IRS Modernization: Continued Progress Necessary for Improving	 
Service to Taxpayers and Ensuring Compliance (20-MAY-03,	 
GAO-03-796T).							 
                                                                 
Congress passed the IRS Restructuring and Reform Act of 1998 in  
response to frustration with the Internal Revenue Service's (IRS)
inability to effectively carry out its mission. IRS's inability  
to deliver new computer systems that worked, allegations of abuse
of taxpayers by IRS employees, and taxpayers greeted by busy	 
signals when calling IRS for assistance all fed the frustration. 
The act set two goals for IRS--improve service to taxpayers while
continuing to enforce compliance with the tax laws. The act also 
mandated annual joint congressional oversight hearings, of which 
this is the fifth and final.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-796T					        
    ACCNO:   A06924						        
  TITLE:     IRS Modernization: Continued Progress Necessary for      
Improving Service to Taxpayers and Ensuring Compliance		 
     DATE:   05/20/2003 
  SUBJECT:   Agency missions					 
	     Congressional oversight				 
	     Customer service					 
	     Internal controls					 
	     Strategic planning 				 
	     Taxpayers						 

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GAO-03-796T

                                       A

Test i mony Before Congressional Committees For Release on Delivery
Expected at 10: 00 a. m. EDT IRS MODERNIZATION Tuesday, May 20, 2003
Continued Progress

Necessary for Improving Service to Taxpayers and Ensuring Compliance

Statement of James R. White Director, Strategic Issues Robert F. Dacey
Director, Information Technology Systems Issues Steven J. Sebastian
Director, Financial Management and Assurance

GAO- 03- 796T

a

GAO United States General Accounting Office

IRS*s accomplishments in the 5 years since the act was passed are
significant. IRS has increased its capacity to manage with, for example,
more effective controls over information system acquisition and better

performance measures. In addition, the improvements have had a noticeable
impact on service to taxpayers. Taxpayers have an easier time reaching IRS
by telephone and are increasingly using IRS*s Web site to download tax
forms and publications and check the status of their refunds.
Nevertheless, IRS is only part of the way to where taxpayers and Congress
expect it to be. Compliance is perhaps IRS*s greatest challenge looking
forward. Although

IRS lacks current data about the level of voluntary compliance, what is
known is that there have been significant and pervasive declines in many
of IRS*s key compliance and collections programs. As a result of these
declines, taxpayers have less incentive to voluntarily comply, thereby
potentially undermining the integrity of the tax system and risking
revenue collections. Reversing this decline will be a challenge. Another
challenge will be closing the gap between the level and quality of
taxpayer services that IRS provides and what Congress and taxpayers want
and expect. Despite improvements, almost one- third of callers receive
busy signals or hang up without receiving service, and almost 20 percent
get incorrect answers to tax law questions.

The means for realizing IRS*s goals is continued progress modernizing, but
this will be a challenge. The scope and complexity of the business systems
modernization is growing, but management capacity is still maturing.
Longstanding computer security weaknesses continue to threaten the
confidentiality, integrity, and availability of sensitive systems and
taxpayer data. Performance, financial, and human capital management all
need

further improvement. IRS is also challenged to realize the increased
staffing levels for service and compliance called for in recent IRS budget
requests.

IRS*s Key Modernization Challenges Congress passed the IRS Restructuring
and Reform Act of

1998 in response to frustration with the Internal Revenue Service*s (IRS)
inability to effectively carry out its mission. IRS*s inability to

deliver new computer systems that worked, allegations of abuse of
taxpayers by IRS employees, and taxpayers greeted by busy signals when
calling IRS for assistance all fed the frustration. The act set two goals
for IRS* improve service to taxpayers while continuing to enforce
compliance with the tax laws. The act also mandated annual joint
congressional oversight hearings, of which this is

the fifth and final. GAO is not making any new recommendations. However,
numerous recommendations made in previous GAO reports about how to deal
with the challenges facing IRS are cited. www. gao. gov/ cgi- bin/ getrpt?
GAO- 03- 796T. To view the full report, including the scope

and methodology, click on the link above. For more information, contact
James R. White at (202) 512- 9110 or whitej@ gao. gov. Highlights of GAO-
03- 796T, a report to

Congressional Committees

May 20, 2003

IRS MODERNIZATION

Continued Progress Necessary for Improving Service to Taxpayers and
Ensuring Compliance

Page 1 GAO- 03- 796T

Mr. Chairman and Members of the Committees: We are pleased to be here
today to contribute to this joint oversight hearing on the Internal
Revenue Service (IRS). Five years ago, Congress passed the IRS Reform and
Restructuring Act of 1998 1 (Restructuring Act), as part of an effort to
modernize IRS and provide taxpayers with

additional rights and protections. In this hearing, the fifth and final
one mandated by the Restructuring Act, we will report on IRS*s
accomplishments over recent years and the challenges ahead.

Throughout the 1990s, Congress grew increasingly frustrated with IRS*s
inability to effectively carry out its mission. IRS*s inability to deliver
new computer systems that worked, allegations of abuse of taxpayers by IRS
employees, and taxpayers greeted by busy signals when calling IRS for
assistance all fed the frustration. In response, Congress established the
National Commission on Restructuring IRS in 1995 and passed the
Restructuring Act in 1998, which increased Congress*s oversight of the
agency. In passing the act, Congress set two basic goals for IRS: improve
service to taxpayers while continuing to enforce compliance with the tax
laws.

Since passing the Restructuring Act, Congress has maintained its increased
oversight of IRS. For example, Congress has reviewed IRS*s expenditure
plans for its Business Systems Modernization (BSM) program before allowing
authorized funds to be spent. Congressional committees have also held
numerous hearings on IRS*s modernization progress, including the five
joint oversight hearings.

In addition to oversight, Congress has invested in IRS. In the last 5
years, Congress has appropriated $1.35 billion for BSM. Congress also has
virtually fully funded IRS*s annual budget requests for each year.

Now, halfway through the 10 years that the then Commissioner projected
modernization would take, is a good time to take stock* to look back on
what has been accomplished to date. We are pleased to report that, while

still far from realizing the goals set by the Restructuring Act, what has
been accomplished is significant.

