IRS Modernization: Continued Progress Requires Addressing	 
Resource Management Challenges (19-MAY-05, GAO-05-707T).	 
                                                                 
Since the passage of the IRS Restructuring and Reform Act of 1998
(RRA 98), the Internal Revenue Service (IRS) has faced the	 
challenge of managing its resources to simultaneously improve	 
service to taxpayers, assure taxpayers' compliance with the tax  
laws, and modernize its antiquated information systems. As	 
requested, this statement provides our assessment of IRS's	 
current performance in the areas of taxpayer service, tax law	 
enforcement, and systems modernization. Looking ahead, this	 
statement also describes the challenges that IRS faces in	 
addressing resource constraints as well as realizing efficiency  
and information systems improvements.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-707T					        
    ACCNO:   A24399						        
  TITLE:     IRS Modernization: Continued Progress Requires Addressing
Resource Management Challenges					 
     DATE:   05/19/2005 
  SUBJECT:   Agency missions					 
	     Budget administration				 
	     Congressional oversight				 
	     Customer service					 
	     Information security				 
	     Internal controls					 
	     Performance management				 
	     Performance measures				 
	     Strategic planning 				 
	     Tax administration 				 
	     Tax administration systems 			 
	     Tax law						 
	     Taxpayers						 
	     IRS Business Systems Modernization 		 
	     Program						 
                                                                 
	     IRS National Research Program			 

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GAO-05-707T

                 United States Government Accountability Office

GAO 	Testimony Before Congressional Committees

For Release on Delivery

Expected at 3:00 p.m. EDT IRS MODERNIZATION

Thursday, May 19, 2005

     Continued Progress Requires Addressing Resource Management Challenges

Statement of James R. White, Director
Strategic Issues

David A. Powner, Director
Information Technology Management Issues

Steven J. Sebastian, Director
Financial Management and Assurance

Gregory C. Wilshusen, Director
Information Security Issues

GAO-05-707T

[IMG]

May 19, 2005

IRS MODERNIZATION

Continued Progress Requires Addressing Resource Management Challenges

What GAO Found

IRS's most noticeable progress has been in IRS's taxpayer service, which
has been of special concern to the Congress. Since the passage of RRA 98,
improvements in access to IRS by telephone, the accuracy of answers given
to taxpayer inquiries, and the growth of IRS's Web site, which now
provides a variety of services, have been noteworthy accomplishments.

IRS experienced declines in enforcement staffing after 1998, but recently
stopped the declines and begun to show increases. Despite this,
enforcement remains a high risk area because of the continued need to
improve enforcement and make progress towards reducing the tax gap.

IRS has made significant progress in establishing management controls and
acquiring infrastructure as part of the BSM program, as well as
significant progress in addressing financial management issues. However,
BSM remains at risk because of the scope and complexity of modernization
activities and the need for better management capacity to avoid repeating
the program's history of schedule delays and cost overruns.

Looking ahead, continuing the progress described above depends on IRS
addressing resource constraints and realizing efficiency and systems
improvements. We highlight several such opportunities:

o  	Developing long-term goals would help IRS and Congress assess agency
performance and make budget decisions.

o  	Considering additional funding enhancements such as user fees and
private debt collection which may help mitigate budget constraints.

o  	Leveraging nonfederal partners such as states to assist with tax law
enforcement and volunteers to help provide taxpayer service.

o  	Prioritizing taxpayer service activities could help IRS minimize the
impact of budget cuts.

o  	Targeting enforcement resources could help IRS make more efficient use
of available resources and help the agency make progress towards reducing
the tax gap.

o  	Creating the necessary systems to enable IRS to develop accurate cost
accounting information would help IRS make resource allocation decisions.

o  	Developing and using better productivity data would help IRS make
productivity improvements and thereby make better use of available
resources.

o  	Making needed management improvements would help IRS bring planned new
information systems on-line in a timely and cost-effective manner.

o  	Making needed improvements to assure information systems security
would reduce vulnerabilities.

                 United States Government Accountability Office

Mr. Chairman and Members of the Committees:

Mr. Chairman, we are pleased to participate in this joint review of the
Internal Revenue Service (IRS). Since passage of the IRS Restructuring and
Reform Act of 1998 (RRA 98), IRS has faced the challenge of managing its
resources to simultaneously improve service to taxpayers, assure
taxpayers' compliance with the tax laws, and modernize its antiquated
information systems. As you are well aware, making these improvements is
important. IRS is responsible for collecting the roughly $2 trillion in
tax revenue used to fund the government and annually touches more
Americans than any other federal agency. IRS's service and enforcement
efforts influence Americans' confidence in the fairness of the tax system
and their perception of the effectiveness of their government.

As requested, this statement provides our assessment of IRS's current
performance in all three areas. We then look ahead, describing the
challenges that IRS faces in addressing resource constraints as well as
realizing efficiency and information systems improvements.

Our discussion of both recent progress and challenges facing IRS is based
primarily on recently issued GAO products. We used our recent reports and
testimony on IRS's budget, the tax gap, filing season reviews, financial
audits, systems modernization activities, Business Systems Modernization
(BSM) expenditure plans, and information security. Our work was performed
in accordance with generally accepted government auditing standards.

In summary, IRS has made progress in improving service and modernizing
operations, but the gains have not been uniform. The most noticeable
progress has been in IRS's taxpayer service, an area that has been of
special concern to the Congress. Access to IRS by telephone, the accuracy
of answers given to taxpayer inquiries, and the growth of IRS's Web site,
which now provides a variety of services, including forms and
instructions, information on the status of refunds, and answers to
frequently asked questions, have been noteworthy accomplishments in the
years since passage of RRA 98. With respect to tax law enforcement, IRS
experienced declines in enforcement staffing after 1998 but has recently
stopped the declines and begun to show increases. However, tax law
enforcement remains a high-risk area because of the need to improve
enforcement and make progress towards reducing the tax gap-the

difference between taxes owed and taxes paid on time.1 As for systems
modernization, IRS has made significant progress in establishing
longoverdue management controls and in acquiring foundational system
infrastructure and applications as part of the BSM project, as well as
significant progress in addressing financial management issues. However,
BSM remains at risk because of the scope and complexity of modernization
activities and the need for better management capacity to avoid repeating
the program's history of schedule delays and cost overruns.

Looking ahead, continued progress depends on IRS addressing resource
constraints and realizing efficiency and systems improvements. Long-term
goals would help stakeholders, including the Congress, evaluate the
adequacy of IRS's budget. Further, additional resources might be brought
to bear by, perhaps, additional user fees or the leveraging of nonfederal
partners beyond what is now done with states and volunteers. Efficiency
gains may be possible by, for example, prioritizing taxpayer services in
order to focus on those that provide greater benefit, targeting
enforcement by using better data on noncompliance, collecting more
accurate cost information to improve day-to-day and long-term decision
making, and realizing productivity improvements. Finally, IRS needs to
bring planned new systems on line in a timely and cost-effective manner
while also assuring systems security. GAO has outstanding recommendations
related to taxpayer service, tax law enforcement, BSM, and systems
security. IRS is in general agreement with our recommendations and is in
the process of implementing many of them.

1 In April 2005, we discussed the tax gap in testimony before the Senate
Committee on Finance (GAO-05-527T). In our statement, we reported that IRS
recently released its tax gap estimate for tax year 2001. IRS estimated
that the difference between taxes owed and taxes paid on time was between
$312 billion and $353 billion. After tax law enforcement recovers a
portion of the unpaid taxes, IRS estimates it will eventually recover some
of this tax gap, resulting in a net tax gap of between $257 billion and
$298 billion in tax year 2001.

IRS Has Improved IRS has made noticeable progress in improving taxpayer
service since

passage of RRA 98. While progress has also been made in the tax law
Taxpayer Service enforcement and BSM areas, however, serious ongoing
issues have kept but Enforcement both on our high-risk list.2

  and BSM Remain High Risk

IRS Has Improved IRS has made meaningful progress in four key taxpayer
service areas; Taxpayer Service but paper and electronic processing,
telephone assistance, IRS's Web site, and Is Shifting Priorities walk-in
assistance. Table 1 shows IRS performance in these areas since

2002. While the progress is widespread, table 1 also shows that there are
some areas of performance that merit attention, especially in light of
current and proposed cuts to IRS's taxpayer service budget. In fiscal year
2005 and in its proposed 2006 budget, IRS is shifting priorities by
reducing taxpayer service and increasing resources for enforcement.

