[Congressional Record Volume 148, Number 147 (Thursday, November 14, 2002)]
[Senate]
[Pages S11069-S11075]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
AVERTING A BREAKDOWN IN FEDERAL TAX ENFORCEMENT
Mr. LEVIN. Madam President, many have said they want the next
Congress to work on tax reform. Any tax reform effort we undertake,
however, needs to address the grave warning recently provided by IRS
Commissioner Charles O. Rossotti about the need for immediate steps to
avert a breakdown in federal tax enforcement.
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Mr. Rossotti has just completed 5 years of work to restore confidence
in the effectiveness and fairness of the IRS. He left the
administration last week after submitting a report to the IRS Oversight
Board summarizing his efforts and the current state of the IRS. His
overall conclusion was that, while the IRS made significant progress
over the last 5 years in revamping its procedures and improving
interactions with average taxpayers, the IRS is ``losing the war'' on
stopping tax cheats.
Mr. Rossotti wrote that while the size and the complexity of the Tax
Code have continued to increase, IRS enforcement resources have
continue to diminish. He described the IRS as ``outnumbered'' and
facing a huge and growing gap ``between the number of taxpayers whom
the IRS knows are not filing, not reporting or not paying what they
owe, and our capacity to require them to comply.'' Using specific facts
and figures, he provides data supporting the shocking statistic that
four out of five U.S. tax cheats will likely escape detection and
correction action due to the IRS' limited resources to enforce the tax
laws.
Mr. Rossotti also summarized what is happening among tax
professionals to enable so-called sophisticated taxpayers to escape
paying their fair share, and what the likely consequence is for honest
taxpayers left footing the bill. Here is what he said:
Recognizing the IRS' diminished capacity, promoters and
some tax professionals are selling a wide range of tax
schemes and devices designed to improperly reduce taxes to
taxpayers based on the simple premise that they can get away
with it. When this perception becomes increasingly
widespread, the essential pillar or our tax system is lost--
namely, the belief of honest taxpayers that if someone does
not pay what he or she owes, then the IRS will do something
about it.
Mr. Rossotti's full analysis appears in the report he filed with the
IRS Oversight Board, and I ask unanimous consent for the complete text
of that report to appear in the record following my remarks.
The PRESIDING OFFICER. Without objection, it is so ordered.
(See exhibit 1.)
Mr. LEVIN. This report not only sets out the scope and causes of the
growing enforcement problems at the IRS, it also identifies practical
and immediate steps that can be taken by Congress to avert an
enforcement breakdown. Essentially, it comes down to Congress'
providing the IRS with a steady increase of 2 percent per year over the
next 5 years in resources for audits, investigators, and enforcement
actions. This increase is not only modest, the numbers show that it
will more than pay for itself through the collection of taxes that have
improperly been withheld.
Federal tax reform is an important goal, but any reform effort must
include a clear-eyed recognition of the growing problem of tax
compliance and the need to revitalize the agency charged with ensuring
all Americans pay their fair share. Mr. Rossotti was scheduled to bring
the enforcement problem to the attention of Congress at a hearing in
October, but that hearing was cancelled after, according to press
reports, he was asked by the administration not to disclose his report
or recommendation for increased enforcement resources.
To further contribute to an understanding of the scope and nature of
tax noncompliance, my staff on the Permanent Subcommittee on
Investigations has been digging into the problems of offshore tax
evasion and tax promoters shopping improper tax shelters. I hope to
have more to report on these issues early next year.
In the meantime, I urge all my colleagues to read Mr. Rossotti's
report in full and take its warnings and advice to heart as we approach
tax reform issues in the coming year.
Exhibit 1
Report to the IRS Oversight Board--Assessment of the IRS and the Tax
System
As the Board requested, and as my term of office draws to a
close, I want to share with you my thoughts on the current
state of the IRS, our tax administration system, as well as
the opportunities and challenges that the agency and new
commissioner will face.
The IRS is today capable of executing its mission with
increasing effectiveness and efficiency. We made measurable
progress on a number of high priority areas, such as e-
filing, telephone and in-person taxpayer service, protection
of taxpayer rights and burden reduction. We stabilized and
refocused our key compliance activities to make the best use
of our limited resources and are identifying and attacking
systematic areas of non-compliance, such as the promotion and
use of abusive tax devices. Financial management improved, as
evidenced by unqualified audit opinions. Internal morale,
which was heavily affected by criticism and internal and
external change, turned around. Perhaps most importantly, we
regained the confidence of the public and other stakeholders.
For the longer term, the IRS created a firm foundation upon
which to make further progress. It includes: a modern
organization structure with clear accountability for meeting
the widely varying needs of specific taxpayer segments;
information systems and support organizations capable of
supporting operations efficiently while managing
modernization; and a planning and management process for
allocating resources, assigning goals to managers and
measuring progress.
Our Business System Modernization Plan is beginning to
deliver tangible benefits to taxpayers and practitioners.
Equally important, we have a complete vision and architecture
to guide the continuing modernization of every IRS business
process and supporting technology.
The plans in place for FY 2003 and FY 2004 reflect
aggressive but achievable productivity gains, exceeding those
that were historically achieved in the private financial
sector.
Taken together, these achievements demonstrate the progress
we made over the past five years in the entire way we serve
taxpayers, although finishing the job will still take the
full decade I originally projected.