1 Pub. L. 105- 206.

Page 2 GAO- 03- 796T

 IRS has increased its capacity to manage. While still only partway to
where it needs to be, IRS has put in place an organizational structure and
improved processes to set strategic priorities, allocate resources, and
achieve results aligned with priorities. IRS has established a strategic
planning and budgeting process, put in place many of the management
controls needed to effectively acquire and implement modernized business
information systems, reorganized around taxpayer groups, established a
balanced performance measurement system, implemented a new employee
evaluation system, and issued reliable annual financial statements.

 The modernization accomplishments to date have had a noticeable impact
on service to taxpayers. For example, taxpayers are more frequently
reaching, and waiting less time to speak to, telephone assistors and are
increasingly using IRS*s Internet Web site to download forms and
publications and get other types of information, such as the status of
their refund.

The service improvements mean that the congressional oversight, efforts
made by IRS managers and employees, and dollars invested in modernization
are beginning to show payoffs that American taxpayers can see. Less
apparent on the list of accomplishments is compliance. While

several significant compliance efforts have been started, few have been
completed.

With a new commissioner just confirmed, now is also a good time to list
the challenges facing IRS in the coming 5 years. Last year in this same
hearing, we said that IRS was at a critical juncture, in part, because of
the

impending change of commissioners and the challenges a new commissioner
would face. With the change just completed, IRS remains at essentially the
same critical juncture. Both of IRS*s goals* improving taxpayer service
and ensuring compliance* are challenges. Similarly, the means for
achieving these goals* modernization of management and systems* is a
challenge. Without continued focus by managers and employees on
modernizing, IRS would put the progress made to date at risk and
jeopardize the possibility of realizing Congress*s twin goals for
modernization.

 The area where progress is least apparent* compliance* is perhaps IRS*s
most significant risk and greatest challenge looking forward. Compliance
is a risk, in part, because neither IRS nor we know the level of voluntary
compliance, which compliance problems are the most significant, and what
the impact changes and IRS*s compliance programs and efforts have on the
level of voluntary compliance. What is known is that there have

Page 3 GAO- 03- 796T

been significant and pervasive declines in many of IRS*s key compliance
and collections programs. The declines can be seen in measures such as
cases closed, staffing levels, cases not worked, and the inventory of
uncollected tax debt. As a result of these declines, taxpayers have less
incentive to voluntarily comply, thereby potentially undermining the
integrity of the tax system and risking revenue collections. Reversing
this decline will be a challenge.

 While service to taxpayers has improved, gaps remain between the quality
of taxpayer services that IRS provides and what Congress and taxpayers
want and expect. For example, while the percentage of callers who receive
busy signals or hang up without receiving service has fallen since 1997,
it

still remains at 32 percent.  Continuing the progress that has been made
in modernizing management

remains another challenge. The scope and complexity of the BSM is growing,
but management capacity is still maturing. Long- standing computer
security weaknesses continue to threaten the confidentially, integrity,
and availability of sensitive systems and taxpayer data.

Performance, financial, and human capital management all need further
improvement. Finally, realizing the increased staffing levels for service
and compliance called for in recent IRS budget requests has not always
been possible.

Our assessment of both major accomplishments and key challenges is based
primarily on recently issued GAO products and ongoing reviews.

Over the 5 years since the Restructuring Act was passed, IRS has made
significant progress in modernizing. Figure 1 shows some of the major
accomplishments of the last 5 years. The figure includes actions that have
been implemented or completed and that represent significant steps in the

overall modernization effort. The figure is meant to illustrate important
progress* it does not show every accomplishment. IRS Has Improved

Management and Taxpayer Service

Page 4 GAO- 03- 796T

Figure 1: Selected Major IRS Accomplishments in Modernizing, 1999- 2003

Most of the accomplishments shown in figure 1 are internal management
improvements that will not be noticed by taxpayers, such as management
controls for information systems acquisition and implementation. While
such improvements do not directly affect taxpayers, they should lay a
foundation for improving service and ensuring compliance.

Figure 1 does include some accomplishments that are noticeable to
taxpayers such as the ability to check the status of their refund using
the Internet and the increase in electronically filed returns. One
accomplishment* the new software for revenue agents to help conduct
business audits* involves IRS*s enforcement programs.

IRS has completed a number of major modernization steps to help improve
management of its operations. While IRS still faces challenges in each of
the areas discussed below, the steps completed to date are major

accomplishments. IRS*s multibillion dollar BSM program is critical to the
success of the agency*s efforts to transform its manual, paper- intensive
business IRS Has Made

Management Improvements

Modernizing Business Systems

Page 5 GAO- 03- 796T

operations and fulfill its obligations under the Restructuring Act. To
date, about $1.35 billion has been appropriated and released for BSM.

IRS*s challenges in modernizing its business systems date back to the
mid1990s, when we reported on a number of technical and management
weaknesses and made a series of recommendations for correcting them and
limiting modernization activities and spending until they were corrected.
2 It was then that we designated the modernization program as a high- risk
area. 3 These challenges remained virtually unchanged until 1999, as IRS
made limited progress in correcting its weaknesses and our ongoing reviews
of the program continued to identify additional weaknesses and produce
additional recommendations.

Beginning in 1999, IRS started making progress in strengthening its
modernization management controls and capabilities. For example, IRS
submitted and Congress approved the first of a series of expenditure, or
spending, plans for BSM. These plans facilitate congressional oversight
and provide a description of the expenditures, functionality, and delivery
schedule planned for each project. Other notable accomplishments since
1999 include (1) developing and using a modernization blueprint, commonly
called an enterprise architecture, to guide and constrain its
modernization projects and (2) investing incrementally in its projects,
both of which are leading practices of successful public and private
sector organizations.

Since 2001, IRS has progressed in establishing the infrastructure on which
future business applications will run. Establishing this infrastructure is
a necessary prerequisite for business applications that are intended to
provide benefits to taxpayers and IRS. In addition, it has delivered three
applications that are today producing benefits. For example, the Customer
Communications 2001 project improved the telecommunications

2 U. S. General Accounting Office, Tax Systems Modernization: Management
and Technical Weaknesses Must Be Corrected If Modernization Is to Succeed,
GAO/ AIMD- 95- 156 (Washington, D. C.: July 26, 1995), and Tax Systems
Modernization:

Blueprint Is a Good Start But Not Yet Sufficiently Complete to Build or
Acquire Systems,

GAO/ AIMD/ GGD- 98- 54 (Washington, D. C.: Feb. 24, 1998). 3 U. S. General
Accounting Office, High- Risk Series: An Overview, GAO/ HR- 95- 1
(Washington, D. C.: February 1995).

