**Written Statement of Nina E. Olson\
National Taxpayer Advocate**

**Before the**

**Committee on the Budget\
U.S. House of Representatives**

**On**

**The IRS and the Tax Gap**

**February 16, 2007**

**Table of Contents**

[I. Why the Tax Gap Matters 3](#why-the-tax-gap-matters)

[II. Overview of the Primary Causes of the Tax Gap
3](#overview-of-the-primary-causes-of-the-tax-gap)

[III. Broad Strategies to Address the Tax Gap
3](#broad-strategies-to-address-the-tax-gap)

[A. Tax Simplification 3](#tax-simplification)

[B. Expanded Third-Party Information Reporting
3](#expanded-third-party-information-reporting)

[C. A More Robust IRS Compliance Program That Appropriately Balances
Taxpayer Service and Enforcement Measures
3](#a-more-robust-irs-compliance-program-that-appropriately-balances-taxpayer-service-and-enforcement-measures)

[IV. A Proposal to Revise the Congressional Budget Rules to Improve IRS
Funding Decisions
3](#a-proposal-to-revise-the-congressional-budget-rules-to-improve-irs-funding-decisions)

[A. Overview of the Problem of IRS Underfunding
3](#overview-of-the-problem-of-irs-underfunding)

[B. The Consequences of Underfunding the IRS
3](#the-consequences-of-underfunding-the-irs)

[1. Failure to Collect Unpaid Taxes 3](#failure-to-collect-unpaid-taxes)

[2. Bad Results 3](#bad-results)

[a. Outsourcing Tax Collection 3](#outsourcing-tax-collection)

[b. Neglect of Important Taxpayer Service Programs
3](#neglect-of-important-taxpayer-service-programs)

[C. Recommendations 3](#recommendations)

[1. Congress should consider revising its budget rules in a manner that
allows the budget and appropriations committees to make a judgment about
the answer to the question: "What level of funding will maximize tax
compliance, particularly voluntary compliance, with our nation's tax
laws, with due regard for protecting taxpayer rights and minimizing
taxpayer burden?" and then set the IRS funding level accordingly,
without regard to spending caps.
3](#congress-should-consider-revising-its-budget-rules-in-a-manner-that-allows-the-budget-and-appropriations-committees-to-make-a-judgment-about-the-answer-to-the-question-what-level-of-funding-will-maximize-tax-compliance-particularly-voluntary-compliance-with-our-nations-tax-laws-with-due-regard-for-protecting-taxpayer-rights-and-minimizing-taxpayer-burden-and-then-set-the-irs-funding-level-accordingly-without-regard-to-spending-caps.)

[2. In allocating IRS resources, Congress should keep in mind that tax
compliance is a function of both high quality taxpayer service and
effective tax-law enforcement, and it is essential that the IRS continue
to maintain a balanced approach to improving tax compliance.
3](#in-allocating-irs-resources-congress-should-keep-in-mind-that-tax-compliance-is-a-function-of-both-high-quality-taxpayer-service-and-effective-tax-law-enforcement-and-it-is-essential-that-the-irs-continue-to-maintain-a-balanced-approach-to-improving-tax-compliance.)

[3. Congress should provide increases in IRS personnel funding at a
steady but gradual pace, perhaps two percent to three percent a year
above inflation. We do not think the IRS can ramp up its staffing more
quickly without encountering significant transitional difficulties.
However, Congress should consider providing more rapid funding increases
for technology and research improvements, as the transitional challenges
of absorbing additional resources are probably less significant in these
areas and the potential exists to generate substantial productivity
gains.
3](#congress-should-provide-increases-in-irs-personnel-funding-at-a-steady-but-gradual-pace-perhaps-two-percent-to-three-percent-a-year-above-inflation.-we-do-not-think-the-irs-can-ramp-up-its-staffing-more-quickly-without-encountering-significant-transitional-difficulties.-however-congress-should-consider-providing-more-rapid-funding-increases-for-technology-and-research-improvements-as-the-transitional-challenges-of-absorbing-additional-resources-are-probably-less-significant-in-these-areas-and-the-potential-exists-to-generate-substantial-productivity-gains.)

[4. To assist Congress in performing its oversight responsibilities and
determining the appropriate IRS funding level in future years, Congress
should require the IRS to provide annual or semiannual reports detailing
IRS's progress in handling all significant categories of work, including
the known workload, the percentage of the known workload the IRS is able
to handle and the percentage of the known workload the IRS is not able
to handle, the additional resources the IRS would require to perform the
additional work, and the likely return-on-investment of performing that
work.
3](#to-assist-congress-in-performing-its-oversight-responsibilities-and-determining-the-appropriate-irs-funding-level-in-future-years-congress-should-require-the-irs-to-provide-annual-or-semiannual-reports-detailing-irss-progress-in-handling-all-significant-categories-of-work-including-the-known-workload-the-percentage-of-the-known-workload-the-irs-is-able-to-handle-and-the-percentage-of-the-known-workload-the-irs-is-not-able-to-handle-the-additional-resources-the-irs-would-require-to-perform-the-additional-work-and-the-likely-return-on-investment-of-performing-that-work.)

[V. Conclusion 3](#conclusion)

[VI. Exhibit A: Cash Economy -- Administrative Recommendations
3](#exhibit-a-cash-economy-administrative-recommendations)

[VII. Exhibit B: Cash Economy -- Legislative Recommendations
3](#exhibit-b-cash-economy-legislative-recommendations)

[VIII. Exhibit C: Requiring Brokers to Track and Report Cost Basis --
Legislative Recommendation
3](#exhibit-c-requiring-brokers-to-track-and-report-cost-basis-legislative-recommendation)

Mr. Chairman, Ranking Member Ryan, and distinguished Members of the
Committee:

Thank you for inviting me to testify today about "The IRS and the Tax
Gap."[^1] In the National Taxpayer Advocate's 2006 Annual Report to
Congress, issued last month, I made a recommendation to address the tax
gap that falls squarely within the jurisdiction of the Budget Committee
-- namely, to change the budget rules by which IRS funding decisions are
made to provide funding at whatever level will maximize tax compliance,
with due regard for protecting taxpayer rights and minimizing taxpayer
burden. I will describe my proposal in more detail below after first
summarizing the components of the tax gap and describing my perspective
on the best strategies to address it.

# Why the Tax Gap Matters

In my 2006 report, I designated the tax gap as the second most serious
problem facing taxpayers (after the alternative minimum tax). From a
taxpayer perspective, I am deeply concerned that compliant taxpayers are
paying a great deal of money to subsidize noncompliance by others. Using
data from the IRS's 2001 National Research Program study, if we divide
the estimated 2001 net tax gap of \$290 billion[^2] by the estimated
108,209,000 households that existed in the United States in that
year[^3] we see that each household was effectively assessed an average
"surtax" of about \$2,680 to subsidize noncompliance.[^4] That is an
extraordinary burden to ask our nation's compliant taxpayers to bear
every year, and it is imperative that we take steps to reduce that
burden.[^5]

Noncompliance has a corrosive effect on tax compliance. If compliant
taxpayers believe that everyone else is paying his or her fair share,
they are likely to remain compliant. But no one wants to feel like a
"tax chump." If compliant taxpayers feel like they are overpaying, some
will reach a point where they resent it and stop complying or comply at
a lower level.

In other words, there is a degree to which compliance breeds more
compliance and noncompliance breeds more noncompliance. That is largely
why each additional dollar the IRS collects is thought to increase
federal revenue by substantially more than a dollar. Greater compliance
-- whether brought about through taxpayer service or enforcement -- can
pay for itself many times over.

# Overview of the Primary Causes of the Tax Gap

Last year, the IRS substantially updated its tax gap estimates as a
result of a set of audits it performed on individual income tax returns
filed for 2001. The results of the audits show that withholding and
third-party information reporting are the key drivers of tax compliance.
Reporting compliance rates are about 99 percent on wages subject to
withholding and third-party information reporting, about 96 percent on
income subject to full third-party information reporting (*e.g.,*
interest and dividends) -- yet less than 50 percent on income *not*
subject to third-party information reporting.[^6]

At the same time, the complexity of the tax code is a driver of
noncompliance because it creates loopholes that aggressive taxpayers can
exploit. Corporate tax shelters and abusive schemes pursued by
individual taxpayers exist largely because of ambiguities in the law.
Tax-law or procedural complexity is also responsible for the significant
majority of taxpayer reporting errors.[^7]

Finally, the lack of funding provided to the IRS to maximize taxpayer
service (especially outreach and education) and enforcement (where the
IRS was only able to conduct face-to-face audits of one out of every 435
taxpayers last year) prevents the IRS from maximizing tax
compliance.[^8]

# Broad Strategies to Address the Tax Gap

Broadly speaking, I have advocated three strategies for closing the tax
gap: (1) fundamental tax simplification, with an emphasis on making
economic transactions more transparent; (2) expanded third-party
information reporting and, in certain situations, tax withholding on
non-wage income; and (3) a more robust IRS compliance program that
appropriately balances taxpayer service and enforcement.

## **Tax Simplification**

In my annual reports to Congress, I have highlighted numerous examples
of tax law complexity and described the consequences of that complexity
for taxpayers and tax administration. For taxpayers seeking to comply
with the law, complexity presents a huge obstacle. To cite a few
examples, the alternative minimum tax (AMT) and the earned income tax
credit (EITC) affect millions of taxpayers yet present substantial
compliance burdens. The sheer number of alternative incentives that the
tax code provides for saving for education and retirement baffles many
taxpayers, including sophisticated taxpayers.

For taxpayers seeking to exploit loopholes, complexity presents
countless opportunities. Many law firms, accounting firms, and
investment banking firms have made tens of millions of dollars by
scouring the Code for ambiguities and then advising taxpayers to enter
into transactions, with differing levels of business purpose or economic
substance, to take advantage of those ambiguities. The IRS devotes
significant resources to identifying these transactions and challenging
them, where appropriate, but many are legitimate under existing law and
many more fall into a grey area.