However, amidst what I believe is justified optimism for
continued improvements in the performance of the IRS lies a
critical problem. We are winning the battle, but losing the
war. Over the last ten years, the size and complexity of the
tax system increased enormously. Beyond the simple increase
in number of taxpayers and revenue dollars, the majority of
tax revenues now come from sources that are more subject to
manipulation by those who wish to pay less than the law
requires and much more difficult and time consuming for our
agents to uncover. Meanwhile, the size of the IRS
declined, not just relatively but in absolute terms,
because of 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 whom the IRS knows are not filing, not
reporting or not paying what they owe, and our capacity to
require them to comply.
Recognizing the IRS' diminished capacity, promoters and
some tax professionals are selling a wide range of tax
schemes and devices designed to improperly reduce taxes to
taxpayers based on the simple premise they can get away with
it. When this perception becomes increasingly widespread, the
essential pillar of our tax system is lost--namely, the
belief of honest taxpayers that if someone does not pay what
he or she owes, then the IRS will do something about it.
If the trend of the last ten years is allowed to continue,
it is only a matter of time until this problem will emerge
into the forefront of public consciousness, likely leading to
an eruption of criticism such as has occurred periodically in
the last 50-year history of the IRS.
Fortunately, it is not too late to solve this problem, nor
is it an open-ended problem. In fact, in the past year we
succeeded in quantifying better than ever the resources we
need. Modernization and internal productivity improvements
will provide a major part of the needed gains. However, these
alone will not be sufficient to close the gap, even if we
assume greater productivity gains than the private sector was
able to achieve over a decade.
To succeed, we need more trained personnel to close the
known compliance gap while continuing to protect taxpayer
rights and provide essential services. Specifically, we must
add approximately 2 percent annual net increase in staffing
over five years. Even with this increase, the size of the IRS
by 2010 would be smaller than it was 20 years earlier in 1990
while the economy will have increased 86 percent.
Over the same period, we must also fund adequate increases
for computer modernization programs to accelerate the
delivery of key projects and benefits that will provide for
greater service, efficiency and productivity.
Together with effective management of the IRS, this modest
level of resources can reverse the dangerous trend the tax
system is currently taking--but only if it is consistently
provided. If, on the other hand, the trend of the past ten
years is maintained, in which the demands on tax
administration increase and the capacity of the IRS declines,
the eventual cost for our nation is certain to be enormous.
Starting Point
Before I discuss the opportunities and challenges that lie
ahead, it is helpful to place them in their proper historical
context.
By the mid-1990s, the public, Congress and most key
stakeholders had lost confidence in the IRS. According to the
Roper Starch surveys, favorable public opinion of the IRS
steadily declined since the early 1980s, reaching an all-time
low of 32 percent in 1998. The results of the American
Customer Satisfaction Index of key federal agencies were
similarly alarming. The IRS measured the lowest of any agency
or institution in both surveys.
Taxpayers were not alone in their negative perceptions.
Congress and many of our
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stakeholders also lost confidence in the agency's ability to
do its job at an acceptable level. In 1995, the Tax Systems
Modernization program was terminated after several billion
dollars were spent. Handling complaints about IRS treatment
of constituents became a time-consuming duty in many
congressional offices, and many stakeholders, especially
those representing small business, had an adversarial
relationship with the agency.
Poor quality service to taxpayers over the telephone or in
person contributed to the public's low perceptions. At the
nadir in the mid-1990s, the IRS registered 400 million busy
signals a year on its toll-free lines, and when taxpayers did
reach the IRS, the likelihood of getting an accurate answer
or resolution to a problem was low.
A number of external factors also buffeted the IRS. Budget
and staff cuts, rapid economic growth and the shift in the
tax base from middle-income wage earners and domestic
corporations to upper-income entrepreneurs, passthrough
entities and global corporations, all contributed to a
diminished capacity to cope with service and compliance
demands.
The IRS responded to this pressure by emphasizing
enforcement revenue and statistics as a way of justifying its
budget. The IRS measured the success of its compliance
activities by direct enforcement revenues. This is like a
police department assessing its success by the number of
traffic tickets written rather than by the safety and
security of the community it serves. As we well know from the
ensuing fallout, this grave mistake further alienated the
public, yet failed to address the systematic, emerging
compliance and budget problems.
While emphasizing enforcement statistics, the IRS was also
slow to update its compliance practices, such as models used
to select returns for audits and the management of the exam
and collection processes. Until we changed it recently,
$100,000 was the highest income class used by the IRS in
assigning exam cases, although people with incomes over
$100,000 pay more than 60 percent of the income tax.
Moreover, although exam coverage was declining, many of
these examinations concentrated on relatively straightforward
issues of deductions or timing differences, such as the use
of cash versus accrual accounting by small businesses. Very
little emphasis was placed on partnerships and trusts, high-
income individuals or offshore accounts, although vast sums
of income flow through these entities. There was no specific
program to identify and combat promoters of abusive tax
devices. The IRS succeeded in winning some tax shelter court
cases, but there was no overall strategy for dealing with
corporate tax shelters.
achieving a turnaround
The IRS addressed, although certainly not completely
solved, the major problems and internal constraints it faced
five years ago. Some are resolved; clear plans are in place
to correct the remaining ones over the next five years. This
work provided the foundation for steady improvement in the
effectiveness and efficiency with which the IRS carries out
its mission.
