Tax Administration: Increasing EFT Usage for Installment Agreements Could
Benefit IRS (Letter Report, 06/10/98, GAO/GGD-98-112).

Pursuant to a congressional request, GAO reviewed the best practices
being used by delinquent debt collectors, and if they offer the Internal
Revenue Service (IRS) any prospects for improving collection efforts,
focusing on the: (1) uses and benefits of electronic funds transfer
(EFT); (2) experiences of two states that use EFT in their tax
installment agreement programs and the benefits they have obtained; and
(3) potential benefits IRS might realize by increasing EFT usage in its
installment agreement program.

GAO noted that: (1) EFT is widely used by various types of organizations
in receiving and transferring money; (2) it is used for various payment
transactions and for collecting consumer payments; (3) relative to paper
transactions, EFT provides better accuracy, lower mailing and processing
costs, and fewer delinquencies and defaults; (4) because of these
benefits, some financial organizations routinely offer incentives to
consumers who enter into EFT arrangements; (5) both Minnesota and
California changed their installment agreement programs to promote tax
payments by EFT; (6) Minnesota has required taxpayers entering into new
installment agreements since July 1995 to pay by EFT, with some
exceptions; (7) in April 1997, California initiated procedures to let
taxpayers make installment agreement payments by EFT; (8) as of
mid-November 1997, EFT usage was about 90 percent in Minnesota and about
60 percent in California; (9) according to state officials, Minnesota
and California both have seen a sharp decrease in their installment
agreement default rates, in part due to EFT; (10) in Minnesota,
officials said that default rates were reduced from about 50 percent to
between 3 and 5 percent; and in California, officials said that they
were reduced from about 40 percent to about 5 percent; (11) officials in
both states said that the lower default rates have resulted in
collecting revenues from installments faster; (12) officials in both
Minnesota and California said they have achieved administrative cost
savings from greater use of EFT, which has reduced the amount of paper
processing and mailing costs related to their installment agreement
programs; (13) additional administrative cost savings have occurred
because fewer resources have been needed for follow-up collection
enforcement on defaulted agreements; (14) IRS' installment agreement
program has not taken advantage of the benefits of EFT to the extent
that Minnesota and California reported, as only about 1.5 percent of
IRS' delinquent taxpayers were using EFT for installment agreements as
of September 30, 1997; (15) because its current program is similar to
these states' non-EFT programs, it seems likely that IRS could expect to
achieve a reduction in its installment agreement default rates and lower
administrative costs if more taxpayers paid their installments by EFT;
and (16) in fiscal year 1997, IRS' costs to process EFT installment
payments were 37 percent lower than the cost to process non-EFT
installment payments.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-98-112
     TITLE:  Tax Administration: Increasing EFT Usage for Installment 
             Agreements Could Benefit IRS
      DATE:  06/10/98
   SUBJECT:  Electronic funds transfer
             Delinquent taxes
             Taxpayers
             Installment payments
             Government collections
             Collection procedures
             Cost control
             Debt collection
IDENTIFIER:  Minnesota
             California
             IRS Installment Agreement Program
             
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Cover
================================================================ COVER


Report to Congressional Requesters

June 1998

TAX ADMINISTRATION - INCREASING
EFT USAGE FOR INSTALLMENT
AGREEMENTS COULD BENEFIT IRS

GAO/GGD-98-112

EFT Usage for Installment Agreements

(268752)


Abbreviations
=============================================================== ABBREV

  ACH - Automated Clearing House
  EFT - electronic funds transfer
  FMS - Financial Management Service
  FTB - Franchise Tax Board
  IRS - Internal Revenue Service
  MDOR - Minnesota Department of Revenue
  NACHA - National Automated Clearing House Association
  NAFTA - North American Free Trade Agreement

Letter
=============================================================== LETTER


B-275098

June 10, 1998

The Honorable Bill Archer
Chairman, Committee on Ways and Means
House of Representatives

The Honorable Nancy L.  Johnson
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives

For years, the Internal Revenue Service (IRS) has allowed taxpayers
to pay delinquent taxes in installments, primarily through a
paper-based system in which IRS mails monthly statements to
taxpayers, who, in turn, are to mail monthly payments back to IRS. 
In fiscal year 1997, taxpayers defaulted on $6.5 billion in
installment agreements--almost as much as the $6.7 billion IRS
collected through installments.\1

Because of your interest in improving IRS' ability to collect
delinquent taxes, you asked us to identify the best practices
currently used by delinquent debt collectors and analyze them to
determine if they offer IRS any prospects for improving its
collection efforts.  This report discusses one such practice,
specifically, the use of electronic funds transfer (EFT) for making
installment tax payments.  EFT is a means of conducting financial
transactions by using computers and electronic technology to transfer
money instead of using checks and other paper documents.  IRS
currently accepts EFT payments from taxpayers with installment
agreements, but only a small percentage of taxpayers use this method. 