2 GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.: January
2005).

  Table 1: IRS Performance in the First Weeks of the Filing Season, 2002-2005

Volume in thousands

                 Actual returns processeda 2002 2003 2004 2005

                       Paper 24,491 22,117 20,232 17,607

                     Electronic 35,067 38,627 42,988 45,848

                              Telephone assistance

                    Total callsb                  34,489 27,905 29,058 23,340 
               Answered by assistors              9,208  9,434  10,116  9,421 
               Answered by automation             25,281 18,471 18,942 13,919 
      Customer service representative level of                                
                      service                        62%  82%    84%      83%

c

    Average speed of answer 227 seconds 183 seconds 199 seconds 235 seconds

Accounts accuracy rate estimatesd 88% 88% 89% 92% +/- 1% +/- 1% +/- 1% +/-
1%

d

Tax law accuracy rate estimates 84% 81% 76% 87% +/- 1% +/- 1% +/- 1% +/-
1%

                              Internet assistance

             Forms and publications downloadede N/A N/A N/A 70,321

f

                Refund status inquiries N/A 9,300 14,300 16,400

                               Walk-in assistance

                 Total walk-in contactsg N/A 2,740 2,433 2,163

h

Returns prepared at IRS walk-in sites 436 291 186

i

Returns prepared at volunteer sites 466 594 741

Source: IRS.

aFrom January 1 to March 22, 2002; March 21, 2003; March 19, 2004; and
March 18, 2005.

bTotal calls (i.e., calls answered by assistors and automation) and CSR
level of service are based on actual counts from January 1 to March 16,
2002; March 15, 2003; March 13, 2004; and March 12, 2005. The 2002 totals
include increased call demand as a result of the Economic Growth and Tax
Relief Reconciliation Act of 2001 (Pub. L. No. 107-16 (2001)).

cFrom January 1 to March 16, 2002; March 15, 2003; March 13, 2004; and
March 12, 2005.

dBased on a representative sample estimated at the 90 percent confidence
level from January to February 2002, 2003, 2004, and 2005.

eAs of February 28, 2005.

                               Returns Processing

fFrom January 1 to March 20, 2003; 2004; and 2005.

gFrom January 1 to March 15, 2003; March 13, 2004; and March 12, 2005.

hFrom January 1 to March 16, 2002; March 15, 2003; March 13, 2004; and
March 12, 2005.

iFrom January 1 to March 9, 2002; March 8, 2003; March 13, 2004; and March
12, 2005.

As shown in table 1, electronic filing has increased while paper filing
has dropped. The increase in electronic filing has allowed IRS to reduce
the resources devoted to processing. As shown in figure 1, IRS reduced the
staff devoted to processing paper returns between 1999 and 2004 by just
over 1,100 staff years. The figure also shows that as the number of
e-filed returns has increased, the number of staff years used to process
those returns has not increased. The decline in paper processing staff
allowed IRS to close its Brookhaven processing center in 2003.3 In
addition, IRS is in the process of closing its paper processing operation
in Memphis.

3 In March 2005 we reported that IRS successfully completed the rampdown
at Brookhaven without any significant disruptions in service.
(GAO-05-319R)

                              Telephone Assistance

Figure 1: Change in Methods of Tax Return Filing Since 1999

Staff years

Individual tax returns (in millions) 5,000 120

4,500

100 4,000

3,500 80

3,000

2,500 60

2,000

40 1,500

1,000 20

500

                                       00

                   1999 2000 2001 2002 2003 2004 2005a 2006a

Fiscal year

Staff years devoted to electronic filing

Staff years for selected major paper processing activities

Electronic returns processed

Paper returns processed

Source: GAO analysis of IRS data.

aFiscal years 2005 and 2006 are IRS projections and, given the current
lower e-file growth rates, the estimates may be optimistic.

In addition to saving IRS resources, electronic filing offers benefits to
taxpayers in that it allows taxpayers to receive refunds faster and is
less error prone. IRS employees manually transcribe paper tax return
information into IRS's computer systems, which can introduce errors.

As shown in table 1, by several measures IRS's telephone service has
improved since 2002. One measure of access, the customer service
representative (CSR) level of service (the percentage of taxpayers who
attempted to reach CSRs and actually got through and received service)
increased from 62 percent to 83 percent. Accuracy also showed some
improvement; accounts accuracy (accuracy of answers to taxpayer questions
about their accounts) exceeded 90 percent in 2005. However, taxpayers are
waiting somewhat longer in 2005 to get answers than in 2002, 2003, and
2004.

Web Site

IRS and Volunteer Walk-in Sites

IRS's Web site is performing well. A relatively recent addition to IRS's
menu of services, the Web site first became available during the 1996
filing season. We found it to be user friendly because it was readily
accessible and easy to navigate. An independent weekly study ranked it in
the top 4 out of 40 federal government web sites in terms of
accessibility.

The site is used extensively. In the early weeks of the 2005 filing season
the IRS Web site was visited about 83 million times by users who viewed
about 628 million pages and downloaded about 70.3 million forms and
publications. IRS's Web site continues to provide two very important tax
service features: (1) "Where's My Refund," which enables taxpayers to
check on the status of their refund and (2) Free File, which provides
taxpayers the ability to file their tax return electronically for free.
This filing season IRS provided new functionality for "Where's My Refund"
whereby taxpayers whose refunds could not be delivered by the Postal
Service (i.e., returned as undeliverable mail), could change their
addresses on the Web site.

Taxpayer use of IRS's walk-in sites has decreased while use of volunteer
sites has increased. As shown in figure 2, IRS projects it will see about
3.4 million visits to its 400 walk-in sites this year, down from over 3.5
million in 2004 and about 4.3 million in 2001. Over the same period, IRS
expects taxpayer visits to volunteer sites to increase to just over 2
million visits in 2005; a substantial increase over about 1.6 million
visits in 2004 and fewer than 1 million in 2001. IRS continues to
encourage taxpayers to use volunteer sites for return preparation.

Figure 2: Assistance Provided by IRS Walk-in and Volunteer Sites,
2001-2006 Filing Seasons

Millions at IRS walk-in sites

Millions at volunteer sites 66

55

44

33

22

11

0 0.20 0 2001 2002 2003 2004 2005a 2006a 2001 2002 2003 2004 2005a 2006a
Fiscal year Fiscal year

Return preparation at walk-in sites Return preparation at volunteer sites

Other walk-in contacts

Source: GAO-05-416T page p.33, and GAO of IRS data.

Note: "Other walk-in contacts" includes assistance for account notices,
tax law inquiries, forms, and
compliance work, but not return preparation. For the walk-in sites, the
time periods covered are
December 31, 2000, through April 28, 2001; December 30, 2001, through
April 27, 2002;
December 29, 2002, through April 26, 2003; and December 28, 2003, through
April 24, 2004. For
volunteer sites, the time period covered for 2001 is January 1, 2001,
through April 21, 2001; all other
periods are the same as those for IRS walk-in sites.

aFiscal years 2005 and 2006 are IRS projections.

This shift is important because it transfers time-consuming services,
particularly return preparation, to volunteers and allows IRS to
concentrate on services that only it can provide, such as account
assistance or compliance work. While it reduces the demand on IRS
resources, the shift from IRS to volunteer sites has raised concerns about
the quality of service provided. We and the Treasury Inspector General for
Tax Administration (TIGTA) have called attention to the quality of service
at both IRS walk-in and volunteer sites. IRS has separate quality
initiatives under way at both IRS walk-in and volunteer sites, although
data remain limited and cannot be compared to prior years.

Post-Filing Taxpayer Service 	Another concern is post-filing service to
taxpayers when IRS has undertaken compliance or collection actions. An
example of this is the release of federal tax liens against taxpayers'
property. IRS is required to release a federal tax lien within 30 days
after the date the tax liability is satisfied or has become legally
unenforceable or the Secretary of the Treasury has accepted a bond for the
assessed tax but, as have we reported for several years as part of our
financial audits, most recently in November 2004, IRS has not always met
this standard.4

IRS Has Stopped Declines In Enforcement Staffing, but Enforcement Remains
High Risk

We have long been concerned about tax noncompliance and IRS efforts to
address it. Collection of unpaid taxes was included in our first high-risk
series report in 1990, with a focus on the backlog of uncollected debts
owed by taxpayers. In 1995, we added Filing Fraud as a separate high-risk
area, narrowing the focus of that high-risk area in 2001 to Earned Income
Credit Noncompliance because of the particularly high incidence of fraud
and other forms of noncompliance in that program. We expanded our concern
about the Collection of Unpaid Taxes in our 2001 high-risk report to
include not only unpaid taxes (including tax evasion and unintentional
noncompliance) known to IRS, but also the broader enforcement issue of
unpaid taxes that IRS has not detected. In our high-risk update that we
issued in January,5 we consolidated these areas into a single high-risk
area-Enforcement of Tax Laws-because we believe the focus of concern on
the enforcement of tax laws is not confined to any one segment of the
taxpaying population or any single tax provision.