Public confidence in the IRS rebounded. The Roper Starch
surveys found our rating increased each of the past three
years after 1998's historic low. The University of Michigan's
American Customer Satisfaction Index survey released in
December 2001 showed greatly improved customer satisfaction
among individual taxpayers--the largest favorable gain of the
30 federal agencies surveyed.
In May 2002, the Federal Performance Project, a
collaboration of Government Executive Magazine and George
Washington University's Department of Public Administration,
released its scorecard on federal agencies. The IRS earned a
``B-'', as compared to a ``C'' three years ago. While the
trend is good, much more remains to be done. The IRS can be
and should be managed at the ``A'' level and is on its way to
achieving this.
This turnaround in public confidence reflects the clear
progress in five distinct areas: (1) customer service, (2)
stakeholder relations, (3) compliance, (4) internal
management, and (5) technology and modernization.
Customer service
The customer service improvements were the most visible to
individual taxpayers. The upward trend in telephone service
was particularly important given how far we had to climb. By
the end of the 2002 filing season, taxpayers were receiving
correct responses to 83.6 percent of tax law questions and
89.9 of account questions. Access to service and time spent
waiting, while still below private sector standards, improved
substantially. Average wait time is down 26 percent from the
previous year. Assistor access rose from 56 percent only two
years ago to nearly 70 percent this year.
Last year, Web site usage smashed all records with 2.7
billion hits and 336 million files downloaded. We are well on
our way to a new record this year. Also, in January 2002, we
introduced a newly designed and more accessible Web site.
E-filing tripled over the past five years, and this filing
season, was up 16 percent over the previous one. We are
systematically removing the remaining barriers to e-filing.
For example, this year, virtually all 1040 forms and
schedules could be filed electronically, and no paper
signature document was required. Improved electronic tax
administration is also critical to better serving business
taxpayers, especially given the number of forms and payments
they must file and make. In September 2001, we launched
Electronic Federal Tax Payment System On-Line that allows
businesses large and small to save precious time by making
their federal payments on-line.
We are also building a new e-file system that will grow and
serve taxpayers for years to come. Scheduled to start in
2004, it will address the current system's problems. For
example, it will accept complex business returns, such as
1120s, eliminate software barriers and resolve
standardization issues, such as reject codes and validations.
Service in local taxpayer assistance centers, which was
extremely poor in many places, improved in both quality and
consistency. However, it will still take several more years
to reach fully acceptable standards. Taxpayers can now
schedule appointments in more than 400 locations for face-to-
face meetings with IRS employees to resolve account or case
problems. This helps make the well-received idea of ``Problem
Solving Days'' a regular part of IRS everyday operations.
While making these improvements, we are also requiring fewer
personnel details from the compliance functions to filing
season duty--an expensive and very unpopular practice.
Within the limits of a complex and changing Tax Code, the
IRS acted to reduce taxpayer burden. For example, we
simplified forms, such as the Schedule D for reporting
capital gains. We also rewrote and simplified procedures,
such as those for distributions from qualified retirement
plans. We removed 2.6 million small business taxpayers from
the time-consuming reporting and record-keeping requirements
of reconciling tax returns with balance sheets. We
eliminated the need for most small businesses to use the
more burdensome accrual method of accounting for tax
purposes. We implemented a new and much more reliable way
of measuring taxpayer burden. In the newly created Office
of Taxpayer Burden Reduction, we also have an organization
dedicated to continuously measuring and reducing burden.
The IRS implemented 71 taxpayer rights provisions of RRA
98, including such major provisions as collection due
process, expanded innocent spouse relief, third party
notification and expanded opportunities for offers in
compromise. The Taxpayer Advocate Service was established as
an effective independent entity within the IRS. It assists
taxpayers with hardship cases and makes recommendations to
improve the way IRS works for them. Because of these efforts,
the number of taxpayers with serious unresolved cases, such
as those that generate a need for intervention by a
congressional office, declined. More generally, our improved
service helped to reduce the numbers of cases needing TAS
intervention. In 2002, case receipts fell from 194,790 to
169,390 compared with the same 9-month period in 2001.
Stakeholder relations
In the past, relations with IRS stakeholders were often
strained and adversarial. Through improved communications and
frequent, substantive meetings, our relationship with
Congress, oversight bodies and business groups--especially
small businesses--greatly improved. Congressional hearings,
once contentious, have been almost universally positive and
constructive--although not without tough questioning. Much
closer relationships were formed with organizations
representing practitioners and small businesses. A consortium
was forged with the software industry on the thorny issue of
no-cost e-filing.
One of our basic strategies is to develop the kind of
stakeholder relationships that can improve the efficiency and
effectiveness of our services. Over the past few years, we
developed a method of engaging stakeholders as part of our
decision-making process. We call the new approach, ``Engage
and Then Decide'' as contrasted with ``Decide and Then
Explain.'' Seriously engaging key stakeholders as a regular
part of the decision-making process has shown that it
improves the final product, shortens the time for decisions
and implementation, and strengthens relationships.
Although we successfully used this engagement approach, and
have much experience with the hazards and costs of the
opposite approach, IRS top management must continue to work
hard to ensure that it is employed in all decision-making
processes because it is so different from traditional
practice in the federal government.