In this report, we (1) describe some of the uses and benefits of EFT,
(2) discuss the experiences of two states that use EFT in their tax
installment agreement programs and the benefits they have obtained,
and (3) discuss the potential benefits IRS might realize by
increasing EFT usage in its installment agreement program. 

In conducting our work, we reviewed literature on EFT and interviewed
officials in two states, Minnesota and California, that are
recognized as having innovative collection practices.  We also
contacted other EFT users, including private sector organizations and
the Department of the Treasury's Financial Management Service (FMS). 
Our analysis is based on a review of information obtained from these
sources and, in particular, on a comparison of EFT use in the states'
installment agreement programs and IRS' program. 


--------------------
\1 These amounts include taxes, interest, penalties, and fees. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

EFT is widely used by various types of organizations, such as banks,
credit unions, and mortgage companies, in receiving and transferring
money.  It is used for various payment transactions, such as payroll,
pension, and dividends, and for collecting consumer payments. 
Relative to paper transactions, EFT provides better accuracy, lower
mailing and processing costs, and fewer delinquencies and defaults. 
Because of these benefits, some financial organizations routinely
offer incentives, such as interest rate reductions on loans and
waivers on fees, to consumers who enter into EFT arrangements. 

Both Minnesota and California changed their installment agreement
programs to promote tax payments by EFT.  Minnesota has required
taxpayers entering into new installment agreements since July 1995 to
pay by EFT, with some exceptions.  In April 1997, California
initiated procedures to let taxpayers make installment agreements
payments by EFT.  As of mid-November 1997, EFT usage was about 90
percent in Minnesota and about 60 percent in California. 

According to state officials, Minnesota and California both have seen
a sharp decrease in their installment agreement default rates, in
part due to EFT.  In Minnesota, officials said that default rates
were reduced from about 50 percent to between 3 and 5 percent; and in
California, officials said that they were reduced from about 40
percent to about 5 percent.  Officials in both states said that the
lower default rates have resulted in collecting revenues from
installments faster. 

In addition, officials in both Minnesota and California said they
have achieved administrative cost savings from greater use of EFT,
which has reduced the amount of paper processing and mailing costs
related to their installment agreement programs.  Additional
administrative cost savings have occurred because fewer resources
have been needed for follow-up collection enforcement on defaulted
agreements. 

IRS' installment agreement program has not taken advantage of the
benefits of EFT to the extent that Minnesota and California reported,
as only about 1.5 percent of IRS' delinquent taxpayers were using EFT
for installment agreements as of September 30, 1997.  Because its
current program is similar to these states' non-EFT programs, it
seems likely that IRS could expect to achieve a reduction in its
installment agreement default rates and lower administrative costs if
more taxpayers paid their installments by EFT.  In fiscal year 1997,
IRS' costs to process EFT installment payments were about 37 percent
lower than the cost to process non-EFT installment payments. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Section 6159 of the Internal Revenue Code authorizes IRS to allow
taxpayers to pay their taxes in installments, with interest, if this
would facilitate collection of the liability.  IRS procedures allow
taxpayers to enter into an installment agreement any time during the
collection process, which involves sending notices to taxpayers,
contacting them by telephone and in person, and using enforcement
tools such as liens against their property and levies against their
financial assets. 

In 1992, IRS changed its installment agreement program by allowing
(1) most IRS staff with taxpayer contact to approve agreements up to
a certain dollar level, (2) taxpayers to obtain agreements up to a
certain dollar level without providing financial information to
demonstrate the need for an agreement, and (3) taxpayers to request
agreements when they file their tax returns.  As of September 30,
1997, IRS had about 2.9 million installment agreements outstanding,
worth about $13.2 billion, thus averaging about $4,600 per agreement. 

To request an installment agreement, a taxpayer completes an optional
Form 9465:  Installment Agreement Request.  In January 1996, IRS
revised the form by providing space for taxpayers to add the
information needed to set up an EFT agreement, based on a
recommendation we made.\2 Before the form was revised, taxpayers
could make arrangements to pay their installment payments by EFT, but
few did. 