A simpler tax code could reduce these administrative challenges
enormously.

Moreover, traditional economic analysis focuses on the goals of equity
and efficiency in writing the tax laws. To those, I would add
transparency. To the extent we can revise the Code to provide greater
transparency of payments of income without imposing undue burden on
taxpayers, the higher compliance rates associated with third-party
information reporting can be more readily achieved in a broader array of
transactions.

## **Expanded Third-Party Information Reporting**

Expanding third-party information reporting would clearly improve
compliance, but we must be realistic in taking into account the burden
third-party information reporting imposes on payors of income. If our
sole objective were to maximize the amount of tax revenue, we could
simply require that anyone making a taxable payment to another person
report the payment to the IRS. But requiring everyone making a taxable
payment to file a report with the government would impose more burden
than most of us would be willing to bear. No one wants to be obligated
to file a document with the IRS every time he takes a cab ride, has
someone mow his lawn, or calls a plumber to fix a broken faucet.

To address the tax gap, we should begin by identifying various
categories of transactions that currently are not subject to information
reporting and determine, on a case-by-case basis, whether the benefits
of requiring reporting outweigh the burdens such a requirement would
impose. In many cases, we will ultimately decide that it is
inappropriate to impose a reporting requirement. But in some cases, we
may decide that requiring reporting is appropriate.

To cite one example, I recommended in my 2005 Annual Report to Congress
that Congress consider requiring broker-dealers to track and report
their customer's cost-basis in stocks and mutual funds when sales are
made. Under existing rules, brokers are required to file a Form 1099-B
(Proceeds from Broker and Barter Exchange Transactions) with the IRS
whenever a customer sells a security. However, the reporting rules only
require the broker to report the gross proceeds the customer receives
upon the sale. The broker does not have to report the customer's cost
basis in the security. That omission is significant because a taxpayer's
gain or loss on the sale of a security is measured by the excess of
gross proceeds over cost basis. Thus, the absence of cost-basis
reporting provides an opportunity for noncompliance that the IRS rarely
will detect without an audit.

The absence of a requirement that brokers track and report customers'
cost basis in securities has two consequences. First, it often imposes
significant compliance burdens on taxpayers who may not have kept track
of their cost basis. To illustrate, a taxpayer who has held AT&T stock
since the 1980s has received shares in more than a dozen companies over
the years, and on each such occasion, the taxpayer's cost basis had to
be split between his existing holding and the spun-off company.
Similarly, most mutual fund customers elect to have dividend and capital
gain distributions automatically reinvested, and the customer's
aggregate basis in a mutual fund holding changes upon each such
distribution. If taxpayers don't have complete records, they will be
unable to determine or substantiate their basis in many instances. We
recommended requiring brokers to track and report cost basis primarily
because it would make compliance much easier for honest taxpayers.

But the second consequence of the absence of cost basis reporting is
that it affords less honest taxpayers with significant opportunities to
overstate their basis and therefore understate their tax liabilities.
Reliable estimates of the amount of underreporting in this area are
difficult to come by, but two professors have sized the problem at about
\$25 billion a year.[^9] IRS officials studying the NRP data believe the
revenue loss is substantially lower, but they agree that the level of
underreporting reaches into the billions of dollars.[^10] We have spoken
with representatives of the brokerage industry and believe on balance
that the revenue benefits of requiring brokers to track and report cost
basis exceed the burdens the requirement would impose.

I am pleased that bills were introduced in both the House and the Senate
last year to implement our proposal, and I am pleased that the Treasury
Department has included it among the revenue proposals it sent to
Congress earlier this month. Bipartisan bills have been introduced in
the new Congress by Congressmen Rahm Emanuel and Walter Jones in the
House and by Senators Evan Bayh, Tom Coburn and 11 other original
co-sponsors in the Senate. I strongly urge Congress to enact this
measure.

Another example: Under current law, an individual taxpayer can escape
information reporting by incorporating. This is true even if the
taxpayer is performing the same services that would be subject to Form
1099-MISC (Miscellaneous Income) reporting if the taxpayer were
conducting business as an unincorporated entity.

For Form 1099-MISC information reporting purposes, I believe there
should be no distinction between taxpayers providing the same services
for compensation merely because one taxpayer has incorporated and
another has not. There are, of course, many valid reasons for choosing
to conduct business as a corporation, but information-reporting
avoidance should not be such a reason. Corporate taxpayers who intend to
comply with the tax law should have no objections to receiving a Form
1099-MISC for compensation for services performed or to IRS awareness of
this compensation. Thus, we recommend that corporate taxpayers
(including Subchapter S corporations) be subject to Form 1099-MISC
reporting requirements to the same extent that unincorporated businesses
are today.

We also recommend that Congress consider requiring information reporting
on gross proceeds from sales conducted on Internet auction and sales
sites. As with current rules governing Form 1099 reporting, such reports
could be subject to a *de minimis* annual exemption (say, \$600). One
recent study found that 700,000 Americans reported that eBay sales
constitute their primary or secondary source of income.[^11] The IRS
must have the tools needed to address under-reporting of this income.

My office has made a number of proposals to reduce the tax gap both
through more third-party information reporting and through other
methods. The Exhibits that follow my statement summarize our main
recommendations.

## **A More Robust IRS Compliance Program That Appropriately Balances Taxpayer Service and Enforcement Measures**

The IRS can do more -- much more -- to improve tax compliance.

Despite a finding by a leading IRS researcher that the direct and
indirect benefits of IRS's preparing tax returns for low income
taxpayers pays for itself many times over,[^12] the IRS has reduced by
about half the number of tax returns it helps low-income taxpayers
prepare in its walk-in sites.[^13] Despite the challenges individuals
who start small businesses face in learning for the first time about the
legal requirements they face as employers (including the payroll
responsibilities of income and employment tax withholding, paying over
tax to the IRS, reporting to the IRS, and reporting to the employee),
the IRS has substantially reduced its field outreach operation.[^14]
Despite the number of taxpayers in certain states with taxable income
from farming activities, the IRS has apparently declared questions about
farm income and expenses "out of scope" for IRS walk-in sites in those
areas.[^15]

On the enforcement side, the IRS is currently conducting face-to-face
audits of only about one out of every 435 tax returns.[^16] It does not
have the resources to pursue a significant percentage of its accounts
receivable. And the private debt collection initiative, a controversial
program that is projected to raise only about \$1.4 billion over the
next 10 years,[^17] results from the IRS's lack of resources to pursue
these cases itself.

# A Proposal to Revise the Congressional Budget Rules to Improve IRS Funding Decisions

## **Overview of the Problem of IRS Underfunding**

The Internal Revenue Service is effectively the Accounts Receivable
Department of the United States Government. On a budget of about \$10.6
billion,[^18] the IRS currently collects about \$2.24 trillion a
year.[^19] That translates to an average return-on-investment (ROI) of
about 210:1.[^20]

Rather than recognizing the IRS's unique role as the revenue generator
for the federal government, however, the congressional budget rules
treat spending for the IRS exactly the same way they treat spending for
all other federal agencies.

The current budget procedures work essentially as follows: Early each
year, a spending ceiling is established for a category of programs that
in recent years included the Department of Transportation, the
Department of the Treasury (of which the IRS is a part), the Department
of Housing and Urban Development, the Judiciary, the District of
Columbia, and independent federal agencies.[^21] The House and Senate
Appropriations subcommittees with jurisdiction over this grouping of
federal programs must apportion the total number of dollars it receives
among them. If more funding was provided for transportation programs,
for example, less funding was available for the IRS. Thus, the IRS
competes dollar-for-dollar against many other federal programs for
resources.

These procedures make little sense. The IRS collects about 96 percent of
all federal revenue.[^22] The more revenue the IRS collects, the more
revenue Congress may spend on other programs or may use to cut taxes or
reduce the deficit. The less revenue the IRS collects, the less revenue
Congress has available for other purposes.

If the federal government were a private company, its management clearly
would fund the Accounts Receivable Department at a level that it
believed would maximize the company's bottom line.

Since the IRS is not a private company, maximizing the bottom line is
not -- in and of itself -- an appropriate goal. But the public sector
analogue should be to maximize tax compliance, especially voluntary
compliance, with due regard for protecting taxpayer rights and
minimizing taxpayer burden. If the IRS were given more resources,
studies show the IRS could collect substantially more revenue.

Former IRS Commissioner Charles Rossotti has written:

> When I talked to business friends about my job at the IRS, they were
> always surprised when I said that the most intractable part of the
> job, by far, was dealing with the IRS budget. The reaction was usually
> "Why should that be a problem? If you need a little money to bring in
> a lot of money, why wouldn't you be able to get it?"[^23]

Yet obtaining a little extra money to bring in a lot of extra money
remains an intractable challenge for the IRS. Over the past few years,
Congress has focused increasing attention on the "tax gap" -- the
difference between taxes owed and taxes paid. As part of this
discussion, it should be recognized that the IRS currently suffers from
a "resources gap," and the IRS's lack of resources is a significant
impediment to its ability to help close the tax gap and thereby reduce
the federal budget deficit.[^24]

## **The Consequences of Underfunding the IRS**

The failure to fund the IRS at appropriate levels leads to two sets of
consequences. First, the IRS lacks the resources to collect a
significant amount of unpaid tax, resulting in a larger tax gap and a
larger budget deficit. Second, the lack of resources often leads the IRS
to take steps that are, in my judgment, unwise from the standpoint of
tax compliance and taxpayer rights.

### **Failure to Collect Unpaid Taxes**

In his final report to the IRS Oversight Board in 2002, former
Commissioner Rossotti presented a discussion titled "Winning the Battle
but Losing the War" that detailed the consequences of the lack of
adequate funding for the IRS. He identified 11 specific areas in which
the IRS lacked resources to do its job, including taxpayer service,
collection of known tax debts, identification and collection of tax from
non-filers, identification and collection of tax from underreported
income, and noncompliance in the tax-exempt sector.

