Tax Administration: Continued Progress Modernizing IRS Depends on
Managing Risks (14-MAY-02, GAO-02-715T).			 
                                                                 
In light of the fourth anniversary of the Internal Revenue	 
Service (IRS) Restructuring and Reform Act of 1998, which	 
established Congress' expectation that IRS modernize to better	 
meet taxpayer needs, GAO gave an overview of IRS's current	 
performance and resources and then assessed the progress that IRS
has made modernizing and the risks to continued progress.	 
Overall, IRS has seen increased workload, decreased staffing, and
significant changes in the allocation of resources between	 
taxpayer assistance programs and its compliance and collection	 
programs. Between 1995 and 2001, IRS's workload, measured by	 
returns filed, increased by 10 percent while aggregate staffing  
declined by 14 percent. Over the same time, there was a 	 
significant internal reallocation of resources with a		 
disproportionate decline in compliance and collection program	 
staffing to accommodate more emphasis on taxpayer service, such  
as telephone assistance, and to information systems operation and
investment. Electronic filing of returns increased but not enough
to reduce paper returns sufficiently to free significant	 
processing resources for use elsewhere. The reallocation of	 
resources shows signs of beginning to produce more accurate	 
service for taxpayers, but the compliance and collection programs
have seen large and pervasive declines in performance indicators 
such as audit rates, collection cases closed, enforcement actions
such as liens and levies, and raw productivity. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-715T					        
    ACCNO:   A03337						        
  TITLE:     Tax Administration: Continued Progress Modernizing IRS   
Depends on Managing Risks					 
     DATE:   05/14/2002 
  SUBJECT:   Income taxes					 
	     Taxpayers						 
	     Electronic forms					 
	     Tax returns					 
	     Customer service					 
	     Performance measures				 
	     Information resources management			 
	     Strategic planning 				 
	     Best practices					 
	     IRS Customer Account Data Engine Program		 
	     IRS Offer in Compromise Program			 

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GAO-02-715T
     
Testimony Before Congressional Committees

United States General Accounting Office

GAO For Release on Delivery Expected at 10: 00 a. m., Tuesday, May 14, 2002
TAX ADMINISTRATION

Continued Progress Modernizing IRS Depends on Managing Risks

Statement of James R. White, Director, Tax Issues Randolph C. Hite,
Director, Information Technology

Architecture and Systems Issues Steven J. Sebastian Acting Director,
Financial Management

Issues

GAO- 02- 715T

Page 1 GAO- 02- 715T

Mr. Chairman and Members of the Committees: We are pleased to be here today
as we approach the fourth anniversary of the Internal Revenue Service (IRS)
Restructuring and Reform Act of 1998, which established Congress?
expectation that IRS modernize to better meet taxpayer needs. As you
requested, our statement gives an overview of IRS?s current performance and
resources and then assesses the progress that IRS has made modernizing and
the risks to continued progress. Our overview and the rest of our statement
are based primarily on issued reports or ongoing work for the committees
holding this hearing.

Overall, since the mid- 1990s IRS has seen increased workload, decreased
staffing, and significant changes in the allocation of resources between
taxpayer assistance programs and its compliance and collection programs. Any
overview of a large agency must condense and summarize a great deal of
information. We selected data, presented in seven figures in the appendix to
this statement, to illustrate some of the key trends at IRS since the mid-
1990s. As our figures show

 Between 1995 and the end of 2001 IRS?s workload, measured by returns
filed, increased by about 10 percent while aggregate staffing declined by
about 14 percent. (See figure 1.)

 Over the same time, there was a significant internal reallocation of
resources with a disproportionate decline in compliance and collection
program staffing to accommodate more emphasis on taxpayer service, such as
telephone assistance, and to information systems operation and investment.
(See figure 2 in comparison with figure 1.)

 Electronic filing of returns increased but not enough to reduce paper
returns sufficiently to free significant processing resources for use
elsewhere. (See figure 3.)

 The reallocation of resources shows signs of beginning to produce more
accurate service for taxpayers, but the compliance and collection programs
have seen large and pervasive declines in performance indicators such as
audit rates, collection cases closed, enforcement actions such as liens and
levies, and raw productivity (measured by cases closed per unit of staff
time without adjusting for possible quality changes). (See figures 4, 5, 6
and 7.)

Page 2 GAO- 02- 715T

Mr. Chairman, IRS is at a critical juncture. Commissioner Rossotti, who has
led IRS?s modernization efforts for the past 4- 1/ 2 years, has said that he
will be stepping down in November. That will be about half way through the
10 years that he estimated would be needed to modernize IRS. During his
tenure, IRS has made important progress at laying the management foundation
for a more modern agency able to respond to taxpayer needs faster, more
accurately, and at lower cost. However, at this time, the foundation is not
complete and neither is the structure to be built on the foundation - the
reengineered processes that would deliver better service to taxpayers. To
continue modernizing, IRS must successfully manage some significant risks
that threaten progress. Areas of risk include IRS?s compliance and
collection programs that have seen large declines, systems modernization
where several large systems are moving into deployment and performance
management where new measures and systems are being implemented.