For each month that an agreement is in effect, IRS prepares and mails
a statement to the taxpayer.  Taxpayers with non-EFT agreements are
to mail the payment coupons back with their payments.  These
documents must be processed monthly in order to update the taxpayers'
accounts. 

According to the National Automated Clearing House Association
(NACHA), a national electronic banking trade association, electronic
payment transaction volumes are growing faster than check volumes. 
The clearinghouse association reported that EFT transactions in 1996
rose 15 percent, to nearly 4 billion transactions that represented
over $12 trillion, which was 9 percent higher than the amount in
1995.  By comparison, check volumes rose by about 1 percent during
this period.  Also, in 1995, more than 500,000 companies across the
nation used the Automated Clearing House (ACH) Network for EFTs,
involving payment transactions such as payroll, pensions, and
dividends and to collect consumer payments.\3 Large businesses and
corporations are currently required to use EFT to make federal and
state tax deposits.  EFT use should increase further as provisions in
the North American Free Trade Agreement (NAFTA) are implemented that
will eventually require most employers to pay their federal tax
deposits electronically.\4 Further, the Debt Collection Improvement
Act of 1996 requires that most federal benefit checks be disbursed
electronically beginning in 1999.\5


--------------------
\2 See Tax Administration:  Administrative Improvements Possible in
IRS' Installment Agreement Program (GAO/GGD-95-137, May 2, 1995). 

\3 The ACH Network is a nationwide electronic payment and collection
system used to make EFT financial transactions.  The Network consists
of the ACH operators, including the Federal Reserve Bank System, and
participating financial institutions--commercial banks, credit
unions, etc.--which provide services to businesses and consumers. 
The Network's rules and operating guidelines are established by
NACHA. 

\4 NAFTA (P.L.  103-182) requires that the Secretary of the Treasury
develop regulations to implement an EFT system for the collection of
federal tax deposits. 

\5 The act (P.L.  104-134) requires that almost all federal benefit
payments, such as social security, veterans benefits, and pensions
(but not tax refunds) be made using EFT by January 1, 1999. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

Our objectives were to (1) describe some of the uses and benefits of
EFT, (2) discuss the experiences of two states that use EFT in their
tax installment agreement programs and the benefits they have
obtained, and (3) discuss the potential benefits IRS might realize by
increasing EFT usage in its installment agreement program. 

To address the first objective, we judgmentally selected a limited
number of financial institutions, including 8 banks, 1 credit union,
and 14 mortgage companies, to obtain information on their use of EFT
and its benefits to them and their customers.  In addition, we spoke
with officials from NACHA and the National Credit Union Association
about the uses and benefits of EFT to financial institutions and
their customers.  We also contacted officials from FMS, which is
ultimately responsible for collecting most of the nontax delinquent
debts owed the federal government.  FMS is also involved in the
government's overall efforts to maximize the use of EFT as required
by the Debt Collection Improvement Act of 1996.  We obtained from
FMS, but did not independently verify, information on IRS' cost to
process installment agreement payments by paper processes and by EFT. 

To address our second objective, we identified two states--Minnesota
and California--that have made changes to their installment agreement
programs that resulted in most delinquent taxpayers using EFT to pay
their installments.  We visited these states because we had consulted
with them in our previous work on ways to improve federal tax
collection efforts.  On that basis, we were aware of their efforts to
undertake innovative practices to improve tax administration.  Also,
we contacted the Federation of Tax Administrators--an organization of
state and municipal tax and revenue agencies--to identify state tax
departments that are recognized as having successful collection
programs, and both states were mentioned by the Federation. 

To assess the potential benefits IRS might realize by increasing EFT
usage in its installment agreement program, we obtained data on its
existing program and analyzed its installment agreement default
rates.  We did not independently verify the statistical data we
obtained on IRS' installment agreement program.  The information we
obtained on IRS' current use of EFT helped us determine the
feasibility of IRS' making changes to its program similar to those
that Minnesota and California have made.  We interviewed IRS
Collection officials at the National Office to obtain current
information on the processes and procedures IRS uses in collecting
delinquent federal taxes to ensure that our comparisons between IRS
and others were based on the most recent IRS practices.  We did not
perform an independent analysis to estimate the cost savings IRS
might receive from additional EFT use.  Lastly, we discussed the
changes Minnesota and California have made to their program with IRS
officials to obtain their perspectives on how similar changes might
affect IRS' program. 