Commissioner Rossotti provided estimates of the revenue cost in each of
the 11 areas based on IRS research data. In the aggregate, the data
indicated that the IRS lacked the resources to handle cases worth about
\$29.9 billion each year. It placed the additional funding the agency
would have needed to handle those cases at about \$2.2 billion.[^25]

Significantly, this estimate reflects only the potential *direct*
revenue gains. Economists have estimated that the indirect effects of an
examination on voluntary compliance provide further revenue gains. While
the indirect revenue effects cannot be precisely quantified, two of the
more prominent studies in the area suggest the indirect revenue gains
are between six and 12 times the amount of the proposed adjustment.[^26]

I want to emphasize that the existing modeling in this area is not
especially accurate, and estimates of both the direct and indirect
effects of IRS programs vary considerably. As I will discuss below, the
IRS needs to develop better modeling to produce more accurate
return-on-investment estimates. But I also want to emphasize that almost
all studies show that, within reasonable limits, each additional dollar
appropriated to the IRS should generate substantially more than an
additional dollar in additional federal revenue assuming the funding is
wisely spent.

### **Bad Results**

#### **Outsourcing Tax Collection**

In the same report, former Commissioner Rossotti reported the IRS was
receiving sufficient resources to work only 40 percent of some 4.5
million accounts receivable cases each year. IRS research estimated that
with an additional \$296.4 million, the agency could collect \$9.47
billion.[^27] That translates to a return on investment of 32:1. Among
collection cases handled solely through phone calls, the IRS has
estimated an ROI of about 13:1.[^28]

Because Congress has not provided IRS with sufficient funding to work
these accounts, the Administration requested the authority to outsource
the collection of certain tax debts to private collection agencies.
Congress granted the requested authority in 2004,[^29] and the IRS began
to send cases to private debt collectors in September of 2006.

Under the terms of the program, the IRS is paying out commissions of up
to 25 percent of each dollar collected to the private collection
agencies. The IRS is also bearing significant additional costs to
create, maintain, and oversee the program.[^30]

Internal IRS estimates show that the IRS, if given the funding, could
generate a substantially higher ROI than private contractors receiving
commissions of nearly 25 percent can produce. For each dollar a PCA
collects, the IRS will receive about 75 cents and the PCA will keep
about 25 cents, resulting in an ROI of, at best, about 3:1. The
significant administrative costs the IRS is incurring to run the
program, including the opportunity costs of pulling experienced IRS
personnel off higher dollar work to assist with this initiative, reduce
the ROI further. Despite supporting the use of private debt collectors
because of IRS resource limitations, IRS Commissioner Mark Everson has
repeatedly acknowledged that IRS employees could collect unpaid taxes
more cheaply and efficiently.[^31]

The result of underfunding the IRS in this area is that the government
is not maximizing its revenue collection and the risk of taxpayer rights
violations has been heightened due to the use as collectors of
non-governmental employees who will receive only limited taxpayer-rights
training.[^32]

#### **Neglect of Important Taxpayer Service Programs**

The IRS has long acknowledged that taxpayer service plays a significant
role in promoting tax compliance. In fact, its current strategic plan is
based on the principle: "Service + Enforcement = Compliance."[^33] Yet
two examples illustrate the neglect of important services that likely is
resulting in a higher tax gap.

**Tax Return Preparation.** The IRS historically has prepared tax
returns for low income taxpayers at its walk-in sites (called "Taxpayer
Assistance Centers," or "TACs"). Low income taxpayers generally qualify
for the earned income tax credit (EITC), which is a refundable credit
that caps out at \$4,536 in 2006. Studies show that the average
overclaim rate for EITC benefits is between 27 percent and 32
percent.[^34] IRS personnel who prepare tax returns are trained to ask
questions that minimize the likelihood of EITC overclaims and thus can
save the government hundreds of dollars per return. Yet to free up
resources for other program initiatives, the IRS has substantially
reduced return preparation at its TACs. The number of tax returns it
prepared dropped from 665,868 in FY 2003 to a projected 305,000 in FY
2006.

IRS data for tax years 2002 through 2004 suggest that EITC returns
prepared by IRS TACs may be significantly more compliant than
self-prepared and commercially prepared returns. Discriminant Function
(DIF) scores[^35] for self-prepared returns were between 21 and 26
percent higher than returns prepared at the TACs and between 25 and 31
percent higher than returns prepared by commercial preparers.[^36]

These findings are corroborated by examination results for EITC returns
for these tax years. As compared with TAC-prepared returns, average
audit assessments among EITC returns for tax years 2002 - 2004 ranged
from about \$640 to \$1,300 higher for self-prepared returns and from
about \$820 to \$1,300 higher for commercially prepared returns.[^37]
Similarly, a study conducted in 1996 that examined the relationship
between IRS return preparation and compliance over a ten-year period
showed that an increase in the number of returns prepared by the IRS
correlates with improvements in compliance among filers of individual
returns.[^38]

**Small Business Outreach.** IRS data show that self-employed taxpayers
account for the largest chunk of the tax gap and indicate that the tax
compliance rate for self-employed taxpayers runs at about 43
percent.[^39] Much of the underreporting is deliberate, but some is not.
For example, many small businesses are started by individuals who lack
detailed knowledge of the tax laws and do not have the resources to hire
tax attorneys or accountants. When they hire a few workers, they often
do not realize that they are assuming tax reporting, tax withholding,
and tax payment obligations, and they often do not understand enough
about the details of complying with the requirements to do so with
reasonable effort.

After the IRS Restructuring and Reform Act of 1998, the IRS developed a
function known as Taxpayer Education and Communications, or "TEC." TEC
was the IRS's outreach arm to small businesses to try to educate them
about the complexity of their tax obligations. For 2002, TEC was named
the Small Business Administration's agency of the year for what the SBA
called its outstanding progress in creating an effective education and
compliance assistance program for small business and self-employed
taxpayers.[^40] Yet in the name of achieving "efficiencies," TEC was
"realigned" in February 2005 through a merger with other outreach
functions and redesignated as "Stakeholder Liaison." Prior to the
realignment, TEC had 536 employees. After the realignment, Stakeholder
Liaison staffing included 219 employees.[^41] In my view, the reduction
in TEC staffing will reduce tax compliance and place a greater burden on
IRS enforcement personnel.

I cite these examples to make two points. First, although I disagree
with certain decisions the IRS has made, the failure to provide the IRS
with adequate resources to collect taxes has forced the IRS to cut
corners in places where corners should not have to be cut. Second, I
cite the examples of tax return preparation and TEC to underscore the
important role taxpayer service plays in promoting tax compliance. As I
discuss below, additional funding for the IRS should be provided in a
balanced manner. The revenue derived from direct enforcement actions may
be easier to measure, but the effects of taxpayer service may be equally
significant and perhaps more significant.

## **Recommendations**

### **Congress should consider revising its budget rules in a manner that allows the budget and appropriations committees to make a judgment about the answer to the question: "What level of funding will maximize tax compliance, particularly voluntary compliance, with our nation's tax laws, with due regard for protecting taxpayer rights and minimizing taxpayer burden?" and then set the IRS funding level accordingly, without regard to spending caps.**

This recommendation, in my view, boils down to simple common sense. Just
as a business could not survive if it did not seek to maximize revenue
collection, the federal government has less revenue to spend (or use to
reduce the deficit or cut taxes) if it fails to optimize tax collection.
Taxes are truly the lifeblood of government, for without tax revenue,
there would be no government programs. As the National Taxpayer
Advocate, I will be the first to raise objections if the pursuit of
revenue proceeds without due regard for protecting taxpayer rights and
minimizing taxpayer burden. But the existing budget rules, which pit the
revenue center of the government in direct competition with cost centers
and do not have a mechanism for explicitly taking into account the
revenue the IRS is likely to generate, are not logical. The
congressional budget rules are the one piece of the tax gap over which
your committee has direct control, and I urge you to consider
improvements to the process.

One way to implement the proposal I have outlined would be to keep the
IRS within its existing appropriation bill but break that bill into two
parts -- one providing a funding cap for the IRS and one providing a
funding cap for all other programs under that bill. The budget
committees would set the funding cap for the IRS.[^42] The
appropriations committees then would retain discretion to appropriate
funds at the cap or at a lesser level and to provide direction
concerning how the funds are to be spent. The rules should explicitly
authorize the committees to set the cap at a level that they believe
will maximize tax compliance, especially voluntary compliance, with due
regard for the protection of taxpayer rights and minimization of
taxpayer burden. In setting the cap and making funding decisions, the
budget and appropriations committees would consider the President's
budget request as well as input from the tax-writing committees, the
Congressional Budget Office, the Joint Committee on Taxation, the
Government Accountability Office, the Congressional Research Service and
any other office that they choose to consult to obtain revenue estimates
and guidance concerning the likely return on IRS spending.

We offer this approach only as an illustration of a way to implement the
general principle we are recommending. We do not have sufficient
expertise in the congressional budget process to craft a comprehensive
solution, and we are cognizant of the important roles that the budget
committees, the appropriations committees, and the tax-writing
committees play. Our overriding recommendation is simply that the
committees of jurisdiction collaborate to devise and implement
procedures that reflect the general principles we have outlined.

We note that in each of the past three years, the Administration has
proposed a contingent budgetary mechanism known as a "program integrity
cap" in an attempt to provide the IRS with additional funding. Under
this mechanism, additional funding for tax-law enforcement would have
been provided if, but only if, Congress agreed to fund at least the
existing base of enforcement activities. The Senate has endorsed the
concept, but the House did not go along. Although there may have been
subtle differences in detail, a similar approach was used in FY 1995 to
give the IRS additional funding.[^43] Because the Budget and
Appropriations committees have become familiar with this mechanism, it
may be a viable way to channel additional funding to the IRS.