The following summarizes our main points regarding the progress IRS has made
and the risks that need to be managed.

 Some of the most important steps that IRS has taken to lay the foundation
for ultimately providing better service to taxpayers and ensuring compliance
with the tax laws are in the areas of organization and management of
performance, systems acquisition and development, and financial management.

 After much planning, in October 2000, IRS transitioned to a new
organizational structure with four operating divisions focused on different
types of taxpayers.

 About the same time, IRS implemented a new strategic planning, budgeting,
and performance management process, designed to reconcile competing
priorities with the realities of available resources. Using that process,
IRS has determined that almost 2,300 staff positions could be redirected
toward higher- priority needs. In addition, IRS now has an evaluation system
for front line employees that is aligned with the mission and goals of the
agency and is developing a sorely needed measure of voluntary compliance.

 With respect to systems modernization, IRS has made important progress in
establishing the systems infrastructure, delivering two systems
applications, and establishing the controls and capabilities needed to
effectively acquire and deploy modernized systems.

 Finally, with respect to financial management, IRS has for 2 consecutive
years prepared financial statements that received unqualified opinions.

Page 3 GAO- 02- 715T

Many of these steps increase IRS?s management capacity. Some are beginning
to deliver better service to taxpayers or more efficient use of resources.

 To realize the promise of modernization to deliver better service to
taxpayers while ensuring compliance with the tax laws, IRS must finish
building a strong management foundation and must use this foundation to make
the substantive business practice changes that could improve its efficiency
and service to taxpayers. There are risks in several areas that threaten
continued progress.

 One area of risk is IRS?s compliance and collection programs that have
declined, sometimes dramatically, since 1996. Many view these programs, such
as audits to determine whether taxpayers have accurately reported the amount
of taxes they owe and collection followup with taxpayers who have not paid
what is owed, as critical for maintaining the public?s confidence in our tax
system. The commissioner has emphasized the need to reverse the trends in
these programs.

 Another area of risk is systems acquisition and deployment. Since 1999,
Congress has provided almost $1 billion for investment in IRS?s business
systems. Despite the important progress in building management capacity, IRS
is not where it committed to be in acquiring infrastructure and business
application systems and is not where it needs to be in implementing
management controls and capabilities. This increases the risk of not
delivering promised systems capabilities on time and within budget. As IRS
moves forward, this risk is amplified because system interdependencies and
complexity increase dramatically during the later phases of system projects.

 Certain aspects of performance management are another risk area. IRS needs
to ensure that it has comparable performance measures over time and
sufficient data to assess performance. IRS needs to routinely do better
evaluations of its programs to determine the factors that affect performance
and identify ways to improve.

 A final risk area is financial management. Although it received an
unqualified audit opinion, IRS has had to assign staff to manually analyze
and correct the data generated by its financial systems. This approach,
which takes months to complete, does not produces timely information for
managing the agency.

Page 4 GAO- 02- 715T

The following highlights some of the most important steps that IRS has taken
to lay the foundation for ultimately providing better service to taxpayers
and ensuring compliance with the tax laws.

First, during fiscal year 2001, IRS transitioned to a new organizational
structure with four divisions having responsibility for administering tax
law for a set of taxpayers with similar needs. By reorganizing in this
manner, IRS sought to establish clearer lines of responsibility and
accountability for improving service to taxpayers and resolving their
problems. Through such improvements, IRS expected to better enable taxpayers
to comply with the tax laws.

Because many major reengineering efforts were to be led by the new
divisions, it is too early to judge the impact that the reorganization has
had in improving service. The widescale reorganization was accomplished with
no serious disruption of recent filing seasons. The filing season for most
individual taxpayers extends from January 1st to April 15th. It is during
that time when most taxpayers file their returns, call IRS with questions,
and make other contacts with IRS related to filing. To its credit, IRS was
able to reorganize while managing the challenges associated with the sheer
scope of filing season activities, including the year 2000 transition.

To make decisions for fiscal year 2002 and subsequent year operations, IRS
implemented a new strategic planning, budgeting, and performance management
process during fiscal year 2000. The process begins, as outlined in figure
1, with the operating divisions preparing strategic assessments that
describe significant trends, issues, and problems and identifies proposals
for dealing with them. After receipt and review of the strategic
assessments, the commissioner provides detailed guidance (step 2) to the
operating divisions for developing their strategy and program plans (step
3). These plans are then incorporated (step 4) into an IRS- wide performance
plan (which sets out measurable objectives such as the number of audits to
be done). These plans are, in turn, incorporated into IRS?s budget
justification (which sets out its resource requests to Congress). The
remaining steps (5 and 6) involve allocating resources across IRS divisions
and programs and monitoring division adherence to the planning and budgeting
decisions. Improved Foundation

for Tax Administration

New Organizational Structure

New Budgeting and Planning System

Page 5 GAO- 02- 715T

Figure 1: IRS?s Strategic Planning Process

Source: GAO?s review of IRS?s planning documentation

This process provides IRS senior management with a means to reconcile
competing priorities with the realities of available resources. Through the
use of this process in developing its budget request for fiscal year 2003,
IRS identified a myriad of expected efficiency improvements, technological
enhancements, labor- saving initiatives, and workload decreases that it
projects will enable it to redirect about $158 million (about 2,300 staff
positions) to higher- priority areas. This accounted for two out of every
three additional staff that IRS believed was needed.