We requested comments on a draft of this report from the Commissioner
of Internal Revenue.  His comments are discussed at the end of this
letter and are reprinted in appendix I. 

We did our work between October 1996 and December 1997, according to
generally accepted government auditing standards. 


   USES AND BENEFITS OF EFT
------------------------------------------------------------ Letter :4

Private sector financial institutions and government agencies use EFT
for a variety of transactions.  They do so because EFT has lower
default rates and is less expensive, faster, and more reliable than
paper transactions.  Benefits, such as the convenience of EFT, also
extend to the customers of these organizations. 

EFT transactions involve the paperless transfer of funds between
accounts in financial institutions, which allows for transactions
such as the direct deposit of payroll checks, mortgage payments, and
installment payments.  According to a NACHA official, most financial
institutions can both make and receive EFT transactions, although
some smaller institutions sometimes restrict the type of payment
transactions they make. 

Information from NACHA shows that, relative to paper transactions,
EFT provides lower loan defaults, better accuracy, and reduced
mailing and processing costs.  A credit union loan official, for
example, said defaults of loans, usually defined as missed payments,
are lower with automated payments.  In addition, EFTs are about
one-third less expensive to handle than paper transactions, according
to one banking official with whom we spoke.  Exact savings, though,
vary by individual financial institution, depending on its internal
processing systems and costs. 

Representatives from financial institutions and FMS told us that the
benefits of EFT for customers as well as financial institutions are
many.  The financial institution officials told us that the cost
savings from EFT were great enough for them to offer incentives to
customers who use direct deposit and other electronic transactions. 
A credit union, for example, provides a 1-percentage-point discount
on home equity lines of credit that are repaid using EFT.  Officials
from two banks told us that they waive monthly checking account fees
for customers whose paychecks are directly deposited into their
accounts.  Another bank offers a discount on consumer loans that are
repaid by EFT as a way of keeping existing customers and attracting
new ones. 

Customers could also benefit from the reliability and accuracy of
electronic payments and deposits.  FMS data, for example, showed that
direct deposit recipients are 20 times less likely to have a problem,
such as lost checks, with EFT than with deposits by check.  Some of
the other benefits for customers were the convenience and savings by
not having to go to a bank to deposit checks or to write a check and
use postage to mail it. 

Congress passed the Debt Collection Improvement Act of 1996 requiring
the use of EFT for most federal benefit payments (tax refunds are
excluded) by January 1, 1999, because it recognized the advantages of
electronic transactions.  According to Treasury data, about 60
percent of all federal benefits are now paid electronically, and
Treasury estimates that the government could save more than $500
million over the next 5 years by switching the remaining payments to
EFT.  However, EFT generally requires individuals to have bank
accounts to access the funds, and some recipients of government
checks do not have bank accounts.  Congress is considering what it
might do to mitigate the adverse effects of the 1996 legislation--for
example, allowing recipients who do not have bank accounts to access
their payments by other electronic means, such as automated teller
machine cards from an account held by a disbursing agency. 


   TWO STATES' USE OF EFT FOR
   INSTALLMENT TAX PAYMENTS AND
   ITS BENEFITS
------------------------------------------------------------ Letter :5

One use of EFT, as it relates to tax administration, is for
installment tax payments.  The two states we visited, Minnesota and
California, made changes to their installment agreement programs that
make EFT the primary means taxpayers use to pay their taxes in
installments.  Both states promoted the changes to make their
installment agreement programs more effective and efficient, and
officials in both states attributed reductions in their default rates
and administrative costs to EFT use. 


      OVERVIEW OF MINNESOTA'S
      PROGRAM
---------------------------------------------------------- Letter :5.1

The Minnesota Department of Revenue (MDOR) is that state's primary
tax collection agency and, as such, administers the installment
agreement program covering delinquent taxes owed by individuals and
businesses.  In 1995, MDOR tested the use of EFT in its installment
agreement program.  EFT was available in the installment agreement
program before the test, but it was not used extensively.  The
results of the test were compared with MDOR's non-EFT program.  MDOR
officials told us the test showed that by requiring EFT payments,
their installment agreement program could be made more efficient and
effective.  This led MDOR to revise its policy on installment
agreements to require EFT for tax payments beginning in July 1995,
with a few exceptions. 

One exception was for cases where the EFT requirement would create an
undue hardship on a taxpayer.  For example, if a taxpayer did not
have a bank account, which is necessary for electronic transactions,
the requirement could be waived.  Also, payment agreements of less
than 4 months' duration may be exempt from EFT. 