Tax law enforcement is a high-risk area in part because of the size of the
tax gap. IRS's recent estimate of the difference between what taxpayers
timely and accurately paid in taxes and what they owed ranged from $312
billion to $353 billion for tax year 2001. IRS estimates it will
eventually recover some of this tax gap, resulting in a net tax gap from
$257 billion to $298 billion. The tax gap arises when taxpayers fail to
comply with the tax laws by underreporting tax liabilities on tax returns;
underpaying taxes due from filed returns; or "nonfiling," which refers to
the failure to file a required tax return altogether or in a timely
manner.

4 GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial
Statements, GAO-05-103 (Washington, D.C.: Nov. 10, 2004).

5 GAO-05-207.

Tax law enforcement is also high risk because past declines in IRS's
enforcement activities threatened to erode taxpayer compliance. In recent
years, the resources IRS has been able to dedicate to enforcing the tax
laws have declined. For example, the number of revenue agents (those who
examine complex returns), revenue officers (those who perform field
collection work), and special agents (those who perform criminal
investigations) decreased over 21 percent from 1998 through 2003. However,
IRS achieved some staffing gains in 2004 and expects modest gains in 2005.
IRS's proposal for fiscal year 2006, if funded and implemented as planned,
would return enforcement staffing in these occupations to their highest
levels since 1999.6

Concurrently, IRS's enforcement workload-measured by the number of
taxpayer returns filed-has continually increased. For example, from 1997
through 2003, the number of individual income tax returns filed increased
by about 8 percent. Over the same period, returns for high-income
individuals grew by about 81 percent.7 Due to their income levels, IRS
believes that these individuals present a particular compliance risk. In
light of declines in enforcement staffing and the increasing number of
returns filed, nearly every indicator of IRS's coverage of its enforcement
workload has declined in recent years. Although in some cases workload
coverage has begun to increase, overall IRS's coverage of known workload
is considerably lower than it was just a few years ago. Figure 3 shows the
trend in examination rates-the proportion of tax returns that IRS examines
each year-for field, correspondence, and total examinations since 1995.
Field examinations involve face-to-face examinations and correspondence
examinations are typically less comprehensive and complex, involving
communication through written notices. IRS experienced steep declines in
examination rates from 1995 to 1999, but the examination rate has slowly
increased since 2000. However, as the figure shows, the increase in total
examination rates of individual filers has been driven mostly by
correspondence examinations, while more complex field examinations
continue to decline.

6 GAO, Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
Request and Interim Results of the 2005 Filing Season, GAO-05-416T
(Washington, D.C.: Apr. 14, 2005).

7 High-income individuals are those reporting $100,000 or more of "total
positive income," which is, in general, the sum of all positive amounts
shown for the various sources of income reported on individual tax returns
and thus excludes net losses.

Figure 3: Audit Rate of Individual Income Tax Returns, Fiscal Years
1995-2004

Audit rate 2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Fiscal year

Field Correspondence Total

Source: GAO analysis of IRS data.

Further, IRS's workload has grown ever more complex as the tax code has
grown more complex. IRS is challenged to administer and explain each new
provision, thus absorbing resources that otherwise might be used to
enforce the tax laws. Concurrently, other areas of particularly serious
noncompliance have gained the attention of IRS and the Congress, such as
abusive tax shelters and schemes employed by businesses and wealthy
individuals that often involve complex transactions that may span national
boundaries. Given the broad declines in IRS's enforcement workforce, IRS's
decreased ability to follow up on suspected noncompliance, and the
emergence of sophisticated evasion concerns, IRS is challenged in
attempting to ensure that taxpayers fulfill their obligations.

On the collection front, IRS's use of enforcement sanctions, such as
liens, levies, and seizures, dropped precipitously during the mid and late
1990s. In fiscal year 2000, IRS's use of these three sanctions was at 38
percent, 7 percent, and 1 percent, respectively, of fiscal year 1996
levels. However, beginning in fiscal year 2001, IRS's use of liens and
levies began to

increase. By fiscal year 2004, IRS's use of liens, levies, and seizures
reached 71 percent, 65 percent, and 4 percent of 1996 levels,
respectively.

IRS is working to further improve its enforcement efforts. In addition to
recent favorable trends in enforcement staffing, correspondence
examinations, and the use of some enforcement sanctions, IRS has recently
made progress with respect to abusive tax shelters through a number of
initiatives and recent settlement offers that have resulted in billions of
dollars in collected taxes, interest, and penalties. In addition, IRS is
developing a centralized cost accounting system, in part to obtain better
cost and benefit information on compliance activities, and is modernizing
the technology that underpins many core business processes. It has also
redesigned some compliance and collections processes and plans additional
redesigns as technology improves. Finally, the recently completed National
Research Program (NRP) study of individual taxpayers not only gives us a
benchmark of the status of taxpayers' compliance but also gives IRS a
better basis to target its enforcement efforts.

IRS Has Made Progress in Implementing BSM, but Program Has History of Cost
Overruns and Schedule Delays and Is High Risk

IRS has long relied on obsolete automated systems for key operational and
financial management functions, and its attempts to modernize these aging
computer systems span several decades. Modernization has encountered a
long history of continuing delays and design difficulties and the impact
of these problems on IRS's operations led GAO to designate IRS's systems
modernization as a high-risk area in 1995 and it remains so today.

IRS's current modernization program, BSM, is a highly complex,
multibillion-dollar program that is the agency's latest attempt to
modernize its systems. BSM is critical to supporting IRS's taxpayer
service and enforcement goals. For example, BSM includes projects to allow
taxpayers to file and retrieve information electronically and to provide
technology solutions to help reduce the backlog of collections cases. BSM
is also important to allow IRS to provide the reliable and timely
financial management information needed to account for the nation's
largest revenue stream and better enable the agency both to determine and
to justify its resource allocation decisions and congressional budgetary
requests.

Over the past year, IRS has deployed initial phases of several modernized
systems under its BSM program. The following provides examples of the
systems and functionality that IRS implemented in 2004 and the beginning
of 2005.

o  	Modernized e-File (MeF). This project is intended to provide
electronic filing for large corporations, small businesses, and tax-exempt
organizations. The initial releases of this project were implemented in
June and December 2004, and allowed for the electronic filing of forms and
schedules for the form 1120 (corporate tax return) and form 990
(tax-exempt organizations' tax return). IRS reported that, during the 2004
filing season, it accepted over 53,000 of these forms and schedules using
MeF.

o  	e-Services. This project created a Web portal and provided other
electronic services to promote the goal of conducting most IRS
transactions with taxpayers and tax practitioners electronically. IRS
implemented e-Services in May 2004. According to IRS, as of late March
2005, over 84,000 users have registered with this Web portal.

o  	Customer Account Data Engine (CADE). CADE is intended to replace IRS's
antiquated system that contains the agency's repository of taxpayer
information and, therefore, is the BSM program's linchpin and highest
priority project. In July 2004 and January 2005, IRS implemented the
initial releases of CADE, which have been used to process filing year 2004
and 2005 1040EZ returns, respectively, for single taxpayers with refund or
even-balance returns. According to IRS, as of March 16, 2005, CADE had
processed over 842,000 tax returns so far this filing season.

o  	Integrated Financial System (IFS). This system replaced aspects of
IRS's core financial systems and is ultimately intended to operate as its
new accounting system of record. The first release of this system became
fully operational in January 2005.

In prior years, IRS deployed several systems, including (1) Customer
Communications 2001, to improve telephone call management, call routing,
and customer self-service applications; (2) Customer Relationship
Management Examination, to provide off-the-shelf software to IRS revenue
agents to allow them to accurately compute complex corporate transactions;
and (3) Internet Refund/Fact of Filing, to improve taxpayer self-service
by providing to taxpayers via the Internet instant refund status
information and instructions for resolving refund problems.

Although IRS is to be applauded for delivering important BSM
functionality, the BSM program is far from complete. Future deliveries of
additional functionality of deployed systems and the implementation of
other BSM projects are expected to have a significant impact on IRS's

taxpayer services and enforcement capability as well as its efforts to
continue to improve its financial management. For example, IRS has
projected that CADE will process about 2 million returns in the 2005
filing season. However, the returns being processed in CADE are the most
basic and constitute less than 1 percent of the total tax returns expected
to be processed during the current filing season. IRS expects the full
implementation of CADE to take several more years. Another BSM project-the
Filing and Payment Compliance (F&PC) project-is expected to increase (1)
IRS's capacity to treat and resolve the backlog of delinquent taxpayer
cases, (2) the closure of collection cases by 10 million annually by 2014,
and (3) voluntary taxpayer compliance. As part of this project, IRS plans
to deliver an initial limited private debt collection capability in
January 2006, with full implementation of this aspect of the F&PC project
to be delivered by January 2008 and additional functionality to follow in
later years. Finally, full implementation of CADE, as well as the
successful implementation of future releases of IFS and efforts to address
the impact of IRS's decision to discontinue the Custodial Accounting
Project (CAP) will be critical to addressing many of IRS's remaining and
long-standing financial management issues.