In February 2000, IRS implemented a new evaluation system for its managers
and in October 2001 implemented a new evaluation system for front- line
employees. These systems were developed to structurally align performance
expectations for managers and employees with IRS?s strategic goals. An
employee evaluation system can be a powerful tool in New Employee Evaluation

System

Page 6 GAO- 02- 715T

helping an agency achieve its mission and ensuring employees at every level
of the organization are working toward common ends. Evaluation systems
should help employees understand their responsibilities and how their day-
to- day work contributes toward meeting their agency?s strategic goals as
well as providing a mechanism for giving employees candid, specific feedback
on how well they are meeting their rater?s expectations. For agencies like
the IRS that are undergoing a cultural change, the employee evaluation
system helps reinforce behaviors and actions that support the agency?s
mission. IRS recognizes that it may take a while before the new evaluation
systems achieves the intended results of balancing taxpayer needs while at
the same time enforcing the tax laws. These expectations may appear to
conflict so managers and employees may need time to better understand what
the new performance expectations mean in terms of their daily work and which
behaviors they should change in order to put IRS?s new operational
environment into practice.

IRS has made progress in developing a way to measure the voluntary
compliance of individual taxpayers without placing an undue burden on them.
Each year billions of dollars in taxes are not voluntarily reported and
paid. To understand the overall extent of noncompliance, IRS plans to
implement its study of tax reporting compliance later this fall. The study
should provide IRS with data to update the criteria it uses to select tax
returns for audit and thereby reduce the number of compliant taxpayers
selected. Also, the study is intended to provide detailed information about
compliance, such as why taxpayers fail to comply with a specific tax law
provision. Having such information should enable IRS to make operational
changes such as modifying tax forms and instructions or to recommend tax law
changes that could improve compliance.

Over the past 3- plus years, IRS has made important progress in establishing
the infrastructure systems that are to provide the platforms upon which
future business applications will run. Establishing this infrastructure is a
necessary prerequisite to introducing the business applications that are in
turn intended to provide benefits to taxpayers and IRS. During this time,
IRS has also made important progress in delivering two system applications-
Customer Communications 2001 and Customer Relationship Management Exam- that
are producing benefits as of today. For example, Customer Communications
2001, which is software improvements to IRS?s customer service telephone
system, was implemented last summer and is now routing taxpayer calls with
common Progress in Measuring

Voluntary Compliance Business Systems Modernization

Page 7 GAO- 02- 715T

questions to automated menu driven information services, thereby freeing IRS
customer service representatives to answer complex or less common inquiries.

IRS has also made progress in building and readying for deployment, business
applications to, among other things, replace existing antiquated information
technology systems that have hampered IRS?s ability to improve customer
service to taxpayers. In particular, IRS has been building and is planning
to pilot in July 2002, the first release of its Customer Account Data Engine
(CADE)- a modern relational database designed to replace IRS?s tape- based
data management system- for taxpayers with simple tax returns. IRS plans to
implement this release in January 2003 in time for the 2003 filing season
and plans to implement four additional CADE releases, each for progressively
more complex tax returns, over the next 4 years with the goal of having CADE
fully implemented by 2006.

In addition, IRS has made progress in addressing our recommendations to
establish the modernization management controls needed to effectively
acquire and implement major systems. For example, we have consistently
recommended since 1995 that IRS develop and implement an enterprise
architecture (modernization blueprint) to guide and constrain the
acquisition of business systems modernization (BSM) systems; IRS recently
issued an updated a version of its Enterprise Architecture for how it wants
to transition its business systems environment, thus giving a highlevel
roadmap to manage and control business and technological change.

The nature of IRS?s progress thus far should not be viewed solely in the
context of what taxpayer service and IRS efficiency benefits are being
realized today. Rather, this progress should also be viewed in terms of
laying the necessary foundation from which the benefits of future
applications can be realized. As a matter of fact, at this point in time,
the level of tangible mission- related benefits that have been realized from
modernization investments are not yet commensurate with costs incurred. In
our view, this is not unreasonable because as depicted in figure 2, the
expected return on these and future investments are to materialize later
when new business applications are brought on line.

Page 8 GAO- 02- 715T

Figure 2: Notional BSM Benefits Versus Costs

Source: GAO

For 2 consecutive years, IRS has produced financial statements that present
fairly, in all material respects, in conformity with U. S. generally
accepted accounting principles, IRS?s assets, liabilities, net position,
changes in net position, budgetary resources, reconciliation of net costs to
budgetary obligations, and custodial account activity. This unqualified
opinion was achieved through the extraordinary efforts of IRS?s senior
management and staff to compensate for serious internal control and system
deficiencies discussed in the risk section of this statement. Additionally,
IRS continues to make progress on several significant internal control and
compliance issues that contribute to its difficulties in producing reliable
and timely information. Financial Reporting

cost benefits

Time Cost and Benefit Amounts

IRS is here cost

benefits Time Cost and Benefit Amounts

IRS is here

Page 9 GAO- 02- 715T

IRS faces risks in several areas that if not successfully managed could
threaten the agency?s ability to continue making progress modernizing.