The policy also allowed taxpayers with existing installment
agreements to continue with their non-EFT arrangements or convert to
EFT.  The state required that taxpayers continue to comply with their
current tax obligations as a condition for gaining approval to pay
delinquent taxes by installment, regardless of whether EFT is used. 
According to information obtained from MDOR, Minnesota taxpayers may
be given about 1 year to pay off their installment agreements. 

MDOR reported to us that, as of mid-November 1997, about 90 percent
of MDOR's 4,200 installment agreements were EFT agreements,
representing about 90 percent of the delinquent taxes in the state's
installment agreement program.  Taxpayers with waivers and those
continuing their non-EFT arrangements accounted for the other 10
percent. 


      OVERVIEW OF CALIFORNIA'S
      PROGRAM
---------------------------------------------------------- Letter :5.2

The California Franchise Tax Board (FTB) is that state's agency
responsible for collecting income taxes.  Taxpayers owing delinquent
personal income taxes may be granted approval to pay their debts in
installments.  Previously, EFT was not available in the installment
agreement program, but in April 1997, following MDOR's success with
EFT usage, FTB implemented procedures for taxpayers to make
installment agreement payments by EFT.  According to the procedures,
taxpayers who have been approved to pay their tax liabilities in
installments must usually pay by EFT.  As in Minnesota, FTB allows
taxpayers waivers to using EFT in certain circumstances--for example,
a taxpayer has no bank account, a low dollar amount is owed, or EFT
would create a hardship.  Taxpayers must also comply with their
current tax obligations as a condition of paying delinquent taxes in
installments, regardless of whether EFT is used. 

A state official told us that FTB revised its installment agreement
application form to include space for an EFT authorization.  If the
taxpayer provided the necessary information for the state to process
the EFT authorization, the installment agreement request was usually
approved.  If a taxpayer did not complete the EFT authorization,
state officials said that they would encourage EFT use by
specifically discussing its benefits with the taxpayer.  FTB
officials would inform applicants about the potential benefits of
using EFT--for example, they would not have to worry about writing
and mailing checks or money orders or be concerned that their
payments did not arrive on time.  If a taxpayer still did not elect
EFT, the state would require a more strenuous review of the
taxpayer's application, including a review of their financial status. 
At the time of our study, approximately 8,000 of the 13,000
agreements made since April 1997--about 60 percent--were set up to
use EFT.  These 8,000 EFT agreements represented about 90 percent of
the delinquent taxes owed in the new agreements. 


      EFT HAS LOWERED THE DEFAULT
      RATES OF INSTALLMENT
      AGREEMENTS IN MINNESOTA AND
      CALIFORNIA
---------------------------------------------------------- Letter :5.3

According to state officials in Minnesota and California, one of the
benefits they have realized by promoting EFT use in their installment
agreement programs has been a substantial reduction in the programs'
default rates.  These officials said that the benefits of lower
default rates included more timely payments and increased collection
of taxes owed. 

While the precise definition may vary, generally an installment
agreement is in default if payments are not made.  Some of the
amounts owed in defaulted installment agreements are subsequently
paid after further collection actions by the states.  Some are never
paid. 

EFT was available, but not used extensively, in MDOR's installment
agreement program before the July 1995 requirement was implemented. 
The program's default rate was then about 50 percent.  Since the
requirement was implemented, most of the state's taxpayers with
installment agreements have used EFT, and according to MDOR
officials, the default rate for EFT installment agreements dropped to
between 3 and 5 percent. 

The California FTB's overall installment agreement default rate also
decreased sharply after EFT use was promoted.  Officials told us that
before EFT was available, the default rate for installment agreements
was about 40 percent.  As of October 1997, about 6 months after FTB
implemented its EFT procedures, the default rate for new EFT
agreements was about 5 percent.  FTB officials told us that although
their EFT procedures had only been in effect for a relatively short
time, they expect their default rate to continue to remain lower than
before EFT use. 

Recurring EFT payments are generally set up to be made on a specific
day of the month, which reduces some of the problems related to
non-EFT arrangements, such as taxpayers' forgetting to send in their
payments or sending in the wrong amount.  Officials in both states
said that, because these problems were reduced, some of the amounts
owed were received sooner and without the need for follow-up
collection actions, such as letters, telephone calls, liens, levies,
or seizures. 