Compliance
As the Board is well aware, we do not have the resources to
attack every case of non-compliance. Therefore, we must apply
our resources to where non-compliance is greatest while still
maintaining adequate coverage in other areas. We must also
use carefully, but effectively, the enforcement tools
available to us.
After careful study, we identified some of the most serious
and current compliance problem areas. These include: (1)
promoters of tax schemes of all varieties, (2) the misuse of
devices such as trusts and offshore accounts to hide or
improperly reduce income, (3) abusive corporate tax shelters,
(4) underreporting of tax by higher-income individuals, and
(5) accumulation and the failure to file and pay large
amounts of employment taxes by some employers.
To address these problems, we revamped our compliance
programs to refocus our resources and to use a full scope of
tools and
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techniques. They range from educating the public, to
systematically identifying promoters and participants, to
reinvigorating enforcement actions such as summons
enforcement, injunctions and criminal investigation of
promoters.
If we can eliminate confusion and errors before a return or
form is ever filed, America's taxpayers will be spared
countless numbers of notices and communications with the IRS.
If we can warn taxpayers not to participate in ``too good to
be true'' tax schemes, we can save taxpayers from penalties
and more. Moreover, the agency will be in a better position
to use its limited compliance resources on the most serious
cases of non-compliance.
To achieve these purposes, we created dedicated taxpayer
education and pre-filing organizations in our operating
divisions, e.g., TEC and SPEC in SB/SE and W&I respectively,
and pre-filing technical staffs in LMSB and TEGE. We also
created new pre-filing tools, such as pre-filing agreements
and industry issue resolution published guidance. We greatly
stepped up our output of traditional forms of published
guidance, including revenue rulings and notices, by
increasing their emphasis in Chief Counsel and forging an
effective working relationship with Treasury's Office of Tax
Policy.
For example, this past year, both the TEC and SPEC
organizations worked to raise public awareness about the
slavery reparation schemes. Materials were distributed
nationally and locally to African-American churches and
religious coalitions, fraternities, sororities and
associations, including the NAACP and the Urban League. As a
result, the average weekly number of incoming slavery
reparation claims declined from 1,538 in CY 2001 to 63 this
year.
Although these preventive measures hold great promise, we
must still detect, correct and deter non-compliance. We must
focus resources, improve efficiency and use our enforcement
powers appropriately, all of which we are doing.
As identified through our research and strategic planning,
both SB/SE and LMSB are directing their examination resources
at the most important cases and issues. Exam and collection
reengineering are focused on improving the efficiency with
which these cases are carried out. For example, SB/SE is
tackling business tax cases, such as unpaid, in-trust taxes,
including employment and withholding taxes, much earlier than
in the past.
Within two years, our new Filing and Payment compliance
modernization program will begin to reduce from several years
to six months or less the time required to resolve most
collection cases.
Other initiatives, first outlined in our Strategic Plan,
are taking effect. Earlier this year, we began matching
information reported on Schedule K-1 with income or losses
reported on Form 1040 and other schedules. We also
reinvigorated the use of long dormant enforcement tools that
are needed to deal with serious cases of non-compliance, and
especially, promoted tax schemes. For example, we are
aggressively identifying promoters and schemes through
summonses of records, including John Doe summonses on credit
card accounts in offshore tax havens and vendor summonses to
refine that data.
Multiple approaches were taken to aggressively attack the
use of abusive tax shelters. The LMSB organization initiated
43 contacts of promoters to uncover lists of taxpayers
participating in their shelters. In addition, a tax shelter
disclosure initiative was launched earlier this year. As of
August 1, 2002, the IRS processed 1,664 disclosures from
1,206 taxpayers who came forward. These disclosures cover
2,264 tax returns and involved more than $30 billion in
claimed losses or deductions. Moreover, we announced a new
policy in June 2002 to request tax accrual work papers when
we audit returns that claim a tax benefit from certain tax
avoidance transactions that we identified as abusive.
Civil and Criminal Lead Development Centers (LDC) were also
established to identify cases of abusive tax promoters. For
example, the Civil LDC works leads received from within the
IRS, or from external sources, and conducts Internet searches
looking for abusive tax promoters and promotional materials.
Also, the Webster Report gave a detailed blueprint for
making Criminal Investigation a more effective component of
tax administration. The need to refocus CI's resources on tax
cases was the centerpiece of this report. CI's top priority
is now investigating promoters and participants in illegal
tax schemes. We also established a closer working
relationship between field counsel and the operating
divisions on compliance work.
This new emphasis on action against promoters has already
shown results. The numbers of actions related to promoters
went from ``none'' to a vigorous program. As of July 8, 2002,
we had nine promoter injunctions granted, 11 promoter
injunctions pending in District Court and three pending at
the Department of Justice, 150 promoter exams and information
requests underway, and 51 ongoing criminal investigations
(numbers are for FY 01 through 02).
Also, key to successfully executing our compliance program
is better data. As I discussed, the IRS failed to detect new
areas of non-compliance in part because of a reliance on
increasingly obsolete data from the old Taxpayer Compliance
Measurement Program. (TCMP was last conducted in 1988.) In
addition, we designed and are now implementing a National
Research Program that will obtain the essential information
with far less burden on the taxpayer. New scoring models are
being developed using 21st century techniques, with interim
models already deployed.