The first area of risk involves the declines in compliance and collection
programs. Taxpayers? willingness to voluntarily comply with the tax laws
depends in part on their confidence that their friends, neighbors, and
business competitors are paying their share of taxes.

To help provide that assurance, IRS operates six major compliance programs.
These programs (1) check for math errors and unpaid balances during returns
processing, (2) determine taxes due from apparent nonfilers detected through
computer matching, (3) determine taxes due from apparent underreporters
detected through computer matching, (4) audit tax returns filed by
individuals, (5) audit tax returns filed by corporations, and (6) audit
other tax returns such as estate and gift returns.

IRS also operates two separate collection programs for dealing with
taxpayers who are delinquent in paying the taxes they owe. These programs
pursue collection through (1) telephone contacts with the taxpayers and (2)
personal visits with the taxpayers by IRS field staff.

As part of our ongoing work for the House Ways and Means Subcommittee on
Oversight, we identified large and pervasive declines across the compliance
and collection programs, except for returns processing, between fiscal years
1996 and 2001. For example, individual and corporate audit productivity as
measured by cases closed per unit of staff time declined 31 and 47 percent,
respectively, while field and telephone collection productivity declined
over 20 percent. These productivity declines coupled with reduced staffing
has translated to declines in coverage. That is, the proportion of
individual and corporate tax returns that were audited declined 63 and 60
percent, respectively, and the percentage of delinquencies closed by
telephone and field collection declined by 15 and 45 percent, respectively.
Figures 2, 5 and 6 in the appendix provide additional data.

The decline in collection coverage reflected the collection programs?
inability to work a growing proportion of the delinquent cases referred from
the compliance programs. In response, by fiscal year 2001, IRS was deferring
collection action on about one out of three assigned Risks to Continued

Modernization Progress

Compliance and Collection Declines

Page 10 GAO- 02- 715T

delinquencies. By the end of fiscal year 2001, we estimate that IRS had
deferred collecting taxes from about 1.3 million taxpayers 1 who owed about
$16.1 billion. 2 Absent significant operational change, IRS officials said
that they had little expectation of reopening many deferred collection
cases.

The declines in IRS?s compliance and collection programs affected taxpayers
in several ways.

 The likelihood that taxpayer noncompliance would be detected and pursued
by IRS declined. For example, coverage in the nonfiler program declined by
69 percent by the end of fiscal year 2001.

 The length of time that taxpayers owed back taxes at the time they were
assigned to collection increased between 1996 and 2001 although IRS intended
that by deferring collection action on some older collection cases it could
get to newly assigned cases quicker.

 The amount of penalties and interest continued to accumulate on deferred
collection cases, making future payment increasingly demanding if
subsequently pursued by IRS.

 The likelihood that delinquent taxpayers would experience enforced
collection such as through levies placed on their wages or bank accounts
declined about 64 percent from 1996 to 2001, although there has been some
upturn from 2000 to 2001 (see figure 6 in the appendix).

Taken together, changes such as these have reduced the incentives for
voluntary compliance. Also, some available, but very limited, data suggest
that voluntary compliance may have begun to deteriorate. For example, the
number of apparent individual nonfilers increased about three and one- half
times faster than the individual tax filing population.

IRS managers are concerned about the decline in compliance and collection
programs and the extent that this threatens voluntary compliance. A
significant decline in voluntary compliance would undermine IRS?s
modernization effort.

1 Estimate is from a random sample. The 95- percent confidence interval is
1.25 million to 1.35 million taxpayers. 2 Estimate is from a random sample.
The 95- percent confidence interval is $14.8 billion to $17. 4 billion.

Page 11 GAO- 02- 715T

Since the start of IRS? modernization program in late 1999, the program has
received almost $1 billion and expects to need about another $2.5 billion
over the next 5 years. In fiscal year 2002, this funding supports 20 ongoing
system acquisition projects, currently at different life- cycle stages along
with initiatives to develop the capabilities for managing the acquisition
projects.

Despite the important progress discussed above, IRS is not where it
committed to be in acquiring both infrastructure and application systems and
not where it needs to be in implementing modernization management controls.
This is because IRS?s first priority and emphasis has been to get the newer,
more modern systems- with their anticipated benefits to taxpayers- up and
running. In so doing, however, the establishment of management capacity to
ensure that these systems are introduced successfully has not been given
equal attention and thus has not kept up. Simply stated, proceeding without
these controls increases the risk of not delivering promised system
capabilities on time and within budget. Moreover, these risks are amplified
as IRS moves forward because interdependencies among current ongoing
projects and the complexity of associated work activities to be performed,
have and will continue to increase dramatically as more system projects move
into the latter stages of their life cycles and are deployed. More recently,
IRS has acknowledged this risk and initiated efforts to better balance
controls with project pace and workload.