Page 6 GAO- 03- 796T

infrastructure, including telephone call management, call routing, and
customer self- service applications. 4 In response to congressional
direction and our previous concerns about

projects getting ahead of the agency*s ability to manage them effectively,
5 IRS scaled back its projects, giving priority to implementing needed
management capacity. In our February 2002 report, 6 we again recommended
that the Commissioner of Internal Revenue reconsider the scope and pace of
the program to better balance it with the agency*s capacity to handle the
workload. In response, IRS took steps to better align the pace of the
program with the maturity of IRS*s controls and management capacity,
including reassessing the portfolio of projects that it had planned to
proceed with during the remainder of fiscal year 2002

and reducing the planned scope and pace of the program for fiscal year
2003.

Information security is a critical consideration for any organization that
depends on information systems and computer networks to carry out its
mission or business. It is especially important for government agencies,
like IRS, where the public*s trust is essential. The dramatic expansion in
computer interconnectivity and the rapid increase in the use of the
Internet are changing the way IRS communicates and conducts business.
Without proper safeguards they also pose enormous risks that make it
easier for individuals and groups with malicious intent to access
sensitive information, commit fraud, or disrupt operations.

Due to the nature of its mission, IRS collects and maintains a significant
amount of personal and financial data on each American taxpayer. These
data typically include the taxpayer*s name, address, Social Security
number, dependents, and income. The confidentiality of this sensitive
information is important because if this information is disclosed to

4 The other two are Customer Relationship Management Examination, which
provides offthe- shelf software to IRS revenue agents to allow them to
accurately compute complex corporate transactions, and Internet Refund/
Fact of Filing, which improves customer selfservice by providing taxpayers
with instant refund status information and instructions for resolving
refund problems via the Internet.

5 U. S. General Accounting Office, Business Systems Modernization: Results
of Review of IRS* March 2001 Expenditure Plan, GAO- 01- 716 (Washington,
D. C.: June 29, 2001). 6 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.: Feb. 28,
2002). Securing Taxpayer Information

Page 7 GAO- 03- 796T

unauthorized individuals, taxpayers could be exposed to a loss of privacy
and to financial loss and damages resulting from identity theft and
financial crimes.

IRS has made important progress toward improving information security over
taxpayer data and implementing a comprehensive agencywide information
security program. It has established and updated a substantial set of
information security policies, standards, and guidelines that generally
provide appropriate guidance to personnel responsible for securing IRS
information systems and data. If effectively implemented, these would
protect IRS information systems and taxpayer data from many threats. IRS
has also increased the resources devoted to securing its systems and data*
increasing, for example, the number of specialists assigned to the office
responsible for ensuring that IRS has effective security programs in
place. To help improve the security of IRS*s systems and taxpayer data,
IRS has also (1) implemented and improved control measures that limit
physical access to facilities and computing resources and (2) established
a virus protection and eradication program that helps to protect against
new malicious software threats as they emerge.

A major principle of IRS*s modernization strategy is that understanding
the taxpayer*s point of view and improving service is fundamental to
helping the majority of taxpayers who are willing to comply with the tax
laws and pay what they owe. To help realize this customer- focused
approach to providing service, in October 2000 IRS reorganized into four
divisions, each responsible for a group of taxpayers with similar needs,
such as IRS*s Small Business/ Self- Employed Division.

A sound organizational performance and human capital management system is
essential for assessing how well IRS meets its goals and for identifying
and making programmatic improvements. IRS has made progress by
establishing a system of balanced measures to hold managers and frontline
staff more accountable for improving performance. For example, IRS
determined that the three elements of balanced measures were customer
satisfaction, employee satisfaction, and business results (quality and
quantity measures) to ensure balance among priorities. Similarly, in
October 2001, IRS implemented its new employee evaluation system for
frontline employees. This main human capital management system, like the
one implemented earlier for executives and managers, was designed to
structurally align performance expectations for employees with IRS*s three
strategic goals to encourage behaviors and actions that support and
advance those goals. Reorganizing IRS and Managing

Performance

Page 8 GAO- 03- 796T

In 2000, IRS implemented a new strategic planning and budgeting process
that provides the framework for developing goals, objectives, and measures
at the operating division level. Although we have not evaluated the effect
of the process on IRS performance, the operating divisions are

identifying strategic goals intended to be tailored to the specific
characteristics and needs of their taxpayers. IRS senior management is
also using the process to reconcile competing priorities and resource
needs of the operating divisions.

Current and accurate financial information is critical to informed
decision making by senior management. IRS has made considerable progress
towards improving financial management, including achieving unqualified
(clean) audit opinions on financial statements.

When former Commissioner Rossotti was confirmed in November 1997, IRS was
exhibiting virtually the same pervasive financial management weaknesses we
had been reporting since we began auditing IRS*s financial statements in
1992. These weaknesses, which led GAO to add IRS financial management to
its high- risk list in 1995, 7 stemmed not only from IRS*s reliance on
obsolete and inadequate financial management systems, but also from the
serious weaknesses in IRS*s policies and procedures. In the five years
that have passed since 1997, however, IRS has made considerable progress
in addressing weaknesses in its financial management systems and internal
controls by, for example, committing extensive additional resources. This
and other efforts have resulted in reducing the number of material
internal control weaknesses and attaining unqualified opinions on its
financial statements. This achievement was due in no small part to the
strong commitment made by senior IRS management.

During our audit of IRS*s custodial financial statements 8 in fiscal year
1997, we found material weaknesses in IRS*s internal controls that had
shown little improvement since our first audit in fiscal year 1992. These
weaknesses included an inadequate financial reporting process,

7 GAO/ HR- 95- 1. 8 The Custodial Financial Statements report the assets,
liabilities and results of activities related to IRS responsibilities for
implementing federal tax legislation, including collecting federal tax
revenue, refunding overpayments of taxes, and pursuing collections of
amounts owed. IRS also has administrative activities, which include
managing costs funded by appropriations and reimbursements from other
federal agencies, state and local

governments, and the public. Improving Financial Management

Page 9 GAO- 03- 796T

deficiencies in controls to properly manage unpaid assessments, and
deficiencies controls over tax refunds and computer security. To overcome
these weaknesses, IRS implemented extensive compensating procedures that
enabled it to derive reliable balances related to its custodial activity
such as taxes receivable, enabling IRS to receive, for the first time in
fiscal year 1997, an unqualified opinion on its custodial financial
statements.