Officials in both states also said that they experienced increased
collections from installment agreements after changing their programs
to promote EFT.  Collections increased if payments made through EFT
would not have otherwise been made.  However, the states had not
measured the dollar amounts that directly related to changing their
programs.  Also, they found it difficult to determine if other
effects, such as economic conditions, were a factor; and in
California, the program was less than a year old when we completed
our field work.  The officials from both states told us, however,
that they had not made any other changes to their installment
agreement programs that would account for the increased collections. 


      EFT HAS REPORTEDLY REDUCED
      THE ADMINISTRATIVE COSTS OF
      INSTALLMENT AGREEMENTS IN
      MINNESOTA AND CALIFORNIA
---------------------------------------------------------- Letter :5.4

In discussing the benefits of EFT with officials in California and
Minnesota, we were told that EFT use reduced the administrative costs
of their installment agreement programs.  Officials in both states
said that the greater use of EFT has reduced the amount of paper
processing and mailing costs related to their installment agreement
programs.  Additional administrative cost savings have occurred
because fewer resources were needed to follow up on defaulted
agreements. 

Administrative cost savings from EFT stem from not having to process
and handle paper relating to the financial transactions.  With EFT,
much of the personnel costs used to generate and process documents
and the mailing costs generally associated with paper financial
transactions can be reduced or eliminated.  Officials in California
and Minnesota said that they reduced their installment agreement
programs' administrative costs by eliminating most of the paper
documents they previously sent taxpayers, which also reduced
taxpayers' need to send paper documents back to the states for
processing. 

Before changing their installment agreement programs to promote EFT,
Minnesota and California had procedures that required sending
taxpayers monthly statements.  Taxpayers sent back their remittances,
such as paper coupons and checks and money orders, which had to be
manually processed.  Under their current programs, the two states do
not send monthly statements to taxpayers using EFT.  This is because
state officials said that the taxpayers' bank statements show that
the EFT payment was made, and the statement provides the taxpayer
with notification. 

Although precise estimates were unavailable, officials in both states
said that administrative cost savings have resulted from EFT use,
which has streamlined the administrative operations of their
installment agreement programs.  According to data collected during
MDOR's pilot test of EFT, for example, several thousand work hours
were saved by not having to prepare and process the paperwork
typically needed for manual agreements.  Further savings stemmed from
reduced paper and postage costs, which officials estimated to be
about 50 cents per agreement per month.  Another benefit from
reducing the amount of paper used in the programs was the reduced
paperwork burden for taxpayers. 

Officials in both states said that fewer resources are being used to
follow up on defaulted agreements because there are fewer defaults
with EFT.  Defaulted agreements generally require follow-up actions,
such as contacting the taxpayers and using enforcement actions, such
as liens, levies, and seizures.  In general, contacting taxpayers and
using enforcement actions would increase administrative costs. 


   INCREASING EFT USAGE OFFERS
   POTENTIAL BENEFITS TO IRS
------------------------------------------------------------ Letter :6

IRS has the potential to achieve benefits by expanding the use of EFT
in its installment agreement program.  At the time of our review, IRS
had EFT payment arrangements with only 1.5 percent of taxpayers who
had installment agreements.  The reported experiences of Minnesota
and California, whose former programs were similar to IRS' current
program, showed that encouraging greater EFT use has resulted in
fewer defaulted agreements and administrative cost savings.  Many
private and other public organizations have reported that they, too,
have benefited from electronic financial transactions. 

For fiscal 1997, IRS had about $6.5 billion in defaulted agreements,
nearly half its $13.2 billion inventory of 2.9 million outstanding
agreements.  Table 1 shows IRS' installment agreement defaulted
dollars and our estimated default rates for fiscal years 1994 to
1997.  Even a slight reduction in IRS' default rate could lead to
faster and increased collection of many tax dollars because IRS'
defaulted agreements are in the billions of dollars annually. 

Of the total agreements in 1997, about 41,500--or 1.5 percent--were
being paid by EFT. 



                                Table 1
                
                 IRS' Installment Agreement Defaults by
                           Rates and Dollars

Fiscal year                               1994    1995    1996    1997
--------------------------------------  ------  ------  ------  ------
Default rate                               35%     37%     39%     43%
Default dollars (in millions)           $3,961  $4,714  $5,635  $6,479
----------------------------------------------------------------------
Note:  The default rates were estimated by dividing the number of
defaults by the ending inventories of installment agreements for each
year.  Although cohort data were not available, our results should
reasonably approximate such data because the average age of
agreements in the inventories was just under a year and our analysis
covers a short period. 

Source:  GAO computations of IRS data. 