However, we have two concerns about the use of program integrity caps.
First, the mechanism operates simply to mitigate the effects of what we
are arguing is a flawed conceptual approach to funding the IRS. It would
not alter the existing framework under which the IRS competes for
funding against other government programs, and it would not peg future
IRS funding decisions to the goal of maximizing tax compliance. I
believe a change to the process along the lines of what I am
recommending would be far preferable in the long run and would be more
likely to result in a consistent ramp-up in funding year-over-year.
Second, the mechanism in the past has been proposed solely to boost
enforcement spending (*i.e.,* the additional funding could be used only
for tax-law enforcement and would only be provided if Congress agreed to
fund at least the existing base of enforcement activities). As discussed
below in more detail, tax compliance is a function not only of
enforcement but also of taxpayer service, and it is important to
maintain a balanced approach between the two. If program integrity caps
are used in the future, we urge that consideration be given to providing
additional funding for taxpayer service as well as enforcement.

### **In allocating IRS resources, Congress should keep in mind that tax compliance is a function of both high quality taxpayer service and effective tax-law enforcement, and it is essential that the IRS continue to maintain a balanced approach to improving tax compliance.**

As noted, recent attempts to give the IRS additional funding beyond the
levels provided under the spending caps have focused exclusively on
providing additional funding for enforcement activities. That is so
largely because the *direct* ROI resulting from enforcement actions is
somewhat susceptible to measurement, while the deterrent effect of
enforcement actions and the effect of taxpayer service are too amorphous
to quantify. However, it is important to emphasize that direct
enforcement revenue in FY 2006 came to only \$48.7 billion, or
2 percent, of total IRS tax collections of \$2.24 trillion.[^44] The
remaining 98 percent of IRS tax collections resulted from a combination
of taxpayer service programs and the *indirect* (*i.e.,* deterrent)
effect of IRS enforcement actions. To make budgeting decisions by
striving to maximize the 2 percent of collections without grappling
adequately with what is required to maximize the remaining 98 percent of
collections is a bit like letting the tail wag the dog.

The Administration's FY 2008 budget request acknowledges this dilemma.
It states: "The IRS cannot currently measure either the impact of
deterrence or service, but they are positive."[^45] In fact, there are
no reliable data that show whether the IRS would achieve a greater ROI
if it spends additional funds on service or on enforcement. In the
absence of such data, one might think the government would err on the
side of assisting taxpayers in complying with the law rather than
disproportionately ramping up enforcement. If Congress continues to
provide the IRS with greater increases for enforcement each year simply
because the ROI of direct enforcement can be quantified, the cumulative
effect of those increases over time will be to relatively shift the IRS
away from taxpayer service and toward tougher enforcement -- with no
evidence that such a shift will increase revenues and with the
possibility that such a shift might decrease revenues.

As former Commissioner Rossotti has written:

> Some critics argue that the IRS should solve its budget problem by
> reallocating resources from customer support to enforcement. In the
> IRS, customer support means answering letters, phone calls, and visits
> from taxpayers who are trying to pay the taxes they owe. Apart from
> the justifiable outrage it causes among honest taxpayers, I have never
> understood why anyone would think it is good business to fail to
> answer a phone call from someone who owed you money.[^46]

Because of recent budget pressures and additional service obligations
brought about by the late passage of the tax extenders bill and the
administration of telephone excise tax refunds, the IRS is actually
expecting that it will reduce the percentage of phone calls it answers
from the mid-80s to the mid-70s this year, if not lower. The IRS has
been working hard on a five-year taxpayer service strategic plan,
developed in response to a Senate Appropriations directive in FY 2006.
This plan was developed in collaboration with my office and the IRS
Oversight Board. It is an excellent product, and it describes well how
the IRS can improve its ability to meet taxpayer service needs.

I urge you to keep in mind that taxpayer service provides a positive
ROI, and the ROI of taxpayer service may even exceed the ROI of
enforcement. The budget rules should be crafted to ensure that the
ability to score direct revenue gains resulting from enforcement does
not drive results that may be counterproductive. Perhaps the
"scorekeepers" could use a blended ROI of taxpayer service and
enforcement actions to support a balanced approach to additional IRS
funding.

Many aspects of taxpayer service are akin to a wholesale operation that
reaches groups of taxpayers (*e.g.,* outreach and education), while IRS
audits constitute a far more costly retail operation that requires
individual taxpayer contact. The IRS should pursue a balanced approach
to tax compliance that puts priority emphasis on improving IRS outreach
and education efforts, while reserving targeted enforcement actions to
combat clear abuses and send a message to all taxpayers that
noncompliance has consequences.[^47]

### **Congress should provide increases in IRS personnel funding at a steady but gradual pace, perhaps two percent to three percent a year above inflation. We do not think the IRS can ramp up its staffing more quickly without encountering significant transitional difficulties. However, Congress should consider providing more rapid funding increases for technology and research improvements, as the transitional challenges of absorbing additional resources are probably less significant in these areas and the potential exists to generate substantial productivity gains.**

In former Commissioner Charles Rossotti's final report to the IRS
Oversight Board in 2002, he described the serious total staffing
shortages the IRS was facing. He stated that the IRS needed "steady
growth in staff in the range of 2 percent per year."[^48] The context
shows he was discussing real increases (*i.e.,* increases above those
required to maintain current services).

At first blush, real annual staff growth of two percent might appear to
be an extremely limited request, but the IRS faces significant
challenges in adding and training staff. Examination and collection
procedures, in particular, are complex, as is the underlying tax law,
and experienced personnel must be pulled off revenue-producing priority
cases to provide extensive training to new hires. Moreover, new hires
generally have lower productivity rates and require significantly closer
supervision than experienced employees to ensure they do not take
incorrect actions, including actions that impair or violate taxpayer
rights.

However, the IRS probably can absorb more rapid funding increases in
technology and research, both of which have the potential to increase
IRS productivity substantially.

Better technology would allow the IRS to achieve significant
efficiencies in a broad range of taxpayer service and enforcement areas.
For example, it would allow the IRS to offer taxpayers a wider range of
e-filing options to increase the number of taxpayers who file their
returns electronically rather than on paper (which would save IRS the
cost of manually entering data from the roughly 64 million individual
income tax returns it received on paper in FY 2005),[^49] and it would
allow the IRS to expand its document-matching capabilities, which tend
to produce high returns on investment because automated processes are
relatively inexpensive to operate and maintain.

Better research would allow the IRS to assess the most cost effective
ways of meeting taxpayer service needs and to target its limited
enforcement resources to maximize its return on investment. We discuss
the importance of obtaining more accurate ROI estimates for the IRS's
major categories of work under Recommendation #4 below.

In the past, congressional support for additional IRS funding has come
in fits and starts. It will not be helpful to provide too much
additional funding immediately. It also will not be helpful to provide
additional funding for a year or two and then to change direction. To
maximize the IRS's ability to do its job, the IRS needs to receive
gradual but steady real increases in its total funding every year for at
least the next five to ten years.

### **To assist Congress in performing its oversight responsibilities and determining the appropriate IRS funding level in future years, Congress should require the IRS to provide annual or semiannual reports detailing IRS's progress in handling all significant categories of work, including the known workload, the percentage of the known workload the IRS is able to handle and the percentage of the known workload the IRS is not able to handle, the additional resources the IRS would require to perform the additional work, and the likely return-on-investment of performing that work.**[^50]

In this connection, Congress should consider directing the IRS to
undertake additional research studies, perhaps utilizing the expertise
of outside experts, to improve the accuracy of its ROI estimates for
various categories of work, especially taxpayer service and the indirect
effect of enforcement actions, including the downstream costs of such
work. Improved methods should also be developed to verify,
retrospectively, the *marginal* ROI that the IRS has achieved for each
category of work.

To provide Congress with meaningful information, the IRS will need to
conduct more research to improve the accuracy of its ROI calculations.
As we have noted above, direct enforcement revenue constitutes only
about two percent of the revenue the IRS collects. Ninety-eight percent
of the revenue the IRS collects derives from its taxpayer service
programs and the indirect deterrent effect of its enforcement
activities. Yet the IRS currently does not have adequate data on which
to make accurate estimates of the ROI of its various categories of work,
including taxpayer service programs and the indirect effect of its
enforcement activities as a whole and broken down by their key
components. Developing better data should be made a priority objective.
Moreover, ROI estimates should include costs relating to the downstream
consequences -- such as increased phone calls or correspondence, Appeals
conferences, and Taxpayer Advocate Service cases -- of the various
categories of IRS work.

We acknowledge that developing reasonably accurate modeling is a
significant challenge and will require a commitment of resources.
Nonetheless, we have recommended in the past and continue to believe
that this information will aid the IRS substantially in making resource
allocation decisions and will provide Members of Congress with
additional information on which to base future funding decisions.[^51]

# Conclusion

The tax gap is a serious problem because it deprives the government of
revenue it needs and it creates inequities between compliant taxpayers
and noncompliant taxpayers. There is no silver bullet that will
eliminate the tax gap. I believe significant progress can be made,
however, by following an approach that emphasizes fundamental tax
simplification, expanded third-party information reporting, and a more
robust IRS compliance program.

The Budget Committee has the jurisdiction to change the existing budget
rules that, in my view, have unreasonably constrained IRS funding and
limited the agency's ability to maximize tax compliance. I urge the
Committee to use its jurisdiction to improve the process by which IRS
funding decisions are made.

# Exhibit A: Cash Economy -- Administrative Recommendations

  --------------------------------------------------------------------------------------------
  **Recommendation**                   **Summary**         **Reason**
  -------------------- --------------- ------------------- -----------------------------------
  1                    Expand use of   Send self-employed  Self-employed taxpayers who want to
                       Electronic      taxpayers a letter  comply with their estimated tax
                       Federal Tax     to remind them when payment obligations sometimes fail
                       Payment System  estimated tax       because they have difficulty
                       (EFTPS)         payments are due    estimating income, remembering
                                       and offer the       oddly spaced payment dates (April
                                       option of paying    15, June 15, September 15 and
                                       electronically, by  January 15), and saving enough
                                       phone or via        money each quarter. When they fail
                                       automatic monthly   to pay enough estimated taxes, they
                                       (or biweekly)       are more likely to understate their
                                       withdrawals from    liability.
                                       the taxpayer's bank 
                                       account free of     
                                       charge.             