During fiscal years 1998 and 1999, we were unable to issue a clean opinion
on five of IRS*s six financial statements due to the continued affects of
the material weaknesses in IRS*s internal controls. We were able to
continue to issue unqualified opinions on IRS*s statements of custodial
activity, primarily due to IRS*s extensive use of compensating procedures.
Beginning in fiscal year 2000, IRS received an unqualified opinion on all
six of its financial statements by successfully producing a single set of
financial statements that were fairly stated in all material respects.
This significant achievement was made possible by years of strong
commitment and hard work by both IRS senior management and staff to
develop and implement compensating procedures to overcome the fundamental
systems and internal control deficiencies that continued to exist and
enable IRS to report reliable financial balances at fiscal year- end. IRS
also instituted monthly reconciliations of its Fund Balance with Treasury,
a

process similar to companies or individuals reconciling their checkbooks
to monthly bank statements, thereby eliminating this issue as a material
weakness.

In fiscal year 2002 IRS reported its financial results and received an
unqualified audit opinion 6 weeks after the close of the fiscal year*
about 75 days ahead of the reporting deadline required by the Office of
Management and Budget. As before, this achievement, and continued progress
in addressing its material internal control weakness, was the culmination
of years of IRS efforts to refine the compensating procedures it has
relied on to overcome material weaknesses, in its internal controls,

as well as making substantive improvements in the way it records
transactions, maintains records, and reports financial results.

IRS has improved and expanded service to taxpayers, including the
accessibility of telephone assistance and increased electronic filing and
Internet services. These improvements are a significant accomplishment,
but IRS taxpayer service is not yet at the level that taxpayers and
Congress want. Also, IRS has begun to reap some rewards from electronic
filing* Taxpayers Have Seen

Some Improvements in Service

Page 10 GAO- 03- 796T

for example, the closing of its paper processing operations at its
Brookhaven location.

Since the mid- 1990s, access to telephone assistance, an important
function that affects millions of taxpayers, has improved. In 1997, about
49 percent of calls to IRS primary assistance lines either received a busy
signal or were abandoned before being answered. This compares to about 32
percent of calls to date in 2003. As figure 2 illustrates, other measures
of access show improvement as well. The percentage of calls where
taxpayers attempted to reach an assistor and received service increased
from about 70 to 83 percent between the 2001 and 2003 filing seasons. The
figure also shows that callers are waiting less time to speak with an
assistor and are hanging up less frequently before getting through.
Telephone service is important because it affects so many taxpayers. In
2002, IRS received over 100 million phone calls.

IRS*s telephone service improvements are, in part, the results of numerous
improvement efforts sustained over time. In 1999, IRS centralized its
tollfree telephone operations and established the Joint Operations Center
to enable it to route calls to assistors across the country based on
actual availability data. Similarly, from 2000 through 2003, IRS made
several business process changes and implemented new technology. For
example, in 2001, IRS shifted millions of calls to its automated service
so it could use its assistors to answer more challenging taxpayer calls.
Also, as part of its Customer Communications Project, IRS enhanced its
call routing system.

Figure 2 shows that the accuracy of tax law information provided to
taxpayers by assistors has remained relatively stable. According to IRS
officials, accuracy stayed stable despite simpler calls being routed away
from assistors to automated systems. Improved Telephone Service

Page 11 GAO- 03- 796T

Figure 2: Improvements in IRS*s Service and Assistor Response, 2000- 2003

Note: CSR level of service* of the calls that IRS estimates were from
taxpayers attempting to reach an assistor, the calls that received
service; Assistor response level* of the calls that reached an assistor,
the percentage in which the caller waited 30 seconds or less; Abandon
rate* of the calls routed to an assistor, the percentage that hung up
before speaking to an assistor; and Tax law correct response rate* of the
calls in which IRS provided tax law information, the percentage in which
the assistor provided correct answers. IRS has comparable data only for
the years shown. Accessibility data covers the period of January through
mid- April. The correct response rate covers the period January through
April and is an estimate (90- percent confidence level +/- 1 percentage

point).

Although it still represents less than half of all individual income tax
returns, electronic filing grew from almost 12 million returns in 1995 to
an estimated 53 million in 2003, as shown in figure 3. The figure also
shows that the number of paper returns is declining. The growth of
electronic filing is one key to IRS*s modernization strategy, because
electronic filing allows IRS to control costs and improve customer service
by reducing labor- intensive processing of paper tax returns. As a result,
IRS is phasing out its paper processing operations in the Brookhaven
location. Increased Electronic Filing and

Internet Services

Page 12 GAO- 03- 796T

Figure 3: Increase in Individual Electronic Returns and Decrease in Paper
Returns, 1995- 2003

Note: GAO estimated that, based on the number of returns received
electronically to date, IRS will receive a total of 53 million returns
filed electronically in 2003.

Another indication that taxpayers are receiving payoffs from modernization
is the breadth and quality of the services provided on IRS*s Internet Web
site. The services being offered to taxpayers and tax practitioners via
the Web site have grown considerably over the last few years, and it is
used more each year by taxpayers and tax practitioners. As of March 31,
2003, about 283 million forms and publications had been downloaded since
the beginning of the filing season.

IRS*s Web site is a critical part of modernization because, according to
IRS, it is more cost- effective than other methods of providing taxpayer
assistance, such as answering telephone calls. The IRS Web site currently
provides a way for taxpayers and tax practitioners to receive assistance
without having to call or visit an IRS office. Among other things, the
site provides the potential to download hundreds of tax forms and
publications, contains current information on tax issues and electronic
filing, and, in a more recent feature, gives taxpayers the opportunity to
check the status of their refunds. The capability to check the status of

Page 13 GAO- 03- 796T

refunds is particularly important because IRS data shows it has decreased
the refund call inquiries handled by IRS*s telephone operations and has
the potential to further decrease those calls, enabling assistors to
handle more complicated calls about tax laws or customer accounts that
cannot be answered through automation.