Another benefit IRS might achieve is administrative cost savings if
more of the payments it now receives by check (and other paper
documents) were made by EFT.  Administrative cost savings could
result from (1) lower costs to process taxpayers' remittances, (2)
lower postage and handling costs, and (3) lower collection
enforcement costs.  Administrative cost savings would result even if
the default rate remained the same, but based on the reported
experience of others who use EFT, lower default rates are also likely
to occur. 

According to NACHA, the published literature, and the organizations
we contacted that used EFT, electronic payments are less expensive to
process than payments made by check, and default rates are lower. 
For example, a 1993 study for NACHA reported that the average
processing cost for a payment through the ACH system was about 46
percent less than the average processing cost for a check. 

Routinely, IRS uses lockboxes for installment agreement payments. 
Under the lockbox concept, taxpayers are to mail payments to a
lockbox, which is a postal rental box serviced by a commercial bank. 
The bank is to process the payments and transfer the funds to a
federal government account, record the payment and payer information
on a computer tape, and forward the tape to IRS for use in updating
taxpayers' accounts.  FMS, which pays the lockbox fees, reported to
us that the average cost in fiscal year 1997 to process an IRS
installment agreement payment through lockboxes was 76 cents per
transaction versus 48 cents per transaction to process a payment by
EFT.  Thus, FMS data show that IRS' EFT costs are 28 cents lower or
about 37 percent less than its lockbox costs.  This shows that IRS
has the potential to reduce the costs it pays banks to process
installment agreement payments by increasing the number of EFT
payments and decreasing the number of lockbox payments. 

By promoting EFT use, IRS could further reduce the administrative
cost of its installment agreement program.  IRS could achieve
additional cost savings by not sending taxpayers who make EFT
installment payments a monthly statement, as it currently does for
all taxpayers with installment agreements.  This would save IRS
postage and handling costs and would be similar to the practices for
EFT installment agreements in Minnesota and California.  It is also
similar to practices used by many private sector organizations,
especially for recurring EFT payments of the same dollar amount.  In
addition, administrative cost savings pertaining to collection
enforcement would be lower as fewer resources would be needed to
pursue fewer taxpayers in default. 


   IRS HAS CONCERNS ABOUT
   REQUIRING EFT USE IN
   INSTALLMENT AGREEMENTS
------------------------------------------------------------ Letter :7

In 1995, we reported on ways IRS could make administrative
improvements to its installment agreement program.\6 IRS officials
then agreed that EFT had advantages over the standard installment
agreement.  According to officials at that time, EFT agreements (1)
are cheaper to service than the standard agreement, (2) eliminate the
chance that a taxpayer will forget to make a payment or send less
than the agreed-upon amount, (3) result in quicker deposit of funds
to Treasury accounts, and (4) may reduce default rates. 

During this review, we met with IRS Collection officials, including
the Assistant Commissioner (Collection), to obtain their views about
expanding EFT use in the installment agreement program and to
determine if there were any barriers or concerns in doing so.  The
officials generally agreed with the comments IRS officials made in
our 1995 report, but they expressed concerns about requiring EFT use,
which is one option for expanding its use.  The Assistant
Commissioner told us that IRS had considered expanding EFT use for
installment agreements in the past but did not develop definite plans
to do so.  With regard to making EFT a requirement, he said that this
raises many issues for IRS, including policy, legal, and operational
concerns. 

From a policy perspective, the Assistant Commissioner said that IRS
attempts to treat all taxpayers the same, and he was uncertain
whether requiring or suggesting to taxpayers that they use a certain
payment procedure would be fair unless all taxpayers had to abide by
it.  In this regard, we note that IRS now routinely requires
taxpayers to use a specified method to pay taxes.  For example,
compliant taxpayers whose federal tax deposits are over $50,000 are
required to use EFT.\7 Thus, requiring delinquent taxpayers, such as
those with installment agreements, to use EFT would not appear to be
contrary to existing IRS procedures on specifying payment methods for
certain taxpayers.  In addition, there are circumstances in which IRS
can impose even stricter payment procedures on delinquent taxpayers. 
For example, IRS can require a delinquent employer to file returns
and pay the applicable tax monthly rather than quarterly. 

The IRS officials were not certain what legal issues would have to be
dealt with, and they did not provide specifics at our meeting with
them.  Also, because IRS is attempting to be more customer-service
oriented, the Assistant Commissioner felt that imposing a requirement
that delinquent taxpayers use EFT to make installment payments might
contradict the current customer service emphasis.  In this regard, we
noted that many organizations, as in California, promote EFT use by
specifically informing their customers of the benefits it offers
them, which includes enhanced customer service and convenience. 