Testimony before you last spring outlined the same general concern that we
are stating today. 3 At that time, we feared that systems workload and pace
were getting too far ahead of the agency?s ability to deal with them
effectively, i. e., having proper management controls and capacity in place.
Since then, IRS has continued to move forward with its ongoing
infrastructure and business application projects while simultaneously taking
steps to implement missing management controls and capabilities. During this
time, however, the imbalance in project workload and needed management
capacity has remained a concern. More recently, our report of this past
February 4 recommended that the commissioner of internal

3 U. S. General Accounting Office, IRS Modernization: Continued Improvement
in Management Capability Needed to Support Long- Term Transformation, GAO-
01- 700T (Washington, D. C.: May 8, 2001).

4 U. S. General Accounting Office, Business Systems Modernization: IRS Needs
to Better Balance Management Capacity with Systems Acquisition Workload,
GAO- 02- 356 (Washington, D. C.: February 28, 2002). Business Systems

Modernization Risk

Page 12 GAO- 02- 715T

revenue reconsider the scope and pace of the program to better strike a
balance with the agency?s capacity to handle the workload. The commissioner
agreed, promising action in these areas. In particular, the commissioner
agreed to align the pace of the program with the maturity of IRS? controls
and management capacity. The commissioner also made correcting remaining
management controls weaknesses a priority. Figure 3 illustrates IRS?s
approach to developing projects and controls and the degree to which
projects have gotten ahead of controls.

Figure 3: Concurrent Development of Program- Level Controls and Projects

Source: GAO.

We nevertheless remain concerned because projects are entering critical
stages and not all essential management controls are in place and
functioning. In particular, in our ongoing work for the appropriations

IRS is here IRS is here

Selected Ke y Projects

STIR IRFoF (Release 1)

e-Services CADE (Releases 1,2) Enterprise Architecture

Selected Management Capabilities (e.g. Configuration Mgmt, Quality
Assurance, Risk Mgmt) ProgramManagement Office

Prog ra

m Manage ment Capability

Denotes management capability fully established Denotes management
capability fully established 1/01 7/02 1/03 7/01 Other projects (15)

1.0 1. 1 2.0

Denotes Milestone 4 - completion of detailed design and development /
beginning of deployment Denotes Milestone 4 - completion of detailed design
and development / beginning of deployment Denotes Milestone 3 - beginning of
detailed design and development 1/02

Page 13 GAO- 02- 715T

subcommittees, we found that IRS is proceeding with building and deploying
systems before it has (1) fully implemented mature software acquisition
management processes, (2) developed and deployed a human capital management
strategy, and (3) established effective cost and schedule estimating
practices.

Weaknesses in any one of these modernization management controls introduces
an unnecessary element of risk to the BSM program, but the combination of
these weaknesses introduces a level of risk that increases exponentially
over time. IRS has reported that BSM projects have already encountered cost,
schedule, and/ or performance shortfalls. Our analysis has showed that weak
management controls contributed directly to these problems, or were the
basis for prudent, proactive IRS decisionmaking not to start or continue
projects.

Given that IRS? fiscal year 2002 BSM spending plan supports progress towards
the later phases of key projects and continued development of other
projects, it is likely that BSM projects will encounter additional cost,
schedule, and performance shortfalls. Figure 4 depicts this combination of
circumstances.

Page 14 GAO- 02- 715T

Figure 4: Current Time Line Depicting Escalating Program Execution Risk

Source: GAO.

IRS acknowledges these risks and is committed to addressing them. For
example, we recommended to IRS that it make implementing missing controls a
management priority 5 and as we recently reported, 6 the commissioner in
2001 hired an executive- with extensive private- sector experience- to lead
the BSM program office and this official has developed plans to address each
missing control, assigned responsibilities and milestones for their
completion, and is managing IRS?s progress in executing the plans. These
plans address all of our outstanding major

5 See, for example, U. S. General Accounting Office, Tax Systems
Modernization: Results of Review of IRS? Third Expenditure Plan, GAO- 01-
227 (Washington D. C.: January 22, 2001).

6 U. S. General Accounting Office: Business Systems Modernization: Results
of Review of IRS?s March 2001 Expenditure Plan, GAO- 01- 716 (Washington D.
C.: June 29, 2001), and GAO- 02- 356.

IRS is here IRS is here

Selected Key Projects

STIR IRFoF (Release 1)

e-Services CADE (Releases 1,2) Enterprise Architecture

Selected Management Capabilities (e.g. Configuration Mgmt, Quality
Assurance, Risk Mgmt) ProgramManagement Office

Prog ram Manage

me nt Capa

bility

Denotes management capability fully established 1/01 7/02 1/03 7/01 Other
projects (15)

1.0 1. 1 2.0

Denotes Milestone 4 - completion of detailed design and development /
beginning of deployment Denotes Milestone 4 - completion of detailed design
and development / beginning of deployment Denotes Milestone 3 - beginning of
detailed design and development

Execution Risk 1/02

Page 15 GAO- 02- 715T

recommendations on human capital management, software acquisition,
information technology risk management, and enterprise architecture
compliance.

Timing is critical. While the lack of controls can be risky in projects?
early stages, it is essential that such controls be in place when projects
enter detailed system design, development, and implementation. To mitigate
this added risk, IRS needs to fully implement the remaining management
controls that we have recommended.