For IRS to build on the gains made since passage of RRA 98, the agency
must address numerous challenges related to resource management. IRS faces
budgetary constraints that may be addressed in part through the
development of goals for assessing performance and to help in making
budget decisions, looking for opportunities to enhance its funding, and
leveraging the resources of nonfederal partners. IRS also faces the
challenges of improving efficiency in taxpayer service and tax law
enforcement, developing useful cost accounting tools, and improving
productivity. Finally, IRS faces information systems challenges in both
BSM and systems security shortfalls.

  Continued Progress Depends on IRS Addressing Resource Constraints and
  Realizing Efficiency and Systems Improvements

Long-term Goals Would For IRS, the Congress, and IRS's other stakeholders,
long-term goals can Help IRS Assess be used to assess performance and
progress towards these goals, and Performance and Make determine whether
budget decisions contribute to achieving those goals.

Without long-term goals, the Congress and other stakeholders are

Budget Decisions 	hampered in evaluating whether IRS is making
satisfactory long-term progress. Further, without such goals, the extent
to which IRS's 2006 budget request would help IRS achieve its mission over
the long term is less clear.

A recent Program Assessment Rating Tool (PART) review conducted by the
Office of Management and Budget (OMB) reported that IRS lacks longterm
goals.8 As a result, IRS has been working to identify and establish
long-term goals for all aspects of its operations for over a year. 9 IRS
officials said these goals will be finalized and provided publicly as an
update to the agency's strategic plan in the near future.

Long-term goals and results measurement are a component of the statutory
strategic planning and management framework that the Congress adopted in
the Government Performance and Results Act of 1993.10 As a part of this
comprehensive framework, long-term goals that are linked to annual
performance measures can help guide agencies when considering
organizational changes and making resource decisions. For example,
longterm goals would provide IRS with a framework for assessing budgetary
tradeoffs between taxpayer service and enforcement and whether IRS is
making satisfactory progress towards achieving those goals. Similarly,
long-term goals could help identify priorities within the taxpayer service
functions (e.g., if the budget for taxpayer service were to be cut and
efficiency gains did not offset the cut, long-term goals could help guide
decisions about whether to make service cuts across a broad or target
selected services).

Perhaps most important, long-term compliance goals coupled with periodic
measurement of compliance levels would provide IRS with a better basis for
determining to what extent its various day-to-day service

8 The PART was applied during the fiscal year 2004 budget cycle to
"programs" selected by OMB. The PART includes general questions in each of
four broad topics to which all programs are subjected: (1) program purpose
and design, (2) strategic planning, (3) program management, and (4)
program results (i.e., whether a program is meeting its long-term and
annual goals). OMB also makes an overall assessment on program
effectiveness.

9 IRS has one long-term goal set by the Congress in RRA 98 for IRS to have
80 percent of all individual income tax returns filed electronically.

10 Pub. L. No. 103-62 (1993). The Government Performance and Results Act
of 1993 seeks to improve the management of federal programs, as well as
their effectiveness and efficiency, by requiring executive agencies to
prepare multiyear strategic plans, annual performance plans, and annual
performance reports. Under the act, strategic plans are the starting point
for setting goals and measuring progress towards them. The act requires
executive agencies to develop strategic plans that include an agency's
mission statement, long-term general goals, and the strategies that the
agency will use to achieve these goals. The plans should also explain the
key external factors that could significantly affect achievement of these
goals, and describe how long-term goals will be related to annual
performance goals.

and enforcement efforts contribute to compliance in the long run.
Furthermore, long-term, quantitative goals may help IRS consider new
strategies to improve compliance, especially since these strategies could
take several years to implement. For example, IRS's progress toward the
goal of having 80 percent of all individual tax returns electronically
filed by 2007 has required enhancement of its technology, development of
software to support electronic filing, education of taxpayers and
practitioners, and other steps that could not be completed in a short time
frame. Focusing on intended results can also promote strategic and
disciplined management decisions that are more likely to be effective
because managers who use fact-based performance analysis are better able
to target areas most in need of improvement and select appropriate
interventions.

Considering Funding Enhancements Could Help Mitigate Budget Constraints

Identifying potential new sources of funds could be an opportunity for
helping to mitigate IRS's budget constraints. Current examples of resource
enhancers-user fees and private debt collection-may provide useful models
for IRS and Congress to consider. User fees are collected from
identifiable recipients of special benefits beyond those accruing to the
general public. In 2004, IRS collected over $137 million in user fees for
a wide range of services, including installment agreements, offers in
compromise, and Freedom of Information Act (FOIA) requests.11 In fiscal
year 2004, about 82 percent of all user fees collected by IRS were for
installment agreements or Employee Plans and Exempt Organizations letter
rulings and determination letters.12 The 1995 Treasury Appropriation Act
specifies that IRS can keep a maximum of $119 million per year of the user
fees it collects, with the rest of the user fees going into the Treasury

11 Installment agreements are for taxpayers who cannot pay the full amount
owed on their tax returns when due. IRS charges a one-time fee to these
taxpayers, and allows them to make monthly installment payments. An offer
in compromise (OIC) is an agreement between a taxpayer and IRS that
resolves the taxpayer's tax liability for less than the full amount owed
for taxes, interest, and penalties. IRS charges a one-time fee. FOIA
requestors are charged a one-time fee and are provided with agency records
as requested, with some exceptions.

12 A letter ruling is a written determination issued in response to a
written inquiry from an individual or an organization about its status for
tax purposes or the tax effects of its acts or transactions, prior to the
filing of returns or reports that are required by the revenue laws. A
determination letter is a written determination that applies the
principles and precedents previously announced by IRS to a specific set of
facts. It is issued only when a determination can be made based on clearly
established rules in a statute, a tax treaty, the regulations, a
conclusion in a revenue ruling, or an opinion or court decision that
represents the position of IRS.

general fund. In 2004, IRS retained about $90 million from the user fees
collected (see table 2). In comparison, IRS's total spending in 2004 was
$10.7 billion.

Table 2: User Fees and Reimbursable User Fees Collected by IRS, Fiscal Year 2004

                              Dollars in millions

                                      Fiscal year 2004 User fees to User fees 
                                            user                     retained 
                Fee type                fees collected General Fund    by IRS 
         Installment agreements                   69.4          0.0 
          Offers in compromise                     6.6          0.0 
       Employee plans and exempt                  43.1         41.2 
             organizations                                          
    letter rulings and determination                                
                letters                                             
    Chief Counsel letter rulings and               9.3          5.5 
         determination letters                                      
    Photocopy reimbursable user fees               6.4          0.0 
                 Other                             2.8          1.2 
                 Total                           137.6         47.9 

Source: IRS officials.

In setting certain user fees, IRS must follow Internal Revenue Code (IRC)
Section 7528, which authorizes user fees for letter rulings, opinion
letters, determination letters, and similar requests.13 IRC Section 7528
requires that user fees (1) vary according to categories or subcategories,
(2) take into account the average time and difficulty of requests by
categories or subcategories, (3) be payable in advance, and (4) be subject
to appropriate exemptions and reduced fees within limits specified by
Section 7528. IRS is precluded from expending any fees collected pursuant
to IRC Section 7528 unless provided by an appropriations act. As mentioned
earlier, the 1995 Treasury Appropriation Act specifies that IRS can keep a
maximum of $119 million per year in user fee collections.

13 Section 7528 was added to the Code by section 202 of the Temporary
Assistance for Needy Families Block Grant Program, Pub. L. 108-89, and was
extended to September 30, 2014, by section 690 of the American Jobs
Creation Act of 2004, Pub. L. 108-357.

OMB Circular A-25, User Charges, establishes general federal policy for
user fees assessed for government services by executive branch agencies.14
A-25 requirements include (1) identifying services and activities that
convey special benefits; (2) determining their full cost or market price,
as appropriate; (3) biennial reviews of user fees for unanticipated cost
or market price changes; and (4) biennial reviews of agency programs not
subject to user fees to determine if such fees should be assessed.

Private debt collection provides another example of a revenue enhancement
model that may be useful for IRS. The 2004 American Jobs Creation Act
permitted IRS to contract with private collection agencies (PCA) to
collect some federal tax debts and allows IRS to keep a portion of the
funds collected by PCAs.15 PCAs will not replace IRS's own collection
resources, but will handle cases that do not require enforcement action or
discretion in resolving tax liabilities. According to IRS, the private
debt collection program will help reduce the significant and growing
amount of uncollectable cases that are not currently collected, and enable
IRS to focus existing resources to address more difficult cases. IRS will
begin a limited implementation phase of the private debt collection in
2005, and full implementation is planned for 2007. The law allows IRS to
retain and use up to 25 percent of any amounts collected to pay for
collection services and IRS collection enforcement activities. IRS expects
to retain $10 million of PCA collections in fiscal year 2007 and more in
later years.