Despite the progress modernizing and the improvements in taxpayer service,
IRS faces significant challenges looking ahead. Perhaps IRS*s most
significant risks and biggest challenges are in the area of compliance* an
area wherein accomplishments have not been very apparent. Compliance is a
risk, in part, because IRS does not have current data on how well
taxpayers are complying with the tax laws and therefore cannot
appropriately target areas for improvement nor can assess the impact
changes to its compliance program have on the level of voluntary
compliance. However, the available data show declines in many of IRS*s
enforcement activities, such as collections. The declines have prompted
concerns that taxpayers* willingness to voluntarily comply could be put at
risk. Meeting IRS*s goal of ensuring compliance is a challenge because of
the effort and resources that will be required to reverse these program

declines. Meeting IRS*s goal of improving taxpayer service also presents a
challenge. Despite IRS*s accomplishments, there remains a gap between the
quality of service that taxpayers currently receive and the service that
taxpayers and Congress want and expect.

A key to ensuring compliance and improving taxpayer service is continuing
to modernize IRS*s management and systems. This includes delivering
modernized systems; ensuring computer systems security; improving
performance, financial, and human capital management; and increasing
resources for taxpayer service and compliance.

A visible enforcement program is considered by many as critical for our
tax system to encourage voluntary compliance with the tax laws. While
improving taxpayer service may enhance voluntary compliance, taxpayers*
willingness to voluntarily comply with the tax laws depends in part on

their having confidence that their friends, neighbors, and business
competitors are paying their fair share of taxes. To provide that
confidence, IRS operates a number of compliance and collection programs,
including computerized checks for nonfiling and underreported income,
audits, and telephone and field collections. Collecting taxes due Key
Challenges,

Especially in Compliance, Remain

Declines in Enforcement Programs Make Ensuring Compliance a Challenge

Page 14 GAO- 03- 796T

the government 9 has always been a challenge for IRS, but in recent years
the challenge has grown.

Understanding taxpayers* compliance with the nation*s tax laws is
essential to IRS improving the effectiveness of its programs to enforce
and promote voluntary compliance. While IRS strives to ensure that

enforcement audits are targeted at noncompliant taxpayers, this has become
increasingly difficult to do because the information used to identify
potentially noncompliant tax returns is out of date. We remain concerned
about IRS*s ability to appropriately allocate its enforcement resources,
including staff, to its various compliance and collections activities.
Without current data on voluntary compliance, IRS does not know which is
the highest priority area of noncompliance.

IRS*s new effort to review compliance, the National Research Program
(NRP), should, if implemented as planned, provide IRS with the first up-
todate information on compliance rates and sources of noncompliance since
it last measured the compliance rate using 1988 tax returns. IRS has
agreed with recommendations we made regarding implementation of NRP and
more effective use of such data in the strategic, planning, budgeting, and
performance management process.

Absent measures of voluntary compliance, the only compliance- related data
available are on IRS*s enforcement programs. In recent years, steep
declines have occurred in some of IRS*s compliance programs for individual
taxpayers and in programs to collect delinquent taxes. These trends have
triggered concerns that taxpayers* motivation to voluntarily comply with
their tax obligations could be adversely affected. Since the

9 Total unpaid taxes due the government include (1) delinquent taxes that
IRS is attempting to collect, (2) taxes that IRS knows are due but has
decided not to pursue collecting, and (3) an unknown amount of unpaid
taxes that IRS has not identified. Limited Information on Voluntary
Compliance

Enforcement Program Declines

Page 15 GAO- 03- 796T

mid- 1990s, we have issued six reports on IRS compliance and collection
trends in response to congressional concerns. 10 Figure 4 shows compliance
program trends for various income ranges. The

audit contact rates for the highest and lowest income individuals
essentially converged at around .8 percent in fiscal years 2001 and 2002.
Most of the audits of the lowest income individuals dealt with earned
income credit claims. Document matching contact rates 11 for all three
income ranges rose somewhat from 2001 through 2002. However, rates for all
three income ranges ended significantly lower in 2002 than 1993.

10 U. S. General Accounting Office, Tax Administration: Audit Trends and
Results for Individual Taxpayers, GAO/ GGD- 96- 91 (Washington, D. C.:
Apr. 26, 1996); Tax Administration: IRS* Audit and Criminal Enforcement
Rates for Individual Taxpayers Across the Country, GAO/ GGD- 99- 19
(Washington, D. C.: Dec. 23, 1998); Tax Administration: Use of Nonaudit
Contacts, GAO/ GGD- 00- 7 (Washington, D. C.: Mar. 16, 2001); IRS Audit
Rates: Rate of Individual Taxpayers Has Declined With the Effect on

Compliance Unknown, GAO- 01- 484 (Washington, D. C.: Apr. 25, 2001); Tax
Administration: Impact of Compliance and Collection Program Declines on
Taxpayers,

GAO- 02- 674 (Washington, D. C.: May 22, 2002); and Tax Administration:
IRS Should Continue to Expand Reporting on Its Enforcement Efforts, GAO-
03- 378 (Washington, D. C.: Jan. 31, 2003).

11 Document matching is where IRS compares information provided by a third
party, for example a bank, against taxpayer return information to identify
discrepancies.

Page 16 GAO- 03- 796T

Figure 4: IRS Individual Audit and Document Matching Contact Rates by
Income Level, Fiscal Years 1993- 2002 Collection programs have also
declined as shown in figure 5. As we reported in May 2002, from fiscal
years 1996 through 2001 trends in the collection of delinquent taxes
showed almost universal declines in collection program performance,
whether measured in terms of percentage of workload completed, 12 cases
closed, direct staff time, productivity, or unpaid taxes collected. 13
From 1996 through 2002, IRS was unable to keep up with the growth in
collections workload.

12 Workload is the number of delinquent accounts assigned to field and
telephone collection. Work completed is the number of delinquent accounts
worked to closure, excluding accounts for which collection work has been
deferred. 13 GAO- 02- 674.