Obviously, our success in compliance also depends on a
cadre of highly qualified trained individuals to perform
tasks that require a high level of judgment. After a freeze
of nearly six years, recruitment for professional
occupations, such as revenue agent and revenue officer,
restarted; training was completely revamped and improved; and
employee engagement became part of balanced measures and
everyday management.
Internal management
The IRS successfully made the transition to a modern
customer-focused organization in which a management team has
clear responsibility for meeting the needs of a specific set
of taxpayers. The service needs and compliance issues of the
90 million taxpayers with wage and investment income are
vastly different from those of large and mid-sized
businesses, which in turn are different from those of small
businesses and tax-exempt organizations. One team now works
full time to understand and meet the needs of each set of
taxpayers and has nationwide authority to execute its plans,
eliminating the historically deep and counterproductive
organizational separation between the ``field'' and the
``national office.''
Supporting these operating divisions are specialized
functional units and shared services organizations to provide
information technology and common support services throughout
the organization.
As part of the reorganization, the number of management
layers was reduced and the role of executives and senior
managers is being redirected towards substantive engagement
in tax administration, rather than predominantly
administrative duties. A new model of executive recruitment
was successfully established, which includes a recruitment of
a limited number of highly experienced top executives from
private industry and other government agencies to complement
our internally-developed executives.
Many specialized programs, ranging from processing business
returns to handling innocent spouse claims to answering tax
law calls, are being consolidated into fewer locations with
fewer management layers. This enables greater standardization
and faster implementation of improvements.
An entirely new system of balanced measures has been
designed and implemented, aligning goals throughout the
organization down to the territory and site level.
The gains in service and the widespread redirection of
compliance programs over the last two years reflect the
benefits of a more customer-focused and accountable
organization. The major benefits are still to come, in the
form of continuous improvements in productivity and quality
in every major program.
The improvements in customer service and other programs can
also be linked to increased employee engagement in our
mission and goals, increased and improved training and
heightened focus on employee concerns. Among the most
important of these concerns was the fair and careful
administration of Section 1203--the so called ten deadly
sins--so that no employee was wrongly disciplined under this
section. In addition, legislative proposals were formulated
and are under consideration by Congress to alleviate employee
anxiety over Section 1203.
Because of these actions and focus, and according to a
recent Gallup survey of IRS employees, the level of
engagement within the Service increased from 49th to the 56th
percentile of all public sector organizations tracked by the
organization.
The IRS is also the steward of massive taxpayer revenue and
budget and financial resources, and we are expected to
properly account for the government's money and property. To
this end, internal accounting standards were raised to a
higher level. For the past two fiscal years, we received
unqualified GAO opinions on our financial statements for both
the Revenue and Administrative accounts. This year, we have
plans in place to close the books months earlier than in
prior years and to address remaining material weaknesses over
the next two years.
As our FY 2003 and 2004 budget requests demonstrate,
strategic planning, budgeting, resource allocation and
performance goals were aligned. For the first time, we fully
integrated development of our budget with the establishment
of performance measures.
Technology and modernization
Critical to our success was better managing our massive
technology and Business Systems Modernization program. From
15 separate information systems operations, we created one
MITS organization that has the job of serving all of our
operating units and managing our modernization program.
As part of this major transition, standards were
established and largely implemented for hardware and
software. We consolidated mainframes from 12 centers to three
and established one standard for desktop and laptop hardware
and software. We implemented a nationwide e-mail and voice
messaging systems, standard office automation software, and
security certifications and standards. We deployed important
interim applications systems, including Intelligent Call
Routing, Integrated Case Processing and the Integrated
Collection System.
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Business Systems Modernization laid the foundation for
success of this massive program. Both the long-term vision
and enterprise architecture were established and embedded as
a living blueprint for all business and technology
improvement programs.
BSM began delivering projects with tangible and meaningful
benefits to taxpayers, such as moving the first set of
taxpayers to a modern, reliable database early next year.
Over the next five years, all individual taxpayers will be
moved to it, cutting times for refunds on e-filed returns to
less than a week and allowing us to provide taxpayer and
employees with up-to-the-minute accuracy on their accounts.
Of paramount importance, we implemented the first project on
our new security system, which provides one standard for
ensuring the security of all future IRS data and systems.
All major management processes, which are needed to manage
this program on a continuing basis, were improved. Our goal
is to obtain certification in the near future as only the
second agency in the federal government to reach Level Two in
the Software Engineering Institutions Capability Maturity
Model.
Steady Progress Can Continue Year after Year
The aforementioned progress and achievements do not mean
that the IRS solved all of its problems, or that there are no
more opportunities to improve. Rather, it means that the IRS
addressed the major impediments and obstacles that previously
stood in the way of progress and has a clear committed plan
to continually reach even higher levels of performance. There
should be no doubt that the IRS can be raised to a level of
quality and efficiency comparable to the best managed
financial services organizations.
Winning the Battle but Losing the War
Despite significant improvements in the management of the
IRS, the health of the federal tax administration system is
on a serious long-term downtrend. This is systematically
undermining one of the most important foundations of the
American economy.
The source of this problem is 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.