  2                    Revise Form     Include separate    This revision would encourage
                       1040, Schedule  lines showing (1)   taxpayers to report income even if
                       C               the amount of       it is not subject to information
                                       income reported on  reporting. Taxpayers are more
                                       Forms 1099 and (2)  likely to report income that is
                                       other income not    reported to the IRS by third
                                       reported on Forms   parties on information returns,
                                       1099.               such as Forms 1099. Some taxpayers
                                                           appear to believe that income not
                                                           reported on information returns is
                                                           not subject to tax or at least that
                                                           the IRS will not notice if they do
                                                           not report it. Separating out gross
                                                           receipts on the income tax form as
                                                           we propose would likely improve
                                                           compliance by emphasizing to
                                                           taxpayers that income not reported
                                                           on information returns is still
                                                           subject to tax. It may also suggest
                                                           to them that the IRS will notice if
                                                           they do not report any other
                                                           income. Another benefit of such a
                                                           revision is that it would allow the
                                                           IRS to match the income reported on
                                                           Schedule C with income reported on
                                                           Forms 1099 more easily.

  3                    Revise business Include two         These two questions would encourage
                       income tax      questions: (1) Did  taxpayers to comply with
                       return forms    you make any        information reporting requirements.
                                       payments over \$600 They would also suggest to
                                       in the aggregate    taxpayers that the IRS is looking
                                       during the year to  at information reporting compliance
                                       any unincorporated  and that there is additional risk
                                       trade or business?  to avoiding the information
                                       (2) If yes, did you reporting requirements by paying
                                       file all required   contractors \"under the table.\"
                                       Forms 1099?         Payments reported to the IRS on
                                                           information returns are much more
                                                           likely to be reported on the
                                                           payee\'s income tax return. Thus,
                                                           increased information reporting
                                                           compliance would cause contractors
                                                           (payees) to report more of their
                                                           income.

  4                    Implement more  Encourage taxpayers Research shows that taxpayers are
                       voluntary       to enter into       most compliant in paying taxes on
                       withholding     voluntary           income subject to withholding.
                       agreements      withholding         Unlike payments to employees,
                                       agreements by       payments to independent contractors
                                       agreeing not to     are generally not subject to
                                       challenge the       withholding. Businesses sometimes
                                       classification of   have difficulty determining whether
                                       workers who are a   service providers should be
                                       party to such an    classified as employees or
                                       agreement.          independent contractors and the IRS
                                       (Statutory          often challenges such
                                       authority exists    determinations. These agreements
                                       under IRC §         could reduce both underreporting by
                                       3402(p)(3), but the payees and the controversy
                                       IRS may need to     associated with worker
                                       work with the       classification.
                                       Treasury Department 
                                       to issue            
                                       regulations before  
                                       it can use its      
                                       authority and may   
                                       prefer additional   
                                       legislative         
                                       authority.)         

  5                    Institute       Require mandatory   By the time a payor receives a
                       backup          backup withholding  backup withholding notice from the
                       withholding     to begin more       IRS, the payee (service provider)
                       more quickly    quickly when        may no longer be receiving payments
                                       taxpayers provide   from the service recipient. Thus,
                                       an invalid TIN to   the IRS has lost the opportunity
                                       the payor.          for backup withholding. For
                                                           additional information see National
                                                           Taxpayer Advocate 2005 Annual
                                                           Report to Congress 238-248 (MSP:
                                                           Limited Scope of Backup Withholding
                                                           Rules).

  6                    Use more        Use more of the     The IRS currently uses information
                       available       information         from Forms 8300 to identify returns
                       information     available from      that may have unreported income. It
                                       state and local     also receives and uses state income
                                       governments as well tax audit reports as well as sales
                                       as information from tax records, which a
                                       Forms 8300 (Report  cross-functional team has concluded
                                       of Cash Payments    could be used more consistently and
                                       Over \$10,000       effectively. States and localities
                                       Received in a Trade also impose business license taxes
                                       or Business) when   or require different classes of
                                       selecting returns   licenses, which are sometimes based
                                       for audit and when  on gross receipts. Such information
                                       auditing them.      may be useful in detecting
                                                           unreported income. Local property
                                                           taxes are also based on the value
                                                           of real and personal property.
                                                           Taxpayers whose property holdings
                                                           are disproportionately large in
                                                           comparison to the income reported
                                                           on their federal income tax returns
                                                           may be underreporting their income.
                                                           The IRS could combine all of this
                                                           information, perhaps in conjunction
                                                           with the UI-DIF (or to improve it),
                                                           for selecting returns for audit and
                                                           auditing them.

  7                    Establish local A local planning    Because tax compliance trends and
                       compliance      organization could  norms are frequently local, it will
                       planning        work to identify    be difficult for the IRS to
                       organizations   local compliance    effectively address them without
                                       challenges, direct  local feedback about how its
                                       the IRS\'s local    strategies are affecting taxpayers
                                       response, and       in a given community. The IRS needs
                                       measure its         such information and feedback so
                                       effectiveness.      that it can adjust its strategy to
                                                           effectively address local
                                                           compliance issues. If noncompliance
                                                           is so commonplace in a local market
                                                           that the price of a good or service
                                                           does not reflect tax compliance
                                                           costs, suppliers may be unable to
                                                           both pay their taxes and compete.
                                                           However, if the IRS could motivate
                                                           a critical number of businesses in
                                                           a given market to report their
                                                           income, then the market price for
                                                           their goods or services would
                                                           increase so that businesses could
                                                           both compete and pay their taxes.
                                                           As the IRS's activity starts to
                                                           affect market prices, research
                                                           suggests it could produce a
                                                           dramatic increase in voluntary
                                                           compliance in the local cash
                                                           economy as it changes local norms.
                                                           A national cash economy program
                                                           office could replicate successful
                                                           local strategies nationwide.

  8                    Create a cash   The cash economy    The EITC Program Office coordinates
                       economy program program office      EITC related activities, measures
                       office          would coordinate    the results of its initiatives and
                                       research, outreach, takes responsibility for ensuring
                                       and compliance      that the program works as intended,
                                       efforts aimed at    even though it relies on many other
                                       improving income    parts of the IRS to achieve its
                                       reporting           goals. As with EITC initiatives,
                                       compliance among    responsibility for initiatives that
                                       cash economy        may improve income reporting by
                                       participants, as    cash economy participants is
                                       the EITC program    dispersed throughout the IRS.
                                       office has done     Nobody at the IRS with the
                                       with respect to     authority to coordinate research,
                                       EITC compliance.    outreach, and compliance efforts
                                                           takes primary responsibility for
                                                           reducing underreporting among
                                                           cash-economy participants. As a
                                                           result, the IRS is not as effective
                                                           as it could be in improving
                                                           compliance among cash-economy
                                                           participants. For example, a
                                                           cash-economy program office could
                                                           work with IRS Research to measure
                                                           the impact of initiatives to reduce
                                                           underreporting by cash-economy
                                                           participants. TIGTA and GAO
                                                           generally agree that such measures
                                                           would help the IRS to reduce the
                                                           tax gap. A cash-economy program
                                                           office could also be justified on
                                                           the basis that the EITC has a
                                                           program office and the amount of
                                                           the tax gap attributable to
                                                           cash-economy participants dwarfs
                                                           the amount of the tax gap
                                                           attributable to EITC claimants.

  9                    Educate cash    Educate cash        In addition to the satisfaction of
                       economy         economy             obeying the law and avoiding
                       participants    participants about  potential civil and criminal
                                       the benefits of     penalties and interest charges,
                                       reporting their     such benefits may include, for
                                       income and study    example, an increase in retirement
                                       the effect of such  benefits; disability benefits;
                                       efforts to          survivors benefits; Medicare
                                       determine whether   benefits; access to credit; earned
                                       they are cost       income tax credits; and the ability
                                       effective.          to gain admission to the U.S. or a
                                                           visa-status adjustment for family
                                                           members or employees. The IRS could
                                                           test this concept by educating
                                                           taxpayers through outreach and
                                                           various media targeting
                                                           cash-economy participants in
                                                           communities where compliance is low
                                                           and such benefits are not well
                                                           known. Researchers have suggested
                                                           that publicity about such benefits,
                                                           when combined with other
                                                           enforcement initiatives, may
                                                           significantly improve reporting
                                                           compliance in a given community.