As noted, IRS has made progress in revamping its performance management
system. However, several aspects of the system put IRS?s ability to
effectively measure, assess, and improve organizational and employee
performance at risk.

First, IRS needs to ensure that it has comparable performance measures and
sufficient data to assess performance. As part of its agencywide efforts to
develop balanced performance measures, IRS continues to revise some measures
and develop new ones to judge its performance. Although we recognize the
need to improve measures, changes interrupt the possibility to establish
trends and compare performance between periods. In past years, 7 our
assessment of IRS?s filing season performance included comparisons of
various performance measures against IRS?s goals and prior years?
performance. We have been unable to make such a comparison for some measures
8 because IRS (1) revised some measures that it had been using to assess
performance and established some new measures and (2) had not established
targets for new or revised measures. For example, during the 2001 filing
season, IRS made numerous changes, such as renaming measures and revising
formulas, to its measures for processing paper returns, refunds, and
remittances. Specifically, of 12 measures, 9 5 were new, 3 were revised, and
1 did not have a set target.

7 U. S. General Accounting Office, Tax Administration: Assessment of IRS?
2000 Filing Season, GAO- 01- 158, (Washington, D. C.: Dec. 22, 2000). 8 U.
S. General Accounting Office, Tax Administration: Assessment of IRS? 2001
Filing Season, GAO- 02- 144, (Washington, D. C.: Dec. 21, 2001). 9 There
were 12 measures listed in IRS?s Strategy and Program Plan, dated July 25,
2001 and October 29, 2001. Performance Management

Risks

Page 16 GAO- 02- 715T

Similarly, of the 15 telephone measures in place, 10 7 were either new or
revised and 4 did not have targets set. Measures of telephone accuracy are
examples of how new and revised measures make it difficult to assess IRS?s
performance in providing quality telephone assistance over time. Also,
figure 4 of the appendix shows that because of changes made to its telephone
measures, IRS does not have sufficient time- series data for each of its
four measures of telephone accuracy to make a thorough assessment of how
well IRS is meeting its goal of providing ?world class? telephone service.

As a result, managers, Congress and other stakeholders may have difficulty
using information from new or revised measures. Although some IRS managers
may be aware of these changes to measures, we found little or no
documentation that disclosed the changes for outside stakeholders. All in
all, IRS officials agreed with our assessment that it is difficult to put
the reported results into context because of the absence of performance
goals and trend data. However, while the officials understood the importance
of such information, they also said they rely heavily on other information,
such as workload indicators and other management information, that they have
used for years to identify and correct problems that could affect activities
and help judge IRS?s overall success.

In addition to having comparable measures to gauge performance, IRS needs to
do more and better evaluations of its business practices so that it can
determine the factors that affect program performance and identify ways to
more effectively use resources and improve service. Over the past year, we
have reported on several of IRS?s efforts to improve the efficiency of its
programs that were hindered by insufficient program evaluation efforts.
These programs dealt with the Offer in Compromise Program, telephone
assistance accessibility and accuracy, and employment tax compliance

 In our report on IRS?s Offer in Compromise Program, which allows taxpayers
to settle their tax liability for less than the full amount, 11 we pointed
out that IRS lacked program evaluation plans for various initiatives it
undertook to try to reduce the offer inventory and

10 There were 15 measures listed in the Strategy and Program Plan as of July
25, 2001. As of October 29, 2001, one measure, ?Toll- Free Automated
Completion Rate,? was deleted. 11 U. S. General Accounting Office, Tax
Administration: IRS Should Evaluate the Changes to its Offer in Compromise
Program, GAO- 02- 311 (Washington, D. C.: Mar. 15, 2002).

Page 17 GAO- 02- 715T

processing time. In addition, IRS lacked performance and cost data needed to
monitor program performance and had not set goals for offer processing time
that were based on taxpayer needs, other benefits, and costs.

 Our report on IRS?s telephone assistance 12 showed that IRS missed some
opportunities to analyze data to better understand the factors affecting
telephone performance, including the actions it took to improve performance.
IRS collected and analyzed a variety of data about the key factors affecting
telephone access and accuracy. However, IRS officials sometimes reached
conclusions about these key factors without conducting analyses to test
their conclusions.

 In our report on IRS?s efforts to improve the compliance of small
businesses with requirements that they report and pay employment taxes, 13
we noted that IRS had developed several new programs designed to prevent or
reduce employment tax delinquencies by speeding up or enhancing the
notification to certain groups of businesses. However, IRS had not
successfully followed through on its plans to evaluate new early
intervention programs.

In responding to our recommendations on these programs, IRS recognized the
necessity and importance of evaluating program performance and agreed with
our recommendations on ways to better assess and measure program results.

As IRS moves forward with modernization, the capacity to conduct sound
performance evaluations on its current and planned operations will be one
building block for success. The Government Performance and Results Act
(GPRA) of 1993, IRS?s guidance, and our prior work all stress the need for
analyses of program performance to determine the factors affecting
performance and to identify opportunities for improvement. 14 We recognize
that some analysis can be costly, and thus, the costs need to be balanced
against the benefits. Considering that IRS devotes considerable

12 U. S General Accounting Office, IRS Telephone Assistance: Limited
Progress and Missed Opportunities to Analyze Performance in the 2001 Filing
Season, GAO- 02- 212 (Washington D. C.: Dec. 7, 2001).

