
        legislative proposals are discussed below.

Specific Legislative Proposals
    The Administration's fiscal year 2009 budget includes a number of 
legislative proposals intended to improve tax compliance while 
minimizing the burden on compliant taxpayers as much as possible. These 
include:
  --Expand information reporting.--Compliance with the tax laws is 
        highest when payments are subject to information reporting to 
        the IRS. Specific information reporting proposals would:
    --Require information reporting on payments to corporations;
    --Require basis reporting on security sales;
    --Require information reporting on merchant card payment 
            reimbursements;
    --Require a certified Taxpayer Identification Number (TIN) from 
            contractors;
    --Require increased information reporting on certain Government 
            payments;
    --Increase information return penalties; and
    --Improve the foreign trust reporting penalty.
  --Improve compliance by businesses.--Improving compliance by 
        businesses of all sizes is important. Specific proposals to 
        improve compliance by businesses would:
    --Require electronic filing by certain large organizations; and
    --Implement standards clarifying when employee leasing companies 
            can be held liable for their clients' Federal employment 
            taxes.
  --Strengthen tax administration.--The IRS has taken a number of steps 
        under existing law to improve compliance. These efforts would 
        be enhanced by specific tax administration proposals that 
        would:
    --Expand IRS access to information in the National Directory of New 
            Hires for tax administration purposes;
    --Permit disclosure of prison tax scams;
    --Make repeated willful failure to file a tax return a felony;
    --Facilitate tax compliance with local jurisdictions;
    --Extend statutes of limitations where State tax adjustments affect 
            Federal tax liability; and
    --Improve the investigative disclosure statute.
  --Expand penalties.--Penalties play an important role in discouraging 
        intentional non-compliance. A specific proposal to expand 
        penalties would impose a penalty on failure to comply with 
        electronic filing requirements.

Improve Tax Administration and Other Miscellaneous Proposals
    The Administration has put forward additional proposals relating to 
IRS administrative reforms. Five of these proposals are highlighted 
below:
  --The first proposal modifies employee infractions subject to 
        mandatory termination and permits a broader range of available 
        penalties. It strengthens taxpayer privacy while reducing 
        employee anxiety resulting from unduly harsh discipline or 
        unfounded allegations.
  --The second proposal allows the IRS to terminate installment 
        agreements when taxpayers fail to make timely tax deposits and 
        file tax returns on current liabilities.
  --The third proposal eliminates the requirement that the IRS Chief 
        Counsel provide an opinion for any accepted offer-in-compromise 
        of unpaid tax (including interest and penalties) equal to or 
        exceeding $50,000. This proposal requires that the Secretary of 
        the Treasury establish standards to determine when an opinion 
        is appropriate.
  --The fourth proposal extends the IRS authority to use the proceeds 
        received from undercover operations through December 31, 2012. 
        The IRS was previously authorized to use proceeds it received 
        from undercover operations to offset necessary and reasonable 
        expenses incurred in such operations. This authority expired on 
        December 31, 2007.
  --The fifth proposal equalizes penalty standards between tax return 
        preparers and taxpayers, reducing unnecessary conflicts of 
        interest between them. The standard applicable to tax return 
        preparers for undisclosed positions would be ``substantial 
        authority'' but for certain reportable transactions with a 
        significant purpose of tax avoidance, the existing standard 
        would persist (i.e., the preparer should have a reasonable 
        belief that the position, more likely than not, would be 
        sustained on the merits).

                               CONCLUSION

    Thank you again, Mr. Chairman, for the opportunity to appear this 
morning and update the subcommittee on the filing season and the fiscal 
year 2009 proposed IRS budget. In my short tenure, I have found IRS 
employees to be professional, hardworking, and dedicated.
    I am committed to working hard everyday to provide taxpayers the 
high level of service they deserve and to pursue enforcement actions 
against those unwilling to meet their tax obligations.
    We need resources to execute against our plan, and I hope this 
subcommittee will support the full funding of the Administration's 
fiscal year 2009 proposed budget.
    I also urge this subcommittee to support the enactment of the 
legislative proposals included in the budget to improve compliance. 
Collectively, they will generate more $36 billion over the next 10 
years if enacted.
    I will be happy to respond to any questions.

                              CONTRACTORS

    Senator Durbin. In preparation for this hearing, I am 
hoping that you have read Parade magazine in last Sunday's 
newspaper because my first question relates to enforcement and 
an article in that Parade magazine. It was under their so-
called intelligence report entitled ``Are You Paying for 
Corporate Fat Cats?'' 61 percent of U.S. corporations paid no 
taxes, including 39 percent of large companies, according to 
this article. They went on to describe one company in 
particular, which I would like to ask you about.
    It turns out that one company employs one-third of our 
private contractors in Iraq. That company is Kellogg, Brown & 
Root (KBR), a former subsidiary of Halliburton. The company has 
54,000 people working in Iraq. Of these, over 21,000, including 
10,500 Americans, are considered Cayman Island hires. What has 
happened is that this company has created some subsidiaries or 
offices in the Cayman Islands, and by listing these employees 
paid by our Government as Cayman Island hires, they avoid 
paying the Medicare and Social Security taxes that all other 
American workers pay.
    So here we have Federal taxpayer dollars, emergency 
appropriations adding to our deficit to fund the private 
contractors who are being channeled through the Cayman Islands 
so that they will not have to pay taxes into the United States 
for Medicare and for Social Security. I want to know if the IRS 
is looking into it, and I want to know what more we can do to 
try to stop this.
    Mr. Shulman. Thank you for the question. Let me just state 
before I start, I obviously cannot speak about any specific 
taxpayers or any tax matters because of privacy laws. Let me 
just react on a general level, and then we would be happy to 
follow up.
    We are well aware and focused on the issue of independent 
contractors. Employment taxes are one of our responsibilities. 
Any issue with employment taxes is very fact-specific. We have 
a 20-point factor test that gets into the specific facts of a 
case. It is difficult for corporations and us to work through 
these issues, but we have a number of investigations ongoing in 
relation to employment taxes and subcontractors, and we view 
that as part of our job.
    I would also mention something I have spoken about publicly 
is that one of the challenges of our next 5 years is going to 
be grappling with the global economy, globalization, 
international tax issues. I have sat down with our team that 
focuses on these areas. I am quite familiar with these issues 
from my experience as a securities regulator and the global 
flow of capital. So issues around cross-border trade, employees 
located in multiple countries, paying the proper amount of U.S. 
taxes is something that is going to get focus from me.
    Senator Durbin. And I might say that it is not just KBR. A 
2004 study by the Government Accountability Office found that 
24 of the largest Federal contractors, contractors we pay by 
our Government, use the Cayman Islands to shave their tax 
bills. This bothers me that American companies doing the right 
thing are being penalized and other companies are profiting 
simply because they are creating these phony tax havens like 
the Cayman Islands.

                        PRIVATE DEBT COLLECTION

    Now let us talk for a minute about an issue that you have 
been asked a lot about, and that is this private collection 
agency for the IRS. This has been in place for a while now, 
these private debt collectors. There are several of them across 
the country, and they are not doing a very good job. If you 
take a look at our own IRS employees collecting taxes, the 
return on investment for taxpayers is 13 to 1. For the private 
collectors, it is only 3 to 1. To date, after spending $71 
million on startup and ongoing maintenance costs through the 
end of fiscal year 2007, the IRS private tax collection program 
has lost us $50 million.
    Why should we continue this?
    Mr. Shulman. This is an issue that I understand quite well 
has a lot of attention, and there are people who support the 
program and detractors from the program. I have committed to 
get my arms around this. As you can imagine, there are a 
variety of programs, most programs, that I still need some time 
to get up to speed on, and I am going to spend time getting up 
to speed on this.
    What I will tell you is I know the program has been 
authorized in the past by Congress. I have been told by the 
people at the IRS that they are working this program to the 
best of their abilities. We are very focused on the protection 
of taxpayer rights and data privacy. This year the program will 
do better than break even, and so there are variety of sunk 
costs that have not been recovered, but it is now at a point 
where it actually is bringing dollars into the Federal coffer.
    So on this one, I would say I plan on looking at it closely 
and studying the issue and would be happy and like to have 
further conversations.
    Senator Durbin. Thank you.

                          FORMS AND COMPLEXITY

    Senator Brownback.
    Senator Brownback. Thank you, Mr. Chairman.
    Do you really need 800 different forms?
    Mr. Shulman. As we have had a chance to discuss, clearly 
the tax law is complex. Clearly, that adds burden on the 
American people and makes our job difficult. I cannot speak to 
all the specific forms 4 weeks into the job.
    I will tell you a goal of mine is to create as much clarity 
as we can within the context of the law to the American people, 
make it as easy as possible, given the complexity of the law, 
for the American people to comply with their tax obligation.
    Senator Brownback. I hope you will look at that. That is 
just mind-boggling to me.
    I was just looking at the numbers that were just handed to 
me. The IRS spends $2 billion on taxpayer service helping 
people figure out their taxes. It is estimated that taxpayers 
spend $150 billion to figure out their taxes, either hiring 
third parties or in time taken away from other activities. $150 
billion that people are spending to figure out their taxes. 
That is amazingly high.
    Do you have any sense of how that compares to other 
countries in the developed world?
    Mr. Shulman. I do not, Senator.
    Senator Brownback. You have now got a growing set of 
countries that have moved to a flat tax. I think there is 
something like 16 that have gone to that system. I think it 
would be an interesting question to look at, what those 
countries spend in tax preparation time and money versus other 
places.

                           STIMULUS PAYMENTS

    Are you going to have any difficulty getting the economic 
stimulus checks out on time?
    Mr. Shulman. Since I have started the job, obviously this 
is something I am very focused on. Three times a week I have 
been in meetings with our staff. Everything looks like it is on 
track to have direct deposit checks go out the first week in 
May--start going out--and paper checks start going out shortly 
thereafter. So from everything I know, being in here 4 weeks, 
things look like they are on track to get the stimulus payments 
out on time.
    Senator Brownback. And to hit the dates?
    Mr. Shulman. Hit the targets that are on our web site that 
we have promised all along.
    Senator Brownback. You have said that you have spent a lot 
of time getting people signed up to file tax forms so they 
could get their stimulus check. Did you get a number of new 
registrants filing tax returns? I believe you had a special 
super Saturday, March 29, to do this?
    Mr. Shulman. We did something I am quite proud of, and it 
was a great way to start my first Saturday on the job. I went 
out to a retired veterans home and worked with our team. And we 
had 700 sites around the country open that Saturday, staffed 
with about one-half IRS and one-half volunteers. That day we 
had over 50,000 come into that combined group of sites.
    We are tracking very closely people who we think are only 
filing for stimulus payments. Yesterday we just got all the 
2007 returns. We are still processing paper returns. Later this 
month, we are actually going to look at the number of returns, 
try to figure out who we think is eligible, who has not filed 
yet, and then do another round of outreach. Our plan is 
actually to enlist both the administration and Members of 
Congress, if we see States where it looks like a lot of people 
have not availed themselves of the stimulus payments. We are 
going to be doing outreach and we will try to bring you in, as 
well, as partners.
    Senator Brownback. I do not know if many Members of 
Congress want to be very closely associated with the IRS, but 
maybe if it is passing checks out, that would change it.
    Do you have any idea of numbers of what you are talking 
about here? I see your activities, but do you have any idea on 
numbers?
    Mr. Shulman. We do not. It is very hard to estimate how 
many people are eligible. We are going to have a much better 
sense at the end of this month, and I can assure you our team 
will work on it. I have been pushing on this, and we are going 
to, hopefully by the end of the month, have a real sense of how 
many have come in and how many we think might still be 
eligible, based on Social Security rolls and other sources, and 
go out to more people.
    Senator Brownback. Will you be publishing, putting those 
numbers forth publicly?
    Mr. Shulman. We would be happy to share them with you.
    Senator Brownback. I think it would be good just because we 
are all very concerned about the economy, how many people are 
going to get checks, or an estimate?
    Mr. Shulman. Well, I am sorry. I might have misspoken. I 
was talking about the people who normally do not file who are 
eligible. We do have estimates of the broad numbers. We 
anticipate sending out over $100 billion in stimulus payments 
this year to over 130 million taxpayers. That is the gross 
number. We have not pinpointed the people who may be eligible 
who otherwise would not file a tax return, which is a group 
that we are very focused on providing service to.
    Senator Brownback. My time is up, but that is the number I 
was asking for, the number of people that you think would 
qualify but are not in the system getting or are not signed up, 
in your estimation who that would be? I would like to see if we 
could get that number.
    Mr. Shulman. Absolutely.
    Senator Durbin. Senator Allard.

                         CONSERVATION EASEMENTS

    Senator Allard. Thank you, Mr. Chairman.
    I want to pursue my opening comments on the conservation 
easements of Colorado. It is my understanding in mid-November, 
the Internal Revenue Service began making settlement offers to 
a significant number of conservation easement donors under 
audit in Colorado. According to your agency, the settlements 
were only offered in those cases where the sole issue between 
the owner and the Internal Revenue Service was the valuation. 
The offers generally fell into a bucket where the IRS stated 
only 30 percent or 60 percent or 75 percent of the original 
value of the charitable donation was allowed.
    And the question I have is, what were the criteria that you 
used to place different taxpayers into these various buckets, 
and did the IRS indicate in writing to the donor how and why 
you arrived at your decision, and if not, why?
    Mr. Shulman. Senator, I understand this issue. I had the 
opportunity to speak with your colleague from Colorado, Senator 
Salazar, at length about this issue. And what I shared with him 
I will share with you. I have also done some research on this, 
knowing that this would be of issue to you.
    My belief is that our job is to implement the tax laws in a 
way that achieves the intent of the policy that Congress puts 
forward, and so I share your goal that you talked about. The 
goal for quality of life and open space in Colorado is what we 
should be pursuing, which means we should make sure that we do 
not unduly restrict people trying to do the right thing and 
donate open space.
    I have been briefed on this issue, and I will tell you what 
I know. And I would like to come back with Steve Miller for 
anything I do not know, and meet with you and continue to 
pursue this.
    Since last fall, there has been some good progress, and 170 
offers have been made. The numbers I was given were higher than 
the ones you just discussed, and so I have to dig into it more. 
But I understand that, in general, these 170 offers across the 
board--the general number was in the 70 percent range of the 
tax deduction that people had looked for. So it was a little 
higher.
    Senator Allard. I just want to clarify for the record. You 
determined that it was overvalued by 70 percent. Is that what 
you said?
    Mr. Shulman. No, that people were offered 70 percent of 
their original claim. So if they claimed $100, they were----
    Senator Allard. You said, well, we will give you $70.
    Mr. Shulman. $70--and that is in aggregate of these 
offers--is the number as I understand.
    Senator Allard. Got you.
    Mr. Shulman. I also know that you requested that we be 
liberal in granting extensions of time for people to analyze 
offers and come back, and the Service was responsive to that.
    And I have been told that 20 to 25 more offers will go out 
in the next several weeks.
    These offers were the valuation cases. There are a number 
of much more complex cases that were put behind the valuation 
cases to move forward. They are very fact-intensive. We are 
coordinating with the State of Colorado on all of those. So 
there is some time around coordination and these will take some 
more time.
    Let me also tell you that the people running this program 
have told me they understand the frustration that you have 
around the length of time this has taken, and that they are not 
happy with the pace and would like to pick up the pace. They 
actually asked me for some more resources for appraisers, and 
it is something that I authorized today to try to move this 
backlog through. As I said, I believe we need to be thorough, 
but we also need to be expeditious, so people can get on with 
their business.
    Regarding the exact criteria, I have talked to the team 
about the program. I have not talked about any specific cases. 
I am 4 weeks into the job. I would like to request, if I could, 
to come back and talk with you.
    What I will tell you is I believe we need to move the 
backlog. I have requested and authorized to put some more 
appraisers onto these cases, and I will be focused on it. I 
have told your colleague Senator Salazar that as well.
    Senator Allard. Well, we are interested in seeing--you 
certainly have general criteria that you come to in doing your 
appraisals, and we would like to look at the qualifications of 
your appraiser on land values in Colorado particularly and have 
a concern about where maybe the Colorado Department of Revenue 
has already done a lot of the investigation, I hope you are not 
duplicating what they do. Maybe you can just assume that they 
have done a pretty good job and you follow with that and maybe 
save some time and expedite some of these jobs. And if you feel 
like you cannot, I would like to know why you feel like the 
State of Colorado is not doing an adequate job, and you need to 
go ahead and do that.
    So I have a list of questions here, and my time is expired 
here. So we would like to get those to you and then you can 
review them and get back and give us some detail on where we 
are on getting this process moving forward in Colorado. Thank 
you.
    Mr. Shulman. Thank you.
    Senator Allard. Thank you, Mr. Chairman.

                      MISCLASSIFICATION OF WORKERS

    Senator Durbin. Thanks, Senator Allard.
    Commissioner Shulman, this may have been done before you 
arrived, but the IRS prepared 16 legislative proposals and 
several administrative proposals for closing the tax gap with 
their 2009 budget submission. The one that is missing is a 
pretty big one. It is the misclassification of workers. It 
accounts for $148 billion in lost taxes each year. It 
represents 43 percent of the gross tax gap that we face as a 
country. It relates to people who call themselves independent 
contractors and evade payment of taxes that they are duly owing 
to the Federal and State government.
    So I would like to ask you if you are familiar with this 
issue, if you know of any initiatives underway, if you can 
explain why it was not included as one of the proposals to 
close the tax gap.
    Mr. Shulman. I was not here when that tax gap proposal, the 
general one, was put together, although I have studied it and I 
support moving forward with those proposals. I was also asked a 
lot about the tax gap during my confirmation hearing with the 
Senate Finance Committee. And I have made a commitment to take 
a fresh look at the tax gap and at least engage in a dialogue. 
And some of the tax gap issues have political consequences, as 
well as administrative consequences, which are going to be 
beyond the IRS's purview, but my promise is to study it, come 
to my conclusions, and at least engage in that dialogue.
    I do not want to answer your question wrong. I mean, my 
focus, and what I believe, is that a huge part of the tax gap 
is small business, pass-through business, and self-employed. 
And I have looked at that issue and am a big supporter of at 
least having the dialogue around information reporting and 
other issues around there. All of the studies I have done 
around the tax gap show that where there is withholding, there 
are the highest levels of compliance. Where there is 
information reporting, so people know that someone else is 
reporting information about them, there is the next highest 
level, and where there is no reporting and it is just on the 
honor system, there is a lower level of compliance, although a 
lot of people--most Americans--want to pay their fair share, 
and do pay their fair share, in taxes.
    So I think that is what you are referring to. If not, I 
apologize for not being responsive.
    Senator Durbin. That is, and I will certainly give you time 
to take a look at that. A little more time.
    Senator Brownback.

                           STIMULUS PAYMENTS

    Senator Brownback. Yes. On the next panel, one of the 
testimonies will be from the National Taxpayer Advocate, Nina 
Olson. I was just looking at her testimony. They were saying 
that you are planning on tax rebate checks to the 130 million 
taxpayers who file income tax returns, but also you must 
identify and process returns from and payments to more than 
20.5 million people who have no filing requirement, yet are 
qualified for a tax rebate. That was just the number that has 
come out of this testimony. And if that is the case, that is a 
big number you are going to need to hit in pretty short order.
    Mr. Shulman. Yes. That number--let me speak to that. I was 
hesitant to throw that one out because that was the gross 
estimate early on in the process. That does not take into 
account potentially eligible people on Social Security who are 
married, but who are not both eligible. So that number would be 
drawn down. It does not take into account dependents or people 
who are claimed as dependents on other forms. So I think that 
was the early gross estimate. We are going to have a much 
better sense once we get the filed numbers in.
    Let me also just tell you, there are a variety of reasons--
when I was out at the retired veterans home, there are a lot of 
people who are not part of the system and have not filed a 
return and might not want to file a return.
    Senator Brownback. They are not interested in being part of 
the system. I understand that.
    Mr. Shulman. Yes, to get their $300 check.
    So we are very focused on doing everything the IRS can do. 
I understood your comment about maybe not wanting to go out 
with us and publicize this, but we are going to try to be 
creative, once we see these numbers, about enlisting as many 
people as we can to get the word out.
    Senator Brownback. It is just that everybody is concerned 
about the economy. This was a big bipartisan push by the 
Congress and the administration to get this done. So we want as 
broad a reach as possible, and 20 million is a large number of 
people. But also I understand what you are saying about not 
everybody wanting to be in the system. Still, getting all those 
checks out is going to take a lot of work and you are on a 
short tether to get it done in the time period you are talking 
about.
    Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Mr. Commissioner. I appreciate 
it very much.
    And we are now going to invite panel number 2 to be seated. 
The panel includes Mr. J. Russell George, Mr. Paul Cherecwich, 
and Ms. Nina Olson. They have submitted extensive written 
statements, and Senator Brownback and I would appreciate it if 
they would do their best to confine themselves to 5-minute 
statements. Any statement that goes beyond 5 minutes, they will 
be presumed guilty and subject to penalties and interest.
    Mr. George, how would you like to start?

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

    Mr. George. Thank you, Chairman Durbin, Ranking Member 
Brownback. I appreciate the opportunity to testify on the 
Internal Revenue Service's fiscal year 2009 budget.
    As you heard from the Commissioner, the IRS's proposed 
fiscal year budget requests approximately $11 billion in direct 
appropriations. This amount is approximately a 4.3 percent 
increase over its fiscal year 2008 budget. The 2009 budget 
request seeks an increase of $337 million for enforcement. 
Meanwhile, funding for taxpayer services remains virtually the 
same as the 2008 appropriation. Funding for the business 
systems modernization project is reduced by more than 16 
percent.
    The previous Commissioner of Internal Revenue frequently 
stated that taxpayer service plus enforcement equals 
compliance. The budget request provides a 7 percent increase 
for the IRS's enforcement activities. As you are well aware and 
noted earlier, our Nation has a tax gap estimated to be grossly 
about $345 billion per year. A vital component of the effort to 
reduce the amount requires the IRS to take steps to ensure that 
everyone who owes Federal taxes pays their debt.
    The fiscal year 2009 budget request seeks nearly $361 
million in program increases for IRS enforcement initiatives. 
This amount accounts for 77 percent of the agency's overall 
funding increase. Part of the enforcement initiative funding 
would allow the Service to hire just over 3,000 new enforcement 
and operation support employees. The IRS estimates that these 
new employees will help generate more than $2 billion in 
additional annual enforcement revenue by fiscal year 2011.
    In addition to hiring new employees, IRS enforcement 
initiatives will focus on enhancing activities targeted at 
improving compliance. The budget request supports this by 
proposing funding to reduce the tax gap for large and small 
businesses, as well as the self-employed, increase compliance 
of domestic taxpayers with offshore activity, and minimize 
revenue loss by increasing document matching efforts.
    The initiatives also include increased support for research 
to better understand the reasons for taxpayer noncompliance and 
implementation of legislative proposals to improve compliance.
    It is noteworthy that the 2009 budget request does not seek 
additional funding for any taxpayer service initiatives above 
the 2008 funding levels. This was of concern to the Treasury 
Inspector General for Tax Administration (TIGTA). As you know, 
at the request of this subcommittee and Congress as a whole, 
the IRS has expended considerable resources to develop the 
taxpayer assistance blueprint. Many of the blueprint's 
initiatives would provide IRS customers with services similar 
to those that they are accustomed to receiving from private 
financial organizations such as online access to their 
accounts.
    The IRS must continue to determine the kinds of assistance 
taxpayers want and need to ensure that the blueprint strategy 
is effectively implemented to meet those demands. However, most 
of these initiatives were not funded in 2008 and would remain 
unfunded in fiscal year 2009.
    A key component of any success the IRS would hope to 
achieve in providing better service, as well as increased 
enforcement, is its business systems modernization effort. The 
modernization program has been a long-term challenge for the 
IRS. The 2009 budget request cuts funding for projects that are 
at the heart of the IRS's efforts to replace its antiquated 
computer systems. The program is in its 10th year and has paid 
out approximately $2.5 billion for contractor services. In 
addition, the IRS has spent $265 million through fiscal year 
2007 in internal IRS costs and plans to spend an additional 
$223 million on a program in fiscal year 2008.
    According to the IRS's original plan, the modernization 
program should have been past the halfway point this year. 
Although the IRS has made advances in the effort, it has not 
progressed as anticipated. While the IRS has improved its 
project management and contract oversight, the program remains 
behind schedule, over budget, and is not delivering what was 
promised.
    For example, the IRS originally planned to complete the 
replacement of its individual master file with the customer 
accounts data engine in 2005. The current estimated completion 
date for this replacement is the year 2012.
    In January 2005, the Government Accountability Office 
designated business systems modernization as a high-risk area. 
One reason for that designation is that the IRS's new systems 
need to include adequate audit trails to capture improper 
intrusions and unauthorized transactions.
    Consistent with recommendations made by TIGTA in the past, 
the IRS has narrowed its efforts and is focused on three of its 
most important projects: the customer accounts data engine, the 
accounts management services, and the modernized e-file 
program. At this time, TIGTA does not know what impact the cuts 
on the modernization budget may have on these programs. The IRS 
declined to provide TIGTA with that information.
    The final issue I will discuss--I beg your indulgence, Mr. 
Chairman--is the impending retirement wave. Thirty percent of 
the IRS's current employees will be eligible to retire within 
the next 2 years, while nearly 40 percent of its executives are 
currently eligible to retire. GAO has designated human capital 
as a high-risk Government-wide concern. TIGTA has also 
designated the strategic management of human capital as one of 
the IRS's major management challenges. The loss of 
institutional knowledge places several of the IRS's critical 
projects at great risk, including the multiyear, multi-billion 
dollar effort to modernize its technology and related business 
processes.
    It is vital that the IRS effectively implement the human 
capital strategies listed in its fiscal year 2009 budget 
request. Not only will the IRS need to place significant focus 
on recruiting, it will need to ensure that the new employees 
reach their full potential. At the same time, the IRS will need 
to retain its more experienced employees and capture the 
knowledge of those who leave the IRS.
    Mr. Chairman, Ranking Member Brownback, thank you for your 
indulgence. I hope my discussion will help you in your 
deliberations.
    Senator Durbin. Thank you, Mr. George.
    [The statement follows:]

         Prepared Statement of the Honorable J. Russell George

    Chairman Durbin, Ranking Member Brownback, and Members of the 
subcommittee, thank you for the opportunity to testify today. My 
comments will focus on the Internal Revenue Service's (IRS) fiscal year 
2009 budget and, at your request, the Treasury Inspector General for 
Tax Administration's (TIGTA) fiscal year 2009 budget request. I will 
also briefly comment on the status of the 2008 Filing Season.
    The IRS administers America's tax laws and collects approximately 
95 percent of the revenues that fund the Federal Government. The IRS 
has four major components: the Wage and Investment Division, the Small 
Business/Self-Employed Division, the Large and Mid-Size Business 
Division and the Tax Exempt and Government Entities Division. Together, 
these divisions are largely responsible for collecting more than $2 
trillion in tax revenues each year. At a time when our Nation is at 
war, it is imperative to identify the resources required to support the 
IRS's role as steward of the country's tax administration system.
    The IRS must continue to address management and operational issues, 
including modernization of its computer systems, addressing the tax 
gap, protecting taxpayer rights, and ensuring the security of its 
resources. To that end, the IRS has requested $11.4 billion to fund the 
agency's operations for fiscal year 2009. This is a 4.3 percent 
increase over the 2008 enacted budget. The IRS's fiscal year 2009 
budget request for systems modernization is $40 million less than the 
fiscal year 2008 enacted amount. The IRS does not specify which 
programs will absorb these costs, only that the requested amount will 
allow continued progress on key modernization projects. However, 
millions of taxpayers entrust the IRS with sensitive financial and 
personal data stored and processed by its computer systems. The IRS 
faces enormous challenges in securing this vast amount of personally 
identifiable information, including ensuring that all systems have 
sufficient controls to prevent and detect intrusions and improper 
accesses.
    The budget request includes a 7 percent increase for enforcement 
and less than a 1 percent increase for taxpayer service. In 2007 the 
IRS finalized strategies to reduce the tax gap and improve customer 
service.\1\ The IRS is in the preliminary stages of both strategies. 
Determining what role taxpayer service plays in increasing voluntary 
compliance and reducing the tax gap will continue to be a challenge in 
the near future. The IRS must strive to enforce the tax laws fairly and 
efficiently while balancing service and enforcement to promote 
voluntary compliance and reduce taxpayer burden.
---------------------------------------------------------------------------
    \1\ Reducing the Federal Tax Gap: A Report on Improving Voluntary 
Compliance (Washington, D.C.: Aug. 2, 2007); The 2007 Taxpayer 
Assistance Blueprint Phase 2 (Washington, D.C.: 2007).
---------------------------------------------------------------------------
         OVERVIEW OF THE IRS'S FISCAL YEAR 2009 BUDGET REQUEST

    The proposed fiscal year 2009 IRS budget requests approximately 
$11.4 billion in direct appropriations, $107.9 million from 
reimbursable programs, and $177.7 million from user fees. The direct 
appropriation is approximately a $469.1 million increase (4.3 percent) 
over the fiscal year 2008 enacted level of $10.9 billion.
    In fiscal year 2008, the IRS requested a budget of approximately 
$11.1 billion, an increase of $498 million (4.7 percent) over its 
fiscal year 2007 spending authority. The amount enacted by Congress for 
fiscal year 2008 was $203 million (1.8 percent) less than the budget 
request. Congress also made substantial changes in budget priorities in 
fiscal year 2008 by increasing the Taxpayer Services appropriation by 
$46.9 million above the IRS's request while cutting the 
Administration's Enforcement and Operations Support appropriation 
requests by a total of $235 million. The budget request also included a 
net increase in the overall size of the IRS of nearly 1,800 Full-Time 
Equivalent \2\ employees.
---------------------------------------------------------------------------
    \2\ A Full-Time Equivalent is a measure of labor hours. One Full-
Time Equivalent is equal to 8 hours multiplied by the number of 
compensable days in a particular fiscal year.
---------------------------------------------------------------------------
    The fiscal year 2009 IRS budget request includes appropriations for 
five IRS budget accounts (categories): Enforcement, Operations Support, 
Taxpayer Services, Business Systems Modernization, and the Health 
Insurance Tax Credit Administration (see Figure 1). 