  10                   Obtain more and Sponsor research to IRS researchers have previously
                       better research identify the most   estimated that the indirect effect
                                       effective use of    of an average examination on
                                       IRS resources after voluntary compliance is between six
                                       taking into account and 12 times the amount of the
                                       the direct and      proposed adjustment. However, not
                                       indirect effects of all audits have the same effect on
                                       IRS activities on   compliance. A dollar spent auditing
                                       tax revenue.        cash economy industries with high
                                                           rates of noncompliance may have a
                                                           very different effect than a dollar
                                                           spent auditing corporate tax
                                                           shelters. On the other hand, a
                                                           dollar spent on making it easier
                                                           for taxpayers to comply with their
                                                           tax obligations, for example by
                                                           revising forms, improving EFTPS,
                                                           and answering tax law questions,
                                                           has a positive indirect effect on
                                                           compliance. The IRS does not have
                                                           current research to show where the
                                                           next dollar is best spent. We do
                                                           not even know whether the next
                                                           dollar is better spent on
                                                           enforcement or taxpayer service.
                                                           Thus, in the absence of better
                                                           research, the IRS cannot make fully
                                                           informed resource-allocation
                                                           decisions.
  --------------------------------------------------------------------------------------------

# Exhibit B: Cash Economy -- Legislative Recommendations

+---+-----------+------------------+-----------------------------------+
| * |           | **Summary**      | **Reason**                        |
| * |           |                  |                                   |
| R |           |                  |                                   |
| e |           |                  |                                   |
| c |           |                  |                                   |
| o |           |                  |                                   |
| m |           |                  |                                   |
| m |           |                  |                                   |
| e |           |                  |                                   |
| n |           |                  |                                   |
| d |           |                  |                                   |
| a |           |                  |                                   |
| t |           |                  |                                   |
| i |           |                  |                                   |
| o |           |                  |                                   |
| n |           |                  |                                   |
| * |           |                  |                                   |
| * |           |                  |                                   |
+===+===========+==================+===================================+
| 1 | Amend     | Amend IRC § 3406 | Current withholding and           |
|   | I         | to create a      | information-reporting provisions  |
|   | RC § 3406 | three-pronged    | do not adequately capture income  |
|   | to        | reporting and    | from transactions in the cash     |
|   | encourage | payment system   | economy. Unreported payments      |
|   | c         | that encourages  | include:                          |
|   | ompliance | compliance by:   |                                   |
|   | in        |                  | -   Deliberate "under the table"  |
|   | certain   | -   Instituting  |     cash payments.                |
|   | cas       |     backup       |                                   |
|   | h-economy |     withholding  | -   Payments that are reported    |
|   | tra       |     on payments  |     with an invalid TIN or        |
|   | nsactions |     to taxpayers |     payee/TIN mismatch.           |
|   |           |     who have     |                                   |
|   |           |     demonstrated | -   Payments subject to           |
|   |           |     "substantial |     information reporting that    |
|   |           |                  |     are not reported.             |
|   |           |  noncompliance"; |                                   |
|   |           |                  | Withholding is not required on    |
|   |           | -   Releasing    | payments to non-employees, and    |
|   |           |     backup       | skirting information reporting    |
|   |           |     withholding  | requirements for payments to      |
|   |           |     on payments  | independent contractors is easy   |
|   |           |     to taxpayers | and relatively painless.          |
|   |           |     who become   |                                   |
|   |           |                  | Payors wishing to comply with     |
|   |           |   "substantially | their information-reporting       |
|   |           |     compliant"   | obligations may be reporting      |
|   |           |     and who      | payments to independent           |
|   |           |     agree to     | contractors who have supplied     |
|   |           |     schedule and | invalid TINs. Under existing      |
|   |           |     make future  | provisions, these payors may not  |
|   |           |     payments     | know that a payee's TIN is        |
|   |           |     through the  | invalid until several payments    |
|   |           |     Electronic   | have been made.                   |
|   |           |     Funds        |                                   |
|   |           |     Transfer     | Furthermore, the motivation to    |
|   |           |     Payment      | comply with current Forms         |
|   |           |     System       | 1099-MISC and W-9 requirements is |
|   |           |     (EFTPS);     | not particularly compelling. The  |
|   |           |                  | toll charge for a missing or      |
|   |           | -   Providing    | incorrect Form 1099-MISC or W-9   |
|   |           |     that payors  | is \$50.                          |
|   |           |     will not be  |                                   |
|   |           |     required to  |                                   |
|   |           |     institute    |                                   |
|   |           |     backup       |                                   |
|   |           |     withholding  |                                   |
|   |           |     on taxpayers |                                   |
|   |           |     who present  |                                   |
|   |           |     payors with  |                                   |
|   |           |     a valid IRS  |                                   |
|   |           |     "Compliance  |                                   |
|   |           |                  |                                   |
|   |           |    Certificate". |                                   |
+---+-----------+------------------+-----------------------------------+
| 2 | Amend     | Amend            | Current law requires IRS to use   |
|   | IRC       | IRC § 6302(h) to | EFTPS to collect at least 94      |
|   | § 6302(h) | require IRS to   | percent of depository taxes. In   |
|   | to        | promote          | contrast, the IRS received less   |
|   | require   | estimated tax    | than one percent of all estimated |
|   | IRS to    | payments through | tax payments through EFTPS in tax |
|   | promote   | EFTPS and        | year 2004.                        |
|   | estimated | establish a goal |                                   |
|   | tax       | of collecting at | Making estimated tax payments can |
|   | payments  | least 75 percent | be cumbersome, particularly for   |
|   | through   | of all estimated | self-employed taxpayers. EFTPS    |
|   | EFTPS.    | tax payment      | has the potential to alleviate    |
|   |           | dollars through  | some estimated tax problems       |
|   |           | EFTPS by FY      | because it is convenient and      |
|   |           | 2012.            | relatively easy to use. Moreover, |
|   |           |                  | taxpayers can use EFTPS to        |
|   |           |                  | schedule automatic estimated      |
|   |           |                  | payments.                         |
+---+-----------+------------------+-----------------------------------+
| 3 | Amend IRC | Amend IRC        | Some independent contractors may  |
|   | § 3       | § 3402(p)(3) to  | wish to enter into withholding    |
|   | 402(p)(3) | specifically     | agreements with their payors. It  |
|   | to        | authorize        | is currently unclear, however,    |
|   | spe       | voluntary        | whether statutory authority       |
|   | cifically | withholding      | exists to enter into such         |
|   | authorize | between          | agreements. IRC § 3402(p)(3) is   |
|   | voluntary | independent      | silent on voluntary withholding   |
|   | wi        | contactors and   | agreements in the independent     |
|   | thholding | se               | contractor/payor context. Section |
|   | between   | rvice-recipients | 3402(p)(3) is the only section    |
|   | in        | (as defined in   | under which a voluntary           |
|   | dependent | IRC              | withholding agreement between a   |
|   | co        | § 6041A(a)(1)),  | payor and an independent          |
|   | ntractors | and to specify   | contractor would be permitted.    |
|   | and       | that independent |                                   |
|   | s         | contractors who  |                                   |
|   | ervice-re | enter into       |                                   |
|   | cipients. | voluntary        |                                   |
|   |           | withholding      |                                   |
|   |           | agreements with  |                                   |
|   |           | payor service    |                                   |
|   |           | recipients will  |                                   |
|   |           | be treated as    |                                   |
|   |           | employees only   |                                   |
|   |           | to the extent    |                                   |
|   |           | specified in the |                                   |
|   |           | agreements, and  |                                   |
|   |           | allow such       |                                   |
|   |           | independent      |                                   |
|   |           | contractors to   |                                   |
|   |           | continue to      |                                   |
|   |           | deduct ordinary  |                                   |
|   |           | and necessary    |                                   |
|   |           | business         |                                   |
|   |           | expenses under   |                                   |
|   |           | IRC § 162(a).    |                                   |
+---+-----------+------------------+-----------------------------------+
| 4 | Amend IR  | A                | Taxpayers report 96 percent of    |
|   | C § 6041A | mend IRC § 6041A | income from transactions subject  |
|   | to        | to require       | to information reporting. The     |
|   | require   | third-party      | percentage of reported income     |
|   | th        | information      | decreases significantly, however, |
|   | ird-party | reporting for    | when transactions are not subject |
|   | in        | applicable       | to information reporting. Under   |
|   | formation | payments to      | current law, an individual        |
|   | reporting | corporations, as | taxpayer can escape Form          |
|   | for       | defined in       | 1099-MISC information-reporting   |
|   | a         | IRC § 7701(2)(3) | by incorporating. A taxpayer      |
|   | pplicable | (including       | attempting to avoid 1099-MISC     |
|   | payments  | corporations     | reporting need only include in    |
|   | to        | electing to be   | its business name an indication   |
|   | corp      | taxed under      | that it is doing business as a    |
|   | orations. | subchapter S of  | corporation in order to release   |
|   |           | the Internal     | the service-recipient from the    |
|   |           | Revenue Code).   | IRC § 6041A reporting             |
|   |           |                  | requirements.                     |
|   |           |                  |                                   |
|   |           |                  | For Form 1099-MISC                |
|   |           |                  | information-reporting purposes,   |
|   |           |                  | there should be no distinction    |
|   |           |                  | between taxpayers who are         |
|   |           |                  | incorporated and those who are    |
|   |           |                  | not.                              |
+---+-----------+------------------+-----------------------------------+

# Exhibit C: Requiring Brokers to Track and Report Cost Basis -- Legislative Recommendation

+---------------+------------------+-----------------------------------+
| **Rec         | **Summary**      | **Reason**                        |
| ommendation** |                  |                                   |
+---------------+------------------+-----------------------------------+
| Amend         | Amend            | When transactions are subject to  |
| IRC § 6045(a) | IRC § 6045(a) to | information reporting to the      |
| to authorize  | authorize the    | government, tax compliance is     |
| the Secretary | Secretary of the | generally very high -- well over  |
| of the        | Treasury to      | 90 percent. The opportunity for   |
| Treasury to   | prescribe        | noncompliance upon sale of mutual |
| require       | regulations that | funds or stocks is considerable   |
| brokers to    | require brokers  | under current law, because the    |
| track and     | to report        | taxpayer's basis is not reported  |
| report cost   | information not  | to the government.                |
| basis in      | only regarding   |                                   |
| connection    | gross proceeds   | This proposal also helps          |
| with the sale | but also         | taxpayers (and that was our       |
| of mutual     | regarding        | primary reason for proposing it.) |
| funds and     | adjusted basis   | Today, more Americans own stocks  |
| stocks.       | in connection    | or mutual funds than ever before. |
|               | with the sale of | Most mutual fund investors elect  |
|               | mutual funds and | to have their dividend and        |
|               | stocks. To       | capital gain distributions        |
|               | facilitate       | automatically reinvested in their |
|               | accurate basis   | funds, causing their aggregate    |
|               | reporting,       | adjusted bases to change upon     |
|               | financial        | each such reinvestment. Many      |
|               | institutions     | mutual fund companies assist      |
|               | that hold mutual | their investors by keeping track  |
|               | funds or stocks  | of adjusted basis, but some do    |
|               | for customers    | not. With regard to stock         |
|               | should, when a   | investors, most brokers keep      |
|               | customer         | track of purchases their          |
|               | transfers assets | customers make, but they do not   |
|               | to a successor   | necessarily update their basis    |
|               | financial        | records to reflect stock splits,  |
|               | institution, be  | spin-offs, and other corporate    |
|               | required to      | restructurings. While taxpayers   |
|               | provide the      | are properly required to keep     |
|               | customer's       | adequate records to substantiate  |
|               | adjusted basis   | their tax reporting, the reality  |
|               | in the           | is that some investors hold       |
|               | transferred      | stocks or mutual funds for        |
|               | mutual fund and  | decades, and it is simply not     |
|               | stock holdings   | realistic to expect that all      |
|               | to the successor | taxpayers will keep perfect       |
|               | financial        | records for long periods of time. |
|               | institution.     |                                   |
+---------------+------------------+-----------------------------------+