Page 17 GAO- 03- 796T

Figure 5: Percentage of Collections Workload Not Completed, Fiscal Years
1996 to 2002

The increasing gap between collection workload and work completed led IRS
in March 1999 to start deferring collection action on billions of dollars
in delinquencies. By the end of fiscal year 2002, after the deferral
policy had been in place for about 3 and one- half years, IRS had deferred
taking collection action on about $15 billion in unpaid taxes, interest,
and penalties. As of 2002, IRS was deferring collection action on about
one out of three collection cases. As of September 30, 2002, IRS had a
total inventory of $112 billion of known unpaid taxes with some collection
potential. 14 There are significant compliance problems associated with
the EIC that

have led us to list IRS*s tax administration of the credit as a high- risk
area 14 The $112 billion includes two categories of known unpaid taxes:
(1) taxes due from taxpayers for which IRS can support the existence of a
receivable with a taxpayer agreement or a favorable court ruling (federal
taxes receivable), and (2) compliance assessments in which neither the
taxpayer nor the court has affirmed that the amounts are owed. Earned
Income Credit

Noncompliance

Page 18 GAO- 03- 796T

for the federal government. 15 Under the code, taxpayers who meet earned
income, family size, and other requirements are authorized to claim the
EIC. The credit offsets the impact of the Social Security taxes paid by
lowincome workers and is intended to encourage low- income persons to seek
work rather than welfare. For most recipients, the credit amount exceeds
the amount of their income tax liability; in such cases, because the
credit is refundable, the taxpayers receive a refund.

IRS estimates that of the $31.3 billion in EICs claimed by taxpayers in
tax year 1999, about $8.5 billion to $9.9 billion should not have been
paid. 16 This level of noncompliance has remained relatively unchanged
even after

a 5- year effort to reduce it. IRS has to balance its efforts to combat
noncompliance with its efforts to ensure that qualified persons claim the
credit. With the data available, we were able to estimate that for every
three households that claimed the credit, there was an additional eligible
household that did not. 17 Because IRS has struggled to reduce the
overclaim rate and because of the magnitude of the financial risk, EIC
noncompliance has been and remains both a management challenge and a high-
risk area.

Early in 2002, the Assistant Secretary of the Treasury and the IRS
Commissioner established a joint task force to seek new approaches to
reduce EIC noncompliance. The task force sought to develop an approach to
validate EIC claimants* eligibility before refunds are made, while
minimizing claimants* burden and any impact on EIC*s relatively high
participation rate. Through this initiative, administration of the EIC
program would become more like that of a social service program such as
Food Stamps or Social Security Disability, for which proof of eligibility
is required prior to receipt of any benefit. IRS*s 2004 budget proposes
new

spending to implement this strategy and it intends to ramp up rapidly.
Planning and implementation for this initiative will proceed
simultaneously. The success of the initiative will depend on careful
planning and close management attention as IRS*s implementation
progresses.

15 U. S. General Accounting Office, Major Management Challenges and
Program Risks: Department of the Treasury, GAO- 03- 109 (Washington, D.
C.: January 2003). 16 IRS estimated that $1.2 billion would be recovered
as a result of enforcement efforts. 17 U. S. General Accounting Office,
Earned Income Tax Credit Eligibility and Participation, GAO- 02- 290R
(Washington, D. C.: Dec. 14, 2001).

Page 19 GAO- 03- 796T

Despite progress, improving service to taxpayers remains a challenge for
IRS. The progress that IRS has made to date in modernizing has, as noted,
improved service but not to the level that taxpayers, Congress, and IRS
management agree is needed.

Providing good service to taxpayers by making it as easy as possible for
them to understand and meet their tax obligations could improve voluntary
compliance* payments and tax returns filed without IRS audit and
collection action* and reduce the need for these intrusive and costly
enforcement activities. According to IRS, preventing compliance problems
by educating and informing taxpayers, or helping taxpayers resolve
problems early on, is less expensive and time- consuming for both IRS and
the taxpayer than enforcement action taken later. Facilitating voluntary
compliance is especially important because the U. S. tax system relies on
it. About 98 percent of all tax revenue collected is paid through
withholding, remittances sent with tax returns, or other forms of payment
without any IRS enforcement action. While IRS has improved service in some
areas, millions of taxpayers still

have difficulty reaching IRS by telephone, and when they do, they may not
be able to rely on the accuracy of information IRS provides. For example,
IRS data shows that 32 percent of calls to IRS either received a busy
signal or were abandoned without receiving service. In addition, about 20
percent of callers received inaccurate information when calling IRS with
tax law questions.

Similarly, the accuracy of the assistance provided at IRS*s walk- in sites
is below expectations. While it has improved in recent years, 25 percent
of answers provided were incorrect so far in 2003. Revamping taxpayer
service will require that IRS simultaneously meet the other significant
management challenges discussed in this testimony. For example, to ensure
that changes result in efficient, improved service, IRS will need to
establish consistent, comparable measures and conduct more

and better program evaluations to identify ways to improve service.
Modernization is the means for achieving IRS*s two goals of improving
service and ensuring compliance. Figure 6 shows four key components of
modernization. Each alone is a significant challenge* in combination they
are an even greater challenge. Closing the Gap between

Actual and Desired Taxpayer Service Remains a Challenge

Modernization Is Key to Improving Service and Ensuring Compliance

Page 20 GAO- 03- 796T

Figure 6: IRS*s Key Modernization Challenges

IRS*s modernization strategy includes reengineering efforts intended to
automate or eliminate work, improve productivity, and free up staff time
that can then be redirected to service and compliance programs.
Reengineering efforts rely heavily on IRS*s BSM program.

Despite important progress in IRS*s BSM program, it remains a high- risk
challenge for two reasons. 18 First, the scope and complexity of the
program are growing. Specifically, the number of projects under way
continues to increase, and the tasks associated with those projects that
are moving beyond design and into development are by their nature more

complex and risky. Second, IRS*s modernization management capacity is
still maturing. For example, IRS has yet to fully implement a strategic
approach to ensuring that it has sufficient human capital resources. It
has also yet to fully implement management controls in such areas as
estimating costs and employing performance- based contracting methods.