    Within these appropriation accounts, the IRS seeks to increase 
funding for Enforcement, Operations Support, and the Health Insurance 
Tax Credit Administration while decreasing funding for Business Systems 
Modernization (Modernization). The budget request seeks an Enforcement 
Appropriation of $5.12 billion, an increase of $337 million (7.1 
percent) over the current fiscal year 2008 appropriation of $4.78 
billion. The funding for Taxpayer Services remains the same as the 
fiscal year 2008 enacted level.
    The Modernization program is a complex effort to modernize IRS 
technology and related business processes. It involves integrating 
thousands of hardware and software components while replacing outdated 
technology and maintaining the current tax system.
    The Modernization program is in its 10th year and has received 
approximately $2.5 billion for contractor services. Additionally, the 
IRS had spent $265 million through fiscal year 2007 for internal IRS 
costs, and plans to spend an additional $223 million on the program in 
fiscal year 2008. According to the IRS's original plan, the 
Modernization program should be past the halfway point in Calendar Year 
2008. However, the IRS has not completed as many Modernization projects 
as planned because it has received less funding than initially 
anticipated and has had difficulties in managing the scope and 
complexity of the work. For example, the Customer Account Data Engine 
(CADE) is the foundation of the Modernization program. The IRS 
originally planned to complete replacement of its Individual Master 
File with the CADE in 2005.\3\ The current estimated completion date 
for this replacement is 2012.
---------------------------------------------------------------------------
    \3\ The Individual Master File is the IRS database that stores 
individual taxpayer account information.
---------------------------------------------------------------------------
    Although the IRS has made advances in its Modernization effort, it 
has not progressed as anticipated. TIGTA has reported that inconsistent 
compliance with project development controls has contributed to delays 
in project deliveries, increased development costs, and reduced 
capabilities.\4\ Since fiscal year 2002, TIGTA's Modernization program 
annual assessments have cited the following four specific challenges 
the IRS needs to overcome to deliver a successful modernization effort:
---------------------------------------------------------------------------
    \4\ Annual Assessment of the Business Systems Modernization Program 
(Reference Number 2007-20-121, dated August 24, 2007).
---------------------------------------------------------------------------
  --Implement planned improvements in key management processes and 
        commit necessary resources to enable success;
  --Manage the increasing complexity and risks of the Modernization 
        program;
  --Maintain the continuity and strategic direction with experienced 
        leadership; and
  --Ensure that contractor performance and accountability are 
        effectively managed.
    Accordingly, because solutions to the IRS's serious and intractable 
financial management problems largely depend upon the success of its 
Modernization efforts, in January 2005 the financial management risk 
was combined with the Modernization risk into the Business Systems 
Modernization high-risk area.\5\ Modernization remains a high risk for 
the IRS. One reason is that all of its new systems need to include 
adequate audit trails.
---------------------------------------------------------------------------
    \5\ In January 2005, the Government Accountability Office (GAO) 
combined its two previous high-risk areas, IRS Business Systems 
Modernization and IRS Financial Management, into one Business Systems 
Modernization high-risk area. See U.S. Government Accountability 
Office, GAO-05-207, High Risk Series: An Update (2005).
---------------------------------------------------------------------------
    For fiscal year 2008, the IRS requested funding of approximately 
$222.7 million for Modernization, a cut of 16.6 percent ($44.4 million 
from the $267.1 million enacted). This cut is expected to eliminate at 
least 25 employees. However, the fiscal year 2008 enacted amount was an 
increase of $54.4 million (25.6 percent) from the $212.7 million 
enacted for fiscal year 2007.
    The fiscal year 2009 budget request does not specify which programs 
will absorb the cuts, although it states that the requested amount will 
allow continued progress on key modernization projects, including the 
CADE, Accounts Management Services (AMS), and Modernized e-File (MeF). 
However, the Government Accountability Office (GAO) recently issued a 
report that included proposed spending by major project.\6\ Figure 2 
shows the funding proposed for major Modernization projects in fiscal 
year 2009 compared to the amounts enacted for fiscal year 2008:
---------------------------------------------------------------------------
    \6\ Internal Revenue Service: Fiscal Year 2009 Budget Request and 
Interim Performance Results of IRS's 2008 Tax Filing Season, (GAO 08-
567, dated March 2008).

            FIGURE 2.--BUSINESS SYSTEMS MODERNIZATION PROJECTS IN FISCAL YEAR 2009 IRS BUDGET REQUEST
                                            [In millions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                   Fiscal year     Change from
                            Project                                Fiscal year     2009 budget     fiscal year
                                                                  2008 enacted       request       2008 enacted
----------------------------------------------------------------------------------------------------------------
Customer Account Data Engine...................................            58.5            58.8             0.3
Accounts Management Services...................................            29.0            26.2            (2.8)
Modernized e-File..............................................            55.8            25.0           (30.8)
Core Infrastructure............................................            39.2            32.0            (7.2)
Architecture, Integration, and Management......................            35.1            35.0            (0.1)
Management Reserve.............................................             4.3             2.3            (2.0)
                                                                ------------------------------------------------
      Subtotal Capital Investments.............................           221.9           179.3           (42.6)
Business Systems Modernization Labor...........................            44.0            42.0            (2.0)
                                                                ------------------------------------------------
      Subtotal Program Request.................................           265.9           221.3           (44.6)
Maintaining Current Levels.....................................             1.2             1.4             0.2
                                                                ------------------------------------------------
      Total Business Systems Modernization Budget..............           267.1           222.7           (44.4)
----------------------------------------------------------------------------------------------------------------
Source: TIGTA analysis of GAO Report, Internal Revenue Service: Fiscal Year 2009 Budget Request and Interim
  Performance Results of IRS's 2008 Tax Filing Season (GAO 08-567, dated March 2008).

    TIGTA requested information from the IRS on the impact of the 
proposed funding on the projects above, which the IRS declined to 
provide. The IRS also declined to provide this information to GAO for 
its report.
Customer Account Data Engine
    The IRS states that the CADE is the lynchpin modernization project 
to replace the antiquated master file. The master file currently 
requires 2 weeks to update taxpayer tax accounts. The CADE consists of 
current and planned databases and is designed to post information to 
taxpayers' accounts daily rather than weekly, which will facilitate 
faster refunds to taxpayers and provide IRS employees with more up-to-
date and accurate account information.
    The latest release of the CADE, Release 3.0, was originally 
developed to deliver 17 new functions and capabilities. The IRS divided 
Release 3.0 into two sub-releases. CADE Release 3.1 contained four 
major functions and was deployed between August and October 2007. CADE 
Release 3.2 included seven major functions and was delivered in 
February 2008. The major functions delivered include the capability of 
processing tax returns with a disaster area designator; processing tax 
returns claiming the Earned Income Tax Credit, Credit for Child and 
Dependent Care, and requests for Split Refunds; providing address 
change service requests; and validating tax balances. The remaining six 
functions will be determined for delivery in future releases of the 
CADE. These additional capabilities were expected to significantly 
increase the volume of returns posting to the CADE from the 
approximately 11.2 million returns posted during Calendar Year 2007. As 
of March 28, 2008, about 21.1 million tax returns had been posted to 
the CADE.
    In 2009, the IRS plans to continue the development of the CADE in 
stages, and its fiscal year 2009 budget request includes $58.8 million 
for the project. TIGTA's review of CADE Release 2.1 found that tax 
return information was accepted and generally posted accurately to CADE 
accounts during the 2007 Filing Season.\7\ However, several programming 
problems were affecting the accurate posting of Itemized Deductions, 
Adjusted Gross Income, and Taxable Income amounts. TIGTA reported this 
issue to the IRS, and it promptly corrected the programming. TIGTA is 
currently reviewing the accuracy of the expanded capabilities offered 
by the most current release of the CADE.\8\
---------------------------------------------------------------------------
    \7\ The Customer Account Data Engine Release 2.1 Generally Posted 
Tax Return Information Accurately (Reference Number 2007-40-131, dated 
August 10, 2007).
    \8\ Customer Account Data Engine Release 3, (Audit Number 2008-20-
009).
---------------------------------------------------------------------------
Accounts Management Services Project
    The IRS is continuing to modernize its databases to provide 
immediate access to account data, enable real-time transaction 
processing, and ensure daily account settlement to improve customer 
service and business results. The Accounts Management Services (AMS) 
project, initiated in May 2006, was chartered to address these needs. 
The project objective is to provide an integrated approach to view, 
access, update, and manage taxpayer accounts. This is accomplished by 
providing IRS employees with the tools to access information quickly 
and accurately in response to complex customer inquiries and to update 
taxpayer accounts on demand. The fiscal year 2009 budget request 
includes $26.2 million for the AMS project.
    In March 2008, TIGTA determined that the AMS project team 
successfully implemented project management processes and activities, 
which included project justification, contract management, risk 
management, configuration management, performance management, and 
transition management.\9\ The AMS project team successfully planned 
work schedules, identified and addressed potential risks to project 
development, and coordinated with appropriate staff to implement 
initial release capabilities. Although the AMS project team is on 
schedule to make the proposed processing capabilities available, its 
implementation is dependent on the IRS's Modernization and Information 
Technology Services organization's abilities to integrate these project 
capabilities into taxpayer account processing.
---------------------------------------------------------------------------
    \9\ The Account Management Services Project Is Meeting Its 
Development Goals (Reference Number 2008-20-053, dated March 3, 2008).
---------------------------------------------------------------------------
    The IRS, however, does not collect all transactions and audit logs 
on its modernized systems, including CADE and AMS. Without audit logs, 
the IRS cannot conduct proper intrusion investigations and hold 
individuals accountable for unauthorized transactions and disclosures.

Modernized e-File
    The MeF project provides a standard filing structure for all types 
of IRS tax returns and can meet performance and capacity needs with 
enhanced and up-to-date technologies, therefore providing greater 
appeal to external customers and stakeholders. The MeF project's goal 
is to replace the IRS's current tax return filing technology with a 
modernized, Internet-based electronic filing platform.
    In fiscal year 2009, the IRS will continue development of Release 
7, which was initiated in fiscal year 2008. Release 7 will roll out an 
additional 90 supporting schedules and forms that will expand the reach 
of MeF to 99 percent of the e-File population, or approximately 93.7 
million filers. The IRS's fiscal year 2009 budget request includes $25 
million for the MeF project.
    Previous TIGTA audits of the MeF project found that the IRS's plans 
for processing additional tax forms using the MeF system were 
uncertain, including plans to schedule development of the U.S. 
Individual Income Tax Return (Form 1040) family. In addition, the IRS 
can improve its management of requirements development and testing 
activities to assure that the requirements expected and approved for 
deployment are the requirements that are actually deployed.\10\
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    \10\ The Modernized e-File Project Can Improve the Management of 
Expected Capabilities and Associated Costs (Reference Number 2007-20-
005, dated December 27, 2006); The Modernized e-File Project Can 
Improve Its Management of Requirements (Reference No. 2007-20-099, 
dated July 9, 2007).
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    Furthermore, TIGTA continues to be concerned that the IRS is 
developing its modernized systems and bringing them online without 
adequately contemplating the security implications.

Human Capital
    The IRS, like many organizations, is concerned about an impending 
retirement wave, or brain drain. According to the IRS, 30 percent of 
its current employees will be eligible to retire by 2010 and nearly 40 
percent of its executives are currently eligible to retire. The GAO has 
designated human capital as a ``high risk'' Government-wide concern and 
recently reported that ample opportunities exist for agencies to 
improve. TIGTA has also designated the strategic management of human 
capital as one of the IRS's major management challenges.
    Due to the potential loss of institutional knowledge, the IRS has 
several critical projects underway, such as a 5-year strategic plan for 
enhancing the services it provides to taxpayers and a complex, 
multiyear, multibillion dollar effort to modernize its technology and 
related business processes. The IRS is also battling a tax gap,\11\ as 
well as implementing and adjusting to changes in its managerial and 
executive pay structure.
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    \11\ 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.
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    It is critical that the IRS effectively implement the human capital 
strategies listed in the IRS's fiscal year 2009 budget request. While 
acting to replace those employees lost through retirement and other 
attrition, the fiscal year 2009 budget request seeks more than 3,000 
additional Full-Time Equivalents. The IRS states that additional 
employees will lead to increased revenue of more than $2 billion by the 
time new employees reach their full potential in fiscal year 2011. Not 
only will the IRS need to place a significant focus on recruiting, it 
will need to ensure that new employees reach their full potential. At 
this same time, the IRS will need to retain its more experienced 
employees and capture the knowledge of those who leave the IRS.
    If the IRS is not able to effectively accomplish the human capital 
strategies:
  --There might not be a sufficient number of qualified employees to 
        adequately administer the tax code. In addition, fewer 
        qualified employees may be on the front-line to assist 
        taxpayers.
  --The tax gap could increase if high-performing, well-trained 
        taxpayer service and enforcement personnel cannot be hired and 
        retained.
  --The IRS might not be able to replace its leadership cadre and 
        ensure that significant projects remain on track.
  --The aging workforce could retire before its vast knowledge of tax 
        administration is transferred to younger workers.
    TIGTA has an ongoing Human Capital audit strategy reviewing these 
areas and will continue to monitor the IRS's efforts to strategically 
plan and monitor human capital resources to ensure having the right 
resources in the right place at the right time to achieve its mission 
and goals.
                security of the internal revenue service
    Privacy and security are growing concerns in nearly every 
organization, both private and public. As technology advances, the 
IRS's ability to protect sensitive information must advance to meet new 
threats. In addition to the IRS's commitment to protect sensitive 
taxpayer data and personally identifiable information, a robust 
security program also requires adequate financial and human capital 
resources.
    Each year, millions of taxpayers entrust the IRS with their 
sensitive financial and personal data that are stored in and processed 
by IRS computer systems. The risk that this sensitive data could be 
compromised and computer operations disrupted continues to increase. 
Both internal factors, such as the increased connectivity of computer 
systems and greater use of portable laptop computers, and external 
factors, such as the volatile threat environment related to increased 
phishing scams and hacker activity, contribute to these risks.

Network Security
    Because the IRS sends sensitive taxpayer and administrative 
information across its networks, routers and switches on the networks 
must have sufficient security controls to deter and detect unauthorized 
use. In March 2008, TIGTA reported that access controls for IRS routers 
were not adequate and reviews to monitor security configuration changes 
were not conducted to identify inappropriate use.\12\ Of 374 accounts 
for employees and contractors to access routers and switches in 
performing system administration duties, 141 (38 percent) did not have 
proper authorization to access the routers. Of particular concern, 27 
employees and contractors had accessed the routers and switches to 
change security configurations.
---------------------------------------------------------------------------
    \12\ Inadequate Security Controls Over Routers and Switches 
Jeopardize Sensitive Taxpayer Information (Reference Number 2008-20-
071, March 26, 2008).
---------------------------------------------------------------------------
    To authenticate users, the IRS relies on a security application 
that requires users to enter an account name and password. Users 
circumvented this control by setting up unauthorized accounts that 
appeared to be shared-user accounts. Any person who knew the password 
to these accounts could have changed configurations without 
accountability and with little chance of detection. For this reason, 
the IRS requires that shared accounts be used only on a limited basis 
and that they be subjected to special authorization controls. However, 
during fiscal year 2007, 4.4 million (over 84 percent) of the 5.2 
million accesses to the routers were made by the 34 user accounts. 
Audit trail reviews necessary to detect security events were also not 
being conducted. The IRS agreed with TIGTA's findings and is taking 
corrective actions to address the recommendations made to correct these 
weaknesses.

Database Security
    The IRS stores its taxpayer, financial, and other data in more than 
2,100 databases. TIGTA reported in fiscal year 2008 that high-risk 
weaknesses continue to exist and sufficient corrective actions have not 
been taken.\13\ TIGTA scanned IRS networks and determined that 11 
percent of the approximately 1,900 databases scanned had one or more 
installation accounts with a default or blank password. A total of 369 
installation accounts had default or blank passwords, including 26 
containing powerful database administrator privileges.
---------------------------------------------------------------------------
    \13\ Internal Revenue Service Databases Continue to Be Susceptible 
to Penetration Attacks (Report Reference Number 2008-20-029, dated 
December 14, 2007).
---------------------------------------------------------------------------
    Databases found with default or blank passwords during the scans 
included those that contained personally identifiable tax information. 
Malicious users can exploit accounts with default or blank passwords to 
steal taxpayer identities and carry out fraud schemes.
    TIGTA made several recommendations, including ensuring that 
security training is provided to employees with key security 
responsibilities and improving the process for identifying and 
correcting accounts with blank or default passwords by expanding the 
scanning criteria. IRS management agreed with all of the 
recommendations in the report and plans to take appropriate corrective 
actions.

                        IMPROVE TAXPAYER SERVICE

    Since the late 1990s, the IRS has increased its delivery of quality 
customer service to taxpayers. The first goal in the IRS's current 
strategic plan is to improve taxpayer service. However, since the late 
1990s, the IRS has allocated more resources to its collection, 
examination, and criminal investigation functions and fewer resources 
to taxpayer service functions. See Figure 3 for a comparison of funding 
for taxpayer service and enforcement since fiscal year 2006.



    As a result of this resource shift and other factors, in July 2005, 
Congress requested that the IRS develop a 5-year plan, including an 
outline of which services the IRS should provide and how it will 
improve services for taxpayers. The IRS developed the plan, the 
Taxpayer Assistance Blueprint, in two phases.
    The IRS is already facing challenges with its Blueprint. For the 
Phase I report, the conclusions and strategic improvement themes were 
valid; however, not all information was accurate or consistent.\14\ 
Given the importance of this plan as the IRS moves forward, 
inaccuracies and inconsistencies will put the plan at risk of 
improperly aligning service content, delivery, and resources with 
taxpayer and partner expectations. In fiscal year 2007, the IRS issued 
its Taxpayer Assistance Blueprint Phase 2 report that details the 
research and analyses efforts of the IRS and outlines the Blueprint 
Strategic Plan for taxpayer services. The Phase 2 report contains 
information from over 100 data sources and represents the first large-
scale effort to attempt to collect data specific to Taxpayer Assistance 
Center customers. In February 2008, TIGTA reported that the data in the 
Phase 2 report was for the most part accurate.\15\
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    \14\ The Strategic Improvement Themes in the Taxpayer Assistance 
Blueprint Phase I Report Appear to Be Sound; However, There Were Some 
Inaccurate Data in the Report (Reference Number 2007-40-078, dated 
March 18, 2007).
    \15\ The Taxpayer Assistance Blueprint Phase 2 Was Generally 
Reliable, but Oversight of the Survey Design Needs Improvement 
(Reference Number 2008-40-059, dated February 5, 2008).
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    A second review of the Phase 2 report focused on the Taxpayer 
Assistance Center \16\ Geographic Footprint--the IRS's step-by-step 
process for future decisions regarding Taxpayer Assistance Center 
locations--and found that inaccurate and incomplete management 
information continues to delay its implementation.\17\ The IRS has yet 
to determine the optimum locations for the Taxpayer Assistance Centers 
and which taxpayers they most effectively serve. Additionally, of the 
41 criteria used for the Taxpayer Assistance Center Geographic 
Blueprint, 19 (46 percent) contained inaccurate or incomplete data. 
Without accurate and complete data, the IRS cannot measure the 
effectiveness of the Taxpayer Assistance Center Program or determine 
where to best offer its face-to-face services.
---------------------------------------------------------------------------
    \16\ Taxpayer Assistance Centers are walk-in sites where taxpayers 
can receive answers to account and tax law questions, as well as 
assistance in preparing their tax returns.
    \17\ Inaccurate and Incomplete Data Has Adversely Affected the 
Implementation of the Taxpayer Assistance Center Geographic Footprint 
(Audit # 200740042), Draft issued March 20, 2008.
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    The IRS is also still unable to measure how closing Taxpayer 
Assistance Centers might affect taxpayers and compliance. The IRS does 
not have the means to capture all interactions between a Taxpayer 
Assistance Center employee and a taxpayer to determine why the taxpayer 
visited the Taxpayer Assistance Center, what service he or she 
received, and, most importantly, the effect the service or action had 
on the taxpayer's future compliance.
    The President' fiscal year 2009 budget request for the Taxpayer 
Service Program is $2.15 billion. The fiscal year 2009 funding for the 
direct appropriation maintains the fiscal year 2008 enacted level. The 
Operations Support budget provides an additional $1.5 billion to 
support taxpayer services.
  --Fiscal year 2009 program decreases include funds provided in the 
        fiscal year 2008 enacted. Specifically, $31 million is being 
        used for long-term investments that would not be duplicated in 
        2009, and $8 million from the Community Volunteer Income Tax 
        Assistance (VITA) Matching Grant Program that was provided in 
        fiscal year 2008 and is still available through fiscal year 
        2009.
  --Fiscal year 2009 increases include an additional 426 Full-Time 
        Equivalents and $14.8 million to fully fund postal costs.
    The budget request does not include funding to support any taxpayer 
service initiatives that increase its 2009 request over the 2008 
enacted amount. The IRS has expended considerable resources to develop 
the Blueprint and many of its initiatives would provide its customers 
with the same services currently available to them from private 
financial organizations. Most of the Blueprint initiatives have not 
been funded. The IRS must continue to find out what assistance 
taxpayers want and need, and ensure that the Blueprint Strategy Plan is 
effectively implemented.
    The IRS is implementing a new matching grant program for the 
Community VITA Grant Program with $8 million in fiscal year 2008 
funding. The IRS's Volunteer Program, including the VITA and the Tax 
Counseling for the Elderly Programs,\18\ plays an increasingly 
important role in the IRS's efforts to improve taxpayer service and 
facilitate participation in the tax system. TIGTA recently reviewed the 
Tax Counseling for the Elderly Program and found that it has not been 
effectively administered. The IRS does not have effective controls or 
monitoring processes to ensure that funds are appropriately spent, and 
management information is not sufficient to provide adequate oversight 
for the program. The IRS is using TIGTA's audit results to develop the 
VITA grant program.\19\
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    \18\ The Tax Counseling for the Elderly Program is a grant program 
that provides free tax help to people age 60 and older using grants 
appropriated. The Tax Counseling for the Elderly Program appropriation 
was $3.95 million for each of fiscal years 2005 through 2007 and $3 
million in fiscal year 2008.
    \19\ Oversight and Administration of the Tax Counseling for the 
Elderly Program Need Improvement.
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                    ENHANCE ENFORCEMENT OF TAX LAWS

    A compelling challenge confronting the IRS is tax compliance. Tax 
compliance initiatives include the administration of tax regulations, 
collection of the correct amount of tax for businesses and individuals, 
and oversight of tax-exempt and Government entities. Late in fiscal 
year 2007, the Department of the Treasury and the IRS issued a report 
on improving voluntary compliance.\20\ The report outlines steps that 
the IRS plans to take to increase voluntary compliance and reduce the 
tax gap.
---------------------------------------------------------------------------
    \20\ Internal Revenue Service, U.S. Department of the Treasury, 
Reducing the Federal Tax Gap: A Report on Improving Voluntary 
Compliance (2007).
---------------------------------------------------------------------------
    The fiscal year 2009 IRS budget request seeks nearly $361 million 
in program increases for IRS enforcement initiatives, which account for 
77 percent of the agency's overall funding increase of $469 million. 
Part of the enforcement initiative funding is intended to hire 3,057 
new IRS Enforcement and Operations Support employees who are expected 
to help generate over $2 billion \21\ in additional annual enforcement 
revenue, once the new hires reach full potential in fiscal year 2011. 
The $361 million increase is split between three appropriation 
accounts: Enforcement ($261 million), Operations Support ($97 million), 
and Taxpayer Services (nearly $3 million). Many of the same or similar 
enforcement proposals described in the fiscal year 2009 budget request 
were included in the fiscal year 2008 IRS budget request but not funded 
by Congress in the final appropriations bill, the Consolidated 
Appropriation Act of 2008.\22\ The programs included in the enforcement 
initiatives in the fiscal year 2009 IRS budget request are shown in 
Figure 4:
---------------------------------------------------------------------------
    \21\ Amount does not include annual $3.6 billion expected from 
legislative proposals.
    \22\ Consolidated Appropriation Act of 2008, Public Law 110-161.

                FIGURE 4.--ENFORCEMENT INITIATIVE PROGRAMS IN FISCAL YEAR 2009 IRS BUDGET REQUEST
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                            Staffing
                                                            Expected     increase (full- Included in fiscal year
                Program                       Cost       revenue fiscal       time       2008 IRS budget request
                                                            year 2011     equivalents)
----------------------------------------------------------------------------------------------------------------
Reduce the tax gap for small business/           $168.5            $981           1,608  Yes
 self-employed taxpayers.
Reduce the tax gap for large businesses            69.5             544             519  Yes
Improve tax gap estimates, measurement             51.1              16             393  Yes
 and detection of non-compliance.
Increase reporting compliance of U.S.              13.7             102             124  No
 taxpayers with offshore activity.
Expand document matching...............            35.1             359             413  Yes
Implement legislative proposals to                 23.0           3,600  ..............  Yes
 improve compliance.
                                        ------------------------------------------------------------------------
      Totals...........................           360.9           5,602           3,057  .......................
----------------------------------------------------------------------------------------------------------------
Source: TIGTA analysis of fiscal year 2008 and fiscal year 2009 IRS Budget Requests.

                         ADDRESSING THE TAX GAP

    Tax compliance initiatives include administering tax regulations, 
collecting the correct amount of tax for businesses and individuals, 
and overseeing tax-exempt and Government entities for compliance. 
Increasing voluntary compliance and reducing the tax gap are currently 
the focus of many IRS initiatives. Nevertheless, the IRS is facing 
significant challenges in obtaining more complete and timely data, and 
developing the methods necessary for interpreting the data. The IRS 
must continue to seek accurate measures for the various components of 
the tax gap and the effectiveness of the actions taken to reduce it. 
Broader strategies and better research are needed to determine what 
actions are most effective in addressing non-compliance.

Unreported Self-Employment Taxes Contribute to the Tax Gap
    According to the GAO, outlays from the main trust funds of the 
Social Security and Medicare programs are projected to exceed revenues 
in the next decade. As the tax collector for these programs, the IRS 
must ensure that self-employed taxpayers meet their tax 
responsibilities by assessing and collecting the proper amount of self-
employment taxes. Self-employment tax is estimated to make up about $39 
billion (72 percent) of underreported employment taxes, or 11 percent 
of the total gross tax gap, making it one of the largest components of 
the tax gap.
    TIGTA's fiscal year 2007 review of the self-employment tax found 
that IRS procedures were inconsistent for identifying Form 1040 
reporting income on line 21 that is potentially subject to the self-
employment tax.\23\ Also, there was a significant problem with 
assigning an audit code to tax returns with potentially unreported 
self-employment taxes.
---------------------------------------------------------------------------
    \23\ Identification of Unreported Self-Employment Taxes Can Be 
Improved (Reference Number 2008-30-001, dated October 11, 2007).
---------------------------------------------------------------------------
    TIGTA recommended that the IRS: (1) improve processing of those tax 
returns with potential self-employment tax liabilities and provide 
additional training to tax examiners; (2) strengthen reviews of tax 
returns for potential unpaid self-employment taxes; and (3) reconsider 
the decision to cancel TIGTA's previous recommendation to immediately 
work significant unreported self-employment tax cases with refunds 
available and no response or an inadequate response to any letter 
issued by the IRS.
    IRS management agreed with the first two recommendations and 
disagreed with the third. The IRS planned to explore the possibility of 
expanding existing returns processing training material issued in 
January 2008. However, IRS management stated that the parameters could 
not be accurately identified to ensure that the IRS would not be 
withholding the refunds of taxpayers who were not subject to self-
employment taxes. Based on the findings of this and previous audits, 
TIGTA maintained that it was feasible for the IRS to begin examining 
the tax returns of taxpayers who appear to owe a significant amount of 
self-employment tax, have an available refund, and have not responded 
to contact letters from the IRS.