[^1]: The views expressed herein are solely those of the National
    Taxpayer Advocate. The National Taxpayer Advocate is appointed by
    the Secretary of the Treasury and reports to the Commissioner of
    Internal Revenue. The statute establishing the position directs the
    National Taxpayer Advocate to present an independent taxpayer
    perspective that does not necessarily reflect the position of the
    IRS, the Treasury Department, or the Office of Management and
    Budget. Accordingly, Congressional testimony requested from the
    National Taxpayer Advocate is not submitted to the IRS, the Treasury
    Department, or the Office of Management and Budget for prior
    approval. However, we have provided courtesy copies of this
    statement to both the IRS and the Treasury Department in advance of
    this hearing.

[^2]: *See* IRS News Release 2006-28, IRS Updates Tax Gap Estimates
    (Feb. 14, 2006) (accompanying charts). The National Research Program
    study estimated that the "gross tax gap" was about \$345 billion and
    the "net tax gap" (*i.e.,* the gross tax gap reduced by late
    payments and amounts collected as a result of IRS enforcement
    actions) was about \$290 billion. The IRS's most current estimate of
    the tax gap is based primarily on audits it conducted on tax returns
    filed for 2001.

[^3]: U.S. Census Bureau, Population Division (data as of March 2001).

[^4]: The IRS's most current estimate of the tax gap is based primarily
    on audits it conducted on tax returns filed for 2001.

[^5]: Significantly, the IRS Oversight Board reports there is
    substantial public support for an enhanced IRS compliance program
    provided that it is balanced. The Oversight Board conducts an annual
    survey of taxpayer attitudes and found that two-thirds of taxpayers
    support additional funding for both IRS assistance and enforcement.
    *See* IRS Oversight Board, *2005 Taxpayer Attitude Survey*.

[^6]: *See* IRS News Release 2006-28, IRS Updates Tax Gap Estimates
    (Feb. 14, 2006) (accompanying charts).

[^7]: When IRS auditors conducted approximately 46,000 audits of
    individual taxpayers for purposes of the National Research Program,
    the auditors were asked, for each issue they identified, to
    characterize the reason for noncompliance. Among issues that IRS
    auditors examined that resulted in a change in tax liability, the
    auditors listed 67 percent as inadvertent mistakes, 27 percent as
    computational errors or errors that flowed automatically, and only 3
    percent of errors as intentional. Internal Revenue Service
    (unpublished data from National Research Program). The precision of
    these data may be open to question because it is impossible for an
    auditor to determine the intent of a taxpayer at the time the
    taxpayer prepared a return. In the absence of contrary data,
    however, these data at a minimum should persuade IRS to conduct
    significant new studies on the causes of noncompliance. A separate
    study by the Government Accountability Office analyzed the
    misreporting of capital gains transactions. The study concluded that
    33 percent of taxpayers who misreported their income from securities
    transactions reported more capital gains than they actually
    realized. Where misreporting is inadvertent, from a statistical
    standpoint, one would expect that 50 percent of errors would be on
    the high side and 50 percent of errors would be on the low side.
    Thus, GAO's finding that 33 percent of all taxpayer errors tended to
    cause overpayments of tax (and thus were clearly inadvertent)
    implies that an equal percentage of inadvertent errors caused
    taxpayers to underpay their tax -- or, put differently, that 66
    percent of all errors in capital gains misreporting were inadvertent
    and only 34 percent were intentional. Government Accountability
    Office, Ref. No. GAO-06-603, *Capital Gains Tax Gap: Requiring
    Brokers to Report Securities Cost Basis Would Improve Compliance if
    Related Challenges Are Addressed* at 12 (June 2006).

[^8]: Internal Revenue Service, *Fiscal Year 2006 Enforcement and
    Service Results* (Nov. 20, 2006).

[^9]: Joseph M. Dodge & Jay A. Soled, *Inflated Tax Basis and the
    Quarter-Billion-Dollar Revenue Question,* 106 Tax Notes 453 (Jan.
    24, 2005).

[^10]: *See* Department of the Treasury, General Explanation of the
    Administration's Fiscal Year 2008 Revenue Proposals 64 (February
    2007). Treasury provides a 10-year revenue estimate of just \$6.7
    billion. We note, however, that Treasury's proposal would not take
    effect until 2009, and it would only require basis reporting with
    regard to securities purchased after that date. In the early years,
    many securities sold would have been purchased prior to the
    effective date of the proposal and thus would be exempt from
    reporting.

[^11]: John Cassidy, *Going Long,* The New Yorker, July 10 & 17, 2006,
    at 99 (citing an AC Nielsen study).

[^12]: *S**ee* Alan H. Plumley, Pub. 1916, *The Determinants of
    Individual Income Tax Compliance: Estimating the Impacts of Tax
    Policy, Enforcement, and IRS Responsiveness* 41 (Oct. 1996).

[^13]: IRS Wage & Investment Operating Division, *Business Performance
    Review, Wage and Investment Operating Division, FY 2006*; IRS Wage &
    Investment Operating Division, *Business Performance Review, Wage
    and Investment Operating Division, FY 2005*; IRS Wage & Investment
    Operating Division, *Business Performance Review, Wage and
    Investment Operating Division, FY 2004*; IRS Wage & Investment
    Operating Division, *Business Performance Review, Wage and
    Investment Operating Division, FY 2003.*

[^14]: IRS Small Business/Self Employed Operating Division, Response to
    Taxpayer Advocate Information Request (Sept. 5, 2006).

[^15]: This concern was raised by a taxpayer during a 2006 Town Hall
    meeting with the National Taxpayer Advocate in Fargo, North Dakota.

[^16]: Internal Revenue Service, *Fiscal Year 2006 Enforcement and
    Service Results* (Nov. 20, 2006).

[^17]: *See* IRS News Release IR-2006-42, *IRS Selects Three Firms to
    Take Part In Delinquent Tax Collection Effort* (March 9, 2006).

[^18]: Department of the Treasury, *FY 2007 Budget in Brief* at 59.

[^19]: Government Accountability Office, GAO-07-136, *Financial Audit:
    IRS's Fiscal Years 2006 and 2005 Financial Statements* at 95 (Nov.
    2006). The IRS actually collected \$2.51 trillion on a gross basis
    in FY 2006, but issued \$277 billion in tax refunds.

[^20]: When collecting tax from the vast majority of taxpayers who file
    returns and pay all or substantially all of the tax they owe
    voluntarily, the cost the IRS incurs per taxpayer is very low. As
    the IRS attempts to collect tax from noncompliant taxpayers through
    broader outreach efforts or through examination and collection
    actions, the cost per taxpayer rises substantially. Therefore, the
    *marginal* ROI the IRS achieves as it attempts to collect unpaid
    taxes is likely to be considerably lower than the *average* ROI of
    210:1 that the IRS achieves on taxes paid voluntarily. But if the
    IRS were given more resources, most data indicate that the IRS could
    generate a substantially positive marginal ROI.

[^21]: In the current Congress, the Appropriations subcommittees have
    been restructured, and the IRS will be funded through the
    Appropriations Subcommittee on Financial Services and General
    Government.

[^22]: Government Accountability Office, GAO-07-136, *Financial Audit:
    IRS's Fiscal Years 2006 and 2005 Financial Statements* 68 (Nov.
    2006).

[^23]: Charles O. Rossotti, *Many Unhappy Returns: One Man's Quest to
    Turn Around the Most Unpopular Organization in America* 278 (2005).
    On pages 278-286, Mr. Rossotti presents an interesting personal
    perspective on the budget process and the politics behind the
    chronic under-funding of the IRS.

[^24]: The chairman and ranking member of the Senate Budget Committee
    supported additional funding for the IRS in the FY 2007 budget
    resolution. Senator Judd Gregg acknowledged that the existing budget
    procedures have the effect of shortchanging the IRS. He said: "We've
    got to talk to the \[Congressional Budget Office\] about scoring on
    \[additional funding provided to IRS\]. Clearly there's a return on
    that money." Dustin Stamper, *Everson Pledges to Narrow Growing Tax
    Gap,* 110 Tax Notes 807 (Feb. 20, 2006). Similarly, Senator Kent
    Conrad stated: "Rather than a tax increase, I think the first place
    we ought to look . . . is the tax gap. If we could collect this
    money, we'd virtually eliminate the deficit." Emily Dagostino,
    *Senate Budget Resolution Would Increase IRS Enforcement Funding,*
    110 Tax Notes 1129 (Mar. 13, 2006).

[^25]: Commissioner Charles O. Rossotti, *Report to the IRS Oversight
    Board: Assessment of the IRS and the Tax System* 16 (Sept. 2002).

[^26]: Alan H. Plumley, Pub. 1916, *The Determinants of Individual
    Income Tax Compliance: Estimating The Impacts of Tax Policy,
    Enforcement, and IRS Responsiveness* 35-36 (Oct. 1996); Jeffrey A.
    Dubin, Michael J. Graetz & Louis L. Wilde, *The Effect of Audit
    Rates on the Federal Individual Income Tax*, 1977-1986, 43 Nat. Tax
    J. 395, 396, 405 (1990).