As seen in the next chart, ``Trends in Indicators of IRS
Workload and Resources,'' from 1992 to 2001, weighted average
returns filed, a measure of overall IRS workload, increased
by 16 percent because of the economy's growth. However,
during this same period, FTEs dropped 16 percent from 115,205
in FY 1992 to 95,511 in FY 2001. Since more and more of the
IRS' declining resources are required to perform essential
operational functions--such as processing returns, issuing
refunds and answering taxpayer mail--a disproportionate
reduction occurred in Field Compliance personnel, falling
28 percent from 29,730 in FY 1992 to 21,421 in FY 2002.
In assessing these trends, it is extremely important to
recognize a critical fact: tax administration workload
increases every year because of increased filings by
taxpayers related to the long-term growth of the economy.
These workload increases affect every facet of tax
administration, from processing returns to answering
correspondence to collecting delinquent returns to accounting
for payments and refunds. In addition to this growth related
to the economy, tax legislation often adds additional
workload.
Looking more closely at the most recent five years (see
chart), we see that the number of income tax returns
increased by 12 million, while 19 tax bills were passed that
changed 292 tax code sections and required 515 changes to
forms and instructions. On the average, IRS workload grows at
a compounded rate of 1.8 percent per year. Therefore, just to
handle this increased workload, the IRS would either have to
add staff--which is what occurred fairly consistently for the
45-year period from 1950 through 1995--or would have to
increase productivity by 1.8 percent per year just to stay
even.
Federal Tax System Has Been Growing and Changing Rapidly From 1997
Through 2002
Volume of activity has been growing rapidly
Income Tax Returns: 12 Million Increase--9.4%.
IRS Gross Collections: $527 Billion Increase--32.5%.
IRS Refunds Issued: $121 Billion Increase--61.3%.
Tax Code has been changing rapidly
19 Public Laws passed.
293 Tax Code provisions changed.
171 (58%) of provisions with concurrent or retroactive
effective dates.
515 completed changes to forms and/or instructions.
Restructuring and Reform Act added many taxpayer rights
71 taxpayer rights.
1,900 implementing actions.
Hundreds of thousands of new transactions per year.
Innocent spouse.
Collection due process.
Offers in compromise.
Third party notification.
Section 1203 allegations.
Special events created additional activity and change
Century date change required massive three year project.
Advance rate reduction credit--126 million notices, 91
million taxpayers, $39 billion.
Returns of political organizations (section 527)--new
reporting to IRS.
September 11th terrorist attack--victims relief, IRS
security response, money laundering task forces.
Anthrax threat--rapid response required prior to 2002
Filing Season.
Globalization is increasing international tax activity
U.S. controlled foreign corporations up 25%.
Foreign controlled corporations up 31%.
Resources have been shrinking
IRS full-time equivalent personnel: -2,952.
This is no different from a car company producing 1.8
percent more cars or a hospital servicing 1.8 percent more
patients. But, rather than increasing staff, IRS staff
decreased during this period, creating a major gap in IRS
capacity to administer the tax system.
In addition to growth in raw numbers, the tax revenue
stream is now dominated by sources that provide greater
opportunities for manipulation by those who wish to take
advantage of the decline in IRS compliance resources. For
example, returns for taxpayers with incomes exceeding
$100,000 grew by 342 percent over 1991 levels. The enormous
amounts of money that flow through ``passthrough'' entities--
such as partnerships, trusts and S-corporations--also adds to
the complexity of tax administration and increases the
opportunities for underreporting of income. In Tax Year 2000,
these ``passthrough'' entities filed 4.78 million returns
with gross revenue of $6 trillion and income to partners/
shareholders of more than $660 billion.
The IRS Restructuring and Reform Act of 1998 added major
new or expanded taxpayer rights programs, such as innocent
spouse relief, third party notification and collection due
process. The rights are very important to taxpayers but
created very substantial additional resource demands on the
IRS to process hundreds of thousands of new transactions and
additional steps in existing audits and collection actions.
Business globalization creates another administration
complexity and more opportunities for reducing U.S.-reported
income. From 1997-2002, U.S.-controlled foreign corporations
and foreign-controlled corporations grew respectively by 25
and 31 percent.
Looking at this imbalance, one fact emerges. The IRS is
simply out-numbered when it comes to dealing with the
compliance risks. As noted, IRS employment (FTEs), and in
particular, Field Compliance FTE steadily declined. With the
decline in personnel came a decline in the coverage of all
types of returns (see chart). Even after we refocus on the
most egregious non-compliance cases, we can only handle a
small fraction of them.
COVERAGE OF ALL TYPES PLUMMETED 60-70%
[Number of cases per thousand returns]
------------------------------------------------------------------------
Correspondence In person Exam of
Fiscal year Document exam (non- exam of passthrough
matching EITC) individuals entities*
------------------------------------------------------------------------
1992............. 33.1 4.0 5.8 5.1
1993............. 23.7 2.6 6.3 5.5
1994............. 23.3 2.0 6.8 5.0
1995............. 23.6 3.5 6.0 4.6
1996............. 16.6 2.6 5.6 4.7
1997............. 7.9 3.5 5.8 5.5
1998............. 14.3 2.8 4.7 5.7
1999............. 14.4 1.1 3.1 4.5
2000............. 10.8 0.9 2.0 3.6
2001............. 9.1 1.2 1.5 2.9
------------------------------------------------------------------------
*Primarily Partnerships, S-Corporations and Fiduciaries.