Leveraging Nonfederal Partners Is Another Way to Accomplish More

IRS has leveraged nonfederal resources to make improvements to taxpayer
service and tax law enforcement. The examples below highlight the variety
of such leveraging and could provide a basis for exploring whether
additional such opportunities exist.

One example involving taxpayer service is the Free File Alliance. In 2003
IRS entered into a 3-year agreement with the Free File Alliance, a
consortium of tax preparation companies that provides free electronic
filing to taxpayers who access any of the companies via a link on IRS's

14 Circular A-25 applies to executive branch agencies assessing charges
under the general user fee statute enacted in the Independent Offices
Appropriations Act of 1952 and codified at 31 U.S.C. 9701. The circular
also provides guidance to agencies imposing user fees under other statutes
to the extent that the circular is not inconsistent with the statute in
question.

15 The American Jobs Creation Act of 2004, P.L. 108-357.

Web site. IRS has benefited from this partnership because it encourages
electronic filing of tax returns. For example, as of March 16, 2005, 3.6
million tax returns had been filed via Free File, which represents a 44
percent increase over the same time period last year.

IRS has also established partnerships with states and several cities to
assist in combating abusive tax schemes.16 In September 2003, IRS
announced the establishment of a nationwide partnership to combat abusive
tax avoidance. Under agreements with individual states, IRS shares
information on abusive tax avoidance transactions and those taxpayers who
participate in them. The agreements creating this partnership were
designed to enable States and IRS to move more aggressively in addressing
this tax compliance problem. The partnership also includes joint public
outreach activities to more effectively counter the claims of those
marketing tax schemes.

Another example of IRS's effort to leverage nonfederal resources is the
over 13,500 volunteer sites run by community-based coalitions. IRS awards
grants, trains and certifies volunteers, and provides reference materials,
computer software and, in some cases, computers to these volunteer
organizations to assist primarily low-income and elderly taxpayers prepare
their returns. Since 2001, the number of taxpayers seeking return
preparation assistance at volunteer sites has increased an average of 19
percent per year. During the 2004 filing season, taxpayers had over five
times more returns prepared at volunteer sites than at IRS walk-in sites.
This trend reflects IRS's strategy to shift return preparation to sites
staffed by volunteer and community-based coalitions that are overseen by
IRS. IRS has encouraged the shift by advertising the locations of these
sites.

As we noted earlier, the shift of taxpayers from walk-in to volunteer
sites is important because it has transferred time-consuming services,
particularly return preparation, from IRS to volunteer sites and allowed
IRS to concentrate on services that only it can provide, such as account
assistance or compliance work. However, as we also noted earlier, there
have been concerns raised about the quality of service at both walk-in and

16 Abusive tax schemes encompass distortions of the tax system such as
falsely describing the law (saying, for example, that the income tax is
unconstitutional), misrepresenting facts (for instance, promoting the
deduction of personal expenses as business expenses), or using trusts or
offshore bank accounts to hide income.

volunteer sites. In addition, in her January 2005 report,17 the Taxpayer
Advocate expressed concern about the reduction of face-to-face services,
such as those offered at walk-in sites. She stated that IRS's plan does
not adequately provide for the segment of the population that continues to
rely on the interaction provided by walk-in sites. Better data about the
quality of service at volunteer sites would provide a baseline for making
decisions about how to better manage quality.

Prioritizing Taxpayer Service Could Minimize Impacts of Budget Cuts

For at least two reasons, this is an opportune time to review the menu of
taxpayer services that IRS provides. First, IRS's budget for taxpayer
services was reduced in 2005 and an additional reduction is proposed for
2006. These reductions have forced IRS to propose scaling back some
services, including the hours of telephone contact availability. Second,
as we have reported, IRS has made significant progress in improving the
quality of its taxpayer services. For example, IRS now provides many
Internet services that did not exist a few years ago, and has noticeably
improved the quality of telephone services. This opens up the possibility
of maintaining the overall level of taxpayer service but with a different
menu of service choices. Cuts in selected services could be offset by the
new and improved services.

Generally, as indicated in the budget, the menu of taxpayer services that
IRS provides covers assistance, outreach, and processing. Assistance
includes answering taxpayer questions via telephone, correspondence, and
face to face at its walk-in sites. Outreach includes educational programs
and the development of partnerships. Processing includes issuing millions
of tax refunds.

When considering program reductions, we support a targeted approach rather
than across-the-board cuts.18 A targeted approach helps reduce the risk
that effective programs are reduced or eliminated while ineffective or
lower priority programs are maintained.

With the above reasons in mind for reconsidering IRS's menu of services,
we have compiled a list of options for targeted reductions in taxpayer

17 National Taxpayer Advocate, 2004 Annual Report to Congress (Washington,
D.C.: Dec. 31, 2004)

18 GAO, 21st Century Challenges: Reexamining the Base of the Federal
Government, GAO-05-325SP (Washington, D.C.: February 2005).

service. The options on this list are not recommendations, but are
intended to contribute to a dialogue about the tradeoffs faced when
setting IRS's budget. The options presented meet at least one of the
following criteria that we generally use to evaluate programs or budget
requests.19 These criteria include that the activity:

o  duplicates other efforts that may be more effective and/or efficient;

o  	historically does not meet performance goals or provide intended
results as reported by GAO, TIGTA, IRS, or others;

o  experiences a continued decrease in demand;

o  	lacks adequate oversight, implementation and management plans, or
structures and systems to be implemented effectively;

o  	has been the subject of actual or requested funding increases that
cannot be adequately justified; or

o  	has the potential to make an agency more self-sustaining by charging
user fees for services provided.

We recognize that the options listed below involve tradeoffs. In each
case, some taxpayers would lose a service they use. However, the savings
could be used to help maintain the quality of other services. We also want
to give IRS credit for identifying savings, including some on this list.
The options include the following:

o  	Closing walk-in sites. As discussed previously, taxpayer demand for
walkin services has continued to decrease and staff answer a more limited
number of tax law questions in person than staff answer via telephone.

o  	Limiting the type of telephone questions answered by IRS assistors.
IRS assistors still answer some refund status questions even though IRS
provides automated answers via telephone and its Web site.

o  	Mandating electronic filing for some filers such as paid preparers or
businesses. As noted, efficiency gains from electronic filing have enabled
IRS to consolidate paper processing operations.

o  	Charging for services. For example, IRS provides paid preparers with
information on federal debts owed by taxpayers seeking refund anticipation
loans.

19 The derivation of these criteria is detailed in our earlier testimony,
Internal Revenue Service: Assessment of Fiscal Year 2006 Budget Request
and Interim Results of the 2005 Filing Season, GAO-05-416T (Washington,
D.C.: Apr 14, 2005).

Targeting Enforcement Could Make More Efficient Use of Resources

Multiple enforcement strategies could help IRS reduce the tax gap. Given
its size, even small or moderate reductions in the net tax gap could yield
substantial returns. For example, based on IRS's most recent estimate, a 1
percent reduction in the net tax gap would likely yield more than $2.5
billion annually.

Although reducing the tax gap may be an attractive means to improve the
nation's fiscal position, achieving this end will be a challenging task
given persistent levels of noncompliance. IRS has made efforts to reduce
the tax gap since the early 1980s; yet the tax gap is still large-although
without these efforts it could be even larger. Also, IRS is challenged in
reducing the tax gap because the tax gap is spread across the five
different types of taxes that IRS administers, and a substantial portion
of the tax gap is attributed to taxpayers who are not subject to
withholding or information reporting requirements. Moreover, as we have
reported in the past,20 closing the entire tax gap may not be feasible or
desirable, as it could entail more intrusive recordkeeping or reporting
than the public is willing to accept or more resources than IRS is able to
commit.

Although much of the tax gap that IRS currently recovers is through
enforcement actions, a sole focus on enforcement will not likely be
sufficient to further reduce the net tax gap. Rather, the tax gap must be
attacked on multiple fronts and with multiple strategies on a sustained
basis. For example, efforts to simplify the tax code and otherwise alter
current tax policies may help reduce the tax gap by making it easier for
individuals and business to understand and voluntarily comply with their
tax obligations. For instance, reducing the multiple tax preferences for
retirement savings or education assistance might ease taxpayers' burden in
understanding and complying with the rules associated with these options.
Also, simplification may reduce opportunities for tax evasion through
vehicles such as abusive tax shelters. For any given set of tax policies,
IRS's efforts to reduce the tax gap and ensure appropriate levels of
compliance will need to be based on a balanced approach of providing
service to taxpayers and enforcing the tax laws.