Schedule C Hobby Losses Contribute to the Tax Gap
    About 1.5 million taxpayers, many with significant income from 
other sources, filed Form 1040 Schedules C (Profit or Loss From 
Business) showing no profits, only losses, over four Tax Years 2002-
2005; 73 percent were assisted by tax practitioners. By claiming these 
losses to reduce their taxable incomes, about 1.2 million of the 1.5 
million taxpayers potentially avoided paying $2.8 billion in taxes in 
Tax Year 2005. Changes are needed to prevent taxpayers from continually 
deducting losses in potential not-for-profit activities to reduce their 
tax liabilities.
    The ``hobby loss'' provision and related regulations do not 
establish specific criteria for the IRS to use in determining whether a 
Schedule C loss is a legitimate business expense without conducting a 
full examination of an individual's books and records.\24\ The purpose 
of the hobby loss provision was to limit the ability of wealthy 
individuals with multiple sources of income to apply losses incurred in 
``side-line'' diversions to reduce their overall tax liabilities. TIGTA 
reported in September 2007 that 332,615 high-income taxpayers received 
the greatest benefit by potentially avoiding approximately $1.9 billion 
in taxes for tax year 2005.\25\
---------------------------------------------------------------------------
    \24\ Internal Revenue Code Section 183 (Activities not engaged in 
for profit); related Treasury Regulation Section 1.183-1.
    \25\ Significant Challenges Exist in Determining Whether Taxpayers 
With Schedule C Losses Are Engaged in Tax Abuse (Reference Number 2007-
30-173, dated September 7, 2007).
---------------------------------------------------------------------------
    The law does not require a taxpayer to have a reasonable 
expectation of profit; rather, the taxpayer needs only the 
``objective'' of making a profit. Internal Revenue Code (I.R.C.) 183 
makes it difficult for the IRS to efficiently administer tax law that 
ensures taxpayers are not deducting not-for-profit losses to reduce 
their taxes on other incomes year after year.
    TIGTA recommended that the IRS provide a copy of the report to the 
Department of the Treasury, Office of Tax Policy, to consider 
legislative changes to I.R.C.  183. The proposal should include 
establishing a clearly defined standard or bright-line rule for 
determining whether an activity is a business or a not-for-profit 
activity. Due to the large number of these tax returns being prepared 
by tax practitioners, TIGTA also recommended that the IRS continue 
coordinating with practitioner organizations to encourage compliance 
with existing provisions.
    In their response to the report, IRS officials stated that they 
agreed with the recommendations and planned to take appropriate 
corrective actions. The IRS plans to coordinate with the Office of 
Legislative Affairs to forward a copy of the final report to the 
Department of the Treasury, Office of Tax Policy, and to include key 
messages and talking points about I.R.C. 183 tax obligations as a 
fiscal year 2008 outreach initiative directed to practitioner 
organizations.

                         LEGISLATIVE PROPOSALS

    The fiscal year 2009 IRS budget request includes 16 legislative 
proposals--13 submitted in prior budget requests--that are expected to 
generate $36 billion in additional tax over 10 years as a result of 
improving tax compliance and administration. Of the 13 proposals in 
prior budget requests, 12 await some form of congressional action. Many 
of these proposals also represent a significant part of the IRS 
strategy to improve tax compliance and reduce the tax gap described in 
the IRS's August 2, 2007, report, Reducing the Federal Tax Gap: A 
Report on Improving Voluntary Compliance.

                           2008 FILING SEASON

    The 2008 Filing Season appears to be progressing without major 
problems. As of March 29, 2008, the IRS reported that it had received 
approximately 86.8 million tax returns. Of those, approximately 62.2 
million were filed electronically (e-filed) (an increase of 9.3 percent 
from this time in 2007), and approximately 24.6 million were filed on 
paper (an increase of 4.8 percent from this time in 2007). 
Additionally, nearly 69.8 million refunds totaling approximately $172 
billion had been issued. Of these, 50.8 million (73 percent of all 
refunds) were directly deposited to taxpayer bank accounts, an increase 
of 7.3 percent compared to 2007.
    Use of the IRS's free online filing program had been declining in 
prior years. However, based on the current volume, it appears that 
taxpayers are increasingly taking advantage of this option, as the 
number has increased by 17.4 percent from 2007. Additionally, the 
number of taxpayers who e-file from their home computers increased by 
17.3 percent this filing season.
    So far this filing season, over 2 million tax returns have been 
prepared by volunteers, an increase of 22 percent over the 2007 Filing 
Season. TIGTA's accuracy rate at the Volunteer Program sites has 
improved from 56 percent last year to 67 percent this year. The IRS is 
reporting a 76 percent accuracy rate. Volunteers are doing a better job 
using the tools and information available when preparing tax returns.
    As of March 29, 2008, use of IRS.gov is up over 19 percent, with 
almost 122 million visits to the Web site. Nearly 26 million taxpayers 
went to IRS.gov to obtain their refund information via the ``Where's My 
Refund?'' option, a 19.7 percent increase over the same time period 
last year.
    Additionally, calls to the toll-free assistance lines are up from 
the 2007 Filing Season and the Level of Service \26\ is lower, 
primarily because taxpayers are calling about the stimulus payments. 
The IRS had planned to provide an 82 percent Level of Service for 
fiscal year 2008, but has projected that the Level of Service could be 
as low as 74 percent. For the 2008 Filing Season (as of March 29, 
2008), the IRS had already answered about 112 percent of the planned 
10.9 million assistor-answered calls. Its 80 percent Level of Service 
is 4.5 points lower than the actual 2007 Filing Season Level of Service 
of 84.5 percent. Additionally, the IRS had planned to answer 14.8 
million automated calls but has answered 16.1 million automated calls.
---------------------------------------------------------------------------
    \26\ The Level of Service is the primary measure of service to 
taxpayers. It is the relative success rate of taxpayers who call for 
services on the IRS toll-free telephone lines.
---------------------------------------------------------------------------
                   economic stimulus act of 2008 \27\
---------------------------------------------------------------------------
    \27\ Economic Stimulus Act of 2008, Pub. L. No. 110-185 (2008).
---------------------------------------------------------------------------
    In keeping with the intent of the Economic Stimulus Act of 2008, 
the IRS expects to issue more than $100 billion in stimulus payments 
(often referred to as rebates) and is trying to ensure that everyone 
who is entitled to a rebate knows what to do to receive it. The IRS 
sent Economic Stimulus Payment Notices (Notice 1377) to more than 130 
million taxpayers who filed a Tax Year 2006 income tax return. 
Beginning in May, an additional notice will be mailed to those 
taxpayers eligible for the payments to explain the payment amount and 
how it was calculated. The IRS believes it will receive significantly 
fewer calls to its toll-free telephone information line as a result of 
issuing the advance notices.
    As of March 28, 2008, the IRS had received an estimated 1.4 million 
tax returns from individuals who filed them solely to receive the 
rebates. Because these are tax returns that would generally not be 
filed, the normal IRS refund controls are not designed for this 
situation. The IRS is evaluating alternatives to identify any of these 
tax returns that are fraudulent so it can prevent any associated 
fraudulent stimulus payments. TIGTA is currently evaluating the 
controls over the processing of these tax returns and monitoring their 
volume and effect on the 2008 filing season.
    Since the Economic Stimulus Act of 2008 was enacted, the IRS has 
been receiving an average of more than 63,000 calls per day above 
normal volume to its toll-free telephone lines related to the upcoming 
rebates. The IRS is using over 1,000 Automated Collection System \28\ 
telephone assistors to take rebate telephone calls during their regular 
tours of duty and has also trained more than 500 tax examiners and 
assistors who normally work taxpayer correspondence and paper casework 
to answer general rebate calls.
---------------------------------------------------------------------------
    \28\ The Automated Collection System is an integral part of the IRS 
process for collecting unpaid taxes and securing unfiled tax returns 
from both individual and business taxpayers. When taxpayers do not 
comply with the IRS's computer-generated notices, Automated Collection 
System tax examiners attempt to contact them by telephone to secure 
payments or unfiled returns. The Automated Collection System is the 
computer system that assigns these cases to the individual tax 
examiners.
---------------------------------------------------------------------------
    The IRS stopped the issuance of Automated Collection System 
enforcement tools (systemic notices and letters were stopped on 
February 22 and systemic levies were stopped on February 29). However, 
issuance of regular delinquency notices on accounts not yet assigned to 
the Automated Collection System has not been stopped, and the IRS 
expects to reserve 40 percent to 50 percent of the available Automated 
Collection System staff to answer calls from taxpayers who respond to 
these notices. The IRS plans to restart the notices when telephone 
demand decreases. The IRS reports that the foregone revenue associated 
with these actions could be as high as $666 million.

  TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION FISCAL YEAR 2009 
                             BUDGET REQUEST

    TIGTA was created by Congress to provide independent oversight of 
the IRS. TIGTA's audits and investigations protect and promote the fair 
administration of the Nation's tax system. Responsibilities include 
ensuring that the IRS is accountable for more than $2 trillion in tax 
revenue received each year. Audit recommendations aim to improve IRS's 
systems and operations while maintaining fair and equitable treatment 
of taxpayers. Investigations are focused on IRS employee misconduct and 
infrastructure security, as well as external attempts to corrupt 
Federal tax administration.
    TIGTA's Office of Audit (OA) conducts audits that advise Congress, 
the Secretary of the Treasury, and IRS management of high-risk issues, 
problems, and deficiencies related to the administration of IRS 
programs and operations. Audits not only focus on the economy and 
efficiency of IRS functions but also ensure that taxpayers' rights are 
protected and the taxpaying public is adequately served. Overall, as of 
March 31, 2008, audit reports potentially produced financial 
accomplishments of $172.5 million, and potentially impacted 
approximately 1,217,000 taxpayer accounts in areas such as taxpayer 
burden, rights, and entitlements. OA develops an annual audit plan that 
communicates oversight priorities to Congress, the Department of the 
Treasury, and the IRS. Emphasis is placed on mandatory coverage imposed 
by the IRS Restructuring and Reform Act of 1998 \29\ and other 
statutory authorities, as well as issues impacting computer security, 
taxpayer rights and privacy, and financial-related audits. OA's work 
focuses on the IRS's major management challenges, the progress in 
achieving its strategic goals, the elimination of the IRS's systemic 
weaknesses, and the IRS's response to the President's Management Agenda 
initiatives.
---------------------------------------------------------------------------
    \29\ Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in 
scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 
U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
---------------------------------------------------------------------------
    TIGTA's Office of Investigations (OI) conducts investigations that 
protect the integrity of IRS employees, contractors, and other tax 
professionals; provides for infrastructure security; and protects from 
external attempts to threaten or corrupt the administration of Federal 
tax laws.
    TIGTA's OI investigates employee misconduct involving unauthorized 
access (UNAX) of confidential taxpayer records, theft, false 
statements, financial fraud, taxpayer abuses, and extortion.
    OI assists in maintaining IRS employee and infrastructure security 
by investigating incidents of threats or assaults made against IRS 
employees, facilities, and data infrastructure. As mentioned 
previously, the IRS's fiscal year 2009 budget request seeks a 7.1 
percent increase in its enforcement appropriation. This continued focus 
on enforcement has resulted in OI receiving higher levels of reported 
assaults and threats against IRS personnel. Additionally, the IRS's 
increasing reliance on electronic processes has resulted in an 
increased need for OI to investigate and respond to cyber attacks.
    TIGTA also investigates allegations involving external attempts to 
corrupt tax administration, such as bribes offered by taxpayers to 
compromise IRS employees, the use of fraudulent IRS documentation to 
commit crimes, taxpayer abuse and misconduct by tax practitioners, 
impersonation of IRS employees, and the corruption of IRS programs 
through procurement fraud.
    TIGTA faces major human capital challenges in delivering and 
adapting its oversight activities to the increasingly complex and high-
risk issues associated with IRS operations. Some of these issues 
include detection and investigation of fraud and electronic crime, 
procurement activities, taxpayer privacy, and an increasing number of 
requests for IRS program reviews from Congress and other IRS 
stakeholders. While adapting to this changing environment, 
approximately 37 percent of TIGTA employees are eligible for retirement 
by fiscal year 2011.
    Additionally, in order to accomplish its mission, TIGTA employees 
need to possess the appropriate skills. As the IRS continues to 
modernize and operate in an automated environment, it is essential that 
TIGTA auditors and investigators are appropriately trained to operate 
in this environment.
    To help address these challenges, TIGTA has initiated or is 
initiating the following actions in fiscal year 2008:
  --Created the Office of Inspections and Evaluations whose mission is 
        to provide TIGTA with additional flexibility, capacity and 
        capability to provide value-added products and services to 
        improve tax administration and promote good Government. This 
        function was created and staffed by a realignment of existing 
        resources.
  --Implementing a bureau-wide electronic learning management system 
        containing a skills assessment program that identifies the 
        critical skills needed for each of TIGTA's major occupations 
        and provides a means to assess resident skill levels. Based on 
        the results, TIGTA will develop a strategic recruitment program 
        to fill critical vacancies with the skills necessary to carry 
        out its increasingly complex oversight activities and align 
        future hiring in critical geographic areas.
  --Building its first Senior Executive Service Candidate Development 
        Program. The objective of the program is to promote a greater 
        understanding of the mission and culture of the Federal 
        Government and to train outstanding leaders and prepare them 
        for the Senior Executive Service.
    Mr. Chairman, as you requested, I will discuss TIGTA's 2009 budget 
needs. From fiscal year 2001 to fiscal year 2007, TIGTA's labor 
expenses have grown 20 percent from $88 million to $106.3 million, 
despite a substantial reduction in Full-Time Equivalents (a decrease of 
16 percent from 938 to 792). Labor costs currently account for 80 
percent of TIGTA's annual budget. As the number of TIGTA employees 
covered under the more expensive Federal Employees Retirement System 
increases, labor costs will continue to rise, reducing the funds 
available to TIGTA for non-labor spending.
    Since fiscal year 2001, TIGTA has only been able to meet its 
financial obligations through Full-Time Equivalent losses and 
implementation of cost-cutting initiatives in non-labor expense 
categories. From fiscal year 2001 to fiscal year 2007, non-labor 
spending (such as training, travel, equipment, etc.) fell 9 percent 
from $19.5 million to $17.7 million. These costs currently consume 13 
percent of TIGTA's annual budget.
    The fiscal year 2009 President's budget request for TIGTA will be 
used to continue to provide critical audit and investigative services, 
ensuring the integrity of tax administration on behalf of the Nation's 
taxpayers. While there are a number of critical areas in which TIGTA 
will provide oversight, highlights of TIGTA's investigative and audit 
priorities include:
  --Adapting to the IRS's continually evolving operations and 
        mitigating intensified risks associated with modernization;
  --Addressing the tax gap and enforcement efforts;
  --Responding to threats and attacks against IRS employees, property, 
        and sensitive information;
  --Improving the integrity of IRS operations by detecting and 
        deterring fraud, waste, abuse or misconduct by IRS employees;
  --Conducting comprehensive audits, inspections, and evaluations that 
        include recommendations for cost savings and enhancing the 
        IRS's service to taxpayers; and
  --Informing Congress and the Secretary of the Treasury of problems 
        and progress made to resolve identified issues.
    The total resources needed in fiscal year 2009 to support TIGTA's 
mission are $146,636,000, including $145,736,000 from direct 
appropriations and approximately $900,000 from reimbursable agreements. 
This is a $5.2 million (3.7 percent) increase over the fiscal year 2008 
spending authority compared with the IRS's 4.3 percent increase.
    I hope my discussion of the continuing challenges that face the IRS 
and TIGTA will assist you as you consider the fiscal year 2009 budget. 
Mr. Chairman and Members of the subcommittee, thank you for the 
opportunity to share my views.

    Senator Durbin. You should have filed for an extension 1 
minute and 6 seconds ago.
    Willie Nelson will be your hearing officer.
    On behalf of the IRS Oversight Board, Paul Cherecwich.

STATEMENT OF PAUL CHERECWICH, JR., CHAIRMAN, INTERNAL 
            REVENUE SERVICE OVERSIGHT BOARD
    Mr. Cherecwich. Chairman Durbin, Ranking Member Brownback, 
and members of the subcommittee staff who are here, thank you 
very much. My name is Paul Cherecwich. I am chair of the IRS 
Oversight Board.
    One of our most important responsibilities is to ensure the 
IRS budget and related performance expectations support the IRS 
strategic plans. I would like to take this time to summarize 
the Board's recommendations for the IRS fiscal year 2009 
budget.
    If I had one word to characterize the difference between 
the Board's recommendations and the President's request, it 
would be ``direction.'' I have taken the liberty of making a 
chart of one of the key figures in my written statement because 
I think that best illustrates the difference in the direction 
the Board is recommending.
    This chart shows the four major line items in the IRS 
budget. The Board wants to spend more for service and 
information technology (IT) modernization. The President would 
spend less. It would appear that the Board and the President 
have similar recommendations for enforcement, but when you get 
inside the numbers, there are real differences in balance. And 
the Board would spend about $100 million more for 
infrastructure, but the President's budget would keep the 
infrastructure budget at its present underfunded state.
    Let us start at the top with funding for taxpayer service. 
To put it simply, the Board wants the IRS to do more service, 
not less, especially service that helps taxpayers better 
understand their obligations and service targeted at 
underserved taxpayers. Most of the additional money for service 
that Congress added to the IRS budget last year would be 
eliminated by the President's budget. The Board believes the 
taxpayer assistance blueprint needs to be funded, and I have 
personally visited volunteers in tax assistance (VITA) sites in 
Utah, Georgia, and Kansas and can tell you that VITA is 
delivering important services to underserved taxpayers.
    With respect to enforcement, it may seem that the Board and 
the President are making identical recommendations, for the 
funding is so close, about $360 million. And reality is my 
written statement shows the Board's recommended enforcement 
programs are spread more broadly and not focused exclusively in 
a few areas. As discussed in my statement, the Board has also 
questioned the ability of the IRS to absorb the requested 
staffing in its small business, self-employed, and large 
business divisions.
    With respect to infrastructure, that is something that 
tends to be forgotten, but it is really quite important. The 
Board believes more funding for security is important in an age 
where the IRS is under increasing pressure to protect its 
databases from assault and keep taxpayer records private. I 
note that just the last week my colleague, Mr. George, issued a 
report chastising the IRS for their lack of security. The IRS 
does put a high priority on maintaining taxpayer privacy, but 
more should be done.
    People are also an important part of the IRS infrastructure 
and more attention must be paid to having an aging workforce 
effectively pass along their skills and special expertise to 
the next wave of leaders and employees.
    Now, the biggest difference in dollars between the Board 
and the President's budget is in business systems modernization 
(BSM). We have a $185 million difference between the Board's 
recommendation and the President's recommendation. By the way, 
this is the appropriations line. Technology modernization will 
result in major benefits to taxpayers and the Government. The 
Board believes the BSM to be the highest priority because of 
its ability to contribute to reducing the tax gap in the long 
term. We simply have to make progress faster. TIGTA and GAO 
have recently been reporting positively on the business systems 
modernization program. This is not the time to go backward in 
funding.
    Among other things, erratic funding makes program 
management more difficult and creates staffing issues for both 
the IRS and the contractors. When projects are cut back, you 
always lose the talented people you most want to keep.
    Few taxpayers would use a financial institution that 
updated its accounts weekly. Yet, we accept that for the IRS. 
This has to change.
    Modernized systems are required for electronic filing and 
financial controls. The failure of funding to upgrade the 
integrated financial system is going to prevent the IRS from 
managing its own accounts better.
    Now that I have summarized the Board's recommendations on 
the four major accounts, let me make a point on the entire IRS 
budget. There is a television program on the Discovery channel 
called ``Myth Busters'' whose avowed mission is to separate 
truth from fiction, and I want to bust a myth about the IRS. 
The myth is that taxpayers who are also voters will be unhappy 
if too much money is appropriated for the IRS. The Board has 
tested that myth in our taxpayer attitude surveys and found it 
was wrong. My written statement provides the details.

                           PREPARED STATEMENT

    In conclusion, the Congress must choose whether it wants to 
pursue short-term growth in enforcement activity over a more 
balanced path that stresses the benefits of long-term 
investments in technology infrastructure, service, and 
research.
    Thank you for the opportunity to present the board's views.
    Senator Durbin. Thanks.
    [The statement follows:]

               Prepared Statement of Paul Cherecwich, Jr.

    Chairman Durbin, Ranking Member Brownback, and members of the 
Subcommittee, thank you for this opportunity to present the Oversight 
Board's views on the administration's fiscal year 2009 IRS budget 
request. My name is Paul Cherecwich and I serve as Chairman of the IRS 
Oversight Board. My testimony explains the Board's recommendations for 
the IRS fiscal year 2009 budget and why the Board believes this level 
of funding is needed to meet the needs of the country and of taxpayers.
    Created as part of the IRS Restructuring and Reform Act of 1998 
(RRA 98), the Oversight Board's responsibilities include overseeing the 
IRS in its administration, management, conduct, direction and 
supervision of the execution and application of the internal revenue 
laws. The Board is also responsible for ensuring that the IRS' 
organization and operations allow the agency to carry out its mission. 
To this end, the Board was given specific responsibilities for 
reviewing and approving annual budgets and strategic plans.
    In fulfilling its responsibilities, the Board must ensure that the 
IRS' budget and the related performance expectations contained in the 
performance budget support the annual and long 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 developed a formal 
report in which it explains why it has recommended this budget for the 
IRS. I request that my statement and the report be entered into the 
committee record.

              FISCAL YEAR 2009 IRS BUDGET RECOMMENDATIONS

    One of the IRS Oversight Board's most important statutory 
responsibilities is to ensure that the IRS' budget request supports the 
agency's annual and long-term strategic plans. A budget request is more 
than a mechanism for appropriating funding; it's also a plan and a 
commitment. Not only does a proposed budget request funding, it also 
describes the activities the IRS will perform, how those activities 
align with the long-range strategic plan, and identifies measures to 
evaluate the expected results. A performance budget, properly used, 
enhances the ability of the IRS to meet its short-term performance 
targets and three strategic plan goals: (1) improve customer service; 
(2) enhance enforcement of the tax law; and (3) modernize the IRS 
through its people, processes and technology.
    Achieving these three strategic goals will enable the IRS to 
address the most serious problem facing tax administration today--
reducing the tax gap, the difference between what taxpayers should be 
paying and what they actually pay in a timely manner. The size of the 
tax gap is significant, with the IRS' most recent estimates placing it 
at approximately $290 billion (net) annually, based on 2001 tax 
returns. The imperative for closing the tax gap has never been greater. 
An annual net tax gap of $290 billion averages to about $2,200 per 
individual tax return, an enormous burden for the average taxpayer, and 
one that should not be tolerated by honest taxpayers. It is far too 
large to be dismissed lightly--it imposes a large burden on all 
taxpayers and undermines respect for tax administration.
    The IRS Oversight Board recommends an IRS fiscal year 2009 budget 
of $11.737 billion, an increase of $845 million over the enacted fiscal 
year 2008 amount of $10.892 billion, as summarized in Tables A-1 and A-
2 in Appendix A.
    The recommended budget takes a long-term view of IRS needs. Despite 
the severity of the tax gap, the Board believes such a view is both 
warranted and needed. In submitting its fiscal year 2009 budget 
recommendations to the Treasury Department in June 2007, the Board 
identified increased funding for Business Systems Modernization (BSM), 
security, infrastructure, and research as high priorities. These 
initiatives offer the best opportunity to reduce the tax gap in the 
long term.
    By following this approach, the Board's recommended budget 
maintains balance at its core: enforcement, taxpayer service, business 
systems modernization, and employee development must be adequately 
funded for the IRS to succeed in all parts of its mission and to ensure 
the long-term health of our tax administration system.
    The Board's recommended IRS budget compares to the President's 
request of $11.361 billion, an increase of $469 million over the fiscal 
year 2008 enacted appropriation. Although the two budgets are within 
3.3 percent, they take different approaches to funding priority program 
initiatives at the margin. The Board recommends a total of $644 million 
in program initiatives, spread among four areas: enforcement, taxpayer 
service, infrastructure and IT, and BSM. The President's budget 
requests a nearly identical amount of funding for enforcement 
initiatives as the Board, but cuts taxpayer service and BSM funds, and 
includes no program initiatives for infrastructure and IT. Figure 1 
shows the differences in graphic form.



    Although both budgets have as a core objective the reduction of the 
tax gap, the Board recommends funding initiatives across the full range 
of IRS functions and taxpayer segments. In contrast, the President's 
budget has as its central focus a short-term effort to build up IRS 
revenue-producing enforcement staffing at a time when the IRS is hard-
pressed to replace the high number of experienced employees who are 
retiring. Increased staffing is important, but the Oversight Board 
believes the IRS cannot ``audit its way out of the tax gap,'' and 
should avoid the temptation to close the tax gap with large staffing 
increases in revenue-producing functions that cannot be absorbed 
effectively. The Board believes its recommended budget avoids this 
problem by focusing on ways to make the IRS more efficient in the long 
term, and putting more resources into technology, infrastructure, and 
service as well as enforcement.
    Because reducing the tax gap is of critical importance, the Board 
has identified a subset of its recommended initiatives as having the 
highest priority. These initiatives are generally infrastructure and 
research intensive and will have the greatest effect on reducing the 
tax gap in the long term, and are identified in Table 1.