The effect of these trends was to create a gap in what work
the IRS should be doing and what it had the capacity to do.
In the last two years, the IRS made progress in quantifying
this gap, which is summarized below. As noted, the majority
of the workload gap is in compliance.
SELECTED TAX ADMINISTRATION PROGRAMS WORK DONE AND NOT DONE
[Dollars in millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Known workload in contacts or cases/yr Direct cost to fill gap
---------------------------------------------------------------- Direct revenue -------------------------------
Required Done Gap %Gap loss per year FTEs Dollars
--------------------------------------------------------------------------------------------------------------------------------------------------------
Service To Compliant Taxpayers:
Phone Service Level of Service...... 87.5 71.5 16.0 18 NA $2,274 $114.8
In-Person Service................... NA NA NA NA NA 3,084 196.7
---------------------------------------------------------------------------------------------------------------
[[Page S11074]]
Total............................. NA NA NA NA NA 5,358 311.5
===============================================================================================================
Collection of Known Tax Debts:
Field and Phone Accounts Receivable 4,506,060 1,816,713 2,689,347 60 9,470 5,450 296.4
(TDA)..............................
===============================================================================================================
Identification and Collection of Taxes
from Non-Filers:
Non-Filer Cases (TDI)............... 2,490,749 625,025 1,865,724 75 1,693 2,016 101.5
===============================================================================================================
Collection of Underreported Tax:
Document Matching................... 13,300,000 2,926,980 10,373,020 78 6,960 4,740 229.2
===============================================================================================================
Identification and Collection of
Underreported Tax:
Cases of Abusive Devices to Hide 82,100 17,000 65,100 79 447 3,418 272.1
Income.............................
Individuals Over 100,000 Income..... 123,006 54,468 68,538 56 266 2,603 207.2
Individuals Under 100,000 Income.... 843,380 296,986 546,394 65 4,492 7,435 430.1
Small Corporations.................. 39,659 29,721 9,938 25 54 640 50.9
Mid and Large Corporations.......... 24,523 17,684 6,839 28 6,526 1,812 180.0
---------------------------------------------------------------------------------------------------------------
Total............................. 1,112,668 415,859 696,809 63 11,786 15,908 1,140.3
===============================================================================================================
Tax Exempt:
Reporting Compliance................ 20,690 6,780 13,910 67 NA 1,192 101.6
===============================================================================================================
Grand Total....................... NA NA NA NA 29,909 34,664 2,180
--------------------------------------------------------------------------------------------------------------------------------------------------------
For each category of compliance, the IRS computed the
number of known cases of taxpayers who did not file or pay,
or who substantially underreported their taxes. These
numbers, therefore, represent not general estimates or
assumptions, but specific taxpayer cases. Based on the
information available to the IRS, they should and could be
treated as cases of non-compliance through collection, audit
or other actions.
However, as can be seen from the chart, only a fraction of
each category of case, even the most serious, can be worked
with available resources. The ``gap'' represents the number
of cases that should be, but cannot be worked because of
resource limitations. These cases represent tens of billions
of dollars per year that could be, but are not collected.
More importantly, they represent a failure of fairness to the
millions of honest taxpayers whose commitment to paying their
taxes is based on the assumption that the IRS will act if
they or their neighbors do not pay their fair share.
Tax professionals, promoters, sophisticated taxpayers and
even some ordinary taxpayers are becoming more aware of our
deteriorating ability to deal with compliance. Increasingly,
this issue is being reported by publications ranging from The
Wall Street Journal, the New York Times, Fortune and Forbes,
and even on national television.
Recognizing the IRS' diminished capacity, promoters and
some tax professionals are selling a wide range of schemes
and devices to taxpayers based on the simple premise they can
probably get away with it. When this perception becomes
increasingly widespread, the essential pillar of the fairness
of our tax system is lost.
Our John Doe summonses of records for credit cards issued
by offshore banks in tax haven countries revealed one facet
of the problem. Just one of these summons, issued in 2000 to
MasterCard, yielded a large database of transactions by those
using cards issued by banks in Antigua, Barbuda, the Bahamas
and the Cayman Islands. Many of these taxpayers were
solicited through various channels by a variety of promoters.
Indeed, some sophisticated tax professionals, including
those in accounting and law firms and investment banks, are
aggressively marketing tax shelters to their clients. Some of
these turn out to be abusive tax avoidance transactions
prohibited by the Treasury Department.
Demand is also driving up supply. There is widespread
anecdotal evidence from honest practitioners about clients
demanding that their return preparer find a way to reduce
reported income, to the point of refusing advice from honest
professionals to comply with required reporting and
disclosure. In effect, they are saying, ``Get me one of these
deals or I will take my business elsewhere.'' This has
reached the point where recently a former IRS Commissioner
was faxed a solicitation from a ``Senior Investment Manager''
that began, ``As we approach December 31st, you may have a
large income tax liability for the year 2002. The amount you
pay could be up to you.''
Although it is impossible to prove conclusively that
attitudes towards tax compliance shifted, we must make
informed judgments about behavior and trends. The only
responsible conclusion I can draw is that the trend in
attitudes of taxpayers and tax professionals poses a real
threat to the health of the tax system and ultimately to the
American economy.