[^27]: Commissioner Charles O. Rossotti, *Report to the IRS Oversight
    Board: Assessment of the IRS and the Tax System* 16 (Sept. 2002).

[^28]: Government Accountability Office, GAO-06-1000T, *Tax Compliance:
    Opportunities Exist to Reduce the Tax Gap Using a Variety of
    Approaches,* at 17 (July 26, 2006).

[^29]: Pub. L. No. 108-357, § 881(a)(1) (enacting IRC § 6306).

[^30]: For a detailed discussion of the private debt collection program,
    *see* National Taxpayer Advocate 2006 Annual Report to Congress at
    34-61 (Most Serious Problem: *True Costs and Benefits of Private
    Debt Collection)*.

[^31]: *See, e.g.,* Dustin Stamper, *Everson Admits Private Debt
    Collection Costs More, Defends Return Disclosure Regs,* 111 Tax
    Notes 11 (Apr. 3, 2006).

[^32]: Senator Max Baucus recently highlighted another example of the
    counterproductive impact of shortchanging IRS funding. In FY 2006,
    Congress imposed a one-percent across-the-board funding rescission
    on domestic discretionary spending, and the IRS absorbed a reduction
    of about \$100 million as a consequence. Citing GAO data, Senator
    Baucus estimated that the \$100 million in "savings" would
    ultimately cost the U.S. Treasury about \$1 billion in lost tax
    collections. He stated: "\[E\]ven small reductions in collection and
    taxpayer services are penny-wise, pound-foolish. Sparing the IRS
    budget may be the best way to bring in more owed revenue and end
    deficit spending." News Release, Senator Max Baucus, *\$100 Million
    Budget Cut to IRS May Cost \$1 Billion or More in 2006 Tax
    Collections* (May 22, 2006).

[^33]: In the preface to the National Taxpayer Advocate 2006 Annual
    Report to Congress, I argue that compliance should be viewed as a
    third category or IRS emphasis rather than as the sum of service and
    enforcement. There are many compliance activities the IRS
    undertakes, such as document matching, that catch errors taxpayers
    make either inadvertently or negligently. In my view, these
    activities should be classified as "compliance" activities, and the
    "enforcement" label should be reserved for cases of willful
    violation of the laws. I argue that nomenclature matters in this
    area because if the IRS treats willful and inadvertent compliance
    the same way, IRS personnel will treat innocent taxpayers harshly
    and taxpayers will feel that the IRS has dealt with them unfairly,
    perhaps alienating them from the tax system and reducing their
    future compliance.

[^34]: Internal Revenue Service, Compliance Estimates for Earned Income
    Tax Credit Claimed on 1999 Returns 3 (Feb. 28, 2002).

[^35]: The DIF score is an estimate of the likelihood of non-compliance
    on a return. A higher score indicates a higher likelihood of
    non-compliance.

[^36]: IRS Compliance Data Warehouse, Individual Returns Transaction
    File data for tax years 2002-2004.

[^37]: IRS Compliance Data Warehouse, Audit Inventory Management System
    data for tax years 2002-2004.

[^38]: *See* Alan H. Plumley, Pub. 1916, *The Determinants of Individual
    Income Tax Compliance: Estimating The Impacts of Tax Policy,
    Enforcement, and IRS Responsiveness* 41 (Oct. 1996).

[^39]: *See* IRS News Release, *IRS Updates Tax Gap Estimates,*
    IR-2006-28 (Feb. 14, 2006) (accompanying charts).

[^40]: *See Closing the Tax Gap and the Impact on Small Business,*
    Hearing Before the House Comm. on Small Business, 109^th^ Cong.
    (Apr. 27, 2005) (testimony of John Satagaj, President and General
    Counsel, Small Business Legislative Council).

[^41]: IRS Small Business/Self Employed Division response to Taxpayer
    Advocate Service Information Request (Sept. 5, 2006).

[^42]: Two caps would have to be established for total appropriations --
    one for the IRS and one for all other discretionary spending.

[^43]: For FY 1995, the congressional budget resolution provided for an
    adjustment of budget resolution spending levels to allow additional
    funding for an "Internal Revenue Service Compliance Initiative."
    H. Con. Res. 218, 103^rd^ Cong. § 25 (1994). The provision
    authorized an adjustment to reflect amounts of additional new budget
    authority or additional outlays of up to \$405 million per year
    provided certain conditions were met. Although there is no
    indication the initiative failed or generated strong opposition,
    control of Congress changed the next year and the provision was
    subsequently repealed. H. Con. Res. 67, 104^th^ Cong. § 209 (1995).
    The joint explanatory statement accompanying the conference report
    on the FY 1995 budget resolution provision (which originated as
    Section 54 of the Senate amendment to the House-passed budget
    resolution) provided additional information about the specifics of
    the approach:

    > Section 54 of the Senate amendment allows for additional
    > appropriations for an Internal Revenue Service Compliance
    > initiative. If the Congress appropriates the base amounts
    > requested for the Internal Revenue Service in the President's
    > budget for fiscal year 1995 and a variety of other conditions are
    > met, then Congress can also appropriate additional amounts for a
    > compliance initiative without triggering points of order that
    > might otherwise lie against such legislation.
    >
    > Under sections 54(a) and 54(b) of the Senate amendment, upon the
    > reporting of an appropriation bill funding the compliance
    > initiative and the satisfaction of the conditions listed, the
    > Chairman of the appropriate Budget Committee must file revised
    > appropriations caps, allocations to the Appropriations Committee,
    > functional levels, and aggregates to clear the way for the
    > incremental spending for the initiative. This procedure parallels
    > that used in reserve funds . . . , which allow deficit-neutral
    > legislation to proceed without points of order even if that
    > legislation pays for direct spending with revenues. Similarly,
    > section 54 of the Senate amendment allows appropriations
    > legislation to proceed without points of order if it is
    > demonstrated that the revenues raised by those appropriations
    > would offset the costs of the appropriations.
    >
    > The first parenthetical language in the matter after subsection
    > (a)(3) establishes the first condition precedent, that the
    > Congress appropriate the base amounts requested for the Internal
    > Revenue Service in the President's Budget for fiscal year 1995.
    > Subsection (d) lists the other conditions: enactment of a Taxpayer
    > Bill of Rights 2, initiation of an Internal Revenue Service
    > educational program as mandated by the Taxpayer Bill of Rights 1
    > and 2, a finding by the Congressional Budget Office that by virtue
    > of revenues raised, the appropriations will not increase the
    > deficit, and a restriction of funds made available pursuant to
    > this authority to carrying out Internal Revenue Service compliance
    > initiative activities.
    >
    > The House resolution contains no such provision.
    >
    > The conference agreement contains as section 25 a provision
    > similar to that in Section 54 of the Senate amendment. In
    > particular, section 25(a)(2) of the conference agreement more
    > explicitly spells out the condition precedent that Congress first
    > appropriate the base amounts requested for the Internal Revenue
    > Service in the President's Budget for fiscal year 1995 before the
    > provisions of this section apply. Similarly, the conference
    > agreement revises subsection (d), which sets forth the other
    > conditions precedent.

    H.R. Conf. Rep. No. 103-490 at 58 (1994).

[^44]: In FY 2006, IRS enforcement activities (collection actions,
    examinations, and document matching) resulted in the direct
    collection of \$48.7 billion. Internal Revenue Service, *Fiscal Year
    2006 Enforcement and Service Results* (Nov. 20, 2006). Total tax
    collection by the IRS, after the issuance of tax refunds, was \$2.24
    trillion. Government Accountability Office, GAO-07-136, *Financial
    Audit: IRS's Fiscal Years 2006 and 2005 Financial Statements* 95
    (Nov. 2006).

[^45]: Department of the Treasury, FY 2008 Budget-in-Brief at 56.

[^46]: Charles O. Rossotti, *Many Unhappy Returns: One Man's Quest to
    Turn Around the Most Unpopular Organization in America* 285 (2005).

[^47]: For research purposes, we believe it is important to study
    inadvertent errors as well as deliberate misreporting. Knowledge
    about inadvertent errors can be used to clarify ambiguous laws or
    administrative guidance both to help increase future compliance and
    to better apply IRS outreach, education, and other voluntary
    compliance initiatives.

[^48]: Commissioner Charles O. Rossotti, *Report to the IRS Oversight
    Board: Assessment of the IRS and the Tax System* 18 (Sept. 2002).

[^49]: Internal Revenue Service Data Book: 2005, table 3 (showing that
    the total number of individual income tax returns filed in FY 2005
    was 132,844,632) and table 4 (showing that the total number of
    individual income tax returns filed electronically in FY 2005 was
    68,476,328). The total number of individual income tax returns filed
    on paper in FY 2005 -- 64,368,304 -- is the difference between these
    numbers.

[^50]: Much of this information was published in former Commissioner
    Rossotti's final report to the IRS Oversight Board. Commissioner
    Charles O. Rossotti, *Report to the IRS Oversight Board: Assessment
    of the IRS and the Tax System* 16 (Sept. 2002). However, we have not
    seen updated statistics published in this format since that time.

[^51]: The congressional budget rules currently prohibit the
    Congressional Budget Office or the Office of Management and Budget
    from treating changes in discretionary appropriations to the IRS as
    giving rise to scorable increases in tax receipts. See H.R. Conf.
    Rep. No. 101-964 (1990). *See also* Office of Management and Budget,
    *OMB Circular No. A-11*, Part 8, Appendix A, Principle 14 (2006).
    Since changes to IRS funding levels undoubtedly have an impact on
    tax collections, this prohibition seemingly reflects the practical
    difficulty of devising accurate estimates. Yet accurate estimates
    obviously would be helpful to Congress, and we believe the IRS
    should make developing better estimates a priority objective.