       TABLE 1.--IRS OVERSIGHT BOARD HIGHEST PRIORITY INITIATIVES
                          [Dollars in millions]
------------------------------------------------------------------------
                                                                 Amount
------------------------------------------------------------------------
Technology/Infrastructure:
    Fund Business Systems Modernization in Line with Current      $141.0
     Strategy.................................................
    Enhance IT Security.......................................     $16.7
    Enhance Contingency Planning and Disaster Recovery........      $8.7
    Implement Security Auditing...............................      $6.8
    Preserve quality IT workforce in applications development.     $36.8
    Build alternate power supply for computing center.........     $11.0
                                                               ---------
      Subtotal, Technology/Infrastructure.....................    $221.2
                                                               =========
Enforcement: Improve tax gap estimates, measurement, and           $11.1
 detection of non-compliance..................................
Taxpayer Service: Research Taxpayer Burden, Complexity, and        $10.0
 Compliance...................................................
                                                               ---------
      Total Highest Priority Initiatives......................      $2.3
------------------------------------------------------------------------

    None of these initiatives, except the enforcement initiative for 
improving tax gap estimates, are funded in the President's budget. 
Moreover, as shown in Figure 1, the BSM program and taxpayer service 
programs undergo reductions of $45 million and $47 million, 
respectively. The Board recommends that the appropriated IRS fiscal 
year 2009 budget closely follow the priorities and balance reflected in 
this statement.
    The following sections discuss the Board's budget recommendations 
in the context of each of the IRS' strategic goals.
Strategic Goal 1--Improve Taxpayer Service
    IRS customer service has made consistent gains since fiscal year 
2002. For example, Toll-Free Tax Law Accuracy and Accounts Accuracy are 
at 91 percent and 93 percent respectively in fiscal year 2007, as 
compared to 84.4 percent and 90 percent 5 years ago. Of particular 
note, overall customer satisfaction with IRS Toll-Free Service has held 
steady at 94 percent for four consecutive years. Such stability is most 
welcome and a good indicator that best practices have taken root.
    As a result, a more pressing challenge is to deliver more extensive 
electronic self-assistance tools and to perform research that 
identifies innovative ways to expand taxpayer education and outreach to 
all taxpayer segments, especially those who are now under served.
    To a large degree, many of the IRS' customer service activities are 
designed to respond to taxpayer inquiries. Examples include toll-free 
telephone service and Taxpayer Assistance Centers. Overall, the IRS has 
done a good job fielding and answering questions, whether via toll-free 
telephone, the Internet, or in person at Taxpayer Assistance Centers.
    The IRS expends considerably fewer resources on education and 
outreach services. A broader approach to customer service would entail 
giving taxpayers access to self-service applications so they could 
``pull'' specific information on accounts or tax law, and ``pushing'' 
answers, information and updates to taxpayers, practitioners and other 
affected parties as the need for such information became apparent. 
Lastly, the IRS must seize opportunities to provide innovative 
outreach, education and community partnerships. For example, given 
limited resources and elimination of programs such as TeleFile, the IRS 
must also work to broaden and strengthen partnerships, such as 
Volunteers in Tax Assistance (VITA).
    To take service to the next level, the IRS must better understand 
the taxpayers they serve. The IRS must conduct more insightful 
research, and develop services better tailored to the specific needs of 
particular taxpayer segments. By better understanding taxpayers, the 
IRS can focus both its service and enforcement efforts to increase 
compliance through targeted pre-filing, filing, and post-filing 
efforts. The IRS must find out what kind of information and assistance 
taxpayers need and the most effective ways of delivering that 
information to them.
    In the last 2 years, the IRS has put considerable effort into 
developing the Taxpayer Assistance Blueprint (TAB), which establishes a 
5-year plan for delivering service to taxpayers. This vision entails a 
much broader use of electronic interactions between taxpayers, 
practitioners and the IRS, such as account management and the ability 
to resolve taxpayer issues securely over the Internet. The TAB 
describes an IRS that is an ``interactive and fully integrated, online 
tax administration Agency'' with the capability ``for any exchange or 
transaction that occurs face-to-face, over the phone, or in writing to 
be completed electronically.'' These types of services are much along 
the lines of what customers of large financial institutions already 
experience today but are still for the most part unavailable to 
taxpayers.
    The Oversight Board disagrees with the President's program 
reductions for taxpayer service and recommends that the following three 
initiatives be funded for a total of $26.3 million:
  --Maintain Processing of Critical Pension Plan Returns ($6.3 
        million);
  --Research Taxpayer Burden, Complexity, and Compliance ($10 million); 
        and
  --Expand Volunteer Income Tax Assistance and Low Income Tax Clinics 
        ($10 million).
    The first initiative supports customer service by providing funds 
to maintain processing of essential pension plan return information 
while transitioning to a new mandated electronic filing system 
``EFAST2'' in 2010. It also enables processing of residual returns that 
are IRS-only forms and not part of the mandated EFAST2 system (Form 
5500EZ and Schedule SSA filings).
    The second initiative provides funding to enhance understanding of 
the interaction between taxpayer burden, tax law complexity, and 
taxpayer compliance. This research will help improve understanding of 
these inter-relationships, in keeping with strategies put forth in the 
Taxpayer Assistance Blueprint (TAB) and the Department of the Treasury 
report, A Comprehensive Strategy for Reducing the Tax Gap.
    The third initiative provides funding to improve service to two 
taxpayer segments with special needs: the growing number of elderly and 
the ethnically diverse. These taxpayer segments face unique challenges 
in meeting their tax obligations because of limited access to or 
inability to use all of the channels offered for service delivery. 
Additional resources will enhance the IRS's volunteer return 
preparation and other services provided by the Volunteer Income Tax 
Assistance (VITA) and the Low Income Tax Clinic programs with emphasis 
on both targeted taxpayer segments. Such services help created a more 
fair and just tax system.

Strategic Goal 2--Enhance Enforcement of the Tax Law
    Increases in IRS enforcement activity intended to produce gains in 
direct revenue collection must be balanced with a broad view of the tax 
gap. The Board recognizes that increased enforcement activity over the 
past five years has produced noticeable results--enforcement revenue 
has increased from $34.1 billion in fiscal year 2002 to $59.2 billion 
in fiscal year 2007, a gain of nearly 74 percent. The IRS estimates 
that it can produce more than a four-to-one return on every dollar 
invested in additional enforcement resources, a fact that the Board 
believes warrants the appropriation of additional enforcement funding.
    However, while the Board applauds the increases in enforcement 
activity and revenue, it also recognizes that the IRS cannot ``audit 
its way out'' of the tax gap. There is wide belief, as evidenced by the 
Board's recommendations for reducing the tax gap and the Treasury 
Department's tax gap strategy, A Comprehensive Strategy for Reducing 
the Tax Gap, that an integrated set of comprehensive actions is needed. 
Even a large infusion of resources for more enforcement personnel--
something highly unlikely--would not eliminate the tax gap. There are 
many reasons for taxpayer non-compliance. Only a balanced program that 
promotes voluntary compliance across a broad continuum of taxpayers, 
from education and service for those who want to comply, to enforcement 
and even criminal prosecutions for those who refuse to comply, can be 
effective.
    Table 2 compares the Board's and President's enforcement 
initiatives. Although very close in dollars, the President's 
initiatives place more emphasis on enforcement resources that can be 
shown to produce revenue in the short term. The Board takes a broader 
view of enforcement, and recommends program increases in such areas as 
expanded collection of proper taxes from recipients of Federal 
payments, investigation of tax-related criminal activity, Bank Secrecy 
Act compliance, tax exempt organization examination, more published 
guidance for Tax Exempt taxpayers, additional litigation staff, and tax 
preparer monitoring.
    Additional enforcement resources produce a positive return on 
investment and result in short-term benefits, so the benefits of 
increased enforcement are apparent. However, increases in enforcement 
resources must also be balanced with more systemic long-range actions 
that improve voluntary compliance, and priorities must be considered as 
budget resources are limited. The Oversight Board considers technology 
modernization and research a higher priority than additional 
enforcement resources, in recognition of the long-term impact that 
technology modernization and research have on the IRS' ability to work 
more efficiently to reduce the tax gap and to be better able to focus 
both its service and enforcement resources optimally.

               TABLE 2.--COMPARISON OF ENFORCEMENT INITIATIVES FOR BOARD'S AND PRESIDENT'S BUDGETS
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
    Oversight board's budget enforcement                       President's budget  enforcement
                initiatives                     Amount                   initiatives                    Amount
----------------------------------------------------------------------------------------------------------------
Reduce the Tax Gap for Small Business/Self-       $120.7  Reduce the Tax Gap for Small Business/         $168.50
 Employed.                                                 Self-Employed.
Increase Reporting Compliance of Domestic           16.4  Improve Reporting Compliance of U.S.             13.70
 Taxpayers with Offshore Activity.                         Taxpayers with Offshore Activity.
Reduce the Tax Gap for Large Businesses....         52.0  Reduce the Tax Gap for Large Business....        69.49
Expand Federal Payment Levy Program........         17.3  .........................................  ...........
Reduce Tax Fraud...........................         72.2  .........................................  ...........
Enhance Financial Investigations of                 24.0  .........................................  ...........
 Narcotics Trafficking Organizations.
Enhance BSA Compliance Program.............          3.4  .........................................  ...........
Address Complexity through Up-Front                  8.9  .........................................  ...........
 Guidance, Education, and Correction.
Expand Examination of Tax Exempt                    28.6  .........................................  ...........
 Organizations.
Increase Tax Court Litigation..............          5.8  .........................................  ...........
Implement New Procedural Tax Court                   3.4  .........................................  ...........
 Requirements.
Improve Tax Gap Estimates, Measurement, and         11.1  .........................................        51.06
 Detection of Non-Compliance.
Increase Monitoring of Preparers...........          2.5  .........................................  ...........
                                             ...........  Expand Document Matching.................        35.06
                                             ...........  Implement Legislative Proposals to               23.05
                                                           Improve Compliance.
                                            --------------------------------------------------------------------
      Total Enforcement....................        366.3  .........................................       360.85
----------------------------------------------------------------------------------------------------------------

    Another factor that must be considered is the degree to which 
additional staffing can be absorbed into various IRS organizational 
units. Figure 2 depicts the distribution of new hires in major IRS 
organizations under the President's and Board's budgets. The Board 
believes its budget strikes a more balanced posture across all IRS 
organizational units and expands enforcement resources for a range of 
activities that are important elements of IRS enforcement, although 
they do not generate revenue directly, such as examination of tax 
exempt organization reporting, regulation of pension plans, and 
criminal investigation of tax fraud and abusive tax shelters. These 
activities are all part of a balanced, enforcement program that has as 
a goal the promotion of voluntary compliance among all taxpayer 
segments.
    To better understand the impact of both budgets on the Small 
Business/Self-Employed (SB/SE) and Large and Mid-Sized Business (LMSB) 
organizations, the Board examined hiring requirements during fiscal 
year 2009 for both divisions. Table 3 shows the number of Mission 
Critical Occupation (MCO) employees projected to be on-rolls as of 
September 30, 2008, as well as the hiring requirements contained in 
both budgets. The Board has used a rule of thumb that 15 percent new 
hires is a reasonable limit on the amount of new employees that can be 
effectively accommodated into an organization in a year. It had 
concerns with the hiring implications of its own budget on SB/SE, but 
thought this risk could be mitigated. The President's budget would 
increase the percentage of new hires in SB/SE to over 23 percent of its 
employees in fiscal year 2009, and over 16 percent for LMSB.




      TABLE 3.--SB/SE AND LMSB HIRING REQUIREMENTS IN THE BOARD'S AND PRESIDENT'S FISCAL YEAR 2009 BUDGETS
----------------------------------------------------------------------------------------------------------------
                                                                  Operating Unit Mission Critical Occupations
                                                             ---------------------------------------------------
                                                               Oversight board budget      President's budget
                                                             ---------------------------------------------------
                                                                 SB/SE         LMSB        SB/SE         LMSB
----------------------------------------------------------------------------------------------------------------
Projected on rolls as of 9/30/2008..........................       19,394        5,126       19,394        5,126
                                                             ---------------------------------------------------
Projected Attrition Hires in fiscal year 2009...............        2,612          403        2,612          403
Projected New Hires in fiscal year 2009 to Meet Budget              1,177          273        1,918          433
 Request....................................................
                                                             ---------------------------------------------------
      Total Attrition Hires and New Hires...................        3,789          676        4,530          836
                                                             ---------------------------------------------------
Percent of Hires to total MCO population....................         19.5         13.2         23.4         16.3
----------------------------------------------------------------------------------------------------------------

    As in fiscal year 2006 through fiscal year 2008, the administration 
proposes to include its requested enforcement increases as a Budget 
Enforcement Act program integrity cap adjustment. The Oversight Board's 
recommended enforcement initiatives would also qualify for such 
treatment, should Congress decide to make such an adjustment.

Strategic Goal 3--Modernize the IRS Through its People, Processes and 
        Technology
    The most effective strategy for reducing the tax gap in the long 
term is to provide the IRS with modern technology that enables it to 
operate at a high performance level. The Board has no doubts that a 
high performing organization with high service, quality, and 
satisfaction levels also minimizes taxpayer burden. Under such 
conditions, service and enforcement activities are prompt, efficient, 
and correct.
    The Board has identified program initiatives for IT and 
infrastructure activities that are funded under the BSM and Operations 
Support accounts. These initiatives will further modernize the IRS core 
IT systems used for tax administration, upgrade its infrastructure, and 
improve its security posture.

           BUSINESS SYSTEMS MODERNIZATION PROGRAM INITIATIVE

    Tax administration is a knowledge-intensive activity and the IRS 
depends heavily on information technology (IT) to leverage the 
knowledge and perform its mission. The IRS has made slow but steady 
progress in replacing its antiquated IT systems. The most noticeable 
improvements to taxpayers have been increased use of electronic 
products and services to interact with the IRS. However, the IRS' 
performance is still hampered by archaic IT systems used for central 
record-keeping that update taxpayer account information on a weekly 
instead of a daily basis.
    The Board has long advocated that the BSM program be funded at a 
higher level so progress could be made more quickly. Admittedly the 
program experienced a series of cost and schedule overruns during its 
first several years, and the result has been to slow down the funding 
stream to levels that dictate only modest progress can be made in 
modernizing the core IRS master files and account management systems. 
Because of its long-term effect on reducing the tax gap, the Board 
considers increasing BSM funding so that the pace of IT modernization 
can be increased as having the highest priority.
    Figure 3 compares the BSM budget recommended by the Oversight 
Board, the amount requested by the President, and the BSM funding 
appropriated by Congress for fiscal years 2003 to 2008. BSM funding 
needs to be restored to the levels realized in fiscal year 2003 and 
fiscal year 2004 to make progress faster.




    Table 4 shows the Board's and President's budgets for the BSM 
program in fiscal year 2009. Had the Board's funding recommendations 
been followed, the IRS would be closer to the day when it could update 
its central records on a daily basis.

 TABLE 4.--APPLICATION OF FISCAL YEAR 2009 BSM FUNDING TO PROJECTS IN THE IRS OVERSIGHT BOARD'S AND PRESIDENT'S
                                                     BUDGETS
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                          Oversight board         President
                                                                       -----------------------------------------
                                                               Fiscal              Increase             Increase
                     Project activities                         year     Fiscal      over     Fiscal      over
                                                                2008      year      fiscal     year      fiscal
                                                                          2009    year 2008    2009    year 2008
----------------------------------------------------------------------------------------------------------------
Customer Account Data Engine................................      58.5      80.0      21.5       58.8       0.3
Accounts Management Services................................      29.0      47.4      18.4       26.2      (2.8)
Modernized e-File...........................................      55.8      36.1     (19.7)      25.0     (30.8)
Common Services Project.....................................  ........      16.0      16.0   ........  .........
Integrated Financial System.................................  ........      73.0      73.0   ........  .........
Core Infrastructure; Architecture Integration & Management;       78.6      98.1      19.5       69.3      (9.3)
 and Management Reserve.....................................
                                                             ---------------------------------------------------
      Subtotal Capital Investments..........................     221.8     350.6     128.8      179.3     (42.6)
BSM Labor...................................................      45.2      56.7      11.5       43.4      (1.8)
                                                             ===================================================
      BSM Program Total.....................................     267.1     407.3     140.2      222.7     (44.4)
----------------------------------------------------------------------------------------------------------------
Note: BSM program excludes $1.2 million of corporate costs in Operations Support.

    The Board believes that when implemented, modernized IT systems 
will literally save taxpayers billions of dollars in burden reduction 
and make the IRS much more efficient. For example, replacement of the 
Individual Master File by the Customer Account Data Engine (CADE) will 
allow the IRS to update the tax accounts for individuals on a daily 
basis, instead of its current weekly update process. The Oversight 
Board expects that a rapid refund from the IRS of 3 to 5 days will 
reduce the number of Refund Anticipation Loans (RALs). The National 
Consumer Law Center and Consumer Federation of American estimate that 
approximately 12 million American taxpayers spent an unnecessary $1.6 
billion on RALs in 2004 (the latest year for which data is available) 
to obtain their refund monies faster by 2 weeks. Moreover, daily 
updating of account records will give IRS employees and taxpayers 
access to the most current taxpayer account data, eliminating the 
problems associated with having various data bases with less than 
current status. The Oversight Board expects that daily posting of 
account information will improve the IRS' analysis capability and 
greatly reduce the burdens associated with the account resolution 
process.
    The Modernized e-File system not only makes it easier for taxpayers 
to file tax returns with the IRS, it reduces the human resources needed 
to receive and process tax returns and eliminates the error-prone 
transcription process. For corporate filers, it helps the LMSB division 
improve currency and cycle time in working large corporate tax cases. 
When implemented for individual tax returns, it will make the 
electronic filing process even simpler than it is today with the 
current legacy electronic filing system.
    The Integrated Financial System (IFS) will provide necessary 
improvements to the system the IRS uses to manage its financial 
resources, clearly a must for any agency, especially one that is 
responsible for managing taxpayers' accounts as well as its own 
appropriated resources. The IFS upgrade is needed to ensure that the 
IRS remains in compliance with Federal accounting and other financial 
management requirements. The additional funding for the IFS initiative 
will enable the IRS to add procurement and asset management modules to 
the existing IFS application and integrate related business processes 
with core accounting and financial management operations. The funding 
will also provide for the subsequent transfer of IFS to a Shared 
Service Center and thereby maintain its longer term viability.
    The Board believes that funding for the BSM program should be 
accelerated, not slowed down. Failure to fund the IRS BSM program at 
higher levels, in the view of the Board, is a case of being penny-wise 
and pound foolish.
       information technology/infrastructure program initiatives
    The IRS must be held to the highest standards for security and data 
integrity while increasing its engagement in the electronic world in 
which most taxpayers already live. Meeting this dual challenge of high 
security and a high degree of electronic interaction with taxpayers 
demands that the IRS have a modern information systems and 
infrastructure.
    The Board recommends six program initiatives for a total of $103 
million that will improve the IRS' operations by allowing it to make 
critical improvements to its technology and personnel infrastructure. 
By comparison, the President's budget contains no initiatives for IRS 
infrastructure.
    Three of the initiatives, totaling $32.2 million, enhance the IRS' 
security posture as the way the IRS does business continues to evolve 
and security threats seem to increase on a daily basis. Data security 
has taken on an expanded meaning in a post-9/11 world. Terrorists from 
around the globe are actively working to exploit weaknesses in 
Government IT security systems with the intent of producing both great 
physical and economic harm. Disrupting IRS returns processing and 
stealing sensitive information could wreak havoc on the economy and 
financial markets. The IRS cannot be complacent with respect to 
security, and the Board recommends the following security initiatives:
  --Enhance IT Security ($16.7 million);
  --Enhance Contingency Planning and Disaster Recovery ($8.7 million); 
        and
  --Implement Security Auditing ($6.8 million).
    The first initiative enables the IRS to further implement key IT 
security and privacy safeguards to assure the integrity of sensitive 
taxpayer and employee data and supporting infrastructure processes. 
Protecting taxpayer data is paramount. The second initiative is to 
enhance the IRS enterprise-wide contingency planning and disaster 
recovery capabilities to support critical business systems. Any 
unavailability of critical IRS business systems poses an unacceptably 
high risk to the Nation's security. The third initiative, Security 
Auditing, will allow the IRS to more effectively monitor key networks 
and systems to identify any unauthorized activities.
    The remaining three initiatives, for a total of $71.3 million, 
allow the IRS to improve other elements of its infrastructure. They 
are:
  --Redesign Form 990 for Tax Exempt Organizations ($23.5 million);
  --Preserve Quality IT Workforce in Applications Development ($36.8 
        million); and
  --Build Alternate Power Supply for the Computing Centers ($11 
        million).
    The first initiative, the only one that is not considered high 
priority, is recommended because it brings new efficiencies to tax 
filing for a segment of taxpayers who are frequently ignored because 
their tax returns do not produce revenue--tax exempt organizations. The 
Form 990 tax return is difficult to complete for tax exempt 
organizations to complete and for reviewers to comprehend. Worse, it 
fails to provide the IRS with sufficient information to detect and 
analyze compliance trends in the sector and target enforcement actions 
as needed.
    The second initiative will give the IRS better tools to retain its 
IT workforce by mitigating intellectual and experiential loss through a 
series of supporting strategies such as workforce re-tooling, 
succession planning, and retention. The third initiative provides 
alternate power supply for three of the IRS's computing centers. 
Currently there is but a single power supply facility at each of the 
computing centers. An alternate power supply capability at each of the 
three computing centers would ensure the continuous operation of, and 
continuous access to, tax processing systems at the computing centers 
during unplanned emergencies and planned power supply tests, and avoid 
the revenue loss and overtime expense associated with the current 
process that requires total shut down periods.

  INVESTING IN IRS IS A GOOD BUSINESS DECISION SUPPORTED BY THE PUBLIC

    In spite of recommendations made by the IRS Oversight Board, the 
IRS has not been funded at the most effective levels to achieve its 
strategic objectives. Figure 4 illustrates funding recommendations made 
by the Board since its inception, the President's budget request during 
this same time frame, and the funding appropriated by Congress. One of 
the principal reasons for this so-called ``resource gap'' is the budget 
process which treats the IRS the same as it does all other 
discretionary spending requests. It does not credit the IRS with 
bringing in 95 percent of all the revenue to fund the Federal 
Government, nor does it recognize the previously discussed four-to-one 
return on every dollar invested in tax enforcement.
    The Oversight Board has urged previously Congress to view funding 
of the IRS as an investment.\1\ Other members of the tax administration 
community, such as the National Taxpayer Advocate and the National 
Treasury Employees Union, have made similar recommendations.\2\
---------------------------------------------------------------------------
    \1\ IRS Oversight Board reports, Fiscal Year 2006 IRS Budget 
Recommendations/Special Report, Fiscal Year 2007 IRS Budget 
Recommendations/Special Report, and Fiscal Year 2008 IRS Budget 
Recommendations/Special Report.
    \2\ NTA, 2006 Report to Congress, Section 2, p. 445, and Statement 
of Colleen M. Kelley, President, National Treasury Employees Union, 
Testimony Before the House Committee on Ways and Means, May 23, 2007.



    There are a number of approaches that Congress could take to 
achieve this result, such as funding the IRS outside of budget caps, 
and the Board believes that the implementation of such a change is best 
left for Congress to decide. The Board would be remiss, however, if it 
didn't point out providing additional funds to the IRS has been 
consistently supported by nearly two out of three members of the 
public. In its annual Taxpayer Attitude Survey, the Board has asked 
taxpayers whether they support additional funding for the IRS. The 
results for 2005 through 2007 are shown in Table 5.

                          TABLE 5.--RESULTS OF TAXPAYER ATTITUDE SURVEY ON IRS FUNDING
----------------------------------------------------------------------------------------------------------------
                                                        Percent completely agree        Percent mostly agree
                 Survey question 11                  -----------------------------------------------------------
                                                        2007      2006      2005      2007      2006      2005
----------------------------------------------------------------------------------------------------------------
The IRS should receive extra funding to enforce tax         24        24        20        40        39        43
 laws and ensure taxpayers pay what they owe........
The IRS should receive extra funding so it can              21        24        22        42        42        44
 assist more taxpayers over the phone and in person.
----------------------------------------------------------------------------------------------------------------

    The Board believes such strong support indicates the public 
understands the need for effective tax administration and realizes 
that, ultimately, it pays for itself.

                               CONCLUSION

    Approving a budget is not just about money; it's also about 
choices. The Board believes its budget recommendations, if implemented, 
will put the IRS on an effective long-term path to achieving the IRS 
strategic goals, improving voluntary compliance, and reducing the tax 
gap.
    Although the Board's recommended budget is $375 million more than 
the President's request, there are some important decisions that must 
be made with respect to priorities and balance. The Congress must not 
only decide the amounts to be appropriated, but must also choose 
whether it wants to pursue short-term growth in enforcement activity 
over a more balanced path that stresses the benefits of long-term 
investments in technology, infrastructure, service, and research.

   Appendix A.--IRS Oversight Board Recommended IRS Fiscal Year 2009 
                                 Budget

   TABLE A-1.--IRS OVERSIGHT BOARD'S RECOMMENDED FISCAL YEAR 2009 IRS
                      BUDGET BY PROGRAM INITIATIVE
                        [In millions of dollars]
------------------------------------------------------------------------
                                                              Amount
------------------------------------------------------------------------
Fiscal Year 2008 Enacted Appropriation.................       10,892.38
    Base Adjustments...................................          262.62
    Savings/Reinvestments..............................          (61.65)
                                                        ----------------
      Fiscal Year 2008 Base Budget.....................       11,093.35
                                                        ================
                      INITIATIVES
 
Enforcement:
    Reduce the Tax Gap for Small Business/Self-Employed          120.7
    Increase Reporting Compliance of Domestic Taxpayers           16.4
     with Offshore Activity............................
    Reduce the Tax Gap for Large Businesses............           52.0
    Expand Federal Payment Levy Program................           17.3
    Reduce Tax Fraud...................................           72.2
    Enhance Financial Investigations of Narcotics                 24.0
     Trafficking Organizations.........................
    Enhance BSA Compliance Program.....................            3.4
    Address Complexity through Up-Front Guidance,                  8.9
     Education, and Correction Opportunities...........
    Expand Examination of Tax Exempt Organizations.....           28.6
    Increase Tax Court Litigation......................            5.8
    Implement New Procedural Tax Court Requirements....            3.4
    Improve Tax Gap Estimates, Measurement, and                   11.1
     Detection of Non-Compliance.......................
    Increase Monitoring of Preparers...................            2.5
                                                        ----------------
      Total Enforcement................................          366.3
                                                        ================
Taxpayer Services:
    Maintain Processing of Critical Pension Plan                   6.3
     Returns...........................................
    Research Taxpayer Burden, Complexity, and                     10.0
     Compliance........................................
    Expand Volunteer Income Tax Assistance and Low                10.0
     Income Tax Clinics................................
                                                        ----------------
      Total Service....................................           26.3
                                                        ================
Infrastructure/IT:
    Enhance IT Security................................           16.7
    Enhance Contingency Planning and Disaster Recovery.            8.7
    Implement Security Auditing........................            6.8
    Redesign Form 990 for Tax Exempt Organizations.....           23.5
    Preserve Quality IT Workforce in Applications                 36.8
     Development.......................................
    Build Alternate Power Supply for the Computing                11.0
     Centers...........................................
                                                        ----------------
      Infrastructure/IT Initiatives Subtotal...........          103.5
                                                        ================
Business Systems Modernization (BSM)...................          142.4
HITCA..................................................            5.50
                                                        ================
      Total Initiatives................................          644.00
                                                        ================
Fiscal Year 2009 Budget Request........................       11,737.35
Fiscal Year 2009 Request Increase over Fiscal Year 2008          844.97
 Base..................................................
Fiscal Year 2009 President's Request for IRS...........       11,361.51
Increase Over President's Budget Request...............          375.8
------------------------------------------------------------------------


                           TABLE A-2.--IRS OVERSIGHT BOARD'S RECOMMENDED FISCAL YEAR 2009 IRS BUDGET BY APPROPRIATION ACCOUNT
                                                                [In millions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                               Taxpayer                    Ops
                                                                               services   Enforcement    support        BSM        HITCA        Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fiscal Year 2008 Enacted Appropriation.....................................     2,150.0      4,780.0      3,680.1        267.1        15.2     10,892.4
    Base Adjustments.......................................................        54.7        125.0         81.2          1.4         0.3        262.6
    Savings/Reinvestments..................................................       (10.5)       (48.8)        (2.2)  ..........        (0.2)       (61.6)
                                                                            ----------------------------------------------------------------------------
      Fiscal Year 2009 Base Budget.........................................     2,194.2      4,856.2      3,759.0        268.4        15.4     11,093.4
                                                                            ============================================================================
                                INITIATIVES
 
Enforcement:
    Reduce the Tax Gap for Small Business/Self-Employed....................         2.9         94.0         23.8   ..........  ...........       120.7
    Increase Reporting Compliance of Domestic Taxpayers with Offshore        ...........        13.8          2.6   ..........  ...........        16.4
     Activity..............................................................
    Reduce the Tax Gap for Large Businesses................................  ...........        44.0          8.0   ..........  ...........        52.0
    Expand Federal Payment Levy Program....................................         0.4         16.5          0.4   ..........  ...........        17.3
    Reduce Tax Fraud.......................................................  ...........        55.8         16.4   ..........  ...........        72.2
    Enhance Financial Investigations of Narcotics Trafficking Organizations  ...........        21.0          3.0   ..........  ...........        24.0
    Enhance BSA Compliance Program.........................................  ...........         2.8          0.6   ..........  ...........         3.5
    Address Complexity through Up-Front Guidance, Education, and Correction         1.1          6.5          1.3   ..........  ...........         8.9
     Opportunities.........................................................
    Expand Examination of Tax Exempt Organizations.........................         0.2         23.3          5.1   ..........  ...........        28.6
    Increase Tax Court Litigation..........................................  ...........         5.0          0.8   ..........  ...........       115.8
    Implement New Procedural Tax Court Requirements........................  ...........         2.8          0.5   ..........  ...........         3.4
    Improve Tax Gap Estimates, Measurement, and Detection of Non-Compliance  ...........         7.6          3.5   ..........  ...........        11.1
    Increase Monitoring of Preparers.......................................  ...........         2.2          0.4   ..........  ...........         2.5
                                                                            ----------------------------------------------------------------------------
      Total Enforcement....................................................         4.7        295.2         66.5   ..........  ...........       366.3
                                                                            ============================================================================
Taxpayer Services:
    Maintain Processing of Critical Pension Plan Returns...................         6.0   ...........         0.2   ..........  ...........         6.3
    Research Taxpayer Burden, Complexity, and Compliance...................  ...........  ...........        10.0   ..........  ...........        10.0
    Expand VITA and Low Income Tax Clinics.................................         9.8   ...........         0.2   ..........  ...........        10.0
                                                                            ----------------------------------------------------------------------------
      Total Service........................................................        15.8   ...........        10.5   ..........  ...........        26.3
                                                                            ============================================================================
Infrastructure/IT:
    Enhance IT Security....................................................  ...........  ...........        16.7   ..........  ...........        16.7
    Enhance Contingency Planning and Disaster Recovery.....................  ...........  ...........         8.7   ..........  ...........         8.7
    Implement Security Auditing............................................  ...........  ...........         6.9   ..........  ...........         6.9
    Redesign Form 990 for Tax Exempt Organizations.........................  ...........  ...........        23.5   ..........  ...........        23.5
    Preserve Quality IT Workforce..........................................  ...........  ...........        36.8   ..........  ...........        36.8
    Build Alternate Power Supply for the Comp Centers......................  ...........  ...........        11.0   ..........  ...........        11.0
                                                                            ----------------------------------------------------------------------------
      Infrastructure/IT Initiatives Subtotal...............................  ...........  ...........       103.5   ..........  ...........       103.5
                                                                            ============================================================================
Business Systems Modernization (BSM).......................................  ...........  ...........         1.2        141.2  ...........       142.4
HITCA......................................................................  ...........  ...........  ...........  ..........         5.5          5.5
                                                                            ----------------------------------------------------------------------------
      Total Initiatives....................................................        20.5        295.2        181.6        141.2         5.5        644.0
                                                                            ============================================================================
Fiscal Year 2009 Budget Recommendation.....................................     2,214.7      5,151.4      3,940.6        409.7        20.9     11,737.4
Fiscal Year 2009 Recommendation over Fiscal Year 2008 Enacted..............        64.7        371.4        260.6        142.6         5.7        845.0
Fiscal Year 2009 President's Request for IRS...............................     2,150.0      5,117.3      3,856.2        222.7        15.4     11,361.5
Increase Over President's Budget Request...................................        64.7         34.2         84.5        187.0         5.5        375.9
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Senator Durbin. Taxpayer Advocate, Nina Olson.

STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER ADVOCATE, 
            INTERNAL REVENUE SERVICE

    Ms. Olson. Chairman Durbin, Ranking Member Brownback, and 
members of the subcommittee, thank you for inviting me to 
testify on the proposed budget of the IRS for fiscal year 2009.
    As an initial matter, I want to acknowledge that the IRS is 
doing an excellent job with most of its core services as 
illustrated by its ability to pull off the recent filing season 
despite the late AMT patch and the need to apply its limited 
resources to providing stimulus payments. There are always 
tasks the IRS could perform better and I will address some of 
those today, but I think it is important to take a moment to 
reflect on the vast responsibilities the IRS must meet to 
collect the revenue our Government requires to function and to 
acknowledge how much the IRS does very well.
    Now, I would like to emphasize five points.
    First, in my 2006 annual report to Congress, I recommended 
that Congress provide the IRS with after-inflation budget 
increases of about 2 to 3 percent a year for the foreseeable 
future. Assuming the funds are wisely spent, I believe that 
each additional dollar appropriated for the IRS will generate 
substantially more than $1 in increased Federal revenue. 
Providing adequate funding for the IRS, which is in reality the 
accounts receivable department of the Federal Government, is a 
wise financial investment.
    Second, one of the most critical choices facing tax 
administration is how to allocate resources between taxpayer 
services and tax law enforcement. While I believe that both 
categories would benefit from additional funding, I am 
concerned that the IRS has been emphasizing enforcement at the 
expense of taxpayer services. Over the 5-year period, fiscal 
year 2004 through fiscal year 2008, GAO concluded that funding 
for enforcement has increased substantially while funding for 
taxpayer services has been reduced. The budget proposal for 
fiscal year 2009 would continue this trend.
    Moreover, while the taxpayer services appropriation is 
currently $2.2 billion, more than 70 percent of those funds are 
used for filing and account services, mostly the processing of 
tax returns. Return processing is not pure taxpayer service but 
also constitutes the first step in screening returns for audit. 
The budget subcategory titled ``pre-filing taxpayer assistance 
and education'' is what most people think of as core taxpayer 
service, and significantly, only 6 percent--6 percent--of the 
IRS budget, or $645 million, is currently devoted to this area. 
The budget proposal would reduce this $645 million taxpayer 
service amount by about $28 million, a reduction of 4.35 
percent in nominal terms and a larger reduction after taking 
into account inflation.
    There are no reliable data that show that more enforcement 
is more effective than more taxpayer service in increasing 
compliance. I believe the IRS can produce a positive return on 
investment from more funding in both areas, but given limited 
resources, I think it is misguided to continue to ramp up 
enforcement at the expense of providing core taxpayer services.
    Third, research plays a vital role in helping the IRS make 
the major strategic and operational decisions needed to 
effectively administer the tax system. Just as research and 
development (R&D) is critical to a technology company as it 
seeks to improve the products and services it provides to 
customers, tax administration-related research is critical to 
the IRS as it seeks to meet taxpayer service needs and improve 
tax compliance in a cost effective manner. For that reason, I 
have consistently advocated for a more robust IRS research 
capability.
    The Taxpayer Advocate Service has initiated or worked with 
the IRS to conduct taxpayer-centric research on several 
enforcement and service issues. Some of these projects have 
been undertaken in response to appropriations directives and 
they are detailed in my written statement.
    In my annual reports to Congress and in prior testimony, I 
have expressed serious concerns about many aspects of the 
private debt collection initiative. I now add to these concerns 
the issue of foregone revenue. Very simply, the PDC initiative 
will cost the Government more than $81 million in foregone 
revenue this year, and the cost is likely to reach nearly $500 
million over the next 6 years. Moreover, 46 percent of the 
fully paid liabilities included in PDC gross revenue have been 
collected through offsets or direct payments made by the 
taxpayer after receiving a letter from the IRS informing the 
taxpayer that his or her account would be placed with a private 
collection agency (PCA), but before the PCA made contact with 
the taxpayers. These fully paid liabilities are a direct result 
of IRS action, not action taken by the PCA. Although the 
purpose of the private debt collection (PDC) program is 
obviously to raise revenue, the PDC program has lost revenue in 
absolute terms and will continue to cost the Government 
significant foregone revenue each year.
    I will make my fifth point in my written statement so I am 
not penalized.
    Senator Durbin. Thank you very much, Ms. Olson.
    [The statement follows:]

                  Prepared Statement of Nina E. Olson

    Mr. Chairman, Ranking Member Brownback, and distinguished Members 
of the Subcommittee: Thank you for inviting me to submit this written 
statement regarding the proposed budget of the Internal Revenue Service 
(IRS) for fiscal year 2009. I will address the overall level of funding 
I believe the IRS should receive, the allocation of that funding 
between enforcement and taxpayer service, and a number of important tax 
administration issues in which this Committee has expressed an 
interest. I approach these issues from my perspective as the National 
Taxpayer Advocate, the voice for taxpayers and taxpayer rights inside 
the IRS.\1\
---------------------------------------------------------------------------
    \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. However, the National Taxpayer Advocate presents an 
independent taxpayer perspective that does not necessarily reflect the 
position of the IRS, the Treasury Department, or the Office of 
Management and Budget. 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.
---------------------------------------------------------------------------
    As a threshold matter, I want to acknowledge that the IRS is doing 
an excellent job with most of its core services, and it is seriously 
attempting to improve its operations in other areas. This filing season 
alone demonstrates that when the IRS devotes its full attention to a 
task, it performs it extraordinarily well. As I noted in my 2007 Annual 
Report, late-year tax-law changes impact both taxpayers and the IRS, 
and the uncertainty surrounding such changes increases the risk that 
problems will arise with basic service delivery and return 
processing.\2\ These challenges increase when the IRS must devote 
substantial resources during the filing season to a major new 
initiative, such as preparing to issue the recently authorized economic 
stimulus payments. To deliver these payments, the IRS not only must 
process payments to the over 130 million taxpayers who currently file 
income tax returns, but it also must identify and process returns from 
and payments to more than 20.5 million persons who have no filing 
requirement.\3\ All of these exigencies divert the IRS from other 
important work, yet the fact that the IRS has managed to turn on a dime 
and deliver this filing season without significant glitches is a 
testament to the extraordinary people who work at the IRS.
---------------------------------------------------------------------------
    \2\ See National Taxpayer Advocate 2007 Annual Report to Congress 
3-12 (Most Serious Problem: The Impact of Late-Year Tax-Law Changes on 
Taxpayers).
    \3\ Approximately 20.5 million persons received Social Security or 
Veterans benefits and are therefore likely to qualify for stimulus 
payments but did not file tax returns in 2006. IRS News Release, 
Special Economic Stimulus Payment Packages Go to Social Security, 
Veterans Recipients, IRS-2008-37 (Mar. 10, 2008). There is also an 
unknown number of low income taxpayers who ordinarily would not have a 
filing requirement but will have to file this year to receive stimulus 
payments.
---------------------------------------------------------------------------
    There are always tasks the IRS could perform better--and I will 
address some of them below--but I think it is important to take a 
moment to reflect on the vast responsibilities the IRS must meet to 
collect the revenue our Government requires to function and to 
acknowledge how much the IRS does very well.

To Increase Federal Revenue, Congress Should Provide Increases in IRS 
        Personnel Funding at a Rate of About Two Percent to Three 
        Percent a Year Above Inflation
    In my 2006 Annual Report to Congress, I recommended that Congress 
provide the IRS with after-inflation increases of about 2 percent to 3 
percent a year for the foreseeable future. Assuming the funds are 
wisely spent, I said that I believe increasing the IRS budget at this 
rate is an excellent financial investment. I continue to believe this 
is the case.
    Most Federal expenditure programs are just that--expenditure 
programs. The funds are intended to be spent on worthwhile programs, 
but the expenditures generally do not directly generate more Federal 
revenue.
    The IRS is different. The IRS is effectively the Accounts 
Receivable Department of the Federal Government, and it collects about 
96 percent of all Federal revenue.\4\ On a budget of about $10.6 
billion,\5\ the IRS collected about $2.24 trillion in fiscal year 
2006.\6\ In other words, every $1 spent on the IRS produced about $210 
in Federal revenue.\7\
---------------------------------------------------------------------------
    \4\ Government Accountability Office, GAO-07-136, Financial Audit: 
IRS's Fiscal Years 2006 and 2005 Financial Statements 84 (Nov. 2006).
    \5\ Department of the Treasury, Fiscal Year 2007 Budget in Brief at 
59.
    \6\ Government Accountability Office, GAO-07-136, Financial Audit: 
IRS's Fiscal Years 2006 and 2005 Financial Statements at 95 (Nov. 
2006). The IRS actually collected $2.51 trillion on a gross basis in 
fiscal year 2006, but issued $277 billion in tax refunds.
    \7\ When collecting tax from the vast majority of taxpayers who 
file returns and pay all or substantially all of the tax they owe 
voluntarily, the cost the IRS incurs per taxpayer is very low. As the 
IRS attempts to collect tax from noncompliant taxpayers through broader 
outreach efforts or through examination and collection actions, the 
cost per taxpayer rises substantially. Therefore, the marginal ROI the 
IRS achieves as it attempts to collect unpaid taxes is likely to be 
considerably lower than the average ROI of 210:1 that the IRS achieves 
on taxes paid voluntarily. But if the IRS were given more resources, 
most data indicate that the IRS could generate a substantially positive 
marginal ROI.
---------------------------------------------------------------------------
    If the Federal Government were a private company, its management 
clearly would fund the Accounts Receivable Department at whatever level 
it believed would maximize the company's bottom line. Since the IRS is 
not a private company, maximizing the bottom line is not--in and of 
itself--an appropriate goal. But the public sector analogue should be 
to maximize tax compliance, especially voluntary compliance, with due 
regard for protecting taxpayer rights and minimizing taxpayer burden. 
Studies show that if the IRS were given more resources, it could 
collect substantially more revenue.
    In his final report to the IRS Oversight Board in 2002, former 
Commissioner Charles Rossotti presented a discussion titled ``Winning 
the Battle but Losing the War'' that detailed the consequences of the 
lack of adequate funding for the IRS. He identified 11 specific areas 
in which the IRS lacked resources to do its job, including taxpayer 
service, collection of known tax debts, identification and collection 
of tax from non-filers, identification and collection of tax from 
underreported income, and noncompliance in the tax-exempt sector.
    Commissioner Rossotti provided estimates of the revenue cost in 
each of the 11 areas based on IRS research data. In the aggregate, the 
data indicated that the IRS lacked the resources to handle cases worth 
about $29.9 billion each year. It placed the additional funding the 
agency would have needed to handle those cases at about $2.2 
billion.\8\
---------------------------------------------------------------------------
    \8\ Commissioner Charles O. Rossotti, Report to the IRS Oversight 
Board: Assessment of the IRS and the Tax System 16 (Sept. 2002).
---------------------------------------------------------------------------
    Significantly, this estimate reflected only the potential direct 
revenue gains. Economists have estimated that the indirect effects of 
an examination on voluntary compliance provide further revenue gains. 
While the indirect revenue effects cannot be precisely quantified, two 
of the more prominent studies in the area suggest the indirect revenue 
gains are between 6 and 12 times the amount of a proposed 
adjustment.\9\
---------------------------------------------------------------------------
    \9\ Alan H. Plumley, Pub. 1916, The Determinants of Individual 
Income Tax Compliance: Estimating The Impacts of Tax Policy, 
Enforcement, and IRS Responsiveness 35-36 (Oct. 1996); Jeffrey A. 
Dubin, Michael J. Graetz & Louis L. Wilde, The Effect of Audit Rates on 
the Federal Individual Income Tax, 1977-1986, 43 Nat. Tax J. 395, 396, 
405 (1990).
---------------------------------------------------------------------------
    I want to emphasize that the existing modeling in this area is not 
especially accurate, and estimates of both the direct and indirect 
effects of IRS programs vary considerably. As I will discuss below, the 
IRS needs to develop better modeling to produce more accurate return-
on-investment estimates. But I also want to emphasize that almost all 
studies show that, within reasonable limits, each additional dollar 
appropriated to the IRS should generate substantially more than an 
additional dollar in Federal revenue, assuming the funding is wisely 
spent.

The IRS Currently Spends Only Six Percent of Its Budget on Taxpayer 
        Assistance and Education; a More Equitable Balance Between 
        Taxpayer Services and Enforcement Should Be Achieved
    One of the most critical choices facing tax administration is how 
to allocate resources between taxpayer services and tax-law 
enforcement. While I believe that both categories would benefit from 
additional funding--and I do not believe the categories should be 
viewed as mutually exclusive--I am concerned that the IRS has been 
emphasizing enforcement at the expense of taxpayer service.
    After the administration issued its fiscal year 2008 budget 
proposal last year, the GAO analyzed recent IRS funding trends. Over 
the 5-year period fiscal year 2004 through fiscal year 2008, it 
concluded that funding for enforcement has increased substantially 
while funding for taxpayer services has been reduced. Based on the 
administration's proposal for fiscal year 2008, it pointed out that 
funding over the fiscal year 2004 through fiscal year 2008 period would 
increase by 19.4 percent for enforcement while funding for taxpayer 
services would decline by 3.8 percent.\10\ The final appropriations 
bill for fiscal year 2008 made a modest adjustment to the 
administration's proposal, providing about $46.9 million more for 
taxpayer service and $145 million less for enforcement.\11\
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    \10\ Government Accountability Office, GAO-07-673, Internal Revenue 
Service: Interim Results of the 2007 Tax Filing Season and the Fiscal 
Year 2008 Budget Request 27 (April 2007). These numbers are apparently 
not adjusted for inflation. GAO reported that overall IRS funding would 
increase, on an inflation-adjusted basis, by a mere 0.5 percent from 
fiscal year 2004 to fiscal year 2008 under the Administration's 
proposal. Id. at 26.
    \11\ Compare Department of the Treasury, Fiscal Year 2009 Budget in 
Brief at 53 with Department of the Treasury, Fiscal Year 2008 Budget in 
Brief at 55.
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    However, the proposal for fiscal year 2009 would continue the trend 
of spending relatively more on enforcement. The pending budget proposal 
would increase enforcement spending by $490 million (7 percent), while 
increasing spending for taxpayer services by only $23 million (0.6 
percent).\12\ Thus, after inflation, the proposal would reduce taxpayer 
services spending still further.
---------------------------------------------------------------------------
    \12\ Department of the Treasury, Fiscal Year 2009 Budget in Brief 
at 54. These dollar amounts reflect the allocation of the Operations 
Support budget to the Taxpayer Services and Enforcement categories.
---------------------------------------------------------------------------
    Moreover, the budget categories of ``Taxpayer Services'' and 
``Enforcement'' are misleading. Of the $2.2 billion in the ``Taxpayer 
Services'' category, only $645 million, or 6 percent of the IRS budget, 
is currently allocated for ``Pre-filing Taxpayer Assistance and 
Education.'' \13\ A significant majority of funds under the ``Taxpayer 
Services'' category is allocated for ``Filing and Account Services,'' 
which largely covers the processing of tax returns. Returns processing 
is hardly a pure service activity. While it does enable the IRS to 
issue tax refunds, it is an internal processing function that also 
constitutes the first step in screening returns for audit. In any 
event, it is far removed from the type of taxpayer service that informs 
taxpayers about their tax obligations and assists them in complying 
with the laws. The budget proposal would reduce funding for taxpayer 
assistance and education from $645 million to $617 million--a reduction 
of 4.34 percent in nominal terms and a larger reduction after taking 
into account inflation.\14\
---------------------------------------------------------------------------
    \13\ Id. at 53.
    \14\ Department of the Treasury, Fiscal Year 2009 Budget in Brief 
at 53.
---------------------------------------------------------------------------
    I am deeply concerned about this long-term shift in the balance 
between taxpayer services and enforcement and the fact that only 6 
percent of the IRS budget is devoted to pre-filing taxpayer assistance 
and education, which I view as core taxpayer service. There is no 
reliable data showing that more enforcement is more effective than more 
taxpayer service in increasing compliance. I believe the IRS can 
produce a positive return on investment from more funding in both 
areas. But given limited resources, I think it is misguided to continue 
to ramp up enforcement at the expense of taxpayer service.
    The concerns I am expressing about the relative shift in emphasis 
from taxpayer service to enforcement do not reflect simply the 
misgivings of a zealous taxpayer advocate. My concerns are shared by 
former IRS Commissioner Rossotti. In a memoir about his experience 
running the IRS from 1997 to 2002, Mr. Rossotti wrote:

    Some critics argue that the IRS should solve its budget problem by 
reallocating resources from customer support to enforcement. In the 
IRS, customer support means answering letters, phone calls, and visits 
from taxpayers who are trying to pay the taxes they owe. Apart from the 
justifiable outrage it causes among honest taxpayers, I have never 
understood why anyone would think it is good business to fail to answer 
a phone call from someone who owed you money.\15\
---------------------------------------------------------------------------
    \15\ Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to 
Turn Around the Most Unpopular Organization in America 285 (2005).

    At his confirmation hearing, Commissioner Shulman said that he 
believes the choice between service and enforcement is a ``false 
choice'' because the IRS must do both well.\16\ I agree completely. But 
the IRS needs adequate funding in both areas to do the job.
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    \16\ Hearing Before the S. Comm. on Finance, 110th Cong. (2008) 
(Jan. 29, 2008) (statement of Douglas H. Shulman).
---------------------------------------------------------------------------
The IRS Has Improved Its Research in Recent Years, But Significant 
        Improvements Are Still Needed
    Research plays a vital role in helping the IRS make the major 
strategic and operational decisions needed to effectively administer 
the tax system. Just as R&D is critical to a technology company as it 
seeks to improve the products and services it provides to customers, 
tax administration-related research is critical to the IRS as it seeks 
to meet taxpayer service needs and improve tax compliance in a cost-
effective manner. For that reason, I have consistently advocated for a 
more robust IRS research capability.
    The IRS has more information available today than it did 5 years 
ago, particularly in the area of taxpayer service because of ongoing 
work in connection with the Taxpayer Assistance Blueprint. However, the 
IRS should continue to expand its available knowledge and should make 
research an integral part of its next strategic plan. In particular, 
the IRS should make it a priority to improve the accuracy of its return 
on investment (ROI) estimates for various categories of work, 
particularly taxpayer service and the indirect effect of enforcement 
actions. Improved methods should also be developed to verify, 
retrospectively, the marginal ROI that the IRS has achieved for major 
categories of its work. Such information would be extremely helpful in 
guiding future resource-allocation decisions.
    Because of the value I place on research, TAS has initiated or 
worked with the IRS to conduct taxpayer-centric research on enforcement 
and service issues. Some of these projects have been undertaken in 
response to Appropriations directives. For example, TAS Research is 
currently working with the central IRS research function and the 
research functions in the IRS's Wage & Investment and Small Business/
Self-Employed Divisions to develop and implement a 5-year research plan 
to enhance taxpayer service in support of the Taxpayer Assistance 
Blueprint initiative. TAS Research is collaborating with the IRS 
research community to develop a 5-year research plan directly 
supporting enterprise-wide strategic goals. TAS Research is working 
with the central IRS research function to identify and quantify the 
numerous factors that impact taxpayer compliance behavior. TAS Research 
is working with the Office of Electronic Tax Administration and 
Refundable Credits to study alternatives for increasing electronic 
filing, and will work with the IRS's National Research Program to 
conduct research into the causes of noncompliance (whether advertent or 
inadvertent).
    In addition, TAS Research is involved in a number of other 
initiatives addressing significant tax administration issues, such as:
  --A collaborative effort with the research function in the Wage & 
        Investment Division to explore development of a filter for the 
        Federal Payment Levy Program to protect low income taxpayers 
        from systemic levies;
  --A collaborative effort with the Office of Program Evaluation and 
        Risk Analysis (OPERA) to explore new applications of ``agent-
        based modeling,'' a technology that simulates taxpayer behavior 
        in social networks, to tax administration issues;\17\
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    \17\ National Taxpayer Advocate 2007 Annual Report to Congress, 
vol. 2 (Research Study: Simulating EITC Filing Behaviors: Validating 
Agent Based Simulation for IRS Analyses: The 2004 Hartford Case Study).
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  --A collaborative effort with the IRS research community to explore 
        ways to positively influence the impact practitioners and 
        preparers have on taxpayer compliance; and
  --Ongoing research by an independent contractor into the impact 
        preparers have on taxpayer compliance.\18\
---------------------------------------------------------------------------
    \18\ National Taxpayer Advocate 2007 Annual Report to Congress, 
vol. 2 (Research Study: Study of the Role of Preparers in Relation to 
Taxpayer Compliance with Internal Revenue Laws).
---------------------------------------------------------------------------
    In Volume 2 of the 2007 National Taxpayer Advocate's Annual Report 
to Congress, I published a comprehensive literature review of the 
cognitive and normative factors that influence taxpayer compliance 
behavior.\19\ In another section of the report, I adopt the central 
recommendation of the study--that the IRS should establish a cognitive 
learning and applied research laboratory to explore how taxpayer 
values, social norms, and cognitive processes influence taxpayers' 
compliance.\20\
---------------------------------------------------------------------------
    \19\ National Taxpayer Advocate 2007 Annual Report to Congress, 
vol. 2 (Research Study: Normative and Cognitive Aspects of Tax 
Compliance: Literature Review and Recommendations for the IRS Regarding 
Individual Taxpayers).
    \20\ See National Taxpayer Advocate 2007 Annual Report to Congress 
158 (Most Serious Problem: Taxpayer Service and Behavioral Research).
---------------------------------------------------------------------------
    Toward that end, TAS Research is proposing a survey conducted as a 
component of the National Research Program (NRP), in which an 
independent firm surveys taxpayers who were subjects of NRP audits and 
explores the causes of any detected noncompliance and the factors 
influencing taxpayer compliance behavior. This information, combined 
with the compliance data from the NRP audits themselves and the 
observations of IRS auditors about the reasons for the detected 
noncompliance, should provide a rich resource for future studies and 
initiatives, and should improve the IRS's ability to improve taxpayer 
compliance.\21\
---------------------------------------------------------------------------
    \21\ For an example of how one might conduct such a study and an 
interesting analysis of some of the attitudinal and knowledge factors 
that might impact taxpayer compliance in a self-assessment tax system, 
see Ern Chen Loo, Margaret McKerchar, & Ann Hansford, An International 
Comparative Analysis of Self-Assessment: What Lessons are there for Tax 
Administrators?, 20 Australian Tax Forum 667 (2005).
---------------------------------------------------------------------------
    I cite these studies as important examples of research studies that 
I hope and expect will improve the IRS's ability to serve taxpayers and 
collect revenue. However, these studies are merely a starting point. If 
the IRS has better information, it can make more informed resource 
allocation decisions. Absent clear information, the IRS unavoidably 
bases its resource allocation decisions on intuition and bases its best 
guesses on incomplete data, and that is obviously not an ideal way to 
make decisions.

The IRS Is Paying More Attention to Taxpayer Services, But Significant 
        Challenges Remain
    In 2006, Congress directed the IRS to prepare a Taxpayer Assistance 
Blueprint (TAB), which was released last April.\22\ The TAB was 
intended to serve as a strategic plan for taxpayer service and lead to 
the development of taxpayer-centric, research-based models to help the 
IRS make decisions about taxpayer service and the delivery of face-to-
face service. Because of the TAB and my own office's research, we know 
more than ever about taxpayers' needs and preferences, and their 
willingness to try new methods of service delivery.\23\
---------------------------------------------------------------------------
    \22\ H. Rep. No. 109-307, at 209 (2005). The Senate Committee 
Report provides further detail on the content of the 5-year plan, 
directing the IRS to: ``. . .  undertake a comprehensive review of its 
current portfolio of taxpayer services and develop a 5-year plan that 
outlines the services it should provide to improve services for 
taxpayers. This plan should detail how it [IRS] plans to meet the 
service needs on a geographic basis (by State and major metropolitan 
area), including any proposals to realign existing resources to improve 
taxpayer access to services, and address how the plan will improve 
taxpayer service based on reliable data on taxpayer service needs. As 
part of this review, the Committee strongly urges the IRS to use 
innovative approaches to taxpayer services, such as virtual technology 
and mobile units. The IRS also should expand efforts to partner with 
State and local governments and private entities to improve taxpayer 
services. S. Rep. No. 109-109, at 134 (2005).
    \23\ See National Taxpayer Advocate 2006 Report to Congress, vol. 2 
(Research Study: Study of Taxpayer Needs, Preferences, and Willingness 
to Use IRS Services).
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    Over the last 2 years, the IRS has begun to reverse its trend in 
recent years of limiting the types of services and methods of delivery. 
I applaud the IRS for creating a Services Committee--the counterpart to 
the Enforcement Committee--thereby enabling the entire IRS senior 
leadership to consider and coordinate taxpayer service initiatives. The 
IRS currently is undertaking many initiatives to assist taxpayers in 
claiming economic stimulus payments, including keeping the IRS's walk-
in sites--known as Taxpayer Assistance Centers, or TACs--open on more 
Saturdays during the filing season. I am also pleased that IRS 
management has indicated a willingness to consider reinstating Problem 
Solving Days and taking a geographic approach to determining which 
topics to designate as ``out-of-scope'' (e.g., the IRS should not treat 
farm-related questions as ``out-of-scope'' in TACs located in areas 
where there is a significant amount of farming activity). The IRS has 
also recently relaxed its stringent rules that generally prevented 
taxpayers from obtaining copies of their tax return transcripts at the 
TACs.\24\
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    \24\ Previously the IRS required taxpayers to obtain transcripts of 
their accounts through the toll-free service, which would mail a 
transcript within seven to ten days. Taxpayers could only obtain 
transcripts at TACs in ``emergency'' situations. It was TAS's 
experience that the TACs almost never acknowledged an emergency 
situation. In fact, since that policy was in place, TAS transcript 
cases have increased sharply. The IRS's more flexible transcript policy 
should result in fewer TAS cases in this area.
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    It remains to be seen, however, whether the IRS will dedicate the 
resources--both in terms of personnel, dollars, and priorities--
necessary to make the TAB a reality. I discuss a few of my concerns 
below.

            Sustained Funding for Taxpayer Services Is Crucial to 
                    Meeting Taxpayer Needs

    Any reduction in the IRS's taxpayer service budget presents a 
significant challenge to implementation of the TAB. In fact, taxpayer 
service funding should be increased so that, while the IRS continues to 
deliver its traditional services, programs developed by the TAB team 
are not just piloted but are instead fully implemented. For example, 
this filing season the IRS is piloting an approach in the TACs called 
``Facilitated Self Assistance.'' Under this model, taxpayers who come 
to certain TACs for assistance may carry out designated service tasks 
on IRS.gov or the IRS phone system with the help of a live IRS 
assistor. Preliminary feedback from the 15 TACs offering Facilitated 
Self-Assistance has been positive. Without sufficient funding, however, 
the IRS will be unable to expand the pilot testing, let alone fully 
implement the program, no matter how successful it might be. If the 
financial support for taxpayer service is not sufficient, the TAB 
process will have been for naught--having produced many interesting 
ideas and important research that simply cannot be implemented or 
applied.