The continuing challenge for IRS is to ensure that the pace of acquiring
systems does not exceed the agency*s ability to manage them effectively, a
problem we have reported 19 in the past. The imbalance between program
pace and management capacity adds significant cost, schedule, and
performance risks that escalate as a program advances. For example, as

18 U. S. General Accounting Office, High- Risk Series: An Update, GAO- 03-
119 (Washington, D. C.: January 2003). 19 GAO- 01- 716 and GAO- 02- 356.
Delivering Modernized Business Systems

Page 21 GAO- 03- 796T

indicated in IRS*s March 2003 expenditure plan, most of the BSM
initiatives or project milestones experienced cost increases and/ or
schedule delays exceeding 10 percent of the estimated cost and duration
stated in the November 2001 plan. Moreover, these risks increase as IRS
moves forward because interdependencies among current ongoing projects and
the complexity of associated workload activities to be performed increase
dramatically as more system projects are built and deployed.

IRS has acknowledged these risks and has initiatives planned or under way
to address them. The timely implementation of these initiatives is
critical. While the lack of controls can be risky in a project*s early
stages, it is essential that such controls be in place when multiple
interdependent

projects are being designed, developed, and implemented. To mitigate this
added risk, IRS needs to fully implement the remaining management controls
that we have recommended. Until that time, the BSM program remains high
risk, and we will continue to monitor IRS*s progress in this

area. As the BSM program moves forward, there are several other challenges
and risks to the successful and timely implementation of future planned
modernized systems. A major issue is the ability to successfully integrate
modernized systems with the reengineered business processes being
implemented in the operating divisions. Failure to coordinate the
acceptance and operation of new systems may result in increased costs and
delayed delivery of benefits to taxpayers. Finally, a major concern for
all aspects of the program is the extent to which the program will be

consistently funded in an environment of budgetary deficits and competing
priorities. Without a consistent level of funding, IRS will have
difficulty establishing the infrastructure needed to build and sustain
additional modernized systems and expediting the replacement of the
outdated systems currently in use.

Although IRS has made important progress securing its systems, information
security remains a challenge. Long- standing computer control weaknesses
continue to threaten the confidentiality, integrity, and availability of
sensitive systems and taxpayer data. IRS*s inconsistent implementation of
electronic access controls at its facilities did not effectively prevent,
limit, or detect access to computing resources. In addition, weaknesses in
other information system controls (including physical security,
segregation of duties, software change controls, and service continuity)
reduced IRS*s effectiveness in protecting and controlling physical access
to assets, minimizing the risk of errors or Ensuring Computer Systems

Security

Page 22 GAO- 03- 796T

fraud, mitigating the risk of unauthorized or inappropriate software
programs, and ensuring the continuity of data processing operations when
unexpected interruptions occur. Further, access to key computer
applications was not always limited to authorized persons for authorized
purposes. These weaknesses increased the vulnerability of data processed
by IRS*s information systems and continued to expose IRS*s tax processing
operations to disruption. As a result, we continued to report information
security as a material weakness in our report on IRS*s fiscal year 2002
financial statements. 20 An underlying cause of these weaknesses is that,
although it has made

important progress, IRS had not yet fully implemented certain elements of
its agencywide information security program. The challenges facing IRS are
to adequately (1) identify and assess information security risks to
determine needed security measures, (2) implement and comply with its
security policies and controls to meet those needs, (3) promote awareness
and provide security- related training so that employees understand the
risks and the policies and controls that mitigate them, (4) monitor the
effectiveness of established policies and controls, and (5) mitigate known
security vulnerabilities. IRS has acknowledged the seriousness of its

information security weaknesses and has revised its approach to
implementing the agencywide information security program. Until IRS can
fully implement an effective program and adequately mitigate its
information security weaknesses, it will remain at heightened risk of
access to critical hardware and software by unauthorized individuals, who
could intentionally or inadvertently read, add, alter, or delete sensitive
data or computer programs. Such individuals could possibly obtain personal
taxpayer information and use it to commit financial crimes in the
taxpayer*s name (identity fraud), such as establishing credit and
incurring debt.

Challenges remain in three important areas of management* performance,
financial, and human capital. As noted in our discussion of
accomplishments, IRS has made significant progress in these three areas.
By continuing to show progress in these areas, IRS will be better able to
improve taxpayer service and better ensure compliance.

20 U. S. General Accounting Office, Financial Audit: IRS*s Fiscal Years
2002 and 2001 Financial Statements, GAO- 03- 243 (Washington, D. C.: Nov.
15, 2002). Improving Performance,

Financial, and Human Capital Management

Page 23 GAO- 03- 796T Performance Management

Our work over recent years shows that IRS faces challenges in managing and
judging its performance.

 First, IRS needs to ensure that its organizational performance measures
are objective and reliable, consistent through time, and limited to key
performance indicators. Such performance measures would enable IRS
managers to monitor progress over time without being overwhelmed by too
much information.

 Second, IRS needs to associate explicit goals with its performance
measures. Without goals, it is difficult to determine if appropriate
progress is being made.

 Third, IRS needs to conduct more and better programs evaluations. Such
evaluations could help managers and staff better understand what they are
trying to accomplish, how their actual performance compares to their
objectives, and the reasons for any gaps. This would provide a more
informed basis for determining how to improve performance.

 Finally, in keeping with the Government Performance and Results Act of
1993, 21 IRS should continue its efforts to better link budget requests
with program results. Such a link could allow Congress to make more
informed budget decisions and better oversee IRS*s use of resources.

Financial Management

Financial systems and internal control weaknesses continue to preclude IRS
from providing managers current, accurate financial information with which
to make day- to- day decisions affecting IRS*s operations. These
weaknesses include

 an inadequate financial reporting process, resulting in IRS not being
able to prepare reliable financial statements without extensive
compensating procedures or not having current and reliable ongoing
information to support management decision making and to prepare cost-
based performance measures; 21 Pub. L. 103- 62 was enacted to hold federal
agencies accountable for achieving program results.

Page 24 GAO- 03- 796T

 weaknesses in controls over billions in unpaid tax assessments,
resulting in IRS*s inability to properly manage unpaid assessments and
leading to increased taxpayer burden;

 weaknesses in controls over the identification and collection of tax
revenues due the federal government and the issuance of tax refunds,
resulting in potentially billions of dollars in improper payments and lost
revenue to the federal government; and

 weaknesses in controls over property and equipment, resulting in IRS*s
inability to have reliable and timely information on its balance of
property and equipment throughout the year and to reasonably ensure that
its property and equipment are safeguarded and used only in accordance
with management policy.

