[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.

[[Page S11070]]

  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

[[Page S11071]]

     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

[[Page S11072]]

     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.

[[Page S11073]]

       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.

                          ____________________