            Internet Services Are Important, But They Cannot Be the 
                    Only Game in Town

    Insufficient funding increases the temptation for the IRS to put 
all its eggs in one basket when it comes to taxpayer service--namely, 
self-assisted Internet services. The Internet may be adequate for 
taxpayers who are comfortable handling financial transactions online, 
but the TAB's research studies showed that a certain percentage of 
taxpayers, and particular types of tax issues, require personal 
interaction--by telephone, face-to-face, or both.
    For example, we now know that nearly 25 percent of taxpayers do not 
have Internet access.\25\ Additionally, more than 25 percent of 
taxpayers stated that they are unwilling to use the IRS website for any 
service activities in the future.\26\ Among taxpayers who used IRS 
services between mid-2004 and mid-2006, about 45 percent of those who 
called the IRS and more than 75 percent of those who visited the IRS 
stated they would not use the IRS website. When probed further as to 
why they would not use the website, more than half gave a reason that 
suggests they could not use the website due to lack of computer 
equipment, Internet access or computer savvy.\27\ Approximately 75 
percent of taxpayers stated they do not feel comfortable sharing 
personal information via the Internet.\28\ Approximately 12 percent of 
taxpayers have some type of disability, \29\ and about 6 percent of 
taxpayers speak a language other than English at home.\30\
---------------------------------------------------------------------------
    \25\ W&I Research, Opinion Survey of Taxpayer Resources and 
Services, 2006--Question 7--22.5 percent-24.6 percent.
    \26\ W&I Research, Opinion Survey of Taxpayer Resources and 
Services, 2006--Question 8--25.3 percent-27.4 percent.
    \27\ IRS Oversight Board, 2006 Service Channels Survey, Questions 
17, 19 & 20: About 50 percent (42.5 percent-57.5 percent) of taxpayers 
who called or visited the IRS are unwilling to use IRS.gov (i.e., 37.2 
percent-52.7 percent of those who called and 60.5 percent-92.7 percent 
of those who visited the IRS stated they would not use the IRS Internet 
site). More than 23 percent of taxpayers called or visited the IRS 
between mid-2004 and mid-2006, which translates to roughly 32 million 
taxpayers (based on a filing population of slightly less than 135 
million). About half of taxpayers who use IRS phone or TAC services, 
approximately 16 million taxpayers, are unable or unwilling to use the 
Internet. IRS, 2006 Filing Season Statistics, Cumulative Through 10/27/
06, Individual Income Tax Returns total receipts = 134,919,000.
    \28\ IRS Oversight Board, 2006 Service Channels Survey, Question 
11: 70.2 percent-76.2 percent do not feel comfortable sharing personal 
information over the Internet. Reasons include privacy concerns (33.4 
percent-40.8 percent) and Internet security issues (41.9 percent-49.6 
percent).
    \29\ W&I Research, Opinion Survey of Taxpayer Resources and 
Services, 2006, Question 19: 87.2 percent-88.7 percent of taxpayers do 
not have a disability.
    \30\ W&I Research, Opinion Survey of Taxpayer Resources and 
Services, 2006, Question 20: 5.4 percent-6.8 percent of taxpayers speak 
a language other than English.
---------------------------------------------------------------------------
    The IRS has an obligation to provide services through methods that 
will assist all taxpayers. The IRS must therefore maintain and improve 
its telephone and face-to-face services for as long as there is a 
segment of the population that needs it--which, given the complexity of 
the tax law and IRS procedures, will be as far into the future as I can 
see.

            The IRS Should Expand and Improve the Services Provided by 
                    Taxpayer Assistance Centers

    For several years I have highlighted problems with the IRS's 
delivery of face-to-face taxpayer services in the TACs.\31\ In my 2007 
Annual Report to Congress, I identified several problems that limit the 
usefulness of the TACs, including the insufficient number and staffing 
of TACs and the significant conditions for obtaining return preparation 
assistance that have the effect of deterring taxpayers from seeking 
service.
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    \31\ See National Taxpayer Advocate 2007 Annual Report to Congress 
162-182 (Most Serious Problem: Service at Taxpayer Assistance Centers), 
see also National Taxpayer Advocate 2006 Annual Report to Congress xi-
xiv (Taxpayer Assistance Blueprint: The National Taxpayer Advocate's 
Perspective); National Taxpayer Advocate 2005 Annual Report to Congress 
2-24 (Most Serious Problem: Trends in Taxpayer Service); National 
Taxpayer Advocate 2004 Annual Report to Congress 8-66 (Most Serious 
Problem: Customer Service in a Complex and Changing Tax Environment).
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            The Location and Number of TACs May Not Be Adequate

    In 2001, the IRS committed to opening 118 new TACs in the following 
seven to 8 years.\32\ Unfortunately, none of these new TACs was opened, 
and the IRS even initiated an unsuccessful effort to close 68 TACs.\33\ 
The TAB concluded that TAC offices were adequately serving only 60 
percent of the United States population.\34\ In order to make better 
decisions about the location, number, and staffing of TACs, the IRS 
developed a decision tool about TAC operations. However, that tool only 
includes the present TAC locations. It is not clear whether the IRS 
will use this program to consider adding TAC locations, even though TAB 
research demonstrates that TAC coverage across the United States is 
insufficient. Thus, we recommend that the IRS conduct additional 
research of population segments to determine the volume, scope, and 
type of services that taxpayers require by geographical location, and 
utilize its TAC decision tool to identify the most appropriate number 
and placement of TACs.
---------------------------------------------------------------------------
    \32\ National Taxpayer Advocate 2001 Annual Report to Congress 49.
    \33\ IRS News Release, IRS to Create Efficiencies with Taxpayer 
Assistance Centers, IR-2005-63 (June 27, 2005).
    \34\ Internal Revenue Service, Taxpayer Assistance Blueprint: Phase 
2, at 116 (Apr. 17, 2007).
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            TAC Staffing and the Availability of Services Are 
                    Inadequate To Meet Taxpayer Needs

    Only 55 percent of TACs are open for 36 to 40 hours per week, and 
during the last 3 years, the IRS reduced TAC staffing by 9 percent, 
leaving most TAC offices with staffing shortages.\35\ Although the IRS 
is now hiring seasonal workers to ease the staffing crunch, I believe 
the IRS should make a firm commitment to providing TACs with the level 
of staffing necessary to meet taxpayer needs.
---------------------------------------------------------------------------
    \35\ Information obtained from IRS Wage & Investment Division 
(Field Assistance function) (September 2007).
---------------------------------------------------------------------------
            The IRS Should Meet its Fundamental Tax Administration 
                    Responsibility To Provide Tax Return Preparation 
                    Assistance for Low Income Taxpayers

    I am concerned that the IRS imposes too many barriers and 
limitations on tax preparation. I am pleased that the IRS heeded our 
earlier criticism and has changed its position on requiring taxpayers 
to visit a TAC twice in order to obtain return preparation services--
once to make the appointment and once to have the return prepared. 
However, the IRS continues to downplay its own role in tax preparation.
    To my mind, tax preparation is a core service for the tax 
administrator. The tax administrator cannot look to the nonprofit 
sector alone to meet the needs of the millions of low income taxpayers, 
including many elderly taxpayers, who cannot afford to pay a return 
preparer. Yet the IRS continues to straddle the line--it prepares 
enough returns to allow it to claim it is providing the service but 
makes it very difficult in some cases for taxpayers to obtain 
assistance. For example, the IRS has declared returns involving 
cancellation of debt income ``out of scope'' both for the TACs and for 
volunteer preparation sites, \36\ even though those subjects are highly 
likely to impact the very taxpayers who are eligible for TAC services 
(whether because of credit card debt forgiveness or home foreclosures). 
Thus, these low income taxpayers have no alternative but to pay for 
return preparation, something they generally cannot afford to do.
---------------------------------------------------------------------------
    \36\ IRS Small Business/Self-Employed Division, Response to TAS 
Information Request (Oct. 30, 2007).
---------------------------------------------------------------------------
    It is not just individual taxpayers who suffer from this 
restriction on preparation services in the TACs. Today, organizations 
exempt from tax under IRC  501(c)(3) are generally required to file an 
e-postcard annually if their gross receipts are normally $25,000 or 
less, providing the IRS with basic contact information and informing 
the IRS whether the organization is still a going concern.\37\ Failure 
to file for 3 consecutive years will result in automatic revocation of 
the organization's exempt status.\38\
---------------------------------------------------------------------------
    \37\ IRC  6033(i); IRC  6033(a)(3)(B); Announcement 82-88, 1982-
25 I.R.B. 23.
    \38\ IRC  6033(j).
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    Approximately half of exempt organizations have all-volunteer 
staffs and another third have fewer than 10 employees.\39\ These 
smaller nonprofits frequently lack professional tax guidance and rely 
on their volunteers to deal with the IRS.\40\ Yet the TACs have agreed 
to assist exempt organizations with filing the e-postcard on the 
condition that the IRS not publicize the availability of this 
assistance. Thus, the only way a small exempt organization will know 
whether the IRS will help it is if it happens to visit a TAC on its own 
initiative. This ``we will provide you service but we won't tell you 
about it'' approach falls well short of the level of service the public 
has a right to expect from its Government.
---------------------------------------------------------------------------
    \39\ IRS, TE/GE Fiscal Year 2005 Strategic Assessment 3 (Feb. 2, 
2005).
    \40\ Id.
---------------------------------------------------------------------------
            The IRS Should Explore Alternative Methods of Delivering 
                    Face-to-Face Services

    In 2003, the IRS committed to providing alternative methods of 
service to taxpayers.\41\ Among the ideas proposed were alternative 
locations to brick-and-mortar TACs and mobile units specifically 
tailored to the needs of the communities they serve.\42\ I support 
these ideas, and I strongly encourage the IRS to pursue them and to 
explore other service methods as well. For example, the IRS should 
partner with State tax agencies, or other service-oriented Government 
agencies such as the Social Security Administration, to provide one-
stop shopping for taxpayers. Additionally, the IRS could co-locate with 
other agencies, both State and Federal, to offer services targeting a 
specific taxpaying population (e.g., co-locate with Departments of 
Motor Vehicles to offer excise fuel tax assistance to truck drivers).
---------------------------------------------------------------------------
    \41\ National Taxpayer Advocate 2003 Annual Report to Congress 149.
    \42\ Id.
---------------------------------------------------------------------------
    I commend the IRS's recent coordination of ``Super Saturday'' to 
assist taxpayers in filing economic stimulus payment returns. The IRS 
should replicate that approach in similar efforts targeted at other 
groups of taxpayers. The IRS previously sponsored ``Problem Solving 
Days,'' where taxpayers could receive assistance on any tax issue and 
potentially have their problems resolved with one contact. The IRS 
should bring back Problem Solving Days using Super Saturday as a model 
and aggressively market the effort to taxpayers. Other initiatives 
could include National Filing Days, which I recommended in my 2007 
Annual Report to Congress, where taxpayers who are currently not in 
compliance with their tax obligations could come to the IRS and be 
brought into compliance.\43\
---------------------------------------------------------------------------
    \43\ National Taxpayer Advocate 2007 Annual Report to Congress 257.
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            The IRS Should Expand Outreach and Education in the Exempt 
                    Organization Sector

    If the IRS is to increase compliance by exempt organizations (EOs), 
more resources must be devoted to outreach to, and education of, these 
organizations. I commend the Tax Exempt and Government Entities (TE/GE) 
Division's Customer Education and Outreach (CE&O) office for its 
existing efforts to address the needs of EOs. CE&O has done much with 
few resources, but it cannot adequately carry out its mission without 
better funding. TE/GE allocated only approximately $1.2 million or 1.4 
percent of its $85.4 million fiscal year 2007 EO budget to education 
and outreach.\44\ The number of EO education and outreach full-time 
equivalents (FTEs) has stagnated at approximately 12 for the last three 
fiscal years \45\ while the number of EOs has grown by more than 70,000 
per year.\46\ Twelve FTEs are simply not enough to carry on the 
important work of EO education and outreach, regardless of how cost-
effective and innovative the IRS's outreach methods may be.
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    \44\ Information received from Tax Exempt/Government Entities 
Division (Nov. 7, 2007).
    \45\ Information received from Tax Exempt/Government Entities 
Division (Nov. 6, 2007); IRS, Tax Exempt and Government Entities 
Business Performance Review 21 (May 9, 2007).
    \46\ Remarks of Steven T. Miller, Commissioner, IRS Tax Exempt and 
Government Entities Division, before the Philanthropy Roundtable (Dec. 
10, 2007).
---------------------------------------------------------------------------
    TE/GE has leveraged its limited EO education and outreach resources 
through increased use of electronic means. Electronic education and 
outreach is an excellent tool that should be used in conjunction with, 
but not supplant, face-to-face and non-electronic outreach. For 
example, the Charities and Non-Profits page of the IRS website contains 
many useful materials, but the IRS needs to proactively distribute hard 
copies of those materials through partners and outreach sessions rather 
than wait for EOs to find and view them online. Moreover, the IRS must 
obtain better data on EOs' access to the Internet, how EOs use the 
Internet, and EOs' willingness and ability to change how they use the 
Internet before investing further in electronic education and outreach.
    IRS Daily Delinquency Penalty (DDP) abatement rates reveal that 
there is great potential to reduce noncompliance with more education 
and outreach. The IRS may assess a DDP when an EO files an information 
return with missing or incorrect information \47\ but will abate the 
DDP if the penalized organization later supplies the missing 
information or corrects the error and shows reasonable cause for the 
mistake.\48\ Between 2000 and 2005, the IRS abated almost 62 percent of 
all assessed DDPs and nearly 68 percent of all assessed DDP dollars 
(nearly $857 million).\49\ A study conducted by the IRS in 2003 found 
that most assessed DDPs were attributable to organizations' failure to 
include Schedules A and B with their returns.\50\
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    \47\ IRC  6652(c)(1)(A).
    \48\ IRC  6652(c)(4).
    \49\ IRS Enforcement Revenue Information System (ERIS) and 
Statistics of Income (SOI) for EO Returns, 2000-2005 DDP assessments 
and abatements. See also National Taxpayer Advocate 2006 Annual Report 
to Congress 491 (Legislative Recommendation: Increase the Exempt 
Organization Information Return Filing Threshold).
    \50\ Ogden Form 990 Study, Attachment to Memorandum for Director, 
Exempt Organization SE:T:EO, EO Correspondence Review and Timeframes 
(Oct. 2003).
---------------------------------------------------------------------------
    The annual cycle of DDP assessment and abatement is not good for 
anyone. EOs that receive DDP assessments due to curable errors must use 
their resources to get the IRS to abate the penalty. Alternatively, 
they may simply pay the penalties to avoid dealing with the IRS but are 
likely to be penalized again if they do not work with the IRS to find 
out why the penalties were assessed. The DDP assessment/abatement cycle 
also wastes IRS resources. When more than 60 percent of all assessed 
DDP penalties are abated, IRS employees are spending significant time 
determining whether the mistakes that gave rise to the assessments were 
attributable to reasonable cause.

            To Reduce the Tax Gap, the IRS Should Place More Emphasis 
                    on Combating Noncompliance in the Cash Economy

    As you know, the gross ``tax gap''--the amount of tax that is not 
voluntarily and timely reported and paid--stood at an estimated $345 
billion in 2001 and remains a serious problem.\51\ As a result, 
households that comply with their tax obligations effectively pay a 
``surtax'' averaging about $2,680 per year to subsidize noncompliance 
by others.\52\ Where taxable payments are reported to the IRS by third 
parties, taxpayers generally report well over 90 percent of their 
income.\53\ By contrast, where taxable payments are not reported to the 
IRS by third parties, reporting compliance drops below 50 percent.\54\ 
Therefore, it should come as no surprise that underreported income from 
the ``cash economy''--which, for tax administration purposes, we define 
as taxable income from legal activities that is not subject to 
information reporting or withholding--is probably the single largest 
component of the tax gap, likely accounting for over $100 billion per 
year.\55\
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    \51\ The gross tax gap is the amount of tax that is imposed by law 
for a given tax year, but not voluntarily and timely paid. The net tax 
gap is the portion of the gross tax gap that remains uncollected after 
taking into account late payments and IRS enforcement actions for a 
given tax year. The 2004 IRS National Research Program study estimated 
the 2001 gross tax gap at $345 billion and the net tax gap at $290 
billion. IRS, Tax Gap Map for Year 2001 (Feb. 2007), available at 
http://www.irs.gov/pub/irs-utl/tax_gap_update_070212.pdf. These figures 
do not include unpaid tax on income from illegal activities.
    \52\ If we divide the estimated 2001 net tax gap of $290 billion by 
the estimated 108,209,000 U.S. households in 2001, we see that each 
household was effectively assessed an average ``surtax'' of about 
$2,680 to subsidize noncompliance. See U.S. Census Bureau, Population 
Division (data as of Mar. 2001).
    \53\ See IRS News Release, IRS Updates Tax Gap Estimates, IR-2006-
28 (Feb. 14, 2006) (accompanying charts), available at http://
www.irs.gov/newsroom/article/0,,id=154496,00.html.
    \54\ Id.
    \55\ Id. Underreporting makes up about 83 percent of the tax gap 
($285 billion of the $345 billion gap). Underreporting of business 
income by individuals--from sole proprietors, rents and royalties, and 
pass-through entities--accounted for about $109 billion. Associated 
underreporting of self-employment taxes by unincorporated businesses 
accounts for another $39 billion. Id.
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    Noncompliance in the cash economy merits special attention because 
the IRS's traditional enforcement tools such as document matching and 
audits are less effective when there is no third-party reporting, and 
also because it is growing. According to one study, the percentage of 
all income subject to third-party information reporting fell from 91.3 
percent in 1980 to 81.6 percent in 2000.\56\ The IRS's filing 
projections suggest that the cash economy and the amount of unreported 
income may continue to grow.\57\
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    \56\ Kim Bloomquist, Trends as Changes in Variance: The Case of Tax 
Noncompliance, presented at the 2003 IRS Research Conference (June 
2003) (citing growth in capital gains, partnership, and small business 
income).
    \57\ The IRS expects the number of individual returns from small 
business or self-employed taxpayers to grow by about 33 percent between 
2006 and 2014, while the number of individual returns from other 
taxpayers is expected to decline by about 2 percent over the same 
period. IRS Office of Research, Research, Analysis and Statistics, 
Document 6292, Fiscal Year Return Projections for the United States, 
2007-2014 (Sept. 2007), available at http://www.irs.gov/pub/irs-soi/
d6292.pdf.
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            The IRS Should Establish a Cash Economy Program Office To 
                    Increase the Effectiveness of its Efforts

    In my 2007 Annual Report to Congress, I proposed a comprehensive 
strategy to address the cash economy portion of the tax gap that 
consisted of 15 administrative recommendations and seven legislative 
recommendations.\58\ As a threshold matter, I believe the IRS should 
establish a Cash Economy Program Office. The office would have 
responsibility for coordinating efforts to improve compliance in the 
cash economy. At present, there is no single unit or executive within 
the IRS with responsibility for ensuring that enforcement, research, 
and educational activities aimed at the cash economy are implemented in 
a coordinated fashion. The IRS uses a coordinated approach to address 
certain other issues--an example being the EITC Program Office--and I 
believe a program office would help the IRS address the cash economy as 
well. Such an office would bring accountability to the effort because 
it could measure its success based on the impact of IRS initiatives on 
compliance by cash economy participants.\59\ Absent a strategic, 
coordinated approach, the IRS is less likely to make progress in 
reducing noncompliance in the cash economy.
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    \58\ See National Taxpayer Advocate 2007 Annual Report to Congress 
35-65 (Most Serious Problem: The Cash Economy), 490-502 (Legislative 
Recommendation: Measures to Address Noncompliance in the Cash Economy), 
and vol. 2, at 1-43 (Research Study: A Comprehensive Strategy for 
Addressing the Cash Economy).
    \59\ The Treasury Inspector General for Tax Administration and the 
Government Accountability Office both generally agree that measures 
that promote accountability would help the IRS reduce the tax gap. See, 
e.g., Government Accountability Office, GAO-06-208T, Multiple 
Strategies, Better Compliance Data, and Long-Term Goals Are Needed to 
Improve Taxpayer Compliance (Oct. 26, 2005); Written Statement of 
Russell George, Treasury Inspector General for Tax Administration, 
Hearing Before the Senate Committee on Appropriations Subcommittee on 
Transportation, Treasury, the Judiciary, Housing and Urban Development, 
and Related Agencies on the Internal Revenue Service's Fiscal Year 2006 
Budget Request (Apr. 7, 2005).
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            The IRS Should Research the Most Effective Use of Its Audit 
                    Resources

    In addressing the cash economy, the IRS should also leverage its 
limited audit resources by investing in research to identify the most 
effective uses of these resources after taking into account the direct 
and indirect effects of IRS activities on tax revenue. In addition to 
the direct revenue that audits generate from the taxpayer for the 
period(s) under audit, as discussed above, economists estimate the 
indirect effects or ``ripple effects'' of an audit on voluntary 
compliance by other taxpayers or by the same taxpayer in future periods 
provide even greater revenue gains.\60\ The IRS needs more and better 
research on how best to use limited audit resources to improve 
compliance in the cash economy. For example:
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    \60\ See, e.g., Alan H. Plumley, Pub. 1916, The Determinants of 
Individual Income Tax Compliance: Estimating The Impacts of Tax Policy, 
Enforcement, and IRS Responsiveness 35-36 (Oct. 1996).
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  --Should the IRS use more correspondence examinations or face-to-face 
        examinations in cash economy industries? Does the answer depend 
        on the industry?
  --To achieve the greatest impact, should audits be clustered either 
        geographically or within industries, so as to generate maximum 
        publicity and possibly change local or industry norms, or 
        should audits be more spread out in a dispersed pattern of 
        ``touches''?
  --Do audits have an even greater ``ripple'' effect on compliance when 
        coupled with outreach and education targeted at unaudited 
        members of the same community?
    My other recommendations fall into four broad categories: (1) 
making compliance easier, (2) increasing income visibility and the 
productivity of audits, (3) increasing the focus on preparers, and (4) 
identifying areas where additional research is needed to help the IRS 
understand how it can efficiently improve voluntary compliance.\61\
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    \61\ See National Taxpayer Advocate 2007 Annual Report to Congress 
35-65 (Most Serious Problem: The Cash Economy), 490-502 (Legislative 
Recommendation: Measures to Address Noncompliance in the Cash Economy), 
and vol. 2, at 1-43 (Research Study: A Comprehensive Strategy for 
Addressing the Cash Economy).
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The Private Debt Collection Initiative Will Cost the Federal Government 
        at Least $81 Million in Foregone Revenue Annually and Should Be 
        Terminated

    In my Annual Reports to Congress and in prior testimony, I have 
expressed serious concerns about many aspects of the private debt 
collection (PDC) initiative, including the potential for violations of 
taxpayer rights, the fact that private collection agency (PCA) 
procedures are less transparent to the public--and to congressional 
oversight--than IRS procedures, and the evidence that the so-called 
``simple'' cases on which the program was initially promoted do not 
exist in significant numbers.\62\
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    \62\ See National Taxpayer Advocate 2007 Annual Report to Congress 
411-431 (Status Update: Private Debt Collection); National Taxpayer 
Advocate 2006 Annual Report to Congress 34-61 (Most Serious Problem: 
True Costs and Benefits of Private Debt Collection) and 458-462 
(Legislative Recommendation: Repeal Private Debt Collection 
Provisions); IRS Private Debt Collection: Hearing Before the H. Comm. 
on Ways and Means, 110th Cong. (May 23, 2007) (statement of Nina E. 
Olson, National Taxpayer Advocate).
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    I now add to these concerns the issue of foregone revenue. Very 
simply, the PDC initiative will cost the Government more than $81 
million in foregone revenue this year, and the cost is likely to reach 
nearly a half billion dollars over the next 6 years. I explain below 
how I arrive at this conclusion.
    The IRS projects that it will use $7.65 million in appropriated 
funds in fiscal year 2008 to administer the PDC program, and it 
anticipates relatively steady costs in future years.\63\ At the same 
time, the IRS estimates that the program will generate gross revenue 
averaging about $23 million this year and next, \64\ and it is unlikely 
that gross revenue will increase in future years unless the nature of 
the program changes significantly. By these calculations and after 
subtracting the direct costs of the program ($7.65 million) and 
commissions payable to the PCAs (about $4.60 million), the program can 
be expected to yield annual net revenue of about $11 million. Thus, an 
annual IRS expenditure of $7.65 million will produce annual net revenue 
of about $11 million, which translates to about a 1.45:1 net return on 
investment (ROI).\65\
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    \63\ E-mail from Director, PDC Program Office, to TAS Attorney 
Advisor (Feb. 29, 2008).
    \64\ Id.
    \65\ As discussed in the text below, the data I have cited actually 
overstate the likely ROI because the IRS's cost estimates are not 
comprehensive (e.g., they do not include the time that Taxpayer 
Advocate Service case advocates spend assisting taxpayers who request 
our help with PDC cases or the time senior IRS executives must devote 
to studying, monitoring, and answering continual questions about the 
program) and the IRS's revenue estimates include funds that the IRS 
collects on the basis of its initial letter--before the PCAs make any 
contact with the taxpayers.
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    If the PDC program did not exist and the IRS instead allocated 
$7.65 million in appropriated funds to its Automated Collection System 
(ACS) function, the ROI would be substantially higher. IRS data shows 
that the average ROI for the ACS program is about 20:1, which means an 
expenditure of $7.65 million would generate annual revenue of $153 
million.\66\ In testimony before the House Ways and Means Committee 
last May, Acting Commissioner Kevin Brown placed the ACS ROI somewhat 
lower, at about 13:1.\67\ Even accepting the lower figure, a 13:1 ROI 
on an expenditure of $7.65 million would produce gross revenue of 
$99.45 million and net revenue (after subtracting the $7.65 million 
expenditure) of $91.8 million.
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    \66\ We have computed the full cost of an average ACS employee at 
slightly less than $75,000 (assuming GS-8, step 5). The current average 
amount collected by an ACS employee per year is about $1.53 million. 
That volume of collection translates to a return-on investment on the 
average ACS employee of about 20:1.
    \67\ IRS Private Debt Collection: Hearing Before the H. Comm. on 
Ways and Means, 110th Cong. (May 23, 2007) (testimony of Kevin M. 
Brown, Acting Commissioner of Internal Revenue).
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    Thus, the IRS's expenditure of $7.65 million in appropriated funds 
is generating about $11 million in net revenue when applied to the PDC 
program but should generate at least $91.8 million if applied to its 
ACS collection function. In other words, the opportunity cost of 
spending $7.65 million of appropriated funds on the PDC program each 
year is $81 million, and possibly much more.
    Since the purpose of private debt collection is to raise revenue, 
the fact that it is costing the Government $81 million or more each 
year destroys whatever thin rationale might remain for its existence.