These weaknesses and the computer security control weaknesses previously
discussed render IRS incapable of reporting current, reliable information
regarding its operations to management, Congress, and the public and
adversely affect its ability to effectively fulfill its

responsibilities as the nation*s primary collector of federal revenue.
IRS*s financial management has been on our list of high- risk government
operations since 1995. 22 The future challenge for IRS will be to continue
the improvements made in

recent years and develop and implement the fundamental long- term
solutions that are needed to address the internal control weaknesses we
have identified. Resolving many of IRS*s most serious financial management
challenges will depend on the successful implementation of its new
financial management system, which will not occur for several years. For
example, IRS*s Integrated Financial System (IFS) is intended to provide
IRS with a single general ledger that is compliant with existing

standards and integrated with its subsidiary records. However, IFS is not
scheduled to be fully functional and able to provide reliable cost
information that can be used by IRS in routine management decision making
until at least fiscal year 2005. IRS is also implementing the Customer
Account Data Engine and the Custodial Accounting Project to replace the
current primary taxpayer database and address IRS weaknesses in management
of unpaid assessments. However, these systems are not scheduled for full
implementation until at least fiscal year

22 U. S. General Accounting Office, Major Management Challenges and
Program Risks: A Governmentwide Perspective, GAO- 03- 95 (Washington, D.
C.: January 2003).

Page 25 GAO- 03- 796T

2007, at which time IRS*s custodial transactions will be fully integrated
with IFS. In the interim, several serious financial management issues will
continue to exist.

In the near term, however, some problems can be addressed through the
continued efforts and commitment of IRS senior management and staff. IRS
will need to continue to refine the accounting procedures it relies on to
compensate for the deficiencies in its automated systems. More

important, IRS will need to continue its efforts to enhance the way it
processes transactions, maintains records, and reports financial results.
Other problems, which involve IRS modernizing its financial management
systems, will take years to fully achieve and require the continued
commitment of the new Commissioner if they are to be brought to a
successful conclusion.

Human Capital Management

IRS*s new human capital performance management system could be a powerful
tool in helping the agency achieve its mission. The system could reinforce
behaviors that support strategic goals by clearly aligning employee and
organizational objectives, ensuring that managers* expectations are
specific and output- or outcome- oriented, and monitoring whether employee
feedback is useful and aligned with IRS*s goals. To help ensure IRS
achieves such benefits, we have made several

recommendations. For example, for telephone performance, we have called
for systems and evaluations to identify gaps in assistors* skills, meet
training needs to fill those gaps, monitor and address the causes of
attrition, and ensure that human capital management practices help IRS
achieve taxpayer service goals. Similarly, with respect to BSM, we have
recommended full implementation of its strategic approach for ensuring
sufficient human capital resources.

Realizing increased staffing levels for taxpayer service and compliance
programs, called for in IRS*s recent budget requests, has proven to be
challenging. Since 2001, IRS*s budget requests have made increasing its

compliance and collection staff one of several key priorities. In its 2001
budget request, IRS asked for funding for the Staffing Tax Administration
for Balance and Equity initiative, which was designed to provide
additional

staff for examination, collection, and other enforcement activities.
However, as shown in figures 7 and 8, staffing in two key compliance and
collections occupations were lower in 2002 than in 2000. This continues a
general trend of declining staffing in these occupations for a number of
years. Increasing Resources for

Service and Compliance

Page 26 GAO- 03- 796T

Figure 7: Number of Revenue Agents, Fiscal Years 1996- 2002 Figure 8:
Number of Revenue Officers, 1996- 2002

The declines in compliance and collection staffing occurred for several
reasons, including increased workload and unfunded costs. In September
2002, the Commissioner attributed the decline in compliance staffing to
increases in workload in other essential operations, such as processing
returns, issuing refunds, and answering taxpayer mail. In the most
recently

Page 27 GAO- 03- 796T

completed fiscal year, 2002, IRS faced unbudgeted cost increases, such as
rent and pay increases, of about $106 million. As a result, IRS had to
delay hiring revenue agents and officers. IRS noted in its 2002 budget
request that any major negative changes in the agency*s financial posture,
such as unfunded salary increases, will have a negative effect on staffing
levels.

IRS has also been unable to realize internal savings that would allow it
to shift staff to higher priority areas. Our review of IRS*s 2004 budget
request, as well as its experience thus far in fiscal year 2003, raises
questions about whether IRS will be able to achieve the proposed internal
savings. According to IRS officials, four of the seven most significant
efforts outlined in its 2004 budget request* in terms of staff years and
dollars to be saved* will not achieve all of their projected savings
because the projections were based on assumptions that will not be
realized.

Recent trends in the electronic filing program also have implications for
IRS*s ability to shift resources to higher priority areas. The increase to
an estimated 53 million returns represented the smallest percentage
increase in the last 9 years. The current growth rate will not allow IRS
to achieve its goal to have 80 percent of all tax returns filed
electronically by 2007. Instead, based on current growth rates, IRS will
achieve about 61 percent of all individual returns by 2007.

This year, like every other year since the initiation of electronic
filing, IRS has taken actions to alleviate impediments to electronic
filing and encourage taxpayers to file electronically. IRS entered into an
agreement with the Free File Alliance, a consortium of 17 tax preparation
companies, to offer free on- line tax preparation and filing services for
at least 60 percent of all taxpayers. However, as of April 16, 2003, only
about 2.7 million taxpayers file via the Free File Alliance consortium,
and IRS estimated that only about 1 million were new electronic filers.
Slower growth in electronic filing will reduce IRS*s ability to shift
resources out of paper return processing. IRS has come a long way from
where it was in the mid- 1990s. It is easy to

lose sight of progress when it is gradual, but over the last 5 years, IRS
has significantly enhanced its management capabilities and has succeeded
in improving service to taxpayers. This progress in modernizing was
achieved with a consistent, sustained focus on certain fundamentals of
good management, such as controls over systems acquisition, financial
data, and performance measures. Concluding

Observations

Page 28 GAO- 03- 796T

Looking forward, IRS will be challenged to meet the expectations of
taxpayers and Congress. The same focus on management fundamentals that
proved successful over the last 5 years should help the new Commissioner
deal with these challenges.

Mr. Chairman, this concludes my prepared statement. I would be happy to
answer any questions.

(450209)

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