Furthermore, providing quality services to taxpayers is an important part
of any overall strategy to improve compliance and thereby reduce the tax

20 GAO, Taxpayer Compliance: Analyzing the Nature of the Income Tax Gap,
GAO/T-GGD-97-35 (Washington, D.C.; Jan. 9, 1997).

gap. As we have reported in the past,21 one method of improving compliance
through service is to educate taxpayers about confusing or commonly
misunderstood tax requirements. For example, if the forms and instructions
taxpayers use to prepare their taxes are not clear, taxpayers may be
confused and make unintentional errors. One method to ensure that forms
and instructions are sufficiently clear is to test them before use.
However, we reported in 2003 that IRS had tested revisions to only five
individual forms and instructions from July 1997 through June 2002,
although hundreds of forms and instructions had been revised in 2001
alone.22

Finally, in terms of enforcement, IRS will need to use multiple strategies
and techniques to find noncompliant taxpayers and bring them into
compliance. One pair of tools has been shown to lead to high levels of
compliance: withholding tax from payments to taxpayers and having third
parties report information to IRS and the taxpayers on income paid to
taxpayers. For example, banks and other financial institutions provide
information returns (Forms 1099) to account holders and IRS showing the
taxpayers' annual income from some types of investments. Similarly, most
wages, salaries, and tip compensation are reported by employers to
employees and IRS through Form W-2. Preliminary findings from NRP indicate
that more than 98.5 percent of these types of income are accurately
reported on individual returns.

Regularly measuring compliance can offer many benefits, including helping
IRS identify new or major types of noncompliance, identify changes in tax
laws and regulations that may improve compliance, more effectively target
examinations of tax returns or other enforcement programs, understand the
effectiveness of its programs to promote and enforce compliance, and
determine its resource needs and allocations. For example, by analyzing
1979 and 1982 compliance research data, IRS identified significant
noncompliance with the number of dependents claimed on tax returns and
justified a legislative change to address the noncompliance. As a result,
for tax year 1987, taxpayers claimed about 5 million fewer dependents on
their returns than would have been expected without the change in law. In
addition, tax compliance data are

21 GAO/T-GGD-97-35.

22 GAO, Tax Administration: IRS Should Reassess the Level of Resources for
Testing Forms and Instructions, GAO-03-486 (Washington, D.C.: Apr. 11,
2003).

useful outside of IRS for tax policy analysis, revenue estimating, and
research.

IRS research officials have proposed a compliance measurement study that
will allow IRS to update underreporting estimates involving flow-through
entities. This study, which IRS intends to begin in fiscal year 2006,
would take 2 to 3 years to complete. Because either individual taxpayers
or corporations may be recipients of income (or losses) from flow-through
entities, this study could affect IRS's estimates for the underreporting
gap for individual and corporate income taxes.

While these data and methodology updates could improve the tax gap
estimates, IRS has no documented plans to periodically collect more or
better compliance data over the long term. Other than the proposed study
of flow-through entities, IRS does not have plans to collect compliance
data for other segments of the tax gap. Also, IRS has indicated that given
its current research priorities, it would not begin another NRP study of
individual income tax returns before 2008, if at all, and would not
complete such a study until at least 2010. When IRS initially proposed the
NRP study, it had planned to study individual income tax underreporting on
a 3-year cycle.

According to IRS officials, IRS has not committed to regularly collecting
compliance data because of the associated costs and burdens. Taxpayers
whose returns are examined through compliance studies such as NRP bear
costs in terms of time and money. Also, IRS incurs costs, including direct
costs and opportunity costs-revenue that IRS potentially forgoes by using
its resources to examine randomly selected returns, which may include
returns from compliant taxpayers, as opposed to traditional examinations
that focus on taxpayer returns that likely contain noncompliance and may
more consistently produce additional tax assessments.

Although the costs and burdens of compliance measurement are legitimate
concerns, as we have reported in the past, we believe compliance studies
to be good investments. Without current compliance data, IRS is less able
to determine key areas of noncompliance to address and actions to take to
maximize the use of its limited resources. The lack of firm plans to
continually obtain fresh compliance data is troubling because the
frequency of data collection can have a large impact on the quality and

utility of compliance data. As we have reported in the past, the longer
the time between compliance measurement surveys, the less useful they
become given changes in the economy and tax law.23

In designing its recently completed NRP study, IRS balanced the costs,
burdens, and compliance risk of studying that area of the tax gap. Any
plans for obtaining and maintaining reasonably current information on
compliance levels for all portions of the tax gap would similarly need to
take into account costs, burdens, and compliance risks in determining
which areas of compliance to measure and the scope and frequency of such
measurement.

The NRP survey had an added benefit of including the use of casebuilding
to aid examiners in determining whether IRS needs to have any contact with
taxpayers to verify the accuracy of information reported on their tax
returns. The casebuilding tools consisted of data from both IRS and
thirdparty sources. IRS's NRP casebuilding included return information
from the prior 3 years, audit history, payment and filing history,
information return data reported by third parties (banks, lending
institutions, and others), and bank reports on large cash transactions.
NRP casebuilding tools also included data from third-party sources, such
as external public database containing real estate and other asset
ownership information (e.g., motor vehicle registrations and ownership of
luxury items like watercraft and aircraft). Another third-party data
source was the Dependent Data Base, which is a combination of Department
of Health and Human Services and Social Security Administration data.
These data were used to provide custody information that can be used to
help determine the validity of dependent and Earned Income Tax Credit
(EITC) claims. Use of these data helped IRS enforcement staff to rule out
compliance issues that could be verified without contacting taxpayers.

As IRS moves to further strengthen enforcement and introduce enforcement
initiatives, one management challenge will be coordinating across IRS
programs and offices. An initiative that identifies noncompliance has
resource implications for downstream activities such as collections,
criminal investigations, and appeals. Without appropriate, coordinated
follow-up, compliance initiatives run the risk of becoming toothless. IRS
has experienced this sort of imbalance in the past. For

23 GAO, IRS Plans to Measure Tax Compliance Can Be Improved, GAO/GGD-93-52
(Washington, D.C.: Apr. 5, 1993).

example, in 2002 we reported on the growing backlog of collections cases
generated by the upstream exam and assessment functions that the
downstream collections function lacked the capacity to pursue.24

Accurate Cost Information Would Help IRS Make Resource Allocation
Decisions

Managing a federal agency as large and complex as IRS requires managers to
constantly weigh the relative costs and benefits of different approaches
to achieving the goals mandated by the Congress. Management is constantly
called upon to make important long-term strategic as well as daily
operational decisions about how to make the most effective use of the
limited resources at its disposal. As constraints on available resources
increase, these decisions become correspondingly more challenging and
important. In order to rise to this challenge, management needs to have at
its disposal current and accurate information upon which to base its
decisions, and to enable it to monitor the effectiveness of actions taken
over time so that appropriate adjustments can be made as conditions
change.

However, in its ongoing effort to make such increasingly difficult
resource allocation decisions and defend those decisions before the
Congress, IRS management has long been hampered by a lack of current and
accurate information concerning the costs of the various options being
considered. This has impaired management's ability to properly decide
which, if any, of the options at hand are worth the cost relative to the
expected benefits. For example, accurate and timely cost information may
help IRS consider changes in the menu of taxpayer services that it
provides by identifying and assessing the relative costs, benefits, and
risks of specific projects. Without reliable cost information, IRS's
ability to make such difficult choices in an informed, reasoned manner is
seriously impaired. Similarly, IRS should periodically reassess the prices
it charges taxpayers in user fees for various services, such as entering
into installment agreements and making determinations about the tax
exemption status of certain organizations. The cost of providing such
services is supposed to be a major factor in setting the related fees.
However, without timely and reliable cost information, the basis for the
fees becomes problematic. The lack of reliable cost information also means
that IRS cannot prepare cost-based performance measures to assist in
measuring the effectiveness of its programs over time.

24 Tax Administration: Impact of Compliance and Collection Declines on
Taxpayers, GAO-02-674 (Washington, D.C.: May 22, 2002).

IRS lacks reliable and timely cost information because prior to fiscal
year 2005, it did not have a cost accounting system to accumulate and
report the reliable cost information that managers needed to support
informed decision making. Instead, management often relied on a
combination of the limited existing cost information; the results of
special analysis initiated to establish the full cost of a specific,
narrowly defined task or item; and estimates based on the best judgment of
experienced staff. In fiscal year 2005, IRS implemented a cost accounting
module as part of the first release of its IFS. However, while this module
has much potential and has begun accumulating cost information, management
has not yet determined what the full range of its cost information needs
are or how best to tailor the capabilities of this module to serve those
needs. IRS has also not yet implemented a related workload management
system intended to provide the cost module with detailed personnel cost
information. In addition, because it generally takes several years of
historical cost information to support meaningful estimates and
projections, IRS cannot yet rely on this system as a significant planning
tool. It will likely require several years and implementation of
additional components of IFS before the full potential of IRS's cost
accounting module will be realized. In the interim, IRS decision making
will continue to be hampered by inadequate underlying cost information.