            The $7.65 Million Cost Estimate for the PDC Program Fails 
                    to Capture Significant Costs

    In addition to consuming $7.65 million in annual operating costs, 
the PDC program required $70 million in start-up costs. The IRS 
previously estimated that it would recoup these ``sunk'' costs in 
fiscal year 2008 but now acknowledges that fiscal year 2010 is the 
earliest point at which the initiative is likely to ``break even.'' 
\68\ Moreover, as of September 2007, the IRS had 54 employees (and this 
total does not include Modernization & Information Technology Services 
(MITS) infrastructure or TAS case working employees) working on the 
initiative and overseeing 62 employees from the PCAs.\69\
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    \68\ The 2008 Filing Season: Hearing Before the H. Comm. on Ways 
and Means, 110th Cong. (Mar. 13, 2008) (testimony of Linda E. Stiff, 
Acting Commissioner of Internal Revenue).
    \69\ IRS Response to Information Request on PDC Initiative (Sept. 
2007).
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    The annual expenditure of $7.65 million is significant for an 
initiative that is failing in most respects. Additionally, we have 
learned that the $7.65 million cost estimate provided by the IRS does 
not include numerous expenses. The $7.65 million cost estimate includes 
PDC-related costs incurred by the IRS referral unit and most IRS 
headquarters staff as well as costs incurred by MITS for support and by 
TAS to cover the cost of one employee assigned to work with the PDC 
Project Office. However, the $7.65 million cost estimate does not 
include the PDC-related costs incurred by the IRS Office of Chief 
Counsel, which is periodically consulted for legal advice; the IRS 
Office of Legislative Affairs, which has spent considerable time 
presenting the program to Members and Committees of the Congress and 
responding to inquiries; by TAS for working with more than 1,500 
taxpayers who have sought our assistance on PCA-related cases; or by 
other IRS functions that have helped to support the program.\70\ We 
have been unable to obtain a complete estimate of the costs of the 
program.
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    \70\ IRS Response to TAS Request for Information (April 10, 2008).
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            The IRS's Own Collection Actions Account for a Significant 
                    Portion of the PDC Program's Full-Paid Accounts

    Almost half--specifically, 46 percent--of the fully paid 
liabilities included in PDC gross revenue has been collected through 
offsets or direct payments made by the taxpayer after receiving a 
letter from the IRS informing the taxpayer that his or her account 
would be placed with a PCA but before the PCA made contact with the 
taxpayer.\71\ These fully paid liabilities are a direct result of IRS 
action--not action taken by a PCA.
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    \71\ The 46 percent of fully paid liabilities includes payments 
received by the IRS through the following means: (a) dollars received 
by the government 10 calendar days or less after the IRS transferred 
the account to the contractor; (b) unidentified payments (i.e., 
payments that cannot be matched and posted to a debtor's account within 
the contractor's inventory of accounts); (c) dollars collected in 
excess of an individual's balance, resulting in overpayment by the 
debtor; (d) dollars received on any account 11 calendar days or more 
after the account was returned to the IRS except as specifically 
described by contract; and (e) dollars received through Federal, State 
or local administrative, tax refund, salary, Treasury offset, Federal 
Levy payment or other type of offset or other administrative action 
which results in the reduction or elimination of the debt in a manner 
beyond the scope of the contractor's performance. IRS, Request for 
Quotation, Request No. TIRNO-05-Q-00187, at 22 ( A.4.1). The National 
Taxpayer Advocate's 2006 Annual Report to Congress reported that, while 
the IRS would not send accounts to private collectors that were already 
subject to levy under the Federal Payment Levy Program (FPLP), the IRS 
would not recall accounts already assigned to a PCA if the account 
becomes subject to an FPLP levy after assignment. National Taxpayer 
Advocate 2006 Annual Report to Congress 43. When the IRS first 
described its vision of the PDC program to Congress, the IRS maintained 
that cases under enforcement action were not the types of cases that 
would be referred to private collectors. Private Debt Collection: 
Hearing Before the Subcomm. on Oversight of the House Comm. on Ways and 
Means, 108th Cong. (May 13, 2003) (testimony of Commissioner Mark W. 
Everson). As a consequence of the IRS's decision to leave FPLP cases 
with private collectors, private collectors are contacting taxpayers 
whose Social Security payments are already under active FPLP levies and 
are demanding full payment of the tax liability.
---------------------------------------------------------------------------
    Moreover, more than half of the payments received by the PDC 
initiative are fully paid liabilities.\72\ In many of these cases, the 
IRS had taken no action on the accounts after its standard ``notice 
stream'' had run its course. However, these data seem to indicate that 
if the IRS were to spend 41 cents on a letter to taxpayers sometime 
after the end of the standard notice stream to say, in effect, ``Hello, 
we're back,'' the IRS could obtain a meaningful return.
---------------------------------------------------------------------------
    \72\ IRS, Filing Payment Compliance Advisory Council (April. 14, 
2008) at 3.
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            The Inventory of ``Easy'' Cases for PCAs To Work Has 
                    Largely Dried Up

    The PDC initiative has taken several steps to address the lower 
than expected revenue, which are deviations from the original intent of 
the initiative.\73\ Because the number of ``easy'' cases was also 
smaller than expected, the IRS began to include older inventory which 
is more difficult to resolve.\74\ The IRS is still searching for other 
types of cases to hand over to the PCAs, many of which are complex, 
require discretion, and are already being worked by the IRS's own 
collection function. For example, the IRS is studying the feasibility 
of assigning cases in which the taxpayer has not agreed to the entire 
outstanding tax liability.\75\ The IRS is also considering placing with 
the PCAs cases that ACS is currently working, and it is studying 1,500 
modules to identify cases that it can move from actual IRS ACS 
inventory to the PCAs.\76\ Thus, the IRS is now proposing to give the 
PCAs the types of cases that the IRS itself is already working and 
could continue to work at a greater rate in the future. Placing these 
types of cases with the PCAs is precisely the opposite of the premise 
on which the program was sold--namely, giving PCAs only the easy cases 
the IRS itself otherwise would not work.\77\
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    \73\ Former Commissioner Mark Everson testified: ``Private 
collectors will work the easy cases, thereby ensuring that they will 
not engage in `inherently governmental' activities and that the IRS 
will be able to focus on more complex work.'' Private Debt Collection: 
Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and 
Means, 108th Cong. (May 13, 2003) (statement of Commissioner Mark W. 
Everson). I also testified to that point: ``The IRS has stated that it 
will only send to PCAs those cases that meet the following criteria: 
(1) the taxpayer has either agreed to the tax debt and/or has made 
three or more payments toward that debt; and (2) the taxpayer appears 
to have the ability to pay this debt in full immediately or within 36 
months. It is vital to the success of this proposal that only those 
cases that fit these parameters are selected and referred to the 
PCAs.'' IRS Use of Private Debt Collection Agencies by the IRS: Hearing 
Before the Subcomm. on Oversight of the H. Comm. Ways and Means, 108th 
Cong. (May 13, 2003) (statement of Nina E. Olson, National Taxpayer 
Advocate).
    \74\ The IRS had to remove 15,500 cases from the initial inventory 
of 42,800 cases that would possibly have been assigned to private 
collectors. These cases were removed because the taxpayer had previous 
shelved delinquencies. IRS, Filing & Payment Compliance Advisory 
Council Presentation 9 (July 31, 2006).
    \75\ IRS, Filing and Payment Compliance Advisory Council (Jan. 14, 
2008) at 7.
    \76\ IRS, Filing and Payment Compliance Advisory Council (Feb. 11, 
2008) at 10.
    \77\ Private Debt Collection: Hearing Before the Subcomm. on 
Oversight of the H. Comm. on Ways and Means, 108th Cong. (May 13, 2003) 
(testimony of Commissioner Mark W. Everson).
---------------------------------------------------------------------------
            The IRS Has Left Cases in the Control of PCAs for Much 
                    Longer Than It Originally Intended

    The IRS's concern about the PDC initiative's low revenue might have 
influenced the IRS decision to extend the timeframe for which 
unresolved cases from the initial stage of the PDC program (known as 
Release 1.1) will remain with the PCAs.\78\ Initially, the IRS planned 
to recall taxpayer accounts after 12 months.\79\ However, the IRS 
extended the recall to 18 months and now has extended it until the 
collection curve on these cases declines, but it is not clear how 
significant the decline must be for the recall to begin.\80\ Nor is it 
clear how frequently the PCAs attempt to collect on these cases or 
whether the taxpayers would be better off if their cases were sent back 
to the IRS.
---------------------------------------------------------------------------
    \78\IRS, Filing and Payment Compliance Advisory Council (Mar. 10, 
2008) at 12.
    \79\IRS, Request for Quotation, Request No. TIRNO-05-Q-00187, at 22 
( A.4.5). Taxpayer accounts will be automatically recalled after 12 
months unless the account condition warrants continued work efforts by 
the Contractor assigned the case. Conditions that would warrant an 
extension of the placement period may include acceptable payment within 
60 calendar days prior to recall date or approval from the Contracting 
Officer's Technical Representative (COTR). The IRS can request the 
return of a case at any time upon notice to the PCA.
    \80\ IRS, Filing and Payment Compliance Advisory Council (Mar. 10, 
2008) at 12.
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            To Evaluate the Cost Effectiveness of the PDC Program, an 
                    ``Apples-to-Apples'' Comparison Between IRS 
                    Employees and PCA Employees Is Needed

    As I have recommended in my reports to Congress, to determine the 
true efficiency and effectiveness of PCAs to the IRS collection 
function, I believe the IRS should design and implement a true apples-
to-apples comparison of IRS and PCA collection.\81\ The version of the 
IRS fiscal year 2008 funding bill reported by this Committee last year 
directed the IRS to conduct a test to make such a comparison.\82\ 
Although this mandate was not contained in the final funding 
legislation, the IRS has taken steps toward implementing an apples-to-
apples test. In January of 2008, the IRS created a team, which included 
TAS, to design such a test. The test would use IRS employees with 
similar skill sets as the PCA employees and limit IRS enforcement 
powers so their authority to take action on a case would mirror that of 
the PCAs, thereby creating an apples-to-apples comparison. In addition, 
it would create an entry-level bridge position for IRS employees who 
would like to obtain collection experience. These employees could work 
these easy cases that only require a phone call or could help locate 
taxpayers. This would be an opportunity for the IRS to train new 
collection employees and address the IRS's challenge to fill behind an 
aging workforce. Now that the test has been designed, it is time to put 
it into action so the IRS can honestly evaluate who can do this work 
better.
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    \81\ See National Taxpayer Advocate 2007 Annual Report to Congress 
416-418, and National Taxpayer Advocate 2006 Annual Report to Congress 
34-61.
    \82\ Financial Services and General Government Appropriations Act, 
2008, H.R. 2829, 110th Cong.  113 (as reported by S. Comm. on 
Appropriations, July 13, 2007).
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The IRS Should Reassess Its Approach to e-filing to Ensure That the 
        Needs of All Taxpayers Are Addressed and that All Taxpayers May 
        Prepare Their Returns and File Directly with the IRS Without 
        Charge

    While the IRS has made impressive progress in increasing the rate 
of electronic filing, it is still far from reaching the congressionally 
mandated goal of 80 percent.\83\ During the 2007 filing season, almost 
57 percent of all individual returns were filed electronically.\84\ As 
the tax administrator, the IRS has the authority to determine the 
policies and criteria that entities must meet to participate in the e-
file program. In important respects, however, it appears that the IRS 
has historically relinquished control of the electronic filing program 
to private industry and faces difficulty in re-asserting ownership of 
the program. Considering the significant benefits e-filing affords to 
both the IRS and taxpayers, we are pleased that the IRS is currently 
evaluating its role in the e-file program in order to increase the rate 
of e-file and to properly align its policies and procedures to meet the 
best interests of taxpayers and the agency itself. We encourage the IRS 
to consult with the Office of the Taxpayer Advocate on this important 
matter, and we look forward to lending support in any manner possible.
---------------------------------------------------------------------------
    \83\ 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 was not achieved by 2007. However, we believe Congress 
should reiterate its commitment to requiring the IRS increase the e-
filing rate as quickly as possible.
    \84\ IRS News Release, IRS E-File Opens for 2008 Filing Season for 
Most Taxpayers, IR-2008-5 (Jan. 10, 2008).
---------------------------------------------------------------------------
    The IRS has an incentive to increase the rate of electronic filing 
to the highest level possible. Electronic filing of tax returns brings 
benefits to both taxpayers and the IRS.\85\ From a taxpayer 
perspective, e-filing improves accuracy by eliminating the risk of IRS 
transcription errors, pre-screens returns to ensure that certain common 
errors are fixed before returns are 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 permits the IRS 
to shift resources to other areas), allows the IRS to capture return 
data electronically, and enables the IRS to process and review returns 
more quickly.\86\
---------------------------------------------------------------------------
    \85\ See S. Rep. No. 105-174, at 39-40 (1998).
    \86\ See IRS Fact Sheet, 2008 IRS E-File, FS-2008-4 (Jan. 2008).
---------------------------------------------------------------------------
    Nearly one-third of all individual returns processed by the IRS 
through October 2007--or 43 million returns--were prepared using 
software yet mailed rather than submitted electronically.\87\ These 
taxpayers could have e-filed their returns once they were prepared 
using computer software, but for some reason, the taxpayers chose to 
file paper returns. If the IRS successfully converts a significant 
portion of these taxpayers to electronic filing, it would approach, and 
perhaps surpass, the 80 percent e-filing goal.
---------------------------------------------------------------------------
    \87\ IRS Tax Year 2006 Taxpayer Usage Study (through Oct. 26, 
2007).
---------------------------------------------------------------------------
    I have advocated for years for the IRS to place a basic, fill-in 
template on its website to permit taxpayers to self-prepare their tax 
returns and file directly with the IRS for free.\88\ There is no reason 
why taxpayers should be required to pay transaction fees to file their 
returns electronically. A free template and direct filing portal would 
address some taxpayers' cost and security concerns and would result in 
a greater number of e-filed tax returns. For those taxpayers who are 
comfortable preparing their returns without assistance, the Government 
should provide the means for them 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 would remain free to purchase one.
---------------------------------------------------------------------------
    \88\ See, e.g., National Taxpayer Advocate 2004 Annual Report to 
Congress 471-477. We have proposed that the IRS create an electronic 
tax return that is analogous to the paper environment, but that also 
incorporates the benefits of electronic technology. Specifically, the 
return should be fill-in, with math checking and number-transfer 
capability. The fill-in return should link to line-by-line IRS 
instructions for each form, and where the IRS instructions reference a 
publication, there should be active links to specific sections of the 
forms. Where the instructions or publications have worksheets embedded 
in them, these worksheets should be fill-in, with math-checking and 
number-transfer capability. These capabilities are important, since 
they will substantially reduce the number of ``math error'' notices the 
IRS must issue each year.
---------------------------------------------------------------------------
    During a visit to the Australian Taxation Office (ATO) last month, 
I had the opportunity to learn first-hand about Australia's e-file 
program. The ATO built e-tax, a direct filing program, completely in-
house and officially launched the program in 1999. The resulting e-file 
(e-tax) rates are impressive.\89\ For the 2005-2006 tax period, 
approximately 49 percent of all individuals who self-prepared filed 
their returns through e-tax, while only 7.5 percent of U.S. taxpayers 
who self-prepared their returns used Free File for tax year 2006 (and 
only 2.9 percent of all individual income tax returns filed in tax year 
2006 were prepared using Free File).\90\ Further, only tax agents (the 
Australian equivalent to tax return preparers) use commercial software 
to prepare and file returns.\91\ It is our understanding that the IRS 
is currently evaluating the Australian taxation system. We hope the IRS 
can apply lessons learned from Australia's experience to our own e-file 
program, especially with regard to ATO's direct filing program, e-tax.
---------------------------------------------------------------------------
    \89\ Unlike Free File, e-tax is available to taxpayers at all 
income levels. For information on e-tax, see http://www.ato.gov.au/
corporate/content.asp?doc=/content/83847.htm&pc=001/001/001/
005&mnu=&mfp=&st=&cy=1 (last visited April 7, 2008).
    \90\ Australian Taxation Office, Taxation Statistics 2005-06, 
available at http://www.ato.gov.au/content/downloads/
00117625_2006CH2PER.pdf (last visited April 7, 2008); E-Gov, IRS Free 
File Performance Measures--Summary View, available at http://
www.whitehouse.gov/omb/egov/c-7-3-irs.html (last visited April 7, 
2008). Specifically, 1,521,780 individual self-preparers filed through 
Australia's e-tax program in tax year 2005/2006 out of a total of 
3,132,230 self-preparers. The remaining 8,378,729 individual taxpayers 
used tax agents (return preparers). In the United States, 3.9 million 
individual taxpayers self-prepared for tax year 2006 on Free File out 
of 49 million total self-preparers. Approximately 135 million U.S. 
individual returns were filed for tax year 2006. IRS Document 6149, 
Calendar Year Return Projections by State, CY 2007-2014 (Rev. 12.2007), 
Table 1.
    \91\ Tax agents are regulated by the statutorily created Tax Agent 
Boards located in every state. For more information on the relationship 
between tax agents and tax administration in Australia, see http://
www.ato.gov.au/corporate/content.asp?doc=/content/66215.htm (last 
visited March 27, 2008).
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    Recent, highly publicized phishing schemes confirm the need for the 
IRS to develop a free fill-in template and direct filing portal. During 
the 2007 filing season, for example, an Internet tax scam lured 
taxpayers into entering confidential tax return information on sites 
masquerading as Free File sites, and these taxpayers became victims of 
identity theft.\92\ It is understandable that some potential Free File 
users fall victim to scams, especially when taxpayers wishing to 
prepare their returns pursuant to an IRS sanctioned program visit the 
official IRS website only to be directed to one of 19 potentially 
unfamiliar commercial websites. All taxpayers should have the option to 
prepare and file their Federal income tax returns on the IRS's own 
website.\93\ Although Free File is accessible through the official IRS 
website, not all taxpayers are eligible to use the program. 
Approximately 30 percent of individual taxpayers--which amounts to more 
than 40 million taxpayers--are ineligible for IRS Free File.\94\ 
Moreover, the IRS exerts little control over the content of each Free 
File program. As a consequence, each of the programs has its own 
eligibility requirements, capabilities and limitations, and the 
complexity is confusing to taxpayers.
---------------------------------------------------------------------------
    \92\ See IRS News Release, Late Tax Scam Discovered; Free File 
Users Reminded to Use IRS.gov, IR-2007-87 (April 13, 2007). The IRS is 
also aware of several phishing schemes during the 2008 filing season. 
See IRS News Release, IRS Warns of New E-Mail and Telephone Scams Using 
the IRS Name; Advance Payment Scams Starting, IR-2008-11 (Jan. 30, 
2008).
    \93\ Congress contemplated the IRS developing a basic electronic 
template in the IRS Restructuring and Reform Act of 1998, Pub. L. No. 
105-206, 112 Stat. 685 (1998). The RRA 98 conference report states that 
``the conferees also intend that the IRS should continue to offer and 
improve its Telefile program and make available a comparable program on 
the Internet.'' H.R. Rep. No. 105-599, at 235 (1998) (Conf. Rep.).
    \94\ Taxpayers must have adjusted gross income of $54,000 or less 
to be eligible. See IRS Fact Sheet, 2008 IRS E-File, FS-2008-4 (Jan. 
2008); Free Online Electronic Tax Filing Agreement Amendment (2005), 
available at http://www.irs.gov/pub/irs-efile/free_file_agreement.pdf 
(last visited on April 7, 2008). Ironically, some members of the Free 
File Alliance provided free services to 100 percent of taxpayers under 
the initial term of the Free File Agreement and wanted to continue to 
do so, but the Treasury Department agreed with the Free File Alliance 
to place a cap on the number of taxpayers who would qualify for free 
tax preparation and filing services. As a consequence, Free File 
members are now restricted in the number of taxpayers to whom they may 
offer their services.
---------------------------------------------------------------------------
    Despite the IRS's best efforts, some paper filers will refuse to 
convert to e-file. For those cases, the IRS should develop 2-D bar code 
technology, which would provide taxpayers and the IRS with many of the 
same benefits as electronic filing.\95\ It is my understanding that the 
IRS has already incorporated this technology into other functions.
---------------------------------------------------------------------------
    \95\ To utilize 2-D bar code technology, a taxpayer or preparer 
uses software to complete the return. Once printed, the return has a 
horizontal and vertical bar code containing tax return information. The 
IRS scans the return, captures the data, decodes it, and processes the 
return as if it had been sent electronically.
---------------------------------------------------------------------------
    Pursuant to an Appropriations directive, the IRS Office of 
Electronic Tax Administration and Refundable Credits (ETA) is 
developing a comprehensive strategic plan to meet the 80 percent e-file 
goal.\96\ ETA has commissioned MITRE to conduct the Advancing E-File 
Study, and we are pleased that the study will determine or review the 
following items:
---------------------------------------------------------------------------
    \96\ Staff of H. Comm. on Appropriations, 110th Cong., H.R. 2764, 
Consolidated Appropriations Act, 2008, Pub. L. 110-161, Explanatory 
Statement at 871 (Comm. Print 2007); Staff of H. Comm. on 
Appropriations, 110th Cong., Financial Services and Government 
Appropriations Bill, 2008, at 28 (Comm. Print July 2007). Although the 
deadline for submission of the study was March 1, 2008, the IRS Office 
of Electronic Tax Administration and Refundable Credits has faced 
considerable challenges during the current filing season, and it is 
planning to complete the study later this year.
---------------------------------------------------------------------------
  --The characteristics of paper and e-filers as well as potential 
        barriers to e-file;
  --The current third-party model of tax administration and current 
        trends in State and foreign governments; and
  --Potential strategies to increase the rate of e-file or any other 
        means to receive return information electronically. This will 
        entail a review of direct filing with the IRS, 2-D bar coding, 
        and Telefile.\97\
---------------------------------------------------------------------------
    \97\ Information Provided by Electronic Tax Administration (Jan. 
30, 2008); Diane Freda, IRS to Study Direct Filing Portal, 2-D Bar 
Coding to Boost E-Filing, BNA Daily Tax Report (Jan. 29, 2008); MITRE 
IRS FFRDC, Center for Enterprise Modernization, IRS Advancing E-File 
Study: Draft Overview of Findings to Date (Jan. 31, 2008) (on file with 
the Office of the Taxpayer Advocate).
---------------------------------------------------------------------------
    I believe this study represents an important first step in the 
Government's fulfilling its core responsibility to taxpayers in a 
secure and straightforward fashion, without competing with the private 
sector. The Appropriations directive states that this strategic plan 
should be developed in consultation with me and other stakeholders, and 
I look forward to continuing to work with the IRS on this study.
    Finally, I believe that the IRS should take a more proactive role 
in the electronic filing arena by setting the policies and standards 
for participation in the IRS e-file program. Such policies and 
procedures should align with the needs of both taxpayers and tax 
administration. All high quality return preparation and filing products 
should have equal access to the market, reflect the latest tax law 
changes, and be compatible with filing season peaks in demand as well 
as IRS's computer and processing needs. Moreover, all programs should 
meet IRS established minimum standards for data and identity security, 
and these standards should apply to both for-profit and free tax 
preparation offerings.\98\ Unless the IRS takes corrective action, the 
IRS remains in a reactive position at the whim of private industry and 
is forced to devote scarce resources to address the downstream 
consequences of potentially avoidable problems. We are encouraged that 
the IRS is currently evaluating its role in the e-file program as part 
of the Advancing E-File Study and look forward to lending support to 
the study as well as to receiving periodic briefings of research 
findings as the study progresses.
---------------------------------------------------------------------------
    \98\ At the time of this writing, it is not clear how many of the 
programs listed on the IRS e-file partner webpage would meet IRS-
developed data or identity security specifications.
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Taxpayer Advocate Service Case Receipts Have Risen by 47 Percent Since 
        Fiscal Year 2004 While the Number of Case Advocates Available 
        To Work Taxpayer Cases Has Declined by 13 Percent
    I will close with a brief report on my own organization, the 
Taxpayer Advocate Service (TAS), and its role in identifying and 
mitigating the downstream consequences of IRS actions and programs, and 
improving taxpayers' attitudes toward the tax system. Since I became 
the National Taxpayer Advocate in 2001, I am pleased to say that TAS 
has grown up as an organization and substantially improved its ability 
to assist taxpayers. In fiscal year 2001, our quality measures showed a 
performance level of 71.6 percent. In fiscal year 2007, TAS's talented 
and dedicated employees managed to achieve a quality rating of 90.5 
percent. The performance of TAS employees since fiscal year 2004 has 
been particularly commendable--TAS case receipts rose an overwhelming 
47 percent from fiscal year 2004 to fiscal year 2007,\99\ while the 
number of case advocates available to work those cases declined by 13 
percent over the same period. Yet we have managed to handle this 
increased workload while maintaining consistent case quality over these 
3 years.
---------------------------------------------------------------------------
    \99\ In fiscal year 2007, TAS received a total of 247,839 cases. In 
fiscal year 2004, TAS received a total of 168,856 cases.
---------------------------------------------------------------------------
    The increase in TAS cases is not surprising. The IRS has 
substantially increased the number of its compliance actions in recent 
years,\100\ and about 65 percent of TAS's cases are classified as 
``compliance'' related.\101\ Increasing the number of compliance cases 
inevitably produces a corresponding increase in TAS cases. Thus, the 
greater IRS emphasis on enforcement has resulted in a greater need for 
TAS services. Economic downturns also contribute to increases in TAS 
inventory, as taxpayers who lose their jobs and become unable to pay 
their tax bills get into trouble with the IRS and seek assistance.\102\
---------------------------------------------------------------------------
    \100\ On the Examination side, the number of individual return 
closures increased by 37 percent and the number of business return 
closures increased by 102 percent from fiscal year 2004 to fiscal year 
2007. On the Collection side, the number of levies increased by 85 
percent, the number of liens increased by 28 percent, and the number of 
seizures increased by 54 percent over the same period. See Internal 
Revenue Service, fiscal year 2007 Enforcement and Services Results 
(Jan. 17, 2008) (accompanying fiscal year 2007 Enforcement and Services 
Tables), available at http://www.irs.gov/pub/irs-news/
irs_enforcement_and_service_tables_fy_2007.pdf.
    \101\ In fiscal year 2007, TAS classified 160,131 case receipts as 
compliance-related and 87,708 as service-related, for a total of 
247,839 case receipts.
    \102\ TAS received 86,261 economic burden case receipts in fiscal 
year 2007 compared with 34,653 in fiscal year 2004--a 149 percent 
increase.
---------------------------------------------------------------------------
    TAS is able to assist most taxpayers who seek our help. Overall, 
TAS was able to obtain full relief for the taxpayer in 69 percent of 
the cases we closed in fiscal year 2007 and partial relief in an 
additional 4 percent of our cases.
    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, as evidenced by the results 
for the last 2 years. In fiscal year 2006 and fiscal year 2007, the 
percentage score for overall satisfaction of the taxpayers who came to 
TAS was 85 percent and 83 percent, respectively. Equally important, 50 
percent of taxpayers stated that they felt better about the IRS as a 
whole after coming to TAS. Even among taxpayers who did not obtain the 
result they sought, an impressive 34 percent reported that they had a 
more positive opinion of the IRS because of their experience with 
TAS.\103\
---------------------------------------------------------------------------
    \103\ For fiscal year 2006, the Gallup Organization collected the 
customer satisfaction data for the Taxpayer Advocate Service. In fiscal 
year 2007, TAS began using a new vendor, Macro International, to 
conduct its surveys.
---------------------------------------------------------------------------
    However, I am concerned that with the increasing volume, 
complexity, and urgency of TAS's caseload, the cycle time for our cases 
has begun to increase. Closed case cycle time was 71.1 days in fiscal 
year 2004 but has risen to 80.6 days in fiscal year 2008.\104\ These 
results are hardly surprising. If you increase the workload of a 
customer service organization by 47 percent and reduce the number of 
employees available to assist customers by 13 percent, you are 
essentially increasing the average workload of each employee by nearly 
70 percent. And because TAS generally assists taxpayers only where they 
face an imminent economic burden because of an IRS collection action or 
where normal IRS procedures have failed, TAS does not have much 
flexibility to turn away cases. Indeed, TAS expects to receive more 
than 250,000 cases in fiscal year 2008, and our case inventory 
continues to rise. If the balance between TAS staffing and the number 
of cases we handle does not improve, I am concerned that TAS is in 
jeopardy of becoming part of the IRS problem rather than the advocate 
for the solution, as Congress intended.
---------------------------------------------------------------------------
    \104\ Fiscal Year 2008 data reflects case closures from October 1, 
2007 through March 31, 2008 (six months).
---------------------------------------------------------------------------
    Lastly, I provide a brief report on the Low Income Taxpayer Clinic 
(LITC) program, which is administered by my office. For fiscal year 
2008, the IRS's Taxpayer Services appropriation included $9 million for 
LITC grants. This appropriation represented an increase of $1 million 
compared with the 2007 grant cycle.\105\ The LITC program currently 
funds 154 clinics in all 50 States, the District of Columbia, Puerto 
Rico, and Guam, thus meeting my goal of having at least one LITC in 
each State. The increased appropriation allows us to provide funding 
for new clinics as well as to provide increased funding for existing 
clinics that have expanded or plan to expand their services to 
underserved areas and populations. This additional funding also has 
enabled the LITC Program to work toward its goal of funding at least 
one controversy and at least one English as a Second Language (ESL) 
clinic in every State. The LITC Program Office, in conjunction with TAS 
Research, has identified locations where there are significant 
populations of low income and ESL taxpayers who are not currently 
served by a clinic. Recently, we announced a supplemental grant period 
to solicit qualified organizations willing to address the needs of 
these identified areas.\106\
---------------------------------------------------------------------------
    \105\ Although appropriations are made on a fiscal-year basis, 
grants for the LITC program are awarded on a calendar-year basis (which 
we refer to as the ``grant cycle'').
    \106\ Low Income Taxpayer Clinic Grant Program; Availability of 
2008 Supplemental Grant Application Period, 73 Fed. Reg. 15,841-42 
(Mar. 25, 2008).
---------------------------------------------------------------------------
Conclusion
    Compared to the IRS of 10 years ago, the IRS of 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 have 
brought about fairly dramatic improvements, and the Taxpayer Assistance 
Blueprint, created in response to an Appropriations directive, provides 
a useful roadmap to maintain and improve the delivery of taxpayer 
services. On the enforcement side, the IRS has been ramping up its 
enforcement of the tax laws, particularly with regard to corporate tax 
shelters and high-income individuals, and the results have generally 
been positive.
    But the IRS can, and should, do better. To increase voluntary 
compliance, the IRS should incorporate an ongoing taxpayer-centric 
assessment of taxpayer service needs into its strategic plans. It 
should consider whether it can meet taxpayer service needs adequately 
when it devotes only 6 percent of its budget to taxpayer assistance and 
education. It should conduct research (including applied research) into 
the causes of noncompliance and apply the resulting knowledge to IRS 
enforcement strategies, including those pertaining to the cash economy. 
Finally, the IRS must have sufficient resources to move forward with 
its technological improvements, which are critical to its ability to 
improve both its Taxpayer Services and Enforcement functions.