13 U. S. General Accounting Office, Tax Administration: IRS?s Efforts to
Improve Compliance With Employment Tax Requirements Should Be Evaluated,
GAO- 02- 92 (Washington, D. C.: Jan. 15, 2002).

14 U. S. General Accounting Office, Managing for Results: Challenges
Agencies Face in Producing Credible Performance Information, GAO/ GGD- 00-
52 (Washington, D. C.: Feb. 4, 2000).

Page 18 GAO- 02- 715T

resources to many of its programs, the benefits of analysis -identifying

ways to more effectively use resources and improve service -could be
substantial.

Another performance management risk deals with IRS?s ability to link its
budget requests with program results. GPRA requires agencies to establish
linkages between resources and results so that the Congress and the American
public can gain a better understanding of what is being achieved in relation
to what is being spent. As we recently reported, 15 IRS has made progress in
linking some of its budget justification to performance goals, but in other
instances the budget justification lacked performance goals or contained
inconsistencies between the budget request and performance goals.

 IRS?s congressional justification has several good links between the
resources being requested and IRS?s performance goals. For example, IRS?s
budget includes an increase of 213 full- time equivalents and $14.1 million
to improve its telephone level of service, and its performance measures show
an expected increase in toll- free telephone level of service from 71.5
percent in fiscal year 2002 to 76.3 percent in fiscal year 2003.

 In some instances, IRS?s congressional justification contained no
performance goals against which the Congress can hold IRS accountable. For
example, the budget request includes increased resources for systematic
noncompliance problems identified by the commissioner of Internal Revenue,
such as for abusive corporate tax shelters and failure to pay large
accumulations of employment taxes, yet it is unclear from IRS?s budget
justification how many resources IRS intends to devote to each of these
problems. And, for none of these areas does the budget justification include
performance measures and goals that Congress can use to assess IRS?s
progress in addressing these major compliance problems. In recent testimony,
we suggested that the House Ways and Means Subcommittee on Oversight ask IRS
for more specifics on its goals, performance measures and resource plans.

A major purpose of GPRA and IRS?s strategic planning, budgeting, and
performance management system is to support better- informed decisions

15 U. S. General Accounting Office, Internal Revenue Service: Assessment of
Budget Request for Fiscal Year 2003 and Interim Results of 2002 Tax Filing
Season, GAO- 02- 580T (Washington, D. C.: Apr. 9, 2002).

Page 19 GAO- 02- 715T

on allocating scarce resources by focusing on the results likely to be
achieved and then supporting subsequent oversight and accountability by
establishing transparent measures to assess performance. IRS?s new planning
process and the linkages in its budget justification between some of its
resource requests and expected results are commendable steps to implement
this management approach. Improved linkages in IRS?s budget justifications
would better enable Congress to make difficult resource allocation decisions
and to hold IRS accountable for achieving results with the resources it is
provided.

Although for the second consecutive year, IRS was able to produce financial
statements covering its tax custodial and administrative activities in
fiscal years 2001 and 2000, 16 that were fairly stated in all material
respects, this was only achieved because of the commitment of significant
staff resources, time, and the use of compensating processes to overcome
serious internal control and system deficiencies.

The major control and system deficiencies that we identified during our most
recently completed financial audit included:

 An inadequate financial reporting process;

 Weaknesses in controls over unpaid assessments;

 Weaknesses in controls over the identification and collection of tax
revenues due the federal government and issuance of tax refunds;

 Inadequate controls over property and equipment;

 Weaknesses in controls over its budgetary activity; and

 Weaknesses in computer security controls. To overcome these problems, IRS
relied on costly, time- consuming processes; statistical projections;
external contractors; substantial adjustments; and monumental human efforts
that extended nearly 4 months after the September 30, 2001, fiscal year-
end. These costly efforts produced tens of billions of dollars of
adjustments and would not have been necessary if IRS?s systems and controls
operated effectively.

IRS?s current method of producing financial statements is not a workable
long- term solution to meeting its financial reporting responsibilities for

16 U. S. General Accounting Office, Financial Audit: IRS?s Fiscal Years 2001
and 2000 Financial Statements, GAO- 02- 414 (Washington, D. C.: Feb. 27,
2002). Financial Management

Risks

Page 20 GAO- 02- 715T

two basic reasons. First, the extent of manual review and changes to
financial records is so substantial, and requires so much commitment from
both management and the employees who do this time- pressure work, that it
is questionable whether this effort is sustainable year after year. Second,
the time frames acceptable for year- end financial reporting are being
compressed. The Office of Management and Budget has announced that, by 2004,
government agencies will be required to produce financial reports within 6
weeks of year- end. The Treasury Department has established a goal of
meeting such a compressed schedule during 2002. Without significant and
systemic changes in how IRS processes transactions, maintains its records,
and reports its financial results to accompany its extensive compensating
processes, IRS?s ability to meet this accelerated reporting deadline while
sustaining an unqualified opinion on its financial statements is
questionable.