Productivity Improvements Could Help Offset Budget Cuts

IRS needs to make the most use of its available resources and a key to
this is improved productivity. Productivity is defined as the efficiency
with which inputs are used to produce outputs. It is measured as the ratio
of outputs to inputs. Productivity and cost are inversely related-as
productivity increases, average costs decrease. Consequently, information
about productivity can inform budget debates as a factor that explains the
level or changes in the cost of carrying out different types of
activities. Improvements in productivity either allow more of an activity
to be carried out at the same cost or the same level of activity to be
carried out at a lower cost.

Sound productivity data are an important element of meaningful
productivity improvement efforts. As part of our review of IRS process
improvement initiatives,25 private sector executives we met with stressed
the benefits of productivity analysis. They said that an inadequate

25 GAO, Tax Administration: Planning for IRS's Enforcement Process Changes
Include Many Key Steps But Can Be Improved, GAO-04-287 (Washington, D.C.:
Jan. 20, 2004).

understanding of productivity makes it harder to distinguish processes
with a potential for improvement from those without such potential. GAO's
Business Process Reengineering Assessment Guide also highlighted the
importance of being able to identify processes that are in greatest need
of improvement.26

Opportunities exist to improve enforcement productivity data and give IRS
managers a more informed basis for decisions on how to make improvements.
Statistical methods that are widely used in both the public and private
sectors can be used to adjust productivity measures for quality and
complexity. In particular, by using these methods, managers can
distinguish productivity changes that represent real efficiency gains or
losses from those that are due to changes in quality standards. These
methods could be implemented using data currently available at IRS. The
cost of implementation would be chiefly the staff time required to adapt
the statistical models. Although the computations are complex, the methods
can be implemented using existing software. We currently have under way a
separate study that illustrates how these methods can be used to create
better productivity measures at IRS.

Additional Management Improvements Needed for BSM Success

The BSM program has a long history of significant cost increases and
schedule delays, which, in part, has led us to report this program as high
risk since 1995.27 In January 2005 letters to congressional appropriation
committees, IRS stated that it had showed a marked improvement in
significantly reducing its cost variances. In particular, IRS claimed that
it reduced the variance between estimated and actual costs from 33 percent
in fiscal year 2002 to 4 percent in fiscal year 2004. However, we do not
agree with the methodology used in the analysis supporting this claim.
Specifically, (1) the analysis did not reflect actual costs, but instead
reflected changes in cost estimates (i.e., budget allocations) for various
BSM projects; (2) IRS aggregated all of the changes in the estimates
associated with the major activities for some projects, such as CADE,
which masked that monies were shifted from future activities to cover
increased costs of current activities; and (3) the calculations were based
on a percentage of specific fiscal year appropriations, which does not
reflect that these are multiyear projects.

26 GAO, Business Process Reengineering Assessment Guide, GAO/AIMD-10.1.15
(Washington, D.C.: April 1997).

27 GAO-05-207.

In February 2002 we expressed concern over IRS's cost and schedule
estimating and made a recommendation for improvement.28 IRS and its prime
systems integration support (PRIME) contractor have taken action to
improve their estimating practices, such as developing a cost and schedule
estimation guidebook and developing a risk-adjustment model to include an
analysis of uncertainty. These actions may ultimately result in more
realistic cost and schedule estimates, but our analysis of IRS's
expenditure plans29 over the last few years shows continued increases in
estimated project life-cycle costs (see fig. 4).

28 GAO, Business Systems Modernization: IRS Needs to Better Balance
Management Capacity with Systems Acquisition Workload, GAO-02-356
(Washington, D.C.: Feb. 28, 2002).

29 BSM funds are unavailable until the IRS submits to congressional
appropriations committees for approval a modernization expenditure plan
that (1) meets the OMB's capital planning and investment control review
requirements; (2) complies with IRS's enterprise architecture; (3)
conforms with IRS's enterprise life-cycle methodology; (4) is approved by
IRS, the Department of the Treasury, and OMB; (5) is reviewed by GAO; and
(6) complies with acquisition rules, requirements, guidelines, and systems
acquisition management practices.

Figure 4: Life-cycle Cost Estimates for Key BSM Projects

Estimates (dollars in millions) 200

180

160

140

120

100

80

60

40

20

0 11/01 11/02 3/03 9/03 1/04 7/04

Date expenditure plans submitted to the Congress (month/year)

Customer Account Data Engine, Release 1
e-Services
Modernized e-File, Release 1
Custodial Accounting Project, Release 1
Integrated Financial System, Release 1

Source: GAO analysis of IRS data.

The Assistant Chief Information Officer (CIO) for BSM stated that IRS's
cost and schedule estimating has improved in the past year. Our comparison
of IRS's reported project costs and milestone completion dates presented
in the July 2004 and April 2005 expenditure plans shows that two BSM
projects, CADE Releases 1.1 and 1.2, were delivered at the estimated cost
and on or before the scheduled completion dates projected in the July 2004
expenditure plan. It is important to note that this recent success is
based on project cost and schedule estimates that were rebaselined in the
second quarter of fiscal year 2004 with delivery dates in late fiscal year
2004 and early fiscal year 2005. It is too early to tell whether this
signals a fundamental improvement in IRS's ability to accurately forecast
project costs and schedules.

The reasons for IRS's cost increases and schedule delays vary. However, we
have previously reported that they are due, in part, to weaknesses in
management controls and capabilities. We have previously made
recommendations to improve BSM management controls, and IRS has

IRS Is Adjusting the BSM Program in Response to Budget Reductions

implemented or begun to implement these recommendations. For example, in
February 2002, we reported that IRS had not yet defined or implemented an
information technology human capital strategy, and recommended that IRS
develop plans for obtaining, developing, and retaining requisite human
capital resources.30 In August 2004, the current Associate CIO for BSM
identified the completion of a human capital strategy as a high priority.
Among the activities that IRS is in the process of implementing are
prioritizing its BSM staffing needs and developing a recruiting plan. IRS
has also identified, and is in the process of addressing, other major
management challenges. For example, poorly defined requirements have been
among the significant weaknesses that have been identified as contributing
to project cost overruns and schedule delays. As part of addressing this
problem, in March 2005, the IRS BSM office established a requirements
management office, although a leader has not yet been hired.

The BSM program is undergoing significant changes as it adjusts to
reductions in its budget. Figure 5 illustrates the BSM program's requested
and enacted budgets for fiscal years 2004 through 2006.31 For fiscal year
2005, IRS received about 29 percent less funding than it requested (from
$285 million to $203.4 million). According to the Senate report for the
fiscal year 2005 Transportation, Treasury, and General Government
appropriations bill, in making its recommendation to reduce BSM funding,
the Senate appropriations committee was concerned about the program's cost
overruns and schedule delays. In addition, the committee emphasized that
in providing fewer funds, it wanted IRS to focus on its highest priority
projects, particularly CADE.32 In addition, IRS's fiscal year 2006 budget
request reflects an additional reduction of about 2 percent, or about $4.4
million, from the fiscal year 2005 appropriation.

30 GAO, Business Systems Modernization: IRS Needs to Better Balance
Capacity With Systems Acquisition Workload, GAO-02-356 (Washington, D.C.:
Feb. 28, 2002).

31 IRS uses the appropriated funds to cover contractor costs related to
the BSM program. IRS funds internal costs for managing BSM with another
appropriation. These costs are not tracked separately for BSM-related
activities.

32U.S. Senate, Senate Report 108-342.

Figure 5: Changes in the BSM budget (dollars in millions)

e-ServicesFY04 FY05

FY06 No funds requested for FY06

Filing and Payment ComplianceFY04 FY05 FY06 No funds appropriated for FY05

Modernized e-FileFY04 FY05

FY06

Customer Account Data EngineFY04 FY05

FY06

Custodial Accounting ProjectFY04 FY05 No funds requested for FY05

FY06 No funds requested for FY06

Integrated Financial System FY04

FY05 No funds requested for FY05

FY06 No funds requested for FY06

Core infrastructure projectsFY04 FY05

FY06

                     Architecture, integration, FY04 and management FY05 FY06

Management reserveFY04 FY05

FY06

0 102030405060708090 Millions of dollars

Requested

Enacted Source: IRS. Note: The BSM account authorizes funds to be
obligated for 3 years.