                        PRIVATE DEBT COLLECTION

    Senator Durbin. What a loser this private debt collection 
is. I mean, it just seems like we are stuck on this. Not to say 
anything negative about our colleagues, but my guess is that it 
is just a nice, little business with a bunch of employees in 
several places in America that the Senator and Congressmen want 
to keep open, but it sounds like it is a bad deal. This is 
privatization that is costing us more than if we used the 
public employee. Is that your conclusion?
    Ms. Olson. Well, I think that it originated in a concern 
that there was a pool of taxpayers that the IRS was not 
currently touching and that we were not going to get additional 
appropriations to hire employees to touch those taxpayers. And 
what has turned out is that, first, that pool of cases, the 
ones that are easy to work, do not exist. We are running out of 
those cases and we are reaching into cases that the IRS is 
actually scheduled to work, and we are stretching the bounds of 
what PCAs can do efficiently.
    The second thing we have found is what I highlighted in my 
testimony, that a lot of these cases, if the IRS sent a 
letter--we get a return that a lot of these cases have just 
been sitting there----
    Senator Durbin. You said 46 percent.
    Ms. Olson. For a 41-cent stamp, we would get the taxpayer 
going, oh, they are back on the scene. We need to respond to 
them instead of our other creditors.
    Senator Durbin. Of course, if the private debt collector 
gets in, they get what? Twenty-five cents on $1?
    Ms. Olson. Well, up to 25 cents on $1? Yes, correct.
    Senator Durbin. So that seems like a loser.
    Mr. George, about this brain drain, do you know what the 
IRS is doing to use student loan forgiveness to either recruit 
or retain talented people?
    Mr. George. Actually I do not, Mr. Chairman. Allow us to 
get back to you on that.
    Senator Durbin. Would you?
    Mr. George. But if I may, though, could I briefly address 
the private debt collection issue?
    Senator Durbin. Sure.
    Mr. George. Because TIGTA recently conducted an audit and 
there are a couple of facts that I would like to share with 
this subcommittee for your appreciation.
    As of February 23 of this year, the total cases assigned to 
the private debt collection agencies are approximately 98,000 
with the dollars assigned of just under $900 million. The 
actual payments received as a result of this program are $46.19 
million. Out of this, the commissions paid to the private debt 
collectors has been just over $7 million. The number of 
accounts paid. Again, out of approximately 98,000, the total 
number of accounts fully paid is just over 12,000. The number 
of accounts entering into installment agreements is just over 
5,000, and the number of accounts referred to, as we call them, 
taxpayer account services is just over 1,300.
    We really do not know whether or not a simple letter would 
achieve these results. We have not done the research to give 
you a definitive answer in that regard. But Senator Brownback 
may recall that when he was on the Government Reform 
Subcommittee, chaired by Congressman Stephen Horn, over 10 
years ago, we worked on this very issue. Back then the program, 
the pilot that was established, was an abject failure. No one 
would disagree with that point. Here we just simply do not know 
whether the startup costs are those that the private sector 
would simply assume are a part of doing business as the startup 
costs.
    So the bottom line is I am saying I want to make sure that 
this tax gap is addressed somehow and if turning to a project 
such as a private debt collection would help address it----
    Senator Durbin. It sounds objective and valid, but it is 
not working. How long have we been trying this now?
    Ms. Olson. The program started in September 2006, and in 
fact, the way it is structured is any payments that come in the 
first 10 days in response to the first letter the IRS sends to 
the taxpayer saying, hello, we are back, we are going to send 
your case out to the private debt collectors if you do not 
respond to us, are non-commissionable payments. And we do have 
those numbers. In 2007, out of the $32 million--is that how 
much we collected? And $31 million in 2007. About $5 million 
came in the first 10 days.
    So you can see it is about 19 percent of the collections 
were in response to the IRS letter, and I maintain that if we 
sent a letter saying, hello, we are back and we could levy on 
your bank account, on your pay stub, all the things that we 
could do, we would get a response.
    Senator Durbin. I am going to go over time here.
    Senator Brownback. I will not tax you.
    Senator Durbin. Thanks. No penalties, no interest.

                     BUSINESS SYSTEMS MODERNIZATION

    Mr. Cherecwich, my experience has been that the Federal 
Government is not very darned good when it comes to business 
modernization systems. And I have some personal experience 
since 9/11 trying to get the FBI to have an updated computer 
system. I cannot tell you how much money we have wasted in that 
effort and still are not where we ought to be.
    There are similar efforts that have been made in trying to 
verify visas coming in and out of this country. For more than 
10 years, we have failed to come up with what appears to be a 
pretty simple task.
    So what kind of confidence do you have if more money is 
funneled into the IRS for business modernization systems and 
technology that it is going to be well spent?
    Mr. Cherecwich. A couple of responses to that, Senator. 
Typically with high-tech projects, you have a little bit of 
risk going into them, and delays and failure to meet schedules 
are to be expected. Any business that tries to install a 
massive computer system like we are talking about, a massive 
information system, will expect to have hiccups along the road. 
What happens in business when you get a hiccup along the road 
is not that you cut the funding because they are bad boys. You 
turn around and you provide the support in the manner in which 
you feel that they can deal with that.
    Now, how do I feel comfortable that they can deal with 
that? The IRS in the last few years has developed something 
they call a modernization and visions strategy for their 
computer systems, their information structures. And this 
modernization and visions strategy is a tool in which projects 
can be prioritized and the appropriate management assigned to 
make them work. It is an overall program that gives me a great 
deal of comfort that the IRS is on a proper path to properly 
manage this.
    Where we will run into difficulty is this ramped-down stuff 
where we start losing all the skilled people. We need to have 
good, steady, level funding and keep moving forward.
    Senator Durbin. I am going to ask my ranking member a favor 
here. I have to take a phone call, and if he would be kind 
enough to ask questions and recess the subcommittee meeting. I 
want to personally thank the panel and others who have been 
here today to help us.
    Senator Brownback.
    Senator Brownback [presiding]. Thank you very much.
    All those in favor of a flat tax?
    I have got to wait until he gets out of the room.

                           TAX SIMPLIFICATION

    I want to look at tax complexity. You guys are very 
familiar with this Code. I think the difficulties of 
enforcement are interesting.
    I presume all of you would agree with me that if Congress 
provided a simpler Code, that there would be more compliance 
with the tax system.
    Mr. Cherecwich. It is hard to argue with that one.
    Mr. George. I agree, Senator Brownback.
    Senator Brownback. Have you studied or looked at other 
countries that have simplified codes--other industrialized 
countries that have a similar system and know of compliance 
rates? Nina?
    Ms. Olson. Well, I think that some of them are--although 
the IRS might not like this heard--comparable to us. Some of 
them have divided their tax systems between a modest income tax 
and then a value-added tax or a goods and services tax.
    I think that some of the directions talking about a return-
free system, some of the systems like Sweden where they have so 
much information on their individuals, that they have a very 
high compliance rate, but they know more about their citizens--
--
    Senator Brownback. Yes. Well, our folks do not really go 
for that.
    Ms. Olson [continuing]. Than United States people would 
want.
    Senator Brownback. But are there other industrialized 
countries that have simplified systems that are not thoroughly 
penetrated into a person's personal information?
    Ms. Olson. I was just in Australia this past month for a 
tax conference, and they have a system that has income tax, has 
a pay as you earn essentially system, so that many people just 
like the United Kingdom do not have to file taxes because the 
taxes are paid by the employer and you pay what you pay each 
paycheck and you do not do a return reconciling. You only file 
a return when you have sole proprietorship income or capital 
gains, you know, transactions that the tax system would not 
know about. And then the rest of the tax is made up by either a 
goods and services or a value-added tax, which is paid along 
the way and is invisible to the individual taxpayer at least.
    Senator Brownback. What would you like to see us do to 
simplify the system?
    Obviously, up here in Congress we use the Tax Code to try 
to manipulate the economy, to try to stimulate the economy, to 
try to get people to do certain things. And each attempt adds a 
layer of complexity, and we are all guilty of it. Every 
lobbyist in town is hired by somebody to do something in this 
Tax Code, and they are very good. So you have got an incredibly 
complex Tax Code.
    But what would you like to see us do? What should we do on 
tax simplification?
    Ms. Olson. Well, let me hedge my comments by saying I do 
not do tax policy. I look at this from the taxpayer's 
perspective in terms of being asked to comply with the laws and 
the difficulty there. And so I will not go into whether it 
needs to be a flat tax or what kind of tax. But whatever tax 
system we have it has to be intuitive to the basic taxpayer and 
not impose arcane rules like the alternative minimum tax that 
confuses people.
    I think that the President's reform panel made some really 
interesting proposals, and I would like to see some of them 
revisited.
    I think that, as well, we do need to look around the world 
and see what other industrial nations are doing and what the 
differences are with their population and our population. We 
have to keep the taxpayer's perspective in mind and say what is 
it that taxpayers can handle so that we do not set them up for 
problems.
    Senator Brownback. I have studied some on the flat tax 
systems in different countries, and the countries I have gone 
to are generally second world countries. But they substantially 
lowered their rate. They simplified their system. They 
increased Government revenue substantially in those places and 
they increased compliance. Currently, with high rates and 
complexity, a lot of people just said, I am out of here. I am 
going to figure a way around you guys, and did. But if it got 
down to a rate that was fairly simple, a lot more people will 
say, well, rather than trying to skip around this, I will pay 
it. That is that intuitive piece, I think, of what you are 
saying.
    Ms. Olson. Yes. Well, and I think also that goes to 
something else we have been recommending which is that IRS do 
more research into the reasons that taxpayers do not comply 
because once you learn that, you can incorporate that into not 
only just how do you do your outreach and your education and 
your enforcement initiatives, but also into your system design. 
If you know what causes taxpayers to not comply, whether it is 
attitude or the sheer complexity of the laws, they get 
confused, that informs how your system should look.
    Senator Brownback. Do we know the answer to that, Mr. 
George?
    Mr. George. Well, I have to, at the outset, say, Senator 
Brownback that, as Nina indicated, tax policy is not my 
bailiwick and actually under directives within the Department, 
I am not in a position to advocate a particular policy.
    That stated, there is no question that if there were a 
simplified tax system, more people would easily or more readily 
comply with their requirements. For example, I note that if the 
legislation that is before Congress helping to determine the 
cost basis of stocks were enacted, that would most definitely, 
I think, help in terms of the overall compliance with people 
acknowledging what they paid and what they owe after stock 
transactions. I actually had an opportunity to raise this issue 
with Jim Cramer of CNBC and he readily acknowledged that that 
would be a very helpful device and that it would not be too 
burdensome on the financial industry.
    Senator Brownback. It would seem like all you guys could 
help us quite a bit if, as we are proposing tax changes, which 
happen every year in the Congress, you had some sort of 
complexity index or rating of what this is going to do on 
making the Tax Code more complex. Our focus is the policy 
initiative we are trying to hit with the money we have. That is 
the whole game. We want to go green and we have got this pool 
of money. So how do we get this policy into that amount of 
money? But we never really look at the complexity issue of what 
it is going to do to the complexity of the code and its impact.
    It would be a helpful exercise actually, particularly 
because I think right now what people are most fed up with is 
the complexity of the Code. I would like to see the rates 
lower. I think most people would like to see the rates lower. 
But what really drives them nuts is how complex this thing is.
    Mr. Cherecwich. Senator, our Board conducts an annual 
attitude survey among taxpayers, which I referred to earlier. 
Among the findings of that survey is most Americans think it is 
inappropriate to try to cheat on their taxes. They think it is 
appropriate to pay the taxes as required.
    Given the complexity of the Tax Code, we feel that it is 
very important to balance the combination of services with 
enforcement. We have a tax gap and we cannot audit our way out 
of the tax gap. We have to have this balance with services and 
enforcement. And that is the reason why our recommended budget 
for fiscal year 2009 has that balance in recognition of the 
complexity that you talk about.
    Senator Brownback. I think you also note in there if it was 
not as complex, you would not have quite as big a tax gap. That 
is a feature of it as well. That is our role here in Congress, 
and I think we need to do a lot better on that.
    Thank you all very much for being here.

                     ADDITIONAL COMMITTEE QUESTIONS

    The record will remain open for a period of 1 week for 
people to be able to submit additional questions or for 
panelists to submit statements into the record.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

            Questions Submitted by Senator Mary L. Landrieu

    Question. Last year, I sent a letter to Acting Commissioner Stiff, 
suggesting several ways to alleviate some of the financial burdens on 
individuals who are being taxed on these grants. In Commissioner 
Stiff's December 27, 2007 letter to me, she responded that all but one 
of my suggestions required a legislative fix. The one suggestion she 
did not address--providing families more time to pay back any tax 
attributable to their grant--would have provided short term relief and 
would have allowed us more time to craft a legislative solution to the 
problem.
    Why didn't Commissioner Stiff address this solution?
    Answer. I understand that then-Acting Commissioner Stiff intended 
the response to indicate the mitigation you requested, extending the 
time to pay back tax attributable to a Road Home grant, requires 
legislative action. We apologize for not being clearer in this regard.
    Question. Could the IRS have allowed for an extension of time?
    Answer. No, there is no legal basis to extend the time period for 
affected taxpayers to pay the tax due. Legislation would be required in 
order to provide additional time to pay the tax due in this case, 
either by extending the payment date or providing for a payment of tax 
over a number of years.
    Question. What was the basis for concluding that the IRS could not 
provide additional time for hurricane victims to pay back any tax 
attributable to a Road Home grant?
    Answer. The IRS does not have the discretion applicable to provide 
taxpayers with an extension of time to pay taxes due.
    Question. Are there other administrative steps that the IRS can 
implement to mitigate the effects of its decision to tax Road Home 
grants?
    Answer. Because, as discussed above, our administrative flexibility 
is limited under the law, the IRS has focused on providing information 
to keep taxpayers well-informed on this issue. Representatives from the 
IRS met with tax professionals and others to provide tax assistance on 
Road Home grant issues (among other tax issues relating to the 
hurricane). The IRS continues to keep an open dialogue with local tax 
professionals to identify and address emerging filing issues, including 
issues involving Louisiana Recovery Authority (LRA) Grants and the 
effect of the taxpayer reporting a casualty loss in a prior tax year. 
The IRS website has a page dedicated to providing information on 
disaster relief, which includes detailed responses to frequently asked 
questions for hurricane victims concerning the tax implications of Road 
Home grants, including the tax-benefit rule.
                                 ______
                                 
              Questions Submitted by Senator Wayne Allard

    Question. Can you please provide me with an accurate and detailed 
account outlining where the IRS audit process involving conservation 
easements currently stands in Colorado?
    Answer. The status of the audit process is as follows:
  --We have issued 183 private offer letters. These private letter 
        offers are similar to settlement proposals. The letters address 
        over 400 tax years and over 103 easements. They concern over 
        $38,900,000 in claimed easement donation value.
  --Of the 183 offer letters, 64 (35 percent) have been accepted, 91 
        (50 percent) have been rejected, and 28 (15 percent) are 
        pending.
  --We expect to send a small number of additional offer letters within 
        the next several weeks.
  --Audits are continuing for 316 taxpayers, 489 tax years, and 159 
        easements.
  --Audits have concluded for 356 taxpayers, 667 tax years, and 168 
        easements.
    Question. Does the IRS have any intention of refocusing its 
investigation off of legitimate easements and focus solely on those who 
have been targeted by the state?
    Answer. The IRS strives to avoid focusing its investigations on 
legitimate easements. Our efforts have focused on two approaches. 
First, we attempted to resolve through our settlement offer program 
those cases in which the sole issue was valuation of the easement. 
Although this approach resolved many cases, we will need to do further 
work with respect to those taxpayers who declined to accept the 
settlement offer. Second, we have been investigating some of the 
organizations that have been targeted by the state of Colorado as 
promoters of questionable or abusive easements. We intend to pursue our 
work with respect to these cases as we complete our work on 
conservation easements in Colorado and elsewhere across the United 
States.
    Question. In mid-November, the IRS began making settlement offers 
to a significant number of conservation easement donors under audit in 
Colorado. According to the IRS, the settlements were only offered in 
those cases where the sole issue between the donor and the IRS is 
valuation.
    The offers generally fell into a ``bucket'' where the IRS stated 
only 30 percent, 60 percent, or 75 percent of the original value of the 
charitable donation was allowed.
    What were the criteria the IRS used to place different taxpayers 
into these various ``buckets''? Did the IRS indicate in writing to the 
donor how or why the IRS arrived at their decision? If not, why?
    Answer. The IRS established the three separate categories after 
reviewing factors that affected the strength of the taxpayers' 
appraisals and other substantiation of the deductions claimed, with the 
highest allowance percentage being provided to those taxpayers the IRS 
believed had the strongest cases, taking into account the hazards of 
litigation. A 30 percent allowance offer was made to those taxpayers 
that had subdivided their properties into small parcels, such as 35 
acre parcels, in connection with making a contribution of an easement.
    The primary difference between the 60 percent and 75 percent 
categories was the extent of the taxpayer's appraisal process; 75 
percent was offered to those identified as having undergone an 
appraisal process that was identical or similar to Colorado's ``Great 
Outdoors Colorado'' (GOCO) process; and 60 percent was offered to all 
other taxpayers. GOCO is a state program intended to encourage 
conservation and preservation, including through conservation 
easements.
    We attached as Appendix A a copy of the standard form of letter 
that was sent to the taxpayers, as well as one of its attachments--a 
letter from the state of Colorado concerning the resolution of state 
income tax liability. The standard letter invites taxpayers to contact 
the IRS with any questions they may have. Many taxpayers who received 
this letter have done so, and have discussed their offers and the 
reasons for them with Revenue Agents and Engineers.
    Question. Since the IRS investigations began into the 2003 
easements how much money has the IRS recuperated and how much taxpayer 
money has been spent on the blanket audit of conservation easements in 
Colorado?
    Answer. Our information systems do not track costs in this fashion. 
To date in Colorado we have assessed $6.9 million in tax, penalties, 
and interest in these cases.
    We respectfully note that decisions on administering the tax laws 
generally are not guided exclusively by a cost-benefit approach as 
contemplated by the question. Other considerations, including 
requirements of the tax law, the deterrent effect on taxpayers, and the 
interests of justice, must be taken into account.
    Question. Wouldn't the IRS be more successful in recuperating tax 
dollars if it investigated the same fraud the state uncovered rather 
than auditing good easements that have been shown to meet rigorous 
state and national standards?
    Answer. The IRS commenced this examination program because of 
problems reported and discovered in conservation easement donations 
generally, but initially focused on Colorado after the State of 
Colorado expressed its concerns regarding valuation and other issues 
involving donations made in Colorado. The State initiated its actions 
after our work elsewhere had begun. We have and will continue to work 
collaboratively with the State of Colorado and will focus on what we 
believe are the more egregious cases.
    Question. How much money does the IRS expect to spend defending its 
settlement offers in court? Do you find this to be a good way of using 
taxpayer's dollars?
    Answer. No reliable estimate of such costs is possible until we 
know better the number of cases involved. However, as we choose how to 
audit and resolve cases, we always take into account limited resources 
and long-term strategies. We experience such choices in virtually every 
examination initiative.
    Question. Does the IRS have appraisers or other professionals that 
are experts in conservation easements? If not, why?
    Answer. Yes, the IRS does have a number of appraisers and other 
specialists who are experts in valuing various forms of property, and 
who have valued conservation easements for federal income tax purposes.
    Question. Has the IRS used the experts in conservation easement 
valuation or tax law that have offered their expertise? If not, why?
    Answer. Yes, and we will be using more. The IRS is currently 
working to hire additional experts to work Colorado cases, including 
cases involving potentially abusive promotions of easements.
    Question. The longer these cases remain pending, the more impact 
they can have on land conservation in Colorado. When does the IRS 
expect to conclude their investigation?
    Answer. The IRS understands the need to be expeditious in 
attempting to resolve these cases. The IRS has already completed 
examination work in Colorado easement cases involving 168 easements. 
Cases involving 159 easements remain open at this time. The IRS 
continues to work toward completing its examinations involving Colorado 
easements, and we recently dedicated additional resources to complete 
them as quickly as possible. Although the IRS expects to conclude many 
of its examinations of the existing open Colorado conservation easement 
cases by December 2008, we expect that the balance of the examinations 
work will not be completed until as late as June 2009. This timeframe 
does not include the time required for cases to work their way through 
the Appeals and litigation processes.

                               APPENDIX A

Internal Revenue Service
(IRS Address)
Date:
  
(Taxpayer name)
(Address        )
  
  
Department of the Treasury
  
Refer Reply to:
Group:
Person to Contact:
  
Employee Identification Number:
Contact Telephone Number:

    Dear (Taxpayers name):
    This letter is to inform you that Appeals has considered the 
federal tax implications of a group of returns reflecting charitable 
contributions of conservation easements in the state of Colorado. 
Because your conservation easement is within that group, the Internal 
Revenue Service proposes to resolve the issue(s) related to the 
conservation easement contribution claimed on your federal income tax 
return for XXXX(tax year) under Delegation Order 4-25, as described 
below. This proposed offer must be accepted within 30 days of the date 
of this letter.
    This resolution reflects Appeals' assessment of the hazards of 
litigation. Appeals has concluded the settlement proposed in this 
letter is an equitable resolution of the issue(s). Absent atypical 
facts and circumstances, you (investor or investor partner) should not 
expect a resolution of the tax issue on terms that are more favorable 
than the terms offered in this letter. If you do not accept this offer, 
the resolution of your case in Appeals will be based on the merits of 
the issues presented and may in fact be less favorable than the terms 
of this letter.
    If you accept this offer, the Service will resolve your 
conservation easement on the following terms. For purposes of this 
settlement:
      1. The government will treat the easement you donated during the 
        year 20xx as a qualified conservation easement contribution.
      2. The allowed amount of the conservation easement contribution 
        is based upon the amount of the value of the easement 
        originally claimed and the hazards of litigation. Please see 
        the attached Form 4549A.
      3. If you sold or transferred the Colorado state tax credit 
        resulting from the donation of the conservation easement, the 
        amount you received in exchange for the sale or transfer will 
        be subject to tax as ordinary income. Please see the attached 
        Form 4549A.
      4. If the settlement results in an adjustment for a period(s) 
        other than the period(s) listed in the first paragraph of this 
        letter, you will file amended returns reflecting the settlement 
        and furnish copies of same to the person named above.
      5. You are liable for interest as provided by law.
    You are not eligible for this settlement offer if the conservation 
easement in question involves:
      1. An appraisal that determines the highest and best use for the 
        property is the extraction of natural resources where such 
        resources have not been shown to exist or to be economically 
        feasible to extract.
      2. A quid pro quo arrangement.
      3. Property which was purchased or sold within 18 months of the 
        contribution of the conservation easement.
      4. A contribution made to a donee organization that either does 
        not qualify under section 501(c) (3) of the Internal Revenue 
        Code or is under active consideration for termination of its 
        exempt status.
      5. An appraisal from a participant or individual who was involved 
        in the promotion or marketing of conservation easements or 
        under investigation for inflated valuations.
      6. Conservation land easement on property outside the state of 
        Colorado.
      7. The legal issue of whether the contribution is a qualified 
        conservation contribution under section 170(h) of the Internal 
        Revenue Code.
    In addition, you are not eligible for this settlement offer if you 
are:
      A. A party to a court proceeding (individual or as a partner in a 
        TEFRA partnership) in which the determination of the tax 
        treatment of the conservation easement is at issue.
      B. A partner, owner, promoter, or advisor in the business of 
        developing real estate.
      C. A promoter, partner of a promoter, or employee of a promoter 
        of a conservation easement transaction.
      D. A person under criminal tax investigation. This includes a 
        person under related criminal tax investigation by the Service 
        or the Department of Justice, or a person who has been notified 
        before the date of execution of the Form 906, closing 
        agreement, that the Service or the Department of Justice 
        intends to commence a tax related criminal investigation of 
        that person.
    If any of the above exclusions applies, you are not eligible for 
this settlement offer.
    If you are eligible for this settlement offer and wish to resolve 
your Colorado conservation easement issue on the terms set forth above, 
you must sign and return the enclosed Forms 870-AD (triplicate original 
signatures) and Forms 906 (triplicate original signatures) to the 
person whose name is listed above within 30 days of the date of this 
letter.
    You must thereafter cooperate with the Service to resolve your case 
expeditiously. In addition if the Service requests additional 
information, or documents necessary to effect this settlement, you must 
provide those documents within 20 calendar days of the request. The 
Service will grant an extension of the 20 day period only in 
exceptional circumstances and at its discretion.
    The settlement is not binding until both you and the Service sign a 
specific matters closing agreement (Form 906) and Form 870-AD resolving 
the issues for all taxable years affected by this transaction in 
accordance with the above terms. When the Service signs the specific 
matters closing agreement, the one-year period of limitations on 
assessment will begin under section 6229(f) of the Internal Revenue 
Code for investor partners.
    Full payment of the liabilities under this offer is expected by the 
date the closing agreement and Form 870-AD are returned to the Service. 
If you are unable to make full payment, you must submit complete 
financial statements (Form 433-A or Form 433-B, as appropriate) and 
return them to the person whose name is listed above.
    If you choose not to accept this proposed settlement or you are not 
eligible for this settlement, development of the issue will continue. 
If the issue is still in dispute at completion of the examination, you 
may request an Appeals conference.
    This settlement is solely a settlement of civil tax matters. No 
statement contained herein shall be deemed to be an admission by the 
Service. Nothing herein shall preclude the Service from asserting a 
position on the merits that is different from this settlement in 
contexts other than those concerning the civil tax liability of the 
taxpayer-parties whose cases are settled under this offer.
    If you choose to have a representative you must authorize such 
representation by completing a Form 2848, Power of Attorney and 
Declaration of Representative. You can obtain this form from a local 
IRS office, through our website at www.irs.gov or by calling 1-800-829-
3676.
    Also, enclosed is a letter from the state of Colorado which 
provides instructions on resolving your state income tax liability 
involving this issue provided that you resolve your federal tax matter 
at this time.
    If you have any questions, please contact the person whose name and 
telephone number appear at the top of this letter.
            Sincerely,
                              Name of Person Issuing Letter
                                     Title of Person Issuing Letter
Enclosures:
    Form 906
    Form 870-AD
    Form 4549A
    Form 433-A
    Form 433-B
    State of Colorado letter

                             State of Colorado,    
                         Taxpayer Service Division,
                                     Department of Revenue,
                          Denver, Colorado 80261, November 1, 2007.

            COLORADO DEPARTMENT OF REVENUE SETTLEMENT OFFER

    Taxpayers who participate in the Internal Revenue Service's 
conservation easement donation settlement offer will also be eligible 
for a settlement offer from the Colorado Department of Revenue 
according to the terms set forth below. The IRS will advise the 
Colorado Department of Revenue of the identity of taxpayers who qualify 
for their offer as allowed through our information sharing agreement.
    In order to accept the Colorado offer, the taxpayer must file an 
amended return for all affected tax years within 30 days of the 
acceptance and execution of the IRS' settlement offer. The amended 
return(s) will include:
  --Adjustments to federal taxable income matching the federal 
        settlement adjustments;
  --Adjustment to Colorado's federal charitable contribution deduction 
        addback to the extent applicable to the federal settlement 
        adjustments;
  --Repayment by the easement donor of 50 percent of the gross 
        conservation easement tax credit that would have been 
        disallowed under the federal settlement adjustments. The donor 
        may pay this amount rather than having the transferees 
        assessed.
    Questions regarding this offer should be referred to Richard 
Giardini at the Colorado Department of Revenue at 303-866-3900.
                                          Richard Giardini,
         Colorado Department of Revenue, Taxpayer Service Division.

                          SUBCOMMITTEE RECESS

    Senator Brownback. The hearing is recessed.
    [Whereupon, at 4:13 p.m., Wednesday, April 16, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
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