If these problems and conditions are left unaddressed, we
could face an enormous crisis in confidence in the tax
administration system. It would not be surprising if this
problem emerged into the forefront of public concern, causing
an eruption about the IRS similar to those that occurred
periodically over the last 50 years. The long-term impact on
the economy and our nation of not reversing this trend will
be extremely high.
What Is Needed
What is the answer? Fortunately, the problem is not open-
ended and can be solved with a reasonable amount of
resources. We need what the National Commission on
Restructuring the IRS argued for five years ago: a steady and
consistent budget. It must consist of two items over the next
five years. The first is a steady growth in staff in the
range of 2 percent per year. The second is steadily increased
funding for modernization until this program levels off
several years from now.
Together with aggressive increases in productivity, as
called for by the IRS Strategic Plan, this combination can
solve the problem by the end of this decade. In fact, as
shown in the ``Closing the Gap'' chart below, a combination
of 2 percent per year staff growth with 3 percent per year
productivity growth will keep up with increasing demand and
close the gap by 2010. But without both elements--modest but
steady staff growth and aggressive productivity increases--
the trend will not be reversed.
Computer systems alone, even with the most aggressive
reasonable assumptions about the productivity gains from
modernization, cannot solve the problem. Trained and
effective staff is also required. However, modernization will
allow the IRS to perform the tax administration function with
proportionately fewer staff than in the past. If the IRS
staff grew by 2 percent per year through 2010, the total
staff would still be smaller than it was 20 years earlier
(1990), while the economy is projected to be 86 percent
larger in real GDP and the tax system far more complex.
There is another critical point. Sufficient funding must be
provided to fund the actual projected staffing. There is no
``extra'' funding lying around to ``absorb'' items that are
mandated, but not paid for. As shown below, the IRS dollar
budget consistently under-funded advertised staffing levels.
The actual number of FTEs is lower every year than proposed
in the budget. This is the effect of making unrealistically
optimistic assumptions about such items as pay raises,
inflation and other mandates, including specific mailing and
notification requirements.
IRS DOLLAR BUDGET HAS CONSISTENTLY UNDER-FUNDED ADVERTISED STAFFING LEVEL
[Full Time Equivalent [FTE] Personnel without EITC]
----------------------------------------------------------------------------------------------------------------
FY 2000 FY 2001 FY 2002 FY 2003 FY 2004
----------------------------------------------------------------------------------------------------------------
FY 2000 President's Budget.................................... 96,767 ........ ........ ........ ........
FY 2001 President's Budget.................................... 95,523 98,051 *99,873 ........ ........
FY 2002 President's Budget.................................... 95,155 97,273 99,116 ........ ........
FY 2003 President's Budget.................................... ........ 95,511 97,548 98,727 ........
FY 2004 Treasury Submission................................... ........ ........ 97,423 96,182 98,182
----------------------------------------------------------------------------------------------------------------
* Includes 1,822 FTE for STABLE Annualization.
[[Page S11075]]
Our plan already requires very rapid and sustained
productivity growth of over 3 percent per year--in excess of
the 2 to 2.4 percent achieved in the private sector. It
supposes complete success of BSM, aggressive reallocation of
internal resources, such as eliminating some submissions
processing centers, rapid growth of e-filing, and use of
productivity enhancing techniques, such as competitive
sourcing for some activities. These items make it possible to
cope with growth in filings and filling the gap in required
workload with very limited staff growth, but do not make it
possible in addition to ``absorb'' unfunded but required line
items.
Simplifying the Tax Code
Most informed observers are justifiably horrified at the
complexity of the Tax Code. The cost of taxpayer compliance
with this code is over $80 billion per year, more than eight
times the cost of the IRS budget. The sheer size and
complexity in itself can be a source of disrespect for the
law. Therefore, it is a worthy, though difficult and
uncertain, challenge to pursue simplification to the maximum
extent possible.
However, there is no proposal that has been seriously
advanced for simplification that would have any significant
effect in the foreseeable future on the problem of IRS
resources.
Apart from the fact that even simplifying changes take time
and effort to develop, pass in Congress and to implement, the
reality is that the gap in IRS resources is so large that
nearly all of our resources are required to perform the basic
operations of the tax system and to pursue the clearest and
most important cases of non-compliance.
With the exception of some resources in the large corporate
sector, the IRS redirected nearly all compliance resources
away from less significant technical tax issues to cope with
current operational requirements and the most serious cases
of non-filing, non-payment or underreporting of income. Even
then, resources are far below what is required.
The only reasonable course is to pursue parallel paths: to
address the practical problem the tax administration system
faces by gradually closing the gap in the capacity of the IRS
to perform its essential tasks, while pursuing a parallel
path attempting tax simplification.
Conclusion
Five years ago, the IRS embarked on a new direction.
Following it, we achieved much progress for America's
taxpayers, although we have much more left to do to improve
the entire way the IRS works. Today, we are faced with a
growing crisis--in our ability to do our job and the fairness
of our tax system. We cannot turn our back on this crisis or
believe that it will go away, because it will not. But like
five years ago, I believe the problem is solvable. We know
the right course of action and we should have the courage and
resolve to take it.
____________________