Moreover, weaknesses in controls and systems deficiencies threaten
modernization efforts.

 First, qualified staff whose input is critical to developing a modernized
financial management system are the same individuals responsible for
implementing the compensating processes to generate the annual financial
statements. The tremendous time and effort it takes to derive the financial
statements may make it impractical for these individuals to effectively
devote the time needed to ensure the new system meets ongoing reporting
needs.

 Second, because of the extent of adjustments to prevent misclassification
of financial data, unverified data extracts are of questionable utility to
IRS management. For example, without timely and reliable data on unpaid tax
assessments IRS is unable to promptly identify and focus collection efforts
on accounts most likely to prove collectible. Also, IRS has difficulties in
relating taxpayer accounts that may be jointly responsible for unpaid taxes
so that the correct liability of each taxpayer is readily discernable. This
has contributed to instances of both taxpayer burden and lost revenues to
the federal government.]

The challenge for IRS is to balance its short- term goals of improving its
compensating processes with its long- term needs of overhauling its
financial systems.

IRS is part way through what is intended to be a major organizational
transformation. Real progress has been made laying the foundation for a more
modern agency. To avoid delays in realizing the promise of Concluding

Observations

Page 21 GAO- 02- 715T

modernization for improved service to taxpayers while ensuring compliance
with the tax laws, the new commissioner should be willing to work within the
existing general framework for modernization and be willing to build on the
foundation that has been laid. Progress will also require successfully
managing the risks outlined in our statement.

Mr. Chairman, this concludes our statement. We would be pleased to respond
to any questions that you or other committee members may have.

Page 22 GAO- 02- 715T

Overall, since the mid- 1990s IRS has seen increased workload, decreased
staffing, and significant changes in the allocation of resources between
taxpayer assistance programs and its compliance and collection programs. We
selected data, presented in the following seven figures, to illustrate some
of the key trends at IRS since the mid- 1990s.

Figure 1: IRS Workload as Measured by Returns Filed Has Increased While
Total Staffing Has Decreased

Source: GAO?s analysis of IRS?s data.

Appendix: Overview of Trends in Tax Administration

Number of returns (millions) and staff (thousands) 0 50

100 150

200 250

1995 1996 1997 1998 1999 2000 2001 Fiscal year

Total IRS staff (average positions) All tax returns (including individual,
corporation, partnership, employment, estate, and other)

Page 23 GAO- 02- 715T

Figure 2: Enforcement Staffing Has Declined Proportionately More Than Total
Staffing

Source: GAO?s analysis of IRS?s data.

Number of employees 0 2,000

4,000 6,000

8,000 10,000

12,000 14,000

16,000 1995 1996 1997 1998 1999 2000 2001 Fiscal year

Revenue agents Revenue officers Document matching staff (FY 2001 data not
available)

Page 24 GAO- 02- 715T

Figure 3: Individual Electronic Returns More Than Tripled While Paper
Returns Decreased by About 15 Percent

Source: GAO?s analysis of IRS?s data.

Number of returns (millions) 0 20

40 60

80 100

120 1995 1996 1997 1998 1999 2000 2001 Fiscal year

Paper returns Electronic returns

Page 25 GAO- 02- 715T

Figure 4: Telephone Accuracy Is Increasing

Note: IRS has two types of measures for assessing the accuracy of its
responses to taxpayer calls concerning (1) tax law issues and (2) IRS?s
records on their accounts. The quality rate is the percentage of calls in
which assistors followed all IRS procedures for the call type and provided
correct answers. The correct response rate is the percentage of calls in
which assistors provided correct answers for the call type, discounting
procedural errors. IRS has comparable data only for the years shown.

Source: GAO?s analysis of IRS?s data.

Percentage 0 10

20 30

40 50

60 70

80 90

100 1999 2000 2001 2002 Filing season

Tax law quality rate Account quality rate Tax law correct response rate
Account correct response rate

Page 26 GAO- 02- 715T

Percent of returns filed 0 1

2 3

1996 1997 1998 1999 2000 2001 Fiscal year

Individual returns Corporate returns Partnership returns

Figure 5: Audit Rates Have Declined

Source: GAO?s analysis of IRS?s data.

Page 27 GAO- 02- 715T

Figure 6: Gap Between New Delinquency Cases and Delinquency Cases Closed;
Declines in the Use of Liens and Levies

Source: GAO?s analysis of IRS?s data.

Number of cases (thousands) 0 1000

2000 3000

4000 5000

6000 1996 1997 1998 1999 2000 2001 Fiscal year

New deliquency cases Delinquency cases closed Liens files Levies issued

Page 28 GAO- 02- 715T

Figure 7: Raw Productivity Declined for Six of Eight Compliance and
Collection Programs

Source: GAO analysis of IRS data.

(440105)

Productivity index 0 20

40 60

80 100

120 140

1996 1997 1998 1999 2000 2001 Fiscal year

Returns processing Underreporter Nonfilers Individual audit

Corporation audit Other audit Telephone collection Field collection
*** End of document. ***