It is too early to tell what effect the budget reductions will ultimately
have on the BSM program. However, the significant adjustments that IRS is
making to the program to address these reductions are not without risk,
could potentially impact future budget requests, and will delay the
implementation of certain functionality that was intended to provide
benefit to IRS operations and the taxpayer. For example,

o  	Reductions in management reserve/project risk adjustments. In response
to the fiscal year 2005 budget reduction, IRS reduced the amount that it
had allotted to program management reserve and project risk adjustments by
about 62 percent (from about $49.1 million to about $18.6 million).33 If
BSM projects have future cost overruns that cannot be covered by the
depleted reserve, this reduction could result in (1) increased budget
requests in future years or (2) delays in planned future activities (e.g.,
delays in delivering promised functionality) to use those allocated funds
to cover the overruns.

o  	Shifts of BSM management responsibility from the PRIME contractor to
IRS. Due to budget reductions and IRS's assessment of the PRIME
contractor's performance, IRS decided to shift significant BSM
responsibilities for program management, systems engineering, and business
integration from the PRIME contractor to IRS staff. For example, IRS staff
are assuming responsibility for cost and schedule estimation and
measurement, risk management, integration test and deployment, and
transition management. There are risks associated with this decision. To
successfully accomplish this transfer, IRS must have the management
capability to perform this role. Although the BSM program office has been
attempting to improve this capability through, for example, implementation
of a new governance structure and hiring staff with specific technical and
management expertise, IRS has had significant problems in the past
managing this and other large development projects, and acknowledges that
it has major challenges to overcome in this area.

o  	Suspension of the Custodial Accounting Project (CAP). Although the
initial release of CAP went into production in September 2004, IRS has
decided not to use this system and to stop work on planned improvements
due to budget constraints. According to IRS, it made this decision after
it evaluated the business benefits and costs to develop and maintain CAP
versus the benefits expected to be provided by other projects, such as
CADE. Among the functionalities that the initial releases of CAP were
expected to provide were (1) critical control and reporting capabilities

 33 We did not include in our calculations reductions to specific project risk
 adjustment amounts that were made for reasons other than the fiscal year 2005
                               budget reduction.

mandated by federal financial management laws; (2) a traceable audit trail
to support financial reporting; and (3) a subsidiary ledger to accurately
and promptly identify, classify, track, and report custodial revenue
transactions and unpaid assessments. With the suspension of CAP, it is now
unclear how IRS plans to replace the functionality this system was
expected to provide, which was intended to allow the agency to make
meaningful progress toward addressing long-standing financial management
weaknesses. IRS is currently evaluating alternative approaches to
addressing these weaknesses.

o  	Reductions in planned functionality. According to IRS, the fiscal year
2006 funding reduction will result in delays in planned functionality for
some of its BSM projects. For example, IRS no longer plans to include form
1041 (the income tax return for estates and trusts) in the fourth release
of Modernized e-File, which is expected to be implemented in fiscal year
2007.

The BSM program is based on visions and strategies developed in 2000 and
2001. The age of these plans, in conjunction with the significant delays
already experienced by the program and the substantive changes brought on
by budget reductions, indicates that it is time for IRS to revisit its
longterm goals, strategy, and plans for BSM. As we have previously
reported, such an assessment would include an evaluation of when
significant future BSM functionality would be delivered.34 IRS's Associate
CIO for BSM has recognized that it is time to recast the agency's BSM
strategy because of changes that have occurred subsequent to the
development of the program's initial plans. According to this official,
IRS is in the process of redefining and refocusing the BSM program, and he
expects this effort to be completed by the end of this fiscal year.
However, clear milestones for completing these activities have not been
defined and we plan to address this in our ongoing 2005 BSM expenditure
plan review for the appropriations committees.

IRS Needs to Remedy Information security is a critical consideration for
any organization that Serious Information depends on information systems
and computer networks to carry out its Security Weaknesses over mission or
business. It is especially important for government agencies

where maintaining the public's trust is essential. In December 2002,
theTaxpayer and Bank Congress enacted the Federal Information Security
Management Act ofSecrecy Act Information 2002 (FISMA) to strengthen
security of information and systems within

34 GAO-05-416T.

federal agencies.35 FISMA requires each agency to develop, document, and
implement an agencywide information security program to provide
information security for the information and systems that support the
operations and assets of the agency. IRS relies extensively on
interconnected information systems to perform vital functions, such as
collecting and storing taxpayer data, calculating interest and penalties,
and generating refunds. In addition to processing its own financial and
tax information, IRS provides information processing support to the
Financial Crimes Enforcement Network (FinCEN), a Treasury bureau
responsible for administering and enforcing the Bank Secrecy Act (BSA) and
its implementing provisions.

While IRS has made progress in correcting or mitigating previously
reported information security control weaknesses, serious control
weaknesses continue to exist over key financial and tax processing
information systems. For example, during our review of information
security at IRS facilities in 2004,36 we determined that IRS corrected or
mitigated 32 of the 53 weaknesses that we reported as unresolved at the
time of our last review in 2002. In addition to the 21 previously reported
weaknesses that remained uncorrected, we identified 39 new information
security control weaknesses during this review that placed sensitive
taxpayer and BSA data-including information related to financial crimes,
terrorist financing, money laundering, and other illicit activities-at
significant risk of unauthorized disclosure, modification, and
destruction. These include the following:

o  	Access controls over the mainframe computing environment provided no
logical separation between IRS's taxpayer data and FinCEN's BSA data,
allowing all 7460 mainframe users-IRS employees, non-IRS employees, and
contractors-regardless of their official duties, the ability to read and
modify taxpayer and BSA data, including information about citizens, law
enforcement personnel, and individuals subject to investigation. Thus, IRS
users could read or copy BSA information, and law enforcement users could
read or copy taxpayer information.

o  	User accounts and passwords were not adequately controlled to ensure
that only authorized individuals had access to IRS's servers and networks,

35 FISMA was enacted as title III, E-Government Act of 2002, Pub. L. No.
107-347, 116 Stat. 2946 (Dec. 17, 2002).

36 GAO, Information Security: Internal Revenue Service Needs to Remedy
Serious Weaknesses over Taxpayer and Bank Secrecy Act Data, GAO-05-482
(Washington, D.C.: Apr. 15, 2005).

thereby increasing the risk that unauthorized users could gain authorized
user ID and password combinations to claim a user identity and then use
that identity to gain access to sensitive taxpayer or BSA data.

o  	Audit and monitoring of security-related events on IRS's servers
suffered from insufficient retention of security logs, heightening the
risk of unauthorized system activity going undetected.

o  	Security over access to sensitive areas was jeopardized due to the
lack of accountability over the issuance of master keys at an IRS
facility, thereby increasing the likelihood that an unauthorized person
could gain possession of a master key and use it to unlock sensitive
computing areas within the facility.

These information security control weaknesses exist primarily because IRS
has not fully implemented an agencywide information security program to
effectively protect the information and information systems that support
the operations and assets of the agency. Consequently, these identified
weaknesses in information security controls impair IRS's ability to ensure
the confidentiality, integrity, and availability of sensitive financial,
taxpayer and FinCEN's BSA data hosted at its facility.

We made recommendations to the Secretary of the Treasury to direct the IRS
Commissioner to take several actions to fully implement a comprehensive
agencywide information security program and to determine whether taxpayer
data have been disclosed to unauthorized individuals.37 In addition, we
recommended that the Secretary of the Treasury direct the FinCEN Director
to perform an assessment to determine whether BSA data have been disclosed
to unauthorized individuals. The Acting Deputy Secretary of the Treasury
generally agreed with the recommendations and identified specific
completed and planned corrective actions, which we did not verify.

IRS is operating in a difficult budget environment. On the one hand, its
workload-represented by the number of returns and the complexity of

                                   Concluding

                                  Observation

those returns-is growing. On the other hand, IRS faces pressure to hold
down spending.

Addressing the resource challenges summarized in this statement can help
policy makers assessing IRS's budget. Long-term goals can help determine

37 GAO-05-482.

overall budgetary requirements. Revenue enhancements and the leveraging of
nonfederal resources can help, to some extent, meet those requirements.
Productivity gains and successful new investments in systems can help
ensure that existing resources are used as efficiently as possible,
helping minimize the need for additional funding. Addressing these
resource challenges does not promise a painless way out of difficult
budget decisions. However, it could provide a clearer picture of the
tradeoffs involved.

Mr. Chairman, this concludes my testimony. I would be happy to answer any
questions you may have at this time.

Contact and	For further information on this testimony, please contact
James White on (202) 512-9110 or [email protected]. Individuals making key
contributions to

Acknowledgments 	this testimony include Perry Datwyler, George Guttman,
Tonia Johnson, David Lewis, Neil Pinney, Jeffrey Schmerling, Henry
Sutanto, and Jenniffer Wilson.

(450411)

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