The IRS Collection officials articulated operational concerns about
expanding EFT use.  Regarding making EFT a requirement, they said
that IRS would probably have difficulty handling the potentially
large number of taxpayer inquiries that might occur from changing its
program.  In particular, the Assistant Commissioner felt that the
service centers would be unable to manage the expected large number
of waivers for potential hardships that could result if EFT payments
were required.  We realize that provisions would be necessary to
handle hardship waivers if EFT is to be required, and one way would
be to provide taxpayers with waivers without their having to verify
the hardships.  This would be similar to the way IRS currently
approves taxpayers' applications for streamlined installment
agreements without verification of their ability to pay in full. 

Another concern expressed by the Assistant Commissioner was that many
taxpayers pay installments in cash and that to require EFT would
probably make this group of taxpayers, who essentially manage their
finances on a cash basis, even less compliant in paying their taxes. 
We could not verify the extent of this potential concern because IRS
had no specific data on how many taxpayers currently pay installments
in cash.  We note, however, that such taxpayers could be granted
automatic waivers. 


--------------------
\6 GAO/GGD-95-137. 

\7 Section 6302(h) Internal Revenue Code. 


   CONCLUSIONS
------------------------------------------------------------ Letter :8

The reported successful practices of two states in using EFT for
installment agreement payments appear to offer IRS the potential to
make its installment agreement program more effective and efficient. 
In Minnesota and California, EFT is now the method used by most
taxpayers to make their installment payments.  With EFT, the two
states reported they have reduced the percentage of taxpayer defaults
and decreased the administrative costs of their installment agreement
programs while achieving higher and faster collections.  The benefits
reported by these states were achieved with programs that included
waivers in certain circumstances.  Other users, such as banks, have
also acknowledged the benefits of EFT, and the federal government has
taken steps to promote greater usage for other nontax payments. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :9

In his letter dated April 15, 1998, the Commissioner of Internal
Revenue concurred with our report findings that greater use of EFT
might increase the efficiency and effectiveness of IRS' installment
agreement program.  Our draft report included a recommendation that
IRS develop a strategy to increase EFT usage for installment
payments, and the Commissioner stated that IRS is amenable to
pursuing a voluntary program that promotes EFT installment payments. 
IRS agreed to revisit its procedures and training materials "to
ensure there is sufficient emphasis on educating taxpayers on the
benefits of EFT and encouraging taxpayers to sign up for EFT
agreements." IRS also reiterated the concerns it has about requiring
EFT usage for installment agreements, as discussed in this report
(see pp.  13 and 14). 

As we were finalizing our report, the IRS Commissioner announced
major structural and organizational changes for the agency, and
congressional leaders were considering legislation calling for one of
the most far-reaching overhauls of IRS in decades.  The proposed
changes most likely will affect IRS' administrative operations and
processes and future interactions with taxpayers.  The proposals
include, among other things, ways to improve the service IRS provides
to taxpayers and expand taxpayers' rights in their dealings with IRS. 

Given the complexities of the proposed IRS restructuring and the need
to prioritize the necessary changes to IRS' administrative processes,
we are not making a recommendation regarding EFT to IRS at this time. 
However, as it continues to develop strategies to improve tax
administration and the services it provides to taxpayers, IRS may
want to review the potential benefits that greater use of EFT for
installment payments can offer it and taxpayers. 


---------------------------------------------------------- Letter :9.1

We are sending copies of this report to the Ranking Minority Members
of the House Ways and Means Committee and the Subcommittee on
Oversight, the Chairman and Ranking Minority Member of the Senate
Committee on Finance, various other congressional committees, the
Secretary of the Treasury, the Commissioner of Internal Revenue, and
other interested parties.  We also will make copies available to
others upon request. 

Please contact me at (202) 512-9110 if you or your staff have any
questions.  The major contributors to this report are listed in
appendix II. 

James R.  White
Associate Director, Tax Policy
 and Administration Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
============================================================== Letter 



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

Charlie W.  Daniel, Assistant Director
Keith E.  Steck, Evaluator
Joseph E.  Jozefczyk, Adviser
Elizabeth W.  Scullin, Communications Analyst

CHICAGO FIELD OFFICE

Thomas D.  Venezia, Core Group Manager
David R.  Lehrer, Evaluator-in-Charge


*** End of document. ***